TIME TO INTERPRET DISGORGEMENT INTO SCRA: NEED FOR INVESTOR PROTECTION: Part I
[Sneha Rath is a 3rd-year student at National Law University Odisha]
Section 11B of the Securities and Exchange Board of India Act, 1992 ("SEBI Act") empowers the Board to issue directions to and impose a penalty upon any person or class of persons covered under Section 12, or companies in matters covered under Section 11A, and to disgorge an amount that may have been either wrongly gained or loss averted, in the interest of the investors in securities and the securities market. Section 11B of the SEBI Act was inserted through an amendment in 2014 with an aim to incorporate and establish disgorgement as an exclusive power of the Board.
In Indian securities law, disgorgement has its genesis in the statutory provisions of the SEBI Act, the Depositories Act, 1996 ("Depositories Act") and the Securities Contracts (Regulation) Act, 1956 ("SCR Act"). So far, the move to include disgorgement in Section 12A of the SCR Act and Section 19 of the Depositories Act, 1996 through Securities Law Amendment Act was considered a ‘legislative sanction to disgorgement’, until SAT opined in the case of Pawan Kumar Satyanarayan v. SEBI (Pawan Kumar) that disgorgement cannot be traced in the SCR Act. This article examines the issue in depth.
Facts of The Matter
In the case of Pawan Kumar, Heena Developers P. Ltd. (Heena Ltd.) had transferred certain shares of the IFL Promoters Ltd. (the company) to the Notices in off-market transactions. However, Heena Ltd. did not receive any payment from the transfer of such shares. It was thereafter alleged by Heena Ltd. that non-payment by the Noticees had resulted in a violation of Section 16 of the SCR Act read with SEBI Notification no. S.O. 184(E) dated March 01, 2000. SEBI conducted an inquiry and investigation into the alleged irregularities in the scrip of the company. The Adjudicating Officer ("AO"), inquired and adjudged under section 23H of the SCR Act, for the alleged violation of Section 16 of the SCR Act read with SEBI Notification No. G.S.R. 219 (E) dated March 02, 2000 and Sections 13 and 18 of SCR Act read with Section 2(i) of the SCR Act.
A show-cause notice (SCN) was issued, but could not be delivered to the Noticees 1 to 3 and 6 to 8. Noticee 5 replied stating that they had purchased the shares of the company and had immediately paid for the same. Noticee 4 replied stating that they had some commercial dealings with Noticee 1 who had issued a cheque in their favour for an amount of Rs 11,25,000. However, Noticee 1 shared 74,000 shares instead which Noticee 4 sold in an open market and realized about Rs.10,55,004.
After considering all the material evidence on record and hearing the Noticees 4 & 5, the AO made the following observations: By relying on the precedent SEBI v. Classic Credit Limited, the AO was of the opinion that Noticees 1 to 3 and 6 to 8 had admitted to the charges levied against them in the SCN as they neither defended themselves through reply nor appeared for their hearings. He then went on to observe that since the contract for selling of securities between Heena and the Noticees was not executed through any stock exchange platform, it should have qualified for a spot delivery contract under Section 2(i)(a) of the SCR Act as the transfer of shares was done through an off-market transaction. Nevertheless, he ruled that the present matter involving Heena Ltd. does not qualify as a spot delivery contract either, as contrary to Section 2(i)(a) of the SCR Act, there was no payment on the same day as date of contract or the next day of the actual delivery/transfer of shares.
Thereafter, the AO passed an order under Section 23-I of the SCR Act read with Rule 5 of the Rules, whereby a “penalty was imposed on the Noticees under Section 23H of the SCRA for entering into transactions which were not in conformity with Section 2(i) of the SCR Act and thus, contrary to the provisions of Section 13 of the SCR Act”.
In response to the order by the AO, Noticee 4 filed an appeal before SAT. After considering the facts of the case and arguments of the parties, the SAT partially overruled the AO’s order by reducing the penalty from Rs.11,76,600 to Rs. 2,00,000, on the basis that AO’s order lacked the reasoning for the same.
A. Interpretation Of Sections 12A of the SCR Act & 11B Of The SEBI Act: Tracing Disgorgement
1. Indian Jurisprudence on Disgorgement in Securities Law
The SAT had already established in law in the case of Sterlite Industries v. SEBI, that SEBI’s power to direct disgorgement pursuant to Section 11B of the SEBI Act was only remedial in nature. Going forward, the SAT interpreted the nature of the disgorgement principle to be akin to the principle of restitution, so as to strip the wrongdoer off of those gains only that have been accrued by him through unlawful means. This equitable remedy to put the wrongdoer back in the same position where he would have been before he broke the law, was to further investor protection measures in the Indian securities market. With the introduction of the Finance Act, 2018, the powers of SEBI under Section 11B of the SEBI Act were extended to ‘issue directions and penalty’. Since the securities law in India (SEBI) is heavily influenced by the US capital markets, it is imperative to discuss the developments around ‘disgorgement’ in the USA.
2. Reference to developments in the USA’s securities law
Recently, the US Court’s ruling in Liu v. SEC has sparked a debate around the computation of disgorgement in India owing to the fact reinforced in this case that disgorgement has its roots in principles of equity. Prior to this, a major development in the US securities laws was observed when its Court ruled in the case of Kokesh v. SEC that disgorgement is a penal measure. This was the view of the US Court owing to the observation that disgorgement is awarded for violation of laws against the State and not the aggrieved person. The Finance Act, 2018 in India was a response to the development in the case of Kokesh, wherein the same was reflected through the insertion of the word ‘penalty’ in the provision of 11B in the SEBI Act. However, the SAT went ahead to observe in Gagan Rastogi v. SEBI that “Kokesh was issued by applying limitation treating it as a criminal penalty in the facts of that matter and this ratio is not universally followed thereafter”.
3. Tracing Disgorgement Through Interpretation
In the case of Pawan Kumar, the SAT was of the opinion that SCR Act does not contain any provision for disgorgement. However, this seems far from being true. Following are the developments which could support the claim of the author: The 2014 amendment introduced disgorgement as an exclusive power of the Board to correct the wrongs meted out to investors category including individuals, intermediaries, companies or corporations. On a careful reading of the Section 11B of the SEBI Act, Section 12A of the SCR Act and Section 19 of the Depositories Act, it becomes clear that the Board is empowered to take actions against those in the securities market who engage in unfair activities such as illegal profit-making from sale of securities under the SCR Act, illegal trading on recognized stock exchange platforms, etc, thus resulting in sanction for disgorgement. Further, it is evident from the past ruling that SAT has recognized the power of the Board to issue directions for disgorgement.
Mere exclusion of the word ‘disgorge or disgorgement’ does not dilute the power of the Board to issue directions in the nature of disgorgement for equitable remedy and impose a penalty for non-compliance with the provisions of SEBI’s legislations. Moreover, it is reasonable to opine that the objective of disgorgement is for the investors and against the wrong-doers in the securities market. Furthermore, the creation of SCR Act was to regulate one aspect of the securities market i.e. the sale of securities through a contract. Thus, if any entity, individual or corporate tries to act unfairly under the SCR Act’s provisions, it is only reasonable that they should attract a penalty for the same.