Prohibited Trading Activities

These restrictions protect customers and market integrity by preventing firms from placing their interests ahead of proper trading conduct.

Is the Firm Trading Ahead or Recommending Excessive Activity?

• Front running of block transactions occurs when a member or associated person with material, nonpublic market information about an imminent block transaction causes a buy or sell order in the security or a related financial instrument to be executed before the information is public, stale, or obsolete.
• Covered front-running accounts include an account in which the member or associated person has an interest, an account over which either exercises investment discretion, or a customer or affiliate account whose holder received the information.
• Public availability of block information begins only after the entire block transaction has been completed and publicly reported.
• An equity transaction of 10,000 shares or more generally is a block, although a smaller transaction can qualify.
• Trading ahead of customer orders occurs when a member holding a customer equity order trades for itself on the same side at a price that would satisfy the order without immediately executing the customer order up to the proprietary size at the same or a better price.
• Churning or excessive trading can arise when a series of recommended transactions is excessive and unsuitable when taken together. For a covered recommendation to a retail customer, the series must be in the customer's best interest when taken together.
• Regulation Best Interest (Reg BI) coverage applies when a broker-dealer recommends a securities transaction or investment strategy, including an account recommendation, to a retail customer.
• Retail customer means a natural person, or the legal representative of that natural person, who receives the recommendation and uses it primarily for personal, family, or household purposes.
• Best-interest standard requires the recommendation to serve the customer's best interest without putting the firm's or representative's interest first.
• Reg BI obligations include disclosure, care, conflict-of-interest, and compliance obligations.

Exam Tip: Gotchas

• Front running and trading ahead of customer orders are separate prohibitions. A block-transaction fact pattern points to front running; a customer-order fact pattern points to trading ahead of the customer.
• Excessive trading concerns a series of recommended transactions taken together. One recommended transaction in isolation does not establish the same concern.
• A block transaction stays nonpublic until the entire block is completed and publicly reported. Reporting part of the block is not enough.

Which Manipulation, Markup, and Payment Practices Are Prohibited?

• Market manipulation can involve conduct intended to improperly affect a security's market price.
• An excessive markup is an unfair charge in a principal securities transaction. Determine the price's fairness from all relevant circumstances. The 5% policy is guidance, not a safe harbor or fixed ceiling, and even a markup of 5% or less can be unfair.
• Payments involving publications cannot be given to influence or reward a person's action concerning publication or circulation of material that affects or is intended to affect a security's market price.
• Payments for market making cannot be accepted from an issuer, affiliate, or promoter for quoting, making a market, or submitting the related application.

Exam Tip: Gotchas

• Principal markups use a price test. Determine price fairness from all relevant circumstances. The 5% policy is guidance, not a safe harbor or fixed ceiling, and even a markup of 5% or less can be unfair.
• Manipulation and payment reviews use their own tests. Check fraudulent conduct for manipulation and the payer, purpose, and exception for payments.
• A payment connected to market activity is not automatically prohibited. Identify the payer, purpose, and whether a stated exception applies.

Are Breakpoint Sales, Customer Sharing, or Relationship Disclosures Involved?

• A prohibited breakpoint sale occurs when investment company shares are sold just below a breakpoint so the seller can share in the higher sales charge.
• FINRA considers the facts and circumstances, including records of a bona fide asset-allocation program designed for diversification and investment goals that warns customers they may lose breakpoint reductions.
• Improper sharing in profits and losses is prohibited sharing in the profits or losses of customer accounts.
• Commercial honor and just and equitable principles of trade require high standards of commercial honor and fair dealing.

Exam Tip: Gotchas

• A sale just below a breakpoint is prohibited when it lets the seller share in the higher sales charge. The purpose is to avoid the available discount.
• Sharing in customer profits or losses is improper. The prohibition covers both sides of the account result.

What Should You Check on Exam Day?

• Match block front running and customer-order trading ahead to their distinct triggers. For excessive trading, assess a series of recommended transactions taken together.
• Apply Reg BI to a recommended securities transaction, strategy, or account when the recipient is a retail customer using it for personal, family, or household purposes. Its obligations are disclosure, care, conflict-of-interest, and compliance.
• For principal markups, assess price fairness under all relevant circumstances. Treat 5% as guidance, not a safe harbor or fixed ceiling, because even 5% or less can be unfair.
• For publication payments, identify whether value is intended to influence or reward publication-related action. For market-making payments, check the payer and the purpose.
• Separate breakpoint avoidance from customer profit-and-loss sharing.