US ruling must inform disgorgement review in India

Disgorgement of gains made by wrongdoing is a favourite subject in financial sector regulation. In India, securi­ties law recognises disgorgement of gains wrongfully made and losses wro­ngfully averted. However, there has been intense controversy on the subject with little clarity from the regulator in the absence of any stated policy or set of principles on how the regulator would compute what is the quantum of wrongful gain or wrongful loss.

A judgment on disgorgement by the US Supreme Court rendered last week, specifically in the context of securities regulation, lays down some guiding principles. These issues are often the subject of dispute in India. Indian securities regulations, particularly those relating to market manipulation, are in substance, replicated from the US law on the subject. 

Therefore, our courts and tribunals often look to the rulings of the US Supreme Court to examine how they have dealt with the issues. Inevitably, the American approach to disgorgement comes in for discussion in Indian securities litigation.

First, the US Supreme Court has rul­ed that disgorgement is an equitable remedy and not a punitive remedy. What this means is that disgorgement is meant to remedy the wrong, and not meant to punish the wrong-doer. It is another matter that remedying a wrong can have the effect of wrong-doer feeling punished. However, the core principle is that any attempt to disgorge amounts far in excess of the gains made by the wrong-doer would not be equitable relief and would be punitive instead. The court has held that disgorgement that does not exceed the net profits made would be equitable relief and not punitive.

Second, the court has discussed the need to have regard to restitution of victims with the sums disgorged. Often,  regulators and governments take the stance that evicting a wrong-doer from possession of ill-gotten gains is in itself remedy for the rest of society. De­privation of the wrong-doer is not a self-contained remedy. The Securities Ap­pellate Tribunal has held such a view too in India, that is to say, disgorgement in a vacuum without corresponding effort or intent to restore the victims with the monies disgorged is unacceptable. The explicit ruling by the US Supreme Court would bring this very important facet to distinguish between a penalty and an equitable remedy.  

Merely getting the state to pocket the ill-gotten gains extracted from the wrong-doer would be a penalty and therefore, in order to disgorge monies from private hands, there should be a corresponding intent and effort to identify how to distribute the money. An Indian quick-fix may take the form of sending the money to an investor protection fund. The US Supreme Court has left it to the lower courts (it remanded the case in appeal) to determine on facts if monies are incapable of being distributed and if equitable principles would otherwise be met in such circumstances.

Third, the court has ruled that the disgorgement would have to be of net profits and not of the money earned.  There must be regard for legitimate expenses incurred. This is a vital element, often overlooked when reviewing the impact of the law on the wrong-doer. Often, it is found that the wrong committed is embedded in a lot else that was not wrong. Using disgorgement as a blunt weapon to extract every rupee of income instead of applying one’s mind to what precisely was not wrongful, and deducting legitimate expenses incurred (say, taxes or salaries paid) from wrongful income is an exercise that is brushed aside. The US Supreme Court says courts must have regard to such facts to determine what is the wrongful gain to be disgorged since it is an equitable remedy and not a penalty.

Finally, another blunt measure ado­pted by regulators is to pick the monetary equivalent from any person who is a party to a chain of transactions and imposing a “joint and several liability” — in layman’s terms, any one person may be chased for the wrongful gains made by all. The court has acknowledged that in concerted wrongdoing, collective liability may be imposed, but one must necessarily have regard to the inability to disgorge monies from someone who does not actually possess the wrongful gain.

A dissenting judge has gone further to state that the majority was wrong in permitting regulators to expand “equitable relief” to include disgorgement. According to him, disgorgement, if it is to be considered equitable, should be limited to net profits alone, can never be joint and several in its impact, and must necessarily be meant only to compensate victims.

It is time to empirically study every case of disgorgement effected in India and to study what principles ought to govern the manner of computation of disgorgement. It must be remembered that damages claims are different from disgorgement claims. In India, the regulators do not need to convince any court on the quantum of disgorgement since the regulators are themselves the courts of the first instance. With greater power comes greater responsibility.

The author is an advocate and independent counsel; Twitter: @SomasekharS