How can SEBI curb insider trading?

While SEBI’s action against the deemed front running operation carried out by Axis Mutual Fund dealer Viresh Joshi is commendable and welcome, the complex nature of the operations suggests that the hold was more accidental than inevitable. This represents only a sample of what is probably a large tribe of fund managers and others who misappropriate price-sensitive information before it reaches the public.

Unpublished price-sensitive information (UPSI) is a major obstacle to fairness and scrutiny in the functioning of the stock and bond markets. People who have access to information that can move the price of a stock or bond – so-called insiders – can use it for their own financial gain. This is unfair to investors who do not have access to such undisclosed information.

Suppose Company A decides to acquire Company B at a substantial premium to B’s current market price. People in the know, key employees of A, or its investment bankers or lawyers, may be tempted to hoard B’s shares, which will rise after the takeover is announced and make a killing. This is just one example of insider trading.

Key personnel of mutual funds and pension funds are aware of their fund mandates. They can ‘run ahead’ of the fund as it moves to execute the buy/sell decision, making similar purchases in their personal capacity and benefiting from price changes affected by the fund’s larger transactions. This is known as front-running.

Fund managers can also use the funds in other ways for their personal gains. They may buy funds already in their personal portfolios to increase their value, or hold or delay the sale of such stocks to prevent their value from falling (this is called scalping). These generate thin profit margins because front-runners and scalpers must enter and exit the stock over a short period of time before other factors come into play and change the price dynamics.

Illegal gains slightly overstated in the case of Axis Mutual Fund dealer and his associates 35 crores. But to get these benefits, the mutual fund may have to suffer huge losses. Savvy investors who keenly watch trades made by those they identify as front-runners can add to the volume of trades, which can lead to price changes that partially offset the planned gains for the fund. can be neutralized by

SEBI’s investigation into Viresh Joshi’s conduct revealed a complex web of ‘managers’ and ‘supporters’ who provided various types of demat accounts for the alleged front-running. Ownership of these accounts is distributed among their friends, parents, spouses, siblings and in-laws, and is spread across geographies that extend from the Arabian Sea to Dubai. The investigation revealed surnames such as ‘Sorcerer’ and ‘Asadfag’.

SEBI whole-time member SK Mohanty’s order reads like a script for a Netflix crime thriller, taking not only names but also call records, identification of call locations using cell phone towers, matching KYC details of phone numbers, disparate- Contains separate client identification module. The revelation emails misspelled the recipient email addresses of some parts of the country, informants, regulators, and controlling managers at Axis, suggesting blackmail rather than any intention to expose.

It is not clear that the complex web of deceit and treachery can be easily replicated. There are two other ways to uncover and stop such abusive personal trading by key personnel of funds.

One is for an asset management company to monitor earnings from securities booked by its employees and their relatives. Unusually attractive accounts will be worthy of further investigation.

Another is to analyze, using algorithms, trading patterns in the temporal vicinity of major trades by money. One-off instances of scaling or front running may escape attention, but any continuous activity will create patterns that analytics should be able to pick up on.

The best bet is to use the consent scale to consolidate a person’s diverse financial activities and present an overall picture. For that, operators in the financial markets would need to consent to having their data identified and audited.

The technical support is there to complement the kind of snooping that was done in SEBI’s action against Viresh Joshi and his associates. It should be put to good use.

A final resort would be to make the funds accountable for the activity of their personnel, and subject them to penalties exceeding three times the illegal earnings that SEBI collects from those found guilty of front-running. This would encourage funds to more closely monitor the conduct of their employees.