Having covered SEBI’s various powers in our previous columns, the focus this time shifts to remedies and actions taken by the securities market regulator for violations. One such tool in SEBI’s armory is that of disgorgement.
The term disgorgement, at its core, refers to the act of surrendering those gains or profits that were obtained through unlawful means, to deprive such parties of the fruit of their illegal actions. Jurisprudentially rooted in the doctrine of equity, it is used extensively as a remedy for contractual breaches as well, to solve for unjust enrichment. In the securities market, disgorgement is a great leveler and a valuable tool in cases where parties have benefited from securities violations, allowing the regulator to restore status quo ante.
SEBI’s journey on disgorgement is marked by interesting jurisprudence which has, over the years, sketched a neat outline of the use of these equitable powers in the securities market.
The power to direct disgorgement was initially never expressly provided for in the SEBI Act, 1992 (“SEBI Act”). In fact, in the case of ‘Hindustan Lever Ltd. v. SEBI’, SEBI directed compensation of INR 3 crores (approx.) to be paid by Hindustan Lever Ltd. (“HLL”) to UTI. One would recall that this case revolved around a SEBI investigation that concluded that HLL as an insider had purchased shares of Brooke Bond in violation of the SEBI (Insider Trading) Regulations, 1992 and that non-disclosure of information regarding a potential merger had disadvantaged the purchasers, thereby mandating a compensation to be paid. While the Appellate Authority agreed with SEBI's conclusion that information of the merger was price sensitive, it did not read the power to direct compensation into the scheme of the SEBI Act and held that “We are of the view that it is a settled principle of law that for imposing a pecuniary burden, there must be specific provisions in law and there should be specific regulations for giving an opportunity to the affected person to present its case before any burden can be imposed on it by an Authority like SEBI. Use of omnibus powers for imposing pecuniary burden cannot be the intent of law. 25. We, therefore, find that the order of SEBI to award compensation to UTI apart from suffering from procedural deficiencies also lacks in jurisdiction.”
The matter is currently pending before the Supreme Court.
Even in the case of ‘Rakesh Agrawal v. SEBI’, a direction to compensate disadvantaged counterparties was set aside by SAT on merits itself and in doing so, SAT made an important observation. It held that “any pecuniary burden sought to be imposed by the legislature upon citizens, must be expressly for in the concerned Act/ Regulation. Section 11B of the said Act does not contain any such specific provision…. The Board does not have any power to direct the Appellant to pay the said amount by way of compensation, pursuant to Section 11B of the said Act…”
The 2006 IPO scam, however, proved to be an inflection point for the theory of disgorgement in the Indian capital markets, paving the way for its judicial acceptance as a statutorily permissible remedy. In a case involving cornering of retail allotments in IPOs, spanning dozens of cartels, SEBI not only issued a detailed order, expounding on why the scope of Section 11B must be read in its widest amplitude, but also set out the ill-gotten gains of offenders in such detail, calculating the disgorgement amount as a multiple of the number of shares allotted to the offending parties and the difference between the closing price on listing date and the IPO allotment price. In matters that impact retail investors, the equitable imperative is often significant enough to interpret the law in a manner that will restore the overall sense of universal morality and that sentiment is precisely what propelled disgorgement into centre stage here. Across a number of subsequent orders connected to this 2006 IPO scam, the underlying tenet of elevating disgorgement as a necessary facet of SEBI’s powers to issue directions under Section 11B became increasingly clear, including in orders of the appellate tribunal. In the case of ‘Karvy Stock Broking Ltd. vs. SEBI’, the Tribunal clarified the chief purpose of disgorgement and held that “Since the chief purpose of ordering disgorgement is to make sure that the wrongdoers do not profit from their wrongdoing, it would follow that the disgorgement amount should not exceed the total profits realized as the result of the unlawful activity.”
In other words, even if disgorgement did not exist expressly in the statute, it became increasingly essential to read it in as a ubiquitous adjunct to SEBI’s powers, in order to preserve investor interest and do right by affected parties. Subsequently, disgorgement became almost de riguer in SEBI orders concerning insider trading and market fraud, with its powers to do so consistently upheld by SAT as well. In ‘Ranjana Kothari vs. SEBI’, the SAT in fact called upon SEBI to consider disgorgement in cases where illegal gains were made, and no such directions for disgorgement were issued by SEBI. It held, “We may observe that the Securities and Exchange Board of India only initiated adjudication proceedings against the appellants and was satisfied by imposing small amounts of penalties on the delinquents (the appellants herein). The appellants who purchased shares while in possession of the unpublished price sensitive information are still continuing to enjoy the fruits of the ill-gotten gains that they made…This was a fit case where the Board also should have initiated proceedings under sections 11 and 11B of the Act for issuing appropriate directions to the appellants and other insiders to ensure that they do not take advantage of their wrongdoing. It is only through such directions that they could have been directed to disgorge their ill-gotten gains....”
This approach extended not just to realised gains, but notional ones as well. In ‘Dushyant N. Dalal and Ors. vs. SEBI’, SAT held that “Surely the appellants cornered the shares through illegal means and they cannot be heard to say that notional profits should not be worked out merely because they continue to hold some of them. They cannot be allowed to unjustly enrich themselves.”.
In 2014, disgorgement found unambiguous statutory status, when the Section 11B of the SEBI Act was finally amended to add an explanation, specifically clarifying that the power of disgorgement was always available with SEBI. It now reads as follows:
“For the removal of doubts, it is hereby declared that the power to issue directions under this section shall include and always be deemed to have been included the power to direct any person, who made profit or averted loss by indulging in any transaction or activity in contravention of the provisions of this Act or regulations made thereunder, to disgorge an amount equivalent to the wrongful gain made or loss averted by such contravention.”
