'Mandate First, Gains Later; SEBI Compliance, Never Falter': Supreme Court To AMCs And Mutual Fund Houses

The Supreme Court on Monday coined a "mirror disclaimer" for asset management companies as it upheld the Securities Appellate Tribunal's (SAT) ruling affirming SEBI's findings that Kotak Mahindra Asset Management Company (AMC) and its trustee company. and certain senior executives violated regulatory norms over investments made by six Fixed Maturity Plans (FMPs) in Essel Group-linked debt securities.

A bench of Justices Dipankar Datta and Satish Chandra Sharma upheld the penalties imposed by SEBI's Whole Time Member and Adjudicating Officer while leaving undisturbed the SAT's decision to set aside the regulator's direction requiring Kotak AMC to disgorge a part of its management and advisory fees.

Announcing the operative part of the judgment, the bench said it found no reason to interfere with the findings returned by the SAT and SEBI.

"Then after we have given our reasons for upholding the order of the SAT and the WTM together with the order of the Adjudicating Officer. We have upheld the penalty that has been imposed on three sets of appellants.", it ruled.

The court also rejected a plea seeking leniency for the senior executives on the ground that investors ultimately did not suffer any financial loss.

"We have considered Mr. Diwan's submission that, so far as the senior executives are concerned, their cases should be considered in the light of no loss having been suffered in the ultimate run, but unfortunately, we have not been able to persuade ourselves to agree with that too. Therefore, the penalty imposed on the senior executives is also upheld.", the top court noted. 

Apart from affirming the penalties, the Supreme Court directed Kotak AMC to pay ₹30 lakh as costs and Kotak Trustee to pay ₹20 lakh. The amounts are to be deposited within two months and distributed equally among beneficiaries identified by the Secretary General.

"We have imposed cost of ₹30 lakh on Kotak AMC and ₹20 lakh on Kotak Trustee. And we have said that this amount is to be deposited within two months, whereupon the Secretary General will apportion it amongst the beneficiaries who have to be identified, and equally, it has to be distributed amongst them.", it ordered. 

At the outset of the judgment, the bench referred to the familiar disclaimer accompanying mutual fund investments to underscore the responsibilities of fund managers.

"So we have started our judgement a bit unusually. We have quoted the usual disclaimer and the advisory. Mutual fund investments are subject to market risks. Read all scheme related documents carefully. An average Indian is more than familiar with this unmistakable phrase. Displayed at the most noticeable places, it cautions potential investors of the likely risks of investment in mutual funds. The present appeals deal with one such risky scenario, ostensibly created by the appellants."

Concluding the pronouncement, the bench said it had coined a "mirror disclaimer" for asset management companies and fund houses.

"We have concluded our judgement with a mirror disclaimer warning managers of AMCs and fund houses. We have coined this phrase, 'Mandate first, gains later; SEBI compliance, never falter.'"

Background

The dispute arises from SEBI action against Kotak Mahindra AMC over investments in six Fixed Maturity Plans (FMPs) launched between 2013-2017 and maturing in April-May 2019, which had exposure to Essel Group entities backed by pledged Zee Entertainment Enterprises Ltd (ZEEL) shares.

These schemes had invested in zero-coupon non-convertible debentures issued by Essel Group entities, including Konti Infrapower & Multiventures Pvt. Ltd. and Edison Utility Works Pvt Ltd The investments were backed by pledged shares of ZEEL, provided by an Essel promoter entity, with a stipulated collateral cover of around 150%.

Following a sharp fall in ZEEL's share price on January 24, 2019, the collateral cover dropped and was not restored, leading to extension of maturity of underlying securities till September 30, 2019 and delayed repayments to investors. SEBI thereafter issued show cause notices to Kotak AMC, its trustee company and officials alleging lack of due diligence, improper extension of maturity and failure to protect investor interests.

By orders dated August 27, 2021 and June 30, 2022, SEBI found lack of due diligence, improper extension of maturity. Rejecting Kotak's contention, the Securities Appellate Tribunal held that the AMC had failed to adequately assess the financial strength of the issuer entities and had primarily relied on pledged ZEEL shares.

“In our considered view, appellants failed to exercise adequate care and due diligence expected from a professional Mutual Fund Asset Management Company, the Mutual Fund Trustee Company and its professional employees who were part of the decision-making process to invest in Konti and Edison”, the appellate tribunal had observed.

While upholding penalties and regulatory violations, SAT set aside the disgorgement direction.