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MUMBAI : The Securities Exchange Board of India (Sebi) is probing practices adopted by at least 20 Indian-domiciled alternative investment funds (AIFs) managing as much as 10,000 crore, two people with direct knowledge of the development said.

Sebi is probing the alleged violations to establish transparency across the AIF ecosystem, they said, seeking anonymity.

The violations include dividend stripping, inadequate diversification, abrupt change in control at AIFs, non-adherence to stated investment mandate, conflicts of interest, valuation policies, priority payouts, and outsourcing management (of investments) to other entities.

“Why should priority payouts happen? Don’t you want AIFs to be as safe as other equity investments?" Ashwani Bhatia, a whole-time director, Sebi, said in an interview on the sidelines of an event organized by the Federation of Indian Chambers of Commerce and Industry on Tuesday. However, he did not comment on the other situations that Sebi may be inquiring into.

Some AIFs offer select limited partners, or investors, in AIFs a priority payout, whereby they get their principal investment back before other investors. This may especially happen in the case of distressed funds, where there may be greater investment risks.

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“Sebi wants to ensure that the AIF principle—that of a pooling vehicle—is maintained. Anything that is outside the contract needs to be stated clearly and communicated to all investors," a third person, a fund manager with knowledge of Sebi’s thinking said. Perhaps, the regulator views priority payouts as a violation of this principle, he added.

Sebi has also questioned certain domicile status of limited partners and general partners to ascertain whether a specific investment should be treated as a foreign direct investment (FDI) or an AIF investment. “It is the job of Sebi to ask questions. I cannot comment on whether active investigations are on," Bhatia said. A separate email query to a Sebi spokesperson went unanswered.

Some of Sebi’s investigations were to ensure tax compliance, the people cited above said. For instance, dividend stripping comes into play as a tax avoidance measure, wherein investors are known to buy into securities just ahead of the dividend payout and exit investment at a loss after the payout when the price of the share has been adjusted downwards for paying a dividend. Without accounting for the dividends, the investor could 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 valuations, Sebi may be creating a methodology to calculate startup valuations under AIFs. Funds have also been asked to clarify if some startup investments received benefits under Department for Promotion of Industry and Internal Trade (DPIIT). Besides, Sebi is also concerned about the valuations of many mid-sized initial public offerings driven by AIF and venture capital money, the people said.

AIF funds under scrutiny are category III funds under Sebi’s AIF regime, including hedge funds, or private investment in public enterprises (PIPE) funds that invest in public markets, they added. In addition, category II AIF funds, including private equity and private debt funds, and category I AIFs, comprising mostly angel and impact funds, have also received notices.

In the past three years, many fund managers have raised capital from high-net-worth individuals and family offices, but they have not strictly adhered to Sebi norms, which triggered the scrutiny. “They have been more aggressive to generate better returns at the cost of compliances," the second person said. “There is a significant gap between what is applicable to AIFs under regulations and what angel funds are doing."

The regulatory programme governing AIFs is designed to distinguish them from retail-focused mutual funds, said Richie Sancheti, founder of law firm Richie Sancheti Associates.

“The regime reinforces and fills in the gaps in market-determined outcomes, primarily through disclosure requirements and by defining the scope of code of conduct for constituents of the AIF.

Sebi’s regulatory coverage provides confidence and flexibility to allow funds to serve sophisticated private fund investors. Sebi, however, has been routinely pushing its agenda to promote more efficiency, competition, and transparency," Sancheti added.

The regulator is also keen to understand how funds price their schemes and how they distribute the payouts, the people cited above said.

Similarly, startup valuations are fairly opaque, and AIF investments in startups are much unlike a mutual fund or a portfolio management fund investment portfolio. Sebi has been trying to study the methodology for valuations for AIFs, too, the fund manager cited above said.

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ABOUT THE AUTHOR

Jayshree P Upadhyay

Jayshree heads a team of reporters focussing on legal, regulatory, investigative stories. She has worked for over a decade, reporting on financial scams, legal stories and the intersection of corporate and regulatory issues. She is based in Mumbai and has previously worked with Business Standard, Mint, The Morning Context and Bloomberg TV India.
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