Insider Trading Detection: FINRA’s Vital Role in Ensuring Market Integrity

Every day, FINRA's Insider Trading Detection Program uses sophisticated technology and analytics to monitor 100% of trading in stocks, options and bonds for potentially suspicious activity around material news events, resulting in hundreds of referrals to the SEC and law enforcement every year. 

On this episode, we hear from Sam Draddy, a Senior Vice President of the Market Abuse Unit within FINRA's Market Regulation and Transparency Services, and Karen Braine, Vice President of the Insider Trading Detection Program, about how they connect trading data, information from public sources and from companies and FINRA firms to pull together actionable intelligence. 

Resources mentioned in this episode:

Episode 23: Insider Trading: Finding the Needle in the Haystack

Blog: FINRA Plays a Vital Role in Exposing Insider Trading

SEC Litigation Release: Sean R. Steward et al.

SEC Litigation Release: Andreas Bechtolsheim

SEC Litigation Release: Joseph C. Lewis et al.

Listen and subscribe to our podcast on Apple Podcasts, Google Podcasts, Spotify or wherever you listen to your podcasts. Below is a transcript of the episode. Transcripts are generated using a combination of speech recognition software and human editors and may contain errors. Please check the corresponding audio before quoting in print. 
 

FULL TRANSCRIPT 

00:00 - 00:30

Kaitlyn Kiernan: Every day, FINRA's Insider Trading Detection Program uses sophisticated technology and analytics to monitor 100% of trading in stocks, options and bonds, for potentially suspicious activity around material news events, resulting in hundreds of referrals to the SEC and law enforcement every year. On this episode, we hear from two leaders of the program about how they connect trading data, information from public sources and from companies and FINRA firms to pull together actionable intelligence. 

00:30 – 00:39

Intro Music

00:39 - 01:08

Kaitlyn Kiernan: Welcome to FINRA Unscripted. I'm your host, Kaitlyn Kiernan. I'm excited to welcome two guests to today's show to talk about a topic that is hard not to find fascinating and that's insider trading. Joining me today are Sam Draddy, a Senior Vice President of the Market Abuse Unit within FINRA's Market Regulation and Transparency Services. Also joining me is Karen Braine, a Vice President on Sam's team focusing on insider trading detection. Sam and Karen, thanks for joining me. 

01:08 - 01:09

Sam Draddy: Thanks for having us, Kaitlyn. 

01:09 - 01:10

Karen Braine: Thank you. 

01:10 - 01:24

Kaitlyn Kiernan: So, to start off, can you both introduce yourselves and share a bit about your background and your role at FINRA? Sam, how about you start? You've been with us on the show before, but now you are in a little bit of a new place at FINRA. 

01:24 - 02:10

Sam Draddy: I am, and thank you again for having me, Kaitlyn. It's good to be back. So, my current position, as you noted, is the head of Market Abuse within the Market Regulation Transparency Services department. And it is a new area we recently integrated from our prior role in Member Supervision over to this team. I started my career as a FINRA registered rep many, many moons ago as a Series 7 rep and then moved over to be a criminal prosecutor in the Baltimore County State's Attorney's Office for Maryland. And from there, I combined my financial and criminal background and litigation background and worked at the SEC for seven years in the Division of Enforcement. And then I've been here at FINRA for 17 years working in the insider trading fraud world. And again, I'm thrilled to be here today. 

02:11 - 02:15

Kaitlyn Kiernan: Great. Thanks, Sam. And how about you, Karen? You are joining us for the first time today. 

02:15 - 02:52

Karen Braine: Yes, I am. Thank you for having me. I lead the Insider Trading and Front Running programs at FINRA. We total about 65 staff, including dedicated investigators whose sole role it is to investigate potential insider trading and a really stellar management team. So, I started my career in finance, in the back office of a mutual fund. I obtained a couple of FINRA licenses and developed an interest in the regulation of the industry. I've been with the Insider Trading program also about 17 years. Like Sam, I started as an investigator and I've served in several leadership roles over the years. 

02:52 - 03:01

Kaitlyn Kiernan: Thanks, Karen. And at the highest level, what is insider trading and what's FINRA's role when it comes to detecting this conduct? 

