Can the Securities and Exchange Board of India make a fraudster or other wrong doer in the securities markets compensate the wronged persons? The answer, generally, is that SEBI cannot do so. This question is important because the parties are normally required to approach other forums which could include courts, Consumer Protection Forums, etc. However, a recent order of SEBI, following an order by the Securities Appellate Tribunal, has opened the door to this aspect to a little extent. This order is significant for several reasons. SEBI is an expert body in the securities markets with fairly broad powers. It has a huge infrastructure at its command to investigate, adjudicate and punish. The groundwork for determining whether a person has committed such a fraud, etc. would be laid down by SEBI through such orders. SEBI also has, as we will see later, the powers to disgorge gains made by wrongdoers. In some cases, such as in the alleged scams in initial public offerings, SEBI even went the extra mile and made arrangements for distribution of these illegal gains to those at whose cost such gains were made. The next logical step ought be to allow such things on a general basis and perhaps even allow persons who have suffered losses to approach SEBI.
However, this has not happened mainly because of certain inherent limitations on SEBI under the law. SEBI is not an adjudicator of disputes. It would surely punish fraudsters. It may debar them from markets. It may make them pay penalty, though such penalty goes in government coffers and not to help those who lost monies. It may prosecute such persons too. It also orders parties who have illegally collected monies to refund them , with interest. However, an aggrieved person could not approach SEBI and require it to make a wrongdoer compensate the loss he had suffered. Indeed, till recently, it was a little uncertain whether SEBI had powers even to disgorge illegitimate gains. A clarificatory amendment was however made in 2014 to explicitly give such powers to SEBI.
However, compensating loss caused by fraudsters continued to remain out of SEBI’s legal powers. The investors were thus forced to approach the long drawn procedures in courts. An investor may get some satisfaction when such fraudsters are punished, but he still would remain short of his hard earned monies. However, thanks to persistent efforts of an investor who lost money to a company and its Promoters through fraud, there is a glimmer of hope that SEBI may be required to do broader justice in such matters. By a recent decision of SEBI, which indeed was following the directions of the Securities Appellate Tribunal (“SAT “), SEBI has acknowledged such responsibility. A final order is awaited, since calculation of ill-gotten monies is in progress. While it would be interesting to see the legal reasoning SEBI provides for passing such final order and also see its fate in appeals, if any, it would be worth to consider this decision.
SEBI’s decision
The decision was in case of the applicants Harishchandra and Ramkishori Gupta (“the Applicants”) in the matter of Vital Communications Limited (“Vital”)(SEBI Order dated 1st April 2016).
To summarise from the facts as narrated in the Order, Vital, a listed company, had made a preferential issue of equity shares to certain parties. SEBI found that a significant portion of the funding for such preferential issue was made by Vital itself. Many of the preferential allottees were also found to be connected to Vital/its Promoters. Thereafter, a spate of catchy advertisements were issued of proposed buyback of shares at a high price, preferential issue at even higher price, and for issue bonus shares. None of this actually took place in the manner described in the advertisements.However, along with such advertisements, certain preferential allottees sold a substantial quantity of shares. Effectively thus, the advertisements helped the parties to sell equity shares at a high price to unsuspecting investors. Since the ruling price then was much lower than the price that could be expected if the promises as per the advertisements had actually been carried out, investors rushed in and bought the shares. SEBI investigated and uncovered the facts and took action against the parties by debarring them, etc.
However, this left the investors with losses. The Applicants approached SEBI praying that their losses should be compensated. SEBI refused to do claiming that it had no powers under SEBI Act to order the company and/or its directors to compensate the Applicants. The Applicants filed an appeal to the SAT. SAT ordered that if SEBI found Vital guilty of fraud, “…it may consider directing the concerned entity or Vital to refund the actual amount spent by the applicants on purchasing the shares in question and with appropriate interest”.
