FRANKLIN TEMPLETON TRUSTEE SERVICES PRIVATE LIMITED AND ANOTHER v. AMRUTA GARG AND OTHERS ETC.

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A made subject matter of inquiry or investigation and therefore no directions or orders under Section 11 or 11B of the Act can be passed. No doubt, clause (a) to Regulation 39(2) gives primacy to the opinion of the trustees and does not require prior approval of SEBI, yet SEBI is entitled to conduct an inquiry and investigation when justified and necessary to ascertain whether the trustees have acted in accordance with their B fiduciary duty and also for reasons which would fall within the four corners of clause (a) to Regulation 39(2). If the trustees have acted for extraneous and irrelevant reasons and considerations, the action would be in violation of clause (a) to Regulation 39(2) and therefore amenable to action under the SEBI Act, including directions under Section 11B.

55Copy pinpoint55. The view we have taken is in consonance with the earlier decision of the Gujarat High Court in Alka Synthetics and Trading v. SEBI,15 wherein it was observed that power under Section 11B is in the nature of issuing a command to persons referred to in the provision to do a certain act or to forbear from doing a certain act, if as a result of an enquiry, SEBI is satisfied about the necessity of issuing such direction for the purposes mentioned in clauses (a), (b) and (c). The Gujarat High Court, in our opinion, rightly observed that while Section 11 operates in the field of laying down general regulatory measures as a matter of policy, Section 11B operates in the field of prescribing a specified code of conduct in relation to specified persons or classes of persons. On the issue of application of principles of natural justice, it was noted that Section 11B empowers SEBI to issue directions only after it is satisfied about the conditions referred to in the provision, as a result of making or causing to be made an enquiry – which necessarily implies a pre- decisional hearing. Similar view was subsequently expressed in Nikhil F T. Parikh v. Union of India16, wherein the same High Court was of the view that Section 11B, being an enabling provision, must be so construed as to subserve the purpose for which it has been enacted. As the term ‘measure’ is not defined in the SEBI Act, the High Court gave it a meaning prescribed in general parlance, as incorporating anything desired or done with a view to the accomplishment of a purpose, a plan or course of G action intended to obtain some object, any course of action proposed or adopted by a Government. The Securities Appellate Tribunal in Sterlite Industries (India) Ltd. v. SEBI,17 has given an expansive interpretation 15 (1999) 95 Comp Cas 663 16 (2014) 2 GLH 582 17 H 2001 SCC OnLine SAT 28.

FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD. v. 603 AMRUTA GARG [SANJIV KHANNA, J.]

to Section 11 and Section 11B of the SEBI Act, observing that they give enormous authority to SEBI. As long as the power exercised under Section 11B is subject to the provisions of the SEBI Act and well within the legal and constitutional frame work, intended to achieve the purposes of the SEBI Act and subjecting the persons specified in the section, the power will sustain. The Appellate Tribunal called it a wholesome provision designed to achieve the objectives of the SEBI Act.

56Copy pinpoint56. The Trustees and the AMC in their written submissions filed before the High Court interpreting the SEBI Act and the Regulations had conceded that SEBI has extensive powers with respect to the regulation of mutual funds including the trustee’s decision to wind up a scheme of the mutual fund. Section 11(1) of the SEBI Act states that it is the duty of SEBI to protect the interest of investors in securities and to promote the development of, and to regulate the securities market, by “such measures as it thinks fit”. Under Section 11B of the SEBI Act, SEBI has broad powers to issue appropriate directions if it is satisfied after inquiry that such directions are necessary in the interest of investors or for orderly development of securities market or to prevent the affairs of any intermediary being conducted in a manner detrimental to the interest of investors or the securities market or to secure proper management of any intermediary or other person. The power of SEBI extends to regulating and monitoring the functioning and decisions taken by mutual funds, the trustees and the AMC. SEBI has the power to pass any direction if it deems fit in the interest of unitholders. The trustees and the AMC have specifically stated: “It is evident form the aforesaid provisions that the SEBI has extensive powers to regulate, supervise, issue directions with respect to and inspect and investigate into the affairs of a mutual fund, including with respect to the decision of the trustee to wind up a mutual fund scheme under Regulation 39(2)(a) of the Mutual Funds Regulations, including to even stop the winding up of a mutual fund scheme, if deemed necessary. The existence of such powers of the SEBI is further reinforced by Section 11D of the G SEBI Act, which empowers the SEBI to pass an order requiring any person who, ‘has violated, or is likely to violate, any provisions of this Act, or any rules or regulations made thereunder” to ‘cease and desist’ from committing such violation. It is submitted that whether SEBI would choose to exercise this H

