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{{short description|Prohibited financial transaction}}
{{About|the financial practice|the practice as applied to domain names|domain name front running}} {{About|the financial practice|the practice as applied to domain names|domain name front running}}
'''Front running''', also known as '''tailgating''', is the practice of entering into an equity (]) trade, ], ], ], or ] to capitalize on advance, nonpublic knowledge of a large ("block") pending transaction that will influence the price of the underlying security.<ref>{{cite web|url=http://www.nasdaq.com/investing/glossary/f/front-running|author=Nasdaq|title=Glossary: Front running}}</ref> In essence, it means the practice of engaging in a personal or ] securities transaction in advance of a transaction in the same security for a client's account.<ref>{{Cite web|url=https://www.lawinsider.com/dictionary/front-running|title=Front Running Definition: 124 Samples}}</ref> Front running is considered a form of ] in many markets.<ref> (2017)</ref> Cases typically involve individual brokers or brokerage firms trading stock in and out of undisclosed, unmonitored accounts of relatives or confederates.<ref>{{cite web|url=https://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171574978|author=United States Securities and Exchange Commission|title=SEC Charges Dallas-Based Trader With Front Running}}</ref> Institutional and individual investors may also commit a front running violation when they are privy to ]. 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.<ref>{{cite web|url=http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=10860|author=Financial Industry Regulatory Authority|title=''FINRA Manual Online'', Rule 5270: Front Running of Block Transactions}}</ref><ref>{{cite web|title=Front-running; an Unethical Behavior|url=http://www.cmic.sec.gov.lk/wp-content/uploads/2012/09/Front-running.doc-an-Unethical-Behavior.pdf|website=www.cmic.sec.gov.lk|publisher=Sri Lanka SEC|access-date=25 July 2014}}</ref>


⚫ In 2003, several ] and ] companies became embroiled in an illegal late trading scandal made public by a complaint against ] brought by New York Attorney General ]. A resulting ] investigation into allegations of front-running activity implicated ], ], ], Strong Mutual Funds, ], ], and ].<ref name="renamed_from_2003_on_20141226061313">{{cite news|title=Image Repair: Mutual funds still recovering 10 years after scandal |url=http://www.investmentnews.com/article/20130908/REG/309089973 |publisher= | first=Jeff|last=Benjamin|date=September 8, 2013}}</ref>
'''Front running''' is the illegal practice of a ] executing ] on a ] for its own account while taking advantage of advance knowledge of pending orders from its customers. When orders previously submitted by its customers will predictably affect the price of the security, purchasing first for its own account gives the broker an unfair advantage, since it can expect to close out its position at a profit based on the new price level. The front running broker either buys for his own account (before filling customer buy orders that drive up the price), or sells (where the broker sells for its own account, before filling customer sell orders that drive down the price).<ref>{{cite web|title=Front-running; an Unethical Behavior|url=http://www.cmic.sec.gov.lk/wp-content/uploads/2012/09/Front-running.doc-an-Unethical-Behavior.pdf|website=www.cmic.sec.gov|publisher=SEC|accessdate=25 July 2014}}</ref>


Following interviews in 2012 and 2013, the FBI said front running had resulted in profits of $50 million to $100 million for the bank.
⚫ In 2003, several ] and ] companies became embroiled in an illegal late trading scandal made public by a complaint against ] brought by New York Attorney General ]. A resulting ] investigation into allegations of front-running activity implicated Edward D. Jones & Co., Inc., ], ], Strong Mutual Funds, ], ], and ].<ref name="renamed_from_2003_on_20141226061313">{{cite news|title=Image Repair: Mutual funds still recovering 10 years after scandal |url=http://www.investmentnews.com/article/20130908/REG/309089973 |publisher= | first=Jeff|last=Benjamin|date=September 8, 2013}}</ref>
Wall Street traders may have manipulated a key derivatives market by front running ] and ].<ref> FBI suspects front running of Fannie, Freddie in swaps market</ref>

The terms originate from the era when stock market trades were executed via paper carried by hand between trading desks.<ref>{{cite book|title=Reminiscences of a Stock Operator |year=1923|author=Edwin Lefèvre|author-link=Edwin Lefèvre}}</ref> 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 ], 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.<ref>{{cite news|url=https://www.nytimes.com/2016/07/21/business/dealbook/how-traders-use-front-running-to-profit-from-client-orders.html|title=How Traders Use Front-Running to Profit From Client Orders|work=The New York Times|date=20 July 2016 |last1=Moyer |first1=Liz }}</ref>


==Explanation== ==Explanation==
⚫ For example, suppose a broker receives a market ] from a customer to buy a large block—say, 400,000 shares—of some stock, but before placing the order for the customer, the broker buys 20,000 shares of the same stock for their own account at $100 per share, then afterward places the customer's order for 400,000 shares, driving the price up to $102 per share and allowing the broker to immediately sell their shares for, say, $101.75, generating a significant profit of $35,000 in just a short time. This $35,000 is likely to be just a part of the additional cost to the customer's purchase caused by the broker's ].


