Insider trading blitz planned

Exchange lobbies for changes that would introduce fuzzy software spy

The London Stock Exchange is urgently lobbying for a change in the law to make it easier to prosecute insider trading. Pressure on government and other regulators to make insider dealing a civil offence has been stepped up ahead of the introduction of artificial intelligence technology which the Stock Exchange hopes will dramatically improve its detection of market manipulation.

The Exchange is concerned that the usefulness of much sharper detection methods will be blunted by the inability of those carrying out subsequent investigation and prosecution to improve on their poor record.

Richard Kilsby, director of market services, said: "The danger is that the better we get at detection, the more frustrated we will become with the lack of effective remedies."

The lobbying efforts are being focused on the Home Office, which is understood to be the most reticent about changing the law. The Securities and Investment Board, the City watchdog, and the Treasury, have become more sympathetic to a move that would reduce the burden of proof in prosecuting insider dealers.

A change in the law would allow the lower "more likely than not" standard of proof used in civil disputes as opposed to the much more exacting "beyond reasonable doubt" standard demanded in criminal prosecutions. Those successfully prosecuted would not go to jail, but face heavy fines.

The Exchange's concern has received greater impetus as it moves towards the installation from August of revolutionary surveillance software. This will coincide with the start-up of the final stage of modernisation of the Sequence electronic trading platform.

Instead of the current monitoring system, based on alerts triggered by unusual price movements, the artificial intelligence techniques will create a system that can learn from the data, growing and adapting.

"Much of what we have done is to develop methods to make sense of the mass of data which goes through the exchange every day," said Konrad Feldman, a founder of SearchSpace, the small computer company creating the new system.

Using fuzzy logic, genetic algorithms and neural networks, the data is used to build profiles of all entities in the market, whether individual shares, sectors, or market users.

"Once the profiling is in place the other techniques are aimed at what could be called data forensics, where we find patterns that are unusual and have a high probability of being instances of market abuse," Mr Feldman says.

By identifying what announcements are important, the system hopes to identify opportunities for insider trading. "What we want is to find the person who deals ahead of an announcement without moving the share price. That is the most heinous sort of insider trading," Mr Kilsby said. Using a combination of intelligent systems, the new software hopes to detect dealing rings where several individuals, or one individual with several accounts, trade across all their accounts for the purpose of insider dealing or market manipulation.

Costing several hundreds of thousands of pounds, the Stock Exchange project is the biggest so far undertaken by SearchSpace, a company founded two and a half years ago by a group of doctoral students at University College of London.