Īnother source of conflicts of interest is potential front running, in which case the buy-side clients suffer from significantly higher trading costs. One example of an alleged conflict of interest can be found in charges brought by the Australian Securities & Investments Commission against Citigroup in 2007. Investment banks are required to have a Chinese wall separating their trading and investment banking divisions however, in recent years, especially since the Enron scandal, these have come under closer scrutiny. Īs investment banks are key figures in mergers and acquisitions, it is possible (though prohibited) for traders to use inside information to engage in merger arbitrage. There are a number of ways in which proprietary trading can create conflicts of interest between a bank's interests and those of its customers. When an investment bank believes a buyout is imminent, it often sells short the shares of the buyer (betting that the price will go down) and buys the shares of the company being acquired (betting the price will go up). When a company plans to buy another company, often the share price of the buyer falls (because the buyer will have to pay money to buy the other company) and the share price of the purchased company rises (because the buyer usually buys those shares at a price higher than the current price). One of the more-notable areas of arbitrage, called risk arbitrage or merger arbitrage, evolved in the 1980s. Investment banks, which are often active in many markets around the world, constantly watch for arbitrage opportunities. The trade will remain subject to various non-market risks, such as settlement risk and other operational risks. In the most basic sense, arbitrage is defined as taking advantage of a price discrepancy through the purchase or sale of certain combinations of securities to lock in a market-neutral profit. One of the main strategies of trading, traditionally associated with banks, is arbitrage. Many reporters and analysts believe that large banks purposely leave ambiguous the proportion of proprietary versus non-proprietary trading, because it is felt that proprietary trading is riskier and results in more volatile profits. Proprietary traders may use a variety of strategies such as index arbitrage, statistical arbitrage, merger arbitrage, fundamental analysis, volatility arbitrage, or global macro trading, much like a hedge fund. Proprietary trading can create potential conflicts of interest such as insider trading and front running. Proprietary trading (also known as prop trading) occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money (instead of using depositors' money) in order to make a profit for itself.
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