Order in the matter of Kotak Mahindra Mutual Fund

The aforesaid entities are hereinafter referred to by their respective names/serial numbers or collectively as “the Noticees”.

BACKGROUND:

1. Securities and Exchange Board of India ('SEBI') appointed a Chartered Accountant firm (hereinafter referred to as 'the auditor') to conduct inspection of Kotak Mahindra Mutual Fund (hereinafter referred to as “Kotak Mutual Fund') for the period from April 01, 2014 to March 31, 2016. The observations made during the inspection were communicated to Kotak Mahindra Asset Management Company Limited and Kotak Mahindra Trustee Company Limited (hereinafter referred to as 'KMAMC' and 'KMTCL', respectively and collectively referred to as 'the Noticees'). The Noticees had submitted their comments/ explanations on the observations of the inspection vide a common letter dated March 09, 2017.

2. Based on the observations made by the auditor and comments received from the Noticees, it was noted that the Noticee had failed to comply with the requirements of certain SEBI Circulars (mentioned in ensuing paragraphs) and, therefore, SEBI initiated adjudication proceedings and appointed an Adjudicating Officer (hereinafter referred to as ‘AO’) to inquire and adjudicate the matter. 3. The AO vide Show Cause Notice dated July 23, 2018 made the following allegations against the Noticees:

a. No funds of a scheme shall be parked in short term deposits (‘STDs’) of a bank i.e. HDFC Bank which has invested in that scheme. In this regard, four instances where units of a scheme have been redeemed and purchased back within short period of time by HDFC Bank and within that period, STDs have been placed with HDFC Bank by the scheme. It was alleged in the SCN that the Noticees had not put any system in place so as to avoid violation of the SEBI Circular. No. SEBI/IMD/CIR No.1/91171/07 dated April 16, 2007 (‘STD Circular’).

b. As regards requirement of publication of the half-yearly un-audited results, half-yearly portfolio disclosures, abridged annual report in the prescribed format and despatch of abridged annual report within the stipulated time period – for many investors, invalid email IDs have been maintained and, therefore, the same could not be sent to the investors as email id’s were invalid. Thus, it was alleged in the SCN that the Noticees have not complied with provisions of para 2 (ii) (a) to (e) of the SEBI Circular No. Cir/ IMD/ DF/ 16 / 2011 dated September 08, 2011 (‘2011 Circular’) and para 4 of the SEBI Circular No. SEBI/ IMD/ CIR No. 8 / 174648 / 2009 dated August 27, 2009 (‘2009 Circular’).

c. In case of application of cut off timings for redemption in ‘Cash’ for Gold Exchange Traded Funds (‘Gold ETFs’), the cash component was calculated considering previous day’s Net Asset Value (‘NAV’). Thus, it is alleged that the Noticees have not complied with provisions of para 6 (3) of the SEBI Circular No. SEBI/IMD/CIR No.11/78450/06 dated October 11, 2006 (‘”2006 Circular”).

d. It was also alleged that for the violation of aforesaid SEBI Circulars, the Noticees have not complied with provisions of Clause 2 and 9 of the Code of Conduct as specified in Fifth Schedule read with Regulation 10(a) of SEBI (Mutual Funds) Regulations 1996 (hereinafter referred to as ‘MF Regulations’).

4. The Adjudicating Officer after conducting inquiry into the alleged violations by the Noticees, including affording them opportunity of hearing, passed Order dated October 12, 2018 disposing-off the aforesaid show cause notice dated July 23, 2018 without imposing any penalty. In respect of the allegations made in the show cause notice dated July 23, 2018, the Adjudicating Officer vide said Order dated 12, 2018 observed as under:

“12. The first allegation against the Noticees is that funds of KMMF’s scheme was parked in STDs of a bank i.e. HDFC Bank which has invested in that scheme leading to violation of para 5 and 8 of the STD Circular which has been adopted and recognized by amendment dated May 28, 2007 as already examined. On cumulative reading of said clause 8 of Seventh Schedule and paras 5 and 8 of the STD Circular it is noted that the condition imposed therein by way of investment restriction prohibit parking of funds of a scheme in short term deposit of a bank which has invested in that scheme, pending deployment of funds of the scheme. The STD Circular does not ban investment by a mutual fund scheme in STDs of any bank which has not invested in that scheme at the time of fund raising. In other words, when funds raised by a mutual fund are yet to be deployed (i.e. “pending deployment”), the investment in STDs cannot be made in the same bank from which funds were raised in the scheme. The primary objective of the STD Circular seems to prevent round-tripping of funds provided by a bank to a mutual fund and which in turn parks the same funds back in the bank.

