To regulate or to over-regulate?

Author: | Published: 17 Jul 2012
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In the span of a week, the Securities and Exchange Board of India (Sebi) has made two significant changes. It has finally notified the SEBI (Alternative Investment Funds) Regulations, 2012, and has overhauled its mechanism for settlement of offences by consent of Sebi and the alleged offender (the Consent Order Scheme).

The Regulations regulate nearly all private pools of capital or investment vehicles (private equity, real estate funds, hedge funds, and so on) that were hitherto largely unregulated. The intention is to ensure that funds are channelled in the desired space in a regulated manner. The Regulations target funds incorporated or established in India in any form subject to certain exemptions.

Sebi has categorised Alternate Investment Funds (AIFs) into three mutually exclusive categories – funds with positive spillover on the economy, those employing diverse or complex trading strategies and a third residuary category (which is actually named as Category II). It is now mandatory for all AIFs to register in at least one of the three categories depending on their objectives. Multiple schemes can be launched by any AIF, under the same category. However, if a scheme falls under a different category, AIF will be required to obtain fresh registration under such other category.

The new Regulations also contemplate certain additional qualifications such as minimum corpus, continuing minimum interest of the manager/sponsor in an AIF, maximum number of investors, and so on, for registration. Some of these provisions are resulting in over-regulation by Sebi which may drive funds out of India. The tax treatment for most AIFs is still not clear. Even though the Regulations have already been notified, relevant foreign investment laws need consequential amendments.

Another important change brought in by Sebi is the modification of its earlier circular of 2007 containing the Consent Order Scheme. The amendment has been brought about with "a purpose of providing more clarity on its scope and applicability". One of the strongest criticisms against the scheme until now has been its lack of transparency and leniency in certain cases.

The most significant change contemplated by Sebi is the near exclusion of certain types of violations from the consent order process. These exclusions include insider trading, front running, failure to make an open offer for a takeover, manipulation of net asset value by mutual funds, and failure to make disclosures in offering documents for issuances of securities. Certain other offences materially affecting investors' interests have also been included. The intention here clearly seems to be to exclude those offences "which in the opinion of SEBI are very serious and/or have caused substantial losses to the investors". Sebi has, however, retained the power to settle serious offences at its discretion under the Consent Order Scheme. Consent orders, containing the alleged misconduct, legal provisions alleged to have been violated, facts and circumstances of the case and the consent terms, will be hosted on Sebi's website.

Other important changes are the introduction of a period of limitation for filing a consent application, conditions under which such applications can be rejected and detailed guidelines for computing settlement fees payable for particular offences. These provisions do seem to make the procedure less arbitrary and more transparent.

Whether the above amendments qualify as reforms in the truest sense of the term will only become clear with time.

Nitu Agarwal and Manali Gogate




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