Frontrunning may not be so easy after SEBI whip

Relocating dealing desk to AMC premises, introducing concept of AMC Broking Houses and increasing penal measures like debarment and exponentially huge fine may check frontrunning to a great extent.

Securities and Exchange Board of India’s (SEBI) direction to create an institutional framework for frontrunning is a welcome move. The circular could have been more blunt and direct with respect to creation of ‘specific’ market infrastructure to minimize instances of frontrunning.

The menace of frontrunning: In simple words, frontrunning means running ahead of somebody. In market parlance, if somebody is buying shares ahead of big order by institutional clients and sells the same after increase in share prices due to that big order, it is called frontrunning. It can be of several types. For example, buying of shares before telecast of stock recommendation by an expert; buying shares before rebalancing of index; buying shares before publication of research paper by big broking houses; buying stocks before its inclusion in derivative segment are some instances of frontrunning. In this article, we are discussing the 5^thAugust 2024 circular of SEBI related to frontrunning.

The existing mechanism: The mutual fund houses have a set mechanism of buying stocks. The Equity Research Department recommends equities based on fundamentals. The stock is examined on technical parameters. The recommendations are sent to the Executive Director (Investment). He is flooded with such research recommendations. He takes a call on buying/selling stock based on decision of investment committee. The recommendations are sent to fund managers of related mutual funds. They take a decision and send their requirement to the dealing room. The dealing room has empaneled list of Stock Brokers and their dealers. The buy/sell orders are passed on to such brokers/dealers. The process involves flow of information outside the premises of mutual houses in the last leg of investment when the recommendations are passed on to brokers/dealers. This is a weak point.

In most of the cases of frontrunning, the brokers/dealers have taken positions in personal account or in the account of their high net worth investors before executing order of the mutual fund houses. This distorts the market framework.

The remedial measures: A simple remedy of this frontrunning menace is to set up Brokers’ desk in the mutual fund premises itself and govern this desk with the same rules and regulations which apply to the Department of Equity Research, Department of Investment and Dealing room officials of mutual fund houses. Further, the mutual fund houses should be given NSE/BSE membership so that they are not dependent on ‘outside’ broking entities for execution of buy/sell order.