How Nasdaq Watches for Insider Trading06.10.2016
This article first appeared on MarketWatch
The business of rooting out insider trading and market manipulation has gone high-tech.
Brokerage firms and stock exchanges all over the world have joined traditional market watchdogs like the Financial Industry Regulatory Authority and the Securities and Exchange Commission in using high-tech tools to quickly and efficiently quickly spot “too-good-to-be-true” trades by insiders and those who know them.
Nasdaq, Inc. NDAQ, +0.29% , for example, uses state-of-the-art software acquired in 2010 from SMARTS Group, a leading provider of market surveillance solutions to exchanges, regulators and brokers. Nasdaq is using that acquisition to diversify its commercial technology business and provide the same tools it used in-house to 40 marketplaces, 11 regulators and 100 market participants across 65 markets globally.
A multi-faceted team of markets, legal, fraud and financial reporting compliance professionals, primarily based in Nasdaq’s “MarketWatch Center” in Rockville, Maryland tracks the activities of its listed companies and those who trade Nasdaq-listed shares in real-time around the clock. (Nasdaq’s MarketWatch has no affiliation with this publication, which shares its name.)
At the MarketWatch Center, Nasdaq watches the markets using software with a colorful graphical user interface that’s peppered with charts and graphs, helping them visualize trends and spot unusual activity as millions of trades flicker by each day.
Graphic displaying buy vs sell interest, with buy interest as blue bars and sell interest as red bars.
Martina Rejsjö, the head of the group, relocated from Nasdaq’s Stockholm office two years ago. Her group reviewed 51,549 issuer disclosures in 2015, typically all the 8-K filings with the SEC but also the earnings press releases that go out four times a year.
Martina Rejsjö, Vice President of Nasdaq MarketWatch, watches issuers, participants and trading activity across asset classes and markets.
Companies must notify the exchanges about news of “a material event or a statement dealing with a rumor,” that will go out between 7 a.m. and 8 p.m. by “telephone” at least 10 minutes before the announcement is made. Nasdaq’s review of these disclosures for material market moving information resulted in 425 trading halts in 2015, down from 509 in 2014 even though the volume of disclosures reviewed was more last year.
The Nasdaq MarketWatch team sets up alerts to look for disclosure activity that could require a halt and trading activity that could signal manipulative trading or a technical problem that could also require a halt. Although her analysts consult closely all day with companies on everything, the exchange has the last word on halts, says Rejsjö. When reviewing company disclosures, they are looking for “material events” that can move the market.
• An auditor resignation or a first-time “going-concern”
• Senior executive or director changes of a material nature or a change in control
• An announcement of a reorganization or an acquisition, including mergers, tender offers, asset transactions
• A bankruptcy filing
• Deviation in actual results compared to previously issued guidance
• Previously undisclosed, surprise material news such as new products, Food and Drug Administration approvals or revised financial outlook
When looking at unusual trade activity, the analysts check for significant price movement combined with higher volumes, especially concentrated from one broker. They are also looking for larger than usual transactions and block trades. Sudden and rapid price increases or drops are seen clearly on their charts along with moves in the opposite direction of market indices such as the Nasdaq Composite or the Dow Jones Industrial Average. The team also tracks online sites for rumors, and reviews blog posts and Twitter feeds.
MarketWatch at Nasdaq monitors velocity, based on total volume against the expected volume for a certain stock, and force – the buy:sell ratio which indicating whether there is more pressure on the buy or sell side.
The MarketWatch team reviewed 387,260 surveillance alerts in 2015, resulting in 689 referrals to Finra for further review and drill-down on the activity at the brokerage firm level. Finra has its own proprietary market surveillance software, called Sonar, that it uses to identify activity for review. That surveillance is supplemented by the referrals and tips from customers, the public or exchanges like Nasdaq.
Cameron Funkhouser, the executive vice president in Finra’s Office of Fraud Detection & Market Intelligence, said in an interview said that they receive “all kinds of market intelligence from many sources. Between the surveillance and the investigation,” said Funkhouser, “we are going broad and deep, looking at who traded and when, down to the customer level, and which accounts made money.”
A primary target for surveillance at Finra is mergers-and-acquisition activity. “The starting point may be a referral from an exchange like Nasdaq or our own surveillance alerts. We look for unusual price or volume movement, married with the trading timeline and a network analysis of the relationships between those who made profitable trades.” Finra is also responsible for reviewing options activity. “The real leverage in insider trading,” says Funkhauser, “is in options.”
Last year Finra referred approximately 421 instances of potential insider trading to the SEC, which then assesses those cases for further investigation and possibly civil enforcement action. The SEC can also make a referral to the Department of Justice for a criminal case. A spokesman from the SEC declined comment on its cooperation with Finra and the exchanges on insider trading or market manipulation referrals.
Two recent SEC insider trading enforcement actions began with Nasdaq MarketWatch referrals to Finra, said a Nasdaq spokesman. On June 3 the SEC charged childhood friends with insider trading in pharmaceutical stocks. On May 31 the SEC charged an investment banker with passing inside information to his plumber in exchange for a new bathroom.
Nasdaq also disciplines its members on its own and in conjunction with FINRA. In April of this year, Deutsche Bank Securities was fined $3 million for failing to report and failing to correctly report options positions to the required Large Options Positions Report. Deutsche Bank Securities also failed to have an adequate system and procedures for supervision related to compliance with options reporting, according to a settlement whose findings Deutsche Bank did not agree with or deny.
In March FINRA and Nasdaq announced that they jointly censured and fined Wedbush Securities Inc. $675,000 for supervisory violations in connection with its handling of a client’s redemption activity and trading of leveraged exchange-traded funds. The firm’s failures led to chronic fails to deliver in several ETFs for more than two years. Wedbush did not admit or deny the findings.
Nasdaq also fined Great Point Capital $1.05 million in December for manipulating the price discovery process Nasdaq uses to cross buy and sell orders at a single price at the opening and closing of the session. Great Point did not admit or deny the findings.
This helps to minimize the risk level and protect market participants from compliance breeches.
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