⚫ This example uses unusually large numbers to get the point across. In practice, computer trading splits up large orders into many smaller ones, making front-running more difficult to detect. Moreover, the U.S. ]'s 2001 change to pricing stock in pennies, rather than fractions of no less than 1/8 of a dollar,<ref>{{Federal Register|67|50739}}</ref> facilitated front running by reducing the extra amount that must be offered to step in front of other orders.
⚫ For example, suppose a broker receives a market ] from a customer to buy a large block—say, 400,000 shares—of some stock, but before placing the order for the customer, the broker buys 20,000 shares of the same stock for his own account at $100 per share, then afterward places the customer's order for 400,000 shares, driving the price up to $102 per share and allowing the broker to immediately sell his shares for, say, $101.75, generating a significant profit of $35,000 in just a short time. This $35,000 is likely to be just a part of the additional cost to the customer's purchase caused by the broker's ].


⚫ By front-running, the broker has put his or her own financial interest above the customer's interest and is thus committing ].{{Clarify|date=November 2024}} In the United States, they might also be breaking laws on ] or ].
⚫ This example uses unusually large numbers to get the point across. In practice, computer trading splits up large orders into many smaller ones, making front-running more difficult to detect. Moreover, the U.S. ]'s 2001 change to pricing stock in pennies, rather than fractions of no less than 1/8 of a dollar, facilitated front running by reducing the extra amount that must be offered to step in front of other orders.

⚫ By front-running, the broker has put his or her own financial interest above the customer's interest and is thus committing ]. In the United States, he or she might also be breaking laws on ] or ].


==Other uses of the term== ==Other uses of the term==

Front-running may also occur in the context of insider trading, as when those close to the ] of a firm act through ] ahead of the announcement of a sale of stock by the CEO, which will in turn trigger a drop in the stock's price. Khan & Lu (2008: 1) define front running as "trading by some parties in advance of large trades by other parties, in anticipation of profiting from the price movement that follows the large trade". They find evidence consistent with front-running through short sales ahead of large stock sales by CEOs on the ]. Front-running may also occur in the context of insider trading, as when those close to the ] of a firm act through ] ahead of the announcement of a sale of stock by the CEO, which will in turn trigger a drop in the stock's price. Khan & Lu (2008: 1) define front running as "trading by some parties in advance of large trades by other parties, in anticipation of profiting from the price movement that follows the large trade". They find evidence consistent with front-running through short sales ahead of large stock sales by CEOs on the ].


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A third-party trader may find out the content of another broker's order and buy or sell in front of it in the same way that a self-dealing broker might. The third-party trader might find out about the trade directly from the broker or an employee of the brokerage firm in return for splitting the profits, in which case the front-running would be illegal. The trader might, however, only find out about the order by reading the broker's habits or tics, much in the same way that poker players can guess other players' cards. For very large market orders, simply exposing the order to the market, may cause traders to front-run as they seek to close out positions that may soon become unprofitable. A third-party trader may find out the content of another broker's order and buy or sell in front of it in the same way that a self-dealing broker might. The third-party trader might find out about the trade directly from the broker or an employee of the brokerage firm in return for splitting the profits, in which case the front-running would be illegal. The trader might, however, only find out about the order by reading the broker's habits or tics, much in the same way that poker players can guess other players' cards. For very large market orders, simply exposing the order to the market, may cause traders to front-run as they seek to close out positions that may soon become unprofitable.


