July 27, 2022 | Jennifer Clarke
Estimated reading time: 4 minutes
Who’s looking over your shoulder? SEC uses data analytics to detect bad actors
The Securities and Exchange Commission (SEC) has proudly announced its use of data analysis in pursuing enforcement action in three separate instances of insider trading.
In a press release, the SEC has said that its Enforcement Division’s Market Abuse Unit’s Analysis and Detection Centre, which uses data analytics to detect suspicious trading patterns, has been the catalyst for insider trading charges issued against nine individuals.
The nine individuals were charged in three different cases which yielded nearly $7 million in illicit profits. In all three cases, three individuals shared confidential information with friends, who then traded on that information. The three individuals in question were:
1. A former chief information security officer (CISO)
In this instance, the former CISO at Lumentum and his four friends traded ahead of two corporate acquisition announcements by Lumentum, gaining $5.2 million in illicit profits. The SEC allege that, through his work at Lumentum, the CISO knew of material non-public information (MNPI) that it planned to acquire the two companies and traded using that MNPI.
2. An investment banker
An investment banker and a foreign exchange trader at a large financial institution, who were old school friends, colluded to make over $275,000 by illegally trading ahead of four acquisition announcements. The SEC allege that the investment banker, through his work, knew of the acquisition announcements ahead of time and traded from that insider information.
3. A former FBI trainee
In this instance, the former FBI trainee secretly reviewed the confidential binder documents of his romantic partner who was a lawyer acting on a large business deal. The FBI trainee informed his friend of the upcoming deal, who traded on that information and made $82,000 and $1.3 million respectively. After the event, the friend bought the FBI trainee a Rolex to thank him for the tip.
In each of the three cases parallel criminal charges are simultaneously being pursued.
There are three vital lessons to be learned from the SEC’s recent action:
1. The SEC will pursue illicit activity against individuals – they’re not just saving enforcements for the big banks
While the cumulative cost of ill-gotten gains in these three cases amounted to more than $7 million, on an individual level these aren’t front-page grabbing profits. Despite this, the SEC has still feverishly pursued this individuals, leading to fines and simultaneous criminal charges.
This action feeds into an emerging focus from global financial regulators – one that leaves no holds barred for individual bad-actors, or even negligence. As we saw recently in the US, the New York City Bar Association has published a Framework for Chief Compliance Officer Liability in the Financial Sector, which a CFTC Commissioner has actively explored as a use case.
In the UK, the Law Commission has similarly published an options paper for the government on how it can ensure corporations are held to account for serious crimes. Within this paper are far-reaching options for identifying and prosecuting senior managers, CEOs and CFOs who consent to, connive in, or fail to prevent certain malpractice.
Looking ahead, regulators are honing in on individual accountability. It’s no longer enough for individuals to bury their head in the sands and hope it goes away.
2. Data analytics are closing the gap on illicit activity, enabling regulators to more accurately detect non-compliance and take action, fast
The past five years have seen unbridled technological innovation in the detection of bad actors and non-compliance. The banks were the early adopters, implementing technology that would use data analytics to detect and prevent risk. As was inevitable, global regulators are now using the same technology to simultaneously look for malfeasance.
This means a number of things, not least that the regulators are sharpening their gaze. They no longer need to rely on regulatory reporting alone to understand the in-house operations of those under their watch, they can see the issues for themselves. In turn, this means that non-compliance, or even compliance that isn’t “good”, will now be detected and penalised by regulators faster than before. For compliance teams with gaps in their systems, there’s less room to hide.
3. If the regulators are using technology, you should too
Regulators have, generally speaking, remained technology agnostic throughout the digitisation of finance. They don’t mind how you comply, as long as you’re compliant.
However, with more and more regulators turning to technology – from FINRA’s use of AI in its exam and risk monitoring program, to the SEC’s use of data analytics – there’s a burgeoning subtext that those they regulate should be doing the same. As the SEC’s Nick Cook said as far back as 2019, it is “untenable for regulators and central banks to not have an opinion on technology given it is so embedded in the markets we regulate.”
If the regulators are using technology, firms should be too.