Alerts & Updates 16th Jan 2024

Season Of Settlements for Alternative Investment Funds

Authors

Naresh Thacker Partner | Mumbai
Ria Dalwani Principal Associate

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  • An Overview

    As 2023 drew to a close, SEBI gave effect to settlements initiated by two Alternative Investment Funds under the SEBI (Settlement Proceedings) Regulations, 2018, (“Settlement Regulations”). In this article, ELP has reflected on the nature of the disputes involving a Category II Alternative Investment Fund and Category III Alternative Investment Fund, respectively, which were settled recently.

    By way of background, Settlement Regulations came into effect on  January 1, 2019, and replaced the erstwhile SEBI (Settlement of Administrative and Civil Proceedings) Regulations, 2014. The Settlement Regulations sets out the procedures for settling disclosure-related violations, complying with refund requirements, and offering exit or purchase options for investors in line with securities laws.

    Aligned with Securities and Exchange Board of India’s (“SEBI”) objectives of protecting investor interests and regulating the securities market, the Settlement Regulations aim to integrate the quasi-judicial processes with alternative dispute resolution mechanisms. This integration was intended to create a more efficient and harmonized system, eliminating conflicts and delays.  Having said that, the Settlement Regulations carve out exceptions for matters which cannot be settled (i.e., breach of regulations related to insider trading, disclosure of unpublished price-sensitive information, and engaging in fraudulent or unfair trade practices) and persons who cannot apply for settlement (i.e., wilful defaulters, fugitive economic offenders, etc.).

    Alternative Investment Fund (“AIF”) structures have evolved into increasingly complex forms, such as debt funds, fund of funds, hedge funds, amongst others. As they develop, inadvertent/advertent minor infractions and violations are likely to arise along the way.

  • The case of a Category II AIF

    On December 11, 2023, SEBI exercised its authority to settle the violations in Cleanmax Renewable Trust[1]. In Cleanmax Renewable Trust[2]the Sponsor (Clean Max Enviro Energy Solutions Pvt. Ltd.) and the Investment Manager (Clean Max Energy Ventures Pvt. Ltd.) (collectively “Applicants”) of a Category II Alternative Investment Fund filed a joint sou motu application under the Settlement Regulations, to propose settlement of enforcement proceedings that may be initiated against them for violations of Regulation 20 (13) of SEBI (Alternative Investment Funds) Regulation, 2012 (“AIF Regulations”) (read with SEBI Circular dated  June 19, 2014 on ‘Guidelines on disclosures, reporting and clarifications under AIF Regulations’).

    • As per Regulation 20(13) of the AIF Regulations, prior approval from SEBI is required in the event of a change in control of the AIF or of the AIF’s Sponsor, or the Investment Manager. On August 20, 2021, Augment India I Holdings, LLC, a U.S.-based investment firm acquired 60% (approx.) of the Sponsor’s share capital. Thus, the Sponsor’s control stood changed and this influenced the control of the Investment Manager, which is a wholly owned subsidiary of the Sponsor. Subsequently, SEBI’s post-facto approval for the “change in control” of the Sponsor and of the Investment Manager was obtained on March 16, 2023. Nevertheless, the AIF did not obtain prior approval as per Regulation 20(13) for the change in control.
    • SEBI’s circulars dated June 19, 2014, and July 18, 2014, mandate AIFs to obtain consent from 75% unit holders upon a change in control of the Sponsor/Investment Manager of the AIF. Although consent from all contributors was obtained, it was executed with a delay of 68 days.

    To resolve potential proceedings arising from these delayed compliances, the Applicants engaged with SEBI’s Internal Committee, proposed revised settlement terms, and eventually settled the matter by remitting INR 17.4 lacs as per the High-Powered Advisory Committee’s (“HPAC”) recommendation.

  • The case of a Category III AIF

    By a Settlement Order dated December 18, 2023, a settlement came into effect in Unifi AIF, a Category III Alternative Investment Fund [3]. Unifi (“Applicant”) invoked the Settlement Regulations to settle enforcement proceedings that may be initiated against it for non-compliance of the AIF Regulations along with (read with the Circular dated 18 December 2014[4]), by neither admitting nor denying any finding of fact or conclusion of law.

