đ§ Scams At Mutual Funds Making Headlines: Why?
Frontrunning scams are all the rage right now. Here's why so many of them are being unearthed at the same time.
Scams and frauds have now become a daily part of our lives and our newspaper headlines.
For instance, just in FY21 India reported 229 bank frauds each day.
But recently a specific kind of scam has taken over the headlines: front running scams.
Wondering what this scam is and why it is suddenly so popular? ReadOn!
â ď¸ The Anatomy of A Scam
Letâs first quickly understand how a front running scam works.
You see, mutual funds offer their clients a large variety of stocks to choose from.
The fund managers and their investment teams decide which stocks they will be buying after appropriate research.
Now, there is a significant time gap between taking the decision to buy the stock and actually buying the stock.
And sometimes insiders who have the knowledge about what stocks the fund will buy are tempted during this period.
So, what they do is buy this stock before the fund decides to do so.
But they can't do this directly. SEBI has norms preventing mutual fund employees from directly profiting through the sale of any securities that they have prior knowledge about for a 30-day period.Â
So, this is done through the accounts of family members or friends or even through brokers.Â
Then when the fund buys the stock in bulk, the price of the stock goes up and these people now have stocks that are much more highly-priced than before.
They then dump these stocks and book profits.
Simple!
Wait, doesnât this sound like insider trading?
Well, yes it kind of is except that insider trading is usually limited to a particular sector or company.
But because large mutual fund houses mostly deal with stocks from all sectors, front running scams are more widespread and cause more harm. How?
You see, if a lot of people buy a particular stock before the mutual fund house buys it, then the stock becomes more expensive for the fund (because increased trading has raised prices).
Also, the price of the stock may fall drastically when all these scammers exit it after the fund has bought it, harming investors.
đ¤ Why is This Scam Suddenly in Vogue?
Well, there could be several reasons behind it and one is Covid (yes, weâll be blaming everything on this pandemic).
With Covid, fund managers, their investment teams and brokers all began working from home.
This made it difficult for fund houses and SEBI to track their communication, making it easy for such scams to perpetrate.
But wait, some scams like the Axis Mutual Fund one have been ongoing since before Covid.
Why are they coming to the forefront now?
The Axis case was a special one.
It was uncovered because of human nature and our instincts to keep a keen eye on the finances of those around us.
You see, some people around the Axis mutual fund manager Viresh Joshi noticed that he was leading a lifestyle much more lavish than he should have been able to afford.
He was driving a Lamborghini!
So, these comments about his extravagance led the mutual fund house and then the SEBI to look into his finances.
But shouldnât the SEBI have better tools than public comments to catch such scammers?
Yes, the SEBI uses AI to keep track of stock transactions that could possibly be motivated by an insider tip.
But this algorithm was so far monitoring large trades by only those connected to fund managers.
So these scammers instead of relying on friends and family started renting demat accounts to make these trades in small batches, thus evading the SEBI.
But now SEBIâs algorithm has caught on to this as well, bringing forth more cases.
The three most recent cases are: Axis Mutual Fund, IIFL, and Fidelity Investments.
While the Axis managers in question have just been sacked with an investigation going on, those involved in the IIFL and Fidelity cases have been asked to return the profits they made, and pay fines worth Rs. 8 and 10 lakhs and have been barred from entering the security markets for 2 years and 5 years respectively.
Whatâs more, to prevent such scams from happening the SEBI is planning on making it mandatory for those working in brokers' terminals and other such posts to work from the office.
Plus, it is seeking permission to decrypt and track digital communications of suspects.
However, this may not be enough. Scams and frauds are definitely something that cannot be prevented (thanks to the ingenuity of criminals and their constantly changing methods), but the SEBI can impose harsher punishments to at least make criminals think twice before committing such crimes.
âĄIn a line: Front running scams are now becoming common because of new fraud techniques and work from home but are also being unearthed thanks to SEBIâs improved algorithm.
đĄQuick question: What more can the SEBI do to stop these scams?
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