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A power is a matter, which may be determined by SEBI in its wisdom and there may be numerous reasons why SEBI may not wish to interfere in a winding up decision by a trustee under Regulation 39(2)(a) including the reasons submitted by SEBI in its affidavit such as the fact that reversal of a decision to wind up a mutual fund scheme would likely cause a run on the scheme as well as severe market contagion (Reference is made to Paras 18,19 at Pg. 6 and 7 of the Delhi Reply; Paras 34 and 35 at Pg. 11 and 12 of the Gujrat Reply; and Paras 11 and 12 at Pgs. 5 and 6 of the Madras Reply); however, on a reading of the scheme of the SEBI Act and regulations as a whole, it is submitted that it is clear that such a power does exist.”

57Copy pinpoint57. However, we agree with the High Court that the Regulations have been framed in exercise of power conferred by Section 30 of the SEBI Act which authorises them to make regulations consistent with the provisions of the SEBI Act to carry out the purpose of the SEBI Act. D The very object of the SEBI Act is to preserve confidence of the investors and to regulate the capital market, including mutual funds. In the first portion of this order, we have elaborately referred to the Regulations which thereby create a three-tier system of the sponsor, the AMC and the trustees. There are stipulations regulating the activities of the trustees and the AMC whose powers, obligations and rights have been expressly E laid down. The power to regulate mutual funds, once accepted, would include the power to make regulations for winding up of a scheme of the mutual fund. Not framing any regulation in this regard would have amounted to dereliction of duty on the part of SEBI and subjected it to adverse comments.

58Copy pinpoint58. It cannot be accepted that the trustees under clause (a) to Regulation 39(2) have been given absolute and unbridled power to wind up a scheme. Language of clause (a) to Regulation 39(2) states that the trustees must form an opinion on the happening of any event which requires the scheme to be wound up. Further, as per Regulation 39(3), G the trustees are bound to give notice disclosing the circumstances leading to the winding up of the scheme. These notices along with the reasons have to be communicated to SEBI and made known to the unitholders by publication in two daily newspapers having circulation all over India and a vernacular newspaper having circulation at the place where the mutual fund is formed. The trustees are, therefore, required to come to H

FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD. v. 605 AMRUTA GARG [SANJIV KHANNA, J.]

a conclusion that due to specific circumstances articulated in writing, the scheme is required to be wound up. Two-thirds of the trustees are independent persons who are not associated with the sponsor,18 and no director, officer or employee of the AMC can be appointed as a trustee. 19 The trustees hold the assets of the scheme in fiduciary capacity on behalf of the investors. They are experts in the field and, therefore, conferred the power under Regulation 39(2)(a) to decide whether or not a scheme should be wound up. The words used in the statute including delegated legislation are to be understood in the light of that particular statute and not in isolation. A duly enacted law cannot be struck down on the mere ground of vagueness unless such vagueness transcends into the realm of arbitrariness (See Nisha Priya Bhatia v. Union of India and C Another 20). In the context of the present case, the expression ‘occurrence of any event’ is not to be read in isolation but with the words ‘requires the scheme to be wound up’. The expression ‘any event’ is therefore qualified with the said requirement. Read in this manner, there is no vagueness which can be described as transcending into realm of arbitrariness, on the other hand, the pre-requisite statutory mandate is clear. This is not a case of excessive delegation wherein the legislative function has been abdicated and passed on to the trustees who can act as per their whims and fancies. The essential legislative function is the determination of legislative policy and its formulation as a rule of conduct. In commercial matters varied and different situations can arise which may warrant winding up. Complexities in matters of business and commerce can be bafflingly intricate and riddled with urgencies and difficulties. Therefore, there is need for flexibility. Otherwise, the trustees would be compelled to first take the approval of SEBI, which may have its own consequences. F

