Shaun Cartoon
Arnold Bloch Leibler, Melbourne
scartoon@abl.com.au

Eileen Liu
Arnold Bloch Leibler, Melbourne
eliu@abl.com.au

Background

The stated aim of the regulatory reforms was to demonstrate the commitment of Australia’s (former) Federal Government to ‘reducing red tape for business, supporting job creation and competitive remuneration, and incentivising employers and employees to work together to contribute to a strong and sustained post-Covid-19 economic recovery.’

To this end, the new regulatory regime includes a few contentious rules that may encourage companies that offer employee share schemes (ESS) to alter their plan design. This article will explore some of the key regulatory issues associated with operating ESS in Australia. It is not intended to comprehensively walk through the new regime.

The regulatory framework

In Australia, the Corporations Act 2001 (Cth) imposes a number of rules and restrictions that typically apply to companies that issue securities to retail investors. These rules and restrictions relate, for example, to disclosure, hawking and advertising. There are also financial services licensing requirements that apply in respect of the provision of financial advice that may apply to the operator of an ESS.

The status quo

Australia’s securities legislation has for some time provided discrete exemptions from the disclosure requirements that would typically apply where an offer of securities is made to certain persons who are ‘senior managers’ and ‘sophisticated investors’, and other offers made as part of a ‘small scale offering’ within the meaning of the Australian securities law (disclosure exemptions).

For ESS offers that did not fall into one of those discrete categories, the employer company would typically be required to rely on instruments (the class orders) issued by Australia’s securities regulator, the Australian Securities and Investments Commission (ASIC). The class orders yielded extremely disparate outcomes for listed companies compared to their unlisted counterparts. In general, many listed companies previously relied on the class order, which provided relief for the operation of most of the common types of ESS in the market. Conversely, the class order that applied to unlisted companies effectively prevented them from offering meaningful and broad-based equity participation by capping the value of offers made in reliance on that class order to AUD $5,000 per year.

Although the new regulatory regime was introduced in October 2022, companies were permitted to continue making ESS offers relying on the relief provided under the ASIC class orders until 1 March 2023; many (particularly listed companies) were content to continue doing so. However, offers can no longer be made in reliance on the relief provided under the class orders.

Interaction between the old and new regimes

The new regime preserves the existing legislative disclosure exemptions (briefly mentioned above). While employer companies can continue making offers of ESS interests in reliance on these existing legislative disclosure exemptions, they should be aware that the relief provided by these existing legislative disclosure exemptions is limited to relief from the disclosure requirements that would otherwise apply.

In contrast, the new regime provides broader regulatory relief. As such, employer companies should consider whether relief from compliance with the licensing, advertising, hawking or on-sale provisions would also be beneficial.

The new regime often also allows offers that receive relief from disclosure under the existing legislative exemptions to benefit from the additional regulatory relief available under the new regulatory regime with minimal additional effort.^[1]

Qualifying for relief under the new regime

Figure 1 summarises the eligibility requirements that must be met for an ESS offer to receive regulatory relief under the new regime. The key takeaway is that how onerous it is for a broad-based ESS offer to receive regulatory relief under the new regime will depend on whether the participant will need to incur financial outlay in connection with the terms of their offer.

Figure 1: compliance with Australia’s new ESS regulatory regime

Where the participant is not required to pay money for the issue or grant of their offer (eg, for restricted stock units (RSUs), performance rights and phantom cash offers), those offers can be made to a broad range of participants, and the required disclosures are often limited to the requirement to express that the offer is being made under the new regime.^[2]

However, where a broad-based offer is made that requires the payment of an issue price or an exercise price (eg, shares acquired under purchase plans or options), the situation is more complicated. To receive regulatory relief under the new regime, the employer company would need to comply with a streamlined version of the prospectus requirements with respect to offers of securities made to the general market.

There will also be other compliance requirements that the employer company must consider. For example, there are:

• limitations on the extent to which businesses can raise capital from employees relative to other shareholders;
• if the ESS scheme has an associated trust, contribution plan or loan, that the trust, contribution plan or loan meets certain requirements; and the 
• inclusion of certain mandatory standard terms, including those pertaining to directors’ personal liability.