13. In this case, from the impugned four instances of alleged deviation it is noted that redemption HDFC Bank had redeemed its units in KMMF prior to parking of funds of scheme of KMMF in STDs with it. Admittedly, units were purchased by HDFC bank after parking of funds by KMMF in STD with it. Thus, it is subsequent to such parking of funds of scheme by KMMF in HDFC Bank that the later subscribed to the units of KMMF. On the dates of parking of funds by KMMF in HDFC Bank, it did not have exposure in the respective scheme of KMMF. Further, the amounts of the funds of schemes parked by KMMF in STDs with HDFC Bank and the amounts of the subsequent investments made by HDFC Bank in the units of KMMF does not match and have no co-relation. These facts show that it was not a case of round-tripping of funds invested by HDFC Bank in the units of KMMF which in turn parked the same funds back in the STDs with HDFC Bank .Thus, it was not the parking of funds raised in the scheme of KMMF from HDFC Bank in the STDs with HDFC bank as restricted in para 5 read with para 8 of the STD Circular. I, therefore, find that the charge in this regard is not made out.

14. The second allegation against the Noticees is that email IDs of the investors maintained by them were invalid leading to violation of 2009 Circular and 2011 Circular. It is noted that the auditor had verified email IDs maintained by the Noticees of 120 investors on sample basis and observed that in few instances, email of ‘Kotak and R&T’ is given and in some instances the email ID did not seem to be correct and same e-mail IDs feature against the names of multiple investors who do not seem to be related. The Noticees have admitted that there were some incorrect ids, but action had been taken to identify the incorrect email ids and to rectify the situation. In this regard, the Noticees have demonstrated that out of 120 cases, 91 cases bearing the e-mail id - ‘pmsmf.reports@kotak.com’ did not pertain to the unit-holders of KMMF and were the clients of KMAMC’s PMS where the clients had given KMAMC the role of a service provider to handle their investments. The Noticees have further demonstrated that two email IDs that had Kotak’s email id were those of employees of Kotak who were themselves the unit-holders of KMMF. It is noted that the basis of allegation in this regard is that the KMMF has not submitted any proof of physical dispatch to each investor were found invalid. In this regard, it is noted that the auditor in his report, the document relied upon in support of this allegation, had taken note of the submission that invalid e-mail ids were removed and physical copy of the annual accounts are mailed to the investors whose emails are found invalid. The auditor has further observed that scheme wise annual report of KMMF was displayed on the websites of KMMF and AMFI. The Noticees have claimed that the observation in this regard are relating to the inspection 2014-2016. There are no complaints from any unit-holders and corrective steps were taken as on date. Considering these facts and circumstances that default if any in this regard at the relevant time was procedural and venial and it is also not blameworthy to impose penalty. ………………………

