Introduction
Front running in mutual funds is a practice where a broker or a trader executes orders on a security based on advanced knowledge of pending orders from clients. It is a form of insider trading that can adversely affect the returns of mutual fund investors.
How Front Running Works
Brokers or traders who engage in front running monitor the orders placed by mutual fund managers for buying or selling securities. They then execute their own trades ahead of these large orders, taking advantage of the price movement that will likely occur when the mutual fund order is executed.
Examples of Front Running
For example, if a mutual fund manager is planning to buy a large quantity of a particular stock, a front runner might buy shares of that stock before the mutual fund order is executed, driving up the price. Once the mutual fund order is executed, the front runner can then sell their shares at a profit.
Case Studies
- In 2003, the Securities and Exchange Commission (SEC) charged a brokerage firm with front running mutual fund trades. The firm was accused of using advance knowledge of mutual fund orders to profit from their own trading activities.
- In 2016, a hedge fund manager was found guilty of front running mutual fund orders by placing trades on securities based on non-public information he obtained from his role as a trustee of a mutual fund.
Impact on Investors
Front running can have a significant impact on the returns of mutual fund investors. By driving up prices before executing large orders, front runners can reduce the returns that would have been generated by the mutual fund.
Preventing Front Running
To prevent front running, mutual fund managers can take steps such as breaking up large orders into smaller ones, using dark pools, or placing orders at different times. Regulators also play a role in monitoring and enforcing rules against front running.
Conclusion
Front running in mutual funds is a practice that undermines the integrity of the market and can harm the returns of mutual fund investors. By understanding how front running works and taking steps to prevent it, investors can protect their investments and uphold the principles of fair and transparent trading.
