Employee share purchase schemes under the Financial Markets Conduct Act 2013

What is an employee share purchase scheme?

An employee share purchase scheme (“Scheme”) is defined by the Financial Markets Conduct Act 2013 (“FMCA”) as a scheme that is, “established by an entity under which employees or directors of the entity or any of its subsidiaries … may acquire specified financial products … that are issued by the entity”. 

Essentially, a Scheme will enable employees, directors, managers and occasionally contractors (“Employee”) of an employer to “buy into” that employer’s business (“Employer”) by purchasing financial products in the Employer, namely equity securities or shares. 

Schemes do not have a particular shape or form meaning that Schemes can either be simple and designed to benefit a small number of key Employees (such as directors and managers) for a single issue of shares, or Schemes can be detailed and complex, intended to apply to a wide range and number of Employees over a long period of time and for multiple share issues.  As such, Schemes are diverse and have the potential to encompass any arrangement whereby Employees can acquire shares issued by the particular Employer.

What are the benefits of an employee share purchase scheme?

The benefits of Schemes can be wide-ranging to both the Employer and the participants of the Scheme. 

A key advantage is the retention (and attraction) of key Employees.  The general consensus is that where an Employee has a mind-set that he or she is an ‘owner’ of the Employer, that particular Employee’s vested interest in the Employer will be realised in the work he or she does.  International research has reinforced this concept and indicates that Schemes can be conducive to an Employer’s growth and productivity, while at the same time fostering a sense of loyalty amongst its Employees.

Directly related to the retention (and attraction) of key Employees is the incentivisation of those key Employees.  This links in with the concept set out above that where an Employee has a vested interest in the Employer, this interest will be realised in the work he or she does.  Where an Employee stands to experience a gain and/or profit through the success of the Employer, this prospect incentivises that Employee to work harder to realise that gain and/or profit. 

Schemes can also be useful for the succession planning of ownership of a particular Employer.  By allowing Employees to slowly buy into the Employer, Employees are able to slowly work their way to a director level, eventually taking over the existing leadership of the Employer and thereby providing for a smooth transition in ownership of the Employer.

Another benefit of a Scheme is that it provides an Employer with a method of rewarding Employee performance that does not negate or reduce the operating cashflow of the Employer.

Employee share purchase schemes under the Securities Act 1978

Reviewing the history of Schemes in New Zealand highlights a general reluctance to implement a Scheme due to the complexity and costs associated with a Scheme’s establishment and maintenance.

Under the Securities Act 1978 (“the Former Act”), Employees of an Employer were generally considered to be members of the public, meaning that Schemes would be caught by the underlying rule of the Former Act which provided that an issuer of securities could only offer securities to the public for subscription where that offer was accompanied by an authorised advertisement, investment statement and/or registered prospectus.

While the Former Act contained particular exemptions that, in particular situations, might exclude a certain Scheme from the required compliance with the underlying rule, it was often found that these exemptions could be difficult to apply with Employers finding that the Scheme may not wholly fit under any one particular exemption.

One such example of an exemption under the Former Act was the Securities Act (Employee Share Purchase Schemes – Unlisted Companies) Exemption Notice 2011 which was introduced to provide relief for unlisted companies.  While the exemption notice did reduce some costs and particular administrative issues, the underlying requirement for a registered prospectus remained and it also introduced a number of restrictive conditions, all of which contributed to an exemption notice that lacked effect.

A further exception to the underlying rule was section 3 of the Former Act, which provided that an offer made only to a ‘close business associate’ could be exempt from the standard disclosure requirements.  However, a review of case law and commentary on the Former Act indicates that a close business associate is viewed as someone who is more than an ordinary worker of the Employer, and is more closely linked to a person who holds a position of leadership, such as a director or manager.  As such, ordinary workers of the Employer were normally unable to come within the exception provided for in section 3.

In light of these (and other) difficulties posed by the Former Act, Employers have largely tended to avoid implementing Schemes.  However, with the replacement of the Former Act by the FMCA in 2014, Schemes have been given a new lease of life, with a specific exemption being included for such Schemes under the FMCA.

Employee share purchase schemes under the Financial Markets Conduct Act 2013?

The introduction of the FMCA has made it easier for Employers to participate in Schemes.  Section 8 of Schedule 1 to the FMCA provides for a specific exemption for Schemes whereby an offer of shares or an option to acquire shares in an Employer or one of its subsidiaries to an Employee under a particular Scheme does not need to comply with the standard FMCA disclosure requirements, provided that certain conditions are complied with.

Those conditions are three-fold and are set out below:

• The offer must be made to the Employee as part of the Employee’s remuneration, or the offer must be made in connection to the Employee’s employment/engagement;
• The raising of funds cannot be the primary purpose behind the offer to the Employee; and
• The number of shares issued in the Employer under all Schemes that the Employer is operating in any 12 month period cannot exceed 10% of the total number of shares in the Employer that are on issue.

In addition, by offering Employees the chance to participate in a Scheme, Employers must still provide Employees with certain information, including:

• A warning statement in respect of the Scheme which outlines the particular exemption under the FMCA being relied upon by the Employer, and which is intended to explain what the offer is, what the risks of investment to the Employee are, and sets out a general requirement on the Employee to be prudent in his or her investigations of the Scheme;
• Basic information regarding the Scheme, including the terms and conditions; and
• Access to the Employer’s most recent annual report and financial statements.

Further considerations

When considering whether or not to establish a Scheme, Employers should also turn their attention to other considerations, which include (without limitation), factors such as:

• The number of shares able to be offered (in light of the restrictions described above), and consequently the number of shares that will be offered;
• What price the shares will be offered at, which will dictate what the Employer entity is valued at; and
• Particular time constraints, such as how long an Employee must first work for the Employer before being able to participate in a Scheme (which can also directly assist with fostering Employer loyalty and incentivise Employees to remain with the Employer).

Another important consideration is the tax consequences for both the Employer and Employee.  Toward the end of 2015, the Inland Revenue Department announced that certain situations might be considered tax avoidance, with Schemes now included as such a situation (whereas they had previously been accepted by the IRD).  The tax consequence of a Scheme arises as a result of Employees being able to purchase shares in the Employer at a discounted price (pursuant to the Scheme).  That discount is the difference between the market value of the shares and the purchase price, which is a taxable benefit to the Employee.

In light of the above, it is clear that setting up a Scheme can be a protracted and complex process with a variety of considerations to pay attention to.  As such, both legal and accounting advice should be sought in order to ensure a Scheme is structured so as to meet an Employer’s particular aims and objectives, while at the same time maintaining attractiveness to Employees.

If you would like further information please contact Laura Monahan on 07 958 7479.