SEC market-abuse chief takes trader-based approach

Fri Feb 25, 2011 12:34pm EST

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NEW YORK, February 25 (Complinet) - The Securities and Exchange Commission market-abuse unit is using new approaches to in an effort to better identify insider trading and abusive conduct by market professionals.

Unit Chief Daniel Hawke said the SEC is using a trader-based approach to look for patterns across groups of people, such as related trades across different products and markets by a single trader or connected group of traders. The new approach has given the SEC a greater ability to detect relationships among traders, and bring cases against large trading networks.

Daniel Hawke, who is the national unit chief of the market abuse unit in the SEC Division of Enforcement, and director of its Philadelphia regional office, was speaking to a gathering of industry practitioners earlier this month at the SIFMA Compliance and Legal Society in New York.

The market abuse unit is structured to deal with a trend toward more-organized insider trading, Hawke said.

Historically, cases have been one-off or limited in scope, in terms of numbers of securities or traders involved. He characterized insider trading as "very tribal" in nature, involving only a close-knit circle of friends and family members with a high degree of trust among one another.

However, in the last few years, an increasing number of market professionals have been involved in tipping and trading on material non-public information. The establishment of the market-abuse unit in 2010 was in response to this "institutionalization" or "professionalization" of insider trading among market professionals. In addition to taking an issuer-based approach, where monitoring would be focused on a single stock, the market abuse unit is looking at traders and asking what securities are common to them.

The SEC market abuse unit currently consists of a staff of 50 and 2-3 specialists and support staff across eight regional offices and its home office. Ten of the staff are in New York, nine in Washington, with the rest spread between Los Angeles, Denver, Chicago, Philadelphia, San Francisco and Boston. Sanjay Wadhwa, who is deputy of the unit, and assistant regional director of the SEC's New York office, is among those leading the Galleon insider trading case.

RISK-BASED APPROACH

Hawke is in a unique position given that he is both regional director and chief of one of the new specialized enforcement units. He has participated in the restructuring of both the enforcement and Office of Compliance Inspections and Examinations (OCIE) programs.

The SEC is developing stronger risk-assessment capabilities in its enforcement and exams, given that it lacked a robust system to identify risk, or to deploy resources based on risks and emerging trends.

Enforcement director Robert Khuzami and OCIE head Carlo DiFlorio were fully engaged in bringing regional leaders together in a way that improved performance management and accountability at all levels, Hawke said. The regional directors are now better integrated with the SEC national leadership, and regularly talk with one another on national program issues.

Each regional office is now able to see tips, complaints and referrals coming into other regional offices. This is part of the larger SEC system to track incoming tips, and which goes toward having better intelligence-gathering and risk management.

In the division of enforcement, management streamlining also eliminated a tier of management at the branch chief level, which has resulted in a ratio of six staff to one manager, roughly double that of the past.

ENFORCEMENT UNITS

Hawke described the five specialized enforcement units created by the SEC in response to recognition that they needed to develop more specific expertise. The unit scopes were decided after extensive debate and analysis, and they represent 20-30 percent of the enforcement division staff.

-- Asset management group: covers investment advisers, hedge funds, private equity and valuation, has 60 staff attorneys and specialists, is led jointly by Rob Kaplan and Bruce Karpati.

-- Market abuse unit: covers market structure investigations, large scale and organized insider trading, large cap market manipulation, and system platform violations, is led by Hawke and his deputy Sanjay Wadhwa.

-- Structured and new products unit: is led by Kenneth Lench and his deputy Reid Muoio, covering portfolio trading strategies in products such as complex derivatives and financial products, comprises 30 people.

-- Municipal securities and public pensions: is led by Elaine Greenberg in Philadelphia and her Deputy Mark Zehner, and recently conducted the case against State of New Jersey for misrepresentation of public pension liabilities.

-- Foreign corrupt practices: an area in which enforcement made their reputation in 1970s with the 'questionable payments' cases, is led by Cheryl Scarboro and comprises 20 people.

The division of enforcement created the Office of Market Intelligence to collect and analyze information from the public that may have come in to the division. SEC Chairman Mary Schapiro has stated that a new central tips, complaints and referrals system is also being developed. The five specialized units all have interaction with market intelligence office, and it will also work closely with the new whistleblower staff.

SUBPOENAS IN MINUTES

Among the reforms to the division of enforcement's process is the delegation of formal authority by the commission to the director of enforcement and, through the director, to the division's senior officers. The new power allows, sometimes on very short notice, a unit chief like Hawke to approve a formal investigation if there is a need for subpoena power. Thus, if the SEC has examiners at a firm which refuses to produce documents it can issue a formal order "in a few minutes."

The SEC is putting intense focus on its own internal controls, in the same way it expects regulated firms to. Among the controls it has put in place is a system for better tracking Wells notices -- the notices that enforcement staff use to inform individuals and entities that the staff is considering recommending charges to the commission against them.

The Dodd-Frank Act contains a requirement for the SEC to better monitor the use of Wells notices. Staff will now need to decide, within six months of issuing a notice, unless extended, whether to recommend an enforcement action, and firms can expect staff to be more aggressive in completing the Wells process within the six-month period.

NEW EXAMS

Restructuring of the OCIE, the inspections and exams office, began in 2010 and is still continuing, although more it is more decentralized than enforcement. The goal of OCIE's restructuring is to clarify OCIE's mission and develop a more risk-focused program through improved industry compliance, better communications, and new ways to conduct exams. OCIE is seeking to improve its ability to detect and prevent fraud, monitor new and emerging risks, set up a robust risk analysis capability, and inform SEC policy.

Governance of OCIE has been restructured so that it is more inclusive of the agency's regional directors and associate regional directors, who each participate on either OCIE's new executive committee or one of its four steering committees.

OCIE is establishing specialist working groups some of which compliment the subject matter of the division of enforcement's specialized units. They include new and structured products, equity market structure and trading practices, fixed income and municipal securities, microcap fraud, marketing and sales practices. Hawke confirmed that OCIE incorporated planning for hedge fund examinations as it has proceeded with its restructuring, as well as for state examination of investment advisors with under $100 million in assets under management.

A streamlined exam process will also be more efficient in the way examinations are conducted and by incorporating what is learned from the exams into the OCIE's risk assessment process and communicating relevant information within the SEC. This involves better use of information technology by making the process more automated. Hawke acknowledged that "our technology is very outdated" and said improvements would be "very budget dependent."

(This article first appeared in Complinet (www.complinet.com) Complinet, part of ThomsonReuters, is a leading provider of connected risk and compliance information and on-line solutions to the global financial services community.) (Nick Paraskeva is principal of Reg-Room LLC, which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Complinet. He can be contacted at nparaskeva@nyc.rr.com.)

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