In recent times, India’s mutual fund industry has been hit by several allegations of front-running. The Securities and Exchange Board of India (SEBI) has taken action in three cases, including the ongoing investigation of Axis Mutual Fund. Mint investigates the crisis.
What has SEBI discovered now?
Front-running is a market malpractice where a dealer, trader or fund manager who is aware of a large upcoming share purchase order, buys the same shares in bulk in advance. Such bulk orders drive up the share price. In Fidelity Group, 68 instances of front-running were detected in Infosys, Power Grid, PNB Housing and Axis Bank stocks. In the India Infoline (IIFL) group, it was in shares of Kansai Nerolac Paints Limited, Tata Global and Siemens Limited. Entities found involved in front running have been barred from the markets for 2-5 years, asked to return their profits. and pay the monetary penalty.
What was the modus operandi?
At Fidelity International, Vaibhav Dhadda, a businessman and now a former employee, used to inform his wife and mother of fund purchases, and use their accounts for front-running. Dhadda also used other accounts. In IIFL’s case, Santosh Singh (dismissed in 2021), the group’s equity dealer, passed on stock-specific information to his friend Adil Suthar, which was used to transact and profit. Both also used so-called mule accounts, which are demat accounts created in the name of people who are either poor or have low financial literacy. These accounts are loaned to front-runners against a fee.
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How does front-running affect investors, markets?
Individual gains aside, the sanctity of front-running fair markets and price discovery raises a question mark. Since a bulk purchase occurs before a large purchase by a fund or a large investor, the stock price has already increased, which affects the price at which the fund ultimately buys the stock, in turn affecting investors in the fund.
What is the responsibility of the fund?
The first level of check is with the fund house, which must ensure that none of its dealers and dealers are using the privileged information for personal gain. Each fund house has a code of conduct and it is the responsibility of the CEO to ensure strict compliance. Fund houses are also required to maintain a record of calls made by these officers during business hours. Fund houses that have been in the news for front-running say these are cases of one or two bad apples, and they have zero tolerance for any non-compliance.
What is SEBI doing in this matter?
Both these cases have been under investigation for the past few years, and orders were passed after the investigation was completed. But these are not the only cases; SEBI is probing two-three more cases. The increased scrutiny of front-running is largely due to changes in surveillance norms to counter new methods of manipulation. SEBI had developed an algorithm a few years back, which is equipped to capture the new modus operandi. The regulator may seek more oversight powers.