Explained: Why is Sebi probing Quant MF and how will it impact investors?

Sebi's investigation stems from red flags raised by their surveillance system. These flags indicated a potential pattern where trades by certain entities closely mirrored those of Quant Mutual Fund

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Market watchdog Securities and Exchange Board of India (Sebi) is looking into investment company Quant Mutual Fund because of suspected irregularities in how they manage investments.  

Here's a breakdown of the reasons:

• Sebi noticed discrepancies during their regular inspections of Quant MF.
• These concerns could be related to activities like front-running, where someone uses privileged information to make trades before clients, giving themselves an unfair advantage.
• Front-running is a deceptive practice where someone with advanced knowledge of upcoming trades uses that information to make personal securities purchases before executing client orders. This allows them to profit unfairly by manipulating the market.

Here's an example:

• Imagine "ABC Mutual Fund" decides to invest heavily in a particular mid-cap stock called "XYZ Ltd." due to its strong growth potential.
• A fund manager at ABC, aware of this upcoming large purchase order, might be tempted to engage in front-running:
• Before placing the official order for ABC Mutual Fund, the fund manager uses their own personal brokerage account to buy a significant amount of XYZ Ltd. shares at the current market price.Once ABC Mutual Fund places its large order, the demand for XYZ Ltd. stock skyrockets due to the sheer volume. This drives the price up significantly .
•  The fund manager then quickly sells their own shares of XYZ Ltd. at the inflated price, profiting from the information they had about the upcoming large purchase by their own fund.

Raghu Kumar, a certified financial planner, explains the impact of Front Running investigation result for investors:

• If the fund managers are involved in this front running scam, they are going to be penalized and will be removed from their current roles, which will raise a question mark on the performance of the funds.
• If this is done by the dealers or other employees who are not engaged in the stock shortlisting exercise. They will also be removed from their current roles. However, this won’t have a significant impact on the fund performance.
• In both of these scenarios, Asset Management Company will adopt strict and advanced measures to ensure this kind of instances do not repeat in future and investors interest is safeguarded.

Where did this Sebi probe stem from?
According to reports, Sebi investigation stems from red flags raised by their surveillance system. These flags indicated a potential pattern where trades by certain entities closely mirrored those of Quant Mutual Fund. This similarity suggests that someone might have been leaking information about upcoming fund purchases, allowing others to capitalize before the price rose due to Quant's large order.

Sebi's actions:

• Search and Seizure: Sebi conducted raids at Quant's headquarters in Mumbai and the suspected beneficiaries' location in Hyderabad.
• Digital Device Seizure: Sebi allegedly  seized mobile phones and computers to analyze digital communication and potentially uncover suspicious activity.

Why is Sebi suspicious?

Matching transactions: Sebi's surveillance system flagged a pattern – transactions by unknown individuals (suspected beneficiaries) suspiciously matching Quant MF's trades.

Information leak: Sebi suspects someone within Quant or the brokerage firm they use might be leaking confidential information about upcoming trades. This information could be used by the "suspected beneficiaries" to make profitable trades before the official execution, giving them an unfair advantage.

Who is Sebi targeting?

Quant Executives: Sebi is likely focusing on Quant executives with access to non-public trade details like order size and timing. These are the individuals who could potentially leak such information.

Suspected Beneficiaries: Sebi will likely question these individuals to understand their connection to the alleged insider trading and how they might have profited from leaked information.

 Quant MF confirmed that it has received inquiries from Sebi

The email said, “We want to assure you that Quant Mutual Fund is a regulated entity, and we are always fully committed to cooperate with the regulator throughout any review. We will provide all necessary support and continue to furnish data to SEBI on a regular and as-needed basis.”

Founded by Sandeep Tandon, Quant MF has been one of the fastest growing mutual fund in the country. The fund house received SEBI approval to enter MF business in 2017. It crossed assets of Rs 50,000 crore in January with 26 schemes and 54 lakh folios. Quant MF has seen significant growth in recent years driven by retail inflows. Its AUM surged from Rs 233 crore in March 2020 to Rs 80,470 crore presently.

Sandeep Tandon is the founder of Quant group, with over 25 years experience in the financial services industry. At present, Sandeep oversees investment decisions in 22 schemes at Quant Mutual Fund.

What will be the impact on investors? 

"Quant MF funds have enough large cap investments in even small and mid funds of theirs. Both the funds have almost 10% each in Reliance alone. Liquidity is not a problem at all from the redemption perspective if at all. There might be selling in mid & small stocks that Quant holds and expect some under performance by the funds in the near term. What will happen to the funds in the long run is any body’s guess. If SEBI finds front running, flows will slow down / redemptions will happen and hence near term under performance but their process to select stocks have been working well and if the funds deliver returns, investors memory is weak and we all know that," said  Kirtan Shah, founder of Credence Wealth Advisors LLP,  on X.

Will front running affect mutual fund unitholders? 

"Yes. The personal orders by the fund manager and associates can be large enough* to drive up the price before the AMC buys the stock. *If it is not large enough, why would the matter come to light?!

Naturally, now, many investors may want to exit. This could cause redemption pressure and affect the NAV. Some market players may short the large holdings of the fund house. No one can predict what will happen. My guess is that redemptions will increase, but it may not be so high to affect the NAV too much. Things should settle down in a few days. For now, the fund manager can use the cash equivalents or large cap stock to handle redemptions," said M Pattabiraman,  Associate professor, IIT Madras and author of the book ""You can be Rich Too".

Apart from Quant, some other mutual fund houses are also suspected of irregular activities. These activities could involve things like insider trading and front-running, which are illegal and disadvantage investors.

SEBI's actions:

• To prevent such practices in the future, SEBI recently announced new rules. These rules require mutual fund companies (AMCs) to have better monitoring systems and internal controls. This will help identify suspicious activity and prevent insider trading and front-running. 
• Sebi is also placing more responsibility on AMC management to ensure ethical practices.
• To encourage whistleblowing and transparency, AMCs will need to implement mechanisms for employees to report suspicious activity.

Earlier Action:

• SEBI already extended insider trading regulations to cover mutual funds.
• This prevents employees from using unpublished price-sensitive information for personal gain.