18. …………………………………I note that there was no concern raised by the auditors with respect to such NAV calculation and the limited observation of the past auditors was that the aforesaid deviation / practice was not clearly mentioned in the SID. In this respect, SEBI had issued an advisory vide its letter dated November 20, 2015. Admittedly, the aforesaid limited observation of the past auditors was addressed by the Noticees by mentioning the methodology of calculation in the SID as well as in the website of KMAMC. As earlier deviation was closed with satisfaction after disclosures were made, the instant alleged default is a standalone deviation. The charge is that the Noticees had not changed the method of calculation of cash component for gold redemption and previous days’ NAV was used for such calculation of NAV as observed during the present inspection for the period 2014-2016. In my view, the NAV calculation in case of Gold ETF redemption should be in terms of the 2006 Circular and the disclosure of any deviation in this regard on SID of the scheme and website of asset management company would not amount to compliance of the requirements of 2006 Circular with regard to cut-off timings for NAV calculation for redemption in case of Gold ETF. I, therefore, find that the Noticees should have and must comply with the requirements of the 2006 Circular in this regard. …………………….. 21. In the instant matter, the allegation is only with regard to methodology adopted for calculating minor cash component on redemption. Admittedly, the question has been raised with regard to only 11 instances and the total impact of the difference amounts to only ` 2,103.10/- and the difference percentage ranges from 0.0019% to -0.0199%. Overall, on adoption of previous days’ NAV, the unit-holders have made a profit of ` 2,103.10/-. I also note that the auditors have not brought out any adverse impact on unit-holders. There is no material to demonstrate that the adoption of previous days’ NAV for redemption of cash component had any impact on NAV of the units of the scheme or which suggest any design to take price advantage or to cause any loss to any unit-holder or to the mutual fund in this case. I also note that there are no investor complaints on record in this regard.”

5. In respect of aforesaid observations and findings made in the AO Order, it was felt that the Order passed by the AO in as much as not holding the Noticees liable and not imposing penalty under Sections 15D(b), 15E and 15HB of the SEBI Act, 1992 is erroneous and not in the interest of the securities market. As such, a show cause notice dated November 12, 2018 was issued under Section 15-I(3) of the SEBI Act, 1992 (hereinafter referred to as ‘SCN’) to the Noticees on the following grounds:

i. Circumvention of guidelines w.r.t Short Term Deposits: a. The para 5 of the SEBI Circular No. SEBI/IMD/CIR No.1/91171/07 dated 16 April, 2007, inter alia, states that “Trustees shall ensure that no funds of a scheme may be parked in short term deposit of a bank which has invested in that scheme.” Further, as per the para 8 of the said circular, “Trustees shall certify in the half-yearly reports that the provision of the Regulation pertaining to parking of funds in short term deposits - pending deployment is being complied with at all points of time.” Therefore, it is the intention of the said circular that the restriction of not placing STDs with a bank which has invested in the scheme shall also be maintained in future i.e. at all points of time.

b. It is alleged that there is violation of said circular for the alleged conduct as elaborated in the SCN.

ii. Invalid Email Ids of investors:

Out of 120 samples of invalid email ids, although the AO has accepted logic of Noticees w.r.t 93 email ids but AO has failed to take into account the other 27 invalid email ids which deprived investors of various information and also violated their confidentiality.

iii. Cut off timing guidelines not observed in case of Gold ETF

The AO has upheld that the Noticees have violated the 2006 circular w.r.t cut off timings but failed to impose any penalty. The compliance of this circular was critical and was necessary in the interest of the investors.

6. Vide aforesaid SCN dated November 12, 2018, the Noticees were advised to show cause as to why appropriate penalty should not be imposed against them in terms of Section 15D (b), 15E and 15HB of the SEBI Act, 1992 for the violations alleged in the show cause notice dated July 23, 2018 issued by the AO. The copies of show cause notice dated July 23, 2018 and AO Order dated October 12, 2018 were also enclosed along with the SCN dated November 12, 2018. The Noticees were also advised to file their reply within a period of twenty one days from the date of receipt of the said SCN.

7. A common reply dated January 02, 2019 has been received from the Noticees denying all the allegations made in the SCN and submitted that no case has been made out for invoking the provision of Section 15-I (3) of the SEBI Act, 1992 for reviewing the AO Order dated October 12, 2018.

8. In compliance with the principles of natural justice, an opportunity of hearing was provided on March 05, 2019 when Mr. Mr. Somasekhar Sundaresan, Advocate along with Ms. Yugandhra Khanwilkar, Advocate appeared on behalf of both of the Noticees and made submissions mainly on the lines of reply dated January 02, 2019. Mr. K Ramchandran and Mr. Nilesh Shah Dhirajlal from Kotak Mahindra Asset Management Company Limited (Noticee No. 1) were also present during the course of hearing. The Advocate, representing the Noticees, further requested time for filing written submissions which was allowed. A written note on argument (written submissions) dated March 29, 2019 has been received from the Noticees on April 04, 2019.

