SEBI’s Investor Compensation Mechanism in India: A Regulatory Void

[Tirth is a student at Institute of Law, Nirma University.]

The safety of investments made in the securities market has often been compromised. Over the years, numerous investors have incurred substantial losses due to several market malpractices, violations of securities regulations, and a lack of market awareness. To address this, the Securities and Exchange Board of India (SEBI) established the Investor Protection and Education Fund (IPEF) for protection of investors under Section 11 of the Securities and Exchange Board of India Act 1992 (Act) and regularized it under Investor Protection and Education Fund Regulations 2009 (IPEF Regulations). The IPEF covers the disgorged illegal gain or profits made through any malpractice, along with such other contributions made by SEBI. The fund collected under IPEF is utilized to compensate eligible and identifiable investors who have incurred losses, provide legal aid, support educational activities, investor awareness, and training programs.

As per SEBI’s annual report for the year 2024-2025, the expenditure from IPEF in the year 2025 dropped to 2.6 crore from 11.9 crore in the year 2023. The report further stated that the expenditure from IPEF has persisted in the range of 0 to 0.5%, indicating its negligible utilization. Concurrently, as SEBI does, market institutions such as stock exchanges and depositories are also mandated to maintain an investor protection fund, which also witnessed a similar pattern of growing corpus and decreasing expenditure. Even though the fund size is growing with minimal expenditure, investors are not compensated for the losses due to the discretionary use of IPEF. This highlights an unaddressed issue of the absence of a clear compensation mechanism for expeditiously compensating investors.

This article critically analyses the present compensation mechanism and its challenges, such as selective usage of funds, burden of proof on investors, and SEBI’s discretionary power. Further, it examines SEBI’s power to direct compensation under the Act and proposes a more structured and direct compensation mechanism by laying out a comparison with the United States’ compensation mechanism.

Present Compensation Mechanism and Its Issues

Under the present compensation mechanism, SEBI does not directly grant compensation to the investors as it lacks explicit statutory power to do so directly from disgorged funds, unless channeled through IPEF. As per the IPEF Regulations, any amount disgorged under Section 11B of the Act, Section 12A of the Securities Contracts (Regulation) Act 1956, or Section 19 of the Depositories Act 1996, is required to be credited to the IPEF. The amount accumulated has to be utilized for the protection of investors, including compensation to the investors for the loss incurred. Compensation shall be disbursed solely to eligible and identifiable investors who are able to furnish documentary evidence for the losses directly linked to the malpractice. This may exclude those investors who suffered a loss and were not in a position to establish a direct linkage to the event. Further, the eligibility criteria may only cover specific malpractice, such as manipulation in an Initial Public Offering, where a linear, traceable link can be established, thus disqualifying other legitimately harmed investors.

The primary purpose of the IPEF is to protect investors from any untoward event that may occur. The IPEF Regulations give a discretionary power to SEBI for compensating the investors, leading to unnecessary procedural delay and selective usage of the IPEF. This unfettered discretion may result in the denial of compensation to genuinely harmed investors. Such a scenario will give investors limited access to the IPEF, making compensation a rarity instead of a norm. One such rare instance was the Roopalben Panchal IPO scam, where SEBI had distributed 23.29 crores to investors due to irregularities in allotting shares. Further, it appears that money accumulated in the IPEF is selectively used. By the end of 2024, SEBI organized approximately 43,000 investor awareness programs, and its online educational campaigns reached around 329 million viewers, potentially educating a larger investor base. Despite the growing size of the corpus, spending on alternative investor protection measures remains negligible. Let alone the proceeds from the disgorged amount, Regulation 11 of the IPEF Regulations permits the accumulated money to be used for investments, and interest earned on the same is also added to the IPEF, financially strengthening the IPEF. It indicates that although the fund size is financially strong, it is failing to benefit the investors it is intended to protect, thereby demanding a clear mechanism to compensate investors rapidly after the unlawfully gained amount has been disgorged.

