Consensus says that the Securities and Exchange Commission’s approval of a rule creating a consolidated audit trail — CAT — is imminent. The rule will likely come before the end of the quarter but will not include a real-time data provision requirement. However, even after the rule’s approval, the building and implementing of the audit trail will be a long ways off.
After the rule is passed by the SEC, the self-regulatory organizations, exchanges and brokers will meet to discuss the rule’s provisions and agree on how to build the audit trail and pay for it. Industry professionals estimated this could take several months or even a year, stretching into 2013 before a final blueprint is constructed and approved. Then, perhaps in late 2013 or 2014, the CAT will be operational.
Creation of an audit trail is a top priority at the SEC. Currently, regulators do not have a single database of comprehensive and readily accessible trade data regarding orders and executions. The SEC now wants to get the trail up and running sooner rather than later, and is willing to drop, at least for the time being, its controversial real-time reporting requirement.
The SEC had issued a request for proposal for a data service provider that could give regulators a broad swath of real-time existing market data that is currently available. According to Brendon Weiss, vice president of legal and government affairs at NYSE Euronext, this RFP might help the SEC estimate the cost of building a CAT. The RFP is posted on the Internet.
"That is a baby step to collecting real-time data and may assist the Commission in determining the real cost of an audit trail," he said.
The CAT was originally proposed by the SEC on May 26, 2010, just 20 days after the "flash crash." The thinking behind the audit trail was to give regulators a central database of trade information to help them reconstruct trades during a turbulent event in the markets, like the flash crash. The information gathered from trades during an event would allow rule makers to analyze what happened and possibly help set up safeguards to prevent future occurrences.
Robert Colby, an attorney with Davis Polk & Wardwell and former deputy director of the SEC’s Division of Trading and Markets, believes CAT is coming soon. That’s because an audit trail is at the top of the SEC’s to-do list for the equity markets, he said.
"I’ve heard the rumors about it coming this quarter," Colby said, "and have been expecting it any day."
Other knowledgeable market sources echo Colby’s prediction that CAT is coming soon, perhaps with a final rule approved by the end of the first quarter. The SEC declined to comment.
After the rule is approved, there is still much work to be done before the audit trail is built and operating. Many details will still need to be worked out by the actual builders of the audit trail and the self-regulatory organizations. The two main questions? Who will provide the data and who will pay for CAT?
There is no certainty about what data the SEC will require for CAT, sources said. But, it is certain that costs will rise higher, the more data the SEC mandates in the audit trail.
Why? The SEC and the brokers and trading venues were at loggerheads over two main sticking points: whether the audit trail will provide data in real time and who will pay for the system. Industry professionals said real-time data provision will likely not be in the final rule, and SEC Chairman Mary Schapiro recently admitted as much.
"We’re going to be rational here because it’s really important to get this basic structure in place sooner than later," Schapiro said in an interview with The Wall Street Journal.
The SEC had been pushing for access to trade information immediately after the trade is executed. This would help speed up inquiries and provide answers in the shortest possible time. However, the SEC has estimated it would cost upward of $4.1 billion to build such a system and $2.1 billion annually to maintain it.
The brokers and trading venues countered that real-time data provision would be too costly and ultimately hurt investors. Many brokers and detractors wrote in comment letters that given the low-commission environment, the costs associated with building CAT would likely be passed on to consumers–either directly as a fee or in some sort of tax.
Schapiro said she now supports slowly speeding up reporting times once the system is finalized. Even if the dream of real-time reporting is not dead, it does not look like it will materialize anytime soon.
Still, the process of building CAT is not going to be easy. Many issues remain unresolved.
"Even after approval by the SEC, finalizing a CAT will not be an easy process," Colby said. "It could take a long time for the SROs to work out the details."
But the SEC has already begun to solicit vendors and other data providers on data availability and the cost by issuing an RFP back in December. However, if the SEC wants even more data than might be publicly and readily available to be included in CAT, then that is where things get more complex, NYSE’s Weiss said.
The industry initially gasped at the SEC’s astronomical price tag to create and operate the system. Several industry officials told Traders Magazine there are cheaper ways to build an audit trail, such as using an existing system such as OATs and adding more data functionality.
Weiss said one of the SEC’s goals for CAT was to be able to have individual identifier information for each participant in a trade. This would allow the regulators to get the trade information they need faster and without having to go through the brokers.
Currently, the SEC has to rely on the broker-dealers to provide the investor’s identity or go through the electronic blue sheets, which are requests for trade information sent out by the regulator to market makers, brokers and/or clearinghouses.
Some believe this is too cumbersome a process to go through every time the SEC gets a tip or sees something in the market they might want to review in more depth. If identifiers are included in CAT, regulators could access data faster and directly, rather than waiting for the broker to answer a request.
"The SEC can’t see through the broker to find out who is the end investor," Weiss said. "That information is a big part of what the audit trail is supposed to garner."
Davis Polk’s Colby added that the SEC will need to decide which of the wide variety of data types it proposed should be included in the final CAT. For example, the SEC proposed including types of so-called "soft data" in the CAT — examples are commission rates paid, subaccount allocations and short-sale borrow information.
More data translates into a higher overall cost. Even if CAT is created using an existing system as a base, such as the Financial Industry Regulatory Authority’s OATS system, the price tag still could be in the hundreds of millions. That would be a drag on the beleaguered industry participants, brokers and exchanges, Weiss said.
"Ultimately, it is difficult to say that the end investor won’t bear the cost of this system," he said. "The price tag to implement such a program as proposed by the Commission seems like it would result in a pass-through type fee."
One idea that has been discussed throughout the industry, he said, is whether or not a fee would be assessed on all message traffic.
Both Colby and Weiss said that with so many details yet to be ironed out, CAT won’t be up and running for a few years, perhaps as many as three, until all parties from the SEC to the SROs to the brokers can find common ground and agree on the details and costs.
"NYSE Euronext is supportive of a more comprehensive audit trail as a necessary step in improving the market structure and surveillance capabilities," Weiss said. "However, the SEC and industry need to work out the timing and structure in order to proceed with building it."
