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What Is Front Running?

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  • Written By: Geri Terzo
  • Edited By: A. Joseph
  • Last Modified Date: 10 April 2014
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    Conjecture Corporation
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Front running is a form of insider trading in the financial markets, and it is an illegal practice. It can occur in multiple sets of circumstances, although a common form of front running involves a stock broker with knowledge of an upcoming trade, possibly by the brokerage firm in which he is employed. In this situation, a broker or trader might buy or sell a stock with knowledge of a forthcoming position that a brokerage house will take. That position is an institutional-size order that will materially affect the stock's price. Trading on such sensitive information that is not available either to clients or the public is a form of front running, and it is not only unethical, it also is illegal.

The practice of front running can also be based on analyst research. Analysts in the financial community have the potential to move the stock market based on a rating they assign to individual securities, such as a "buy," "sell" or "hold" rating. A forthcoming rating at a brokerage house might circulate at a firm prematurely, prompting some brokers to buy or sell a security ahead of that rating or a research report's distribution to clients. This is a form of front running.

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Another contentious area for front running could be an institutional investment bank where investment bankers and stock brokers alike are employed. Investment bankers are responsible for issuing securities in the stock market, and brokers are responsible for selling those shares. In the United States, the Sarbanes-Oxley Act of 2002 was formalized in an attempt to mitigate front running between research analysts and investment bankers. The law was designed in part to create a metaphorical wall within large financial institutions. This wall serves as a legal barrier to separate professionals making investment decisions from those professionals with access to sensitive and undisclosed information that could influence investment decisions.

The front running of stocks is not limited to financial institutions and applies to any individual with access to early information that is likely to move a stock. For instance, if any employee of a financial institution relays internal information about a security to a family member, and that relative trades based on the inside information, this is considered a form of illegal front running. Even the operator of a printing press who views financial information before a publication is widely available might be considered guilty of insider trading activity.

It is not always possible to prove circumstances where the front running of securities is occurring. Since it can happen across a broad array of conditions, and given that large sums of money are traded in the stock market every day, regulators can not keep track of every individual trade. When a trader or stock broker tips his or her hand to an important client or to a family member in a telephone conversation, for instance, there might be no evidence of the communication that led to an unethical trade.

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Discuss this Article

Sporkasia
Post 2

Enforcing the laws regarding front running finance is virtually impossible. Sure, some people who break the laws are caught and convicted, but what percentage of the law breakers go untouched?

I don't know the answer to that question, but I would guess that the number of people involved in front running who are never detected is greater than the number of those people convicted of the crime.

Drentel
Post 1

Playing by the rules is something I am in favor of, but is it realistic to think that investment brokers and bankers who gain this insider information are not going to use it themselves or pass it along to a relative or friend? Even for an honest person, the temptation has to be great. It's natural to take advantage of information that can improve your situation.

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