Disgorgement harbours the principle of giving up the possession of profits illegally obtained, leading to unjust enrichment. Black’s Law Dictionary defines disgorgement as “the act of giving up something (such as profits illegally obtained) on demand or by legal compulsion”. Unjust enrichment implies the privilege of certain acquired benefits, which is unjustifiable under a legal purview. Therefore, the wrongdoer has to return the equivalent unlawful gains. The idea behind such a remedial measure is that no one should enjoy wrongful possessions. Consequently, it can be said that disgorgement is a primary and basic remedy because, even before deciding on a punishment, the wrongdoer is stripped of unlawful profits. Thus, restoring the status quo ante is its aim.
The post aims to understand the nature of disgorgement. The author takes a deep dive into whether disgorgement is an equitable remedy or a penal measure.
Evolution of disgorgement in India
The Securities and Exchange Board of India (“SEBI”) directed disgorgement in Hindustan Lever Limited v. SEBI, which was an unsuccessful attempt. Next, SEBI made another unsuccessful attempt in Rakesh Agarwal v. SEBI. The Securities Appellate Tribunal (‘SAT’) held that directions of disgorgement were penal in nature, and therefore SEBI was restricted by section 11B of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”), under which SEBI was only empowered to pass remedial directions. Another endeavour followed this in the Roopal Ben Panchal scam, where, aware of its past, SEBI termed it ‘a useful equitable remedy because it strips the perpetrator of the fruits of his unlawful activity and returns him to the position he was in before he broke the law’. SEBI was cognizant of its past unsuccessful effort and thus characterised it as a ‘useful compensatory remedy’. The disgorgement directed by SEBI was upheld by the SAT. The SAT clarified that since disgorgement aims to strip the unlawful profits from the wrongdoers, the disgorgement amount should never exceed the total gains realised of the illicit act. This was also held in Karvy Stock Broking Ltd. v. SEBI. In Shailesh S. Jhaveri A. v. SEBI, the SAT held that SEBI’s power to order disgorgement was only limited to those wrongdoers who made unlawful gains and that the disgorged amount cannot under no circumstances exceed those gains.
Position of law following the 2014 SEBI amendment
Before 2014, section 11B of the SEBI Act dictated the power to issue directions. In 2014, section 11B of the act was amended to incorporate and establish disgorgement as an exclusive power. Section 12A of the Securities Contract Regulation Act, 1956 (‘SCRA’) and section 19 of the Depositories Act, 1996 are similar to section 11B of the SEBI Act. The former two sections were amended by way of the Securities Law Amendment Act to include the definition and the legislative sanction to disgorgement. Thus, in the context of Indian securities law, SEBI’s power to direct disgorgement has its roots in statutory provision to be found in the SEBI Act, the Depositories Act, 1996 and the SCRA. The amount of money disgorged used to be credited to the Consolidated Fund of India, but now it is to be credited to the Investor Protection and Education and Education Fund. SEBI uses this power to furnish restitution to affected investors and then use such funds coupled with interest thereon for investor welfare and education.
Is disgorgement an equitable remedy or a penal measure?
To delve into the question at hand, it becomes imperative to explore the U.S stance regarding securities law, as the US capital markets heavily influence SEBI. In the jurisdictions of the U.S. and India, disgorgement was neither a punitive measure nor did it dwell with the damages sustained by the victims of the unjust enrichment. It was considered a monetarily equitable remedy. A penalty, by nature, is retributive as it aims at bestowing a punishment. But, on the other hand, the objective of disgorgement is to compel the wrongdoer to give up the profits. This was the standard stance, but the changing trends in the judicial approach coupled with amendments indicate a shift in the nature of disgorgement.
The shift was evident in Kokesh v. SEC, where the U.S. Supreme Court took the approach that disgorgement can be pigeonholed as a ‘penalty’. The Court viewed that disgorgement was awarded due to violating laws against the State rather than affecting the rights of an aggrieved person. In India, the shift in the nature of disgorgement from equitable to punitive was evident as well. The Finance Act, 2018 bought specific legislative changes in 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’. Before the amendment, section 15HB of the SEBI Act conferred the power to impose penalties in case of contravention when no separate penalty was provided. Thus, providing both the equitable remedy and penalty under a single section created confusion regarding the nature of the disgorgement.
