In the previous article we have seen the broad patterns of structural organisations of MFs, as trusts and as corporate entitles obtaining internationally, and how Mutual Funds in India initially the Unit Trust of India and subsequently the Mutual Funds of Nationalised Baniks were set up.

Considering the inherent fiduciary nature of the functions, arm's length relationships were sought to be built into the various constituents of a mutual fund, primarily through separate entities and delineating the role and responsibility of the asset management companies and the Trustees and regulations on affiliate transactions. Arm's length relationships were also expected to be achieved by requiring a certain proportion of Trustees to be independent of the sponsor, requiring independent directors on the board of the AMC and requiring an independent custodian to be appointed.

Following the notification of the SEBI (Mutual Funds), Regulations, 1993, SEBI gained further experience in administering the Mutual Funds Regulations and regulating the mutual fund industry. SEBI, based on the discussions held with the representatives of AMFI (Association of Mutual Funds of India) and in light of the regulatory experience gained prepared the "Mutual Funds 2000" Report which recommended certain changes in the Regulations. The revised Regulations of 1996 also sought to address the concerns expressed in various quarters regarding the functioning of the mutual funds and effectiveness of the Board of Directors of the AMC, the role of independent directors and also sought to impose further checks and balances on the board of directors of the AMC under the overall supervision of the Trustees and additional obligations on the Trustees. The genesis of these obligations lies in the principle that Trustees of a mutual fund are the first level regulators. The Regulations have laid great emphasis on strengthening the Trusteeship function by providing specific responsibilities on the Trustees and conferring greater powers to the Board of Trustees for improving the governance of the mutual funds. It has sought to enhance the level of supervision over the functioning of the funds and asset management companies by the Trustees inter alia by stipulating periodical review of the activities of the AMC by the Trustees, reporting by the AMC to the Trustees and by the Trustees to SEBI.

The additional obligations cast on the Trustees by the SEBI (Mutual Funds) Regulations, 1996 are;

1. calling for a Report from the compliance department of AMC periodically;

2. calling for information from the AMC to satisfy itself that the AMC has not given any undue or unfair advantage to any affiliates, dealt with any of the affiliates of the AMC in any manner detrimental to the investors and not provided for in the Regulations;

3. reviewing all transactions with affiliates and payments made by the mutual fund to affiliates periodically;

4. calling from the AMC the information on the procedure for empanelment of brokers and satisfying itself that the AMC has taken adequate care in the choice of brokers, in monitoring and following up of transactions with brokers and avoiding undue concentration of business with brokers;

5. reviewing all service contracts such as custody arrangements or transfer agency of the securities periodically;

6. reviewing the investor grievances redressal mechanism periodically;

7. filing their own transaction details in securities on half yearly basis with SEBI;

8. calling for similar details in respect of the board of directors and key personnel of the AMC;

9. furnishing to SEBI a certificate on a half yearly basis stating that the Board of Trustees has examined these statements and has satisfied itself that there has been no instance of self dealing or front running by any of the directors of the Trustee company and the AMC, employees of the AMC and the Trustee company.

A Conference of Chairman/Sponsors of the Board of Trustees of Mutual Funds was convened by SEBI in February, 1997. This was to take note of the provisions/changes introduced through the SEBI (Mutual Funds) Regulations, 1996. At this conference, serious concern and reservations were expressed by various Trustees in regard to the liability and exposure of the trustees under the newly amended regulations and the expectations of SEBI about the role of the trustees. Particular concern was expressed about the lack of infrastructure support available with the trustees and its inconsistency with the nature of performance now expected from them. The arrangements under which trustees were currently functioning were not of a nature that would enable them to discharge any of these heavy responsibilities. Fears were also expressed that they might even discourage persons with experience and of eminence from accepting such responsibilities. The Regulations require trustees to be persons of experience. The Regulations also require trustees to be persons of ability, integrity and standing. The expectation was that the association of such trustees would lend credibility to the Mutual Funds. At the Conference, it was pointed out that this imbalance needed to be carefully studied so that trustees are placed in a position to discharge the responsibilities and functions expected of them and are also simultaneously provided with infra-structure support and a working regime which enabled them to play an appropriate role in the Mutual Funds Industry. There should neither be over-expectation from an imperfect and imbalanced system nor any lowering of the role they are expected to play as monitors in the first instance.

Taking note of these observations, SEBI constituted a Committee under the Chairmanship of Mr.P.K.Kaul to recommend a work pattern which would enable discharging of responsibilities by the trustees as envisaged under the Scheme and the Regulations.

The terms of reference of the Committee were :

1. to work out a model management information system particularly at asset management company (AMC) and Trustee levels as also the Reporting systems to SEBI;

2. to recommend necessary clarification regarding the manner of compliance of some of the provisions of the Regulations;

3. to look into the feasibility of organising mutual funds alternatively as companies and the applicability of the Indian Trusts Act vis-a-vis Trustees.

