INTRODUCTION

Mutual fund is a mechanism for pooling the resources by issuing

units to the investors and investing funds in securities in accordance
with objectives as disclosed in offer document. Investments in
securities are spread across a wide cross-section of industries and
sectors and thus the risk is reduced. Diversification reduces the risk
because all stocks may not move in the same direction in the same
proportion at the same time. Mutual fund issues units to the
investors in accordance with quantum of money invested by them.
Investors of mutual funds are known as unit holders. The investors
in proportion to their investments share the profits or losses. The
mutual funds normally come out with a number of schemes with
different investment objectives, which are launched from time to
time. A mutual fund is required to be registered with SEBI, which
regulates securities markets before it can collect funds from the
public.
The small investors who generally lack expertise to invest on their
own in the securities market have reinforced the saying Put not
your trust in money, put your money in trust. They prefer some
kind of collective investment vehicle like, MFs, which pool their
marginal resources, invest in securities and distribute the returns
therefrom among them on cooperative principles. The investors
benefit in terms of reduced risk and higher returns arising from
professional expertise of fund managers employed by the MFs. This
approach was conceived in the USA in the 1930s. In developed
financial markets, MFs have almost overtaken bank deposits and
total assets of insurance funds.

Experiment with MFs in India began in 1964 with the establishment

of Unit Trust of India (UTI). UTI lost its monopoly status in 1987
with the entry of other public sector MFs promoted by public sector
banks and insurance companies. The industry was opened to private
sector, including foreign institutions, in 1993 giving Indian investors
a broader choice and increasing competition to public sector funds.
SEBI (Mutual Fund) Regulations, 1996 as amended till date define
mutual fund as a fund established in the form of a trust to raise
moneys through the sale of units to the public or a section of the
public under one or more schemes for investing in securities
including money market instruments or gold or gold related
instruments or real estate assets.
Key features of a mutual fund that flow from the definition are:

It is established as a trust
It raises moneys through sale of units to the public or a

section of the public

The units are sold under one or more schemes

HISTORY OF MUTUAL FUND INDUSTRY IN INDIA

The history of mutual funds in India can be broadly divided into four
distinct phases
FIRST PHASE 1964-87
An Act of Parliament established Unit Trust of India (UTI) on 1963.
It was set up by the Reserve Bank of India and functioned under the
Regulatory and administrative control of the Reserve Bank of India.
In 1978 UTI was de-linked from the RBI and the Industrial

Development Bank of India (IDBI) took over the regulatory and

administrative control in place of RBI. The first scheme launched by
UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700
crores of assets under management.
SECOND PHASE 1987-1993 (ENTRY OF PUBLIC SECTOR
FUNDS)
1987 marked the entry of non- UTI, public sector mutual funds set
up by public sector banks and Life Insurance Corporation of India
(LIC) and General Insurance Corporation of India (GIC). SBI Mutual
Fund was the first non- UTI Mutual Fund established in June 1987
followed by Canbank Mutual Fund (Dec 87), Punjab National Bank
Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of
India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC
established its mutual fund in June 1989 while GIC had set up its
mutual fund in December 1990. At the end of 1993, the mutual
fund industry had assets under management of Rs.47,004 crores.
THIRD PHASE 1993-2003 (ENTRY OF PRIVATE SECTOR
FUNDS)
With the entry of private sector funds in 1993, a new era started in
the Indian mutual fund industry, giving the Indian investors a wider
choice of fund families. Also, 1993 was the year in which the first
Mutual Fund Regulations came into being, under which all mutual
funds, except UTI were to be registered and governed. The
erstwhile Kothari Pioneer (now merged with Franklin Templeton)
was the first private sector mutual fund registered in July 1993. The
1993 SEBI (Mutual Fund) Regulations were substituted by a more
comprehensive and revised Mutual Fund Regulations in 1996. The
industry now functions under the SEBI (Mutual Fund) Regulations

1996. The number of mutual fund houses went on increasing, with

many foreign mutual funds setting up funds in India and also the
industry has witnessed several mergers and acquisitions. As at the
end of January 2003, there were 33 mutual funds with total assets
of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541
crores of assets under management was way ahead of other mutual
funds.
FOURTH PHASE SINCE FEBRUARY 2003
In February 2003, following the repeal of the Unit Trust of India Act
1963 UTI was bifurcated into two separate entities. One is the
Specified Undertaking of the Unit Trust of India with assets under
management of Rs.29,835 crores as at the end of January 2003,
representing broadly, the assets of US 64 scheme, assured return
and certain other schemes. The Specified Undertaking of Unit Trust
of India, functioning under an administrator and under the rules
framed by Government of India and does not come under the
purview of the Mutual Fund Regulations.
The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB
and LIC. It is registered with SEBI and functions under the Mutual
Fund Regulations. With the bifurcation of the erstwhile UTI which
had in March 2000 more than Rs.76,000 crores of assets under
management and with the setting up of a UTI Mutual Fund,
conforming to the SEBI Mutual Fund Regulations, and with recent
mergers taking place among different private sector funds, the
mutual fund industry has entered its current phase of consolidation
and growth.

