February 05, 2013

The SEC has had a pretty good run of winning convictions for insider trading cases over the past couple of years. Since 2009 the SEC has netted about 70 insider trading convictions, including Raj Rajaratnam and Rajat K. Gupta who are probably the most famous, or now infamous, recent convicts.

And the SEC isn't slowing down. Mathew Martoma, a former portfolio manager at SAC Capital, is accused of receiving insider information to make trades that made SAC Capital $276 million in profits, dwarfing the $63 million Rajaratnam made from his insider trading scheme.

However, while insider trading cases make for good publicity for the SEC -- following a time when they missed some pretty large (ok enormous) ponzi schemes (Madoff) -- investors are worried about a lot more than a few dishonest traders using insider information.

Video: Will Mary Jo White Improve Policing of Electronic Markets?

Broadly, it seems that many investors are concerned about the fragmented and fragile equities market structure in the United States. Too often have technology glitches caused wild swings or losses. These technology errors, including the 2010 Flash Crash, the Facebook IPO debacle and the scuttling of the BATS Exchange IPO, have raised serious questions about how the markets operate.

Each day, traders are reporting strange blips, hiccups and mini flash crashes in individual stocks. Many times the cause is as simple as a balky data feed, or an exchange that had a problem with a matching engine. Other times, some investors suspect algo-fueled conspiracies that flood specific stocks with orders, or other high-tech market shenanigans designed to take advantage of problems with the current market structure.

[To read more about some of the most memorable chairmen of the SEC, visit: 6 Most Memorable SEC Chiefs.]

The SEC could and should play a role when it comes to investigating the market abnormalities. At the very least, the SEC should be able to tell investors that it looked at a specific situation, reviewed the data and discovered that it was a benign faulty server, or a bad data feed. If the SEC could do that, a good deal of confidence would be restored to investors. And then, the SEC could begin to look at some of the more complex cases that might be connected to market manipulation.

However, despite good intentions, the SEC isn't yet capable of policing the electronic markets effectively. It takes days, weeks or months for the SEC to review data on simple market incidents, which alone gets investors nervous. It took the SEC over five months to issue its Flash Crash report, which was widely panned by market observers. And when traders complain or speculate about electronic market manipulation, the SEC seemingly remains quiet, allowing rumors to spread and the perception to grow that there is an un-level playing field for high-speed traders and "average" investors.

Over the next few years Mary Jo White, who will likely be the next SEC chairman, will need to help the commission revamp and upgrade it market surveillance capabilities. White has a good record as a prosecutor and the SEC will continue to crack down on insider trading and other infractions. But when investors and traders know what is happening in the markets long before the regulators do, it sets a bad tone.

White, like her predecessors, will be challenged when it comes to improving market surveillance capabilities. The SEC is playing catch up in a technological race where the other participants not only have a huge head start, but have larger budgets and a depth of knowledge about electronic trading that the SEC lacks. Many of the individual brokers IT budgets exceed the entire operating budget for the SEC.

White will need to bring in experts and newer technologies that can help monitor and analyze data very quickly. If the SEC can do this, it will help improve investor confidence much more than all of the convictions from insider trading convictions combined.

Greg MacSweeney is editorial director of InformationWeek Financial Services, whose brands include Wall Street & Technology, Bank Systems & Technology, Advanced Trading, and Insurance & Technology.