Home / Opinion / Columns /  Franklin and Carlyle episodes: Blue-chip firms must be above suspicion

Two large and reputed American investment companies are currently embroiled with the securities regulator in India. The first is Franklin Templeton Asset Management (India), which is a subsidiary of its giant American parent. The other one is private equity firm, The Carlyle Group. Franklin abruptly shut down six of its large debt mutual funds last year, ostensibly to protect the funds from any further value erosion, since it was facing huge redemption pressure and was unable to liquidate fast-enough in a market spooked by the covid pandemic. This was last April. Investors felt cheated as they couldn’t redeem their units. Hence, a lawsuit was filed in Chennai by an investors’ forum. As a result, systematic redemptions have been going on, and, as of this writing, nearly 71% of the original value (when the funds were frozen) has been or will soon be repaid. This is much better than losing the entire amount. But the Securities and Exchange Board of India (Sebi), after its own investigation, has passed a 100-page order that holds Franklin guilty on many counts. One charge is a mis-categorization of funds, which concerns their being sold as debt funds even though they were found to have violated Sebi’s category norms on risk, liquidity and duration. Sebi has also charged Franklin with smuggling credit risk and illiquid instruments into those schemes. Also, that timely exit options were not exercised. Thus, the charges are of both omission and commission, and these acts are tantamount to a failure to safeguard investor trust. A fine was imposed as penalty, and Franklin is required to return nearly 500 crore collected as management fees since 2018. Franklin denies any wrongdoing, and will appeal against the order. Sebi also found Franklin’s distribution head Vivek Kudva guilty of an unfair trade practice that is equivalent to insider trading, as he had liquidated his own holdings of those funds just before their freeze. He was privy to internal decisions, so his action’s timing is suspect even if this pertains to mutual funds and not individual stocks. Franklin is sure to argue that the details of its portfolio had been known to Sebi all along, and nothing was hidden. Litigation is sure to be long-drawn.

As for Carlyle, it is a major investor in PNB Housing Finance Ltd. The board of this mortgage lender recently approved the issue of additional preference shares to Carlyle, which would raise its shareholding from 32% to well above 50% and give it a controlling stake. This mere announcement caused the price of the company’s shares to nearly double. It is as if Carlyle had made a profit even before investing the additional amount. A proxy advisory firm, Shareholders Empowerment Services (SES), has alleged that the issue of preference shares is unfair and abusive to minority shareholders. If the company had wanted to raise capital, it could have done so equitably by offering a rights issue to all shareholders. Such an arrangement would have made it possible for existing shareholders to renounce their rights in favour of Carlyle for a market-discovered price. The pop in the stock’s market price could have made this profitable to those renouncing their rights. Besides, SES says, the relatively low price of the preference shares does not factor in any “control premium", even though equity control will pass on to Carlyle. Sebi is now scrutinizing this deal worth nearly 4,000 crore. It may very well lead to a replacement of the preference issue with a rights issue. Another report in the Indian Express raises doubts if the independent directors who approved the issue were really exercising their “independence" and guarding minority rights.

Both the Franklin and Carlyle cases involve blue-chip names, with whom one does not usually associate wrongdoing, least of all violations of investor trust. Since the matters are sub judice, we can’t be sure of the eventual culpability of the accused. However, the facts, as known in the public domain, put the actors in a grey area. Were those charged with fiduciary duty in breach? Should they not be required to pass the ‘Caesar’s wife’ test? That is, we expect not just no wrongdoing, but no suspicion of it either. Undoubtedly, it is a slippery slope from pursuing sharp practices to beat the competition (say, to generate higher returns in debt funds) to crossing a red line into illegality. If it was done in broad daylight, why did the regulator not raise a flag? It is like blaming the police for not being vigilant over an impending crime. Of course, regulators typically wake up late. There should be no condoning of any lethargy on Sebi’s part. Nor of the other stakeholders, such as rating agencies and auditors. But blue-chip names of finance firms are expected to be ahead on compliance. They are repositories of public and investor trust, which is precious but fragile. All it takes is one scam perpetrated by a big name to set investor confidence back and invite a backlash of new and draconian regulation, that too typically after the horses have bolted. Think of Nirav Modi and the ban on ‘letters of understanding’. Or the long-term funk after periodic scams in Indian markets. In the US, Lehman’s crash led to its harsh Dodd-Frank legislation. This was even after many blue-chip Wall Street firms had paid billions of dollars in fines. Trust can be rebuilt, but the process is painstaking and slow. It has many contributors, including fund managers, regulators, courts and dispute-settlement mechanisms. But it is also the very foundation of economic prosperity, one on which all businesses and the economy depend for growth, and it must not weaken.

Ajit Ranade is chief economist at Aditya Birla Group.

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