Equity-based compensation plans are becoming increasingly popular throughout Russia. The crisis years contributed to their development, as they enabled employers to motivate their employees without compounding cash-flow difficulties. As our Moscow office notes below, there are still some legal uncertainties concerning the operation of equity-based compensation plans in Russia.
The implementation of equity-based compensation plans with respect to employees of Russian companies is mainly regulated by Russian labour, securities, currency control and tax laws. Of these, it is the securities legislation that has been the subject of the most important recent developments. Amendments to the Federal Law No. 39-FZ “On Securities Market” dated 22 April 1996 (the “Securities Market Law”) adopted on 28 April 2009 (the “Amendments”) only allow foreign issuers to offer their securities to qualified investors if the securities are not admitted for placement or public circulation in Russia. As most employees are not qualified investors, this theoretically has the effect of preventing the grant of equity-based awards using foreign issuers’ shares in Russia.
There may nevertheless be avenues available for foreign employers seeking to grant equity-based awards to employees in Russia, but uncertainty still remains and employers would be well advised to exercise caution and to seek appropriate legal advice.
The Former Regime
Under the previous regime, there were only two ways in which foreign securities would be eligible for “placement” or “public circulation”:
1. if there was a relevant international treaty between the Russian Federation and the country of incorporation of the foreign issuer; or
2. if a cooperation agreement existed between the Federal Service for Financial Markets (the “FSFM”) and the relevant securities market regulatory authority of the country of incorporation of the foreign issuer.
The Securities Market Law therefore effectively prohibited placement (regardless of whether such placement was public or private) or public circulation of foreign issuers’ securities in the absence of a relevant international treaty or cooperation agreement.
The New Position
The Amendments have significantly changed the regime for the offering, placement and circulation of foreign securities in the Russian Federation. The Securities Market Law now states that foreign securities that have not been admitted to public placement and/or public circulation in Russia, as well as foreign financial instruments that have not been recognized as securities, may not be offered in Russia “in any form or by any means”, including by way of advertising, to an unlimited number of persons or to persons who are not “qualified investors” under Russian law.
The term “offering” can be construed broadly to include, among other things, distribution of the plan materials, enrolment forms and other relevant materials in relation to the plan in Russia, as well as the holding of any presentations or other similar events in connection with the plan in Russia.
Furthermore, the procedure for securities to be admitted to public placement and/or public circulation involves a number of steps, including registration of a foreign securities prospectus with the FSFM, the Russian securities regulator. However, this procedure is not yet fully operational, as the full set of rules and regulations designed to implement the legislative amendments has yet to be developed. It should be noted that the wording of the new rules is rather vague and, in certain cases, allows for multiple interpretations.
We are also aware that the FSFM is currently working on a draft regulation that should allow “non-qualified investors”, such as foreign individuals and Russian employees (acting under relevant provisions of their employment agreements), to acquire foreign securities that are not admitted for placement or public circulation in Russia. However, no formal declarations have been issued so far on this point by the FSFM, and employers should therefore continue to operate under the assumption that the law applies as stated in its written form.
Implications for Employers
As explained above, and based on a literal reading of the prevailing rules and limitations, shares of a foreign issuer that are not admitted to public placement and/or public circulation in Russia may not be offered under equity-based compensation plans to “nonqualified investors” in Russia (either in connection with their initial placement or further resale). Since employees are unlikely to be recognised as qualified investors under Russian law, they will not be able to acquire shares under equity-based compensation plans in Russia. Hence, on the face of it, the implementation of such plans in Russia would likely be a violation of Russian securities law regulations.
Given the lack of clarity in the law and the fact that the changes are relatively recent, there are no guaranteed solutions to dealing with the issues raised by the Amendments. Specific advice would need to be obtained for each particular situation. There are, however, certain measures that employers can take to minimize the risk of breaching the above restrictions.
