Wharton Forensic Analytics Lab
Imagine a world where financial bad actors could be quickly detected before committing a large-scale fraud or catastrophe––saving firms time, money, and most important–––preserving reputation and public trust.
The Wharton Forensic Analytics Lab (WFAL) aims to be the world’s foremost source of research and teaching expertise on the application of data analytics to issues related to insider trading, financial irregularities, and white-collar crime. Research by WFAL’s award-winning faculty has been cited numerous times in academic and popular business media and has quickly become a reliable source for policy-makers and regulatory bodies, including the SEC. WFAL envisions a virtuous cycle of research informed by practitioner needs, and practice grounded in scientific evidence––disrupting the siloes of academia to foster real-world change.
Op-ed: How the SEC Can and Should Fix Insider Trading Rules
Large, seemingly well-timed stock sales by executives at Pfizer, Moderna and others have garnered significant attention. The companies quickly defended their executives by pointing out that many of these stock sales were preplanned, according to a “10b5-1 plan.” In theory, these plans allow insiders who are not in possession of material non-public information to commit to a series of trades well in advance of market-moving events and provide “safe harbor” against violations of securities laws. If used as intended, these plans provide corporate insiders with a tool to trade their shares and obtain liquidity without raising legal concerns. But like any tool, these plans can be misused. Our research shows that the recent examples are the tip of the iceberg.
Op-ed: Insider Trading Loopholes Need to Be Closed
Current rules still allow executives to time their share sales to maximize gains. Caroline Crenshaw, SEC Commissioner, and Daniel Taylor, Associate Professor of Account at The Wharton School see a “cooling off period” as one solution.
Commentary on the SEC's HFCA Act Disclosure and Identification of Non-compliant Issuers
We provide analysis and comments with the intent of helping the SEC identify issuers that have filed an annual report containing an audit report by a public accounting firm that is located in a foreign jurisdiction where the PCAOB is unable to inspect or investigate the audit. We identify 226 issuers that meet the non-inspection criteria as defined within the HFCA Act, and an addition 44 issuers with unique situations that may require additional guidance from the SEC. These issuers have a combined market cap. in excess of $2 trillion. We also analyze and discuss current issuer disclosures relating to the inability of the PCAOB to inspect the issuer’s audits, and find that issuers are generally not providing the detailed disclosures necessary to comply with the HFCA Act.
Commentary on the SEC's Proposed Amendments to Rule 144 and Form 144
We support the Commission’s proposal to modernize Form 144. Under the current rule, 99.3% of Form 144s are filed on paper every year (over 700,000 from 2001 to 2020). The Commission’s current practice is to retain hard copies of these paper filings for 90 days in the Commission’s Public Reading Room in Washington DC and not post them on EDGAR (see Exhibit 1 for an example of a Form 144). This arcane practice would be of little consequence if the information contained in Form 144s was of no interest to investors; on the contrary, the demand for information on these Form 144s is sufficiently high that data providers regularly visit the Reading Room to scan, digitize, and disseminate Form 144s to corporate clients. As a result, data on over 700,000 Form 144s is available from third-party data providers (e.g., The Washington Service and Thomson/Refinitiv) but not EDGAR. In effect, the Commission has created a two-tiered disclosure system that makes “public disclosure” accessible to large institutional clients, but inaccessible to individual investors. The Proposal would end this practice by mandating Form 144 be filed electronically on EDGAR.
Paper filings do not protect investors, do not promote efficient and fair markets, and do not promote capital formation. Electronic reporting does all three––it ensures the public, capital providers, and the Commission have timely access to information about officers’ and directors’ transactions and data on their associated 10B5-1 plans.
Gaming the System: "Red Flags" of Potential 10b5-1 Abuse
In this Closer Look, we present new evidence on the trading behavior of corporate executives using a unique dataset of over 20,000 10b5-1 plans, including their associated adoption dates and trades. We show that a subset of executives use these plans to engage in opportunistic, large-scale selling that appears to undermine the purpose of Rule 10b5-1. We identify three “red flags” associated with opportunistic use of 10b5-1 plans. (1) Plans with a short cooling-off period. (2) Plans that entail only a single trade. (3) Plans adopted in a given quarter that begin trading before that quarter’s earnings announcement. Sales made pursuant to these plans avoid significant losses, and anticipate considerable stock price declines that are well in excess of industry peers.
