Big Data is Watching You
As trading markets grow more complex, the SEC increasingly relies on analytics to spot suspicious activity. Here’s what financial professionals need to know about the process.
June 11, 2020 – It seems like the kind of crime that might be tough to catch: A financial professional cherry-picks stock trades for his clients. When he places trades on their behalf, he first runs the trades through a dummy account that he controls. If the trades lose money, he allocates them to the clients’ accounts. If the trades gain money, he allocates them to his own account. Heads, he wins. Tails, they lose. However, he will get caught when the SEC uses data analysis to identify suspicious trading patterns.1 The financial professional has to pay back his ill-gotten gains, plus interest, and is banned from the securities industry for life. The firm he works with often must pay a fine and revamp their oversight processes.
In fact, that scenario shows how the agency’s approach to fighting fraudulent trades, insider trading, and other problems in the investment community is changing. In the past, the SEC took a more reactive stance. It waited until it received a notification about suspicious trading activity, often in advance of a merger announcement, and then investigated to see who traded in the security, and why. In other words, the investigation wouldn’t begin until after the trade happened, and it relied heavily on interviewing the people involved (who were more likely to have been able to coordinate their stories once they knew they were under investigation)
The Special Ops of Enforcement
In 2010, things changed. The SEC reorganized its enforcement division and created a Market Abuse Unit to get better at spotting suspicious activity. Within that unit is an Analysis and Detection Center (ADC), a kind of special-operations team of people with very specific expertise in trading, programming or white-collar criminal investigations. This in-house expertise allows the SEC to be far more proactive, identifying suspicious trading patterns as they’re happening. As a result, investigations can get far down the tracks before traders get tipped off.2
The ADC can run analytics that sift through traded data going back 15 years—and billions of rows of buy and sell orders—to spot patterns in which some people consistently trade ahead of good or bad news about a specific investment.3
That kind of analytical firepower is necessary because of the sheer size of the market. The SEC’s Office of Compliance Inspections and Examinations is responsible for overseeing nearly 13,500 financial professionals—a number that grew more than 17% in the past five years—who collectively have about $84 trillion under management. Nearly 3,700 of those financial professionals have more than $1 billion within their own firms.4
And the enforcement tools are going to get better. Currently, the Market Abuse Unit does not have direct access to market trading data. Instead, it has “blue sheets,” or trade histories, that it pulled from various brokerage firms during investigations.3 (It’s like soldiers pulling hard drives out of a terrorist’s house and then using the information from those hard drives to prosecute additional people.)
But in the future, all trades—every order, execution, and cancellation—will be on a central database called a Consolidated Audit Trail. That database will pull information directly from stock exchanges and the Financial Industry Regulatory Authority (FINRA), giving regulators a more complete picture of the market at any given time. That system is currently in development and it should start rolling out in late 2020.5
What It Means for Firms
For financial professionals and their clients, this all should be reassuring. However, it puts an increasing burden on firms to make sure they have a strong plan in place to track and report all data regarding their clients’ trades. Compliance is more important than ever.
The SEC used to act like a security guard when it came to enforcement. Today, it acts like a surveillance system that’s monitoring markets 24/7. That smart, data-driven approach is good news for everyone.
1 “Press Release: SEC Brings Settled Actions Charging Cherry-Picking and Compliance Failures,” SEC, Aug. 26, 2019.
2 Daniel M. Hawke, “SEC Data Analysis in Insider Trading Investigations,” CLS Blue Sky Blog, Aug. 21, 2019.
3 “Here’s How the SEC is Using Big Data to Catch Insider Trading,” Fortune, Nov. 1, 2016.
4 2020 Examination Priorities, Office of Compliance Inspections and Examinations.
5 “Update on Consolidated Audit Trail, Temporary COVID-19 Staff No-Action Letter; Reducing Cybersecurity Risks,” SEC, March 17, 2020.
CSC-0622-2227032-INV-E