Prohibited activities and penalties

Like many lists of things, especially criminal actions, there is no possible way to make a complete list of all prohibited activities, as new ones are “discovered” by dishonest persons.

The major prohibited activities under FINRA rules, some of which we go into more detail in this, or other sections. Some are simply pretty obvious

• Manipulative and deceptive practices: No person involved in the industry can use manipulative, deceptive, or fraudulent practices, or use any form of market manipulation. Market manipulation we will discuss later in this section.
• Insider trading is the use of non-public material information to buy or sell stock, or simply being in the possession of said information, and conducting transaction in the security. We go into more detail in another section on insider trading.
• Suitability must be followed: We cannot knowingly make unsuitable recommendations to any customer. This is why we have to strive for as full and complete customer identification information as possible.
• Misleading communications: We cannot communicate false, exaggerated, or promissory claims in communications. We must follow the communications rules and filing requirements.
• Borrowing or lending money to a customer not in the borrowing or lending business, unless they fall into an exception. Easy exception would be for registered reps of broker-dealers; immediate family, outside friend, outside business partner, registered rep of the same member firm. Of course your individual firms may have their own, more strict rules.
• A representative selling away. That is participating in an outside securities transaction where the representative either didn’t ask for permission or ignored being denied permission.
• Front running is trading in front of client’s orders to profit from large customer’s orders when the market price changes in reaction to the large order.
• There are others, but those are a nice list to start with. Use your best judgment. Remember, if the question is asking for what is NOT prohibited, that means 3 of them are prohibited. It might be easier to find the wrong answers sometimes.

Market manipulation

Simply defined market manipulation, is the prohibited activities that artificially change the price and/or volume results of the market. Just like it is impossible the create a “list of all illegal actions”, because criminals will keep coming up with new ones (try and explain crypto crimes to a law enforcement officer in the 90s), this is merely a list of the most commonly discussed and tested market manipulation practices.

Painting the tape - Painting the tape is simply the process of placing successive orders in small increments in at successfully increasing or decreasing numbers, in order to try and increase or decrease the price unethically.

Wash trade/matched orders - Matched orders is the larger category. It involved transactions that “do not result in material change of beneficial ownership”. If someone buys and sells 1 million shares of the same security, at the same time, that doesn’t really cost them anything, other than potentially sales commissions, but it does make it look like a large increase in volume, which could drive up demand.

There can be some easy confusions with similar words. Wash sale is very different than wash trade. Wash sale simply means reentering a transaction that was closed at a capital loss within 30 days of realizing the loss. It simply voids the loss. Wash sale is not unethical or illegal, the person simply doesn’t get to keep the capital losses to write off later. Matching orders is equally quite different from matched orders. Matching orders is simply the process of finding someone who wants to buy what someone else wants to sell. If someone wants to sell 1,000 shares of ABC, and another client places an order around the same time to buy 1,000 shares of ABC, those orders match, and the transaction commences.

Bear raids - Bear raids refer to attempts to move the price of the stock by selling large numbers of shares short, and then pocketing the difference between that initial price and the new lower price. Massive increases in shorting of a stock generally cause the price to go down. This violates SEC rules, which stipulate that short sales must be on an uptick in price.

Spoofing and layering - These are manipulations usually used by high-frequency traders. Spoofing is placing bids or offers with the intent to cancel before execution. Layering is a form of spoofing where the trader places multiple orders on one side of the book in order to create false impressions of heavy buying or selling, a false impression of volume.

Marking the open/close - Two related manipulative actions, basically trying to effect the “closed at” price, or the “opened at” price of a security to benefit the person committing the manipulative action. Marking the close would be buying or selling very near the end of the day, to help drive the market up or down, in order to get the “market closed at” price to reflect a benefit to them, and not reality. Marking the open is similar, just trying to get the first price of the day. Marking the close is a much more common manipulative practice.

Frontrunning - Frontrunning, or front running, appears to be closely related to insider trading, in that insiders at the firm have information that will effect a securities price. Unlike insider trading, where the information could be a merger, or a investigation, or a failed test, or anything personally related to the industry or company, frontrunning is more about market effects. The firm would buy or sell a large amount of stock, before putting in a clients order in that same security. When they place the even larger, generally institutional client order, they know that the larger order will effect the price of the stock, and therefore they benefit when the price goes up or down, depending on the information and order they place.

Trading in advance of a research report - Similar in regards to frontrunning, trading in advance of research reports can also be thought of as similar to insider trading. This time though, it isn’t confidential information about the business or industry events, it is not about knowledge of institutional orders that will effect the price the person can benefit from. In trading advance of research reports, also sometimes simply referred to as trading ahead, research analysts at our firm have compiled a new report that is going out next week. It has either extremely positive, or negative, findings about the company, so we know it likely will raise or lower the price due to the inherent recommendation. So someone with knowledge of this report, goes and buys or sells securities before it is publicly available.

