Prospectus Directive Puts a Cloud Over Employee Share Plans

For years, commentators have noted a correlation between higher levels of corporate productivity and the presence of employee share plans: vehicles through which workers can purchase or otherwise acquire equity in their employers.

For some companies in the UK and Europe, however, recent legislation has caused confusion as to the continuing viability of employee share plans.

The Prospectus Directive, issued in July 2005 and now being implemented by EU member states, contains measures that affect employee equity participation, and could lead to some plans being withdrawn altogether.

Most of the companies affected are those whose listings are outside of the EU: on American, Swiss, Australian, Japanese or other stock exchanges. When one considers that 60% of the foreign assets held by US corporations are based in the EU (and employing more than four million people), one appreciates the potential scale of the Directive's impact.

In a survey of major, non-EU companies conducted by Linklaters in 2006, nearly half said that the Prospectus Directive was adversely affecting their ability to offer employee share plans, while one-fifth reported that they were considering changes to such plans, including reduction of share awards and cancellation.

HOW HAS THIS COME TO BE?

The intention of the Prospectus Directive is to help harmonise European capital markets. It broadly achieves this aim for the purpose of IPOs and debt offerings.

Employee share plans, which used to be very lightly regulated, have also been caught in its slipstream. The Directive views some plans as offers of securities and, as a result, considers that they should carry the same investor protection characteristics as a share bought on the open market.

EU-listed companies are for the most part exempt from the Directive. However many non-EU companies are not, and they will either have to issue an expensive and time-consuming prospectus if they want to offer shares to their employees, or pick their way through a maze of country-specific regulation.

To further complicate the situation, some EU member states have applied the Directive in different ways, using different definitions of terms (such as 'securities') and even applying restrictions on giving shares away for free.

This is confusing non-EU companies, who are concerned that they and their directors may fall foul of securities legislation, despite their best efforts to comply.

POSSIBLE PENALTIES

Penalties for non-compliance are significant. Directors face the risk of criminal prosecution, being personally liable for information in the prospectus.

In some cases, prospectus-related documentation may be in a language of the country where it is issued and may be different to that normally filed in their own country. Directors will be naturally concerned at the prospect of putting their signature to a document that they can't read.

Non-compliance could also mean that participants in share plans make claims for compensation in the event of the stock price falling below the level at which shares were originally granted.

THE COST OF COMPLIANCE

In addition to these concerns, the Directive is generating considerable expense. In the Linklaters survey, companies reported bills of up to $1m in Directive-related costs to operate their share plans in the EU.

These will include advertising costs in some countries, as well as the cost of re-drafting financial information drawn up under GAAP to make it compatible with IFRS.

In the words of one respondent to the survey, "If clarification and relief is not forthcoming in the near future, I believe that it will be the employees in the EU that will ultimately suffer because employers are going to cancel the plans as being too costly or difficult to operate in the current regulatory environment."

This would be a tragedy of major proportions, affecting employees, employers and the overall economy alike.

SHARE PLAN POPULARITY

The survey confirmed the popularity of share plans with 86% of respondents (who collectively accounted for annual sales approaching $400bn) having plans in operation in one or more EU countries.

The biggest concentration was in the UK, followed by France and Germany, although several reported plans in operation even in the smallest economies such as Cyprus and Malta. Most of these plans have been in operation for more than five years, and a third of them have been running for over a decade.

On a conservative estimate, many tens of billions of dollars of European savings are at stake. The value of individual share plans varies, but over 50% of the Linklaters survey (which alone accounted for around 150,000 EU employees) reported an annual value of more than $5,000. A third put the number at more than $10,000.

More importantly in the long term, the absence of employee share plans at non-EU companies (or sub-optimal plans, designed to meet Directive exemptions) could put them at a competitive disadvantage to locally-based employers, thus damaging national and regional competitiveness.

WHAT CAN BE DONE?

It is not clear at present whether or when the EU or member states will address the shortcomings of the Prospectus Directive. Much hinges on the ongoing discussions between EU Commissioners and the US Securities and Exchange Commission with regard to the equivalence of GAAP and IFRS, though this is unlikely to fix the problem much before the end of the current decade.

In the meantime there is a big issue on the table for finance directors of European subsidiaries of non-EU companies, as well as their boardroom colleagues.

Employee pay and compensation form the biggest element of cost in many companies, and getting the mix of staff benefits right - salary, healthcare, pensions and other benefits - is a key element in maximising competitiveness.

Companies embracing employee share ownership enjoy higher productivity, improved shareholder returns and faster growth than those that don't.

The UK's Employee Ownership Index, for example, showed that listed companies with a significant degree of share ownership out-performed the FTSE all-share and the FTSE 100 by a wide margin over the five years to mid-2003.

At the very least, employee share plans play an important part in the overall incentives mix. To lose them as an unintended consequence of legislation would be bad for business, as well as bad for employees.