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Difficulty: Very hardProhibited Market Manipulation and Fraudulent Practices

During a routine compliance review, an analyst discovers that a retail trader established two separate accounts at different financial firms, both ultimately controlled by the same beneficial owner. Over a two-week period, the trader repeatedly entered simultaneous buy and sell limit orders for a thinly traded equity security between these two accounts at identical prices and sizes. These transactions created the false appearance of active market interest without any actual change in economic ownership or risk. Which of the following correctly identifies this prohibited market practice and the scope of regulatory enforcement authority regarding criminal sanctions?

  1. The activity constitutes wash trading, and criminal prosecution must be brought by federal law enforcement authorities such as the Department of Justice, because self-regulatory organizations lack criminal jurisdiction.Answer
  2. B
    The activity constitutes spoofing, and criminal prosecution must be brought by federal law enforcement authorities such as the Department of Justice, because self-regulatory organizations lack criminal jurisdiction.
  3. C
    The activity constitutes wash trading, and FINRA maintains independent statutory authority to institute criminal proceedings and bring federal indictment charges against the trader.
  4. D
    The activity constitutes interpositioning, which occurs because the executing firms improperly acted in a dealer capacity rather than an agency capacity during order matching.

Answer

The prohibited activity is wash trading, and criminal prosecution must be pursued by federal authorities like the Department of Justice because SROs lack criminal enforcement power.
The scenario describes wash trading, which occurs when transactions are executed across accounts belonging to the same beneficial owner to generate deceptive volume or price signals without transferring actual risk. Furthermore, while regulatory entities like FINRA monitor trading and penalize members administratively, criminal prosecution requires referral to government prosecutors such as the Department of Justice.

Step-by-Step Solution

1
Analyze the trader's activity described in the scenario
Simultaneous buy and sell transactions between accounts controlled by the same beneficial owner result in no change of actual economic ownership, but generate artificial trading activity.
By definition, executing offsetting transactions with no change in beneficial ownership to create a false impression of liquidity or market interest is wash trading.
2
Distinguish wash trading from other manipulative practices
Spoofing relies on entering and quickly canceling non-bona fide orders, whereas wash trading involves completed trades that lack true beneficial ownership transfer.
Identifying the precise mechanics of the trade execution establishes the exact regulatory violation.
3
Evaluate the regulatory enforcement jurisdiction for criminal offenses
Self-Regulatory Organizations (SROs) such as FINRA have civil/administrative jurisdiction over member firms and associated persons, whereas criminal prosecutions fall exclusively under governmental entities like the Department of Justice (DOJ).
SROs can issue fines, censure, or bar individuals, but cannot file criminal charges or seek imprisonment.

Key Concept

Wash Trading and Regulatory Enforcement Authority Limits
Estimated Time:1m 45s
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Topics

Prohibited Market Manipulation and Fraudulent Practices