In like a Lion… CAT claws its way to compliance

Late on Tuesday, November 14th, Wall Street history was made when the SEC declined requests from exchanges to delay the implementation of Rule 613 — or the CAT (Consolidated Audit Trail). Originally, the 20 Self-Regulatory Organizations (or SROs) were supposed to go live on November 15, 2017. These would then be followed by large Broker-Dealers in 2018, and smaller B/Ds the next year. Exchanges were required to begin feeding trading data into CAT by November 15th, but many are not completely ready to comply. Word on the Street is that many players are waiting and watching to see if the SEC will come through with a compromise to push back the date for compliance.

For sure there is a fair amount of confusion around CAT, and it is still unclear if not complying could result in fines from regulatory bodies like the SEC. In the meantime, the Financial Services Industry is still convinced that their arguments to delay the rule for one year are legitimate. Many on the Street believe that the denial of the delay is perhaps the SEC strong arming SROs to lessen their delay demands. Clarity has been hazy as the industry waits with bated breath for the outcome of this monumental event. The story unfolded like this…

Scrambling for a Plan

Well, it’s not like the SEC could ignore the 2010 Flash Crash. The Crash pummeled the stock market which experienced an unparalleled $1 Trillion loss within minutes, only to be followed by a soaring rebound that largely erased the fall. The incident shook the integrity of the market to its core. Worse yet, it took months for regulators to amass and analyze the data needed to uncover the root cause of the phenomenon. The event left the SEC scrambling for an explanation, as well as a plan to promise global markets it would never happen again. Thus Rule 613, the Consolidated Audit Trial (CAT), was born.

Rule 613 sounded like a good idea. The CAT database would process roughly 58 Billion records daily, giving regulators all the data needed to reconstruct markets and analyze the life cycle of individual trades. This new system would both allow regulators to quickly uncover the reasons for a massive price swing, as well as help identify manipulative or unlawful trading operations. As a result, the SEC would finally have the full picture of a trade lifecycle which is what they wanted. No more opaque markets too filled with trading too chaotic to decipher — just the crystalline and complete view of actions and re-actions of which regulators dream.

CAT Complaints

Beware the Breach

But the seams of this well woven plan started to come undone as the date for compliance crept closer. The first major tear began when the SEC revealed its corporate filings database, the EDGAR system, had been compromised just as consumer credit agency Equifax had been hacked. Industry participants quickly took the opportunity to suggest that the SEC should conduct a full review of its systems. Cyber-security risks, they said, were too high to rush into the implementation of the largest depository for securities trading the world has ever seen. Their view was that the dangers to markets and investors alike, posed too much of a risk to move forward with the first of the compliance deadlines.

Let’s Get Personal

And that’s not all. Many industry executives are wary of plans to include investors’ personal identifiable data, such as Social Security numbers and Dates of Birth, in reporting requirements. Exchanges complained that demanding highly sensitive personal information on every person who trades equity markets through time, is just asking too much. To address these concerns, SEC Chairman Jay Clayton said his agency was conducting a review to make sure the agency wasn’t collecting unnecessary personal information. He attempted to calm the crowd by insisting the SEC will not retrieve sensitive information from the CAT unless “we believe appropriate protections are in place,” Clayton said, “and unless the information was needed for our mission”.

Funding the Unfathomable

Funding of the project has also caused turmoil. Financial participants including broker-dealers and the exchanges have complained about the fees they are required to pay to cover the cost of CAT. Plagued by disagreement, the actual implementation of Rule 613 started to seem more and more remote — but no such luck. Although Stock Exchanges and industry participants implored the SEC to delay the roll out of the new system, based on the initial response from the SEC it seems to have been in vain. Regulators may have felt a further delay of the program, which is already approaching eight years in the making, would add to wavering confidence in the SEC, as well as in the project.

While the current market situation is causing uncertainty, CAT is currently upon us. The trick now is for Financial Services firms to find a way to make lemonade out of regulatory lemons. Could CAT actually be a good thing for the industry at large? It’s time for participants to ponder the pros of CAT.