By Kirsten Wegner, CEO, Modern Markets Initiative
Few would disagree that America’s financial markets are the envy of the world, with trades for the retail investor typically executed in less than a second, with zero trading commission. And as we saw at the height of Covid-19 volatility in March of 2020, electronic market makers and brokers provide deep liquidity, even through the most extreme market conditions.
But today these efficiencies created by broker-dealers are at risk of being rolled back because of a long-simmering issue that is now approaching the boiling point and is riddled with industry conflicts of interest and tens of millions of dollars in wasted spending. And the only solution that remains is for the nation’s top securities regulator to take control of the self-regulators on this matter.
The issue at hand is a seemingly obscure securities market project known as the consolidated audit trail – or CAT. First proposed legislatively after the 2010 “Flash Crash,” the CAT would collect and identify every order, cancellation, modification and trade execution for all exchange-listed equities and options across all U.S. markets.
Despite the enormity of this technology project, industry support has been strong for the CAT. Market participants realize that a complete logging of trading activity would lead to enhanced regulatory protection, thereby boosting investor confidence, while potentially eliminating various legacy surveillance systems. The exchanges have devoted nearly a decade to trying to help structure the CAT, with hundreds of working group so-called “CAT calls” between committees of exchanges, creating dozens of specifications documents.
But missing in the meetings was the presence of savvy, in-the-trenches market technologists who know how to build out – and accurately price – such a vast endeavor. As a result, the project has been nothing short of a debacle. The shocking cost of this endeavor to date, with virtually nothing to show for it, is now priced at ten times the initial estimates. This includes an $80 million write-off for a failed launch of the CAT, only to be relaunched with a new vendor.
At the end of the day, retail investors and institutional investors – such as 529 college savings plans, pension funds and other retirement savings account plans, will be asked to help foot the bill.
The cause of this epic fiasco lies not in finger pointing but in process. The Securities and Exchange Commission (SEC) outsourced the project to the industry self-regulatory body, FINRA, and the national securities exchanges, to plan, implement, and maintain the CAT that would allow regulators to more efficiently and accurately track activity in U.S. equity and options markets. This process has put the exchanges in the impossible situation of having to develop a CAT fee structure to pass on costs to brokers, with no financial accountability to the exchanges themselves. Combine this with the dearth of industry input even allowed into the process, and we are left with one of the most expensive flops in securities market history.
The SEC has invited comments on a new proposed funding model for the CAT. At the very least, the commission should direct FINRA and the exchanges to conduct good faith outreach with the broader broker-dealer community to collaborate toward a transparent, workable and equitable alternative that mitigates against the inherent conflicts of interest, and grounds the costs in a way that resembles real-world, market costs of goods and services.
An even better solution is for the SEC itself take control of the situation and develop an effective CAT plan that the entire industry can rally around. The Commission has the infrastructure in place to do so through its many industry advisory committees, regulatory expertise and vast rule-making experience. The exchanges and FINRA have been dealt a bad hand and it’s time to reshuffle and re-deal the deck.
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Kirsten Wegner is the CEO of the Modern Markets Initiative, a Washington, D.C. -based non-profit organization for education and advocacy of innovation in the financial markets.
