Legal Definitions - scalping

The term "scalping" has several distinct meanings, primarily in the context of commerce and finance:

• 1. Reselling Scarce Items for Profit

  This refers to the practice of purchasing items that are in high demand and limited supply, such as tickets for popular events or exclusive products, and then reselling them at a significantly inflated price above their original face value. This usually occurs when the original supply has been exhausted and demand remains strong.

  • Example A: Concert Tickets
    A highly anticipated music festival announces its lineup, and tickets sell out within minutes of going on sale. An individual uses automated software to buy dozens of tickets at the standard price. They then list these tickets on a secondary market website for three to five times their original cost, knowing that many fans were unable to purchase them directly and are willing to pay a premium to attend.

    Illustration: This is scalping because the individual acquired scarce concert tickets at face value and resold them at a significantly inflated price due to high demand, profiting from the scarcity and the inability of genuine fans to buy directly.

  • Example B: Limited Edition Collectibles
    A popular toy manufacturer releases a limited edition action figure, with only a few thousand units available worldwide. Enthusiasts and collectors rush to buy them online, but many are quickly purchased by individuals who have no intention of keeping them. These buyers immediately list the figures on auction sites for hundreds of dollars above their retail price, capitalizing on their rarity and the strong collector demand.

    Illustration: This scenario demonstrates scalping as these individuals acquired a highly sought-after, limited-supply item and then resold it at an exorbitant profit, exploiting its scarcity and the intense desire of collectors.

• 2. Investment Adviser Front-Running

  In the financial sector, "scalping" describes an unethical and often illegal practice where an investment adviser or broker buys shares of a particular security for their *own* personal account *before* recommending that same security to their clients. The adviser anticipates that their clients' subsequent collective purchases will drive up the security's price, allowing the adviser to then sell their own shares at a profit.

  • Example A: Stock Recommendation
    A financial advisor conducts extensive research and determines that a specific technology stock is undervalued and poised for significant growth. Before issuing a "strong buy" recommendation to their large client base, the advisor secretly purchases a substantial number of shares of that stock for their personal investment portfolio. Once the recommendation is disseminated and clients begin buying, the stock's price rises, and the advisor sells their personal shares for a quick gain.

    Illustration: This is scalping because the advisor used their privileged position and influence over clients to profit personally from the price increase they knew their clients' collective buying would cause, without disclosing this conflict of interest.

  • Example B: Mutual Fund Manager
    A manager overseeing a large mutual fund decides to significantly increase the fund's holdings in a particular corporate bond issue. Knowing that the fund's substantial purchase will likely push up the bond's market price, the manager first buys a smaller quantity of the same bond for their personal account. After the mutual fund completes its large transaction and the bond's price increases, the manager sells their personal holdings for a profit.

    Illustration: This exemplifies scalping as the fund manager front-ran their own fund's large transaction, using knowledge of an impending institutional purchase to personally profit from the anticipated price movement.

• 3. Excessive Markup or Markdown by a Market-Maker

  A third meaning of "scalping" refers to a market-maker (an entity that stands ready to buy and sell a particular security) charging an excessively large difference between the price at which they buy a security (the bid price) and the price at which they sell it (the ask price) during a transaction. While market-makers are compensated for providing liquidity, an unreasonable "spread" or markup/markdown can be considered an abuse of their position and a violation of regulatory guidelines.

  • Example A: Illiquid Bond Transaction
    A small institutional investor needs to quickly sell a specific type of municipal bond that is not frequently traded. A market-maker agrees to buy the bond but offers a price significantly below its current fair market value. The market-maker then immediately sells the bond to another buyer at a much higher price, pocketing an unusually large profit margin on the transaction.

    Illustration: This is scalping because the market-maker exploited the investor's urgency and the bond's illiquidity to charge an excessive markdown (buying too low) and then an excessive markup (selling too high), creating an unfair profit spread.

  • Example B: Over-the-Counter Stock
    A client wishes to purchase shares of a less common stock traded over-the-counter (OTC). The market-maker for that stock quotes a selling price that is disproportionately higher than the price they would pay to acquire those shares, far exceeding what would be considered a reasonable compensation for facilitating the trade and taking on risk.

    Illustration: This constitutes scalping as the market-maker applied an excessive markup on the transaction, taking advantage of their role as the primary facilitator for that particular security to extract an unreasonable profit from the client.