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Difficulty: HardProhibited Market Manipulation and Fraudulent Practices

A market maker receiving a customer limit order to buy 1,000 shares of an equity security at 45.00executesapurchaseforitsproprietaryaccountat45.00 executes a purchase for its proprietary account at 44.95 prior to executing the customer's order. In defense of the trade, the firm claims that acting as a principal market maker permits prioritizing firm trades over customer orders and that FINRA lacks authority to discipline member firms without SEC criminal prosecution. Which of the following statements accurately evaluates the market practice and regulatory framework described?

  1. The trader engaged in prohibited trading ahead (front-running), and FINRA as an SRO possesses regulatory authority to enforce rules, conduct disciplinary proceedings, and sanction member firms without requiring SEC criminal prosecution.Answer
  2. B
    The trader engaged in illegal wash trading by purchasing shares for the firm's inventory prior to filling the customer limit order, which is only actionable if beneficial ownership did not change.
  3. C
    The trader's conduct is permissible because acting as a dealer executing principal transactions grants statutory priority over customer agent orders in equity securities.
  4. D
    The trader's action constitutes prohibited front-running, but FINRA cannot impose regulatory sanctions or fines because SROs lack legal authority to discipline members without prior SEC criminal conviction.

Answer

The trader engaged in prohibited trading ahead (front-running), and FINRA as an SRO possesses regulatory authority to enforce rules, conduct disciplinary proceedings, and sanction member firms without requiring SEC criminal prosecution.
Executing a proprietary trade while holding an unexecuted customer order that could be executed at the same or better price violates FINRA Rule 5320 (Prohibition Against Trading Ahead of Customer Orders). Additionally, FINRA functions as an SRO with full authority to bring administrative disciplinary actions and impose sanctions on member firms without requiring an SEC criminal conviction.

Step-by-Step Solution

1
Analyze the trading activity described in the scenario.
Executing a proprietary trade ahead of an unexecuted customer order at a price that would satisfy the customer's order constitutes front-running / trading ahead (FINRA Rule 5320).
Broker-dealers are prohibited from placing firm financial interests ahead of pending customer orders.
2
Evaluate the broker-dealer role defense.
The firm's status as a principal dealer does not exempt it from customer order protection rules.
Market makers acting as dealers must still observe order display and protection duties to maintain market integrity.
3
Evaluate the self-regulatory organization (SRO) authority claim.
FINRA has statutory administrative power under the Securities Exchange Act of 1934 to investigate, fine, suspend, or bar member firms and representatives.
SRO enforcement mechanisms operate independently of criminal court convictions.

Key Concept

Front-Running / Trading Ahead and SRO Enforcement Authority
Estimated Time:2m 0s
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Topics

Prohibited Market Manipulation and Fraudulent Practices