15 Alternative investment funds (AIFs) are being investigated by the market regulator SEBI for various incorrect practices and the creation of hybrid structures.
One of the key aspects SEBI is investigating is that AIFs are emerging as vehicles for company founders and high net worth investors to buy shares in initial public offerings (IPOs). In an IPO, AIF can bid high and hold shares on behalf of their clients with whom they have special deals or agreements. Also, the lawyers have reached agreements on the effect of loans granted to clients by AIF, the sources said.
SEBI recently tightened norms for IPO investing, making it difficult for HNIs to bet on primary market issuance as their allocation has been kept on par with retail investors. But AIFs are also allowed pre-IPO placements and can acquire a large stake in any company even during an IPO, giving them an advantage and targeting shady deals, sources said.
“Section 15EA of the SEBI Act 1992 was inserted by the Government (Treasury Department) by a recent amendment in 2019 and several orders imposing penalties on AIFs have not been issued. But the recent order SEBI issued against Indgrowth Capital Advisors LLP for violating AIF rules is an indication that the regulator has stepped up its oversight of a well-regulated but less-enforced regime of AIFs. Inspections and enforcement have been stepped up,” said Sumit Agarwal, founder of Regstreet Law Advisors and former SEBI officer.
Alternatives to P-Notes
In the past, SEBI had banned offshore derivatives called participatory notes (P-notes) on the idea that they facilitate the round-trip of black money. Sources said similar concerns are now being raised at some AIFs.
The AIF industry in India is now worth over $75 billion, which it has achieved in less than five years after structures against P-Notes were enacted. AIFs are doubling almost every year.
AIFs are privately held investment vehicles that pool money from sophisticated investors, whether Indian or overseas, to invest in India. Aside from the minimum certificate size, there is no other specific structure that AIF must follow and therefore in many cases it can be difficult to identify the ultimate beneficiary or client of a particular AIF coming through foreign jurisdictions.
Violation of the investment limit
Another aspect that the regulator takes care of is that AIF are not allowed to invest more than 10 percent of their investable funds in any of their invested companies. Prior to SEBI, there were instances where AIFs breached these standards. Sources said SEBI recently issued an order penalizing AIF Indgrowth Capital Advisors LLP for violating norms related to investment limits, and similarly the regulator will issue additional orders in the coming months.
Indgrowth AIF had submitted two separate letters in February 2020 stating different figures for its investable funds, ₹429 crore and ₹456.76 crore. Upon investigation, SEBI found that Indgrowth AIF had actively violated and exceeded the permitted investment limit of 10 percent of investable funds when investing in shares of Ugro Capital and Indgrowth AIF.
The fund stated that it had a body of ₹476 crore of which the estimated expenses (management fee etc.) were ₹20 crore and thus the investable fund was ₹456 crore. 10 percent of this remaining corpus, after expenses, amounted to ₹45.6 crore, which was the limit he could invest in any of his investment companies. But SEBI disagreed, and the issue here was two-fold, namely the calculation of “investable funds” and the mis-disclosure to SEBI.
SEBI acknowledged that `42 crore` was actually spent on the AIF. However, £23m was the estimated dividend and mutual fund income that AIF managers would receive (which was permitted under the PPM, a main document disclosing all necessary information about AIFs to potential investors). SEBI took the view that if the estimated expenses were £42m, the corpus amount less expenses would be £434m and 10 per cent of that would be £43m, resulting in AIFs against the 10 per cent – Violated the norm.
In SEBI’s view, would the AIF have adjusted the estimated expenses against the estimated return from the fund’s temporary parking/investment and thus reduced the estimated expenses, and consequently increased the return on the “investable fund” by the extent of .
Released on July 10, 2022
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