Chapter 11: Governance of Funds and Due Diligence — Short Notes (Part Two: Regulation on Governance Structure in AIFs)

This is Part Two of the comprehensive study notes for Chapter 11: Governance of Funds and Due Diligence, focusing exclusively on Section 11.3 (Regulation on Governance Structure in AIFs). This section covers the regulatory frameworks governing fund administration, Investment Committees, investor grievance redressal (SCORES), Online Dispute Resolution (ODR), and Cyber Security.

11.3 Regulation on Governance Structure in AIFs

11.3.1 Fund Governance Framework

In a trust-based Alternative Investment Fund (AIF) structure, the governance architecture is centered around three primary pillars:

1. The AIF Trust
2. The Investment Management Company (the Asset Management Company or AMC / Investment Manager)
3. The Trustee

The Board of Directors of the AMC is entrusted with the overall supervision and oversight of the investment management functions of the AIF trust. Conversely, the Trustee is responsible for the overall administration of the trust's affairs.

The respective investment functions, responsibilities, and fiduciary obligations of both the investment manager and the trustee are spelt out in:

• The Trust Deed (or Indenture of Trust).
• The Investment Management Agreement (IMA).
• Relevant regulatory provisions of the SEBI (Alternative Investment Funds) Regulations, 2012.

11.3.2 The Investment Committee (IC): Constitution, Roles & Approvals

An AIF's investment proposals are prepared by the investment team of the fund management office and put up to the Investment Committee (or the manager) for in-principle and final screening and recommendations.

Contents of an Investment Proposal

Each proposal submitted to the committee typically contains detailed, structured information about the target investee company:

• Executive Summary: Details of the proposed transaction, background, overall deal mechanics, team recommendation, and the core investment thesis.
• Company Overview: History, business description, products and applications, key customers, suppliers, competitors, organizational structure, and biographies of the management team.

Responsibilities of the Investment Committee (IC)

The Sponsor or Investment Manager of an AIF may constitute an Investment Committee (IC) to approve the investment decisions of the fund, subject to strict regulatory conditions:

• Regulatory Responsibility: The members of the Investment Committee are jointly and severally responsible for the decisions taken by the committee.
• Compliance Compliance: The IC members must ensure that all decisions taken comply with the SEBI (Alternative Investment Funds) Regulations.
• Note on Large Value Funds (LVFs): Under SEBI guidelines, the specific liabilities of members of an Investment Committee set up by a "Large Value Fund for Accredited Investors" (LVF) follow separate relaxed standards, though the complete details of these exceptions are not fully detailed in the current workbook passages.

11.3.3 Grievance Redressal Mechanism (SCORES Platform)

SEBI enforces a strict dual-review mechanism for resolving investor complaints against AIFs using its centralized electronic portal, SCORES (SEBI COmplaints Redress System).

Step 1: First Review & Action Taken Report (ATR)

• Upon receipt of an investor complaint, the Designated Body for AIFs initiates the first review and seeks clarifications from the AIF manager on the Action Taken Report (ATR).
• The Designated Body is required to upload the finalized ATR on the SCORES platform within 10 days, which is then automatically routed to the complaining investor.

Step 2: Second Review & SEBI Intervention

• If the investor is unsatisfied with the designated body's resolution, they can request a second review within 15 calendar days of receiving the revised ATR.
• SEBI Direct Cognizance: SEBI will step in and directly take cognizance of the complaint for a second review if:
  1. The investor remains unsatisfied with the initial ATR.
  2. The ATR submission faces a delay of more than 10 calendar days.
• Upon SEBI's intervention, the AIF must promptly submit a revised ATR directly to SEBI on the SCORES platform within the specific timeline mandated by the regulator.
• Resolution Status: A complaint is officially treated as "resolved", "disposed", or "closed" only when SEBI formally changes the status to disposed or closed on the SCORES portal.

11.3.4 Online Dispute Resolution (ODR) Portal

As an alternative to SCORES or conventional civil litigation, investors can opt for the Online Dispute Resolution (ODR) route to resolve grievances.

• Platform Creation: Market Infrastructure Institutions (MIIs) are responsible for setting up and operating the ODR Portal.
• Mandatory Enrolment: It is compulsory for all AIFs to enrol on the ODR Portal and implement the associated dispute resolution processes.
• Enrolment Protocol: AIFs execute electronic terms and agreements with MIIs and ODR Institutions using their existing credentials from the SEBI SCORES portal or the SEBI Intermediary portal.
• Public Disclosure: AIFs must prominently display a link to the ODR portal on their official websites or trading platforms.
• Common ODR Grievances: Common issues resolved through this platform include contact persons being unavailable, demat accounts being transferred without authorization, and related administrative disputes.

11.3.5 Cyber Security and Cyber Resilience Framework (CSCRF)

Given the rapid technological advancements in securities markets, SEBI has implemented a robust Cyber Security and Cyber Resilience Framework (CSCRF) to secure critical data and protect investor privacy.

• Joint Compliance Responsibility: The Investment Manager, the Trustee, and key management personnel are jointly responsible for maintaining compliance with SEBI's operational risk and cybersecurity policies.
• Graded Approach: The framework applies a graded system, classifying SEBI Regulated Entities (REs) into five distinct categories.
• AUM Determination: The categorization of an AIF is decided at the beginning of each financial year, based on the Assets Under Management (AUM) recorded in the previous financial year.

Graded Categorisation of Regulated Entities (REs) Under CSCRF

Key Terms & Exam-Relevant Definitions

• Designated Body (for AIFs): An intermediary or regulatory division assigned to conduct the first-level review of investor complaints, interface with the AIF manager, and upload Action Taken Reports (ATRs) on SCORES.
• Action Taken Report (ATR): A formal document filed by the AIF manager outlining the specific steps and remedies implemented to resolve an investor grievance.
• SCORES: SEBI COmplaints Redress System; an online platform for investors to lodge, track, and seek redressal for complaints against listed companies and registered intermediaries.
• ODR Portal: Online Dispute Resolution Portal; a platform established by Market Infrastructure Institutions (MIIs) to resolve disputes between investors and AIFs via electronic arbitration or mediation.
• CSCRF: Cyber Security and Cyber Resilience Framework; SEBI's graded regulatory standard designed to protect regulated entities from cyber threats, data breaches, and system outages.

Key Takeaways

1. Dual Board-Trustee Governance: The AMC Board oversees the investment manager's functions, while the Trustee maintains administrative control of the AIF trust.
2. Joint and Several IC Liability: Members of the Investment Committee (IC) bear joint and several liability for ensuring all fund investment decisions strictly comply with SEBI (AIF) Regulations.
3. Strict ATR Timelines: AIFs must coordinate with the Designated Body to upload ATRs on SCORES within 10 days of receiving a complaint. Delayed ATRs (beyond 10 days) trigger direct SEBI intervention.
4. Mandatory ODR Integration: Enrolment on the electronic ODR portal is mandatory for all AIFs, and a portal link must be clearly displayed on their digital platforms.
5. Graded CSCRF Standards: Graded cybersecurity requirements apply based on fund size, with AIF schemes holding Rs. 1000 crore or more in AUM classified as "Qualified REs" subject to the highest security audits.