Combating Market Manipulation: Wash Sales, Front Running, and New Regulations
Market manipulation is a serious concern for financial regulators as it undermines the integrity of the market and damages investor confidence. Two forms of market manipulation that have recently come under scrutiny are wash sales and front running.
Wash sales occur when an investor sells a security at a loss and then purchases the same or a similar security within a 30-day period before or after the sale. The primary aim of a wash sale is often to claim a tax loss while still holding onto the security. However, this practice can also be utilized to manipulate the market by creating an appearance of buying pressure for the security.
On the other hand, front running happens when a broker or trader enters into a trade after obtaining knowledge of a future transaction that will affect the security’s price. For instance, a broker may buy a stock for personal gain just before executing a large buy order for a client, knowing that the buy order will cause the price to go up. This permits the broker to profit at the client’s expense.
To tackle market manipulation, regulators have adopted sophisticated data analytics to detect patterns of suspicious activities. The SEC’s Market Abuse Unit (MAU), which was established in 2010, utilizes data analytics to identify potential market abuse. In 2022, the SEC implemented several high-profile enforcement actions based on the MAU’s data analytics.
The Financial Industry Regulatory Authority (FINRA) has proposed regulations to address “spoofing” and “layering,” two practices that deceive the market. Spoofing involves traders placing orders with the intention of canceling them before execution, creating an illusion of demand that can push up prices. In contrast, layering occurs when traders place numerous orders on one side of the market with no intention of executing them, creating a false impression of supply that can pull down prices.
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