CHAPTER 3

REGULATORY FRAMEWORK OF
MUTUAL FUNDS IN INDIA

CONTENTS

3.1. Introduction

3.2. Regulations for UTI Mutual Fund

3.3. Reserve Bank of India Guidelines on Mutual

Funds

3.4. Guidelines issued by Ministry of Finance,

Government of India

3.5. SEBI Regulations on Mutual Funds

3.6. Functioning of Regulatory System-A Critical
Review
3.7. Approach to Self-Regulatory Organization

References
 CHAPTER 3

REGULATORY FRAMEWORK OF MUTUAL FUNDS IN INDIA

3.1. INTRODUCTION

This chapter deals with the various guidelines and regulations issued by the Reserve
Bank of India, Government of India and SEBI so far for improving the functioning of
mutual funds in India. More specifically, this chapter aims at reviewing critically the
various regulations issued by the SEBI, their impact on mutual funds and to suggest
the areas where regulations are to be strengthened and where they have to be relaxed.

Need and Objectives of Mutual Fund Regulation

In India, there is a strong need for an effective regulation for mutual funds so that the
(Singh & Singh, 2001)1. In fact,
as compared to direct investment in equity, investors assume mutual funds as a safe
avenue for investment. So in order to provide safety to the investors about their
investment, strict regulations are required to direct the operations of mutual funds so
ted.

In fact, for any type of investment safety of the invested amount is desired. High
default risk is involved, if safety is not assured. Generally, mutual fund investments
involve high default risk as compared to other forms of investment such as bank
deposits, debentures and equity shares Bank deposits are protected by the capital
adequacy norms, debentures are secured by mortgage and equity investment is
protected by asset structure of the company. But mutual funds have no such
arrangement and, therefore, more risky. Risk may also arise because of fraud and
some other unscrupulous activities. This is because the intermediaries in the security
market are highly equipped with sophisticated infrastructure and skills. They can
easily make the investors fool using attractive offers and advertisements. Many
incidents of this type of fraud are experienced by investors in the past few years.
Hence, a strong regulatory framework becomes necessary in order to (a) provide
safety and protection to investors, (b) ensure that the mutual funds are managed for
the benefit of the investors with a fiduciary responsibility by charging a rational
67
management fee, (c) establish confidence among the investors that the funds pooled
are invested with some spelt out investment objectives and policies, (d) offer investors
adequate information, (e) formulate rules for fair valuation of investments, NAV,
repurchase price and redemption price. It may be mentioned here that protection of
investors interest was one of the basic objectives of the SEBI and also it was agreed
and pointed out by the then Prime Minister, Late Rajiv Gandhi in his budget speech
(Union Budget, 1987-88)2.
However, Gower (1986)3 suggested four methods
for the protection of rights of investors:

Regulating the modus operandi of the body in which the investor invests.
Regulating the terms of investment.
Providing full disclosure about the terms of investment.
Regulating the activities of intermediaries.

In nutshell, a strong regulatory frame work was needed to regulate the activities of the

gain their confidence and mere participation.

In India, there is multiplicity of regulations and guidelines for the regulation of mutual
funds which are issued by UTI, Government of India, Reserve Bank of India and
SEBI. However, at present the job of regulation of mutual funds is entrusted to SEBI.

3.2. REGULATIONS FOR UTI MUTUAL FUNDS

The setting up of UTI in 1964 was the real start of mutual fund industry in India. The
regulation of UTI was out of the purview of the SEBI. UTI was being regulated with
the help of provisions laid down in the U.T.I. Act, 1963. As regards to mutual fund
business, the important provisions of the UTI Act, 1963 include:

UTI will not invest more than 5% of its capital or more than 10% of the capital
outstanding of any company, though it could subscribe to bonds and
debentures without these limits.

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 The mutual funds should distribute 90% of its income from dividend and
interest and gains from sale of securities to the investors.

UTI was not under SEBI purview. It was run with its own rules and regulations.
However, a uniform set of regulations was required to look after the activities of UTI
and other mutual funds. The Narasimham Committee (1992)4 on financial sector
reform also suggested for equal set of regulations for various mutual funds including
UTI. The Vaghul Committee (1993)5 also recommended for a common set of
regulations for all mutual fund business. As a consequence, UTI was bifurcated and
UTI Mutual fund comes under the purview of SEBI.

3.3. RESERVE BANK OF INDIA GUIDELINES ON MUTUAL FUNDS

Being the controller of financial activities, the RBI issued some guidelines (RBI
Bulletin, 1987)6 in 1987 for the regulation of mutual fund activities in India.

Mutual fund should be constituted as a trust under the Indian Trust Act and at
least two outside trustees should be there.
Mutual funds should have a full time executive for its day to day management.
Every sponsor bank should contribute at least 25 lakhs.
A clear statement of objectives and policies for the fund must be laid down
and published.
Operations must be restricted to capital market instruments and mutual funds
are not to undertake direct or indirect lending, underwriting, bills discounting
and money market operations.
A management information system (MIS) should be evolved to maintain data
to submit various reports.

3.4. GUIDELINES ISSUED BY THE MINISTRY OF FINANCE,

GOVERNMENT OF INDIA.

The Ministry of Finance of the Government of India issued the first set of guidelines
in June 1990. As per these guidelines, all mutual funds will require the approval of the

69
Controller of Capital Issues and thereafter be registered with the SEBI. The
contribution of sponsoring institutions was fixed at a minimum of 2 crores to the
corpus of the fund. A mutual fund shall not invest more than 5% of its assets in the
shares of any company.

