INTRODUCTION
I. A Conference of Chairman/Sponsors of the Board of Trustees of Mutual
Funds was convened by SEBI in February, 1997. This was to take note of
the provisions/changes introduced through the SEBI (Mutual Funds) Regulations,
1996. At this conference, serious concern and reservations were expressed
by various Trustees in regard to the liability and exposure of the trustees
under the newly amended regulations and the expectations of SEBI about
the role of the trustees. Particular concern was expressed about the lack
of infrastructure support available with the trustees and its inconsistency
with the nature of performance now expected from them. The arrangements
under which trustees were currently functioning were not of a nature that
would enable them to discharge any of these heavy responsibilities. Fears
were also expressed that they might even discourage persons with experience
and of eminence from accepting such responsibilities. The Regulations require
trustees to be persons of experience. The Regulations also require trustees
to be persons of ability, integrity and standing. The expectation was that
the association of such trustees would lend credibility to the Mutual Funds.
At the Conference, it was pointed out that this imbalance needed to be
carefully studied so that trustees are placed in a position to discharge
the responsibilities and functions expected of them and are also simultaneously
provided with infra-structure support and a working regime which enabled
them to play an appropriate role in the Mutual Funds Industry. There should
neither be over-expectation from an imperfect and imbalanced system nor
any lowering of the role they are expected to play as monitors in the first
instance.
II. Taking note of these observations, SEBI constituted a Committee
under my Chairmanship asking me and my fellow Committee members to recommend
a work pattern which would enable discharging of responsibilities by the
trustees as envisaged under the Scheme and the Regulations.
III. The constitution of the Committee was as follows :
1. Shri. P K Kaul, Chairman.
2. Shri. N V Iyer, Chairman Board of Trustees, ICICI MF
3. Shri. Samuel Forester, Chairman Board of Trustees, Templeton
MF could not attend
so Shri Vijay Advani, CEO attended the meetings.
4. Shri. S S Bhandari, Trustee, PNB MF
5. Shri. S C Bafna, Former Member, Company Law Board
6. Shri. K N Atmaramani Managing Director, Tata MF could not
attend so Shri. A P
Kurien, Chairman AMFI attended the meetings on behalf of AMFI.
7. Kum. D N Raval, Executive Director (Law) SEBI.
8. Shri. Pratip Kar, Executive Director, SEBI, Member Secretary.
IV. The terms of reference of the Committee were :
a) to work out a model management information
system particularly at asset
management company
and Trustee levels as also the Reporting systems to SEBI;
b) to recommend necessary clarification
regarding the manner of compliance of some
of the provisions
of the Regulations;
c) to look into the feasibility of organising
mutual funds alternatively as companies and the applicability of the Indian
Trusts Act vis-a-vis Trustees.
V. The Committee was constituted with wide representation from the
Trustees of mutual fund industry, legal experts and AMFI.
VI. To enable a better appreciation of the complex problems involved,
it may be of advantage to give brief history of Mutual Funds.
VII. Mutual Funds are unique in more than one sense. For one,
mutual funds are investment vehicles in which investors have collectively
entrusted their savings in the belief that they have better expertise and
skills for investing than their own. The task of keeping up this
trust is by no means easy. Mutual funds are also unique
in that they are organised and operated by fund managers whose primary
loyalty and pecuniary interest lie outside the enterprise. These
two features taken together bring about certain inherent conflicts of interest
and create potential for abuse. Hence the need for an effective oversight
of mutual funds. For the very same reasons the task of supervision
is both expedient and difficult - a task which was complex but yet necessary.
VIII. The mutual funds can be organised in two ways. One, the
Trust structure and the other, the Company structure. In both these
structures, there is an entity which undertakes the designing and marketing
of schemes, raises money from the public under the schemes and manages
the money on behalf of its owners. This entity is the fund manager or an
Asset Management Company (AMC) . To segregate the collected funds from
this entity’s own funds, the corpus is placed in a legal vehicle. It is
the character of this legal vehicle that determines the character of the
Fund itself. If this vehicle is a corporate entity then the fund acquires
the name of an investment company as in the US and UK and if the entity
is a Trust, the fund acquires the name of mutual fund as in UK and
India, for example. Irrespective of the nature of the structure, what is
more fundamental is that in view of the fiduciary role of the AMC or the
fund manager towards the public, there is a need for supervision of the
activities of the AMC or fund manager by a separate body. This supervisory
role is fulfilled by the Board of Trustees and in a corporate structure
by the Board of directors of the Investment company.
IX. Unit Trust of India (UTI), which has a structure different from
the three tiered structure of other mutual funds in India was established
by the Government of India to encourage private savings and investment.
It was formed under a special Act of Parliament, viz. The Unit
Trust of India Act, 1963 as a corporate body. The promoter-sponsor
of UTI is the Government of India through the Reserve Bank and Financial
institutions. In the true sense however they were the only owners of the
initial units of the UTI. The UTI Act provides
that the general superintendence, direction and management of the affairs
and business of the Trust shall vest in a Board of Trustees which may exercise
all `powers and do all acts and things which may be exercised or done by
the Trust”. The Board of Trustees comprises nominees of the Central
Government, RBI, IDBI, LIC SBI, participating financial institutions
and an Executive Trustee to be appointed by IDBI. The
UTI Act stipulates that there shall be an Executive Committee which shall
consist of The Chairman of the Board, Executive Trustee and two other Trustees.
Subject to such general or special directions as the Board may from time
to time give, the Executive Committee shall be competent to deal
with any matter within the competence of the Board of Trustees. The
Executive Committee in effect, performs the asset management functions.
Thus, the activities of the Executive Committee which itself comprises
members of the Board of Trustees, are overseen by the Board of Trustees
themselves. In matters involving public interest, the Central
Government and the Reserve Bank of India have powers to give directions.
X. The management structure of UTI is thus distinct from the remaining
mutual funds in more than one way. First, unlike other mutual funds,
it is a statutory body corporate and not a Trust under the Indian Trusts
Act. Second, there is no separate asset management company with a
separate Board of directors of AMC to manage the schemes. The functions
of the Board of directors of AMC, and Trustees are combined in the Executive
Committee and Board of UTI. The Sponsors exist in the form of Government
and IDBI, though they do not hold any equity in the Trustee company or
AMC for none exists. SEBI at present regulates UTI through a special
regulatory dispensation effective from July 1, 1994 which inter alia requires
UTI to file offer documents in accordance with the SEBI (Mutual Funds)
Regulations (“Regulations”) and allows SEBI to inspect UTI. This
arrangement in SEBI’s view is only an intermediate step and according to
SEBI, it would be desirable to amend or repeal the UTI Act to bring UTI
and other mutual funds under a common regulatory framework. In the
meanwhile UTI has set up three separate asset management Committees as
directed by SEBI.
XI. When the public sector banks were allowed to set up mutual funds,
the first mutual fund was set up by the State Bank of India in 1987 prior
to the establishment of SEBI. State Bank of India preferred
to adopt the Trust route and set up the mutual fund as a Trust under the
Indian Trust Act 1882. Other mutual funds followed suit and thus
Trusts set up under the Indian Trusts Act came to be the adopted legal
form of mutual funds in India. The author or Settlor of the Trust
came to be principal Trustee and also functioned as the fund
manager.
XII. These mutual funds combined the role of Trustee, fund manager
and custodian in the sponsoring bank. There was little demarcation in the
role and responsibilities and the structure was open to conflict of interests.
XIII. Other mutual funds that were set up later adopted the same pattern
and thus, over time, Trusts set up under the Indian Trusts Act became the
accepted legal form for establishment of Mutual Funds in India. The author
or Settlor of the Trust became the principal Trustee and also functioned
as the fund manager.
