Listen to this post

Summary: This blog explores SEBI’s informal guidance on the creation and invocation of pledged shares, particularly for financing of ESOPs, and the expansion of compliance officers’ obligation to determine what constitutes a “bona fide” transaction.

Background

The practice of pledging shares to finance the exercise of employee stock options (“ESOPs”) is not new. However, the regulatory position on such arrangements, particularly in the context of insider trading restrictions, has long been unclear. This changed recently when a listed entity (“Company”) sought interpretive guidance from SEBI on specific issues relating to its ESOP schemes (“ESOP Schemes”).

SEBI’s response, made public in May 2026, provides important clarity on the treatment of pledge-related transactions undertaken by designated persons (“DPs”) in connection with exercise of ESOPs during periods of trading window closure.

For context, the Company’s ESOP Schemes required to be exercised within three months of vesting. During this period, certain DPs proposed to obtain financial assistance from banks or financial institutions by pledging:

  • equity shares of the Company already held by them; and/or
  • equity shares that may be allotted upon exercise of the vested ESOPs.

Simultaneously, the Company’s Code of Conduct mandated closure of the trading window from 15 days prior to the last day of each quarter and opening two trading days after the announcement of financial results for the respective quarter. Consequently, this kept the trading window closed for DPs for approximately 30–45 days, overlapping with the ESOP exercise window and raising compliance concerns.

Against this backdrop, the Company sought guidance under the SEBI (Informal Guidance) Scheme, 2025, on the interpretation of certain provisions under the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”).

The queries broadly addressed three issues under the PIT Regulations:

  • whether creation of pledge over the shares by the DPs for availing financial assistance from banks / financial institutions for exercising ESOPs and subsequent invocation / revocation of a pledge by DPs within six months of its creation would be construed as a contra trade;
  • whether pledge-related transactions carried out during the trading window closure period in connection with ESOP exercises could be treated as bona fide transactions; and
  • whether pledges created during the closure period for specific personal purposes, such as housing or medical emergency, would be regarded as bona fide transactions for obtaining pre-clearance from the Compliance Officer.

SEBI evaluated these queries broadly in light of Regulation 9(1) read with Clause 4(3)(a) of Schedule B of the PIT Regulations, which recognises pledges for bona fide purposes, such as raising of funds, as exempt from trading window restrictions, subject to pre-clearance.

Revocation and Invocation: Understanding “Trading” Through Ownership Change

SEBI addressed a central issue on whether pledge-related transactions, specifically revocation and invocation, constituted “trades” and attracted contra trade restrictions. It referred to an earlier informal guidance issued in 2025 (SEBI/HO/ISD/OW/2025/20748/1)[1] and its FAQs on PIT Regulations,[2] which broadly construe “trade” to include “dealing” in securities. Within this framework, the regulator implicitly emphasised a change in the beneficial ownership of shares as a key determinant.

Revocation of a pledge does not involve transfer of ownership, as the shares revert to the pledgor, which distinguishes it from transactions involving actual market dealing. Accordingly, revocation is generally treated differently from conventional trading activity and may not ordinarily trigger contra trade concerns.

In contrast, invocation of a pledge results in a transfer of beneficial ownership of shares to the lender and may be considered akin to a sale of shares. However, SEBI clarified that invocation, by itself, does not automatically amount to a contra trade. Instead, its characterisation depends on the broader transactional context.

Specifically, invocation may not be treated as a contra trade provided the DP does not undertake any acquisition of shares, other than via the exercise of ESOPs, within a period of six months prior to or subsequent to the invocation of the pledge. Thus, the regulatory approach is conditional rather than absolute in that invocation is not per se exempt, but its compliance implications depend on the absence of offsetting trades within the prescribed six-month window.

Bona Fide Pledges and the Role of the Compliance Officer as the Gatekeeper

The second set of issues centred on whether pledge transactions undertaken during trading window closure could qualify as “bona fide” and, therefore, fall outside the restriction.

Clause 4(3)(a) of Schedule B[3] read with Regulation 9(1) of the PIT Regulations[4] provides that trading window restrictions inter alia do not apply to pledges of shares by DPs for bona fide purposes, such as raising of funds, subject to pre-clearance by the Compliance Officer and compliance with the respective regulations made by SEBI.

A key question was on the interpretation of the phrase “such as” in Clause 4(3)(a) of Schedule B of the PIT Regulations. SEBI clarified that the phrase is illustrative, not exhaustive or exclusive, indicating that the PIT Regulations do not provide a closed list of permissible bona fide purposes. Consequently, whether a particular pledge is bona fide must be determined on a case-by-case basis. SEBI placed primary responsibility for this assessment on the Compliance Officer to evaluate the transaction in light of the code of conduct and the specific facts of the case.

Importantly, SEBI also noted that while companies may classify certain categories of transactions as bona fide within their internal codes, such classifications must remain consistent with the PIT Regulations and other applicable SEBI frameworks. Therefore, purposes suggested by the Company, such as purchasing a house, repaying a home loan, or addressing medical emergencies, do not automatically qualify as bona fide. Every transaction must undergo scrutiny by the Compliance Officer, who is obliged to independently satisfy the test of legitimacy and regulatory compliance, as assessed through the pre-clearance mechanism.

Conclusion

The Informal Guidance underscores a structural tension common to listed companies with active ESOP Schemes, namely, the overlap between ESOP exercise windows and trading window closure periods.

SEBI’s approach reflects a calibrated balance. Invocation of a pledge is treated as a transaction involving a change in ownership and, therefore, potentially within the scope of trading restrictions, whereas its classification as a contra trade is made conditional, with a limited carve-out for ESOP-related acquisitions. Revocation, by contrast, is generally distinguished on account of the absence of ownership transfer and is treated more leniently.

More significantly, the guidance reinforces the central role of the Compliance Officer as the gatekeeper in assessing the bona fide nature of pledge transactions. By interpreting the category of bona fide purposes as open-ended, SEBI has preserved flexibility while placing the burden of principled decision-making on internal compliance frameworks.

In this light, companies would benefit from articulating clear and consistent criteria within their Codes of Conduct to guide such determinations.

[1] Informal Guidance dated August 4, 2025

[2] Comprehensive FAQs on PIT Regulations (2024)

[3] Clause 4(3)(a) of Schedule B of the PIT Regulations provides that “The trading window restrictions mentioned in sub-clause (1) shall not apply in respect of – (a) transactions specified in clauses (i) to (iv) and (vi) of the proviso to sub-regulation (1) of regulation 4 and in respect of a pledge of shares for a bona fide purpose such as raising of funds, subject to pre-clearance by the compliance officer and compliance with the respective regulations made by the Board;

[4] Regulation 9(1) of the PIT Regulations provides that “The board of directors of every listed company and the board of directors or head(s) of the organisation of every intermediary shall ensure that the chief executive officer or managing director shall formulate a code of conduct with their approval to regulate, monitor and report trading by its designated persons and immediate relatives of designated persons towards achieving compliance with these regulations, adopting the minimum standards set out in Schedule B (in case of a listed company) and Schedule C (in case of an intermediary) to these regulations, without diluting the provisions of these regulations in any manner.”