2 Mastering PPM Filing and Compliance for AIFs

Key Takeaways:

- AIFs must use a prescribed template for PPMs, consisting of Part A for minimum disclosures and Part B for supplementary information.

- PPMs must be filed with SEBI through a registered Merchant Banker, who provides a due diligence certificate.

- The First Close of a scheme must be declared within 12 months of SEBI's communication for taking the PPM on record.

- AIFs must conduct an annual audit of compliance with PPM terms, except for specific exemptions.

- Changes to PPM terms must be intimated to investors and SEBI within a month of the financial year-end, along with a Merchant Banker's due diligence certificate.

Detailed Narrative:

The Private Placement Memorandum (PPM) is a pivotal document that Alternative Investment Funds (AIFs) must provide to prospective investors, disclosing all necessary information about the fund. To ensure a minimum standard of disclosure, the Securities and Exchange Board of India (SEBI) has mandated a template for PPMs, which comprises two parts.

Part A of the PPM template is dedicated to minimum disclosures, providing a simple and comparable format for essential information. Part B serves as a supplementary section, allowing AIFs the flexibility to provide additional details they deem fit. The templates for PPMs of AIFs raising funds under Category I and Category II are provided in Annexure 1, while the template for Category III AIFs is found in Annexure 2.

In accordance with Regulation 12(2) of the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations), AIFs must launch schemes subject to filing the PPM with SEBI through a SEBI-registered Merchant Banker. The Merchant Banker is responsible for independently exercising due diligence on all disclosures in the PPM, ensuring their veracity and adequacy, and providing a due diligence certificate in the format specified in Annexure 3. The Merchant Banker appointed for filing the PPM must not be an associate of the AIF, its sponsor, manager, or trustee.

Regarding the validity of PPMs, Regulation 12(4) of the AIF Regulations stipulates that the First Close of a scheme must be declared by an AIF in the manner specified by SEBI. In this context, the First Close must be declared no later than 12 months from the date of SEBI's communication for taking the PPM on record. For open-ended schemes of Category III AIFs, the First Close refers to the close of their Initial Offer Period. The corpus of the scheme at the time of declaring the First Close must not be less than the minimum corpus specified in the AIF Regulations for the respective category or sub-category.

To ensure compliance with the terms of the PPM, AIFs are mandated to carry out an annual audit of such compliance. The audit can be conducted by an internal or external auditor or legal professional, except for sections related to 'Risk Factors', 'Legal, Regulatory and Tax Considerations', and 'Track Record of First Time Managers', which are optional. The audit findings, along with corrective steps, must be communicated to the Trustee or Board of Directors or Designated Partners of the AIF, the Board of Directors or Designated Partners of the Manager, and SEBI within six months from the end of the financial year. However, AIFs that have not raised funds from investors are exempt from this audit requirement but must submit a Certificate from a Chartered Accountant to that effect within six months from the financial year-end.

Any changes in the terms of the PPM and the documents of the fund or scheme must be intimated to investors and SEBI on a consolidated basis within one month of the end of each financial year. This intimation must be submitted through a Merchant Banker, along with a due diligence certificate provided by the Merchant Banker in the format specified in Annexure 5.

The chapter also addresses material changes to the PPM, which may significantly influence an investor's decision to continue investing in the AIF. In such cases, the AIF must provide an exit option to existing unit holders who do not wish to continue after the change. The process for providing the exit option, including valuation methodologies and timelines, is outlined in detail.

FAQs:

Q1: What is the purpose of the PPM template prescribed by SEBI?

A1: The PPM template ensures a minimum standard of disclosure is maintained across all AIFs, providing prospective investors with essential information in a simple and comparable format.

Q2: Why is a Merchant Banker required for filing the PPM?

A2: A SEBI-registered Merchant Banker is responsible for conducting due diligence on the PPM disclosures, ensuring their veracity and adequacy, and providing a due diligence certificate.

Q3: What is the significance of the First Close timeline?

A3: The First Close timeline ensures that AIFs declare the initial closing of a scheme within a reasonable period after SEBI's communication for taking the PPM on record, demonstrating their commitment to the scheme.

Q4: Why is an annual audit of compliance with PPM terms necessary?

A4: The annual audit ensures that AIFs adhere to the terms and conditions outlined in their PPMs, protecting the interests of investors and maintaining transparency.

