'MF trustees should regulate distributors'

The Securities and Exchange Board of India has taken note of mis-selling in the financial sector and is planning to regulate the distributors, the only unregulated part of the industry. Sebi Chairman M Damodaran, in an exclusive interview, to Monika Halan talks of his plans of getting the mutual fund agents in line.

The Sebi order on mutual fund amortisation has come very late. The NFO game has been on for two years. Why did it take so long?

First, we need to see AMFI (Association of Mutual Funds in India) as an industry organisation. Industry interests cannot, on a long-term basis, be different from those of the investing community. I thought AMFI would be able to come out with satisfactory solutions to the problems that existed.

It discussed the problems, but there was no clear view, so AMFI asked us to take some steps. So we did. We changed the fee structure, asked MFs not to use the term IPO and 'at par', and also pulled up fund houses on specific misleading advertisements.

One of our major concerns now is with the distribution industry. The AMCs are regulated and investors are coming in. And then you have distributors who are not regulated, who are driving the churn because there is enough money to be pulled in and are also encouraging fund houses to indulge in questionable practices.

We wanted AMFI to address this. Here, as expected, there was no unanimity; some fund houses are happy and some are not, depending upon the value systems they subscribe to. So we gave them time, we thought they would come up with alternatives. But they are no closer to a solution today. So we thought it best that we announce our intention of regulating distributors.

How do you plan to do this?

One of the ways we thought of is to involve the trustees more. Trustees exist today as representatives of the investor and ensuring that the asset management compnay (AMC) does a reasonable job. So, we thought, why not ask the trustees to see whether there are distribution practices that are against the interest of the investor.

In some sense, we haven't used the trustees well enough. I also think the trustees have not asserted themselves adequately. But maybe they do not have a clear understanding of their role.

It could also be because trustees are appointed by those who set up the fund. If you have the sponsor, the chairman of the sponsor company, heading the AMC and you have his number two as the associate member of the trustee company, what role can the trustee play? Do you expect this number two or three to question the practices of an AMC headed by his own chairman?

But more than how many trustees are independent -- a majority need to be independent -- it is really who they are that is important. Just as companies have independent directors, it depends on who these people are and to whom they owe their allegiance.

Right now the role of trustees is only on paper, it has not been activated.

Exactly. They may be meeting with the prescribed periodicity, but what do they do during the meeting? They also get the prescribed agenda (in terms of what Sebi requires them to comment on) from the AMC, since they have no independent source. We want to get trustees activated.

Of course, there is another model, which has been adopted in Europe -- some countries have a professional trustee company to whom you contract out the function of trusteeship.

Isn't that in the Cadogan Report?

Yes, that report has said that Sebi should look into this. But I really don't think this gets the kind of acceptance we are looking at.

That is one model. To have a few trustee companies, who understand the role and responsibilities of the job better and do this for a fee. You can argue that to continue the business relationship they might drop their guard. But, really you won't get a perfect solution. Even without going in for that, Sebi could engage with the trustees a little more because they are first-level regulators of this industry at the fund level. To consider them to be batting for us is something we have to do.

Can you do that without changing the 1996 Regulations?

Yes, we can do that. This is on the cards, in fact, even as I speak to you today, half the papers here are details of the trustees. (Patting the papers to his left).

Funds say that they are unable to control the distributors. Can Sebi regulate just by activating the trustees or is there a need to get the distributors to register with you?

Ultimately, that is where we are headed. We are headed to a situation where the distributors will be registered with us, as in the US.

But in the US, if you notice, it is not the SEC (Securities Exchange Commission) that regulates them but the NASD (National Association of Securities Dealers). We don't have a strong SRO (self-regulatory organisation) tradition as yet. Why I said we'll involve the trustees is because of the kind of problems we are facing.

Let us take a situation, of say, one distributor and five asset management companies. This distributor is looking at who is giving more commission. In the interest of fairness, let's say he's looking at the top five funds that are performing. But in that top five or six, what is it that is driving him to push one fund against the other? If an investor says, "I believe this is the best performing fund and I want