1.0 INTRODUCTION
Bankruptcy and scams represent two distinct yet intertwined challenges that pose significant threats to the stability and trustworthiness of financial institutions. These issues can lead to far-reaching consequences that extend beyond the immediate financial realm, impacting stakeholders, investor confidence, and the broader economy. Bankruptcy occurs when a financial institution, be it a company, bank, or investment firm, becomes unable to meet its financial obligations. Whereas, financial scams involve deliberate deceit to gain an unfair advantage or ill-gotten gains. This comprehensive report looks into the intricate dynamics surrounding these challenges, with a focused analysis of the Axis Bank Mutual Funds scam as a case study by examining how they ripple through the financial sector, we gain insights into their influence on stakeholders, trust among investors, and the overall stability of the economy.
2.0 UNDERSTANDING BANKRUPTCY IN FINANCIAL INSTITUTIONS
Bankruptcy in the context of financial institutions refers to the legal status where a financial institution, such as a bank, credit union, or investment firm, is unable to meet its financial obligations and liabilities due to insufficient funds. This condition arises when the institution's debts exceed its assets, resulting in severe financial distress and an inability to continue its normal operations.
2.1 Triggers for Bankruptcy
Asset Quality Deterioration: It refers to a situation when the quality of assets of financial institutions decreases due to factors like adverse market conditions or economic downturn. Financial institutions, in such cases, are required to maintain more liquidity to prepare themselves for potential losses.
Liquidity Shortages: When financial institutions fail to meet their short-term obligations, a liquidity crisis may arise. This may occur due to a loss of confidence or a sudden withdrawal of funds by counterparties.
Excessive Leverage: When an institution is under high debt and fails to generate earnings equivalent to or more than the interest expenses it is said to be highly leveraged.
Credit Risks and Default: When the majority of the debts given by a financial institution turn into bad debts, this may put an excessive load on the institution’s financial condition. A series of defaults can undermine its financial health.
Market Volatility: A highly volatile or fluctuating market may erode the basics of a financial institution.
Regulatory Non-Compliance: Incapability or ignorance to comply with regulatory requirements, such as capital adequacy ratio or risk management standards, may pave a path to potential regulatory intervention and bankruptcy.
2.2 Legal Procedures and Consequences of Bankruptcy
Filing for Bankruptcy: Bankruptcy may either be filed voluntarily or by the respective regulator. In the case of financial institutions, “resolution authority” may intervene in the process to maintain financial stability in the market.
Asset Valuation and Liquidation: A detailed assessment of the assets of the institution is conducted by the competent authority to determine an accurate financial position & repay the creditors to the extent possible.
Creditor Hierarchy: Bankruptcy follows a predefined order for repaying creditors, often prioritizing secured creditors (those with collateral) and then unsecured creditors. However, the depositors receive special treatment to protect the stability of the financial system.
Stakeholder Impact: Shareholders majorly suffer losses as their capital diminishes highly. However, the impact may be on the society as a whole & its degree may vary on the size of the institution.
Restructuring and Resolution: Depending on the regulatory approach, the financial institution may also undergo restructuring to continue operations or be resolved by selling its assets and liabilities to other similar institutions.
Regulatory Response: Regulatory authorities may take steps to enhance monitoring, improve risk management practices, and implement reforms through law to prevent similar failures in the future.
3.0 IMPACT ON STAKEHOLDERS
Shareholders: Shareholders are considered to be the equity investors of the company. When the scam becomes public, they may try to redeem their shares and due to the volume of shares being dumped, the value decreases significantly.
Example: In the Axis Mutual Fund front-running scandal, while Axis Bank itself was not involved directly its reputation suffered. The scandal led to a decrease in Axis Bank's stock price, causing financial losses for the parties concerned.
Customers/Clients: Customers or clients might face delayed or disrupted services and may lose their trust in the institution’s ability to safeguard their interests.
Example: In the Saraha Group scam, thousands of investors in Eastern India lost their hard-earned money. These investors, often from lower-income backgrounds, faced significant financial distress due to the collapse of the Ponzi scheme.
Employees: Employees of the institution under distress may face uncertainty about their jobs. Scandals can lead to downsizing, cost-cutting measures, or even closure, resulting in job loss.
Example: In the Satyam Computer Services scam, employees faced job insecurity and reputational damage as the company's fraudulent practices were exposed. The company's accounting fraud led to a loss of business, affecting the job prospects of many employees.