The regulations also states that one mutual fund should not invest in another mutual
fund and should not keep deposits with companies and body corporate. Further,
mutual funds should distribute 80% or more of the income earned to the unit holders.

In 1992, another set of guidelines (RBI Bulletin, 1992)7 was issued with the following
provisions:

Scope

Mutual funds which invest mainly in capital market and partly in money
market shall follow these guidelines:

(i) Exclusive investment in money market would be under the regulation of

Reserve Bank of India and investment in money market instruments of
other mutual funds would be under the regulation of the Securities and
Exchange Board of India.
(ii) Offshore funds having non-resident investors shall be outside the
jurisdiction of these guidelines.
(iii) Mutual funds dealing with assets other than securities may be outside the
purview of these guidelines.

However, all existing mutual funds should conform to these guidelines within a
period of 6 months from the date of issue of these guidelines.

Establishment

Mutual funds shall be established in the form of trusts under the Indian Trusts
Act and the business of the fund shall be started only with the authorization of
SEBI. The guidelines also provide that the companies with sound track record
and goodwill shall sponsor a mutual fund and the operation of the funds shall
be in the hand of Asset Management Companies.

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Asset Management Company (AMC)

The Securities and Exchange Board of India (SEBI) shall authorize the asset
management companies for mutual fund business. However, the AMCs should
have sound track record, general reputation and fairness in their working. The
guidelines provide that persons having good reputation and at least 10 years
professional experience in the field of portfolio management, investment
analysis, financial administration etc. shall be eligible for becoming Directors
of AMCs. Moreover, the Board of Directors of AMC should consist of at least
50% independent directors who have no connection with the sponsoring
agency.

As per the guidelines, an AMC is prohibited to act as Trustee of a Unit Trust.

The function of an AMC is only management of mutual funds and other
related activities. It is not allowed to undertake any other business activity.
Also, no person should be director of more than one AMC.

Trustees and Trust Companies

It is provided that separate trust companies should carry out the functions of
Trusteeship. However, until the establishment of such companies, existing
debenture-trustees, banks and financial institutions having sufficient repute
and experience may be permitted to act as mutual fund trustees. It is provided
that at least 50% of the Board of Trustees shall be independent who have no
connection with the sponsoring institutions. The composition of the Board of
Trustees should be intimated to the SEBI along with the eligibility of members
of the trust. It is the responsibility of the trustees to ensure that the guidelines

charges to the fund are as permitted, income due to the fund is properly
accounted for and the distributions from the fund are properly made.

Trust Deeds

The trust deed should be submitted by the sponsor to SEBI for prior approval.
The deed should include all the measures essential for protecting the interest
of investors.

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Custodian

The guidelines provide that the mutual funds shall use the custodial services
from a custodian having registered with the SEBI. However, the custodian
should be independent. He should not have any touch with the AMC.

Schemes

The guidelines provided that mutual funds should be allowed to float different
types of schemes- closed and open-end schemes subject to registration with
the SEBI. The capital limit is fixed at 20 crores for closed-end scheme ad
50 crores for open-end schemes. The guidelines further provided that the
subscription should be refunded to the investors if the minimum amount of
20 crores / or 50 crores or 60% of the amount, whichever is higher, is not
raised in case of closed-end scheme and open end scheme respectively.
Moreover, closed end schemes are required to be listed on stock exchanges.
Open-end schemes should be sold and repurchased at predetermined prices
based on Net Asset Value which is to be published at least once in a week.
Each scheme should be transacted by a responsible fund manager.

Investment Limitations

As per guidelines, mutual funds are not allowed to advance any loan for any
purpose. Funds will be invested only in transferable securities. A mutual fund

Taking together all the schemes, no mutual fund should invest more than 5%
of the corpus in the shares and debentures of any specific sector. However, in
case of sectoral mutual funds this provision shall not be applied. It is provided
that no scheme should invest in or lend to another scheme under the same
AMC. In case of transfer from one scheme to another, the guidelines provided
that the transfer should be made only at prevailing market prices, the
objectives of both the schemes should be matched. The unquoted instruments
may be transferred only with the approval of the Board of Trustees.

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Winding up

The guidelines provided that at the end of the fixed duration period of a
closed-end scheme, it should be wound up. However, the scheme should be
extended for a further duration if it is permitted by the SEBI. In case of open
end scheme, if the total number of units outstanding after repurchase falls
below 50% of the originally issued number of units, the scheme should be
wound up.

Expenses

Investment management and advisory fees shall be charged by the AMC

subject to the ceiling fixed in the guidelines : (a) 1.25% of the weekly average
net assets as long as the net assets do not exceed 100 crores, and (b) 1% of
the excess amount over 100 crores. Moreover the AMC may charge the
mutual fund various other expenses such as initial issue expenses, recurring
and transaction costs, marketing and selling expenses, brokerage, fees payable
to trustees and custodian etc. However, the initial issue expenses should be less
than 6% of the total funds raised under each scheme and all expenses should be
clearly identified and appropriately attributed to individual schemes.

Income Distribution
The guidelines provided that all mutual funds must distribute a minimum of
90% of their profits in any given year.

Rights of the Parties

The guidelines provided for the change of the AMC for various reasons. The
Trustee Company/ Board or sponsor has the right to change the AMC. Further,
the AMC may be changed if 75% of the investors in the fund want to change
it. However, in case any change of AMC is recommended by the Trustee
Company / Board or sponsor, it should be subject to scrutiny and approval of
SEBI.