Only Offer Foreign Shares Outside Russia
Employers should ensure that no offering of foreign shares to “non-qualified investors” in Russia is made within Russia. In practical terms, this means that ideally employees should be flown to a location outside Russia to review the plan documentation. It is potentially arguable that it may be acceptable for employees to view the plan documents via a website hosted on a foreign server; however, the risk of breaching the Securities Market Law would still exist in this scenario, as the documents would be accessed using Russian IP addresses. Execution of the award agreements (if necessary) should also be conducted outside Russia, either by the employees themselves or by an appropriately authorised individual with a power of attorney.
Employers should also keep in mind that the restrictions on distributing plan materials within Russia exist not only at the initial offering of the awards to employees, but also when subsequent or on-going distributions of information are made in relation to the plan. This will affect the way in which employers communicate with Russian employees on matters such as the vesting of their awards, or the making of amendments to the plan rules. Use of internet platforms which provide on-going plan information and are hosted on foreign servers may mitigate the risk of breaching the Securities Market Law, but again this risk is not eliminated given that employees will still be accessing the information using Russian IP addresses.
Apply for Admission of Foreign Shares to Public Placement or Circulation
Employers may wish to consider applying for admission of the shares to public placement and/or public circulation in Russia once all the necessary legal regulations implementing the provisions of the Securities Market Law come into force. Indeed, the Moscow Interbank Currency Exchange (“MICEX”) has recently registered its amended listing rules with the FSFM to allow technically for the admission of foreign securities. This means that the principal parts of the regulatory framework for the admission of foreign securities to a Russian stock exchange have essentially been set up; however, its practical implementation is still pending. Additionally, once implementation begins, certain deficiencies may be revealed which could require further regulatory changes. As such, employers seeking to apply for admission of their shares may need to prepare themselves for any teething issues arising from the implementation of the Amendments.
In terms of the process for making an application for admission of foreign shares to public placement and/or circulation in Russia, we estimate that it would take roughly 1.5 to 2 months for registration of the foreign securities prospectus with the FSFM and admission of the foreign securities with MICEX to be completed. The potential costs involved are not yet clear; however, we anticipate that the primary costs would arise from preparation of the prospectus. Applying for admission of the shares would carry the advantage of ensuring that the Securities Market Law has been complied with when offering equity-based compensation plans in Russia. However, employers will then be subject to the costs and administrative burdens associated with on-going disclosure requirements.
However, given the possibility that regulations exempting equity-based compensation plans may be introduced in due course, applying for admission of the shares may be a somewhat drastic step. The wisest course of action for employers is perhaps to bide their time until the final status of equity-based compensation plans under the Securities Market Law becomes clear.
Structure Awards to Provide for Cash‑Settlement
Finally, it is also possible to structure plans so as to provide for cash settlement, without the actual placement or transfer of shares. However this would still require careful structuring to avoid violation of Russian securities law restrictions.
The main difficulty with cash-settlement arises from the absence of a definition of “foreign financial instrument” in the Securities Market Law. Even a cash-settled award would not be free from the residual risk of being viewed as an offering of a “foreign financial instrument”. However, it is arguable that the restrictions on the offering of “foreign financial instruments” are primarily targeted at the protection of the rights and lawful interests of Russian investors and are intended to capture securities, commodities, options and commercially similar instruments. Since cash-settled awards are very different in nature (i.e. offered on a private basis; cannot be resold on the secondary market) they do not bear the risks associated with market instruments. To get some comfort on this point from the regulator, an employer may wish to consider obtaining a transaction-specific clarification from the FSFM (such clarification, however, will not have force of law and will not create a binding precedent).
Equity-based compensation plans will continue to play an important role in the compensation of Russian-based employees. However, until further clarification is received as to whether equity-based compensation plans are subject to the Securities Market Law restrictions, employers will need to give careful thought and seek appropriate legal advice to ensure that the structuring and execution of their plans do not fall foul of the amended Securities Market Law.