A sword of Damocles on Franklin Templeton

Dark clouds of suspicion are hovering over Franklin Templeton and its plans to wind up six debt funds through an e-voting process. Many are calling it just the tip of the iceberg.

Let’s re-check some facts. India’s entire mutual fund industry has investments of approximately ₹25 lakh crores from the public of which ₹12 lakh crores is in debt. Hypothetically, if other debt funds fall in the same category as Franklin Templeton, and the unit holders do not raise their voice, they would lose a minimum of ₹7.2 lakh crores out of the ₹12 lakh crores.

At the heart of the controversy is six debt schemes and why Franklin Templeton was openly legitimising the erosion of these unit holders by putting a stamp of approval on the process. In  short, there is no logic in the move because Franklin Templeton had taken a line of credit to pay the investors. Now, the interest is borne by existing investors for the outgoing investors.

Now what is interesting is that Franklin Templeton has itself said the recovery of monies will take upto five years. Given the fact that the six schemes had ₹28,000 crores worth assets under management, average loss to the unitholders — taking 20% as average realisation – would be ₹22,400 crores.

In short, the entire principal amount is wiped off.

This is serious because in contrast to the equity schemes, debt schemes are considered more secure where the principal amount of the unit-holder is almost assured like deposits in the banks. Yet, there is no commitment either from Franklin Templeton or SEBI that at least the principal amount of all Unit-holders is secure and shall be repaid.

No wonder Securities and Exchange Board of India (SEBI) has also drawn flak, the market regulator coming under pressure from many investors who took to social media to ask why it was turning a blind eye to such a huge impact on the investors. Many even reminded SEBI about its preamble: To protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto.

The market regulator has initiated a forensic audit and hired Choksi & Choksi, a top chartered firm, which will submit its report within a month. There are many charges hanging on Franklin Templeton, including if a whopping ₹4000 crores was moved out a day before their fund did the closure for redemption. Many are even asking SEBI if the lost cash was mostly structured to be handled outside. If this happens actually, clients may not object as they cannot seek legal remedy due to the nature of the cash or investment running into a whopping ₹20,000 crore plus. Many schemes have largely invested in one or few companies which means the borrower and the lender knew the arrangement and also had created alternate recourse.

There are other issues as well. Franklin Templeton ran the schemes as credit risk funds, which have a majority of investments in papers with lower credit rating. It was done by fund managers only because SEBI specified the duration of the securities but not credit ratings for debt scheme papers. It is quite possible that large portions of investments in the funds in question actually consisted of bonds and securities issued by companies belonging to certain business groups. Worse, the schemes had sizable exposure to unlisted papers. Franklin Templeton managers did not take care of credit risk. And eventually, when COVID-19 hit India, Franklin Templeton was unable to sell the papers in a market that froze in the wake of COVID-19.

“We are in receipt of the audit notice from the Regulator and continue to provide information as required,” said a Franklin Templeton Spokesperson.

Choksi & Choksi is likely to investigate if there were collusion between the fund house and bond-issuing corporates, and if there were instances of conflicts of interest of directors or senior officials, and if there were transactions that were prejudicial to the interest of investors in the schemes, and if there were any regulatory violations. The scope of investigation, in short, is unlimited. Franklin Templeton will have to answer all questions, the most important being whether there has been circumvention of rules on fund management.

On paper, the wound-up schemes which are no longer available for redemption after 23 April, 2020, include: Franklin India Ultra Short Bond Fund, Franklin India Short Term Income Fund, Franklin India Credit Risk Fund, Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund and Franklin India Income Opportunities Fund.

But the process of investigation is easier said than done. For the records, the Gujarat High court has stayed the e-voting process following a plea from 83 year-old Arzeen Piruz Khambatta, his wife Persis Khambatta and Khambatta family trust of soft drink major Rasna against Franklin Templeton alleging that the winding up of six debt schemes is improper, arbitrary, taken in haste and illegal. The total investment of these three entities in Franklin Templeton schemes is to the tune of  ₹6.55 crore. The family members also made Securities and Exchange Board of India (SEBI) and Ministry of Corporate Affairs (MCA) a party to the case. The matter will be next heard on 12 June.

Franklin had issued e-voting notices to 30,000 unit holders’ seeking authorisation to monetise the underlying securities set aside on May 28, 2020.

The Khambatta family alleged that the bona fide and innocent unit holders are being arm-twisted to accept the decision of winding up which is detrimental to them and taken solely to hide the acts of mismanagement of funds by Franklin Templeton.

The family said Franklin Templeton has not been run to the ground due to COVID-19 crisis but by conscious acts of mismanagement. These investments were neither prudent nor in-line with disclosures made in scheme related documents. “Public money has been misused for personal gains instead of making safe investments in tradable and investment grade securities,” the plea said, adding the fall in assets managed by these schemes between the lockdown announcement till winding up decision was  ₹5,200 crores or 17% of the AUM (assets under management). However, for the rest of the industry fall in AUM for the same category of funds was  ₹2,596 crore.

The abrupt winding-up of debt schemes is also under the lens of Madras High Court which directed to issue notices to Santosh Kamath (CEO), Sanjay Sapre (President), other key management people and trustees. The court also sought a status report from SEBI. An online petition is being planned for www.change.org to showcase unity & solidarity amongst unit-holders / investors which shall then be forwarded to Franklin Templeton Investments in the United States and also the Prime Minister’s Office (PMO). The plea was filed by Chennai Financial Markets Accountability (CFMA), a society in Chennai to protect the interest of investors.

Tough times for Franklin Templeton.