Can SEBI question your fund manager’s buy-sell decision?

SEBI last week fined HSBC Asset Management Rs 5 lakh.

Can a mutual fund house be made liable for bad investment decisions? A recent order by the capital markets regulator, after HSBC Asset Management (India) Private Ltd (erstwhile L&T Investment Management Ltd) made losses of around Rs 42.01 crore in three stocks, seems to have answered this question.

The Securities and Exchange Board of India (SEBI) last week fined HSBC Asset Management Rs 5 lakh for violations wherein the asset management company (AMC) was found failing in exercising due diligence in their investment decisions and in maintenance of records as mandated by regulations.

Earlier, in the same case, an Adjudicating Officer (AO) in August 23, 2023 had disposed of the proceedings and exonerated the AMC. However, in November 2023, SEBI reopened the case and passed fresh orders, holding that the AO's Order was “erroneous” and prejudicial to the interest of the securities market.

What’s the case?

SEBI had appointed an auditor to conduct an inspection of L&T Mutual Fund for the period April 1, 2019 to March 31, 2021. The auditor submitted the inspection report on July 15, 2022. Based on the findings of the inspection, SEBI alleged a violation of Mutual Funds Regulations by L&T Investment Management Ltd.

Also read | Gold BeES gets budget boost: Should you invest?

Accordingly, adjudication proceedings against L&T Mutual Fund was disposed of without any penalty.

Meanwhile, L&T Mutual Fund was acquired by the HSBC Group in May 17, 2023. The case was later reopened by the capital markets regulator, and accordingly, the present proceeding was conducted against HSBC MF.

Based on the findings of the inspection, it was found that the fund house had not properly recorded its investment decisions as per SEBI regulations as it had failed to maintain records containing data, facts and opinions in support of scrip wise investment decisions.

It also found that the fund house did not record detailed reasons in subsequent purchase and sale in shares it invested in. Further, the fund house failed to ensure and verify that due diligence was being exercised while making investment decisions.

Stocks in focus

The order focussed on investments and sales by three schemes of L&T MF in three companies which had resulted in losses.

With respect to Sadbhav Engineering, Rs 17.73 crore was invested during April 25, 2019 to May 8, 2019. Later, all shares of Sadbhav Engineering were sold on April 23, 2020, booking a loss of Rs 14.97 crore or about 84 percent of the funds invested.

On August 7, 2020, the fund house invested Rs 16.28 crore in Hindustan Zinc. All the shares of the company were sold during September 14-17, 2020, booking a loss of Rs 1.62 crore.

In Vodafone Idea, a scheme of the fund house made an investment of Rs 61.59 crore on December 4, 2019. However, all shares were sold after 44 days and 70 days at an average rate of Rs 4.51 per share, booking a loss of Rs 25.43 crore.

SEBI’s observations

According to a July 2000 SEBI circular, AMCs must maintain records in support of each investment decision which will indicate the data, facts and opinion leading to that decision.

Also read | In your early 30s and planning to retire by 50? Here are a few things to keep in mind

In the recent order, SEBI noted that on the scrip of Sadbhav Engineering, the fund house relied upon a research report dated July 31, 2019 prepared based on annual audited financials for the FY 2018-19. The report had a buy recommendation at Rs 141 for the shares. However, the initial investment of Rs 17.73 crore was made in the equity shares of said company at the average price of Rs 235.98 per share during the period from April 25, 2019 to May 8, 2019, whereas the report was dated July 31, 2019 after the initial investment was done in the scrip of Sadbhav Engineering.

“Under the circumstances, I find it difficult to accept that proper due diligence was carried out for making this investment,” said Kamlesh C. Varshney, Whole Time Member, SEBI.

SEBI further observed that investments made in all the three scrips were later on sold and for which, no records detailing the reasons had been maintained to justify the decisions.

The fund house had used phrases such as “need to raise cash for tactical reasons”, “Reducing Exposure” and “Switching to better opportunities” as rationale.

“The very purpose of the July 2000 Circular is to require AMCs to maintain proper reasons in support of each of their investment decision, so as to enable the AMC to produce the same when called upon to justify the reasons for their investment decisions. Just recording standardised phrases alone, cannot be treated as compliance with the provisions of the July 2000 circular,” the order said.

What does it mean for investors?

According to the order, SEBI has the power to review an order even if the same has resulted in the exoneration of an entity.

Further, the order clarified that the investment decisions made by the AMCs may be right or wrong and should not be questioned in hindsight merely because they resulted in a loss. To be sure, SEBI reiterated that reasons for every purchase and sale, subsequent to the first investment must be maintained by the fund houses.

Also read | How removal of indexation for homeowners may lead to better returns

While there should be a detailed research report analysing various factors for each investment decision taken for the first time, the reasons for subsequent purchase and sales in the same scrip should be recorded.

The SEBI order noted that the assets under management (AUM) of the Indian mutual fund Industry has grown from Rs 9.45 trillion as on April 30, 2014 to Rs 57.26 trillion as on April 30, 2024, more than a six-fold increase in a span of 10 years.

“Such companies are not risking their own money but risking thousands of investors’ hard-earned money and therefore, as the custodian of funds, they are accountable to the public at large with respect to their decision making process,” Varshney wrote in the order.