Landmark order, but...

The Securities and Exchange Board of India's order on disgorgement is a landmark decision, because this is the first time in India that the regulator has sought financial compensation for the aggrieved party""the retail investor. So far in the history of capital markets, the retail investor has only lost money in the scams, which have occurred every few years. Sebi's view that "thousands of genuine retail investors...were deprived of their rightful opportunity to get allotment in IPOs under the retail category" is valid, and this has set the base for the finding now that the market players who turned a "Nelson's eye" to the compliance with KYC (know your client) norms should be held liable for the loss caused to retail investors. In ascertaining the sum, Sebi has calculated the extent of disgorgement as the listing gains enjoyed by rogue investors in public share offerings, to the extent of shares allotted to them.

Elsewhere in the world, "disgorgement" has long been used as an effective civil enforcement remedy to recover profits from violators of securities law. By disgorgement, the regulator forces the violator to give up the fruits of his illegal behaviour. The US Securities and Exchange Commission has regularly collecting disgorgement funds over the years""from Michael Milken to Martha Stewart.

However, several questions arise in the present case. First, the money to be paid to retail investors who lost out has to be taken from those who enjoyed unwarranted gains, i.e. those who "engorged" in the IPO scam. These are not the market intermediaries whom Sebi has focused on, namely the depositories and depository participants (DPs)""who only got their regular fees and nothing more. These intermediaries may be guilty, as Sebi has already determined, of violating the "know your client" norms, but they are not the ones who "engorged" and who therefore should now be asked to disgorge. The "engorgement" was done by the dummy investors in whose names shares were allotted, and it should be possible to take those shares and sell them in the market, with the loss that has been calculated by retail investors being paid to them, and the balance returned to those who got the allotment. The logical flaw in Sebi's order is in mixing up a penalty for misconduct (which it can legitimately levy on market intermediaries who err) with disgorgement; both are a financial drain, but the logic of each is quite different.

The Rs 116-crore question is what happens to the disgorgement fund, since the money has been made payable to Sebi. In the US, the SEC set up the Fair Funds for Investors in 2002 to benefit investors who have lost money because of illegal practices of other investors or companies, and fair funds are now playing an increasing role in enforcement. But even in the US, the aggrieved parties have received little money despite a provision for the appointment of an administrator. The task of identifying the affected parties involves detailed work, but should not be shirked for that reason. The outcome to be avoided is Sebi pocketing the money""as the tax authorities do when they recover excise duties illegitimately collected from customers by companies. That would be very unjust engorgement.