Legal & Regulatory Environment - Chapter 2

Legal & Regulatory Environment - Chapter 2

One of the major advantages of the mutual fund route has been that it is very closely regulated. Apart from SEBI, which is the nodal regulator for mutual funds, there are multiple levels of regulation that make mutual funds a lot more structured in their approach. Here are some of the key regulators and the way they regulate the mutual funds business. Remember, regulation of mutual funds is a mix of external regulation as per the statute and self regulation.

Major Regulation Points For Mutual Funds In India

While mutual funds as an intermediary are regulated by SEBI, mutual funds also come under RBI regulation for debt funds and liquid funds as they predominantly invest in government paper. In addition, there is also a first level regulation of mutual funds by NSDL and CDSL for their demat activity and by NSE and BSE in case of listed mutual funds. Let us look at the multiple regulation points for mutual funds.


Regulation of mutual funds by SEBI

Securities and Exchange Board of India (SEBI) is the regulatory authority for securities markets in India.  It regulates, among other entities, mutual funds, depositories, custodians and registrars and transfer agents in India. The relevant guidelines governing mutual funds are laid out in the SEBI (Mutual Funds) Regulations, 1996, as amended time and again. For a detailed and comprehensive list of circulars issued by SEBI on this subject, one can visit the mutual funds section on the SEBI website, In case, mutual funds or mutual fund investors or intermediaries are aggrieved by a ruling of SEBI, they can always file an appeal with the Securities Appellate Tribunal (SAT).

Regulation of mutual funds by RBI

While SEBI continues to be the nodal regulating agency for the mutual funds, some segments have their own independent regulatory bodies. For instance, RBI regulates the money market and foreign exchange market in the country. Therefore, mutual funds need to comply with RBI regulations regarding investment in the money market, investments outside the country, investments from people other than resident Indians, remittances (inward and outward) of foreign currency etc.


Self Regulatory organizations (SRO) for mutual funds

The role of SRO in MF regulations needs to be understood clearly. SEBI only lay down the broad policy framework, and leave the micro-regulations to the SRO. In the context of mutual funds, exchanges like the NSE, BSE and MSEI as well as the principal depositories like NSDL and CDSL are vested with self-regulatory responsibilities. Mutual Funds in India are in the process of getting an SRO to oversee its distributors. AMFI is not an SRO.


AMFI regulation – as an association not as an SRO

AMCs in India are members of Association of Mutual Funds in India (AMFI), an industry body created to promote the interests of mutual fund industry. This is akin to associations like CII, ASSOCHAM, NASSCOM, FICCI etc. AMFI has the following objectives.

  • To define and maintain high professional and ethical standards in all areas of operation
  • To recommend and promote best business practices and code of conduct for members
  • To interact with SEBI and represent on all matters concerning mutual funds
  • To represent MFs to the Government, RBI and other bodies
  • To develop a cadre of well-trained agent-distributors with training and certification
  • To undertake nationwide investor awareness programme to promote mutual funds
  • To disseminate credible and reliable information on mutual fund Industry

AMFI has outlined detailed AMFI Code of Ethics (ACE) and the AMFI code of conduct for Intermediaries. We shall see this in greater detail at the end of the chapter.


SEBI Guidelines For Circulation Of Unauthenticated News


SEBI issued guidelines to all market intermediaries relating to circulation of unauthenticated news through various modes of communication. Highlights are as under:

  • Market intermediaries registered with SEBI must enforce internal code of conduct for employees/temporary staff/voluntary workers etc and must not encourage or circulate rumours or unverified information
  • Access to Blogs/Chat forums/Messenger sites should either be restricted or supervised and proper logs maintained for audit trail.
  • Employees should be instructed that any market related news should be forwarded only after the same has been seen and approved by the Compliance Officer. The code must also define penalties for violation of the code of conduct.


