Axis MF scandal: What is front running and why is it illegal?

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Axis Mutual Fund, which manages assets of more than Rs 25 lakh crore, on Friday suspended two fund managers for directing the company’s transactions through their personal accounts. But what exactly is the forward stroke?

The first is to trade in stocks or any asset based on inside knowledge of a future transaction that will affect its price | Representative image Photo: iStock

Front running is an illegal practice of using non-public information to buy or sell securities ahead of a large order in order to benefit from the subsequent predictable price movement after such order is executed.

While insider trading is about pocketing quick gains through an unpublished stream of information about a company, front-running refers to the use of non-public information to buy or sell stocks or enter into options. .

Also read: Towards mutual funds? Then you need to read these clarifications by SEBI

When mutual funds place a large order, some fund managers buy the same shares in their personal accounts before executing the mutual fund order. When MFs buy in large quantities, the stock price should rise. The buyer then sells his shares for a big profit.

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Regulators frown on this practice because front-running disrupts market equilibrium and normal price discovery in addition to creating a false or misleading appearance of trading in the securities market.

Front running under Indian law

SEBI recognized the practice of front running as an undesirable manipulative practice in its advisory document in 1995. It was subsequently brought within the scope of the SEBI (Prohibition of Fraudulent and Unfair Business Practices Relating to the Securities Market) Regulation ), 1995.

Currently, Regulation 4(2)(q) of the Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market (SEBI) Regulations, 2003 encompasses front running as a fraudulent and unfair practice:

According to SEBI regulations: “Trading in securities shall be considered a manipulative, fraudulent or unfair business practice…if it involves an order for securities placed by any person, while he or she is directly or indirectly in possession of information that is not publicly available, relating to an impending large transaction in that security, its underlying securities or its derivative.

On February 1, 2019, the 2003 regulations were expanded to prohibit front running by non-intermediaries and individuals.

Front race case

Sebi has investigated and penalized several fund companies and fund managers in the past for showing leadership, which is very common among mutual fund companies and overseas portfolio investors.

In December 2021, a Deutsche Mutual Fund fund manager and his parents paid nearly Rs 5 crore to settle with the Sebi. The amount paid by them included settlement fees, illicit gains and interest collected on ill-gotten gains.

In another case in 2021, SEBI sought to debar 27 capital market entities for being connected to a front running case. The regulator has alleged that the three brokers working at Reliance Securities Ltd and entities linked to them played a lead role in buying and selling orders for the Tata Absolute Return Fund from the Tata Alternative Investment Fund.

In December 2020, the regulator barred 16 entities from accessing capital markets for up to seven years for engaging in front-running. Of the 16 entities, six were asked to hand over illegal earnings of almost Rs 20 crore.

Read also: Another mutual fund scam: 2 managers of Axis MF suspended for ‘front running’

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