Mutual fund due diligence and fair valuation duties require timely disclosure, maturity compliance and prompt redemption for close-ended debt schemes.

Asset management companies must conduct issuer-specific due diligence and maintain research records before investing close-ended debt schemes, rather than relying on promoter reputation, refinancing expectations or collateral analysis alone. Material deterioration in collateral and repayment prospects must be disclosed promptly to unitholders. Close-ended schemes may invest only in securities maturing by the scheme maturity date unless a compliant rollover, including required disclosures and unitholder consent, is undertaken. Schemes must be fully wound up and redemption proceeds dispatched within the prescribed period. Withholding affected debt exposure while paying other assets may create an unauthorised segregated portfolio, although the described breach was treated as technical. Debt instruments must be fairly valued at their realisable value, reflecting heightened credit risk and repayment uncertainty.

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Issues: (i) Whether the asset management company exercised due diligence and maintained adequate research records before investing the fixed maturity plans in the issuers' zero coupon non-convertible debentures; (ii) Whether adverse developments affecting the collateral and repayment prospects were timely disclosed to unitholders; (iii) Whether extension of the debentures' maturity beyond the maturity of the close-ended schemes was permissible; (iv) Whether partial redemption and delayed payment to unitholders violated the requirements for winding up and redemption of close-ended schemes; (v) Whether withholding the exposure to the issuers created an impermissible segregated portfolio; (vi) Whether the debentures were valued in accordance with fair-valuation requirements.

Issue (i): Whether the asset management company exercised due diligence and maintained adequate research records before investing the fixed maturity plans in the issuers' zero coupon non-convertible debentures.

Analysis: Regulations 25(1), 25(2) and 25(16), read with clauses 6 and 9 of the Fifth Schedule, required reasonable diligence, proper care, independent professional judgment and investment solely in unitholders' interests. The circular dated 27.07.2000 required records supporting each investment decision and a detailed research report analysing relevant factors for a first investment. The investment approval material did not identify or meaningfully assess the issuers, their financial condition, repayment capacity, actual pledged-share exposure, or downside risks. The investment was principally premised on the reputation of the promoter group, anticipated refinancing and a 1.50-times equity collateral cover, notwithstanding the issuers' weak financials and the volatility and inadequacy of that collateral. Research relating to the collateral company could not substitute research into the issuers of the debt instruments.

Conclusion: The asset management company failed to exercise due diligence, proper care and high professional standards, and failed to maintain the required issuer-specific research basis for the investments, against the asset management company.

Issue (ii): Whether adverse developments affecting the collateral and repayment prospects were timely disclosed to unitholders.

Analysis: Clause 2 of the Fifth Schedule required adequate, accurate, explicit and timely dissemination of information concerning the scheme's financial position and affairs. The fall in the collateral cover, the failure to replenish it, the proposed restructuring through lenders, and the failure of that arrangement were material adverse developments requiring prompt disclosure. Disclosure was instead made shortly before scheme maturities, after a substantial delay. The available registrar confirmation and email records, however, established that status communications were sent to investors; therefore, the distinct charge that there was no proof of communication was not sustained.

Conclusion: The delayed disclosure of material adverse developments violated the timely-information obligation, against the asset management company.

Issue (iii): Whether extension of the debentures' maturity beyond the maturity of the close-ended schemes was permissible.

Analysis: The circular dated 11.12.2008 required a close-ended debt scheme to invest only in securities maturing on or before the scheme's maturity date. A rollover required compliance with Regulation 33(4), including the prescribed disclosures and written consent of unitholders. Extending the issuers' debentures until 30.09.2019 was an active investment decision that caused the securities to mature after the schemes, without a compliant rollover or unitholder consent. The provisions concerning non-performing assets or illiquid securities did not apply because the debentures were neither declared non-performing nor treated as such.

Conclusion: The extension of the debentures beyond the schemes' maturity dates was impermissible and violated the applicable investment restrictions, against the asset management company.

Issue (iv): Whether partial redemption and delayed payment to unitholders violated the requirements for winding up and redemption of close-ended schemes.

Analysis: Regulations 39(1) and 53(b), read with the Code of Conduct, required close-ended schemes to be wound up on expiry and redemption proceeds to be dispatched within 10 working days. Because the asset management company had extended the debentures, it lacked the full scheme assets at maturity and made only partial payments, with final payments occurring in September 2019. Regulation 53(b) was applicable to redemption on maturity of close-ended schemes, as also reflected in the scheme documents.

Conclusion: The failure to fully redeem the schemes and pay the unitholders within the prescribed period violated the winding-up and redemption requirements, against the asset management company.

Issue (v): Whether withholding the exposure to the issuers created an impermissible segregated portfolio.

Analysis: By paying the portion of the portfolios represented by other securities while withholding payment attributable to the issuers' debentures until September 2019, the portfolios were effectively divided into a main portion and a separate portion containing the affected debentures. This was done without an enabling scheme provision, acknowledgement of a credit event, or compliance with the procedure under the circular dated 28.12.2018. Given that the schemes were close-ended, the segregation had no standalone impact on investors.

Conclusion: The conduct amounted to an unauthorised segregated portfolio, but was treated as a technical violation not requiring further action.

Issue (vi): Whether the debentures were valued in accordance with fair-valuation requirements.

Analysis: Regulations 25(19) and 47 and the Eighth Schedule required valuation reflecting the realisable value of investments. The applicable valuation circulars required fair valuation for debt securities with residual maturity exceeding 60 days. Following the collateral shortfall, inability to restore security cover, uncertainty regarding repayment and the extended maturity, the debentures' values should have reflected the heightened credit risk. Continued amortisation-based and incrementally increasing values did not reflect market reality. Outsourcing valuation did not displace the asset management company's statutory responsibility, and incorrect NAV also affected trading in units of the listed close-ended schemes.

Conclusion: The debentures were not fairly valued at their market realisable value, against the asset management company.

Final Conclusion: The established failures in diligence, disclosure, scheme-maturity compliance, redemption and valuation warranted regulatory, compensatory and monetary consequences, while the portfolio-segregation breach was confined to a technical contravention.

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