In a big victory to investors, the High Court of Karnataka on Saturday said that the Franklin Templeton Trustees Services (FT Trustees) Pvt Ltd cannot implement its decision of prematurely winding-up six open ended debt oriented Mutual Fund (MF) schemes without obtaining the consent of the unitholders in the form of a simple majority.
The consent of unitholders is mandatory as per Regulation 18(15)(a) of the Security Exchange Board of India (Mutual Funds) Regulations, 1996 when the majority of the trustees decide to wind up or prematurely redeem the units, the HCK said while declining to interfere with the FT Trustees’ April 20, 2020 decision to prematurely wind-up the six schemes.
A Division Bench comprising Chief Justice Abhay Shreeniwas Oka and Justice Ashok S Kinagi delivered the verdict while disposing of the petitions filed by unitholders, who had challenged the decision of the FT Trustees to wind-up the schemes without duly following the MF regulations.
However, the Bench stayed the operation of its verdict for six weeks to enable the FT Trustees and the Franklin Templeton Asset Management (FT-AMC)India Pvt Ltd to approach the Supreme Court.
No redemption
Meanwhile, the Bench also clarified that there cannot be any redemption by the unitholders during this period of six weeks of stay, while also directing the FT Trustees and the FT AMC not to indulge in any borrowing or claim liabilities in relation to these six schemes.
The petitions ---filed by unitholders, Amruta Garg in the Delhi High Court and 83-year-old investor Areez Phirozsha Khambatta and his wife-- in the High Court of Gujarat was transferred to the Karnataka High Court in June following a direction from the Supreme Court. A public interest litigation petition filed by M/s Chennai Financial Markets and Accountability in Madras High Court was also heard along with these petitions.
With Saturday's verdict the process, initiated by the FT Trustees and FT AMC by issuing a notice May 28 to call a meeting of unitholders to authorise through e-voting the trustees or Deloitte Touche Tohmatsu India LLP to take further steps for winding up of the schemes, cannot be implemented.
61 hours of VC hearing
The Bench, while appreciating the cooperation of advocates, who argued from London, New Delhi, Mumbai, Chennai and Bengaluru through video conference hearing due to COVID-19 norms said that this case has shown that any complicated legal matter can be effectively conducted through video conferencing.
Pointing out that the proceedings in these petitions were heard through video conferencing without any major technical glitches for 61 hours spread over 25 days of court sessions since July and internet connectivity was lost only once, the Bench appreciated the participation of lawyers using video conference facility.
Six schemes
The six schemes to be wound up are: Franklin India Low Duration Fund; Franklin India Dynamic Accrual Fund; Franklin India Credit Risk Fund; Franklin India Short Term Income Plan; Franklin India Ultra Short Bond Fund; Franklin India Income Opportunities Fund.
Holding that the unitholders are entitled to the copies of the resolution of the trustees to wind up the schemes, the Bench directed the FT Trustees to given to the petitioners the copies of the resolutions dated April 20 and May 28, which were submitted to the court in a sealed cover.
Forensic audit
While stating that petitioners are not entitled to copies of SEBI’s forensic audit/investigation report on six schemes as the audit is not yet reached a final conclusion, the Bench directed the SEBI to examine the question of taking action within six weeks after completion of audit/investigation.
SEBI’s role
The Bench said that the SEBI should have played a very proactive role in such matters though there was no need for the trustees to take prior approval from SEBI for winding up the schemes. The also upheld the constitutional validity of the regulations related to winding up of mutual fund schemes in SEBI’s regulations.
The SEBI had supported the contention of the FT Trustee and FT AMC that the Regulation 39(2)(a) of the MF Regulations don’t prescribe ratification by the unitholders for the trustees’ decision to wind-up the schemes.
Also, the SEBI had favoured continuation of the wind-up process requesting the High Court to allow e-voting by unitholders as per May 28 notice to authorise the trustees or any agency to liquidate assets.
“If the decision to wind-up is reversed, the trustees would have to reopen the schemes for the transaction and all unitholders would put 100 per cent redemption requests immediately. To meet such redemption requestions, MF would have to sell securities in distress at a very deep discount as the whole market is aware of the present distress... Any distress sale of assets of a scheme would reduce NAV (Net Asset Value) which will be detrimental to all the unitholders of the schemes. This, in turn, would create a widespread contagion effect across the entire mutual fund industry and harming the interest of all the investors at large,” the SEBI had argued
Petitioners’ contentions
It was contended on behalf of the petitioners that the winding-up process was illegal as no consent from the unitholders were sought for trustees’ decision to wind up while alleging that the problem of ‘liquidity stress’ had arisen much prior to impact of Covid-19 and the pandemic situation was used only as an excuse for winding up. The petitioners had also alleged that the SEBI had failed to discharge its duties effectively while challenging the constitutional validity of the regulations related to winding up of mutual funds.