Legal and Regulatory Framework

1Who regulates what

India's financial regulators each look after one part of the system: RBI (banks, money and foreign exchange markets), SEBI (securities markets, including mutual funds), IRDAI (insurance) and PFRDA (pensions). They work under the Ministry of Finance. Mutual funds are regulated by SEBI, but they also follow RBI rules where foreign exchange or overseas investment is involved.

Example A mutual fund launching an international fund needs to follow SEBI's scheme rules and also RBI's limits on overseas investment.

Remember

• SEBI regulates mutual funds; RBI rules apply to forex/overseas investment.

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2SEBI's role and key reforms

SEBI's basic job, from its preamble, is to protect the interests of investors in securities and to promote the development of, and regulate, the securities market. For mutual funds, SEBI's Mutual Funds Regulations set the rules.

Reforms you should know:

• Scheme performance is compared with a Total Return Index (TRI), which includes dividends, because scheme returns include dividends too.
• The Potential Risk Class (PRC) matrix shows a debt scheme's maximum interest rate risk (Macaulay duration) and maximum credit risk (Credit Risk Value).
• Segregated portfolios (side pockets) let a debt scheme separate a bad bond after a credit event, so all investors are treated fairly.
• After the 2008 liquidity crisis, SEBI stopped early redemption in FMPs and banned the term "liquid plus" in scheme names.

Example A large-cap fund earned 14% in a year. The Nifty price index rose 12.5%, but the TRI (with dividends) rose 13.8%. Comparing with TRI shows the fund's real outperformance was only 0.2%.

Exam trap TRI is used because scheme returns include dividends; it is not easier to beat. And SEBI does not fix interest rates or guarantee returns.

Remember

• TRI benchmarking, PRC matrix for debt, segregated portfolios.

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3Investment restrictions on schemes

SEBI limits what schemes can do, to keep risk under control:

• Schemes buy and sell on a delivery basis (no speculative intraday trading). Derivatives and short selling are allowed only within SEBI's frameworks.
• Investments should generally be in listed or to-be-listed securities. Exceptions include government securities and money market instruments (other than commercial paper).
• A scheme may invest in another scheme without charging fees on that portion, within limits.
• A fund of funds (FoF) invests in other mutual fund schemes, but an FoF cannot invest in another FoF, and ordinary schemes cannot invest in FoFs.
• Money waiting to be invested may be parked in short-term deposits of scheduled commercial banks.

Exam trap Unlisted commercial paper is not allowed under the listed-securities rule; unlisted government securities and other money market instruments are.

Example A debt scheme has just received ₹200 crore in subscriptions but the bonds it wants will be issued next week. It may park the money in short-term deposits of a scheduled commercial bank until then.

Remember

• Delivery basis; mostly listed securities.
• No FoF-in-FoF; inter-scheme investment without fees.

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4Advertising rules

Mutual fund advertisements must be accurate, fair and not misleading. Key rules:

• The standard warning must appear word for word: "Mutual Fund investments are subject to market risks, read all scheme related documents carefully."
• No testimonials, no exaggerated slogans. Celebrities may be used only for industry-level awareness campaigns, with SEBI's prior approval.
• Performance must be shown in a standard way: for a scheme older than 3 years, returns for 1, 3 and 5 years and since inception, with benchmark returns.
• If the fund manager manages more than six schemes, the ad must show the total number of schemes and the top 3 and bottom 3 performers.
• An IDCW ad must say that the NAV will fall by the amount paid out and any statutory levy.

Example An ad says "Our fund gave 32% last year!" without the 3- and 5-year figures, the benchmark and the standard warning. That breaks the code.

Exam trap The standard warning cannot be paraphrased. "Past performance may or may not be sustained" is a different disclaimer.

Remember

• Standard warning word for word.
• More than 6 schemes per manager → show top 3 and bottom 3.

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5Investors' rights and obligations

• An investor can change distributor without needing a no-objection certificate from the old one.
• An investor can inspect key documents such as the trust deed and investment management agreement.
• If a scheme's fundamental attributes change, unitholders get an exit window of at least 30 days at NAV without exit load.
• 75% of unitholders can vote to wind up a scheme or terminate the AMC.
• Investors can nominate up to 10 nominees and can pledge units.
• Investors are expected to read the scheme documents (caveat emptor).

Example Sunita wants to move her folio from Distributor A to Distributor B. The AMC must make the change on her written request; it cannot insist on an NOC from Distributor A.

Remember

• Change of distributor: no NOC needed.
• Fundamental attribute change: 30-day load-free exit.

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6Complaints and grievance redress

Investors should first approach the AMC's investor service centre and escalate within the AMC if needed. The AMC must resolve complaints within 21 calendar days. If unhappy, the investor can complain on SCORES, SEBI's online complaint system, and then use the online dispute resolution mechanism.

Example Rahul's redemption hasn't reached his bank account in 10 days. He should first write to the AMC. If it is not resolved within 21 days, he can file on SCORES.

Remember

• AMC first; resolve within 21 calendar days; then SCORES.

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7AMFI's codes of conduct

• ACE (AMFI Code of Ethics): for AMCs and trustees; it sets higher, more explicit standards than SEBI's code and supplements it.
• AGNI (AMFI Guidelines & Norms for Intermediaries): the code of conduct for distributors.

If a distributor breaks the code, AMFI first asks for an explanation within 3 weeks. If the reply is unsatisfactory or not received, it issues a warning letter. A second proven breach can lead to cancellation of the ARN, with a right to appeal.

Exam trap A first breach does not lead to immediate ARN cancellation or a monetary penalty.

Example A distributor offers clients a free gold coin for every ₹5 lakh invested. AMFI asks him to explain within 3 weeks. If his reply is unsatisfactory, he gets a warning letter; a second proven breach can cost him his ARN.

Remember

• ACE = AMCs and trustees; AGNI = distributors.
• Breach: explanation in 3 weeks → warning → ARN cancellation on repeat.

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