Material Omissions & Market Manipulation
Overview
Both the Uniform Securities Act (USA), Investment Advisers Act of 1940, and other securities laws make it clear that fraud will not be tolerated.
🔑 Direct quote from the USA:
It is unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly:
To employ any device, scheme, or artifice to defraud, or
To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or
To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person
- 📌 Questions on this topic will test your ability to recognize fraudulent activities, which are subject to criminal penalties.
- 🔑 A criminal action occurs when a law or rule is broken willfully (knowingly). Fraud is generally treated as willful conduct, so it’s typically considered a criminal action.
SCOPE — fraud vs. prohibited practice. The USA anti-fraud language applies to any person, in connection with the offer, sale or purchase of any security, directly or indirectly. That is far broader than rules that apply only to registered persons. As the chapter states below: “While many of the prohibited actions we’ve discussed relate to registered persons (broker-dealers, agents, investment advisers, and IARs), anyone can manipulate the market. It doesn’t matter if it’s a financial professional or a retail investor. Criminal penalties can apply to all types of persons.”
Topics covered
Many of the criminal actions discussed in this chapter are also covered on other licensing exams, including the SIE, Series 6, and Series 7. The chapter also covers topics emphasized by NASAA:
- Failure to disclose material facts
- Market manipulation
- General unlawful actions
- Taking advantage of vulnerable adults
- Warning signs of fraud
- Modern forms of fraud
Failure to disclose material facts
🔑 Definitions — Material fact
| Term | Definition | Example |
|---|---|---|
| Material fact | Any fact relating to a security or investment product that could entice a securities transaction | Not a material fact: Disney is a corporation (virtually all publicly traded companies are corporations). Material fact: Disney has been paying a regular cash dividend to investors for decades, but they suspended dividend payments indefinitely in early 2020 due to the COVID-19 pandemic |
- If a registered person knowingly omits a material fact when discussing securities, they can be subject to criminal penalties. This issue comes up most often when recommendations are made.
- Because of the nature of their business and their fiduciary duty, the obligation to disclose all material facts is most applicable to investment advisers and investment adviser representatives (IARs).
⚠️ Who owes what disclosure
| Party / situation | Disclosure obligation |
|---|---|
| Investment advisers and IARs | Most applicable — fiduciary duty means obligation to disclose all material facts |
| Broker-dealer and/or agent receiving an unsolicited order | Not under the same obligation to disclose all material facts about the security. However, some disclosures (for example, the price of the security or unique market circumstances) are required when they’re pertinent to the transaction itself |
⚠️ Intentional vs. unintentional omission
| Type | Consequence |
|---|---|
| Willful (knowing) omission | Criminal penalties |
| Legitimate mistake / unintentional omission | Person won’t be subject to criminal penalties. Civil liabilities could still apply. |
- It’s possible for a registered person to omit a material fact unintentionally, although that should be uncommon. It’s part of the job to be informed about a security, especially when making a recommendation.
Market manipulation
Market manipulation comes in many forms, and it’s always prohibited. When someone engages in activity that artificially influences the price of a security, they’re manipulating the market.
Forms covered:
- Painting the tape
- Matched orders
- Wash trades
- Marking the open/close
- Pump and dump schemes
- Free riding
🔑 Forms of market manipulation
| Practice | Definition | Example |
|---|---|---|
| Painting the tape | Creating the false appearance of market activity. Often done with thinly traded stocks, which are easier to influence because there’s less normal trading activity | A group of financial professionals picks a rarely traded common stock. The stock is traded heavily between group members, creating a noticeable increase in trading volume. That uptick attracts attention and leads other investors to make speculative purchases. As demand increases, the price rises. After the increase, the group sells and collects a profit. |
| Matched orders | Painting the tape done in a group | See above |
| Wash trades | Painting the tape done by one person through several of their own accounts | See above |
| Marking the open or close | Placing trades right before the market opens or closes solely to influence the stock’s price. A stock’s opening and closing prices are closely watched and widely reported | A group places a large number of buy orders for a thinly traded stock right before the market opens, hoping to push the price upward. If the stock opens higher than expected, other investors “jump on the bandwagon.” Increased demand pushes the price up further, and the professionals sell for a quick profit. The same approach can be used near the market close. Either way, prohibited. |
| Pump and dump scheme | An investor with a large social media following “talks up” a thinly traded stock to encourage followers to buy it; the information shared is misleading and overstates the prospects of the issuer’s business | As followers buy, the market price rises. The investor who “pumped” the stock sells after the price increase, making a quick profit. Prohibited and subject to criminal penalties. |
| Free riding | Buying a security and selling it before paying with settled funds, which violates Regulation T | If the investor sells before paying, they’re effectively using the broker’s funds to complete the trade without putting up their own capital. |
🔑 Free riding penalty
| Item | Rule |
|---|---|
| Penalty | The brokerage firm must freeze the investor’s account for 90 days |
| During the freeze | All purchases must be fully funded in advance |
| Account type | Free riding is a violation in cash accounts. ⚠️ It’s possible to avoid free riding violations in a margin account by using borrowed funds to cover purchases while waiting for sales to settle |
⚠️ While many of the prohibited actions we’ve discussed relate to registered persons (broker-dealers, agents, investment advisers, and IARs), anyone can manipulate the market. It doesn’t matter if it’s a financial professional or a retail investor. Criminal penalties can apply to all types of persons.
