Anyone who has been in the financial services industry for any length of time knows that insider trading is a perennial focus area for the SEC. Despite the agency’s efforts over the past several decades, significant insider trading cases continue to make headlines, including this recent New York Times article. In a case announced in early December 2018, the SEC filed insider trading charges against an IT contractorand two other individuals it alleged made approximately $600,000 in profits derived from trading on material, non-public information. That announcement followed a series of other insider trading charges in 2018 including those brought against a Silicon Valley executive, a U.S. Congressman, an NFL player, and an Equifax executive, among others.
While financial services firms need written insider trading policies, such policy documents alone will likely be ineffective in completely eliminating trades made based on non-public information. The good news is that there are steps firms can take to lower insider trading risk beyond disseminating anti-insider trading policies. First, improving firm culture can go a long way in reducing the likelihood of insider trading and other compliance violations. Compliance departments can also leverage regulatory compliance technology tools and best practices to more readily identify and address questionable transactions.
Tips from “Tipper X”
At a recent ComplySci event, Tom Hardin from Tipper X Advisors LLC shared a cautionary tale gleaned from personal experience aiding the FBI as “Tipper X”, helping the government establish and prosecute more than 80 insider trading cases.
When he entered the industry in 2006, Mr. Hardin was thrust into a culture where many of his competitors openly traded on inside information in order to obtain attractive returns for themselves and for investors. Caught up in a culture of illegal activity, Mr. Hardin proceeded to place a series of trades himself based on insiders’ tips. He explained that he rationalized his bad conduct, reasoning that the infractions were minor and that his actions weren’t hurting anyone. Of course, insider trading is not a victimless crime.
Mr. Hardin subsequently became an informant for the FBI, cooperating with the bureau through 2009 on dozens of securities fraud investigations. While he was ultimately able to avoid prison time, his felony conviction was career-altering and impacted his relationships and his health.
Best Practices for Insider Trading Compliance
Several risk factors make insider trading and other compliance violations more likely, including situations where employee decision-making is isolated and those where employees working in remote offices are thinly-supervised. Improving the firm’s compliance culture and investing in technology can help in these situations.
Fostering a Culture of Compliance
Compliance tone from the top – and “mood in the middle” – play an enormous role in whether employees feel they can “get away with” bending the rules. In firms that adopt a “trust, but verify” mentality, compliance culture begins at the most senior levels of the organization, with management buy-in and curation across department lines. Mentorship opportunities, measuring the firm’s culture periodically, and involving compliance in the performance management process are all ways firms seek to improve their compliance cultures.
Leveraging RegTech Solutions
Firms can also lower their risk of insider trading violations by investing in regulatory compliance solutions designed to do just that.
The SEC and other regulators have embraced technology as a means of ingesting, reviewing, and dissecting vast amounts of industry data to detect insider trading and other securities law violations. One example is the SEC’s National Exam and Analytics Tool (NEAT), which allows OCIE’s examiners to analyze years of trades, validate blotters, and much more – quickly, and efficiently. Financial services firms that don’t follow suit by investing in technology may find themselves struggling to explain why they failed to identify problematic trades.
Of course, insider trading risks can occur at both the firm level and the employee level. Portfolio managers and traders sometimes use material, non-public information in an attempt to boost performance and benefit the firm. Individual employees may trade on insider information with the hopes of reaping illicit profits in their own investment accounts. Technology solutions can help address insider trading on both levels.
An effective RegTech solution is one that allows firms to monitor firm-level and personal trades, conduct regression testing, and spot trends. On the individual side, technology allows firms to incorporate and consider trading activity in the context of political contributions, gifts, attestation responses, and more. Compliance technology can also play a key role in helping firms meet their books and records requirements and prepare for regulatory examinations.
How Do Your Firm’s Anti-Insider Trading Efforts Stack Up?
The harsh reality is that no organization, regardless of its compliance efforts, size, or reputation, can entirely eliminate insider trading risks. Firms must recognize that the risks are very real, and that those risks come with the potential for significant regulatory consequences – none of them good.
Creating and fostering a culture of compliance at every level of the firm, and investing in sophisticated regulatory compliance technology, can help your firm identify and address potential issues, limiting risk exposure.