[Federal Register Volume 77, Number 148 (Wednesday, August 1, 2012)]
[Rules and Regulations]
[Pages 45721-45814]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-17918]
[[Page 45721]]
Vol. 77
Wednesday,
No. 148
August 1, 2012
Part II
Securities and Exchange Commission
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17 CFR Part 242
Consolidated Audit Trail; Final Rule
Federal Register / Vol. 77, No. 148 / Wednesday, August 1, 2012 /
Rules and Regulations
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-67457; File No. S7-11-10]
RIN 3235-AK51
Consolidated Audit Trail
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting Rule 613 under the Securities Exchange Act of 1934 (``Exchange
Act'' or ``Act'') to require national securities exchanges and national
securities associations (``self-regulatory organizations'' or ``SROs'')
to submit a national market system (``NMS'') plan to create, implement,
and maintain a consolidated order tracking system, or consolidated
audit trail, with respect to the trading of NMS securities, that would
capture customer and order event information for orders in NMS
securities, across all markets, from the time of order inception
through routing, cancellation, modification, or execution.
DATES: Effective Date: October 1, 2012.
FOR FURTHER INFORMATION CONTACT: Rebekah Liu, Special Counsel, at (202)
551-5665; Jennifer Colihan, Special Counsel, at (202) 551-5642; Carl
Tugberk, Special Counsel, at (202) 551-6049; or Leigh Duffy, Special
Counsel, at (202) 551-5928, Division of Trading and Markets, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Executive Summary
II. Introduction
A. Need for, and Objectives of, a Consolidated Audit Trail
1. Use and Limitations of Current Sources of Trading Data
2. Regulatory Improvements With a Consolidated Audit Trail
3. Large Trader Reporting System Rule
B. Summary of Proposed Rule 613
C. Summary of General Comments on the Proposed Rule
1. Industry Support for a Consolidated Audit Trail
2. Commenters' Views on the Overall Costs of the Proposed Rule
and the Resulting Framework of the Adopted Rule
3. Comments on the Process for Creating a Consolidated Audit
Trail
4. Comments on Alternatives to the Proposed Consolidated Audit
Trail
III. Discussion
A. NMS Plan
1. Description of the Rule
B. Elements of the NMS Plan
1. Recording and Reporting
2. Central Repository
3. Other Required Provisions of the NMS Plan
C. NMS Plan Process
1. Comments on the NMS Plan Process
2. Adopted Rule
3. NMS Plan Costs
4. Consideration of Burden on Competition and Promotion of
Efficiency, Competition, and Capital Formation
D. Implementation of Rule 613 After Approval of the NMS Plan
IV. Paperwork Reduction Act
A. Summary of Collection of Information Under Rule 613
B. Use of Information
C. Respondents
D. Total Annual Reporting and Recordkeeping Burden for the
Creation and Filing of the NMS Plan
1. Preliminary Burden Hour Estimates From Proposing Release
2. Revised Burden Hour Estimates
E. Collection of Information Is Mandatory
F. Confidentiality
G. Retention Period of Recordkeeping Requirements
V. Regulatory Flexibility Act Certification
VI. Statutory Authority
I. Executive Summary
In today's high-speed electronic markets, trading is widely
dispersed across a variety of market centers, including exchanges,
Alternative Trading Systems (``ATSs''), such as dark pools and
Electronic Communication Networks (``ECNs''), and over-the-counter
broker-dealers acting as market makers or block positioners. In their
capacity as SROs, the Financial Industry Regulatory Authority
(``FINRA'') and some of the exchanges currently maintain their own
separate audit trail systems for certain segments of this trading
activity, which vary in scope, required data elements and format. In
performing their market oversight responsibilities, SRO and Commission
staffs today must rely heavily on data from these various SRO audit
trails.
As discussed more fully in part II.A below, there are shortcomings
in the completeness, accuracy, accessibility, and timeliness of these
existing audit trail systems. Some of these shortcomings are a result
of the disparate nature of the systems, which make it impractical, for
example, to follow orders through their entire lifecycle as they may be
routed, aggregated, re-routed, and disaggregated across multiple
markets. The lack of key information in the audit trails that would be
useful for regulatory oversight, such as the identity of the customers
who originate orders, or even the fact that two sets of orders may have
been originated by the same customer, is another shortcoming.
Though SRO and Commission staff also have access to sources of
market activity data other than SRO audit trails, these systems each
suffer their own drawbacks. For example, data obtained from the
Electronic Blue Sheet (``EBS'') \1\ system and equity cleared reports
\2\ comprise only trade executions, and not orders or quotes. In
addition, like data from existing audit trails, data from these sources
lacks key elements important to regulators, such as the time of
execution, and, in the case of equity cleared reports, the identity of
the customer. Furthermore, recent experience with implementing
incremental improvements to the EBS system has illustrated some of the
[[Page 45723]]
overall limitations of the current technologies and mechanisms used by
the industry to collect, record, and make available market activity
data for regulatory purposes.\3\
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\1\ EBSs are trading records requested by the Commission and
SROs from broker-dealers that are used in regulatory investigations
to identify buyers and sellers of specific securities. See
Securities Exchange Act Release No. 44494 (June 29, 2001), 66 FR
35836 (July 9, 2001) (File No. S7-12-00) (adopting Rule 17a-25). See
also Securities Exchange Act Release Nos. 26235 (November 1, 1988),
53 FR 44688 (November 4, 1988) (approving the Chicago Board Options
Exchange's (``CBOE'') rule for the electronic submission of
transaction information); 26539 (February 13, 1989), 54 FR 7318
(February 17, 1989) (approving the National Association of
Securities Dealers' (n/k/a FINRA) rule for the electronic submission
of transaction information); and 27170 (August 23, 1989), 54 FR
37066 (September 6, 1989) (approving the Philadelphia Stock
Exchange's (n/k/a NASDAQ OMX PHLX LLC) (``Phlx'') rule for the
electronic submission of transaction information).
To partially address some of the current limitations of the EBS
system, and to provide the Commission, in the short term, with more
detailed and timely trade information for large traders, the
Commission recently adopted new Rule 13h-1 concerning large trader
reporting. See Securities Exchange Act Release No. 61908 (July 27,
2011), 76 FR 46960 (August 3, 2011) (``Large Trader Release''). Rule
13h-1 requires ``large traders'' to identify themselves to the
Commission and make certain disclosures to the Commission on Form
13H. As adopted, Rule 13h-1 requires certain broker-dealers to
capture and report through EBS the time of execution for any trade
involving a large trader and a Commission-issued large trader
identifier that identifies the large trader. See also Section
II.A.3., infra.
On April 20, 2012, the Commission, among other things, extended
the time by which registered broker-dealers were required to comply
with Rule 13h-1 to allow broker-dealers additional time to develop,
test, and implement enhancements to their recordkeeping and
reporting systems as required under Rule 13h-1. See Securities
Exchange Act Release No. 66839, 77 FR 25007 (April 26, 2012) (Order
Temporarily Exempting Broker-Dealers From the Recordkeeping,
Reporting, and Monitoring Requirements of Rule 13h-1 Under the
Securities Exchange Act of 1934 and Granting an Exemption for
Certain Securities Transactions) (``Large Trader Extension'').
\2\ The Commission uses the National Securities Clearing
Corporation's (``NSCC'') equity cleared report for initial
regulatory inquiries. This report is generated on a daily basis by
the SROs and is provided to the NSCC in a database accessible by the
Commission, and shows the number of trades and daily volume of all
equity securities in which transactions took place, sorted by
clearing member. The information provided is end-of-day data and is
searchable by security name and CUSIP number.
\3\ See Large Trader Extension, supra note 1.
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The Commission therefore believes that the regulatory data
infrastructure on which the SROs and the Commission currently must rely
generally is outdated and inadequate to effectively oversee a complex,
dispersed, and highly automated national market system. In performing
their oversight responsibilities, regulators today must attempt to
cobble together disparate data from a variety of existing information
systems lacking in completeness, accuracy, accessibility, and/or
timeliness--a model that neither supports the efficient aggregation of
data from multiple trading venues nor yields the type of complete and
accurate market activity data needed for robust market oversight.
To address this problem and improve the ability of the SROs and the
Commission to oversee the securities markets, on May 26, 2010, the
Commission proposed Rule 613,\4\ with the goal of creating a
comprehensive consolidated audit trail \5\ that allows regulators to
efficiently and accurately track all activity in NMS securities
throughout the U.S. markets. As proposed--and summarized in part II.B
below--Rule 613 required SROs to jointly submit an NMS plan \6\ that
would govern the creation, implementation, and maintenance of a
consolidated audit trail, including a central repository to receive and
store consolidated audit trail data. In the proposed Rule, the
Commission specified many requirements that the NMS plan, and by
extension the consolidated audit trail, must meet, ranging from details
of the data elements to be collected, to the timing of data
transmissions, to specific standards for data formatting.
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\4\ See Securities Exchange Act Release No. 62174 (May 26,
2010), 75 FR 32556 (June 8, 2010) (``Proposing Release''). The
comment file is on the Commission's Web site at: http://www.sec.gov/comments/s7-11-10/s71110.shtml.
\5\ In this release, ``consolidated audit trail'' means both a
system capable of capturing a complete record of all transactions
relating to an order, from origination to execution or cancellation,
and the complete record for an order generated by such a system, as
the context may require.
\6\ NMS plan is defined in Rule 600(b)(43) to mean ``any joint
self-regulatory organization plan in connection with: (i) [t]he
planning, development, operation or regulation of a national market
system (or a subsystem thereof) or one or more facilities thereof;
or (ii) [t]he development and implementation of procedures and/or
facilities designed to achieve compliance by self-regulatory
organizations and their members with any section of [Regulation NMS]
* * *.'' 17 CFR 240.600(b)(43). Such NMS plan may be subject to
modification prior to approval by the Commission pursuant to Rule
608 of Regulation NMS, as discussed in Section III.C.2.a.v., infra.
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Among its various requirements, the proposed Rule mandated that the
NMS plan developed by the SROs must in turn require each SRO and its
members to capture and report specified trade, quote, and order
activity in all NMS securities \7\ to the central repository in real
time, across all markets, from order inception through routing,
cancellation, modification, and execution. The proposed Rule also
mandated that the NMS plan require the creation of unique order
identifiers to facilitate the ability of regulators to view cross-
market activity, as well as unique customer identifiers to enhance the
ability of regulators to reliably and efficiently identify the
beneficial owner of the account originating an order or the person
exercising investment discretion for the account originating the order,
if different from the beneficial owner.
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\7\ ``NMS security'' is defined in Rule 600(a)(46) of Regulation
NMS to mean ``any security or class of securities for which
transaction reports are collected, processed, and made available
pursuant to an effective transaction reporting plan, or an effective
national market system plan for reporting transactions in listed
options.'' 17 CFR 242.600(a)(46). NMS stock is defined in Rule
600(47) to mean ``any NMS security other than an option.'' 17 CFR
242.600(a)(46). A listed option is defined in Rule 600(a)(35) of
Regulation NMS to mean ``any option traded on a registered national
securities exchange or automated facility of a national securities
association.'' 17 CFR 242.600(a)(35).
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The Commission received 64 comment letters from 56 commenters in
response to the proposed consolidated audit trail representing a wide
range of viewpoints, as summarized in part II.C below.\8\ The
commenters included national securities exchanges, a national
securities association, technology providers, academics, broker-
dealers, organizations representing industry participants, individual
investors, and members of Congress.\9\ Of the comment letters received,
13 expressed support for the proposal; \10\ 36 expressed support, but
suggested modifications to certain provisions of the proposal; \11\
five solely suggested modifications to the proposal; \12\ two opposed
the proposal; \13\ and seven neither supported nor opposed the
substance of the proposal.\14\ Concerns raised in these comment letters
included: (1) The appropriateness of real-time reporting of required
data to the central repository; \15\ (2) the scope of the required data
elements, including the use of unique order identifiers and unique
customer identifiers; \16\ and (3) the burden and costs associated with
the proposal.\17\ In addition, a number of commenters offered
alternative approaches and made suggestions regarding the creation,
implementation, and maintenance of the consolidated audit trail.\18\
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\8\ See Exhibit A for a citation key to the comment letters
received by the Commission on the proposed rule. The Commission also
received four comment letters that do not address the substance of
the consolidated audit trail proposal. See Ericson Letter; Kondracki
Letter; Grady Letter; Deep Liquidity Letter.
\9\ The Commission notes that, in some cases, commenters fell
into more than one such category.
\10\ See Vannelli Letter; Beach Letter; Foothill Letter; Green
Letter; Wealth Management Letter; McCrary Letter; Anastasopoulos
Letter; Triage Letter; FTEN Letter; Middle Office Letter; Correlix
Letter; Lettieri Letter; Bean Letter.
\11\ See ICI Letter; Thomson Reuters Letter; Scottrade Letter;
Liquidnet Letter; FINRA/NYSE Euronext Letter; BOX Letter; Nasdaq
Letter I; Nasdaq Letter II; TIAA-CREF Letter; GETCO Letter; BATS
Letter; SIFMA Letter; SIFMA February 2012 Letter; CBOE Letter;
Direct Edge Letter; Angel Letter; IAG Letter; Managed Funds
Association Letter; Mansfield Letter; Marketcore Letter; Kumaraguru
Letter; Ameritrade Letter; FINRA Letter; Wells Fargo Letter; Noetic
Partners Letters; Knight Letter; FIF Letter; FIF Letter II; Albany
Letter; Endace Letter; Ross Letter; FINRA Proposal Letter; Schumer
Letter; FIA Letter; STA Letter; Van Bokkelen Letter.
\12\ See Belanger Letters; SIFMA Drop Copy Letter; Wachtel
Letter; High Speed Letter (recommending next steps in the
development of the consolidated audit trail).
\13\ See BondMart Letter; Leuchtkafter Letter.
\14\ See Broadridge Letter; FIX Letter; Know More Letter; Aditat
Letter; iSys Letter; Kaufman Letter; Berkeley Letter.
\15\ See Scottrade Letter, p. 1; ICI Letter, p. 4-6; FINRA/NYSE
Euronext Letter, p. 4; GETCO Letter, p. 2; BATS Letter, p. 1-2;
SIFMA Letter, p. 3-8; SIFMA February 2012 Letter, p. 1; CBOE Letter,
p. 4-5; Direct Edge Letter, p. 3; FINRA Letter, p. 10-13; Wells
Fargo Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter;
Broadridge Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy Letter,
p. 1; Ross Letter, p. 1; FINRA Proposal Letter, p. 3; FIA Letter, p.
1-2.
\16\ See Ameritrade Letter, p. 3; Kumaraguru Letter, p. 1; FINRA
Proposal Letter, p. 6-8, 13 and Appendix A.; Angel Letter, p. 2-3;
Managed Funds Association Letter, p. 2; SIFMA Letter, p. 11-12, 14;
SIFMA Drop Copy Letter, p. 2; Liquidnet Letter p. 6-7; FINRA Letter,
p. 4, 7-9; CBOE Letter, p. 2; Knight Letter, p. 2; Scottrade Letter,
p. 1; DirectEdge Letter, p. 3; FIF Letter, p. 2-3, 6-7; FIF Letter
II, p. 2; BOX Letter, p. 2; Wells Fargo Letter, p. 3; Ross Letter,
p. 1; ICI Letter, p. 3; Thomson Reuters Letter, p. 3; Endace Letter,
p. 1-2; GETCO Letter, p. 4.
\17\ See Thomson Reuters Letter, p. 2; Liquidnet Letter, p. 1;
CBOE Letter, p. 2, 4-5; Nasdaq Letter I, p. 2; Angel Letter, p. 1-2;
IAG Letter, p. 3.; Kaufman Letter, attachment p. 3; Wells Fargo
Letter, p. 3-4; Noetic Partners Letter, p. 2; Leuchtkafer Letter, p.
1-5; Broadridge Letter, p. 3; FINRA Proposal Letter, p. 2-3.; High
Speed Letter, p. 1; Belanger Letter, p. 7-8; Correlix Letter, p. 2.;
FTEN Letter, p. 13; SIFMA Letter, p.1-8, 15-16; FINRA/NYSE Euronext
Letter, p 4, 7; FINRA Letter, p. 3, 10-13; Scottrade Letter, p. 1;
ICI Letter, p. 4-6; GETCO Letter, p. 2; BATS Letter, p. 1-2; Direct
Edge Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter;
Broadridge Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy Letter,
p. 1; Ross Letter, p. 1; SIFMA February 2012 Letter; FIA Letter, p.
1-2; Noetic Partners Letter II, p. 2; High Speed Letter, p. 1.
\18\ See FINRA Proposal Letter; Angel Letter, p. 3; BOX Letter,
p. 2; BATS Letter, p. 2; CBOE Letter, p. 2-3; SIFMA Letter, p. 16-
18; Wells Fargo Letter, p. 2; Knight Letter, p. 3; FIF Letter, p. 5-
6; Schumer Letter, p. 1; FIF Letter, p. 1-3; FINRA Letter, p. 3, 6;
FINRA/NYSE Euronext Letter, p. 8, 14; SIFMA Drop Copy Letter.
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In consideration of the views expressed, suggestions for
alternatives, and other information provided by those commenting on the
proposed Rule, the Commission is adopting Rule 613 with significant
modifications to the proposed requirements for the NMS plan submitted
to the Commission for its consideration. In certain instances these
modifications alter the data and collection requirements of the
proposed Rule. In other instances, the adopted Rule has been altered to
be less prescriptive, and hence less limiting, in the means SROs may
use to meet certain requirements. Some of the more significant changes
are as follows:
Replacing Real-Time Reporting with a Requirement to Report
Data by 8 a.m. of the Next Trading Day. The adopted Rule no longer
requires that the NMS plan provide for the reporting of order event
data \19\ to the central repository in real time; rather, it provides
that the NMS plan must require the reporting of order event data to the
central repository by 8 a.m. Eastern Time on the trading day following
the day such information has been recorded by the SRO or the
member.\20\ The NMS plan may accommodate voluntary submissions of order
event data prior to 8 a.m. on the following trading day, but it may not
mandate a reporting deadline prior to 8 a.m.
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\19\ As used herein, the term ``order event data'' is used to
refer to the information reported pursuant to Rule 613(c)(3) and
identified in Rule 613(c)(7)(i) through (v), generally including:
(1) The Customer-ID(s) for each customer, including the person
giving a modification or cancellation instruction; (2) the CAT-
Order-ID; (3) the CAT-Reporter-ID of the broker-dealer, national
securities exchange, or national securities association receiving,
originating, routing, modifying, cancelling or executing an order,
and to which an order is being routed; (4) the identity and nature
of the department or desk to which an order is routed, if routed
internally at the broker-dealer; (5) the date an order was received,
originated, routed, modified, cancelled, or executed; (6) the time
an order was received, originated, routed, modified, cancelled, or
executed; (7) material terms of an order and any changes of such
terms, if modified; (8) the price and remaining size of an order, if
modified; (9) execution capacity (principal, agency, riskless
principal); (10) execution price and size; and (11) whether the
execution was reported pursuant to an effective transaction
reporting plan or the Plan for Reporting of Consolidated Options
Last Sale Reports and Quotation Information (``OPRA''). See Section
III.B.1.d., infra. Information reported pursuant to Rule 613(c)(4)
and identified in Rule 613(c)(7)(vi) through (viii) is referred to
as ``supplemental data.''
\20\ See Rule 613(c)(3); Sections II.A., III.B.1.e., infra.
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Providing More Flexibility to Determine the Format of Data
Reported to the Central Repository. The proposed Rule mandated that the
NMS plan require the SROs and their members to collect and provide to
the central repository the required order and event information in a
uniform electronic format. The adopted Rule instead allows the SROs to
determine the details of how market participants would transmit data to
the central repository (which might include multiple electronic
formats, rather than a uniform electronic format), subject to a more
general requirement that data must be transmitted in a manner that
ultimately allows the central repository to make this data available to
regulators in a uniform electronic format.\21\
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\21\ See Rule 613(c)(2); Sections III.B.1.f., III.B.2., infra.
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Eliminating the Requirement to Report Orders with a Unique
Order Identifier. The proposed Rule mandated that each order reported
to the central repository be tagged with a unique identifier that is
the same throughout the order's entire lifecycle. In the adopted Rule,
this requirement is replaced with a more general requirement that once
all order events are transmitted to the central repository, the
repository must be able to efficiently and accurately link together all
lifecycle events for the same order, and make available to regulators
this linked order data.\22\
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\22\ See Rule 613(j)(1); Section III.B.1.d.iv., infra.
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Extending the Compliance Period for Small Broker-Dealers.
Under the adopted Rule, the NMS plan may provide that small broker-
dealers be allowed up to three years, rather than two years as
proposed, from the effectiveness of the NMS plan to provide the
required data to the consolidated audit trail.\23\
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\23\ See Rule 613(a)(3)(vi); Section III.B.1.c., infra.
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In addition to the above modifications, the Commission has also
added a number of new requirements to the adopted Rule in response to
general concerns expressed by commenters regarding the process for the
development and implementation of the NMS plan. Some of the more
significant of these additions are as follows:
Considering and Explaining Choices and Available
Alternatives. The adopted Rule requires that the NMS plan describe and
discuss any reasonable alternative approaches to the creation of the
consolidated audit trail that were considered by the SROs and why the
approach set forth by the NMS plan was selected.\24\
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\24\ See Rule 613(a)(1)(xii); Section III.C.2.a., infra.
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Planning for Future System Efficiencies. The adopted Rule
requires that the NMS plan provide a plan to eliminate existing rules
and systems (or components thereof) that are rendered duplicative by
the consolidated audit trail, including identification of such rules
and systems (or components thereof). Further, to the extent that any
existing rules or systems related to monitoring quotes, orders, and
executions provide information that is not rendered duplicative by the
consolidated audit trail, such plan must also include an analysis of
(1) whether the collection of such information remains appropriate, (2)
if still appropriate, whether such information should continue to be
separately collected or should instead be incorporated into the
consolidated audit trail, and (3) if no longer appropriate, how the
collection of such information could be efficiently terminated.
Finally, such plan must also discuss the steps the plan sponsors
propose to take to seek Commission approval for the elimination of such
rules and systems (or components thereof); and a timetable for such
elimination, including a description of how the plan sponsors propose
to phase in the consolidated audit trail and phase out such existing
rules and systems (or components thereof).\25\
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\25\ See Rule 613(a)(1)(ix); Section III.C.2.a., infra.
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Considering Input. The adopted Rule requires the NMS plan
to address the process by which the plan sponsors solicited views of
their members and other appropriate parties regarding the creation,
implementation, and maintenance of the consolidated audit trail,
provide a summary of the views of such members and other parties, and
describe how the plan sponsors took such views into account in
preparing the NMS plan.\26\ In addition, the adopted Rule also requires
the NMS plan to provide for the establishment of an Advisory Committee
whose function will be to advise the plan sponsors on the
implementation, operation, and administration of the central
repository.\27\
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\26\ See Rule 613(a)(1)(xi).
\27\ See Rule 613(b)(7). For a further discussion of the
composition of the Advisory Committee, see Section III.B.3.b.,
infra.
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Periodic Reviews of the Consolidated Audit Trail. To help
assure the Commission that as financial markets evolve and new
technologies emerge, the consolidated audit trail remains a useful
regulatory tool, the adopted Rule mandates that the NMS plan must
require the central repository's Chief Compliance Officer to regularly
review the operations of the consolidated audit trail, and, in light of
[[Page 45725]]
market and technological developments, make appropriate recommendations
for enhancements to the consolidated audit trail.\28\
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\28\ See Section III.B.2., infra.
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The Commission has also added certain requirements to the adopted
Rule in response to specific concerns expressed by commenters with
respect to the use of consolidated audit trail data. Some of the more
significant of these additions are as follows:
Enhancing Security and Privacy Requirements. Commenters
have expressed concerns regarding the risk of failing to maintain
appropriate controls over the privacy and security of consolidated
audit trail data. Accordingly, the adopted Rule requires the NMS plan
to include additional policies and procedures that are designed to
ensure the rigorous protection of confidential information collected by
the central repository.\29\
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\29\ See Rule 613(e)(4).
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Addressing and Limiting Errors. Commenters have also
expressed concerns about the potential for errors in the consolidated
audit trail; the adopted Rule requires the SROs to provide in their NMS
plan detailed information regarding anticipated error rates as well as
the plan's proposed error correction process.\30\
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\30\ See Rule 613(e)(6); Section III.B.2., infra.
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The Commission generally believes that the collective effect of the
modifications and additions described above will be to significantly
expand the set of solutions that could be considered by the SROs for
creating, implementing, and maintaining a consolidated audit trail and
to provide the SROs with increased flexibility in how they choose to
meet the requirements of the adopted Rule, relative to the alternatives
that would have been available under the requirements of the proposed
Rule. The Commission further believes that these changes address or
mitigate the principal concerns raised by commenters--including
concerns regarding the extent and cost of the systems changes required
by the SROs and their members--while continuing to enable the SROs and
the Commission to achieve significant benefits from the consolidated
audit trail.\31\ Each of the modifications and additions noted above is
described and explained in detail in part III below.
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\31\ See Section II.A., infra, for a discussion of the
objectives of the consolidated audit trail.
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Given these changes and the wide array of commenters' views on how
to best create, implement, and maintain a consolidated audit trail, the
Commission expects that the SROs will seriously consider various
options as they develop the NMS plan to be submitted to the Commission
for its consideration.\32\ Indeed, some commenters recognized that a
consolidated audit trail could be created, implemented, and maintained
in a number of ways, and thus recommended that the Commission replace
the specific systems requirements of the proposed Rule with more
general ``end-user'' requirements, perform an analysis of how existing
audit trail systems do and do not meet the needs of regulators, and
perhaps even engage in a formal request-for-proposal (``RFP'')
process.\33\
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\32\ See, e.g., FINRA Letter, p. 14 (advocating that SROs build
off existing audit trails to develop a consolidated audit trail) and
Nasdaq Letter I, p. 11-12 (arguing against building off existing
audit trail systems and supporting the development of new system to
establish a consolidated audit trail).
\33\ See Nasdaq Letter I, p. 12; FIF Letter II, p. 2-3; STA
Letter, p. 1-3; Direct Edge Letter, p. 2-3, 5.
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In light of the expanded solution set that should be available
under the changes described above and commenter views on the NMS plan
development process, the adopted Rule now requires the SROs to provide
much more information and analysis to the Commission as part of their
NMS plan submission. These requirements have been incorporated into the
adopted Rule as ``considerations'' that the SROs must address, and
generally mandate that the NMS plan discuss: (1) The specific features
and details of the NMS plan (e.g., how data will be transmitted to the
central repository, when linked data will be available to regulators);
(2) the SROs' analysis of NMS plan costs and impact on competition,
efficiency, and capital formation; (3) the process followed by the SROs
in developing the NMS plan (e.g., the requirement to solicit input from
members of the SROs and other appropriate parties); and (4) information
about the implementation plan and milestones for the creation of the
consolidated audit trail.
These requirements are intended to ensure that the Commission and
the public have sufficiently detailed information to carefully consider
all aspects of the NMS plan ultimately submitted by the SROs,
facilitating an analysis of how well the NMS plan would allow
regulators to effectively and efficiently carry out their
responsibilities. To help elicit the most appropriate information and
analysis from the SROs in response to these requirements, the
Commission is furnishing further details about how it envisions
regulators would use, access, and analyze consolidated audit trail data
through a number of ``use cases.'' These use cases and accompanying
questions should help the SROs prepare an NMS plan that better
addresses the requirements of the adopted Rule, as well as aid the
Commission and the public in gauging how well the NMS plan will address
the need for a consolidated audit trail.\34\
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\34\ See Section III.C.2.b., infra.
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Because the Commission believes the adopted Rule permits a wider
array of solutions to be considered by the SROs than the proposed Rule
did and because the Commission and the public will be able to avail
themselves of much more information and analysis in connection with the
NMS plan submission, the Commission is also making significant
modifications to the process by which it will consider the costs and
benefits of the creation, implementation, and maintenance of a
consolidated audit trail, as well as the potential impacts on
efficiency, competition, and capital formation. In particular, the
methodology that the Commission used in the Proposing Release to
estimate the costs of creating, implementing, and maintaining a
consolidated audit trail may be no longer suitable. As discussed in the
Proposing Release, the approximately $4 billion cost estimate for the
creation and implementation of a consolidated audit trail was primarily
based on averages for the development from scratch of new, very large-
scale market systems.\35\ However, the Commission's rationale for this
approach was predicated on some of the specific technical requirements
of the proposed Rule, especially those related to the real-time
collection and standard formatting of all data. As such, the approach
assumed that the consolidated audit trail would not be able to build on
existing trade, order, and audit trail systems. As noted above, these
assumptions may no longer be valid since several of the specific
technical requirements underlying the Proposing Release's approach have
been substantially modified. The Commission believes these changes
would now permit a wider array of solutions to be considered by the
SROs, including solutions that could capitalize on existing systems and
standards.\36\
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\35\ The methodology in the Proposing Release assumed that the
scope of the required systems changes would be comparable to those
made in connection with Regulation NMS. See Proposing Release, supra
note 4, at 32597, n. 352.
\36\ See, e.g, FINRA Letter, p. 14; SIFMA Letter, p. 16-18.
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In light of these changes, the Commission believes that the
economic consequences of the consolidated audit trail now will become
apparent only over the course of the multi-step process
[[Page 45726]]
for developing and approving an NMS plan that will govern the creation,
implementation, and maintenance of a consolidated audit trail. In
particular, the Commission believes that the costs and benefits of
creating a consolidated audit trail, and the consideration of specific
costs as related to specific benefits, is more appropriately analyzed
once the SROs narrow the expanded array of choices they have under the
adopted Rule and develop a detailed NMS plan. The Commission therefore
is focusing its economic analysis in this Release on the actions the
SROs are required to take upon approval of the adopted Rule--
specifically the requirement that the SROs develop an NMS plan,
utilizing their own resources and undertaking their own research, that
addresses the specific details, cost estimates, considerations, and
other requirements of the Rule.\37\ A robust economic analysis of the
next step--the actual creation and implementation of a consolidated
audit trail itself--requires information on the plan's detailed
features (and their associated cost estimates) that will not be known
until the SROs submit their NMS plan to the Commission for its
consideration. Accordingly, the Commission is deferring this analysis
until such time as it may approve any NMS plan--that is, after the NMS
plan, together with its detailed information and analysis, has been
submitted by the SROs and there has been an opportunity for public
comment.
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\37\ See Rule 613(a)(1).
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To that end, the adopted Rule requires that the SROs: (1) Provide
an estimate of the costs associated with creating, implementing, and
maintaining the consolidated audit trail under the terms of the NMS
plan submitted to the Commission for its consideration; (2) discuss the
costs, benefits, and rationale for the choices made in developing the
NMS plan submitted; and (3) provide their own analysis of the submitted
NMS plan's potential impact on competition, efficiency and capital
formation. The Commission believes that these estimates and analyses
will help inform public comment regarding the NMS plan and will help
inform the Commission as it evaluates whether to approve the NMS plan.
In this way, the Commission can develop estimates of the costs for the
creation, implementation, and maintenance of the consolidated audit
trail that benefit from cost data and information provided by the SROs.
The Commission notes that this approach is suited for the multi-
step nature of the particular process for developing and approving an
NMS plan that will govern the creation, implementation, and maintenance
of a consolidated audit trail. Further, because the Commission is
deferring its final analysis of the consolidated audit trail until
after a detailed NMS plan has been submitted to the Commission for its
consideration and the public has had an opportunity to comment, the
adopted Rule has been modified to include a mandate that in determining
whether to approve the NMS plan and whether the NMS plan is in the
public interest, the Commission must consider the impact of the NMS
plan on efficiency, competition, and capital formation of creating,
implementing, and maintaining the NMS plan.\38\ The Commission also
will consider the costs and benefits of the creation, implementation,
and maintenance of the consolidated audit trail pursuant to the details
proposed in the NMS plan submitted to the Commission for its
consideration.
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\38\ See Rule 613(a)(5).
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As a result of the new requirements for SROs to provide additional
information about costs and a number of other aspects of the NMS plan
they submit, the Commission is extending the timeframe for the
submission of the NMS plan from 90 days from the date of approval of
Rule 613 to 270 days from the date of publication of the adopting
release for Rule 613 (``Adopting Release'') in the Federal Register.
The Commission also is altering the timeframe within which SROs must
submit proposed rule changes to require their members to comply with
the requirements of the Rule and the NMS plan approved by the
Commission \39\ and the deadline for submitting the document required
by Rule 613(i) regarding the possible expansion of the scope of the NMS
plan.\40\
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\39\ The proposed Rule would have required SROs to submit such
proposed rule changes on or before from 120 days from approval of
the Rule. Because the adopted Rule permits the SROs up to 270 days
from the date of publication of the Adopting Release in the Federal
Register to submit NMS plans, the Commission believes that the more
appropriate deadline for SROs to submit rule changes is 60 days from
the date the Commission approves an NMS plan.
\40\ Specifically, the adopted Rule provides SROs six months,
instead of two months, after effectiveness of the NMS plan to submit
this document to the Commission.
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II. Introduction
A. Need for, and Objectives of, a Consolidated Audit Trail
The Commission believes that the Rule adopted today is an
appropriate step in the creation of a consolidated audit trail which,
when implemented, should substantially enhance the ability of the SROs
and the Commission to oversee today's securities markets and fulfill
their responsibilities under the federal securities laws. Rule 613
requires the submission of an NMS plan to create, implement, and
maintain the first comprehensive audit trail for the U.S. securities
markets, which will allow for the prompt and accurate recording of
material information about all orders in NMS securities, including the
identity of customers, as these orders are generated and then routed
throughout the U.S. markets until execution, cancellation, or
modification. This information will be consolidated and made readily
available to regulators in a uniform electronic format.
This section reviews the current status and limitations of
existing, discrete audit trails and discusses how a consolidated audit
trail could address those limitations and improve the ability of the
SROs and the Commission to perform their regulatory functions. To
perform this review, the Commission is, in part, drawing upon its own
experiences in using existing audit trails to carry out its regulatory
duties.\41\ The Commission also is relying on information provided to
the Commission from other regulators who use existing audit trail
systems, broker-dealers and organizations representing industry
participants, and those with expertise in data management and
technology solutions that may be applicable to the adopted
requirements.
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\41\ See Proposing Release, supra note 4, at 32558-61.
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1. Use and Limitations of Current Sources of Trading Data
It has become increasingly challenging for SROs and the Commission
to oversee the U.S. securities markets across the multitude of trading
venues, given the huge volume of orders and trades that are generated,
routed, transformed, and then re-routed across dozens of venues every
day. Among the challenges is the fact that there is no single,
comprehensive audit trail available to regulators.\42\ At present, the
SROs and the Commission must use a variety of data sources, including
EBS,\43\ equity cleared reports,\44\ and SRO audit trail data to help
fulfill their regulatory obligations. As a result, among other issues,
regulatory authorities face many challenges in obtaining, reconciling,
and making effective use of even the limited
[[Page 45727]]
order and execution data that is available, thereby hindering the
conduct of market surveillance, investigation and enforcement
activities, and market reconstructions and analyses.\45\
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\42\ See FINRA/NYSE Euronext Letter, p. 1-3; Nasdaq Letter I, p.
1-5.
\43\ See note 1, supra; Proposing Release, supra note 4, at
32557-58.
\44\ See note 2, supra.
\45\ The term ``market reconstruction'' is used to refer to the
efforts by SRO and Commission staff to collect and process detailed
trade and order data, often from multiple and varied data sources
(e.g., market participants, trading venues, and other SROs) to
recreate the sequence of events and market conditions that existed
over a given period of time. A recent example of this occurred
following the ``Flash Crash'' of May 6, 2010, with the market
reconstruction analysis undertaken by Commission and the Commodity
Futures Trading Commission (``CFTC'') staff, which can be found in
the ``Findings Regarding the Market Events of May 6, 2010: Report of
the Staffs of the CFTC and the SEC to the Joint Advisory Commission
Emerging Regulatory Issues.'' See http://www.sec.gov/news/studies/2010/marketevents-report.pdf.
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The ultimate effectiveness of core SRO and Commission regulatory
efforts depends on the following four qualities of trade and order
(collectively ``market'') data:
Accuracy. Is the data about a particular order or trade
correct?
Completeness. Does the data represent all market activity
of interest, or just a subset? Is the data sufficiently detailed to
provide the required information?
Accessibility. How is the data stored? How practical is it
to assemble, aggregate, reconcile, and process the data? Can all
appropriate regulators acquire the data they need?
Timeliness. When is the data available to regulators? How
long will it take to process before it can be used for regulatory
analyses?
SROs generally use market data in the form of audit trails to
identify potential misconduct in the markets they oversee, including
attempts to manipulate market quotations, inflate trading or order
volume artificially, or profit from non-public information. When these
surveillance efforts identify suspicious trading activity, SROs have a
responsibility to open investigations in which they assemble and review
additional market data to assess the nature and scope of the potential
misconduct. When an SRO detects persistent problems in the market it
oversees, it may write new rules for its members to address the
problems. To inform these rulemaking efforts, SROs frequently gather
and analyze significant amounts of market data. The effectiveness of
such efforts is largely determined by the qualities of the data
available.\46\
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\46\ The Commission recognizes that the accuracy of the data
available may also be subject to occasional errors, including errors
caused by rare and unexpected events.
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The qualities of such market data are also primary determinants of
the Commission's ability to fulfill its statutory mission. The
Commission uses market data in most of its investigations of potential
securities law violations. In many of these investigations, market data
analysis frames the issues for investigation and is a primary means of
identifying relationships between individuals and entities whose
activities may threaten the integrity of the securities markets or
create substantial and unnecessary investor losses. The Commission also
uses audit trails and other sources of market data to: (1) Inform its
priorities for examinations of broker-dealers, investment advisers and
SROs; (2) supplement the data and information it collects during those
examinations; and (3) determine the nature and scope of any potential
misconduct the examinations identify. The Commission also relies
heavily on market data to identify patterns of trading and order
activity that pose risks to the securities markets and to inform
regulatory initiatives, as well as to perform market reconstructions.
In addition, the Commission relies on market data to improve its
understanding of how markets operate and evolve, including with respect
to the development of new trading practices, the reconstruction of
atypical or novel market events, and the implications of new markets or
market rules. As is the case for the SROs, the effectiveness of such
efforts by the Commission is largely determined by the qualities of the
data available.\47\
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\47\ The effectiveness of such efforts with respect to cross-
market activities within the Commission's jurisdiction depends on
the qualities of data from multiple sources, such as separate SRO
audit trails used for equities and equity options. See Section
II.A.1.c., infra. This dependency also exists with respect to market
activities that involve other products outside the Commission's
jurisdiction, such as futures and certain swaps. See note 239,
infra.
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As described in the following sections, each of the present sources
of market data available to regulators suffers from deficiencies
limiting its effective use.
a. The EBS System
The EBS system is currently the only available source of data that
allows regulators to obtain the identity of customers of broker-dealers
who have executed trades. The SROs and the Commission have depended on
this system for decades to request trading records from broker-dealers.
The EBS system, supplemented by the requirements of Rule 17a-25 under
the Exchange Act,\48\ is generally used by SRO and Commission staff to
assist in the investigation of possible securities law violations,
typically involving insider trading and market manipulations.\49\ In
its electronic format, the EBS system provides certain detailed
execution information, upon request by SRO or Commission staff, for
specific securities during specified timeframes. However, EBS data,
which is currently sourced from the so-called back-office records of
clearing brokers, are limited to executed trades and do not contain
information on orders or quotes (and thus no information on routes,
modifications, and cancellations). Also, in frequent cases where
brokers utilize average-price accounts to execute and aggregate
multiple trades for one or more customers, the details of each
individual trade execution are typically lost when reported through the
EBS system because it is only the average aggregate price and volume of
a series of executed trades that are transmitted to the clearing
systems for processing.\50\
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\48\ 17 CFR 240.17a-25. Rule 17a-25 codified the requirement
that broker-dealers submit to the Commission, upon request,
information on their customer and proprietary securities
transactions in an electronic format. The rule requires submission
of the same standard customer and proprietary transaction
information that SROs request through the EBS system in connection
with their market surveillance and enforcement inquiries.
\49\ See Rule 17a-25; supra note 1, and accompanying text.
\50\ See FIF Letter I, p. 3; SIFMA Letter, p. 18-19.
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Furthermore, the EBS data currently includes only the dates, but
not the times, of each trade execution (regardless of whether or not
the trade represents an average-price series of executions).\51\ Since
there could be many broker-dealers trading a given security on a given
day of interest, to reconstruct trading on the market for one security
on one day could involve many, perhaps hundreds, of EBS requests.
Consequently, EBS data, alone, are not generally useful for price or
short sale manipulations analysis, order flow analysis, depth-of-book
analysis, or any large-scale market reconstructions in which the timing
of events is required to build a useful picture of the market.\52\
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\51\ As adopted, Rule 13h-1 requires certain broker-dealers to
capture and report through EBS the time of execution for any trade
involving a large trader and a Commission-issued large trader
identifier that identifies the large trader. See Large Trader
Release and Large Trader Extension, supra note 1.
\52\ A 1990 Senate Report acknowledged the immense value of the
EBS system, but noted that ``it is designed for use in more narrowly
focused enforcement investigations that generally relate to trading
in individual securities. It is not designed for use for multiple
inquiries that are essential for trading reconstruction purposes.''
See S. Rep. No. 300, 101st Cong., 2d Sess. 2-5 (1990), at 48.
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In addition, though the EBS system provides the names associated
with each account in which a trade has been
[[Page 45728]]
placed, these names are based on the separate records of each broker-
dealer providing data to the EBS system, and the same party may be
identified by a different name across multiple broker-dealers.
Experience of staff at the Commission has shown \53\ that it is
difficult to perform cross-broker customer analysis of trading since
the same customer may be known by different names depending on the
account and broker-dealer through which it traded.
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\53\ See, generally, Sections II.A.1. and II.A.2., infra.
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The EBS system also typically requires SRO and Commission staff
needing EBS data to request the information from each broker-dealer,
and complete responses from each broker-dealer may take days or weeks
depending upon the scope of the request. As a result of these various
limitations, the EBS system is generally only used by regulators in
narrowly-focused enforcement investigations that generally involve
trading in particular securities on particular dates or with specific
broker-dealers.
b. Equity Cleared Reports
In addition to the EBS system and Rule 17a-25, the SROs and the
Commission also rely upon the NSCC \54\ equity cleared report for
initial regulatory inquiries.\55\ This report is generated on a daily
basis by the SROs, is provided to the NSCC, and shows the number of
trades and daily volume of all equity securities in which transactions
took place, sorted by clearing member. The information provided is end-
of-day data and is searchable by security name and CUSIP number.\56\
This information is also provided to the Commission upon request. Since
the information made available on the report is limited to the date,
the clearing firm, and the number of transactions cleared by each
clearing firm, its use for regulatory purposes is quite limited--equity
cleared reports basically serve as a starting point for certain types
of investigations, providing a tool the Commission can use to narrow
down the clearing firms to contact concerning transactions in a certain
security.
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\54\ See note 2, supra, and accompanying text.
\55\ The Commission also uses the Options Cleared Report, with
data supplied by the Options Clearing Corporation (``OCC''), for
analysis of trading in listed options. The OCC is an equity
derivatives clearing organization that is registered as a clearing
agency under Section 17A, 15 U.S.C. 78q-1, of the Exchange Act, and
operates under the jurisdiction of both the Commission and the CFTC.
\56\ A CUSIP number is a unique alphanumeric identifier assigned
to a security and is used to facilitate the clearance and settlement
of trades in the security.
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c. SRO Audit Trails
In addition to EBS data and equity cleared reports, the SROs and
the Commission rely on data collected through individual SRO audit
trails. Most SROs maintain their own specific audit trails applicable
to their members. For example, the National Association of Securities
Dealers (``NASD'') \57\ established its Order Audit Trail System
(``OATS'') \58\ in 1996, which required NASD (n/k/a FINRA) members to
report certain trade and order data on Nasdaq-listed equity securities.
OATS was later expanded to include OTC equity securities. Similarly,
the NYSE implemented its Order Tracking System (``OTS'') \59\ in 1999
under which its members were required to report certain trade and order
data on NYSE-listed securities. Beginning in 2000, several of the
current options exchanges implemented the Consolidated Options Audit
Trail System (``COATS'').\60\ In addition, many of the exchanges have
created their own audit trails to assist in surveillance activities.
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\57\ In 2007, NASD and the member-related functions of NYSE
Regulation, Inc., the regulatory subsidiary of New York Stock
Exchange LLC (``NYSE''), were consolidated. As part of this
regulatory consolidation, the NASD changed its name to FINRA. See
Securities Exchange Act Release No. 56146 (July 26, 2007), 72 FR
42190 (August 1, 2007). FINRA and the National Futures Association
(``NFA'') are currently the only national securities associations
registered with the Commission; however, the NFA has a limited
purpose registration with the Commission under Section 15A(k) of the
Exchange Act, 15 U.S.C. 78o-3(k). See also Securities Exchange Act
Release No. 44823 (September 20, 2001), 66 FR 49439 (September 27,
2001).
\58\ See In the Matter of National Association of Securities
Dealers, Inc., Order Instituting Public Proceedings Pursuant to
Section 19(h)(1) of the Securities Exchange Act of 1934, Making
Findings and Imposing Remedial Sanctions, Exchange Act Release No.
37538 (August 8, 1996), Administrative Proceeding File No. 3-9056
and Report Pursuant to Section 21(a) of the Securities Exchange Act
of 1934 Regarding the NASD and The Nasdaq Stock Market LLC
(``Nasdaq''). See also Securities Exchange Act Release No. 39729
(March 6, 1998), 63 FR 12559 (March 13, 1998) (order approving
proposed rules comprising OATS) (``OATS Approval Order'').
\59\ See Securities Exchange Act Release No. 47689 (April 17,
2003), 68 FR 20200 (April 24, 2003) (order approving proposed rule
change by NYSE relating to order tracking) (``OTS Approval Order'').
\60\ See In the Matter of Certain Activities of Options
Exchanges, Administrative Proceeding File No. 3-10282, Securities
Exchange Act Release No. 43268 (September 11, 2000) (Order
Instituting Public Administrative Proceedings Pursuant to Section
19(h)(1) of the Securities Exchange Act of 1934, Making Findings and
Imposing Remedial Sanctions) (``Options Settlement Order''). See,
e.g., Securities Exchange Act Release No. 50996 (January 7, 2005),
70 FR 2436 (order approving proposed rule change by CBOE relating to
Phase V of COATS).
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Recently, FINRA expanded its OATS requirements from covering only
Nasdaq-listed and OTC equity securities to covering all NMS stocks.\61\
To avoid duplicative reporting requirements, the NYSE, NYSE Amex LLC
(n/k/a ``NYSE MKT LLC'') (``NYSE Amex''), and NYSE ARCA, Inc. (``NYSE
Arca'') subsequently replaced their OTS audit trail requirements for
members who are also members of either FINRA or Nasdaq (and therefore
subject to OATS requirements) with rules that allow these members to
satisfy their reporting obligations by meeting the new OATS
requirements.\62\
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\61\ See Securities Exchange Act Release No. 63311 (November 12,
2010), 75 FR 70757 (November 18, 2010) (SR-FINRA-2010-044) (order
approving proposed rule change by FINRA relating to the expansion of
OATS to all NMS stocks).
\62\ See Securities Exchange Act Release Nos. 65523 (October 7,
2011), 76 FR 64154 (October 17, 2011) (SR-NYSE-2011-49); 65524
(October 7, 2011), 76 FR 64151 (October 17, 2011) (SR-NYSEAmex-2011-
74); 65544 (October 12, 2011), 76 FR 64406 (October 18, 2011) (SR-
NYSEArca-2011-69).
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Although these developments with respect to the scope of FINRA's
OATS rules reduce the number of audit trails with disparate
requirements, they still do not result in a comprehensive audit trail
that provides regulators with accurate, complete, accessible, and
timely data on the overall markets for which regulators have oversight
responsibilities. In particular, data collected by FINRA pursuant to
FINRA's Rule 7400 series (``OATS data'') does not provide a complete
picture of the market because though OATS collects data from FINRA
members with respect to orders and trades involving NMS stocks, OATS
does not include trade or order activity that occurs on exchanges, or
at broker-dealers that are not FINRA or Nasdaq members. Nor does OATS
include exchange quotes, principal orders submitted by FINRA members
registered as market makers, or options data.\63\ In
[[Page 45729]]
performing its own regulatory oversight of the markets, FINRA has
chosen to create an internal process in which it augments the data it
collects via OATS with trade execution data from other exchanges with
which it has a regulatory services agreement. This process provides
FINRA with a wider view of the markets than that provided by OATS
alone, but linking data in this fashion does not yield fully accurate
results.\64\ For these reasons, the Commission believes that the
augmented OATS data currently falls short of providing an efficient
source of data for analyzing cross-market activities, or tracking an
order through its entire cycle from generation through routing to
execution, modification or cancellation.
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\63\ See FINRA Rule 7410(j) (defining ``Order'' for purposes of
OATS, to mean ``any oral, written, or electronic instruction to
effect a transaction in an NMS stock or an OTC equity security that
is received by a member from another person for handling or
execution, or that is originated by a department of a member for
execution by the same or another member, other than any such
instruction to effect a proprietary transaction originated by a
trading desk in the ordinary course of a member's market making
activities.'' Additionally, Nasdaq, Nasdaq OMX BX, Inc. (``BX'') and
Phlx equities (``PSX'') members that are registered as market makers
in a certain security are similarly exempted from recording OATS
audit trail data for the security in which they are registered to
make a market. See Nasdaq and BX Rules 6951(i); PSX Rule 3401(i).
The Commission notes that members of Nasdaq, BX and PSX, that
are not also members of FINRA, are required by those exchanges to
record the audit trail data required by OATS; however, they are only
required to report that data through OATS upon request by their
respective exchanges. See Nasdaq and BX Rules 6955(b); PSX Rule
3405(b). Additionally, as of October 17, 2011, members of NYSE and
NYSE Amex, who are not also FINRA members, are required to record
their trade and order activity. These non-FINRA members are not
required to report this data through OATS unless requested. See NYSE
and NYSE Amex Equities Rules 7450(b); see, e.g., Securities Exchange
Act Release Nos. 65523 (October 7, 2011), 76 FR 64154 (October 17,
2011); 65524 (October 7, 2011), 76 FR 64151 (October 17, 2011);
65544 (October 12, 2011), 76 FR 64406 (October 18, 2011) (notice of
immediate effectiveness of proposed rule change to adopt the FINRA
Rule 7400 series, the OATS rules, and making certain conforming
changes to the NYSE and NYSE Amex Equities rules). Members of NYSE
Arca, who are not also FINRA members, were required to record their
trade and order activity as of March 31, 2012. See NYSE Arca
Equities Rule 7450(b); see Securities Exchange Act Release No. 65544
(October 12, 2011), 76 FR 64406 (October 18, 2011) (notice of
immediate effectiveness of proposed rule change to adopt the FINRA
Rule 7400 series, the OATS rules, and making certain conforming
changes to the NYSE Arca Equities rules). See also Securities
Exchange Act 66094 (January 4, 2012), 77 FR 1545 (January 10, 2012)
(notice of immediate effectiveness to extend the implementation date
of the NYSE Arca Equities Rule 7400 Series, the OATS rules, for
Equity Trading Permit Holders that are not FINRA members from
January 31, 2012 to March 31, 2012).
\64\ FINRA has represented to Commission staff that, as part of
its own surveillance activities, FINRA acquires some of this order
handling system data from non-FINRA members to supplement the data
it receives from its members via OATS, but that matching data across
the audit trails yields varying levels of success and accuracy due
to the disparate methods used by the different order handling
systems to collect and store data. FINRA represented that, during
the period from November 28, 2011 to February 24, 2012,
approximately 2% of reportable OATS data related to exchange orders
could not be linked with matching exchange data. See Commission
Staff Memorandum to File No. S7-11-10 regarding telephone
conversations with FINRA, dated April 17, 2012 (``Commission Staff
Memorandum''). Also, since this process only involves acquiring
trade and order data from select sources, it still does not produce
a complete record of all market activity. The Commission notes that,
when considering data covering a time period of approximately 26
months, the percentage of reportable OATS data related to exchange
orders that could not be linked with matching exchange data remained
at approximately 2%. Id.
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OATS data also suffers from a lack of timeliness, partly as a
result of the problems with the accuracy of the data as collected, and
partly because of its lack of completeness. When FINRA receives an end-
of-day OATS file from a member, it takes an hour for FINRA to
acknowledge receipt of the report and approximately another 24 hours to
determine if there is a syntax error \65\ in the report.\66\ During
this time, FINRA performs over 152 validation checks on each order
event reported to OATS. Thus, FINRA performs over 40 billion separate
checks each day to ensure OATS data conforms to all applicable
specifications.\67\ Each of these checks can result in OATS data
submissions being rejected and generating an error message.\68\ As a
result of these validation checks, almost 425,000 reports per day, on
average, are rejected and must be corrected.\69\ In addition to the 24
hours needed to identify errors within a report, it takes another two
business days to determine whether a file that is syntactically correct
nevertheless contains errors in content related to internally-
inconsistent information about processing, linking, and routing orders.
Once a member is advised of such errors, the member has up to five
business days to re-submit a corrected file. However, error corrections
are limited to only those that are required to remedy internal
inconsistencies within a given member's submission. Cross-firm
inconsistencies in which, for example, one member reports routing an
order to a second member, but the second member does not report
receiving or processing such an order, are identified as unmatched or
unlinkable data records, but neither firm corrects these types of
reporting errors. The net result yields a historical data record of
market activity that contains a small but permanent number of incorrect
or irreconcilable trade and order events.\70\
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\65\ Common reasons given by FINRA for syntax rejections
include: Missing mandatory fields, invalid fields, and invalid field
combinations (e.g., a Limit Price without a Time in Force Code).
OATS will reject records as duplicates if more than one record is
submitted with the same Order Receiving Firm Market Participant
Identifier, Order Received Date, and Order Identifier or if more
than one record contains all of the same information. http://www.finra.org/Industry/Compliance/MarketTransparency/OATS/FAQ/P085542 (last viewed on May 23, 2012).
\66\ See Commission Staff Memorandum, supra note 64. FINRA
estimates that, from the period November 28, 2011 to February 24,
2012 approximately 0.10% of the intra-firm data reported daily by
broker-dealers were rejected for errors. Id. The Commission notes
that, when considering data covering a time period of approximately
26 months, the percentage of the intra-firm data reported daily by
broker-dealers rejected for errors was more than double this amount.
Id.
\67\ See FINRA Letter, p. 11. FINRA represented to Commission
staff that many of the validation errors result from problems
encountered in translating order information from broker-dealer
formats into OATS format. See Commission Staff Memorandum, supra
note 64.
\68\ Id.
\69\ Id.
\70\ FINRA estimates that during the period from November 28,
2011 to February 24, 2012 approximately 0.5% of each day's
reportable events remained unmatched (i.e., multi-firm events, such
as routes, that cannot be reconciled). See Commission Staff
Memorandum, supra note 64. When considering data covering a time
period of approximately 26 months, the percentage of each day's
reportable events remaining unmatched was more than double this
amount. Id.
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Given the time it takes to process each OATS file, and the nature
of the process in which errors are detected, reported back to members,
and then corrected, inter-firm surveillance by FINRA typically does not
begin until 5 business days after receipt of OATS data. In addition,
the final product of the FINRA process is available to FINRA, but is
not stored in a market-wide database or a central repository that is
readily accessible to other regulators. This is because SROs do not
typically have access to the internal systems of another SRO, though
they may share some sources of underlying data.\71\
---------------------------------------------------------------------------
\71\ For example, FINRA has been given access to order audit
trail information from certain SROs pursuant to Regulatory Services
Agreements.
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Because the Commission does not have direct access to OATS data and
other SRO audit trails and because each SRO only has direct access to
its own audit trails, requests must be made to the Intermarket
Surveillance Group (``ISG'') \72\ or SROs to conduct an analysis on
order data. It can take days or weeks, depending on the scope of the
information requested, to receive responses to requests. Once the
responses to its requests for information are received, the Commission,
or any SRO undertaking the same task, must commit a significant amount
of time and resources to process and cross-link the data from the
various formats used by different SROs before it can be analyzed and
used for regulatory purposes. Whether or not this process is successful
depends on the accuracy, completeness, and format of the data received,
as well as how readily data from different SROs can be reliably linked.
For example, staff at the Commission working on the analysis of the May
6, 2010 ``Flash-Crash'' found it was not possible to use the data from
existing audit trails to accurately or comprehensively reconstruct
exchange
[[Page 45730]]
and ATS equity limit order books for NMS securities as required to
fully analyze the events of that day.\73\
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\72\ ISG is an international group of exchanges, market centers,
and regulators that perform market surveillance in their respective
jurisdictions. The organization provides a forum for its members to
share information and coordinate regulatory efforts to address
potential intermarket manipulation and trading abuses.
\73\ See Section II.A.2.b., infra.
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A further difficulty in using existing audit trails to conduct
cross-market surveillance is the lack of consistency in both format and
content among the various audit trails. Not all SROs collect data using
the OATS format. In addition, each options exchange maintains its own
COATS audit trail in a different format and includes different
supplemental data items in its audit trail. These differences make it
difficult and labor intensive for regulators to view options trading
activity across multiple markets, and the lack of any combined equity
and options audit trail is a significant impediment to regulators
performing cross-product investigations and analyses.
An additional shortcoming of existing SRO audit trails is the lack
of customer identifiers. In general, existing SRO audit trails only
identify the broker-dealer handling the order and not the account
holder or the person exercising investment discretion for the account
holder, if different. This limitation makes the process of identifying
the customers involved in unusual trading patterns or market events
very difficult. Even determining whether or not an unusual trading
pattern exists is challenging if the data does not identify trades by a
single customer at multiple broker-dealers. Requests therefore must be
made to one or more broker-dealers to obtain information about the
customer or customers behind an order. Multiple requests may be
necessary before the information is obtained. EBS data may have to be
requested as a supplement. A further challenge arises in any type of
customer-based cross-market analysis because there is no standard
convention for how customers are identified at different broker-
dealers--the same party directing trades across multiple venues, or
through different broker-dealers, can be known by many different names.
Not having customer information at the early stage of surveillance
can also impair the accuracy, and thus efficacy, of certain
surveillances. The patterns that emerge when trade and order activity
is aggregated across all customers of a broker-dealer often exhibit
characteristics that can be quite different from the (initially)
unobservable patterns of trade and order activity of each individual
customer at that broker-dealer. This could result in what are known as
``false positive signals,'' in which market activities that initially
are flagged as being potentially manipulative by a surveillance system
are later found not to be potentially manipulative once more detailed
customer data from the broker-dealer is requested and analyzed. In
contrast, potentially manipulative activities may be missed by a
surveillance system that cannot identify the customers behind each
order or trade if those activities are otherwise obscured by non-
manipulative activities of other customers of the same broker-dealer
such that the aggregate patterns of trading do not appear potentially
manipulative.
Given the various limitations described above, the Commission does
not believe that existing audit trails, with their current features,
provide regulators with an efficient or adequate method of monitoring
and surveilling the market for NMS securities. The Commission notes,
for example, that FINRA summarizes the current cross-market systems as
follows: ``The current systems in place to achieve effective cross-
market surveillance, such as the ISG, are incomplete. For example, the
ISG audit trail data has numerous shortcomings, including: (1) It does
not capture quote/orders away from a market's inside market (i.e.,
those quotes/orders below the best bid or above the best offer); (2) it
currently identifies participants of a trade only to the clearing
broker, not down to the executing broker level; (3) data submitted by
participants is not validated; (4) certain data fields are not
mandatory; and (5) there are no service level agreements to ensure that
participants submit timely and accurate information.'' \74\
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\74\ See FINRA/NYSE Euronext Letter, p. 3.
---------------------------------------------------------------------------
2. Regulatory Improvements With a Consolidated Audit Trail
The NMS plan required by the Rule, if approved by the Commission,
will improve the quality of audit trail data by, among other things:
(1) Identifying with a unique ``Customer-ID'' the account holder(s)
with respect to an account at a registered broker-dealer and, if
different, any person authorized to give the broker-dealer trading
instructions for such account; (2) identifying the time of each key
event in the life of an order according to synchronized business
clocks; (3) requiring the reporting of comprehensive order lifecycle
data; and (4) including all NMS securities in one audit trail. As
discussed below, the Commission believes that these improvements should
have the potential to result in the following: (1) Improved market
surveillance and investigations; (2) improved analysis and
reconstruction of broad-based market events; and (3) improved market
analysis. In addition, a consolidated audit trail has the potential to
result in a reduction in disparate reporting requirements and data
requests.
a. Improved Market Surveillance and Investigations
A consolidated audit trail will expand the data available for
regulators to perform surveillance and investigations for illegal
activities such as insider trading, wash sales, or manipulative
practices. In particular, a consolidated audit trail will help
surveillance and investigations by facilitating risk-based
examinations, allowing more accurate and faster surveillance for
manipulation, improving the process for evaluating tips, complaints,
and referrals (``TCRs''), and promoting innovation in cross-market and
principal order surveillance.
i. Risk-Based Examinations
A consolidated audit trail will facilitate risk-based examinations.
Risk-based examinations require access to accurate and timely data so
that the scope of the examination can be properly set to cover the
areas of identified risks. Regulators currently may request audit trail
data directly from the broker-dealer, work with the broker-dealer to
understand the format and definitions in the data, validate that
information with a third party, and analyze the data to determine
whether the initial assumptions concerning risk were valid. This effort
requires significant resources from both the regulator and the broker-
dealer, all of which may be wasted if the resulting analysis shows that
the assumptions of risk justifying the examination of a particular
subject were not founded. Thus, this resource-intensive process does
not necessarily reveal the subjects most worthy of examination, and
does not permit an effective pre-examination review of a subject's
trading practices.
In contrast, a consolidated audit trail would permit regulators,
for example, to identify risks and appropriate subjects for
examinations relating to certain types of trading by creating and
comparing metrics based on the complete (and possibly cross-market)
activities of a broker-dealer or customer. Signals based on such
metrics could, for example, identify outlier patterns in the ratio of
order activity to execution, which may be an indication of potentially
manipulative practices. Currently, this method is impractical because,
as described above, it requires the consolidation of many audit trails
[[Page 45731]]
that store data in non-uniform formats, participant information in SRO
audit trails often does not consistently identify the executing broker-
dealer, and there is no uniform method of identifying customers.
In sum, consolidated audit trail data that meets the minimum
requirements for the NMS plan specified in the Rule would allow
regulators to create a process that focuses much more of their
resources on those firms for which specific activities over specific
time periods warrant follow up. The subsequent examinations would thus
be more precise, resulting in more efficient use of regulatory
resources, potentially reducing the need for multiple document
requests, and ultimately reducing the sometimes significant compliance
burden on a broker-dealer or other subject.
ii. Market Manipulation
In addition to helping regulators focus their resources and better
identify areas in which potentially manipulative trading activity may
be occurring, a consolidated audit trail will greatly aid the analysis
of the potential manipulation itself. The current methodology to
analyze order and trade data requires a tremendous amount of time and
resources to construct an accurate picture of when trades are actually
executed. Typically, this includes: (1) Broker-dealers and other
registrants responding to multiple requests from the Commission and
SROs; (2) SROs devoting regulatory resources to obtaining, analyzing,
and reporting data requested by the Commission; and (3) Commission
staff reconciling inconsistent order data provided by different SROs
with respect to different markets.
In addition, while SRO audit trail data identifies the dates and
times of trades by a particular broker-dealer, SRO audit trail data
does not reveal the identities of the customers initiating the trades
executed by the broker-dealers. Accordingly, to identify customers
placing trades through a broker-dealer, regulatory staff must obtain
EBS data and integrate such data with SRO audit trail data. This is a
cumbersome process because there is no automated process to link the
two data sources. To determine the exact execution time for trades by a
particular customer, regulatory staff must obtain a third set of data
from the broker-dealer's trading and order handling system. These
processes can take many months. In some cases, the laborious process of
assembling the data delays other critical investigative or analytical
steps. In other cases, investigators or analysts forego the process of
determining when trades occurred, limiting their analysis to more
accessible information. As a result, SRO and Commission staffs may fail
to ascertain the full scope of misconduct under investigation or the
causes of unusual market events at issue.
Even more critically, the absence of reliable information about who
initiated which orders makes detection of schemes that involve repeat
instances of activity through accounts at multiple broker-dealers
difficult. Schemes of this sort may be among the most harmful and
difficult to police, but without a customer identifier that
consistently and uniquely identifies responsibility for orders across
all broker-dealers, no amount of technical sophistication and
securities market insight can produce a data query or analysis to
detect them.\75\
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\75\ Examples of schemes that typically rely on orders from
accounts at multiple brokers include: (1) ``Network'' insider
trading schemes in which the participants cultivate multiple sources
of non-public information and trade on the information they receive
over an extended period of time and through accounts at a large
number of broker-dealers; (2) wash trading; and (3) order layering.
Unlike insider trading, for example, which is neither defined nor
expressly prohibited in the Act, wash trading is specifically
prohibited in the statute. The entering of matched orders for the
purpose of creating the illusion of market activity or to
artificially affect the price is one of the oldest and most
difficult to detect manipulative practices. Technology that permits
the routing of thousands of orders to different venues in micro
seconds has made cross market surveillance for this activity
extremely difficult. ``Order layering'' is similar to wash trading.
In this practice, a market participant can enter numerous non-bona
fide market moving orders, often in substantial size relative to a
security's legitimate volume to create the false impression of buy
or sell side pressure. When such orders induce others to execute
against profitable limit orders, the market participants immediately
cancel the pending orders that manipulated the price. As with wash
sales, multiple traders can enter orders on different venues,
impacting the NBBO and making the activity difficult to detect.
---------------------------------------------------------------------------
With the data provided by the consolidated audit trail, regulatory
staff would be able to conduct such analyses in a much shorter period
of time. In addition, the process of analysis with a consolidated audit
trail would be inherently more reliable than the manual reconstruction
process currently available, reducing the risk of inaccuracies.
Furthermore, the ability to process and meaningfully analyze audit
trail data more quickly would allow regulatory staff to employ
proactive methods of identifying potentially manipulative activities.
The Commission therefore believes a consolidated audit trail would make
the overall process of identifying and analyzing potentially
manipulative trading practices much more focused, accurate, and
efficient.\76\
---------------------------------------------------------------------------
\76\ For example, implementation of a consolidated audit trail
also will help regulators monitor reliance on the use of the safe
harbor provision for issuer repurchases in Rule 10b-18 under the
Exchange Act. 17 CFR 240.10b-18. Rule 10b-18 under the Exchange Act
provides issuers with a safe harbor from liability for manipulation
under Sections 9(a)(2) and 10(b) of the Exchange Act, and Rule 10b-5
under the Exchange Act, when they repurchase their common stock in
the market in accordance with the Rule's manner, timing, price, and
volume conditions. The data required to be included in the
consolidated audit trail will assist regulators in monitoring issuer
repurchases that rely on Rule 10b-18's safe harbor protections to
ensure that they comply with all required criteria.
---------------------------------------------------------------------------
The timely availability of data to regulators also impacts the
efficacy of detecting (and possibly mitigating the effects of) some
types of market manipulation. For example, some pernicious trading
schemes are designed to generate large ``quick-hit'' profits in which
participants attempt to transfer the proceeds from the activity to
accounts outside of the reach of domestic law enforcement as soon as
the offending transactions have settled in the brokerage account
(typically three days after execution). If the SROs detect such schemes
and promptly report them to the Commission, the Commission potentially
could seek asset freezes that limit the transfer of funds until charges
against the account holder are resolved. The Commission believes that a
consolidated audit trail in which uniform data about market activities
are efficiently collected and processed soon after such activities
occur, and in which data are available to regulators in a timely
manner, would more frequently and effectively allow regulators to use
this approach.
iii. Tips and Complaints
A consolidated audit trail also would significantly improve the
processes used by the SROs and the Commission for evaluating tips and
complaints about trading activity.\77\ It is not uncommon for market
participants or those with experience in market data to sometimes note
atypical trading or quoting patterns in publicly-available market data.
A consolidated audit trail would allow regulatory staff to quickly
determine whether a particular instance of an atypical activity
(regardless of how it was originally identified), such as an abnormally
high level of quote traffic, is worthy of further investigation.
---------------------------------------------------------------------------
\77\ The Commission receives an average of over 200 market-
related TCRs each month.
---------------------------------------------------------------------------
Today, such an analysis of TCRs is difficult and cumbersome. Even a
preliminary review requires analysis by each exchange or ATS to
identify the activity in question and to determine its scope.
Regulators then must consolidate the analyses from each such market
center to determine the identities of those responsible for the
atypical
[[Page 45732]]
activity in question. To the extent that the activity originates from
several market participants, regulators must conduct additional
analysis on each of those participants, and possibly other
participants, to discover information that could identify the
customer(s) originating the orders that created the atypical activity.
Without a unique customer identifier included in the order and trade
data, this may not be possible. The consolidated audit trail would
significantly improve the multi-stage process, enabling regulatory
staff to make efficient queries on orders and more quickly determine
whether the TCR can be ``closed'' or if further analysis and
investigation are warranted.
iv. Cross-Market and Principal Order Surveillance
Investigations of cross-market activity may be more efficient with
a consolidated audit trail as such an audit trail may provide
regulators with data not currently consolidated across markets and/or
data not currently available to regulators such as broker-dealer
principal orders, including market maker quotes. For example, in an
attempt to manipulate the market, a broker-dealer could use numerous
principal sell orders across multiple venues to give the misleading
appearance of broad sell-side pressure, and then send a buy principal
order at a favorable price to take advantage of the market momentum
created by the misleading sell orders. This type of activity would be
difficult to readily identify with current audit trails, but it could
be the target of a routine surveillance of a consolidated audit trail.
The Commission notes, for example, the statement of FINRA and NYSE
Euronext that, ``[p]articularly since the implementation of Regulation
NMS in 2007, there has been a significant increase in market linkages,
the result of which is that trading activity on one market can have a
profound effect on other markets. This, in turn, has led to the
realization that market manipulation, by its very nature, is
facilitated cross-market where, for example, trading on one market is
used to affect a security's price while trading on another market is
used to take advantage of that price change.'' \78\
---------------------------------------------------------------------------
\78\ See FINRA/NYSE Euronext Letter, p. 2.
---------------------------------------------------------------------------
In addition, the consolidation of order data with direct access for
all relevant regulators may create opportunities for regulators to
develop entirely new methods of surveillance, and to keep existing
forms of surveillance up to date as new market practices and new market
technologies continue to rapidly evolve. In fact, as described more
fully below, SROs are required by the Rule to incorporate the expanded
audit trail data into their surveillance systems.\79\
---------------------------------------------------------------------------
\79\ See Rule 613(f).
---------------------------------------------------------------------------
b. Improved Analysis and Reconstruction of Broad-Based Market Events
A consolidated audit trail will significantly improve the ability
of regulators to reconstruct broad-based market events so that they and
the public may be informed by an accurate and timely accounting of what
happened, and possibly why. The sooner a reconstruction can be
completed, the sooner regulators can begin reviewing an event to
determine what, if any, regulatory responses might be required to
address the event in an effective manner.
For example, on the afternoon of May 6, 2010, the U.S. equity and
equity futures markets experienced a sudden breakdown of orderly
trading, when broad-based indices, such as the Dow Jones Industrial
Average Index and the S&P 500 Index, fell about 5% in just five
minutes, only to rebound soon after (the ``Flash Crash''). Many
individual equities suffered even worse declines, with prices in over
300 stocks and exchange-traded funds falling more than 60%. In many of
these cases, trades were executed at a penny or less in stocks that
were trading at prices of $30 or more only moments earlier before
prices recovered to their pre-Flash Crash levels.\80\
---------------------------------------------------------------------------
\80\ See note 45, supra.
---------------------------------------------------------------------------
The Commission immediately formed an interdisciplinary team from
across the Commission to analyze the events of May 6, 2010, identify
possible causes, inform the public of what happened, and aid in
formation of regulatory responses. The CFTC took similar steps. Within
a few weeks, staff at the Commission and the CFTC released a joint
preliminary report that described the event and, in general terms, the
market conditions prior to and during the rapid decline.\81\ However,
at that time the staffs were unable to definitively identify the
specific conditions or circumstances that could have caused,
contributed to, or exacerbated the event. Though the SROs and the
Commission quickly implemented a single-stock circuit breaker pilot
program as an initial response, a more complete regulatory response
required a full and robust analysis of additional data.
---------------------------------------------------------------------------
\81\ See ``Preliminary Findings Regarding the Market Events of
May 6, 2010: Report of the Staffs of the CFTC and the SEC to the
Joint Advisory Commission Emerging Regulatory Issues.'' (May 18,
2010). See http://www.sec.gov/sec-cftc-prelimreport.pdf.
---------------------------------------------------------------------------
From the start of the investigation, many market participants had
suggested that the sudden withdrawal of liquidity in the equity markets
may have resulted in the rapid decline of prices as orders to
immediately sell (many from retail investors) found no interest on the
buy side (from market professionals).\82\ To fully understand how such
conditions could occur, Commission economists needed to analyze the
order books for thousands of equities. Commission staff requested order
book data from several exchanges that sell such data or could readily
put such data together, but this data did not represent the whole
market. Commission staff attempted to use order data from OATS and
several SRO audit trails to reconstruct order books for thousands of
equities traded on exchanges that do not maintain or could not provide
order book data. Although it was possible to link the data from
different sources to show trading activity for a particular stock over
a specific period of time, the accuracy, completeness, and content of
the combined data sets were not sufficient to allow for an accurate
reconstruction of the order books. This hindered staff in determining
what happened to liquidity before, during, and after the Flash Crash.
Two major problems were the inability to identify and eliminate
duplicate orders from the data and the inability to accurately sequence
events across the multiple data sources.
---------------------------------------------------------------------------
\82\ For detailed discussions and chronologies of the
investigation into the events of May 6, 2010, see SEC (http://www.sec.gov/spotlight/sec-cftcjointcommittee.shtml) and CFTC (http://www.cftc.gov/PressRoom/Events/AdvisoryCommitteeMeetings/index.htm)
webcasts and minutes of public meetings held with the Joint CFTC-SEC
Advisory Committee on Emerging Regulatory Issues on May 24, 2010,
June 22, 2010, August 11, 2010, November 5, 2010, and February 18,
2011.
---------------------------------------------------------------------------
As described in the final joint report issued by the staffs of the
CFTC and the Commission on September 30, 2010, Commission staff were
only able to create a comprehensive view of the order books by
acquiring, processing, and aggregating four distinct data sets that
each contained a subset of order book information from each of the four
exchanges that could provide such information: Nasdaq ModelView, NYSE
Openbook Ultra, NYSE ARCABook, and BATS Exchange.\83\ Given the
enormous volume of data that needed to be processed (more than 5.3
billion records), even small changes to the integration and aggregation
process took
[[Page 45733]]
significant computer time to test and implement.
---------------------------------------------------------------------------
\83\ See note 45, supra, at p. 11.
