Different Between Front Running & Insider Trading

Front running is an unethical or illegal trading practice where a broker or trader executes trades in anticipation of large client orders. The goal is to benefit from the price movements that these large orders are likely to cause.

Here is how it typically works:

• A broker, privy to a client’s large buy or sell order, places their own trade ahead of executing the client’s order.
• For example, if a broker knows that a client plans to purchase a significant number of shares in a company, they may buy shares beforehand. Once the client’s large order is executed, the demand pushes the stock price higher, allowing the broker to sell their shares at a profit.

Key characteristics of front running:

• It is often carried out by brokers or financial intermediaries who have access to confidential client orders.
• This practice is considered unethical and is illegal in most jurisdictions, including India, as it breaches the trust between the client and the broker.

What is insider trading?

Insider trading involves buying or selling securities based on material, non-public information about a company. This practice is considered illegal when the information used provides an unfair advantage over other investors who do not have access to it.

Types of insider trading:

Illegal insider trading:

• This occurs when individuals use confidential information to trade securities for personal gain.
• Example: A company executive learns about an upcoming merger and buys shares before the announcement, profiting from the subsequent price surge.

Legal insider trading:

• This happens when company insiders, such as executives or employees, trade shares of their organisation after adhering to regulatory guidelines.
• For instance, insiders can trade during pre-declared trading windows and after disclosing their transactions publicly.

Key characteristics of insider trading:

• It involves the use of sensitive, non-public information.
• Illegal insider trading undermines market fairness and transparency, leading to severe penalties when detected.

Difference between front running and insider trading

While both practices involve exploiting information for financial gain, their methods and legal implications differ significantly. Below is a comparison to highlight these differences:

Understanding these differences is crucial for recognising how each practice impacts market integrity.

Advantages of front running

From an ethical and regulatory standpoint, there are no genuine advantages to front running. However, perpetrators may see the following short-term benefits:

• Profitability: Traders engaging in front running can exploit price movements to earn quick profits.
• Market manipulation: By acting on client orders, these individuals can influence market dynamics to their advantage.

It is important to note that such actions are illegal and come with severe consequences.

Front running poses significant risks and consequences, including:

Legal penalties:
Regulatory authorities, such as SEBI in India, impose heavy fines and imprisonment for individuals caught engaging in front running.
Disclaimer: Investments in securities markets are subject to market risks. Please read all scheme-related documents carefully before investing.

Reputational damage:
Financial professionals found guilty of front running often face irreparable damage to their careers and credibility.

Market impact:
Front running undermines trust in financial markets, discouraging participation from retail and institutional investors.

While illegal insider trading has no advantages, legal insider trading can have some positive implications when conducted ethically and transparently:

Alignment of interests:
Legal insider trading allows employees to invest in their company, aligning their interests with shareholders.

Market signalling:
Publicly disclosed insider trading can signal confidence in the company’s prospects, potentially influencing investor sentiment.

The disadvantages of insider trading, particularly illegal insider trading, are severe and far-reaching:

Legal consequences:
Individuals caught engaging in illegal insider trading face fines, imprisonment, and disqualification from holding key positions in organisations.
Disclaimer: Past performance is not indicative of future returns.

Market distortion:
Insider trading creates an uneven playing field, eroding investor confidence in the fairness of financial markets.

Ethical concerns:
It violates the principles of transparency and fairness, which are fundamental to market integrity.

Front running and insider trading are two unethical practices that exploit information for financial gain. While front running involves trading ahead of large client orders, insider trading leverages sensitive, non-public company information. Both practices undermine market fairness and come with significant legal and reputational consequences.

Ethical compliance is essential for maintaining trust and integrity in financial markets. As an investor, it is important to remain informed about such practices to protect your investments and make sound financial decisions.
Disclaimer: Bajaj Broking does not provide investment advisory services.