lawyers in India

Dematerialized Securities

Written By: Trinath Tadakamalla
Cyber law in India
Legal Service
  • 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. Essentially, unlike the traditional method of possessing a share certificate to the effect of ownership of shares, in the demat system, the shares are held in a dematerialized form. 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.

    Under Section 68 B of the Companies Act, inserted by the Companies (Amendment) Act, 2000, it is mandated that every initial public offer made by a listed company in the excess of Rs 10 Crores has to be issued in dematerialized form by complying with the requisite provisions of the Depositories Act, 1996.

    Depository system

    A major weakness in the Indian stock market has been the lack of depository services on modern lines . Depositories provide for maintenance of ownership records in a book entry form. Before the Depositories Ordinance introduced the depositories system in India, every share transfer required to be accomplished by a physical movement of share certificates to, and the registration with the company concerned.

    The two models of the depository system are:
    1. Dematerialization, wherein, by operation, there is no physical scrip in existence as neither the individual who owns the shares nor the depository keeps scrips. The depository maintains the electronic ledger of the securities under his control.
    2. Immobilization, wherein the physical scrips are held in the depository vaults, supporting the book entry records kept on the

    Two types of ownership are contemplated under the depository system and can be briefly put forth as follows:
    1. A registered owner is the depository who holds the securities in his name.
    2. 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.

    Process of conversion of securities into the demat form

    Securities specified as being eligible for dematerialization by the depository in its bye laws and as under the SEBI (Depositories and Participants) Regulations, 1996 (the Regulations) can be converted or issued in a dematerialized form. The process of conversion of securities into a dematerialized form or the issuance of the same in a dematerialized form can be explained thus:

    1. Firstly, the issuer company, whose securities are eligible for dematerialization, has to enter into an agreement with a depository for dematerialization of securities already issued, or proposed to be issued to the public or existing shareholders .
    2. The investor is given an option to hold the securities in a dematerialized form and it is his prerogative to exercise the option to hold the securities in that manner.
    3. The depository enters into an agreement with the participants who are the agents of the depository and co-functionaries in the process of dematerialization of securities .
    4. Any person can then enter into an agreement, through the participant, with the depository for availing the services provided by the depository.
    5. Upon the entering into such agreement with the depository, the person has to surrender the certificate pertaining to the securities sought to be dematerialized to the issuer. This surrender is effected in the following manner:
    (i) The person (beneficial owner) who has entered into an agreement with the participant for dematerialization of the securities has to inform the participant about the details of the certificate of such securities.
    (ii) The beneficial owner has to then surrender the said certificate to the participant.
    (iii) The participant informs the depository about the particulars of the securities to be dematerialized and the agreement entered into between him and the beneficial owner.
    (iv) The participant then transfers the certificate pertaining to the said securities to the issuer along with the details and particulars of the securities.
    (v) These certificates are mutilated upon receipt by the issuer and substituted in the records against the name of the depository, who is the registered owner of the said securities. A certificate to this effect is sent to the depository and all stock exchanges where the security is listed.
    (vi) Subsequent to this, the depository enters the name of the person who has surrendered the certificate of security as the beneficial owner of the dematerialized securities.
    (vii) The depository also enters the name of the participant through whom the process has been carried out and sends an intimation of the same to the said participant.

    6. Once the aforesaid process of dematerialization is carried out, the depository has the responsibility to maintain all the records pertaining to the securities that have been dematerialized.

    Advantages of Dematerialization

    The advantages of dematerialization of securities can be summarized as follows:
    A. 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.

    B. It enables processing of share trading and transfers electronically without involving share certificates and transfer deeds, thus eliminating the paper work involved in scrip-based trading and share transfer system.

    C. Transfer of dematerialized securities is immediate and unlike in the case of physical transfer where the change of ownership has to be informed to the company in order to be registered as such, in case of transfer in dematerialized form, beneficial ownership will be transferred as soon as the shares are transferred from one account to another.

    D. The investor is also relieved of problems like bad delivery, fake certificates, shares under litigation, signature difference of
    transferor and the like.

    E. There is no need to fill a transfer form for transfer of shares and affix share transfer stamps.

    F. There is saving in time and cost on account of elimination of posting of certificates.

    G. The threat of loss of certificates or fraudulent interception of certificates in transit that causes anxiety to the investors, are eliminated.

    Disadvantages of Dematerialization

    The disadvantages of dematerialization of securities can be summarized as follows:
    A. Trading in securities may become uncontrolled in case of dematerialized securities.

    B. 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.

    C. Multiple regulatory frameworks have to be confirmed to, including the Depositories Act, Regulations and the various Bye Laws of various depositories. Additionally, agreements are entered at various levels in the process of dematerialization. These may cause anxiety to the investor desirous of simplicity in terms of transactions in dematerialized securities.

    However, the advantages of dematerialization 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 advanced market and dematerialization addresses such issues and is a step towards the advancement of the market.

    The author can be reached at: [email protected] / Print This Article

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