59Copy pinpoint59. The Statement of Additional Information dated 30th June, 2019 issued by Franklin Templeton Mutual Fund, under Heading VI – ‘Duration of the Scheme and Winding Up’, provides a general indication as to when a scheme can be wound up under the Regulations, the relevant portion of which is extracted below: G “VI. DURATION OF THE SCHEME AND WINDING UP xx xx xx 18 Regulation 16(5) 19 Regulation 16(3) 20 (2020) 13 SCC 56 H

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A However, in terms of the SEBI Regulations, the Scheme may be wound up if: i. There are changes in the capital markets, fiscal laws or legal system, or any event or series of events occurs, which, in the opinion of the Trustee, requires the Scheme to be wound up; or xx xx xx ”

60Copy pinpoint60. We have agreed with the High Court that the opinion of the trustees under clause (a) to Regulation 39(2), therefore, must be consented to by the unitholders in terms of the mandate of Regulation 18(15)(c). In view of this interpretation, the argument challenging constitutional validity of the Regulations on the ground that they give unbridled and absolute power to the trustees loses much of its sting and force. There are, therefore, sufficient guidance and safeguards in the Regulations itself on the power of the trustees to decide on winding up of the fund.

61Copy pinpoint61. The Regulations, in our opinion, rightly draw the distinction between creditors and the unitholders. The unit holders are investors who take the risk and, therefore, entitled to profits and gains. Having taken the calculated risk, they must also bear the losses, if any. Unitholders E are not entitled to fixed return or even protection of the principal amount (See Regulations 38 and 38A).21 Creditors, on the other hand, are entitled to fixed return as per mutually agreed contracts. Their rate of return is in the nature of interest and not profit or loss. Creditors are not risk 21 Guaranteed Returns

F 38. No guaranteed return shall be provided in a scheme, - (a) unless such returns are fully guaranteed by the sponsor or the asset management company; (b) unless a statement indicating the name of the person who will guarantee the return, is made in the offer document; (c) the manner in which the guarantee is to be met has been stated in the offer document. Capital Protection oriented schemes G 38A. A capital protection oriented scheme may be launched, subject to the following: (a) the units of the scheme are rated by a registered credit rating agency from the viewpoint of the ability of its portfolio structure to attain protection of the capital invested therein; (b) the scheme is close ended; and (c) there is compliance with such other requirements as may be specified by the Board H in this behalf.

FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD. v. 607 AMRUTA GARG [SANJIV KHANNA, J.]

takers as is the case with the unitholders. In this sense, unitholders are A somewhat at par with the shareholders of a company. The waterfall mechanism under the Companies Act, or the Indian Bankruptcy Code, gives primacy to the dues of the creditors over the shareholders. Identical is the position of the unitholders. In fact, the argument that the unitholders should be treated pari passu with the creditors is farfetched. Similarly, B the contention that unitholders are identically placed as home buyers under the Indian Bankruptcy Code is equally frail and a weak argument. Home buyers pay money to the builder and enter into a contract for purchase of immovable property. Home buyers are not risk or partakers in gains or losses like investors in a mutual fund. Home buyers under the Bankruptcy Code are treated as creditors till the ownership rights in the immovable property are transferred to them, but they do not take the risks and are not entitled to benefit of profits or suffer losses, as are taken by the unitholders who invest in the mutual funds without any guarantee of returns and know that the investment, including the principal, are subject to market risks. To equate the unitholders with either the creditors or the home buyers will be unsound and incongruous.

