Mutual fund houses tighten the noose around staff to prevent front-running cases

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Markets watchdog Securities and Exchange Board of India (Sebi) had last week come out with its final order on IIFL and Fidelity front-running cases. The dealers in both the cases, took advantage of their knowledge of impending trades of the funds they were handling, and used mule accounts to put their own orders ahead of these funds. In the process, the dealers made over Rs 4 crore of wrongful gains.

More recently, Axis Mutual Fund had come under scrutiny for irregularities in some of its schemes. While the fund house’s internal investigation is yet to disclose its findings, the allegations are of front-running. Sebi is also probing the matter and Axis MF is keeping it updated with its investigation.

It is not just mutual funds, where front-running can take place, as the IIFL case showed that the dealer was also placing order for IIFL’s Alternate Investment Funds (AIFs).

Mutual fund industry executives say they are putting in place more controls to make sure that any front-running could be clamped down early on.

Monitoring Dealing Activities

Mutual funds have started to look at getting external reviews done of their dealing and trade practices. “We want to these reviews extensively on a quarterly basis. We also want to tighten our whistleblower policy,” said chief executive officer of a fund house, requesting anonymity.

“While some fund houses were already doing it, others are also looking at monitoring the effectiveness of execution. So, when the fund places an order, is there any inconsistency on the number of times it is getting the best-possible price,” said a another chief executive officer, requesting anonymity.

“If the fund is not able to get the best price and that keeps happening, then something might be wrong,” he said.

Former mutual fund CEO and financial industry veteran R Balakrishnan the role of fund manager and dealers should be separate. “While it may not matter so much in a passively-managed fund, in a fund like an arbitrage fund, it is important that there is a distinction,” he said.

In front-running cases, it is often the relatives or friends of the chief perpetrator that are used for their mule accounts.

“Some fund houses, which still didn’t have this mechanism in place, are now seeing how they can gather trade details of the declared relatives and close relatives in a systematic manner from the RTAs’ itself,” the second CEO said.

No Work-from-Home for Investment Team

Mutual fund houses now want all members of the investment team to work from office. “The investment teams need to be in office during the market hours. There won’t be any work-from-home flexibility given to them to work once or twice a week from home,” said a third CEO.

Industry executives say the WFH after Covid-19 had made it difficult to ensure all controls were being implemented in an effective way.

Industry body Association of Mutual Funds in India (AMFI) has also issued an advisory urging mutual funds to withdraw any flexibility given to the employees, especially those handling critical functions such as investment dealing, operations, compliance and risk management.

“Having investment teams fully back in office will ensure that there is no remote system access given to anyone,” the third CEO said.

According to R Balakrishnan, this is more of a culture issue than a control issue. “You can have as many controls, but a dishonest individual can still find a way to indulge in wrongful activities,” he said.

According to him, creating a centralised database can be one of the solutions. “SEBI can create a database of individuals that are caught for any wrongdoing in broking, mutual funds, PMS, AIFs, or any other part of the financial markets. The HRs should be directed to hire only those employees that have clearance from this database,” he said.

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