Case: Desmond Anthony D'Souza Vs. Sbi Mutual Fund

Oral Judgment: (Dr. D.Y. Chandrachud, J.)The Petitioner, who appears in person, has filed these proceedings under Article 226 of the Constitution, seeking the following reliefs:(i) An order setting aside a scheme of merger of the One India Fund floated by the State Bank of India (SBI) with the SBI Magnum Equity Fund; (ii) A direction to the management of the SBI Mutual Fund to call a meeting of all investors, seeking their views on whether the swap ratio is fair and why no dividend was declared for more than five years; (iii) An independent audit into the affairs of the One India Fund; and (iv) In the alternative, that the deposit of Rs.2 lakhs made by the Petitioner be returned with interest as applicable to Fixed Deposits together with an additional amount of 0.5 percent applicable to senior citizens.2. In December 2006, the Petitioner invested an amount of Rs.2 lakhs in a Mutual Fund by the name of One India Fund floated by SBI in respect of which he was allotted 20,000 units in January 2007. The grievance of the Petitioner is that though other SBI Mutual Funds yield high returns to investors, the One India Fund has not resulted in any return to investors over six years. According to the Petitioner, the disclosure that Mutual Funds are subject to market fluctuations, merely implies that the dividend can vary and would not justify an assumption that no dividend can be declared at all for several years. The case of the Petitioner is that the management has disregarded the interests of the depositors and the investments which were made by the Investment Team have been negligent. Effective 10 August 2012, a merger was announced of the One India Fund Scheme with the SBI Magnum Equity Fund Scheme on the basis of the prevailing Net Asset Value (NAV) as of that date. This according to the Petitioner, will result in detriment to the investors because the NAV of the fund which is to be merged is quoted almost at par whereas that of the SBI Magnum Equity Fund is above Rs.28. According to the Petitioner, sanction ought to have been taken at a meeting of the General Body.3. Initially an affidavit in reply was filed on behalf of the First Respondent on 6 August 2012. Among other things, an objection to the maintainability of the Petition was raised on the ground that the First Respondent is not State within the meaning of Article 12 of the Constitution. The First Respondent stated that the Scheme Information Document of the SBI One India Fund made it clear that returns under the Fund were not guaranteed or assured and that equity instruments carry market risks. In the present case, it was stated that the scheme was an open ended diversified equity scheme with 70 to 100 percent of asset allocation under equities and equity related instruments including derivatives which made the scheme more prone to risk as compared to a debt scheme. The First Respondent stated that in pursuance of an application submitted to SEBI for the merger of the scheme with the Magnum Equity Fund, an approval was received on 20 June 2012. The Magnum Equity Fund is stated to be a large cap diversified equity fund and considering the growth potential of Indian large caps coupled with the capacity of the fund to deliver consistent long term performance, the merger is stated to be in the interest of investors.4. By an order dated 8 August 2012, this Court directed impleadment of SEBI as a party to these proceedings. Moreover, there was a direction that a further affidavit be filed on the following issues which were raised in the order of the Court:(i) The extent of mobilization of funds for the One India Fund since its inception;(ii) An assessment by the Respondent of the reasons why the fund did not result in returns;(iii) The internal oversight machinery, if any, that is provided by the Respondent in respect of the decisions taken by the fund manager in regard to investments;(iv) The rationale for the proposed merger of the One India Fund with Magnum Equity Fund; and(v) The basis on which the swap ratio for the merger was arrived at.This was without prejudice to the contention of the First Respondent with reference to Article 12 of the Constitution. Following the directions of the Court, a formal impleadment of SEBI has remained to be carried out by the Petitioner in person which will be done during the course of the day. An affidavit in reply has been filed by the First Respondent as directed. SEBI has filed its own affidavit as well.5. We have heard the Petitioner in person as well as Counsel appearing on behalf of the Respondents.6. Under Section 12 of the Securities and Exchange Board of India Act, 1992 and Regulation 3 of the SEBI (Mutual Funds) Regulations, 1996, every mutual fund is required to be registered with SEBI, which regulates the market in securities before funds can be collected from investors. A mutual fund scheme envisages the pooling of resources of investors to whom units are issued of securities in accordance with the objectives as disclosed in the offer