Inside SEBI’s Audit Lens: How AIFs Can Stay Audit-Ready
What fund managers must know to stay audit-ready.
India's Alternative Investment Fund (AIF) ecosystem has matured significantly in recent years in terms of capital flow and regulatory oversight. As the sector grows, so too does the attention of the Securities and Exchange Board of India (SEBI), which has sharpened its focus on compliance, transparency, and investor protection. For AIF managers, the stakes are rising - regulatory scrutiny is no longer episodic but structural.
In this environment, understanding how to prepare for a SEBI audit is about operational hygiene. Drawing on recent reports and insights from regulatory bodies and top advisory firms, this article outlines the most common audit triggers, areas of non-compliance, and actionable steps AIF managers can take to ensure their fund is audit-ready.
SEBI’s Evolving Audit Framework for AIFs
SEBI’s 2022–23 Annual Report provides a detailed account of its audit and enforcement activities. The regulator has moved from a compliance-by-certification model to an active inspection framework.
According to SEBI, audits now pay particular attention to areas such as:
Valuation methodologies and disclosures
Co-investment practices and preferential treatment
Fund expenses and fee structures
Related-party transactions and side agreements
Investor reporting and risk disclosures
The transition from passive monitoring to active surveillance signals that SEBI is looking at is not only compliance on paper, but also at the spirit of the law. This places an onus on fund managers to ensure their processes are aligned with both the regulatory text and intent.
Where Funds Commonly Go Wrong
Reports from KPMG, PwC India, and top legal firms such as AZB & Partners and Trilegal have highlighted recurring compliance gaps observed during SEBI audits. These include:
Valuation inconsistencies: In several instances, fund managers lacked documented, independent valuation policies or failed to provide adequate disclosures to investors.
Unclear co-investment terms: SEBI has flagged concerns where co-investment arrangements were not offered equitably to all eligible investors, leading to questions of transparency and fairness.
Side letters and preferential terms: Selective disclosures or arrangements with certain LPs can raise red flags if they are not consistently disclosed or aligned with fund documents.
Sponsor commitments: Inadequate sponsor skin-in-the-game, or lack of clarity around sponsor obligations often creates governance friction.
Delayed reporting: Timeliness in providing quarterly reports, financials, and material updates remains a concern, especially in offshore or multi-layered structures.
These findings highlight the importance of embedding compliance into the fund’s DNA rather than treating it as a formality to be managed when audits arise.
Legal and Operational Implications of Non-Compliance
Non-compliance during a SEBI inspection can result in more than just reputational damage. The legal and operational consequences may include:
Regulatory censure and penalties
Restrictions on future fundraising rounds
Mandated restructuring of fund documents or governance processes
Loss of LP confidence, particularly among institutional investors
Moreover, ongoing SEBI inspections and follow-up actions can be time-consuming and resource-draining for internal teams. Proactive audit readiness can help fund managers avoid disruption, build trust, and improve long-term fund performance.
How AIF Managers Can Prepare for SEBI Inspections
Based on current regulatory trends and advisory firm insights, fund managers should implement the following practices to prepare for regulatory scrutiny:
1. Build a Robust Compliance Function
Invest in a dedicated compliance team or an external compliance advisory. Ensure the function is empowered to act independently and has visibility into all fund operations, including investment, reporting, and investor relations.
2. Standardise Documentation and Internal Policies
Ensure valuation policies, co-investment rights, related-party transactions, and expense allocations are clearly documented and aligned with fund agreements. Avoid informal arrangements or discretionary deviations that could raise questions.
3. Review and Test Reporting Processes
Conduct internal reviews of quarterly and annual investor reporting. Ensure that disclosures are complete, timely, and consistent across all investor classes. Automate where possible to minimise errors.
4. Establish a Side Letter Register
Maintain a centralised record of all side letters, along with a framework to track consistency of terms and disclosures. This transparency mitigates the risk of regulatory surprise and LP backlash.
5. Proactively Engage with Legal Counsel
Ensure all fund activities, restructurings, and capital calls are vetted through legal counsel familiar with AIF regulations. Establish a quarterly check-in rhythm even outside audit cycles.
Sector Signals- Why Scrutiny Is Likely to Increase
As the AIF segment crosses new fundraising milestones, regulators are focusing on systemic risk. The SEBI Chairperson’s recent public remarks have consistently emphasised the regulator’s commitment to investor protection and transparency within private capital structures.
Coupled with global best practices and cross-border regulatory coordination, AIFs operating in India can expect higher disclosure expectations, more frequent inspections, and tighter enforcement in areas such as ESG claims, co-investment disclosures, and offshore feeder structures.
A notable observation from PwC’s analysis is that funds prepared for SEBI audits tend to demonstrate higher levels of LP confidence and investor retention. Regulatory readiness is not merely defensive; it is also a signalling tool in a competitive fundraising environment.
Conclusion
The message from regulators is clear- as AIFs scale, they must mature in compliance. Regulatory audits are no longer reactive; they have become proactive tools for ensuring market integrity.
Fund managers who approach compliance as a leadership function, integrating legal, operational, and investor-aligned practices, stand to benefit not only through smoother audits but also through stronger relationships with LPs, improved governance, and long-term brand credibility. Being audit-ready is a continuous process of aligning ambition with accountability.