Some listed companies have employee welfare/ Employee Stock Ownership Plan (ESOP) schemes, which are operated through a trust. Though the trust is set up to provide employee benefits, there is apprehension that a few may use the trust to deal in their own securities, with the object of inflating, depressing, maintaining or causing fluctuation in the share price. This results in regulatory concerns and can be viewed as insider trading/ unfair trade practice.
To address these concerns, the Securities and Exchange Board of India (SEBI) has prohibited listed companies from framing an employee benefit scheme that involves acquisition of own securities from the secondary market. Listed companies, which have already implemented such schemes, need to ensure compliance with the new requirement by June 30, 2013. Companies also need to sell shares previously purchased from the secondary market by the same date. The decision will help regulators curb insider trading and unfair trade practices, which are viewed as major threat to capital markets worldwide. In few cases, the application of this requirement may result in practical issues.
A company had set up an ESOP trust 10 years back, when it was not listed. At the time of setting up, the trust purchased the company’s shares from one of its shareholders. One argument is that the trust had purchased shares from the secondary market and, therefore, the same need to be sold by June 30, 2013. However, the counter-argument may be that SEBI’s circular should cover only shares purchased post-listing, and not before that date.
An ESOP trust purchased shares from the secondary market. It has also been allotted new shares by the company. Out of the combined stock, the ESOP trust has been allotting shares to employees on exercise of ESOP. From remaining shares held by the trust, how should the company identify shares purchased from the market and requiring sale?
Companies may need to consult legal professionals for such issues. If needed, they may also raise these issues to SEBI/ stock exchange for guidance.
Apart from legal/ practical issues, an accounting issue arising from the amendment is that a company had given an advance to the ESOP trust, acting as its extension, for purchase of shares from the market. The price of shares held by the trust has declined significantly. Till date, the company did not provide for the decline as it was considered to be temporary. However, under the revised circumstances, the company does not expect share price to increase significantly by June 30, or the trust has sold the shares at a loss. How should the company treat loss arising on advance, due to the trust’s dealing in its own shares?
The SEBI ESOP guidelines and the Institute of Chartered Accountants of India’s (ICAI) Guidance Note on Accounting for Employee Share-based Payments state that the trust administers the plan on behalf of the company. Hence, the company will recognise any ESOP expense as if the company itself is administering the plan. However, there is no guidance on accounting for such loss (or gain) incurred by the trust. Based on practices followed and guidance under Ind-AS, the following views may be argued:
The company has incurred loss on advance given to trust (third party), which needs to be charged to profit and loss immediately.
The trust has made an investment on the company’s behalf. Accounting standard AS 13 requires other than temporary loss on investment to be recognised in profit and loss. AS 13 also requires gain/ loss on sale to be recognised in profit and loss.
Based on principles laid down in Ind-AS 32, a company cannot recognise any gain or loss arising on its own shares in profit and loss. Thus, it should recognise the loss to the extent it pertains to own shares directly in equity.
The ICAI may consider providing appropriate guidance on the matter. Till such time, depending on past practices and substance of the arrangement, differing practices are likely.
The author is Senior Professional in a member firm of Ernst & Young Global
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