3.1 Role of Regulators in India

  1. Who regulates mutual funds in India?
  • Securities and Exchange Board of India (SEBI) is the regulator of mutual funds.
  • It regulates securities market in general. Apart from mutual funds, SEBI also regulates Stock Exchanges, Custodians, Registrar and Transfer Agents, Depositories, etc.
  1. Which guidelines of SEBI regulate mutual funds?
  • SEBI (Mutual Funds) Regulations, 1996.
  • Apart from the regulations, SEBI keeps issuing circulars from time to time. It also issues master circulars which contain essence of various circulars issued upto specified date.
  • They are available on – sebi.gov.in.
  1. Do mutual funds needs to comply with rules and regulations of any other Regulator organisations apart from SEBI?

Yes. Example –

  • Reserve Bank of India (RBI) – RBI regulates, among other things, money market and foreign exchange market. When mutual funds invest in money market or outside the country or accept investment from people outside the country or receive and pay remittances in foreign exchange, they have to comply with RBI’s regulations.
  • Stock Exchanges – Every stock exchange has its own listing, trading and margining rule. Mutual funds have to deal with some stock exchanges. They need to comply with the rules of those stock exchanges.
  1. Where can one file appeal against SEBI’s ruling?
  • A person aggrieved by SEBI’s ruling can file an appeal with Securities Appellate Tribunal (SAT).

3.1.2 Self Regulatory Organisations (SRO)

  1. What is an SRO and what does it do?

The concept of Self-Regulatory Organisations is more common in developed countries. In India too, there are SROs. SROs are formed by the market players to regulate their members.

  1. What is the difference in the functions of a statutory regulatory body set up by the Government and an SRO?

The statutory regulatory bodies set up by Government of India are responsible for laying down broad policy framework. SROs are responsible for micro-regulations of its members.

  1. Give some examples of SROs.
  • ICAI – regulates its own members
  • BSE, NSE, MSEI – These securities exchanges regulate their trading members as well as the firms listed on stock exchange.

3.1.3 Association of Mutual Funds of India (AMFI)

  1. What does AMFI do?

AMFI promotes interest of mutual fund industry. It is an industry body.

  1. Who are AMFI’s members?

Asset Management Companies (AMCs) are its members.

  1. What are the objectives of AMFI?
  • To define and maintain high professional and ethical standards in all areas of operation of mutual fund industry.
  • To recommend and promote best business practices and code of conduct to be followed by members and others engaged in the activities of mutual fund and asset management including agencies connected or involved in the field of capital markets and financial services.
  • To interact with the Securities and Exchange Board of India (SEBI) and to represent to SEBI on all matters concerning the mutual fund industry.
  • To represent to the Government, Reserve Bank of India and other bodies on all matters relating to the Mutual Fund Industry.
  • To undertake nationwide investor awareness programme so as to promote proper understanding of the concept and working of mutual funds.

To disseminate information on Mutual Fund Industry and to undertake studies and research directly and/or in association with other bodies.

3.1.4 AMFI Code of Ethics (ACE)

How does AMFI promote investor’s interest?

  1. To promote investor’s interest AMFI promotes high ethical and professional standards in Mutual Fund industry. It does this by making AMFI Code of Ethics.
  2. AMFI has laid down AMFI Code of Ethics (ACE) which are a set of good practices to be followed by Asset Management Companies while dealing with investors, intermediaries and public.
  3. SEBI (Mutual Funds) Regulations, 1996 requires Asset management Companies to follow Code of Conduct laid down in its Fifth Schedule. AMFI’s Code of Ethics supplement SEBI’s Code of Conduct and lays down even higher standards.
  4. SEBI’s Code of Conduct lays down broad principles. AMFI’s Code of Ethics goes into much more detail.

3.1.5 AMFI’s Code of Conduct for Intermediaries

  1. What is the Code of Conduct laid by AMFI for intermediaries?
  • AMFI Guidelines & Norms for Intermediaries (AGNI) – Code of Conduct laid by AMFI for intermediaries who sell mutual fund products like individual agents, brokers, distribution houses and banks.
  1. What does AMFI do when an intermediary breaks the Code of Conduct?
  • Seek explanation from Intermediary – AMFI will write to intermediary, send him a copy of complaint and ask him to provide an explanation within 3 weeks.
  • Issue warning letter – If the intermediary does not provide an explanation to AMFI within 3 weeks or his explanation is not satisfactory, AMFI will issue a warning letter to intermediary. The warning is that if the intermediary violates the Code of Conduct again, his registration will be cancelled.
  • Cancel registration – If the intermediary violates the Code for the second time and the violation is proven, then AMFI will cancel his registration. All the Asset Management Companies will be intimated about the cancellation.
  1. The intermediary has a right to file an appeal to AMFI against the cancellation of his registration.

