Personal Website of R.Kannan - Learning Circle
Mutual Funds - Recommendations
of PK Kaul Committee

1. All information and documents relating to the compliance process should be authenticated/adopted by the Board of Directors of the AMC who are entrusted with the primary responsibility in this regard. In like manner, the Board of Directors of the Trustee Company would review all information and documents to be received from the AMC as required under the compliance process. The requirement of adoption by the Board of Directors of the AMC and the Board of Trustees/Board of Directors of the Trustee Company ensures that the sponsor's nominees on these Boards are a party to and are responsible for the compliance process. The need for this was in light of the fact that there is an unavoidable linkage between the sponsor and the mutual fund, and though the sponsor is in a position to indirectly influence the decision making of the AMC and the Trustees, it is not liable for any such decisions.(necessary provision incorporated in the regulation trough an amendment)

2. The definition of Trustee under Regulation 2(y) should be revised to read as the Board of Trustees or the Trustee Company who hold the property of the Mutual Fund in trust for the benefit of the unit holders. By defining the trustee company as a trustee, the Board of Directors of the trustee company would, in relation to their liability for acts of omission or commission be governed in like manner as Directors of companies under the Companies Act.(necessary amendment to the regulation 2(y) already carried out)

3. A comprehensive Mutual Funds statute should be enacted for governing Mutual Funds and the following provision, on the lines of Section 633 of the Companies Act could be incorporated in the proposed Act- (pending compliance)

   "633. (1)If in any proceeding for negligence, default, breach of duty, misfeasance or breach of trust against an officer of a company it appears to the Court hearing the case that he is or may be liable in respect of the negligence, default, breach of duty, misfeasance or breach of trust, but that he has acted honestly and reasonably, and that having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused, the Court may relieve him, either wholly or partly, from his liability on such terms as it may think fit :

       Provided that in a criminal proceeding under this sub-section, the Court shall have no power to grant relief from any civil liability which may attach to an officer in respect of such negligence, default, breach of duty, misfeasance or breach of trust.

   Where any such officer has reason to apprehend that any proceeding will or might be brought against him in respect of any negligence, default, breach of duty, misfeasance or breach of trust, he may apply to the High Court for relief and the High Court on such application shall have the same power to relieve him as it would have if it had been a Court before which a proceeding against that officer for negligence, default, breach of duty, misfeasance or breach of trust had been brought under sub-section (1)

   No Court shall grant any relief to any officer under sub-section (1) or sub-section (2) unless it has, by notice served in the manner specified by it, required the Registrar and such other person, if any, as it thinks necessary, to show cause why such relief should not be granted."

4. Regarding transactions of Trustees in securities, trustees will be required to file the details of their holdings as on April of that financial year at the time of becoming a Trustee of the mutual fund and thereafter change in holdings should be reported at the end of the year. Also, every month, all transactions of buy or sell for more than Rs. 1 lakh should be reported to the trust. (necessary amendment to regulation effected)

5. Regarding the manner of discharging the responsibilities cast on the Trustees under the 1996 Regulations, the Committee is of the view that :-

   1. Due diligence requirements on the part of the Trustees to help them discharge their responsibilities effectively should be laid down. General Due Diligence requirements include that the Trustees should be discerning in the appointment of the directors on the board of the AMC, should review the desirability of continuance of the AMC if substantial irregularities are noted in any of the schemes and not allow the AMC to float new schemes, arrange for test checks of service contracts and immediately report to SEBI of any special development in the mutual fund.(amendment effected)

   2. Specific Due Diligence requirements include - (all provisions incorporated)

      1. obtaining internal audit reports at regular intervals from independent auditors appointed by the Trustees (as it is the generally accepted principle that a person acting on expert advice in good faith is construed to have fulfilled his obligations, emphasis has been laid on independent audit).

      2. obtaining compliance certificates at regular intervals from the AMC. holding meeting of Trustees more frequently.

      3. considering the Reports of the independent auditor and compliance reports of AMC at the meetings of Trustees for appropriate action.

      4. maintaining records of the decisions of the Trustees at their meetings and of the minutes of the meetings.

      5. prescribing and adhering to a code of ethics by the Trustees, AMC and its personnel.

      6. communicating in writing to the AMC of the deficiencies and checking on the rectification of deficiencies.

6. The Committee is of the view that the words "take reasonable steps" may be added before the words "to ensure" , in the appropriate regulations dealing with obligations of the Trustees. Also, AMCs may adopt a uniform Management Information System and the Board of Trustees/ Trustee Company may adopt a uniform half-yearly reporting format. (since added)

7. Further it has been proposed that there should be a suitable savings clause in the Trust deed and a provision in the Regulations which should allow that if the Trustees, while carrying out their duties have acted bona-fide and in good faith, they should be deemed to have performed their duties and should be discharged from further liabilities. Additionally, Trustees who have acted in good faith and without negligence should also be protected through appropriate indemnification insurance as is the practice in the US and UK. (the said clause is provided through an amendment)

8. The one third non-rotational directors on the board of the Trustee Company should comprise independent directors only. (all provisions regarding independent directors included in the Regulation by way of amendments)

9. The frequency of the meetings of the Trustees / Board of Directors of the Trustee Company should be increased to at least once in two months. As Company Law recognises the validity of Resolutions passed by circulation vide Section 289, in line with advancement of technology, meetings through conference telecommunications should also be a permissible mode of holding such meetings.

10. The quorum for any meeting of the Board of Trustees or directors of the Trustee company should not be regarded as constituted unless there be present at least one independent Trustee/Director.

11. The minimum number of Trustees should be five and the maximum number shall be at the discretion of the mutual fund. The fraction shall be rounded off to the nearest integer.

12. The role of the independent directors is proposed to be enhanced and it is felt that they should pay specific attention to :

    1. the Investment Management Agreement and the compensation paid under the agreement

    2. service contracts with affiliates- proof that the AMC charged higher fees than outside contractors for the same services would help in establishing such liability.

    3. selecting the company's independent directors

    4. securities transactions involving affiliates to the extent such transactions are permitted.

    5. selecting and nominating individuals to fill independent directors vacancies.

    6. code of ethics which must be designed to prevent fraudulent, deceptive or manipulative practices by insiders in connection with personal securities transactions.

    7. the reasonableness of fees paid to sponsors, AMC and any others for services provided to a company.

    8. principal underwriting contracts and their renewals.

    9. any service contract between the company and the associates of the AMC.

13. A growing need has been felt for providing administrative support to the Trustees by the AMC for effective discharge of responsibilities commensurate with the work involved, by appointment of appropriate staff under a suitable hierarchy. The costs of such administration and staff would be payable out of the trustee fees that are charged to the schemes and the overall cap of recurring expenses including Trustees fees should be increased to 3%. However, the expenses excluding Trustee fees should not exceed the present cap of 2.5%.(appointment of compliance officer to ensure compliance & report to the trustees effected by way of amendment)

14. All communications to the AMC including correspondence from SEBI would also be marked to the administrative office of the Trustees. The Trustees may also independently correspond with SEBI. All reports submitted by the AMC to SEBI would have to be submitted to the administrative office of the Trustees.(Provided)

    Recommendations of the Committee proposing to enact a new legislation to provide for establishment and regulation of mutual funds are included in the next article