Professional Documents
Culture Documents
OVERVIEW
SUBMITTED
TO:
SUBMITTED BY:
Mr. Anurag Kumar Srivastava
Vivek
Sriram
Faculty Company Law I
Roll No.
260
Semester
V
S. No.
Title
Pg. No.
1
2
3
4
5
6
Dematerialization A Prelude
Depository System
Process of Dematerialization
Excess Dematerialization
Conclusion
Bibliography
3
7
10
11
16
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Dematerialization A Prelude
The traditional method of possessing shares involved holding a physical share certificate.
Dematerialized securities are securities that are not on paper and a certificate to that
effect does not exist. They exist in the form of entries in the book of depositories. This
system works through a depository who is registered with the Securities and Exchange
Board of India (SEBI) to perform the functions of a depository as regulated by SEBI.
The Companies Act, 1956 makes it mandatory for any Company making an Initial Public
Offer of Rs. 10 crore or more to issue shares in a dematerialized form alone.1
Thus, it is clear that Dematerialization refers to conversion of a share certificate from its
physical form to electronic form.
The Depositories Act, 1996 enacted by the Indian Parliament has now facilitated
paperless trading by way of dematerialisation of shares. Securities and Exchange Board
of India (SEBI) and the Government of India together have endeavored from time to time
to ensure that the concept of paperless trading is effectively implemented for the benefit
of the investors at large.
1
Share certificates were sometimes lost in transit. In that scenario, the investors
had to give an indemnity bond to the Company, which involved a cost to the
investor, besides depriving him of the opportunity to sell the shares at the
opportune time.
Time taken to receive the shares was also quite long compared to the present
dematerialized environment.
Secondary market operations were fraught with bad paper due to signature
differences, forged and fake certificates, stolen certificates and delayed transfer
resulting in low confidence in the market place.
Apart from the above problems which were faced by the Investors, there was another
problem which was identified from the Issuers perspective. In public issues, Companies
were / are incurring several costs in distributing the share certificates to the investors.
2
In case of investors purchasing the shares from the secondary market, there are certain
costs incurred by the companies. After the shares are transferred into the investors name,
the expenses on corporate benefits distribution will be same for all shareholders owning
the shares in physical form.
In the new system, the ownership of records is kept in electronic form and the physical
movement of securities is replaced by a book entry system. This system was seen as a
solution to the problems associated with the process of physical movement, such as, long
delays in transfer, bad deliveries due to faulty completion of paper work, signature
difference with the specimen on record with the listed companies and other procedural
lapses.
Advantages of Dematerialization
Thus, the advantages of dematerialization can be summed up as follows:
Share certificates, on dematerialization, are cancelled and the same will not be
sent back to the investor. The shares, represented by dematerialized share
certificates are fungible and, therefore, certificate numbers and distinctive
numbers are cancelled and become non-operative. The depository system and
dematerialized securities offer paperless trading and transfer of shares through the
use of technology.
The investor is also relieved of problems like bad delivery, fake certificates,
shares under litigation, signature difference of transferor and the like.
There is no need to fill a transfer form for transfer of shares and affix share
transfer stamps.
The biggest advantage that maintaining shares in a fungible format is the cost
effectiveness that it has provided to the Issuing Companies.
Disadvantages of Dematerialization
Though the advantages of Demat shares outweigh the disadvantages, there are a few
disadvantages which exist with respect to Demat shares which have to be looked into
with caution.
It is incumbent upon the capital market regulator to keep a close watch on the
trading in dematerialized securities and see to it that trading does not act as a
detriment to investors. The role of key market players in case of dematerialized
securities, such as stock-brokers, needs to be supervised as they have the
capability of manipulating the market.
Prior to the introduction of the De-mat form Companies had to incur the following costs
with regard to physical shares.
Variable expenses
Share Transfer
Apart from the risks entailed with holding and dealing with physical share certificates the
above costs were major burdens for the Organizations and they have been able to do
away with the same by switching to the Demat format.
