Earlier this year, the Securities and Exchange Board of India (“SEBI”) amended the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“Listing Regulations”), to structure the unregulated compensation and profit sharing arrangements/agreements between shareholders/third parties with the employees, including the key managerial personnel, directors and promoters of listed investee companies (“Regulation 26(6)”). These arrangements were widely used by private equity investors to not only incentivize the promoters/key employees/directors but to accelerate the growth of the company and its consequent valuation to benefit the investors and other shareholders at large. But, from SEBI’s view point, these arrangements were a breeding ground for corporate governance issues and unfair trade practices. We have in our earlier article1, discussed the implications of the above SEBI amendment. While the Listing Regulations were amended to incorporate Regulation 26(6) vide its notification dated January 4, 2017, certain ambiguities related to interpretation of the Regulation 26(6) persist.
To recap, let us briefly examine the scope of the notified Regulation 26(6) which cover the following arrangements:
- Arrangement should be between employee (including key managerial personnel or director or promoter) of a listed entity, either himself or on behalf of any other person, and any shareholder/third party with regard to compensation or profit sharing.
- The arrangement should be in connection with dealings in securities of such listed entity.
- Prior approval should be obtained from the board of directors and public shareholders (by way of ordinary resolution).
SEBI vide its notification clarified that the approval required by the listed entity is not from SEBI (as previously understood) but from the board of directors and the public shareholders for entering into any sort of profit sharing/compensation arrangement under the Listing Regulations.
Furthermore, SEBI has recently, vide two separate informal guidance letters under the SEBI (Informal Guidance) Scheme 2003, as discussed below, thrown light on the applicability of such compensation related arrangements:
- In the matter of Accelya Kale Solutions Limited (“Accelya Case”) wherein an arrangement was entered into between the group company and certain Indian employees (in the capacity of also being members of global executive committee), in respect of certain deferred consideration/additional deferred consideration which was not linked to the value of securities of an Indian listed company but was related to sale of securities of an offshore group company, SEBI vide its letter dated May 12, 2017 took the view that Regulation 26(6) is not applicable to the payment arrangement with the employees since such deferred consideration in the application pertains to the third and final tranche of the purchase price of those securities which were not of the listed entity in India, but that of an offshore entity.
The above view taken by SEBI is in line with Regulation 26(6) which pertains to the restrictions on employees of a listed entity entering into agreements for himself or any on behalf of any other person, with any shareholder or any other third party with regard to compensation or profit sharing “in connection with dealings in the securities of such listed entity”. Since the compensation, in the Accelya Case, was related to the shares of an offshore company and not that of the Indian listed company, the Indian listed company was not required to seek approval from the board and shareholders under Regulation 26(6).
- Interestingly, in another case of MAPE Advisory Group Private Limited (“MAPE Case”), Hewlett Packard Enterprise Company (“HPE”), the ultimate holding company of Mphasis Limited (a BSE and NSE listed company), issued incentive letters to certain employees of Mphasis Limited and certain employees of a number of wholly owned unlisted subsidiaries of Mphasis Limited in respect of certain payments to such employees. Guidance was requested from SEBI with respect to the payments to be made to the relevant employees of the subsidiaries of Mphasis Limited and whether such payments would fall under Regulation 26(6). SEBI vide its letter dated July 19, 2017, took the view that even the employees of the subsidiary company of the listed entity i.e., Mphasis Limited would fall within the scope of Regulation 26(6).
Extension of the applicability of Regulation 26(6) to employees of a subsidiary company of a listed entity (as held in the MAPE Case) is interesting as from the bare reading of the Regulation 26(6) it is clear that the restriction is imposed on the arrangement with employees of the listed company with regard to compensation or profit sharing in connection with the dealings in the securities of the said listed entity. While the intended purpose of the SEBI’s guidance letters was to remove potential ambiguities, it has now proceeded to expand the scope of the applicability of Regulation 26(6) itself (without amending the Listing Regulations).
1 “Compensation Agreements Under SEBI Scanner”, by Seema Jhingan, Neha Yadav and Saniya Kothari: