India markets regulator looks to plug gaps allowing founders to own stock options

India's capital markets regulator is planning to change its rules to address concerns around founders and family members of tech or app-based startups owning shares under the employee stock ownership plan (ESOP), two sources told Reuters.

The Securities and Exchange Board of India (SEBI) does not want founders to own stock options if they have rights akin to those enjoyed by promoters, the sources with direct knowledge of the matter said.

A decision in this regard could come sometime this year, the sources added.

Under Indian laws, promoters hold direct and indirect control over the company, advice, direct and instruct the board of directors, and have the right to nominate directors to the board, but are barred from owning ESOPs.

"In new-age tech companies, founders have reduced their shareholding to below 10% and have stayed away from the promoter tag," the first source said.

The regulator is examining the gap in the law and whether it is being misused, the source added.

One key example has been One97 Communications Ltd (PAYT.NS), popularly known as Paytm, whose founder, Vijay Shekhar Sharma, owned 14.7% equity a year before filing to go public in 2021.

As per 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 in 2021, which made him eligible to receive shares under the ESOP.

This seems like an instance unique to Paytm, where the trust route has been used to reduce direct equity holding to below 10%, the second source said.

"The intention of the regulations is to include all structures for equity holding. This is a gap which needs to be plugged, it will be done via an amendment to SEBI's stock options rules," the source added.

Emailed queries sent to Paytm and SEBI were not answered immediately. The sources declined to be named as the discussions are confidential.

Institutional Investor Advisory Services (IIAS) first flagged concerns around Sharma's ESOP purchases in January.

Equity held in trust structures is not addressed directly and the designation of a founder is not defined, COO Hetal Dalal said, highlighting the two key gaps in the current regulations.

"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".

The larger issue of how founders should be defined is being addressed by a special purpose, 20-member panel headed by former Chief Justice of Punjab and Haryana High Court, Shiavax Jal Vazifdar, the first source said.

"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," the source added.

In 2021, to keep with global practices, SEBI issued a consultation paper that suggested moving away from the promoter tag to the controlling shareholder tag, but it hasn't yet formalized the norms.

Reuters