INVESTMENT LAW PROJECT

TOPIC:

MUTUAL FUND- HOW FAR IT IS A

PROTECTIVE VEHICLE FOR RETAIL
INVESTORS

SUBMITTED TO:

SUBMITTED BY:

MR. VIKAS GUPTA

SAMRAAT SINGH
BBA LLB(H)
8th SEMESTER
A3221511077

INDEX
INTRODUCTION

3.

DEFINITION

4.

A BREIF HISTORY

5.

ADVANTAGES

6.

TYPES OF MUTUAL FUNDS

8.

MUTUAL FUND IN INDIA

11.

RETAIL INVESTORS MAKING COSTLY MISTAKES

12.

MUTUAL FUNDS REGULATION

16.

INVESTOR PROTECTION IN INDIA

17.

CONCLUSION

19.

BIBLIOGRAPHY

20.

INTRODUCTION
As you probably know, mutual funds have become extremely popular over the last 20
years. What was once just another obscure financial instrument is now a part of our daily
lives. More than 80 million people, or one half of the households in America, invest in
mutual funds. That means that, in the United States alone, trillions of dollars are invested
in mutual funds.
There are a lot of investment avenues available today in the financial market for an
investor with an investable surplus. He can invest in Bank Deposits, Corporate
Debentures, and Bonds where there is low risk but low return. He may invest in Stock of
companies where the risk is high and the returns are also proportionately high. People
began opting for portfolio managers with expertise in stock markets who would invest on
their behalf. Thus we had wealth management services provided by many institutions.
However they proved too costly for a small investor. These investors have found a good
shelter with the mutual funds.
Mutual fund industry has seen a lot of changes in past few years with multinational
companies coming into the country, bringing in their professional expertise in managing
funds worldwide. In the past few months there has been a consolidation phase going on in
the mutual fund industry in India. Now investors have a wide range of Schemes to choose
from depending on their individual profiles.
In fact, too many people, investing means buying mutual funds. After all, it is common
knowledge that investing in mutual funds is (or at least should be) better than simply
letting your cash waste away in a savings account, but, for most people, that's where the
understanding of funds ends. As you might have guessed, it's not that easy. Mutual funds
are an excellent idea in theory, but, in reality, they haven't always delivered

Definitions

Mutual Fund - A mutual fund brings together money from many people and
invests it in stocks, bonds or other assets. The combined holdings of stocks, bonds
or other assets the fund owns are known as its portfolio. Each investor in the fund
owns shares, which represent a part of these holdings. It is important to note that
there is market risk involved when investing in mutual funds, including possible
loss of principal.
Mutual funds are investment companies that pool money from investors at large
and offer to sell and buy back its shares on a continuous basis and use the capital
thus raised to invest in securities of different companies

In fact, too many people, investing means buying mutual funds. After all, it's common
knowledge that investing in mutual funds is (or at least should be) better than simply
letting your cash waste away in a savings account, but, for most people, that's where the
understanding of funds ends. It doesn't help that mutual fund salespeople speak a strange
language that is interspersed with jargon that many investors don't understand.
An investment vehicle that is made up of a pool of funds collected from many investors
for the purpose of investing in securities such as stocks, bonds, money market
instruments and similar assets. Mutual funds are operated by money managers, who
invest the fund's capital and attempt to produce capital gains and income for the fund's
investors. A mutual fund's portfolio is structured and maintained to match the investment
objectives stated in its prospectus.
Originally, mutual funds were heralded as a way for the little guy to get a piece of the
market. Instead of spending all your free time buried in the financial pages of the Wall
Street Journal, all you had to do was buy a mutual fund and you'd be set on your way to
financial freedom. As you might have guessed, it's not that easy. Mutual funds are an
excellent idea in theory, but, in reality, they haven't always delivered. Not all mutual
funds are created equal, and investing in mutuals isn't as easy as throwing your money at
the first salesperson who solicits your business.

