SEBI Introduces Rules to Stop Front Running and Insider Trading in Mutual Funds

The Securities and Exchange Board of India (SEBI) has introduced new regulations for mutual funds, mandating asset management companies (AMCs) to establish an institutional mechanism to prevent violations like fraudulent transactions and front-running.

According to a SEBI circular dated August 5, these regulations aim to identify and prevent front-running and fraudulent transactions in securities managed by AMCs. The responsibility for implementing these measures lies with the CEO, managing director, or equivalent officials, as well as the Chief Compliance Officer of the AMC.

SEBI has set a three-month deadline for larger AMCs to implement the new mechanism, while smaller fund houses have a six-month timeframe. Specifically, AMCs with assets under management (AUM) below ₹10,000 crore must comply within six months.

"The chief executive officer, managing director, or equivalent rank, along with the chief compliance officer, will be accountable for implementing the institutional mechanism to deter market abuse, including front-running and fraudulent transactions," SEBI stated while amending the MF regulations on August 2.

AMCs are now required to implement systems and procedures that generate alerts and establish policies for action in cases of market abuse. Possible actions include suspension or termination of employees, brokers, or dealers involved in potential market abuse. Additionally, AMCs must review all recorded communications, such as chats, emails, access logs, CCTV footage, and entry logs to the premises.

SEBI has also instructed fund houses to provide a confidential whistle-blower channel for employees, directors, trustees, and others to report suspected fraudulent or unethical practices.

Furthermore, SEBI will relax the mandate requiring mutual funds to record face-to-face communication, including out-of-office interactions, effective one year from now. Currently, fund houses record all fund manager and dealer communications during market hours.

The Association of Mutual Funds in India (AMFI) is developing a standard operating framework for this mechanism. Presently, mutual funds follow varying internal surveillance practices.

Fund houses must implement a system where alerts for suspicious activity are automatically generated, and they must maintain a record of these alerts, observations, and actions taken. This report will be included in the mandatory half-yearly reports submitted to SEBI.

"We have already strengthened our internal surveillance systems and implemented stringent measures to prevent potential abuse," stated the head of a leading fund house.

SEBI approved the mechanism at its board meeting in April, following instances of front-running by dealers and brokers in mutual funds.

Last month, SEBI also mandated stock brokers to establish an institutional mechanism for preventing and detecting fraud or market abuse. This includes measures such as trading activity surveillance systems, internal controls, and whistle-blower policies. Separately, but on a related note, trading in mutual fund units will also fall under the SEBI Prohibition of Insider Trading regulations, starting November 1.