62Copy pinpoint62. The expression ‘due and payable’ with reference to the liabilities is significant. The words ‘due and payable’ have to be interpreted with reference to the context in which the words appear.22 In the context in question they refer to the present liabilities which may be in praesenti or in futuro. There must be an existing obligation though the appointed date of payment may not have arrived. ‘Payable’, in this context, means capable of being paid, suitable to be paid and legally enforceable. It would exclude labilities that are time barred or those not payable in facts or in law.23 In case of any dispute a summary but thorough inquiry may be made to ascertain whether the liability is due and payable.24 Obviously, F the liabilities which are not due and payable would not get preferential treatment, thereby reducing the amounts payable to the unitholders.

63Copy pinpoint63. Since the Regulations are in the nature of economic regulations, while exercising the power of judicial review, we would exercise restraint unless clear grounds justify interference. We would not supplant our G views for that of the experts as this can put the marketplace into serious jeopardy and cause unintended complications. Policy decisions can only 22 B.K. Educational Services Private Limited v. Parag Gupta and Associates, (2019) 11 SCC 633. 23 Union of India v. Raman Iron Foundry, (1974) 2 SCC 231 24 Regulations do not bar civil remedy. H

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A be faulted on the grounds of mala fides, unreasonableness, arbitrariness and unfairness, in addition to violation of fundamental rights or exercise of power beyond the legal limits. The principle of manifest arbitrariness requires something to be done in exercise in the form of delegated legislation which is capricious, irrational or without adequate determining principle. Delegated legislations that are forbiddingly excessive or disproportionate can also be manifestly arbitrary. In view of the interpretation placed by us and the discussion above, the Regulations under challenge do not suffer from the vice of manifest arbitrariness.

64Copy pinpoint64. However, we must now refer to a grey area, which we would, at this stage, not like to decide till we have full facts and decision in the adjudication proceedings. The issue relates to interpretation of Regulation 53, which reads: “53. Every mutual fund and asset management company shall, (a) despatch to the unitholders the dividend warrants within 189[30] days of the declaration of the dividend; D (b) despatch the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase; (c) in the event of failure to despatch the redemption or repurchase proceeds within the period specified in sub-clause (b), the asset management company shall be liable to pay interest to the unitholders at such rate as may be specified by SEBI for the period of such delay; (d) notwithstanding payment of such interest to the unit-holders under sub-clause (c), the asset management company may be liable for penalty for failure to despatch the redemption or repurchase proceeds within the stipulated time. Clause (b) to Regulation 53 requires that the AMC shall despatch the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase. Regulation 40, as noticed above, states that on or from the date of publication of notice under Regulation 39(3)(b), the trustees of the AMC, as the case may be, shall cease to cancel or create units of the scheme; cease to issue or redeem units of the scheme; and cease to carry on any business activity in respect of the scheme so wound up.

65Copy pinpoint65. Issue in question would, therefore, arise whether the AMC or the trustees are bound to honour and pay the redemption or repurchase proceeds for requests received before the date of publication of notice

FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD. v. 609 AMRUTA GARG [SANJIV KHANNA, J.]

