AMFI Releases SOPs to Handle Front-running In Mutual Funds
August 30, 2024 Mutual Fund
After numerous cases of front-running, the Indian mutual fund industry body, the Association of Mutual Funds in India (AMFI) has come up with Standard Operating Procedures (SOPs) to keep a check on instances of front-running.
This comes after the capital market regulator, the Securities and Exchange Board of India (SEBI), earlier this month, came out with a circular asking mutual fund houses to put in place an institutional mechanism to curb front-running.
The regulator even announced that with effect from November 1, 2025, mutual funds houses will be covered under the sphere of SEBI (Prohibition of Insider Trading) Regulations, 2015 or PIT Regulations.
Accordingly, the capital market regulator also amended the PIT Regulations on June 26, 2024. Mutual funds are now treated as “securities” when it comes to insider trading.
Furthermore, the regulator expanded the definition of “insider” to include people connected inside and outside the fund house who have access to Unpublished Price Sensitive Information (UPSI), such as…
- Employees of the mutual fund house
- The board of directors of the fund house
- The sponsor of the fund house and holding company
- Other connected to the fund house, viz. auditors, bankers, legal advisers, distributors, etc.
- An immediate relative of the connected person
Taking into account these amendments, AMFI has framed SOPs for fund houses to curb possible front-running activity. Here’s what is suggested…
As per the standards, Asset Management Companies (AMCs) must develop adequate investment processes & systems for alert generations for suspicious trades, processing, examination, escalation, and review of the alerts.
The AMC will be required to review all recorded communication of key employees, the entry logs of the AMC premises, and CCTV footage to examine suspicious alerts. Moreover, to access dealing rooms, biometrics will be mandatory.
The alerts will be based on the suspicious trading activity and will be 3-tiered. The first set of alerts will be based on participation volume and volume-weighted average price of large caps, mid-caps and small-caps. Next, price movements during deal execution and block trades as well as scrip volumes traded one hour before the AMC’s trade will be taken into account. Then the alerts that are identified as suspicious will be probed further.
The AMCs need to generate such alerts at least on a weekly basis plus inform the board of directors and trustees of such alerts generated along with the result of the examination conducted.
Now, while mutual fund employees take prior approval from the compliance teams before placing their trades, AMCs will be allowed to review their transactions and those of their immediate relatives if linked to suspicious alerts and access trade-related data from exchanges and depositories taking into account their PAN.
[Read: How to Track Mutual Funds With PAN]
To avoid suppressing any fraudulent activities, AMCs will also have to ensure that the fund managers and dealers go on mandatory leave of at least 10 business days in a financial or calendar year, with not less than five business days’ leave at a stretch.
Furthermore, AMCs can take action against brokers linked to suspicious alerts. Accordingly, the broker-empanelled agreements will now include a clause to allow for actions against front-running, including abrupt termination of services without cause.
AMCs will thus now have to formulate written policies & procedures (including employee guidelines/rules and terms of employment) concerning the examination of suspicious alerts and for taking actions in case of potential market abuse, including front-running and fraudulent transactions by employees and connected entities.
To ensure compliance with the standards, the Chief Executive Officer (CEO) or Managing Director (MD) or persons of equivalent or analogous rank and chief compliance officer will be required to put in place an institutional mechanism.
These standards will be implemented phase-wise beginning with equity mutual funds. By November 2, 2024, all trades in equity securities (excluding overseas equities) in mutual fund schemes with total assets under management (AUM) of more than Rs 10,000 crore would come under the ambit of institutional mechanism for identification and deterrence of market abuse, including front-running and fraudulent transactions in securities.
For equity mutual fund schemes with AUM less than Rs 10,000 crore, the standards would be implemented by February 2, 2025.
In the case of trades in schemes, arbitrage schemes and overseas securities across all schemes need to follow the new standards by May 2, 2025, irrespective of the AUM.
And lastly, in the case of debt mutual funds and all other securities, such as commodities, real estate investment trusts, infrastructure investment trusts, etc, would be covered by August 2, 2025.
What Should Investors Do?
It is recommended that investors consider fund houses that follow robust investment processes and systems and not give weightage to star fund managers when selecting mutual fund schemes for their portfolio.
To make a suitable choice of a plethora of schemes available, consider your age, risk profile, investment objective, the financial goals you are addressing, and the time in hand to achieve those goals envisioned financial goals. This need-based analysis shall help you own befitting mutual fund schemes (or any other investment product for that matter) in the portfolio.
Further, to make the best choice among mutual funds, evaluate a host of quantitative (viz. returns across time periods, risk taken to clock returns, risk-adjusted returns, performance across market cycles) and qualitative parameters (viz. portfolio characteristics, the percentage of AUM of the fund house actually performing – to judge whether a fund house is a prudent asset manager or mere asset gatherer – also the credentials of the fund manager, etc.) when selecting schemes under consideration. Don’t just look at past returns of mutual funds, as they are not an indicator of future returns.
Be thoughtful in your approach. And when in doubt, don’t hesitate to reach out to a SEBI-registered investment adviser.
Happy Investing!
This article first appeared on PersonalFN here
