Prohibited Activities

Prohibited activities are serious because they damage both clients and market integrity. Some prohibited conduct is directed at the market itself, such as insider trading or manipulation. Other prohibited conduct is directed at the client relationship, such as unauthorized trading or churning. In both cases, the representative’s conduct can create regulatory exposure, civil liability, internal discipline, and reputational harm.

For CPH purposes, the strongest answer usually does three things:

1. identifies the exact type of misconduct
2. explains why it is unfair or abusive
3. states the need for escalation, documentation, and compliance involvement

Prohibited Conduct Is Not One Single Category

Students should avoid treating all prohibited conduct as though it works the same way. Common categories include:

• insider trading and tipping
• market manipulation
• frontrunning
• churning
• unauthorized or discretionary trading without proper authority

The conduct differs, but the exam often tests the same underlying principle: the representative or dealer is using information, control, or market access in a way that is unfair to the client or to the market.

Insider Trading and Tipping

Insider trading occurs when someone trades while in possession of material non-public information. Tipping occurs when that person shares the information with someone else who then trades or may trade on it.

Students should focus on the two-part test:

• the information is material, meaning it would reasonably be expected to affect the market price or influence an investment decision
• the information is not public

Common exam facts include pending mergers, earnings surprises, financing developments, major litigation, or significant regulatory decisions that have not yet been announced.

The prohibition applies not only to classic corporate insiders. It can also apply to anyone who receives and misuses the information.

Market Manipulation

Market manipulation involves conduct intended to create a false or misleading appearance of trading activity, price, or market interest. Examples can include:

• pump-and-dump schemes
• spoofing or layering
• wash trades
• matched orders
• other deceptive activity designed to distort price discovery

The key issue is not merely that the price moved. The issue is that the activity was designed to mislead the market or to create an artificial price or trading impression.

    flowchart TD
	    A[Potential misconduct] --> B{Main target of the conduct}
	    B -->|Market fairness| C[Manipulation or insider trading]
	    B -->|Client order priority| D[Frontrunning]
	    B -->|Client account control| E[Unauthorized trading or churning]
	    C --> F[Escalate as market-abuse issue]
	    D --> F
	    E --> G[Escalate as client-conduct issue]
	    F --> H[Document, investigate, and report internally]
	    G --> H

The diagram helps classify the issue. It does not replace legal analysis, but it does help students identify whether the facts point first to market abuse or to abuse of the client relationship.

Frontrunning

Frontrunning happens when a person trades ahead of a known client order or other pending order flow in order to benefit from the expected price movement. The problem is misuse of order information.

The exam often tests frontrunning by contrasting it with insider trading:

• insider trading is about misuse of material non-public issuer information
• frontrunning is about misuse of knowledge of a pending client or firm order

Both are prohibited, but the information source is different.

Suspicion Should Trigger Escalation Before Proof Is Final

The strongest CPH answer usually does not wait for complete certainty before escalating a serious red flag. If the facts reasonably suggest:

• misuse of confidential information
• suspicious personal trading ahead of client flow
• unexplained account activity
• apparent manipulation patterns

the issue should be preserved, escalated, and reviewed. A representative or branch should not try to resolve a possible market-abuse issue informally just because the full evidence is not yet assembled.

Churning

Churning is excessive trading in a client’s account for the purpose of generating commissions or other compensation rather than serving the client’s interests.

A strong churning analysis usually asks:

• how active the trading is
• whether the trading fits the client’s objectives
• how much cost the trading generates
• whether the pattern benefits the representative more than the client

High turnover alone does not prove churning, but high turnover plus weak client benefit and high compensation impact is a serious red flag.

Unauthorized Trading and Improper Discretion

Unauthorized trading occurs when the representative enters or changes a trade without proper client authority. This can happen when:

• the client did not approve the trade
• the client approved only a different transaction
• the representative changes key terms without new authorization
• the representative effectively uses discretion in a non-discretionary account

Students should be careful here. A representative may discuss an idea with the client generally, but that does not create open-ended trading authority unless the account arrangement and approvals actually permit it.

Reporting and Escalation Matter

When prohibited activity is suspected, the issue should not be handled as casual branch gossip or left only with the individual representative. Good practice includes:

• preserving notes, order details, and communications
• escalating promptly to branch supervision or compliance
• preventing further questionable activity while the matter is reviewed
• distinguishing between a conduct issue, a market-integrity issue, and a client-complaint issue

This is where current CIRO-era language matters. Many conduct fact patterns are not merely ethical concerns. They are supervision and gatekeeping issues.

Client Benefit Does Not Legitimize Prohibited Conduct

Students should also reject arguments based on supposed good intent. A representative may believe that:

• trading ahead will help secure a better position
• unauthorized changes will improve execution
• aggressive turnover will increase return

That reasoning does not cure the misconduct. Prohibited conduct is assessed by the fairness and authority of the action, not only by whether the representative claims to have meant well.

Common Pitfalls

• Confusing frontrunning with insider trading.
• Treating aggressive sales activity as acceptable when it is really churning.
• Assuming a client probably would have agreed, so the trade is not unauthorized.
• Focusing only on profit or loss instead of the fairness of the conduct.
• Waiting for a complaint before escalating an obvious market-abuse red flag.

Key Takeaways

• Prohibited activities can target either the market or the client relationship.
• Insider trading, tipping, manipulation, and frontrunning involve misuse of information or market access.
• Churning and unauthorized trading usually arise from abuse of the client relationship.
• The strongest response is usually prompt internal escalation, record preservation, and supervisory involvement.
• Students should identify the exact misconduct rather than using a generic ethics label.

Sample Exam Question

A representative learns that a large client buy order will likely move the price of a thinly traded stock. Before entering the client order, the representative buys the same stock in a personal account. Later that week, the same representative places several short-term trades in another client’s account even though the client did not approve the changes in timing and size.

Which statement is strongest?

• A. The first issue is insider trading and the second issue is only a service problem.
• B. The first issue is frontrunning and the second issue may be unauthorized trading.
• C. Both issues are acceptable if the representative expected the trades to help the clients.
• D. Neither issue matters unless the clients suffered a financial loss.

Answer: B. Trading ahead of a known client order is frontrunning. Changing trade details without authority may be unauthorized trading. Both require escalation even before loss is measured.