Other Trading Practices Reaching Customer Orders

Most of these prohibitions turn on a purpose or a state of mind. Buying at rising prices, or entering an order that another order offsets, is ordinary trading until the named purpose or the required knowledge is present.

Three others name no purpose at all: whether the member's purchases or sales for an account it is directly or indirectly interested in are excessive in view of its financial resources or in view of the market for the security, whether the member offered that a transaction or transactions will influence the closing transaction in that security, and whether a joint account was promptly reported.

Which Securities Does the Rule Reach?

Six of the rule's seven prohibitions are written against a designated security, which it defines as any national market system (NMS) stock as that term is defined in Regulation NMS.

Following that definition into Regulation NMS:

• An NMS security is any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options.
• An NMS stock is any NMS security other than an option.

Exam Tip: Gotchas

• A listed option is an NMS security but not an NMS stock. The stock definition subtracts options, so a listed option is outside the designated-security scope this rule uses.
• The scope term governs six of the seven prohibitions, not all seven. Six speak of a designated security, so an over-the-counter equity that is not an NMS stock sits outside those six. The manipulative operation prohibition names no security, and the scope term enters it only through the sentence deeming a pool, syndicate or joint account to be such an operation.

What Is Prohibited in a Series of Rising or Falling Prices?

No member shall execute or cause to be executed, or participate in an account for which there are executed, purchases of any designated security at successively higher prices, or sales of any such security at successively lower prices, for any of three purposes:

• Creating or inducing a false, misleading or artificial appearance of activity in the security.
• Unduly or improperly influencing the market price for the security.
• Establishing a price which does not reflect the true state of the market in the security.

Exam Tip: Gotchas

• Participation is enough. The member need not enter the orders; participating in an account for which such purchases or sales are executed is inside the prohibition.
• Rising prices alone are not the violation. One of the three named purposes has to be present, so a genuine accumulation program that lifts the price is not what the paragraph reaches.

Which Transactions Create a False Appearance of Activity?

A separate paragraph names one transaction and two kinds of order entry a member may not engage in for the purpose of creating or inducing a false or misleading appearance of activity in a designated security, or a false or misleading appearance with respect to the market in that security:

• A transaction in the security which involves no change in the beneficial ownership of it.
• Entering an order for the purchase of the security with the knowledge that an order of substantially the same size, and at substantially the same price, for the sale of the security has been or will be entered by or for the same or different parties.
• Entering an order for the sale of the security with the knowledge that an order of substantially the same size, and at substantially the same price, for the purchase of the security has been or will be entered by or for the same or different parties.

Exam Tip: Gotchas

• The matched-order prohibition is written twice, once from each side. The buy-side and sell-side versions are separate prohibitions, and either alone is a violation.
• The offsetting order can belong to someone else. The rule reaches orders entered by or for the same or different parties, so an arrangement between two firms is covered.
• The purpose clause has two limbs. A false appearance of activity in the security, or a false appearance with respect to the market in it.

What Else Does the Rule Prohibit?

Three shorter prohibitions round out the conduct rules:

• Excessive trading for an interested account. No member shall execute purchases or sales of any designated security for any account in which the member is directly or indirectly interested, where those purchases or sales are excessive in view of the member's financial resources or in view of the market for the security.
• False or misleading information. No member shall make any statement or circulate and disseminate any information concerning a designated security which the member knows or has reasonable grounds for believing is false or misleading, or would improperly influence the market price of the security.
• Closing-price offers. No member shall offer that a transaction or transactions to buy or sell a designated security will influence the closing transaction in that security.

Exam Tip: Gotchas

• The excess is measured two ways. Against the member's own financial resources, or against the market for that security, and either measure can make the trading excessive.
• The information standard is not limited to actual knowledge. Reasonable grounds for believing the statement is false or misleading is enough, and a statement that would improperly influence the price is caught even where it is not false.
• The closing-price paragraph bans the offer itself. No execution is needed; offering that transactions will influence the closing transaction is the violation.

What Counts as a Manipulative Operation?

No member shall participate or have any interest, directly or indirectly, in the profits of a manipulative operation, or knowingly manage or finance one. The rule then deems three things:

Exam Tip: Gotchas

• Managing or financing carries a knowledge element that the profit interest does not. Holding an interest in the profits, directly or indirectly, is prohibited on its own terms, while managing and financing are prohibited where done knowingly.
• A pool can be caught without being created for the purpose. The deeming clause reaches an account organized or used intentionally to influence the price unfairly.

When May a Member Hold a Joint Account?

No member or person associated with a member shall, directly or indirectly, hold any interest or participation in any joint account for buying or selling a designated security, unless such joint account is promptly reported to FINRA.

The report should contain four items for each account:

• Name of the account, with the names of all participants and their respective interests in profits and losses.
• A statement regarding the purpose of the account.
• The name of the member carrying and clearing the account.
• A copy of any written agreement or instrument relating to the account.

Exam Tip: Gotchas

• This is the one paragraph written as a prohibition with an exit. The joint account interest is permitted once the account is promptly reported, so the answer is not that joint accounts are banned.
• The four items are what the report should contain. They describe the contents rather than the condition, and it is the prompt reporting that lifts the prohibition.
• The duty-bearer here is wider. Most paragraphs of the rule bind the member; this one names the member and any person associated with a member.

Trading ahead of a customer order, and the use of manipulative or deceptive devices, are covered in the unit on identifying and avoiding prohibited practices with customer orders.

What Should You Check on Exam Day?

• Confirm the security is an NMS stock before applying any prohibition except the one against participating or having an interest in the profits of a manipulative operation, or knowingly managing or financing one, which names no security.
• On a successive-price fact pattern, find the purpose. One of the three named purposes has to be present.
• On matched orders, check for knowledge of an offsetting order of substantially the same size and price that has been or will be entered by or for the same or different parties.
• Read a joint account question for the reporting, not for a ban. Prompt reporting to FINRA is what permits the interest.
• Check whether the member is directly or indirectly interested in the account before applying the excessive-trading paragraph.