Securities Exchange Board of India (SEBI): G. Mahalingam (Whole Time Member) held that while directors are not prohibited from trading in units of the schemes managed by the Asset Management Company, they should ensure that such trading conforms to ethical and moral standards and legal norms expected to be complied by a person entrusted with quasi-fiduciary responsibilities.
Unfair trade Practice or Fraudulent?
Whether the redemption of units in some schemes of a mutual fund by a director of the Asset Management Company of the Mutual Fund and his immediate family, at a time when the said schemes were facing significant redemption pressure (schemes were later wound up) and the director was allegedly in possession of material non-public information relating to the same, would fall within the scope of ‘fraudulent’ or ‘unfair trade practice’ as defined under SEBI(Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003.
Background
Franklin Templeton Mutual Fund (FT-MF) is s SEBI registered mutual fund. Franklin Templeton Asset Management Company Ltd. (“FT–AMC”) is the Asset Management Company and Franklin Templeton Trustee Services Pvt. Ltd. (“Trustees”) acts as the Trustee of FT–MF.
Vide notice dated 23-04-2020, Trustees informed the unit holders of certain schemes of FT-MF that it was winding up the schemes in conformity with the provisions of Regulation 39(2)(a) of the SEBI (Mutual Fund) Regulations, 1996.
SEBI ordered Forensic Audit/Inspection in terms of Regulation 66 of the Mutual Fund Regulations and found that Noticee’s 1, 2 and 3 had redeemed units in the Impugned Debt Schemes during the period. In view of the same, SEBI issued a Show Cause Notice.
Analysis, Law and Decision
Insider trading Regulations
Insider Trading Regulations, when they were notified in 1992, primarily sought to prohibit ‘insiders’ connected to the issuer of the security from trading on the basis of superior information obtained during the course of their employment or association with the issuer; whereas the PFUTP Regulations covered other forms of trading done by exploiting information asymmetries by any person, even though he may not be an ‘insider’ or connected to an ‘insider’.
Board noted that Courts have recognized that certain types of trades executed on the basis of superior information would fall within the definition of ‘fraud’ under PFUTP Regulations 2003.
Laws dealing with information asymmetries (PIT Regulations and PFUTP Regulations) essentially seek to address the issues arising out of disparities in access to material information, that is otherwise not legally available to general investors, and to prevent those persons having access to such superior information from exploiting the informational advantage, in order to protect the integrity of the market and maintain investor confidence.
Bench noted that Noticee 1 could reasonably be expected to be privy to material non-public information and it was held that redemption of units was done while being in possession of material non-public information.
Board expressed that the timing of the trades is also crucial circumstantial, evidence in the present matter.
Trades by Noticee 2, who is the wife of Noticee 1, was undertaken on March 23, 2020, and March 24, 2020- i.e. the trades were done in close proximity to the dates when Noticee 1 started redeeming his investments as well as that of Noticee 3. It is further seen that on March 24, 2020, both Noticee 1, on behalf of Noticee 3, and Noticee 2 were redeeming units.
It needs to be borne in mind that Noticee 2 was also experienced finance professional in her own right. Given her experience, she was expected to be aware of the sensitivity of the transactions undertaken by Noticee 1, being a key functionary of the AMC with access to material non-public information and its implications.
Given the facts and circumstances under which Noticee 2 had redeemed the units, it leads the Bench to conclude that such redemptions were done on the basis of material non-public information Noticee 1 had in respect of the Impugned Debt Schemes.
Whether the redemptions can be considered as fraudulent trades?
SEBI held that it found it difficult to hold that redemption of units by the Noticees satisfies the parameters of ‘fraud’ as defined under regulation 2(1)(c) read with regulation 3(a) of the PFUTP Regulations 2003, also the conduct of the Noticees did not satisfy the requirements for sustaining the charge under regulation 4(2)(q) of PFUTP Regulations 2003.
Whether the redemptions can be considered as an Unfair trade practice?
‘Unfair trade practice’ is not defined under the PFUTP Regulations 2003.
