Letting the CAT Out of the Bag

In her February keynote address at the annual Securities and Exchange Commission (SEC) Speaks conference in Washington, DC, SEC Chair Mary Jo White called the soon-to-be-developed Consolidated Audit Trail (CAT) "a game changer for monitoring and overseeing the market."
But five years after the Flash Crash, and several market dislocations later, efforts to implement the CAT ─ originally greenlighted by then-Chair Mary Schapiro in 2009 ─ have hit more delays than expected, threatening to impede its implementation for several years.
Today, due in no small part to media-fueled anxiety over the purported evils of high-frequency trading and dark pools, the investing public is still largely uncertain of the SEC's ability to monitor and actively regulate the US markets. And investor confidence is not the only threat to the health of the US markets ─ capital flight is also a growing risk, as reflected by Siemens' decision to delist its NYSE-listed ADRs in favor of Germany-based exchanges. That decision came on the heels of aggressive SEC enforcement actions against the company and its officials.

Regulating the Street
In fact, during the post-financial crisis years, the SEC has leveraged its exam and enforcement resources as its primary means to regulate Wall Street. Two of the message cases brought by the SEC's Market Abuse Unit in tandem with the Office of Market Oversight have included: the Facebook IPO matter intricately detailing the technical issues that occurred during the IPO launch; and the Knight Capital fiasco, claiming that Knight failed to maintain controls over its automated order routing system. Further, on the heels of the Liquidnet action alleging misuse of subscriber data, SEC officials have promised future actions alleging manipulative trading practices in dark pools and increased enforcement of the market access rule.

Missing Matters
Though impressive, these actions capture only entity-centric or venue-centric conduct. Missing are matters alleging cross-market manipulations. One can only imagine what will become apparent to regulators with granular, lifecycle transaction data that is clock synchronized across markets ─ data the CAT will ultimately deliver. This unparalleled data trove will enable the SEC to pivot away from its enforcement-heavy focus and move toward modern, effective market regulation. More importantly, in the hands of the exchanges, the CAT will provide a means for accomplishing unprecedented self-regulation, allowing the SROs to autonomously identify and investigate anomalous patterns and suspicious events which pose threats not only to their specific venues, but more broadly to the fair and orderly operation of the National Market System.

Mixed Signals
Recently, however, the SEC has been sending mixed signals as to how the CAT fits into its future. In November, the SEC touted the adoption of Regulation SCI ─ which primarily codifies the industry's already existent duty to act prudently when attaching automated systems to the markets ─ as "marking an historic shift in regulation." Notably, in the 743-page adopting release, there is only a passing footnoted reference to the CAT. Further troubling signs came in February, during a panel presentation on order routing, where an SEC academic commented that proactive measures such as the CAT may be premature because "the problem is that no one's actually defined the problem," leaving one to wonder whether those in charge of the SEC's regulatory and analytical divisions are speaking a different language than the boots on the ground.
A properly implemented CAT ─ one that accommodates "drop copy" reporting of multiple message formats ─ will insure against future obsolescence, be compatible with industry innovations, accommodate additional asset classes as they are added, and permit the seamless integration of other regulatory obligations into its platform, such as large trader reporting. If done right, the CAT will also cut costs by paving the way for the retirement of systems with limited use such as the SEC's top-of-book data aggregation feed known as "MIDAS," antiquated systems like electronic bluesheets, and ineffective systems such as Finra's Order Audit Trail System.

Fending Off
Moreover, if CAT can be implemented expeditiously, industry efforts to fend off Finra's stop-gap measure known as CARDS, should be successful. According to the trade group SIFMA, CARDS would bear a projected price-tag of over $1 billion in its first year alone: $680 million to build and more than $360 million per annum to maintain. That is substantially more than any of the competitive bids to build and operate the CAT for the first five years. And despite its hefty price-tag, CARDS' proposed functionality would be subsumed by a fully-implemented CAT. A number of industry experts, members of Congress, and one outspoken SEC Commissioner, Michael Piwowar, have echoed these concerns, describing the CARDS proposal as "superfluous," "duplicative," and imposing "significant costs," at least in part because the "CAT is on the horizon."

One can only imagine what will become apparent to regulators with granular, lifecycle transaction data that is clock synchronized across markets ─ data the CAT will ultimately deliver. This unparalleled data trove will enable the SEC to pivot away from its enforcement-heavy focus and move toward modern, effective market regulation.

Vocal
Within the past year, Senator Mark Warner has also been vocal in his views concerning the SEC's participation in the CAT process, telling Chair White that the SEC must be proactive during CAT development efforts. In response, White told the Senator that the SEC had assigned a senior staff person to oversee the effort, as well as an industry expert to "supplement" the staff and "assist the Commission in its evaluation of the SRO's recommendations." Since then, however, there has been no additional public information on the activities of these individuals or the SEC's progress in actually appointing an independent, dedicated CAT czar.
The industry can only hope that the SEC will promptly select an individual who is empowered to assume a meaningful role in all phases of the CAT development process.
An empowered CAT czar would be best positioned to resolve the logistical obstacles currently affecting the CAT's development, and, ultimately, its implementation. Additionally, a CAT czar would provide comfort to the SROs in taking routine procedural steps without first obtaining formal approval from the SEC (which often takes months even in ideal settings). Finally, effective coordination through a CAT czar would help quell a series of critiques from industry observers that the decision to choose a processor is taking too long, that momentum for the project is flagging, and that conflicts of interest have been allowed to infiltrate the process.

Components
The fundamental components of effective markets are liquidity, transparency and fairness. But without a proactive SEC working hand-in-hand with industry to expeditiously build the CAT and perfect cross-market surveillance, public confidence remains at risk as the media and other commentators continue to compare our markets to casinos. And given these dynamics, the investing public may ultimately be persuaded. After all, in Vegas, the odds ─ and the house rules ─ are clearly posted.

Thomas Sporkin, a partner in BuckleySandler's Washington, D.C. office, previously served as a senior US Securities and Exchange Commission official. He currently represents individuals and entities in matters before the SEC, self-regulatory organizations, and other federal and state agencies. Until his departure from the SEC in June 2012, he served on the SEC's Consolidated Audit Trail rule writing team.
Timothy J. Coley is an associate in the firm's Washington, D.C. office and focuses on government investigations and enforcement actions, capital markets, and complex litigation.
BuckleySandler LLP is part of the CATPRO consortium, including partners Hewlett Packard, Booz Allen, and J. Streicher Analytics. CATPRO is one of six bidders seeking to build and operate the CAT.