Meet the SEC’s Brainy New Crime Fighters: ‘Quants’ Are Agency’s Latest Weapon Against Financial Misdeeds

http://www.wsj.com/articles/meet-the-secs-brainy-new-crime-fighters-1418601581

Meet the SEC’s Brainy New Crime Fighters: ‘Quants’ Are Agency’s Latest Weapon Against Financial Misdeeds

Lori Walsh, left, chief of the Securities and Exchange Commission Enforcement Division’s Center for Risk and Quantitative Analysis, with Howard Kaplan, a data analyst in the SEC’s enforcement division, in Washington. T.J. KIRKPATRICK FOR THE WALL STREET JOURNAL

SCOTT PATTERSON

Updated Dec. 14, 2014 10:39 p.m. ET

Long outgunned by Wall Street’s legions of Ph.D.s, the Securities and Exchange Commission is arming itself with mathematicians and computer programmers of its own to catch bad market actors.

The question is whether this is an arms race government regulators can hope to win.

The SEC is mustering its mathematical firepower in its Center for Risk and Quantitative Analytics, which was created last year soon after Mary Jo White took charge of the agency to help it get better at catching Wall Street misconduct. The enforcement unit, led by 14-year SEC veteran Lori Walsh, is housed deep within the warrens of the SEC’s Washington headquarters, and staffed by about 10 employees trained in fields such as mathematical finance, economics, accounting and computer programming.

Ms. Walsh says access to new sources of data and new ways of processing the data have been key to finding evidence of wrongdoing. “When you look at data in different ways, you see new things,” she said in an interview.

While SEC investigators have been using computer models for several years to detect fraud, the approach has gained added steam under Ms. White, agency officials say. The regulator, known for its platoons of lawyers with little experience in math or coding, is hiring more employees versed in computer programing and mathematics and pressing the old guard to get up to speed with the new methods, these officials say.

The SEC says the group has identified and referred hundreds of firms and individuals to enforcement investigators for further review. “What would have previously taken us weeks or even months to do now sometimes takes minutes or hours,” SEC enforcement chief Andrew Ceresney said in an interview.

But SEC critics remain skeptical. The agency has long been seen as lacking sophistication in emerging technologies.

Recent revelations by a pair of academic groups that the SEC’s own system for delivering news favors rapid-fire traders, as reported by The Wall Street Journal, has added to the agency’s reputation for being behind the curve.

Moreover, the unit’s methods remain unproven by some measures. No investigations spurred by its findings have led to a successful enforcement case, and it remains unclear whether enforcement officials are widely embracing the leads it generates. SEC officials say it often takes years for investigations to reach a conclusion.

And Wall Street firms, for their part, are able to offer quantitative analysts—or “quants”—far higher pay packages than the regulator. The SEC’s access to market data also remains limited. In 2012, it approved a massive new computer system to track markets, known as the Consolidated Audit Trail, but the system isn’t likely to come online for several years, experts say.

But other troves of computerized data are becoming more available, such as bank-account data, digitized regulatory filings and new submissions required by the 2010 Dodd-Frank financial overhaul, SEC officials say. They add that the unit’s quantitative approach, plus the explosion of new data provided by computerized markets and digital filings by public companies, have made them more able than ever before to sniff out fraud and other financial crimes.

The origins of Ms. Walsh’s unit date to the revelations in late 2008 and 2009 that the SEC had for years missed multiple tips that Bernard Madoff had been stealing from investors in his hedge fund. As part of a broader restructuring of the enforcement unit, the SEC in 2010 created the Office of Market Intelligence to screen tips and other information for enforcement cases. Ms. Walsh, who holds a doctorate in financial economics from Pennsylvania State University, briefly led the unit in 2012.

In July 2013, she took charge of the Center for Risk and Quantitative Analytics, which began with three employees. Funded in part by a $50 million technology reserve fund established by the Dodd-Frank financial legislation, it has been looking into everything from accounting fraud to insider trading to scams in the Jumpstart Our Business Startups Act, a 2012 law passed by Congress that loosens restrictions on how small firms can raise cash.

Ms. Walsh’s group has built a database of trades from small-stock pump-and-dump schemes the SEC has prosecuted in the past in order to find patterns that can help them uncover new schemes. It also tracks the performance of hedge funds and ties them to underlying holdings at the funds, looking for whether managers are accurately reporting performance results.

The unit is developing new methods to get financial data, Ms. Walsh says. Big banks used to report a great deal of data, such as bank-account holdings, in hard copy. In recent months, members of Ms. Walsh’s group have been pressuring banks to supply the data in computer-readable format. That can make it easier to detect frauds such as Ponzi schemes, SEC officials say, since it lets investigators track cash flows and see whether firms are actually investing the cash.

 

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