The Securities and Exchange Board of India (“SEBI”) vide its circular dated February 05, 2020, had introduced certain disclosure standards by way of a private placement memorandum (“PPM”) template that all SEBI registered Alternative Investment Funds (“AIFs”) were expected to adhere to. The PPM template inter-alia provided for disclosures under the term “Excuse and Exclusion” and “Direct Plan for investors and constituents of fees that may be charged by the AIFs”.Despite the PPM template, SEBI observed certain disclosure-related inconsistencies and lack of transparency. SEBI by way of circulars dated April 10, 2023, updated the regulatory framework by way of new guidelines to bring in consistency related to disclosures in the PPM.
A. Excusing an investor from an investment of AIF
Under the new guidelines, SEBI, in consultation with the Alternative Investment Policy Advisory Committee (“AIPAC”), has decided that an AIF may excuse its investors from participating in a particular investment only under the following circumstances:
(i) Violation of applicable law (based on legal opinion)
If the investor, basis opinion of a legal professional or a legal advisor, confirms that its participation in the investee entity would be in violation of an applicable law or regulation; or
(ii) Contravention of internal policy of the investor
If an investor had disclosed to the investment manager, as part of the contribution agreement or any other agreement signed with the AIF, that the participation of the investor in a particular type of investee entity will be a breach of its internal policy and hence it must be considered excused. Further, the investment manager is expected to tighten the contribution agreement or any other agreement by placing the onus of disclosing by way of reporting any change in the terms of the disclosed internal policy within 15 days on the investor.
(iii) Determination by investment manager
The AIF may also exclude an investor from participating in a particular investment opportunity, if the investment manager of the AIF determines that the investor’s participation would violate any applicable law or regulation or would result in material adverse effect on the AIF. The investment manager must record the rationale for this exclusion, alongside supporting documents, if any.
(iv) Partial exclusion
In case an investor is an AIF or any other investment vehicle, then it may be partially excused from participation in an investment opportunity to the extent of the contribution of the said investment vehicle’s underlying investors, who are to be excused from such investment opportunity. The investment manager must record the rationale for this exclusion, alongside supporting documents, if any.
SEBI through the new guidelines has sought to streamline the disclosure and provide specific circumstances that may warrant the excusal of a particular investor.
Through inclusion of contravention of internal policy, SEBI has sought to recognise investor rights. However, it has also sought to ensure that cherry picking of investments does not occur. To that effect, an investor is required to intimate the investment manager in advance about its internal policies and also intimate any change thereof within 15 days.
In addition, SEBI has also empowered the investment manager to exclude any investor if the investment manager is satisfied that participation of the investor shall result in violation of applicable law or regulation or lead to a material adverse effect on the AIF. This is an important clarification as it allows the investment manager to exclude a particular investor if its presence is likely to adversely impact the AIF or returns of all the other investors in the AIF. The investment manager cannot exercise this option frivolously and must record the rationale behind the same.
B. Direct plan for schemes & trail model for distribution commission for AIFs
SEBI had earlier in its consultation paper dated February 01, 2023, highlighted the prevalence of double payment and mis-selling occurring in investments through placement agents/ distributors or other intermediaries. In furtherance of the same, SEBI has introduced a Direct Plan for schemes of AIFs and trail model for distribution commission in AIF to provide flexibility and bring transparency in expenses.
Direct Plan for schemes of AIFs
The schemes of AIF shall have a ‘Direct Plan’ option for investors and these Direct Plans shall not entail any distribution/ placement fee.
Further, AIFs shall ensure that the investors who approach it via a SEBI registered intermediary, which is separately charging the investor any fee are onboarded via Direct Plan only. The fee may be in the nature of advisory fee or portfolio management fee.
Trail model for distribution commission in AIFs
Firstly, AIFs must disclose distribution fees/ placement fees, if any, in the PPM circulated to investors of AIF/ scheme of AIF at the time of onboarding itself.
Secondly, Category I and Category II AIF may pay up to one-third of total distribution fee/ placement fee to the distributors on an upfront basis and the remaining distribution fee shall be paid on an equal trail basis over the tenure of the fund.
Thirdly, Category III AIF shall charge a distribution fee/ placement fee, if any, to investors only on an equal trail basis i.e. no upfront distribution/ placement fee shall be charged by Category III AIFs directly or indirectly to their investors. Further, any distribution fee/ placement fee paid shall only be from the management fee received by the manager of such Category III AIFs.
While SEBI’s move to introduce a Direct Plan and mandatory trail component for distribution commission or placement fee in AIFs is a welcome step for investors, restricting payment of distribution/ placement fee only from the Category III manager’s management fee seems to be unduly restrictive for the investment manager. It is fair that placement agency fee is borne by investors who invest in the fund through placement agents, which now seems to be disallowed.
Considering the series of regulatory amendments and proposals from SEBI in the recent past, it appears that the regulatory framework for AIFs is in the process of getting overhauled towards a higher degree of restrictions and regulatory oversight. This approach, however, deviates from globally accepted norms for regulating private funds, which raise money from sophisticated investors and enjoy higher degree of commercial freedom in conducting their activities.