Indian IPO Market - Prospects & Challenges
(by R.Kannan)
(This article of mine was originally published in "ICFAI READER" issue of October 2004
published by The ICFAI University Press)

Investor Compensation for wrong Allotments
(What are the ways through which investors can be compensated for wrong allotment of shares
as is the case with ONGC? Who should take action for such compensation?)

Investors cannot gain from unintentional mistakes committed by officials of the stock exchange or the intermediaries. But if they happen to suffer consequent to such wrong allotment of shares, they are eligible to be compensated for the loss sustained by them. The investor cannot gain by selling the share that he secured on account of a wrong allotment and making a gain for himself. But if he sells on account of a bonafide belief that the share allotted was his rightful property and subsequently had to purchase from the cash market at a higher price than for what he has sold to deliver the share to the buyer, he incurs a loss for no fault of his, and for this he is eligible to be reimbursed.

Thus if A is given a wrong allotment of 10 shares of ONGC at Rs.750/-. He pays Rs.7500/-. He is eligible to get back this amount with interest until the date of reimbursement. Otherwise he is not eligible for ownership of shares allotted when it was detected that the allotment in question was made erroneously.

But before such detection A had sold the shares allotted at Rs.810/- per share and receives Rs.8100/- on the settlement day. But on the settlement day he is unable to deliver the shares, as the stock exchange had come to know that his allotment was erroneously made. A is therefore compelled to buy the shares at the cash market at Rs.820/- and fulfils his contract. In this process he pays Rs.8200/- plus brokerage on the purchase, while he would have received only Rs.8100/-. He is therefore eligible to be reimburse the difference amount of Rs.100/- and brokerage charges incurred by him.

The responsibility for compensating A should be by the Stock exchange from out of the Investor Protection Fund. The stock exchange describes the system of trading through this medium as anonymous trading, implying that seller and buyer have no direct interaction. The system by which it shields the investors from market risk is called Novation. No doubt this responsibilities are mentioned primarily with regard to secondary market, its responsibilities for the primary market cannot be different. The registrar to issue is an intermediary under control of the stock exchange and the stock exchange by rules of procedure is to involve at the stage of selecting the allottees from the total list of subscribers.

The Investor Protection Fund or the Customer Protection Fund created and maintained by the Stock Exchange has to be administered by way of a trust created for the purpose.

The trust consists of at least one public representative, one representative from the registered investor associations recognized by Sebi and the executive director of the concerned stock exchange. The onus is on the exchanges to ensure that the funds in the IPF or CPF are well isolated and that it is immune from any liabilities of the exchanges.

Contributions to the fund by the exchange will be made in the following way - one per cent of the listing fees received, on a quarterly basis; 100 per cent of the interest earned on the one per cent security deposit kept by the issuer companies at the time of the offering of securities for subscription to the public, immediately on refund of the deposit; the difference of amount of auctions and close-out price; the amount received from the proceeds from the sale of the securities written off among others. The exchange has to ensure that the members contribute at least one per cent of the transaction fees charged by it to the to the IPF.

This amount shall be contributed on an annual basis based on the turnover of the broker for the previous year. In respect of filing claims the exchanges have to publish a notice inviting the legitimate claimants to file claims against the defaulter member brokers within a specified period of time, called as the "specified period". The claims received against the defaulter members during the specified period shall be eligible for compensation from the IPF. The IPF Trust may adopt the arbitration mechanism at the stock exchange to determine the legitimacy of the claims received from the claimants.

One anomaly is that penalties levied and collected by SEBI from erring intermediaries, who really are the cause for such investor claims, cannot be appropriated to the IPF, as these are credited to the Government Account. This is an anomaly as SEBI being an autonomous body, must also have financial autonomy to retain the fees and penalties collected by it to be utilised to discharge its development responsibilities. Another autonomous body IRDA disputed this issue with the Government and has been permitted to retain its collections.