Sebi’s Franklin Templeton order might not stand SAT scrutiny

The fund house had abruptly shut six of its debt schemes last April, soon after the post-covid lockdowns brought the economy to its knees. A common sentiment is that the fund house should pay the price for creating panic among its investors, especially since it paid little heed to liquidity and credit risks in a number of its schemes. Sebi’s order will certainly appeal to those who adopt this line of thinking. But experts say the order may not stand scrutiny at the Securities Appellate Tribunal (SAT). “It’s very unlikely Sebi’s order against Franklin Templeton will be upheld by the appellate tribunal. A fine of over ₹500 crore for some technical violations pointed in the order clearly looks like a case of regulatory overreach," says an expert on securities market regulation, requesting anonymity. Franklin has already said it will challenge the order at the Securities Appellate Tribunal.

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“There is an attempt to make an example out of the Franklin Templeton case. But if Sebi is going to largely rely on technical violations on issues such as scheme categorization rules and the duration of a fund, it may be a difficult battle to win, as the fund house is very likely to have played by the prevailing rules," says a debt fund manager at a rival firm.

Indeed, one of Franklin’s main arguments in its exchanges with Sebi has been that it has filed multiple compliance reports, and that “no concerns regarding violation of the categorization circulars have been raised in past audits/inspections." The firm added, “Otherwise, (we) would have been prompt in addressing the same".

While it may look a bit cheeky to point out to a regulator that non-compliance wasn’t pointed out early enough in the day, this does suggest the possibility that Franklin did indeed comply with the letter of Sebi’s rules and regulations.

The fact that no violations came to light in the various compliance reports and audits and inspections may well be because the rules themselves allowed many of the investment decisions the regulator is now frowning upon.

As luck would have it, Franklin’s decision to shut down its schemes has worked out fairly well for its investors. Already, 71% of all funds have been returned, and the mark-to-market value of the unsold securities as on 31 May suggests investors may get away without any haircut. The multiple liquidity schemes unleashed by the central bank post-covid have helped many mutual funds offload illiquid paper. Franklin investors, in one sense, have had the best of both worlds.

In the years running up to the debt fund crisis, they earned abnormal, almost equity-like returns, while having the benefit of very low volatility. And now, they look set to get nearly all of their investment back. The fund house is likely to argue that far from being short-changed, investors in its schemes got exactly what they were sold—higher returns in exchange for higher risk.

Of course, the fact remains that by abruptly shutting down the schemes, the fund house did create panic among its investors. While SAT may be sympathetic to this sentiment, it will look for actual rule violations before upholding Sebi’s ruling. On that front, the order does appear to fall short, especially when it comes to justifying an over ₹500 crore fine.