SC upholds SEBI action against Kotak AMC, says compliance with securities regulations mandatory

New Delhi, Jul 13 (PTI) The Supreme Court on Monday upheld regulatory action taken by the Securities and Exchange Board of India (SEBI) against Kotak Mahindra Asset Management Company (Kotak AMC), Kotak Mahindra Trustee Company and several of their senior executives. The top court ruled that compliance with securities regulations is mandatory regardless of whether the investors ultimately suffer losses or earn profits. A bench comprising Justices Dipankar Datta and Satish Chandra Sharma dismissed appeals filed by Kotak AMC, Kotak Trustee and six senior executives challenging orders of the Securities Appellate Tribunal (SAT), which had substantially upheld SEBI's findings of regulatory violations relating to six Fixed Maturity Plan (FMP) schemes. "The appeals do not deserve to be entertained; thus, we dismiss the appeals of KOTAK AMC, KOTAK TRUSTEE and the Senior Executives," said Justice Datta, who authored the judgment for the bench. The bench, in its judgment, referred to the famous advertisement cautioning investors: "Mutual fund investments are subject to market risks, read all scheme-related documents carefully." "An average Indian is more than familiar with this unmistakable phrase. Brandished at most noticeable places, it cautions potential investors of the likely risks of investment in mutual funds. The present appeals deal with one such risky scenario ostensibly created by the appellants," the judgment said. The dispute arose from Kotak AMC's decision in 2019 to defer redemption of investments made in debt securities issued by Essel Group companies after the value of pledged Zee Entertainment shares declined sharply. Instead of enforcing the pledged security or winding up the close-ended schemes on their scheduled maturity dates, Kotak AMC restructured the repayment arrangement and withheld a portion of the investors' money beyond the schemes' maturity dates. "Insofar as the investors are concerned, we pity them. Did they have a choice not to accept the course of action adopted by KOTAK AMC? The conscious decision to extend the maturity dates of ZCNCDs (zero-coupon non-convertible debentures) beyond the maturity dates of the Schemes was not a choice left for the unitholders to elect," the verdict said. "That was not a contingency, which they could foresee. In an ideal scenario, the unitholders were assured that, even in the event of a default on the debentures, their investments would be protected through the realization of the pledged shares serving as collateral — the very rationale underlying the creation of security in the first place," it said. KOTAK AMC departed completely from the proposed action, it said, adding that trotting behind it was KOTAK TRUSTEE which bee-lined the action instead of its independent assessment. "As the trustee company holding the funds of unitholders in a fiduciary capacity, KOTAK TRUSTEE was bound to independently assess whether the course was, first, in adherence with the extant regulations, and secondly, whether the course was in the interest of the unitholders," it said. Rejecting the fund house's principal defence that the decision ultimately benefited investors by preventing losses, the bench held that regulatory compliance under the SEBI Act and the SEBI (Mutual Funds) Regulations, 1996 is "consequence-neutral". "The regulations make no distinction between a breach resulting in profit and a violation resulting in loss," the bench said, adding that allowing regulatory breaches merely because investors eventually benefited would undermine market discipline and encourage future violations. The verdict emphasised that mutual fund regulations require close-ended schemes to be fully redeemed on their maturity dates unless they are formally rolled over with the informed written consent of investors and prior disclosures to SEBI. Since Kotak AMC had neither obtained investors' consent nor followed the statutory procedure for rolling over the schemes, the violation was "brazen and indefensible", the bench said. The bench also upheld SEBI's findings that Kotak AMC failed to exercise adequate due diligence while investing Rs 266 crore in debt securities issued by financially weak Essel Group entities. It said that the investment committee had relied primarily on pledged Zee Entertainment shares as collateral instead of properly evaluating the issuers' financial health and associated risks. The verdict found that Kotak AMC failed to make timely disclosures to both investors and SEBI regarding its decision to restructure the investments and delay redemptions. It said that SEBI was informed only after it sought an explanation, while investors had no meaningful opportunity to consent to or reject the altered course of action. It upheld the monetary penalties imposed on Kotak AMC, Kotak Trustee and the individual executives, holding that experienced market professionals could not plead good faith after consciously departing from the regulatory framework. The bench also imposed litigation costs of Rs 30 lakh on Kotak AMC and Rs 20 lakh on Kotak Trustee. The amounts are to be deposited with the Supreme Court within two months and distributed equally among ten charitable organisations working for destitute children, cancer patients, women in distress, elderly persons without family support, victims of crime and other vulnerable groups. PTI SJK SJK KSS KSS