Fit and proper person

Before SEBI asks whether a fund is competent, it asks whether the people behind it are fit to be trusted with other people's money. That question has a formal name and a written test.

The sponsor — the person or persons who set up the AIF, including the promoter of a company or the designated partner of an LLP — must satisfy the requirements of a fit and proper person under the criteria in Schedule II of the SEBI (Intermediaries) Regulations, 2008. So must the manager, the entity appointed by the sponsor to manage the fund's investments.

It is not a one-off. It is a standing condition, which is why any change in the sponsor or designated partner must be informed to SEBI, and a change in control of the AIF or of the investment management company needs SEBI's prior approval.

SEBI may take account of any consideration it deems fit, including but not limited to:

(a) The positive limb — integrity, honesty, ethical behaviour, reputation, fairness and character of the person.

(b) The negative limb — the person not having any of the following disqualifications:

• a criminal complaint or charge sheet filed against the person and pending;
• an order of restraint, prohibition or debarment passed against the person, or recovery proceedings initiated and pending;
• the person having been declared insolvent or categorised as a wilful defaulter;
• the person having been found to be of unsound mind by a court of competent jurisdiction, where that finding is in force.

Note how low the bar for disqualification sits on the first two. A charge sheet filed and pending is enough — there is no requirement of conviction. Recovery proceedings initiated and pending are enough. The test is about present suitability to hold a registration, not about guilt.

The same standard runs through the registration decision. Among the conditions SEBI applies when granting an AIF registration is that the applicant, sponsor and manager are fit and proper persons based on these criteria, and applicants must be fit and proper to participate in the securities market.

The trustee is held to a related but separately worded standard: a person of ability and integrity, not guilty of moral turpitude, any economic offence or violation of any securities law — and the trustee cannot be the manager, director (including independent director), officer or employee of an investment company.

Three sponsors apply to register a Category II AIF with a target corpus of Rs 750 crore.

Sponsor A's position is the one candidates get wrong. He has been convicted of nothing. The test is not "has he been convicted" but "is a criminal complaint or charge sheet filed and pending", and it is.

Assume the fund is registered with sponsors B and D, with B holding the sponsor commitment. Eighteen months later, B sells its holding in the investment management company to a listed NBFC. That is a change in control of the investment manager, so prior approval from SEBI is required before investment activities may be carried on — the fund cannot simply intimate the change after the fact, and the incoming controller must itself clear the fit and proper test.

Chapter 3 (Concepts in the Alternative Investment Funds Industry) sets out the criteria in full at 3.1.2 while describing the sponsor, and applies the same test to the investment manager at 3.1.4. Chapter 4 repeats it as a registration condition. Expect a question listing four circumstances and asking which one does not disqualify, and a question on whether a change requires intimation to SEBI or prior approval — change of sponsor or designated partner is intimation; change in control is prior approval.

• A pending charge sheet disqualifies. Conviction is not required. This is the single most common trap on the topic.
• The criteria live in Schedule II of the SEBI (Intermediaries) Regulations, 2008, not in the AIF Regulations. The AIF Regulations borrow them.
• Sponsor and manager are both tested; so, in substance, is anyone taking control of either.
• Intimation versus prior approval. A change in sponsor or designated partner is intimated to SEBI. A change in control of the AIF, the sponsor or the investment manager needs prior approval.
• The list is inclusive, not exhaustive. SEBI "may take account of any consideration as it deems fit" — clearing the four disqualifications does not guarantee the person is fit and proper.
• The trustee's standard is worded differently — ability, integrity, no moral turpitude, no economic offence, no securities law violation — and adds the independence bar against being the manager or an officer of an investment company.