Large limit orders can be "front-run" by "order matching" or "penny jumping". For example if a buy ] for 100,000 shares for $1.00 is announced to the market, many traders may seek to buy for $1.01. If the market price increases after their purchases, they will get the full amount of the price increase. However, if the market price decreases, they will likely be able to sell to the limit order trader, for only a one cent loss. This type of trading is probably not illegal, and in any case, a law against it would be very difficult to enforce.<ref name="Trading and Exchanges">{{cite book|last1=Harris|first1=Larry|title=Trading and Exchanges|date=24 October 2002|publisher=Oxford University Press|location=New York|isbn=0-19-514470-8|edition=First}}</ref> Large limit orders can be "front-run" by "]" or "penny jumping". For example, if a buy ] for 100,000 shares for $1.00 is announced to the market, many traders may seek to buy for $1.01. If the market price increases after their purchases, they will get the full amount of the price increase. However, if the market price decreases, they will likely be able to sell to the limit order trader, for only a one cent loss. This type of trading is probably not illegal, and in any case, a law against it would be very difficult to enforce.<ref name="Trading and Exchanges">{{cite book|last1=Harris|first1=Larry|title=Trading and Exchanges|date=24 October 2002|publisher=Oxford University Press|location=New York|isbn=0-19-514470-8|edition=First}}</ref>


Other types of traders who use generally similar strategies are labelled "order anticipators." These include "sentiment-oriented technical traders," traders who buy during an asset ] even though they know the asset is overpriced, and squeezers who drive up prices by threatening to corner the market. Squeezers would likely be guilty of ], but the other two types of order anticipators would not be violating any US law.<ref name="Trading and Exchanges"/> Other types of traders who use generally similar strategies are labelled "order anticipators." These include "sentiment-oriented technical traders", traders who buy during an asset ] even though they know the asset is overpriced, and squeezers who drive up prices by threatening to corner the market. Squeezers would likely be guilty of ], but the other two types of order anticipators would not be violating any US law.<ref name="Trading and Exchanges"/>


"Front running" is sometimes used informally for a broker's tactics related to trading on proprietary information before its clients have been given the information. "Front running" is sometimes used informally for a broker's tactics related to trading on proprietary information before its clients have been given the information.


In insurance sales, front running is a practice in which agents "leak" information (usually false) to consumers about a competitor insurance company that leads the consumer to believe that the company's products or services are inferior, or worthless. The agent subsequently obtains a sale at the consumer's expense, earns a commission, and the consumer may have given up a perfectly good product for an inferior one as the result of the subterfuge.
⚫ For example, analysts and brokers who buy shares in a company just before the ] is about to recommend the stock as a strong buy, are practising this type of "front running". Brokers have been convicted of securities laws violations in the United States for such behavior. In 1985, a writer for the ], ], tipped off brokers about the content of his column '''''Heard on the Street''''', which based upon publicly available information would be written in such a way as to give either good or bad news about various stocks. The tipped off brokers traded on the information. Winans and the brokers were prosecuted by the prosecutor ], tried and convicted of securities fraud. Their convictions were upheld by the ] in 1986.<ref>* , Supreme Court decision</ref>


⚫ For example, analysts and brokers who buy shares in a company just before the ] is about to recommend the stock as a strong buy, are practising this type of "front running". Brokers have been convicted of securities laws violations in the United States for such behavior. In 1985, a writer for the ], ], tipped off brokers about the content of his column '''''Heard on the Street''''', which based upon publicly available information would be written in such a way as to give either good or bad news about various stocks. The tipped off brokers traded on the information. Winans and the brokers were prosecuted by the prosecutor ], tried and convicted of securities fraud. Their convictions were upheld by the ] in 1986.<ref>* , Supreme Court decision</ref>
One common practice of ] (HFT) is a form of front running, where they peer into various exchanges and try to detect orders as they propagate from a broker's order router. HFT traders place many small orders that indicate buying/selling pressure. Those with the shortest lag in reaching other exchanges then place orders on those exchanges to catch the rest of the order, at a more advantageous price.<ref>{{cite news |last=Kroft |first=Steve |date=March 30, 2014 |title=Is the U.S. stock market rigged? |url=http://www.cbsnews.com/news/is-the-us-stock-market-rigged/ |newspaper=CBS News |accessdate=November 2, 2014}}</ref> According to ] writer Austin Tymins, HFT firm ] made billions of dollars front-running the trades of large institutional investors, many of which are investing on behalf of middle-class clients.<ref>{{cite news |last=Tymins |first=Austin |date=September 30, 2014 |title=The Rigged Market: A Review of Flash Boys |url=http://harvardpolitics.com/books-arts/rigged-market-review-flash-boys/ |newspaper=Harvard Political Review |accessdate=October 30, 2014}}</ref>

