In the ever-evolving landscape of corporate governance, the winds of change are sweeping through India’s boardrooms, leaving in their wake a trail of digitized securities and a narrative of transformation. The government, in a bold move, has introduced the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023, signaling a pivotal moment in the way securities are issued and managed.
As we navigate the intricacies of this regulatory overhaul, our blog unfurls the story amendment in Rules which is game-changer for public companies, compelling them to bid farewell to physical share warrants and embrace the digital era. The tale weaves through the corridors of these companies, echoing the call for a seamless transition from tangible to intangible assets.
But the narrative extends beyond the public sector; recent amendment thrusts private companies into the spotlight, mandating them to shed the paper trail and embrace dematerialization. The saga unfolds with a surprising twist – government companies stand exempt, adhering to a distinct regulatory script.
Our blog further delves into the action items for private companies, emphasizing the importance of obtaining International Securities Identification Numbers (ISINs), promoting dematerialization, and ensuring compliance with depository regulations. We have also tried to cover the exemption to Small Companies and the impact of this move to subsidiary of Foreign holding companies – how they are mandatorily required to dematerialize the shares and what shall be the status of a Nominee Shareholder? The compliance deadline, set for September 30, 2024, has become a critical countdown for these entities.
As the story progresses, we unravel the impacts of dematerialization on the financial market – from reducing risks associated with physical certificates to simplifying transfer processes and enhancing corporate governance. The dematerialization process, we argue, is a strategic move towards a more secure, efficient, and accountable landscape for private company transactions.
As the ink on these rules dried, we delved into Rule 9, a chapter that rewrote the script for Public Companies, commanding them to transform physical share warrants into a digital one through dematerialization within six months. A notice echoed through the corridors of these companies, calling on bearers to surrender their paper treasures and embrace the digital realm of securities. A story unfolded on websites and in newspapers, narrating the transformation from tangible to intangible, from the old guard to the new.
Public companies that issued share warrants before the Companies Act, 2013, and have not yet converted them into shares face new requirements and they are required to comply with certain timelines:
The company must notify the bearers via Form PAS-8 on their website and publish the same notice in a vernacular newspaper and an English newspaper. If a bearer fails to surrender the share warrants within the specified time, the company is obligated to convert them into dematerialized form and transfer them to the Investor Education and Protection Fund.
This change encourages transparency and ensures that share warrants are brought in line with modern dematerialization practices.
The saga wasn’t limited to public companies alone; private companies, too, found themselves at the heart of a narrative marked by dematerialization. Rule 9B emerged as a pivotal plot point, mandating every private company, save for the humble small ones (Small Companies), to cast off the shackles of paper securities and embrace the digital embrace within eighteen months from 31st March 2023.
Additionally, these private companies must ensure that all securities held by their promoters, directors, and key managerial personnel are dematerialized before making any new securities offers, buybacks, issuing bonus shares, or rights offers.
Existing holders of securities intending to transfer or subscribe to new securities must also ensure their holdings are in dematerialized form. This encourages a shift towards more secure and efficient dematerialization practices.
In a surprising twist, government companies stood exempt from this narrative, following a distinct regulatory script.
As the tale unfolded, small private companies found refuge in the exemption, shielded by the definition of a paid-up share capital of INR 4 crores or below and a turnover of INR 40 crores or below. Every private company, which is not a small company as on or after 31 March 2023, shall be required to comply with the new requirements within 18 months of closure of such financial year (Compliance Date). The timeline for compliance became the ticking clock for private companies, each one striving to align with the new order by September 30, 2024.
We would like to lay emphasis here on the status of subsidiary of a foreign holding company – The subsidiary of a foreign holding company will not be classified as a small company and hence they will be mandatorily required to comply with the dematerialization of shares.
In terms of action items, pursuant to the Amendment, every Private Company is required to do following compliances:
| Sl No. |
Action Points |
| 1 | Obtain the International Securities Identification Number (ISIN) for all existing securities issued by it. |
| 2 | Promote, propagate and facilitate dematerialization of all its existing securities by the holders of such securities. |
| 3 | Once the share capital of the Private Company is dematerialised, the Private Company must issue securities only in dematerialized form. |
| 4 | Ensure that prior to any issue of securities, all the securities held by its promoters, directors and key managerial personnel are held in dematerialised form. |
| 5 | submit Form PAS-6 (Half yearly return for reporting of shares held in Demat form) to the Registrar of Companies (ROC), along with the relevant fee, within 60 days from the conclusion of each half-year, duly certified by a company secretary. |
Every Private Company shall ensure the following with respect to interaction with depository:
The amendments aimed at ensuring the integrity of the financial market and maintaining transparency within the system. First of all, dematerialisation procedure effectively reduces the risks linked to physical certificates, including the potential for theft, loss, and forgery. It leads to simplification of the transfer process, resulting in simplified transactions and decreased administrative complications. The dematerialisation method confers the benefit of stamp duty exemption on transfers, resulting in lower transaction costs.
This alteration improves the corporate governance framework by facilitating increased transparency and mitigating malpractice occurrences which will leads to protection of Investor Interests. Investor protection refers to the policies and legislation put in place to protect investors’ rights and interests. It is a collection of behaviours and procedures aimed at promoting transparency. This approach is expected to improve and streamline the settlement process, increasing investor faith in the system.
These measures aim to curb Benami transactions and mitigate the risks associated with improper share dealings and seek to create a more robust and accountable financial environment. This not only aligns with the overarching goal of maintaining market integrity but also addresses concerns related to the potential misuse of financial instruments.
The dematerialisation process will also contribute significantly to the reduction of paperwork in the handling of physical records and the overall modernisation of India’s corporate governance. There might also be some savings by eliminating paperwork that may have included processing fees.
Status of a Nominee Shareholder
In accordance with Section 10 of the Depository Act of 1996, the depository is designated as the registered owner but does not possess voting rights. The entitlement to all rights and benefits associated with securities lies with the beneficial owner. Additionally, all shareholders are considered beneficial owners within the depository system, even if a specific shareholder is merely acting as a nominee. This legal stance may present practical challenges for a holding company seeking to control the actions of nominee shareholder(s). The conceptual and procedural distinctions between the Act and the Depository Act warrant careful examination by both beneficial owners and nominees before entering into such arrangements in the future. Practical solutions may include exploring options such as establishing a joint demat account for actual and nominee shareholders for nominee shares, incorporating restrictions on the transfer or pledge of nominee shares in the Articles of Association, or implementing measures like freezing the ISIN for specific purposes. However, the adoption of each option necessitates thorough consideration, given the diverse legal, operational, and compliance aspects involved.
Holding shares in a dematerialised form not only creates operational efficiencies for shareholders but also addresses challenges faced by financial institutions in the foreclosure of physical shares. The foreclosure process for dematerialised shares is notably more straightforward, presenting a positive shift for financial institutions. In sum, the dematerialisation mandate emerges as a comprehensive step towards fostering a more secure, efficient, and accountable landscape for private company transactions in India. This measure not only enables compliance but also contributes to the overall integrity and transparency of transactions involving private company securities.
But like any good tale, there is a twist in the epilogue. The mandatory dematerialization introduced foreign investors to a new chapter, wherein they will be required to open demat accounts in the country, increasing compliance costs for private companies.
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