Tailgating vs. Front-Running in Finance: What's the Difference?
Tailgating is a practice in the financial industry where brokers or financial advisors execute orders on their accounts using the information provided by customers for their trades. This practice is highly unethical, even though it is not illegal. However, the Securities and Exchange Commission (SEC) has the authority to take action against firms that use customer-provided information to make profits.
Basics
Tailgating, in the financial world, occurs when a broker, financial advisor, or any investing agent executes a security transaction for a client and then duplicates the same trade for themselves. Although tailgating is not illegal, it is viewed as unethical and discouraged by professionals in the industry.
Tailgating in the Financial Industry
Tailgating is a legal but highly unethical act in the financial world. It should not be confused with insider trading, which involves using confidential information to buy or sell securities. In tailgating, a broker follows a client's trade request and executes the same trade for their own account based on the client's information.
While tailgating is not illegal according to the SEC, the agency can take action against firms that exploit this practice to make profits using customer-provided information. An example is Merrill Lynch, which faced a $10 million penalty and a cease-and-desist order for misusing customer information on its proprietary trading desk.
Front-Running vs. Tailgating
It's important to distinguish tailgating from front-running, an illegal practice where the practitioner trades for themselves before executing the client's trade. Tailgating is frowned upon in the investment industry as it relies on the client's information, potentially risking the advisor's reputation and financial well-being if the information turns out to be false or faulty.
Tailgating Example
John, a financial advisor, receives information from his client, Jane, about Company X's plans to launch a new product which is expected to boost the firm's revenue. Based on this information, John believes that the new product will lead to an increase in Company X's stock price. At Jane's request, John buys 500 shares for her. Additionally, John buys 500 shares for himself, expecting to benefit from the potential increase in Company X's stock price.
Conclusion
While tailgating may not be illegal, it is an unethical practice in the financial industry that can harm clients and damage the reputation of professionals who engage in it. Investors need to be aware of this practice and work with reputable advisors who prioritize their clients' interests.