New norms for unlisted public companies shares: Insisting for demat form is a big jolt for benami crooks, but implementation is key

A new rule has been notified by the Ministry of Corporate Affairs for all unlisted public companies. They can now issue new shares/securities or allow their transfer after 2 October 2018 only in demat form. In other words, issue or transfer of shares in the traditional paper form will not be allowed.

Further, even in respect of existing shares, all such companies are required to facilitate their demat/digitisation. If any new issue or buyback of securities is to be made, existing holding of securities of the promoters, directors and key management personnel will have to be converted into demat form. Any security holder who desires to subscribe to further securities in such a company will have to first ensure that his existing holdings are also dematerialised.

The benefits are many. But as seen later herein, the primary objective seems to be tackling benami holdings. This can be seen as a part of several concerted steps and changes in laws. However, first, let us review the background and the broad details of the new requirements.

Representational image. Reuters.

Representational image. Reuters.

The new rules require all such companies to also register with a depository and provide facility to all existing security holders to dematerialise their securities. This will affect unlisted public companies whose number is reported to be 60,000-75,000.

Public companies are not necessarily large in size. They may have been formed as such for various reasons. The new requirements, however, do not make any distinction between large and small companies or companies with large or small share capital.

Listed companies already have significant requirements mandating demat of shares for promoters and now for public shareholders too. Now similar requirements have been extended to the next level – viz., unlisted public companies. It is possible that in the near future, even private companies may be so required.

Holding shares in physical form has been the traditional method since the inception of company law. Paper certificates used to be made in elaborate creative fonts and forms and thus had become an art form of sorts. However, they faced difficulty. Paper certificates can be lost or damaged or even destroyed. This requires an expensive and prolonged procedure to get duplicate ones. This process often resulted in litigation.

Frauds were also possible through forged signature and other devious tricks. Transfer of shares in paper form also involved significant delay.

In demat form, the shares are bits of data. Transfer would be fast and even instantaneous. Generally, there is no worry that the shares would be destroyed or damaged.

The new rules also require companies to submit a half-yearly audit report with regard to compliance of certain requirements relating to dematerialisation.

While these are obviously valuable benefits, the core objective seems to be to detect and control benami shareholding and thus generally bring shareholding subject to regulatory requirements of tax, money laundering, anti-corruption, etc.

If the shares are in demat form, their records are with the demat agency, that is an independent third party. There is a clear trail for each holding, transfer, etc. Shareholders holding shares in demat form would also be identifiable on account of KYC identification.

Thus, this new requirement can be seen in context of the broader scheme of action being taken by the government. Companies have already been subject to a recent requirement under the Companies Act that the ultimate beneficial owners be identified. There have been amendments to the Benami Transactions Prohibition Act too.

However, there are concerns. The first is the obviously short notice of less than three weeks to implement these provisions. This may not be enough for the new rules to even reach all the companies well in time. Even otherwise, the registration procedure can be time consuming.

Secondly, registration with demat agency would result in additional costs. The shareholders too would have to open a demat account and this process may take some time too. The companies are required to maintain a security deposit of two years fees with the depository and the share transfer agent. However, there would be savings in stamp duty in case of transfer.

Strangely, the consequences of not complying or delayed compliance of these provisions are unclear.

Will the companies who do not comply with these requirements be subject only to a token fine? Will the new issue of shares or transfer of shares be held to be invalid? Will there be any prosecution, particularly if there was any fraudulent intent? Would such weak structure of the law may be the escape door for benami holders and thus defeating the objective?

All in all, this is a good requirement, even if cumbersome in the short-term. It will help achieve several objectives that are beneficial in the public interest. It will not be surprising if in the near future, even existing shares in such companies are mandatorily required to be converted into demat form. Further, the requirements may eventually be extended to private companies too, in one go or in phases.

(The author is a chartered accountant)


Updated Date: Sep 15, 2018 11:57 AM

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