Stocks, shares, and debentures made easy

Author’s Note

The words stocks, shares, and debentures are often confused and misunderstood. This blogpost focuses on the explanation of these terms.

You need to discuss these terms when you are thinking about having a company or a startup or becoming a co-founder.

Functioning knowledge of stocks, shares, and debentures is essential for everyone.

This blogpost is aimed at explaining stocks, shares, and debentures with examples while discussing laws related to them.

Table of Contents

1. An Introduction to Shares, Stocks, and Debentures
2. Difference between Stock and Shares
3. Understanding Shares from a legal viewpoint
4. Things about Shares that you must know
5. How can you own a share?
6. Criminal offenses by defaulters in the Capital Market
7. Debentures
8. Differences Between Shares and Debentures

An Introduction to Shares, Stocks, and Debentures

Almost every human activity requires money directly or indirectly. No one would say no to too much money, but a problem arises when a large portion of this money is in cash, as it would become difficult to handle and store. To solve this purpose, people started storing money in banks, but the returns were fixed and often not too high.

Stocks, shares, and debentures are securities in which a person can invest money and earn a high return on investment, albeit at a greater risk, which means that while a person may earn a lot, he may also stand to lose a lot of money.

Stocks shares and debentures are often used collectively but a more intricate study into its nature and the laws governing them would prove otherwise.

Difference between Stock and Shares

Stock and shares are interdependent terms, however, the difference between both can be explained with the help of an example of a vegetable salad. While serving a salad, you cannot put 1, 2, 3, 4 or such ‘salads’ in your plate, you can only put 1, 2, 3 or 4 pieces/slices of cucumber or tomato or onions on your plate. Stock symbolizes salad and shares symbolizes cucumber which means that a group of shares is known as stock.

You don’t buy individual stocks, but you buy individual shares, which collectively become a stock. Moreover, 100 shares refer to 100 shares in one company, but 100 stocks can refer to 1 share each in 100 companies.

While talking about ownership of shares in a company a person can say he owns 100 shares in the company, or collectively he owns stock in the company. ‘100 stock’ in the company is incorrect use of the terminology.

Stocks are an investment in a company and that company’s profit. Investors buy these stocks to earn a certain amount of return on their investments. They are an investment in the company which means that you share ownership of the company. However, it does not give you the right to exercise your votes in the company’s board meetings except you own a huge or larger amount of share in the company.

Fact: The two major platforms in India for stock exchange-listed as the world’s 10th and 11th largest stock exchange are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) respectively.

Understanding Shares from a legal viewpoint

According to Section 2 (84) of the Indian Companies Act, 2013, a ‘share’ means a share in the share capital of a company. Shares are units of ownership interest in a corporation or financial asset that provide for an equal distribution in any profits if any are declared, in the form of dividends.^[1] This means that if a person owns 50 out of 1000 shares in a company, he is a 5% owner of the company. The dividend rate is ascertained by the company based on the profits (if any). The dividend earned by that person is then calculated based on the rate of dividend declared by the company. For eg: If the rate of dividend is 5% and a person owns 50 shares worth Rs. 100 each, then his dividend will be 5% of 5000 (total value of shares) which equals to Rs. 250.

Section 43 of the Indian Companies Act, 2013 (hereinafter referred to as the “Companies Act”) denotes two kinds of share common shares, and preference shares, with the former being riskier than the latter, thus most companies issue common shares.

Common shares are riskier as the dividends earned by the holder is based on the profit earned by the company, but owners of preference shares get a fixed dividend, without the influence of profit earned. But when the company defaults, the preferential shareholders are paid on a priority basis than the common shareholders.^[2]

Things about Shares that you must know

1. Share is a way of raising funds for company benefits such as the growth of assets and profits.
2. The value of shares is uncertain and is affected by multiple factors such as the growth of company, demand, and supply of stock, etc.
3. The owners of the stocks are called shareholders.
4. A holder of preference shares doesn’t hold any voting rights but has the benefit of a fixed payout as compared to an owner of a common share, who has voting rights but his dividend will be based on the profit made by the company.^[3]
5. Dividends are payouts by the company to its shareholders out of its profits. It also means that, if in a financial year, the company does not record in any profits, the shareholders will not get any dividend.^[4]
6. Shares are bought and sold on the stock market, which is a place where shares of public companies are listed and their trade is carried out.^[5]

How can you own a share?

A company first fixes the entire capital and divides it into shares by setting a face value of each share. Face value of shares refer to the initial price of the share as set by the company. If a company’s capital is Rs. 10,000 with each share being worth Rs. 10, then total shares will be 1000.

A prospectus is then prepared by the company, giving the details of the working of the organization, past performances, share price, and other relevant details. This prospectus is circulated on the internet or any other medium to spread it, then it is given to stockbrokers.

Those who wish to purchase shares must show their intent to do so by filling a share application form and sending it to the company. After receiving all applications, the company will issue the shares to the people.

