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Question

Difficulty: HardProhibited Market Manipulation and Fraudulent Practices

A proprietary trader at a member firm frequently enters large buy orders for an equity security at prices higher than the current national best bid without intending to execute them. As soon as other market participants react by raising their offer prices, the trader cancels the non-bona fide buy orders and immediately sells their pre-existing long position at the newly inflated prices. When reviewing these trading patterns, a junior compliance analyst misinterprets the activity as a wash trade, while another staff member asserts that self-regulatory organizations cannot penalize such actions. Which of the following statements correctly identifies the market manipulation tactic and the regulatory authority that applies?

  1. The practice constitutes spoofing, a prohibited manipulative tactic, and FINRA has full authority to investigate and discipline associated persons and member firms for engaging in it.Answer
  2. B
    The practice constitutes wash trading because the entering and canceling of orders leaves the beneficial ownership of the security unchanged.
  3. C
    The practice is spoofing, but because FINRA is a self-regulatory organization rather than a government agency, it lacks legal authority to bring enforcement actions for market manipulation.
  4. D
    The practice is legitimate market making because market participants acting as principal dealers are permitted to submit and pull quote layers to test market liquidity.

Answer

The practice constitutes spoofing, a prohibited market manipulation tactic under federal securities laws and SRO rules, and FINRA possesses full regulatory authority to investigate and discipline member firms and associated persons for engaging in it.
Entering non-bona fide quotes into the order book with the intent to cancel them prior to execution to trick other market participants and manipulate prices is the definition of spoofing. FINRA, as a Self-Regulatory Organization under SEC supervision, has explicit authority to monitor trading, conduct investigations, and impose disciplinary sanctions on registered individuals and member firms for market manipulation violations.

Step-by-Step Solution

1
Analyze the trader's order entry pattern
Entering non-bona fide orders intending to cancel them before execution to artificially push prices up is identified as spoofing.
Spoofing creates a false impression of market demand, whereas wash trading involves actual executed trades where beneficial ownership does not change.
2
Evaluate SRO regulatory authority
FINRA, as an SRO registered with the SEC, has jurisdiction to enforce rules against manipulative practices and sanction member broker-dealers and registered personnel.
Although FINRA is not a government agency, federal securities laws grant SROs disciplinary powers over member firms and associated persons.

Key Concept

Market Manipulation Tactics (Spoofing vs. Wash Trading) and SRO Enforcement Authority
Estimated Time:1m 15s
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Topics

Prohibited Market Manipulation and Fraudulent Practices