The Committee held several meetings and deliberated on all the provisions relevant to the role and responsibilities and liabilities of the Trustees under the Regulations and the Indian Trust Act and on the issues which came up before SEBI in the course of administration of the Regulations. The Committee had the opportunity of discussing the principles and practices and the regulatory framework governing the role of Trustees and independent directors of investment companies with particular reference to the mutual fund industry in the US. The Committee noted that in the US , the role of the board of directors of the investment company was central to policing the conflicts of interest inherent in the structure of mutual funds. As the mutual funds collect moneys from the public, the Committee acknowledged that the Trustees need to play the role of an "internal watch dog" in protecting the interests of the unit holders.

The Committee was seized with the task of allaying the concerns of Trustees in regard to the true scope of he Regulations while at the same time ensuring the due role of Trustees in exercising checks and balances. The mutual funds in India, barring the Unit Trust of India were governed by the Indian Trusts Act and constituents of the Mutual Fund were as under :

1. The sponsor who establishes a Mutual Fund under a duly registered instrument of trust.

2. The Asset Management Company constituted as a company under the Companies Act entrusted with the management of the funds of the Mutual Fund, and

3. The Trustees who hold the property of the Mutual Fund in trust and supervise the functions of AMC for the benefit of the unit holders, could either be a set of individuals forming a Board of Trustees or constituted as a Trustee Company under the Companies Act.

4. The Custodian who carries out custodial services for the Mutual Fund.

The rights, duties and obligations of Trustees under the Indian Trusts Act are well recognised and well settled by a law which is in force for over a century. The Trustees are expected to discharge their duties as men of prudence with reasonable care, skill and diligence in respect of property entrusted to them as they would bestow upon their own property. There are stringent consequences for dereliction of duty and breach of trust. Given the savings of large sections of the public which in turn requires the entrustment of management of those funds to an AMC, it would throw up a whole set of complications and issues. The position is further compounded by detailed regulations as under regulation 18 with 23 sub-regulations stipulating rights and obligations of the Trustees. Again, many of the Trustees are organised as trustee companies and therefore the individuals are on the Board of Directors of the Trustee Company whose conduct is regulated under the Companies Act. The inter-action and inter-play of the Indian Trusts Act, the Companies Act and the SEBI Regulations, 1996, creates great apprehension in the minds of Trustees.

Similarly, the role of the AMC is akin to that of Managers or Managing Agents. A role of this nature is hardly visualised under the Indian Trusts Act where the basic thrust is obligation attaching to ownership of property and arising out of confidence reposed in the Trustees for the benefit of the beneficiaries. The Trust Act, therefore, does not adequately deal with management of trust property in the nature of a Mutual Fund.

In the same way, the sponsor who establishes Mutual Fund is similar to the author of a Trust. However, the author of a trust has a very limited role to play after settling a trust. But that is not the case in relation to the sponsor of a Mutual Fund who has a continuing interest in the Mutual Fund and whose credibility is significantly responsible for mobilising of savings of the public in a Mutual Fund.

It is seen on a broad overview of the 1996 Regulations that the rights, duties and obligations of all these constituents of a Mutual Fund need further codification. It is clear that the Regulations visualise that there are basic requirements before a person can be a sponsor of the Mutual Fund. To quote, the sponsor should have a sound track record and general reputation of fairness and integrity in all his business transactions. There are similar threshold expectations in respect of the Trustees and Asset Management Company and Custodian. It would, therefore, be eminently desirable that all these matters are codified under a single statute under which Mutual Funds can be constituted as corporate bodies. This will ensure establishing Mutual Funds on a permanent basis like companies and enable the law to clearly and unequivocally set out the rights, duties and obligations of the various constituents. On enactment of such a law as an Act of Parliament, the various constituents would clearly be aware of their rights, duties and obligations and likewise the unit-holders and regulatory authorities would also know what can be expected of the various constituents. There would also be progressive evolution of practice of accountability, disclosures and governance as in the case of corporate entities. Pending the enactment of the separate statute there is need to selectively modify the 1996 regulations to address the various concerns that were expressed by Trustees to SEBI.

The Report of the Committee is presented in two parts during May 1998. The first part outlines the structure of the Mutual Funds as envisaged under the SEBI (Mutual Funds) Regulations, 1996. The specific obligations of Trustees under the Regulations, provisions of the Indian Trusts Act and the international experience are given in the second part. Annexure1 to the Report is a compilation of the role of the sponsor, obligations of the AMC and the responsibilities of the Trustees as provided in the Regulations. Annexure 2 discusses the suggested manner of discharging the obligations by the Trustees. Annexure 3 contains the model of the MIS checklist that may be furnished by AMC to the Trustees. Annexure 4 is a model reporting format of report to be furnished by the Trustees to SEBI.

The recommendations of the Committee are given in the next two articles. The recommendations were incorporated in the SEBI (Mutual Fund) Regulations 1996 through amendments carried out in the year 1998. However the corporatisation of Mutual funds though a single enactment is to be done by the Government and the matter is still pending. In the decades to come the mutual fund Industry is bound grow enormously rivaling the Banking and Insurance set up. The need for such a legislation is sure to become more pressing in the days to come