By kartik singh, a second-year STUDENT OF at NLUO, CUttack
Disgorgement refers to the repayment of unlawful profits earned by an individual arising from unlawful activities. Disgorgement of ill-gotten profits has been a potent tool for global regulatory authorities in preserving the interests of the stakeholders in the securities markets. In spite of having a provision to that effect incorporated under Section 11B of the SEBI Act, 1992, added by an amendment in 2013, the Indian market regulatory authorities have been hesitant in enforcing such powers, primarily due to the lack of clarity in the legislation itself and precedents thereof as to how the amount for disgorgement must be computed. The Indian courts and tribunals, thus, often look to foreign pronouncements on the subject.
The Indian regulatory law for disgorgement has been inspired by the provisions of the US securities law, therefore, the developments in the US securities market are of considerable importance to the Indian regulatory regime. Recently, the US Supreme Court’s decision in Liu v. SEC has thrown light on the issue of the quantum and computation of disgorgement amount by expounding certain guiding principles for the same. Considering the absence of such a computation mechanism in the Indian securities regulations, the ruling serves as an example for India.
The Securities and Exchange Commission (‘SEC’) charged Charles Liu and Xin Wang with defrauding Chinese investors of a project that the couple falsely claimed met the requirements of the Immigrant Investment Program, following which they diverted the investment funds to overseas marketers and by paying themselves generous salaries. Proceedings were initiated against them and the matter ultimately reached the US Supreme Court.
Observations of the US Supreme Court: A guiding example for the Indian Framework
Firstly, the US Supreme Court categorically observed that the power to order disgorgement must not be viewed as a “punitive remedy”, rather it must be considered as an “equitable remedy” i.e. the same must be meant to remedy the wrong and not to punish the wrongdoer. The amount ordered to be disgorged must not exceed the amount of ill-gains gained by the wrongdoer, the contrary of which would fall within the ambit of a “punitive remedy”. The Securities Appellate Tribunal (‘SAT’) in Gagan Rastogi v. SEBI and Shadilal Chopra v. SEBI had too observed the same principle. The US ruling further exemplifies the principle by providing useful direction to enable the courts and tribunals to differentiate between an equitable order and a punitive order.
Secondly, the Supreme Court noted that the process of disgorgement must be followed by the restitution of such amount to the victims of the wrongdoing. It is often observed that the regulatory authorities disgorge the amount and then claim to have brought justice to the victims. The US Supreme Court depreciated such practice and observed that the true essence of the disgorgement provision would only prevail if the process of restitution of the disgorged amount is followed. Emphasizing the point that mere collection of the disgorged amount and depositing the same in the government treasury would amount to a penalty, the Supreme Court ordered to follow the principle of restitution. To facilitate this, the regulatory authorities must consider the number of stakeholder/victims of the wrongdoing and pass necessary order to protect their interests. A similar approach has been adopted by SAT in Ram Kishori Gupta v. SEBI, wherein it observed the exclusion of principle of restitution in the disgorgement process to be unacceptable, remarking “disgorgement without restitution does not serve any purpose”. Again, the backing of the US Supreme Court on the aforesaid principle augurs well for the Indian securities framework going forward.
Thirdly, the US Supreme Court noted that the disgorgement of money must be computed based on the net profits earned by the wrongdoer and not from the money earned from the wrongdoing. It must be taken into account that the wrongdoer may have incurred certain legitimate expenses during the course of wrongdoing. It would be unfair to account and extract such legitimate expenses through the process of disgorgement. Depreciating such practice of the regulatory authorities, the court remarked that there have been instances where they have used disgorgement as a tool to shirk their responsibility of applying their mind in order to compute the “actual” amount for disgorgement i.e. by deducting the legitimate expenses incurred by the wrongdoer.
In the Indian framework too, it is often seen that the authorities order to disgorge the entire amount in question instead of acknowledging the legitimate expenses of the wrongdoer. The US Supreme Court acknowledging such facet said the same can be done by analysing the facts and circumstances of each case, following which the remedy would be truly equitable in nature.
Lastly, the court also raised concerns about the repeated use of the “jointly and severally liable” principle by the regulatory authorities. Generally, fraudulent activities are committed by several individuals in connivance of each other. Consequently, authorities punish or impose a penalty on one of the wrongdoers for the acts of others using the ‘jointly and severally liable’ principle. The court was of the opinion that although the use of such principle is justified and may be reasonable in circumstances peculiar to a case, however, in cases of disgorgement authorities must be mindful of the person being asked to disgorge the amount unlawfully gained by the wrongdoers as such person may not actually be in possession of the unlawful gains, thereby impeding his ability to disgorge the amount to the regulatory authorities.
The US ruling has certainly paved the way for developing a mechanism to ascertain the disgorgement amount from the wrongdoer. While it may be argued that the securities market of the US is different than that of the Indian market, the principles enunciated by the court form the basic structure and the essence as to the computation for disgorgement. Disgorgement differs from a claim of damages, the former being a right in rem and the latter being a right in personam, thus, the method developed by the courts over the years in computing claims for damages must not be applied for the purpose of disgorgement.
Further, disgorgement, especially in the Indian context, allows the regulators to be more liberal in deciding the quantum since they are themselves the court of first instance. The concept of disgorgement is still at a nascent stage and it is expected that the US ruling would guide the development of the subject in India.