[Federal Register Volume 81, Number 95 (Tuesday, May 17, 2016)]
[Notices]
[Pages 30614-31124]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-10461]
[[Page 30613]]
Vol. 81
Tuesday,
No. 95
May 17, 2016
Part II
Securities and Exchange Commission
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Joint Industry Plan; Notice of Filing of the National Market System
Plan Governing the Consolidated Audit Trail; Notices
Federal Register / Vol. 81 , No. 95 / Tuesday, May 17, 2016 /
Notices
[[Page 30614]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-77724; File No. 4-698]
Joint Industry Plan; Notice of Filing of the National Market
System Plan Governing the Consolidated Audit Trail
April 27, 2016.
Table of Contents
I. Introduction
II. Background
III. Description of the Plan
A. Statement of Purpose and Request for Comment
1. Background
2. Request for Exemption from Certain Requirements under Rule
613
3. Requirements Pursuant to Rule 608(a)
B. Summary of Additional CAT NMS Plan Provisions and Request for
Comment
1. Reporting Procedures
2. Timeliness of Data Reporting
3. Uniform Format
4. Clock Synchronization
5. Time Stamp Granularity
6. CAT-Reporter-ID
7. Customer-ID
8. Order Allocation Information
9. Options Market Maker Quotes
10. Error Rates
11. Regulatory Access
12. Security, Confidentiality, and Use of Data
IV. Economic Analysis
A. Introduction
B. Summary of Expected Economic Effects
C. Framework for Economic Analysis
1. Economic Framework
2. Existing Uncertainties
3. Request for Comment on the Framework
D. Baseline
1. Current State of Regulatory Activities
2. Current State of Trade and Order Data
3. Request for Comment on the Baseline
E. Benefits
1. Improvements in Data Qualities
2. Improvements to Regulatory Activities
3. Other Provisions of the CAT NMS Plan
4. Request for Comment on the Benefits
F. Costs
1. Analysis of Expected Costs
2. Aggregate Costs to Industry
3. Further Analysis of Costs
4. Second-Order Effects and Other Security-related Costs
5. Request for Comment on the Costs
G. Efficiency, Competition, and Capital Formation
1. Competition
2. Efficiency
3. Capital Formation
4. Related Considerations Affecting Competition, Efficiency and
Capital Formation
5. Request for Comment on Efficiency, Competition, and Capital
Formation
H. Alternatives
1. Alternatives to the Approaches the Exemption Order Permitted
to be Included in the Plan
2. Alternatives to Certain Specific Approaches in the CAT NMS
Plan
3. Alternatives to the Scope of Certain Specific Elements in the
CAT NMS Plan
4. Alternatives to the CAT NMS Plan
5. Request for Comment on the Alternatives
I. Request for Comment on the Economic Analysis
V. Paperwork Reduction Act
A. Summary of Collection of Information under Rule 613
1. Central Repository
2. Data Collection and Reporting
3. Collection and Retention of NBBO, Last Sale Data and
Transaction Reports
4. Surveillance
5. Participant Rule Filings
6. Written Assessment of Operation of the Consolidated Audit
Trail
7. Document on Expansion to Other Securities
B. Proposed Use of Information
1. Central Repository
2. Data Collection and Reporting
3. Collection and Retention of NBBO, Last Sale Data and
Transaction Reports
4. Surveillance
5. Written Assessment of Operation of the Consolidated Audit
Trail
6. Document on Expansion to Other Securities
C. Respondents
1. National Securities Exchanges and National Securities
Associations
2. Members of National Securities Exchanges and National
Securities Association
D. Total Initial and Annual Reporting and Recordkeeping Burden
1. Burden on National Securities Exchanges and National
Securities Associations
2. Burden on Members of National Securities Exchanges and
National Securities Associations
E. Collection of Information is Mandatory
F. Confidentiality
G. Recordkeeping Requirements
H. Request for Comments
VI. Solicitation of Comments
I. Introduction
Pursuant to Section 11A of the Securities Exchange Act of 1934 (the
``Act'') \1\ and Rule 608 thereunder,\2\ notice is hereby given that on
February 27, 2015, BATS Exchange, Inc., BATS-Y Exchange, Inc., BOX
Options Exchange LLC, C2 Options Exchange, Incorporated, Chicago Board
Options Exchange, Incorporated, Chicago Stock Exchange, Inc., EDGA
Exchange, Inc., EDGX Exchange, Inc., Financial Industry Regulatory
Authority, Inc., International Securities Exchange, LLC, ISE Gemini,
LLC, Miami International Securities Exchange LLC, NASDAQ OMX BX, Inc.,
NASDAQ OMX PHLX LLC, The NASDAQ Stock Market LLC, National Stock
Exchange, Inc., New York Stock Exchange LLC, NYSE MKT LLC, and NYSE
Arca, Inc. (collectively, ``SROs'' or ``Participants''), filed with the
Securities and Exchange Commission (the ``Commission'' or ``SEC'') a
National Market System Plan Governing the Consolidated Audit Trail (the
``CAT NMS Plan'' or ``Plan'').\3\ On December 24, 2015, the SROs
submitted an Amendment to the CAT NMS Plan.\4\ A copy of the CAT NMS
Plan, as modified by the Amendment, is attached as Exhibit A hereto.
The Commission is publishing this Notice to solicit comments on the CAT
NMS Plan. The Commission also is publishing notice of, and soliciting
comment on, an analysis of the potential economic effects of
implementing the CAT NMS Plan, as set forth in Section IV of this
Notice, and the collection of information requirements in the CAT NMS
Plan as required by the Paperwork Reduction Act, as set forth in
Section V of this Notice.
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\1\ 15 U.S.C. 78k-1.
\2\ 17 CFR 242.608.
\3\ See Letter from Participants to Brent J. Fields, Secretary,
Commission, dated February 27, 2015. Pursuant to Rule 613, the SROs
were required to file the CAT NMS Plan on or before April 28, 2013.
At the SROs' request, the Commission granted exemptions to extend
the deadline for filing the CAT NMS Plan to December 6, 2013, and
then to September 30, 2014. See Securities Exchange Act Release Nos.
69060 (March 7, 2013), 78 FR 15771 (March 12, 2013); 71018 (December
6, 2013), 78 FR 75669 (December 12, 2013). The SROs filed the CAT
NMS Plan on September 30, 2014 (the ``Initial CAT NMS Plan''). See
Letter from the SROs, to Brent J. Fields, Secretary, Commission,
dated September 30, 2014. The CAT NMS Plan filed on February 27,
2015, was an amendment to and replacement of the Initial CAT NMS
Plan (the ``Amended and Restated CAT NMS Plan''). On December 24,
2015, the SROs submitted an Amendment to the Amended and Restated
CAT NMS Plan. See Letter from Participants to Brent J. Fields,
Secretary, Commission, dated December 23, 2015 (the ``Amendment'').
On February 9, 2016, the Participants filed with the Commission an
identical, but unmarked, version of the Amended and Restated CAT NMS
Plan, dated February 27, 2015, as modified by the Amendment, as well
as a copy of the request for proposal issued by the Participants to
solicit Bids from parties interested in serving as the Plan
Processor for the consolidated audit trail. See Exhibit A and infra
note 29. Unless the context otherwise requires, the ``CAT NMS Plan''
shall refer to the Amended and Restated CAT NMS Plan, as modified by
the Amendment. The Commission notes that the application of ISE
Mercury, LLC for registration as a national securities exchange was
granted on January 29, 2016. See Securities Exchange Act Release No.
76998 (January 29, 2016), 81 FR 6066 (February 4, 2016). The
Commission understands that ISE Mercury, LLC will become a
Participant in the CAT NMS Plan and thus is accounted for as a
Participant for purposes of this Notice.
\4\ See Amendment, supra note 3.
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II. Background
The Commission 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
[[Page 30615]]
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.
Currently, FINRA and some of the exchanges 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. However, as noted in Section IV.D 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.\5\
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\5\ The Commission notes that the SROs have taken steps in
recent years to update their audit trail requirements. For example,
NYSE, NYSE Amex LLC (n/k/a ``NYSE MKT LLC'') (``NYSE Amex''), and
NYSE ARCA, Inc. (``NYSE Arca'') have adopted audit trail rules that
coordinate with FINRA's OATS requirements. See Securities Exchange
Act Release No. 65523 (October 7, 2011), 76 FR 64154 (October 17,
2011) (concerning NYSE); Securities Exchange Act Release No. 65524
(October 7, 2011), 76 FR 64151 (October 17, 2011) (concerning NYSE
Amex); Securities Exchange Act Release No. 65544 (October 12, 2011),
76 FR 64406 (October 18, 2011) (concerning NYSE Arca). This allows
the SROs to submit their data to FINRA pursuant to a Regulatory
Service Agreement (``RSA''), which FINRA can then reformat and
combine with OATS data. Despite these efforts, however, significant
deficiencies remain. See Section IV.D.2, infra.
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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'') \6\ system and equity cleared reports
\7\ 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 identity of the
customer in the case of equity cleared reports. Furthermore, recent
experience with implementing incremental improvements to the EBS system
has illustrated some of the overall limitations of the current
technologies and mechanisms used by the industry to collect, record,
and make available market activity data for regulatory purposes.\8\
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\6\ 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.
\7\ 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.
\8\ See Securities Exchange Act Release No. 64976 (July 27,
2011), 76 FR 46960 (August 3, 2011) (``Large Trader Release'').
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Recognizing these shortcomings, on July 11, 2012, the Commission
adopted Rule 613 of Regulation NMS under the Act.\9\ Rule 613 required
the SROs to submit a national market system (``NMS'') plan to create,
implement, and maintain a consolidated audit trail (``CAT'') 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 in a single,
consolidated data source.\10\ On February 27, 2015, the SROs submitted
the CAT NMS Plan.\11\
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\9\ See Securities Exchange Act Release No. 67457 (July 18,
2012), 77 FR 45722 (August 1, 2012) (``Adopting Release''); see also
Securities Exchange Act Release No. 62174 (May 26, 2010), 75 FR
32556 (June 8, 2010) (``Proposing Release'').
\10\ See 17 CFR 242.613(a)(1), (c)(1), (c)(7).
\11\ See supra note 3.
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The SROs also submitted a separate NMS plan and an exemptive
request letter related to the CAT NMS Plan. Specifically, on September
3, 2013, the SROs filed an NMS Plan pursuant to Rule 608 governing the
SROs' review, evaluation, and ultimate selection of the Plan Processor
\12\ for the consolidated audit trail (the ``Selection Plan'').\13\ The
Selection Plan was published for comment in the Federal Register on
November 21, 2013 and approved by the Commission on February 21,
2014.\14\ Subsequently, the SROs filed three amendments to the
Selection Plan, two of which were approved by the Commission on June
17, 2015 and September 24, 2015 \15\ The CAT NMS Plan reflects the
process approved by the Commission for reviewing, evaluating and
ultimately selecting the Plan Processor, as set forth in the Selection
Plan, as amended. Second, on January 30, 2015, the SROs filed an
application,\16\ pursuant to Rule 0-12 under the Act,\17\ requesting
that the Commission grant exemptions from certain requirements of Rule
613. The Commission granted the exemptions on March 1, 2016.\18\ The
CAT NMS Plan
[[Page 30616]]
published for comment in this Notice reflects the exemptive relief
granted by the Commission.
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\12\ As set forth in Section 1.1 of the CAT NMS Plan, the Plan
Processor ``means the Initial Plan Processor or any other Person
selected by the Operating Committee pursuant to SEC Rule 613 and
Sections 4.3(b)(i) and 6.1, and with regard to the Initial Plan
Processor, the Selection Plan, to perform the CAT processing
functions required by SEC Rule 613 and set forth in [the CAT NMS
Plan].''
\13\ See Securities Exchange Act Release No. 70892 (November 15,
2013), 78 FR 69910 (November 21, 2013) (``Selection Plan Notice'').
\14\ See id.; see also Securities Exchange Act Release No.
71596, 79 FR 11152 (February 27, 2014) (``Selection Plan Approval
Order'').
\15\ See Securities Exchange Act Release Nos. 75192 (June 17,
2015), 80 FR 36028 (June 23, 2015) (Order Approving Amendment No. 1
to the Selection Plan); 75980 (September 24, 2015), 80 FR 58796
(September 30, 2015) (Order Approving Amendment No. 2 to the
Selection Plan); Letter from SROs to Brent J. Fields, Secretary,
Commission, dated March 29, 2016; see also Securities Exchange Act
Release Nos. 74223 (February 6, 2015), 80 FR 7654 (February 11,
2015) (Notice of Amendment No. 1 to the Selection Plan); 75193 (June
17, 2015), 80 FR 36006 (June 23, 2015) (Notice of Amendment No. 2 to
the Selection Plan).
\16\ See Letter from Participants to Brent J. Fields, Secretary,
Commission, dated January 30, 2015 (``Exemptive Request Letter'').
Specifically, the SROs request exemptive relief from the Rule's
requirements related to: (1) The reporting of Options Market Maker
quotations, as required under Rule 613(c)(7)(ii) and (iv); (2) the
reporting and use of the Customer-ID under Rule 613(c)(7)(i)(A),
(iv)(F), (viii)(B) and 613(c)(8); (3) the reporting of the CAT-
Reporter-ID, as required under Rule 613(c)(7)(i)(C), (ii)(D),
(ii)(E), (iii)(D), (iii)(E), (iv)(F), (v)(F), (vi)(B), and (c)(8);
(4) the linking of executions to specific subaccount allocations, as
required under Rule 613(c)(7)(vi)(A); and (5) the time stamp
granularity requirement of Rule 613(d)(3) for certain manual order
events subject to reporting under Rule 613(c)(7)(i)(E), (ii)(C),
(iii)(C) and (iv)(C). On April 3, 2015, the SROs filed a supplement
related to the requested exemption for Rule 613(c)(7)(vi)(A). See
Letter from Robert Colby, FINRA, on behalf of the SROs, to Brent J.
Fields, Secretary, Commission, dated April 3, 2015 (``April 2015
Supplement''). This supplement provided examples of how the proposed
relief related to allocations would operate. On September 2, 2015,
the SROs filed a second supplement to the Exemptive Request Letter.
See Letter from the SROs to Brent J. Fields, Secretary, Commission,
dated September 2, 2015 (``September 2015 Supplement''). This
supplement to the Exemptive Request Letter further addressed the use
of an ``effective date'' in lieu of a ``date account opened.''
Unless the context otherwise requires, the ``Exemption Request''
shall refer to the Exemptive Request Letter, as supplemented by the
April 2015 Supplement and the September 2015 Supplement.
\17\ 17 CFR 240.0-12.
\18\ See Securities Exchange Act Release No. 77265 (March 1,
2016), 81 FR 11856 (March 7, 2016) (``Exemption Order''). The
Commission requests comment specifically on the advantages and
disadvantages of each aspect of the relief granted in the Exemption
Order and whether the approaches permitted by the Exemption Order to
be included in the CAT NMS Plan are preferable to those originally
permitted by Rule 613. See Request for Comment Nos. 168-170 (Options
Market Maker Quotes), 135-161 (Customer ID), 128-134 (CAT-Reporter-
ID), 162-167 (Linking Order Executions to Allocations) and 114-127
(Time Stamp Granularity), infra.
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III. Description of the Plan
As described further in this Section III of this Notice, the SROs
propose to conduct the activities of the CAT through CAT NMS, LLC, a
jointly owned limited liability company formed under Delaware state
law; and to that end, the SROs submitted the CAT NMS, LLC's limited
liability company agreement (the ``LLC Agreement''), including exhibits
and appendices attached thereto, to the Commission as the CAT NMS Plan.
The SROs also submitted a cover letter that included a description of
the CAT NMS Plan, along with the information required by Rule 608(a)(4)
and (5) under the Act,\19\ which is set forth below in Section III.A of
this Notice as substantially prepared and submitted by the SROs. Set
forth in Section III.B is a summary of additional CAT NMS Plan
provisions and requests for comment.\20\
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\19\ 17 CFR 242.608(a)(4) and (a)(5).
\20\ All capitalized terms not otherwise defined herein shall
have the meaning ascribed to them in Rule 613, the Adopting Release,
or the CAT NMS Plan, as applicable.
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The LLC Agreement, attached hereto as Exhibit A, sets forth a
governing structure, whereby the Operating Committee will manage the
CAT NMS, LLC, and each SRO will be a member of, and have one vote
within, the Operating Committee.\21\ The LLC Agreement details the
Operating Committee's procedures for selecting the Plan Processor,\22\
who will be contracted to build the CAT, as well as the functions and
activities of the Plan Processor. The LLC Agreement also sets forth the
responsibilities of the Central Repository which, under the oversight
of the Plan Processor, will receive, consolidate and retain the CAT
Data.\23\ The LLC Agreement also lists the requirements regarding the
recording and reporting of CAT Data by the SROs as well as by broker-
dealers, the security and confidentiality safeguards for CAT Data,
surveillance requirements, fees and costs associated with operating the
CAT, as well as other reporting and Technical Specifications and
requirements.\24\
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\21\ See CAT NMS Plan, supra note 3, at Article IV.
\22\ See id. at Article V; see also Order Approving Amendment
No. 1 to the Selection Plan and Order Approving Amendment No. 2 to
the Selection Plan, supra note 15.
\23\ See CAT NMS Plan, supra note 3, at Article VI.
\24\ See id.
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In Appendix C to the LLC Agreement, the SROs address the
considerations listed in Rule 613(a)(1), providing information and
analysis regarding the specific features, details, costs, and processes
related to the CAT NMS Plan. Appendix D to the LLC Agreement provides
an outline of the CAT's minimum functional and technical requirements
for the Plan Processor.
A. Statement of Purpose and Request for Comment
The following statement of purpose provided herein is substantially
as prepared and submitted by the SROs to the Commission.\25\ Throughout
the statement of purpose, the Commission has inserted requests for
comment. The portion of this Notice prepared by the Commission will re-
commence in Section III.B.
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\25\ See CAT NMS Plan, supra note 3.
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* * * * *
1. Background
On July 11, 2012, the Commission adopted Rule 613 \26\ to require
the national securities exchanges and national securities association
to jointly submit a national market system plan to create, implement,
and maintain a consolidated audit trail and central repository.\27\
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.\28\
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\26\ 17 CFR 242.613.
\27\ 17 CFR 242.613(a)(1).
\28\ See Adopting Release, supra note 9, at 45743.
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Since the adoption of Rule 613, the Participants have worked to
formulate an effective Plan. To this end, the Participants have, among
other things, developed a plan for selecting the Plan Processor,
solicited and evaluated Bids, and engaged diverse industry participants
in the development of the Plan. Throughout, the Participants have
sought to implement a process that is fair, transparent, and consistent
with the standards and considerations in Rule 613.
a. The Request for Proposal and Selection Plan
On February 26, 2013, the Participants published a request for
proposal (``RFP'') soliciting Bids from parties interested in serving
as the Plan Processor.\29\ The Participants concluded that publication
of an RFP was necessary to ensure that potential alternative solutions
to creating the Plan and the CAT could be presented and considered, and
that a detailed and meaningful cost-benefit analysis could be
performed. The Participants asked any potential bidders to notify the
Participants of their intent to bid by March 5, 2013. Initially, 31
firms submitted intentions to bid, four of which were Participants or
affiliates of Participants. In the following weeks and months, the
Participants engaged with potential bidders with respect to, among
other things, the selection process, selection criteria, and potential
bidders' questions and concerns.\30\
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\29\ See Appendix A of the CAT NMS Plan for the Consolidated
Audit Trail National Market System Plan Request for Proposal (issued
February 26, 2013, version 3.0 updated March 4, 2014). Other
materials related to the RFP are available at http://catnmsplan.com/process/.
\30\ In an effort to ensure Bidders were aware of all
information provided in response to Bidders' questions related to
the RFP, the Participants published answers to questions received
from Bidders available at http://catnmsplan.com/process/.
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On September 4, 2013, the Participants filed with the Commission a
national market system plan to govern the process for Participant
review of the Bids submitted in response to the RFP, the procedure for
evaluating the Bids, and, ultimately, selection of the Plan Processor
(the ``Selection Plan'').\31\ The Commission approved the Selection
Plan as filed on February 21, 2014.\32\ On March 21, 2014, the
Participants received ten Bids in response to the RFP.
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\31\ See Selection Plan Notice, supra note 13.
\32\ See Selection Plan Approval Order, supra note 14.
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The Selection Plan divides the review and evaluation of Bids, and
the selection of the Plan Processor, into various stages, certain of
which have been completed to date.\33\ Specifically, pursuant to the
Selection Plan, the Selection Committee reviewed all Bids and
determined which Bids contained sufficient information to allow the
Participants to meaningfully assess and evaluate the Bids. The ten
submitted Bids were deemed ``Qualified Bids,'' \34\ and so passed to
the next stage, in which each Bidder presented its Bids in person to
the Participants on a confidential basis. On July 1, 2014, after
conducting careful analysis and comparison of the Bids, the Selection
Committee voted and selected six Shortlisted Bidders, thus eliminating
four Bidders from continuing in the process.\35\ The Selection
Committee,
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subject to applicable recusal provisions in the Selection Plan, will
determine whether Shortlisted Bidders will be provided the opportunity
to revise their Bids. After the Selection Committee further assesses
and evaluates the Shortlisted Bids, including any permitted revisions
to the Bids, the Selection Committee will select the Plan Processor via
two rounds of voting by the Senior Voting Officers as specified in the
Plan.\36\
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\33\ See, e.g., id. at 11154.
\34\ A list of Qualified Bidders is available at http://catnmsplan.com/web/groups/catnms/@catnms/documents/appsupportdocs/p493591.pdf. The Commission notes that this Web site address has
been updated to http://www.catnmsplan.com/process/p493591.pdf.
\35\ The announcement and list of the Shortlisted Bidders is
available at http://catnmsplan.com/web/groups/catnms/@catnms/documents/appsupportdocs/p542077.pdf. The Commission notes that this
Web site address has been updated to http://www.catnmsplan.com/pastevents/p542077.pdf. Additionally, the Commission notes that the
Selection Committee further narrowed the list of Shortlisted Bidders
to three Shortlisted Bidders. See Participants, SROs Reduce Short
List Bids from Six to Three for Consolidated Audit Trail (November
16, 2015), available at http://www.catnmsplan.com/pastevents/catnms_release_downselect_111615.pdf.
\36\ See Selection Plan Approval Order, supra note 14, at 11154.
The SEC published a notice of an amendment to the Selection Plan,
which proposed to amend the Selection Plan in two ways. First, the
Participants proposed to provide opportunities to accept revised
Bids prior to approval of the CAT NMS Plan, and second, to allow the
list of Shortlisted Bids to be narrowed prior to Commission approval
of the CAT NMS Plan. See Notice of Amendment No. 1 to the Selection
Plan, supra note 15. In addition, the Participants filed a second
amendment to the Selection Plan, which would require the recusal of
a Bidding Participant in a vote in any round by the Selection
Committee to select the Plan Processor from among the Shortlisted
Bidders if such Bidding Participant's Bid, a Bid submitted by an
Affiliate of such Bidding Participant, or a Bid including such
Bidding Participant or its Affiliate is also considered in that
round. See Notice of Amendment No. 2 to the Selection Plan, supra
note 15. The prior Selection Plan required recusal of a Bidding
Participant under such circumstances in the vote in only the second
round by the Selection Committee to select the Plan Processor from
among the Shortlisted Bidders. The Commission notes that Amendment
Nos. 1 and 2 have been approved. See Order Approving Amendment No. 1
to the Selection Plan and Order Approving Amendment No. 2 to the
Selection Plan, supra note 15.
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b. Selection Plan Governance and Operations
The Selection Plan established an Operating Committee responsible
for formulating, drafting, and filing with the Commission the Plan and
for ensuring that the Participants' joint obligations under Rule 613
were met in a timely and efficient manner.\37\ Each Participant
selected one individual and one substitute to serve on the Operating
Committee, with other representatives of each Participant permitted to
attend Operating Committee meetings.\38\ In formulating the Plan, the
Participants also engaged multiple persons across a wide range of roles
and expertise, engaged the consulting firm Deloitte & Touche LLP as a
project manager, and engaged the law firm Wilmer Cutler Pickering Hale
and Dorr LLP to serve as legal counsel in drafting the Plan. Within
this structure, the Participants focused on, among other things,
comparative analyses of the proposed technologies and operating models,
development of funding models to support the building and operation of
the CAT, and detailed review of governance considerations. Since July
2012, the Participants have held approximately 608 meetings related to
the CAT.\39\ These governance and organizational structures will
continue to be in effect until the Commission's final approval of the
Plan.\40\
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\37\ Id.
\38\ Id.
\39\ Additional information regarding these meetings can be
found at http://catnmsplan.com/. The Commission notes that the
number of meetings in the SROs' statement is as of February 27,
2015. See CAT NMS Plan, supra note 3.
\40\ See Selection Plan Approval Order, supra note 14, at 11155.
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c. Engagement With Industry Participants
Throughout the process of developing the Plan, the Participants
consistently have been engaged in meaningful dialogue with industry
participants with respect to the development of the CAT. From the
outset of this process, the Participants have recognized that industry
input is a critical component in the creation of the Plan. To this end,
the Participants created a Web site \41\ to update the public on the
progress of the Plan, published requests for comment on multiple issues
related to the Plan, held multiple public events to inform the industry
of the progress of the CAT and to address inquiries, and formed, and
later expanded, a Development Advisory Group (the ``DAG'') to solicit
more input from a representative industry group.
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\41\ The Web site is available at http://catnmsplan.com/.
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The DAG conducted 43 meetings \42\ to discuss, among other things,
technical and operational aspects the Participants were considering for
the Plan. The Participants twice issued press releases soliciting
participants for the DAG, and a wide spectrum of firms was deliberately
chosen to provide insight from various industry segments affected by
the CAT.\43\ The DAG currently consists of the Participants, and 27
diverse firms and organizations (including broker-dealers of varying
sizes, the Options Clearing Corporation, a service bureau and three
industry trade associations) with a variety of subject matter
expertise.\44\ The DAG meetings have included discussions of topics
such as Options Market Maker quote reporting, requirements for
capturing Customer-IDs, time stamps and clock synchronization,
reporting requirements for order handling scenarios, cost and funding,
error handling and corrections, and potential elimination of Rules made
redundant by the CAT.\45\
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\42\ In addition to these meetings, DAG subcommittee meetings
also were held. The Commission notes that the number of meetings in
the SROs' statement is as of February 27, 2015. See CAT NMS Plan,
supra note 3.
\43\ For a list of DAG members, see Summary of the Consolidated
Audit Trail Initiative at 13 (Jan. 2015), available at http://catnmsplan.com/web/groups/catnms/@catnms/documents/appsupportdocs/p571933.pdf. The Commission notes that the list of DAG members
appears on page 6 of the linked document, which is dated May 2015.
\44\ The list of current DAG members is available at http://catnmsplan.com/PastEvents/.
\45\ See, e.g., Summary of the Consolidated Audit Trail
Initiative, supra note 43, at 14.
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In addition, the CAT Web site includes a variety of resources for
the public with respect to the development of the CAT. The site
contains an overview of the process, an expression of the guiding
principles behind the Plan development, links to relevant regulatory
actions, gap analyses comparing the requirements of Rule 613 with
current reporting systems, the CAT implementation timeline, a summary
of the RFP process, a set of frequently-asked questions (updated on an
ongoing basis), questions for comment from the industry, industry
feedback on the development of the Plan, and announcements and notices
of upcoming events. This Web site, along with the requests for comments
and many public events (announced on the site), have been a venue for
public communication with respect to the development of the Plan.
2. Request for Exemption From Certain Requirements Under Rule 613
Following multiple discussions between the Participants and both
the DAG and the Bidders, as well as among the Participants themselves,
the Participants recognized that some provisions of Rule 613 would not
permit certain solutions to be included in the Plan that the
Participants determined advisable to effectuate the most efficient and
cost-effective CAT. Consequently, on January 30, 2015, the Participants
submitted to the Commission a request for exemptive relief from certain
provisions of Rule 613 regarding: (1) Options Market Maker quotes; (2)
Customer-IDs; (3) CAT-Reporter-IDs; (4) linking of executions to
specific subaccount allocations on Allocation Reports; and (5) time
stamp granularity for manual order events.\46\ Specifically, the
Participants requested that the Commission grant an exemption from:
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\46\ See Exemptive Request Letter, supra note 16.
[[Page 30618]]
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Rule 613(c)(7)(ii) and (iv) for Options Market Makers with
regard to their options quotes;
Rule 613(c)(7)(i)(A), (c)(7)(iv)(F), (c)(7)(viii)(B) and (c)(8)
which relate to the requirements for Customer-IDs;
Rule 613(c)(7)(i)(C), (c)(7)(ii)(D), (c)(7)(ii)(E),
(c)(7)(iii)(D), (c)(7)(iii)(E), (c)(7)(iv)(F), (c)(7)(v)(F),
(c)(7)(vi)(B) and (c)(8) which relate to the requirements for CAT-
Reporter-IDs;
Rule 613(c)(7)(vi)(A), which requires CAT Reporters to record
and report the account number of any subaccounts to which the
execution is allocated; and
The millisecond time stamp granularity requirement in Rule
613(d)(3) for certain manual order events subject to time stamp
reporting under Rules 613(c)(7)(i)(E), 613(c)(7)(ii)(C),
613(c)(7)(iii)(C), and 613(c)(7)(iv)(C).
The Participants believe that the requested relief is critical to the
development of a cost-effective approach to the CAT.\47\
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\47\ The Commission notes the Participants' request for
exemptive relief was granted on March 1, 2016. See Exemption Order,
supra note 18.
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3. Requirements Pursuant to Rule 608(a)
a. Description of Plan
Rule 613 requires the Participants to ``jointly file . . . a
national market system plan to govern the creation, implementation, and
maintenance of a consolidated audit trail and Central Repository.''
\48\ The purpose of the Plan, and the creation, implementation and
maintenance of a comprehensive audit trail for the U.S. securities
market described therein, is to ``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.''
\49\ It ``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.'' \50\ The SROs note that
the following summarizes various provisions of the Plan, which is set
forth in full as Exhibit A to this Notice.
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\48\ 17 CFR 242.613(a)(1).
\49\ See Adopting Release, supra note 9, at 45726.
\50\ Id. Note that the Plan also includes certain recording and
reporting obligations for OTC Equity Securities.
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(1) LLC Agreement
The Participants propose to conduct the activities related to the
CAT in a Delaware limited liability company pursuant to a limited
liability company agreement, entitled the Limited Liability Company
Agreement of CAT NMS, LLC (``Company''). The Participants will jointly
own on an equal basis the Company. The Company will create, implement
and maintain the CAT. The limited liability company agreement (``LLC
Agreement'') itself, including its appendices, is the proposed Plan,
which would be a national market system plan as defined in Rule
600(b)(43) of NMS.
(2) Participants
Each national securities exchange and national securities
association currently registered with the Commission would be a
Participant in the Plan. The names and addresses of each Participant
are set forth in Exhibit A to the Plan. Article III of the Plan
provides that any entity approved by the Commission as a national
securities exchange or national securities association under the
Exchange Act after the Effective Date may become a Participant by
submitting to the Company a completed application in the form provided
by the Company and satisfying each of the following requirements: (1)
Executing a counterpart of the LLC Agreement as then in effect; and (2)
paying a fee to the Company in an amount determined by a Majority Vote
of the Operating Committee as fairly and reasonably compensating the
Company and the Participants for costs incurred in creating,
implementing and maintaining the CAT (including such costs incurred in
evaluating and selecting the Initial Plan Processor and any subsequent
Plan Processor) and for costs the Company incurs in providing for the
prospective Participant's participation in the Company, including after
consideration of certain factors identified in Section 3.3(b) of the
Agreement (``Participation Fee''). The amendment of the Plan reflecting
the admission of a new Participant will be effective only when: (1) It
is approved by the SEC in accordance with Rule 608 or otherwise becomes
effective pursuant to Rule 608; and (2) the prospective Participant
pays the Participation Fee.
A number of factors are relevant to the determination of a
Participation Fee. Such factors include: (1) The portion of costs
previously paid by the Company for the development, expansion and
maintenance of the CAT which, under GAAP, would have been treated as
capital expenditures and would have been amortized over the five years
preceding the admission of the prospective Participant; (2) an
assessment of costs incurred and to be incurred by the Company for
modifying the CAT or any part thereof to accommodate the prospective
Participant, which costs are not otherwise required to be paid or
reimbursed by the prospective Participant; (3) Participation Fees paid
by other Participants admitted as such after the Effective Date; (4)
elapsed time from the Effective Date to the anticipated date of
admittance of the prospective Participant; and (5) such other factors,
if any, as may be determined to be appropriate by the Operating
Committee and approved by the Commission. In the event that the Company
and a prospective Participant do not agree on the amount of the
Participation Fee, such amount will be subject to review by the SEC
pursuant to Section 11A(b)(5) of the Exchange Act.
An applicant for participation in the Company may apply for limited
access to the CAT System for planning and testing purposes pending its
admission as a Participant by submitting to the Company a completed
Application for Limited Access to the CAT System in a form provided by
the Company, accompanied by payment of a deposit in the amount
established by the Company, which will be applied or refunded as
described in such application. To be eligible to apply for such limited
access, the applicant must have been approved by the SEC as a national
securities exchange or national securities association under the
Exchange Act but the applicant has not yet become a Participant of the
Plan, or the SEC must have published such applicant's Form 1
Application or From [sic] X-15AA-1 Application to become a national
securities exchange or a national securities association, respectively.
All Company Interests will have the same rights, powers,
preferences and privileges and be subject to the same restrictions,
qualifications and limitations. Once admitted, each Participant will be
entitled to one vote on any matter presented to Participants for their
consideration and to participate equally in any distribution made by
the Company (other than a distribution made pursuant to Section 10.2 of
the Plan). Each Participant will have a Company Interest equal to that
of each other Participant.
Article III also describes a Participant's ability to Transfer a
Company Interest. A Participant may only Transfer any Company Interest
to a national securities exchange or national securities association
that succeeds to the business of such Participant as a result of a
merger or consolidation with such Participant or the Transfer of all or
substantially all of
[[Page 30619]]
the assets or equity of such Participant (``Permitted Transferee''). A
Participant may not Transfer any Company Interest to a Permitted
Transferee unless: (1) Such Permitted Transferee executes a counterpart
of the Plan; and (2) the amendment to the Plan reflecting the Transfer
is approved by the SEC in accordance with Rule 608 or otherwise becomes
effective pursuant to Rule 608.
In addition, Article III addresses the voluntary resignation and
termination of participation in the Plan. Any Participant may
voluntarily resign from the Company, and thereby withdraw from and
terminate its right to any Company Interest, only if: (1) A Permitted
Legal Basis for such action exists; and (2) such Participant provides
to the Company and each other Participant no less than thirty days
prior to the effective date of such action written notice specifying
such Permitted Legal Basis, including appropriate documentation
evidencing the existence of such Permitted Legal Basis, and, to the
extent applicable, evidence reasonably satisfactory to the Company and
other Participants that any orders or approvals required from the SEC
in connection with such action have been obtained. A validly
withdrawing Participant will have the rights and obligations discussed
below with regard to termination of participation.
A Participant's participation in the Company, and its right to any
Company Interest, will terminate as of the earliest of: (1) The
effective date specified in a valid resignation notice; (2) such time
as such Participant is no longer registered as a national securities
exchange or national securities association; or (3) the date of
termination for failure to pay fees. With regard to the payment of
fees, each Participant is required to pay all fees or other amounts
required to be paid under the Plan within thirty days after receipt of
an invoice or other notice indicating payment is due (unless a longer
payment period is otherwise indicated) (the ``Payment Date''). If a
Participant fails to make such a required payment by the Payment Date,
any balance in the Participant's Capital Account will be applied to the
outstanding balance. If a balance still remains with respect to any
such required payment, the Participant will pay interest on the
outstanding balance from the Payment Date until such fee or amount is
paid at a per annum rate equal to the lesser of: (1) The Prime Rate
plus 300 basis points; or (2) the maximum rate permitted by applicable
law. If any such remaining outstanding balance is not paid within
thirty days after the Payment Date, the Participants will file an
amendment to the Plan requesting the termination of the participation
in the Company of such Participant, and its right to any Company
Interest, with the SEC. Such amendment will be effective only when it
is approved by the SEC in accordance with Rule 608 or otherwise becomes
effective pursuant to Rule 608.
From and after the effective date of termination of a Participant's
participation in the Company, profits and losses of the Company will
cease to be allocated to the Capital Account of the Participant. A
terminated Participant will be entitled to receive the balance in its
Capital Account as of the effective date of termination adjusted for
profits and losses through that date, payable within ninety days of the
effective date of termination, and will remain liable for its
proportionate share of costs and expenses allocated to it for the
period during which it was a Participant, for obligations under Section
3.8(c) regarding the return of amounts previously distributed (if
required by a court of competent jurisdiction), for its indemnification
obligations pursuant to Section 4.1, and for obligations under Section
9.6 regarding confidentiality, but it will have no other obligations
under the Plan following the effective date of termination. The Plan
will be amended to reflect any termination of participation in the
Company of a Participant, provided that such amendment will be
effective only when it is approved by the SEC in accordance with Rule
608 or otherwise becomes effective pursuant to Rule 608.
Request for Comment
1. Do Commenters believe that the process for a national securities
exchange and national securities association to become a Participant
pursuant to and under the CAT NMS Plan is clearly and adequately set
forth in the CAT NMS Plan? Do Commenters believe that the process for,
and the circumstances under which a Participant could voluntarily
terminate its participation as a Participant to the CAT NMS Plan is
clearly and adequately set forth in the CAT NMS Plan? If not, what
additional details should be provided? Do Commenters believe that these
two processes are appropriate and reasonable?
2. Do Commenters believe that the process and enumerated factors
for determining the Participation Fee are clear and reasonable under
the CAT NMS Plan? If not, what additional modifications, if any, should
be considered in the Participation Fee determination process?
3. Are restrictions on the transfer of a Company Interest
appropriate and reasonable? If not, why not? What additional
limitations or factors, if any, should be imposed on such transfers?
Please explain.
4. Do Commenters believe that permitting the termination of a
Participant that continues to be a registered national securities
exchange or national securities association from participation in the
Company is an appropriate recourse for failure to pay Participant fees?
If not, can Commenters recommend an alternative remedy? Please explain.
5. Are there other circumstances that should trigger termination of
participation in the Company? If yes, what are they?
(3) Management
Article IV of the Plan establishes the overall governance structure
for the management of the Company. Specifically, the Participants
propose that the Company be managed by an Operating Committee.\51\
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\51\ The Operating Committee will manage the Company except for
situations in which the approval of the Participants is required by
the Plan or by non-waivable provisions of applicable law.
---------------------------------------------------------------------------
The Operating Committee will consist of one voting member
representing each Participant and one alternate voting member
representing each Participant who will have a right to vote only in the
absence of the Participant's voting member of the Operating Committee.
Each of the voting and alternate voting members of the Operating
Committee will be appointed by the Participant that he or she
represents, will serve at the will of the Participant appointing such
member and will be subject to the confidentiality obligations of the
Participant that he or she represents as set forth in Section 9.6. One
individual may serve as the voting member of the Operating Committee
for multiple Affiliated Participants, and such individual will have the
right to vote on behalf of each such Affiliated Participant.
The Operating Committee will elect, by Majority Vote, one of its
members to act as Chair for a term of two years. No Person may serve as
Chair for more than two successive full terms, and no Person then
appointed to the Operating Committee by a Participant that then serves,
or whose Affiliate then serves, as the Plan Processor will be eligible
to serve as the Chair. The Chair will preside at all meetings of the
Operating Committee, designate a Person to act as Secretary, and
perform such other duties and possess such other powers as the
Operating Committee may from time
[[Page 30620]]
to time prescribe. The Chair will not be entitled to a tie-breaking
vote at any meeting of the Operating Committee.
Each of the members of the Operating Committee, including the
Chair, will be authorized to cast one vote for each Participant that he
or she represents on all matters voted upon by the Operating Committee.
Action of the Operating Committee will be authorized by Majority Vote
(except under certain designated circumstances), subject to the
approval of the SEC whenever such approval is required under the
Exchange Act and the rules thereunder. For example, the Plan
specifically notes that a Majority Vote of the Operating Committee is
required to: (1) Select the Chair; (2) select the members of the
Advisory Committee (as described below); (3) interpret the Plan (unless
otherwise noted therein); (4) approve any recommendation by the Chief
Compliance Officer pursuant to Section 6.2(a)(v)(A); (5) determine to
hold an Executive Session of the Operating Committee; (6) determine the
appropriate funding-related policies, procedures and practices
consistent with Article XI; and (7) any other matter specified
elsewhere in the Plan (which includes the Appendices to the Plan) as
requiring a vote, approval or other action of the Operating Committee
(other than those matters expressly requiring a Supermajority Vote or a
different vote of the Operating Committee).
Article IV requires a Supermajority Vote of the Operating
Committee, subject to the approval of the SEC when required, for the
following: (1) Selecting a Plan Processor, other than the Initial Plan
Processor selected in accordance with Article V of the Plan; (2)
terminating the Plan Processor without cause in accordance with Section
6.1(p); (3) approving the Plan Processor's appointment or removal of
the Chief Information Security Officer, Chief Compliance Officer, or
any Independent Auditor in accordance with Section 6.1(b); (4) entering
into, modifying or terminating any Material Contract (if the Material
Contract is with a Participant or an Affiliate of a Participant, such
Participant and Affiliated Participant will be recused from any vote);
(5) making any Material Systems Change; (6) approving the initial
Technical Specifications or any Material Amendment to the Technical
Specifications proposed by the Plan Processor; (7) amending the
Technical Specifications on its own motion; and (8) any other matter
specified elsewhere in the Plan (which includes the Appendices to the
Plan) as requiring a vote, approval or other action of the Operating
Committee by a Supermajority Vote.
A member of the Operating Committee or any Subcommittee thereof (as
discussed below) shall recuse himself or herself from voting on any
matter under consideration by the Operating Committee or such
Subcommittee if such member determines that voting on such matter
raises a Conflict of Interest. In addition, if the members of the
Operating Committee or any Subcommittee (excluding the member thereof
proposed to be recused) determine by Supermajority Vote that any member
voting on a matter under consideration by the Operating Committee or
such Subcommittee raises a Conflict of Interest, such member shall be
recused from voting on such matter. No member of the Operating
Committee or any Subcommittee will be automatically recused from voting
on any matter except matters involving Material Contracts as discussed
in the prior paragraph, as otherwise specified in the Plan, and as
follows: (1) If a Participant is a Bidding Participant whose Bid
remains under consideration, members appointed to the Operating
Committee or any Subcommittee by such Participant or any of its
Affiliated Participants will be recused from any vote concerning: (a)
Whether another Bidder may revise its Bid; (b) the selection of a
Bidder; or (c) any contract to which such Participant or any of its
Affiliates would be a party in its capacity as Plan Processor; and (2)
if a Participant is then serving as Plan Processor, is an Affiliate of
the Person then serving as Plan Processor, or is an Affiliate of an
entity that is a Material Subcontractor to the Plan Processor, then in
each case members appointed to the Operating Committee or any
Subcommittee by such Participant or any of its Affiliated Participants
shall be recused from any vote concerning: (a) The proposed removal of
such Plan Processor; or (b) any contract between the Company and such
Plan Processor.
Article IV also addresses meetings of the Operating Committee.\52\
Meetings of the Operating Committee may be attended by each
Participant's voting Representative and its alternate voting
Representative and by a maximum of two nonvoting Representatives of
each Participant, by members of the Advisory Committee, by the Chief
Compliance Officer, by other Representatives of the Company and the
Plan Processor, by Representatives of the SEC and by such other Persons
that the Operating Committee may invite to attend. The Operating
Committee, however, may, where appropriate, determine to meet in
Executive Session during which only voting members of the Operating
Committee will be present. The Operating Committee, however, may invite
other Representatives of the Participants, of the Company, of the Plan
Processor (including the Chief Compliance Officer and the Chief
Information Security Officer) or the SEC, or such other Persons that
the Operating Committee may invite to attend, to be present during an
Executive Session. Any determination of the Operating Committee to meet
in an Executive Session will be made upon a Majority Vote and will be
reflected in the minutes of the meeting. In addition, any Person that
is not a Participant but for which the SEC has published a Form 1
Application or Form X-15AA-1 to become a national securities exchange
or national securities association, respectively, will be permitted to
appoint one primary Representative and one alternate Representative to
attend regularly scheduled Operating Committee meetings in the capacity
of a non-voting observer, but will not be permitted to have any
Representative attend a special meeting, emergency meeting or meeting
held in Executive Session of the Operating Committee.
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\52\ Article IV also addresses, among other things, different
types of Operating Committee meetings (regular, special and
emergency), frequency of such meetings, how to call such meetings,
the location of the meetings, the role of the Chair, and notice
regarding such meetings.
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The Operating Committee may, by Majority Vote, designate by
resolution one or more Subcommittees it deems necessary or desirable in
furtherance of the management of the business and affairs of the
Company. For any Subcommittee, any member of the Operating Committee
who wants to serve thereon may so serve. If Affiliated Participants
have collectively appointed one member to the Operating Committee to
represent them, then such Affiliated Participants may have only that
member serve on the Subcommittee or may decide not to have only that
collectively appointed member serve on the Subcommittee. Such member
may designate an individual other than himself or herself who is also
an employee of the Participant or Affiliated Participants that
appointed such member to serve on a Subcommittee in lieu of the
particular member. Subject to the requirements of the Plan and non-
waivable provisions of Delaware law, a Subcommittee may exercise all
the powers and authority of the Operating Committee in the management
of the business and affairs of the Company as so specified in the
resolution of the
[[Page 30621]]
Operating Committee designating such Subcommittee.
Article IV requires that the Operating Committee maintain a
Compliance Subcommittee for the purpose of aiding the Chief Compliance
Officer as necessary, including with respect to issues involving: (1)
The maintenance of the confidentiality of information submitted to the
Plan Processor or Central Repository pursuant to Rule 613, applicable
law, or the Plan by Participants and Industry Members; (2) the
timeliness, accuracy, and completeness of information submitted
pursuant to Rule 613, applicable law or the Plan by Participants and
Industry Members; and (3) the manner and extent to which each
Participant is meeting its obligations under Rule 613, Section 3.11,
and as set forth elsewhere in the Plan and ensuring the consistency of
the Plan's enforcement as to all Participants.
