Analysis of MCA Dematerialisation of Shares Rules By CS G Sriram


Partner
Mamta Binani & Associates

Introduction

The Investors invest in the securities of companies with an expectation that they will receive a good return on their investments.

The investors get their return on investments by the way of dividend from the profits of the company as well as through corporate benefits like bonus shares etc. In case the investee company is listed, the investor concerned also expects to benefit from trading in such security in the secondary market. The corporate action benefits are credited directly to the Demat Account of the respective investor/shareholder if their shares are held in a Demat form. But the shareholders who hold the shares in physical form do not receive those benefits immediately.

The Depositories Act was passed by the Parliament in the year, 1996 which facilitates the conversion of Physical Shares into electronic form or to a Demat form.

Even after the advancement in the use of technology in maintaining securities in Demat form still 2.3 per cent of India’s $2-trillionplus market capitalization is held in the Physical Form.

Number of Listed Companies in India

There are about 7000 listed companies in India. Out of these, approximately 5000 companies are listed on Bombay Stock Exchange and 2000 Companies listed on National Stock Exchange.

Retail investors own stocks worth Rs 1.24 lakh crore in physical form, while mutual funds hold Rs 45,760 crore worth of paper stock.

Number of active Companies

[1]There were more than 11.89 lakh active companies at the end June, 2018. Out of them, 71,506 were public companies and 11.10 lakh companies were private, as per data compiled by the Ministry of Corporate Affairs.
 
Earlier Notifications by the Ministry of Corporate Affairs:-

Considering the importance of dematerialization of shares and Investor Protection the Government of India, Ministry of Corporate Affairs and the Capital Market Regulator SEBI has taken lot of measures over the recent years.

In the year 2011, the Ministry of Corporate Affairs issued a draft set of rules as Companies (Dematerialization of Certificates) Rules 2011[2] for mandating the Public Companies and its subsidiaries which have raised money by issue of shares, debentures, by accepting public deposits, stock, bond or any other financial instruments from public, other than from directors of the company, shall issue and keep such share certificates, debenture certificates and certificates issued for Receipt of deposits, stock, bond or any other financial instruments in dematerialized form only, in the manner prescribed in the Depositories Act, 1996 and regulation made thereunder.

But this Draft Companies (Dematerialization of Certificates) Rules, 2011 was withdrawn by the Ministry of Corporate Affairs on 28/10/2011[3].

Reasons for Withdrawal of Draft Companies (Dematerialization of Certificates) Rules, 2011 by Ministry of Corporate Affairs

The Ministry of Corporate affairs has withdrawn the Draft Companies (Dematerialization of Certificates) Rules, 2011 because a similar proposal was included in clause 29 of the Companies Bill 2011 then[4].

The Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018

[5] Now, The Ministry of Corporate Affairs has issued the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018 on 10.09.2018

The Notification is regarding the issue of securities in the dematerialized form by the Unlisted Public Companies only.

Reasons behind the Amendment Rules

Shell Companies

Earlier in the year September 2017, the Ministry of Corporate Affairs had struck off 200,000 Companies that were suspected to be shell companies and directed banks to restrict the operation of bank accounts of such companies by the directors of such companies or their authorized representatives.

Shell Companies, though not defined under the Companies Act, are those that adhere to basic company laws and are used to avoid taxes and convert black money into white.

Shell Company is a corporate entity without active business operations or significant assets. They are often created to avoid taxes and many big companies create shell corporations to avoid taxes without attracting legal actions.

But many shell companies park black money, carry out illegal transactions and sometimes act as facilitators of money laundering. Often, shell companies remain untraceable and happen to be the vehicle of choice for money launderers, bribe givers and takers, tax evaders and financiers of terrorism.

Usually, these Shell Companies will not file the Income Tax Returns or Roc Returns in a proper and timely manner. Many shell companies are manipulating the Accounting transactions before filing their Returns
[6] According to the News Paper report one shell company has been found to have as many as 2,100 bank accounts and there are about 50 companies which had multiple banks accounts ranging around 450, 600, 900 and 2,100 etc.

Most of the Benami holdings are held in these shell Companies Only. It is very difficult to find the real ownership of the Shares and the shareholders are untraceable and there is no transparency in the shareholdings of the Company.

Therefore,
  1. To enhance the Transparency in the ownership of shares
  2. To Curb the Benami Transactions
  3. To weed out the shell companies which is used for Money laundering and other illicit activities and
  4. A fight against black money
The Ministry of Corporate Affairs has notified the aforesaid amendment

A copy of the Companies (prospectus and Allotment of Securities) Third Amendment Rules, 2018 can be downloaded using the following link:


Details of the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018 notification as follows:-
 
1. Date of Notification
 
Notification is issued by the Ministry of Corporate Affairs on 10th September 2018
 
2. Date from which the Notification will come into effect
 
This notification will come into effect from 2nd October 2018.
 
