Companies Act Section 40

Companies Act Section 40: Securities to be Dealt with in Stock Exchanges

1. Application for Stock Exchange Listing

One of the primary conditions outlined in Section 40 of the Companies Act is that any company intending to make a public offer must first ensure that its securities are listed on a recognized stock exchange. 

This provision serves as a crucial regulatory measure to maintain transparency, promote investor protection, and provide a secure and organized marketplace for securities trading.

Stock Exchange Approval Process:

Mandatory Application: 

Before making any public offer of securities, a company is required to apply to one or more recognized stock exchanges to obtain permission for its securities to be traded on those exchanges. 

This means that companies cannot offer their securities to the public unless they have taken steps to secure a listing on a formal and regulated stock exchange.    

Purpose of the Requirement: 

The purpose of requiring stock exchange approval is to ensure that the company's securities are traded in an environment that is subject to regulatory oversight. 

This safeguards investors by providing them with access to a fair and organized marketplace where they can trade securities with transparency and confidence.

2. Disclosure in Prospectus

The prospectus is a key document in any public securities offering, providing potential investors with vital information about the company and the securities being offered. 

Under Section 40, specific disclosures related to stock exchange applications must be included in the prospectus to ensure clarity and transparency for investors.

Stock Exchange Details in the Prospectus: 

If the company has applied to one or more stock exchanges for permission to list its securities, this information must be clearly disclosed in the prospectus. 

This includes naming the stock exchange(s) where the securities will be dealt with. 

Purpose of the Disclosure: 

This requirement ensures that investors are fully informed about where the company’s securities will be traded and have the ability to verify that the company has applied for stock exchange approval. 

It also enhances investor confidence by signaling that the securities will be available for trading in a regulated environment.

3. Handling of Monies Received

The law also establishes strict rules regarding the handling of funds received from investors during a public offering. 

This is designed to protect investors’ money and ensure it is only used for specific, authorized purposes.

Separate Bank Account Requirement: 

All money received from the public for subscription to the company’s securities must be held in a separate bank account. 

This account must be maintained with a scheduled bank, which is a bank listed under the Reserve Bank of India Act, ensuring a level of financial stability and oversight.

Authorized Use of Funds: 

The funds in this separate bank account can only be used for two specific purposes:

1. Adjustment Against Allotment: 

The funds may be adjusted against the allotment of securities, provided that the company has obtained permission to list its securities on the stock exchange(s) mentioned in the prospectus. 

This means the company can use the subscription money to issue securities to investors only after the stock exchange has approved the listing.

2. Refund to Applicants: 

If the company is unable to allot the securities, whether due to stock exchange rejection or any other reason, it must return the subscription money to the applicants within the timeframe specified by the Securities and Exchange Board of India (SEBI). 

This protects investors from financial losses if the offering cannot proceed.

Investor Protection: 

This provision ensures that investors’ funds are protected and cannot be misused. 

The strict rules regarding the use of funds reflect the importance of maintaining trust between companies and the investing public during public securities offerings.

4. Invalid Conditions

The law goes further to ensure that investors are not coerced or misled into waiving their rights under this section. 

Prohibition of Waivers: 

Any condition in the application for subscription that seeks to waive an applicant’s compliance with the requirements of this section is automatically considered void. 

This means that no investor can be asked or compelled to give up their rights regarding the proper handling of subscription money or the stock exchange listing process.

Investor Safeguards: 

This provision adds another layer of protection for investors, ensuring that they cannot be tricked into accepting conditions that would undermine their legal rights or financial security.

5. Penalties for Non-Compliance

The Companies Act imposes significant penalties on companies that fail to comply with the provisions of Section 40. 

This is designed to enforce accountability and ensure that companies follow the prescribed rules when dealing with public money and stock exchange listings.

Fines for the Company: 

If a company violates any part of Section 40, it is liable to pay a fine ranging from a minimum of five lakh rupees to a maximum of fifty lakh rupees. 

This hefty penalty reflects the seriousness of the offense and serves as a deterrent against non-compliance.

Fines for Officers in Default: 

In addition to penalizing the company itself, the law also holds responsible officers of the company accountable. 

Any officer found to be in default of the section’s requirements can face fines of between fifty thousand rupees and three lakh rupees. 

This ensures that both the company and its management are incentivized to comply with the law.

Ensuring Accountability: 

These penalties are designed to promote diligence and compliance at both the corporate and individual levels, reinforcing the importance of following the legal processes laid out in the Companies Act.

6. Commission Payment

Finally, the law allows companies to pay commissions to individuals who help facilitate the subscription to its securities, subject to certain conditions. 

This recognizes that companies may need to incentivize intermediaries to assist with the process of attracting investors, but ensures that such payments are regulated to prevent abuse.

Conditions for Commission Payment: 

The payment of commissions is allowed only if it adheres to the prescribed conditions, which may include limits on the amount that can be paid and the circumstances under which such commissions can be offered. 

These conditions are established to maintain fairness and transparency in the securities subscription process.

Controlled Use of Commissions: 

The use of commissions is regulated to ensure that they are not used in a way that could mislead investors or unfairly influence the securities market. 

By setting these conditions, the law balances the need for companies to attract investors with the need to maintain ethical standards in the public offering process.