Introduction

When a stockbroker receives an order from a client, he may have an incentive to trade on his own account to take advantage of the information contained in the order. When he does so before executing the client's order, he is ‘front-running’ the order, a practice which has become the object of increasing debate and attention by stock exchange regulators. The main reason for this increasing interest is that the introduction of dual-capacity trading in many stock exchanges has eliminated the traditional barriers between the brokerage and dealership function: the same intermediaries are allowed to collect orders from clients and trade on their own account as dealers. In London the ‘Big Bang’ in 1986 eliminated the distinct roles of ‘jobbers’ and ‘brokers’. In Paris and Madrid, the reforms of 1988 and 1989 respectively allowed stock exchange members also to deal on their own account. In other countries, such as Italy and Germany, the major banks have traditionally dealt in dual capacity on a massive scale, acting as the main conduit for public orders and as the most important players in the stock market, either via representatives (in Germany) or via exchange members (in Italy). In these two countries, the opportunity to front-run clients' orders has thus always been open to banks.

By front-running a broker–dealer can exploit privileged information about the order flow that is about to come onto the market.