in terms of Regulation 39(3). Interpreting the word ‘business’ in clause A (a) of Regulation 40, the Division Bench of the High Court has held that this expression refers to business activity and, therefore, would include payment of redemption proceeds to the unitholders, which would include the request for redemption received prior to the date of publication under Regulation 59(3). The High court has, accordingly, held: B “228. As regards redemption requests received prior to compliance with clause (3) of Regulation 39, the argument of AMC and the Trustees was that in view of clause (d) of Regulation 53, the redemption or repurchase proceeds are required to be dispatched within ten working days from the date of redemption notwithstanding the decision of winding up. As held earlier, the C dispatch of redemption proceeds or repayment of redemption proceeds is also a part of business activity of a Scheme which is completely prohibited once the Regulation 40 triggers in. Therefore, the argument that the redemption requests made by the unit-holders on 23rd April, 2020 were required to be honoured even after D Regulation 40 had triggered in cannot be accepted. Once there is a compliance with clause (3) of Regulation 39, the mandatory provisions of Regulation 40 forthwith operate. There is no exception carved out to any of the clauses in Regulation 40. It is obvious that such a failure to dispatch the redemption or repurchase proceeds due to applicability of provision of Regulation E 40 cannot be termed as a failure within the meaning of sub-clause (c) of Regulation 53. Therefore, the consequences such as payment of interests and penalty as provided in clause (c) of Regulation 53 may not follow.”

66Copy pinpoint66. On the aspect of borrowings etc. by the AMC to make payment F towards redemption, the High Court has held: “225. But, in the context of the Scheme of the Mutual Funds Regulations, this Court will have to consider the meaning of ‘business activities’. As stated in the earlier part of our discussion, a Scheme is launched by AMC with the approval of the Trustees. G There are different categories of Schemes in which the investments are made by the members of the public. From plain reading of the provisions of Regulation 43, it is clear that the money received from the unit-holders and investors is required to be invested by AMC strictly in accordance with Regulation 43. The investments are to be made subject to investment restrictions specified in the H

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A seventh schedule. As far as borrowings are concerned, clause (2) of Regulation 44 provides that the Mutual Fund shall not borrow except to meet temporary liquidity needs of the Mutual Fund for the purpose of repurchase, redemption of units or payment of interest or dividend to the unit-holders. The proviso to clause (2) of Regulation 44 clearly provides that a Mutual Fund shall not borrow more than twenty percent (20%) of the net assets of the Scheme and the duration of such borrowing shall not exceed a period of six months. Thus, in short, the business of a Mutual Fund consists of (i) launching Schemes, (ii) receiving the investments from the unit-holders/investors, (iii) investing the money so collected from the unit-holders/investors in accordance with Regulation 43 and other relevant Regulations and (iv) paying the returns in various modes to the unit-holders/investors. The returns can be in the form of repurchase of the units, redemption of units, payment of interest or dividend to the unit-holders, as the case may be, depending upon the nature of the Scheme. Making D such returns is certainly a business activity of a Scheme. The income so generated by investments made in accordance with Regulation 43, can also be invested by AMC. Clause (3) Regulation 44 provides that save as otherwise expressly provided, a Mutual Fund shall not advance any loans for any purposes. However, E clause (4) of Regulation 44 provides that a Mutual Fund may lend and borrow securities in accordance with the framework relating to short selling and securities lending and borrowing specified by SEBI. The provisions of Mutual Funds Regulations are intended to regulate activities of Mutual Funds for promoting its healthy growth and for protecting interest of unit-holders. In a case F of Taxation law, the rules of interpretation applicable provide that if there are two interpretations possible, the one in favour of assessee will have to be preferred. In case of Mutual Funds Regulations, a construction needs to be adopted which will subserve the object of SEBI Act.

G 226. It is pertinent to note here that clause (a) of Regulation 40 uses the words “business activities in respect of the Scheme” and not merely business of the Scheme. As siated earlier, the activities of repurchase of units, redemption of units or payment of interest or dividend are also a part of business of a Scheme. In view of clause (2) of Regulation 44, a Mutual Fund can borrow only for H

FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD. v. 611 AMRUTA GARG [SANJIV KHANNA, J.]

the purposes of meeting temporary liquidity needs for the purpose A of repurchase, redemption of units, payment of interests or dividend to the unit-holders. For example, if there are large number of requests for redemption of units by the unit-holders in respect of ‘open ended Scheme’, a Mutual Fund may face temporary liquidity crunch. In such a situation, it is permissible for a Mutual Fund to make borrowings only for payment of redemption amount. B Therefore, borrowings made as specified in clause (2) of Regulation 44 will certainly amount to ‘business activities’ of a Mutual Fund or a Scheme, inasmuch as, such borrowings are made for the purpose of meeting demand for redemption which is a part of business of the Scheme. C

