Employee Share Schemes under the new Financial Markets Conduct Act 2013

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Read our article on Employee Share Schemes under the New Financial Markets Conduct Act 2013

What is an employee share scheme?

The new Financial Markets Conduct Act 2013 (FMCA) defines employee share purchase scheme as “a scheme established by an entity under which employees or directors of the entity or of any of its subsidiaries (or other eligible persons referred to in clause 8 of Schedule 1 of the FMCA) may acquire specified financial products (as defined in that clause) that are issued by the entity”.

So the concept of an employee share scheme is a very broad one – essentially it is any scheme or arrangement under which employees, directors or in some cases contractors may acquire shares issued by the business. It can take any shape or form that the business wants it to. For example, a company may create a very simple scheme designed to apply to a small number of key employees (directors or senior managers) for a one-off issue of shares or, by contrast, a company may create a detailed and complex scheme designed to apply to all types of employees and to be used over a long period of time for many different issues of shares.

Note that the definition above refers only to new shares issued by the company, not to existing shares transferred from one person to another person.

Why put an employee share scheme in place?

Possible benefits of offering an employee share scheme are as follows:

  • it can attract and retain key staff. It is widely acknowledged that employee ownership can lead to greater commitment, incentivisation and retention of key people i.e. employees think and act like owners, with a vested interest in the success of their employer;
  • it can be a good way to deal with succession planning of a business through the transition of the ownership in a managed way; and
  • it can be used to reward performance of employees (i.e. a bonus), without impacting on the company’s working capital or cash flow position.

Many New Zealand businesses have been reluctant to implement employee share schemes in the past, due to the complexity and often expensive cost of establishing and maintaining an employee share scheme under the old legislation.

However, recent legislative changes will make the process easier for businesses to put an employee share scheme in place. Businesses might want to consider how they can take advantage of these new rules.

Difficulties with the previous law

One of the main hurdles for companies offering an employee share scheme was complying with the requirements of the Securities Act 1978 (Securities Act).

Application of Securities Act

Generally speaking, section 33 of the Securities Act requires that an issuer of securities (including equity securities, such as shares) can only offer those securities to the public for subscription if the offer is accompanied by an authorised advertisement, investment statement or registered prospectus (which can be expensive and time consuming). An employee share scheme is caught by this general rule of the Securities Act, as it involves a company issuing shares to its employees (who are usually deemed to be “members of the public” under the Securities Act). There are various exemptions and exceptions to this general rule, some of which may apply to employee share schemes but, as described below, it can be difficult trying to fit within one or more of these exceptions.

Exemption Notice

The Securities Act (Employee Share Purchase Schemes – Unlisted Companies) Exemption Notice 2011 (there is also an exemption notice for listed companies) provides certain relief to unlisted companies who issue securities (shares) to employees under a scheme. However, this exemption notice does not remove the requirement for the issuer to prepare and register a prospectus in relation to such an offer. It removes a lot of the requirements for particular information that is ordinarily required to be included in a registered prospectus and it removes the time restriction for which the prospectus will remain valid. However, there are several restrictive conditions imposed on an offer under the exemption notice and the cap on the number of shares which can be issued to employees under a scheme in any 12 month period is more stringent (5%) than the cap under the new law, which is described below (10%).

So the exemption notice is helpful in that it reduces some of the cost and administrative burden on the issuer but it is of limited use as it does not eliminate the need for a registered prospectus and the exemption contains a number of restrictive conditions.

Exceptions to General Rule

The Securities Act also includes various exceptions to the general requirements, some of which are summarised below.

Section 3(2) of the Securities Act lists various offers which shall not constitute an offer of securities to the public, the most relevant example being offers to relatives or close business associates of the issuer or of a director of the issuer.

The “close business associates” exception has historically been the most commonly used (and most likely to succeed) exception to exclude employee share schemes from the ambit of the Securities Act. However, it too is of limited use. The Securities Act provides, at section 3(3), that a person shall not be precluded from being regarded as a member of the public in regard to any offer of securities by reason only that he or she is an employee or client of, or a holder of securities previously issued by, the issuer of the securities.

Further, various case law and commentary regarding the exception for close business associates confirms that a close business associate must be more than just an employee or client of the issuer. Something more is required for this exception, such as having regular contact with the directors of the issuer, having access to financial information about the issuer or generally having an intricate knowledge of the business and performance of the issuer. So while this exception may be fine for CEOs, CFOs and senior managers of a business, it is unlikely to apply to employees below senior management level.

