Securities Regulation Daily SEC sharpens oversight claws with proposed consolidated audit trail
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Wednesday, April 27, 2016

SEC sharpens oversight claws with proposed consolidated audit trail

By Amanda Maine, J.D.

By a unanimous vote, the SEC proposed a National Market System (NMS) plan to create a consolidated audit trail (CAT) that would give regulators access to a comprehensive database of information about orders entered and trades executed across the U.S. securities markets. The plan was submitted jointly by the SROs after nearly four years in development.

CAT. The proposed CAT plan, which would apply to NMS securities and over-the-counter equity securities, would require SROs and broker-dealers to submit certain information during the different stages in the lifecycle of an order to a central repository. The information includes unique identifiers for customers and broker-dealers; the date and time of the order event; and material terms of the order, such as the security symbol, price, size, and order type.

The initial maximum error rate for reported data is 5 percent, with an eventual goal of 1 percent. Previously granted exemptive relief from NMS Rule 613 is also reflected in the plan, which serves to provide SROs with the flexibility to propose approaches that are more efficient and cost-effective.

The activities of the CAT would be conducted by the SROs through a Delaware limited liability company, which would be jointly owned by the SROs, giving each SRO one vote on an operating committee charged with managing the company. The SEC and the SROs would have access to the data contained in the central repository for regulatory and oversight purposes. The plan also establishes data security requirements regarding connectivity, data transfer, encryption, storage, access, breach management, and personally identifiable information (PII).

Under Regulation NMS Rule 608, the Commission must approve the CAT plan within 180 days. If approved, SROs would be required to select a plan processor within two months. SROs would be required to begin reporting data to the central repository within one year of approval. Large broker-dealers and small-broker dealers would be required to report data to the central repository within two and three years, respectively.

Chair White’s remarks. Speaking at the open meeting, Chair Mary Jo White said that once the CAT has been completed, it will be one of the world’s “most comprehensive and sophisticated financial databases.” Regulators need the ability to keep pace with quickening developments in the marketplace and to fully realize the benefits that advanced technology has already created in the markets, she said.

Given that every segment of the market infrastructure will be impacted by the CAT plan, White urged all market participants, including investors, exchanges, FINRA, broker-dealers, clearing organizations, and technology providers to give their perspectives on the proposal. She also noted that the CAT plan includes a detailed economic analysis with a discussion of the costs and benefits of the creation, implementation, and maintenance of the CAT, and encouraged market participants to comment on this as well. White also highlighted three particular areas on which the Commission is seeking comment: the reasonableness of the proposed 5 percent maximum error rate, the 50 millisecond clock synchronization standard and its associated costs, and data security. On the last issue, White observed that the CAT data is highly sensitive information that needs to be secured and she requested that people with expert IT knowledge give their views the proposal.

Stein’s remarks. Commissioner Kara Stein said the need for a comprehensive CAT has been proven over and over again. She cited the “Flash Crash” of May 6, 2010, and the less drastic but still concerning market volatility on August 24, 2015, noting that it took the SEC four months and thousands of employee hours to reconstruct the events and to prepare reports on the incidents. Months-long delays to analyze market events are unacceptable in this day and age, Stein said.

Stein observed that the SEC, in its original release directing the SROs to establish a CAT plan, identified four qualities that are needed for market data to be effective: accuracy, completeness, accessibility, and timeliness. She urged commenters to examine the proposals through this lens, stating that the CAT needs to be done right the first time. In particular, she cited the proposed 5 percent data error rate as one element of the plan to evaluate because allowing incorrect data reporting of up to 5 percent of the time could undermine the CAT’s effectiveness.

Piwowar’s remarks. Commissioner Michael Piwowar praised the work of the staff as well as past commissioners for their work on the CAT, calling it an ambitious project during a busy time at the SEC. He singled out three areas in particular on which he would like to hear perspectives. The CAT plan as proposed would retire duplicative regulatory data reporting systems such as the Order Audit Trail System (OATS), he said, and requested comments on the reasonableness of eliminating redundancies and the proposed timeline.

He is also seeking views on whether the risks related to PII are reasonable and whether the safeguards proposed in the CAT plan provide for adequate security of customer-specific information. Finally, he noted that developing and maintaining the CAT will be an incredibly costly endeavor. He requested that market participants give their perspectives on the costs and benefits of each component of the plan and the plan in general.

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