6/6/2014 Wall Street & Technology - Customized Analytics Are a Must for Compliance and Fraud Detection

http://www.wallstreetandtech.com/compliance/customized-analytics-are-a-must-for-compliance-and-fraud-detection/a/d-id/1260050?print=yes 1/4
0 COMMENTS
COMMENT NOW
Tweet 0 0
8/13/2008
02:15 PM
Sam Bennikutty, Senior Manager, Financial Services; and Vikas Agarwal, Manager, Financial Services,
Commentary
Customized Analytics Are a Must for Compliance
and Fraud Detection
In addition to highlighting aberrations, a well-implemented integrated analytics approach also
offers operational improvement.
Over the past year, the SEC and Financial Industry Regulatory Authority (FINRA) have begun
broadly examining funds, advisers and broker-dealers by using complex analytics techniques. While
analytics are not new to buy-side organizations, incorporating improved technologies and processes
into regulator focus areas does provide new opportunities to improve operations and better target
compliance requirements. Customized analytics may be developed using advanced methods that
address these areas and bring multiple benefits to buy-side firms.
Last November, the SEC released "Forensic Measures for Funds and Advisers" to guide firms on
the types of analytic tests that funds and advisers could include as part of their compliance
program. With the increased regulatory scrutiny on trading practices, firms must look beyond
assessing controls to analyzing voluminous and often complex data. Sometimes referred to as
forensic testing, an integrated analytics approach to compliance programs has become a necessity.
The Five Focus Areas
One of the challenges in developing effective and meaningful compliance and fraud tests is that
most asset management organizations require a level of customization not available through
packaged solutions. Using techniques that embrace newly developed visualization capabilities that
give insight into business activity evidenced in the data can provide greater value in compliance and
operational improvement. Areas that should be considered include:
Portfolio management and trade allocation. Focusing on hedge funds and mutual funds
business, the most important tests in this area must ensure that the firm complies with fund rules
and prospectuses. Analytics can also examine performance disparities across clients, funds and
managers, and can test for noncompliant activities. The goal of these tests is to find hidden patterns
Share
6/6/2014 Wall Street & Technology - Customized Analytics Are a Must for Compliance and Fraud Detection
http://www.wallstreetandtech.com/compliance/customized-analytics-are-a-must-for-compliance-and-fraud-detection/a/d-id/1260050?print=yes 2/4
or relationships that traditional spot checks or threshold testing would miss.
Broker arrangement and execution. With the implementation of Reg NMS, intended to provide
transparency into whether customers are receiving best prices for their trades, broker favoritism
and best execution have become serious buy-side concerns. The most important tests analyze
commissions and look for correlations among sales and trades, soft dollars, and management
overrides.
Financial reporting and fund accounting. The accounting integrity of positions flowing through
to financial statements poses a significant area of risk to controllers' departments. The most
important functions in this area now focus on ensuring the integrity of reference data (i.e., security
master files) across disparate order management and account systems, as well as reconciliations
with third-party vendors that manage different aspects of the business (e.g., custodians). Financial
statement analytics focus on identifying fraud in journal entries, particularly cash-based
transactions.
Gifts and entertainment. Firms making investment decisions now have a responsibility to closely
analyze employees' expense behaviors and patterns. The most important tests include comparing
sales and trading activities to trader and portfolio manager expenses. More-basic tests include
keyword searches, statistical analysis by expense type, and levels and variance testing.
Personal trading. Inappropriate personal trading risk may result in compliance issues and elicit
questions about a buy-side firm's professionalism. Firms often lack all the data needed to identify
cases of insider trading that may go across multiple firms and parties. However, they do have the
ability to compare their investment stakeholders' trades to major events on the Street and within
their firms, and to view disparities between individual accounts and client performance. At a
foundational level, firms should analyze their restricted securities master for integrity and accuracy.
While not comprehensive, these items cover target areas that can guide buy-side firms to direct
their compliance thinking toward analytics. Many of them are traditionally tested through process
controls, but employees may find new ways around these areas that analytics can help identify. This
testing helps to strengthen controls and identifies new controls to put in place.
The Underlying Benefits of Analytics Testing
In each of the areas above, proper use of analytics testing can yield benefits that go beyond
fundamental compliance. Well-implemented analytic techniques typically produce improvements in
three key areas: fraud detection, compliance and operational improvement.
