The Securities and Exchange Board of India (“SEBI”) vide its circular dated April 28, 20211 (“Circular”)2 has introduced a regulatory framework for alignment of interest of the key employees (“Key Employees”) of asset management companies (“AMCs”) with that of the unitholders of the mutual fund scheme. While SEBI has taken steps to standardise the mutual fund scheme categories and characteristics of each category3, the management of risk return profile of the mutual fund schemes rests with the AMCs and the Key Employees. The Key Employees of an AMC hold the position of trust and responsibility and have access to all the price sensitive information. The code of conduct for fund managers and dealers introduced by SEBI4 prohibits the Key Employees from unfair use of such information and places a fiduciary duty upon the Key Employees to not engage in any unethical practices with respect to such information. However, basis various observations received from the market stakeholders and analysis of audit reports by SEBI, it was observed by that certain employees and trustees of the AMCs took undue advantage of the price sensitive information they had about the company which led to a conflict of interest between the Key Employees and the unitholders of the mutual fund schemes.5 This also led to abuse of individual position of trust and responsibility by the Key Employees and the trustees of the AMCs.
In the aforesaid background, SEBI, on the recommendations received from the SEBI Mutual Fund Advisory Committee, mandated the payment of compensation of the Key Employees of the AMCs in the form of units of mutual fund schemes in which they have a significant role as a good stewardship practice and to ensure an increased trust of investors in mutual funds. This article briefly with the framework prescribed under the Circular and its overall impact.
The Circular prescribes the framework for compensation of the Key Employees of the AMCs in the form of units of the scheme(s). The salient features of the Circular are as under:
|Applicability of the Circular
|Compensation of Key Employees
|Proportion of compensation
|Period of compensation
|Lock-in period of minimum 3 (three) years or the tenure of the scheme, whichever is less.
|Option of diversifying the unit holdings
|In case of dedicated fund managers managing only a single scheme/ single category of schemes, 50% of compensation may be by way of units of the scheme managed by the fund manager and the remaining 50% may be by way of units of those schemes whose risk value as per the risk-o-meter is equivalent or higher than the scheme managed by the fund manager.
|Redemption of the units
|Redemption of units in case of resignation and superannuation
|Oversight of compliance
|Disclosure of compensation
|Every scheme to disclose the compensation, in aggregate, paid in the form of units to the Key Employees on the website of the AMC.
The implementation of the Circular shall surely introduce greater accountability in the scheme performance as the key employees shall share the investment risk at par with the unitholders of the scheme. This shall ensure a deeper commitment from Key Employees in their own schemes, thereby positioning mutual fund investing as a preferred and trusted route for investors. However, by introducing a wide definition for who would be classified as a “Key Employee” for the purposes of the Circular, SEBI has inadvertently put small fund houses who do not offer a hefty package to its key personnel in a tough spot, particularly in the current COVID struck times as such fund houses risk losing its key talent. In other fund houses also the junior talent that squarely falls within the definition shall be forced to lock twenty percent (20%) of their income for a period of three (3) years which shall create cash flow issue. Further, creates a window of regulatory arbitrage in favour of exchange traded funds, index funds, overnight funds that have been explicitly excluded from the purview of the Circular. The clawback of the units being triggered in the event of violation of code of conduct, fraud and gross negligence shall be beneficial from a market standpoint. Overall, the Circular is a double edged sword as it introduces greater accountability which is a positive for the market, and at the same time it throws up several implementation challenges and it shall be interesting to see how the market responds and adapts to the same.