The SEC keeps using data analytics to help with its investigations

In three separate actions on July 25, 2022, the U.S. Securities and Exchange Commission (SEC) charged nine people with insider trading.

In three separate actions on July 25, 2022, the U.S. Securities and Exchange Commission (SEC) charged nine people with insider trading. They are accused of making illegal gains of more than $6.8 million. Even though the facts of each alleged violation are interesting on their own, what really stands out is that all three involve the SEC using data analytics to find suspicious trading patterns. In this post, we'll give a brief overview of what the Division of Enforcement has done and what we can learn from how they've used data analytics to look into insider trading.

A Brief Look at Insider Trading

The first complaint is about alleged insider trading by the chief information security officer (CISO) of a public company before two major acquisitions by his employer in 2021 and 2) the CISO's alleged tips to four of his friends who also traded on the same material, non-public information (MNPI) (the CISO Complaint). Several relief defendants were also charged by the SEC with getting some of the $5.2 million in ill-gotten gains. The SEC says that the CISO made specific deals with some tippees in which they either agreed to split trading profits with the CISO or the CISO gave them cash to trade. As is common with SEC complaints about tipping, the CISO Complaint says that the CISO and the tippees were friends and that they talked to each other often. This is meant to show that the CISO received a "personal benefit" from the alleged tipping.

In a second complaint, the SEC says that an investment banker stole confidential information from his employer and told a close friend and former classmate about four acquisitions that were about to happen between 2017 and 2018. (hereinafter Banker Complaint). The SEC makes specific claims about how the investment bank warned that certain information was MNPI and how the investment banker ignored those warnings to help his friend. The SEC says that the banker's friend bought call options with his brother's brokerage account before each of the four acquisitions. From the trades, the tippee is said to have made $275,000. As part of its claim that the investment banker got something out of the tips, the agency said that the friend gave the banker $85,000 three years after the last tip under the guise of a loan.

The third complaint says that a former Federal Bureau of Investigation (FBI) trainee and his friend made $82,000 and $1.3 million, respectively, from trades based on MNPI (hereinafter the FBI Trainee Complaint). The SEC says that the former FBI trainee got information about a plan for one company to buy another company from his then-girlfriend, who was an associate attorney at a law firm. During the pandemic, the FBI trainee worked in the same apartment as his partner. This is how he or she found out about the possible transaction. The SEC's complaint says that the FBI trainee "explicitly or implicitly" agreed to keep information about his partner's work secret. After using the supposed MNPI to trade on his own, the former FBI trainee is said to have told a close friend, who bought 35,382 shares of stock in one of the companies two weeks before the transaction. The SEC said that in exchange for the tip, the friend bought a Rolex watch and paid for a vacation.

For the actions described above, the U.S. Department of Justice (DOJ) also filed criminal charges.

Analytics are still being used.

SEC's EPS Initiative, in which the SEC's Division of Enforcement used data analytics to find possible accounting mismanagement. Even though they are in different areas, the three insider trading cases this week show that the SEC is still using data analytics to help its enforcement programme. In fact, Gurbir S. Grewal, who is in charge of the SEC's Enforcement Division, said, "[The SEC] stands ready to use all of our expertise and tools to root out wrongdoing and hold bad actors accountable, no matter what industry or profession they work in."

Using data analytics is nothing new for the SEC when it comes to insider trading, of course. Since a long time ago, the Division of Enforcement has used trading data from different broker dealers and other market makers (called "blue sheets") to find strange or suspicious trading patterns. 1 Attorneys and other experts in the Division of Enforcement can use data as a starting point for using more traditional enforcement tools like subpoenas and testimony.

When you look at the alleged trades from the three complaints, it's not hard to see that some of these trades would make it clear to the agency that something is wrong in any blue sheet analysis. For example, the CISO Complaint says that one of the tipees 1) bought 82,000 shares of company stock and 3,014 call options days before one announcement and then 2) sold the position four days after the announcement, making more than $1 million in allegedly illegal gains. In the FBI Trainee Complaint, the SEC says that the "tippee" bought 35,382 shares in the two weeks before the merger. This is said to be an illegal gain of about $1.3 million. The Division of Enforcement could easily start an investigation if someone bought something right before a good news announcement and made a lot of money.

Also, other data from the complaints shows that the SEC has access to other data tools. For example, the SEC is just now filing charges in the Banker Complaint for tips and trades that happened in 2017 and 2018. Even though the staff could have started an investigation based on trade data or something else, it's also possible that they did so because of the $85,000 wire transfer that the friend sent to the investment banker in 2021.

Even though this is just a guess, it's possible that the wire transfer triggered a Suspicious Activity Report (SAR). This is a report that banks send to the Financial Crimes Enforcement Network when they notice something suspicious.

Connect (FinCEN). Under the Bank Secrecy Act (BSA), banks are required to help government agencies like the SEC fight financial fraud. This includes keeping records of certain cash purchases, filing reports for cash transactions over $10,000, and reporting suspicious transactions that could be signs of criminal activity. The SEC's Enforcement Division often uses SAR information as another piece of data to find leads for investigations and to add to its investigations.

Even though it's not in the SEC's complaint, the DOJ's press release about the FBI trainee says that his name came up in an investigation by the Financial Industry Regulatory Authority (FINRA).

Regulatory Authority (FINRA) into buying and selling shares of the target company. FINRA keeps an eye on both the stock market and the options market for anything that seems odd. Since FINRA can't go after people who trade on insider information, it sends suspicious trades to the SEC.

In other words, the SEC uses FINRA's surveillance tools as well as its own analysts to keep an eye on the markets for anything that looks fishy.