OBJECTIVE OF THE STUDY

Securities regulation in India is in the process of evolution and cant
be identified either with the UK or the US type of regulation. In
India,

under

the

present

framework,

the

regulation

of

all

participants in the securities market (with the exception of issuers

of capital) is the responsibility of SEBI.
As the prime regulator of capital market activities in India, SEBIs
basic objective is to protect the interest of investors. This objective
has been stated in the preamble of the Securities and Exchange
Board of India Act 1991, thus... to protect the interest of the
investors in securities and to promote the development of, and to
regulate, the securities market and for matters connected therewith
or incidental thereto. Accordingly, all capital market activities,
including those of mutual funds, are covered under the above
objectives so far as investor protection is concerned.
The SEBI regulations of 1993 were the first attempt to bring mutual
funds under a regulatory framework and to give directions to their
functioning. However, as noted earlier, new regulations were passed
in 1996 and these have many similarities with the Investment
Companies Act 1940 of the US as far as mutual fund regulation and
investor interests are concerned. The regulatory and supervisory
powers of SEBI also stand strengthened by the securities law
(Amendment) Ordinance, 1995 which empowers SEBI to impose
penalties for violation of its regulations. Under this amendment
SEBI is also allowed to file complaints in courts without prior
approval of the central government. SEBI has thus emerged as an
autonomous and powerful regulator of mutual fund in India.

RESEARCH METHODOLOGY
This study is a descriptive research wherein the source for the data
will be secondary. There has been very limited published data and
information with regard to this study.
Hence the study will try to understand the regulations with relation
to the mutual funds. This study will cover all the legal aspects in
relation to initiation of legal proceedings to effect welfare of
investors in mutual funds.

LEGAL FRAMEWORK FOR MUTUAL FUNDS

The regulation of mutual funds in India is set forth in the SEBI
(Mutual Fund) Regulations. SEBI (Mutual Funds) Regulations, 1996
were notified by SEBI in exercise of its powers conferred by section
30 read with clause (c) of section 11(2) of SEBI Act, 1992. The
mutual funds defined in these regulations are modeled after the
UKs Unit Trust, and are contractual plans. The legal framework for
Indias mutual funds, as described below, is built around the
concept of a sponsor, a mutual fund, a board of trustees, and an
asset management company.
The sponsor establishes the mutual fund, board of trustees, and
asset Management Company. SEBI regulations require that a
sponsor own at least a 40% share of an asset management
company and have a track record of at least five years in the
financial industry.
The concept of a mutual fund under SEBI regulations, unlike that in
Europe and the US, does not mean an individual fund offered as a

product to final investors. Such individual funds are referred to as

schemes in India. A mutual fund is defined as a fund established in
the form of a trust and with a trust deed. It is therefore a passthrough vehicle that does not make decisions or have the status of
a juridical person.
In fact, the typical use of the term mutual fund in India is similar to
what is known as a fund family in the US; the group of schemes
managed by UTI is called the UTI Mutual Fund. The board of
trustees has the authority to make all decisions related to the
mutual fund, and is governed by both SEBI regulations and the
Indian Trusts Act. Many of these mutual funds take the form of a
trustee company, in which case the 1956 Companies Act applies.
The Board of Trustees shoulders all of a mutual funds liabilities,
retains oversight over the asset management company, and has the
role of protecting the rights and interests of the final investors.
Specifically, the Board of Trustees (1) names the asset management
company (prior approval from the SEBI is required). (2) approves
the

schemes

(individual

mutual

funds)

set

by

the

asset

management company, (3) concludes an investment management

agreement

with

the

asset

management

company

to entrust

management of the assets, (4) submits to the SEBI a semi-annual

mutual fund activity report and a sworn statement that the asset
management company managed the scheme independent of its
other activities, and (5) names a custodian. Two-thirds of the
trustees must be independent of the sponsor.
The asset management company, upon approval from the Board of
trustees and the SEBI, establishes and manages a scheme under
the mutual fund. At least half of the asset management companys
board of directors must not be an associate of, or associated in any

manner with, the sponsor or the trustees. The asset-management

company must maintain at all times a net worth of Rs 100 million.

