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How Sebi can counter insider trading


It is time for the government to leverage the permission layer of applications that leverage Aadhaar, the unique identity number of Indian residents, to enable simultaneous audits and advanced analysis of companies’ activities in the financial markets.

While Sebi’s action against a supposed pre-emptive operation conducted by Axis Mutual Fund dealer Viresh Joshi is commendable and welcome, the intricate nature of the operations discovered suggests the capture was more accidental than inevitable. It represents just one instance of what is likely a large group of fund managers and others who misuse price sensitive information before it reaches the public.

Unpublished price sensitive information (UPSI) is a major obstacle to honesty and scrupulousness in the functioning of stock and bond markets. Those who have access to information that could influence the price of a stock or bond – the so-called insiders – could use it for their own financial gain. This is unfair to investors who do not have access to such classified information.

Let’s say company A decides to acquire company B at a hefty premium to B’s current market price. Experts, key people at A, or his investment banker or attorney, might be tempted to buy B’s stock. hit, which would skyrocket once the takeover is announced and would make a killing. This is just one example of insider trading.

Key employees at mutual funds and pension funds are aware of orders that their funds will place. They can ‘lead’ the fund as it makes the buy/sell decision, make similar purchases in their personal capacity and take advantage of the price changes caused by the fund’s large trades. This is what is known as front running.

Fund managers may also use the fund for personal gain in other ways. They could have the fund buy stocks already in their personal portfolio just to boost their prices, or prevent or delay the sale of such stocks to prevent their value from falling (this is called scalping). These generate thin profit margins because frontrunners and scalpers have to get in and out of stocks in a short period of time before other factors come into play and change price dynamics.

The illegal profits in the case of the Axis Mutual Fund dealer and his associates are pegged at just over 35 crores. But to make these gains, the mutual fund could have suffered greater losses. Savvy investors who keep a close eye on trades executed by people they identify as frontrunners can increase trading volume, causing price changes that may partially negate the planned gains for the fund itself.

The Sebi investigation into Viresh Joshi’s behavior revealed a complex web of “arrangers” and “enablers” who made several demat accounts available to the alleged frontrunner. Ownership of these accounts is split among their friends, parents, spouses, siblings and in-laws, and spread across a geography that spans the Arabian Sea, stretching to Dubai. The investigation revealed aliases 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 details, identification of call locations using cell phone towers, matching of phone number KYC details, subscriber identification modules of various parts of the country, whistleblowers, revealing emails with identically misspelled email addresses from regulators and controlling executives at Axis, indicating blackmail rather than any intent to expose.

It is far from self-evident that such an unfolding of complex networks of deceit and fraud can be easily replicated. There are two other ways to expose and prevent such abusive personal transactions by key personnel at funds.

One is that the asset manager monitors the securities income posted by their employees and their relatives. Abnormally lucrative bills would deserve closer scrutiny.

Another is analyzing, using algorithms, trading patterns in the temporal proximity of large transactions by funds. One-time instances of scalping or front running may escape notice, but any sustained activity would lead to patterns that analysis should be able to pick up on.

Using the permission layer to consolidate an individual’s various financial activities and present a holistic view is the way to go. To do so, market participants in the financial markets would have to agree to have their data identified and monitored.

Technological assistance exists to supplement the kind of detective work required for the Sebi’s action against Viresh Joshi and his associates. It must be used.

A final measure would be to make funds accountable for the activities of their staff, subject to penalties heavier than the treble illegal income Sebi collects from those found guilty of front-running. This would give the funds an incentive to better monitor the behavior of their employees.

Joanna Swanson

Joanna Swanson is Europe correspondent at the Thomson Reuters Foundation based in Brussels covering politics, culture, business, climate change, society, economies and inclusive tech. With specific focus in breaking news, she has covered some of the world's most significant stories.