Wednesday, June 22, 2016

Disgorgement of profits – profits made in violation of SEBI directions vs. profits made in violation of law

In perhaps a first, SEBI has ordered impounding of profits that were made through legitimate and non-manipulative trades though in violation of SEBI directions not to trade.

An earlier order against certain persons had “prohibited them from buying, selling or dealing in the securities market, directly or indirectly, till further orders.”. While such directions were in force, such parties allegedly dealt in securities indirectly and earned huge profits.

SEBI ordered impounding of such profits of Rs. 27.44 crores (including interest of Rs.8.45 crores @12% pa till date of order). This is pending completion of investigation after which SEBI may pass final orders for disgorgement of such profits.

The order is interesting. The earlier order prohibiting them from such dealings was because of alleged market manipulations by such persons. However, while the parties violated this order of prohibition, they did not carry out any manipulations in such dealings. The profits have been made from dealings in securities that were otherwise in ordinary course of business. The interesting question is whether such profits can and should be subject of disgorgement.

The explanation to Section 11B of the SEBI Act clarifies that SEBI has power to order  disgorgement of “wrongful gains” made “by indulging in any transaction or activity in contravention of the provisions of this Act or regulations made thereunder”. The question is whether this would include profits made in contravention of directions of SEBI. The requirement also is that such “wrongful gains” should have been made “by such contravention”. Whether such gains can be said to be “wrongful” and also whether they are made “by such contravention”.

SEBI does have power to levy penalty where any person does not comply with directions of SEBI. Section 15HB provides for a penalty of upto Rs. 1 crore on a person who “fails to comply with any provision of this Act, the rules or the regulations made or directions issued by the Board”.

Whether SEBI should disgorge such amounts is also an interesting question. For answering this question, an incidental question could be whether such directions were punitive or preventive (decision of Supreme Court in SEBI vs. Ajay Agarwal ((2010) 3 SCC 765) is relevant here). A person who indulges in manipulative transactions may be prevented from repeating them by prohibiting him from dealings in securities. However, if he yet carries out such dealings, albeit in a legitimate manner without any manipulations, he can be penalised for violating the directions. Should he be asked to surrender the profits made too? The penalty of Rs. 1 crore under Section 15HB would not be a sufficient deterrent to a person who has opportunity for making, as in the present case, far higher profits.

One looks forward to the final order in this case. Hopefully, if it does order disgorgement, it also gives detailed reasoning and legal basis for disgorgement in such situations.

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