Franklin Templeton Case: Decision To Wind Up Was A Camouflage By Trustees Using COVID-19 As An Excuse: Unit Holder Submits Before Supreme Court

A division Bench of Justices Abdul Nazeer and Sanjeev Khanna, today 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.

During the hearing Senior Advocate Ravindra Shrivastava appearing for one of the unitholders Amruta Garg submitted that he has challenged validity of the regulations. There are serious questions regarding the winding up of Franklin Templeton which was a camouflage by the trustees using Covid as an excuse.

This is an unprecedented situation for the Court to interpret SEBI and the Mutual Fund regulations. This is the first instance of winding up of a Mutual Fund house, and despite all problems of Covid19, none of the other Mutual Fund houses took the drastic measure of winding up.

Talking about the history of mutual funds in India, Senior Counsel submitted that in 1963 the Mutual funds entered Indian Market for the first time at the Government of India and RBI's initiative. The Indian Government through a resolution established SEBI in 1988 to promote and orderly growth of securities market for investors protection. The SEBI Mutual Fund Regulations were framed in 1996 by SEBI and under the framework all aspects of Mutual Funds schemes are regulated, the prime and fundamental object being protection of the investors.

He added that, an Investment Management Agreement executed between Trustee and Franklin Templeton Asset management India to act as Investment Manager to the schemes of Franklin Templeton Mutual Funds. In May 2016 SEBI issued circular regarding restriction in mutual funds, and laid down that philosophy, restriction or redemption would apply during excess redemption request that could apply in overall market crisis situation rather than exceptional circumstances of entity-specific situations.

Mr. Shrivastava stated that in 2017, SEBI issued circular classifying mutual funds schemes into 5 heads including Equity scheme, Debt scheme, Hybrid Scheme, Solution-oriented scheme and other schemes. The unit holder had invested 5,00,000 in FISTIP in 2018, and the IL&FS scan broke out in the capital market. SEBI issued master circular 3 for effective regulation of mutual fund industry & which is compilation of all circulars applicable to Mutual funds.

In March 2020 Covid19 pandemic was declared. Franklin Templeton requested SEBI for enhancement of Borrowing limit given in MFR from 20% to 30% for Franklin India Opportunities Fund, and SEBI acceded to its request. Franklin Templeton India's President sent a mail to SEBI on subject of Liquidity Management suggestions in wake of Covid and suggested measures to assuage investor fears and improve liquidity of mutual funds.

A proposal was sent by Franklin Templeton to SEBI to wind up certain fixed income schemes under the Franklin Templeton Mutual Fund in wake of the economic scenario, and SEBI's views were asked while making out a case for winding up of 6 mutual funds schemes. SEBI conveyed that their request for enhancement of borrowing limit has been acceded subject to condition that increased limit will only be utilised for redemption of units.

The Trustee(respondent) abruptly issued notice under Regulation 39(2)(a) of Mutual Fund Regulations. In April 2020 RBI announced 50,000 crore Special Liquidity Facility for Mutual Fund in view of volatility in capital markets. SEBI issued a press release in May 2020 stating that in the current scenario FT should focus on returning money of investors as soon as possible. FT Mutual Fund then requested SEBI for grant of extension in time for enhanced borrowing limit. Circular was issued by SEBI for all mutual funds for listing of MF schemes that are in process of winding up, that they shall be listed on recognised stock exchange subject to compliance listing formalities.

Srivastava added that SEBI didn't respond to Franklin Templeton's question on winding up. Winding up should not be the first recourse but the last resort. It has huge after effect. Even the High Court had come down heavily on SEBI and made remarks on how the thing was dealth with in a wrong way.

Regarding the issue of vires, Senior Counsel stated that under Regulation 39(2)(a) the sole power is given to trustee, and is absolutely riddled and unparalleled power with no checks and balances or protection. This amounts to excessive deliberation of powers to Trustee and is arbitrary under Article 14.

With regards to the issue of validity of the Regulations, he stated that the SEBI Act provides power to SEBI to issue directions in interest of Investors. If winding up is necessitated in any case, SEBI has power to issue final directions under Section 11(b). Even though Trustees can initiate the winding up the final call has to be taken by SEBI.