Q5: What constitutes a material change in the PPM, and what is the process for handling such changes?

A5: Material changes are those that significantly influence an investor's decision to continue investing in the AIF, such as changes in the sponsor, manager, control, or fee structure. In such cases, AIFs must provide an exit option to dissenting investors, following a specific process outlined in the chapter.

Key Precedents:

1. SEBI (Alternative Investment Funds) Regulations, 2012:

- Regulation 12(2):

Requirement for AIFs to launch schemes subject to filing the PPM with SEBI through a Merchant Banker.

- Regulation 12(4):

Stipulation for declaring the First Close of a scheme within a specified timeline.

2. SEBI Circular No. SEBI/HO/IMD/DF6/CIR/P/2020/24 dated February 05, 2020:

- Introduced the template for PPMs of AIFs raising funds under Category I and Category II (Annexure 1).

- Introduced the template for PPMs of AIFs raising funds under Category III (Annexure 2).

- Mandated the annual audit of compliance with PPM terms.

3. SEBI Circular No. SEBI/HO/IMD/IMD-I/DF6/P/CIR/2021/645 dated October 21, 2021:

- Specified the format for the due diligence certificate to be provided by the Merchant Banker (Annexure 3).

- Prohibited the appointment of an associate of the AIF, its sponsor, manager, or trustee as the Merchant Banker for filing the PPM.

- Provided the format for the due diligence certificate for intimating changes in the PPM (Annexure 5).

4. SEBI Circular No. SEBI/HO/AFD-1/PoD/P/CIR/2022/155 dated November 17, 2022:

- Specified the timeline for declaring the First Close of a scheme.

- Outlined the requirements for the corpus of the scheme at the time of declaring the First Close.

5. SEBI Circular No. SEBI/HO/IMD/IMD-I/DOF6/CIR/2021/549 dated April 07, 2021:

- Mandated the intimation of changes in PPM terms to investors and SEBI within one month of the financial year-end.

These precedents, including the AIF Regulations and various SEBI circulars, provide the legal framework and guidelines for filing PPMs, ensuring transparency, investor protection, and compliance within the AIF industry.

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Here's the AIF circular's verbatim Chapter 2

Chapter 2 - Filina of Private Placement Memorandum (‘PPMM and related compliance requirements

2.1. Template(s) for PPM{2} and disclosures in PPM{3}

2.1.1. Private Placement Memorandum (‘PPM’) is a primary document in which all the necessary information about the AIF is disclosed to prospective investors. To ensure that a minimum standard of disclosure is made available in the PPM, a template has been mandated for the PPM, providing certain minimum level of information in a simple and comparable format. AIFs are also permitted to provide additional information in their PPM.

2.1.2. Thus, the template for PPM shall have two parts viz.

Part A - section for minimum disclosures, and

Part B - supplementary section to allow full flexibility to the Fund in order to provide any additional information, which it deems fit.

2.1.3. The template for PPM of AIFs raising funds under Category I and Category II is provided at Annexure 1. The template for PPM of AIFs raising funds under Category III is provided at Annexure 2.

2.1.4. Every AIF shall, in its PPM provide a detailed tabular example of how the fees and charges shall be applicable to the investor including the distribution waterfall.

2.1.5. Regulation 11(2) of the AIF Regulations requires that an AIF shall include history of disciplinary actions in its PPM. In this regard, it is clarified that all AIFs shall include in their PPM, disciplinary history of:

(i) AIF, sponsor, manager and their directors/partners/promoters and associates;

(ii) If applicant is a trust, trustees or trustee company and its directors.

Such disciplinary history shall, inter alia, include:

a) Details of outstanding/pending and past cases (where the person has been found guilty) of litigations, criminal or civil prosecution, disputes, non-payment of statutory dues, overdue to/defaults against banks or financial institutions, contingent liabilities not provided for, proceedings initiated for economic offences or civil offences, adverse findings with respect to compliance with securities laws, penalties levied, disputed tax liabilities, etc.

b) Any disciplinary action taken by the Board or any other regulatory authority.

In case of operational actions such as administrative warnings/deficiency letters, the same may be grouped together and summarized. However, if the investor seeks details of the summarized portion, the same shall be provided by the AIF to the investor.

