An Analysis of the Dilution of the Equitable Nature of Disgorgement
The author, Keya Rebello, is a 5th Year B.A L.L.B. (Hons.) student at School of Law, CHRIST (Deemed to be University), Bangalore.
There is a considerable degree of confusion surrounding the legal nature of disgorgement proceedings in India, especially considering the amendments that have been made to the Securities and Exchange Board of India Act, 1992 and the changes in the jurisprudence of securities law in the United States.
While disgorgement is generally considered to be an equitable remedy since it can be traced to the principle of restitution, given recent developments, disgorgement may also be considered deterrent in nature. Section 11B of the SEBI Act was amended in 2014, to include disgorgement within the scope and ambit of the overarching powers of the Board. However, the changes made to the SEBI Act by means of the Finance Act of 2018, have watered down the distinction between the equitable and punitive nature of disgorgement.
Furthermore, in the landmark case of Kokesh v. Securities and Exchange Commission, the Supreme Court of the United States held that disgorgement could be considered a punitive measure in certain specific instances. The position in India was clarified in the case of Gagan Rastogi v. SEBI where it was held that disgorgement is an equitable remedy. However, the current stance does not address the unavoidable obligation to deter future violations, considering that one of the primary objectives of SEBI is to safeguard the securities market.
This article will analyse whether the conflict between the dual nature of disgorgement is reconcilable, in the absence of legislative clarification. Additionally, it will also delve into the necessity to resolve this conflict, given that the nature of disgorgement will have a pronounced impact on issues of liability, particularly when the offences in question are related to fraud, diversion of funds and financial mismanagement.
BACKGROUND
Disgorgement, according to Black’s Law Dictionary, is the “act of giving up something (such as profits illegally obtained) on demand or by legal compulsion.” [1] It is conceptually traced to the principle of restitution considering that it is a profits-based remedy. Securities law in India is a dynamic and constantly evolving body of law, and is to a large extent, affected by changes in American jurisprudence.
In India, the 2014 Amendment to the Securities and Exchange Board of India Act, (hereinafter referred to as the ‘SEBI Act’) clarified that the powers of SEBI would be inclusive of the power to direct the disgorgement of any profit or averted loss made through a transaction in violation of the provisions of the Act or any regulations made thereunder. [2]
Disgorgement has been extensively interpreted and evolved through the course of many precedents. Initially, the principle of disgorgement was not held to be applicable in an Indian context, particularly, in the case of Rakesh Agarwal, [3] however the turning point, was the Roopal Ben Panchal case, [4] where the Court applied the principle of disgorgement, and specified that it was an equitable principle. This case was the foundation of the general approach taken by Courts in India which clarified that disgorgement was, in fact, an equitable remedy.
However, of late, courts seem to have adopted a more deterrent approach when it comes to disgorgement, in order to protect the securities market and deter future violations. The dichotomous relationship between the equitable and punitive nature of disgorgement must be analysed on the basis of two limbs. Firstly, the terminology employed in the SEBI Act, and the changes that have been effectuated through the amendments. Secondly, the effect of American precedents on Courts in India.
I. TERMINOLOGY EMPLOYED IN THE SEBI ACT
The terminology employed in the SEBI Act is indicative of the sententia legis thus implying that the argument in support of disgorgement as an equitable remedy can be traced to the structure of the Act. Penalties are provided separately in the Act from Section 15A to Section 15HA. If disgorgement were to be considered a penal remedy it would not have been provided separately under Section 11B. [5] Moreover, Section 28A differentiates between a failure to pay a penalty and a failure to comply with a direction for disgorgement. Thus, it can be reasonably inferred that the legislature intended to draw a difference between disgorgement and other penalties levied under the Act.
Conversely, the Finance Act of 2018 seems to indicate that the equitable nature of disgorgement has been watered down. [6] The title of the marginal note to Section 11B was “power to issue directions” prior to the 2018 Amendment. However, after the amendment, it became the “power to issue directions and penalty.” This would indicate that disgorgement could be considered a punitive measure.
Additionally, the title of the marginal note to Section 15J of SEBI Act before the amendment was “factors to be taken into account by the adjudicating officer”. After the amendment, it became, “factors to be taken into account while adjudging the quantum of penalty”. By way of this amendment, it is now clear that Section 15J enumerates the factors to be considered in the determination of quantum of ‘penalty’. Thus, there is a considerable degree of confusion about the nature of disgorgement based on the provisions of the Act.
II. AMERICAN PRECEDENTS
Although American precedents are persuasive in value, they have been applied during multiple instances in an Indian context. In the case of Securities and Exchange Commission v. Kokesh, [7] the equitable nature of disgorgement was diluted when the Court held that the 5-year limitation established by Section 2462 of the United States Code was of a punitive and not equitable nature, as applicable to the proceedings of the Securities and Exchange Commission. Apart from the fact that the Kokesh case was related to a very specific matter, it was overruled in the Charles Liu case where the American Supreme Court held that disgorgement is equitable in nature. [8]
Furthermore, the Kokesh case is inapplicable in India, because the Securities Appellate Tribunal clarified the dilemma in Gagan Rastogi v. SEBI where it held that disgorgement in India is equitable and not penal, and that the ratio of the former case was limited to specific facts and circumstances and, thus could not be universally applied. [9]
CONCLUSION
In conclusion, it is clear that disgorgement in India is an equitable remedy, in line with the approach adopted by the courts. However, if disgorgement is an equitable remedy, this would not explain how courts have time and time again held that key managerial personnel are jointly and severally liable in disgorgement proceedings, particularly in instances of insider trading, diversion of funds and fraudulent activities under the Prohibition of Fraudulent and Unfair Trade Practices Regulations, 2003. [10] Disgorgement, as an equitable remedy is rooted in individual liability, however, when the directors of a company have committed fraud, there may be a need to deter future violations, especially given the seriousness of fraud as an offence.
The objective of Section 11B is relevant to determine the purpose of disgorgement. The purpose of disgorgement is to protect the securities market, which means that there is a consequent need to deter transactions which directly or indirectly facilitate unlawful enrichment especially when the directors were aware of and possibly profited from such enrichment. In the absence of clarification from the legislature, these factors will be of the utmost importance, to determine the nature of disgorgement.
[1] BLACKS LAW DICTIONARY, (11th ed.).
[2] Securities Laws (Amendment) Act 2014, No. 27, Acts of Parliament, 2014 (India).
[3] Rakesh Agrawal v. Securities and Exchange Board of India, (2004) 1 Comp. L.J. 193 SAT.
[4] In Re Roopal Ben Panchal, WTM/GA/60.ISD/04/06.
[5] Securities and Exchange Board of India Act, 1992, §11B, No. 15, Acts of Parliament, 1992 (India).
[6] Finance Act, 2018, No. 13, Acts of Parliament, 2018 (India).
[7] Kokesh v. Securities and Exchange Commission, 137 S. Ct. 1635 (2017).
[8] Charles Liu v. Securities and Exchange Commission, 140 S. Ct. 1936 (2020).
[9] Gagan Rastogi v. Securities and Exchange Board of India, 2019 SCC OnLine SAT 79.
[10] Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations 2003.
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