Front Running and the HSBC Trading Scandal

Search traffic for the term front running surged by 2,400% on our site last evening and continues to grow. Not surprisingly, the traffic bump is due to this news story involving front running. Briefly, two HSBC Holdings PLC (HSBC) executives have been accused of front running or using information from customer trades in 2011 to set up their own trades for profit. In this particular case, the two HSBC executives used an exchange transaction of $3.5 billion into British pounds for profits of almost $8 million. (For related reading, see: HSBC Lays Off Dozens of Investment Bankers.)

What Is Front Running?

Front running is the “unethical practice of a broker trading an equity in his personal account based on advanced knowledge of pending orders from the brokerage firm or from clients, allowing him to profit from the knowledge.” The purchase of British Pounds was sure to drive up its price. Both traders bought British Pounds in anticipation of the transaction and generated profits of $3 million within a single day. At the same time, they charged the client $5 million in transaction fees. This is not the first time that Wall Street traders have been accused of profiting off information from customer trades. Back in 2009, 14 trading firms paid $69 million to settle similar charges related to front running.

How Are Regulators Dealing With Front Running?

By the very nature of their job, brokers and investment firms are privy to inside information about customer traders. In recent times, electronic systems, that match buyers with sellers without human intervention, have made the process efficient and less prone to crime. However, specialist firms, such as Goldman Sachs Group Inc. (GS) and E*Trade Markets, are still responsible for large orders that could result in significant market swings. Proving trader culpability in making personal profit can be a difficult job.

In yesterday’s case, lawyers used a personal phone call to prove the accused men’s intent. Regulators also approved FINRA Rule 5270 in 2012. The rule places a bunch of restrictions on brokers who are dealing in such trades. For example, they are prohibited from trading in the same security or related financial instrument that is the subject of an imminent block transaction. (For more, see: Panama Papers: Top 10 Banks for Offshore Companies.)

The HSBC Case

Coincidentally, it has been reported that HSBC conducted its own investigation into the $3.5 billion deal in 2014. The review of the transaction concluded that there was no breach of the banks internal code of conduct. However, it seems U.S. authorities disagree: One of the traders has been arrested and there is a warrant out for the second trader’s arrest.

Originally posted at Investopedia: Front Running and the HSBC Trading Scandal (HSBC) | Investopedia

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