Franklin Templeton Unit-Holder to Supreme Court: COVID-19 used as Camouflage

Franklin Templeton Unit-Holder to Supreme Court: COVID-19 used as Camouflage

A Division Bench of the Supreme Court of India (SC) comprising of Justices Abdul Nazeer and Sanjeev Khanna, heard the plea by Franklin Templeton wherein the order of the Karnataka High Court (HC) was challenged. The HC in its order has restrained winding up of six of its debt schemes without obtaining the consent of its investors by a simple majority.

The Apex Court will hear the arguments of the parties and examine various other issues involved in the matter including malfeasance, the validity of the regulation, the question of vires, etc.

The Top Court on 12 February 2021, negated all objections and upheld the validity of the e-voting process for winding up of six mutual fund schemes of Franklin Templeton. The SC has directed the disbursement of funds to be done in terms of its previous orders.

It was further observed by the SC that the consent of unit holders means the consent of a majority of unitholders and not just that party to the scheme. The Court directed in its earlier order that the amount of Rs. 9122 crores that is cash ready with Franklin Templeton as of 15th January 2021 be distributed amongst the unit holders under the six mutual fund schemes.

The Apex Court further directed the Franklin Templeton Trust Services and the asset management company to co-operate with SBI Mutual Funds in this regard and furnish to them entire data and details.

It further said that the process should be completed within 20 days from the date of this order. It gave liberty to the parties to move an application and approach this Court in case of any difficulty in the process.

In April Franklin Templeton had announced its decision to wind up six debt funds citing low liquidity. Nearly 3 lakh investors are estimated to be affected by its decision. That after this decision some investors moved to the HCs. Franklin Templeton seeking consolidation of various petitions filed concerning the winding up of debt funds.

Senior Advocate Ravindra Shrivastava appeared on behalf of one of the unit-holders named Amruta Garg. The Senior Advocate submitted before the SC that he has challenged the validity of the regulations.

It was mentioned before the Court that there are serious questions regarding the winding up of Franklin Templeton. It was claimed that the winding-up process was a camouflage by the trustees and they used Covid-19 as an excuse.

It is the first instance of winding up of a Mutual Fund house, and despite all problems of Covid19, none of the other Mutual Fund houses took the drastic measure of winding up. The Court is dealing with such an unprecedented situation wherein it will interpret SEBI and the Mutual Fund Regulations.

He mentioned that an Investment Management Agreement was executed between Trustee and Franklin Templeton Asset management India for acting as an Investment Manager to the schemes of Franklin Templeton Mutual Funds.

The SEBI issued a circular in May 2016 regarding restriction in mutual funds and laid down that philosophy, restriction, or redemption would apply during excess redemption requests that could apply in overall market crisis rather than exceptional circumstances of entity-specific situations.

In 2017, the SEBI issued circular classifying mutual funds schemes into 5 heads including an Equity scheme, Debt scheme, Hybrid Scheme, Solution-oriented scheme, and other schemes.

He added that the unitholder in 2018 had invested 5,00,000 in Franklin India Short Term Income Plan (FISTIP), and the Infrastructure Leasing and Financing Services (IL&FS) scan broke out in the capital market. The regulatory body issued master circular 3 for effective regulation of the mutual fund industry and which is a compilation of all circulars applicable to Mutual funds.

He mentioned that in March 2020 Covid19 pandemic was declared in India. A request was made by Franklin Templeton from the regulatory body for enhancing the borrowing limit given in MFR from 20% to 30% for Franklin India Opportunities Fund, SEBI acceded to its request.

It was further highlighted that a proposal was sent by Franklin Templeton to SEBI for winding up its certain fixed income schemes due to the economic scenario.

The view of the regulatory body was taken while making out a case for winding up 6 mutual funds schemes. It was conveyed by the SEBI that their request for enhancement of borrowing limit has been acceded subject to the condition that increased limit will only be utilized for the redemption of units.

That the respondent-Trustee had abruptly issued a notice under Regulation 39(2)(a) of Mutual Fund Regulations. In April 2020 RBI announced a 50,000 crore Special Liquidity Facility for Mutual Fund given volatility in capital markets.

In May 2020, the SEBI issued a press release wherein it stated that in the current scenario of Franklin Templeton should focus on returning the money of investors immediately.

Franklin Templeton made a request to the SEBI for granting an extension in time for an enhanced borrowing limit. The SEBI issued a circular for all mutual funds for a listing of Mutual Fund schemes that are in process of winding up. It was directed by the regulatory body that they shall be listed on the recognized stock exchange subject to compliance listing formalities.

