Front-running Cases in Mutual Funds: All You Need to Know

September 18, 2023 Mutual Fund

The mutual fund industry in India has been growing rapidly; it is experiencing brisk growth in assets under management driven by financialisation and expectations for further penetration into an untapped growing population.

In July, the prominent market indices, such as S&P BSE Sensex and Nifty 50, were soaring at their all-time highs, with the overall AUM surpassing Rs 45 lakh crore. Besides, the mutual fund industry also touched new highs across key data points like SIP contribution, SIP AUM, and SIP accounts amongst others.

[Read: Sensex @65,000: The Mutual Fund Investment Strategy to Follow Now]

Data as on September 15, 2023
(Source: ACE MF) 

On the contrary, amidst the growing scale of the mutual fund industry, allegations of malpractices by the fund houses have surfaced in recent times. Specifically, the claims of Front-running within mutual funds have startled investors.

India’s mutual fund (MF) industry is experiencing a state of flux; while ample opportunities are knocking at the door, it’s equally concerned with challenges related to these Front-running cases.

What Is Front-running Activity in Mutual Funds?

Front-running is a form of insider trading, which is an illegal act or a practice where the market participants deal in security through a personal account after receiving information in advance about a large trade volume to be bought or sold.

Front-running is regarded as a sort of market manipulation; the person who does it anticipates changes in a security’s price based on insider knowledge. These transactions are carried out before the bulk buy/sell transaction to profit from the price movement brought on by the latter, even before the clients can act.

For instance, suppose a dealer receives a sizable order to purchase 1,00,000 shares of the XYZ company. When shares of a corporation are bought in huge quantities, their price typically increases. To take advantage of the anticipated increase in share price, the dealer purchases shares of the same company using his or her personal account before executing the huge transaction.

The trading rooms of brokers and mutual fund houses are highly secure environments with stringent confidentiality protocols in place. However, despite such strict regulations, there have been violations in mutual funds.

Front-running, insider trading, and misuse of information are not uncommon in the world of investments, and over the past few years, several such instances have come to light.

Here are some examples of misconduct related to the Front-running activity that have occurred recently:

1. Axis Mutual Fund Suspends 2 Fund Managers:

Axis Mutual Fund is the seventh-largest mutual fund house in India, with approximately Rs 2.6 lakh crore in assets under management (AUM). Axis Mutual Fund announced that it suspended two of its fund managers due to possible violations on May 06, 2022.

The allegations against two fund managers at Axis Mutual Fund are very serious and involve Front-running, accepting payments from brokers in exchange for disclosing confidential information and collaborating with them to execute illegal orders.

Viresh Joshi, who held the position of chief trader and fund manager for equity at Axis Mutual Fund, and Deepak Agrawal, who served as an assistant fund manager for equity, are the two employees who have been suspended.

Recently, the Securities and Exchange Board of India (SEBI) issued an Interim-order-cum-Show-cause Notice to Viresh Joshi – the prime accused in the Axis Mutual Fund front-running case and 20 others who were involved in unveiling their modus operandi.

The regulator has identified Rs 30.55 crore as ill-gotten gains made through the Front­running activities and directed that this amount be seized. According to SEBI, the fraudsters’ ring members referred to Joshi as ‘Jadoogar’ (the magician) in their WhatsApp messages. Additionally, a letter from a whistleblower provided specific information on how his accounts were allegedly used for Front-running activities.

I have listed below our articles that covered this controversial front-running case in depth…

• Here’s How SEBI Has Pulled Up Entities Involved in the Axis Mutual Fund Front-running Case
• Axis Mutual Fund Suspends Two Fund Managers for Alleged Irregularities. Know the Details Here

It has now been just over a year since Axis Mutual Fund was the centre of a significant Front-running scandal.

2. Deutsche Mutual Fund case

Akash Singhania, the fund manager for Deutsche Mutual Fund, together with his parents Ashok Kumar and Premalata Singhania, agreed to settle a Front-running case in December 2021 by paying Rs 5 crores.

Singhania had access to information about incoming orders from the fund house as the fund manager. In the names of his parents, he opened four trading accounts that were used to purchase shares before the fund house made its orders and to sell those shares at higher prices. According to SEBI, they generated gains of more than Rs 1.4 crore from this Front-running activity.

3. SEBI Banned a Group of 3 Individuals in Mutual Funds

Due to their involvement in a Front-running scheme, three people were restricted from participating in capital markets after SEBI issued a ruling barring them in May 2021. The individuals in question were Anita Mhatre, a trading account holder, Rakesh Shah, a dealer affiliated with Reliance Capital Mutual Fund, and Sanjay Parekh, a dealer employed with Anurag Stock & Broking.

