Bates Research - 08-24-17

SEC Data Analytics Team Strikes Again

The SEC is not slowing down in its extensive use of sophisticated data analytics to drive enforcement efforts. Last week, the agency brought charges against seven individuals who participated in complex insider trading schemes that netted millions of dollars in illegal profits. The case has garnered significant attention because the defendants were caught by the SEC using data analytics despite the defendants’ use of sophisticated methods and new communications technologies to evade detection. Bates has played a leadership role in the public discussion of the enforcement implications and use of big data analysis by the regulatory agencies. (See here and here.) In this post we review some recent enforcement developments and the increasing role of the SEC’s Market Abuse Unit (MAU)’s Analysis and Detection Center (ADC).

Enforcement and Big Data Matters at the SEC

Questions posed by commentators earlier this year about whether the SEC under Chair Jay Clayton would be as aggressive as his predecessor in the use of data analytics (see, e.g. here) for enforcement purposes have been answered. The most recent litigation against a former IT employee of a large bank suggests the SEC will continue embracing analytics. That conclusion should give potential perpetrators of fraud pause and give compliance professionals cause to strengthen their efforts.

The instant case involves an IT specialist who misused his access to a bank computer system to tip off friends and family about information “on 30 impending corporate deals from October 2014 to April 2017.” The defendants went on to net more than two million dollars on illicit transactions made possible by the inside information. Though allegedly “inexperienced” at trading, several of the defendants used “encrypted, self-destructing smartphone messaging application[s] and used shell companies to carry out their insider trading.”

The attempts at deception were unsuccessful due to the work of the SEC’s Analysis and Detection Center. According to the press release, the ADC “uses data analysis tools to detect suspicious patterns such as improbably successful trading across different securities over time,” and used “enhanced detection capabilities” to uncover the insider trading scheme. Steven Peikin, Co-Director of the SEC Enforcement Division, emphasized that “the tippers and traders in this case are alleged to have used various methods to try to cover their tracks, but their efforts failed.”

The ADC and Other Recent Cases

Notwithstanding other regulatory agencies deploying regulatory surveillance and enforcement resources, such as FINRA’s Office of Fraud Detection and Market Intelligence (OFDMI) (see Bates post on FINRA’s bad actor initiatives), attention has been focused on the SEC’s Market Abuse Unit to indicate the intentions and direction of the new regulators.

According to a recent report in the National Law Review, the SEC is pursuing both large and small insider trading cases with intention. The MAU-ADC activities are meant to “serve as a reminder that violations can be identified, even if trades are relatively small,” and that the SEC is taking “strides to find cases on its own, not simply waiting for tips or FINRA referrals.” The article affirmed that the MAU “proactively launches its own investigations through data mining and advanced detection.” It cites to recent cases (i.e. SEC v. Hartung, SEC v. Fung and SEC v. Alpert.) in which the ADC has had a material influence in the prosecution. As the report states, “these cases demonstrate that the SEC is uncovering new leads through data analysis.” A legal analysis published on Lexology describes how the SEC is using the data analysis of the ADC to identify suspicious trading patterns in other fraud investigations—i.e. “cherry-picking” cases—as well as insider trading cases (see, for example, SEC v. Breton.)

Former MAU Chief Daniel Hawke was recently quoted by Reuters describing the ADC as “a virtual, decentralized group within the MAU” and comprised of industry specialists hired because they possessed unique analytical, statistical, programming, or investigative skills.” He noted that the ADC was established with the intention to go on the “offense…to be proactive by identifying patterns, connections and relationships among traders and institutions at the outset of investigations" and to develop and deploy "automated trading data analysis that would give the SEC strategic advantages in the way it conducts complex trading investigations, particularly those involving large institutions." Mr. Hawke identified the specialties that make up the ADC. These include expertise in (1) complex financial investigations; (2) quantitative analysis and statistics; (3) trading strategies; (4) index arbitrage and ETFs; (5) market structure, compliance and regulatory risk; (6) broker-dealers; (7) high-frequency trading; and (8) and market intelligence accounting.

The touting of these cases by the SEC implies that there will be no backing away from the original design of the ADC: to proactively search large datasets to uncover patterns of potential fraud.

Financial Institutions: Be Prepared

At a SIFMA-Bates forum held earlier this year, Scott Lucas, Managing Director of Bates Group’s Regulatory and Internal Investigations Practice offered a blunt assessment of the enforcement environment: “as regulators increasingly rely on big data analytics to bring forward cases, it is incumbent upon market participants to be able to conduct the same type of big-data-driven review in responding to investigations” Similarly, Bates Group Experts Shane Shook and Rajeev Bhattacharya, observed: “the data analytics landscape has drastically changed from just a decade ago;” “there is a need for financial services firms to keep pace with the regulators’ powerful analytics capabilities.” Bates Group is ramping up its resources consistent with these assessments, (see here) but their original message is increasingly resonant. “Financial services firms need to be aware of what their data says about them, now more than ever,” said Alex Russell, Director of Bates Group’s Institutional and Complex Litigation practice and co-leader of Bates Group’s Big Data practice. “Regulators are increasingly relying on, and re-examining, data that has been provided in response to a variety of prior regulatory requests. Previously unrelated data can become a driving factor in generating new enforcement activity, and firms need to be aware of that.” 

The SEC’s aggressive enforcement activity based on increasingly sophisticated data analytics should be a deterrent to bad actors, but it should also act as a warning to professional traders and portfolio managers. For compliance professionals responsible for monitoring illegal activity, the SEC cases should reinforce the importance of getting firm processes in order, including information controls, review of employee personal trading, and other internal surveillance. Bates Group will continue to update you on new developments. Stay tuned for another look at this recent insider trading case next month via an in-depth discussion with our leading experts when we will talk about the broader trend of data analytics and enforcement activity in general.

Editor’s Note: Bates Research will be on vacation next week. We will resume our normal publication schedule after Labor Day. Have a happy and safe holiday.


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