The Indian financial market is experiencing phenomenal growth in mutual funds and portfolio management services (PMS). The mutual fund and PMS industries are two of the fastest growing investments in India. A mutual fund pools money from several investors to invest in a pooled diversified securities portfolio, while PMS is a discretionary portfolio management service that provides customized investment decisions for high-net-worth individuals (HNI's).

The Securities and Exchange Board of India (SEBI), as an apex regulatory body, regulates the securities market in India. SEBI's regulatory framework for mutual funds and PMS seeks to protect the interests of investors, asset managers, and all stakeholders and to allow for market growth. This note examines SEBI's regulatory regime for mutual funds and PMS and analyzes the legality of mutual funds and PMS, discussing case law relating to both PMS and mutual funds.

Regulatory Framework Regarding Mutual Funds

Mutual funds in India operate under SEBI (Mutual Funds) Regulations, 1996.^[1] This Act has been amended many times to keep up with the changing financial environment. It provides complete details of the working of mutual funds in India. The major provisions of the Act include:

• Registration and Eligibility: Mutual funds must be registered with SEBI. Sponsors, trustees, and asset management companies (AMCs) must meet specific eligibility criteria to ensure financial stability and governance standards.
• Organizational Structure: Mutual funds operate under a trust structure, with the sponsor setting up the trust, trustees overseeing operations, and the AMC managing investments, ensuring a clear separation of roles.
• Investment Restrictions: Regulations impose limits on exposure to single securities, group companies, and derivatives to ensure diversification and risk management, protecting investors from undue concentration risks.
• Disclosure Requirements: Mutual funds must give complete disclosures through offer documents, key information memorandums, and periodic reports, ensuring investors are well-informed about objectives, risks, and performance.
• Advertisement and Sales Practices: SEBI regulates marketing practices to prevent misrepresentation, requiring advertisements to be fair, accurate, and not misleading, with guidelines on performance claims and risk disclosures.

These fund managers and AMCs owe a standard of care which obligates them to act in the best interests of the investors. They also have a form of liability of misrepresentation which means that any misrepresentations, misleading disclosures or breaches of the SEBI regulations could be subject to penalties, suspension as well as cancellation of their registration. In the case of SEBI vs. Sahara India Real Estate Corporation Ltd. (2012),^[2] the Hon'ble Supreme Court of India highlighted SEBI's broad powers to regulate investment products, setting a precedent for investor protection that extends to mutual funds, focusing on disclosure and transparency. This ruling also signifies the overarching role of the judiciary in enabling the regulation of financial markets and holding corporations and their executives accountable. Similarly, in the case of Escorts Mutual Fund vs. SEBI,^[3] the Securities Appellate Tribunal upheld SEBI's regulatory measures, focusing on the importance of adherence to the SEBI (Mutual Funds) Regulations, 1996. This case highlighted judicial support for SEBI's enforcement actions with an emphasis on achieving transparency and investor protection through regulation.
 

Regulatory Framework for Portfolio Management Services

Portfolio Management Services (PMS) are regulated under the SEBI (Portfolio Managers) Regulations, 2020,^[4] which replaced the previous 1993 framework. The regulation aims to improve investor protection and transparency in portfolio management. Some of the key provisions include:

• Registration and Compliance: Portfolio Managers must be registered with SEBI, with a minimum net worth requirement increased from ₹2 crore to ₹5 crore to ensure only capable entities offer PMS.
   
• Minimum Investment Threshold: The minimum investment amount for clients using PMS has been raised to ₹50 lakh. SEBI aims to target high-net-worth individuals and ensure that clients have meaningful investments in their portfolios.
   
• Risk Disclosure: PMS providers are required to disclose risks associated with investment strategies and obtain explicit consent from clients.
   
• Performance Reporting: Regular reporting of portfolio performance and fees is mandated to ensure transparency between PMS and clients.
   
• Fiduciary Responsibilities: The regulations impose a fiduciary duty on portfolio managers to act in the best interests of their clients, ensuring fair treatment and ethical management of investments.