Every shareholder will be issued a certificate of share according to the provisions of Section 46 (1) of the Companies Act which states that:

“A certificate, issued under the common seal, if any, of the company or signed by two directors or by a director and the Company Secretary, wherever the company has appointed a Company Secretary], specifying the shares held by any person, shall be prima facie evidence of the title of the person to such shares.”

Selling of stock in a company is a fairly easy process and can be done in an off-market transaction (which transfers the shares directly from person to person).

Both the transferor and receiver must have a Demat account (dematerialized account to hold information on shares owned by a person) in either the National Securities Depository (NSDL) or Central Depository Services (India) (CDSL).

The transferor has to give details of the receiver, including the name of his Depository, his Depository Identity Number, the name of the Security being traded, the ISIN number (a code unique to the shares of a company) and the number of shares transferred.^[6]

The Securities and Exchange Board of India (SEBI) oversees the exchange of shares listed on the stock market. It is a non – statutory body established in 1988 through the SEBI Act, 1988 for regulating the commodity market in India. Section 24 of the Companies Act confers powers to SEBI for issue and transfer of securities. It is an important part of the Indian stock market and its main aim is to protect the interest of the investors in the capital market. SEBI makes the market a more investable place for people by eliminating potential frauds.

The issue and sale of the shares are regulated by the Companies Act. The key provisions include:

1. Section 26 states that while allotting shares, a company must issue a prospectus including all necessary information about the company and the price of the share.
2. Section 34 restricts any false information in the prospectus and prescribes a punishment under Section 447.
3. According to Section 34 no company can allot shares to people without reaching the capital mentioned in the prospectus.
4. The company proceeds to call for further share capital if any such provision was made in the prospectus regarding differential payments.^[7]

After the minimum subscription goal is reached, the company will issue shares to those who have subscribed. The rate of dividend will be determined by the company as per the profit made and subsequently disclosed to the shareholders.

Criminal offenses by defaulters in the Capital Market

1. A company that makes a statement or omission in the prospectus, and the statement turns out to be untrue, then the company may be held criminally liable if the inclusion or omission was made to deceive or mislead the person.

E.g.: If a company has increased its share price on the pretext that they have recently signed a new deal, when in fact the new deal hasn’t been made; and if the company yet mentions the increased share price in the prospectus, then the person authorizing the shares may be held liable.^[8]

1. A person who makes an untrue statement regarding a company’s shares to induce another person into subscribing for the shares would be held liable for making such a statement.^[9]
2. Section 416 of the Indian Penal Code, 1860, criminalizes the offense of personation where if a person not authorized to sign a certificate of share impersonates himself as an authorizing body issue/sells shares to an individual to gain monetary benefits will be held liable for cheating by personation.
3. Any person who makes multiple applications for shares in a company with different combinations of his name and surname or makes multiple applications in a company using fictitious names will be held liable for the personation.^[10]
4. If a person sells shares by giving out false information and imitating that the shares have good rates and making a person believe that he/she will be in profit after buying that, it will impose a punishment for cheating and dishonesty according to Section 420 of Indian Penal Code, 1860.
5. If a person personates as the owner of shares in the company and unlawfully takes the benefit of the shares which belong to the rightful owner of the shares, such a person will be held liable for the personation.^[11]

Debentures

A debenture is one of the most typical forms of long term loans which a company can take, on which the holder earns a periodical fixed rate of interest. When the period of debentures expires, the company buys them back from the holder at the same price originally paid for it. The process of issue and purchase of debentures remain the same as in shares.

The money raised by the sale of debentures forms part of the company’s capital structure, but not its share capital as debenture holders are creditors of the company as opposed to shareholders who are owners of the company. Another important feature of debentures is they are convertible, which means that they can be converted into shares after a predetermined period of time. Further features of debentures are outlined in the following table, by drawing comparisons to features of shares.

Differences Between Shares and Debentures

1. James Chen, Stock Trading Strategy and Education, Investopedia ( 05 April 2020, 10:00 PM) https://www.investopedia.com/terms/s/shares.asp. ↑
2. Kimberly Amadeo, Preferred vs Common Stock and Types, The Balance (10 April 2020, 6:00 PM) https://www.thebalance.com/preferred-stock-definition-vs-common-stock-types-3305954. ↑
3. Section 47 Indian Companies Act, 2013. ↑
4. Section 51, Indian Companies Act, 2013. ↑
5. Section 23, Indian Companies Act, 2013. ↑
6. Dr. Tejinder Singh Rawal, Loads of Money: Guide to Intelligent Stock Market Investing. ↑
7. Section 49, Indian Companies Act, 2013. ↑
8. Section 34, Indian Companies Act, 2013. ↑
9. Section 36, Indian Companies Act, 2013. ↑
10. Section 38, Indian Companies Act, 2013. ↑
11. Section 57, Indian Companies Act, 2013. ↑
12. Section 71 (8), Indian Companies Act, 2013. ↑
13. Section 71 (1), Indian Companies Act, 2013. ↑
14. Section 71 (2), Indian Companies Act, 2013. ↑
15. Section 71 (8), Indian Companies Act, 2013. ↑