The SEC’s $10 million settlement with “alternative data” provider App Annie Inc. is charting the agency’s road map for boosting oversight of the growing but largely unregulated big data sector.
The App Annie case—a first-of-its-kind case in which the Securities and Exchange Commission accused the company of violating securities law with misrepresentation—underscored emerging legal risks for data sellers and their hedge fund clients that use controversially-sourced information.
Alternative data refers to corporate information not found in financial statements and other traditional sources—from satellite images and customers’ app use to mobile geolocation data analytics and social media mentions. Hedge funds and other trading firms buy such data to gain an edge in the market.
The SEC, starting in early 2020, has made it a priority to examine how traders use alt data, as some of it could verge on insider information. But the App Annie case reflects the agency’s broadening focus on the sector to include data sellers and their sales claims and disclosures. Heightened regulatory risks could also accelerate alt data sellers and buyers’ efforts to craft uniform standards on disclosures and usage.
“The regulation of data and what information gets captured by this data is now clearly on the radar of the SEC,” said Doru Gavril, a partner in Freshfields Bruckhaus Deringer LLP’s Disputes, Litigation and Arbitration practice.
SEC Enforcement Director Gurbir Grewal intimated as much, recently highlighting the App Annie case as part of the agency’s proactive approach on enforcement.
“We are not waiting for accidents to happen. We are trying to address emerging risks before they cause harm to investors,” Grewal said in an Oct. 6 speech.
App Annie settled allegations that it committed fraud and violated Section 10(b) of the Exchange Act when it made misrepresentations to trader clients about how it aggregated and anonymized data on corporate mobile apps, according to the SEC’s settlement order. Section 10(b) prohibits manipulation and deception “in connection with” the purchase or sale of a security.
App Annie neither admitted or denied the SEC’s findings in the settlement order.
The SEC recently has been examining whether trading firms use alt data to conduct trades that could amount to insider trading. Traders are required to avoid using material non-public information in their trading algorithms in ways that might constitute insider trading.
But applying securities law to start cracking down on data sellers is a new wrinkle, attorneys say.
“It’s a novel and bold theory of liability,” Gavril said. “We’re going to see an increasing number of investigations that use this type of theory and this fact pattern to see if there is an opportunity for the commission to pursue other enforcement actions.”
At the core of the SEC’s settlement last month were App Annie’s alleged omissions and misrepresentations about how it collected and shared data from companies’ mobile apps—such as app downloads, usage metrics and app-generated revenue.
The SEC said App Annie lied to their corporate clients about how the company sorted, aggregated and anonymized nonpublic, confidential app data. App Annie then sold manipulated app usage metrics to traders, despite assuring them that the data was in compliance with federal securities laws, the SEC said.
App Annie’s deception led to traders unknowingly using the confidential data, potentially exposing them to insider trading claims, the SEC said.
Traders likely would have cut ties if they had known that App Annie wasn’t aggregating and anonymizing mobile analytics data as it promised, the SEC said in its Sept. 14 order.
Hedge funds and private equity funds that buy alt data could face enforcement actions if they haven’t done the right diligence to avoid using the confidential information of public companies, said Kelly Koscuiszka, a partner at Schulte Roth & Zabel who advises private funds on regulatory compliance and investigations.
Enforcement against private funds would likely focus on policies and procedures in dealing with alt data sellers, in addition to insider trading charges, she said.
The App Annie case is accelerating hedge funds and other traders’ efforts to scrutinize the disclosures that alternative data suppliers provide, attorneys said.
Institutional traders have invested heavily in trading algorithms that are entirely dependent on the data they’re fed.
SEC scrutiny could threaten the viability of traders’ proprietary algorithms if they’re found to be using material non-public information, said Avi Gesser, a partner in Debevoise & Plimpton LLP’s Data Strategy & Security Group.
“You run the risk some regulator will say you are supposed to remove that data because you’re not supposed to have it,” Gesser said.
Private funds are going to more closely scrutinize the compliance guarantees they get from alternative data vendors in light of the App Annie settlement, Koscuiszka said, citing industry best practices that are emerging.
“Many of the vendors never thought of themselves as being regulated by the SEC or in any kind of securities-type industry,” Koscuiszka said.
Alt data providers and their trading firm customers have been trying to unify behind industry standards to stave off more enforcement actions.
They know that “if you want to protect yourself, you can’t operate like you’re in the Wild West,” said Sarah McKenna, CEO of Sequentum, an alternative data and software provider.
The Alternative Data Council, a working group founded by the Financial Information Services Association, has developed model forms of disclosures, due diligence practices and other tools for sharing alt data. The association is part of the Software and Information Industry Association.
“Data vendors are able to see the types of things they need to be able to attest to,” said McKenna, whose company is a member of the data council. “These things didn’t exist even as recently as 2018.”