Franklin India case – what you should do now

It’s been close to 8 months since Franklin India took the extraordinary step of winding up six of its debt funds. After much wrangling in courts, the Supreme Court’s order on December 3^rd has provided a clearer way forward in the Franklin India case. In line with the judgement delivered by the Karnataka High Court, the Supreme Court has directed the Franklin AMC to seek unitholders’ approval to actually wind up the schemes.

Following this, Franklin India AMC sent a communication to investors in the six schemes. This communication was to inform the investors that the AMC will seek their consent to wind up the schemes. The actual notice for voting, detailing the process and dates, will follow. The voting window and procedure are not yet out. Until this vote is done, the schemes will continue to remain closed off to any redemption; i.e., the prevailing situation with respect to these schemes will continue.

The future of the schemes depends on the vote. So what is the vote about, and how should you vote?

What the vote is for

If you recall, the first vote that Franklin India sought from unitholders was to approve liquidizing the securities held in each fund. It was not for the winding up decision itself, because of the way the AMC interpreted the SEBI Mutual Fund regulations.

In other words, the AMC had decided to wind up without investor consent and sought consent only to sell assets.

But, as the Karnataka High Court had observed, if the Trustees had decided to wind up a scheme under Regulation 39 of the SEBI MF Regulations, it is bound by obligation under a different Regulation 18 to seek the consent of unitholders for the same. A simple unitholder majority is needed for this.

The vote now, therefore, is for you to approve the original winding up decision that was taken in April 2020. You can vote either Yes or No.

• What a Yes vote implies: If you vote yes, you will be approving the winding up. That means, you won’t be able to place redemption orders. You will leave it to the AMC to go ahead with liquidating the debt instruments so that the money will be returned eventually to you. Your investment will slowly be paid back to you as and when each scheme monetizes the instruments.
• What a No vote implies: If you vote no, then the AMC will have to open up the schemes to redemptions (and fresh investments, but nobody’s going to put money back in). So you will be able to place a redemption request. However, it then becomes a normal open-ended scheme and you will therefore get the prevailing NAV (and not the NAV as on the winding up date). If the fund sells instruments at discounts in order to meet the redemption, you will suffer losses. This may well happen simply because almost all investors will rush to take back their money and a scheme with illiquid instruments (which is the case with a high proportion of Franklin’s closed schemes) cannot possibly sell all its illiquid instruments (if it sells at all) at a good price.

Once the vote is done, and if there’s a simple majority of the Yes vote then winding up is approved. In that case, the AMC will send a second vote to allow them to liquidate the instruments in each scheme, to execute and complete the winding up process. This second vote will be the one that Franklin AMC originally sought from you in June.

What should your vote be?

Our recommendation is that you vote Yes. Allow the schemes to be wound up. There appears to be no good reason to vote ‘No’ on this question and disagree to winding up the schemes.

People advocating that seem to be under the impression that somehow if the schemes get opened at some point, the AMC will allow redemption of units at the NAV of the date of shut down (April 24th), or that they will be legally required to. We believe that this extremely unlikely.

We continue to believe (as we have noted previously), that this situation was poorly handled by the AMC and poorly regulated by SEBI. But together, they have presented us with a ‘fait accompli’ – a deed already done. There’s no real choice if you are to get your money back without suffering further losses. Remember that it was an inability to meet redemptions that pushed Franklin India AMC into winding up the schemes in the first place.

The schemes, since April, have received interest accruals and prepayments on some instruments. Cash levels in some schemes are already at reasonable levels, and credit markets are more vibrant than they were when this saga first unfolded. This gives hope that the AMC will find it easier to liquidate at better prices. The table below shows the cash level in each scheme as of November 27, 2020.

In the current situation, the only thing that you can do is try and get as much of your money back as soon as possible. And voting ‘yes’ is the only way to prevent this bad situation from getting worse.

Why all this?

If you’re wondering whether going to the courts helped at all, it did in a couple of ways:

• One, it sent a strong signal to AMCs that investor consent for investor’s money is a must. There can be no 2 ways to interpret law just because it was poorly framed by the regulator.
• Second, the Courts have, in no uncertain terms, slammed SEBI for being a ‘silent spectator’ and for not being proactive. SEBI cannot also take the cover of not having the powers.

In simple words, it served as a wake up call for the regulator, which went all out with ‘product improvisation’ and failed in its ‘investor protection’ role. For a giant AMC such as Franklin Templeton, it was a lesson in humility and not taking investor and investor money for granted.