SEBI investigates Choice Broking on front-running suspicions, say sources; brokerage denies regulatory action

Sources told Moneycontrol that SEBI's probe by the surveillance department allegedly revolved around suspicious trading activity. Officials had gone to investigate front-running of a big client's trades but, according to sources, there appeared to be evidence to suggest that the brokerage's employees were involved in front-running multiple big clients' trades.

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"In fact, there seems to have been a parallel trading system set up for this," said one of the persons, adding that this trading system would be used to place orders before the dealer punched in the big client's orders.

Front-running involves an entity privy to non-public information about a big investor's trades (buying or selling of securities). This entity then uses this knowledge to benefit from the subsequent big investor's trades. It can cause substantial losses to the big investor, usually an institutional client like a portfolio management service or a mutual fund or proprietary firm.

A source explained why a broker doing such activities would be particularly concerning: "Brokers often handle multiple high-value orders from various big clients. This puts them in a position of immense influence and responsibility. Any misuse of this privileged information can lead to substantial financial losses for clients and can severely impact market fairness and transparency."

Front-running trades can be executed in two patterns—the buy-buy-sell (BBS) pattern or sell-sell-buy (SSB) pattern. In this particular instance, according to sources, the BBS patterns were observed more.

Here's how SEBI's previous orders, following investigations into other front-running entities, defined these patterns of trading:

Buy-buy-sell (BBS): In this type of front-running behaviour, a broker, by using the non-public information regarding an impending buy order of the big client, places his buy order before the execution of the client’s. As a result, by the time the client's buy is  executed, the price of the security would have risen and then the front-runner sells the securities bought earlier at the higher price, pocketing the difference. The BBS pattern of front-running denotes ‘buy’ by the front-runner, 'buy’ by the client and ‘sell’ by the front-runner, in that order.

Sell-sell-buy (SSB):Here, the sequence is reversed: ‘sell’ by the front-runner, ‘sell’ by the client and ‘buy’ by the front-runner. The broker in this instance uses the non-public information regarding an impending sell order from the client and places his sell order(s) before that of the client goes through. When the client's sell order is executed, it is at a price lower than it would have been had the broker not sold first, which allows the front-runner to buy back the securities at a lower price to meet his obligations which he had created earlier by selling securities.