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 Accounting Requirements

The guidelines provided that accounting for all the schemes should be required
to be done for the same year ending and mutual funds must calculate weekly
NAVs at the last available closing market prices.

Disclosure and Reporting

Mutual funds shall be liable to disclose and report any information to the
SEBI, if it desires so, about any scheme, AMC, custodian, sponsor, accounting
policies, marketing and advertisements and any other item thinks it fit.

In January 1993, the Government of India has issued another set of guidelines
which was more or less same as the guidelines given by the Ministry of
Finance on February 14, 1992.

As per the new guidelines, option trading, short selling or carry forward
transactions are prohibited for mutual funds. They are allowed to invest only
in transferable securities or privately placed debentures or securities debt. The
new guidelines prescribe the advertisement code, contents of trust deed and
the scheme wise balance sheet. As per guidelines, the SEBI has the right to
appoint inspectors for the inspection of mutual funds. It has also the right to
appoint an auditor for investigating the books of accounts of mutual funds.
The guidelines also empowered the SEBI to cancel registration of any mutual
fund if there is violation of the guidelines or there is any deliberate
manipulation or price rigging.

3.5. SEBI REGULATION ON MUTUAL FUNDS

The government of India entrusted the job of regulation of mutual funds to SEBI in
March 1991. Since then, the SEBI has issued several sets of guidelines and
regulations. The first set of guidelines (SEBI Guidelines, 1991)8 was issued in October
1991. The guidelines provided that AMC should be chaired by an independent person
and 50% of the Board of Trustees of the AMC should be outside directors having no
connection with the bank. They shall not be entitled to any remuneration other than

74
sitting fees. Above all, AMCs should concentrate only on the management of mutual
funds and not any other activities.

The second set of regulations {SEBI (MF) Regulations, 1993}9 was issued by the
SEBI in January 1993 for the systematic development of mutual fund industry. In
fact, nothing new was included in the new set of regulation rather earlier guidelines &
regulations were kept in practice.

The regulations of 1993 were revised in December, 1996 in order to meet the
requirements of the changing scenario in the mutual fund activities. As per the new
regulations {SEBI (MF) Regulations, 1996}10, (i) the rights and obligation of the
trustees increased. They had to ensure that the AMC was managing the fund in a
proper way, (ii) the minimum net worth of the AMC has been raised from 5 crores
to 10 crores. The minimum requirement of corpus amount for close-ended and
open-ended schemes has been withdrawn, (iii) the minimum period for listing was
extended to six months, (iv) the reissue of repurchased units in case of close ended
scheme into an open ended one were permitted, (v) mutual funds are permitted to
borrow not more than 20% of the net assets of the scheme for a period of 6 months to
meet temporary liquidity requirements, (vi) the weekly publication of NAV was made
mandatory. Earlier it was one month for open ended schemes and three months for
close-ended schemes, (vii) the repurchase price of open-ended schemes should not be
lower than 93 percent of NAV and the resale price not higher than 107 percent of
NAV. Further the difference between the repurchase price and sale price of the unit
shall not exceed 7 percent of sale price (ix) every mutual fund and AMC shall
despatch to the unit holders the dividend warrants within 42 days of the declaration of
the dividend and also despatch the redemption or repurchase proceeds within 10
working days from the date of redemption or repurchase, (ix) the investment norms
were made liberal to provide greater flexibility in this respect.

The SEBI (Mutual Funds) Regulations 1996 were subsequently amended in several
times in 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2006, 2008, 2009, 2010
and 2011 to include more and more provisions for ensuring better management and
investor protection.

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SEBI Guidelines (2000-03)

issued a series of guidelines. In 2000-01, the SEBI issued a code of conduct

for advertisement banning mutual funds from making assurance or claims
based on past performance that might mislead the investors. Mutual funds
were asked to disclose the non-performing assets (NPAs) and illiquid portfolio
every six months. Also they were asked to disclose the benchmark indices in
case of equity oriented schemes in order to enable the investor to compare the
performance of a scheme with the given benchmark. To enable the investors to
make informed decisions, mutual funds have been directed to fully revise and
update offer document and memorandum at least once in two years. They are
directed to reduce initial offer period from a maximum of 45 days to 30 days.

In 2001-02, the SEBI asked the AMCs to maintain records of each decision of
investment in equity and debt securities and made it mandatory to launch the
scheme within six month of its approval. Mutual funds are required to disclose
large unit holding in the scheme which are over 25 percent of NAV. A
common format is prescribed for all mutual fund schemes to disclose their
entire portfolios on a half yearly basis so that the investors can get meaningful
information on the deployment of funds.

During 2002-03, a uniform method was evolved to calculate the sale and
repurchase price of the units. The SEBI (Mutual funds) Regulations were
again amended. The new regulations required that the trustees should meet at
least six times a year and also to include modalities for payment to and
recovery from investors in case discrepancy in calculation of NAV due to non-
recording of transaction. Mutual funds have been instructed to obtain unique
client code (UCC) either from the BSE or NSE before commencing trading.
Mutual funds have been advised to collect information regarding bank account
number and PAN from investors, wherever the total value of investment is

has fixed the daily schedules for mutual fund for NAV based sales and
redemption of their schemes. Moreover, in November 2003, the SEBI issued
norms to check the abuse of the mutual vehicle by large corporate investors

76
for tax benefits. The new norms stipulate that each mutual fund scheme should
have at least 20 investors and no single investors should hold more than 25%
of the total corpus of the scheme.

