Introduction
A fractional share is any stock or other security that a shareholder holds in comparison to a full share. A fraction of a share of stock in a business is known as a fractional share. If the Company Law Committee’s proposal to permit fractional shareholding in India is adopted, an investor who wants to invest 500 rupees in a company where each share is worth 1000 rupees will be able to do so by purchasing 50% of the stock for 500 rupees rather than the complete share as necessitated under the present system. The owner of a fraction of a share will be regarded the same as any other owner of complete shares and will realize gains or losses from stock ownership at the same rate. Fractional shares are created by corporate actions such as stock splits, mergers and acquisitions and actions of brokerages selling highly priced stocks.
This essay aims to analyze the concept of fractional shareholding and to gain an understanding of the existing laws internationally while analyzing the feasibility of the same in India.
As per section 4(1)(e) of the Companies Act 2013 (CA-13), the amount of share capital with which the company is to be registered with, the division into shares of a fixed amount, and the volume of shares to which the subscribers to the memorandum consent to subscribe cannot be lower than a single share.
According to Table F-Schedule I of CA-13, the company is not obliged or required to recognize any equal, contingent, or partial interest in any share or any interest in any fractional part of a share, unless provided by statutory regulations or otherwise provided or any other rights concerning such shares. No individual may be acknowledged by the corporation as holding any shares if the conditions stated above remain unfulfilled.
The Company Law Committee (Committee) discussed the possibility of retaining and selling fractional shares in light of the market’s growing presence of retail investors. Retail investors might want to invest in specific blue-chip companies, but the excessively high cost of a single share might prevent them from possessing an entire share. Investors would be able to spend exact and predetermined budgeted amounts in businesses whose shares are otherwise inaccessible due to exorbitant prices if the holding and trading of fractional shares were permitted.
The Committee recommended an amendment to CA-13 to add provisions allowing the issue, possession, and transfer of fractional shares for a class or classes of companies that comply with any relevant laws. Only shares of such classes that have been dematerialized should be dispersed. Following consultations with the Securities Exchange Board of India (SEBI), such suggestions may be made for listed businesses. This suggestion does not apply to circumstances in which fractional shares are momentarily created as a result of corporate action and only pertains to situations in which the business would issue new fractional shares.
For the past few years, brokerages like Charles Schwab and Robinhood have begun trading in fractional shares, enabling investors to spend as little as one cent on popular stocks like Amazon and Google. Currently, Indian investors can purchase fractional shares on internet trading platforms to trade in the markets of the United States of America (USA).
- Purchase of Mutual Funds and ETFs– Fractional shares would enable small retail investors to allocate a set sum to stocks, mutual funds or exchange-traded funds (ETFs) of their choosing, allowing them to broaden their diversification without being restricted to a small number of stocks or shares. Retail investors would then be able to “shop” with virtually unlimited freedom in terms of available choices. Diversification helps investors lower the risks associated with particular stocks, which boosts their trust leading to the construction of a balanced portfolio.
- Dividend Reinvestment Function- If the issue of fractional shares is permitted in India, several brokerage firms may offer a dividend reinvestment function, which would allow investors’ wealth to compound over time leading to the reinvestment of dividends for the participants in the financial markets.
- Democratization of Trading- The issue of fractional shares would democratize stock trading as it would provide an opportunity for novice and small retail investors to experiment with their investment strategies and eventually earn a substantial return on their investments, which might not have been feasible without the safety net afforded to investors in the form of fractional shareholding.
- Dollar- Cost Averaging- The implementation of fractional shareholding would lead to increased dollar cost averaging. Dollar-cost averaging is postulated as the practice of systematic investment of equal amounts of money at regular intervals in a wide range of securities, notwithstanding the price of a security.
Allowing the investor to allocate modest sums of money periodically through dollar-cost averaging is a choice that enables the investor to incur a lower expenditure per share and mitigation of risk that may arise due to macroeconomic externalities. This investment strategy prohibits the investor from investing in a specific company at a price that may later turn out to be unfavourable. Investors in India would be suitably favoured by such a strategy.
