It happens to us all at some point. The mutual fund or the insurance agent pesters you, follows you home and to office, calls you with "good" deals, tells you of this great opportunity to buy into. . . in short, nags you to buy the product he's selling.

And if you succumb, for whatever reason, have you noticed that the agent literally holds his breath till you sign the cheque? He relaxes only when you hand over the signed cheque and whatever documents he asks for. Sure, agents are supposed to sell you the product that's right for you, but is that the reason for his rejoicing when you do buy? More often than not, he's busy calculating his commission, which can be anything from 2.25 per cent to 40 per cent, depending on the product.

But that's not a bad thing -- if he has sold you a product that meets your financial needs, and not one that will only give him the means to buy his new car. And more importantly, has disclosed what he makes when he offers the product for sale to you.

Unfortunately, agents generally run riot when selling, essentially looking out for their interests first, and yours almost never. In a country where mutual funds and insurance companies are well regulated, it is unfortunate that the 'last mile' is neglected and agents are given a free rein.

They may tell you that they have to pass an exam before they are let loose on customers, but Munnabhai tactics invariably win the day when it comes to passing these exams. And after this one exam, there really is no check on what they sell, to whom and why.

But because agents bring in the business, they are able to dictate terms to the funds or insurance companies, who are forced to shell out ever-increasing amounts as commission. Often, agents get other goodies as well -- expensive gifts, foreign trips and even clandestine cash -- for selling expensive products. And so they push these products at you.

Of course, if you give in and buy, you not only end up with a product you don't need, you end up paying for the agent's freebies as well.

This is not something new. Anyone who has ever bought a financial product from an agent knows of this to some extent. But it's only now that the market regulator, Sebi (the Securities and Exchange Board of India), has decided to step in. Sebi recently announced its intention of reining in mutual fund distributors, and its chief, M. Damodaran, in an exclusive interview (See: 'Trustees should regulate distributors') told Outlook Money about how this would happen.

Says Damodaran: "Mutual funds are definitely one of the things that Sebi will look into in calendar year 2006."

As a starting point, Sebi seems determined to remove the mantle of investor protection that the industry association, Association of Mutual Funds in India (AMFI), has taken upon itself. AMFI is an industry association that looks after the interest of its members who are asset management companies (AMCs), it is not a self-regulatory organisation (SRO) that looks after investor interests. Making clear that he is looking at another body to look after the investors, Damodaran then outlines three areas of change.

The first and most important step is the involvement of trustees of mutual funds. Damodaran says Sebi will get MF trustees to take a more proactive role in protecting investor interest since they are the first-level regulator. The regulator will also insist upon mutual fund distributors registering with Sebi, instead of only with AMFI.

And finally, Sebi plans to strengthen its staff with the recruitment of 270 MBAs, lawyers and CAs over the next two years, some of whom will help monitor the agents.

All of this is undoubtedly good news, which should allow the investor to make an informed choice about his money rather than buy into sharp sales practices that are so common today. But who are the trustees of mutual funds and how will they help you? And if they can help you, why haven't they done this sooner?

The Trustees

Mutual funds in India are set up as a three-tier structure: sponsor, trustee and AMC. The idea is to prevent the promoter of the mutual fund from running riot with investors' money. The three-tier structure was adopted at a time when the market was plagued by a series of scams -- plantations, IPOs, pyramid schemes -- that saw promoters collecting large sums of money and simply vanishing.

Loose regulation and regulatory overlap prevented the gatekeepers from stopping the bandits. To prevent a repeat of this fraud and to give the retail investor a safe and steady bus to ride the markets on, Sebi put in place the 1996 Mutual Fund Regulations. Shailesh Haribhakti, chairman, Financial Planning Standards Board (FPSB), India, says, "The mutual fund regulations in India are among the best in the world."

So watertight are these regulations that not a single mutual fund has decamped with the investors' money in India. While the risk of fraud is virtually non-existent, investors still have to bear the risk of market uncertainty and distributor self-interest.

The reason for the safety of the money is that it at no time belongs to the promoter or the AMC, but is held in trust by the trustees in the name of the investors. The AMC is only a fee-for-service provider, and it does not own the money. Sebi allows the AMC to charge a fee (not to exceed 2.5 per cent at the highest slab) for managing investors' money.

The trustees have a fiduciary responsibility to investors, and are legally appointed and authorised to hold assets in trust for investors.

They manage assets for the benefit of investors rather than for their own profit. The way mutual funds are structured allows trustees to simply contract out the asset management function to the AMC for a fee that is deducted from the investors' money each year.

As already mentioned, the AMC does not own the money and is simply a service provider. Sebi is hoping to use the fact that service providers can be sacked for non-performance or unethical business practices, to energise the trustees into taking action.

Great responsibilities: The trustees are accountable to investors for the funds held in trust. In fact, if investors can prove that the trustees have violated their fiduciary responsibilities, the trustees can be jailed and their personal assets attached. It may sound draconian, but remember that the trustees are responsible for the money you give the mutual fund in good faith.

