Legal Structure — who holds your money, and who watches them

The question this chapter answers

You hand ₹5,000 to a mutual fund. Where does it actually go, and what stops the fund house from spending it on office furniture?

The answer is the structure — and it was designed with checks and balances precisely so that no single party ever controls both your money and the decisions about it.

Why a trust, and not a company

SEBI defines a mutual fund as a fund established in the form of a trust, registered under Regulation 3, raising money through the sale of units to the public under one or more schemes, to invest in securities, money market instruments, gold or gold-related instruments, silver or silver-related instruments, and other assets SEBI specifies.

Four features flow from that definition:

• It is established as a trust
• It raises money by selling units to the public or a section of the public
• Units are sold under one or more schemes
• The schemes invest in securities, gold, silver or real estate assets

Mutual funds are governed by the Indian Trusts Act, 1882. The trust deed itself is registered under the Indian Registration Act, 1908.

Here is why the trust form matters, and it is the single most important idea in this chapter.

In a company, if the company fails, creditors come for the company's assets. In a trust, the assets are held for the beneficiaries — and the beneficiaries here are you, the unitholders. The scheme's money is legally not the AMC's money. If the AMC collapses tomorrow, your portfolio is not available to its creditors.

That is not a technicality. It is the entire reason the structure exists.

The six players

1. Sponsor — the person or firm behind the whole business. Applies to SEBI for registration, then invests in the AMC's capital.

To qualify, a sponsor must:

• Be in financial services for at least 5 years
• Have positive net worth in all 5 immediately preceding years
• Have positive liquid net worth more than the proposed capital contribution to the AMC
• Have net profit after depreciation, interest and tax in each of the preceding 5 years
• Have average net annual profit of at least ₹10 crore over those 5 years
• Be a fit and proper person

Read that list again and notice what it is doing. It is filtering for people who already have money and a track record, so that the person launching a fund is not someone with everything to gain and nothing to lose.

2. Trustees — the guardians. The trust acts through its trustees, and their job is protecting the interests of the beneficiaries — the unitholders. They can be individuals (jointly called the Board of Trustees) or a trustee company acting through its Board of Directors.

Eligibility under Regulation 11 — a trustee must:

• Meet fit and proper criteria
• Not be a director, officer or employee of an AMC
• Not be a trustee of any other mutual fund
• Furnish whatever information SEBI asks for

Prior SEBI approval is required before anyone is appointed trustee. And at least two-thirds of the trustees must be independent — not associates of the sponsor, the AMC or the trustee company.

3. The Mutual Fund Trust — created by the sponsor in favour of the trustees, through a trust deed whose clauses SEBI prescribes. The first trustees are named in the trust deed, which also sets out how trustees are changed.

4. AMC (Asset Management Company) — runs the schemes day to day. Appointed by the sponsor or trustees, with SEBI approval. The trustees sign an investment management agreement with it setting out its responsibilities.

Requirements:

• Directors must have adequate professional experience in finance and financial services, and be fit and proper
• At least 50% of directors must not be associates of the sponsor, its subsidiaries or the trustees
• AMC directors, including the Chairman, cannot simultaneously sit on the board of any mutual fund's trustee company
• No person may be a director in more than one AMC
• Net worth of at least ₹50 crore, effective 1 January 2024, maintained continuously — and it is the sponsor's responsibility to ensure this

The AMC provides the offices, staff, software, advertising and sales promotion, and deals with regulators and service providers. It must exercise due diligence so that investments never conflict with SEBI regulations or the trust deed.

How an AMC can be sacked: by a majority of the trustees, or by 75% of the unitholders. Either way, any change needs prior approval of SEBI and the unitholders.

If control of the AMC changes hands, the protections are specific and worth memorising:

• Prior approval of trustees and SEBI
• Written communication to each unitholder (email is acceptable where registered)
• Advertisement in one English daily with nationwide circulation, and one newspaper in the language of the region where the mutual fund's head office is
• Unitholders get an exit option at prevailing NAV with no exit load, over a period of not less than 30 calendar days from that communication

You are never trapped in a fund whose owner changed without your say.

5. Custodian — physically holds the assets. Accepts and gives delivery of securities, and settles all transactions on behalf of the schemes. Appointed by the trustees, under a custodial agreement, and must be registered with SEBI under the SEBI (Custodian) Regulations, 1996.

