Franklin Templeton order: Supreme Court upholds consent of unitholders must in winding-up of mutual fund schemes

The next hearing on other aspects of the case is slated for October, 2021, unless early hearing is sought by the parties.

The Supreme Court (SC) has ruled that consent of unitholders is mandatory when winding-up schemes of a mutual fund. While the order on other aspects of Franklin Templeton wind-up case is still pending, the apex court gave its view on how SEBI’s wind-up regulations should be interpreted.

The SC has taken view that after wind-up notice is sent to unitholders, fresh investments and redemptions in the schemes can be frozen, but after this unitholders’ consent on winding-up needs to be taken before moving forward.

“…we hold that the consent of the unitholders, as envisaged under clause (c) to Regulation 18(15), is not required before publication of the notices under Regulation 39(3). Consent of the unitholders should be sought post publication of the notice and disclosure of the reasons for winding up under Regulation 39(3),” the SC said in its order.

SC refrained from passing any order on other aspects of the case related to allegations of preferential payments, mismanagement of funds, violation of investment objectives and withholding of price-sensitive information. The SC bench said, once the “facts are clear and ascertained”, it would look into these.

Also read: SAT grants interim relief to Franklin Templeton in case against SEBI order

In November, 2020, Franklin Templeton Mutual Fund (FT MF) had moved SC to appeal against Karnataka High Court’s (HC) order that unitholders’ consent is needed before winding-up.

Unitholders’ rights can co-exist with trustees’ expertise

One of the contentions of SEBI, FT MF and its trustees has been that unitholders are a “large and disparate body of lay persons without domain expertise, have been erroneously conferred the right to veto and overrule the decision of the domain experts.” The trustees have been referred to as domain experts.

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SC said that the regulations envision unitholders as perceptive investors. That is the reason trustees are required to be transparent and keep the unitholders informed. Regulations require various disclosures from mutual funds, so that unitholders can make an informed decision on investing or withdrawing their investments.

“…they are not placid onlookers, impuissant and helpless when the trustees decide to wind up the scheme in which they have invested. The stature and rights of the unitholders can co-exist with the expertise of the trustees and should not be diluted because the trustees owe a fiduciary duty to them.”

How FT interpreted SEBI rules?

Regulation 39 of SEBI’s MF regulations states that the fund house can close or wind-up an open-ended scheme if the trustees feel it is required or if 75 percent of the unitholders of a scheme pass a resolution to wind up the scheme or if SEBI directs the winding up in unitholders’ best interests.

Also read: Karnataka HC raps Sebi for not being proactive in Franklin Templeton wind-up

Franklin Templeton has said that it exercised the first option, when deciding to wind-up six of its debt schemes in April, 2020.

However, certain unitholders of the schemes approached the courts, stating the fund house should have followed regulation 18(15)(c), which says trustees shall obtain consent of the unitholders before winding-up.

Also read: Fundsgate: How the Karnataka High Court Shredded Franklin Templeton’s and SEBI’s arguments on investor consent

Franklin Templeton also followed regulation 40, which says that after trustees decide to wind-up, the schemes must stop all redemptions and investments immediately. In accordance with regulation 41, FT MF followed up by asking unitholders to vote on who they would want to appoint for liquidating the schemes. However, this voting got stayed as the Khambatta family, who held investments in FT MF schemes, sought Gujarat HC’s intervention.

(This is a developing story. Please check back for updates)