Learn about market manipulation tactics like front running, marking the open/close, backing away, and freeriding to pass the FINRA SIE Exam.
Understanding market manipulation is pivotal in complying with securities regulations. This segment explores four specific manipulative activities: front running, marking the open/close, backing away, and freeriding. Each carries its unique rules and ethical considerations, imperative for the FINRA Securities Industry Essentials® (SIE®) Exam. Below, we provide detailed explanations, real-life examples, and integrative visuals to cement your understanding.
Front running is the unethical practice of a broker executing orders on a security for its own account while taking advantage of advance knowledge of pending orders from its customers. This action exploits non-public information regarding large transactions that could affect the security’s price.
Consider a broker who is aware that a client intends to purchase a large number of shares of XYZ Corporation. Anticipating a price increase, the broker buys XYZ shares for their own portfolio before executing the client’s order. Once the client places their order and the share price rises, the broker benefits personally from the favorable price movement.
The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) view front running as fraudulent and deceitful, subjecting offending brokers to severe penalties.
flowchart TD
A[Broker receives large client order] --> B[Broker buys shares]
B --> C[Client order executed]
C --> D[Stock price rises]
B --> E[Broker profits]
Marking the open or the close refers to the practice of manipulating stock prices at the opening or closing of the market to affect the stock’s price and, consequently, its market perception.
A trader buys a large block of shares in the final minutes of trading to artificially inflate the price. This skewed closing price portrays misleadingly improved performance metrics for the stock in public perception, potentially influencing investor decisions.
Manipulating opening or closing prices can alter investor impressions, affecting decisions and market stability. Regulatory bodies monitor such actions to maintain fair trading environments.
graph TD;
A(Trading Day) --> B(Market Close)
B -->|Manipulative Action| C(Artificial Price Increase)
C --> D(Investor Misperception)
Backing away occurs when a market maker fails to honor a published bid or ask price, hindering orderly trading and adversely affecting market confidence.
Imagine a market maker publishing an offer to buy shares at $50. When approached to execute a sale, the market maker declines to honor this price, disrupting the participant’s ability to trade based on the published information.
Backing away disrupts trading operations, breaches trust among market participants, and can invite regulatory scrutiny for undermining market transparency.
Freeriding involves buying securities without paying for them initially, selling them before the purchase payment clears, and using proceeds from the sale to cover the original purchase price. This practice violates settlement rules and exposes brokers to financial risks.
An investor places an order to buy shares but does not have immediate funds. They quickly sell the shares before the purchase payment is settled, using the sale proceeds to pay for the original purchase.
Freeriding could lead to account restrictions and potentially damaging regulatory action, emphasizing the importance of education on proper trading protocols.