SEBI

SEBI Mandates Internal Fraud Detection Rules for AMCs

The Indian mutual fund industry of around Rs. 50 trillion is witnessing a significant expansion by establishing a robust internal fraud detection mechanism. The Securities Exchange Board of India (SEBI) mandates the establishment of a comprehensive surveillance and internal fraud mechanism like frontrunning, insider trading, etc. Here, we mainly delve into the modern internal fraud detection mechanism, which focuses on the advanced SEBI’s regulatory framework adopting evolving market dynamics and emerging risks.

What are the Recent SEBI Guidelines for AMCs?

The SEBI (Mutual Fund) Regulations of 1996 were recently amended to institute a formal mechanism for the detection and deterrence of potential market fraud and internal abuse. Recently issued SEBI guidelines for registered asset management companies to enhance surveillance systems, escalation processes, and internal control mechanisms for monitoring and identifying the specific types of misconduct or fraud.

Objective of the Internal Fraud Detection Mechanism for AMCs

The objective of the SEBI’s amendment proposal for the institution of an internal fraud detection mechanism is as provided below:

• Identification and deterrence of potential market abuse and fraudulent transactions;
• Enhancing responsibility and accountability for AMC management;
• Identification of market manipulation strategies;
• Mark unauthorized trading without the client’s consent or exceeding authorized limits.

Reasons for Instituting Internal Fraud Detection Mechanism

The following are the reasons why SEBI mandated the AMCs for the institution of robust internal fraud detection mechanisms for mutual funds.

1. Improved Monitoring System

Improvement of the monitoring and surveillance system is one of the crucial reasons for instituting the internal fraud detection mechanism for mutual funds in AMCs. The improved monitoring system provides for manual examination, algorithmic analysis, and effective red flag identification, which ultimately leads to earlier detection of suspected internal fraud.

2. Internal Control Procedure

Establishing an internal control procedure is another crucial reason for instituting an internal fraud detection mechanism. A strong internal control procedure comprising clear and well-documented guidelines is considered the fundamental requirement for preventing mutual fund fraud, ensuring trade execution, and informed dissemination.

3. Process for Escalating Issues

The internal fraud detection mechanism establishes a well-defined process and framework for escalating issues and red flags and promptly reports to the respective department. Further, there is a need for an open and transparent escalation process that establishes trust and promotes accountability among the organization’s employees.

Steps to Implement SEBI’s Internal Fraud Detection Mechanism

The SEBI’s update, which mandates the institution of the internal fraud detection mechanism, is considered a significant move towards the protection of the interest of investors. The steps required for the implementation of SEBI’s internal fraud detection mechanism are provided below:

1.    Investment in Technology

The AMCs must make relevant investments in tech-driven and advanced surveillance tools and analytical platforms to ensure effective fraud monitoring and detection of red flags in trading activities.

2.    Building Culture for Compliance

AMCs must build a strong culture to facilitate compliance by conducting employee training on fraud detection and encouraging ethical behaviour among the organization’s employees.

3.    Regular Review and Improvement

AMCs must regularly review and improve their internal fraud detection mechanisms based on market trends and updated regulatory requirements.

4.    Alert-Based Surveillance Mechanism

The AMCs must develop an alert-based and prompt handling system to monitor red flags and fraudulent activities within the organization.

Benefit of Robust Internal Fraud Detection Mechanism

The implementation of the robust internal fraud detection mechanism is beneficial for both the investors and the mutual fund industry. Consider the following benefits of establishing a robust internal fraud detection mechanism for AMC:

Ø Enhanced Investor’s Protection

The internal fraud detection mechanism enhances and protects the investor’s confidence. Simply, it fosters the protection and ethical management of the investors’ investments and hard-earned money.

Ø Improved Market Integrity

The effective implementation of the internal fraud detection mechanism ensures that fairness and integrity in the market environment are improved and promoted.

Ø Improvised Risk Management System

The implementation of the internal fraud detection mechanism provides an improvised risk management system to facilitate the discipline and identify potential areas of vulnerability among AMCs.

Ø Strong Regulatory Framework

Implementing the internal fraud detection mechanism for AMCs provides a strong regulatory framework to govern and protect investors’ interests in the mutual fund industry.

Ø Action on Suspicious Alerts

The implementation of the internal fraud detection mechanism, which imposes action against employees or brokers suspected of market abuse, helps ensure integrity within the organisations, mitigates financial risks and upholds regulatory compliance.

Ø Ensures Accountability

The implementation of the internal fraud detection mechanism ensures accountability for the abuse and fraudulent activities carried out by the AMCs.

Period for Implementing Internal Fraud Detection Mechanism

The larger AMCs with larger fund institutions must comply with the SEBI’s finalisation guidelines for internal fraud detection within the 3-month deadline period. Further, the smaller AMCs are granted an extension period of another 3 months to implement the new internal fraud detection mechanism.  Lastly, the timely implementation of the internal fraud detection mechanism is crucial to approaching and striking a balance between internal control and the fraud detection system adopted by the AMCs.

Conclusion

The new mechanism ensures the establishment of uniform surveillance and internal procedural control to detect any fraud or misconduct within the AMCs. Upon the implementation of the internal fraud detection mechanism by the AMCs, the Securities Exchange Board of India is required to relax the framework associated therewith. Further, the measures issued by the SEBI mainly focus on placing surveillance systems and internal control obligations over the AMCs.

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