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Difficulty: MediumProhibited Market Manipulation and Fraudulent Practices

An individual investor opens accounts at two separate brokerage firms under the same name and tax identification number. Over several trading sessions, the investor places simultaneous buy and sell orders of equal size for a thinly traded equity security between these two accounts, resulting in no net change in beneficial ownership, solely to create the appearance of active trading volume and induce others to trade. Which of the following statements correctly identifies this prohibited practice and its regulatory standing?

  1. A
    The activity is spoofing, because placing offsetting orders across separate firm accounts creates false market depth designed to trick algorithmic traders into cancelling existing quotes.
  2. The activity is wash trading, a fraudulent market manipulation tactic prohibited under federal securities laws and self-regulatory organization (SRO) rules.Answer
  3. C
    The activity is wash trading, which violates self-regulatory organization (SRO) ethical guidelines but falls outside the statutory enforcement jurisdiction of the Securities and Exchange Commission (SEC).
  4. D
    The activity is an unauthorized principal dealer markup violation, caused by the broker-dealers failing to execute the trades in an agency capacity.

Answer

The activity is wash trading, a fraudulent market manipulation tactic prohibited under federal securities laws and self-regulatory organization (SRO) rules.
Executing matching buy and sell orders that result in no beneficial ownership change to fabricate artificial trading volume is the exact definition of wash trading. Wash trading is illegal under Section 9(a)(1) of the Securities Exchange Act of 1934 and FINRA Rule 2010.

Step-by-Step Solution

1
Analyze the trading activity described in the scenario
The investor is executing offsetting buy and sell orders for the same security across separate accounts with no change in beneficial ownership.
Identifying the lack of beneficial ownership change pinpoints the specific market manipulation archetype.
2
Distinguish between prohibited market practices
Transactions with no change in beneficial ownership created to simulate artificial volume are defined as wash trading (unlike spoofing, which relies on unexecuted non-bona fide orders).
Wash trades mislead the market regarding real trading volume and investor demand.
3
Verify regulatory jurisdiction
Wash trading violates statutory federal laws enforced by the SEC as well as rules established by self-regulatory organizations like FINRA.
Both federal securities statutes and SRO rules strictly forbid deceptive and manipulative trading practices.

Key Concept

Wash Trading and Market Manipulation Prohibitions
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Topics

Prohibited Market Manipulation and Fraudulent Practices