3. For which companies are these Rules applicable?
 
As per the Notification these newly inserted Rules are applicable to the Unlisted Public Companies only.
 
4. What is the duty of the Unlisted Public Companies after this notification?
 
The Unlisted Public Companies should issue the securities only in the demat form and also should take necessary steps to facilitate dematerialization of all its existing securities of the Company in accordance with the provisions of Depositories Act 1996 and regulations made thereunder.
 
5. What are the provisions of the Depositories Act, 1996 for issuing and facilitating dematerialization of securities?
 
Agreement between depository and issuer
 
According to Regulation 29 of the Securities and Exchange Board of India ( Depositories and Participants) Regulations 1996
 
  • Either on the issuer or on the investor exercising an option to hold his securities with a depository in dematerialised form, the issuer shall enter into an agreement with the depository to enable the investor to dematerialise the securities. 
But, no such agreement shall be required to be entered into where the State or the Central Government is the issuer of Government securities.
 
  • Where the issuer has appointed a Registrar to the Issue or Share Transfer Agent, who has been granted certificate of registration by the Board under sub-section (1) of section 12 of the Act, the depository shall enter into a tripartite agreement with the issuer and the Registrar to the Issue or Share Transfer Agent, as the case may be, in respect of the securities to be declared by the depository as eligible to be held in dematerialised form.
6. Whether the Unlisted Public Companies can issue securities in the physical form after 02nd October 2018?
 
No, from 02nd October 2018, every Unlisted Public Company which offers the issue of any securities or buyback of securities or issue of bonus shares or right issue or Private Placement shall issue the shares only in dematerialized Form.
 
7. Is it Mandatory for the Promoters, Directors and Key Managerial Personnel to have their securities in the demat form?
 
Yes, from 02nd October 2018, every unlisted Public Company’s Promoters, Directors and Key Managerial Personnel should hold their entire lot of securities of the Company in demat mode in accordance with the provisions of the Depositories Act 1996 before issue of any securities or buyback of securities or issue of bonus shares or right issue or Private Placement by the Company.
 
8. Whether the transfer of shares held in physical form can be done by the existing shareholders after 02nd October 2018?
No, from 02nd October 2018, onwards an unlisted Public Company shares can be transferred only through the Demat form. It means the holder of physical shares should first get their shares dematerialized and then they can only transfer their shares.
No transfer of physical shares can be done on or after 02nd October 2018.

9. Whether the existing shareholders have to convert their shares in the demat form?
 
Yes, the existing shareholders must convert their existing shares into the demat mode, if they want to subscribe for any further shares in the Company on or after 02nd October 2018.
 
For example: if the existing shareholders wish to subscribe for any shares in the company by way of right issue, Private Placement or Bonus issue etc. on or after 02nd October 2018 then they should first convert their existing shares into demat mode before subscribing for the new shares.
 
10. What are the necessary steps the Unlisted Public Company should take to facilitate dematerialization of its existing securities and comply with this Rules?

The Unlisted public companies which are not having dematerialization facility should apply to the Depositories with required documents for getting the International Security Identification Number(ISIN).

The application shall be accompanied with the fees as specified by the depositories.

In other words, every unlisted public company is now obligated to facilitate dematerialisation of all its existing securities by making necessary application to a depository as defined in clause (e) of sub-section (1) of section 2 of the Depositories Act, 1996 and shall secure International Security Identification Number (ISIN) for each type of security and shall in-form all its existing security holders about such facility.

11. What is mean by ISIN Number?
 
ISIN stands for International Securities Identification Number (ISIN). It is an international numbering system set up by the International Organization for Standardization (ISO) to number specific securities, such as stocks (equity and preference shares), bonds, options and futures.
 
ISIN contains 12 characters in total, which comprise of both alphabets and numbers. The first two digits stand for the country code, the next nine digits are the unique identification number for the security while the last digit is a check digit to prevent errors.
 
E.g.: ISIN for State Bank of India (SBI) is INE062A01012.
 
12. How many depositories are there in our country at present?

At present, there are two Depository organisations in our Country.
  1. National Securities Depository Limited (NSDL) and
  2. Central Depository Service (India) Limited (CDSL)
 
13. To which depository the Company should apply for getting the demat facility and ISIN Number?
 
It is the wish of the Company and it can either apply with CDSL or NSDL or with both.
 
14. Is it necessary to appoint the Registrar and share transfer agent by an unlisted public company while facilitating dematerialization of securities?
 
No.

However, the dematerialization and share transfer of securities involves various processes, it is better to appoint a Registrar and Share Transfer agents to handle the securities demat and transfer related work on behalf of the Company.
 