3.1.6 Guidelines for Circulation of Unauthenticated News

  1. Who has laid down guidelines to prevent circulation of unauthenticated news?
  • SEBI
  1. What are the guidelines to prevent circulation of unauthenticated news?
  • Internal Code of Conduct – Intermediary should lay down internal controls and Code of Conduct for his employees, temporary staff, voluntary workers. They should be instructed that they should not circulate rumours or unverified news.
  • Restricted Access to Blogs/ Chat Forums – Intermediary should either restrict his employees’ access to Blogs/ Chat Forums/ Messenger sites or if the access is allowed then it should be under supervision.
  • Maintain Records of Usage – If the employees of intermediary are using Blogs/ Chat Forums/ Messenger sites, then logs of usage should be maintained like records as specified by Regulations.
  • Authentication of Market Related News – If employees of intermediary receive any market related news by email, this news should not be forwarded unless the same has been verified as authentic by Intermediary’s Compliance Officer. If employee fails to do so, he will have violated SEBI Act/ Rules/ Regulations. Compliance Officer will also be liable under breach of duty.

3.1.7 Due Diligence Process by AMCs for Distributors of Mutual Funds

Note: Important – 

  1. Who will qualify for due diligence review?

SEBI has placed a responsibility on AMCs to carry out a due diligence review of the distributors who qualify in any of the following four criteria –

  • Multiple Point Presence (More than 20 locations).
  • AUM raised over ?100 crore across industry in non-institutional category but including high networth individual (HNIs).
  • Commission received over ?1 crore p.a. across industry.
  • Commission received over ?50 Lakhs from a single mutual fund.
  1. What factors will be checked to see if the distributors qualify fit and proper criteria?

While empanelling distributors and during review process, AMCs are required to check if the distributors fulfil “fit and proper” criteria. For this, the following factors are checked –

  • Business model, experience and proficiency in the business
  • Record of regulatory/ statutory levies, fines and penalties, legal suits, customer compensations made; causes for these and resultant corrective actions taken
  • Review of associates and subsidiaries on above factors
  • Organisational controls to ensure that the following processes are delinked from sales and relationship management processes and personnel:
  • Customer risk/ investment objective evaluation
  • MF scheme evaluation and defining its appropriateness to various customer risk categories.
  1. What are the two categories in which distributor’s relationship with his client can be categorized?


  • Distributor offers advice while distributing.
  • The distributor will sell only appropriate product.
  • Appropriateness is selling of only that product which is best suited for investor based on his risk appetite.

Execution only

If the distributor is not offering advice just executing the transaction, he is still required to do the following –

  • If the distributor believes that the investment which the investor is about to do is not appropriate, he shall send a written communication to the investor informing him that it is unsuitable. The communication should be acknowledged by the investor.
  • The distributor will have to obtain investor’s confirmation that the transaction is execution only and that he had received distributor’s advice about inappropriateness of the proposed investment before the transaction.
  • On such execution transactions investor is only required to pay standard transaction charges.
  1. Can a mutual fund distributor sell mutual fund products of its group/ affiliate/ associate?

Yes, provided the distributor make full disclosure that he is selling mutual fund product of group/ affiliate/ associate.

  1. What will be checked while reviewing compliance and risk management functions of the distributor?
  • Criteria used by the distributor to review the products and the periodicity of such review.
  • Factors checked while determining the risk appetite of the customer, categorization of the investment and periodicity of such review.
  1. What other kinds of due diligence will be performed?
  • Review of transaction, exceptions identification, escalation and resolution process by internal audit.
  • Recruitment, training, certification and performance review of all personnel engaged in the business.
  • Customer on-boarding and relationship management process, service standards, enquiry/ grievance handling mechanism.
  • Internal/ external audit process, their comments/ observations as it related to MF distribution business.
  • Findings of ongoing review from sample survey of investors.

