Trading Ahead

What Is Trading Ahead?

The term trading ahead refers to a situation in which a market maker prioritizes the interests of their firm ahead of other investors. This involves trades made by brokers using their firms' accounts rather than matching available bids and offers from other market participants. Trading ahead is illegal under Financial Industry Regulatory Authority (FINRA) regulations, which means market makers can't trade ahead of other customer or broker-dealer orders.

Key Takeaways

  • Trading ahead occurs when a market maker uses their firm's account to make a trade instead of matching available bids and offers from others in the market.
  • It occurs when a market maker knowingly puts the interest of their firm ahead of those of other market participants.
  • Trading ahead gives market makers an unfair information advantage to the detriment of retail investors and traders.
  • The act is banned by FINRA as well as most major exchanges and often comes with stiff fines, penalties, and even censures.
  • Regulations do allow for certain exceptions to the trading ahead rules, including those for large orders, institutional orders, and ISO exceptions.

Understanding Trading Ahead

Market makers or market specialists are a key part of the infrastructure of secondary market trading. Many market makers are firms (and those that work for them), which provide individual investors with trading services. They work to match buyers and sellers in the open market through a bid-ask trading system. This system allows them to profit from bid-ask spreads generated on each trade.

Specialists can trade from their own accounts to complete any trades as long as only one leg of the transaction is offered. But the trade becomes illegal when a market maker knowingly chooses to trade with their own account to complete a transaction when there are unexecuted orders that are available from investors that could be filled at the same price or better.

For instance, if a customer submits an order to sell 100 shares at $10.00, and there is a bid for $10.05, a market maker could not sell the $10.05 bid ahead of the customer's order. Likewise, if the best bid were instead $10.00, the market maker could only sell at $10.00 once the customer has executed all 100 shares at that price.

Trading ahead is a violation of market trading practices. A market maker who uses securities from their own account ahead of other orders in the open market is in violation of trading ahead. The act may provide the market maker with a better trading price while inhibiting the fair market price for the open market. Trading ahead could also create an unsubstantiated profit for the market specialist.

As noted above, rules established by FINRA and individual exchanges have been instituted to monitor and penalize market trading specialists who violate trading ahead rules. Firms found in violation may face fines, penalties, and even censures.

The act of trading ahead can occur through the development of standard market practices.

Special Considerations

Trading ahead was initially prohibited by NYSE Rule 92. The New York Stock Exchange (NYSE) and other exchanges, including the American Stock Exchange (AMEX), replaced Rule 92 with FINRA Rule 5320 in order to reduce regulatory duplication and streamline compliance. This became effective on Sept. 12, 2011.

FINRA Rule 5320 provides detailed direction on trading ahead and its prohibitions. It is also informally known as the Manning rule. The ruling requires that market makers have documented policies and procedures regarding trading rules and that firms adhere to the documentation rules outlined in FINRA Rule 5310. Rule 5320 also provides for many exceptions to the prohibition of trading ahead.

But the regulations do allow for certain exceptions. Some of these exceptions include:

  • Large orders
  • Institutional orders
  • No-knowledge exceptions
  • Riskless principal exceptions
  • ISO exceptions

A market maker can also satisfy an exception if they immediately execute a customer's order up to the size and price (or better) than what they executed for their own book.

Regardless of the motivation, trading ahead is considered a disruption to the orderly and efficient market trading standards that regulators seek to uphold for all investing participants. That is unless the trading ahead is done without the knowledge of the existing orders.

Real-World Example of Trading Ahead

In July 2020, FINRA fined Chicago-based Citadel Securities for violating trading ahead regulations. The agency found that Citadel's over-the-counter (OTC) trading systems were programmed to adhere to trading ahead standards. Despite this, there were controls and other settings in place that removed "hundreds of thousands" of larger orders from that net.

Among some of the other findings, FINRA also concluded that the firm didn't have any supervisory controls in place to ensure that orders were compliant with existing regulations.

FINRA fined Citadel $700,000 in fines as a result of its investigation. The firm was also censured and was required to pay restitution to affected clients in addition to interest for any orders placed at prices that were below those traded through its own account. The company was also required to certify that it examined its systems to ensure that customer orders are properly displayed and that the firm is in compliance with FINRA rules and regulations.

Citadel neither accepted nor denied the allegations but it did consent to the sanctions imposed by FINRA.

Article Sources
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  1. FINRA. "FINRA Requests Comment on Proposed Consolidated FINRA Rules Governing Limit and Market Order Protection."

  2. U.S. Securities and Exchange Commission. "Self-Regulatory Organizations; New York Stock Exchange LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Deleting the Text of NYSE Rule 92 and Adopting a New NYSE Rule 5320 that is Substantially the Same as Financial Industry Regulatory Authority Rule 5320 to Prohibit Trading Ahead of Customer Orders with Certain Exceptions (commonly known as the Manning Rule)," Pages 1 and 9.

  3. FINRA. "5320. Prohibition Against Trading Ahead of Customer Orders."

  4. FINRA BrokerCheck Report. "CITADEL SECURITIES LLC," Pages 86-88.

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