9. The contentions raised by the Noticees vide their reply dated January 02, 2019, submissions made during the course of hearing on March 05, 2019 and those raised in the written submission dated March 29, 2019 are summarised as under:

A. Application of Section 15-I(3) of the SEBI Act, 1992:

a. Vide reply dated January 02, 2019, it was submitted that the contentions raised in the reply filed before AO are not repeated and the same are sought to be incorporated by reference, as Section 15-I (3) does require SEBI to have regard to the material on record which includes their erstwhile reply dated August 24, 2018, and submissions, made before the AO.

b. Referring to the provision of Section 15-I(3) of SEBI Act, 1992 and the Statement of Objects and Reasons of Securities Laws (Amendment) Bill, 2014 {whereby Section 15-I(3) has been inserted in the SEBI Act, 1992}, the Noticees have submitted that this power is granted by Parliament only to enhance penalty where it is felt that the Order passed by an AO is erroneous and that such an error would not be in the interest of the securities market and this jurisdiction cannot be lightly invoked and used to deal with every situation where a different view is possible.

c. The SCN is flawed and without jurisdiction as it merely seeks to reopen the case without showing anything as to what is erroneous and how such error leads to the AO Order being against the interest of the securities market.

d. Further, referring to Section 263 of the Income Tax Act, 1961 which is in pari materia to the powers given to SEBI under Section 15-I (3) of SEBI Act, 1992, it was submitted that none of the condition is fulfilled which are required for invoking the power of review of AO Order. Reference was made to the Judgement of Hon’ble Supreme Court passed in the matter of Malabar Industrial Co. Ltd. vs. CIT, Kerala State [(2000) 2 SCC 718], wherein it was observed as under:

“6. A bare reading of this provision makes it clear that the prerequisite to exercise of jurisdiction by the Commissioner suo moto under it, is that the order of the Income-tax Officer is erroneous insofar as it is prejudicial to the interests of the revenue. The Commissioner has to be satisfied of twin conditions, namely, (i). the order of the Assessing Officer sought to be revised is erroneous; and (ii) it is prejudicial to the interests of the revenue. If one of them is absent -- if the order of the Income-tax Officer is erroneous but is not prejudicial to the revenue or if it is not erroneous but is prejudicial to the revenue-- recourse cannot be had to Section 263(1) of the Act. 7. There can be no doubt that the provision cannot be invoked to correct each and every type of mistake or error committed by the Assessing Officer; it is only when an order is erroneous that the section will be attracted. An incorrect assumption of facts or an incorrect application of law will satisfy the requirement of the order being erroneous. In the same category fall orders passed without applying the principles of natural justice or without application of mind. 8. The phrase prejudicial to the interests of the revenue is not an expression of art and is not defined in the Act. Understood in its ordinary meaning it is of wide import and is not confined to loss of tax…………….. 10. The phrase prejudicial to the interests of the revenue has to be read in conjunction with an erroneous order passed by the Assessing Officer. Every loss of revenue as a consequence of an order of Assessing Officer cannot be treated as prejudicial to the interests of the revenue, for example, when an Income-tax Officer adopted one of the courses permissible in law and it has resulted in loss of revenue; or where two views are possible and the Income-tax Officer has taken one view with which the Commissioner does not agree, it cannot be treated as an erroneous order prejudicial to the interests of the revenue unless the view taken by the Income-tax Officer is unsustainable in law.”

e. Based upon the aforesaid judgement of Hon’ble Supreme Court, it was contended that:

i. The Order of AO must not only be erroneous but must also be prejudicial to the interest of the securities market and if either of these two features is absent, there can be no recourse to this jurisdiction.

ii. Each and every type of mistake or error committed by the AO would not lead to invocation of this jurisdiction. An incorrect assumption of facts or an incorrect application of law would be necessary or the error should be in the nature of violation of natural justice or be tainted by non-application of mind.

