### Professional Disclosures and Due Diligence Obligation for Mutual Fund Asset and Trustee Companies Legal Principle: Mutual funds must conduct independent credit due diligence regardless of collateral and ensure timely disclosure of adverse events affecting redemption. Core Ruling: Disgorgement of management fees is impermissible as a remedy for deficient service absent evidence of wrongful gain or averted loss.

In brief

The question

Whether the appellants exercised due care and diligence and provided high standards of service while taking the decision to invest in Essel Group Companies.

The court held

The Tribunal affirmed the findings of lack of due diligence, regulatory violations, and inadequate disclosure.

It also directed

It upheld the monetary penalties of ₹50 Lakhs on the AMC and ₹1.60 Crores on the Trustees/Employees.

However, it set aside the direction to refund/disgorge the investment management and advisory fees, holding that deficient service is a ground for penalty but not for disgorgement in the absence of wrongful gain.

Appeal No. 654 of 2021 was allowed in part, and Appeal No. 527 of 2022 was dismissed.

Stay on penalties was extended for 8 weeks.

01Facts

Kotak Mahindra Mutual Fund launched six Fixed Maturity Plans (FMPs) between 2013 and 2017.

¶ 22(i)

The AMC invested a portion of these funds in Zero Coupon Non-Convertible Debentures (ZCNCDs) issued by Konti Infrapower and Edison Utility Works—entities belonging to the "Essel Group".

¶ 4(iv)-(v)

These investments were secured by a pledge of Zee Entertainment Enterprises Limited (ZEEL) shares at 1.5x cover.

¶ 4(vii)

In January 2019, ZEEL share prices crashed, and the issuers failed to provide top-up collateral.

¶ 4(viii)

Consequently, the AMC unilaterally extended the maturity dates of the ZCNCDs beyond the FMPs' maturity dates and made only partial redemptions to unit holders at the time of the FMPs' scheduled closures.

¶ 22(ix)

SEBI's Whole Time Member (WTM) and Adjudicating Officer (AO) passed orders directing a refund of management fees, a 6-month ban on new FMPs, and penalties totaling ₹2.10 Crores.

¶ 2-3

02Issues

i.Whether the appellants exercised due care and diligence and provided high standards of service while taking the decision to invest in Essel Group Companies.

¶ 23(i)

ii.Whether the appellants violated the MF Regulations by extending the maturity dates of the investments and making partial redemptions of the FMPs.

¶ 23(ii)

iii.Whether the disclosures made to the unit holders regarding adverse developments were timely and adequate.

¶ 23(iii)

iv.Whether the direction for disgorgement of investment management fees was legally sustainable.

¶ 32

03Law Applied

The Court applied the SEBI (Mutual Fund) Regulations, 1996, specifically Regulations 25(2) regarding due diligence, 33(4) regarding winding up of schemes on maturity, 60 regarding disclosures to unit holders, and the Code of Conduct under the Fifth Schedule.

¶ 2, 26.1

It further interpreted Section 11-B of the SEBI Act, 1992, which empowers the Board to order disgorgement only in cases of "wrongful gain" or "averted loss".

¶ 30

The Tribunal relied on *Karvy Stock Broking Ltd. v. SEBI*, establishing that disgorgement is a restitutive remedy for unjust enrichment, not a punitive measure.

¶ 32

Provisions in the judgment · 1 · Linked ones open on LawLens

Companies Act, 2013 Section 447

04Reasoning

The Tribunal found that the AMC failed to conduct independent credit research on the actual issuers (Konti and Edison), relying solely on the promoter’s reputation and collateral, which contradicted the SIDs.

¶ 24.3-24.5

Regarding the extension of maturity, the Tribunal held that FMPs are closed-ended schemes mandated to invest in securities maturing on or before the scheme's end date; thus, the AMC’s unilateral extension and partial redemption violated Regulation 33(4).

¶ 25.2-25.4

On disclosures, the Tribunal rejected the argument that "timely" is undefined, noting that a three-month delay (January to April 2019) in informing unit holders of the collateral shortfall was unacceptable.

¶ 26.2-26.4

However, regarding disgorgement, the Tribunal observed that since the unitholders ultimately suffered no monetary loss and the AMC was legally entitled to management fees for services rendered (notwithstanding the deficiency), there was no "wrongful gain" to justify disgorgement under Section 11-B.

¶ 32