Article IV also sets forth the requirements for the formation and
functioning of an Advisory Committee, which will advise the
Participants on the implementation, operation and administration of the
Central Repository, including possible expansion of the Central
Repository to other securities and other types of transactions.
Article IV describes the composition of the Advisory Committee. No
member of the Advisory Committee may be employed by or affiliated with
any Participant or any of its Affiliates or facilities. The Operating
Committee will select one member from representatives of each of the
following categories to serve on the Advisory Committee on behalf of
himself or herself individually and not on behalf of the entity for
which the individual is then currently employed: (1) A broker-dealer
with no more than 150 Registered Persons; (2) a broker-dealer with at
least 151 and no more than 499 Registered Persons; (3) a broker-dealer
with 500 or more Registered Persons; (4) a broker-dealer with a
substantial wholesale customer base; (5) a broker-dealer that is
approved by a national securities exchange: (a) To effect transactions
on an exchange as a specialist, market maker or floor broker; or (b) to
act as an institutional broker on an exchange; (6) a proprietary-
trading broker-dealer; (7) a clearing firm; (8) an individual who
maintains a securities account with a registered broker or dealer but
who otherwise has no material business relationship with a broker or
dealer or with a Participant; (9) a member of academia with expertise
in the securities industry or any other industry relevant to the
operation of the CAT System; (10) an institutional investor trading on
behalf of a public entity or entities; (11) an institutional investor
trading on behalf of a private entity or entities; and (12) an
individual with significant and reputable regulatory expertise. The
members selected to represent categories (1) through (12) above must
include, in the aggregate, representatives of no fewer than three
broker-dealers that are active in the options business and
representatives of no fewer than three broker-dealers that are active
in the equities business. In addition, upon a change in employment of
any such selected member, a Majority Vote of the Operating Committee
will be required for such member to be eligible to continue to serve on
the Advisory Committee. Furthermore, the SEC's Chief Technology Officer
(or the individual then currently employed in a comparable position
providing equivalent services) will serve as an observer of the
Advisory Committee (but not be a member). The members of the Advisory
Committee will have a term of three years.\53\
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\53\ Four of the initial twelve members of the Advisory
Committee will have an initial term of one year, and another four of
the initial twelve members of the Advisory Committee will have an
initial term of two years.
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Members of the Advisory Committee will have the right to attend
meetings of the Operating Committee or any Subcommittee, to receive
information concerning the operation of the Central Repository, and to
submit their views to the Operating Committee or any Subcommittee on
matters pursuant to the Plan prior to a decision by the Operating
Committee on such matters. A member of the Advisory Committee will not
have a right to vote on any matter considered by the Operating
Committee or any Subcommittee. In addition, the Operating Committee or
any Subcommittee may meet in Executive Session if the Operating
Committee or Subcommittee determines by Majority Vote that such an
Executive Session is advisable.\54\ Although members of the Advisory
Committee will have the right to receive information concerning the
operation of the Central Repository, the Operating Committee retains
the authority to determine the scope and content of information
supplied to the Advisory Committee, which will be limited to that
information that is necessary and appropriate for the Advisory
Committee to fulfill its functions. Any information received by members
of the Advisory Committee will remain confidential unless otherwise
specified by the Operating Committee.
---------------------------------------------------------------------------
\54\ The Operating Committee may solicit and consider views on
the operation of the Central Repository in addition to those of the
Advisory Committee.
---------------------------------------------------------------------------
Article IV also describes the appointment of Officers for the
Company. Specifically, the Chief Compliance Officer and the Chief
Information Security Officer, each of whom will be employed solely by
the Plan Processor and neither of whom will be deemed or construed in
any way to be an employee of the Company, will be Officers of the
Company. Neither such Officer will receive or be entitled to any
compensation from the Company or any Participant by virtue of his or
her service in such capacity (other than if a Participant is then
serving as the Plan Processor, compensation paid to such Officer as an
employee of such Participant). Each such Officer will report directly
to the Operating Committee. The Chief Compliance Officer will work on a
regular and frequent basis with the Compliance Subcommittee and/or
other Subcommittees as may be determined by the Operating Committee.
Except to the extent otherwise provided in the Plan, including Section
6.2, each such Officer will have such fiduciary and other duties with
regard to the Plan Processor as imposed by the Plan Processor on such
individual by virtue of his or her employment by the Plan Processor.
In addition, the Plan Processor will inform the Operating Committee
of the individual who has direct management responsibility for the Plan
Processor's performance of its obligations with respect to the CAT.
Subject to approval by the Operating Committee of such individual, the
Operating Committee will appoint such individual as an Officer. In
addition, the Operating Committee by Supermajority Vote may appoint
other Officers as it shall from time to time deem necessary. Any
Officer appointed pursuant to Section 4.6(b) will have only such duties
and responsibilities as set forth in the Plan, or as the Operating
Committee shall from time to time expressly determine. No such Officer
shall have any authority to bind the Company (which authority is vested
solely in the Operating Committee) or be an employee of the Company,
unless in each case the Operating Committee, by Supermajority Vote,
expressly determines otherwise. No person subject to a ``statutory
disqualification'' (as defined in Section 3(a)(39) of the Exchange Act)
may serve as an Officer. It is the intent of the Participants that the
Company have no employees.
[[Page 30622]]
Request for Comment
6. Do Commenters believe that the organizational, governance and/or
managerial structure of CAT NMS, LLC is in the public interest? Why or
why not?
7. Do Commenters believe that the organizational, governance, and/
or managerial structure set forth in the CAT NMS Plan, including the
role of the Operating Committee, is appropriate and reasonable? If not,
please explain.
8. The CAT NMS Plan specifies the corporate actions that require a
Majority Vote and the corporate actions that require a Supermajority
Vote. Do Commenters believe that such voting procedures are appropriate
and reasonable? Should any corporate actions require a higher or lower
voting threshold than specified in the Plan? Are there any corporate
actions that should require a Supermajority Vote? Please explain.
9. Do Commenters believe that the CAT NMS Plan should explicitly or
more clearly specify who should determine whether a systems change or
amendment is ``material''? If so, who? Please explain.
10. Do Commenters believe that two successive full terms is an
appropriate and reasonable term limit for a Person to serve as chair of
the Operating Committee? If not, please explain.
11. Section 1.1 defines Conflict of Interest to mean that the
interest of a Participant (e.g., commercial, reputational, regulatory,
or otherwise) in the matter that is subject to the vote; (a)
interferes, or would be reasonably likely to interfere with that
Participant's objective consideration of the matter; and (b) is, or is
reasonably likely to be, inconsistent with the purpose and objectives
of the Company, and the CAT, taking into account all relevant
considerations, including whether a Participant that may otherwise have
a conflict of interest has established appropriate safeguards to
eliminate such conflicts of interest and taking into account the other
guiding principles set forth in the LLC Agreement. Do Commenters
believe this definition of ``Conflict of Interest'' is appropriate and
reasonable? Please explain.
12. Do Commenters believe that the definition of Conflict of
Interest of the CAT NMS Plan properly reflects the business interests
of each Participant and the Operating Committee? If not, please
explain. Do Commenters believe that the CAT NMS Plan governing
procedures on Conflicts of Interest and recusals contained in Section
4.3(d) of the CAT NMS Plan, reasonably and adequately address Conflicts
of Interest? If not, please explain. Are there other conflicts of
interest that may arise for any Participant that are not addressed in
the CAT NMS Plan definitions or governing procedures? If so, what?
13. Is the CAT NMS Plan clear and reasonable regarding whether it
permits the Operating Committee to delegate the authority to vote on
matters to a Subcommittee? If so, in what circumstances? Are there any
circumstances in which a Subcommittee would or should be prohibited
from voting in place of the Operating Committee? Please explain.
14. Do Commenters believe that the Advisory Committee structure and
provisions set forth in the CAT NMS Plan are appropriate and
reasonable? Is the size of the Advisory Committee as contemplated by
the Plan appropriate and reasonable? Are the Advisory Committee member
categories reasonable and adequately representative of entities
impacted by the CAT NMS Plan? Would expanding membership on the
Advisory Committee to any additional types of entities enhance the
quality of the input it would provide to the Operating Committee?
Please explain.
15. Is the mechanism for determining who serves on the Advisory
Committee (i.e., selection by the Operating Committee) appropriate and
reasonable? Should Participants be required to publicly solicit
Advisory Committee membership interest? Should the Advisory Committee
be able to self-nominate replacement candidates? Please explain.
16. Do Commenters believe that the CAT NMS Plan's requirement that
Advisory Committee members serve on the Advisory Committee in their
personal capacities, and that the Operating Committee members serve on
the Operating Committee as representatives of their employers who are
the Plan Participants create different incentives for members of the
Advisory Committee and members of the Operating Committee? If so, in
what ways? Do Commenters believe that these differing incentives would
impact the regulatory objective of the CAT? If so, in what ways?
17. The CAT NMS Plan outlines the size, tenure and membership
categories of the Advisory Committee members. Do Commenters believe
there are any additional or alternative factors that should be taken
into consideration in structuring the Advisory Committee that would
benefit the operation of the CAT? If so, what are those additional or
alternative factors? How would these factors benefit the operation of
the CAT?
18. Are the roles and responsibilities of the Advisory Committee
clearly and adequately set forth in the CAT NMS Plan? If not, why not?
Should additional details on these roles and responsibilities be
provided? If so, what additional details should be provided?
19. Are there any alternatives for involvement by the Advisory
Committee that could increase the effectiveness of the Advisory
Committee? For example, should the Advisory Committee be given a vote
in connection with decisions regarding the CAT NMS Plan, equivalent to
the vote each Participant has? If so, please specifically identify the
alternatives for involvement and how those alternatives could increase
the effectiveness of the CAT.
20. Do Commenters believe that the Advisory Committee is structured
in a way that would allow industry to provide meaningful input on the
implementation, operation, and administration of the CAT? If not,
please explain and/or provide specific suggestions for improving the
Advisory Committee structure. Should additional authority be given to
the Advisory Committee, for example allowing it to initiate its own
recommendations? Should additional mechanisms through which the
industry or others could provide input be included in the CAT NMS Plan?
\55\ Should the Operating Committee be required to respond to the
Advisory Committee's views, formally or informally, in advance of or
following a decision by the Operating Committee? Should the Operating
Committee be required to include Advisory Committee views in filings
with the Commission? Please explain.
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\55\ See Section IV.E.4, infra, for additional requests for
comment on the Advisory Committee.
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21. Do Commenters believe that the Plan's provision that prohibits
the Advisory Committee from attending any Executive Session of the
Operating Committee is appropriate and reasonable?
22. Do Commenters believe that the CAT NMS Plan adequately sets
forth provisions regarding the scope, authority, and duties of the
Officers of the CAT, as well as the scope and authority of the Plan
Processor generally? If not, what further provisions should the CAT NMS
Plan set forth with respect to Officers and the Plan Processor and why?
23. Do Commenters believe that the Operating Committee and the
proposed CAT NMS Plan governance structure would ensure effective
corporate governance, process and action? Why or why not?
[[Page 30623]]
24. The CAT NMS Plan provides that emergency meetings of the
Operating Committee may be called at the request of two or more
Participants, and may be held as soon as practical after such a meeting
is called. Do Commenters believe that there should be a different
method for the Operating Committee to meet and take action in the event
of an emergency? Should the CAT NMS Plan denote certain emergency
situations in which the Operating Committee must be required to take
action on an expedited basis? If so, what time period would be
reasonable to require action by the Operating Committee and what
mechanisms or processes should the Operating Committee be required to
follow?
25. What, if any, impact on the Operating Committee's governance
and voting do Affiliated Participant groups have? Do Commenters believe
that the Operating Committee's governance and voting provisions set
forth in the CAT NMS Plan, including the definitions of Supermajority
Vote and Majority Vote, are appropriate and reasonable in light of
these Affiliated Participant groups? What, if any, additional
governance and voting provisions or protections should be included? Is
there an alternative model for voting rights that would be more
appropriate and reasonable, for example distributing votes using a
measure other than exchange licenses?
26. Do Commenters believe the use of Executive Session is
appropriate and reasonable? Is a Majority Vote the appropriate
mechanism for the Operating Committee to go into Executive Session?
Should the CAT NMS Plan specify particular scenarios for which an
Executive Session is or is not appropriate?
27. Do Commenters believe that the provisions in the CAT NMS Plan
regarding the mechanics of voting by the Operating Committee, the
Selection Committee, or other entities are appropriate and reasonable?
Does the CAT NMS Plan include sufficient detail on when voting should
be carried out openly (e.g., in the presence of other attendees at a
committee meeting) as opposed to when voting may be conducted by secret
ballot or by some other confidential method? What are the advantages
and disadvantages of different voting methodologies? Would particular
actions or decisions regarding CAT be better suited to one voting
methodology over others? Please explain.
28. Are there any other matters relating to the operation and
administration of the Plan that should be included in the Plan for the
Commission's consideration? If so, please identify such matters and
explain why and how they should be addressed in the Plan.
(4) Initial Plan Processor Selection
Article V of the Plan sets forth the process for the Participants'
evaluation of Bids and the selection process for narrowing down the
Bids and choosing the Initial Plan Processor. The initial steps in the
evaluation and selection process were and will be performed pursuant to
the Selection Plan; the final two rounds of evaluation and voting, as
well as the final selection of the Initial Plan Processor, will be
performed pursuant to the Plan.\56\
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\56\ By its terms, the Selection Plan will terminate upon
Commission approval of the Plan.
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As discussed above, the Selection Committee has selected the
Shortlisted Bids pursuant to the Selection Plan. After reviewing the
Shortlisted Bids, the Participants have identified the optimal proposed
solutions for the CAT and, to the extent possible, included such
solutions in the Plan.\57\ The Selection Committee will determine, by
majority vote, whether Shortlisted Bidders will have the opportunity to
revise their Bids. To reduce potential conflicts of interest, no
Bidding Participant may vote on whether a Shortlisted Bidder will be
permitted to revise its Bid if a Bid submitted by or including the
Participant or an Affiliate of the Participant is a Shortlisted Bid.
The Selection Committee will review and evaluate all Shortlisted Bids,
including any permitted revisions submitted by Shortlisted Bidders. In
performing this review and evaluation, the Selection Committee may
consult with the Advisory Committee and such other Persons as the
Selection Committee deems appropriate, which may include the DAG until
the Advisory Committee is formed.
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\57\ As noted above, the Participants stated their belief that
certain exemptive relief is necessary to include in the Plan all of
the provisions the Participants believe are part of the optimal
solution for the CAT. The Commission notes that the request for
exemptive relief was granted on March 1, 2016. See Exemption Order,
supra note 18.
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After receipt of any permitted revisions, the Selection Committee
will select the Initial Plan Processor from the Shortlisted Bids in two
rounds of voting where each Participant has one vote via its Voting
Senior Officer in each round.\58\ No Bidding Participant, however, will
be entitled to vote in any round if the Participant's Bid, a Bid
submitted by an Affiliate of the Participant, or a Bid including the
Participant or an Affiliate of the Participant is considered in such
round.\59\ In the first round, each Voting Senior Officer, subject to
the recusal provision in Section 5.2(e)(ii), will select a first and
second choice, with the first choice receiving two points and the
second choice receiving one point. The two Shortlisted Bids receiving
the highest cumulative scores in the first round will advance to the
second round.\60\ In the event of a tie, the tie will be broken by
assigning one point per vote to the tied Shortlisted Bids, and the
Shortlisted Bid with the most votes will advance. If this procedure
fails to break the tie, a revote will be taken on the tied Bids with
each vote receiving one point. If the tie persists, the Participants
will identify areas for discussion, and revotes will be taken until the
tie is broken.
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\58\ If the proposed amendment to the Selection Plan is
approved, the Selection Committee may determine to narrow the number
of Shortlisted Bids prior to the two rounds of voting.
\59\ This recusal provision is included in the Plan, as well as
in an amendment to the Selection Plan. See Order Approving Amendment
No. 2 to the Selection Plan, supra note 15.
\60\ Each round of voting throughout the Plan is independent of
other rounds.
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Once two Shortlisted Bids have been chosen, the Voting Senior
Officers of the Participants (other than those subject to recusal) will
vote for a single Shortlisted Bid from the final two to determine the
Initial Plan Processor. If the tie persists, the Participants will
identify areas for discussion and, following these discussions, revotes
will be taken until the tie is broken. As set forth in Article VI of
the Plan, following the selection of the Initial Plan Processor, the
Participants will file with the Commission a statement identifying the
Initial Plan Processor and including the information required by Rule
608.
(5) Functions and Activities of CAT System
A. Plan Processor
Article VI describes the responsibilities of the selected Plan
Processor. The Company, under the direction of the Operating Committee,
will enter into one or more agreements with the Plan Processor
obligating the Plan Processor to perform the functions and duties
contemplated by the Plan to be performed by the Plan Processor, as well
as such other functions and duties the Operating Committee deems
necessary or appropriate.
As set forth in the Plan, the Plan Processor is required to develop
and, with the prior approval of the Operating Committee, implement
policies, procedures, and control structures related to the CAT System
that are consistent with Rule 613(e)(4), Appendix C and Appendix D. The
Plan
[[Page 30624]]
Processor will: (1) Comply with applicable provisions of 15 U.S. Code
Sec. 78u-6 (Securities Whistleblower Incentives and Protection) and
the recordkeeping requirements of Rule 613(e)(8); (2) consistent with
Appendix D, Central Repository Requirements, ensure the effective
management and operation of the Central Repository; (3) consistent with
Appendix D, Data Management, ensure the accuracy of the consolidation
of the CAT Data reported to the Central Repository; and (4) consistent
with Appendix D, Upgrade Process and Development of New Functionality,
design and implement appropriate policies and procedures governing the
determination to develop new functionality for the CAT including, among
other requirements, a mechanism by which changes can be suggested by
Advisory Committee members, Participants, or the SEC. Such policies and
procedures also shall: (1) Provide for the escalation of reviews of
proposed technological changes and upgrades to the Operating Committee;
and (2) address the handling of surveillance, including coordinated,
Rule 17d-2 under the Exchange Act or Regulatory Surveillance
Agreement(s) (RSA) surveillance queries and requests for data. Any
policy, procedure or standard (and any material modification or
amendment thereto) applicable primarily to the performance of the Plan
Processor's duties as the Plan Processor (excluding any policies,
procedures or standards generally applicable to the Plan Processor's
operations and employees) will become effective only upon approval by
the Operating Committee. The Plan Processor also will, subject to the
prior approval of the Operating Committee, establish appropriate
procedures for escalation of matters to the Operating Committee. In
addition to other policies, procedures and standards generally
applicable to the Plan Processor's employees and contractors, the Plan
Processor will have hiring standards and will conduct and enforce
background checks (e.g., fingerprint-based) for all of its employees
and contractors to ensure the protection, safeguarding and security of
the facilities, systems, networks, equipment and data of the CAT
System, and will have an insider and external threat policy to detect,
monitor and remedy cyber and other threats.
The Plan Processor will enter into appropriate Service Level
Agreements (``SLAs'') governing the performance of the Central
Repository, as generally described in Appendix D, Functionality of the
CAT System, with the prior approval of the Operating Committee. The
Plan Processor in conjunction with the Operating Committee will
regularly review and, as necessary, update the SLAs, in accordance with
the terms of the SLAs. As further contemplated in Appendix C, System
Service Level Agreements (SLAs), and in Appendix D, System SLAs, the
Plan Processor may enter into appropriate service level agreements with
third parties applicable to the Plan Processor's functions related to
the CAT System (``Other SLAs''), with the prior approval of the
Operating Committee. The Chief Compliance Officer and/or the
Independent Auditor will, in conjunction with the Plan Processor and as
necessary the Operating Committee, regularly review and, as necessary,
update the Other SLAs, in accordance with the terms of the applicable
Other SLA. In addition, the Plan Processor: (1) Will, on an ongoing
basis and consistent with any applicable policies and procedures,
evaluate and implement potential system changes and upgrades to
maintain and improve the normal day-to-day operating function of the
CAT System; (2) in consultation with the Operating Committee, will, on
an as needed basis and consistent with any applicable operational and
escalation policies and procedures, implement such material system
changes and upgrades as may be required to ensure effective functioning
of the CAT System; and (3) in consultation with the Operating
Committee, will, on an as needed basis, implement system changes and
upgrades to the CAT System to ensure compliance with applicable laws,
regulations or rules (including those promulgated by the SEC or any
Participant). Furthermore, the Plan Processor will develop and, with
the prior approval of the Operating Committee, implement a securities
trading policy, as well as necessary procedures, control structures and
tools to enforce this policy.
In addition, the Plan Processor will provide the Operating
Committee regular reports on the CAT System's operation and
maintenance. Furthermore, upon request of the Operating Committee or
any Subcommittee, the Plan Processor will attend any meetings of the
Operating Committee or such Subcommittee.
The Plan Processor may appoint such officers of the Plan Processor
as it deems necessary and appropriate to perform its functions under
the Plan and Rule 613. The Plan Processor, however, will be required to
appoint, at a minimum, the Chief Compliance Officer, the Chief
Information Security Officer, and the Independent Auditor. The
Operating Committee, by Supermajority Vote, will approve any
appointment or removal of the Chief Compliance Officer, Chief
Information Security Officer, or the Independent Auditor.
The Plan Processor will designate an employee of the Plan Processor
to serve, subject to the approval of the Operating Committee by
Supermajority Vote, as the Chief Compliance Officer. The Plan Processor
will also designate at least one other employee (in addition to the
person then serving as Chief Compliance Officer), which employee the
Operating Committee has previously approved, to serve temporarily as
the Chief Compliance Officer if the employee then serving as the Chief
Compliance Officer becomes unavailable or unable to serve in such
capacity (including by reason of injury or illness). Any person
designated to serve as the Chief Compliance Officer (including to serve
temporarily) will be appropriately qualified to serve in such capacity
based on the duties and responsibilities assigned to the Chief
Compliance Officer and will dedicate such person's entire working time
to such service (or temporary service) (except for any time required to
attend to any incidental administrative matters related to such
person's employment with the Plan Processor that do not detract in any
material respect from such person's service as the Chief Compliance
Officer). Article VI sets forth various responsibilities of the Chief
Compliance Officer. With respect to all of his or her duties and
responsibilities in such capacity (including those as set forth in the
Plan), the Chief Compliance Officer will be directly responsible and
will directly report to the Operating Committee, notwithstanding that
she or he is employed by the Plan Processor. The Plan Processor,
subject to the oversight of the Operating Committee, will ensure that
the Chief Compliance Officer has appropriate resources to fulfill his
or her obligations under the Plan and Rule 613. The compensation
(including base salary and bonus) of the Chief Compliance Officer will
be payable by the Plan Processor, but be subject to review and approval
by the Operating Committee. The Operating Committee will render the
Chief Compliance Officer's annual performance review.
The Plan Processor also will designate an employee of the Plan
Processor to serve, subject to the approval of the Operating Committee
by Supermajority Vote, as the Chief Information Security Officer. The
Plan Processor will also designate at least one other employee (in
addition to the person then serving as Chief Information Security
Officer), which employee the Operating
[[Page 30625]]
Committee has previously approved, to serve temporarily as the Chief
Information Security Officer if the employee then serving as the Chief
Information Security Officer becomes unavailable or unable to serve in
such capacity (including by reason of injury or illness). Any person
designated to serve as the Chief Information Security Officer
(including to serve temporarily) will be appropriately qualified to
serve in such capacity based on the duties and responsibilities
assigned to the Chief Information Security Officer under the Plan and
will dedicate such person's entire working time to such service (or
temporary service) (except for any time required to attend to any
incidental administrative matters related to such person's employment
with the Plan Processor that do not detract in any material respect
from such person's service as the Chief Information Security Officer).
The Plan Processor, subject to the oversight of the Operating
Committee, will ensure that the Chief Information Security Officer has
appropriate resources to fulfill the obligations of the Chief
Information Security Officer set forth in Rule 613 and in the Plan,
including providing appropriate responses to questions posed by the
Participants and the SEC. In performing such obligations, the Chief
Information Security Officer will be directly responsible and directly
report to the Operating Committee, notwithstanding that he or she is
employed by the Plan Processor. The compensation (including base salary
and bonus) of the Chief Information Security Officer will be payable by
the Plan Processor, but be subject to review and approval by the
Operating Committee, and the Operating Committee will render the Chief
Information Security Officer's annual performance review. Consistent
with Appendices C and D, the Chief Information Security Officer will be
responsible for creating and enforcing appropriate policies,
procedures, standards, control structures and real time tools to
monitor and address data security issues for the Plan Processor and the
Central Repository, as described in the Plan. At regular intervals, to
the extent that such information is available to the Company, the Chief
Information Security Officer will report to the Operating Committee the
activities of the Financial Services Information Sharing and Analysis
Center (``FS-ISAC'') or comparable bodies to the extent that the
Company has joined FS-ISAC or other comparable body.
The Plan Processor will afford to Participants and the Commission
such access to the Representatives of the Plan Processor as any
Participant or the Commission may reasonably request solely for the
purpose of performing such Person's regulatory and oversight
responsibilities pursuant to the federal securities laws, rules, and
regulations or any contractual obligations. The Plan Processor will
direct such Representatives to reasonably cooperate with any inquiry,
investigation, or proceeding conducted by or on behalf of any
Participant or the Commission related to such purpose.
The Operating Committee will review the Plan Processor's
performance under the Plan at least once each year, or more often than
once each year upon the request of two Participants that are not
Affiliated Participants. The Operating Committee will notify the SEC of
any determination made by the Operating Committee concerning the
continuing engagement of the Plan Processor as a result of the
Operating Committee's review of the Plan Processor and will provide the
SEC with a copy of any reports that may be prepared in connection
therewith.
The Operating Committee, by Supermajority Vote, may remove the Plan
Processor from such position at any time. However, the Operating
Committee, by Majority Vote, may remove the Plan Processor from such
position at any time if it determines that the Plan Processor has
failed to perform its functions in a reasonably acceptable manner in
accordance with the provisions of the Plan or that the Plan Processor's
expenses have become excessive and are not justified. In making such a
determination, the Operating Committee will consider, among other
factors: (1) The reasonableness of the Plan Processor's response to
requests from Participants or the Company for technological changes or
enhancements; (2) results of any assessments performed pursuant to
Section 6.6; (3) the timeliness of conducting preventative and
corrective information technology system maintenance for reliable and
secure operations; (4) compliance with requirements of Appendix D; and
(5) such other factors related to experience, technological capability,
quality and reliability of service, costs, back-up facilities, failure
to meet service level agreement(s) and regulatory considerations as the
Operating Committee may determine to be appropriate.
In addition, the Plan Processor may resign upon two year's (or such
other shorter period as may be determined by the Operating Committee by
Supermajority Vote) prior written notice. The Operating Committee will
fill any vacancy in the Plan Processor position by Supermajority Vote,
and will establish a Plan Processor Selection Subcommittee to evaluate
and review Bids and make a recommendation to the Operating Committee
with respect to the selection of the successor Plan Processor.
Request for Comment
29. The CAT NMS Plan, Section 6.1 (Plan Processor) sets forth
details regarding the Plan Processor's responsibilities. Do Commenters
believe that the enumerated responsibilities of the Plan Processor are
appropriate and reasonable? Please explain.
30. Do Commenters believe that the CAT NMS Plan provides the
Operating Committee with sufficient authority to maintain oversight of
the Plan Processor? Is the Plan Processor given too much discretion?
Too little? Please explain.
31. The CAT NMS Plan provides in Section 6.1(s) that a Plan
Processor may resign upon giving two years notice of such resignation.
Do Commenters believe that two years is a sufficient amount of notice
to ensure a replacement Plan Processor could be selected? Is two years
too long a period to require notice of resignation? Why or why not?
32. The CAT NMS Plan includes two provisions governing removal of
the Plan Processor. Section 6.1(q) allows the Operating Committee to
remove the Plan Processor at any time by a Supermajority Vote. Do
Commenters believe it is appropriate for the Operating Committee to
have authority to remove the Plan Processor without cause upon a
Supermajority Vote? Why or why not?
33. Section 6.1(r) of the CAT NMS Plan allows the Operating
Committee to remove the Plan Processor by a Majority Vote if it
determines that the Plan Processor has failed to perform its functions
in a reasonably acceptable manner in accordance with the provisions of
the CAT LLC Agreement or that the Plan Processor's expenses have become
excessive and are not justified. Do Commenters believe it is
appropriate and reasonable for the Operating Committee to have the
authority to remove the Plan Processor on these bases using a Majority
Vote? Why or why not, and with respect to which of these bases? Do
Commenters believe there are other grounds upon which the Operating
Committee should have the ability to remove the Plan Processor upon a
Majority Vote?
34. The CAT NMS Plan states that the Plan Processor must implement
policies and procedures consistent with Rule
[[Page 30626]]
613(e)(4). Further, Rule 613(e)(4) requires that the CAT NMS Plan
include policies and procedures to be used by the Plan Processor to
ensure: (1) The security and confidentiality of all information
reported to the Central Repository; (2) the timeliness, accuracy,
integrity, and completeness of the data provided to the Central
Repository; and (3) the accuracy of the consolidation by the Plan
Processor of the data provided to the Central Repository. Do Commenters
believe that such policies and procedures are adequately described in
Appendix D of the CAT NMS Plan? Do Commenters believe such policies and
procedures are appropriate and reasonable? Do Commenters believe that
additions or deletions should be made to the policies and procedures?
If so, please describe.
35. The CAT NMS Plan provides that the CCO and CISO, while Officers
of CAT NMS, LLC, would be employees of the Plan Processor. Do
Commenters believe that this arrangement creates any conflicts of
interest that could undermine the ability of the CCO and CISO to
effectively carry out their responsibilities under the CAT NMS Plan?
Please describe any such conflicts of interest and explain how they
could affect the performance of the CCO or CISO's CAT-related duties.
36. The CAT NMS Plan provides that the Operating Committee must
approve the CCO and CISO selected by the Plan Processor by
Supermajority Vote, that the CCO and CISO shall dedicate their entire
working time to their service as CCO or CISO, that the Operating
Committee shall have oversight over the Plan Processor's compensation
of and provision of resources to the CCO and CISO, and that the CCO and
CISO shall report directly to and receive annual performance reviews
from the Operating Committee.\61\ Do Commenters believe that these
provisions adequately address any conflicts of interest resulting from
the CCO and CISO being employees of the Plan Processor? Are there
additional steps that could be taken to insulate the CCO and CISO from
being unduly influenced by the Plan Processor?
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\61\ See CAT NMS Plan, supra note 3, at Sections 6.2(a)(i)-(iv),
b(i)-(iv).
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37. The CAT NMS Plan provides that the CCO and CISO would not, to
the extent permitted under applicable law, have fiduciary or similar
duties to CAT NMS, LLC, but that they may have fiduciary or similar
duties to the Plan Processor to the extent that their employment with
the Plan Processor entails such duties.\62\ Do Commenters believe that
these provisions could affect the ability of the CCO and CISO to carry
out their CAT-related duties? Would any alternative provisions be
preferable? For example, should the Plan remain silent regarding the
CCO and CISO's fiduciary or other duties to the Plan Processor and CAT
NMS, LLC? Should the Plan require the CCO and CISO to affirmatively
undertake fiduciary or similar duties to CAT NMS, LLC? Should the Plan
Processor be required to select individuals who do not have fiduciary
or similar duties to the Plan Processor to be the CCO or CISO? What are
the advantages and disadvantages to each approach?
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\62\ See id. at Section 4.6(a), 4.7(c).
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38. Is the mechanism by which changes to CAT functionality can be
suggested to the Plan Processor by the Advisory Committee members,
Participants, or the SEC appropriate and reasonable? Why or why not?
39. Is the Operating Committee's role in the hiring of the CCO,
CISO, and Independent Auditor appropriate and reasonable? Should the
Advisory Committee be consulted on these decisions? Why or why not?
B. Central Repository
The Central Repository, under the oversight of the Plan Processor,
and consistent with Appendix D, Central Repository Requirements, will
receive, consolidate, and retain all CAT Data. The Central Repository
will collect (from a SIP or pursuant to an NMS Plan) and retain on a
current and continuing basis, in a format compatible with the
Participant Data and Industry Member Data, all data, including the
following: (1) Information, including the size and quote condition, on
quotes, including the National Best Bid and National Best Offer for
each NMS Security; (2) Last Sale Reports and transaction reports
reported pursuant to an effective transaction reporting plan filed with
the SEC pursuant to, and meeting the requirements of, Rules 601 and
608; (3) trading halts, LULD price bands and LULD indicators; and (4)
summary data.\63\
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\63\ In the CAT NMS Plan as attached hereto as Exhibit A,
Section 6.5(a)(ii)(D) was amended to clarify that ``summary data''
refers to ``summary data or reports described in the specifications
for each of the SIPs and disseminated by the respective SIP.''
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Consistent with Appendix D, Data Retention Requirements, the
Central Repository will retain the information collected pursuant to
paragraphs (c)(7) and (e)(7) of Rule 613 in a convenient and usable
standard electronic data format that is directly available and
searchable electronically without any manual intervention by the Plan
Processor for a period of not less than six years. Such data when
available to the Participant regulatory Staff and the SEC will be
linked. In addition, the Plan Processor will implement and comply with
the records retention policy contemplated by Section 6.1(d)(i).
Consistent with Appendix D, Data Access, the Plan Processor will
provide Participants and the SEC access to the Central Repository
(including all systems operated by the Central Repository), and access
to and use of the CAT Data stored in the Central Repository, solely for
the purpose of performing their respective regulatory and oversight
responsibilities pursuant to the federal securities laws, rules and
regulations or any contractual obligations. The Plan Processor will
create and maintain a method of access to the CAT Data stored in the
Central Repository that includes the ability to run searches and
generate reports. The method in which the CAT Data is stored in the
Central Repository will allow the ability to return results of queries
that are complex in nature including market reconstruction and the
status of order books at varying time intervals. The Plan Processor
will, at least annually and at such earlier time promptly following a
request by the Operating Committee, certify to the Operating Committee
that only the Participants and the SEC have access to the Central
Repository (other than access provided to any Industry Member for the
purpose of correcting CAT Data previously reported to the Central
Repository by such Industry Member).\64\
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\64\ See CAT NMS Plan, supra note 3, at Appendix C, The Security
and Confidentiality of Information Reported to the Central
Repository, and Appendix D, Data Security, describe the security and
confidentiality of the CAT Data, including how access to the Central
Repository is controlled.
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Request for Comment
40. Do Commenters believe that the requirements presented in
Appendix D, Central Repository Requirements, are sufficiently detailed
to guide the Plan Processor in how to build and operate the Central
Repository with regard to receiving, consolidating, and retaining data?
If not, what additional information should the requirements contain?
Are there any requirements that should be eliminated? Will such
provisions give the Plan Processor too much discretion or flexibility
in how to build and operate the Central Repository with regard to
receiving, consolidating, and retaining data? Please identify and
explain why such requirements are not necessary or appropriate.
41. Do Commenters believe that the information provided in Appendix
D, Data Access, is sufficiently detailed to
[[Page 30627]]
inform the Plan Processor and regulators how access to data will be
granted? Are the controls and security provisions related to regulatory
access to data appropriate and reasonable? Should additional provisions
be included? If so, please identify and explain why such provisions are
necessary. Should any provisions be modified or eliminated? Will such
provisions give the Plan Processor too much discretion or flexibility
in how to build and operate the Central Repository with regard to
regulator access to the data? If so, please identify and explain why
such provisions should be modified or not included in the CAT NMS Plan.
42. The CAT NMS Plan does not mandate a specific method for primary
data storage of CAT Data, but does require that the storage solution
would meet the security, reliability, and accessibility requirements
for the CAT, including storage of personally identifiable information
(``PII'') data, separately. The CAT NMS Plan also indicates several
considerations in the selection of a storage solution including
maturity, cost, complexity, and reliability of the storage method. The
Commission requests comment on whether the CAT NMS Plan should mandate
a particular data storage method. Why or why not? What are the
advantages and disadvantages for CAT of the various storage methods?
C. Data Recording and Reporting by Participants
The Plan also sets forth the requirements regarding the data
recording and reporting by Participants.\65\ Each Participant will
record and electronically report to the Central Repository the
following details for each order and each Reportable Event,\66\ as
applicable (``Participant Data''; also referred to as ``Recorded
Industry Member Data'', as discussed in the next Section):
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\65\ Participants may, but are not required to, coordinate
compliance with the recording and reporting efforts through the use
of regulatory services agreements and/or agreements adopted pursuant
to Rule 17d-2 under the Exchange Act.
\66\ The CAT NMS Plan defines ``Reportable Event'' as
``includ[ing], but . . . not limited to, the original receipt or
origination, modification, cancellation, routing, execution (in
whole or in part) and allocation of an order, and receipt of a
routed order.'' See CAT NMS Plan, supra note 3, at Section 1.1.
for original receipt or origination of an order: (1) Firm Designated
ID(s) (FDIs) for each customer; (2) CAT-Order-ID; (3) SRO-Assigned
Market Participant Identifier of the Industry Member receiving or
originating the order; (4) date of order receipt or origination; (5)
time of order receipt or origination (using time stamps pursuant to
Section 6.8); (6) the Material Terms of the Order; \67\ and (7)
other information as may be determined by the Operating
Committee.\68\
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\67\ For a discussion of the Material Terms of the Order
required by Rule 613, see Adopting Release, supra note 9, at 45750-
52. The Commission notes that the Participants include in the Plan a
requirement for the reporting of the OTC equity security symbol as
one of the ``Material Terms of the Order.'' See CAT NMS Plan, supra
note 3, at Section 1.1.
\68\ In the CAT NMS Plan as attached hereto as Exhibit A, the
provisions of Section 6.3 enabling the Operating Committee to
require Participants to record and report ``other information'' were
removed.
for the routing of an order: (1) CAT-Order-ID; (2) date on which the
order is routed; (3) time at which the order is routed (using time
stamps pursuant to Section 6.8); (4) SRO-Assigned Market Participant
Identifier of the Industry Member or Participant routing the order;
(5) SRO-Assigned Market Participant Identifier of the Industry
Member or Participant to which the order is being routed; (6) if
routed internally at the Industry Member, the identity and nature of
the department or desk to which the order is routed; (7) the
Material Terms of the Order; and (8) other information as may be
determined by the Operating Committee.\69\
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\69\ Id.
for the receipt of an order that has been routed, the following
information: (1) CAT-Order-ID; (2) date on which the order is
received; (3) time at which the order is received (using time stamps
pursuant to Section 6.8); (4) SRO-Assigned Market Participant
Identifier of the Industry Member or Participant receiving the
order; (5) SRO-Assigned Market Participant Identifier of the
Industry Member or Participant routing the order; (6) the Material
Terms of the Order; and (7) other information as may be determined
by the Operating Committee.\70\
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\70\ Id.
if the order is modified or cancelled: (1) CAT-Order-ID; (2) date
the modification or cancellation is received or originated; (3) time
at which the modification or cancellation is received or originated
(using time stamps pursuant to Section 6.8); (4) price and remaining
size of the order, if modified; (5) other changes in Material Terms,
if modified; (6) whether the modification or cancellation
instruction was given by the Customer, or was initiated by the
Industry Member or Participant; and (7) other information as may be
determined by the Operating Committee.\71\
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\71\ Id.
if the order is executed, in whole or in part: (1) CAT-Order-ID; (2)
date of execution; (3) time of execution (using time stamps pursuant
to Section 6.8); (4) execution capacity (principal, agency or
riskless principal); (5) execution price and size; (6) the SRO-
Assigned Market Participant Identifier of the Participant or
Industry Member executing the order; and (7) whether the execution
was reported pursuant to an effective transaction reporting plan or
the Plan for Reporting of Consolidated Options Last Sale Reports and
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Quotation Information; and
other information or additional events as may be determined by the
Operating Committee \72\ or otherwise prescribed in Appendix D,
Reporting and Linkage Requirements.
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\72\ Id.
As contemplated in Appendix D, Data Types and Sources, each
Participant will report Participant Data to the Central Repository for
consolidation and storage in a format specified by the Plan Processor,
approved by the Operating Committee and compliant with Rule 613. As
further described in Appendix D, Reporting and Linkage Requirements,
each Participant is required to record the Participant Data
contemporaneously with the Reportable Event. In addition, each
Participant must report the Participant Data to the Central Repository
by 8:00 a.m. Eastern Time on the Trading Day following the day that the
Participant recorded the Participant Data. Participants may voluntarily
report the Participant Data prior to the 8:00 a.m. Eastern Time
deadline.
Each Participant that is a national securities exchange is required
to comply with the above recording and reporting requirements for each
NMS Security registered or listed for trading on such exchange or
admitted to unlisted trading privileges on such exchange. Each
Participant that is a national securities association is required to
comply with the above recording and reporting requirements for each
Eligible Security for which transaction reports are required to be
submitted to the association.
D. Data Reporting and Recording by Industry Members
The Plan also sets forth the data reporting and recording
requirements for Industry Members. Specifically, subject to Section
6.4(c), and Section 6.4(d)(iii) with respect to Options Market Makers,
and consistent with Appendix D, Reporting and Linkage Requirements,
each Participant, through its Compliance Rule, will require its
Industry Members to record and electronically report to the Central
Repository for each order and each Reportable Event the information
referred to in Section 6.3(d), as applicable (``Recorded Industry
Member Data'')--that is, Participant Data discussed above. In addition,
subject to Section 6.4(c), and Section 6.4(d)(iii) with respect to
Options Market Makers, and consistent with Appendix D, Reporting and
Linkage Requirements, each Participant, through its Compliance Rule,
will require its Industry Members to record and report to the Central
Repository the following (``Received Industry Member Data'' and,
[[Page 30628]]
collectively with the Recorded Industry Member Data, ``Industry Member
Data''): (1) If the order is executed, in whole or in part: (a) An
Allocation Report that includes the Firm Designated ID when an
execution is allocated (in whole or in part); \73\ (b) SRO-Assigned
Market Participant Identifier of the clearing broker or prime broker,
if applicable; and (c) CAT-Order-ID of any contra-side order(s); (2) if
the trade is cancelled, a cancelled trade indicator; and (3) for
original receipt or origination of an order, information of sufficient
detail to identify the Customer.
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\73\ In the Amendment to the CAT NMS Plan, language in Section
6.4(d) that read, ``that includes the Firm Designated ID when an
execution is allocated (in whole or in part)'' was removed because
the definition of ``Allocation Report'' includes this information.
---------------------------------------------------------------------------
With respect to the reporting obligations of an Options Market
Maker with regard to its quotes in Listed Options, Reportable Events
required pursuant to Section 6.3(d)(ii) and (iv) will be reported to
the Central Repository by an Options Exchange in lieu of the reporting
of such information by the Options Market Maker. Each Participant that
is an Options Exchange will, through its Compliance Rule, require its
Industry Members that are Options Market Makers to report to the
Options Exchange the time at which a quote in a Listed Option is sent
to the Options Exchange (and, if applicable, any subsequent quote
modifications and/or cancellation time when such modification or
cancellation is originated by the Options Market Maker). Such time
information also will be reported to the Central Repository by the
Options Exchange in lieu of reporting by the Options Market Maker.\74\
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\74\ See Section III.B.9, infra, and accompanying requests for
comment.
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Each Participant will, through its Compliance Rule, require its
Industry Members to record and report to the Central Repository other
information or additional events as prescribed in Appendix D, Reporting
and Linkage Requirements.
As contemplated in Appendix D, Data Types and Sources, each
Participant will require its Industry Members to report Industry Member
Data to the Central Repository for consolidation and storage in a
format(s) specified by the Plan Processor, approved by the Operating
Committee and compliant with Rule 613. As further described in Appendix
D, Reporting and Linkage Requirements, each Participant will require
its Industry Members to record Recorded Industry Member Data
contemporaneously with the applicable Reportable Event. In addition,
consistent with Appendix D, Reporting and Linkage Requirements, each
Participant will require its Industry Members to report: (1) Recorded
Industry Member Data to the Central Repository by 8:00 a.m. Eastern
Time on the Trading Day following the day the Industry Member records
such Recorded Industry Member Data; and (2) Received Industry Member
Data to the Central Repository by 8:00 a.m. Eastern Time on the Trading
Day following the day the Industry Member receives such Received
Industry Member Data. Each Participant will permit its Industry Members
to voluntarily report Industry Member Data prior to the applicable 8:00
a.m. Eastern Time deadline.\75\
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\75\ See Section III.B.2, infra, and accompanying requests for
comment.
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Each Participant that is a national securities exchange must
require its Industry Members to report Industry Member Data for each
NMS Security registered or listed for trading on such exchange or
admitted to unlisted trading privileges on such exchange. Each
Participant that is a national securities association must require its
Industry Members to report Industry Member Data for each Eligible
Security for which transaction reports are required to be submitted to
the association.
Request for Comment
43. Sections 6.3(d) and 6.4(d) of the CAT NMS Plan set forth the
details that Participants and Industry Members must report to the
Central Repository. Do Commenters believe that these details will be
sufficient to allow the Central Repository to link information to
accurately reflect the lifecycle of an order? If not, what additional
information should be required to be reported for this purpose?
44. Sections 6.3 and 6.4 of the CAT NMS Plan require Participants
and Industry Members to record and report to the Central Repository
other information or additional events as may be prescribed in Appendix
D, Reporting and Linkage Requirements. Do Commenters believe that the
CAT NMS Plan is sufficiently clear regarding the ``other information or
additional events as may be prescribed in Appendix D'' that may be
required? Please explain. Are these ``other information or additional
events prescribed in Appendix D'' appropriate and reasonable? Please
explain.
45. The CAT NMS Plan does not specify the format in which CAT
Reporters must submit data, and states the Plan Processor will specify
the format. Do Commenters believe that the CAT NMS Plan should specify
a particular format? If so, what format? Please explain.
E. Regular Written Assessment
As described in Article VI, the Participants are required to
provide the Commission with a written assessment of the operation of
the CAT that meets the requirements set forth in Rule 613, Appendix D,
and the Plan at least every two years or more frequently in connection
with any review of the Plan Processor's performance under the Plan
pursuant to Section 6.1(m).\76\ The Chief Compliance Officer will
oversee this assessment and will provide the Participants a reasonable
time to review and comment upon the written assessment prior to its
submission to the SEC. In no case will the written assessment be
changed or amended in response to a comment from a Participant; rather
any comment by a Participant will be provided to the SEC at the same
time as the written assessment.
