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Should Section 4(1)(E)(I) Of The Companies Act Of 2013 Be Repealed To Permit The Issue Of Fractional Shares?

This blog provides an outline of what a fractional share is ,the legal obstacles in the path of implementing it ,whether it is boon if implemented in India ;plus this blog also covers the benefits and drawbacks of issuing fractional shares. Lastly this blog gives an opinion on whether section 4 of the companies act,2013 should be repealed or not.

During the Covid-19 outbreak, the Indian Stock Exchange saw a tremendous increase in the number of retail investors, with millennials and Gen-Z showing exceptional engagement. Retail shareholding in Indian companies reached a" 15-year high in June 2022," according to the National Stock Exchange.

This is very welcome news for our country's economy. Nonetheless, there is still a long way to go in terms of retail investor engagement in India. The Indian capital markets' legal and regulatory structure discourages investors from engaging in the market. For example, the Companies Act, 2013 that prohibits investors from purchasing or holding fractional shares. According to the Section 4(1)(e)(i) of the Companies Act 2013, selling, trading and investing in Fractional shares is not allowed.

This section explicitly mentions that:
"The number of shares which the subscribers to the MoA agree to subscribe should not be less than one share". Moreover even the holding of fractional shares is not allowed and is mentioned in Table F under schedule I of the Act.

With the potential to lower entry barriers for ordinary investors, the Company Law Committee has recommended an amendment to the Indian Companies Act, 2013, to make fractional share investment a reality in the nation.

What Is Meant By Fractional Shares?

As the name suggests fractional share is a portion, slice or a part of one single share, basically it is called as a partial share of a company's stock. Fractional share allows an investor to purchase a unit of stock rather than a whole unit. The purchase of such a stock is possible by buying them via fractional share programs , brokerage or a marketplace that provides this service.

With this platform, an individual share of stock can be divided into a larger number of smaller units, and those fractional shares can subsequently be acquired by investors. Suppose that a share of a particular firm is now selling for Rs. 70,000.Under the traditional investment model, the investor had to purchase the entire share of Rs.70,000 But, with fractional share investing, the investor can acquire a portion of the share, such as 1/2thth or 1/10th of the share, at a price equal to that fraction. This may allow anyone with as little as Rs. 200 or Rs. 300 to invest in the stock market.

How Are Fractional Shares Created?

When a complete share of stock is broken into smaller pieces, fractional shares are generated.

This can occur in a variety of ways:
  1. Stock splits:
    When a corporation splits its stock, it provides present shareholders extra shares. For example, in a 2-for-1 stock split, you will receive one more share for each share you already possess. It is possible to wind up with less than a complete share, which is known as a fractional share.
  2. Dividend reinvestment plans (DRIPs):
    DRIPs are plans that some businesses provide to their shareholders. Instead of receiving cash dividends, shareholders can use the money to automatically purchase more shares in the company under these plans. If the dividend payment is insufficient to acquire a complete share, the remainder will be utilised to purchase a fraction of a share.
  3. Brokers and trading platforms for stocks:
    Several brokers and trading platforms allow customers to purchase and sell sections of a share rather than the entire item. This is referred to as share slicing or fractioning. That implies you may invest any amount of money and still own a portion of a share.

Why Should Fractional Shares Be Implemented In India In Comparision To USA?

Fractional share investing has grown in popularity, particularly among beginning investors who may not have the cash to acquire complete shares of pricey firms. The legislation, norms, and reality of fractional share investment, on the other hand, might differ by country and location. Because the notion of fractional shares originated in the United States, it is vital to study the United States in this perspective.

Most importantly the suggestions given by CLC in its report is based on the stock market of US .This ignores significant disparities between the two countries. Let us now look at how Indian stockbrokers differ from their American counterparts. Mutual funds and exchange-traded funds (ETFs) are the greatest approach for regular investors in India to gain diversified exposure to stocks. You may argue that fractional investing allows younger and newer investors to sample the markets with lesser quantities.

In India, there are around more than 10 firms with a market value more than Rs. 10,000 and approximately 500+ enterprises with a market value greater than Rs. 1000. While the demand may be smaller than that of the US in absolute terms, with the US having a per capita income of $52,000 and India having a per capita income of $2,000, the requirement of having such an ecosystem in place may surface sooner rather than later.

The average income of Indian households is lower than that of the United States, the necessity for permitting fractional shares arises. On the other hand, fractional investing is not feasible since Indian brokers can only act as middlemen for their customers and not as principals. Brokers in India are just middlemen who take orders and pass them to exchanges. Upon the completion of an order, the shares are kept in the clients' names in a demat account with a depository . If fractional investing is to become a viable option in India, significant regulatory adjustments are necessary.

If we also consider the fact that the United States uses an unconventional approach to dealing in fractional shares. The Securities and Exchange Commission (SEC) of the United States has concluded that fractional share transactions are treated the same as full share purchases under securities laws and regulations. This means that fractional shares are subject to the same regulations and laws as full shares, including insider trading restrictions and transparency obligations.