XIV. With the establishment of SEBI under the SEBI Act, 1992, mutual
funds other than the UTI, were for the first time brought under the regulatory
purview of SEBI. At that time, no special legislation similar to the UTI
Act existed under which the mutual funds could be incorporated. Historically,
SEBI found that mutual funds had been set up by public sector banks adopting
the trust route because using the route of the Companies Act appeared to
be more complex as it could have also led to multiple regulatory jurisdiction.
Sufficient information is not available as to whether, at this stage, a
rigorous examination of the advantages and disadvantages of the two alternative
routes were undertaken or not. Nonetheless, the SEBI (Mutual Funds) Regulations
provided for setting up of mutual funds as Trusts under the Indian Trusts
Act of 1882. It may not be out of place to mention that the Indian Trusts
Act of 1882 was enacted to govern private Trusts and envisaged a different
manner of conduct and supervision of operations. Quite clearly, it did
not at that time take into account the nature of activities that will be
involved in the functioning of mutual funds.
XV. SEBI, while framing the Mutual Fund Regulations, gave a lot of
consideration to two major factors, one, that mutual funds garner large
moneys from the pubic for investment in a dynamic market place which require
specialisation on the part of persons performing these functions. Secondly,
there could arise potential conflicts of interest which were to be avoided
by ensuring arm’s length relationship between various functionaries. Such
stipulation of arm’s length relationship ensures that the person who performs
a function is answerable to another and does not assess or judge his own
performance. The Regulations stipulated a three tiered structure of entitites
for carrying out different functions of a mutual fund, but placed the primary
responsibility on the trustees. Internationally, irrespective of the route
adopted, a three tiered structure exists and there is a segregation between
the responsibility of fund management and the trustee or supervisory responsibility.
XVI. Considering the inherent fiduciary nature of the functions, arm’s
length relationships were sought to be built into the various constituents
of a mutual fund, primarily through separate entities and delineating the
role and responsibility of the asset management companies and the Trustees
and regulations on affiliate transactions. Arm’s length relationships were
also expected to be achieved by requiring a certain proportion of Trustees
to be independent of the sponsor, requiring independent directors on the
board of the AMC and requiring an independent custodian to be appointed.
XVII. Following the notification of the SEBI (Mutual Funds), Regulations,
1993, SEBI gained further experience in administering the Mutual Funds
Regulations and regulating the mutual fund industry. SEBI, based on the
discussions held with the representatives of AMFI and in light of the regulatory
experience gained prepared the “Mutual Funds 2000” Report which recommended
certain changes in the Regulations. The revised Regulations of 1996 also
sought to address the concerns expressed in various quarters regarding
the functioning of the mutual funds and effectiveness of the Board of Directors
of the AMC, the role of independent directors and also sought to impose
further checks and balances on the board of directors of the AMC under
the overall supervision of the Trustees and additional obligations on the
Trustees. The genesis of these obligations lies in the principle
that Trustees of a mutual fund are the first level regulators. The Regulations
have laid great emphasis on strengthening the Trusteeship function by providing
specific responsibilities on the Trustees and conferring greater powers
to the Board of Trustees for improving the governance of the mutual funds.
It has sought to enhance the level of supervision over the functioning
of the funds and asset management companies by the Trustees inter alia
by stipulating periodical review of the activities of the AMC by the Trustees,
reporting by the AMC to the Trustees and by the Trustees to SEBI.
XVIII. The additional obligations cast on the Trustees by the SEBI
(Mutual Funds) Regulations, 1996 are ;
1 calling for a Report from the compliance department of AMC periodically;
2 calling for information from the AMC to satisfy itself that the AMC
has not given any undue or unfair advantage to any affiliates, dealt with
any of the affiliates of the AMC in any manner detrimental to the investors
and not provided for in the Regulations;
3 reviewing all transactions with affiliates and payments made by the
mutual fund to affiliates periodically;
4 calling from the AMC the information on the procedure for empanelment
of brokers and satisfying itself that the AMC has taken adequate care in
the choice of brokers, in monitoring and following up of transactions with
brokers and avoiding undue concentration of business with brokers;
5 reviewing all service contracts such as custody arrangements or transfer
agency of the securities periodically;
6 reviewing the investor grievances redressal mechanism periodically;
7 filing their own transaction details in securities on half yearly
basis with SEBI;
8 calling for similar details in respect of the board of directors
and key personnel of the AMC;
9 furnishing to SEBI a certificate on a half yearly basis stating that
the Board of Trustees has examined these statements and has satisfied itself
that there has been no instance of self dealing or front running by any
of the directors of the Trustee company and the AMC, employees of the AMC
and the Trustee company.
XIX. The Committee held several meetings and deliberated on all the
provisions relevant to the role and responsibilities and liabilities of
the Trustees under the Regulations and the Indian Trust Act and on the
issues which came up before SEBI in the course of administration of the
Regulations. The Committee had the opportunity of discussing the
principles and practices and the regulatory framework governing the role
of Trustees and independent directors of investment companies with particular
reference to the mutual fund industry in the US. The Committee noted
that in the US , the role of the board of directors of the investment company
was central to policing the conflicts of interest inherent in the structure
of mutual funds. As the mutual funds collect moneys from the public,
the Committee acknowledged that the Trustees need to play the role of an”
internal watch dog” in protecting the interests of the unit holders.
XX. The Committee was seized with the task of allaying the concerns
of Trustees in regard to the true scope of he Regulations while at the
same time ensuring the due role of Trustees in exercising checks
and balances. The mutual funds in India, barring the Unit Trust of India
were governed by the Indian Trusts Act and constituents of the Mutual Fund
were as under :
(a) The sponsor who establishes a Mutual Fund under a duly registered
instrument of
trust.
(b) The Asset Management Company constituted as a company under
the Companies
Act entrusted with the management of
the funds of the Mutual Fund, and
(c) The Trustees who hold the property of the Mutual Fund in
trust and supervise the
functions of AMC for the benefit of
the unit holders, could either be a set of
individuals forming a Board of Trustees
or constituted as a Trustee Company under
the Companies Act.
(d) The Custodian who carries out custodial services for the Mutual
Fund.
XXI. The rights, duties and obligations of Trustees under the Indian
Trusts Act are well recognised and well settled by a law which is in force
for over a century. The Trustees are expected to discharge their duties
as men of prudence with reasonable care, skill and diligence in respect
of property entrusted to them as they would bestow upon their own property.
There are stringent consequences for dereliction of duty and breach of
trust. Given the savings of large sections of the public which in turn
requires the entrustment of management of those funds to an AMC, it would
throw up a whole set of complications and issues. The position is further
compounded by detailed regulations as under regulation 18 with 23 sub-regulations
stipulating rights and obligations of the Trustees. Again, many of the
Trustees are organised as trustee companies and therefore the individuals
are on the Board of Directors of the Trustee Company whose conduct is regulated
under the Companies Act. The inter-action and inter-play of the Indian
Trusts Act, the Companies Act and the SEBI Regulations, 1996, creates
great apprehension in the minds of Trustees.
XXII. Similarly, the role of the AMC is akin to that of Managers or
Managing Agents. A role of this nature is hardly visualised under the Indian
Trusts Act where the basic thrust is obligation attaching to ownership
of property and arising out of confidence reposed in the Trustees for the
benefit of the beneficiaries. The Trust Act, therefore, does not adequately
deal with management of trust property in the nature of a Mutual Fund.