Supreme Court in the decision of SEBI v. Kanaiyalal Baldevbhai Patel, (2017) 15 SCC 1 has observed that the scope of the term ‘unfair trade practise’ is wider than that of the term ‘fraud’ and activities which do not satisfy the parameters of ‘fraud’ could independently have proceeded under Regulation 4(1) if it can be considered as an ‘unfair trade practice’.
Bench expressed that the primary purpose for having laws prohibiting trading on the basis of asymmetric access to information is to foster confidence in the securities markets. Such trading by directors of a company is also a breach of the fiduciary duty as the insider effectively converted corporate information for private profits to the detriment of the other investors.
SEBI expressed that Regulations 18(25)(B)(vi) and 18(27)(vi), respectively, required the Trustees and the independent directors of the AMC/Trustee to put in place a ‘code of ethics’ which were designed to prevent fraudulent, deceptive or manipulative practices by insiders in connection with personal securities transactions. It was further noted that the AMC had formulated a Policy on Conflict of Interest.
Policy, which listed the obligations of the relevant persons, inter alia, requires employees and directors to “not [participate] in decision making in case person [is] having actual perceived or potential conflicts of interest in the transaction” and also requires them to “pro-actively report any actual perceived or potential conflicts of interest.”
Board added that Noticee 1 being a person having wide experience in securities market, it was expected that his conduct would be line with the quasi-fiduciary responsibility that a director of an AMC owed to the unitholders of the mutual fund.
On making an investment in the impugned debt schemes, Noticee 1 should have upfront declared his investments to AMC and should have sought to recuse himself from any decision related to the Impugned Debt Schemes and should have also refrained himself from accessing any non-public information relating to the schemes, material or non-material.
Therefore, the conduct of Noticee 1 in redeeming units in the Impugned Debt Schemes while in possession of material non-public information was not in line with the high ethical standards expected of a person vested with such quasi-fiduciary responsibilities and the same was also not in compliance with the ‘code of ethics’ and the ‘Conflict of Interest Policy’ of the AMC which clearly spelt out restrictions on dealing in securities while in possession of material non-public information.
Redemption of units by a director of the asset management company of a mutual fund while being privy to material non-public information cannot be considered as fair conduct.
Conclusion
Redemption of units by the Noticee 1 on his own behalf and on behalf of Noticee 3 while being privy to material non-public information was an ‘unfair trade practice’ and in contravention of Regulation 4(1) of PFUTP 2003.
Facts and circumstances and timing of the redemptions made by Noticee 2 lead to a distinct likelihood that the said redemptions were also based on material non-public information passed on by Noticee 1.
Since during the course of proceedings, Noticee 3 expired, proceedings against were abated.
However, since Noticee 1 had done the transactions on behalf of Noticee 3, the directions of disgorgement will be applicable to the corpus standing in the name of Noticee 3 also.
Directions
- Noticee 1 and Noticee 2 shall be restrained from accessing the securities market and further prohibited from buying, selling or otherwise dealing in securities, directly or indirectly, or being associated with the securities market in any manner, whatsoever, for a period of one (1) year from the date of this order. During the period of restraint, Noticee 1 and Noticee 2 shall not liquidate their existing holding of securities including the units of mutual funds.
- Noticee 1 and Noticee 2 shall jointly and severally transfer the amounts mentioned within a period of forty-five (45) days, from the date of receipt of this order. In case of failure to do so, simple interest at the rate of 12% per annum shall be applicable from the expiry of the said 45 days till the date of actual transfer;
- Noticee 1 shall be liable to pay a monetary penalty of Rs 4 crores for the redemptions undertaken on his own behalf and on behalf of Noticee 3, and Noticee 2 shall be liable to pay a monetary penalty of Rs 3 crores for the redemptions from her account, under Section 15HA of the SEBI Act, 1992;
- Noticee 1 and Noticee 2 shall pay their respective penalties within a period of forty-five (45) days, from the date of receipt of this order. In case of failure to do so, simple interest at the rate of 12% per annum shall be applicable from the expiry of the said 45 days till the date of actual payment.
[Franklin Templeton Mutual Fund, In Re., 2021 SCC OnLine SEBI 131, decided on 7-06-2021]