03:02 - 03:35

Karen Braine: Insider trading, at its core, is the use of material, nonpublic information to trade in the securities of a company prior to a material market-moving news event. FINRA is contracted by the U.S securities exchanges to surveil their markets for potential insider trading. We cover 100% of the U.S marketplace in stocks, bonds, options and other securities derivatives. We conduct hundreds of insider trading investigations a year, which last year resulted in more than 450 referrals to the SEC and other regulators. 

03:36 - 03:41

Kaitlyn Kiernan: And why is FINRA so well positioned to detect this activity? 

03:41 - 04:24

Karen Braine: FINRA is uniquely positioned to detect insider trading because of our cross-market view of trading activity. We have the ability to see trades no matter where they're placed or executed, giving us a complete picture of what's happening in the market. We have a robust insider trading program and the depth, the diversity and the expertise of our investigative staff. In addition, we have strong partnerships with other regulators, including the SEC, criminal authorities and foreign regulators. And finally, we have amazing technology and data analytics partnerships within FINRA that yield innovative solutions to the challenges to detecting and investigating the activity of what can be some very creative bad actors. 

04:25 - 04:44

Kaitlyn Kiernan: Sam, when we last talked to you on this podcast back in 2018 on Episode 23, the Insider Trading Detection Program was part of its own group with a mouthful of an acronym. Then it moved to Member Supervision and now it's over with Market Regulation in the Surveillance and Market Intelligence Team. Can you tell us why all these changes? 

04:45 - 06:30

Sam Draddy: I'll go all the way back to 2007, when we actually started off in Market Regulation, so, we've come full circle over the last 15 years or so. And the reason why we initially moved out of Market Regulation is because we formed our own department after the Madoff and Stanford scandals and the financial world completely changed, and the regulation of the markets changed because of those scandals. And we became part of the Office of Fraud Detection and Market Intelligence within FINRA, where all the fraud matters that came through the organization, including exam findings, surveillance tips and complaints, were all run through the Office of Fraud Detection and Market Intelligence, and that included the Insider Trading team. 

Then we had some reorganization, became part of Member Supervision about four years ago, which actually turned out to be a huge bonus because we were immersed with our exam program. We found many ways of collaborating, sharing, regulatory intelligence that had never existed before with our exam program. And it was a tremendous experience that will make us, really, a better organization moving forward. 

And then fast forward to September of last year, where, as we said before, we turned our roots back to market regulation. And really, this is our true home – to be housed with all the other surveillance teams, including all of the manipulation teams, makes perfect sense. We have access, as Karen noted, to incredible partners and technology, particularly teams like the Surveillance and Optimization team, which works with our surveillance patterns, our Trading and Analytics team that we partner with on data analytics, and an incredible technology team that provides us product and technical support on all of our tools and surveillances. So, collectively, our Market Regulation and Transparency Service department now covers the entire waterfront of surveillance for just about every potential trading scenario for the U.S markets. 

06:30 - 06:48

Kaitlyn Kiernan: So, you mentioned data and analytics. And Karen, before you mentioned that FINRA has top notch technology. So, this has always been at the heart of the Insider Trading Detection Program but how has FINRA's use of technology in this space evolved in recent years? 

06:48 - 07:15

Karen Braine: Put simply, we're analyzing more data faster, and we're using that data in more innovative ways to make connections between insiders at companies and traders in that company securities prior to a material news event. We continuously add external data sources and enrich internal data sources to make the most use of intelligence that is produced by FINRA's regulatory and examination programs. 

07:16 - 07:24

Kaitlyn Kiernan: And Sam has CAT, the Consolidated Audit Trail, has that had any impact on FINRA's ability to detect potentially suspicious activity? 

07:25 - 08:30

Sam Draddy: Yes, Kaitlyn, it's had a very significant impact. In fact, the Consolidated Audit Trail, or as you call it, CAT, has a number of attributes that our prior to trading data sets don't have. First, it has the full lifecycle of an order, which is incredibly important in conducting investigations in this area, particularly insider trading. It provides a wider view of trading across securities other than the trade data that we previously used. It's not confined to review period limits that we normally need to request trade data from our member firms. 

