Equal trail basis

A distributor who is paid everything in year one has no reason to care about year five. That is the problem this rule attacks.

On an equal trail basis means the distribution or placement fee is spread evenly over the life of the investment, instead of being taken at the start. The workbook puts it as a prohibition: no upfront distribution fee or placement fee shall be charged, directly or indirectly.

There is a second limb, and it is the sharper one. Any such fee that is paid must come only out of the management fee the manager receives. The fund does not pay it on top. The manager funds it from its own income.

The rule applies to Category III AIFs. It sits inside a wider framework for AIF distribution commissions, which also decides when an investor must be on-boarded with no commission at all.

Where it sits. Chapter 9, section 9.7.3 (Agreement with Distributor), reproducing the SEBI circular dated 10 April 2023 on distribution and placement commissions for AIF products. The framework has three limbs:

1. The Direct Plan limb. Investors who approach the AIF through a SEBI-registered intermediary that is separately charging the investor a fee — an advisory fee or a portfolio management fee — must be on-boarded via Direct Plan only, which involves no payment of commissions. The logic is no double-dipping: if the investor already pays the intermediary, the fund does not pay it as well.
2. The disclosure limb. In all other cases, the AIF discloses the distribution fee or placement fee, if any, to investors at the time of on-boarding.
3. The equal trail limb. Category III AIFs shall charge distribution or placement fee, if any, only on equal trail basis — no upfront fee, directly or indirectly — and any such fee paid shall be only from the management fee received by the managers of such Category III AIFs.

What the distribution agreement carries around it. The agreement is between the Investment Manager and the distributor. It defines the distributor's role and prescribes a Code of Conduct, and the workbook lists covenants a distributor gives:

• no statement or act altering, adding to, modifying or erasing any marketing literature or document issued or provided by the Investment Manager, or filled in by an investor;
• no debt or liability incurred on the Investment Manager's behalf without specific written authority;
• reasonable endeavours to attend the Manager's seminars, meetings and training sessions; and
• no rebate of any amount offered, directly or indirectly, as an inducement to buy, redeem or transact units.

The agreement also fixes the commercial arrangement, the marketing support, the representations and warranties, and usually the products or geography it covers.

The two words that carry the weight. Equal rules out a front-loaded trail dressed up as a trail. Only from the management fee rules out routing the same money through the fund as an expense.

The fund, the fee rates and the amounts are illustrative; the prohibition, the source-of-payment rule and the Direct Plan rule are the workbook's.

Meridian Absolute Return Fund is a Category III AIF. An investor, Mrs Nandini Rao, commits Rs 10 crore for a 5-year term through a distributor. The manager charges a 2% management fee and agrees a 1% distribution fee.

What is barred. Paying the distributor the whole five years of fee in year one:

1% x Rs 10 crore x 5 years = Rs 50 lakh paid upfront   ->  NOT PERMITTED

No upfront distribution or placement fee may be charged, directly or indirectly, by a Category III AIF.

What is permitted. The same Rs 50 lakh spread evenly:

Notice the last column. The trail is not an extra Rs 10 lakh charged to the fund. It comes out of the manager's Rs 20 lakh, leaving the manager Rs 10 lakh. Mrs Rao's cost is the 2% management fee, whether or not a distributor was involved.

Now change the route. Suppose Mrs Rao came to the fund through a SEBI-registered investment adviser who already charges her an advisory fee. She must then be on-boarded via Direct Plan only — no commission at all, so the whole Rs 20 lakh a year stays with the manager and no trail is paid.

And a Category II fund. Limbs 1 and 2 still apply, but the equal trail prohibition in limb 3 is written for Category III AIFs.

Chapter 9, section 9.7.3 (Agreement with Distributor) carries the SEBI circular of 10 April 2023 as a short numbered list, which is exactly the shape of an examinable rule. The PPM audit scope in section 9.5.2 also requires a review of the distributions and additional return charged to the investors, so the fee framework surfaces again there.

Expect: the phrase equal trail basis and what it excludes (any upfront fee, directly or indirectly), which category the equal trail rule names (Category III), where the fee must come from (the management fee received by the manager), and when an investor must go Direct Plan only (arriving through a SEBI-registered intermediary that is separately charging the investor a fee).

• Two conditions, not one. Equal trail and paid only out of the management fee. A trail paid as a fund expense breaches the rule even if it is perfectly even.
• The equal trail limb names Category III AIFs. The Direct Plan and disclosure limbs are written for AIFs generally.
• Direct Plan is triggered by the intermediary charging the investor, not by the investor asking. If a SEBI-registered intermediary is separately charging an advisory or portfolio management fee, the on-boarding must be Direct Plan with no commission.
• "Directly or indirectly" closes the side doors. An upfronted trail, a one-time marketing support payment or a sponsorship in place of commission is still an upfront fee.
• Disclosure is at on-boarding, not in the first annual report.
• The no-rebate covenant is about the investor, not the distributor. A distributor may not pass back any amount as an inducement to transact.
• Do not import the mutual fund rule. Full trail model is SEBI's equivalent prohibition for mutual fund distributors, written from a different paper. The AIF rule is narrower in scope and adds the source-of-payment condition.