Front running

Front running, also known as tailgating, is the practice of entering into an equity (stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pending transaction that will influence the price of the underlying security.[1] In essence, it means the practice of engaging in a personal or proprietary securities transaction in advance of a transaction in the same security for a client's account.[2] Front running is considered a form of market manipulation in many markets.[3] Cases typically involve individual brokers or brokerage firms trading stock in and out of undisclosed, unmonitored accounts of relatives or confederates.[4] Institutional and individual investors may also commit a front running violation when they are privy to inside information. A front running firm either buys for its own account before filling customer buy orders that drive up the price, or sells for its own account before filling customer sell orders that drive down the price. Front running is prohibited since the front-runner profits come from nonpublic information, at the expense of its own customers, the block trade, or the public market.[5][6]

In 2003, several hedge fund and mutual fund companies became embroiled in an illegal late trading scandal made public by a complaint against Bank of America brought by New York Attorney General Eliot Spitzer. A resulting U.S. Securities and Exchange Commission investigation into allegations of front-running activity implicated Edward D. Jones & Co., Inc., Goldman Sachs, Morgan Stanley, Strong Mutual Funds, Putnam Investments, Invesco, and Prudential Securities.[7]

Following interviews in 2012 and 2013, the FBI said front running had resulted in profits of $50 million to $100 million for the bank. Wall Street traders may have manipulated a key derivatives market by front running Fannie Mae and Freddie Mac.[8]

The terms originate from the era when stock market trades were executed via paper carried by hand between trading desks.[9] The routine business of hand-carrying client orders between desks would normally proceed at a walking pace, but a broker could literally run in front of the walking traffic to reach the desk and execute his own personal account order immediately before a large client order. Likewise, a broker could tail behind the person carrying a large client order to be the first to execute immediately after. Such actions amount to a type of insider trading, since they involve non-public knowledge of upcoming trades, and the broker privately exploits this information by controlling the sequence of those trades to favor a personal position.[10]

  1. ^ Nasdaq. "Glossary: Front running".
  2. ^ "Front Running Definition: 124 Samples".
  3. ^ The New Market Manipulation, 66 Emory Law Journal 1253 (2017)
  4. ^ United States Securities and Exchange Commission. "SEC Charges Dallas-Based Trader With Front Running".
  5. ^ Financial Industry Regulatory Authority. "FINRA Manual Online, Rule 5270: Front Running of Block Transactions".
  6. ^ "Front-running; an Unethical Behavior" (PDF). www.cmic.sec.gov.lk. Sri Lanka SEC. Retrieved 25 July 2014.
  7. ^ Benjamin, Jeff (September 8, 2013). "Image Repair: Mutual funds still recovering 10 years after scandal". [Investment News].
  8. ^ Reuters FBI suspects front running of Fannie, Freddie in swaps market
  9. ^ Edwin Lefèvre (1923). Reminiscences of a Stock Operator.
  10. ^ Moyer, Liz (20 July 2016). "How Traders Use Front-Running to Profit From Client Orders". The New York Times.