Explained: The full impact of SEBI’s Franklin Templeton order on investors and the MF industry

On June 14, the capital market regulator, Securities and Exchange Board of India (SEBI) imposed monetary penalties on senior officials of Franklin Templeton Asset Management India. It fined Sanjay Sapre, its chief executive officer (CEO), Santosh DasKamath, its chief investment office - fixed income, other fund managers in the debt team, the trustees and the fund house's compliance officer.  This was SEBI's third big order on Franklin Templeton in a week.

Prior to that on June 7, the capital market regulator Securities and Exchange Board of India (SEBI) had come out with an order holding Franklin Templeton India guilty of wrongdoing. This order pertains to the case of the fund house suddenly winding up six of its debt schemes, in April 2020.

In a separate order back then, SEBI also found Vivek Kudva, Head of Asia-Pacific Distribution, his wife, Roopa Kudva and his mother Vasanthi Kudva, guilty of withdrawing their own personal money from these six debt funds. They did it days before the schemes were to be wound up, after having known crucial non-public information. In simple words, SEBI said that they knew more about how badly those MF schemes were placed, which regular investors were not aware of. SEBI asked Kudva and his wife to return Rs 22.64 crore and levied a combined penalty of Rs 7 crore. Kudva’s mother wasn’t separately fined, since it was established that Kudva had been managing her funds.

So, what are the consequences for the larger MF industry from this order? Here’s all that investors need to know.

Why was Franklin Templeton penalised?

In April 2020, Franklin Templeton shocked investors and the MF industry alike, by winding up six of its debt schemes. It froze redemptions and said it will sell the underlying securities and return the money to investors. This, as per initial estimates, could take as long as four years.

Franklin Templeton blamed its decision on the illiquid debt market, due to the onset of the COVID-19 pandemic. More than Rs 25,000 crore worth of investor’s money was stuck in these schemes.

Investors were angry. Meanwhile, presumably on the basis of the complaints filed by the investors in various High Courts, SEBI started its investigation in the way the funds were managed. It appointed an external auditor to inspect the fund house, its registrar and transfer agent and its trustees.

In October, the Karnataka HC ruled – later upheld by the SC – that the trustees must take unitholders’ consent before winding up the schemes. This closed one of the two chapters in the Franklin Templeton case. A majority of the investors approved the winding up and money began to get distributed. So far, the fund house has returned Rs 17,214 crore to investors.

The second chapter of the Franklin Templeton saga was to establish whether the fund house mismanaged its schemes. After a lot of back and forth among all stakeholders, SEBI finally issued its order last week, where it found Franklin Templeton guilty of mismanaging its funds.

SEBI also fined the fund managers for what it said was mismanaging the funds. Is this common? 

SEBI penalising fund managers on account of mismanagement is a rare case of imposing penalties. Instead, there have been more instances of penalties imposed on fund officials for offences like front running.

In the case of Franklin Templeton, SEBI has not just penalised the fund house because of lose controls, absence of adequate monitoring of risks that the fund managers actually took as opposed to what they were supposed to take, but it has also fined the entire debt funds management team who were involved in managing the six wound-up debt schemes.

SEBI fined senior official Vivek Kudva. What did he do?

In its investigation, the auditors also found that some senior employees had withdrawn their own money from these schemes, days and weeks before they were wound up. It was found that these senior officials had access to non-pubic information about how bad the state of these schemes was really. Kudva, his wife and mother withdrew Rs 30.70 crore in all.

SEBI was of the opinion that Kudva’s withdrawal was akin to the captain fleeing the troubled ship with the first available life boat. The regulator asked Kudva and family to return Rs 22.64 crore and levied a monetary penalty.

Why are these orders significant?

These orders are arguably the most significant for the MF industry.

The Karnataka HC as well as the SC confirmed SEBI’s MF regulations that require a fund house to first get unitholders’ approval to wind-up a scheme. The rules were always there, but no fund house had ever had to use them before. FT used it under extraordinary circumstances that had the industry and investors divided on the best way forward. The Courts reminded everyone that rules are rules.

Kudva’s order is also unprecedented. Already, fund managers and senior officials have a lot of restrictions on buying and selling shares. They are privy to price-sensitive information and SEBI has restrictions to prevent front-running. A few raw apples have been caught in the past. But there were no restrictions on them in buying and selling MF schemes, as they couldn’t gain at somebody else’s expense by doing so. Nor could they influence a scheme’s net asset value (NAV). But as Kudva’s own conduct shows, senior officials can get an unfair advantage if they know more than what others do.

I have been receiving my money back from the wound-up schemes. Will the ruling impact money distribution?

You will continue to get your money back as and when SBI Mutual fund manages to generate sums by selling the underlying assets.

How will this order affect the mutual funds industry?

SEBI’s order on Franklin Templeton will nudge other fund houses to temper credit risks in their debt schemes.

It may also push them to be more careful while interpreting SEBI’s regulations. Franklin Templeton had taken credit risks in duration-strategy schemes, saying that SEBI had only spelled out the duration limits of such schemes and was silent on the credit risks. SEBI obviously did not take kindly to the misinterpretation of rules. Industry experts that Moneycontrol spoke to say that the spirit of the regulations is just as important as the actual words that they spell out.