FEDERATION OF EURO-ASIAN STOCK EXCHANGES
Types of market manipulation
• Front Running: The practice of a broker
trading ahead of an order for a client positions
the broker to benefit from the price movement
caused by the client order. In a fragmented
market a broker’s order can be executed on
one trading venue and the client’s order
executed on another, making it impossible to
see the connection at the exchange level.
Considered in isolation, there is nothing wrong
with these trades. Effective surveillance must
be carried out by a team with access to the
consolidated, broker identified, principal
agency tagged trading data across venues.
• Bait and Switch: In this scenario a market
participant tries to achieve a better price by
convincing other investors that there is a large
aggressive buyer (seller) active in a company,
when in fact the same investor is actually
selling (buying). In a multiple venue setting,
the two parts of the manipulative strategy can
be split across two venues. For example, the
large buying bait order may be placed on the
market that has the most liquidity and the least
risk of execution, while the owner of the bait
order is selling the same security on another
venue. Isolated surveillance is blind to this
activity.
ANNUAL REPORT APRIL 2011
• Dark Pool Gaming: Dark pools don’t
provide any pre-trade transparency so
investors don’t know the best bid or offer
(BBO). In the U.S. and Europe dark pools are
restricted to executing trades within or at the
consolidated or primary listing BBO. Dark
pools can be gamed by placing orders onto
the lit books that narrow or move the reference
BBO. Buyers who want to trade in the dark
may place sell orders onto the primary market
to reduce the reference sell price. Those
orders need only be for a small number of
shares, enough to register as the best BBO,
making this a low cost strategy to significantly
change the overall trade value of a large block
in the dark. We have advised customers to
deploy alerts that look for small trades in the
dark, which test for liquidity, followed by a
change in the spread on the lit book and then
a large trade on the dark book. This pattern
may indicate that a broker is moving prices on
the lit book to improve its executions on the
dark book. To identify this, the dark pool
needs to have knowledge of the lit book BBO.
• Taking Advantage of Market Open
Differences: This type of market manipulation
takes advantage of the same security trading
on markets with different open times and
where the closed market is primary. A large
order is placed into the opening auction on
the primary market, which although closed
can still signal to the open markets that a price
adjustment is necessary. Theoretically, a trader
wanting to sell at a high price could place a
large buy order at a very high price into the
pre-open on the primary market and hope that
the open markets’ prices react. There is no
risk of the buy order being executed since it
was placed on a closed market. To spot this
activity, the non-primary markets will need to
have the indicative opening prices on the
primary markets fed into their surveillance
system. Alternatively, the regulatory agent
would need to have full order book
surveillance of all markets.
• Trading halts: Market operators commonly
respond to high volatility in a single security by
halting trading in a stock and issuing a price
query to the listed company. This allows the
market participants to assimilate any newly
disclosed information and allows price
discovery to occur through a call auction. In
some cases alternative markets ignore the halt
and continue trading, allowing participants
with unfair access to information to trade
before the primary market re-opens.
Regulators need to ensure that a uniform
process is followed by all trading venues
based on a clear halting framework.
CONTACT INFORMATION
Contact Name Mr. Henri Bergström
E-mail henri.bergstrom@nasdaqomx.com
Website www.nasdaqomx.com
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