These are the specific manipulation schemes the SIE exam tests. Each one involves deliberately distorting market prices, volume, or investor behavior.
Common Manipulation Schemes
| Type | Definition | How It Works |
|---|---|---|
| Market rumors | Spreading false or misleading information to influence a security's price | Posting false news, making misleading statements to other traders |
| Pump and dump | Artificially inflating a stock's price through false statements, then selling at the inflated price | Promote a thinly traded stock with hype, sell once price rises, price crashes |
| Front running | Trading ahead of a known pending customer order to profit from the expected price movement | Broker buys stock for their own account BEFORE executing a large customer buy order |
| Excessive trading (churning) | Making trades primarily to generate commissions rather than benefit the customer | High turnover ratio, high commission-to-equity ratio, in-and-out trading |
| Marking the close | Executing trades at or near market close to artificially influence the closing price | Placing orders designed to raise or lower the last reported price |
| Marking the open | Executing trades at or near market open to artificially influence the opening price | Similar to marking the close but targets the opening price |
| Backing away | A market maker refusing to honor a published bid or offer at the quoted price and size | Posting a bid of $50 but refusing to buy when a seller arrives at that price |
| Freeriding | In a cash account, selling securities before paying for them | Buying stock, selling at a profit before settlement without ever paying |
| Withholding | A broker-dealer keeping shares of a hot IPO for its own account or its employees instead of distributing them to customers | A firm allocates hot IPO shares to employee accounts rather than to the public |
Exam Tip: Gotchas
- Front running vs. insider trading: Front running involves a broker trading ahead of a customer order. Insider trading involves material nonpublic information (MNPI) from a corporate source. A broker acting on a pending customer order is front running, not insider trading, even though both are illegal.
- Churning requires three elements: (1) the rep controlled the account, (2) trading was excessive given the customer's objectives, and (3) the rep acted with intent to defraud or reckless disregard. All three must be present.
- Freeriding and withholding are two distinct violations, often tested together. Freeriding is a cash account violation: the trade executes on the trade date, but payment is not due until settlement (T+1). A customer who buys, watches the price rise, and sells before making payment is using the sale proceeds to fund the original purchase without putting up any capital; that is the Reg T freeriding violation. Withholding is an IPO allocation abuse: a broker-dealer keeps shares of a hot new issue for its own account or its employees instead of distributing them to customers. The two share a name only because FINRA's predecessor addressed both under one historical interpretation, "Free-Riding and Withholding"; on the exam, treat them as separate terms for separate conduct.
- Backing away applies only to market makers. Regular investors cannot "back away" because they do not publish firm quotes.
Think of it this way: Every manipulation scheme boils down to one of two things: fake information (rumors, pump and dump) or fake trading activity (wash trading, marking the close). If the question describes misleading words, think information-based. If it describes misleading trades, think activity-based.
Additional Manipulation Concepts
- Matched orders / wash trading - pre-arranged buy and sell orders between parties to create the appearance of active trading without a genuine change in ownership
- Painting the tape - executing a series of transactions to create artificial activity, making it appear there is genuine investor interest in a security
Exam Tip: Gotchas
- Wash trading and painting the tape both create fake volume, but wash trading uses pre-arranged trades between cooperating parties, while painting the tape uses a series of actual transactions by one party or group to simulate interest.
How to Spot Each Scheme
| If You See... | It's Likely... |
|---|---|
| Broker buys stock, then executes a large customer order | Front running |
| High commission-to-equity ratio, frequent in-and-out trades | Churning |
| Thinly traded stock promoted with exaggerated claims, then sold | Pump and dump |
| Pre-arranged trades between two accounts with no real change in ownership | Wash trading |
| Market maker refuses to fill at quoted price | Backing away |
| Trades placed right before the closing bell to move the price | Marking the close |