It is now widely reported that SEBI has taken what would appear to be strong action against the manager of Franklin Mutual Funds (Franklin Templeton Asset Management (India) Private Limited/Franklin). They have been ordered to return, with high interest, the fees they have earned on managing the funds. They have been banned for two years from making any new debt fund issue. A penalty of Rs 5 crore has been levied.
The question is, in light of SEBI’s findings about wrongful practices in the funds, are these actions enough? Do they give any serious relief to the investors? If not, what is lacking, and where?
The SEBI findings are pretty damning (though not agreed to by Franklin, who plan to appeal). SEBI has said that the critical Macaulay Duration has been calculated incorrectly. That all the six funds in question were practically run similarly, rather than distinctly as is what the rulebook says, and as is how they were presented to investors. That important terms of investment were merely in ‘commercial understanding’ and not enforceable in law. That what really were loans made were treated as securities. That there was a lack of due diligence in making investments.
There are other findings but one statement by SEBI summarises it in fairly blunt words: “The serious lapses and violations appear to be a fall out of the Noticee’s obsession to run high yield strategies without due regard from the concomitant risk dimensions.”
That the investors have suffered is obvious. Their investments could not be redeemed for an indefinite time. It is hugely disappointing when SEBI finds that all the six funds were managed as ‘credit risk’ funds. The question then is, if the findings are so damning, is justice done to them?
Investors are told that some Rs 512 crore (Rs 451 crore of management fees charged by Franklin and Rs 61 crore being interest at 12 percent pa) will be returned to them. The figure of Rs 512 crore does look hefty, but, in context, it is small. The funds managed literally tens of thousands of crores. On an annual basis, the fees amounted barely 1 percent. The penalty of Rs 5 crore then looks even meagre, and in any case it goes to the government coffers.
For an investor, the ban on Franklin from setting up new debt funds, is only a consolation, not relief or even justice. If indeed, as SEBI has held, that there were serious violations of law and of good fund management practices, has the loss caused to the investors quantified, even as estimates? Considering the size of the funds managed, the amounts could be huge and the actions taken then suddenly sound tame.
If that be so, what was lacking? Is the law inadequate or has SEBI not done enough? It seems a bit of both.
The law is inadequate because though there are ample and even minutely-detailed rules laid down for mutual funds, on critical aspects they are missing or ambiguous. Take the critical issue of Macaulay Duration. This is a reasonably good indicator of the maturity term of investments made. It helps the investor decide whether to take risks of investment in longer term debt with expectations of higher returns or go for short term, lower return investments. The problem is that this term does not appear to be well-defined in the regulations.
The differing views of Franklin and SEBI on how it should be calculated are apparent from the order itself. Then there is question on how much flexibility a fund has in making investment decisions. Will funds have wide discretion in making decisions using their business sense and expertise? Or will SEBI be looking over their shoulder and correcting, more so with hindsight wisdom?
SEBI has also held that there was lack of due diligence, proper risk management, etc. However, the order does not detail what the well-accepted standards are and how the Franklin’s practices lacked in this regard.
SEBI has levied a fairly high interest of 12 percent. Does this have basis in law? All these will surely be aggressively argued in the appeal before the SAT (and possibly further). If the order gets reversed or diluted, it will be the proverbial insult over injury to the investors.
An important question of law would be: Does SEBI have powers to order relief in respect of losses suffered by the investors? Or do the investors have no choice but to pursue this in civil actions before courts, which would take years, maybe decades?
It is interesting to contrast this with the SEBI order of same date against a director (and family members) of Franklin on this matter itself. The director was found to have redeemed his investments in the funds on the basis of his inside/non-public knowledge about impending problems in the funds. SEBI has ordered them to refund most of the amounts they have received, with interest, and get redemptions only along with the remaining investors. Surely, SEBI could have applied similar principles and considered comparable orders against Franklin?
Curiously, SEBI has levied a penalty of Rs 7 crore on the director and his wife, while the penalty on Franklin is a mere Rs 5 crore! This may sound strange. However, here too, the law appears to be lacking. SEBI has cited multiple provisions dealing with lapses by mutual funds, each of which provides for a maximum penalty of Rs 1 crore. The penalty of Rs 5 crore is the aggregate of penalties under these multiple provisions. While for individuals, the penalty can be three times the gains wrongfully made or Rs 25 crore, whichever is higher.
All in all, the order does leave a sense of dissatisfaction. Mutual funds today manage trillions of rupees. In the aftermath of such findings, even if as a kneejerk reaction, investors would be worried about how well other funds are managed. If there too are lacunae, what relief would they get?
If the law and SEBI’s actions are found to be wanting, then it is bad even for the industry. One hopes that this order becomes a case study for a serious relook at the law and its enforcement.(Disclosure: The author/family hold investments in the funds of Franklin Templeton in respect of which the SEBI order has been made.)