aif regulations - vinod kothari

7/25/2019 AIF Regulations - Vinod Kothari

1/6

AIF Regulations: Meaning of Ownership Interests andInvestor Interests in a Company

[The following is the first in a series of posts contributed by Vinod Kothari and Soma agaria. Theauthors can be reached at [email protected] [email protected]]

!" ACK#RO$%&

There has been a speculation and confusion regarding the extent of applicability of the SE! "#lternative

!nvestment $und% &egulations' ()*( "+AIF Regulations,%' particularly in the case of alternative

investment funds "+AIFs,% set up as companies. !t is notable that the #!$ &egulations permit an AIFto be

organised either as a company' a limited liability partnership "+ ''(,%' or a trust. !n case of the SE!

"-enture apital $unds% &egulations' *//0' the options of organising a fund as a company' trust or a body

corporate were available. 1owever' most venture capital funds were actually orgnaised as trusts.

The difficulty arises from a reading of the definition of an #!$' and is further compounded by the definition

of +units,. &egulation ("*%"b% of the #!$ &egulations defines the term an #!$ to mean' sub2ect to theexceptions set out therein' any fund established or incorporated in !ndia in the form of a trust or a

company or an 334 or a body corporate which5

"a% is a privately pooled investment vehi)le whi)h )olle)ts fundsfrom investors' whether !ndian or

foreign' for investing it in a))ordan)e with a defined investment poli)y for the *enefit of its

investors6 and

"b% is not covered under the Securities and Exchange oard of !ndia "7utual $unds% &egulations' *//0'

Securities and Exchange oard of !ndia "ollective !nvestment Schemes% &egulations' */// or any other

regulations of the oard to regulate fund management activities.

The #!$ &egulations do not define the word +investor,. 1owever' the definition of the term +unit, includes

shares' and therefore' every shareholder becomes a unitholder' and by extension' an investor. !f'

therefore' every shareholder of a company is taken to be an investor' then every company' other than a

listed public company' irrespective of what business the company carries on' is a privately pooled vehicle

which collects money from its sareholders to be used in a particular manner. The 8uestion that' therefore'

arises' and in relation to which no clarification has been issued by SE!' is whether all privately pooled

capital' such as contribution of ownership capital to a company' would fall within the purview of the #!$

&egulations.

!f any application of funds by a company is taken to be covered by the expression +investing it in

accordance with a defined investment policy,' then every company becomes an #!$. #nd if the expression

+investing it in accordance with a defined investment policy,is taken to mean investments as commonly

understood' then every investment company becomes an #!$. There are thousands of investment

companies registered with the &eserve ank of !ndia "+RI,% and yet other thousands which are not

registered. 9bviously' the idea of #!$ &egulations could not have been to bring all such investment

companies' currently under &!:s non banking finance company regime' also under #!$ &egulations. !f

the idea of the #!$ &egulations was to include only such funds as companies gather and manage other

than shareholders: money' then that meaning is not at all clear from the extant definition of either #!$ or

units.
mailto:[email protected]:[email protected]:[email protected]:[email protected]


2/6

+" ,-A. IS R/#$'A./&0

SE! intends to regulate a pooling vehicle which essentially pools capital from various investors and

investing such capital in accordance with defined investment policy. The idea is to ensure benefit to the

investors.

;ho are investors< The Blacks Law Dictionary (9thEdition)defines an investor as a buyer of a security or

other property who seeks to profit from it without exhausting the principal' i.e. a person who spends

money with an expectation of earning profit. =nder common parlance' investors are outsiders who are

neither the owners of the pooling vehicle' nor are they the managers. Therefore' it makes good sense to

have excluded owners and managers.

(.* Meaning of investment

The Blacks Law Dictionary (9thEdition)defines investment to mean expenditure to ac8uire property or

assets to produce revenue' a capital outlay. $urthermore' P Ramanatha Aiyars, The Law Lexicon,

(rdedition)has also similarly defined the term investment to signify the laying out of money in such a

manner that it may produce a revenue' whether the particular method be a loan or the purchase of stocks'

securities' or other property.[*]

The term investment is defined in the #ccounting Standard #S *> as assets held by an enterprise for

earning income by way of dividends' interest and rentals' for capital appreciation' or for other benefits to

the investing enterprise and assets held as stock?in?trade are not investments.

