Disgorgement of profits – profits made in violation of SEBI directions vs. profits made in violation of law

In
perhaps a first, SEBI has ordered
impounding of profits that were made through legitimate and non-manipulative trades
though in violation of SEBI directions not to trade.

An
earlier order against certain persons had “prohibited them from buying, selling
or dealing in the securities market, directly or indirectly, till further
orders.”. While such directions were in force, such parties allegedly dealt in
securities indirectly and earned huge profits.

SEBI ordered impounding of such profits of
Rs. 27.44 crores (including interest of Rs.8.45 crores @12% pa till date of
order). This is pending completion of investigation after which SEBI may pass
final orders for disgorgement of such profits.

The order is interesting. The earlier order
prohibiting them from such dealings was because of alleged market manipulations
by such persons. However, while the parties violated this order of prohibition,
they did not carry out any manipulations in such dealings. The profits have
been made from dealings in securities that were otherwise in ordinary course of
business. The interesting question is whether such profits can and should be
subject of disgorgement.

The explanation to Section 11B of the SEBI
Act clarifies that SEBI has power to order  disgorgement of “wrongful gains” made “by
indulging in any transaction or activity in contravention of the provisions
of this Act or regulations made thereunder
”.
The question is whether this would include profits made in contravention
of directions of SEBI. The requirement also is that such “wrongful
gains
” should have been made “by such contravention”. Whether such
gains can be said to be “wrongful” and also whether they are made “by such
contravention
”.

SEBI does have power to levy penalty where any person does not
comply with directions of SEBI. Section 15HB provides for a penalty of upto Rs.
1 crore on a person who “fails to comply with any
provision of this Act, the rules or the regulations made or directions issued by the Board”.

Whether SEBI should disgorge such amounts is also an interesting question. For
answering this question, an incidental question could be whether such directions
were punitive or preventive (decision of Supreme Court in SEBI vs. Ajay Agarwal
((2010) 3 SCC 765) is relevant here). A person who indulges in manipulative
transactions may be prevented from repeating them by prohibiting him from
dealings in securities. However, if he yet carries out such dealings, albeit in
a legitimate manner without any manipulations, he can be penalised for violating the directions. Should he be asked to
surrender the profits made too? The penalty of Rs. 1 crore under Section 15HB
would not be a sufficient deterrent to a person who has opportunity for
making, as in the present case, far higher profits.

One looks forward to the
final order in this case. Hopefully, if it does order disgorgement, it also
gives detailed reasoning and legal basis for disgorgement in such situations.

About the author

CA Jayant Thakur

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