document. Mutual Fund Schemes typically invest in debt equity and other instruments. As the affidavit filed by SEBI states that before the Court, a mutual fund in India comprises of four constituents: (i) Sponsor; (ii) Board of Trustees or Trustee Company; (iii) the Asset Management Company (AMC); and (iv) the Custodian. The Trust is established by a sponsor who is in the position of a promoter, while the trustees hold the property in trust for the benefit of unit holders. A SEBI approved Asset Management Company manages the fund by making investments in securities. A Custodian, who is registered with SEBI, holds securities of various schemes of the fund in his custody. The trustees are vested with a general power of superintendence over the Asset Management Company and monitor the performance of the fund. The sponsor, who is the settlor of the trust, is required to contribute at least 40% of the capital of the Asset Management Company which is formed for managing the assets of the trust. The assets of the trust comprise assets of the schemes which are floated by the Asset Management Company with the approval of the trustees. Mutual Fund Schemes may be open ended or closed ended or they may have a particular investment focus of portfolio composition. The Net Asset Value (NAV) of the scheme is the market value of the securities held by the scheme. The NAV per unit represents the market value of securities divided by the total number of units of the scheme on any particular date. Under Regulation 30(1) of the Mutual Fund Regulations, advertisements in respect of every scheme have to be in conformity with the Advertisement Code specified in the Sixth Schedule. Among conditions in the Schedule, is a stipulation containing a caution that mutual fund investments are subject to market risks. The trustees and the Asset Management Company have specified obligations in respect of the mutual fund. The trustees, who hold the property of the mutual fund in Trust for unit holders, have wide ranging responsibilities, including ensuring that systems are in place prior to the launch of schemes, ensuring that associates are not dealt with in a manner detrimental to the interests of investors, ensuring that the investors grievances are duly redressed by the AMC and that the activities of the AMC are in accordance with the Regulations. The AMC as investment manager is under an obligation to ensure that investment of funds pertaining to any scheme is not contrary to the provisions of the Regulations and the Trust Deed. The Mutual Fund Regulations inter alia stipulate a requirement of at least fifty percent of directors being independent and of the directors having sufficient professional experience.7. SEBI has stated that the affairs of the mutual fund are monitored at two levels. Initial monitoring is done by the trustees through the process of periodic reporting of the AMC. A meeting of the trustees is required to be held at least once in two months and at least six meetings are required to be held in a year. SEBI also monitors the activities of an AMC both onsite and offsite. SEBI appoints auditors for periodic inspections of the mutual fund. SEBI mandates the submission of Compliance Test Reports bi-monthly, submission of accounts half yearly and annually by the AMC and half yearly Trustee Reports by the trustees. The Regulations stipulate that the mutual fund schemes should be managed/operated in the interests of all classes of unit holders and not in the interest of specific classes. The affidavit filed by SEBI describes the measures which have been built into the Regulations to ensure that a potential conflict of interest between the AMC/Sponsor and its associates is avoided :i. The AMC is not allowed to invest in any of its schemes unless full disclosure of its intention to invest has been made in the offer documents. Further, an AMC shall not be entitled to charge any fees on such investments in its schemes.ii. The AMC is restricted from investing in listed securities issued by group companies (associates) of the sponsor of the Mutual Fund beyond 25% of the net assets of the scheme.iii. The AMC is not allowed to invest in unlisted securities or securities issued on private placement basis by group companies (associates) of the sponsor.iv. Any broking entity which is associated with the sponsor cannot do business for the AMC for more than 5% of the total transactions done by the AMC for all the schemes of the Mutual Fund during a quarter.v. An entity cannot act as a custodian of the Mutual Fund if the sponsor of its associates hold 50% or more of voting rights of custodian or where 50% or more of directors on the custodian represent the interests of sponsor/associate.vi. If the AMC utilizes the services of an in-house registrar, then the trustees of the mutual fund have to ensure that the rates being paid to the in-house Registrar are competitive.vii. The AMC can use the services of its associates for selling and marketing of the units of its schemes subject to disclosures in the half yearly financial