Home > Topics > Mutual Fund Management > Trust & Trustees – Legal Structure & Duties
← PreviousNext →

Trust & Trustees – Legal Structure & Duties

Introduction

The trust structure forms the legal backbone of the mutual fund industry in India. Unlike a company where shareholders own the assets, in a mutual fund, all assets are held in a Public Trust created specifically for the benefit of unit holders. The Trustees act as the guardians of this trust, ensuring that the interests of lakhs of small investors are protected. This chapter explains the legal framework of the trust structure and the critical role played by trustees in safeguarding investor wealth.

The Trust Structure in Mutual Funds

Legal Framework

Every mutual fund in India must be constituted as a Public Trust registered under the provisions of the Indian Trusts Act, 1882. This legal requirement is mandated by SEBI (Mutual Funds) Regulations, 1996. The trust structure serves as a protective mechanism that separates the ownership of fund assets from their management.

The trust is established through a legal document called the Trust Deed, which is executed between the sponsor (as the settler) and the trustees. This Trust Deed outlines the objectives of the trust, the rights and obligations of the trustees, the manner in which the trust property shall be managed, and the procedures for appointment and removal of trustees.

Why Trust Structure?

The trust structure is specifically designed to ensure maximum protection for investors' money. Under this structure:

  1. Legal Ownership: The trustees are the legal owners of all mutual fund assets on behalf of the unit holders. This means the assets cannot be claimed by the sponsor, the AMC, or any creditors of these entities.

  2. Beneficial Ownership: While trustees are the legal owners, the unit holders are the beneficial owners. This means all income, profits, and gains from the trust property belong solely to the unit holders in proportion to their holdings.

  3. Ring-Fencing: The trust structure creates a legal ring-fence around investor money. Even if the sponsor or AMC faces financial difficulties or bankruptcy, the mutual fund assets held in the trust remain completely protected and cannot be attached by creditors.

  4. Fiduciary Relationship: The trustees owe a fiduciary duty to the unit holders, meaning they must always act in the best interests of investors and not for personal gain.

The Board of Trustees

Composition and Structure

The Board of Trustees is a body of individuals appointed to oversee the mutual fund on behalf of unit holders. SEBI regulations mandate specific requirements for the composition of this board to ensure independence and effective oversight:

Minimum Number of Trustees

A mutual fund must have a minimum of four trustees on its board. This number ensures adequate representation and prevents concentration of power in the hands of one or two individuals.

Independence Requirement

One of the most crucial requirements is that at least two-thirds (66.67%) of the trustees must be independent. An independent trustee is defined as a person who:

  • Is not, and has not been, associated with the sponsor or any of its associates in any capacity during the preceding three years
  • Does not have any material pecuniary relationship with the sponsor, the AMC, or their associates
  • Is not a relative of any person associated with the sponsor or AMC
  • Does not hold any position in the sponsor organization or its group companies

This independence requirement ensures that the majority of trustees can take decisions objectively without any conflict of interest.

Example of Trustee Composition

For a mutual fund with 6 trustees:

  • Independent Trustees: At least 4 (66.67%)
  • Non-Independent Trustees (may be from sponsor): Maximum 2 (33.33%)

Appointment and Tenure of Trustees

Appointment Process

Trustees are initially appointed by the sponsor when the mutual fund is established. However, any subsequent appointments must be made by the existing trustees themselves, subject to SEBI approval. This ensures continuity and prevents undue influence by the sponsor.

Tenure

Trustees are typically appointed for a period of five years and are eligible for reappointment. The Trust Deed specifies the exact tenure and reappointment procedures.

Removal of Trustees

A trustee can be removed from office in the following circumstances:

  • If convicted of any criminal offense involving moral turpitude
  • If found to be of unsound mind
  • If declared insolvent
  • If absent from three consecutive board meetings without valid reason
  • If found to have acted in a manner detrimental to the interests of unit holders

Duties and Responsibilities of Trustees

The trustees shoulder immense responsibility as guardians of investor wealth. Their duties can be categorized as follows:

1. Oversight of Asset Management Company (AMC)

The primary duty of trustees is to exercise continuous oversight over the functioning of the AMC. This includes:

Monitoring Investment Decisions: Trustees must ensure that all investment decisions made by the AMC are in accordance with the stated investment objectives of each scheme and comply with SEBI regulations. They must verify that the portfolio does not violate any concentration norms (such as the limit on investment in a single stock or sector).

Performance Review: Trustees are required to review the performance of each scheme on a quarterly basis. They must analyze whether the schemes are meeting their investment objectives and whether investors are getting fair value for the management fees being charged.

Risk Management: Trustees must ensure that the AMC has adequate risk management systems in place. They must review the risk profile of each scheme and ensure that risk disclosures to investors are accurate and complete.

2. Approval of New Schemes and Changes

Before the AMC can launch any new mutual fund scheme or make any fundamental changes to an existing scheme, it must obtain the approval of the trustees. The trustees must satisfy themselves that:

  • The proposed scheme is in the interest of investors
  • The investment strategy is clearly defined and feasible
  • Adequate risk disclosures are being made
  • The scheme does not duplicate existing offerings unnecessarily

Similarly, any changes to fundamental attributes of a scheme (such as investment objective, asset allocation pattern, or fee structure) require trustee approval and, in many cases, unit holder consent through a special resolution.

