The Mutual Fund industry in India is not yet ready for self-regulation and must not be forced to regulate itself.
By Sucheta Dalal
For over a year now the Securities and Exchange Board of India (SEBI) has been putting enormous pressure on the Association of Mutual Funds of India (AMFI) to convert itself from an industry association to a Self Regulatory Organisation (SRO) like the stock exchanges.
In effect, SEBI wants to distance itself from the primary responsibility for regulating mutual funds by creating a buffer in between. This also means that the next time there is a big problem in the industry where a mutual fund is found to have defrauded investors on caused them losses, investors will not be able to blame the regulator directly. Instead, the regulator will join investors in pulling up AMFI – an association of mutual funds, for having failed to supervise one of its members.
Obviously, there is a huge problem with this situation. Although Self-Regulation by capital market intermediaries was a fashionable trend the U.S. in the late 1980s and early 1990s, the experiment has failed-- not only in the U.S. but all over the world.
In fact, there is a move towards tougher supervision in the new century after spate of scandals hit the New York Stock Exchange (NYSE), almost all the biggest mutual funds in the world (most have paid hundreds of million dollars in penalties) and the world’s top blue chip companies and audit firms.
In India, the mutual fund industry has always been controversial.No sooner were bank mutual funds established 1990, Canbank Mutual Fund and others were caught in the Securities Scam. Later the massive grey market in subscribing to Morgan Stanley units and its poor performance affected all foreign mutual fund.Then we saw the double-debacle of Unit Trust of India (UTI) – the most trusted of them all – in 1998 and 2000 and more recently the Samir Arora scandal.
Also, the industry has always been beleaguered by charges of Fund Managers colluding with stockbrokers in front running their investments and price ramping. These seemed to be substantiated by SEBI’s action against the high profile Sameer Arora (of Alliance Capital).
If that weren’t enough, a survey by a private research agency has shown that the Mutual Fund industry is less of an aggregator of retail savings and more of a Portfolio Manager for companies and high networth individuals.
Some Mutual Fund schemes were found to have a single investor and several others had just three or four investors. Industry sources insist that the system works in favour of high networth investors; they pay lower entry and exit loads and are often given the benefit of higher Net Asset Values (NAVs) in order to attract their business.
All this points to the need for tighter and more stringent supervision of Mutual Funds, rather than for the regulator to abdicate its responsibility. But instead of discussing the issue with investors, who are the one group that will be worst affected by the move, SEBI has been quietly pressuring AMFI to become a self-regulator.
Now consider this. The Chiefs of large Mutual Funds head all of AMFI’s committees and it is to be expected that they will head the supervisory structure in the SRO as well. Cadogan Financial Services, an international company that surveyed the Indian Mutual Fund industry on behalf of a multilateral agency, points out a major flaw in trying to turn AMFI into an SRO is conflict of interest. It says that disciplinary action against one Mutual Fund will immediately create business opportunities for rival mutual funds – and hence is unworkable.
This means that AMFI members could, hypothetically form a nice cartel that ignores most malpractices or it could gang up against newer and well performing Funds to kill their growth.Those who disagree with this hypothesis must only look at the list of mutual funds punished by SEBI, that are published in its latest annual report.
SEBI issued 35 warning letters last year, but doesn’t say to which Funds.Only two funds paid penalties after adjudication, despite all the problems mentioned earlier. Alliance Mutual Fund paid a hefty penalty of Rs 2.89 crore in the Sameer Arora case and JM Mutual Fund paid Rs 50 lakhs.
Last year (2002-03) SEBI had issued 35 deficiency letters to 21 mutual funds.
Birla Sunlife reported a Rs 10.82 crore deficit in its balances and accounts; however since the Asset Management Company paid up the money with interest, the regulator did not punish it. Those who paid a fine included Reliance, Kotak, First India, Dundee, LIC and Sriram Mutual Funds.
The year before that (2001-02) it issued 48 warning and deficiency letters to 20 Mutual Funds. The names included Tata, DSP-Merrill Lynch, Sriram, LIC, Alliance, Kothari and Escorts.
The list of names that have been penalised shows that the industry is not yet ready for self-regulation. Are any of these Funds capable of sitting in judgement of the others? Clearly not. If anything, investors need to question whether the fact that only two major mutual funds were penalised this year points to deficiency in SEBI’s supervision. Fortunately for investors, large sections of the Mutual Fund industry is well aware of the pitfalls of self regulation and has vehemently opposed the SEBI move. It is now important that mutual fund investors also raise their voice and convey to SEBI that a dangerous experiment with self-regulation is against their interest.
This articles first appeared in the Divvya Bhaskar in Gujarati