Sucheta Dalal :SEBI orders fail twice over in disgorgement case
Sucheta Dalal

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SEBI orders fail twice over in disgorgement case  

Dec 4, 2007

SEBI asked to complete investigations establish guilt and hand out penalties


By Sucheta Dalal


SEBI’s (the Securities and Exchange Board of India) “first-ever” disgorgement order of 22 November 2006 ended in a fiasco last week, as did its directive to the promoters of NSDL (National Securities Depository Limited) to implement management changes.


Both orders of the regulator had been issued in a blaze of publicity. The disgorgement, was a first ever effort to repay investors who were cheated – although in this case, it was more of a loss of opportunity, when IPO allotments were dubiously cornered through tens of thousands of illegal multiple applications.


However, even a simple reading of the orders made it evident that they were ill conceived and were bound to fail in an appeal. Even an ordinary person knows three things: that the principles of natural justice demand that guilt has to be established before deciding a penalty; secondly, that unlike a penalty imposed on a wrongdoer, only someone who has made illegal gains can be asked to disgorge them and conversely, an entity that has not made any illegal gains cannot be made to disgorge them. But this is exactly what SEBI, in its wisdom, ordered at the end of November 2007 – it also found fit to issue ex-parte orders against institutions such as the depositories, who are unlikely to run away or shut shop, without giving them a hearing. What is more, in the entire year while the matter went into appeal, SEBI made no attempt to bolster its case by completing investigations and establishing guilt and illegal enrichment.


To recap, a year ago, SEBI directed 10 entities to cough up Rs 115.81 crore within six months as disgorgement for their role in the multiple application scam. They included the two depositories NSDL (National Securities Depository Limited) and CDSL (Central Depository of Securities Limited), Karvy Stock Broking, HDFC Bank, Khandwala Integrated Financial Services, IDBI Bank, Jhaveri Securities, ING Vysya Bank, Pravin Ratilal Share & Stock Broking and Pratik Stock Vision who were held jointly and severally liable.


Let us look at exactly what happened before SAT. The facts are that SEBI issued an ex parte, ad interim order dated 27 April 2006. It also agreed before the SAT that its investigation proceedings were still in progress at various stages. And, Justice N.K.Sodhi observed, ‘strangely enough, even before determining the guilt if any the board has ordered them to disgorge Rs 115.82 crore on 21th November 2006’. SEBI had also ‘not established whether the entities indicted in the disgorgement order had made any ill-gotten gains’. While it has not issued a show cause notice to those indicted, the wording of the order suggested that ‘there would be no separate hearing granted (to the accused entities) and the findings of SEBI’s order would be coterminous with the findings of the enquiry’. This, said the learned judge, was a clear violation of the principles of natural justice.


In a nutshell the SAT order observed the following:

  1. The board cannot ask anyone to disgorge without first determining guilt as well as illegal gains.
  2. Every erring entity cannot be held liable to disgorge. Only those who have made illegal or unethical gains can be asked to disgorge their ill-gotten profit.
  3. The issue of disgorgement should have been decided only after passing final orders establishing guilt.

Consequently, SAT set aside the order.


If this were not enough, SEBI also ate humble pie with regard to its other directive (as part of the same disgorgement order) to the promoters of the National Securities Depository Limited (NSDL) to “to take all appropriate actions to revamp management without further loss of time and to ensure that the direction was strictly enforced”. This directive also went into appeal and was (Appeal No.78 of 2006) decided on 22nd November 2007. Justice N.K.Sodhi was the presiding officer.


In this case, SEBI did give NSDL a hearing and its order to revamp management was in fact treated like a show cause notice. Strangely enough, after the hearing, SEBI failed to pass any final order until the NSDL appeal came up for hearing.


Instead, Rafique Dada, the senior counsel for SEBI told the SAT court that “the observations made in the impugned order, including those in paras 17.14 and 17.18 (directing revamp of management) were only prima facie observations made in aid of the show cause notice and final orders will be passed by the board on consideration of the material collected in the course of the investigation”.


He further stated that directions to the promoters of NSDL to revamp management were not mandatory and had also been made in aid of the show cause notice.

In view of these statements, the appeal was dismissed as infructuous and SAT ordered expeditious completion of the investigation that has been pending since 2006.

SEBI’s order, its failure to follow them up and their ignominious failure before the appellate authority have once again highlighted the arbitrary and capricious functioning of the regulation under its present Chairman.


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-- Sucheta Dalal