XXIII. In the same way, the sponsor who establishes Mutual Fund
is similar to the author of a Trust. However, the author of a trust has
a very limited role to play after settling a trust. But that is not the
case in relation to the sponsor of a Mutual Fund who has a continuing interest
in the Mutual Fund and whose credibility is significantly responsible for
mobilising of savings of the public in a Mutual Fund.
XXIV. It is seen on a broad overview of the 1996 Regulations that the
rights, duties and obligations of all these constituents of
a Mutual Fund need further codification. It is clear that the Regulations
visualise that there are basic requirements before a person can be a sponsor
of the Mutual Fund. To quote, the sponsor should have a sound track record
and general reputation of fairness and integrity in all his business
transactions. There are similar threshold expectations in respect of the
Trustees and Asset Management Company and Custodian. It would, therefore,
be eminently desirable that all these matters are codified under a single
statute under which Mutual Funds can be constituted as corporate bodies.
This will ensure establishing Mutual Funds on a permanent basis like companies
and enable the law to clearly and unequivocally set out the rights, duties
and obligations of the various constituents. On enactment of such a law
as an Act of Parliament, the various constituents would clearly be aware
of their rights, duties and obligations and likewise the unitholders and
regulatory authorities would also know what can be expected of the various
constituents. There would also be progessive evolution of practice of accountability,
disclosures and governance as in the case of corporate entities. Pending
the enactment of the separate statute there is need to selectively modify
the 1996 regulations to address the various concerns that were expressed
by Trustees to SEBI.
XXV. The Mutual Fund industry is still a fledging industry. Since
the time the first mutual fund was set up in 1987 & private sector
funds came into operation in 1993, the markets have undergone vast changes
in size, diversity of players and significant improvements in market infrastructure.
The structure of the industry, standards and practices have also evolved
with the changes in the market. The mutual fund as an industry came
to be regulated under the jurisdiction of SEBI for the first time only
5 years back. Since then, the Mutual Fund Regulations and the entire
regulatory framework have also changed significantly. The new Regulations
notified in 1996 & amendments carried out thereafter provide ample
evidence to this evolutionary process. On one hand, the new regulations
envisioned in the Mutual Funds 2000 Report and which were expressed through
the notification of the Regulations, expanded the scope of the industry
and gave greater freedom to the fund managers while on the other,
they provided for empowerment of investors and laid emphasis on both internal
and external monitoring, surveillance mechanisms which included disclosures,
standardisation of accounting and valuation norms and code of ethics.
XXVI. The setting up of this Committee and its recommendations form
yet another important milestone in the process of the evolution of the
regulatory framework for mutual funds. The ultimate objective of
all these exercises is to better protect the investors’ interests, sustain
their confidence in the industry and ensure that mutual funds develop on
healthy lines and become effective instruments for capital formation, both
by mobilising resources from the household sector and by ensuring its efficient
allocation.
XXVII. The Report of the Committee is presented in two parts. The first
part outlines the structure of the Mutual Funds as envisaged under the
SEBI (Mutual Funds) Regulations, 1996. The specific obligations of
Trustees under the Regulations, provisions of the Indian Trusts Act and
the international experience are given in the second part.
Annexure1 to the Report is a compilation of the
role of the sponsor, obligations of the AMC and the responsibilities of
the Trustees as provided in the Regulations. Annexure
2 discusses the suggested manner of discharging the obligations by
the Trustees. Annexure 3 contains
the model of the MIS checklist that may be furnished by AMC to the Trustees.
Annexure 4 is a model reporting format of report
to be furnished by the Trustees to SEBI.
PART I
STRUCTURE OF THE INDIAN MUTUAL FUNDS
1.1 There are four constituents of a mutual fund in India, the sponsor, the board of Trustees or Trustee company, the asset management company and the custodian. The sponsor is the Settlor of the Trust which holds Trust property on behalf of investors who are the beneficiaries of the Trust. The sponsor is also required to contribute at least 40% of the capital of the asset management company which is formed for managing the assets of the Trust. The assets of the Trust comprise of properties of the schemes which are floated by the asset management company with the approval of the Trustees. Schemes may have different characteristics - they may be open or closed ended or may have a particular investment focus or portfolio composition. Finally, the safe custody of assets of the Trust is entrusted to one or more custodians. The schematic representation of the structure of mutual funds in India is given below.
Annexure I is a compilation of the roles and responsibilities of the sponsor, the AMC and the Trustees as envisaged under the Mutual Funds Regulations, 1996, arising primarily with reference to regulation 7, regulation 18 and regulation 25.
1.2 As mutual funds are set up as Trusts, there is a need for a sponsor to settle and to be the settlor or author of the Trust and initiate the process and take all steps for the establishment of the mutual fund. The sponsor’s function begins with filing an application with SEBI for grant of registration, satisfying the eligibility criteria for the sponsor laid down in the Regulations, incorporating and capitalising the asset management company and the Trustee company , nominating directors on the board of the AMC and appointing Trustees or directors on the Trustee company and finally establishing the mutual fund after obtaining registration from SEBI. The sponsor generally lends its name to the mutual fund and as such performs the function of a promoter.
1.3 Although the above structure of mutual fund essentially involves four independent constituents, but in essence the sponsor’s role is inextricably woven into two major constituents of the mutual fund namely Trustees and the AMC. In most cases the sponsor holds even 100% of the capital of the AMC. If a Trustee company is set up to act as Trustees to the mutual fund, the capital of such Trustee company is also contributed by the sponsor.
Thus the sponsor has virtually all the controlling interest in the AMC and the Trustee company. The Trustees including the independent Trustees are appointed by the sponsor and the continuance of the Trustees in the Board of Trustees largely depend on the sponsor. In view of the unavoidable linkage of the sponsor with the mutual fund irrespective of the legal structure a mutual fund may take, there is a likelihood of the sponsor indirectly influencing the decision making of the AMC and the Trustees though under the Regulations or the Indian Trust Act, the sponsor is not liable for any such decisions. The only obligation that the Regulations impose upon the sponsor is that in the case of shortfall in the net worth of the AMC or if there is a shortfall in the returns assured in an assured return scheme, the sponsor is required to step in to meet such shortfall if the sponsor is the guarantor. Internationally also it is difficult to completely avoid such linkages, as the independent directors of the investment company or the asset management companies are selected by the promoters of the asset management company and appointed by the asset management company.
1.4 The compliance process spelt out in regulation 58 requires the Mutual Fund, the AMC, the Trustee, the Custodian and the sponsor to make such disclosures or submit such documents as may be called by SEBI. The Mutual Fund and the AMC are also specifically required to furnish the following to SEBI :
(a) Copies of Annual audited statements of accounts of the Funds and of each scheme.
(b) A copy of Half Yearly unaudited accounts.
(c) Quarterly statement of movements in net assets of each scheme with a portfolio statement with changes from the previous period for each scheme.
1.5 In addition, there are disclosures of :
(i) The annual report conforming to the Eleventh Schedule. The financial statements are required to be approved at a meeting of the Board of Directors of the AMC and the Trustee Company.
(ii) On-going disclosures of the net asset values (NAV).
(iii) Offer documents for schemes launched by AMC and approved by Trustees.
(iv) AMC to submit quarterly reports to the Trustees on activities of the AMC and compliance of the 1996 Regulations.
(v) AMC to furnish information and documents to Trustees as and
when required by Trustees.
(vi) The Trustees to furnish to SEBI half-yearly
(a) a report on activities of the Mutual Fund
(b) a certificate of satisfaction that there have been no instances
of self dealing and front-running, and
(c) a certificate regarding activities of the AMC.