The amended Regulations {SEBI (MF) Regulations,2006}11 of 2006 explains a

capital protection oriented scheme as a mutual fund scheme which is
designated as such and endeavors to protect the capital invested there in
through suitable orientation of its portfolio structure. Such a scheme may be
launched subject to certain conditions: (a) the units of the scheme are rated by
a registered credit rating agency from the view point of the ability, of its
portfolio structure to attain protection to the capital invested therein; (b) the
scheme is close-ended; and (c) there is compliance with such other
requirements as may be specified by the Board in this behalf. The regulations
also provided that mutual fund shall pay the minimum filling fee specified in
the second schedule to the Board while filling the offer document under sub
regulation (1) and balance fee shall be paid within such time as may be
specified by the Board. Moreover, the AMC shall not repurchase units of a
capital protection orientation scheme before the end of the maturity period.

SEBI (Mutual Funds)(Amendment) Regulations, 2008

12
The amended Regulations {SEBI (MF) Regulations, 2008} , deals with real
estate mutual funds. These regulations provided that in case of a real estate
mutual fund scheme, the title deed of real estate assets held by it may be kept
in the custody of a custodian registered with the Board. As per the regulations,
an existing mutual fund may launch a real estate mutual fund scheme if it has
an adequate number of key personnel and directors having adequate
experience in real estate. Every real estate mutual fund scheme shall be close
ended and its units shall be listed on a recognized stock exchange. The scheme
shall not undertake any lending or housing finance activities. Every real estate
mutual fund scheme shall invest at least 35% of the net asset of the scheme
directly in real estate assets. Subject to sub-regulation (1), every real estate
mutual fund scheme shall invest (a) at least 75% of the net assets of the
scheme in (i) real estate asset; (ii) mortgage backed securities (iii) equity
shares or debentures of companies engaged in dealing in real estate assets or in

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undertaking real estate development projects; whether listed on a recognized
stock exchange in India or not; and (b) the balance in other securities. The
regulations put some restrictions on investment. It is provided that (a) no
mutual fund shall invest more than 30% of its net asset in a single city and the
investment limit is restricted up to 15% in case of any single real estate
project. It is further provided that no mutual fund shall transfer real estate
assets amongst its schemes.

As per the regulations, the real estate asset held by a real estate mutual fund
scheme shall be valued (a) at cost price on the date of acquisition; and (b) at
fair price on every 19th day from the day of its purchase. The NAV of every
real estate mutual fund scheme shall be calculated and declared at the close of
each business day on the basis of the most current valuation of the real estate
assets held by the scheme and accrued income thereon, if any.

Further, the AMC shall exercise due diligence in maintenance of the assets of
real estate mutual fund scheme and shall ensure that there is no avoidable
deterioration in their value. It shall record in writing, the details of its decision
making process in buying or selling real estate assets together with the
justifications for such decisions and forward the same periodically to the
trustees. The trustees shall ensure that the AMC has the necessary expertise,
internal control system and risk management mechanism to invest in and
manage investments in real estate assets on a continuous basis. The regulations
also state that the offer documents of real estate mutual fund schemes shall
contain disclosures which are adequate for investors to make informed
investment decisions and such further disclosures as may be specified by the
Board.

SEBI (Mutual Funds)(Amendment) Regulations, 2009

The amended regulations{SEBI (MF) Regulations,2009} 13 provided that every

close ended scheme shall be listed on a recognized stock exchange within such
time period and subject to such conditions as specified by the Board. Such
listing shall not be mandatory for scheme existed prior to the commencement
of the amended regulations if the said scheme provides for periodic repurchase
facility to all the unit holders with restriction, if any, on the extent of such

78
repurchase or if the said scheme provides for monthly income or caters to
special classes of persons like senior citizens, women, children, widows or
physically handicapped or any special class of persons providing for
repurchase of units at regular intervals or if the details of such repurchase
facility are clearly disclosed in the offer document. The amended regulations,
2009 provided that the AMC shall issue to the applicant a statement of
accounts specifying the number of units allotted to the applicant as soon as
possible but not later than 30days from the date of closure of the initial
subscription list and/or from the date of receipt of the request from the unit
holders in any open ended scheme. An applicant in a close ended scheme shall
have the option either to receive the statement of accounts or to hold units in
dematerialized form and the AMC shall issue to such applicant, a statement of
account specifying the number of units allotted to the applicant or issue units
in dematerialized form as soon as possible but not later than 30 days from the
date of closure of the initial subscription list.

SEBI (Mutual Funds) (Amendment) Regulations, 2010

The SEBI (Mutual Funds) Regulations, 1996 was further amended on July 29,
2010 to include some new provisions. The regulations {SEBI(MF)
14
Regulations,2010} provided that the total expenses of the scheme excluding
issue or redemption expenses, whether initially borne by the mutual fund or by
the AMC, but including the investment management and advisory fee shall be
subject to the following limits : (1) In case of a fund of funds scheme, the total
expenses of the scheme including the management fees shall be either: (i) not
exceeding 0.75% of the daily or weekly average net asset, depending upon
whether the NAV of the scheme is calculated on daily or weekly basis; or (ii)
it may consist of (a) management fees for the scheme not exceeding 0.75% of
the daily or weekly average net assets depending upon whether the NAV of
the scheme is calculated on daily or weekly basis ; (b) other expense relating
to administration of the scheme; and (c) charges levied by the underlying
schemes; provided that the weighted average of the total expense ratio shall
not exceed 2.50% of the daily or weekly average net asset of the scheme ; (2)
In case of an index fund scheme or exchange traded fund , the total expenses
of the scheme including the investment and advisory fees shall not exceed

79
1.5% of the weekly average net assets; (3) In case of any other scheme (i) on
the first 100 cores of the daily or average weekly net asset 2.5% ; (ii) On
the next 3 crores of the daily or weekly net asset 2.25% ; (iii) On the next
300 crores of the daily or average weekly net asset 2.0%; (iv) On the balance
of the asset 1.75% , provided that in respect of a scheme investing in bond
such recurring expense shall be lesser by at least 0.25% of the daily or weekly
average net asset outstanding in each financial year.

