What it means
Regulators and courts order disgorgement when someone has profited from conduct such as market manipulation, insider dealing, mis-selling, bribery or breach of a fiduciary duty. The order attaches to the money made from the conduct, and it is usually calculated separately from any fine.
The distinction from a penalty matters to anyone reading a settlement announcement. A headline figure of $9,000,000 might be $6,000,000 of returned profit and $3,000,000 of actual penalty, and only the penalty part represents a loss beyond what the business should never have had.
Calculating the amount is where most of the argument sits. Regulators typically start with gross gains and allow a deduction only for costs directly tied to producing those gains, refusing deductions for general overheads, marketing or the wrongdoer's own compensation.
Prejudgment interest is normally added, on the reasoning that the wrongdoer had the use of the money in the meantime. Where identifiable victims exist, the disgorged sum is often paid into a fund and distributed to them rather than kept by the regulator.
For finance teams the accounting nuance is timing. Once a disgorgement is probable and can be estimated, it becomes a provision on the balance sheet and hits the income statement, often well before any cash leaves, which is why a settlement can move reported profit long before it is paid.
The scope of these orders has narrowed in some jurisdictions after court challenges over how far back a claim can reach and whether the money must be returned to identifiable victims. Businesses negotiating a settlement now argue hard over the measurement period, because a claim running back eight years rather than three can multiply the figure several times over.
In practice
Real-world examples.
Example
An investment adviser routes client trades through an affiliate and keeps $780,000 of undisclosed rebates. The regulator orders the full amount returned plus interest, and the money is distributed to the affected clients rather than retained.
Example
A pharmaceutical distributor is found to have promoted a product for an unapproved use, generating $22,000,000 of attributable sales. After deducting $9,000,000 of direct manufacturing and distribution costs, the settlement requires $13,000,000 to be handed over alongside a separate penalty. The distributor's attempt to deduct sales commissions and head office costs is refused.
Example
An executive sells shares two days before a profit warning and avoids a $310,000 loss. The court treats the avoided loss as a gain from the conduct and orders it disgorged, on top of a trading ban.
Formula
Calculation
Disgorgement = gross gains from the wrongful conduct - directly attributable costs, plus prejudgment interest
A brokerage sells an unsuitable product and is found to have generated $4,200,000 of revenue from those sales. It can evidence $1,300,000 of direct costs, mainly third-party product fees and settlement charges tied to the same transactions.
Net gain: $4,200,000 - $1,300,000 = $2,900,000
Prejudgment interest at 5% simple for three years: $2,900,000 x 5% x 3 = $435,000
Disgorgement ordered: $2,900,000 + $435,000 = $3,335,000
The regulator also imposes a separate civil penalty of $1,000,000, so the total cash outflow is $3,335,000 + $1,000,000 = $4,335,000. Only the $1,000,000 penalty is a cost above and beyond returning what was wrongly earned.Case study
Seen in the real world.
Calder Point Advisers is a fictional advisory firm created for this illustrative case. Over four years it placed clients into an in-house fund without disclosing that the fund paid the firm an extra 1.1% management fee, which produced $5,600,000 of additional revenue.
When the conduct surfaced, Calder Point argued that its cost of servicing those clients should be deducted, pointing to salaries, office costs and technology. The regulator accepted only $900,000 of costs directly linked to running the fund, leaving a net gain of $4,700,000, and added $705,000 of interest calculated at 5% simple over three years.
The firm paid $5,405,000 in disgorgement plus a $1,500,000 penalty, and its auditors required the full $6,905,000 to be provided for in the year the settlement became probable. The chief executive's later comment, in the illustrative telling, was that the undisclosed fee had never actually been the firm's money to spend.
Watch out
Common mistakes.
- Reading a disgorgement order as a fine, when it is a return of profits and the punitive element is usually a separate figure.
- Expecting general overheads and executive pay to be deductible from the gain, when regulators normally allow only directly attributable costs.
- Assuming no harm means no order, when disgorgement can follow profit from conduct even where individual victims are hard to identify.
Questions
People also ask.
Who receives disgorged money?
Where identifiable victims exist it is commonly paid into a fund and distributed to them, and otherwise it typically goes to the public purse or the regulator.
Is disgorgement tax deductible?
Generally not, since amounts returned as the proceeds of wrongdoing and related penalties are usually denied deduction, though the treatment varies by jurisdiction.
Can a company be ordered to disgorge profits made by a rogue employee?
Yes, if the company received the benefit of the conduct, the order commonly attaches to the company rather than only to the individual.
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