Mutual funds are often seen as safe havens for retail investors—professionally managed, diversified, and regulated. Yet, behind the glossy brochures and promise of fiduciary responsibility lies one of the most insidious practices in financial markets: front-running.
Front-running occurs when insiders exploit advance knowledge of a fund’s large trades to make personal profits. This not only erodes investor trust but also undermines the very foundation of fairness in financial markets. Over the years, several high-profile front-running scandals have rocked the mutual fund industry in India and globally, exposing the cracks in surveillance and regulatory enforcement.
This article explores how front-running works, why it’s so damaging, key scandals where SEBI intervened, and what reforms are necessary to protect investor interests.
What Is Front-Running?
Front-running is the illegal practice where fund managers, dealers, or associated brokers trade securities for personal benefit based on advance, non-public knowledge of large trades a mutual fund is about to execute.
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Mechanics:
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A fund decides to buy/sell a large block of shares.
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Insiders aware of this trade buy before (in case of a purchase) or sell before (in case of a sale).
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Once the fund executes, the large order moves the price in the insider’s favor.
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The insider exits, pocketing the difference.
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Example:
If a fund is about to buy 10 lakh shares of a company, an insider buys shares in advance. When the fund’s massive order drives up the price, the insider sells at a profit.
Why Front-Running Is Scandalous
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Betrayal of Trust
Investors trust fund managers to act in their best interest. Front-running directly betrays this fiduciary duty. -
Unfair Advantage
Insiders exploit non-public information, violating principles of transparency and fairness. -
Investor Losses
The fund pays inflated prices (in case of purchases) or receives depressed prices (in case of sales), directly hurting investor returns. -
Reputational Damage
Every scandal erodes confidence in the mutual fund industry, deterring retail participation.
Historic Front-Running Scandals in India
1. HDFC Mutual Fund Case (2014)
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Incident: SEBI investigated instances where insiders allegedly leaked trade information from HDFC Mutual Fund. Brokers used this information to profit from advance trades.
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Outcome: SEBI banned several brokers and individuals, though evidence against fund executives remained circumstantial.
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Lesson: Even top fund houses can be vulnerable to collusion between dealers and brokers.
2. Axis Mutual Fund Front-Running Scandal (2022)
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Incident: In May 2022, Axis Mutual Fund suspended two fund managers—Viresh Joshi (Chief Dealer) and Deepak Agarwal—on allegations of front-running.
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Mechanism: They allegedly leaked fund trading information to certain brokers who made profits. In return, kickbacks were routed back to the fund managers.
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Impact: NAVs of some Axis schemes were questioned, and investor confidence took a hit.
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SEBI’s Response: Investigations are ongoing, with SEBI imposing penalties on intermediaries involved.
3. Religare and Sundaram Fund Cases (2010–2012)
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SEBI penalized dealers and brokers in multiple cases where fund orders were shared with external parties. Though not as large as Axis, they exposed systemic vulnerabilities.
Global Parallels
Front-running is not unique to India.
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United States: The 2003 mutual fund scandal saw hedge funds colluding with brokers to engage in front-running and late trading, leading to billions in penalties.
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UK & Europe: Regulators have repeatedly cracked down on fund dealers misusing order flow information.
SEBI’s Regulatory Framework Against Front-Running
SEBI treats front-running as a form of fraudulent and unfair trade practice (FUTP) under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003.
Key measures include:
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Surveillance Systems: Exchanges and SEBI track unusual trading patterns.
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Dealer Rotation: Mutual funds are encouraged to rotate dealers to prevent entrenched collusion.
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Broker Audits: Fund-broker relationships are monitored for unusual trades.
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Whistleblower Protection: Insiders can report misconduct anonymously.
Yet, detection remains difficult because front-running often involves subtle trades across multiple accounts.
The Mechanics of Collusion
Front-running often involves multiple actors:
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Fund Dealer: Leaks upcoming trades.
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Broker: Executes advance trades in personal or associate accounts.
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Kickbacks: Profits are shared through cash, offshore accounts, or bogus consultancy fees.
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Fund Manager: May turn a blind eye if involved in profit-sharing.
The sophistication of networks makes enforcement challenging.
Why SEBI “Looks Late”
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Proof of Intent: Proving that a trade was based on leaked information, not mere speculation, is difficult.
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Delayed Detection: Investigations often occur months later, by which time evidence is diluted.
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Low Penalties: Fines, often in crores, may not deter scams that generate higher illegal profits.
Impact on Investors
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Erosion of NAVs: Funds end up buying higher or selling lower, directly hurting investor wealth.
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Exit Pressure: When scandals break, retail investors panic and redeem units, hurting fund stability.
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Systemic Distrust: Repeated front-running cases discourage long-term retail participation in mutual funds.
How to Protect Against Front-Running
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For Investors:
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Choose fund houses with strong governance and transparent practices.
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Avoid chasing short-term performance; look at compliance history.
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Track fund manager turnover and disciplinary actions.
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For Regulators:
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Strengthen surveillance with AI-driven anomaly detection.
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Impose stricter penalties, including jail terms for fund insiders.
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Increase accountability of trustees for fund operations.
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For Fund Houses:
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Segregate dealing and compliance teams.
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Rotate dealers frequently.
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Deploy independent audits of trade execution.
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Ethical Dimension
Front-running strikes at the moral core of investing. It transforms professionals entrusted with safeguarding retail wealth into predators exploiting privileged access. More damaging than monetary losses is the erosion of faith in collective investment vehicles.
As Indian households increasingly embrace mutual funds, the industry’s credibility depends on zero tolerance for such practices.
Conclusion
The scandal of front-running in mutual funds is not just about illicit profits; it is about breach of fiduciary trust. From the HDFC case to Axis Mutual Fund in 2022, each episode has shown that even marquee institutions can succumb to greed.
For SEBI, the challenge lies not only in punishing offenders but also in building deterrence through stricter laws, higher penalties, and advanced surveillance. For fund houses, the mandate is ethical clarity—investors’ trust must outweigh dealer profits.
Until front-running is eradicated, every retail investor remains vulnerable to invisible theft from within. The scandal may be recurring, but so too must be the fight against it.
