The wealth of all the people living along this highway is going to change.
Why?
Because highways bring with them commercial activity.
Restaurants can be opened. Petrol pumps. Hotels. Warehouses. All of those.
Naturally, the price of land around the highway shoots up.
When the news is announced that a highway is going to be built, people quickly start buying this land (this is why the price shoots up).
Now, if you already own land there, your land’s value can grow much more than when others buy land.
Or, if you could buy the land before everyone else gets to know about the highway, you could make a lot of money.
Let’s say someone in the government already knows about this. And before the news is announced, they buy some land.
Later, they sell this land to someone else, after the news of the new highway has been announced; after the price of land has shot up.
Immediately, many people will point out that this is wrong.
A member of the government is supposed to serve the public, not take unfair advantage of their position.
Make no mistake. There is nothing wrong if a member of the government buys land and sells land based on publicly available info.
But if they use info only they know to buy land – and therefore make the public pay a higher price – it is wrong.
This, everybody knows.
This is called front running.
And in the stock markets, it is illegal.
How does front-running in the stock markets work?
Let’s say a fund manager of a mutual fund is managing a fund that has over Rs 15,000 cr.
In one of the meetings, the fund manager and his/her team decide to invest Rs 500 cr in the stock of a new company in the next 2 weeks.
Then, the fund manager goes and buys Rs 5 crore of this same share from his/her personal account – before the mutual fund he/she is managing buys the stock.
What’s the big deal?
He/she bought some shares. If the company’s share price goes up in the future, he/she gains some money. But his mutual fund also gains that money.
So what’s the problem here? What’s wrong with this?
This is the part that many individual investors do not understand.
You see, the share price is dependent on demand and supply.
When you invest Rs 10,000 in a company whose shares are worth lakhs of crores, your purchase doesn’t do much. The amount is small.
But, when a really big amount is invested, it causes the share price to rise.
So, if someone is investing crores, it can cause the share’s price to actually go up.
If the fund manager in the example above invests a big chunk of money, the share price has gone up – even before the mutual fund has bought the shares.
This is bad for the investors who invested in that mutual fund. Their possible returns are slightly compromised.
Ultimately, when the mutual fund buys a large number of shares, the price will go up fast. At this point, the fund manager will sell from his/her personal account – thus making a quick profit.
This is a conflict of interest.
This is why it is not moral or ethical for a fund manager to buy shares from his personal account before the mutual fund he/she manages buys the same shares.
The fund manager is essentially cheating his/her customers.
This is different from insider trading though it sounds similar.
The regulator is absolutely strict about this and keeps an eye on such activities.
As for the ongoing case, the regulator has started placing restrictions and penalties. We’ll learn more about it as time goes.
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