It is time the government leveraged the consent layer of applications that use Aadhaar, the unique identity number of Indian residents, to enable simultaneous audits and sophisticated analysis of companies’ activities in the financial markets.
It is time the government leveraged the consent layer of applications that use Aadhaar, the unique identity number of Indian residents, to enable simultaneous audits and sophisticated analysis of companies’ activities in the financial markets.
While Sebi’s crackdown on an alleged front-running operation carried out by Viresh Joshi, a trader for Axis investment funds, is commendable and welcome, the complicated nature of the operations uncovered suggests the catch was accidental rather than inevitable. She is just one example of what is likely a large group of fund managers and others who misuse price-sensitive information before it becomes public.
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While Sebi’s crackdown on an alleged front-running operation carried out by Viresh Joshi, a trader for Axis investment funds, is commendable and welcome, the complicated nature of the operations uncovered suggests the catch was accidental rather than inevitable. She is just one example of what is likely a large group of fund managers and others who misuse price-sensitive information before it becomes public.
Unpublished Price Sensitive Information (UPSI) is a major hurdle to fairness and scruples in the functioning of stock and bond markets. Those who have access to information that could affect the price of a stock or bond — known as insiders — could use it for their own financial gain. This is unfair to investors who do not have access to such undisclosed information.
Suppose Company A decides to acquire Company B at a hefty premium to B’s current market price. Those in the know, key people at A, or his investment banker or attorney, might be tempted to hoard B’s stock, which would skyrocket and make a huge profit once the acquisition was announced. This is just one example of insider trading.
Key people at mutual funds and pension funds are aware of the orders their funds are about to take. They could “run ahead” of the fund in making the buy/sell decision, make similar purchases in their private capacity, and benefit from price changes caused by the fund’s large transactions. This is called front running.
Fund managers can also use the fund in other ways for their own personal benefit. They could get the fund to buy stocks already in their personal portfolio just to increase their prices, or prevent or delay the sale of such stocks to prevent their value from falling (this is known as scalping ). These generate small profit margins as front-runners and scalpers need to enter and exit stocks on short timeframes before other factors come into play and change price dynamics.
The illicit profits in the case of the Axis mutual fund trader and his associates are estimated to be slightly higher €35 crores. But to make those gains, the mutual fund could have suffered bigger losses. Savvy investors who closely monitor trades by those they identify as top performers could increase trading volume and cause price changes that could partially offset the profit projected for the fund itself.
The Sebi investigation into Viresh Joshi’s behavior revealed a complex web of “arrangers” and “enablers” who provided a variety of demat accounts for the alleged front-running. Ownership of these accounts is divided between their friends, parents, spouse, siblings and in-laws and stretches across the Arabian Sea to Dubai. The investigation revealed code names such as “Jadugar” and “Asdfg”.
Full-time Sebi member SK Mohanty’s order reads like the script of a Netflix crime thriller, with not only assumed names but also call recordings, identifying call locations using cell towers, matching KYC details of phone numbers, subscriber identification modules from different parts of the Landes, whistleblower, revealing emails with identical misspelled recipient email addresses from regulators and controlling managers at Axis, suggesting blackmail rather than detection intent.
It is far from obvious that such an unwinding of complex webs of deception and fraud can be easily reproduced. There are two other ways to detect and prevent such abusive personal dealings by key people at funds.
On the one hand, the asset management company monitors the income from the securities booked by its employees and their families. Abnormally lucrative accounts would merit further scrutiny.
Another is to use algorithms to analyze trading patterns around the time of major fund trades. One-off instances of scalping or front running might escape attention, but any sustained activity would produce patterns that analytics should be able to spot.
Using the consent layer to consolidate different financial activities of an individual and present a holistic picture is the best choice. For this, the actors in the financial markets would have to agree to the identification and verification of their data.
There’s technological support to complement the kind of detective work that went into Sebi’s action against Viresh Joshi and his allies. It should be used.
A final measure would be to hold funds accountable for the activities of her staff and face penalties greater than triple the illicit revenue Sebi collects from those found guilty of front-running. That would give the cash registers an incentive to monitor the behavior of their employees more closely.
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