Individual investor/Institutional investor was required to pay 0.5 percent of purchase
value of share as stamp duty under physical environment which has been totally removed
under demat conditions. Further, issues pertaining to bad paper like, signature difference,
fake or forged certificate, etc. besides delay in transfer, are eliminated and thus investor is
a direct beneficiary. The price risk faced by the investor has also been eliminated. As per
some unofficial estimates, the cost related to the bad paper was to the extent of about 20
per cent of the market value of shares. Currently this figure is estimated to be almost nil.3
Depository system
A Depository system facilitates holding of shares in an electronic form and enables
transaction of such shares by a Depository Participant (DP). The DP acts as the link
between the investor and the Depository. The DP is the representative of the investor and
the agent of the Depository.
Thus, a Depository is essentially an organisation like a Central Bank where the securities
of a shareholder are held in the electronic form at the request of the shareholder through
3
Supra note 2
Immobilization, wherein the physical scrips are held in the depository vaults,
supporting the book entry records kept on the computer.
Depository Participants
The Depository Participants are the link between the Shareholder, the Company and the
Depository. Banks, Financial Institutions, Custodians, Stock Brokers etc. can become
DPs subject to their meeting certain requirements prescribed by the Depositories and
SEBI. An investor can open his/her account with one or more DPs as he/she likes. The
procedure for opening an account with the Depository Participant is similar to opening a
Savings Bank Account with the Bank. After having opened the account, an investor can
hold shares of any number of companies in his/her account, provided all such companies
have entered the depository system.
In a Depository System, there is a possibility of 2 kinds of ownership. They are:6
Registered Owner: A registered owner is the depository who holds the securities in his
name.
National Securities Depository Ltd (NSDL) was the first Indian Depository; promoted by the Industrial
Development Bank of India, the Unit Trust of India and the National Stock Exchange to provide electronic
depository facilities for securities traded in the equity and the debt market
5
Central Depository Services India Ltd (CDSL) is the other Indian Depository; promoted by the Stock
Exchange, Mumbai in association with Bank of India, Bank of Baroda, State Bank of India and HDFC
Bank.
6
Trinath Tadakamalla, Dematerialized Securities,
http://www.legalserviceindia.com/articles/dematerialized_securities.htm, visited on 10 th October, 2006
Beneficial Owner: A beneficial owner is the person whose name is recorded as such with
the depository. Though the securities are registered in the name of the depository actually
holding them, the rights, benefits and liabilities in respect of the securities held by the
depository vest in the beneficial owner.
The depository model is based on the deposit of securities by the owner of the securities
with a certified depository. Subsequently, an entry is made in the name of the said owner,
manifesting his ownership of the securities upon which the person depositing the
securities becomes the beneficial owner in respect of the said securities. The service
provided in relation to this by the depository is that of recording of allotment of securities
or transfer of ownership of securities in the record of the depository.
Thus, the Depository System works very much like the banking system. A bank holds
funds in accounts whereas a Depository holds securities in accounts for its clients. A
Bank transfers funds between accounts whereas a Depository transfers securities between
accounts. In both systems, the transfer of funds or securities happens without the actual
handling of funds or securities. Both the Banks and the Depository are accountable for
the safe keeping of funds and securities respectively.
Charges Levied by the DP
Depository participants (DPs) impose various charges on the institutional as well as on
individual clients under various heads for providing services. The services available in
dematerialised environment that are extended to the clients are as follows:7
Dematerialisation
Rematerialisation
Custodial services
Hypothecation
Supra note 2
This is an illustrative list of services available. The system of charging a fee for the
services extended to an investor is in two-layers. The Depository charges the DPs and
DPs in turn collect fee/charges from the investor. Each DP uses different norms to
classify charges depending on the extent of services rendered. NSDL has a provision for
collecting a one-time fee of 0.05 percent of market capitalization of the company, as
custody fees for life. For these companies, no custody charge is supposed to be charged
from the investors for life.
Process of Dematerialization
Open Account with a DP: The process of opening an account with a Depository
Participant is similar to the opening of a bank account. First, the investor will have to
open an account with a Depository Participant (DP) of his/her choice by filling up an
Account Opening Form and signing a Participant-Client Agreement. The Investor will
be then given a unique client ID number, which must be quoted in all correspondence
with the DP.
