Sebi warnings to mutual funds more than double in FY19

In some cases, Sebi has resorted to further legal proceedings, depending on the gravity of the violation.

ET Online
Market regulator Securities and Exchange Board of India (Sebi) has stepped up its vigil on domestic asset management companies (AMCs) as mutual funds have emerged as the preferred investment route for a large number of retail investors.

In FY19, the regulator shot off 47 warning letters to various MFs — a steep rise from 17 in FY18 and 27 in FY17, data accessed through a Right to Information (RTI) application showed.

Charging excessive fees and commissions along with nonadherence to sectoral limits in debt funds and borrowing for purposes other than what’s allowed under MF regulations are some of the main reasons for issuing the letters, Sebi said in response to a query.


In some cases, Sebi has resorted to further legal proceedings, depending on the gravity of the violation. The development comes as mutual funds are currently facing regulatory heat for some of its investment practices, especially in the debt segment. Sebi is also said to have initiated adjudication proceedings against at least two AMCs.

“FY19 wasn’t a smooth year for mutual funds as fund houses faced pressure both from the regulator and unit holders,” said a leading fund manager working with a domestic AMC. “The challenges were also unique like in the case of Zee Entertainment where some of the funds were forced to enter into a standstill agreement with debtors.” Investors in many schemes took a mark-to-market loss due to the holdings in IL&FS and some of its subsidiary companies, DHFL and Sintex.

The fund manager said that the regulator has worked proactively and has plugged most of the gaps that were being exploited by the AMCs. For instance, one of the major violations by the fund houses, according to the RTI, was that investors belonging to T-15 cities and locations outside India were categorized as B-15 and distributors were being paid higher commissions.
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Commission paid to a distributor for an investor based out of Thane or Noida were being charged at B-15 rates even though these areas should have been considered as part of Mumbai and Delhi. This promoted Sebi to revisit the commission framework and first change it to B-30 and subsequently directed fund houses to charge the additional 30 bps applicable on B-30 cities only on retail AUMs.

The regulator has also clamped down on the conflict of interest between fund houses and banks. In some cases, it was observed that mutual funds were parking short-term deposits in banks which were investors in the scheme. “AMCs failed to incorporate appropriate checks and balances to ensure that banks do not subsequently invest in the said schemes,” Sebi said in the RTI response.

There have been instances where AMCs have borrowed for purposes other than those allowed under the mutual fund regulations. “At times, the borrowing has been for larger interest of the AMC and not the unitholder, which the regulator wants to crack down,” said the CEO of a domestic fund house.

Sebi warnings more than double
The regulator has found instances of close-ended schemes, investing assets which had a maturity beyond the maturity of the scheme, thereby resulting in loss to the scheme due to premature liquidation. “This is not in the best interest of investors, as they could suffer a loss,” said a fund manager. Sebi has, however, declined to provide data on the warning letters received by each fund house.
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Debt mutual funds have received warnings from Sebi for violations, including not valuing the investments as per regulations, non-adherence to the sectoral limits resulting in concentration of risks. “This happened due to redemption pressures where the AMC is unable to sell the illiquid or troubled security, thereby leading to an increase in its percentage in the portfolio,” said a debt fund manager.

The problems for debt funds started late last year when infrastructure conglomerate IL&FS defaulted on its debt obligations. It was followed by liquidity crunch in the debt papers of Deewan Housing Finance in September 2018 which adversely impacted investor sentiment in corporate bond market.
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