Creditors: Creditors who have lent money to the institution may face an increased risk of delayed payments or even default, especially if the institution's financial health deteriorates due to the scandal. An institution's creditworthiness may impact its ability to raise funds in the future.
Example: In the Sahara India Parivar scam, the company raised funds from investors through Optionally Convertible Debentures. Creditors in the form of investors faced the risk of not receiving their promised returns, impacting their financial well-being.
Regulators: Regulatory authorities are tasked with monitoring the financial markets and ensuring fair practices. Financial scams strain regulators' resources as they investigate and take action against defaulters. Regulators may also face criticism for not preventing the scam from being involved in it.
Example: The Speak Asia Online scam drew regulatory attention for operating a pyramid scheme under the cover of an online survey company. The regulatory authorities had to intervene to protect investors and dismantle the fraudulent scheme.
4.0 REGULATORY AND LEGAL RESPONSES
Regulators and government play a crucial role in responding to bankruptcy and financial scams to safeguard the integrity of financial markets, protect investors, and maintain economic stability. They implement a range of laws, regulations, and oversight mechanisms to prevent, detect, and address these issues effectively
Governments enact a suite of laws and regulations that serve as the foundation for managing bankruptcy and confronting financial scams. Securities law mandates transparent disclosure practices, compelling public companies to provide timely and accurate financial information to investors. For instance, the Securities and Exchange Board of India (SEBI) implements regulations that mandate listed companies to provide timely and accurate information about their financial performance, business operations, and potential risks. Bankruptcy laws offer a legal framework for individuals and businesses facing insolvency. These laws provide options for restructuring debt, liquidating assets, and negotiating with creditors. They provide a structured process to manage financial distress while preserving creditors’ rights and economic stability. Anti-fraud regulations are also crucial, criminalizing activities such as market manipulation, insider trading, and fraudulent reporting.
Additionally, regulators and governments possess the authority to enforce regulatory compliance and impose penalties. Civil fines, restitution orders, and criminal charges are potential consequences for individuals and entities involved in fraudulent activities or financial scams. Asset recovery mechanisms are employed to freeze ill-gotten gains and initiate legal actions to retrieve funds acquired through scams, ensuring compensation for victims.
5.0 PREVENTIVE MEASURES AND RISK MANAGEMENT
Financial institutions have a vital role in maintaining the integrity of the financial system and ensuring investor trust. To prevent scams and bankruptcy, institutions can adopt a series of strategies that focus on due diligence, risk management, and robust corporate governance.
One key approach is the implementation of thorough due diligence and Know Your Customer (KYC) procedures. By meticulously researching clients, counterparties, and business partners, financial institutions can assess their legitimacy before engaging in transactions. This step forms a critical defence against potential scams and helps maintain the institution’s reputation. Internal controls are another essential tool. By establishing stringent protocols, institutions can actively monitor transactions, swiftly detect any unusual activities, and prevent unauthorized actions. These controls should be continuously updated to adapt to evolving risks and challenges. Employee training plays a significant role in scam prevention. Educating staff about ethical conduct, compliance regulations, and the identification of suspicious activities empowers them to be vigilant against potential scams. Moreover, ensuring a separation of duties is essential. By distributing responsibilities across the institution, the concentration of power in one individual is minimized, reducing the risk of fraudulent actions going unnoticed. To further manage risks, institutions can adopt a comprehensive risk management approach. Regular evaluations of potential vulnerabilities, both internal and external, enable institutions to develop strategies to mitigate identified risks. Stress testing also plays a role in evaluating the institution’s resilience to adverse economic conditions.
In terms of corporate governance, establishing independent board oversight is pivotal. A diverse board with independent members can provide impartial judgment, challenge management decisions, and promote accountability. Transparent reporting of financial information, operations, and risk management practices is crucial to maintain investor confidence. By upholding a strong code of conduct, institutions can ensure that ethical behaviour and accountability are deeply embedded in their culture.
6.0 CASE STUDY- AXIS MF FRONT-RUNNING SCAM
In May 2022, Axis Mutual Fund’s fund manager, Viresh Joshi, was implicated in a front scam. Front-running is an unethical and illegal practice that involves a person or entity using advanced knowledge of upcoming significant trades to gain an unfair advantage in the financial markets. It typically occurs in securities markets, where an individual or institution, often a broker or trader, places their orders ahead of a large trade they are aware of. Joshi along, with a network of accomplices, allegedly misused confidential trading information for personal gain.