(vii) Trustees to report to SEBI any violation of the Regulations in the conduct of the business of the Mutual Fund.
The Committee recommends that all information and documents relating
to the compliance process, more particularly highlighted above, need to
be authenticated/adopted by the Board of Directors of the AMC who are entrusted
with the primary responsibility in this regard. In like manner, the Board
of Directors of the Trustee company would review all information and documents
to be received from the AMC as required under the compliance process. The
requirement of adoption by the Board of Directors of the AMC and the Board
of Trustees/Board of Directors of the Trustee Company ensures that the
sponsor’s nominees on these Boards are a party to and are responsible for
the compliance process.
ROLE, RESPONSIBILITY AND OBLIGATIONS OF THE AMC
1.6 The obligations of the Asset Management Company vis-a-vis the Trustees as laid down in the Regulations are given in Annexure 1.
1.7 The regulations envisage that the Trustees will appoint an AMC to manage the funds mobilised under its various schemes and enter into an Investment Management Agreement (IMA) for the purpose.
1.8 There has been a spectrum of opinion expressed by market participants as well as investor associations about the effectiveness of the Board of Directors of the AMC and the role of independent directors, and the extent to which the board can function independent of the sponsor. Though the Regulations provide that notwithstanding anything contained in any contract or agreement, the AMC or its directors or other officers shall not be absolved of liability to the mutual fund for their acts of commission and omission, it has been represented that the Regulations lay the responsibilities on the Trustees for the activities of the AMC and the Board of AMC has not been made sufficiently liable or any specific responsibilities laid down for them. There is therefore a need to identify areas where the Board of Directors of the AMC will be made responsible for certain obligations laid down on them. One such way of bringing accountability has already been indicated in para 1.4.
ROLE AND RESPONSIBILITY OF THE TRUSTEES
1.9 Regulation 16 provides for appointment of Trustees to hold the property of the mutual fund in Trust. Trusteeship of a mutual fund could either be with a Trustee company or Board of Trustees. The Board of Trustees or Board of Directors of Trustee Company is the quintessence of corporate governance in mutual funds. Trustees are essentially the front-line regulator or regulators of the first resort and this aspect has been emphasised in the Regulations. The Regulations have also laid down objective criteria for qualification and selection of Trustees. The Regulations specifically mention that the Board of Trustees should fulfil the fiduciary responsibility cast on them, so that investors have confidence in them. It should comprise persons of eminence, standing and competence who would be able to fulfil such responsibilities.
The Committee recommends that the definition of Trustee under Regulation 2(y) should read :
”Trustees” mean the Board of Trustees or the Trustee Company who hold the property of the Mutual Fund in trust for the benefit of the Unit holders”
By defining the trustee company as a trustee it would ensure limitation of liability of the trustees. The Board of Directors of the trustee company would in relation to their liability for acts of omission or commission be governed in like manner as Directors of companies under the Companies Act. Upon enactment of a Mutual Funds statute, a provision therein on the lines of Section 633 of the Companies Act would be appropriate. The said section reads as follows :
“633. (1) If in any proceeding for negligence, default, breach of duty, misfeasance or breach of trust against an officer of a company it appears to the Court hearing the case that he is or may be liable in respect of the negligence, default, breach of duty, misfeasance or breach of trust, but that he has acted honestly and reasonably, and that having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused, the Court may relieve him, either wholly or partly, from his liability on such terms as it may think fit :
Provided that in a criminal proceeding under this sub-section, the Court shall have no power to grant relief from any civil liability which may attach to an officer in respect of such negligence, default, breach of duty, misfeasance or breach of trust.
(2) Where any such officer has reason to apprehend that any proceeding will or might be brought against him in respect of any negligence, default, breach of duty, misfeasance or breach of trust, he may apply to the High Court for relief and the High Court on such application shall have the same power to relieve him as it would have if it had been a Court before which a proceeding against that officer for negligence, default, breach of duty, misfeasance or breach of trust had been brought under sub-section (1)
(3) No Court shall grant any relief to any officer under sub-section (1) or sub-section (2) unless it has, by notice served in the manner specified by it, required the Registrar and such other person, if any, as it thinks necessary, to show cause why such relief should not be granted.”
Pending enactment of a separate statute for Mutual Funds, the spirit and essence of Section 633 of the Companies Act as given above should form the basis to assess the quality of governance by the Trustees.
PART II
OBLIGATIONS OF TRUSTEES:
2.1 The obligations of the Trustees as laid down in the Regulations
are given in the Annexure 1.
2.2 Trustees have to play a supervisory role in ensuring that
the Trust property is being managed in accordance with the Trust deed and
in the interest of the beneficial owners of the Trust. The obligations
of the Trustees are contained in the Regulations and the Trust deed.
The Trustees should also comply with the Code of Conduct specified in the
fifth schedule to the regulations. Some of the key obligations of
the Trustees as contained in the Trust deed and the Regulations are;
? to act in the interest of the unit holders
? to take reasonable care to ensure that the funds under the schemes
floated by the AMC are managed in accordance with the Trust deed and the
regulations
? to supervise the collection of any income due to be paid to the scheme
and for claiming any repayment of tax, and holding any income received
in Trust for the holders in accordance with the Trust deed and regulations
? to make such disclosures to the unit holders as are essential in
order to keep them informed about any information which may have an adverse
bearing on their investments.
MANNER OF DISCHARGING DUTIES BY TRUSTEES:
2.3 Though the Trust deeds contain provisions to limit the circumstances
in which the Trustee is expected to know about or take action in the events
of default, it is however acknowledged that it would be difficult for Trustees
to claim immunity in circumstances, where clearly they should have been,
but were not aware of the problems or where the response of the Trustees
were less than diligent. However, it is also true that the Trustees
are not connected with the day to day activities of the mutual fund and
do not have a monitoring mechanism and infrastructure in place to effectively
discharge their obligations. The question that arises therefore is what
standard of knowledge and understanding of the operations of the Fund should
be expected of the Trustees?
2.4 Section 15 of The Indian Trust Act provides “ that a Trustee is bound to deal with the Trust property as carefully as a man of ordinary prudence would deal with such property if it were his own”. The spirit of this provision has been built into the regulations which require the Trustees to “ensure” and “certify” various matters. However, the difficulties that arise are
a) what amounts to adequate diligence on the part of the Trustees
is not mentioned in the Regulations;
b) under what circumstances the Trustees would be construed to
have discharged their obligations under the regulations is not specified
in the Regulations.
c) basis of certification and what amounts to “ensuring” are
not explicitly provided in the Regulations.
The problems get compounded as the Trustees do not have any organisation
and infrastructure of their own and do not look after the day to day
affairs of the fund.
The Committee recommends that
? due diligence requirements on the part of the Trustees to help them discharge their responsibilities effectively be laid down. These may be as follows;
A. General Due Diligence :
? As the Board of directors of the AMC are to be appointed with the
approval of the Trustees under the Regulations, the Trustees should be
discerning in the appointment of the directors on the board of AMC.
This itself would act as a first line monitoring by the Trustees.
For this purpose the Trustees should carefully peruse the Bio-data of the
personnel.
? Trustees should review the desirability of continuance of the AMC
if substantial irregularities are noted in any of the schemes and should
not allow the AMC to float new schemes.
? Under the Indian Trust Act, the beneficiary has a right that the
Trust property shall be properly protected , held and administered by proper
persons and by a proper number of such persons. All service providers should
hold appropriate registrations from the regulators. Trustees should arrange
for test checks of service contracts.
? Trustees should immediately report to SEBI of any special development
in the mutual fund.