---------------------------------------------------------------------------
By early July 2010, staff at the CFTC had completed a very detailed
analysis of the full order book of the S&P 500 E-Mini futures contract
and were able to show how liquidity in that contract had been eroding
for most of the day. The CFTC's detailed second-by-second analysis of
trading during the Flash Crash itself revealed how buy-side depth in
the S&P 500 E-Mini futures virtually evaporated as broad market indices
rapidly fell 5%.\84\ However, until a similar analysis could be
completed in the equity markets, neither regulators nor the public
would know whether an evaporation of liquidity was also present in the
equity markets, and whether the timing of such an event preceded or
followed the liquidity event in the futures market. Ultimately, it took
Commission staff nearly five months to complete an accurate
representation of the order books of the equity markets for May 6,
2010. Even then, the reconstruction was not fully complete and only
contained an estimated 90% of trade and order activity for that
day.\85\ However, it was sufficiently comprehensive to allow staff to
perform a robust analysis of the equity markets revealing how ``the
decline in full-depth buy-side liquidity for the E-Mini precede[d] that
of the SPY and [the stocks composing] the S&P 500,'' and how ``drops in
[stock] prices [became] increasingly more severe with ever-larger drops
in liquidity.'' \86\
---------------------------------------------------------------------------
\84\ Id.
\85\ Id.
\86\ Id. at p. 18, 80.
---------------------------------------------------------------------------
Had there been a consolidated audit trail in place on May 6, 2010,
regulators would likely have been able to much more quickly and
efficiently perform these types of detailed analyses. This in turn
could have dramatically shortened the time during which regulators, as
well as the public, remained uncertain about what actually happened
during the Flash Crash.
c. Improved Market Analysis
In addition to the surveillance and reconstruction benefits
described above, a consolidated audit trail would also significantly
improve the ability of regulators to monitor overall market structure,
so that both the Commission and the SROs can be better informed in
their rulemakings. In January 2010 the Commission published a concept
release on equity market structure that discusses how the markets have
rapidly evolved from trading by floor-based specialists to trading by
high-speed computers. The concept release poses a number of questions
about the role and impact of high-frequency trading strategies and the
movement of trading volume from the public national securities
exchanges to dark pools.\87\
---------------------------------------------------------------------------
\87\ See Securities Exchange Act Release No. 61358 (January 14,
2010), 75 FR 3594 (January 21, 2010) (``Concept Release on Equity
Market Structure'').
---------------------------------------------------------------------------
Over the past two years there has been considerable discussion
about these topics by regulators, market participants, the media, and
the general public. Nevertheless, numerous open questions remain
because of a lack of consolidated market data, making certain types of
market-wide analysis impractical. For example, existing research on
high frequency trading cannot precisely identify high frequency
traders. As a result, studies of high frequency trading have been
limited in their ability to thoroughly examine such strategies and
their impact on the market, leaving many open questions. Having more
precise data on who is trading (and from which general patterns of
order submission could be inferred) would help regulators better
understand the impact of high frequency trading on markets. Similar
analyses also could be performed for other aspects of general market
structure, such as those discussed in the concept release related to
dark pools and internalization. In addition, having access to a
consolidated audit trail will provide the Commission and SROs with
better data to conduct retrospective analyses of rules and pilots.
Informed analysis of these topics requires consolidating audit trails
so that quotes and trades across multiple exchanges can be linked
(either by customer type or by specific customer) with order flow and
trades from the many dozens of over-the-counter venues.
d. Potential Reduction in Disparate Reporting Requirements and Data
Requests
The Commission believes that a consolidated audit trail will reduce
the burdens on SROs and broker-dealers associated with producing
regulatory data. In particular, the consolidated audit trail may reduce
burdens from ad hoc data requests.
The Commission believes that the creation of a consolidated audit
trail may reduce the number and types of ad hoc requests made by
regulators to market participants for data concerning their trading
activities. In particular, regulators could use direct access to data
in the consolidated audit trail for investigations or analyzing trends
or broad market activities instead of requesting data from market
participants. In addition, regulators could use this direct access to
analyze the activities of a single trader across multiple markets,
which today requires requests for data from multiple market
participants. Regulators would therefore likely make fewer ad hoc
requests. The Commission, however, does not believe that all ad hoc
requests for data from market participants will be replaced by
obtaining data from the consolidated audit trail. A detailed
investigation of a particular firm may require types of data from that
firm that are not stored in the consolidated audit trail, or that
relate to periods prior to the implementation of the consolidated audit
trail. In addition, in cases in which there are discrepancies, or even
suspected discrepancies, between a firm's actual trading activities and
what is stored in the consolidated audit trail's central repository,
regulators are likely to request data directly from market participants
for verification and investigative purposes.
3. Large Trader Reporting System Rule
The Commission believes that a consolidated audit trail will be
able to build upon various aspects of the large trader reporting system
that was recently adopted by the Commission.\88\ Rule 13h-1, which
establishes the large trader reporting system, requires large traders
to identify themselves to the Commission and make certain disclosures
to the Commission on Form 13H. Upon receipt of Form 13H, the Commission
issues a unique identification number to the large trader, which the
large trader then will be required to provide to those broker-dealers
through which the large trader trades. Registered broker-dealers will
be required to maintain specified transaction records for each large
trader and to report that information to the Commission upon request.
The Large Trader Rule requirements are designed to enable the
Commission to promptly and efficiently identify significant market
participants and collect data on their trading activity so that
Commission staff can reconstruct market events, conduct investigations
and bring enforcement actions as appropriate.
---------------------------------------------------------------------------
\88\ See note 1, supra.
---------------------------------------------------------------------------
Several commenters noted that portions of the requirements of Rule
13h-1 overlapped with certain provisions of proposed Rule 613 and
requested that the Commission harmonize the rules.\89\ One commenter
[[Page 45734]]
stated that the Commission should consider implementing only those
portions of Rule 13h-1 that would not be affected by, or be redundant
to, the implementation of the consolidated audit trail proposal.\90\
Another commenter suggested that the Commission mandate compliance only
with those aspects of Rule 13h-1 that would operate as part of the
consolidated audit trail--the large trader identifier in particular--so
they could be leveraged in the creation of the consolidated audit
trail.\91\ Yet another commenter believed that, upon implementation of
the consolidated audit trail, it would not be necessary for large
traders to identify themselves to their broker-dealers pursuant to Rule
13h-1, because the consolidated audit trail already would require
broker-dealers to include a customer identifier for every order.\92\
The commenter explained that, if customer information is collected as
part of the consolidated audit trail, the Commission and SROs could run
queries to identify customers with significant trading volume.\93\
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\89\ See ICI Letter, p. 6-7; Liquidnet Letter, p. 4-5; SIFMA
Letter, p. 18-19; CBOE Letter, p. 6 (questioning the need for a
large trader reporting system if a consolidated audit trail is
implemented).
\90\ See FINRA/NYSE Euronext letter, p. 7.
\91\ See SIFMA Letter, p. 18.
\92\ See Liquidnet Letter, p. 5.
\93\ Id.
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The Commission believes that both Rules are necessary to enhance
regulatory oversight of the markets and its members. Key aspects of
Rule 13h-1 define the types of entities that are large traders, and who
must register with the Commission and file and keep current certain
background information on Form 13H. These aspects of Rule 13h-1 are not
addressed by Rule 613 and would not be superseded by it. Rather, the
information collected by the registration of large traders would
further complement the data collected for a consolidated audit trail.
To this end, Rule 613 requires that large trader identifiers also be
reported to the central repository as part of any large trader's
customer account information.\94\
---------------------------------------------------------------------------
\94\ See Rule 613(j)(4).
---------------------------------------------------------------------------
The Commission does note, however, that other aspects of Rule 13h-1
may be superseded by Rule 613. Specifically, the trade reporting
requirements of Rule 13h-1 are built upon the existing EBS system. To
the extent that, as described in Section II.A.2.iv.d., data reported to
the central repository under Rule 613 obviates the need for the EBS
system, the Commission expects that the separate reporting requirements
of Rule 13h-1 related to the EBS system would be eliminated.\95\
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\95\ Though certain reporting requirements of Rule 13h-1 may
eventually be unnecessary due to Rule 613, the Commission notes that
Rule 13h-1 will be implemented much more expeditiously compared to
the consolidated audit trail, and therefore will address the
Commission's near-term need for access to more information about
large traders and their activities.
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B. Summary of Proposed Rule 613
Proposed Rule 613 would have required that the SROs propose an NMS
plan that included provisions regarding: (1) The operation and
administration of the NMS plan; (2) the creation, operation and
oversight of a central repository; (3) the data required to be provided
by SROs and their members \96\ to the central repository; (4) clock
synchronization; (5) compliance by national securities exchanges,
FINRA, and their members with Rule 613 and the NMS plan; and (6) a plan
for the possible expansion of the NMS plan to products other than NMS
securities.
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\96\ Section 3(a)(3)(A) of the Exchange Act defines the term
``member'' to mean: ``(i) Any natural person permitted to effect
transactions on the floor of the exchange without the services of
another person acting as broker; (ii) any registered broker or
dealer with which such a natural person is associated; (iii) any
registered broker or dealer permitted to designate as a
representative such a natural person; and (iv) any other registered
broker or dealer which agrees to be regulated by such exchange and
with respect to which the exchange undertakes to enforce compliance
with the provisions of the [Exchange Act], the rules and regulations
thereunder, and its own rules.'' Section 3(a)(3)(A) further provides
that, ``[f]or purposes of Sections 6(b)(1), 6(b)(4), 6(b)(6),
6(b)(7), 6(d), 17(d), 19(d), 19(e), 19(g), 19(h), and 21 of [the
Exchange Act], the term `member' when used with respect to a
national securities exchange also means, to the extent of the rules
of the exchange specified by the Commission, any person required by
the Commission to comply with such rules pursuant to Section 6(f) of
this title.'' Finally, Section 3(a)(3)(B) provides that ``[t]he term
`member' when used with respect to a registered securities
association means any broker or dealer who agrees to be regulated by
such association and with respect to whom the association undertakes
to enforce compliance with the provisions of [the Exchange Act].''
See 15 U.S.C. 78c(a)(3)(A) and 15 U.S.C. 78c(a)(3)(B).
---------------------------------------------------------------------------
Specifically, proposed Rule 613 would have required the SROs to
jointly file an NMS plan with the Commission to govern the creation,
implementation, and maintenance of a consolidated audit trail and a
central repository.\97\ The NMS plan would have been required to
provide for an accurate, time-sequenced record of an order's life, from
receipt or origination, through cancellation or execution. In
particular, the proposed Rule would have required the NMS plan to
require that the SROs and their respective members collect and provide
to the central repository data for each ``reportable event,'' defined
to include the receipt, origination, modification, cancellation,
routing, and execution (in whole or in part) of an order, with respect
to any NMS security. This data would have been required to be collected
and provided to the central repository in a uniform electronic format
on a real-time basis.
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\97\ The proposed Rule would have explicitly required each
national securities exchange and national securities association to
be a sponsor of the NMS plan submitted pursuant to the Rule and
approved by the Commission. See proposed Rule 613(a)(4).
``Sponsor,'' when used with respect to an NMS plan, is defined in
Rule 600(a)(70) of Regulation NMS to mean any self-regulatory
organization which is a signatory to such plan and has agreed to act
in accordance with the terms of the plan. See 17 CFR 242.600(a)(70).
---------------------------------------------------------------------------
Under the proposed Rule, the data collected upon the receipt or
origination of an order would have included: a unique order identifier;
a unique customer identifier; \98\ a unique identifier for the broker-
dealer receiving or originating the order; the date and time of receipt
or origination of the order; and the ``material terms of the order.''
\99\ For orders that are modified or cancelled, the data collected in
real time would have included: The date and time the modification or
cancellation was received or originated; the price and remaining size
of the order; changes in the material terms of the order (if the order
is modified); and the identity of the person giving the modification or
cancellation.
---------------------------------------------------------------------------
\98\ Proposed Rule 613(j)(1) would have defined the term
``customer'' to mean the beneficial owner(s) of the account
originating the order and the person exercising investment
discretion for the account originating the order, if different from
the beneficial owner(s).
\99\ The proposed Rule would have defined ``material terms of
the order'' to include, but not be limited to: The NMS security
symbol; security type; price (if applicable); size (displayed and
non-displayed); side (buy/sell); order type; if a sell order,
whether the order is long, short, or short exempt; if a short sale,
the locate identifier, open/close indicator, time in force (if
applicable), whether the order is solicited or unsolicited, and
whether the account has a prior position in the security; if the
order is for a listed option, option type (put/call), option symbol
or root symbol, underlying symbol, strike price, expiration date,
and open/close; and any special handling instructions. See proposed
Rule 613(j)(3).
---------------------------------------------------------------------------
For orders that are routed, data collected in real time would have
included: The unique order identifier, the date and time the order was
routed; The unique identifier of the broker-dealer or national
securities exchange routing the order; the unique identifier of the
broker-dealer or national securities exchange receiving the order; if
routed internally at a broker-dealer, the identity and nature of the
department and desk to which the order was routed; and the material
terms of the order.
For orders received that were routed, data collected in real time
would have included all the information for orders that are routed,
except the identity and nature of the department and desk to which the
order was routed, if routed internally at a broker-dealer; however,
[[Page 45735]]
the date and time the order was routed would be replaced by the date
and time the order was received.
For the execution of an order, data collected in real time would
have included: the unique order identifier; the date and time of
execution; the execution size and price; the unique identifier of the
SRO or broker-dealer executing the order; the capacity of the broker-
dealer executing the order (i.e., principal, agency, riskless
principal); and whether the execution was reported pursuant to an
effective transaction reporting plan or the OPRA Plan.\100\
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\100\ ``The OPRA Plan'' is the Plan for Reporting of
Consolidated Options Last Sale Reports and Quotation Information
filed with the Commission pursuant to, and meeting the requirements
of, Rule 608 of Regulation NMS. The OPRA Plan governs the
dissemination of trade and quotation information for listed options.
In this capacity, it provides real-time quotation and transaction
information to market participants. See 17638 (March 18, 1981), 22
SEC Docket 484 (March 31, 1981) (order approving the OPRA Plan).
---------------------------------------------------------------------------
Because certain information may not be readily available at the
time of the reportable event, the proposed Rule would have required the
NMS plan to require each SRO and its members to collect and provide to
the central repository certain information, in a uniform electronic
format, promptly after receipt of such information, but in no instance
later than midnight of the day that the reportable event occurred or
when the SRO or its member receives such information. Under the
proposed Rule, this data would have included: The account number for
any subaccounts to which the execution is allocated (in whole or part);
the unique identifier of the clearing broker or prime broker, if
applicable; the unique order identifier of any contra-side order;
special settlement terms, if applicable; short sale borrow information
and identifier; the amount of a commission, if any, paid by the
customer, and the unique identifier of the broker-dealer(s) to whom the
commission is paid; and, if the execution is cancelled, a cancelled
trade indicator.
The proposed Rule would have required that the SROs jointly file an
NMS plan with the Commission within 90 days after approval of the Rule.
In addition, the SROs would have been required to select a plan
processor within two months of the effectiveness of the NMS plan, as
well as provide the Commission a document outlining how the SROs would
propose to expand the audit trail to include non-NMS securities and
additional transactions. The proposed Rule also would have required the
SROs to file proposed rule changes to require their members to comply
with the requirements of the proposed Rule and the NMS plan within 120
days of the effectiveness of the NMS plan. The SROs would have been
required to begin reporting data to the central repository within one
year after the effectiveness of the NMS plan, and their members would
have been required to begin reporting data to the central repository
within two years after the effectiveness of the NMS plan.
As proposed, the NMS plan would have been required to include
specific plan provisions, detailing: The plan governance structure, the
processes of admission and withdrawal of plan sponsors, the percentage
of votes required to effectuate amendments to the plan, the allocation
of central repository costs among the plan sponsors, and the
appointment of a Chief Compliance Officer (``CCO'') of the central
repository. The proposed Rule would have required all plan sponsors to
develop and implement a surveillance system, or enhance existing
surveillance systems, reasonably designed to make use of the
information contained in the consolidated audit trail. This information
would be available to the Commission and the SROs for regulatory and
oversight purposes only. The proposed Rule also would have required the
NMS plan to require information be collected in a convenient and usable
standard electronic data format, directly available and searchable
electronically without any manual intervention for a period of not less
than five years. This information would have been required to be
available immediately, or, if immediate availability was not reasonably
and practically achieved, any search query would have to begin
operating on the data not later than one hour after the search query
was made. Additionally, the proposed Rule would have required the NMS
plan to include policies and procedures, including standards, to be
utilized by the plan processor to ensure the security and
confidentiality of all information submitted to the central repository,
and all SROs and their employees, as well as all employees of the
central repository, would have been required to agree to use
appropriate safeguards to ensure the confidentiality of such data. The
proposed Rule also would have required SROs and their members to
synchronize their business clocks that are used for the purposes of
recording the date and time of any event that must be reported under
the proposed Rule consistent with industry standards. Further, the
proposed Rule would have required the central repository to collect and
retain, on a current and continuing basis, and in a format compatible
with the other information collected pursuant to the proposed Rule, the
national best bid and national best offer (``NBBO'') information for
each NMS security. Transaction reports reported pursuant to an
effective transaction reporting plan filed with the Commission pursuant
to, and meeting the requirements of, Rule 601 of Regulation NMS under
the Exchange Act,\101\ and last sale reports reported pursuant to the
OPRA Plan filed with the Commission pursuant to, and meeting the
requirements of, Rule 608 of Regulation NMS under the Exchange Act also
would have been required to be collected and retained.
---------------------------------------------------------------------------
\101\ The effective transaction reporting plans include the
Consolidated Tape Association Plan (``CTA Plan'') and the Joint
Self-Regulatory Organization Plan Governing the Collection,
Consolidation and Dissemination of Quotation and Transaction
Information for Nasdaq-listed Securities Traded on Exchanges on an
Unlisted Trading Privilege Basis (``UTP Plan'').
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C. Summary of General Comments on the Proposed Rule
The Commission requested comments on all aspects of the proposed
Rule, including the potential costs and benefits.\102\ In particular,
the Commission encouraged commenters to identify, discuss, analyze, and
supply relevant data regarding any such costs or benefits.\103\ In
response, commenters provided views and opinions regarding the
regulatory usefulness of a consolidated audit trail; the overall costs
of the proposed Rule, focusing on those requirements that commenters
believed would be the most costly or burdensome to implement; \104\ the
process for creating and implementing a consolidated audit trail; and
alternatives to the proposed Rule's approach to creating, implementing,
and maintaining a consolidated audit trail. These comments are
discussed below.
---------------------------------------------------------------------------
\102\ See Proposing Release, supra note 4, at 32586 and 32594.
\103\ Id.
\104\ For comments on general costs of the proposed Rule, see,
e.g., Thomson Reuters Letter, p. 2; Liquidnet Letter, p. 1; CBOE
Letter, p. 2; Nasdaq Letter I, p. 2; Angel Letter, p. 1-2; IAG
Letter, p. 3.; Kaufman Letter, attachment p. 3; Wells Fargo Letter,
p. 4; Noetic Partners Letter, p. 2; Leuchtkafer Letter, p. 1-5;
Broadridge Letter, p. 3; SIFMA Letter, p. 1-2, FINRA Letter, p. 3;
FINRA Proposal Letter, p. 2.; High Speed Letter, p. 1; Belanger
Letter, p. 7-8.
---------------------------------------------------------------------------
1. Industry Support for a Consolidated Audit Trail
Commenters provided a wide range of opinions, and shared their
concerns, regarding specific aspects of the proposed Rule.\105\
However, many of the
[[Page 45736]]
commenters and their representatives who are involved with regulating
and operating securities markets--as well as many of the commenters who
otherwise populate data for, or make use of, existing audit trail
systems (such as broker-dealers)--expressed support for the creation of
a single consolidated audit trail.
---------------------------------------------------------------------------
\105\ See Section II.C., infra, for a discussion of specific
concerns raised by commenters.
---------------------------------------------------------------------------
FINRA and NYSE Euronext, filed a joint letter, ``vigorously
support[ing] the establishment of a consolidated audit trail,'' and
stating, among other things, that ``the evolution of the U.S. equity
markets and the technological advancements that have recently taken
place have created an environment where a consolidated audit trail is
now essential to ensuring the proper surveillance of the securities
markets and maintaining the confidence of investors in those markets.''
\106\
---------------------------------------------------------------------------
\106\ See FINRA/NYSE Euronext Letter, p. 1. NYSE Euronext is the
publicly traded parent of a number of subsidiaries, including three
SROs, NYSE, NYSE Amex, and NYSE Arca.
---------------------------------------------------------------------------
The NASDAQ OMX Group, Inc. similarly states that ``[m]arket
developments and fragmentation of market centers with varying market
structures and levels of transparency have created inefficiencies and
potential gaps in cross-market regulation,'' and that ``[c]omplete
transparency is the only way to ensure fair and orderly markets.''
\107\
---------------------------------------------------------------------------
\107\ See Nasdaq Letter I, p. 2. The NASDAQ OMX Group, Inc. is
the publicly traded parent of a number of subsidiaries, including
three SROs, Nasdaq, Phlx, and BX.
---------------------------------------------------------------------------
Other commenters also stated their general support for the creation
of a consolidated audit trail. According to Direct Edge Holdings, LLC
(``Direct Edge''), ``[t]he proposed consolidated audit trail (`CAT')
system would significantly enhance the capabilities of regulators to
police trading across asset classes; replace existing audit trails and
consolidate trading and execution data for the asset classes under the
Commission's jurisdiction * * * enable regulators to create a more
complete timeline of an order's lifecycle; and facilitate large-scale
market reconstructions * * * .'' \108\
---------------------------------------------------------------------------
\108\ See Direct Edge Letter, p. 1. Direct Edge is the parent of
two SROs, EDGA Exchange, Inc. and EDGX Exchange, Inc.
---------------------------------------------------------------------------
Although CBOE expressed some concerns in its comment letter about
the ``breadth, expense, and timetable of the Proposal'' \109\ (concerns
that were shared by other commenters),\110\ it ``recognizes there are
potential benefits to be obtained from CAT, and agrees that a central
repository with uniform data submitted by all markets could enhance SRO
and SEC oversight of the markets.'' \111\ CBOE further stated that,
``[i]n particular, a CAT that contains a customer identifier on an
order by order basis would enhance significantly the audit trails of
the markets.'' \112\
---------------------------------------------------------------------------
\109\ See CBOE Letter, p. 2.
\110\ See, e.g., Scottrade Letter, p. 1; ICI Letter, p. 4-6;
FINRA/NYSE Euronext Letter, p. 4; GETCO Letter, p. 2; BATS Letter,
p. 1-2; SIFMA Letter, p. 3-8; Direct Edge Letter, p. 3; FINRA
Letter, p. 10-13; Wells Fargo Letter, p. 3; Knight Letter, p. 2-3;
Leuchtkafer Letter; Broadridge Letter, p. 3; SIFMA Proposal Letter,
p. 1; FINRA Proposal Letter, p. 3.; Liquidnet Letter, p. 3 & p. 5-6;
Ameritrade Letter, p. 2-3
\111\ Id.
\112\ Id.
---------------------------------------------------------------------------
BATS Exchange, Inc. (``BATS'') expressed general support for the
Commission's proposal, stating, ``[o]ver the last several years,
liquidity has dispersed across multiple interconnected venues, such
that no one market center can claim a majority share of equity
securities transactions. However, regulatory tools have not evolved to
keep pace with these changes, and the limited existing processes and
data available to analyze inter-market trading are inadequate. As a
consequence, regulators rely on inefficient processes to reconstruct
inter-market trading activity, including ad hoc requests to members for
trading data when a potential problem is identified.'' \113\
---------------------------------------------------------------------------
\113\ See BATS Letter, p. 1.
---------------------------------------------------------------------------
Liquidnet, Inc. (``Liquidnet''), an ATS, generally stated that,
``[i]n the long run, a properly-designed system that provides for
centralized reporting of data should be more cost-efficient than the
current patchwork system for collecting audit trail data.'' \114\
Liquidnet outlined seven specific benefits of a consolidated audit
trail, ranging from ``[reducing] the time that regulatory personnel
must expend to request and collect data from market participants on a
case-by-case basis,'' to ``[reducing] the cost of reconstructing,
analyzing, and reporting on significant market events such as those
that occurred on May 6, 2010.'' \115\
---------------------------------------------------------------------------
\114\ See Liquidnet Letter, p. 1.
\115\ Id. at p. 1-2.
---------------------------------------------------------------------------
The Securities Industry and Financial Markets Association
(``SIFMA''), an industry group that represents, among other entities,
hundreds of securities firms that could be impacted by the creation of
a consolidated audit trail, ``believes that a centralized and
comprehensive audit trail would enable the SEC and securities self-
regulatory organizations (`SROs') to perform their monitoring,
enforcement, and regulatory activities more effectively.'' \116\ SIFMA
further states that, ``[i]n the current era of electronic trading,
regulators need efficient access to order and execution data from both
broker-dealers and exchanges. Indeed, a consolidated audit trail is a
much-needed improvement over today's fragmented audit trail
platforms.'' \117\ As did a number of other commenters,\118\ SIFMA also
expressed concerns about, and suggested alternatives to, some specific
aspects of the proposed Rule, which will be further discussed below.
---------------------------------------------------------------------------
\116\ See SIFMA Letter, p. 1-2.
\117\ Id. at p. 2.
\118\ See, e.g., FINRA/NYSE Euronext Letter, p. 7, FINRA Letter,
p. 3, FINRA Proposal Letter, p. 1-16, FTEN Letter, p. 1, 4-5,
Correlix Letter, p. 2-3; BOX Letter, p. 2; BATS Letter, p. 2.; CBOE
Letter, p. 2; Angel Letter, p. 2; Wells Fargo Letter, p. 2; Knight
Letter, p. 3; FIF Letter, p. 5-6; Schumer Letter, p. 1.
---------------------------------------------------------------------------
Finally, the Commission notes that members of the Financial
Information Forum, whose participants include ``trading and back office
service bureaus, broker-dealers, market data vendors and exchanges,''
agree that ``an enhanced audit trail system could increase the
effectiveness of cross-market surveillance through better data
availability and integration.'' \119\
---------------------------------------------------------------------------
\119\ See FIF Letter, p. 1.
---------------------------------------------------------------------------
When the perspectives of these commenters are combined with the
Commission's own experiences (as described above in Section II.A.1.c.),
a common theme emerges: There is substantial room for improvement in
the collection of and access to trading data beyond what is available
today from existing audit trails and other sources. The Commission
agrees with many of the commenters that one of the main benefits of a
consolidated audit trail will be to improve the efficiency and adequacy
of a regulatory process of collecting and accessing audit trail data
that directly affects and impacts a significant number, and wide
variety, of market participants.
2. Commenters' Views on the Overall Costs of the Proposed Rule and the
Resulting Framework of the Adopted Rule
With respect to general costs for the proposal, commenters
expressed differing views. As discussed below, some commenters thought
that the Commission overestimated the burdens of creating,
implementing, and maintaining a consolidated audit trail, while others
argued that the Commission had underestimated such burdens.
Nasdaq was among those commenters that stated that the Commission
had overestimated the burdens. Specifically, Nasdaq stated that
``innovative technology exists to meet many of the Commission's goals
at significantly
[[Page 45737]]
lower costs than estimated in the Proposing Release,'' and that SROs
should be able to weigh the costs and benefits of various designs.\120\
Other commenters also expressed similar opinions stating that a
consolidated audit trail accomplishing the Commission's goals could be
implemented for less than the preliminary estimates.\121\ Two firms
with experience in processing and analyzing market data, FTEN and
Thomson Reuters, each noted that current technology could convert data
from disparate systems into a uniform format, resulting in a less
costly implementation of the consolidated audit trail.\122\ FTEN stated
that ``currently available commercial systems are capable of
immediately accomplishing CAT goals of real-time cross-market
transparency, accountability and control with no implementation risk
and for far less than the estimated multi-billion dollar price tag.''
\123\ It further suggested that ``[t]he SEC should leverage already
deployed and commercially available solutions that are in production
use today by major market participants * * * .'' and an ``iterative
approach [that] would leverage existing systems to capture order and
execution data in real-time from liquidity destinations (exchanges,
ECNs, ATSs and dark pools) and `map' the data back to original trade
submissions by market participants without requiring integration with,
or changes to, market participants systems or to liquidity destination
systems and without modifying existing order flow.'' \124\ Similarly,
another commenter recommended a technology solution that could handle
the required data in milliseconds and that ``significantly reduces disk
space required, which can potentially save millions of dollars when
dealing with multiple terabytes of data.'' \125\ One commenter
suggested an entirely different approach through the use of an
``adaptive graph indexing-based architecture'' as the basis for the
consolidated audit trail platform, instead of using a central
repository, and explained that this technology would keep trading data
within each SRO.\126\
---------------------------------------------------------------------------
\120\ See Nasdaq Letter I, p. 2.
\121\ See Thomson Reuters Letter, p. 2; Noetic Partners Letter,
p. 2; FTEN Letter, p. 1; Ross Letter; Correlix Letter, p. 2.; FINRA
Proposal Letter, p. 2.; High Speed Letter, p. 1; Belanger Letter, p.
7-8; Aditat Letter, p. 2 (stating that FIX protocol is already used
in the industry today, making it cheaper to create systems to handle
consolidated audit trail data as the data already exists in a
``suitable format'').
\122\ See FTEN Letter, p. 13; Thomson Reuters Letter, p. 2-3.
\123\ See FTEN Letter, p. 1.
\124\ Id. at p. 3.
\125\ See Know More Software Letter, p. 1.
\126\ See Belanger Letter, p. 4.
---------------------------------------------------------------------------
On the other hand, numerous commenters expressed general concerns
about the costs of implementing a consolidated audit trail relative to
the benefits to be gained. For example, one commenter stated that
``there can be no doubt whether market regulators need a consolidated
audit trail;'' however, the commenter questioned whether a system as
costly as the consolidated audit trail was necessary to detect
violations such as frontrunning, spoofing, and layering, which are
violations the Commission has rarely pursued in the recent past.\127\
---------------------------------------------------------------------------
\127\ See Leuchtkafer Letter, p. 4. See also IAG Letter, p. 3.
---------------------------------------------------------------------------
As discussed above, many commenters expressed general support for
the creation of a consolidated audit trail, but believed that, as
proposed, the implementation would be too costly and that the Rule
should be modified.\128\ Concern about the proposed real-time
requirements for reporting data to the central repository was a common
theme expressed by these commenters,\129\ including those who
maintained that a requirement to provide data on a real-time basis
would be too burdensome due to the extensive systems changes that would
be needed to comply with such a requirement.\130\ Some of these
commenters argued that a real-time reporting requirement would require
many industry participants to build entirely new systems or undertake
significant technological upgrades.\131\ SIFMA, in particular,
estimated that the cost per broker-dealer to implement real-time
reporting could be millions of dollars and that the cost of capturing
options quotes in real time alone could exceed the Commission's $2.1
billion estimate for the annualized cost of the audit trail.\132\ SIFMA
further argued that broker-dealers would incur costs associated not
only with establishing and maintaining the infrastructure to support
real-time reporting, but also due to regulatory risk if they are not
able to achieve 100 percent compliance with the proposed Rule.\133\
While SIFMA opposed a real-time reporting requirement, and encouraged
the Commission to adopt a next day or later reporting requirement,\134\
SIFMA also stated that ``if the SEC determines to require reporting of
certain data elements in real-time or near real-time, we believe such
data should be limited to reporting of `key business events.' '' \135\
SIFMA further stated that, ``if the definition of real-time allowed for
reporting within minutes (e.g. 10-15 minutes) of the events, it would
be substantially less intrusive on order management systems and may
allow for greater flexibility in designing reporting systems
architecture and more standardized content for events such as order
modifications * * * .'' \136\ SIFMA described how a reporting system
using ``drop copies'' \137\ could be ``achievable in the relative near
term,'' although it noted that its proposed process would not, among
other things, include a unique Customer ID or a unique order
identifier.\138\
---------------------------------------------------------------------------
\128\ See, e.g., SIFMA Letter, p. 2, 15-16; FINRA/NYSE Euronext
Letter, p. 7; FINRA Letter, p. 3; Angel Letter, p. 2; CBOE Letter,
p. 2-6 (suggesting several ways that the costs of the proposal could
be reduced, including: Leveraging existing SRO experience with audit
trail systems and imposing uniformity across markets in those
systems; requiring the submission of audit trail information through
a batch process after the close of the trading day; deleting the
requirement that all market maker quotes be submitted to the
proposed consolidated audit trail; making clear that broker-dealers
have no obligation to report order information that has already been
reported to an exchange; and revisiting the need for a large trader
reporting system if that proposed rule is adopted.).
\129\ See Scottrade Letter, p. 1; ICI Letter, p. 4-6; FINRA/NYSE
Euronext Letter, p. 4; GETCO Letter, p. 2; BATS Letter, p. 1-2;
SIFMA Letter, p. 3-8; CBOE Letter, p. 4-5; Direct Edge Letter, p. 3;
FINRA Letter, p. 10-13; Wells Fargo Letter, p. 3; Knight Letter, p.
2-3; Leuchtkafer Letter; Broadridge Letter, p. 3; FIF Letter, p. 4;
SIFMA Drop Copy Letter, p. 1; Ross Letter, p. 1; FINRA Proposal
Letter, p. 3; SIFMA February 2012 Letter; FIA Letter, p. 1-2.
\130\ See Section III.F.2., infra; see also, e.g., BATS Letter,
p. 1-2; Broadridge Letter, p. 3; FIF Letter, p. 4-5; FINRA/NYSE
Euronext Letter, p. 7; FINRA Letter, p. 3; ICI Letter, p. 4-5;
Knight Letter, p. 2; Scottrade Letter, p. 1-2; SIFMA Letter, p. 3-6;
SIFMA February 2012 Letter. Some commenters also questioned whether
the costs to provide data on a real-time basis would outweigh the
benefits. See Scottrade Letter, p. 1-2; FINRA/NYSE Euronext Letter,
p. 4; GETCO Letter, p. 2; BATS Letter, p. 2; SIFMA Letter, p. 3-8;
CBOE Letter, p. 4; FINRA Letter, p. 11-13; Wells Fargo Letter, p. 3;
ICI Letter, p. 4-6; GETCO Letter, p. 2; Direct Edge Letter, p. 3;
Leuchtkafer Letter; SIFMA Drop Copy Letter, p. 1; Ross Letter, p. 1;
FINRA Proposal Letter, p. 3; SIFMA February 2012 Letter; FIA Letter,
p. 2.
\131\ See Scottrade Letter, p. 1-2; ICI Letter, p. 4-5; SIFMA
Letter, p. 4; Knight Letter, p. 2. See also Broadridge Letter, p. 3;
FIF Letter, p. 4; FIA Letter, p. 2.
\132\ See SIFMA Letter, p. 4-6.
\133\ Id. at p. 5.
\134\ See SIFMA Letter, p. 3-4.
\135\ See SIFMA Drop Copy Letter.
\136\ Id.
\137\ A ``drop copy'' is an electronic copy of a message
automatically generated by the existing order management and
execution systems used by broker-dealers and SROs.
\138\ See SIFMA Drop Copy Letter.
---------------------------------------------------------------------------
Commenters also expressed general concerns regarding the costs of
other aspects of the Proposed Rule. For example, Global Electronic
Trading Company (``GETCO''), a market maker in equities and equity
options, urged the Commission to consider whether quotation information
already
[[Page 45738]]
disseminated by SROs could be reported instead of requiring the SROs
and their members to report all quotation information to reduce costs
for the industry.\139\ Another commenter, Wells Fargo Advisors, argued
that the inclusion of a unique customer identifier would add
``tremendous incremental cost to the [consolidated audit trail].''
\140\
---------------------------------------------------------------------------
\139\ See GETCO Letter, p. 3-4.
\140\ See Wells Fargo Letter, p. 3.
---------------------------------------------------------------------------
Many commenters provided suggestions and views on how the costs of
creating and implementing a consolidated audit trail might be lowered.
For example, financial technology firm, Correlix, Inc. (``Correlix''),
stated that relying on existing infrastructure, where possible, could
bring down the cost and amount of time it would take to implement the
consolidated audit trail.\141\ Correlix further stated that existing
technology already is able to provide ``a complete end-to-end history
of message and order data from the market participant to the execution
venue's matching engine and back to the originator,'' and that allows
clients to run customized queries and reports on the data.\142\
---------------------------------------------------------------------------
\141\ See Correlix Letter, p. 2-3.
\142\ Id.
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A variety of commenters, including SROs and broker-dealers, also
believed it would be more cost efficient to use the existing OATS
infrastructure specifically as a basis for a consolidated audit trail,
rather than to purchase or create an entirely new system.\143\
Commenters further argued that existing audit trails could be expanded
economically and quickly.\144\
---------------------------------------------------------------------------
\143\ As discussed in Section II.C.4, infra, both SIFMA and
FINRA submitted several comment letters with increasing levels of
detail on the extent to which existing infrastructures could be used
to achieve different forms of the various reporting requirements of
the proposed Rule. In one of its later comment letters, FINRA
submitted a detailed blueprint describing how it would build a
consolidated audit trail that it believed would meet the primary
objectives of the proposed Rule in a relatively short timeframe and
with minimum costs to the industry. See FINRA Proposal Letter; SIFMA
Letter, p. 16-18. See also BOX Letter, p. 2; BATS Letter, p. 2.;
CBOE Letter, p. 2-3; Angel Letter, p. 2-3; Wells Fargo Letter, p. 2;
Knight Letter, p. 3; FIF Letter, p. 5-6; Schumer Letter, p. 1; FIA
Letter, p. 3.
\144\ See, e.g., FINRA/NYSE Euronext Letter; FINRA Letter;
Schumer Letter, p. 1.
---------------------------------------------------------------------------
In contrast, other commenters expressed the view that costs could
be reduced not by using existing audit trail infrastructures, but
rather by using new, innovative technology to create the consolidated
audit trail.\145\ Noetic Partners, a financial technology firm,
explained that technologies are currently available to build a system
that would capture ``full-depth'' data with ``compression and near-line
storage'' in a system that would enable fast retrieval and analysis of
data, and opined that, based on existing technology, a consolidated
audit trail could be implemented for substantially less than the
Commission's preliminary estimates.\146\ This commenter stated that,
based on available technology, a fully functional consolidated audit
trail could be implemented in months, rather than years, at an initial
cost of less than $100 million.\147\
---------------------------------------------------------------------------
\145\ See Noetic Partners Letter II, p. 2; High Speed Letter, p.
1 (opining that estimated costs could be reduced if data were stored
in an off-the-shelf cloud-based storage system or if a petabyte
storage facility was built to store data and also estimating that
``an integrated analysis system combining bespoke software for
first-cut filtering of data from the repository, along with
[commercial off-the-shelf software] for detailed analysis, could be
developed for less than $10M''). See also Know More Software Letter,
p. 1; Belanger Letter, p. 4; FTEN Letter, p. 1, 13.
\146\ See Noetic Partners Letter II, p. 2.
\147\ Id.
---------------------------------------------------------------------------
An aggregate analysis of the many specific opinions described above
suggests that commenters' views regarding the costs of creating,
implementing, and maintaining a consolidated audit trail fall into one
of two general categories. One set of commenters expressed the view
that many, if not all, of the requirements of the proposed Rule could
be met in a cost-effective fashion if current audit trail systems were
replaced with new technologies and systems. However, another set of
commenters expressed the view that a number of the requirements of the
proposed Rule would be very costly to implement, and, instead,
suggested that the most cost-effective method of creating a
consolidated audit trail would be to relax some of the proposed
requirements and build upon the infrastructure of existing audit trail
systems.
Therefore, as discussed above and in detail below,\148\ in response
to these comments, and specific comments discussed throughout this
Release,\149\ the Commission is adopting Rule 613 with substantive
changes to some of the specific collection, reporting, and data
requirements of the Rule.\150\ The Commission believes that these
changes significantly expand the solutions that could be considered by
the SROs for creating, implementing, and maintaining a consolidated
audit trail and provide the SROs with increased flexibility in how they
choose to meet the requirements of the Rule compared with the
requirements of the proposed Rule. For example, the Rule no longer
requires real-time reporting \151\ or only one unique order identifier;
\152\ thus, the Rule would accommodate an NMS plan based on the types
of solutions proposed by SIFMA and FINRA. However, to guide the SROs in
their development of the NMS plan, the Rule includes several specific
considerations \153\ that the Commission intends to use to evaluate the
submitted NMS plan and consider its costs and benefits.
---------------------------------------------------------------------------
\148\ See Section I., supra.
\149\ See, generally, Section III., infra.
\150\ See Section I., supra, for a summary of the changes to
proposed Rule 613.
\151\ See Rule 613(c)(3); Section I., supra; Section III.B.1.e.,
infra.
\152\ See Rule 613(j)(1); Section I., supra; Section
III.B.1.d.iv., infra.
\153\ See Rule 613(a)(1)(i) through (xii); Section I., supra;
Section III.C.2.a., infra.
---------------------------------------------------------------------------
The changes from the Proposing Release provide the SROs with the
flexibility to submit an NMS plan that provides creative solutions that
harness innovative technology or that build on existing audit trail
systems.
3. Comments on the Process for Creating a Consolidated Audit Trail
The Commission received comments regarding the process through
which a consolidated audit trail should be created. As proposed, the
Rule required that the SROs submit an NMS plan setting forth the
details for the creation, implementation, and maintenance of a
consolidated audit trail within 90 days of approval of the Rule. A few
commenters suggested that more time be allotted for the planning and
design of the NMS plan.\154\ FIF and the Security Traders Association
(``STA'') recommended extensive, ``up-front business analysis,'' \155\
explaining that if conducted ``during the CAT plan development process,
[they] are confident that issues would emerge earlier in the process,
leading to more efficient and cost-effective solutions.'' \156\ These
commenters believed that the business analysis would require many
discussions involving the Commission, the SROs and teams comprising
members of the securities industry.\157\
---------------------------------------------------------------------------
\154\ See FIF Letter II, p. 2-3; STA Letter, p. 2; Nasdaq Letter
I, p. 6-7.
\155\ See FIF Letter II, p. 1, 3; STA Letter, p. 1, 3.
\156\ See FIF Letter II, p. 2; STA Letter, p. 1.
\157\ See FIF Letter II, p. 1; STA Letter, p. 1-2.
---------------------------------------------------------------------------
In this regard, several commenters suggested that the Commission
undergo a RFP or request for information (``RFI'') process to create
and implement a consolidated audit trail.\158\ Specifically, FIF urged
the Commission to perform a RFP process ``to determine the best
technical solution for developing a
[[Page 45739]]
consolidated audit trail.'' \159\ FIF suggested that the Commission
``should outline a set of goals and guiding principles they are
striving to achieve as part of the adopted CAT filing and leave the
determination of data elements and other technical requirements to [an]
industry working group.'' \160\ Similarly, Direct Edge suggested that
Commission staff should form and engage in a working group to develop
an RFP for publication by the Commission.\161\ DirectEdge explained
that an RFP process would facilitate the identification of the costs
and benefits of the audit trail, as well as the consideration of a
wider range of technological solutions.\162\ Further, commenters,
including Broadridge Financial Solutions, Inc., a technology
provider,\163\ also requested more specific information about the audit
trail system to better assess the Commission's initial cost estimates
and to determine the best approach to the consolidated audit
trail.\164\
---------------------------------------------------------------------------
\158\ See FIF Letter, p. 1, 9; FIF Letter II, p. 1-2; STA
Letter, p. 2; Direct Edge Letter, p. 2-3, 5.
\159\ See FIF Letter, p. 1.
\160\ See FIF Letter II, p. 2.
\161\ See Direct Edge Letter, p. 2-3, 5. See also STA Letter, p.
1-3 (recommending the use of working groups comprising the
Commission, FINRA, exchanges, broker-dealers, investors, vendors,
and institutional asset managers to conduct business analysis and
requisite discussions with the industry in planning a consolidated
audit trail that meets the Commission's goals).
\162\ Id. at p. 3.
\163\ See Broadridge Letter, p. 2.
\164\ See Broadridge Letter, p. 2; FIF Letter, p. 8. See also
Ross Letter, p. 1 (discussing examples of information security
details to consider); Nasdaq Letter I, p. 6 (stating that the
proposed Rule provided ``incomplete technical information on which
design and features make the most sense'').
---------------------------------------------------------------------------
To gather the necessary information, commenters argued that the
timeframe for submitting an NMS plan should be extended. FIF and STA
opined that the time needed to perform the analysis to produce a
``detailed blueprint for CAT'' \165\ would be closer to six
months,\166\ rather than the proposed 90 days.\167\ As a basis for
their suggestions, FIF provided a breakdown of the time and the types
of work needed for FINRA's expansion of OATS to all NMS
securities.\168\ FIF noted that over one-third of the time required for
the project was spent on conducting business analysis, and that one-
third of the time was spent on project development.\169\
---------------------------------------------------------------------------
\165\ See FIF Letter II, p. 1-2; STA Letter, p. 2.
\166\ See FIF Letter II, p. 2; STA Letter, p. 2-3; see also
Nasdaq Letter I, p. 7 (arguing for ``scheduling flexibility at the
initial stage'' of designing the consolidated audit trail).
\167\ See proposed Rule 613(a)(1).
\168\ See FIF Letter II, p. 3. The commenter also provided the
cost to the industry for the expansion of OATS to all NMS stocks--
$48 million. The Commission notes that this is the cost for the
project as a whole, not solely for the planning phase, and therefore
is not entirely applicable to the cost of the creating and filing
the NMS plan required by Rule 613.
\169\ The time remaining was spent on ``testing and other
activities.'' See FIF Letter II, p. 3.
---------------------------------------------------------------------------
In response to these comments, the Rule requires the SROs to
provide more information and analysis to the Commission as part of
their NMS plan submission than would have been required under the
proposed Rule. As discussed in more detail below, these requirements
have been incorporated into the Rule as ``considerations'' that the
SROs must address, and they generally mandate that the NMS plan
submitted to the Commission for its consideration discuss certain
important features and details of the NMS plan, such as how data will
be transmitted to the central repository, as well as an analysis of NMS
plan costs and impact on efficiency, competition, and capital
formation, the process followed by the SROs in developing the NMS plan,
and information about the implementation plan and milestones for the
creation of the consolidated audit trail.\170\ These requirements are
intended to ensure that the NMS plan is the result of a thorough and
well-developed plan for creating, implementing, and maintaining the
consolidated audit trail, and the Proposing Release highlighted the
importance of these types of considerations. In Section III.C. below,
the Commission also provides details about how it envisions regulators
would use, access, and analyze consolidated audit trail data through a
number of ``use cases'' to help the SROs prepare a sufficiently
detailed NMS plan that addresses the requirements of the adopted
Rule.\171\
---------------------------------------------------------------------------
\170\ See Section III.C.2.a., infra.
\171\ See Section III.C.2.b., infra.
---------------------------------------------------------------------------
Because of the additional information and analysis required to be
included in the NMS plan, the Commission is extending the amount of
time allowed for the SROs to submit the NMS plan. Rule 613(a)(1)
provides that ``[e]ach national securities exchange and national
securities association shall jointly file on or before 270 days from
the date of publication of the Adopting Release in the Federal Register
a national market system plan to govern the creation, implementation,
and maintenance of a consolidated audit trail and central repository as
required by this section.'' The Commission will publish the NMS plan
submitted in accordance with Rule 608 of Regulation NMS under the
Exchange Act \172\ for public comment and will approve the NMS plan if
the Commission determines it is necessary or appropriate in the public
interest, for the protection of investors and the maintenance of fair
and orderly markets, to remove impediments to, and perfect the
mechanisms of, a national market system, or otherwise in furtherance of
the purposes of the Act.\173\ The Commission also will consider whether
the NMS plan submitted for its consideration would achieve the
objectives of the Rule.
---------------------------------------------------------------------------
\172\ 17 CFR 242.608.
\173\ 17 CFR 242.608(b)(2).
---------------------------------------------------------------------------
4. Comments on Alternatives to the Proposed Consolidated Audit Trail
Several commenters, many of whom generally supported the concept of
a consolidated audit trail, recommended alternatives for how a
consolidated audit trail should be created, implemented, and
maintained. In particular, the Commission received comments suggesting
various ways that the OATS system could be modified to serve as the
central repository for the consolidated audit trail. FINRA submitted a
blueprint for a modified version of OATS that listed certain changes to
address the Commission's proposed requirements for the creation,
implementation, and maintenance of the consolidated audit trail.\174\
The proposed modifications included, for example, the addition of data
elements capturing whether an order was solicited, customer account
type, a large trader identifier,\175\ and a unique identifier for
branch office and registered representative to the data reported to
OATS; \176\ using OATS to capture order and quote data from all
national securities exchanges and eventually OPRA; the inclusion of
options, fixed income securities, security-based swaps, principal
orders and orders originating in firm-controlled accounts for purposes
of working a customer order in OATS; the use of CRD numbers to identify
broker-dealers; an exchange data processing gateway for OATS to
validate submissions from exchanges; full access to regulators of
queryable consolidated audit trail data through the FINRA web portal;
\177\ and OATS' acceptance of limited drop-copy report information from
broker-dealers on a 15-minute reporting basis.\178\
[[Page 45740]]
However, FINRA's blueprint provided that the large trader identifier
should be used initially to identify market participants, as the
complexities of tracking retail accounts, the infrequent amount of
trading by retail investors, and the large number of such investors
make requiring a unique customer identifier difficult.\179\
---------------------------------------------------------------------------
\174\ See FINRA Proposal Letter.
\175\ See FINRA Proposal Letter, p. 4, 6 (arguing against
requiring the name and address of the beneficial owner of an
account, as well as of the individual making the investment
decision, and against requiring tax identification or social
security numbers for individual investors).
\176\ Id. at p. 7 and Appendix B.
\177\ Id.
\178\ Id. at p. 3-4 (noting that this information would be
available for query by regulators within one hour of receipt, would
include a unique order identifier and MPID, and would be added on
T+1 to the ``order lifecycle'' using OATS and TRF data).
\179\ Id. at p. 4.
---------------------------------------------------------------------------
Another commenter from the academic field believed that a modified
version of OATS (including fields incorporating ultimate customer
account information, a reduction in the time stamp standard to
milliseconds or even microseconds, and standardized clock
synchronization requirements), coupled with a requirement that
exchanges must report to OATS, would allow OATS to fulfill the needs of
the consolidated audit trail in a less costly manner than originally
proposed.\180\ This commenter stated that the Commission's needs could
be met by ``a few tweaks to the existing trade reports and by extending
OATS to cover all NMS stocks and executions at exchanges.'' \181\
---------------------------------------------------------------------------
\180\ See Angel Letter, p. 3 (also noting, ``While the OATS data
are extremely useful for understanding market behavior and for
searching for various violations, these data are not really needed
for real time surveillance. Real time surveillance is generally
focused on the question of whether or not some change needs to take
place immediately * * *. The extensive OATS data regarding the
handling of individual orders are more useful for economic analysis
and enforcement activities and do not need to be reported in real
time.'')
\181\ Id.
---------------------------------------------------------------------------
Several commenters, including SROs and broker-dealers, generally
believed that it would be more cost and time efficient to use a form of
OATS as a basis for the consolidated audit trail than to purchase or
create a new system.\182\ For example, FINRA/NYSE Euronext stated that
modifying existing systems would reduce both the time and cost to
develop a consolidated audit trail, explaining that ``the programming
changes needed to comply with an entirely new system are substantially
greater than expanding existing protocols,'' \183\ while BATS suggested
that significant cost savings may be realized by building a
consolidated audit trail that ``leverages elements of OATS.'' \184\
FINRA/NYSE Euronext also argued that existing audit trails could be
expanded ``economically and quickly,'' \185\ noting that use of such
systems, such as FINRA's OATS, could make the central repository
unnecessary.\186\ Similarly, FINRA believed that using OATS as a
foundation of the consolidated audit trail would make the consolidated
audit trail easier to implement,\187\ as opposed to building a new
system, which could take years to establish and would likely result in
``negative unintended consequences'' during development.\188\ FIF
suggested leveraging FINRA's Trade Reporting and Compliance Engine as a
basis for the coverage of debt securities.\189\
---------------------------------------------------------------------------
\182\ See FINRA Proposal Letter; BOX Letter, p. 2; BATS Letter,
p. 2.; CBOE Letter, p. 2-3; Angel Letter, p. 2-3; SIFMA Letter, p.
16-18; Wells Fargo Letter, p. 2; Knight Letter, p. 3; FIF Letter, p.
5-6; Schumer Letter, p. 1; FIA Letter, p. 1-3.
\183\ See FINRA/NYSE Euronext Letter, p. 7. See also FINRA
Letter, p. 3 (stating that ``the necessary components to an
effective, comprehensive, and efficient consolidated audit trail
are: (1) Uniform data (both data content and data format); (2)
reliable data; and (3) timely access to the data by SROs and the
SEC. FINRA believes this can be achieved most effectively,
efficiently, and expeditiously by expanding FINRA's existing OATS
requirements to additional securities and non-FINRA member broker-
dealers and by consolidating exchange data in a central repository
to be used with OATS data'').
\184\ See BATS Letter, p. 2.
\185\ See FINRA/NYSE Euronext Letter, p. 14; FINRA Letter.
\186\ Id.
\187\ See FINRA Letter, p. 6. Specifically, FINRA proposed
enhancements to OATS and outlined a phased approach for
implementation. It explained that, under its approach,
implementation would begin with equity securities in the first two
phases, followed by options in the third and fourth phases. FINRA
further proposed that it could ``establish an intraday abbreviated
order submission capability based on SIFMA's drop-copy proposal.''
FINRA estimated the initial cost for the first two phases of the
OATS enhancement would be between $100 to $125 million and the
ongoing annual costs to be between $30 million and $40 million.
While FINRA's proposal appears to include many of the elements
required by Rule 613, the Commission notes that the proposal does
not include a Customer-ID (which was similarly lacking in the SIFMA
proposal), nor would all broker-dealers be required to report order
information to the central repository (certain firms that route
orders exclusively to another reporting firm that is solely
responsible for further routing decisions would be exempt from
reporting obligations; additionally, FINRA proposed retaining
exemptive authority in certain limited situations to provide relief
to small member firms that do not otherwise qualify for exclusion
from the definition of an OATS Reporting Member). Further, FINRA's
proposal would not collect customers' names, addresses and account
numbers. See FINRA Proposal Letter, p. 10; 14-16; Appendix. The
Commission believes a unique Customer-ID and customer account
information are critical to the efficacy and usefulness of the
consolidated audit trail, and therefore is requiring the NMS plan
submitted for its consideration to include such information.
\188\ Id. This commenter also noted that OATS compliance rates
have improved to over 99% since the system was first implemented,
and emphasized that creating a new system would result initially in
low compliance rates until users became familiar with the system.
Id. at p. 11; see also FINRA/NYSE Euronext Letter, p. 8.
\189\ See FIF Letter, p. 6 (also providing thoughts on the
functionalities of OATS that should be considered in creating the
consolidated audit trail, such as OATS' ability to identify and
reject duplicative reporting; to link reports between firms and
Nasdaq exchanges without using a unique customer identifier; its
possible flexibility in incorporating additional order types; its
current incorporation of quote data; and its current identification
of index arbitrage and program trading, and ability to possibly add
a large trader identification field ``to enhance analysis of high
volume, algorithm trading'').
---------------------------------------------------------------------------
Two SROs, BOX and CBOE, recommended the joint use of both OATS and
COATS.\190\ BOX suggested an expansion of OATS and COATS to include
customer information,\191\ and CBOE stated that it believed that
certain aspects of OATS and COATS could be combined, with the addition
of customer and routing broker information, and new formats.\192\ The
Commission also received an alternative proposal from a commenter that
was not based on OATS, but on a combination of automatically-generated
drop-copies and the Financial Information eXchange (``FIX'')
protocol.\193\ SIFMA urged reporting on a T+1 basis as it believed
real-time reporting would require significant changes to existing order
management and trading systems.\194\ If T+1 reporting were not adopted,
however, SIFMA's proposal suggested that certain data be provided to
the central repository in near real time, such as data pertaining to
``key business events'' such as order receipt and origination, order
transmittal, execution, modification, and cancellation. SIFMA's
proposal listed the specific data elements to be reported for each
event, but, to achieve quick implementation, did not include unique
customer or order identifiers, or an identifier for algorithmic
orders.\195\
---------------------------------------------------------------------------
\190\ See BOX Letter, p. 2; CBOE Letter, p. 2.
\191\ See BOX Letter, p. 2.
\192\ See CBOE Letter, p. 2.
\193\ See SIFMA Drop Copy Letter. The FIX Protocol is a series
of messaging specifications for the electronic communication of
trade-related messages. It has been developed through the
collaboration of banks, broker-dealers, exchanges, industry
utilities and associations, institutional investors, and information
technology providers from around the world. These market
participants share a vision of a common, global language for the
automated trading of financial instruments. See http://fixprotocol.org/what-is-fix.shtml (last viewed on May 30, 2012).
\194\ Id. at p. 1.
\195\ Id. at p. 1-2.
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The Commission has considered the comments on alternative
proposals, including those based on OATS, and has made significant
modifications to the proposed Rule in light of such comments. Each of
these modifications is discussed in detail in Section III. below. But
the Commission notes more generally that, as adopted, Rule 613 does not
prescribe a specific audit trail collection system or a particular
method of data collection to be used for the central repository. In
addition, the Commission believes that certain modifications to Rule
613, such as
[[Page 45741]]
allowing data to be reported by 8:00 a.m. Eastern Time the following
trading day, rather than in real time as proposed, provide the SROs
with a wider range of options for how they choose to meet the
requirements of the adopted Rule compared with the requirements of the
proposed Rule. This wider range of options could more easily
accommodate an OATS-based approach or other approaches for the creation
of a consolidated audit trail, as suggested by commenters, consistent
with the requirements of Rule 613.
The Commission notes, however, that OATS, in its current form, has
certain limitations and does not include certain attributes that the
Commission deems crucial to an effective and complete consolidated
audit trail.\196\ Some of the limitations of OATS that would need to be
addressed to meet the requirements of Rule 613 include:
---------------------------------------------------------------------------
\196\ See Section II.A.1.c., supra.
---------------------------------------------------------------------------
At present, only FINRA members are required to report
trade and order activity through OATS. The resulting exclusion of some
exchange-based and other types of non-member activity could lead to
significant gaps in the data as an order is generated, routed, re-
routed, and finally executed, canceled, or modified;
OATS does not currently require the collection of market-
making quotes submitted by registered market makers (in those stocks
for which they are registered), resulting in further, significant gaps
in the data;
OATS is a part of a process by which FINRA collects data
from its members for its own regulatory use. OATS is not a central
repository and therefore does not presently provide other regulators
with ready access to a central database containing processed,
reconciled, and linked orders, routes, and executions ready for query,
analysis, or download; and
OATS does not presently collect options data, and does not
afford regulators an opportunity to perform cross-product surveillance
and monitoring;
OATS does not collect information on the identities of the
customers of broker-dealers from whom an order is received. As
discussed above in Section I., the Commission believes that the
integrated inclusion of such data elements into a single consolidated
audit trail provides many important regulatory benefits.
III. Discussion
A discussion of each of the key provisions of Rule 613, as adopted,
is set forth below.
A. NMS Plan
1. Description of the Rule
a. Implementation of the Consolidated Audit Trail Through an NMS Plan
As proposed, the consolidated audit trail would have been created,
implemented, and maintained through an NMS plan approved by the
Commission. As proposed, Rule 613(a)(1) would have required each
national securities exchange and national securities association to
jointly file on or before 90 days from approval of the Rule an NMS plan
to govern the creation, implementation, and maintenance of a
consolidated audit trail and a central repository.\197\ The Commission
would then have been required to publish the NMS plan for public
comment pursuant to Rule 608 of Regulation NMS under the Exchange
Act,\198\ and, following the period of public comment, would consider
whether or not to approve the NMS plan. In the Proposing Release, the
Commission stated its expectation that the exchanges and FINRA would
``cooperate with each other and take joint action as necessary to
develop, file, and ultimately implement a single NMS plan to fulfill
this requirement.'' \199\
---------------------------------------------------------------------------
\197\ This Section III.A. discusses the use of a NMS plan to
create, implement, and maintain a consolidated audit trail. Section
III.C., infra, focuses on the process the SROs must follow when
submitting the NMS plan to the Commission.
\198\ 17 CFR 242.608. See Rule 613(a)(2).
\199\ See Proposing Release, supra note 4, at 32568.
---------------------------------------------------------------------------
The Commission requested comment on this approach. Specifically,
the Commission requested comment on whether requiring the exchanges and
FINRA to jointly file an NMS plan that would contain the requirements
for a consolidated audit trail was the most effective and efficient way
to achieve the objectives of Rule 613, or whether the Commission should
require the exchanges and FINRA to standardize or otherwise enhance
their existing rules. The Commission further requested comment on which
approach would be most efficient in improving the ability to monitor
cross-market trading, or to undertake market analysis or
reconstructions, and why.
Two commenters discussed how the consolidated audit trail should be
created and implemented through an NMS plan.\200\ One noted that the
Rule should provide the SROs with sufficient flexibility to develop an
NMS plan that meets the overarching goals of the Commission.\201\ The
second suggested that the Rule should ``include only the elements
needed for a [consolidated audit trail], and then leave it up to the
SROs, [securities information processors] and involved vendors to
develop the specifications for the data elements to be specified in the
NMS plan, which would ultimately be subject to public comment and SEC
approval.'' \202\
---------------------------------------------------------------------------
\200\ See Thomson Reuters Letter, p. 2; CBOE Letter, p. 7.
\201\ See Thomson Reuters Letter, p. 2.
\202\ See CBOE Letter, p. 7.
---------------------------------------------------------------------------
Other commenters objected in principle to the use of an NMS plan to
create and implement the consolidated audit trail.\203\ One commenter
stated that implementing the consolidated audit trail through an NMS
plan would be ``difficult and inefficient,'' given the need ``to
respond and adapt quickly to new ways of trading and handling orders,''
and believed it would be difficult to jointly make necessary technology
changes under an NMS plan because, based on the commenter's experience
of collecting data for an existing audit trail, ``technology changes
and changes to technical specifications must be made regularly and
promptly with respect to firm-specific reporting requirements,
interpretations, and codes to keep up with complex and evolving trading
and routing strategies.'' \204\ Another commenter argued that an NMS
plan is ``unnecessary * * * given all of the governance issues with NMS
plans'' because ``[t]he Commission can get most of what it needs with a
few tweaks to the existing trade reports and by extending OATS to cover
all NMS stocks and executions at exchanges.'' \205\
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\203\ See FINRA Letter, p. 15; Angel Letter, p. 3.
\204\ See FINRA Letter, p. 15.
\205\ See Angel Letter, p. 3.
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For the reasons discussed below, the Commission continues to
believe that an NMS plan filed pursuant to Rule 608 of Regulation NMS
\206\ is the most effective mechanism to implement the consolidated
audit trail, and is adopting Rule 613 with a number of modifications
and clarifications to address the concerns of commenters.\207\
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\206\ See Rule 613(a). The proposed Rule provided that the NMS
plan must be filed with the Commission pursuant to Rule 608. Adopted
Rule 613(a)(2) clarifies that the NMS plan must also satisfy the
requirements set forth in Rule 608(a). See Rule 608(a) of Regulation
NMS; 17 CFR 242.608(a).
\207\ See Section III.C., infra.
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The Commission believes that the creation, implementation, and
maintenance of the consolidated audit trail through an NMS plan will
ensure that the SROs' expertise as the ``front line'' regulators of
securities markets is drawn upon to develop the details of the
consolidated audit trail, and to make appropriate adjustments as
warranted to respond to changes in the securities markets and
technology going forward.
[[Page 45742]]
As such, under the Commission's approach, Rule 613 outlines a broad
framework for the creation, implementation, and maintenance of the
consolidated audit trail, including the minimum elements the Commission
believes are necessary for an effective consolidated audit trail.
Additionally, Rules 613(a)(1) and (a)(4), which require that each SRO
jointly file and be a sponsor of the NMS plan, is being adopted as
proposed. The Commission continues to believe that requiring all SROs
to jointly file the NMS plan to establish the consolidated audit trail,
as opposed to the flexibility provided by current Rule 608 of
Regulation NMS under the Exchange Act,\208\ which permits any two or
more SROs to submit an NMS plan, is appropriate because such a
requirement is expected to result in an NMS plan that is the product of
negotiation and compromise among all of the SROs; in this regard, the
NMS plan submitted to the Commission also may be more readily
implemented as the NMS plan should take into consideration the
capabilities of every SRO.
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\208\ 17 CFR 242.608. See Rule 613(a)(2).
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In response to the commenter that advocated granting additional
flexibility to the SROs in developing the requirements of the NMS
plan,\209\ the Commission has made significant modifications to the
Rule in several respects to increase the options available to SROs in
developing the requirements of the NMS plan.\210\ Furthermore, in
instances where Rule 613 sets forth minimum requirements for the
consolidated audit trail, the Rule provides flexibility to the SROs to
draft the requirements of the NMS plan in a way that best achieves the
objectives of the Rule. For example, Rule 613 requires the NMS plan
submitted to the Commission for its consideration to require material
terms of an order, such as order type, to be collected by the central
repository.\211\ However, the Rule does not enumerate specific order
types or prescribe the format or nature of how this information would
be represented. This would be left to the SROs developing the NMS plan
and allows flexibility for the future, when new order types may be
introduced and added, if appropriate.
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\209\ See Thomson Reuters Letter, p. 2.
\210\ See Section I., supra; Sections III.B., III.C., infra.
\211\ See Section III.B.1.d.i.(A)., infra.
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Similarly, in response to the commenter stating that implementing
the consolidated audit trail through an NMS plan would be ``difficult
and inefficient'' given the need to respond and adapt quickly to new
ways of trading and handling orders,\212\ the Commission notes that,
while the NMS plan submitted to the Commission for its consideration
must contain the minimum necessary elements for the consolidated audit
trail, and any amendments to an effective NMS plan initiated by plan
sponsors will require approval by Commission order, the SROs should
have flexibility to accommodate a variety of technological and other
market developments without amending the NMS plan (e.g., through the
issuance and updating of technical specifications that are reasonably
and fairly implied by the NMS plan). Underscoring this need to ensure
the consolidated audit trail is regularly updated to remain compatible
with best market practices, the Commission, as discussed in Section
III.C.2.a.i., also has added general requirements to Rule 613 with
regards to SROs monitoring and planning for the technological evolution
of the consolidated audit trail. Further, as noted in Section III.B.3
below, the NMS plan must include a governance structure for the central
repository that is designed to ensure efficient decision-making.
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\212\ See FINRA Letter, p. 15.
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The Commission has also considered the comment that recommended
that the Commission should leave it to the SROs, securities information
processors (``SIPs'') and vendors to develop the specifications for the
data elements in the NMS plan.\213\ The Commission agrees in principle
with the commenter, and believes that market participants other than
SROs also could have valuable insights regarding the design of the
specifications for the data elements, the central repository, and other
aspects of the Rule. To address this concern, the adopted Rule requires
the SROs to explain in the NMS plan the process by which they solicited
views of their members regarding the creation, implementation, and
maintenance of the consolidated audit trail, a summary of the views of
such members, and how the plan sponsors took such views into account in
preparing the NMS plan.\214\ In addition, the Rule requires the NMS
plan submitted to the Commission for its consideration to provide for
the creation of an Advisory Committee to afford SRO members, and other
interested parties as permitted by the NMS plan,\215\ the opportunity
to have input on the creation, implementation, and maintenance of the
consolidated audit trail.\216\ The Commission also notes that nothing
in the Rule precludes the SROs, as plan sponsors, from consulting with
others, including the SIPs and vendors, as they craft the NMS plan.
Finally, pursuant to Rule 608(b)(1), the NMS plan will be published for
public comment.\217\ Thus, all interested persons, including market
participants, regulatory authorities, and the general public, will have
an opportunity to provide meaningful comments on the details and costs
of the NMS plan submitted to the Commission, which the Commission will
review and consider.
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\213\ See CBOE Letter, p. 7.
\214\ See Rule 613(a)(1)(xi).
\215\ See Rule 613(b)(7)(i). Because members of the SROs will be
required to report data pursuant to the NMS plan, the Rule provides
that the plan must require that the Advisory Committee include
representatives of the member firms of the SROs. However, the
Commission believes that it is advisable for the SROs to consider
including other interested parties such as SIPs, vendors, investors,
and/or academics on the Advisory Committee. In addition, the
Commission expects that the Advisory Committee would include the
Commission's Chief Technology Officer as an observer. See Section
III.B.3.b., infra.
\216\ See Rule 613(b)(7).
\217\ 17 CFR 242.608(b)(1).
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In response to the commenter that believed that the objectives of
the consolidated audit trail could be achieved ``with a `few tweaks' to
the existing trade reports and by extending OATS,'' \218\ the
Commission notes, as described above, that existing trade reports and
the current OATS process combined do not meet many of the requirements
the Commission believes are essential for a consolidated audit trail.
The Commission therefore believes that an NMS plan, as noted above,
provides an effective mechanism for the SROs to create, implement, and
maintain a consolidated audit trail meeting such requirements. However,
it also notes that the adopted Rule does not preclude the
infrastructure, nomenclature, format, or any other aspects of an
existing order audit trail system, such as OATS, from being used for
the consolidated audit trail, provided the NMS plan proposing to
establish such an audit trail otherwise meets the requirements of Rule
613. The Commission stresses that existing order audit trails lack
critical information such as the identity of the customer, data on
principal orders or quotes, and a way to link orders across markets--
information that the Commission believes is essential to the
consolidated audit trail.\219\
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\218\ See Angel Letter, p. 3.
\219\ See Section II.A., supra. The Commission notes that, in
the Proposing Release, it used the term ``proprietary orders'' to
describe orders that were generated for the account of a broker-
dealer. See Proposing Release, supra note 4, at 32570.
To avoid confusion with the proposed ``Volcker Rule,'' which
proposes new regulations with respect to ``proprietary'' trading by
commercial banks and their affiliates, the Commission is using the
term ``principal orders'' in this Release to describe orders that
were generated for the account of a broker-dealer. See Securities
Exchange Act Release No. 65545 (October 12, 2011), 76 FR 68846
(November 7, 2011) (File No. S7-41-11).
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[[Page 45743]]
B. Elements of the NMS Plan
As discussed above, the adopted Rule requires the SROs to submit an
NMS plan to create, implement, and maintain a consolidated audit
trail.\220\ As adopted, the Rule permits the SROs to consider a wider
array of solutions, in creating, implementing, and maintaining a
consolidated audit trail. The Rule, however, also sets forth certain
minimum requirements of the consolidated audit trail that must be
included in the NMS plan submitted by the SROs to the Commission for
its consideration. The Commission believes that it is important to set
forth certain minimum requirements to ensure that the consolidated
audit trail will be designed in a way that provides regulators with the
accurate, complete, accessible, and timely market activity data they
need for robust market oversight. The minimum audit trail requirements
that must be included in the NMS plan submitted by the SROs are
discussed below.
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\220\ See Section I., supra.
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1. Recording and Reporting
a. Products and Transactions Covered
As proposed, Rule 613 would have applied to secondary market
transactions in all NMS securities, which includes NMS stocks and
listed options.\221\ In the Proposing Release, the Commission also
addressed the possibility of expanding the scope of the consolidated
audit trail over time. Specifically, proposed Rule 613(i) would have
required the NMS plan to include a provision requiring each national
securities exchange and national securities association to jointly
provide to the Commission, within two months after effectiveness of the
NMS plan, a document outlining how such exchanges and associations
would propose to incorporate into the consolidated audit trail
information with respect to equity securities that are not NMS
securities, debt securities, primary market transactions in NMS stocks,
primary market transactions in equity securities that are not NMS
securities, and primary market transactions in debt securities. The
document also would have been required to identify which market
participants would be required to provide the additional data and to
include an implementation timeline and a cost estimate for including
such data in the consolidated audit trail.\222\ The Commission
requested comment on whether expanding the consolidated audit trail to
include the products and transactions specified above was an
appropriate approach to the eventual expansion of the consolidated
audit trail, and, if so, an appropriate and realistic timetable for
doing so.
---------------------------------------------------------------------------
\221\ See proposed Rule 613(c)(5).
\222\ The Commission notes that any expansion of the
consolidated audit trail to cover non-NMS securities would be
effectuated through notice and comment.
---------------------------------------------------------------------------
Several commenters expressed opinions on the scope of the products
and transactions proposed to be covered by the Rule and how their
inclusion in the consolidated audit trail should be phased in under the
Rule.\223\ One commenter urged the Commission to consider including
additional asset classes in the scope of the products covered by the
Rule, and specifically questioned the value of the consolidated audit
trail without the inclusion of information on futures and other
derivatives.\224\
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\223\ See Liquidnet Letter, p. 2 (suggesting limiting the scope
of the first phase of audit trail implementation to end-of-day-
reporting to ensure that it can be completed in a timely and cost-
effective manner; this commenter also recommended that the first
phase apply the consolidated audit trail to all market participants,
not just the SROs, as proposed). See also FIF Letter, p. 7
(suggesting that the consolidated audit trail cover just NMS
stocks--then at a later date, all NMS securities, including
options); FINRA Proposal Letter, p. 5 (suggesting several phases of
expansion, beginning with NMS stocks and over-the-counter (``OTC'')
equity securities, and ultimately including standardized options,
fixed income securities, conventional options, and security-based
derivatives in the consolidated audit trail); SIFMA Letter, p. 16-17
(believing that OATS could form the basis for the consolidated audit
trail, stating that OATS should be modified to include non-Nasdaq-
listed securities, listed options, quotes, street side and exchange-
to-exchange routing and market making and recommending phasing in
NMS stocks first, then any additional data elements, then listed
options and, finally, non-NMS securities); FIF Letter II, p. 2
(suggesting that the consolidated audit trail have ``multi-
instrument capabilities, most importantly options and futures but
also fixed income and other instruments).
\224\ See Broadridge Letter, p. 4.
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The Commission also received comment on the proposed Rule's
approach for considering a possible future expansion of the products
and transactions covered by the consolidated audit trail. One commenter
believed that its technology would allow development of a platform that
would support multiple asset classes and expansion of the consolidated
audit trail for use by other regulators.\225\ Other commenters
expressed general support for expanding the scope of products
covered.\226\ One specifically suggested expanding the scope of the
Rule, for example, to include the ``creation of instruments that
underlie the securities that make up [mortgage-backed securities] and
[asset-backed securities].'' \227\ Another suggested expanding the
consolidated audit trail to all securities submitted to an exchange or
clearing agency.\228\ Yet another commenter, however, argued against
allowing the exchanges, through the NMS plan, to have primary
responsibility for specifying the data requirements of non-exchange-
traded asset classes, stating that exchanges lacked experience with
these instruments.\229\
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\225\ See Nasdaq Letter II, p. 3.
\226\ See Liquidnet Letter, p. 2; FINRA Proposal Letter, p. 5;
SIFMA Letter, p. 16-17; Marketcore Letter, p. 1.
\227\ See Marketcore Letter, p. 1.
\228\ See Ameritrade Letter, p. 3. See also Mansfield Letter, p.
1 (suggesting other data, including ``metrics'' and ``market
environmental information'' to be included in the consolidated audit
trail).
\229\ See Direct Edge Letter, p. 4.
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The Commission has considered the comments discussed above and is
adopting the Rule as proposed with respect to the scope of the
securities that must be covered at this time, but, as described below,
acknowledges the importance of a mechanism for considering other types
of products in the future. Specifically, the adopted Rule requires that
consolidated audit trail data be collected for all NMS securities.\230\
However, the Commission also is adopting the requirement that the NMS
plan require the SROs to jointly submit a document outlining a possible
plan for expansion of the consolidated audit trail, as proposed, but
with three modifications from the proposed Rule.
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\230\ See Proposing Release, supra note 4, at 32568-70; Rule
613(c)(5).