"There has to be a robust mechanism to benefit the investors. Salaried people, middle class people invest their hard earned money in these mutual funds with hope of earning money. Mutual fund is a collective investment scheme according to provisions of the act. According to the Act, if after the inquiry it is found to be in interest of the investor or the securities market, it may issue directions to any person, which may include Trustees, as may be in the investor's interest"

Shrivastava stated that when there is a fundamental premise of winding up as big as this one, some authority, which in the present case is SEBI itself, should cause an inquiry to see if what Franklin was saying, and the grounds of Covid19 taken by it was correct or not.

"A direction can be made before an inquiry is done or made to be done" the Bench said

"I agree. That's the safeguard. SEBI as a regulator is supposed to look into it if the decision is in interest of investors or not."- Shrivastava responded.

Senior Advocate Shrivastava then cited Section 30 of the Act that provides SEBI Board the power to frame regulations. He stated that sub regulation 12 states that the Trustee shall be accountable for and be custodian of respective schemes. So mutual funds are in nature of a trust and under the trustees. Its not strictly a contract, but relationship is entirely fiduciary. According to Regulation 39, a close ended scheme be wound up only of expiry of the duration of the scheme.

"When 3/4th of unit holders have made a requisition, why is the consent required? " the Bench remarked.

"Thats how the regulations have been framed" - Shrivastava answered.

"You are saying that in case of close ended scheme we cannot redeem it without closure of the scheme" Bench stated.

"Yes you cannot " - Shrivastava answered.

Senior Counsel stated that the top Courts judgement could set a precent for the future. There are so many Mutual fund houses, if all the trustees start taking decisions like these and decide to wind up, the investors would be helpless.

"It was a premeditated decision of the Trustees of winding up, for their own reasons" Shrivastava stated.

Further, he added that in its counter affidavit SEBI stated that the Trustees decision for winding up was final and it could not do anything. However, that cannot be the case. SEBI must get in as a regulator, otherwise there is no other authority to protect the investors. It is stated in the Regulation that on completion of the winding up the Trustees are supposed to inform the Board and the unit holder. But there is no point in doing that. There is no provision for appeal under the SEBI Act, so the investors would have no recourse as even Article 226 has limited authority.

Shrivastava then brought to Court's attention that the High Court had said that SEBI did not act prudently and diligently in the present matter. Every event cannot justify winding up.

The next submission made by Senior advocate Shrivastava was regarding the decision of winding up and the winding up notice. He stated that in the master circular, the fundamental attributes include the type of scheme, investment objective, investment pattern and term of issue and Redemption is included. Even if Franklin Templeton's case that due to Covid19 demands for redemption was being made is accepted then the option for them would have been to go for suspension.

Are you saying that Covid19 would be covered under suspension? Bench asked

He added that even if something is not covered, does not mean SEBI can not direct suspension.This is not an embargo on powers of SEBI. SEBI should've seen if the situation was due to COVID. It is completely wrong to say that there was increased demand of redemption due to Covid.

"According to Franklin Templeton, from March 2020 abnormal level of redemption demands were being seen. The suspension that was thought viable on 14th April was found not viable on 20th April due to the Regulation. It is Franklin Templeton's own submission that their other schemes are not impacted by Covid. COVID is not selective in its treatment. Their other mutual fund schemes are not impacted by it."- Shrivastava remarked

On 23rd April the final notice was issued stating due to Covid-19, the schemes had to be wound up. According to Shrivastava, the declaration of winding up without approval of SEBI and invocation of Regulation 40 to wind up was a colourable exercise of power.

Advocate Puneet Jain appearing for another unit holder submitted that the 6 mutual fund schemes involving are all open ended schemes. In such schemes, there is a right to buy and a right to sell on declared NAV. On NAV basis when a unit is issued its representation would be equal for all other schemes. NAV is calculated on sum total of securities assigned by Mutual Fund House divided by number of units.

Elaborating on the difference between equity mutual funds debt mutual funds, Jain stated that in equity funds the value of securities is market determined, but in a debt market, the mutual fund industry is required to give security and not give loans, because if you give loans you become a bank and mutual funds are not banks.

"What Franklin Templeton started doing was granting loans and getting securities issued in their names"- Jain stated.

"To issue debentures also a company has to follow certain guidelines and follow SEBI guidelines." the Bench observed

Jain further stated that Franklin Templeton did run all these schemes as a Credit risk fund without looking at their investment objective, even though the idea of those schemes was that when money is put in those schemes, responsibility is on the mutual fund House to ensure that there is liquidity.

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.

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 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