[Shaivi Shah is a 3rd year student and Palash Moolchandani a 4th year student, both at National Law University, Odisha]
The Black’s Law Dictionary defines disgorgement as “the act of giving up something (such as profits illegally obtained) on demand or by legal compulsion”. In India, since the enactment of the Securities and Exchange Board of India Act, 1992, the tool of disgorgement has been used to recover unjust enrichment gained by any participant in the capital markets. Historically, disgorgement was considered to be an equitable remedy; however, over the years, this has been diluted.
Recently, the US Supreme Court, in Liu v. SEC, redefined the computation of disgorgement. In doing so, it reinforced the fact that disgorgement, in its essence, has its roots placed in the principles of equity. Indian courts have extensively relied on US securities law owing to its maturity and sophistication. Hence, this ruling has inevitably sparked a conversation regarding its applicability to the Indian scenario.
This post discusses the evolution of disgorgement in India and the subsequent shift in its nature from being equitable to punitive. Further, it breaks down the view of the US Supreme Court in Liu v. SEC, determines the cue that India can take from it and finally concludes.
Disgorgement in India
The endeavour of the Securities and Exchange Board of India (SEBI) to apply disgorgement began with the case of Hindustan Lever Limited v. SEBI,  18 SCL 311. After being unsuccessful in its first attempt, SEBI ordered disgorgement for the second time in Rakesh Agrawal v. SEBI. Unfortunately, yet again, the Securities Appellate Tribunal (SAT) dismissed SEBI’s claim by holding that directions of disgorgement are penal in nature and that SEBI, by the virtue of section 11B of the SEBI Act, can only pass remedial directions. However, three years later, the SAT finally upheld SEBI’s disgorgement order in the Roopal Ben Panchal case. It held that section 11B includes the power to direct disgorgement. Further, it also clarified that SEBI’s disgorgement remedy is equitable and not penal.
Additionally, in Karvy Stock Broking Ltd v. SEBI, the SAT stipulated that SEBI’s power to order disgorgement is only limited to those wrongdoers who have made illegal gains and that the disgorgement amount cannot exceed those gains. Finally, to ensure consistency in its directions, in 2014, section 11B was amended to include disgorgement as an explicit direction that SEBI can pass. Since then, SEBI has been actively using this power to regulate the securities market effectively.
Shift in the Nature of Disgorgement: Equitable to Punitive
Historically, courts both in the US and India have maintained that disgorgement operates as an equitable relief and not as a punitive measure. The objective of penal laws is to punish the wrongdoer and deter wrongs against the state, whereas disgorgement is compensatory in nature and is meant to square off any unjust enrichment gained. However, after analysing recent legislative amendments and court decisions, the notion of disgorgement as an equitable remedy seems to have been diluted.
The US Supreme Court recently observed the change in the approach of courts in Kokesh v. SEC. The Court opined that disgorgement is in the nature of a ‘penalty’ and would, therefore, be subject to statutory limitations. Its reasoning was based on the observation that the primary objective of the regulators in seeking disgorgement is to deter violations in the securities market rather than compensating the victim.
Likewise,the Indian securities regime has seen its own shift in the nature of disgorgement from equitable to punitive. By way of the Finance Act, 2018, a critical amendment was introduced to the SEBI Act which facilitated the shift. The marginal note to section 11B was changed from “Power to issue directions” to “Power to issue directions and penalty”. This amendment was puzzling, as section 15HB already granted powers to the board to issue penalties in case of contravention of the law and directions by the SEBI, where such penalty had not been separately provided for.
The characteristics of the equitable remedy of disgorgement and that of a penalty are similar in that both seek to recover money from a defaulter who has obtained it as a wrongful gain through contravention of the law. Thus, providing for both in the same section without any clear distinction, particularly in light of the existence of section 15HB, convolutes the understanding of the nature of disgorgement.
This can be seen through the order SEBI passed with respect to Beejay Investment & Financial Consultants. In this case, SEBI passed a prohibitory order against certain persons, banning them from trading on the securities market owing to the commission of market manipulation. Regardless of this order, the said persons traded indirectly on the market and made substantial profits. SEBI then passed a disgorgement order against them amounting to INR 27.44 crore. In this case, disgorgement was awarded for violation of the prohibitory order and not for violation of the law. Violation of a prohibitory order is provided for as a penalty under section 15HB. Further, section 11B only covers wrongful gains obtained by violation of the law, and does not extend to a violation of prohibitory orders. Thus, it was seen that the two provisions were used interchangeably, blurring the nature of disgorgement as equitable or punitive.