Any further litigations/cases, etc. as may arise in the course of the activities of the AIF shall be appropriately incorporated in the PPM and intimated to the investors.

2.1.6. With respect to disclosure of disciplinary history as per para 2.1.5 above, the same shall be applicable for the last 5 years and where monetary penalty is involved, in all cases where such penalty is greater than 5 lakh rupees. With respect to disputed tax liabilities, the same shall not apply to liabilities in personal capacity of an individual. Contingent liabilities shall be as disclosed in books of accounts of the entity.

2.2. Modalities for filing of PPM through a Merchant Banker{4}

In terms of Regulation 12(2) of the AIF Regulations, AIFs shall launch scheme(s) subject to filing of PPM with SEBI through a SEBI registered Merchant Banker. In this context, the following is specified:

2.2.1. The Merchant Banker shall independently exercise due diligence of all the disclosures in the PPM, satisfy itself with respect to veracity and adequacy of the disclosures and provide a due diligence certificate. The format of due diligence certificate is given at Annexure 3.

2.2.2. While filing draft PPM at the time of registration or prior to launch of new scheme on the SEBI intermediary portal, the due diligence certificate provided by the Merchant Banker shall also be submitted, along with other necessary documents.

2.2.3. The details of the Merchant Banker shall be disclosed in the PPM.

2.2.4. The Merchant Banker appointed for filing of PPM shall not be an associate of the AIF, its sponsor, manager or trustee.

2.3. Validity of PPM - Timeline for declaration of First Close of schemes of AIFs{5}

In terms of Regulation 12(4) of AIF Regulations, the first close of the scheme shall be declared by an AIF in the manner as may be specified by SEBI from time to time. In this regard, the following is specified:

2.3.1. The First Close of a scheme shall be declared not later than 12 months from the date of SEBI communication for taking the PPM of the scheme on record.

2.3.2. In case of open ended schemes of Category III AIFs, the First Close shall refer to the close of their Initial Offer Period.

2.3.3. Corpus of the scheme at the time of declaring its First Close shall not be less than the minimum corpus specified in AIF Regulations for the respective category/sub-category of the AIF.

2.3.4.The commitment provided by sponsor or manager at the time of declaration of First Close, to the extent to meet the aforesaid minimum corpus requirement, shall not be reduced or withdrawn or transferred, post First Close.

2.3.5.The First Close of Large Value Fund for Accredited Investors (“LVF”) scheme shall be declared not later than 12 months from the date of grant of registration of the AIF or date of filing of PPM of scheme with SEBI, whichever is later.

2.3.6.In case the First Close of a scheme is not declared within the timeline specified above, the AIF shall file a fresh application for launch of the said scheme as per applicable provisions of AIF Regulations by paying requisite fee to SEBI.

2.4. Audit of terms of PPM{6}

2.4.1. In order to ensure compliance with the terms of PPM, it is mandatory for AIFs to carry out an annual audit of such compliance. The audit shall be carried out either by an internal or external auditor/legal professional. However, audit of sections of PPM relating to ‘Risk Factors’, ‘Legal, Regulatory and Tax Considerations’ and Track Record of First Time Managers’ shall be optional.

2.4.2. Audit of compliance with terms of PPM, shall be conducted at the end of each Financial Year and the findings of audit along with corrective steps, if any, shall be communicated to the Trustee or Board of Directors or Designated Partners of the AIF, Board of directors or Designated Partners of the Manager and SEBI, within 6 months from the end of the Financial Year.

2.4.3. The requirement of audit of compliance with terms of PPM shall not apply to AIFs which have not raised any funds from their investors. However, such AIFs shall submit a Certificate from a Chartered Accountant to the effect that no funds have been raised, within 6 months from the end of the Financial Year.

2.4.4. The requirements as mentioned at para 2.1.1, 2.1.3 and 2.4.1 above shall not apply to the following:

(i) Angel Funds as defined in AIF Regulations.

(ii) AIFs/Schemes in which each investor commits to a minimum capital contribution of 70 crore rupees (USD 10 million or equivalent, in case of capital commitment in non-INR currency) and also provides a waiver to the fund from the requirement of PPM in the SEBI specified template and annual audit of terms of PPM, in the manner provided at Annexure 4.

