2009 (7) TMI 769 - HC - Companies Law

Whether the Circular dated 30-6-2009 under which the mutual funds are barred from charging entry load is ultra vires and illegal as SEBI does not have any power to issue the said circular under section 11(2)(b) of the Securities and Exchange Board of India Act 1992? Held that - The circular is for the benefit of the investors. It ensures transparency or openness as distributors have been asked to disclose the commissions they are entitled to under different competing schemes of various mutual funds so that the investor can make a considered choice. Conflict of interest is avoided or at least informed to the investor. Distributor is required to disclose commission if any payable to him by the mutual fund on the investment made by the investor. Thus the circular does not bar payment of commission by a mutual fund but mutual funds cannot charge upfront load. The distributor is entitled to charge for his services from the investor as per mutual contract. The scheme enforces and provides that there will be no entry load for all mutual funds. SEBI is an expert body which is entitled to regulate the market and has now issued circular dated 30-6-2009. In economic matters and matters relating to finance courts are reluctant to interfere unless clear violation of Article 14 is made out. Appeal dismissed.

Issues Involved:
1. Validity of SEBI's power to issue the circular under Section 11(2)(b) of the SEBI Act, 1992.
2. Alleged infringement of Articles 19(1)(g) and 21 of the Constitution of India.
3. Alleged violation of Article 14 of the Constitution of India.

Detailed Analysis:

1. Validity of SEBI's Power to Issue the Circular:
The petitioners challenged the circular issued by SEBI on 30-6-2009, which barred mutual funds from charging entry loads. They argued that SEBI lacked the authority under Section 11(2)(b) of the SEBI Act, 1992, to issue such a circular. Section 11(1) of the Act broadly empowers SEBI to protect investors' interests and regulate the securities market by any measures it deems fit. Sub-section (2) lists specific measures SEBI may take, but it does not limit the general powers granted under sub-section (1). The court held that SEBI's authority to regulate the securities market includes the power to control the issuance of new mutual funds and related commissions. Therefore, SEBI can regulate entry loads and issue relevant circulars. The argument that SEBI cannot regulate unregistered intermediaries like distributors was rejected, as Section 11(2)(b) empowers SEBI to regulate both registered and unregistered intermediaries.

2. Alleged Infringement of Articles 19(1)(g) and 21:
The petitioners contended that the circular violated their right to trade and livelihood under Articles 19(1)(g) and 21 of the Constitution. The court found no merit in this argument, stating that the circular did not prohibit the petitioners from carrying on their trade as distributors. Instead, it allowed them to negotiate service fees directly with investors. Thus, their right to trade and livelihood was not infringed.

3. Alleged Violation of Article 14:
The petitioners argued that the circular discriminated against them, violating Article 14 of the Constitution, by treating mutual fund distributors differently from life insurance agents, who can earn commissions up to 40%. They claimed the circular favored larger distributors like banks. The court dismissed this argument, stating that life insurance policies and mutual funds serve different purposes and cannot be treated as the same class. SEBI does not regulate life insurance policies, and the rate of return on mutual funds is market-driven, unlike life insurance policies. The court emphasized that Article 14 allows classification as long as it is reasonable and non-discriminatory. The circular aimed to benefit investors by ensuring transparency and requiring distributors to disclose their commissions, thus avoiding conflicts of interest.

Conclusion:
The court concluded that the circular was intended to benefit investors by ensuring transparency and preventing conflicts of interest. It allowed distributors to charge for their services based on mutual contracts with investors. The court recognized SEBI's expertise in regulating the market and upheld the circular, emphasizing judicial restraint in economic matters. Citing the Supreme Court's decision in R.K. Garg v. Union of India, the court highlighted the need for legislative flexibility in economic regulation.

In view of the above, the writ petition was dismissed.

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