The independence rule: if the sponsor or its associates control 50% or more of the custodian's voting rights, or if 50% or more of the custodian's directors represent the sponsor's interest, that custodian cannot be appointed — unless specific conditions are met.

An independent custodian ensures the securities really are held for the benefit of investors. It also tracks corporate actions — dividends, bonuses, rights.

6. RTA (Registrar and Transfer Agent) — maintains investor records. Processes purchases, redemptions and switches, moves the money, updates the scheme's unit capital, maintains your folio, and generates your account statement. Its offices act as Investor Service Centres (ISCs).

Two details the exam likes: the RTA is appointed by the AMC, and appointing one is not compulsory — the AMC may do it in-house. But all RTAs must register with SEBI.

Who appoints whom — the table to memorise

This is the most reliably tested content in the chapter, and the logic is consistent: anything that needs to be independent of the AMC is appointed by the trustees.

Inside the AMC

Compliance. The Compliance Officer signs the due-diligence certificate in scheme documents for new issues, confirming that all regulations are complied with and all intermediaries hold the required registrations. To protect independence, the Compliance Officer reports directly to the head of the AMC and must report any non-compliance directly and immediately to the trustees.

Fund management — the core. Three sub-teams:

• Analysts identify opportunities — equities, debt, credit, interest rates, sectors, the economy
• Fund managers evaluate them and decide. Scheme performance is the fund manager's responsibility
• Dealers place orders with brokers on the fund managers' instructions

Operations and customer services. Front office (branch) and back office together form the Customer Services Team; many AMCs now run call centres and chatbots. Within this group sit the RTA function, the Custody team (settlement), and the Fund accounting team, which maintains each scheme's books and calculates NAV daily.

Under SEBI's Risk Management Framework, risk management is an independent and specialised function in every AMC, with dedicated risk officers for investment risk, compliance risk, operational risk and cyber security.

Sales and marketing — branding, advertising, events, and the distribution channel. This is the team a distributor actually deals with.

Other functions — Finance/Accounts (note: different from fund accounting), Administration, HRD and Information Technology.

The service providers around the fund

Fund accountant — calculates NAV from each scheme's assets and liabilities. May be in-house or outsourced, and needs no SEBI registration.

Auditors — and here is a crucial separation. Scheme accounts are maintained independently of the AMC's accounts, and the scheme auditor must be different from the AMC auditor. The scheme auditor is appointed by the trustees; the AMC auditor by the AMC.

Distributors — sell suitable schemes, may be empanelled with more than one AMC, and may be individuals or institutions (distribution companies, brokers, banks). They must pass NISM-Series-V-A and register with AMFI. There is also a new cadre of distributors, permitted to sell a limited set of schemes, who qualify by clearing NISM-Series-V-B (Mutual Fund Foundation).

Collecting bankers and payment aggregators — the scheme's bank accounts sit with collecting bankers appointed by the AMC. Newer entrants include payment gateways, digital wallets and payment banks.

KYC Registration Agencies (KRAs) — KYC is mandatory under the Prevention of Money Laundering Act. Without KRAs you would repeat KYC for every fund house. SEBI issued KRA regulations in 2011, creating a common KYC. KRAs are registered with SEBI, must maintain confidentiality, and are mandated to have computerised connectivity to share data with one another.

Valuation agencies — for fair valuation of non-traded or thinly traded debt securities, there must be at least two valuation agencies providing a valuation matrix. AMFI has appointed CRISIL Ltd. and ICRA Ltd.

Credit rating agencies — rate debt securities. Ratings are an initial input, before the fund manager's own due diligence. Categories like Corporate Bond and Credit Risk funds are defined by rating. For FMPs, the AMC may disclose the proposed rating profile before building the portfolio, and must then invest only within that profile or in less risky (higher-rated) paper.

Depositories and depository participants — hold securities in electronic form. NSDL and CDSL are India's two depositories. ETF units must compulsorily be held in demat form, since only demat securities can trade on exchanges. Other units, if not dematerialised, are tracked through account statements.

Stock exchanges — mutual fund units can be transacted on exchange platforms: BSE StAR MF and NSE's NMF-II. Close-ended fund and ETF units are compulsorily listed on at least one exchange; open-ended funds are available through special segments.

The one thing to take away

Your money never sits with one party who can do as they like. The AMC decides what to buy, the custodian holds it, the RTA records who owns what, the trustees supervise all of them, and SEBI regulates the lot. Every one of those separations exists because somewhere, at some time, somebody abused the absence of it.