PMS agreements are customized for individual clients, so they are legally binding. If breached, one could have civil or criminal liability exposure. PMS providers cannot engage in misconduct that is regarded as adverse to the interests of the client as dictated by SEBI regulations.

In the case of SEBI vs. Pyramid Saimira Theatre Ltd. (2010),[5] SEBI emphasized the importance of transparency and accountability in portfolio management. SEBI also inflicted penalties on the party for fraudulent practices, and established the importance of strict regulatory framework.

Similarly, in the Karvy Stock Broking Ltd. Case (2019),[6] SEBI found that the brokerage in question misused client securities by failing to treat client securities as separated from its own, pledging client securities as collateral for borrowed funds, and misusing the funds it obtained via the pledged client securities for the benefit of related parties. SEBI's actions against Karvy Stock Broking Ltd. for its misuse of client securities emphasized the importance of treating client assets separately and the importance of fiduciary duties.

Comparative Analysis of MF and PMS Regulations

While both Mutual Funds (MFs) and Portfolio Management Services (PMS) are regulated by SEBI, they exist within two separate regulatory frameworks, dictated by differences in investor base, flexibility, and risk to return ratios. Mutual Fund are focused on the retail investor and provide a standardized and highly accessible investment structure, with generally lower risk associated. The retail investor has a much broader investor base, which influences the degree of regulation and restrictions over disclosure to protect an unsophisticated investor.

PMS has a IRR investment targets limited mainly to high-net-worth individuals (HNIs) and institutional investors, and provides possess and more personalized feedback for recipients. With personalized customized investment solutions, clients must be ready for more flexibly involved risks rigidly disclosed as with financial returns.

In this way, all investment advisers continue the duty to ensure that clients are aware of the risks involved, while normal mutual funds are bound to emphasize simplicity/mass variety; and protection of the ordinary investor. The regulated worlds of PMS and mutual funds provide advantages/disadvantages for the individual investors to understand the more complex components of their investment approach and styles.

Conclusion
SEBI's regulation of Mutual funds and Portfolio Management Services has played a major role in the development and stability of India's capital markets. Through a strong legal framework, SEBI has reinforced confidence in investors and bolstered manifest integrity of capital markets. The market's participants can comply with, and understand regulations, to mitigate legal implications and further develop a well-organized and fair financial system.

It is important to note that market participants need to overcome various hurdles including regulatory overlap and gaps related to government enforcement, for the regulatory system to continue to further strengthen the system to protect investors. The legal implications from the examples as outlined from case laws, show the enforcement powers of SEBI and the importance of protecting investors. Judicial precedents further establish the importance of complying with regulations, thereby adding further integrity to the financial ecosystem.

References:

1. Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, [Last amended on February 07, 2023], Securities and Exchange Board of India, https://www.sebi.gov.in/legal/regulations/feb-2023/securities-and-exchange-board-of-india-mutual-funds-regulations-1996-last-amended-on-february-07-2023-_69213.html.
2. Sahara India Real Estate Corpn. Ltd. v. SEBI, (2012) 10 SCC 603
3. Escorts Mutual Fund v. P. Sri Sai Ram, Adjudicating Officer, Securities & Exchange Board of India, 2002 SCC OnLine SAT 1.
4. Securities and Exchange Board of India (Portfolio Managers) Regulations, 2020, [last amended Feb. 7, 2023], Securities and Exchange Board of India, https://www.sebi.gov.in/legal/regulations/feb-2023/securities-and-exchange-board-of-india-portfolio-managers-regulations-2020-last-amended-on-february-07-2023-_69223.html.
5. Pyramid Saimira Theatre Ltd. v. Securities and Exchange Board of India, 2010 SCC OnLine SAT 146
6. Securities and Exchange Board of India, Ex Parte Ad Interim Order in Respect of Karvy Stock Broking Limited (Nov. 22, 2019), https://www.sebi.gov.in/enforcement/orders/nov-2019/ex-parte-ad-interim-order-in-respect-of-karvy-stock-broking-limited_45049.html.