Unlisted entities and equity incentives for employees – rule changes from 1 October 2022

Key points for unlisted entities

• Commencement Date is 1 October 2022.
• If an eligible ESS does not require payment, or borrowing funds, to participate, it will generally not be required to comply with the financial product disclosure, financial product design and distribution, and financial services licensing requirements of the Corporations Act (Disclosure & Licensing Laws). However, any associated trust will need to comply with specified requirements.
• If an eligible ESS does require payment, or borrowing funds, to participate, the offer will need to comply with an issue cap, comply with a participant monetary cap, include specified streamlined disclosure and contain required contractual terms. Any associated trust, contribution plan and loan arrangement will need to comply with specified requirements.
• Applications to acquire eligible ESS interests cannot be made until 14 days after receiving the required ESS offer document and information. ESS application money must be held in trust until the ESS interests are issued or transferred or the money is returned to the ESS participant.
• New ESS related criminal offences have been introduced regarding misleading or deceptive statements or omissions, from ESS offer documents or supporting information, and regarding certain persons failing to inform the issuer if they become aware of a misleading or deceptive statement or omission in an ESS offer document or supporting information.

Unlisted entities which can make offers

The new rules will apply to unlisted entities and listed entities not included in the official list of:

(a)     an Australian financial market operated by an Australian market licensee, such as the Australian Securities Exchange; or

(b)     a foreign financial market determined by the Australian Securities and Investments Commission (ASIC).

Entities which are listed on other internationally recognised financial markets can apply to ASIC for their ESS offers to be made on the same basis as the new rules for listed entities.

Participating in offers

To be eligible for the regulatory relief under the new rules, the offer may only be made to specified primary participants or certain related persons to a primary participant (such as certain immediate family members, controlled bodies corporate or a related self-managed superannuation fund).

A primary participant is an existing (or prospective) employee of, director of, or person who provides services to:

(a)     the body corporate issuing the ESS interest or an associated entity; or

(b)     the responsible entity of the listed scheme to which the ESS relates or an associated entity.

An associated entity includes a subsidiary and controlled entities. Casual employees and contractors will no longer be required to meet a specified percentage of a full time equivalent threshold to be eligible to participate.

The financial products which can be offered

To be eligible for the regulatory relief under the new rules, only certain financial products may be offered under the ESS (ESS Interests).

The ESS Interests for an unlisted body corporate are:

(a)     a fully paid share;

(b)     a beneficial interest in a fully paid share; or

 (c)     a unit in, an incentive right (which includes a dividend equivalent right), or an option to acquire, a fully paid share.

Under the new rules, it is no longer required that the share is an ordinary share.

Permitted trust structures

To be eligible for the regulatory relief under the new rules, where an ESS offer under which ESS Interests may be issued or transferred by a trustee of a trust, the trust deed of the trust must satisfy the following requirements:

(a)     activities of the trustee (as trustee of the trust) must be limited to managing the ESSs of the issuer;

(b)     the trustee must maintain written records of the administration of the trust;

(c)      the trustee must not charge any fees or charges for administering the trust, other than reasonable disbursements charged to the trust and amounts charged to the issuer; and

(d)     if the trustee is an associated entity of the issuer, the trustee may only exercise voting rights associated with the ESS Interests in accordance with the instructions of the participants or consistent with the trustee's fiduciary duties.

Under the new rules, there is no longer a percentage limit on the number of ESS Interests that the trustee may hold.

Permitted contribution plans

Under the existing rules, an ESS offer which allows the participant (the Contributor) to make regular payments or elect to have regular deductions made from their wages or salary, for the purposes of acquiring ESS Interests under the offer (Contribution Plan) are not eligible for regulatory relief unless the offers are limited to senior managers of the issuer group or made under an Australian regulated disclosure document.

In order to be eligible for the regulatory relief under the new rules, the Contribution Plan must satisfy the following requirements:

(a)     the Contributor must agree in writing to the terms of the Contribution Plan before participating in the plan;

(b)     before acquiring ESS Interests under the ESS offer, the payments or deductions under the Contribution Plan must be held on trust in an account with an Australian-authorised deposit-taking institution which is solely kept for that purpose;

(c)      the Contributor may elect to discontinue the payments or deductions under the Contribution Plan at any time; and

(d)     if the Contributor elects to discontinue, within 45 days of the election any deductions from salary or wages must cease and all deductions and payments standing to the credit of the Contributor, and any interest, must be repaid to the Contributor.

Permitted loan arrangements

Under the existing rules, ESS offers which provide a loan to ESS participants for the purposes of acquiring ESS Interests under the offer (Loan) are not eligible for regulatory relief.

The new rules allow a Loan to be made with ESS offers provided the Loan is on the following terms (unless the ESS participant is already a shareholder of the issuer at the time the Loan is offered or made):

(a)     the Loan has no interest or fees payable;

(b)     in the event of default in payment of the Loan, recourse is limited to forfeiture of the ESS Interests acquired using the Loan; and

(c)      the borrower under the Loan must be the participant who will acquire the ESS Interests offered under the ESS.

Issue Cap

If the ESS requires payment to participate, the issuer must reasonably believe that the ESS offer complies with an issue limit on the proportion of the issuer's fully paid shares or registered scheme interests which can be acquired under the ESS offers.

The Issue Cap is calculated based on the maximum number of shares that the unlisted entity may issue (directly or indirectly) as a result of the ESS offer and that have been issued, or could have been issued, under ESS offers made during the previous rolling three years (ending on the date of the ESS offer).

