Jake Thomases: A Step in the Right Direction

It’s a rare piece of regulation that makes the regulated entities nod their heads in agreement and say, “Yep, that was necessary, and we look forward to complying.” Thus far, that has been the universal response to July’s decision by the US Securities and Exchange Commission (SEC) to require national securities exchanges and the Financial Industry Regulatory Authority (Finra) to establish a plan for the creation of a consolidated audit trail (CAT). Considering that no piece of regulation which followed the 2008 financial crisis generated this much positive energy, you have to figure the SEC really got this one right.

Rule 613 forces Finra and the exchanges to collaboratively develop, implement, and maintain a single CAT that would capture every equity and equity options order, as well as order cancellations and modifications, across all US exchanges.

The goal is to give regulators the ability to monitor and analyze trading activity market-wide, with an eye toward detecting financial crime and unraveling the cause of disastrous events like the Flash Crash of May 6, 2010.

“NYSE Euronext strongly supports the decision by the US Securities and Exchange Commission to establish a consolidated audit trail for the trading of national market system securities that will assist regulators in reconstructing market events and monitoring for market abuse,” says NYSE Euronext COO Larry Leibowitz. “Technological and market structure evolution have created a complex and fragmented environment where comprehensive intermarket surveillance across all national market system (NMS) markets is essential to ensuring the overall integrity of our nation’s equities markets and the confidence of investors in those markets.”

Echoed Support
A Nasdaq official echoes that support. So does Direct Edge and Finra. All use words like “market integrity” and “investor confidence.” None say the SEC went too far. None talk about unintended consequences, or limiting the free market, or Big Brother, or use any of the usual dog whistles.

Slipping equity volumes caused by a loss of investor confidence is one reason why exchanges are willing to make sacrifices to bring investors back into the fold. Another reason for their largesse might be the mixed feelings many of them still have about high-frequency trading (HFT), which Nasdaq and Direct Edge recently made efforts to curb.

“In carrying out their responsibilities, regulators must be able to corral this vast amount of disparate data in a way that allows us to monitor, correlate, and analyze a vast stream of market events and transactions,” says SEC chair Mary Schapiro.

After the Flash Crash, HFT was the butler with the bloody candlestick and no alibi—in other words, the lead suspect. Unwinding the trading activity of all those high-frequency market-makers over just a few hours was a four-month process that took dozens of regulators. They had to sift through disparate audit trails that are currently maintained individually by Finra and the exchanges, finding data that was not only mismatched but at times inaccurate and inaccessible.

In addition to being able to reconstruct events, the SEC says a consolidated audit trail will enable it to better investigate market manipulation, insider trading, and other nefarious activities. It also wants to look into the new data pool and see its own reflection—that is, evaluate how its own rules are affecting the trading patterns of broker-dealers. And by combining all trade data into one feed, it would be forced to submit fewer ad hoc requests to market participants and reduce some of their reporting burdens.

The only dispute is over the next trading day reporting requirement for broker-dealers. Let’s hope the lack of a real-time requirement doesn’t end up scuttling the investigation after the next Flash Crash. I’d hate to lose these warm-and-fuzzies.