SIE Exam: Prohibited Activities
Section 3 — Understanding Trading, Customer Accounts and Prohibited Activities (31% of exam)
The SIE exam devotes significant attention to activities that are prohibited under securities laws and FINRA rules. Insider trading — trading on material nonpublic information — is a core concept, including the tipper/tippee liability framework where both the person who shares the information and the person who trades on it can be held liable. Front-running, which involves placing personal or proprietary trades ahead of a pending customer order, is another key prohibition. Market manipulation tactics you must recognize include wash trading (creating the illusion of activity), matched orders, painting the tape, spoofing, and marking the close. Churning (excessive trading to generate commissions) and selling away (conducting private securities transactions without firm approval) are frequently tested. Other prohibited activities include sharing in customer accounts (generally prohibited unless certain conditions are met), guaranteeing customers against losses, unauthorized trading, spreading rumors, and free-riding (using proceeds of a sale to pay for the purchase without adequate funds). Understanding the penalties for these violations and how they are enforced by the SEC and FINRA is essential for the exam.
Key Concepts
Insider Trading
Trading based on material nonpublic information in violation of a duty of trust. Both the tipper (who shares info) and tippee (who trades on it) can be liable.
Front-Running
Placing a personal or proprietary trade ahead of a pending customer order to profit from the anticipated price movement the customer's order will cause.
Churning
Excessive trading in a customer's account primarily to generate commissions rather than to serve the customer's investment objectives.
Market Manipulation
Includes wash trading, matched orders, painting the tape, spoofing, and marking the close — all designed to create false or misleading appearances of market activity.
Selling Away
Conducting private securities transactions outside the scope of the member firm without providing prior written notice to the firm.
Sharing in Customer Accounts
Generally prohibited for registered representatives. Exceptions exist if the firm approves and the rep shares proportionally to their financial contribution.
Practice Questions
Question 1 of 4
Under the Securities Exchange Act of 1934, insider trading is best defined as:
Question 2 of 4
A corporate executive tells her friend about an upcoming merger before it is publicly announced. The friend then buys stock in the target company. In this scenario, who may be liable for insider trading?
Question 3 of 4
Which of the following best describes the prohibited practice of front-running?
Question 4 of 4
Which of the following manipulative practices involves executing trades in a security to create the appearance of active trading and attract other investors?
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What prohibited activities are on the SIE exam?
The SIE tests insider trading, front-running, churning, market manipulation (wash trading, matched orders, painting the tape, spoofing), selling away, sharing in customer accounts, guaranteeing against losses, unauthorized trading, spreading rumors, and free-riding.
What is the penalty for insider trading?
The Insider Trading Sanctions Act of 1984 authorizes civil penalties of up to three times the profits gained or losses avoided (treble damages). Criminal penalties can include fines up to $5 million for individuals and up to $25 million for firms, plus prison sentences of up to 20 years.