What is Front-Running?

434 reads · Last updated: December 5, 2024

Front-running is trading stock or any other financial asset by a broker who has inside knowledge of a future transaction that is about to affect its price substantially. A broker may also front-run based on insider knowledge that their firm is about to issue a buy or sell recommendation to clients that will almost certainly affect the price of an asset.This exploitation of information that is not yet public is illegal and unethical in almost all cases. Front-running is also called tailgating.

Definition

Front running refers to the practice where brokers trade stocks or other financial assets based on non-public insider information that is expected to significantly affect their prices. This behavior is typically illegal and unethical as it exploits undisclosed information. Front running is also known as tailgating.

Origin

The concept of front running emerged with the development of financial markets, particularly in the late 20th century, as securities markets became more complex and information technology advanced. Key events include the crackdown on insider trading by the U.S. Securities and Exchange Commission (SEC) after its establishment in 1934.

Categories and Features

Front running can be categorized into two main types: trading based on internal company information and trading based on imminent analyst reports. The former involves company insiders or those closely connected to the company, while the latter involves financial analysts or brokerage firm employees. Both share the characteristic of trading on non-public information, offering high risk and high reward, but also posing the risk of legal penalties.

Case Studies

A notable case is the 2001 Enron scandal, where many executives sold large amounts of stock before the company's bankruptcy, exploiting undisclosed financial issues. Another case is the 2012 SAC Capital Advisors insider trading case, where the firm was fined $1.8 billion for trading based on non-public drug trial results.

Common Issues

Investors often misunderstand the legality of front running, believing it is permissible if undetected. However, front running is illegal in most jurisdictions and can lead to severe legal consequences. Additionally, investors may underestimate the risk of detection and potential reputational damage.

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