iii. Every loss of revenue as a consequence of AO Order would not amount to prejudicial to the interest of the revenue and where two views are possible and the Ld. AO has taken one view, such a position would not tantamount to an erroneous order that is prejudicial to the interest of the securities market.

f. The power given under Section 15-I (3) of the SEBI Act, 1992 is not an appellate jurisdiction and it comes into action only when there is an error that will also adversely affect the interest of the securities market. The Noticees have submitted that the AO Order is within the confines of the law and there is no error of law and, as such, no scope of ruling that the AO Order is against the interest of the securities market.

g. In support of its above contention, the Noticees have also referred to the Judgements of Hon’ble Supreme Court in the matter of CIT, Shimla vs. Green world Corporation (2009) SCC 69, CIT, Gujrat-II vs. Kwality Steel Supplier Complex (2017) 14 SCC 548, CIT vs. Gabriel India Ltd. (1993) 203 ITR 108: 1993 SCC Bom 526, CIT vs. Arving Jewellers (2003) 259 ITR 502: 2002 Guj 396.

B. Application of STD Circular a. In respect of allegation of circumventing the guidelines with respect to Short Term Deposits (STD), the Noticees have submitted that the Circular dated April 16, 2007 (STD Circular) existed prior to the amendment to Mutual Funds Regulations made on May 28, 2007 which confirms that the STD Circular is a guideline and not a regulation, which would be a subordinate legislation.

b. The STD Circular prohibits placement of funds in a STD by a mutual fund scheme to whose units a bank has just invested. There is no prohibition on investment by a mutual fund scheme in the STD of any bank that has at any point of time in the past been a unit holder or proposes to be a unitholder in future. Para 8 of the STD Circular only refers to the deposit in STD of funds raised that are pending deployment. Further, there is also no prohibition on a bank from investing in units of a mutual fund scheme if the latter has invested in an STD with the former.

c. The main purpose of the STD Circular is to prevent round tripping of funds that may be provided by a bank to a mutual fund which in turn parks the same money back with the bank. It is also submitted that there is no allegation of violation of this nature by Kotak Mutual Fund and that the deposit by Kotak Mutual Fund in HDFC Bank precedes the investment by the bank in the units of Kotak Mutual Funds. The Noticee has referred to and relied upon the following details of investment made in the STD:

Table – 1 (Details of Funds parked in STDs by Liquid Fund Scheme of Kotak Mutual Fund) Sr. Type Security Name STD STD Redeemed Subscribed No of Date Maturit by HDFC by HDFC. Schem y Date Bank on Bank on e 1. LIQ HDFFD 7.25% 30.09. 30.12. 28.09. 01.10. 000017 HDFC 2015 2015 2015 2015 Bank FD (91 days) 2. LIQ HDFFD 7.25% 30.09. 30.12. 28.09. 01.10. HDFC 000017 2015 2015 2015 2015 Bank FD (91 days) 3. LIQ HDFFD 7.25% 30.09. 30.12. 28.09. 01.10. 000017 HDFC 2015 2015 2015 2015 Bank FD (91 days) 4. LIQ HDFFD 6.00% 30.11. 07.12. 26.11. 01.12. HDFC

000017 Bank FD 2015 2015 2015 2015 (91 days)

d. The Noticees have submitted that, in each case, there was no pending investment by HDFC Bank in the mutual fund schemes of Kotak Mutual Fund and also the amount of the STDs and the amount of investment by HDFC Bank in the units of Kotak Mutual Funds have no co-relation. It is also mentioned that banks normally opts for redemption at the end of a quarter and make subscription at the start of the calendar quarter.

e. It is contended that perverse reading of STD Circular is bad in law and, therefore, the allegation is not maintainable.

