Prohibited Activities and Trading Violations Explained for the SIE Exam

The SIE expects you to recognize the conduct violations that get reps and firms in trouble: insider trading, market manipulation, churning, and a handful of specific rep misconduct rules. On the exam — 75 scored questions in 105 minutes, passing score 70 — these sit in “Understanding Trading, Customer Accounts and Prohibited Activities,” the second-largest section at 31% of the exam. Most questions are short scenarios where you name the violation: “a rep buys stock ahead of a big client’s order” is front running; “excessive trades to rack up commissions” is churning; “trading on a not-yet-announced merger” is insider trading.

Insider trading

Insider trading is buying or selling a security based on material nonpublic information (MNPI). “Material” means a reasonable investor would consider it important — an upcoming merger, an earnings surprise — and “nonpublic” means it isn’t yet available to everyone. Anyone who trades on that information, or tips it to someone else, can be liable: under the classic tipper–tippee rule, both the person who passes the information (the tipper) and the person who trades on it (the tippee) are responsible.

Congress strengthened these laws with the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), which toughened penalties and extended liability to control persons — supervisors and firms that fail to prevent insider trading by their people.

Penalties. Insider trading carries both civil and criminal exposure. Civilly, the SEC can seek treble damages — up to three times the profit gained or loss avoided. Criminally, an individual faces fines of up to $5 million and up to 20 years in prison; a firm can be fined up to $25 million.

Scenario: Alice, a broker at BigBank, learns her firm will acquire TechCo tomorrow. She buys TechCo shares today, before the news is public, and sells at a profit once the stock jumps on the announcement. That’s insider trading — she traded on MNPI, and both she and anyone who tipped her could be liable.

Market manipulation

Market manipulation covers schemes that artificially distort a stock’s price or trading activity. The ones the SIE wants you to recognize:

• Front running — trading ahead of a known large order. A rep who knows a client is about to place a huge buy (which will push the price up) and buys for their own account first is front running: they’re profiting from nonpublic knowledge of the order.
• Marking the open / marking the close — entering trades right at the open or close to move the official opening or closing price. Since many investors and funds benchmark to closing prices, this distorts the signal.
• Painting the tape (matched orders / wash trades) — trades that create a false appearance of activity or price movement. In a wash trade, the same party (or colluding parties) buys and sells with no real change of ownership, making a stock look active to lure others in.
• Spoofing and layering — entering large orders you intend to cancel, to fake supply or demand. A trader might post big sell orders to make supply look heavy, push the price down, buy cheap, then cancel the fake sells.
• Pump and dump — hyping a stock (often a thinly traded penny stock) with rumors or misleading claims to inflate the price, then dumping shares into the buying.
• Capping and pegging — manipulating the underlying stock to protect an options position. A call writer might sell the stock near the close (capping) to keep it from rising above the strike; a put writer might buy the stock (pegging) to keep it from falling below the strike.

Churning

Churning is excessive trading in a customer’s account primarily to generate commissions rather than to benefit the client. Historically two elements had to be present: the rep had control over the account (through discretion or de facto influence) and the trading was excessive given the customer’s objectives. FINRA removed the control element from its quantitative suitability obligation in 2020, so excessive trading alone can now constitute the violation — control is no longer required to prove it. The tell is that the customer’s results aren’t the point — the commissions are. It violates Rule 2111’s quantitative suitability obligation and, for retail customers, Regulation Best Interest, which require activity to fit the customer’s needs, not the rep’s paycheck.

Scenario: A rep with discretion buys and sells the same funds in a retiree’s account week after week, generating fees while the account value barely moves. High turnover with no purpose, in an account the rep controls, is churning.

Other prohibited practices

The SIE tests a roster of specific rep violations. Each is prohibited (some with conditions where noted):

• Unauthorized trading — entering an order without the customer’s approval in a non-discretionary account.
• Guaranteeing against loss — a rep or firm may never promise a customer won’t lose money. FINRA Rule 2150 flatly prohibits guarantees against loss.
• Sharing in a customer’s account — generally not allowed. A rep may share in a customer’s gains and losses only with prior written approval from the firm and customer, and (outside limited family exceptions) the sharing must be proportionate to the rep’s own contribution.
• Selling away (private securities transactions) — a rep selling securities not offered by the firm without the firm’s prior written approval. It’s governed by FINRA Rule 3280; the rep must give the firm written notice and get sign-off first.
• Commingling — mixing customer funds or securities with the firm’s own assets, instead of keeping customer property segregated.
• Misrepresentation or omission — lying about, or leaving out, material facts in a securities transaction.
• Freeriding — in a cash account, buying a security and selling it before paying for the purchase. It violates Regulation T and triggers a 90-day freeze, during which the account can only buy with cash paid up front. (In underwriting, “freeriding” also refers to withholding shares of a hot issue to profit later.)
• Backing away — a market maker failing to honor its firm quote when another party tries to trade at that price.
• Interpositioning — needlessly inserting a third party between the customer and the best available market, just to generate extra fees.

