The Securities and Exchange Board of India (“SEBI”) has recently adopted a more assertive approach towards enforcement across the Alternative Investment Funds (“AIFs”) space. Recent enforcement actions reflect SEBI’s growing focus and vigilance on ensuring that AIFs operate with greater accountability, transparency, and strict adherence to the regulatory framework. This is evident in its recent adjudication orders viz. order against KellyGamma Fund, a Category III AIF (hereinafter referred to as the “Matter 1”), India Asset Growth Fund, a Category II AIF (hereinafter referred to as “Matter 2”) and India Asset Growth Fund – II, a Category II AIF (hereinafter referred to as “Matter 3”).
This article presents key insights from SEBI’s findings in the aforesaid orders and outlines important compliance takeaways for investment managers, key managerial personnels (“KMPs”), trustees, and investors navigating the evolving AIF regulatory landscape. In the instance of all the three orders mentioned above, SEBI conducted an inspection of the books of accounts and other records of the relevant fund/scheme for a specified period. During the course of such inspections, SEBI observed non-compliances on various counts and some of the key observations are summarized below along with a snapshot of the penalty imposed by SEBI in such matters:
A. Minimum Capital Contribution from each Investor
SEBI, in a couple of matters, observed that the funds had breached the minimum investor contribution requirement prescribed under Regulation 10(c) of the AIF Regulations. As per the said regulation, AIF shall not accept an investment of less than INR 1,00,00,000 from any investor. In both cases, certain contributors had certain capital commitments to the respective schemes but failed to make capital contribution towards such commitment.
In one matter, where the fund could showcase that it had taken adequate efforts in following up and the contributor could not make the complete drawdown on account of financial difficulties (the contributor was subject to various proceedings and had assets attached by the Income Tax Department), SEBI had taken a lenient view. Whereas, in another matter, SEBI stated that fund’s failure to drawdown the full committed amount from multiple investors, absence of any other steps taken by the investment manager against the defaulting contributors, resulted in giving benefit to a select class of investors. It further noted that the burden of managing partial drawdowns and pursuing defaulting investors not only increases the administrative and operational burden for the fund but also adversely impacts the overall fund performance. SEBI concluded that the fund, its manager and KMPs failed to operate in a manner aligned with the best interest of all investors and were therefore in violation of the AIF Regulations.
One of the key takeaways from these orders is that the investment manager’s discretion to not take penal actions despite having the contractual ability must be exercised only in rare, exceptional and justified circumstances. SEBI viewed exercise of the discretion as violative of the principles of fairness and equality among investors, which granted an unfair advantage to those investors who failed to contribute their entire capital commitment.
B. Breach of investment concentration limits
SEBI also observed that the funds had breached the investment concentration limits under the AIF Regulations. Specifically, Regulation 15(1)(c) mandates that Category II AIFs shall not invest more than 25% of their investible funds in a single investee company. Similarly, under Regulation 15(1)(d), Category III AIFs are restricted from investing more than 10% of their investable funds or their new asset value in any one investee company.
In one of the matters, the breach was argued to be on account of a bona fide and inadvertent error and the fund had taken prompt corrective steps to rectify the inadvertent noncompliance wherever possible. In another matter, the fund initially invested a larger sum in a portfolio company calculating the investible funds on the basis of target corpus instead of actual corpus at the time of making such investment. It was argued that due to various unforeseen macroeconomic events, the target corpus could not be achieved resulting the fund with higher exposure in the portfolio company.
Despite the explanations, SEBI held that compliance with investment concentration limits is fundamental and must be strictly adhered to at all times and accordingly found both funds to be in violation of the AIF Regulations. In particular, SEBI clarified in its order that macroeconomic conditions cannot be accepted as a valid justification for a fund’s failure to diversify its investment. SEBI’s approach in these cases reflects that it views the investment concentration limits as sacrosanct, given their role in protecting investor interests and managing portfolio risk. Any breach of concentration norms, even if inadvertent has drawn hard stance from SEBI.
C. Investment in non-liquid instruments
As per one of the orders, the fund violated Regulation 15(1)(f) of the AIF Regulations and parked its un-invested portion of the investible funds in mutual fund schemes that were not liquid in nature. Regulation 15(1)(f) of the AIF Regulation mandates that any un-invested portion of the investible funds, as well as divestment proceeds which are pending distribution to investors, must be invested in liquid mutual funds or bank deposits or other liquid assets of higher quality such as Treasury bills, Triparty Repo Dealing and Settlement, Commercial Papers, Certificates of Deposits, etc., until the funds are either deployed in line with the investment objective or distributed to investors in accordance with the terms of the fund documents. The fund contended that it had relied on statements describing the schemes as ‘ultra-liquid’ in nature and exited such investments once the actual asset allocations were clarified.