Submission of DRF8: Thereafter, the investor will have to fill up and submit a
Dematerialisation Request Form (DRF) provided by the DP duly signed by all the holders
and surrender the physical shares intended to be dematted to the DP. The DP upon receipt
of the shares and the DRF, will issue the investor an acknowledgement and will send an
electronic request to the Company/ Registrars and Transfer Agents of the Company
through the Depository for confirmation of demat. The DP will simultaneously surrender
8
10
the DRF and the shares to the Company / Registrars and Transfer Agents of the Company
with a covering letter requesting the Company to confirm demat. The Registrars and
Transfer Agents of the Company, after necessary verification of the documents received
from the DP, will cancel the physical shares and confirm demat to the Depository. This
confirmation will be passed on by the Depository to the DP which holds the investors
account. After receiving this confirmation from the Depository, the DP will credit the
investors account with the number of shares dematerialized. The DP will hold the shares
in the dematerialized form thereafter on behalf of the investor. The Investor then becomes
the beneficial owner of these dematerialized shares.
Defacing Share Certificate: When the shares are submitted for dematerialisation, the DP
will
deface
the
share
certificates
with
the
stamp
SURRENDERED
FOR
DEMATERIALISATION. This ensures that the shares are not lost in transit or misused
till credit is received by the investor in his/her demat account.
Excess Dematerialization
In terms of section 9 (1) of the Depositories Act, 1996, all securities held by a depository
shall be dematerialised and shall be in a fungible form. In the past, SEBI had come across
some cases where the listed companies had dematted more securities than their
listed/issued capital. As the securities in the dematerialized environment are fungible,
once these fungible securities enter the market, it has been found to be almost impossible
to distinguish these securities from the other securities. This has enabled duplicate or fake
securities to find way into the system. This is a matter of concern for the regulator and
therefore, has been engaging the attention of SEBI9 for quite some time.
The SEBI has identified two types of excess securities in the system:
V.S. Sundaresan, Discussion paper on measures to check excess dematerialisation of securities and prelisting grey market in securities issued in initial public offers (ipos) proposed amendments to the sebi
(depositories and participants) regulations 1996, http://www.sebi.gov.in/commreport/discussion.pdf,
visited on 14th October, 2006
11
Excess of Issued Capital: The other kind of excess securities is where the
securities in existence (physical and demat) are in excess of issued capital of a
listed company. This would imply that duplicate securities are in existence.
Measures Taken by SEBI to address the aforesaid problems
12
continue to obtain in-principle approval from all the exchanges where it is listed as was
provided in the aforesaid circular dated March 8, 2001.10
Further, in September 2003 vide Regulation 54(5) of the SEBI (D&P)(second
Amendment) Regulations, 2003, it was provided that within 15 days of receipt of the
certificate of security from the participant, the issuer shall confirm to the depository that
securities comprised in the said certificate have been listed on the stock exchange or
exchanges where the earlier issued listed securities are listed and shall also after due
verification immediately mutilate and cancel the certificate and substitute in its record the
name of the depository as the registered owner and shall send a certificate to this effect to
the depository and to every stock exchange where the security is listed. These efforts
have resulted in considerable reduction in the number of cases where the dematerialized
capital was in excess of the listed capital of a listed company. However, a blanket ban on
dematerialization of any unlisted securities of a listed company was not feasible in view
of the provisions of section 8 of the Depositories Act, 1996, in terms of which the
investor has the option to receive security certificate or hold securities with depository in
a dematerialised form.
Excess of Issued Capital: In order to address the problem arising out of
dematerialisation of securities in excess of issued capital of a listed company, SEBI
issued a circular dated December 31, 2002, mandating all companies to subject
themselves to secretarial audit on a quarterly basis. With the objective of strengthening
the regulatory framework to address the aforesaid problem, SEBI brought in changes in
the manner of handling share registry work by inserting regulation 53A in SEBI (D&P)
Regulations, 1996 with effect from September 2, 2003. This regulation provides that 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. Further, with the insertion of Regulation 55A
in SEBI (D&P) Regulations, 1996, on September 2, 2003, the requirement of submission
10
Supra note 8
13
of secretarial audit by listed companies to stock exchanges, with effect from September
30, 2003, has been made a regulatory requirement. A circular was also issued on March 3,
2004 re-emphasizing the need to comply with the provisions of Regulation 55A.
Proposed Measures by the SEBI11
Despite the various measures initiated by SEBI as enumerated above, the problems
arising out of excess demat have not been completely resolved. Therefore, it is felt that
certain further preventive steps would be necessary, in the interest of securities market, to
tackle this issue. While the measures taken in the past include casting a responsibility on
the listed company and the stock exchanges, the issue now needs a fresh look from the
point of systemic issues with the depositories. One of the preventive steps could be to put
certain responsibilities on the depositories to ensure that the securities are not dematted in
excess of listed/issued capital.