SEBI (Mutual Funds) Regulations, 2011

SEBI has reviewed all old regulations and introduce modifications, wherever
necessary. It has further amended the regulations of 1996 on August 30, 2011.
The regulation {SEBI (MF) Regulations,2011}15 emphasized on expansion of
the derivatives segment, central listing authority, sweat equity norms, delisting
norms etc. It has already amended the takeover code and modified the
portfolio management service guidelines (Singh, 2012)16. As per the
Regulations, 2011, the AMC shall not invest in any of its scheme unless full
disclosure of its intention to invest has been made in offer documents,
provided that an AMC shall not be entitled to change any fee on its investment
in that scheme. The AMC shall not crazy out its operations including trading
desk, unit holder servicing and investment operations outside the territory of
India, provided that the AMC having any of its operation outside India shall
wind up and bring them within the territory of India within a period of one
year from the date of notification of amended regulation 2011.

As per the regulations, every infrastructure debt fund scheme shall invest at
least 90% of the net asset of the scheme in the debt security or securitized debt
instruments of infrastructure companies or projects or special purpose vehicle
which are created for the purpose of facilitating or promoting investment in
infrastructure or bank loan in respect of completed and revenue generating
projects of infrastructure companies or special purpose vehicles. The balance
amount shall be invested in equity shares, convertibles, infrastructure
development projects or money market instruments and bank deposits. But the
regulations provided that no mutual fund shall invest more than 30% of its net
assets in a single project, provided that this limit may be raised upto 50% of

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 the net asset of the scheme with the prior approval of the Board of Trustees.
Further, no infrastructure debt fund scheme shall invest in any unlisted
security of the sponsor or its associate issued by way of preferential allotment.
The Regulations provided that the NAV of every infrastructure debt fund
scheme shall be calculated and declared at least once in each quarter. The
valuation policy approved by the Board of AMC shall be disclosed in the
scheme information document.

The summary of regulatory framework of mutual funds in India is depicted in Exhibit

3.1 as under:

Exhibit 3.1

Summary of Regulatory Framework of Mutual Funds in India

Regulatory Name of Major Provisions
Bodies Regulation
U.T.I U.T.I Act, 1963 1. UTI will not invest more than 5% of its capital or
(For U.T.I more than 10% of the capital outstanding of any
Mutual Funds) company.
2. Mutual funds should distribute 90% of income to the
investors.
Reserve RBI Guidelines, 1. Mutual funds should be constituted in the form of
Bank of 1987 trusts.
India 2. A mutual fund should have a full time executive for
its regular management.
3. Funds shall have clear statement of objectives and
policies.
4. MIS should be evolved.
Ministry of 1.First set of 1. Mutual funds will require the approval of Controller
Finance, Guidelines, June of Capital Issues.
Government 1990 2. All mutual funds should be registered with SEBI.
of India 2.Second set of 3. Mutual funds shall not invest more than 5% of its
assets in the shares of any company.
Guidelines,
4. One mutual fund should not invest in another mutual
Februrary,1992
fund.
3.Third set of 5. AMC shall be authorized for mutual fund business
Guidelines, by the SEBI.
January, 1993 6. Schemes should get SEBI registration before
floating.
7. Same accounting year should be followed by mutual
funds.
8. Mutual funds must distribute 90 % of income in a
year.

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 9. Mutual funds must disclose any information to the
SEBI, if it desires so.
11. Mutual funds should maintain separate accounts for
each scheme.

Securities & 1. SEBI 1. AMC shall be chaired by an independent person

Exchange Guidelines for and will concentrate only on the management of the
Board of Mutual Funds, Fund.
October, 1991. 2. NAVs shall be published weekly.
India
2. SEBI 3. Mutual funds shall have to disclose the NPAs and
(SEBI)
Regulations for illiquid portfolios every 6 months.
Mutual Funds, 4. Mutual funds should disclose the benchmark for
January, 1993. performance evaluation.
3. SEBI (Mutual 5. Each scheme of mutual funds should be managed by
Funds) a fund manager.
Regulations, 1996. 6. Mutual funds shall not advance loan facility to unit
4. SEBI (Mutual holders.
Funds) 9. A capital protection scheme may be launched if it is
(Amendment) rated by a registered credit rating agency.
Regulations 10. An existing mutual fund may launch a real estate
mutual fund scheme if it has an adequate number of
key personnel and directors having experience in real
estate.
11.
to be strictly followed by mutual funds.
12. The AMC shall not invest in any of its scheme
unless full disclosure of its intention to invest has been
made in offer documents.
13. Each mutual fund scheme should have at least
twenty (20) investors and no investors should hold
more than 20% of the total corpus of the scheme.

Source: Compiled by the Researcher.

Recent Regulatory changes

Since the onset of global financial crisis, the Indian mutual fund industry has
experienced series of regulatory changes. The SEBI has put its emphasis more on
investor protection and accordingly various policy initiatives have been taken in
recent years.

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 1. Ban on entry load

From August 2009, SEBI has banned the mutual fund entry load in order to
enable the investors the right to negotiate the commission directly with the
distributors. The idea behind the ban on entry load was to bring transparency
in the commission payment and to encourage investment of longer horizon.

2. No additional management fees

In order to attract more investors, SEBI has directed the asset management
companies to scrap the additional management fee of 1% for the fund
launched on load basis. It suggested launch of - basis.

3. Documentation

Earlier record of investor documents were maintained by the mutual fund

to maintain the record of investor documents which also includes Know Your
Customer (KYC) details.

4. Disclosure of investor complaints

In order to enhance transparency in the mutual fund grievance redressal

mechanism, SEBI has made it mandatory for mutual funds to disclose investor
complaints in their annual reports. Mutual funds are directed to follow this
decision from the annual report of 2009-2010.

3.6. FUNCTIONING OF REGULATORY SYSTEM- A CRITICAL REVIEW

In India the need for a strong regulatory system for mutual funds was felt far back. In
different time periods the government appointed different committees in order to
evolve a strong mechanism. The Abid Hussain Committee (1989)17 on capital market
emphasized on the need for strengthening regulatory frame work for mutual funds. In
March 1991, the government in principle entrusted the job of regulation of mutual
funds to the SEBI. The Dave Panel (1991)18 recommended for strong guidelines for
the orderly functioning of mutual funds.

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Since inception of UTI, the first mutual fund in India, it was regulated by its own set
of regulations. After the entry of public and private sector in the mutual fund industry,
various sets of regulations were issued by different agencies viz. RBI, the Ministry of
Finance, Government of India and the SEBI. The Reserve Bank of India (RBI) issued
guidelines in 1987, The Ministry of Finance of Government of India issued guidelines
in 1990 and the SEBI started issuing guidelines in 1991 and amended the same in
several times. In fact, the objective of such guidelines and regulations was to ensure
sound and transparent working of the mutual industry in order to gain investors
confidence by providing adequate protection to investors.

However, the regulatory frame work of mutual fund in India was under severe
criticism, though the chief regulatory agency the
measures for better regulation from time to time. However, some past studies pointed
out inconsistencies in mutual fund operations and reason for such inconsistency, as
pointed out, was the lack of an effective regulatory framework. The SEBI regulations
are, no doubt, well-intentioned. But in practice there is scope for violation of

(Singh & Singh, 2001)19 . As there was no single regulatory body, the
guidelines issued by the RBI, Ministry of Finance and the SEBI from time to time
lack legal backing and were often contradictory thus compounding the confusion.
(Bhatia & Batra, 2008)20.The guidelines issued by different agencies simultaneously
was nothing but a sign of lack of systematic planning and co-ordination leading to
ineffective regulation of mutual funds. The main aspects of criticism are mentioned
hereunder.

1. Absence of single comprehensive law

In India, the government has not yet enacted any single uniform law in order
to regulate mutual fund activities. As a result, in case of any violations, no
specific law can be applied to deal with the situation. Mutual funds are often
violating the various guidelines taking the opportunity of loopholes of multiple
laws.

In principle the SEBI was entrusted the job of supervision and control of
mutual funds. But frequent interference of the Government on various matters
creates problems before the SEBI to act independently. It means that the SEBI

84
 was on the one hand treated as the sole regulator but on the other hand it lacks
effective decision making power. This was evident during the case of an
investigation of activities of Can bank Mutual Fund. The SEBI found serious
irregularities in its working and the SEBI debarred the fund to issue new
schemes. But ultimately, the ministry of finance took the case and directed the
SEBI to grant clearance to Can bank Mutual Fund to continue business. This
weakens the role of SEBI and affects the interest of investors adversely.

2. Violation of Regulations and Guidelines

In spite of having various regulations, mutual funds, often, without following

the regulations acted arbitrarily. They prudently violate the regulations.
Guidelines were there for disclosing the risk factor in an investment by the
mutual funds. But initially mutual funds were making the investor fool without
disclosing this risk factor clearly and showing high rate of return than bank
deposits.

In recent years, as per SEBI guidelines, mutual funds are compelled to insert a
risk clause strictly in their advertisement and accordingly mutual funds are

investments are subject to market risks, past performance is not necessarily

In case of mutual
fund advertisements this alarming statement should be inserted in the main
part of the advertisement with bold letters.

Also many mutual funds do not mention clearly in their advertisement about
the investment objective, performance record, pricing, valuation methods and
redemption provisions. All these mislead the investors.

As per Government guidelines and SEBI regulations, the mutual fund should
work independently having no relationship with sponsors. But in practice
SEBI found that many bank sponsored mutual funds are not working
independently. It was found that the Canbank Mutual Fund was engaged with
such activities that provided benefit to its sponsor Canara Bank by diverting

85
 the resources of the fund. The same situation was found in case of PNB
Mutual Fund, Indian Bank Mutual Fund, and SBI Mutual Fund. This practice
is against the interest of investors and hence a strong control is required to be
exercised to make the mutual funds act independently.

Further, as per Reserve Bank of India guidelines, mutual funds are prohibited
to involve them with any speculative activities. It is provided that whenever
any sale or purchase is made, the physical transfer should be made. But it is
found that transactions are being settled without physical transfer of securities.
Also instances were found for short sale and carryover of transactions which
lead to speculation and proved detrimental to the interest of the investors.

The SEBI regulations prohibited the mutual fund to grant loan to private
companies and security agents. But this regulation was violated by many
mutual funds. The SEBI found that the 30 crores
and
(Singh, 2003)21.

3. Involvement in Securities Scam

Involvement of many mutual funds in securities scam in 1992 demanded a

strong regulatory framework for mutual funds in India. The existing guidelines
& regulations failed to stop the occurrence of financial scandal in the form of
Securities Scam in 1992 leading to huge financial loss incurred by the mutual
fund industry in India. As per estimate of the Joint Parliamentary Committee
(JPC, 1994)22, a sum of 5000 crores was involved in the scam. Can bank
Mutual Fund , UTI, Citibank, SBI Mutual Fund and many other Indian and
foreign banks are found involved in the scam. This scam has distorted the
working of mutual funds and the capital market and has shaken the confidence
of investors in mutual funds. (Singh, 2003)23

4. Poor Redressal of Grievances

The existing steps and guidelines and regulations provide little scope for
redressal
in recent years that the SEBI has taken the matter seriously. Often investors
put complain of non-receipt of investment certificates, payment of dividends

86
 and interest, return of invested money at the end of funds life and transfer of
securities. But they were not getting timely response which badly affected

Functioning of SEBI as a regulator

The role of the SEBI was under question several times. SEBI has conducted certain
special investigation on the working of mutual funds. It is reported that some mutual
funds were not complying with the regulations issued by the SEBI. In an investigation
ges of the investment registers in the case of BOI Mutual

industries had been torn off. Further, in the case of Festival Bonanza Growth Scheme,
BOI Mutual fund handed over 20.50 crores to stock broker Harshad Mehta. It
apparently bought the shares of Karnataka Ball Bearings, a firm deep in the red, at a
(Business Today, 1994)24.

In 1992, the Janaki Raman Committee (RBI Bulletin, 1992)25 appointed by the RBI
found that Can Bank and SBI Mutual fund have misappropriated the funds by
indulging in irregularities. Further, the Joint Parliamentary Committee appointed by
the Government of India noticed that many mutual funds viz. Can Bank Mutual Fund,
Bank of India Mutual Fund, SBI Mutual Fund, LIC Mutual Fund, GIC Mutual Fund,
PNB Mutual Fund and Indian Bank Mutual Fund were involved in irregularities in
securities transactions, violating guidelines & regulations issued by the SEBI. In fact,
these irregularities were caused due to inadequate regulations and weak regulatory

BOI Mutual Fund have not followed the Regulation No. 49 relating to registration of

(SEBI Annual Report, 1994)26.

Many other evidences for violation of guidelines were found by the SEBI. All these
indicated that the regulatory framework is not adequate to regulate the operations of
mutual funds in India which demanded the need for more effective regulatory
mechanism with appropriate measures. In recent years, the SEBI is treated as the sole
regulatory authority of mutual funds and it has amended the regulations and
modifications. However, some new regulations are also not free of criticism. In
respect to ban on entry load, industry experts have argued that it has hit the margins of

87
AMCs. Also, since mutual funds do not have their own distribution network and due
to higher commission on Unit Linked Insurance Plan (ULIPs), there is danger of
mutual funds losing their market to insurance companies. Also scraping the additional
management fee on schemes launched on load basis may squeeze the margins earned
by the AMCs. Mutual funds stern displeasure with the SEBI on the order of ban on

fund houses used to pass the entry load to the distributors, but now with the ban we
will see less number of NFOs. Not that there will be no NFOs, but that certainly
come down in the next few months which will in turn hit the profitability of fund
(Economic Times, 2009)27.

here
are chances that people will pay us but during a bear run, we fear the advisory fee will

Mutual fund industry in India is not weak is respect of regulations and guidelines,
rather the industry is rich in this regard. The thing is that there are innumerable
guidelines and regulations prescribed by various agencies which often lead to chaos
and complexities and left several loopholes opened for the mutual funds. In fact, the
various misdeeds, distortions and violations of guidelines are due to the absence of
strict regulatory Act for mutual funds. Therefore, the Government of India should
pass a separate Act only for regulation of mutual fund industry giving the SEBI full
authority.

Debatable Aspects for Further Regulation

There are some pertinent areas for further regulation where debate is going on since
last long among the various parties concerned to mutual funds. Some crucial aspects
are mentioned hereunder.

a. Voting Rights to Mutual Funds

In India as per the Companies Act (Indian Companies Act, 1956)28, mutual
funds being trusts, cannot exercise voting power but this can be exercised by a
public trustee who is a Government official, which is as good as not exercising
at all. However, the AMFI is in favour of voting rights to mutual funds. It
opines that this enables mutual funds to have a say in the decision making and

88
 sponsors like bank and financial institutions, in their role as merchant bankers
and lenders have access to inside information which coupled with voting
rights encourage the fund managers to indulge in unscrupulous practices such
ealth
(Jayadev,
1998)29.

b. Ceiling on Corpus Amount

The SEBI regulations are silent on the maximum amount to be collected

under each scheme. Hence, sometimes the retention of oversubscription poses
difficulty in managing the fund as well as redemption also. Some experts
viewed that there should be a limit of the retention of over-subscribed amount.

investors. So regulations need to be strengthened here.