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\76\ The Commission notes that the applicable provision in the
Amendment is Section 6.1(n).
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Request for Comment
46. Do Commenters believe that the details and requirements
regarding the regular written assessment of the operation of the CAT
provided in Section 6.6 of the CAT NMS Plan are appropriate and
reasonable? Would additional details or requirements for this
assessment be beneficial?
47. Do Commenters believe that the Chief Compliance Officer should
oversee the regular written assessment, as is required by Section 6.6?
If not, would another party be better suited to this role?
F. Time Stamps and Synchronization of Business Clocks
Section 6.8 of the Plan discusses time stamps and the
synchronization of Business Clocks. Each Participant is required to
synchronize its Business Clocks (other than such Business Clocks used
solely for Manual Order Events) at a minimum to within 50 milliseconds
of the time maintained by the National Institute of Standards and
Technology, consistent with industry standards. In addition, each
Participant must, through its Compliance Rule, require its Industry
Members to: (1) Synchronize their respective Business Clocks (other
than such Business Clocks used solely for Manual Order Events) at a
minimum to within 50 milliseconds of the time maintained by the
National Institute of Standards and Technology, and maintain such a
synchronization; (2)
[[Page 30629]]
certify periodically that their Business Clocks meet the requirements
of the Compliance Rule; and (3) report to the Plan Processor and the
Participant any violation of the Compliance Rule pursuant to the
thresholds set by the Operating Committee. Furthermore, each
Participant is required to synchronize its Business Clocks and, through
its Compliance Rule, require its Industry Members to synchronize their
Business Clocks used solely for Manual Order Events at a minimum to
within one second of the time maintained by the National Institute of
Standards and Technology, consistent with industry standards, and
maintain such synchronization. Each Participant will require its
Industry Members to certify periodically (according to a schedule
defined by the Operating Committee) that their Business Clocks used
solely for Manual Order Events meet the requirements of the Compliance
Rule. The Compliance Rule of a Participant shall require its Industry
Members using Business Clocks solely for Manual Order Events to report
to the Plan Processor any violation of the Compliance Rule pursuant to
the thresholds set by the Operating Committee. The Participants stated
their belief that pursuant to Rule 613(d)(1) that these synchronization
standards are consistent with current industry standards.
Each Participant shall, and through its Compliance Rule require its
Industry Members to, report information required by Rule 613 and this
Agreement to the Central Repository in milliseconds. To the extent that
any Participant utilizes time stamps in increments finer than the
minimum required by the Plan, the Participant is required to make
reports to the Central Repository utilizing such finer increment when
reporting CAT Data to the Central Repository so that all Reportable
Events reported to the Central Repository could be adequately
sequenced. Each Participant will, through its Compliance Rule: (1)
Require that, to the extent that its Industry Members utilize time
stamps in increments finer than the minimum required in the Plan, such
Industry Members will utilize such finer increment when reporting CAT
Data to the Central Repository; and (2) provide that a pattern or
practice of reporting events outside of the required clock
synchronization time period without reasonable justification or
exceptional circumstances may be considered a violation of SEC Rule 613
and the Plan. Notwithstanding the preceding sentences, each Participant
and Industry Member will be permitted to record and report Manual Order
Events to the Central Repository in increments up to and including one
second, provided that Participants and Industry Members will be
required to record and report the time when a Manual Order Event has
been captured electronically in an order handling and execution system
of such Participant or Industry Member in milliseconds. In conjunction
with Participants' and other appropriate Industry Member advisory
groups, the Chief Compliance Officer will annually evaluate and make a
recommendation to the Operating Committee as to whether industry
standards have evolved such that the required synchronization should be
shortened or the required time stamp should be in finer increments. The
Operating Committee will make determinations regarding the need to
revise the synchronization and time stamp requirements.
Request for Comment \77\
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\77\ See Sections III.B.4 and III.B.5, infra, for additional
requests for comment on clock synchronization and time stamp
granularity.
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48. Do Commenters believe that the CAT NMS Plan's requirement that
Participants and Industry Members synchronize their Business Clocks to
within 50 milliseconds of the time maintained by the National Institute
of Standards and Technology (``NIST'') is appropriate and reasonable?
Do Commenters agree with the Participants that this clock offset
tolerance represents current industry standards? Would a tighter clock
offset tolerance be feasible?
49. Do Commenters believe that the CAT NMS Plan's requirement that
Participants and Industry Members report information to the Central
Repository in milliseconds is appropriate and reasonable? Would a more
granular time stamp requirement be feasible? Do Commenters agree with
the Participants that time stamp granularity to the millisecond
represents current industry standards?
50. How should ``industry standard,'' for purposes of the CAT NMS
Plan's clock synchronization and time stamping requirements, be
determined? Do Commenters believe that ``industry standard'' should be
based on current industry practice? If not, how should ``industry
standard'' be defined? What other factors, if any, should be considered
in defining such ``industry standards''?
G. Technical Specifications
Section 6.9 of the Plan establishes the requirements involving the
Plan Processor's Technical Specifications. The Plan Processor will
publish Technical Specifications that are at a minimum consistent with
Appendices C and D, and updates thereto as needed, providing detailed
instructions regarding the submission of CAT Data by Participants and
Industry Members to the Plan Processor for entry into the Central
Repository. The Technical Specifications will be made available on a
publicly available Web site to be developed and maintained by the Plan
Processor. The initial Technical Specifications and any Material
Amendments thereto will require the approval of the Operating Committee
by Supermajority Vote.
The Technical Specifications will include a detailed description of
the following: (1) The specifications for the layout of files and
records submitted to the Central Repository; (2) the process for the
release of new data format specification changes; (3) the process for
industry testing for any changes to data format specifications; (4) the
procedures for obtaining feedback about and submitting corrections to
information submitted to the Central Repository; (5) each data element,
including permitted values, in any type of report submitted to the
Central Repository; (6) any error messages generated by the Plan
Processor in the course of validating the data; (7) the process for
file submissions (and re-submissions for corrected files); (8) the
storage and access requirements for all files submitted; (9) metadata
requirements for all files submitted to the CAT System; (10) any
required secure network connectivity; (11) data security standards,
which will, at a minimum: (a) Satisfy all applicable regulations
regarding database security, including provisions of Regulation Systems
Compliance and Integrity under the Exchange Act (``Reg SCI''); (b) to
the extent not otherwise provided for under the Plan (including
Appendix C thereto), set forth such provisions as may be necessary or
appropriate to comply with Rule 613(e)(4); and (c) comply with industry
best practices; and (12) any other items reasonably deemed appropriate
by the Plan Processor and approved by the Operating Committee.
Amendments to the Technical Specifications may be made only in
accordance with Section 6.9(c). The process for amending the Technical
Specifications varies depending on whether the change is material. An
amendment will be deemed ``material'' if it would require a Participant
or an Industry Member to engage in significant changes to the coding
necessary to submit information to the Central Repository pursuant to
the Plan, or if it is required to safeguard the
[[Page 30630]]
security or confidentiality of the CAT Data. Except for Material
Amendments to the Technical Specifications, the Plan Processor will
have the sole discretion to amend and publish interpretations regarding
the Technical Specifications; however, all non-Material Amendments made
to the Technical Specifications and all published interpretations will
be provided to the Operating Committee in writing at least ten days
before being published. Such non-Material Amendments and published
interpretations will be deemed approved ten days following provision to
the Operating Committee unless two unaffiliated Participants call for a
vote to be taken on the proposed amendment or interpretation. If an
amendment or interpretation is called for a vote by two or more
unaffiliated Participants, the proposed amendment must be approved by
Majority Vote of the Operating Committee. Once a non-Material Amendment
has been approved or deemed approved by the Operating Committee, the
Plan Processor will be responsible for determining the specific changes
to the Central Repository and providing technical documentation of
those changes, including an implementation timeline.
Material Amendments to the Technical Specifications require
approval of the Operating Committee by Supermajority Vote. The
Operating Committee, by Supermajority Vote, may amend the Technical
Specifications on its own motion.
Request for Comment
51. Do Commenters believe that the list of items to be included in
the Technical Specifications, as set forth in Section 6.9(b) of the CAT
NMS Plan, is appropriate and reasonable? Do Commenters believe that
detailed descriptions of any of the listed items should be included in
the CAT NMS Plan rather than in the Technical Specifications? Do
Commenters believe that the list addresses all of the areas that should
be included in the Technical Specifications? Are there other aspects of
the CAT that require Technical Specifications? If so, please identify
and explain why the additional Technical Specifications are needed.
52. Do Commenters believe the Plan Processor should have sole
discretion to amend and publish interpretations regarding the Technical
Specifications, except for Material Amendments? Why or why not? What
discretion or input, if any, should the Operating Committee or other
parties, including the Advisory Committee, have in amending and
publishing Technical Specifications interpretations?
53. How should Technical Specifications be communicated to the
industry? Why?
54. What are the incentives for the Operating Committee to review
the Plan Processor's interpretation of Technical Specifications and
verify that the interpretation is consistent with the regulatory
objectives of the Plan? What are the best practices to ensure
sufficient review by the Operating Committee? What provisions of the
Plan are in place to ensure that the Operating Committee follows these
practices? What provisions, if any, could be strengthened? Please
explain and provide supporting examples and evidence, if available.
55. The CAT NMS Plan provides that non-Material Amendments and
published interpretations will be deemed approved ten days following
provision to the Operating Committee, unless two unaffiliated
Participants call for a vote to be taken on the proposed amendment or
interpretation. Do Commenters have any views on this process? If so,
please explain.
56. Do Commenters have any views regarding the definition of
Material Amendments? Is the definition too broad? Too narrow? Please
explain. Do Commenters have any views on who should be responsible for
determining whether an amendment to the Technical Specifications is a
Material Amendment? Do Commenters believe the CAT NMS Plan clearly
states who shall have the responsibility to make the determination? Do
Commenters have any views on how the determination should be made?
Please explain.
57. The CAT NMS Plan requires that Material Amendments be approved
by the Operating Committee by Supermajority Vote and allows the
Operating Committee to amend the Technical Specifications on its own
motion by Supermajority Vote. Do Commenters have any views on these
processes? If so, please explain.
58. The CAT NMS Plan provides that the Plan Processor's business
continuity planning must include a secondary site for critical staff,
capable of recovery and restoration of services within 48 hours, with
the goal of next day recovery. Should the CAT NMS Plan provide
additional details regarding ``the goal of next day recovery''? Do
Commenters believe a 48-hour recovery and restoration period is too
long? Too short? Please explain. Should the CAT NMS Plan impose any
other requirements on the Plan Processor to better assure the Plan
Processor is able to transition to the secondary site within the
specified time frames? If so, what?
H. Surveillance
Surveillance issues are described in Section 6.10. Using the tools
provided for in Appendix D, Functionality of the CAT System, each
Participant will develop and implement a surveillance system, or
enhance existing surveillance systems, reasonably designed to make use
of the consolidated information contained in the Central Repository.
Unless otherwise ordered by the SEC, within fourteen months after the
Effective Date, each Participant must initially implement a new or
enhanced surveillance system(s) as required by Rule 613 and Section
6.10(a) of the Plan. Participants may, but are not required to,
coordinate surveillance efforts through the use of regulatory services
agreements and agreements adopted pursuant to Rule 17d-2 under the
Exchange Act.
Consistent with Appendix D, Functionality of the CAT System, the
Plan Processor will provide Participants and the SEC with access to all
CAT Data stored in the Central Repository. Regulators will have access
to processed CAT Data through two different methods: (1) An online
targeted query tool; and (2) user-defined direct queries and bulk
extracts. The online targeted query tool will provide authorized users
with the ability to retrieve CAT Data via an online query screen that
includes the ability to choose from a variety of pre-defined selection
criteria. Targeted queries must include date(s) and/or time range(s),
as well as one or more of a variety of fields. The user-defined direct
queries and bulk extracts will provide authorized users with the
ability to retrieve CAT Data via a query tool or language that allows
users to query all available attributes and data sources.
Extraction of CAT Data will be consistent with all permission
rights granted by the Plan Processor. All CAT Data returned will be
encrypted, and PII data will be masked unless users have permission to
view the PII contained in the CAT Data that has been requested.
The Plan Processor will implement an automated mechanism to monitor
direct query usage. Such monitoring will include automated alerts to
notify the Plan Processor of potential issues with bottlenecks or
excessively long queues for queries or CAT Data extractions. The Plan
Processor will provide the Operating Committee or its designee(s)
details as to how the monitoring will be accomplished and the metrics
that will be used to trigger alerts.
The Plan Processor will reasonably assist regulatory Staff
(including those of Participants) with creating queries. Without
limiting the manner in which
[[Page 30631]]
regulatory Staff (including those of Participants) may submit queries,
the Plan Processor will submit queries on behalf of regulatory Staff
(including those of Participants) as reasonably requested. The Plan
Processor will staff a CAT help desk, as described in Appendix D, CAT
Help Desk, to provide technical expertise to assist regulatory Staff
(including those of Participants) with questions about the content and
structure of the CAT Data.
Request for Comment
59. What features of the CAT NMS Plan will facilitate the creation
of enhanced surveillance systems? Are the minimum functional and
technical requirements for the Plan Processor set forth in Appendix D
consistent with the creation of enhanced surveillance systems? What, if
any, additional requirements or details should be provided in the CAT
NMS Plan to ensure that the Plan facilitates the creation of enhanced
surveillance systems?
60. Under the CAT NMS Plan, will regulatory Staff have appropriate
access to the Central Repository? Specifically, do Commenters believe
that the online targeted query tool and user-defined direct queries and
bulk extracts described in Sections 8.1 and 8.2 of Appendix D will
enable regulatory Staff to use the data in the Central Repository to
carry out their surveillance, analysis, and other regulatory functions?
If not, why not and what should be added? Does the CAT NMS Plan provide
sufficient detail to determine if regulators will have appropriate
access? If not, what additional details should be provided?
61. Do Commenters believe that the provisions in Section
6.10(c)(ii) of the CAT NMS Plan regarding permission rights granted by
the Plan Processor, encryption, and masking of PII are appropriate and
reasonable? Would these provisions affect the ability of Commission or
SRO regulatory Staff to access and use the data in the Central
Repository? If so, what additional or different provisions would
mitigate the impact on regulatory access to and use of the data?
62. Do Commenters believe that the query monitoring mechanism to be
implemented by the Plan Processor, as described in Section 6.10(c)(iii)
of the CAT NMS Plan, is appropriately designed to help enable
regulators to carry out their regulatory functions? If not, what
additional details or functionality should be provided? Will the
provisions regarding Plan Processor assistance of regulatory Staff and
submission of regulatory Staff queries (Sections 6.10(c)(iv)-(v) of the
CAT NMS Plan) and the CAT user support functionality (as described in
Section 10.2 of Appendix D) provide sufficient assistance to regulators
in carrying out their regulatory functions?
I. Information Security Program
As set forth in Section 6.12, the Plan Processor is required to
develop and maintain a comprehensive information security program for
the Central Repository that contains, at a minimum, the specific
requirements detailed in Appendix D, Data Security. The information
security program must be approved and reviewed at least annually by the
Operating Committee.
Request for Comment
63. Do Commenters believe the CAT NMS Plan should include a
discussion of policies and procedures applicable to members of the
Advisory Committee to ensure the security and confidentiality of the
operation of the CAT (for example, requiring members of the Advisory
Committee to enter into a non-disclosure agreement with the Company)?
If so, what additional measures should be considered?
64. Do Commenters believe the CAT NMS Plan should detail the
policies and procedures applicable to regulatory users of the CAT that
would ensure the security and confidentiality of the CAT Data and the
operation of the CAT? If so, what measures should be considered? Do
Commenters have any views on how such policies and procedures should be
enforced? Please explain.
(6) Financial Matters
Articles VII and VIII of the Plan address certain financial matters
related to the Company. In particular, the Plan states that, subject to
certain special allocations provided for in Section 8.2, any net profit
or net loss will be allocated among the Participants equally. In
addition, subject to Section 10.2, cash and property of the Company
will not be distributed to the Participants unless the Operating
Committee approves by Supermajority Vote a distribution after fully
considering the reason that such distribution must or should be made to
the Participants, including the circumstances contemplated under
Section 8.3, Section 8.6, and Section 9.3. To the extent a distribution
is made, all Participants will participate equally in any such
distribution except as otherwise provided in Section 10.2.
Article XI addresses the funding of the Company. On an annual basis
the Operating Committee will approve an operating budget for the
Company. The budget will include the projected costs of the Company,
including the costs of developing and operating the CAT System for the
upcoming year, and the sources of all revenues to cover such costs, as
well as the funding of any reserve that the Operating Committee
reasonably deems appropriate for prudent operation of the Company.
Subject to certain funding principles set forth in Article XI, the
Operating Committee will have discretion to establish funding for the
Company, including: (1) Establishing fees that the Participants will
pay; and (2) establishing fees for Industry Members that will be
implemented by Participants. In establishing the funding of the
Company, the Operating Committee will seek to: (1) Create transparent,
predictable revenue streams for the Company that are aligned with the
anticipated costs to build, operate and administer the CAT and the
other costs of the Company; (2) establish an allocation of the
Company's related costs among Participants and Industry Members that is
consistent with the Exchange Act, taking into account the timeline for
implementation of the CAT and distinctions in the securities trading
operations of Participants and Industry Members and their relative
impact upon Company resources and operations; (3) establish a tiered
fee structure in which the fees charged to: (a) CAT Reporters that are
Execution Venues, including ATSs, are based upon the level of market
share, (b) Industry Members' non-ATS activities are based upon message
traffic, and (c) the CAT Reporters with the most CAT-related activity
(measured by market share and/or message traffic, as applicable) are
generally comparable (where, for these comparability purposes, the
tiered fee structure takes into consideration affiliations between or
among CAT Reporters, whether Execution Venues and/or Industry Members);
(4) provide for ease of billing and other administrative functions; (5)
avoid any disincentives such as placing an inappropriate burden on
competition and a reduction in market quality; and (6) build financial
stability to support the Company as a going concern. The Participants
will file with the SEC under Section 19(b) of the Exchange Act any such
fees on Industry Members that the Operating Committee approves, and
such fees will be labeled as ``Consolidated Audit Trail Funding Fees.''
To fund the development and implementation of the CAT, the Company
will time the imposition and collection of all fees on Participants and
Industry Members in a manner
[[Page 30632]]
reasonably related to the timing when the Company expects to incur such
development and implementation costs. In determining fees for
Participants and Industry Members, the Operating Committee shall take
into account fees, costs and expenses (including legal and consulting
fees and expenses) incurred by the Participants on behalf of the
Company prior to the Effective Date in connection with the creation and
implementation of the CAT, and such fees, costs and expenses shall be
fairly and reasonably shared among the Participants and Industry
Members. Consistent with Article XI, the Operating Committee will adopt
policies, procedures, and practices regarding the budget and budgeting
process, assignment of tiers, resolution of disputes, billing and
collection of fees, and other related matters. As a part of its regular
review of fees for the CAT, the Operating Committee will have the right
to change the tier assigned to any particular Person pursuant to this
Article XI.\78\ Any such changes will be effective upon reasonable
notice to such Person.
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\78\ The Commission notes that Section 11.1(b) of the CAT NMS
Plan states that the Participants would file fees for Industry
Members approved by the Operating Committee with the Commission. The
Operating Committee may only change the tier to which a Person is
assigned in accordance with a fee schedule filed with the
Commission.
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The Operating Committee will establish fixed fees to be payable by
Execution Venues as follows. Each Execution Venue that executes
transactions, or, in the case of a national securities association, has
trades reported by its members to its trade reporting facility or
facilities for reporting transactions effected otherwise than on an
exchange, in NMS Stocks or OTC Equity Securities will pay a fixed fee
depending on the market share of that Execution Venue in NMS Stocks and
OTC Equity Securities. The Operating Committee will establish at least
two and no more than five tiers of fixed fees, based on an Execution
Venue's NMS Stocks and OTC Equity Securities market share. For these
purposes, market share will be calculated by share volume. In addition,
each Execution Venue that executes transactions in Listed Options will
pay a fixed fee depending on the Listed Options market share of that
Execution Venue. The Operating Committee will establish at least two
and no more than five tiers of fixed fees, based on an Execution
Venue's Listed Options market share, with market share calculated by
contract volume. Changes to the number of tiers after approval of the
Plan would require a Supermajority Vote of the Operating Committee and
Commission approval under Section 19(b) of the Exchange Act, as would
the establishment of the initial fee schedule and any changes to the
fee schedule within the tier structure.\79\
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\79\ The Commission notes that the Participants could choose to
submit the proposed fee schedule to the Commission as individual
SROs pursuant to Rule 19b-4 or jointly as Participants to an NMS
plan pursuant to Rule 608 of Regulation NMS. Because the proposed
fee schedule would establish fees, whether the Participants
individually file it pursuant to Section 19(b)(3)(A)(ii) of the Act,
or jointly file it pursuant to Rule 608(b)(3)(i) of Regulation NMS,
the proposed fee schedule could take effect upon filing with the
Commission. See 15 U.S.C. 78s(b)(3)(A)(ii); 17 CFR 242.608(b)(3)(i).
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The Operating Committee also will establish fixed fees payable by
Industry Members, based on the message traffic generated by such
Industry Member. The Operating Committee will establish at least five
and no more than nine tiers of fixed fees, based on message traffic.
For the avoidance of doubt, the fixed fees payable by Industry Members
pursuant to this paragraph will, in addition to any other applicable
message traffic, include message traffic generated by: (1) An ATS that
does not execute orders that is sponsored by such Industry Member; and
(2) routing orders to and from any ATS system sponsored by such
Industry Member.
Furthermore, the Operating Committee may establish any other fees
ancillary to the operation of the CAT that it reasonably determines
appropriate, including: Fees for the late or inaccurate reporting of
information to the CAT; fees for correcting submitted information; and
fees based on access and use of the CAT for regulatory and oversight
purposes (and not including any reporting obligations).\80\
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\80\ As it relates to any fees that the Operating Committee may
impose for access and use of the CAT for regulatory and oversight
purposes, the Commission interprets the provisions in the Plan
relating to the collection of fees as applying only to Participants
and Industry Members, and thus the Commission would not be subject
to such fees.
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The Company will make publicly available a schedule of effective
fees and charges adopted pursuant to the Plan as in effect from time to
time. Such schedule will be developed after the Plan Processor is
selected. The Operating Committee will review the fee schedule on at
least an annual basis and will make any changes to such fee schedule
that it deems appropriate. The Operating Committee is authorized to
review the fee schedule on a more regular basis, but will not make any
changes on more than a semi-annual basis unless, pursuant to a
Supermajority Vote, the Operating Committee concludes that such change
is necessary for the adequate funding of the Company.
The Operating Committee will establish a system for the collection
of fees authorized under the Plan. The Operating Committee may include
such collection responsibility as a function of the Plan Processor or
another administrator. Alternatively, the Operating Committee may use
the facilities of a clearing agency registered under Section 17A of the
Exchange Act to provide for the collection of such fees.
Each Participant will require each Industry Member to pay all
applicable fees authorized under Article XI within thirty days after
receipt of an invoice or other notice indicating payment is due (unless
a longer payment period is otherwise indicated). If an Industry Member
fails to pay any such fee when due, such Industry Member will pay
interest on the outstanding balance from such due date until such fee
is paid at a per annum rate equal to the lesser of: (1) The Prime Rate
plus 300 basis points; or (2) the maximum rate permitted by applicable
law. Each Participant will pay all applicable fees authorized under
Article XI as required by Section 3.7(b).
Disputes with respect to fees the Company charges Participants
pursuant to Article XI will be determined by the Operating Committee or
a Subcommittee designated by the Operating Committee. Decisions by the
Operating Committee on such matters shall be binding on Participants,
without prejudice to the rights of any Participant to seek redress from
the SEC pursuant to SEC Rule 608 or in any other appropriate forum. The
Participants will adopt rules requiring that disputes with respect to
fees charged to Industry Members pursuant to Article XI be determined
by the Operating Committee or a Subcommittee. Decisions by the
Operating Committee or Subcommittee on such matters will be binding on
Industry Members, without prejudice to the rights of any Industry
Member to seek redress from the SEC pursuant to SEC Rule 608 or in any
other appropriate forum.
Request for Comment
65. Do Commenters believe that the provisions in the CAT NMS Plan
regarding the funding and budget of the Company to operate the CAT (as
described in Article XI) are appropriate and reasonable? Specifically,
do Commenters believe that the tiered funding model described in
Section 11.2(c) of the CAT NMS Plan and the fixed-tier funding model
described in
[[Page 30633]]
Section 11.3 of the CAT NMS Plan are appropriate and reasonable?
66. What are Commenters' views regarding the methodology in the CAT
NMS Plan to establish and impose fees on Participants and the industry?
Do Commenters believe that the fee system described in Sections 11.2
and 11.3 of the CAT NMS Plan will result in an equitable and fair
allocation of CAT-related fees between Participants, other types of
Execution Venues, and Industry Members? Will the fee system in the
Plan, including consideration of the distinctions in securities trading
operations, impose higher costs upon or result in any competitive
advantage to some types of Execution Venues or Industry Members as
opposed to others? If yes, are those differences in fees appropriate
and reasonable? Will this proposed fee system create incentives to
execute orders in certain Execution Venues over others? What
alternative fee systems, if any, would be more appropriate?
67. Do Commenters believe that assessing fees based on market share
and message traffic, as described in Sections 11.2 and 11.3 of the CAT
NMS Plan, is appropriate and reasonable? Specifically, is it
appropriate and reasonable to base Industry Member fees on message
traffic and Execution Venue fees on market share? Will this method of
calculating fees impose higher costs upon or result in any competitive
advantage to some types of Execution Venues or Industry Members as
opposed to others? What fee calculation method, if any, would be more
appropriate?
68. Are the tier levels appropriate and reasonable? Why or why not?
Is the number of tiers contemplated (2-5 for Execution Venues and 5-9
for Industry Members) appropriate and reasonable? Why or why not?
69. Do Commenters believe that giving the right to the Operating
Committee to change the fee tier assigned to any particular Person as
set forth in Section 11.1(d) of the CAT NMS Plan is appropriate and
reasonable? If not, why not? What alternative process, if any, would be
more appropriate?
70. Do Commenters believe that giving the right to the Operating
Committee to change the fee tier assigned to any particular Person as
set forth in Section 11.1(d) of the CAT NMS Plan conflicts with the
tier structure of fees as set forth in Section 11.2(c) of the CAT NMS
Plan, which will be based on the market share for Execution Venues, and
message traffic for Industry Members? Why or why not?
71. Section 11.1(d) of the CAT NMS Plan also provides that any
change to a Person's fee tier will be effective upon reasonable notice
to such Person. Do Commenters believe that a notice to any such Person
is necessary, given that the CAT NMS Plan provides that a Person will
change fee tiers based on market share or message traffic, as
applicable? Why or why not? What should constitute reasonable notice?
72. Do Commenters believe the Operating Committee's ability to
establish additional fees for ``access and use of the CAT for
regulatory and oversight purposes'' (as described in Section 11.3(c) of
the CAT NMS Plan) is appropriate and reasonable? Would this provision
affect the ability of regulatory Staff to access and use the data in
the Central Repository? If so, what additional or different provisions
would mitigate the impact upon regulatory access to and use of the
data?
73. Do Commenters believe that the funding provisions in Section
11.1 of the CAT NMS Plan provide sufficient authority and guidance to
the Operating Committee to establish and maintain such reserves as are
reasonably deemed appropriate by the Operating Committee for the
prudent operation of the Company? If not, why not?
74. Do Commenters believe that the provisions in the CAT NMS Plan
regarding the collection of fees (Section 11.4 of the CAT NMS Plan) and
fee disputes (Section 11.5 of the CAT NMS Plan) are appropriate and
reasonable? If not, what alternatives do Commenters suggest?
75. Do Commenters believe the CAT NMS Plan provides sufficient
detail regarding the proposed cost allocation among the Plan Processor
and regulators with respect to hardware and software costs that may be
required in order to use CAT Data? If not, what are the risks of not
providing sufficient detail and what requirements should be set forth
in the CAT NMS Plan? For example, since there will only be one Plan
Processor, what are the risks of significant costs for regulators to
the extent regulators will need to contract with the Plan Processor for
additional computing resources, storage costs and data transfer costs?
76. Should the Operating Committee be required to consult the
Advisory Committee when setting fees and performing regular reviews of
fees? Please explain.
(7) Amendments
Section 12.3 of the CAT NMS Plan, which governs amendments to the
Plan, states that, except with respect to the addition of new
Participants (Section 3.3), the transfer of Company Interest (Section
3.4), the termination of a Participant's participation in the Plan
(Section 3.7), amendments to the Selection Plan (Section 5.3 [sic]) and
special allocations (Section 8.2), any change to the Plan requires a
written amendment authorized by the affirmative vote of not less than
two-thirds of all of the Participants, or with respect to Section 3.8
by the affirmative vote of all the Participants. Such proposed
amendment must be approved by the Commission pursuant to Rule 608 or
otherwise becomes effective under Rule 608. Notwithstanding the
foregoing, to the extent that the SEC grants exemptive relief
applicable to any provision of this Agreement, Participants and
Industry Members will be entitled to comply with such provision
pursuant to the terms of the exemptive relief so granted at the time
such relief is granted irrespective of whether the LLC Agreement has
been amended.
(8) Compliance Rule Applicable to Industry Members
Under Article III, each Participant agrees to comply with and
enforce compliance by its Industry Members with the provisions of Rule
613 and the Plan, as applicable, to the Participant and its Industry
Members. Accordingly, the Participants will endeavor to promulgate
consistent rules (after taking into account circumstances and
considerations that may impact Participants differently) requiring
compliance by their respective Industry Members with the provisions of
Rule 613 and the Plan.
(9) Plan Appendices
The Plan includes three appendices.\81\ Appendix A provides the
Consolidated Audit Trail National Market System Plan Request for
Proposal, as issued February 26, 2013 and subsequently updated. In
addition, Rule 613(a)(1) requires that the Plan discuss twelve
considerations that explain the choices made by the Participants to
meet the requirements specified in Rule 613 for the CAT. In accordance
with this requirement, the Participants have addressed each of the
twelve considerations in Appendix C. Finally, Appendix D describes the
technical requirements for the Plan Processor.
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\81\ Appendix B is reserved for future use.
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b. Governing or Constituent Documents
Rule 608 requires copies of all governing or constituent documents
relating to any person (other than a self-regulatory organization)
authorized to implement or administer such plan on behalf of its
sponsors. The Participants will submit to the Commission such
[[Page 30634]]
documents related to the Plan Processor when the Plan Processor is
selected.
c. Development and Implementation Phases
The terms of the Plan will be effective immediately upon approval
of the Plan by the Commission (the ``Effective Date''). The Plan sets
forth each of the significant phases of development and implementation
contemplated by the Plan, together with the projected date of
completion of each phase. These include the following, each of which is
subject to orders otherwise by the Commission:
Within two months after the Effective Date, the Participants
will jointly select the winning Shortlisted Bid and the Plan
Processor pursuant to the process set forth in Article V. Following
the selection of the Initial Plan Processor, the Participants will
file with the Commission a statement identifying the Plan Processor
and including the information required by Rule 608;
Within four months after the Effective Date, each Participant
will, and, through its Compliance Rule, will require its Industry
Members to, synchronize its or their Business Clocks and certify to
the Chief Compliance Officer (in the case of Participants) or the
applicable Participant (in the case of Industry Members) that it has
met this requirement;
Within six months after the Effective Date, the Participants
must jointly provide to the SEC a document outlining how the
Participants could incorporate into the CAT information with respect
to equity securities that are not NMS Securities,\82\ including
Primary Market Transactions in securities that are not NMS
Securities, which document will 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, the implementation
timeline, and a cost estimate;
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\82\ In the Amendment to the CAT NMS Plan, Section 6.11 excludes
OTC Equity Securities from the document the Participants would
submit to the Commission, since the Participants plan to include OTC
Equity Securities as well as NMS Securities in the initial phase in
of CAT.
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Within one year after the Effective Date, each Participant must
report Participant Data to the Central Repository;
Within fourteen months after the Effective Date, each
Participant must implement a new or enhanced surveillance system(s);
Within two years after the Effective Date, each Participant
must, through its Compliance Rule, require its Industry Members
(other than Small Industry Members) to report Industry Member Data
to the Central Repository; and
Within three years after the Effective Date, each Participant
must, through its Compliance Rule, require its Small Industry
Members to provide Industry Member Data to the Central Repository.
In addition, Industry Members and Participants will be required to
participate in industry testing with the Central Repository on a
schedule to be determined by the Operating Committee. Furthermore,
Appendix C, A Plan to Eliminate Existing Rules and Systems (SEC Rule
613(a)(1)(ix)), and Appendix D, Data Types and Sources, set forth
additional implementation details concerning the elimination of rules
and systems.
The Chief Compliance Officer will appropriately document objective
milestones to assess progress toward the implementation of this
Agreement.
Request for Comment
77. Under the CAT NMS Plan, the SROs' rules would require that
their members become CAT Reporters. What mechanism should there be to
ensure that all CAT Reporters would participate in all pre-
implementation activities, including connectivity and testing? Please
explain.
78. Do Commenters believe that the CAT NMS Plan allows for
sufficient pre-implementation testing support for CAT Reporters,
including providing CAT Reporter feedback and accuracy reports? If not,
what requirements should be added to the CAT NMS Plan?
79. Do Commenters believe that full implementation of the CAT would
allow for the retirement of OATS? Please explain. Are any identified
gaps with respect to OATS' data elements not addressed in the CAT NMS
Plan? If yes, what are they?
80. The CAT NMS Plan provides for a single Plan Processor. As such,
do Commenters believe there are adequate and appropriate incentives for
continuous CAT innovation and cost reductions by the Plan Processor and
the Participants? If not, explain and describe what additional
incentives may be implemented in the CAT NMS Plan or related
documentation. What competition might be encouraged to lead to further
innovations and reduced costs for future CAT technologies?
81. Do Commenters believe that the proposed CAT NMS Plan sets forth
acceptable milestones to measure the progress of developing and
implementing the CAT? Why or why not?
82. The CAT NMS Plan sets forth significant phases of development
and implementation and a projected timetable for each stage. Are these
projections appropriate and reasonable? If not, why not, and what is a
more appropriate and reasonable timeline?
83. The CAT NMS Plan's ``Access to the Central Repository for
Regulators'' Section \83\ sets forth a milestone requiring the
publication of the finalized document detailing methods of access to
the Central Repository one (1) month before Participants are required
to begin reporting. Do Commenters believe this allows sufficient time
for Participants to build applications to access the Central Repository
when CAT goes live? If not, please explain and describe any related
modifications to this Section.
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\83\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.10(d).
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d. Analysis of Impact on Competition \84\
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\84\ The Commission reiterates that Section III.A of this
Notice, including this subsection III.A.3.d, is substantially as
prepared and submitted by the SROs to the Commission. The
Commission's Economic Analysis in respect of the Plan's impact on
competition is set forth in Section IV of this Notice.
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The Plan states that it does not impose any burden on competition
that is not necessary or appropriate in furtherance of the purposes of
the Exchange Act. Section 8 of Appendix C, An Analysis of the Impact on
Competition, Efficiency and Capital Formation, discusses the
competition impact of the Plan in detail.\85\ In addition, the
Participants do not believe that the Plan introduces terms that are
unreasonably discriminatory for the purposes of Section 11A(c)(1)(D) of
the Exchange Act.\86\ As noted in Section III.A.3.a, supra, the
Participants are aware that potential conflicts of interest are raised
because a Participant, or an Affiliate of a Participant, may be both
submitting a Bid (or participating in a Bid (e.g., as a subcontractor))
and participating in the evaluation of Bids to select the Plan
Processor. As described in Section III.A.3.a, the Selection Plan
previously approved by the Commission and incorporated in the Plan
includes multiple provisions designed to mitigate the potential impact
of these conflicts by imposing restrictions on the Voting Senior
Officers and by requiring the recusal of Bidding Participants for
[[Page 30635]]
certain votes taken by the Selection Committee.
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\85\ The Commission notes that as required under Rule
613(a)(1)(viii), the SROs set forth in the CAT NMS Plan a discussion
of their analysis of the impact on competition, efficiency and
capital formation of creating, implementing, and maintaining the CAT
NMS Plan. See 17 CFR 242.613(a)(1)(viii) and CAT NMS Plan, supra
note 3, at Appendix C, Section B.8. The SROs' analysis in Section
B.8 of Appendix C to the CAT NMS Plan, which is more detailed than
as set forth in this Section III of this Notice, is organized as
follows: (a) Impact on Competition--both for Participants and
Broker-Dealers, (b) Impact on Efficiency, (c) Impact on Capital
Formation, and (d) Impacts of the CAT NMS Plan Governance on
Efficiency, Competition, and Capital Formation. See CAT NMS Plan,
supra note 3, at Appendix C, Section B.8. The Commission's analysis
in respect of the Plan's impact on competition, efficiency and
capital formation includes discussions of the SROs' analysis
regarding the same and is in Section IV of this Notice. See Section
IV.G, infra.
\86\ 15 U.S.C. 78k-1(c)(1)(D).
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e. Written Understanding or Agreements Relating to Interpretation of,
or Participation in, the Plan
The Participants have no written understandings or agreements
relating to interpretations of, or participation in, the Plan other
than those set forth in the Plan itself. For example, Section
4.3(a)(iii) states that the Operating Committee only may authorize the
interpretation of the Plan by Majority Vote, Section 6.9(c)(i)
addresses interpretations of the Technical Specifications, and Section
8.2 addresses the interpretation of Sections 8.1 and 8.2. In addition,
Section 3.3 sets forth how any entity registered as a national
securities exchange or national securities association under the
Exchange Act may become a Participant.
f. Dispute Resolution
The Plan does not include a general provision addressing the method
by which disputes arising in connection with the operation of the Plan
will be resolved. The Plan does, however, provide the means for
resolving disputes regarding the Participation Fee. Specifically,
Article III states that, in the event that the Company and a
prospective Participant do not agree on the amount of the Participation
Fee, such amount will be subject to the review by the SEC pursuant to
Section 11A(b)(5) of the Exchange Act.\87\ In addition, the Plan
addresses disputes with respect to fees charged to Participants and
Industry Members pursuant to Article XI. Specifically, such disputes
will be determined by the Operating Committee or a Subcommittee
designated by the Operating Committee. Decisions by the Operating
Committee or such designated Subcommittee on such matters will be
binding on Participants and Industry Members, without prejudice to the
rights of any Participant or Industry Member to seek redress from the
SEC pursuant to Rule 608 or in any other appropriate forum.
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\87\ 15 U.S.C. 78k-1(b)(5).
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* * * * *
This marks the end of the statement of purpose as set forth above
and as substantially prepared and submitted by the SROs.
B. Summary of Additional CAT NMS Plan Provisions and Request for
Comment
The Commission requests and encourages any interested person to
comment generally on the proposed CAT NMS Plan. In addition to the
specific requests for comment throughout the release, the Commission
requests general comment on all aspects of the proposed CAT NMS Plan.
The Commission encourages Commenters to provide information regarding
the advantages and disadvantages of each aspect of the proposed CAT NMS
Plan. The Commission invites Commenters to provide views and data as to
the costs and benefits associated with the proposed CAT NMS Plan. The
Commission also seeks comment regarding other matters that may have an
effect on the proposed CAT NMS Plan.
1. Reporting Procedures
The CAT NMS Plan requires CAT Reporters to comply with specific
reporting procedures when reporting CAT Data to the Central
Repository.\88\ Specifically, CAT Reporters must format CAT Data to
comply with the format specifications approved by the Operating
Committee.\89\ CAT Reporters must record CAT Data contemporaneously
with the applicable Reportable Event \90\ and report such data to the
Central Repository by 8:00 a.m. Eastern Time on the next Trading
Day.\91\ The obligation to report CAT Data applies to ``each NMS
Security registered or listed for trading on [a national securities]
exchange or admitted to unlisted trading privileges on such exchange,''
and ``each Eligible Security for which transaction reports are required
to be submitted to such [national securities] association.'' \92\
Further, the Participants are required to adopt Compliance Rules \93\
that require Industry Members, subject to their SRO jurisdiction, to
report CAT Data.\94\
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\88\ See CAT NMS Plan, supra note 3, at Sections 6.3-6.4;
Appendix D, at Section 2.1.
\89\ See id. at Sections 6.3(a), 6.4(a). The CAT NMS Plan also
requires that the Operating Committee-approved format must be a
format specified by the Plan Processor and Rule 613 compliant.
\90\ See id. at Section 6.3(b)(i) and Section 6.4(b)(i).
\91\ See id. at Section 6.3(b)(ii), Section 6.4(b)(ii), and
Appendix C, Section A.1(a)(ii). Participants may voluntarily report
CAT Data prior to the 8:00 a.m. Eastern Time deadline. Id. The CAT
NMS Plan defines ``Trading Day'' as the date ``as is determined by
the Operating Committee.'' The CAT NMS Plan also provides that ``the
Operating Committee may establish different Trading Days for NMS
Stocks (as defined in SEC Rule 600(b)(47), Listed Options, OTC
Equity Securities, and any other securities that are included as
Eligible Securities from time to time.'' Id. at Section 1.1.
\92\ See id. at Section 6.3(c)(i)-(ii) and Section 6.4(c)(i)-
(ii).
\93\ The CAT NMS Plan defines the ``Compliance Rule'' to mean
``with respect to a Participant, the rules promulgated by such
Participant as contemplated by Section 3.11.'' Id. at Section 1.1.
Section 3.11 of the CAT NMS Plan provides that ``each Participant
shall comply with and enforce compliance, as required by SEC Rule
608(c), by its Industry Members with the provisions of SEC Rule 613
and of [the LLC Agreement], as applicable, to the Participant and
its Industry Members. The Participants shall endeavor to promulgate
consistent rules (after taking into account circumstances and
considerations that may impact Participants differently) requiring
compliance by their respective Industry Members with the provisions
of SEC Rule 613 and [the LLC Agreement].'' Id. at Section 3.11.
\94\ See id. at Section 6.4(c)(i)-(ii).
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The CAT NMS Plan requires specific data elements of CAT Data that
must be recorded and reported to the Central Repository upon: (i)
``original receipt or origination of an order,'' \95\ (ii) ``routing of
an order,'' \96\ and (iii) ``receipt of an order that has been
routed.'' \97\ Additionally, the CAT NMS Plan requires that a CAT
Reporter must record and report data related to an ``order [that] is
modified or cancelled,'' \98\ and an ``order [that] is executed, in
whole or in part,'' \99\ as well
[[Page 30636]]
as ``other information or additional events as may be prescribed in
Appendix D, Reporting and Linkage Requirements.'' \100\ The CAT NMS
Plan also requires Industry Member CAT Reporters to report additional
data elements for (i) an ``order [that] is executed, in whole or in
part,'' \101\ (ii) a ``trade [that] is cancelled,'' \102\ or (iii)
``original receipt or origination of an order.'' \103\ Further, each
Participant shall, through Compliance Rules, require Industry Members
to record and report to the Central Repository information or
additional events as may be prescribed to accurately reflect the
complete lifecycle of each Reportable Event.\104\
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\95\ For ``original receipt or origination of an order,'' the
CAT NMS Plan specifies the following data elements: (i) Firm
Designated ID(s) for each Customer; (ii) CAT-Order-ID; (iii) SRO-
Assigned Market Participant Identifier of the Industry Member
receiving or originating the order; (iv) date of order receipt or
origination; (v) time of order receipt or origination (using time
stamps pursuant to Section 6.8 of the CAT NMS Plan); and (vi)
Material Terms of the Order. Id. at Section 6.3(d)(i).
\96\ For ``routing of an order,'' the CAT NMS Plan specifies the
following data elements: (i) CAT-Order-ID; (ii) date on which the
order is routed; (iii) time at which the order is routed (using time
stamps pursuant to Section 6.8 of the CAT NMS Plan); (iv) SRO-
Assigned Market Participant Identifier of the Industry Member or
Participant routing the order; (v) SRO-Assigned Market Participant
Identifier of the Industry Member or Participant to which the order
is being routed; (vi) if routed internally at the Industry Member,
the identity and nature of the department or desk to which the order
is routed; and (vii) Material Terms of the Order. Id. at Section
6.3(d)(ii).
\97\ For ``receipt of an order that has been routed,'' the CAT
NMS Plan specifies the following data elements: (i) CAT-Order-ID;
(ii) date on which the order is received; (iii) time at which the
order is received (using time stamps pursuant to Section 6.8); (iv)
SRO-Assigned Market Participant Identifier of the Industry Member or
Participant receiving the order; (v) SRO-Assigned Market Participant
Identifier of the Industry Member or Participant routing the order;
and (vi) Material Terms of the Order. Id. at Section 6.3(d)(iii).
\98\ For an ``order [that] is modified or cancelled,'' the CAT
NMS Plan specifies the following data elements: (i) CAT-Order-ID;
(ii) date the modification or cancellation is received or
originated; (iii) time at which the modification or cancellation is
received or originated (using time stamps pursuant to Section 6.8 of
the CAT NMS Plan); (iv) price and remaining size of the order, if
modified; (v) other changes in the Material Terms of the Order, if
modified; and (vi) whether the modification or cancellation
instruction was given by the Customer or was initiated by the
Industry Member or Participant. Id. at Section 6.3(d)(iv).
\99\ For an ``order [that] is executed, in whole or in part,''
the CAT NMS Plan specifies the following data elements: (i) CAT-
Order-ID; (ii) date of execution; (iii) time of execution (using
time stamps pursuant to Section 6.8 of the CAT NMS Plan); (iv)
execution capacity (principal, agency or riskless principal); (v)
execution price and size; (vi) SRO-Assigned Market Participant
Identifier of the Participant or Industry Member executing the
order; and (vii) 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.
Id. at Section 6.3(d)(v).
\100\ See id. at Section 6.3(d)(vi).
