Imagine that the XYX (not a real name) stock has a bid of 50.05 and an ask of 50.12. A discount broker currently has two orders. One is a limit buy at 50.11 and the other is a limit sell at 50.06. Can the broker buy the stock from the first client at 50.06 (using the broker's money ) and then immediately resell it to the other client for 50.11?
4 Answers
This would be frontrunning. Stock brokers generally have a fiduciary duty to their clients, and front running someone you have a fiduciary duty towards is illegal.
Front running, also known as tailgating, is the prohibited practice of entering into an equity (stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pending transaction that will influence the price of the underlying security.[1] In essence, it means the practice of engaging in a Personal Securities Transaction in advance of a transaction in the same security for a client's account.[2] Front running is considered a form of market manipulation in many markets.[3]
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The buyer and the seller are getting filled at prices that are better than the current bid/ask quote, aka inside the spread. How is that front running? The broker isn't trading in advance of a large customer order nor is he capitalizing on **nonpublic knowledge of a large ("block") pending transaction that will influence the price of the underlying security. Commented Dec 28, 2020 at 13:04
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STEP 1: (in the US) Always ask your broker if they are a fiduciary. Commented May 4, 2021 at 22:27
No. A Stock Broker is not trading anything - all he is is forwarding orders to the exchange. If he does not do that he is actually committing fraud - at least because he invoices you the fee the exchange calls for it (unless you are having one of those "free" trading accounts).
Trading stocks is regulated in pretty much every jurisdiction and unless you talk of some really low end OTC stocks these days where the broker may work together with a dealer / market maker, no - he simply is not trading to start with. Brokers are basically (especially these days) glorified call center agents or (as organizations) order forwarding systems. At least unless you are really rich.
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1The question asks whether they can trade, not whether stock brokers generally are. They can submit the sell, then submit their own buy order at 50.06, and putting aside other market activity, they would get stock, at which point they can submit the buy, then submit their own sell. Commented Dec 28, 2020 at 7:35
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1Ah, and he can not. Trading is very limited. He CAN NOT - what he CAN is set of a counter order, but whether this one executes against this particular client or not is not something the broker has influence over.– TomTomCommented Dec 28, 2020 at 9:39
The SEC defines Internalization as:
When you place an order to buy or sell a stock, your broker has choices on where to execute your order. Instead of routing your order to a market or market-makers for execution, your broker may fill the order from the firm's own inventory. This is called "internalization." In this way, your broker's firm may make money on the "spread" – which is the difference between the purchase price and the sale price.
Linked to the above page is another page which explains Your Broker Has Options for Executing Your Trade:
Just as you have a choice of brokers, your broker generally has a choice of markets to execute your trade:
For a stock that is listed on an exchange, such as the New York Stock Exchange (NYSE), your broker may direct the order to that exchange, to another exchange (such as a regional exchange), or to a firm called a "third market maker." A "third market maker" is a firm that stands ready to buy or sell a stock listed on an exchange at publicly quoted prices. As a way to attract orders from brokers, some regional exchanges or third market makers will pay your broker for routing your order to that exchange or market maker—perhaps a penny or more per share for your order. This is called "payment for order flow."
For a stock that trades in an over-the-counter (OTC) market, such as the Nasdaq, your broker may send the order to a "Nasdaq market maker" in the stock. Many Nasdaq market makers also pay brokers for order flow.
Your broker may route your order – especially a "limit order" – to an electronic communications network (ECN) that automatically matches buy and sell orders at specified prices. A "limit order" is an order to buy or sell a stock at a specific price.
Your broker may decide to send your order to another division of your broker's firm to be filled out of the firm's own inventory. This is called "internalization." In this way, your broker's firm may make money on the "spread" – which is the difference between the purchase price and the sale price.
Brokers must adhere to best execution practices that are regulated by the SEC and individual exchanges. What I do not know is what limitations are placed on brokers when it comes to Internalization.
answered Dec 28, 2020 at 12:45
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1I don't see how Internalization (selling using shares already in inventory) matches OP's question "Can the broker buy the stock from the first client at 50.06 (using the broker's money) and then immediately resell it to the other client for 50.11?"– RonJohnCommented Dec 28, 2020 at 13:41
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1@RonJohn - It's not the broker's own money. I don't know what the restrictions are regarding internalization so you may be right. Consider this: The OP's set up is that the current NBBO quote is $50.05 and an ask of $50.12. If their orders are sent to the exchange, they become the market on each side and the quote becomes $50.06 by $50.11 and there is no fill until some counterparty crosses the spread and one or both of their orders get filled. If the broker fills their orders, both get better than current market price and both are happy. It's not front running. But is it kosher? I dunno. Commented Dec 28, 2020 at 15:04
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1And to complicate this even more, brokers are allowed to do cross trades across different client accounts if one client wants to buy and another wants to sell. The broker can match the orders without sending the orders to the stock exchange but he must report the transactions after the fact but in a timely manner and time-stamped with the time and price of the cross. These trades must also be executed at a price that corresponds to the prevailing market price at the time. See Investopedia. Commented Dec 28, 2020 at 15:05
Yes, that's called being a dealer. That is how they make money.
answered Dec 28, 2020 at 3:41
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1Dealers make money by charging transaction fees and service fees, not by trading. (Unless you have evidence to otherwise prove your assertion.)– RonJohnCommented Dec 28, 2020 at 6:37
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1@RonJohn LOL, maybe learn anything about stock brokerage, or look up the terms "market maker" in a dictionary? Duh. You know I used to work for Merrill Lynch (and Dean Witter before that). In fact, when I worked at Fidelity my ENTIRE JOB was to try to quantify how much the different Wall Street brokerages were making off of us. "Service fees" are peanuts. They would not even be able to keep the lights on with service fees. You know that most brokerages don't even charge transaction fees anymore. Do you even have a brokerage account? Commented Dec 28, 2020 at 13:34
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3The Accumulation and TomTom answers give citations. Yours is a one-line assertion without facts.– RonJohnCommented Dec 28, 2020 at 13:39
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3Not on Stack Exchange. You say you used to work for ML, DW and Fidelity, but ignore the fact that "on the Internet, no one knows you're a dog".– RonJohnCommented Dec 28, 2020 at 14:06