Insider Trading, the Buy Side, and the Coming Crackdown: What to Know and What to Do
By Steve Brown, Managing Director and Head of Business Development, StarCompliance
Concerns surrounding insider trading related to the misuse of material, nonpublic information (“MNPI”) aren’t new for buy-side firms, but with so many employees still working from home the compliance equation has changed. Fully remote and hybrid work environments mean firms must move past manual monitoring processes to those better suited to this new state of affairs. The impetus to rethink how buy-side employees are monitored is also coming from new efforts by the U.S. Securities and Exchange Commission and the Department of Justice to crack down on illegal insider trading whenever and wherever it occurs.
The SEC minces no words
Case in point, on July 21, 2022, the SEC announced insider trading charges against a former Coinbase product manager, his brother, and his friend for trading ahead of certain crypto-asset listings. The product manager helped coordinate Coinbase’s public listing announcements, which it treated as confidential information that employees must not trade on or tip others off on.
But from June 2021 to April 2022, the product manager tipped the timing and content of upcoming crypto-asset listings to his brother and his friend. According to Carolyn M. Welshhans, acting chief of the Enforcement Division’s Crypto Assets and Cyber Unit, the results were as follows: “The defendants collectively earned over $1.1 million in illegal profits by engaging in an alleged insider trading scheme that repeatedly used material, nonpublic information to trade ahead of Coinbase listing announcements. As today’s case demonstrates, whether in equities, options, cryptoassets, or other securities, we will vindicate our mission by identifying and combatting insider trading in securities wherever we see it.”
Another case worth noting is the following: In March 2020, just as the pandemic was getting underway in the U.S., and just as so many employees in financial services were going remote, the SEC’s Division of Enforcement issued this very direct and unequivocal statement: “We wish to emphasize the importance of maintaining market integrity and following corporate controls. … Given these unique circumstances, a greater number of people may have access to material, nonpublic information than in less challenging times. Those with such access … should be mindful of their obligations to keep this information confidential and to comply with the prohibitions on illegal securities trading.”
Fast forward to April 2022, and the SEC issued a risk alert on investment advisor MNPI compliance issues “to provide investment advisers, investors, and other market participants with information concerning notable deficiencies that the staff has cited related to Section 204A of the Investment Advisers Act of 1940 … [which] requires all investment advisers … to establish, maintain, and enforce written policies and procedures that are reasonably designed, taking into consideration the nature of the adviser’s business, to prevent the misuse of material, non-public information by the adviser or any person associated with the adviser.”
New challenges, new solutions
The SEC isn’t mincing words when it comes to MNPI and insider trading, so nor shall I. Here are three ways to help make sure your buy-side firm stays on the right side of regulators when it comes to MNPI:
1. Use control room software as a workflow solution
The desire to pre-clear transactions can kill momentum, but it doesn’t have to. Modern control room software offers a centralized place from which potentially risky employee activity can be monitored and sensitive data tracked. Pre-clearing an employee, whether a portfolio manager or research analyst, can now be easily handled through a control room software solution. Need to record a call or securely store notes from a conversation? That can all be done in good control room software solutions and the automated workflows they offer.
2. Keep an eye on your alternative data
If your firm uses alternative data in its day-to-day operations, and you feel it contains MNPI, or that MNPI was uncovered in its use, the name associated with it can easily be put on a restricted or watch list in a control room software solution. Another way to use such a solution would be to report if a value-added investor has inadvertently shared MNPI with a portfolio manager. Finally, another not-uncommon use of alternative data on the buy-side is the use of satellite imaging or similar data that affirms qualitative or quantitative research. Again, the right kind of compliance software—along with the right policies, procedures, and controls—will help to monitor for that kind of activity.
3. Incorporate remote-work monitoring
As employees start to return to the office on hybrid schedules, firms are looking for ways to save money. With the rise of these kinds of schedules, firms may be considering hoteling, aka shared-space working. Buy-side firms need to be able to document and track the activity of who’s working with whom in private or shared spaces. To address this, good control room software will have the ability to connect with a firm’s HR system: enabling it to capture who’s public or private and where someone is working.
A final word from the DOJ
“We are keenly interested in sending a message that insider trading is still around, we are still around, and we are going to enforce it when we find it.” So said Damian Williams, the U.S. attorney for the Southern District of New York at a July 25 news conference announcing charges against nine defendants in four insider-trading cases. All the cases allege the misuse of material nonpublic information.
Buy-side firms have always had to worry about MNPI and insider trading. The changing world of work has heightened those concerns and focused them in a new and challenging direction, as has an emboldened SEC and DOJ. There’s likely no going back on either front. But as new challenges present themselves, so do new solutions: solutions that can make all the difference when it comes to keeping insider trading risk at any buy-side firm to the absolute minimum.