\101\ For an ``order [that] is executed, in whole or in part,''
the CAT NMS Plan specifies the following additional data elements:
(i) An Allocation Report; (ii) SRO-Assigned Market Participant
Identifier of the clearing broker or prime broker, if applicable;
and (iii) CAT-Order-ID of any contra-side order(s). Id. at Section
6.4(d)(ii)(A).
\102\ For a ``trade [that] is cancelled,'' the CAT NMS Plan
specifies the following additional data element: A cancelled trade
indicator. Id. at Section 6.4(d)(ii)(B).
\103\ For ``original receipt or origination of an order,'' the
CAT NMS Plan specifies the following additional data element(s): The
Firm Designated ID, Customer Account Information, and Customer
Identifying Information for the relevant Customer. Id. at Section
6.4(d)(ii)(C).
\104\ Id. at Appendix D, Section 3.
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Request for Comment
84. Do Commenters believe that the data recording, reporting, and
formatting procedures described in the CAT NMS Plan are appropriate and
reasonable? Would providing additional details or requirements on these
procedures enhance the quality of CAT Data reported to the Central
Repository or the efficiency and cost-effectiveness of the CAT?
85. Do Commenters believe that the CAT NMS Plan, including Appendix
D thereto, requires sufficient outreach, support, training, guidance
and/or documentation to ensure that CAT Reporters are able to make data
transmissions to the Central Repository that are complete and timely?
If not, please explain. Describe what, if any, further requirements may
be needed.
86. Do Commenters believe that the CAT NMS Plan should have a
formal communications plan, other than the public Web site, to provide
CAT Reporters the information they would need in order to set-up or
configure their systems to record and report CAT Data to the Central
Repository? If so, how, when, and by whom should such information be
disseminated to CAT Reporters?
87. Do Commenters believe the Plan should require a specific method
for entering CAT Data upon each CAT Reportable Event or upon updates
and corrections to CAT Reportable Events? If so, what method? Please
explain.
88. Do Commenters believe that the CAT NMS Plan should include a
requirement that the Participants and the Plan Processor set forth a
more detailed schedule, with milestones, for CAT Reporters to adhere to
in setting-up or configuring their systems to become CAT Data reporting
compliant? If so, please explain and describe what details and
milestones should be included in the schedule (e.g., publication of
Technical Specifications and announcements of CAT Reporter-facing
technology changes).
2. Timeliness of Data Reporting
Section 6.3(b)(ii) of the CAT NMS Plan requires each Participant to
report Participant Data to the Central Repository by 8:00 a.m. Eastern
Time on the Trading Day following the day the Participant records such
data.\105\ Additionally, a Participant may voluntarily report such data
prior to this deadline.\106\ Section 6.4(b)(ii) states that each
Participant shall, through its Compliance Rule, require its Industry
Members to report Recorded Industry Member Data to the Central
Repository by 8:00 a.m. Eastern Time on the Trading Day following the
day the Industry member records such data, and Received Industry Member
Data to the Central Repository by 8:00 a.m. Eastern Time on the Trading
Day following the day the Industry Member receives such data.\107\
Section 6.4(b)(ii) of the CAT NMS Plan also states that each
Participant shall, through its Compliance Rule, permit its Industry
Members to voluntarily report such data prior to the applicable 8:00
a.m. Eastern Time deadline.\108\
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\105\ See CAT NMS Plan, supra note 3, at Section 6.3(b)(ii); see
also id. at Appendix C, Section A.1(a)(ii); Appendix D, Sections
3.1, 6.1.
\106\ Id. at Section 6.3(b)(ii).
\107\ Id. at Section 6.4(b)(ii).
\108\ Id.
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Request for Comment
89. The CAT NMS Plan requires that all Participants report
Participant Data to the Central Repository by 8:00 a.m. Eastern Time on
the Trading Day following the day the Participant records such
data,\109\ and that Industry Members report Recorded Industry Member
Data to the Central Repository by 8:00 a.m. Eastern Time on the Trading
Day following the day the Industry Member records such data \110\ and
Received Industry Member Data to the Central Repository by 8:00 a.m.
Eastern Time on the Trading Day following the day the Industry Member
receives such data.\111\ Do Commenters believe that the CAT NMS Plan
provides sufficient detail and information to determine whether the
applicable 8:00 a.m. Eastern Time data reporting deadlines provided in
the CAT NMS Plan are achievable? If not, why not?
---------------------------------------------------------------------------
\109\ Id. at Section 6.3(b)(ii).
\110\ Id. at Section 6.4(b)(ii).
\111\ Id.
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90. Do Commenters believe that CAT Reporters will submit their
reports at or about the same time? If all or most of the CAT Reporters
would report at or just before 8:00 a.m. Eastern Time, what, if any,
impact would there be on the necessary CAT infrastructure? Would this
place an excessive burden on the Plan Processor? Do Commenters believe
this would increase operational risk and/or increase costs? If so,
please explain. Are there alternative reporting mechanisms that could
reduce such risks?
91. The CAT NMS Plan provides that the Plan Processor must be able
to handle two times the historical peak data to ensure that, if a
significant number of CAT Reporters choose to submit data at or around
the same time, the Plan Processor could handle the influx of data.\112\
Do Commenters believe that the SROs' estimate of capacity is
sufficient? If not, why not and what capacity should be required?
---------------------------------------------------------------------------
\112\ Id. at Appendix C, Section A.1(a)(ii); see also id. at
Section IV.H.2.g., infra.
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92. Do Commenters believe that the CAT NMS Plan allocates, or
requires the Plan Processor to have, sufficient resources to work with
the approximately 1,800 CAT Reporters that would, under the CAT NMS
Plan, have to establish secure connections over which CAT Data will
flow from their systems to the Central Repository? Do Commenters
believe that the Plan Processor could implement the CAT Reporters'
Central Repository connections nearly simultaneously without
compromising testing periods and implementation timelines?
3. Uniform Format
The CAT NMS Plan does not mandate the format in which data must be
reported to the Central Repository.\113\ Appendix D states that the
Plan
[[Page 30637]]
Processor will determine the electronic format in which data must be
reported, and that the format will be described in the Technical
Specifications.\114\ Appendix C specifies that CAT Reporters could be
required to 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.\115\
Similarly, Sections 6.3(a) and 6.4(a) of the CAT NMS Plan require that
CAT Reporters report data to the Central Repository in a format or
formats specified by the Plan Processor, approved by the Operating
Committee, and compliant with Rule 613.\116\
---------------------------------------------------------------------------
\113\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(f); see also id. at Appendix C, Section A.1(a).
\114\ Id. at Appendix D, Section 2.1. Appendix D states that
more than one format may be allowed to support the various market
participants that would report information to the Central
Repository. Id.; see also id. at Section 6.9.
\115\ Id. at Appendix C, Section A.1(b).
\116\ Id. at Section 6.3(a) and Section 6.4(a).
---------------------------------------------------------------------------
The CAT NMS Plan requires that data reported to the Central
Repository be stored in an electronic standard format.\117\
Specifically, Section 6.5(b)(i) of the CAT NMS Plan requires the
Central Repository to retain the information collected pursuant to Rule
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 by the Plan Processor for a period of
not less than six (6) years.\118\ Such data must be linked when it is
made available to the Participant's regulatory Staff and the
Commission.\119\
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\117\ Pursuant to the Plan, for data consolidation and storage,
as noted above, such data must be reported in a uniform electronic
format or in a manner that would allow the Central Repository to
convert the data to a uniform electronic format. Id. at Appendix C,
Section A.1(b).
\118\ Id. at Section 6.5(b)(i).
\119\ Id.
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Request for Comment
93. The CAT NMS Plan provides that CAT Reporters could be required
to 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. Do Commenters
believe that if data is reported to the Central Repository in a non-
uniform format, the proposed CAT NMS Plan includes sufficient
requirements or details to determine whether the Central Repository
could reliably and accurately convert such data to a uniform electronic
format, for consolidation and storage, without affecting the quality of
the data? If not, what additional requirements or details should be
provided in the CAT NMS Plan prior to the Commission's approval of such
plan?
94. If Commenters believe that it is not necessary to provide
additional requirements or details, if any, in the CAT NMS Plan, what
additional requirements or details should be included in the Technical
Specifications to determine whether the Central Repository could
reliably and accurately convert such data to a uniform electronic
format, for consolidation and storage?
95. Do Commenters believe the CAT NMS Plan's lack of a mandated
uniform format in which data must be reported to the Central Repository
would affect the accuracy of CAT Data collected and maintained under
the CAT? If so, how? Would reporting data in a uniform format result in
greater accuracy? If so, please explain.
96. Do Commenters believe the CAT NMS Plan's lack of a mandated
uniform format in which data must be reported to the Central Repository
would affect the completeness of CAT Data collected and maintained
under the CAT? If so, how? Would reporting data in a uniform format
result in more complete CAT Data? If so, please explain.
97. Do Commenters believe the CAT NMS Plan's lack of a mandated
uniform format in which data must be reported to the Central Repository
would affect the accessibility of CAT Data collected and maintained
under the CAT? If so, how? Would reporting data in a uniform format
result in a different level of accessibility? If so, please explain.
98. Do Commenters believe allowing CAT Reporters to report data to
the Central Repository in a non-uniform format would affect the
timeliness of data collected and maintained under the CAT? How would
the requirement that the Central Repository convert non-uniform data to
a uniform format affect the timeliness of the data collected and
maintained under the CAT? Would reporting data in a uniform format
result in a different level of timeliness of data reporting? If so,
please explain.
99. Do Commenters believe that allowing CAT Reporters to report
data to the Central Repository in a non-uniform format is more
efficient and cost-effective than requiring data to be reported in a
uniform format? Would allowing CAT Reporters to report data to the
Central Repository in a non-uniform format merely transfer the costs
from individual CAT Reporters to the Central Repository? Would
centralization of the costs of converting data to a uniform format
reduce costs? Please explain.
100. Do Commenters believe that allowing CAT Reporters to report
data to the Central Repository in a non-uniform format would affect the
security and confidentiality of CAT Data? If so, how? Would reporting
data in a uniform format create different security or confidentiality
concerns? If so, please explain.
4. Clock Synchronization
Pursuant to Section 6.8(a) of the CAT NMS Plan, each Participant
and Industry Member, (through the Compliance Rule adopted by every
Participant), must synchronize its Business Clocks,\120\ at a minimum,
to within 50 milliseconds of the time maintained by the NIST,
consistent with industry standards.\121\ The Participants believe that
a 50-millisecond clock offset tolerance represents the current industry
clock synchronization standard.\122\ Industry Members must maintain
such a clock synchronization standard; certify periodically (according
to a schedule to be defined by the Operating Committee) that their
Business Clocks meet the requirements of the Compliance Rule; and
report to the Plan Processor and the Participant any violation of the
Compliance Rule pursuant to the thresholds set by the Operating
Committee.\123\ Pursuant to Section 6.8(c) of the CAT NMS Plan, the
Chief Compliance Officer, in conjunction with the Participants and
other appropriate Industry Member advisory groups, annually must
evaluate and make a recommendation to the Operating Committee as to
whether the industry standard has evolved such that the clock
synchronization standard should be tightened.\124\
---------------------------------------------------------------------------
\120\ The CAT NMS Plan defines a ``Business Clock'' to mean ``a
clock used to record the date and time of any Reportable Event
required to be reported under SEC Rule 613.'' Id. at Section 1.1.
\121\ Id. at Section 6.8(a)(i)-(ii).
\122\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\123\ Id. at Section 6.8(a)(ii).
\124\ Id. at Section 6.8(c).
---------------------------------------------------------------------------
Appendix C describes the process by which Participants determined
that a 50-millisecond clock offset tolerance was consistent with
industry standards.\125\ To that end, the Participants and Industry
Members reviewed their respective internal clock synchronization
technology practices,\126\ and reviewed the results of The Financial
Information Forum (``FIF'') Clock Offset Survey, a clock
synchronization survey conducted by FIF.\127\ In light of their
internal reviews
[[Page 30638]]
and the FIF Clock Offset Survey, the Participants concluded that a
clock offset tolerance of 50 milliseconds represented an aggressive but
achievable standard.\128\
---------------------------------------------------------------------------
\125\ Id. at Appendix C, Section D.12(p).
\126\ Id.
\127\ Id. at Appendix C, n.236. See Financial Information Forum,
FIF Clock Offset Survey Preliminary Report (February 17, 2015),
available at http://www.catnmsplan.com/industryfeedback/p602479.pdf
and http://catnmsplan.com/web/groups/catnms/@catnms/documents/appsupportdocs/p602479.pdf. (``FIF Clock Offset Study'').
\128\ Id. The Participants note in Appendix C that according to
the FIF Clock Offset Survey, annual maintenance costs would escalate
to 102%, 123% and 242% if clock synchronization standards moved to 5
milliseconds, 1 millisecond and 100 microseconds, respectively,
indicating that maintenance costs rapidly escalate as clock
synchronization standards increase beyond 50 milliseconds. Id.
---------------------------------------------------------------------------
Appendix C discusses mechanisms to ensure compliance with the 50-
millisecond clock offset tolerance.\129\ The Participants anticipate
that they and Industry Members will adopt policies and procedures to
verify the required clock synchronization each trading day before the
market opens, as well as periodically throughout the trading day.\130\
The Participants also anticipate that they and Industry Members will
document their clock synchronization procedures and maintain a log
recording the time of each clock synchronization performed, and the
result of such synchronization, specifically identifying any
synchronization revealing any clock offset between the Participant's or
Industry Member's Business Clock and the time maintained by the NIST
exceeding 50 milliseconds.\131\ The CAT NMS Plan states that once both
large and small broker-dealers begin reporting to the Central
Repository, and as clock synchronization technology matures further,
the Participants will assess, in accordance with Rule 613, tightening
CAT's clock synchronization standards to reflect changes in industry
standards.\132\
---------------------------------------------------------------------------
\129\ See id. at Appendix C, Section A.3(c).
\130\ See id.
\131\ See id. It was noted that such a log would include results
for a period of not less than five years ending on the then current
date. Id.
\132\ See id. at Appendix C, Section D.12(p).
---------------------------------------------------------------------------
Request for Comment \133\
---------------------------------------------------------------------------
\133\ See Sections IV.D.3, IV.E.4 and IV.H.5, infra, for further
clock synchronization related requests for comment.
---------------------------------------------------------------------------
101. Do Commenters believe that a clock offset tolerance of 50
milliseconds is appropriate and reasonable, in light of the increase in
the speed of trading over the last several years? If not, what would an
appropriate and reasonable standard be?
102. What are current clock synchronization practices? Do
Commenters believe that current industry clock synchronization
practices are sufficiently rigorous in light of current trading speeds?
If not, please explain.
103. Would a smaller clock offset tolerance be reasonably
achievable? If so, please identify such tolerance and any incremental
additional costs that achieving that smaller clock offset tolerance
might entail.
104. If Commenters believe that, in light of the current speed of
trading, the clock offset tolerance should be more rigorous, what, if
any transition period would be reasonable and appropriate for reducing
the clock offset tolerance standards of CAT?
105. What is the range of clock synchronization practices across
the industry?
106. Do Commenters believe the range of clock synchronization
practices should be considered when considering the appropriate clock
synchronization standard?
107. If an SRO or broker-dealer can or does synchronize its clocks
to an offset tolerance more rigorous than 50 milliseconds, do
Commenters believe that that SRO or broker-dealer should be required to
synchronize its clocks to that standard? Why or why not? If so, how, if
at all, would that affect sequencing of Reportable Events in CAT?
108. Do Commenters believe that certain categories of market
participants should be held to a smaller or larger clock offset
tolerance? If so, what category of market participant and why? How, if
at all, would that affect sequencing of Reportable Events in CAT?
109. Do Commenters believe a 50-millisecond clock offset tolerance
would materially impair the quality and accuracy of CAT Data? If so,
please explain. Would such a standard undermine the ability of the
Central Repository to accurately and reliably link order and sequence
event data across venues, or combine it with other sources of trade and
order data? If so, please explain. Is there a benefit from applying the
same uniform clock offset tolerance to all market participants, or
would a variable clock offset tolerance approach be preferable? For
example, should a high-volume market participant trading on multiple
exchanges and ATSs have the same clock offset tolerance as a small
retail-focused regional office? Would the benefits of a smaller clock
offset tolerance for service bureaus that report but do not record
order events be lower than for other types of CAT Reporters? Would the
benefits of a smaller clock offset tolerance for clearing brokers that
record and report information available only after an execution be
lower than for other types of CAT Reporters? Please explain.
110. The CAT NMS Plan provides that as time synchronization
standards evolve, the Participants would assess, on an annual basis,
the ability to tighten the clock synchronization standards for CAT to
reflect changes in industry standards. Do Commenters believe that this
would establish an appropriately rigorous process and schedule for the
Participants to evaluate whether the clock synchronization standard
should be tightened? Are there any other factors that should affect
when and how to tighten the clock synchronization standard?
111. Do Commenters believe the CAT NMS Plan provides adequate
enforcement provisions to ensure CAT Reporters synchronize Business
Clocks within the proposed 50-millisecond clock offset tolerance? If
not, what additional enforcement provisions should the CAT NMS Plan
provide?
112. Do Commenters believe that sufficient detail has been provided
in the CAT NMS Plan concerning the reasonable justification or
exceptional circumstances that would permit a pattern or practice of
reporting events outside of the specified clock synchronization
standard?
113. The CAT NMS Plan generally requires CAT Reporters to record
and report Reportable Events with a time stamp of at least to the
millisecond but provides for a 50 millisecond clock offset tolerance.
Do Commenters believe the time stamp granularity requirement and the
clock offset tolerance should correspond more closely or even
identically? If so, please explain, including what such time stamp
granularity requirement and clock offset tolerance should be.
5. Time Stamp Granularity
The CAT NMS Plan requires CAT Reporters to record and report the
time of each Reportable Event using time stamps reflecting current
industry standards, which should be at least to the millisecond, except
with respect to events that involve non-electronic communication of
information (``Manual Order Events'').\134\ Furthermore, the Plan
requires
[[Page 30639]]
Participants to adopt rules requiring that CAT Reporters that use time
stamps in increments finer than milliseconds use those finer increments
when reporting to the Central Repository.\135\ For Manual Order Events,
the Participants determined that time stamp granularity at the level of
a millisecond is not practical.\136\ Accordingly, the CAT NMS Plan
provides that each Participant and Industry Member shall be permitted
to record and report Manual Order Events to the Central Repository in
increments up to and including one second, provided that Participants
and Industry Members shall be required to record and report the time
when a Manual Order Event has been captured electronically in an order
handling and execution system of such Participant or Industry Member
(``Electronic Capture Time'') in milliseconds.\137\
---------------------------------------------------------------------------
\134\ See CAT NMS Plan, supra note 3, at Section 1.1. The SROs
requested exemptive relief from Rule 613 so that the CAT NMS Plan
may permit CAT Reporters to report Manual Order Events with a time
stamp granularity of one second, in lieu of a time stamp granularity
of one millisecond. See Exemptive Request Letter, supra note 16, at
34. The Commission granted exemptive relief on March 1, 2016 in
order to allow this alternative to be included in the CAT NMS Plan
and subject to notice and comment. See Exemption Order, supra note
18.
\135\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\136\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c). The Participants state that they received industry feedback
through the DAG that suggests that the established business practice
with respect to Manual Order Events is to manually capture time
stamps with granularity at the level of a second because finer
increments cannot be accurately captured when dealing with manual
processes which, by their nature, take longer to perform than a time
increment of under one second. Id. The Participants agree that, due
to the nature of transactions originated over the phone, it is not
practical to attempt granularity finer than one second, as any such
finer increment would be inherently unreliable. Id.
\137\ See CAT NMS Plan, supra note 3, at Section 6.8(b).
---------------------------------------------------------------------------
Request for Comment \138\
---------------------------------------------------------------------------
\138\ See Section IV.D.3, infra, for further time stamp
granularity related requests for comment.
---------------------------------------------------------------------------
114. Are the time stamp granularity standards for both electronic
and non-electronic reportable events appropriate and reasonable? If
not, why not and what would be a better alternative?
115. Do Commenters believe the CAT NMS Plan's time stamp
granularity requirement is precise enough to reliably and accurately
sequence Reportable Events? If not, why not? Is there a better time
stamp approach and what should the requirement(s) be?
116. To what degree does the millisecond or less time stamp
granularity requirement enable or prevent regulators' ability to
sequence events that occur in different execution venues? Please
explain.
117. Are certain CAT Reportable Events more time-sensitive than
other CAT Reportable Events? If so, what events are more time-sensitive
and why? What systems are more likely to process these more sensitive
events and to what level of time stamp granularity are such events
processed? Where are those systems located (i.e., within broker-
dealers, service bureaus, execution venues)? Please explain.
118. What market participant systems, if any, should have less
granular time stamp requirements? Why? What time stamp granularity
standard should these systems have? Why?
119. What market participant systems, if any, should have more
granular time stamp requirements? Why? What time stamp granularity
standard should these systems have? Why?
120. The Commission granted an exemption from Rule 613 in order to
allow the alternative of permitting CAT Reporters to report Manual
Order Events with a time stamp granularity of one second, in lieu of
the Rule 613 requirement that the CAT NMS Plan require CAT Reporters to
report with a time stamp granularity of one millisecond, to be included
in the CAT NMS Plan and subject to notice and comment.\139\ Do
Commenters believe that the CAT NMS Plan's one-second time stamp
granularity standard for Manual Order Events is appropriate and
reasonable? If not, why not? Would a more granular time stamp
requirement for Manual Order Events be feasible?
---------------------------------------------------------------------------
\139\ See Exemption Order, supra note 18.
---------------------------------------------------------------------------
121. What alternative approach with respect to Manual Order Events
may be preferable? Could the provisions in the CAT NMS Plan related to
Manual Order Events be more narrowly tailored to, for example, only
apply to CAT Reporters who are unable to record and report Manual Order
Events with a time stamp granularity of one millisecond?
122. The SROs note in the Exemption Request that recording and
reporting Manual Order Events with a time stamp granularity of at least
one second would result in little additional benefit, and, in fact,
could result in adverse consequences such as creating a false sense of
precision for data that is inherently imprecise, while imposing
additional costs on CAT Reporters. Do Commenters agree? Why or why not?
123. If Manual Order Events are recorded and reported with a time
stamp granularity of one second, what, if any, challenges do Commenters
believe would arise with respect to the sequencing of order events (for
the same order) and orders (for a series of orders)? Would the one
millisecond standard originally provided for in Rule 613 be preferable?
Please explain.
124. Do Commenters believe the CAT NMS Plan's requirement that time
stamp granularity (other than for Manual Order Events) should be to at
least the millisecond is granular enough in light of current practices?
If not, why not?
125. The CAT NMS Plan provides that as time stamp standards evolve,
the Participants would assess, on an annual basis, the ability to
require more precise time stamp granularity standards for CAT to
reflect changes in industry standards. Do Commenters believe that this
establishes an appropriately rigorous schedule for the Participants to
evaluate whether time stamp granularity requirements could potentially
be set to finer increments? Are there any other factors that should
affect when and how the requirements for time stamp granularity
increments could be made more precise?
126. Do Commenters believe the CAT NMS Plan provides adequate
enforcement provisions to ensure CAT Reporters time stamp Reportable
Events to a granularity of one millisecond (and for Manual Order Events
to a granularity of one second)? If not, what additional enforcement
provisions should the CAT NMS Plan provide?
127. Do Commenters believe that the CAT NMS Plan's requirement that
Participants and Industry Members synchronize Business Clocks used
solely for Manual Order Events to within one second of the time
maintained by the NIST is appropriate and reasonable? Would a tighter
clock synchronization standard for Business Clocks used solely for
Manual Order Events be feasible?
6. CAT-Reporter-ID
Sections 6.3 and 6.4 of the CAT NMS Plan require CAT Reporters to
record and report to the Central Repository an SRO-Assigned Market
Participant Identifier \140\ for orders and certain Reportable Events
to be used by the Central Repository to assign a unique CAT-Reporter-ID
\141\ for purposes of identifying each CAT Reporter associated with an
order or Reportable Event (the ``Existing Identifier Approach'').\142\
The CAT NMS Plan
[[Page 30640]]
requires the reporting of SRO-Assigned Market Participant Identifiers
of: The Industry Member receiving or originating an order; \143\ the
Industry Member or Participant from which (and to which) an order is
being routed; \144\ the Industry Member or Participant receiving (and
routing) a routed order; \145\ the Industry Member or Participant
executing an order, if an order is executed; \146\ and the clearing
broker or prime broker, if applicable, if an order is executed.\147\ An
Industry Member would report to the Central Repository its existing
SRO-Assigned Market Participant Identifier used by the relevant SRO
specifically for transactions occurring at that SRO.\148\ Similarly, an
exchange reporting CAT Reporter information would report data using the
SRO-Assigned Market Participant Identifier used by the Industry Member
on that exchange or its systems.\149\ Over-the-counter (``OTC'') orders
and Reportable Events would be reported with an Industry Member's FINRA
SRO-Assigned Market Participant Identifier.\150\
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\140\ The CAT NMS Plan defines an ``SRO-Assigned Market
Participant Identifier'' as ``an identifier assigned to an Industry
Member by an SRO or an identifier used by a Participant.'' See CAT
NMS Plan, supra note 3, at Section 1.1.
\141\ Rule 613 defines a CAT-Reporter-ID as ``a code that
uniquely and consistently identifies [a CAT Reporter] for purposes
of providing data to the central repository.'' 17 CFR 242.613(j)(2).
\142\ The SROs requested exemptive relief from Rule 613 so that
the CAT NMS Plan may permit the Existing Identifier Approach, which
would allow a CAT Reporter to report an existing SRO-Assigned Market
Participant Identifier in lieu of requiring the reporting of a
universal CAT-Reporter-ID. See Exemptive Request Letter, supra note
16, at 19. The Commission granted exemptive relief on March 1, 2016
in order to allow this alternative to be included in the CAT NMS
Plan and subject to notice and comment. See Exemption Order, supra
note 18.
\143\ See CAT NMS Plan, supra note 3, at Section 6.3(d)(i) and
Section 6.4(d)(i).
\144\ Id. at Section 6.3(d)(ii) and Section 6.4(d)(i).
\145\ Id. at Section 6.3(d)(iii) and Section 6.4(d)(i).
\146\ Id. at Section 6.3(d)(v) and Section 6.4(d)(i).
\147\ Id. at Section 6.4(d)(ii)(A)(2). Industry Members are
required by the CAT NMS Plan to record and report this information.
See CAT NMS Plan, supra note 3, at Section 6.4(d)(ii).
\148\ See Exemption Order, supra note 18, at 31-41.
\149\ See id. at 20.
\150\ Id.
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The CAT NMS Plan requires the Plan Processor to develop and
maintain the mechanism to assign (and to change, if necessary) CAT-
Reporter-IDs.\151\ For the Central Repository to link the SRO-Assigned
Participant Identifier to the CAT-Reporter-ID, each SRO must submit, on
a daily basis, all SRO-Assigned Market Participant Identifiers used by
its Industry Members (or itself), as well as information to identify
the corresponding market participant (for example, a CRD number or
Legal Entity Identifier (``LEI'')) to the Central Repository.\152\
Additionally, each Industry Member shall be required to submit to the
Central Repository information sufficient to identify such Industry
Member (e.g., CRD number or LEI, as noted above).\153\ The Plan
Processor would use the SRO-Assigned Market Participant Identifiers and
identifying information (i.e., CRD number or LEI) to assign a CAT-
Reporter-ID to each Industry Member and SRO for internal use across all
data within the Central Repository.\154\ The Plan Processor would
create and maintain a database in the Central Repository that would map
the SRO-Assigned Market Participant Identifiers to the appropriate CAT-
Reporter-ID.\155\
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\151\ See CAT NMS Plan, supra note 3, at Appendix D, Section
10.1. Changes to CAT-Reporter-IDs must be reviewed and approved by
the Plan Processor. Id. The CAT NMS Plan also requires the Central
Repository to generate and assign a unique CAT-Reporter-ID to all
reports submitted to the system based on sub-identifiers that are
currently used by CAT Reporters in their order handling and trading
processes (described in the Exemption Request as SRO-assigned market
participant identifiers). See CAT NMS Plan, supra note 3, at
Appendix D, Section 3; see also Exemption Order, supra note 18, at
31-41.
\152\ See CAT NMS Plan, supra note 3, at Section 6.3(e)(i).
\153\ Id. at Section 6.4(d)(vi).
\154\ See Exemption Order, supra note 18, at 31-41.
\155\ Id. at 20.
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The consolidated audit trail must be able to capture, store, and
maintain current and historical SRO-Assigned Market Participant
Identifiers.\156\ The SRO-Assigned Market Participant Identifier must
also be included on the Plan Processor's acknowledgment of its receipt
of data files from a CAT Reporter or Data Submitter,\157\ on daily
statistics provided by the Plan Processor after the Central Repository
has processed data,\158\ and on a secure Web site that the Plan
Processor would maintain that would contain each CAT Reporter's daily
reporting statistics.\159\ In addition, data validations by the Plan
Processor must include confirmation of a valid SRO-Assigned Market
Participant Identifier.\160\
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\156\ See CAT NMS Plan, supra note 3, at Appendix D, Section 2.
\157\ See id. at Appendix D, Section 7.1.
\158\ See id. at Appendix D, Section 7.2.
\159\ See id. at Appendix D, Section 10.1.
\160\ See id. at Appendix D, Section 7.2. The CAT NMS Plan also
notes that both the CAT-Reporter-ID and the SRO-Assigned Market
Participant Identifier would be data fields for the online targeted
query tool described in the CAT NMS Plan as providing authorized
users with the ability to retrieve processed and/or validated
(unlinked) data via an online query screen. See id. at Appendix D,
Section 8.1.1.
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Request for Comment
128. The Commission granted an exemption from Rule 613 in order to
allow the Existing Identifier Approach to be included in the CAT NMS
Plan and subject to notice and comment. The Existing Identifier
Approach would allow a CAT Reporter to report an existing SRO-Assigned
Market Participant Identifier in lieu of Rule 613's requirement that a
CAT Reporter must report a universal CAT-Reporter-ID.\161\ Do
Commenters believe that allowing the Existing Identifier Approach would
be more efficient and cost-effective than the Rule 613 approach of
requiring a CAT-Reporter-ID to be reported for each order and
reportable event in accordance with Rule 613(c)(7)? \162\ Why or why
not? Or do Commenters believe that the Rule 613 approach is preferable?
Why or why not? Would implementation of the Existing Identifier
Approach merely transfer costs from CAT Reporters to the Central
Repository?
---------------------------------------------------------------------------
\161\ See Exemption Order, supra note 18.
\162\ See supra note 142.
---------------------------------------------------------------------------
129. Do Commenters believe that the Existing Identifier Approach
would affect the accuracy of CAT Data? Would the Rule 613 approach
result in greater accuracy? If so, please explain.
130. Do Commenters believe that the CAT NMS Plan's proposed
Existing Identifier Approach would affect the accessibility of CAT
Data? If so, how? Would the Rule 613 approach result in a different
level of accessibility? If so, please explain.
131. Do Commenters believe that the CAT NMS Plan's proposed
Existing Identifier Approach would affect the timeliness of CAT Data?
If so, how? Would the Rule 613 approach result in greater timeliness?
If so, please explain.
132. Do Commenters believe the Existing Identifier Approach would
affect the security and confidentiality of CAT Data? If so, how? Would
the Rule 613 approach result in a different level of security and
confidentiality? If so, please explain.
133. What challenges or risks do Commenters believe the Plan
Processor would face in linking all SRO-Assigned Market Participant
Identifiers to the appropriate CAT-Reporter-IDs? What, if anything,
could be done to mitigate those challenges and risks?
134. The CAT NMS Plan does not require that an Industry Member
provide its LEI to the Plan Processor as part of the identifying
information used to assign a CAT-Reporter-ID. The CAT NMS Plan permits
an Industry Member to report its CRD number in lieu of its LEI for this
purpose. Do Commenters believe that the CAT NMS Plan should mandate
that Industry Members provide their LEIs, along with their SRO-Assigned
Market Participant Identifiers, to the Plan Processor for purposes of
developing a unique CAT-Reporter-ID? Why or why not?
7. Customer-ID
a. Customer Information Approach
Rule 613(c)(7)(i)(A) requires that for the original receipt or
origination of an order, a CAT Reporter report the ``Customer-ID(s) for
each Customer.'' \163\ ``Customer-ID'' is defined in Rule 613(j)(5) to
mean ``with respect to a customer, a code that uniquely and
[[Page 30641]]
consistently identifies such customer for purposes of providing data to
the Central Repository.'' \164\ Rule 613(c)(8) requires that ``[a]ll
plan sponsors and their members shall use the same Customer-ID and CAT-
Reporter-ID for each customer and broker-dealer.'' \165\
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\163\ See 17 CFR 242.613(c)(7)(i)(A).
\164\ See 17 CFR 242.613(j)(5).
\165\ See 17 CFR 242.613(c)(8).
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In Appendix C, the Participants describe the ``Customer Information
Approach,'' \166\ an alternative approach to the requirement that a
broker-dealer report a Customer-ID for every Customer upon original
receipt or origination of an order.\167\ Under the Customer Information
Approach, the CAT NMS Plan would require each broker-dealer to assign a
unique Firm Designated ID to each Customer.\168\ As the Firm Designated
ID, broker-dealers would be permitted to use an account number or any
other identifier defined by the firm, provided each identifier is
unique across the firm for each business date (i.e., a single firm may
not have multiple separate customers with the same identifier on any
given date).\169\ According to the CAT NMS Plan, broker-dealers would
submit an initial set of Customer information to the Central
Repository, including, as applicable, the Firm Designated ID, the
Customer's name, address, date of birth, individual tax payer
identifier number (``ITIN'')/social security number (``SSN''),
individual's role in the account (e.g., primary holder, joint holder,
guardian, trustee, person with power of attorney) and LEI,\170\ and/or
Large Trader ID (``LTID''), if applicable, which would be updated as
set forth in the CAT NMS Plan.\171\
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\166\ The SROs requested exemptive relief from Rule 613 so that
the CAT NMS Plan may permit the Customer Information Approach, which
would require each broker-dealer to assign a unique Firm Designated
ID to each trading account and to submit an initial set of
information identifying the Customer to the Central Repository, in
lieu of requiring each broker-dealer to report a Customer-ID for
each Customer upon the original receipt or origination of an order.
See Exemptive Request Letter, supra note 16, at 12. The Commission
granted exemptive relief on March 1, 2016 in order to allow this
alternative to be included in the CAT NMS Plan and subject to notice
and comment. See Exemption Order, supra note 18.
\167\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(a)(iii).
\168\ Id. at Appendix C, Section A.1(a)(iii). The CAT NMS Plan
defines a ``Firm Designated ID'' as ``a unique identifier for each
trading account designated by Industry Members for purposes of
providing data to the Central Repository, where each such identifier
is unique among all identifiers from any given Industry Member for
each business date.'' See id. at Section 1.1.
\169\ Id. at Appendix C, Section A.1(a)(iii).
\170\ The CAT NMS Plan provides that where a validated LEI is
available for a Customer or entity, this may obviate a need to
report other identifier information (e.g., Customer name, address,
EIN). Id. at Appendix C, Section A.1(a)(iii) n.31.
\171\ The CAT NMS Plan states that the Participants anticipate
that Customer information that is initially reported to the CAT
could be limited to Customer accounts that have, or are expected to
have, CAT Reportable Event activity. For example, the CAT NMS Plan
notes accounts that are considered open, but have not traded
Eligible Securities in a given time frame, may not need to be pre-
established in the CAT, but rather could be reported as part of
daily updates after they have CAT Reportable Event activity. Id. at
Appendix C, Section A.1(a)(iii) n.32.
---------------------------------------------------------------------------
Under the Customer Information Approach, broker-dealers would be
required to report only the Firm Designated ID for each new order
submitted to the Central Repository, rather than the ``Customer-ID'' as
defined by Rule 613(c)(j)(5) and as required by Rule 613(c)(7)(i)(A),
and the Plan Processor would associate specific Customers and their
Customer-IDs with individual order events based on the reported Firm
Designated IDs.\172\ Within the Central Repository, each Customer would
be uniquely identified by identifiers or a combination of identifiers
such as an ITIN/SSN, date of birth, and, as applicable, LEI and
LTID.\173\ The Plan Processor would be required to use these unique
identifiers to map orders to specific Customers across all broker-
dealers.\174\ To ensure information identifying a Customer is updated,
broker-dealers would be required to submit to the Central Repository
daily updates for reactivated accounts, newly established or revised
Firm Designated IDs, or associated reportable Customer
information.\175\
---------------------------------------------------------------------------
\172\ See id. at Appendix C, Section A.1(a)(iii). The CAT NMS
Plan also requires broker-dealers to report ``Customer Account
Information'' upon the original receipt of origination of an order.
See CAT NMS Plan, supra note 3, at Section 1.1, Section
6.4(d)(ii)(C).
\173\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(a)(iii).
\174\ Id.
\175\ The CAT NMS Plan notes that because reporting to the CAT
is on an end-of-day basis, intra-day changes to information could be
captured as part of the daily updates to the information. To ensure
the completeness and accuracy of Customer information and
associations, in addition to daily updates, broker-dealers would be
required to submit periodic full refreshes of Customer information
to the CAT. The scope of the ``full'' Customer information refresh
would need to be further defined, with the assistance of the Plan
Processor, to determine the extent to which inactive or otherwise
terminated accounts would need to be reported. Id. at Appendix C,
Section A.1(a)(iii) n.33.
---------------------------------------------------------------------------
Appendix C provides additional requirements that the Plan Processor
must meet under the Customer Information Approach.\176\ The Plan
Processor must maintain information of sufficient detail to uniquely
and consistently identify each Customer across all CAT Reporters, and
associated accounts from each CAT Reporter, and must document and
publish, with the approval of the Operating Committee, the minimum list
of attributes to be captured to maintain this association.\177\ In
addition, the Plan Processor must maintain valid Customer and Customer
Account Information \178\ for each trading day and provide a method for
Participants and the Commission to easily obtain historical changes to
that information (e.g., name changes, address changes).\179\ The Plan
Processor also must design and implement a robust data validation
process for submitted Firm Designated IDs, Customer Account Information
and Customer Identifying Information, and be able to link accounts that
move from one CAT Reporter to another due to mergers and acquisitions,
divestitures, and other events.\180\ Under the Customer Information
Approach, broker-dealers will initially submit full account lists for
all active accounts to the Plan Processor and subsequently submit
updates and changes on a daily basis.\181\ Finally, the Plan Processor
must have a process to periodically receive full account lists to
ensure the completeness and accuracy of the account database.\182\
---------------------------------------------------------------------------
\176\ See id. at Appendix C, Section A.1(a)(iii).
\177\ Id. Section 9.1 of Appendix D also addresses, among other
things, the minimum attributes that CAT must capture for Customers
and the validation process for such attributes. Id. at Appendix D,
Section 9.1.
\178\ Id. at Appendix D, Section 9.1. In relevant part,
``Customer Account Information'' is defined in the Plan to include,
but not be limited to, account number, account type, customer type,
date account opened, and large trader identifier (if applicable).
See id. at Section 1.1.
\179\ See id. at Appendix C, Section A.1(a)(iii).
\180\ Id. at Appendix C, Section A.1(a)(iii). The CAT NMS Plan
defines ``Customer Identifying Information'' to mean ``information
of sufficient detail to identify a Customer, including, but not
limited to, (a) with respect to individuals: Name, address, date of
birth, individual tax payer identification number (``ITIN'')/social
security number (``SSN''), individual's role in the account (e.g.,
primary holder, joint holder, guardian, trustee, person with the
power of attorney); and (b) with respect to legal entities: name,
address, Employer Identification Number (``EIN'')/LEI) or other
comparable common entity identifier, if applicable; provided,
however, where the LEI or other common entity identifier is
provided, information covered by such common entity identifier
(e.g., name, address) would not need to be separately submitted to
the Central Repository.'' See id. at Section 1.1.
\181\ Id. at Appendix C, Section A.1(a)(iii).
\182\ Id.
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b. Account Effective Date vs. Account Open Date
Rule 613(c)(7)(viii)(B) requires broker-dealers to report to the
Central Repository ``Customer Account Information'' upon the original
receipt or origination of an order.\183\ The CAT
[[Page 30642]]
NMS Plan defines ``Customer Account Information'' to include, in part,
the Customer's account number, account type, customer type, date
account opened and LTID (if applicable).\184\ The Plan, however,
provides that in two limited circumstances, a broker-dealer could
report the ``Account Effective Date'' in lieu of the date an account
was opened.\185\ The first circumstance is where a relationship
identifier--rather than an actual parent account--has been established
for an institutional Customer relationship.\186\ In this case, no
account open date is available for the institutional Customer parent
relationship because there is no parent account, and for the same
reason, there is no account number or account type available.\187\
Thus, the Plan provides that in this circumstance, a broker-dealer
could report the ``Account Effective Date'' of the relationship in lieu
of an account open date.\188\ Further, the Plan provides that where
such an institutional Customer relationship was established before the
broker-dealer's obligation to report audit trail data is required, the
``Account Effective Date'' would be either (i) the date the broker-
dealer established the relationship identifier, or (ii) the date when
trading began (i.e., the date the first order is received) using the
relevant relationship identifier, and if both dates are available and
differ, the earlier date.\189\ Where such relationships are established
after the broker-dealer's obligation to report audit trail data is
required, the ``Account Effective Date'' would be the date the broker-
dealer established the relationship identifier and would be no later
than the date the first order was received.\190\ Regardless of when the
relationship was established for such institutional Customers, the Plan
provides that broker-dealers may report the relationship identifier in
place of Rule 613(c)(7)(viii)(B)'s requirement to report the ``account
number,'' and report ``relationship'' in place of ``account type.''
\191\
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\183\ 17 CFR 242.613(c)(7)(viii)(B). ``Customer Account
Information'' is defined in Rule 613(j)(4) to ``include, but not be
limited to, account number, account type, customer type, date
account opened, and large trader identifier (if applicable).'' 17
CFR 242.613(j)(4).
\184\ See CAT NMS Plan, supra note 3, at Section 1.1.
\185\ Id. The SROs requested exemptive relief from Rule 613 so
that the CAT NMS Plan may permit broker-dealers to report to the
Central Repository the ``effective date'' of an account in lieu of
requiring each broker-dealer to report the date the account was
opened in certain limited circumstances. See Exemptive Request
Letter, supra note 16, at 13. The Commission granted exemptive
relief on March 1, 2016 in order to allow this alternative to be
included in the CAT NMS Plan and subject to notice and comment. See
Exemption Order, supra note 18.
\186\ See Exemption Order, supra note 18; see also September
2015 Supplement, supra note 16, at 4-5.
\187\ See September 2015 Supplement, supra note 16, at 6.
\188\ See CAT NMS Plan, supra note 3, at Section 1.1.
\189\ See id.
\190\ See id.
\191\ See id.
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The second circumstance where a broker-dealer may report the
``Account Effective Date'' rather than the date an account was opened
as required in Rule 613(c)(7)(viii)(B) is when particular legacy system
data issues prevent a broker-dealer from providing an account open date
for any type of account (i.e., institutional, proprietary or retail)
that was established before CAT's implementation.\192\ According to the
Plan, these legacy system data issues may arise because:
---------------------------------------------------------------------------
\192\ See id.; see also September 2015 Supplement, supra note
16, at 7-9.
---------------------------------------------------------------------------
(1) A broker-dealer has switched back office providers or clearing
firms and the new back office/clearing firm system identifies the
account open date as the date the account was opened on the new system;
(2) A broker-dealer is acquired and the account open date becomes
the date that an account was opened on the post-merger back office/
clearing firm system;
(3) Certain broker-dealers maintain multiple dates associated with
accounts in their systems and do not designate in a consistent manner
which date constitutes the account open date, as the parameters of each
date are determined by the individual broker-dealer; or
(4) No account open date exists for a proprietary account of a
broker-dealer.\193\
---------------------------------------------------------------------------
\193\ See CAT NMS Plan, supra note 3, at Section 1.1.
---------------------------------------------------------------------------
Thus, when legacy systems data issues arise due to one of the four
reasons above and no account open date is available, the Plan provides
that broker-dealers would be permitted to report an ``Account Effective
Date'' in lieu of an account open date.\194\ When the legacy systems
data issues and lack of account open date are attributable to above
reasons (1) or (2), the ``Account Effective Date'' would be the date
the account was established, either directly or via a system transfer,
at the relevant broker-dealer.\195\ When the legacy systems data issues
and lack of account open date are attributable to above reason (3), the
``Account Effective Date'' would be the earliest available date.\196\
When the legacy systems data issues and lack of account open date are
attributable to above reason (4), the ``Account Effective Date'' would
be (i) the date established for the proprietary account in the broker-
dealer or its system(s), or (ii) the date when proprietary trading
began in the account, i.e., the date on which the first orders were
submitted from the account.\197\
---------------------------------------------------------------------------
\194\ Id.
\195\ Id.
\196\ Id.
\197\ Id.
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c. Modification/Cancellation
Rule 613(c)(7)(iv)(F) requires that ``[t]he CAT-Reporter-ID of the
broker-dealer or Customer-ID of the person giving the modification or
cancellation instruction'' be reported to the Central Repository.\198\
Because the Customer Information Approach no longer requires that a
Customer-ID be reported upon original receipt or origination of an
order, and because reporting the Customer-ID of the specific person
that gave the modification or cancellation instruction would result in
an inconsistent level of information regarding the identity of the
person giving the modification or cancellation instruction versus the
identity of the Customer that originally received or originated an
order, Section 6.3(d)(iv)(F) of the CAT NMS Plan modifies the
requirement in Rule 613 and instead requires CAT Reporters to report
whether the modification or cancellation instruction was ``given by the
Customer or was initiated by the Industry Member or Participant.''
\199\
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\198\ 17 CFR 242.613(c)(7)(iv)(F) (emphasis added).
\199\ See CAT NMS Plan, supra note 3, at Section 6.3(d)(iv)(F).
The SROs requested exemptive relief from Rule 613 so that the CAT
NMS Plan may permit CAT Reporters to report whether a modification
or cancellation instruction was given by the Customer associated
with the order, or was initiated by the broker-dealer or exchange
associated with the order, in lieu of requiring CAT Reporters to
report the Customer-ID of the person giving the modification or
cancellation instruction. See Exemptive Request Letter, supra note
16, at 12-13. The Commission granted exemptive relief on March 1,
2016 in order to allow this alternative to be included in the CAT
NMS Plan and subject to notice and comment. See Exemption Order,
supra note 18.