results and the abridged scheme-wise annual report.viii. Associate directors shall not constitute more than 50% of the Board of Directors of the AMC and not more than 1/3rd of the Board of Trustees/Trustee Company.The Regulations also stipulate that the controlling interest of the AMC cannot be altered until prior approval of trustees and SEBI is obtained and a written communication about a proposed change is sent to each unit holder, besides which a publication of an advertisement in a national newspaper is mandatory. Unit holders are also furnished with an option to exit on the prevailing Net Asset Value without any exit load. Similarly, no alteration in the fundamental attributes of any scheme is permissible without a written communication of a proposed change to each unit holder and without an option being furnished for exiting from the scheme on the prevailing NAV without the exit load.8. Under the regulatory regime, a mut ual fund is permitted to declare dividends subject to SEBI Guidelines. The Regulations specify prudential norms for investments by mutual funds in Schedule Seven which includes limits for investments in rated and unrated debt instruments issued by a single issuer and limits for total investment in unrated debt instruments, limits for investments in a single company and limits for investments in unlisted companies.9. The First Respondent which is a Private Limited Company is registered as an Asset Management Company under the SEBI (Mutual Funds) Regulations, 1996 since December 1993. SBI holds 67% shares of the First Respondent. Government of India holds 61.58% shares in SBI. The scheme information document pertaining to the SBI One India Fund contains a specific disclosure of the fact that returns under the scheme were not guaranteed or assured since equity instruments are subject to market risks. One India Fund was an open ended diversified equity scheme with seventy to a hundred percent asset allocation under equities and equity related instruments including derivatives. The First Respondent is a joint venture between SBI and the subsidiary of a French Company. Since the launch of the SBI One India Fund Scheme in 2007, an amount of Rs. 1846.88 crores has been mobilised. The affidavit filed by the First Respondent states before the Court that the scheme was benchmarked against the BSE 200 Index and the scheme therefore, postulates an investment in a varied mix of Companies. The First Respondent has stated in the affidavit that the period of initial deployment of the funds of the scheme coincided with a sharp rally in the equities market, namely, the last leg of the previous market rally of 2003- 2007. Between March and December 2007 though the scheme delivered absolute returns of over 30%, it is stated to have underperformed the benchmark (BSE 200) as funds were deployed during the period of sharp rally in the market. However, as on 31 July 2012 in one year, two year and three year performance, the scheme is stated to have outperformed the bench mark by 4.2%., 0.5 % and 2% (annualised) respectively. The First Respondent has stated that the reason why the scheme could not make profits was that during the period, stock markets remained range bound and shares in the BSE 200 component did not move up substantially. The scheme, it has been submitted, did not declare dividend as the mandate was to invest in equity markets, which have not delivered meaningful returns in the previous five years. The NAV of the Scheme in the dividend option as at the end of each financial year from launch until the date of merger is stated to be as follows :DateNAV (Rs.)August 10, 201210.43March 31, 201110.84March 31, 201010.69March 31, 20095.47March 31, 20089.9March 30, 20079.94As regards the internal oversight machinery provided by the First Respondent in regard to the investment decisions of the fund manager, the affidavit has explained in detail the processes and systems which have been put into place. This includes the formation of broad based investment committees which conduct a periodical review of portfolio holding, articulate the investment strategy and oversee the risk management system. A Committee led by the Chief Risk officer monitors activities independently for risk management. The First Respondent has a Risk Management Committee Board headed by an independent director on the Board of Directors which supervises risk management activities.10. As regards the decision to merge the One India Fund with the Magnum Equity Fund, it has been stated that this was intended to improve the performance of the scheme which was below expectation. The Magnum Equity Fund is a large cap diversified equity fund and considering the growth potential and the capacity of the fund to deliver consistent long term performance, it has been stated that the merger would be in the interests of investors. The allotment of units was to take place on the basis of the NAV on 10 August 2012 which is the date of merger. The units allotted in the Magnum Equity Fund were based on an amount equal to the value of the