US Supreme Court Ruling in Liu v. SEC: Lessons for India
The most significant aspect of this 8:1 ruling is the express mandate of the court to recognize disgorgement as an equitable remedy that should be computed on the basis of the net profit earned. The Court held: “A disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible” under 15 U.S.C. § 78u(d)(5). In order to be equitable, certain legitimate expenses expended by defaulters must be accounted for and, thus, disgorgement must only be charged on the net profit accrued. However, no guidelines to determine these legitimate expenses were provided for, and instead it was stated that every case must be examined on the basis of its specific facts and circumstances, keeping in mind the principles of equity.
In India, as seen earlier in the post, the muddy waters surrounding the nature of disgorgement managed to alter its essence from equitable to punitive. The clarification provided by this judgement that the purpose of disgorgement is to remedy the wrong and not punish the wrongdoer is an important step in resolving the current shift in stance, as India has historically taken substantial cue from the American securities regime.
Further, the Court reiterated the importance of the role of restitution in disgorgement remedies. It noted that the recent instances of non-conformity with the principle of restitution were against the essence of disgorgement as an equitable remedy. Referring to the SEC’s 2019 Annual Report from the Division of Enforcement, it observed that less than 50% of the total amount collected through disgorgement was returned to wronged investors. The practice of not returning disgorged amounts to affected investors was considered by the Court, which concluded: “The equitable nature of the profits remedy generally requires the SEC to return a defendant’s gains to wronged investors for their benefit.” Without this, the true essence of disgorgement would not prevail.
India suffers a similar fate. The latest available Annual Accounts of the SEBI for the FY 2017 show that a meagre 10% of the amount collected as disgorgement and deposited in the Investors Protection and Education Fund was spent, while the remaining 90% is lying idle. The SAT, in Ram Kishori Gupta v. SEBI held that “the basic idea behind disgorgement is restitution. As an investor protection measure, the Appellants need to be compensated, since disgorgement without restitution does not serve any purpose.” However, seeing that restitution is not being followed in practice, one hopes that the decision in Liu v. SEC will reinforce this concept in India.
It remains to be seen whether the judgement in Liu v. SEC will serve as a beacon of encouragement to the Indian securities regime to prevent disgorgement from veering off the path of equity. It is of utmost importance that there be a framework designed to foster uniformity and objectivity in the determination of ‘legitimate expenses’ and net profits. Further, it is necessary to formulate a detailed mechanism to delineate the manner of providing for restitution to affected investors. Ultimately, it remains for the regulator to determine whether disgorgement will retain its roots of equity or whether it will be dispensed in a manner that promotes administrative convenience over protecting the provenance of the remedy.
– Shaivi Shah & Palash Moolchandani
 Himani Patel v. SEBI, 2009 SCC OnLine SAT 98; Shadilal Chopra v. SEBI, 2009 SCC OnLine SAT 183; Dushyant N. Dalal v. SEBI, 2010 SCC OnLine SAT 328.
I have one comment to make namely,
a. With respect to Amendment by way of Finance Act, 2018 and addition of word “Penalty” in Section 11B.
Please note that prior to the amendment, debarment, disgorgement and other directions under Section 11B used to be issued by a Whole Time Member (WTM) of SEBI and the Adjudication proceedings/penalty orders were passed by an independent Adjudication officer who was not below the rank of a Division Chief. Therefore, in a case where both debarment proceedings and adjudication proceedings were initiated, SEBI used to have two different Show Cause Notices and two orders. The procedure led to two authorities deciding on the same issue and the noticee had to appear twice before SEBI. The procedure was cumbersome and saw some conflicting orders also.
To remove this anomaly, SEBI Act and the rules to conduct a penalty proceedings have been amended and in the cases where both the proceedings need to be initiated, a Whole Time Member has now been given the power to issue the directions as mentioned in Section 11 as well as levy a penalty. The penalty which will be imposed by a WTM will be as per Section 15/Chapter VI of SEBI Act and it’ll be in addition to the disgorgement amount provide the ill-gotten gain or loss avoided is calculated. Further, the penalty would go to Consolidated Fund and disgorgement amount will go to Investor Protection Fund. Therefore, the amendment in the SEBI Act does not change the nature of disgorgement by SEBI which is an equitable remedy.