Insider Trading- HDFC MFund in spotlight

(This incidence, involving the transgressions of a dealer with the high profile HDFC Mutual Fund, proves the old adage “Wall Street writes its own rules”. It also shows the dishonesty of the Indian media when it comes to covering news)

Insider trading is not uncommon. Almost every fund manager at some point has indulged in it. Often it could be for the fund he manages. In some cases, there are rogues who abuse their position for personal gains. SEBI has done well to document a case where a dealer of HDFC mutual fund (unfortunately, the fund with perhaps the highest level of trust in the public eye) has been caught in the act of ‘front’ running. ( See http://www.indianexpress.com/news/sebi-bars-hdfc-amc-exec-three-others-from-market/635317/0 for the story. Order copy can be had from SEBI website)
SEBI has ordered the Trustees of the HDFC Mutual Fund to conduct an inquiry in to this and ascertain whether such dubious practices were in continuance later and also to beef up the internal controls etc., Pending completion of the enquiry, SEBI order advises that:
“” i) HDFC Asset Management Company Limited shall not utilize the services of Mr. Nilesh Kapadia (the dealer in question) for the trading activities done on behalf of HDFC Asset Management Company Limited and shall institute an internal inquiry to be conducted by the trustees of HDFC Mutual Fund in the matter; and
ii) Mr. Nilesh Kapadia and HDFC Asset Management Company Limited shall jointly deposit the estimated losses identified so far as per Annexure-A of this order, to the Trustees of HDFC Mutual Fund. This amount shall be held by the Trustees in an account segregated for this purpose, till further orders by Securities and Exchange Board of India in this matter. “”

In the beginning of the order, there is a statement that reads as under:
“However, no apparent connections were noted by the stock exchanges. The preliminary findings of SEBI in respect of the said references are given in the following paragraphs. “
I leave it to the reader to figure out why SEBI is so circumspect. On going through the order, it is obvious that there is foul play and the parties who have actually indulged in front running, have links with the accused dealer. See the latter part of the order which reads as under:
“The investigation conducted so far in the matter had revealed 38 instances over 24 scrip days spread across BSE and NSE during April to July 2007. In these instances, Mr. Rajiv Ramniklal Sanghvi/Mr. Chandrakant P. Mehta/Mrs. Dipti Paras Mehta were placing buy/sell orders ahead of substantial buy/sell orders of HDFC AMC. The buy/sell by the abovementioned persons were successively followed by the buy/sell by HDFC AMC till finally, the aforesaid persons could square off their trades within the same trading session, substantially against the orders of HDFC AMC that were still coming in. In the investigated instances, the volumes accumulated by the said individuals were also found to be significantly large. Thus, the instances apparently represented front running. In the 38 instances mentioned in the following tables, Mr. Rajiv Ramniklal Sanghvi, Mr. Chandrakant P. Mehta and Mrs. Dipti P. Mehta have made substantial intra day profits by front running the orders of HDFC AMC. “
In spite of the above, there is hesitation to make a guilty pronouncement!

The incidents documented by SEBI happened in 2007! The amount of gain they have calculated to the gentleman in question is around Rs.23 million.

Some things about the order stare you in the face:

i) The amounts were with reference to three years ago. Surely, the question of interest and penalty seems to have been forgotten by SEB (One thought is that hopefully, SEBI will do something once the Trustees submit their report to SEBI)I;
ii) The deals narrated in the SEBI order relate to a three month period in 2007. Does it mean that the dealer became honest after this?
iii) The SEBI order merely asks the AMC to conduct an ‘inquiry”! Technically, the dealer can get away scot free! All he has to do is to pay up some amount! He can continue to work with the AMC in some other capacity.
iv) The front running done here is far more crooked than plain and simple insider trading. The guy had the wherewithal to transfer the gains on the illicit trades by screwing the fund investors;
v) Why is not SEBI forcing a full inquiry by an independent audit firm (rather than leave it to the Trustees) in to the fund’s entire history when the said gentleman was in the same position? Everyone knows that the Trustees do not have detailed knowledge about the working and most of them are there because of the name and prestige attached to being on a panel for HDFC family?;

To my mind, this seems like a serious case of fraud and needs to be probed further. HDFC Fund has to come out in to the open and make the outcome of the inquiry public. Disgorgement of the gain has to be done, at some cost.

Another thing is that this incident clearly shows the absence of checks and balances at the fund house. These are incidents that normal prudence ought to have immediately. Every fund house has a recording system and if the compliance officer had only bothered, this would have been caught.
I also wonder why there is no penalty levied on either the dealer or the fund house.
This incident proves several things:

i) HDFC as a fund house has good clout with the media. Few newspapers carried this and the TV channels, which normally go to town with any frivolous news, remained quiet;
ii) If there is no punishment, then there is no deterrent to this crime. That, to me is the biggest failure of the legal system, when it comes to things financia;
iii) SEBI is being very indulgent in this case.