Understanding Law of Disgorgement in One Read

Author: Aayush Ashok Kothari

Market regulators, all over the world have used disgorgement as a method of recovering the profit made through illegal means. So, the question arises, what exactly is disgorgement?

In layman’s language, disgorgement means repaying the profit made by a person using unlawful means or unethical ways. So, hypothetically, if Mr. A makes $100 profit by using unlawful means, the court may direct him to disgorge $100 plus interest to the court. Recovering of this amount from the wrongdoer is called “disgorgement”.

Disgorgement serves to remedy securities law violations by depriving violators of the fruits of their illegal conduct.[1]

However, repaying the ill-gotten gains may sound similar to compensation, but it is not the same. So, how does disgorgement differ from compensation? Compensation in its simplest form is making good all the losses incurred by the victims. So, this makes it a remedy in personem.

But in case of disgorgement, it goes beyond compensation, the wrongdoer repays the ill-gotten gains to the government and hence it is a remedy in rem. It may also recover the illegal profits made by the persons through the wrongdoer, from the wrongdoer.[2]Although disgorged funds may often go to compensate securities fraud victims for their losses, such compensation is distinctly a secondary goal.

Justice Baer, in case of SEC v. Lorin[3], stated “I will not label disgorgement a ‘fine, penalty, or forfeiture’ in light of the operation of disgorgement, which merely deprives one of wrongfully obtained proceeds

Disgorgement in India

Security Exchange Board of India (hereinafter referred to as “SEBI) has the power to disgorge the ill-gotten gains under Section 11B of the SEBI Act. However, the origin of this section can be traced back to the 1995 amendment. The statement and object of this amendment show that there was a need to empower the board to makes its own regulations in consultation with the central government.

Therefore, section 11B provides that the directions can be issued to any person or class of persons referred to in section 12 of the Act, or any person associated with the securities market, to any company in respect of matters specified in section 11A of the SEBI Act.

Securities Appellate Tribunal (hereinafter referred to as “SAT”) has explained the concept of disgorgement in case of Karvy Stock Broking v. SEBI[4]. It stated that, in commercial terms, disgorgement is the forced giving up of profits obtained by illegal or unethical acts.

It is neither a punishment nor is it concerned with the damages sustained by the victims of the unlawful conduct. Disgorgement of ill-gotten gains may be ordered against one who has violated the securities laws/regulations but it is not every violator who could be asked to disgorge. Only such wrongdoers who have made gains as a result of their illegal act(s) could be asked to do so.

The amount of disgorgement cannot exceed the total profits realized from the unlawful activity. The onus of proving that it does not exceed the total profit is upon the board.

Further, the SAT, in the case of NSDL v. SEBI[5]also held that, no person shall be directed to disgorge any amount before determining the guilt and whether they have made any illegal gains.

Let us have a look at the most recent case of Gagan Rastogi v. SEBI[6], before the SAT. In this case, the tribunal held that, firstly, equitable remedy demands that disgorgement has to be made from the point of unjust enrichment. Secondly, under the Indian context, disgorgement is treated as an equitable remedy and is not a penal provision.

Lastly, ratio laid down in the Kokesh case (discussed below) is inconclusive and not universally applicable.

Even in the much controversial case of NSE (National Stock Exchange) co-location case, SEBI ordered NSE to pay an enormous amount of Rs.1,000 crores which even includes disgorgement of Rs.625 crores.

So, can SEBI levy interest on the amount disgorged?

In 2017, the Supreme Court of India has, in the case of Dushyant N. Dalal v. SEBI[7], cleared the air on whether SEBI can levy interest on the amount sought to be disgorged. SEBI has been empowered to levy interest by insertion of section 28A which was added by virtue of 2014 amendment.

This section was given retrospective operation, but the court affirmed the SAT’s view and held that charging of interest belongs to the realm of substantive law and not procedural law since it affects the vested rights of the parties. Time and again, the courts have taken the view that substantive laws can only have prospective operation only[8].

