The Securities and Exchange Board of India (Sebi) has served a fresh show cause notice to Kotak Mahindra Asset Management for delay in repayment of money to unitholders of four close-ended debt schemes that held securities of Essel Group on their maturity, said three people with direct knowledge of the matter. The regulator has alleged that Kotak Mutual has violated rules that require fund houses to pay back the entire money on the declared net asset value (NAV) when a scheme matures, said the people mentioned above. This is the second show cause notice sent to the fund house on the matter.

Unitholders of Kotak’s fixed maturity plans (FMPs) weren’t paid in full on maturity after a few mutual funds in late January 2019 entered into the so-called standstill agreement with Subhash Chandra’s Essel Group following the plunge in shares of Zee Entertainment and Dish TV.

Kotak AMC paid back the investors of these schemes in September 2019 after it managed to recover the dues from Essel Group.

Promoter groups had pledged their shares of both the companies to borrow from mutual funds and finance companies. Essel Group’s cash-strapped founders had failed to replenish the collateral after the share prices dropped. The inability to recover the money from Essel Group in time has resulted in the show cause notices with a miffed Sebi questioning the legality of such agreements between mutual funds and bond issuers.

The fresh show cause notices to Kotak AMC are for delay in repayments in four FMPs namely 187, 189, 193 and 194. These four funds had invested between 10% and 20% of the total assets in the debt papers of Essel that had come up for maturity in April-May 2019. The earlier show cause notice to Kotak AMC in May 2019 was for FMPs — 127 and 183.

Email queries to Sebi and Kotak AMC remained unanswered.

“The issue here is the standstill agreement and Sebi thinks fund houses should have avoided such an agreement,” said a lawyer with direct knowledge of the matter.

Fund houses have been defending the standstill agreement on the grounds that its absence would have resulted in investors in schemes that invested in Essel Group papers taking a bigger hit.

“A mutual fund entering into a ‘standstill’ agreement with its borrower, permitting an extended tenure for the debt instrument and not invoking the security even on account of non-timely repayment, is fine from a lender-borrower contractual stand-point but may not be construed by Sebi as compliant with the spirit of mutual fund regulations,” said Tejesh Chitlangi, partner, IC Universal Legal.

Last year, Sebi had also issued a show cause notice to HDFC MF, which had given unitholders of its FMPs the option of rolling over investments for another 380 days instead of redeeming at maturity in mid-April of 2019.

HDFC MF, however, absorbed the Essel papers worth ₹500 crore that the debt schemes held into its own books, resulting in unitholders getting back their entire money. Earlier this year, HDFC MF settled the matter with Sebi through the consent mechanism.

Experts said Sebi may have been more lenient with HDFC MF because investors got money on time. “HDFC AMC took a hit on its books and compensated the investors out of pocket. Later, when Essel repaid its dues, it recouped the money,” said the top executive of a fund house. “On the other hand, Kotak AMC waited for Essel to pay back and then investors were paid.”

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