---------------------------------------------------------------------------
Rule 613(i) requires that the SROs jointly provide the Commission a
document outlining how the SROs could incorporate the following
additional products into the consolidated audit trail: Equity
securities that are not NMS securities, debt securities, primary market
transactions in equity securities that are not NMS securities, and
primary market transactions in debt securities (``expansion
document''). The adopted Rule also requires the expansion document to
include details for each order and reportable event that may be
required to be provided, which market participants may be required to
provide the data, an implementation timeline and a cost estimate. The
first modification from the proposed Rule is a technical change
clarifying that Rule 613(i) is requiring the SROs to provide
[[Page 45744]]
the Commission with a document that outlines how an expansion of the
consolidated audit trail could be accomplished in the future and is
not, at this time, requiring that the SROs commit to expanding the
consolidated audit trail beyond secondary market transactions in NMS
securities.\231\ However, the Commission notes that Rule 613(i) retains
the requirement that SROs include an implementation timeline and a cost
estimate; in this regard, the Commission expects that the SROs will
address fully in the expansion document how any such expansion of the
consolidated audit trail could be implemented in practice, and that
such document would include sufficient detail for the Commission to
ascertain how the SROs could proceed with such expansion. The
Commission would expect to make the expansion document publicly
available on its Web site and to solicit a wide range of comment on it
to further inform and facilitate the expansion of the consolidated
audit trail if appropriate, taking into account the relevant
considerations contemplated by Rule 613(a)(1). In addition, the
expansion document could inform the detailed plans that are to be
prepared at least every two years by the CCO of the NMS plan.\232\
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\231\ See Rule 613(i). Specifically, Rule 613(i) now provides
that the SROs provide a document outlining how such exchanges and
associations ``could'' incorporate non-NMS securities into the
consolidated audit trail, rather than how the exchanges and
associations ``would propose to'' incorporate non-NMS securities;
and that the exchanges and associations should provide details for
each order and reportable event that ``may'' be required to be
provided, and which market participants ``may'' be required to
provide the data. As proposed, the comparable provision of Rule
613(i) required that the exchanges and associations should provide
details for each order and reportable event that ``would'' be
required to be provided, and which market participants ``would'' be
required to provide the data.
\232\ See Section III.B.3.b., infra.
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In addition, after considering the comments received relating to
the potential expansion of the consolidated audit trail and how such an
expansion might occur,\233\ the Commission is making the second
modification to the proposed Rule to extend the deadline for submitting
the expansion document from two months to six months from the date of
effectiveness of the NMS plan approved by the Commission. The
Commission believes that the additional four months will provide the
time necessary after the approval of the NMS plan by the Commission for
the SROs to consider how they might expand the consolidated audit trail
to capture orders and trading in these additional securities and thus
will aid the Commission in receiving an outline or plan from the
exchanges and associations that has had the benefit of additional time
for analysis and planning. Finally, given the extension of the deadline
for submitting the expansion document and the importance of information
regarding primary market information in NMS stocks relative to other
types of transactions as discussed in Section III.B.1.a. below, the
Commission is removing the requirement that the expansion document
discuss all primary market transactions in NMS stocks and is, instead,
as discussed later, requiring that a discussion of the feasibility,
benefits, and costs of incorporating into the consolidated audit trail
information about allocations in primary market transactions in NMS
securities be addressed with the NMS plan submission.\234\ However, the
expansion document must still include a discussion of primary market
transactions in equity securities that are not NMS securities.
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\233\ See Ameritrade Letter, p. 3; Liquidnet Letter, p. 2;
Marketcore Letter, p. 1; FINRA Proposal Letter, p. 5; SIFMA Letter,
p. 16-17.
\234\ See Rule 613(a)(1)(vi). See also Section III.C.2.a.i.,
infra.
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The Commission agrees in principle with the commenters that
advocated a phased approach to implementation.\235\ The Commission,
however, has determined not to modify the proposed scope of the Rule,
which applies to orders in NMS securities. The Commission also adopts
substantially its proposed implementation timeframes that apply if and
when the NMS plan is approved,\236\ except that the NMS plan may
provide up to one additional year before small broker-dealers will be
required to provide information to the central repository.\237\
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\235\ See note 222, supra.
\236\ See Rule 613(a)(3), which states that the NMS plan must
require the plan sponsors: (i) Within two months after effectiveness
of the NMS plan to select a plan processor; (ii) within four months
after effectiveness of the NMS plan to synchronize their business
clocks and require the members of each such exchange and association
to synchronize their business clocks; (iii) within one year after
effectiveness of the NMS plan to provide to the central repository
the data specified in Rule 613(c); (iv) within fourteen months after
effectiveness of the NMS plan to implement a new or enhanced
surveillance system(s) as required by Rule 613(f); (v) within two
years after effectiveness of the NMS plan to require their members,
except those members that qualify as small broker-dealers as defined
in Sec. 240.0-10(c), to provide to the central repository the data
specified in Rule 613(c); and (vi) within three years after
effectiveness of the NMS plan to require their members that qualify
as small broker-dealers as defined in Sec. 240.0- 0(c) to provide
to the central repository the data specified in Rule 613(c).
\237\ See Section III.D., infra.
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The Commission continues to believe that the Rule's requirement to
include secondary market transactions in all NMS securities (i.e., both
listed equities and options) is a reasonable first step in the
implementation of the consolidated audit trail. In addition, the
Commission believes that applying the Rule solely to NMS securities
should allow for a less burdensome implementation of the consolidated
audit trail as compared to applying the Rule to a broader set of
securities,\238\ in large part because market participants already have
experience with audit trails for transactions in these securities. And,
as discussed in detail above,\239\ there are many significant benefits
of a consolidated audit trail that includes NMS securities (even if it
is only limited to NMS securities).
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\238\ The Commission also believes that limiting the application
of the Rule initially to only NMS securities should help ensure that
the implementation schedule prescribed by the Rule is achievable.
See Section III.D., infra.
\239\ See Section II.A.2, supra.
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With regards to a phased approach to implementation, the Commission
notes that the data recording and reporting requirements would apply
initially, as proposed, to the SROs but not to their members. This will
allow members additional time to, among other things, implement the
systems and other changes necessary to provide the required information
to the central repository, including capturing customer and order
information that they may not have previously been required to collect.
Should the SROs determine that additional implementation phases might
be appropriate (e.g., applying the Rule first to equities and then to
listed options), the Commission notes that the Rule does not preclude
the SROs from proposing such phases, so long as the outer time
parameters specified in the Rule, which the Commission is adopting as
proposed, are met.\240\
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\240\ See note 223, supra.
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The Commission agrees with commenters that the inclusion of
additional products (even at a later date) could further enhance the
ability of the SROs and the Commission to conduct effective market
oversight for financial products currently trading in the
marketplace.\241\ The Commission also
[[Page 45745]]
believes that it could be beneficial for the consolidated audit trail
to be expanded over a reasonable period of time to include information
on primary market transactions in equity and debt securities, as this
data could be used to quickly assess potential violations of various
rules under the Exchange Act such as, for example, Regulation M and
Rule 10b-5.\242\ For example, the primary market transaction data would
allow regulators to more quickly identify whether any participant in an
offering sold short prior to the offering in violation of Regulation M.
The primary market transaction data would allow for identification of
the cost basis for purchases by intermediaries and make it easier to
assess whether subsequent mark-ups to investors in primary offerings
are fair and reasonable and, if not, whether there has been a violation
of the antifraud provisions of the federal securities laws, including
Rule 10b-5.
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\241\ The Commission notes that the financial markets have
become increasingly interrelated, with transactions occurring in the
futures markets affecting transactions in the securities markets. To
the extent that instruments other than NMS securities (e.g., futures
on a securities index or security-based swaps) can be substitutes
for trading in NMS securities, or are otherwise linked to such
trading (e.g., as part of a strategy that involves multiple
products), having access to an audit trail that includes these
instruments would improve regulators' ability to more quickly detect
potentially manipulative or other illegal activity that could occur
across markets. The Commission recognizes, however, that any such
expansion to include products not under the Commission's
jurisdiction, and thus not contemplated by this Rule, would need to
be coordinated with the CFTC or other applicable regulatory
authorities, and would likely require a separate rulemaking, which
would include a consideration of the costs and benefits of such an
expansion. In this regard, the Commission believes that it could be
beneficial to discuss with the CFTC, at the appropriate time, the
possibility of including within the consolidated audit trail data
relating to futures or swap products regulated by the CFTC that are
based on securities. The Commission is therefore directing the
Commission staff to work with the SROs, the CFTC staff, and other
regulators and market participants to determine how other asset
classes, such as futures, might be added to the consolidated audit
trail. The information from such an expanded consolidated audit
trail could benefit both the CFTC and the Commission.
An example of a non-NMS security is a security-based swap. The
Commission notes that, separately, it has proposed rules requiring
the reporting of security-based swap information to registered
security-based swap data repositories (``SDR'') or the Commission.
See Securities Exchange Act Release No. 63446, File No. S7-34-10
(November 19, 2010), 75 FR 75208 (December 2, 2010) (proposing
Regulation SBSR under the Exchange Act providing for the reporting
of security-based swap information to registered security-based SDR
or the Commission, and the public dissemination of security-based
swap transaction, volume, and pricing information); see also
Securities Exchange Act Release No. 63447, File No. S7-35-10
(November 19, 2010), 75 FR 77306 (December 10, 2010) (proposing
rules governing the SDR registration process, duties, and core
principles).
\242\ See 17 CFR 242.100 et seq.; 17 CFR 240.10b-5. Rule 105 of
Regulation M prohibits the short selling of equity securities that
are the subject of a public offering for cash and the subsequent
purchase of the offered securities from an underwriter or broker or
dealer participating in the offering if the short sale was effected
during a period that is the shorter of the following: (i) Beginning
five business days before the pricing of the offered securities and
ending with such pricing; or (ii) beginning with the initial filing
of such registration statement or notification on Form 1-A or Form
1-E and ending with the pricing. Thus, Rule 105 prohibits any person
from selling short an equity security immediately prior to an
offering and purchasing the security by participating in the
offering.
Rule 10b-5 provides that ``[i]t shall be unlawful for any
person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any
facility of any national securities exchange, (a) [t]o employ any
device, scheme, or artifice to defraud, (b) [t]o make any untrue
statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading, or (c)
[t]o engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person, in
connection with the purchase or sale of any security.''
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The Commission considered the comment letter that agreed that
``policing the market requires a comprehensive approach'' but asserted
the exchanges should not be primarily responsible for specifying
requirements relating to asset-backed securities and other debt
instruments, including swap instruments that are not exchange-
traded.\243\ In response, the Commission notes the Rule requires the
SROs to submit a document outlining a plan for the possible expansion
of the NMS plan to non-NMS securities--namely debt securities and
equity securities that are not NMS securities.\244\ The Commission also
notes that FINRA, the SRO responsible for oversight of trading in the
over-the-counter market, would participate in the preparation of such
expansion document, and expects that FINRA would provide substantial
input as to how the consolidated audit trail might be expanded to
include non-NMS securities. Because the consolidated audit trail will
be jointly owned and operated by the SROs pursuant to the NMS plan,
however, the Commission believes that the involvement of all of the
SROs in any potential expansion process is appropriate.
---------------------------------------------------------------------------
\243\ See Direct Edge Letter, p. 4.
\244\ See Rule 613(i).
---------------------------------------------------------------------------
The Commission also notes that any expansion of the consolidated
audit trail to include transactions in non-NMS securities would be
effected through public notice and comment, and take into account the
relevant considerations contemplated by Rule 613(a)(1). Furthermore,
adopted Rule 613(b)(7), discussed in more detail later in this
Release,\245\ requires the NMS plan to include an Advisory Committee,
which includes members of the plan sponsors and other interested
parties as set by the NMS plan,\246\ that would be available to provide
consultation on matters concerning the central repository, including
the securities subject to the Rule. Therefore, the Commission believes
that the participation of FINRA, the public, and the Advisory Committee
should assist the SROs in devising a document outlining the expansion
of the consolidated audit trail to other securities.
---------------------------------------------------------------------------
\245\ See Section III.B.3.b., infra.
\246\ See note 2145, supra.
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The Commission continues to believe that the expansion document
required by Rule 613(i) will provide valuable information to the
Commission and help inform the Commission about the likely efficacy of
expanding the scope of the consolidated audit trail to include
information on equity securities that are not NMS securities, debt
securities, primary market transactions in equity securities that are
not NMS securities, and primary market transactions in debt securities.
In addition, the expansion document will aid the Commission in
assessing the feasibility and impact of the plan sponsors' proposed
approach.
The Commission acknowledges that plan sponsors will incur costs to
prepare the expansion document. For example, plan sponsors will be
required to address, among other things, details for each order and
reportable event for which data may be submitted; which market
participants may be required to provide the data; an implementation
timeline; and a cost estimate. Thus, the plan sponsors must, among
other things, undertake an analysis of technological and computer
system acquisitions and upgrades that would be required to incorporate
such an expansion. The Commission, however, believes that it would be
beneficial to receive a document outlining how the plan sponsors could
incorporate into the consolidated audit trail securities in addition to
NMS securities, such as over-the-counter equity and debt securities, as
soon as practicable. This is because such an expansion document will
aid the Commission in assessing both the feasibility of expanding the
audit trail to these additional securities, possibly including, as
commenters urged, instruments that underlie mortgage-backed securities
and asset-backed securities, and the resulting potential benefits to
the securities markets as a whole if the consolidated audit trail is
expanded in the manner described in the document submitted by the plan
sponsors pursuant to Rule 613(i).
b. Orders and Quotations
As proposed, Rule 613 would have required that information be
provided to the central repository for every order in an NMS security
originated or received by a member of an exchange or FINRA. Proposed
Rule 613(j)(4) would have defined ``order'' to mean: (1) Any order
received by a member of a national securities exchange or national
[[Page 45746]]
securities association from any person; (2) any order originated by a
member of a national securities exchange or national securities
association; or (3) any bid or offer.\247\ In sum, the Commission
proposed that the Rule cover all orders (whether for a customer or for
a member's own account), as well as quotations in NMS stocks and listed
options.\248\
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\247\ See Proposing Release, supra note 4, at 32570; proposed
Rule 613(j)(4).
\248\ Id.
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The Commission requested comment about the scope of its proposed
definition of ``order,'' including whether principal orders \249\
should be included in the scope of the consolidated audit trail and
whether there are any differences between orders and quotations that
should be taken into account with respect to the information that would
be required to be provided to the central repository. The Commission
also requested comment on whether non-firm quotations should be
included in the consolidated audit trail and marked to show that they
are not firm.\250\
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\249\ See note 219, supra.
\250\ See Proposing Release, supra note 4, at 32571.
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Commenters generally supported the inclusion of principal orders in
the definition of ``order,'' \251\ but some expressed concern about
including market maker quotations in the consolidated audit trail.\252\
In particular, these commenters thought that the volume of quotes
proposed to be collected was so large that it would require market
participants to increase the capacity of their systems that would
transmit data to the central repository, and thus recommended that
market maker quotations be exempted from the Rule's reporting
requirements.\253\ One of these commenters specifically suggested that
the Rule use the same approach as is currently used for the COATS--
which contains order, quote (but only the top of market quote) and
transaction data for all market participants.\254\
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\251\ See FINRA Letter, p. 10; SIFMA Letter, p. 15; Liquidnet
Letter, p. 3; FINRA Proposal Letter, p. 6.
\252\ See SIFMA Letter, p. 13; CBOE Letter, p. 5.
\253\ See SIFMA Letter, p. 13; CBOE Letter, p. 5.
\254\ See CBOE Letter, p. 5. See also Options Settlement Order,
supra, note 60. See, e.g., Securities Exchange Act Release No. 50996
(January 7, 2005), 70 FR 2436 (order approving proposed rule change
by CBOE relating to Phase V of COATS).
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The Commission also received two comments regarding the inclusion
of non-firm orders and quotes in the consolidated audit trail. One
commenter, consistent with the proposed Rule, stated that only firm
orders and quotes should be included.\255\ Another commenter, however,
believed that the proposed Rule did not go far enough, and stated that
the Rule should require that information relating to indications of
interest or similar communications be reported to, among other things,
assist the SROs and the Commission in detecting ``spoofing,'' \256\
where a market participant enters and quickly cancels limit orders or
quotations with the intent of having those non-bona fide orders or
quotations change the NBBO or create a misperception of the available
market liquidity to induce others to change their trading decisions.
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\255\ See Liquidnet Letter, p. 3.
\256\ See Ameritrade Letter, p. 3.
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In addition to the comments regarding inclusion of principal and
non-firm orders and quotes in the consolidated audit trail, some
commenters suggested ways to narrow the definition of ``order.'' One
commenter would exempt ``non-trading transfers of securities within a
legal entity, such as internal journals of securities within a desk or
aggregation unit,'' from the mandatory reporting requirements.\257\
Another commenter--an options exchange--recommended that the Commission
only require consolidated NBBO data to be reported with respect to
options quotations, noting that there are millions of quotes per day on
its exchange and that certain options, including out-of-the-money
options, are subject to a high volume of quotation updates but generate
limited trading activity.\258\
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\257\ See SIFMA Letter, p. 15.
\258\ See BOX Letter, p. 3.
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The Commission considered the comments regarding the scope of the
quotes and orders that should be included in the Rule's definition of
``order,'' and acknowledges that costs will be incurred by SROs and
their members to record and report this information to the central
repository and by the central repository to receive, consolidate, store
and make accessible such information.\259\ The Commission also
acknowledges that requiring the recording and reporting of all quotes
and orders may entail more costs, such as additional development time
and storage capacity, than if the Commission did not require the
recording and reporting of market maker quotes or out-of-the-money
options. Nevertheless, because the Commission continues to believe that
many of the benefits of a consolidated audit trail can only be achieved
if all orders and quotations are included, the Commission is adopting
the definition of ``order'' in Rule 613(j)(4) (renumbered as Rule
613(j)(8)), as proposed, to include orders received by a member of an
exchange or FINRA from any person, any order originated by a member of
an exchange or FINRA, and any bid or offer, including principal
orders.\260\
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\259\ Such costs might include the costs to purchase or build
new systems and/or costs to modify existing systems to record and
report the required data. As discussed in Section I., supra, the NMS
plan would include detailed information about costs for the public
and the Commission to consider.
\260\ See Rule 613(j)(4).
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The Commission believes it is important for the consolidated audit
trail to capture information for all principal orders and market maker
quotations because principal orders and market maker quotations
represent a significant amount of order and transaction activity in the
U.S. markets. Effective surveillance of their trading is critical to
detecting a variety of types of potential misconduct such as
manipulation and trading ahead. By providing regulators comprehensive
information about principal orders and market maker quotations
throughout the U.S. markets--information that is not available to
regulators today using existing audit trails--the consolidated audit
trail would allow regulators to efficiently surveil for manipulative
and other illegal activity by market making and other proprietary
trading firms. In addition, any comprehensive market reconstruction or
other market analysis would need to take into account principal orders
and market maker quotations--which, as noted above, constitute a large
percentage of the orders and trades in today's markets--to provide a
complete and accurate picture of market activity.
Furthermore, the Commission believes that including principal
orders and market maker quotations in the consolidated audit trail
would permit SROs to more efficiently monitor the market for violations
of SRO rules. Such monitoring requires determination of the exact
sequence of the receipt and execution of customer orders in relation to
the origination and execution of principal orders or market maker
quotations. For example, SROs would be able to use the consolidated
audit trail data to more efficiently detect instances when a broker-
dealer receives a customer order and then sends a principal order or
quote update to an exchange ahead of the customer order, potentially
violating the trading ahead prohibitions in SRO rules.\261\
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\261\ See, e.g., FINRA Rule 5320; NYSE Arca Equities Rule 6.16.
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In addition, information on principal orders or market maker
quotations could
[[Page 45747]]
be useful in investigating illegal ``spoofing.'' The availability to
regulators of comprehensive information about principal orders and
market maker quotations would allow them to more efficiently and
effectively identify the source of the orders or quotations and, thus,
better determine whether the quoted price was manipulated or simply a
response to market forces.
A further example where information on principal orders and market
maker quotations would enhance regulatory efforts is in reviewing
``layering'' or other manipulative activity. Layering is a form of
market manipulation where orders are placed close to the best buy or
sell price with no intention to trade in an effort to falsely overstate
the liquidity in a security. Layering attempts to manipulate the shape
of the limit order book to move the price of a security or influence
the trading decisions of others. Layering is often effected with
principal orders, so inclusion of principal orders in the consolidated
audit trail would aid regulators in the detection of this manipulative
practice.\262\
---------------------------------------------------------------------------
\262\ See Section II.A., supra.
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The Commission considered the comment that recommended excluding
certain quotations, such as those generated for out-of-the-money
options, from the definition of ``orders'' required to be reported to
the central repository.\263\ The Commission, however, believes that
such quotations must be included in the consolidated audit trail.
Although there may be a high volume of quotations in out-of-the-money
options with limited resulting trading activity, the Commission
believes that having a record of those quotations is necessary to allow
regulators to surveil high-speed quoting strategies for manipulative or
other illegal behavior and to assess the impact of market making and
other high-frequency quoting behaviors on the quality of the markets.
Including these quotations is necessary for example, because the
Commission may investigate allegations of a broker-dealer engaging in
the practice of flooding the market with out-of-the-money option
quotations for the purpose of manipulating the price of the option or
related security, or to overload exchange execution systems. Based on
the foregoing, to ascertain whether any illegal activity might be
occurring through the misuse of quoting, the consolidated audit trail
must require all bids and offers to be collected and reported to the
central repository.
---------------------------------------------------------------------------
\263\ See BOX Letter, p. 3.
---------------------------------------------------------------------------
The Commission also considered the comment that asserted that
``non-trading transfers of securities within a legal entity, such as
internal journals of securities within a desk or aggregation unit''
should be exempt from the reporting requirements of the Rule.\264\ In
response to this comment, the Commission notes that Rule 613 does not
require the reporting of such transfers because they are not
``orders,'' as defined under Rule 613(j)(8). However, Rule 613 does
require the NMS plan to require the reporting of the internal routing
of orders at broker-dealers.\265\
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\264\ See SIFMA Letter, p. 15.
\265\ See Rule 613(c)(7)(ii)(F). The Commission notes that the
NMS plan submitted by the plan sponsors would need to provide
appropriate detail as to how orders routed within a single broker-
dealer would be reported. For example, the NMS plan would need to
address the routing of an order received by a customer-facing sales
desk within a broker-dealer to a separate trading or market-making
desk within the same broker-dealer that actually determines how to
execute the order.
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The Commission also considered the comment that recommended
including indications of interest in the definition of ``order.'' \266\
The Commission, however, is not including indications of interest in
the definition of ``order'' for purposes of the consolidated audit
trail because the Commission believes that the utility of the
information such data would provide to regulators would not justify the
costs of reporting the information. Indications of interest are
different than orders because they are not firm offers to trade, but
are essentially invitations to negotiate. As such, the Commission
believes that indications of interest are less likely to be used as a
vehicle for illegal activity, such as manipulation or layering, because
they would be less likely to induce a response from other market
participants.
---------------------------------------------------------------------------
\266\ See Ameritrade Letter, p. 3.
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c. Persons Required To Report Information to the Central Repository
Under proposed Rule 613(c)(5), each national securities exchange
and its members would have been required to collect and provide to the
central repository certain data for each NMS security registered or
listed on a national securities exchange, or admitted to unlisted
trading privileges on such exchange; and, under proposed Rule
613(c)(6), each national securities association and its members would
have been required to collect and provide to the central repository
certain data for each NMS security for which transaction reports would
be required to be submitted to a national securities association.
Proposed Rule 613(c)(7) would have required each national securities
exchange, national securities association, and any member of such
exchange or association to collect and provide to the central
repository certain details, delineated in such Rule, for each order and
each reportable event. The Commission requested comment on whether
requiring SROs and their members to report the required order
information to the central repository was appropriate.
Several commenters broadly objected to the requirement that all
broker-dealers report consolidated audit trail information to the
central repository and/or proposed alternatives to such a
requirement.\267\ One commenter suggested that introducing brokers
should be permitted to rely on their clearing firms for reporting to
the central repository, arguing that requiring separate reporting by
introducing brokers and clearing firms ``will only dilute the economic
benefits realized by Introducing Brokers through such clearing
arrangements and may result in increased costs to customers.''\268\
This commenter also stated that it does not believe there is
appreciable benefit to the Commission, FINRA or the markets in general
in mandating reporting by introducing brokers.\269\
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\267\ See CBOE Letter, p. 5; TIAA-CREF Letter, p. 2; Wachtel
Letter, p. 1; SIFMA Letter p. 13; FINRA Proposal Letter, p. 5-6;
GETCO Letter, p. 3-4; Nasdaq Letter II, p. 3.
\268\ See TIAA-CREF letter, p. 2-3. Another commenter echoed
this concern and recommended that the consolidated audit trail
develop a means to avoid such duplicative reporting, explaining that
this is a problem with the current OATS system. See Wells Fargo
Letter, p. 2.
\269\ See TIAA-CREF letter, p. 2.
---------------------------------------------------------------------------
Similarly, another commenter urged the Commission to exclude
broker-dealers from the consolidated audit trail reporting requirements
if they route their orders exclusively to another reporting firm that
is solely responsible for further routing decisions, on the basis that
this would essentially result in duplicative reporting.\270\ In
addition, this commenter recommended the Commission exempt small
broker-dealers from the reporting requirements if compliance would be
unduly burdensome.\271\ Another commenter, a small broker-dealer that
manually handles orders, specifically suggested that the Commission
adopt a provision similar to FINRA Rule 7470, which provides FINRA
staff the authority to grant exemptions to broker-dealers that solely
handle orders manually from
[[Page 45748]]
OATS recording and data transmission requirements.\272\
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\270\ See FINRA Proposal Letter, p. 5-6.
\271\ Id.
\272\ See Wachtel Letter, p. 1. The Commission notes any
exemptions granted by FINRA under FINRA Rule 7470 may not exceed a
period of two years, unless extended. See FINRA Rule 7470. FINRA's
authority to grant exemptions under FINRA Rule 7470 expires on July
10, 2015. See FINRA Rule 7470(c).
---------------------------------------------------------------------------
Three commenters argued that broker-dealers should not be required
to report quotation information to the central repository that is
available from other market participants.\273\ Specifically, one
commenter argued that broker-dealers should not be required to report
information to the central repository that has already been reported to
an SRO (e.g., market maker quotes) because the SRO would also be
reporting the information to the central repository.\274\ Another
commenter stated that it ``believes that, rather than requiring quote
reporting by broker-dealers, only the exchanges and FINRA (through its
Alternative Display Facility and proposed Quotation Consolidation
Facility) should be required to report quotations,'' and added that
``[t]he exchanges and FINRA are in a position to provide quotation
information at a lower cost and with more accuracy.'' \275\ Similarly,
a third commenter urged the Commission to consider ``whether
surveillance systems could rely on quotation information disseminated
by the SROs,'' instead of requiring all quotation data to be sent
separately to the repository.\276\
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\273\ See CBOE Letter, p. 5-6; SIFMA Letter, p. 13; GETCO
Letter, p. 3-4.
\274\ See CBOE Letter, p. 5-6 (stating its belief that ``it
would be redundant for both the market makers and the exchanges to
all submit this information to the CAT. We recommend that the
exchanges be permitted to submit information on market maker quotes
to the CAT. Market makers who submit quotes to an exchange would
have no obligation other than to correctly identify themselves to
the exchange as the party submitting the quotation. The exchange
could add the rest of the required information (participant
identifier, unique order identifier, etc.) to the quote and transmit
it to the CAT'').
\275\ See SIFMA Letter, p. 13.
\276\ See GETCO Letter, p. 3-4. Another commenter proposed to
develop a platform that would collect audit trail information from
the SROs and other sources of information, and thus reduce the
obligations on broker-dealers to report data. See Nasdaq Letter II,
p. 3.
---------------------------------------------------------------------------
The Commission considered the comments objecting to the requirement
that broker-dealers report all consolidated audit trail information to
the central repository. However, for the reasons discussed below, the
Commission is adopting the requirements as proposed with regard to the
obligation of members to report required data to the central
repository.\277\ Specifically, the Commission is adopting Rules
613(c)(5) and (6) as proposed. Rule 613(c)(5) provides that ``[t]he
national market system plan submitted pursuant to this section shall
require each national securities exchange and its members to record and
report to the central repository the information required by [Rule
613(c)(7)] for each NMS security registered or listed for trading on
such exchange or admitted to unlisted trading privileges on such
exchange,'' and Rule 613(c)(6) provides that ``[t]he national market
system plan submitted pursuant to this section shall require each
national securities association and its members to record and report to
the central repository the information required by paragraph (c)(7) of
this section for each NMS security for which transaction reports are
required to be submitted to the association.''
---------------------------------------------------------------------------
\277\ See Rules 613(c)(5) through (7).
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In essence, the Commission believes these provisions are
appropriate because they require each party--whether a broker-dealer,
exchange or ATS--that takes an action with respect to an order, and
thus has the best information with respect to that action, to record
and report \278\ that information to the central repository.\279\ For
example, the broker-dealer originating an order--whether received from
a customer or generated as a principal order--is in the best position
to record the terms of that order, including the time of origination,
as well as the unique customer and order identifiers. If the
originating broker-dealer is required to record the time each order in
a rapid series of principal orders is generated, for example,
regulators will be able to more accurately reconstruct the sequence of
those orders for purposes of conducting market surveillances for
manipulative or other illegal activity, or for performing market
reconstructions. In addition, requiring the originating broker-dealer
to record the time an order was received from a customer could then
help regulators more accurately determine whether the broker-dealer
quickly traded ahead of the customer order. On the other hand, if the
recording and reporting requirements initially applied only to the
executing or routing broker-dealer, or the exchange in the case of
market maker quoting, regulators would not know the precise time the
order or quote was originated, and would not be able to implement or
perform as efficiently effective surveillances, such as those discussed
above. In addition, the lack of precise order origination time could
interfere with the ability of regulators to perform accurate market
reconstructions or analyses, particularly with respect to high
frequency trading strategies. Thus, the Commission believes that every
broker-dealer (and exchange) that touches an order must record the
required data with respect to actions it takes on the order,
contemporaneously with the reportable event, to ensure that all
relevant information, including the time the event occurred, is
accurately captured and reported to the consolidated audit trail.\280\
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\278\ The Commission notes that the Rule does not preclude the
NMS plan from allowing broker-dealers to use a third party to report
the data required to the central repository on their behalf. In
particular, the Commission recognizes that introducing brokers may
wish to contract with clearing broker-dealers for this purpose and
that the SROs may need to amend their rules to address the
allocation of responsibility between the parties. In such cases, the
Commission expects that the clearing contract, as mandated by the
SRO's rules, as amended, would address the allocation of
responsibility for the reporting of required data.
\279\ The Commission has adopted Rule 613(c)(5) and (6) using
the terms ``record'' and ``report'' the required audit trail data,
rather than ``collect'' and ``provide'' the required audit trail
data, as proposed. See also Section III.B.1.e., infra.
\280\ The Rule as adopted requires the NMS plan submitted to the
Commission for its consideration to require broker-dealers and SROs
to record and report to a central repository only the audit trail
information for actions each took with respect to an order. For
example, if a member receives an order from a customer, the member
will be required to report its receipt of that order (with the
required information) to the central repository. If the member then
routes the order to an exchange for execution, the member will be
required to report the routing of that order (with the required
information) to the central repository. Likewise, the exchange
receiving the routed order will be required to report the receipt of
that order from the member (with the required information) to the
central repository. If the exchange executes the order on its
trading system, the exchange will be required to report that
execution of the order (with the required information) to the
central repository, but the member will not also be required to
report the execution of the order. If the member executes the order
in the OTC market, however, rather than routing the order to an
exchange (or other market center) for execution, the member will be
required to report the execution of the order (with the required
information) to the central repository. In this regard, there is no
duplicative reporting of audit trail information because each market
participant is required to report only the audit trail data for the
actions it has taken with respect to an order.
The Commission notes that, for orders that are modified or
cancelled, Rule 613(c)(7)(iv) would require the broker-dealer who
received the modification from a customer, for example, to report
the order modification to the central repository. Thus, if broker-
dealer A received a modification to a customer's order from the
customer, broker-dealer A would be required to report such
modification to the central repository. If broker-dealer A had
already routed the customer's order to another broker-dealer
(``broker-dealer B''), the customer's modification would also need
to be reported by broker-dealer A to broker-dealer B. The receipt of
the customer's modification by broker-dealer B would also need to be
reported to the central repository, pursuant to Rule 613(c)(7)(iv).
The same reporting obligations would apply if the modification were
originated by broker-dealer A.
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While a broker-dealer will be required to record any actions it
takes with
[[Page 45749]]
respect to an order because such recordation would capture information,
particularly the time stamp, which is needed by regulators for the
reasons discussed above, the Commission notes that nothing in the Rule
precludes the NMS plan submitted to the Commission for its
consideration from allowing an introducing broker or other broker-
dealer to use a third party, such as a clearing broker-dealer, to
report the data recorded by the introducing broker or other broker-
dealer to the central repository.
The Commission acknowledges that SROs and their members will incur
costs to record and report the audit trail data required by Rules
613(c)(5), 613(c)(6) and 613(c)(7).\281\ The Commission also
acknowledges that, in some instances, the information required to be
recorded and reported by some market participants, for example, market
makers, may indeed be available from other market participants (in the
case of market makers, the exchanges) and that there might be
additional costs for all market participants to record and report
information. However, for the reasons noted above, the Commission
believes that requiring every market participant that touches an order
to record and report the required audit trail data to the central
repository, and thus requiring these market participants to incur these
costs is appropriate. The Commission believes that such costs will
depend on the exact details of how information is to be recorded and
reported to the central repository, including whether third-parties,
such as clearing-brokers or exchanges, facilitate the transmission of
such data. But because these costs depend on details that are not being
prescribed by the Commission, Rule 613 requires that the SROs must, in
their proposal of the specific mechanisms by which data will be
reported to the central repository, include cost estimates of their
solution, as well as a discussion of the costs and benefits of the
various alternatives considered but not chosen.\282\ More so, as
discussed above in Section I, once the Commission receives the
submitted NMS plan, it will be able to use such plan-specific details
and costs estimates, as well as public comment on the NMS plan, in
determining whether to approve the NMS plan.
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\281\ Such costs might include the costs to purchase or build
new systems and/or costs to modify existing systems to record and
report the required data. As discussed in Section I., supra, the NMS
plan would include detailed information about costs for the public
and the Commission to consider.
\282\ See Section III.C.2.iii., infra.
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The Commission also considered the comment that small broker-
dealers should be granted an exemption from the Rule,\283\ and, as
discussed in Section III.D., is adopting Rule 613(a)(3)(vi), which
provides that the NMS plan shall require each SRO to require small
broker-dealers to provide audit trail data to the central repository
within three years after effectiveness of the NMS plan, as opposed to
within two years as proposed.\284\ The Commission believes that
completely exempting small broker-dealers from reporting requirements
would be contradictory to the goal of Rule 613, which is to create a
comprehensive audit trail. In effect, an exemption to small broker-
dealers from the requirements of the Rule would eliminate the
collection of audit trail information from a segment of the broker-
dealer community and would thus result in an audit trail that does not
capture all orders by all participants in the securities markets for
NMS securities. The Commission notes that illegal activity, such as
insider trading and market manipulation, can be conducted through
accounts at small broker-dealers just as readily as it can be conducted
through accounts at large broker-dealers. In addition, granting an
exemption to certain broker-dealers might create incentives for
prospective wrongdoers to utilize such firms to evade effective
regulatory oversight through the consolidated audit trail. The
Commission recognizes, however, that small broker-dealers, particularly
those that operate manual systems, might be particularly impacted
because of their more modest financial resources and may need
additional time to upgrade to an electronic method of reporting audit
trail data to the central repository, and thus believes that allowing
the NMS plan to permit such broker-dealers up to an extra year to begin
reporting data to the central repository if the plan sponsors believe
such an accommodation is reasonable, is appropriate. The Commission
believes up to an additional year could allow small broker-dealers
extra time to explore the most cost-effective and most efficient method
to comply with the Rule. The Commission acknowledges that permitting
small broker-dealers up to three years to begin reporting the required
audit trail data to the central repository will delay the ability of
regulatory authorities to obtain full information about all orders from
all participants, which in turn will result in delaying the full
regulatory benefit of the consolidated audit trail. However, the
Commission believes that such an accommodation to small broker-dealers
is reasonable, given the fact that small broker-dealers may face
greater financial constraints in complying with Rule 613 as compared to
larger broker-dealers.\285\ The Commission also notes that many small
broker-dealers are introducing broker-dealers and may be able to use
their clearing broker-dealers to report the data to the central
repository, thereby potentially reducing some of their costs.
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\283\ See Wachtel Letter, p. 1.
\284\ See Section III.D., infra.
\285\ If a clearing broker-dealer receives an order from a small
broker-dealer during the period between the time the Rule is
applicable to large broker-dealers and the time the Rule is
applicable to small broker-dealers, the broker-dealer performing the
clearing function for the small introducing broker will be subject
to only the requirements of the Plan applicable directly to the
clearing broker-dealer, while the small introducing broker will not
be subject to the reporting requirements at that time.
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d. Reportable Events and Consolidated Audit Trail Data Elements
As proposed, Rule 613 would have required SROs and their respective
members to provide certain information regarding each order and each
``reportable event'' to the central repository. A reportable event
would have been defined in proposed Rule 613(j)(5) to include, but not
be limited to, the receipt, origination, modification, cancellation,
routing, and execution (in whole or in part) of an order.
For the reportable event of receipt and origination of an order,
proposed Rule 613(c)(7)(i) would have required the reporting of the
following data elements: (1) Information of sufficient detail to
identify the customer; (2) a unique customer identifier for each
customer; (3) customer account information; (4) a unique identifier
that would attach to an order at the time of receipt or origination by
the member; (5) a unique identifier for the broker-dealer receiving or
originating an order; (6) the unique identifier of the branch office
and registered representative receiving or originating the order; (7)
the date and time (to the millisecond) of order receipt or origination;
and (8) the material terms of the order.
For the reportable event of routing of an order, proposed Rule
613(c)(7)(ii) would have required the reporting of the following
information by the member or SRO that is doing the routing, each time
an order is routed: (1) The unique order identifier; (2) the date on
which an order was routed; (3) the exact time (in milliseconds) the
order was routed; (4) the unique identifier of the broker-dealer or
national securities exchange that routes the order; (5) the unique
identifier of the broker-dealer or
[[Page 45750]]
national securities exchange that receives the order; (6) the identity
and nature of the department or desk to which an order is routed if a
broker-dealer routes the order internally; and (7) the material terms
of the order.
Rule 613(c)(7)(iii), as proposed, also would have required the
collection and reporting by the SRO or member receiving a routed order
of the following information: (1) The unique order identifier; (2) the
date on which the order is received; (3) the time at which the order is
received (in milliseconds); (4) the unique identifier of the broker-
dealer or national securities exchange receiving the order; (5) the
unique identifier of the broker-dealer or national securities exchange
routing the order; and (6) the material terms of the order.
For the reportable events of modification or cancellation of an
order, proposed Rule 613(c)(7)(iv) would have required the following
data be collected and reported: (1) The date and time (in milliseconds)
that an order modification or cancellation was originated or received;
(2) the price and remaining size of the order, if modified; (3) the
identity of the person responsible for the modification or cancellation
instruction; and (4) other modifications to the material terms of the
order.
For full or partial executions of an order, proposed Rule
613(c)(7)(v) would have required the following information to be
collected and reported to the central repository: (1) The unique order
identifier; (2) the execution date; (3) the time of execution (in
milliseconds); (4) the capacity of the entity executing the order
(whether principal, agency, or riskless principal); (5) the execution
price; (6) the size of the execution; (7) the unique identifier of the
national securities exchange or broker-dealer executing the order; and
(8) whether the execution was reported pursuant to an effective
transaction reporting plan or pursuant to the OPRA Plan.
The Commission received comments on the information proposed to be
recorded and reported to the central repository for each reportable
event (i.e., the consolidated audit trail data elements) but did not
receive comments on the proposed definition of reportable event in
proposed Rule 613(j)(5) (i.e., the events that trigger consolidated
audit trail reporting requirements). However, the Commission is making
clarifying changes to proposed Rule 613(j)(5) (renumbered as Rule
613(j)(9)) to define a ``reportable event'' as including the original
receipt of a customer's order by a broker-dealer; the origination of an
order by a broker-dealer (i.e., a principal order); and the receipt of
a routed order. Thus, Rule 613(j)(9), as adopted, provides that ``[t]he
term reportable event shall include, but not be limited to, the
original receipt or origination, modification, cancellation, routing,
and execution (in whole or in part) of an order, and receipt of a
routed order.'' The Commission believes these changes from the proposal
are appropriate because they conform Rule 613(j)(9) to the provisions
of Rule 613(c)(7). Specifically, Rule 613(c)(7) is structured around
each ``reportable event;'' therefore, audit trail data is listed
according to the data that must be reported upon ``original receipt or
origination'' of an order (Rule 613(c)(7)(i)); ``routing'' of an order
(Rule 613(c)(7)(ii)); ``receipt of an order that has been routed''
(Rule 613(c)(7)(iii)); ``modification or cancellation'' of an order
(Rule 613(c)(7)(iv)); and ``execution'' of an order (Rule 613(c)(7)(v)
and (vi)).
As noted above, the Commission received comments on the information
proposed to be recorded and reported to the central repository with
each reportable event (i.e., the consolidated audit trail data
elements) and, in response, is adopting the Rule with certain
modifications from the proposed Rule with respect to certain of the
consolidated audit trail data elements. In so adopting the Rule, the
Commission acknowledges that costs will be incurred by SROs and their
members to record and report this information to the central repository
and by the central repository to receive, consolidate, store and make
accessible such information.\286\ However, the Commission believes that
the costs to SRO members for reporting this information, and the costs
to the central repository for collecting and storing this information,
will significantly depend on the exact details of how this information
will be gathered and transmitted by the various types of market
participants covered by Rule 613. The Commission is therefore requiring
the SROs to include as part of the NMS plan submitted to the Commission
for its consideration pursuant to the Rule, details of how each of the
different data elements would be recorded, reported, collected, and
stored, as well as cost estimates for the proposed solution, and a
discussion of the costs and benefits of alternate solutions considered
but not proposed. The Commission also notes that the SROs are not
prohibited from proposing additional data elements not specified in
Rule 613 if the SROs believe such data elements would further, or more
efficiently, facilitate the requirements of the Rule.
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\286\ In particular, the Commission acknowledges that certain
elements are not collected by existing audit trails and thus SROs
and members would incur additional costs to record and report such
information. The Commission also acknowledges that there might be
additional costs with respect to assigning customer identifiers, the
broker-dealer identifiers and the order identifiers because such
assignments might, depending on the NMS plan, require coordination
amongst various different entities and possibly further systems
changes.
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Once the SROs have submitted an NMS plan with these details, the
Commission will be able to use this information to determine whether to
approve the NMS plan. The Commission at this time is only directing the
SROs to develop and submit a detailed NMS plan that includes each of
the data elements. The Commission is not making a final determination
of the nature and scope of the data elements to be included in the
consolidated audit trail--as discussed above, these determinations will
be made after the SROs submit the NMS plan, and the Commission and
public have had an opportunity to consider the proposed data elements.
Rather, at this time the Commission is only making a more limited
determination. The benefits the Commission and the public will receive
from being able to consider the detailed costs and benefits of the
specific set of data elements submitted to the Commission for its
consideration pursuant to the Rule justify the costs of preparing the
NMS plan with such data elements included.
A discussion of these consolidated audit trail data elements
follows.
i. Material Terms of the Order
As proposed, Rule 613 would have required broker-dealers to report
the material terms of the order upon origination or receipt of an order
and upon routing, modification, and cancellation of an order.\287\
Proposed Rule 613(j)(3) (renumbered as Rule 613(j)(7)) defined material
terms of the order to include, but not be limited to, the following
information: (1) The NMS security symbol; (2) the type of security; (3)
price (if applicable); (4) size (displayed and non-displayed); (5) side
(buy/sell); (6) order type; (7) if a sell order, whether the order is
long, short, or short exempt; \288\ (8) if a short sale,
[[Page 45751]]
the locate identifier; (9) open/close indicator; (10) time in force (if
applicable); (11) whether the order is solicited or unsolicited; (12)
whether the account has a prior position in the security; (13) if the
order is for a listed option, option type (put/call), option symbol or
root symbol, underlying symbol, strike price, expiration date, and
open/close; and (14) any special handling instructions.
---------------------------------------------------------------------------
\287\ See proposed Rules 613(c)(7)(i)(I), 613(c)(7)(ii)(G),
613(c)(7)(iii)(F), and 613(c)(7)(iv)(D).
\288\ A broker or dealer currently must mark all sell orders of
any equity security as long, short, or short exempt. See Rule
200(g)(1) under the Exchange Act, 17 CFR 242.200(g)(1). A sell order
may be marked short exempt only if the conditions of Rule 201(c) or
(d) under the Exchange Act are met (17 CFR 242.201(c) and (d)). See
Rule 200(g)(2) under the Exchange Act, 17 CFR 242.200(g)(2).
---------------------------------------------------------------------------
The Commission requested comment on whether there are any items of
information that are required to be recorded and reported by existing
audit trail rules, or to be provided to the SROs or the Commission upon
request, that were not proposed but should have been included in the
Rule. One commenter suggested that two data elements be added to aid
regulators in detecting the original source of orders that violate laws
or are involved in market manipulations.\289\ Specifically, this
commenter recommended that the proposed Rule should capture the
identity of the individual who originated the order (in addition to
identifying the firm) and the system he or she used to originate the
order.\290\ Another commenter questioned the need for information
regarding whether an account has a prior position in a security.\291\
The commenter expressed skepticism about the value of knowing, in real
time, whether the customer has a prior position in the security, since
the length of time the position has been held would not be captured.
This commenter also questioned how the Commission's requirement that
the prior position in a security be reported would work in the
situation where a client has multiple accounts but it is the first time
the client has opened a position in one of the accounts.\292\ Another
commenter provided specific information on the exact data elements that
it could incorporate into the consolidated audit trail if it were
chosen as the central processor under Rule 613.\293\
---------------------------------------------------------------------------
\289\ See Kumaraguru Letter, p. 1.
\290\ Id.
\291\ See Ameritrade Letter, p. 3.
\292\ Id.
\293\ See FINRA Proposal Letter, Appendix A.
---------------------------------------------------------------------------
The Commission considered the views of the commenter that
questioned the value of knowing whether a customer has a prior position
in a security. The Commission also considered the commenter's concern
about potential reporting complications for clients with multiple
accounts, as well as general comments urging the Commission to reduce
the burdens of the Rule, and is adopting proposed Rule 613(j)(3)
(renumbered as Rule 613(j)(7)) with modifications to delete certain
data elements.
After considering the commenters' views, and re-evaluating the
necessity of requiring certain specific data elements, the Commission
has determined not to require the locate identifier (if a short sale);
whether the order is solicited or unsolicited; and whether the account
has a prior position in the security. The Commission believes the
consolidated audit trail can still achieve significant benefits without
requiring the routine recording and reporting of these specific data
elements to the central repository.\294\ While this information may be
useful for certain investigations and market analyses, the Commission
believes that this additional data could be readily obtained from a
follow-up request to a broker-dealer if the other data required by
proposed Rule 613(j)(3), particularly relating to the customer behind
the order, is included in the consolidated audit trail. Thus, the
Commission believes that it is unnecessary to require this additional
data to be reported as a standard part of the consolidated audit trail.
In effect, the Commission believes that the benefits of having these
specific audit trail data elements are minimal. As such, the Commission
does not believe the benefits to the Commission and the public to
consider the detailed costs and benefits of such data elements justify
the costs to SROs for including them in their NMS plan submission.
---------------------------------------------------------------------------
\294\ See Section II.A.2., supra.
---------------------------------------------------------------------------
In response to the commenter who recommended that the proposed Rule
should capture the identity of the individual who originated the order
(in addition to identifying the firm) and the system he or she used to
originate the order,\295\ the Commission notes that Rule 613 defines
``customer'' as: ``(i) The account holder(s) of the account at a
registered broker-dealer originating the order; and (ii) any person
from whom the broker-dealer is authorized to accept trading
instructions for such account, if different from the account
holder(s).'' \296\ The Rule does not require the identification of the
individual registered representative who placed the order.\297\
Further, the Commission does not believe that ``the system he or she
used to originate the order'' is of significant enough regulatory value
to require that information to be recorded and reported under Rule 613
at this time.
---------------------------------------------------------------------------
\295\ See Kumaraguru Letter, p. 1.
\296\ See Rule 613(j)(3); see also Section
III.B.1.d.iii.(C).(2)., infra (discussing the definition of
``customer'' as applied to investment advisers).
\297\ See Section III.B.1.d.ii., infra, for a discussion of the
proposed requirement to report the unique identifier of the
registered representative receiving or originating an order.
---------------------------------------------------------------------------
(A) Order Type
As proposed, the Rule would have required that members report the
order type as an element of the material terms of an order. In the
Proposing Release, the Commission explained that the proposed Rule does
not specify the exact order types (e.g., market, limit, stop, pegged,
stop limit) that could be reported under the Rule in recognition that
order types may differ across markets and an order type with the same
title may have a different meaning at different exchanges.\298\ The
Commission also noted that markets are frequently creating new order
types and eliminating existing order types. Thus, the Commission
preliminarily believed that it would not be practical to include a list
of order types in the proposed Rule as part of the required information
to be reported to the central repository.
---------------------------------------------------------------------------
\298\ See Proposing Release, supra note 4, at 32575.
---------------------------------------------------------------------------
The Commission received one comment in response to its request for
comment on its proposed approach to handling order types. This
commenter believed that the Commission did not think that order types
were needed for the consolidated audit trail, and argued that this
information is ``essential for any attempts to use the order data to
reconstruct the state of the limit order book at any point in time.''
\299\ The Commission agrees that information about an order's type is
important and notes that the Rule, as proposed, did require order types
to be reported.\300\ Thus, the Commission is adopting the Rule, as
proposed, to require plan sponsors to include in the NMS plan submitted
to the Commission for its consideration a requirement for SROs and
members to report the order type as an element of the material terms of
an order. The Rule, however, does not provide an exhaustive list of
order types, as the Commission continues to believe that it is not
feasible to do so in its Rule, for the reasons stated in the Proposing
Release.\301\ Rather, the Commission believes the plan sponsors should
be responsible for determining how to describe and categorize specific
order types in the NMS plan or in the NMS plan's technical
specifications, as there is more flexibility to amend such
[[Page 45752]]
documents and the SROs would have the most familiarity with the
variations among the order types on their markets. The Commission notes
that specific order types may differ across markets, and even an order
type with the same title may have a different meaning at different
exchanges. Further, SROs regularly develop new order types to respond
to changes in market structures and trading strategies, and any list of
order types will likely need to be updated over time.
---------------------------------------------------------------------------
\299\ See Angel Letter, p. 2-3.
\300\ Order type information is important because it reflects
the intention of the person originating an order with regard to how
an order should be handled, and also provides information regarding
the potential impact of orders on the market.
\301\ See Proposing Release, supra note 4, at 32575.
---------------------------------------------------------------------------
(B) Special Handling Instructions
The proposed Rule also would have required that that any special
handling instructions be reported as part of the material terms of an
order.\302\ The Commission specifically requested comment in the
Proposing Release on whether the Rule should require, as part of the
disclosure of special handling instructions, the disclosure of an
individual algorithm that may be used by a member or customer to
originate or execute an order, and, if so, how such an algorithm should
be identified. The Commission received one comment noting the
importance of requiring the special handling instructions to be
included in the consolidated audit trail.\303\ This commenter believed
that special handling instructions were important for reconstructing
the limit order book.\304\ Regarding algorithms, commenters generally
were not in favor of unique identifiers for algorithms.\305\ One
commenter urged against requiring customer information at the level of
``individual strategy, trading desk, or particular algorithm * * *.''
\306\ Another commenter stated that the proposed rule should not
require that unique customer identifiers be affixed to computer
algorithms.\307\ This commenter pointed out that algorithms change
daily, which would result in uncertainty about whether new identifiers
are needed. Further, the commenter argued that firms would need to
develop safeguards to ensure proprietary algorithms and trading
strategies are not appropriated by competitors. This commenter
suggested that, instead of requiring a unique customer identifier, the
Commission could require that a ``flag'' be appended to orders
generated by an algorithm.
---------------------------------------------------------------------------
\302\ See proposed Rule 613(j)(3).
\303\ See Angel Letter, p. 2-3.
\304\ Id.
\305\ See Managed Funds Association Letter, p. 2; SIFMA Letter,
p. 11; SIFMA Drop Copy Letter, p. 2.
\306\ See Managed Funds Association Letter, p. 2.
\307\ See SIFMA Letter, p. 11. SIFMA subsequently submitted an
alternative proposal that did not include a flag for algorithms,
citing lack of clarity in the Commission's definition of algorithmic
order, and stating that the FIX standard lacks existing fields to
flag such orders. Id. at 2.
---------------------------------------------------------------------------
The Commission agrees with the commenter that supported the
proposed requirement that special handling instructions be reported
\308\ and is adopting this requirement as proposed.\309\ The Commission
believes that such information will be useful to regulators in
attempting to recreate an SRO's limit order book for market
reconstructions. When performing market reconstructions, it is
important for regulators not only to have information regarding what
orders were on the book, but the conditions or special instructions
attached to those orders. Such information can be of key importance in
determining the amount of accessible liquidity at any price point and
whether or not certain orders were entitled to be executed at various
price levels.
---------------------------------------------------------------------------
\308\ See Angel Letter, p. 2-3.
\309\ See Rule 613(j)(7).
---------------------------------------------------------------------------
Additionally, the Commission considered the comments received
regarding whether an individual algorithm should be reported and
identified as part of an order's special handling instructions, and has
determined not to adopt that requirement in recognition that algorithms
change frequently and therefore it may be difficult to determine when
and if new algorithm identifiers are necessary. The Commission also
considered one commenter's concern regarding the proprietary nature of
algorithms and the risk of competitors appropriating algorithms if they
were required to be identified in the consolidated audit trail.
However, the Commission notes that, because the disclosure of whether
an order is a result of an algorithm that makes trading decisions based
on a programmed investment strategy might be useful for the Commission
and the SROs to sort or filter trade data to re-construct market events
or to better evaluate potentially manipulative behavior or intent, the
SROs may want to consider whether it would be feasible to include a
``flag'' or other indicator that would reveal whether an order was the
result of an algorithmic trading calculation. Such a flag would not
identify the actual algorithm used, but could instead indicate whether
the order was the result of an algorithmic trade. Appending such a
``flag'' or indicator may aid regulatory authorities in their efforts
to make preliminary assessments about market activity and better allow
the SROs and the Commission to monitor the usage of algorithms over
time. The Commission acknowledges that by not requiring that algorithms
be recorded and reported to the central repository, the consolidated
audit trail may not contain an audit trail data element that might
prove useful to regulatory authorities. The Commission, however,
believes that, should regulatory authorities need such information,
regulators can submit a request for this information and obtain the
information about whether the order was the result of an algorithm
readily from the broker-dealer that handled the order.
ii. Unique National Securities Exchange, National Securities
Association and Broker-Dealer Identifiers
The Commission proposed to require each member originating or
receiving an order from a customer, and each national securities
exchange, national securities association, and member that subsequently
handles the order to report its own unique identifier to the central
repository. Proposed Rule 613(c)(7)(i)(E) (renumbered as
613(c)(7)(i)(C)) would have provided that any member of an SRO, that
originally receives from a customer or originates a principal order,
shall collect and electronically report ``the unique identifier of the
broker-dealer receiving or originating the order.'' Similarly, proposed
Rule 613(c)(7)(ii)(D) provided that the SRO or any member of such SRO
that routes an order shall collect and electronically report ``the
unique identifier of the broker-dealer or national securities exchange
routing the order.'' Proposed Rule 613(c)(7)(ii)(E) provided that the
SRO or any member of such SRO routing an order shall collect and
electronically report ``the unique identifier of the broker-dealer or
national securities exchange receiving the order.'' Proposed Rule
613(c)(7)(iii)(D) provided that the SRO or any member of such SRO that
receives an order shall collect and electronically report ``the unique
identifier of the broker-dealer or national securities exchange
receiving the order.'' Proposed Rule 613(c)(7)(iii)(E) provided that
the SRO or any member of such SRO that receives an order shall collect
and electronically report ``the unique identifier of the broker-dealer
or national securities exchange routing the order.'' Proposed Rule
613(c)(7)(iv)(E) required, for a modification or a cancellation of an
order, the identity of the person giving such instruction. Proposed
Rule 613(c)(7)(v)(F) provided that the SRO or any member of such SRO
that executes an order in whole or part report ``the unique identifier
of the broker-dealer or national securities
[[Page 45753]]
exchange executing the order.'' Further, the Commission proposed to
require a member receiving an order from a customer to report, if
applicable, ``the unique identifier of the branch office and the
registered representative receiving or originating the order.'' \310\
---------------------------------------------------------------------------
\310\ See Proposed Rule 613(c)(7)(i)(F).
---------------------------------------------------------------------------
Commenters generally supported the proposed use of unique
identifiers for exchanges and broker-dealers.\311\ One commenter
explained that cross-market surveillance efforts are unduly complicated
if a single market participant has a different identifier for each
market, and stated that the current market participant identifier
(``MPID'') system needed to be updated.\312\ This commenter, however,
questioned whether it was necessary for branch office and registered
representative information to be included in the consolidated audit
trail, stating that the information would increase the amount of data
reported to the consolidated audit trail, but would be useful only in
certain circumstances.\313\ In another letter, the same commenter
proposed to use Central Registration Depository (``CRD'') numbers to
uniquely identify broker-dealers.\314\ Under this system, the commenter
suggested that SROs would be required to link the CRD numbers to unique
MPIDs to create a cross-referenced database, so that data could be
searched and retrieved at the firm level (by CRD number) or by the
unique market center identifiers used by firms for each transaction on
a specific market center.\315\ For activity not occurring on a national
securities exchange, the commenter proposed continued reporting with
MPIDs currently used for OATS reporting.\316\ Another commenter
supported the use of MPIDs as unique identifiers for broker-dealers,
suggesting that the MPIDs of the firms originating each order should be
added to the trade report, but stated that only FINRA and the
Commission should be allowed to access this information.\317\
---------------------------------------------------------------------------
\311\ See SIFMA Letter, p. 12; Liquidnet Letter, p. 6; FINRA
Letter, p. 4; FINRA Proposal Letter, p. 6.
\312\ See FINRA Letter, p. 4 (explaining that ``multiple firms
can currently be represented by a single MPID that is used for
market access arrangements and is assigned to another firm that has
no direct relationship to the trading activity being reported under
that MPID''). This commenter also supported the use of more specific
``sub-identifiers'' to allow regulators to distinguish between desks
or trading units within a firm.
\313\ Id. at p. 9. FINRA also requested that the Commission
reconsider the need for reporting the identification of the
beneficial owner, the identification of the person exercising
investment discretion, and the unique identifier of the branch
office and registered representative. For further discussion of this
comment, see note 170 supra and accompanying text.
\314\ See FINRA Proposal Letter, p. 6, 13. The CRD is the
central licensing and registration system operated by FINRA which
contains employment, qualification and disciplinary histories for
securities industry professionals who do business with the public.
\315\ See FINRA Proposal Letter, p. 6, 13.
\316\ Id. at p. 6.
\317\ See Angel Letter, p. 2.
---------------------------------------------------------------------------
After considering commenters' views requesting additional
flexibility with respect to the unique identifiers requirement for
national securities exchanges, national securities associations, and
members, the Commission has determined to adopt the Rule to require
plan sponsors to include in the NMS plan submitted to the Commission
for its consideration a requirement for such unique identifiers,
substantially as proposed. The Commission, however, has made two
technical changes to the Rule text from the proposal to: (1) Add a
defined term, ``CAT-Reporter-ID,'' in adopted Rule 613(j)(2) to refer
to these unique identifiers, and (2) expressly permit that a ``code''
be used that uniquely and consistently identifies the national
securities exchange, national securities association, or member.
Specifically, adopted Rule 613(j)(2) provides that ``[t]he term CAT-
Reporter-ID shall mean, with respect to each national securities
exchange, national securities association, and member of a national
securities exchange or national securities association, a code that
uniquely and consistently identifies such person for purposes of
providing data to the central repository.''
In response to the commenters that stated that firms' current MPIDs
or CRD numbers may work as a viable unique broker-dealer identifier,
the Commission believes it is appropriate to leave the decision of
whether to specify an existing identifier, such as a firm's MPID or CRD
number, or some other identifier such as one created under the unique
legal entity identifier (LEI) standard under development by the
International Standards Organization (``ISO'') (ISO 17442),\318\ as the
unique broker-dealer identifier, to the plan sponsors to assess and
propose in the NMS plan. Therefore, while the adopted Rule continues to
require the NMS plan to require these unique identifiers, the Rule does
not specify which identifier to use, nor does the Rule specify the
process for assigning unique broker-dealer identifiers.\319\ In this
regard, the Commission expects the plan sponsors to establish a
process, to be described in the NMS plan, by which every national
securities exchange, and every member of a national securities exchange
or national securities association, can obtain a CAT-Reporter-ID.
---------------------------------------------------------------------------
\318\ This standard is being developed by Technical Committee 68
(TC68) of ISO, in whose meetings a Commission staff representative
participates. Its final publication is subject to the resolution of
specific issues on implementation, operating procedures, and the
need to coordinate with a global legal entity identifier initiative
conducted by the global regulatory community, in which a Commission
staff representative is also participating.
\319\ One commenter requested the Commission consider how the
Department of the Treasury's newly-created Office of Financial
Research (``OFR'') would impact reporting requirements imposed by
the consolidated audit trail. See SIFMA Letter, p. 22-23. The
commenter noted that the collection powers granted to the OFR, as
well as its authority to require standardized reporting of data,
could affect how data is submitted to the consolidated audit trail.
Id. at p. 22. The commenter suggested that any information that is
provided to the consolidated audit trail should not be required to
be provided to the OFR again or in a different format. Id. The
Commission understands that the OFR has been participating in and
encouraging efforts by interested parties to have a standard for
assigning unique entity identifiers created by an internationally
recognized standards body (``IRSB'') and that the ISO has issued a
draft ISO standard, ISO 17442, for the financial services industry
that is proposed to provide a viable global solution for the
accurate and unambiguous identification of legal entities engaged in
financial transactions. See ISO Press Release ``ISO Financial
Services Standard Wins Industry Support Six Months Ahead of
Publication,'' July 25, 2011. Because the ISO standard is still in
draft form and issues of implementation, governance and operating
procedures remain to be resolved, the Commission does not believe
that it is appropriate for it to mandate the use of the ISO standard
at this time. The Commission notes, however, that to the extent that
unique entity identifiers become available from an IRSB, Rule 613
provides SROs with sufficient flexibility to submit, if they so
chose, an NMS plan that makes use of those identifiers and requires
all or some reporting parties to obtain such identifiers, assuming
such identifiers otherwise meet the requirements of the Rule.
---------------------------------------------------------------------------
The Commission also is adopting, substantially as proposed, rules
requiring the NMS plan submitted to the Commission for its
consideration to require each SRO and its members to report the unique
identifier of the broker-dealer or SRO for each reportable event in the
life of an order to the central repository, except to make two
technical changes: to include the new defined term, ``CAT-Reporter-ID''
and to require the CAT-Reporter-ID or Customer-ID, if applicable, of
the person giving a cancellation or modification instruction.\320\
Specifically, Rule 613(c)(7)(i)(C), as adopted, provides that any
member of an SRO that originally receives from a customer or originates
a principal order shall record and report ``[t]he CAT-Reporter-ID of
the broker-dealer receiving or originating the order.'' Rule
613(c)(7)(ii)(D) provides that any national securities exchange or
[[Page 45754]]
any member of an SRO that routes an order shall record and report
``[t]he CAT-Reporter-ID of the broker-dealer or national securities
exchange routing the order.'' Rule 613(c)(7)(ii)(E) provides that any
national securities exchange or member of an SRO that routes an order
shall record and report ``[t]he CAT-Reporter-ID of the broker-dealer,
national securities exchange, or national securities association to
which the order is being routed.'' Rule 613(c)(7)(iii)(D) provides that
the SRO or any member of an SRO that receives a routed order shall
record and report ``[t]he CAT-Reporter-ID of the broker-dealer,
national securities exchange, or national securities association
receiving the order.'' Rule 613(c)(7)(iii)(E) provides that the SRO or
any member of an SRO that receives a routed order shall record and
report ``[t]he CAT-Reporter-ID of the broker-dealer or national
securities exchange routing the order.'' Rule 613(c)(7)(iv)(F) provides
that the SRO or any member of an SRO that receives an instruction to
modify or cancel an order shall record and report ``[t]he CAT-Reporter-
ID of the broker-dealer or Customer-ID of the person giving the
modification or cancellation instruction.'' Rule 613(c)(7)(v)(F)
provides that the national securities exchange or any member of an SRO
that executes an order in whole or part shall record and report ``[t]he
CAT-Reporter-ID of the broker-dealer or national securities exchange
executing the order.'' Rule 613(c)(7)(vi)(B) provides that, if an order
is executed in whole or part, a member of an SRO shall record and
report ``[t]he CAT-Reporter-ID of the clearing broker or prime broker,
if applicable.''
---------------------------------------------------------------------------
\320\ See proposed Rule 613(c)(7)(iv)(E) (requiring the
reporting of the identity of the person giving a modification or
cancellation instruction for an order); adopted Rule
613(c)(7)(iv)(F) (requiring the CAT-Reporter-ID or Customer-ID of
such person instead).
---------------------------------------------------------------------------
The Commission notes that CAT-Reporter-IDs will be reported to the
central repository for each reportable event that the member or SRO is
reporting to the central repository. The requirement to report CAT-
Reporter-IDs in this manner will help ensure that regulators can
determine which market participant took action with respect to an order
at each reportable event. The Commission does not believe that the CAT-
Reporter-ID of each member or market that touches an order needs to be
tagged to and travel with an order for the life of the order, as long
as the CAT-Reporter-ID of the member or exchange taking the action is
reported to the central repository, and an order identifier(s) is
reported at every reportable event of the order. The Commission
believes the details of how these data are reported to the central
repository, and the specific methodologies used by the central
repository to assemble time-sequenced records of the full life-cycle of
an order, is best left to the expertise of the SROs as they develop the
NMS plan to be submitted to the Commission for its consideration.
Instead, as adopted, Rule 613 requires that data in the central
repository be made available to regulators in a linked fashion so that
each order can be tracked from origination through modification,
cancellation, or execution, and that the parties routing or receiving
routes, or otherwise performing such actions, are identified for every
reportable event.
After considering the comment opposing the requirement to report to
the central repository the unique identifier of the branch office and
registered representative receiving or originating an order,\321\ the
Commission has reconsidered the requirement in proposed Rule
613(c)(7)(i)(F) and is not adopting this requirement.\322\ While this
audit trail data may be useful in the context of certain investigations
or market analyses, upon further consideration, the Commission believes
that this information need not be required by Rule 613 because it is
not critical information to help identify the customer responsible for
trading a security, nor to capturing the entire life of an order as it
moves from origination to execution or cancellation. In addition, the
Commission believes that a requirement that a unique identifier of the
branch office and registered representative receiving or originating
the order be reported may not provide enough information in an initial
assessment of whether illegal or manipulative activity is occurring in
the marketplace to warrant that this information be required in the
audit trail created by Rule 613. Further, should regulators determine
that the identity of the branch office and registered representative
receiving or originating the order is needed to follow-up on a specific
issue, they may request the information directly from the broker-dealer
as broker-dealers are required to make and keep records identifying the
registered representative that receives an order pursuant to Exchange
Act Rules 17a-3(a)(6)(i) \323\ and 17a-4(b)(1).\324\ As such, the
Commission does not believe the benefits of including this information
in the consolidated audit trail justify the costs to SROs for requiring
them to devise a methodology to identify the branch offices and
registered representatives receiving or originating an order, and a
mechanism for reporting this type of data to the central repository.
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\321\ See note 313, supra.
\322\ See proposed Rule 613(c)(7)(i)(F).
\323\ 17 CFR 240.17a-3(a)(6)(i).
\324\ 17 CFR 240.17a-4(b)(1).
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iii. Unique Customer Identifier
(A) Proposed Rule
As proposed, Rule 613 would have required every SRO and broker-
dealer to report a unique customer identifier to the central repository
for any order originated by or received from such customer.\325\
Specifically, proposed Rule 613(c)(7)(i)(B) (renumbered as Rule
613(c)(7)(i)(A)) would have required that a national securities
exchange, national securities association or any member of such
exchange or association that originally receives or originates an order
to collect and electronically report ``a unique customer identifier for
each customer.'' In the Proposing Release, the Commission noted that
the unique customer identifier should remain constant for each
customer, and have the same format, across all broker-dealers.\326\
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\325\ See Rule 613(j)(3) for a definition of ``customer.''
\326\ See Proposing Release, supra note 4, at 32573; proposed
Rule 613(c)(7)(i)(B).
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The Commission requested comment on possible ways to develop and
implement unique customer identifiers. For example, the Commission
solicited input about who should be responsible for generating the
identifier; whether a unique customer identifier, together with the
other information with respect to the customer that would be required
to be provided under the proposed Rule, would be sufficient to identify
individual customers; and whether there were any concerns about how the
customer information would be protected. The Commission specifically
requested comment on what steps should be taken to ensure that
appropriate safeguards are implemented with respect to the submission
of customer information, as well as the receipt, consolidation, and
maintenance of such information in the central repository.
(B) Comments on Proposed Rule 613(c)(7)(i)(B)
The Commission received comments that supported the general notion
that identifying customers in an audit trail would be beneficial for
regulatory purposes.\327\ One commenter stated that a customer
identifier on an order-by-order basis would ``enhance significantly the
audit trails of the
[[Page 45755]]
markets.'' \328\ Similarly, another commenter agreed that identifying
the customer would be useful to regulators for purposes of market
surveillance and enforcement.\329\ Another commenter noted that it
``fully supports more granularity in an order audit trail, such as
obtaining high-level customer identity information (e.g., large trader
identification), so that patterns of trading across multiple market
centers can be quickly and readily identified, and [the commenter]
agrees that the timeframe needed to identify customers should be
greatly reduced; however, [the commenter] question[s] the utility of
receiving the identity of both the beneficial owner and the person
exercising the investment discretion, if different, for each and every
order reported to the consolidated audit trail.'' \330\
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\327\ See CBOE Letter, p. 2; Managed Funds Association Letter,
p. 2; FINRA Letter, p. 9; SIFMA Drop Copy Letter, p. 1; SIFMA
Letter, p. 9.
\328\ See CBOE Letter, p. 2.
\329\ See Managed Funds Association Letter, p. 2.
\330\ See FINRA Letter, p. 9.
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However, other commenters disagreed with the need for a unique
customer identifier and the proposed Rule's requirements for reporting
a unique customer identifier with every order. These commenters
generally focused on the complexity and cost of the systems changes
required to implement the unique customer identifier requirement for
every customer; \331\ the complexity in the process for assigning
unique customer identifiers; \332\ the alternative ways that a customer
could be identified without requiring a unique customer identifier as
proposed; \333\ and the concerns about how the privacy of customers
might be compromised if every customer was assigned a unique customer
identifier.\334\
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\331\ See SIFMA Drop Copy Letter, p. 1. See also SIFMA Letter,
p. 9.
\332\ See Liquidnet Letter, p. 4; SIFMA Letter, p. 10-11; Knight
Letter, p. 2; Scottrade Letter, p. 1; Direct Edge Letter, p. 3;
FINRA Proposal Letter, p. 4.
\333\ See Angel Letter, p. 2; FIF Letter, p. 2; BOX Letter, 2.
\334\ See SIFMA Letter, p. 10; Wells Fargo Letter, p. 3; Ross
Letter, p. 1; ICI Letter, p. 3; FIF Letter, p. 2.
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One commenter discussed the complexity and cost of the systems
changes required to implement the unique customer identifier
requirement, as set forth in the Rule.\335\ This commenter, who did not
believe the Commission should require a unique customer identifier for
every customer, noted the ``complexity of the technology development
work involved'' in adding this identifier to the audit trail.\336\ The
commenter added that the work required to update internal architecture
to report customer identifiers would be ``substantial'' because broker-
dealer systems and processes may access and maintain customer (and
proprietary) identification information in different ways and at
different levels of specificity, and that sales and trading systems
would need to be modified to report the unique customer identifiers
with every order. This commenter also noted the ``significant costs''
generally associated with requiring a unique customer identifier.\337\
---------------------------------------------------------------------------
\335\ See SIFMA Drop Copy Letter, p. 1. See also SIFMA Letter,
p. 9.
\336\ Id.
\337\ See SIFMA Letter p. 9, 10.
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A few commenters also submitted their views on the complexity of
the process for assigning unique customer identifiers.\338\ One
commenter noted that the process for assigning unique customer
identifiers that the Commission discussed in the Proposing Release
(i.e., generating unique customer identifiers based on the input by a
broker-dealer of a customer's social security number or tax
identification number) would not create an administrative burden on
individuals and non-broker-dealer entities.\339\ Another commenter,
however, noted difficulties associated with implementing a centralized
process for assigning, storing and utilizing standardized customer
identifiers \340\ and another commenter characterized the
``implementation of a centralized customer identification system'' as a
``monumental task.'' \341\ Another commenter believed that to satisfy
the Rule's requirements, the industry would need to implement a
completely new market-wide system to satisfy the unique customer
identifier requirement, noting that this might not be feasible on the
proposed timeline.\342\ Another commenter characterized the collection
of a unique customer identifier as a ``significant project unto
itself.'' \343\ One commenter observed that given the large number of
retail investors (some with multiple accounts), the complexities
associated with tracking retail investors' accounts, and the relatively
small and infrequent amount of trading by typical retail investors, the
Rule should not require unique customer identifiers for every
customer.\344\ Another commenter urged the Commission to specify
whether the process required that a unique customer identifier be
submitted at the time an order is originated or received and the
procedure to be followed if an identifier is not available.\345\
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\338\ See Liquidnet Letter, p. 4; SIFMA Letter, p. 10-11; Knight
Letter, p. 2; Scottrade Letter, p. 1; Direct Edge Letter, p. 3;
FINRA Proposal Letter, p. 4; SIFMA Letter, p. 11.
\339\ See Proposing Release, supra note 4, at 32573; Liquidnet
Letter, p. 4.
\340\ See SIFMA Letter, p. 10.
\341\ See Knight Letter, p. 2.
\342\ See Scottrade Letter, p. 1. See also Knight Letter, p. 2;
Direct Edge Letter, p. 4.
\343\ See Direct Edge Letter, p. 3.
\344\ See FINRA Proposal Letter, p. 4.
\345\ See SIFMA Letter, p. 11.
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A few commenters suggested alternative ways to identify a customer,
rather than through a unique customer identifier.\346\ One commenter
suggested that customers could be identified by amending the current
trade report.\347\ Another commenter believed that ``sophisticated
analysis could identify trading activity that might be coordinated,
without using an account identifier, and that regulators could then
perform further analysis to determine who traded by using [EBS] and
other methods already available to the staff.'' \348\ Another commenter
noted that a possible method for identifying customers could be by
linking customer information in EBS to trading information in
OATS.\349\ Another commenter noted that ``[i]t makes economical sense
to use the current OATS and COATS audit trails and to expand those
audit trails to include additional customer information, thereby
providing a more complete audit trail for regulatory oversight for post
trade analysis rather than building another audit trail system.'' \350\
---------------------------------------------------------------------------
\346\ See Angel Letter, p. 2; FIF Letter, p. 2; BOX Letter, p 2.
