Front-Running

Now that you understand the manipulation tactics that create false market activity, let's look at front-running, a violation where an agent exploits advance knowledge of a customer's order for personal gain.

Definition

Front-running occurs when a broker-dealer or agent, with knowledge of a pending customer order (or block transaction) that is likely to affect the market price, executes a trade for their own account (or a favored account) before executing the customer's order.

The front-runner profits by trading ahead of the price movement the customer's order is expected to cause.

Why Front-Running Is Prohibited

  • It is a breach of fiduciary duty to the customer
  • The agent uses material nonpublic information (the pending customer order) for personal gain
  • The customer may receive a worse price because the agent's order has already moved the market
  • Prohibited under the antifraud provisions (Uniform Securities Act (USA) Section 101) and FINRA Rule 5270 (front-running of block transactions)

Exam Tip: Gotchas

  • A pending customer order is material nonpublic information. The customer's order itself is MNPI to the agent. Trading on that knowledge is a fraud violation regardless of whether the agent heard any news about the underlying company.

Examples

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.

Key Elements

  • Knowledge: Agent knows about a pending customer order
  • Timing: Agent trades for their own account before executing the customer order
  • Impact: Customer's order is likely to affect the market price
  • Violation: Breach of fiduciary duty + use of material nonpublic information

Exam Tip: Gotchas

Front-running does not require that the agent actually profit. The violation occurs when the agent trades ahead of the customer's order. Even if the agent's trade does not ultimately move the market or generate a profit, placing the order with knowledge of the pending customer order is the violation.