Section 5(2CC) of the Securities Act provides further exceptions from certain parts of the Securities Act and the Securities Regulations 2009 (Regulations) for “eligible persons”. A person is an “eligible person” under the Securities Act if the person is one or more of the following (as defined in the Securities Act): wealthy, experienced in investing money or experienced in the industry or business to which the security relates. However, the thresholds for falling within these categories are high and it can be a time consuming and laborious exercise in establishing that a person is an “eligible person”. Very few employees are likely to fall within the “eligible persons” categories.

We note that there has been a change in approach by the regulators in recent years to tighten the interpretation of the exceptions under the Securities Act; what used to be considered sufficient to fall within an exception may no longer be enough.

In summary, the exceptions to the general rule under the Securities Act are ad hoc and messy; there may often be several exceptions which might applicable to a particular offer and set of potential subscribers, however, it can be difficult to fit within the exceptions (this in itself can be a time consuming and costly exercise) and it is not always clear whether an issuer is covered by the exceptions or not. This has contributed to many businesses steering clear of employee share schemes in the past.

What are the changes to the law?

The FMCA was passed in August 2013. The FMCA replaces the Securities Act and several other related pieces of legislation in what has been described as the largest overhaul of securities law in New Zealand since the 1970s. Parts of the FMCA came into force on 1 April 2014 (including the new specific exception for employee share purchase schemes) and the remainder of the FMCA comes into force on 1 December 2014. We are currently in a transition period during which both the Securities Act and the new FMCA are in force and issuers can elect which legislation to operate under.

The new exception for employee share purchase schemes means that such schemes will not need the full disclosure documentation and companies will not need to register audited financial accounts.

Section 8 of Schedule 1 of the FMCA sets out the new exception for employee share purchase schemes. The new law provides a much simpler and clearer exception; it is set out all in one place and has clearly defined parameters. The key provisions of this exception are as follows.

An offer of specified financial products to an eligible person under an employee share purchase scheme does not require disclosure under Part 3 of the FMCA if:

  • The offer is made as part of the remuneration arrangements for the eligible person or is otherwise made in connection with the employment or engagement of the eligible person; and
  • Raising funds for the issuer is not the primary purpose of the offer to the eligible person; and
  • The total number of specified financial products issued or transferred under all of the issuer’s employee share purchase schemes to eligible persons in any 12-month period does not exceed 10% of the specified financial products of the issuer that are of the same class as at the start of the 12-month period.

An eligible person is defined in the FMCA as meaning directors and employees of the issuer or any of its subsidiaries and also includes a person who provides personal services (other than as an employee) principally to the issuer or any of its subsidiaries. Specified financial products means equity securities (shares) or other prescribed financial products.

Warning Statement and Information to be provided

Despite the exception, and from a consumer protection perspective, it is still important that employees receive basic information about the investment. The new Financial Markets Conduct (Phase 1) Regulations 2014 (Regulations) require companies to provide the following to all prospective subscribers under an employee share purchase scheme before an application is made:

  • a document that contains the prescribed warning statement (detailed below);
  • a document that contains a description of the employee share purchase scheme and its terms and conditions; and
  • a copy of the issuer’s latest annual report and/or the relevant financial statements.

One or more of these documents may be combined in a single document.

The warning statement referred to above is prescribed in the Regulations and explains to potential subscribers that:

  • they are being offered particular financial products (such as shares) and what this means;
  • there is a risk that if the issuer runs into financial difficulties, the subscriber may lose some or all of the money it has invested;
  • New Zealand law normally requires certain information to be provided to investors before they invest;
  • in this case the usual rules do not apply because the offer of financial products is being made under an employee share purchase scheme, meaning that the subscriber may not receive all of the information usually required and that the subscriber may have fewer other legal protections for this investment; and
  • to ask questions, read all documents carefully and seek independent financial advice before committing to the investment.

Summary

The new exception for employee share purchase schemes clarifies who shares may be offered to under such a scheme, the terms and limitations of such offers are clearly defined and, most importantly, provided this exception is complied with, no registered prospectus is required in relation to the offer. The warning statement and information required to be provided is much shorter and simpler than the usual disclosure requirements, allowing employers to offer an employee share scheme on a more flexible and cost effective basis than before.

If you are interested in hearing more about the change in law relating to employee share schemes and the most appropriate way to structure an employee share scheme for your business, please contact a member of our Business Team.  Our Business Team members specialise in investment law compliance, employee share schemes, restructuring, commercial contracts and transactions and general business compliance advice.

DISCLAIMER: The content of this document is general in nature and is not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.

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Copyright © Cavell Leitch. All rights reserved. Redistribution is only permitted with express written permission. For enquiries please contact us. This article by its nature cannot be comprehensive and cannot be relied on by clients as advice. It is provided to assist clients to identify legal issues on which they should seek legal advice. Please consult the professional staff of Cavell Leitch for advice specific to your situation.