Why the Supreme Court sided with SEBI against Kotak AMC

Hello folks, you're tuned in Finshots Daily, and in today's episode, we explain why the Supreme Court upheld a SEBI order against Kotak AMC.
But before we begin, here's a quick note from Dean Ditto. This weekend, we're hosting a free two-day insurance masterclass that helps you build real financial security by understanding health and life insurance the right way. Well, the masterclass is completely free, and you can head to the link in the description to register while you see its last. Okay, let's start with the story.
This week, the Supreme Court upheld a 2.1 crore penalty imposed on Kotak Mahindra Asset Management Company and its trustee company, Kotak Mahindra Trustee Company, which oversees whether the AMC compiles with SEBI regulations and acts in the best interests of investors. The penalty itself isn't huge, but the judgment settles an important question. Can an asset manager break mutual fund rules if doing so ultimately protects investors? Well, the Apex Court's answer was a clear no. And to understand why, we will have to go back to between 2013 and 2016 when Kotak AMC launched six close-ended fixed maturity plans, or FMPs. For the uninitiated, FMP is similar to a bank fixed deposit, except that it's structured as a debt mutual fund. You can invest only during the fund's initial offer period. After that, the fund closes for fresh investments, which is why it's labeled close-ended. The AMC then takes this money and invests it in debt securities issued by governments or companies, making sure that these securities mature on or before the FMP itself. And at the end of the scheme's tenure, investors receive their money back along with whatever returns those debt investments have generated.
Unlike a bank FD though, these returns aren't guaranteed. Now, coming back to these FMPs, Kotak AMC invested about 266 crore rupees in debentures issued by two SL Group companies, Conti Infrapower and Multiventures, and Edison Utility Works.
If SL Group sounds familiar, that's because it's Zee Entertainment's parent company. And these debentures were secured by pledged shares of Zee itself. Think of it as a collateral for a loan. Since debentures are essentially loans, the borrower often offers something valuable as security, if the borrower, well in this case SL, repays on time, the collateral is returned. But if it defaults, the lender, which is Kotak, can sell that collateral to recover the money. In this case, the collateral happened to be Zee's shares. When came 2019, SL Group was battling a severe debt crisis and Zee's stock price crashed, which in effect created a new problem. The pledged Zee shares were suddenly worth much less than before and no longer provided sufficient security for the debentures. Normally, SL would have had to pledge additional shares to restore the required level of collateral, but it couldn't. And that left Kotak AMC with two choices. It could either immediately sell the pledged Zee shares and recover whatever money it could or restructure the debentures, giving SL more time to repay.
Kotak chose the second option for one simple reason. Dumping such a large quantity of Zee shares into the market would have pushed the stock price down even further, hurting not just Kotak's investors, but also every other lender and investor exposed to Zee. So instead of forcing a sale, Kotak extended the repayment timeline. And when the FMPs finally matured, Kotak AMC repaid most of the investors' money on time, withholding a small portion and paying it out roughly five months later along with interest. SEBI, however, viewed this as a serious violation and penalized Kotak AMC, its trustee company and a bunch of senior execs, including Kotak AMC's Managing Director, Neelay Shah. But hey, then Kotak actually do the more prudent thing here. After all, it wasn't just thinking about its own investors, but also about everyone else who could have been hurt by a fire sale of z-shares. So why did SEBI still find them? See, FMPs come with a fixed majority date. That means investors must be paid in full when the scheme matures, unless they're first asked whether they'd like to roll over or extend the scheme. Kotak AMC didn't do that. Which is why despite the fact that investors eventually got all their money back with interest and nobody actually lost money or even complained, SEBI still viewed this as a serious violation and passed two separate penalty orders in 2021 and 2022 One against Kotak AMC and another against the trustee company and its senior execs. Now, you can imagine that Kotak wasn't happy about this.
Its argument was probably the same one that's been running through your mind while reading this story. Sure, we technically broke a rule, but investors didn't lose anything. In fact, they were probably better off because if we'd sold the Z shares immediately, everyone would have suffered bigger losses. So why penalize good faith, investor-friendly behavior? And that's exactly what Kotak said when it challenged SEBI's order before the SAT, that is Securities Appellate Tribunal, the body that hears appeals against SEBI's decisions. SAT, however, wasn't convinced, so the case eventually landed before the Supreme Court, which wasn't convinced either.