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Difficulty: MediumProhibited Market Manipulation and Fraudulent Practices

A compliance analyst at a member broker-dealer is evaluating surveillance reports flagging two distinct trading patterns:

1. A trader submits non-bona fide buy orders above the prevailing bid and cancels them immediately prior to execution to inflate the apparent market demand.
2. A customer executes simultaneous buy and sell transactions in identical quantities of the same stock across two accounts with identical beneficial ownership.

Which of the following statements regarding these flagged activities are correct? (Select all that apply.)

  1. Submitting non-bona fide orders intended to be canceled before execution to manipulate security prices constitutes spoofing, which is a prohibited market practice.Answer
  2. Executing offsetting transactions that result in no change in beneficial ownership constitutes wash trading, which illegally generates misleading trading activity.Answer
  3. C
    Entering non-bona fide orders to alter price perception is defined as wash trading, whereas executing offsetting orders without a change in ownership is defined as backing away.
  4. D
    Self-Regulatory Organizations (SROs) such as FINRA hold independent criminal prosecution powers to file criminal charges against market manipulators without government jurisdiction.

Answer

The correct statements are that submitting non-bona fide orders intended to be canceled before execution constitutes spoofing, and executing transactions resulting in no change in beneficial ownership constitutes wash trading.
Submitting non-bona fide orders intended to be canceled before execution is the precise definition of spoofing. Executing buy and sell transactions where beneficial ownership does not change is the precise definition of wash trading. Both practices are illegal under federal securities laws and SRO rules.

Step-by-Step Solution

1
Analyze the first trading scenario involving non-bona fide quotes.
Entering orders with no intention of execution to trick other market participants into reacting is defined under SEC and FINRA rules as spoofing.
Spoofing creates a false impression of market demand or supply and is strictly prohibited under federal securities laws.
2
Analyze the second trading scenario involving offsetting transactions across accounts under identical beneficial ownership.
Simultaneous buy and sell orders where beneficial ownership does not change is defined as wash trading.
Wash trading creates fraudulent volume indicators and gives the public a false impression of liquidity in the security.
3
Evaluate regulatory jurisdiction regarding market manipulation violations.
SROs like FINRA discipline member firms and associated persons administratively, but cannot file criminal charges.
Criminal prosecutions require government authority (e.g., U.S. Department of Justice working in tandem with the SEC).

Key Concept

Market Manipulation Tactics (Spoofing vs. Wash Trading) and Regulatory Scope
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Topics

Prohibited Market Manipulation and Fraudulent Practices