The senior advocate stated that SEBI did not respond to Franklin Templeton's question on winding up. It was argued by Mr. Srivastava that winding up should not be the first recourse but the last resort. He added that the HC also came down heavily on SEBI and made remarks on how the thing was dealt with in a wrong way.

He stated regarding the issue of vires that under Regulation 39(2)(a) the sole power is given to the trustee, and is riddled and unparalleled power with no checks and balances or protection. This amounts to excessive deliberation of powers to Trustee and is arbitrary under Article 14 of the Constitution of India.

Regarding the issue of the validity of the Regulations, he mentioned that the SEBI Act provides power to SEBI to issue directions in the interest of Investors. If winding up is necessitated in any case, SEBI has the power to issue final directions under Section 11(b). Even though Trustees can initiate the winding up the final call has to be taken by SEBI.

He emphasized that when there is a fundamental premise of winding up some authority, such as SEBI should inquire whether the claim made by Franklin was correct or it was merely an excuse wherein they took advantage of a pandemic.

While hearing the submissions of the senior counsel the bench stated, "A direction can be made before an inquiry is done or made to be done."

Mr. Shrivastava mentioned Section 30 of the Act that deals with the SEBI Board's power to frame regulations. He added that the Trustee shall be accountable for and be the custodian of respective schemes. So mutual funds are in nature of trust and under the trustees. According to Regulation 39, a close-ended scheme is wound up only of expiry of the duration of the scheme.

To the aforesaid submissions of the senior advocate, the SC bench remarked "When 3/4th of unitholders have made a requisition, why is the consent required?" "You are saying that in case of a close-ended scheme we cannot redeem it without closure of the scheme," the bench asked the senior counsel.

The senior counsel responded in affirmation and stated that yes it cannot be done. He added that the Apex Court's verdict could set a precedent for the future. He emphasized the fact that there are so many Mutual fund houses, if all the trustees start making decisions like these and decide to wind up, the investors would be helpless.

The senior counsel highlighted that the SEBI mentioned in its counter-affidavit that the Trustees decision for winding up was final and it could not do anything. However, the SEBI must get in as a regulator; otherwise, there is no other authority to protect the investors.

The Regulation provides that on completion of the winding-up the Trustees are supposed to inform the Board and the unitholder. There is no provision for appeal under the SEBI Act, so the investors would have no recourse as even Article 226 of the Constitution has limited authority.

The senior counsel brought the attention of the Top Court to the fact that the HC had said that SEBI did not act prudently and diligently in this matter. It was stated that every event cannot justify winding up.

He further mentioned that in the master circular, the fundamental attributes include the type of scheme, investment objective, investment pattern, and term of issue, and Redemption is included. He said that in the instant case due to pandemic there was a demand for redemption that was accepted and then the option for them would have been to go for suspension.

To the above submission of the counsel, the bench asked, "Are you saying that Covid19 would be covered under suspension?"

The advocate submitted before the SC that if something is not covered under the Act it does not mean that the SEBI cannot direct suspension. This is not an embargo on the powers of the regulatory body. It was the duty of the SEBI to verify the correctness of the claim made by Franklin Templeton. It is completely wrong to say that there was increased demand for redemption due to Covid.

He remarked that "It is Franklin Templeton's submission that their other schemes are not impacted by Covid. COVID is not selective in its treatment. Their other mutual fund schemes are not impacted by it."

On 23rd April the final notice was issued stating due to Covid-19, the schemes had to be wound up. According to Shrivastava, the declaration of winding up without the approval of SEBI and invocation of Regulation 40 to wind up was a colourable exercise of power.

Advocate Puneet Jain appeared on behalf of another unit-holder mentioned before the Court that the 6 mutual fund schemes involving are all open-ended schemes. In such schemes, there is a right to buy and a right to sell on declared Net Asset Value (NAV).

He added that on NAV basis when a unit is issued its representation would be equal for all other schemes. It is calculated on the sum total of securities assigned by Mutual Fund House divided by a number of units.

Mr. Jain further submitted while elaborating on the difference between equity mutual funds debt mutual funds, that inequity funds the value of securities is market-determined, but in a debt market, the mutual fund industry is required to give security and not give loans, because if you give loans you become a bank and mutual funds are not banks.

He added that Franklin Templeton did run all these schemes as a Credit risk fund without looking at their investment objective, even though the idea of those schemes was that when money is put in those schemes, responsibility is on the mutual fund House to ensure that there is liquidity.