I have a piece in today’s @EconomicTimes where I argue that extending insider trading regulations to mutual fund units would be a disastrous idea -akin to killing mosquitoes with nuclear weapons - with massive collateral damage on the innocent. Here is a summary

At first blush, it sounds like a logical extension of insider trading prohibition. After all, in two instances SEBI has caught a registrar and key management persons selling units of about to blow up schemes before the blow up had become public knowledge.

First, the offence is one of front running and not insider trading. Front running is the offence of trading ahead of your client, putting the client at a disadvantage. A classic case is that of a broker placing her own order ahead of punching the client’s order.

That may sound like legal semantics and mere differences in nomenclature, but it is important. You can’t prosecute forgery by altering the definition of theft, even though both are offences. Such convulsions in the language have consequences.

Second, such acts are already prohibited both by six SEBI circulars since 2001 and by the anti-fraud regulations of SEBI. If more clarity is required, both can be amended to make front-running in mutual fund schemes clearly prohibited.

Third, the definitions create several burdens, which as we will see, create problems for the honest and the ‘connected’. A vast swathe of people are ‘deemed’ connected that allows such person to access unpublished price sensitive information.

There are three classes of people, who are impacted by this proposal. First is those who work inside mutual funds including its key persons. Second are those who work with mutual funds as service providers or professionals. That would include lawyers like me.

Third would be those unconnected to mutual funds but who choose to invest in equity solely through mutual funds, so as to avoid even an allegation of either impropriety or insider trading. This category would include big accounting firm members, judges, CXOs of listed companies.

For the first class of people, there are already six circulars and one regulation which prohibit the action SEBI is seeking to prohibit. So there appears little difference except certain reporting duties about trades in mutual fund units.

For the second class, and to a lesser degree for the third class this will be catastrophic. For professionals like me, this mutual fund carve out was extremely important because the current insider trading laws define price sensitive information broadly.

So if I provide some legal advice to a listed company about a contract, the advice would make me deemed connected and any purchase of shares in the company would open me up to criminal charges if the company came out with good quarterly numbers (of which I had no idea).

Once connected to a company in some remote and irrelevant fashion, the trade by itself would make me a criminal, and I would be obliged to rebut the presumption that someone tipped me off about the financial numbers.

As it is impossible to prove the negative, in the absence of a camera on my head 24X7, I would find it nearly impossible to dis-prove that I’m not a criminal. For this reason, I have not traded in stocks for the past nearly 15 years.

Mutual funds give me the immunity from such charges because purchasing funds breaks the causal chain. SEBI has exempted them from the definition of securities in the insider trading regulations for that very reason.

The proposed amendments would make me a rebuttable criminal even if I purchase mutual fund units given that I occasionally advise mutual funds, though I have never once advised any fund about to get into trouble.

When only a few schemes blow up every decade, and SEBI has only shown 2 known cases of such front running, this is a disproportionate remedy which will primarily hurt honest people like me.

This cannot be the outcome SEBI wants for honest people who wish to invest in the markets without even the remotest possibility of inappropriate behaviour.

Using nuclear weapons to eliminate mosquitoes is not a good idea. Mosquitoes will survive, millions of regular folks would be devastated. Me included.