Keeping It Private: Do’s and Dont’s For AIF distributors
Simrat Singh and Manisha Ghosh | finserv@vinodkothari.com
Alternative Investment Funds (AIFs) are privately pooled investment vehicles that are registered with and regulated by SEBI. These funds raise capital from a group of investors and deploy it in accordance with pre-defined investment strategies that are disclosed upfront. The returns generated from such investments, after deducting applicable expenses, are distributed back to the investors.
As per Regulation 4(b) of the SEBI (Alternative Investment Funds) Regulations, 2012, (‘AIF Regulations’) AIFs are explicitly prohibited, through their constitutional documents, from making any public invitation to subscribe to their securities. SEBI has also reiterated this position in its FAQs (see FAQ No. 11). While this preserves the private nature of AIFs, it often limits managers’ ability to reach the right investors, as they cannot publicly advertise their schemes. In many cases, managers first design a specific investment strategy and then seek investors whose risk and investment appetite aligns with it, requiring direct, one-on-one communication. To focus on their core function of managing investments, AIF managers may not want to handle investor outreach directly. Instead, delegate this ‘distribution function’ to intermediaries who already have the required network and access to investors. Although the AIF Regulations do not explicitly provide for the provisions governing the eligibility, role and responsibilities of the AIF distributors, SEBI, through a 2023 Circular, has acknowledged their role and prescribed a framework for distributor’s commission.
There still remains ambiguity on the functioning of AIF distributors. As mentioned above, the 2023 SEBI Circular only provides that an AIFs shall only approach investors through a SEBI registered intermediary. Beyond prescribing eligibility, there are no explicit provisions under the SEBI regulations specifically addressing the functioning or obligations of AIF distributors.
Given that the role of a distributor could potentially conflict with the fundamental principle of AIF units being privately placed, and in the absence of detailed regulatory guidance, it is crucial that any appointment of a distributor is undertaken with appropriate safeguards to ensure compliance and to avoid any regulatory breach.
In this note we list down the Dos and Don’ts for distribution of units of AIFs based on the requirements prescribed under the AIF Regulations, NISM Study materials for AIF Distributors, IFSCA Capital Market Intermediaries Regulations.
There is a 2-fold principle ingrained in the following Dos and Don’ts:
- Units of AIFs shall be sold to only such investors who understand the risk and return profile of the product;
- No invitation to the public to subscribe to units of AIF shall be made.
Dos and don’ts for the AIF managers engaging distributors
| Dos ✔️ | Don’ts❌ |
|---|---|
| Distribution agreement: AIF manager to enter into a distribution agreement with the distributor which clearly outlines the respective rights, obligations and duties of both the parties; Distributor eligibility: Ensure that the distributor has requisite licenses/ qualifications for distribution. Suitable clauses may be added in the reps & warranties section of the agreement in this regard; Investor parameters: Provide indicative parameters such as minimum net worth, financial capability, investor category, liquidity needs, investment objectives, experience, etc. to the distributors to determine sophistication of the investors; Distributor oversight: Conduct due diligence and periodically monitor the operations of the distributor to ensure that adequate risk-profiling is being done and only permitted investors are being approached; Payment of commission: In terms of the 2023 Circular of SEBI, in case of Cat III AIF, it shall charge distribution fee only on trail basis i.e., no upfront fee shall be charged. However, in case of Cat I and II AIFs, it may pay up to one-third of the total distribution fee/placement fee to the distributors on upfront basis, and the remaining distribution fee/ placement fee shall be paid to the distributors on equal trail basis over the tenure of the fund; Commission disclosure: Fee to be paid to the distributors shall be disclosed upfront to the investors; Controlled distribution: Ensure that the distribution is targeted, non-public and controlled by giving clear criterias to distributors regarding investors acceptability | No mass marketing: Do not cause or allow to be caused mass marketing or public advertisement; No guaranteed returns: Do not allow distributors to make any guaranteed returns or NAV-linked claims Do not permit investment by other AIFs if the fund is authorised to invest in AIFs. Material functions not be outsourced: Do not outsource fund management or fiduciary responsibilities to distributors. Minimum investor limit: Do not accept investors below the minimum investment threshold i.e. Rs. 1 Cr./Rs. 25 Cr./ Rs 25 Lakhs, as the case maybe or beyond 1,000 investors per scheme. No indirect inducements: Do not offer any indirect inducements or pass-backs to investors by or through distributors. |
