SEBI is probing the alleged breaches to establish transparency in the AIF ecosystem, he said, seeking anonymity.
Violations include dividend segregation, inadequate diversification, abrupt changes in control over AIFs, non-compliance with alleged investment orders, conflicts of interest, valuation policies, priority payments, and outsourcing management (of investments) to other entities.
“Why should there be priority payments? Don’t you want AIFs to be as safe as other equity investments?” Sebi whole time director Ashwini Bhatia said in an interview on the sidelines of an event organized by Federation of Indian Chambers of Commerce and Industry on Tuesday. However, he did not comment on the other situations which are being probed by SEBI.
Some AIFs offer priority payments to select limited partners or investors in the AIF, allowing them to get their original investment back before other investors. This can be especially the case with distressed funds, where there may be higher investment risk.
“SEBI wants to ensure that the AIF principle – that of a pooling vehicle – is maintained. Whatever is out of contract should be clearly stated and communicated to all investors,” said a third person, a fund manager with knowledge of SEBI’s thinking. Perhaps, regulatory priority payments should be considered in violation of this principle. Looks as it is, he said.
SEBI has also questioned certain domicile status of limited partners and general partners to ascertain whether a specific investment should be treated as Foreign Direct Investment (FDI) or AIF investment. “It is the job of SEBI to ask questions. I cannot comment on whether an active investigation is underway or not.
Some of the investigation by SEBI was to ensure compliance, the people mentioned above said. For example, dividend stripping comes into play as a tax-avoidance measure, in which investors are known to buy in securities just before dividend payments and exit investments at a loss after payment, when the stock’s stock is sold. The price has been adjusted downwards to be paid. Dividend. Without accounting for dividends, the investor can report a loss on the investment, adjusting for gains elsewhere. The dividend stripping provisions were extended to AIFs (now classified under securities) during this year’s budget.
On valuation, SEBI may formulate a methodology for computing startup valuation under AIF. The fund has also been asked to clarify whether certain startup investments have benefitted under the Department for Promotion of Industry and Internal Trade (DPIIT). Besides, Sebi is also concerned about valuation of several medium-sized initial public offerings driven by AIFs and venture capital funds, the people said.
He said the AIF funds under scrutiny are Category III funds under the AIF regime of SEBI, which include hedge funds, or Private Investment in Public Enterprises (PIPE) funds, which invest in public markets. In addition, Category II AIF funds, which include private equity and private debt funds, and Category I AIFs, which mostly include angel and impact funds, have also received notices.
Over the past three years, several fund managers have raised capital from high-net-worth individuals and family offices, but they have not strictly adhered to SEBI norms, triggering an investigation. Another person said, “They have been more aggressive to generate better returns at the cost of compliance. There is a significant gap between what applies to AIFs and what angel funds are doing under the rules.”
The regulatory program governing AIFs is designed to differentiate them from retail-focused mutual funds, said Richie Sancheti, founder of law firm Richie Sancheti Associates.
“Governance strengthens and fills gaps in market-determined results primarily through disclosure requirements and by defining the scope of the Code of Conduct for components of the AIF.
SEBI’s regulatory coverage provides confidence and flexibility to allow funds to serve sophisticated private fund investors. SEBI, however, is pursuing its agenda regularly to promote greater efficiency, competition and transparency,” Sancheti said.
The regulator is also keen to understand how funds price their schemes and how they distribute payments, said the people cited above.
Similarly, startup valuations are fairly opaque, and AIF investments in startups are in contrast to mutual fund or portfolio management fund investment portfolios. SEBI is also trying to study the methodology for valuation of AIFs, said the fund manager cited above.
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