2021 (7) TMI 751 - SC - SEBI

SEBI powers to issue directions and levy penalty - trustee s decision to wind up a scheme of the mutual fund - Interpretation of the term consent in Regulation 18(15)(c) - HELD THAT - The quotation highlights that interpretation is sometimes a three-stage process. At first, the words being interpreted should be understood according to their grammatical meaning in their literal and popular sense. In the second stage, we consider whether in the given context the plain meaning is obscure as the text gives rise to choice of more than one interpretation, or the propositional interpretation fails to achieve the manifest purpose of the legislation, reduces it to futility, is practically unworkable or even illogical. In such cases at the third stage, the court applying interpretative tools selects or blue-pencils an interpretation advancing the legislative intent without rewriting the provision. The legislative intent is gathered not by restricting it to the language of the provision, rather in the light of the object and purpose of the provision and the legislation. The courts do lean towards a pragmatic and purposive interpretation as there is an assumption that the draftsmen legislate to bring about a functional and working result. Harmonious interpretation of Regulation 18(15)(c) with Regulations 39 to 42 - Held that - Consent for the purpose of Regulation 18(15)(c) refers to the consent of the majority of the unitholders present and voting, and in case of a poll, the computation would be with reference to the number of units held by the unitholder. In fact, in the course of hearing, it was conceded that majority of the unitholders belong to provident fund trusts or pension funds. The voting pattern referred to in our earlier order reflects that voting under Regulation 18(15)(c) is possible and can work smoothly without much difficulty. The apprehensions expressed, therefore, do not carry much weight. It is obvious that where the unitholders vote against winding up, consequences would follow and accordingly the scheme would not be wound up. This is a natural and normal consequence which will have to be given effect to. It would, as stated above, happen rarely and that too would not happen without any genuine and good reason. The consent of the unitholders, as envisaged under clause (c) to Regulation 18(15), is not required before publication of the notices under Regulation 39(3). Consent of the unitholders should be sought post publication of the notice and disclosure of the reasons for winding up under Regulation 39(3). To complete interpretation of Regulation 18(15), we have to record that clause (a) applies and requires the trustees to obtain consent of the unitholders whenever required by SEBI in the interest of the unitholders. Clause (b) states that the trustees would obtain consent of the unitholders whenever required to do so on the requisition made by three-fourths of the unitholders of any scheme. Accordingly, clause (a) would apply whenever SEBI mandates and clause (b) applies whenever three-fourths of the unitholders of the scheme make a requisition. The High Court was right in observing that the trustees and the AMC have understood and accepted that the consent of unitholders of the scheme would be necessary if the majority of the directors of the trustee company decide to wind up a scheme. Challenge to the constitutional validity of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 - HELD THAT - No doubt, clause (a) to Regulation 39(2) gives primacy to the opinion of the trustees and does not require prior approval of SEBI, yet SEBI is entitled to conduct an inquiry and investigation when justified and necessary to ascertain whether the trustees have acted in accordance with their fiduciary duty and also for reasons which would fall within the four corners of clause (a) to Regulation 39(2). If the trustees have acted for extraneous and irrelevant reasons and considerations, the action would be in violation of clause (a) to Regulation 39(2) and therefore amenable to action under the SEBI Act, including directions under Section 11B. The power of SEBI extends to regulating and monitoring the functioning and decisions taken by mutual funds, the trustees and the AMC. SEBI has the power to pass any direction if it deems fit in the interest of unitholders. It cannot be accepted that the trustees under clause (a) to Regulation 39(2) have been given absolute and unbridled power to wind up a scheme. Language of clause (a) to Regulation 39(2) states that the trustees must form an opinion on the happening of any event which requires the scheme to be wound up. Further, as per Regulation 39(3), the trustees are bound to give notice disclosing the circumstances leading to the winding up of the scheme. These notices along with the reasons have to be communicated to SEBI and made known to the unitholders by publication in two daily newspapers having circulation all over India and a vernacular newspaper having circulation at the place where the mutual fund is formed. We have agreed with the High Court that the opinion of the trustees under clause (a) to Regulation 39(2), therefore, must be consented to by the unitholders in terms of the mandate of Regulation 18(15)(c). In view of this interpretation, the argument challenging constitutional validity of the Regulations on the ground that they give unbridled and absolute power to the trustees loses much of its sting and force. There are, therefore, sufficient guidance and safeguards in the Regulations itself on the power of the trustees to decide on winding up of the fund. The Regulations, in our opinion, rightly draw the distinction between creditors and the unitholders. The unit holders are investors who take the risk and, therefore, entitled to profits and gains. Having taken the calculated risk, they must also bear the losses, if any. Unitholders are not entitled to fixed return or even protection of the principal amount The Regulations under challenge do not suffer from the vice of manifest arbitrariness.

