NASAA Series 63Ethical Practices and ObligationsHard
An agent receives a large, unexpected bonus and decides to invest a portion of it. The agent purchases shares of a promising small-cap stock for their personal account. The following day, the agent recommends the same small-cap stock to several clients, for whom it is suitable. The agent ensures the clients' orders are placed after their own. This action, while seemingly benign, could be considered:
- AFront-running.
- BChurning.
- CMisappropriation.
- DSelling away.
Show answer & explanationAnswer & explanation
Correct answer: A. Front-running.
Front-running occurs when a broker or agent executes trades for their own account ahead of a client's orders, taking advantage of the anticipated price movement that the client's larger order might cause. Even if the agent believes the stock is suitable for the client, placing their own order first to benefit from potential price impact is unethical.
Why the other options are wrong
- B. Churning involves excessive trading in a client's account, not trading ahead of client orders.
- C. Misappropriation is the unlawful taking or use of another's property, not applicable here.
- D. Selling away is conducting securities transactions outside the firm, which is not the case here.
Front-running
The unethical and illegal practice of a broker or agent executing trades for their own account based on advance knowledge of a pending client order that is likely to affect the market price of the security.
- Agent trades for personal account.
- Trade occurs *prior* to client's order.
- Exploits anticipated price movement from client's order.
- Violates fiduciary duty and fair dealing.
Memory trick: Client first, then yourself.