And really, most importantly, its speed. CAT is near real time so we can uncover suspicious trades in an incredibly expedited manner. And all of these attributes of CAT taken together mean we have a more enhanced ability to uncover suspicious trading that we might not otherwise have been able to detect. So, for example, this allows us a greater ability to detect spoofing, layering, match trading and marking scenarios that are taking place over extended periods of time in different securities. And for purposes of this podcast, the use of CAT will also help us identify potential insider trading much more rapidly as well. 

08:31 - 08:44

Kaitlyn Kiernan: And so, Karen had already mentioned that in 2023, FINRA referred more than 450 insider trading cases. Why do we refer these matters and not bring the cases ourselves? 

08:45 - 09:55

Sam Draddy: Well, first, we actually do refer matters internally at FINRA and that is traditionally to FINRA Enforcement, but now we have a Market Investigations team within our Market Regulation and Transparency Services area that we do refer conduct to. If a firm or registered rep is engaged in some form of insider trading, we will pursue that internally at FINRA. Sometimes that could even involve a firm customer trading on material nonpublic information, and that in turn might lead to a supervision case against a firm, which again would be brought by FINRA. But as you know, the vast majority of the insider trading cases end up as referrals to the SEC and also to the FBI and the Department of Justice. And there are a few reasons for this. First, we have delegated authority by the SEC as our regulator to conduct this type of work. Second, we have contractual agreements with all of the U.S equity and options exchanges to perform this insider trading, surveillance and investigative work on their behalf. But finally, and most importantly, the mandate of FINRA is to protect investors. And I can think of no regulatory work more important than uncovering, pursuing and referring insider traders for prosecution, to protect investors, and to protect the integrity of the markets.

09:56 - 10:04

Kaitlyn Kiernan: And Karen, when your team refers a case, how much information are you providing? How much groundwork goes in before that referral is made? 

10:05 - 11:22

Karen Braine: Well, to start, insider trading investigations can take anywhere from six to eight months or so. We produce quite a comprehensive document that can range between 10 and 30 pages. 

As part of our investigative process, we collect a tremendous amount of data from multiple sources and use that information to form connections between traders and the stock leading up to a news announcement and people who had material, nonpublic information about that market moving news event prior to its public disclosure. We distill the millions of trades that can occur surrounding the news event into the most suspicious accounts. We investigate the traders and then conduct even more analysis to determine whether the trading is potential insider trading, and then who has jurisdiction over the activity. 

Our referrals include extensive background on the traders who are trading suspiciously, how they might be connected to someone with material nonpublic information, and a complete analysis of the individual or entity's trading patterns and activity leading into the subject news. To find a potential source of material nonpublic information, we use data collected during the investigative process. We use social media and geographic proximity analytics, to name just a few of the tools that we use. 

11:23 - 11:40

Kaitlyn Kiernan: Sounds like a substantial amount of information that you're sharing. And I believe there's a recent trend that's emerged in insider trading involving what's called shadow trading. Can you tell us what shadow trading is and what the current state of the law is with regard to shadow trading? 

11:41 - 13:24

Karen Braine: Sure. Shadow trading is when an individual obtains material, nonpublic information about a company, and instead of trading in the securities of that company prior to a material market moving news announcement, trades in the securities of a different economically linked or comparable company. By that I mean a company that's considered to move with the same market forces – a direct or indirect competitor, a supplier or a purchaser, for example. 

Recently, the SEC received a very favorable ruling in a case involving shadow trading by an individual named Matthew Panuwat. He was an executive of a publicly traded company who had material, nonpublic information about a pending acquisition of his company. Instead of trading in the securities of his own company that was about to be acquired, he purchased a very large, bullish options position in another economically linked company that stood to increase in value after the acquisition of his company. After the acquisition was announced, he profited over $100,000 from his trades prior to the announcement. 

The court said that it was reasonable to infer that other companies that had unsuccessfully attempted to acquire the executive's company would turn their attention to other economically linked companies after losing out to the ultimate acquirer. And more broadly, the court endorsed the SEC's argument that information regarding business decisions by a supplier or a purchaser or a peer can have impact on a company and are in fact material. So, that's a potentially far-reaching endorsement by the court of shadow trading as insider trading. 

