Described: What front-running is, and why is Sebi looking at Quant Mutual Funds

The Securities and Exchange Board of India (Sebi) is reportedly conducting an investigation into Quant Mutual Fund (MF) regarding alleged front-running activities. This involves accusations that certain individuals within the fund may have engaged in unethical trading practices for personal gain.

According to media reports, the market regulator executed search and seizure operations at various locations in Mumbai and Hyderabad. During these operations, Sebi questioned Quant dealers and other individuals connected to the case to gather more information.

Here’s an explanation of what is happening at Quant Mutual Fund, one of India’s fastest-growing asset managers.

First, let's clarify what front-running entails.

Front-running occurs when a mutual fund manager or trader executes orders on a security for their own account before executing orders for their clients. This gives the trader an unfair advantage, as they can profit from the expected movement in the security’s price that results from the larger client orders that follow.

Is front-running illegal?

Yes, front-running is considered highly unethical and illegal. It exploits confidential information and undermines the integrity of the market. This practice breaches the trust and fiduciary duty that fund managers owe to their clients. Regulatory bodies like Sebi enforce strict rules to prevent such activities and ensure fair and transparent markets.

Amit Goel, Co-Founder & Chief Global Strategist at Pace 360, explained, "Front-running essentially involves buying stocks before the fund itself does, driving the price up. This means the fund buys at a higher price, potentially impacting returns for investors."

He added, "Front-running erodes investor trust in the fund house, which can lead to redemptions, affecting the fund's Net Asset Value (NAV). The investigation itself can create uncertainty, causing investors to hold off on further investments or even redeem existing ones until the situation is resolved."

How worried should investors be?

For ordinary investors, front-running can have several negative consequences:

- Higher cost: Investors might end up paying more for securities due to artificial price movements caused by front-running.
- Less favourable prices: The advantage held by front-runners often results in worse trade execution prices for regular investors.
- Erosion of confidence: When such practices come to light, it shakes investor confidence in the fairness and integrity of financial markets.

However, Goel reassures that in most cases, investor money in mutual funds is held securely. "Even if the fund house is penalized, investor money is typically not directly at risk. Sebi, as the regulator, focuses primarily on protecting investor interests," he said.

What is Quant Mutual Fund saying?

Quant Mutual Fund has acknowledged receiving inquiries from Sebi. In a statement, the fund house said, "We will provide all necessary support and continue to furnish data to Sebi on a regular and as-needed basis."

Quant Mutual Fund, which has grown rapidly from managing Rs 100 crore in 2019 to over Rs 93,000 crore currently, is now under scrutiny for its internal practices. Sebi’s reported action against Quant highlights its commitment to maintaining market fairness.

It’s worth noting that this isn’t the first time Sebi has taken such actions. In 2022, a similar investigation into Axis Mutual Fund for front-running resulted in 21 entities being barred from accessing capital markets.

What could be the consequences?

The findings of the investigation could impact some of the smaller stocks held by the fund, such as RBL Bank Ltd., Aarti Pharmalabs Ltd., and Ador Welding Ltd. If Quant Mutual Fund or any of its individuals are found guilty of front-running, they could face severe penalties, including fines, suspension, and possible legal action.

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