The percentage limit of the Issue Cap is 20% for unlisted entities. However, under the new rules, if the constitution of the issuer specifies a percentage limit, that limit will apply instead.

Monetary Cap

Under the regulatory relief provided by the existing rules, there is a monetary cap of A$5,000 per participant per year.

Under the new rules, the monetary cap for a participant in a particular year is the sum of:

(a)     $30,000;

(b)     if there are unexercised options or incentive rights of the participant from the previous 5 years, an amount equal to the price that would have been paid for those unexercised options or incentive rights;

(c)      70% of any distributions that a participant receives in that year from EIS Interests acquired pursuant to all offers under the ESS; and

(d)     70% of cash bonuses the participant has received in that year.

The monetary cap is applied up until the unlisted entity is listed on an official list of an eligible financial market or there is an executed sale agreement to acquire securities or financial products, covering the participant's ESS Interests or underlying shares which is open to acceptance by the participant (Liquidity Event). When a Liquidity Event occurs, the monetary cap is lifted so participants can acquire an unlimited amount of ESS Interests. However, payments by participants must be made no longer than 7 days before an anticipated Liquidity Event. The amounts paid in anticipation a Liquidity Event must be held on trust and be returned as soon as practicable if the Liquidity Event does not occur.

Required employee share schemes disclosure

Under the existing rules, the regulatory relief is only available where offers of the EIS Interests are made for no more than nominal consideration and made in, or be accompanied by, an ESS offer document.

Under the new rules, if the ESS requires payment to participate, an ESS offer must be made in, or be accompanied by, an ESS offer document. An ESS offer document must:

(a)     include either the terms of the ESS offer (and any associated trust, contribution plan or loan arrangement) or a summary of those terms with a statement that, on request, a copy of the full terms will be provided to the ESS participant;

(b)     include an advice warning, a general product risk warning and a general product value warning;

(c)      state the application period during which the participant may accept the ESS offer;

(d)     for non-ordinary shares (or units, incentive rights, or options granted in relation to non-ordinary shares), state the rights attached to shares being offered and how those shares differ from ordinary shares;

(e)     include, or direct the participant to, any Australian compliant financial product disclosure document prepared by the issuer in the 12 months before the start of the application period;

(f)      include financial information disclosure in the form of the most recent financial reports lodged with ASIC or otherwise a balance sheet and profit loss statement prepared in accordance with applicable accounting standards;

(g)     include a valuation document for the ESS Interests being offered in the form of a current disclosure document (i.e. offer information statement, or prospectus), a copy of an executed agreement for the purchase of underlying shares on arm's length terms where the acquirer is not an associate of the issuer, or a valuation report prepared in accordance with Australian tax law requirements; and

(h)     include a statement that the issuer is solvent.

Offers of options and incentive rights require disclosure upfront, regardless of whether the acceptance of the offer requires payment or not. However, where there is no payment upfront, the offer document is the only form of disclosure required at the point of the offer. Offers of options and incentive rights with both an upfront price and exercise price must provide the required disclosure at both points. In addition, before each exercise period during which the option or incentive right can be exercised or an amount can be paid allowing the incentive right to vest, the financial information disclosure, valuation document and solvency statement must be provided at least 14 days prior.

Under the new rules, there is no longer a requirement to lodge with ASIC a notice of intention to rely on the regulatory relief.

Required employee share schemes terms

To be eligible for the regulatory relief under the new rules, the terms of an ESS offer must address new requirements. These include:

(a)     an ESS participant cannot acquire an ESS Interest until 14 days after receiving the required ESS offer document and information;

(b)     the ESS offer document and any supporting documents must not include any misleading or deceptive statements or omissions;

(c)      certain specified persons (including directors of the issuer and persons named in the offer with their consent) are required to inform the issuer if they become aware of any misleading, deceptive, out of date, omitted or otherwise materially incorrect part of the offer document or supporting documents; and

(d)     a liability regime under which an ESS participant who suffers loss or damage from an out of date or misleading or deceptive statement or omissions, or a failure to provide required supporting documents, can recover damages from specified persons (including the issuer and directors of the issuer). The liability regime may limit liability in certain circumstances, including where the persons establish a due diligence type defence, did not know that the statement was misleading or deceptive or was unaware of a new circumstance that has arisen during the application period.

Dealing with ESS application money

Application money received from ESS participants must now be held in trust until the ESS Interests are issued or transferred, or the money is returned to the participant.

New ESS related criminal offences

There are new criminal offences under the new rules. These include:

(a)     making an ESS offer or distributing an application for an ESS offer if the ESS documents or supporting information contains a misleading or deceptive statement, an omission that causes the document to be misleading or deceptive, or does not reflect a new circumstance that has arisen during the application period for the offer, where the misleading or deceptive statement or omission or the new circumstance is materially adverse from the point of view of the ESS participant; and

 (b)    certain persons (including directors of the issue and persons named in the offer with their consent) failing to inform the issuer if they become aware of any misleading, deceptive, out of date, omitted or otherwise materially incorrect part of the offer document or supporting documents.

There are specified defences to the offence in (a) above, including where the person made all reasonable inquiries, and having made such inquiries did not know the statement was misleading or deceptive or did not know a new circumstance had arisen, or placed reasonable reliance on another person, or the relevant documents were updated as soon as reasonably practicable.