The Ministry of Corporate Affairs (MCA) has notified the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018 (Rules) via Circular dated 10-9-2018.
The underlying intent in issuing the Rules is to make it mandatory for the unlisted public companies (along with the listed companies) to maintain the securities in the dematerialised form and to facilitate the dematerialisation of all the existing securities.
As per the records, there are around 66,000 unlisted public companies. These Rules are notified with the objective to streamline the issue and transfer of securities process by replacing the outdated process (physical certificates of securities) with the dematerialisation (electronic storage) of securities process.
Dematerialisation of securities has multiple benefits for all quarters.
Benefits for security holders
(i) Fast and convenient transfer securities.
(ii) No stamp duty is to be affixed on securities instrument.
(iii) No risks pertaining to physical certificates e.g., fake, damaged, soiled, mutilated certificates, bad delivery, postal delays, thefts, etc.
(iv) Less paperwork and transaction costs.
(v) No need to split certificates to sell only a part of securities.
(vi) Transmission of securities is effected by a depositary participant, no need for the security holder to notify/interact with the company.
Benefits to the company
(i) Reducing the cost of new issues due to lower printing and distribution costs.
(ii) Raising efficiency level of Registrars and transfer agents and the Secretarial Department.
(iii) Expeditious service to shareholders.
Benefits to brokers
(i) Reduction in delayed settlement risk.
(ii) More business due to increase in volume of trading.
(iii) No scope for bad delivery or forgery.
These Rules have come into effect from 2-10-2018. The following are the definitions of the keywords to have clear understanding of implications of these keywords in the context of the Rules:
(i) “Dematerialisation of securities” is the transformation of physical securities into demat (electronic) format and process of electronic storage of securities.
(ii) “Dematerialised securities” are securities that do not exist in physical (paper) form along with non-existence of any physical certificate. Dematerialised securities will be stored in the form of entries in the depositories book.
(iii) “Depository” can be an entity, organisation, bank, or a financial institution that preserve the financial securities in dematerialised form and assist the investor in the trading of securities. Existing depositories in India are National Securities Depository Limited (NSDL) and Central Depository Service (India) Limited (CDSL).
(iv) “Depository Participant” (DP) is the mode for electronic storage of shares and will act as the depository agent. DP will serve as a connection amid the investor and the company by acting as the investor representatives.
(v) “Registrar and share transfer agent” (R&T agent) is an agent that facilitates the register and preservation of all the information related to the investors’ transactions.
(vi) “Beneficial owner” is a person whose name is recorded as such with a depository and will be holder of the rights, benefits and liabilities associated with the securities held by such depository.
The following are the key directives issued by the MCA in this regard:
(i) The unlisted public companies will have to mandatorily issue and transfer of securities in dematerialised form and switch all the existing securities into dematerialised form within the specified time duration subject to provisions of the Depositories Act, 1996.
(ii) It is the responsibility of the unlisted public company to convert all the securities owned by the promoters, key personnel and directors into dematerialised form subject to provisions of the Depositories Act, 1996 prior to issuing an offer (issue/buyback of securities, issue of bonus shares or rights offer).
(iii) Every holder of securities of unlisted public companies is obligated to convert such holder existing securities into dematerialised form prior to any transfer of the existing securities or to subscription of the new securities issued by the unlisted public companies.
(iv) It is the obligation of the unlisted public company to secure international security identification number (ISIN) for each type of security and to educate about such facility to the existing security holders.
(v) Unlisted public company has to submit the audit report on half-yearly basis to the Registrar within whose jurisdiction the registered office of such company is located.
(vi) Investor Education and Protection Fund Authority (authority) is the competent authority to handle with the grievances of the security holders of the unlisted public companies.
(vii) Any action against the depository/participant/registrar to any issue or share transfer agent shall be instigated by the authority in consultation with Securities and Exchange Board of India (SEBI).
(viii) Every unlisted public company has to comply with the following rules prior to making any offer (issue/buyback of securities, bonus issue or right shares):
(a) No default in the payment of related fees to depository/registrar/share transfer agent.
(b) Maintenance of security deposits with depository/registrar/share transfer agent for not less than 2 years fees.
(c) Compliance with all rules and regulations issued by the SEBI and depository in relation to dematerialisation of securities of unlisted public company.
These Rules will simplify the process of issuance and transfer of securities to bring more transparency in the capital market transactions and to uplift the corporate governance standards.
Dematerialisation of shares procedure
(i) A demat account has to be opened with a depository participant (DP) by the beneficiary owner to procure a demat account number.
(ii) A request for dematerialisation of securities via dematerialisation request form (DRF) along with securities certificates (which has to be dematerialised) will be submitted by the client (registered owner) to the DP.
