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Difficulty: HardProhibited Market Manipulation and Fraudulent Practices

A FINRA compliance examiner reviewing trading logs at a registered broker-dealer flags two distinct customer account scenarios:

Scenario 1: A registered representative places a series of small buy orders for an illiquid stock in the final minute of trading to artificially lift the reported closing price and inflate the valuation of a collateral portfolio.

Scenario 2: A retail investor purchases $10,000 worth of stock in a cash account, sells the position two days later prior to depositing funds, and attempts to pay for the initial purchase using the proceeds from the sale.

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

  1. Scenario 1 describes 'marking the close,' which is a prohibited market manipulation tactic intended to alter the official closing price of a security.Answer
  2. Scenario 2 describes 'freeriding,' a violation of Federal Reserve Regulation T that typically results in a 90-day account freeze.Answer
  3. C
    Scenario 1 describes 'wash trading,' because the transactions were entered near market close without genuine investment intent.
  4. D
    Scenario 2 describes 'churning,' because the customer closed out the position before settlement occurred.

Answer

The correct statements identify Scenario 1 as marking the close (prohibited market manipulation) and Scenario 2 as freeriding (a Regulation T violation).
Marking the close is a fraudulent trading tactic aimed at influencing market perception or collateral valuations by trading near the closing bell. Freeriding is a specific payment breach under Regulation T where an investor attempts to pay for a purchase using the proceeds of a sale of that same security prior to depositing required cash.

Step-by-Step Solution

1
Analyze Scenario 1
Entering orders right before the trading day ends to artificially alter the closing price is defined under FINRA and SEC rules as 'marking the close.'
Marking the close distorts market prices and valuation metrics.
2
Analyze Scenario 2
Buying stock in a cash account and selling it before paying for the purchase constitutes 'freeriding.'
Under Federal Reserve Board Regulation T, full cash payment must be made before securities can be sold, or the account will face a mandatory 90-day restriction.
3
Evaluate distractors
Wash trading requires no change in beneficial ownership; churning requires excessive broker-driven trading for commission generation. Neither definition matches the scenarios provided.
Correctly distinguishing market manipulation terminology prevents misclassification of compliance violations.

Key Concept

Prohibited Market Manipulation and Customer Account Violations (Marking the Close vs. Freeriding)
Estimated Time:2m 0s
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Topics

Prohibited Market Manipulation and Fraudulent Practices