MFs need structural changes to protect investors and ensure market integrity

India’s mutual fund industry has grown at a dizzying pace over the past few years, with assets under management swelling by the year, in a buoyant market. Yet it was only last month that the securities market regulator notified the inclusion of units of a mutual fund under Sebi’s insider trading rules. And almost promptly thereafter, a couple of days ago it came out with a consent order indicating that Bank of India Investment Managers, its CEO Sandeep Dasgupta, and his wife and daughter had violated regulatory rules. They subsequently settled it by paying a fine of over Rs. 3 crore. The charge brought upon the boss of the fund house and the fund manager was that the asset management company carried out inter-scheme transfers leading to the transfer of high-risk securities to other schemes which are in the medium-to-low-risk segment, going against its stated investment aims. Other failings include violating the fund house’s valuation policy relating to marking its securities. The governance collapse is also reflected in the regulatory order which charges the fund manager, Alok Singh, of having pulled out his full holding on the basis of unpublished information regarding the valuation of some securities.

The new Sebi rules relating to insider trading and mutual fund units which kicked in on November.24 clearly say that those in possession of unpublished price-sensitive information would not be permitted to trade in mutual fund units when either the Net Asset Value (NAV) of the scheme could get affected or the interests of unit holders could get compromised. What makes this case unique is that the regulatory finding that the compliance officer of the fund house, the person mandated to ensure adherence to all rules and regulations, was “ sleeping at the wheel“. The amount involved may be piddly going by past cases of insider trading violations, but serious enough to raise questions as to whether this relatively light rap on the knuckles is adequate regulatory punishment in a case of serious governance failure and integrity. Could it be because of the recent vintage of the mutual fund insider trading rules and the violations having taken place during the period when this rule did not cover mutual funds?

Late though, the regulator now appears to be mindful of the need to ensure accountability. The new Sebi rules say that the CEO of an asset management company with the approval of trustees should put in place adequate and effective system of internal controls to make sure that fund houses comply with rules. It is hard to fathom how this regulatory gap on insider trading in India’s mutual fund industry wasn’t plugged for long though fund managers and others were covered under the Fraudulent and Unfair Trade Practices or FUTP regulations for front running.

Earlier this year, the Karnataka High Court had not been too kind to Sebi in the case of another fund house, Franklin Templeton, which had wound up six schemes saying that the regulator was expected to play a very proactive role by questioning the asset management company, trustees and the sponsor about compliance with the mutual fund regulations. The court had then said that unit holders of the affected schemes would be justified in their criticism that Sebi was a silent spectator. Deliverance from all these will come only if the regulator shows that it is able to prevent abuse early enough and protect investors to retain trust and confidence. That would also call for improved supervisory and surveillance oversight and stiffer punishment for wrong doers.

It is also incumbent now on Sebi to push an awareness campaign on index funds, which account for a substantial corpus of investor funds globally. With assets under management of over Rs. 40 lakh crore at the end of November this year, mutual funds may be “sahi hai“ for now. But structurally, it makes sense to educate the growing number of Indian savers that putting money in index funds without the burden of fund management expenses and risks posed by fund managers is a better way of saying “sahi hai“.