15. When this ISIN Number will be issued by the depository?
 
Once the document submitted by the Company along with the application which is found in order then the depository will send the tripartite agreement which is to be signed between the Company and the Registrar and Share Transfer Agent and the depository.
 
16. Is there any annual fee that is to be paid to the Depositories?
 
Yes, the Annual charges are to be paid to the depository and Registrar and Share Transfer Agent as per the tripartite agreement.
 
17. Whether any security deposit is to be paid for the dematerialization of shares?

Yes, the Company should maintain security deposit at all times which is not less than the two years fees with the Depository and Registrar and share transfer agent.

18. Whether Securities and Exchange Board of India Regulations are applicable to this Unlisted Public Companies after availing the dematerialization facility?

Yes, the Unlisted Public Companies must comply with SEBI Regulations, Rules, Directions and Guidelines with respect to Dematerialization shares and other Matters incidental thereto.

19. Whether the Company is allowed to issue or offer any securities, buyback or issue any bonus or right shares in case of default in paying any fees to the Depositories or Registrar or share Transfer Agent?

No, as per the sub-rule 5 of this the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018 no unlisted Public Companies is allowed to issue or offer any securities, buyback or issue any bonus or right shares to any persons until the payment is made to the Depositories or Registrar or Share Transfer Agent.

20. What are the provisions applicable to these unlisted Public Companies after availing the Dematerialization facility?

The Unlisted Public Companies have to Comply with the provisions of the following Acts and regulations

I. Depositories Act 1996

  1. Option to opt out in respect of any security(Section 14)
  2. Power of Board to call for information and enquiry (Section 18)
  3. Power of Board to give directions in certain cases-(Section 19)
  4. Penalties
The Issuer Company or its agent is liable for the penalties specified in the following sections
Penalty for failure to furnish information, return, etc-(Section 19A)
Penalty for failure to enter into an agreement-(Section 19 B)
Penalty for failure to redress investors’ grievances-(Section 19 C)
Penalty for delay in dematerialisation or issue of a certificate of securities-(Section -19D)

II. Securities and Exchange Board of India (Depositories and Participants Regulations,1996
)

  1. Manner of handling share registry work. (Regulation 53A)
  2. Redressal of investor grievances (Regulation 53B)
  3. Maintain a record of certificates of Securities (Regulation 54(7))
  4. Reconciliation of Securities (Regulation 55)
  5. Connectivity(Regulation 56)
According to Regulation 56, every issuer or its agent should establish continuous electronic means of communication with the depository with which it has entered into an agreement.
  1. Information regarding Book closure and Record date ( Regulation 57)
  2. Obligations on inspection by the Board- (Regulation 61)
  3. Liability for action in case of default by the issuer or its agent(Regulation 64 A)
  4. Securities and Exchange Board of India (Registrar and share Transfer agents Regulations,1993)
if the Company itself is a Registrar and share Transfer agent then it has to comply with all the provisions of  Securities and Exchange Board of India (Registrar and share Transfer agents Regulations, 1993)
 
21. Is any report is required to be submitted to the registrar after availing the dematerialization facility?
 
 
Yes , as per the sub-rule 8 of this Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018 and Under provision of Regulation 55A of the SEBI (Depositories and Participants) Regulations, 1996, now this unlisted Public companies which has availed the dematerialization facility are required to submit Reconciliation of Share Capital Audit Report on a Half-yearly basis to Registrar of Companies whose Jurisdiction the Registered office of the company is situated which audited by a practising Company Secretary, for the purpose of reconciliation of share capital held in depositories and in physical form with the issued/listed capital.
 
22. To whom the grievances of the security holders, if any have to be filed?
 
The security holders can file their securities-related grievances to the Investor Education and Protection Fund authority (IEPF).
 
The Investor Education and Protection Fund authority (IEPF) will initiate action against the depository and Registrar and share transfer agents after prior consultation with SEBI.
 
Conclusion:-

Dematerialization of shares provides numerous benefits to the shareholders, some of which are:-

1. The risks pertaining to physical certificates like loss, theft, forgery and damage are eliminated completely with a DEMAT account.
2. The lack of paperwork enables quicker transactions and higher efficiency in trading.

3. Trading has become more convenient as one can trade through computers at any location, without the need of visiting a broker.


4. The shares that are created through mergers and consolidation of companies are credited automatically in the DEMAT account.


5. As all the transactions occur through the depository participant, a trader does not need to communicate individually with each and every company.
 
6. There is no need for stamp duty for transfer of securities; this brings down the cost of transaction significantly.

7. One can also choose to take a loan against securities which are held in a DEMAT account by offering it as a collateral to the lender.
A Demat account holder can buy or sell any amount of shares. However, there is a limit on the number of transactions done using physical securities.

Therefore, considering the above facts the Unlisted Public Companies must avail the dematerialization facility for their Company shares and comply with the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018.
 
 
 
 
 
 

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