India’s securities regulator, the Securities and Exchange Board of India (SEBI), is reportedly considering changing its rules to address concerns about the ownership of shares by founders and family members of tech or app-based startups under the employee stock ownership plan (ESOP). Two anonymous sources with direct knowledge of the matter told that SEBI does not want founders to own stock options if they have rights similar to those enjoyed by promoters. Under Indian laws, promoters have direct and indirect control over the company and the right to nominate directors to the board, but they are barred from owning ESOPs. The regulator is examining the gap in the law and whether it is being misused, one of the sources said. The decision on this matter could come sometime this year, the sources added.
One of the key examples cited was One97 Communications Ltd, commonly known as Paytm, whose founder Vijay Shekhar Sharma owned 14.7% equity a year before filing to go public in 2021. According to current regulations, “a director who either himself, through his relative or any corporate body, directly or indirectly, holds more than 10% of the outstanding equity shares of the company” is not eligible to receive stock options. Sharma reduced his shareholding to 9.1% by transferring 30.97 million shares to Axis Trustee Services Limited, acting on behalf of the Sharma family trust, making him eligible to receive shares under the ESOP.
The sources indicated that this seems like an instance unique to Paytm, where the trust route has been used to reduce direct equity holding to below 10%. SEBI is reportedly planning to amend its stock options rules to plug the gap in the regulations, which is intended to include all structures for equity holding. Emailed queries sent to Paytm and SEBI were not answered immediately, and the sources declined to be named as the discussions were confidential.
Institutional Investor Advisory Services (IIAS) had first raised concerns around Sharma’s ESOP purchases in January, highlighting two key gaps in the current regulations: equity held in trust structures is not addressed directly, and the designation of a founder is not defined. Hetal Dalal, COO of IIAS, said that as a result, founders in new-age tech companies enjoy all the benefits of being promoters and become eligible to receive ESOPs, but have none of the limitations and legal responsibilities of promoters. A special purpose panel, consisting of 20 members and headed by former Chief Justice of Punjab and Haryana High Court Shiavax Jal Vazifdar, is currently addressing the larger issue of how founders should be defined. The panel has held two meetings so far and is drafting a report on simplifying and strengthening the current norms around mergers, acquisitions, and fundraising, according to one of the sources.
In 2021, SEBI issued a consultation paper that proposed moving away from the promoter tag to the controlling shareholder tag to align with global practices, but it has not yet formalized the norms.