All about front-running and what needs to be done to prevent it

What is front-running?

Front-running is a dubious market practice in which a dealer, trader or employee gets wind of a big order for buying or selling shares that will be placed by a fund or big investor and gets ‘in front’ of the trade. Large orders usually move a stock’s price. By buying shares just before the big order hits the market and selling them once the price moves up, the front-runner pockets illegal gains from his advance knowledge. A reverse strategy is used with sell trades. Front-running by insiders can adversely impact investors in a fund by bidding up the prices they get to buy stocks or hammering down the prices at which they get to sell. 

Usually, there are two parties to a front-running operation. An information carrier who gets advance information about the big investor’s orders because he/she is an employee, dealer or trader for it, and the front-runner who is usually a friend, acquaintance or relative who puts through the actual trades.

Why is it in news now?

Last Friday, Axis Mutual Fund issued a public notice removing and replacing two of its fund managers, Viresh Joshi and Deepak Agarwal, from seven of its schemes — its Banking, Technology, Consumption, and Nifty ETFs and Axis Value, Quant and Arbitrage Funds. This move was accompanied by speculation that the managers were suspended on front-running charges. Axis Mutual Fund hasn’t explicitly mentioned front-running charges, but it has confirmed that it has been investigating “potential irregularities” with the help of external advisors.

Is it a common wrongdoing among mutual funds?

Front-running is not an offence specific to the mutual fund industry. Front-running can occur in any situation where an employee, dealer, trader or broker executing trades for any big investor — be it a mutual fund, foreign portfolio investor, pension fund, insurer, or HNI gets advance information on big buy or sell orders that are about to be placed and trades on this information.

Also read

SEBI lens on 2 fund managers suspended by Axis MF

In India, SEBI has detected cases of front-running among foreign portfolio investors, dealers, brokerages and mutual funds. In June 2021, SEBI passed an order against three dealers of Reliance Securities and their connections for front-running the trades of Tata Absolute Return Fund, an alternative investment fund.

Earlier, it unearthed evidence that a relative of a trader employed at foreign portfolio investor, the Fidelity Group, regularly front-ran the trades of 11 entities in the group. In 2006-07, SEBI found evidence that an equity dealer at HDFC Mutual Fund passed on trading information to Ikab Securities and Investments. It levied fines on both the front-runners and the mutual fund.

Are regulations in place to prevent such practices?

Yes, SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 clearly define front-running and characterises  it as a fraudulent and unfair practice. SEBI has invoked this section many times to pass orders against front-runners.

What more should be done to prevent it?

Surveillance mechanisms of stock exchanges are most useful to uncover instances of front-running. Surveillance software that tracks real-time trades in the market is well-equipped to spot similar trading patterns between big investors and individuals, which forms the basis for front-running investigations by the regulator.

Therefore, rooting out such cases calls for a stringent examination of surveillance data by the exchanges and the quick escalation of any suspicious trades to SEBI. Putting in place clear whistle-blower policies with anonymity for the informer at the exchanges, big institutions, and brokers trading in the markets can help flag a nexus between market players at an early stage.

SEBI will also need to consider more stringent punishments for information carriers and front-runners when investigations find hard evidence of wrongdoing. Soft measures such as barring the entities from securities markets for a temporary period, levying a low-key fine or settling with the accused without admitting to the offence, may not suffice.

COMMENT NOW