Why is front running unethical and what can be done to prevent it? An explainer

In February, The Securities and Exchange Board of India (SEBI) declared that it had imposed a ban on Viresh Joshi, the former chief dealer of Axis Mutual Fund, and 19 other individuals in connection to a case of front running.

The market regulator found that wrongful gains of ₹30.5 crore had been made due to the suspected front-running activities and ordered for these proceeds to be confiscated from the implicated entities.

To understand this piece of information better, we decode what is front-running in this article.

What is front running in the stock market?

The Indian stock market has seen a lot of growth in recent years, and it has attracted a lot of investors from all over the world. This has resulted in increased competition in the market, and with it has come the increased risk of market manipulation.

Front running is one such form of market manipulation that occurs when a broker or trader executes a trade on behalf of a customer and then trades ahead of that customer’s order to benefit from the ensuing price movement. It is illegal in many countries and is considered a breach of fiduciary duty by the broker or trader. The trader or broker profits at the expense of their customer by exploiting the customer’s order.

It is a type of insider trading that occurs when a broker or trader is privy to the details of a customer’s trade and then uses that information to their own benefit. This can be done by executing their own trade ahead of the customer’s order and then profiting from the price movements which occur as a result of the customer’s order.

For example, a broker might use knowledge of a major institutional order to purchase the same stock from his personal account before the order takes place. The broker then sells the stock after the order is executed, making a profit from the increase in the stock price. This practice is illegal and unethical as it creates an unfair advantage for the broker and can be detrimental to the market as a whole.

Front running is a serious concern for investors as it erodes their confidence in the market. It also distorts the price discovery process and can lead to market manipulation.

How to prevent front-running practices?

In order to prevent front-running, it is important to put in place comprehensive surveillance mechanisms and strengthen the surveillance software used by stock exchanges to track real-time trades. Surveillance software should be able to detect similar trading patterns between big investors and individuals, which can help identify instances of front-running.

In addition to this, it is important to put in place clear whistle-blower policies with anonymity for the informer, so as to ensure that any suspicious activity between market players can be flagged at an early stage.

Brokers should also be required to adhere to a stringent code of conduct, which should include provisions for preventing front-running. Further, SEBI should also take measures to ensure that there is a proper disclosure of any large trades by big investors, so that any potential front-running can be checked by the regulator.

By implementing these measures, it will become easier to detect and prevent front-running. This will not only help protect the interests of investors, but will also help maintain the integrity of the market.