2.5. Changes in PPM{7}

2.5.1. At the time of submission of final placement memorandum to SEBI, any changes which have been made vis-a-vis the draft placement memorandum submitted to SEBI at the time of application shall be listed clearly in the covering letter. Further, the changes shall also be highlighted in the copy of the final placement memorandum.

2.5.2. Any changes in terms of PPM and in the documents of the fund/scheme shall be intimated to investors and SEBI on a consolidated basis, within 1 month of the end of each financial year. Such intimation shall specifically mention the changes carried-out in the PPM and the documents of the fund/scheme, along with the relevant pages of revised sections/clauses{8}.

2.5.3. Such intimation to SEBI for changes in terms of PPM shall be submitted through a Merchant Banker, along with the due diligence certificate provided by the Merchant Banker. The format of due diligence certificate for intimating the changes in the placement memorandum is given at Annexure 5. The Merchant Banker appointed for filing of PPM shall not be an associate of the AIF, its sponsor, manager or trustee{9}.

2.5.4. ‘Material changes’ may be construed as changes in the fundamental attributes of the fund/scheme. In case of material changes significantly influencing the decision of the investor to continue to be invested in the AIF, the process as mentioned hereunder shall be complied with. Such changes shall include, but not be limited to the following:

(a) Change in sponsor/manager (not including an internal restructuring within the group),

(b) Change in control of sponsor/manager,

(c) Change in fee structure or hurdle rate which may result in higher fees being charged to the unit holders.

The following process shall be followed by the AIF:

(i) Existing unit holders who do not wish to continue post the change shall be provided an exit option. The unit holders shall be provided not less than one month for expressing their dissent.

(ii) In case of open-ended schemes of the AIF, the exit option may be provided by either of the following:

A. Buying out of units of the dissenting investors by the manager/ any other person as may be arranged by the manager, valuation of which shall be based on market price of underlying assets.

B. Redemption of units of the investors through sale of underlying assets.

(iii) In case of close-ended schemes of the AIF, the exit option may be provided as under:

A. The exit option shall be provided by buying out of units of the dissenting investors by the manager/ any other person as may be arranged by the manager.

B. Prior to buying out of such units, valuation of the units shall be undertaken by two independent valuers and the exit shall be at value not less than average of the two valuations.

(iv) The responsibility to provide exit to the dissenting investors shall be on the manager. The expenses for the entire process shall be borne by the manager/sponsor/proposed new manager or sponsor and shall not be charged to the unit holders.

(v) The entire process of exit to dissenting investors shall be completed within 3 months from the date of expiry of last date of the offer for dissent.

(vi) The trustee of AIF (in case AIF is a trust)/ sponsor (in case of any other AIF) shall be responsible for overseeing the process, ensuring compliance and regularly updating SEBI on the developments.

2.5.5. With respect to para 2.5.4 above, the process for exit under the clause shall not apply in cases where the AIF has approval of not less than 75% of unit holders by value of their investment in the AIF with respect to sub-clauses (a) and (b).

Note:-

{2}SEBI Circular No. SEBI/HO/IMD/DF6/CIR/P/2020/24 dated February 05, 2020

{3}SEBI circular No. CIR/IMD/DF/14/2014 dated June 19, 2014 and SEBI Circular No. CIR/IMD/DF/16/2014 dated July 18, 2014

{4}SEBI Circular No. SEBI/HO/IMD/IMD-I/DF6/P/CIR/2021/645 dated October 21, 2021

{5}SEBI circular No. SEBI/HO/AFD-1/PoD/P/CIR/2022/155 dated November 17, 2022

{6}SEBI Circular No. SEBI/HO/IMD/DF6/CIR/P/2020/24 dated February 05, 2020 and SEBI Circular No. SEBI/HO/IMD/DF6/CIR/P/2020/99 dated June 12, 2020

{7}SEBI circular No. CIR/IMD/DF/14/2014 dated June 19, 2014, SEBI Circular No. CIR/IMD/DF/16/2014 dated July 18, 2014

{8}SEBI circular No. SEBI/HO/IMD/IMD-I/DOF6/CIR/2Q21/549 dated April 07, 2021

{9}SEBI Circular No. SEBI/HO/IMD/IMD-I/DF6/P/CIR/2021/645 dated October 21, 2021