The Securities and Exchange Board of India (Sebi) has drawn flak from the Karnataka High Court for its handling of the Franklin Templeton (FT) crisis that led the asset manager to shut six of its debt schemes.
Sebi did not possess a copy of the resolution dated April 23 passed by the board of directors of FT Trustees providing for winding up and did not respond to the e-mail dated April 14 sent by the AMC, the court observed in its judgement on Saturday.
Sebi also failed to reply to the letter dated April 20 addressed by the trustees, in which permission and guidance of the regulator was sought for winding up of the schemes.
FT Mutual Fund shut six of its debt schemes on April 23, citing redemption pressures and lack of liquidity in the debt market.
The court further observed that Sebi was not aware whether compliance of sub clauses (a) and (b) clause (3) of regulation 39 was made by the trustees. This clause deals with the trustees giving notice disclosing the circumstances leading to the winding up of the scheme to the board and in two daily newspapers and a vernacular one.
“Even for Sebi, such a winding up was an extraordinary event. Sebi did not bother to even enquire about the compliance with clause (3) of regulation 39 by the trustees.
Sebi did not bother to ascertain whether redemptions and borrowings ceased assuming that compliance of clause (3) of regulation 39 was made,” the court stated in its 336-page judgement.
The court also criticised Sebi for not placing on record a copy of an order appointing a forensic auditor, and producing it before the court on September 2 even though the hearing had commenced on August 12.
“As a watchdog, Sebi was expected to play a very proactive role by questioning AMC, trustees and sponsor about the compliances with the provisions of the mutual fund regulations. The investors/unit-holders of the said schemes will be justified in their criticism that Sebi was a silent spectator,” the court said.
Some legal experts believe that the High Court’s observation may lead Sebi to review the regulations governing winding up of mutual funds, which give power to the trustees to wind up schemes after taking unitholders' consent without requiring any approval from Sebi.
“While mutual funds are set up as trusts and decision-making has currently been left to trustees and unitholders, the fact that Sebi encourages retail investors to use mutual funds as a mechanism to invest in the securities market could lead to stricter regulation,” said Vaneesa Agrawal, founder, Thinking Legal.
"The requirement for consent of a simple majority of unitholders essentially impairs the fiduciary authority of the trustees to solely decide on winding up a scheme," added Suneet Barve, partner, IC Universal Legal.
According to him, there is already a provision in Reg 39 (2)(a) whereby 75 per cent of unitholders may require a scheme to be wound-up. Moreover, he says, there may be practical difficulties in obtaining prior consent of unitholders as not everyone may be qualified or technically equipped to understand the intricate aspects of the scheme’s investments to decide on a consent.
"The present regulations may have to be relooked at so that the flexibility to wind up a scheme at the sole decision of trustees is retained, with proper caveats, if so desired," said Barve.
While upholding the validity of regulations 39 to 40 of the mutual fund regulations, the court has observed that when the trustees decide to wind up a scheme by taking recourse to sub-clause (a) of clause (2) of regulation 39, the Trustee Company is bound by its statutory obligation under sub-clause (c) of clause (15) of regulation 18 to obtain the consent of unitholders.
The former sub-clause says a mutual fund may be wound up on the happening of any event because of which the trustees believe the schemes need to be shut. The latter sub-clause says trustees shall obtain the consent of the unitholders when the majority of the trustees decide to wind up or prematurely redeem the units.
Sebi now has the option of challenging the judgement by filing a special leave petition before the Supreme Court. “Sebi may not immediately change the regulation pertaining to winding-up of schemes but will appeal to SC on the observation that it didn't act proactively,” said advocate PR Ramesh.
Dear Reader,
Business Standard has always strived hard to provide up-to-date information and commentary on developments that are of interest to you and have wider political and economic implications for the country and the world. Your encouragement and constant feedback on how to improve our offering have only made our resolve and commitment to these ideals stronger. Even during these difficult times arising out of Covid-19, we continue to remain committed to keeping you informed and updated with credible news, authoritative views and incisive commentary on topical issues of relevance.
We, however, have a request.
As we battle the economic impact of the pandemic, we need your support even more, so that we can continue to offer you more quality content. Our subscription model has seen an encouraging response from many of you, who have subscribed to our online content. More subscription to our online content can only help us achieve the goals of offering you even better and more relevant content. We believe in free, fair and credible journalism. Your support through more subscriptions can help us practise the journalism to which we are committed.
Support quality journalism and subscribe to Business Standard.
Digital Editor
RECOMMENDED FOR YOU