'New regulations not to dampen use of stock options'

The recent debate on the new insider trading prescription on ESOPs reminds one of the famous quote by Justice Holmes - "Life of law has not been logic, it has been experience". In recent years there have instances where ESOPs have been used to manipulate stock prices, and also as poison pills to defend hostile bids. Perhaps while framing the new regulations it is this experience that may have prevailed over Sebi.

The genesis of the controversy arises out of an ambiguity in the regulations which could be construed to imply that an employee cannot exercise stock options if he has sold shares of the company in the last six months, and further cannot sell such shares for six months if such shares have been acquired pursuant to the exercise of a stock option. Historically, in the developed economies such as the US and UK, and as also in India, the insider trading laws are based on the fundamental principle that the "insiders" owe a fiduciary duty to the "outsiders" and therefore should not act in a manner detrimental to their interests.

As rightly noted by the Sodhi Committee, typically this principle should not apply to "intra-company" exercises (a transaction solely between the company and the holder) since the holders do not receive any price advantage as against the other shareholders as the exercise price is pre-determined.

It is on this philosophical basis that there is general outcry by corporate India against the new regulation. While, the arguments against Sebi's onerous prescription may not be devoid of merit, in practice the economics for issuing ESOPs as a form of incentive is too compelling to be affected adversely by the new regulations. Further, with Sebi's efforts to promote start-up listing, and the evolving start-up culture in India wherein top executives are giving up their lucrative pay packages for joining start-ups in the hope of making windfall gains through ESOPs, the use of ESOPs as a form of remuneration will become more profound.

In light of this economic reality, the restrictions under the new regulation should not dampen the use of stock options as these restrictions do not appear insurmountable. Having said that, a robust and flexible ESOP regime is only in the larger market interest, and hence it would be only in the best interest of the market if Sebi lends its ears to corporate India.

Nishchal Joshipura
Partner, M&A and private equity, Nishith Desai Associates Services