B. Specific Due Diligence:
The manner in which specific due diligence could be carried out by the Trustees in fulfilment of the various obligations in the Regulations is given regulation wise in Annexure 2. Broadly, these are;
? obtaining internal audit reports at regular intervals from independent
auditors appointed by the Trustees - as it is the generally accepted
principle that a person acting on expert advice in good faith
is construed to have fulfilled his obligations, emphasis has been laid
on independent audit.
? obtaining compliance certificates at regular intervals from the AMC.
? holding meeting of Trustees more frequently.
? considering the Reports of the independent auditor and compliance
reports of AMC at the meetings of Trustees for appropriate action.
? maintaining records of the decisions of the Trustees at their meetings
and of the minutes of the meetings.
? prescribing and adhering to a code of ethics by the Trustees,
AMC and its personnel.
? communicating in writing to the AMC of the deficiencies and checking
on the rectification of deficiencies.
2.5 A related issue is that the Regulations
which lay down the responsibilities of the AMC for carrying on the
activities of the mutual fund, mention that the ” AMC shall take reasonable
steps to ensure” compliance with the Regulations. As against this
provision, the corresponding provision in the Regulation, which stipulate
the obligations on the Trustees requires them to “ensure” compliance with
the Regulations. In consonance with the principle laid down in the
Indian Trust Act, 1882 that the Trustees are expected to exercise
diligence as a man would ordinarily do in his own case, the Committee felt
that there is a need to harmonise these provisions and the principles laid
down in Indian Trust Act, 1882.
The Committee recommends that
? the words “take reasonable steps” may be added before the words “to
ensure” , in the appropriate regulations dealing with obligations of the
Trustees.
2.6 Given the need for the Trustees to step up to the challenge
of monitoring complex issues and performing more functions now more
than ever before there should be appropriate monitoring systems which
would be acceptable to and relied upon by the Trustees. To this end, an
Management Information System (MIS) specifying the content and in particular,
information related to affiliate and group transactions, may be devised.
The Committee recommends that
? Asset Management Companies may adopt a uniform Management Information
System.
A model format of MIS checklist is given in Annexure
3.
Presumably, this action of the Trustees by itself will enhance
the accountability of the Board of the AMC. But it needs to be mentioned
that the reports received by the Trustees will have to be reviewed
by the Board of Trustees as they would be responsible for taking appropriate
timely action.
2.7 In tune with the intention of placing the Trustees as the frontline regulators the Regulations stipulate submission of periodical reports by the AMC to the Trustees and half yearly reporting by the Trustees to SEBI . SEBI would be expected to step in as a last resort measure. Therefore, there is a need for the Trustees to explicitly inform SEBI of the activities of the mutual fund and whether the Trustees are satisfied with the functioning of the AMC and other service providers. As there is no model form of reporting by the Trustees to SEBI, it is desirable to have a uniform reporting standard.
The Committee recommends that
1 The Board of Trustees or the Trustee company as the case may be may adopt a uniform half yearly reporting format.
A model format of half yearly report is given in Annexure
4.
POWERS OF TRUSTEES
2.8 The Regulations and the Investment Management Agreement already
vest the Trustees with adequate powers to obtain from the AMC all information
concerning the operations of the various schemes at such intervals and
in such a manner as required to ensure that the AMC is complying with the
provisions of the Trust deed as well as the Regulations. The
Indian Trust Act also vests general authority on the Trustee to do all
acts which are reasonable and proper for the realisation, protection or
benefit of the Trust property. Additionally, under the
Regulations, the Trustees have the power to dismiss the AMC under
certain events of default, with the approval of SEBI.
LIABILITY OF TRUSTEES:
2.9 Trustees are liable for non performance of obligations under the Trust deed, non-compliance of the Regulations and for breach of Trust. Section 3 of the Indian Trust Act, 1882 defines “breach of Trust” as a “ breach of any duty imposed on a Trustee as such by any law for the time being in force “. The quantum of liability of a Trustee for breach of Trust is the loss sustained by the Trust estate. The general principle is that the Trustee is liable to make good the loss that has resulted by his breach of Trust. Where there has been breach of Trust, it is not open to the Trustee to plead in justification that there would have been no loss and that the breach was immaterial. The extent of loss arising from the breach of Trust is not confined to the immediate loss but to all consequential losses. The liability of Trustees committing breach of Trust is joint and several. There is no primary liability as between Trustees but all are liable. The beneficiary is entitled to recover from all Trustees till he gets his full claim satisfied.
2.10 The following are some of the instances of breach of Trust;
a A contravention of the duties imposed upon a Trustee by the Trust
deed or the law governing his duties.
b An act or default which has prejudiced the beneficiary or the Trust
property
c Any neglect or omission of duty on the part of the Trustees.
d Where a Trustee failed to take necessary steps to prevent a co-Trustee
from receiving and misapplying the Trust funds.
e Failure to furnish accounts to beneficiary
f Improper variation of authorised security.
g Concurrence by a Trustee in a breach of Trust by a co-Trustee would
be breach of Trust.
2.11 In tune with the Indian Trust Act but not going beyond it,
sub-regulation (2) of Regulation 15 stipulates that the Trust deed shall
not contain a clause which has the effect of limiting or extinguishing
the obligations and liabilities of the Trust in relation to any mutual
fund or the unit holders or indemnifying the Trustees or the AMC for loss
or damage caused to the unit holders by their acts of negligence or acts
of commissions or omissions. Besides, under the Indian Trusts
Act, 1882, the Trustees are also jointly and severally liable for breach
of Trust committed by co-Trustees. However, the generally accepted
principle is that Trustees would not be liable for acts done in good faith
and without negligence. In considering the liability of Trustees for breach
of Trust the distinction has to be borne in mind between an innocent breach
of Trust and fraudulent one. Section 36 (2) The Unit Trust of India
Act, 1963 provides that a Trustee of the Board shall not be responsible
for any Trustee or for any other officer or other employee of the Trust
or for any loss of expenses resulting to the Trust in respect of anything
done in good faith in the execution of the duties of his office or in relation
thereto. Considering the unlimited liability imposed
on the Trustees ,it is desirable to make the liability of the Trustees
explicit and provide for an Insurance cover. It should be clarified that
the responsibility of the Trustees is to act collectively unless any specific
duties or obligations are delegated by the Board of Trustees/Board of Directors
of the Trustee Company.
The Committee recommends that
a there should be a suitable savings clause in the Trust deed and a
provision in the Regulations which should allow that if the Trustees,
while carrying out their duties have acted bona-fide and in good faith,
they should be deemed to have performed their duties and should be discharged
from further liabilities.
b Trustees who have acted in good faith and without negligence should
also be protected through appropriate indemnification insurance as is the
practice in the US and UK. SEBI may take up the issue with the Association
of Mutual Funds of India.
APPOINTMENT AND TERM OF OFFICE OF TRUSTEES
2.12 The sponsor being the Settlor of the Trust appoints the
Trustees for all mutual funds registered with SEBI. In case of UTI,
the Board of Trustees of the Unit Trust of India consists of 11 Trustees,
of whom one is appointed by the Central Government, one by the Reserve
Bank of India, four by the IDBI, one by LIC, one by SBI, two by participating
institutions and an Executive Trustee appointed by IDBI. Under the Act,
the Chairman and the Executive Trustee hold office for 5 years and the
other Trustees hold office for four years but are eligible for reappointment.
The Mutual Fund Regulations permit the sponsor to appoint Trustees with
the approval of SEBI on the condition that at least two thirds of
the Trustees or directors of the Trust company should be independent.
In the case of Board of Trustees, the appointment of the Trustees is permanent
in nature unless otherwise specified in the Trust deed.