SEBI Defined Due Diligence Process For Distributors Of Mutual Funds

SEBI has mandated AMCs to put in place a due diligence process to regulate distributors subject to their qualifying on one of the criteria:

  1. Multiple point presence (More than 20 locations)
  2. AUM raised over Rs. 100 crore in the non-institutional category
  3. Commission received of over Rs.1 Crore annually across industry
  4. Commission received of over Rs.50 Lakhs from a single mutual fund

At the time of empanelling distributors and during the review process, the AMC has to undertake due diligence process of the distributor on a number of factors including business model, experience, proficiency, track record, regulatory record, organizational controls, capacity for customer risk evaluation, ability to customize solutions etc.

The AMC shall also review the compliance and risk management functions of the distributor, which will inter alia include:

  • The criteria for review of products
  • Parameters to include when judging risk appetite of clients
  • Review of transactions, escalation and resolution
  • Recruitment, training, certification of sales personnel
  • Customer on-boarding and relationship management process
  • Servicing standards and grievance handling mechanism
  • Internal / external audit processes

SEBI Regulation – Investment Restriction On Schemes

SEBI Regulations provide for various limits to the kind of investments permitted. There are general restrictions and group level restrictions. Here are some key SEBI restrictions.

General Restrictions

  • Mutual Funds can only buy and sell securities on delivery basis in the name of the respective scheme
  • The Mutual Fund shall not advance loans or invest in unlisted or privately placed securities of any group company of the sponsor
  • A Scheme can invest in other schemes of the same Mutual Fund or other Mutual Funds limited to 5% of the scheme NAV
  • Mutual Fund under all its schemes shall not own more than 10% of a company’s paid up capital bearing voting rights

Restrictions on investment in Debt Securities

  • Scheme shall not invest more than 10% of its NAV in investment grade debt instruments issued by a single issuer.
  • Investment in unrated debt securities of a single issuer shall be limited to 10% of its net assets and the total investments shall not exceed 25%
  • Parking of funds in short-term deposits with all scheduled commercial banks shall be limited to 15% percent of the net assets of the scheme

Restrictions on Group Exposure

Mutual Funds / AMCs shall keep the total exposure of debt schemes of mutual funds in a particular sector to a limit of 25% percent of the net assets of the scheme. Recent regulations have made debt investment restrictions more stringent after the crisis surrounding IL&FS and the Essel Group.

Restrictions on investment in Equity

  • At least 80% of the ELSS funds should be invested in equity and equity-linked securities to qualify for Section 80C benefits
  • Any equity Scheme shall not invest more than 10% percent of its net assets in the equity shares and equity related instruments of one company
  • Not more than 5% of the net assets of the scheme will be invested in unlisted equity shares and equity related instruments.

Investment Objective, Investment Policy And Investment Strategy

These are not regulatory restrictions but internal definitions of the AMC that define the investment contours of each fund scheme. Let us look at what these 3 concepts actually are.

  1. Investment Objective defines the broad investment charter and can include capital appreciation, stability, regular returns, diversification etc
  2. Investment Policy describes in elaborate detail the kind of portfolio that will be maintained by the specific mutual fund
  3. Investment Strategy outlines the approach to be followed in investing the funds to achieve the investment objective


SEBI Regulation – Investor Rights And Obligations

Investors in mutual funds are assured of a number of rights in terms of service standards, information receipt, redressal of grievances etc. Let us look at some of the major rights of the investors in mutual funds under various categories.

Service Standards mandated for a Mutual Fund

  • Schemes other than ELSS and RGESS can remain open for subscription for a maximum of 15 days and must allot units or refund money within 5 business days of closure of NFO.
  • In the event of delays in refunds (in case of NFOs), investors need to be paid interest at the rate of 15% for the period of the delay and must be borne by the AMC
  • Open-ended schemes, other than ELSS, have to re-open for ongoing sale / re-purchase within 5 business days of allotment
  • Statement of accounts are to be sent to investors within 5 days of the transaction except in case of SIP/STP/SWP where it can be sent in 10 days
  • Statement of Account must be sent to active investors regularly and on demand at no cost. For dormant investors it can go with the annual statement.
  • Consolidated Statement of Accounts (across mutual funds based on PAN of the investor) must be sent to investor by email every calendar month of transactions in the folio
  • Investor can choose to hold the mutual fund units in the form of unit certificates or in their demat accounts
  • The daily NAV must be published in at least 2 daily newspapers having circulation all over India while the NAV and re-purchase price are to be updated in the website of AMFI and the fund by 9 pm the same day
  • The investor can pledge the units to offer security to a financier. In addition, dividend warrants must be dispatched to investors within 30 days of declaration while redemption cheques must be dispatched within 10 working days


