These private-equity and venture capital funds, registered with the Securities and Exchange Board of India (Sebi) as AIFs, failed to adhere to the fund tenures they had specified in their respective offer documents while garnering the corpus, the people cited above said. Many of the early funds, floated around 2013-14, were scheduled to wind up their operations by 2021-2022.
Rules say a fund can extend its lifecycle by up to two years, but two-thirds of investors in such a fund must give their consent for tenure extension. And once the life of a fund comes to an end, the AIF manager is required to liquidate all the holdings and distribute the proceeds among the investors within a year. Some of these funds are also facing the heat since they went ahead and extended the tenures even though Sebi is yet to provide any exemptions.
In some cases, Sebi observed that the fund managers concerned had unilaterally extended the tenure of the funds without informing the market regulator.
“The rules clearly say the winding up must be completed within one year, and Sebi is well within its rights to initiate action against them,” said one of the sources cited above. “However, this is like a double whammy for the funds that expected Sebi to provide them some leeway. Instead, they have now received Sebi notices.”
Protection of Investor Interests
An email sent to Sebi remained unanswered.
Some believe the Sebi action is aimed at simultaneously ensuring protection of investor interests and transparency standards in a wealth-management segment aimed at savvy and deep-pocketed savers.
“Given the nature of risks involved in private capital, it should not be a surprise if a handful of funds face challenges in realising their investments within the time frame mandated by current regulations,” said a person privy to the development. “As of now, any extension of an AIF beyond two years is not allowed; however, in-specie distribution of assets or liquidation is among the permitted options.”
In-specie distribution refers to allocation of shares in investee companies in favour of the individual AIF contributor if the fund fails to liquidate the illiquid stock and distribute the proceeds. “While investor interest is key, it is also important to ensure that a truthful record of fund value and performance is maintained and disclosed at all times,” said the person cited immediately above.
To be sure, PE and VC funds investing in unlisted companies, such as startups, were unable to liquidate their holdings within the one-year timeline due to poor liquidity conditions in the market. Several global and domestic factors, including liquidity drainage by central banks across the globe, led to poor appetite among prospective investors in shares of the old AIFs.
In some cases, the funds were able to find willing buyers, albeit at significantly lower valuations.
Sebi has already asked the respective fund managers to explain why they unilaterally extended tenures of the funds, said the people cited above. Technically, Sebi can levy a penalty on the AIF for not adhering to the norms, while the respective fund managers may be subject to separate penal action, say legal experts.
Between June and October 2022, several funds made representations to the market regulator seeking an extension of timelines. They requested Sebi to allow the funds an additional year to liquidate the holdings. Also, some of the AIFs wanted Sebi to permit further extension of fund life by another two years.
“Since any extension beyond two years of the original term is legally not permissible, AIFs still extending tenures are at Sebi’s mercy that it might take a lenient view, given that disposal of illiquid investments by way of fire-sales, write-offs or an impractical in-kind distribution hurts investor interest,” said Tejesh Chitlangi, senior partner, IC Universal Legal. “The regulator should consider notifying a policy whereby further limited extension, albeit with higher threshold of investor approval, is permitted.”
The regulator is concerned about AIF fund managers forcing their clients to wait longer than originally anticipated. Generally, the rules governing AIFs are ‘light touch’ in nature since only sophisticated investors willing to put in Rs 1 crore or more at one go are allowed to invest in these funds. However, in the recent past, the regulator has been tightening the vigil around AIFs. On one hand, the regulator has tweaked the rules to ensure better governance and transparency, while on the other, Sebi is also initiating proceedings against funds found to be flouting the rules.
“There is far more supervision on AIFs these days with Sebi seeking to impose uniform standards of governance across the industry,” said another person cited above.