Front-Running

Front-running differs from the manipulation tactics covered so far because it exploits advance knowledge of a real customer order, not fake trading activity.

What Is Front-Running?

Front-running involves misusing knowledge of a pending customer order to execute a trade for a personal or favored account ahead of the customer. A common example involves a large order expected to affect the market price.

The front-runner seeks to benefit from trading before the customer's order. The conduct need not produce a profit.

Why Is Front-Running Prohibited?

• It breaches the duty to deal fairly with the customer by trading ahead of their order
• The agent misuses confidential customer-order information for a personal or favored-account trade. The specific block-order prohibition requires material nonpublic block information; other protections also reach non-block orders
• The customer may receive a worse price because the agent's order has already moved the market
• State antifraud provisions can also apply when the facts establish a fraudulent or deceptive practice. Material nonpublic information is an element of the specific block-order prohibition, not a universal element of every non-block trading-ahead violation
• Also targeted directly by FINRA's rule on front running of block transactions, which bars a member or associated person from trading while holding material nonpublic information about an imminent block transaction
• Smaller, non-block orders are also protected by other trading-ahead or antifraud requirements; absence of likely market impact is not blanket permission to trade first

Exam Tip: Gotchas

• The confidential order can supply the material nonpublic information. No separate company announcement is needed in a block-order scenario. Do not assume every small order is material or that smaller orders have no protection.

What Does Front-Running Look Like?

Example 1 (buying ahead of a large buy order): A customer places a large buy order for 50,000 shares of XYZ stock. Before entering the customer's order, the agent buys 1,000 shares of XYZ for their personal account, anticipating the price will rise once the large order is executed.

Example 2 (selling ahead of a large sell order): An agent learns that an institutional client is about to sell a large block of bonds. The agent sells bonds from their own account first, before the institutional sale depresses the price.

In both cases, the agent's personal trade comes first, and the customer's trade comes second; the agent "runs" ahead of the customer.

What Should You Identify in a Block-Order Scenario?

• Knowledge: Agent holds material nonpublic information about an imminent block transaction
• Account: Agent trades for a personal or other covered account
• Timing: The block information has not become public, stale, or obsolete
• Use: The advance trade uses that information rather than independently executing an earlier customer order

Exam Tip: Gotchas

Front-running does not require an actual profit or price movement. In the block-order scenario, the prohibited execution using material nonpublic block information establishes the violation even if the advance trade loses money.

What Should You Check on Exam Day?

• Identify the confidential customer-order information, advance trade, and account being favored.
• The block-order prohibition does not exhaust the protection for smaller customer orders.
• An actual profit, customer loss, or price movement is not required in the prohibited block-order scenario.