India's Supreme Court on Monday upheld the Securities and Exchange Board of India's (SEBI) penalties totalling Rs 2.1 crore on Kotak Mahindra Asset Management Company, its trustee company and six senior executives, ruling that mutual fund regulations must be followed regardless of whether investors ultimately made money.
A bench of Justices Dipankar Datta and Satish Chandra Sharma dismissed appeals filed by Kotak AMC, Kotak Mahindra Trustee Company and senior executives including Managing Director Nilesh Shah, affirming findings of the Securities Appellate Tribunal and SEBI that they breached mutual fund regulations while managing six fixed maturity plans in 2019.
The court upheld a Rs 50 lakh penalty on Kotak AMC and Rs 1.6 crore of penalties on the trustee company and six executives, including Rs 30 lakh on Shah. It also imposed litigation costs of Rs 30 lakh on Kotak AMC and Rs 20 lakh on the trustee company.
The case arose from Kotak Mutual Fund's investments of Rs 266 crore in zero coupon non-convertible debentures issued by Konti Infrapower & Multiventures Pvt. Ltd. and Edison Utility Works Pvt. Ltd., both part of the Essel group. The debt was backed by pledged shares of Zee Entertainment Enterprises.
After Zee shares fell sharply in early 2019, reducing the value of the collateral, Kotak opted to restructure the debt instead of invoking the pledged shares. That decision resulted in delays in redeeming six close-ended fixed maturity plans, with around Rs 376 crore being paid to investors after the schemes had matured.
SEBI alleged that Kotak AMC failed to carry out adequate due diligence before investing in financially weak Essel entities, unlawfully extended the maturity of the debt instruments beyond the schemes' maturity dates and failed to adequately disclose its actions to investors and the regulator.
Rejecting Kotak's defence that investors ultimately benefited because the restructuring prevented losses, the court held that "market integrity being the paramount consideration, profit or loss to investors is immaterial to determine whether a regulatory infraction has occurred."
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It further said, "A wrongdoer cannot be allowed to use the plea of the investors having gained, notwithstanding the violation, as a shield for evading penalty."
The bench also endorsed SEBI's findings that Kotak had failed to exercise due diligence, observing that the focus under the mutual fund regulations "should... have been on diligence, not dividends."
In strongly worded observations, the court described the breach as "brazen and indefensible", said the parties had "adopted a course unknown to law" and criticised them for keeping investors and the market regulator "in the dark". It concluded the judgment with a warning to the mutual fund industry: "Mandate first, gains later; SEBI compliance, never falter."
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