A Brief History Of The Mutual Fund

Mutual funds really captured the public's attention in the 1980s and '90s when mutual
fund investment hit record highs and investors saw incredible returns. However, the idea
of pooling assets for investment purposes has been around for a long time. Here we look
at the evolution of this investment vehicle, from its beginnings in the Netherlands in the
18th century to its present status as a growing, international industry with fund holdings
accounting for trillions of dollars in the United States alone.
In the Beginning
Historians are uncertain of the origins of investment funds; some cite the closed-end
investment companies launched in the Netherlands in 1822 by King William I as the first
mutual funds, while others point to a Dutch merchant named Adriaan van Ketwich whose
investment trust created in 1774 may have given the king the idea. Ketwich probably
theorized that diversification would increase the appeal of investments to smaller
investors with minimal capital. The name of Ketwich's fund, Eendragt Maakt Magt,
translates to "unity creates strength". The next wave of near-mutual funds included an
investment trust launched in Switzerland in 1849, followed by similar vehicles created in
Scotland in the 1880s.
The idea of pooling resources and spreading risk using closed-end investments soon took
root in Great Britain and France, making its way to the United States in the 1890s. The
Boston Personal Property Trust, formed in 1893, was the first closed-end fund in the U.S.
The creation of the Alexander Fund in Philadelphia in 1907 was an important step in the
evolution toward what we know as the modern mutual fund. The Alexander Fund
featured semi-annual issues and allowed investors to make withdrawals on demand.

A Brief of How Mutual Funds Work

Mutual funds can be either or both of open ended and closed ended investment
companies depending on their fund management pattern. An open-end fund offers to sell
its shares (units) continuously to investors either in retail or in bulk without a limit on the
number as opposed to a closed-end fund. Closed end funds have limited number of
shares. Mutual funds have diversified investments spread in calculated proportions
amongst securities of various economic sectors. Mutual funds get their earnings in two
ways. First is the most organic way, which is the dividend they get on the securities they
hold. Second is by the redemption of their shares by investors will be at a discount to the
current NAVs (net asset values).

Advantages of Mutual Funds

Since their creation, mutual funds have been a popular investment vehicle for investors.
Their simplicity along with other attributes provides great benefit to investors with
limited knowledge, time or money. To help you decide whether mutual funds are best for
you and your situation, we are going to look at some reasons why you might want to
consider investing in mutual funds.
1. Diversification:
One rule of investing, for both large and small investors, is asset diversification.
Diversification involves the mixing of investments within a portfolio and is used to
manage risk. For example, by choosing to buy stocks in the retail sector and offsetting
them with stocks in the industrial sector, you can reduce the impact of the performance of
any one security on your entire portfolio. To achieve a truly diversified portfolio, you
may have to buy stocks with different capitalizations from different industries and bonds
with varying maturities from different issuers. For the individual investor, this can be
quite costly.
By purchasing mutual funds, you are provided with the immediate benefit of instant
diversification and asset allocation without the large amounts of cash needed to create
individual portfolios. One caveat, however, is that simply purchasing one mutual fund
might not give you adequate diversification - check to see if the fund is sector or industry
specific. For example, investing in an oil and energy mutual fund might spread your
money over fifty companies, but if energy prices fall, your portfolio will likely suffer.
2. Economies of Scale:
The easiest way to understand economies of scale is by thinking about volume discounts;
in many stores, the more of one product you buy, the cheaper that product becomes. For
example, when you buy a dozen donuts, the price per donut is usually cheaper than
buying a single one. This also occurs in the purchase and sale of securities. If you buy
only one security at a time, the transaction fees will be relatively large.
Mutual funds are able to take advantage of their buying and selling size and thereby
reduce transaction costs for investors. When you buy a mutual fund, you are able to
diversify without the numerous commission charges. Imagine if you had to buy the 10-20
stocks needed for diversification. The commission charges alone would eat up a good
chunk of your savings. Add to this the fact that you would have to pay more transaction
fees every time you wanted to modify your portfolio - as you can see the costs begin to
6

