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Understanding how SEBI probes irregularities at mutual fund companies

ICICIdirect 7 Mins 10 Jul 2024

Have you ever thought that your mutual is not passing all the returns it makes from your money? Or if something fishy is happening behind the walls? Good if you have such questions. As it is essential to ask such questions. In the past, there has been news of wrongdoings by Asset Management Companies (AMCs). However, the good news is that SEBI, every time, has been able to punish the wrongdoer. How exactly is SEBI doing it, and what are the rules for AMCs. We look at all the details in this article.

Rules for AMCs

Concerning buying and selling of underlying assets, here are some of the rules AMCs need to follow:

  • Portfolio Disclosure: AMCs are required to disclose the portfolio holdings of each scheme regularly, allowing investors to understand the underlying assets they are invested in.
  • Transaction Reporting: SEBI regulations mandate reporting of all buy and sell transactions of underlying assets to ensure transparency and prevent manipulative activities.
  • Fair Dealing: SEBI regulations emphasize fair dealing for all investors. AMCs must ensure all schemes get access to investment opportunities at fair market prices.
  • Insider Trading Prevention: AMCs have strict guidelines to prevent insider trading. This includes restrictions on employees and related parties from dealing in underlying assets based on non-public information.

How does SEBI handle the regulations at AMCs?

To understand how SEBI handles the regulation, we need to understand the below two terms:

  • Front Runner: front running is an unethical practice where someone uses privileged information about upcoming trades to make personal profits for themselves or someone else before the actual trade is executed for the intended client.
  • Dealing Room: It is a department within an AMC responsible for executing buy and sell orders for the various mutual fund schemes it manages.

SEBI strictly prohibits front-running by AMC personnel. It is to ensure fair dealing for all mutual fund investors. SEBI has established a chain of communication to ensure it does not happen. As per SEBI guidelines, every order to buy or sell a stock should have a trail that should be easily established in an audit.

The fund manager should pass an order to the dealing room, and the chief dealer has to process the order. As you would have figured out by now, the dealing room is the only place where front running can happen. So close tracking of it is required. And how AMCs take care of it? We look in the next section.

What measures do AMCs take to maintain regulations?

Rules are fine, but how are AMCs ensuring these regulations are implemented, and nothing wrong happens. The first thing most AMCs do, as per SEBI mandate, is put in place a system to track and log every movement in the dealing room.

For example, every time a member makes an entry or exit from the dealing room, an entry is created in logs. So, once the fund manager passes the order and an exit is logged, it should be marked as a red flag for AMC to evaluate.

Apart from this, AMCs ensure that personal laptops and phones are not allowed in the dealing room and all communication is logged in the system.

Benefits of SEBI's vigilance to investors

Below are the benefits of SEBI's vigilance to investors:

  • Prevents Insider Trading and Front Running: SEBI's regulations and compliance checks make it difficult for AMC personnel to misuse insider information for personal gain. It ensures all investors have a fair chance and protects them from manipulative activities.
  • Valuation Practices: SEBI regulations ensure AMCs have proper valuation processes for underlying assets. It leads to an accurate calculation of the scheme's Net Asset Value (NAV), which reflects the per-unit value of the investor's holding.
  • Ethical Practices: SEBI's vigilance encourages ethical practices within AMCs, which fosters investor trust and confidence in the mutual fund industry.

Before you go

We hope the article would have given you confidence in mutual fund investing if there was a doubt or question mark. The SEBI’s process for probing irregularities at mutual fund companies is comprehensive and rigorous. It involves detection, preliminary assessment, formal investigation, evidence collection, and enforcement actions.

Through this systematic approach, SEBI ensures that mutual fund companies adhere to regulatory standards, maintain transparency, and protect investor interests. This regulatory oversight is crucial for maintaining the integrity and stability of the mutual fund industry in India.

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