SEBI undertook final investigation and did find wrongdoing and fraud. SEBI passed various directions against the parties. However, still, it did not pass orders providing for compensation to the investors who were duped into making investments. The Applicants once again appealed to SAT . SAT once again passed an order asking SEBI to do the needful. SEBI then passed an order that it will look into quantification of ill gotten gains and thereafter pass orders for disgorgement and restitution. It then thus finally gave a proper hearing to the Applicants on the issue of compensation. However, on review, SEBI found that its own orders/investigation had not made a proper calculation of the ill gotten gains by the Company/ Promoters. Accordingly, finally SEBI undertook vide this recent and latest order to determine the amount of ill gotten gains to take the matter to its next and final step of ordering such parties to return (i.e., effectively compensate) the gains made to the Applicants, who suffered losses. Interestingly, while the original fraudulent advertisement & sale of shares took place in 2002, it is only in 2016, after several petitions and appeals by the Applicants that SEBI has initiated action. It will still be some time before the amount of ill gotten gains would be calculated, then hopefully recovered from the parties and paid to the Applicants who have suffered losses.
Disgorgement – a history of uncertainties
Disgorgement, simply stated, is taking away ill-gotten gains from the wrong doer. A person may, for example, make gains from insider trading in violation of the applicable Regulations. SEBI may order such person to disgorge such gains and pay them over to SEBI. Till very recently, whether SEBI could, in law, order disgorgement was debated. However, the SEBI Act was amended vide the SEBI (Amendment) Act, 2014, with effect from 18th July 2013, specifically giving it power to disgorge gains made in violation of specified provisions of law. However, even these amendments expressly permit only disgorgement. The objective is only to ensure that the wrong doers do not keep their ill gotten gains. They do not specifically expressly provide for payment of these disgorged amounts to those who were at the losing end (though SEBI has passed some orders of such type). Further, it was still unclear law whether an investor can initiate such action. Now, this order creates a precedent that SEBI can undertake such exercise of disgorging such ill-gotten gains and then reimburse them to those whom they belonged.
Limitations
An important distinction to be made here is that this case is no precedent for investors being able to approach SEBI to get general disputes resolved and get the whole of their losses recovered. It only means that SEBI will disgorge gains made from acts/omissions in violation of specified securities laws. And that only such gains will go back to the hands of investors. The investors may have suffered a higher loss, but if its flow cannot be traced to the pockets of such wrong doers, then there may be nothing to recover to that extent. Thus, the investor may not get the whole of their losses compensated.
In any case, if SEBI cannot recover such monies as for example when the fraudsters do not have sufficient assets, the investors would still have lesser amounts to receive.
However, SEBI/SAT has ordered that interest shall also be disgorged and paid, irrespective of whether the fraudster had earned such interest or not. This, though an extension of the power of disgorgement, does give relief for the time element.
There is another type of situation where there may be fraud but the amount of gains made by the fraudster may not match with the losses of the investor. For example, a broker/adviser may give wrongful/fraudulent advice to gain commission fees. The investor may invest monies and then end up losing a large sum of money. However, disgorgement permits forfeiture of ill-gotten gains. In such a case would include only the brokerage/fees, which would be a small fraction of the loss. A purely contractual or similar dispute will not be covered. These continue to remain within the domain of civil courts, stock exchanges, etc.
Scope of disgorgement
As the amended Section 11B makes it clear, disgorgement is of all gains made from violations of SEBI Act and Regulations. Thus, gains made not just from fraud but from any violation of specified securities laws. Thus, even though the decision in this case related to a fraud, the principle would clearly extend to gains from any other violation of Securities Laws. And thus, those who suffer on account of violation of Securities Laws may get compensated.
Conclusion
A fresh, even if hesitant and incomplete, chapter has opened in the history of Securities Laws. While it is too early to draw final conclusions, investors now do have a better measure to recover their losses that is formal, speedier and effective. However, much depends on the final order, the manner in which losses are determined and recovered and also the legal reasoning SEBI adopts for such order. It will also have to be seen whether such orders are appealed against and what appellate Tribunal/ courts decide. The fact that the orders of SAT and SEBI both talk of restitution to be “considered in accordance with the provisions of the SEBI Act, 1992 …and the regulations framed thereunder” is also interesting since there could still be some legal uncertainties about the whole process
