Dematerialization of Securities: Rules for Private & Unlisted Public Companies

Understand the new Rule 9B in the Companies (Prospectus and Allotment of Securities) Rules, 2014, mandating dematerialization of securities for private and unlisted public companies. Explore the benefits, compliance deadlines, and procedures involved. Stay informed about this significant shift in handling securities for enhanced transparency and investor protection.

Ministry Of Corporate Affairs vide its notification dated 27th October 2023 has inserted new Rule 9B in the Companies (Prospectus and Allotment of Securities) Rules, 2014 (hereinafter referred to as the said rules).

Pursuant to Rule 9B, Every Private Company other than a small company shall issue the securities only in Dematerialized Form; and facilitate the dematerialization of all its securities. A private company, which as on the last day of a financial year, ending on or after 31st March 2023, is not a small company as per audited financial statements for such financial year, shall, within eighteen months of the closure of such financial year i.e., 30th September 2024, comply with the provisions of this rule.

Dematerialization: Dematerialization is the process of converting physical shares into an electronic form. Shares once converted into dematerialized form are held in Demat Form. Actual stock certificates are slowly being removed and retired from circulation in exchange for electronic recording. Dematerialization is for enhancing transparency, investor protection, and governance in the corporate sector.

Benefits of Dematerialization: The elimination of risks associated with physical certificates such as loss, theft, mutilation, and fraud, would be a key benefit of the decision to have shares in demat form. Other benefits include improving the corporate governance system by increasing transparency and preventing malpractices such as benami shareholding, back-dated issuance of shares, exemption from payment of stamp duty on transfer, and ease in transfer, pledge, etc, of securities.

Pursuant to the above amendment, Rule 9A & Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules, 2014 (hereinafter referred to as the said rules) shall be read as under:

1. Every Unlisted Public Company and Every Private Company other than a Small Company (hereinafter referred to as the “Applicable Private Companies”) (Unlisted Public Company and Applicable Private Companies hereinafter collectively referred to as Applicable Companies) shall Issue the securities only in dematerialized form; and facilitate the dematerialization of all its existing securities.

Analysis: Every Unlisted Public Company and Applicable Private Companies Shall Issue the securities only in dematerialized form. These provisions shall also be applicable to existing securities.

2. Every Unlisted Public Company and Applicable Private Companies making any offer for the issue of any securities or buyback of securities or issue of bonus shares or rights offer shall ensure that before making such offer, the entire holding of securities of its promoters, directors, key managerial personnel has been dematerialized in accordance with provisions of the Depositories Act 1996 and regulations made there under.

3. Every holder of securities of an Unlisted Public Company and Applicable Private Companies:

• who intends to transfer such securities shall get such securities dematerialized before the transfer; or
• Who subscribes to any securities of an Unlisted Public Company and Applicable Private Companies (whether by way of private placement or bonus shares or rights offer) shall ensure that all his existing securities are held in dematerialized form before such subscription.

Analysis: Existing holder cannot transfer any security until it is dematerialized and If any holder wants to purchase security then he should ensure that all its existing securities are in demat form.

4. Every Unlisted Public Company and Applicable Private Companies shall facilitate the dematerialization 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 the International Security Identification Number (ISIN) for each type of security and shall in-form all its existing security holders about such facility.

5. Every Unlisted Public Company and Applicable Private Companies shall ensure that-

6. it makes timely payment of fees (admission as well as annual) to the depository and registrar to an issue and share transfer agent in accordance with the agreement executed between the parties;

7. it maintains a security deposit at all times, of not less than two years, fees with the depository and registrar to an issue and share transfer agent in such form as may be agreed between the parties; and

8. it complies with the regulations or directions or guidelines or circulars, if any, issued by the Securities and Exchange Board or Depository from time to time with respect to the dematerialization of shares of Unlisted Public Companies and Applicable Private Companies and matters incidental or related thereto.

9. No Unlisted Public Company and Applicable Private Companies which has defaulted in sub-rule (5) shall make an offer of any securities or buyback its securities or issue any bonus or right shares till the payments to depositories or registrar to an issue and share transfer agent are made.

10. Except as provided in sub-rule (8), the provisions of the Depositories Act 1996 the Securities and Exchange Board of India (Depositories and participants) [Regulations, 2018], and the Securities and Exchange Board of India (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 shall apply mutatis mutandis to the dematerialization of securities of Unlisted Public Companies and Applicable Private Companies.

11. Every Unlisted Public Company and Applicable Private Companies governed by this rule shall submit Form PAS-6 to the Registrar with such fee as provided in Companies (Registration Offices and Fees) Rules, 2014 within sixty days from the conclusion of each half-year duly certified by a company secretary in practice or chartered accountant in practice.

12. A The Company shall immediately bring to the notice of the depositories any difference observed in its issued capital and the capital held in dematerialized form.

13. The grievances, if any, of security holders of Unlisted Public Companies and Applicable Private Companies under this rule shall be filed before the Investor Education and Protection Fund Authority.

14. The Investor Education and Protection Fund Authority shall initiate any action against a depository or participant or registrar to an issue and share transfer agent after prior consultation with the Securities and Exchange Board of India.

Small Company means a company, other than a public company-

• paid-up share capital of which does not exceed four crore rupees, or such higher amount as may be prescribed which shall not be more than ten crore rupees; and
• turnover of which as per profit and loss account for the immediately preceding financial year does not exceed forty crore rupees or such higher amount as may be prescribed which shall not be more than one hundred crore rupees.

Provided that nothing in this clause shall apply to-

i. a holding company or a subsidiary company;

ii. a company registered under section 8; or

iii. a company or body corporate governed by any special Act;

Impact of the above amendments:

Now all Private Companies that are not small Companies or all Private Companies that are Holding or Subsidiary Companies will be required to obtain the International Security Identification Number (ISIN) for each type of security and shall inform all its existing security holders about such facility. Further, the said Private Companies cannot raise money by way of issuance of Securities, or the Securities of such Companies cannot be transferred unless the same is in Dematerialized Form. Further, all such Private Companies will have to file Form PAS-6 on half yearly basis.

What is the procedure for obtaining Demat connectivity by the company?

• Hold a Board meeting to consider and approve the proposal for obtaining DEMAT connectivity for securities with the depositories.
• Appoint a Registrar and Transfer Agent (RTA).
• After the appointment of RTA, the company shall file an application along with relevant documents with the depository for obtaining DEMAT connectivity.
• The company, depository, and RTA shall enter into a Tripartite agreement in respect of securities that are to be declared as eligible to be held in dematerialized form.
• After verification of the application and other documents, the depository will provide the DEMAT connectivity to the company and allocate ISIN to the securities of the company.
• Then, the shareholders of the company may approach the RTA for the dematerialization of their securities.

Conclusion:

The introduction of Rule 9B in the Companies (Prospectus and Allotment of Securities) Rules, 2014 marks a significant shift in the way private companies handle their securities. The requirement to dematerialize securities brings greater transparency and protection for investors. It’s important for private companies to understand the implications of this rule and ensure they are in compliance. Moreover, the procedure for obtaining demat connectivity should be followed diligently to navigate this transition successfully. In summary, these rules aim to modernize and secure the issuance and management of securities in private companies, ushering in a new era of financial accountability and transparency in the corporate sector.

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Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement