This article on ‘LEGAL AND REGULATORY FRAMEWORK OF MUTUAL FUNDS’ is written by an intern at Legal Upanishad.
The article will focus on the legal and regulatory framework of mutual funds. The article covers the types of mutual funds, their uses, and regulations. Mutual funds are regulated by the SEBI (Mutual funds) Regulations 1996 and various governmental bodies. The term mutual fund is typically used in various countries such as the US, Canada, India, and many more countries worldwide. Mutual funds have various advantages and disadvantages and the impact of these are properly regulated through the various laws and provisions enacted by the government.
WHAT ARE MUTUAL FUNDS?
A mutual fund is defined as a body which pools resources by issuing units to purchasers and investing these funds in securities in accordance with the businesses as mentioned in the offer document. These mutual funds are generally classified into two bodies – Open-ended and Close-ended mutual funds.
The Open-ended mutual funds can be purchased on any transaction day as well redeemed on any transaction day. These open-ended mutual funds prove to be highly liquid. The Close-ended mutual funds are purchased only during NFO is the New Fund Offer and be redeemed only at maturity. The close-ended mutual funds are low on liquidity. The schemes of mutual funds can also be classified as index funds, income-oriented schemes, growth-oriented schemes, hybrid schemes, and many more.
STRUCTURE OF A MUTUAL FUND:
A mutual fund is structured in the form of a trust. These mutual funds have regularities under them known as sponsors, trustees, asset management companies, custodians, and many more. The sponsor or sponsors manage this trust. He is like a promoter of a company. They hold the property of the company for the benefit of holders. The AMC controls the funds by assembling investments. The custodian, registered with SEBI holds securities of the company in its custody. All these bodies are regulated and managed under one regulation named SEBI (Mutual funds) Regulation 1996.
LEGAL FRAMEWORK OF MUTUAL FUNDS:
Even though the mutual funds are in the form of trusts, they are actual legal entities and are often formed as a business trust or corporation. To be considered legal the mutual funds in India must be formed in a trust under the Indian Trust Act, 1882. Along with the trust act they should be registered under the SEBI (Mutual fund) Regulations 1996.
The regulation permits the mutual fund to accumulate funds from the dealing of units to the common public. It requires the mutual fund to deal in securities only as mentioned under the regulations. Under the regulation, the beneficiary and the trustee are of principal and agent.
REGULATORY FRAMEWORK OF MUTUAL FUNDS:
The Indian capital markets are primarily regulated by the Securities and Exchange Board of India. SEBI regulates mutual funds as well. These funds must be registered under SEBI. The appointment of the various regulators in the mutual fund such as trustees, AMC, custodians is compulsory to be regulated and under the purview of SEBI. Based on these regulations, the mutual funds have to send a 7-year compliance report to SEBI concerning the structure of the mutual funds. Earlier the Reserve bank of India was also a regulatory body of mutual funds namely the money market mutual funds.
However since SEBI has taken over the capital markets regulation, RBI is involved with the Indian Mutual Funds Industry, only to a restricted extent. They now only regulate the bank’s sponsors of sponsored mutual funds. Along with SEBI, these mutual funds are also regulated by various acts such as the Companies Act 2013, Ministry of Finance, Indian Trust Act. The mutual fund cannot offer guaranteed returns unless they have prior approval from the RBI. As SEBI and RBI regulate these mutual funds, they are in turn being regulated by The Ministry of Finance for smooth functioning. Hence if the Mutual funds are not in favor of the decisions given by SEBI, they can appeal to the Ministry of Finance.
SEBI GUIDELINES FOR MUTUAL FUNDS:
SEBI requires that the mutual funds must set up an AMC with a total of 50% independent directors. Independent Directors means the directors who are not an inherent part of the company and not related to the company in any manner. The mutual fund must have a minimum of Rs. 50 crore and Rs. 20 crore corpus for an open-ended and close-ended mutual fund respectively.
The guidelines state that these mutual funds must invest the amount within 9 months of the amount raised. SEBI must inspect these mutual funds every year to comply with the provisions. The regulation also requires the person to be first registered before setting up a mutual fund. It must be set up in the form of a trust which requires that the deed must be executed between the trustees and the sponsors under the Indian Registration Act.
SEBI ensures that the person involved in the setting up and management of Mutual Fund must be of integrity, ability and to ensure legal compliance. The mutual fund must comply with the making and production of various documents such as offer documents, scheme information documents, statements of additional information, fact sheets, etc.
The fact sheets must contain the true financial information of the Mutual Fund. This includes the Net Asset Value – which gives the value of the mutual fund on a single day, expense ratio, exit loads, past performance, risk category, etc. SEBI periodically ensures this information is up to date and true and fair to protect the interests of the investors.
CONCLUSION AND SUGGESTIONS:
The Indian Mutual Funds industry has seen a commendable transformation in recent times due to the ever-increasing participation of investors because of the diversification of businesses beyond the common boundaries of business. At present these mutual funds are regulated commendably by the SEBI, RBI, CA, etc. This legal and regulatory framework of mutual funds has developed over time in India. The future and rise of mutual funds are considered to be vivid. SEBI has been improving the framework with the introduction of various amendments.
Although SEBI has been issuing regular amendments and improvements in these regulations, they must be followed and understood in a more unified sense. The penalties regarding defaults must be made more stringent to avoid any misbehaving by the funds. The interests of investors must be more thoroughly protected and anti-defaulter to make sure the investors can invest without any fear of defaults and frauds. More transparency and accountability will ensure an investor-friendly mutual funds market and help in increasing revenue directly for the investors and indirectly for the nation.
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3) Diva Rai, Mutual Funds Regulation In India, (2020).
4) Shubhamm Sukhlecha, Securities Law and Capital Markets, (2020)