Fund managers and senior officials have to seek numerous permissions before investing their money. They have restrictions in terms of which shares they can and cannot buy, and also on the timing of such purchases. These steps are taken to make sure they don’t front-run or use inside information to their advantage. That is why most of them prefer to invest in mutual funds (MF). Unlike shares, investors in MFs cannot manipulate share price and make unfair gains at others’ expense. But the way Vivek Kudva sold his fund investments in Franklin Templeton brought to light the unfair advantage he took as a board member.
Kudva, Head of Asia-Pacific distribution at Franklin Templeton, and his wife Roopa Kudva, withdrew Rs 30.70 crore from the six debt funds, days before they were wound up. Kudva also withdrew his mother’s investments. The Securities and Exchange Board of India (SEBI) concluded in its investigation that Kudva knew about the poor state of the six debt schemes. The Kudva couple withdrew their money between March 20 and April 3. The schemes were wound-up on April 23.
Although Kudva did not commit any fraud, his conduct may nudge fund houses to stop their top officials and directors from withdrawing during a rough patch.
Investing in shares akin to traversing hoops
After senior executives give a written request of which stock and how much they want to buy, the compliance officer seeks the approval of all the fund managers. Only then the key official can buy the share. The permission is valid for just seven trading days.
Any share that the fund house has traded in the past 15 days is out of bounds, till the 15-day ‘cooling period’ is over. Once bought, they cannot sell the share for at least six months. “We even discourage our top officials from buying shares where the fund manager is most likely to invest. The top 100-odd stocks are most commonly looked at. That effectively makes all the large-cap stocks out of bounds for our top employees,” says the compliance officer of a large fund house who did not want to be named.
From 2015, top officials are also now required to submit a trading plan that specifies the shares that they wish to buy or sell over a period of 12 months.
Easier to buy MF units
Fund managers and key officials don’t need any prior approvals if they wish to buy or sell MFs. They just need to inform their fund house within seven days of buying a scheme. Employees have to hold the units for 30 days; exemptions are liquid and money market funds. They cannot take profits – they can sell or redeem if there is a loss.
If there is a likelihood of a change in the investment objective of the scheme, the manager cannot withdraw his money.
Or, if there is a likelihood of a rights or bonus issue, a dividend that has not been informed to investors, then the official cannot take investments out.
Other red flags include changes in the fundamental attribute and asset allocation, and moves to make close-ended schemes to open-ended ones or vice-versa. In all cases, sale is prohibited.
The compliance officer of a mid-sized fund house says he stopped one of his MF fund managers from withdrawing his money in a debt scheme two years ago. The scheme’s net asset value (NAV) was headed for a fall after one of its underlying instruments defaulted and was most likely to see a fall in its credit rating. That was the period of the credit crisis.
To be sure, none of the above criteria applied to Kudva’s withdrawals.
Also read: Explained: How SEBI arrived at all the penalties in the Franklin Templeton case
Right versus wrong behaviour
Compliance officers of mutual funds that Moneycontrol spoke to said that fund managers and officials should be more careful. “From the time discussions start internally to the time we put out the public notice, there is always a gap. As soon as deliberations start internally, there should be an immediate stop to all redemptions by top officials from that scheme,” says a compliance officer from another mid-sized fund.
“Additionally, the registrar & transfer agents can also be told to block any withdrawal requests from any employee, since officials are not required to take compliance approval for trading in MF units. They are merely supposed to report later,” says the compliance officer of a large fund house. This person says that the MF industry is watching this development very closely, as Franklin Templeton now gets ready to appeal to the Securities Appellate Tribunal (SAT). The SAT will finally take a call whether Kudva’s withdrawal was justified or not.
On the other hand, an industry official says that the current SEBI regulations are robust enough and mandate that that fund houses do not allow such withdrawals (by senior officials) made at crucial junctures which will affect the other unitholders. There is no change that fund houses need to do now due to this incident of Vivek Kudva, if the fund houses have been following these provisions in letter and spirit. Even if the fund houses leave aside those precise conditions laid down in SEBI regulations that prevent senior officials and trustees from withdrawing their own MF units, Kudva’s action was an ‘unfair trade practice’ whereby, as per SEBI’s investigation, he was aware of the deteriorating nature of the schemes. “That’s inside information, and according to SEBI’s findings, Kudva withdrew based on an inside information. That is clear violation of current SEBI regulations and placed Vivek Kudva at an unfair advantage vis-a-vis other unitholders” he says.
Kudva maintains that he had no idea that the schemes were headed for closure when he withdrew his money in March. He also maintains that as soon as the schemes were closed, he had set aside his corpus and placed himself “in a similar position as investors in April 2020. I have always acted in accordance with SEBI regulations, including in this instance. My personal transactions in the two schemes (under winding-up) have been conducted in good faith and with no intent to gain unfair benefit. My interests therefore remain fully aligned with outcomes that investors in the two schemes under winding up will have,” he says.