\347\ See Angel Letter, p. 2. This commenter stated that ``[i]t
would be relatively simple and cheap to add four fields to each
trade report that would contain the account numbers of the buyer and
seller and the Market Participant Identifier (MPID) for the original
order entry firms.''
\348\ See FIF Letter, p. 2. This commenter recommended that the
requirement for such unique customer identifiers be tabled until
after regulators have experience using CAT without this identifier.
\349\ See FIF Letter, p. 2.
\350\ See BOX Letter, p. 2.
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Commenters also discussed the need for both a large trader
identification number under Rule 13h-1 under the Exchange Act, the
Commission's Rule implementing the large trader reporting system,\351\
and a unique customer identifier under Rule 613.\352\ One commenter
stated that the Commission could alleviate some of the burdens of the
proposed Rule, and increase the effectiveness of an identification
system, if it required only large trader identification numbers to be
reported instead of requiring a unique customer identifier for every
customer.\353\ This commenter believed that the Commission and the SROs
are unlikely
[[Page 45756]]
to be interested in routine transactions by small investors and would
much more likely need accurate information about the orders of large
traders because they are most likely to engage in transactions large
enough to impact prices.\354\ Another commenter noted that an
alternative would be to only identify entities that have sponsored or
direct access to market centers via a relationship with a sponsoring
market participant and to identify customers whose trading activity
would be required to be disclosed pursuant to Rule 13h-1.\355\
---------------------------------------------------------------------------
\351\ See Section II.A.3., supra.
\352\ See SIFMA Letter, p. 11; FINRA Proposal Letter, p. 6-7.
\353\ See SIFMA Letter, p. 11.
\354\ Id. See also FINRA Proposal Letter, Appendix B (setting
forth a method for identifying large traders through the
``registration of unique market participant identifiers rather than
by requiring broker-dealers to provide the CAT processor with any
large trader numbers assigned by the SEC in order reports, thereby
minimizing the ability of market participants to reverse engineer a
large trader's identity or trading strategy'').
\355\ See FINRA Proposal Letter, p. 6-7.
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Certain commenters discussed concerns about how the privacy of
customers might be compromised if every customer was assigned a unique
customer identifier.\356\ One commenter, noting the Commission's
discussion in the Proposing Release that the unique customer
identifiers could be based on a customer's social security number or
taxpayer identification number, believed that the Commission's approach
raises ``serious privacy concerns.'' \357\ Another commenter noted that
``there is a legitimate privacy concern with having the unique customer
identifier available to the marketplace, and creating a means to
protect that privacy would add tremendous incremental cost to the
[consolidated audit trail].'' \358\ One commenter questioned how long
and at what level customer information would be encrypted,\359\ and
another noted that ``[t]he proposal needs to clarify who will have
access to customer data and how confidentiality will be ensured.''
\360\
---------------------------------------------------------------------------
\356\ See SIFMA Letter, p. 10; Wells Fargo Letter, p. 3; Ross
Letter, p. 1; ICI Letter, p. 2; FIF Letter, p. 2.
\357\ See SIFMA Letter, p. 10 (noting that ``in recent years,
increased concerns about identity theft and client confidentiality
have led the securities industry to move away from using social
security identification numbers or taxpayer identification numbers
as a way to monitor clients and customers. The SEC has affirmed that
it would guard access to customer social security and taxpayer
identification numbers with even more safeguards than it does other
information in the central repository of the consolidated audit
trail. Although the SEC has a strong record of protecting investor
privacy, the very presence of potentially billions of unique
customer identifiers tied to personal information in a central
repository would create a substantial risk of misuse and identity
theft. The risk of unique customer identifiers being stolen or
misused would be magnified in a real-time reporting system'').
\358\ See Wells Fargo Letter, p. 3. However, this commenter also
noted that, ``[w]hile the full panoply of privacy concerns that flow
from having a unique order identifier being available to every
participant in the order execution process may be difficult to
assess, creating a system that has that unique identifier available
for primarily the post trade review likely solves both the privacy
and cost issues in a manner reasonable for both clients, market
participants and regulators.'' Id.
\359\ See Ross Letter, p. 1 (asking at what level of security to
encrypt customer data, and for how long to encrypt it for, as well
as how long the Commission would need to decrypt the customer's
name--whether on a real time or overnight basis, and noting that
data encryption is expensive and could enlarge message sizes.) See
also ICI, p. 3 (suggesting that the Commission expressly state who
would have access, when they could access it, and how they could use
it; and also recommending requiring that all data sent to the
central repository be encrypted and that certain fields be
``masked'' or that reporting of information in such fields be
delayed until end-of-day to reduce concerns about leaked information
being used for frontrunning).
\360\ See FIF Letter, p. 2.
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(C) Adopted Rule
(1) Need for a Unique Customer Identifier
The Commission recognizes that the implementation of the unique
customer identifier requirement may be complex and costly, and the
reporting of a unique customer identifier will require SROs and their
members to modify their systems to comply with the Rule's requirements.
The Commission, however, believes that unique customer identifiers are
vital to the effectiveness of the consolidated audit trail. The
inclusion of unique customer identifiers should greatly facilitate the
identification of the orders and actions attributable to particular
customers and thus substantially enhance the efficiency and
effectiveness of the regulatory oversight provided by the SROs and the
Commission. Without the inclusion of unique customer identifiers, many
of the benefits of a consolidated audit trail as described above in
Section II.2. would not be achievable.
For example, unique customer identifiers will make regulatory
inquiries and investigations more efficient by eliminating delays
resulting from the current need to send information requests to
individual market participants in search of this key information, as
well as reducing the burden on regulators and market participants of
such requests.\361\ The identity of the customer is often necessary to
tie together potential manipulative activities that occur across
markets and through multiple accounts at various broker-dealers.
Existing audit trails, however, do not identify the customer
originating the order and thus do not allow SRO and Commission
regulatory staff to quickly and reliably track a person's trading
activity wherever it occurs in the U.S. securities markets. A unique
customer identifier connected to each order will allow the SROs and the
Commission to more quickly identify the customer that originated each
order and therefore potentially more quickly and efficiently stop
manipulative behavior through the submission of orders. In certain
cases this might limit the losses of parties injured by malfeasance who
currently may suffer losses during the weeks or months that it can
currently take for regulators to obtain customer information through
written requests for information.
---------------------------------------------------------------------------
\361\ Because existing SRO audit trails do not require customer
information to be reported, regulators must request that information
identifying the customer, often from a multitude of sources, which
can result in significant delays in investigating market anomalies
or violative trading. Additionally, indirect access to an exchange
(such as ``sponsored access'' arrangements) also has made it more
difficult to use the current EBS system and Rule 17a-25 to identify
the originating customer because the broker-dealer through whom an
order is sent to an exchange may not know or have direct access to
information identifying the customer who originally submitted the
order.
---------------------------------------------------------------------------
Further, unique customer identifiers will aid regulators in
reconstructing broad-based market events. Specifically, having unique
customer identifiers will aid regulators in determining how certain
market participants behaved in response to market conditions and may
even reveal the identity of the market participant(s) who caused or
exacerbated a broad-based market event. More so, unique customer
identifiers would enable regulators to disaggregate the market activity
of different participants in ways that could help address many
important questions related to equity and equity options market
structure, ranging from more detailed analyses of the potential impacts
of high frequency trading, to studies of market liquidity, to trend
analyses of the trading costs and general efficiency by which investors
use our public markets to acquire or dispose of their securities
holdings.
The Commission has considered commenters' concerns about the
complexity of the process for creating and assigning unique customer
identifiers and understands and acknowledges that the process of
creating and assigning unique customer identifiers may not be simple
and may result in additional costs to SROs and their members.\362\ The
Commission also considered the commenters' views that there may be
alternative ways to identify the customer responsible for orders, and
that, in the view of some
[[Page 45757]]
commenters, every individual customer need not be identified for
purposes of an audit trail. As noted above, the Commission believes
that the identification of each customer responsible for every order is
critical to the effectiveness of a consolidated audit trail and does
not agree that the commenters' alternative means of identifying a
customer would be as effective as the method proposed by Rule 613. For
example, the Commission considered the comment that customers could be
identified by amending the trade report, but this approach would fail
to identify customers associated with orders that are not
executed.\363\ Additionally, account numbers are assigned by broker-
dealers for their own customers only, and account numbers vary between
broker-dealers. Thus, the identity of a customer from a specific
account number would not be apparent to regulators without the time-
consuming requests for information Rule 613 specifically is seeking to
avoid. The use of unique customer identifiers would permit regulators
to readily trace market activity by the same customer back to that
unique customer identifier even if such market activity were affected
across multiple accounts and broker-dealers.
---------------------------------------------------------------------------
\362\ See notes 331-334, supra, and accompanying text.
\363\ See Angel Letter, p. 2.
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The Commission also considered the recommendations of some
commenters that the consolidated audit trail should use the large
trader identifier instead of a unique customer identifier.\364\ The
Commission, however, does not believe that the commenters' approach
will address the regulatory need to obtain information on and to
identify the holders of accounts for all order activity in the market
for NMS securities because the use of the large trader identifier alone
would identify only those traders that self-report as ``large traders''
pursuant to Rule 13h-1 and are assigned a large trader unique
identifier. Thus, under the commenters' suggested approach, only a very
small portion of customers--the very largest traders in the market--
would be assigned a unique identifier for purposes of the consolidated
audit trail. Smaller traders, however, also can be perpetrators of
illegal activity, or otherwise impact the market. Accordingly, the
Commission believes that information on all customers is necessary to
achieve the goal of Rule 613.
---------------------------------------------------------------------------
\364\ See SIFMA Letter, p. 9-11; FINRA Proposal Letter, p. 4 and
6.
---------------------------------------------------------------------------
Despite the wide and disparate array of views from commenters on
the costs, complexities, and most efficient methodologies to generate
and collect unique customer identifiers, the Commission believes that
the potential benefits of including this information in the
consolidated audit trail justify the costs to the SROs in requiring
that they develop and include a detailed framework for unique customer
identification as part of the NMS plan to be submitted for
consideration by the Commission and the public. Therefore, the
Commission is adopting the Rule substantially as proposed to provide
that the NMS plan must require every member to report a unique customer
identifier to the central repository upon origination or receipt of an
order as required by Rule 613(c)(7)(i)(A). The Commission, however, is
changing the term ``unique customer identifier,'' as used in the
proposed Rule, to the term ``Customer-ID.'' Adopted Rule 613(j)(5)
defines the term ``Customer-ID'' to mean, ``with respect to a customer,
a code that uniquely and consistently identifies such customer for
purposes of providing data to the central repository.'' \365\
---------------------------------------------------------------------------
\365\ For purposes of the following discussion, the Commission
will use the terms ``unique customer identifier'' and ``Customer-
ID'' interchangeably.
---------------------------------------------------------------------------
Given the complexity and the various existing options for
identifying a customer, the Commission believes that the plan sponsors,
by engaging in a detailed process that combines their own expertise
with that of other market participants, are in the best position to
devise a methodology for, and estimate the costs of, including customer
identifiers in the consolidated audit trail. Once the NMS plan was
submitted, the Commission and the public would then be able to consider
the details and costs of such a framework.
The Commission notes that the Rule does not specify the process for
assigning the unique customer identifiers, or the format for such
identifiers; rather, the Rule contemplates that the plan sponsors have
the flexibility to determine the precise way to assign or ``code''
these identifiers. In this regard, the Commission expects the plan
sponsors to establish a process by which every broker-dealer can, in a
cost-effective manner, obtain a unique customer identifier, or
Customer-ID, for each of their customer(s).\366\ The Commission also
expects the plan sponsors to establish a process by which unique
customer identifiers are reported to the central repository, and how
this information is linked to the name and address of customers as
stored in the central repository. The Commission further notes that
Rule 613 does not specify that unique customer identifiers must be
attached to every reportable event as orders are routed from one market
or broker-dealer to another, or that these identifiers are reported at
the same time and fashion as other customer-identifying information.
Rather, the Commission is relying on the SROs, and other market
participants,\367\ to develop a proposal that maximizes efficiency and
security, and that data in the central repository be made available to
regulators in a linked fashion so that each order, and all subsequent
reportable events, can be readily traced back to one or more customers
through their unique identifiers.
---------------------------------------------------------------------------
\366\ Under the Rule, each customer would be assigned a unique
customer identifier, or Customer-ID. However, an order may have more
than one Customer-ID if the account holder differs from the person
from whom the broker-dealer is authorized to take trading
instructions or if more than one person is an account holder for the
account or is authorized to give trading instructions for the
account.
\367\ See Rule 613(a)(1)(xi).
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In response to the commenter that questioned what should happen if
a unique customer identifier was not available,\368\ the Commission
notes that the Rule does not set out a process for addressing a
situation where a unique customer identifier is not available to a
broker-dealer and/or customer. Instead, the Commission believes that
the plan sponsors are in the best position to address this situation as
they develop the overall process for assigning unique customer
identifiers. In response to the comment that requested the Commission
specify whether a unique customer identifier is required to be reported
at the time an order is originated or received,\369\ the Commission
notes that Rule 613(c)(7)(i)(A) requires that the NMS plan require that
this information be recorded contemporaneously with the reportable
event, but permits the reporting of the identifier by 8:00 a.m. Eastern
Time on the trading day following the day such information has been
recorded.\370\ In addition, in response to the commenter that believed
that the consolidated audit trail should identify market participants
with direct or sponsored access to markets,\371\ the Commission notes
that under the Rule, to assure the Commission and the SROs of an
accurate and complete audit trail for every action that every market
participant takes with respect to an order, the sponsored party will be
assigned a Customer-ID and the
[[Page 45758]]
sponsoring broker-dealer will be assigned a CAT-Reporter ID under Rule
613.
---------------------------------------------------------------------------
\368\ See SIFMA Letter, p. 11.
\369\ See SIFMA Letter, p. 11.
\370\ See Section III.B.1.e., infra.
\371\ See FINRA Letter, p. 8-9.
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The Commission also considered the privacy and security concerns
that commenters raised with respect to the use of Customer-IDs.\372\ In
response to these comments, the Commission is revising proposed Rule
613, as discussed in more detail in Section III.B.2.e. below, to
include additional mechanisms to safeguard the privacy and
confidentiality of the audit trail data, including the Customer-ID, in
large part to address the privacy concerns raised by commenters.\373\
In response to the commenter that questioned when and at what level
customer information would be encrypted,\374\ the Commission notes
that, while Rule 613 does not explicitly require that this information
be encrypted, the Rule contains several safeguards to ensure the
privacy and confidentiality of the audit trail data. Specifically,
adopted Rule 613(e)(4) requires the NMS plan to include policies and
procedures, including standards, to be used by the plan processor to
ensure the security and confidentiality of all information reported to
the central repository. In addition, one of the considerations the NMS
plan must address is how the security and confidentiality of all
information, including customer information, reported to the central
repository, will be ensured.\375\ Based on these provisions, the
Commission believes that plan sponsors would need to make sure customer
information is protected, and the plan sponsors could require such data
to be encrypted.
---------------------------------------------------------------------------
\372\ See ICI Letter, p. 2-4; SIFMA Letter, p. 10-11; Angel
Letter, p. 2; Ross Letter, p. 1.
\373\ See Section III.B.2.e., infra.
\374\ See Ross Letter, p. 1.
\375\ See Rule 613(a)(1)(iv).
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Additionally, the Commission believes that privacy concerns also
could be mitigated if the plan sponsors determine, as permitted by Rule
613, that the unique customer identifiers not travel with the order,
and instead be reported to the central repository only upon the receipt
or origination of an order. Therefore, if the plan sponsors make this
decision, the SROs and their members will not be able to use the unique
customer identifier to track the identity of a customer(s) or a
customer's order flow.\376\ While the unique customer identifier will
be linked to information that is sufficient to identify a customer
(e.g., the name and address of the customer) and customer account
information \377\ at the central repository, this information will be
accessible only by regulators for regulatory purposes.\378\ The
Commission also notes that the plan sponsors could determine not to
require that a customer's social security number or tax identification
number be used as a customer's unique identifier to the extent they
believe that there are privacy and confidentiality concerns.
---------------------------------------------------------------------------
\376\ See also Section III.B.2.e., infra, for a discussion of
the provisions in the NMS plan designed to protect the privacy and
confidentiality of the consolidated audit trail data.
\377\ See Rule 613(j)(4).
\378\ See Rule 613(e)(2). See also Section III.B.2.d., infra.
---------------------------------------------------------------------------
(2) Definition of ``Customer''
As proposed, Rule 613(j)(1) (renumbered as Rule 613(j)(3)) defined
``customer'' as ``[t]he beneficial owner(s) of the account originating
the order; and [t]he person exercising investment discretion for the
account originating the order, if different from the beneficial
owner(s).'' The Commission received two comments regarding the
inclusion of beneficial owners in the definition of customer. One
commenter questioned the use of a unique customer identifier for both a
beneficial owner of an account and the person exercising investment
discretion, if different, and noted that if a trade comes into
question, the person exercising investment discretion, not the
beneficial owner, likely will be the ``first person of interest in any
type of review or investigation of such trading activity.'' \379\
Another commenter requested further clarity regarding the definition of
``customer'' for purposes of Rule 613, and suggested that the
Commission should define ``beneficial owner'' to be sure this term is
applied correctly.\380\ This commenter specifically stated that ``[t]he
SEC should also provide a definition for the terms `beneficial owner'
and `customer' to eliminate any doubts as to whom these labels apply.
For example, is the `customer' the entity directing the trade or the
beneficial owner of the account?'' and added that, ``for registered
investment advisers, the unique customer identifier should be
associated with the investment adviser rather than the underlying
beneficial owner. Frequently, investment advisers aggregate orders for
multiple beneficial owners in `bulk' orders that are routed together
and allocated on an average-priced basis to ensure best execution.''
\381\
In response to commenters' concerns about the use of the term
``beneficial owner,'' the Commission is revising Rule 613(j)(1), as
proposed (renumbered as Rule 613(j)(3)), to state that ``[t]he term
`customer' shall mean: (i) [t]he account holder(s) of the account at a
registered broker-dealer originating the order; and (ii) [a]ny person
from whom the broker-dealer is authorized to accept trading
instructions for such account, if different from the account
holder(s).'' The Commission believes that the revised Rule will provide
it with the customer information required to achieve the objectives of
the consolidated audit trail.\382\
---------------------------------------------------------------------------
\379\ See FINRA Letter, p. 9.
\380\ See SIFMA Letter, p. 11.
\381\ Id.
\382\ The Commission also notes that it retains the authority to
request additional information from broker-dealers (and other market
participants it regulates) where information about a customer of a
broker-dealer beyond that required by Rule 613(j)(3) is needed to
fulfill its mission.
---------------------------------------------------------------------------
In adopting this revised definition, the Commission is clarifying
its intent that, with respect to the ``account holder'' reference under
Rule 613(j)(3), the NMS plan submitted to the Commission for its
consideration must require broker-dealers to capture information on
only the individuals or entities that currently are required to be
recorded in the books and records of the broker-dealer pursuant to Rule
17a-3(a)(9) under the Exchange Act.\383\ Because this provision does
not require broker-dealers to obtain information about their account
holders beyond what they are required to obtain today, the Commission
believes the modification to the proposed Rule is appropriate because
it will reduce the proposed Rule's burden on broker-dealers in
recording and reporting information about a ``customer,'' as that term
will be defined under Rule 613(j)(3). The Commission notes that, under
the Rule, as adopted, for joint accounts--where two individuals are
required to provide information under Rule 17a-3 of the Exchange Act
for one account--information for both persons listed on the joint
account would be recorded and reported under Rule 613.\384\
---------------------------------------------------------------------------
\383\ Rule 17a-3(a)(9), among other things, requires a broker-
dealer to make and keep a record of the name and address of the
``beneficial owner'' of each cash or margin account with the broker-
dealer. 17 CFR 240.17a-3(a)(9). Rule 613 is not intended to alter in
any way the information that a broker-dealer is currently required
to obtain under Rule 17a-3(a)(9).
\384\ The Commission notes that, under Rule 613, both joint
account holders would also receive their own unique customer
identifier.
---------------------------------------------------------------------------
The Commission also believes that it is important to capture the
person that has authority to give trading instructions to a broker-
dealer for an account, if different from the account holder, because
such person likely will be of interest in a review or investigation of
activity in such account.
[[Page 45759]]
Thus, the Commission is modifying the proposed Rule to clarify its
intent that under Rule 613 the NMS plan also must capture, in the
definition of customer, ``[a]ny person from whom the broker-dealer is
authorized to accept trading instructions, if different from the
account holder(s).'' \385\ Knowing the identity of the person who is
authorized to give the broker-dealer trading instructions for an
account, whether the account holder or an adviser or other third party,
is a vital component in the investigative process. Further, when
investigating violations of the federal securities laws, it is
important to promptly identify all potentially relevant parties who may
have made trading or investment decisions, which could include both the
person authorized to give the broker-dealer trading instructions for
such account and the account holder.\386\
---------------------------------------------------------------------------
\385\ See Rule 613(j)(3)(ii).
\386\ For the purpose of Rule 613(j)(3), natural persons who are
employed by an entity that is an account holder, and who are
authorized to trade for that account, are not considered different
from the account holders, and are therefore not covered by Rule
613(j)(3)(i).
---------------------------------------------------------------------------
Pursuant to the revised definition of ``customer'' under adopted
Rule 613, for example, if an order is entered to buy or sell securities
for the account of an investment company or other pooled investment
vehicle (a ``fund''), the Rule will capture, in the definition of
customer, the fund itself or, if the account at the broker-dealer is
held only in the name of the fund's investment adviser from whom the
broker-dealer is authorized to accept trading instructions, the Rule
will capture the investment adviser.\387\ If the account at the broker-
dealer is held in the name of the fund itself, the Rule will capture
both the name of the fund (pursuant to Rule 613(j)(3)(i)), as well as
the name of the fund's investment adviser from whom the broker-dealer
is authorized to accept trading instructions (pursuant to Rule
613(j)(3)(ii)). In addition, if an adviser enters an order on behalf of
clients that each maintain separate accounts at the broker-dealer
originating the order, using those accounts, the Rule would capture
both the adviser--as the person providing trading instructions to the
broker-dealer (pursuant to Rule 613(j)(3)(ii))--and the clients, who
are the account holders at the broker-dealer (pursuant to Rule
613(j)(3)(i)). If an adviser instead enters an order to buy or sell
securities using its own account held at the broker-dealer originating
the order, the Rule would capture the adviser (pursuant to Rule
613(j)(3)(i)) but would only capture any client accounts to which the
adviser allocates executed trades (pursuant to Rule 613(c)(7)(vi)) if
those client accounts were held separately at the same broker-dealer as
well.
---------------------------------------------------------------------------
\387\ Pursuant to the definition of ``customer'' under adopted
Rule 613, the Rule would not capture owners of a fund because they
are not the account holders at the broker-dealer.
---------------------------------------------------------------------------
Furthermore, in cases where multiple individuals in the same
trading firm transact through a single account maintained at a broker-
dealer in the name of that trading firm, the Rule will require the NMS
plan to require recording and reporting of the Customer-ID of the
trading firm associated with that account, and not the Customer-IDs of
the individual traders who had placed the orders.\388\ The Commission
understands that in some cases broker-dealers may have knowledge of the
individual traders transacting within the same firm-wide account, and
may even provide reports to the firm holding the account that
summarizes trade activity according to individual trader. Because such
information is not captured by the Rule, but may be useful in informing
regulators about the potential manipulative activities, the SROs may
wish to consider how such information might be incorporated into the
consolidated audit trail in the future.
---------------------------------------------------------------------------
\388\ This is because, for the purpose of Rule 613(j)(3),
natural persons who are employed by an entity that is an account
holder, and who are authorized to trade for that account, are not
considered different from the account holders, and are therefore not
covered by Rule 613(j)(3)(ii).
If an individual creates and operates two separate entities (as
an employee of each such entity) that each maintain a trading
account at one or more broker-dealers, the broker-dealers would be
required to record and report the Customer-IDs of those entities,
and not the customer ID of the individual trader.
---------------------------------------------------------------------------
The Commission is also modifying a related provision of the Rule,
Rule 613(c)(7)(i)(A), to reflect that more than one Customer-ID must be
provided upon original receipt or origination of an order if the
account holder and the person authorized to give the broker-dealer
trading instructions for such account are different or if more than one
person is an account holder for the account (such as, for example,
joint account holders). Specifically, Rule 613(c)(7)(i)(A) provides
that ``Customer-ID(s)'' (i.e., multiple Customer-IDs) must be provided
for each customer, if that is applicable. In addition, the Commission
notes that every ``customer,'' as defined by Rule 613(j)(3) will be
assigned a Customer-ID; thus, two Customer-IDs maybe associated with
one order under the Rule.
iv. Unique Order Identifier
As proposed, the Rule would have required the NMS plan to require
each member of an exchange or FINRA to attach, to each order received
or originated by the member, a unique order identifier that would be
reported to the central repository and that would remain with that
order throughout its life, including routing, modification, execution,
or cancellation. Specifically, proposed Rule 613(c)(7)(i)(D)
(renumbered as Rule 613(c)(7)(i)(B)) would have provided that the
national market system plan shall require each national securities
exchange, national securities association, and any member of such
exchange or association to collect and electronically provide to a
central repository details for each order and each reportable event,
including, but not limited to, ``a unique identifier that will attach
to the order at the time the order is received or originated by the
member and remain with the order through the process of routing,
modification, cancellation, and execution (in whole or in part).'' In
the Proposing Release, the Commission stated that the use of such an
identifier would allow the SROs and the Commission to efficiently link
all events in the life of an order and help create a complete audit
trail across all markets and broker-dealers that handle the order.\389\
Proposed Rules 613(c)(7)(ii)(A), 613(c)(7)(iii)(A), and 613(c)(7)(v)(A)
would have required the reporting of a unique order identifier to the
central repository for the reportable events of routing and execution.
The Commission did not propose to mandate the format of such an
identifier or how the identifier would be generated.
---------------------------------------------------------------------------
\389\ See Proposing Release, supra note 4, at 32576.
---------------------------------------------------------------------------
The Commission requested comment on whether a unique order
identifier that would remain with the order for its life would be
necessary or useful for an effective consolidated audit trail. The
Commission also specifically requested comment on, among other things,
the feasibility and merits of its proposed approach for attaching a
unique order identifier to an order, as well as on how multiple
``child'' orders that may result if the original ``parent'' order is
subsequently broken up, or an aggregation of multiple original orders
into a single order, should be addressed.
Several commenters expressed opinions on the proposed unique order
identifier requirement, with some noting that the Commission's proposal
imposed ``significant'' burdens or challenges on market participants,
and others offering alternatives to the
[[Page 45760]]
Commission's approach to identifying orders.\390\ For example, some
commenters suggested that the Rule permit the approach used for OATS
reporting, in which the broker-dealer initiating or receiving an order
would generate its own order identifier, but pass on a separate routing
identifier to the entity to which it routes the order, which would
generate its own order identifier, but retain and report that routing
identifier as well, so that information about the order can be linked
together as it is passed from venue to venue.\391\ One of these
commenters also believed that the OATS approach would avoid certain
complexities that could occur with a unique order identifier, such as
when the original order is broken up into multiple ``child''
orders.\392\ In a subsequent comment letter, the commenter stated that
it could require two new order event types that would allow customer
orders handled on a riskless principal or agency basis to be linked to
the related representative orders.\393\ Another of the commenters
suggested that ``the adopted CAT filing should require that an order be
tracked through its lifecycle and [the Commission should] leave the
technical details to [a] requirements analysis.'' \394\
---------------------------------------------------------------------------
\390\ See Thomson Reuters Letter, p. 3; Liquidnet Letter, p. 6-
7; SIFMA Letter, p. 12; FINRA Letter, p. 7; FIF Letter, p. 3; FIF
Letter II, p. 2.
\391\ See Liquidnet Letter, p. 6-7; SIFMA Letter, p. 12; FINRA
Letter, p. 7; FIF Letter, p. 3.
\392\ See FINRA Letter, p. 7-8. FINRA expressed concern that, if
two child orders from the same parent order are sent to the same
market center, regulators would need to look at time stamps and
other attributes, such as share quantity and price, to attempt to
create an accurate linkage for each individual child order. FINRA
stated that this complexity could be avoided if members used a
separate unique routed order identifier for each routed order. Id.
\393\ See FINRA Proposal Letter, p. 7-8.
\394\ See FIF Letter II, p. 2.
---------------------------------------------------------------------------
Another commenter was concerned that, if the originating firm's or
customer's name was used as part of the unique order identifier, this
could create ``potential privacy information risks as every new
destination (both internally across information barriers within a firm
and externally across broker-dealers) would see where an order
originated.'' \395\ Similarly, a third commenter supported the OATS
approach of linking a series of separate order identifiers in part
because it believed that, if a unique identifier were to pass from
firm-to-firm, there was a risk that information about the origin of an
order might be inferred.\396\ Yet another commenter recommended that
the Commission standardize how the order identifier should be
structured to ensure consistent reporting between firms, instead of
leaving this decision to the plan sponsors.\397\
---------------------------------------------------------------------------
\395\ See SIFMA Letter, p. 12. See also SIFMA Drop Copy Letter,
p. 2 (suggesting a routed order identifier or a child order
identifier which would be separate from the unique order identifier
of the parent order, and would be reported to the consolidated audit
trail separately on a non-real-time basis, as well as linkage
information).
\396\ See FIF Letter, p. 3 (recommending the linking of the
order information in a fashion similar to OATS whereby the
information would only be available to regulators).
\397\ See SIFMA Letter, p. 12. In addition, another commenter
suggested that order identifiers should be unique by broker and day,
similar to the approach used by OATS. See Liquidnet Letter, p. 7.
---------------------------------------------------------------------------
The Commission has considered the comments received regarding the
requirement that the NMS plan mandate a unique order identifier, and is
adopting Rule 613 with significant modifications \398\ that provide
more flexibility for the SROs, as the plan sponsors, to determine
whether the NMS plan will require a single unique order identifier or a
``series of order identifiers.'' Specifically, the Rule, as adopted,
requires that every order have a ``CAT-Order-ID,'' defined as ``a
unique order identifier or series of unique order identifiers that
allows the central repository to efficiently and accurately link all
reportable events for an order, and all orders that result from the
aggregation or disaggregation of the order.'' \399\
---------------------------------------------------------------------------
\398\ See Rule 613(c)(7)(i)(B); Rule 613(c)(7)(ii)(A); Rule
613(c)(7)(iii)(A); Rule 613(c)(7)(iv)(A); Rule 613(c)(7)(v)(A); Rule
613(c)(7)(vi)(C); and Rule 613(j)(1).
\399\ See Rule 613(j)(1).
---------------------------------------------------------------------------
The Commission has modified the Rule from the proposal so that the
SROs can draw upon their own expertise, as well as those of other
market participants, in developing the most accurate and efficient
methodology for tracking an order through its life. Thus, the SROs may
submit an NMS plan in which they require a single unique order ID to
travel with each originating order; the SROs may submit an NMS plan in
which, as suggested by a number of commenters, a series of order IDs,
each generated by different market participants, is reported to the
central repository in a manner that allows for the accurate linking of
reportable events; or the SROs may submit an NMS plan based on any
other methodology that meets the requirements of the Rule.
The Commission expects that the details of the methodology proposed
by the SROs in the NMS plan will, in part, be based on how the
generation and reporting of order identifiers would interact with other
technical details involving order tracking in the consolidated audit
trail, such as the potential for multiple orders to be aggregated,
routed, and disaggregated. However, though the Commission is not
prescribing a particular methodology, the Rule does require that SROs
take into account a number of considerations, such as accuracy and
cost, in designing their methodology.\400\
---------------------------------------------------------------------------
\400\ See Section III.C.2.a., infra.
---------------------------------------------------------------------------
The Commission notes that, with this modification, a wider array of
possible solutions is now available to the SROs as they develop the NMS
plan to be submitted to the Commission for its consideration, including
those that may better accommodate the infrastructure of existing audit
trails and thereby potentially, and possibly significantly, reduce
implementation burdens. As indicated above, several commenters
suggested that the Rule accommodate the linked order identifier
approach, currently used by OATS.\401\ However, the Commission also
notes that, though the adopted Rule could accommodate such an approach,
there historically have been limitations on the accuracy and
reliability of linking orders in OATS.\402\ It will therefore be very
important for the NMS plan to demonstrate how the approach it has
selected will ensure that information about all reporting events
pertaining to an order will be efficiently and accurately linked
together in a manner that allows regulators efficient access to a
complete order audit trail.\403\ As discussed below, the reliability,
accuracy, and confidentiality of the data reported to and maintained by
the central repository, as well as the method by which the data in the
central repository can be accessed by regulators, are considerations
for the Commission in evaluating the NMS plan.\404\
---------------------------------------------------------------------------
\401\ See FIF Letter, p. 3; Liquidnet Letter, p. 7; SIFMA
Letter, p. 12; SIFMA Drop Copy Letter, p. 12; FINRA Letter, p. 8.
\402\ See Section II.A., supra.
\403\ See Rule 613(j)(1). For example, one of the methods that
the SROs could consider using to demonstrate the efficacy of their
approach would be to engage appropriate third party experts to
confirm that the system's proposed design and functionality would
achieve its stated accuracy and reliability benchmarks.
\404\ See Section III.C.2.a.i., infra; Rule 613(a)(1)(iii) and
(iv).
---------------------------------------------------------------------------
The Commission emphasizes that, under the adopted Rule, regardless
of the specific method chosen by the SROs, all orders reported to the
central repository must be made available to regulators in a uniform
electronic format and in a form in which all events pertaining to the
same originating order are linked together in a manner that ensures
timely and accurate retrieval of the information for all reportable
events
[[Page 45761]]
for that order.\405\ The Commission believes the consolidated audit
trail will still achieve significant benefits with this modification.
---------------------------------------------------------------------------
\405\ See Rule 613(e)(1).
---------------------------------------------------------------------------
The Commission recognizes the complexities of order routing in
today's markets, including, as noted by a commenter,\406\ the frequent
splitting of larger orders into numerous ``child'' orders or the
bundling of smaller orders into one larger order. The Commission
believes, however, that since, in today's complex markets, orders are
currently and routinely aggregated and disaggregated, practical
solutions to record such orders can be developed by the plan sponsors
to ensure they are accurately and efficiently tracked through a variety
of aggregation and disaggregation events.
---------------------------------------------------------------------------
\406\ See FINRA Letter, p. 4-7.
---------------------------------------------------------------------------
With regard to the concern expressed by a commenter that the use of
an order identifier(s), as required by Rule 613, could provide the
ability to deduce the origin of an order, thereby revealing
confidential trading strategies or raising privacy concerns,\407\ the
Commission notes that this commenter assumed that a unique order
identifier ``would very likely require members to include the
originating firm's or customer's name as part of the identifier.''
\408\ The Commission believes, however, that the SROs will be able to
devise a way to assign order identifiers--through random number
sequences or otherwise--that would protect the identity of broker-
dealers and their customers from disclosure to persons other than
authorized regulatory personnel. The Commission also notes that, as
discussed in Section III.B.2.e. infra, the adopted Rule requires the
NMS plan submitted to the Commission for its consideration to
incorporate a variety of policies and procedures to ensure the security
and confidentiality of all information reported to the central
repository.
---------------------------------------------------------------------------
\407\ See SIFMA Letter, p. 12. See also FIF Letter, p. 3.
\408\ See SIFMA Letter, p. 12.
---------------------------------------------------------------------------
Furthermore, because the Rule requires the SROs to discuss the
details of each aspect of the NMS plan submitted to the Commission for
its consideration, the Commission and the public will be able to
consider how well the methodology the SROs developed to link reportable
events for the same order meets the considerations of accuracy and
reliability, as well as those of security and confidentiality. The
Commission will then be able to use this information in determining
whether to approve the NMS plan submitted.
v. Time Stamp
The proposed Rule would have required SROs and their members to
report the date and time, to the millisecond, that an order was
originated or received, routed out, and received upon being routed,
modified, cancelled, and executed.\409\ Specifically, proposed Rules
613(c)(7)(i)(H) (renumbered as 613(c)(7)(i)(E)), 613(c)(7)(ii)(C),
613(c)(7)(iii)(C), 613(c)(7)(iv)(B) (renumbered as 613(c)(7)(iv)(C)),
and 613(c)(7)(v)(C) provided that the ``time of order receipt or
origination (in milliseconds)'' would be recorded for every order
originated or received, routed, modified, cancelled or executed, by a
broker-dealer or SRO.
---------------------------------------------------------------------------
\409\ See proposed Rules 613(c)(7)(i)(H), 613(c)(7)(ii)(C),
613(c)(7)(iii)(C), 613(c)(7)(iv)(B), 613(c)(7)(v)(C).
---------------------------------------------------------------------------
Several commenters expressed opinions on the time stamp
requirement. One commenter believed a millisecond standard was not
precise enough, explaining that many exchanges currently execute orders
in less than a millisecond.\410\ This commenter explained that, to
detect the manipulative or fraudulent behavior of high frequency
traders, it is necessary that time stamps be accurate to a level more
detailed than the speed at which trades are executed; otherwise, it
would not be possible to determine the time sequence in which trades
occurred. The commenter suggested that reports from execution venues
(e.g., exchanges, ATSs, dark pools, and large internalizers) should be
required to be accurate to 0.01 milliseconds.\411\ This commenter also
suggested that a more liberal time stamp standard of one second might
be more appropriate for low-volume broker-dealers.\412\ Another
commenter, however, expressed concern about the proposed millisecond
time stamp requirement, explaining that, ``[a]lthough firm systems tend
to capture time stamps in milliseconds, reporting in milliseconds would
require changes to internal systems given that existing audit trails
such as OATS require reporting of time stamps accurate only to the
second.'' \413\ Another commenter believed that, because computers have
a certain rate of error when keeping time (``time drift''), it is
difficult to sequence orders based on millisecond time stamps.\414\ As
a result, according to this commenter, there is ``no real value in
requiring data to this level of specificity [based on milliseconds],
especially if the goal of time stamping is to sequence the lifecycle of
a single order as it moves from origination to execution.'' \415\
---------------------------------------------------------------------------
\410\ See Endace Letter, p. 1-2.
\411\ See Endace Letter, p. 1. The Commission notes that this
commenter also suggested that the same time increment be extended to
market data feeds to help increase transparency and deter fraudulent
activity; however, this comment is outside the scope of this
Release.
\412\ Id. at 2-3.
\413\ See SIFMA Letter, p. 14.
\414\ See FIF Letter, p. 6-7.
\415\ Id. See Section III.B.1.d.v., infra, for further
discussions of ``time drift'' and the issues raised by this
commenter in that regard.
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The Commission has considered the comments regarding the precision
of the proposed time stamp requirement for the consolidated audit trail
and is adopting the millisecond time stamp requirement with
modifications from the proposal.\416\ As adopted, the Rule provides
that the NMS plan submitted shall require the time stamps as set forth
in Rule 613(d)(3).\417\ Rule 613(d)(3) provides that the NMS plan must
require each SRO and its members to ``[u]tilize the time stamps
required by paragraph (c)(7) of this section, with at minimum the
granularity set forth in any national market system plan submitted
pursuant to this section, which shall reflect current industry
standards and be at least to the millisecond.'' Rule 613(d)(3) also
provides that, ``[t]o the extent that the relevant order handling and
execution systems of any national securities exchange, national
securities association, or member of such exchange or association
utilize time stamps in increments finer than the minimum required by
the national market system plan, such plan shall require such national
securities exchange, national securities association, or member to
utilize time stamps in such finer increments when providing data to the
central repository, so that all reportable events reported to the
central repository by any national securities exchange, national
securities association, or member can be accurately sequenced.'' Rule
613(d)(3) further provides that ``[t]he national market system plan
shall require the sponsors of the national market system plan to
annually evaluate whether industry standards have evolved such that the
required time stamp standard should be in finer increments.''
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\416\ See Proposed Rules 613(c)(7)(i)(H), 613(c)(7)(ii)(C),
613(c)(7)(iii)(C), 613(c)(7)(iv)(B), and 613(c)(7)(v)(C).
\417\ See Rules 613(c)(7)(i)(E), 613(c)(7)(ii)(C),
613(c)(7)(iii)(C), 613(c)(7)(iv)(C), and 613(c)(7)(v)(C).
---------------------------------------------------------------------------
The Commission notes that SIPs currently support millisecond time
stamps \418\ and other entities in the
[[Page 45762]]
securities industry currently conduct business in millisecond
increments or finer.\419\ The Commission believes that, given the speed
with which the industry currently handles orders and executes trades,
it is important that the consolidated audit trail utilize a time stamp
that will enable regulators to better determine the order in which
reportable events occur. The entry time of orders can be critical to
enforcement cases. For example, the timing between order origination
and order entry is important in investigating possible market abuse
violations, such as trading ahead of a customer order. In general,
determining whether a series of orders rapidly entered by a particular
market participant is manipulative or otherwise violates SRO rules or
federal securities laws, otherwise being able to reconstruct market
activity, or performing other detailed analyses, requires the audit
trail to sequence each order accurately. The Commission believes that,
for many types of common market activities that operate at the level of
milliseconds or less, time stamps in increments greater than a
millisecond would not allow this sequencing with any reasonable degree
of reliability.
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\418\ See, e.g., Securities Industry Automated Corporation's
(``SIAC'') Consolidated Quotation System (``CQS'') Output
Specifications Revision 40 (January 11, 2010); SIAC's Consolidated
Tape Service (``CTS'') Output Specifications Revision 55 (January
11, 2010); and Nasdaq's Unlisted Trading Privileges Plan Quotation
Data Feed Interface Specifications Version 12.0a (November 9, 2009).
\419\ See, e.g., http://batstrading.com/resources/features/bats_exchange_Latency.pdf (describing, among other things, the
time it takes to accept, process, and acknowledge or fill a member
order).
---------------------------------------------------------------------------
In response to the comment that a millisecond standard is not
sufficiently precise, as many exchanges currently execute orders in
less than a millisecond,\420\ adopted Rule 613(d)(3) provides that the
NMS plan must require that, to the extent that the order handling and
execution systems of any SRO or broker-dealer utilize time stamps in
increments finer than the minimum required by the NMS plan time stamps,
such SRO or member must use time stamps in such finer increments when
reporting data to the central repository, so that reportable events
reported to the central repository by any SRO or member can be
accurately sequenced. The Commission believes this approach will
improve the accuracy of records with respect to the sequencing of
events that occur very rapidly, especially with respect to those market
participants that have elected to use time stamps in increments finer
than a millisecond.
---------------------------------------------------------------------------
\420\ See Endace Letter, p. 1.
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The Commission recognizes, as a commenter noted,\421\ that
computers have a certain rate of deviation when keeping time. The
requirement that clocks be synchronized within a level of granularity
to be specified in the NMS plan \422\ is designed to ensure that time
drift does not exceed a defined level of deviation. However, the
Commission believes that time stamps reported with a millisecond or
finer granularity would still provide significant benefits even,
contrary to one commenter's assertion,\423\ if the time drift between
systems is larger than a millisecond. This is because such time stamps
would still allow an accurate sequencing of reportable events as may
commonly occur within in a single system, tied to a single clock, at
levels of a millisecond or finer (e.g., high-frequency trading
algorithms). Any drift of such a system's clock relative to the clocks
of other systems may of course hinder the time-sequencing of cross-
system events, but it would not preclude the ability of regulators from
performing a detailed, accurate time-sequenced analysis of all the
orders, cancellations, modifications, and executions performed by the
specific system of interest.\424\ In this regard, the Rule is analogous
to the current requirements for OATS reporting: FINRA requires clocks
to be synchronized to the second, and requires time stamps to be
reported to FINRA in seconds, unless those time stamps are captured by
the FINRA member in milliseconds, in which case they must reported to
FINRA in milliseconds (notwithstanding the clock sync remaining at a
second).\425\
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\421\ See FIF Letter, p. 7.
\422\ See Section III.B.1.h., infra, for a discussion of clock
synchronization.
\423\ See FIF Letter, p. 6-7.
\424\ Similarly, although reporting in increments finer than a
millisecond would also enable the accurate time-sequencing of events
originating from within a single system or systems operating off the
same clock, the Commission recognizes that the effects of time drift
across the clocks of different systems could limit the efficacy of
time-sequencing sub-millisecond events across those systems.
\425\ See FINRA's Order Audit Trail System, Frequently Asked
Questions, http://www.finra.org/Industry/Compliance/MarketTransparency/OATS/NMS/P122893 (last visited on May 15, 2012).
---------------------------------------------------------------------------
The Commission acknowledges that changes (with their associated
costs) might be required to internal broker-dealer systems to comply
with a millisecond time stamp requirement. However, given the benefits
outlined above, and the apparent widespread use of millisecond time
stamps in the industry today,\426\ the Commission believes the cost of
requiring the SROs to develop a plan that provides for millisecond time
stamps, and to discuss the costs and benefits of the specific solution
chosen, is justified.
---------------------------------------------------------------------------
\426\ See Endace Letter, p. 1 (stating that ``[t]oday Exchanges
such as NYSE Euronext and BATS are claiming that they are executing
orders in less than a millisecond (see Wall Street Journal on the
January 6th 2010) and are displaying details of these trades in
increments of milliseconds on their market data feeds. Clearly from
an Exchange perspective the publishing of trade data at one
millisecond increments is not just possible, its current practice.
However, Endace believes that one millisecond increments is not good
enough''); SIFMA Letter, p. 14 (acknowledging that, ``[a]lthough
firm systems tend to capture time stamps in milliseconds, reporting
in milliseconds would require changes to internal systems given that
existing audit trails such as OATS require reporting of time stamps
accurate only to the second'').
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The Commission also acknowledges that broker-dealers who presently
report time stamps to OATS in millisecond increments, but whose systems
direct and capture their order activity in finer time increments, could
incur costs associated with these time stamps being reported to the
central repository with the same granularity at which they are recorded
by the broker-dealers.\427\ The Commission recognizes that there may be
alternatives to reporting events in finer than millisecond increments
that enable the central repository to use a different method for
accurately time-sequencing sub-millisecond events originating from
within a system or systems on a single clock. Therefore, in developing
the NMS plan to be submitted to the Commission for its consideration,
if the SROs identify one or more such alternatives, the Commission
believes that they should address such alternatives in the NMS
plan,\428\ how such alternatives (i.e., an alternative to reporting in
finer than millisecond increments) would ensure that reportable events
may be accurately time-sequenced at the sub-millisecond level, and the
costs associated with such alternatives both on their own terms and
relative to a requirement to report events in the same sub-millisecond
time stamp as used by a broker-dealer for directing and capturing
orders.\429\
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\427\ See SIFMA Letter, p. 14.
\428\ See Rule 613(a)(1)(xii).
\429\ See Rule 613(a)(1)(vii).
---------------------------------------------------------------------------
The Commission also notes that, because millisecond time stamps may
become inadequate to investigate trading as technology evolves and
trading speeds increase, the adopted Rule requires that the NMS plan
submitted to the Commission for its consideration require the plan
sponsors to annually evaluate whether industry standards have evolved
such that a finer increment time stamp is appropriate. As this approach
is tied to the then-current industry standard used to assess whether to
shorten the future time stamp increment, the Commission also believes
that this approach helps assure that the time stamps in the
consolidated
[[Page 45763]]
audit trail will be in line with technological developments. Should the
industry standard move to a finer time standard, the plan sponsors
could modify the minimum standard required by the NMS plan by
submitting an amendment to the NMS plan under Rule 608 of Regulation
NMS. Such an amendment would need to be considered and would be subject
to approval by the Commission, as well as subject to public notice and
comment.\430\
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\430\ See Rule 608(b)(1) under Regulation NMS, 17 CFR
242.608(b)(1).
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vi. Additional Routing Data Elements
Proposed Rules 613(c)(7)(ii) and (iii) would have required that
certain additional information be collected and reported specifically
to allow regulators to track the life of an order through the routing
process. The Commission requested comment as to whether information
regarding the routing of orders would be necessary or useful for an
effective consolidated audit trail, and asked if any information, in
addition to the data elements proposed, should be included in the
consolidated audit trail relating to routing.
One commenter noted that the proposed Rule would capture the
routing of an order internally within a broker-dealer, but not the
routing of an order internally within an exchange from one execution
system to another.\431\ This commenter also noted that, as proposed,
the Rule would not require an SRO or member to report information
indicating that an order was ``flashed'' or otherwise displayed in a
``step-up'' mechanism.\432\ The commenter believed that this
information would be important for the consolidated audit trail to
capture.\433\
---------------------------------------------------------------------------
\431\ See GETCO Letter, p. 4.
\432\ Id.
\433\ Id.
---------------------------------------------------------------------------
The Commission believes that it is important to capture the routing
of an order internally within a broker-dealer to, for example, evaluate
best execution practices.\434\ Capturing the time at which a broker-
dealer received a customer's order and the time that such order was
executed can help determine if the broker-dealer delayed acting on its
customer's order. The time at which an order was routed can affect the
evaluation of whether the broker-dealer fulfilled its best execution
obligations, and, thus, the Commission believes that this internal
broker-dealer routing information should be captured by Rule 613. The
Commission, however, does not believe that data regarding order
processing (i.e., management of an order) within exchange systems is as
useful as data regarding internal routing within a broker-dealer \435\
because, for example, unlike broker-dealers, exchanges do not have best
execution obligations. Further, any issues with an SRO's internal
processing would occur at a single venue--the SRO--and, thus, there
could be direct follow-up with the SRO. Additionally, the Commission
notes that the consolidated audit trail will not collect information
indicating whether orders were flashed or displayed in a ``step-up''
mechanism as it concerns an exchange's internal processing and
dissemination to its members of an order in the instance when the
exchange cannot execute the order because the exchange does not have
any available trading interest at the NBBO (depending on the side of
the order).\436\ Orders that are flashed or displayed through a ``step-
up'' mechanism are not executable because they are displayed only to
members of an exchange as an indication of a broker-dealer's interest.
The Commission believes it is appropriate not to require the reporting
of these flashed or ``stepped-up'' orders to the central repository
because, as noted above, the Commission believes that the tracing of
processes within an exchange is not as material to regulators as the
routing of orders between markets. Further, as stated, SROs do not have
the same legal obligations with regard to handling customer orders as
broker-dealers; therefore, the Commission does not believe it is
necessary, at this time, to require the consolidated audit trail to
track an SRO's internal processing of orders.
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\434\ OATS rules currently require the recording and reporting
of orders routed internally. See FINRA Rule 7440(c).
\435\ The Commission acknowledges that certain orders received
by an exchange may be routed to another exchange; however, the
routing of such an order to the other exchange is largely subject to
the rules of the exchange and Rule 613 will capture such routing as
a reportable event.
\436\ In general, flash orders are communicated to certain
market participants and either executed immediately or withdrawn
immediately after communication. The Commission has proposed and
sought comment on whether to amend Rule 602 of Regulation NMS under
the Exchange Act to eliminate an exception for the use of flash
orders by equity and options exchanges. See Securities Exchange Act
Release Nos. 60684 (September 18, 2009), 74 FR 48632 (September 23,
2009); 62445 (July 2, 2010), 75 FR 39625 (July 9, 2010).
---------------------------------------------------------------------------
The Commission has considered the comments related to the data that
is required to be recorded and reported when an order is routed and is
adopting Rules 613(c)(7)(ii) and (iii) substantially as proposed.\437\
The Commission notes that the Rule requires that the NMS plan require
the broker-dealer routing an order and the broker-dealer receiving a
routed order--both actions that are defined as ``reportable events''
under Rule 613--record and report the CAT-Reporter-ID of the broker-
dealer routing the order and the CAT-Reporter-ID of the broker-dealer
receiving the routed order. The Commission believes the requirement to
report this information on both the routing and receiving end of a
route is not duplicative but, rather, is useful. Specifically,
information regarding when a broker-dealer received a routed order
could prove useful in an investigation of allegations of best execution
violations to see if, for example, there were delays in executing an
order that could have been executed earlier. In addition, if a market
participant is required to report when it receives an order, regulators
could solely rely on information gathered directly from that market
participant when examining or investigating the market participant. For
example, if a regulator needs to investigate a delay between the time a
market participant received an order and the time the market
participant acted on the order, under Rule 613, as adopted, the
regulator could use information recorded and reported by the market
participant itself, rather than rely on information about the receipt
and action taken on the order that would be provided by a third party.
Information from a third party may be less accurate in general and may
not accurately reflect events to the extent there are latencies in
order transmission. In addition, the Commission relies on data such as
that which would be recorded under Rule 613(c)(7)(ii) and (iii) to
improve its understanding of how markets operate and evolve, including
with respect to the development of new trading practices, the
reconstruction of atypical or novel market events, and the implications
of new markets or market rules. For these reasons, the Commission
believes that it is important to have both the routing broker-dealer
and the receiving broker-dealer report their CAT-Reporter-IDs to the
central repository, and that such information could aid regulatory
authorities when analyzing the trades of market participants.\438\
---------------------------------------------------------------------------
\437\ See Section III.B.1.d.vi., supra, for a discussion of the
modifications to Rule 613(c)(7)(ii) through (iii).
\438\ The Commission notes that OATS rules also require both the
FINRA reporting member routing an order and the FINRA reporting
member receiving the order to record and report certain audit trail
data. See FINRA Rule 7440(C). See also Rule 613(c)(7)(ii)(D) and
Rule 613(c)(7)(iii)(D) through (E).
---------------------------------------------------------------------------
To reflect terms that have been modified elsewhere in the Rule as
[[Page 45764]]
adopted, the terms ``unique order identifier'' and ``unique
identifier'' in Rule 613(c)(7)(ii) and (iii) have been replaced with
the terms ``CAT-Order-ID'' and ``CAT-Reporter-ID.'' In addition, Rule
613(c)(7)(ii) and (iii) now reflect the new time stamp requirement
contained in Rule 613(d)(3). Specifically, Rules 613(c)(7)(ii)(C) and
613(c)(7)(iii)(C) provide that the time at which an order is routed or
received must be recorded and reported pursuant to Rule 613(d)(3),
rather than simply in milliseconds as proposed. The Commission believes
these conforming changes are appropriate to reflect the revised terms
in the adopted Rule.
vii. Additional Modification, Cancellation, or Execution Data Elements
In addition to the data elements discussed above, proposed Rules
613(c)(7)(iv) and (v) would have required that certain information be
collected and provided specifically to allow regulators to track the
life of an order through modification, cancellation, or execution. The
Commission requested comment as to whether information required under
the Rule as proposed would be sufficient to create a complete and
accurate consolidated audit trail, and asked if any information, in
addition to the data elements proposed, should be included in the
consolidated audit trail relating to modifications, cancellations, or
executions.
In response, one commenter noted that broker-dealer order
management systems may differ in their treatment of order modifications
and cancellations, as some, for example, may capture or report only
modified data elements, and not necessarily all of the elements of a
modified order.\439\ The commenter recommended that the consolidated
audit trail accommodate such differences, and further suggested
requiring only the submission of the order identifier for a cancelled
order, not the order's other data elements.\440\ Another commenter
believed that, ``[a]s in the case of the current OATS system, execution
data provided to the consolidated audit trail should identify where the
trade was publicly reported and have a common identifier that links the
audit trail execution reports for the buy and sell orders to the public
trade report.'' \441\
---------------------------------------------------------------------------
\439\ See SIFMA Drop Copy Letter, p. 4.
\440\ Id.
\441\ See Liquidnet Letter, p. 7.
---------------------------------------------------------------------------
After consideration of the comments regarding the specific audit
trail data required for orders that are modified, cancelled, or
executed, the Commission is adopting Rules 613(c)(7)(iv) and (v)
substantially as proposed, with a modification to require that the NMS
plan include a requirement that the CAT-Order-ID for such orders also
be recorded and reported to the central repository. This modification
is designed to ensure that an order identifier be reported for orders
that have been modified or cancelled. The Commission believes that the
order identifier is a critical piece of information that will
efficiently link an order across markets. Adopted Rules 613(c)(7)(iv)
and (v) will also require that the NMS plan submitted to the Commission
for its consideration require the recording and reporting of the CAT-
Reporter-ID of the broker-dealer or Customer-ID of the person giving
the modification or cancellation instruction to reflect the new
terminology of the adopted Rule. In addition, Rules 613(c)(7)(iv) and
(v) reflect the new time stamp requirement contained in Rule 613(d)(3),
as adopted. Specifically, Rules 613(c)(7)(iv)(C) and 613(c)(7)(v)(C)
provide that the time at which an order is modified, cancelled, or
executed must be recorded and reported pursuant to Rule 613(d)(3),
rather than simply in milliseconds as proposed.
The Commission believes it is necessary to require the NMS plan to
require the information under Rule 613(c)(7)(iv) and (v) for each order
and reportable event because it will assist the Commission and SROs in
identifying all changes made to an order (including an execution) and
those market participants responsible for the changes (or execution).
The Commission believes this information, in combination with the
proposed information pertaining to order receipt or origination, will
provide regulators with a comprehensive view of all material stages and
participants in the life of an order. Among other things, this order
information should help regulators investigate suspicious trading
activity in a more efficient manner than is currently possible.
Regulators will have access to information identifying the customer
behind the order and will also see how a customer's order is handled
across markets. This data also will improve regulators' understanding
of how markets operate and evolve, including with respect to the
development of new trading practices, the reconstruction of atypical or
novel market events, and the implications of new markets or market
rules. In addition, the Commission believes that most of the data
proposed to be recorded and reported by the Rule for order
modification, cancellation, and execution is data that most broker-
dealers already generate in the course of handling an order pursuant to
the existing audit trail requirements of several SROs.\442\
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\442\ See, e.g., FINRA Rule 7440(d); Nasdaq Rule 6950; NYSE Rule
132B.
---------------------------------------------------------------------------
The Commission notes that regulatory staff at an SRO or the
Commission could use execution information required under Rule
613(c)(7)(v), which will be consolidated with the other audit trail
information required under Rule 613 to, for example, detect patterns of
reported and unreported transactions effected by a broker-dealer in a
particular security by comparing the data reported to the central
repository regarding an execution with information reported pursuant to
a transaction reporting plan or the OPRA Plan. Depending on the results
of that analysis, regulators may undertake further inquiry into the
nature of trading by that broker-dealer to determine whether the public
received accurate and timely information regarding executions, and
whether the broker-dealer complied with the trade reporting obligations
contained in SRO rules. Patterns of reported and unreported
transactions by a particular broker-dealer could also be indicia of
market abuse, including the failure to obtain the best execution for
customer orders, or possible market manipulation. Thus, the ability to
compare the consolidated order execution data, including customer
information, with the trades reported to the consolidated tape would be
an important component of an effective market surveillance program that
is not possible today because regulators currently do not have access
to comprehensive cross-market audit trail data, and the process of
identifying customers is very labor intensive, time-consuming, and
error prone.
In response to the commenter that recommended that the consolidated
audit trail accommodate differences in the treatment of modifications
by broker-dealer order management systems (i.e., those that report only
the modified data elements, not the entire order), and suggested that
only an order identifier be reported for a cancellation, not the
cancelled order's other data elements,\443\ the Commission notes that
Rule 613 does not require all of the data elements of a modified order
to be reported to the central repository. The Rule only requires the
NMS plan to require the reporting of the CAT-Order-ID; the date and
time the modification
[[Page 45765]]
is received or originated; the CAT-Reporter ID of the broker-dealer or
the Customer-ID of the person giving the modification instruction; if
modified, the price and remaining size of the order; and any other
changes to the material terms of the order. The adopted Rule also
requires the NMS plan to require the date and time a cancellation is
received or originated and the CAT-Reporter-ID of the broker-dealer, or
Customer-ID of the person, giving the cancellation instruction to be
reported to the central repository. The Commission believes this will
ensure that regulators can determine the market participant or person
responsible for the cancellation of an order,\444\ and the date and
time of the cancellation.
---------------------------------------------------------------------------
\443\ See SIFMA Drop Copy Letter, p. 4.
\444\ See Section III.B.1.iii., supra.
---------------------------------------------------------------------------
In response to the commenter that suggested that the Rule should
require that the execution data be linked with the public trade report
using a common identifier,\445\ the Commission notes that Rule
613(c)(7)(v)(G) requires the NMS plan submitted to the Commission for
its consideration to require that, for an order that has been executed,
the SRO or member that executes the order must report to the central
repository whether the execution was reported pursuant to an effective
transaction reporting plan or OPRA, as applicable. The Commission has
considered the commenter's further suggestion that a common identifier
link the audit trail execution reports for the buy and sell orders to
the public trade report and is not mandating such a requirement under
Rule 613; the Commission believes that Rule 613 and its requirements
provide a sufficient initial framework for collecting audit trail data
that will enhance the ability of regulators to surveil the market for
NMS securities.\446\ Accordingly, the Commission is adopting Rule
613(c)(7)(v)(G), as proposed, which requires that the plan sponsors
include in the NMS plan submitted to the Commission for its
consideration a requirement that the broker-dealer report to the
central repository whether a trade was reported pursuant to an
effective transaction reporting plan or OPRA.
---------------------------------------------------------------------------
\445\ See Liquidnet Letter, p. 7.
\446\ While the Commission is not requiring that execution data
be linked with the public trade report using a common identifier,
the Commission notes that the Rule does not prohibit the SROs from
including a provision in the NMS plan for the establishment of a
common identifier to link the audit trail execution reports for buy
and sell orders to the public trade report.
---------------------------------------------------------------------------
e. Rule 613(c)(3): Information To Be Recorded Contemporaneously With
the Reportable Event and Reported to the Central Repository by 8:00
a.m. Eastern Time on the Trading Day Following the Day Such Information
Has Been Recorded
i. Proposed Rule 613(c)(3)
As proposed, Rule 613(c)(3) would have required the NMS plan to
require each SRO and member to collect and provide to the central
repository, on a ``real time'' basis, key data for each order and each
reportable event, including the origination or receipt of an order, as
well as the routing, cancellation, modification, or execution of the
order.\447\ Specifically, the proposed Rule would have provided that
``[t]he national market system plan submitted pursuant to this section
shall require each national securities exchange, national securities
association, and member to collect and provide to the central
repository the information required by paragraphs (c)(7)(i) through (v)
of this section on a real time basis.'' \448\ In the Proposing Release,
the Commission noted that ``real time'' meant ``immediately and with no
built in delay from when the reportable event occurs.'' \449\
---------------------------------------------------------------------------
\447\ See Rule 613(j)(9) for a definition of ``reportable
event.''
\448\ See proposed Rule 613(c)(3).
\449\ See Proposing Release, supra note 4, at 32572.
---------------------------------------------------------------------------
ii. Comments on Proposed Rule 613(c)(3)
The Commission received a variety of comments about the
achievability of the real-time requirement; the accuracy of audit trail
data that would be collected and provided in real time; the necessity,
merits and usefulness of real-time audit trail data; the costs of real-
time reporting; and the proposed Rule's requirement that all audit
trail data be collected and reported in real time. These comments are
discussed below.
Several commenters believed that reporting data on a real-time
basis was achievable.\450\ Of these comments, one commenter stated that
its current systems could be used to support real-time reporting, and
that real-time reporting may be easier to achieve than intraday or end-
of-day batch processing.\451\ Similarly, another commenter, endorsing
the use of FIX Protocol, stated that FIX Protocol is already widely
used throughout the financial industry, and that ``[a]ll FIX messages
are generated in real time for trading.'' \452\
---------------------------------------------------------------------------
\450\ See Thomson Reuters Letter, p. 3; Aditat Letter, p. 2;
FTEN Letter p. 3; Ameritrade Letter, p. 1 (stating that the
scalability of its systems could support real-time reporting);
Nasdaq Letter II, p. 3 (stating that a platform supported by FTEN
and SMARTS technology would support the real-time provision of
data).
\451\ See Ameritrade Letter, p. 1.
\452\ See Aditat Letter, pp. 1-2. FIX Protocol is a series of
messaging specifications for the electronic communication of trade-
related messages. It has been developed through the collaboration of
banks, broker-dealers, exchanges, industry utilities and
associations, institutional investors, and information technology
providers from around the world. See What is FIX? available at
http://fixprotocol.org/what-is-fix.shtml (last visited on May 7,
2011).
---------------------------------------------------------------------------
A significant number of commenters, however, expressed concern
about the proposed requirement that the audit trail data be collected
and provided to the central repository in real time.\453\ Some of these
commenters focused on the effect a real-time reporting requirement
would have on their systems, and the systems changes that might be
needed to achieve real-time reporting. Specifically, commenters argued
that a real-time collection and provision requirement would require
many industry participants to build entirely new systems or to
undertake significant technological upgrades to comply with a real-time
reporting requirement.\454\ Other commenters stated that real-time
reporting would strain their order handling systems and result in
latencies and delays in the processing of customer orders.\455\
Additionally, one commenter questioned the ability of a real-time
consolidated audit trail system to handle periods of immense volume,
like the volume on May 6, 2010.\456\
---------------------------------------------------------------------------
\453\ See Scottrade Letter, p. 1; ICI Letter, pp. 4-6; FINRA/
NYSE Euronext Letter, p. 4; GETCO Letter, p. 2; BATS Letter, pp. 1-
2; SIFMA Letter, pp. 3-8; SIFMA February 2012 Letter, p. 1; CBOE
Letter, pp. 4-5; Direct Edge Letter, p. 3; FINRA Letter, pp. 10-13;
Wells Fargo Letter, p. 3; Knight Letter, pp. 2-3; Leuchtkafer
Letter; Broadridge Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy
Letter, p. 1; Ross Letter, p. 1; FINRA Proposal Letter, p. 3; FIA
Letter, pp. 1-2.
\454\ See Scottrade Letter, pp. 1-2; ICI Letter, pp. 4-5; SIFMA
Letter, pp. 4-5; Knight Letter, p. 2. See also BATS Letter, p. 2;
Broadridge Letter, p. 3; FIF Letter, p. 4; GETCO Letter, pp. 3-4;
CBOE Letter, p. 4; FIA Letter, p. 2. In particular, FIA noted its
belief that ``real-time reporting accounts for a significant portion
of the considerable costs associated with the CAT.'' See FIA Letter,
p. 2.
\455\ See FINRA/NYSE Euronext Letter, p. 5; FINRA Letter, p. 13;
SIFMA Letter, p. 5; CBOE Letter, p. 4 (stating that, ``given the
increased speed of order submission, quote changes, and order
cancellation, modifications and executions, a real time submission
requirement could strain the systems capacities and computer
resources of SROs and many member firms'').
\456\ See FINRA Letter, p. 13. See also Berkeley Letter, p. 2
(noting the ``peta-scale'' problem of collecting audit trail data
generally).
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Other commenters who expressed concern about the real-time
reporting requirement questioned the accuracy of data that would be
reported in real
[[Page 45766]]
time.\457\ One commenter, for example, noted that there would not be an
opportunity for data validation if consolidated audit trail data were
required to be reported in real time.\458\ Another commenter stated
that the real-time processing required by real-time reporting would
create data integrity issues and, thus, lead to poorer data quality as
compared to an approach with a more liberal timeframe, such as next
day, or ``T+1,'' reporting.\459\ FINRA similarly commented that the
data integrity issues that arise when audit trail data is provided on a
T+1 basis would be exacerbated by a real-time system.\460\ FINRA stated
that it performs over 40 billion data validations of order events
submitted through OATS every day, and requires its members to repair
rejected OATS data.\461\
---------------------------------------------------------------------------
\457\ See FINRA/NYSE Euronext Letter, p. 5-6; Knight Letter, p.
2-3; CBOE Letter, p. 4; Wells Fargo Letter, p. 3; FINRA Letter, p.
11-12; SIFMA Letter, p. 5; Direct Edge Letter, p. 3; FIA Letter, p.
2.
\458\ See FINRA/NYSE Euronext Letter, p. 5-6 (noting that
``drawing conclusions based solely on real time data increases the
potential for inaccuracy because the data has not gone through the
full range of validations * * * .''). See also Wells Fargo Letter,
p. 3 (``[A]ccurate market information often does not happen in real
time.''); FINRA Letter, p. 11-12 (stating that current order-
handling practices make ``accurate real time order reporting
problematic, and automated surveillance is only useful if the
underlying data is accurate and complete * * * .''); SIFMA Letter,
p. 5 (``There also would be data integrity costs in the form of less
reliable data, or data that would have to be revised or resubmitted
where it otherwise may not have been required if firms had a short
window of time to more thoroughly `scrub' or validate their
submissions.''); Direct Edge Letter, p. 3 (``Real-time data may be
less reliable than information collected after the validations that
come with settling a transaction.'').
\459\ See Knight Letter, p. 2-3. See also CBOE Letter, p. 4
(``[G]enerally our belief is that next day (T+1) data, which
incorporates additional information such as cleared trade data, is a
better report resource for generating surveillance and compliance
reviews.''); FINRA/NYSE Euronext Letter, p. 6 (stating that, ``from
a market surveillance standpoint, reliable and complete data
received on a T+1 basis * * * is generally superior to unvalidated
real-time data''); FIA Letter, p. 2 (``We believe the Commission's
Proposal overvalues any potential benefits achieved by real-time
reporting as compared to reporting on day after trade, or `T+1,'
basis.'').
\460\ See FINRA Letter, p. 11-12.
\461\ Id. at p. 11.
---------------------------------------------------------------------------
A number of commenters discussed whether a real-time reporting
requirement is necessary. One commenter stressed that the real-time
availability of data would facilitate the identification of cross-
market events and their origins.\462\ This commenter explained that a
platform developed using FTEN and SMARTS technology would include real-
time risk management and surveillance capabilities.\463\ However, most
commenters did not believe that real-time data typically would be
useful to the Commission and SROs.\464\ One commenter explained that
using audit trail data before having an opportunity to validate it
``may result in a severely distorted picture of trading and interfere
with effective oversight.'' \465\ Another commenter stated that ``real-
time order information is inherently incomplete and could even be
inaccurate and therefore misleading to the users of the data.'' \466\
Some commenters were of the view that the Commission had significantly
overvalued the regulatory benefit of real-time data.\467\ One of these
commenters noted that, ``[b]ased on its experience in conducting
surveillance, [it] does not believe that it is essential that all of
the information proposed to be captured in the CAT be received real
time or near-real-time.'' \468\ A commenter suggested that, to the
extent any information had to be submitted in real time, it should be
limited to data related to certain key events, such as order receipt
and origination, order transmittal, execution, modification, and
cancellation.\469\ Other commenters generally questioned the value of
real-time audit trail data, arguing that regulators would still need to
rely on traditional investigative techniques, such as taking testimony,
to establish securities law violations.\470\ Another commenter believed
that ``[m]any potential uses for the data, including enforcement
inquiries probing market behavior, may require either multiple days'
worth of data, or data from other markets that is not available on a
real-time basis,'' limiting the ability to use such real-time data
provided by the consolidated audit trail.\471\
---------------------------------------------------------------------------
\462\ See Nasdaq Letter I, p. 9-10.
\463\ See Nasdaq Letter II, p. 3.
\464\ See ICI Letter, p. 5; Leuchtkafer Letter; GETCO Letter, p.
2; FIA Letter, p. 2; Scottrade Letter, p. 2; BATS Letter, p. 2;
Angel Letter, p. 3; Broadridge Letter, p. 3; CBOE Letter, p. 4;
FINRA/NYSE Euronext Letter, p. 4, 6; FINRA Letter, p. 11; SIFMA
Letter, p. 3, 7; SIFMA Drop Copy Letter, p. 1; FINRA Proposal
Letter, p. 4, 10-11.
\465\ See FINRA Letter, p. 11.
\466\ See SIFMA February 2012 Letter, p. 1.
\467\ See FINRA/NYSE Euronext Letter, p. 4; FINRA Letter, p. 11;
FIA Letter, p. 2.
\468\ See FINRA Proposal Letter, p. 4.
\469\ See SIFMA Drop Copy Letter, p. 1-2. See also FINRA
Proposal Letter, p. 10.
\470\ See GETCO Letter, p. 2; BATS Letter, p. 2.
\471\ See FIA Letter, p. 2.
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Some commenters questioned whether the substantial costs that would
be associated with providing the data on a real-time basis would
outweigh the benefits.\472\ One commenter believed that ``the SEC has
significantly overestimated the incremental utility of real-time data
over data received on a T+1 basis'' and that ``the costs associated
with the breadth of real-time reporting proposed by the Commission
would be significant and far outweigh the minimal regulatory benefit
gained by such a reporting system.'' \473\
---------------------------------------------------------------------------
\472\ See Scottrade Letter, p. 1-2; FINRA/NYSE Euronext Letter,
p. 4; GETCO Letter, p. 2; BATS Letter, p. 2; SIFMA Letter, p. 3-8;
SIFMA February 2012 Letter, p. 1; CBOE Letter, p. 4; FINRA Letter,
p. 11-13; Wells Fargo Letter, p. 3; FIA Letter, p. 2.
\473\ See FINRA/NYSE Euronext Letter, p. 4. Similarly, FINRA
believes '' the SEC has significantly overvalued the regulatory
benefits to be achieved * * * while underestimating some of the
problems with relying on real-time data. This is true not only
because certain information is difficult, if not impossible, to
provide on a real-time basis, but also because real-time data is
less reliable.'' See FINRA Letter, p. 10-11. See also SIFMA February
2012 Letter, p. 1 (stating, ``[a]ny potential incremental benefit of
receiving this information on a real-time basis is, in our view,
substantially outweighed by the additional expense and
implementation delays associated with building and maintaining a
real-time system''); FIA Letter, p. 2 (``It is not apparent to us
from the Proposal that the additional costs associated with a real-
time audit trail, compared to a T+1 audit trail, would be offset by
any incremental benefits to the Commission.'').
---------------------------------------------------------------------------
Some commenters who questioned the value of the real-time reporting
requirement also suggested that the Commission consider a different
timeframe for the reporting of audit trail information. Several
commenters, for example, suggested a later timeframe for reporting
audit trail data to the central repository. One commenter, an exchange,
stated that ``[o]ur strong preference would be for submission of
information to the central repository through a batch process after the
close of the trading day involved.'' \474\ Another commenter suggested
a compromise whereby broker-dealers would be subject to next day (or
later) reporting requirements, while the SROs could leverage their
existing real-time monitoring tools and provide real-time trading
information for use in the consolidated audit trail.\475\ Several
commenters recommended that the Commission permit end-of-day
reporting.\476\ One commenter noted that end-of-day reporting would
alleviate some of the practical challenges firms would face with a
requirement to identify beneficial owners on a real-time basis.\477\
Another commenter suggested that a reporting deadline of 10-15 minutes
would be substantially more workable than a ``real-time'' reporting
requirement.\478\ Finally, one commenter
[[Page 45767]]
suggested that broker-dealers and SROs should retain audit trail
information, and submit it only upon regulatory request, so that the
central repository would only collect data needed for investigations or
surveillance purposes.\479\
---------------------------------------------------------------------------
\474\ See CBOE Letter, p. 4.
\475\ See SIFMA Letter, p. 3; see also SIFMA February 2012
Letter, p. 1 (questioning the regulatory need for real-time data
versus data provided on an ``end-of-day or `T+1'' basis); FIA
Letter, p. 2.
\476\ See Scottrade Letter, p. 2; ICI Letter, p. 5; BATS Letter,
p. 2; Angel Letter, p. 3; Broadridge Letter, p. 3.
\477\ See ICI Letter, p. 6.
