Clearing the air

| Updated on October 27, 2020

The Karnataka HC order clarifies important points of law on winding up of mutual funds

In India, mutual funds are prone to rolling out new schemes quite frequently, but when existing ones under-perform or outlive their usefulness, they are more likely merged or rebranded than shuttered for good. This is perhaps why Franklin Templeton (FT) India’s sudden announcement in April on winding up six of its popular debt schemes owing to liquidity issues amid Covid, caused so much consternation among investors and triggered litigation. Petitions filed by aggrieved investors against the Asset Management Company (AMC), Trustees and the sponsor challenged the legality of FT’s decision to wind up schemes, questioned SEBI regulations that allow it, sought directions to FT to immediately honour redemption requests and alleged mismanagement by the Trustees and AMC personnel. The Karnataka High Court, hearing these petitions, has resolved some important points of law by upholding the relevant SEBI regulations and the Trustees’ right to wind up schemes. But it has also ruled that the Trustees cannot go ahead with winding up without obtaining the consent of unitholders by simple majority. Refraining from ruling on other aspects, the Court has directed SEBI to consider further action against the AMC and others, once forensic audit findings are out.

While winding up a mutual fund should prima facie be as simple as launching one, it is SEBI’s rather ambiguously drafted regulations on winding up that seem to have muddied the issue. Sections 39 to 41 of its mutual fund regulations seem to give a carte blanche to the Trustees by stating that a scheme may be wound up ‘on the happening of any event’ which in their opinion requires it. Section 41 goes on to say that Trustees shall call a unitholder meeting to ‘take steps’ for winding up. FT had taken shelter under these sections to go ahead with the winding up at the behest of its Trustees, while approaching investors for consent later as a fait accompli. But the Court has called attention to section 18 that expressly requires Trustees to seek unitholder consent whenever units are prematurely redeemed. This interpretation appears fair and sets a sound precedent, as mutual funds are essentially pass-through vehicles — where investors bear the entire burden of profits or losses from critical decisions on a scheme.

Other issues, however, remain unaddressed. Investors, for instance, may like Trustees to perform additional due diligence and inform them before approving such decisions, and would prefer AMCs to be held to definite timelines and NAVs at which their claims will be settled. A plugging of such loopholes by SEBI through a redrafting of its regulations may help protect investor interests in future cases of winding up. However, this is likely to be cold comfort to investors stuck in FT’s debt schemes at this juncture. With the Court delaying the operation of its order for six weeks and FT promising to appeal against the decision, FT investors face a long wait ahead for their money.

Published on October 27, 2020

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