At the moment, the only way to create fractional shares in India is through business acts such as stock splits, mergers, and acquisitions. Because India does not consider fractional share investments to be full share purchases, various policies are required to manage possible risks and safeguard investors. Certain risks can be created such as liquidity risk, valuation , price impact because of this unique market structure for investors.

The CLC conclusions ignored these critical distinctions between the Indian and American stock markets. As a result, their proposal that fractional shares be issued in India in accordance with American procedures may not be totally appropriate or acceptable. It is critical to underline the significance of this divergence in order to ensure that any advice or actions are customised to the unique setting of the Indian stock market.

Benefits Of Fractional Shares

  1. Building a balanced and diversified portfolio:
    Fractional shares would allow small retail investors to dedicate a fixed amount of money to the companies or exchange traded funds (ETFs) of their choice, rather than being compelled to limit the breadth of diversification by investing in only a few stocks. Individual investors would be able to go stop shopping with nearly endless options to choose from. Diversification assists investors in reducing the risks connected with certain securities, hence increasing their faith in them.
  2. Dividend reinvestment:
    If the concept of fractional shares is implemented in India, certain brokerage firms may provide dividend reinvestment, allowing investors' wealth to compound over time.
  3. Lowers the entrance barrier:
    The notion of fractional shares allows new and small investors to dabble in the stock market and gain considerable returns on investments that would otherwise be impossible.
  4. Dollar-cost averaging options:
    Dollar-cost averaging entails investing the same amount of money on a regular basis, regardless of whether the share price is high or low. This allows you to buy more shares when prices are low and fewer shares when prices are high. It assists you in reducing the dangers associated with unpredictability in the market. This is an excellent way to have your money increase slowly over time. This approach may also be used to invest money in India.

Drawbacks Of Fractional Shares

  1. Shareholder voting rights:
    While we lack empirical evidence to judge the implications of shareholder voting rights in the case of fractional shares in the Indian context, the procedure of trading in fractional shares in the United States vests brokerage firms with the overarching authority in deciding how fractional share holders' voting rights would be practised, such as in the case of Stash voting as to the affidavit. As a result, by putting more power in the hands of brokers rather than average investors, the ultimate purpose would be undermined.
  2. Stock selection:
    Even in areas where fractional shares are extensively utilised, many of the businesses listed there do not have fractional shares accessible. As a result, if a similar concept is implemented in India to increase retail investment, the very purpose of diversified investing will be undermined to some extent in relation to companies that may not opt for providing tradable fractional shares, in which case investors will have to rely on the traditional approach. Shareholders have the following voting rights: Although we lack factual facts to make a decision.
  3. Liquidity:
    Another possible disadvantage of fractional shares is that they may be more difficult to liquidate than other types of shares. This might be because trade in fractional shares is likely to be much lower than trading in conventional shares. However, it has been noticed that brokers in the United States may not process orders or work at a slower rate of completing orders if they choose to wait for a particular amount of fractional shares to accrue before executing a deal. The demand and supply of fractional shares is another parameter that may influence the rate of liquidity.
  4. Transfers:
    Depending on the operating regulations of the brokers in the United States, investors may encounter difficulties transferring shares to other brokers if the existing players do not permit it. Additionally, the entire process of disposing fractional shares may result in tax consequences that were not planned in the first place. It remains to be seen how the Government will apply the entire legislation concerning fractional shares; nonetheless, the constraints encountered in the US can serve as a reference point for Indian retail investors.

It is now obvious that fractional shares provide an accessible and easy way for investors to own a piece of a stock without having to purchase the entire share, making them an appealing investment choice for retail investors. The existing regulatory climate in India, however, limits the issuing of fractional shares.

Though CLC's recommendation to amend the CA-13 to allow the issuance, holding, and transfer of fractional shares is encouraging, there is a flaw in this report in that it fails to acknowledge and distinguish the stock broker system of the United States from that of India and proceeds to make recommendations based on US law.

In India, fractional shares can only be formed by corporate acts; nevertheless, there are no explicit rules in place. As a result, while developing rules, Indian legislators should evaluate differences with the US and modify them to the Indian market. Clarification on the handling of fractional shares as a unique asset, for example, is critical to minimise investor and regulatory uncertainty.Additionally, India may take a different approach to proxy voting rights than the United States. The latter provides the brokerage business the option to authorise it or not, but India can make it mandatory by amending CA-13 Section 105

Investing in fractional shares is not yet a well-established practise in India, and the Indian government must develop more detailed guidelines before this can become a feasible choice for investors.

Award Winning Article Is Written By: Ms.Rishika Anand, 1 year B COM.LLB student from Institute of Law, Nirma University.
Awarded certificate of Excellence
Authentication No: AP311939734642-29-0423

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