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Difficulty: MediumProhibited Market Manipulation and Fraudulent Practices

A proprietary trader at a broker-dealer submits a series of large buy orders for a thinly traded equity security significantly above the current bid price. The trader has no intention of executing these orders; instead, the goal is to create the false appearance of intense buying interest so other market participants raise their bids. As soon as the market price rises, the trader cancels all the pending buy orders before execution and sells the firm's long inventory at the higher price. Which of the following prohibited practices has the trader committed?

  1. Spoofing, because the trader entered non-bona fide orders intended to be canceled prior to execution to manipulate market prices.Answer
  2. B
    Wash trading, because the trader executed offsetting transactions between accounts under common ownership without a change in beneficial ownership.
  3. C
    Unauthorized principal dealing, because market makers are legally prohibited from trading out of firm inventory when customer orders are pending.
  4. D
    An SRO criminal violation, because FINRA holds statutory jurisdiction to criminally prosecute individuals for deceptive quote submissions.

Answer

Spoofing, because the trader entered non-bona fide orders intended to be canceled prior to execution to manipulate market prices.
The correct answer identifies spoofing. Spoofing is a form of market manipulation where a market participant submits non-bona fide orders (orders they do not intend to execute) to artificially move security prices or create a false impression of market liquidity, canceling the orders before execution to profit on secondary trades.

Step-by-Step Solution

1
Analyze the trader's actions in the scenario
The trader submitted large buy orders without the intent to execute them, then canceled them after driving up the price to sell inventory.
Identifying whether orders were bona fide (intended to execute) or non-bona fide (intended to mislead and be canceled) is critical to categorizing the violation.
2
Distinguish between prohibited market manipulation tactics
Entering non-bona fide orders to create fake market interest and canceling them before execution constitutes spoofing, not wash trading.
Wash trading requires actual trade execution with no change in beneficial ownership, whereas spoofing relies on submitting and canceling non-bona fide orders.

Key Concept

Spoofing vs. Other Prohibited Practices
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Topics

Prohibited Market Manipulation and Fraudulent Practices