\478\ See SIFMA Drop Copy Letter, p. 1. The commenter stated
that ``implementation options and complexity are significantly
different if the reporting regime is within `minutes' rather than
`seconds.' If real-time reporting is required in seconds, then
significant re-engineering is required within broker-dealer order
management systems and trading systems to support such a requirement
(e.g., passing additional information between systems, performance
tuning to compensate for additional processing of payload). Instead,
if the definition of real-time allows for reporting within minutes
(e.g., 10-15 minutes) of the events, it would be substantially less
intrusive on order management systems and may allow for greater
flexibility in designing reporting systems architecture and more
standardized content for events such as order modifications, as
described below. Also, as with prior implementations of new trade
reporting regimes in the U.S. (e.g., ACT and TRACE), having more
liberal reporting timeframes for an appropriate initial period
(e.g., 12 months or more) to provide a sufficient period to optimize
processes would be very helpful.'' This commenter also questioned
``the need for real-time reporting of the entire set of data
elements in the CAT proposal,'' and believed that ``reporting on a
T+1 (or in some cases later) basis should satisfy the SEC's stated
regulatory objectives more efficiently.'' Id. See also Nasdaq Letter
II, p. 3 (stating its proposed platform could support the provision
of data in real time or within 10-15 minutes using drop copies).
\479\ See GETCO Letter, p. 4. The commenter also believed this
approach would lower the costs of the consolidated audit trail.
---------------------------------------------------------------------------
One commenter, who did not specifically advocate either real time
or reporting on an end-of-day basis, supported a requirement that all
trades be reported in a standardized format that will be accessible to
the SEC at the end of each trading day.\480\
---------------------------------------------------------------------------
\480\ See Bean Letter, p. 1.
---------------------------------------------------------------------------
Some commenters suggested alternative means of collecting audit
trail information, assuming such audit trail data would not be on a
real-time basis and would not be through the reporting regime set forth
by Rule 613. For example, one commenter suggested the Commission
consider ``a consolidation'' of [OATS] and [COATS], audit trails that
are produced on a T+1 basis; and a review of the prospect of extracting
specific real-time data from surveillance reports currently used by
SROs to perform post trade analysis, such as the Large Option Position
Report * * * and large trader reports, to obtain real-time risk
information that may impact a particular NMS issue or the market in
general.'' \481\ This commenter believed that a requirement of real-
time reporting should be considered only after other available sources
of data have been carefully reviewed, and only to the extent that such
a requirement is both necessary and economically feasible.\482\ Another
commenter, however, urged the Commission not to ``lower its
expectations for the CAT and accept a more limited audit trail based
exclusively on existing systems.'' \483\ One commenter suggested that
the Commission consider a ``hybrid'' approach that would enhance
elements of the quotation and transaction information reported in real
time, while collecting and reporting more specific order information on
a T+1 basis or later.\484\
---------------------------------------------------------------------------
\481\ See BOX Letter, p. 2.
\482\ Id. at p. 3.
\483\ See Nasdaq Letter II, p. 2.
\484\ See FINRA/NYSE Euronext Letter, p. 6. This commenter
stated that ``[a]n alternative to the all-encompassing real time
order audit trail set forth in the Proposal would be to standardize
and consolidate existing real time reporting systems (e.g.,
enhancing trade reporting and quotation systems with standardized
and uniform identification for all broker-dealers) and enhance
existing reporting requirements where the need is narrowly
focused.'' See also FINRA Proposal Letter, p. 3-4, 10-11.
---------------------------------------------------------------------------
Two commenters commented on the meaning of ``real time.'' \485\ One
commenter noted that ``[our members] request clarification on the
definition of real-time data submission as it relates to each data
element required by CAT. The granularity/definition of real-time for
each element will have a major impact on SROs, their members and CAT
system development from both a data quality and database design
perspective . * * *'' \486\ The other commenter noted that the ``[t]he
term `real time' is used throughout the document, but never defined.
(There are several distinct meanings in the computer industry.)'' \487\
---------------------------------------------------------------------------
\485\ See FIF Letter, p. 4; Ross Letter, p. 1.
\486\ See FIF Letter, p. 4.
\487\ See Ross Letter, p. 1.
---------------------------------------------------------------------------
The Commission also received comments specifically relating to the
cost of reporting the audit trail information in real time under the
Rule as proposed. One commenter believed it would cost $1.25 million in
initial costs to comply with the Rule as proposed.\488\ The commenter
divided its $1.25 million estimate into development costs of $750,000
and hardware costs of $500,000 (including hardware, circuits,
etc.).\489\ In addition, this commenter believed the development
timeframe would be 9-12 months ``once final architecture is drafted,''
and would require approximately 6,000 hours of development work.\490\
Notably, this commenter said that ``[t]he assumptions that drove this
analysis were that any real time reporting of order events would
leverage the capabilities contained within the [OATS] reporting today
and that the revised real time system would retire the legacy systems
of Bluesheets, OATS, OTS and TRACE.'' \491\ With respect to ongoing
costs to provide information, this commenter also stated that it
believed the Commission had underestimated the ongoing costs of the
proposal.\492\ However, another commenter, who opined that the goals of
the consolidated audit trail could be achieved for significantly lower
costs than the Commission originally estimated, stated that, if the
Rule permitted market participants to modify existing systems for
collecting and reporting audit trail information, the consolidated
audit trail objectives could ``be achieved and perhaps even
surpassed.'' \493\
---------------------------------------------------------------------------
\488\ See Ameritrade Letter, p. 2.
\489\ Id.
\490\ Id.
\491\ Id.
\492\ Id.
\493\ See Thomson Reuters Letter, p. 2.
---------------------------------------------------------------------------
iii. Adopted Rule 613(c)(3)
As described in detail below, the Commission is adopting Rule 613
with two significant modifications to the proposed requirement that the
NMS plan submitted to the Commission for its consideration require the
collection and provision of key audit trail data to the central
repository on a ``real time'' basis. First, the Rule, as adopted, no
longer requires the real-time reporting of consolidated audit trail
data but, instead, provides that order event audit trail data must be
reported ``by 8:00 a.m. Eastern Time on the trading day following the
day such information has been recorded by the national securities
exchange, national securities association or member.'' \494\ Second,
the adopted Rule clarifies that this data is to be recorded
``contemporaneously with the reportable event,'' instead of in ``real
time.'' \495\
---------------------------------------------------------------------------
\494\ See Rule 613(c)(3). The Rule further provides that the NMS
plan ``may accommodate voluntary reporting prior to 8:00 a.m.
Eastern Time, but shall not impose an earlier reporting deadline on
the reporting parties.'' Id.
\495\ Id.
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(A) Reporting of Audit Trail Data by 8:00 a.m. Eastern Time on the
Trading Day Following the Day Such Information Has Been Recorded
The Commission has considered the commenters' concerns regarding a
``real-time'' reporting requirement for audit trail data, including its
achievability and cost effectiveness; the accuracy of audit trail data
recorded and reported in real time; and the necessity, merits, and
usefulness of real-time audit trail data.\496\
---------------------------------------------------------------------------
\496\ See Scottrade Letter, p. 1-2; Angel Letter, p. 3; ICI
Letter, p. 3-6; FINRA/NYSE Euronext Letter, p. 4, 6; GETCO Letter,
p. 2; BATS Letter, p. 1-2; SIFMA Letter, p. 3-8; CBOE Letter, p. 4-
5; Direct Edge Letter, p. 3; FINRA Letter, p. 10-13; Wells Fargo
Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter; Broadridge
Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy Letter, p. 1; Ross
Letter, p. 1; FINRA Proposal Letter, p. 3; Nasdaq Letter II, p. 3-4;
FIA Letter, p. 1-2.
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[[Page 45768]]
On the one hand, the Commission recognizes that there may be very
considerable costs imposed on the industry if audit trail data was
required to be reported to the central repository in real time--indeed,
the Commission, in the Proposing Release, estimated the costs of
creating a real-time consolidated audit trail by assuming that such a
requirement would necessitate the wholesale creation of new industry-
wide systems. On the other hand, the Commission also received a variety
of comments suggesting that real-time reporting could be achieved in a
cost-effective manner.\497\ And yet other commenters suggested a hybrid
approach. For example, SIFMA commented that, although it believed real-
time reporting as originally proposed by the Commission would be too
costly, intra-day reporting of a subset of audit data delayed 10-15
minutes would be possible. SIFMA further described how such reporting
might be accomplished through the use of ``drop-copy'' data.\498\
---------------------------------------------------------------------------
\497\ See Thomson Reuters Letter, p. 3; Aditat Letter, p. 2;
FTEN Letter p. 3; Ameritrade Letter, p. 1 (stating that the
scalability of its systems could support real-time reporting);
Nasdaq Letter II, p. 3 (stating that a platform supported by FTEN
and SMARTS technology would support the real-time provision of
data).
\498\ See SIFMA Drop Copy Letter.
---------------------------------------------------------------------------
With respect to concerns about the accuracy of consolidated audit
trail data if real-time reporting were required, the Commission
recognizes that the real-time reporting of data could result in
accuracy issues to the extent SROs and broker-dealers would need to re-
enter the required audit trail data into a separately prepared
regulatory report containing the required audit trail data for
submission to the central repository, as is the case today with OATS
reports.\499\ The Commission notes, however, that the use of certain
existing technologies, such as ``drop copies'' described by SIFMA,
could provide reliable and accurate audit trail data to the central
repository because such ``drop copies'' would reflect the information
captured by an SRO or member's order management and execution systems
to enter, route, modify, and execute or cancel orders.
---------------------------------------------------------------------------
\499\ See Section II.A.1.c., supra.
---------------------------------------------------------------------------
The Commission believes that, whether or not real-time reporting of
data is required, the creation, implementation, and maintenance of a
consolidated audit trail will likely be a complex and significant
undertaking for the industry. It therefore recognizes the practical
advantages of a more incremental, or more gradual, approach to such an
undertaking. After considering the many comments received on the use of
real-time data by regulators, the Commission has recognized that,
although there might be some additional benefits to receiving data and
monitoring the markets intra-day (such as for certain enforcement
investigations and the facilitation of real-time cross-market
surveillance), the majority of the regulatory benefits gained from the
creation of an industry-wide consolidated audit trail, as described in
the Proposing Release, do not require real-time reporting. Indeed, the
extent of the potential uses of a consolidated audit trail discussed in
Section II.A.2., supra, which do not rely on a real-time reporting
requirement, illustrate the value of a consolidated audit trail even if
data is not reported in real-time. Instead, the Rule, as adopted,
provides that the NMS plan must require that order event data be
reported ``by 8:00 a.m. Eastern Time of the trading day following the
day such information has been recorded by the national securities
exchange, national securities association or member.'' \500\
---------------------------------------------------------------------------
\500\ See Rule 613(c)(3). The Commission notes that Rule 613, as
proposed, was inconsistent in its use of the terms ``provide'' and
``report.'' To eliminate this inconsistency, the Commission is
replacing all uses of ``provide'' with ``report,'' which the
Commission believes more accurately describes the requirement the
Commission is imposing on national securities exchanges, national
securities associations, and members.
---------------------------------------------------------------------------
The Commission notes that, while the Rule provides that the NMS
plan must impose a reporting deadline of 8:00 a.m. Eastern Time of the
trading day following the day such information has been recorded by the
national securities exchange, national securities association or
member, the Rule also provides that the NMS plan may accommodate SROs
and members that voluntarily satisfy their reporting obligations
earlier.\501\
---------------------------------------------------------------------------
\501\ See note 494, supra.
---------------------------------------------------------------------------
The Commission acknowledges that, by replacing the requirement that
the SROs develop a plan for real-time reporting with a requirement for
reporting by 8:00 a.m. the next trading day, the Commission has
precluded the possibility that, as some commenters suggested, a
mandatory real-time reporting NMS plan might be developed by the SROs
for consideration by the Commission and the public.\502\ However, given
the overall scope and complexity of creating a consolidated audit
trail, the Commission has determined that it would be more beneficial
to have the SROs and their members focus on those key aspects of a
consolidated audit trail that the Commission believes would be the most
useful for improving regulatory oversight and monitoring (including,
but not limited to, the use of unique customer identifiers, the ability
to accurately link an order across its lifecycle, the inclusion of
market making quotes, and the addition of options data), rather than
focus on how to develop an NMS plan for real-time reporting that may
not yield benefits that are equally as useful.\503\ The Commission also
believes that, as a consequence of this modification, the Rule, as
adopted with the 8:00 a.m. reporting deadline, will more readily
accommodate a consolidated audit trail that could build upon existing
audit trail infrastructures. Meeting the requirement of the Rule may no
longer necessitate the creation of completely new infrastructures. In
particular, the Commission notes that the OATS technical specifications
require OATS data to be reported by 8:00 a.m. the following calendar
day.\504\ Thus, the Rule, as adopted, would permit the SROs to submit
an NMS plan to the Commission for its consideration with reporting
timeframes comparable to OATS' requirement, with which all FINRA
members are presently capable of complying.\505\ As a result, broker-
dealers might need to make fewer systems changes to comply with the
[[Page 45769]]
Rule than they would have had to make if real-time reporting were
required, though, as discussed in Section II.C.4., supra, OATS in its
present form would still need to be modified to meet certain of the
other requirements of this Rule.\506\ Nevertheless, as suggested by
many commenters, fewer systems changes to comply with the Rule should
lead to lower costs incurred by broker-dealers.\507\
---------------------------------------------------------------------------
\502\ See note 453, supra, and accompanying text.
\503\ The Commission notes that, consistent with adopting an
incremental approach to the creation of a consolidated audit trail,
even though it is not requiring audit-trail data to be reported in
real time, it is adding various additional requirements, discussed
in Section III.C.2.a., infra, to the Rule regarding the evolution of
the consolidated audit trail, including the possibility for reduced
reporting times in the future as technologies evolve.
\504\ The current OATS technical specifications require OATS
reporting by 8:00 a.m. on the calendar day after the reportable
event. The Commission notes that the FINRA rules for OATS reporting,
however, require that data ``shall be transmitted on the day such
event occurred''--unless information required by FINRA Rule 7440(b),
(c), or (d) (order receipt and origination; order transmittal; order
modifications, cancellations, and executions) is unavailable--in
such cases, OATS requires reporting on the day the information
becomes available. See FINRA Rule 7450(b)(2). Because of the
discrepancy between the technical specifications and the applicable
FINRA rule, the Commission approved FINRA's proposed rule change to
allow OATS reporting as late as 8:00 a.m. the next day. See
Securities Exchange Act Release No. 66021 (December 21, 2011), 76 FR
81551 (December 28, 2011).
\505\ The Commission notes that the Rule, as adopted, provides
that an NMS plan must require information to be reported by 8:00
a.m. the following trading day, while OATS requires information to
be reported by 8:00 a.m. the following calendar day. Thus, the Rule
as adopted provides for a longer reporting period than does OATS
with respect to weekends and holidays.
\506\ As noted in the Proposing Release, supra note 4, at 32592,
broker-dealers that rely mostly on their own internal order routing
and execution management systems would have needed to make changes
to or replace those systems to collect and report the required order
and reportable event information to the central repository to comply
with the proposed Rule.
\507\ See e.g., BATS Letter, p. 2; CBOE Letter, p. 2-3; Wells
Fargo Letter, p. 2; Knight Letter, p. 3; High Speed, p. 1; FTEN
Letter p. 1; Correlix Letter, p. 2; Thomson Reuters Letter, p. 2;
FINRA Proposal Letter, p. 16; FINRA/NYSE Euronext Letter, p. 7.
---------------------------------------------------------------------------
An additional consequence of the Commission's decision not to
require real-time reporting is that, since meeting the requirements of
the Rule may no longer necessitate the wholesale creation of new
systems, the Commission's proposed cost estimates, which were based on
this assumption, may no longer be applicable. As discussed in Section
II.C.2., supra, the Commission believes that given the many different
ways in which the SROs may develop an NMS plan that meets an 8:00 a.m.
reporting requirement, the costs of such reporting will be highly
dependent on the details of the specific plan proposed. The Rule, as
adopted, therefore directs the SROs to provide these details, along
with associated costs, in the NMS plan submitted to the Commission for
the Commission and the public to consider. The Commission will be able
to consider this information when determining whether to approve the
NMS plan submitted.
(B) Recording of Audit Trail Data Contemporaneously With the Reportable
Event
As noted above, the Rule as proposed would have required SROs and
their members to ``collect'' audit trail data ``on a real time basis.''
In response to commenters who commented on the meaning of ``real
time,'' the Commission is adopting this provision with modifications
from the proposed Rule. Specifically, Rule 613(c)(3), as adopted,
requires that ``[t]he national market system plan submitted pursuant to
this section shall require each national securities exchange, national
securities association, and member to record the information required
by paragraphs (c)(7)(i) through (v) of this section contemporaneously
with the reportable event.''
The Commission believes that the term ``contemporaneously'' better
reflects its intent, as noted in the Proposing Release, that
information should be collected immediately and with no built-in delay
from when the reportable event occurs. While, in response to
commenters, the Commission is no longer requiring the real-time
reporting of information, the Commission believes it is important for
SROs and broker-dealers to ``record'' the events contemporaneously. The
Commission expects that compliance with this requirement will not be
difficult for SROs and broker-dealers with automated systems, which
will contain much, if not all, of the data to be reported to the
central repository as a result of processing and saving a record of any
actions taken by the SRO or broker-dealer. On the other hand, broker-
dealers that do not use automated systems will have to ensure that
reportable events are manually recorded as they are occurring. In
addition, the adopted Rule uses the term ``record'' in Rule 613(c)(3),
instead of the proposed term ``collect,'' because the Commission
believes that term more accurately reflects its intent that a
contemporaneous record be made when an order event occurs.
f. More Flexible Format for Reporting Consolidated Audit Trail Data to
the Central Repository
In the Proposing Release, the Commission expressed its preliminary
view that data would need to be collected and provided by SROs and
their members to the central repository in a uniform electronic format
to assure regulators that they will have ready access to comparable
cross-market data.\508\ Specifically, Rule 613(c)(2), as proposed,
provided that ``[t]he national market system plan submitted pursuant to
this section shall require each national securities exchange, national
securities association, and member to collect and provide to the
central repository the information required by paragraph (c)(7) of this
section in a uniform electronic format.''
---------------------------------------------------------------------------
\508\ See Proposing Release, supra note 4, at 32572.
---------------------------------------------------------------------------
However, the Commission received comments suggesting that audit
trail data does not necessarily need to be provided by SROs and their
members to the central repository in a uniform electronic format, and
that such data instead could be converted automatically into a uniform
format by the central repository or a third party using existing
technology, which could result in lower cost for the securities
industry than originally estimated.\509\ Specifically, two commenters
indicated that technology exists today to convert or ``normalize'' data
that may be produced from disparate systems into a uniform format and
that, as a result, implementation of the consolidated audit trail could
be simpler and less costly than originally contemplated by the
Commission.\510\ One of these commenters stated that a number of risk
management services and surveillance systems currently receive
automatically-generated copies, or ``drop copies,'' of order and
execution messages, in real time, from a variety of broker-dealers and
exchanges, and convert that information into a common standard
format.\511\ Two other commenters suggested that firms that currently
use FIX should be allowed to continue utilizing FIX,\512\ stating that
FIX's prevalence in the financial industry would make it cheaper and
easier to use FIX as the protocol of the consolidated audit trail.\513\
Another commenter stated it could collect information directly from
exchanges and other sources of information to minimize reporting
obligations, and could leverage its own technology to get information
directly from exchanges.\514\
---------------------------------------------------------------------------
\509\ See FTEN Letter, p. 3-4, 13-15; Thomson Reuters Letter, p.
2-3.
\510\ Id.
\511\ See FTEN Letter, p. 4, 12, 14. See also SIFMA Drop Copy
Letter.
\512\ See FIX Letter, p. 1; Aditat Letter, p. 2.
\513\ Id.
\514\ See Nasdaq Letter II, p. 3.
---------------------------------------------------------------------------
In response to these comments, the Commission has modified this
aspect of the proposed Rule. Specifically, adopted Rule 613(c)(2)
allows the NMS plan to provide that SROs and their members can report
data either ``in a uniform electronic format'' or ``in a manner that
would allow the central repository to convert the data to a uniform
electronic format, for consolidation and storage.'' \515\ In light of
the comments that data from multiple sources could be converted into a
uniform format,\516\ this modification provides SROs with the
flexibility, in devising the NMS plan, to better accommodate a range of
proposals, including those based on leveraging technology in a cost-
effective manner by permitting data to be converted to a uniform
electronic format at the broker-dealer level or at the central
repository. The Commission does not believe this change will reduce the
accuracy or accessibility of the audit trail data provided to
regulators (since
[[Page 45770]]
the Rule still requires data to ultimately be provided to regulators in
a uniform electronic format).
---------------------------------------------------------------------------
\515\ See Rule 613(c)(2).
\516\ See FTEN Letter, p. 3-4, 13; Thomson Reuters Letter, p. 2-
3. See also SIFMA Drop Copy Letter.
---------------------------------------------------------------------------
Further, by providing the SROs the ability to use a number of
approaches to normalization, broker-dealers and SROs may not need to
make substantial changes to their order management and execution
systems to comply with Rule 613; instead, the central repository or the
broker-dealers could convert such data into a uniform electronic
format, and the Rule now provides the plan sponsors with the
flexibility to use this approach in the NMS plan submitted to the
Commission for its consideration. The Commission believes that, to the
extent it avoids requiring broker-dealers and SROs to make substantial
changes to their order management and execution systems to comply with
Rule 613 regarding a uniform electronic format, this type of approach
could be a more efficient and cost-effective method for collecting the
specified audit trail data required by the Rule.\517\ The Commission
expects that the NMS plan submitted for its consideration will specify
how any normalization approach that might be included in the plan will
lead to accurate and reliable data.\518\
---------------------------------------------------------------------------
\517\ The Commission believes that, if the NMS plan does not
require data to be reported to the central repository in a uniform
format, broker-dealers and SROs may not have to make substantial
changes to their order management and execution systems to comply
with Rule 613, and thus may face lower costs than if data were
required to be reported in a uniform format because in that
instance, broker-dealers may need to make substantial changes to
their order management and execution systems to comply with Rule
613. The Commission acknowledges, however, that there would be costs
to convert data to a ``uniform electronic format for consolidation
and storage.'' On balance, however, the Commission preliminarily
believes that broker-dealers might benefit from economies of scale
when normalizing data.
\518\ See Rule 613(a)(1)(iii).
---------------------------------------------------------------------------
g. Timeframe for Reporting Other Data Elements to the Central
Repository
i. Proposed Rule 613(c)(4)
While most order and execution information would have been required
to be reported to the central repository on a real-time basis under the
proposed Rule, the Commission also recognized that not all information
required to be reported to the consolidated audit trail would be
available to the SROs and their members in real time.\519\ In general,
the audit trail data required under this timeframe reflected
information not typically available until later in the order handling
and execution process. This information that would have been provided
on an extended timeframe included: (1) The account number for any
subaccounts to which the execution is allocated (in whole or part); (2)
the unique identifier of the clearing broker or prime broker (if
applicable); (3) the unique order identifier of any contra-side
order(s); (4) special settlement terms (if applicable); (5) the short
sale borrow information and identifier; (6) the amount of a commission,
if any, paid by the customer and the unique identifier of the broker-
dealer(s) to whom the commission is paid; and (7) the cancelled trade
indicator (if applicable) (collectively, ``supplemental audit trail
data'').\520\ Proposed Rule 613(c)(4) would have permitted the
supplemental audit trail data to be reported to the central repository
promptly after the national securities exchange, national securities
association, or member received the information, but in no instance
later than midnight of the day that the reportable event occurs or the
SRO or member receives such information.
---------------------------------------------------------------------------
\519\ See Proposing Release, supra note 4, at 32578.
\520\ See proposed Rule 613(c)(4), 613(c)(7)(vi) through (vii).
---------------------------------------------------------------------------
The Commission solicited comments on proposed Rule 613(c)(4) and
its requirement that certain audit trail information not available in
real time be reported promptly after the national securities exchange,
national securities association, or member received the information,
but in no instance later than midnight of the day that the reportable
event occurs or the SRO or member receives such information. One
commenter believed that the timeframe for reporting the specific
consolidated audit trail data listed above should be lengthened to T+1
or later.\521\ This commenter was concerned that requiring broker-
dealers to report certain data elements by midnight could disrupt the
trading of certain products.
---------------------------------------------------------------------------
\521\ See SIFMA Letter, p. 8; SIFMA Drop Copy Letter, p. 1.
---------------------------------------------------------------------------
ii. Adopted Rule 613(c)(4)
After considering the commenter's views on proposed Rule 613(c)(4),
the Commission is adopting the Rule with three modifications from the
proposed Rule. First, to parallel the 8:00 a.m. deadline by which order
event data must be reported to the central repository under adopted
Rule 613(c)(3), adopted Rule 613(c)(4) requires that the NMS plan
provide that supplemental audit trail data be reported by 8:00 a.m.
Eastern Time on the trading day following the day the member receives
the audit trail data, and provides that the plan may accommodate
voluntary reporting prior to 8:00 a.m. Eastern Time, but shall not
impose an earlier reporting deadline on the reporting parties.
Second, the adopted Rule no longer requires the reporting of (1)
special settlement terms, (2) the amount of commission, if any, paid by
the customer, and the unique identifier of the broker-dealer to whom
the commission is paid, and (3) the short sale borrow information and
identifier. Third, adopted Rule 613(c)(4) requires that the NMS plan
provide for the reporting of certain customer identification and
customer account information by 8:00 a.m. Eastern Time on the trading
day following the day the member receives such data, instead of in
``real time,'' as proposed.\522\ These modifications are discussed in
more detail below.
---------------------------------------------------------------------------
\522\ See Rule 613(c)(7)(viii).
---------------------------------------------------------------------------
(A) Reporting Timeframe
In response to the comments regarding the timing for reporting of
consolidated audit trail data elements,\523\ the Commission is adopting
Rule 613(c)(4) with modifications to the timeframe for reporting
supplemental audit trail data. Specifically, the Rule no longer
requires that supplemental audit trail data be reported ``promptly''
after the broker-dealer receives the information but no later than
midnight of the day that the reportable event occurred; rather, adopted
Rule 613(c)(4) requires the NMS plan to provide that supplemental audit
trail data be reported by 8:00 a.m. Eastern Time on the trading day
following the day the broker-dealer receives such information. Although
the NMS plan may permit broker-dealers to report such information prior
to that time, it may not require such earlier reporting. The Commission
believes it is appropriate that there be an extended timeframe for
reporting this data because this information (e.g., allocation to
subaccounts) might not be available until later in the order handling
and execution process and, on balance, the Commission does not believe
it is necessary that it be reported to the central repository
``promptly''. Instead, the modification to Rule 613(c)(4), as proposed,
now requires that the NMS plan provide that the supplemental audit
trail data be reported by 8:00 a.m. Eastern Time following the day the
member receives the information, which parallels the adopted Rule
613(c)(3) timeframe for reporting event data. The Commission believes
this more flexible standard should reduce implementation burdens and
simplify the requirements of adopted Rule 613, without materially
[[Page 45771]]
reducing the utility of the consolidated audit trail.
---------------------------------------------------------------------------
\523\ See Section III.B.1.g.i., supra.
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The Commission notes that it has made a clarifying change to Rule
613(c)(4), as proposed, to specify that the obligation to report the
supplemental audit trail data to the central repository only falls on a
broker-dealer, and not on a national securities exchange or national
securities association.\524\ The Commission believes that this change
is appropriate because only broker-dealers receive the types of audit
trail data described in Rule 613(c)(vi) through (viii).\525\
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\524\ Rule 613(c)(4) now requires that ``each member of a
national securities exchange or national securities association''
provide the information set forth in the Rule; as proposed, Rule
613(c)(4) required ``each national securities exchange, national
securities association, and member'' to provide the information set
forth in the Rule.
\525\ The Commission has also amended Rule 613(c)(4), as
proposed, to include the provision of information sufficient to
identify the customer and customer account information. See Rule
613(c)(7)(viii); Section III.B.1.g.ii.(C)., supra.
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(B) Elimination of Certain Data Elements
As previously noted, proposed Rule 613(c)(4) would have required
that the following information be reported to the central repository:
(1) The account number for any subaccounts to which the execution is
allocated (in whole or part); (2) the unique identifier of the clearing
broker or prime broker (if applicable); (3) the unique identifier of
any contra-side order(s); (4) special settlement terms (if applicable);
(5) the short sale borrow information and identifier; (6) the amount of
a commission, if any, paid by the customer and the unique identifier of
the broker-dealer(s) to whom the commission is paid; and (7) cancelled
trade indicator (if applicable).\526\
---------------------------------------------------------------------------
\526\ See proposed Rule 613(c)(4), 613(c)(7)(vi),
613(c)(7)(vii).
---------------------------------------------------------------------------
After considering general comments suggesting that the Commission
reduce the proposed reporting obligations under Rule 613, the
Commission is not requiring the following data elements to be reported
to the central repository: (1) Special settlement terms; (2) the amount
of commission, if any, paid by the customer; (3) the unique identifier
of the broker-dealer to whom the commission is paid; and (4) the short
sale borrow information and identifier.\527\ While this data may be
useful in the context of certain investigations or market analyses,
upon further consideration, the Commission believes that these data
elements should not be required by Rule 613 because the Commission does
not typically find that these particular audit trail data elements
provide enough information relevant to an initial assessment of whether
illegal or manipulative activity is occurring in the marketplace to
warrant that they be required as a standard part of the audit trail
created by Rule 613. If the Commission or the SROs find that such
information would be useful to their regulatory responsibilities, they
may request the information directly from the broker-dealer with the
obligation to record this information, although requests related to
short sale borrow information may pose unique challenges. In effect,
the Commission believes that the benefit of having these specific audit
trail data elements in the consolidated audit trail at this time is
unlikely to justify the recording and reporting burden on broker-
dealers of providing these elements, particularly in light of the other
information required to be reported under Rule 613 and the regulators'
ability to obtain this information through a follow-up request. The
Commission notes that, if the SROs believe that having such data
elements as part of the consolidated audit trail could be useful to
their regulatory responsibilities, the SROs could determine to require
SROs and their members to record and report such data as part of the
NMS plan.
---------------------------------------------------------------------------
\527\ See proposed Rules 613(c)(7)(vi)(D), 613(c)(7)(vi)(E), and
613(c)(7)(vi)(F).
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With respect to the account number for any subaccounts to which the
execution is allocated (in whole or in part)--an audit trail data
element that will be required by Rule 613(c)(4), as adopted--the
Commission notes that obtaining allocation information is important
because part of the goal of Rule 613 is to obtain audit trail
information for the life of an order, which would include how an order
was ultimately allocated (i.e., to which specific customer and
account). The Commission notes, however, that the Rule requires the NMS
plan to require a broker-dealer to report only the account number of
any subaccounts to which an execution is allocated that is contained in
its own books and records for accounts and subaccounts it holds; there
is no obligation for the broker-dealer to obtain any additional
information about accounts or subaccounts from other broker-dealers or
non-broker-dealers who submitted the original order. The Commission
further notes that broker-dealers will remain subject to existing
regulatory requirements, including recordkeeping and suitability
requirements (e.g., ``know your customer'' rules). Including the
account number of any subaccounts to which an execution is allocated in
the consolidated audit trail will allow regulators to understand how an
allocation of the securities was made among customers of a broker-
dealer to, for example, determine if the broker-dealer was favoring a
particular customer, to better understand the economic interests of the
customer, or as it relates to possible enforcement actions. Similarly,
having information regarding the identity of the clearing broker or
prime broker for the transaction, the identity of any contra-side
order(s), and a cancelled trade indicator by 8:00 a.m. Eastern Time on
the trading day following the day that the member receives such
information will aid the Commission and the SROs in knowing all of the
parties that touched an order (including the clearing broker, prime
broker, and contra-side party to the order), and whether the order was
cancelled. The Commission believes that all of this information will
facilitate regulatory improvements as discussed above in Section
II.A.2.
(C) Movement of Certain Data Elements From Event Data to Supplemental
Audit Trail Data
As proposed, Rule 613 would have required that, in addition to the
Customer-ID, customer account information and other specified
information sufficient to identify a customer be reported in real
time.\528\ The Commission requested comment about the feasibility of
this requirement. Several commenters expressed concern over the
proposed requirement that customer information be reported in real time
upon origination or receipt of an order.\529\ One commenter believed
that leakage of customer information could ``negatively impact investor
willingness to trade in the U.S. markets,'' \530\ and, instead, urged
regulators to rely on EBS to provide customer information.\531\ Another
commenter did not think it was feasible to provide customer information
in real time.\532\ Another commenter suggested that the Commission
``pare down its list of data points to focus on what would appear
[[Page 45772]]
on a trade ticket and certain client demographic information.'' \533\
This commenter explained that its suggested approach ``makes sense
because for most brokers pulling trade ticket information from frontend
systems will be straightforward, and client demographics should be
easily pulled and populated onto a system for easy retrieval.'' \534\
Another commenter was of the view that only customer information
regarding the person exercising investment discretion for the account
originating the order, such as an investment adviser, should be
required to be reported.\535\ This commenter explained that if a trade
is not executed an investment advisor would not typically provide
information about the owners of the underlying accounts to the broker-
dealer and thus this commenter suggested that it would be more
practical to disclose underlying account information in relation to
executed trades.\536\ Another commenter suggested that there be a
``requirements analysis'' that considers the availability of order and
trade data, and noted that allocation data is not available at the time
of order entry.\537\
---------------------------------------------------------------------------
\528\ See Proposing Release, supra note 4, at 32573; proposed
Rule 613(c)(7)(i)(A), (C).
\529\ See Liquidnet Letter, p. 3; Direct Edge Letter, p. 4
(emphasizing that it would be more important for exchanges to obtain
the identity of the brokers on both sides of an execution for cross-
market surveillance purposes); SIFMA Letter, p. 6, 9; Ameritrade
Letter, p. 3.
\530\ See FIF Letter, p. 2-3.
\531\ This commenter suggested an alternative if the Commission
believed customer information was necessary, using both EBS and
OATS: EBS could send the central repository customer account
information (including account number), and OATS would add a field
for the account number to link the OATS reports and customer
information together. Id. at p. 2-3.
\532\ See SIFMA Letter, p. 6, 9.
\533\ See Ameritrade Letter, p. 2-3.
\534\ Id.
\535\ See Liquidnet Letter, p. 3.
\536\ See Liquidnet Letter, p. 3, 5-6.
\537\ See FIF Letter II, p. 2.
---------------------------------------------------------------------------
In recognition of commenters' concerns that this information may
not be available in real time \538\ and to reduce the reporting burdens
on broker-dealers, the Commission is moving data elements, including
the customer's name, address, and account information, and large trader
identifier (if applicable) (collectively defined as ``customer
attributes'') from the order event data category to the supplemental
audit trail data category.\539\ As a result, the Commission is adopting
the Rule to provide that the NMS plan require that customer attributes
\540\ including the customer's name, address,\541\ and customer account
information be reported under Rule 613\542\ no later than 8:00 a.m.
Eastern Time on the trading day following the day that the member
receives the information.\543\ The Commission expects that the
Customer-ID will be able to be linked to the customer attributes in the
consolidated audit trail.
---------------------------------------------------------------------------
\538\ See SIFMA Letter, p. 6; Liquidnet Letter, p. 3.
\539\ See also Rule 613(j)(4) which defines ``customer account
information'' to include, but not be limited to, account number,
account type, customer type, date account opened, and large trader
identifier (if applicable).
\540\ Rule 613(j)(3), as adopted, defines the term ``customer''
to mean the account holder(s) of the account at a registered broker-
dealer originating the order; and any person from whom the broker-
dealer is authorized to accept trading instructions for such
account, if different from the account holder(s).
\541\ See Proposing Release, supra note 4, at 32573.
\542\ The Commission notes that, under the Rule, a broker-dealer
must only report the account number for the account the customer
used to submit an order, not the account numbers for all accounts of
a customer.
\543\ See Rule 613(c)(4).
---------------------------------------------------------------------------
The Commission believes that, to realize many of the objectives of
a consolidated audit trail, the specific attributes of a customer must
be recorded and, when needed, made available to regulators. Without
these customer attributes, the data recorded is effectively anonymized,
which would prevent regulators from using the enhanced consolidated
audit trail data to take any enforcement action against specific
individuals. The Commission believes customer attributes \544\ are
necessary because regulatory authorities need to accurately and
efficiently identify the customer to effectively surveil and analyze
the markets, and enforce the securities laws. For example, as noted in
the Proposing Release,\545\ a trader may trade through multiple
accounts at multiple broker-dealers. Being able to identify the account
holder aids in the identification and investigation of suspicious
trading activity. Accordingly, the unique customer identifier that is
required to be reported to the central repository for original receipt,
origination, modification, or cancellation of an order,\546\ and that
links together all reportable events by the same customer, must
ultimately link back to information regulators could use to identify
the party. With this information, regulators could more quickly
initiate investigations, and more promptly take appropriate enforcement
action. While this information could be requested from broker-dealers
by the Commission and the SROs on a case-by-case basis, the Commission
believes that achieving these benefits requires having such information
maintained in a uniform format that is readily accessible to the
Commission and the SROs.
---------------------------------------------------------------------------
\544\ As adopted, Rule 613(c)(7)(viii) provides that, ``[f]or
original receipt or origination of an order, the following
information: (A) Information of sufficient detail to identify the
customer; and (B) Customer account information'' be recorded and
reported to the central repository.
\545\ See Proposing Release, supra note 4, at 32578.
\546\ See Section III.B.1.d.iii., supra.
---------------------------------------------------------------------------
Furthermore, in response to the commenters concerns with respect to
the confidentiality of this sensitive information,\547\ and as
discussed in more detail below, the adopted Rule includes requirements
for enhanced safeguards with respect to the privacy and confidentiality
of consolidated audit trail data, including customer information.\548\
---------------------------------------------------------------------------
\547\ See FIF Letter, p. 3.
\548\ See Section III.B.3.b., infra.
---------------------------------------------------------------------------
In response to the commenter who suggested only information
appearing on the trade ticket and certain client demographic
information \549\ be collected, the Commission notes that it may be
feasible for the NMS plan to allow customer identifying and account
information to be reported by a broker-dealer to the central repository
only when the customer opens or closes an account (or at the time the
consolidated audit trail is first implemented for pre-existing
accounts)--this information may not need to be re-reported with every
order.\550\ Under this approach, the specified customer attributes may
be stored in the central repository and automatically linked to an
order whenever an order with the applicable Customer-ID is reported. As
the Commission noted in the Proposing Release,\551\ broker-dealers
today, as part of their books and records requirements, must take
reasonable and appropriate steps to ensure the accuracy of the customer
information with respect to orders received.\552\ Following adoption of
the Rule, and the creation and implementation of the consolidated audit
trail, broker-dealers will continue to be subject to this requirement
as they report customer information to the central repository. The
Commission believes that allowing the specified customer attributes to
be reported to the central repository by 8:00 a.m. Eastern Time on the
trading day following the day that a broker-dealer first receives this
information appropriately balances the regulatory need with the
practical burdens of supplying it in real time as originally proposed.
---------------------------------------------------------------------------
\549\ See Ameritrade Letter, p. 2-3.
\550\ However, if any information previously reported by a
broker-dealer to the central repository changes, the broker-dealer
would need to report the updated information to the central
repository by 8:00 a.m. Eastern Time on the trading day following
the day that the broker-dealer receives the updated information.
\551\ See Proposing Release, supra note 4, at 32566.
\552\ See, e.g., Rules 17a-3, 17a-4, 17a-25 under the Exchange
Act, 17 CFR 240.17a-3, 17a-4, 17a-25.
---------------------------------------------------------------------------
In response to the commenter who stated that an investment adviser
would not typically provide information about the owners of the
underlying accounts to the broker-dealer if the trade is not
executed,\553\ the Commission notes that, in the case of an adviser
that enters an order to buy or sell securities using its own account
held at the broker-dealer originating the order, the Rule, as adopted,
would only require the NMS
[[Page 45773]]
plan to require the capture of information about the owners of the
underlying client accounts for which the order was placed if there is
an executed trade, and if the executed trade is allocated (pursuant to
Rule 613(c)(7)(vi)) to the accounts of the adviser's clients at the
same broker-dealer.\554\ However, the Commission notes that, in the
case of an adviser that enters an order on behalf of clients that each
maintain separate accounts at the broker-dealer originating the order,
using those accounts, the Rule would require the NMS plan to require
the capture of both the adviser--as the person providing trading
instructions to the broker-dealer (pursuant to Rule 613(j)(3)(ii))--and
the clients, who are the account holders at the broker-dealer (pursuant
to Rule 613(j)(3)(i)), even if the order did not result in execution.
---------------------------------------------------------------------------
\553\ See Liquidnet Letter, p. 3, 5-6.
\554\ See Rule 613(j)(3); see also Section
III.B.1.d.iii.(C)(2)., supra (discussing the definition of
``customer'' as applied to investment advisers).
---------------------------------------------------------------------------
Finally, in the Proposing Release,\555\ the Commission specifically
requested comment on whether there are laws or other regulations in
other jurisdictions that would limit or prohibit members from obtaining
the proposed customer information for non-U.S. customers. The
Commission also requested comment on how members currently obtain such
information. If broker-dealers did encounter special difficulties in
obtaining customer information from other jurisdictions, the Commission
requested comment on how the proposed consolidated audit trail
requirements should be modified to address such difficulties.
---------------------------------------------------------------------------
\555\ See Proposing Release, supra note 4, at 32573.
---------------------------------------------------------------------------
The Commission received one comment on this issue.\556\ The
commenter expressed concern that, if broker-dealers were forced to
refuse orders from non-U.S. customers because the laws of another
jurisdiction prohibited disclosure of certain customer information,
U.S. broker-dealers would be penalized and trading activity may shift
offshore.\557\ The commenter recommended that the Commission adopt a
limited exemption that would allow broker-dealers to accept orders from
non-U.S. broker-dealers without providing customer information, in
recognition of the fact that these broker-dealers are subject to
regulation in their home countries.\558\
---------------------------------------------------------------------------
\556\ See SIFMA Letter, p. 21.
\557\ Id.
\558\ Id.
---------------------------------------------------------------------------
In the Rule, as adopted, ``customer'' is defined as ``(i) [t]he
account holder(s) of the account at a registered broker-dealer
originating the order; and (ii) [a]ny person from whom the broker-
dealer is authorized to accept trading instructions for such account,
if different from the account holder(s).'' Under this definition, the
non-U.S. broker-dealer referred to above is the ``customer'' of the
U.S. broker-dealer for purposes of the rule. The U.S. broker-dealer
would be required to record customer information for transactions in
NMS securities only with respect to its foreign broker-dealer customer.
There is no requirement to record information about the customers of
such foreign broker-dealer. Because the Rule as adopted does not
require a non-U.S. broker-dealer placing orders in NMS securities
through a U.S. broker-dealer to provide information about its customers
to the consolidated audit trail, the Commission believes that the
requested limited exemption is unnecessary.
Although the Commission is aware that the privacy laws of some, but
not all, foreign jurisdictions may hinder a foreign broker-dealer's
ability to disclose personal identifying and account information of
their customers absent customer authorization, the Rule as adopted does
not require the foreign broker-dealer to disclose this information
about its customers.\559\ Accordingly, a non-U.S. customer desiring to
trade in the U.S. markets would be permitted to do so through a foreign
broker-dealer without having to disclose its personal data to the
consolidated audit trail. Because the Rule as adopted does not require
a foreign broker-dealer to disclose personal identifying and account
information of its customers to the consolidated audit trail, the
Commission does not believe that trading in NMS securities will shift
offshore as a result of the customer identification requirements.
---------------------------------------------------------------------------
\559\ The Rule does, of course, require the NMS plan submitted
to the Commission for its consideration to require the foreign
broker-dealer to disclose information about itself to the U.S.
broker-dealer, as such information would be expected to be part of
the records of the U.S. broker-dealer holding a foreign broker-
dealer account.
---------------------------------------------------------------------------
h. Clock Synchronization
As proposed, Rules 613(d)(1) and (2) required that the NMS plan
filed with the Commission include a requirement that each SRO and its
members synchronize their business clocks that they use for the
purposes of recording the date and time of any event that must be
reported to the time maintained by the National Institute of Standards
and Technology (``NIST''), consistent with industry standards.\560\ The
SROs and their members also would have been required to annually
evaluate the clock synchronization standard to determine whether it
should be changed to require finer increments, consistent with any
changes to industry standards.\561\ This clock synchronization would
have been required to occur within four months after effectiveness of
the NMS plan.\562\
---------------------------------------------------------------------------
\560\ See proposed Rule 613(d)(1).
\561\ See proposed Rule 613(d)(2).
\562\ See proposed Rule 613(a)(3)(ii).
---------------------------------------------------------------------------
A few commenters expressed concerns with the Commission's proposed
approach to clock synchronization, and a few commenters provided
comments specifically relating to the Commission's estimated costs
relating to clock synchronization.\563\ One commenter preferred a
synchronization standard measured in seconds and believed that
synchronizing at the millisecond level would require specialized
software configurations and expensive hardware.\564\ This commenter
also was of the view that there could be material problems with systems
latency if processors were required to re-synchronize clocks every few
seconds to address ``time drift'' issues--further deviations from the
time maintained by the NIST that may occur after a clock is
synchronized.\565\ Another commenter suggested that a clock
synchronization standard shorter than the three second standard
currently required by FINRA for OATS compliance might be impossible to
achieve across market participants.\566\ A third commenter was
concerned that implementing clock synchronization could require firms
to make modifications to a variety of related applications.\567\ One
commenter noted that synchronizing clocks to milliseconds would require
costly specialized software and hardware.\568\
---------------------------------------------------------------------------
\563\ See SIFMA Letter, p. 14; FIF Letter, p. 6-7; Broadridge
Letter, p. 3; Endace Letter, p. 2.
\564\ See FIF Letter, p. 6.
\565\ See FIF Letter, p. 6-7 (stating that currently ``time
drift'' is an issue, despite advancements in synchronization
technology, with at least one exchange experiencing time drifts
between one and three seconds, and the SIP having its own time
drift).
\566\ See SIFMA Letter, p. 14.
\567\ See Broadridge Letter, p. 3.
\568\ See FIF Letter, p. 7.
---------------------------------------------------------------------------
On the other hand, one commenter--a provider of data capture and
time stamping technology--noted that ``[t]he advent of relatively low
cost GPS receivers that derive absolute timing information accurate to
better than 0.1 micro-seconds has significantly eased the problem of
clock synchronization across multiple global locations,'' that ``[s]uch
technology costs a few thousands of dollars per installation,'' and
that ``[i]t is already in use by exchanges and high frequency
[[Page 45774]]
traders.'' \569\ Another commenter expressed support generally for the
Commission's proposed approach to clock synchronization.\570\
---------------------------------------------------------------------------
\569\ See Endace Letter, p. 2.
\570\ See Liquidnet Letter, p. 8.
---------------------------------------------------------------------------
After considering the comments received on this issue, the
Commission is adopting Rule 613(d)(1) as proposed. As this provision
requires that the NMS plan require clock synchronization consistent
with industry standards, the Commission expects the NMS plan that is
submitted to specify the time increment within which clock
synchronization must be maintained, and the reasons the plan sponsors
believe this represents the industry standard. The Commission notes
that FINRA currently requires its members to synchronize their business
clocks used for OATS reporting to within one second of the time
maintained by NIST.\571\ The Commission believes that the current
industry standard for conducting securities business is more rigorous
than one second. For example, as one commenter noted, technology used
today by exchanges and high frequency trading firms synchronizes clocks
to increments well within the millisecond level.\572\ The Commission
recognizes, as another commenter noted, that some firms may need to
upgrade their technology to meet the industry standard,\573\ and that
there will be attendant costs for such upgrading.\574\
---------------------------------------------------------------------------
\571\ See OATS Reporting Technical Specifications (May 3, 2011),
available at http://www.finra.org/web/groups/industry/@ip/@comp/@regis/documents/appsupportdocs/p123579.pdf (last accessed December
8, 2011). In addition, FINRA allows clock drift of an additional two
seconds before re-synchronization is required.
\572\ See Endace Letter, p. 2.
\573\ See FIF Letter, p. 6-7.
\574\ The Commission notes that one commenter suggested that the
cost might be limited because GPS receivers could be used and
installed for a few thousand dollars per installation. See Endace
Letter, p. 2.
---------------------------------------------------------------------------
The Commission continues to believe that it is appropriate to
require members of the securities industry to synchronize their clocks
to the time maintained by NIST. Effective clock synchronization is
essential to maintaining an accurately time-sequenced consolidated
audit trail, particularly one where time stamps will be in millisecond
increments or less. Because the consolidated audit trail will capture
trading activity occurring across markets, if the business clocks used
by SROs and their members for the purposes of recording the date and
time for reportable events are not properly and consistently
synchronized, the consolidated audit trail data will not be accurately
time-sequenced. It is critical for the consolidated audit trail to
allow regulators the capability to accurately determine the order in
which all reportable events occur.\575\
---------------------------------------------------------------------------
\575\ See Section III.B.1.d.v., supra (explaining the importance
to enforcement cases of an accurately timed record of order events).
---------------------------------------------------------------------------
The Rule as proposed required that both the SROs and their members
annually evaluate the clock synchronization standard to determine
whether it should be changed to require finer increments, consistent
with any changes in the industry standard.\576\ The Commission believes
that the obligation to evaluate the clock synchronization standard
annually should be borne by the SROs as the plan sponsors, not SRO
members. The Commission believes that it is appropriate for the SROs,
as regulators of the securities markets and users of the consolidated
audit trail data, to have the obligation to evaluate whether a change
in the clock synchronization standard is warranted.\577\ Therefore, the
adopted Rule provides that the NMS plan shall require SROs to evaluate
annually the clock synchronization standard set forth in the NMS
plan.\578\
---------------------------------------------------------------------------
\576\ See proposed Rule 613(d)(2).
\577\ See Rule 613(d)(2).
\578\ Rule 613(d)(2) provides that ``[e]ach national securities
exchange and national securities association [shall] evaluate
annually the clock synchronization standard to determine whether it
should be shortened, consistent with changes in industry standards *
* *.''
---------------------------------------------------------------------------
The Commission recognizes, as a commenter noted,\579\ that time
drift is an issue that must be addressed by the plan sponsors, to
prevent a deterioration of the accuracy of the data in the consolidated
audit trail. Therefore, the Commission expects the NMS plan to address
the maximum amount of time drift that would be allowed before clocks
must be re-synchronized, and why this is consistent with the industry
standard.
---------------------------------------------------------------------------
\579\ See FIF Letter, p. 7.
---------------------------------------------------------------------------
As with many other aspects of the Rule, the costs of this
requirement are highly dependent on the details of the solution
proposed by the SROs because the Commission is leaving it up to the
SROs to determine the maximum allowable time drift. As such, the SROs
must discuss in their submitted plan the clock-synchronization standard
they proposed, what alternatives were considered, and the rationale
behind their choice. Once the NMS plan is received, the Commission, as
well as the public, will be able to consider the extent to which the
proposed synchronization standard supports the ability of regulators to
fully achieve the benefits afforded by the creation of a cross-market
consolidated audit trail.
2. Central Repository
a. Central Repository as a Facility of the SROs
As proposed, Rule 613(e) required that the NMS plan provide for the
creation and maintenance of a central repository,\580\ which would have
been a ``facility'' of each exchange and FINRA.\581\ The central
repository would have been jointly owned and operated by the exchanges
and FINRA, and the NMS plan would have been required to provide,
without limitation, the Commission and SROs with access to, and use of,
the data reported to and consolidated by the central repository for the
purpose of performing their respective regulatory and oversight
responsibilities pursuant to the federal securities laws, rules, and
regulations.\582\ Each of the exchanges and FINRA would have been a
sponsor of the plan \583\ and, as such, would have been jointly
responsible for selecting a plan processor to operate the central
repository.\584\
---------------------------------------------------------------------------
\580\ See proposed Rule 613(e)(1).
\581\ The term ``facility'' is defined in Section 3(a)(2) of the
Exchange Act, with respect to an exchange, to include ``its
premises, tangible or intangible property whether on the premises or
not, any right to use such premises or property or any service
thereof for the purpose of effecting or reporting a transaction on
an exchange (including, among other things, any system of
communication to or from the exchange, by ticker or otherwise,
maintained by or with the consent of the exchange), and any right of
the exchange to the use of any property or service.'' 15 U.S.C.
78c(a)(2).
\582\ See proposed Rule 613(e)(2).
\583\ See proposed Rule 613(a)(4).
\584\ See proposed Rule 613(a)(3)(i).
---------------------------------------------------------------------------
The Commission requested comment on the need for a central
repository to receive and retain the consolidated audit trail
information, whether there would be alternatives to creating a central
repository for the receipt of order audit trail information, and
whether it would be practical or appropriate to require the SROs to
jointly own and operate the central repository.
A few commenters discussed the proposed ownership structure of the
central repository.\585\ One commenter argued that the central
repository should be owned and operated by the Commission, or a non-SRO
formed specifically to operate the central repository, and expressed
concern that the central repository could be used by SROs as a source
of revenue through the imposition of penalties.\586\ Another commenter
recommended that the Commission own the repository and not outsource it
to a third party, explaining
[[Page 45775]]
that, in systemically important events, it may be necessary to have
immediate and direct access to the data, without an intermediary.\587\
Yet another commenter noted that the decision to use OATS or another
system as the basis for the consolidated audit trail system should be
separate from the choice of the party that will be responsible for
building and operating the central repository.\588\
---------------------------------------------------------------------------
\585\ See Ameritrade Letter, p. 4; High Speed Letter, p. 1; BATS
Letter, p. 2.
\586\ See Ameritrade Letter, p. 4.
\587\ See High Speed Letter, p. 1.
\588\ See BATS Letter, p. 2.
---------------------------------------------------------------------------
The Commission received a couple of comments specifically regarding
the costs of the creation and maintenance of the central repository.
FINRA, in one of its comment letters, submitted a ``blueprint'' for a
version of a consolidated audit trail based on enhancements to OATS--
though without certain key elements proposed to be required by the
adopted Rule--and estimated initial costs for developing the repository
to be between $100 million and $125 million, with ongoing annual costs
to be between $30 million and $40 million.\589\ Another commenter
suggested the use of cloud computing for the central repository which
it believed would cost less than $10 million per year.\590\
---------------------------------------------------------------------------
\589\ See FINRA Proposal Letter, p. 14-16.
\590\ See High Speed Letter, p. 1.
---------------------------------------------------------------------------
The Commission has considered the comments and is adopting as
proposed the requirement in Rule 613(e)(1) that the NMS plan provide
for the creation of a central repository. The Commission believes that
having a central repository is important to ensuring access to
consolidated data for the Commission and SROs, and for ensuring
consistency, quality, and security in the audit trail data.
As adopted, Rule 613(e)(1) does not dictate a particular audit
trail collection system to be used as the central repository for the
consolidated audit trail, but, instead, delineates the required core
features of such a system.
The Commission considered the commenter's recommendation that it
should own the central repository \591\ but determined that such
ownership is not necessary as long as the central repository has the
core features articulated in the Rule, the Commission and SROs have
full access to the audit trail data for regulatory purposes, and the
central repository is a facility of each SRO subject to Commission
oversight.\592\ The Commission notes that, because the central
repository will be jointly owned by, and a facility of, each SRO, it
will be subject to Commission oversight. The Commission will have
unfettered access to the data in the central repository without being
its owner.
---------------------------------------------------------------------------
\591\ See Ameritrade Letter, p. 4.
\592\ See note 581, supra (describing the nature of a
``facility'').
---------------------------------------------------------------------------
The Commission also considered the comment that the central
repository should be owned by a non-SRO specifically formed to operate
the central repository.\593\ The Commission, however, believes that it
will have more regulatory authority over the central repository as a
facility of each SRO than it would have if the central repository were
owned or operated by a non-SRO. First, the Commission has the statutory
obligation to oversee the SROs, including facilities thereof, and to
ensure that SROs enforce compliance by their members with the
respective SRO's rules, and the federal securities laws, rules, and
regulations.\594\ Second, a facility of an SRO is subject to the rule
filing requirements of Section 19(b) of the Exchange Act.\595\
---------------------------------------------------------------------------
\593\ See Ameritrade Letter, p. 4.
\594\ See, e.g., 15 U.S.C. 78b; 15 U.S.C. 78f(b); 15 U.S.C. 78o-
3(b); 15 U.S.C. 78s(h)(1).
\595\ Section 19(b)(1) of the Exchange Act defines the term
``proposed rule change'' to mean ``any proposed rule or rule change
in, addition to, or deletion from the rules of [a] self-regulatory
organization.'' Pursuant to Section 3(a)(27) and 3(a)(28) of the
Exchange Act, the term ``rules of a self-regulatory organization''
means (1) the constitution, articles of incorporation, bylaws and
rules, or instruments corresponding to the foregoing, of an SRO, and
(2) such stated policies, practices and interpretations of an SRO
(other than the Municipal Securities Rulemaking Board) as the
Commission, by rule, may determine to be necessary or appropriate in
the public interest or for the protection of investors to be deemed
to be rules.
---------------------------------------------------------------------------
In response to the commenter who expressed concern that the plan
sponsors would use the central repository to generate revenue through
penalties,\596\ the Commission notes that any penalty provisions must
be provided in the NMS plan submitted to the Commission for its
consideration, or in a future amendment to the NMS plan, if the NMS
plan is approved. The Commission will review the NMS plan submitted for
its consideration, which also will be subject to public notice and
comment, to assure itself that the NMS plan is designed to be applied
fairly and otherwise in a manner consistent with the Exchange Act. The
Commission expects that the NMS plan's penalty provisions would provide
sufficient detail regarding the circumstances in which any penalties
would apply, and any restrictions on how payments of such penalties may
be used, to permit the Commission to determine that such penalty
provisions are fair and consistent with the Exchange Act. As the
central repository will be a facility of the plan sponsors, the rules
governing it must be consistent with the Exchange Act.\597\ In
addition, future amendments to the penalty provisions would either be
reviewed as an amendment to the NMS plan, under Rule 608 of Regulation
NMS, or, because the central repository is a facility of the SROs, as a
proposed rule change of the central repository under Section 19 of the
Exchange Act.\598\ Additionally, the Commission has the authority to
review any action taken or failure to act by any person under an
effective NMS plan, pursuant to Rule 608(d)(1) of Regulation NMS.\599\
Lastly, any penalty provisions included in the NMS plan approved by the
Commission will be subject to the Commission's inspection and
examination program of SROs to ensure they are implemented fairly in a
manner consistent with the Exchange Act.\600\
---------------------------------------------------------------------------
\596\ See Ameritrade Letter, p. 4.
\597\ See note 581, supra (describing the nature of a
``facility'').
\598\ 15 U.S.C. 78s.
\599\ 17 CFR 242.608(d)(1). If the Commission does not make a
finding that the action or failure to act is consistent with the
provisions of the NMS plan and was applied in a manner consistent
with the Act, or if it finds that such action or failure to act
imposes any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act, the Commission, by order,
can set aside such action and/or require such action with respect to
the matter reviewed as the Commission deems necessary or appropriate
in the public interest, for the protection of investors, and the
maintenance of fair and orderly markets, or to remove impediments
to, and perfect the mechanisms of, the NMS plan. 17 CFR
242.608(d)(3).
\600\ The Commission notes that, as part of its inspection and
examination program, its staff has the authority to examine the
application of any penalty provisions in the NMS plan to determine
whether they have been applied fairly. In this manner, the
Commission will be able to monitor how the plan sponsors have
applied any penalty provisions set out in the NMS plan approved by
the Commission.
---------------------------------------------------------------------------
In response to the comments regarding the costs of the creation and
maintenance of a central repository, the Commission notes that the
costs would be highly dependent on the decisions the SROs make with
respect to each of the areas in which the Commission has provided
flexibility to the SROs in crafting the NMS plan to be submitted to the
Commission for its consideration. For example, cost estimates could
vary depending on whether the NMS plan requires unique order
identifiers or permits ``a series of order identifiers.'' Such cost
estimates also could vary because the Rule does not specify details
regarding, among other things, the security and confidentiality
procedures of the central repository, the system for assigning customer
identifiers, the format(s) of data reported to the central repository,
the methods by which regulators will access data in the central
repository, whether an annual independent evaluation will be
[[Page 45776]]
required, how reportable events related to the same order will be
linked, or how errors will be processed. Such information will be known
only after the filing of the NMS plan and, thus, the Commission
believes it is appropriate to defer consideration of such costs until
the NMS plan is submitted for its consideration. Once it is submitted,
the Commission will be able to use this information in determining
whether to approve the NMS plan.
The Commission notes that other provisions of the Rule that are
applicable to the central repository, discussed below, have been
modified from the proposal, including provisions relating to the format
in which the data may be reported,\601\ and to the security and
confidentiality of the consolidated audit trail data.\602\
---------------------------------------------------------------------------
\601\ See Section III.B.2.b., infra; Rule 613(e)(1).
\602\ See Section III.B.2.e., infra; Rule 613(e)(4)(i).
---------------------------------------------------------------------------
b. Receipt, Consolidation, and Retention of Data
1. Audit Trail Data
In addition to providing for the creation and maintenance of the
central repository, Rule 613(e), as proposed, also would have required
the central repository to receive, consolidate, and retain all data
reported by the SROs and their members pursuant to the Rule and the NMS
plan.\603\
---------------------------------------------------------------------------
\603\ See proposed Rule 613(e)(1).
---------------------------------------------------------------------------
The Commission is adopting, substantially as proposed, the
provisions in Rule 613(e) regarding the responsibility of the central
repository to receive, consolidate, and retain the audit trail data,
but with a few modifications to reflect changes the Commission made to
other sections of Rule 613.\604\
---------------------------------------------------------------------------
\604\ See Sections III.B.1.d. and III.B.1.f., supra.
---------------------------------------------------------------------------
The first change to Rule 613(e)(1) is a conforming change to the
modification in adopted Rule 613(c)(2) that permits the NMS plan to
provide that audit trail data be reported to the central repository
either in a uniform electronic format, or in a manner that would allow
the central repository or a third party to convert the data to a
uniform electronic format for consolidation and storage.\605\ Given the
need for cross-market comparability and ready access,\606\ the adopted
Rule requires that, to the extent the NMS plan does not require that
data be reported to the central repository in a uniform electronic
format, the central repository must convert the data to a uniform
electronic format for consolidation and storage.\607\ The Commission
notes that, regardless of whether the NMS plan submitted to the
Commission for its consideration elects to have the central repository
normalize audit trail data reported, the Rule requires the central
repository to consolidate and store the data in a uniform electronic
format.
---------------------------------------------------------------------------
\605\ See Rule 613(c)(2); see Section III.B.1.f., supra.
\606\ See Proposing Release, supra note 4, at 32564. See also
Section III.B.2.d., infra.
\607\ See note 516, supra.
---------------------------------------------------------------------------
The second change to Rule 613(e)(1) reflects the Commission's view
that, while it is appropriate to provide the plan sponsors with the
flexibility to determine how an order will be identified, audit trail
data must be stored in the central repository in a manner that will
allow order information to be retrieved in a timely and accurate
fashion. Accordingly, adopted Rule 613(e)(1) requires that the audit
trail data consolidated in the central repository be stored ``in a form
in which all events pertaining to the same originating order are linked
together in a manner that ensures timely and accurate retrieval * * *
for all reportable order events for that order.'' The Commission notes
that, regardless of whether the NMS plan submitted to the Commission
for its consideration elects to use a series of order identifiers or a
unique order identifier, the Rule requires the central repository to be
able to link together all reporting events pertaining to an order.
In looking ahead to considering the overall cost of creating,
implementing, and maintaining a consolidated audit trail in connection
with the NMS plan, the Commission recognizes that, in addition to the
costs to SRO members who would be required to record and report data to
the central repository, there also will be costs associated with
creating and maintaining a central repository. These costs may include:
(1) The purchase and maintenance of servers and systems to receive,
consolidate, and retain audit trail data, and to allow access to and
searches on the data; (2) the development of policies and procedures
relating to the timeliness, accuracy, completeness, security, and
confidentiality of the data collected; (3) the development and
maintenance of a comprehensive information security program for the
central repository; and (4) dedicated staff, including a CCO.
2. NBBO Information, Transaction Reports, and Last Sale Reports
In addition to receiving, consolidating, and retaining audit trail
data reported pursuant to Rule 613(c), Rule 613(e)(5), as proposed,
would have required the central repository to collect and retain, on a
current and continuing basis and in a format compatible with the
information collected pursuant to Rule 613(c)(7),\608\ the NBBO
information for each NMS security,\609\ as well as transaction reports
reported pursuant to an effective transaction reporting plan filed with
the Commission pursuant to, and meeting the requirements of, Rule 601
of Regulation NMS under the Exchange Act.\610\ In addition, last sale
reports reported pursuant to the OPRA Plan filed with the Commission
pursuant to, and meeting the requirements of, Rule 608 of Regulation
NMS under the Exchange Act would have been required to be collected and
retained.\611\
---------------------------------------------------------------------------
\608\ See Section III.B.1.d., supra.
\609\ See proposed Rule 613(e)(5)(i).
\610\ The effective transaction reporting plans include the CTA
Plan and the UTP Plan. See note 101, supra; proposed Rule
613(e)(5)(ii).
\611\ See proposed Rule 613(e)(5)(iii).
---------------------------------------------------------------------------
One commenter expressed its belief that, ``[a]s in the case of the
current OATS system, execution data provided to the consolidated audit
trail should identify where the trade was publicly reported and have a
common identifier that links the audit trail execution reports for the
buy and sell orders to the public trade report.'' \612\ The Commission
believes that the proposed requirement for the central repository to
collect and retain NBBO information, as well as transaction reports and
last sale reports,\613\ would facilitate the ability of SRO and
Commission staff to search across order, NBBO, and transaction
databases. Moreover, inclusion of NBBO information would permit
regulators to compare order execution information to the NBBO
information readily as all of the information will be available in a
compatible format in the same database. This information also would be
available to the Commission to assist in its oversight efforts.
---------------------------------------------------------------------------
\612\ See Liquidnet Letter, p. 7. See also Section III.B.d.vii.,
supra.
\613\ See proposed Rule 613(e)(5)(i) through (iii).
---------------------------------------------------------------------------
Additionally, requiring the central repository to collect and
retain the NBBO and transaction information in a format compatible with
the order execution information would aid in monitoring for regulatory
compliance (e.g., Rule 201 of Regulation SHO). Also, this information
would be useful in conducting market analyses (e.g., how order entry
affects NBBO prices and depth). The Commission believes that the
requirement that the central repository collect transaction reports
reported pursuant to the CTA, UTP, and OPRA plans \614\ would allow
regulators to more efficiently evaluate certain
[[Page 45777]]
trading activity. For example, a pattern of unreported trades may cause
the staff of an SRO to make further inquiry into the nature of the
trading to determine whether the public is receiving accurate and
timely information regarding executions and that market participants
are continuing to comply with the trade reporting obligations under SRO
rules. Similarly, a pattern of unreported transactions could be indicia
of market abuse, including failure to obtain best execution for
customer orders or possible market manipulation. The Commission
believes that having the quotation and transaction information
currently collected with respect to NMS securities in the same data
repository--and in a compatible format--as part of the consolidated
audit trail would enhance regulatory efficiency when analyzing the
data.
---------------------------------------------------------------------------
\614\ See proposed Rule 613(e)(7)(i) through (iii).
---------------------------------------------------------------------------
After considering the comment on this provision,\615\ the
Commission is adopting proposed Rule 613(e)(5)(ii) and (e)(5)(iii)
(renumbered as Rule 613(e)(7)(ii) and (e)(7)(iii)), as proposed, and
the requirement of proposed Rule 613(e)(5)(i) (renumbered as Rule
613(e)(7)(i)) for the NMS plan to require the central repository to
collect and retain NBBO information for each NMS security substantially
as proposed, but is clarifying that the NBBO information must include
size and quote condition.\616\ NBBO size information is integral to
determining whether best execution and order handling requirements were
satisfied for a particular order because these requirements depend on
the relationship between the size of the order and the displayed size
at the NBBO. NBBO quote condition information is integral to
determining whether or not quotes are immediately accessible. For
example, quote condition information that identifies whether the quote
reflecting the NBBO was automated, and therefore subject to trade-
through protection, or manual \617\ may be an important consideration
in determining whether the duty of best execution was satisfied. The
NBBO price, size, and quote condition is used by regulators to evaluate
members for compliance with regulatory requirements, such as the duty
of best execution or Rule 611 of Regulation NMS.\618\ The Commission
acknowledges that there will be costs to the central repository to
purchase and to retain NBBO information, transaction reports, and last
sale reports. However, the Commission believes that the benefits
associated with having such information included in the central
repository justify the costs to the SROs of requiring that they include
this in the NMS plan submitted to the Commission for its review.
---------------------------------------------------------------------------
\615\ See Liquidnet Letter, p. 7.
\616\ Quote condition is a field in the CQS feed that provides
information on a quote, including whether such quote is an opening
quote, closing quote, news pending, slow on ask side, slow on bid
side, order imbalance or non-firm quote. See CQS Output Multicast
Line Interface Specification, Version 48 (October 11, 2011),
Appendix G.
\617\ Manual quotes are not eligible for automatic execution and
do not have trade through protection under Rule 611 of Regulation
NMS. See 17 CFR 242.600(57) for a definition of a protected bid or
protected offer.
\618\ 17 CFR 242.611.
---------------------------------------------------------------------------
3. Retention of Information
As proposed, Rule 613(e)(6) would have provided that the NMS plan
require the central repository to retain the information collected
pursuant to Rule 613(c)(7) and (e)(5) in a convenient and usable
standard electronic data format that is directly available and
searchable electronically without any manual intervention for a period
of not less than five years. The information would have been required
to be available immediately, or, if immediate availability could not
reasonably and practically be achieved, a search query would have been
required to begin operating on the data not later than one hour after
the search query is made.\619\
---------------------------------------------------------------------------
\619\ See proposed Rule 613(e)(6).
---------------------------------------------------------------------------
One commenter suggested that the Commission modify the time
standard for the availability of older data to a next day (or later)
standard, as the need for regulators to have immediate access to the
data diminishes over time. The commenter stated that a requirement that
the data be made available the next day, or after another longer period
of time, would be less burdensome on the consolidated audit trail
system and less costly, while still meeting the needs of
regulators.\620\ Another commenter believed that there could be
difficulties in querying and analysis because the proposal did not
specify how the data would be stored in the central repository.\621\
---------------------------------------------------------------------------
\620\ See Nasdaq Letter I, p. 10-11.
\621\ See Ross Letter, p. 1.
---------------------------------------------------------------------------
In response to the commenters' concerns, the Commission is
modifying the proposed Rule. Specifically, Rule 613(e)(8) (renumbered
from proposed Rule 613(e)(6)) provides that ``[t]he national market
system plan submitted pursuant to this section shall require the
central repository to retain the information collected pursuant to
[Rules 613(c)(7) and (e)(7)] in a convenient and usable standard
electronic data format that is directly available and searchable
electronically without any manual intervention for a period of not less
than five years.'' The adopted Rule does not require, as was proposed,
that the consolidated audit trail data be available immediately, or if
immediate availability cannot reasonably and practically be achieved,
any search query must begin operating on the data not later than one
hour after the search query is made.\622\
---------------------------------------------------------------------------
\622\ See proposed Rule 613(e)(6).
---------------------------------------------------------------------------
The Commission believes that it is unnecessary for the Rule to
require a timeframe within which consolidated audit trail data must be
available or a timeframe for when a search must begin after the query
is made because, as discussed below,\623\ the Rule, as adopted,
includes a provision that requires the NMS plan to specifically address
the ``time and method by which the data in the central repository will
be made available to regulators, in accordance with paragraph (e)(1) of
this section, to perform surveillance or analyses, or for other
purposes as part of their regulatory and oversight responsibilities.''
\624\ The Commission will consider the response to this provision
contained in the NMS plan submitted by the plan sponsors to the
Commission, regarding the time and method by which the data in the
central repository can be accessed and used by regulators as part of
their regulatory and oversight responsibilities--which would encompass
queries--as it evaluates the NMS plan. The Commission believes this
provision provides flexibility to the SROs to devise an access
requirement that meets the needs of regulators in a cost-effective and
timely manner,\625\ rather than establishing a strict deadline for all
data to be accessible from the central repository.
---------------------------------------------------------------------------
\623\ See Section III.C.2.a.i., infra.
\624\ See Rule 613(a)(1)(ii).
\625\ The Commission acknowledges there would be costs to the
central repository for retaining data received or collected by the
central repository pursuant to Rule 613. As discussed in Section I.,
supra, the NMS plan submitted to the Commission for its
consideration will include a detailed analysis of the costs of the
Rule for the Commission and the public to consider after the NMS
plan has been submitted.
---------------------------------------------------------------------------
c. Timeliness, Accuracy, Integrity, and Completeness of the
Consolidated Data
As proposed, Rule 613(e)(4)(ii) would have required the NMS plan to
include policies and procedures, including standards, for the plan
processor to ensure the timeliness, accuracy, and completeness of the
data provided to the central repository. In addition, proposed Rule
613(e)(4)(iii) would have required that the NMS plan include policies
and procedures, including standards for the plan processor to reject
data provided to
[[Page 45778]]
the central repository that does not meet these validation parameters,
and for SROs and members to re-transmit corrected data. Finally,
proposed Rule 613(e)(4)(iv) would have required that the NMS plan
include policies and procedures, including standards, to ensure the
accuracy of the consolidation by the plan processor of the data
provided to the central repository.
The Commission requested comment on these proposed
requirements.\626\ The Commission asked if this approach was practical
to ensure the integrity of the data, and whether there were alternative
methods that would achieve the same purpose that would be preferable.
The Commission also requested comment on how much latency would result
from a validation procedure.
---------------------------------------------------------------------------
\626\ See Proposing Release, supra note 4, at 32582.
---------------------------------------------------------------------------
The Commission received comments focusing concern on the potential
for errors in the consolidated audit trail and the negative effects of
errors in the consolidated audit trail.\627\ One commenter stated that
the ``key principles [that] best ensure that the regulatory goals of
the consolidated audit trail are met in a cost efficient manner''
include a system that ``avoids data quality issues through data
validation safeguards and a structure that reads data as close to the
point of origin as possible to avoid data translation errors when data
is processed through intermediary applications.'' \628\ Another
commenter stated that ``the CAT facility would also need a mechanism to
identify and correct data that was inaccurate.'' \629\ Another
commenter noted that, ``if any other protocol [other than FIX] is used
a translation is required to transform data into a different protocol.
This introduces error and offers the potential for manipulation of the
data. Using FIX means the SEC is looking at the original format of the
data.'' \630\
---------------------------------------------------------------------------
\627\ See Aditat Letter, p. 2; FIF Letter, p. 4; FINRA Letter,
p. 11; Nasdaq Letter I, p. 8.
\628\ See Nasdaq Letter I, p. 8.
\629\ See FIF letter, p. 4.
\630\ See Aditat Letter, p. 2.
---------------------------------------------------------------------------
As a point of reference, summary data about OATS provided by FINRA
to Commission staff indicates that approximately 0.25% of the intra-
firm data reported daily by members contains errors.\631\ Additionally,
according to FINRA, when errors relating to the linkage of order
reports are detected, members have no obligation to correct the
errors.\632\ As a result, approximately 1-2% of each day's recorded
events remain unmatched (i.e., multi-firm events, such as order
routing, that cannot be reconciled).\633\ This deficiency in the OATS
process diminishes the completeness and overall usefulness of the audit
trail OATS creates.
---------------------------------------------------------------------------
\631\ See Commission Staff Memorandum, supra, note 64.
\632\ Id.
\633\ Id.
