AMFI plugs hole for Third Party scam

When investing in mutual fund schemes, it is very common to call up a broker and issue a cheque to him in the name of fund schemes. The cheque does not necessary be from you, so it could be from your spouse or your friend or as a matter of fact from anybody. The regulatory bodies wouldn’t have thought that this simple flexibility could actually lead to various scams.

Hence, to plug this seemingly innocuous hole in the mutual fund investment mode, AMFI has come up with guide lines to not allow any Third Party cheques[PDF] when investing in mutual fund schemes.

As per guidelines issued by the Association of Mutual Funds in India (AMFI), mutual funds are required to put in place strong processes by November 15, 2010 to ensure that Third-Party payment instruments are not used for mutual fund subscriptions.

So from 15th Nov, you will have to issue cheque from your account when investing in mutual fund in your name. The few exceptions are like parent investing on behalf of minor child or employer on behalf of employee.

But what is the Third Party Scam? It is simply a common case of trusting a middle-man and not doing due diligence. Here is how it works: You ask a broker to suggest a mutual fund scheme, and issues a cheque against that mutual fund scheme. He will fill a form and get your signature, but the problem is not in filling the form or not reading it properly, the actual problem is of trusting the broker. The broker can simply go home, shred the form you filled, then fill another form in his own name and submit the cheque along with the form issues by you. Since mutual fund accepts Third Party cheques, your money is being used by the broker to have scheme in his name. He simply needs to forge the receipt and give it back to you. The broker could simply redeem the money without you noticing anything.

The interesting aspect is that SEBI dis-allowed third party cheque in stock investment few years ago, but it is continued in mutual funds. I believe that AMFI has taken the right step in this direction, thus blocking these Third Party scams.