Securities Industry Essentials (SIE) ExamOverview of Regulatory FrameworkHard
A broker-dealer firm's research analyst has just completed a highly anticipated report on a specific company. Before the report is publicly disseminated, the firm's trading desk uses the information in the report to execute trades for the firm's proprietary account. This practice is known as:
- AFree riding.
- BChurning.
- CShadow trading.
- DFront-running.
Show answer & explanationAnswer & explanation
Correct answer: D. Front-running.
Front-running occurs when a broker-dealer or a registered representative executes trades for their own account or a proprietary account based on advanced knowledge of a pending customer order or research report that is likely to affect the market price. This is an unethical and illegal practice.
Why the other options are wrong
- A. Free riding is when a client buys and sells securities without paying for the purchase.
- B. Churning is excessive trading in a client's account to generate commissions.
- C. Shadow trading is a less common term and generally refers to trading in a competitor company's stock based on confidential information about one's own company, not specifically trading ahead of research.
Front-Running
Front-running is the illegal practice of entering into an equity trade, options, futures, or foreign exchange contract with advance knowledge of a pending transaction that will influence the price of the underlying security.
- Trading ahead of customer orders or market-moving information.
- Using non-public information to gain an unfair advantage.
- Applies to firm proprietary accounts or individual RRs.
- Illegal and unethical.
Memory trick: Manipulation: 'F.C.S.R.' – Front-running, Churning, Shadow, Riding.