Most of these fall under FINRA conduct rules (such as Rule 2010 on standards of commercial honor, Rule 2150 on guarantees and sharing, and Rule 3110 on supervision) and the antifraud provisions of the Securities Exchange Act of 1934 — Section 10(b) and Rule 10b-5.

Spot the violation

Violation	What it is	The tell
Insider trading	Trading on material nonpublic information	A rep learns of a secret takeover and buys before the news; tipper and tippee are both liable
Front running	Trading your own account ahead of a known large order	A rep buys for herself right before executing a client’s block order, then sells into the move
Marking the close	Trades near the close to move the closing price	Buy orders in the last minute push the reported close up
Painting the tape	Matched/wash trades that fake activity	Traders pass a stock among themselves with no real ownership change
Churning	Excessive trading in a controlled account for commissions	Weekly in-and-out trades that only generate fees
Unauthorized trading	A trade without the customer’s permission	A rep trades a cash account the customer never approved
Guaranteeing against loss	Promising no loss (always banned)	“Buy this — I guarantee you’ll make money”
Selling away	Selling securities outside the firm without approval	A rep sells private notes on the side, unknown to the firm
Freeriding	Buying and selling before paying (cash account)	Buy Monday, sell Friday, never pay — account frozen 90 days

Penalties and consequences

FINRA can fine reps and firms, require restitution, suspend registrations, or bar someone from the industry entirely — and it publicizes the sanctions. Serious misconduct can also bring investor lawsuits and, for fraud-based violations, criminal charges. Insider trading is the sharpest example: beyond FINRA discipline, the SEC can pursue treble civil damages, and prosecutors can seek criminal fines and prison. The other violations — churning, unauthorized trading, manipulation — typically draw FINRA fines and suspensions, plus civil liability if investors are harmed.

Exam traps to avoid

• Front running vs insider trading. Front running is trading ahead of a customer’s large order; insider trading is trading on material nonpublic corporate news. “Ahead of a big client order” = front running; “on inside company info” = insider trading.
• Excessive trading can be enough on its own. Churning once required both control and excessive trading, but FINRA removed the control element from quantitative suitability in 2020 — so a pattern of excessive trading can violate the rule without proof that the rep controlled the account.
• You can never guarantee against loss. Any promise that a customer “won’t lose money” — even casually worded — is prohibited.
• Freeriding freezes the account 90 days. Selling in a cash account before paying triggers a 90-day restriction requiring cash up front.
• Selling away = around the firm. Selling securities the firm didn’t approve, without written notice and sign-off, is a violation even if no one is harmed.
• Wash trades and painting the tape create fake activity. No real change of ownership — just the appearance of volume or price movement.

Once you can name the violation from a one-sentence scenario, test yourself with the free SIE diagnostic to see how the SIE actually frames prohibited-activity questions.

Frequently asked questions

What is insider trading?

Insider trading is buying or selling a security based on material nonpublic information — information a reasonable investor would find important that hasn’t been released to the public. Trading on it is illegal, and both the person who tips the information and the person who trades on it can be held liable.

What is churning?

Churning is excessive trading in a customer’s account primarily to generate commissions rather than to serve the customer. It traditionally required two things — the rep controlled the account and traded it excessively — but FINRA removed the control element from its quantitative suitability rule in 2020, so excessive trading relative to the customer’s goals can now be enough on its own. It violates Rule 2111 and, for retail customers, Regulation Best Interest.

What is front running?

Front running is trading for your own or your firm’s account ahead of a customer’s known large order that’s likely to move the price. It’s different from insider trading — front running is about nonpublic knowledge of a pending trade, while insider trading is about nonpublic corporate information.

What is the penalty for insider trading?

Civilly, the SEC can seek up to three times (treble) the profit gained or loss avoided. Criminally, an individual can face fines up to $5 million and up to 20 years in prison, and a firm can be fined up to $25 million — on top of FINRA sanctions like fines, suspension, or a bar.

What is freeriding?

Freeriding is buying a security in a cash account and selling it before paying for the purchase. It violates Regulation T and triggers a 90-day freeze, during which the account can only buy securities paid for in full up front.

Can a broker guarantee I won’t lose money?

No. FINRA Rule 2150 prohibits a rep or firm from guaranteeing a customer against loss. A broker can explain risks honestly, but can never promise a gain or a no-loss outcome — even phrased casually.

The quick way through this section: read the scenario and match the tell. Trading on secret company news is insider trading; jumping ahead of a client’s order is front running; trading a controlled account into the ground for fees is churning; and any promise of “no loss” is always wrong.