!t is true that behind every outlay of capital the ultimate purpose is to earning revenue. 1owever' there is a

difference in the intentions and purposes while outlaying capital "a% by way of an ownership capital and

"b% solely with the purpose of earning profit.

To our understanding where two or more persons come together with a common objective and

work together to pursue that common objective, it cannot be said to constitute an AIF. There is an

element of control is present in an ownership interest.

(.( Key determinants of an AIF

The key deciding factors' as set out in the definition' are5

"a% a privately pooled investment vehicle6

"b% collection of funds from investors6

"c% investment made in accordance with a well defined investment policy6 and

"d% investments are made for the benefit of the investors.

Therefore' funds are collected from investors on a private placement basis which are invested in

accordance with an investment policy is drawn with an idea to earn returns in form of dividends' etc.' for

the benefit of the investors.
http://www.blogger.com/blogger.g?blogID=3202774368551476669#_ftn1http://www.blogger.com/blogger.g?blogID=3202774368551476669#_ftn1


3/6

!n an ownership capital scenario' the primary benefit is attributable to the entity "the company or a 334' for

instance% and the purpose is the growth of such entity. $urthermore' unlike an #!$' there are no third party

funds involved.

#s the #!$ &egulations are unclear on the extent of its applicability in case of companies' guidance can

be sought from other 2urisdictions.

!" $nited States

!n the =S' the !nvestment ompany #ct' */) "+$S A)t,% regulates an investment company' which has

been defined as an issuer of securities that5

"a% is' holds itself out to be' or proposes to be engaged primarily in the *usiness of investing1

reinvesting1 or trading in se)urities6

"b% is engaged or proposes to engage in the business of issuing face amount certificates of the instalmenttype' or has been engaged in this business and has such a certificate outstanding6 or

"c% is engaged or proposes to engage in the business of investing' reinvesting' owning' holding' or trading

in securities' and owns or proposes to ac8uire investment securities having a value exceeding )A of the

value of the issuer:s total assets "exclusive of government securities and cash items% on an

unconsolidated basis.

The $inancial #ccounting Standards oard "+FAS,% sets out the following criteria for determination of an

Binvestment company:5[*]

+!" An in#estment com$any is an entity that does %oth o& the &ollowin'

a" %tains &*nds &rom an in#estor or in#estors and $ro#ides the in#estor(s) with $ro&essional in#estment

mana'ement ser#ices

%" Commits to its investor(s that its business purpose and onl! substantive activities are investing

the funds for returns from capital appreciation, investment income, or both"

+" An in#estment com$any and its a&&iliates do noto%tain or ha#e the o%ecti#e o& o%tainin' ret*rns or

%ene&its &rom their in#estments that are either o& the &ollowin'

a" ther than ca$ital a$$reciation or in#estment income"

%" "ot available to noninvestors or are not normall! attributable to ownership interests ", [emphasis

supplied]

9f course' the above criteria are only indicative and cannot be construed as a litmus test for

determination of an investment company. 1owever' it is pertinent to note that a clear distinction has %een

made %etween the in#estment interest andownershi$ interest' the latter being excluded as an investment

company.


4/6

+" $nited Kingdom

Section (>C of the $inancial Services and 7arkets #ct' ())) defines a collective investment scheme to

mean5

+any in#estment arran'ements with res$ect to $ro$erty o& any descri$tion, incl*din' schemes, money, the

$*r$ose or effect o& which is to ena%le $ersons takin' $art in the arran'ements (whether %y %ecomin'

owners o& the $ro$erty or any $art o& it or otherwise) to $artici$ate in or recei#e $ro-ts or income arisin'

&rom the ac.*isition, holdin', mana'ement or dis$osal o& the $ro$erty or s*ms $aid o*t o& s*ch $ro-ts or

income",

!t has been further stated that the participants in such scheme shall not have day?to?day control over the

management of the property' whether or not they have the right to be consulted or to give directions.

$urthermore' both of the following characteristics shall be satisfied5

"a% the contributions of the participants' and the proDts or income out of which payments are to be made

to them' shall be pooled6 and

"b% the property shall be managed as a whole by or on behalf of the operator of the scheme.

Therefore' a collective investment scheme is an arrangement that enables a number of investors to pool

their assets and have these professionally managed by an independent manager. [(]The segregation

between management and investors' therefore' is 8uite clear.

