Mint Explainer: Front-Round Cases and Sebi’s Fight Against Market Manipulation

Cases involving high-profile funds such as Axis Mutual Fund and Quant Mutual Fund have recently made headlines due to their links to these cases. The regulator, which is using cutting-edge technology and has expanded supervision, saw the number of investigations triple to 83 in the last financial year, compared to financial year 2023. Mint explains Sebi’s growing efforts to clamp down on front-running and its impact on retail investors and the future.

What is forward running? How does this affect retail investors?

Front-running, also known as tailgating, is a form of market manipulation. It is the trading of a stock or financial instrument by a broker, dealer or employee who has confidential information about a future transaction that will affect its price. The intermediary operates on the basis of information that is not public and could affect the price of securities on the market.

This poses a serious risk to retail investors, especially those without access to confidential information. When market leaders use confidential data to their advantage, they can artificially inflate prices, forcing ordinary investors to buy stocks or securities at inflated prices. This creates an unlevel playing field, often causing retail investors to overpay for their investments.

Read also: Surviving the Frontal Storm: An Investor’s Handbook

Moreover, front-running undermines confidence in financial markets. If retail investors believe the system is unfair or manipulated by those with privileged access, they may be discouraged from participating. This reluctance not only limits their investment opportunities, but also hinders broader market development.

What are the most important housings in a Sebi scanner?

The Axis Mutual front case gained a lot of importance after Sebi in 2023 excluded Viresh Joshi, fund manager of Axis Mutual Fund, and 20 entities associated with him in a front case related to the fund. The regulator has identified ₹30.55 crore as ill-gotten gains obtained through frontline operations and ordered the amount to be confiscated.

In June, Quant Mutual Fund came under Sebi’s scrutiny, with the regulator probing allegations of front-running at the financial firm, which has grown exponentially over the past five years.

There are at least ten front running cases pending before SAT arising from Sebi orders passed in FY24. These include cases against Rohit Mankotia, Banhem Stock Broking, V Marc India, NNM Securities Ltd, CHL Stocks Concepts, Mauria Udyog, Sasidhar V , Quest Investment Advisors and cases involving companies such as Wockhardt and Bank of India AXA MF.

What are Sebi’s current amendments on key MF issues?

At the Sebi board meeting in April, the market watchdog approved changes to the mutual fund rules, which it says are aimed at establishing an institutional mechanism to identify and discourage front-running and fraudulent transactions. The regulator presented a consultation document on this matter in May last year. This came after the regulator noticed a significant increase in the number of front-running cases, which could potentially lead to market abuse.

Indeed, due to the requirement to record all communications between dealers and fund managers, in April the board exempted the recording of personal conversations, including interactions outside the office, during market hours. This will happen after AMC implements the institutional mechanism mentioned earlier.

Read also: Sebi targets asset management companies as part of crackdown on market abuses

The regulator has asked industry body Association of Mutual Funds in India (Amfi) to lay down detailed standards for such institutional mechanisms. The mechanism includes enhanced supervisory systems, internal control procedures and escalation processes designed to identify, monitor and respond to certain types of misconduct, including front running, insider trading and misuse of sensitive information.

What is the number of regulatory actions for anticipatory and related breaches?

Sebi has stepped up its crackdown on market abuses by introducing tighter surveillance systems and strengthening cooperation with stock exchanges to detect abnormal trading patterns. According to its annual report for FY24, Sebi has taken up 24 front running investigations in FY23 and 83 cases in FY24.

In FY24, Sebi conducted searches and seizures involving 106 entities at 83 locations across seven cities across the country. Based on alerts generated by its internal surveillance system, investor complaints and data from stock market research reports, Sebi uncovered evidence of fraudulent activities that are actionable under the Prohibition of Fraudulent and Unfair Trade Practices Rules, 2003. Most appeals heard by Securities Appellate Court (SAT), i.e. 58.9%, resulted from violations of the provisions on the prohibition of fraudulent and unfair commercial practices or the provisions of the PFUTP.

What legal experts say

Ragini Singh, founder of Ragini Singh and Associates, believes that fast algorithms equip traders with the technology to profitably exploit non-public information, sometimes seconds before it becomes available in the public domain. Combined with increased regulatory oversight, this appears to be driving an increase in frontline cases. This is expected to increase the number of cases filed before the SAT after Sebi issues prohibitory orders.

Singh also said that due to the intricate structure of transactions, it is not always easy to detect front-running. However, the solution must be increased supervision by Sebi.

Vaibhav Kakkar, senior partner at Saraf and Partners, said: “Some regulatory uncertainty remains regarding what constitutes a ‘substantial transaction’ in the context of a front running case, and dominant entities continue to evolve and adopt unique front running trading patterns. “Sebi, however, has taken several measures to tackle front-running practices, including preventing offending entities/persons from accessing the securities market.”

The regulator’s commitment to combating front running is also evident in its recently issued circular on the establishment of enhanced supervisory systems, internal control procedures and escalation processes by asset management companies to identify and deter front running in the Indian market, he said. .