MFs forced to compensate investors

“We are examining the whole issue," said a Securities and Exchange Board of India (Sebi) official aware of the development.

In the first such instance in the Rs7 trillion Indian mutual fund industry, Sebi has already compelled BNP Paribas Asset Management India Pvt. Ltd and Deutsche Asset Management (India) Pvt. Ltd to compensate investors after it carried out an inspection in February.

BNP Paribas has been found guilty of transferring losses from one set of fixed-maturity plans (FMPs) to another, thus unfairly forcing losses on investors in the second set of schemes. Deutsche Asset Management erroneously valued some assets in one of its debt schemes, leading to a shortfall in returns for investors.

The Sebi inspection found that in fiscal 2008-09 both the fund houses violated rules and compromised the interests of investors.

“BNP Paribas paid about Rs20 crore and Deutsche paid nearly Rs3 crore to the affected investors," said the second person mentioned above. Neither of them wanted to be identified, given the sensitivity of the matter.

Mint has reviewed a copy of the letter addressed to affected investors by one of the asset management companies.

Accounting violations are rare in the mutual fund industry as every transaction has to be reported to Sebi and verified by the auditors. The Sebi spokesperson declined to comment for this story.

“The said payments were made pursuant to a review of valuation guidelines and application of such revised guidelines to the investments in some of Fortis Fixed-Term Plans existing in early 2009 of Fortis Mutual Fund," a BNP Paribas spokesperson said. “The resultant valuation surplus was distributed recently to the investors in consultation with Sebi."

The episode occurred when the fund house was owned by a different entity.

BNP Paribas was originally formed as ABN Amro Asset Management (India) Ltd. In 2008, it was renamed Fortis Mutual Fund, and in 2010 was rechristened BNP Paribas Mutual Fund. It has assets worth Rs4,674 crore.

A Deutsche Group spokesperson in India denied any violation of norms. “We would like to state that there has been no violation of any mutual fund regulations by Deutsche Asset Management that has resulted in any losses to the investors in our debt schemes," the spokesperson said. “All our schemes meet Sebi’s as well as our stringent internal guidelines."

On being asked about compensating the investors, the spokesperson said: “We have emailed you our response. Beyond that, I cannot comment."

Deutsche manages Rs8,187 crore in assets.

There are 41 asset management companies in the Indian mutual fund industry.

“Sebi conducted inspections and found one AMC guilty of transferring certain assets under one set of FMP schemes to another at a price higher than the actual market value then," one of the two persons said.

This was done through inter-scheme transfers, but it forced investors in the buyer schemes to incur losses. In April, Sebi ordered them to compensate investors. Both the AMCs have already done so.

Sebi has tightened mutual fund norms extensively since 2009. Among many moves, the most prominent was to scrap the entry load or upfront commission paid to distributors for investing in a scheme. Sebi’s latest move to inspect schemes that have been closed and forcing the AMCs to compensate the affected investors indicates that the regulator is continuing with its investor-centric approach under its new chief U.K. Sinha, who took over from C.B. Bhave on 18 February.

FMPs are close-ended debt schemes that usually invest in fixed-return instruments such as certificates of deposit, commercial paper and bonds that mature at the end of the FMP’s term. These plans typically have a tenure of 90 days to three years.

Sebi allows FMP securities to be sold at fair market value, provided the sale protects the interests of unit holders.

“For BNP Paribas, there could be two critical violations. Firstly, displaying an act of discrimination among investors by forcing losses on one set of investors to benefit another set; and secondly, using inter-scheme transfer to unfairly pass on losses to a set of investors, thereby beating the whole objective of inter-scheme transfers," said one of the two persons cited above.

“Transferring assets from one scheme to another at a loss and then concealing it is a gross violation of Sebi norms," he added.

For Deutsche AMC, the violation could be in the form of breaching valuation policies, said the second person.

“While buying or selling illiquid debt securities, fund houses value the scrips as per the valuation matrix provided by rating agencies Crisil (Ltd) and Icra (Ltd)," said the head of fixed income at a large domestic fund house.

“If a fund manager anticipates losses on certain debt papers during redemption, he may transfer the securities to another scheme by way of inter-scheme transfers," he said, requesting anonymity. “If the market value of the securities transferred is lower than the price at which they were bought from another scheme, the investors suffer."

“Such losses should be verified in the accounts of the AMC by its internal auditors. Some fund houses have a practice of verifying all scheme-related investments on a daily basis before cross-verifying them on a quarterly basis by another auditor," he said. “If such losses are not accounted for, it amounts to a serious violation of Sebi norms."

Profits and losses on schemes are recorded in the revenue accounts of AMCs. If profit on the sale of investments shown in the revenue account includes profit or loss on inter-scheme transfer of investments within the same mutual fund, the AMC needs to disclose the aggregate separately without clubbing the profit or loss on sale of investments to third parties. If this is not done, it amounts to a violation of Sebi norms.

In September-October 2008, mutual fund houses faced redemption pressure on FMPs when a liquidity crisis gripped the financial system in the wake of the collapse of US investment bank Lehman Brothers Holdings Inc., forcing the Reserve Bank of India to open a special window for mutual funds.

Also, till that time, fund houses were allowed to indicate returns on FMPs and buy instruments having varying maturities, irrespective of the tenures of the FMPs. So, a one-year FMP could buy a bond that would have matured after, say, two years. Additionally, FMP investors were allowed to redeem investments any time during the tenure of the FMPs by paying an exit fee.

To ensure that panic redemptions do not negatively impact existing investors as well as the FMPs’ health, Sebi changed the rules first in December 2008 and again in early 2009 through a set of directives.

The new rules banned FMPs from giving indicative yields and offering premature redemption. FMPs were also told to invest in instruments that matured in line with the scheme.

These rules not only ensured that the books of AMCs were not hurt by any redemption pressure, but also increased transparency for investors.

Sebi has also come out with a string of regulations for debt funds, as well as several other areas governing the mutual fund industry, including better disclosure.

anirudh.l@livemint.com

Milestone Alert!
Livemint tops charts as the fastest growing news website in the world 🌏 Click here to know more.

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!