An argument has been made against the feasibility of fractional shareholding in India by Zerodha- a popular stock brokerage which has been analyzed further.
Role of Broker in India vs USA- In the USA, the stockbroker can perform the functions of a dealer as well and is referred to as a broker-dealer. A broker performs the functions of an agent while a dealer behaves as a principal. A “broker” is defined in the US as any person engaged in the business of effecting transactions in securities for the accounts of other investors while a dealer refers to any person engaged in the business of buying and selling securities for his account, employing a brokerage or otherwise.
In India, brokers are merely agents who collect orders and transfer them to financial exchanges. After the execution of an order, the shares are held in the name of the clients in a dematerialized account with a depository like Central Depository Services (CDSL) and National Securities Depository Limited (NSDL).
The difference in types of companies- It has further been argued that there are a greater number of stocks in America with higher prices compared to India. In India, there are just 16 companies that have a market price greater than Rs. 10,000 compared to the USA where 300 companies have a market price greater than 10,000 rupees.
While the author cannot fault the technical analysis made, it is to be noted that the majority of retail investors would prefer to invest in blue-chip stocks to mitigate the risk. It is difficult for retail investors to dedicate the same amount of time and financial resources that institutional investors possess. Quantitative firms are employed by investment banks and hedge funds. The analysts in these firms design sophisticated mathematical models for identifying the optimal trading strategy for trading on the stock exchanges and models to mitigate risks which lie beyond the reach of the ordinary retail investor.
Limited Selection of Stocks– Brokerages providing options for fractional shareholding may have a specific set of stocks that are reserved for fractional shareholding which may not align with the set of stocks the investor desires to purchase.
Trade execution may not take place in real-time: If the brokerage fractional shareholding does not execute the trades in real-time, choosing to execute trades in larger volumes rather than on an individual basis, it may leave investors susceptible to market fluctuations.
Conclusion
In conclusion, the recommendations of the Committee are commendable and suitably timed, as India is witnessing an unprecedented rise in the participation of retail investors on the stock exchanges. In the year 2021, there were 1.42 crore first-time retail investors, with their contribution to the total stock exchange turnover rising to 45% from 39% previously.
India’s recent share of savings in financial instruments such as shares and debentures contrasted to its overall financial savings is roughly 4.8%–5.0%, which is insignificant compared to the USA (where such a share is 36.5%). This indicates India’s vast, unexplored potential for household participation in the financial markets, which could help sustain its financial sector. Numerous industry experts have stated that the present shift is not an ephemeral trend but a long-term phenomenon that, if harnessed appropriately, could open new avenues in the Indian stock exchanges. The current recommendations are in line with the stated notion.
However, before implementing any of the recommendations related to the issue of fractional shares, several operational challenges must be overcome. The main questions that need to be addressed are whether trading in fractional shares would require its stock market platform or if it would be possible to do so on the current ones. Second, particularly in the case of publicly traded companies, maintaining the register of members may present difficulties.
Therefore, the current recommendations would help India derive the maximum gains from the increased retail investor participation in the financial markets and would certainly be a positive development in its financial future.
The author argues that the concept of fractional shareholding cannot be applied in India presently until the issues around bonus shares and rights issues are sorted. The regulators will have to amend the laws to allow such actions and there will have to be changes made to the tax statutes. The author proposes the addition of a provision in Chapter IV to allow the issue, holding, and transfer of equity shares lower than one unit for specific classes of companies could be a feasible idea if the structural issues that could threaten the viability of fractional shareholding are solved.
The author concedes that fractional shares may be a useful financial instrument, but there is still a lack of knowledge regarding costs and unforeseen consequences. Since fractional shares are a nascent financial instrument, the most suitable method for the implementation is for regulators to hire specialists to research their subtler effects and then ensure brokers disclose all profits generated once the system has been established.
(This article has been authored by Ishita Ayala, a law student at National Law University, Odisha)
CITE AS: Ishita Ayala, “The Implementation of Fractional Shareholding in India” (The Contemporary Law Forum, 30 May 2023) <tclf.in/2023/05/30/the-implementation-of-fractional-shareholding-in-india/> date of access.