2025 (11) TMI 686 - AT - SEBI

Inter-scheme transfers by AMC lawful under Schedule-VII and July 27, 2000 SEBI circular; IST rules override general duties

The SAT (LB) allowed the appeals, holding that inter-scheme transfers (ISTs) by the AMC were legally permissible and complied with specific MF provisions ... Mutual fund schemes - Inter-scheme Transfers (ISTs) - transfers of certain debt securities by an asset management company (AMC) from open-ended schemes to close-ended schemes (inter-scheme transfers, 'ISTs') - violations of the provisions of MF Regulations and applicable SEBI Circular - CEO and the 3 Fund Managers failure to discharge their duty in carrying out adequate research, record-keeping and conflict management in respect of such ISTs from open-ended schemes qua the investors of close-ended schemes - Applicability of general due diligence and Code of Conduct provisions vis-à-vis specific IST provisions - principle of generalia specialibus non derogant - HELD THAT:- It is not in dispute that such Inter-scheme Transfers (ISTs) are permissible in law and are not unusual in the MF industry, as AMCs keep rebalancing their portfolio, depending upon the business prudence. The appellant too had carried out in all 315 ISTs during the Inspection period. We do not find that respondent has made out a case for violation of the circular dated July 27, 2000. Undisputedly, the original investment decision in respect of these 5 debt securities was made in 2014 and, there is no finding that it was not in accordance with the investment objective of the schemes of AMC. With regard to subsequent impugned ISTs of these 5 debt securities, which the AMC was holding since 2014, from its open-ended to close-ended schemes, reasons have been recorded. Undisputedly, there was no fresh purchase of the same scrips from the market. Thus, the ISTs duly complied with the process of due diligence as stipulated in the circular of July 2000. In the absence of any allegation of private gains or having positions in the open-ended schemes, their business decisions cannot be questioned on the whims and fancy of the AO after a considerable gap of time. The regulator is expected to ensure that due process is followed in such rebalancing. Under the circumstances, even violation of Para-6 is not proved. In our considered view, decision of the AMC to transfer certain securities from one scheme to another is purely a professional business decision taken by the fund manager in accordance with due process, following the decision of the investment committee and on recording reasons in terms of circular of July 2000. No finding has been brought before us as to whether the trustees and AMC lacked in their integrity. Hence, there is no case for violation of Para-8 either. Moreover, as held by us, these general allegations without being supported by specific evidences, cannot be the sole basis for holding the impugned ISTs in violation of MF regulations, brushing aside the finding that the same are compliant with the specific provisions of Schedule-VII. In view of the principle of generalia specialibus non derogant, in the event of conflict between a general provision and a specific provision, the specific provision will prevail over the general one. Applying this principle, the Hon’ble Supreme Court in J.K. Cotton Spinning & Weaving Mills Co. Ltd. vs. State of UP17 [1960 (12) TMI 77 - SUPREME COURT], has held that in cases of conflict between a specific provision and a general one, the specific prevails over the general and the general provision applies only to such cases which are not covered by the special provision. The appellant has contended that out of 5 such debt securities, in 4 projected returns have yielded, while the 5th one suffered a minor loss - Having held that the AO cannot step into the shoes of the professional experts, we don’t find it appropriate to examine the business prudence of the decisions of the AMC. We have already held that the appellant had met the specific conditions for such ISTs in terms of Schedule-VII and exercised due diligence as per the July 27, 2000 circular. We further note that this circular also requires AMCs to develop a mechanism to verify exercise of due diligence for making investment decisions, which is to be reported by the AMC in their reports to trustees, who, in turn, are required to report the same to the SEBI in the half-yearly reports. However, keeping in view our decision in the matter, we do not need to probe it further. Appeals are allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether transfers of certain debt securities by an asset management company (AMC) from open-ended schemes to close-ended schemes (inter-scheme transfers, 'ISTs') during the inspection period violated the specific conditions of Paragraph 3, Schedule VII of the Mutual Fund Regulations (prevailing market price; conformity with investment objective) or the general duties of due diligence, care and fiduciary obligations under Regulation 25(1), 25(2) and Clauses 4, 6, 8 and 9 of the Code of Conduct in Schedule V. 2. Whether the regulator (Adjudicating Officer) could, on the basis of inspection findings, apply general standards of due diligence and conflict-of-interest principles to impugn bona fides of ISTs that complied with specific procedural requirements in Schedule VII and the SEBI circular dated July 27, 2000. 3. Whether absence of contemporaneous adverse public information, reliance on ratings, subsequent repayment outcomes, internal minutes and investment committee processes negate or support findings of breach of due diligence, conflict of interest, or unfair treatment of unit-holders. 4. Whether comparison with practices of other AMCs (lack of empirical yardsticks) and hindsight assessment of securities' subsequent performance can justify findings of regulatory violation and imposition of penalty without considering statutory mitigating factors. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Legality of ISTs under Paragraph 3, Schedule VII and July 27, 2000 Circular Legal framework: Paragraph 3, Schedule VII permits transfers between schemes only if (a) at prevailing market price on spot basis and (b) securities conform to transferee scheme's investment objective. The July 27, 2000 Circular prescribes recording of detailed investment report for first-time investments and reasons for subsequent purchases/sales; mechanism for due diligence and reporting to trustees/SEBI. Precedent treatment: Principle of specific provision prevailing over general (generalia specialibus non derogant) applied; reference to regulatory sequencing and subsequent circulars that imposed additional safeguards later (Oct 8, 2020) noted as not applicable to inspection period. Interpretation and reasoning: The Tribunal examined whether ISTs contravened the two specific conditions. No allegation or evidence established that transfers were not at prevailing market prices or that transferred securities were outside the investment objectives of transferee schemes. The initial investments dated to 2014 complied with the circular's due diligence process; subsequent ISTs involved no fresh market purchases and were accompanied by recorded reasons and investment committee consideration. Ratio vs. Obiter: Ratio - Specific Schedule VII conditions govern legality of ISTs and were satisfied; therefore ISTs not unlawful on that basis. Obiter - Observations on inapplicability of later circular safeguards to the inspection period. Conclusions: ISTs met the specific statutory requirements and the July 27, 2000 Circular's procedural due-diligence framework; no violation of Paragraph 3, Schedule VII or the circular established. Issue 2 - Applicability of general due diligence and Code of Conduct provisions vis-à-vis specific IST provisions Legal framework: Regulation 25(1) requires reasonable steps and due diligence to ensure investments are not contrary to regulations and trust deed; Regulation 25(2) requires due diligence akin to that exercised by others in the business; Clauses 4, 6, 8, 9 of Schedule V impose duties to avoid conflicts, act in unitholders' interest, maintain integrity/fairness and exercise independent professional judgment. Precedent treatment: Applied doctrine that specific statutory provisions (Schedule VII) displace or constrain general provisions when in conflict; referenced principle from authority that specific provision prevails over the general. Interpretation and reasoning: The Tribunal held that the AO relied on general standards of due diligence and conflict avoidance to override the specific IST regime. There was no pleading or evidence that ISTs contravened trust deed or investment objectives (Reg. 25(1)), nor that the AMC derived private/personal gain or had undisclosed conflicts (Clause 4). On Reg. 25(2), absence of empirical comparators or defined yardsticks made a claim that due diligence was below industry standard unsustainable. Documentary evidence showed investment committee deliberations and recorded rationales, and compliance with July 27, 2000 circular processes. Ratio vs. Obiter: Ratio - Where a specific regulatory framework governs ISTs and its conditions are satisfied, general allegations of insufficient due diligence/conflict cannot stand without specific evidence; Obiter - Caution against expanding conflict-of-interest concept to inter-unit-holder preference absent personal interest. Conclusions: Findings of breach of Regulation 25(1), 25(2) and Clauses 4, 6, 8, 9 cannot be sustained when specific Schedule VII conditions and circular procedures are met and no evidence of personal conflicts or trust-deed contraventions exist. Issue 3 - Use of hindsight, ratings, contemporaneous information and internal minutes in assessing due diligence Legal framework: Regulatory assessment must be based on contemporaneous information and reasonable standards of professional judgment; due diligence is judged as reasonable prudence, not perfection (citing Chandra Kanta Bansal principle as to 'reasonableness'). Precedent treatment: Tribunal emphasized limits on regulator substituting its view for professional decisions of fund managers; reliance on outcome-based hindsight is improper to establish breach where procedural requirements met. Interpretation and reasoning: The Tribunal reviewed conflicting contentions about whether securities were 'stressed' at time of ISTs. It found that some adverse statements of the AO were contradicted by investment committee minutes and that the AMC had documented rationales. Subsequent repayment or losses were not determinative; however, because specific formal requirements were satisfied and no contemporaneous prohibition or objective contravention was shown, hindsight could not be the sole basis for violation findings. The Tribunal declined to evaluate business prudence of fund managers beyond verifying compliance with prescribed processes. Ratio vs. Obiter: Ratio - Hindsight assessment of security performance cannot supplant evidence of contemporaneous due diligence and compliance with specific procedural safeguards; Obiter - Notes on evidentiary weight of investment committee minutes and ratings. Conclusions: Absence of contemporaneous adverse information identified by regulator and presence of recorded rationales weigh against finding inadequate due diligence; hindsight does not justify regulatory penalty in such circumstances. Issue 4 - Comparative practices, empirical yardsticks, and mitigation in penalty imposition Legal framework: Regulation 25(2)'s 'same as other persons' standard requires appropriate comparators and empirical basis; Section 15J (penalty mitigation) principles require consideration of disproportionate gain, investor loss and repetitive defaults when imposing penalties (as argued by appellants). Precedent treatment: Tribunal required tangible comparative evidence to hold conduct inconsistent with industry standard; noted that later SEBI circulars introduced further safeguards but were not retrospective. Interpretation and reasoning: The AO's generalized assertion that such ISTs were not observed in other AMCs lacked defined metrics; given heterogeneity of schemes and strategies, comparison without empirical findings is unreliable. The Tribunal found that imposing penalties without considering statutory mitigating factors and without demonstrating investor loss or unfair advantage was inappropriate. Ratio vs. Obiter: Ratio - Regulatory findings based on industry-comparison require empirical yardsticks; penalty should not follow from unsupported generalizations. Obiter - Comment that trustees and regulators remain responsible for oversight but must respect procedural and evidentiary bounds. Conclusions: Absent empirical comparison and demonstrable investor harm or unfair gain, penalty imposition was unwarranted; mitigation considerations were not properly applied. Overall Conclusion and Disposition The Tribunal concluded that the ISTs complied with the specific statutory conditions in Schedule VII and the procedural due-diligence requirements of the July 27, 2000 Circular; general allegations of lack of due diligence, conflict of interest and unfairness under Regulation 25 and Schedule V were not substantiated with specific evidence. Application of general standards could not override specific provisions; outcome-based hindsight and unsupported industry comparisons were insufficient to sustain findings or penalties. Accordingly, the Tribunal set aside the adjudicating order and allowed the appeals with no costs.