The case relates to Kotak Mutual Fund’s six close-ended debt schemes (FMPs), which had invested in Zero Coupon Non-Convertible Debentures (NCDs) issued by Konti Infrapower & Multiventures and Edison Utility Works, part of the Essel Group, the promoter group of Zee Entertainment Enterprises. The investments were secured by pledged shares of Zee, with a collateral requirement of 150% of exposure. In January 2019, the Zee share price crashed, causing the collateral value to fall below the required level. The Essel entities failed to top up the pledge, and the debentures were eventually repaid months later after selling pledged shares.
Sebi alleged several regulatory violations, including a lack of due diligence while investing in Essel group companies, failure to properly assess the creditworthiness of issuers, improper valuation of securities and delayed disclosures of developments to investors, among other things. The asset manager had challenged Sebi orders issued in 2021 and 2022 concerning investments made in debt instruments of Essel Group companies. SAT largely upheld Sebi’s findings that Kotak AMC failed to exercise due diligence, violated mutual fund rules by extending maturities, and delayed disclosures to investors, even though investors ultimately did not suffer monetary losses.
The tribunal observed that Kotak AMC did not assess the financial strength of the issuer companies and made an investment decision based on the pledge of shares of Zee rather than the issuers’ credit profile.
SAT noted that investments should primarily be based on the intrinsic strength of the issuing company, not merely on collateral security.
“Investors repose trust in mutual fund companies and invest their hard-earned money. In our considered view, making investment in Konti and Edison based on a pledge, without assessing the financial strength of the companies, is a serious lapse. This is compounded by not informing the investors timely manner about the events leading to the partial redemption. In view of these serious lapses, we do not find any merit in the submissions with regard to penalty,” SAT said.
However, SAT held that Sebi’s direction to refund a portion of investment management fees was not justified because disgorgement requires proof of wrongful gain, and Sebi couldn’t establish that Kotak AMC made any illegal profit. Hence, the tribunal set aside the disgorgement order, though other findings were upheld. “As per the order received earlier today, the Hon’ble SAT has granted relief on the issue of disgorgement of fees while upholding the Sebi order on penalties,” said a spokesperson for Kotak Mahindra AMC.