3.2 Investment Restrictions for Schemes

SEBI has placed various restrictions on mutual fund schemes for the protection of investors. These are –

  1. General Restrictions
  • Mutual Funds will buy and sell securities on delivery basis. The securities will be bought in the name of the mutual fund and transferred in the account of the scheme.
  • Mutual funds will not give loans.
  • Scheme will not invest in unlisted or privately placed securities of associate or group company of the sponsor. Investment in listed securities of the group companies of the sponsor will be limited to 25 percent of net assets.
  • A scheme may invest in other schemes of the same mutual fund or other mutual funds. However, the investment amount will not be more than 5 percent of the net assets value of the scheme. Mutual funds will not charge fees on such investments. This will not apply to fund of funds.
  • A mutual fund under all of its schemes shall not own more than 10 percent of the paid up capital of a company bearing voting rights.
  • Sponsor of a mutual fund, its associate or a group company, the Asset Management Company, through the schemes of the mutual fund or otherwise, individually or collectively, will not own more than 10% or more share holding or voting rights in Asset Management Company or trustee company of any other mutual fund.
  1. Restrictions on Investment in Debt Securities
  • A scheme shall not invest more than 10 percent of its net assets in investment grade debt security of a single issuer. This limit can be raised to 12 percent with the approval of trustees. The limit will not apply to Government Securities, Treasury Bills, CBLO.
  • A scheme shall not invest more than 10 percent of its net assets in unrated securities of a single issuer and total investment in such securities will not exceed 25 percent of its net assets.
  • A scheme shall not park more than 15 percent of its net assets in short term deposits of a scheduled commercial bank. This limit can be raised to 20 percent with the approval of trustees. However, the scheme cannot invest in short term deposits of such a bank that has invested in the scheme. No management fee shall be charged on such investment.
  1. Group Exposure
  • Mutual funds/ AMC shall not invest more than 25 percent of net assets of its scheme in one sector. (This will exclude investment in Bank CDs, CBLO, G-Secs, T-Bills, Short Term Deposits of Scheduled Commercial Banks, AAA rated securities issued by Public Sector Banks, Public Financial Institutions, Public Sector Units).
  • Additional exposure to financial service sectors not exceeding 10 percent shall be allowed only if the exposure is being taken in Housing Finance Companies (HFCs).
  • Additional exposure to Housing Finance Companies (HFCs) will be allowed only if it is in the securities rated AA and above and the HFCs are registered with National housing Bank (NHB). Total investment in HFCs shall not exceed 25 percent of the net assets.
  1. Restrictions on Investment in Equity Securities
  • At least 80 percent of ELSS funds should be invested in equity and equity linked securities.
  • A scheme shall not invest more than 10 percent of its net assets in equity shares and equity related instruments of one company. (The limit is not applicable on index funds/ sector funds/ industry specific schemes.)
  • An open-ended scheme will not invest more than 5 percent of its net assets in unlisted equity shares and equity related instruments. For close-ended scheme, this limit is 10%.

3.2.1 Investment Objective

Investment objective is broad investment charter. By examining a scheme’s investment objective an investor can determine the asset class in which the scheme will invest i.e. equity, debt, etc.

Examples of investment objective –

  1. Investment objective of diversified equity scheme – To generate capital appreciation from a portfolio of predominantly equity related securities.
  1. Investment objective of diversified debt scheme – To generate income by investing predominantly in a wide range of debt and money market securities.
  1. Investment objective of a balanced scheme – To achieve growth by investing in equity and equity related investments, balanced with income generation by investing in debt and money market instruments.

3.2.2 Investment Policy

Investment policy describes the kind of portfolio that will be maintained in great detail. Example –

  1. The portfolio will comprise of mid -cap stocks.
  2. Investment will be made in large-cap stocks.
  3. 65% of the investment will be made in equity and equity related securities and the rest will be invested in short term debt securities and money market instruments.

3.2.3 Investment Strategy

How a fund achieves its investment objectives is determined by its investment strategy. Investment strategy will be decided by many factors –

  • What is the Investment Horizon?
  • What is the strategy for Selection of Securities?
  • How will the schemes determine the right buying price?
  • How will the scheme determine the right time to sell?
  • How much can the scheme invest in different asset classes?

3.3 Investors’ Rights & Obligations

3.3.1 Service Standards of a Mutual Fund towards its Investors

(Note: ELSS or Equity Linked Saving Scheme qualifies under Section 80C of Income Tax Act)

