SEBI Asks MFs To Pay 20% of Key Mutual Fund Employees’ Salary by Way of Scheme Units
Moneylife Digital Team 29 April 2021
Market regulator Securities and Exchange Board of India (SEBI) issued a circular stipulating that minimum of 20% of the salary of the key employees of asset management companies (AMCs) must be paid in the form of scheme units in which they have a role, in an obvious attempt to make them more accountable for their investment decisions. The regulator’s move comes in the aftermath of the Franklin Templeton fiasco (where six debt schemes were wound down) and seeks to bring in additional accountability. The provisions of this circular shall be applicable with effect from 1 July 2021. 
In order to align the interest of the key employees (chief executive-CEO, chief investment officer-CIO, chief operating officer-COO, fund managers and others) of the AMCs with the unit-holders (investors) of the mutual fund schemes, it has been decided that a part of compensation of the key employees of the AMCs shall be paid in the form of units of the scheme(s), the circular stated.
According to the circular, minimum of 20% of the salary, perks, bonus and non-cash compensation (gross annual cost to the company-CTC) net of income tax and any statutory contributions like provident fund (PF) and national pension scheme (NPS) of the key employees of the AMCs will be paid in the form of units of mutual fund schemes in which they have a role. 
This is designed to make fund managers have their ‘skin in the game’. The move has been welcomed widely by retail investors at the conceptual level, but it remains to be seen how it is implemented. 
SEBI’s circular added that the compensation paid as mutual fund units will be locked-in for a minimum period of three years or tenure of the scheme, whichever is less. 
However, SEBI has allowed these key employees to borrow from the AMC in exigencies such as medical emergencies or on humanitarian grounds. However, key employees would not be able to redeem such units within the lock-in period in case of resignation or retirement before attaining the age of superannuation.
In cases of violation of code of conduct, fraud and gross negligence, the units will be clawed back, and the redeemed amount will be credited to the scheme.
SEBI added that apart from CEOs and fund managers, chief investment officers, chief risk officers, chief information security officers, chief operation officers, fund managers, compliance officers, sales heads, heads of other departments, direct reportees to the CEO (excluding personal assistant or secretary), fund management team, research team and dealers of the AMC will be paid a part of their compensation as mutual fund units.
Exchange traded funds (ETFs), index funds, overnight funds and existing close ended schemes have been excluded from the order. 
This is being viewed as a welcome move, since the key employees will have minimum 20% of their own salary in their own schemes, they will have to eat what they cook and, secondly, when compliance is aligned with money and penalty, it works even better. As of now, only a few countries like the US require disclosures about managers' investments in their schemes.
A mutual fund distributor from Mumbai told Moneylife that this is bound to improve investor sentiment, increase penetration and in turn increasing return efficiency. “Investors derive lot of comfort when their fund manager is also invested in the same schemes. However, most fund managers’ bonuses and employee stock ownership plan (ESOPs), which make a large component of their compensation, are completely linked to their performance—how much extra return (alpha) they make. So, this might not make a large difference in incentive but it is being viewed as a large change in governance, seeking to put an end to episodes like the Franklin Templeton fiasco, which devastated the investors’ confidence,” the distributor added. Leaks from the forensic audit findings indicate serious breach of fiduciary duty by Franklin Templeton, suppression of concerns raised internally and possible front-running in the form of hefty redemptions by senior management just before it shut the six debt schemes.
However, several mutual funds are reportedly unhappy with SEBI’s move. In a series of hard-hitting tweets, Radhika Gupta, CEO and managing director (MD) of Edelweiss Mutual Fund, contended that it would be "extremely problematic in implementation."
Ms Gupta explained that the circular applies to not just senior employees but junior research staff, dealers, and support function heads too. Elaborating further, she pointed to the possible unintended consequences, “These people do not earn the kind of money CEOs and CIOs do. It is forcing them to lock 20% of their income for 3 years. It mandates how much one saves. For a guy earning 15-20 lakh, imagine how difficult it is to put away 3-4 lakh. We are constraining employee cash flows. Circular suggests we have to invest in all schemes basis weighted AUM.” 
The nature of schemes the employee has a key role in would align or impact how his/ her money is invested. 
Ms Gupta further argued "So if I run 80-20 debt-equity business that is my forced asset allocation. For a mid-cap fund manager, he has to invest in his schemes or a higher risk grad," she said, adding, "just because I run a mid-cap fund doesn’t mean this is my risk appetite! And a liquid fund manager has to park money in liquid for three years. For a CEO or sales head, I have to invest in every scheme of my AMC? Every single scheme? That is going to be very difficult."
She premised the implication that in order to implement the circular, mutual funds will be forced to pay everyone 20% more and this would hit the business and cost structure.
She pointed out that hiring good talent will get even more difficult, with the marketing head and chief technology officer (CTO), who are not even involved investment decisions, being forced to park 20% of their pay for three years. People will choose not to work in mutual fund sector then. 
“If we wanted to build skin in the game a simple rule would do it: for people earning more than 50 lakhs, 50 (or some percent) of your investments (not assets) should be in your own funds,” she suggested.
She also questioned how can fund houses decide on variable pay compensation at the start of the year when it depends on employees’ performance in that year.
She also raised questions about why such rules do not apply to "employees of banks, insurance companies and other financial institutions. Why these rules for one industry?”
She, however, acknowledged that 70% of her investments are made in Edelweiss MF. "My CIOs, FMs, sales head, and product head also invest meaningfully in our funds. We needed no internal policy or regulation to do this. We love our products, trust our people. It’s called soul in the game," she concluded.
Kamal Garg
1 year ago
"Skin in the game v/s Soul in the game".
Good analysis. On a larger canvas, it seems the decision is fair and just required due to rampant misuse of investors' hard earned money in various schemes and investment therein by fund managers.
Though as pointed out, the implementation will be tedious and difficult because every employee will have to invest 20% of their CTC in various schemes with whom he is directly/indirectly connected based upon the aum of these schemes on weighted average basis. Difficult to implement. However, what will happen if there is a thorough and sea change in the aum of one/some of such schemes in future and therefore there is a different weighted average allocation. How would one scale down its investment in such schemes where the aum has been falling. And then, investment for 3 years in liquid funds/debt funds is also unrequired.
1 year ago
The views against this new responsibility on fund managers expressed by some here is totally skewed. In binding the employees with the Co. most of the Cos. give ESOP as part of salary, perks. Why it cannot apply to employees who handle thousands of crores of money of retail investors with immunity and are hand in glove with brokers ?
Free Helpline
Legal Credit