Self-dealing

A person who works inside a fund house knows things outsiders do not. What the scheme owns. What it needs to buy. What price it can be pushed to pay.

Self-dealing is using that position to do business with the fund itself, and coming out ahead unfairly. The gain does not come out of the market. It comes out of the scheme, which means it comes out of the unit holders.

The AMFI Code of Ethics bans it flatly. It sits in the same section as front running, and the two are usually named together.

The difference between them is the counterparty. In front running you trade ahead of the fund. In self-dealing you trade with the fund.

The definition, from AMFI Code of Ethics clause 6.3. Members or any of their directors, officers or employees shall not indulge in self-dealing, which the code describes as "using their position to engage in transactions with the fund by which they benefit unfairly at the expense of the fund and the unit-holders".

Note what the test does not require. There is no threshold, no minimum amount, and no need to prove the scheme lost money in the end. The elements are a position, a transaction with the fund, and an unfair benefit at the fund's expense.

The flat prohibition that gives it teeth. Clause 5.2 does not ask for disclosure and does not weigh fairness. Members shall not knowingly buy or sell securities for any of their schemes from or to:

• any director, officer or employee of the member; and
• any trustee, or any director, officer or employee of the Trustee Company.

The surrounding clauses. Clause 6.1 requires members to avoid conflicts of interest in managing the schemes and to keep unit holders' interest paramount. Clause 6.2 bans front running. Clause 6.6 stops employees, officers and directors working as agents or brokers for selling the member's own schemes, except in their capacity as employees.

How it is meant to be caught. Clause 3.4 puts the monitoring on a calendar. All transactions of purchase and sale of securities by key personnel directly involved in investment operations must be disclosed to the member's compliance officer at least half-yearly, and then reported to the Board of Trustees if found to conflict with the fund's transactions. Under the code's enforcement section, records are kept for at least three years.

A cross-reference, clearly labelled. This paper stops at the code. Series III-C's workbook adds the trustee side: trustees furnish SEBI a half-yearly certificate that they have satisfied themselves there were no instances of self-dealing or front running by any trustee, AMC director or key personnel. That certificate is not examined in this paper.

Kaveri Asset Management Ltd runs a corporate bond scheme. Names and figures are illustrative; the clauses are the code's.

The transaction. Mr Deven Raut, a fixed income dealer at the AMC, personally holds Rs 2 crore face value of a listed NCD. The market has thinned and quotes are around Rs 96 per Rs 100 of face value. He arranges for the scheme to buy the whole lot from him at Rs 99.50.

Every element is present. He used his position. He transacted with the fund. He benefited unfairly at the scheme's expense. That is self-dealing under clause 6.3.

And it fails clause 5.2 anyway. The scheme bought securities from an employee of the member. The clause forbids that outright, so the AMC would still be in breach even if he had sold at Rs 96 and taken no benefit at all.

Contrast, same dealer. Suppose instead he learns the scheme will place a Rs 40 crore buy order for a different bond tomorrow, and he buys Rs 50 lakh of it today for himself at a pre-order price. He never transacts with the fund; he transacts with the market, ahead of it. That is front running under clause 6.2.

What the compliance officer sees. His own dealings reach the compliance officer at least half-yearly under clause 3.4, go to the Board of Trustees because they conflict with the fund's transactions, and stay on record for at least three years.

Chapter 10 (Legal and Regulatory Environment), section 10.3.1, reproduces the AMFI Code of Ethics in full, and self-dealing is clause 6.3 under Operations. The examinable move is almost always a definition match: two short descriptions are offered, one of trading ahead of the fund and one of transacting with the fund, and you assign front running and self-dealing correctly. Expect also a question on who the code binds — AMCs and trustees, not distributors — and on the half-yearly disclosure of key personnel's own trades.

• Front running is trading ahead of the fund; self-dealing is transacting with the fund. The counterparty is the tell, and this pair is the most commonly swapped in the chapter.
• No loss to the scheme need be proved. The test is an unfair benefit at the expense of the fund and the unit holders.
• Clause 5.2 is a flat ban, not a disclose-and-proceed rule. A scheme may not knowingly buy from or sell to the member's own directors, officers or employees, or the Trustee Company's.
• The code binds members — AMCs and trustees. Distributors and other intermediaries are covered by AGNI instead.
• A key person's own market trade is not automatically self-dealing. It becomes a reportable conflict under clause 3.4; it becomes self-dealing only when the fund is the counterparty.
• Disclosure of key personnel's trades is at least half-yearly to the compliance officer, and records run at least three years.