  1. NFO Duration – Maximum duration = 15 dayse. 15 days is the maximum times a scheme (except ELSS) can remain open for subscription.
  2. Refund or Allotment Duration – Once NFO closes, the scheme (except ELSS) has to allot units or refund money within 5 business days of closure of NFO.
  1. Interest for Delay Period – If there is a delay in payment of refund then interest @ 15 percent p.a. for the delay period needs to be paid. This interest cannot be charged to the scheme.
  1. Re-opening Period – Open ended schemes must re-open for sale/ repurchase within 5 business days of allotment.
  1. Statement of Account (SOA) are to be sent to the investor –
  • NFO – Within 5 business days of closure of NFO.
  • Post NFO Investments – Within 5 business days of receiving request from investor.
  • Initial Transaction – Within 10 business days.
  • Ongoing – Within 10 business days of the end of calendar quarter.
  • On specific request – Within 5 business days.
  • Dormant Investor (no transactions during last 6 months) – SOA can be sent along with Portfolio Statement or Annual Return
  • Soft copy will be mailed every month if instructed by investor.
  1. Consolidated Statement of Account – Statement of investments across all mutual funds mapped by PAN of the investor. Sent every month when there is a transaction.
  1. Demat – An investor can receive units (both open-ended and closed-ended) in his Demat account. Units in demat form are freely transferable.
  1. Transferability of ELSS units – During the statutory minimum holding period of ELSS (3 years), units cannot be transferred. After this period units can be transferred.
  1. Unit Certificate – If an investor asks for a Unit Certificate, the mutual fund has to provide it within 5 business days. The Certificate is of no transactional use as it is non-transferable.

A unit Certificate is different from a Statement of Account (SOA) in following ways –

  • SOA shows – Opening Balance, Closing Balance, Transactions during the Period. Unit Certificate only shows – Number of Units held.
  • SOA is like bank pass book. Unit Certificate is like Balance Confirmation certificate.
  1. NAV Calculation – NAV of a scheme shall be calculated daily and published on the website of AMFI and the Mutual Fund. Mutual funds shall also send latest NAV to investor through SMS if requested.
  1. Nominees – An investor can appoint up to 3 nominees (in case of investor’s demise) along with the distribution percentage. If no percentage specified, units will be distributed equally.
  1. Pledge Units – Units of a mutual scheme can be pledged as security against loan taken by investor.
  1. Dividend Warrants – Dividend Warrants must be sent within 30 days of dividend declaration.
  1. Redemption Cheques – Redemption cheques must be sent within 10 days of receipt of redemption request.
  1. Interest on Delay – If there is delay in sending redemption cheques or dividend warrants, interest @ 15 percent has to be paid. This interest cannot be charged to the scheme.

3.3.2 Other Rights of an Investor

  1. Beneficial Ownership – Unit holders have a right to beneficial ownership in the scheme’s assets.
  2. Change Distributor – Investors can change their distributors or invest in a direct format. They do not need to provide a No Objection Certificate to Mutual Fund from existing distributor.
  3. Dematerialised Form – If an investor chooses to, he can hold mutual fund units in dematerialised form. The mutual fund will coordinate with RTA and Depository Participant.
  4. Statement of Portfolio – Mutual Funds shall, within 10 days of end of half year (31st March and 30th September), send to investor a complete statement of its scheme portfolio.
  5. Right to Inspect Key Documents – Unitholders can inspect Trust Deed, Investment Management Agreement, Custodial Service Agreement, RTA Agreement, Memorandum Of Association & Articles Of Association of the AMC.
  6. Half Yearly Disclosures – Mutual Funds shall, within 1 month of end of half year (31st March and 30th September), publish a copy of its unaudited financial results on their website.

Annual Report on Redressal of Complaints

Mutual Funds have to prepare an annual report (in a SEBI prescribed format) on redressal of complaints received against –

  • Mutual Fund
  • Authorised Persons
  • Distributors
  • Its Employees

The complaints have to be categorised. For each category of complaint, the mutual fund has to report –

  • Number of Complaints
  • Time Period of Resolution
  • If Unresolved, how long have they remained unresolved.

Trustees have to sign the report. The report will be published on AMFI’s website, mutual fund’s website and in the annual report of mutual fund.

Scheme-wise Annual Report or its abridged summary will be sent by mutual funds to unit holders within 4 months of the end of financial year. The report can be sent to an investor’s registered e-mail address in SEBI’s prescribed format.

Mutual funds shall publish an advertisement that the annual report is published on their website. This advertisement will be in all India edition of at least two newspapers one in English and the other in Hindi.

Unitholders can request the report in either physical format or electronic format. This request can be given through SMS, telephone, e-mail or written letter.

Consolidated Account Statement

Consolidated Account Statement (CAS) will be sent to investors on a monthly basis. It will have following –

  • Scheme Names where investor has invested
  • Number of Units Held
  • Market Value of Units

CAS (half yearly) of September and March will have following additional details

  • Commission paid to the distributor against investor’s schemes (during the half year).
  • Total Expense Ratio (regular plan and direct plan) of the schemes in which investor has invested.

Half yearly CAS will be issued to all investors except those who have no mutual fund investments or where no commission has been paid to distributors against their investments.

