The effect of the pandemic has not been confined to health and has extended to other interesting debates in various fields of law. One issue which has caught the public eye is the controversy surrounding the decision of Franklin Templeton Trustees (FTT) to foreclose their debt fund schemes, purportedly to preempt losses weeks after nationwide shutdown. Considering the wide-ranging challenges to the decision in various high courts, including public interest suits, criminal charges, etc, the Supreme Court consolidated all matters and transferred them for an expedited consideration of the Karnataka High Court, which has issued a detailed decision. A first in the space of mutual fund governance and delineating the empowerment of the trustees versus the rights of contributions of the unit holders, the verdict assumes significance as it not just addresses the controversy, but also reflects on a larger landscape – democratising governance.
The grain of the list amongst the various legal issues confronting the High Court was whether mutual fund trustees could unilaterally decide to wind up the scheme or does their decision require investors’ confirmation to obtain enforceability. The fund relied on the Securities and Exchange Board of India (Sebi) Regulations to highlight three situations where winding up was permitted: (i) directions of Sebi, (ii) with consent of 75 per cent investors, or (iii) on an event which, in the opinion of the trustees, requires the scheme to be wound up”. The FTT enumerated the prevailing circumstances in the run-up to their decision for winding up, inter alia the pessimist outlook in capital markets owing to the bulging Covid infections, nationwide lockdown, etc, to contend that it arrived at a considered opinion that winding up was to protect investors’ interests. It was contended by FTT that intrinsically an investment in a mutual fund was a private contract between the investors and the trustees to the exclusion of public interest considerations so as to warrant judicial scrutiny.
The High Court adverted to the controversy by elevating the prism of inquiry beyond the contentions. Examining the entrustment of empowered and steering responsibility of Sebi as a market regulator, the court took pains to reverberate Sebi’s mandate to “promoting the orderly and healthy growth of securities market and protecting the interests of the investors/unit-holders”. The court, exercising its empowerment as a constitutional court, held that it was its prerogative to issue directions for highlighting lack of proactive monitoring and enforcement of regulations by Sebi. The High Court’s directions, on fundholders’ rights (and the non-interference by the Supreme Court) directing that a Sebi-monitored e-voting process be initiated, assumes significance. It instituted a new avenue for market-participants craving for judicial monitoring of market regulator’s inactions. The tenor and underlying intent of the court is laudable to restore equilibrium and protection of investors, the Supreme Court has granted a stay with a cautious note that it shall not set a binding precedent and that shall examine the High Court’s order on January 21.
On the merits of the controversy, the High Court has, justifiably so, refused to adjudge the FTT’ appraisal of market-volatility and whether the “situation could have undergone a drastic change even in the matter of a few hours considering the liquidity crisis and volatile situation created by lockdown”. Acknowledging that it is beyond the prowess of constitutional courts to determine whether the winding up of the scheme would be conducive or detrimental to the investors, the Court has categorically declared that such ‘commercial decisions’ are best left to subject-matter experts. The Court recorded that “latitude has to be given to [their, meaning trustees] decision making process based on commercial considerations…” It reassures the market-players against judicial interference in their commercial dealings and the exclusive domain of the market-regulator to ensure observance of fair-play.
The High Court has given impetus to an important corporate governance principle in the functioning of mutual funds by concluding that the domain of the trustees to unilaterally decide on winding up without declared confirmation by majority investors is non-negotiable. The ‘fiduciary’ capacity of the trustees and their obligation, both within the regulatory framework or otherwise, to operate in the best interests of the investors, mandated investors’ approval thereby reconstructing the trustees’ determination as a ‘proposal’ rather than a ‘decision’. In essence, the High Court has sown seeds of democracy within the functioning of the mutual funds elevating investors as active participants in fund governance and realigned their status as against free-riders who invest for returns and stood divorced from participation in the decision-making process.
It is true that the decision is limited to ensuring investor participation at the wind-down stage, it is nonetheless a step forward given that under the current framework investors have no say. It is equally true that the High Court’s slant of the regulations will have to stand the test of the Supreme Court’s probe. Nevertheless, the Supreme Court’s directions to not stall the e-voting process further strengthens the importance of unit holders’ rights. Whereas the outcome of investor votes will be known after the meeting, it is interesting to observe how the winds of change sown by the Court can be accentuated to increase investor participation in mutual fund decision-making processes.
(Authors are partners, BMR Legal. Views are personal)