Hacking + Securities Fraud = New Face Of Insider Trading – Analysis


By Ajey Lele and Munish Sharma*

An important indictor to judge a country’s financial health is the behaviour of the Stock Market Index. All over the world, investors in stock markets trade on the basis of both analysis and speculation. On many occasions stock prices fluctuate in a matter of seconds, involving enormous financial transactions. Individual stock prices are influenced by information released by publicly listed companies about their business plans, deals, mergers and acquisitions or balance sheets. Many brokers are keen to acquire information about a company’s profile well in advance before it is made available officially. This helps them earn profit by trading appropriately and for making investment decisions. Some people do use unfair practices (such as insider trading) to acquire such knowledge in advance. The present generation of stock market operations is fully IT enabled. In this digital era, critical information traverses through various computing resources and communication channels, processed, stored or disseminated both internally and externally. In one technically savvy insider trading practice, an amalgamation of hackers and fraudsters has startled the U.S. Securities and Exchange Commission. Hackers were able to gain access to the release data on the servers of distributors such as Business Wire, Marketwired and PR Newswire. Equipped with this information, a little ahead of the time it went public, investors traded on stocks and made extraordinary profits.

As a business practice, third party financial wires facilitate corporate communication such as press release and regulatory disclosure to discrete audience – media, financial markets, regulatory disclosure systems, investors and websites. This information is time-critical and strategic. In the above mentioned case of securities fraud, hackers gained access to the servers and passed on the news releases to their affiliates operating out of the United States and Ukraine. This enabled the latter to trade in the stocks of Boeing, Hewlett-Packard, Caterpillar, Oracle, etc. According to news reports, U.S. authorities have already charged 32 members of an alleged international hacking and insider trading ring. The possibility of a malware on the servers of financial wires providers cannot be ruled out. It is quite evident that securities frauds in the form of insider trading have percolated into the cyber realm.

Last year, the enterprise security firm FireEye unveiled an advanced hackers’ syndicate, named as FIN4, which targeted the email correspondence of top executives and advisors of large pharmaceutical and financial companies. Since a lot of information exchanges take place through email, the hacker group specifically targeted email accounts to get business information that could be leveraged to trade in stocks. Given the fact that email systems are used extensively by executives and the extent of known human or system vulnerabilities, information remains susceptible to unauthorised access. A large syndicate of hackers and stock market brokers or hedge fund managers can collude to manipulate both national and international stock markets.

Financial markets are heavily dependent on information technology for operations, transactions and analytics. Moreover, enormous amount of critical information traverses over the servers facilitating email systems and the financial wires, both of which are vulnerable to hacking or unauthorised access due to vast numbers of users. There are stringent regulatory mechanisms, such as disclosures, surveillance, wiretap, call detail record access and aggregator software to crack down on insider trading. But, the two instances cited above indicate a quantum change in the modus operandi of stock market fraudsters, which renders most of the mechanisms ineffective. The insider trading practice need not rest upon individuals to divulge information, either deliberate or imprudent. A hack into the email account of a top executive through a spam or a malware on the servers of financial wire service providers can simply circumvent traditional ways and means to contain insider trading. Fraudsters have moved leaps ahead of regulators who still depend upon conventional apparatus.

The Securities and Exchange Board of India (SEBI), the stock market watchdog and regulator, has mechanisms in place to prevent and control insider trading in India. The long awaited Prohibition of Insider Trading Regulations of SEBI was notified in January 2015, replacing the old insider trading norms. Now, SEBI has been granted access to Call Details Records, although it cannot wiretap or conduct surveillance. The technological prowess of hackers has outpaced the detection mechanisms and preparedness of regulators, having grave implications for Indian stock markets as well.

The new incarnation of insider trading falls outside the regulator’s perimeter, and even corporations or their employees might not be aware of information theft. Such instances would become legally challenging to determine liability or penalty. Despite various monitoring and preventive measures, stock markets have always been prone to frauds. It is taxing for the regulator to be vigilant and detect any sort of malpractice at an early stage. To add to the woes of regulators, hacker groups have turned their attention to stock markets, and this time, not just to disrupt operations but to trade and make financial gains.

Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.

Originally published by Institute for Defence Studies and Analyses (www.idsa.in) at http://idsa.in/idsacomments/HackingSecuritiesFraudNewFaceofInsiderTrading_alele_020915.html

Manohar Parrikar Institute for Defence Studies and Analyses (MP-IDSA)

The Manohar Parrikar Institute for Defence Studies and Analyses (MP-IDSA), is a non-partisan, autonomous body dedicated to objective research and policy relevant studies on all aspects of defence and security. Its mission is to promote national and international security through the generation and dissemination of knowledge on defence and security-related issues. The Manohar Parrikar Institute for Defence Studies and Analyses (MP-IDSA) was formerly named The Institute for Defence Studies and Analyses (IDSA).

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