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Employee Conflicts of Interest Insider Trading MNPI & Enterprise Conflicts Regulations

The Importance of Market Abuse Surveillance

Market abuse covers a wide range of behaviors that serve to manipulate investors, give brokers an unfair advantage, or disrupt the market’s trajectory—so you need compliance solutions that raise red flags for all sorts of eventualities. Here, we discuss the importance of market surveillance as well as some irritatingly common examples.

Market abuse surveillance [the basics]
What you risk without a market abuse surveillance system
What does a market abuse surveillance system monitor for?
Market abuse regulations to know
Tips to protect your firm against market abuse
How Star can help

The basics of market abuse surveillance

Market abuse surveillance refers to the monitoring of financial transactions to detect illegal or otherwise abusive trading behavior such as stock price spikes or sudden changes in trading volume. While financial markets are heavily regulated worldwide, regulations tend to vary by country, so surveillance systems can be fallible if they don’t monitor for a certain regulation. Monitoring and reporting market abuse is an industry requirement, so the need for surveillance is, without question, universal—the primary differences come down to the efficacy of a firm’s surveillance system.

Today’s financial regulators have essentially rendered manual surveillance obsolete to avoid the risk of human error. As the Financial Conduct Authority stated in their Market Watch 69 newsletter in May 2022, it is no longer sufficient to have “generic calibration across (and within) asset classes, where the nature and scale of the metrics involved (e.g. price movement) are significantly different.”

Financial firms are expected to have automated surveillance systems that:

  • Provide a clear, auditable trail for investigators
  • Can perform sophisticated tests powered by machine learning on up to a million daily trades
  • Are appropriately intuitive and user-friendly

While it used to be more common for firms to operate under in-house surveillance systems, the shifting tides of financial regulations make it almost impossible for bespoke, legacy systems to keep up. As regulations become stricter and more complex, the need for third-party, automated surveillance systems grows.

Automated market surveillance software should capture all trade data, test and analyze it against a regulatory rules engine, and escalate any potential anomalies for swift investigation. Without these capabilities, regulated firms risk exposing themselves to devastating financial and disciplinary consequences.

What you risk without a market abuse surveillance system

Just as the regulatory landscape is constantly evolving, so too are the ways in which bad actors can manipulate markets for their own gain. With this evolution also comes the risk that financial regulators could change what constitutes material nonpublic information (MNPI) or a breach of compliance. Without an automated, easy-to-update surveillance system, firms risk any or all of the following:

  • Falling out of compliance with increasingly complex and stringent regulations
  • Becoming the target of ever-more-creative market abuse tactics
  • Drowning under massive volumes of data in need of monitoring

Julia Hoggett, the FCA’s Director of Market Oversight, acknowledged in an October 2020 speech that COVID-19 had a significant impact on the proliferation and manifestation of market abuse (if not necessarily the types of abuse itself). “The manner of surveilling for them must, therefore, also change,” Hoggett said. “It is essential in changing times that firms identify the risks associated with the new environment in which we are all operating.”

Consequences for failing to detect market abuse include:

  • Heavy fines
  • Reputational damage
  • Permanent firm closure
  • Prison time

Since regulations are becoming tighter and more specific and penalties are becoming harsher, the need for equally comprehensive surveillance solutions is necessary for survival in the financial industry.

What does a market abuse surveillance system monitor for?

Billions of electronic records are generated each day by firms across the globe, whether through financial apps, trade transactions, emails, recorded phone calls, and other e-communication channels. Traditionally, firms have had separate market abuse surveillance systems monitoring each one of these channels, which results in a siloed view of daily activity—not ideal for maintaining compliance.

Today’s compliance software solutions are designed to integrate with a firm’s current surveillance systems and provide visibility between discrete channels. This allows separate departments to access and analyze all personal trading, insider trading, and MNPI activity under one umbrella.

Ideally, a surveillance system’s machine learning capabilities should be able to solve for all types of market abuse, from the common to the obscure. The following is a non-exhaustive list of market abuse tactics to be aware of as you vet market abuse surveillance or financial compliance software solutions.

  • Insider trading: Perhaps the most well-known type of market abuse outside of financial circles, insider trading refers to the practice of initiating a trade while in possession of information not yet made public (usually from one’s own company). A surveillance system might raise a red flag if it detects an individual buying or selling stock associated with a company that they are connected to or if that stock is not publicly projected to rise or fall in the near future, or if a trader initiates an uncharacteristic transaction.
  • Shadow trading: A newer, slightly nebulous spin on insider trading, shadow trading involves trading stock in one company while in possession of MNPI regarding another, closely correlated or economically linked company. For example, if a trader has knowledge of an upcoming merger between two pharmaceutical firms, they may trade in the stock of a third pharmaceutical company they predict will be affected. The Securities and Exchange Commission (SEC) has only recently recognized shadow trading as grounds for penalty. Surveillance or personal trading compliance software may enable firms to limit trades by those who specialize in certain sectors, since they are most likely to obtain sector-specific MNPI.
  • Front-running: Front-running is essentially the same as insider trading—trading stock on not-yet-public information—but the broker trades on behalf of a client, rather than for their own company. The same surveillance tools that monitor for insider or personal trading should be able to detect potential cases of front-running.
  • Parking: This occurs when a stock is sold with the understanding that the original owner will buy it back shortly, thereby concealing the stock’s true ownership while maintaining the facade of compliance. Surveillance systems will pick up on this back-and-forth transaction and flag it for review.
  • Cancel and correct: A broker will enter a trade with the intention of selling a security at or below the asking price, then cancel the trade in the hopes that the price will continue to fall. Once the “best ask” price is sufficiently low, the broker will initiate a real trade for the much lower price. The “repeat” trades should trigger a compliance review.
  • Wall crossing: Technically not prohibited, wall crossing is the act of making additional parties aware of MNPI. Before doing so, the party in possession of the MNPI must provide an ironclad reason for sharing it and impose strict confidentiality requirements. The recipient must also consent to being “wall crossed” and confirm that they understand they must not trade until the information is made public. If they do, alarm bells will sound and all parties will be penalized.
  • Market sounding: This involves a trader revealing information (non-public or otherwise) to investors ahead of a proposed trade to gauge their reactions. The trader will then make a decision based on the level of perceived interest. Market abuse surveillance systems can monitor communications between traders and investors to identify any instances of collusion or influence.