Investor Redressal

  • If an investor has a complaint, he can go to Investor Service Centre. He can also contact senior officials in the AMC. If investor’s complaints are still not resolved, he can write to SEBI.
  • If there are pending investor complaints, SEBI may refuse to grant permission to AMC to launch a new scheme.
  • Offer Document of a scheme mentions number of investor complaints received and number of complaints redressed.

Changes in Fundamental Attributes of a Scheme

Changes in fundamental attributes of a scheme cannot be made by AMC/ trustee unless –

  • All Unit Holders are informed about the change (written communication). Further, advertisement is given in two newspapers – 1. English (national circulation), 2. Local language (of the region where head office of AMC is located).
  • Existing unit holders are given opportunity to exit the scheme at existing NAV without exit load. This window must remain open for at least 30 days.

Termination of AMC

AMC’s appointment to a mutual fund can be terminated by –

  • Majority of Trustees
  • 75% of Unit Holders (in practice, Unit Holding)

Winding Up of Scheme

A scheme can be wound up if a resolution is passed by 75% of Unit Holders (in practice, Unit Holding).

Consent of Unit Holders

Trustees must obtain consent of Unit Holders when –

  • SEBI requires them to do so, in the interest of Unit Holders.
  • 75% of Unit Holders (in practice, Unit Holding) require them to do so.
  • Trustees decide to wind up or prematurely redeem the scheme.

Suit Against Trustees

An investor can file suit against Trustees/ AMC for breach of trust if he feels they have not fulfilled their obligations.

Consolidation of Schemes

Sometimes two or more schemes are merged into one. This merger or consolidation of schemes shall not be considered a change in fundamental attributes of the scheme if the following conditions are met –

  • There is no change in any other fundamental attributes of the scheme that continues after other schemes have merged in it.
  • The interests of unitholders of the final surviving scheme are not adversely affected.
  • There were such circumstances which merited merger of the schemes
  • The proposal of consolidation of schemes is first approved by Board of Directors and Trustees of the mutual fund. Then, the proposal is sent to SEBI. SEBI would communicate its observations.
  • A letter will be issued to the Unitholders informing them about the merger. This letter must incorporate the final observations of SEBI. A copy of the letter must have been filed with SEBI.

3.3.3 Limitations of Rights of Unitholders

Cannot file Suit against a Trust – Mutual Funds are constituted as Trusts. Trusts are notional entities. A suit cannot be filed against notional entity. However, suit can be filed against trustees.

Caveat Emptor (Buyer Beware) – A unitholder cannot seek legal protection on the grounds that he was not aware on the matters of law and matters fairly and transparently mentioned in the Offer Document.

Only investors can initiate legal proceedings – A unitholder can initiate legal proceedings against AMC and Trustees in some cases. However, a person who is not unitholder cannot do so.

3.3.4 Unclaimed Amounts

Sometimes mutual funds are left with dividend and redemption amounts that are not claimed by investors. This unclaimed dividend and redemption amount has to be invested by the mutual fund in money market through a liquid scheme formed especially for investing unclaimed amount.

There shall no exit load in this scheme. AMC can recover management and advisory fees of upto 0.50 percent per annum.

  • If an investor claims money within 3 years, payment is based on prevailing NAV.
  • If an investor claims money after 3 years, payment is based on NAV at the end of 3 years.

AMC must make continuous efforts to remind investors that collect their money.

Annual Report of the mutual funds must mention unclaimed amounts of each scheme.

3.3.5 Proceeds of Illiquid Securities

At the time of winding up or maturity of a scheme, there might be certain securities that were non-recoverable at that time. Later, the security might become liquid.

If money can be recovered by selling the security within 2 years and the amount is large, then it shall be paid to the old investors. If not, then it will be transferred to Investor Education Fund maintained by each mutual fund.

3.3.6 Investor’s Obligations

For investing in mutual funds, investors must provide PAN (Permanent Account Number) and must complete formalities of KYC (Know Your Customer). However, investor investing through micro-SIP is given relaxation.

All investor must provide bank account details with the redemption requests.

3.4 Can a Mutual Fund Scheme go bust?

Many strong checks and balances have been made which prevent mutual fund schemes from going bust.

  • Investments are managed by AMC. Assets of a scheme are held by a Custodian. These work under the control of Trustees.
  • If sponsors wish to leave, they need to bring other sponsors acceptable to SEBI. If investors are not comfortable with the new sponsors, they can leave the scheme within 30 days without paying exit load.
  • The Custodian who holds the assets is largely independent of the sponsor and AMC. Hence, this provides structural protection to the assets of the scheme.

Quick Revision

[WATU 11]

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Categories: Education