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St. Thomas Law Review

David M. Bovi

First Page

103

Document Type

Article

Abstract

In the financial arena, the name of the game is money--make it now, make it fast, make a lot. To some players in this financial game, the question of whether to play fairly or unfairly, legally or illegally, is not debated. Their only issue of concern is how much, how fast, and what are the chances of being caught. Throughout history, this attitude has fostered the creation of a countless number of fraudulent schemes and contrivances with the sole purpose of making fast and easy money, regardless of the consequences to other players in the game. One particular fraudulent scheme, pervasive on many exchanges across the country and around the world, is front-running. Front-running occurs when a broker trades on a security while in possession of material nonpublic information concerning the imminent block transaction of one of his customers. The transaction is consummated in order for the broker to capitalize on the possession of the material non-public information. Specifically, a broker buys or sells a security prior to the execution of a block transaction so as to benefit from the price change reasonably expected to follow the execution of the block order. Self-regulatory organizations (SROs) take the position that frontrunning is actively "inconsistent with just and equitable principles of trade," and therefore violates the rules of these organizations. These rules and positions, however, do not appear to deter front-running. The problems that front-running creates demonstrate the need for a uniform rule to govern trading on the exchanges. Rule 10b-5 may be that rule. Yet, whatever rule is utilized or enacted, some traders will nevertheless continue to front-run orders and exploit customers to their maximum advantage. Although most players will stay just inside the legal boundaries, some players will be tempted to see what they can get away with. The Securities and Exchange Commission's (SEC) position regarding the application of section 10(b) and Rule 10b-5 to front-running block transactions is unclear. Presently, the SEC has only regulated front-running through its oversight authority over the SROs pursuant to the Securities Exchange Act of 1934 (Exchange Act). The SEC has done no more than suggest that the exchanges designate front-running as a practice "inconsistent with just and equitable principles of trade." To date, however, the SEC itself has yet to commence an enforcement proceeding against any person or persons for front-running block transactions; thus, providing the basis for this paper. This article, while confining its discussion to front-running in the securities market, will first resolve the question of whether front-running is violative of section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. Next, it will determine whether the costs and consequences of falling under this section will deter and/or prevent brokers and broker-dealer firms from front-running, given the lucrative economic incentives that front-running offers. Finally, it will demonstrate that if the SEC creates new rules or utilizes current ones, the game will be fairer since it will be played on a more level playing field. However, trading is, and always will be, an adversarial game, "a game as rough as the dollars at stake warrant.

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