units in the SBI One India Fund, on the date of merger. Investors holding units in the growth option were allotted units in the growth option in the transferee fund. Similarly, investors holding units in the dividend option were allotted units of the dividend option in the transferee fund. The swap ratio has been computed as the proportion between the NAV of the SBI One India Fund Scheme and the NAV of the SBI Magnum Equity Fund as of 10 August 2012. The NAV of the SBI One India Fund on the date of merger was Rs.10.43. The NAV of the SBI Magnum Equity Fund (Growth Option) on the date of merger was Rs.42.97 resulting in a swap ratio of 0.243 units. The NAV of the dividend option in the SBI Magnum Equity Fund on the date of merger was Rs.28.87 resulting in a swap ratio of 0.361 units.11. We have carefully considered the disclosures which have been made on affidavit both by SEBI and by the First Respondent. We have made a reference to those disclosures in a considerable degree of detail since the Petitioner, who appears in person, has articulated his line of enquiry in these proceedings bona fide and with a considerable amount of painstaking research. The issue raised related to the well being of investors and accountability towards their needs and concerns. Regulatory mechanisms must provide for accountability, responsiveness and transparency. SEBI has put into place Regulations which regulate the activities of mutual funds. The Regulations contain specific provisions that are designed to ensure that trustees and AMCs conduct their activities in a manner which would not be detrimental to and would protect the interests of investors. In the present case, there is nothing on the record whatsoever that would lead to the inference that there was lapse on the part of SEBI in ensuring that its regulatory regime is duly complied with. In so far as the First Respondent is concerned, it is evident that the One India Fund Scheme was an open ended diversified scheme. By its very nature, a Mutual Fund scheme whose object is the investment of funds in the equity market is subject to market risks that are associated with equity investments. The highlights of the scheme as disclosed in the scheme information document in fact indicated that between 70 to 100% of the net assets would be in the form of equity and equity related investments including derivatives with a high risk profile. The table which has been extracted earlier would indicate that the NAV of the One India Fund Scheme varied between Rs.5.47 on 31 March 2009 and Rs.10.84 on 31 March 2011. The returns of an investor would, therefore, of necessity depend upon the timing of the investment. For instance, investors when the NAV had fallen to a level as low as Rs.5.47 on 31 March 2009would stand to sustain a fair rate of appreciation of the investment as compared to investors who invested at the relatively higher NAV of Rs.10.84 on 31 March 2011.12. On this state of the record, it would not be appropriate for this Court to issue directions of the nature that are sought in these proceedings. The scheme for the merger of the One India Fund with the Magnum Equity Fund has received the approval of SEBI. The approval which has been granted by SEBI is not demonstrated to be based on extraneous considerations or without due application of mind to the relevant statutory requirements. A meeting of all the investors of the One India Fund Scheme is not mandated. The decision has been explained to be in the interests of depositors. In any event, consistent with the regulations any investor who did not desire the conversion of his investment to the Magnum Equity Fund was at liberty to exit from the scheme on the prevailing NAV without an exit load. In these circumstances, we find no reason or justification to order an independent outside audit. The requirements of audit are already in place under the regulations which have been made by SEBI. Finally, it will not be permissible for the Court to direct that the investment made by the Petitioner in the amount of Rs.2 lakhs should be returned with interest as payable on a fixed deposit of a nationalized bank. Fixed deposits of nationalized banks do not bear the risks associated with an investment in an equity based mutual fund scheme. But that is the very reason why the returns on fixed deposits, though stable, offer a much lower return than what an equity based mutual fund investment may provide. An investor in an equity based mutual fund scheme is conscious of the fact that the returns are liable to vary and that in a given case where the market has underperformed, as during the period here, returns may not be forthcoming. We, therefore, do not consider that the prayer for relief would be maintainable.13. In the view which we have taken, it is not necessary to render a conclusive finding on whether the First Respondent is state for the purposes of Article 12.14. For these reasons and having considered the matter in all its perspectives, we do not find any case for interference under Article 226 of the Constitution.