Unlisted companies must also consider the limitations on the annual monetary outlay that participants can incur, and provide additional financial, valuation and solvency information about the company to the participant.

Anticipated effect of the new regime on plan design

Tax is traditionally the key body of law that drives the design of ESS.

As the new regulatory regime imposes more onerous compliance requirements on certain types of plans, it is possible that the new regulatory regime may also influence the design of ESS that operate in Australia. For example, the new regime may encourage employer companies to move away from option plans and towards share appreciation rights.

The types of plans that are most efficient for an employer to operate (from a regulatory perspective) are not necessarily the most tax-advantaged or financially attractive plans from the participant’s perspective. For example, in Australia, one of the most popular types of tax advantaged ESS is a start-up qualifying option plan. Where an option is eligible to be taxed under the startup rules, it will not typically be taxed on grant, vesting or exercise. Instead, it is typically taxed under the capital gains tax regime when the underlying share is sold.

However, for an offer of options to meet the eligibility criteria to receive start-up tax treatment, one of the requirements is that the participant must pay an exercise price that is at least equal to the market value of an underlying share on the grant date.^[3] The requirement to pay an exercise price means that the more onerous regulatory requirements in the new ESS rules must be complied with. This example demonstrates the tension in plan design in pursuing tax concessions on the one hand, and regulatory simplicity on the other.

Points of contention in the new regime

Directors’ personal liability

Directors’ personal liability is an issue that needs to be front of mind when structuring a broad-based ESS offering that requires financial outlay from the participants.

For such offers to receive regulatory relief under the new regime, the terms of the offer must, among other things, allow a participant who suffers loss or damage from an out-of-date, deceptive or misleading statement, an omission, or a failure to provide the required supporting documents, to recover damages from certain persons. This includes a contractual right to recover personally from the company’s directors.^[4]

As the offer documentation typically represents a contractual arrangement between the employer company and the participants, any express term in the offer document that purports to impose liability on a third party (eg, a director) may not be legally effective unless that third party has agreed to assume that liability. Companies therefore need to give some thought as to how best to ensure that the necessary right for a participant to recover damages is effectively included in the offer. One possibility is for those who are liable persons to sign a deed poll to assume personal liability.

Issue cap

As noted above, certain offers that are made in reliance on the new regime are subject to an issue cap. Broadly, this is intended to limit the extent to which employer companies can raise capital from their employees.

An offer will not comply with the issue cap if the total number of shares the subject of ESS interests that are issued in a rolling three-year period exceeds the relevant percentage of issued shares or interests in the company. The percentage is the amount specified in the company’s constitution or, if no such percentage is stated:

• five per cent for listed companies; and
• twenty per cent for unlisted companies.

The issue cap ostensibly only applies to ESS offers made on terms that require financial outlay from the participant. However, in determining whether a company has exceeded the relevant issue cap threshold, it appears that all ESS interests must be taken into account, including those issued for no monetary consideration (eg, shares that are or can be acquired on vesting of RSUs). Though it appears this issue may be overcome by amending the company’s constitution, there may be little appetite to do so.

Issuance of ESS interests to discretionary trusts

In Australia, discretionary trusts are the most common vehicle used by family groups to hold assets. This structure has, at least historically, been popular because of perceived asset protection and the ability to stream income and capital gains of the trust to different beneficiaries.

Although ESS interests are most commonly granted to participants in their individual capacities, sometimes a participant may prefer to nominate an entity to hold the ESS interests on their behalf. In these circumstances, the most desirable means of holding the interests is generally in their family trust. However, employer companies that make ESS offers under the new regime should proceed with caution when granting ESS interests to a nominee on the employee’s behalf. The new regime does not expressly facilitate the granting of ESS interests to a discretionary trust.

Wide powers of the regulator

The new regime confers upon ASIC a variety of regulatory tools to monitor, enforce and modify the new ESS regime. This includes wide exemption and modification powers.

Accordingly, ASIC issued an instrument in December 2022 that notionally modified numerous provisions in the principal act, including those that relate to:

• salary sacrificing arrangements;
• the issue cap;
• financial information;
• supplementary disclosure; and
• subsequent sales.

As such, when considering the application of the new regime, all instruments in force should be read alongside the principal legislation.