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Request for Comment
135. The Commission granted an exemption from Rule 613 in order to
allow the Customer Information Approach to be included in the CAT NMS
Plan and subject to notice and comment. The Customer Information
Approach would require each broker-dealer to assign a unique Firm
Designated ID to each trading account and to submit an initial set of
information identifying the Customer to the Central Repository, in lieu
of Rule 613's requirement that a CAT Reporter must report a Customer-ID
for each Customer upon the original receipt or
[[Page 30643]]
origination of an order. Do Commenters believe that allowing broker-
dealers to report a Firm Designated ID to the Central Repository is
more efficient and cost-effective than the Rule 613 approach of
requiring broker-dealers to report a unique Customer-ID upon original
receipt or origination of an order? Would allowing CAT Reporters to
report a Firm Designated ID to the Central Repository merely transfer
the costs from individual broker-dealers to the Central Repository? Or
do Commenters believe that the Rule 613 approach is preferable? Why or
why not?
136. If broker-dealers are permitted to report a Firm Designated
ID, do Commenters believe the proposed CAT NMS Plan includes
sufficiently detailed requirements to determine whether the Plan
Processor could use the Firm Designated ID to identify a Customer?
137. Do Commenters believe the CAT NMS Plan's proposal to permit
reporting a Firm Designated ID would affect the accuracy of CAT Data
collected and maintained under the CAT compared to the Rule 613
approach that requires a unique Customer-ID? If so, how? Would
permitting reporting a Firm Designated ID result in more complete CAT
Data? If so, please explain.
138. Do Commenters believe the CAT NMS Plan's proposal to permit
reporting a Firm Designated ID would affect the accessibility of CAT
Data collected and maintained under the CAT compared to the Rule 613
approach? If so, how? Would permitting reporting a Firm Designated ID
result in CAT Data being more accessible? If so, please explain.
139. Do Commenters believe allowing broker-dealers to report a Firm
Designated ID to the Central Repository would affect the timeliness of
data collected and maintained under the CAT compared to the Rule 613
approach? Would permitting reporting a Firm Designated ID result in
more timely CAT Data? If so, please explain.
140. Do Commenters believe there are any increased risks related to
allowing a broker-dealer to report a Firm Designated ID rather than a
unique Customer-ID to the Central Repository? How difficult would it be
for the Central Repository to utilize a Firm Designated ID for each
account?
141. Do Commenters believe that the CAT NMS Plan has provided
sufficient information to determine whether the Central Repository
could use a Firm Designated ID to efficiently, reliably and accurately
link orders and Reportable Events to a Customer?
142. Do Commenters believe that the CAT NMS Plan includes
sufficient safeguards or policies to assure that the same Firm
Designated ID would not be used for multiple Customers?
143. The CAT NMS Plan does not require that a broker-dealer provide
an LEI to the Plan Processor as part of the identifying information
used to assign a Customer-ID at the Central Repository. The CAT NMS
Plan provides that a broker-dealer must report its LEI, if available,
but allows a broker-dealer to report another comparable common entity
identifier, if an LEI is not available. Do Commenters believe that the
CAT NMS Plan should mandate that broker-dealers provide an LEI as part
of the information used by the Plan Processor to uniquely identify
Customers? Why or why not?
144. Do Commenters believe that reporting the Firm Designated ID,
rather than a unique Customer-ID, would affect the security and
confidentiality of CAT Data? If so, how? Would permitting reporting a
Firm Designated ID result in a different level of security and
confidentiality of CAT Data? If so, please explain.
145. The CAT NMS Plan provides that an initial set of Customer
Account Information and Customer Identifying Information would be
reported to the Central Repository by broker-dealers upon the
commencement of reporting audit trail data to the Central Repository by
that broker-dealer, and that such Customer Identifying Information
would be updated as set forth in the CAT NMS Plan. Do Commenters
believe that the approach for reporting an initial set of Customer
Account Information and Customer Identifying Information and updates to
such information thereafter as set forth in the CAT NMS Plan would
affect the quality, accuracy, completeness, accessibility or timeliness
of the data? If so, what additional requirements or details should be
provided in the CAT NMS Plan?
146. Do Commenters believe that allowing broker-dealers to report
an initial set of Customer Account Information and Customer Identifying
Information and updates to such information thereafter is more
efficient and cost-effective than the Rule 613 approach for identifying
Customers under Rule 613? Or do Commenters believe that the Rule 613
approach is preferable? Why or why not?
147. Do Commenters believe there are any increased risks as a
result of allowing a broker-dealer to report an initial set of Customer
Account Information and Customer Identifying Information and updates to
such information thereafter to be reported to the Central Repository?
How difficult would it be for the Central Repository to ingest the
Customer Account Information and Customer Identifying information, and
any updates thereafter?
148. Do Commenters believe that the CAT NMS Plan provides
sufficient information to determine whether the Central Repository
could use the initial set of Customer Account Information and Customer
Identifying Information and updates to such information thereafter to
efficiently, reliably and accurately link orders and Reportable Events
to a Customer?
149. Do Commenters believe that reporting an initial set of
Customer Account Information and Customer Identifying Information and
updates to such information thereafter would affect the security and
confidentiality of CAT Data? If so, how? Would reporting an initial set
of Customer Account Information and Customer Identifying Information
and updates to such information result in a different level of security
and confidentiality? If so, please explain.
150. As part of the Customer Identifying Information reported to
the Central Repository, the CAT NMS Plan requires a broker-dealer to
report PII such as the Customer's name, address, date of birth, and
ITIN/SSN. Do Commenters believe there is data that could be reported by
broker-dealers and used by the Central Repository to identify Customers
that is not PII? What types of data would this be? If data other than
PII is used to identify a Customer, do Commenters believe that such
data would be sufficiently unique to ensure that Customers can be
accurately identified by the Central Repository?
151. If data other than PII is used by the Central Repository to
identify a Customer, would the use of such data affect the quality or
completeness of the CAT audit trail, as compared to the use of PII to
identify a Customer?
152. Do Commenters believe that if broker-dealers reported data
other than PII to identify Customers, the accessibility and timeliness
of the data collected and maintained under the CAT would be affected?
If the data would be affected, in what way(s)?
153. Would relying on data other than PII to identify a Customer be
a more efficient and cost-effective way to identify Customers, as
compared to relying on PII to identify a Customer?
154. Do Commenters believe that there would be increased risks to
the reliability of the CAT audit trail data if broker-dealers were
required to identify a Customer with data that does not include PII?
155. If broker-dealers report data other than PII to identify
Customers, do Commenters believe that the Central Repository could
efficiently, reliably
[[Page 30644]]
and accurately link orders and Reportable Events to a Customer?
156. Do Commenters believe that the proposed CAT NMS Plan provides
sufficient information to determine when broker-dealers would report
the ``Account Effective Date'', rather than the date the Customer's
account was opened as required by Rule 613? Is there any ambiguity in
the circumstances under which a broker-dealer would report an ``Account
Effective Date'' rather than the date a Customer's account was opened?
157. Do Commenters believe reporting of the ``Account Effective
Date'' rather than the account open date for a Customer's account under
the Rule 613 approach would affect the quality, accuracy, completeness,
accessibility or timeliness of the CAT data? If it does, what
additional requirements or details should be provided in the CAT NMS
Plan prior to the Commission's approval of such Plan? Or do Commenters
believe that the Rule 613 approach is preferable? Why or why not?
158. Do Commenters believe that reporting the ``Account Effective
Date'' would provide sufficient information to the Central Repository
to facilitate the ability of the Plan Processor to link a Customer's
account with the Customer?
159. Do Commenters believe that allowing the reporting of the
``Account Effective Date'' would be more efficient and cost-effective
than requiring the Rule 613 approach of reporting of a Customer's
account open date? Or do Commenters believe that the Rule 613 approach
is preferable? Why or why not? Would allowing CAT Reporters to report
the ``Account Effective Date'' rather than the date a Customer's
account was opened merely transfer the costs from individual CAT
Reporters to the Central Repository?
160. Do Commenters agree that the proposed approach for reporting
the ``Account Effective Date,'' which differs depending on whether the
account was established before or after the commencement of reporting
audit trail data to the Central Repository as set forth in the CAT NMS
Plan, is a reasonable approach? Why or why not?
161. The Commission granted an exemption from Rule 613 to permit
the alternative of allowing CAT Reporters to report whether the
modification or cancellation of an order was given by a Customer, or
initiated by a broker-dealer or exchange, in lieu of requiring the
reporting of the Customer-ID of the person giving the modification or
cancellation instruction, to be included in the CAT NMS Plan and
subject to notice and comment. To what extent does the approach
permitted by the exemption affect the completeness of the CAT? Would
the information lost under the approach permitted by the exemption
affect investigations or surveillances? If so, how?
8. Order Allocation Information
Section 6.4(d)(ii)(A)(1) of the CAT NMS Plan provides that each
Participant through its Compliance Rule must require that Industry
Members record and report to the Central Repository an Allocation
Report that includes the Firm Designated ID when an execution is
allocated in whole or part.\200\ The CAT NMS Plan defines an Allocation
Report as ``a report made to the Central Repository by an Industry
Member that identifies the Firm Designated ID for any account(s),
including subaccount(s), to which executed shares are allocated and
provides the security that has been allocated, the identifier of the
firm reporting the allocation, the price per share of shares allocated,
the side of shares allocated, the number of shares allocated to each
account, and the time of the allocation.'' \201\ The CAT NMS Plan
explains, for the avoidance of doubt, that an Allocation Report shall
not be required to be linked to particular orders or executions.\202\
---------------------------------------------------------------------------
\200\ See CAT NMS Plan, supra note 3, at Section
6.4(d)(ii)(A)(1); see also April 2015 Supplement, supra note 16. The
SROs requested exemptive relief from Rule 613 so that the CAT NMS
Plan may permit Industry Members to record and report to the Central
Repository an Allocation Report that includes the Firm Designated ID
when an execution is allocated in whole or part in lieu of requiring
the reporting of the account number for any subaccount to which an
execution is allocated, as is required by Rule 613. See Exemptive
Request Letter, supra note 16, at 26-27. The Commission granted
exemptive relief on March 1, 2016 in order to allow this alternative
to be included in the CAT NMS Plan and subject to notice and
comment. See Exemption Order, supra note 18.
\201\ See CAT NMS Plan, supra note 3, at Section 1.1; see also
April 2015 Supplement, supra note 16.
\202\ See CAT NMS Plan, supra note 3, at Section 1.1.
---------------------------------------------------------------------------
Request for Comment
162. The Commission granted an exemption from Rule 613 in order to
allow the alternative of permitting the CAT NMS Plan to provide that
Industry Members record and report to the Central Repository an
Allocation Report that includes the Firm Designated ID when an
execution is allocated in whole or part. This alternative is in lieu of
the requirement in Rule 613 that Industry Members must report the
account number for any subaccount to which an execution is
allocated.\203\ Do Commenters believe that providing the information
required in an Allocation Report as a means to identify order events
and information related to the subaccount allocation information (the
``Allocation Report Approach'') would be more efficient and cost-
effective than the Rule 613 approach requiring the reporting of the
account number for any subaccount to which an execution is allocated?
Or do Commenters believe that the Rule 613 approach is preferable? Why
or why not?
---------------------------------------------------------------------------
\203\ See Exemption Order, supra note 18.
---------------------------------------------------------------------------
163. Do Commenters believe that the Allocation Report Approach
would affect the completeness of CAT Data? If so, how? Would the
Allocation Report Approach result in more complete CAT Data? If so,
please explain.
164. Do Commenters believe that the Allocation Report Approach
would affect the accessibility of allocation information? If so, how?
Would the Allocation Report Approach result in more accessible CAT
Data? If so, please explain.
165. Do Commenters believe that the Allocation Report Approach
would affect the timeliness of allocation information? If so, how?
Would the Allocation Report Approach result in more timely CAT Data? If
so, please explain.
166. Do Commenters believe the Allocation Report Approach would
affect the security and confidentiality of CAT Data? If so, how? Would
the Allocation Report Approach result in a different level of security
or confidentiality? If so, please explain.
167. Do Commenters believe that the Allocation Report Approach
described by the SROs is feasible? What challenges or risks would CAT
Reporters face in providing such information? What challenges or risks
would the Plan Processor face when ingesting such information and
linking it to the appropriate Customers' accounts?
9. Options Market Maker Quotes
Section 6.4(d)(iii) of the CAT NMS Plan states that, with respect
to the reporting obligations of an Options Market Maker under Sections
6.3(d)(ii) and (iv) regarding its quotes \204\ in Listed Options, such
quotes shall be reported to the Central Repository by the relevant
Options Exchange in lieu of reporting by the Options Market Maker.\205\
Section
[[Page 30645]]
6.4(d)(iii) further states that each Participant that is an Options
Exchange shall, through its Compliance Rule, require its Industry
Members that are Options Market Makers to report to the Options
Exchange the time at which a quote in a Listed Option is sent to the
Options Exchange (and, if applicable, the time of any subsequent quote
modification and/or cancellation where such modification or
cancellation is originated by the Options Market Maker).\206\ Such time
information also shall be reported to the Central Repository by the
Options Exchange in lieu of reporting by the Options Market Maker.\207\
---------------------------------------------------------------------------
\204\ Rule 613(c)(7) provides that the CAT NMS Plan must require
reporting of the details for each order and each Reportable Event,
including the routing and modification or cancellation of an order.
17 CFR 242.613(c)(7). Rule 613(j)(8) defines ``order'' to include
``any bid or offer.'' 17 CFR 242.613(j)(8).
\205\ See CAT NMS Plan, supra note 3, at Section 6.4(d)(iii).
The SROs requested exemptive relief from Rule 613 so that the CAT
NMS Plan may permit Options Market Maker quotes to be reported to
the Central Repository by the relevant Options Exchange in lieu of
requiring that such reporting be done by both the Options Exchange
and the Options Market Maker, as is required by Rule 613. See
Exemptive Request Letter, supra note 16, at 2. In accord with the
exemptive relief requested, the SROs committed to require Options
Market Makers to report to the Exchange the time at which a quote in
a Listed Option is sent to the Options Exchange. Id. at 3. The
Commission granted exemptive relief on March 1, 2016 in order to
allow this alternative to be included in the CAT NMS Plan and
subject to notice and comment. See Exemption Order, supra note 18.
\206\ See CAT NMS Plan, supra note 3, at Section 6.4(d)(iii).
\207\ Id.
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Request for Comment
168. The Commission granted an exemption from Rule 613 in order to
allow the alternative of permitting Options Exchanges to report Options
Market Maker quotes to the Central Repository in lieu of requiring such
reporting by both the Options Exchange and the Options Market Maker as
is required by Rule 613, to be included in the CAT NMS Plan and subject
to notice and comment.\208\ Do Commenters believe that permitting
exchanges to report quote information sent to them by Options Market
Makers, including the Quote Sent Time, to the Central Repository would
affect the completeness or quality of CAT Data? If so, what information
would be missing?
---------------------------------------------------------------------------
\208\ See Exemption Order, supra note 18.
---------------------------------------------------------------------------
169. Under Rule 613, Options Market Makers would report their
quotes to the Central Repository and time stamps would be attached to
such quotes. Under the exemption, Options Market Makers would include
the Quote Sent Time when sending quote information to the Options
Exchanges. What, if any, are the risks of permitting the Options
Exchanges to report information Options Market Makers otherwise would
be required to report?
170. Do Commenters believe that the cost savings from permitting
Options Exchanges to report information Options Market Makers would
otherwise have to report makes this a preferable approach than Rule
613?
10. Error Rates
The CAT NMS Plan defines Error Rate as ``the percentage of
[R]eportable [E]vents collected by the [C]entral [R]epository in which
the data reported does not fully and accurately reflect the order event
that occurred in the market.'' \209\ Under the CAT NMS Plan, the
Operating Committee sets the maximum Error Rate that the Central
Repository would tolerate from a CAT Reporter reporting data to the
Central Repository.\210\ The Operating Committee reviews and resets the
maximum Error Rate, at least annually.\211\ If a CAT Reporter reports
CAT Data to the Central Repository with errors such that their error
percentage exceeds the maximum Error Rate, then such CAT Reporter would
not be in compliance with the CAT NMS Plan or Rule 613.\212\ As such,
``the Participants as Participants or the SEC may take appropriate
action for failing to comply with the reporting obligations under the
CAT NMS Plan and SEC Rule 613.'' \213\ The CAT NMS Plan, however, does
not detail what specific compliance enforcement provisions would apply
if a CAT Reporter exceeds the maximum Error Rate.
---------------------------------------------------------------------------
\209\ See CAT NMS Plan, supra note 3, at Section 1.1; see also
Rule 613(j)(6).
\210\ See id. at Section 6.5(d)(i).
\211\ See id. at Appendix C, Section A.3(b).
\212\ See id. at Appendix C, Section A.3(b) and Rule 613(g) and
(h).
\213\ See id. at Appendix C, Section A.3(b).
---------------------------------------------------------------------------
The CAT NMS Plan sets the initial maximum Error Rate at 5% for any
data reported pursuant to subparagraphs (3) and (4) of Rule
613(c).\214\ The SROs highlight that ``the Central Repository will
require new reporting elements and methods for CAT Reporters and there
will be a learning curve when CAT Reporters begin to submit data to the
Central Repository'' in support of a 5% initial rate.\215\ Further, the
SROs state that ``many CAT Reporters may have never been obligated to
report data to an audit trail.'' \216\ The SROs believe an initial
maximum Error Rate of 5% ``strikes the balance of making allowances for
adapting to a new reporting regime, while ensuring that the data
provided to regulators will be capable of being used to conduct
surveillance and market reconstruction.'' \217\ In the CAT NMS Plan,
the Participants compared the contemplated Error Rates of CAT Reporters
to the error rates of OATS reporters in the time periods immediately
following three significant OATS releases in the last ten years.\218\
The Participants state that for the three comparative OATS releases:
\219\ An average of 2.42% of order events did not pass systemic
validations; an average of 0.36% of order events were not submitted in
a timely manner; an average of 0.86% of orders were unsuccessfully
matched to a trade reporting facility trade report; an average of 3.12%
of OATS Route Reports were unsuccessfully matched to an exchange order;
and an average of 2.44% of OATS Route Reports were unsuccessfully
matched to a report by another reporting entity.\220\
---------------------------------------------------------------------------
\214\ See id. at Section 6.5(d)(i).
\215\ See id. at Appendix C, Section A.3(b).
\216\ See id.
\217\ See id.
\218\ See id. The SROs note that the three comparative releases
are known as ``(1) OATS Phase III, which required manual orders to
be reported to OATS; (2) OATS for OTC Securities which required OTC
equity securities to be reported to OATS; and (3) OATS for NMS which
required all NMS stocks to be reported to OATS.'' Id.
\219\ See id. The SROs note that the calculated ``combined
average error rates for the time periods immediately following [the
OATS] release across five significant categories for these three
releases'' was used in setting in the initial maximum Error Rate.
Id.
\220\ See id.
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The Participants, moreover, anticipate reviewing and resetting the
maximum Error Rate once Industry Members (excluding Small Industry
Members) begin to report to the Central Repository and again once Small
Industry Members report to the Central Repository.\221\
---------------------------------------------------------------------------
\221\ See id.
---------------------------------------------------------------------------
The Participants thus propose a phased approach to lowering the
maximum Error Rates among CAT Reporters based on the period of time
reporting to the Central Repository and whether the CAT Reporters are
Participants, large broker-dealers or small broker-dealers.\222\ The
Plan sets forth a goal of the following maximum Error Rates \223\ where
``Year(s)'' refers to year(s) after the CAT NMS Plan's date of
effectiveness:
---------------------------------------------------------------------------
\222\ See id.
\223\ See id.
[[Page 30646]]
Table 1--Maximum Error Rates Schedule
----------------------------------------------------------------------------------------------------------------
One year % Two years % Three years % Four years %
----------------------------------------------------------------------------------------------------------------
Participants.................................... 5 1 1 1
Large Industry Members.......................... N/A 5 1 1
Small Industry Members.......................... N/A N/A 5 1
----------------------------------------------------------------------------------------------------------------
The CAT NMS Plan requires that the Plan Processor to: (i) Measure
and report errors every business day; \224\ (ii) provide CAT Reporters
daily statistics and error reports as they become available, including
a description of such errors; \225\ (iii) provide monthly reports to
CAT Reporters that detail a CAT Reporter's performance and comparison
statistics; \226\ (iv) define educational and support programs for CAT
Reporters to minimize Error Rates; \227\ and (v) identify, daily, all
CAT Reporters exceeding the maximum allowable Error Rate.\228\ To
timely correct data-submitted errors to the Central Repository, the
Participants require that the Central Repository receive and process
error corrections at all times.\229\ Further, the CAT NMS Plan requires
that CAT Reporters be able to submit error corrections to the Central
Repository through a web-interface or via bulk uploads or file
submissions, and that the Plan Processor, subject to the Operating
Committee's approval, support the bulk replacement of records and the
reprocessing of such records.\230\ The Participants, furthermore,
require that the Plan Processor identify CAT Reporter data submission
errors based on the Plan Processor's validation processes.\231\
---------------------------------------------------------------------------
\224\ See id. The CAT NMS Plan sets forth that the Plan
Processor shall provide the Operating Committee with regular Error
Rate reports. Id. at Section 6.1(o)(v). The Error Rate reports shall
include each of the following--if the Operating Committee deems them
necessary or advisable--``Error Rates by day and by delta over time,
and Compliance Thresholds by CAT Reporter, by Reportable Event, by
age before resolution, by symbol, by symbol type (e.g., ETF and
Index) and by event time (by hour and cumulative on the hour)[.]''
Id.
\225\ See id. at Appendix C, Section A.3(b).
\226\ See id.
\227\ See id. at Appendix D, Section 10.1. The CAT NMS Plan sets
forth support programs that shall include educational programs,
including FAQs, a dedicated help desk, industry-wide trainings,
certifications, industry-wide testing, maintaining Technical
Specifications with defined intervals for new releases/updates,
emailing CAT Reporter data outliers, conducting annual assessments,
using test environments prior to releasing new code to production,
and imposing CAT Reporter attendance requirements for testing
sessions and educational and industry-wide trainings. Id.
\228\ See id. at Appendix D, Section 10.4.
\229\ See id. at Appendix C, Section A.3(b).
\230\ See id.
\231\ See id. At a minimum, the processes would include
validating the data's file format, CAT Data format, type,
consistency, range, logic, validity, completeness, timeliness and
linkage. See id. at Appendix D, Section 7.2.
---------------------------------------------------------------------------
Request for Comment \232\
---------------------------------------------------------------------------
\232\ See Section IV.E.4, infra, for further Error Rate related
requests for comment.
---------------------------------------------------------------------------
171. Do Commenters believe the CAT NMS Plan's initial maximum Error
Rate of 5% for CAT Data reported to the Central Repository is
appropriate in light of OATS' current error rate of less than 1%? \233\
Why or why not?
---------------------------------------------------------------------------
\233\ See Section IV.E.1.b(1), infra.
---------------------------------------------------------------------------
172. Please provide examples of error rates that are generally
accepted with respect to other regulatory data reporting systems. At
what error rate should data be considered materially unreliable? Please
explain.
173. Do Commenters believe the CAT NMS Plan's initial maximum Error
Rate of 5% would negatively affect the quality of CAT Data? Why or why
not? In explaining why or why not, please address each quality
(accuracy, completeness, timeliness and accessibility) separately.
174. Do Commenters believe that it was reasonable for the
Participants to compare the contemplated Error Rates of CAT Reporters
to the error rates of OATS reporters in the time periods immediately
following three significant OATS releases in the last ten years? Why or
why not?
175. If not 5%, what initial maximum Error Rate do Commenters
believe Participants and Industry Members should be subject to and why?
176. What impact, if any, do Commenters believe a 5% initial
maximum Error Rate would have on Industry Members' costs of compliance?
Please describe the costs of correcting audit trail data. Given the
costs of correcting audit trail data, do Commenters believe that
establishing a lower maximum Error Rate could be less costly to
Industry Members? Why or why not? How much less costly?
177. What impact, if any, do Commenters believe a 5% initial
maximum Error Rate would have on the timing of the retirement of any
redundant audit trail systems and any related costs? Please explain.
Should the actual Error Rate for CAT Data affect the timing of the
retirement of any redundant audit trail systems? If so, why? If not,
why not?
178. Do Commenters believe the CAT NMS Plan's target maximum Error
Rate of 1% for CAT Data reported to the Central Repository pursuant to
the CAT NMS Plan's phased approach is the appropriate target maximum
Error Rate in light of current industry standards? If not, why not? If
not 1%, what target maximum Error Rate do Commenters believe
Participants and Industry Members should be subject to and why?
179. Do Commenters believe there are any increased risks as a
result of allowing CAT Data subject to an initial maximum Error Rate of
5% to be reported to the CAT? How difficult would it be for the Central
Repository to process and analyze CAT Data based on data reported
subject to an initial maximum Error Rate of 5%? Specifically, what are
the increased risks, if any, of CAT Data reported subject to an Error
Rate of 5% in respect of combining or linking data within the Central
Repository or across other sources of trade and order data currently
available to regulators?
180. Do Commenters believe there are any increased risks as a
result of allowing CAT Data subject to a target maximum Error Rate of
1% to be reported to the CAT? How difficult would it be for the Central
Repository to process and analyze CAT Data based on data reported
subject to a target maximum Error Rate of 1%? Specifically, what are
the increased risks, if any, of CAT Data reported subject to an Error
Rate of 1% in respect of combining or linking data within the Central
Repository or across other sources of trade and order data currently
available to regulators?
181. The CAT NMS Plan provides that the Participants would review
and reset, at least on an annual basis, the maximum Error Rate. Do
Commenters believe that this establishes an appropriately rigorous
schedule for the Participants to evaluate whether the maximum Error
Rate could potentially be set to a lower rate? Are there any other
factors that should affect when and how the maximum Error Rate is set?
182. The CAT NMS Plan provides as a goal a four-year phased
approach schedule to lower the maximum Error
[[Page 30647]]
Rate segmented by Participants, large broker-dealers and small broker-
dealers. Do Commenters believe a phased schedule is appropriate and
reasonable? Do Commenters believe establishing segments is appropriate
and reasonable, and if so are these the appropriate Error Rate
groupings? What alternative groupings, if any, do Commenters believe
are the appropriate Error Rate groupings?
183. Do Commenters believe that the CAT NMS Plan is clear whether
the four-year phased approach is a goal? Should it be more than a goal?
Please explain.
184. Do Commenters believe the phased approach for CAT
implementation, whereby SROs would begin reporting CAT Data one year
prior to other CAT Reporters and two years prior to small CAT
Reporters, would affect the quality of the CAT Data and the number of
available CAT Data items in the audit trail?
185. Do Commenters believe the CAT NMS Plan provides adequate
enforcement provisions to ensure CAT Reporters submit data to the
Central Repository no higher than the maximum Error Rate? If not, what
additional enforcement provisions should the CAT NMS Plan provide?
186. Do Commenters believe that there should be a lower initial
maximum Error Rate and/or a more accelerated or slower reduction of the
target maximum Error Rate? Would an accelerated reduction of the target
maximum Error Rate facilitate the earlier retirement of any redundant
audit trail system? What should the initial maximum Error Rate and/or
what should be the schedule for reducing the target maximum Error Rate?
187. What framework and criteria should regulators adopt when
determining whether to retire potentially redundant regulatory data
reporting systems? Please explain when and how such retirement should
take place.
188. Do Commenters believe the CAT NMS Plan sets forth sufficient
consequences for a CAT Reporter exceeding the maximum Error Rates? If
not, what should be those consequences?
189. Do Commenters believe that some errors are of greater concern
than others? If so, what types of errors are more or less problematic?
Should the type of error be considered when calculating Error Rates? If
so, how should the Plan Processor take into account different types of
errors when calculating Error Rates? How should the Participants take
into account different types of errors when setting Error Rates?
11. Regulatory Access
Under Section 6.5(c) of the CAT NMS Plan, the Plan Processor must
provide regulators access to the Central Repository for regulatory and
oversight purposes and create a method of accessing CAT Data that
includes the ability to run complex searches and generate reports.\234\
Section 6.10(c) requires regulator access by two different methods: (1)
An online targeted query tool with predefined selection criteria to
choose from; and (2) user-defined direct queries and bulk extractions
of data via a query tool or language allowing querying of all available
attributes and data sources.\235\ Additional requirements concerning
regulator access appear in Section 8 of Appendix D.\236\
---------------------------------------------------------------------------
\234\ See CAT NMS Plan, supra note 3, at Section 6.5(c).
Appendix C provides objective milestones to assess progress
concerning regulator access to the Central Repository. See id. at
Appendix C, Section C.10(d).
\235\ Id. at Section 6.10(c). Section 6.10(c) also requires the
Plan Processor to reasonably assist regulatory staff with queries,
submit queries on behalf of regulatory staff as requested, and
maintain a help desk to assist regulatory staff with questions
concerning CAT Data. Id.
\236\ See id. at Appendix D, Section 8.
---------------------------------------------------------------------------
The CAT NMS Plan requires that CAT must support a minimum of 3,000
regulatory users and at least 600 such users accessing CAT concurrently
without an unacceptable decline in performance.\237\ Moreover, CAT must
support an arbitrary number of user roles and, at a minimum, include
defined roles for both basic and advanced regulatory users.\238\
---------------------------------------------------------------------------
\237\ Id. at Appendix D, Section 8.1.
\238\ Id.
---------------------------------------------------------------------------
a. Online Targeted Query Tool
Sections 8.1.1, 8.1.2, and 8.1.3 of Appendix D contain further
specifications for the online targeted query tool.\239\ The tool must
allow for retrieval of processed and/or validated (unlinked) data via
an online query screen that includes a choice of a variety of pre-
defined selection criteria.\240\ Targeted queries must include date(s)
and/or time range(s), as well as one or more of a variety of fields
listed in Section 8.1.1 (e.g., product type, CAT-Reporter-ID, and
Customer-ID).\241\ Targeted queries would be logged such that the Plan
Processor could provide monthly reports to the SROs concerning metrics
on performance and data usage of the search tool.\242\ The CAT NMS Plan
further requires that acceptable response times for the targeted search
be in increments of less than one minute; for complex queries scanning
large volumes of data or large result sets (over one million records)
response times must be available within 24 hours of the request; and
queries for data within one business date of a 12-month period must
return results within three hours regardless of the complexity of
criteria.\243\ Under the CAT NMS Plan, regulators may access all CAT
Data except for PII data (access to which would be limited to an
authorized subset of Participant and Commission employees) and the Plan
Processor must work with regulators to implement a process for
providing them with access and routinely verifying a list of active
users.\244\
---------------------------------------------------------------------------
\239\ Id. at Appendix D, Sections 8.1.1-8.1.3.
\240\ Id. at Appendix D, Section 8.1.1.
\241\ Id.
\242\ Id.
\243\ Id. at Appendix D, Section 8.1.2. Appendix D, Section
8.1.2 contains further performance requirements applicable to data
and the architecture of the online query tool. Id.
\244\ Id. at Appendix D, Section 8.1.3.
---------------------------------------------------------------------------
b. User-Defined Direct Queries and Bulk Extraction of Data
Section 8.2 of Appendix D outlines the requirements for user-
defined direct queries and bulk extraction of data, which regulators
would use to obtain large data sets for internal surveillance or market
analysis.\245\ Under the CAT NMS Plan, regulators must be able to
create, save, and schedule dynamic queries that would run directly
against processed and/or unlinked CAT Data.\246\ Additionally, CAT must
provide an open application program interface (``API'') that allows use
of analytic tools and database drivers to access CAT Data.\247\ Queries
submitted through the open API must be auditable and the CAT System
must contain the same level of control, monitoring, logging, and
reporting as the online targeted query tool.\248\ The Plan Processor
must also provide procedures and training to regulators that would use
the direct query feature.\249\ Sections 8.2.1 and 8.2.2 of Appendix D
contain additional specifications for user-defined direct queries and
bulk data extraction, respectively.\250\
---------------------------------------------------------------------------
\245\ Id. at Appendix D, Section 8.2.
\246\ Id.
\247\ Id.
\248\ Id. Direct queries must not return or display PII data but
rather display non-PII unique identifiers (e.g., Customer-ID or Firm
Designated ID). The PII corresponding to these identifiers could be
gathered using the PII workflow described in Appendix D, Data
Security, PII Data Requirements. See id. at Appendix D, Section
4.1.6.
\249\ Id. at Appendix D, Section 8.2.
\250\ Id. at Appendix D, Sections 8.2.1 and 8.2.2.
---------------------------------------------------------------------------
c. Regulatory Access Schedule
Section A.2 of Appendix C addresses the time and method by which
CAT
[[Page 30648]]
Data would be available to regulators.\251\ Section A.2(a) requires
that data be available to regulators any point after the data enters
the Central Repository and passes basic format validations.\252\ After
errors are communicated to CAT Reporters on T+1, CAT Reporters would be
required to report corrected data back to the Central Repository by 8
a.m. Eastern Time on T+3.\253\ Regulators must then have access to
corrected and linked Order and Customer data by 8:00 a.m. Eastern Time
on T+5.\254\ Section A.2(b) generally describes Bidders' approaches
regarding regulator access and use of CAT Data and notes that although
the SROs set forth the standards the Plan Processor must meet, they do
not endorse any particular approach.\255\ Section A.2(c) outlines
requirements the Plan Processor must meet for report building and
analysis regarding data usage by regulators, consistent with, and in
addition to, the specifications outlined in Section 8 of Appendix
D.\256\
---------------------------------------------------------------------------
\251\ Id. at Appendix C, Section A.2.
\252\ Id. at Appendix C, Section A.2(a). Appendix C, Section
A.3(e) indicates this would be no later than noon EST on T+1. Id. at
Appendix C, Section A.3(e).
\253\ Id. at Appendix C, Section A.1(a)(iv); Appendix D, Section
6.1.
\254\ Id. at Appendix C, Section A.2(a).
\255\ Id. at Appendix C, Section A.2(b).
\256\ Id. at Appendix C, Section A.2(c). Appendix C, Section
A.2(d) addresses system service level agreements that the SROs and
Plan Processor would enter into. Id. at Appendix C, Section A.2(d).
---------------------------------------------------------------------------
Request for Comment \257\
---------------------------------------------------------------------------
\257\ See Section IV.H.5, infra, for further regulatory access
related requests for comment.
---------------------------------------------------------------------------
190. Do Commenters believe the CAT NMS Plan's ``Functionality of
the CAT System'' Section (Section 8 of Appendix D) describes with
sufficient detail how a regulator would access, use and analyze CAT
Data? If not, describe what, if any, additional requirements and
details should be provided and how.
191. Do Commenters believe the CAT NMS Plan's ``Functionality of
the CAT System'' Section sufficiently addresses all regulators' end-
user requirements? If not, please explain. Describe what, if any,
additional requirements and details should be provided and how.
192. If Commenters believe that the CAT NMS Plan's ``Functionality
of the CAT System'' Section does not cover all regulators' end-user
requirements, please describe how regulators would integrate their
applications in a timely and reasonable manner.
193. The CAT NMS Plan permits the CAT to be implemented in a way
that would (1) require regulators to download entire data sets and
analyze such data within the regulator or the regulators' cloud or (2)
permit regulators to analyze sets of data within the CAT using
applications or programs selected by the Commission. What do Commenters
believe are the advantages and disadvantages to each approach?
194. Do Commenters believe the CAT NMS Plan's T+5 schedule for
regulatory access to corrected and linked Order and Customer data is
the appropriate schedule in light of current industry standards? If
not, why not? Do Commenters believe that the SROs' determination of
current industry standards is reasonable or appropriate? Do Commenters
believe that it is appropriate to base the timing for regulatory access
on industry standards? Why or why not?
195. If the T+5 schedule is not appropriate, when do Commenters
believe regulatory access to corrected and linked Order and Customer
data should be provided and why? Do Commenters believe the SROs' should
include in the CAT NMS Plan detailed provisions with milestones in
achieving a more accelerated regulatory access schedule to corrected
and linked Order and Customer data?
196. Do Commenters believe the Plan's proposed error correction
timeframe--i.e., communication of errors on T+1, corrected data
resubmitted by CAT Reporters by T+3, and corrected data available to
regulators by T+5--is feasible and appropriate in light of current
industry standards? If not, why not, and how long do Commenters believe
these error correction timeframes should be and why? Are shorter
timeframes feasible and appropriate in light of current industry
standards? Why or why not?
197. To what extent do Commenters believe the CAT NMS Plan's T+5
regulatory access schedule to corrected and linked Order and Customer
data would affect the accuracy, completeness, accessibility and/or
timeliness of CAT Data collected and maintained under the CAT? How?
198. To what extent do Commenters believe the Plan's three-day
window of error correction would affect the accuracy, completeness,
accessibility and/or timeliness of CAT Data collected and maintained
under the CAT? How?
199. Regulators' technology teams would be required to work with
the Plan Processor to integrate their applications under the CAT NMS
Plan. What, if any, are the risks to this approach? Should the Plan
Processor be required to enter into support contracts with regulators?
If so, please explain. Describe what, if any, service contract terms
should be set forth in the CAT NMS Plan or set forth in any related
documents. Do Commenters have any concerns about the security or
confidentiality of CAT Data resulting from a service contract between
the Plan Processor and the regulators? If so, please explain. If
Commenters have any security or confidentiality concerns resulting from
a service contract between the Plan Processor and the regulators,
please specify any appropriate service contract terms that would
address the concerns.
200. How do Commenters believe the Plan Processor should set
pricing for a regulator seeking additional functionality from the Plan
Processor under the CAT? What, if anything, do Commenters believe
should govern pricing for additional functionality by the Plan
Processor? For example, should pricing or contract standards (e.g.,
reasonable, commercially reasonable, etc.), agreed-upon profit
margins--or minimums and maximums, etc.--be included under the CAT NMS
Plan or any related documentation? If so, please explain.
201. Do Commenters believe the CAT NMS Plan appropriately
encourages or incentivizes the Participants and the Plan Processor to
incorporate new technology and to innovate? Does the CAT NMS Plan
appropriately encourage or incentivize the Plan Processor to have a
flexible and scalable solution? Do Commenters believe that the CAT NMS
Plan would result in a CAT that has adequate system flexibility and
scalability to incorporate improvements in technology and future
regulatory, analytic and data capture needs? Why or why not?
202. Does the regulatory access approach set forth in the CAT NMS
Plan provide regulators with sufficient tools to maximize their
regulatory activities, actions, and improve their surveillances? If
not, why not and what should be added?
203. The CAT NMS Plan provides that targeted queries and data
extractions would be logged so that the Plan Processor can provide the
Operating Committee, the Participants, and the Commission with monthly
performance and usage reports including data such as the user ID of the
person submitting the query and the parameters of the query. Do
Commenters believe that the data to be recorded in these logs and
provided in these reports to each Participant and to the SEC would be
appropriate and useful? Should any data elements be added or removed
from these reports?
204. Do Commenters believe it is appropriate for the Plan Processor
and the Operating Committee to also have access to these logs and
monthly performance and usage reports? How should the Plan Processor
and
[[Page 30649]]
Operating Committee be permitted to use these logs and reports? To the
extent that these logs and reports are accessible by the Plan Processor
and the Operating Committee, should any data elements be added or
removed? Should additional details or requirements be added to the CAT
NMS Plan to clarify what the content of these logs and reports would be
and which parties would have access to them?
12. Security, Confidentiality, and Use of Data
The CAT NMS Plan provides that the Plan Processor is responsible
for the security and confidentiality of all CAT Data received and
reported to the Central Repository, including during all communications
between CAT Reporters and the Plan Processor, data extraction, data
manipulation and transformation, loading to and from the Central
Repository, and data maintenance by the Central Repository.\258\ The
Plan Processor must, among other things, require that individuals with
access to the Central Repository agree to use CAT Data only for
appropriate surveillance and regulatory activities and to employ
safeguards to protect the confidentiality of CAT Data.\259\
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\258\ See CAT NMS Plan, supra note 3, at Section 6.5(f)(i),
(iv).
\259\ Id. at Section 6.5(f)(i).
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In addition, the Plan Processor must develop a comprehensive
information security program as well as a training program that
addresses the security and confidentiality of all information
accessible from the CAT and the operational risks associated with
accessing the Central Repository.\260\ The Plan Processor must also
designate one of its employees as Chief Information Security Officer;
among other things, the Chief Information Security Officer is
responsible for creating and enforcing appropriate policies,
procedures, and control structures regarding data security.\261\ The
Technical Specifications, which the Plan Processor must publish, must
include a detailed description of the data security standards for
CAT.\262\
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\260\ Id. at Sections 6.1(m), 6.12.
\261\ Id. at Section 6.2(b).
\262\ Id. at Section 6.9.
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Appendix D of the CAT NMS Plan sets forth minimum data security
requirements for CAT that the Plan Processor must meet.\263\ For
example, Appendix D enumerates various connectivity, data transfer, and
encryption requirements such as that the CAT System must have encrypted
internet connectivity, CAT Reporters must connect to CAT infrastructure
using secure methods such as private lines or virtual private network
connections over public lines, CAT Data must be encrypted in flight
using industry standard best practices, PII data must be encrypted both
at rest and in flight, and CAT Data stored in a public cloud must be
encrypted at rest.\264\ Additional requirements regarding data storage,
data access, breach management, and PII data are also specified in
Appendix D.\265\
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\263\ Id. at Appendix D, Section 4.
\264\ Id. at Appendix D, Section 4.1.1, 4.1.2.
\265\ Id. at Appendix D, Section 4.1.3-4.1.6.
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In addition, the Participants must establish and enforce policies
and procedures that ensure the confidentiality of the CAT Data obtained
from the Central Repository, limit the use of CAT Data obtained from
the Central Repository solely for surveillance and regulatory
purposes,\266\ implement effective information barriers between each
Participant's regulatory and non-regulatory Staff with regard to CAT
Data, and limit access to CAT Data to designated persons.\267\ However,
a Participant may use the Raw Data \268\ it reports to the Central
Repository for ``commercial or other'' purposes if not prohibited by
applicable law, rule or regulation.\269\
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\266\ The Commission notes that regulatory purposes includes,
among other things, analysis and reconstruction of market events,
market analysis and research to inform policy decisions, market
surveillance, examinations, investigations, and other enforcement
functions.
\267\ Id. at Section 6.5(f)(ii), (g).
\268\ Raw data is defined as ``Participant Data and Industry
Member Data that has not been through any validation or otherwise
checked by the CAT System.'' Id. at Section 1.1.
\269\ Id. at Section 6.5(f)(i).
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Request for Comment
205. Do Commenters believe that the CAT NMS Plan appropriately
allocates responsibility for the security and confidentiality of CAT
Data among the Participants, the Plan Processor, and other parties? If
not, how should these responsibilities be allocated?
206. Do Commenters believe that the data security requirements set
out in Appendix D are appropriate and reasonable? Should any additional
details or requirements be provided?
207. What, if any, specific details or requirements regarding data
security and confidentiality do Commenters believe should be included
in the information security program, training program, and Technical
Specifications to be developed by the Plan Processor? Should additional
details on the content of these programs and specifications be
provided?
208. What, if any, specific details or requirements regarding data
confidentiality do Commenters believe should be included in the
policies and procedures to be developed by the Participants? Should
additional details on the content of these policies and procedures be
provided?
209. Do Commenters believe that the CAT NMS Plan includes
sufficient safeguards to prevent the misuse of CAT Data by employees or
agents of the Participants or other persons with access to the Central
Repository? For example, do Commenters believe that requiring
information barriers between regulatory and non-regulatory staff \270\
and permitting the use of CAT Data only for regulatory, surveillance,
and commercial or other purposes as permitted by law \271\ are
effective measures to prevent the misuse of CAT Data? Should the CAT
NMS Plan set forth additional detail regarding the distinction between
regulatory and non-regulatory staff and between the appropriate and
inappropriate use of CAT Data for commercial or other purposes? Should
the CAT NMS Plan prescribe any specific information barriers? If so,
what should be prescribed in the CAT NMS Plan?
---------------------------------------------------------------------------
\270\ See id. at Section 6.5(f)(ii)(A).
\271\ See id. at Section 6.5(f)(i)(A).
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210. Do Commenters believe the data access and breach management
provisions described in Appendix D of the CAT NMS Plan \272\ are
effective mechanisms for monitoring and preventing the misuse of CAT
Data? Why or why not? Would any additional details or requirements make
these provisions more effective?
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\272\ See id. at Appendix D, Sections 4.1.4, 4.1.5.
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211. Which persons or entities should have the responsibility to
monitor for and prevent the misuse of CAT Data? For example, should the
Chief Compliance Officer or the Chief Information Security Officer have
this responsibility? Why or why not? Should additional details be
provided to clarify where this responsibility lies?
212. Do Commenters believe it is appropriate for Participants to be
permitted to use all Raw Data reported to the Central Repository for
commercial purposes? If not, what particular types of Raw Data would be
inappropriate to use for commercial purposes?
213. Do Commenters believe that the CAT NMS Plan adequately
addresses the protection and security of PII in CAT? If not, why not
and what should be added to the CAT NMS Plan? For example, should the
CAT NMS Plan provide that PII is accessible only when required, that
PII be properly masked,
[[Page 30650]]
and/or that it be safeguarded such that it would not be improperly
accessible?
214. Do Commenters believe that there are alternative methods or
information that could be used in lieu of requiring the reporting of
Customer PII to the Central Repository that, without diminishing the
quality of CAT Data available to regulators or impairing regulators'
ability to use CAT Data to carry out their functions, would create less
risk of a breach of the security or confidentiality of the personal
information of Customers? If so, what methods or information,
specifically, could serve as such an alternative to PII? \273\
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\273\ See Section III.B.7, supra, for additional PII related
requests for comment.
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215. Do Commenters believe that the CAT NMS Plan includes adequate
requirements regarding the operational security of the CAT System?
What, if any, additional details or requirements should be provided?
Should the CAT NMS Plan require the Plan Processor to have the ability
to monitor for threats, attacks, and anomalous activity on a 24/7 basis
through a Security Operations Center (``SOC'') or a similar capability?
