Wednesday, October 17, 2012

AIF Regulations: Meaning of Ownership Interests and Investor Interests in a Company – Part III


[The following post is the last of the series contributed by Vinod Kothari and Soma Bagaria. The authors can be reached at vinod@vinodkothari.com and soma@vinodkothari.com respectively. The first two posts in the series can be found here and here.]

In India, a company form of a fund is not very prevalent because of several constraining and restricting reasons. Some of those can be summarized as hereunder:

1.             Separation of management and investment

As can be noted, a scheme or a fund contemplates management by an external manager and does not constitute an in-house management mechanism. Where the funds are privately pooled for a common purpose and managed in-house on the bases of a private arrangement, agreement or understanding, it cannot be construed as an AIF.

The intention of SEBI is clear: (a) to protect interests of the investors; and (b) ensure proper management of the capital of the investors. Where there is no public money involved, SEBI clearly cannot have any intent to monitor.

2.             Difficulties with a company form of AIF

Despite the flexibility in organisational form that might have been SEBI’s objective in giving the choice of the organisational form, the company form is eminently unsuitable for an AIF. Reasons are several.

First, Category III AIFs may be open-ended. In case of companies, open-ended company would mean free buyback of shares of a company, which is not permissible under the Companies Act, 1956 where buyback of shares by a company is restricted.

Second, whether closed-ended or open-ended, most AIFs have a limited life span – in case of companies, thinking of taking the company to winding up will be an extremely protracted exercise.

Third, in addition to the above, there are entry and exit norms applicable under the FDI policy, which do not apply in case of LLPs and trusts.

Last, needless to mention the continuous compliance issues associated with a company.

The reason why the corporate form might have made sense elsewhere in the world is that the US regulation (Investment Company Act) is an overarching law on all investment companies. In India, the idea of SEBI could not have been to regulate investment companies.

Our recommendation will be that companies should be completely excluded from the AIF regulations, or it should be clarified that in case of companies, only such part of investment corpus as is different from the share capital of the company is counted as size of the AIF. In case of LLPs, general partners are in the nature of owners/managers of the LLP, while limited partners are external investors. The AIF Regulations should be focused only on the limited partners’ investments.

(Concluded)

- Vinod Kothari & Soma Bagaria

1 comment:

Sathish said...

The arguments laid out in the post can hardly be refuted on two counts: (1) a meticulous interpretation of the regulations brought out (2) Even on the basis of first principles, the fundamental role of any securities regulator is to manage/regulate intricate issues flowing out of various so called agency relationships such as intermediary-client, company-investor, etc. But where the investor himself has a control over the ownership interest, the securities regulator should have no business.