add up. With mutual funds, you can make transactions on a much larger scale for less
money.
3. Divisibility:
Many investors don't have the exact sums of money to buy round lots of securities. One
to two hundred dollars is usually not enough to buy a round lot of a stock, especially after
deducting commissions. Investors can purchase mutual funds in smaller denominations,
ranging from $100 to $1,000 minimums. Smaller denominations of mutual funds provide
mutual fund investors the ability to make periodic investments through monthly purchase
plans while taking advantage of dollar-cost averaging. So, rather than having to wait until
you have enough money to buy higher-cost investments, you can get in right away with
mutual funds. This provides an additional advantage - liquidity.
4. Liquidity:
Another advantage of mutual funds is the ability to get in and out with relative ease. In
general, you are able to sell your mutual funds in a short period of time without there
being much difference between the sale price and the most current market value.
However, it is important to watch out for any fees associated with selling, including backend load fees. Also, unlike stocks and exchange-traded funds (ETFs), which trade any
time during market hours, mutual funds transact only once per day after the fund's net
asset value (NAV) is calculated.
5. Professional Management:
When you buy a mutual fund, you are also choosing a professional money manager. This
manager will use the money that you invest to buy and sell stocks that he or she has
carefully researched. Therefore, rather than having to thoroughly research every
investment before you decide to buy or sell, you have a mutual fund's money manager to
handle it for you.

The flow chart below describes broadly the working of a mutual fund:

Types of mutual funds are:

Value stocks :

Stocks from firms with relative low Price to Earning (P/E) Ratio usually pay good
dividends. The investor is looking for income rather than capital gains.
Value funds are those mutual funds that tend to focus on safety rather than growth, and
often choose investments providing dividends as well as capital appreciation. They invest
in companies that the market has overlooked, and stocks that have fallen out of favour
with mainstream investors, either due to changing investor preferences, a poor quarterly
earnings report, or hard times in a particular industry.
Investing in value fund involves identifying fundamentally sound stocks that are trading
at a discount to their fair value. The fund manager buys these stocks and holds them until
the stock bounce backs to its fair value. The fund managers identify undervalued stocks
in the market on the basis of fundamental analysis techniques. In this process stocks with
low price to earnings ratios are tagged. These stocks are then closely reviewed to see
which ones have the greatest growth potential and are paying high dividends.

Growth stock :

Stocks from firms with higher low Price to Earning (P/E) Ratio, usually pay small
dividends. The investor is looking for capital gains rather than income.
Based on company size, large, mid, and small cap
Stocks from firms with various asset levels such as over $2 Billion for large; in between
$2 and $1 Billion for mid and below $1 Billion for small.
8

Income stock :

The investor is looking for income which usually comes from dividends or interest. These
stocks are from firms which pay relative high dividends. This fund may include bonds
which pay high dividends. This fund is much like the value stock fund, but accepts a little
more risk and is not limited to stocks.

Enhanced index :

This is an index fund which has been modified by either adding value or reducing
volatility through selective stock-picking.

Stock market sector :

The securities in this fund are chosen from a particular marked sector such as Aerospace,
retail, utilities, etc.

Defensive stock :

The securities in this fund are chosen from a stock which usually is not impacted by
economic down turns.

Real estate :

Stocks from firms involved in real estate such as builder, supplier, architects and
engineers, financial lenders, etc.

Socially responsible :

This fund would invest according to non-economic guidelines. Funds may make
investments based on such issues as environmental responsibility, human rights, or
religious views. For example, socially responsible funds may take a proactive stance by
selectively investing in environmentally-friendly companies or firms with good employee
relations. Therefore the fund would avoid securities from firms who profit from alcohol,
tobacco, gambling, pornography etc.

Tax efficient :
9

Aims to minimize tax bills, such as keeping turnover levels low or shying away from
companies that provide dividends, which are regular payouts in cash or stock that, are
taxable in the year that they are received. These funds still shoot for solid returns; they
just want less of them showing up on the tax returns.

Convertible :

Bonds or Preferred stock which may be converted into common stock.

Junk bond :

Bonds which pay higher that market interest but carry higher risk for failure and are rated
below AAA.

Mutual funds of mutual funds :

This funds that specializes in buying shares in other mutual funds rather than individual
securities.

Exchange traded funds (ETFs) :

Baskets of securities (stocks or bonds) that track highly recognized indexes. Similar to
mutual funds, except that they trade the same way that a stock trades, on a stock
exchange.
Exchange Traded Funds (ETFs) represent a basket of securities that is traded on an
exchange, similar to a stock. Hence, unlike conventional mutual funds, ETFs are listed on
a recognized stock exchange and their units are directly traded on stock exchange during
the trading hours. In ETFs, since the trading is largely done over stock exchange, there is
minimal interaction between investors and the fund house. ETFs can be categorized into
close-ended ETFs or open-ended ETFs.
ETFs are either actively or passively managed. Actively managed ETFs try to outperform
the benchmark index, whereas passively-managed ETFs attempt to replicate the
performance of a designated benchmark index.