What would be the costs and benefits of such a requirement?
216. Appendix C of the CAT NMS Plan discusses solutions for
encrypting data at rest and in motion. Appendix D of the CAT NMS Plan
states that all CAT Data must be encrypted in flight, and PII Data must
encrypted in flight and at rest. Do Commenters believe that the Plan's
data encryption requirements are adequate for CAT Data and PII Data?
Why or why not? Do Commenters believe that the CAT NMS Plan provides
sufficient information and clarity regarding data encryption
requirements? Do Commenters believe that there is a particular method
for data encryption, in motion and/or at rest, that should be used?
217. Appendix D, Section 4.1.1 of the CAT NMS Plan states that the
CAT System must have ``encrypted internet connectivity.'' What are the
risks, if any, of allowing Internet access from the Central Repository,
even if encrypted? Please explain. Do Commenters believe that the
encrypted connection requirement in the CAT NMS Plan should apply to
communication paths from the Central Repository to the Internet and/or
connections from CAT to/from trusted parties? What challenges would the
Plan Processor face in implementing either option? Does one option
provide more robust security than the other? Why or why not?
218. To the extent the requirement for ``encrypted internet
connectivity'' applies to connectivity between the Central Repository
and trusted parties such as the Commission and the Participants, do
Commenters believe that the CAT NMS Plan should require that these
parties and the Plan Processor enter into formal Memoranda of
Understanding or Interconnection Security Agreements that document the
technical, operational, and management details regarding the interface
between the CAT System and these parties? Why or why not?
219. With respect to industry standards, do Commenters believe that
the CAT NMS Plan should be updated to include standards and
requirements of other NIST Special Publications (``SPs'') that were not
mentioned in Appendix D (e.g., NIST SP 800-86 for incident handling,
800-44 for securing public-facing web servers, 800-146 for cloud
security)? Why or why not?
220. Do Commenters believe that the Plan should be updated more
broadly to include the NIST family of guidance documents? Why or why
not?
221. Throughout the Plan, there are numerous references to
leveraging ``industry best practices'' pertaining to compliance
subjects such as system assessments and disaster recovery/business
continuity planning. How do ``industry best practices'' compare to NIST
guidance in these areas? Do Commenters believe that the Plan Processor
should implement NIST guidance for the Plan rather than industry best
practices? Why or why not?
222. The CAT NMS Plan states that the Plan Processor must conduct
third party risk assessments at regular intervals to verify that
security controls implemented are in accordance with NIST SP 800-
53.\274\ Do Commenters believe that the CAT NMS Plan should adopt the
meaning and terminology of Security Assessment and Authorization as
defined by the NIST and/or other NIST guidance in the CAT NMS Plan,
particularly within the requirements set forth in Appendix D to the CAT
NMS Plan? Why or why not?
---------------------------------------------------------------------------
\274\ See CAT NMS Plan, supra note 3, at Appendix D, Section
5.3.
---------------------------------------------------------------------------
223. Do Commenters believe that the CAT NMS Plan should include
requirements regarding how the Plan Processor should categorize data
from a security perspective? For example, should the Plan Processor be
required to implement data categorization standards consistent with
Federal Information Processing Standard (``FIPS'') 199 or NIST SP 800-
60? Why or why not? Would including data categorization requirements in
the CAT NMS Plan improve data integrity, availability, segmentation,
auditing, and incident response? Why or why not?
224. The CAT NMS Plan provides that CAT must follow NIST SP 800-
137--Information Security Continuous Monitoring for Federal Information
Systems and Organizations in addition to a limited number of related
monitoring provisions.\275\ Do Commenters believe that the CAT NMS Plan
provides sufficient and robust information related to continuous
monitoring program requirements? Why or why not?
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\275\ See id. at Sections 6.1(g), 6.10(c), Appendix C, Section
A.4, Appendix D, Sections 2.2, 4.1.2, 4.1.4, 4.2, 8.3, 8.4.
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225. Do Commenters believe the CAT NMS Plan adequately sets forth
the roles and responsibilities of independent third party risk
assessment functions, including the consistent description of their
specific functions and performance frequency? For example, are the CAT
NMS Plan independent third party risk assessment provisions consistent
with ``industry best practices''? Or should the CAT require a greater
or lesser performance frequency than as described in the CAT NMS Plan?
As another example, do the technical assessments described in Section
6.2, Appendix C, Section A.5, and the NIST SP 800-53 requirements noted
in Appendix D, Section 4.2, adequately and clearly establish the roles
and responsibilities of the parties assessing the technical aspects of
the CAT?
226. Do Commenters believe the CAT NMS Plan should specify the
general audit and independent assessment requirements and the proper
timeframes for when those assessments should occur? For instance, are
there assessments that may need to occur on an annual basis? If so,
what are those assessments? Are there assessments that may need to
occur more frequently? If so, what are those assessments and why do
they need to occur more frequently?
227. Do Commenters believe that the CAT NMS Plan requirements for
conducting ad hoc penetration testing and an application security code
audit by a reputable third-party in Appendix D, Section 4.1.3 ``prior
to launch'' and periodically as defined by SLAs are consistent with
industry best practices? Should additional testing or audits be
required? Why or why not? Should testing or audits be required to occur
more frequently than required by the CAT NMS Plan and SLAs? Why or why
not?
228. Do Commenters believe that the third party risk assessments
and penetration tests required by the CAT
[[Page 30651]]
NMS Plan could themselves compromise the security or confidentiality of
CAT Data? Please explain.
229. In Section 6.2(b)(vi) of the CAT NMS Plan, the Chief
Information Security Officer is required to report to the Operating
Committee the activities of the Financial Services Information Sharing
and Analysis Center (``FS-ISAC'') or other comparable body. Do
Commenters believe there are other cyber and threat intelligence
bodies, in addition to FS-ISAC, that the Plan Processor should join?
Why or why not?
230. Do Commenters believe the CAT NMS Plan effectively describes
the verification process when CAT Reporters connect to the Central
Repository network? For example, which specific individual(s) at a CAT
Reporter would be allowed access to CAT for reporting and verification
purposes? Should there be a public key exchange process?
231. Do Commenters believe the CAT NMS Plan provides sufficient
detail regarding the ability of CAT to determine whether a regulator's
queries are shielded from the Plan Processor (including its staff,
officers, and administrators) as well as other regulators and users of
CAT? If not, what specifically should be added to the CAT NMS Plan?
232. Do Commenters believe that the CAT NMS Plan should require an
audit of all CAT Reporters' data security? If so, which person or
entity should have responsibility for such an audit, and what should
the scope and elements of the audit be? Please estimate the cost of
such audits. What other changes, if any, should be made to the CAT NMS
Plan to provide for the allocation of sufficient resources whereby such
an audit could be carried out?
233. Do Commenters believe the CAT NMS Plan should require the Plan
Processor to provide a ``blanket'' security authorization to operate
(``ATO'') document (or its equivalent) prior to CAT Reporters sending
CAT Data?
IV. Economic Analysis
A. Introduction
When adopting Rule 613, the Commission noted that the adopted Rule
permitted the SROs to consider a wider array of solutions than did the
proposed Rule. The Commission stated its belief that, as a result,
``the economic consequences of the consolidated audit trail now will
become apparent only over the course 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.'' \276\
In particular, the Commission noted its belief 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.'' \277\ The Commission also noted that a ``robust economic
analysis of . . . 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.'' \278\ Accordingly, the Commission
deferred its economic analysis of the actual creation, implementation,
and maintenance of the CAT until after submission of an NMS plan.
---------------------------------------------------------------------------
\276\ See Adopting Release, supra note 9, at 45725-6.
\277\ Id.
\278\ Id. at 45726.
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To assist in that analysis, Rule 613, as adopted, 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.\279\ The Commission
stated that it believed that these estimates and analyses would help
inform public comment regarding the CAT NMS Plan and would help inform
the Commission as it evaluates whether to approve the CAT NMS
Plan.\280\
---------------------------------------------------------------------------
\279\ Id.; see also 17 CFR 242.613(a)(1)(vii), (viii), (xi),
(xii).
\280\ See Adopting Release, supra note 9, at 45726. Rule
613(a)(5) requires that ``[i]n 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 [Rule] 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.''
17 CFR 242.613(a)(5).
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The Commission is sensitive to the economic effects of the CAT NMS
Plan,\281\ including its costs and benefits and its impact on
efficiency, competition and capital formation. In the Adopting Release
for Rule 613, the Commission considered the economic effects of the
actions the SROs were 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.\282\ As noted in the Adopting Release,
however, Rule 613 provided the SROs with ``flexibility in how they
[chose] to meet the requirements of the adopted Rule,'' \283\ allowing
the SROs to consider a number of different approaches in developing the
CAT NMS Plan.
---------------------------------------------------------------------------
\281\ See CAT NMS Plan, supra note 3.
\282\ See Adopting Release, supra note 9, at 45726.
\283\ Id. at 45725.
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In accordance with the approach articulated by the Commission in
the Adopting Release, the Commission is hereby publishing its economic
analysis of the CAT NMS Plan and is soliciting comment thereon. This
Section reflects the Commission's preliminary analysis and conclusions
regarding the economic effects of the creation, implementation and
maintenance of the CAT pursuant to the details proposed in the NMS plan
submitted to the Commission for its consideration. The analysis is
divided into eight topics: (1) A summary of the expected economic
effects of approving the CAT NMS Plan; (2) a description of the
economic framework for analyzing the economic effects of approving the
CAT NMS Plan; (3) a discussion of the current, or ``Baseline,'' audit
trail data available to regulators, and the sources of such data; (4) a
discussion of the potential benefits of the CAT NMS Plan; (5) a
discussion of the potential costs of the CAT NMS Plan; (6) an economic
analysis of the CAT NMS Plan's impact on efficiency, competition, and
capital formation; (7) a discussion of alternatives to various features
of the CAT NMS Plan and to the CAT NMS Plan itself; and (8) a request
for comment on the Commission's preliminary economic analysis.
B. Summary of Expected Economic Effects
As the Commission explained in the Adopting Release, the Commission
believes that the regulatory data infrastructure on which the SROs and
the Commission currently must rely is outdated for effective oversight
of a complex, dispersed, and highly automated national market
system.\284\ In performing their oversight responsibilities, regulators
today must attempt to cobble together disparate data from a variety of
existing information systems, each lacking in completeness,
[[Page 30652]]
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.\285\ The Commission has analyzed
the expected economic effects of the CAT NMS Plan in light of these
existing shortcomings and the goal of improving the ability of SROs and
the Commission to perform their regulatory activities to the benefit of
investors.\286\
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\284\ See id. at 45723.
\285\ See id.
\286\ The Commission noted current SRO audit trail limitations
in the Proposing Release and the Adopting Release. See Proposing
Release, supra note 9, at 32563-68; Adopting Release, supra note 9,
at 45726-30. Rule 613 is designed to address these limitations.
---------------------------------------------------------------------------
In general, the Commission preliminarily believes that, if
approved, the CAT NMS Plan would result in benefits by improving the
quality of the data available to regulators in four areas that affect
the ultimate effectiveness of core regulatory efforts--completeness,
accuracy, accessibility and timeliness.\287\ The Commission
preliminarily believes that the improvements in these data qualities
that would be realized from approval of the CAT NMS Plan would
substantially improve regulators' ability to perform analysis and
reconstruction of market events, and market analysis and research to
inform policy decisions, as well as perform other regulatory
activities, in particular market surveillance, examinations,
investigations, and other enforcement functions. Regulators depend on
data for many of these activities and the improvements in the data
qualities would thus improve the efficiency and effectiveness of such
regulatory activities. As explained further below, these improvements
could benefit investors by giving regulators more and better regulatory
tools to provide investors with a more effectively regulated trading
environment,\288\ which could increase capital formation, liquidity,
and price efficiency. Data improvements could enhance regulators'
ability to provide investors and the public with more timely and
accurate analysis and reconstruction of market events, and to develop
more effective responses to such events.\289\ Improved understanding of
emerging market issues resulting from enhanced market analysis and
research could inform regulatory policies that improve investor
protection through better market quality, more transparency, and more
efficient prices.
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\287\ See Adopting Release, supra note 9, at 45727 (discussing
four ``qualities'' of trade and order data that impact the
effectiveness of core SRO and Commission regulatory efforts:
Accuracy, completeness, accessibility, and timeliness); see also
Section IV.E, infra, for a detailed discussion of the expected
benefits of the CAT NMS Plan.
\288\ See Section IV.E.2, infra.
\289\ See Section IV.E.2.a, infra.
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In terms of completeness, the Plan requires the reporting of
certain additional data fields, events, and products.\290\ More
importantly, the CAT NMS Plan requires certain data elements useful for
regulatory analysis to be available from a single data source. Having
relevant data elements available from a single source would simplify
regulators' data collection process and facilitate more efficient
analyses and surveillances that incorporate cross-market and cross-
product data.
---------------------------------------------------------------------------
\290\ See CAT NMS Plan, supra note 3, at Sections 6.3, 6.4; see
also 17 CFR 242.613(c)(7).
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With respect to the accuracy of available data, the Commission
preliminarily believes that the requirements in the Plan would improve
data accuracy significantly. For example, the Commission expects that
the requirements to store the CAT Data in a uniform linked format and
the use of consistent identifiers for customers and market participants
would result in fewer inaccuracies as compared to current data sources.
These accuracy improvements should significantly reduce the time
regulators spend processing the data and finding solutions when faced
with inaccurate data. The Commission preliminarily believes that the
requirements in the Plan for clock synchronization and time stamp
granularity would improve the accuracy of data with respect to the
timing of market events, but the improvements would be modest. The
Commission preliminarily believes that the Plan would improve
regulators' ability to determine the sequence of a small percentage of
market events relative to all surrounding events.\291\
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\291\ The CAT NMS Plan would also require that CAT Reporters'
business clocks be synchronized to within 50 milliseconds of the
time maintained by the NIST, which would increase the precision of
the time stamps provided by the 39% of broker-dealers who currently
synchronize their clocks with less precision than what is called for
by the Plan. See supra note 125. Independent of the potential time
clock synchronization benefits, the order linking data that would be
captured in CAT should increase the proportion of events that could
be sequenced accurately. This reflects the fact that some records
pertaining to the same order could be sequenced by their placement
in an order lifecycle (e.g., an order submission must have occurred
before its execution) without relying on time stamps. This
information may also be used to partially sequence surrounding
events.
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The Commission also preliminarily believes that the Plan would
increase the accessibility of data for SROs and the Commission, because
regulators would be able to access the CAT Data directly.\292\ This,
coupled with the improvements in completeness, would vastly increase
the scope of information readily available to regulators and
significantly reduce the number of data requests from the several
hundred thousand requests regulators make each year. The increased
scope of readily available information should facilitate more data-
driven regulatory policy decisions, broaden the potential
surveillances, expand the opportunities for SRO and Commission analysis
to help target broker-dealers and investment advisers for examinations
and help to perform those examinations.
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\292\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.2, Appendix D, Section 8.1; see also 17 CFR 242.613(e)(2).
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Finally, the Commission preliminarily believes that the CAT NMS
Plan would improve the timeliness of available data. Because regulators
would be able to access uncorrected data the day after an order event
and would be able to access corrected and linked data five days after
an order event,\293\ many data elements would be available to
regulators more quickly than they are currently and the amount of time
regulators would need to acquire and process data before running
analyses would be reduced. For example, the corrected and linked data
available on T+5 would identify the customer account associated with
all order events, information that currently takes ten days or longer
for regulators to obtain and then need to link to other data sources
for use. These improvements in timeliness, combined with improvements
in completeness, accessibility, and accuracy discussed above, would
improve the efficiency of regulatory analysis and reconstruction of
market events, as well as market analysis and research that informs
policy decisions, and make market surveillance, examinations,
investigations, and other enforcement functions more efficient,
allowing, for example, the SROs and the Commission to review tips and
complaints more effectively.
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\293\ CAT Data would be reported by 8:00 a.m. Eastern Time on
day T+1 and made available to regulators in raw form after it is
received and passes basic formatting validations with an error
correction process completed by 8:00 a.m. Eastern Time on day T+5.
While the Plan does not specify exactly when these validations would
be complete, the requirement to link records by 12:00 p.m. Eastern
Time on day T+1 gives a practical upper bound on this timeline. See
CAT NMS Plan, supra note 3, at Appendix C, Sections A.2(a), A.3(a),
Appendix D, Section 6.2.
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The Commission notes that the Plan lacks information regarding the
details of certain elements of the Plan likely to affect the costs and
benefits associated
[[Page 30653]]
with it, primarily because those details have not yet been determined,
and this lack of information creates some uncertainty about the
expected economic effects. As discussed further below, lack of
specificity surrounding the processes for converting data formats and
linking related order events creates uncertainty as to the anticipated
improvements in accuracy because such processes have the potential to
create new data inaccuracies. Lack of specificity surrounding the
process for regulators to access the CAT Data also creates uncertainty
around the expected improvements in accessibility. For example, while
the Plan indicates that regulators would have an on-line targeted query
tool and a tool for user-defined direct queries or bulk
extraction,\294\ the Plan itself does not provide an indication for how
user-friendly the tools would be or the particular skill set needed to
use the tools for user-defined direct queries. However, the Commission
has analyzed the expected economic effects of the Plan to the extent
possible with the information available, noting areas of uncertainty in
its analysis where applicable. The Commission has also considered
whether certain provisions related to the operation and administration
of the Plan could mitigate some of the uncertainties.\295\
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\294\ See CAT NMS Plan, supra note 3, at Appendix D, Sections
8.1.1, 8.1.2.
\295\ See Section IV.E.3.d, infra.
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The Commission also preliminarily believes that more effective and
efficient regulation of securities markets and market participants
resulting from approval of the CAT NMS Plan could significantly benefit
investors and the integrity of the market. For example, the Commission
preliminarily believes that more effective and efficient surveillance
and enforcement would detect a higher proportion of violative market
activity. This additional detection could not only reduce violative
behavior through potential enforcement actions, but through deterrence
if market participants believe violative activities are more likely to
be detected. Because violative activity degrades market quality and
imposes costs on investors and market participants, reductions in
violative activity would benefit investors and market integrity.
Likewise, more effective and efficient risk assessment and risk-based
examinations should more effectively facilitate the selection of market
participants for examination who have characteristics that elevate
their risk of violating the rules. Decreasing the amount of violative
activity by targeting exams in this way would provide investors with a
more effectively regulated trading environment and hence better market
quality. Further, access to audit trail data that is comprehensive,
accurate, and timely could improve regulatory reconstruction of market
events, market analysis, and research resulting in an improved
understanding of emerging market issues and regulatory policies that
better encourage industry competition, thus improving investor
protection through better transparency and more efficient prices.\296\
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\296\ See Section IV.E.2.a, IV.E.2.b, infra.
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Further, regulatory initiatives that are based on a more thorough
understanding of underlying events and their causes, and that are
narrowly tailored to address any market deficiency, could improve
market quality and thus benefit investors. Moreover, access to more
complete and linked audit trail data would improve regulators' ability
to analyze and reconstruct market events, allowing regulators to
provide investors and the public with more accurate explanations of
market events, to develop more effective responses to such events, and
to use the information to assist in retrospective analyses of their
rules and pilots.
The Commission has also evaluated the potential costs that would
result from approval of the CAT NMS Plan. In particular, using
information included in the Plan, information gathered from market
participants through discussions, surveys of market participants, and
other relevant information, the Commission has preliminarily estimated
the potential costs associated with building and maintaining the
Central Repository as well as the costs to report data to the Central
Repository. Currently, the 20 Participants spend $154.1 million
annually on reporting regulatory data and performing surveillance,
while the approximately 1,800 broker-dealers anticipated to have CAT
reporting responsibilities spend $1.6 billion annually on regulatory
data reporting, for total current industry costs of $1.7 billion
annually for regulatory data reporting and surveillance by SROs. The
Commission preliminarily estimates the cost of the Plan as
approximately $2.4 billion in initial aggregate implementation costs
and recurring annual costs of $1.7 billion.\297\ The primary driver of
the annual costs is the data reporting costs for broker-dealers, which
are estimated to be $1.5 billion per year. For both large and small
broker-dealers, the primary driver of both current $1.6 billion
reporting costs and projected $1.5 billion CAT reporting costs is costs
associated with staffing. Estimates of the costs to build the Central
Repository are based on Bids that vary in a range as high as $92
million. Current estimates of annual operating costs are based on Bids
that vary in a range up to $135 million. The eventual magnitude of
Central Repository costs is dependent on the Participants' selection of
the Plan Processor, and may ultimately differ from estimates discussed
above if Bids are revised as the bidding process progresses.
Furthermore, the Plan anticipates a period of duplicative reporting
responsibilities preceding the retirement of potentially duplicative
regulatory data reporting systems; these duplicative reporting costs
are likely to be significant.\298\
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\297\ See Section IV.F.2, Table 9, infra.
\298\ The economic analysis discusses duplicative reporting
costs in Section IV.F.2, infra.
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Drawing from the discussion in the CAT NMS Plan,\299\ the
Commission expects that, if approved, the Plan would have a number of
additional economic effects, including effects on efficiency,
competition, and capital formation. The Commission preliminarily
believes that the Plan generally promotes competition. However, the
Commission recognizes that the Plan could increase barriers to entry
because of the costs to comply with the Plan. Further, the Commission's
analysis identifies several limiting factors to competition but Plan
provisions and Commission oversight could address such limiting
factors. The Commission preliminarily believes that the Plan would
improve regulatory analysis and reconstruction of market events, as
well as market analysis and research that informs policy decisions. In
addition, the Plan would improve enforcement related activities,
including the efficiency of regulatory activities such as market
surveillance, examinations, investigations, and other enforcement
functions that could enhance market efficiency by reducing violative
activity that harms market efficiency. Finally, the Commission
preliminarily believes that the Plan could have positive effects on
capital formation and allocative efficiency and that the threat of a
security breach at the Central Repository is unlikely to significantly
harm capital formation. The Commission recognizes that the Plan's
likely effects on competition, efficiency and capital formation are
dependent to some extent on the
[[Page 30654]]
performance and decisions of the Plan Processor and the Operating
Committee in implementing the Plan, and thus there is necessarily some
uncertainty in the Commission's analysis. Nonetheless, the Commission
believes that the Plan contains certain governance provisions, as well
as provisions relating to the selection and removal of the Plan
Processor, that mitigate this uncertainty by promoting decision-making
that could, on balance, have positive effects on competition,
efficiency, and capital formation.
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\299\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8; see also Section IV.G, infra.
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The Commission notes that while the Participants developed the Plan
in compliance with Rule 613 by considering information from industry
representatives, the Commission has discretion to approve the Plan
subject to changes or conditions that the Commission deems necessary or
appropriate.\300\ Therefore, as a part of this economic analysis, the
Commission analyzed numerous alternatives to provisions of the CAT NMS
Plan and to the CAT NMS Plan itself. The Commission analyzes
alternatives to the approaches the Exemption Order permitted the
Participants to include in the Plan; \301\ alternatives to certain
specific approaches in the Plan; alternatives to the scope of certain
specific elements of the Plan; and the broad alternative of modifying
OATS or another existing system to meet the requirements of Rule 613
instead of approving the Plan. Finally, the Commission requests comment
on alternatives discussed in this economic analysis, alternatives
considered in the Plan, and on whether the Commission should consider
any additional alternatives.
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\300\ See 17 CFR 242.608(b)(1) (``No national market system plan
. . . shall become effective unless approved by the Commission . .
.''); 17 CFR 242.608(b)(2) (``Within 120 days of the date of
publication of notice of filing of a national market system plan . .
. the Commission shall approve such plan . . . with such changes or
subject to such conditions as the Commission may deem necessary or
appropriate, if it finds 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.'').
\301\ See Exemption Order, supra note 18.
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C. Framework for Economic Analysis
As discussed above, the Commission is conducting an economic
analysis of the CAT NMS Plan filed by the SROs on February 27, 2015, as
amended, as anticipated in the Adopting Release for Rule 613.\302\ In
particular, the Commission has carefully evaluated the information in
the CAT NMS Plan, including the twelve considerations required by Rule
613 \303\ and the details of the decisions left to the discretion of
the SROs. The Commission has also considered information drawn from
outside the Plan in order to assess potential economic effects not
addressed therein. To provide context for this analysis, this Section
describes the economic framework for the analysis and seeks to identify
uncertainties within that framework.
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\302\ See Adopting Release, supra note 9, at 45789.
\303\ See 17 CFR 242.613(a)(1).
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1. Economic Framework
a. Benefits
The CAT NMS Plan would create a new data source that could replace
the use of some current data sources for many regulatory activities. As
such, the economic benefits of the CAT NMS Plan would come from any
expanded and more efficient regulatory activities facilitated by
improvements to the data regulators use. Therefore, the framework for
examining benefits in this economic analysis involves first considering
whether and to what degree the CAT Data would improve on the Baseline
of current trading and order data in terms of the four qualities of
accuracy, completeness, accessibility, and timeliness.\304\
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\304\ See Adopting Release, supra note 9, at 45727.
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Through these improvements in the data, the economic analysis then
considers the degree to which the Plan would result in improvements to
regulatory activities such as the analysis and reconstruction of market
events, in addition to market analysis and research conducted by SROs
and Commission Staff, as well as market surveillance, examinations,
investigations, and other enforcement functions. These potential
improvements, based on the regulatory objectives of the CAT NMS Plan
described in the Adopting Release,\305\ relate to the overall goal of
substantially enhancing the ability of the SROs and the Commission to
oversee securities markets and fulfill their regulatory
responsibilities under the securities laws. The economic analysis
explores how the improvements to these regulatory activities provide
economic benefits to investors and the market. Among other things,
potential benefits that could result from the CAT NMS Plan include
benefits rooted in changes in the behavior of market participants. For
example, requirements to report certain data elements or events to the
CAT could have the beneficial effect of deterring rule violations
because the inclusion of certain data fields and improvements in the
ability to surveil for violations could increase the perceived costs of
violating rules and regulations. Potential benefits could also stem
from improved investor protection, such as from more effective
surveillance and more informed, data-driven rulemaking.
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\305\ See id. at 45730.
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(1) Data Qualities
In the Adopting Release, the Commission identified four qualities
of trade and order data that impact the effectiveness of core SRO and
Commission regulatory efforts: Accuracy, completeness, accessibility,
and timeliness.\306\ In assessing the potential benefits of the CAT NMS
Plan, the Commission's economic analysis compares the data that would
be available under the Plan to the trading and order data currently
available to regulators to determine whether and to what degree the
Plan would improve the available data with respect to those four
qualities.
---------------------------------------------------------------------------
\306\ See id. at 45727. Accuracy refers to whether the data
about a particular order or trade is correct and reliable.
Completeness refers to whether a data source represents all market
activity of interest to regulators, and whether the data is
sufficiently detailed to provide the information regulators require.
While current data sources provide the trade and order data required
by existing rules and regulations, those sources generally do not
provide all of the information of interest to regulators in one
consolidated audit trail. Accessibility refers to how the data is
stored, how practical it is to assemble, aggregate, and process the
data, and whether all appropriate regulators could acquire the data
they need. Timeliness refers to when the data is available to
regulators and how long it would take to process before it could be
used for regulatory analysis. As explained in the Baseline, Section
IV.D, infra, the trading and order data currently available to
regulators suffers from deficiencies in all four dimensions.
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(2) Regulatory Activities
Any economic benefits would derive from how such improved data
would affect regulatory activities. Therefore, to analyze the potential
benefits of the CAT NMS Plan, the economic analysis also evaluates the
potential of the CAT NMS Plan to meet the regulatory objectives set out
in the Adopting Release for Rule 613. The objectives are: Improvements
in the analysis and reconstruction of broad-based market events;
improvements in market analysis in support of regulatory decisions; and
improvements in market surveillance, investigations, and other
enforcement activities.\307\
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\307\ See Adopting Release, supra note 9, at 45730.
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A. Analysis and Reconstruction of Broad-Based Market Events
The economic analysis considers whether and to what extent the CAT
NMS Plan would facilitate regulators'
[[Page 30655]]
performance of analysis and reconstruction of market events,
potentially helping to better inform both regulators and investors
about such market events and speeding the regulatory response following
market events. Regulators perform reconstructions of market events so
that they and the public can be informed by an accurate accounting of
what happened (and, possibly, why it happened). As discussed in the
Benefits Section,\308\ market reconstructions can take a significant
amount of time, in large measure due to various deficiencies in the
currently available trading and order data in terms of the four
qualities described above.\309\ The sooner regulators complete a
reconstruction and analysis of a market event, the sooner investors can
be informed and the sooner regulators can begin reviewing the event to
determine what happened, who was affected and how, and whether the
analysis supports potential regulatory responses.\310\ In addition, the
improved ability for regulators to generate prompt and complete market
reconstructions could provide improved market knowledge, which could
assist regulators in conducting retrospective analysis of their rules
and pilots.
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\308\ See Section IV.E.2.a, infra.
\309\ See Section IV.C.1.a(1), supra.
\310\ See Adopting Release, supra note 9, at 45732.
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B. Market Analysis in Support of Regulatory Decisions
The economic analysis considers whether and to what extent the CAT
NMS Plan would enhance the ability of the SROs and the Commission to
conduct market analysis and research, including analysis of market
structure, and the degree to which it would improve regulators' market
knowledge and facilitate consideration of policy questions of interest.
The SROs and Commission Staff conduct data-driven analysis on market
structure, in direct support of both rulemaking and other regulatory
decisions such as SRO rule approvals. The Commission also relies on
such analysis to improve understanding of market structure in ways that
could inform policy. Finally, SROs conduct market analysis and research
on their own regulatory initiatives. Improvements in the ability to
conduct market analysis could further improve analysis related to
regulatory decisions and potentially influence those regulatory
decisions to the benefit of investors and the markets more generally.
C. Market Surveillance and Investigations
The economic analysis examines whether the CAT NMS Plan would
improve market surveillance and investigations, potentially resulting
in more effective oversight of trading, better investor protection, and
deterrence of violative behavior. As described in more detail in the
Baseline Section,\311\ both SROs and the Commission conduct market
surveillance, examinations, investigations, and other enforcement
functions targeting illegal activities such as insider trading, wash
sales, or manipulative practices. Improvements in market surveillance
and investigations could come in the form of ``facilitating risk-based
examinations, allowing more accurate and faster surveillance for
manipulation, improving the process for evaluating tips, complaints,
and referrals . . ., and promoting innovation in cross-market and
principal order surveillance.'' \312\
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\311\ See Section 0, infra.
\312\ See Adopting Release, supra note 9, at 45730.
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b. Costs
The economic analysis evaluates the costs of building and operating
the Central Repository; the costs of CAT reporting for Participants,
broker-dealers, and service bureaus; and other CAT-related costs. Where
the CAT NMS Plan provides estimates of these costs, the economic
analysis evaluates those estimates and re-estimates them when
necessary. The economic analysis also discusses the drivers of these
costs, and whether broker-dealers may or may not pass these costs down
to their customers. In addition, the economic analysis assesses whether
the CAT NMS Plan has the potential to result in cost savings. Rule 613
requires the Plan to discuss ``[a] plan to eliminate existing rules and
systems (or components thereof) that would be rendered duplicative by
the consolidated audit trail.'' \313\ As a part of its consideration of
the costs of the CAT NMS Plan, the economic analysis considers costs
from duplicative reporting for some period of time as well as potential
cost savings from the retirement of duplicative regulatory reporting
systems.
---------------------------------------------------------------------------
\313\ 17 CFR 242.613(a)(1)(ix).
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The economic analysis also considers whether the CAT NMS Plan could
result in second order effects, such as changes to the behavior of
market participants, that impose certain costs. For example, the CAT
NMS Plan's tiered funding model could lead to costly efforts by market
participants to try to control their tiers in order to affect their fee
payments, such as reducing activity levels near the end of an activity
level measuring period to avoid being classified as a higher activity
level firm. In addition, Participants, their members, and investors
could incur costs if their private information were accessed in the
event of a security breach of the Central Repository. The economic
analysis considers these and other elements of the Plan that could lead
to distortions in behavior by market participants.
2. Existing Uncertainties
The Commission has carefully analyzed the information in the CAT
NMS Plan, as well as other relevant data, in order to assess the
economic effects of the Plan. As discussed throughout the analysis, in
certain cases the Commission lacks information needed to evaluate all
of the potential economic effects of the CAT NMS Plan, creating
uncertainty in some potential benefits and costs. The primary drivers
of uncertainty include the fee schedule applicable to funding the
Central Repository (the ``Funding Model''), which has not yet been
finalized, the deferral of decisions on certain discretionary elements
including the Technical Specifications applicable to the CAT, and a
lack of detailed information that would enable the Commission to assess
certain economic effects with greater precision. The implications of
each primary area of uncertainty for the Commission's economic analysis
are discussed below.
First, as noted above, the economic analysis evaluates information
provided in the CAT NMS Plan on the economic effects of the Plan, as
well as information drawn from outside of the Plan. However, the
Commission lacks detailed information regarding some of the individual
costs and discretionary decisions in the Plan, including the Funding
Model. Specifically, the Plan does not outline the proportion of CAT
costs that would be allocated to Participants versus broker-dealers.
This uncertainty limits the Commission's ability to evaluate the
economic effects of the Plan in some cases. However, the Commission has
analyzed the expected economic effects of the Plan to the extent
possible with the information available, and where the Commission can
identify such areas of uncertainty, the economic analysis addresses
this uncertainty. In addition, the Commission requests comments to help
resolve such uncertainties during the consideration of the CAT NMS
Plan.
Second, certain elements of the CAT NMS Plan would not be finalized
until after the selection of a ``Plan
[[Page 30656]]
Processor.'' \314\ Among these are the security and confidentiality
procedures of the Central Repository,\315\ the precise methods by which
regulators would access data in the Central Repository,\316\ and the
complete Technical Specifications.\317\ The Plan also provides the Plan
Processor the ``sole discretion'' to publish interpretations of the
Technical Specifications, including interpretations of permitted values
in data elements.\318\
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\314\ See CAT NMS Plan, supra note 3, at Article VI. The Plan
Participants have engaged in a bidding process to select a Plan
Processor, and the leading candidate bidders have proposed different
solutions. In certain instances, the Plan Participants have decided
to adopt the solutions proposed by whichever bidder they select.
\315\ See Section 0, infra, for additional discussion of risks
and uncertainties related to data security.
\316\ Rule 613(e)(1) requires the CAT NMS Plan to create a
Central Repository to collect, link, and store CAT Data and to make
that data available to regulators. See 17 CFR 242.613(e)(1).
\317\ The CAT NMS Plan contains minimum standards and principles
for setting many of Technical Specifications, see CAT NMS Plan,
supra note 3, at Section 6.9, and the Commission's economic analysis
reflects those minimum standards and principles. However, because
the detailed Technical Specifications are not yet finalized by the
Participants, the Commission cannot fully assess any corresponding
costs and benefits.
\318\ See id. at Section 6.9.
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Because these and other elements of the Plan have not yet been
finalized, the Commission cannot assess how and to what extent they
could affect the overall economic effects of the Plan. The Commission's
economic analysis is therefore limited to the extent that the economic
effects of the Plan depend on decisions that would be made after
approval of the Plan. However, the Commission has identified these
areas of uncertainty and has assessed the economic effects of the Plan
to the best of its ability in light of these existing uncertainties.
Given the range of possible outcomes with respect to both the costs
and benefits of the CAT NMS Plan that depend on future decisions, the
Commission also recognizes the importance of provisions of the Plan
related to the operation and administration of the CAT. In particular,
governance provisions of the Plan related to voting by the Operating
Committee and the involvement of the Advisory Committee may help
promote better decision-making by the relevant parties. Such provisions
could mitigate concerns about potential uncertainty in the economic
effects of the Plan by giving the Commission greater confidence that
its expected benefits would be achieved in an efficient manner and that
costs resulting from inefficiencies would be avoided. As part of this
economic analysis, the Commission therefore considers these features of
the Plan.\319\
---------------------------------------------------------------------------
\319\ See Section 0, infra.
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3. Request for Comment on the Framework
The Commission requests comment on all aspects of the Framework for
the Economic Analysis on the CAT NMS Plan. In particular, the
Commission seeks responses to the following questions:
234. Do Commenters believe that the general economic framework
applied in this analysis is appropriate? If not, which considerations
should be added or removed?
235. Do Commenters agree with the approach to identifying benefits
of the CAT NMS Plan? Are there important sources of benefits that are
not discussed here? Are the data qualities important for regulatory
uses? Are there additional data qualities that the Commission should
consider? Are the regulatory objectives important and beneficial for
investors? Are there additional regulatory objectives that the
Commission should consider?
236. Do Commenters agree with the approach taken in this analysis
for examining the costs of CAT? Please explain.
237. Do the Commenters agree with the approach for analyzing second
order effects? Are there other sources of economic effects that the
Commission should consider?
238. Do Commenters agree with the Commission's characterization of
uncertainties in the economic analysis? How important are these
uncertainties to the Commission's consideration of the CAT NMS Plan?
Are there other sources of uncertainty that the Commission should
consider?
239. Do Commenters agree with the Commission's preliminary
assessment that governance provisions of the Plan related to voting by
the Operating Committee and the involvement of the Advisory Committee
may help promote better decision-making by the relevant parties and
thus mitigate concerns associated with uncertainties in the economic
effects of the Plan? Please explain.
D. Baseline
The CAT NMS Plan would create a new regulatory dataset that SROs
and the Commission would use to supplement or replace their current
data sources. The Adopting Release states that ``improvements [in the
quality of audit trail data] should have the potential to result in the
following: (1) [I]mproved market surveillance and investigations; (2)
improved analysis and reconstructions of broad-based market events; and
(3) improved market analysis.'' \320\ To assess the overall economic
impact of the CAT NMS Plan, the economic analysis uses as the Baseline
the current state of trade and order data and the current state of
regulatory activity that relies on that data. The Baseline discusses
the currently available sources of data, limits in available data that
could impact regulatory activity, how regulators currently use the
available data, and the burden that producing that data imposes on SROs
and broker-dealers.
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\320\ See Adopting Release, supra note 9, at 45730.
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1. Current State of Regulatory Activities
The SROs and the Commission use data to analyze and reconstruct
market events, conduct market analysis and research in support of
regulatory decision-making, and conduct market surveillance,
examinations, investigations, and other enforcement functions. The
trend in this area is to use more automated and data-intensive methods
as regulators' activities adjust to the data and technology available.
The following Sections describe these regulatory activities and how
regulators currently use data.
a. Analysis and Reconstruction of Market Events
In the Adopting Release, the Commission described how it expected
CAT Data to significantly improve the ability of regulators to
reconstruct market events so that the public might be informed by an
accurate and timely accounting of the events in question.\321\ In a
market reconstruction, regulators seek to provide an accurate and
factual accounting of what transpired during a market event of interest
by conducting a thorough analysis of the available market data. These
events often encompass activity in many securities across multiple
trading venues, requiring the linking and analysis of data from
multiple sources. Examples of recent market reconstructions include the
Commodity Futures Trading Commission (``CFTC'') and SEC's analysis of
the May 6, 2010 ``Flash Crash,'' \322\ analysis of equity market
[[Page 30657]]
volatility on August 24, 2015,\323\ and the multi-agency report on the
U.S. Treasuries market on October 15, 2014.\324\
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\321\ See id. at 45732-33.
\322\ See Findings Regarding the Market Events of May 6, 2010:
Report of the Staffs of the CFTC and SEC to the Joint Advisory
Committee on Emerging Regulatory Issues (September 30, 2010)
(``Flash Crash Analysis''), available at http://www.sec.gov/news/studies/2010/marketevents-report.pdf.
\323\ See Staff of the Office of Analytics and Research,
Division of Trading and Markets, Research Note: Equity Market
Volatility on August 24, 2015 (Dec. 2015) available at http://www.sec.gov/marketstructure/research/equity_market_volatility.pdf;
see also Austin Gerig and Keegan Murphy, The Determinants of ETF
Trading Pauses on August 24th, 2015, White Paper (February 2016)
available at http://www.sec.gov/marketstructure/research/determinants_eft_trading_pauses.pdf.
\324\ See U.S. Department of the Treasury, Board of Governors of
the Federal Reserve System, Federal Reserve Bank of New York, U.S.
Securities and Exchange Commission, and U.S. Commodity Futures
Trading Commission, Joint Staff Report: The U.S. Treasury Market on
October 15, 2014 (July 13, 2015), available at http://www.sec.gov/reportspubs/special-studies/treasury-market-volatility-10-14-2014-joint-report.pdf.
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b. Market Analysis and Research
In the Adopting Release, the Commission described how it expected
CAT Data to improve the ability of regulators to monitor overall market
structure and better understand its relationship with market behavior,
so that the Commission and the SROs could be better informed in their
policy decisions.\325\ The Commission and SRO Staffs conduct data-
driven analysis on market structure, in direct support of both
rulemaking and other regulatory decisions such as SRO rule approvals as
well as retrospective analyses of rules and pilots. The Commission also
relies on data analysis to inform its market structure policy. SROs
also conduct market analysis and research on their own regulatory
initiatives. Examples of data-driven market analysis include reports on
OTC trading,\326\ small capitalization stock trading,\327\ the Limit
Up-Limit Down Pilot,\328\ short selling,\329\ and high frequency
trading.\330\
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\325\ See Adopting Release, supra note 9, at 45733.
\326\ See Laura Tuttle, Alternative Trading Systems: Description
of ATS Trading in National Market System Stocks (October 2013)
available at http://www.sec.gov/divisions/riskfin/whitepapers/alternative-trading-systems-10-2013.pdf; Laura Tuttle, OTC Trading:
Description of Non-ATS OTC Trading in National Market System Stocks
(March 2014), available at http://www.sec.gov/dera/staff-papers/white-papers/otc-trading-white-paper-03-2014.pdf.
\327\ See Securities Exchange Act Release No. 74892, Order
Approving the National Market System Plan to Implement a Tick Size
Pilot Program (May 6, 2015), 80 FR 27514, 27534, 27541 (May 13,
2015); see also Charles Collver, A Characterization of Market
Quality for Small Capitalization US Equities (September 2014),
available at http://www.sec.gov/marketstructure/research/small_cap_liquidity.pdf.
\328\ See SRO Supplemental Joint Assessment, available at http://www.sec.gov/comments/4-631/4-631.shtml; Memo to File from the
Division of Economic and Risk Analysis regarding the Cornerstone
Analysis of the Impact of Straddle States on Options Market Quality
(February 8, 2016), available at http://www.sec.gov/comments/4-631/4631-42.pdf; see also Gerig and Murphy, supra note 323.
\329\ See Memo to Chairman Christopher Cox from Daniel Aromi and
Cecilia Caglio regarding an Analysis of Short Selling Activity
during the First Weeks of September 2008, (December 16, 2008)
available at http://www.sec.gov/comments/s7-08-09/s70809-369.pdf;
Memo to Chairman Christopher Cox from Daniel Aromi and Cecilia
Caglio regarding an Analysis of a Short Sale Price Test Using
Intraday Quote and Trade Data (December 17, 2008) available at
http://www.sec.gov/comments/s7-08-09/s70809-368.pdf; Memo from the
Office of Economic Analysis regarding an Analysis of the July
Emergency Order Requiring a Pre-borrow on Short Sales (January 14,
2009) available at http://www.sec.gov/spotlight/shortsales/oeamemo011409.pdf.
\330\ See Austin Gerig, High-Frequency Trading Synchronizes
Prices in Financial Markets, available at http://www.sec.gov/dera/staff-papers/working-papers/dera-wp-hft-synchronizes.pdf; see also
Staff of the Office of Analytics and Research, Division of Trading
and Markets, Research Note: Equity Market Volatility on August 24,
2015 (December 2015) available at http://www.sec.gov/marketstructure/research/equity_market_volatility.pdf.
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c. Market Surveillance and Investigations
Regulators perform market surveillance and investigation functions
that rely on access to multiple types of market data. In the Adopting
Release, the Commission discussed how data limitations impact
surveillance and investigations, including risk-based examinations,
market manipulation investigations, tips and complaints, and cross-
market and principal order surveillance.\331\ The following Sections
update and broaden the discussion from the Adopting Release to describe
the current state of SRO surveillance and SRO and Commission
examinations and enforcement investigations.
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\331\ See Adopting Release, supra note 9, at 45730-32.
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(1) Current SRO Surveillance
Rule 613(f) requires the SROs to develop and implement a
surveillance system, or enhance existing surveillance systems,
reasonably designed to make use of the CAT Data.\332\ For the purposes
of this economic analysis, the Commission considers surveillance to
involve SROs running automated processes on routinely collected or in-
house data to identify potential violations of rules or regulations. As
such, surveillance does not include processes run on data that the SROs
request only when needed. SRO surveillance can help protect investors
by having systems in place that can be used to detect fraudulent
behavior and anomalous trading. For instance, SROs use surveillance
systems, developed internally or by a third party, to detect violations
of trading rules, market abuse, or unusual behavior, in real time,
within one day, or within a few weeks of the activity in question. The
exchanges are responsible for surveillance of their own exchanges, and
FINRA is responsible for off-exchange and cross-market surveillance.
FINRA also provides surveillance services to U.S. equity and options
exchanges through regulatory services agreements with nearly every
equity market and all options exchanges.\333\ FINRA also currently
conducts several cross-market surveillance patterns, such as
surveillance focused on wash sales, front running, relationship
trading, and high frequency trading.
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\332\ See 17 CFR 242.613(f).
\333\ See Richard G. Ketchum, FINRA Chairman and CEO, Testimony
Before the Subcommittee on Capital Markets and Government Sponsored
Enterprises Committee on Financial Services (May 1, 2015), available
at https://www.finra.org/newsroom/speeches/050115-testimony-subcommittee-capital-markets-and-government-sponsored-enterprises;
Richard G. Ketchum, FINRA Chairman and CEO, Testimony Before the
Subcommittee on Securities, Insurance and Investment, United States
Senate (March 3, 2016), available at http://www.finra.org/newsroom/speeches/030316-testimony-subcommittee-securities-insurance-and-investment-united-states.