C. In respect of invalid Email Ids:

f. In respect of invalid email ids of investors, the Noticees have submitted that out of 120 cases, 91 cases were the clients of Kotak AMC’s Portfolio Management Services (“PMS”) where clients had given Kotak AMC the role of a service provider to handle their investments. Apart from these 91, two cases having Kotak’s email id were pertaining to an employee of Kotak and of his spouse and that in respect of other incorrect ids steps were taken to rectify the situation.

g. Further, the Noticees have referred to the observations made by the AO in its Order dated October 12, 2018 wherein AO has taken note of the auditor report that invalid ids were removed and physical copies of annual accounts were mailed, scheme wise annual report were displayed on the website of the Noticees and of Association of Mutual Fund Industry (AMFI), there are no complaint from any investor and that the corrective steps were taken by the Noticees.

h. In respect of the allegations made in the SCN that AO has failed to take into account the other 27 invalid email ids which deprived investors of various information, the Noticees have referred to para 14 of the AO Order dated October 12, 2018 wherein AO has noted that “14. The Noticees have admitted that there were some incorrect ids, but action had been taken to identify the incorrect email ids and to rectify the situation.”

i. Further, referring to the Order dated June 16, 2011 passed by Hon’ble SAT in the matter of Religare Securities Ltd.[SAT Appeal No. 23 of 2011], it is submitted that the object of inspection is not the imposition of penalty but the betterment of practices and improvement of the market intermediary.

D. In respect of Gold ETF:

j. In respect of cash component of Gold ETF, the Noticees have submitted that the Circular dated September 28, 2006 is intended to be made applicable to mutual funds that invest in securities and not to mutual funds in the form of ETFs that invest in a commodity like gold. It is also stated that the schemes that are not linked to securities would follow the guidelines on a mutatis mutandis basis and that, when the compliance is not possible in relation to identical treatment of those seeking redemption in gold as compared with those seeking redemption in cash, a deviation was made.

k. In support of its contention, the Noticees have also mentioned that AMFI vide letter dated September 17, 2018 made a representation to SEBI highlighting the unique structure of ETFs and requested to deal with the anomaly posed by applying an outdated guidelines to a Gold ETF when the Guideline would only apply to mutual fund schemes that invest in money market instruments and securities.

l. It is also mentioned that the AO vide its Order dated October 12, 2018 has rejected the submissions made before him but bearing in mind that allegation related to only 11 instances of the cash component being considered of previous days resulting in total impact of the difference amounts to only Rs. 2,103.10/-, the AO did not impose any penalty for the same. In this respect, it is contended that without appreciating the factors taken into account by the AO, the SCN states that the compliance of 2006 Circular was critical and was necessary in the interest of the investors.

m. At last, it is submitted that, even if SEBI invoke Section 15-I(3), it would still have to have the regard to Section 15J of the SEBI Act, 1992 which includes the amount of disproportionate gain or unfair advantage, the amount of loss caused to the investor(s) and the repetitive nature of default.

CONSIDERATION OF ISSUES AND FINDINGS:

10. I have considered the SCN dated November 12, 2018, reply dated January 02, 2019 filed by the Noticees, the submissions made during the course of hearing on March 05, 2019, the written submissions dated March 29, 2019 and other materials available on record including the records of adjudication proceedings. I note that, while making examination of the allegations made in the SCN dated November 12, 2018, the issue arises for consideration in this matter is as to whether the facts and circumstances of the case require the invocation of powers under section 15-I(3) of the SEBI Act, 1992.

11. It would be appropriate to refer to Section 15-I (3) of the SEBI Act, 1992 which reads as under: [(3) The Board may call for and examine the record of any proceedings under this section and if it considers that the order passed by the adjudicating officer is erroneous to the extent it is not in the interests of the securities market, it may, after making or causing to be made such inquiry as it deems necessary, pass an order enhancing the quantum of penalty, if the circumstances of the case so justify: Provided that no such order shall be passed unless the person concerned has been given an opportunity of being heard in the matter: Provided further that nothing contained in this sub-section shall be applicable after an expiry of a period of three months from the date of the order passed by the adjudicating officer or disposal of the appeal under section 15T, whichever is earlier.]

12. Section 15-I (3) of the SEBI Act, 1992 was inserted by the Securities Laws (Amendment) Act, 2014 to enhance the quantum of penalty, if the order of AO, in the opinion of Board (as delegated to Whole Time Member) is erroneous and not in the interest of the securities market.

