Securities Exchange Board of India (Sebi) has put a halt to Alternative Investment Funds (AIFs) with a priority distribution model from accepting fresh commitments, the markets regulator said on Wednesday evening.
A priority distribution model allows some investors to exit ahead of others, which is currently not against the law as it is not explicitly restricted in AIF Regulations mandated by the regulator.
However, this is likely to change. On Wednesday, Sebi noted that some schemes of AIFs have been allowing a waterfall distribution in such a way that a set of investors “share loss more than pro rata to their holding” in comparison to other investors as the latter is allowed to exit the AIF earlier than the former.
While this is not a violation of the Sebi AIF regulations according to the current regime, the “regulator believes it is unfair and unethical,” a person familiar with regulator’s thinking said. This allowed losses to be passed on to others in a disproportionate manner, ifsome other investors within the AIF have been allowed to exit on priority
"We have seen that sometimes one class of investors have a better bargaining power than the another and hence they are able to procure better rights or protection mechanism, through better waterfall mechanisms. This is generally not asked for by the former class in order to provide undue advantage to the latter class, but to ensure that their investments are protected. However, eventually, it may become disadvantageous to one class," said Dipti Lavya Swain, founder and managing partner, DLS Law Offices.
“The aforesaid matter is being examined by Sebi in consultation with Alternative Investment Policy Advisory Committee, AIF industry associations and other stakeholders. Meanwhile, it has been decided that schemes of AIFs which have adopted aforesaid priority distribution model, shall not accept any fresh commitment or make investment," Sebi said in its circular.
Sebi’s adverse stance on “priority payouts” was first reported by Mint on 14 September.
“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 with Mint on the sidelines of an event organized by the Federation of Indian Chambers of Commerce and Industry on 14 September.
At the time Mint had also reported that the regulator is probing as many as 20 AIFs for a series of violations which included 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.