caalley logo

The alley for Indian Chartered Accountants

Sebi proposes measures to curb mis-selling in alternate investment funds

Mumbai, February 4, 2023 

Under the recommendations, commission to be charged on trail basis

The Securities and Exchange Board of India (Sebi) has proposed measures to curb mis-selling in Alternate Investment Funds (AIFs) including mandatory offering of direct plans and introduction of trail model for distribution commission.

The regulator has said that in certain cases the quantum of upfront commissions for AIF distribution fees has gone up to around 4-5 per cent of committed amount.

“Such high upfront commissions, particularly in sharp contrast to the trail commissions for other products, increase the chances of mis-selling of AIF schemes,” noted Sebi.

In a discussion paper issued on Friday, Sebi has proposed on adopting a trial model of distribution commissions.

Under the proposed norms, all investors for categories of AIFs will be charged distribution fee on trail basis but for Category I and II AIFs, certain higher amounts may be charged. Though, this amount could be one-third of the present value of total fee paid upfront in the first year.

At present, investors were being charged upfront commission fee by distributors on the total committed amount.

The market watchdog has already done away with upfront commissions from mutual funds and portfolio management services (PMS). Once these proposals are approved, the arbitrage in treatment will be removed.

“Our fear is that there might be vulnerabilities in the sector, including valuation shocks and mis-sellings, which could slow down the pace costing us 5-7 years in actual capital formation,” Sebi whole-time member Ananth Narayan had said last month in an address.

“Investments in AIFs are mostly illiquid and require a commitment for long term. For an investment of Rs 1 crore, the client’s net worth should at least be Rs 10 crore. Even though the investments move in tranches, the full commission on the total committed amount is paid upfront currently as distributors prefer upfront rather than trail which come over many years,” said Mohit Gang, Co-founder & CEO, Moneyfront.

Additionally, Sebi’s proposal for mandating direct plans comes to root out double taxation on investors who used to come through financial advisors. These investors were charged twice – once in the form of advisory fee or portfolio management fee, and separately via the AIF distribution fee.

“AIFs to ensure that any investor approaching an AIF through an intermediary, that is separately charging the investor a fee (such as advisory or portfolio management fee), invests in the AIF via the direct plan route only,” said Sebi.

The regulator has also recommended that investors on-boarded through direct plans should be provided for an adjusted higher number of units as lower distribution charges are applicable on them.

“In case of AIFs, since the subscription to units of AIF is on a private placement basis, Sebi does not regulate the fees payable by the unit holders. However, Sebi expects the fund manager to maintain transparency for the fees it proposes to charge. If there is any mis-selling and the interest of investors is compromised, then SEBI has the right to step in and regulate such activities for investor protection,” said Hemang Parekh, Partner, DSK Legal.

AIFs can invest in venture capital funds, startups, and unlisted securities. Investment commitments in AIFs have shown multifold growth in the last five years. At the end of June, 2017, the total commitments raised were at less than Rs 1 trillion which by June, 2022 had risen to Rs 6.94 trillion. Of this, Rs 5.61 trillion is for category II AIFs and nearly Rs 74,500 crore for category III AIFs.

Comments on the discussion paper are to be submitted by February 18.

[The Business Standard]

Read more on:
Don't miss an update!
Subscribe to our newsletter