An auction is resorted to when there is a default in delivery by a broker. An auction is the exchanges mechanism through which, in a settlement, a buyer broker gets shares in the eventuality of default by the selling broker. This default occurs when a short seller fails to square up the position, or a seller fails to deliver shares on time, or a seller delivers bad/wrong shares.
The whole process of this auction event can be illustrated as under:
An auction is a mechanism utilised by the exchange to fulfill its obligation towards the buying trading members. Thus, when the selling broker fails to deliver the shares, exchange conducts an open market purchase by way of an open auction and the shares so bought through the auction are delivered to the buying broker.
If the shares could not be bought in the auction i.e. if the shares were not offered for sale in the auction, the exchange squares up the transaction as per SEBI guidelines. The guideline in force stipulates that the transaction is squared up at the highest price on the NSE from the relevant trading period till the auction day or at 20% above the last available closing price on the NSE on the auction day, whichever is higher. The pay-in and pay-out of funds for auction square-up is held along with the pay-out for the relevant auction.