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More than a dozen AIFs under SEBI scanner

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Market regulator finds AIFs flouting investment caps and creation of hybrid structures

As many as 15 alternative investment funds (AIFs) are being probed by market regulator SEBI for various malpractices and the creation of hybrid structures.

One of the key aspects that SEBI is looking into is that AIFs are turning into vehicles for company promoters and high net worth investors for cornering shares in the initial public offers (IPOs). In the IPOs, AIFs can put a large bid and hold shares on behalf of their clients with whom they have special arrangements or agreements. Also, lawyers have structured agreements to the effect of loans to the AIFs by clients, sources said.

SEBI has recently tightened norms on IPO investments, which is creating difficulties for HNIs to bet on the primary market issuances since the allocation to them has been put on par with retail investors. But AIFs are allowed even pre-IPO placements and can even corner large a stake during the IPO in any company, thereby giving them an edge and the motive for dubious deals, the sources said. 

“Section 15EA of SEBI Act, 1992 was inserted by way of a recent amendment in 2019 by the Government (Ministry of Finance) and not many orders have been passed imposing penalties on AIFs. But a recent order that SEBI passed against Indgrowth Capital Advisors LLP for violations of the AIF rules is an indication that the regulator has increased its surveillance, inspection and enforcement in relation to a well-regulated but under-enforced regime of AIFs,” said Sumit Agrawal, Founder, Regstreet Law Advisors & former SEBI Officer.

Substitute for P-notes

In the past, SEBI had banned offshore derivative instruments called Participatory Notes (P-notes) with the view that they facilitated round-tripping of black money. Similar concerns are now being raised on some of the AIFs, sources said.

The AIF industry in India now commands a size of more than $75 billion, which it has achieved in less than five years after structures were passed against P-notes. AIFs are nearly doubling every year. 

AIFs are privately pooled investment vehicles that collect funds from sophisticated investors, whether Indian or foreign, for investing in India. Apart from minimum ticket size, there is no other specific structure that AIFs have to follow and hence in several instances it could become difficult to know the ultimate beneficiary or client of a certain AIF who is coming via foreign jurisdiction.

Flouting investment caps

Another aspect that is being looked into by the regulator is the requirement that AIFs cannot invest more than 10 per cent of their investible funds in any of their investee companies. SEBI has come across instances where AIFs were flouting these norms.  Recently, SEBI came out with an order wherein it imposed a fine on an AIF Indgrowth Capital Advisors LLP for violation of norms regarding investment cap and similarly the regulator will come out with more orders in the coming months, sources said.

Indgrowth AIF had provided two separate letters in February 2020 wherein it quoted stated different figures for its investible funds, ₹429 crore and ₹456.76 crore. On investigations, SEBI found Indgrowth AIF had actively breached and exceeded the permissible investment limit of 10 per cent of investible funds while investing in the shares of Ugro Capital and Indgrowth AIF.

The fund said that it had a corpus of ₹476 crore out of which estimated expenditure (management fees etc) was ₹20 crore and hence investible funds was ₹456 crore. The 10 per cent of that remaining corpus after deducting the expenditure came to ₹45.6 crore, which was the limit that it could invest in any of its investee company. But SEBI had a different take and here the bone of contention was twofold on the computation of “investible funds” and incorrect disclosure to SEBI.

SEBI took a view that the AIF had actually an expense of ₹42 crore. However ₹23 crore was the estimated dividend and mutual fund income the AIF managers would receive (which was permissible under the PPM, a primary document in which all the necessary information about the AIF is disclosed to prospective investors). SEBI took a view that if estimated expenditure was ₹42 crore then corpus amount minus expenditure would be ₹434 crore and 10 per cent of that is ₹43 crore which put the AIF in breach of the 10 per cent norms.

In SEBI’s view if the AIF had set off the estimated expenditure against the estimated returns derived from temporary parking/ investment of funds and therefore the estimated expenditure got reduced, and as a consequence, the “investible funds” got increased to the extent of the returns.