13. As mentioned in paras 5 and 6 above, the first allegation is in respect of violation of SEBI Circular dated April 16, 2007 at four instances where Liquid Fund Scheme of the Kotak Mutual Fund placed STDs with the HDFC Bank, details of which are as under:

Table – 2 (Details of redemption of investment by HDFC Bank and parking of funds by Kotak Mutual Fund in STD of HDFC Bank)

Date of Rede Date of Amount Date of Amount of Redemption mptio STD of STD HDFC Investment by HDFC n placed by Bank Bank from amou Kotak investing Kotak nt Mutual in Kotak Mutual Fund with Mutual Fund HDFC Fund Bank 28-09-2005 30-09-2015 100 Crore 01-10-2015 200 Core 28-09-2005 100.94 30-09-2015 100 Crore 01-10-2015 Crore 28-09-2005 30-09-2015 100 Crore 01-10-2015 26-11-2015 250.85 30-11-2015 45 Crore 01-12-2015 250 Crore Crore

14. In respect of alleged contravention of SEBI Circular dated April 16, 2007, the AO has observed that subsequent to parking of funds by Liquid Fund Scheme of Kotak Mutual Fund in STDs of HDFC Bank, the HDFC Bank subscribed to the units of same Scheme of the Kotak Mutual Fund. On the dates of parking of funds by Liquid Fund Scheme of Kotak Mutual Fund in STDs of HDFC Bank, the HDFC Bank had no existing investment in that Scheme of Kotak Mutual Fund. AO has also observed that it was not the case that Liquid Fund Scheme of the Kotak Mutual Fund parked funds raised from the HDFC Bank back in the STDs of the HDFC Bank, as restricted under para 5 and 8 of the SEBI Circular dated April 16, 2007.

15. I note that inspection of Kotak Mutual Fund was conducted by SEBI through S Ramanand Aiyar, Chartered Accountants (auditor) from August 02, 2016 to December 20, 2016 and submitted its report to SEBI. After examining the observations made in the inspection report, SEBI initiated adjudication proceedings and appointed an adjudicating officer on May 22, 2018. The communication order of appointing AO to inquire into the alleged violations by the Noticees was issued to AO on May 29, 2018. It has been brought to my notice that, subsequently, SEBI vide letter dated July 09, 2018 addressed to AMFI communicated in para 2 (c) of the said letter that there were instances where funds of a scheme parked in STD of a bank which has invested in that scheme and AMC failed to incorporate appropriate checks & balances to ensure that bank does not subsequently invest in the said scheme. Further, vide said letter, the members of AMFI were also advised to take corrective actions in respect of the observations made therein. As such, all the members of AMFI (i.e. the Mutual Funds) need to take appropriate steps to ensure compliance with the advisory issued by SEBI vide letter dated July 09, 2018, among other, to have a system in place to ensure that any scheme of a Mutual Fund should not accept investment from a bank where that scheme has parked its funds in STDs of that bank.

16. Now, the issue arises as to whether the findings made in the AO Order dated October 12, 2018, as referred to in para 14 above, is erroneous and against the interest of securities market which would require invocation of powers under Section 15-I(3) of the SEBI Act, 1992. I note that the findings of AO is based on the inspection report which has observed that no funds of a scheme has been parked in STD of a bank which has invested in that scheme. The inspection report also noted that HDFC Bank redeemed the units of Liquid Funds Scheme and purchased the same within a short period of time and within that period STDs were placed with the HDFC Bank by the Liquid Fund Scheme of Kotak Mutual Fund.

