What Is Round-Trip Trading?
Round-trip trading largely refers to the unethical practice of purchasing and selling shares of the same security time and time again in an attempt to manipulate observers into believing that the security is in high demand. This behavior differs greatly from a legal and ethical round-trip trade, which every investor completes when they buy and later sell a security.
- Round-trip trading generally refers to an unethical market-manipulation behavior.
- Repeated buying and selling of securities can inflate trading volume and balance sheet figures (something Enron did).
- Round-trip trading should not be confused with a legal, normal, round-trip trade that investors make every day whenever they close a position they have opened.
Understanding Round-Trip Trading
Round-trip trading is an attempt to create the appearance of a high volume of trades, without the company behind the security experiencing an increase in income or earnings. These types of trades can be conducted several ways, but most commonly they are completed by a single trader selling and purchasing the security in the same trading day, or by two companies buying and selling securities between themselves. This practice is also known as churning or wash trades.
Round-trip trading can easily be confused with legitimate trading practices, such as the frequent round-trip trades made by pattern day traders. These traders typically execute many transactions in the same day. Although they do have minimum standards they must practice, such as keeping at least $25,000 of account equity before completing these types of transactions, and reporting their net gains or losses on the transactions as income, rather than pretending gains are investments and losses are expenses.
Another instance of acceptable round-trip trades is a swap trade, where institutions will sell securities to another individual or institution while agreeing to repurchase the same amount at the same price in the future. Commercial banks and derivative products practice this type of trading regularly. But the dynamics of this kind of trading do not inflate volume statistics or balance sheet values.
Round-Trip Trading in the News
One of the most famous instances of round-trip trading was the case of the collapse of Enron in 2001. By moving high value stocks to off-balance-sheet special purpose vehicles in exchange for cash or a promissory note, Enron was able to make it look like they were continuing to earn a profit while hedging assets on their balance sheets. These transfers were backed by Enron’s stocks, making the illusion a veritable house of cards waiting to collapse. And collapse it did. In addition to other poor and deceptive bookkeeping practices, Enron was able to fool Wall Street and the public into believing that the company was still one of the largest and most profitably secure institutions in the world when in fact they were barely treading water.
The Securities and Exchange Commission (SEC) opened an investigation into the activities and several people were prosecuted and imprisoned. The accounting firm that handled Enron’s bookkeeping also went under because of their participation in the deceit. The firm was found guilty of obstruction of justice by shredding paperwork that would implicate members of the board and high-ranking Enron employees.
Although Enron’s bankruptcy was at one time the largest on record, that title has since been passed many times over to companies like Lehman Brothers and Washington Mutual.