Gap between letter and spirit in the role of mutual fund trustees

Asset management company (AMC) trustees have a fiduciary duty of managing the interest of unitholders of mutual fund (MF) schemes. Trustees must ensure that there is no failure in compliance or procedures that can lead to lapses in the investment process and thereby be detrimental for investors. The recent episodes of winding-up of some MF schemes, and the alleged malpractices in MF houses such as front-running, tailgating, and kickbacks to distributors have brought into the limelight the role of trustees who are the first level regulators of the ₹38 trillion MF industry. These incidents question the responsibilities laid upon the trustees, as per market regulator Securities and Exchange Board of India (Sebi) MF Regulations of 1996, which include ensuring due diligence in operations and compliance by AMCs such that the investor interest is protected.

The question being raised now is whether trustees are discharging their duties effectively. The scheme winding-up episode of April 2020 brings to attention the Clause 39 (2a) of Sebi MF regulations. It stipulates that an MF scheme can be closed “…on the happening of any event, which in the opinion of trustees, requires the scheme to be wound up.” This winding-up was pinned to the opinion of trustees. The question here is whether such a decision was independently evaluated by the trustees in the interest of the unitholders or steered by the AMCs. Thus, if the AMC-trustee distance is only in letter and not in spirit, then it is a roadblock to good governance.

The other responsibility on the trustees, as stipulated under Regulation (18) (23) (b) of the Sebi MF Regulations ,is certifying that they have “satisfied themselves of no instance of self-dealing or front-running by any of the trustees, directors and key personnel of AMC”. Though the trustees have been given this responsibility, the questions that arise are: Are the trustees monitoring the performance of the fund managers; seeking reasons for fund underperformance? Overall, is the culture of ensuring process adherence in MFs missing?

Other fiduciary duties of trustees on fair treatment to clients, cost of schemes, valuation, are also questionable. The culture of freebies and kickbacks has thrived and taken innovative forms even after strict elimination rules. Thus, there is a need to assess if trustees are effectively discharging their vested responsibilities. Are they ensuring that AMC business is carried out in accordance with the stipulated regulations? Are they capable of enforcing best practices?

The overall accountability of trustees to unitholders is much desired. Trustees should frequently communicate with the unitholders and provide their insights about the functioning of AMCs. With regard to their fiduciary duties, they should prove the point that “mutual funds sahin hain” and “trustees hain na” for investors. This will be a much-desired booster for investor confidence.

The role of trustees has been accorded great importance ever since several steps were taken towards their efficient functioning over the last two decades. The P. K. Kaul Committee set up by  Sebi in 2003 suggested several things which entailed increased accountability of trustees. It was felt that the administrative support to trustees should be enhanced such that there is less dependency on AMCs. In 2020, Sebi specified the appointment of a dedicated trustee officer to provide administrative assistance to trustees in monitoring various activities of an AMC and enabling them to discharge their duties effectively. But, how does one monitor the independence and accountability of these trustee officers. 

The ideal framework for trustees could perhaps be to work in splendid isolation from the AMC or adopt the far-sighted framework suggested by the Kaul Committee of having the concept of professional trustee companies which would be wholly independent of the AMC and its promoters. This can be done through a three-pronged approach — first, the institution of trustees should be endowed with its own capital to cut down dependency on AMCs in any form (salaries, operations, infrastructure, etc.); two, they should be appointed by the regulator and mandated to report directly to it. And three, the trustee office should have a team of competent people who understand the specialized MF business. Removing the dependence of trustees on AMCs will reduce any conflict of interest and help them in effectively discharging their duties and protecting the interests of unitholders.

Mitu Bhardwaj and Rasmeet Kohli are working with the National Institute of Securities Markets.  Views are personal.