MUTUAL FUNDS IN INDIA

10

There are a lot of investment avenues available today in the financial market for an
investor with an investable surplus. He can invest in Bank Deposits, Corporate
Debentures, and Bonds where there is low risk but low return. He may invest in Stock of
companies where the risk is high and the returns are also proportionately high. The recent
trends in the Stock Market have shown that an average retail investor always lost with
periodic bearish tends. People began opting for portfolio managers with expertise in stock
markets who would invest on their behalf. Thus we had wealth management services
provided by many institutions. However they proved too costly for a small investor.
These investors have found a good shelter with the mutual funds.
Mutual fund industry has seen a lot of changes in past few years with multinational
companies coming into the country, bringing in their professional expertise in managing
funds worldwide. In the past few months there has been a consolidation phase going on in
the mutual fund industry in India. Now investors have a wide range of Schemes to choose
from depending on their individual profiles.
GROWTH OF MUTUAL FUNDS IN INDIA
The securities and Exchange Board of India (SEBI) came out with comprehensive
regulation in 1993 which defined the structure of Mutual Fund and Asset Management
Companies for the first time.
Several private sectors Mutual Funds were launched in 1993 and 1994. The share of the
private players has risen rapidly since then.
Currently there are 34 Mutual Fund organizations in India managing 1, 02,000 crores.

How Funds Can Earn Money for retail investors:

You can earn money from your investment in three ways:
Dividend Payments A fund may earn income in the form of dividends and interest on
the securities in its portfolio. The fund then pays its shareholders nearly all of the income
(minus disclosed expenses) it has earned in the form of dividends.
Capital Gains Distributions The price of the securities a fund owns may increase.
When a fund sells a security that has increased in price, the fund has a capital gain. At the
end of the year, most funds distribute these capital gains (minus any capital losses) to
investors.

11

Increased NAV If the market value of a fund's portfolio increases after deduction of
expenses and liabilities, then the value (NAV) of the fund and its shares increases. The
higher NAV reflects the higher value of your investment.
With respect to dividend payments and capital gains distributions, funds usually will give
you a choice: the fund can send you a check or other form of payment, or you can have
your dividends or distributions reinvested in the fund to buy more shares (often without
paying an additional sales load).
Factors to Consider- Thinking about your long-term investment strategies and tolerance
for risk can help you decide what type of fund is best suited for you. But you should also
consider the effect that fees and taxes will have on your returns over time.
Degrees of Risk -All funds carry some level of risk. You may lose some or all of the
money you invest your principal because the securities held by a fund go up and
down in value. Dividend or interest payments may also fluctuate as market conditions
change.
Before you invest, be sure to read a fund's prospectus and shareholder reports to learn
about its investment strategy and the potential risks. Funds with higher rates of return
may take risks that are beyond your comfort level and are inconsistent with your financial
goals.

RETAIL INVESTORS MAKE COSTLY MISTAKES

Mounting evidence demonstrates that retail investors make predictable, costly mistakes.1
They save too little, they trade too frequently, they buy high and sell low, they invest in
fad instruments they do not understand, and they pay excessive fees.
In an August 2012, 200-page study prepared in response to a DoddFrank2 mandate, the
Securities & Exchange Commission (SEC) concluded that American investors lack
basic financial literacy.
3
The study found that investors do not understand basic concepts such as diversification,
investment costs, inflation, and compound interest, and that they lack the knowledge
necessary to protect themselves from fraud.
4
Despite investors seemingly limited competence, regulatory and market developments
increasingly require retail investors to navigate the financial markets themselves. Over
the past thirty-five years, participant-directed 401(k) plans have largely replaced
professionally managed pension plans.

