Why Financial Sector Employees are Walking a Thin Line with Personal Securities Transactions

Calls for seamless monitoring of employees’ financial transactions are growing louder and louder. Spectacular cases in securities trading are forcing the financial industry to introduce more intensive control mechanisms.

When it comes to personal securities transactions, financial sector employees often find themselves walking a thin line. Personal securities trading triggered some serious financial scandals – with far-reaching consequences. As a result, many banks and financial institutions have decided it is time to scrutinize their monitoring systems. They are keen to ensure they can detect anomalies at an early stage and keep a meticulous eye on their employees’ personal securities transactions.

Combating Market Abuse and Insider Trading

The EU Market Abuse Regulation (MAR) No. 596/2014 aims to combat insider trading and market manipulation. It is complemented by the Directive on criminal sanctions for insider dealing and market manipulation (Market Abuse Directive = MAD II).

Its objective is to ensure that all investors, depending on their personal risk appetite, should have an opportunity to make investment decisions based on the available information, without other investors taking advantage of their access to information (insider dealing) or sending false signals to mislead the market (market manipulation).

Seamless Monitoring to Detect Insider Dealing

Insiders are people who have access to non-public information about a company’s share price. Article 14 of the Market Abuse Regulation MAR prohibits the following acts:

• Engaging in or attempting to engage in insider dealing
• Recommending that another person engage in insider dealing or induce another person to engage in insider dealing
• Unlawfully disclosing inside information

Detecting insider dealing is no easy task. Relationship managers in banks know when companies are planning to make strategic changes and understand the potential impact on the share price. That’s why they are not usually allowed to trade the financial products of companies that they work with.

On top of this, banks require their employees to report personal share transactions and those of family members, regardless of which bank carried out the trade. This is done via a duplicate detection system. The custodian bank automatically sends information about the securities transaction to the person’s employer. This is designed to prevent employees or their personal contacts from benefiting from the insider knowledge that they gain in the course of their work.

How to Discover and Prevent Fraud in Securities Trading

There is a whole raft of well-known potential fraud scenarios including

• Churning
• Wash Trades
• Pump and Dump / Trash and Cash
• Marking the Close
• Painting the Tape
• Front / Parallel Running
• Snake Trading

The aim of these is to send out misleading signals about the supply, demand or price of a financial instrument.  It is the job of compliance teams to bring all these scenarios under a set of rules, monitor them systematically and update them constantly. And, of course, this is also the job of the software that maps these scenarios, reports violations, and is flexible enough to make on-the-fly adjustments without having to wait for a new release.

Defining Compliance Rules – A Tough Job for Compliance Teams

Compliance officers have to define the rules relating to suspicious employee transactions. This is much harder than it appears at first glance because it usually affects the whole organisation, including all business units and group structures. There is also a great deal of work involved in evaluating data from all securities orders, recording master data and stock exchange data, and dealing with guidelines for employee transactions and the bank’s proprietary trading.

Why Monitoring has to Match the Bank’s Business Model

The bank’s business model is one of the key criteria for monitoring employee transactions. Retail banks have a large customer base with lower financial holdings, whereas private banks tend to have fewer customers but with a higher net worth. As a result, securities trading is governed by different guidelines and thresholds. Compliance teams have to set up the right kind of monitoring for the particular institution, ensure that its performance is adapted to the transaction volume, and maintain complete documentation and historization.

What are the Challenges for IT Departments?

Most banks use a variety of IT systems that have evolved over the years. It is often the case that different business units use different systems, and the information does not all come from the core banking system. It is up to IT to track process chains, decide whether sub-systems should be replaced, and whether critical factors exist due to reliance on external providers, both financially and temporally. Lack of resources also make life difficult for IT departments. Monitoring securities trading is often done via random checks, but this is no longer enough. Today, banks have to urgently consider the use of automation in order to ensure complete and thorough monitoring.

Attracting Unwanted Attention

Deliberate manipulation of share or market prices and insider dealing are criminal offences. According to §119 of Germany’s Securities Trading Act, they are punishable by a fine or imprisonment. Cases like these grab the headlines when they occur in high-profile institutions. However, going beyond this, they can also cause serious reputational damage, incur high legal costs, and lead to temporary or permanent occupational bans of individual persons.

How to Resolve this Problem?

Banks and financial service providers who are considering changing their monitoring systems can get practical tips on the following issues:

1. Covering all business areas and IT systems that are involved in the brokerage and execution of securities transactions.
2. Recording process steps, including order statuses such as withdrawn orders or cancelled settlements.
3. Extensive automation of monitoring and flexibility for fast go-to-market.
4. Ensuring performance based on transaction volume
5. Automating the duplicate detection process for third-party banking transactions.
6. Selecting a suitable provider with strong experience in this field.

Learn more about monitoring scenarios and automation options. You can download the white paper here.