Here's how SEBI probes irregularities at mutual fund companies

While it is still early to conclude the nature of irregularities, regulatory sources say that wrongdoings like front running can be probed and established, as the necessary surveillance and safety measures are already in place.

So, how does SEBI probe allegations related to front running at mutual funds?

Establishing the chain

The first and foremost step of the probe is to establish the chain of communication.

People familiar with earlier SEBI probes of fund houses say that in the case of mutual funds, the important thing is to understand the manner in which information related to buy or sell orders flow.

“The manner in which an order is executed is fully codified in the regulations and each step leaves a trail that can be very easily established in an audit,” said a person familiar with SEBI probes.

“The investment committee or the fund manager will pass on the order information to the dealing room and the chief dealer will then process the order. The flow is clearly laid down and it is easy for the AMC to identify an irregularity, if highlighted,” added the person on conditions of anonymity.

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Interestingly, SEBI rules clearly state that each and every movement in the dealing room has to be logged and monitored. For instance, every time a member of the dealing room enters or moves out of the dealing room, the entry and exit is logged in the system.

Further, personal phones and laptops are not allowed within the dealing room and so, all communication is though the officials channels, thereby once again logged in the system.

So, if for instance, an irregularity is highlighted in a certain trade or order, it can be easily verified by the chain or the chronology in which the information related to the order was passed and executed.

Identifying the alleged perpetrator

There have been earlier instances of front running at AMCs and orders have been passed against much bigger fund houses, including HDFC MF and Axis MF.

Also Read: Axis MF front running case: SEBI bars Viresh Joshi, 20 others from accessing capital markets

Once SEBI establishes the chain and the persons involved, it focuses on the movement to pinpoint the leak.

“There will always be a lag between the time the fund manager passes on the information to the dealing room to execute a certain trade and the time of the actual trade. That is basically the window the alleged wrongdoer has for front running,” said the person quoted above.

“Now if someone has to trade in that window, then the same cannot be done from the dealing room and he has to step out and use his personal phone to pass on the information. SEBI rules are such that this cannot be done without the system knowing it. The entry/exit from the dealing room will be logged and also his calls,” he said.

Incidentally, SEBI has powers to get the call records of any entity who is the subject of a regulatory probe – a fact corroborated by many earlier SEBI orders.

If there are suspicious transactions, then connecting the beneficiaries through call records and fund trails helps the capital market watchdog to establish the chain and identify the alleged wrongdoers.

“SEBI can triangulate the call records and positions to establish the links that act as solid proof that can stand the test of law in any court,” said the source.

Indeed, as the past is replete with instances when SEBI has used such data and information to establish both the motive and the connivance of a group of individuals while looking into serious wrongdoings including insider trading and front running.

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According to industry players, in the case of Quant Mutual Fund as well, the regulator will only need to put all the pieces of the puzzle in proper place – basis the existing checks and balances -- to unravel the irregularities.