Dematerialization of Securities by Private Companies

The Ministry of Corporate Affairs (MCA) has taken another significant step on 27th October 2023 by introducing new rules under the Companies (Prospectus & Allotment of Securities) Second Amendment Rules, 2023 making the dematerialization of shares mandatory for private companies except small companies.

Mandatory dematerialization of shares for private companies is a significant regulatory change. It is likely aimed at enhancing transparency, accountability, and efficiency in the private sector. By digitizing shareholding information, this move can streamline processes like share transfers, reduce the risk of fraud or manipulation, and make it easier to track ownership changes. This step aligns with the broader global trend towards digitalization in corporate governance, making it easier to monitor and regulate ownership structures.

Overall, it seems like a positive development for the corporate sector.

However, companies may need to adapt to comply with these new rules, including setting up necessary infrastructure and ensuring proper compliance with dematerialization procedures. It could be beneficial in the long run, fostering a more organized and transparent ecosystem for private companies. Initially the dematerialization of shares was made mandatory for public companies with effect from 2nd October 2018, and now it has been extended to private companies other than small companies.

The dematerialization of shares refers to the process of converting physical share certificates into electronic or digital form. In the traditional system, shares were represented by physical certificates, but with technological advancements, many countries have shifted towards a paperless system. The process typically involves opening a demat account with a depository participant (DP), submitting physical share certificates for dematerialization, and receiving electronic shares in your demat account linked to your unique identification number. Dematerialization has become the norm in many financial markets, promoting efficiency, security, and ease of transactions for shareholders and investors.

Some of the Key Highlights of this notification:

1. A private company, which as on 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 18 months of closure of such financial year, facilitate dematerialisation of all its securities.

2. Every private company other than small company making any offer for issue of any securities or buyback of securities or issue of bonus shares or rights offer, after the date when it is required to comply with this rule, shall ensure that

before making such offer, entire holding of securities of its promoters, directors, key managerial personnel has been dematerialised.

3. Every holder of securities of the private company other than small company, who intends to transfer such securities on or after the date when the company is required to comply with this rule, shall get such securities dematerialised before the transfer.

4. Every holder of securities of the private company other than small company, who subscribes to any securities of the concerned private company whether by way of private placement or bonus shares or rights offer on or after the date when the company is required to comply with this rule shall ensure that all his securities are held in dematerialised form before such subscription.

The deadline for private companies to transition all their securities into dematerialized form is September 30th, 2024. Companies will likely need to ensure they comply with this requirement before the deadline to avoid any regulatory repercussions.