INVESTOR PROTECTION AND MUTUAL FUNDS INDIA

The SEBI (Mutual Funds) Regulations 1996 lays down many
measures to protect mutual funds investors. Some of the measures
are briefly discussed below.
SEBI has incorporated several provisions to screen mutual funds at
the entry level, similar to the provisions for a fit and proper test in
the UK. Every mutual fund shall be registered with SEBI and the
registration will be granted on the fulfillment of certain conditions
laid down in the regulations for efficient and orderly conduct of the
affairs of a mutual fund. The regulation further stipulate that the
sponsor must have a sound track record and experience in the
relevant field of financial services for a minimum period of five
years, professional competence, financial soundness and a general
reputation for fairness and integrity in all business transactions.
SEBI has laid down conditions for the appointment of trustees and
has specified their obligations as well as detailed guidelines on the
trust deed. The AMC is to be approved by SEBI. SEBI has also laid
down terms and conditions for the approval of the AMC, one of the
conditions of approval being that the AMC has a net worth of not
less than Rs 10 crores. The directors of the AMC are to be persons
having adequate professional experience in finance and financial
services- related fields. The key personnel of the AMC should not
have been working for any AMC or mutual fund or any intermediary
whose registration has been suspended or cancelled at any time by
the board. Mutual funds may have a custodian who is to be

approved by SEBI, and one of the preconditions for approval is a

sound track record, general reputation and fairness of transactions.
SEBI has laid down several provisions for pre-launch and postlaunch disclosures to ensure that investors can take informed
decisions on the basis of factual information supplied by a mutual
fund.
No new schemes can be launched by any mutual fund unless the
trustees have approved the same and a copy of document has been
filed with the board. SEBI has also stipulated that the AMC should
stipulate the minimum amount it seeks to raise under scheme and
the extent of oversubscription to be retained. There are clear
regulatory provisions regarding the listing of close-ended schemes,
refunds, transfer and sending of unit certificates to investors. In
addition it has been stipulated that the names of the trustees of the
mutual fund and the director of the AMC should be disclosed in the
prospectus of the fund. The investment objectives and strategy, as
well as the appropriate percentage share of investment to be made
in various instruments are also to be disclosed. No guarantee of
returns can be given unless they are fully guaranteed by the
sponsors or the AMC and a statement indicating the manner of
guarantees is to be made in the offer document.

A CASE STUDY - TRANSACTION IN EXCESS OF

PERMISSIBLE LIMITS
SEBI vs. Shriram Mutual Fund & Others Appeal No. 9523-24 of
2004
a) Adjudicating Officer (AO) on Shriram Mutual Fund (SMF)
imposed a penalty of Rs. 2 lakh as it had repeatedly exceeded

the permissible limits of transactions through its associate

broker, in terms of Regulation 25(7) (a) of SEBI (Mutual
Funds) Regulations.
b) On an appeal by SMF, Securities Appellate Tribunal vide its
final judgment and order dated August 21, 2003, set aside
AOs order inter alia on the ground that the limit was not
exceeded intentionally.
c) SEBI filed an appeal under SECTION 15Z of the SEBI Act in
the Honorable Supreme Court.
d) The Honorable Supreme Court pronounced its final judgment
and order on May 23, 2006. Honorable Supreme Court set
aside the judgment of SAT and settled the issues as under:

Mens rea is not an essential ingredient for contravention

of the provisions of a Civil Act.

Penalty is attracted as soon as contravention of the
statutory obligation as contemplated by the Act is
established, and therefore the intention of the parties

committing such violation becomes immaterial.

Unless the language of the statue indicated the need to
establish the element of mens rea, it is generally
sufficient to prove that a default in complying with the

statue has occurred.

Once the contravention is established, the penalty has
to

follow

and

only

the

quantum

of

penalty

is

discretionary.
The SAT has erroneously relied on the judgment of
Hindustan Steel Limited vs. State of Orissa (AIR 1970
SC 253) as the said case has no application in the
present case which relates to imposition of civil liabilities

under

SEBI

Act

and

Regulations,

and

is

not

criminal/quasi-criminal proceeding.
Imputing mens rea into the provisions of Chapter VIA
against the plain language of the statue frustrates the
entire purpose and object of introducing Chapter VIA
which was to give teeth to the SEBI to secure strict
compliance of the Act and the Regulations.

CONCLUSION
Like other countries, India has a legal framework within which
mutual funds must be constituted. Unlike in the UK, where two
distinct-trust and corporate-are allowed with separate regulations
depending on their nature-open or closed end. In India, open end
and closed end funds are constituted along one unique structure-as
unit trusts. A mutual fund in India is allowed to issue open-end and
closed-end schemes under a common legal structure. Therefore, a
mutual fund may have several different schemes (open-ended and
closed ended) under it i.e., under one unit trust at any point of
time. However, like the USA, all the funds and their open end and
closed end schemes are governed by the same regulations and the
regulatory body, the SEBI. The structure that is required to be
followed by mutual funds in India is laid down under SEBI (Mutual
Fund) Regulations, 1996.