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Last Updated : Oct 29, 2020 10:20 AM IST | Source: Moneycontrol.com

Fundsgate: How the Karnataka High court shredded Franklin Templeton’s and SEBI’s arguments on investor consent

Franklin Templeton did not ask for investor consent when it decided to wind up its six debt funds in April. Investors disagreed and dragged it to court

At the heart of the court battle between Franklin Templeton mutual fund and some of its investors who took it to court earlier this year, is the winding up six debt funds without taking unitholders consent. On October 24, the Karnataka High Court ruled that the fund house must take investors consent before closing the schemes. In doing so, it ripped apart the fund house’s and Securities and Exchange Board of India’s (SEBI’s) arguments that SEBI rules do not mandate asking investors’ permission before winding up.

Why the confusion? Regulation 39 in SEBI’s MF rules specifically deals with ‘winding up’ of schemes. This regulation states that the fund house can close an open-ended scheme if the trustees feel a dire need 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. Any one of these three reasons is enough.

Defending its moves

Close

Franklin Templeton said that it exercised the first option here. As liquidity in the debt markets had dried up earlier this year due to the COVID-19 pandemic, many debt funds, including those of Franklin Templeton’s, faced massive redemptions. The fund house said has redemptions continued, these six debt funds would have had to sell their securities at throwaway prices and investors would have suffered a loss.

Investors weren’t happy. They pointed to Regulation 18 (15) (c). This regulation says trustees shall obtain consent of the unitholders when the majority of the trustees decide to wind up the schemes. This lapse was why some aggrieved investors dragged the fund house to court.

Franklin Templeton also relied on two other pieces of regulations related to ‘winding up’. Regulation 40 states that after a fund house’s trustees decide to wind up a scheme, the scheme must stop all redemptions and investments immediately. Regulation 41 says that trustees will then seek unitholders approval to, by a simple majority, authorise the trustees or some other person to take charge of the winding up process.

Franklin Templeton did both. In fact, it said, that as regulations (Regulation 39) specifically say ‘winding up,’ they did everything that SEBI had laid out in case a fund house does indeed prematurely wind up a scheme.

Court takes grim view

The Karnataka High Court took a stern view of the trustees’ obligations as articulated in Regulation 18. “An obligation is a legal duty to do or not to do any act,” it said in its order. But doesn’t Regulation 39 give trustees as well as 75 percent of investors, both, the power to wind up a scheme? Breaking down Regulation 39 further, it reminded Franklin Templeton and SEBI that 75 percent of unitholders coming together and deciding to wind up a scheme is different from the trustees obtaining consent from unitholders after trustees take a call to wind it up (as per Regulation 18-15-c).

The Court pointed out that 75 percent of the investors can decide to wind up the scheme; they can initiate the winding up on their own, going by Regulation 39. Here, SEBI has mandated the minimum number of investors required.

But Regulation 18 is silent on the nature of majority while asking for unitholders approval. This approval, said the High Court, can only mean a simple majority. The High Court elaborated that unitholders consent is required even if the trustees decide on their own to wind up. In short, Regulation 18 and 39 must be read in harmony; something that the fund house and SEBI did not do.

Didn’t Franklin Templeton ask for unitholders’ consent? In its arguments, the fund house had said that it did ask unitholders consent on assigning an authority (trustees or Deloitte) to oversee the winding up of the schemes and returning money back to investors. This, said the fund house to the court, is what it believed to be a direct connection between the consent that Regulation 18-15-c talks about and the approval that Regulation 41 seeks. The fund houses had said in the court that there is no difference between the word ‘approval’ and ‘consent’.

The High Court threw out this argument too. It reminded the fund house that the approval sought under Regulation 41 is “only on the issue who will take steps for winding up of the scheme….the approval under Regulation 41 has nothing to do with the decision to wind up a scheme.”

One other argument that both SEBI and the fund house tried to put forth was that taking consent of unitholders for winding up a scheme could have disastrous consequences. If unit holders vote against the closure of the scheme, other investors might rush for redemptions, forcing the scheme to sell its securities at throwaway prices. Hence, the fund house and trustees were the ideal people to decide, according to their contention.

That is not a valid excuse for the trustees forgetting their own obligations under Regulation 18; something that the court noted was already mentioned in the Statement of Additional Information (SAI) of Franklin Templeton’s schemes. Moneycontrol has a copy of the SAI. “After having made this representation, the trustees cannot now contend to the contrary and say that they are not under any obligation to obtain such a consent,” said the High Court order.

Fundsgate is a periodic column on all things mutual funds and personal finance.
First Published on Oct 29, 2020 10:20 am
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