Front-running refers to the unethical practice of a broker or trader exploiting advance knowledge of a forthcoming transaction on behalf of a client, to capitalize on the anticipated price movement that will result from the trade. This practice is considered a violation of securities laws and regulations, as it involves an abuse of privileged information and undermines fair and transparent financial markets.

Here’s how front-running typically occurs:

1. **Advanced Knowledge:**
– A broker or trader with access to pending orders from clients gains advance knowledge of a significant transaction. This information may include details about the size, direction, and timing of the upcoming trade.

2. **Capitalizing on Information:**
– Armed with this privileged information, the unscrupulous broker or trader may execute their own trades ahead of the client’s order. By doing so, they can take advantage of the anticipated price movement that will likely result from the client’s large transaction.

3. **Profiting from Price Movements:**
– Once the client’s order is executed and the market reacts to the large trade, the front-runner can profit from the price movement. They may have bought or sold securities at a more favorable price before the market adjusted to the impact of the client’s order.

Front-running is detrimental to the integrity of financial markets for several reasons:

– **Breaches Fiduciary Duty:** Brokers and traders owe a fiduciary duty to act in the best interests of their clients. Front-running violates this duty by putting the personal interests of the broker ahead of those of the client.

– **Undermines Market Integrity:** Front-running erodes the fairness and transparency of financial markets. It creates an uneven playing field, where those with privileged information can gain an unfair advantage over other market participants.

– **Erodes Investor Confidence:** Knowing that front-running can occur undermines investor confidence in the fairness of the financial markets. Investors may be less willing to participate in markets they perceive as being manipulated or unfair.

Regulators and securities exchanges have implemented measures to detect and prevent front-running. These measures include strict rules against the misuse of confidential client information, enhanced surveillance and monitoring systems, and severe penalties for individuals or entities found guilty of front-running.

Investors and clients should be aware of the risks associated with front-running and work with reputable brokers and financial institutions that adhere to ethical standards and regulatory requirements. Additionally, regulatory bodies play a crucial role in enforcing rules and maintaining the integrity of financial markets.