Fraud detection. The greatest risk for any buy-side firm is intentional employee misconduct, which
can result in reputational damage, compliance penalties, even criminal charges. Analytics and out-
of-the-box surveillance tools may highlight only obvious employee misconduct. Because most
organizations already have controls in place to detect these situations, the challenge is in
developing techniques to identify more-sophisticated fraud.
An effective method is to develop analytics techniques combining disparate data sets to detect
unusual patterns or anomalies that may highlight fraudulent behavior. These techniques tend to be
6/6/2014 Wall Street & Technology - Customized Analytics Are a Must for Compliance and Fraud Detection
http://www.wallstreetandtech.com/compliance/customized-analytics-are-a-must-for-compliance-and-fraud-detection/a/d-id/1260050?print=yes 3/4
COMMENT | EMAIL THIS | PRINT | RSS
customized to the buy-side firm based on the types of transactions, various application packages in
place, the means by which these packages are integrated and the firm's overall control
environment. By developing these techniques through historical data, they can be converted and
installed into preventive controls or surveillance. Depending on the firm's environment, the insights
from historical analytics may be applied directly to the technical environment through database-
stored procedures or may be used to fine-tune and customize existing package installations.
Compliance. These same historical analytics techniques can be expanded to address compliance
concerns, as many compliance rules are targeted at eliminating fraudulent activity and ensuring
open and fair markets. Often, the best strategy is to start by implementing compliance analytics
methods and then expanding them to address advanced fraud detection. The approach taken is
largely dependent on the objectives of the buy-side firm, the maturity of its control systems and its
immediate business objectives.
The best implementations of compliance analytics can be adapted to preventative controls.
Compliance dashboards and regular reports highlighting compliance exceptions are common
applications of the analytics rules developed during testing.
Operational improvement. The underlying benefit to a firm performing in-depth data analysis is
that it gains insights into its business operations from the bottom up. Occasionally, trying to perform
data acquisition and combining disparate but related information can reveal unexpected
disconnects. For instance, differences in reference data between multiple security master instances
may uncover control weaknesses in either technical or business process controls intended to
provide for the consistent referencing and tagging of securities across functional areas.
In more-sophisticated examples, data analyses may also highlight inefficiencies in applying
compliance initiatives. It is not uncommon for a list of projects with meaningful operational
improvements to be created out of an effort originally focused on addressing compliance concerns.
One of the truisms of analytics testing is that its value is highest at its inception. The intelligence of
analytics is in the interactive question/answer nature of examining the data. Once developed,
analytics shifts from intelligent examination of data to one of monitoring and reporting. Over time, as
business processes continue to evolve and improve, and new regulations are introduced or
business events occur that cause systems or process disruption, analytics techniques that were
once effective become obsolete. As a result, the key is to have a continuous improvement approach
to analytics. The benefits of such a program bring ongoing returns to the business and ultimately
become a key differentiator of a buy-side firm through customer assurance, reduced regulatory
costs and improved business operational efficiency.
Increased compliance pressures and buy-side investment policies necessitate that compliance
officers and heads of risk management use analytics to understand potential risks. Implementing
holistic programs that test SEC and FINRA focus areas can yield multiple benefits for an
organization that include managing the risks of fraud and potential noncompliance and the
identification of operational improvement opportunities. Firms seeking to stay ahead of the
compliance curve should reevaluate the use of controls and require thought leadership in detection
and prevention compliance programs that stress the use of advanced analytics tools and
techniques.
MORE INSIGHTS
6/6/2014 Wall Street & Technology - Customized Analytics Are a Must for Compliance and Fraud Detection
http://www.wallstreetandtech.com/compliance/customized-analytics-are-a-must-for-compliance-and-fraud-detection/a/d-id/1260050?print=yes 4/4
Webcasts
App Ratings: How to Drive Them Up
Is PaaS Really Necessary?
More Webcasts
White Papers
Security Brief: Transforming Traditional Security Strategies into an Early Warning System for Advanced Threats
Software Defined Storage - The Missing Link for Cloud and the Software Defined Datacenter
More White Papers
Reports
How the Internet of Things Will Change Your Business
Strategy: Social Is a Business Imperative
More Reports
Copyright 2014 UBM Electronics, A UBM company, All rights reserved. Privacy Policy | Terms of Service