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FINRA has responsibility to oversee and regulate OTC trading of
exchange-listed and non-exchange-listed securities, as well as trading
in corporate and municipal debt instruments and other fixed income
instruments. Also, FINRA conducts cross-market surveillance for
approximately 99% of the listed equity market and approximately 70% of
the listed options market.\334\ To conduct cross-market surveillance,
FINRA uses a variety of online and offline surveillance techniques and
programs to reconstruct market activity, using trading data and quote
information that is captured throughout the trading day, as well as
order audit trail data reported daily. FINRA's cross-market
surveillance is able to identify a single broker-dealer's manipulative
activity across multiple markets, as well as manipulative activity of
multiple market participants acting in concert across multiple
markets.\335\
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\334\ See Richard G. Ketchum, FINRA Chairman and CEO, Testimony
Before the Subcommittee on Securities, Insurance and Investment,
United States Senate (March 3, 2016), available at http://www.finra.org/newsroom/speeches/030316-testimony-subcommittee-securities-insurance-and-investment-united-states.
\335\ See FINRA 2015 Regulatory and Examinations Priorities
Letter, at 14, available at https://www.finra.org/sites/default/files/p602239.pdf; see also FINRA 2016 Regulatory and Examinations
Priorities Letter, at 12, available at https://www.finra.org/sites/default/files/2016-regulatory-and-examination-priorities-letter.pdf.
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Additional surveillance is conducted by exchange-operating SROs,
some of it
[[Page 30658]]
conducted as trading activity occurs. This surveillance can include
detection of market manipulation, violations of trading rules, and
other unusual behavior.
(2) Examinations
In the Adopting Release, the Commission explained how it expected
CAT Data to facilitate risk-based examinations.\336\ SROs currently
conduct exams of broker-dealers for violations of trading-related
federal laws, rules, and regulations and for violations of SRO rules
and regulations.\337\ In 2015, FINRA's Member Regulation Department
conducted approximately 2,400 broker-dealer examinations.\338\ The
Commission currently conducts exams of broker-dealers, transfer agents,
investment advisers, investment companies, municipal advisers, clearing
agencies, the national securities exchanges, other SROs such as FINRA
and the Municipal Securities Rulemaking Board, and the Public Company
Accounting Oversight Board (``PCAOB''). The Commission conducted 493
broker-dealer examinations in 2014 and 484 in 2015, 70 exams of the
national securities exchanges and FINRA in 2014 and 21 in 2015. In
addition, the Commission conducted 1,237 investment adviser and
investment company examinations in 2014 and 1,358 in 2015. Virtually
all investment adviser examinations and a significant proportion of the
Commission's other examinations involve analysis of trading and order
data.
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\336\ See Adopting Release, supra note 9, at 45730-31.
\337\ SEC Rule 17d-2 permits SROs to propose joint plans among
two or more SROs for the allocation of regulatory responsibility.
Where 17d-2 agreements are in place, SROs have joint plans with
respect to their common members (i.e., members of both/all the SROs
party to an agreement under Rule 17d-2) for common rules (i.e.,
rules that are identical or substantially identical). Commission
approval of a plan filed pursuant to Rule 17d-2 relieves an SRO of
those regulatory responsibilities allocated by the plan to another
SRO. See 17 CFR 240.17d-2. Exchanges also enter into Regulatory
Services Agreements (``RSAs'') whereby one SRO contractually agrees
to perform regulatory services for another. However, RSAs do not
relieve the contracting SRO from regulatory responsibility for the
performance of any regulatory services allocated pursuant to the RSA
and are not filed with the Commission for approval.
\338\ This estimate is based on Staff discussions with FINRA.
See also FINRA overview of Member Regulation available at http://www.finra.org/industry/member-regulation.
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Examinations of broker-dealers and investment advisers involve
intensive analysis of trading data. Examinations seek to determine
whether the entity being examined is: Conducting its activities in
accordance with the federal securities laws, rules adopted under these
laws, and SRO rules; adhering to the disclosures it has made to its
clients, customers, the general public, SROs and/or the Commission; and
implementing supervisory systems and/or compliance policies and
procedures that are reasonably designed to ensure that the entity's
operations are in compliance with the applicable legal
requirements.\339\
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\339\ See SEC, Examination Information for Entities Subject to
Examination or Inspection by the Commission (June, 2014), available
at http://www.sec.gov/about/offices/ocie/ocie_exambrochure.pdf.
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The Commission and certain SROs, such as FINRA, use a risk-based
approach to select candidates and to determine exam scope and
focus.\340\ ``Risk-based examinations'' seek to increase regulatory
efficiency by using preliminary data analysis to direct examination
resources towards entities and activities where risks of violative or
illegal activity are the highest. The Commission uses risk and data
analysis before opening an exam to identify broker-dealers and
investment advisers for areas of focus such as suspicious trading, as
well as during an exam to identify the particular activities of a
broker-dealer or investment adviser that could trigger certain
compliance and supervisory risks.
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\340\ FINRA conducts regulatory examinations by contract on
behalf of all the options and equities exchanges, except for the
Chicago Stock Exchange, Inc. (``CHX'') and the National Stock
Exchange, Inc. (``NSX''). Accordingly most exchanges also employ a
risk-based approach to examination selection and scope. CHX examines
members on a cycle basis. NSX recently resumed operations in
December, 2015. See Securities Exchange Act Release No. 76640
(December 14, 2015), 80 FR 79122 (December 18, 2015).
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Because of the data-intensive nature of examinations, the
Commission and SROs have systems, such as the Commission's National
Exam Analytics Tool (``NEAT''), to combine, standardize, and analyze
exam data. The NEAT system allows examiners to import trade blotter
data to conduct commission analysis, cross trades analysis, bunch price
analysis, trading pattern analysis, and restricted trade analysis.
However, as discussed further below, there are limitations on the trade
blotter data imported by the NEAT system.\341\
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\341\ See Section IV.D.2.b, infra.
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(3) Enforcement Investigations
The Adopting Release details how the Commission expects the CAT
Data to aid in the analysis of potential manipulation.\342\ The
Commission and SROs undertake numerous investigations to enforce the
securities laws and related rules and regulations, including
investigations of market manipulations (e.g., marking the close, order
layering, spoofing,\343\ wash sales, trading ahead), insider trading,
and issuer repurchase violations. As noted below, the Commission
estimates that 30-50% of enforcement investigations use trade and order
data, and any of these types of investigations, in addition to numerous
other investigations, could potentially utilize CAT Data.\344\
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\342\ See Adopting Release, supra note 9, at 45731.
\343\ Layering and spoofing are manipulations 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.
\344\ See infra note 345 and accompanying text. The percentage
of enforcement investigations that could be expected to utilize CAT
Data depends on the percentage of investigations that involve
broker-dealers, investment advisers and investment companies.
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SROs rely primarily on surveillance to initiate investigations
based on anomalies in the trading of securities. The Commission
initiates enforcement investigations when SROs or others submit
reliable tips, complaints, or referrals, or when the Commission becomes
aware of anomalies indicative of manipulation. After the detection of
potential anomalies, a tremendous amount of time and resources are
expended in gathering and interpreting trade and order data to
construct an accurate picture of when trades were actually executed,
what market conditions were in effect at the time of the trade, which
traders participated in the trade, and which beneficial owners were
affected by the trade. In 2015, the Commission filed 807 enforcement
actions, including 39 related to insider trading, 43 related to market
manipulation, 124 related to broker-dealers, 126 related to investment
advisers/investment companies, and one related to exchange or SRO
duties. In 2014, the Commission filed 755 enforcement actions,
including 52 related to insider trading, 63 related to market
manipulation, 166 related to broker-dealers, and 130 related to
investment advisers/investment companies, many of which involved trade
and order data.\345\ Similarly, FINRA brought 1,397 disciplinary
actions in 2014 and 1,512 in 2015.\346\
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\345\ See Year-by-Year SEC Enforcement Statistics, available at
https://www.sec.gov/news/newsroom/images/enfstats.pdf. The total
number of actions filed is not necessarily the same as the number of
investigations. An investigation may result in no filings, one
filing, or multiple filings. Additionally, trade and order data may
be utilized in enforcement investigations that do not lead to any
filings.
\346\ See FINRA statistics available at http://www.finra.org/newsroom/statistics.
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[[Page 30659]]
(4) Tips and Complaints
The Adopting Release discussed how the Commission expected CAT Data
to improve the processes used by the SROs and the Commission for
evaluating tips and complaints.\347\ Market participants or those with
experience in analyzing market data sometimes notice atypical trading
or quoting patterns in publicly available market data, and these
observations sometimes result in a tip or complaint to a regulator.
Regulators investigate thousands of tips and complaints each year. In
fiscal years 2014 and 2015, the Commission received around 15,000
entries in its Tips, Complaints and Referrals (``TCR'') system,
approximately one third of which related to manipulation, insider
trading, market events, or other trading and pricing issues.
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\347\ See Adopting Release, supra note 9, at 45731-32.
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Analysis of tips and complaints follows three general stages.
First, regulators ensure that the tip or complaint contains sufficient
information to facilitate analysis. The second stage involves a
triaging effort in which regulators may use directly accessible data or
make phone calls and other informal queries to determine if the tip or
complaint is credible. For tips and complaints that seem credible, the
third stage involves a more in-depth investigation or examination,
which follows the processes described above for examinations and
enforcement investigations.
2. Current State of Trade and Order Data
To assess how and to what degree the CAT NMS Plan would affect the
trade and order data available to regulators, the economic analysis
considers what data regulators use currently and the limitations in
that data.
a. Current Sources of Trade and Order Data
The SROs and the Commission currently use a range of trading and
order data sources for the regulatory activities discussed above. The
types of data and ease of use can vary widely from one source to the
next. Some data sources provide access to in-depth information on a
narrow slice of the market, while others reveal more limited
information but with broader market coverage. This Section reviews the
primary sources of data currently available to regulators, describing
the content of the data provided and examples of their specialized
uses. There are limitations on each of the data sources discussed below
that reduce their usefulness for regulatory purposes. These limitations
and their impact on the ability of the SROs and the Commission to use
the data sources for regulatory purposes are explained in Section
IV.D.2.b below.
(1) SRO Data
Most SROs maintain audit trails that contain the trade and order
data that they obtain from members. Regulators have access to at least
three sources of audit trail data. First, the National Association of
Securities Dealers (``NASD'') \348\ established its Order Audit Trail
System (``OATS'') \349\ in 1998, which required NASD (n/k/a FINRA)
members to report certain trade and order data regarding NASDAQ-listed
equity securities.\350\ OATS was later expanded to include OTC equity
securities and all NMS stocks.\351\ Second, beginning in 2000, several
of the current options exchanges implemented the Consolidated Options
Audit Trail System (``COATS'').\352\ Finally, each equity and options
exchange keeps an audit trail of orders and trades that occur on its
market.\353\
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\348\ 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).
\349\ See Securities Exchange Act Release No. 39729 (March 6,
1998), 63 FR 12559 (March 13, 1998) (order approving proposed rules
comprising OATS) (``OATS Approval Order'').
\350\ The FINRA Web site states: ``FINRA has established the
Order Audit Trail System (OATS), as an integrated audit trail of
order, quote, and trade information for all NMS stocks and OTC
equity securities. FINRA uses this audit trail system to recreate
events in the life cycle of orders and more completely monitor the
trading practices of member firms.'' FINRA, OATS, available at
http://www.finra.org/industry/oats (listing further information on
OATS).
\351\ See Securities Exchange Act Release No. 63311 (November
12, 2010), 75 FR 70757 (November 18, 2010) (order approving proposed
rule change by FINRA relating to the expansion of OATS to all NMS
stocks).
\352\ See, e.g., In the Matter of Certain Activities of Options
Exchanges, Order Instituting Public Administrative Proceedings
Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934,
Making Findings and Imposing Remedial Sanctions, Securities Exchange
Act Release No. 43268 (September 11, 2000) (``Options Settlement
Order''); Securities Exchange Act Release No. 50996 (January 7,
2005), 70 FR 2436 (January 13, 2005) (order approving proposed rule
change by Chicago Board Options Exchange, Incorporated (``CBOE'')
relating to Phase V of COATS).
\353\ See, e.g., infra notes 358-364 and accompanying text. For
example, the NYSE tracks counterparties on every trade in its
Consolidated Equity Audit Trail Data (``CAUD'') system, and records
electronic order events in a System Order Data (``SOD'') database.
See Proposing Release, supra note 9, at 32564-68 (proposing
Consolidated Audit Trail and discussing equity exchange audit
trails). The SROs provided data in various proprietary formats to
the Commission in support of the investigation of the May 6th, 2010
``Flash Crash.'' These data sources are briefly discussed in the
Flash Crash Analysis, supra note 322.
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Specifically, for each of these stages in the life of an order,
FINRA Rule 7440 requires the recording and reporting of the following
information, as applicable, including but not limited to: For the
receipt or origination of the order, the date and time the order was
first originated or received by the reporting member, a unique order
identifier, the market participant symbol of the receiving reporting
member, and the material terms of the order; \354\ for the internal or
external routing of an order, the unique order identifier, the market
participant symbol of the member to which the order was transmitted,
the identification and nature of the department to which the order was
transmitted if transmitted internally, the date and time the order was
received by the market participant or department to which the order was
transmitted, the material terms of the order as transmitted,\355\ the
date and time the order was transmitted, and the market participant
symbol of the member who transmitted the order; for the modification or
cancellation of an order, a new unique order identifier, original
unique order identifier, the date and time a modification or
cancellation was originated or received, and the date and time the
order was first received or originated; \356\ and for the execution of
an order, in whole or in part, the unique order identifier, the
designation of the order as fully or partially executed, the number of
shares to which a partial
[[Page 30660]]
execution applies and the number of unexecuted shares remaining, the
date and time of execution, the execution price, the capacity in which
the member executed the transaction, the identification of the market
where the trade was reported, and the date and time the order was
originally received. FINRA Rule 7440 also requires reporting of the
account type,\357\ the identification of the department or terminal
where an order is received from a customer, the identification of the
department or terminal where an order is originated by a reporting
member, and the identification of a reporting agent if the agent has
agreed to take on the responsibilities of a reporting member under Rule
7450.
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\354\ The specific information required to be reported includes:
The number of shares; designation as a buy or sell or short sale;
designation of the order as market, limit, stop, or stop limit;
limit or stop price; date on which the order expires and if the time
in force is less than one day, the time when the order expires; the
time limit during which the order is in force; any request by a
customer that a limit order not be displayed, or that a block size
limit order be displayed, pursuant to Rule 604(b) of Regulation NMS;
any special handling requests; and identification of the order as
related to a program trade or index arbitrage trade. See FINRA Rule
7440(b).
\355\ The specific information required includes the number of
shares to which the transmission applies, and whether the order is
an intermarket sweep order. See FINRA Rule 7440(c).
\356\ For cancellations or modifications, the following
information also is required: If the open balance of an order is
canceled after a partial execution, the number of shares canceled;
and whether the order was canceled on the instruction of a customer
or the reporting member. See FINRA Rule 7440(d).
\357\ ``Account type'' refers to the type of beneficial owner of
the account for which the order was received or originated. Examples
include institutional customer, individual customer, employee
account, market making, and proprietary. See FINRA, OATS Reporting
Technical Specifications, at 4-2, available at http://www.finra.org/sites/default/files/OATSTechSpec_01112016.pdf.
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A majority of options exchanges require their members to provide
the following information with respect to orders entered onto their
exchange: (1) The material terms of the order; \358\ (2) order receipt
time; \359\ (3) account type; (4) the time a modification is received;
(5) the time a cancellation is received; (6) execution time; and (7)
the clearing member identifier of the parties to the transaction.\360\
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\358\ The specific information required includes option symbol;
underlying security; expiration month; exercise price; contract
volume; call/put; buy/sell; opening/closing transaction; price or
price limit; and special instructions. See, e.g., BATS Exchange,
Inc. (``BATS'') Rule 20.7; BOX Options Exchange LLC (``BOX'')
Chapter V, Section 15; CBOE Chapter VI, Rules 6.24 and 6.51; NASDAQ
Options Market (``NOM'') Rule Chapter V, Section 7; NYSE Amex Rules
153, Commentary .01, and 962; NYSE Arca Rules 6.67, 6.68, and 6.69;
and NASDAQ OMX PHLX LLC (``Phlx'') Rules 1063 and 1080.
\359\ The required information also includes identification of
the terminal or individual completing the order ticket. See id.
\360\ See id.
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Although SROs that operate exchanges collect much of their audit
trail information directly from their internal systems, broker-dealers
also have the responsibility to report regulatory data to SRO audit
trails. Some broker-dealers perform nearly all of these data reporting
requirements in-house, whereas others contract with service bureaus to
accomplish this data reporting.\361\ This reporting can represent a
significant burden on broker-dealers.
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\361\ See Section IV.F.1.c(2), infra, for a discussion of how
broker-dealers decide whether or not to outsource their regulatory
reporting.
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Audit trail data have become more useful to regulators over time.
As noted above, FINRA expanded OATS from covering only NASDAQ listed
securities to include OTC equity securities and all NMS stocks.\362\
Commission Staff understands that FINRA has also begun collecting
additional SRO audit trail data, provided voluntarily from most
exchanges, to supplement OATS data. In addition, NYSE, NYSE Amex LLC
(n/k/a ``NYSE MKT LLC'') (``NYSE Amex''), and NYSE ARCA, Inc. (``NYSE
Arca'') eliminated their OTS audit trail requirements and replaced them
to coordinate with the OATS requirements, so that members who are also
members of either FINRA or NASDAQ (and therefore subject to OATS
requirements) are able to satisfy their reporting obligations by
meeting the OATS requirements.\363\ As a result of all of these
changes, the combined data from these different audit trails \364\ now
cover most order events in equities.
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\362\ See supra note 351.
\363\ See Securities Exchange Act Release No. 65523 (October 7,
2011), 76 FR 64154 (October 17, 2011) (concerning NYSE); Securities
Exchange Act Release No. 65524 (October 7, 2011), 76 FR 64151
(October 17, 2011) (concerning NYSE Amex); Securities Exchange Act
Release No. 65544 (October 12, 2011), 76 FR 64406 (October 18, 2011)
(concerning NYSE Arca).
\364\ Other SRO audit trails have varied reporting requirements.
Some exchanges have detailed audit trail data submission
requirements for their members covering order entry, transmittal,
and execution. See CHX Article 11, Rule 3(b); NASDAQ Rules 6950-6958
(substantially similar to the OATS rules); NASDAQ OMX BX Rules 6950-
6958 (substantially similar to OATS rules). The audit trail rules of
the other exchanges incorporate only standard books and records
requirements in accordance with Section 17 of the Exchange Act, 15
U.S.C. 78q. See, e.g., NSX Chapter VI, Rule 4.1.; BATS Chapter IV,
Rule 4.1; CBOE Rule 15.1 (applicable to CBOE Stock Exchange
(``CBSX'')); International Securities Exchange, LLC (``ISE'') Rule
1400; NYSE Arca Equities Rule 2.24. One exchange only requires its
members to make and keep books and records and other correspondence
in conformity with Section 17 of the Exchange Act and the rules
thereunder, with all other applicable laws and the rules,
regulations and statements of policy promulgated thereunder, and
with the exchange's rules. See NSX Chapter VI, Rule 4.1. Though not
an audit trail, the Large Options Position Report (``LOPR'') is also
a source of SRO data that is used for surveillance, examination, and
enforcement purposes by SRO and Commission staff. The data is
collected pursuant to FINRA Rule 2360(b)(5), Reporting of Options
Positions, under which each member must file a report for each
account in which they have an interest in a position of 200 or more
options contracts, on the same side of the market. Any increases or
decreases in this position must also be reported. The Options
Clearing Corporation (``OCC'') is the service provider for the
processing of these reports, which are used at will by the SROs for
surveillance purposes. The Commission also frequently uses LOPR for
enforcement investigations of insider trading and market
manipulation cases.
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SRO audit trail data is used for market reconstructions and market
analyses, and to inform policy decisions, both by the Commission and by
SROs. Regulators also use SRO audit trail data extensively for
surveillance, examinations, investigations, and other enforcement
functions. Current SRO market surveillance relies primarily on data
from the SRO audit trails, generated directly from the exchange servers
and from OATS. Likewise, SRO examinations and investigations pull
information from their own audit trails before seeking data from
others. Commission examinations and investigations also rely heavily on
SRO audit trails to start the process of tracing a particular trade
from its execution to the order initiations and customer information,
and the audit trails can be useful for manipulation investigations or
other regulatory activities that require analyses of microcap
securities trading activity. There are, however, limitations on SRO
audit trail data that reduce their usefulness to regulators. For
example, for the examinations mentioned above, Commission examination
Staff may undertake a laborious process of linking SRO audit trail data
with EBS data, because SRO audit trail data does not contain customer
information.\365\ These and other limitations are discussed in Section
IV.D.2.b, infra.
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\365\ See Section IV.D.2.b, infra.
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(2) Equity and Option Cleared Reports
The SROs and Commission also have access to equity and option
cleared reports. Clearing broker-dealers report their equity and option
cleared data on a daily basis and the NSCC and the OCC aggregate the
data across the market and generate the reports.\366\ The reports show
the number of trades and daily cleared trade and share volume, by
clearing member, for each equity and listed option security in which
transactions took place. Regulators can query these reports directly
through an internal online system that interfaces with the Depository
Trust and Clearing Corporation (``DTCC'') data by security name and
CUSIP number.\367\ The
[[Page 30661]]
originating source of the DTCC cleared equity data is the Securities
Information Automation Corporation (``SIAC'') and the originating
source of the cleared options data is the OCC.
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\366\ NSCC provides clearing, settlement, risk management,
central counterparty services and a guarantee of completion for
certain transactions for virtually all broker-to-broker trades
involving equities, corporate and municipal debt, American
depositary receipts, exchange-traded funds, and unit investment
trusts. See DTCC, About DTCC, NSCC, available at http://www.dtcc.com/about/businesses-and-subsidiaries/nscc.aspx. The OCC is
an equity derivatives clearing organization that is registered as a
clearing agency under Section 17A of the Act, 15 U.S.C. 78q-1, and
operates under the jurisdiction of both the Commission and the CFTC.
See OCC, About OCC, available at http://www.optionsclearing.com/about/corporate-information/what-is-occ.jsp.
\367\ A CUSIP number is a unique alphanumeric identifier
assigned to a security and facilitates the clearance and settlement
of trades in the security. See SEC, Fast Answers, CUSIP Number,
available at www.sec.gov/answers/cusip.htm.
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Equity and option cleared reports provide a way for regulators to
directly access a dataset to see how much trading volume is accounted
for by a particular clearing broker. As such, these data are often used
at the beginning of an examination or investigation to start
identifying the market participants that may have additional data
needed to pinpoint a particular activity. But there are limitations on
these reports that reduce their usefulness to regulators. For example,
the information available on the reports is limited to the date, the
clearing firm, and the number of transactions cleared by each clearing
firm on each SRO. These and other limitations are discussed in Section
IV.D.2.b, infra.
(3) Electronic Blue Sheets
Broker-dealers provide detailed data to regulators in the form of
EBS. The EBS data, provided pursuant to Rule 17a-25 under the Act,\368\
facilitate investigations by the SROs and Commission Staff,
particularly in the areas of insider trading and market manipulations.
The EBS system provides certain detailed execution information in its
electronic format \369\ upon request by SRO or Commission Staff. This
information often includes the employer of the beneficial owner of an
account,\370\ which can be important to insider trading investigations,
and in some cases, a tax identification number.\371\
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\368\ 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.
\369\ For a proprietary transaction, Rule 17a-25 requires a
broker-dealer to provide the following information electronically
upon request: (1) Clearing house number or alpha symbol used by the
broker-dealer submitting the information; (2) clearing house
number(s) or alpha symbol(s) of the broker-dealer(s) on the opposite
side to the trade; (3) security identifier; (4) execution date; (5)
quantity executed; (6) transaction price; (7) account number; (8)
identity of the exchange or market where the transaction was
executed; (9) prime broker identifier; (10) average price account
identifier; and (11) the identifier assigned to the account by a
depository institution. See Rule 17a-25(a)(1), (b)(1)-(3), 17 CFR
240.17a-25(a)(1), (b)(1)-(3). For customer transactions, the broker-
dealer also is required to include the customer's name, customer's
address, the customer's tax identification number, and other related
account information. See Rule 17a-25(a)(2), 17 CFR 240.17a-25(a)(2);
see also infra note 372 and accompanying text (discussing additional
information on ``large traders'' reported through EBS).
\370\ Employer information is required by some SRO EBS rules.
See, e.g., NYSE and FINRA Rule 8211. While employer information is
not required under Rule 17a-25, Commission staff sometimes request
and receive this information.
\371\ Tax identification numbers are not required to be reported
in EBS for average price, allocation, riskless principal, foreign
accounts, and subaccounts.
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The EBS system also provides additional information on market
participants who meet the definition of ``large traders'' and have
self-identified to the Commission as required by Rule 13h-1.\372\ Large
traders who file Form 13H with the Commission are assigned a ``large
trader identification number'' by the Commission and must provide that
number to their brokers for inclusion in the EBS records that are
maintained by the clearing brokers. Rule 13h-1, subject to relief
granted by the Commission,\373\ requires that execution time be
captured (to the second) for certain categories of large traders. Large
trader data provide the Commission with a way to acquire information
about the activities of large traders and allow the activities of large
traders to be more readily aggregated across or partitioned by multiple
broker-dealers. Regulators generally use data from the EBS system
extensively in enforcement investigations, for which EBS data are
vital, particularly insider trading investigations. But again, there
are limitations on EBS data. For example, EBS data are cumbersome to
use for broad analyses, such as analysis and reconstruction of market
events, market analysis and research, and some examinations, because of
the fragmentation of the data. These and other limitations are
discussed in Section IV.D.2.b, infra.
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\372\ See Securities Exchange Act Release No. 64976 (July 27,
2011), 76 FR 46960 (August 3, 2011). A ``large trader'' is defined
as a person whose transactions in NMS securities equal or exceed 2
million shares or $20 million during any calendar day, or 20 million
shares or $200 million during any calendar month. SEC Rule 13h-1, 17
CFR 240.13h-1, requires those market participants who meet the
definition of ``large traders'' to comply with a number of
requirements, including filing Form 13H with the Commission to
receive a large trader identification number. Id.
\373\ See Securities Exchange Act Release No. 76322 (October 30,
2015), 80 FR 68590 (November 5, 2015).
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(4) Trade Blotters and Order Tickets
Investment advisers and broker-dealers maintain data in the form of
order tickets and trade blotters that regulators can obtain on
request.\374\ Order tickets are in-house records maintained by
investment advisers and broker-dealers that provide order details,
including time stamps of order initiation and placement, special order
types, any special instructions for the order, and plans for the
allocation of shares and prices across accounts and subaccounts. Order
tickets also identify account owners. Commission Staff collects order
tickets regularly for examinations, and occasionally also for market
manipulation investigations.
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\374\ Rule 204-2 requires investment advisers to maintain a
memorandum of each order given by the investment adviser for the
purchase or sale of any security. 17 CFR 275.204-2(a)(3). Rule 17a-
3(a)(1) requires broker-dealers to maintain a trade blotter. 17 CFR
240.17a-3(a)(1).
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Broker-dealers maintain data in trade blotters that are similar to
EBS. However, the trade blotters also contain more information,
including the commissions paid in executing each order, time stamps of
when an order is received and when it is executed (and the number of
fills), and the pricing information for all executions in the
order.\375\ SROs use trade blotters in examinations of their members.
Commission Staff uses trade blotters frequently for examinations,
including in almost every broker-dealer, investment adviser, and hedge
fund examination, as well as for insider trading and market
manipulation investigations. Regulators use trade blotter data to
determine the order entry time and execution time for trades by a
particular customer in examinations and enforcement investigations.
Trade blotters are also the primary data source used in regulatory
investigations for which subaccount allocation information is important
for determining violative behavior, such as cherry-picking and front-
running cases. There are limitations on trade blotter and order ticket
data that reduce their usefulness to regulators, however. For example,
regulators lack direct access to these data; in order to acquire trade
blotter and order ticket data, regulators need to send a request to
each individual broker-dealer to obtain its data, which can be a
lengthy and cumbersome process. These and other limitations are
discussed in Section IV.D.2.b, infra.
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\375\ Regulators could also request a trade confirmation instead
of a trade blotter. A trade confirmation shows the customer, the
symbol, execution price, trade date, settlement date and commission.
A trade blotter is more detailed than a trade confirmation. A trade
blotter is what a firm itself records and the exact information
recorded varies by firm. Typically, regulators look to the trade
confirmation when they have questions about the veracity of a firm's
blotter, but generally prefer to request the trade blotter due to
its greater detail.
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[[Page 30662]]
(5) Trading and Order Handling System Data
Broker-dealers and exchanges also collect and maintain records of
activity in their order handling systems and internal matching
systems.\376\ This data may include order receipt, modification or
routing information not otherwise reported to SROs. Some elements of
these data exceed the scope of information captured in EBS, SRO audit
trail, trade blotter, or order ticket data; for example, SRO audit
trail data sometimes excludes market-making activity. But certain
market making activity is included in the data that broker-dealers and
exchanges are required to maintain pursuant to Section 17(a) of the Act
\377\ and Rule 17a-3 thereunder.\378\ Regulators use these trading and
order handling system data in investigations and examinations to
further analyze issues discovered during their analysis of data from
other sources. Like other current sources of data, there are
limitations on trading and order handling system data that reduce their
usefulness to regulators. For example, a lack of standardization
results in variations in trading and order handling system data across
broker-dealers. These and other limitations are discussed in Section
IV.D.2.b, infra.
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\376\ Internal matching systems of broker-dealers may include
Alternative Trading Systems (``ATSs'') or automated trading systems
that provide liquidity to received orders without interacting on a
registered exchange. The Commission understands that some broker-
dealers rely on their clearing firms to collect and maintain records
relating to routed orders on their behalf. Broker-dealers that
operate their own internal matching systems are more likely to
collect and maintain their own records.
\377\ 15 U.S.C. 78q(a).
\378\ 17 CFR 240.17a-3. For example, market makers are only
required to report information on orders that are executed.
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(6) Public Data
Exchanges and SROs also make data available to the public, in some
cases on a commercially-available basis,\379\ that regulators could
access for their regulatory activities. One type of public data is
``consolidated'' data feeds that are disseminated by registered
Securities Information Processors (``SIPs'') pursuant to joint SRO
plans.\380\ For a fee, the SIPs distribute consolidated market data on
recent equity and option transactions and the prevailing best quotes at
each exchange to market data subscribers. In addition, all exchanges
also make data available through direct data feeds. These feeds contain
all data included in the SIP feed, but also include depth of book
information \381\ and, depending on the exchange, may include
additional data, such as the submission, cancellation and execution of
all displayed orders and auction imbalance information on the exchange,
among other things.
---------------------------------------------------------------------------
\379\ In other words, the exchanges and SROs sell the data
publicly and regulators can purchase it.
\380\ ICE serves as the operator for the Consolidated Tape
Association (``CTA'') Plan SIP and the Consolidated Quote System
(``CQS'') Plan SIP. These SIPs collect and disseminate information
on quotes and trades in listed securities, other than NASDAQ listed
securities. The NASDAQ Stock Market LLC serves as the operator for
the Unlisted Trading Privileges (``UTP'') Plan SIP, which collects
and disseminates quote and trade information in NASDAQ listed
securities.
\381\ An exchange's order book consists of all unexecuted orders
at each price. Order book data typically includes the depth
(aggregated number of shares) of the displayed orders at each price
and might include all prices in the order book or the depth at each
price over a range of prices. Displayed orders consist of any order
in which the submitter did not instruct that some or all of the
order be hidden from display.
---------------------------------------------------------------------------
The SEC's Market Information Data Analytics System (``MIDAS'') uses
information disseminated by the SIP feeds, as well as exchange direct
feeds consisting of data that individual exchanges choose to sell to
subscribers. In addition, at the request of Commission Staff, most
equities exchanges produce and make public two datasets with
information on short sales: A file of short selling volume by stock,
which contains the short selling and total volume on that exchange by
symbol, and a file of short selling transactions, which contains trade
information such as time, volume, and price for each transaction
involving a short sale.\382\
---------------------------------------------------------------------------
\382\ See Short Sale Reporting Study, infra note 413, for more
information on available short selling data and the demands for
additional short selling data. This study also describes information
regarding data from Form SH filings. For ten months starting during
the financial crisis, the Commission required certain institutional
investors to submit weekly reports of their short selling activity
and positions.
---------------------------------------------------------------------------
The Commission and SROs use these publicly available trade and
order data to conduct market analyses, market reconstructions,
examinations, and investigations. Because of the accessibility and ease
of use of the public data, regulators often use it as a starting point
or a basis of comparison to other data sources. For example, real-time
surveillance can rely on SIP data, and some insider trading
surveillance relies on information from other publicly available
sources such as news sources. Further, investigations into short sale
market manipulation sometimes start with an analysis of the short
selling data. Some market analyses by regulators rely on public data
alone.\383\ However, there are limitations on these data that reduce
their usefulness to regulators. For example, they do not provide
customer information, order entry time, information about special order
handling codes, counterparties, or member identifiers. These and other
limitations are discussed in Section IV.D.2.b, infra.\384\
---------------------------------------------------------------------------
\383\ See Collver, supra note 327.
\384\ See also Staff of the Office of Analytics and Research,
Division of Trading and Markets, Research Note: Equity Market
Volatility on August 24, 2015 (December 2015) available at http://www.sec.gov/marketstructure/research/equity_market_volatility.pdf.
---------------------------------------------------------------------------
b. Current Limitations of Trade and Order Data
Although regulators have access to trade and order data from the
sources described above,\385\ the available data are, for various
reasons, limited in terms of the four qualities discussed above. In
terms of completeness, current sources do not represent all of the
market activity of interest in sufficient detail in one consolidated
audit trail. In terms of accuracy, current sources may reflect data
errors, insufficiently granular clock synchronization and time stamps,
errors introduced in the process of combining data from different
sources, a lack of consistent customer and broker-dealer identifiers,
and data that is too aggregated at the record level to provide the
information regulators need. With respect to accessibility, the SROs
and Commission lack direct access to most of the data sources described
above, and with respect to timeliness, obtaining trade and order data
from current sources and converting the data into a form in which they
can be analyzed can involve a significant delay from the time of a
particular event of interest.\386\ The qualities of market data are
important to the Commission's ability to fulfill its statutory mission
in an efficient and effective manner. As a result of the limitations on
current data sources, regulators are limited in their ability to
perform the activities outlined in Section IV.D.1, above. Table 2:
Currently Available Data Sources summarizes the key characteristics of
the currently available data sources, which are discussed in more
detail below.
---------------------------------------------------------------------------
\385\ See Section IV.D.2.a, supra.
\386\ As discussed above and in the Adopting Release, accuracy
refers to whether the data about a particular order or trade is
correct and reliable; completeness refers to whether the data
represents all market activity of interest or just a subset, and
whether the data is sufficiently detailed to provide the required
information; accessibility refers to how the data is stored, how
practical it is to assemble, aggregate, and process the data, and
whether all appropriate regulators could acquire the data they need;
and timeliness refers to when the data is available to regulators
and how long it would take to process before it could be used for
regulatory analysis. See supra note 306.
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[[Page 30663]]
[GRAPHIC] [TIFF OMITTED] TN17MY16.327
[[Page 30664]]
(1) Completeness
``Completeness'' refers to whether the data represents all market
activity of interest or just a subset, and whether the data is
sufficiently detailed to provide the required information.\391\ While
current data sources provide trade and order data specified by existing
rules and regulations, those sources do not contain all market activity
that might be required for certain market inquiries, in sufficient
detail, within one consolidated audit trail. To obtain information
regarding a particular market event, regulators may have to piece
together information from different data sources. Further, some data is
not required to be reported at all under existing regulations.\392\
Therefore, current data sources either cover only a limited number of
events and products, or lack some data fields that would be useful to
regulators, each of which impedes effective market surveillance.
---------------------------------------------------------------------------
\391\ See supra note 306.
\392\ See, e.g., Adopting Release, supra note 9, at 45726-30,
45741, 45750 n.286, 45756 n.361 (discussing the incompleteness of
the data recorded by existing audit trail systems such as OATS,
acknowledging that ``certain elements are not collected by existing
audit trails,'' and noting that ``existing SRO audit trails do not
require customer information to be reported''); see also Proposing
Release, supra note 9, at 32564-66, 32603 (discussing gaps in
current required audit trail information and stating that the
proposed rule would require ``national securities exchanges,
national securities associations, and their members to capture . . .
information that is not currently captured under the existing audit
trail or other regulatory requirements'').
---------------------------------------------------------------------------
A. Events and Products
There is currently no single data source that covers all market
activities. EBS data contains executed trades but does not contain
information on orders or quotes (and thus does not provide information
on routes, modifications, or cancellations). Similarly, trade blotters
and order tickets contain only information recorded by that particular
broker-dealer or investment adviser and may contain limited information
about full order lifecycles. SRO audit trail data are limited to
identifying the activity of their members, can have incomplete
information concerning their members, lack order lifecycle information
occurring prior to receipt by an exchange, and may not contain
information regarding principal trading. Furthermore, public
consolidated and direct data feeds provide data about the entire
market, but lack information regarding non-displayed orders and do not
provide sufficient information to identify the different lifecycle
events of a single order.
Individual SRO audit trails are extensive but still incomplete in
their coverage of the activities of the market participants they cover;
they contain only activity of their own members and many do not
necessarily contain all activity by their members. For example, FINRA's
OATS data does not include proprietary orders originated by a trading
desk in the ordinary course of a member's market making activities, or
options data. And while OATS collects data from FINRA members with
respect to orders and trades involving NMS and OTC stocks, OATS does
not include trade or order activity that occurs on exchanges or at
broker-dealers that are not FINRA members.\393\ In addition, while
broker-dealers who are not members of FINRA must be members of an
exchange SRO, an individual exchange SRO's audit trail data is
generally limited to activity taking place on that exchange.\394\
Because broker-dealers who are not members of FINRA may engage in
trading activity in off-exchange markets, a substantial portion of the
trading activity that an exchange SRO supervises is not reported to the
supervising SRO.\395\
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\393\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(ii)(A). OATS includes records showing the routing of an order
to an exchange, but not the outcome of that routing. In performing
its regulatory oversight of the markets, FINRA has created an
internal process in which it augments the data it collects via OATS
with trade execution data from other exchanges with which it has
regulatory service agreements. This process provides FINRA with a
wider view of the markets than OATS previously provided, but linking
data across these sources does not yield fully accurate results. See
Section IV.D.2.b(2), infra for a discussion of the accuracy of
linking across data sources. See infra note 1060 for a discussion of
FINRA's RSAs.
\394\ Currently, Rule 15b9-1 offers an exemption from FINRA
membership that applies if the firm is a member of a national
securities exchange, carries no customer accounts, and has annual
gross income of no more than $1,000 that is derived from securities
transactions effected otherwise than on a national securities
exchange of which it is a member (the `de minimis allowance').
Income derived from transactions for that dealer's own account with
or through another registered broker-dealer do not count toward the
$1,000 de minimis allowance. However, the national securities
exchanges have not generally supervised their members' activity
outside of the markets they operate. The Commission has proposed
modifications to Rule 15b9-1 that would require a dealer to be a
member of a registered national securities association to conduct
most off-exchange activity. See Securities Exchange Act Release No.
74581 (March 25, 2015), 80 FR 18035, 18042 (April 2, 2015)
(``Exemption for Certain Exchange Members'') (proposing to amend
rule 15b9-1 and noting that ``[n]on-Member Firms are not subject to
oversight by [FINRA] and their off-exchange transactions typically
are not overseen by the exchanges of which they may be members,''
and that ``[e]xchanges traditionally have not assumed the role of
regulating the totality of the trading of their member-broker-
dealers . . .'').
\395\ Id. at 18043 n.85. Broker-dealers that are not FINRA
members accounted for 48% of orders sent directly to ATSs in 2014.
Therefore, OATS includes incomplete information on a substantial
portion of off-exchange trading. As of March 2015, 125 of the
approximately 4,209 registered broker-dealers were not members of
FINRA. Id. at 18052. Orders from non-FINRA members accounted for 40%
of orders sent directly to ATSs in 2013, and 32% in 2012. Id. at
18038 n.21.
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Further, not all FINRA members are obligated to report to OATS.
FINRA's rules exempt from reporting certain members that engage in a
non-discretionary order routing process.\396\ Additionally, FINRA has
the authority to exempt other members who meet specific criteria from
the OATS recording and reporting requirements, and has granted
approximately 50 such exemptions.\397\
---------------------------------------------------------------------------
\396\ See FINRA Rule 7410 (Definitions). The Rule specifically
excludes from the definition of ``Reporting Member'' members that
(1) engage in a non-discretionary order routing process and route
all of their orders either to a single receiving Reporting Member or
two Reporting Members, provided orders are routed to each receiving
Reporting Member on a pre-determined schedule and the time period
for the schedule does not exceed one year; (2) do not direct or
maintain control over subsequent routing or execution by the
receiving Reporting Member; and (3) have a written agreement with
the receiving Reporting Member that specifies the respective
functions and responsibilities of each party to effect full
compliance with the OATS recording and reporting rules. Finally, the
receiving Reporting Member must record and report all required
information pertaining to the order.
\397\ See FINRA Rule 7470 (Exemption to the Order Recording and
Data Transmission Requirements). The Rule provides that, for good
cause shown, FINRA may exempt a member from its recording and
reporting requirements if: (1) The member and current control
affiliates and associated persons of the member have not been
subject within the last five years to any final disciplinary action,
and within the last ten years to any disciplinary action involving
fraud; (2) the member has annual revenues of less than $2 million;
(3) the member does not conduct any market making activities in NMS
stock or OTC securities; (4) the member does not execute principal
transactions with its customers; and (5) the member does not conduct
clearing or carrying activities for other firms. This authority
sunsets on July 10, 2019. Approximately 799 firms that are excluded
or exempt from OATS would incur CAT reporting obligations if the
Plan were approved; see also infra note 931, Section IV.F.1.c(2)B.i,
infra.
---------------------------------------------------------------------------
Exchange audit trails also lack information on the order lifecycle
events that occur prior to receipt at the exchange.\398\ SRO audit
trail data available from the Intermarket Surveillance Group (``ISG'')
\399\ does not
[[Page 30665]]
capture quotes/orders away from a market's inside market (i.e., those
quotes/orders below the best bid or above the best offer); currently
identify market participants in a trade only to the clearing broker
level; do not provide information on the executing broker; and contain
certain data fields that are not mandatory.\400\
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\398\ The Commission understands that exchange routing broker-
dealers, which route orders from exchanges to other Execution
Venues, do substantial business, but it is very hard in current data
sources to track orders sent to one exchange that are then sent to
another exchange or off-exchange venue by the exchange routing
broker-dealer.
\399\ The ISG was established in the early 1980s and is
comprised of over 50 international exchanges, market centers, and
market regulators that perform market surveillance in their
respective jurisdictions. The purpose of the ISG is to provide a
framework for the sharing of information and the coordination of
regulatory efforts among exchanges trading securities, options on
securities, security futures products, and futures and options on
broad-based security indexes, to address potential inter-market
manipulations and trading abuses. In effect, the ISG is an
information-sharing cooperative governed by a written agreement. ISG
also provides a forum for ISG members to discuss common regulatory
concerns, thus enhancing members' ability to efficiently fulfill
their regulatory responsibilities. As a condition to membership,
every ISG member must represent that it has the ability to obtain
and freely share regulatory information and documents with other ISG
members, generally unencumbered by rules, nationally imposed
blocking statutes or bank secrecy laws. Regulatory information is
only shared on an as-needed basis and only upon request, and any
information shared through ISG must be kept strictly confidential
and used only for regulatory purposes. The SEC is not a member of
ISG, nor is ISG subject to regulatory oversight by the SEC.
\400\ See Comment Letter from FINRA and NYSE Euronext regarding
Proposing Release (August 9, 2010), available at https://www.sec.gov/comments/s7-11-10/s71110-46.pdf.
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Additionally, some SRO audit trails do not include and are not
required to include activity associated with principal trading, such as
market-making activity. This may result in the exclusion of a
significant amount of activity, particularly for firms with substantial
market-making business activities. Principal trading activity
represents a significant portion of market activity and there are
aspects of the current market regime that may result in the
underreporting of this trading activity. Indeed, an analysis by
Commission Staff estimates that principal trading accounted for 40.5%
of all reported transactions and principal activity accounted for 67%
of all exchange message traffic.\401\ And, because these figures do not
capture principal activity done by trading on-exchange through other
broker-dealers, these estimates are likely to be biased downwards.\402\
---------------------------------------------------------------------------
\401\ The analysis used audit trail data (where orders are
identified at the broker-dealer level), from 10 exchanges, excluding
CHX, and OATS reported off-exchange activity. Message traffic was
defined as order placement, cancellation, or amendment.
\402\ The fact that off-exchange principal trading of non-FINRA
member broker-dealers is not fully reported in OATS, may also bias
these estimates downwards.
---------------------------------------------------------------------------
Finally, no single current data source integrates both equities and
options. The lack of any combined equity and options audit trail data
is a significant impediment to regulators performing cross-product
surveillance.\403\
---------------------------------------------------------------------------
\403\ Likewise no single audit trail combines futures with NMS
Securities either. See Adopting Release, supra note 9, at 45744 for
a discussion of the potential inclusion of futures in CAT Data.
---------------------------------------------------------------------------
B. Data Fields
Each of the available data sources discussed above \404\ is missing
certain data fields that are useful for conducting a variety of
regulatory activities. Furthermore, certain valuable data fields are
not contained in any of the data sources discussed above. For example,
the lack of completeness in the data sources makes it impossible to use
certain key information, such as customer identifiers and allocation
information, in market surveillance. Further, even for single-security
events within a single trading venue, regulators may need to seek data
from multiple sources such as an SRO audit trail and EBS.\405\
---------------------------------------------------------------------------
\404\ See Section IV.D.2.a, supra.
\405\ See Section IV.D.2.a, supra, and Section IV.D.2.b(3)
infra, for a discussion of how regulators access such data.
---------------------------------------------------------------------------
Most notably, the identity of the customer is unavailable from all
current data sources that are reported to regulators on a routine
basis. A unique customer identifier could be useful for many types of
investigations and examinations such as market manipulation
investigations and examinations of investment advisers. As noted above,
some data sources--specifically Large Trader, EBS, trade blotters, and
order tickets--identify customers.\406\ But these data sources are not
reported on a routine basis, provide only one part of the order
lifecycle, and have other inherent limitations.