The Spread of COVID-19 Disclosure
Investors rely on corporate disclosure to make informed decisions about the value of companies they invest in. The COVID-19 pandemic provides a unique opportunity to examine disclosure practices of companies relative to peers in real time about a somewhat unprecedented shock that impacted practically every publicly listed company in the U.S. We examine how companies respond to such a situation, the choices they make, and how disclosure varies across industries and companies.
Governance of Corporate Insider Equity Trades
Corporate executives receive a considerable portion of their compensation in the form of equity and, from time to time, sell a portion of their holdings in the open market. Executives nearly always have access to nonpublic information about the company, and routinely have an information advantage over public shareholders. Federal securities laws prohibit executives from trading on material nonpublic information about their company, and companies develop an Insider Trading Policy (ITP) to ensure executives comply with applicable rules. In this Closer Look, we examine the potential shortcomings of existing governance practices as illustrated by four examples that suggest significant room for improvement.
Follow the Money: Compensation, Risk, and the Financial Crisis
This Closer Look illustrates the relation between executive compensation and organizational risk through the context of the financial crisis of 2008. We demonstrate that the incentives that bankers had to increase firm risk not only increased but increased substantially in the years preceding the financial crisis. We ask: How well do boards understand the relation between compensation and risk? How much attention do directors pay to the risk-taking incentives provided by CEO wealth? Do boards consider the relation between incentives and the risk tolerance of the firm? How much risk should an executive be encouraged to take?
Commentary on the SEC's Proposed Exemption to Internal Control Audits under SOX 404(b)
We comment on the Securities and Exchange Commission’s (the “Commission”) proposed Amendments to the Accelerated Filer and Large Accelerated Filer Definitions. We provide comments and analysis relating primarily to the Request for Comments in Sections II.E and III.D of the proposed Amendments (“Proposal”). Our comments relate to the provisions of the Proposal that would eliminate internal control audits required under Section 404(b) of the Sarbanes-Oxley Act for companies with annual revenue less than $100 million. Part I provides comment on the central premise of the Proposal. Part II provides comments on various aspects of the Commission’s economic analysis. Although it might be socially desirable to encourage investment, and research and development, we believe there are ways to do so without sacrificing oversight.
Commentary on the SEC's Proposed Reporting Threshold for Institutional Investment Managers
We comment on the SEC’s Proposed Reporting Threshold for Institutional Investment Managers (“Proposal”). We estimate the cost savings from the Proposal are economically small, and amount to 0.004% (0.008%) of assets under management for the average (median) affected filer, and 0.02% of assets for the smallest filer. This small cost savings needs to be weighed against the potentially large costs to investors and others created by eliminating a public disclosure that they heavily use. We analyze the usage patterns of the EDGAR system, and specifically the frequency of Form 13F downloads from EDGAR. Our analysis suggests the investing public and other stakeholders are strongly interested in the information in Form 13F filings, particularly those of affected filers, and that exempting such institutions from filing Form 13F would deprive the market of useful information.
ACCT270 - Forensic Analytics
Annual reports, financial statements, and other mandatory disclosures contain large amounts of financial data that provide the foundation for a variety of forward-looking decisions. Recent trends in Big Data and predictive analytics are revolutionizing the way businesses and investors extract meaningful insights from these disclosures. This course teaches students the hands-on
skills necessary to manipulate large-scale financial databases and build predictive models useful for strategic and investment decisions.
The course covers three applications of predictive analytics in this setting: (i) forecasting future earnings, (ii) predicting accounting fraud, and (iii) detecting insider trading. The course draws on cutting-edge academic research in each area; introduce students to the basic SQL coding skills necessary to manipulate Big Data and conduct meaningful analyses; and leverage the datasets and computing power of Wharton Research Data Services.
