What is a pre-arranged trade?
Whether you are a retail trader or a professional market maker or broker, a trader has to stay mindful when protecting herself from what appears to be market manipulation and a market maker should avoid engaging in activities that unintentionally causes him to manipulate prices. Among activities that can impact the integrity of trading is pre-arranged trading.
What is pre-arranged trading? Investopedia provides a working definition:
“Pre-arranged trading can refer to trading that takes place at specified prices, that were mutually agreed to, before execution. Conditional orders generally rely on the concept of pre-arranged prices which allow an investor to set a specified price for execution on an exchange. Over-the-counter (OTC) orders are also pre-arranged in most cases.”
To regulate pre-arranged trading in the commodity markets, the Commodity Futures Trading Commission applies rule 17 CFR 1.38(a) which says the following about the execution of trades in commodities:
“Competitive execution required; exceptions. All purchases and sales of any commodity for future delivery, and of any commodity option, on or subject to the rules of a contract market shall be executed openly and competitively by open outcry or posting of bids and offers or by other equally open and competitive methods, in the trading pit or ring or similar place provided by the contract market, during the regular hours prescribed by the contract market for trading in such commodity or commodity option: Provided, however, That this requirement shall not apply to transactions which are executed non-competitively in accordance with written rules of the contract market which have been submitted to and approved by the Commission, specifically providing for the non-competitive execution of such transactions.”
The policy rationale: Fictitious sales …
Pre-arranged trading has been described by the courts as a form of fictitious sale. The reason for the fictitious sale description is given by the court in Commodity Futures Trading Commission vs. Eric Moncada, et al. (2014) It is fictitious because:
“By determining trade information such as price and quantity outside the pit, then using the market mechanism to shield the private nature of the bargain from public scrutiny, both price competition and market risk are eliminated. Purchases and sales of commodity futures must be executed openly and competitively.”
In other words, according to the court in Moncada, by placing orders for the same commodity future at the identical or near-identical price and so close in time, a market maker eliminates the risk that sell orders will not be executed at a particular price. Eliminating this pricing risk qualifies pre-arranged trades as a fictitious sale.
Are pre-arranged trades easier seen than proved?
The court in Wayne I. Elliot, Francis Maritote, J. Brian Schaer, and Jonathan A. Sioni v. Commodity Futures Trading Commission, held that circumstantial evidence and only a preponderance of that evidence was all that was needed to find liability for trade practices that violated 17 CFR 1.38(a).
Among those circumstances are size, (large trades accounting for abnormal percentage of volume); no gains or losses (suggests trades are non-competitive); no other traders involved (other participants deliberately excluded); trade configuration ( a circular configuration is designed to avoid market risks); audit trail irregularities (are trades being recorded); and trader motivation (are traders seeking profits?).
Conclusion: The irony of avoiding risk
The prevailing narrative and philosophy from market mavens is that trade involves risks and that the greater the risks, the higher the returns. Is this less true in commodities trade where traders take on the risks of prices moving out of their favor while market makers secure their spread no matter where the market prices move?
Alton Drew
6 May 2025
Disclaimer: This post is provided as a thought exercise and should not be substituted for investing or trading advice. If you would like a legal or regulatory analysis of the trading environment, reach out to me at altondrew@altondrew.com.
Lawyers Write the Bets. Bankers Sell the Bets. 