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Axis Mutual Fund saga: What the recent MF controversy is and what can be done to safeguard investors

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By Sagar Kapadia

With great power comes great responsibility; and while wielding power is easy, fulfilling responsibilities is often overlooked. This is what played out in the recent Axis Mutual Fund ruse where a fund manager and an analyst allegedly skirted their regulatory and legal responsibilities towards investors and their fund house. 

While the allegations against them are still under investigation, the duo is believed to have indulged in front-running while employed at the seventh-largest mutual fund in the country. This illegal practice, also called tailgating, involves the trade of securities prior to the fund’s transactions on behalf of investors, allowing incumbents to take advantage of likely price movements. 

Here’s a deep dive into how a mutual fund manager stands to gain unearned rewards from this type of fraud. Fund managers typically identify worthy or investable stocks in advance by leveraging research, analysis and knowledge of market trends. Armed with this data, opportunists can get in front of the trade by passing information to a known dealer. Since large buy/sell orders have the power to move stock prices, the dealer buys or sells huge quantities of the same stock before the fund house makes a move. 

When the fund house finally does buy or sell the target shares, their price undergoes a significant increase or decrease due to the size of the order. Once the price moves positively, the dealer sells already purchased shares or buys back already sold shares at a substantially higher or lower value, radically amplifying his earnings within just a few hours. 

Frequent and well-planned front-running can result in enormous ill-gotten gains; and using mule accounts of associates and partners instead of his own can help a dealer duck responsibility. Through a variety of kickbacks, the dealer then transfers a slice of the stolen pie back to the fund manager, who uses it to enjoy a lavish lifestyle that is discordant with his lawful earnings. 

In fact, it was the excessive lifestyle of one of the fund managers – who stood out not only for driving a Lamborghini, but also owning multiple houses in Mumbai – that put him under the scanner of both SEBI and the fund house. Axis MF was reportedly conducting a suo moto investigation since February, 2022, and has suspended both fund managers for “potential irregularities”. 

While they have been stripped of their roles, no longer managing the 7 MF schemes previously under their purview, this is a matter of grave concern. While most fund houses have formidable control measures to eliminate front-running and other fraudulent activities, they cannot exist in a vacuum, especially without the right WFH policies and data security measures. 

As you can imagine, this is hardly the first time that a fund manager has used his position for personal profit. Another chapter in the front-running story unfolded in December, 2021, when Deutsche Mutual Fund’s fund manager was allegedly found guilty of breaching the Prohibition of Fraudulent and Unfair Trade Practices regulation. In this case, the mule accounts belonged to none other than his parents, who settled the case with SEBI by paying a whopping Rs5 crore. 

Early last year, the market regulator took action against three other people involved in front-running Reliance Capital Mutual Fund (RCMF) trades. Apart from being prohibited from participating in capital markets for 6 months, they were also asked to cede the illegal revenue. That’s not all! In December, 2020, SEBI banned 16 others (including employees of Sterling Group and Sharekhan along with their friends and family) from capital markets for 5 to 7 years. The main perpetrators in this case were asked to remit unlawful gains of Rs.18.98 crore. 

Considering the past and present landscape of MF fraud, the question arises – Kya mutual funds sach mein sahi hain? While the plethora of ads gracing TV screens and smartphones mention that all mutual funds are subject to risk, what retail investors are unaware of is the common and growing risk of front-running. These transgressions have not just made headlines but also eroded trust and impacted returns accrued by fund houses and their clients. 

Some of the ways that SEBI can address this issue would be to not only audit mutual fund houses regularly, but also their managers who possess sensitive or confidential information. Harsher penalties, fast-tracking of all such investigations, and yearly submission of the net worth of top management and managers of mutual funds can together help crack  down on such wrongdoings. 

As Indian Inc continues to grow and bolster the country’s GDP, it is only by upholding their fiduciary responsibility that AMCs and other financial institutions can keep the market ecosystem transparent, stable and attractive. 

(Sagar Kapadia is the Vice President of Forensics, Research & Due Diligence at Marwadi Financial Services. Views expressed are the author’s own. .com does not bear any responsibility for their investment advice)

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