227. Regulation 40 is interlinked with Regulation 41. In view of Regulation 40, the moment compliance is made with clause (3) of Regulation 39, the ‘business activities’ of the Scheme of a Mutual Fund must stop. The creation or cancellation of units and issue or redemption of the units of the said Scheme must also cease. The reasons is, as required by sub-clause (a) of clause (2) of Regulation D 41, all the assets of the Scheme under winding up are required to be disposed of in the best interest of unit-holders and thereafter, as per sub-clause (b) of clause (2) of Regulation 41, the proceeds of the sale are required to be applied firstly towards discharge of liabilities of the Scheme. Secondly, the expenses in connection with the winding up are required to be set apart and thirdly, the balance amount remaining after clearing the liabilities has to be distributed to the unit-holders in proportion to their respective interest in the assets of the Scheme. The object of Regulation 40 of the Mutual Funds Regulation is to ensure that the moment compliance is made with clause (3) of Regulation 39, the assets available at that point of time should be made available for sale. The assets cannot be allowed to be depleied by creating more liability. That is the reason why the redemption must immediately cease. Therefore, it must be held that the borrowings made by AMC, in terms of clause (2) of Regulation 44, are business activities’ of a Scheme within the meaning of clause (a) of G Regulation 40. If borrowings are made in accordance with clause (2) of Regulation 44, the act of replacement of the borrower, as done by the AMC and the Trustees in the present case, will have to be also held to be a part of business activities in respect of the Scheme.” H

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67Copy pinpoint67. The case set up by some parties is at variance with the dictum pronounced by the High Court. They have submitted that the mutual fund must honour the request for redemptions received on or before the date of publication of notice under Regulation 39(3). In other words, Regulation 53(b) must be honoured and complied with even if the time of payment of redemption, the 10 days period stipulated therein, would B fall after the date of publication of the notice under Regulation 39(3). They are of the opinion that it would be illegal not to honour the valid redemption requests. They are also of the opinion that the AMC should be allowed and permitted to borrow money within the prescribed limits to honour such valid redemption requests as long as the valid redemption requests are received prior to the cut-off date for winding up. C

68Copy pinpoint68. Before we answer this aspect, we would like to have greater clarity on the factual matrix, which would be possible once the proceedings in pursuance of show-cause notices etc. are concluded. Notably, many of the appellants have not addressed us on this aspect, their grievance being that the Forensic Audit Report has not been made available to them. At the same time, they did refer to news reports or articles to suggest irregularities and illegalities of different kinds, including preferential payments, breach of trust and mis-management in deployment of funds of the scheme, violation of investment objectives stated in the offer document or scheme information document and breach of trust by withholding price sensitive information etc. Once the facts are clear and ascertained, we would be able to appreciate and understand the practical impact of the respective interpretations, i.e. the interpretation placed by the High Court and the interpretation sought to be placed and preferred by SEBI, the appellants, the trustees and the AMC. This is also the reason why we have refrained from referring and commenting on facts and left the several issues open at this stage. Nevertheless, we clarify that our observations in this Order and the earlier Order should not be read as binding factual findings or conclusions on any disputed facts, which could be a subject matter of a show-cause notice and consequent decision. Of course, the legal interpretation of Regulation 18(15)(c) and Regulations 39 to 42 to the extent indicated above are conclusive and binding. For clarity, we would also observe that any finding given by the High Court on facts or even on legal issues not subject matter of this Order or our earlier Order dated 12th February, 2021 would not be treated as conclusive and binding as the findings are sub-judice and pending before this Court on interpretation as well as merits.

H Nidhi Jain Directions issued.