New Delhi, July 1 -- The Securities and Exchange Board of India (SEBI) has proposed a solution to a longstanding industry concern raised by alternative investment funds (AIFs) over the process of obtaining investor consent for resolutions.

Through a consultation paper issued on July 1, the regulator sought to strike a balance between ease of doing business for fund managers and adequate investor protection by proposing three methodologies that AIFs can use to obtain investor consent. Under existing rules, AIFs are required to secure consent from investors representing at least 75% of the value of the fund's investments.

Separately, the consultation paper proposed replacing the term "associate" with "related party" in provisions relating to conflict-of-interest or conflicted transactions to ensure investor consent is taken for transactions that fall outside the scope of the regulations.

Investor consent threshold

SEBI observed two concerns related to obtaining investor consent. First, investors often do not respond to funds when asked to vote on a resolution. Second, some investors use their vote as leverage to get further concessions from fund managers.

AIFs have also been inconsistent in the way they have taken investor consent. While some funds treat a non-participating investor's vote as consent for a resolution, others wait for explicit approval before passing a resolution.

To standardize the process, SEBI suggested fund managers choose one of three methodologies.

The first is that a non-participating investor's consent will be deemed to have been given after a set period of time, which will be determined by the fund manager. For instance, a fund with 100 investors holding 1% each may see 30 votes in favour of a resolution, 10 against it, while 60 investors may abstain. In this case, 30 and 60 will be counted as consent, and the resolution will be passed.

The second is the present and voting method, under which only participating investors' votes would be counted to determine the 75% threshold for approving a resolution. In the same example as above, with the same voting pattern, there will be 30 votes in favour out of the 40 who participated, meeting the 75% threshold and resulting in the resolution being passed.

The third requires votes to be explicitly cast in favour of a resolution. In the example above, that would mean 30 out of 100, bringing the votes in favour to 30%, and the resolution would not be passed.

The consultation paper detailed the pros and cons of each methodology, saying the fund manager should be given the flexibility to decide which methodology to choose, provided there is adequate disclosure, a written policy and consistent implementation of the methodology.

Conflicted transactions

The AIF Regulations have several safeguards for conflicted or related-party transactions, such as allowing funds to invest in or transact with "associates" only with necessary investor consent and prohibiting certain kinds of funds from investing in associates altogether.

However, SEBI said the definition of "associates" is too narrow, allowing various conflicted transactions to proceed without adequate investor consent.

To address this gap, it suggested using "related party", as defined under the Companies Act, 2013, in place of "associates" for provisions related to conflicted transactions. The term "associate" would be retained in other parts of the AIF Regulations.

The paper also suggested that transactions with related parties of trustees, the fund's board and its designated partners may be excluded from the ambit of conflicted transaction norms. This exemption has been proposed "recognizing the limited role of trustee/Board of directors/designated partners of the AIF in managing the investments and day-to-day operations of the fund."

Published by HT Digital Content Services with permission from VC Circle.