(iii) Prior to submission, the certificates has to be defaced by the client in writing “surrendered for dematerialisation”.
(iv) DRF will be scrutinised by the DP to substantiate the information provided in the DRF. If the DP is satisfied with the information provided in the DRF and supporting documentation, the DP will issue an acknowledgement slip duly signed and stamped, to the client.
The DP verification process of the DRF and the certificates shall be as follows:
Client’s signature on DRF will be authenticated with the client specimen signature on the account opening form.
If the signature is not authenticated then the DP has to establish the client identity.
Comparison of client names on DRF and certificates with the client account.
Check of paid-up status, ISIN, lock-in status and distinctive numbers.
If the securities are not in order the securities will be returned to the client and acknowledgement is obtained.
The DP will reject the DRF request and return the DRF and certificates in case:
Dematerialisation of securities of more than one company with the assistance of a single DRF.
Certificates (mutilated or defaced) which are not readable. DP may direct the client to procure new securities in lieu of such certificates by submitting the certificates to the issuer/R&T agent.
Partial payment of the certain securities certificates submitted in relation to a single DRF. Client may be advised to submit separate DRF for the fully paid-up and partly paid-up securities.
Under a single DRF certain part of securities certificates are locked-in. For such locked-in certificates, the client may be required to submit separate DRF as directed by DP. Client is not permitted to submit certificates locked-in for different reasons with a single DRF.
If the securities are in order, the DRF request will be processed further by updating the relevant details into the depository participant module (DPM—software provided by NSDL to the DP).
The system will generate a dematerialisation request number (DRN) which has to be specified in the space allocated in DRF.
A demat request on the CDSL or NSDL system would be instigated by DP.
Certificates including DRF and a cover letter will be dispatched to the issuer/R&T agent by DP.
If in the opinion of issuer/R&T agent the DRF is in order, the DRF will be accepted by the issuer/R&T agent and the same will be forwarded to the depository module (DM).
Electronic authorisation which is necessary to create appropriate credit balances in the clients accounts will be permitted by the DM. The DPM will credit the client’s account automatically.
Upon the DRF confirmation the client should be informed of the changes to the client account by the DP.
Rejection of DRF by issuer/R&T agent
DRF may be rejected by the issuer/R&T agent in certain cases:
An objection memo will be send to the DP by the issuer/R&T agent with or without DRF and security certificates depending upon the reason for rejection.
Within 15 days of receipt of objection memo the DP/investor are obligated to remove objection reasons.
If the DP/investor has failed to rectify the objection reasons within said 15 days then the DRF will be rejected and the DRF including supporting documents may be returned to DP by the issuer/R&T agent.
Following the rejection of DRF, new DRF (at the client request) may be generated by DP via submitting the securities again to the issuer/R&T agent.
However generation of new request in relation to same securities is prohibited until the prior rejection of securities is informed to NSDL and DP by the issuer/R&T agent.
Transfer of shares by an individual in dematerialised form
(i) For dematerialisation of securities, a demat account has to be opened by the shareholder with depository participant (DP) with surrender of the physical shares.
(ii) Transfer of securities by the shareholder to another demat account can be materialised by directing appropriate instructions to the related DP via delivery instruction slip (DIS).
(iii) DIS has equivalent value and significance of a cheque book. The investor has to take utmost care in handling DIS on par with the cheque book.
(iv) For transfer of securities through the stock exchange, the investor shares have to be transferred from investor demat account to brokers pool account by the DP upon the investor instruction.
(v) For transfer of securities to any buyer’s demat account (off market transaction), an instruction (to transfer securities to the buyer’s concerned demat account) by the investor to the DP should be given.
(vi) From process perspective, the approval of the company is mandatory prior to sanction of transfer of securities by the RTA — following the receipt of company approval then only RTA shall register a transfer of securities in the demat mode.
List of documents required by an issuer
(i) Admission application (issuer of eligible securities) with issuer details (Part I) and security details (Part II).
(ii) Chartered accountant issued networth certificate based on audited annual report of last financial year.
(iii) Board resolution (certified true copy) along with names of authorised signatories by Board to execute documents—list of authorised signatories along with specimen signature.
(iv) R&T agent issued confirmation letter.
(v) Company’s certificate of incorporation along with memorandum and articles of association (certified true copies).
(vi) Audited annual report of last financial year (certified true copy).
(vii) Company is obligated to furnish PAS-3 (certified true copy) provided the company has issued equity shares following the last balance sheet.
(viii) The company has to provide SH-7 (certified true copy) provided there is any variation in face value of shares or reduction in capital following the last balance sheet.
Bhumesh Verma is Managing Partner at Corp Comm Legal and can be contacted at firstname.lastname@example.org.