Quick Answer
Market manipulation schemes tested on the SIE include market rumors, pump and dump, front running, churning, marking the close or open, backing away, freeriding, withholding, wash trading, matched orders, and painting the tape. Each scheme distorts market prices, volume, or investor behavior, and the exam often tests subtle differences among similar-sounding schemes.
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 name overlap is a coincidence. An old NASD interpretation was titled "Free-Riding and Withholding," but it covered hot-issue IPO abuses only, not the cash-account freeriding above. The cash-account version comes from the Federal Reserve payment rules (Regulation T). 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
- Wash trading - the same person is the true buyer and seller, typically routed through different accounts they control, so beneficial ownership never actually changes hands. This can happen in one pair of trades or across many; what defines a wash trade is that no real ownership change occurs, not how many parties appear to be involved
- Matched orders - two or more separate parties secretly prearrange offsetting buy and sell orders so it looks like ownership changed hands when it did not
- Painting the tape - one person or a group executing a series of transactions to create artificial activity, making it appear there is genuine investor interest in a security. Unlike a wash trade, the trader does not have to be both sides of the trade
Exam Tip: Gotchas
- Wash trading and matched orders are not the same thing, even though they're often mentioned together. A wash trade is one person trading with themselves through accounts they control (no beneficial-ownership change). A matched order is two or more separate parties prearranging both sides of a trade. The exam tests this distinction.
- The number of transactions never distinguishes wash trading from painting the tape. A wash trade requires the same person as buyer and seller, even across many trades in different accounts. Painting the tape can be one person or several; the defining element is the intent to induce other investors to trade, not who is on each side.
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 |
| Same person trading through their own accounts, no real change in ownership | Wash trading |
| Two separate parties secretly prearrange offsetting trades | Matched orders |
| Market maker refuses to fill at quoted price | Backing away |
| Trades placed right before the closing bell to move the price | Marking the close |
What Should You Check on Exam Day?
- Can you explain the difference between front running and insider trading, even though both involve trading ahead of information?
- Do you know the three elements required to prove churning against a registered representative?
- Can you explain why freeriding and withholding are different violations, even though their names are often confused?
- Do you know the difference between wash trading and matched orders in terms of how many parties are involved?
- Can you state why backing away applies only to market makers and not to regular investors?