SEBI emphasized that AIFs, being privately pooled investment vehicles that collect money from investors and are registered with SEBI, are expected to exercise a high standard of care and diligence in all its investment decisions.
SEBI observed that the fund’s KMPs, being professionally qualified personnels, were expected to exercise proper due diligence and make informed investment decisions in line with the SEBI’s regulatory framework.
D. Delayed winding up
SEBI, in one of the matters observed that the fund had breached the regulatory timeline to wind up the scheme upon completion of its extended tenure, as mandated under the AIF Regulations. The fund contended that the extensions were due to unforeseen factors like COVID-19 pandemic and insolvency proceedings against several investee companies, which impacted the divestment timelines.
SEBI did not accept these submissions and stated that the fund had issued the PPM keeping in mind the objectives of the scheme and a pre-decided term including any probable extension of the term of the Fund. The investors agreed to such terms as they suited their investment objectives. SEBI emphasized that timelines prescribed under the material documents and the AIF Regulations must be adhered to strictly. While extensions may be permitted under exceptional circumstances, SEBI clarified that it does not give a right to alter the material documents of the fund and applicable provisions of law.
E. Valuation of the units of the fund
SEBI observed in all the three matters that the fund had violated Regulation 23 of the AIF Regulations, which mandates that AIFs must carry out the valuation of their investments in a specified manner and provide investors with a description of the valuation procedure and the methodology used for valuing assets. Additionally, in case of Category III AIFs, calculation of NAV must be independent of the fund management function of the AIF and such NAV must be disclosed to the investors at intervals not longer than a quarter for close ended funds.
In case of one of the funds, the fund failed to disclose the Net Asset Value (“NAV”) at prescribed intervals, while the other funds did not carry out valuation in accordance with the specified regulatory framework. SEBI viewed these lapses as serious breaches that undermine investor transparency and fiduciary obligations of the investment manager and its KMPs.
F. Failure to disclose disciplinary history
In one of the matters, SEBI observed that the fund had failed to disclose the disciplinary history of the sponsor, manager, trustee, their directors, partners, promoters, and associates in the private placement memorandum (PPM). Additionally, it had omitted to disclose material disclosures regarding pending proceedings with the Income Tax Department.
Although a revised PPM containing the relevant disclosures was submitted at a later stage, SEBI noted that these updates were neither in place during the period of examination nor formally communicated to investors through revisions under the PPM. SEBI clarified that the disciplinary history section in the PPM serves a vital disclosure that helps investors understand the potential risks and the track record of the entities and individuals managing their money, ultimately empowering the investors to make well-informed investment decision. Based on these findings, SEBI concluded that the fund, the investment manager and the KMPs failed to comply with their regulatory obligations.
G. Other non-compliances
SEBI noted several instances of delays and failures in the submission of regulatory reports across all three matters. SEBI identified additional lapses, including failure to disclose the investor charter and distribution waterfall to its investors, non-registration with FIU-IND and delay in the appointment of a benchmarking agency.
While SEBI acknowledged that the funds had taken corrective measures to address such issues, it was concluded that such deficiencies nonetheless amounted to breaches of the AIF Regulations and reflected a failure on the part of the fund, its manager, and KMPs to uphold their regulatory responsibilities.
Snapshot of penalties levied in the said matters
|
Matter 1 |
Matter 2 |
Matter 3 |
|
|
AIF |
INR 5,00,000 |
INR 11,00,000 |
INR 12,00,000 |
|
Investment Manager |
INR 1,00,000 |
INR 12,00,000 jointly and severally to be paid by the Investment Manager and identified KMPs |
INR 12,00,000 jointly and severally to be paid by the Investment Manager and identified KMPs |
|
KMPs |
INR 1,00,000 |
||
|
Trustee |
INR 1,00,000 |
INR 6,00,000 |
– |
|
Total Penalty |
INR 8,00,000 |
INR 24,00,000 |
INR 24,00,000 |
Take away
These orders serve as a clear signal to all participants in the AIF ecosystem that strict adherence to AIF Regulations is essential. SEBI has made it evident that any non-compliance—whether intentional or inadvertent—will be subject to close scrutiny and may attract enforcement action. Notably, SEBI has emphasized that investment managers, key managerial personnel (KMPs), and trustees bear fiduciary obligations toward the fund and are responsible for safeguarding investors’ interests. SEBI has even opined that while investment managers may be structured as corporate entities, their operations are driven by KMPs actively managing the fund and as evident with direct penalties on the KMPs, SEBI has held KMPs accountable for regulatory violations committed by AIFs.
Authors: Praroop Jain (Partner) and Naemish Redhu (Associate) are part of the Funds, Asset Management and Regulatory Practice at the Mumbai office.
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