Firms have tried to argue that when they are about to publish a research report that is positive, their purchasing of shares is to help make sure they have the inventory for anticipated customer purchase requests. Regulators do not accept this. FINRA rules state that member firms may not establish, increase, decrease, or liquidate any inventory position, based on knowledge derived from advanced knowledge of research reports.

This is also the reason that member firms are required to establish, maintain, and enforce policies to prevent research reports from going between research and trading departments (information barriers), and to monitor research analysts themselves.

Collusion - Merriam Webster, collusion is defined as “secret agreement or cooperation especially for an illegal or deceitful purpose”. In securities world, traders, brokers, market markers, could all potentially work together to profit at the expense of the general public. Every so often investigations and charges show why these rules are very important. To avoid collusive activities or behaviors, traders must avoid;

• Communicating with different firms where prices are not set independently.
• Communicating with other traders to manipulate prices; getting them to move quotes in a direction, change their quotes, delay transaction reporting, or even misreport transactions on purpose (error accounts exist for accidents, not purposeful manipulation).
• Making statements that could be seen as extortionate, threatening, harassing, or anything similar.
• Providing information they shouldn’t such as customer orders or strategies, market makers orders, strategy, non-public research, upcoming quotes, or similar internal details.
• Backing away or claiming they plan to.

Sanctions for violations of the rules.

There are 2 primary types of “negative” actions that can be applied. We need to be a bit careful, because one of them isn’t really a negative; they aren’t actually penalties, even if they sort of feel and sound that way.

The 2 types of actions could be punitive or non-punitive.

Punitive

Punitive means it actually is a negative, these are the punishments that can be doled out.

Censure

Censure is the lowest level of punitive punishment. It is basically “a slap on the wrist”. Basically, an official letter comes addressed to you; “Wow, we the organization, can’t believe you did that. You did so bad! We are so shocked! … We are going to have to put this in your permanent record, pay this $400 or whatever fine, and don’t you let us catch you doing this again!”-type situation. It is reported on your record, and will be there forever, but it generally is for relatively minor things. You messed up! But likely, mostly accidentally, and they want to make sure to crack the whip hard enough to scare you into not doing it again, but not hard enough to actually really cause damage.

Fines

Often combined with a censure or any of the other consequences, monetary penalties are an extremely common occurrence with any type of punishment. It is rare when a punishment doesn’t include a fine.

Suspension/Revocation

Kicking you out for a period. All resources refer to “suspension and revocation process”, so there doesn’t seem to be a difference if the license under question is being suspended, has been suspended, has been revoked, will be revoked, or anything else like that. All mean the same thing, in that you don’t currently have a licensed as long as it has been suspended or revoked. Once the suspension is over, you are able to come back, and any commissions that had been earned on previous business, before the suspension, can be paid out of escrow. While suspended, no new commissions can be earned.

Expulsion

Kicking your butt out. These SROs are membership organizations, and they can kick you out if they want. Generally a suspension is up to 1 year, and if they plan on suspending you for more than 1 year, they expel you. Generally. Expulsion is different than the next one, barring, in that expulsion does not come with a “don’t bother coming back, you will never be welcome” note, like barring does.

Barring

One of the most severe penalties that can be issued. This is expelling you, kicking you out, removing your license, and explicitly stating, “do not come back, you will never be allowed back, don’t waste your time, or our time, the guards have your picture, go away forever”. Brokercheck keeps track of these people, every person actually, and every story, or movie, is released about these people. Go to Brokercheck, and search for “Jordan Belfort”. If you’ve seen The Wolf of Wall Street, you have heard of that man, and you likely know why he is barred from ever affiliating with a FINRA firm.

Cease & desist

Telling the rep to stop doing what they are doing. It isn’t so much a penalty, but if not followed, would easily lead to one.

Non-punitive

If punitive is actually a punishment, non-punitive are not punishments. They might sound, or seem like it, but they aren’t.

Denial

Denial is simply not allowing the licensee to proceed. It isn’t really a negative, though if you are that licensee it would certainly feel that way. It doesn’t go on your record like the punitive punishments do, and it likely is a clerical error, or something else that a little time will clear up.

Cancellation

Sometimes representatives die, or disappear, or fall off a boat and spend a few years with Wilson on a private island somewhere. If the representative dies, falls into a prolonged coma or similar non functioning state, can’t be located for extended periods of time and presumed missing or dead, or anything similar to that, they can’t actively use the license, the license is canceled. If they turn up, there is nothing stopping them from reapplying.