Understanding the Limits of SEBI’s Compensation Powers

The Act does not expressly grant power to SEBI to compensate. Section 11 of the Act outlines the general functions of SEBI to regulate the securities market. Section 11B of the Act empowers SEBI to issue general directions in the interest of investor protection, including, but not limited to, the inspection of records, impounding and retaining proceeds, and suspension of trading activities. While these powers are extensive, it is pertinent to note that Section 11B, although empowering SEBI to direct disgorgement of unlawful gains or losses caused to investors, does not extend to issuing directions for direct compensation. In accordance with Section 11, any amounts disgorged are mandatorily credited to the IPEF, and their deployment is governed by SEBI’s discretion under the IPEF Regulations. Consequently, the process of compensating affected investors is not automatic or direct but instead must be routed through the IPEF framework, thereby introducing additional administrative and regulatory exercises that may hinder effective redressal.

Over the years, several notable cases have acknowledged that SEBI has no direct power to compensate from the disgorged amount. In the case of Ram Kishori Gupta and Another v. SEBI, the petitioners had filed an appeal before the Securities Appellate Tribunal (SAT) to claim compensation for their loss due to stock market manipulation, which was refuted by SEBI. Subsequently, by directing to pay compensation from IPEF, SAT held that, in the absence of such explicit power under the Act, SEBI ought to have created a proper direct compensation mechanism. It also held that the whole purpose of disgorgement is to restitute investors, without which the disgorged amount serves no purpose. Further, in the case of Sahara India Real Estate Corporation Limited v. SEBI, the Hon’ble Supreme Court, recognizing the gravity of fraudulent activities and misrepresentation by the company, ordered the company to refund the entire deposits to the investors along with the interest. However, there have been precedents where compensation was denied due to a lack of explicit power. In the case of Rakesh Agarwal v. SEBI, SAT held that under Section 11B of the Act, SEBI does not have any power to grant compensation, and the power to impose any such pecuniary burden on the entity should be explicitly prescribed in the statute. The above-mentioned cases reflect instances where courts had intervened to grant compensation. The absence of a clear and direct mechanism has put investors in a situation where approaching the courts is the only reliable recourse left. This not only drags them into prolonged litigation but also discourages them due to the uncertainty and cost involved.

Comparison with the US Compensation Mechanism

The US mechanism, unlike India, is more structured and regular in compensating the investors. The Securities Exchange Commission’s (SEC) Rules on Fair Funds and Disgorgement Funds (FFDF rules) empower the SEC to create a Fair Fund cumulative of disgorged amounts and civil penalties. This fund is created specifically for those investors who have been harmed due to the violation of securities law, deviating from SEBI’s standard, where a single fund is used for multiple welfare schemes. Further, the FFDF rules prescribe the formulation of a distribution plan for the fair fund. Such a distribution plan shall mandatorily include the class of investors that are eligible and identified to be compensated, and the procedure for making and approving the plans. The entire procedure of identifying affected investors and notifying them is controlled by the SEC. Whereas, in India, the burden of proof is on the investors to prove their loss linked to the violation, which yet depends on SEBI’s discretion. The US mechanism is incorporated in the statute through an enforcement process, relieving investors from the trouble of enforcing through the courts. As a result, the SEC has been effectively and regularly able to distribute compensation to the harmed investors, substantially higher in numbers and percentages as compared to SEBI.

Way Forward and Conclusion

Owing to the abysmal usage of the IPEF and issues surrounding it, a strong compensation mechanism is required to be set up, either giving express power to SEBI to direct compensation or creating a fund specifically for compensating affected investors due to the violation of any securities law. A mechanism similar to the one adopted by the SEC will efficiently guide SEBI in protecting the interests of the investors without the need for judicial intervention. Formulating an independent and direct compensation mechanism will not only help in saving the cost and time of investors but also help the regulator to quickly remedy the wrong. Unless channeled towards meaningful restitution, the IPEF’s disgorged funds risk becoming a passive reserve rather than an active instrument of investor protection.