Dos and don’ts for the Distributors of AIF Units
| Dos ✔️ | Don’ts❌ |
|---|---|
| Written agreement with Manager: Enter into a written agreement with investors and issuers, laying down the inter-se relationship, mutual rights, liabilities and obligations and other material details. Private placement only: Solicit investors only through private placement and not through public invitation or advertisement. Investor risk appetite analysis: Assess each investor’s risk appetite and recommend only suitable AIFs. Also, document the assessment. Circulation of approved documents only: Distributors to circulate only approved documents provided by the AIF; avoid independent alterations or additions. Risk acknowledgement declaration: If the client is a sophisticated investor, the distributor shall obtain a declaration to the effect that the investor understands the risks associated with the AIF unit; Material disclosures: Disclose all material information to its prospective clients such as its business, disciplinary history, terms and conditions of distribution services, conflict of interest, affiliations with other intermediaries, etc. Remuneration transparency: If requested by a client, the distributor shall disclose the amount of direct and indirect remuneration and the basis of remuneration it receives; Record maintenance: Maintain adequate records in relation to its clients, in physical or digital form including correspondence with the clients and consent/dissent of the clients, wherever applicable; Conflict management: Take steps to avoid conflicts of interest (whether actual or perceived) and develop appropriate policies and procedures to identify, manage, monitor and where applicable, disclose, those conflicts of interest to the investors in order to prevent them from adversely affecting the interests of the clients Investor screening: All requisite information and application details shall be shared with the investor only after screening and profiling; KYC assistance: Assist the AIF in investor KYC documentation, while ensuring the primary responsibility remains with the AIF; Maintenance of a distributor’s kit: Maintain a Distribution Kit which includes the following:Fund constitution and SEBI registration certificate;PPM and Key Disclosure Statement;Investor presentation;KYC and FATCA requirements;Risk disclosures, FAQs and key timelines;Contact details of key officials of the AIF. Client confidentiality: Maintain and protect confidentiality of its clients’ details, deals and transactions, investment goals which it comes to know in the course of business relationship; Qualified personnel: Ensure that the personnel of the distributor engaging with investors hold a valid NISM Series-XIX-A certification for distribution of Category I and II AIFs, or NISM Series-XIX-B certification for distribution of Category III AIFs, as applicable. Activity segregation: Ensure clear segregation of its proprietary investments and those carried out as part of distribution activities. Further, separate bank accounts to be maintained by the distributors. Enhanced Due-Diligence: Under IFSCA, if a prospective investor is not a ‘sophisticated investor’ then higher due-diligence to be performed on such investor to ensure he/she is aware of the risk and returns; | No misleading statements: Do not engage in mis-leading statements including guaranteeing performance of the scheme; (See this Circular) No premature pitching: Do not pitch or circulate scheme documents before assessing investor suitability; No unauthorized communications to public: Do not respond to press queries or public investor questions about the fund unless specifically authorised by the Fund manager; No unethical inducements: Abstain from attracting clients through unethical means such as offer of rebate/gifts/ referral rewards, etc.; No tampering of documents: Abstain from tampering with the application form and other documents submitted by the client, including inserting, deleting, or changing any information in the application form or any other document provided by the client; No advice which is influenced by commission: Abstain from recommending any scheme to a client on the basis of commission or distribution fees receivable by the distributor; No exaggerated claims: Distributor communication to prospective investors shall not carry any slogan that is exaggerated or unwarranted or slogan that is inconsistent with or unrelated to the nature and risk and return profile of the AIF unit. No risk dilution: Ensure risk factors and disclosures from the PPM are not downplayed in the distribution pitch; No sub-distributors without approval: Appoint sub-distributors only if explicitly permitted by AIF agreement; No independent endorsement: Do not claim or endorse fund quality beyond AIF-provided data. |
Read More:
Can we implement referral bonus scheme for exiting clients
This would depend on the terms of the scheme. Majorly, it should not affect assessment of risk appetite, investor selection and other restrictions. May drop a mail at finserv@vinodkothari.com with complete facts to enable us to comment on it.