13:24 - 13:48

Kaitlyn Kiernan: That's really interesting to note. So, in a recent blog post, which I'll share the link to on FINRA's website about the Insider Trading Detection Program, you noted that the very existence of a FINRA insider trading investigation can be enough to generate actionable intelligence. Can you tell me more about a case where that's true? 

13:48 - 15:39

Sam Draddy: Sure. And actually, I'll talk about the case that was in the blog post, which involves a case that was just brought by the SEC last month. And the case involved an individual by the name of Tyler Loudon, who stole material, nonpublic information from his wife while they were both working remotely from home. Loudon's wife was a mergers and acquisition attorney for BP, which is the large oil and gas company, and she was working on a merger deal between BP and Travel Centers of America. 

So, during her time working on the deal at home, Loudon overheard his wife's phone conversations and even had some conversations directly with his wife about some aspects of the deal, with his wife, of course, assuming these conversations were confidential. What his wife didn't know was that Loudon used the material, nonpublic information he stole from her, to purchase 46,000 shares of Travel Center stock ahead of the public announcement, and ultimately made $1.76 million upon the announcement of the BP-Travel Center's deal. 

FINRA sent a request for information to BP about Loudon's wife's role in the deal, and then Loudon's wife confronted her husband about why FINRA would be inquiring about her work on the deal. According to the SEC complaint, at that point, Loudon immediately confessed to his wife about his trading, and then Loudon told his wife that he purchased the Travel America shares because he wanted to make enough money so that she did not have to work long hours anymore. 

Now, as you can imagine, the helping with the long hours excuse didn't play terribly well, as Loudon's wife moved out of the house almost immediately and divorced him a short time later. But the larger point is that FINRA requests have often been the source of tremendous regulatory intelligence and evidence for the SEC and criminal authorities because it uncovers people's motivations, their communications, and many times they're outright lies, which can all be powerful evidence in insider trading cases. 

15:39 - 16:04

Kaitlyn Kiernan: It generates not just actionable intelligence, but I think from our last episode together, Sam, it seems like it can also generate a fair bit of marital strife in these cases. So, everyone's favorite part of our last episode together was sharing some of the dumbest things people have done in an attempt to get away with insider trading. What stories do you have that stand out in your mind in terms of what people do to try to get away with this? 

16:05 - 19:41

Sam Draddy: Cases where a lack of sense prevailed? I'll go with an older case first and then a couple of newer matters. One case that falls under both one of the dumbest things people have done in insider trading investigations and to your prior question, Kaitlyn, which also demonstrated how the existence of a FINRA investigation generated actionable regulatory intelligence is the Sean Stewart case. 

And this is going back a few years but in that matter, Sean Stewart worked for J.P. Morgan as a managing director. He tipped his father, Robert Stewart, about a deal J.P. Morgan was working on. Then Sean Stewart became aware that FINRA was investigating his father's trading in that deal because of a request that we sent to J.P. Morgan. And J.P. Morgan, in turn confronted Sean Stewart about the FINRA inquiry and his father's trading, and Stewart claimed his father made the decision independently to invest in the stock, and Sean Stewart at that point thought he had covered his tracks. But quite frankly, we don't go away that easily. 

So, Sean Stewart then moved to another firm and continued to tip his father on three additional merger and acquisition deals even after knowing about the FINRA investigation. And the only differences this time was that they had a friend of Sean Stewart's father place the trades instead of the father himself, and his father and his father's friend ultimately made about $1 million in profits on those three deals. But what Sean Stewart didn't know was that the FINRA investigation triggered both SEC and FBI investigations, during which the friend of Sean Stewart's father, who was conducting the trading, became a government witness and wore a wire. And out of those wire conversations came a line I'll never forget. And that became a centerpiece of the criminal case. Sean Stewart's father told his friend on the wire that his son got angry because there was at least one tip his son gave him that the father did not trade on, and Sean said to his father, and I quote from the complaint, "I can't believe it. I handed you this on a silver platter and you didn't invest." Now, Sean Stewart ultimately was found guilty on insider trading charges, and he has since served two years in prison but this will forever be known as the Silver Platter case. 