Decision:
0[ds]11. We have carefully considered the disclosures which have been made on affidavit both by SEBI and by the First Respondent. We have made a reference to those disclosures in a considerable degree of detail since the Petitioner, who appears in person, has articulated his line of enquiry in these proceedings bona fide and with a considerable amount of painstaking research. The issue raised related to the well being of investors and accountability towards their needs and concerns. Regulatory mechanisms must provide for accountability, responsiveness and transparency. SEBI has put into place Regulations which regulate the activities of mutual funds. The Regulations contain specific provisions that are designed to ensure that trustees and AMCs conduct their activities in a manner which would not be detrimental to and would protect the interests of investors. In the present case, there is nothing on the record whatsoever that would lead to the inference that there was lapse on the part of SEBI in ensuring that its regulatory regime is duly complied with. In so far as the First Respondent is concerned, it is evident that the One India Fund Scheme was an open ended diversified scheme. By its very nature, a Mutual Fund scheme whose object is the investment of funds in the equity market is subject to market risks that are associated with equity investments. The highlights of the scheme as disclosed in the scheme information document in fact indicated that between 70 to 100% of the net assets would be in the form of equity and equity related investments including derivatives with a high risk profile. The table which has been extracted earlier would indicate that the NAV of the One India Fund Scheme varied between Rs.5.47 on 31 March 2009 and Rs.10.84 on 31 March 2011. The returns of an investor would, therefore, of necessity depend upon the timing of the investment. For instance, investors when the NAV had fallen to a level as low as Rs.5.47 on 31 March 2009would stand to sustain a fair rate of appreciation of the investment as compared to investors who invested at the relatively higher NAV of Rs.10.84 on 31 March 2011.12. On this state of the record, it would not be appropriate for this Court to issue directions of the nature that are sought in these proceedings. The scheme for the merger of the One India Fund with the Magnum Equity Fund has received the approval of SEBI. The approval which has been granted by SEBI is not demonstrated to be based on extraneous considerations or without due application of mind to the relevant statutory requirements. A meeting of all the investors of the One India Fund Scheme is not mandated. The decision has been explained to be in the interests of depositors. In any event, consistent with the regulations any investor who did not desire the conversion of his investment to the Magnum Equity Fund was at liberty to exit from the scheme on the prevailing NAV without an exit load. In these circumstances, we find no reason or justification to order an independent outside audit. The requirements of audit are already in place under the regulations which have been made by SEBI. Finally, it will not be permissible for the Court to direct that the investment made by the Petitioner in the amount of Rs.2 lakhs should be returned with interest as payable on a fixed deposit of a nationalized bank. Fixed deposits of nationalized banks do not bear the risks associated with an investment in an equity based mutual fund scheme. But that is the very reason why the returns on fixed deposits, though stable, offer a much lower return than what an equity based mutual fund investment may provide. An investor in an equity based mutual fund scheme is conscious of the fact that the returns are liable to vary and that in a given case where the market has underperformed, as during the period here, returns may not be forthcoming. We, therefore, do not consider that the prayer for relief would be maintainable.13. In the view which we have taken, it is not necessary to render a conclusive finding on whether the First Respondent is state for the purposes of Article 12.14. For these reasons and having considered the matter in all its perspectives, we do not find any case for interference under Article 226 of the Constitution.