The good news for trustees is that they've got reams of regulation that support them in this role. The Sebi 1996 Mutual Fund Regulations make sure that the AMC cannot sneeze without reporting to the trustees. Every appointment that the AMC makes, every decision that it takes, every expense that it incurs needs trustee approval. The AMC has to submit quarterly reports on all its functions and has to answer for its performance to the trustees. In fact, many AMCs submit monthly reports to the trustees, simply to hedge their position in case something goes wrong.

The board of trustees has to include independent trustees, apart from representatives from the sponsor. A trustee is said to be independent if he has nothing to do with the sponsor or its associate companies.

In fact, three out of four members of the trustee company need to be independent. And they are supposed to pay special attention to whether the AMC they have hired is charging higher fees than others in the market, whether the fees paid to the sponsors and other service providers like distributors are reasonable, whether the AMC is indulging in unethical business practices and whether they are sticking to their investment mandate as disclosed in the offer document.

And great powers: If the trustees believe that the AMC has failed in its job or if they find that it has mismanaged the funds or otherwise indulged in practices that are against the interest of investors, they can sack the AMC. Of course, this has not happened till now, but the Sebi chief has asked trustees to raise the bar and get AMCs to perform better (not just in returns but also in controlling the distributors better) and thereby, serve investors more efficiently. Damodaran says that threats of dismissal could stop AMCs from giving in to distributor arm-twisting.

But, says N. Sethu, professor, Indian Institute of Capital Markets, there are operational problems here. "The way the funds are structured in India, the sponsor holds 40 per cent stake in the AMC. If the AMC is dismissed, the sponsor will have to take a fresh stake in another AMC, which may not be possible," he says. But the idea of the Sebi chief is not for trustees to individually take on the AMCs but collectively raise the pitch in favour of investor interest. He believes that even a threat of dismissal will be enough to bring about change.

Empowerment at last: Says Sethu: "Trustees are largely good people in India but they may not have understood the scope of their role. Any statement by Sebi on this will empower them." The Sebi chief agrees with this sentiment. He is sure that the names he sees as trustees are "good men and women" who simply may not be aware of the depth of their role as the protector of investor interest.

But now that there is a statement from Sebi regarding the role of the trustee, we could soon see some changes in them. We may, for example, see a new organisation formed by the trustees to represent investor issues. We may finally have trustees who are not afraid to stand up to AMCs and who can insist upon tight regulation of distributors.

The market regulator is doing its bit to ensure that mutual fund trustees take care of your interests. But you, the retail investor, can also help. If you come across agents mis-selling schemes, or funds not sticking to their investment mandate, find out who the independent trustees of that fund are and escalate these issues. After all, the trustees, say Sebi, are supposed to be batting for you.

The biggest problem with the trustee company model in India is that it is a part-time relationship. Elsewhere in the world, they have professional trustee companies, who do this more professionally. Here in India, there is a trustee company with some independent directors and not all are well versed in the mutual fund industry. They attend the meetings but are briefed by the AMC. The trustees' role is that of a sleeping partner and they find it difficult to raise issues. They are unable to play a proactive role.

AMFI's Role

In the existing structure, there is a problem with AMFI projecting itself as an industry representative. It is a body that represents the AMCs and not the investors. The trustees have a fiduciary responsibility and it is their role to represent the investors, or some form of association of trustees should represent investors. But how can we get such a body set up?

Appointment of Trustees

The other issue that needs to be looked into is who appoints the mutual fund trustees. In the present set-up, the names come from the AMCs and there must be some pre-knowledge about the kind of names that will be suggested.

There needs to be an independent method of appointing trustee directors. We need to remember that the trustees should be the main representatives of the unit holders. The AMC, AMFI and all others are service providers who should not be making policy recommendations. The mutual fund trustees are wholly responsible for the funds of the unit holders.

Trustee Fact Sheet

A fact sheet that should help you understand who a trustee is and what he does.

• Every fund house must have at least four trustees.
• Three-fourths of the trustees should be independent.
• Trustees are responsible for investors' money.
• Trustees appoint the AMC to manage investors' money.
• The AMC has to report regularly to the trustees.
• Trustees can fire the AMC for bad performance or unethical trade practices.

5 Questions Trustees Should Ask

• Why are your fund management expenses at the highest slab of 2.5 per cent when some other AMCs charge only 90 basis points for similar work? Very often, AMCs use fund management expenses as a front for unauthorised payments made to distributors.
• What is the exact break-up of the asset management fees that you charge investors each year? This will uncover perks given to the distributor that are outside the legitimate brokerage that is paid upfront.
• What is the value of assets under management every day? Some AMCs target a certain level of assets by paying for them for four days at the end of each month to shore up the assets under management (AUM) figure.
• Why are your returns below the index? The AMC earns its fee for managing investors' money and the least it should do is beat the benchmark. The trustees can fire the AMC for consistent under-performance or mismanaging investors' money.
• Why are your returns so high? Abnormally high returns in a scheme that was sold as a diversified fund for long-term steady returns could be because of taking risky calls. The trustees need to check if the AMC is sticking to its investment mandate.