2" /uropean $nion

The irectives relating to undertakings for collective investment in transferable securities "+$CI.S&ire)tive,%[>]excl*des a collecti#e in#estment *ndertakin' *ndertakin's o& the closed ended ty$e &rom

the $*r#iew o& the /01T2 Directi#e.[]!n other words' a closed?end vehicle' which is what all companies

are' is completely excluded from the =!TS irective.

The irective on #!$ 7anagers by the E= ommittee of the 1ouse of 3ords' #!$ was defined toinclude

hedge funds' private e8uity funds' venture capital f irms' commodities and real estate funds.[C]

3" Singapore

The Securities and $utures #ct "ap (F/% of Singapore defines a collective investment scheme to mean5

+(a) an arran'ement in res$ect o& any $ro$erty 3

(i) *nder which 3

(A) theparticipants do not have da!#to#da! control over the management of the propert!, whether

or not they ha#e the ri'ht to %e cons*lted or to 'i#e directions in res$ect o& s*ch mana'ement4 and

(B) the $ro$erty is managed as a whole b! or on behalf of a manager4

(ii) *nder which the contributionso& the $artici$ants and the $ro&its or income &rom which $ayments are

to %e made to them are pooled4 and

""""""""""""""""""""""""""


5/6

but does not include $

(i) an arran'ement o$erated %y a $erson otherwise than b! wa! of business4

(ii)an arran'ement *nder which each o& the $artici$ants carries on a %*siness other than in#estment

%*siness and enters into the arrangement solel! incidental to that other business4

(iii) an arran'ement *nder which each o& theparticipants is a related corporation of the manager4""""""""""""""""""""""""""""""""""""

(x) a closed#end fundconstit*ted either as an entity or a tr*st4

"""""""""""""""""""""""""""""""""""" ,

1ere again' one would notice a complete exception carved for closed?end funds' which would include all

investment companies.

[*]See !nvestment ompanies Summary of ecisions &eached to ate uring &edeliberations as of

September C' ()*(. #vailable at5 http5GGwww.fasb.orgGcsGlobServer"a% of the =!TS irectives.

[C]http5GGwww.publications.parliament.ukGpaGld())/*)GldselectGldeucomGFGFi.pdf"last visited on 9ctober

*)' ()*(%.

!n !ndia' a company form of a fund is not very prevalent because of several constraining and restricting

reasons. Some of those can be summariLed as hereunder5

!" Separation of management and investment

#s can be noted' a scheme or a fund contemplates management by an external manager and does not

constitute an in?house management mechanism. ;here 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 #!$.

The intention of SE! is clear5 "a% to protect interests of the investors6 and "b% ensure proper management

of the capital of the investors. ;here there is no public money involved' SE! clearly cannot have any

intent to monitor.

+" &iffi)ulties with a )ompany form of AIF

espite the flexibility in organisational form that might have been SE!:s ob2ective in giving the choice of

the organisational form' the company form is eminently unsuitable for an #!$. &easons are several.
http://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175824491189&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobshttp://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175824491189&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobshttp://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175824491189&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobshttp://www.hmrc.gov.uk/collective/what-is.htmhttp://www.hmrc.gov.uk/collective/what-is.htmhttp://www.esma.europa.eu/system/files/L_302_32.pdfhttp://www.publications.parliament.uk/pa/ld200910/ldselect/ldeucom/48/48i.pdfhttp://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175824491189&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobshttp://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175824491189&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobshttp://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175824491189&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobshttp://www.hmrc.gov.uk/collective/what-is.htmhttp://www.esma.europa.eu/system/files/L_302_32.pdfhttp://www.publications.parliament.uk/pa/ld200910/ldselect/ldeucom/48/48i.pdf


6/6

5irst' ategory !!! #!$s may be open?ended. !n case of companies' open?ended company would mean

free buyback of shares of a company' which is not permissible under the ompanies #ct' */C0 where

buyback of shares by a company is restricted.

2econd' whether closed?ended or open?ended' most #!$s have a limited life span M 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 $! policy' which do

not apply in case of 334s 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 =S

regulation "!nvestment ompany #ct% is an overarching law on all investment companies. !n !ndia' the

idea of SE! could not have been to regulate investment companies.

9ur recommendation will be that companies should be completely excluded from the #!$ 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 siLe of the #!$. !n case of 334s' general partners are in the

nature of ownersGmanagers of the 334' while limited partners are external investors. The #!$ &egulations

should be focused only on the limited partners: investments.

aif regulations - vinod kothari

Documents