Franklin Templeton, Insider Trades And A Missing Link In Mutual Fund Regulation
Of the many allegations facing Franklin Templeton Mutual Fund, ranging from high risk strategies to mismanagement, the most egregious is the contention that its officials may have indulged in insider trading.
These are yet only claims made in news reports based on information in an unpublished forensic audit. The audit report was commissioned by SEBI late last year, months after Franklin Templeton announced that it would be winding down six debt schemes due to unviable investments in illiquid corporate debt.
The year-long saga involves multiple litigations, an unitholder vote on winding down the schemes and some repayment of dues. As more of the offending debt is sold down and investors made (close to) whole, Franklin Templeton may regain some of its lost reputation. But one stain will be difficult to erase. That some of its officials and their family members reportedly redeemed investments in the six schemes just weeks ahead of the winding up decision.
Franklin Templeton has earlier denied any insider trading took place. None of the key persons have redeemed any units post the trustees taking the in-principle decision to wind up the schemes, a spokesperson for the fund told BloombergQuint in an emailed statement. “Schemes under winding up continue to have significant investment from employees and management of Franklin Templeton. All redemption applications submitted by unitholders until April 23, 2020, were processed in the normal course of business.”
But at the time of the redemptions no public disclosure was made as no public disclosure is required to be made under the Securities and Exchange Board of India regulations.
To be sure, SEBI’s prevention of insider trading regulations do not cover mutual fund units. But trustees, asset management companies, their employees and directors are mandated to follow them.
That said, SEBI’s mutual fund regulations contain a variety of provisions to deal with conflict or wrongdoing at mutual funds. These prohibit front-running, self-dealing, and mandate disclosures at various levels, from access persons (a wider subset of key managerial people at a mutual fund/AMC), to directors, trustees and ordinary employees.
Personal Securities Transactions
There is a six-month lock-in on all investments in securities to deter trading, Nilesh Shah, chairman of industry body AMFI and managing director of Kotak Asset Management Company, pointed out. This applies to all mutual fund employees.
There are restrictions on primary market transactions and all access persons need prior approval to make a secondary market transaction. “There is a process of prior approval to deter front-running in securities. Also, the mutual fund employee cannot trade in a security for a fortnight where mutual fund has traded,” Shah said.
Trustees have to vouch every six months that there have been no instances of self-dealing or front-running by any of the trustees, directors and key personnel of the asset management company.
Independent directors of the trustees or asset management company are expected to design a code of ethics to prevent fraudulent, deceptive or manipulative practices by insiders in connection with personal securities transactions.
Mutual Fund Investments
No prior approval is needed for sale or purchase of mutual fund units by any fund employee, but disclosure is necessary. The disclosures are to be made internally and periodically filed with SEBI.
There are also curbs on sale/purchase/repurchase/redemption of any mutual fund units by any fund employee ahead of scheme action that has not yet been communicated to investors.
A SEBI circular lists five such scheme actions that trigger a closed period;
- change in the investment objectives
- likelihood of a rights and/or bonus issue
- contemplation to issue dividend
- change in accounting policy, or a significant change in the valuation of any asset
- likelihood of conversion of a close ended scheme to an open -ended scheme and vice versa
The mutual fund regulations do provide certain instances where access employees should not transact until public notice is issued in newspapers, iterated a top mutual fund official who preferred to remain unidentified.
Should Mutual Fund Insider Trades Be Disclosed?
While the extant regulations provide very wide coverage, they do not include two things.
First, and the smaller miss — recovery of a bad debt, or winding-up of a scheme are not explicitly included in the closed period events.
Second, unlike the prompt public disclosures required when insiders at listed entities buy or sell their company securities, there is no mandated public disclosure of sale/purchase of mutual fund units by fund officials (access persons/KMP).
Fund officials explain that may partly be to prevent public panic. Officials may redeem their units for a variety of personal reasons that have little to do with the fortunes of the scheme. The redemptions may be an insignificant portion of their holdings. But public reaction may be short term and adverse.
The counter to that is — it’s a risk listed entities have dealt with for years.
There’s also the argument that all scheme underlying assets are publicly disclosed and like the official or insider, any ordinary investor can invest or redeem based on that.
Well, that may work well for equity schemes, but often risks or credit events in some debt schemes are not equally understood by all investors.
All in all, these arguments may not assuage current concerns that, rare as they may be, events such as a scheme being wound up or a bad debt being recovered are known first only to fund insiders. Who may use that to their benefit. Or the benefit of their family members.
Hence, some argue that insider trades at mutual funds must be disclosed publicly and in a timely fashion, and the closed period events list should be expanded.
Kotak’s Shah acknowledged investor trust is paramount and said both disclosures and a closed period will bring additional level of transparency.
Employees of a mutual fund investing in their own fund’s schemes is prevalent globally, said A Balasubramanian, managing director and chief executive officer of Aditya Birla Sun Life AMC Ltd. While he’s more circumspect about new restrictions, he agreed that “it is worthwhile considering some regulatory framework for monitoring of investments into those funds which gets into any kind of abrupt closure for general public”.
Interestingly, across mutual funds many top officials invest in their own fund’s schemes as an expression of confidence. More restrictions may make that difficult. If each investment or redemption prompted public reaction, or their savings were locked in frequently due to closed periods, fund officials may prefer to invest elsewhere, ironically in other funds.
Disclosures are like sunshine which kills bacteria, the fund official quoted above said. He suggested a materiality threshold so that insignificant insider trades can be excluded. If the access person is withdrawing a very large part of his invested corpus, make it mandatory to inform and document the reason with the compliance offer/board of directors so it creates accountability, he said.
Enforcement not more regulation is the solution, according to securities market lawyer Sandeep Parekh. There’s no need for additional regulations to deal with situations of conflict, front running or fraud in mutual funds. The existing anti-fraud laws are catch-all, but what they catch must be backed by enforcement, he said.
A definitional change or an additional disclosure requirement would increase costs on the honest people, while allowing the crook to find a new way to do the crookedness through friends and relatives. While that is the nature of all regulation — imposing costs on the honest, while hoping to catch the dishonest, in my view imposing new obligations on mutual fund personnel is neither necessary nor truly beneficial.Sandeep Parekh, Managing Partner, FinSec Law Advisors
Yes, India has too often had a regulatory overreaction to individual bad actors. It’s not yet clear if Franklin Templeton qualifies as one. But Shah is clear. Mutual Funds manage the trust of investors.
“It is the responsibility of mutual funds to ensure that like Caesar’s wife they are above suspicion.”