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

Front running is an illegal practice of using non-public information for buying or selling securities ahead of a large order so as to benefit from the subsequent predictable price movement after the execution of such an order.

If insider trading is all about pocketing quick gains from unpublished news flow on a company, front-running refers to the use of non-public information to buy or sell shares or enter into options.

Also read: Into mutual funds? Then you must read these clarifications by SEBI

When mutual funds make a big order, some fund managers buy the same shares in their personal accounts before executing the MFs’ order. When MFs purchase in huge quantities, the price of the share is expected to go up. The buyer then sells his shares to garner a big profit.

Regulators frown at this practice because front-running disturbs market equilibrium and normal price discovery besides creating a false or misleading appearance of trading in the securities market.

Front running under Indian law

SEBI recognised front running as an undesirable manipulative practice in its Consultative Paper in 1995. It was then brought within the ambit of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 1995.

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

According to SEBI regulations: “Dealing in securities shall be deemed to be manipulative, fraudulent or an unfair trade practice… if it involves any order in securities placed by a person, while directly or indirectly in possession of information that is not publicly available, regarding a substantial impending transaction in that security, its underlying securities or its derivative.”

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

Front running cases

Sebi has investigated and penalised several fund houses and fund managers in the past for front-running, which has been very common in mutual fund houses and foreign portfolio investors.

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

In yet another case in 2021, SEBI sought to bar 27 entities from the capital market for being connected to a case of front running. The regulator alleged front-running by the three dealers working at Reliance Securities Ltd and entities linked to them, on buy and sell orders by Tata Absolute Return Fund from the Tata Alternative Investment Fund.

In December 2020, the regulator barred 16 entities from the capital markets for up to seven years for indulging in front running. Of the 16 entities, six were asked to remit illegal gains of nearly Rs 20 crore.

Also read: Another mutual fund scam: 2 Axis MF managers suspended for ‘front running’