    • Adjudication proceedings were initiated against the Applicant, its investment manager and key personnel for the alleged violations of AIF Regulations 18(a) of AIF Regulations, 18(c), and 24(a) read with the said circular i.e., the Applicant invested in a Large Cap Mutual Fund against Regulation 18(a), omitted disclosure of derivative positions and leverage to investors violating Regulation 18(c), and failed to obtain SCORES[5] authentication within the stipulated timeframe as per Regulation 24(a), which necessitates addressing investor grievances.

    In the circumstances, the Applicant and the concerned entities/personnel sought a settlement. The Applicants engaged with SEBI’s Internal Committee and proposed revised settlement terms.  Following HPAC’s recommendation that the settlement amount shall not be drawn from investor funds but from responsible officers, which SEBI’s Whole Time Members approved, a payment of INR 38 lacs was made. Subsequently, it was clarified that a different parameter should have been applied, resulting in an additional payment of INR 11.4 lacs. Once this sum was remitted, the matter was finally resolved.

  • Analysis and Conclusion

    While SEBI exercised its authority to settle the violations in both the above matters, the settlements remain subject to conditions delineated in Regulation 28 of the Settlement Regulations i.e., preserving SEBI’s prerogative to take appropriate action if (i) discrepancies arise (ii)if any representations made during the settlement are found untrue, or (iii) if there’s a breach of the settlement terms. Per Regulation 28, whenever any settlement order is revoked, the amounts paid under the Settlement Regulations are not refundable and SEBI is at liberty to restore/initiate the proceedings with respect to which the settlement order was passed.

    The settlement process is as an alternative enforcement mechanism, for the benefit of the accused party, investors, and the regulatory body.  At the same time, before proceeding, it is crucial to be mindful of inherent factors within the Settlement Regulations. For instance, applicants are mandated to submit an undertaking in a prescribed format, which involves waivers of certain rights. These waivers inter alia encompass – waiver of appeals and reviews before tribunal/court; waiver of raising regulatory-related pleas (including conflict of interest), and waiver of initiating legal actions against SEBI on matters covered in the settlement order, and waiver of any allegations of bias or prejudgment by SEBI, its officers, or HPAC.

    There are certain regulations within the AIF Regulations that grant SEBI and whole-time members complete discretion to reject applications upon receiving information from parties about compliance violations at any stage of the proceedings. Additionally, according to Regulation 16(2), any settlement does not confer a right on the noticee, to enforce the settlement or avoid any enforcement actions. Many such provisions within the Regulations, when read with the schedules, are relevant considerations before choosing to apply for a settlement. The settlement mechanism differs from compounding of offenses provided under several other statutes, where authorities have negligible discretion to reject applications for compounding.

    Nevertheless, it is welcoming to witness the fruition of settlements under the Settlement Regulations inasmuch as it expedites the conclusion of enforcement proceedings, bypasses prolonged litigation, and concurrently safeguards investors’ rights.

    We trust you will find this an interesting read. For any queries or comments on this update, please feel free to contact us at insights@elp-in.com or write to our authors:

    Naresh Thacker, Partner – Email – nareshthacker@elp-in.com
    Ria Dalwani, Principal Associate – Email – riadalwani@elp-in.com

  • References:

    [1] 2023 SCC OnLine SEBI 411
    [2] 2023 SCC OnLine SEBI 411
    [3] 2023 SCC OnLine SEBI 419
    [4] SEBI Circular CIR/OAIE/1/2014
    [5] SEBI Complaints Redress System (SCORES)

The information contained in this document is intended for informational purposes only and does not constitute legal opinion or advice. This document is not intended to address the circumstances of any individual or corporate body. Readers should not act on the information provided herein without appropriate professional advice after a thorough examination of the facts and circumstances of a situation. There can be no assurance that the judicial/quasi-judicial authorities may not take a position contrary to the views mentioned herein.