Differentiation between penalty and disgorgement vide the Finance Act, 2018
It is essential to focus on the distinction between the terms equitable remedy and penalty. As aforementioned, a penalty indicates a punitive action. It may be pecuniary or corporal in nature and is imposed by the state for an offence against its laws; a mere contravention of the law is enough to invoke the needed provision. The judicial trend across jurisdictions is to draw out a difference between penalty and disgorgement. Traditionally, the position in India was that disgorgement is neither a punishment nor concerned with damages sustained by the affected parties. It is a monetarily equitable remedy and not a punitive measure: Dhaval Mehta v. SEBI (SAT Appeal No. 155 of 2008). It would be useful break down Section 11B of the SEBI Act. It consists of three parts:
- circumstances that necessitate SEBI’s intervention (e.g., need to secure proper management);
- to whom SEBI may issue directions (e.g., stockbrokers); and
- an explanation to the section, which statutorily authorises disgorgement.
1. The Marginal Note to section 11B of the SEBI Act prior to the amendment (to the SEBI Act under the Finance Act, 2018) held power with SEBI to issue directions; and post amendment, it can authorise directions and penalty. To sum up, section 11B used to confer SEBI the power to direct disgorgement. Now, the statutory provision empowers SEBI to direct disgorgement and additionally levy penalties.
2. The Marginal Note to section 15J of the SEBI Act before the amendment enumerated the factors to be taken into account by the adjudicating officer. Following the amendment, it included the factors to be considered while adjusting the quantum of penalty. Evidently, the section now encapsulates the factors considered in determining the quantum of ‘penalty’.
3. Section 15J of the SEBI Act emphasised that while adjudging quantum of penalty, the adjudicating officer would have to have due regards of the following factors:
a. the amount of disproportionate gain or unfair advantage, wherever quantifiable, made as a result of the default;
b. the amount of loss caused to an investor or a group of investors as a result of the default; and
c. the repetitive nature of the default.
Following the amendment, in determining the quantum of penalty under section 15I, section 11B or section 11, SEBI or the adjudicating officer shall have due regard to the aforementioned factors. Thus, section 15J had been further amended to determine the penalty, inter alia, under section 11B, which confines the power to disgorge.
In a scenario where SEBI debars certain individuals from dealing in the securities market, yet they take part in specific legal trades indirectly during the term of debarment, the question arises if the appropriate action would be to levy penalty under section 15HB of the SEBI Act (which envisages a maximum penalty of INR 1 crore) or direct disgorgement of unlawful gains (which has no cap to the maximum amount which can be disgorged)?
Well, in contravention of a SEBI order, both penalty and disgorgement may be awarded but, by its nature, disgorgement is incongruent to penalty. However, a more profound concern is if the gains made from the legal trades during the period of debarment constitute unjust enrichment. The author opines that when a person is debarred from accessing the securities market, any transaction undertaken by such person should be deemed unlawful, notwithstanding the legality of the nature of trade. In Beejay Investments & Financial Consultants v. SEBI, SEBI passed a prohibitory order against individuals restricting them from trading on the securities market. Despite this, they traded indirectly on the market and made profits. Then, the SEBI passed a disgorgement order for violation of the prohibitory order and not for violation of the law. Moreover, in Gagan Rastogi v. SEBI, the SAT held that disgorgement is an equitable remedy and not a penal provision and that the decision in Kokesh was due to certain circumstances and cannot be universally applied.
Further, neither the SEBI Act nor the Limitation Act, 1963 prescribes a limitation period within which proceedings should be initiated by the regulator. Thus, the doctrine of delay and laches is inapplicable. Given that the doctrine is an equitable principle, the courts are unlikely to accept it in the securities enforcement context, considering that the objective is to serve the public purpose by protecting the interests of the investors and preserving the integrity of the securities market.
Disgorgement as a remedy of securities law has its roots in equity which has evolved amidst legal lacune that provided for injunctions and debarments but was unsuccessful to deprive the wrongdoers of their unjust enrichment. It is an equitable remedy because disgorgement squares off the unlawful profits rather than punishing the wrongdoer.
– Anoushka Biswas