Legal and Regulatory Environment of Mutual Funds: NISM Series V-B Chapter 10
The Securities and Exchange Board of India (SEBI) is the primary regulator of the Indian securities market, overseeing mutual funds, custodians, depositories, and credit rating agencies. The core mandate of SEBI is to protect investor interests, promote market development, and regulate the environment to ensure transparency and efficiency. To achieve these goals, regulations focus on mandatory disclosures by issuers, the efficiency of transactions, and maintaining low transaction costs. SEBI also works to prevent market malpractices such as deliberate speculation, insider trading, and excessive risk-taking by funds, which ensures that household savings are effectively channelled into the economy.
10.1 Role of SEBI and Regulatory Reforms
SEBI established the SEBI (Mutual Funds) Regulations, 1996, which serve as the foundation for the industry. Over the years, these regulations have been continuously amended to empower investors and standardise operations.
10.1.1 Key Regulatory Reforms
- Scheme Categorization: To reduce investor confusion, SEBI mandated that fund houses can have only one scheme per category (with some exceptions like Index Funds). This process involved merging similar schemes and standardising definitions based on market capitalisation.
- Segregated Portfolios: Introduced during credit crises, this provision allows AMCs to isolate "bad" debt (troubled assets) to protect the remaining unitholders and ensure fair treatment during liquidity risks.
- Mandatory Listing: All close-ended schemes and units of segregated portfolios must be listed on recognised stock exchanges to provide an exit route for investors.
- Total Return Index (TRI): Since February 1, 2018, all mutual fund performance must be benchmarked against the TRI variant of an index, which includes both capital gains and dividends, providing a fairer comparison than the Price Return Index (PRI).
- Transparency: SEBI strictly regulates advertisements, valuation norms, and NAV calculations to ensure the industry remains one of the most transparent investment options.
10.1.2 Investment Restrictions and Portfolio Diversification
To ensure funds remain "true-to-label" and diversified, SEBI mandates specific exposure limits. Mutual funds must buy and sell securities on a delivery basis only and are prohibited from advancing any loans. Furthermore, schemes cannot invest in unlisted or privately placed securities of any associate or group company of the sponsor.
10.2 SEBI Advertisement Code for Mutual Funds
SEBI maintains a rigorous Advertising Code to prevent misleading claims and ensure that investors are provided with accurate, clear, and concise information.
Core Advertisement Rules
- Accuracy: Advertisements must be fair and cannot contain false, biased, or deceptive statements.
- Testimonials and Rankings: The use of testimonials or rankings based on arbitrary criteria is strictly prohibited.
- Celebrity Endorsements: Celebrities are not permitted to feature in advertisements for specific mutual fund schemes. However, SEBI allows celebrity endorsements at the industry level to increase general awareness of mutual funds as a product category, provided no specific AMC or scheme is promoted.
- Standard Warning: Every advertisement must carry the legible warning: "Mutual Fund investments are subject to market risks, read all scheme related documents carefully". For audio-visual ads, this warning must be spoken clearly and run for at least 5 seconds.
Performance Disclosure Guidelines
- CAGR Returns: For schemes older than three years, performance must be shown in terms of Compounded Annual Growth Rate (CAGR) for 1, 3, 5 years, and since inception.
- Standard Investment: Point-to-point returns based on a standard investment of Rs. 10,000 must be shown alongside CAGR figures.
- Manager Performance: Advertisements must disclose performance data of all other schemes managed by the same fund manager to provide a fair view of their track record.
- Short-term Horizon: For liquid and overnight funds, performance can be advertised using simple annualisation of yields if data is available for at least 7, 15, or 30 days.
10.3 Investors’ Rights and Obligations
Investors are granted specific rights to ensure transparency and accountability from AMCs and Trustees.
| Investor Right | Description |
|---|---|
| Beneficial Ownership | Unitholders have a proportionate right to the assets of the scheme and can opt to hold units in demat form, making them freely transferable. |
| Document Inspection | Investors can inspect key documents, including the Trust Deed, Investment Management Agreement, and RTA agreements. |
| Change of Distributor | Investors can change their distributor or switch to direct investing through a written request without needing a "No Objection Certificate" (NOC) from the old distributor. |
| Fundamental Attribute Change | If a scheme’s fundamental attributes change, investors must be given a window (at least 30 days) to exit at the prevailing NAV without any exit load. |
| Termination of AMC | 75% of unitholders (by unit-holding) have the power to terminate the appointment of an AMC or pass a resolution to wind up a scheme. |
| Unclaimed Amounts | AMCs must remind investors to claim dues. If claimed within 3 years, payment is based on prevailing NAV; after 3 years, it is based on the NAV at the end of the third year. |
10.4 Investor Grievance Redressal
Mutual funds must have a formal policy for redressal. The status of complaints must be published in the AMC’s annual report and on the websites of the fund and AMFI.
- SCORES: The SEBI Complaint Redress System is a web-based, centralised platform where investors can lodge and track complaints against listed companies, brokers, and mutual funds.
- Online Dispute Resolution (SMART ODR): This portal provides a platform for resolving disputes that are not satisfied by direct AMC resolution or SCORES.
- Caveat Emptor: The principle of "let the buyer beware" applies; unitholders cannot seek legal protection for matters clearly disclosed in scheme documents.
10.5 AMFI Code of Conduct and Ethics
The Association of Mutual Funds in India (AMFI) sets ethical standards to supplement SEBI regulations.
10.5.1 AMFI Code of Ethics (ACE) for AMCs
The ACE requires AMCs and Trustees to maintain high standards of integrity and fairness. Core principles include:
- Due Diligence: Render high service standards and exercise independent professional judgment.
- Integrity: Schemes must be operated in the interest of all unitholders, not sponsors or associates.
- Front Running and Self-Dealing: Key personnel are strictly prohibited from buying/selling securities ahead of the fund to gain an unfair advantage.
- Fair Valuation: Standardised valuation policies must be followed in accordance with SEBI norms.
10.5.2 Code of Conduct for Intermediaries (AGNI)
Individual agents, brokers, and banks must adhere to the AMFI Guidelines & Norms for Intermediaries (AGNI).
- Investor Interest: Intermediaries must consider the investor's interest as paramount and recommend products based on suitability, not commission.
- Prohibited Practices: They must not engage in churning (over-transacting), splitting applications to earn higher charges, or rebating commissions back to investors.
- Professionalism: Intermediaries must maintain NISM certification, register with AMFI to obtain an ARN, and ensure all sales personnel have an Employee Unique Identification Number (EUIN).
- Disciplinary Action: Violation of the code can lead to warning letters or the cancellation of AMFI registration.
Key Takeaways
- Regulator: SEBI is the statutory body regulating the industry.
- Benchmark: Performance must be compared to TRI.
- Ads: No celebrities in scheme-specific ads; mandatory risk warnings.
- Rights: 75% unitholder majority can terminate an AMC.
- Redressal: SCORES and ODR provide platforms for investor complaints.
- Ethics: AMFI ACE and AGNI codes ensure high ethical standards for both AMCs and distributors.