General unlawful actions
Three general unlawful actions:
- Backing away
- Frontrunning
- Trading ahead
🔑 Definitions
| Practice | Definition | Example |
|---|---|---|
| Backing away | Providing a firm quote on a security and then failing to honor a trade request at that quote. A firm quote is a legitimate security quote provided by a financial firm | A broker-dealer provides a quote for a stock in their inventory at $20 per share. If an investor requests to buy at $20, the broker-dealer “backs away” if they refuse to fill the customer’s order. |
| Frontrunning | A financial professional placing an order for themselves before placing a customer’s order — because a large customer order can “move the market” | An institutional investor requests to buy 100,000 shares of a rarely traded stock. Because the order is so large, the price could rise substantially after submission. To personally benefit, the agent handling the order places a smaller buy order for themselves first, then places the institution’s order. After the price rises, the agent sells for a quick profit. |
| Trading ahead of research | Similar to frontrunning, but involves a research report release. Some research analysts are closely followed, and the market often reacts when they publish | Parsa is a well-respected research analyst who plans to publish a negative report on XYZ stock. Knowing many investors will sell XYZ (driving the price down), Parsa short sells (bets against) XYZ before the report is released to profit. |
| Trading ahead (market maker) | A market maker prioritizing its own trades over a public customer’s. Market makers must prioritize public customer orders over their own | An investor places an order to buy stock from the market maker at $20. At the same time, another customer submits an order to sell the same stock at the market price. The market maker should “cross” the market sell order against the buy order at $20 (if it’s the best price). If instead the market maker buys the stock from the selling investor at $20 and leaves the other investor’s purchase request unexecuted, it has traded ahead of the investor attempting to buy at $20. The public customer should’ve had priority, but the market maker stepped in front. |
- Market makers are similar to used car dealerships: they buy from the public at a marked-down price and resell to the public at a marked-up price. Replace used cars with stocks, and you have a market maker.
⚠️ Frontrunning vs. trading ahead (heavily tested distinction)
| Practice | Who does it | What happens |
|---|---|---|
| Frontrunning | A financial professional | Places a personal trade before placing a customer’s trade to take advantage of a temporary price move |
| Trading ahead | A market maker | “Jumps the line” and doesn’t prioritize public customer orders |
- All of these actions are prohibited and can result in criminal penalties.
- 🔑 If an agent and/or IAR notices any of these actions occurring, they’re obligated to inform their supervisor (a.k.a. principal).
Key points
Definition of fraud
- To employ any device, scheme, or artifice to defraud, or
- To make any untrue statement of a material fact or to omit to state a material fact, or
- To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person
Fraudulent acts
- Willful failure to disclose material facts
- Any form of market manipulation
- Backing away
- Not fulfilling a trade request after offering a firm quote
- Frontrunning
- Placing a personal trade before a large client’s trade
- Trading ahead
- Placing a personal trade before the release of a research report
- Taking advantage of vulnerable adults
Painting the tape
- Trading in the market only to create the appearance of activity
- A prohibited form of market manipulation
- Matched orders occur when done in a group
- Wash trades occur when done by an individual
Marking the close/open
- Flooding the market right before close or after open in order to influence the price
- A prohibited form of market manipulation
Pump and dump schemes
- Overstating the viability of an investment publicly in order to entice others to invest
- A prohibited form of market manipulation
Free riding
- Buying a security and selling it before making payment with settled funds
- A prohibited form of market manipulation
Sources
Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.
| # | Source | Publisher |
|---|---|---|
| 1 | Uniform Securities Act 1956 with NASAA updates — the tested statute | NASAA |
| 2 | Exchange Act 10(b) — manipulative devices | Cornell LII (15 U.S.C. 78j) |
| 3 | Rule 10b-5 — manipulative and deceptive devices | eCFR (17 CFR 240.10b-5) |
| 4 | Achievable Series 65 — chapter 4.6.2 | Achievable (course text) |
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