Similar explanations were added under section 12A of the Securities Contract Regulation Act, 1956 and section 19 of the Depositories Act, 1996. Gradually, the disgorgement remedy became a feature of not just insider trading orders, but most securities market violations, including in cases of intermediaries, where the regulator concluded that some form of profit or benefit could be ascribed to the alleged violation.
Disgorgement being a monetary equitable remedy is an approach consistent world over, but the manner in which such “enrichment” is computed varies considerably.
A case in point is the US securities law regulator, the Securities and Exchange Commission (“SEC”). SEC’s enforcement architecture is slightly different from our own; while it too has a wide arsenal of actions and remedies available, it can initiate some such action through administrative proceedings, while others remain available through orders issued in lawsuits before federal courts, initiated by the SEC. In 1971, a plea for ‘restitution of unlawful gains’ was considered and upheld by the Second Circuit in the insider trading matter of ‘SEC v. Texas Gulf Sulphur', but was limited only to profits made by immediate tippees, not those further down the chain who may have traded whilst in possession of unpiblished price sensitive information (UPSI).
Many decisions thereafter read the SEC’s powers quite extensively, requiring the SEC to only arrive at a “reasonable approximation”, and allowing of reductions to the disgorged amounts by expenses incurred, only on a case by case basis.
The debate around disgorgement’s contours under US law recently reared its head again in two cases, ‘Kokesh v. SEC’, where the US Supreme Court observed that disgorgement was a form of penalty and hence subject to statute of limitations, while leaving open the question of court’s powers to allow SEC to claim such disgorgement, a question finally settled by the Supreme Court in ‘Liu v. SEC’. Upholding SEC’s rights to claim disgorgement as a judicial remedy, the Supreme Court outlined three key principles to stay faithful to its equitable origins:- (1) the amount disgorged must not exceed the net profits; (2) the proceeds must find their way to aggrieved parties; and (3) imposition of joint and several liability must be considered on specific facts.
In India, the calculation of disgorgement has evolved with time and according to the available facts. Although in straightforward insider trading matters, it is often a simple delta of net profits, allowing deduction of statutory dues in some cases, but matters rarely remain that uncomplicated. The effort of this article is not to outline the various formulae used over the years; that is an exercise best undertaken in more depth than one can afford in a column. SAT in its recent order of ‘SRSR Holdings Private Limited v. SEBI', delved into the nuts and bolts of disgorgement calculation and directed SEBI to consider the intrinsic value of the shares as well, while calculating disgorgement. For notional gains in the 2006 IPO scam, SEBI has relied on the difference between listing price and issue price, for corporations, SEBI usually seeks disgorgement of profits accrued during the period under investigation, etc. In the recent order pertaining to the co-location issue at the National Stock Exchange of India Limited, the SATl affirmatively held that “the direction to disgorge must be in relation to any transaction or activity which is contravention of the provisions of the SEBI Act or its Regulations. The direction to disgorge can be issued when it is found that the person has made profit through illegal or unethical acts and is not necessary that in each and every case a direction to disgorge should be passed merely because some provisions of the Act or Regulations have not been adhered to. In doing so, it also held that the direction to disgorge 25% of the salary accrued to certain individuals was patently erroneous, punitive and not covered under powers within Sections 11 and 11B of the SEBI Act.
This computation includes interest as well. Section 28A(1) of the SEBI Act read with section 220 of the Income Tax Act, 1961 gives power to SEBI to levy interest on the amount of disgorgement directed by SEBI. This provision was introduced in 2014 and has been held to have retrospective effect. However, across cases where SEBI levies an interest, the rate ranges anywhere between 4 – 15%, and no uniform method is applied while imposing such interest rate. Interestingly, in a recent matter before SAT, it was argued that levying interest @12% is excessive, arbitrary, and not in line with the past practice of SEBI in similar matters where it has levied a much lower rate of 4-6%, and SEBI was urged to adopt similar yardsticks across classes of matters. While observing that “…especially when it has been urged that SEBI has been imposing lower rate of interest in a large number of matters”, SAT remanded the matter to SEBI inter alia to re-consider all these issues.
While the equities of divesting gains away from those who are unjustly enriched stands established, the natural sequitur to it then is - who receives the funds so disgorged?
In the capital markets, many impacted by insider trading and market fraud are faceless, causal links, often tenuous and some would argue, some such transgressions are even victimless. Under the existing framework, disgorged amounts move into the Investor Protection Fund and unless SEBI is able to identify claimants or aggrieved parties who can be compensated/restituted, these funds are utilised for investor education and related activities. Interestingly, there is a limitation period of seven years from the date of claims notice/invitation for processing such restitution claims. Do these various elements (i.e., interest imposition, no expense deductions) chip away the equities inherent in this remedy? That too for such sums which do not directly recompense affected parties, but lie in a collective fund for general investor welfare? There is considerable scholarship globally that says yes, it does and points out that courts have increasingly accepted disgorgement’s equitable status as somewhat of a truism, without piercing through the façade. Given the slew of recent orders, the time is right for SEBI to formulate some metrics for disgorgement calculation, to allow the regulator, the defence, and the courts, to have the benefit of scenario mapping and objective calculations.
Shruti Rajan is a Partner, Jitesh Maheshwari is a Senior Associate & Khyati Goel is an Associate at Trilegal.
This is the fourth article in the Securities Law series by Trilegal.