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Sebi is getting tougher with front-runners, thanks to some key regulatory changes

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Over the last few years, the market regulator has been given more legal powers to act against offenders.

From 2019, the definition of ‘dealing in securities’ under the law meant more than just buying and selling securities.

The Securities and Exchange Board of India (Sebi) is investigating the recent allegations at Axis Mutual Fund. The fund house suspended two fund managers on May 6 for “potential irregularities”, and market sources said that the charge is of front-running.

Axis Mutual Fund refused to comment on the allegation, when Moneycontrol reached out earlier.

Front-running is when a broker or dealer in collusion with a fund manager places a buy/sell to profit from a coming, big institutional buy/sell order. For example, the broker buys to profit from a big buy order or short sells to profit from a big sell order.

Whatever the reality is, market watchers say that instances of front-running seem to have been on the rise during the pandemic. It could be because there was weaker regulatory oversight.

Calls made and received by fund managers are recorded during market hours to stop them from passing sensitive information to others. But, in a work-from-home situation, this behaviour is harder to track since the managers have access to other phones and other means of communication.

This rise in front-running dovetailed with Sebi’s increased powers to act against offenders.

A decade ago, the regulator was allowing people to settle the case by paying a fine and not admitting guilt; now it is banning the participants from the equity markets for a few years.

A decade ago, a regulator’s ban on entities for this fraudulent practice could get overturned by the Securities and Appellate Tribunal (SAT) because the Prohibition of Fraudulent and Unfair Trade Practices (FUTP) Regulations weren’t comprehensive enough. Now, the rules cover a wider range of players and actions.

Early days of front-running

“The term front-running came to be recognised in India only in the mid-2000s, around 2007 when a dealer of a large broker was seen to be passing on information to certain individuals regarding the impending large sales to be carried out by an institutional client. These individuals in turn had short sold the scrip in large quantities prior to the large sale orders and bought them subsequently at lower prices. Subsequently, the concept gathered spotlight with allegations in HDFC Mutual Fund (in 2010),” said Sumit Agrawal, Founder, Regstreet Law Advisors. Agrawal is a former SEBI officer who handled these matters for close to a decade.

In 2010, an accusation against HDFC AMC’s assistant vice president (equity) Nilesh Kapadia brought the fraudulent practice into the limelight. Sebi barred him and his associates from trading for 10 years and fined them Rs 2 crore.

But when the regulator was passing the order, the law was still vague on who could be penalised for front-running. This weakness came out starkly in a 2012 SAT order that nullified Sebi’s ban on a portfolio manager and his cousins.

In 2009, Sebi found that a portfolio manager at Passport India Dipak Patel had passed on insider information to his cousins Kanaiyalal Baldev Patel and Anandkumar Baldevbhai Patel, and that his cousins had executed synchronised trades. Three years after the market regulator had banned the manager, the appellate tribunal nullified it because the law only banned the intermediary (the portfolio manager or fund manager) from front-running and not other related persons. “In the absence of any specific provision in the Act, rules or regulations prohibiting front running by a person other than an intermediary, we are of the view that the appellants (the portfolio manager and his cousins) cannot be held guilty of the charges levelled against them,” read the order.

Perhaps the HDFC AMC debacle speeded things up, but it is the SAT order that changed the course of things.

A year after the order, Sebi announced its intent to review its rules and reinstate rules from 1995, which prohibited ‘any person’ from front-running and not just the intermediary.

From 2019, the amendment came into effect along with other amendments. From then on, the definition of ‘dealing in securities’ under the law meant more than just buying and selling securities. It now includes any action that can influence the decision of investors and any assistance provided to influence the decision of investors.

“Before 2019, Sebi had to piece together circumstantial evidence and make a case against an offender. After the amendments came into force in 2019, in the backdrop of a few court judgements, the evidentiary threshold has become lesser for Sebi to issue debarment orders. As per the regulator, if there is a suspicious pattern of trade, Sebi can bring a case against the person and the accused has to prove his/her innocence,” said Agrawal.

In 2022, more amendments to FUTP gave Sebi more teeth. The regulator can now hold the books and other documents it needed for investigation for six months, which is five months longer than it was allowed to hold them before. It can now ask for information or record regarding the securities under investigation, from anyone or any entity. It can apply to a judge to allow seizure of books or documents it thinks is relevant to an investigation. It can also issue summons through a fax, electronic mail or electronic instant messaging services, after being digitally signed by a competent authority and ensuring that it doesn’t bounce from the recipient’s mailbox.

Tougher regulator

A marked difference in the regulator’s attitude could be seen after the 2019 amendments.

Last August, Sebi refused to lift a ban it had placed a year before on six people–Santosh Brijraj Singh, Adil Gulam Suthar, Virendra Pratap Singh, Neha Virendra Singh, Gulammohammed Shaikh and Mohammedidrish Shaikh– accused of the same practice at India Infoline Group (IIFL Group). The regulator confirmed its prima facie findings against the accused of violating provisions under Prohibition of Fraudulent and Unfair Trade practices, in using mule accounts to front-run trades of various schemes of IIFL. The regulator probed the accused’s bank transactions and relationships with each other, among other things, to spot SSB (sell-sell-buy) and BBS (buy-buy-sell) patterns in the accused’s transactions.

A year before that, in August 2020, it barred 27 entities from the markets for profiting from the knowledge about trades by Tata Absolute Return Fund. That December, it banned 16 entities from the stock markets for seven years, for profiting from insider information of trades by Sterling Group between 2009 and 2011. Six were asked to hand over Rs 20 crore, which was estimated to be the gains from the transactions.

According to the regulator, an employee of Sterling Group Manish Chaturvedi was given access to several mule accounts by his friend Praveen Jain, through which he traded ahead of orders placed by the Sterling Group. In February 2021, the regulator even fined Jain Rs 35 lakh for facilitating the trade.

The regulator had begun investigating this group in 2015. It took six years for it to reach a conclusion.

Front-running charges aren’t easy to prove. The regulator may be able to prove that an accused knew about an institution’s future trades, but it has to jump through multiple hoops to prove that the beneficiary was related to the accused. Of course, it has to go through bank and trading details, but sometimes it has to also go through social media accounts and in some cases even dig deeper.

In 2019, Sebi had to dive into details given on a matrimonial website to establish a link between a trader at Fidelity Group, Avi Dhadda (aka Vaibhav Dhadda according to his PAN card details), and two people who benefitted from trades placed before and in sync with a few of Fidelity’s funds’ trades. The two people–Alka Dhaddha and Arushi Dhadda–were revealed to be Avi’s mother and sister and were found to have placed 68 such orders.

The regulator held Avi liable for conducting the trades through Alka and Arushi’s trading account, and Alka and Arushi liable for allowing their trading accounts to be used by Avi for this purpose. In June 2021, Sebi passed an order barring them from the market and fining them Rs 2.1 crore.