It also held that it is the Interest Act, 1978 which empowers the board to charge interest. In conclusion, the court held that the whole-time member (hereinafter referred to as “WTM”) was aware of his powers and SEBI rightfully levied interest on the amount sought to be disgorged.

The quantum of money, its calculation and to whom it is to be paid?

The amount in both these countries is upon the court’s discretion. So, in Asia Texx Enterprise Limited v. SEBI[9], the tribunal held that, when third parties benefit from the illegal activities, such ill-gotten money can be recovered from the violator. The logic of this is that a failure to impose disgorgement on such violators would allow them to unjustly enrich their affiliates.

Similarly, in case of SEC v. Contorinis[10], the court held that even if the third parties benefit from the unlawful activities; such an amount can be disgorged from the violator even if he did not control the funds. Also, in the case of SEC v. Clark[11], it is well settled that a tipper can be required to disgorge his tippees’ profits.

There is no hard and fast rule regarding the calculation of the amount. But firstly, the gains are distinguished into legal and illegal. Secondly, there must be a causal link between the illegal gains and the unlawful activities.

There cannot a determination of the exact amount, so the courts have been conferred with some amount of discretion in this case. Basically, there must be a “reasonable approximation of the profits which are causally connected to the violation”[12]

Now that the offence has been committed against the state. In India, the violator is made to the pay this amount to the court and which is further transferred to Investor Education and Protection Funds (IEPF) whereas, in the USA, it is transferred to the district courts having jurisdiction, which may either reimburse the investors or transfer it to the federal treasury.

In the United States, SEC collected nearly $4 billion in 2018. Hence, disgorgement has proved to be an extremely useful method in deterring bad conduct.

What happened in Kokesh v. SEC?

This is one of the landmark judgment[13]on the law of disgorgement. In 2009, the commission brought an enforcement action against Charles Kokesh, who violated various securities law and misappropriated $34.9 million from four business development companies.

The commission found him guilty on all accounts and sought monetary civil penalties, disgorgement and an injunction. Since a five years limitation period is applicable to all monetary civil penalties by virtue of §2462, the district court held that §2462 is not applicable to disgorgement, because it is not a penalty within the meaning of the statute.

The question before the Supreme Court of the United States was, whether this five-years limitation is applicable to disgorgement? The court held that SEC disgorgement operates as a penalty under §2462 for following reasons.

Firstly, SEC disgorgement is imposed as a consequence for violating laws against the state rather than an aggrieved individual. Secondly, SEC disgorgement is punitive in nature. Thirdly, the disgorged amount is paid to the district court who reimburse the victims, but they are not bound to do so.

Fourthly, disgorgement may sometimes exceed the illegal profits, which does not restore the status quo, but may leave the violator worse off. Therefore, any claim must be commenced within 5 years of the date the claim accrued.

In my opinion, even though disgorgement is not widely used by SEBI as much it is used by its counterpart SEC in the United States. I think SEBI should impose disgorgement on amount more than the provable losses so that it can comfortably deprive the violator of the illegal money and also the difference he earned during the pendency of the proceedings.

On 19th July 2019, the government introduced Banning of Unregulated Deposit Schemes Bill, 2019 in the Lok Sabha. This bill seeks to protect the investors by disgorging the illegal deposits. This shows that this government is relying upon the remedial measure more than ever.

[1] SEC v. Fischbach Corp., 133 F.3d 170, 175 (2d Cir. 1997)

[2] Fishbach Corp., 133 F3d 170, 175 2d Cir 1997] [3] 869 F. Supp. 1117, 1121 (S.D.N.Y. 1994)

[4] [2008] 84 SCL 208 (SAT).

[5] [2008] 84 SCL 60 (SAT)

[6] Appeal No.91 of 2015), decided on 12th July 2019

[7] (AIR 2018 SC 447)

[8](2012) 7 SCC 462 at 484

[9](Appeal 219 of 2015),

[10]743 F. 3d 296,

[11]915 F.2d 439, 454 (C.A.9 1990)

[12]SEC v. Happ 392 F.3d 12 (1st Cir. 2004)

[13][2008] 84 SCL 60 (SAT)

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