Upholding disgorgement principles

SAT has consolidated and reaffirmed key principles to guide Sebi’s power to order disgorgement.

sebi, markets
Sebi’s order against NSE and its senior management, to the limited extent of disgorgement was set aside. (IE)

By Sandeep Parekh

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Capital markets operate under a constant threat of malpractices that benefit a select few at the cost of public investors and market integrity. Wrongful conduct such as insider trading, front-running, fraudulent schemes, etc. often results in an unlawful gain or avoidance of loss for the wrongdoer.

Over the years, disgorgement has evolved as a remedial measure to deprive a wrongdoer of gains due to wrongful conduct, termed ‘unjust enrichment’ in legal parlance, and restore status quo ante in the securities market.

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Disgorgement is a gain-based, equitable remedy which seeks to reverse the unjust enrichment of the wrongdoer by stripping them off the fruits of their illegal conduct and placing them in the same position as if no wrongdoing had happened. Under the Securities and Exchange Board of India Act, 1992 (Sebi Act), Sebi is empowered to direct disgorgement of an amount equal to the profit made or loss averted by indulging in any activity in contravention of the Sebi Act or regulations. While determining the amount of disgorgement, factors such as the amount of unfair gain made by the person, liability of connected persons as joint tortfeasors, the amount of interest payable on the disgorgement amount, etc are considered.

The Securities Appellate Tribunal (SAT), in its recent orders in the matters of National Stock Exchange (NSE) v. Sebi and SRSR Holdings Pvt. Ltd. v. Sebi reaffirmed key principles governing Sebi’s power to direct disgorgement of illegitimate gains.

The NSE co-location order

The SAT, by an order, set aside the massive disgorgement order of Rs 624 crores passed by Sebi against NSE for granting brokers preferential access to its co-location facilities. The matter dates back to an order passed by Sebi in 2019, directing NSE to disgorge the sum based on NSE’s revenue from operations, along with 12% interest from April 1, 2014. The senior management of NSE in charge at the relevant time, Ravi Narain and Chitra Ramkrishna, were also directed to disgorge 25% of their salary during their tenures.

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On appeal, SAT held that disgorgement can only be directed in cases where a person has made profit through illegal or unethical means, and observed that NSE’s failure to comply with any provision of the Sebi Act or any regulations formed therein, cannot be the basis of an order of disgorgement, and could lead to the imposition of a penalty at best. However, considering NSE’s failure to fulfil its obligations as a first-level regulator, a direction to deposit a sum of Rs 100 crore in Sebi’s Investor Protection and Education Fund was passed against NSE. Further, NSE’s senior management were not found to have made any illicit gains. SAT noted that the order for disgorgement of 25% of their salary was incorrect, as the salary was received for services offered in a professional capacity as opposed to a profit. In SAT’s view, such direction is tantamount to penal action rather than the equitable remedy that disgorgement is envisaged to be.

Thus, Sebi’s order against NSE and its senior management, to the limited extent of disgorgement was set aside. While arriving at its findings, SAT stated that the direction to disgorge must be in relation to an activity which contravenes the provisions of the Sebi Act or regulations and results in illegitimate profits and cannot be imposed for mere non-compliance of a circular. The direction must also be preceded by a finding of ill-gotten gains made by a person by virtue of engaging in unethical acts, and establish a causal nexus between the wrongful conduct and gains. In terms of quantum, SAT observed that the disgorgement amount shall not exceed the wrongful gain in question.

The Satyam order

In 2018, Sebi directed B Ramalinga Raju along with his two brothers and SRSR Holding Pvt. Ltd. (SRSR) to be disgorged of Rs 813.40 crore along with a 12% interest per annum from January 14, 2009, i.e., the date when the Satyam scam was unearthed. The matter related to the transfer of shareholding in Satyam Computer Services by the Raju brothers to SRSR, which, in turn, pledged shares and raised funds from third-party borrowers, using shares with artificially inflated prices. Aggrieved by the calculation of the disgorgement amount by Sebi, the Raju brothers and SRSR filed appeals against a Sebi order before SAT. While adjudicating on the appeal, SAT analysed pertinent questions such as joint and several liability of different appellants for disgorgement, the relevance of intrinsic value of shares for calculation of disgorgement, and the calculation of interest payable.

In terms of the appellants’ liability for disgorgement, SAT stated that the disgorgement of unlawful gains does not have to happen jointly and severally by different appellants. Disgorgement depends on whether the persons are acting in concert and if the damage caused by each wrong-doer (tortfeasor) is divisible. SAT further held that even if the persons were acting in concert and the damage caused by the joint tort-feasors is divisible, then each of them is liable only for damage attributable to them, individually. SAT found that the appellants made a series of acts at different point of time, the liability attributable to each appellant is divisible and thus, the appellants would only be liable to pay the unlawful gains attributable to their own act. Sebi had adopted the “net profits” method, i.e., amount realised by the sale of shares on deduction of the acquisition cost and taxes payable. In the absence of information pertaining to acquisition costs, Sebi had considered the acquisition cost as nil for the purpose of calculating illicit gains. On appeal, SAT clarified that the same is not permissible and Sebi is required to arrive at some costing of the value of shares. Sebi further held that the underlying and intrinsic value of the shares cannot be considered a component of unlawful gains and must be deducted while quantifying the unlawful gains and cannot be assumed to be nil.

With respect to interest, SAT held that interest becomes payable after computation of the disgorgement. When the disgorgement amount is set aside, the imposition of interest is too. Thus, in light of the low interest charged in other orders passed by Sebi, SAT remanded the matter to Sebi to reconsider charging an interest rate of 12% p.a.

Based on these findings, the matter was remanded to Sebi to pass a fresh order, with a direction to consider the intrinsic value of shares while calculating unlawful gains, which must be calculated individually. Through these orders, SAT has consolidated and reaffirmed key principles to guide Sebi’s power to order disgorgement while also restricting the scope of disgorgement to contraventions that result in illicit gains as opposed to all instances of non-compliance. SAT has provided clarity on key concepts like calculation of disgorgement amount, imposition of joint and several liability on accused persons, and the interest to be levied on the amount liable for disgorgement. These principles would define and channelise Sebi’s powers of disgorgement.

The writer is Managing partner, Finsec Law Advisors

Rashmi Birmole and Anirudh Sood contributed to this article

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First published on: 09-03-2023 at 04:00 IST
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