2025 (11) TMI 203 - Board - SEBI

Registrant barred seven years, AIF registration cancelled for failing fit-and-proper test and holding over 20% beyond six months

SEBI found the registrant failed the 'fit and proper' tests under the AIF and Intermediaries Regulations, having retained over 20% in the AIF ... Eligibility conditions for grant of Alternative Investment Funds (AIF) registration - failure to fulfill the criteria of ‘fit and proper person’ - violated the provisions of Regulation 4(f), 7(1)(a) and 35 of AIF Regulations read with Regulation 9, Clause 2, 3, 6 and 7 of Schedule II of the Intermediaries Regulations - Cancellation of the certificate of registration of Karvy Stock Broking Limited (“KSBL”) as a Stock Broker - Whether the Noticee(s) satisfy the ‘fit and proper person’ criteria as provided under the provisions of AIF Regulations read with Intermediaries Regulations. Accessing the securities market and prohibited from buying, selling or otherwise dealing in securities (including units of mutual funds), directly or indirectly, or being associated with the securities market in any manner whatsoever, for a period of seven (7) years. HELD THAT:- In the instant case, as KSBL is holding more than 20% in Karvy Capital Limited (Manager and Sponsor of Karvy AIFs) and being not ‘fit and proper person’ was required to divest its holding within 6 months from the date of its disqualification. I find that KSBL has failed to divest its holding in Karvy Capital Limited. Accordingly, the Noticee(s) no longer satisfy the ‘fit and proper person’ criteria in terms of the provisions of Regulation 4(f), 7(1)(a) and 35 of AIF Regulations read with Regulation 9, Clause 2, 3, 6 and 7 of Schedule II of Intermediaries Regulations. As a regulator of the capital markets, SEBI has the duty to safeguard the interest of investors and protect the integrity of the securities market. The 'fit and proper person’ criteria aim to uphold market integrity by ensuring that only individuals and entities with a clean track record and sound financial standing can operate as intermediaries. Allowing Noticee(s) who are not ‘fit and proper person’ to continue would leave the door open for future fund raising exercise and other possible misuse of SEBI registration which is not in the interest of the securities market. Therefore, I find no reason to disagree with the recommendation given by the DA in the Enquiry Report. Thus, hereby, cancel the certificate of registration granted to the Noticee(s) viz. Karvy Capital Alternative Investment Trust and KCAP Alternative Investment Fund. ISSUES PRESENTED AND CONSIDERED 1. Whether the Noticees satisfy the 'fit and proper person' criteria under Regulation 4(f) of the AIF Regulations read with Schedule II of the Intermediaries Regulations during the continuity of registration. 2. Whether disqualification of a promoter/controlling shareholder (by way of restraint/prohibition/cancellation of registration) attracts the specific disqualification in Clause 3(b)(iii) of Schedule II and mandates divestment under Clause 6, and if failure to divest justifies invocation of the 'fit and proper' criteria against the intermediary. 3. Whether the existence of board resolutions to surrender registrations and representations of 'no funds raised/no investors' materially affect the determination on continuing non-compliance with the 'fit and proper person' criteria and the appropriateness of cancelling the Noticees' certificates of registration. ISSUE-WISE DETAILED ANALYSIS Issue 1: Continuing application of the 'fit and proper person' criteria to Noticees Legal framework: Regulation 4(f) of the AIF Regulations requires Applicant, Sponsor and Manager to be 'fit and proper persons' as per Schedule II of the Intermediaries Regulations. Clause 7 of Schedule II declares the criteria applicable at application and during continuity of registration. Precedent Treatment: No judicial or prior precedent was cited or applied in the proceedings; determination proceeded on statutory text and regulatory policy. Interpretation and reasoning: The Court treated 'fit and proper' as an ongoing eligibility requirement. The text of Schedule II(7) was read to impose a continuous obligation on intermediaries to ensure persons in clauses 2(b) and 2(c) comply at all times. The Court noted that regulatory restraint/prohibition orders are expressly included among disqualifying events in Clause 3(b)(iii), and therefore an intermediary's continuing compliance must be assessed in light of any such disqualification that affects persons holding controlling interest. Ratio vs. Obiter: Ratio - the holding that 'fit and proper' is a continuing criterion and must be satisfied throughout the continuity of registration, and that the intermediary bears the duty to ensure compliance by its promoters/controllers. Conclusion: The Noticees failed to satisfy the continuing 'fit and proper' requirement because a disqualification of their promoter/controlling shareholder