17. In view of the above, I find that AO proceeded on the basis of material available on record i.e. inspection report, appointment order of AO, SCN dated July 23, 2018 issued by the AO where there was no such allegation of failure to ensure that Noticees have accepted investment from HDFC Bank when funds were parked by its Liquid Fund Scheme in STD of HDFC Bank. In the absence of existence of aforesaid clarification at the time of alleged parking of funds in STDs of HDFC Bank by Liquid Fund Scheme of the Kotak Mutual Fund and subsequently accepting investment from HDFC Bank in that scheme, the AO was right in concluding that there was no violation of said SEBI Circular dated April 16, 2007 based on the aforesaid factual position. The SCN dated November 12, 2018 has stated that, it is the intention of the said circular that the restriction of not placing STDs with a bank which has invested in the scheme shall also be maintained at all points of time. In this respect, I note that in terms of para 5 and 8 of the Circular dated April 16, 2007, there is obligation on the schemes of Mutual Funds to not to park its funds in STDs of a bank which has invested in that scheme and such investment is in existence at the time when such scheme parks its funds in STDs of that bank. Such obligation would not continue when there is no existing investment in the scheme from a bank where funds are being parked in STDs by that scheme. The obligation to ensure that any scheme of a Mutual Fund should not accept investment from a bank where that scheme has parked its fund in STD of that bank, was neither mentioned in the inspection report nor in the AO appointment order nor alleged in the SCN dated July 23, 2018 issued by the AO and, therefore, it cannot be said that AO Order is erroneous. I, therefore, find that under the facts and circumstances of the case, the AO Order dated October 12, 2018 can note be said to be erroneous and, therefore, the same does not warrant invocation of the powers of Section 15-I (3) of the SEBI Act, 1992.

18. The second allegation made in the SCN dated November 12, 2018 is in respect of 120 invalid email ids noted on sample basis during the course of inspection. The SCN has stated that AO has accepted the logic of Noticees with respect to 93 email ids but AO has failed to take into account the other 27 email ids which has deprived investors of various information and also violated their confidentiality. I note that AO has observed that scheme wise annual reports were displayed on the website of the Noticees and AMFI, there were no complaint from any investor and corrective steps were taken by the Noticees and, therefore, AO was of the view that the alleged default was procedural, venial and not blameworthy to impose penalty. In this respect, in the present proceedings, the Noticees vide their reply dated January 02, 2019 have provided the details of all those 120 invalid email ids. With regard to alleged 27 invalid email ids, the Noticees have submitted that 17 invalid email ids were replaced in KRA records and, with respect to 10 invalid email ids, the Noticees have taken up the matter with the investors for correct email id and out of which it has received response from five investors. I find that AO has taken note of the fact that corrective steps were taken by the Noticees and the alleged defaults were rectified. Thus, in view of the facts and circumstances of the case it cannot be said that the AO Order dated October 12, 2018 is erroneous and, therefore, the same does not warrant invocation of the powers of Section 15- I (3) of the SEBI Act, 1992.

19. The third allegation is that even though AO has upheld that the Noticees have violated the 2006 Circular with respect to cut off timings for Gold ETF but failed to impose any penalty. I note that AO has observed that the allegation was only with regard to methodology adopted for calculating minor cash component on redemption at 11 instances and the total impact of the same amounted to Rs. 2,103.10/- (0.0019% to -0.0199%). AO has also noted that on adoption of previous day’s NAV, the unit holders have made a profit of Rs. 2,103.10/-. Considering the facts that the auditor has not brought on record that adoption of previous days NAV for redemption of cash component has caused any impact on the unit holders or on NAV or loss to unit holders or to mutual funds, the AO has observed that the discrepancies were in the nature of minor irregularity and not serious enough to warrant imposition of monetary penalty. I note that, while forming a view to not impose penalty for such discrepancy, the AO has taken into account the factors enumerated under Section 15J of the SEBI Act, 1992 which includes the amount of disproportionate gain or unfair advantage, the amount loss caused to the investors and repetitive nature of the default. As such, in view of the facts and circumstances of the case it cannot be said that the AO Order dated October 12, 2018 is erroneous and, therefore, the same does not warrant invocation of the powers of Section 15-I (3) of the SEBI Act, 1992.

20. In view of the above facts and circumstances, the SCN dated November 12, 2018 is disposed of in terms of the observations made in paras 17 to 19 above.

21. A copy of this Order shall be forwarded to the Noticees.

DATE: May 31, 2019 ANANTA BARUA PLACE: Mumbai WHOLE TIME MEMBER SECURITIES AND EXCHANGE BOARD OF INDIA