In an interim order a week ago, market watchdog Securities and Exchange Board of India (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.

What is it?

If insider trading is all about pocketing quick gains from punting on unpublished news flow on a company, front-running refers to the use of non-public information to buy or sell shares or enter into options or futures contracts in advance of a substantial order from a large institution or fund, hoping to make gains when the institution completes its trade and the information becomes public. It is an illegal practice.

In the above case, SEBI’s preliminary investigations have shown, as per the alerts generated by the internal surveillance system, that three dealers of the broking firm, found to be connected with other entities, seemed to have traded based on the impending orders of the Tata fund.

These entities have either followed a BBS (Buy-Buy-Sell) or SSB (Sell-Sell-Buy) pattern of executing the trades around the orders of the big client, SEBI has alleged.

Why is it important?

When dealers, brokers or other market participants take their own positions ahead of the buy/sell orders of a big institution because they have advance information of a coming order, this increases the cost of acquisition of shares or reduces the sale price for the concerned fund house or institution.

This affects the interests of common investors invested in the institution as it jacks up their buy price or reduces the sell price for a security in the fund’s portfolio. Regulators frown 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.

In this case, SEBI has barred a total of 27 entities including the three dealers from the capital markets for violation of its PFUTP (Prohibition of Fraudulent and Unfair Trade Practices) norms till further direction.

All the entities have been directed not to dispose of any assets, whether immovable or movable except with the prior permission of SEBI. It will pass its final orders once its investigation is completed.

Why should I care?

If you’re a retail investor in a mutual fund, pension fund or market-linked plan, you need to take note that front-running can affect you too. In 2007, SEBI had identified certain instances of front-running by a former equity dealer of HDFC Asset Management Company (AMC). As per SEBI's adjudication orders dated November 2019 and July 2020, the total unlawful gains made by such front-running were ₹1.52 crore and ₹2.86 crore respectively. SEBI had proposed a penalty on the entities connected to the front-running episode and tightened the rules for dealers of mutual funds and other institutions, to plug information leaks on upcoming trades. Not only did HDFC AMC reach a consent settlement with the regulator, it also compensated affected unit-holders for the losses in their accounts due to front-running.

Such malpractices interfere with the fair and smooth functioning of the market. Eventually, investors lose the price advantage on these shares. If these front-running trades had not been been executed, then the HDFC AMC and the other investors could have obtained a better price.

The bottomline

It is not just the small guys who can be short-changed by market manipulation and insider information, big institutions can be tripped up too.

A weekly column that puts the fun into learning.