==Recent cases==
In July 2020 ]'s ] was fined $700,000 for trading ahead of its clients from 2012-2014.<ref>{{Cite web|title=Citadel Securities Fined by Finra for Trading Ahead of Clients|url=https://www.bloombergquint.com/onweb/citadel-securities-fined-by-finra-for-trading-ahead-of-clients|access-date=20 March 2021|website=BloombergQuint|date=21 July 2020 |language=en}}</ref><ref>{{Cite news|date=21 July 2020|title=Citadel Securities Fined by Finra for Trading Ahead of Clients|language=en|work=Bloomberg.com|url=https://www.bloomberg.com/news/articles/21 July 2020/citadel-securities-fined-by-finra-for-trading-ahead-of-clients|access-date=20 March 2021}}</ref>


==See also== ==See also==
* ]
* ] * ]
* ] (An economic theory applicable to front running, where stock brokers are agents, and brokerage clients are principals)


==Notes== ==Notes==
Line 39: Line 45:


==References== ==References==
*{{cite book |first=Larry |last=Harris |title=Trading & Exchanges |publisher=Oxford Press |location=Oxford |year=2003 |chapter=Order Anticipators |isbn= }} * {{cite book |first=Larry |last=Harris |title=Trading & Exchanges |publisher=Oxford Press |location=Oxford |year=2003 |chapter=Order Anticipators }}
*{{cite paper |last=Khan |first=Mozaffar |last2=Lu |first2=Hai |title=Do Short Sellers Front-Run Insider Sales? |date=August 1, 2008 |work=MIT Sloan Research Paper No. 4706-08 |ssrn=1140694 }} * {{cite journal |last1=Khan |first1=Mozaffar |last2=Lu |first2=Hai |title=Do Short Sellers Front-Run Insider Sales? |date=August 1, 2008 |journal=MIT Sloan Research Paper No. 4706-08 |ssrn=1140694 }}


==External links== ==External links==
⚫ * {{cite web |url= http://www.ustreasurymarket.com |publisher= US Treasury Market |title= Front running in government bond market |author= Former trader |date= July 14, 2000 }}
*
* * {{cite web |url= https://www.financeprofessor.com/financenotes/lessonsoftheweek/frontrunning.html |title= Front Running |date= 2001 |publisher= Finance Professor |series= Lessons of the Week |url-status= unfit |archive-date= Nov 22, 2011 |archive-url= https://web.archive.org/web/20111122061255/http://financeprofessor.com:80/financenotes/lessonsoftheweek/frontrunning.html }}
⚫ * {{cite web |url= https://www.reuters.com/article/marketsNews/idINN0530515020090305 |publisher= Reuters |title= SEC charges E*Trade, 5 others, for front running (during 1999 to 2005) |date= Mar 5, 2009 }}
⚫ *
* {{cite web |url= https://blogs.barrons.com/stockstowatchtoday/2013/05/03/charlie-munger-hft-is-legalized-front-running |title= Charlie Munger: HFT is Legalized Front-Running |first= Sam |last= Mamudi |date= May 3, 2013 |publisher= Barrons |series= Stocks to Watch }}
*]

⚫ *
{{Hedge funds}} {{Hedge funds}}
{{Authority control}}


{{DEFAULTSORT:Front Running}} {{DEFAULTSORT:Front Running}}

Latest revision as of 13:57, 6 November 2024

Prohibited financial transaction This article is about the financial practice. For the practice as applied to domain names, see domain name 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. 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. Front running is considered a form of market manipulation in many markets. Cases typically involve individual brokers or brokerage firms trading stock in and out of undisclosed, unmonitored accounts of relatives or confederates. 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.

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 US 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.

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.

The terms originate from the era when stock market trades were executed via paper carried by hand between trading desks. 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.

Explanation

For example, suppose a broker receives a market order from a customer to buy a large block—say, 400,000 shares—of some stock, but before placing the order for the customer, the broker buys 20,000 shares of the same stock for their own account at $100 per share, then afterward places the customer's order for 400,000 shares, driving the price up to $102 per share and allowing the broker to immediately sell their shares for, say, $101.75, generating a significant profit of $35,000 in just a short time. This $35,000 is likely to be just a part of the additional cost to the customer's purchase caused by the broker's self-dealing.

This example uses unusually large numbers to get the point across. In practice, computer trading splits up large orders into many smaller ones, making front-running more difficult to detect. Moreover, the U.S. Securities and Exchange Commission's 2001 change to pricing stock in pennies, rather than fractions of no less than 1/8 of a dollar, facilitated front running by reducing the extra amount that must be offered to step in front of other orders.