Where a Trustee company performs the functions of Trustee, the term
of office of the Trustee directors is subject to the provisions of the
Companies Act, 1956 viz. Section 255 of the Companies Act, 1956 which stipulates
that at least two thirds of the directors shall be those liable to retirement
of which one third shall retire at every annual general meeting.
Therefore, there is a need to strengthen the hands of independent Trustees.
The Committee recommends that
a the one third non-rotational directors on the board of the Trustee
company should comprise the independent directors only.
MEETINGS OF TRUSTEES
2.13 Due diligence requires that the Trustees apprise themselves
of the activities of the fund and take timely action. The Regulations
do not specify at what intervals should the Board of Trustees meet
in order to apprise themselves of the activities of the AMC and the fund.
However if the Trustee is a company, it is governed by Section 285 of the
Companies Act which stipulates that a meeting of the Board of directors
shall be held at least once in every three months and that four such meetings
shall be held in a year. The responsibilities cast on the Trustees
and the provisions in the Indian Trust Act which stipulate liability of
Trustees for breach of Trust or acts of omission or commission of
co-Trustees emphasise the need to hold frequent meetings. The need
for frequent meetings of Trustees is recognised in Section 17 of The Unit
Trust of India Act, 1963 which stipulates that there shall be not less
than six meetings of Trustees in a year and at least once every two months.
The Committee recommends that
a. the frequency of the meetings of the Trustees / Board of Directors
of the Trustee Company should be increased to at least once in two months.
As Company Law recognises the validity of Resolutions passed by circulation
vide Section 289, in line with advancement of technology, meetings through
conference tele-communications should also be a permissible mode of holding
such meetings.
2.14 The Regulations do not specify any quorum for meetings of
Trustees. In the case of a Trustee company, provisions of Section
287 of the Companies Act, 1956 would be applicable, where under a quorum
of not less than one thirds of the directors is needed. Further,
the quorum should be a ‘non-interested’ quorum. In the case
of Unit Trust of India, Regulation 27 (v) of the UTI General Regulations,
1964 stipulates that four Trustees (out of a total of 11 Trustees)
of whom one shall be the Chairman or Executive Trustees shall form the
quorum.
The Committee recommends that
a. the quorum for any meeting of the Board of Trustees or directors
of the Trustee company should not be regarded as constituted unless there
be present at least one independent Trustee/Director.
NUMBER OF TRUSTEES
2.15 The sponsor being the Settlor of the mutual fund appoints
the first Trustees. The Regulations stipulate that the minimum number
of Trustees shall be as stipulated in the Trust deed. Under the Indian
Trust Act, 1882 where the Trust envisages receipt and payment of moneys
there should be minimum of two Trustees. Where the Trustee
is a public limited company the minimum number of directors is three.
The Act also provides that whenever any person appointed as a Trustee disclaims,
or any Trustee either original or substituted has vacated office in any
manner, a new Trustee may be appointed in his place by the person nominated
for that purpose by the instrument of Trust or if there be no such person
by the author of the Trust or the continuing Trustee. SEBI has through
guidelines stipulated that the minimum number of Trustees should be four.
The Unit Trust of India Act, 1964 requires the appointment of 11 Trustees
to the Board of Trustees. To enable the Trustees to discharge
the additional responsibilities as also to mitigate the risk of personal
liability arising out of the co-Trustees breach of Trust or acts of omission
or commissions it is necessary to increase the number of Trustees.
According to recent amended Regulations, 2/3rd of the number of trustees
should be independent trustees who are not associates of the sponsor.
The Committee therefore recommends that
a. the minimum number of Trustees should be five and the maximum number
shall be at the discretion of the mutual fund. The fraction shall be rounded
off to the nearest integer e.g. 3 independent trustees out of five shall
be treated as 2/3rd independent trustees.
ISSUE OF INDEPENDENCE
2.16 The selection of the Trustees is done by the sponsors. This
has raised questions as to how, in this scenario, such Trustees can
be made to function independently and more effectively. Critics of the
role of Trustees believe that because an investment company is a creature
of its sponsor, it is difficult for Trustees to provide effective oversight.
Further as a mutual fund is set up by a sponsor who is a major shareholder
of the Trustee company and AMC and appoints the directors on these companies,
they argue, the independent directors are not truly independent and have
little choice but to toe the line of the sponsor of the fund. It has also
been contended that Trustees never “fire” the AMC and that there is no
effective oversight.
2.17 While it is true that such conflicts are unavoidable,
they could however be managed and limited by ensuring independence of the
board of Trustees. It is essential that independent directors
of Trustees and AMCs take an active role in their governance,. Mutual funds
need the protection provided by a third party monitor and neither SEBI
nor the market is capable of replacing the role of the Trustees and more
particularly that of the independent trustees/directors on their boards.
In this connection the international experience is relevant.
International Experience :
2.18 The role of Trustee directors in policing conflicts of interests is central to the Investment Company Act of USA. The Act establishes a comprehensive regulatory framework premised on the checks and balances of governance and imposes watchdog and other responsibilities on boards of directors, grant shareholder voting rights with respect to particular matters, and authorizes shareholders to seek judicial review of certain fee arrangements.
2.19 The independent directors, in particular, are expected to look after the interests of shareholders by “furnishing an independent check upon management” especially with respect to fees paid to the investment company’s sponsor. Following are the role and responsibilities of the Board of Directors and in particular the independent directors under the Act:
a. ensure the reasonableness of fees paid to investment company sponsors
and others for services provided to a company
b. responsibility for evaluating the advisor’s contract with the investment
company and the compensation paid under the contract.
c. scrutinise principal underwriting contracts and any renewals must
be evaluated and approved by the independent directors.
d. review any service contract between the company and the advisor’s
affiliates.
2.20 In addition to policing conflicts over fees paid to affiliates, investment company boards of directors also police a number of operational activities, some of which involve potentially serious conflicts. The Investment Companies Act and the US Securities Exchange Commission’s rules give independent directors several specific responsibilities in this regard
a. the independent directors select the company’s independent public
accountants
b. oversee securities transactions involving affiliates to the extent
such transactions are permitted.
c. required to select and nominate individuals to fill
independent directors vacancies.
d. the board values certain types of portfolio securities and
sets the time of the day at which NAV is determined
e. the board approves an investment company code of ethics which
must be designed to prevent fraudulent, deceptive or manipulative practices
by investment company insiders in connection with personal securities transactions.
2.21 The SEBI (Mutual Funds) Regulations, 1996 do not lay down any specific responsibilities of the independent directors. In line with the role envisaged in the US Investment Company Act, 1940 it is to be considered whether SEBI should clearly delineate the specific role of independent directors to address the issue of conflicts of interests. The recent amendments to the Regulations which require the Trustees to have two-third independent directors is a step in the right direction. This will also help in addressing the concern that in some situations the disinterested directors may not be able to act with genuine independence because of direct or indirect influence by the sponsor. Further the requirement of an independent majority might make a voting difference, for example in the regulatory provision requiring that a majority of the Trustees can terminate the appointment of AMC.
2.22 The following role is suggested for the independent directors of the Trustees/AMC :
The independent directors should pay specific attention to :
a. the Investment Management Agreement and the compensation paid
under the agreement
b service contracts with affiliates- proof that the AMC charged
higher fees than outside contractors for the same services would help in
establishing such liability.
c selecting the company’s independent directors
d securities transactions involving affiliates to the extent such transactions
are permitted.
e selecting and nominating individuals to fill independent
directors vacancies.
f code of ethics which must be designed to prevent fraudulent, deceptive
or manipulative practices by insiders in connection with personal
securities transactions.
g the reasonableness of fees paid to sponsors, AMC and any
others for services provided to a company.
h principal underwriting contracts and their renewals.
i any service contract between the company and the associates of the
AMC.