c. Capital Adequacy

There is high default risk in mutual fund investment. So in order to safeguard

the interest of investors and the principal amount, the AMC should have
capital adequacy norms like bank deposits, debentures and equity shares.
Regulations should be issued by the SEBI keeping the fact in mind.

d. Borrowing Powers

The open ended mutual funds aim at providing liquidity by continuous

repurchase and resale. To meet the payment schedule, the fund sells some
securities. But in case the securities are not liquidable easily, encashment may
be delayed. The SEBI regulation have no provision for borrowing powers,
therefore, borrowing power is to be given to AMCs.

e. Portfolio Turnover Rate

The portfolio turnover rate affects the stock market price level, investment

89
 costs and the level of risks associated. SEBI should issue regulations on this
aspect so that mutual funds can follow this and disclose the turnover rate in the
annual report.

f. Nomination Facility

SEBI regulations need to be amended in order to permit mutual funds to

provide the service of nomination facility to the unit holders to facilitate easy
transmission of the units.

3.7. APPROACH TO SELF REGULATORY ORGANIZATIONS (SROs)

SROs can exercise some degree of regulatory authority over an industry or profession.
The regulatory authority could be applied in addition to some form of government
regulation, or it could fill the vacuum of an absence of government oversight and
regulation. Initially, the concept of SROs gained popularity in the UK. In the field of
unit trusts and other related organizations, various SROs have been formed viz. the
Investment Management Regulatory Organization (IMRO), Life Insurance and Unit
Trust Regulatory Organization (LAUTRO), Personal Investment Authority (PIA) etc.

In India the concept of SROs has not yet developed but the need for SROs has been
emphasized by market participants, economists and various other interested parties.
Board of India (SEBI) is contemplating to promote
SROs in order to make the regulation more effective. SROs are expected to share the
responsibility with the regulator in framing and administering regulations. Self
regulation is not an independent tool, it complements other tools (Pathak, 2008)30.

The SEBI (Self Regulatory Organizations) Regulations, 2003 provides that SROs
shall always follow the directions of SEBI. They are responsible for investor
protection and education of investors or its members and shall ensure observance of
securities laws by its members. They shall conduct inspection and audit of its
members on a regular basis, submit its annual report to the SEBI, conduct training
programmes for its members and agents and such other functions.

SEBI during 1995-96 took several steps to promote and regulate SROs. Accordingly
various organizations were given recognition to act as SROs viz. Association of

90
Merchant Bankers of India (AMBI) , Association of Mutual Funds of India (AMFI) ,
Association of Custodial Agencies (ACAI) and Registrars Association of India
(RAIN).

Association of Mutual Funds of India (AMFI)

The AMFI was set up on 22nd August, 1995 with the objective to develop the Indian
mutual fund industry on professional and ethical manner and to enhance and maintain
standards so as to provide investors protection. This is the Chief Governing body of
all AMCs and is registered with the SEBI. The AMFI is under the process of
recognizing as SRO in the area of mutual funds in India. It has already applied for
this. we are open to taking up the responsibility
power us in certain areas, as at
first we will take up the regulatory responsibility for certain defined spheres in MF
(Economic Times, 2010)31.

91
 References:

1
Singh, H.K & Singh, M (2001), Mutual Funds and Capital Market, Kanishka
Publishers, New Delhi, p.17.

2
The Union Budget, 1987-88, Economic Times, March, 1987.

3
Gower, L.C.B (1986), Review of Investor Protection, A Discussion Document.

4
Narasimham, M (1992), The Financial System, Nabhi Publication, New Delhi, p-77.

5
Vaghual Committee Recommendations, 1993.

6
RBI Bulletin, December, 1987.

7
RBI Bulletin, March, 1992.

8
SEBI Guidelines, October, 1991.

9
SEBI (Mutual Funds) Regulations, January, 1993.

10
SEBI (Mutual Funds) Regulations, December, 1996.

11
SEBI (Mutual Funds) (Amendment) Regulations, 2006.

12
SEBI (Mutual Funds) (Amendment) Regulations, 2008.

13
SEBI (Mutual Funds) (Amendment) Regulations, 2009.

14
SEBI (Mutual Funds) (Amendment) Regulations, 2010.

15
SEBI (Mutual Funds) (Amendment) Regulations, 2011.

16
Singh, R.K (2012), Role of SEBI in Regulating Mutual Funds, International Journal
of Trade & Commerce, January-June, vol-1, p-45-59.

17
Planning Commission, Government of India,
January, 1989, p-29.

18
Dave Panel Report, 1991.

19
Singh, H.K & Singh, M (2001), Mutual Funds and Capital Market, Kanishka
Publishers, New Delhi, p.22.

92
20
Bhatia, B.S & Batra, G.S (2008), Management of Financial Services, Deep& Deep
Publications, New Delhi.

21
Singh, D (2003), Rajat Publications, New Delhi, p-48.

22
JPC Report 1994 on the Securities Scam 1992.

23
Singh, D (2003), Mutual Funds in India, Rajat Publications, New Delhi, p-49.

24
Business Today, August, 7, 1992, p-80-83.

25
RBI Bulletin, July 1992, p-1121-1147.

26
SEBI Annual Report, 1994.

27
Economic Times, August 14, 2009.

28
Section 153 B (4), Indian Companies Act, 1956.

29
Jayadev, M (1998), Investment Policy & Performance of Mutual Funds, Kanishka
Publishers, New Delhi, p.111.

30
Pathak, B.V (2008), The Indian Financial System, Dorling Kindersley (India) Pvt.
Ltd.

31
Economic Times, June 27, 2010

93