SEBI crackdown on Quant MF: What is front-running? All you need to know

The Securities and Exchange Board of India (SEBI) conducted search operations at two premises of Quant Mutual Funds on suspicion of front-running. The market regulator carried out the searches at Quant’s head office in Mumbai and in Hyderabad. Suspecting front-running transactions, SEBI questioned Quant Mutual fund dealers and persons connected with the case, Moneycontrol reported.

Quant Mutual Funds, the fastest growing MF in the country with assets under management (AUM) of more than ₹90,000 crore, issued a statement, saying it will cooperate with the regulator.

What is front-running?

Front-running, also known as tailgating, is a form of market manipulation. It is the trading in a stock or financial instrument by a broker, dealer or employee who has inside information about a future transaction that would affect its price.

The intermediary works on the basis of information that is not public and would affect the price of securities in the market.

In a circular in May 2012, SEBI defined front running as: usage of non-public information to directly or indirectly buy or sell securities, or enter into options or futures contracts, in advance of a substantial order, on an impending transaction, in the same or related securities or futures or options contracts, in anticipation that when the information becomes public; the price of such securities or contracts may change.

Front-running is considered an unethical practice because brokers or dealers trade in an equity based on information before it is provided to their clients. A fund manager/broker buys or sells securities in advance of a substantial order, or takes a futures or options position on an impending transaction in the same or related futures or options contract. 

Front-running is similar to insider trading. However, the difference is that in the case of front-running, the information does not pertain directly to a company. In the case of insider trading, the information is confidential, company-specific information that is not available to the public.

One method through which front-running is carried out is by using analysts' recommendations before they are made public. Analysts give their clients recommendations on buying, selling or holding stocks. When such recommendations are used by brokers before it reaches the clients, it is considered front-running.

Commonly used patterns for front-running are buy-buy-sell and sell-sell-buy.

In the buy-buy-sell pattern, a front-runner uses non-public information to place his buy order before the client’s order to buy and then sells.

In the sell-sell-buy pattern, the front-runner places a sell order before the client and then buys the shares.

According to the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, amended on January 25, 2022, the Board of Trustees or the Trustee Company that holds the property of the mutual fund in trust for unit holders must furnish every six months a certificate declaring they are satisfied there have been no instances of self-dealing or front-running by any of the trustees, directors and key personnel of the asset management company.

Front-running is illegal in India. In a May 2001 circular, SEBI said any transaction of front-running by any employee directly or indirectly is strictly prohibited. For this purpose, ‘front running’ means any transaction of purchase/sale of a security carried by any employee whether for self or for any other person, knowing fully well that the AMC also intends to purchase/sell the same security for its mutual fund operations, the regulator said.

SEBI had recently approved amendments in its mutual fund regulations to curb front-running and fraudulent transactions. In April, SEBI barred eight entities from the entities on alleged front-running activities.