Now, more recently, there was a case where an analyst at Goldman Sachs was tipping his friend about merger and acquisition deals through an Xbox video chat feature. But I guess this is our modern-day form of passing material, nonpublic information. And I'm not sure if this was just dumb or juvenile or both, but between their Call of Duty and Madden NFL games, their insider trading discussions on Xbox turned out to be their undoing and both have recently pled guilty to criminal insider trading charges. 

And finally, there are two insider trading matters that are fairly recent that have really bugged me because they defy explanation and both involve billionaires. So, the first involves a guy named Joe Lewis, who was worth about $6 billion and who owned Tottenham Hotspur, for all of you European soccer fans listening out there, but Lewis also owned a huge investment firm, and he had access to large amounts of insider information throughout his career. And so, according to the insider trading charges brought against him last year, he made the decision to tip his girlfriend, numerous other friends, and his two private pilots over an eight-year period about a lot of material, nonpublic information he had access to through his investment firm from the years 2013 through 2021. 

Now my question is if you're worth $6 billion and you have enough money to even have not one but two private pilots, why in the world would you give them insider tips when you can actually just tip them with your own money, literally?

19:41 - 19:48

Kaitlyn Kiernan: Yeah, a holiday gift would probably be much appreciated for everyone involved when there's not criminal implications to it. 

19:48 - 21:10

Sam Draddy: Yes, it keeps everyone out of jail as well. The other billionaire case, I'll call it, involves the original investor in Google who's named Andreas Bechtolsheim, who is actually worth $16 billion. So, he far outpaces Mr. Lewis. Now, Mr. Bechtolsheim was the head of a company called Arista Networks. And one day he got a phone call from a colleague at another tech company who wanted Bechtolsheim's advice about making an offer to acquire a tech company called Acacia Networks. 

Now, after Mr. Bechtolsheim offered his advice, he got off the phone and immediately purchased out of the money call options in Acacia in the accounts of a close relative and an associate, and the accounts ended up making in total, $415,000, which is a lot of money, but which, according to a New York Times article, was for Bechtolsheim, literally like a quarter rolling behind the couch. Now, both Lewis and Bechtolsheim have settled their cases, but the larger point here is that these cases really highlight the ultimate forms of greed and arrogance, but are also, quite frankly, as dumb as it gets, and is the type of case that I know motivates me and the entire FINRA Insider Trading team to pursue insider traders every day, no matter how rich and powerful and quite frankly, how dumb these people may be. 

21:10 - 21:38

Kaitlyn Kiernan: Yeah, I had to do a little bit of math there, and the earnings off that instance of insider trading is about 0.002% of his net worth. So, he probably makes that amount and interest in his accounts in a day. So, that really is mind boggling. Now just to wrap up, if folks were to walk away remembering just one thing about FINRA's Insider Trading Detection program from this podcast, what would you hope it would be? 

21:38 - 22:33

Sam Draddy: There's a lot of things I could talk about with FINRA's Insider Trading Program for days on end, but I want everyone to know that we are extremely aware of FINRA's core mission of protecting investors and preserving the integrity of the markets, and the Insider Trading Detection Team lives that mantra every single day. 

Karen noted earlier, this team has vast amounts of experience and expertise. They are passionate, determined and vigilant about detecting and pursuing insider traders in the U.S marketplace. They also work with the most cutting edge, sophisticated surveillance and investigative tools and technology and leverage that in conducting analytics across vast amounts of data that literally cover every trade made every single day in the U.S. Markets. So, if there's one thing I want folks to walk away with from this podcast, is that this team will not let you get away with insider trading in the U.S markets. And for all of you law abiding, hardworking American investors listening, you can trade on that. 

22:34 - 23:00

Kaitlyn Kiernan: Great. Well, Karen and Sam, thank you so much for joining me to provide an update on FINRA's Insider Trading Detection Program. That's it for today's episode, listeners. If you don't already, be sure to subscribe to FINRA Unscripted wherever you listen to podcasts to stay up to date on all of our latest episodes. Today's episode was produced by me, Kaitlyn Kiernan, coordinated by Hannah Krobock and edited and engineered by John Williams. Until next time. 

23:00 – 23:06

Outro Music

23:06 - 23:33

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