10 months ago, we wrote about the front-running scandal that rocked Axis Mutual Fund. Now SEBI, the capital markets regulator, has published a 96-page report of their initial findings and we just couldn’t ignore it.
So in today’s Finshots, we dive into the murky world of front-running once again. But take it one step further — why do people indulge in such practices?
But before we get to today's story. here's a quick sidenote from Team Ditto. If you're someone who has experience in recruitment especially from Colleges, Ditto is looking to hire a Campus Recruiter. So if you're interested or know someone who is, please click this link.
The Story
A Chief Dealer has a very privileged position in a mutual fund company. Their role is simple — help the fund manager buy or sell the stock they want.
If this fund manager is only in charge of 1 mutual fund scheme out of the 10 different ones at the fund house, they’re only privy to what goes in and out of their fund. At least on a real-time basis. They might not be aware of what other fund managers are up to regularly.
But that’s not the case with the dealer. The dealer has a bird’s eye view of what’s happening in each and every fund. All 10 of them. They have a lot of information at their fingertips. They’re the ones who negotiate with brokers to get the best price for the stock. They’re the ones who decide when to place the order given by the fund manager. And that means they have a lot of power too.
Now Uncle Ben might’ve said, “With great power, comes great responsibility.” But apparently, Viresh Joshi, who used to be the Chief Dealer at Axis Mutual Fund didn’t pay heed to this mantra. He misused his power.
How, you ask?
Well, this is the simplified modus operandi from the SEBI report.
Step 1: Joshi bought multiple mobile phone numbers under fictitious IDs. Declared only one official number to Axis Mutual Fund. No one would know better.
Step 2: Called up a person named Sumit Desai who went by the nickname Pintu Bhai! Asked for some mules. What’s that? Well, a mule is a trading account of a random third-party. Someone who’s not connected to Joshi. The nefarious trading activity would take place in this mule account only. The mule would make money. And that way, no one could connect Joshi to the trade. Desai was the arranger.
Step 3: Got another person named Prijesh Kurani who was based out of Dubai too. Kurani would be the one placing the trades in the mules’ accounts whenever Joshi commanded it. Kurani was the enabler.
Step 4: Played the classic front-running game. Whenever he saw that the fund managers at Axis Mutual Fund want to place a big trade on a stock, he’d first inform the buddies. They’d lap up the stock first. Then, Joshi or the Jadugar as he was known, would execute the trade for Axis and the stock price would rise. The buddies would immediately sell what they held. Pocket a cool ₹30.5 crores through this means.
Step 5: Set up an entity called Vintage Capital Investment LLC in Dubai. Appointed Joshi’s father and brother as the shareholders. And got a share of the spoils of the war in Vintage’s bank account — ₹11.6 crores.
Phew!
Anyway, while the report is just prima facie — or what SEBI found in the initial investigation — it’s hard to saw how Viresh Joshi and his coterie can wriggle out of this one.
But the big question is — why do people indulge in such practices?
Well, it’s tough to say. But maybe we can point to 3 key things.
Firstly, it’s the industry!
A few years ago, when researchers from the University of Zurich dug into how prone people from various industries were to dishonesty, they found that banking (or financial services) ranked high on the list. As they put it, “Social norms in the banking sector tend to be more lenient towards dishonest behavior.”
And historically, the stock markets have been the epicentre of dishonesty. Here’s an excerpt from the book House of Nomura that talks about Japan from 200 years ago.
“Stockmarket dealing has always been considered a form of gambling by the Japanese… it was ignored by the general public. Respectable people did not associate with the exchanges of the Meiji period… Even the wealthy who owned shares in the few listed companies did not use the exchange to buy or sell them… brokers were notorious for front-running, trading in shares ahead of clients.”
Yup, front running in the 1800s! So people who indulge in it today are just carrying on the legacy of their predecessors.
Secondly, it could be about where you fall in the pecking order. Or the feeling of ‘the world is unfair to me and I deserve better’. The feeling is quite often a primary cause for cheating.
Let me explain.
So I pulled out the remuneration report of Axis Mutual Fund for FY22. It lists the remuneration of every employee that earned more than ₹1.02 crores in the financial year. And no surprises, the list primarily features fund managers and sales folks. And they don’t even have to be the Chiefs or Heads to make that much money.
Now a Chief Dealer like Viresh Joshi features in that list too. But, if you pull out the same report from the previous couple of years, he’s nowhere to be found. It’s a bit puzzling, isn’t it?
Okay, this is a bit of speculation. But one explanation could be that Viresh Joshi was promoted to also managing mutual fund schemes in 2019. And these weren’t the hugely popular ones too. Till then, he was just a dealer. Someone whose role was limited to placing trades for the fund manager.
And if you look at remuneration reports from other mutual fund companies, you probably won’t find the Dealer earning in crores too. They’re conspicuously absent.
So you can imagine that it’s quite tempting to capitalize on all the power in one’s hands and make some extra money on the side. Live the life that the other crorepati colleagues are leading. Do better than your other Chief Dealer peers.
Again, it’s just speculation.
Finally, there just might be something else that does a better job of explaining all this. A behavioural quirk that’s quite fascinating.
Now you might have heard of Dan Ariely. He’s a professor of behavioural economics and quite famous for his books on irrationality too. And he says that if you look at what standard economics says, people who cheat simply run a cost-benefit analysis. They look at how much money they can make by cheating. Then they figure out the probability of getting caught and the punishment that comes with it. If the benefits look appealing, they cheat.
But when he ran some experiments, he found something different. People don’t really rationalize it this way. Instead, they cheat only to the extent that they don’t feel bad about it. And they can internally rationalize to themselves why they’re doing it. He called it the ‘Personal Fudge Factor’.
And it’s not something set in stone. It can expand and people can cheat a bit more. If they see others cheating, they could be comfortable indulging in a bit of it too.
But when it comes to financial markets, people actually might find it easier to cheat. And they cheat more.
Why’s that, you ask?
Well, Ariely’s theory is that it’s because stocks are intangible. If you look at a robbery, it’s visible. And the impact is clear. But with front-running, you don’t really see the impact of your skullduggery on other people. Because despite your actions, the investors who trust you will probably make money too. Maybe a little less but you can’t really quantify it easily. That makes the entire thing simpler to rationalize too. You convince yourself that you’re not really cheating if you’re not harming anyone.
Combine this with the concept of abstraction.
See, more often than not, you’re not executing these trades in your account. You’re finding a mule. And they're the ones doing the dirty work. You’re just passing information. Sure, cash finally hits your account when the deed is done, but you’re at an arm’s length distance. You’ve abstracted yourself away from the action of cheating. And Ariely says that the less “connected” we feel to our dishonesty, the more we’re willing to do it.
So yeah, cheating becomes easy this way.
Do you have theories about why people tend to cheat — especially in the stock markets? Don’t forget to reply and let us know!
Until then…
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