INFRASTRUTURE AND ADMINISTRATIVE SUPPORT TO THE TRUSTEES
2.23 At present the Trustees do not have separate office infrastructure,
staff and resources to effectively supervise the activities of the AMC.
The Trustees meet periodically in the office of the AMC and mostly rely
on the report submitted by the AMC.
The kind of extensive supervision and ensuring strict compliance that
the Regulations require the Trustees to do, it would be necessary for the
Trustees to have adequate infrastructure and the whole-time involvement
of at least one of the Trustees in the affairs of the mutual fund.
The UTI Act, also stipulates that either the Chairman or Executive
Trustee shall be on a whole time basis. Alternatively, instead of
appointing a whole time trustee, the Trust may appoint an independent officer.
According to sub-regulation (11) of Regulation 18, the trustees are
required to file the details of their holdings in securities on a half-yearly
basis with the trust. The Committee deliberated this issue and was
of the view that the trustees should file the details of their holdings
as on April of that financial year at the time of becoming trustee of the
mutual fund and thereafter change in holdings should be reported at the
end of the year. Also every month all transactions of buy or sell for more
than Rs 1 lakh should be reported to the trust.
The Committee recommends that
a administrative support should be given to the Trustees by the AMC.
b for effective discharge of responsibilities, such administrative support
should be commensurate with the work involved by appointment of appropriate
staff under a suitable heirachy.
c the costs of such administration and staff would be payable out of
the trustee fees that are charged to the schemes.
d all communications to the AMC including correspondence from SEBI
would also be marked to the administrative office of the Trustees. The
Trustees may also independently correspond with SEBI. All reports submitted
by the AMC to SEBI would have to be submitted to the administrative office
of the Trustee.
The intention of the above recommendations is not to dilute the responsibility
of the trustees but to make it more practicable, feasible, meaningful and
to strengthen the position of individual trustees so that the persons of
high standing and independence become trustees and act without any pressure.
In well run companies, there is no dearth of individuals who act as directors.
Similarly, an environment should be created so that eminent individuals
come forward to become trustees.
FEES AND EXPENSES:
2.24 Commensurate with the increased responsibilities, there is bound to be an increase in expenses to be incurred out of trustee fees
a expenses of office infrastructure, staff and resources
b remuneration of staff
c expenses for internal audit
d indemnification of Trustees
e expenses associated with increased frequency of Trustee meetings
viz. travel expenses, sitting fees etc.
The Committee recommends that
a the overall cap of recurring expenses including Trustees fees be increased
to 3%, however the expenses excluding Trustee fees should not exceed
the present cap of 2.5%
CARRYING OUT TRUST FUNCTIONS THROUGH TRUSTEE COMPANY
2.25 As brought out in para 1.3 of the Preface, the role of the
sponsor is inter-woven with the various activities of the mutual fund,
and cannot be abolished whether the structure of the mutual fund
is unitary or in the form of a Trust. The question therefore is that of
mitigating the negative influence of the sponsor. The Regulations
allow the Trust functions of a mutual fund to be carried out by a Board
of Trustees or a Trustee company. A professional Trustee company
like a debenture Trustee, in view of its separate legal character capitalisation
and infrastructure, could be more independent, less prone to potential
influence and be better equipped to handle the challenging role that the
Trustee have to play, compared to a board of Trustees. Towards this end,
the Trusteeship as a business may be encouraged so that professional Trustee
institutions could emerge. However, as the Regulations already permit
this, it may not be made mandatory for the time being.
APPROPRIATE LEGAL STRUCTURE OF MUTUAL FUNDS
2.26. Unit Trust of India (UTI), India’s first mutual fund is
set up as a corporate body under The Unit Trust of India Act, 1963.
The UTI Act is comprehensive and provides for all matters connected with
the activities and management of the Unit Trust. This Act is not
applicable to other mutual funds. In the absence of a
single comprehensive legislation for mutual funds similar to the Investment
Company Act of 1940 in the United States, mutual funds, if
a corporate structure is to be adopted, have to be set up as companies
under the Companies Act, 1956. As the regulatory powers over
mutual funds is vested in SEBI under the SEBI Act, 1992, a mutual
fund set up as a company would be in a situation of multiple regulatory
purview of SEBI and the Department of Company Affairs of the Government
of India. This could have caused hardship and hampered the healthy
growth of the nascent mutual fund industry. The SEBI (Mutual
Funds) Regulations, 1993 therefore stipulated the setting up of the mutual
funds as Trusts under the Indian Trusts Act, 1882.
2.27 The mutual funds being set up as Trusts under the Indian Trusts Act, 1882, have been posing certain legal and practical complexities for the mutual fund industry.
(a) There is the issue of individual/collective liability of Trustees
in a Board of Trustees and of directors in a Trustee company. The
provisions of the Indian Trusts Act prohibit the limiting or extinguishing
of the obligations and liabilities of the Trustees or indemnifying the
Trustees for loss or damages. This provision has been built in Regulation
15 (2) of the SEBI (MF) Regulations.
The Trustee company structure has been preferred over the Board of
Trustees structure, in view of the unlimited personal liability of the
Trustees under the board of Trustees structure. Whereas
the Trust deed does not extinguish or limit the liability of a Trustee
in a board of Trustees, the liability of the director of the Trustee company
would be unlimited only if so provided in the Memorandum and Articles of
Association of the company as per Section 322 of the Companies Act, 1956.
(b) Section 153 of the Companies Act, provides that no notice of any Trust shall be entered on the register of member of companies. A Trustee company has an advantage in this regard as securities can be registered in the name of the Trustee company.
(c) There is the issue of the rights of the beneficial owners
of a Trust vis-a-vis the rights of the shareholders of a company.
2.28 The Indian Trusts Act, 1882, was enacted to provide for establishment of private Trusts and its provisions primarily provide for management of that kind of entities and responsibilities. Mutual Funds in India have now been set up under that Statute of 1882, which never envisaged dealing with multiple stakeholders and transactions of a different kind altogether. There is inadequate evidence to enable a conclusion that other avenues, old or new, were explored before opting for the Trust route.
2.29 It is suggested that to encourage the healthy growth and development of the mutual fund industry, it is desirable to provide for establishment and regulation of mutual funds by a separate comprehensive statute. The rationale is as follows :
1. Institutions of importance in the capital market are usually set
up under important statutes. Besides meeting the regulatory requirements,
the setting up of such institutions under a statute give these institutions
the due recognition of their roles in the capital market. The banks
are governed by the Banking Regulations Act, companies are incorporated
under the Companies Act, 1956, the all India financial institutions were
initially set up under statutes, the stock exchanges are regulated and
administered under the SCRA,1956 and rules framed thereunder, and depositories
are set up under the Depositories Act. The SCRA and Depositories
Act are administered by SEBI. The mutual funds constitute a very
important sector of the capital markets and have immense potential, some
of which is yet to be fully tapped. Time has now come to recognise
the critical role of mutual funds in the development of a healthy capital
market in order to give due recognition to this , it is felt
that like other institutions in capital market, it may be expedient to
have an independent statute for mutual funds.
2. The Indian Trusts Act appropriately deals with property entrusted
by a settlor in the hands of trustees for the benefit of beneficiaries.
It does not contain adequate provisions to deal with a trust where there
is large scale mobilisation of public funds entrusted by prospective investors
for expert fund management to maximise investor value to the fund provider.
