Mint Explainer: Front-running cases and Sebi’s fight against market manipulation

Front-running, a practice that undermines the fairness of financial markets, has come under the spotlight, with the Securities and Exchange Board of India (Sebi) tightening its grip on brokerage firms that have access to information on stock trades and other financial assets.

Cases involving prominent fund houses like Axis Mutual Fund and Quant Mutual Fund have grabbed headlines recently for their links to these cases. The regulator, which is using cutting-edge technology and has expanded surveillance, saw its investigations triple to 83 in the last fiscal year compared to FY23. Mint explains Sebi's growing efforts to clamp down on front-running, and how it affects retail investors, and the way ahead.

What is front-running? How does it affect retail investors?

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.

It poses a serious risk to retail investors, particularly those without access to insider information. When front runners use confidential data to their advantage, they can artificially drive up prices, leaving everyday investors to buy stocks or securities at inflated rates. This creates an uneven playing field, often causing individual investors to overpay for their investments.

Also Read: Surviving the front-running storm: An investor's handbook

Additionally, front-running undermines trust in financial markets. If retail investors believe the system is unfair or manipulated by those with privileged access, they may be discouraged from participating. This reluctance not only limits their investment opportunities but also stifles broader market growth.

Which are the prominent front-running cases under Sebi scanner?

The Axis Mutual front-running case gained a lot of prominence after Sebi, in 2023, barred Viresh Joshi, the fund manager of Axis Mutual Fund, and 20 entities involved with him in a front-running case linked to the fund house. The regulator has identified ₹30.55 crore as ill­-gotten gains made through the front­running activities and directed that this amount be impounded.

In June, Quant Mutual Fund came under the Sebi lens, with the regulator investigating charges of front-running at the financial firm, which has grown exponentially over the last five years.

There are at least ten front running cases pending before SAT arising from Sebi orders passed in FY24. These include cases against Rohit Mankotia, Banhem Stock Broking, V Marc India, NNM Securities Ltd, CHL Stocks Concepts, Mauria Udyog, Sasidhar V, Quest Investment Advisors and those involving companies like Wockhardt and Bank of India AXA MF.

What are Sebi’s current amendments in MF's front-running matters?

In the Sebi board meeting held in April, the market regulator approved amendments to its mutual fund regulations, a move it said is aimed at establishing an institutional mechanism to identify and discourage front-running and fraudulent transactions. A consultation paper in this regard was floated by the regulator in May last year. This was after the regulator saw a significant spike in the number of front-running cases, which could potentially lead to abuse of the markets.

Pertinently, on the requirement to record all communication by dealers and fund managers, the board had in April exempted recording face-to-face communications, including out-of-office interactions, during market hours. This will be made effective after the implementation of the institutional mechanism by the AMCs, as cited earlier.

Also Read: Sebi targets asset management companies in market abuse crackdown

The regulator asked industry body Association of Mutual Funds in India (Amfi) to specify detailed standards for such institutional mechanisms. The mechanism shall consist of enhanced surveillance systems, internal control procedures and escalation processes to identify, monitor and address specific types of misconduct, including front running, insider trading, and misuse of sensitive information.

What is the number of regulatory actions in front-running and related violations?

Sebi has ramped up its crackdown on market malpractices, introducing stricter surveillance systems and enhancing cooperation with stock exchanges to detect irregular trading patterns. According to the annual report of FY24, Sebi took up 24 investigations about front running in FY23 and 83 cases in FY24.

In FY24, Sebi conducted search and seizure operations involving 106 entities at 83 locations covering seven cities across the country. Based on alerts generated by the in-house surveillance system, complaints from investors, and inputs provided by the examination reports of the stock exchanges, Sebi unearthed evidence of fraudulent activities, which is actionable under the Prohibition of Fraudulent and Unfair Trade Practices Regulations of 2003. The majority of the appeals disposed of by Securities Appellate Tribunal (SAT), which is 58.9%, arose from violations of Prohibition of Fraudulent and Unfair Trade Practices or PFUTP regulations.

What legal experts say

Ragini Singh, founder of Ragini Singh and Associates, believes high-speed algorithms equip traders with the technology to exploit non-public information profitably, sometimes seconds before that information is available in the public domain. This, coupled with enhanced regulatory oversight, seems to be resulting in a rise in front-running cases. This is expected to increase the number of cases filed before SAT once Sebi issues prohibitory orders.

Singh also said that due to the convoluted structuring of trades, it is not always easy to detect front-running. Nonetheless, heightened supervision by Sebi must be the way forward.

Vaibhav Kakkar, senior partner at Saraf and Partners said, “There remains some regulatory ambiguity regarding what constitutes a ‘substantial transaction’ in the context of a front running case and front runners continue to develop and adopt unique front running trading patterns. However, Sebi has undertaken several measures to tackle front-running practices, including barring flagrant entities/persons from accessing the securities market.”

The regulator’s commitment to combatting front-running is also evident from the recent circular issued by it on the establishment of enhanced surveillance systems, internal control procedures and escalation processes by asset management companies for identifying and deterring front running activities in the Indian market, he said.

Also Read: Mint Explainer: How Sebi wants to prevent insider trading violations