Auditors Ask PE, VC Funds for reports on Due Diligence

The market regulator’s recent rules that require alternative investment funds to conduct in-depth due diligence of their portfolio companies have put them at loggerheads with their auditors.

According to the Securities and Exchange Board of India (Alternative Investment Funds) (Second Amendment) Regulations, 2021, which came into effect on May 5, the regulator has mandated that fund managers conduct this due diligence to make sure their house is in order.
The statutory auditors want AIFs to follow the regulator and not just undertake a “tick box” approach.

The fund managers and trustees will have to ensure that detailed policies and procedures are in place for investments and that provisions over confidentiality, conflict of interest, Prevention of Money Laundering Act (PMLA) and addressing investor complaints are complied with, said Yashesh Ashar, a partner at tax and regulatory advisory firm Bhuta Shah & Co.
“The policies have to be approved, followed and kept up to date. The auditors of the PPM (private placement memorandum) will be required to check on the detailed policy and procedures as well as the compliance with the code of conduct prescribed under the newly added fourth schedule. The format for reporting requirements to Sebi and trustees could also undergo a change,” Ashar added.

People in the know said while most funds undertake these exercises, the new regulations would likely require them to share the report or the procedures with the auditors.
The due diligence will have to be undertaken at the fund level as well as the investment level.

Auditors are demanding that fund managers inform them how they are making sure that there is no money laundering, conflict of interest or siphoning of funds happening amid the Covid-19 pandemic, said people in the know.
The Sebi regulations are aimed at providing transparency to investors.

The regulations mainly impact the private equity and venture capital funds that are registered under the Alternative Investment Funds Categories 1 & 2 and hedge funds registered under the AIF Category 3 in India.

In some cases, the fund managers may have to conduct full-fledged investigations where red flags are realised by an insider or a whistleblower.

Fund managers will also have to realign investments to comply with the new regulations, as Sebi has put a threshold on the money a fund can invest in a company or another investment vehicle, as ET reported on May 10.S-ET

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