3. Ensuring SEBI Compliance

Trustees are responsible for ensuring that the mutual fund operates in full compliance with SEBI (Mutual Funds) Regulations and other applicable laws. They must:

  • Review compliance reports submitted by the internal auditor and compliance officer
  • Ensure timely filing of all regulatory returns with SEBI
  • Monitor adherence to investment restrictions and portfolio norms
  • Verify that all disclosures to investors are made as per SEBI requirements

4. Appointment of Key Functionaries

Trustees have the authority to appoint (and remove, if necessary) several key functionaries of the mutual fund, including:

  • Asset Management Company: While the sponsor initially proposes the AMC, trustees can change the AMC if they find it is not functioning in the interest of unit holders
  • Custodian: To hold the physical securities and ensure safe custody
  • Auditors: Both internal and statutory auditors
  • Registrar and Transfer Agent (RTA): For maintaining investor records

5. Investor Grievance Redressal

Trustees are required to ensure that a proper mechanism exists for handling investor complaints and grievances. They must:

  • Review the number and nature of investor complaints on a regular basis
  • Ensure prompt resolution of grievances
  • Take corrective action if systemic issues are identified
  • Report to SEBI on investor complaints and their resolution

6. Monitoring NAV Calculation

Trustees must ensure that the Net Asset Value (NAV) of each scheme is calculated accurately and published within the prescribed time limits. Any errors in NAV calculation can cause significant harm to investors, so trustees must verify that proper controls and checks are in place.

7. Safeguarding Assets

Trustees must ensure that all securities and assets of the mutual fund are held by the custodian in a safe and secure manner. They must periodically verify the physical existence and ownership of these assets through reconciliation and inspection procedures.

Powers of Trustees

To enable them to discharge their duties effectively, trustees are vested with certain powers:

  1. Right to Information: Trustees have the right to obtain any information from the AMC that they consider necessary for the performance of their duties.

  2. Right to Inspect Records: Trustees can inspect all books, records, and documents of the AMC relating to the mutual fund.

  3. Power to Issue Directions: Trustees can issue directions to the AMC on any matter relating to the protection of interests of unit holders.

  4. Power to Terminate AMC: In extreme cases where the AMC is not functioning properly, trustees have the power to terminate the AMC's appointment and appoint a new AMC, subject to SEBI approval.

Comparison: Trustees vs AMC

Loading comparison…

Exam Notes: Writing the Answer

Question: "Explain the role of Trustees in a mutual fund. How does the trust structure protect investors?" (15 Marks)

Model Answer Structure:

Introduction: In India, every mutual fund must be constituted as a Public Trust under the Indian Trusts Act, 1882. The trustees act as guardians of this trust, holding all fund assets on behalf of unit holders and ensuring that the Asset Management Company operates in the best interests of investors.

Trust Structure and Protection: The trust structure provides protection through:

  1. Legal ownership of assets vests with trustees, not with sponsor or AMC
  2. Ring-fencing of assets - immune from creditors of sponsor/AMC
  3. Beneficial ownership remains with unit holders
  4. Fiduciary relationship obligates trustees to prioritize investor interests

Composition of Board of Trustees:

  • Minimum four trustees required
  • At least two-thirds must be independent (not associated with sponsor)
  • Appointed initially by sponsor, subsequently by existing trustees
  • Five-year tenure with possibility of reappointment

Key Duties of Trustees:

  1. Oversight of AMC: Monitor investment decisions, review performance quarterly, ensure compliance with investment objectives
  2. Scheme Approval: Approve launch of new schemes and fundamental changes to existing schemes
  3. Regulatory Compliance: Ensure adherence to SEBI regulations and timely filing of returns
  4. Appointment of Functionaries: Appoint/remove AMC, custodian, auditors, and RTA
  5. Investor Protection: Review and resolve investor grievances, monitor NAV calculation
  6. Asset Safeguarding: Ensure proper custody and security of fund assets

Powers of Trustees:

  • Right to obtain information and inspect records of AMC
  • Power to issue directions to AMC for investor protection
  • Authority to terminate AMC appointment in cases of serious violations

Conclusion: The trust structure and the trustees' fiduciary role form the cornerstone of investor protection in the mutual fund industry. By separating legal ownership (trustees) from management (AMC), the structure ensures that investor interests are always paramount.

Summary

  • Every mutual fund must be constituted as a Public Trust under Indian Trusts Act, 1882
  • Trust Deed executed between sponsor and trustees defines the legal framework
  • Trust structure provides ring-fencing of assets, protecting them even if sponsor/AMC faces financial difficulties
  • Board of Trustees must have minimum 4 members with at least 66.67% being independent
  • Trustees are the legal owners of fund assets; unit holders are beneficial owners
  • Key duties include: AMC oversight, scheme approval, compliance monitoring, appointing key functionaries, grievance redressal
  • Trustees owe a fiduciary duty to unit holders - must always act in their best interests
  • Trustees have power to obtain information, inspect records, issue directions, and even terminate AMC if necessary
  • Quarterly reviews of scheme performance and compliance are mandatory

Quiz Time! 🎯

Loading quiz…

← PreviousNext →