Quant Mutual Fund’s statement that the Securities and Exchange Board of India (Sebi) is investigating front-running charges raises a lot of concerns. While the good news is that there hasn’t been any run on the fund’s schemes, the fact remains that the scourge of front-running continues to plague the over Rs 50-trillion industry. Bigger fund houses like HDFC Mutual Fund, Axis Mutual Fund, and, more recently, Life Insurance Corporation of India faced similar crises in the past. Front-running happens when a company insider or broker makes a trade in advance based on information that a big client, a fund house in this case, is planning a big buy in a particular company. The market regulator, on its part, has been prompt in taking action and imposed strict guidelines for fund houses; it even went for surprise audits, but something seems to be still amiss.
Industry experts believe that the problem needs to be analysed from two sides — is it a systemic issue or individual greed? The former, for obvious reasons, is more worrying as it shows that controls in the fund house were not robust enough. But it also throws up another relevant question — did Sebi audits red-flag the issues? If they did not do so, the market regulator needs to sharpen its auditing skills. However, if it was a case of individual greed, the fund house, or for that matter, even Sebi can do little. In such cases, harsh fines, barring such individuals from the stock market, and involving other agencies like income tax department, Central Bureau of Investigation or Enforcement Directorate promptly are the only solutions.
With the Indian stock market growing at a rapid pace and adding millions of new retail investors every year, it is time financial crimes are taken much more seriously. In fact, a good example of harsh penalties globally is Bernie Madoff. The former Nasdaq chairman, whose Ponzi scheme was reported by his own sons in December 2008, was arrested within a day. By March 2009, he was handed a 150-year sentence in less than 150 days. Industry experts say the market regulator needs to come out with orders faster so that both the fund house and investors aren’t kept on tenterhooks for an inordinately long time. A fund house like Quant MF, which is managing Rs 93,000 crore and has over eight million investors, needs a quick resolution, as its functioning is bound to get hampered till there is clarity. Also, more stringent measures need to be implemented, which could mean stricter monitoring and auditing, besides enhanced compliance requirements. If investors have been affected due to front-running, the amounts collected through fines should be added back into the schemes to make good their losses.
A big problem is proving the allegations with evidence. A Sebi consultation paper last year on “Prohibition of unexplained suspicious trading activities” cited multiple cases where Sebi identified unnatural trades resulting in unusual profits, but was unable to prove guilt. The paper claimed that in 2022, some 5,000 suspicious trading alerts were generated, involving 3,588 unique entities, with 97 of these entities appearing more than five times each in suspicious trades. But Sebi could not find conclusive proof of communication. Nevertheless, in the past three years, this is the third case of front-running that the market regulator has unearthed. This should serve as a wake-up call for the entire mutual fund industry.
