An Indian regulator is investigating investments between Nippon India Mutual Fund, the largest foreign-owned fund in the country, and Yes Bank between 2016 and 2019 for suspected misuse of investors’ money, sources said.

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At the time, the parent company of the mutual fund was owned by the Anil Dhirubhai Ambani Group. Yes Bank was taken over by the central bank in 2020 and sold to a consortium of banks after a dramatic rise in toxic assets.

The Securities and Exchange Board of India (SEBI) is probing whether investments by the fund, known at the time as Reliance Mutual Fund, in perpetual bonds of Yes Bank were made as part of a deal whereby in return the lender invested in securities of Anil Ambani group companies, said two sources with direct knowledge of the matter.

The sources declined to be named as the investigation is confidential.

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SEBI’s regulations say that the parent of a mutual fund cannot access investors’ money either directly or indirectly.

If the regulator’s probe results in charges against the fund, its officials or the bank, it could lead to penalties ranging from restrictions on accessing capital markets to monetary penalties. The current owner of the fund, Nippon India, as well as the previous owner could be liable, the sources said.

The market regulator’s probe has not been previously reported.

The fund house itself, senior officials and its former sponsor could face charges for violating regulatory norms under India’s ’Prevention of Fraud and Unfair Trade Practices Relating to Securities Market’ rules, one source said. Yes Bank and its former officials could also face charges, the source added.

Nippon India, the Anil Ambani Group, Yes Bank and SEBI did not respond to requests for comment. Sundeep Sikka, who has been chief executive office of the mutual fund since 2009, did not respond to requests for comment.

Nippon India, a unit of Nippon Life Insurance Co, acquired 75 percent in Reliance Asset Management Company in October 2019 to become the owner of the mutual fund. The transactions under scrutiny date back to before the transfer of ownership, the sources said. Nippon Life did not respond to telephone calls from Reuters seeking comment.

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As of December 2022, Nippon India was the seventh-largest mutual fund in India with assets under management of 2.9 trillion rupees ($35.46 billion) as well as the biggest foreign-owned mutual fund.

The Nippon India mutual fund was the biggest holder of additional tier-1 bonds issued by Yes Bank between 2016 and 2019 and held 250 billion rupees out of the 841 billion rupees of such securities issued by Yes Bank, according to court documents.

These bonds were cancelled in 2020 by Yes Bank as part of its restructuring, which has been challenged in court by bondholders.

As a consequence of this case, the market regulator plans to tighten its rules, said the first source, although any final decision will only come after the investigation is completed.

On Friday, SEBI proposed further tightening of mutual fund regulations asking mutual fund owners to reduce their stake gradually as a measure to check their influence on investment decisions. It did not specify a level to which they must reduce their holdings. Present rules require that mutual fund owners hold a minimum 40% stake.

"If this becomes a rule, this would address issues of conflict of interest and undue influence which have led to bad investment decisions by fund managers," said the first source.

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