12

Unlike traditional pension plans, participant-directed 401(k) plans place the

responsibility for critical investment decisions in the hands of employees, who select
their own investments from a menu of employer-provided alternatives.
This means that low-level employeesindividuals with even less investment knowledge
than the general population6are now investing for retirement with almost no guidance.
To complicate matters further, mutual funds are the dominant investment option provided
by employer-sponsored 401(k) plans and the primary way in which retail investors
participate in the stock market, both in and outside of retirement plans.
7

Unlike other equity investments, notably stock, mutual funds are held primarily by
individual investors.8 This market segmentation means that retail fund investors cannot
benefit from the market discipline exercised by more sophisticated institutions.9 As a
result, there are reasons to doubt the efficiency of the mutual fund market and to ask
whether the market offers retail investors reasonable and comprehensible investment
options. In particular, many commentators are puzzled by the large number of fund
choices and by the persistence of highfee funds that underperform the market.
10

Congress, the SEC, the Department of Labor, and the courts have struggled with the
possibility that market forces are insufficient to protect retail investors from making poor
investment decisions. Regulatory responses designed to protect investors include
mandated disclosure requirements, product limits, and the imposition of fiduciary duties
on employers, brokers, and investment advisers. Widespread litigation over the role of
judicial oversight of mutual fund fees and the scope of employer obligations in designing
retirement plans raises questions about the manner in which individuals make investment
decisions. In one such high profile case, Seventh Circuit Judges Richard Posner and
Frank Easterbrook, although reaching opposite conclusions about investor behavior, each
suggested that the manner in which such decisions are made is critical to evaluating the
appropriate level of regulatory intervention.
11

The importance of understanding investor behavior is not limited to the litigation

context. With employees increasing dependence on their 401(k) plans to deliver
retirement income, employers are rethinking issues such as plan structure and the choice
of investment options.
12
BrightScopes highly publicized online ratings and rankings of 401(k) plans have
heightened employer attention to the importance of plan design.13 Congress has recently
acknowledged the need for a better understanding of investor behavior. In the Dodd
Frank Act, Congress instructed the SEC to conduct a study of investor financial literacy.14
The SECs study was conducted at the most superficial level, however, and provided
limited insight into developing future regulatory policy.
15
Although the SEC found investor mistakes and misconceptions, it did not seek to
identify the reasons for these mistakes or to understand the underlying mechanisms
13

driving investor choices.16 This Article takes up where the SEC study left off. We report
the results of an experiment designed to explore how investors use the information
provided to them, and why they often ignore it. Using a simulated investment game in
which participants were asked to allocate funds in a retirement account among ten mutual
fund alternatives, we offer some insights into how individuals seek and assimilate
information about a funds characteristics.
In particular, our experiment offers a novel addition to the body of experimental evidence
on investor decisionmaking by incorporating a technology that allows us to collect data
on the specific information that investors choose to view. In addition to collecting general
information about the process by which investors choose among mutual fund options, we
employ an experimental manipulation to test the effect of an instruction on the
importance of mutual fund fees. Pairing this instruction with simplified fee disclosure
allows us to distinguish between motivation limits and cognition limits as explanations
for the widespread findings that investors ignore fees in their investment decisions. Our
results offer partial, limited grounds for optimism. On the one hand, within our simplified
experimental construct, our subjects allocated more money, on average, to higher-value
funds.
Furthermore, subjects who received the Fees instruction paid closer attention to mutual
fund fees and allocated their investments into funds with lower fees. On the other hand,
the effects of even a blunt fee instruction were limited, and investors were unable to
identify and avoid clearly inferior fund options. In addition, our results suggest that
excessive and nave diversification strategies are driving many investment decisions. Our
findings are concededly preliminary. More important, because of the simplified nature of
our experiment, our results may not fully explain real-world investment decisions, in
which the stakes and the cost of gathering and evaluating investment information are
much higher. Nonetheless, our research offers a starting point in terms of both
understanding investor behavior and evaluating efforts to improve the quality of investor
decisions. In particular, determining whether effective investor education is possible is
critical to evaluating the manner in which we regulate, structure, and evaluate retail
investing options such as retirement plans.
The Article is organized as follows. Part I briefly describes the regulatory environment
for mutual funds and 401(k) retirement plans. Part II identifies key findings on retail
investor decisionmaking and observes how these findings cast doubt on the effectiveness
of market discipline in the mutual fund market. Part III describes our experiment
structure. Part IV reports our results. Part V explores the implications of our findings and
identifies next steps for additional research.
i

