Sebi takes measures to curb front running, insider trading in mutual funds

To curb front-running and insider trading in mutual funds, the Sebi board on Tuesday decided to amend the regulatory framework by requiring Asset Management Companies (AMCs) to put in place an institutional mechanism for identification and deterrence of potential market abuse.

Also, the board decided to enhance responsibility and accountability of management of AMCs for such an institutional mechanism.

Further, the regulator is looking to foster transparency by requiring AMCs to have a whistle blower mechanism, Sebi said in a press release issued after the conclusion of the board meeting.

This is the second board meeting in as many months after the meeting on March 15.

The institutional mechanism, which is expected to detect and report possible misconduct by AMCs’ employees, dealers, stock brokers or any other connected entities, should 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, misuse of sensitive information among others.

This comes in the wake of Sebi passing orders in two instances of front-running pertaining to Axis AMC and Life Insurance Corporation of India (LIC).

In the Axis AMC case, broker-dealers, certain employees and connected entities were found to have front-run the trades of the AMC and in the case of LIC, an employee of a listed insurance company was observed to be front-running the trades of the company.

”Considering the recent front-running instances observed by Sebi, the board approved amendments to Sebi (Mutual Funds) Regulations, 1996 for enhancing the existing regulatory framework by requiring AMCs to put in place a structured institutional mechanism for identification and deterrence of potential market abuse including front-running and fraudulent transactions in securities,” the regulator said.

While Sebi will specify the broad framework of the institutional mechanism, the industry body Association of Mutual Funds in India (AMFI), in consultation with the markets regulator, would specify detailed standards for such an institutional mechanism.

Further, with respect to the requirement of recording all communication by dealers and fund managers, the board approved exemption from the requirement of recording face-to-face communication, including out-of-office interactions, during market hours. This will be made effective after implementation of the institutional mechanism by the AMCs.

Additionally, the regulator has streamlined prudential norms for passive schemes with respect to exposure to securities of group companies of the sponsor to facilitate a level-playing field for mutual funds.

The board approved amendment to mutual fund rules allowing equity passive schemes, on indices to be specified by Sebi, to take exposure up to the weightage of the constituents in the underlying index. This exposure would, however, be subject to an overall cap of 35 per cent investment in the group companies of sponsor.

Currently, mutual fund schemes are not allowed to invest more than 25 per cent of their net asset value (NAV) in group companies of the sponsor.

The present rule restricts the passive funds to effectively replicate the underlying index, in cases where group companies of sponsor comprise more than 25 per cent in the index. This also puts such AMCs to a relative disadvantage as compared to other AMCs who may not have a sponsor group companies comprising more than 25 per cent in the underlying index.