Franklin Templeton Mutual Fund (FTMF) has emailed investors that it is likely to appeal ‘some aspects’ of the hard-hitting Karnataka High Court (KHC) judgement and seek directions on how to distribute accumulated funds in the six debt schemes that it shut down on 23 April 2020.
The schemes, with a total corpus of about Rs26,000 crore, directly affected 300,000 investors, damaged the credibility of the mutual fund (MF) industry which garnered Rs 27,74,146 crore (September 2020 data) of the savings of ordinary Indians, with a big boost coming from its sweeping slogan ‘mutual fund sahi hai’.
The MF industry has been involved in all sorts of shenanigans for the past 25 years but has rarely been dragged to the court. This time, it was different, mainly because of the intervention of Chennai-based Chennai Financial Markets and Accountability (CFMA) which attacked on multiple fronts and presented an incisive case in court. There was another reason as well – by a quirk of fate, the case landed before one of the best benches that investors could have wished for which was unimpressed by the market watchdog’s claims.
The 24th October judgement of the KHC is not your usual high court judgement that leads to an appeal. The Securities and Exchange Board of India (SEBI) and FTMF filed an appeal in the Supreme Court (SC) against a Gujarat High Court order.
On 19 June 2020, the apex court clubbed four petitions before the High Courts of Gujarat, Madras and Delhi to KHC and requested Chief Justice AS Oka to have them heard by a division bench (Justice Ashok S Kinagi was the second member of the bench), resulting in a detailed 336-page order. Although the Court has allowed six weeks to file an appeal to the SC, it is unlikely to be a cakewalk for FTMF to have it overturned. Let’s examine what the KHC had to say.
The judgement gives SEBI a whipping and an education on its role. Reading it provides an insight into why investors, cheated by intermediaries in a highly regulated industry, go to the high court for justice.
Franklin and Role of Trustees
The order upheld the decision of the trustees to wind up the six schemes but ONLY after obtaining the consent of unit-holders through a simple majority (under sub-clause C of regulation 15) with a stern reminder to the trustees that regulation 18 casts on them “a legal duty to do or not do an act.” The arguments were focused on whether winding up was the only solution (especially after the MF industry was the first to be bailed out with a Rs50,000 crore special liquidity facility from the Reserve Bank of India – RBI -- on 27April, 2020).
The second issue was whether consent obtained from investors of FTMF’s six schemes was to wind up the schemes or toauthorise trustees to decide who will take steps for the winding up. What happens next will depend on the SC hearings; but it is likely that the trustees may end up having to share the basis on which they decided on winding up and whether other alternatives were considered. What is more significant for India’s 20 million investors is how the regulator behaved during this crisis.
SEBI’s Many Failures:
For several years now, SEBI has chosen to remain sphinx-like silence on distressing market developments or assuage investors’ anguish —whether on corporate governance failures, a series of broker frauds or the shenanigans of the MF industry. This may have worked well for SEBI’s top brass, but the KHC judgement, ripping SEBI’s failures, ought to be a wake-up call even for the finance ministry which supervises SEBI.
The 28-year old regulator had to be told by the Court that “prompt action by SEBI was necessary to sustain the confidence of the investors. 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 Funds Regulations. The investors/unit-holders of the said Schemes will be justified in their criticism that SEBI was a silent spectator.”
Isn’t it ironical that, despite repeated amendments to the SEBI Act to give it more powers, the watchdog has forgotten that its first duty is to investors, so much so that investors are increasingly approaching civil courts to push the regulator to do its job?
The Court order says, SEBI’s ‘main obligation’ is to “act as a watchdog to protect the interests of the investors” and the second to ensure that trustees and asset management companies (AMCs) “strictly abide by the SEBI Act and mutual funds regulations.” Did it? Read what the Court had to say.
a)Even for SEBI what happened on 23rd April was an ‘extraordinary event’ and the ‘first case in history’ of Indian MFs where the winding up clause was invoked to shut six schemes. Yet, SEBI admitted that it had not bothered to ascertain compliance with sub-clauses (a) and (b) clause (3) of regulation 39 which that requires them to issue a notice in two newspapers disclosing the circumstances leading to the closure of its schemes.
b)SEBI did not bother to ascertain whether redemptions and borrowings had ceased, simply assuming that FTMF had complied with the regulations.
c)SEBI had to be ordered to file on record the ordering of a forensic audit which is still incomplete and was submitted in a sealed cover.
d)The Court further noted that SEBI did not even possess a copy of the 23April 2020 resolution by FTMF’s trustees to wind up the six schemes.
e)SEBI failed to respond to FTMF’s e-mail of 14 April 2020 or reply to the letter dated 20 April 2020 addressed by the trustees, seeking permission and guidance to wind up the schemes.
SEBI’s stand in Court is significant. The regulator attempted to steamroller the case on three main planks. First, that SEBI is a ‘specialised sectoral regulatory authority’, which is already conducting a forensic audit/inspection/ investigation and the Court should ‘not exercise its jurisdiction’ when the petitions involved ‘disputed questions of fact’.
Secondly, that Section 11 of the SEBI Act and its comprehensive MF regulations empower the regulator “to take any measures as it thinks fit in order to protect the interests of the investors in securities and promote the development of, and to regulate the securities market.” Since these powers were granted by the legislature, courts should ‘refrain from interfering’ in this matter. The judgement exposes how SEBI had failed to use its vast powers.
Thirdly, it argued that petitioners had “not exhausted the efficacious remedies available to them by approaching the Securities Appellate Tribunal.” It was suggested that having filed complaints on SEBI’s complaints redress system (SCORES), investors should wait for the regulator to do its job at its own pace.
The petitioners pointed out that there is “no provision under the SEBI Act for adjudication of complaints of the investors, as a matter of right.” So there is no straight-forward appeal to SAT. Isn’t it ironical that, despite repeated amendments to the SEBI Act to give it more powers, the watchdog has forgotten that its first duty is to investors, so much so that investors are increasingly approaching civil courts to push the regulator to do its job? This is exactly what has been argued by hundreds of petitioners in the Anugrah Stock & Broking scam, where SEBI as well as other first-line regulators have been made a party to the proceedings.
The Role of CFMA and AMFI
CFMA’s role in countering the legal power of SEBI, FTMF and others with incisive points and a multi-pronged attack is important. Apart from the legal route, CFMA got the economic offences wing (EOW) of Chennai police to register an offence. This had Association of Mutual Funds in India (AMFI) rushing to the regulator seeking its intervention against what it called a ‘dangerous and undesirable precedent’. The action exposed AMFI as being nothing but a powerful lobbying organisation very confident of its influence over the regulator, while protecting dodgy behaviour by its own members. CFMA went ballistic over AMFI’s lack of empathy for FTMG’s 300,000 investors and, probably, ensured that SEBI did not heed its pleas. CFMA also filed Right to Information (RTI) applications which brought to light SEBI’s lack of action and refusal to acknowledge the forensic audit it has commissioned, let alone share it with investors.
FTMF and SEBI will, once again, deploy powerful legal power to make their case in SC and we don’t know which way that will go. Hopefully, the legal community will realise that a watchdog that barks on time and bites when necessary is good for everybody’s savings.