In the traditional trusts, the bifurcation of responsibility between trustees
and managers is neither visualised nor clearly delineated and provided
for. Consequent upon the establishment of mutual funds, the healthy
principle of separating management from ownership, control and supervision
has been built into the structure of Mutual Funds under the Mutual Funds
Regulations, 1993 and followed in the Mutual Funds Regulations, 1996.
Therefore, the rights, duties and obligations of the different layers of
the sponsor, the trustees, the AMC, the Custodian, the beneficiaries need
to be focused under a specific statute rather than seeking to enforce these
partly under the SEBI Act of 1992 and partly under the Indian Trusts Act,
1882.
3. The basic thrust of the SEBI Act is protection of investors and
Regulation of the securities market. The Regulations and Rules framed
under that Act need to be consistent with the Act and aimed to carry out
the purposes of the Act (Section30). It is clear under Section 11
that registration and regulation and the working of collective investment
schemes including Mutual Funds falls within the purview of SEBI.
However, SEBI Regulations of 1993 and 1996 have been used to define the
rights, responsibilities and duties of various bodies set up under other
specific legislations like the Indian Trusts Act and the Companies Act.
Such relationship could lead to several legal complexities.
The intention of a regulator should be to reduce the potential for litigation.
4. The complexities are further aggravated when the trustees are constituted
as a company under the Companies Act. The Trustee Company as a person
created in the eyes of law, has also to comply with various provisions
enacted by the statute of Company Law. This adds a further dimension
and increase the complexities. Additionally, if as a measure of investor
protection, regulations are drawn up to spell out the rights, duties and
responsibilities of a Director, the need to harmonise these with the Companies
Act and the Trusts Act becomes necessary.
5. Under the Indian Trusts Act read with the Transfer of Property Act,
there is a rule against perpetuity. The whole idea is to have mutual
funds which continue for generation in perpetual succession. The
Trusts Act does not permit this.
6. While the Companies Act permits perpetual succession, it has various
checks and balances to regulate the rights, duties and responsibilities
of the stake holders. Mobilisation of savings through Unit Trusts
are quasi equity in character and not mere debt instruments. The
thrust of Company Law to protect the interests of creditors in the face
of the privilege of limited liability creates problems in structuring mutual
funds as investment companies.
7. The properties cannot be registered in the name of the trust as
the trust is not an entity or person in the eyes of the law. Such
property needs to be registered in the names of trustees. Whenever
there is a change of trustees, it becomes necessary to register the property
in the names of new trustees. If a mutual fund is constituted as
a body corporate with perpetual succession, it is capable of entering into
contracts and being sued and suing others in its own name and is capable
of holding property as a legal person.
8. The thrust in promoting several mutual funds as opposed to the single
Unit Trust of India existing between 1964 and 1987 was to provide investors
with a choice. The mutual fund industry is intended to be developed
with a particular focus of mobilising public savings in a specified segment
of the financial sector. Mutual Funds in the past have mobilised
upto Rs.1900 crore in a given financial year. In future years, the
amounts annually mobilised are likely to increase substantially.
The regulatory system should facilitate such substantial step up of savings
mobilisation and should also encourage professionalisation of procedures
and practices. This will be best done through a separate statute
which can focus on the special characteristics of such entities.
9. In several countries of the world, a Mutual Funds Act has been passed.
Apart from advanced countries like U.S.A., even smaller countries like
Brazil, Mexico, British Virgin Islands and Seychelles, find it appropriate
to promote mutual funds through a separate statute.
10. The Mutual Fund Act can combine the provisions of various Acts.
It can set out the rights and responsibilities of the board of trustees
and can provide for meetings of trustees and unit holders, proxies, quorum,
facility for nomination etc.. The regulatory authority and
jurisdiction of SEBI under the SEBI Act can extend over the mutual funds.
The powers, obligations and responsibilities of the sponsor can be spelt
out. The rights and obligations of beneficiaries under various schemes
floated by the mutual funds can be specified. Reporting and disclosure
requirements can be built in the Mutual Funds Act.
11. The present anomaly of the mutual funds being set up under the
Indian Trusts Act, 1882, an Act not enacted for the purpose of mutual funds,
would also get rectified. Mutual funds would also not be dependent
on the provisions of other Acts. Through the Mutual Fund Act, necessary
amendments could be carried out in other statutes as was done in the Depository
Act.
12. A single Mutual Fund Act will provide a uniform regulatory framework
for all mutual funds including UTI which is now governed by a separate
statute. UTI Act could be repealed through the Mutual Fund
Act. This would place on a statutory basis, the voluntary arrangement
of UTI complying with the regulations for post-July 1994 schemes.
13. It has also been asserted that if the mutual funds are established
as companies under the Companies Act, 1956, the aforesaid advantages can
be achieved without enactment of a separate Act for mutual funds.
The company may be incorporated solely for the purpose of setting up and
operating the business of mutual fund. Such companies will be subjected
to SEBI Regulations. Such companies will have their objects under
the memorandum of association restricted to mutual fund business. Also
their articles of association will include mandatory requirements of SEBI
Regulations. As regards corporate management like board of directors,
issue of capital, holding of meetings of shareholders and unit holders,
maintenance and auditing of annual accounts, etc. will be governed by the
provisions of the Companies Act. However, the problems of control
on reduction of capital and buy back of capital as provided under the Companies
Act cannot be avoided if this structure is followed. If funds mobilised
through units are recognised with the characteristics like quasi-equity,
problems in defining these rights and difficulties in regulation as observed
in NBFCs will surface.
14. Another complication which remains unresolved is whether shares
held by a Mutual Fund are subject to declaration of beneficial interest
under Section 187C of the Companies Act requiring considerable paper work
to be generated.
15. In the present structure, the ownership of the AMC and the Trustee
company is invariably exclusively with the sponsors. Ensuring independence
of independent Directors on the AMC and the Trustee company becomes extremely
complex. The separate statute would provide for the Board of Managers
as well as the Board of Trustees. The control of the sponsors over
the appointments on these two Boards can be achieved through the statute.
2.30 The Committee deliberated the issue at length. The majority
of members are of the view that a separate statute be enacted for establishment
and regulation of mutual funds. Mutual Funds registered under the
said Act would, upon registration, be a body corporate capable of exercising
all functions of an incorporated entity and having perpetual succession
with limited liability. The Act should clearly spell out the rights,
duties and obligations of the various constituents of the Mutual Fund like
the sponsor, the Trustees, the asset manager, the Custodian, the Registrar,
etc.. Provision should be made registering existing Mutual Funds
under the statute when enacted.
2.31 This Committee, therefore, recommends that SEBI and the Government of India should consider enacting a separate comprehensive Act to govern the management, responsibilities and functioning of the Mutual Funds in India. The Committee considers this important, as in their view, mutual funds are a positive avenue for investment by small investors. As a mobilisor of private funds, the mutual fund industry is bound to develop and grow very substantially in the near future and it is therefore important to provide a structure which is relatively comprehensive yet smooth and easy to operate and administer. The existence of such a framework will greatly enhance the growth potential of this important sector, meant primarily to mobilise resources from the small investors of our society. This will also arrange for their profitable investment in the best interests of the economy and the fund contributor.
2.32 A member of the Committee Ms. D.N. Raval has given a separate note
expressing her own views on some aspects of the report which is enclosed
as Annexure 5.
1. P K KAUL - Chairman
2. S C Bafna
3. Vijay Advani
4. A P Kurien
5. N V Iyer
6. S S Bhandari
7. D N Raval
8. Pratip Kar - Member Secretary