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Franklin Saga: The Legal Issues

Finsec Law Advisors

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On April 23, the trustees of Franklin Templeton Mutual Fund decided to wind up six of their open-ended schemes, citing liquidity crunch due to Covid’19 as the major reason. This is not the first time that the schemes of an open-ended mutual fund are being wound-up. In the past, fund houses such as Invesco Mutual Fund, Tata Mutual Fund and DHFL Pramerica Mutual Fund, have wound-up their schemes for various reasons. However, Franklin’s decision has created a huge hue and cry in the market and has brought up various legal issues concerning winding up of the open-ended mutual fund schemes. One reason for such reaction from the market participants is the cumulative amount involved, running into (approx.) INR 26,000 crore.

Winding up under the Mutual Fund Regulations

The relevant provisions under the SEBI (Mutual Funds) Regulations, 1996 that deals with winding up of an open-ended scheme are:

  • Regulation 18(15)(c) which provides that the trustees shall obtain consent of the unitholders when “majority of trustees decide to wind up or prematurely redeem the units
  • Regulation 39(2) provides various events in which a scheme maybe wound up: (i) on happening of an event which as per the trustees requires winding up, (ii) if 75% of the unitholders decide to do so by passing a resolution, and (iii) if SEBI directs as such in the interest of unitholders. The trustees are then required to issue a notice of winding up under Regulation 39(3). The subsequent provisions deal with process and effects of winding up. Under Regulation 41(1), the trustees are required to “call a meeting of the unitholders to approve by simple majority of the unitholders…to take steps for winding up of the scheme”.

In the case of Franklin, a decision was made by the trustees which was communicated through a notice followed by another notice calling for voting by the unitholders, in accordance with Regulation 41(1). Franklin has given multiple options to its unitholders, should they choose to vote in favour of winding up. However, the process of voting, scheduled for June 12, has been stayed by the High Court of Gujarat through an interim order on June 03 (affirmed on June 08).

Other issues

The existing securities laws provide a SEBI Complaints Redress System (SCORES) whereby an investor can lodge a complaint against a listed entity or an intermediary registered with SEBI. However, the existing system does not provide any immediate or direct relief to an investor. In fact, the SEBI Act, 1992 does not contain any explicit enabling provision to award compensation or other relief to the affected investors. Due to this, in the case of Franklin, many investors have lodged several writ petitions before various courts. The High Courts of Madras and Delhi have issued notices to SEBI and Franklin (the respondents) to respond to the petitions filed before them by various investors. The High Court of Gujarat has already issued a stay order in response to another writ petition. In fact, certain investors have also approached the Supreme Court in the present matter. It is imperative that the SEBI Act is amended to cater to the grievances of the affected parties and provide for appropriate relief, in order to avoid such multiplicity of proceedings.

Further, in light of the Franklin issue, on May 20, SEBI issued a circular making it mandatory for listing of units of mutual fund schemes that are in the process of winding up. It was also stated that trading on stock exchanges by the unitholders will not be mandatory pursuant to listing of such schemes. However, the operational modalities for the same have not been issued yet. In the case of Franklin, considering that the winding-up is itself under challenge before various judicial forums, it seems that listing of these schemes is not foreseeable in the near future.