---------------------------------------------------------------------------
In a comment letter, FINRA discussed the challenge of obtaining
accurate audit trail information if the data was required in real time,
and it noted the actions it undertakes to ensure the accuracy and
completeness of its audit trail data and minimize errors.\634\ FINRA
stated that, ``to ensure the integrity of OATS data submitted, FINRA
performs over 152 separate OATS data validations on each order event,
each of which can result in OATS data submissions being rejected and
generating an error message.\635\ As a result, FINRA performs over 40
billion separate checks each day to ensure OATS data conforms to all
applicable specifications.\636\ Members are then required by rule to
repair and resubmit such data that did not meet OATS
specifications.\637\ Although members' OATS compliance rates are very
high on average, almost 425,000 reports per day, on average, are
rejected and must be corrected.\638\ Accordingly, to use audit trail
data before such validations have been performed may result in a
severely distorted picture of trading and interfere with effective
oversight.'' \639\
---------------------------------------------------------------------------
\634\ See FINRA Letter, p. 11.
\635\ Id.
\636\ Id.
\637\ Id.
\638\ Id.
\639\ Id. FINRA also noted, however, that ``compliance rates for
OATS steadily improved over time as members gained experience with
the system. For example, when the OATS rules were first implemented,
the match rate between executed orders and the related trade report
submitted to an NASD transaction reporting system was only 76%.
Currently, this match rate is consistently over 99%, which reflects
the significant time and effort that has been expended by the
industry to make their systems OATS compliant. FINRA believes that
creation of a new system, rather than building off of an existing
reporting infrastructure, will necessarily create a learning curve
and lead to reduced compliance rates over the short-term.'' Id. The
Commission acknowledges that there could be a learning curve for
compliance with the NMS plan requirements for the reporting of data.
The Commission, however, expects the NMS plan to minimize such
reduced compliance rates to the extent reasonably practicable.
---------------------------------------------------------------------------
With respect to mechanisms to ensure compliance by SROs with the
requirements of the plan, one commenter stated that ``Commission rules
should focus on the reasonable design of systems, processes and
procedures to fulfill their objectives and patterns and practice of
non-compliance rather than looking to any failure as a rule violation.
This is particularly important in the context of data errors or similar
matters.'' \640\
---------------------------------------------------------------------------
\640\ See Nasdaq Letter I, p. 13.
---------------------------------------------------------------------------
Finally, another commenter believed that ``major market
participants'' should retain ``detailed information of all network
packets and trade data at both the ingress and egress of their
infrastructure.'' \641\ This commenter believed that this information
would not need to be forwarded to ``any audit authority'' but explained
that such information could be used by regulators in the event a
``denial of service'' attack were to occur at a network level to slow
market activities or hinder the flow of market information. This
commenter further explained that having this information would
``greatly improve confidence in the integrity of data and act as a
further deterrence for fraudulent activity.'' \642\
---------------------------------------------------------------------------
\641\ See Endace Letter, p. 2-3.
\642\ Id. at p. 3.
---------------------------------------------------------------------------
After consideration of the comments received, the Commission is
adopting Rule 613(e)(4)(ii) substantially as proposed. Thus, the NMS
plan must have policies and procedures, including standards, to ensure
the timeliness, accuracy, and completeness of the data received. The
Commission believes that audit trail data that is timely, accurate, and
complete is critical to the usefulness and effectiveness of Rule 613.
However, the Commission is adding the term ``integrity'' to the list of
items that the policies and procedures adopted by the plan sponsors, as
set forth in Rule 613(e)(4)(ii), must address.\643\ The addition of
``integrity'' is designed to help emphasize that data should not be
subject to benign or malicious alteration, so that such data would be
consistent and reliable at each point of transmission throughout its
lifecycle (i.e., transmission from the SRO or member to the central
repository, data extraction, transformation and loading at the central
repository, data maintenance and management at the central repository,
and data access by regulators). The Commission believes that the
integrity of the audit trail data is critical to the usefulness and
effectiveness of the consolidated audit trail.
---------------------------------------------------------------------------
\643\ Rule 613(e)(4)(ii) provides that the NMS plan shall
include policies and procedures, including standards, to ensure the
timeliness, accuracy, integrity, and completeness of the data
provided to the central repository.
---------------------------------------------------------------------------
The Commission also is adopting Rule 613(e)(4)(iv), renumbered as
Rule 613(e)(4)(iii), as proposed, which provides that the NMS plan
submitted shall include policies and procedures, including standards,
to be used by the
[[Page 45779]]
plan processor to ensure the accuracy of the consolidation by the plan
processor of the data reported to the central repository. The
Commission believes that policies and procedures, including standards,
to be used to ensure accuracy of the consolidated data are important
and necessary because the benefits of ensuring that data is accurately
reported to the central repository would be lost if the consolidation
process is not as equally robust. The regulatory benefits of a
consolidated audit trail are therefore based, in part, on the
timeliness, accuracy, completeness, and integrity of the data
ultimately available to regulators from the central repository.
As described above in Sections III.B.1.f. and III.B.1.d.iv., the
adopted Rule provides the SROs with more flexibility than the proposed
Rule in developing (a) the format(s) of data to be reported to the
central repository, and (b) the methods by which order identifiers will
be used to link reportable events. Accordingly, the Commission expects
the policies and procedures included in the NMS plan submitted to the
Commission for its consideration to apply to both the transmission of
audit trail data from SROs and their members to the central repository,
and the consolidation and retention of that data, and other information
collected pursuant to the Rule, by the central repository, including,
but not limited to, any normalization or conversion of the data to a
uniform electronic format, and procedures for how reportable events are
accurately linked. The Commission believes that it is critical to the
usefulness of the consolidated audit trail that the SROs and their
members report data in a manner that is accurate and complete, and that
the central repository takes any and all appropriate measures to
consolidate and retain that data in the same manner. To the extent the
data is not accurate or complete, the ability of SRO and Commission
staff to utilize the data to accomplish the goal of the consolidated
audit trail will be compromised.\644\
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\644\ See Section II.A., supra.
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In light of the comments the Commission received that noted the
concern about the potential for errors in the consolidated audit trail,
as well as the impact such errors may have on the consolidated audit
trail,\645\ the Commission is revising Rule 613(e)(4)(iii) as proposed
(renumbered as Rule 613(e)(6)(i)). Specifically, Rule 613(e)(6)(i)
requires the NMS plan submitted to the Commission for its consideration
to ``[s]pecify a maximum error rate to be tolerated by the central
repository for any data reported pursuant to Rule 613(c)(3) and (c)(4);
describe the basis for selecting such maximum error rate; explain how
the plan sponsors will seek to reduce the maximum error rate over time;
describe how the plan will seek to ensure compliance with such maximum
error rate and, in the event of noncompliance, will promptly remedy the
causes thereof.'' \646\ Rule 613(e)(6)(ii) states that the NMS plan
shall ``[r]equire the central repository to measure the error rate each
business day and promptly take appropriate remedial action, at a
minimum, if the error rate exceeds the maximum error rate specified in
the plan.'' Rule 613(e)(6)(iii) and (iv) provide that the NMS plan
shall ``[s]pecify a process for identifying and correcting errors in
the data reported to the central repository pursuant to [Rule 613(c)(3)
and (c)(4)], including the process for notifying the national
securities exchanges, national securities associations, and members who
reported erroneous data to the central repository about such errors, to
help ensure that such errors are promptly corrected by the reporting
entity, and for disciplining those who repeatedly report erroneous
data; and * * * [s]pecify the time by which data that has been
corrected will be made available to regulators.'' \647\
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\645\ See Aditat Letter, p. 2; FIF Letter, p. 4; FINRA Letter,
p. 11; Nasdaq Letter I, p. 8.
\646\ See Rule 613(e)(6)(i). The term ``error rate'' is defined
in Rule 613(j)(6) to mean ``[t]he percentage of reportable events
collected by the central repository in which the data reported does
not fully and accurately reflect the order event that occurred in
the market.'' The SROs should consider calculating an aggregate
error rate as well as error rates for subcategories such as trade
reporting and quote reporting.
\647\ See Rule 613(e)(6)(iii) through (iv).
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As noted above, the Commission believes the availability of
accurate consolidated data is a critical component of a useful and
effective audit trail. Ideally, there would be no errors in the
recording or reporting of any audit trail data element, and every data
element of every reportable event would be accurately recorded by the
SROs and their members, and then accurately reported to the central
repository under Rule 613, resulting in a consolidated audit trail that
reflects all actions relating to every order in the market for
securities. However, because the Commission understands that, to some
extent, errors in reporting audit trail data to the central repository
will occur, the Commission believes it is appropriate to adopt a
provision in Rule 613 that requires the NMS plan to set forth the
maximum error rate to be tolerated by the central repository in the
reporting of audit trail data, as well as to specify a process for
identifying and correcting such errors.\648\
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\648\ See Rule 613(e)(6).
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The Commission notes that the Rule leaves to the plan sponsors the
ability to determine the acceptable maximum error rate, although the
Rule does require that the NMS plan must explain the basis for
selecting such rate. The Rule also requires the NMS plan submitted to
the Commission for its consideration to set forth how the plan sponsors
will seek to reduce such maximum error rate over time, thereby
increasing the accuracy of audit trail data. Further, the Rule requires
the NMS plan to have in place a means to ensure compliance with the
maximum error rate so that SROs and their members are incentivized to
comply with the maximum error rate, and to set forth a plan for
promptly remedying the causes for any noncompliance.
Since the Rule leaves many of the specific details regarding error
rates and error-correction processes for the plan sponsors to
determine, and because the accuracy and completeness of data ultimately
received by regulators is of such significance to the effective use of
a consolidated audit trail, the Commission, as well as the public,
would likely consider such details very important in their overall
evaluation of the submitted plan. Furthermore, given that the approval
of any plan by the Commission would, in part, be based on expectations
of maximum error rates, the Commission believes it is equally important
for objective measures to be reported that track how well the plan is
meeting such expectations. Thus, to ensure the accuracy of the audit
trail data generally meets these expectations, Rule 613(e)(6)(ii) also
requires that the error rate identified in the NMS plan be measured
each business day and that remedial action be taken if, on any given
day, the error rate exceeds the maximum error rate set forth in the NMS
plan.\649\
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\649\ The Commission recognizes that in any complex system there
is always a risk of occasional unexpected errors, or errors caused
by rare and unexpected events. However, the Commission believes
that, by tracking error rates on a daily basis, the SROs, and the
Commission would be able to observe any repeated patterns or longer-
term trends that suggest more systematic problems or concerns with
data collection, reporting, or consolidation processes.
---------------------------------------------------------------------------
The Commission also believes it is appropriate to require the SROs
to formulate a process for identifying and dealing with errors, and to
require that the SROs or the members reporting erroneous data be
notified that an error
[[Page 45780]]
in reporting has occurred.\650\ In addition, the Commission believes it
is appropriate to require the SROs to develop a process to help ensure
that errors are promptly corrected by the reporting SRO or member. The
Commission understands that requirements similar to these are currently
implemented by FINRA as part of their OATS process, though cross-firm
errors, such as those leading to irreconcilable or unmatched routes,
are not generally corrected under the OATS process.\651\ The Commission
further believes that disciplining SROs and members that repeatedly
report erroneous audit trail data, as required by Rule 613(e)(6)(iii),
is appropriate given the need to maintain an accurate consolidated
audit trail for regulatory purposes. Finally, given that the NMS plan
submitted to the Commission for its consideration is required to
specify a process for correcting errors, the Commission also believes
it is appropriate to require, pursuant to Rule 613(e)(6)(iv), that the
NMS plan submitted to the Commission for its consideration specify the
time by which data that has been corrected will be made available to
regulators. In reviewing the NMS plan submitted for its consideration,
the Commission will therefore be able to consider the time that
uncorrected but consolidated data (which was reported to the central
repository by 8:00 a.m. Eastern Time on the trading day following the
day such information was recorded) would be available for use by
regulators, the expected error rate of this data, and the time at which
a corrected version of this data would be made available to regulators.
These three parameters will help inform regulators as to the potential
effectiveness of starting different types of surveillance and
monitoring activities at different times.\652\
---------------------------------------------------------------------------
\650\ See Rule 613(e)(6)(iii) through (iv).
\651\ See Commission Staff Memorandum, supra note 64.
\652\ See Rule 613(a)(1)(ii).
---------------------------------------------------------------------------
The Commission acknowledges there would be costs to the central
repository associated with developing policies and procedures related
to the timeliness, accuracy, integrity, and completeness of data,
including, but not limited to, processes for identifying and correcting
errors in the audit trail data received, and measuring the error rate
on a daily basis. However, the size of these costs depends
significantly on the specific details of the NMS plan submitted to the
Commission for its consideration. Once the SROs submit the NMS plan to
the Commission for its consideration specifying the details,
parameters, and estimated costs of such processes, as well as the
maximum error rate expected under such processes, the Commission and
the public will be able to consider this information when determining
whether to approve the NMS plan.
d. Access to the Central Repository and Consolidated Audit Trail Data
for Regulatory and Oversight Purposes
As proposed, each national securities exchange and national
securities association, as well as the Commission, would have had
access to the central repository for the purposes of performing its
respective regulatory and oversight responsibilities pursuant to the
federal securities laws, rules, and regulations.\653\ This access would
have included all systems of the central repository, and the data
reported to and consolidated by the central repository.\654\ In
addition, the Commission proposed to require that the NMS plan include
a provision requiring the creation and maintenance by the central
repository of a method of access to the consolidated data.\655\ This
method of access would have been required to be designed to include
search and reporting functions to optimize the use of the consolidated
data. The Commission requested comment on whether it should allow the
consolidated audit trail data to be made available to third parties,
such as for academic research.
---------------------------------------------------------------------------
\653\ See proposed Rule 613(e)(2).
\654\ Id.
\655\ See proposed Rule 613(e)(3).
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One commenter supported limiting access to the consolidated audit
trail data to the Commission and SROs for regulatory purposes, but
suggested it would also be appropriate to share the data with the
CFTC.\656\ Other commenters supported the idea of providing
``anonymized'' data for academic use, as long as appropriate controls
were established to assure regulators and market participants that
confidential trading information could not be revealed.\657\
Specifically, one commenter endorsed the use of the data ``with
appropriate safeguards'' by academic researchers, explaining that it
will ``promote understanding of the markets,'' and ``lead to better
policy decisions and thus more fair and orderly markets.'' \658\
Similarly, another commenter also supported the use of the data by
certain third parties and stated that ``[a]ccess to real-world data can
help research immensely.'' \659\
---------------------------------------------------------------------------
\656\ See Liquidnet Letter, p. 8-9. See also SIFMA Letter, p.
19.
\657\ See Angel Letter, p. 3; Albany Letter, p.1-4; and TIAA-
CREF Letter, p.4.
\658\ See Angel Letter, p. 3.
\659\ See Albany Letter, p. 1-3. This commenter acknowledged the
privacy concerns involved in making the data available for academic
research, but stated that researchers have faced similar challenges
before and researchers are capable of developing a way to access and
share information without the risk of divulging trading strategies
or identities. The commenter also stated that data released after a
delay would limit the data's usefulness.
---------------------------------------------------------------------------
The Commission also received a comment that argued for extending
access to the consolidated audit trail data to certain individuals who
have a fiduciary responsibility to shareholders of a company. This
commenter explained that such access would allow them to audit all
trading activity in the equity or other derivative securities of that
company.\660\
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\660\ See Van Bokkelen Letter, p. 1.
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The Commission recognizes there may be certain benefits to the
types of expanded access to data in the central repository that has
been suggested by various commenters, but, for the reasons discussed
below, it is adopting the provisions in Rule 613 regarding access by
regulatory authorities at the SROs and the Commission to the systems
operated by the central repository, and to the data received,
consolidated, and retained by the central repository, substantively as
proposed in Rule 613(e)(3), but with one clarification regarding the
requirement for access by regulators.\661\ Specifically, Rule
613(e)(3), as adopted, provides that ``[t]he national market system
plan submitted pursuant to this section shall include a provision
requiring the creation and maintenance by the plan processor of a
method of access to the consolidated data stored in the central
repository that includes the ability to run searches and generate
reports.'' As proposed, Rule 613(e)(3) would have provided that the
central repository must have a ``reporting function.'' The Commission
believes that this language is ambiguous and may have implied that the
central repository was required to do more than respond to search
queries. Accordingly, the Commission is replacing the requirement in
proposed Rule 613(e)(3) that the central repository provide ``search
and reporting functions'' with the requirement that there be ``the
ability to run searches and generate reports.'' The change in language
from that contained in the Rule, as proposed, is not intended to
[[Page 45781]]
change the substance of the requirement.
---------------------------------------------------------------------------
\661\ See Rule 613(e)(3). See also Rule 613(a)(1)(ii) (requiring
the NMS plan to detail how readily the NMS plan will allow data in
the central repository to be accessed by regulators, as well as the
regulators' manner of access); see also Section III.C.2.a.i., infra.
---------------------------------------------------------------------------
In response to the commenter who suggested sharing data with the
CFTC, the Commission notes that it has shared information with the CFTC
in the past and that it intends to continue sharing information when
the situation so warrants. The Commission notes that, among other
arrangements, it currently has information-sharing agreements with
other regulators. The Commission also agrees with commenters that there
may be benefits to allowing academics or other third parties to have
access to data collected by the central repository. Academic and other
third-party analyses are helpful to the Commission in performing its
own evaluation of the economic costs and benefits of regulatory policy.
The Commission also notes that one commenter believes that the ability
of companies to detect manipulative trading activity in their
securities could be enhanced if certain individuals, who have a
fiduciary responsibility to shareholders, were given access to limited
consolidated audit trail data. However, because the creation and
implementation of the consolidated audit trail is in the formative
stage, and in light of commenters' concerns about the privacy and
security of the information, the Commission believes it is premature to
require that the NMS plan require the provision of data to third
parties.
Though the Commission is not specifying a particular process, or
any details, regarding the mechanism(s) by which regulators will access
data in the central repository, the Rule requires the SROs to provide
such details and cost estimates in its NMS plan submitted to the
Commission for its consideration.\662\ Further, as discussed below in
Section III.C.2.c., the Commission is providing the SROs with detailed
regulator use cases for how regulators would likely make use of the
data in the central repository. These regulator use cases are designed
to help the SROs respond with sufficient details in the NMS plan
submitted to the Commission for its consideration so that, along with
associated cost estimates also required to be provided by the SROs, the
Commission and the public will be able to fully consider the NMS plan
submitted.
---------------------------------------------------------------------------
\662\ See Sections III.C.2.a.i through ii., infra; Rule
613(a)(1)(ii) through (vii).
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e. Confidentiality of Consolidated Data
Rule 613(e)(4)(i), as proposed, would have required that the NMS
plan include policies and procedures, including standards, to be used
by the plan processor to ensure the security and confidentiality of all
information reported to, and maintained by, the central repository. The
plan sponsors and employees of the plan sponsors and central repository
would have been required to agree to use appropriate safeguards to
ensure the confidentiality of such data, and not to use such data other
than for surveillance and regulatory purposes.\663\ As proposed, Rule
613 also would have required the NMS plan to include mechanisms to
ensure compliance by the plan sponsors and their members with the
requirements of the plan.\664\
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\663\ See proposed Rule 613(e)(4)(i). However, a plan sponsor
also would be permitted to use the data it submits to the central
repository for commercial or other purposes as otherwise permitted
by applicable law, rule or regulation. Id.
\664\ See proposed Rule 613(h)(3), Rule 613(g)(4).
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In the Proposing Release, the Commission solicited comments
regarding what steps should be taken to ensure appropriate safeguards
with respect to the submission of customer information, as well as the
receipt, consolidation, and maintenance of such information in the
central repository. The Commission requested comment on the issue of
appropriate safeguards to be put in place by the SROs and the central
repository to help ensure confidentiality. The Commission also asked
whether the proposed Rule should: (1) Require that SROs put in place
specific information barriers or other protections to help ensure that
data is used only for regulatory purposes; (2) provide for an audit
trail of the SROs' personnel access to, and use of, information in the
central repository to help monitor for compliance with appropriate
usage of the data; and (3) include a requirement that the NMS plan
include policies and procedures to be used by the plan processor to
ensure the security and confidentiality of information reported to, and
maintained by, the central repository be expanded to include the
content of any searches or queries performed by the SROs or the
Commission on the data.\665\
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\665\ See Proposing Release, supra note 4, at 32582.
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Several commenters expressed concern about how to best ensure the
confidentiality of the data collected.\666\ One commenter generally
argued that safeguards for the audit trail data had not been
sufficiently addressed in the Proposing Release.\667\ Another commenter
recommended that the operator of the central repository and the SROs be
required to implement security policies, processes, and practices
consistent with industry best practices for the protection of sensitive
information and that such policies, processes, and practices be audited
on an annual basis by a third-party expert.\668\ Similarly, one
commenter suggested that vendors also should implement best practices
with regard to security, reliability, and integrity of data.\669\
Another commenter stated that SROs should be subject to the same
privacy and data protection standards as those to which broker-dealers
are subject, and that SRO members should not be held responsible, and
be indemnified by the SROs, for any breaches of customer or firm
information.\670\
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\666\ See Scottrade Letter, p. 2 (expressing concern that
trading strategies and confidential customer information could be at
risk from cyber-attacks or accidental data breaches); ICI Letter, p.
2-4; Ross Letter, p. 1; Liquidnet Letter, p. 4. See also Ameritrade
Letter, p. 3; Thomson Reuters Letter, p. 4; BATS Letter, p. 3;
Managed Funds Association Letter, p. 2-3.
\667\ See Ameritrade Letter, p. 3-4.
\668\ See Liquidnet Letter p. 4.
\669\ See Thomson Reuters Letter, p. 4.
\670\ See TIAA-CREF Letter, p. 4.
---------------------------------------------------------------------------
One commenter offered several specific recommendations for
enhancing the security of audit trail information.\671\ This commenter
suggested that the Commission should expressly state who would have
access to the data, when they could access it, and how they could use
it, and further recommended that all data sent to the central
repository be encrypted, and that certain fields be ``masked'' or be
subject to delayed end-of-day reporting.\672\ In addition, this
commenter suggested that the Commission and each SRO should adopt a
robust information security program, and that the Commission should
explain how it intends to treat requests for audit trail data.\673\
---------------------------------------------------------------------------
\671\ See ICI Letter, p. 2-4.
\672\ Id. at 3.
\673\ Id.
---------------------------------------------------------------------------
Another commenter suggested that the Rule more explicitly enunciate
permissible and impermissible uses of the consolidated audit trail and
suggested including a requirement regarding the SROs' personnel access
to and use of audit trail data, as well as a commitment by the
Commission to review each SRO with respect to the adequacy of
information barriers.\674\ Similarly, a commenter suggested that access
to audit trail data be limited to employees of regulators whose
function is to monitor and surveil that market.\675\ This commenter
supported the restriction that consolidated audit trail
[[Page 45782]]
data only be used for regulatory purposes.\676\
---------------------------------------------------------------------------
\674\ See BATS Letter, p. 3.
\675\ See Managed Funds Association Letter, p. 2-3.
\676\ Id.
---------------------------------------------------------------------------
One commenter asked how and at what level customer data would be
encrypted.\677\ This commenter listed specific aspects of data
encryption that would need to be addressed, and noted that potential
burdens could be associated with encryption.\678\ Finally, one
commenter recommended that the Commission express its intention to
withhold audit trail data from the public pursuant to Freedom of
Information Act (``FOIA'') \679\ exemptions.\680\
---------------------------------------------------------------------------
\677\ See Ross Letter, p. 1.
\678\ Id.
\679\ 5 U.S.C. 552.
\680\ See ICI Letter, p. 4.
---------------------------------------------------------------------------
The Commission considered the concerns expressed by commenters
about the sensitivity of much of the information that will be
consolidated by the central repository, and believes that maintaining
the confidentiality of customer and other information reported to the
central repository is essential. Without adequate protections, market
participants would risk the exposure of highly-confidential information
about their trading strategies and positions.
The Commission notes that it currently has controls and systems for
its own use and handling of audit trail information. Nevertheless,
given the sensitivity of certain information that will be produced by
the consolidated audit trail--as well as the fact that such information
should be more readily available and provided in a more usable format
than existing audit trail information--the Commission intends to review
the controls and systems that it currently has in place for the use and
handling of audit trail information. The Commission further intends to
evaluate whether any additional controls and systems may be required to
adequately protect the sensitive information provided to it under the
consolidated audit trail.\681\
---------------------------------------------------------------------------
\681\ For example, appropriate confidentiality protections will
need to be programmed in any Commission systems that collect, store,
or access data collected from the central repository. In addition,
it may be appropriate to establish multiple access levels for
Commission staff so that staff members are allowed only as much
access as is reasonably necessary in connection with their duties.
---------------------------------------------------------------------------
In addition, adopted Rule 613(e)(4)(i) requires that the NMS plan
include policies and procedures that are designed to ensure
implementation of the privacy protections that are necessary to assure
regulators and market participants that the NMS plan provides for
rigorous protection of confidential information reported to the central
repository. Specifically, adopted Rule 613(e)(4)(i)(A) requires that
``[a]ll plan sponsors and their employees, as well as all employees of
the central repository, agree to use appropriate safeguards to ensure
the confidentiality of such data and agree not to use such data for any
purpose other than surveillance and regulatory purposes, provided that
nothing in [Rule 613(e)(4)(i)(A)] shall be construed to prevent a plan
sponsor from using the data that it submits to the central repository
for regulatory, surveillance, commercial, or other purposes as
otherwise permitted by applicable law, rule, or regulation.'' Further,
in response to a comment,\682\ adopted Rule 613(e)(4)(i)(B) adds the
requirement to the Rule, as proposed, that the plan sponsors adopt and
enforce rules that: (1) Require information barriers between regulatory
staff and non-regulatory staff with regard to access and use of data in
the central repository, and (2) permit only persons designated by plan
sponsors to have access to the data in the central repository.\683\ In
addition, the Commission is modifying the Rule, as proposed, to require
that the plan processor must: (1) develop and maintain a comprehensive
information security program, with dedicated staff, that is subject to
regular reviews by the central repository's CCO, (2) require the
central repository to have a mechanism to confirm the identity of all
persons permitted to access the data, and (3) maintain a record of all
instances where such persons access the data.\684\
---------------------------------------------------------------------------
\682\ See ICI Letter, p. 3
\683\ Rule 613(e)(4)(i)(B); see ICI Letter, p. 3 (recommending
that ``the confidential nature of the information supports limiting
access to the CAT data to regulators and repository staff'').
\684\ See Rule 613(e)(4)(i)(C). The Commission expects that the
central repository's CCO would be responsible for determining the
frequency of these regular reviews in the first instance, in
accordance with industry standards for the review of information
security, taking into account the sensitivity of the data stored in
the central repository. See Rule 613(b)(5) for a description of the
CCO.
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The Commission believes these provisions should create a framework
for the SROs to establish a thorough and exacting process for helping
ensure the continued effectiveness of the confidentiality safeguards.
Further, the Commission believes these additional provisions are
appropriate because they clarify the types of confidentiality
safeguards that the NMS plan submitted to the Commission for its
consideration must have to preserve the confidentiality of the
information that is received, consolidated, and retained by the central
repository. The provision requiring information barriers is designed
to, for example, protect and prevent audit trail data, which are to be
used only for regulatory purposes, from being communicated to any
personnel at an SRO that are engaged in non-regulatory or business
activities. Additionally, the Rule's requirement that policies and
procedures submitted as part of the NMS plan provide that: (i) Only
persons designated by the plan sponsors have access to the central
repository data, (ii) the plan processor have a mechanism to confirm
the identity of all persons permitted access to the data, and (iii) the
plan processor maintain a record of all instances where such persons
access the data. These provisions are designed to assure regulators and
market participants that only designated persons are allowed access to
the consolidated audit trail data, and that the central repository will
have a method to track such access. With respect to the commenter that
suggested the Commission more explicitly enunciate permissible and
impermissible uses of the consolidated audit trail,\685\ the Commission
notes that any security and confidentiality provisions included in the
NMS plan approved by the Commission will be subject to the Commission's
inspection and examination program of SROs to ensure that they are
implemented fairly in a manner consistent with the Exchange Act.\686\
---------------------------------------------------------------------------
\685\ See BATS Letter, p. 3. See also Managed Funds Association
Letter, p. 2-3.
\686\ The Commission notes that, as part of its inspection and
examination program, its staff has the authority to examine the
application of any security and confidentiality provisions in the
NMS plan to determine whether they have been applied fairly. In this
manner, the Commission will be able to monitor how the plan sponsors
have applied any such provisions set out in the NMS plan approved by
the Commission, and whether their uses of the consolidated audit
trail were consistent with the plan and the Exchange Act.
---------------------------------------------------------------------------
The Commission believes that an outline or overview description of
the policies and procedures that would be implemented under the NMS
plan submitted to the Commission for its consideration would be
sufficient to satisfy the requirement of the Rule. The Commission
believes it is important for the NMS plan submitted to the Commission
to establish the fundamental framework of these policies and
procedures, but recognizes the utility of allowing the plan sponsors
flexibility to subsequently delineate them in greater detail with the
ability to make modifications as needed.
The Commission considered the comment that asked when and at what
level customer information would be encrypted.\687\ The Commission
notes
[[Page 45783]]
that, while Rule 613 does not require that this information be
encrypted, the Rule contains several safeguards, discussed in this
section, to ensure the privacy and confidentiality of the audit trail
data. Based on these provisions,\688\ the Commission believes that plan
sponsors would need to make sure customer information is protected,
which could be accomplished by data encryption, if they so choose.
Additionally, the Commission notes that the unique customer identifier
is only reported once to the central repository--by the broker-dealer
that is either originating the order or is the original recipient of
the order. Because the unique customer identifier does not travel with
the order as it is routed to other market participants, only the
originating broker-dealer should be able to determine the identity of
the customer of the order. The Commission considered the comment that
recommended that the Commission express its intention to withhold audit
trail data from the public pursuant to FOIA.\689\ The adopted Rule
places no affirmative obligations on the Commission to provide
information to any third parties. Further, the Commission believes
there are bases under FOIA to withhold customer information, including
5 U.S.C. 552(b)(4) (trade secrets, commercial or financial
information), 5 U.S.C. 552(b)(6) (personal information affecting an
individual's privacy), and 5 U.S.C. 552(b)(8) (records related to
examinations of financial institutions). The Commission intends to
assert all appropriate exemptions in response to a FOIA request for
information related to the consolidated audit trail's customer
information.
---------------------------------------------------------------------------
\687\ See Ross Letter, p. 1.
\688\ Specifically, adopted Rule 613(e)(4) requires the NMS plan
to include policies and procedures, including standards, to be used
by the plan processor to ensure the security and confidentiality of
all information submitted to the central repository. In addition,
one of the considerations the NMS plan must address is how the
security and confidentiality of all information, including customer
information, submitted to the central repository, will be ensured.
See Rule 613(a)(1)(iv).
\689\ See ICI Letter, p. 4.
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The Rule, as adopted, also states that the NMS plan must require
the SROs to adopt penalties for non-compliance with any policies and
procedures of the plan sponsors or central repository, described above,
with respect to information security.\690\ The Commission believes this
provision is appropriate because it provides an incentive to SROs to
comply with the central repository's information security program. The
Commission encourages SROs to include in their comprehensive
information security program developed and maintained by the plan
processor provisions for notifying any customer or other market
participant whose information may have been compromised by a security
breach, so that appropriate remedial steps may be taken.
---------------------------------------------------------------------------
\690\ See Rule 613(e)(4)(i)(D).
---------------------------------------------------------------------------
Additionally, given the importance of the security of data
consolidated in the central repository, and in response to the
commenter who recommended an annual third-party audit of the security
of the central repository,\691\ the Commission has added Rule 613(e)(5)
to require the NMS plan submitted to the Commission for its
consideration to address whether there will be an annual, independent
evaluation of the security of the central repository and (1) if so,
provide a description of the scope of such planned evaluation, and (2)
if not, provide a detailed explanation of the alternative measures for
evaluating the security of the central repository that are planned
instead. As with most information technology systems, the central
repository's system will include measures to assure regulators and
market participants of the security of the system. An independent
evaluation of the security of the central repository could aid the
central repository in identifying and correcting potential areas of
weakness or risk. While the Commission is leaving it to the plan
sponsors to determine whether the NMS plan will require an annual
audit, given the confidential nature of information that will be stored
at the central repository, the Commission believes that the NMS plan
submitted to the Commission for its consideration must, at a minimum,
address whether such an audit is appropriate.
---------------------------------------------------------------------------
\691\ See Liquidnet Letter, p. 4.
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The Commission also notes that, as discussed below,\692\ it is
adding a specific provision that requires the NMS plan submitted to the
Commission for its consideration to discuss the security and
confidentiality of the information reported to the central
repository.\693\ With this information, the Commission, as well as the
public, will be able review in detail how the NMS plan proposes to
ensure the security and confidentiality of such information in deciding
whether to approve the NMS plan.
---------------------------------------------------------------------------
\692\ See Section III.C.2.a.i., infra.
\693\ See Rule 613(a)(1)(iv).
---------------------------------------------------------------------------
The Commission believes that, collectively, these provisions are
appropriate because of the confidential and commercially valuable
information that the central repository will contain. The Commission
believes that the purpose and efficacy of the consolidated audit trail
would be compromised if the Commission, the SROs and their members
could not rely on the confidentiality and security of the information
stored in the central repository. The Commission acknowledges there
would be costs associated with a comprehensive information security
program, including, but not limited to, compensating a CCO and a
dedicated staff, and establishing policies and procedures, as well as
for an annual, independent evaluation of the central repository's
security (if such an evaluation is required by the NMS plan submitted
to the Commission for its consideration) or alternative measures (if
such an evaluation is not). Once the SROs have submitted the NMS plan
to the Commission that, as required, contains details about the
security and confidentiality of the audit trail data, the Commission
and the public will be able to consider this information when
evaluating the NMS plan.
3. Other Required Provisions of the NMS Plan
a. Compliance With the NMS Plan
1. Exchanges and Associations
As proposed, Rule 613(h) would have provided that each plan sponsor
shall comply with the provisions of an NMS plan submitted pursuant to
the proposed Rule and approved by the Commission.\694\ In addition, the
proposed Rule would have provided that any failure by a plan sponsor to
comply with the provisions of the NMS plan could be considered a
violation of the proposed Rule.\695\ The proposed Rule also would have
required that the NMS plan include a mechanism to ensure compliance by
the sponsors with the requirements of the plan.\696\
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\694\ See proposed Rule 613(h)(1).
\695\ See proposed Rule 613(h)(2).
\696\ See proposed Rule 613(h)(3).
---------------------------------------------------------------------------
One commenter expressed concern that there would be competitive
implications if the NMS plan were to include provisions that would
permit SROs to assess penalties against one another for non-
compliance.\697\ This commenter recommended, instead, that the NMS plan
include a ``fee recoupment'' provision so the plan administrator could
recoup costs incurred as a result of an error by a particular SRO.\698\
The commenter maintained that a ``fee recoupment'' provision, coupled
with the risk of Commission disciplinary action for a ``pattern or
practice'' of non-
[[Page 45784]]
compliance, would be a sufficient penalty.\699\
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\697\ See Nasdaq Letter I, p. 13.
\698\ Id.
\699\ Id.
---------------------------------------------------------------------------
After considering the comment received on the issue of compliance
with the NMS plan by exchanges and associations,\700\ the Commission is
adopting Rule 613(h) substantially as proposed, with a modification to
Rule 613(h)(3) to specify that a mechanism to ensure compliance by the
sponsors of the NMS plan with the requirements of the plan ``may
include penalties where appropriate'' and a technical modification to
proposed Rule 613(h)(1) and (2).\701\ The Commission believes that
specifying that the mechanism to ensure compliance by the sponsors of
the NMS plan may include a penalty provision where appropriate provides
the plan sponsors with an appropriate tool--including potential
disciplinary action--to help ensure compliance by SROs with the terms
and provisions of the NMS plan.\702\ The Commission notes that a
penalty provision could provide an incentive for each SRO to comply
with all the provisions of the NMS plan because each SRO will seek to
avoid incurring any penalty under the Rule. The incentive to avoid a
penalty could also reduce the risk of non-compliance with the Rule. The
Commission notes, however, that the adopted Rule does not mandate that
the NMS plan's enforcement mechanism include penalties, as there might
be other mechanisms to enforce or encourage compliance with the Rule,
and the Commission believes that the SROs, in the first instance,
should design such mechanisms in their role as plan sponsors. However,
the Commission expects that if the SROs design compliance mechanisms
that do not incorporate penalties, they would explain in the NMS plan
how such mechanisms are expected to help ensure compliance by SROs with
the terms and provisions of the NMS plan.\703\
---------------------------------------------------------------------------
\700\ Id.
\701\ This technical modification simplifies the language of
Rule 613(h)(1) and (2) from the proposal. Adopted Rule 613(h)(1) and
(2) deletes the language ``submitted pursuant to this section'' and
``of which it is a sponsor.'' Adopted Rule 613(h)(1) and (2), like
the proposed Rule, requires each SRO to comply with the provisions
of the NMS plan ``approved by the Commission.'' Because each SRO
will be a member of the NMS plan approved by the Commission, it is
not necessary to include the phrases not adopted.
\702\ Any such provision would be subject to notice and comment
pursuant to Rule 608 of Regulation NMS.
\703\ The Commission notes that any failure by a national
securities exchange or national securities association to comply
with the provisions of the NMS plan approved by the Commission will
be considered a violation of Rule 613, and that the Commission could
take appropriate steps to address such a violation, including
imposing penalties as appropriate. See Rule 613(h)(2).
---------------------------------------------------------------------------
With respect to the comment concerning the potential competitive
implications of allowing the plan sponsors to impose penalties against
each other for non-compliance, the Commission notes that it will
carefully review the NMS plan submitted for its consideration,
including any proposed mechanisms to help ensure compliance with the
NMS plan and the adopted Rule, to help ensure that penalty provisions,
if any, are designed to be applied fairly and in a manner consistent
with the Exchange Act.\704\ As the central repository will be a
facility \705\ of the SROs, the rules governing it must be consistent
with the Exchange Act. In addition, any future amendment to the penalty
provisions applicable to the SROs would either be reviewed as an
amendment to the NMS plan (effected through public notice and comment
and taking into account the relevant considerations contemplated by
Rule 613(a)(1)) or, because the central repository is a facility of the
SROs, as a proposed rule change of the central repository under Section
19 of the Exchange Act.
---------------------------------------------------------------------------
\704\ See Section III.B.2.a., supra.
\705\ See supra note 581 (describing the nature of a
``facility'').
---------------------------------------------------------------------------
The Commission notes that the Commission's examination authority
under Section 17 of the Exchange Act \706\ extends to the central
repository because it is a facility of the SROs and, thus, the
Commission will have the opportunity to inspect the central repository
and its books and records for compliance with any penalty provisions
set out in the NMS plan. Additionally, the Commission has the authority
to review any actions taken under the NMS plan, pursuant to Rule
608(d)(1) of Regulation NMS,\707\ for burdens on competition, among
other matters.\708\
---------------------------------------------------------------------------
\706\ 15 U.S.C. 78q.
\707\ 17 CFR 242.608(d)(1).
\708\ Id.
---------------------------------------------------------------------------
In response to the comment suggesting a ``fee recoupment''
provision in the NMS plan, the Commission notes that Rule 613(b)(4), as
adopted, provides that ``[t]he national market system plan submitted
pursuant to this section shall include a provision addressing the
manner in which the costs of operating the central repository will be
allocated among the national securities exchanges and national
securities associations that are sponsors of the plan, including a
provision addressing the manner in which costs will be allocated to new
sponsors to the plan.'' In this regard, to the extent a ``fee
recoupment'' is a method for recouping costs incurred by the central
repository as a result of an error in reporting to the consolidated
audit trail, as stated by a commenter,\709\ the Commission notes that,
pursuant to Rule 613(b)(4), the plan sponsors may, if they deem it
appropriate, include a fee recoupment provision in the NMS plan
submitted to the Commission for its consideration.\710\
---------------------------------------------------------------------------
\709\ See Nasdaq Letter I, p. 13.
\710\ Any such provision would be subject to notice and comment
pursuant to Rule 608 of Regulation NMS.
---------------------------------------------------------------------------
2. Members
Proposed Rule 613(g) would have included provisions to subject
members of each SRO to the requirements of Rule 613. Specifically, as
proposed, the Rule would have required each SRO to file with the
Commission, pursuant to Section 19(b)(2) of the Exchange Act \711\ and
Rule 19b-4 thereunder,\712\ a proposed rule change to require its
members to comply with the requirements of the proposed Rule and the
NMS plan.\713\ Further, the proposed Rule directly would have required
each member to (1) collect and submit to the central repository the
information required by the Rule, and (2) comply with the clock
synchronization requirements of the proposed Rule.\714\ The proposed
Rule also would have required that the NMS plan include a provision
that each SRO, by subscribing to and submitting the plan to the
Commission, agrees to enforce compliance by its members with the
provisions of the plan.\715\ Finally, the proposed Rule would have
required the NMS plan to include a mechanism to ensure compliance with
the requirements of the plan by the members of each SRO that is a
sponsor of the NMS plan submitted pursuant to this Rule and approved by
the Commission.\716\
---------------------------------------------------------------------------
\711\ 15 U.S.C. 78s(b)(2).
\712\ 17 CFR 240.19b-4.
\713\ See proposed Rule 613(g)(1). This provision in the
proposed Rule echoes the requirement contained in Rule 608 that
``each self-regulatory organization also shall, absent reasonable
justification or excuse, enforce compliance with any such plan by
its members and persons associated with its members.'' 17 CFR
242.608(c).
\714\ See proposed Rule 613(g)(2).
\715\ See proposed Rule 613(g)(3).
\716\ See proposed Rule 613(g)(4).
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One commenter expressed the view that ``enforcement of [the
consolidated audit trail] . . . should be accomplished through a
policies and procedures rule framework--similar to that of Regulation
NMS. To enforce the rule from a strict liability perspective would
simply be the wrong approach and would result in thousands of technical
[[Page 45785]]
(non-material) violations, which is clearly not the intent of the
rule.'' \717\
---------------------------------------------------------------------------
\717\ See Knight Letter, p. 3.
---------------------------------------------------------------------------
After considering the comment regarding Rule 613's provisions on
compliance with the Rule by members of the SROs, the Commission is
adopting Rule 613(g) substantially as proposed, with technical
modifications to proposed Rule 613(g). These technical modifications
simplify the language of Rule 613(g). Adopted Rule 613(g) does not
include the phrase that applied the requirements therein to each member
of an SRO ``that is a sponsor of the national market system plan
submitted pursuant to this section and approved by the Commission.''
Because each SRO will be a member of the NMS plan approved by the
Commission, it is not necessary to include the deleted language.
In addition, the Commission modified Rule 613(g)(2) as proposed to
provide that, ``[e]ach member of a national securities exchange or
national securities association shall comply with all the provisions of
any approved national market system plan applicable to members.'' This
change requires members to comply with all applicable provisions of the
NMS plan as approved by the Commission instead of with the specific
provisions contained in the Rule relating to recording and reporting
data and clock synchronization since the requirements contained in the
NMS plan may differ or be more specific than the requirements stated in
the Rule.
To be in compliance with the NMS plan, members must record and
report all data elements required by the NMS plan within the time
specified in the plan. To this end, the plan sponsors must develop a
way to ensure that each member that takes action with respect to an
order (e.g., originates, receives, routes, modifies, cancels or
executes an order) records and reports all required elements associated
with a reportable event, as the plan sponsors must also develop a
mechanism to address any lapses in compliance with the NMS plan with a
goal of ensuring the central repository is receiving a complete record
of the life of an order.
The Commission does not agree with the commenter that believed that
enforcement of the consolidated audit trail will necessarily ``result
in thousands of technical (non-material) violations, which is clearly
not the intent of the rule.'' \718\ The Commission notes that the
adopted Rule does not address the means of achieving compliance with
the requirements of the consolidated audit trail. Rather, adopted Rule
613(g) simply provides that the SROs must submit proposed rule changes
to require their members to comply with the requirements of an NMS plan
approved by the Commission.
---------------------------------------------------------------------------
\718\ See Knight Letter, p. 3.
---------------------------------------------------------------------------
The Commission acknowledges there would be costs to the SROs for
filing with the Commission proposed rule changes to require their
members to comply with Rule 613 and the NMS plan approved pursuant
thereto. The Commission, however, believes that the Rule should include
these rule filing requirements for the reasons discussed above.
b. Operation and Administration of the NMS Plan
Proposed Rule 613(b) sets forth requirements concerning the
operation and administration of the NMS plan. As proposed, Rule
613(b)(1) would have required that the NMS plan include a governance
structure to ensure fair representation of the plan sponsors and
provisions governing the administration of the central repository,
including the selection of a plan processor. Rule 613(b)(2), as
proposed, also would have required the plan sponsors to include in the
NMS plan a provision addressing the requirements for the admission of
new sponsors to the plan and the withdrawal of sponsors from the plan.
In addition, proposed Rule 613(b)(3) would have required the NMS plan
to include a provision addressing the percentage of votes required by
the plan sponsors to effectuate amendments to the plan, and proposed
Rule 613(b)(4) would have required that the plan sponsors develop a
process for allocating among themselves the costs associated with
creating and maintaining the central repository, including a provision
addressing the manner in which such costs would be allocated to
sponsors who join the plan after it has been approved.
Finally, proposed Rule 613(b)(5) would have required the NMS plan
to require the appointment of a CCO to regularly review the operation
of the central repository to assure its continued effectiveness in
light of market and technological developments, and make any
appropriate recommendations to the plan sponsors for enhancement to the
nature of the information collected and the manner in which it is
processed. In the Proposing Release, the Commission stated that it
expected the CCO would establish the procedures necessary to ensure
that the operations of the central repository keep pace with technical
developments and to make any necessary upgrades or changes to the
central repository to maintain its efficacy.\719\
---------------------------------------------------------------------------
\719\ See Proposing Release, supra note 4, at 32585.
---------------------------------------------------------------------------
The Commission received comments addressing the proposed
requirements for operation and administration of the NMS plan.\720\ One
commenter suggested that the NMS plan should contain a voting mechanism
that requires less than unanimity, and with an effective tie breaking
mechanism.\721\ This commenter also recommended that the governance
structure ``limit the ability of individual SROs to make modifications
on a unilateral basis that could escalate costs by forcing the operator
and firms to absorb costs that do not advance the interests of
investors.'' \722\
---------------------------------------------------------------------------
\720\ See Nasdaq Letter I, p. 3, 13; Direct Edge Letter, p. 5;
FIF Letter, p. 1, 8; FINRA Letter, p. 15; SIFMA February 2012
Letter, p. 1.
\721\ See Nasdaq Letter I, p. 3, 13.
\722\ Id. at p. 3.
---------------------------------------------------------------------------
Two commenters expressed views on the selection and role of the
plan processor.\723\ One suggested that the SROs should select the
processor through a ``request for proposal.'' \724\ Another commenter
generally believed that the allocation of plan processor costs
warranted more consideration.\725\ This commenter expressed concern
with regard to the SROs owning the plan processor, noting in particular
that unanimous consent would be required for all board actions.\726\
This commenter stated that the plan processor alone should handle
rulemaking and compliance, subject to oversight by an ``industry
group.'' \727\ Another commenter stated that, ``[r]egarding the
governance of the national market system plan [contemplated] by the
proposal, we wish to reiterate that the SEC should provide the broker-
dealer industry with an official `seat at the table' alongside the
SROs, so that [the broker-dealers] can review and comment on system
requirements as they are being developed and vote on plan amendments
going forward.'' \728\
---------------------------------------------------------------------------
\723\ See FIF Letter, p. 1; Direct Edge Letter, p. 5.
\724\ See FIF Letter, p. 8.
\725\ See Direct Edge Letter, p. 4-5.
\726\ Id. at p. 5.
\727\ Id.
\728\ See SIFMA February 2012 Letter, p. 1.
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After considering these comments, for the reasons discussed below,
the Commission is adopting Rule 613(b) as proposed, but with the
addition of two new requirements. Specifically, in addition to the
provisions included in the proposed rule,\729\ Rule 613(b), as
[[Page 45786]]
adopted, provides that the national market system plan submitted shall
include: ``a provision requiring the plan sponsors to provide to the
Commission, at least every two years after effectiveness of the
national market system plan, a written assessment of the operation of
the consolidated audit trail * * *, [and] an Advisory Committee * * *
includ[ing] representatives of the member firms of the plan
sponsors.''\730\
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\729\ Proposed Rule 613(b) required that the NMS plan include
``a governance structure to ensure fair representation of the plan
sponsors, and administration of the central repository, including
the selection of the plan processor, * * * [a] provision addressing
the requirements for the admission of new sponsors of the plan and
the withdrawal of existing sponsors from the plan, * * * [a]
provision addressing the percentage of votes required by the plan
sponsors to effectuate amendments to the plan, * * * [a] provision
addressing the manner in which the costs of operating the central
repository will be allocated among the national securities exchanges
and national securities associations that are sponsors of the plan,
including a provision addressing the manner in which costs will be
allocated to new sponsors to the plan* * * [and the] appointment of
a Chief Compliance Officer to regularly review the operation of the
central repository to assure its continued effectiveness in light of
market and technological developments, and make any appropriate
recommendations for enhancements to the nature of the information
collected and the manner in which it is processed.''
\730\ See Rule 613(b)(6); Rule 613(b)(7).
---------------------------------------------------------------------------
The requirement that the NMS plan require the appointment of a CCO
to regularly review the operation of the central repository and make
any appropriate recommendations for enhancements \731\ is one method to
facilitate the consolidated audit trail's ability to evolve over time
in terms of technology, functionality, and accuracy. Adopted Rule
613(b)(6) supplements this requirement by now requiring that the NMS
plan ``include a provision requiring the plan sponsors to provide to
the Commission, at least every two years after effectiveness of the
national market system plan, a written assessment of the operation of
the consolidated audit trail. Such document shall include, at a
minimum: (i) [a]n evaluation of the performance of the consolidated
audit trail including, at a minimum, with respect to data accuracy
(consistent with [Rule 613(e)(6)]), timeliness of reporting,
comprehensiveness of data elements, efficiency of regulatory access,
system speed, system downtime, system security (consistent with [Rule
613 (e)(4)]), and other performance metrics to be determined by the
Chief Compliance Officer, along with a description of such metrics;
(ii) [a] detailed plan, based on such evaluation, for any potential
improvements to the performance of the consolidated audit trail with
respect to any of the following: improving data accuracy; shortening
reporting timeframes; expanding data elements; adding granularity and
details regarding the scope and nature of Customer-IDs; expanding the
scope of the NMS plan to include new instruments, and new types of
trading and order activities; improving the efficiency of regulatory
access; increasing system speed; reducing system downtime; and
improving performance under other metrics to be determined by the Chief
Compliance Officer; (iii) [a]n estimate of the costs associated with
any such potential improvements to the performance of the consolidated
audit trail, including an assessment of the potential impact on
competition, efficiency, and capital formation; and (iv) [a]n estimated
implementation timeline for any such potential improvements, if
applicable.'' \732\ The Commission believes these provisions will help
plan sponsors understand and evaluate any deficiencies in the operation
of the consolidated audit trail and to propose potential enhancements
to the NMS plan, as appropriate, taking cost effectiveness into
consideration. These provisions also will allow the Commission to
assess any such potential improvements, accounting for the
considerations contemplated by Rule 613(a)(1), the specific
requirements of the approved NMS plan, and any changes or additions to
these requirements that the Advisory Committee, the SROs, or the
Commission may wish to consider in the future. The Commission believes
that such enhancements, if any, to the consolidated audit trail could
improve the ability of the SROs and the Commission to conduct effective
market oversight by keeping up with continually-changing technologies
and markets, by, for example, allowing the SROs and the Commission to
conduct their market oversight more quickly, accurately, and/or
comprehensively, as well as possibly at lower costs. Similarly, the
Commission believes that adding granularity and details regarding the
scope and nature of Customer-IDs, adding new instruments, or including
new trading or order activities could allow regulators to have a more
complete picture of the markets and market participants, which could
also lead to more effective market oversight. The Commission believes
that performing this assessment no later than every two years is
reasonable given the rapid speed at which the markets and related
technologies are evolving. The Commission also believes that the
written assessment, required by Rule 613(b)(6), will help inform the
Commission about the likely feasibility, costs, and impact of, and the
plan sponsors' approach to, the consolidated audit trail evolving over
time. The Commission would expect to make the document publicly
available on its Web site.
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\731\ See Rule 613(b)(5).
\732\ See Rule 613(b)(6). The written assessment could also
further inform the extent to which it could be appropriate to share
certain information collected by the consolidated audit trail with
third parties. See Section III.B.2.d.
---------------------------------------------------------------------------
In response to the comment requesting that the broker-dealer
industry receive a ``seat at the table'' regarding governance of the
NMS plan,\733\ the adopted Rule requires that the NMS plan submitted to
the Commission for its consideration include a provision requiring the
creation of an Advisory Committee, composed at least in part by
representatives of the members of the plan sponsors, ``to advise the
plan sponsors on the implementation, operation and administration of
the central repository.'' \734\ Further, the adopted Rule requires that
the NMS plan submitted to the Commission for its consideration require
that ``[m]embers of the Advisory Committee shall have the right to
attend any meetings of the plan sponsors, to receive information
concerning the operation of the central repository, and to provide
their views to the plan sponsors.'' \735\ Pursuant to the Rule, the NMS
plan also shall set forth the term and composition of the Advisory
Committee, which composition shall include representatives of the
member firms of the plan sponsor.\736\ The Rule further provides that
the plan sponsors may meet without the Advisory Committee members in
executive session if, by affirmative vote of a majority of the plan
sponsors, the plan sponsors determine that such an executive session is
required.\737\ The Commission believes that, given the scope of the
Rule, both in terms of the market participants that may be affected by
the Rule and the breadth of the audit trail information that will be
collected, it is important that the plan sponsors solicit input from
their members because this could help inform the plan sponsors of any
expected or unexpected operational or technical issues that may arise
in the implementation of the Rule and/or the operation of the central
repository, and help assure the Commission and market participants that
any requirements imposed on SRO members will be
[[Page 45787]]
accomplished in a manner that takes into account the burdens on SRO
members. The Commission believes that the Advisory Committee could
provide members of the SROs with a forum for informing the plan
sponsors of any potential implementation or operational issues faced by
them in connection with the consolidated audit trail. Plan sponsors
also will be able to draw on the knowledge and experience of these
members to help assure the Commission and market participants that any
requirements imposed on SRO members will be accomplished in a manner
that takes into account the costs to SRO members. The Commission also
believes that an Advisory Committee could help foster industry
consensus on how to approach and resolve possible issues that may be
disputed, and approaches that may conflict, regarding operation of the
consolidated audit trail. In this regard, the Commission encourages the
plan sponsors to, in the NMS plan, provide for an Advisory Committee
whose composition includes SRO members from a cross-section of the
industry, including representatives of small-, medium- and large-sized
broker-dealers.
---------------------------------------------------------------------------
\733\ See SIFMA February 2012 Letter, p. 1.
\734\ See Rule 613(b)(7)(i).
\735\ See Rule 613(b)(7)(ii).
\736\ See Rule 613(b)(7)(i).
\737\ See Rule 613(b)(7)(ii).
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The Commission believes the requirement for the NMS plan to create
the Advisory Committee, as well as the requirement in Rule
613(a)(1)(xi), discussed below, that requires the NMS plan to require a
discussion of the process by which the plan sponsors solicited the
views of their members on the creation, implementation, and maintenance
of the consolidated audit trail, a summary of those views, and how the
plan sponsors took those views into account when preparing the NMS
plan, are responsive to commenters' views that more input by industry
representatives, such as members of the SROs who are subject to the
requirements of Rule 613, would be advantageous to the creation,
implementation, and maintenance of the consolidated audit trail.\738\
---------------------------------------------------------------------------
\738\ See Rule 613(a)(1)(xi); Section III.C.2.a.iii.c., infra,
for a discussion of the tenth consideration.
---------------------------------------------------------------------------
In addition, because the members of the Advisory Committee will
have the right to attend all meetings of the plan sponsors (with the
exception of executive sessions), to receive information concerning the
operation of the central repository, and to provide their views to the
plan sponsors, the governance process of the central repository will be
more transparent to all market participants that will be affected by
Rule 613. Further, the Commission believes the inclusion of SRO members
on the Advisory Committee will increase the efficacy of the central
repository. These market participants will have first-hand experience
with the operation of the central repository, as they are required to
report data to the facility, allowing them to provide informed input on
any problems currently facing the central repository of which they are
aware, and on any future actions that the central repository might or
should take to address such problems. Finally, the Commission believes
that an Advisory Committee structure that also permits the plan
sponsors to meet in executive session without members of the Advisory
Committee appropriately balances the need to provide a mechanism for
industry input into the operation of the central repository, against
the regulatory imperative that the operations and decisions regarding
the consolidated audit trail be made by SROs who have a statutory
obligation to regulate the securities markets, rather than by members
of the SROs, who have no corresponding statutory obligation to oversee
the securities markets.
The Commission also considered the comment that provided other
suggestions on the governance of the NMS plan and believes that the
commenter's concerns regarding a unanimity requirement in the NMS plan
have merit.\739\ Accordingly, the Commission urges the SROs to take
into account the need for efficient and fair operation of the NMS plan
governing the consolidated audit trail, and consider the
appropriateness of a unanimity requirement and the possibility of a
governance requirement other than unanimity, or even super-majority
approval, for all but the most important decisions. The Commission
believes that an alternate approach may be appropriate to avoid a
situation where a significant majority of plan sponsors--or even all
but one plan sponsor--supports an initiative but, due to a unanimous
voting requirement, action cannot be undertaken.\740\ Therefore, the
Commission believes the SROs should consider alternative governance
structures that would ensure that decisions made by the SROs are both
achieved and implemented efficiently, in the interest of advancing the
Commission's mission. The Commission notes that the NMS plan submitted
to the Commission for its consideration will be published for public
comment, and industry participants will have an opportunity at that
time to submit comments on the governance structures proposed by the
plan sponsors. Further, the Commission believes, as discussed above,
that unanimity need not be the standard for decision-making with regard
to matters relating to the operation of the consolidated audit trail.
Thus, the plan sponsors have flexibility under the Rule to determine
the governance structures that will facilitate the effective and
efficient oversight of the plan processor.
---------------------------------------------------------------------------
\739\ See Nasdaq Letter I, p. 3, 13.
\740\ See, e.g., Options Order Protection and Locked/Crossed
Market (Securities Exchange Act Release No. 60405 (July 30, 2009),
74 FR 39362 (August 6, 2009)) (including a unanimous voting
requirement).
---------------------------------------------------------------------------
In response to the comments regarding the selection and role of the
plan processor,\741\ the Commission believes that the SROs, as the plan
sponsors of the NMS plan governing the operation of the consolidated
audit trail, should retain the authority to select and oversee the plan
processor. The Commission believes that the SROs are in the best
position to understand how the plan processor should operate and to
address the need for changes when necessary. The SROs also have the
flexibility under the Rule to consult the Advisory Committee, for
example, to assist the SROs in their selection process and in their
determination of whether modifications are necessary to address
innovations in the industry if they believe that such participation is
needed.
---------------------------------------------------------------------------
\741\ See FIF Letter, p. 1; Direct Edge Letter, p. 5.
---------------------------------------------------------------------------
The Commission acknowledges that, in addition to the many costs and
burdens associated with the creation, implementation, and maintenance
of a consolidated audit trail, with regards to the specific
requirements discussed in this section, there would be costs to the
SROs for appointing a CCO to the central repository, providing the
Commission with the written assessment of the operation of the
consolidated audit trail, and creating an Advisory Committee.\742\ For
the reasons discussed above, the Commission believes these requirements
are important to the efficient operation and practical evolution of the
consolidated audit trail, and are responsive to many commenters'
concerns about governance structure, cost allocations, and the
inclusion of SRO members as part of the planning process. The
Commission is therefore requiring the SROs to include these
requirements in the NMS plan submitted to the Commission for its
consideration. After the SROs submit
[[Page 45788]]
the NMS plan, the Commission and the public will have more detailed
information in evaluating the NMS plan.
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\742\ As discussed and for the reasons set forth in Section I.,
supra, in light of the multi-step process for developing and
approving an NMS plan that will govern the creation, implementation,
and maintenance of a consolidated audit trail, the Commission is
deferring a detailed analysis of costs and benefits of this
requirement of the Rule until after the NMS plan has been submitted.
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c. Surveillance
As proposed, Rule 613(f) would have required each SRO subject to
the Rule to develop and implement a surveillance system, or enhance
existing surveillance systems, reasonably designed to make use of the
consolidated audit trail data. The Rule, as proposed, also would have
required each SRO to implement its new or enhanced surveillance system
within fourteen months after the effectiveness of the NMS plan.\743\
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\743\ See proposed Rule 613(a)(3)(iv).
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Commenters generally expressed support for the proposal's
requirement that SROs implement surveillance systems that make use of
the consolidated information.\744\ One commenter stated that the
enhanced surveillance that could be achieved with the audit trail would
likely attract additional trading volume to the U.S. markets and that
the consolidated audit trail would benefit the SROs by permitting them
to conduct surveillance themselves, thus ``reducing their risks and
their costs.'' \745\ Another commenter noted that the proposed
consolidated audit trail would be a ``critical first step toward
consolidated market surveillance,'' and would lower costs for markets
and their participants through economies of scale.\746\ A third
commenter opined that a centralized database such as the consolidated
audit trail is necessary to bring together data from exchanges, ECNs,
and dark pools to properly regulate trading.\747\ However, one
commenter maintained that a ``Commission-mandated market regulator''
would be costly for the securities industry and create the potential
for a lack of surveillance innovation.\748\ A commenter recommended
that the Commission monitor the surveillance systems and provide
guidance to the SROs in establishing their surveillances.\749\ Finally,
one commenter suggested that outsourcing surveillance to regulators
could result in lower costs for markets, and recommended several
specific security and analytical features for such a surveillance
system.\750\
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\744\ See Nasdaq Letter I, p. 10; Thomson Reuters Letter, p. 4.
\745\ See Thomson Reuters Letter, p. 4.
\746\ See FINRA/NYSE Euronext Letter, p. 3-4. See also Nasdaq
Letter I, p. 8.
\747\ See IAG Letter, p. 2.
\748\ See BATS Letter, p. 2-3.
\749\ See Nasdaq Letter I, p. 10.
\750\ See iSys Letter, p. 2-3.
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After considering the comments, for the reasons discussed below,
the Commission is adopting Rule 613(f) as proposed. Specifically, the
Rule requires that each SRO develop and implement a surveillance
system, or enhance existing surveillance systems, reasonably designed
to make use of the consolidated information contained in the
consolidated audit trail.\751\ The Commission believes that it is
appropriate to require SROs to enhance their surveillance programs to
make full use of the increased functionalities and the timeliness of
the consolidated audit trail. Additionally, because trading and
potentially manipulative activities could take place across multiple
markets, the Commission supports efforts to coordinate surveillance
among the SROs, such as through a plan approved pursuant to Rule 17d-2
under the Exchange Act,\752\ or through regulatory services agreements
between SROs. In this regard, as commenters have noted, SROs could
``outsource'' surveillance efforts to another SRO, if there are
efficiencies to be gained. With respect to the comment regarding the
benefits to be gained by creating a ``single market regulator,'' the
Commission believes that mandating such an entity or structure goes
beyond the scope of the Rule.\753\
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\751\ See Rule 613(f).
\752\ 17 CFR 240.17d-2.
\753\ The Commission has examined the issue of a single market
regulator in the past, specifically in the Intermarket Trading
Concept Release (see Securities Exchange Act Release No. 47849 (May
14, 2003), 68 FR 27722 (May 20, 2003)); however, a single regulator
structure is not suggested by the adopted Rule.
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The Commission notes that it intends to review its own surveillance
activities in light of the consolidated audit trail and intends to take
steps to enhance its surveillance capabilities to take advantage of
consolidated audit trail data. The Commission anticipates that such
steps will be informed by--and may in turn help inform--the
surveillance enhancement measures required to be taken by the SROs
under adopted Rule 613(f).
The Commission also is adopting Rule 613(a)(3)(iv) as proposed,
which requires the NMS plan to require each SRO to implement its new or
enhanced surveillance system within fourteen months after the
effectiveness of the NMS plan. Since Rule 613(a)(3)(iii) will require
the NMS plan to require SROs to begin reporting to the central
repository within one year after effectiveness of the NMS plan, the
Commission believes the two additional months provided by this
timeframe is reasonable and sufficient to allow SROs to update their
surveillance systems and allow for testing of new surveillances.
The Commission acknowledges there would be costs to the SROs for
developing and implementing surveillance systems, or enhancing existing
surveillance systems, reasonably designed to make use of the
consolidated audit trail. However, the Commission believes it may be
possible for SROs to retire some of their existing, and perhaps less-
efficient, audit trail and surveillance systems once the consolidated
audit trail is operational. As discussed in Section III.C.a.iv. below,
the adopted Rule requires the SROs to consider and discuss the
potential for costs savings if other SRO systems, and their associated
surveillances, were migrated to the consolidated audit trail.\754\ Once
such information is submitted in the NMS plan submitted to the
Commission for its consideration, the Commission and the public will be
able to consider the information in evaluating the NMS plan.
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\754\ These cost savings may accrue to any SRO that would no
longer need to operate a retired system, as well as to any SRO
members that would no longer be required to report to such systems.
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C. NMS Plan Process
As proposed, Rule 613(a)(1) would have required each SRO to jointly
file on or before 90 days from approval of the Rule an NMS plan to
govern the creation, implementation, and maintenance of a consolidated
audit trail and a central repository. Section III.A. above discusses
the use of an NMS plan to create, implement, and maintain a
consolidated audit trail. This Section focuses on the process the SROs
must follow when submitting to the Commission the NMS plan that
satisfies the requirements discussed in Section III.B. above and the
process the Commission will undergo when evaluating whether to approve
the NMS plan.
1. Comments on the NMS Plan Process
The Commission received several comments regarding how best to
develop an NMS plan that will govern the creation and implementation of
a consolidated audit trail, as well as the time needed to do so.
Several commenters suggested that the Commission undergo a RFP or RFI
process to create a consolidated audit trail.\755\ Specifically, one
commenter suggested that the Commission outline a set of goals it
intends to achieve through creation of a consolidated audit trail and
allow an industry working group to
[[Page 45789]]
determine the data elements that must be reported and other technical
requirements.\756\ Another commenter opined that an RFP process would
facilitate the identification of the costs and benefits of the audit
trail, as well as the consideration of a wider range of technological
solutions.\757\ Further, some commenters requested more specific
information about the audit trail system to determine the best approach
for implementing the consolidated audit trail.\758\
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\755\ See FIF Letter, p. 1, 9; FIF Letter II, p. 1-2; STA
Letter, p. 2; Direct Edge Letter, p. 2-3, 5. See also Section
II.C.3.
\756\ See FIF Letter II, p. 2.
\757\ Id. at p. 3.
\758\ See Broadridge Letter, p. 2; FIF Letter, p. 8. See also
Ross Letter, p. 1 (discussing examples of information security
details to consider); Nasdaq Letter I, p. 6 (stating that the
proposed Rule provided ``incomplete technical information on which
design and features make the most sense'').
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Some of these commenters stressed that more time should be allotted
for the planning and design of the NMS plan due to the comprehensive
business analysis that would be needed in the initial stages of the
consolidated audit trail.\759\ Commenters recommended extensive, ``up-
front business analysis,'' \760\ explaining that if conducted ``during
the CAT plan development process, [they] are confident that issues
would emerge earlier in the process, leading to more efficient and
cost-effective solutions.'' \761\ The commenters believed that the
business analysis would require many discussions involving the
Commission, the SROs and teams comprising members of the securities
industry.\762\ The commenters also suggested that the business analysis
could include an RFI ``to engage potential solution providers early in
the process,'' \763\ and stated that the time needed to perform the
analysis to produce a ``detailed blueprint for CAT'' \764\ would be
closer to six months,\765\ rather than the proposed 90 days.\766\ As a
basis for their suggestions, one of the commenters provided a breakdown
of the time and the types of work needed for FINRA's expansion of OATS
to all NMS securities.\767\ This commenter noted that over one-third of
the time required for the project was spent on conducting business
analysis, and that one-third of the time was spent on project
development.\768\
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\759\ See FIF Letter II, p. 2-3; STA Letter, p. 2. See also
Nasdaq Letter I, p. 6.
\760\ See FIF Letter II, p. 1, 3; STA Letter, p. 1, 3. See also
Nasdaq Letter I, p. 6.
\761\ See FIF Letter II, p. 2; STA Letter, p. 1.
\762\ See FIF Letter II, p. 1; STA Letter, p. 1-2.
\763\ See FIF Letter II, p. 2; STA Letter, p. 2.
\764\ See FIF Letter II, p. 1-2; STA Letter, p. 2.
\765\ See FIF Letter II, p. 2; STA Letter, p. 2-3.
\766\ See proposed Rule 613(a)(1).
\767\ See FIF Letter II, p. 3. The commenter also provided the
cost to the industry for the expansion of OATS to all NMS stocks--
$48 million. The Commission notes that this is the cost for the
project as a whole, not solely for the planning phase, and therefore
is not entirely attributable to the cost of the creation and filing
of the NMS plan required by Rule 613.
\768\ The time remaining was spent on ``testing and other
activities.'' See FIF Letter II, p. 3.
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In addition, some commenters noted that a consolidated audit trail
could be implemented in a number of ways, and thus recommended that the
Commission replace the specific system requirements of the proposed
Rule with more general ``end-user'' requirements, perform an analysis
of how existing audit trail systems do and do not meet the needs of
regulators, and perhaps even engage in a formal RFP process.\769\
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\769\ See Nasdaq Letter I, p. 12; FIF Letter II, p. 2-3; STA
Letter, p. 1-3; Direct Edge Letter, p. 2-3, 5.
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2. Adopted Rule
After considering the comments regarding the NMS plan process, the
Commission is adopting proposed Rule 613(a)(1) with modifications.
First, the Rule now requires the SROs to provide much more information
and analysis to the Commission as part of their NMS plan submission.
These requirements have been incorporated into the adopted Rule as
``considerations'' that the SROs must address, and generally mandate
that the NMS plan discuss: (1) The specific features and details of the
NMS plan (e.g., how data will be transmitted to the central repository,
and when linked data will be available to regulators); (2) the SROs'
analysis of NMS plan costs and impact on efficiency, competition, and
capital formation; (3) the process followed by the SROs in developing
the NMS plan (e.g., solicitation of input from members of the SROs);
and (4) the information about the implementation and milestones of the
consolidated audit trail. Second, the Commission is furnishing further
details about how it envisions regulators would use, access, and
analyze consolidated audit trail data through a number of ``use
cases.'' Third, the Commission is extending the amount of time allowed
for the SROs to submit the NMS plan from 90 days from the date of
approval of Rule 613 to 270 days from the date of publication of the
Adopting Release in the Federal Register. A discussion of these
modifications and the ``use cases'' follows.
a. NMS Plan Considerations
As noted above,\770\ the Commission believes that the collective
effect of the modifications and additions described above will be to
significantly expand the solution set that could be considered by the
SROs for creating, implementing, and maintaining the consolidated audit
trail and provide the SROs with increased flexibility in how they
choose to meet the requirements of the adopted Rule. Further, given
these changes to the Rule discussed above and the wide array of
commenter's views on how to best implement a consolidated audit
trail,\771\ the Commission expects that the SROs will seriously
consider various options as they develop the NMS plan to be submitted
to the Commission for its consideration. The costs and benefits of the
consolidated audit trail are highly dependent on the specific solutions
proposed by SROs.
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\770\ See Section I., supra.
\771\ See, e.g., FINRA Letter, p. 14 (advocating that SROs build
off existing audit trails to develop a consolidated audit trail) and
Nasdaq Letter I, p. 11-12 (arguing against building off existing
audit trail systems and supporting the development of new system to
establish a consolidated audit trail). See also Section II.C.4.,
supra.
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Accordingly, as part of the multi-step process for developing and
approving an NMS plan that will govern the creation, implementation,
and maintenance of a consolidated audit trail, the Commission is
deferring its economic analysis of the actual creation, implementation,
and maintenance of a consolidated audit trail itself (in contrast to
the costs of the actions the SROs are required to take upon approval of
the adopted Rule \772\) until such time as it may approve the NMS plan
submitted to the Commission for its consideration. In light of the
expanded set of solutions that should be available as a result of the
changes described above and to facilitate a more robust economic
analysis, the adopted Rule now requires the SROs to provide much more
information and analysis to the Commission as part of their NMS plan
submission. The Commission is therefore requiring the SROs to discuss,
as part of their NMS plan ``considerations'' that detail how the SROs
propose to implement the requirements of the plan, cost estimates for
the proposed solution, and a discussion of the costs and benefits of
alternate solutions considered but not proposed.
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\772\ These actions include the requirement that the SROs
develop an NMS plan, utilizing their own resources and undertaking
their own research that addresses the specific details, cost
estimates, considerations, and other requirements of the Rule.
---------------------------------------------------------------------------
This additional information and analysis are intended to ensure
that the Commission and the SROs have sufficiently detailed information
to carefully consider all aspects of the NMS plan ultimately submitted
by the SROs, facilitating an analysis of the extent to which the NMS
plan would allow regulators to effectively and
[[Page 45790]]
efficiently carry out their responsibilities. The NMS plan submitted by
the SROs will be published for public comment and reviewed by the
Commission for consistency with the Exchange Act and the rules
thereunder. As a result, all interested persons, including market
participants, regulatory authorities, and the general public, will have
an opportunity to provide meaningful comments on the details and costs
of the NMS plan submitted, which the Commission will review and
consider.
i. Features and Details of the NMS Plan
The first six considerations the Rule requires the SROs to address
in the NMS plan relate to the features and details of the NMS plan.
These six considerations require the NMS plan to specify and explain
the choices made by the SROs to meet the requirements specified in the
Rule for the consolidated audit trail. The Commission intends to use
the discussion of these considerations to evaluate the NMS plan
submitted for its consideration and how well it meets the objectives
described in Section II.B.2.
Rule 613(a)(1)(i)
Rule 613(a)(1)(i) requires the NMS plan submitted to discuss
``[t]he method(s) by which data is reported to the central repository,
including, but not limited to, the sources of such data and the manner
in which the central repository will receive, extract, transform, load
and retain such data. * * *'' The Rule also requires the NMS plan to
discuss the basis for selecting such method(s).
The Commission believes that requiring that the NMS plan discuss
the method(s) by which data is reported to the central repository is
important because the method for reporting data and the source of the
data are significant to the effectiveness of the consolidated audit
trail and could affect, and potentially enhance, the reliability and
the accuracy of the data that is reported to the central
repository.\773\ Discussing such method(s), as well as the basis for
selecting such method(s), should help assure the Commission that the
plan sponsors have considered the various alternatives and selected the
method(s) that best achieves the objectives of the consolidated audit
trail in a cost-effective manner.\774\ In addition, Rule 613(a)(1)(i)
requires that the NMS plan describe how the central repository will
receive, extract, transform, load, and retain data because the
Commission believes that this information is integral to a
comprehensive understanding of the operation of the central repository
proposed in the NMS plan.
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\773\ See Section III.B.2.c., supra.
\774\ The Commission notes that another related consideration
that must be discussed by the NMS plan includes the alternative
approaches to creating the consolidated audit trail that the plan
sponsors considered. See Rule 613(a)(1)(xii).
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Rule 613(a)(1)(ii)
Rule 613(a)(1)(ii) requires the NMS plan to address ``[t]he time
and method by which the data in the central repository will be made
available to regulators, in accordance with [Rule 613(e)(1)] to perform
surveillance or analyses, or for other purposes as part of their
regulatory and oversight responsibilities.''
