Compensating Investors: IPO Irregularities

SEBI has recently published a report by the Justice D.P. Wadhwa Committee in connection with irregularities in various IPOs in 2005. The report itself was, however, submitted by the Committee to SEBI as early as December 2007. In those IPOs, certain applications were made by certain persons using fictitious demat and bank accounts in the retail quota “so as to corner shares by using the favourable allotment chances for retail investors”.

While various legal proceedings and investigations have been initiated in the wake of these irregularities, the Wadhwa Committee was entrusted with the task of recommending the procedure for identifying persons who may have been deprived due to such irregularities so that they may be appropriately compensated through reallocation of shares.

After deliberation, the Committee established 3 principles for this purpose:

“a. To quantify the amount of unjust enrichment that has taken place, and which is the subject of reallocation.

b. To identify the genuine applicants who may be considered “deprived”.

c. To decide a basis on which the unjust enrichment is to be reallocated amongst the “deprived” applicants.”

As for the compensation amount through reallocation, the Committee felt that “the amount which is the difference of closing price of shares on the first day of listing / trading at NSE and the IPO price will be considered. These applicants will not be entitled for the market price movements subsequent to the listing.”

As regards the method of reallocation, the Committee recommends a “spillover” method. It notes:

Under this method, totally unsuccessful applicants shall be reallocated shares equally from the afferent pool, till they each receive the minimum shares allotted to the lowest category in the IPO. Once that number is reached, any afferent shares left over shall “spill over” and be reallocated to the partly successful applicants in the firm category and thereafter to the partly successful applicants in drawal of lots categories.

There are questions about the practicality of such an approach. The observations in an Economic Times editorial bear some merit:

[Compensating retail investors] is a long and convoluted process that will usurp regulatory time and attention at a time when there are graver issues that deserve its attention. The effort to compensate individual applicants who were not allotted shares because of the scam is simply not worth the trade-off in terms of time and money spent.

This is not to say perpetrators of the scam should be allowed to go scot free. Most certainly not! They should be made to disgorge their ill-gotten gains of close to Rs 100 crore and should be criminally prosecuted as well. But the money obtained will be better spent beefing up the Investor Protection Fund — and used to educate investors, the vast majority of whom are sorely in need of financial literacy — than going on a wild goose chase trying to identify losers in the IPO scam.

There are also some issues pertaining to the methodology for computing the amount: “Again, the Wadhwa committee arrives at the notional loss as the difference between the issue price and the closing price of the shares on listing. Why assume investors would have sold their shares on listing?”
In some respects, the report lacks a sense of finality as many factors, including the quantum of compensation, are dependent on the outcome of various proceedings pending before different fora that relate to the IPO irregularities.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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