SEBI: Franklin Templeton mutual fund case
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This article is written by Ronika Tater, from the University of Petroleum and Energy Studies, School of Law. In this article, she discusses the inspection of six debt schemes of the Franklin Templeton Mutual Fund case and various other SEBI provisions in relation to the said case.

Introduction

On 23 April 2020, Franklin Templeton Mutual Fund declared voluntarily winding up its six debt mutual fund schemes in India stating redemption pressures and lack of liquidity in the bond market due to the COVID-19 and also to protect the investors’ value. Consequently, on 28th August 2021, the Supreme Court-appointed liquidator SBI Funds Management Pvt Ltd (”SBI MF”) to distribute a portion of Rs 2918.50 crore received from the sale of assets and coupons to its unitholders across all six schemes. Moreover, this action is limited to the below-mentioned funds in India, and all the other funds such as equity, debt, and a hybrid will be unaffected by the decision.

  • Franklin India Low Duration Fund;
  • Franklin India Credit Risk Fund;
  • Franklin India Short term Income Plan;
  • Franklin India Ultra Short Bond Fund/Ultra Short Fund;
  • Franklin India Income Opportunities Fund; and
  • Franklin India Dynamic Accrual Fund.

Meaning of the term mutual funds

There are different types of investment avenues available to the investors, one of them being Mutual Funds. Mutual Fund is formed in the form of a trust comprising sponsor, trustees, assets management company (“AMC”), and a custodian. It is regulated by SEBI (Mutual Fund) Regulations, 1996. A trust is established to raise money through the sale of units. It plays an active role in accumulating wealth and generating income for investors thereby acting as a source for corporates to raise money. The mutual fund industry in India started with the introduction of the Unit Trust of India (UTI) in 1963. Private sector mutual funds were established in 1993, where Franklin Templeton was the first establishment.

Structure of a mutual fund

  • It consists of one or more sponsors who are like a promoter of a company.
  • The trustees of the mutual fund hold its property for the benefit of the unit-holders. It holds the power of superintendency and provides direction to AMC. It also monitors the performance and compliance as per Security and Exchange Board of India (SEBI) Regulations.
  • The AMC authorised by SEBI managed the funds by exposing investments in different types of securities. It consists of a registrar and a transfer agent.
  • The custodian registered with SEBI holds the securities of various schemes of the funds.

Advantages and disadvantages of Mutual Funds

The following are some of the advantages of mutual funds:

  • Investors can render services from experienced and skilled professionals with proficiency in analysing the performance of companies and thereby selecting suitable investments to achieve the aim of the scheme.
  • As mutual funds invest in different segments of the market-leading to a reduction of risk.
  • Mutual funds save time by reducing paperwork and provide a convenient administration by avoiding various problems such as delayed payments or bad deliveries.
  • It has the potential to provide a higher return on investments over the medium to long term.
  • It has relatively lower costs than investing in the capital markets.
  • It provides transparency on the value of the investment made by schemes, the proportion invested in each asset, and information of the fund manager strategy on the scheme.

The following are some of the disadvantages of mutual funds:

  • Diversification of the portfolios may lead to a loss of focus on the securities in different segments.
  • In order to obtain a high return through liquidation of the portfolio, it may lead to large payments on commission and brokerage.
  • Sometimes the fund managers are unaccountable for poor results.
  • Poor planning of investment returns by not researching properly on income, profits, and government policies.
  • Failure to identify the risk involved in the mutual funds as compared to the risk of the market.

Key provisions under SEBI (Mutual Fund) Regulations, 1996

SEBI (Mutual Funds) Regulations,1996, (“Mutual Funds Regulations”) was established with the objective to improve the performance of the mutual fund industry thereby provisioning better service to all categories of the investors and offering a diverse range of innovative products with regard to the interest of the investors. Some of the key provisions as below-mentioned:

  • Schemes launched by the AMC need to be approved by the Board of Trustees and filed with SEBI.
  • The offer documents should properly disclose the related information of all the schemes in order to make informed decisions by the investors.
  • The listing of close-ended schemes should be mandatorily disclosed and listed on a recognised stock exchange.
  • Units of a close-ended scheme can be opened for sale or redemption at a fixed interval and the minimum and maximum amount of same or redemption should be periodicity disclosed in the offer document.
  • Units of a close-ended scheme can be converted into an open-ended scheme with the consent of the majority of the unitholders and properly disclosed in the offer document.
  • Units of a close-ended scheme can be rolled over by passing a resolution of a majority of the shareholders.
  • If the minimum subscription is not satisfied, the AMC shall refund the money back to the investors.
  • A close-ended scheme should be wound up on redemption date or with the consent of the majority of the unitholders passing a resolution for winding up of the scheme as per the directions of the SEBI in order to protect the investors.
  • It is also allowed to invest in foreign debt securities with fully convertible currencies.
  • It is also allowed to invest in government securities and also in both gold and gold-related instruments subject to certain investment restrictions as per SEBI (Mutual Funds) (Amendment) Regulation, 2006.

Analysis of the SEBI – Franklin Templeton mutual fund case

Franklin Templeton Mutual Fund case discusses the compliance of an AMC of a mutual fund with regards to the SEBI (Mutual Funds) Regulations,1996, (Mutual Funds Regulations) leading to the winding up of the six schemes. It also states the internal systems, compliance, risk management practices, inside trading, and method of categorization of schemes by the AMC.