Other Rights of Investors

  • Unit-holders have proportionate right to the beneficial ownership of the assets of the scheme
  • Investors can choose to change their distributor or go direct by giving a request for shifting from regular plan to direct plan.
  • In the case of unit-holding in demat form, demat statement issued by the DP will be treated as compliance with the requirement of Statement of Account
  • Mutual fund must publish a complete statement of the scheme portfolio and the half-yearly unaudited financial results within 1 month from the close of each half year.
  • Debt-oriented, close-ended/interval-schemes/plans need to disclose their portfolio in their website every month, by the 3rd working day of the succeeding month
  • Unit-holders have the right to inspect key documents such as the Trust Deed, Investment Management Agreement, RTA agreement, MOU and MOA of the AMC

What the Consolidated Account Statement must contain

Consolidated Account Statement provides information in terms of schemes where the investor has invested, number of units held and its market value. It must include

  1. the amount of actual commission paid by AMCs/Mutual Funds to distributors (in absolute terms)
  2. The schemes average Total expense ratio (in percentage terms) for each scheme’s applicable plan (regular, direct or both) where he is invested in.

Consolidation of Schemes

Merger or consolidation of schemes is not a change in the fundamental attribute of the surviving scheme if the following conditions are met:

  • There is no other change in the Fundamental attributes of the surviving scheme i.e. the scheme which remains in existence after the merger
  • Mutual Funds are able to demonstrate that the circumstances merit merger or consolidation of schemes and the interest of the unit holders is protected
  • The letter to unit holders shall be issued only after the final observations communicated by SEBI have been incorporated

Limitation of Rights of Unit-holders

  • The trust is a notional entity and hence investors cannot sue the trust but they can file suits against trustees
  • The principle of caveat emptor (let the buyer beware) applies to mutual fund investments.
  • A proposed investor i.e. someone who has not invested in the scheme does not have the right to sue the AMC as he has no invested interest.
  • Investor is obliged to adhere to compliance with respect to PAN No. and KYC documentation except in case of micro SIPs



The AMFI is an industry association to further the long term interests of the mutual fund industry and to represent the mutual funds to the various regulatory and external agencies. Here are some of the key highlights of the AMFI code of ethics.


Members of AMFI (asset management companies) and their key personnel shall conduct themselves with the highest standards of integrity and fairness in all dealings with investors, issuers, market intermediaries, other members and regulatory authorities. In addition, MF schemes shall be organized, operated, managed and their portfolios of securities selected, in the interest of unit holders.

Due diligence

Members shall conduct their business with high standards of service and exercise due diligence and independent professional judgment.


Members must ensure timely dissemination to all unit-holders of adequate, accurate, and explicit information pertaining to investment objectives, investment policies and financial position of the scheme. Members shall periodically disclose to unit-holders investment pattern, portfolio details, ratios of expenses to net assets and total income and portfolio turnover. In addition, all transactions of key management personnel shall be disclosed to avoid conflict of interest.

Professional selling practices

Members shall not use unethical means to induce investors to buy and shall not make exaggerated statement regarding performance of any product or scheme. Investors must be educated of attendant risks in schemes before any investment decision. Members shall deal with fairness with investors. As a matter of policy, no member is allowed to guarantee returns to the investors in mutual funds.

Investment practices

Members must manage schemes in accordance with investment objectives stated and shall not knowingly buy or sell securities for any of their schemes from inside officials.


Members shall avoid conflicts of interest in managing schemes. No officer of the AMC should indulge in front running or self-dealing. Members shall not create false market through price rigging or manipulation or pass sensitive information around. Officers and directors of Members shall not work as agents/ brokers for selling of the schemes. Members are also expected to avoid excessive concentration of business with any broking firm

Reporting practices

Members must follow standardized valuation policies and uniform performance reporting of total return.