14

i 1 See, e.g., Andrea Frazzini & Owen A. Lamont, Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns, 88 J. FIN.
ECON. 299, 319 (2008) (concluding that individual investors have a striking ability to do the wrong thing). 2 DoddFrank Wall Street
Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010) (codified as amended in scattered sections of 7, 12, and
15 U.S.C.).
3 OFFICE OF INVESTOR EDUC. & ADVOCACY, SEC, STAFF STUDY REGARDING FINANCIAL LITERACY AMONG
INVESTORS 15 (2012) [hereinafter SEC STAFF STUDY], available at http://www.sec.gov/news/studies/2012/917-financial-literacystudy-part1.pdf. 4 Id.
5 See Pamela Perun & Joseph John Valenti, Defined Benefit Plans: Going, Going, Gone? 4 & fig.1 (2008), available at
http://planetnow.com/metaPage/lib/Perun-ValentiFinalAppam.pdf (In 1975, over 70% of active employees participated in a defined
benefit plan. In 2005, the majority of active employees (over 75%) participated in a defined contribution plan instead.).
Cf. SEC STAFF STUDY, supra note 3, at 15 (In particular, surveys demonstrate that certain subgroups, including women, AfricanAmericans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater [lack] of
investment knowledge than the average general population.).
7 See INV. CO. INST., 2013 INVESTMENT COMPANY FACT BOOK 95 (53d ed. 2013) [hereinafter ICI FACT BOOK], available at
http://www.icifactbook.org/pdf/2013_factbook.pdf (stating that, in 2012, seventy-two percent of mutual fundholding households owned
mutual fund shares inside retirement plans).
8 See id. At 90 (explaining that households owned eighty-nine percent of total mutual fund assets as of the end of 2012). Institutional use
of mutual funds is limited and consists mostly of money market funds, which are used for cash management. See id. At 105-06.
9 Some mutual funds operate multiple versions that are sold to retail and institutional investors. Although institutional twins typically
charge lower fees than retail funds, one study found that retail funds with an institutional twin perform better, which suggests that, in this
context, retail investors can benefit from the market discipline imposed by institutions. See generally Richard B. Evans & Rdiger
Fahlenbrach, Institutional Investors and Mutual Fund Governance: Evidence from RetailInstitutional Fund Twins, 25 REV. FIN. STUD.
3530 (2012).
10 See, e.g., PETER J. WALLISON & ROBERT E. LITAN, COMPETITIVE EQUITY: A BETTER WAY TO ORGANIZE MUTUAL
FUNDS 8-9 (2007) (observing that the mutual fund industry does not appear to conform to the law of one price).
11 Compare Jones v. Harris Assocs. L.P., 527 F.3d 627, 631-32 (7th Cir. 2008) (Easterbrook, J.) (reasoning that market discipline should
constrain excessive mutual fund fees by driving investors away from costly funds), with Jones v. Harris Assocs. L.P., 537 F.3d 728, 73132 (7th Cir. 2008) (Posner, J., dissenting) (questioning whether high fees actually drive investors away), denying rehg en banc to 527
F.3d 627. The Supreme Court vacated the Seventh Circuit decision without resolving the question. See Jones v. Harris Assocs. L.P., 130 S.
Ct. 1418, 1430-31 (2010) (The debate between the Seventh Circuit panel and the dissent from the denial of rehearing regarding todays
mutual fund market is a matter for Congress, not the courts.).
12 See, e.g., AON HEWITT, 2011 TRENDS & EXPERIENCE IN DEFINED CONTRIBUTION PLANS: PAVING THE ROAD TO
RETIREMENT (2011), available at http://www.aon.com/ attachments/thoughtleadership/2011_Trends_Experience_Executive_Summary_v5.pdf (explaining emerging trends in plan design and administration).
13 See, e.g., Ron Lieber, Spotlighting 401(k) Plans, Thanklessly, N.Y. TIMES, Sept. 17, 2011, at B1 (describing attention received by
Bright Scope ratings and criticisms of its methodology); Christine P. Roberts, Your 401(k) Plans Online Report Cardand What to Do
About It, E IS FOR ERISA (Oct. 5, 2011, 7:49 PM), http://eforerisa.wordpress.com/2011/10/05/your-401k-plans-onlinereport-card-andwhat-to-do-about-it (providing advice to employers on addressing a low Bright Scope rating).
14 DoddFrank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 917, 124 Stat. 1376, 1836 (2010).
15 See generally SEC STAFF STUDY, supra note 3. 16 See id. at iii-vii.