Background of the case

Franklin Templeton Mutual Fund (“FT-MF”) is a mutual fund registered under SEBI. Franklin Templeton Asset Management (India) Pvt. Ltd (“FT-AMC/Noticee”) is the AMC of FT-MF. On 23 April 2020, Franklin Templeton Trustees Services Pvt. Ltd. (“trustees”) declared voluntary winding up of its six schemes in India under the provisions of Regulation 39(2) of the Mutual Funds Regulations. Subsequently, SEBI initiated an inspection to check with regard to FT-MT compliance with the provisions as per the SEBI Act. 

Issues involved

  1. Whether there were any violations by noticee under Section 11(1), 11(4), and 11B of the SEBI Act?
  2. Whether the noticee should be suspended from issuing any new scheme for a specified period?
  3. Whether the noticee should refund the investment management and advisory fees of the debt schemes inspected? 
  4. Whether the noticee should be liable for monetary penalty as prescribed by the SEBI regulations?

Arguments from both parties

Considering the report, SEBI issued a Show Cause Notice (“SCN”) noting the following allegations:

  • The debt scheme was inspected as a Credit Risk Fund scheme, however, it was depicted as a duration based scheme.
  • The noticee failed to disclose its strategy of investing in high yield securities.
  • The notice incorrectly calculated Macaulay duration, leading to long-duration securities in short duration thereby running multiple schemes under the same guard.
  • The terms and conditions of the investment were unclear to both the issuer and investor.
  • The noticee failed to follow the Principles of Fair Valuations thereby failing to reflect the true value of the securities.
  • The noticee failed to disclose the change in terms of investment to valuation agencies and credit rating agencies.
  • The noticee failed to follow proper due diligence and made investments similar to giving loans to issuers.
  • The noticee without the consent of the Board reduced the role of the Business Risk Management Committee thereby not ensuring the independence of the risk management function.
  • The noticee failed to provide any guidance to manage various risks and had not maintained any documentation for investment decisions.
  • The noticee failed to follow the appropriate policy of pro-rata allotment of partial buy-back to all the schemes. However, it allotted a partial buyback on a non-pro-rata basis thereby benefiting investors of one scheme over the other.
  • Lastly, the noticee failed to maintain high standards of integrity, due diligence, proper case, and exercised unprofessional judgment thereby violating the Code of Conduct as mentioned under the Fifth Schedule to the Mutual Funds Regulations.

Further, the noticee rejected all the allegations mentioned under the SCN and stated as follows:

  • Considering the pandemic there is no need to invoke special provisions of the SEBI Act. It also stated that Section 11(1), 11(4), and 11B of the SEBI Act does not have the power to direct an AMC to refund investment management and advisory fees to the investors.
  • The notice does not depict any wrongful gains made or losses averted or any unjust enrichment by the noticee. Thus the noticee acted lawfully and under the provision of the SEBI Act.
  • The noticee stated that any direction against the launching of new schemes will be against the principles of common law Wednesbury principle and the principle of proportionality as mentioned under the Administrative law and may involve penal action by the government or regulatory authorities.
  • The noticee while declining the imposition of the monetary penalty referred to the case of PG Electroplast Ltd. and Ors. v. SEBI, (2019), where the Hon’ble Securities Appellate Tribunal (“SAT”) set aside an order against the adjudicating officer for imposing a monetary penalty. The SAT, while considering the facts and circumstances of the case, stated that even if the parties had not acted with proper due diligence and proper care, the authorities may refuse to impose a penalty if it is a minimal breach of the provisions of the SEBI Act. Hence, in the particular instance, considering the circumstances of the noticee, it is the discretion of the authorities to refuse monetary penalty. 

Order

  • It was held that the noticee as an AMC has violated the provisions under Mutual Funds Regulations. The noticee derived income out of wrongful conduct from the investor is liable to pay a monetary penalty of Rs 5 Crore within 45 days from the date of this Order.
  • The noticee is liable to pay the investment management and advisory fees against the six debt schemes inspected from April 1, 2018, to April 23, 2020, as mentioned in the Order. 
  • Due to the mismanagement on the part of the noticee, it had caused hardship and loss to the investors. Hence, it is reasonable and justified to levy interest on the wrongful gain made by the noticee at the rate of 12% simple interest per annum from April 24, 2020, till the date of this Order.
  • The noticee is prohibited from launching any new debt schemes for two years from the effective date of this Order and the prohibition will start as soon as the six debt schemes inspected for winding up cease to exist as per Regulation 42 of the Mutual Funds Regulations.
  • Furthermore, various irregularities have been noted while running the six debt schemes against the interest of the unitholders. These irregularities consist of failure to exercise due diligence, carry out the proper valuation of securities and ensure a speedy risk management framework. Hence, a proceeding against the employees of FT-AMC should also be considered as they may be liable for these irregularities arising during the course of business of the noticee.

Conclusion

The Franklin case is eye-opening for the investors who trusted that debt funds are safer than traditional debt instruments such as Fixed Deposits or Recurring Deposits. On the other hand, AMCs should also be conscious before stating their products in the market in the name of high returns or comparing it to the traditional instruments.

References

 


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