Rakesh Shah, who had information on upcoming large trades, used to inform Parekh, and he would further use Mhatre’s trading account to purchase securities. The group was able to make a profit of about Rs 8.87 lakh.

4. SEBI Imposed Hefty Fine on HDFC AMC

In November 2019, markets regulator SEBI imposed a total fine of Rs 85 lakh on seven entities for flouting regulatory norms in the front-running of HDFC Mutual fund. This group consists of Nilesh Kapadia (equity dealer), Kalpana Kapadia, Rajiv Sanghavi, Sanjay Sanghavi, Rajiv Sanghavi-HUF, Sonal Sanghavi and Dipti Mehta.

SEBI noted that the entities have disgorged the ill-gotten profits made by them along with interest in compliance with disgorgement orders. Nilesh as the equity dealer of HDFC AMC had the prior knowledge of HDFC’s trades, which he passed on to Rajiv, and then Rajiv bought shares through different accounts from general investors at a lesser price, which would have otherwise been available to HDFC.

The regulatory body fined the entities Rs 10 lakh each as a form of monetary penalty. It additionally imposed Nilesh Kapadia a fine of Rs 25 lakh for misusing his position as a dealer for HDFC AMC.

These are just a few examples from the long list of Front-running cases that have recently taken place in India’s Rs 40 trillion mutual fund industry. There have been more instances of misconduct, such as the IIFL and Fidelity Front-running case, the Franklin Templeton fiasco involving the winding up of six debt schemes, etc.

Likewise, numerous instances of these fraudulent actions occur in the banking and financial services industries.

The SEBI views Front-running as one of the most serious violations. The capital markets regulator SEBI has banned 21 companies, including former fund manager Viresh Joshi of Axis Mutual Fund, from the securities market in connection with the Front-running case at the fund house.

SEBI’s Action Against the Prevention of Front-running Cases:

SEBI proposed setting up internal monitoring systems in mutual fund institutions to detect fraudulent activity in a consultation paper that was published in May 2023. It desires more proactive behaviour from fund houses.

Such a system, in SEBI’s opinion, should be able to detect Front-running, insider trading, improper product sales, and information misuse by Asset Management Companies (AMCs), their employees, distributors, brokers, dealers, and other parties, as well as delays in order execution by their brokers and dealers.

The increased scrutiny of Front-running is largely because of the changes in surveillance norms to counter new ways of manipulation. A few years ago, SEBI created an algorithm that is capable of detecting the new modus operandi. Nowadays, Front-running and insider trading crimes are often discovered by stock market exchanges working in tandem with SEBI to use its monitoring systems.

[Read: Will SEBI’s Forensic Audit on Mutual Funds Pull More Skeletons Out of the Closet?]

Additionally, SEBI is alleged to have established a whistleblower policy. All fund houses, regardless of whether they are listed or not, are now required to have a ‘vigil mechanism/whistle blower policy as applicable to listed AMCs, which specifically addresses market abuse practises,’ according to a proposal from SEBI.

Nonetheless, SEBI also stated that a mutual fund’s intelligence should be able to recognise the subtler aspects of any potential violation, such as changes in lifestyle. This appears to have been a result of media revelations about the opulent lifestyle that Axis MF’s head trader was said to be leading before the fund house fired him in May 2022.

In order to protect the interests of unit holders, the market watchdog has expanded the role and accountability of the mutual fund trustees. Also, it has asked the board of an AMC to constitute a unit-holder protection committee (UHPC).

[Read: SEBI Chief Draws AMFI’s Attention to Form an Ethical Committee]

This is part of SEBI’s effort to establish an impartial review system for AMC decisions that considers the interests of unit holders across all types of products and services. This framework will come into force from January 01, 2024.

To conclude…

The sector frequently urges SEBI to adopt stringent penalties for information carriers and front-runners when its investigations turn up concrete proof of wrongdoing. The firm resolution of SEBI will boost accountability and possibly strengthen the internal control systems of fund houses, thereby safeguarding the interests of investors.

While sincere investors and market players already employ technology to increase speed, accuracy, and convenience, fraudulent minds may be attempting to take advantage of the loops in the digital systems’. SEBI will be targeting all such outrageous participants with forensic audits and enhanced surveillance.

Furthermore, officials in the mutual fund industry claim that they are implementing additional controls and considering conducting external evaluations of dealing procedures in order to ensure that any Front-running or malpractices could be clamped down early on.

This article first appeared on PersonalFN here