By front-running, the broker has put his or her own financial interest above the customer's interest and is thus committing fraud. In the United States, they might also be breaking laws on market manipulation or insider trading.

Other uses of the term

Front-running may also occur in the context of insider trading, as when those close to the CEO of a firm act through short sales ahead of the announcement of a sale of stock by the CEO, which will in turn trigger a drop in the stock's price. Khan & Lu (2008: 1) define front running as "trading by some parties in advance of large trades by other parties, in anticipation of profiting from the price movement that follows the large trade". They find evidence consistent with front-running through short sales ahead of large stock sales by CEOs on the New York Stock Exchange.

While front-running is illegal when a broker uses private information about a client's pending order, in principle it is not illegal if it is based on public information. In his book Trading & Exchanges, Larry Harris outlines several other related types of trading. Though all these types of trading may not be strictly illegal, he terms them "parasitic".

A third-party trader may find out the content of another broker's order and buy or sell in front of it in the same way that a self-dealing broker might. The third-party trader might find out about the trade directly from the broker or an employee of the brokerage firm in return for splitting the profits, in which case the front-running would be illegal. The trader might, however, only find out about the order by reading the broker's habits or tics, much in the same way that poker players can guess other players' cards. For very large market orders, simply exposing the order to the market, may cause traders to front-run as they seek to close out positions that may soon become unprofitable.

Large limit orders can be "front-run" by "order matching" or "penny jumping". For example, if a buy limit order for 100,000 shares for $1.00 is announced to the market, many traders may seek to buy for $1.01. If the market price increases after their purchases, they will get the full amount of the price increase. However, if the market price decreases, they will likely be able to sell to the limit order trader, for only a one cent loss. This type of trading is probably not illegal, and in any case, a law against it would be very difficult to enforce.

Other types of traders who use generally similar strategies are labelled "order anticipators." These include "sentiment-oriented technical traders", traders who buy during an asset bubble even though they know the asset is overpriced, and squeezers who drive up prices by threatening to corner the market. Squeezers would likely be guilty of market manipulation, but the other two types of order anticipators would not be violating any US law.

"Front running" is sometimes used informally for a broker's tactics related to trading on proprietary information before its clients have been given the information.

In insurance sales, front running is a practice in which agents "leak" information (usually false) to consumers about a competitor insurance company that leads the consumer to believe that the company's products or services are inferior, or worthless. The agent subsequently obtains a sale at the consumer's expense, earns a commission, and the consumer may have given up a perfectly good product for an inferior one as the result of the subterfuge.

For example, analysts and brokers who buy shares in a company just before the brokerage firm is about to recommend the stock as a strong buy, are practising this type of "front running". Brokers have been convicted of securities laws violations in the United States for such behavior. In 1985, a writer for the Wall Street Journal, R. Foster Winans, tipped off brokers about the content of his column Heard on the Street, which based upon publicly available information would be written in such a way as to give either good or bad news about various stocks. The tipped off brokers traded on the information. Winans and the brokers were prosecuted by the prosecutor Rudolph Giuliani, tried and convicted of securities fraud. Their convictions were upheld by the United States Supreme Court in 1986.

Recent cases

In July 2020 Ken Griffin's Citadel Securities was fined $700,000 for trading ahead of its clients from 2012-2014.

See also

Notes

  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". .
  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.
  11. 67 FR 50739
  12. ^ Harris, Larry (24 October 2002). Trading and Exchanges (First ed.). New York: Oxford University Press. ISBN 0-19-514470-8.
  13. * Carpenter v. United States, Supreme Court decision
  14. "Citadel Securities Fined by Finra for Trading Ahead of Clients". BloombergQuint. 21 July 2020. Retrieved 20 March 2021.
  15. July 2020/citadel-securities-fined-by-finra-for-trading-ahead-of-clients "Citadel Securities Fined by Finra for Trading Ahead of Clients". Bloomberg.com. 21 July 2020. Retrieved 20 March 2021. {{cite news}}: Check |url= value (help)

References

  • Harris, Larry (2003). "Order Anticipators". Trading & Exchanges. Oxford: Oxford Press.
  • Khan, Mozaffar; Lu, Hai (August 1, 2008). "Do Short Sellers Front-Run Insider Sales?". MIT Sloan Research Paper No. 4706-08. SSRN 1140694.

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