MFs not liable for bad calls; L&T MF case sets template

Sebi stated that the asset management company (AMC) did not record detailed reasons by way of data, facts and opinions while making its buy-sell decisions. Yet, in its final adjudication on Wednesday, the regulator stepped back from imposing any fine on the firm. But the order opens the hood on internal decision-making at one of India’s large and prominent mutual fund houses.

While L&T Mutual Fund was acquired by HSBC Mutual Fund in November 2022, Sebi’s show-cause notice pertains to decisions taken by the firm between 1 April 2019 and 31 March 2021. As per the notice, L&T MF used certain standard phrases such as “investment purchase“, “switching to better opportunities”, “booking profits”. “increasing exposure”, “decreasing exposure”, etc. in support of its buying or selling of a security. Sebi pointed out three instances of such shoddy decisions at the fund house.

L&T Value Fund bought shares of Hindustan Zinc on 7 August 2020 and sold them just around a month later, on 17 September, incurring a loss of ₹1.6 crore. The reason given by the fund house for the rapid exit mentioned was ‘on account of better opportunities and raising cash.’

Responding to the notice, the AMC pointed to uncertainty regarding the delisting of Vedanta shares, the Supreme Court decision allowing arbitration proceedings against the government for Vedanta taking full control of Hindustan Zinc, etc. which led to a bona-fide view that the noticee (L&T Mutual Fund in this case) must cut its exposure.

 

L&T Infrastructure Fund bought shares of Sadbhav Engineering in April-May 2019 and sold them in April 2020 for a loss of ₹14.96 crore. The reason: raising cash for tactical reasons.

As per the show cause notice, the analyst tracking the company seemed to have referred to the standalone results of the company and not the consolidated results which showed a loss for the last four quarters.

“The fact that consolidated results was not specifically extracted in the research report does not mean that the noticee was unaware of the consolidated results, which were in the public domain.There is no stipulation that there must be a formal recording of being aware of publicly,” the AMC said in its reply.

“Investment decisions take into account a range of considerations -including the company’s future earning potential. Past performance cannot be determinative of whether an entity would perform well in the future. The decision to sell was also made at a time of heightened uncertainty during the Covid pandemic and the nationwide lockdown that was in place at the time. These are matters of commercial judgement that cannot become the subject matter of regulatory proceedings,” it added.

L&T Midcap Fund bought Vodafone Idea in December 2019 and sold it barely a month later for a loss of ₹25 crore. The reason for exiting: ‘for reducing exposure and for better investment opportunities.

The analyst’s research report dated 2 December 2019 recommended investment in the said company for medium and long term but the all shares were sold after 44 days and 70 days at an average rate of ₹4.5 per share and the AMC booked a huge loss of ₹25.43 crore, the show cause notice alleged. The annual report of 2018-19 was available on 26 July 2019, but it was reviewed on 2 December 2019, i.e. after a delay of 3 months. On perusal, it is also noted that even the name of the analyst was not mentioned in the research report dated 2 December 2019, the notice added.

“There was a material change in circumstances since the recommendation was made in December 2019. The noticee, like any prudent and responsible institution, reacted to the negative outlook on the telecom sector and the huge financial liability that Vodafone was likely to be saddled with (owing to the Supreme Court’s dismissal of the review petition against its judgement holding telecom companies liable for AGR dues),” the AMC said in its reply.

The notice also found fault with the fund house for updating its research reports on an annual rather than quarterly basis. However L&T MF disputed this. “The fact that financial results of an investee company may be available on a quarterly basis does not mean that the noticee is required to update its research reports on a quarterly basis,” it said in its reply.

In general, L&T MF disputed the principle that Sebi can question a fund for its bona fide investment decisions based on their outcome. “A profitable investment decision could be unreasoned while a loss-making decision could be supported by a plethora of reasons. The quality of diligence cannot be tested,” it said. “The notice in effect second guesses the wisdom of bona-fide commercial decisions taken by the noticee by questioning the adequacy of reasons specified by the noticee, in support of an investment decision. Investment decisions are not akin to quasi-judicial orders which are required to articulate detailed reasons that weighed with the decision maker. Investment decisions are informed by a range of considerations that are essentially subjective,” it added.

In its final order, Sebi noted that there are no specific timelines within which a mutual fund has to update research reports. There is nothing to negate the claims of L&T MF that it was monitoring its portfolio actively. Hence Sebi did not impose any penalty.

“The show-cause notice, however, shows the regulator’s commitment to its investor protection agenda. Instances like this also highlight the industry’s adoption of integrity and best practices. The case is a reminder for industry participants to ensure that reasonable analytical rigour is employed and recorded with equal diligence. One can expect the regulator to fine-tune the regulations around the maintenance of records and adequacy of investment rationales soon enough. Like with most other regulations, such enhancements can be expected to serve as strong guardrails while being conscious enough to offer asset managers enough flexibility to effectively deliver upon their stated mandate,” says Nirav Karkera, head of research at Fisdom.