It’s the cardinal rule for investment professionals: Do not use, share, disseminate or trade on the basis of material, non-public information. Even so, the SEC regularly charges brokers, advisors and other industry insiders with illegal insider trading.
Of course, potential sanctions are not always limited to the individual “bad actors” in insider trading cases. Firms that don’t have mechanisms in place to prevent, detect and correct such violations can find themselves facing regulatory risk too.
Recent SEC Actions
In recent months, the SEC has announced charges involving several financial services professionals in unrelated actions, including the following:
- On May 24, 2017, an SEC complaint alleged that a former government employee was tipped off by an insider at the Centers for Medicare and Medicaid Services (CMS) about pending decisions that could impact companies that receive funds from Medicare for certain services. The former government employee then shared the information with two hedge fund analysts who used the information to recommend that their firm trade in the stocks of four such companies. The result was more than $3.9 million in allegedly illicit profits.
- On April 24, 2017, a VP in the Risk Management department of an investment bank was charged with illegally trading on confidential information. When he learned of an upcoming corporate acquisition through his employer, he allegedly traded on that information in accounts he had hidden from his employer.
- On August 11, 2016, the SEC charged both a stockbroker and his friend with trading on material, non-public information. The charges allege that the broker, along with two other brokers in his firm and an IT executive at a pharmaceutical company, sought to profit from trading in advance of an announcement by the drug manufacturer. The charges further allege that the broker established an account at another firm in an attempt to evade detection by his firm’s compliance department.
Firms and Compliance Staff May Be Liable
When insider trading occurs, it’s not just those directly involved in trading on material, non-public information that are at risk; compliance personnel and their firms can be charged too.
In 2014, a former CCO was charged with willfully aiding and abetting securities law violations when she closed an internal review on a matter that later turned out to be insider trading activity. The company itself paid a $5 million fine and admitted wrongdoing. The CCO, for her part, allegedly altered the record of her internal review when it became clear that the matter was under investigation, giving the appearance she had conducted a more thorough review than actually took place.
More recently, the SEC announced in February 2017 that a brokerage firm paid a $100,000 penalty to settle charges that it hadn’t devoted sufficient resources to its trading surveillance and compliance systems, resulting in 126 instances in a six month period where its hedge fund traded in a stock that was on the firm’s daily restricted list.
Mitigating Insider Trading Risks
Individual analysts, brokers and other firm insiders are not the only ones at risk when an insider trading scheme is uncovered. CCOs and firms without reasonable compliance measures in place to identify and stop insider trading activities may face sanctions and penalties of their own as well.
Most financial services firms include clear, unambiguous prohibitions against insider trading in their codes of ethics, personal trading, and other compliance policies. While simply having policy language prohibiting illegal insider trading probably won’t shield a firm from liability, requiring employees to complete annual (or more frequent) certifications may help strengthen a firm’s position.
Certifications should, themselves, be unambiguous and straightforward, and they should be collected and maintained for everyone in the firm. Using a regulatory compliance platform to automate this process, and to send periodic reminders, can help a firm manage a process that can otherwise become unwieldy. Firms should also leverage technology to identify any “exceptions” reported on such certifications, so the CCO (or designee) can take follow-up actions as needed.
Use Complete and High-Quality Data Feeds
Firms should also use a compliance technology solution to facilitate the pre-clearance process (if applicable) and personal trade monitoring, one that will aggregate employee and firm trade information through direct broker feeds. While doing so is not a guarantee that insider trading will be detected, it can help firms identify potentially problematic activity so it can be investigated further.
Data-driven solutions should provide a mechanism that helps firms do more than simply review individual trade data. When the data and capabilities of a firm’s compliance system allow it to oversee transactions, codes of conduct and police all related activities, patterns and potential issues are more readily apparent and can be addressed appropriately. Of course, it is also critical that any such solution ensures the quality of the underlying data, so firms and compliance officers can rely on the information provided.
Semantic data integrity, which allows for advanced forensic analytics, dynamic risk surveillance and demonstrates the firm’s commitment to compliance, is no longer an option for financial services firms that want to ensure compliance. To learn more about data quality, download our free white paper “Data Quality – Overcoming the Biggest Hurdle for Compliance and Risk Management.”
Evaluate Compliance Controls and Adjust as Needed
As with any type of compliance violation, firms can only do so much to mitigate their risk. If someone associated with the firm is intent on circumventing the rules, they may well find a way to do so – in spite of whatever measures the compliance department puts in place.
Firms should, at least annually, review their compliance procedures and controls around insider trading to ensure processes and mitigation efforts are reasonable and functioning as intended. Making needed adjustments can help limit the firm’s exposure in the event someone associated with the firm is found to have engaged in illegal insider trading.