Changes in fundamental attributes: Mutual Fund Regulations to be strictly followed

Securities Appellate Tribunal (SAT) on 3 May, 2011 delivered an important verdict concerning the protection of mutual fund investors in mutual fund schemes.  In the case of Subramanian R Venkat v. SEBI and others, SAT ordered, when there is any substantial and fundamental change in the attributes of a mutual fund scheme, then such change should be in accordance with regulation 18(5A) of the SEBI (Mutual Funds) Regulations, 1996 (Mutual Fund Regulations).

Background of the case

Respondents (Board of Trustees of HSBC Mutual Fund, HSBC Mutual Fund, HSBC Securities and Capital Markets (India) Private Limited, SPV (an AMC) floated of HSBC Mutual Funds and CEO of AMC floated by HSBC Mutual Fund) (HSBC Mutual Fund) in 2003 floated an open-ended gilt scheme (HSBC Gilt Fund- Short Term Plan-plan in which the appellants invested)(Scheme) by the name of HSBC Gilt Fund to generate income from investing in government securities (Govvies).

Thereafter, in 2009 certain attributes of the Scheme were altered unilaterally by HSBC Mutual Fund, under which (a) name of the scheme was changed from HSBC Gilt Fund- Short Term Plan to HSBC Gilt Fund, (b) benchmark index changed from ‘I-Sec Si-Bex’ to ‘I-Sec Composite Index’, and (c) change in duration of scheme.

Issues

• Whether the impugned changes made in the scheme amounted to changes in the fundamental attributes of the contravention of regulation 18(15A) of the Mutual Fund Regulations?
• Whether the Board of Trustees and the AMC have contravened regulations 18(9) and 18(22) and clause 2,6 and 9 of Fifth schedule of Mutual Funds Regulations?
• Whether the AMC have contravened regulations 18(9), 18(22), 25(1) and 25(16) and clause 2,6 and 9 of Fifth schedule of Mutual Funds Regulations?
• Whether the CEO of the AMC have contravened regulation 25(6A) of Mutual Funds Regulations?

SAT’s verdict

SAT was of the view that the above mentioned-changes are in the nature of change in fundamental attributes of the Scheme.  SAT further held – “In the context of an investment scheme, one of the important factors that an investor looks at is the duration for which the investments are going to be made in the Scheme….There could be other attributes other as well depending upon the nature of the scheme….The powers of the fund manager of bring about the changes in the scheme cannot be disputed but if such changes alter the fundamental attributes of a scheme or modify the scheme affecting the interest of the unit holders-the fund and the managers have to comply with the provisions of regulation of 18(15A) of the Mutual Funds Regulations.”

Takeaways for Transactional Lawyers

Transactional Lawyers in the Mutual Funds space, while involved in the transaction pertaining to the changes in the attributes of the Mutual Fund Scheme must insure that:

•  Requirements of Regulation 18(15A) are fully met.
• Clarifications issued by SEBI under circular (IIMARP/Cir/01/294/98) dated 4 February, 1998 are ‘not the whole and sole’ for determining the fundamental attributes of a Mutual Fund scheme.
• Fundamental attributes of a mutual fund scheme depend on case to case basis.