6.1 Key players
SEBI mentioned along with Viresh Joshi some arrangers and enablers gave life to this scam. Arrangers are the people who play a vital role in facilitating the scam. Enablers consist of people who lent their trading terminals and accounts to facilitate these trades. Without their access to platforms or tools, this scam would not be possible. This includes Nishil Surendra Marfatia, Bhavin Shah, Rupal B. Shah, Olga Trading Pvt Ltd and others.
Viresh Joshi: The mastermind behind the scheme, Joshi used his position as the chief dealer to gain access to confidential trading information and exploited it for personal gain.
Sumit Deasi: A market operator who helped Joshi identify ‘mule accounts’ (trading accounts not registered in his name) to execute the fraudulent trades. He also installed trading software on Kurani’s system.
Prijesh Kurani: A Dubai-based individual who executed trades in mule accounts on Joshi’s behalf and in his family members’ accounts.
Pranav Vora: Facilitated the arrangement of trading accounts and terminals for fraudulent trades.
Vaibhav Pandya: Sumit Desai’s employee who was assigned to share the details of the trading account including ID and passwords with Kurani
6.2 Modulus Operandi
Connections and arrangements: Joshi connected with Desai, who enlisted Kurani to execute the trades. Vora helped arrange trading accounts, and ‘enablers’ like Nishil Marfatia and others provided their accounts and terminals for the scheme.
Use of Mule account: Kurani executed trades in these mule accounts, disguising the true origin of the orders.
Dubai Connection: Joshi established a company in Dubai, Vintage Capital Investment, with Kurani’s assistance. Family members of Kurani and Joshi were made partners in the company. Reports show that from 5 April 2022 to 11 May 2022, the company earned around 11.6 crore rupees.
Concealing identity: Code names like ‘Jadoogar’ which means magician were used to referring to Joshi, keeping his identity hidden during communication.
Funds transfer: Profits from the front-run trades were transferred in unconventional ways, including cash transfer through the Angadia system- a parallel banking system using couriers.
6.3 SEBI’s Action and Penalties
SEBI identified 21 entities, including Joshi and his associates, involved in the fraudulent scheme. It imposed a combined penalty of Rs.30.55 crore and barred these entities from participating in the capital markets Bank accounts were frozen as part of the punitive measures.
6.4 Impacts
The Axis Mutual Fund front-running scandal had several significant impacts:
Reputation damage: The scandal tarnished the reputation of Axis Mutual Fund, one of India’s prominent asset management companies, and eroded investor trust in the institution.
Legal Consequences: The Securities and Exchange Board of India (SEBI) took stringent action against the entities involved. Joshi and 20 other connected entities were banned from participating in the capital markets, and a penalty of Rs.30,55 crore was imposed.
Market Distortion: The front-running activities distorted market fairness by giving certain individuals an unfair advantage in trading, compromising market integrity.
Investor losses: The unethical practices employed by Joshi and his associates could potentially have led to losses for investors who were not privy to the insider information being exploited.
6.5 Economic Consequences
The Axis Mutual Fund front-running scam can have profound impacts on confidence in the financial system, credit availability, economic growth, and stability.
Confidence in the Financial System: The revelation of a front-running scam deteriorates public trust and confidence in the financial system. Investors might become wary of investing in mutual funds or other financial products offered by institutions. Perception of unfair practices that exist can lead to a loss of faith in the integrity of the financial industry as a whole. This erosion of trust may lead to reduced participation in financial markets.
Credit Availability: Lenders may become less willing to issue loans as a result of a financial scandal, tightening lending conditions. Financial institutions involved in a scandal can pay more for borrowing money or have a harder time getting credit themselves. Lenders may tighten their lending standards, and impose greater collateral requirements which could affect firms and customers looking for financing for purchases or investments.
Economic Growth and Stability: Financial scandals can affect the economy as a whole. Capital flows and investments may decline as a result of decreased confidence in the financial system. Because of the uncertainty, firms may postpone expansion plans and consumers may reduce their spending.
