How the SEC is using Data Analytics to find fraud

In the wake of the Bernard Madoff’s $17 billion Ponzi scheme scandal, many observers questioned the ability of the SEC to detect and deter fraud. Little did many of the observers know that the SEC had started the long task of trying to implement a computer based system that would try to identify fraud. One of these systems is based on digital submission of financial documents submitted to the SEC.

The first phase of the process was a three year implementation of a standardized document format called the extensible business reporting language (XBRL). The process was started in 2009 and was completed in 2011. This makes the data available to computers that may track possible fraud digitally. The SEC is using a specially designed program called aberrational performance inquiry, or API.

API looks at the returns from investments and attempts to find anomalies. An invest that makes consistent returns or that has above market returns could be an indication of potential fraud.  There are also risk factors that would be an alert of potential fraud like the auditor of the investments changing to frequently, frequently having trouble meeting filing deadlines, or the return of a fund not matching the stated strategy of the fund. Once a fund has been identified by the computers, a team of auditors reviews the paperwork to determine if the initiating factors can be explained. If they cannot, the team will recomend that a formal investigation be started.

The SEC has also purchased the rights to a software package called Market Information Data Analytics System (Midas) from Tradeworx that they plan to use to track real time trading for fraud. Tradeworx is a company that specializes in high frequency trading. High frequency trading is a type of stock market trading that uses super computers and advanced modeling software to trade stocks than would be possible for a human. High frequency trading looks at making trades in the terms of milliseconds. The SEC will use Midas to combine the strategies of aberrational performance inquiry and algorithms developed by high-speed traders to monitor real-time activity in the stock market.

It should also be noted that in the wake of the Madoff scandal the SEC has stepped up its emphasis on rewarding whistle blowers with the new Whistle Blower Office.

Source: http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2013/CPA/Mar/FraudEarlier.jsp