The SEC’s EDGAR System Needs A Speed Bump


Last week, the SEC filed a complaint against an individual named Nauman A. Aly.   The complaint stated:

“This matter involves defendant Nauman A. Aly’s scheme to fraudulently manipulate the price of publicly-traded securities by filing false information on the Commission’s public database (commonly known as EDGAR). Aly executed this scheme from Pakistan and used it to obtain at least close to half a million dollars in ill-gotten gains.”

The SEC gave further details:

“On April 12, 2016, Aly acquired a large block of out-of-the-money call options in Integrated Device Technology, Inc. (“IDTI”). Minutes later, Aly filed a report on EDGAR stating that he and a group of other people had acquired more than a five percent beneficial interest in IDTI and had written to IDTI’s board of directors offering to buy all of the company’s stock at a 65% premium.”

The filing that Aly made on EDGAR from Pakistan was false.  There was no group of investors that had taken a stake in IDTI. But the market didn’t know this and the news bots that read the 13D filing headlines caused the stock of IDTI to jump 25% in the next 10 minutes.  Here are some facts about the IDTI stock event from April 12th:

Average daily volume: 3.7 million shares

Volume on April 12: 16.8 million shares

Range on April 12: Open $19.39, Low $18.74, high $23.99, close $20.22

Top 3 holders are ETF issuers:  Vanguard 7.5%, Blackrock 5%, State Street 3.5%

Naumann Aly made $425,000 on the out-of-the-money options that he bought before he made the fake filing on EDGAR. How could a guy in Pakistan post a fraudulent story to a SEC database and immediately make almost a half-million dollars?  This was not a sophisticated fraud that was devised by a network of individuals.  One person in a foreign country was able to manipulate the market with the assistance of the SEC’s own system.  This definitely begs a few questions:

What is EDGAR and how can fraudulent information be posted to it so quickly?

The SEC says that “EDGAR’s primary purpose is to increase the efficiency and fairness of the securities market by providing universal public access to time-sensitive corporate information filed with the agency. EDGAR is a crucial source of information for the investing public about securities trading in the United States.”

How easy is it to post documents to EDGAR?

Pretty easy.  The SEC says “a filer must complete a Form ID, which is an electronic application to obtain EDGAR access codes. As part of the application process, each applicant creates a unique passphrase and must provide the applicant’s name, contact information, and other information. After the application is received, EDGAR sends a unique Central Index Key (“CIK”) number in an automated email to the email address on the Form ID application. This CIK code serves as the filer’s logon ID for EDGAR. The CIK code enables filers, among other things, to file documents with the Commission electronically, such as beneficial ownership forms and tender offers to acquire publicly-traded companies.”

How could the SEC have known this filing was possibly a fraud?

The SEC could have cross checked some of the “facts” from the filing before allowing it to be posted to their EDGAR system.  If they had done this, they would have found that many of the facts were false.  Maybe the SEC should install a speed bump and put in place a verification system so filings like this can be screened out before they do significant damage to the market.

Has a fake filing on EDGAR ever happened before?

Yes, according to the WSJ similar fraudulent filings have occurred recently:

“Instances of fake filings have included a bogus takeover offer for Avon Products Inc. in June and fraudulent filings in September mimicking Warren Buffett’s investments in Kraft Heinz Co. and Phillips 66 by an entity unknown to either company or Mr. Buffett’s Berkshire Hathaway Inc.”

Is anybody at the SEC doing anything about this?

In a speech last year, SEC Commissioner Kara Stein recognized that the EDGAR system has some major deficiencies.  She said:

“However, in the last 20 years, technology has evolved, but EDGAR hasn’t changed much. While our IT staff has made important updates, EDGAR has not kept pace with technological advances.”

Unfortunately, we think Commissioner Stein’s concerns will be overlooked and this EDGAR problem will continue to occur until a more high profile situation occurs.

This case demonstrates how quickly markets react to news.  Market makers and specialists who normally would have acted as a sanity check are no longer there to help screen for this type of fraudulent news.  The case also highlights the fact that there is very little real liquidity in the market. Instead, many stocks (especially in the middle of the day) are simply being arbitraged by high frequency trading firms who are inserting themselves as artificial intermediaries looking to scalp a few pennies from less sophisticated algorithms that are leaving predictive patterns.

While the SEC sits backs and ponders whether a 350 microsecond speed bump from IEX is fair, they continue to allow their own antiquated EDGAR system to be used a tool by manipulators to cause substantial damage to the market.  We think they need to get their act together and start focusing on one of their main goals – protecting long term investors.