In 2018, the World Economic Forum released data that highlighted fraud and financial crime as a trillion-dollar industry. Two years later, analysts are citing $3.5 Trillion as the current cost of financial crimes. Throughout the history of market fraud, corrupt actors have made history by finding loopholes to exploit so that they can amass great wealth, illicitly acquired through market abuses such as front running, spoofing, layering, insider trading, and more.
Technology is a double-edged sword: bad actors are using technology to circumnavigate the advanced fraud-detection technology that’s been developed to thwart such efforts.
How does front running work?
With great cleverness and cunning, these fraudsters continue to find ways to camouflage their market abuse, often using technology to aid and enable their crimes. Somehow, these financial criminals are seemingly always one step ahead of those who are tasked with safeguarding money and the markets. Not only do they have intimate knowledge of pending transactions that could affect market value, they also have intimate knowledge of how the surveillance technology that is monitoring them works. Hence, they can concoct schemes to operate outside of the surveillance technology. Of course, the selective application of technology can work both ways, which highlights the twisted irony in the story of technology as it relates to market abuse, front running in particular.
Front running is an illegal form of market manipulation. The fraud is enabled via insider trading and is prosecuted on the grounds of affording the perpetrator with “an unfair advantage.” The typical flow of front running generally follows these steps:
1) a client initiates a large stock purchase request;
2) the broker transacting the purchase executes his/her own order (“front running” the client);
3) the broker then executes the client’s purchase;
4) the stock price goes up;
5) the broker profits from the sale of his/her stock purchase.
Smartphones are a problem
Today, there are more than 5 billion mobile phone users. With dozens of providers now offering “burner phones,” which provide the user with a temporary, unidentifiable number that cannot be traced back to the owner, front running is becoming even more difficult to track. A quick call or text exchange on WhatsApp with a burner phone circumvents surveilled communications and enables the exchange of critical information to enable a front-running crime – without the risk of being caught.
Comparatively, in-house communication systems aren’t wholly effective either. Bloated, proprietary in-house communication solutions have high rates of dissatisfaction and low rates of adoption. This is driving users to independently seek new channels for communication via their personal smartphones, third-party apps and solutions like WhatsApp and the growing number of imitators. The need to monitor and extract relevant insights from the ever-expanding number of external data sources, particularly eComms, is becoming more important while simultaneously becoming more challenging to do so.
For the most part, the technology is available. However, it just can’t be applied ubiquitously and automatically. At least not yet.
Technology is only part of the solution
Today, anyone with internet access or a mobile phone can engage in front running. These technologies are now broadly available to just about everyone around the planet. Analysts who have prior information about a pending investment recommendation upgrade or employees who hear about a pending large deal. For example, they may observe a certain company name mentioned on Slack or other internal eComms channels. And hence, they are positioned to enact front running crimes.
Sending a “stock tip” is surprisingly easy to do, despite increased surveillance and advanced technologies. Police and regulatory agencies are increasingly using technology to monitor civilians as well as commercial brokers, but citizen watchdog efforts and ethics boards are challenging broad access. Apple is notoriously upheld as a champion of privacy, even if the mobile phone holder is accused, or convicted of heinous acts of terrorism and other crimes. Identify theft and crypto-mining are, perhaps, the most notable examples of technology-enabled financial crimes. However, front running, which is a common form of insider trading, will be the theme of the examples featured here.
Recent cases of front running
Ironically, the same technology used to perpetrate these financial crimes can also be used to thwart them and to escape prosecution. The latter is best exemplified by Barclay’s trader, Robert Bogucki, who was allegedly front running by devaluing the HP options that he was trading to drive up his own monetary gains and that of Barclays, the firm that employed him. In the Spring of 2019, the jury was presented with volumes of conversations and transcripts collected from instant chats and emails. Bogucki’s legal team argued that the messages, often as profane as they were banal, were taken out of context. The jury agreed and Bogucki was acquitted.
In 2013, Daniel Bergin, a trader at Cushing MLP Asset Management, was using his wife’s accounts to shield his front running of hundreds of trades. His illicit profits reportedly topped $1.7 Million. Bergin’s wife had a different surname and he failed to disclose her accounts to SEC examiners and allegedly masterminded the scheme through in-person conversations with his wife which were untraceable.
In 2011, Mark Johnson was HSBC’s former global head of foreign-exchange cash trading. He abused his position to create more than $7.3 Million in profits for the bank by front running a large trade issued by one of the bank’s clients. It took a while to detect and prosecute the market abuse, but Johnson was eventually charged and sentenced to two years in prison in April 2018. Around that same time, HSBC was fined $175 Million by the U.S. Federal Reserve for failing to address its traders’ misuse of confidential customer information, and their use of chatrooms to communicate their trading positions with competitors. Johnson has since appealed his case – and lost.
Back in 2010-2013, Credit Suisse was designing algorithms to trade ahead of clients’ limit and stop-loss orders, essentially advocating front running practices towards the goal of generating $2 million in profits. In 2012, a Credit Suisse trader and her foreign exchange counterparts were apprehended for the content captured in their IM chat as they conspired to drive down the price of the Euro/Yen trade. One of the conspirators was concerned enough to text, “smlls [sic] unethical haha” while another texted, “if custy [sic] every found [sic] out we both dead.”
The fox is guarding the henhouse
There’s a bit of a conundrum within the field of market abuse surveillance and how front running is monitored. Financial institutions require that brokers sign contracts which stipulate their conversations will be monitored but employers are challenged to tightly define and walk the delicate line between proactive monitoring and privacy, particularly when it comes to eComms. Employers are also required to show “substantial evidence” to indicate probable cause before a forensic audit to be approved but in order to do so, they run the risk of violating personal privacy for which they are liable.
This issue is particularly acute within the niche of eComms as new modalities are now appearing regularly while regulations, market fraud monitoring systems’ technology and company policies are lagging behind these innovations. Technology, however, is becoming increasingly sophisticated at spotting market abuse by monitoring such things as spikes in e-communication between suspected fraudsters which suggests an opportunity for front running.
And, it becomes a matter of how current the technology is regarding the likelihood of detecting, reporting and successfully prosecuting the front runners. Three critical questions stand out:
- How can financial institutions and law firms be expected to monitor communications that are happening outside of the infrastructure they have developed and routinely monitor?
- How can financial institutions be held responsible for not doing so?
- And, how good is your technology at detecting front running?