[Rahul Sibal is a 4th Year student and Deep Shah a 3rd Year student of NALSAR Hyderabad]
In March this year, the Securities and Exchange Board of India (‘SEBI’) confirmed an interesting interim order that was passed last year. The interim order (the ‘Order’) impounded profits that Beejay Investments derived from trading in securities, with such profits being termed as ‘unlawful gains’. It was held that these trades were in non-compliance of a previous direction that had barred Beejay Investments from undertaking trades for a specified period. Proceeding on this premise, profits derived from trading were impounded, for the “effective implementation of the direction of disgorgement”, if any, that would be passed, post adjudication. Before the Order is analyzed, it is necessary to establish a foundational understanding of ‘disgorgement’.
Put simply, disgorgement can be defined as ‘the act of giving up something (such as profits illegally obtained) on demand or by legal compulsion.’ In other words, disgorgement orders may be understood as orders that require the repayment of gains derived from illegal acts. For a better understanding of disgorgement orders, the reader may refer to two posts on this topic here and here.
It is important to note that the SEBI Act, 1992 (the ‘Act’) did not contain an express provision that allowed SEBI to pass disgorgement orders. Therefore, such orders were initially justified by the Securities Appellate Tribunal (‘SAT’) on the premise that disgorgement orders were ‘equitable remedies’ that did not require explicit statutory authorization. However, the Act was later amended to include an Explanation which clarified that disgorgement orders could be passed under section 11B.
In consequence, such orders would now be understood as a statutory power exercised via section 11B as opposed to as an ‘equitable remedy’. Given that it is now a statutory power, it follows that for gains to be disgorged, the pre-requisites specified under the explanation to section 11B need to be fulfilled. The explanation reads as:
“Explanation.—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.” [Emphasis Supplied]
As is clear from the above explanation, for a gain to be subject to disgorgement it should be derived from the contravention of the provisions of the Act, or the regulations framed thereunder.
Viewed in this background, the interim order in Beejay investments requires a deeper examination as it is unclear whether the expression ‘contravention of the provisions of this Act or regulations’ could be construed to include the non-compliance of directions. This is an important question since the imposition of a disgorgement in Beejay investments is contingent upon this question.
For a better understanding of the facts and controversy pertaining to Beejay Investments, the reader may refer to this blog post.
The question for consideration would thus be:
“Whether the non-compliance of SEBI’s directions would constitute a violation of the Act or Regulations?”
In a format followed previously in this Blog, we seek to bring out the possible arguments arising from both sides, before arriving at a conclusion.
First, a well-established principle of statutory interpretation is that a reading that results in redundancy should not ordinarily be adopted. In this context, it would be profitable to refer to section 11C(1), which enumerates the instances where SEBI can appoint an investigating authority. The provision reads as:
“Where the Board has reasonable ground to believe that—
(a) the transactions in securities are being dealt with in a manner detrimental to the investors or the securities market; or
(b) any intermediary or any person associated with the securities market has violated any of the provisions of this Act or the rules or the regulations made or directions issued by the Board thereunder…” [Emphasis Added]
As can be derived from the above noted provision, the non-compliance of directions has been mentioned as an independent ground, in addition to the violation of Act. In this respect, in case the expression ‘contravention of the provisions of this Act or regulations’ as found in section 11B is expansively interpreted to include the non-compliance of directions, parts of section 11C(1)(b) would turn superfluous. This is because there would exist no reason for non-compliance of directions to be listed as a separate ground under section 11C (1), if the contravention of Act were to include non-compliance of directions.
A similar argument could be made on a comparison between sections 15HB and 11B. For instance, section 15HB, which provides for the imposition of penalties, reads as:
“Whoever fails to comply with any provision of this Act, the rules or the regulations made or directions issued by the Board thereunder for which no separate penalty has been provided, shall be …..” [Emphasis Added]
As has similarly been argued in context of section 11C, the highlighted parts of section 15HB would become redundant if non-compliance of directions is understood to constitute a contravention of the Act. Added to that, the usage of the word ‘or’ in between the expressions ‘provisions of this Act’ and ‘directions issued’ could be construed to suggest that the obligation of compliance with directions would be distinct from the obligation to comply with the Act.
Second, deeming the non-compliance of directions as a ‘contravention of the Act’ could subject the Act to constitutional challenges. Reliance for this assertion is placed on the text of section 24 (reproduced below) which provides for criminal sanction for certain offenses:
24. (1) Without prejudice to any award of penalty by the adjudicating officer under this Act, if any person contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of any rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may extend to [ten years, or with fine, which may extend to twenty-five crore rupees or with both].
(2) If any person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any of his directions or orders, he shall be punishable with imprisonment for a term which shall not be less than one month but which may extend to [ten years, or with fine, which may extend to twenty-five crore rupees or with both]
Now, where the non-compliance of directions is construed to constitute a contravention of the Act, an individual that does not comply with an order passed by an adjudicating officer could be prosecuted under section 24(1) for the ‘contravention of the Act’ in addition to being prosecuted under section 24(2), which specifically concerns the non-compliance of directions. Since both sub-sections envisage criminal liability, section 24 could be subject to being struck down for being violative of Article 20(2) of the Constitution on the ground of ‘double jeopardy’. The implication of such an interpretation further reinforces the view that the non-compliance of directions does not lead to the contravention of a statutory obligation.
Third, despite precedents that have held the SEBI Act to be a remedial statute which is required to be construed purposively, it is unclear whether these precedents can be relied upon for expansively interpreting the Explanation to envisage the imposition of disgorgement orders for non-compliance of directions. In the case of Khemka & Co v. State Of Maharashtra, the Supreme Court made the following observation:
“It is a well settled cannon of construction of statutes that neither a pecuniary liability can be imposed nor an offence created by mere implication.”
Based on the above rationale; since the explanation under section 11B confers SEBI with the power to impose pecuniary liabilities in the form of disgorgement orders, the expression ‘contravention of the provisions of this Act or regulations’ should be read restrictively, and not liberally so as to not include the ‘non-compliance of directions.’
In the next part in the series, we propose to analyze arguments that could be used to support an interpretation that characterizes the obligation to comply with directions as a statutory duty.
– Rahul Sibal & Deep Shah
 It is important to note that the argument proceeds on the premise that the words ‘violation’ and ‘contravention’ have similar connotations.