Introduction, Constitution & Management of Mutual Funds - Financial Markets and Institutions | Financial Markets and Institutions - B Com PDF Download

Definition of 'Mutual Fund'

Definition: A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.

Description: As an investor, you can buy mutual fund 'units', which basically represent your share of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund's current net asset value (NAV). These NAVs keep fluctuating, according to the fund's holdings. So, each investor participates proportionally in the gain or loss of the fund.

All the mutual funds are registered with SEBI. They function within the provisions of strict regulation created to protect the interests of the investor.

The biggest advantage of investing through a mutual fund is that it gives small investors access to professionally-managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult to create with a small amount of capital.

The Constitution and Management of Mutual Funds in India!

In India mutual funds are organized in trust form. The instrument of trust has to be in the form of a deed, duly registered under the provisions of the Indian Registration Act, 1908 executed by the sponsor in favour of the trustees named in such an instru­ment. Trust is a notional entity. It cannot enter into a contract in its own name. It enters into a contract in the name of its trustees.

Two organizational choices were available to setup the mutual funds as trusts. The first was to establish a board of trustees. The members of the board were individual trustees. The other was to set up a company that would function as a trustee company. The company had a board consisting of individual directors.

There were differences in these two organizational forms in respect of individual and collective liabilities of the trustees. Many private sector sponsors preferred the trustee company structure to the board of trustee as the former had some advantages.

The Indian Trusts Act, 1882 prohibits the limiting or extinguishing the obligations and liabilities of the trustees. It further prohibits indemnifying the trustees for the loss or damages faced by the investments.

If the trust is formed as a board of trustees, the liabilities of the individuals become more onerous. Clearly, the liability of the indi­vidual directors in a trustee company (formed under the Companies Act, 1956) could be limited.

It was noticed that many companies refused registration of investments made by mutual funds in the company shares taking advantage of section 158 of the Companies Act, 1956. Setting up a trust company circumvented this difficulty faced by the mutual funds.

The rights of the investors vis-a-vis the trustees were different in these two structures. While a shareholder had control over the board of directors of a trustee company, a unit holder did not have significant control on the board of trustees.

Who Appoints the Trustees?

The fund sponsor will form the trust and appoints a board of trustees. As per the regulations, for a person to qualify as a sponsor, he must contribute at least 40 per cent of the net worth of the asset management company (AMC) and posses a sound finan­cial record over five years period prior to registration.

Who can become trustees?

a. A person of ability, integrity and standing; and

b. Who has not been found guilty of moral turpitude; and

c. Who has not been convicted of any economic offence or violation of any securities laws; and

d. Who has furnished the particulars required under regulation?

An asset management company or any of its officers or employees are not eligible to act as a trustee of any mutual fund. Further, no person who is appointed as a trustee of a mutual fund can be appointed as a trustee of any other mutual fund unless such a person is an independent trustee and he/she has taken prior approval of the mutual fund of which he is a trustee.

Like Investment Company Act, 1940, SEBI (Mutual Funds) Regulations has also made the provision for independent trustees. Two thirds of the trustees shall be independent persons. They shall not be associated with the sponsors in any manner.

Rights and Obligations of the Trustees:

The trustees are accountable for the funds and property of the respective schemes. They should hold the same in trust for the benefit of the unit holders in accordance with SEBI regulations and the provisions of trust deed. The trustees should take steps to ensure that the transactions of the mutual fund are in accordance with the provisions of the trust deed.

Other than this the regulation details the rights and obligations of trustees:

i. The trustees enter into an investment management agreement with the asset management company.

ii. The trustees shall have a right to obtain from the asset management company such information as is considered necessary by the trustees.

The trustees shall ensure before the launch of any scheme that the asset management company has:

a. Systems in place for its back office, dealing room and accounting; appointed all key personnel including fund manager(s) for the scheme(s);

b. Appointed auditors to audit its accounts;

c. Appointed a compliance officer who is responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines instructions etc. issued by SEBI or the Central Government and for redressed of investors’ grievances;

d. Appointed registrars and laid down parameters for their supervision;

e. Prepared a compliance manual and designed internal control mechanisms including internal audit systems;

f. Specified norms for empanelment of brokers and marketing agents.

Trustees watch that the AMC Acts in the Interest of the Unit holders:

a. The trustees shall ensure that an asset management company has been diligent in empanelling the brokers in monitoring securities transactions with brokers and avoiding undue concentration of business with any broker.

b. The trustees shall ensure that the asset management company has not given any undue or unfair advantage to any associates or dealt with any of the associates of the asset management company in any manner detrimental to interest of the unit holders.

c. The trustees shall ensure that the transactions entered into by the asset management company are in accordance with these regulations and the scheme.

d. The trustees shall ensure that the asset management company has been managing the mutual fund schemes independently of other activities and have taken adequate steps to ensure that the interest of investors of one scheme are not being compromised with those of any other scheme or of other activities of the asset management company.

e. The trustees shall ensure that all the activities of the asset management company are in accordance with the provisions of these regulations.

f. Where the trustees have reason to believe that the conduct of business of the mutual fund is not in accordance with these regulations and the scheme, they shall forthwith take such remedial steps as are necessary by them and shall immediately inform SEBI of the violation and the action taken by them.

g. Each trustee shall file the details of his transactions of dealing in securities with the mutual fund on a quarterly basis.

h. The trustees shall be responsible for the calculation of any income due to be paid to the mutual fund and also of any income received in the mutual fund for the holders of the units of any scheme in accordance with these regulations and the trust deed.

The trustees shall obtain the consent of the unit holders:

a. Whenever required to do so by SEBI in the interest of the unit-holders; or

b. Whenever required to do so on the requisition made by three-fourths of the unit holders of any scheme; or

c. When the majority of the trustees decide to wind up or prematurely redeem the units.

The trustees shall ensure that no change in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change which would modify the scheme and affect the interest of unit holders shall be carried out unless,—

i. A written communication about the proposed change is sent to each unit holder and an advertisement is given in one English daily newspaper having nationwide circulation as well as in a newspaper published in the language of the region where the head office of the mutual fund is situated; and

ii. The unit holders are given an option to exit at the prevailing Net Asset Value without any exit load.

Regular Monitoring:

a. The trustees shall call for the details of transactions in securities by the key personnel of the asset management company in his own name or on behalf of the asset management company and shall report to SEBI, as and when required.

b. The trustees shall quarterly review all transactions carried out between the mutual funds, asset Management Company and its associates.

c. The trustees shall [quarterly] review the net worth of the asset management company and in case of any shortfall ensure that the asset management company makes up for the shortfall.

Unit holders Grievances:

a. The trustees shall periodically review all service contracts such as custody arrangements, transfer agency of the securities and satisfy it that such contracts are executed in the interest of the unit holders.

b. The trustees shall ensure that there is no conflict of interest between the manner of deployment of its net worth by the asset management company and the interest of the unit holders.

c. The trustees shall periodically review the investor complaints received and the redressed of the same by the asset management company.

d. The trustees shall abide by the Code of Conduct as specified in the regulations.

Reporting to SEBI:

The trustees shall furnish to SEBI on a half yearly basis, –

i. A report on the activities of the mutual fund;

ii. A certificate stating that the trustees have satisfied themselves 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;

iii. A certificate to the effect that the asset management company has been managing the schemes independently of any other activities.