“Front running” and “tail-gaiting” describe a securities law violation in which an insider – perhaps a broker – uses non-public information to their advantage. For instance, a broker might know that a wealthy client is going to buy a million shares of Company A, which means that the price of that company’s shares will increase. If the broker then buys shares for themselves to profit from the increase in price, they are front running the trade. Front running could also work to a broker’s client’s advantage — unscrupulous brokers might share insider information with their wealthy clients as an illegal business perk.

Front running is unfair to the public and the market as a whole. It also hurts the front-running broker’s client. By utilizing information about the trade in advance, they reduce the likelihood that their client will get the best possible price for their trade. Brokers are required to fulfill their duties according to Regulation Best Interest, which specifically requires the elimination of conflicts of interest between clients and brokers.

FINRA’s Rules on Front Running

The Financial Industry Regulatory Authority (FINRA) has clear rules designed to prevent brokers and registered investment advisers from using information that is not available to the public. There are strict security rules around the release of this type of information, and FINRA also requires that firms maintain and supervise their records.

  • Rule 5270 refers specifically to “block” transactions. Brokers know in advance about block transactions, which FINRA describes as transactions that comprise 10,000 or more shares. Transactions this large will cause a dramatic increase in demand for that stock.
  • Rule 5280 states that brokers cannot execute trades based on the content or timing of a research report that is not yet available to the public.

When Does Front Running Happen?

One 2016 working paper from the European Central Bank found evidence of “pre-release price drift,” showing that prices started to move around 30 minutes before the block transaction, as though certain individuals knew that the price of a stock was about to increase. The paper stated, “To ensure fairness in financial markets, strict release procedures need to be implemented for all market-moving announcements including announcements originating in the private sector.” Unfortunately, those strict securities requirements haven’t always been in place (or have gone unenforced), resulting in investigations by the SEC and millions of dollars in fines.

SEC Investigations of Front-Running

In 2007, the Securities and Exchange Commission investigated the possibility that Wall Street bank employees had leaked information about block trades to preferred clients. The New York Times reported that the SEC suspected that banks may “tip” their clients with front running information. Lori Richards, the director of the Office of Compliance Inspections at the SEC, told the Times: “Mutual fund traders have long complained that their big trades may be front-run by market participants with inside information about their trades, and they believe the price on those trades suffers as a result.” The article points to hedge funds as possible culprits, as many are powerful companies that control significant percentages of the market.

2009 saw 14 firms agree to pay $69 million in fines and forfeited profits. The SEC stated that they had investigated the firms’ activity from 1999 to 2005 and found that the firms had made a total of $58.4 million in front-running profits that should have gone to their customers. In 2004, the SEC filed charges against five large specialist firms – according to the SEC, they had made $150 million in profits through similarly “improper” means.

What Can I Do?

Front running is difficult for an investor to detect, and it took the SEC a long investigation to uncover. Investors should keep in mind that front running and insider trading are major issues facing the securities industry. If you believe your broker or investment adviser did not work in your best interest, you can contact one of the securities attorneys at Fitapelli Kurta for a free case evaluation. Call (877) 238-4175 or email info@fkesq.com.

Leave a Comment