Section 23F of the Securities Contracts (Regulation) Act, 1956 as inserted
by Securities Laws (Amendment) Act, 2004 provides for the following:
Penalty for excess dematerialisation or delivery of unlisted securities
23F. If any person dematerialises securities more than the issued securities of a
company or delivers in the stock exchanges the securities which are not listed in
the recognised stock exchange or delivers securities where no trading permission
has been given by the recognized stock exchange, he shall be liable to a penalty
not exceeding twenty-five crore rupees.
The aforesaid section deals with two distinct things, and provides for
imposition of deterrent penalty of upto Rs.25 crores.:
i. dematerialization in excess of issued capital; and,
ii. Delivering unlisted securities or securities for which no trading
permission has been given in the stock exchanges.
11
Supra note 8
14
15
rupees for each day during which such failure continues or one crore rupees,
whichever is less.
In terms of the aforesaid provision, the primary responsibility for correct reconciliation of
total issued securities with those dematerialized is on the depository. In the absence of
further clarification, there would be indiscriminate liability to penalty under this section
on all concerned, while there would be no system whereby the other players would be
able to ensure proper reconciliation. In such a case, levy of penalty on any innocent
person other tha n the depository may not be justified. There is a need for correctly
identifying the respective responsibilities of the depository, depository participant, issuer,
share transfer agent and the investor in the dematerialization process and casting an
obligation on the depository to develop the systems. This would require suitable
amendments to SEBI (D&P) Regulations, 1996. Once the system is established by the
depository, each of the other persons will be responsible to fulfill his part of the duty
properly and will be liable for any lapse in his sphere of duty.
Conclusion
Dematerialization has almost been made a compulsion by enacting the Depositories Act,
1996 and various Rules and Regulations as provided by the SEBI from time to time.
Though, possessing physical shares is still allowed, it had becomes mandatory for shares
to be dematerialized for the purpose of trading. Further, most brokers prefer their
investors to deal in Demat shares considering the cost efficiency, relatively lower risk and
lesser time taken with these shares. Demat shares have helped do away with the
disadvantages faced by all with physical shares like theft, tearing, etc
The advantages of dematerialization seem to outweigh its disadvantages and the changes
ushered in by SEBI and the Central Government in terms of compulsory
dematerialization of securities are important for developing the securities market to a
degree of advancement. Freely traded securities are an essential component of such an
16
advanced market and dematerialization addresses such issues and is a step towards the
advancement of the market.
With the introduction of DPs, investors do not have to travel long distances to their
brokers to provide them the share certidicates and information for the purposes of trading.
Coupled with the fact that now it takes a much lesser time for the transaction to take
place, Demat becomes a definite necessity.
Caution and due diligence are the two key words in the stock market today and
dematerialization of shares is a step forward towards establishing a relatively investor
friendly market. The advantages of dematerialization have been enumerated in the above
chapters. It is noticed that Dematerialization is a much faster and efficient method of
trading in shares. It is pertinent to note that it is not only an investor friendly system, the
issuing company is also benefited in certain ways like reduction of costs by dealing in
dematerialized securities. Further, apart from establishing a relatively safer trading
system with respect to the dematted securities, the SEBI is constantly regulating the
working of the Depository system and looking to establish a full proof system with
respect to trading in the Stock Exchange in the electronic environment.
Thus, Dematerialization of shares is definitely a positive move, a step which is still being
contemplated in countries like the UK, Hungary, Australia etc.. 12 with the spurt in
technological advancement India is witnessing today it becomes necessary for us to use
the electronic securities system to trade in a full proof system.
12
The Dematerialization of Shares and Share Transfers, www.icsa.org.uk/demat/pdf/Condoc-processFinalDraft1.pdf, visited on 13th October, 2006
17
BIBLIOGRAPHY
[DISCUSSION PAPERS - SEBI]
18
The
Dematerialization
of
Shares
and
Share
www.icsa.org.uk/demat/pdf/Condoc-process-FinalDraft1.pdf,
visited
Transfers,
on
13th
October, 2006
[STATUTES]
19