MC Explains: Why recent SC order in a pump-and-dump case delivered a jolt to SEBI

SEBI's mandate does not include compensating investors who were defrauded, said regulatory experts.

A recent Supreme Court order has ruled that market regulator, Securities and Exchange Board of India (SEBI), cannot re-open a case on which it has already passed a final order.  This judicial principle is called res judicata and applies to SEBI as per the apex court.

Citing previous cases that debated the same principle of law, the apex court ruled on April 7, "it is not open to SEBI to claim that it could pass multiple final orders on the same cause of action." Legal experts believe this can be a double-edged sword.

What was the case?
The case, in which SEBI was the appellant and Ram Kishori Gupta and ANR (and another) were the respondents, started with a SEBI investigation into a pump-and-dump operation in 2005.

The regulator found that telecom equipment supplier Vital Communications Ltd (VCL) and its promoters were involved in allotting shares to 15 companies which were connected to VCL. These companies then bought VCL's shares using funds given by VCL and then sold them in the open market. SEBI banned the company and the other noticees (entities against whom the order was passed) from the securities market for varying periods of time. The regulator then said that neither the company, its promoter group or the preferential issue allottees had made any gain out of the whole exercise and,therefore, did not issue any direction to them to disgorge illegal gains.

Later, Ram Kishori Gupta and Harishchandra Gupta, who had incurred losses from buying the shares, filed appeals to the Securities Appellate Tribunal (SAT) to direct SEBI to reconsider its decision. They wanted to be compensated for their losses to the extent of Rs 52.53 lakh.

SEBI reinvestigated this case and, in 2018, passed an order holding 22 of the earlier 24 notices jointly and severally liable to disgorge gains of Rs 4.55 crore and asking them also to pay an interest of 10 percent per annum from August 1, 2002, around the time the shares were dumped in the open market. But it did not direct the company or its directors to selectively compensate the Guptas, saying that that it would be unfair to compensate a few investors selectively. The Guptas and four of the order's notices including VCL appealed against this order.

SAT in 2019 directed SEBI to compensate the Guptas to the extent of their investment from the Investor Protection and Education Fund (IPEF), and in 2021, said that the disgorgement order was barred by the principle of res judicata. SEBI then filed at appeal with the top court, to appeal against these directions.

How will this affect the regulatory proceedings?
After this, SEBI is more likely to expend more resources and take more time with passing their final orders, according to legal experts.
Sanjay Israni, Partner at Desai & Diwanji, said, "This precedent means SEBI must ensure that its initial orders are comprehensive, addressing all possible violations and remedies like disgorgement at the outset. As a result, SEBI will likely allocate more time and resources to investigations and order drafting to avoid missing critical elements that cannot be addressed later, potentially lengthening the adjudication process."

Israni said that the SC's order is a "double-edged sword". While it promotes legal certainty and market stability, it also limit SEBI's ability to address significant omissions such as disgorgement and thus address investor grievances. He added, "In civil courts, review is possible for errors apparent on the record or new evidence, but SEBI lacks a clear statutory avenue for such corrections."

Abhiraj Arora, Partner at Saraf and Partners, said that it will largely affect noticees (people against who SEBI has passed an order). That said, he believes the effect will largely be theoretical because of a change that happened in 2019.

"Till 2019, it was usual for SEBI to pass two orders on the same case, one by an adjudicating officer who will levy penalties and another by a whole-time member (WTMs) who will pass (preventive or remedial measures such as issuing) directions banning the entity from the market or order disgorgement of illegal gains. In 2019, the SEBI Act was amended to allow WTMs also to pass penalties, to reduce multiplicity of proceedings. Therefore, the instances of having multiple investigations and orders into a single matter had already come down," he said.

"That said, it will affect a few noticees who have recently received showcause notices after final orders were passed involving them," he added.

How will it affect investors?

If investors are not happy with the final order, particularly with the monetary aspect of it, they will need to approach the civil court, according to experts.

SEBI can only direct the errant parties to disgorge illegal gains made from the fraud and the regulator has no mandate to ensure compensation to defrauded investors.

Israni said, "The aspect of compensation has to be looked into by a court of competent jurisdiction. SEBI can offer relief of compensation only through the process of disgorgement."

Arora said, "For investors, investment is subject to market risks and the SEBI mechanism cannot be used to get compensation."