SEC Chairman Paul Atkins has directed agency staff to develop recommendations for changes to the governance and funding of the Consolidated Audit Trail (CAT), including the possibility of the Securities and Exchange Commission taking responsibility for the system.
In an August 10 letter to Robert Walley, Chair of the CAT NMS Plan Operating Committee, Atkins said the SEC has reviewed comments submitted in response to its April concept release on the CAT and other audit trails and data sources.
“Nevertheless, further changes are needed to address the costs, governance, and funding of the CAT,” Atkins wrote in the letter.
Atkins directed SEC staff to explore funding the CAT through appropriated funds and Section 31 transaction fees. He also directed staff to draft a potential rulemaking that would rescind Rule 613 and require exchanges, FINRA and broker-dealers to report CAT data directly to the SEC or its designee.
Under the approach described by Atkins, the SEC would continue to use the existing CAT infrastructure and reporting specifications. Staff will also assess the resources the SEC would need to assume responsibility for the CAT and develop recommendations regarding its governance. Atkins said a transition “would likely not be complete until late 2027”.
The SEC’s April concept release requested public comment on the CAT’s funding and cost management, regulatory purpose, governance, design and scope, cybersecurity and data privacy.
According to Atkins, the Commission received hundreds of comments. He said that “one theme that emerged from the comment file was that investors and market participants want the Commission to take more responsibility for managing and funding this project.”
CAT background and funding
The SEC adopted Rule 613 in 2012 following the May 2010 Flash Crash. The rule required national securities exchanges and FINRA to jointly develop a plan for creating, implementing and maintaining a consolidated audit trail. The CAT was designed to allow regulators to track orders and transactions across the U.S. equities and options markets.
FINRA said in its June 22 comment letter that it uses CAT data for regulatory activities including monitoring for potential market manipulation, fraud, insider trading, front-running and cross-product manipulation. The data is also used for best-execution oversight and examinations, according to FINRA.
The SEC has taken several steps to reduce CAT costs and the amount of information reported to the system. In his August 10 letter, Atkins said the Commission had eliminated reporting of personally identifiable information to the CAT and reduced annual operating costs through exemptive relief and amendments to the CAT NMS Plan.
The CAT NMS Plan participants said in their June 22 comment letter that the self-regulatory organizations had provided $915 million in voluntary, interest-free loans to fund CAT development. The CAT NMS Plan participants also said industry firms had incurred costs to modify their systems to report information to the CAT. The SEC subsequently adopted a revised funding approach while continuing its broader review of the CAT.
Market response and next steps
SIFMA and FINRA addressed CAT funding and governance in their comment letters. In its June 22 comment letter, SIFMA recommended that the SEC take over CAT funding and ultimately eliminate the CAT NMS Plan. SIFMA said its “primary recommendation is for the Commission to take over the funding of the CAT”. The trade group said the SEC should include CAT funding in its annual budget request to Congress and eventually operate the CAT directly.
SIFMA also said industry participants bear 80% or more of CAT costs, while the SEC is “the most significant beneficiary of the CAT and effectively controls it”. The organization recommended creating a CAT advisory committee that would include representatives from alternative trading systems, retail brokers, market makers, self-regulatory organizations and technology and information-security specialists.
FINRA also recommended that the SEC assume responsibility for CAT governance and funding. In its June 22 comment letter, the organization said the CAT “is essential to regulatory oversight of the U.S. capital markets”. FINRA recommended that CAT costs be included in the SEC’s budget, subject to congressional approval, and that Section 31 fees be available as another source of funding.
The regulator also recommended that the SEC establish its own audit-trail reporting rule. FINRA said that rule could replace Rule 613 following a transition period, while the existing CAT infrastructure and reporting specifications could continue to be used. FINRA also addressed the CAT NMS Plan’s voting structure.
The regulator said the plan has 28 participants, with four affiliated exchange groups holding 21 of the 28 votes. FINRA has one vote. “Eleven years after the CAT NMS Plan Participants filed their first proposal for funding CAT, there is still not a permanent funding model in place,” FINRA said.
In a response to Atkins’ letter, Benjamin Schiffrin, director of securities policy at Better Markets, said the organization supports the SEC taking control of the CAT and called for adequate funding. “The Consolidated Audit Trail is the most important tool that the SEC has to fight crime on Wall Street,” Schiffrin said in the Better Markets statement.
He said the CAT allows the SEC to monitor market activity and identify potential market manipulation and other violations. “If the SEC takes over the CAT, it is crucial that the SEC have a plan to fund the CAT’s critical operations while ensuring that it is also able to perform its other vital functions,” Schiffrin said.
In a separate comment letter, Richard Morrison, senior fellow at the Competitive Enterprise Institute (CEI), took a different position, arguing that the CAT should be eliminated rather than placed under SEC control: “The Consolidated Audit Trail should be reformed via elimination,” he wrote in CEI’s comments.
The SEC’s April concept release also requested comments on cybersecurity and data privacy. SIFMA said in its June letter that CAT contains “extremely sensitive order lifecycle data” and recommended changes to the way regulators access and analyze CAT information.
SIFMA also recommended that the SEC revisit its CAT data-security framework and consider a secure analytical workspace for regulatory users. FINRA said it has implemented security controls for its use of CAT data and has developed a secure analytical workspace.
The SEC has already removed personally identifiable information from CAT reporting. Atkins said the Commission would continue to consider the appropriate scope of CAT data as part of its review.
Atkins directed SEC staff to assess the resources required for the Commission to assume responsibility for the CAT and to develop recommendations on governance.
Staff will also consider the potential use of appropriated funds and Section 31 transaction fees to fund the system and prepare potential rulemaking concerning Rule 613 and CAT reporting requirements.
Atkins said the SEC would continue to engage with market participants during the process. A transition to SEC responsibility for the CAT, if pursued, “would likely not be complete until late 2027,” according to Atkins.
