Key Takeaways From SEBI’s Order Against Franklin Templeton
SEBI has pronounced an important order in the Franklin Templeton (FT) case which has now lasted for over a year.
A quick reminder of the facts: FT is an Asset Management Company that came under fire last year when it prematurely shut down six different debt mutual fund schemesand prevented its clients from redeeming their units in them.
Why? Because of a sudden increase in withdrawals from the schemes (which may have been caused by the panic arising due to COVID-19), or so the company says.
From then on began a series of litigations and investigative procedures (in particular, SEBI’s forensic audit) which led to some interesting revelations like:
- the dubious involvement of some FT officials in the winding up process,
- large investments in illiquid and unlisted assets without due diligence,
- special favours doled out to certain investors, and
- immense mismanagement of the fund.
Seems like FT has now graduated from the stage of investigation to retribution because SEBI has just handed it with a whole platter of punishments:
- A two-year ban on launching any new debt schemes.
- Return the fund management fees to the investors of the six funds. The fees are worth ₹451.7cr ($62m) which when added to 12% interest (penalty) brings it to ₹513cr ($71m).
- A ₹5cr ($687,716) penalty on the fund for violating a number of rules and norms.
- Personal penalty on Vivek Kudva (Head of FT, Asia Pacific) and his wife Rupa Kudva by barring them from accessing the Indian securities market for a year in any capacity.
FT has expressed its disagreement with SEBI’s order and decided to appeal the same in the Securities Appellate Tribunal (SAT). But for now, let’s study the possible implications of this order.
The Retributive/Restorative Justice
The foundation of SEBI’s order is based on the premise that FT committed a series of lapses in “scheme categorisation” by replicating high-risk strategies across several schemes.
What this means is that the fund house did not perform the essential task of bucketing high-risk market investments into the designated risk buckets which could have informed the investor early on regarding its associated risks.
In 2017, SEBI created 36 different categories of mutual funds to simplify their regulation. Each category came with its own set of operations and associated risks within which the clubbed mutual fund schemes could exist.
FT not only mishandled the operation of the schemes under different categories, it also did not flag or exercise exit options in securities that were turning illiquid. This was a serious compromise of the interests of the fund holders.
Disproportionately high-risking its portfolio was the next thing highlighted by SEBI. Bloomberg reported that FT was acting as the only lender to 26 out of 88 entities in its debt schemes’ portfolio. This means that in case of their default, the losses would ripple on to FT like high tides. At one point, the fund also held almost all of the zero-coupon bonds of Yes Capital, a part of Yes Bank, which has since then run into bankruptcy.
These are a few examples of the sort of high risk-high reward game that FT had been playing to boost its returns and outperform its rivals. To make matters worse, it was done at the cost of increasing exposure to the client funds which it had a fiduciary responsibility to preserve.
The Scorn (Not Scare) of Regulatory Purgatory
In March 2021, the Supreme Court approved SBI Fund Management’s formula to monetise the assets and distribute the proceeds to the former fund holders of FT’s wound-up schemes. As of June 6th, ₹17,778cr ($2.4bn) worth of assets have been disbursed to the holders, which amounts to more than 70% of the assets under management.
This was merely an attempt to restore the financial entitlements of the unit holders. But in the scheme of regulatory oversight, it was hardly a patch. Considering the increasing financial reach as well as the increasing failures of fund houses in India, it is high time that SEBI starts putting them under stricter vigil.
It can start with a redefinition of laws. There is some serious ambiguity in SEBI’s Mutual Fund Regulations, particularly, Regulation 39(2)(a) which still leaves room for doubt about whether trustees can unilaterally wind up schemes without the majority consent of the unit holders.
The idea of organising mutual funds in the form of trusts is, perhaps, where this conflict arises. The assets of the fund are held by trustees (usually a company acting via its Board). The unit holders are beneficiaries and the managers of the fund are the asset management companies like FT.
So when FT argues that the need of the hour (breakout of the pandemic last year) is what forced their hands to freeze the funds, they are essentially referring to the authorised consent mechanism by which they are empowered to do so without consulting the unit holders.
FYI: This doesn’t include a post-dated and court-managed consent from the unit holders. Yes, we are talking about the vote held on January 19th.
But if reasons like these are allowed to stand, then it could be widely misused and manipulated at the will of fund managers for their gains at the expense of the savings and investments of unit holders.
How Long Before It Happens Again?
At the risk of being painfully realistic, one has to admit that this may not be the last fiasco India’s mutual fund industry will see. FT’s decision last year sent shockwaves around markets and the public which was already witnessing unprecedented economic changes as a result of the pandemic.
In an effort to clear the storm, the RBI also launched a special liquidity window worth ₹50,000cr ($6.8bn) for mutual fund institutions. Too late for FT’s unit holders but a good start to address the loss of finances in the sector.
Market manipulation, sadly, comes with far less punitive measures in India as compared to the West, as seen in the quantum of penalty in SEBI’s order. A ₹5cr institutional payback for wrongdoings that jeopardised nearly ₹30,000cr ($4.1bn) of investors’ money is a slap on the wrist.
Going forward, maintaining the liquidity of corporate securities must be the crucial focus of regulatory bodies. And above all else, enabling a clear-cut, methodical and impartial exit for all investors in exigent situations (like COVID-19) particularly should be a paramount concern.
(Originally published June 9th 2021 in transfin.in)