INVESTOR PROTECTION AND MUTUAL FUNDS REGULATION

Need for regulation
The prevalence of risk associated with investment activity necessitates regulation of the financial
market in general, and the activities of investment management firms in particular. Regulatory
measures, whatever their form and structure, are designed to attain the twin objectives of correcting
market failures and protecting investors from potential loss. The principles of regulating are based on
the following premises:

To correct identified market imperfections and failures in order to improve the market and enhance
competition ;
To increase the benefit to investors from economies of scale and
To improve the confidence of investors in the market by introducing minimum standard of quality.

Regulatory measures can be broadly classified into five categories:

Imposing capital requirements for investment management firms ;
Monitoring and auditing the operations of investment management firms;
Disclosure, and rating of management firms ;
Providing insurance ; and
Setting up minimum standards for investment management firms.
A suitable regulatory structure would be one which is broadened by legislature action and supported by
industry practitioners. In order to formulate a workable and acceptable regulatory structure, the
following points must be noted.

A close inter linkage must be established between the industry and the regulatory body.
Though the basis of such a structure may be legislative, it should be flexible, adaptive and less
bureaucratic.
The regulators should possess a high degree of perception and market experience
The regulatory should have enough authority to enforce the regulatory measures.
The regulators should not indiscriminately change their views as this may create instability in the
market and loss of public confidence.
The structure of regulation should create enough space for investors, for whom the regulatory
system has been developed. The regulators should treat the investors as facilitators in the smooth
functioning of the system.

Effective regulation should take into account both the cost of regulation and value addition. Two types
of costs are usually associated with any regulatory measure; direct and indirect. The direct cost is the
cost of administration and implementation while the indirect cost is the loss of welfare due to
restriction on competition. It is essential that any regulation is formulated only after taking into
account the total cost and implicit benefits. This is more so in a developing country and emerging
market like India, where regulatory expenditure is an additional burden on the public exchequer and
expenses are incurred at the cost of development expenditure. Moreover, in an emerging and semiefficient market like India, investors are exposed to greater volatility and risks. Therefore, in order to
be effective, regulation should be able to protect the investors interests, and the direct benefits must be
more than the indirect benefits and costs of regulation.

Regulation and Investor Protection in India

Securities market regulation in India is in the process of evolution and cannot be identified with the UK
or the US type of regulation. In India, under the present framework, the regulation of all participants in
the securities market (with the exception of issuers of capital) is the responsibility of SEBI.
As prime regulator of capital market activities in India, SEBIs basic objective is to protect the interests
of investors. This objective has been stated in the preamble of the Securities and Exchange Board of
India Act, 1991 thus .to protect the interests of investors in securities and to promote the
development of, and to regulate, the securities market and the matters connected therewith or incidental
thereto. Accordingly, all capital market activities, including those of mutual funds are covered under
the objective so far as investor protection is concerned.
The SEBI Regulations of 1993 were the first attempt to bring mutual funds under a regulatory
framework and to give direction to their functioning. However, as noted earlier, new regulations were
passed in 1996, and these have many similarities with the Investment Company Act, 1940, of the US as
far as mutual funds regulation and investor protections are concerned. The regulatory and supervisory
powers of SEBI also stand strengthened by the Securities Law (Amendment) Ordinance, 1995, which
empowers SEBI to impose penalties for violation of its regulations. Under this amendment, SEBI is
also allowed to file complaints in court without prior approval of the Central Government. SEBI has
thus emerged as an autonomous and powerful regulator of mutual funds in India. The 1996 regulations
lay down many measures to protect mutual funds investors. Some of measures are as under:
SEBI has incorporated several provisions to screen mutual funds at entry level, similar to provision for
a fit and proper test in the UK. Every mutual fund shall be registered with

