Front Running - Other Uses of The Term

Other Uses of The Term

Front-running may also occur in the context of insider trading, as when those close to the CEO of a firm act through short sales ahead of the announcement of a sale of stock by the CEO, which will in turn trigger a drop in the stock's price. Khan & Lu (2008: 1) define front running as "trading by some parties in advance of large trades by other parties, in anticipation of profiting from the price movement that follows the large trade". They find evidence consistent with front-running through short sales ahead of large stock sales by CEOs on the New York Stock Exchange.

While front-running is illegal when a broker uses private information about a client's pending order, in principle it is not illegal if it is based on public information. In his book Trading & Exchanges, Larry Harris outlines several other related types of trading. Though all these types of trading may not be strictly illegal, he terms them "parasitic".

A third-party trader may find out the content of another broker's order and buy or sell in front of it in the same way that a self-dealing broker might. The third-party trader might find out about the trade directly from the broker or an employee of the brokerage firm in return for splitting the profits, in which case the front-running would be illegal. The trader might, however, only find out about the order by reading the broker's habits or tics, much in the same way that poker players can guess other players' cards. For very large market orders, simply exposing the order to the market, may cause traders to front-run as they seek to close out positions that may soon become unprofitable.

Large limit orders can be "front-run" by "order matching" or "penny jumping". For example if a buy limit order for 100,000 shares for $1.00 is announced to the market, many traders may seek to buy for $1.01. If the market price increases after their purchases, they will get the full amount of the price increase. However, if the market price decreases, they will likely be able to sell to the limit order trader, for only a one cent loss. This type of trading is probably not illegal, and in any case, a law against it would be very difficult to enforce. Harris still considers it "parasitic".

Other types of traders who use generally similar strategies are labelled "order anticipators" by Harris. These include "sentiment-oriented technical traders," traders who buy during an asset bubble even though they know the asset is overpriced, and squeezers who drive up prices by threatening to corner the market. Squeezers would likely be guilty of market manipulation, but the other two types of order anticipators would not be violating any US law.

"Front running" is sometimes used informally for a broker's tactics related to trading on proprietary information before its clients have been given the information.

For example, analysts and brokers who buy shares in a company just before the brokerage firm is about to recommend the stock as a strong buy, are practicing this type of "front running". Brokers have been convicted of securities laws violations in the United States for such behavior. In 1985, a writer for the Wall Street Journal, R. Foster Winans, tipped off brokers about the content of his column Heard on the Street, which based upon publicly available information would be written in such a way as to give either good or bad news about various stocks. The tipped off brokers traded on the information. Winans and the brokers were prosecuted by then-prosecutor Rudolph Giuliani, tried and convicted of securities fraud. Their convictions were upheld by the United States Supreme Court in 1986.