Securities Fraud: How the SEC Tracks Suspicious Trading Activity


Securities Fraud: How the SEC Tracks Suspicious Trading Activity

Securities fraud involves the deception of investors through manipulation, false statements, or fraudulent practices. The SEC has extensive resources dedicated to uncovering securities fraud and suspicious trading activity that may be indicative of illegal behavior. This article provides an overview of common signs of securities fraud, how the SEC monitors the markets, enforcement actions, and key takeaways for investors.

What is Securities Fraud?

  • Misrepresentations: Providing false or misleading statements to investors about a security or misleading financial reporting. For example, overstating revenue or earnings.
  • Insider Trading: Buying or selling securities based on material, non-public information in breach of a fiduciary duty. This provides an unfair advantage and undermines market integrity.
  • Accounting Fraud: Intentionally misstating or omitting financial statement information to mislead investors about a company’s financial health. For example, WorldCom and Enron.
  • Pump-and-Dump Schemes: Artificially inflating the price of a stock through false and misleading positive statements, then selling shares when the price peaks. This is a form of market manipulation.
  • Churning: Excessive trading by a broker in a client’s account solely to generate commissions. This breaches the broker’s fiduciary duty.
  • Late-Day Trading: Illegally trading shares after the market has closed at 4:00 PM EST based on news releases or events after close. This allows illegal profits for those with access to this non-public info.

The penalties for securities fraud can include substantial fines and imprisonment. The SEC often pursues disgorgement of ill-gotten gains in addition to fines. For example, in 2020 the average insider trading case resulted in over $25 million in total sanctions.

How the SEC Tracks Suspicious Trading

The SEC monitors over 50 billion records daily across US markets to uncover potential fraud and suspicious trading activity. They employ sophisticated analytics on a massive scale to identify patterns and relationships indicative of securities violations.

The SEC coordinates with FINRA and other regulators to share information. They also have specialized units to investigate particular types of fraud. For example, insider trading cases are often built through analysis of advanced trading patterns, relationships between traders, and events that prompted the suspicious activity.

In particular, the SEC’s Market Abuse Unit uses state-of-the-art technology to uncover suspicious patterns like:

  • Unusual trading spikes before M&A deals or other market-moving news.
  • Relationships between multiple traders engaged in similar suspicious activity.
  • Sudden rise of dormant shell companies with unusual trading volume.
  • Accounts with improbably successful trading strategies.
  • International traders hiding identities using omnibus accounts.
  • Attempts to manipulate prices through high volume wash trades or spoofing orders.

When the automated systems spot anomalies, the SEC performs additional investigation and analysis to determine whether there are legitimate explanations. If not, an enforcement investigation may be opened to gather further evidence of wrongdoing.

SEC Enforcement Actions

When the SEC believes securities fraud or another violation has occurred based on their investigation, they have broad authority to pursue enforcement actions seeking sanctions.

In fiscal year 2022, the SEC brought over 700 total enforcement actions. They imposed penalties of over $6 billion in disgorgement and fines. Insider trading cases accounted for over $1.8 billion of the total sanctions.

Some recent major SEC enforcement actions include:

  • Accounting Fraud: The SEC charged the company and former executives with engaging in accounting misconduct by improperly recognizing unearned discounts to inflate earnings metrics. Kraft Heinz agreed to pay $62 million to settle the charges.
  • Insider Trading Ring: The SEC charged several investment advisors who traded on confidential information about mergers and acquisitions leaked by an attorney friend. Over $5 million in penalties were assessed.
  • Pump-and-Dump Scheme: The SEC filed fraud charges against a group that manipulated stock prices through misleading promotional materials, earning over $100 million illegally.

Beyond penalties against the wrongdoers, a top priority in enforcement actions is returning money to harmed investors. In FY2022, the SEC returned over $3.4 billion to investors, including from disgorged profits.

The SEC also often pursues bars from working in the industry again, such as compliance officer suspensions or brokerage and investment advisor bans. Individual offenders can face considerable prison time for criminal convictions based on SEC case referrals.