I’m going out on a limb here and calling the SEBI decision to allow companies’ ESOP Trusts to buy shares from the market again, as a terrible mistake. This was banned in January 2013, and many companies which had created such trusts to increase their control of the company (and in some cases, to manipulate the share prices) instead of using it to grant shares to employees.

In the Jan 2013 order, SEBI had said that ESOP Trusts could only be issued fresh shares. This obviously involves dilution, and it’s apparent that many companies complained.

SEBI will release the full regulations soon. We’ll have more detailed comments then. But they tell us:

ESOP trusts will be able to buy from the market. This is bad because ESOP trusts don’t have any money – who will give them the money? Answer: the company. So, the company’s paying to buy its own shares, effectively, to give to employees. What if they don’t give these shares to employees?

There seems to be no requirement to actually grant shares to employees. L&T for instance has an ESOP trust that owns 10% of the company, and to my knowledge, has NEVER given any shares to the employees. This is disgusting – the ESOP trust is a manager controlled entity, and therefore they will vote in favour of whatever management wants!

A company (which is owned by all shareholders) can therefore use its money to favour a higher voting share for a few shareholders (the managers). Also, the shares remain ‘cornered’ and therefore create artificial scarcity in the market for the remaining shares.

And there are regulations for “buyback” – the only other way a company can buy back shares from the market. These require that shares be bought back using only free reserves (cannot be borrowed funds), and a buyback means fresh shares cannot be issued for another two years. The ESOP trust buy method can be abused easily to loop around the buyback regulations, and a company can borrow money to buy back shares (and hold it in an ESOP trust). Or they can pay money to an ESOP trust to buy shares from a market and increase its price, and immediately sell shares to some random institutional investor at the same time. This is nothing but market manipulation, and should never have been allowed. But it has been, and we have to deal with it.

(Note: I think buyback regulations have to be loosened up anyhow. But not like this, creating a loophole that only applies to some public companies!)

ESOP Trusts may not be able to sell, and may have to hold shares for at least 6 months. This makes sense. But in my opinion, they should be forced to allocate shares within 2 years of purchase! Without that, an ESOP scheme makes no sense, especially for shares acquired in the market.

There are some other restrictions like no derivatives, regular and detailed disclosure and ESOP trusts are limited to 10% ownership.

What hasn’t been addressed is: what happens if the share prices fall a lot, while the ESOP Trust continues to hold shares? Network18’s Senior Professional Welfare Trust owes more than Rs. 500 cr. to the company, but the shares it owns, if sold, will only fetch a fraction of that amount.

Let’s wait till the regulations are visible. But I’m not holding my breath. This is a big mistake and I think we’re going to see a lot of market manipulation over the next few years, through the abuse of ESOP trusts.

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