The time and method by which data will be made available to
regulators are fundamental to the utility of the consolidated audit
trail because the purpose of the consolidated audit trail is to assist
regulators in fulfilling their responsibilities to oversee the
securities markets and market participants.\775\ The NMS plan submitted
should discuss these issues in detail, guided, in particular, by the
issues and questions raised in the ``Regulator Use Cases'' described in
Section III.C.2.b., below.
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\775\ See Section II.A., supra, for additional discussion of the
timeliness of access to current audit trail data.
---------------------------------------------------------------------------
The importance of this consideration was discussed in the Proposing
Release.\776\ The Commission emphasized the necessity of the data being
in a uniform electronic format so that regulators would be able, among
other things, to effectively and efficiently detect and investigate
illegal trading across markets, without having to spend valuable time
and resources reconciling audit trail formatting differences in the
data.\777\ In addition, the Proposing Release noted that requiring the
order and trade data to be collected in one location in a single format
would allow regulators ready access to the data for use in market
reconstructions, market analyses, surveillance and investigations,\778\
as regulators could then retrieve the information that they need much
faster than the current process of requesting data from multiple
parties without having to reconcile disparate audit trail information.
Also, in the Proposing Release, the Commission noted the importance of
SRO regulatory staff having direct access to consolidated audit trail
data.\779\ The Commission continues to believe that it is vital that
regulators have ready access to the consolidated audit trail data in
the central repository so that this information can be effectively and
efficiently used in fulfilling their regulatory responsibilities.
---------------------------------------------------------------------------
\776\ See Proposing Release, supra note 4, at 32564.
\777\ Id. at 32564-32565 and 32594. Differences in audit trail
data requirements between markets can hinder the ability of
regulators to piece together related illegal trading activity
occurring across several markets.
\778\ Id. at 32594.
\779\ Id. at 32567.
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Rule 613(a)(1)(iii)
Rule 613(a)(1)(iii) requires the NMS plan to address ``[t]he
reliability and accuracy of the data reported to and maintained by the
central repository throughout its lifecycle, including transmission and
receipt from market participants; data extraction, transformation and
loading at the central repository; data maintenance and management at
the central repository; and data access by regulators.''
The Commission believes the reliability and accuracy of the data is
a critical aspect of the consolidated audit trail, because the
usefulness of the data to regulators would be significantly impaired if
it is unreliable or inaccurate. If the reliability and accuracy of
reported data is not maintained by the central repository during the
period it is required to be retained and throughout the various uses to
which it may be put by regulators, then its value to regulators will be
substantially diminished.
Accordingly, the NMS plan submitted should discuss in detail, among
other things, how the consolidated audit trail envisioned by the
sponsors would be designed, tested, and monitored to ensure the
reliability and accuracy of the data collected and maintained by the
central repository (e.g., during transmission from the SRO or member to
receipt by the central repository,\780\ data extraction, transformation
and loading at the central repository,\781\ data maintenance and
management at the central repository,\782\ and data access by
regulators \783\).
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\780\ ``Transmission from the SRO or member to receipt by the
central repository'' refers to the process through which SROs and
their members report data to the central repository.
\781\ ``Data extraction, transformation and loading at the
central repository'' is the process during which the central
repository accepts data reported by the SROs and their members,
converts it into a uniform electronic format, if necessary, and
receives it into the central repository's internal systems.
\782\ ``Data maintenance and management at the central
repository'' refers to the process for storing data at the central
repository, indexing the data for linkages, searches, and retrieval,
dividing the data into logical partitions when necessary to optimize
access and retrieval, and the creation and storage of data backups.
\783\ As noted in Section III.B.1.d.iv., supra, for example,
regardless of whether the NMS plan elects to use a series of order
identifiers or a unique order identifier, it will be very important
to demonstrate how the approach selected in the NMS plan will ensure
that information about all events pertaining to an order will be
reliably and accurately linked together in a manner that allows
regulators efficient access to complete order information.
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[[Page 45791]]
The Commission notes that, when proposing Rule 613, it highlighted
the importance of this consideration by emphasizing that the
reliability and accuracy of the data are critical to the integrity and
effectiveness of the consolidated audit trail.\784\ Indeed, Rule
613(e)(4)(ii), like the proposed Rule, specifically requires the plan
sponsors to establish policies and procedures for the plan processor to
ensure the timeliness, accuracy, and completeness of the audit trail
data reported to the central repository.
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\784\ See Proposing Release, supra note 4, at 32582, 32596.
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Rule 613(a)(1)(iv)
Rule 613(a)(1)(iv) requires the NMS plan to discuss ``[t]he
security and confidentiality of the information reported to the central
repository.''
The Commission is including this consideration because it believes
that keeping the data secure and confidential is crucial to the
efficacy of the consolidated audit trail and the confidence of market
participants. Exposure of highly-confidential information about the
trading strategies and positions of market participants through a
security breach, for example, could impact the confidence of the public
in the central repository and in trading on the U.S. markets. The
Commission understood the importance of security and confidentiality
provisions when it proposed Rule 613(e)(4) to require the NMS plan to
include policies and procedures, including standards, to be used by the
plan processor to ensure the security and confidentiality of all
information reported to, and maintained by, the central
repository.\785\ Numerous commenters also noted the importance of
maintaining the security and the confidentiality of the data collected
pursuant to the proposed Rule.\786\
\785\ In addition, proposed Rule 613(e)(4)(i) required plan
sponsors, and employees of the plan sponsors and central repository
to agree to use appropriate safeguards to ensure the confidentiality
of such data, and not to use such data other than for surveillance
and regulatory purposes.
\786\ See Scottrade Letter, p. 2; ICI Letter, p. 2-4; Liquidnet
Letter, p. 4; Ameritrade Letter, p. 3; Thomson Reuters Letter, p. 4;
BATS Letter, p. 3; Managed Funds Association Letter, p. 2-3; Ross
Letter, p. 1. The Commission notes that it is adopting Rule
613(e)(4) with modifications--the Commission has added provisions to
the Rule to help ensure the confidentiality of the data submitted to
and retained by the central repository. See Section III.B.2.e.,
supra.
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Rule 613(a)(1)(v)
Rule 613(a)(1)(v) requires the NMS plan to address ``[t]he
flexibility and scalability of the systems used by the central
repository to collect, consolidate and store consolidated audit trail
data, including the capacity of the consolidated audit trail to
efficiently incorporate, in a cost-effective manner, improvements in
technology, additional capacity, additional order data, information
about additional securities or transactions, changes in regulatory
requirements, and other developments.''
The Commission believes that the flexibility and scalability of the
systems used by the central repository are important to the
effectiveness of the consolidated audit trail, and, accordingly, the
Commission believes the NMS plan under Rule 613 should address
potential ``built-in'' obsolescence that may arise as a result of the
SROs' choice of systems or technology. For this reason, the NMS plan
should address how, taking into consideration the costs and benefits,
including the potential impact on competition, efficiency, and capital
formation, the consolidated audit trail systems might be designed to
accommodate: (1) Potential growth in the trading volume or message
traffic relating to NMS securities; (2) possible expansion to include
other non-NMS securities; \787\ (3) additional data fields that the
SROs or the Commission might determine to require in the future (such
as new order characteristics); and (4) potential technological
developments that might allow the consolidated audit trail to be
operated in a more timely, reliable, and cost-effective manner.
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\787\ Rule 613(i) requires the NMS plan to include a provision
requiring each SRO to jointly provide to the Commission a document
outlining how the consolidated audit trail could be expanded to
products other than NMS securities. See also Section III.B.1.a.,
supra. The consideration of flexibility and scalability of the
systems requires the SROs to address whether the system proposed in
the SRO's NMS plan submission can accommodate the expansion, while
the document required by Rule 613(i) will discuss more broadly how
the SROs could incorporate into the consolidated audit trail
information with respect to equity securities that are not NMS
securities, debt securities, primary market transactions in equity
securities that are not NMS securities, and primary market
transactions in debt securities, including details for each order
and reportable event that may be required to be provided, which
market participants may be required to provide the data, an
implementation timeline, and a cost estimate.
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As noted in the Commission's Concept Release on equity market
structure,\788\ the market for trading securities has changed
dramatically in recent years and, as technology advances, trading
systems and trading strategies also change. The Commission believes
that it is important for the consolidated audit trail to keep pace with
market developments. It must be designed in a way that allows it to do
so efficiently and in a cost-effective manner to assure regulators of
its continued usefulness. Thus, the Commission has identified the
flexibility and scalability of the systems used by the central
repository to collect, consolidate, and store audit trail data as a
consideration that must be discussed in the NMS plan submitted to the
Commission for its consideration. To sufficiently address this
consideration, the Commission expects the NMS plan to describe in
detail how the consolidated audit trail envisioned by the sponsors
would be designed to accommodate additional message traffic for orders
in NMS securities, how readily capacity could be expanded, and the
existence of any capacity limits. The Commission also would expect the
NMS plan to discuss in detail the extent to which the proposed
consolidated audit trail could accommodate potential additional data
elements, order characteristics, and other types of securities such as
non-NMS securities, debt securities, primary market transactions in
equity securities that are non-NMS securities, and primary market
transactions in debt securities, how quickly this could be done, and
whether any limits exist on the ability of the proposed system to
accommodate these types of changes. Additionally, the Commission would
expect the NMS plan to further discuss whether and how the consolidated
audit trail could be upgraded to keep pace with improvements in
technology, such as improvements to the speed of systems processing.
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\788\ See Concept Release on Equity Market Structure, supra note
87.
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The Commission believes these descriptions are important because,
otherwise, what initially appears to be an effective and cost-effective
NMS plan could become significantly less so over time as markets evolve
and if, for example, order volumes increase, new order types are
developed, and additional data elements or other types of securities,
such as non-NMS securities, debt securities, primary market
transactions in equity securities that are non-NMS securities, and
primary market transactions in debt securities, are potentially
incorporated into the consolidated audit trail.
The Commission notes that issues relating to the potential
flexibility and scalability of the consolidated audit trail were raised
in the Proposing Release. For example, the Commission stated that,
while the proposal was limited to NMS securities, the Commission
ultimately intended the consolidated
[[Page 45792]]
audit trail to cover secondary market transactions in other securities
and information on primary market transactions.\789\ In fact, as
discussed above, the Commission specifically proposed that the NMS plan
contain provisions relating to the possible expansion of the
consolidated audit trail to products other than NMS securities.\790\ In
addition, in the Proposing Release, the Commission specifically noted
its concerns with the lack of scalability of the existing EBS system
and the fact that the volume of transaction data subject to reporting
under the EBS system can be significantly greater than the system was
intended to accommodate in a typical request for data.\791\
---------------------------------------------------------------------------
\789\ See Proposing Release, supra note 4, at 32568-32569.
\790\ Id. at 32569-70.
\791\ Id. at 32567.
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Rule 613(a)(1)(vi)
Rule 613(a)(1)(vi) requires the NMS plan to address ``[t]he
feasibility, benefits, and costs of broker-dealers reporting to the
consolidated audit trail in a timely manner: (A) [t]he identity of all
market participants (including broker-dealers and customers) that are
allocated NMS securities, directly or indirectly, in a primary market
transaction; (B) [t]he number of such securities each such market
participant is allocated; and (C) [t]he identity of the broker-dealer
making each such allocation.''
In the Proposing Release, the Commission stated that ``it would be
beneficial to provide for the possible expansion of the consolidated
audit trail to include information on primary market transactions in
NMS stocks'' and required in proposed Rule 613 that the plan sponsors
address such expansion in a document provided to the Commission within
two months after effectiveness of the NMS plan.\792\ The Commission
continues to believe, for the reasons set forth below, that a potential
expansion of the consolidated audit trail to cover primary market
transactions would be beneficial. Specifically, the Commission believes
that the SROs should address--at the time of the submission of the NMS
plan to the Commission, rather than as part of a later expansion plan--
the feasibility, benefits, and costs of recording and reporting
information about allocations of NMS securities in primary market
transactions as part of the consolidated audit trail.
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\792\ See Proposing Release, supra note 4, at 32569 and 32610.
The Commission noted in the Proposing Release that a ``primary
market transaction is any transaction other than a secondary market
transaction and refers to any transaction where a person purchases
securities in an offering.'' Proposing Release at n. 167.
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As with the data sources discussed in Section II.A, the sources of
information currently available to the Commission regarding allocations
of NMS securities in primary market transactions are each limited in
their ability to provide accurate, complete, accessible, and timely
information.\793\ For example, while the Commission and FINRA can
request information about allocations from the books and records of
broker-dealers, such requests are unduly cumbersome for both regulators
and market participants, potentially involving multiple time-consuming
individual requests.\794\ Other sources of information about
allocations of NMS securities in primary market transactions--including
public sources \795\--are also limited in certain respects.\796\
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\793\ See Section II.A. for a discussion of these four
qualities.
\794\ See, e.g., Exchange Act Rules 17a-3 and 17a-4 (requiring
broker-dealers to make and keep ``records of purchases and sales of
securities'').
\795\ Regulation S-K requires registrants to provide information
related to the number of offered securities that are underwritten by
each syndicate member in an effort to describe the nature of the
obligation of the syndicate members with respect to the offered
securities. See 17 CFR 229.508(a). This information comprises
investor-focused disclosures, rather than information that may be
needed by regulators for investigative and other purposes, such as
the information contemplated by Rule 613(a)(1)(vi).
\796\ For example, FINRA rules require the lead underwriters of
an IPO to collect and provide issuers--but not the public, FINRA, or
the Commission--with names of institutional investors who received
allocations and aggregated information regarding the allocation to
retail investors. See FINRA Rule 5131(d).
The Depository Trust Company (``DTC'') also collects information
on some IPO allocations in its IPO Tracking System at the discretion
of the lead underwriter. See 61 FR 25253 (May 20, 1996). However, as
well as being discretionary and therefore only addressing a subset
of primary market transactions, the IPO Tracking System only
includes allocations to persons with DTC accounts, which generally
excludes retail investors.
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In light of these limitations, data about the allocations of NMS
securities in primary market transactions could also improve market
analysis by the Commission and the SROs, which could in turn help
better inform rulemaking and other policy decisions. Specifically, such
data might aid the Commission and the SROs in better understanding the
role of such allocations in the capital formation process. Combining
this data with the secondary market data to be collected by the
consolidated audit trail could allow regulators to calculate investor
positions and when and how the investors receiving allocations sell
their securities. Such data could also facilitate a better
understanding of how securities are allocated in a primary market
transaction, how allocations differ across broker-dealers and
investors, and what types of investors are allocated securities. This
analysis is virtually infeasible on a market-wide basis today because
the data collection process using current sources of information is so
cumbersome.
In addition, if the consolidated audit trail included data
regarding the allocations of NMS securities in primary market
transactions, SROs could be better able to monitor for compliance with
their rules related to such transactions.\797\ The data also could more
broadly assist SROs in their examinations and investigations related to
allocations in initial public offerings (``IPOs'') and other primary
market transactions by providing a richer data set for evaluating
possible compliance issues. For example, the SROs could use IPO
allocation information, combined with the secondary market transaction
information in a consolidated audit trail, to run surveillance on
whether sales in the IPO auction were marked accurately (i.e., ``long''
or ``short'') and in compliance with applicable requirements.\798\
Allocation data could also allow SROs to conduct surveillance for ``red
flags'' they might develop regarding potential suitability issues
related to customer allocations, as well as potentially improper
allocations to customers (such as kickbacks).
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\797\ See, e.g., FINRA Rules 5130 and 5131. FINRA Rule 5130
imposes certain restrictions on primary market transactions. FINRA
Rule 5131 prohibits certain allocation practices such as
``spinning,'' which refers to an underwriter's allocation of IPO
shares to directors or executives of investment banking clients in
exchange for receipt of investment banking business. See Securities
Exchange Act Release No. 64521 (May 18, 2011), 76 FR 29808 (May 23,
2011) (Order Approving SR-FINRA-2011-017). Certain ``quid pro quo''
practices are also addressed by FINRA Rule 5131.
\798\ Currently, SROs must request customer account information
during examinations of broker-dealers to check for compliance with
order marking rules.
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The Commission could also enhance its own examination and
investigation processes if data regarding the allocations of NMS
securities in primary market transactions were included in the
consolidated audit trail. Without access to a single centralized
database of allocations, Commission staff must rely on more limited
data sources that generally enable only either broad-based sweeps or
one-off investigations based on particularized suspicion of wrongdoing.
Because the relevant data would be readily available for analysis,
including information about allocations as part of the consolidated
audit trail could facilitate the Commission's identification of
particular risks and exam candidates. Other examinations
[[Page 45793]]
undertaken by the Commission staff address whether employees of a
regulated entity are in compliance with the rules applicable to their
transactions related to primary market transactions. Having allocation
information available before such an examination commences could allow
staff to enhance their pre-examination research, better focus on the
sources of potential violations, and ultimately foster more effective
and efficient examinations.
In investigations related to primary market transactions, the
Commission staff generally must obtain data from underwriters post-
transaction, which can take considerable time owing to the limitations
on current sources of data noted above.\799\ Including data about the
allocations of NMS securities in primary market transactions in the
consolidated audit trail could enable investigations to proceed more
efficiently and to more quickly assess whether alleged violations of
various rules under the Exchange Act, such as Regulation M and Rule
10b-5, warrant investigation.\800\ In addition, the Commission believes
that information about allocations could help the SROs and Commission
investigate allegations of improper allocations, such as allocations
subject to ``spinning'' \801\ or ``laddering.'' \802\ Currently, these
types of investigations would require requesting data from
underwriters, and in some cases, other parties (such as investment
advisors) involved in the primary market transaction.
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\799\ This approach also may unduly burden the lead underwriter
as the ``gatekeeper'' of such information and prevents the
Commission and SROs from pursuing investigative techniques that may
rely on reaching out to individual market participants for
preliminary information without using the underwriter.
\800\ See note 242, supra.
\801\ See note 795, supra.
\802\ ``Laddering'' is a practice that generally refers to
inducing investors to give orders to purchase shares in the
aftermarket at particular prices in exchange for receiving IPO
allocations. See NYSE/NASD IPO Advisory Committee report and
Recommendations (May 2003), at 6, available at http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p010373.pdf.
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Given these potential benefits, the Commission believes that it is
important--consistent with its view in the Proposing Release--for the
SROs to address the feasibility, benefits, and costs of recording and
reporting information about allocations of NMS securities in primary
market transactions as part of the consolidated audit trail. However,
unlike other potential additions to the consolidated audit trail--e.g.,
the inclusion of debt securities--that will be contemplated later in
expansion plans, allocations of NMS securities in primary market
transactions are uniquely tied to the central element of the NMS plan--
the reporting of data regarding trading in NMS securities. For example,
allocations in primary market transactions may have a significant
impact on trading and other activity in the secondary market, and
behavior in the primary market may influence behavior in the secondary
market through initial pricing and other mechanisms. More broadly, IPOs
and other primary market transactions continue to be a source of
particular interest for market participants and observers because of,
among other things, their role in the capital formation process. In
light of these considerations, the Commission believes it is
appropriate to require the SROs to address allocations of NMS
securities in primary market transactions at the time that the NMS plan
is submitted under adopted Rule 613(a)(1), rather than as part of an
expansion plan under adopted Rule 613(i).
At the same time, the Commission recognizes that firms may use
systems and methods to handle information regarding allocations of NMS
securities in primary market transactions that differ from those used
to handle information regarding secondary market transactions in such
securities. Such differences may affect the extent to which information
regarding allocations may be readily incorporated into the consolidated
audit trail described by the NMS plan mandated by Rule 613. For
example, the unique features of allocations of NMS securities in
primary market transactions may require different reporting timeframes,
different information security controls, or additional data elements
that would not be required for other information being reported to the
central repository and that are not contemplated by Rule 613. Because
of these potential differences, the Commission believes it is
appropriate to require the SROs to address the feasibility, costs, and
benefits of their members reporting information regarding allocations
of NMS securities in primary market transactions, rather than require
the NMS plan to require such reporting at the outset.
The Commission acknowledges that plan sponsors nevertheless will
incur costs to address the feasibility, benefits, and costs of
incorporating information about allocations of NMS securities in
primary market transactions into the consolidated audit trail. Among
other things, the plan sponsors will need to undertake an analysis of
technological and computer system acquisitions and upgrades that would
be required to include information about such allocations. However,
given the potential benefits described above of including such
information in the consolidated audit trail, the Commission believes
these costs are justified.
ii. Analysis of the NMS Plan
As noted above, in consideration of the views expressed,
suggestions for alternatives, and other information provided by those
commenting on the proposed Rule, the Commission is adopting Rule 613
with significant modifications to a number of the proposed
requirements. In certain instances these modifications alter the data
and collection requirements of the proposed Rule. In other instances,
the adopted Rule has been altered to be less prescriptive, and hence
less limiting, in the means the SROs may use to meet certain
requirements. These modifications significantly expand the solution set
that could be considered by the SROs for creating, implementing, and
maintaining a consolidated audit trail and thus provide the SROs with
increased flexibility in how they choose to meet the requirements of
the adopted Rule, relative to the solution set that would have been
available under the requirements of the proposed Rule.
Because these modifications permit a wider array of solutions to be
considered by the SROs, including solutions that could capitalize on
existing systems and standards,\803\ the assumptions underlying the
Commission's cost estimate in the Proposing Release that new, large-
scale market systems would need to be developed from scratch may no
longer be valid.\804\ Thus, as part of the multi-step process for
developing and approving an NMS plan that will govern the creation,
implementation, and maintenance of a consolidated audit trail, the
Commission is deferring its economic analysis of the actual creation,
implementation, and maintenance of a consolidated audit trail itself
(in contrast to the costs of the actions the SROs are required to take
upon approval of the adopted Rule) \805\ until such time
[[Page 45794]]
as it may approve any NMS plan submitted to the Commission for its
consideration--that is, after the NMS plan, together with its detailed
information, including cost estimates for the creation, implementation,
and maintenance of the consolidated audit trail, and analysis, has been
submitted by the SROs to the Commission and there has been an
opportunity for public comment. The Commission believes that the
information and analyses will help inform public comment regarding the
NMS plan and will help inform the Commission as it evaluates whether to
approve the NMS plan. In this way, the Commission can be better
informed about the costs for the development, implementation, and
maintenance of the consolidated audit trail that benefit from cost data
and information provided by the SROs in conjunction with--and guided
by--their development of an NMS plan that complies with the
requirements of the adopted Rule. In addition, as noted above,\806\ the
Rule includes a mandate that in determining whether to approve the plan
and whether the plan is in the public interest, the Commission must
consider the impact of the NMS plan on efficiency, competition, and
capital formation.
\803\ See, e.g., FINRA Letter, p. 14; SIFMA Letter, p. 16-18.
\804\ The methodology in the Proposing Release assumed that the
scope of the required systems changes would be comparable to those
made in connection with Regulation NMS. See Proposing Release, supra
note 4, at 32597 n. 352. See also Section I., supra.
\805\ These actions include the requirement that the SROs
develop an NMS plan, utilizing their own resources and undertaking
their own research that addresses the specific details, cost
estimates, considerations, and other requirements of the Rule.
\806\ See Section I., supra.
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Rule 613(a)(1)(vii)
Rule 613(a)(1)(vii) requires the NMS plan to include ``[t]he
detailed estimated costs for creating, implementing, and maintaining
the consolidated audit trail as contemplated by the national market
system plan, which estimated costs should specify: (A) [a]n estimate of
the costs to the plan sponsors for creating and maintaining the central
repository; (B) [a]n estimate of the costs to members of the plan
sponsors, initially and on an ongoing basis, for reporting the data
required by the national market system plan; (C) [a]n estimate of the
costs to the plan sponsors, initially and on an ongoing basis, for
reporting the data required by the national market system plan; and (D)
[h]ow the plan sponsors propose to fund the creation, implementation,
and maintenance of the consolidated audit trail, including the proposed
allocation of such estimated costs among the plan sponsors, and between
the plan sponsors and members of the plan sponsors.'' \807\
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\807\ See Rule 613(a)(1)(vii).
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Commenters opined on the costs of funding the consolidated audit
trail in general.\808\ One commenter stated that the Commission should
give ``important consideration to alternative means to help fund the
creation of what is essentially a public utility in [the consolidated
audit trail],'' suggesting the Commission ``should itself pay user fees
to help build and run the [consolidated audit trail],'' or that the
government should underwrite low-cost loans for market participants
aimed to pay the costs of the consolidated audit trail.\809\ Another
commenter suggested that the cost of creating and maintaining the
central repository should be shared among all market participants,
including broker-dealers, ATSs, and exchanges.\810\ Another commenter
stated that, if the Commission requires the SROs to fund the creation
of the consolidated audit trail (i.e., the central repository), SROs
may be forced to raise transaction fees, which would ``resurrect the
distortions caused by high transaction fees, potentially increase the
use of flash orders, if allowed, and discourage trading activity.''
\811\
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\808\ See Wells Fargo Letter, p. 4; SIFMA Letter, p. 22.
\809\ See Wells Fargo Letter, p. 4.
\810\ See Liquidnet Letter, p. 9.
\811\ See SIFMA Letter, p. 22.
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The Commission also received comments regarding the allocation of
the costs of the consolidated audit trail.\812\ One commenter
emphasized that the NMS plan must provide for an equitable allocation
of costs, including the sharing of expansion costs by the parties that
benefit from any new products added to the consolidated audit
trail.\813\ One commenter suggested that the Commission should require
trading venues to allocate system costs for the consolidated audit
trail ``at least partially based on message traffic * * * .'' \814\
Similarly, another commenter, opining that exchanges currently bear a
disproportionate amount of the costs for market surveillance and noting
that exchanges would also be forced to shoulder the costs of the
consolidated audit trail, suggested that other venues, such as ATSs and
internal broker-dealer platforms, should bear a proportionate share of
the costs of creating, implementing, and maintaining the consolidated
audit trail.\815\ This commenter also suggested that the Commission
fund the audit trail using fees assessed on high frequency traders who
cancel a ``disproportionately high'' percentage of their orders,\816\
arguing that this ``would have the added benefit of deterring a
practice that, at best, adds little value in the price discovery
process and, at worst, is potentially manipulative or even
fraudulent.'' \817\
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\812\ See Nasdaq Letter I, p. 13-14; BOX Letter, p. 3; Liquidnet
Letter, p. 9; Kaufman Letter, attachment p. 3.
\813\ See Nasdaq Letter I, p. 13-14.
\814\ See Kaufman Letter, attachment p. 3.
\815\ See Schumer Letter, p. 1.
\816\ Id. at p. 1-2.
\817\ Id. at p. 2.
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The Commission believes that the issues surrounding how the
consolidated audit trail should be funded, and how costs in creating,
implementing, and maintaining the consolidated audit trail should be
allocated, are important, and the Rule requires information about those
issues to be provided by the SROs in the NMS plan submitted to the
Commission for its consideration. In response to comments and in
recognition that an initiative of the size and scope of the
consolidated audit trail necessarily will require substantial
expenditures by the SROs and their members, the Commission is
requiring, pursuant to Rule 613(a)(1)(vii), the SROs to include in the
NMS plan, a discussion of costs and how such costs will be allocated.
As discussed above, the Commission believes that the SROs will incur
costs to create and maintain the central repository.\818\ Also, as
discussed above, SROs and their members may need to make systems
changes or to purchase new systems to record and report the data
required by the NMS plan to the central repository.\819\ SROs and their
members will incur upfront costs, as well as ongoing costs to record
and report such information. Because, as noted above, these costs can
only be analyzed once the SROs narrow the array of choices they have
and develop a detailed NMS plan,\820\ the Commission believes that the
most robust approach for estimating these costs is for the SROs to
provide such cost estimates in conjunction with, and guided by, their
development of the NMS plan. The Commission believes that a fulsome
discussion in the NMS plan of the estimated costs to SROs and their
members will aid commenters in providing useful comments that will
further the Commission's understanding of the cost implications of the
consolidated audit trail. In addition, a fulsome discussion will aid
the Commission in its evaluation of whether to approve the NMS plan and
in conducting its own analysis of the costs and benefits of the NMS
plan.
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\818\ See Section III.B.2., supra.
\819\ See Section III.B.1., supra.
\820\ See Section I., supra.
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There also would be costs associated with establishing and
operating the central repository that will be jointly owned by the plan
sponsors. The Commission believes it is important to understand how the
plan sponsors plan
[[Page 45795]]
to allocate such costs among themselves to help inform the Commission's
decision regarding the possible economic or competitive impact of the
NMS plan amongst the SROs. In addition, although the plan sponsors
likely would initially incur the costs to establish and fund the
central repository directly, they may seek to recover some or all of
these costs from their members. If the plan sponsors seek to recover
costs from their members, the Commission believes that it is important
to understand the plan sponsors' plans to allocate costs between
themselves and their members, to help inform the Commission's decision
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regarding the possible economic or competitive impact of the NMS plan.
Rule 613(a)(1)(viii)
Rule 613(a)(1)(viii) requires the NMS plan to include ``[a]n
analysis of the impact on competition, efficiency, and capital
formation of creating, implementing, and maintaining the national
market system plan.''
Rule 608(a)(4)(ii)(C) under Regulation NMS already requires every
NMS plan submitted to the Commission to be accompanied by an analysis
of the impact on competition of implementation of the plan.\821\ This
requirement is designed to help inform the Commission's evaluation of
whether the NMS plan will impose a burden on competition that is not
necessary or appropriate in furtherance of the purposes of the Exchange
Act. The Rule re-states the application of the Rule 608(a)(4)(ii)(C)
requirement to provide an analysis of the NMS plan's impact on
competition and imposes a requirement that the NMS plan also include an
analysis of the impact on efficiency and capital formation.\822\
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\821\ See 17 CFR 242.608(a)(4)(ii)(C).
\822\ See Rule 613(a)(1)(viii).
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These requirements are designed to help inform the Commission's
understanding of whether the NMS plan may promote efficiency and
capital formation. As an initial matter, the SROs will be providing an
analysis of the economic consequences of the NMS plan they develop and
propose. As noted above, because the specific requirements of the NMS
plan will not be known until the NMS plan is submitted, and the SROs
will be providing that analysis, the Commission will consider the
impact of the proposed consolidated audit trail on efficiency,
competition, and capital formation in deciding whether to approve the
NMS plan. The Commission, however, will consider such analysis in
determining whether to approve the NMS plan and whether the plan is in
the public interest under Rule 608(b)(2). \823\
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\823\ See Rule 613(a)(5).
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iii. Process Followed To Develop the NMS Plan
The following two considerations require the NMS plan to address
how the SROs solicited the input of their members and other appropriate
parties in their design of the NMS plan, and to detail the alternative
consolidated audit trail designs considered and rejected by the SROs.
These considerations will inform the Commission's evaluation of the NMS
plan submitted for its consideration.
Rule 613(a)(1)(xi)
Rule 613(a)(1)(xi) requires the NMS plan to discuss ``[t]he process
by which the plan sponsors solicited views of their members and other
appropriate parties regarding the creation, implementation, and
maintenance of the consolidated audit trail, a summary of the views of
such members and other parties, and how the plan sponsors took such
views into account in preparing the national market system plan.''
The Commission believes that the SROs' consideration of the views
of their members is important because, given the scope of the Rule, it
will affect many market participants and will require them to report a
broad range of audit trail information. Ensuring that market
participants with varied perspectives have a role in developing the NMS
plan submitted to the Commission for its consideration could help
inform the plan sponsors of operational or technical issues that may
arise in the implementation of the NMS plan, and help assure the
Commission and market participants that the requirements imposed on
members are done so in an efficient and cost-effective manner.\824\
Similarly, the Commission believes it is important that the SROs
consider the views of other parties--such as back office service
providers, market operations specialists, and technology and data
firms--as may be appropriate in light of the Rule's goal of creating,
implementing, and maintaining a complex system that may entail changes
to multiple other systems and functionalities involved across the
lifecycle of an order. Such parties could offer operational and
technical expertise to the SROs, including, among other things, by
identifying issues that may arise in the interface between legacy and
new systems. In addition, the inclusion of such parties in the
deliberative process could also result in the introduction of
additional alternative approaches.
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\824\ See Section II.C.3., supra, for a summary of comments
suggesting wider involvement in the development of the consolidated
audit trail.
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The Commission also believes that it is appropriate to require the
SROs to set out in the NMS plan a summary of the views expressed by
such members and other parties and how the SROs took those views into
account in developing the NMS plan. This requirement is designed to
inform the Commission about the extent to which the SROs considered the
views of their members and other appropriate parties as they undertook
the complex task of developing the NMS plan for a consolidated audit
trail, to facilitate a cost estimate by the SROs that takes into
account the costs members will incur in creating, implementing, and
maintaining the consolidated audit trail, as well as to encourage the
consideration of reasonable alternative approaches contemplated by Rule
613(a)(1)(xii) in the plan formulation process.
The Commission received several comments advocating inclusion of
the broker-dealer community and other appropriate parties in the
planning of the consolidated audit trail.\825\ One commenter, with
respect to NMS plan governance, urged the inclusion of ``an official
`seat at the table' alongside the SROs'' for members of the broker-
dealer industry.\826\ Another commenter recommended that the Commission
seek greater SRO and broker-dealer involvement in the front-end
planning before adopting a final rule to make all parties aware of
potential design tradeoffs, and establish appropriate timelines for
implementation and compliance.\827\ A further commenter advocated
allowing working groups to engage in dialogue with the Commission,
broker-dealers and the SROs to effectively conduct the business
analysis needed to build the consolidated audit trail.\828\
Additionally, one commenter suggested that the Commission staff should
form and engage working groups comprised of representatives from the
``affected constituents,'' specifically brokers and ``key technology
vendors,'' \829\ and that such working groups could work with the
Commission to develop a request for proposal.'' \830\ Similarly,
another commenter urged the Commission to require an industry working
group of
[[Page 45796]]
SROs and a representative group of broker-dealers to address the
``complexities involved in developing such a system.'' \831\ One
commenter suggested encouraging the participation of issuers and other
market participants in the creation of the consolidated audit
trail,\832\ and another commenter advocated the inclusion of ``broad
industry participation from the SEC, FINRA, exchange, broker dealer and
vendor communities.'' \833\
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\825\ See FIF Letter II, p. 2; SIFMA February 2012 Letter, p. 1;
STA Letter, p. 1-2.
\826\ See SIFMA February 2012 Letter, p. 1.
\827\ See Broadridge Letter, p. 2.
\828\ See FIF Letter II, p. 2, STA Letter, p. 1-2.
\829\ See Direct Edge Letter, p. 2.
\830\ See Direct Edge Letter, p. 2.
\831\ See Ameritrade Letter, p. 2.
\832\ See IAG Letter, p. 3 (also recommending that the
consolidated audit trail, in general, should involve a reduction in
its size and scope, as well as a review of the capabilities of
existing systems).
\833\ See FIF Letter II, p. 1-3. See also STA Letter, p. 1-3
(recommending the same, but with the inclusion of the investor
community and institutional asset managers).
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The Commission considered the comments recommending wider industry
involvement in the creation of the consolidated audit trail and
believes that, since the consolidated audit trail will be a regulatory
tool used by the SROs and the Commission, it is appropriate for the
SROs, when developing the NMS plan, to request input from the
securities industry as well as technological advice. The Commission
believes that this input should be sought during the preparation of the
NMS plan submitted to the Commission for its consideration,\834\ during
the comment process,\835\ and subsequent to the approval of an NMS
plan.\836\
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\834\ See also Rules 613(a)(1)(vii)(A) and (D), respectively
requiring ``[a]n estimate of the costs to the plan sponsors for
establishing and maintaining the central repository'' and an
explanation of ``[h]ow the plan sponsors propose to fund the
creation, implementation, and maintenance of the consolidated audit
trail, including the proposed allocation of such estimated costs
among the plan sponsors, and between the plan sponsors and members
of the plan sponsors.''
\835\ The Commission notes that any NMS plan submitted and any
amendment to the plan would be subject to notice and public comment,
during which members of the industry and other interested persons
may provide comments on the NMS plan. 17 CFR 242.608(b)(1).
\836\ See Rule 613(b)(7). See also Section III.B.3.b., supra.
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Rule 613(a)(1)(xii)
Rule 613(a)(1)(xii) requires the NMS plan to discuss ``[a]ny
reasonable alternative approaches to creating a consolidated audit
trail that the plan sponsors considered in developing the national
market system plan, including, but not limited to, a description of any
such alternative approach; the relative advantages and disadvantages of
each such alternative, including an assessment of the alternative's
costs and benefits; and the basis upon which the plan sponsors selected
the approach reflected in the national market system plan.'' \837\ The
Commission believes this consideration is appropriate because it
reflects the view, supported by commenters, that there are alternative
approaches to creating, implementing, and maintaining the consolidated
audit trail. The Commission believes that requiring the SROs to discuss
alternatives considered helps ensure that the plan sponsors have
appropriately weighed the merits of the various approaches that might
be considered to create, implement, and maintain the consolidated audit
trail, by requiring the NMS plan to describe the alternatives that the
plan sponsors considered before making any significant decision with
respect to the consolidated audit trail, and the relative advantages
and disadvantages, including costs and benefits, of such alternatives.
The Commission also believes that requiring transparency with respect
to alternative approaches and the decisionmaking process of the SROs
will facilitate public comment on the NMS plan and the wisdom of the
approach selected by the plan sponsors. Similarly, such transparency
should provide the Commission with useful insights into the rationale
for the approach chosen by the plan sponsors as it considers whether to
approve the NMS plan submitted to the Commission. The Commission also
notes that this consideration complements Rule 613(a)(1)(vii),
discussed above, which requires that the NMS plan discuss the detailed
estimated costs to the plan sponsors for creating, implementing, and
maintaining the consolidated audit trail, because this consideration
requires the NMS plan to provide the costs of the alternatives that
were not adopted by the plan sponsors in the NMS plan submitted to the
Commission.
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\837\ See Rule 613(a)(1)(xii).
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iv. Implementation and Milestones of the Consolidated Audit Trail
The following two considerations are designed to elicit additional
information from the plan sponsors about the implementation and
milestones of the consolidated audit trail. These will inform the
Commission's evaluation of the NMS plan submitted to the Commission for
its consideration, particularly in the degree to which the consolidated
audit trail can replace existing data sources and in how effectively
the proposed plan will meet the objectives discussed in Section II.B.2.
Rule 613(a)(1)(ix)
Rule 613(a)(1)(ix) requires the NMS plan to discuss ``[a] plan to
eliminate existing rules and systems (or components thereof) that will
be rendered duplicative by the consolidated audit trail, including
identification of such rules and systems (or components thereof); to
the extent that any existing rules or systems related to monitoring
quotes, orders, and executions provide information that is not rendered
duplicative by the consolidated audit trail, an analysis of: (A)
[w]hether collection of such information remains appropriate; (B) [i]f
still appropriate, whether such information should continue to be
separately collected or should instead be incorporated into the
consolidated audit trail; and (C) [i]f no longer appropriate, how the
collection of such information could be efficiently terminated; the
steps the plan sponsors propose to take to seek Commission approval for
the elimination of such rules and systems (or components thereof); and
a timetable for such elimination, including a description of the
phasing-in of the consolidated audit trail and phasing-out of such
existing rules and systems (or components thereof).'' \838\
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\838\ See Rule 613(a)(1)(ix).
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As noted in the Proposing Release and above, many exchanges and
FINRA each have their own disparate audit trail rules.\839\ Thus, a
member of the various exchanges and FINRA could be subject to the audit
trail rules of, and be required to submit different information to,
more than one exchange and FINRA. In addition, several commenters
discussed the potential reduction in costs for the creation,
implementation, and maintenance of a consolidated audit trail if
existing SRO audit trail requirements were eliminated. In particular,
one commenter stated that, ``over the long-term, the costs of
developing a carefully designed and appropriately scaled consolidated
audit trail could be offset in part by eliminating the individual SRO
reporting requirements imposed under existing audit trail systems.''
\840\ This commenter also urged the SROs and the Commission ``to rely
to the fullest extent possible on the consolidated audit trail data for
market reconstructions, investigations, and analysis, rather than
requesting data from broker-dealers. This would be more efficient for
both firms and regulators and would help maximize the utility of the
consolidated audit trail.'' \841\
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\839\ See Proposing Release, supra note 4, at 32595.
\840\ See SIFMA Letter, p. 2.
\841\ Id.
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[[Page 45797]]
Another commenter similarly stated that ``a consolidated trail and
consolidated market surveillance should achieve economies of scale that
ultimately lower costs for both the markets themselves and the market
participants.'' \842\ This commenter further reasoned that, ``[r]ather
than each SRO separately maintaining its own surveillance staff and
surveillance programs that are searching for the same behavior, and
thus creating redundancies, certain technology and staff resources can
be consolidated into a single enterprise with costs equitably allocated
across all SROs.'' \843\ However, the commenter also pointed out that
``[s]uch consolidation, of course, would not preclude individual SROs
from conducting surveillance for unique attributes and rules of its
marketplace, ensuring that specialized market expertise continues to
inform surveillance and oversight of trading on that market.'' \844\
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\842\ See FINRA Letter, p. 2.
\843\ Id. at p. 2-3.
\844\ See FINRA/NYSE Euronext Letter, p. 4.
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Many other commenters shared similar opinions with regards to the
efficiency effects that a consolidated audit trail would have on market
participants and their requirements to provide data to regulators. One
commenter, for example, listed as one of seven benefits of a
consolidated audit trail that ``it would reduce the time and resources
required by market participants to respond to case-by-case requests
from regulators.'' \845\ Another commenter stated that it ``agrees with
the Commission that the implementation of the proposed consolidated
audit trail would likely render unnecessary existing audit trails and
data obtained through the equity blue sheets system.'' \846\ Similarly,
another commenter also ``agree[d] with the Commission that in
calculating the total cost to the industry of the audit trail it is
important to consider offsetting savings from the retirement of
redundant data feeds such as OATS, OTS, COATS, ISG Equity Audit Trail,
and EBS. In addition, the industry may be able to avoid the cost of
compliance with the Commission's proposed Large Trader Reporting System
if the consolidated audit trail contains sufficient information to meet
those requirements.'' \847\
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\845\ See Liquidnet Letter, p. 1.
\846\ See BATS Letter, p. 4. See also FIA Letter, p. 1; FIF
Letter II, p. 2.
\847\ See Nasdaq Letter I, p. 11. The Commission notes that this
comment letter was submitted prior to the adoption of the Large
Trader Reporting Rule. See note 1, supra, and accompanying text.
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The Commission recognizes that the creation of a consolidated audit
trail could result in efficiency gains for market participants with
respect to their regulatory data reporting requirements and for
regulators with respect to their surveillance activities. The
Commission also recognizes that the consolidated audit trail could
render existing rules and systems that contain the same requirements as
the consolidated audit trail redundant. While the Commission is not at
this time requiring that existing rules and systems be eliminated, the
Rule requires that the NMS plan provide a plan to eliminate existing
rules and systems (or components thereof), including identification of
such rules and systems (or components thereof). Further, to the extent
that any existing rules or systems related to monitoring quotes,
orders, and executions provide information that is not rendered
duplicative by the consolidated audit trail, such plan must also
include an analysis of (1) whether the collection of such information
remains appropriate, (2) if still appropriate, whether such information
should continue to be separately collected or should instead be
incorporated into the consolidated audit trail, and (3) if no longer
appropriate, how the collection of such information could be
efficiently terminated. Finally, such plan must also provide the steps
the plan sponsors propose to take to seek Commission approval for the
elimination of such rules and systems (or components thereof); and a
timetable for such elimination, including a description of how the plan
sponsors propose to phase in the consolidated audit trail and phase out
such existing rules and systems (or components thereof).
The Commission believes that the implementation of a plan to
eliminate duplicative existing rules, systems, and/or components of
such rules and systems, will result in increased efficiency to market
participants who need to comply with the disparate reporting
requirements for orders and with repeated requests for data by
regulators who cannot obtain the data they need from existing sources
of information.
Rule 613(a)(1)(x)
Rule 613(a)(1)(x) requires the NMS plan to include ``[o]bjective
milestones to assess progress toward the implementation of the national
market system plan.''
The creation of a consolidated audit trail is crucial to the
effective oversight of the U.S. securities markets, but at the same
time is an initiative of substantial scope and complexity. Accordingly,
to ensure that the consolidated audit trail is established in a timely
and logical manner, and that the SROs can be held accountable for
maintaining a workable implementation schedule, the NMS plan submitted
is required to set forth a series of detailed objective milestones,
with projected completion dates, toward implementation of the
consolidated audit trail. In addition to being useful for the
Commission in its evaluation of the NMS plan, the milestones will be
used by the Commission in its supervision of the implementation of the
consolidated audit trail. Such milestones could include, but are not
limited to: publication and implementation of the methods for obtaining
a CAT-Reporter-ID and the Customer-ID database, testing of the
collection of order and execution data from a representative subset of
broker-dealers, initial access to the central repository for
regulators, demonstration of linking the full lifecycle of events for
select test orders, cancels, modifications, and executions, and
integration of trade and quote data as currently reported by trading
venues into the central repository.
v. Commission Review
The Commission believes these considerations represent fundamental
characteristics of a meaningful plan to establish an effective and
efficient consolidated audit trail. The Commission will assess the NMS
plan's discussion of the considerations described as part of its
evaluation of the NMS plan.\848\ The Commission notes that, if the NMS
plan submitted does not comply with the requirements of the Rule, or if
the Commission determines changes are necessary or appropriate, the
Commission may amend the NMS plan pursuant to Rule 608(b)(2) of
Regulation NMS with such changes or subject to such conditions as the
Commission may deem necessary or appropriate, taking into account the
considerations contemplated in Rule 613(a)(1).\849\ In addition, should
the NMS plan and the consolidated audit trail not keep pace with market
or technological developments, such that its efficiency or
effectiveness becomes
[[Page 45798]]
impaired,\850\ the Commission itself may, pursuant to Rule 608(b),
propose an amendment to the NMS plan.\851\
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\848\ To further facilitate this review, the Commission expects
that the plan sponsors would keep minutes of their meetings to
formulate the NMS plan, and that such minutes would be readily
reviewable by the Commission.
\849\ 17 CFR 242.608(b)(2). To approve such a plan, the
Commission must find that such plan or amendment is necessary or
appropriate in the public interest, for the protection of investors
and the maintenance of fair and orderly markets, to remove
impediments to, and perfect the mechanisms of, a national market
system, or otherwise in furtherance of the purposes of the Act.
\850\ See Rules 613(a)(1)(v), (b)(6), (d)(2). See also Sections
III.B. and III.C.2.a.i., supra (discussing the consideration of
flexibility and scalability of the systems used by the central
repository; the requirement that the NMS plan require the plan
sponsors to provide a written assessment with an evaluation of, and
a detailed plan to improve, the performance of the consolidated
audit trail at least every two years; and the requirement to
annually evaluate the clock synchronization and time stamp
standards).
\851\ 17 CFR 242.608(a)(2). For example, if the requirements of
the plan are not amended after the annual evaluation of the clock
synchronization and time stamp standards to be consistent with
changes in the industry standards, the Commission has the authority
and means to propose an amendment to those requirements of the plan.
The Commission can approve an amendment to an effective national
market system plan that was initiated by the Commission, by rule. 17
CFR 242.608(b)(2).
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b. Regulator Use Cases
In light of the comments recommending that the Commission undertake
an RFP process and provide more ``business requirements'' \852\ the
Commission believes that it is useful to provide further details about
how it envisions regulators would use, access, and analyze consolidated
audit trail data through a number of ``use cases,'' as might typically
be found in an RFP. These ``use cases'' and accompanying questions set
forth below are derived directly from the considerations described in
adopted Rule 613(a)(1), which, as discussed in Section III.C.2.a.,
originated from key principles of the consolidated audit trail that had
been highlighted by the Commission in the Proposing Release.
Specifically, these ``use cases'' describe the various ways in which,
and purposes for which, regulators would likely use, access, and
analyze consolidated audit trail data. By describing how regulators
would use the consolidated audit trail data, the ``use cases'' and the
related questions are meant to elicit a level of detail about the
considerations that should help the SROs prepare an NMS plan that
better addresses the requirements of the adopted Rule. They should also
aid the Commission and the public in gauging how well the NMS plan will
address the need for a consolidated audit trail. In particular, the
``use cases'' will assist in gauging how well the NMS plan will
specifically address the needs outlined in this Rule, by describing the
features, functions, costs, benefits, and implementation times of the
plan.
---------------------------------------------------------------------------
\852\ See FIF Letter, p. 1, 9; FIF Letter II, p. 1-2; Direct
Edge Letter, p. 2-3, 5; Section III.C.1.a., supra.
---------------------------------------------------------------------------
The Commission notes that it is not including these ``use cases''
and accompanying questions to endorse a particular technology or
approach to the consolidated audit trail; rather, these ``use cases''
and accompanying questions are designed to aid the SROs' understanding
of the types of useful specific information that the NMS plan could
contain that would assist the Commission in its evaluation of the NMS
plan. The Commission also notes that its description of ``use cases''
includes a non-exclusive list of factors that SROs could consider when
developing the NMS plan. The SROs also may include in the NMS plan
submitted to the Commission for its consideration any other information
regarding how data would be stored or accessed that the SROs believe
the Commission or the public may find useful in evaluating the NMS plan
submitted.
1. Analyses Related to Investigations and Examinations
The Commission expects that the consolidated audit trail will
provide regulators the ability to more efficiently conduct targeted
investigations and examinations. These generally require being able to
conduct several types of queries on large amounts of data and extract
targeted segments of such data. These targeted segments are likely to
be much smaller than the bulk extractions discussed in Section
III.C.2.b.2., below.
Off-Line Analysis. Regulators are likely to frequently require the
extraction of relatively small amounts of select data from the
consolidated audit trail database at the central repository for their
own ``off-line'' analyses.\853\ For example, a regulator may need to
extract data on all orders in a particular stock, by a particular
customer, on a particular day, or based on any other combination of
fixed search criteria.\854\ Though the total data extracted may be
small, the number of records that need to be searched to find such data
may be enormous.
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\853\ For purposes of these use-cases, an ``off-line'' analysis
is defined to be any analysis performed by a regulator based on data
that is extracted from the consolidated audit trail database, but
that uses the regulator's own analytical tools, software, and
hardware.
\854\ Fixed search criteria are those that are based on specific
pre-defined data elements that are stored in the consolidated audit
trail database. In contrast, dynamic search criteria are those that
are based on numerical levels, thresholds, or other combinations of
mathematical formula or logic that would require some amount of
additional calculations to be performed on, and derived from, pre-
defined data elements already stored in the database to complete the
search operation and return to the user the data that meets the
requested criteria.
---------------------------------------------------------------------------
i. What technical or procedural mechanisms will regulators be
required to use to request data extractions? Does the NMS plan provide
for a front-end user interface to perform search and extractions? If
not, what types of tools or technologies would regulators need to
implement to send search and extract requests to the database? Would
regulators be permitted to write and submit their own queries (e.g.,
Structure Query Language or ``SQL'') to the database directly? Would
the central repository write and submit queries on behalf of a
regulator at the regulator's request?
ii. What response times should regulators expect from search and
extract requests? Would a search for all trades in a given security by
a given customer over a specified period of time return a response with
all requested data in one minute? One hour? Overnight? How would this
response time scale with the amount of data requested? With the amount
of data being searched?
iii. How would the database effectively process simultaneous
requests by multiple users at one or more regulators? Will each request
be queued serially? Can they be processed in parallel? What is the
effect of simultaneous requests on response times? Would there be
limits to the number of search queries that can be performed at the
same time? Would there be limitations on the size of the extractions
from such queries?
iv. A wide range of users at regulators may need to search and
extract data for analysis. How are users to be administered? If the NMS
plan contemplates a front-end user interface, what validation and
security mechanisms will ensure that only permitted users will have
access to such data? If the plan contemplates direct access through a
means other than a front-end user interface, what security and
validation mechanisms would regulators need to deploy to interact with
the database?
Dynamic Search and Extraction. At times, regulators may need to
identify and extract small amounts of data from the database based on
dynamic search criteria that might require the database to perform
calculations on stored data to meet the specified criteria. A few
examples of dynamic criteria are: searching for trades with trade sizes
above a certain threshold, searching for trades in securities with
execution prices that change more than a certain percentage in a given
period of time, and searching for orders that are canceled within a
certain period of time.
i. Does the NMS plan contemplate allowing for dynamic search
criteria to operate directly on the database? If so, how would the
dynamic search criteria
[[Page 45799]]
be specified and run? What, if any, limitations would there be on the
types of search criteria that can be requested? What are the
implications for response times? If the plan contemplates a front-end
user interface, will dynamic search criteria be included? If the plan
allows for dynamic search criteria through a means other than a front-
end user interface, what types of tools or technologies would
regulators need to implement to request dynamic searches? Have the plan
sponsors considered whether such tools or technologies and the
personnel to use them are currently available to the regulators?
ii. If the NMS plan does not contemplate dynamic search criteria,
please explain how regulators would be able to use the consolidated
audit trail data to perform such searches. Would data need to be
downloaded in bulk by the regulators to accomplish these types of
searches off-line (see below for related questions)?
2. Analyses Related to Monitoring, Surveillance, and Reconstruction
In addition to targeted analysis of select data from the
consolidated audit trail database, regulators will also require the
analysis of data in bulk form. For example, the Commission is likely to
use consolidated audit trail data to calculate detailed statistics on
order flow, order sizes, market depth and rates of cancellation, to
monitor trends and inform SRO and Commission rulemaking. To satisfy the
surveillance requirements of Rule 613(f), regulators may want the
ability to feed consolidated audit trail data into analytical ``alert''
programs designed to screen for potential illegal activities such as
insider trading or spoofing. Surveillances might also benefit if
regulators are able to link consolidated audit trail data with
databases on certain types of material news events or market
participants. This would allow regulators to isolate and aggregate data
on trading in advance of those news events or by those participants. If
preliminary analyses showed problems, the regulators could then request
significant amounts of data for a more thorough and detailed follow-up
analysis. In the event of a large scale market event like the May 6,
2010 ``flash crash,'' regulators are likely to use consolidated audit
trail data to reconstruct market events on the day of the event,
including but not limited to reconstructing entire order books and
trading sequences.
i. What, if any, SRO surveillance data could be replaced by the
consolidated audit trail while still improving SROs' ability to
surveil?
ii. How will the NMS plan allow regulators to address these types
of large-scale, on-going data analyses?
iii. In addition to providing regulators with the ability to search
and extract data, will the NMS plan provide regulators with access to
any plan-hosted applications or interfaces (i.e., those that operate on
plan-based systems and resources) that would enable users to perform
data analyses on, or create reports or graphs from, data stored in the
database (such application or interfaces collectively known as ``hosted
analytical tools'')? If so, how would regulators use and access such
tools? What are the limitations of such tools? Would the tools allow
regulators to perform the analyses discussed in the examples presented
above?
iv. If the NMS plan does not provide regulators with hosted
analytical tools, how would regulators be expected to use their own
resources, software, and hardware to perform such analyses? Would the
plan provide regulators with an application programming interface
(``API'') that allows regulators to develop their own tools that
interact directly with the consolidated audit trail database? If so,
what will the form of such API be? Are there limitations to the number
of systems that could connect to the database? How will the plan
negotiate priorities for connectivity, searches and queries done via
the API? Will there be limitations to the types of queries that could
be performed through the API? What types of in-house technologies and
systems would be required for regulators to connect to the consolidated
audit trail in this fashion?
v. If the NMS plan does not provide regulators with analytical
tools and services and does not provide an API for regulators to
connect their own analytics systems to the database, what mechanism
would the plan provide to regulators for accessing bulk data in a way
that allows for large-scale analyses? Would the plan allow for end-of-
day downloads of an entire day's activity so that regulators could load
this information into their own systems for such analysis? If so, how
is access to such a download to be controlled and implemented? How long
would it take to transmit an entire day's worth of consolidated audit
trail data to each of the regulators that requires such access? 10
minutes? One hour? Multiple hours? Longer than overnight? Do these time
estimates reflect that multiple regulators are likely to simultaneously
download consolidated audit trail data each night? What types of
technologies or systems would be required for regulators to download
this data? What are the expected sizes of such a data download? What
type of systems would each regulator need to deploy to store and
analyze this data? Have the plan sponsors considered whether such
systems and the personnel to operate them are currently available to
the regulators?
vi. Does the plan contemplate data streaming as a method of
transmitting bulk data to each regulator? If so, what is the form and
mechanism of such data streaming? Would the streaming occur intraday as
data is reported to, and processed by, the database, or would the
streaming occur after all (or a majority of, or such other criteria)
data was reported to, and processed by the database (e.g. overnight
streaming)? How would intraday streaming impact the accuracy or
completeness of the data received by regulators? Would data be
transmitted through different methods or with varying delays by
different SROs?
vii. If the plan does not contemplate any bulk data analyses or
means of transmitting data to regulators on a bulk overnight basis or
in an intraday or overnight streaming fashion, describe what
alternative mechanisms, if any, could be used to enable regulators to
perform the types of analyses described at the beginning of the section
(b), as well as the various examples described throughout this document
of how regulators would make use of consolidated audit trail data.
3. Order Tracking and Time Sequencing
As discussed in detail throughout this Release, one of the key
requirements of the consolidated audit trail is to provide regulators
with a complete record of all of the events that stem from a particular
order, from routing to modification, cancellation, or execution. In
addition, these events must be stored by the central repository in a
linked manner--using either a unique order identifier or a series of
unique order identifiers, as discussed in Section III.B.1.d.iv.--so
that regulators can quickly and accurately extract a time-sequenced
history of each event related to an order.
i. What methods will the plan use to create the linkages for order
events as described above? How will regulators access and search on
data in a linked fashion?
ii. What is the technical form of the order identifier(s) that
broker-dealers will be required to send to the consolidated audit trail
database so that these linkages can be created? To what extent will
broker-dealers be able to generate such identifier(s) using their
current systems? To what extent will broker-dealers need to collect or
track
[[Page 45800]]
new data, or modify their systems, to generate such identifier(s)?
iii. Will the transmission of economic data (such as a price) be
sent separately, or via a different technical mechanism, from
noneconomic data (such as the identity of a customer)?
iv. What other changes, if any, will be required of systems
typically in use by broker-dealers to provide such data? To what extent
can existing broker-dealer systems be employed? What modifications will
be necessary? What are the costs and technological ramifications of
such changes?
v. What changes, if any, will be required of the systems currently
in use by regulators to receive such data? To what extent can existing
regulatory systems be employed? What modifications will be necessary?
What are the costs and technological ramifications of such changes?
vi. If data reformatting is required, how much must be done by each
broker-dealer using its own systems and resources prior to sending data
to the central repository, versus being done on the receiving end by
the central repository using plan-based systems and resources?
vii. If multiple methods for collecting and aggregating are
contemplated by the NMS plan, what are the pros and cons of each
method?
viii. How will the plan ensure orders and subsequent events are
properly time-sequenced? At what level of granularity will time stamps
be stored for each event? Milliseconds? Microseconds? Picoseconds?
Describe any differences in the accuracy at which events originating in
the same broker-dealer system can be sequenced versus events across
different systems at the same broker-dealer, or systems at different
broker-dealers. What type of synchronization of clocks will be employed
to minimize inter-system timing inaccuracies?
ix. If time stamps are not stored at a sufficient level of
granularity to properly sequence events, what other data or mechanisms
will the NMS plan provide to meet the requirement that regulators be
able to time-sequence events?
x. Even if time stamps are sufficiently granular to meet the time-
sequencing requirements of today, how would the plan contemplate
increasing that granularity as the speed of trading increases?
4. Database Security, Contingency Planning, and Prospects for Growth
The data stored in the consolidated audit trail database will
contain confidential detailed records of trade and order flow by
customer.
i. How will the plan ensure the security of the database in a way
that provides for flexible access by permitted users at multiple
regulators (i.e., the Commission and the SROs), but denies access to
all other non-permitted users?
ii. What are the plan's policies and procedures with regards to
security? Will the plan make use of any specific national or
international security standards? If so, which ones? Will the plan make
use of third-party reviews of its security procedures?
iii. What types of contingency and backup plans will be employed by
the plan to safeguard against the loss of data due to technical
failures? Will the plan make use of live failover mechanisms so that
data being sent to the database is not inadvertently lost in the event
of a failure? Will contingency plans provide regulators with
uninterrupted access to the database? If not, what are the expectations
for recovery times under different failure scenarios?
iv. As order and trade volumes increase, how does the plan
contemplate handling the need for increased capacity and throughput?
Would the plan be able to accommodate a doubling in daily volume
without materially altering the basic technologies and architecture? A
ten-time increase? A 100-times increase?
5. Database Access
As part of an investigation or examination, regulators may need to
analyze historical trades and orders in the database maintained by the
central repository (though not trade and order events occurring prior
to the implementation of the consolidated audit trail).
i. How much historical data will be stored ``on-line'' in the
database and be available for immediate search and extraction?
ii. How will data be archived if it is no longer stored on-line?
How will regulators access and search data that has been archived?
iii. Will third parties have access to historical data? How will
this access differ from the regulatory access?
c. Extension of Time for Submission of NMS plan
Proposed Rule 613 required the SROs to jointly file the NMS plan
within 90 days from approval of Rule 613. The Commission received a
comment letter specifically suggesting that a six-month period, rather
than the 90-day period originally proposed, would be more appropriate
for the submission of the NMS plan to ensure that the NMS plan is
drafted with an informed understanding of how order and trade
processing works so that the consolidated audit trail systems are
capable of achieving the Commission's objectives.\855\ To this end the
commenter recommended that the Rule mandate the formation of
cross[hyphen]market participant working groups; outline the objectives
of consolidated audit trail rather than identify technical
requirements; and allow six months for the cross[hyphen]participant
working groups to perform a requirements analysis as part of the
development of the NMS plan.\856\
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\855\ See FIF Letter II, p. 2. See also STA Letter, p. 2
(stating ``[t]he SEC should allow six months for the CAT selection
process rather than the two months currently identified in the
proposed release'').
\856\ See FIF Letter II, p. 3.
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In response to this commenter and other commenters that suggested
that the Commission rely on an industry working group to create the
consolidated audit trail \857\ and to provide sufficient time for the
SROs to draft the additional provisions required by the Rule \858\ and
to prepare responses to the considerations and the use cases for
inclusion in the NMS plan,\859\ the Commission is extending the
timeframe for the submission of the NMS plan from 90 days from approval
of Rule 613 to 270 days from the date of publication of the Adopting
Release in the Federal Register.\860\
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\857\ See Direct Edge Letter, p. 2-3, 5. See also STA Letter, p.
1-3.
\858\ These additional provisions relate to: (1) The security
and confidentiality of the central repository (see Rule
613(e)(4)(i)(A) through (D) and Section III.B.2.e., supra); (2)
error rates (see Rule 613(e)(6) and Section III.B.2.c., supra); (3)
an Advisory Committee (see Rule 613(b)(7) and Section III.B.3.b.,
supra); (4) a retrospective assessment of the performance of the
consolidated audit trail, as well as a plan to improve its
performance (see Rule 613(b)(6)(i) through (iv) and Section
III.B.3.b., supra); and (5) potential penalties (see Rule 613(h)(3)
and Section III.B.3.a.1., supra).
\859\ See Sections III.C.2.a. and c., supra.
\860\ See Section I., supra. See also Section III.D., infra, for
a discussion of the timelines pertaining to the implementation of
the consolidated audit trail.
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3. NMS Plan Costs
a. NMS Plan Cost Estimates
This section sets forth the Commission's estimates of the costs to
prepare and file the NMS plan. As noted above, as part of the multi-
step process for developing and approving an NMS plan that will govern
the creation, implementation, and maintenance of a consolidated audit
trail, the Commission is deferring its economic analysis of the
consolidated audit trail (other than with respect to the NMS plan)
until after the NMS plan, together with its detailed information and
analysis, has been submitted by the
[[Page 45801]]
SROs to the Commission for its consideration and there has been an
opportunity for public comment.\861\ The Commission believes that an
economic analysis of the consolidated audit trail is more appropriately
performed once the SROs narrow the expanded array of choices they have
and developed a detailed NMS plan.\862\ At that time, the Commission
will have available to it detailed information provided by the SROs,
and any additional information provided by commenters once the NMS plan
is published for comment. The cost estimates set forth below,
therefore, only reflect the Commission's estimates as to the costs to
the SROs for developing an NMS plan to be submitted to the Commission.
These cost estimates do not reflect the much more significant initial
and ongoing costs that would be incurred if such NMS plan were approved
by the Commission and the implementation of the consolidated audit
trail begins.
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\861\ See Section I., supra. See also Rule 613(a)(5) (providing,
in part, that the Commission ``shall consider the impact of the
national market system plan, or amendment, as applicable, on
efficiency, competition, and capital formation'').
\862\ See Section I., supra.
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The Commission notes that the requirement to develop and submit the
NMS plan also is a collection of information within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\863\ Section IV. below
describes in detail the burdens associated with the requirement that
the SROs develop and submit an NMS plan.
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\863\ 44 U.S.C. 3501 et. seq.
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i. Preliminary Cost Estimates from Proposing Release
In the Proposing Release, the Commission estimated that each SRO,
on average, would incur an aggregate one-time cost of approximately
$234,000 \864\ to prepare and file the NMS plan, for an estimated
aggregate cost of about $3.5 million.\865\
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\864\ Commission staff estimated that each SRO would expend (400
Attorney hours x $305 per hour) + (100 Compliance Manager hours x
$258 per hour) + (220 Programmer Analyst hours x $193 per hour) +
(120 Business Analyst hours x $194 per hour) = $213,540 per SRO to
prepare and file the NMS plan. Commission staff also estimated that
each SRO would outsource, on average, 50 hours of legal work, at an
average hourly rate of $400, for a total of $20,000 per SRO, for an
aggregate one-time cost to prepare and file an NMS plan of $233,540
per SRO. See Proposing Release, supra note 4, at 32596.
The $305 per hour figure for an Attorney; the $258 per hour
figure for a Compliance Manager; the $193 per hour figure for a
Programmer Analyst; and the $194 per hour figure for a Business
Analysis (Intermediate) were from SIFMA's Management & Professional
Earnings in the Securities Industry 2008, modified by Commission
staff to account for an 1800-hour work-year and multiplied by 5.35
to account for bonuses, firm size, employee benefits, and overhead.
Based on industry sources, the Commission estimated that the hourly
rate for outsourced legal services in the securities industry is
$400 per hour.
\865\ Commission staff estimated that the SROs would incur an
aggregate one-time cost of ($233,540 per SRO) x (15 SROs) =
$3,518,100 to prepare and file an NMS plan.
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In making these estimates, the Commission assumed that the cost of
developing and filing the NMS plan pursuant to the proposed Rule would
be comparable to the cost to create other existing NMS plans.\866\
Underlying the Commission's estimates were estimates of the amount of
time the Commission believed would likely be spent by Programmer
Analysts, Business Analysts, Attorneys, and Compliance Managers. The
Commission did not receive any comments on these specific cost
estimates.
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\866\ See Proposing Release, supra note 4, at note 299.
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ii. Revised Cost Estimates
As noted above, the Commission based its original estimates of the
cost to prepare and file the NMS plan on the costs incurred with
existing NMS plans. The adopted Rule, however, has been modified from
the proposed Rule in several significant ways that differentiate the
costs to prepare the NMS plan from all other existing NMS plans. These
modifications require the SROs to: (1) Provide additional information
and analysis while addressing the considerations that are set forth in
Rule 613(a)(1); \867\ (2) include additional provisions that were not
required by the proposed Rule relating to enforcement mechanisms,\868\
security and confidentiality,\869\ and the preparation of a document
every two years that contains a retrospective assessment of the
performance of the consolidated audit trail, as well as a plan to
improve its performance; \870\ (3) address error rates; \871\ and (4)
provide for the creation of an Advisory Committee.\872\
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\867\ See Rule 613(a)(1)(i) through (xii); Section III.C.2.a.,
supra.
\868\ See Rule 613(h)(3); Section III.B.3.a.1., supra.
\869\ See, e.g., Rule 613(e)(4)(i)(A) through (D). For example,
Rule 613(e)(4)(i)(A) requires that the NMS plan require that all
plan sponsors and their employees, as well as all employees of the
central repository, agree to use appropriate safeguards to ensure
the confidentiality of such data and not use such data for purposes
other than surveillance or regulatory purposes. Additionally, Rule
613(e)(4)(i)(B) requires the NMS plan to require that each SRO adopt
and enforce rules that: (1) Require information barriers between
regulatory staff and non-regulatory staff with regard to access and
use of data in the central repository and (2) permit only persons
designated by plan sponsors to have access to the data in the
central repository. See Section III.B.2.e., supra.
\870\ See Rule 613(b)(6)(i) through (iv). See Section
III.B.3.b., supra.
\871\ See Rule 613(e)(6)(i) through (ii). See Section
III.B.2.c., supra. See also Rule 613(e)(6)(iii) through (iv).
\872\ See Rule 613(b)(7).
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(A) Revised Initial Costs To Create and File the NMS Plan
In light of these modifications to the proposed Rule, the
Commission no longer believes that the cost of developing and filing
the NMS plan pursuant to the proposed Rule would be sufficiently
comparable to the cost to create other existing NMS plans to use those
costs as a basis for developing a cost estimate for the NMS plan
required by Rule 613. Instead, as discussed in more detail below, the
Commission is increasing its estimated costs for the development and
filing of the NMS plan due to the increases in the hours that likely
would be spent to create the NMS plan by the SROs.\873\ The Commission
also is adjusting its preliminary cost estimate for the creation and
filing of an NMS plan to reflect updated 2011 wage figures, as well as
the registration of two additional SROs, since the preliminary
estimates were developed.\874\ Specifically, the Commission now
estimates that the aggregate one-time cost for creating and filing an
NMS plan would be approximately $718,000 per SRO,\875\ or approximately
$12.2 million
[[Page 45802]]
in the aggregate,\876\ compared to an initial estimate of $234,000 per
SRO, or approximately $3.5 million in the aggregate, to prepare and
file an NMS plan.\877\
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\873\ Commission staff now estimates that each SRO would expend
700 Attorney hours, 300 Compliance Manager hours, 880 Programmer
Analyst hours, and 880 Business Analyst hours.
\874\ The $378 per-hour figure for an Attorney; the $279 per
hour figure for a Compliance Manager; the $196 per hour figure for a
Programmer Analyst; and the $201 per hour figure for a Business
Analyst (Intermediate) are from SIFMA's Management & Professional
Earnings in the Securities Industry 2011, modified by Commission
staff to account for an 1800-hour work-year and multiplied by 5.35
to account for bonuses, firm size, employee benefits, and overhead.
At the time the Proposing Release was published, there were 14
national securities exchanges. On August 13, 2010, the Commission
granted the application of BATS-Y Exchange for registration as a
national securities exchange. See Securities Exchange Act Release
No. 62719, 75 FR 51295 (August 19, 2010). Additionally, on April 27,
2012, the Commission granted the application of BOX Options Exchange
for registration as a national securities exchange. See Securities
Exchange Act Release No. 66871, 77 FR 26323 (May 3, 2012).
\875\ Commission staff estimates that each SRO would incur an
aggregate one-time cost of (700 Attorney hours x $378 per hour) +
(300 Compliance Manager hours x $279 per hour) + (880 Programmer
Analyst hours x $196 per hour) + (880 Business Analyst hours x $201
per hour) = $697,660 per SRO to prepare and file an NMS plan. In
addition, Commission staff estimates that each SRO would incur a
one-time external cost of (50 legal hours x $400 per hour) =
$20,000. As a result, the Commission staff estimates that the
aggregate one-time cost to each SRO to prepare and file an NMS plan,
including external costs, would be ($20,000 in external costs) +
($697,660 in aggregate internal costs) = $717,660 per SRO to prepare
and file an NMS plan.
\876\ Commission staff estimates that the SROs would incur an
aggregate one-time cost of ($717,660 per SRO) x (17 SROs) =
$12,200,200 to prepare and file an NMS plan.
\877\ See Proposing Release, supra note 4, at 32596.
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The Commission believes that these revised estimates, which include
internal SRO personnel time and external legal costs, are appropriate
based on the impact of the modifications to the proposed Rule on each
of the job categories underlying the estimates. The Commission believes
that the modifications to the proposed Rule will require SRO Programmer
Analysts, Business Analysts, Attorneys, and Compliance Managers to
expend additional time to address the requirements of the Rule. As
discussed in more detail below, the Commission anticipates that the
SROs will spend additional time on many activities, including: (1)
Research; (2) discussions with members, committees and with industry
associations; (3) vendor negotiations; (4) making decisions regarding
the various options and increased flexibility provided by the adopted
Rule; \878\ (5) reviewing alternative NMS plans; (6) choosing between
alternative plans and negotiating to reach a consensus on a single NMS
plan; (7) providing a detailed estimate of the costs associated with
that NMS plan; and (8) drafting the NMS plan. The Commission also
believes that these increased estimates are appropriate in light of the
comments, including the comment that the Commission underestimated the
time the SROs would spend on business analyses to be performed in
designing the NMS plan based on the experience of broker-dealers,
vendors and SROs when OATS was expanded to all NMS stocks.\879\ In
response, as discussed below, the Commission is increasing its
estimated Programmer Analyst, Business Analyst, Attorney, and
Compliance Manager hours.
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\878\ See Section I., supra.
\879\ See FIF Letter II, p. 2-3. See also STA Letter, p. 2-3.
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The Commission notes that the average hourly and cost estimates per
SRO for creating and filing the NMS plan likely overestimated the costs
for some of SROs and underestimated the costs for other SROs. The
Commission also believes that certain SROs, particularly those SROs
under the same holding company, may decide to collaborate and realize
some cost savings on a per SRO basis. On balance, however, the
Commission believes that, these hours and cost estimates are reasonable
on average even if they may not be precise for any specific SRO.
(i) Programmer Analyst
The Commission is increasing its Programmer Analyst hour estimates
from 220 hours to 880 hours per SRO. As discussed in more detail below
in Section IV.D.2.a.i., the Commission anticipates that a Programmer
Analyst would need to spend substantially more time to address the
considerations included in the Rule and the ``use cases.'' Programmer
Analysts may be involved in the NMS plan research, any industry
discussions, negotiations with vendors and SROs, and in developing cost
estimates for the consolidated audit trail. Thus, for these reasons,
the Commission believes it appropriate to increase substantially its
estimate of the number of hours expended by Programmer Analysts in the
creation and filing of the NMS plan.
(ii) Business Analyst
The Commission is increasing its Business Analyst hour estimates
from 360 hours to 880 hours per SRO. As discussed in more detail below
in Section IV.D.2.a.ii., the Commission anticipates that a Business
Analyst would spend substantially more time to address the
considerations and the ``use cases,'' and overall, an amount of time
that is comparable to the time that would likely be spent by Programmer
Analysts because Business Analysts will likely be involved in many of
the same tasks as Programmer Analysts, but have separate
responsibilities as well.
(iii) Attorney
The Commission is increasing its estimates for the hours an
Attorney would likely spend to prepare and file an NMS plan from 400
hours to 700 hours per SRO. As discussed in more detail in Section
IV.D.2.a.iii. below, the Commission anticipates that an Attorney would
spend substantially more time than previously estimated to draft the
NMS plan.
(iv) Compliance Manager
The Commission is increasing its Compliance Manager hour estimate
from 100 hours to 300 hours per SRO. As discussed in more detail below
in Section IV.D.2.a.iv., the Commission anticipates that a Compliance
Manager would spend substantially more time than previously estimated
to draft the NMS plan.
