SEBI Turned A Blind Eye To Franklin Templeton's Violations: Unit Holder Argues In Supreme Court

A division Bench of Justices Abdul Nazeer and Sanjeev Khanna was hearing the plea by Franklin Templeton challenging a Karnataka High Court's order which restrained winding up of six of its debt schemes without obtaining the consent of its investors by a simple majority. After deciding on the validity of the e voting process, the top Court will now hear arguments on various other issues involved in the matter including malfeasance, validity of the regulation, question of vires, etc.

Advocate Puneet Jain appearing for a unit holder submitted that the High Court had made two fold observations, that no consent under law has been taken and there isn't even a pleading that a notice was put it in a newspaper.

In response to Jain's argument that as per the Master Circular only after 2 years of winding up can the money be recovered, the Bench stated that it is deciding on the process of winding up and not redemption, and winding up will happen only when it is ensured that recovery through other means is not possible.

Advocate Jain appearing on behalf of investor Sanyam Jain submitted that the SEBI should have laid down the winding up in a proper manner, but SEBI has since the beginning abdicated itself and left it to the trustees to decide as to what has to be done, what would happen to trustees, etc. Jain submitted that Franklin Templeton had started extending loans. Due to Nirav Modi and other similar scams, banks had become reluctant in giving loans, but several companies were still in need of funds. Since the banks were not giving loans, they approached these debt funds. They then negotiated with Franklin Templeton who would agree to give loan asking them to buy debentures. But this was clear violation of regulation 44(3). That's how this mechanism started in 2012 & got busted in 2018 when IL&FS took place, which is when SEBI realised all this was happening.

Further, Jain stated that the 7th schedule of mutual fund regulations was amended through amendment in 2019 M, and a relaxation was given my amending 5% to 10% in liquid securities there was a limit of 5%. It was a relaxation and not a condition.

Jain argued that Franklin Templeton said in April 2020 that Covid19 effected them, but they should have cleaned their mess long before that. They knew their situation and Covid had nothing to do with that.

"Isn't it also SEBI's duty to see if there was sufficient liquidity? "- Jain said.

Talking about segregation of portfolio, Adv Jain stated that they started segregating portfolios in several other cases, with the first segregation in Jan 2020 being of Yes bank and Vodafone portfolio. However the same segregation procedures were not followed for other portfolios.

"Segregated portfolio is that that portfolio becomes segregated so investors who come in won't have to bear the loss but the unit holders will still continue? "- the Bench asked.

"There are separate unit holders for segregated port folio. So far as segregated portfolios are concerned they are being dealt with by them separately even though they are part of the same scheme. Its not being made part of the winding up process"- Adv Jain answered.

According to Jain, SEBI had basically told Franklin Templeton through its letter that their house was not in order and they were blaming SEBI for it. It issued a circular of May 2020 and allowed listing of these winding up portfolio. However If schemes are listed for winding up the question of redemption is gone.

Adv Puneet Jain further submitted that prior to the circular of 6th Oct 2017, every Mutual fund had its own mechanism with a certain investment objective, etc. SEBI through its circular decided to harmonise it and give it a name, enabling the investors to decide the best schemes based on their investment horizons now. Different schemes were defined by SEBI along with the kind of investments that could be made in those schemes.

"SEBI was aware of everything but they took no action, and kept a blind eye to violations done by Franklin Templeton. Three of the portfolios were segregated already by them in the same portfolio. Why were the other schemes not segregated then?"- Jain stated.

With regards to disclosure of the value of securities, Jain stated that once the portfolio is under winding up, at least now they should disclose full value of the securities. SBI could do this, so at least the real value of these securities would be known.

"When a winding up takes place, circular issued on 20th May stated that close ended funds also be listed. Character of schemes which was open ended fund becomes cold ended fund" - Adv Puneet Jain submitted.

"It does not become a close ended fund. Be responsible with your arguments." - Justice Khanna remarked.

"Don't liquidate your strong arguments by making such arguments.The listing was done for different reasons." - the Bench told Mr Jain.

Regarding the role of SEBI, Jain submitted that in terms of the act, SEBI should have compromised on my behalf. SEBI should have fought Franklin Templeton instead of the unit holders who have to fight them now instead.

Mr Jain argued that the unit holders cannot be treated as shareholders of the company., as they are depositors and have invested funds. If they were a shareholder,the borrowing money could not be paid to them. Therefore, unit holder cannot be treated at par with or akin to a shareholder.

Advocate Jain then put forth his arguments regarding the denial of financial audit report to the unit holders. He stated that before the High Court it was argued that the Investigation audit report cannot be given to us, but the High Court had observed that it cannot be given as the investigation wasn't final yet. But now since the investigation has been finalised, the audit report must be given. Whether or not action has been taken by SEBI based on that audit report, it should still be provided to the investors. The disclosure is required to be made by SEBI under the Right to Information Act, and also under the public interest principle, as there is no valid reason for Franklin Templeton and SEBI to withhold that information.