Summary

Issues Involved:
1. Interpretation of Regulation 18(15)(c) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.
2. Interrelation of Regulations 39 to 42 with Regulation 18(15)(c).
3. Challenge to the constitutional validity of Regulations 39 to 42.
4. Role and powers of SEBI under the SEBI Act.
5. Procedure and manner of winding up mutual fund schemes.
6. Rights and obligations of trustees and unitholders during the winding-up process.
7. Practical implications of the winding-up process, including redemption requests and borrowing limits.

Detailed Analysis:

1. Interpretation of Regulation 18(15)(c):
Regulation 18(15)(c) mandates that trustees must obtain the consent of the unitholders when they decide to wind up or prematurely redeem the units. The term "consent" refers to the "consent of the majority of the unitholders," meaning a simple majority of the unitholders present and voting. This interpretation aims to avoid practical impossibilities and absurdities, ensuring that the decision-making process remains functional and effective.

2. Interrelation of Regulations 39 to 42 with Regulation 18(15)(c):
Regulation 39(2) allows for the winding up of a scheme by trustees, unitholders, or SEBI. When trustees decide to wind up a scheme under Regulation 39(2)(a), they must seek the consent of the unitholders as per Regulation 18(15)(c). This consent should be sought post-publication of the notice under Regulation 39(3), ensuring transparency and allowing unitholders to make informed decisions. The cease and freeze effect of Regulation 40 applies from the date of publication of the notice, halting business activities and redemption of units.

3. Challenge to the Constitutional Validity of Regulations 39 to 42:
The challenge argued that Regulation 39(2)(a) gives unbridled power to trustees to wind up a scheme based on unspecified events, making it arbitrary. However, the court held that the trustees' power is not absolute and must be consented to by the unitholders as per Regulation 18(15)(c). The trustees are also required to disclose the circumstances leading to the winding up, ensuring transparency and accountability. The court found sufficient guidance and safeguards within the regulations, dismissing the challenge of manifest arbitrariness.

4. Role and Powers of SEBI under the SEBI Act:
SEBI has extensive powers to regulate, supervise, and issue directions regarding mutual funds, including the decision to wind up a scheme. SEBI can conduct inquiries and investigations to ensure trustees act in accordance with their fiduciary duties. If trustees act for extraneous reasons, SEBI can intervene under Section 11 and 11B of the SEBI Act. The court emphasized that SEBI's regulatory framework aims to protect investors and maintain market integrity.

5. Procedure and Manner of Winding Up Mutual Fund Schemes:
Regulation 41 outlines the procedure for winding up, requiring trustees to call a meeting of unitholders to authorize the winding-up process. The proceeds from the sale of assets are used to discharge liabilities and meet winding-up expenses, with the balance distributed to unitholders. The process ensures that unitholders are informed and involved in the decision-making, maintaining transparency and protecting their interests.

6. Rights and Obligations of Trustees and Unitholders During the Winding-Up Process:
Trustees hold the assets in a fiduciary capacity and must act in the best interest of unitholders. Unitholders, as investors, have the right to be informed and to consent to the winding-up decision. The court rejected the argument that unitholders are laypersons incapable of making informed decisions, emphasizing their role as discerning investors. Trustees must provide regular reports and disclosures to keep unitholders informed.

7. Practical Implications of the Winding-Up Process:
The court addressed the issue of honoring redemption requests received before the publication of the winding-up notice. It held that once Regulation 40 is triggered, redemption must cease to prevent depletion of assets. The court also discussed the borrowing limits under Regulation 44, allowing mutual funds to borrow for temporary liquidity needs. However, the court deferred a conclusive decision on this issue until the adjudication proceedings are completed, ensuring a thorough examination of the facts.

In summary, the court provided a comprehensive interpretation of the relevant regulations, ensuring a balanced approach that protects unitholders' rights while maintaining regulatory oversight and market stability. The judgment emphasized transparency, accountability, and the importance of informed decision-making in the winding-up process of mutual fund schemes.