Impact on India's Financial System: Increased scrutiny of the mutual fund industry's operations and ethical standards may have resulted from the incident in the case of the Axis Mutual Fund front-running scandal in India. This might make investors rethink their investing decisions, which would affect asset flows in the mutual fund industry. The industry may face slower growth and smaller net inflows as investors become more cautious.
Mitigating Measures: Regulatory organisations like the Securities and Exchange Board of India (SEBI) play a critical role in investigating, punishing wrongdoers, and enacting stronger regulations to prevent similar occurrences to lessen the impact of such tragedies. Rebuilding confidence requires open reporting, improved company governance, and moral business practices. Improved investor education, legislative changes, and industry-wide measures to promote fair and transparent operations could all be used as strategies to regain public trust.
6.6 Lessons learned
Regulatory Vigilance: The case underscores the importance of robust regulatory oversight and enforcement. SEBI’s intervention and punitive actions demonstrate the commitment to maintaining market integrity.
Ethical conduct: Financial institutions must prioritize ethical conduct, transparency, and fair dealing with investors. Breach of trust can have far-reaching consequences.
Risk management: The scandal highlighted the significance of robust risk management practices within financial institutions. Effective controls are crucial to prevent misuse of sensitive information.
Whistleblower Protection: The presence of a whistleblower letter in this case highlights the importance of mechanisms to encourage and protect whistleblowers, as they play a pivotal role in exposing malpractices.
Code of Conduct: Financial institutions must have clear and well-communicated codes of conduct that emphasize compliance with laws, ethical behaviour, and adherence to industry best practices.
7.0 COMPARATIVE ANALYSIS: IMPACTS OF BANKRUPTCY AND SCAMS IN FINANCIAL INSTITUTIONS
Bankruptcy and financial scams both have profound implications for financial institutions, but they differ in their origins and consequences. A comparison between Axis Bank MF front-running scam and the Bernie Madoff Ponzi scheme highlights these similarities and differences in outcomes, stakeholder reactions, and economic repercussions.
7.1 Outcomes
In the Axis Bank MF front-running scam, the outcome involved regulatory penalties, bans, and a tarnished reputation for the institution and individuals involved. On the other hand, the Bernie Madoff Ponzi scheme resulted in massive financial losses for investors, eroding trust in the financial system and leading to Madoff’s imprisonment. While both cases impacted stakeholders negatively, the nature of these impacts varied.
7.2 Stakeholder reactions
In the Axis Bank MF scam, investors faced potential losses due to manipulated market practices, leading to anger and mistrust. However, the Bernie Madoff scheme led to catastrophic financial ruin for investors, evoking a stronger emotional response characterized by shock and betrayal. Additionally, regulators responded more swiftly and severely to the Axis Bank MF scam, showcasing a commitment to maintain market integrity.
7.3 Economic Repercussions
The Axis Bank MF scam’s economic consequences were largely contained due to prompt regulatory intervention. However, the Bernie Madoff scheme had far-reaching economic implications, causing substantial losses for investors, charities, and financial institutions. The magnitude of the Madoff scheme’s impact underscored its systemic risk and highlighted the need for tighter regulations.
7.4 Comparison with Bernie Madoff's Ponzi Scheme
The Bernie Madoff Ponzi scheme shared similarities with the Axis Bank MF scam in terms of investors' losses and regulatory responses. Both cases involved unethical conduct that undermined investor trust. However, the Bernie Madoff scheme was significantly larger and more devastating, with global repercussions and an enduring impact on the perception of financial services.
7.5 Other scams similar to Axis MF Front Running Scam
Speak Asia Online Scam: Speak Asia Online operated a survey-based MLM scheme where participants had to pay membership fees to join. The company promised lucrative returns for completing surveys, but the primary source of income was recruitment. The scheme relied on a constant influx of new members to pay earlier investors, resembling a pyramid scheme.
NSE Co-location Scam: The National Stock Exchange (NSE) co-location scam involved certain brokers allegedly gaining preferential access to the exchange's trading servers, allowing them to execute trades faster than other participants. This advantage allowed the brokers to profit at the expense of other investors. The scam raised concerns about unfair access and potential market manipulation.
8.0 RECOMMENDATION
To effectively address the challenges posed by bankruptcy and scams, a coordinated effort among financial institutions, regulators, and policymakers is essential. Implementing actionable strategies can help mitigate the adverse impacts of these issues and fortify the ecosystem against future crises.
