2022 (8) TMI 657 - SC - SEBI

Payment due for the services rendered to the unitholders prior to the winding up - Upfronting of trail commission - inflows through Systematic Investment Plans - Commission payable to mutual fund distributors - FIFA claims that independent financial advisors/mutual fund distributors are entitled to payment of commission agreed between them and Franklin Templeton Asset Management (India) Private Limited, which are in the nature of recurring expenses as per Regulation 52 of the Security and Exchange Board of India (Mutual Funds) Regulations, 1996 - whether asset management companies/mutual funds shall adopt a full trail model of commission in all schemes, without payment of any upfront commission or upfronting of any trail commission, directly or indirectly? - HELD THAT - FIFA has claimed that the commission payment due to the mutual fund distributors on and from 23rd April 2020 is an amount due and payable under the scheme , as it is an amount or payment that had accrued before the publication of notices under Regulation 39(2)(b), but was not paid as it was payable in future. Commission payable to mutual fund distributors is in the nature of trail, and therefore, is payment due for the services rendered to the unitholders prior to the winding up. This argument is farfetched and fallacious. The recurring liability is not a present liability, but an obligation which, on satisfaction of certain conditions, may accrue in future. The right to claim commission may not accrue and become due and payable. Distributor commission, as a recurring liability, is not payable if the unitholder(s) redeem the unit. Winding up of the scheme entails similar effects and consequences. As noticed above, it is the asset management company which is entitled to charge fees and expenses in terms of sub-regulations (1) and (2) of Regulation 52. The mutual fund distributors are not entitled to direct payment from the unitholders. Payment to the distributors is made by the asset management company, from the amount that they deduct as a recurring expense in terms of Regulation 52(4)(b). On and after publication of the winding up notice in terms of Regulation 39(3)(b), the trustees and the asset management company cannot claim any payment on account of recurring expenses under clause (b) to sub- regulation (4) to Regulation 52. That being the position, as held above, the claim of FIFA has to be rejected. If the amount cannot be due and payable to the principal, the claim of the agent or a third party, in view of the Regulations, must also fail. The claim of FIFA, on the basis of the Circular dated 22nd October 2018, which has been referred to above, is equally misconceived and untenable. The Circular dated 22nd October 2018 bars the asset management company from making upfront payment or upfronting of any trail commission, except in case of inflows through Systematic Investment Plans. It is also stipulated that, when the Systematic Investment Plan is discontinued for a period for which commission is paid, the commission amount has to be recovered on pro rata basis from the distributor. As a deduction, it follows that on publication of notices in terms of Regulation 39(3)(b), the business of the mutual fund comes to a stop and therefore, on and from that date the trail commission is not payable, as the scheme is to be wound up and the money is to be collected and paid to the unitholders, in terms of and as per the mandate of Regulation 41. Even if a distributor renders some services to the unitholders after publication of the notice under Regulation 39(3)(b), it would not entitle him to claim an amount from the asset management company. The Circular dated 22nd October 2018 cannot override the Regulations. The Circular does not intend to do so. It has been issued to bring about transparency in expenses, reduce portfolio churning and mis-selling in mutual fund schemes. The intent behind specifying total expense ratio and the performance disclosure for mutual funds is to bring greater transparency in expenses and to not confer any right on the mutual fund distributors to claim expenses under clause (b) to Regulation 41(2), which pertains to the procedure and manner of winding up. Franklin Templeton Trustee Services Private Limited and Franklin Templeton Asset Management (India) Private Limited have filed an affidavit before us stating that they have borne liquidation expenses amounting to approximately Rs. 40,00,00,000/- (Rupees Forty Crores) towards various services such as liquidator s fee, disbursement expenses, fees for the e-voting platform and the scrutinizer for voting results, etc. It is stated by them that this amount is not intended to be charged to the six Schemes in the interest of the unitholders of the Schemes. We have taken the said statement on record.

Summary

Issues:
1. Claim of commission by independent financial advisors/mutual fund distributors under Regulation 52 of SEBI (Mutual Funds) Regulations, 1996.
2. Interpretation of Regulations 52, 39, 40, and 41 regarding expenses and payments post winding up of schemes.
3. Entitlement of mutual fund distributors to commission post publication of winding up notices.
4. Application of Circular dated 22nd October 2018 in relation to payment of commission.
5. Liquidation expenses borne by Franklin Templeton Trustee Services and Asset Management.

Analysis:
1. The judgment dismisses the application filed by the Foundation of Independent Financial Advisors (FIFA) claiming commission for financial advisors/distributors under Regulation 52 of SEBI (Mutual Funds) Regulations, 1996. The court highlights that commission is applicable when the scheme is operational and not post the publication of winding up notices, emphasizing the ceasure of business activities post such notices under Regulation 39(3)(b).

2. The court rejects FIFA's contention that asset management companies are entitled to fees and expenses post publication of winding up notices under Regulation 39(3)(b). It interprets Regulations 40 and 52 harmoniously, stating that fees and expenses are allowable only when the scheme is in operation, not post the ceasure of business activities.

3. FIFA's claim for commission payment post 23rd April 2020 is refuted by the court, stating that commission is not 'due and payable under the scheme' post winding up. The judgment clarifies that distributor commission is not payable if unitholders redeem units and winding up triggers similar effects.

4. The court addresses FIFA's reliance on the Circular dated 22nd October 2018, emphasizing that post publication of winding up notices, trail commission is not payable. The Circular aims to enhance transparency in expenses and does not confer rights on distributors to claim expenses post winding up under Regulation 41(2).

5. Franklin Templeton Trustee Services and Asset Management's affidavit regarding bearing liquidation expenses is acknowledged by the court, noting that such expenses are not intended to be charged to the six schemes in the interest of unitholders. The judgment dismisses FIFA's application based on the above reasons, without any costs awarded.