Senior Advocate Meenakshi Arora appearing for the Chennai Financial Management Society submitted they are entitled to receive a copy of seeks a copy of the final audit report as if they have to argue on malfeasance and misfeasance, that document becomes singularly most important document for them. Both Gujarat and Karnataka High Court have observed in our favour on issue of handing over of the financial audit report

"They have claimed privilege... you'll have to argue for that..." the Court said.

"We are the investors and they are trustees and there is a fiduciary relationship, which has been broken. Privilege is being claimed by them. They should argue it " Arora submitted.

Arora then brought Court's attention to the statement of object and reasons of the SEBI Act stating that it holds importance in the present case as its establishes SEBI as the regulator for investor protection.

However, SEBI has completely failed in discharging its obligation of investor protection in this case l, specially considering that when Franklin Templeton apologised on May 8th, SEBI went really slow in the process, and even told Karnataka High Court that court must not look at the Choksi and Choksi interim auditor report.

Senior Counsel Arora submitted that the Franklin Templeton took the ground of COVID in March but India was impacted by COVID in only mid-March and went into lockdown in the third week. Prior to that everything was functioning normally. After winding of these schemes was announced on ground of covid, the head of Franklin Templeton in US had even admitted that it was due to reasons including their inability to liquidate funds, etc. She added that several investments were made by Franklin Templeton in companies where no other mutual funds were investing or had ever invested.

According to Arora, the redemptions had started even before Covid19 was announced, but those redemptions may have started due to insider trading or some other issue with funds.

"Why would RBI step in bring and in liquidity of 50,000 crores unless there was a fraud being carried out" - Arora argued.

In response to Arora's arguments that the ground of Covid was taken by Franklin Templeton in March but India was not impacted by Covid by then, the Bench stated that they could not go by the dates, because in India the effect was felt a little later but the world economy was effected a way earlier.

Arora argued that if that was the case why were only these funds affected, when there are so many other funds as well. It was because of their previous actions. Covid 19 is only a farce or camouflage, while in reality it is a complete fraud that has been played on the investors. Franklin Templeton's schemes were already in negative, not due of Covid19 but because of their illiquid investments, Covid is only a sham or a front that has been taken .

Senior Advocate Meenakshi Arora further contended that their allegation is that there is perhaps an insider trading, as while these unit holders were not allowed redemption, many other unit holders were allowed to redeem before the April announcement. Therefore there is a need to investigate if there has been any insider trading or not.

According to Arora, her plea is based on the fact that this case has much more than what meets the eye. She added that if an investor has made an investment in debt scheme with moderate risk and later he gets to know that they were high risk schemes, there is clear breach of fiduciary duty there.

Supreme Court had on 12th February negated all objections and upheld the validity of e-voting process for winding up of six mutual fund schemes of Franklin Templeton. The Court has directed the disbursement of funds to be done in terms of its previous orders.

The Court also observed that the consent of unit holders means the consent of majority of unit holders and not just those party to the scheme. The matter will be taken up on 17th February 2022 for hearing arguments on other issues.

Supreme Court in its previous hearing approved the application filed by SBI Mutual Fund and SBI Funds Management Pvt Ltd, for placing on record the distribution mechanism proposed to be followed while distributing Franklin Templeton's 9122 crores amongst its unit holders, under the six mutual fund schemes. The application followed the top Court's previous order whereby it had directed SBI Mutual Funds to undertake the distribution, dividing the amount amongst unit holders, in proportion to their respective interest in assets of scheme, as agreed by both Franklin Templeton Trust and SEBI.

According to the top Court's direction, the amount of 9122 crores that is cash ready with Franklin Templeton as on 15th January 2021 be distributed amongst the unit holders under the six mutual fund schemes. The Court was examining objections to the e-voting results to decide if disbursal or payment to the unit holders should be made. The Court had asked the Franklin Templeton Trust services and the asset management company to cooperate with SBI Mutual Funds in this regard and furnish to them entire data and details. It has further directed the process to preferably be completed in period of 20 days from date of this order and has given liberty to the parties to can move an application and approach the Court in case of any difficulty in the process.

In December 2020, the Supreme Court had allowed Franklin Templeton Trustees to call for a meeting of unit holders to seek their consent/approval. The top court had hauled up SEBI adding that it had a lot to answer for and why did it not intervene when unit holders started seeking redemption, much like how RBI intervened in cases of banks, to protect depositors.

Franklin Templeton had in April announced its decision to wind up six debt funds citing low liquidity. Nearly three lakh investors are estimated to be affected by this decision. It was after this decision that some investors moved various High Courts. Petitions across High courts were clubbed by the Supreme Court vide an order dated June 24 in the transfer petition filed by Franklin Templeton seeking consolidation of various petitions filed with respect to the winding up of debt funds