The Economics of Misreporting and the Role of Public Scrutiny
This paper examines how the ex ante level of public scrutiny influences a manager’s subsequent decision to misreport. The conventional wisdom is that high levels of public scrutiny facilitate monitoring, suggesting a negative relation between scrutiny and misreporting. However, public scrutiny also increases the weight that investors place on earnings in valuing the firm. This in turn increases the benefit of misreporting, suggesting a positive relation. We formalize these two countervailing forces––”monitoring” and “valuation”––in the context of a parsimonious model of misreporting. We show that the combination of these two forces leads to a unimodal relation. Specifically, as the level of public scrutiny increases, misreporting first increases, reaches a peak, and then decreases. We find evidence of such a relation across multiple empirical measures of misreporting, multiple measures of public scrutiny, and multiple research designs.
with D. Samuels and R. Verrecchia, Journal of Accounting and Economics, 2020
Undisclosed SEC Investigations
One of the hallmarks of the SEC’s investigative process is that it is shrouded in secrecy––only the SEC staff, high-level managers of the company being investigated, and outside counsel are typically aware of active investigations. We obtain novel data on all investigations closed by the SEC between 2000 and 2017––data that was heretofore non-public––and find that such investigations predict economically material declines in future firm performance. Despite evidence that the vast majority of these investigations are economically material, firms are not required to disclose them, and only 19% of investigations are initially disclosed. We examine whether corporate insiders exploit the undisclosed nature of these investigations for personal gain. Despite the undisclosed and economically material nature of these investigations, we find that insiders are not abstaining from trading. In particular, we find a pronounced spike in insider selling among undisclosed investigations with the most severe negative outcomes; and that abnormal selling activity appears highly opportunistic and earns significant abnormal returns. Our results suggest that SEC investigations are often undisclosed, economically material non-public events and that insiders are trading in conjunction with these events.
with T. Blackburne, J. Kepler, and P. Quinn, Management Science 2020
Dark Side of Investor Conferences: Evidence of Managerial Opportunism
While the shareholder benefits of investor conferences are well-documented, evidence on whether these conferences facilitate managerial opportunism is scarce. In this paper, we examine whether managers opportunistically exploit heightened attention around the conference to “hype” the stock. Consistent with hype, we find that managers increase the quantity of voluntary disclosure over the ten days prior to the conference, and that these disclosures increase prices to a greater extent than post-conference disclosures. Investigating managers’ incentives for pre-conference disclosure, we find that the increase in pre-conference disclosure is more pronounced when insiders sell their shares immediately prior to the conference. In those circumstances where pre-conference disclosures coincide with pre-conference insider selling, we find evidence of a significant return reversal: large positive returns before the conference, and large negative returns after the conference. Collectively, our findings are consistent with some managers hyping the stock prior to the conference and selling their shares at inflated prices.
Audit Process, Private Information, and Insider Trading
While the shareholder benefits of audits are well documented, evidence on whether audits can facilitate opportunistic behavior by corporate insiders is scarce. In this paper, we examine whether the audit process facilitates one particular form of opportunism: informed trading by corporate insiders. We focus our analysis on insider trading around the audit report date. We find an increase in trading around the audit report date and that the increase is abnormally large for firms that subsequently report modified opinions. Abnormal increase in trading is concentrated among officers and non-audit committee independent directors, and most pronounced in first-time modified opinions and modified opinions in years where financial results are subsequently restated. These trades are highly opportunistic: they predict restatements, and as a consequence, avoid significant losses. Collectively, our findings provide novel evidence that insiders appear to exploit private information about the audit process––a process ostensibly designed to protect shareholders––for opportunistic gain.
