SEC—Data Analytics Key to Unlocking Fraud Schemes

Why it matters: Data analytics, used by the SEC to find suspicious trading patterns, has in recent years become a formidable weapon in the SEC's arsenal to combat insider trading and other fraudulent trading schemes. Two recent SEC enforcement actions, where the SEC specifically credited the use of data analytics to "crack the case," bear this out.

Detailed discussion: In recent years, the SEC has increasingly used data analytics—performed by the little-known Analysis and Detection Center (ADC) of the SEC Enforcement Division's Market Abuse Unit (Market Abuse Unit)—to unmask insider trading and other fraudulent trading schemes by analyzing data to find suspicious trading patterns. According to a November 2016 article by Reuters (Nate Raymond reporting) that discussed the ADC (formed in 2010) in the context of insider trading cases, the ADC "culls through billions of rows of trading data going back 15 years to identify individuals who have made repeated, well-timed trades ahead of corporate news." Reporter Raymond explained that "[t]he SEC does not have a direct feed of the markets' trading data. Instead, it mines 10 billion rows of 'blue sheet' data of trades executed by brokerages that the agency gathered in various investigations." Raymond quoted former SEC Enforcement Director Andrew Ceresney, who called data analytics the "new frontier," as saying that the SEC has "tremendous amounts of data available to use, and we've been developing tools to take advantage of that."

According to Raymond, ADC analysts use "a home-grown program called Artemis to analyze patterns and relationships among multiple traders" as well as "software from privately-held Palantir Technologies, which identifies links between individuals and entities by connecting pieces of information from multiple data sources. In 2015, the agency awarded a $90 million, five-year contract to Palantir." Raymond quotes Joseph Sansone, Co-Chief of the Market Abuse Unit, as saying that "[t]he ability to see pattern of multiple trades over a matter of months or years gives us confidence to invest resources into investigations."

Raymond said that the SEC's use of data analytics "signals a shift in how the agency initiates insider trading probes, which more often are launched based on referrals from Wall Street's self-regulator Financial Industry Regulatory Authority, or an informant's tip." Raymond added that the SEC's "new strategy" of using data analytics is "starting to show results," with it being credited for the SEC being able to "launch nine insider trading cases, around 7 percent of cases the agency brought since 2014 against people who trade on confidential corporate information."

While Raymond's article focused on insider trading cases, the SEC uses data analysis to identify suspicious trading patterns in other fraud investigations as well. Two recent SEC enforcement actions are illustrative of this point. The first involves a high-profile insider trading case, while the other involves an elaborate investor fraud "cherry-picking scheme." In both cases, the SEC specifically credited the use of data analytics for "cracking the case."

Insider trading: On February 10, 2017, the SEC announced that it had used data analytics to unmask the Chinese national who "reaped massive profits" in excess of $29 million from an insider trading scheme in the weeks leading up to the April 2016 of the acquisition of DreamWorks Animation SKG Inc. (DreamWorks) by Comcast Corp. (Comcast). In addition, the SEC announced that it had obtained an emergency court order freezing five brokerage accounts holding the illegal profits.

The SEC alleged that, prior to the DreamWorks acquisition, Shaohua Yin (Yin), a partner at Hong Kong-based private equity firm Summitview Capital Management Ltd., "allegedly did not trade in DreamWorks stock through his own account but instead traded through five accounts from addresses in Beijing and Palo Alto and on a computer that also accessed Yin's email accounts." The SEC said that the five accounts through which Yin traded were held by Chinese nationals, including his elderly parents, and at one point prior to the acquisition had amassed more than $56 million of DreamWorks stock (the price for which rose 47.3% once the acquisition was announced).

Michele Wein Layne, Director of the SEC's Los Angeles Regional Office, credited the use of data analytics to unmask Yin, stating that, "[d]espite the defendant's alleged attempts to hide his control over these accounts, the SEC's data analytic investigative tools enabled us to determine who was behind the suspicious trading."

"Cherry-picking": On January 25, 2017, the SEC announced that it had uncovered a "cherry-picking" investor fraud scheme using data analytics. The SEC alleged that investment adviser Michael J. Breton and his Massachusetts-based firm, Strategic Capital Management, "agreed to be banned from the securities industry after the agency uncovered an illegal cherry-picking scheme through its data analysis used to detect suspicious trading patterns."

The SEC said that the Market Abuse Unit's analysis of six years of Breton's trading data showed that Breton defrauded 30 clients out of approximately $1.3 million during that period by placing trades through a master brokerage account "and then allocat[ing] profitable trades to himself while placing unprofitable trades into the client accounts."

Market Abuse Unit Co-Chief Sansone said that "[o]ur probing analytical work will continue to root out investment advisers who subject their clients to cherry-picking."