existed and remedial measures required by the regulations were not effected within prescribed timelines. Issue 2: Effect of promoter/control-entity disqualification and mandatory divestment obligations Legal framework: Schedule II(2)(c) extends the 'fit and proper' test to promoters/controlling persons; Clause 3(b)(iii) lists restraint/prohibition/debarment orders as disqualifying; Clause 6 prescribes that disqualification of such persons requires either replacement (if person is in clause 2(b)) or prevention of voting rights and divestment within six months (if person is in clause 2(c)), failing which the 'fit and proper' criteria may be invoked against the intermediary. Precedent Treatment: No prior authority was relied upon or distinguished; statutory scheme alone guided the decision. Interpretation and reasoning: The Court interpreted Clause 3(b)(iii) to encompass cancellation or restraint orders by SEBI against the promoter/controlling entity. Given that the promoter held more than 20% voting rights (an unlisted entity), the promoter's disqualification activated the divestment/cessation obligation under Clause 6. The Court emphasised that the regulatory duty to divest within six months is mandatory and that inability to divest for reasons such as ongoing regulatory proceedings does not waive the intermediary's obligation to ensure compliance. Ratio vs. Obiter: Ratio - a promoter's disqualification under Clause 3(b)(iii) triggers the divestment / voting restriction obligations under Clause 6, and failure to comply permits invocation of the 'fit and proper' criteria against the intermediary leading to regulatory action including cancellation. Conclusion: The promoter/controlling shareholder's disqualification applied to the Manager/Sponsor; the promoter held requisite voting rights; the promoter did not divest within six months; consequently the intermediary ceases to satisfy the statutory 'fit and proper' requirements. Issue 3: Relevance of surrender resolutions and assertion of 'no funds/no investors' to the cancellation decision Legal framework: Regulation 7(1)(a) of the AIF Regulations requires the AIF to abide by the Act and regulations; Regulation 35 indicates remedial action where an AIF contravenes provisions. Schedule II imposes the continuous 'fit and proper' requirement irrespective of fundraising status. Precedent Treatment: No authority was cited that creates an exception to the statutory obligations on account of surrender intentions or lack of funds. Interpretation and reasoning: The Court acknowledged submissions that the Board had passed a resolution to surrender registrations and that no funds had been raised and no investors existed. Nevertheless, it concluded that surrender resolutions and absence of active schemes do not cure the statutory non-compliance where a promoter/controlling person remains disqualified and has not divested as required. The regulator's duty to protect investor interest and market integrity was held to justify preventive measures even where current fundraising is absent, because continued registration presents the potential for future misuse. Ratio vs. Obiter: Ratio - surrender resolutions and no-funds assertions do not negate the statutory requirement to ensure continuous satisfaction of the 'fit and proper' criteria, nor do they preclude the regulator from cancelling certificates where disqualification persists and remedial divestment has not occurred. Conclusion: The Noticees' board resolution to surrender registrations and representations of no funds/no investors were insufficient to override the statutory non-compliance; cancellation remained appropriate to prevent future risk to market integrity. Remedial measure and conclusion on regulatory action Legal framework: The competent authority may take actions recommended by the Designated Authority under the Intermediaries Regulations, including cancellation under Regulation 26(1)(ii) when in the interest of the securities market and protection of investors. Interpretation and reasoning: Having accepted the DA's findings and noting the Noticees' agreement to the DA's recommendation, the Court proceeded on the record to cancel the certificates. The decision was grounded in statutory text, the promoter's in-force disqualification, failure to comply with divestment mandates, and the regulator's duty to safeguard market integrity. Ratio vs. Obiter: Ratio - cancellation of the intermediary's registration is a permissible and appropriate regulatory measure where statutory 'fit and proper' prerequisites are not met continuously and requisite remedial steps (e.g., divestment) are not taken. Conclusion: The competent authority's cancellation of the Noticees' certificates of registration was upheld as justified and necessary in furtherance of investor protection and orderly market functioning; the order operates with immediate effect. Cross-reference: conclusions on Issues 1-3 collectively underpin the cancellation decision.