Firstly, financial institutions should prioritize robust risk management practices. This includes conducting thorough risk assessments to identify vulnerabilities and scenario analysis to evaluate resilience against potential fraud scenarios. Enhancing transparency is equally crucial. Institutions should adopt clear disclosure practices, ensuring stakeholders have access to accurate information about financial health and operations through regular reporting. Stringent due diligence is imperative to prevent engagement with dubious entities. Robust Know Your Customer (KYC) procedures, thorough assessment of third-party vendors, strong regulatory oversight and enhanced surveillance mechanisms can mitigate risk and potential scams. Promoting an ethical organizational culture is also vital. This can be achieved through ethics training for employees and establishing secure and anonymous whistleblowing channels. Policymakers should facilitate international public-private partnerships to share insights, best practices, and information to collectively combat financial fraud. Lastly, enhancing liquidity management in banks by maintaining sufficient liquidity can provide a safeguard against sudden liquidity demands triggered by bankruptcy or scams.
9.0 CONCLUSION
This report has looked into the multifaced dimensions of bankruptcy and financial scams and underscores the critical need for robust preventive measures, effective regulatory responses, and continuous risk management in the financial sector. The Axis Bank Mutual fund (MF) front-running scam serves as a stark reminder of the far-reaching consequences that unethical practices can unleash upon stakeholders and the broader economy. To ensure a resilient financial ecosystem, institutions must prioritize ethical conduct, transparency, and adherence to robust risk management practices. Strengthening regulatory oversight, enforcing compliance, and implementing preventive measures can curb fraudulent activities and enhance market integrity.
10.0 APPENDIX
Axis MF Front Running Scam | CA Rachana Ranade. (n.d.). Www.youtube.com. Retrieved August 25, 2023, from https://www.youtube.com/watch?v=r49SXSZt16o
Axis Mutual Fund Front Running Case - Is IT A Scam? What Should Investors Do? (n.d.). Www.youtube.com. Retrieved August 25, 2023, from https://youtu.be/XmH6yl64eEo?si=jtd2M3ckGIDov7BC
Bhimani, S. (2022, May 22). Should I redeem from Axis Mutual Funds because of the Front-Running Scam? Shabbir Bhimani. https://shabbir.in/axis-mutual-fund-scam /
Gupta, P. K., & Gupta, S. (2015). Corporate frauds in India–perceptions and emerging issues. Journal of Financial Crime, 22(1), 79-103.
Henriques, D. B. (2018). A case study of a con man: Bernie Madoff and the timeless lessons of history's biggest Ponzi scheme. Social Research: An International Quarterly, 85(4), 745-766.
Kriplani, J. (2023, March 1). How Axis MF fraud case was executed. Mint. https://www.livemint.com/companies/news/how-axis-mf-fraud-case-was-executed-11677694675126.html
Nandi, S. (2023, March 22). What Happened In The Axis Mutual Fund Scam? Full Breakdown. The Business Rule. https://thebusinessrule.com/what-happened-in-the-axis-mutual-fund-scam-full-breakdown/
Quisenberry, W. L. (2017). Ponzi of all Ponzis: critical analysis of the Bernie Madoff scheme. International Journal of Econometrics and Financial Management, 5(1), 1-6.
Rajput, R., & Zachariah, R. (2023, February 10). “Front-running probe at Axis MF unearths links to Dubai entities.” The Economic Times. https://economictimes.indiatimes.com/mf/mf-news/front-running-probe-at-axis-mf-unearths-links-to-dubai-entities/articleshow/97751396.cms?from=mdr
Rigg, R., & Schou-Zibell, L. (2009). The financial crisis and money markets in emerging Asia. Available at SSRN 1523044.
Shah, P. (2023, February 28). SEBI impounds ₹30.55-crore ill-gotten gains in Axis Mutual front-running case. BusinessLine. https://www.thehindubusinessline.com/markets/sebi-impounds-3055-crore-ill-gotten-gains-in-axis-mutual-front-running-case/article66564857.ece
- Written by Mukund Mangwani
This article is entire written by the author and Eat My News, which is just a platform for community to express its views, as an entity cannot be held responsible for this content or its correctness. Views expressed here solely belong the author/writer.
You can reach out to the author for any queries directly - mukundmangwani@gmail.com
Coauthors - Dr. Shalini Singh & Hajuna Rafeeq
0 Comments