SEBI and the registration will be granted on the fulfillment of certain conditions laid down in the
regulations for efficient and orderly conduct of the affairs of a mutual fund. The regulations further
stipulate that the sponsor must have a sound track record and experience in the relevant field of
financial services for a minimum period of five years, professional competence, financial soundness,
and a general reputation for fairness and integrity in all business transactions.
SEBI has laid down conditions for the appointment of trustees and has specified their obligations, as
well as detailed guidelines on the trust deed. The AMC is to be approved by SEBI. SEBI has also laid
down the terms and conditions for the approval of the AMC. The directors of the AMC are to be
persons having adequate professional experience in finance and financial services-related fields. The
key personnel of the AMC should not have been working for any AMC or mutual fund or any
intermediary whose registration has been suspended or cancelled at any time by the board.
Mutual funds must have a custodian who is to be approved by SEBI, and one of the preconditions for
approval is a sound track-record, general reputation and fairness in transaction
No new scheme can be launched by any mutual fund unless the same is approved by the trustees and a
copy of the document has been filed with the board. SEBI has also stipulated that the AMC should
stipulate the minimum amount it seeks to raise under the scheme and the extent of oversubscription to
be retained.
There are clear regulatory provisions regarding the listing of close-ended schemes, refunds, transfer
and sending of unit certificates to investors. In addition, it has been stipulated that the names of the
trustees of mutual fund and the director of the AMC should be disclosed in the prospectus of the fund.

The investment objective and strategy, as well as the approximate percentage share of investment to be
made in various instruments are also disclosed. No guarantee of returns can be given unless they are
fully guaranteed by the sponsors or AMC, and a statement indicating the manner of guarantee and the
name of the person who will guarantee the returns is to be made in the offer document.

SEBI has outlined the advertisement code to be followed by mutual funds in making any
publicity regarding a scheme and its performance. SEBI can inspect the books of accounts,
records and documents of a mutual fund, the trustees, AMC and custodian. SEBI can impose a
monetary penalty also for non-compliance.
The Indian regulatory mechanism is centered on statutory provisions of SEBI. There is strong
emphasis on ex-post investigation and disciplining of mutual funds through financial penalties. The
implicit tone of regulation is correction through control. There are enough provisions for disclosure.
Thus, the regulatory mechanism and supervisory control are strong enough for protecting the interests
of investors. However, the level of protection can be enhanced by including a few more elements, like
SROs, investors protection fund and credit rating.
CONCLUSION:
The present study looks at the attitude level of the retail investors towards investment in mutual funds.
The small investors purchase behavior does not have a high level. The buying intent of a mutual fund
product by a small investor can be due to multiple reasons depending upon customers risk return trade
off. Presently, more and more funds are entering the industry and their survival depends on strategic
marketing choices of mutual fund companies, to survive and thrive in this highly promising industry, in
the face of such cut throat competition. Therefore, the mutual fund industry today needs to develop
products to fulfils customer needs and help customers understand how its products to their needs. Thus
the study provokes the authority to take some positive measures for expanding the scope of mutual
funds investment.
Mutual Funds now represent perhaps most appropriate investment opportunity for most investors. As
financial markets become more sophisticated ad complex, investors need a financial intermediary who
provides the required knowledge and professional expertise on successful investing. As the investors
always try to maximize the returns and minimize the risk. Mutual fund satisfies these requirements by
providing attractive returns with affordable risks. The fund industry has already overtaken the banking
industry, more funds being under mutual fund management than deposited with bank. With the
emergence of tough competition in this sector mutual funds are launching a variety of schemes which
caters to the requirement of the particular class of investors. Risk takers for getting capital appreciation
should invest in growth, equity schemes. Investors who are in need of regular income should invest in
income plans.
The stock market has been rising for over three years now. This in turn has not only protected the
money invested in funds but has also helped grow these investments.
This has also instilled greater confidence among fund investors who are investing more into the market
through the MF route than ever before.

BIBLIOGRAPHY

Agarwal, G.D., 1992, Mutual Funds and Investors Interest, Chartered Secretary,
Vol.22, No.1, 23-24.
Atmaramani, 1995, SEBI Regulations A Case for level playing field, Analyst,
December, 60-63.

http://www.mutualfundsindia.com

BAJAJ CAPITAL PUBLICATIONInvestor India (For the month of June and July

Sarkar, A.K., 1991, Mutual Funds in India : Emerging Trends, Management

Accountant, Vol.26, No.3, 171-194.

SEBI NCAER, 2000, Survey of Indian Investors, SEBI, Mumbai.