Wharton Forensic Analytics Lab

Wharton Forensic Analytics Lab 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 corporate transparency.

The Lab has a three‐part mission, focused broadly on the application of academic research to practice and education: (1) create and disseminate new tools and technologies to academics and private sector partners; (2) create and disseminate academic research to media, practitioners, and regulators; and (3) create and disseminate teaching and educational materials to academics and current and prospective students.

Our Work

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.

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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.

 

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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.

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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?

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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.

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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.

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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.

SYLLABUS

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

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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

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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.

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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.

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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

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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

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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

In the News

How the SEC Can and Should Fix Insider Trading Rules

Regeneron Board Member and Executive Sell $1 million in Stock After Trump Touts Treatment

Senators’ Stock Sales Raise Corporate Insider Trading Concern

Stock Sales By Leaders At Coronavirus Testing Company Raise Legal Concerns

‘Bad Optics’ Or Something More? Moderna Executives’ Stock Sales Raise Concerns

U.S. Corporate Crisis Bailouts May Prove Bonanza for Insider Trading, New Study Warns

Pfizer CEO Sold Millions In Stock After Coronavirus Vaccine News, Raising Questions

German Fintech Star Wirecard Said $2 Billion Went ‘Missing’ From its Bank Accounts

SEC Plan Gives Audit Relief to Firms That Wiped Out Over $290 Million

Corporate Partners

Patterned after an engineering lab, the Forensic Analytics Lab seeks to encourage scholarly research and educational materials that have immediate practical value. The Lab connects with corporate and government partners to advance understanding of pressing issues related to insider trading, fraud, and corporate transparency.

Does your company or agency have an application you think would benefit from rigorous research and analytics? Are you interested in sponsoring academic research or co-developing teaching cases on a relevant topic? Interested in learning evidence-based best practices on insider trading, fraud, or corporate transparency? Contact us.

The Team

Our dedicated team of faculty, scholars, and staff are committed to advancing research and teaching in forensic analytics.

Faculty

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Daniel Taylor

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 Lynch Headshot - Square

Bradford Lynch

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.

Doctoral Student 

Affiliated Scholars

John Kepler
Assistant Professor
Stanford University

Delphine Samuels
Assistant Professor
University of Chicago

Phillip Quinn
Associate Professor
University of Washington

Joseph Schroeder
Associate Professor
Indiana University

David Larcker
Professor Emeritus
Stanford University

Brian Tayan
Researcher
Stanford University

Staff

Dengsheng Chen
Predoctoral Researcher