4. Consideration of Burden on Competition and Promotion of Efficiency,
Competition, and Capital Formation
Section 3(f) of the Exchange Act requires the Commission, whenever
it engages in rulemaking and is required to consider or determine
whether an action is necessary or appropriate in the public interest,
to also consider, in addition to the protection of investors, whether
the action would promote efficiency, competition, and capital
formation. Further, Section 23(a)(2) of the Exchange Act requires the
Commission, when making rules under the Exchange Act, to consider the
impact such rules would have on competition. Section 23(a)(2) prohibits
the Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.
The Commission has focused its economic analysis in this Release on
the requirement that the SROs develop an NMS plan, rather than on the
actual creation, implementation, and maintenance of a consolidated
audit trail itself, and is deferring its economic analysis of the
actual creation, implementation, and maintenance of a consolidated
audit trail itself until such time as it may approve the NMS plan
submitted to the Commission for its consideration. The Commission's
consideration of the Rule's impact on efficiency, competition, and
capital formation is consistent with this approach. Because the Rule
focuses only on the process and the requirement of the development of
an NMS plan, the Commission believes that the adopted Rule will have
minimal, if any, impact on efficiency, competition, and capital
formation.
The Commission regards the adopted Rule as only a step in the
multi-step process of developing and approving an NMS plan that will
govern the creation, implementation, and maintenance of a consolidated
audit trail and the Commission recognizes that the creation,
implementation, and maintenance of a consolidated audit trail itself
could potentially have effects on efficiency, competition, and capital
formation. Therefore, Rule 613(a)(5) specifically provides that the
Commission will consider the impact of the NMS plan submitted to the
Commission for its consideration on efficiency, competition, and
capital formation in determining whether to approve the plan or any
amendment thereto. A complete consideration of the impact of the NMS
plan, or any amendment thereto, on efficiency,
[[Page 45803]]
competition, and capital formation, however, requires information that
will not be known until the SROs submit their NMS plan or any amendment
thereto. Accordingly, the Commission is deferring this analysis until
such time as it may approve the NMS plan, or any amendment thereto,
submitted by the SROs. To facilitate the consideration of such possible
impacts, the Rule requires SROs to provide their own analysis of the
plan's potential impact on efficiency, competition, and capital
formation.
D. Implementation of Rule 613 After Approval of the NMS Plan
Proposed Rule 613(a)(3) sets forth a timetable for the
implementation of the consolidated audit trail once the Commission has
approved an NMS plan. The Commission proposed that the data collection
and submission requirements would have applied first to the national
securities exchanges and FINRA, and then to their individual
members.\880\ Specifically, proposed Rule 613(a)(3)(iii) would have
required the plan sponsors to provide to the central repository the
data to be required by the Rule within one year after effectiveness of
the NMS plan. Members of the exchanges and FINRA would have been
required to begin providing to the central repository the data required
by the proposed Rule two years after the effectiveness of the NMS
plan.\881\ This phased approach was intended to allow members
additional time to implement the systems changes necessary to begin
providing the information to the central repository, including
developing procedures to capture any new information required, such as
the unique customer and order identifiers.
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\880\ See proposed Rule 613(a)(3)(iii).
\881\ See proposed Rule 613(a)(3)(v).
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Additionally, proposed Rule 613(g)(1) would have required each SRO
to file a proposed rule change with the Commission on or before 120
days from approval of Rule 613 to require its members to comply with
Rule 613. Further, proposed Rule 613(i) would have required the plan
sponsors to jointly provide to the Commission, within two months after
effectiveness of the NMS plan, a document outlining how the plan
sponsors would propose to incorporate into the consolidated audit trail
information with respect to equity securities that are not NMS
securities, debt securities, primary market transactions in NMS stocks,
primary market transactions in equity securities that are not NMS
securities, and primary market transactions in debt securities,
including details for each order and reportable event that would be
required to be provided, which market participants would be required to
provide the data, an implementation timeline, and a cost estimate.
Although one commenter agreed that the consolidated audit trail
could be implemented according to the timeline originally
proposed,\882\ and another urged the Commission to expedite
implementation of Rule 613,\883\ several commenters stated that more
time would be necessary to develop and implement the NMS plan.\884\
Many commenters suggested extended timelines for various aspects of the
consolidated audit trail.\885\ Two commenters, however, argued that the
timetable for implementation should be shortened,\886\ and one of the
commenters suggested that the Commission use existing infrastructure,
naming OATS as an example, as the basis of the audit trail to save
implementation time.\887\ Another commenter requested that the
Commission move the deadline for submission of the joint document from
the SROs outlining a proposal of how an expansion could occur from two
months, as proposed, to one year after approval of the NMS plan, to
allow time to choose a technology provider and build the infrastructure
of the system, stating that ``[i]t would be far better to develop the
design for the initial products and leverage this knowledge to later
phases.'' \888\
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\882\ See Nasdaq Letter I, p. 3.
\883\ See Bean Letter, p. 1.
\884\ See FINRA/NYSE Euronext Letter, p. 8; FINRA Letter, p. 15;
Scottrade Letter, p. 1; CBOE Letter, p. 7; FIF Letter, p. 8; FIF
Letter II, p. 2-3; STA Letter, p. 2-3; Nasdaq Letter I, p. 6-7;
Wells Fargo Letter, p. 2-3; Direct Edge Letter, p. 2-3.
\885\ See CBOE Letter, p. 6; Thomson Reuters Letter, p. 3;
Liquidnet Letter, p. 2-3, 9; Ameritrade Letter, p. 3; Nasdaq Letter
I, p. 7-9; Scottrade Letter, p. 1; SIFMA Letter, p. 13. See also FIF
Letter, p. 8; FIF Letter II, p. 2-3; STA Letter, p. 2-3; Wells Fargo
Letter, p. 2-3; FINRA/NYSE Euronext Letter, p. 8; FINRA Letter, p.
15.
\886\ See Kaufman Letter, Attachment p. 1; Schumer Letter, p. 1.
\887\ See Schumer Letter, p. 1.
\888\ See Nasdaq Letter I, p. 7.
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The Commission also received two comment letters recommending that
the Rule contain an exemption to accommodate the business model of
small broker-dealers.\889\
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\889\ See FINRA Proposal Letter, p. 5-6; and Wachtel Letter, p.
1.
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After considering the comments regarding the proposed timeline for
implementation of the Rule, the Commission is adopting Rule 613 with
changes to the proposed Rule. First, the Commission is adopting a
deadline of 60 days from effectiveness of the NMS plan (rather than 120
days from approval of the Rule, as originally proposed) by when each
SRO must file with the Commission proposed rule changes to require its
members to comply with the requirements of the Rule and the adopted NMS
plan,\890\ so that SROs can sequence their efforts by acting first on
developing the NMS plan to be submitted to the Commission for its
consideration, and then on proposed rules requiring compliance by their
members. Second, in response to the commenter that advocated extending
the deadline for the plan sponsors for submission of the joint document
outlining how an expansion could occur from two months, as proposed, to
one year after effectiveness of the approved NMS plan, the Commission
is modifying the proposed Rule so that the document will be due to the
Commission within six months (rather than two months as proposed) after
the approval of the NMS plan. The Commission believes that this
additional four months will provide the time necessary after the
submission of the NMS plan to the Commission for the SROs to plan how
to expand the consolidated audit trail to capture orders and trading in
these additional securities.\891\
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\890\ See Rule 613(g)(1).
\891\ The Commission notes that the SROs could begin drafting
the document even before an NMS plan is approved by the Commission.
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The Commission has considered the comment letters that requested an
exemption from the proposed Rule for small broker-dealers,\892\ but, as
discussed above,\893\ does not believe that it is appropriate to
completely exempt smaller broker-dealers from the requirements of the
consolidated audit trail. While the Commission does not believe that it
is appropriate to completely exempt smaller broker-dealers from the
Rule, the Commission, in response to commenters' concerns regarding the
potential difficulties for small broker-dealers, is modifying the time
by when the NMS plan may require small broker-dealers to comply with
Rule 613. The Commission is permitting the SROs in the NMS plan to
allow small broker-dealers up to three years after effectiveness,
rather than two years as proposed, to begin reporting data to the
central repository in recognition that some of these firms may still be
handling orders manually and thus will need additional time to upgrade
to an electronic method.\894\
[[Page 45804]]
Additionally, because many of these broker-dealers may have limited
resources, the Commission encourages plan sponsors to propose in the
NMS plan a requirement that small broker-dealers report data to the
central repository within three years after effectiveness of the NMS
plan, as the Commission believes that providing small broker-dealers a
longer implementation time should assist such broker-dealers in
identifying the most cost-effective and the most efficient manner in
which to procure third-party software or make any systems modifications
or other changes to comply with Rule 613.
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\892\ See FINRA Proposal Letter, p. 5-6; Wachtel Letter, p. 1.
\893\ See Section III.B.1.c., supra.
\894\ See Rule 613(a)(3)(vi); see also Rule 613(a)(3)(v).
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Rule 613(a)(3)(vi) uses the definition of ``small broker-dealer''
contained in Exchange Act Rule 0-10: ``Small entities under the
Securities Exchange Act for purposes of the Regulatory Flexibility
Act.'' \895\ Rule 0-10(c) defines a ``small broker-dealer'' as a broker
or dealer that: (1) Had total capital (net worth plus subordinated
liabilities) of less than $500,000 on the date in the prior fiscal year
as of which its audited financial statements were prepared pursuant to
240.17a5(d) or, if not required to file such statements, a broker or
dealer that had total capital (net worth plus subordinated liabilities)
of less than $500,000 on the last business day of the preceding fiscal
year (or in the time that it has been in business, if shorter); and (2)
is not affiliated with any person (other than a natural person) that is
not a small business or small organization as defined in this
section.\896\ The Commission believes that applying this definition is
appropriate because it is an existing regulatory standard that is an
indication of small entities for which regulators should be sensitive
when imposing regulatory burdens.
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\895\ 17 CFR 240.0-10.
\896\ 17 CFR 240.0-10(c).
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The Commission notes that not all of the timeframes for
implementation are being revised.\897\ As discussed in Section
III.B.1.f., above, the Commission has learned through the comment
process that technology exists today to ``normalize'' information
collected for the consolidated audit trail into a uniform electronic
format, which will allow the required data to be captured and reported
to the central repository more readily than the Commission originally
anticipated. Accordingly, the Commission believes the remaining
proposed implementation timeframes are reasonable and is adopting them
as proposed.
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\897\ Pursuant to Rules 613(a)(3)(i) through (vi), the NMS plan
must require the SROs to meet the following implementation
deadlines: (1) Within two months after effectiveness of the national
market system plan jointly (or under the governance structure
described in the plan) select a person to be the plan processor; (2)
within four months after effectiveness of the national market system
plan synchronize their business clocks and require members of each
such exchange and association to synchronize their business clocks
in accordance with Rule 613(d); (3) within one year after
effectiveness of the national market system plan provide to the
central repository the data specified in Rule 613(c); (4) within
fourteen months after effectiveness of the national market system
plan implement a new or enhanced surveillance system(s) as required
by Rule 613(f); (5) within two years after effectiveness of the NMS
plan, require members of each such exchange and association (except
those that qualify as small broker-dealers as defined in Sec.
240.0-10(c)) to provide to the central repository the data specified
in Rule 613(c); and (6) within three years after effectiveness of
the national market system plan require members of each such
exchange and association that qualify as small broker-dealers as
defined in Sec. 240.0-10(c) to provide to the central repository
the data specified in Rule 613(c).
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IV. Paperwork Reduction Act
Certain provisions of the Rule contain ``collection of information
requirements'' within the meaning of the PRA. The Commission published
notice requesting comment on the collection of information requirements
in the Proposing Release and submitted the proposed collection to the
Office of Management and Budget (``OMB'') for review in accordance with
44 U.S.C. 3507 and 5 CFR 1320.11. An agency may not conduct or sponsor,
and a person is not required to respond to, a collection of information
unless it displays a currently valid OMB control number. The control
number for Rule 613 is OMB Control No. 3235-0671 and the title of the
new collection of information is ``Creation of a Consolidated Audit
Trail Pursuant to Section 11A of the Securities Exchange Act of 1934
and Rules thereunder.''
This Release includes the Commission's estimates of the costs to
create and file the NMS plan.\898\ As noted above, the Commission is
deferring its economic analysis of the consolidated audit trail (other
than with respect to the NMS plan) until after the NMS plan, including
the detailed information and analysis, has been submitted by the SROs
and there has been an opportunity for public comment.\899\ Similarly,
the Commission is discussing below its estimates of the burden hours
associated with the development and filing of the NMS plan but is
deferring its discussion of the much more significant burden hours
associated with the other paperwork requirements of the consolidated
audit trail. The Commission also is deferring its discussion of the
ongoing burden hours associated with the NMS plan because such ongoing
burdens would only be incurred if the Commission approves the NMS plan.
Instead, the Commission will defer these discussions until after the
NMS plan, including the detailed information and analysis, has been
submitted by the SROs and there has been an opportunity for public
comment.
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\898\ See Section III.C.3., supra.
\899\ See Rule 613(a)(5) (providing, in part, that the
Commission ``shall consider the impact of the national market system
plan on efficiency, competition, and capital formation''). See also
Section I., supra.
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A. Summary of Collection of Information Under Rule 613
Rule 613 requires the SROs to develop and file an NMS plan to
govern the creation, implementation, and maintenance of a consolidated
audit trail and central repository for the collection of information
for NMS securities.\900\ The NMS plan must require each SRO and its
respective members to provide certain data to the central repository in
compliance with Rule 613.\901\ The NMS plan also must include a
discussion of specified considerations,\902\ and certain provisions
related to administration and operation of the plan \903\ and the
operation of the central repository.\904\
[[Page 45805]]
Further, the NMS plan is required to include certain provisions related
to compliance by the SROs and their members with the requirements of
the Rule and the NMS plan.\905\
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\900\ See Rule 613(a)(1).
\901\ See Rule 613(c).
\902\ See Rule 613(a)(1)(i) through (xii).
\903\ For example, the NMS plan must include provisions: (1) To
ensure fair representation of the plan sponsors; (2) for
administration of the central repository, including selection of the
plan processor; (3) addressing the requirements for admission of new
plan sponsors and withdrawal of existing plan sponsors; (4)
addressing the percentage of votes required by the plan sponsors to
effectuate amendments to the plan; (5) addressing the manner in
which the costs of operating the central repository would be
allocated among the SROs that are sponsors of the plan, including a
provision addressing the manner in which costs would be allocated to
new sponsors to the plan; (6) requiring the appointment of a Chief
Compliance Officer to regularly review the operation of the central
repository to assure its continued effectiveness, and make any
appropriate recommendations for enhancements to the nature of the
information collected and the manner in which it is processed; and
(7) including an enforcement mechanism to ensure that each SRO and
member is collecting and providing to the central repository the
information required. See Rule 613(b), 613(g)(4), and 613(h)(3).
\904\ For example, the NMS plan must include a provision
requiring the creation and maintenance by the plan processor of a
method of access to the data stored in the central repository, that
includes the ability to run searches and generate reports. See Rule
613(e)(3). Additionally, the NMS plan is required to include
policies and procedures, including standards, to be used by the plan
processor to: (1) Ensure the security and confidentiality of all
information submitted to the central repository; (2) ensure the
timeliness, accuracy, integrity and completeness of the data
provided to the central repository; (and (3) ensure the accuracy of
the consolidation by the plan processor of the data provided to the
central repository. See Rule 613(e)(4). The NMS plan also must
include a provision requiring the plan sponsors to provide to the
Commission, at least every two years after effectiveness of the
national market system plan, a written assessment of the operation
of the consolidated audit trail. See Rule 613(b)(6). The NMS plan is
also required to include an Advisory Committee to advise the plan
sponsors on the implementation, operation and administration of the
central repository. See Rule 613(b)(7). Further, the NMS plan must
specify a maximum error rate to be tolerated by the central
repository for the data it collects, and processes for identifying
and correcting errors in the data, for notifying the entities
responsible for the reporting of the erroneous data, and for
disciplining those who repeatedly report erroneous data. See Rule
613(e)(6)(i) through(iv). The NMS plan must also specify as a time
by which the corrected data will be available to regulators. See
Rule 613(e)(6)(iv).
\905\ The NMS plan must include: (1) A provision that makes each
SRO that sponsors the plan responsible for enforcing compliance by
its members with the provisions of the plan; and (2) mechanisms to
ensure that plan sponsors and their members comply with the
requirements of the plan. See Rules 613(g)(3), 613(g)(4), and
613(h)(3).
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The Commission believes that requiring an NMS plan imposes a
paperwork burden on the SROs associated with preparing and filing the
joint NMS plan.
B. Use of Information
The information contained in the NMS plan submitted to the
Commission for its consideration will provide the Commission and the
public with detailed information regarding how the consolidated audit
trail will be created, implemented, and maintained in order for the
Commission and the public to be able to carefully consider all aspects
of the NMS plan. Further, the information contained in the NMS plan
should facilitate an analysis of how well the NMS plan will allow
regulators to effectively and efficiently carry out their
responsibilities.
C. Respondents
Rule 613 applies to the 16 national securities exchanges and to one
national securities association (FINRA) currently registered with the
Commission.\906\
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\906\ At the time the Proposing Release was published, there
were 14 national securities exchanges. On August 13, 2010, the
Commission granted the application of BATS-Y Exchange for
registration as a national securities exchange. See Securities
Exchange Act Release No. 62719, 75 FR 51295 (August 19, 2010).
Additionally, on April 27, 2012, the Commission granted the
application of BOX Options Exchange for registration as a national
securities exchange. See Securities Exchange Act Release No. 66871,
77 FR 26323 (May 3, 2012).
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D. Total Annual Reporting and Recordkeeping Burden for the Creation and
Filing of the NMS Plan
1. Preliminary Burden Hour Estimates from Proposing Release
In the Proposing Release, the Commission estimated that each SRO,
on average, would spend approximately 840 hours of legal, compliance,
information technology, and business operations time to prepare and
file the NMS plan. All together the SROs would spend an estimated
12,600 hours.\907\ The Commission's 840 hour estimate included internal
personnel time and external legal costs--400 Attorney hours, 100
Compliance Manager hours, 220 Programmer Analyst hours, and 120
Business Analyst hours. Commission staff also estimated that each SRO
would outsource, on average, 50 hours of legal time to develop and
draft the NMS plan, at an average hourly rate of $400, for a total
external cost of $20,000 per SRO.\908\ All together, the SROs would
spend an estimated $300,000 in external costs.\909\
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\907\ Commission staff estimated that each SRO would spend an
aggregate one-time amount of (400 Attorney hours) + (100 Compliance
Manager hours) + (220 Programmer Analyst hours) + (120 Business
Analyst hours) x (15 SROs) = 12,600 burden hours to prepare and file
the NMS plan.
\908\ Based on industry sources, the Commission estimated that
the hourly rate for outsourced legal services in the securities
industry is $400 per hour.
\909\ Commission staff estimated that the SROs would spend
($20,000 per SRO) x (15 SROs) = $300,000 in external costs to
develop and draft the NMS plan.
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In making these estimates, the Commission assumed that the burden
hours necessary for preparing and filing the NMS plan pursuant to the
proposed Rule would be comparable to the burden hours needed to create
other existing NMS plans.\910\ The Commission's estimates included
anticipated work hours for Programmer Analysts, Business Analysts,
Attorneys and Compliance Managers. The Commission did not receive
comments on any of these burden estimates.
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\910\ See Proposing Release, supra note 4, at 32596.
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2. Revised Burden Hour Estimates
As noted above, the Commission based its original estimates of SRO
burden hours to prepare and file the NMS plan on the burden hours spent
for existing NMS plans. The Commission, however, has modified the
proposed Rule in several significant ways that differentiate the burden
hours to prepare the NMS plan from all other existing NMS plans. These
modifications require the SROs to expand the NMS plan in the following
four ways: (1) Provide additional information and analysis to address
the considerations that are set forth in Rule 613(a)(1); \911\ (2)
include additional provisions that were not required by the proposed
Rule relating to enforcement mechanisms,\912\ security and
confidentiality,\913\ and the preparation of a document every two years
that contains a retrospective assessment of the performance of the
consolidated audit trail, as well as a plan to improve its performance;
\914\ (3) address error rates; \915\ and (4) provide for the creation
of an Advisory Committee.\916\
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\911\ See Rule 613(a)(1)(i) through (xii); Section III.C.2.a.,
supra.
\912\ See Rule 613(h)(3); Section III.B.3.a.1., supra.
\913\ See, e.g., Rule 613(e)(4)(i)(A) through (D). For example,
Rule 613(e)(4)(i)(A) requires that the NMS plan require that all
plan sponsors and their employees, as well as all employees of the
central repository, agree to use appropriate safeguards to ensure
the confidentiality of such data and not use such data for purposes
other than surveillance or regulatory purposes. Additionally, Rule
613(e)(4)(i)(B) requires the NMS plan to require that each SRO adopt
and enforce rules that: (1) Require information barriers between
regulatory staff and non-regulatory staff with regard to access and
use of data in the central repository and (2) permit only persons
designated by plan sponsors to have access to the data in the
central repository. See Section III.B.2.e., supra.
\914\ See Rule 613(b)(6)(i) through (iv). See Section
III.B.3.b., supra.
\915\ See Rule 613(e)(6)(i) through (ii). See Section
III.B.2.c., supra. See Rule 613(e)(6)(iii) through (iv).
\916\ See Rule 613(b)(7).
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a. Revised Initial Burden Hours Needed To Prepare and File the NMS Plan
In light of these modifications to the proposed Rule, the
Commission is increasing substantially its estimated burden hours
needed for the development and filing of the NMS plan. The Commission
also is adjusting its preliminary burden hour estimates for the
preparation and filing of an NMS plan to reflect the registration of
two additional SROs after it issued the preliminary estimates.\917\ The
Commission now estimates that the aggregate one-time burden hour amount
for preparing and filing an NMS plan would be approximately 2,760
burden hours with $20,000 in external costs per SRO,\918\ or
approximately 46,920 burden hours and $340,000 in external costs in the
aggregate,\919\ compared to an
[[Page 45806]]
initial estimate of 840 burden hours per SRO with $20,000 in external
costs, or approximately 12,600 burden hours in the aggregate and
$300,000 in external costs, to prepare and file an NMS plan.\920\
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\917\ See note 906, supra.
\918\ Commission staff estimates that each SRO would spend an
aggregate one-time amount of (700 Attorney hours) + (300 Compliance
Manager hours) + (880 Programmer Analyst hours) + (880 Business
Analyst hours) = 2,760 burden hours per SRO to prepare and file an
NMS plan. In addition, Commission staff estimates that each SRO
would incur a one-time external cost of (50 legal hours x $400 per
hour) = $20,000.
\919\ Commission staff estimates that the SROs would incur an
aggregate one-time amount of (2,760 burden hours per SRO) x (17
SROs) = 46,920 burden hours to prepare and file an NMS plan.
Commission staff estimates that ($20,000 per SRO) x (17 SROs) =
$340,000 in external costs to prepare and file the NMS plan.
\920\ See Proposing Release, supra note 4, at 32596.
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The Commission believes that these revised estimates, which include
internal SRO personnel time and external legal costs, are appropriate
based on the Commission's analysis, set forth below, of the impact of
the modifications to the proposed Rule on each of the job categories
underlying the estimates. The Commission believes that the
modifications to the proposed Rule will require SRO Programmer
Analysts, Business Analysts, Attorneys, and Compliance Managers to
expend additional time to address the requirements of the Rule. As
discussed in more detail below, the Commission anticipates that the
SROs will spend additional time on many activities, including: (1)
Research; (2) discussions with members, committees and with industry
associations; (3) vendor negotiations; (4) making decisions regarding
the various options and increased flexibility provided by the adopted
Rule; \921\ (5) reviewing alternative NMS plans; (6) choosing between
alternative plans and negotiating to reach a consensus on a single NMS
plan; (7) providing a detailed estimate of the costs associated with
that NMS plan; and (8) drafting the NMS plan. The Commission also
believes that these increased estimates are appropriate in light of the
comments, including the comment that asserted that the Commission
underestimated the time the SROs would spend on the business analyses
to be performed in designing the NMS plan, based on the experience of
broker-dealers, vendors and SROs when OATS was expanded to all NMS
stocks.\922\ In response, as discussed in more detail below, the
Commission is increasing its estimated Programmer Analyst, Business
Analyst, Attorney and Compliance Manager hours.
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\921\ See Section I., supra.
\922\ See FIF Letter II, p. 2-3. See also STA Letter, p. 2-3.
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The Commission notes that these revised average hourly and cost
estimates per SRO for creating and filing the NMS plan likely
overestimated the costs for some of SROs and underestimated the costs
for other SROs. The Commission also believes that certain SROs,
particularly those SROs under the same holding company, may decide to
collaborate and realize some cost savings on a per SRO basis. On
balance, however, the Commission believes that, these revised hours and
cost estimates are reasonable on average even if they may not be
precise for any specific SRO.
(i) Programmer Analyst
The Commission is increasing its estimates for the hours a
Programmer Analyst would likely spend with respect to the preparation
and filing of the NMS plan from 220 hours, as originally estimated, to
880 hours per SRO. The Commission anticipates that a Programmer Analyst
would need to spend substantially more time to address the
considerations included in the Rule and the ``use cases.''
Specifically, the SROs will need to rely on Programmer Analysts to help
address many of the considerations, as many of those are of a technical
nature. For example, several of the considerations relate to the
specific features and details of the NMS plan. Programmer Analysts
likely will be consulted when the SROs are considering the specific
features and details of the NMS plan. The Programmer Analysts likely
will provide guidance and information regarding whether a particular
feature or detail is technologically possible. The SROs also likely
will consult Programmer Analysts when drafting the additional
provisions required by the Rule. For example, in drafting the security
and confidentiality provisions, Programmer Analysts, who may have
knowledge about the information security practices and issues, may be
consulted to provide input on a draft provisions in light of
technologies with respect to security and confidentiality. Programmer
Analysts also may be consulted with respect to addressing errors rates
because such analysts may have a technical understanding of trading and
reporting systems and be able to provide recommendations on how errors
that are introduced can be addressed. In each of these instances,
Programmer Analysts may be involved in the NMS plan research, any
industry discussions, negotiations with vendors and SROs, and in
developing cost estimates for the consolidated audit trail. Thus, for
these reasons, the Commission believes it appropriate to increase its
estimate of the number of hours expended by Programmer Analysts in the
creation and filing of the NMS plan.
(ii) Business Analyst
The Commission is increasing its estimates for the hours a Business
Analyst would likely spend with respect to the preparation and filing
of an NMS plan from 360 hours per SRO, as originally estimated, to 880
hours per SRO. The Commission anticipates that a Business Analyst would
spend substantially more time to address the considerations and the
``use cases.'' Overall, the Commission anticipates that this amount of
additional time will be comparable to the additional time that would
likely be spent by Programmer Analysts for the same reasons because
Business Analysts will likely be involved in many of the same tasks as
Programmer Analysts, albeit with separate responsibilities. The SROs
will need to rely on Business Analysts to help address many technical
considerations that have relevance to the business and operations of
SROs. The Commission also believes that the SROs will need to rely on
Business Analysts to work with the Programmer Analysts and the
Compliance Managers to analyze the business impact of particular
features and details of the NMS plan. Because Rule 613 is less
prescriptive than the proposed Rule, Business Analysts may have a
larger role in helping to determine which option the NMS plan will
propose. Business Analysts also will likely be involved in determining
the cost estimates and in analyzing the NMS plan's impact on
efficiency, competition, and capital formation. The SROs also likely
will consult with Business Analysts when drafting the responses to the
considerations and the ``use cases,'' as well as the additional
provisions required by the Rule. For example, the SROs likely will
consult with Business Analysts on the feasibility, benefits, and costs
of any technological upgrades that may be required in order to provide
the allocation information described in Rule 613(a)(1)(vi). Further, in
drafting the security and confidentiality provisions, Business Analysts
may have knowledge about the costs and the business risks of certain
security and confidentiality decisions. Business Analysts also may be
consulted with respect to addressing error rates because any decisions
made may impact business operations and the cost estimates. Further,
Business Analysts may likely be consulted by Attorneys with respect to
the performance assessment and improvement plan. In each of these
instances, Business Analysts may be involved in the NMS plan research,
any industry discussions (particularly with members and other SROs),
negotiations with vendors and SROs, and in developing cost estimates
for the
[[Page 45807]]
consolidated audit trail. Thus, for these reasons, the Commission
believes it is appropriate to increase its estimate of the number of
hours expended by Business Analysts in the creation and filing of the
NMS plan.
(iii) Attorney
The Commission is increasing its Attorney hour estimates from 400
hours to 700 hours per SRO. The Commission now anticipates that an
Attorney would spend substantially more time than the Commission had
previously estimated to draft the NMS plan. The NMS plan that Attorneys
would draft must now include a discussion of the considerations and the
additional provisions required by the Rule, and must reflect additional
consultations with Programmer Analysts, Business Analysts and
Compliance Managers. Further, the NMS plan drafted also would likely
reflect additional consultation on the ``use cases.'' The NMS plan
proposal would also likely require Attorney work on the Advisory
Committee requirement and on the NMS plan policies and procedures to be
used by the plan processor \923\ to ensure the security and
confidentiality and accuracy of the information submitted to the
central repository.\924\ Attorney work would also be required on the
mechanism to enforce compliance by plan sponsors with the NMS plan, as
required by Rule 613(h)(3), including penalty provisions, if the plan
sponsors deem appropriate. The Commission believes that an Attorney
would also be involved in the NMS plan research, any industry
discussions, negotiations with vendors, negotiations with SROs (in
particular, to reach consensus on an NMS plan), and in developing cost
estimates for the consolidated audit trail. Thus, for these reasons,
the Commission believes it appropriate to increase its estimate of the
number of hours expended by Attorneys in the creation and filing of the
NMS plan.
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\923\ See Rule 613(e)(4). The Commission believes that an
outline or overview description of the policies and procedures,
including standards, to be used by the plan processor that would be
implemented under the NMS plan submitted to the Commission for its
consideration would be sufficient to satisfy the requirement of the
Rule. The Commission believes it is important for the NMS plan to
establish the fundamental framework of these policies and
procedures, but recognizes the utility of allowing the plan sponsors
flexibility to subsequently delineate them in greater detail with
the ability to make modifications as needed. See Section III.B.2.e.,
supra.
\924\ See Rule 613(e)(4)(i)(A) through (D).
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(iv) Compliance Manager
The Commission is increasing its Compliance Manager hour estimates
from 100 hours to 300 hours per SRO. The Commission now anticipates
that a Compliance Manager would spend substantially more time than the
Commission had previously estimated to draft the NMS plan. Compliance
Managers likely will help shape provisions of the NMS plan that deal
with monitoring member and SRO compliance with the NMS plan's
requirements. Compliance Managers likely will also be involved in the
Advisory Committee requirement. They likely will also work on NMS plan
policies and procedures to be used by the plan processor to ensure the
security and confidentiality and accuracy of the information submitted
to the central repository, and to ensure that these policies and
procedures are feasible for SRO compliance and for member
compliance.\925\ They will likely also work on the mechanism to enforce
compliance by plan sponsors with the NMS plan, as required by Rule
613(h)(3), including penalty provisions, if the plan sponsors deem
appropriate. Further, Compliance Managers will also work on NMS plan
provisions that address error rates and performance assessment and
improvement. The Commission believes that Compliance Managers may also
be involved in the NMS plan research and industry discussions
(particularly with regard to SRO and member compliance issues). Thus,
for these reasons, the Commission believes it is appropriate to
increase its estimate of the number of hours expended by Compliance
Managers in the creation and filing of the NMS plan.
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\925\ See Rule 613(e)(4)(i)(A) through (D).
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E. Collection of Information Is Mandatory
The collection of information discussed above is a mandatory
collection of information.
F. Confidentiality
The Rule requires that the data to be recorded and reported to the
central repository will only be available to the SROs and the
Commission for the purpose of performing their respective regulatory
and oversight responsibilities pursuant to the federal securities laws,
rules, and regulations.\926\ Further, the NMS plan submitted to the
Commission for its consideration pursuant to the adopted Rule is
required to include policies and procedures to ensure the security and
confidentiality of all information submitted to the central repository,
and to ensure that all plan sponsors and their employees, as well as
all employees of the central repository, use appropriate safeguards to
ensure the confidentiality of such data and shall agree not to use such
data for any purpose other than surveillance and regulatory
purposes.\927\
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\926\ See Rule 613(e)(2).
\927\ See proposed Rule 613(e)(4)(i).
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G. Retention Period of Recordkeeping Requirements
The SROs are required to retain records and information pursuant to
Rule 17a-1 under the Exchange Act.\928\ Members are required to retain
records and information in accordance with Rule 17a-4 under the
Exchange Act.\929\
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\928\ 17 CFR 240.17a-1.
\929\ 17 CFR 240.17a-4.
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V. Regulatory Flexibility Act Certification
The Regulatory Flexibility Act (``RFA'') \930\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. Section 603(a) of the Administrative Procedure Act,
as amended by RFA, generally requires the Commission to undertake a
regulatory flexibility analysis of all proposed rules, or proposed rule
amendments, to determine the impact of such rulemaking on ``small
entities.'' \931\ Rule 605(b) of the RFA states that this requirement
shall not apply to any proposed rule or proposed rule amendment, which
if adopted, would not ``have a significant economic impact on a
substantial number of small entities.''\932\
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\930\ 5 U.S.C. 601 et seq.
\931\ Although Section 601(6) of the RFA defines the term
``small entity,'' the statute permits agencies to formulate their
own definitions. The Commission has adopted definitions for the term
``small entity'' for the purposes of Commission rulemaking in
accordance with the RFA. Those definitions, as relevant to this
rulemaking, are set forth in Rule 0-10, 17 CFR 240.0-10. See
Securities Exchange Act Release No. 18451 (January 28, 1982), 47 FR
5215 (February 4, 1982) (File No. AS-305).
\932\ 5 U.S.C. 605(b).
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In the Proposing Release, the Commission requested comment on
whether proposed Rule 613 would have a significant economic impact on a
substantial number of small entities, and, if so, what would be the
nature of any impact on small entities.\933\ The Commission also
requested that commenters provide empirical data to support the extent
of such impact.\934\ The Commission received two comments on the
general anticipated effect of the proposed Rule on small-broker
dealers; FINRA and a small broker-dealer that solely handles orders
manually requested that an exemption from the proposed Rule be adopted
to accommodate the business model of
[[Page 45808]]
small broker-dealers.\935\ In response to the commenters, the
Commission amended the Rule as proposed to provide additional time for
small broker-dealers to comply with the reporting requirements of Rule
613.\936\ The Commission notes that none of the comment letters
received specifically responded to the Commission's initial regulatory
flexibility analysis.
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\933\ See Proposing Release, supra note 4, at 32607.
\934\ Id.
\935\ See FINRA Proposal Letter, p. 5-6 and Wachtel Letter, p.
1.
\936\ See Rule 613(a)(3)(vi).
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As proposed and as adopted, Rule 613 requires the SROs to file an
NMS plan to create, implement, and maintain the consolidated audit
trail. In response to commenters and as discussed in this release, the
Commission has modified the proposed Rule to provide the SROs with a
range of options and greater flexibility for how they choose to meet
the requirements of the Rule. As a result, the Commission will not know
the specific requirements of the NMS plan until it is filed with the
Commission, and cannot analyze how the NMS plan will impact small
entities until then. At this time, there are no small entities
``subject to the requirements'' of Rule 613.\937\
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\937\ Section 604(a)(4) of the RFA.
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However, because Rule 613 requires that the national securities
exchanges and national securities associations (i.e., FINRA) file an
NMS plan with the Commission, for purposes of the RFA, the Commission
is undertaking an analysis of how the NMS plan filing requirement will
impact the exchanges and FINRA to ascertain whether the exchanges and
FINRA are ``small businesses.'' Paragraph (e) of Rule 0-10 provides
that for the purposes of the RFA, an exchange is considered a ``small
business'' if it has been exempted from the reporting requirements of
Rule 601 of Regulation NMS,\938\ and is not affiliated with any person
(other than a natural person) that is not a small business or small
organization as defined in Rule 0-10. Under this standard, none of the
national securities exchanges subject to Rule 613 is a ``small
business'' for purposes of the RFA. In addition, FINRA is not a small
entity as defined in Rule 0-10.\939\ Therefore, the Commission believes
that Rule 613, which requires that the SROs file an NMS plan with the
Commission to create, implement, and maintain the consolidated audit
trail, will not have a significant economic impact on a substantial
number of small entities because this requirement will only apply to
the existing national securities exchanges and national securities
associations, which do not qualify as small entities pursuant to the
RFA.
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\938\ 17 CFR 242.601.
\939\ 13 CFR 121.201.
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For the foregoing reasons, the Commission hereby certifies that,
pursuant to 5 U.S.C. 605(b), Rule 613 will not have a significant
economic impact on a substantial number of small entities.
VI. Statutory Authority
Pursuant to the Exchange Act and particularly, Sections 2, 3(b), 5,
6, 11A, 15, 15A, 17(a) and (b), 19, and 23(a) thereof, 15 U.S.C. 78b,
78c(b), 78e, 78f, 78k-1, 78o, 78o-3, 78q(a) and (b), 78s and 78w(a),
the Commission is adopting Rule 613 of Regulation NMS, as set forth
below.
Text of Rule
List of Subjects in 17 CFR Part 242
Brokers, Reporting and recordkeeping requirements, Securities.
In accordance with the foregoing, Title 17, Chapter II, of the Code
of Federal Regulations is amended as follows.
PART 242--REGULATIONS M, SHO, ATS, AC, AND NMS AND CUSTOMER MARGIN
REQUIREMENTS FOR SECURITY FUTURES
0
1. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
0
2. Add Sec. 242.613 to read as follows:
Sec. 242.613 Consolidated audit trail.
(a) Creation of a national market system plan governing a
consolidated audit trail.
(1) Each national securities exchange and national securities
association shall jointly file on or before 270 days from the date of
publication of the Adopting Release in the Federal Register a national
market system plan to govern the creation, implementation, and
maintenance of a consolidated audit trail and central repository as
required by this section. The national market system plan shall discuss
the following considerations:
(i) The method(s) by which data will be reported to the central
repository including, but not limited to, the sources of such data and
the manner in which the central repository will receive, extract,
transform, load, and retain such data; and the basis for selecting such
method(s);
(ii) The time and method by which the data in the central
repository will be made available to regulators, in accordance with
paragraph (e)(1) of this section, to perform surveillance or analyses,
or for other purposes as part of their regulatory and oversight
responsibilities;
(iii) The reliability and accuracy of the data reported to and
maintained by the central repository throughout its lifecycle,
including transmission and receipt from market participants; data
extraction, transformation and loading at the central repository; data
maintenance and management at the central repository; and data access
by regulators;
(iv) The security and confidentiality of the information reported
to the central repository;
(v) The flexibility and scalability of the systems used by the
central repository to collect, consolidate and store consolidated audit
trail data, including the capacity of the consolidated audit trail to
efficiently incorporate, in a cost-effective manner, improvements in
technology, additional capacity, additional order data, information
about additional securities or transactions, changes in regulatory
requirements, and other developments;
(vi) The feasibility, benefits, and costs of broker-dealers
reporting to the consolidated audit trail in a timely manner:
(A) The identity of all market participants (including broker-
dealers and customers) that are allocated NMS securities, directly or
indirectly, in a primary market transaction;
(B) The number of such securities each such market participant is
allocated; and
(C) The identity of the broker-dealer making each such allocation;
(vii) The detailed estimated costs for creating, implementing, and
maintaining the consolidated audit trail as contemplated by the
national market system plan, which estimated costs should specify:
(A) An estimate of the costs to the plan sponsors for establishing
and maintaining the central repository;
(B) An estimate of the costs to members of the plan sponsors,
initially and on an ongoing basis, for reporting the data required by
the national market system plan;
(C) An estimate of the costs to the plan sponsors, initially and on
an ongoing basis, for reporting the data required by the national
market system plan; and
(D) How the plan sponsors propose to fund the creation,
implementation, and maintenance of the consolidated audit
[[Page 45809]]
trail, including the proposed allocation of such estimated costs among
the plan sponsors, and between the plan sponsors and members of the
plan sponsors;
(viii) An analysis of the impact on competition, efficiency and
capital formation of creating, implementing, and maintaining of the
national market system plan;
(ix) A plan to eliminate existing rules and systems (or components
thereof) that will be rendered duplicative by the consolidated audit
trail, including identification of such rules and systems (or
components thereof); to the extent that any existing rules or systems
related to monitoring quotes, orders, and executions provide
information that is not rendered duplicative by the consolidated audit
trail, an analysis of:
(A) Whether the collection of such information remains appropriate;
(B) If still appropriate, whether such information should continue
to be separately collected or should instead be incorporated into the
consolidated audit trail; and
(C) If no longer appropriate, how the collection of such
information could be efficiently terminated; the steps the plan
sponsors propose to take to seek Commission approval for the
elimination of such rules and systems (or components thereof); and a
timetable for such elimination, including a description of how the plan
sponsors propose to phase in the consolidated audit trail and phase out
such existing rules and systems (or components thereof);
(x) Objective milestones to assess progress toward the
implementation of the national market system plan;
(xi) The process by which the plan sponsors solicited views of
their members and other appropriate parties regarding the creation,
implementation, and maintenance of the consolidated audit trail, a
summary of the views of such members and other parties, and how the
plan sponsors took such views into account in preparing the national
market system plan; and
(xii) Any reasonable alternative approaches to creating,
implementing, and maintaining a consolidated audit trail that the plan
sponsors considered in developing the national market system plan
including, but not limited to, a description of any such alternative
approach; the relative advantages and disadvantages of each such
alternative, including an assessment of the alternative's costs and
benefits; and the basis upon which the plan sponsors selected the
approach reflected in the national market system plan.
(2) The national market system plan, or any amendment thereto,
filed pursuant to this section shall comply with the requirements in
Sec. 242.608(a), if applicable, and be filed with the Commission
pursuant to Sec. 242.608.
(3) The national market system plan submitted pursuant to this
section shall require each national securities exchange and national
securities association to:
(i) Within two months after effectiveness of the national market
system plan jointly (or under the governance structure described in the
plan) select a person to be the plan processor;
(ii) Within four months after effectiveness of the national market
system plan synchronize their business clocks and require members of
each such exchange and association to synchronize their business clocks
in accordance with paragraph (d) of this section;
(iii) Within one year after effectiveness of the national market
system plan provide to the central repository the data specified in
paragraph (c) of this section;
(iv) Within fourteen months after effectiveness of the national
market system plan implement a new or enhanced surveillance system(s)
as required by paragraph (f) of this section;
(v) Within two years after effectiveness of the national market
system plan require members of each such exchange and association,
except those members that qualify as small broker-dealers as defined in
Sec. 240.0-10(c) of this chapter, to provide to the central repository
the data specified in paragraph (c) of this section; and
(vi) Within three years after effectiveness of the national market
system plan require members of each such exchange and association that
qualify as small broker-dealers as defined in Sec. 240.0-10(c) of this
chapter to provide to the central repository the data specified in
paragraph (c) of this section.
(4) Each national securities exchange and national securities
association shall be a sponsor of the national market system plan
submitted pursuant to this section and approved by the Commission.
(5) No national market system plan filed pursuant to this section,
or any amendment thereto, shall become effective unless approved by the
Commission or otherwise permitted in accordance with the procedures set
forth in Sec. 242.608. In determining whether to approve the national
market system plan, or any amendment thereto, and whether the national
market system plan or any amendment thereto is in the public interest
under Sec. 242.608(b)(2), the Commission shall consider the impact of
the national market system plan or amendment, as applicable, on
efficiency, competition, and capital formation.
(b) Operation and administration of the national market system
plan.
(1) The national market system plan submitted pursuant to this
section shall include a governance structure to ensure fair
representation of the plan sponsors, and administration of the central
repository, including the selection of the plan processor.
(2) The national market system plan submitted pursuant to this
section shall include a provision addressing the requirements for the
admission of new sponsors of the plan and the withdrawal of existing
sponsors from the plan.
(3) The national market system plan submitted pursuant to this
section shall include a provision addressing the percentage of votes
required by the plan sponsors to effectuate amendments to the plan.
(4) The national market system plan submitted pursuant to this
section shall include a provision addressing the manner in which the
costs of operating the central repository will be allocated among the
national securities exchanges and national securities associations that
are sponsors of the plan, including a provision addressing the manner
in which costs will be allocated to new sponsors to the plan.
(5) The national market system plan submitted pursuant to this
section shall require the appointment of a Chief Compliance Officer to
regularly review the operation of the central repository to assure its
continued effectiveness in light of market and technological
developments, and make any appropriate recommendations for enhancements
to the nature of the information collected and the manner in which it
is processed.
(6) The national market system plan submitted pursuant to this
section shall include a provision requiring the plan sponsors to
provide to the Commission, at least every two years after effectiveness
of the national market system plan, a written assessment of the
operation of the consolidated audit trail. Such document shall include,
at a minimum:
(i) An evaluation of the performance of the consolidated audit
trail including, at a minimum, with respect to data accuracy
(consistent with paragraph (e)(6) of this section), timeliness of
reporting, comprehensiveness of data elements, efficiency of regulatory
access, system speed, system downtime,
[[Page 45810]]
system security (consistent with paragraph (e)(4) of this section), and
other performance metrics to be determined by the Chief Compliance
Officer, along with a description of such metrics;
(ii) A detailed plan, based on such evaluation, for any potential
improvements to the performance of the consolidated audit trail with
respect to any of the following: improving data accuracy; shortening
reporting timeframes; expanding data elements; adding granularity and
details regarding the scope and nature of Customer-IDs; expanding the
scope of the national market system plan to include new instruments and
new types of trading and order activities; improving the efficiency of
regulatory access; increasing system speed; reducing system downtime;
and improving performance under other metrics to be determined by the
Chief Compliance Officer;
(iii) An estimate of the costs associated with any such potential
improvements to the performance of the consolidated audit trail,
including an assessment of the potential impact on competition,
efficiency, and capital formation; and
(iv) An estimated implementation timeline for any such potential
improvements, if applicable.
(7) The national market system plan submitted pursuant to this
section shall include an Advisory Committee which shall function in
accordance with the provisions set forth in this paragraph (b)(7). The
purpose of the Advisory Committee shall be to advise the plan sponsors
on the implementation, operation, and administration of the central
repository.
(i) The national market system plan submitted pursuant to this
section shall set forth the term and composition of the Advisory
Committee, which composition shall include representatives of the
member firms of the plan sponsors.
(ii) Members of the Advisory Committee shall have the right to
attend any meetings of the plan sponsors, to receive information
concerning the operation of the central repository, and to provide
their views to the plan sponsors; provided, however, that the plan
sponsors may meet without the Advisory Committee members in executive
session if, by affirmative vote of a majority of the plan sponsors, the
plan sponsors determine that such an executive session is required.
(c) Data recording and reporting.
(1) The national market system plan submitted pursuant to this
section shall provide for an accurate, time-sequenced record of orders
beginning with the receipt or origination of an order by a member of a
national securities exchange or national securities association, and
further documenting the life of the order through the process of
routing, modification, cancellation, and execution (in whole or in
part) of the order.
(2) The national market system plan submitted pursuant to this
section shall require each national securities exchange, national
securities association, and member to report to the central repository
the information required by paragraph (c)(7) of this section in a
uniform electronic format, or in a manner that would allow the central
repository to convert the data to a uniform electronic format, for
consolidation and storage.
(3) The national market system plan submitted pursuant to this
section shall require each national securities exchange, national
securities association, and member to record the information required
by paragraphs (c)(7)(i) through (v) of this section contemporaneously
with the reportable event. The national market system plan shall
require that information recorded pursuant to paragraphs (c)(7)(i)
through (v) of this section must be reported to the central repository
by 8:00 a.m. Eastern Time on the trading day following the day such
information has been recorded by the national securities exchange,
national securities association, or member. The national market system
plan may accommodate voluntary reporting prior to 8:00 a.m. Eastern
Time, but shall not impose an earlier reporting deadline on the
reporting parties.
(4) The national market system plan submitted pursuant to this
section shall require each member of a national securities exchange or
national securities association to record and report to the central
repository the information required by paragraphs (c)(7)(vi) through
(viii) of this section by 8:00 a.m. Eastern Time on the trading day
following the day the member receives such information. The national
market system plan may accommodate voluntary reporting prior to 8:00
a.m. Eastern Time, but shall not impose an earlier reporting deadline
on the reporting parties.
(5) The national market system plan submitted pursuant to this
section shall require each national securities exchange and its members
to record and report to the central repository the information required
by paragraph (c)(7) of this section for each NMS security registered or
listed for trading on such exchange or admitted to unlisted trading
privileges on such exchange.
(6) The national market system plan submitted pursuant to this
section shall require each national securities association and its
members to record and report to the central repository the information
required by paragraph (c)(7) of this section for each NMS security for
which transaction reports are required to be submitted to the
association.
(7) The national market system plan submitted pursuant to this
section shall require each national securities exchange, national
securities association, and any member of such exchange or association
to record and electronically report to the central repository details
for each order and each reportable event, including, but not limited
to, the following information:
(i) For original receipt or origination of an order:
(A) Customer-ID(s) for each customer;
(B) The CAT-Order-ID;
(C) The CAT-Reporter-ID of the broker-dealer receiving or
originating the order;
(D) Date of order receipt or origination;
(E) Time of order receipt or origination (using time stamps
pursuant to paragraph (d)(3) of this section); and
(F) Material terms of the order.
(ii) For the routing of an order, the following information:
(A) The CAT-Order-ID;
(B) Date on which the order is routed;
(C) Time at which the order is routed (using time stamps pursuant
to paragraph (d)(3) of this section);
(D) The CAT-Reporter-ID of the broker-dealer or national securities
exchange routing the order;
(E) The CAT-Reporter-ID of the broker-dealer, national securities
exchange, or national securities association to which the order is
being routed;
(F) If routed internally at the broker-dealer, the identity and
nature of the department or desk to which an order is routed; and
(G) Material terms of the order.
(iii) For the receipt of an order that has been routed, the
following information:
(A) The CAT-Order-ID;
(B) Date on which the order is received;
(C) Time at which the order is received (using time stamps pursuant
to paragraph (d)(3) of this section);
(D) The CAT-Reporter-ID of the broker-dealer, national securities
exchange, or national securities association receiving the order;
(E) The CAT-Reporter-ID of the broker-dealer or national securities
exchange routing the order; and
[[Page 45811]]
(F) Material terms of the order.
(iv) If the order is modified or cancelled, the following
information:
(A) The CAT-Order-ID;
(B) Date the modification or cancellation is received or
originated;
(C) Time the modification or cancellation is received or originated
(using time stamps pursuant to paragraph (d)(3) of this section);
(D) Price and remaining size of the order, if modified;
(E) Other changes in material terms of the order, if modified; and
(F) The CAT-Reporter-ID of the broker-dealer or Customer-ID of the
person giving the modification or cancellation instruction.
(v) If the order is executed, in whole or part, the following
information:
(A) The CAT-Order-ID;
(B) Date of execution;
(C) Time of execution (using time stamps pursuant to paragraph
(d)(3) of this section);
(D) Execution capacity (principal, agency, riskless principal);
(E) Execution price and size;
(F) The CAT-Reporter-ID of the national securities exchange or
broker-dealer executing the order; and
(G) Whether the execution was reported pursuant to an effective
transaction reporting plan or the Plan for Reporting of Consolidated
Options Last Sale Reports and Quotation Information.
(vi) If the order is executed, in whole or part, the following
information:
(A) The account number for any subaccounts to which the execution
is allocated (in whole or part);
(B) The CAT-Reporter-ID of the clearing broker or prime broker, if
applicable; and
(C) The CAT-Order-ID of any contra-side order(s).
(vii) If the trade is cancelled, a cancelled trade indicator.
(viii) For original receipt or origination of an order, the
following information:
(A) Information of sufficient detail to identify the customer; and
(B) Customer account information.
(8) All plan sponsors and their members shall use the same
Customer-ID and CAT-Reporter-ID for each customer and broker-dealer.
(d) Clock synchronization and time stamps. The national market
system plan submitted pursuant to this section shall require:
(1) Each national securities exchange, national securities
association, and member of such exchange or association to synchronize
its business clocks that are used for the purposes of recording the
date and time of any reportable event that must be reported pursuant to
this section to the time maintained by the National Institute of
Standards and Technology, consistent with industry standards;
(2) Each national securities exchange and national securities
association to evaluate annually the clock synchronization standard to
determine whether it should be shortened, consistent with changes in
industry standards; and
(3) Each national securities exchange, national securities
association, and member of such exchange or association to utilize the
time stamps required by paragraph (c)(7) of this section, with at
minimum the granularity set forth in the national market system plan
submitted pursuant to this section, which shall reflect current
industry standards and be at least to the millisecond. To the extent
that the relevant order handling and execution systems of any national
securities exchange, national securities association, or member of such
exchange or association utilize time stamps in increments finer than
the minimum required by the national market system plan, the plan shall
require such national securities exchange, national securities
association, or member to utilize time stamps in such finer increments
when providing data to the central repository, so that all reportable
events reported to the central repository by any national securities
exchange, national securities association, or member can be accurately
sequenced. The national market system plan shall require the sponsors
of the national market system plan to annually evaluate whether
industry standards have evolved such that the required time stamp
standard should be in finer increments.
(e) Central repository.
(1) The national market system plan submitted pursuant to this
section shall provide for the creation and maintenance of a central
repository. Such central repository shall be responsible for the
receipt, consolidation, and retention of all information reported
pursuant to paragraph (c)(7) of this section. The central repository
shall store and make available to regulators data in a uniform
electronic format, and in a form in which all events pertaining to the
same originating order are linked together in a manner that ensures
timely and accurate retrieval of the information required by paragraph
(c)(7) of this section for all reportable events for that order.
(2) Each national securities exchange, national securities
association, and the Commission shall have access to the central
repository, including all systems operated by the central repository,
and access to and use of the data reported to and consolidated by the
central repository under paragraph (c) of this section, for the purpose
of performing its respective regulatory and oversight responsibilities
pursuant to the federal securities laws, rules, and regulations. The
national market system plan submitted pursuant to this section shall
provide that such access to and use of such data by each national
securities exchange, national securities association, and the
Commission for the purpose of performing its regulatory and oversight
responsibilities pursuant to the federal securities laws, rules, and
regulations shall not be limited.
(3) The national market system plan submitted pursuant to this
section shall include a provision requiring the creation and
maintenance by the plan processor of a method of access to the
consolidated data stored in the central repository that includes the
ability to run searches and generate reports.
(4) The national market system plan submitted pursuant to this
section shall include policies and procedures, including standards, to
be used by the plan processor to:
(i) Ensure the security and confidentiality of all information
reported to the central repository by requiring that:
(A) All plan sponsors and their employees, as well as all employees
of the central repository, agree to use appropriate safeguards to
ensure the confidentiality of such data and agree not to use such data
for any purpose other than surveillance and regulatory purposes,
provided that nothing in this paragraph (e)(4)(i)(A) shall be construed
to prevent a plan sponsor from using the data that it reports to the
central repository for regulatory, surveillance, commercial, or other
purposes as otherwise permitted by applicable law, rule, or regulation;
(B) Each plan sponsor adopt and enforce rules that:
(1) Require information barriers between regulatory staff and non-
regulatory staff with regard to access and use of data in the central
repository; and
(2) Permit only persons designated by plan sponsors to have access
to the data in the central repository;
(C) The plan processor:
(1) Develop and maintain a comprehensive information security
program for the central repository, with dedicated staff, that is
subject to regular reviews by the Chief Compliance Officer;
[[Page 45812]]
(2) Have a mechanism to confirm the identity of all persons
permitted to access the data; and
(3) Maintain a record of all instances where such persons access
the data; and
(D) The plan sponsors adopt penalties for non-compliance with any
policies and procedures of the plan sponsors or central repository with
respect to information security.
(ii) Ensure the timeliness, accuracy, integrity, and completeness
of the data provided to the central repository pursuant to paragraph
(c) of this section; and
(iii) Ensure the accuracy of the consolidation by the plan
processor of the data provided to the central repository pursuant to
paragraph (c) of this section.
(5) The national market system plan submitted pursuant to this
section shall address whether there will be an annual independent
evaluation of the security of the central repository and:
(i) If so, provide a description of the scope of such planned
evaluation; and
(ii) If not, provide a detailed explanation of the alternative
measures for evaluating the security of the central repository that are
planned instead.
(6) The national market system plan submitted pursuant to this
section shall:
(i) Specify a maximum error rate to be tolerated by the central
repository for any data reported pursuant to paragraphs (c)(3) and
(c)(4) of this section; describe the basis for selecting such maximum
error rate; explain how the plan sponsors will seek to reduce such
maximum error rate over time; describe how the plan will seek to ensure
compliance with such maximum error rate and, in the event of
noncompliance, will promptly remedy the causes thereof;
(ii) Require the central repository to measure the error rate each
business day and promptly take appropriate remedial action, at a
minimum, if the error rate exceeds the maximum error rate specified in
the plan;
(iii) Specify a process for identifying and correcting errors in
the data reported to the central repository pursuant to paragraphs
(c)(3) and (c)(4) of this section, including the process for notifying
the national securities exchanges, national securities association, and
members who reported erroneous data to the central repository of such
errors, to help ensure that such errors are promptly corrected by the
reporting entity, and for disciplining those who repeatedly report
erroneous data; and
(iv) Specify the time by which data that has been corrected will be
made available to regulators.
(7) The national market system plan submitted pursuant to this
section shall require the central repository to collect and retain on a
current and continuing basis and in a format compatible with the
information consolidated and stored pursuant to paragraph (c)(7) of
this section:
(i) Information, including the size and quote condition, on the
national best bid and national best offer for each NMS security;
(ii) Transaction reports reported pursuant to an effective
transaction reporting plan filed with the Commission pursuant to, and
meeting the requirements of, Sec. 242.601; and
(iii) Last sale reports reported pursuant to the Plan for Reporting
of Consolidated Options Last Sale Reports and Quotation Information
filed with the Commission pursuant to, and meeting the requirements of,
Sec. 242.608.
(8) The national market system plan submitted pursuant to this
section shall require the central repository to retain the information
collected pursuant to paragraphs (c)(7) and (e)(7) of this section in a
convenient and usable standard electronic data format that is directly
available and searchable electronically without any manual intervention
for a period of not less than five years.
(f) Surveillance. Every national securities exchange and national
securities association subject to this section shall develop and
implement a surveillance system, or enhance existing surveillance
systems, reasonably designed to make use of the consolidated
information contained in the consolidated audit trail.
(g) Compliance by members.
(1) Each national securities exchange and national securities
association shall file with the Commission pursuant to section 19(b)(2)
of the Act (15 U.S.C. 78s(b)(2)) and Sec. 240.19b-4 of this chapter on
or before 60 days from approval of the national market system plan a
proposed rule change to require its members to comply with the
requirements of this section and the national market system plan
approved by the Commission.
(2) Each member of a national securities exchange or national
securities association shall comply with all the provisions of any
approved national market system plan applicable to members.
(3) The national market system plan submitted pursuant to this
section shall include a provision requiring each national securities
exchange and national securities association to agree to enforce
compliance by its members with the provisions of any approved plan.
(4) The national market system plan submitted pursuant to this
section shall include a mechanism to ensure compliance with the
requirements of any approved plan by the members of a national
securities exchange or national securities association.
(h) Compliance by national securities exchanges and national
securities associations.
(1) Each national securities exchange and national securities
association shall comply with the provisions of the national market
system plan approved by the Commission.
(2) Any failure by a national securities exchange or national
securities association to comply with the provisions of the national
market system plan approved by the Commission shall be considered a
violation of this section.
(3) The national market system plan submitted pursuant to this
section shall include a mechanism to ensure compliance by the sponsors
of the plan with the requirements of any approved plan. Such
enforcement mechanism may include penalties where appropriate.
(i) Other securities and other types of transactions. The national
market system plan submitted pursuant to this section shall include a
provision requiring each national securities exchange and national
securities association to jointly provide to the Commission within six
months after effectiveness of the national market system plan a
document outlining how such exchanges and associations could
incorporate into the consolidated audit trail information with respect
to equity securities that are not NMS securities, debt securities,
primary market transactions in equity securities that are not NMS
securities, and primary market transactions in debt securities,
including details for each order and reportable event that may be
required to be provided, which market participants may be required to
provide the data, an implementation timeline, and a cost estimate.
(j) Definitions. As used in this section:
(1) The term CAT-Order-ID shall mean a unique order identifier or
series of unique order identifiers that allows the central repository
to efficiently and accurately link all reportable events for an order,
and all orders that result from the aggregation or disaggregation of
such order.
(2) The term CAT-Reporter-ID shall mean, with respect to each
national securities exchange, national securities association, and
member of a national securities exchange or national
[[Page 45813]]
securities association, a code that uniquely and consistently
identifies such person for purposes of providing data to the central
repository.
(3) The term customer shall mean:
(i) The account holder(s) of the account at a registered broker-
dealer originating the order; and
(ii) Any person from whom the broker-dealer is authorized to accept
trading instructions for such account, if different from the account
holder(s).
(4) The term customer account information shall include, but not be
limited to, account number, account type, customer type, date account
opened, and large trader identifier (if applicable).
(5) The term Customer-ID shall mean, with respect to a customer, a
code that uniquely and consistently identifies such customer for
purposes of providing data to the central repository.
(6) The term error rate shall mean the percentage of reportable
events collected by the central repository in which the data reported
does not fully and accurately reflect the order event that occurred in
the market.
(7) The term material terms of the order shall include, but not be
limited to, the NMS security symbol; security type; price (if
applicable); size (displayed and non-displayed); side (buy/sell); order
type; if a sell order, whether the order is long, short, short exempt;
open/close indicator; time in force (if applicable); if the order is
for a listed option, option type (put/call), option symbol or root
symbol, underlying symbol, strike price, expiration date, and open/
close; and any special handling instructions.
(8) The term order shall include:
(i) Any order received by a member of a national securities
exchange or national securities association from any person;
(ii) Any order originated by a member of a national securities
exchange or national securities association; or
(iii) Any bid or offer.
(9) The term reportable event shall include, but not be limited to,
the original receipt or origination, modification, cancellation,
routing, and execution (in whole or in part) of an order, and receipt
of a routed order.
By the Commission.
Dated: July 18, 2012.
Elizabeth M. Murphy,
Secretary.
Note: The following exhibit will not appear in the Code of
Federal Regulations.
Exhibit A
Key to Comment Letters Cited in Adopting Release Proposal To Implement
Consolidated Audit Trail (File No. S7-11-10)
1. Letter from Rep. Melissa L. Bean, U.S. Congress, to Mary
Schapiro, Chairman, Commission, dated May 20, 2010 (``Bean
Letter'').
2. Letter from Norris W. Beach to Elizabeth M. Murphy,
Secretary, Commission, dated May 26, 2010 (``Beach Letter'').
3. Letter from Steven Vannelli to Elizabeth M. Murphy,
Secretary, Commission, dated May 26, 2010 (``Vannelli Letter'').
4. Letter from Simhan Mandyam, Managing Partner, Triage Life
Sciences LLC, to Elizabeth M. Murphy, Secretary, Commission, dated
May 26, 2010 (``Triage Letter'').
5. Letter from Paul Drescher, Registered Principal, Foothill
Securities, Inc., to Elizabeth M. Murphy, Secretary, Commission,
dated May 28, 2010 (``Foothill Letter'').
6. Letter from Chandler Green to Elizabeth M. Murphy, Secretary,
Commission, dated June 1, 2010 (``Green Letter'').
7. Letter from Dan T. Nguyen, Wealth Management Company, to
Elizabeth M. Murphy, Secretary, Commission, dated June 5, 2010
(``Wealth Management Letter'').
8. Letter from Nicos Anastaspoulos to Elizabeth M. Murphy,
Secretary, Commission, dated June 6, 2010 (``Anastaspoulos
Letter'').
9. Letter from Ning Wen, Sales Director, Know More Software,
Inc., to Heather Seidel, Division of Trading and Markets, Assistant
Director, Commission, dated June 9, 2010 (``Know More Letter'').
10. Letter from John McCrary to Elizabeth M. Murphy, Secretary,
Commission, dated June 11, 2010 (``McCrary Letter'').
11. Letter from Howard Meyerson, General Counsel, and Vlad
Khandros, Market Structure and Public Policy Analyst, Liquidnet, to
Elizabeth M. Murphy, Secretary, Commission, dated July 19, 2010
(``Liquidnet Letter'').
12. Letters from Justin S. Magruder, President, Noetic Partners,
Inc., to Elizabeth M. Murphy, Secretary, Commission, dated July 22,
2010 and August 3, 2010 (``Noetic Partners Letter I'' and ``Noetic
Partners Letter II).
13. Letter from Martin Koopman, Director, Aditat, to Elizabeth
M. Murphy, Secretary, Commission, dated July 28, 2010 (``Aditat
Letter'').
14. Letter from Courtney Doyle McGuinn, FPL Operations Director,
FIX Protocol Limited, to Elizabeth M. Murphy, Secretary, Commission,
dated August 5, 2010 (``FIX Letter'').
15. Letter from Senator Edward E. Kaufman, U.S. Senate, to
Elizabeth M. Murphy, Secretary, Commission, dated August 5, 2010
(``Kaufman Letter'').
16. Letter from Mahesh Kumaraguru to Elizabeth M. Murphy,
Secretary, Commission, dated August 5, 2010 (``Kumaraguru Letter'').
17. Letter from R. T. Leuchtkafer to Elizabeth M. Murphy,
Secretary, Commission, dated August 5, 2010 (``Leuchtkafer
Letter'').
18. Letter from Horst Simon, Associate Laboratory Director for
Computing Sciences and Division Director, Computational Research
Department, and David Leinweber, Director, LBNL Center for
Innovative Financial Technology Computing Sciences, Lawrence
Berkeley National Laboratory, to Elizabeth M. Murphy, Secretary,
Commission, dated August 8, 2010 (``Berkeley Letter'').
19. Letter from Peter A. Bloniarz, Dean, College of Computing &
Information, University of Albany, George Berg, Associate Professor
and Chair, Department of Computer Science, University of Albany,
Sandor P. Schuman, Affiliated Faculty, Department of Informatics,
University of Albany, to Elizabeth M. Murphy, Secretary, Commission,
dated August 9, 2010 (``Albany Letter'').
20. Letter from Christopher Nagy, Managing Director Order
Strategy, Co-Head Government Relations, and John Markle, Deputy
General Counsel, Co-Head Government Relations, TD AMERITRADE, Inc.,
to Elizabeth M. Murphy, Secretary, Commission, dated August 9, 2010
(``Ameritrade Letter'').
21. Letter from James J. Angel, Associate Professor of Finance,
Georgetown University, Commission, dated August 9, 2010 (``Angel
Letter'').
22. Letter from Eric J. Swanson, Senior Vice President and
General Counsel, BATS Exchange, Inc., to Elizabeth M. Murphy,
Secretary, Commission, dated August 9, 2010 (``BATS Letter'').
23. Letter from Anthony D. McCormick, Chief Executive Officer,
Boston Options Exchange Group, LLC, to Elizabeth M. Murphy,
Secretary, Commission, dated August 9, 2010 (``BOX Letter'').
24. Letter from Charlie J. Marchesani, President Broadridge
Financial Solutions, Inc., to Elizabeth M. Murphy, Secretary,
Commission, dated August 9, 2010 (``Broadridge Letter'').
25. Letter from Eric W. Hess, General Counsel, Direct Edge
Holdings, LLC, to Elizabeth M. Murphy, Secretary, Commission, dated
August 9, 2010 (``Direct Edge Letter'').
26. Letter from Marcia E. Asquith, Senior Vice President and
Corporate Secretary, FINRA, to Elizabeth M. Murphy, Secretary,
Commission, dated August 9, 2010 (``FINRA Letter'').
27. Letter from Marcia E. Asquith, Senior Vice President and
Corporate Secretary, FINRA, and Janet McGinness Kissane, Senior Vice
President and Corporate Secretary, NYSE Euronext, to Elizabeth M.
Murphy, Secretary, Commission, dated August 9, 2010 (``FINRA/NYSE
Euronext Letter'').
28. Letter from Ted Myerson, Chief Executive Officer, Doug
Kittelsen, Chief Technology Officer, and M. Gary LaFever, General
Counsel and Chief Corporate Development Officer, FTEN, to Elizabeth
M. Murphy, Secretary, Commission, dated August 9, 2010 (``FTEN
Letter'').
29. Letter from Karrie McMillan, General Counsel, Investment
Company Institute, to Elizabeth M. Murphy, Secretary,
[[Page 45814]]
Commission, dated August 9, 2010 (``ICI Letter'').
30. Letter from Stuart J. Kaswell, Executive Vice President,
Managing Director and General Counsel, Managed Funds Association, to
Elizabeth M. Murphy, Secretary, Commission, dated August 9, 2010
(``Managed Funds Association Letter'').
31. Letter from Dror Segal and Lou Pizzo, Mansfield Consulting,
LLC, to Elizabeth M. Murphy, Secretary, Commission, dated August 9,
2010 (``Mansfield Letter'').
32. Letter from Andrew C. Small, General Counsel, Scottrade, to
Elizabeth M. Murphy, Secretary, Commission, dated August 9, 2010
(``Scottrade Letter'').
33. Letter from Devin Wenig, Chief Executive Officer, Markets
Division, Thomson Reuters, to Elizabeth M. Murphy, Secretary,
Commission, dated August 9, 2010 (``Thomson Reuters Letter'').
34. Letter from Jon Feigelson, Senior Vice President, General
Counsel and Head of Corporate Governance, TIAA-CREF Individual and
Institutional Services, LLC, to Elizabeth M. Murphy, Secretary,
Commission, dated August 9, 2010 (``TIAA-CREF Letter'').
35. Letter from Ronald C. Long, Director, Regulatory Affairs,
Wells Fargo Advisors, to Elizabeth M. Murphy, Secretary, Commission,
dated August 9, 2010 (``Wells Fargo Letter'').
36. Letter from John A. McCarthy, General Counsel, GETCO, to
Elizabeth M. Murphy, Secretary, Commission, dated August 10, 2010
(``GETCO Letter'').
37. Letter from Michael Erlanger, Managing Principal,
Marketcore, Inc., to Commission, dated August 10, 2010 (``Marketcore
Letter'').
38. Letter from Edward J. Joyce, President and Chief Operating
Officer, Chicago Board Options Exchange, Inc., to Commission, dated
August 11, 2010 (``CBOE Letter'').
39. Letter from Leonard J. Amoruso, Senior Managing Director and
General Counsel, Knight Capital Group, Inc., to Elizabeth M. Murphy,
Secretary, Commission, dated August 11, 2010 (``Knight Letter'').
40. Letter from Jose Manso, Executive Vice President, Sales and
Marketing, Middle Office Solutions LLC, to Commission, dated August
11, 2010 (``Middle Office Letter'').
41. Letter from Manisha Kimmel, Executive Director, Financial
Information Forum, to Elizabeth M. Murphy, Secretary, dated August
12, 2010 (``FIF Letter'').
42. Letter from John Harris, Chief Executive Officer, BondMart
Technologies, Inc., to Commission, dated August 12, 2010 (``BondMart
Letter'').
43. Letter from Joan C. Conley, Senior Vice President and
Corporate Secretary, NASDAQ OMX Group, Inc., to Elizabeth M. Murphy,
Secretary, dated August 12, 2010 (``Nasdaq Letter I'').
44. Letter from Patrick J. Healy, Chief Executive Officer,
Issuer Advisory Group LLC, to Elizabeth M. Murphy, Secretary,
Commission, dated August 15, 2010 (``IAG Letter'').
45. Letter from James T. McHale, Managing Director and Associate
General Counsel, Securities Industry and Financial Markets
Association, to Elizabeth M. Murphy, Secretary, Commission, dated
August 17, 2010 (``SIFMA Letter'').
46. Letter from Mike Riley, Chief Executive Officer, Endace
Technology Limited, to Elizabeth M. Murphy, Secretary, Commission,
dated August 30, 2010 (``Endace Letter'').
47. Letter from Terry Keene, Chief Executive Officer,
Integration Systems LLC, to Elizabeth M. Murphy, Secretary,
Commission, dated November 12, 2010 (``iSys Letter'').
48. Letter from Bonnie K. Wachtel, Wachtel & Co., Inc., to
Elizabeth M. Murphy, Secretary, Commission, dated November 24, 2010
(``Wachtel Letter'').
49. Letter from Richard A. Ross to Elizabeth M. Murphy,
Secretary, Commission, dated December 6, 2010 (``Ross Letter'').
50. Letter from James T. McHale, Managing Director and
Associated General Counsel, Securities Industry and Financial
Markets Association, to David Shillman, Associate Director, Division
of Trading and Markets, Commission, dated January 12, 2011 (``SIFMA
Drop Copy Letter'').
51. Letter from Daniel J. Connell, Chief Executive Officer,
Correlix, Inc., to Elizabeth M. Murphy, Secretary, Commission, dated
February 4, 2011 (``Correlix Letter'').
52. Letter from Richard A. Ross, Founder, High Speed Analytics,
to Elizabeth M. Murphy, Secretary, Commission, dated February 9,
2011 (``High Speed Letter'').
53. Letter from Michael Belanger, President, Jarg Corporation;
Joseph Carrabis, Chief Regulatory Officer and Founder, NextStage
Evolution; Wayne Ginion, Vice President, Enterprise Infrastructure
Services; and David Morf, Partner, Senior Regional Economics
Advisor, Founding Member, Center for Adaptive Solutions, to
Elizabeth M. Murphy, Secretary, Commission, dated April 6, 2011
(``Belanger Letter'') (note, this letter is an amended letter that
replaces a letter submitted by the same parties on March 30, 2011).
54. Letter from Richard G. Ketchum, Chairman and Chief Executive
Officer, FINRA, to Robert Cook, Director, Division of Trading and
Markets, and Carlo DiFlorio, Director, Office of Compliance
Inspections and Examinations, Commission, dated April 6, 2011
(``FINRA Proposal Letter'').
55. Letter from Senator Charles E. Schumer, U.S. Senate, to Mary
L. Schapiro, Chairman, Commission, dated May 9, 2011 (``Schumer
Letter'').
56. Letter from Joan C. Conley, Senior Vice President and
Corporate Secretary, NASDAQ OMX Group, Inc., to Elizabeth M. Murphy,
Secretary, Commission, dated November 18, 2011 (``Nasdaq Letter
II'').
57. Letter from Geraldine M. Lettieri to Elizabeth M. Murphy,
Secretary, Commission, dated November 29, 2011 (``Lettieri
Letter'').
58. Letter from James T. McHale, Managing Director and
Associated General Counsel, Securities Industry and Financial
Markets Association, to Robert Cook, Director, Division of Trading
and Markets, Commission, dated February 7, 2012 (``SIFMA February
2012 Letter'').
59. Letter from John M. Damgard, President, Futures Industry
Association, to Elizabeth M. Murphy, Secretary, Commission, dated
February 22, 2012 (``FIA Letter'').
60. Letter from Manisha Kimmel, Executive Director, Financial
Information Forum, to Elizabeth M. Murphy, Secretary, Commission,
dated March 2, 2012 (``FIF Letter II'').
61. Letter from Jennifer Setzenfand, Chairman, Security Traders
Association, dated March 7, 2012 (``STA Letter'').
62. Letter from Dr. Gil Van Bokkelen, Chairman and Chief
Executive Officer, Athersys, Inc., to Mary Schapiro, Chairman,
Commission, dated March 14, 2012 (``Van Bokkelen Letter'').
[FR Doc. 2012-17918 Filed 7-31-12; 8:45 am]
BILLING CODE 8011-01-P