Political Connections and the Informativeness of Insider Trades
We analyze the trading of corporate insiders at leading financial institutions during the 2007 to 2009 financial crisis. We find strong evidence of a relation between political connections and informed trading during the period in which TARP funds were disbursed, and that the relation is most pronounced among corporate insiders with recent direct connections. Notably, we find evidence of abnormal trading by politically connected insiders 30 days in advance of TARP infusions, and that these trades anticipate the market reaction to the infusion. Our results suggest that political connections can facilitate opportunistic behavior by corporate insiders.
with A. Jagolinzer, D. Larcker, and G. Ormazabal, Journal of Finance 2020
Corporate Governance and the Information Content of Insider Trades
Most corporate governance research focuses on the behavior of chief executive officers, board members,institutional shareholders, and other similar parties. Little research focuses on the impact of executives whose primary responsibility is to enforce and shape corporate governance inside the firm. This study examines the role of the general counsel in mitigating informed trading by corporate insiders. We find that insider trading profits and the predictive ability of insider trades for future operating performance are generally higher when insiders trade within firm-imposed restricted trade windows. However, when general counsel approval is required to execute a trade,insiders’ trading profits and the predictive ability of insider trades for future operating performance are substantively lower. Thus, when given the authority, it appears the general counsel can effectively limit the extent to which corporate insiders use their private information to extract rents from shareholders.
with A. Jagolinzer and D. Larcker, Journal of Accounting Research, 2011
AICPA Notable Contribution to Accounting Literature Award
Arthur Andersen Chaired Associate Professorship
Best Academic Paper Award, Weinberg Corporate Governance Symposium
Analytics at Wharton Teaching Grant
Wharton Teaching Excellence Award
Dean’s Research Grant
Outstanding Research Paper Award, Jacobs Levy Center
Morgan-Stanley Best Discussant Prize
American Accounting Association Competitive Manuscript Award
American Accounting Association Best Dissertation Award
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SEC Advisory Committee Presentations
*Dan Taylor’s presentation: 0:55:44 – 1:11:10
*Dan Taylor’s presentation: 1:36:45 – 1:58:53
In the News
SEC aims to stop insiders dumping stock before the bad news hits | Financial Times
Moneystuff: 10b5-1 plans | Bloomberg
SEC Chairman Calls for New Restrictions on Executive Stock-Trading Plans | The Wall Street Journal
No one is policing corporate America, and white-collar crime is on the rise | Business Insider
PwC to Defend Audit Work, Independence in Whistleblower Trial | Bloomberg Tax
Our dedicated team of faculty, scholars, and staff are committed to advancing research and teaching in forensic analytics.
A tenured professor at The Wharton School, Dr. Taylor is an award-winning researcher and teacher with extensive expertise on issues related to corporate SEC filings, fraud detection, insider trading, and corporate governance. A world-renown scholar, Professor Taylor has written more than 20 articles on these topics published in the leading academic journals in accounting, finance, and management; led seminars at over 100 leading business schools across the globe; won numerous academic and industry awards; and serves on the editorial boards of several top academic journals.
Professor Taylor’s research targets practitioners and regulators, and aims to have direct relevance to current issues facing boards and shareholders. His research is frequently cited in business media, in trade publications, and in rules and regulations promulgated by the Securities and Exchange Commission. His research has been presented at multiple regulatory and enforcement agencies including the SEC, the Public Company Audit Oversight Board, and the Southern District of New York; and has informed multiple investigations by the FBI, Treasury, and Department of Justice.
Associate Professor of Accounting
Arthur Andersen Chair
Bradford is a researcher at The Wharton School interested in how information affects beliefs and decision making, particularly in the realm of ethics and social welfare. Prior to joining Wharton, he used his knowledge of engineering, computer science, and business to invent new technologies, reduce product development cycles, and improve investment efficiency.
While working for Cummins, Bradford invented a safety technology which is now deployed on millions of heavy-duty trucks throughout China. At the leading automotive simulation suite provider, he developed new fluid dynamics models which accelerated analyses 100x, thereby enabling engineers to better optimize designs. After Microsoft’s hardware group wrote off over $1B in capital equipment, he built a customer behavior driven model of investment to identify optimal investment levels, highlighting opportunities to reduce capital expenditures by more than 60%. As a manager at Amazon Alexa, he was the lead inventor on multiple patents facilitating interactions between autonomous agents and was responsible for the products of several teams including metrics and analytics, engagement, and voice enabling the web.
University of Chicago
University of Washington