Mandatory Issue And Conversion Of Securities In Dematerialised Form By Private Companies

Background

The Ministry of Corporate Affairs ("MCA") is empowered under section 29(1A) of the Companies Act, 2013 (the "Act") to prescribe such classes of companies which can hold or transfer the securities only in dematerialized form. Pursuant to such power, MCA, vide notification dated October 27, 2023 ("Amendment") inserted Rule 9B in the Companies (Prospectus and Allotment of Securities) Rules, 2014 ("PAS Rules"), mandating private companies to hold and issue securities only in demat form.

Salient features of the Amendment

1. The Amendment is applicable to a Private Company as defined under the Act except for: (a) small company, i.e., a private company with a paid-up share capital of INR 4 crores or below, and turnover of INR 40 crores or below; and (b) government company. In this context, it is relevant to note that there is no exemption for companies incorporated under section 8 of the Act.
2. 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. Accordingly, the compliance date for every private company (other than a small company) as on 31 March 2023 would be 30 September 2024 ("Demat Last Date").
3. With effect from the respective compliance date for a private company, the private company will be required to (a) issue 'securities' only in dematerialized form; and (b) facilitate dematerialization of all its securities.
4. Further, every private company while making any offer for issue of any securities or buyback of securities or issue of bonus shares or rights offer, shall ensure that before such offer is made, the securities of the private company held by its promoters, directors, key managerial personnel have been dematerialized. Accordingly, as a prerequisite to a private company proposing to invite new investments, the securities of the promoter, director and key managerial personnel of such private company will have to be dematerialized.
5. In the event any person holding any securities in a private company intends to transfer them, such person will have to dematerialize such securities before undertaking the transaction. This would require the buyer to also receive the securities in dematerialized form.

Parties involved in an issue of shares in dematerialized form

1. Issuer: Issuer means the entity that seeks to issue and list its shares on the stock market.
2. Registrar and Transfer Agent (RTA): An RTA is an agent of the issuer. RTA acts as an intermediary between the Issuer and the Depository for providing services such as dematerialization, rematerialization, initial public offers (IPO) and corporate actions.
3. Depository: A Depository is an organization which holds securities (like shares, debentures, bonds, government securities, mutual fund units etc.) of investors in electronic form at the request of the investors through a registered depository participant. It also provides services related to transactions in securities. NSDL and CDSL are the only registered depositories in India.
4. Depository Participant (DP): A DP is an agent of the depository through which it interfaces with the investor and provides depository services. Examples include Zerodha, ICICI Securities, Groww etc.

Process of issue/conversion of shares in dematerialized form

1. Appointment of Registrar & Transfer Agent (RTA): The role of RTA is to act as an intermediary between the Issuer and the Depository for facilitating dematerialization and corporate actions undertaken by the Issuer. It verifies the request received for dematerialization from the depository participant and forwards it to the Issuer. However, it is not mandatory under the Act to appoint RTA if the company has an in-house arrangement. Accordingly, where an RTA is not appointed, the Issuer will be required to perform the said activities itself to enable dematerialization of securities held by the investors.
2. Registration with a Depository: Thereafter, the Issuer must register with either NSDL or CDSL. The Issuer must adhere to the depositories' registration requirements, which differ from their own. The companies intending to issue or provide the securities in demat mode may register themselves on the NSDL/CDSL portal, fill the necessary form along with necessary documents, verify the same and submit the physical copies of these documents. The companies may refer to the detailed process provided on CDSL & NSDL wesite.
3. Issuance of ISIN: Following registration with a Depository, the depositories assign an individual ISIN to every security. A 12-digit identifier called an ISIN is used to identify various securities, including shares, bonds, etc.

Compliances

The private companies are required to ensure compliances applicable to unlisted public company under sub-rule (4) to (10) of Rule 9A of PAS Rules which are summarised as under:

1. Rule 9A (4): Facilitation of dematerialization of all its existing securities by making necessary application to a depository and secure International Security Identification Number (ISIN) for each type of securities. Inform all its existing security holders about such facility.
2. Rule 9A (5): Ensure timely payment of fees (admission as well as annual) to the Depository and RTA in accordance with the agreement executed between the parties. Maintain a security deposit of not less than two years fees with the Depository and RTA at all times. Comply with the regulations or directions or guidelines or circulars, if any, issued by SEBI or Depository from time to time with respect to dematerialization of shares and matters incidental or related thereto.
3. Rule 9A (6): Prohibition on making any offer or buyback or issue of any bonus or right shares until the payments under Rule 9A (5) are made to Depositories or RTA.
4. Rule 9A (7): Comply with the applicable provisions of Depositories Act, 1996; SEBI (Depositories and Participants) Regulations, 2018 and SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993.
5. Rule 9A (8): Filing e-Form PAS-6 to the ROC within sixty days from the conclusion of each half year duly certified by a company secretary in practice or chartered accountant in practice.
6. Rule 9A (8A): Immediately bring to the notice of the Depositories any difference observed in its issued capital and the capital held in dematerialized form.
7. Rule 9A (9) & (10): The grievances, if any, of the security holders will be filed before the Investor Education and Protection Fund Authority (IEPFA). IEPFA will initiate any action against a depository or participant or RTA/STA after prior consultation with the SEBI.

Relevant provisions of Depositories Act, 1996 applicable to the Issuer of securities

1. Section 8: Where an investor opts to hold shares with a depository, the issuer shall intimate such depository the details of allotment of the security.
2. Section 13: Every Issuer shall make available to the depository copies of the relevant records in respect of securities held by such depository.
3. Section 18: The Issuer shall furnish such data information relating to the securities held in a depository to the Securities and Exchange Board of India ("Board") as the Board may require from time to time.
4. Section 19: The Issuer shall comply with the directions as may be issued by the Board from time to time.

Relevant provisions of SEBI (Depositories and Participants) Regulations, 2018

1. Regulation 43 read with Regulation 70: An Issuer exercising an option to hold his securities with a depository in dematerialized form shall enter into an agreement with the depository to enable the investor to dematerialize the securities.
2. Regulation 71: All matters relating to transfer of securities, maintenance of records of holders of securities, handling of physical securities and establishing connectivity with the depositories shall be handled and maintained at a single point i.e. either in-house by the Issuer or by a Share Transfer Agent registered with the Board.

The list of documents and process for appointing NSDL as a depository is provided here and here. The fees and charges applicable on the Issuer for appointing NSDL as a depository is provided here.

The List of documents and process for appointing CDSL as depository is provided here and here The fees and charges applicable on Issuer for appointing CDSL as a depository is provided here.

Penalty

There is no penalty/ fine prescribed under Rule 9B. Therefore, penalty / fine shall be as per Section 450 of the Act, i.e. the company/issuer and every office of the company who is in default or such other person shall be punishable with fine which may extend to ten thousand rupees, and where the contravention is continuing one, with a further fine which may extend to one thousand rupees for every day after the first during which the contravention continues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.