How the Securities and Exchange Commission Tracks Insider Trading
The U.S. Securities and Exchanger Commission (“SEC”) has aggressively pursued insider trading cases from its inception in 1934. The SEC defines insider trading as buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.
The SEC has brought insider trading cases against corporate officers, directors, and employees who traded the corporation’s securities after learning of significant, confidential corporate developments; friends, business associates, family members, and other “tippees” of such officers, directors, and employees who traded the securities after receiving such information; employees of law, banking, brokerage, and printing firms who were given such information in order to provide services to the corporation whose securities they traded; government employees who learned of such information because of their employment by the government; and other persons who misappropriated, and took advantage of, confidential information from their employers.
An “insider” can include officers, directors, major stockholders and employees of an entity whose securities are publicly traded. In general, an insider must not trade for personal gain in the securities of that entity if that person possesses material, nonpublic information about the entity. In addition, an insider who is aware of material, nonpublic information must not disclose such information to family, friends, business or social acquaintances, employees or independent contractors of the entity (unless such employees or independent contractors have a position within the entity giving them a clear right and need to know), and other third parties. An insider is responsible for assuring that his or her family members comply with insider trading laws. An insider may make trades in the market or discuss material information only after the material information has been made public.
Investigating Insider Trading Cases
Until most recently, the SEC investigated insider trading cases only after detecting unusual or suspicious trading patterns in the securities of a company just prior to the public learning of a material event that would affect the company’s valuation or earnings. Material events may be news of a merger or important acquisition, or perhaps the development of a new product or securing an important government contract. Upon learning of a significant material event affecting one or more companies, the SEC can use trading data at its disposal to identify any trades in those securities by one or more persons that appear to have been very fortunate and valuable. The SEC has a significant amount of trading data available to identify suspicious trades, including:
- Blue Sheets. Most trades are conducted by and through registered brokers and dealers who are required to report detailed information on such trades to the SEC through the use of Blue Sheets. Although Blue Sheet data used to actually be transmitted to the SEC in paper form, today it is all accomplished through an automated system. The SEC can use Blue Sheet data to identify suspicious trades by type and dollar amount and timing, and can identify the beneficiary of any suspicious trades.
- Monthly Account Records. Although it must actually request the documents from the brokers and dealers, the SEC can obtain copies of investment account monthly statements for any trading account, including records of all trades, withdrawals and deposits. In a typical investigation, the SEC use these statements to profile the normal trading activity of a person. The account records also include account opening documents, identifying the person who owns the account, including their name and address, telephone number, and employer. SEC staff can use this information to establish a connection between the account holder and any insider.
- Order Tickets. Brokers and dealers maintain detailed records of each customer order and how those trades are executed in an Order Ticket. The Order Ticket includes the day and time that the order was placed and whether the order was solicited or unsolicited.
- Computer Analysis of Trends. The SEC uses sophisticated software to track trading activity by company or even a group of companies or group of similar securities to identify anomalies in trading activity over the course of days, weeks or months. Through this continuous monitoring the SEC is able to identify sudden surges in trading activity. Much of this activity can be readily explained by the public announcement of a significant event, but surges or large trades that occur prior to the public release of material information will almost certainly result in further inquiries by the SEC.
- Public Records. A significant part of all SEC investigations of insider trading is to identify the information that led to the trading activity being investigated. In the ordinary course of investment activity, investors learn of information from press releases, SEC filings, news reports or investment analyst recommendations. The SEC attempts to identify all public releases of information so that it can compare that information to statements later obtained by witnesses and targets of the investigation.
In recent years, the SEC has been able to conduct more sophisticated analysis of trading activity to identify instances of suspicious trades that were previously too small or dispersed to identify using older methods of investigation. SEC Chair Mary Jo White outlined these new efforts in a speech on November 18, 2016, at the New York University School of Law Program on Corporate Compliance and Enforcement. According to Chair White, the SEC created a Center for Risk and Quantitative Analytics within the SEC’s Enforcement Division. The SEC also has a Market Abuse Unit in Enforcement and an Analysis & Detection Center. Together, these new groups use sophisticated computer modeling programs to identify significant trading events and patterns amongst billions of lines of blue sheet trading data. One of these tools is called the Advanced Relational Trading Enforcement Metric Investigation System (ARTEMIS). Another system is called the Abnormal Trading and Link Analysis System (ATLAS). According to remarks by SEC Chair Mary Jo White on April 8, 2016, ARTEMIS “analyzes patterns and relationships among multiple traders using the Division’s electronic database of over six billion electronic equities and options trading records.” That is, these systems mine through Blue Sheet data to identify suspicious trades, allowing the SEC to systematically identify all instances of suspected insider trading.