Unfair competition

Members of AMFI shall not make any statement or become party to any act, practice or competition that is likely to be harmful to the interests of other Members or is likely to place other Members at a disadvantage.

Observance of statutes, rules and regulations

Members shall abide by the letter and spirit of the provisions of the Statutes, Rules and Regulations which may be applicable and relevant to the activities carried on by the Members.


Members must widely disseminate the AMFI Code to all persons and entities covered by the code and encourage and ensure strict adherence to this code to the best of their ability and capacity. Members must also ensure that adequate time, resources and manpower are dedicated to the observance of the code of ethics in letter and in spirit



AMFI has defined and outlined a detailed code of conduct for the intermediaries of mutual funds covering distribution and selling to put the best interest of unit-holders on top.

  • Take necessary and adequate steps to ensure that investor’s interest is protected in all circumstances
  • Adhere to all SEBI Mutual Fund Regulations and guidelines issued from time to time with reference to distributors as well as pertaining to selling, distribution and advertising practices.
  • Comply with SEBI guidelines on preparation of sales, promotional or other literature about schemes. Performance disclosures should also comply with the requirements specified by SEBI.
  • Clearly highlight risk factors of each scheme and desist from misrepresentation and exaggeration
  • Disclose to the investors all material information including all commissions (in the form of trail or any other mode) received for the comparable schemes
  • Refrain from indicating or assuring returns in any type of scheme, unless the scheme is explicitly an assured return scheme
  • Maintain necessary infrastructure to support the AMCs in maintaining high end-to-end service standards to investors.
  • Avoid faulty business practices such as wrong claiming of dividend/redemption cheques, splitting of applications etc.
  • Avoid commission driven malpractices like recommending inappropriate products, encouraging churning and splitting applications
  • Avoid making negative statements about another AMC or scheme and let all comparisons be objective and relevant.
  • Keep abreast with the developments relating in the Mutual Fund Industry as also scheme attributes like loads, liquidity provisions and other material aspects
  • Maintain confidentiality of all investor details, deals and transactions and respect the privacy of investors and their wealth and status
  • Intermediaries shall design solutions to investor needs and shall not rebate commission back to investors nor tempt investors with gifts
  • Take reasonable steps to ensure that the address and contact details filled in the mutual fund application form are investors’ own details. Intermediary should make reasonable efforts to obtain accurate and updated information from the investor and verify it. Any type of changes in the form or tampering is against the code of ethics
  • Sales personnel of intermediaries engaged in sales / marketing shall obtain NISM certification and register with AMFI as also obtain an Employee Unique Identification Number (EUIN) from AMFI
  • Intermediaries shall comply with the Know Your Distributor (KYD) norms and also co-operate with AMCs, AMFI, competent regulatory authorities
  • Furnish all investor documents like Anti-Money Laundering / Combating Financing of Terrorism requirements, including KYC documents / Power of Attorney etc. from time to time.
  • Be diligent in attesting / certifying investor documents and performing In Person Verification (IPV)
  • Adhere to AMFI guidelines and Code of Conduct issued from time to time related to distributors as well as selling, distribution and advertising practices
  • Intimate the AMC and AMFI any changes in the intermediary’s status, constitution, contact details
  • Observe high standards of ethics, integrity and fairness in all its dealings with all parties and render high standards of service
  • Intermediaries shall maintain requisite documentation in respect of the “Advisory” or “Execution Only” services provided by them to investors
  • Intermediaries shall refund to AMCs, all incentives of any nature, including commissions received, that are subject to claw-back as per SEBI regulations
  • In respect of purchases (including switch-in) into any fund from January 1, 2013 from Regular Plan to Direct Plan; all upfront commissions paid are clawed back
  • Desist from fraudulent or unfair trade practices of any kind while selling units of Schemes of any mutual fund. Selling of units of schemes of any mutual fund by any intermediary via false or misleading statements; will be construed as fraudulent / unfair trade practice and appropriate action will be initiated.