Market abuse regulations to know

Financial market regulations are ever-evolving, but the following are particularly pertinent to uncovering and preventing instances of market abuse around the globe.

illustrated table of market abuse regulations to know including SEC Rule 15G

Tips to protect your firm against market abuse

Yes, automated software is critical to maintaining regulatory compliance—but what’s even more important is developing a company-wide culture of compliance. Without an organizational bedrock of good conscience, even the most noble of brokers can be influenced by increasingly subtle market manipulation tactics and the promise of a lucrative payout.

The following are some general tips and best practices for preventing market abuse in your firm.

Stay flexible: When choosing or upgrading your surveillance or compliance software, prepare for sudden increases in alert volume due to more sensitive triggers. Reallocate or cross-train staff as needed to handle the increased volume; be prepared to adjust or recalibrate filters and alerts as needed to reduce alert volumes while still detecting potentially suspicious activity.

Be consistent with your reporting: Report any instances of suspicious activity and consistently evaluate whether they meet the threshold of reasonable suspicion. Even as definitions of unusual activity may change, your reporting process should remain the same.

Ensure equivalent policies for office and remote work: Update policies, provide refreshed training, and establish robust oversight that reflects the new work environment. Pay particular attention to the risks associated with the use of privately owned devices. These policies should be clear and demonstrable to the FCA and firm audit teams.

Foster a strong culture of compliance: Focus on building a culture that minimizes the occurrence of misconduct. In addition to strong policies, emphasize clear conduct expectations for employees, whether they are working in the office or from home. A strong compliance culture is most crucial when risks are high.

Remember that compliance applies to everyone: Not only is compliance with market abuse regulations essential for financial market professionals, but also for those engaged in any kind of personal trading. The significant rise in personal trading accounts during the COVID-19 pandemic has increased the risk of insider trading or misuse of information for personal gain across industries.

Recognize the FCA’s individual account monitoring: Remember that the FCA closely monitors individual accounts. Misusing inside information received during work is a criminal offense. Firms need to make it clear that everyone, at work and at home, has a stake in maintaining clean markets.

Handle inquiries discreetly: Exercise discretion when handling information requests from the FCA. Breaching confidentiality can risk hindering or compromising reviews and investigations into suspected market abuse.

Maintain accurate transaction-reporting data: Consider accurate transaction-reporting data as the ultimate protection for the consumer. Accurate data enables effective market surveillance, facilitates efficient follow-up actions, allows for a comprehensive assessment of market risks, enhances oversight capabilities, and reduces the risk of future market abuse.

Above all, don’t let the increasing complexities of compliance and the risks of market abuse overwhelm your firm.

How Star can help

At StarCompliance, we understand the challenges enterprise firms face in monitoring and managing vast amounts of data while staying on the right side of regulators. That’s why we offer a comprehensive range of services and solutions designed to empower firms with efficient tools to monitor and manage their data and personnel effectively.

Our Insider Trading and Personal Trading solutions are essential components of any market abuse surveillance system, providing compliance teams with the necessary tools to stay informed and in control. With automated screening for employee trades in relation to key market events, Insider Trading enables you to track which employees have access to MNPI and offers insider list management capabilities, centralizing all pertinent project data. Our solution also generates detailed audit records, ensuring you can provide regulators with the necessary documentation.

Using our Personal Trading product, you can streamline the employee personal trading process by providing pre-clearance functionality, granting employees fast and automated approval or denial decisions based on a fully configurable rules engine. You can also establish blackout or restricted lists and apply them to all employees or specific individuals as needed. With easy integrations with your firm’s existing systems, comprehensive surveys of employee records, and thorough analysis of employee trade activity, the Personal Trading product quickly surfaces transaction anomalies or patterns of behavior that may require further investigation.

By choosing Star’s Personal Trading and Insider Trading solutions, you empower your compliance teams to proactively monitor, manage, and mitigate compliance risks, demonstrating your firm’s due diligence and giving you peace of mind.

Corporations & Market Abuse: Why It Needs To Be A Priority
In this free video, two Star subject matter experts explain how you can prevent market abuse in your firm.