SEC Fails to Make Use of Exchanges' Internal Audits

The Securities and Exchange Commission’s investigations into market manipulation and insider trading are thwarted by the fact it fails to make use of exchanges’ internal audits and searches through investigative referrals from exchanges cannot be handled easily on its computer systems, according to a report from the Government Accountability Office. Sen. Charles Grassley (R-Iowa), the ranking Republican on the Senate Finance Committee, requested the report following an investigation his office conducted last year into a foiled up SEC investigation into possible insider trading at Pequot Capital Management.

“It’s a no-brainer that the Commission ought to be at least looking at this information and have a computer system that can spot trends and let investigators to review the data as effectively and efficiently as possible,” Grassley said. “If investigators can’t search the data, it’s like working with one hand tied behind their backs. And it was kind of shocking to know that the SEC doesn’t review the exchanges’ internal audits. That’s inefficiency, and there is no excuse for it.”

The exchanges do not automatically share their audits with the SEC; instead, SEC inspectors must request them when they visit an exchange, typically once a year or even less frequently.

“Given that SROs are entrusted with direct regulation of the securities industry, there is no excuse for them being anything less than completely transparent to the SEC,” Grassley told SEC Chairman Christopher Cox in a letter.

The GAO report, “Opportunities Exist to Improve Oversight of Self-Regulatory Organizations,” also found that whereas exchanges reported five possible trading infractions in 2003, that number ballooned to 190 in 2006.

When these referrals come into the SEC, only the branch chiefs of market surveillance are given access to the data, and, at that, they can only search for stock ticker and date and type of trade—not by a person’s or company’s name. That information is contained in a separate attachment, and, therefore, not searchable online, according to the GAO. Furthermore, referral and case-tracking files are not linked.

Cox, responding to the report in a letter to the GAO, said the Commission will take its recommendations under consideration.