Mutual Funds in India are regulated by the Securities and Exchange Board of India (“SEBI”) through their SEBI (Mutual Funds) Regulations, 1996 (“Regulation”). Commercial Banks and other financial institutions including the NBFCs are regulated by the Reserve Bank of India (“RBI”).

The Banks have a contractual duty towards their customer which creates a fiduciary relationship between the bank and the customer whenever they act as agents, trustees or depositees of the customers.

In the case of Bhita Co-operative Development and Cane Marketing Union Ltd. v. Bank of Bihar the court held that in case of any fraud perpetuated against the customers account through the bank, if the act is due to the negligence of the customer, then the bank is not held liable for the same. But if the bank is negligent in exercising due care imposed upon it to verify genuinity of the documents provided to the bank, then in case of a fraud, the bank is considered liable for the same and the client cannot be debited with any payment made by the bank on such documents.

The mutual funds, as per the Regulations are set up as trusts and hence have a fiduciary duty towards their investors. Trustees assume the fiduciary responsibility to ensure that affairs of mutual fund are conducted in accordance with the regulations and that the interests of investors are protected. These MFs are supposed to deal with the funds of the investors with utmost care, avoid any unsound investments and buy assets for their unit holders at the best possible price. Thus they have been vested with a duty to care and any breach in such duty which causes any injury or loss to the customer would make them liable for compensation and damages.

While laying down the rights and obligations of the Trustees, the Regulation mentions that code of ethics laid down to govern the Trustees must be designed to prevent fraudulent, deceptive or manipulative practices by insiders in connection with personal securities transactions.

The said Regulation with the aim of investor protection pin the liability on the Mutual Funds in case of any default in complying with its provisions. Therefore any Mutual Fund, which indulges in unfair trade practices in securities, shall be dealt with in the manner provided under the Securities and Exchange Board of India (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002. Unfair Trade Practices include fraud, which has been further defined under the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 1995 (which is similar to its definition under Section 17 of the Indian Contract Act, 1872) as:

2 (c) “fraud” includes any of the following acts committed by a party to a contract, or with his connivance, or by his agent, with intent to deceive another party thereto or his agent, or to induce him to enter into the contract:

(1) the suggestion, as to a fact, of that which is not true, by one who does not believe it to be true;

(2) the active concealment of a fact by one having knowledge or belief of the fact;

(3) a promise made without any intention of performing it;

(4) any other act fitted to deceive;

(5) any such act or omission as the law specially declares to be fraudulent;

and “fraudulent” shall be construed accordingly.

Explanation: Mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud, unless the circumstances of the case are such that, regard being had to them, it is the duty of the person keeping silence to speak, or unless his silence is, in itself, equivalent to speech.

The Securities and Exchange Board of India (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations, 2002 provide that in case of any contravention or default by the Mutual Fund of any provisions of the said Regulations, SEBI may suspend or cancel the license of the Mutual Fund along with further actions.

The current position of the courts regarding the liability of Mutual Funds in case of potential or alleged frauds is illustrated by the following cases:

1. Indian Bank Mutual Fund and Ors. v. Securities and Exchange Board of India MANU/DE/2648/2006

In the abovementioned case, the Delhi High Court quashed an order of the SEBI and Central Government (Appellate Authority) issued under the Section 11B of the Securities and Exchange Board of India Act, 1992 (“Act”) against the Mutual Fund on looking into the matters of the said Fund and discovering that it had complied with all the statutory regulations and when it found that the public had not been mislead by the said fund.

2. The Chairman, SEBI v. Shriram Mutual Fund and Anr. AIR 2006 SC 2287

In the instant case, the respondent a Mutual Fund had failed to comply with terms and conditions attached to Certificate of Registration which were statutory in nature. The Hon’ble Supreme Court held that where once it is conclusively established that mutual fund had violated terms of Certificate of Registration and the statutory Regulations, imposition of penalty becomes a sine qua non. But before the penalty is imposed, the contravention by the Mutual Fund has to be established, even though the intention of the party in the matter may be completely irrelevant.

The above case laws exhibit the current trend of regulatory bodies and courts in India. Though the Board tends to lean towards the investors, it is quite settled on the point that every case shall be looked into individually and decided on the basis of the facts of the same. The courts have held that the provisions laid down in the said Act and said Regulations have to be followed while investigating any Mutual Fund or other Financial Body regulated by SEBI and before issuing necessary directions to them.

The RBI through its Master Circular on Frauds: Classification and Reporting which has been revised through the Circular No. DNBS.PD.CC. NO. 149/03.10.042/2009-10 Dated 1-7-2009 to include NBFCs in its purview, lay down the provisions for reporting of frauds to the RBI and other law enforcement agencies for quick and efficient action to be taken against the perpetrators of the offence. The circular classifies different types of fraud as per the provisions of Indian Penal Code, 1860 and provides for setting up of a Special Committee to monitor and review frauds. The Reporting has to be done to the RBI in an FMR-1 form, which requires all the details of the bank which was defrauded to be given along with the details of the person committing the fraud (viz. Staff, Customers or Outsiders). Further the status of actions taken by the financial institution against the perpetrators has to be included.

Hence the current perspective of the courts and other adjudicating authorities in India regarding the liability of Mutual Funds, Banks and other financial institutions in case of a fraud on investor’s or customer’s account is as follows. The authorities in India will not impose a strict liability on the Mutual Funds or the Banks in case of a fraud. In every case of alleged or potential fraud, the courts will look into the matter at hand separately and after forming a complete picture, impose liability on the party that has been negligent. If the Mutual Funds or the Banks have been negligent and the said negligence has led to a breach in duty to care which lay upon such Mutual Funds or Banks and which caused any injury or loss to the customer or investor then they will be considered liable for the same. Moreover if an employee or member of the staff of the Bank or Mutual Fund acting in his official capacity is responsible for such fraud, then they will be vicariously liable for the acts of their employees or agents.

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