Monday, October 11, 2010

MFs must tighten controls to prevent front-running

Back in June this year, market regulator Securities and Exchange Board of India (Sebi) revealed that an investigation had revealed that an equities dealer at HDFC Mutual Fund had been misusing his position to illegally make money in the stock markets.

This dealer would leak advance information of the mutual funds’ stock trades to his accomplices. They would then buy and sell before HDFC Mutual Fund itself did, thereby making money for themselves while causing incidental loss to the mutual fund, or rather, to the mutual fund’s investors.

At that time, Sebi fined HDFC Mutual Fund and banned Nilesh Kapadia (the rogue dealer) from participating in the securities market. It also asked HDFC to overhaul its internal controls and procedures to ensure that this sort of thing didn’t happen again.

I had heard that the incident had triggered panicked reaction in a large number of businesses that trade in equities on behalf of investors. Mutual funds, portfolio management services and insurance companies scrambled to figure out how vulnerable they were to something like this.

From what I know, many of them came to the conclusion that they could not guarantee that a determined and clever operator would not do the same thing. However, as far as investors were concerned, the matter seemed to blow over. Certainly, HDFC Mutual Fund itself seems to have gotten away without any detectable damage to its image among investors.

However, a couple of days ago, a more alarming piece of news has come out. Sebi has stated that it is now engaged in investigating 10 more mutual funds companies for possible cases of front-running. At this stage, they are just investigating and Sebi may or may not discover any actual wrong-doing. Also, it is notable that Sebi did not come out with this information willingly. Instead, it revealed it only in response to an Right To Information (RTI) request by a newspaper.

However, no matter how the investigations go, it is clear that front-running can only be curbed by organisations if they are internally committed to doing so. One important component of this commitment is that such actions should get exemplary punishment. Not just that, the responsibility for laxity in internal controls should actually be considered the real cause for losses suffered by investors. And these things should be done and not just seen as being done.
Those who manage other people’s money have a finite amount of trust and trust once spent is hard to earn back.

Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/analysis/MFs-must-tighten-controls-to-prevent-front-running/articleshow/6726754.cms

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