---------------------------------------------------------------------------
\406\ Trade confirmation data also identifies customers, but
trade confirmation data are much more basic than a trade blotter.
See supra note 375.
---------------------------------------------------------------------------
Because there is currently no data source that includes customer
identities across multiple parts an order lifecycle,\407\ regulators
must engage in a process of linking EBS, trade blotters and order
tickets with SRO audit trails, which can be a burdensome and imperfect
process.\408\ For example, trade blotter and order ticket data that
identifies customers from one broker-dealer may only include customer
names and thus may not be readily matched to similar data from another
broker-dealer, or may require substantial effort and uncertainty to
reconcile across firms. Further, EBS data's limited coverage of trading
activity and lack of some detailed trade information creates
inefficiencies in insider trading investigations. These investigations
often begin with a request for EBS data of trades before a significant
corporate news event that affected a company's stock price. After
identifying accounts that made suspicious trades, investigators often
request additional EBS data of all trades by the accounts during the
same period. If the additional data reveal suspicious trades by the
accounts of the securities of other companies, investigators often must
make a third round of EBS requests for data of trades by all accounts
in those securities. If trading is done in an omnibus account,
Commission Staff must ask firms to provide the identity of the account
holder, and then request account information. To investigate for
manipulation (e.g., marking the close, order layering, spoofing,\409\
wash sales, trading ahead), Commission Staff may also link data from
multiple sources. First, Commission Staff obtains equity and option
cleared reports from an internal online system that interfaces with
data provided by the DTCC. Because the equity and option cleared
reports do not have trade details, Commission Staff may also request
trade information through EBS submissions from one or multiple firms.
If a trade was executed on behalf of another firm, Commission Staff may
then contact the other firm, until Staff can find out who placed the
trade and the account holder. The Commission may then obtain granular
trade information that contains order entry time and order execution
time from firms or brokers via request or subpoena.\410\
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\407\ The Commission approved a FINRA rule that would require
broker-dealers to report to OATS the identity of U.S. registered
broker-dealers that are not FINRA members and broker-dealers that
are not registered in the U.S. but have received an SRO-assigned
identifier in order to access certain FINRA trade reporting
facilities, from whom they receive or route an order. See Securities
Exchange Act Release No. 77523 (April 5, 2016), 81 FR 21427 (April
11, 2016) (Order Approving FINRA Rule to Report Identity of Certain
Broker-Dealers to OATS). CAT would similarly capture this
information upon full implementation.
\408\ For further discussion of the problems associated with
linking, see Section IV.D.2.b(2)C, infra.
\409\ See supra note 343.
\410\ The process to obtain detailed trade information from
firms and brokers via requests or subpoenas generally takes anywhere
from two to four weeks depending on the size of the request.
---------------------------------------------------------------------------
The methods for obtaining such information significantly reduce its
utility, particularly for surveillance and market reconstruction
purposes. Market reconstructions, for example, cannot take advantage of
the detail in the EBS and trade blotter data because of the resources
required to link so many data sources, lack of necessary elements (such
as time stamps in milliseconds) needed to link data sources (for
example, matching large trader reports to activity on a particular
exchange), or the absence of standardized format. To examine a tip or
complaint, regulators may consolidate data from each affected
[[Page 30666]]
market participant to determine the identities of those responsible for
the atypical activity in question. To the extent that the activity
originates from several market participants, regulators must request
data from each of those market participants, and possibly other market
participants, to obtain information that could identify the customer(s)
originating the orders that created the atypical activity.
For many regulatory activities, lack of completeness results in
regulators initially relying upon the most accessible data sources,
with significant information contained only in data sources made
available by request. Starting regulatory functions with incomplete
data sources requires regulators to later make data requests and link
such data request responses. More importantly, however, incomplete or
unconsolidated data interferes with effective surveillance. Access to
data through non-routine means makes investigations and examinations
less efficient, and makes automated surveillance less accurate and less
effective. For example, the publicly available data discussed above
\411\ identify exchanges but lack most of the fields found in some SRO
audit trails or EBS, such as customer information, order entry time,
order execution time, information about special order handling codes,
counterparties, and member identifiers. Similarly, equity cleared
reports contain only the date, the clearing firm, and the volume
cleared by each clearing firm and not the trade size, trade time, or
trade location. Option cleared reports contain only the date, the
clearing firm, number of customer contracts, and number of firm
contracts for the options.
---------------------------------------------------------------------------
\411\ See Section IV.D.2.a(6), supra.
---------------------------------------------------------------------------
Some valuable data fields, such as modifications that make an order
non-displayed and other special handling instructions are consistently
available on only a few data sources or require linking different data
sources.\412\ The lack of direct, consistent access to order display
information and special handling instructions creates inefficiencies in
surveillances, examinations, and investigations that examine hidden
liquidity and the treatment of customer orders. Data that are not
directly accessible by regulators at all include buy-to-cover
information and subaccount allocation information, including the
allocation time. For example, no current data source allows regulators
to directly identify when someone is buying to cover a short sale.
Regulators could use this information to better understand short
selling and for investigations of short sale manipulation. Indeed, the
absence of this information during the financial crisis in 2008 reduced
the efficiency of the reconstruction of investor positions in financial
companies.\413\
---------------------------------------------------------------------------
\412\ Order display information (i.e., whether the size of the
order is displayed or non-displayed) is indicated in the ``Customer
Instruction Flag'' and special handling instructions are indicated
in the ``Special Handling Code'' of an OATS report. The Customer
Instruction Flag is mandatory if a limit or stop price is provided.
A Special Handling Code is required for order modifications, reserve
size orders, when the order is routed electronically to another
member, or when the terms and conditions of the order were derived
from a related options transaction. See FINRA, OATS Reporting
Technical Specifications, at Appendix A (June 26, 2015), available
at http://www.finra.org/sites/default/files/TechSpec_20150825.pdf.
This data is not directly available to all regulators. The
Commission must request this data from FINRA.
\413\ Having access to buy-to-cover information was also one of
the subjects of a Dodd-Frank-mandated study on short sale reporting.
See SEC, Short Sale Position and Transaction Reporting (June 5,
2014) (``Short Sale Reporting Study''), available at http://www.sec.gov/dera/reportspubs/special-studies/short-sale-position-and-transaction-reporting.pdf.
---------------------------------------------------------------------------
Subaccount allocation information needed for regulatory activities
can be difficult for regulators to collect and compile. SRO audit
trails currently do not require allocation reports and broker-dealers
may not have records of the time of a subaccount allocation. When
regulators require an understanding of subaccount allocations for a
regulatory task, they generally request and sift through trade blotter
or EBS data in an attempt to identify allocations and the details of
those allocations. Current trade blotter data contains limited customer
information on allocations and is not required to contain allocation
time information at the subaccount level. While the Commission is
sometimes able to acquire allocation time on trade blotters, not all
broker-dealers keep records in a manner that facilitates efficient
regulatory requests for allocation time information.
The difficulty in obtaining allocation information and the
difficulty in reconstructing allocations with data from broker-dealers
limits the efficiency of certain surveillances and examinations.
Allocation time at the subaccount level is critical for determining
whether some customers are systematically given more favorable
allocation treatment than others. For example, when a broker-dealer
places an order or series of orders for multiple customer accounts that
generates multiple executions at multiple prices, it is possible that
different customers receive different prices in the allocation process.
However, if some customers systematically receive less favorable prices
than others when they should be receiving the same prices for their
executions, this could indicate that the broker-dealer is handling
allocations improperly.\414\
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\414\ If a group of orders are bundled together for execution,
when those same orders are allocated, they should receive the same
(usually average price) allocations. However, if executions are for
orders that are not bundled together, it might be appropriate that
customers for those separate orders would receive differently-priced
allocations.
---------------------------------------------------------------------------
(2) Accuracy
In the Adopting Release, the Commission noted that while ``to some
extent, errors in reporting audit trail data to the central repository
will occur,'' the CAT NMS Plan would improve the quality of data
including improvements to accuracy.\415\ Therefore, the economic
analysis carefully considers the Baseline of the accuracy of data
regulators currently use in order to consider whether and to what
degree the CAT NMS Plan would provide more accurate data.
---------------------------------------------------------------------------
\415\ See Adopting Release, supra note 9, at 45730.
---------------------------------------------------------------------------
The prospect of inaccurate data can result in regulators expending
extra resources to run additional quality checks to ensure reliable
data and conclusions in enforcement investigations, or being unable to
draw reliable conclusions at all. In addition, risk-based analysis may
not properly identify a potential risk that justifies further
examination if the underlying data suffers from inaccuracies.
Ultimately, inaccurate data results in less efficient investigations as
well as less effective surveillance and risk analyses. This economic
analysis considers several forms of data inaccuracy, including data
errors, inaccurate event sequencing, the inability to link data
accurately, inconsistent identifiers, and obfuscating levels of
irreversible data aggregation.
A. Data Errors \416\
Based on Staff experience, the Commission preliminarily believes
that data errors affect most current data and can persist even after
corrections. For
[[Page 30667]]
example, Commission Staff has investigated instances where information
was inaccurately reported by broker-dealers, most notably in EBS data
given to the Commission.\417\ In addition, the Commission believes that
data sources that depend on data translated from back-office systems
can be less accurate than those that come from trading systems, such as
trade blotters and data sourced from exchanges' electronic trading
systems, because the data translation process creates an additional
source of potential errors in code that may not work as intended. Data
from trading systems can also contain errors resulting from a coding
error in the query pulling the data. Such coding errors can affect any
data including trade blotters. For example, trade blotters are stored
using the ticker symbol in effect at the time of the trade. If the
ticker symbol changes between the trade and the data request, the
coding may fail to take the ticker symbol change into account and fail
to retrieve the correct data. The Commission has found that trade
blotter data can often be inaccurate due to improper inclusion of
cancelled orders or corrections, making accurate reconciliation
difficult. Furthermore, trade blotter data can lack security
information including CUSIP, symbol, or description at the subaccount
level, which are important features for helping regulators determine
potential violations.\418\
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\416\ As used herein, the term ``data errors'' refers to
instances where data reflect false information or are missing
information such that they do not reflect order events that occurred
in the market fully and accurately. Under this definition of ``data
errors,'' a trading error or an order entry error would not be a
``data error.'' For example, if a trader submitted an order to an
exchange with an order size of 100,000, an accurate order record
would contain an order size of 100,000. If the trader actually
intended to enter the order size as 1,000, the accurate order record
would still be 100,000 because that would reflect the actual state
of the market at the time. In other words, the 100,000 order size is
not a ``data error.'' If the trader later corrected the order size,
accurate data would reflect the subsequent corrections while still
preserving the accurate state of the market at the time.
\417\ For example, Commission staff have experienced frequent
errors in EBS data such as omitted variables, decimals in the wrong
places, blank account information, and data for the wrong
securities. The Commission has instituted actions against entities
in connection with inaccurate EBS data. See, e.g., Securities
Exchange Act Release No. 75445 (July 14, 2015), In the Matter of OZ
Management, LP, Administrative Proceeding File No. 3-16686 (OZ
Management, LP admitted submitting inaccurate data to four of its
prime brokers); see also Section IV.D.2.b(4), infra, for a
discussion of one impact of inaccurate data.
\418\ In cases where Commission staff has used these data, it
has found that the frequent omission of these important fields in
trade blotter data is generally due to the manner in which the data
is queried by broker-dealers. There are a variety of reasons why
these fields may be excluded from a query. For example, over time
firms make changes to their software systems; records stored by
previous versions, particularly when the records are archived in a
secondary location, may not be fully compatible with software that
is written to access more current versions of this data.
Additionally, sometimes when a broker-dealer or clearing firm merges
or is acquired, its trade data may be compromised due to
incompatible systems or inadequate data storage issues. This problem
was particularly relevant following the financial crisis.
Consequently, staff does not currently believe that this missing
information is caused by a failure of broker-dealers to collect and
retain these variables, but rather that over time this data becomes
less accessible by software tools and may require hand processing by
broker-dealers providing this information.
---------------------------------------------------------------------------
Audit trail data contain errors, as well. The CAT NMS Plan reports
that 2.42% of order events submitted to OATS fail validation
checks,\419\ resulting in the rejection of almost 425,000 reports per
day, on average.\420\ While FINRA sends these records back to its
members to correct, not all data errors are identified because OATS
limits error correction requests to records with internal
inconsistencies within a given member's submission. In particular,
significant error rates in event linking are common because there is no
cross-participant error resolution process; FINRA estimates that 0.5%
of OATS routing reports directed to another FINRA member broker-dealer
cannot currently be linked.\421\ The CAT NMS Plan reports that,
following the rollouts of three major updates to OATS, 0.86% of Trade
Reporting Facility (``TRF'') reported trades could not be matched to
OATS execution reports, 3.12% of OATS route reports could not be
matched to exchange orders, and 2.44% of inter-firm routes could not be
matched to a record of the receiving firm's receipt of a routed
order.\422\
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\419\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(b). When FINRA receives an end-of-day OATS file from a member,
it performs over 152 validation checks on each order event reported
to OATS. Each of these checks can result in rejecting an OATS data
submission and generating an error message. In addition to
validation checks, FINRA determines whether a file that is
syntactically correct nevertheless contains errors in content
related to internally inconsistent information about processing,
linking, and routing orders. For some errors, FINRA requires the
member to provide corrections within five business days after
rejections are available. See OATS Reporting Technical
Specifications, supra note 357, at 6-1--6-10. Duplicate records and
records with symbols that are not reportable to OATS may result in
rejections that do not require repair. Id. at 6-4. Validation checks
refer to tests of whether data is consistent with a set of rules
that specify conditions that should be met by valid data. Validation
checks are typically limited to detecting errors that can be
discovered by a concise set of logical rules using data within scope
at the time the validation test is run. An incorrect price that is
negative would likely be detected by a validation check, while a
price that was a few cents too low may not. Validation checks that
apply across multiple records may be difficult to apply across data
that is submitted at different times.
\420\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(b); see also Adopting Release, supra note 9 at 45729.
\421\ See Section IV.D.2.b(2)C, infra.
\422\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(b).
---------------------------------------------------------------------------
Other audit trail data may also contain errors. For example, the
Commission notes that exchange SROs populate most of the information
with data from their in-house order and trading records, but a few of
these exchange SROs also rely on members to complete their audit
trails.
B. Event Sequencing
The ability to sequence market events is crucial to the efficacy of
detecting and investigating some types of manipulation, particularly
those involving high frequency trading, those in liquid stocks in which
many order events can occur within microseconds, and those involving
orders spread across various markets. In today's market, high frequency
and algorithmic traders can react to changes in the market in a few
milliseconds or less.\423\ Investigations involving algorithmic
trading, therefore, can require the ability to sequence the order and
trade events to within a few milliseconds; however, regulators relying
on currently available data may have difficulty sequencing events that
occur within a second on different trading venues or broker-dealer
systems.\424\ In addition, in one type of trade-based manipulation, a
manipulator might build a short position in a stock, submit sell orders
designed to decrease the stock price, and finally buy at an
artificially low price. To analyze this activity, except when cover
orders precede the sell activity, it would be necessary to determine
whether the orders intending to create an artificial price came before
the orders intending to profit from the artificial price, which becomes
difficult when the systems on which order events occurring close in
time to each other have clocks that are not synchronized. Further,
insufficiently granular time stamps can make sequencing events across
venues impossible.
---------------------------------------------------------------------------
\423\ See, e.g., Joel Hasbrouck and Gideon Saar, Low-Latency
Trading, 16 Journal of Financial Markets 646 (2013) in which the
authors report apparent HFT response times to market events of 2-3
milliseconds. Given technology advances, it is likely that response
times have decreased since their sample period, which ends in June
2008.
\424\ Regulators can sequence events occurring on the same venue
or on the same systems at broker-dealers, but sequencing across
venues or broker-dealer systems that could have clocks that are not
synchronized with each other is more difficult.
---------------------------------------------------------------------------
Thus, the sequencing of order events requires both sufficient clock
synchronization across market participants and time stamps that are
granular enough for accurate sequencing.\425\ As discussed below,
[[Page 30668]]
current clock synchronization standards make this process difficult.
---------------------------------------------------------------------------
\425\ For example, if two market participants report that two
non-simultaneous events happened at 10:15:45, then the time stamps
are not granular enough to sequence the events and regulators would
need sub-second time stamp granularity to distinguish them. If the
two market participants each have up to one-second clock drift from
the actual time, the 10:15:45 time stamps only show that the event
happened between 10:15:44 and 10:15:46. Only when regulators have
both adequate time stamp granularity and sufficient clock offset
tolerances can events be sequenced using time stamps.
---------------------------------------------------------------------------
i. Clock Synchronization
Clock synchronization refers to the synchronization of the business
clocks used by market participants for the purposes of recording the
date and time of market events to a centralized benchmark clock, often
that maintained by the NIST. Clock synchronization helps to ensure that
the time stamps used by various participants are consistent, thereby
allowing regulators to compare time stamps across participants and to
use multiple time stamps to determine the sequence of market events.
The ability of regulators to accurately sequence events can be limited
by the permitted ``offset'' between the clocks--i.e., the length of the
gap that is permitted between a participant's clock and the time
maintained by a centralized benchmark clock.\426\ For example, if the
offset between the clocks is one second, regulators cannot accurately
determine the correct sequence of events in the market occurring within
a two-second period, because each clock may be up to one second fast or
slow.
---------------------------------------------------------------------------
\426\ For example, if a participant's clock records a point in
time as 11:00:00 and the NIST clock records the same point in time
as 11:00:01, then the offset between the clocks is one second.
---------------------------------------------------------------------------
Current rules require most broker-dealers to synchronize their
system clocks to within one second. In particular, FINRA specifies a
clock offset tolerance of one second,\427\ and the NASDAQ Stock Market
and NASDAQ OMX BX require members to comply with FINRA clock
synchronization rules.\428\ CHX specifies a clock offset tolerance of
500 milliseconds.\429\ NYSE MKT and NASDAQ OMX PSX require members to
synchronize their clocks relative to a time source designated by the
Exchange, but do not specify the standard.\430\ NYSE Arca allows
options traders to use any time provider source for clock
synchronization as long as the business clocks it uses on the Exchange
are accurate to within three seconds of the NIST clock or the United
States Naval Observatory Master Clock in Washington DC.\431\
---------------------------------------------------------------------------
\427\ See FINRA Rule 7430 (requiring each member to
``synchronize its business clocks that are used for purposes of
recording the date and time of any event that must be recorded
pursuant to the FINRA By-Laws or other FINRA rules, with reference
to a time source as designated by FINRA, and shall maintain the
synchronization of such business clocks in conformity with such
procedures as are prescribed by FINRA.''). Section 2 of the OATS
Technical Specifications states that all computer system clocks and
mechanical time stamping devices must be synchronized to within one
second of the NIST clock and must be synchronized every day. See
OATS Reporting Technical Specifications, supra note 357, at 2-1. In
November 2014, FINRA issued a Regulatory Notice seeking comment on a
proposal to change the clock offset tolerance to be 50 milliseconds.
This proposal also proposed to move the clock offset tolerance from
the OATS Technical Specifications to FINRA's books and records rules
so that the requirements apply to the recording of the date and time
of any event that FINRA By-Laws or Rules require, not just OATS
requirements. See FINRA, Equity Trading Initiatives: Synchronization
of Business Clocks, Regulatory Notice 14-47, available at http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_14-47.pdf. On February 9, 2016, FINRA filed a
proposed rule change with the Commission. The proposal would reduce
the clock offset tolerance for members' computer clocks that are
used to record events in NMS securities, including standardized
options, and OTC Equity Securities, from within one second of the
NIST atomic clock to within a 50-millisecond tolerance of the NIST
atomic clock. FINRA would require firms with systems that capture
time in milliseconds to comply with the new 50-millisecond clock
offset tolerance within six months of the effective date; remaining
firms that do not have systems which capture time in milliseconds
would have 18 months from the effective date to comply with the 50-
millisecond standard. The proposal would not change the current one-
second clock offset tolerance of the NIST clock requirement for
mechanical clocks or time stamping devices. The proposal would
consolidate and codify the clock synchronization requirements in new
FINRA Rule 4590. The Commission has published notice of this
proposed rule change. See Securities Exchange Act Release No. 77196
(February 19, 2016), 81 FR 9550 (February 25, 2016).
\428\ See NASDAQ Rule 7430A (``(a) Nasdaq members shall comply
with FINRA Rule 7430 as if such Rule were part of Nasdaq's rules.
(b) For purposes of this Rule, references to `the FINRA By-Laws or
other FINRA rules' shall be construed as references to `the Nasdaq
Rules'); NASDAQ OMX BX Rule 6953 (``(a) Exchange members shall
comply with NASD Rule 6953 [superceded by FINRA Rule 7430] as if
such Rule were part of the Exchange's rules. FINRA is in the process
of consolidating certain NASD rules into a new FINRA rulebook. If
the provisions of NASD Rule 6953 are transferred into the FINRA
rulebook, then Equity Rule 6953 shall be construed to require
Exchange members to comply with the FINRA rule corresponding to NASD
Rule 6953 (regardless of whether such rule is renumbered or amended)
as if such rule were part of the Rules of the Exchange. (b) For
purposes of this Rule, references to `the By-Laws or other rules of
the Association' shall be construed as references to `the Rules of
the Exchange.' '').
\429\ See CHX Rule 3, Interpretations and Policies .03 (``These
rules shall not apply to orders sent or received through the
Exchange's matching system or through any other electronic systems
that the Exchange expressly recognizes as providing the required
information in a format acceptable to the Exchange. The Exchange
will not recognize a non-Exchange system as providing information in
an acceptable format unless that system has synchronized its
business clocks for recording data with reference to a time source
designated by the Exchange and maintains that synchronization in
conformity with procedures prescribed by the Exchange.''); Rule 4,
Interpretations and Policies .02 (``Each Participant or layoff
service provider shall synchronize its business clocks that are used
for purposes of recording the date and time of any event that must
be recorded pursuant to this provision with reference to a time
source as designated by the Exchange, and shall maintain the
synchronization of such business clocks in conformity with such
procedures as are prescribed by the Exchange.''); Rule 5,
Interpretations and Policies .01(a) (``Clock synchronization and
timing of the determination of improper trade-throughs. The
Exchange's systems shall routinely, throughout the trading day, use
processes that capture the time reflected on the atomic clock
operated by the National Institute of Standards and Technology and
shall automatically make adjustments to the time recorded in the
Exchange's Matching System to ensure that the period between the two
times will not exceed 500 milliseconds. The Exchange shall determine
whether a trade would create an improper trade-through based on the
most recent NBBO that has been received and processed by the
Exchange's systems.'').
\430\ See NYSE Rule 123, Supplementary Material .23 (``Any
vendor or proprietary system used by a member or member organization
on the Floor to record the details of an order or report for
purposes of this rule must be synchronized with reference to a time
source as designated by the Exchange.''); NYSE MKT Rule 7430 (``Each
member organization shall synchronize its business clocks that are
used for purposes of recording the date and time of any event that
must be recorded pursuant to the Rules of the Exchange, with
reference to a time source as designated by the Exchange, and shall
maintain the synchronization of such business clocks in conformity
with such procedures as are prescribed by the Exchange.''); NASDAQ
OMX PSX Rule 3403 (``Each member organization shall synchronize its
business clocks that are used for purposes of recording the date and
time of any event that must be recorded pursuant to the rules of the
Exchange, with reference to a time source as designated by the
Exchange, and shall maintain the synchronization of such business
clocks in conformity with such procedures as are prescribed by the
Exchange.'').
\431\ See NYSE Arca Options Rule 6.20 (``(a) Each OTP Holder and
OTP Firm must synchronize, within a time frame established by the
Exchange, the business clocks that it uses for the purpose of
recording the date and time of any event that must be recorded
pursuant to the Rules of the Exchange. OTP Holders and OTP Firms may
use any time provider source. Each OTP Holder and OTP Firm must,
however, ensure that the business clocks it uses on the Exchange are
accurate to within a three-second [sic] of the National Institute of
Standards and Technology Atomic Clock in Boulder Colorado (`NIST
Clock') or the United States Naval Observatory Master Clock in
Washington DC (`USNO Master Clock'). This tolerance includes all of
the following: (1) The difference between the NIST/USNO standard and
a time provider's clock; (2) transmission delay from the source; and
(3) the amount of drift of the OTP Holder or OTP Firm's business
clock. For purposes of this Rule, `business clocks' mean an OTP
Holder or OTP Firm's proprietary system clocks. OTP Holders and OTP
Firms must set forth in their written supervisory procedures,
required by Rule 11.18, the manner in which synchronization of
business clocks will be conducted, documented and maintained.'').
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In practice, some broker-dealers currently synchronize their clocks
to smaller clock offset tolerances. FIF surveyed market participants to
gather information on current broker-dealer clock synchronization
practices.\432\ The
[[Page 30669]]
survey found that 29% of respondents currently synchronize their clocks
to permit a maximum clock offset of one second from NIST time.\433\ The
survey further found that 10% of market participants permit a maximum
offset from NIST time that is between 50 milliseconds and one second,
21% of respondents permit a 50-millisecond maximum offset, and 18% of
respondents permit a maximum offset that is less than 50 milliseconds.
The remaining 22% of survey respondents utilize multiple clock offset
tolerances across their systems, ranging from five microseconds to one
second. FIF noted that 69% of firms that achieve a maximum clock offset
of 50 milliseconds or less are large firms reporting more than three
million OATS records per month.
---------------------------------------------------------------------------
\432\ See FIF Clock Offset Survey, supra note 127. The
Commission notes limitations to the survey that could result in
downward bias and imprecision. Specifically, the broker-dealers
represented by the survey are primarily complex and large broker-
dealers in terms of market activity levels; consequently, smaller
broker-dealers are underrepresented. But, as discussed below, the
exclusion of small broker-dealers is unlikely to materially affect
industry costs because smaller broker-dealers are unlikely to incur
significant clock-synchronization costs because the majority of
broker-dealers rely on service bureau clocks to time stamp their CAT
Reportable Events.
\433\ Id.
---------------------------------------------------------------------------
Certain exchanges, the SIPs, and FINRA synchronize their clocks for
their trading, recordkeeping, and other systems. According to FIF, all
exchange matching engines meet a clock offset tolerance of 50
milliseconds.\434\ However, NASDAQ recently stated that all exchanges
trading NASDAQ securities synchronize their matching engines and
quotation systems to within 100 microseconds.\435\ The Commission
understands that the NYSE, the options exchanges, and the SIAC SIP have
comparable clock synchronization standards. In conversations with
Commission Staff, the Participants stated that absolute clock offset on
exchanges averages 36 microseconds.\436\
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\434\ Id.
\435\ See NASDAQ, UTP Vendor Alert #2015-7 (April 24, 2015),
available at https://www.nasdaqtrader.com/TraderNews.aspx?id=UTP2015-07 (describing additional time stamps to
be reported to the SIP, including information on exchange clock
synchronization, and stating that ``[e]xchanges use a clock sync
methodology ensuring that timestamps are accurate within tolerances
of 100 microseconds or less.'').
\436\ In response to questions from Commission Staff, the
Participants surveyed the exchanges to establish their current
average clock offset. All exchanges that currently operate matching
engines responded to the survey, which measured the offset from the
exchange clock to NIST. The Participants noted that the frequency
with which exchanges measure their clock offset ranges from once per
second to once per fifteen minutes, and the procedures to correct
for clock offset vary. Some exchanges correct by slewing, in which
the offset is gradually corrected, while others use stepping, in
which the offset is immediately corrected. The process by which
clock offset is corrected can impact the ability to order events
time stamped by a single clock because stepping could result in a
backwards adjustment in recorded time.
---------------------------------------------------------------------------
Because multiple order events can occur within timeframes of less
than one second, current clock synchronization requirements and
practices greatly limit the ability of regulators to accurately
sequence order events. To examine, among other things, how many events
can be synchronized with current clock offset tolerances, Commission
Staff conducted an analysis of the frequency of events using MIDAS
data.\437\ In the analysis, events are all real-time messages,
consisting of trades, orders, modifications, cancellations and updates
from exchange direct feeds and trades from the FINRA TRFs. The analysis
focused on identifying whether, for each order event, an event at
another venue occurred within a given time range.\438\ For the purposes
of the analysis, events at another venue were called an ``unrelated
event.'' The Commission recognized that order events occurring on the
same venue have sequence numbers that allow sequencing even if orders
have the same time stamp. Therefore, the analysis considered only
whether any unrelated orders existed within a given time range that
could complicate the sequencing across the market.\439\
---------------------------------------------------------------------------
\437\ The MIDAS system does not contain all of the events in a
given security that would be in CAT. Therefore, the analysis is
limited, but still provides useful insights.
\438\ The methodology to calculate these percentages starts with
sorting all event messages for every day chronologically by exchange
time stamp. (MIDAS does not report the exchange time stamp; but it
provides the difference between the MIDAS time stamp and the
exchange or TRF time stamp; the analysis uses this value to derive
the exchange time stamp.) For each event, it calculates the
difference (Delta) between the current time stamp (t0)
and the last time stamp (t-1) in the same security on a
different venue.
Deltanearest last = t0,venue A -
maximum(t-1,venue B, t-1,venue C,
t-1,venue D, t-1,venue E)
This is the shortest time difference
(Deltanearest last) between an event on venue A and a
preceding event on any venue, except for venue A. Next, the analysis
calculates the time difference (Deltanearest next)
between the current time stamp (t0) and the next time
stamp (t1) in the same security on a different venue.
Deltanearest next = minimum(t1,venue B,
t1,venue C, t1,venue D, t1,venue E)
- t0,venue A
Finally, the analysis uses the shorter of the time differences
to evaluate whether an event occurs within a particular time period
of another event in the same security on a different venue.
Deltanearest = minimum(Deltanearest last,
Deltanearest next)
Values are aggregated over one week (June 15, 2015 through June
19, 2015) for the equities analysis; and the options analysis data
is from one day (June 15, 2015).
\439\ Within the analysis, events reported to the TRF are
treated as occurring on a different trading venue than other recent
events because TRF data comprises many separate venues (such as ATSs
and off-exchange market makers). While events within a single
exchange with identical time stamps can potentially be sequenced
through record identifiers recorded by the exchange, for TRF trades
this is often untrue because many venues with independent clocks
contribute to the aggregate TRF data.
Table 3--Percentage of Events Close to Unrelated Events
------------------------------------------------------------------------
Percent of unrelated
events
Nearest event time stamped within ---------------------
Equities Options
------------------------------------------------------------------------
2 seconds......................................... 98.69 93.03
1 second.......................................... 97.95 90.99
100 milliseconds.................................. 92.16 81.17
50 milliseconds................................... 89.12 76.59
10 milliseconds................................... 83.49 64.46
5 milliseconds.................................... 81.28 58.26
2 milliseconds.................................... 77.92 49.30
1 millisecond..................................... 74.31 41.13
200 microseconds.................................. 57.53 21.58
100 microseconds.................................. 48.09 14.51
10 microseconds................................... 21.42 3.13
5 microseconds.................................... 14.44 3.12
------------------------------------------------------------------------
Table 3 shows that 97.95% of the order events for listed equities
and 91% of order events for listed options in the samples occurred
within one second of another unrelated order event in the same
security. At the other extreme in Table 3, 14.44% of the unrelated
order events for listed equities and 3.12% of the unrelated order
events for listed options in the same security occurred within 5
microseconds of another order event in the same security. The
Commission notes that Table 3 underestimates the true frequency of
unrelated events within the given time frames because it includes only
order events that are included in the MIDAS data. As such, the analysis
is unable to include events such as the placing of hidden orders on
exchanges, the placing of orders on an ATS, order originations, order
routes, order receipts, and order cancellations and modifications for
any order not displayed on an exchange order book. Despite this
limitation, Table 3 illustrates how the current frequency of order
events makes sequencing unrelated order events difficult.
ii. Time Stamps
Given the frequency with which order events can occur, regulators
need sufficiently granular time stamps to sequence events across orders
and within order lifecycles. As noted above, even if the clocks
recording time stamps have no clock offset, the granularity of the time
stamp can limit regulators' ability to sequence events accurately.\440\
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\440\ In addition, Craig W. Holden and Stacey Jacobsen,
Liquidity Measurement Problems in Fast, Competitive Markets:
Expensive and Cheap Solutions, 69 Journal of Finance 1747 (2014),
shows that using time stamps in seconds instead of milliseconds can
yield liquidity measurement problems.
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Current data sources have different time stamp granularity
standards. Many public data sources report time in seconds or
milliseconds and some,
[[Page 30670]]
including direct data feeds, report time in microseconds or
nanoseconds. For example, the Options Price Reporting Authority
(``OPRA'') allows for time stamps in nanoseconds and the other SIPs
require time stamps in microseconds for equity trades and quotes,
whereas the short sale transactional data released by exchanges
contains time stamps in seconds.\441\ Currently, OATS requires time
stamps in milliseconds for firms that capture time in milliseconds, but
does not require members to capture time in milliseconds.\442\ EBS
trade times are recorded only to the second; other EBS records must
contain time stamps containing only the transaction date. The lack of
uniform and granular time stamps can limit the ability of regulators to
sequence events accurately and to link data with information from other
data sources.
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\441\ See OPRA Option Price Reporting Authority Binary
Participant Interface Specification Version 1.7 (January 2015),
available at http://www.opradata.com/specs/opra_binary_part_spec.pdf; see also NYSE, Modified Timestamps and
Additional Timestamp Information for Daily TAQ (June 22, 2015),
available at http://www.nyxdata.com/nysedata/default.aspx?tabid=993&id=2784; UTP Vendor Alert #2015-7, supra note
435, regarding additional time stamps to be reported to the SIP.
\442\ See FINRA Rule 7440 (providing that ``[e]ach required
record of the time of an event shall be expressed in terms of hours,
minutes, and seconds; provided that the time of an event shall be
expressed in hours, minutes, seconds, and milliseconds if the
member's system captures time in milliseconds.''). The Commission
approved the requirement that time be expressed in milliseconds if
the member's system captures time in milliseconds on February 27,
2014. See Securities Exchange Act Release No. 71623 (February 27,
2014), 79 FR 12558 (March 5, 2014); see also, FINRA, Equity Trade
Reporting and OATS, Regulatory Notice 14-21 (May 2014), available at
http://www.finra.org/sites/default/files/NoticeDocument/p506337.pdf.
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C. Linking and Combining Data
Sometimes one order or market activity event may be reflected in
information contained in various data sources or in different fields
within the same data source, and fully understanding that activity
requires linking information across the different data sources.
Therefore, regulators analyzing an event or running a surveillance
pattern often need to link data. For example, cross-market examinations
require the cumbersome and time-consuming task of linking many
different data sources.\443\ Regulators combine trading data from
sources such as public feeds, SRO audit trails, EBS data, and trade
blotters when reviewing surveillance alerts to determine whether
violations of rules such as Rule 611 of Regulation NMS occurred \444\
or to examine, for example, whether an entity availing itself of a
market maker exemption is engaging in bona fide market making. In fact,
the data needed for an examination often consist of many audit trails
and are stored in non-uniform formats.\445\ In addition, the analysis
and reconstruction of market events could require linking many
different data sources, such as a dozen SRO audit trails.
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\443\ Such linking is typically conducted electronically with an
algorithm unless the size of the data set is small. This requires
the person attempting to combine and link the data to write computer
code to identify and match the records that need to be linked. This
task involves extensive testing and debugging the first time that
person tries to combine and link those specific data sources.
Further, given the variation in formats across broker-dealers and
other data sources, the code may need to change for each
investigation, requiring a repeat of the extensive testing and
debugging process.
\444\ 17 CFR 242.611.
\445\ In the context of the CAT NMS Plan, the Commission does
not distinguish data format from data taxonomy. See Section III.B.3,
supra. In discussing data format, the Commission combines data
format with data taxonomy. Id. The distinction between format and
taxonomy is not significant in the context of the CAT NMS Plan
because the Plan does not specify either for incoming data and the
Plan effectively requires uniformity in both for regulator access.
Id. SRO audit trails currently differ in both format and taxonomy as
do many other trading and order data sources.
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Regardless of whether order lifecycle reports are reflected in the
same or different data sources, the process of linking lifecycle events
is complex and can create inaccuracies. Merging different data sources
often involves translating the data sources into the same format,\446\
which can be a complex process that is prone to error. Linking records
within or across data sources also requires the sources to share ``key
fields'' that facilitate linkage, along with a successful linking
algorithm. Regulators may be unable to link some data source
combinations accurately because the data sources do not have key fields
in common or the key fields are not sufficiently granular. For example,
regulators cannot always link trade records accurately to EBS records.
The EBS records contain a symbol and date, but the price and size on
the records may reflect multiple trades spread over a period of time.
Sometimes, different data sources may have key fields in common but the
relationship between the fields is not straightforward. In these cases,
the algorithm to link them may be necessarily complex and not entirely
successful. Further, within a single order lifecycle, the order number
may change when a broker-dealer routes the order to another broker-
dealer or exchange or even to another desk at the same broker-dealer.
The inability to link all records affects the accuracy of the resulting
data and can force an inefficient manual linkage process that would
delay the completion of the data collection and analysis portion of the
examination, investigation, or reconstruction.
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\446\ For example, different data sources can format dates and
times differently or may use different notations to signify that the
field contains no value.
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D. Customer and Broker-Dealer Identifiers
The data sources described in Section IV.D.2.a also lack consistent
customer and broker-dealer identifiers, which limit regulators' ability
to track the activity of one client or broker-dealer across the market.
There is no standard convention for how broker-dealers identify
customers.
Regulators face challenges in tracking broker-dealers' activities
across markets due to inconsistent identifiers and a lack of a
centralized database. These challenges occur primarily in the context
of regulatory activities that require manual or ad hoc data analysis,
as is often the case in particular investigations, examinations, and
market studies. In the case of broker-dealers, SROs generally identify
their members within their data using market participant identifiers
(``MPIDs''). However, the MPIDs that identify broker-dealers on
Execution Venues are not standardized across venues; consequently, a
broker-dealer identified as ``ABCD'' on one venue may be identified
differently on another venue, where ``ABCD'' may refer to a different
broker-dealer entirely. Therefore, aggregating a broker-dealer's
activity across venues requires verifying the MPIDs assigned to a
broker-dealer on each venue, usually referencing the broker-dealer by
its Central Registration Depository (``CRD'') number.\447\ In the
course of manual data analysis, the Commission notes that its Staff
have experienced challenges in identifying broker-dealers using CRD
numbers. These challenges can be due to the fact that, although every
broker-dealer has a CRD number, a broker-dealer that routes an order
seldom, if ever, provides a CRD number to the broker-dealer that
accepts the order.\448\
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\447\ The CRD is an automated database operated by FINRA that
stores and maintains information on broker-dealers and their
registered persons relating to their licensing, registration,
complaints, professional background, and disciplinary history. Each
broker-dealer and their registered persons are assigned a CRD number
for identification.
\448\ The Commission and the SROs have generally overcome these
challenges in the context of automated regulatory data analysis, and
found ways to reduce these challenges in some manual data analysis
and can efficiently track broker-dealers across venues. The
Commission understands that FINRA can track broker-dealers across
venues pursuant to its responsibilities under a plan for allocating
regulatory responsibilities pursuant to Rule 17d-2. On September 12,
2008, the Commission declared effective a plan for allocating
regulatory responsibilities pursuant to Rule 17d-2 filed by the
American Stock Exchange, LLC, Boston Stock Exchange, Inc., CBOE
Stock Exchange, LLC, CHX, FINRA, ISE, NASDAQ, NSX, NYSE, NYSE Arca,
NYSE Regulation, Inc., and Philadelphia Stock Exchange, Inc. (the
``Participating Organizations,'' which have since been updated to be
the following SROs: BATS, BYX, CBOE, CHX, EDGA, EDGX, FINRA, NASDAQ
OMX BX, NASDAQ OMX PHLX, NASDAQ, NSX, NYSE, NYSE MKT [f/k/a NYSE
Amex], and NYSE Arca) (``Insider Trading Rule 17d-2 Plan''). The
Insider Trading Rule 17d-2 Plan allocates regulatory responsibility
over common FINRA members (members of FINRA and at least one of the
Participating Organizations) (collectively ``Common FINRA Members'')
for the surveillance, investigation, and enforcement of (i) Federal
securities laws and rules promulgated by the Commission pertaining
to insider trading, and (ii) the rules of the Participating
Organizations that are related to insider trading (``common insider
trading rules''). Under that Plan, the Participating Organizations,
other than FINRA, have been relieved of regulatory responsibility
over Common FINRA Members (i.e., the broker-dealer and its
associated persons) for surveillance, investigation, and enforcement
of the common insider trading rules over such persons with respect
to ``Listed Stocks'' (as defined in that Plan). Accordingly, FINRA
retains regulatory responsibility for Common FINRA Members with
respect to the common insider trading rules--irrespective of the
market(s) on which the relevant trading may occur. Separately, FINRA
performs investigations and enforcement with respect to non-Common
FINRA Members pursuant to a regulatory services agreement between
FINRA and several of the other Participating Organizations. See
Securities Exchange Act Release No. 58536 (September 12, 2008), 73
FR 54646 (September 22, 2008); see also Securities Exchange Act
Release Nos. 58806 (October 17, 2008), 73 FR 63216 (October 23,
2008); 61919 (April 15, 2010), 75 FR 21051 (April 22, 2010); 63103
(October 14, 2010), 75 FR 64755 (October 20, 2010); 63750 (January
21, 2011), 76 FR 4948 (January 27, 2011); and 65991 (December 16,
2011), 76 FR 79714 (December 22, 2011).
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[[Page 30671]]
Regulators sometimes find it necessary to analyze trading activity
at the customer level instead of the broker-dealer level. Consistently
identifying customer account owners across the multiple broker-dealers
with whom they transact is difficult and prone to error. Although, for
example, the EBS system provides the names associated with each account
traded, these names are drawn from 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. Further,
the lack of tax identification numbers in many EBS records limits the
ability for regulators to trace the trading activity of customers
across broker-dealers. Tax identification numbers are not required to
be reported in EBS for average price, allocation, riskless principal,
foreign accounts, and subaccounts. In fact, when one broker-dealer
executes for a second broker-dealer, the tax identification number is
that of the second broker-dealer regardless of whether the second
broker-dealer is trading for a customer.
E. Aggregation
The practice used in some data records of bundling together data
from different orders and trades also can make it difficult to
distinguish the different orders and trades in a given bundle. As an
example, brokers frequently utilize average-price accounts to execute
and aggregate multiple trades for one or more customers. In these
cases, for example with EBS data, the system does not reflect the
details of each individual trade execution, because it reports only the
average aggregate prices and volumes of the various trades within a
series that have been bundled together for reporting purposes. Further,
information on trade allocations aggregate the trade information to
such an extent that it is difficult for regulators to identify when
particular clients may be afforded preferential treatment because it is
challenging to link subaccount allocations to orders and trades.
Equity and options cleared reports provide valuable data to
regulators, but aggregation reduces their usefulness, because the
reports do not have detailed trade information and do not include
activity that does not require clearing.\449\ The volume in these
reports cannot be fully disaggregated and reconciled with the equity
trade execution volume from other data sources used by the Commission,
e.g., TAQ and MIDAS, because the volume in the cleared reports is not
necessarily a summation of all trades. For example, the same trade can
be reported two or more times, by both the buy and the sell sides, for
some OTC transactions and for all trades in NASDAQ exchanges.\450\
Similarly, option cleared reports bundle together multiple executions
by compressing or netting them to facilitate clearing. This aggregation
limits regulators' ability to link records across data sources, as well
as limiting the accuracy with which the data source reflects market
events, which is particularly problematic in applications that require
market reconstruction.
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\449\ The option cleared volume from the OCC contains the
clearing firm, number of customer contracts, and number of firm
contracts for the options.
\450\ This scenario of a trade being reported several times is
generally the result of agreements that permit a broker-dealer to
clear trades on behalf of another broker-dealer and send trades
directly to the NSCC. Broker-dealers often enter into these
agreements to simplify their clearing processes, achieve lower
transaction costs, and take advantage of extended hours of service.
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Finally, issuer repurchase information is aggregated at the monthly
and quarterly level.\451\ This aggregation limits the use of such data
in investigations of the timing of issuer repurchases and issuer stock
price manipulation and in analysis of the use of the Rule 10b-18 issuer
repurchase safe harbor.\452\
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\451\ Issuers report quarterly and monthly repurchases pursuant
to Item 703 of Regulation S-K. This data includes all issuer
repurchases, including tender offers and open market repurchases,
but does not distinguish the type of repurchase. The Commission
notes that Item 703 provides, in part, that issuers must disclose
``the number of shares purchased other than through a publicly
announced plan or program and the nature of the transaction (e.g.,
whether the purchases were made in open-market transactions, tender
offers, in satisfaction of the company's obligations upon exercise
of outstanding put options issued by the company, or other
transactions.'' See 17 CFR 229.703.
\452\ Rule 10b-18 provides issuers with a ``safe harbor'' from
liability for manipulation under Section 9(a)(2) of the Act, 15
U.S.C. 78i(2), and Rule 10b-5 thereunder, 17 CFR 240.10b-5, solely
by reason of the manner, timing, price, and volume of their
repurchases when they repurchase common stock in the market in
accordance with the Section's manner, timing price, and volume
conditions. See 17 CFR 240.10b-18.
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(3) Accessibility
The SROs and Commission also lack direct access--meaning the
ability to log into a system in a manner that would allow them to
gather and analyze the data they need--to many of the data sources
described above. SROs generally have direct access only to their own
audit trails and the public data feeds.\453\ While SROs control the
manner in which they access their own data, their investigations in
some cases require access to the data of other SROs because firms could
trade across multiple SROs. To access another SRO's data, SROs must
send requests to the other SROs \454\ or to the ISG.\455\ SROs needing
information not included in their audit trails or the audit trail of
another SRO must request such information from their members. The SROs
might not be able to acquire data from entities that are not members of
that SRO; non-members are not obligated to provide SROs with data,\456\
any data provided by
[[Page 30672]]
the regulator of the non-member firm would be on a voluntary basis, or
pursuant to the terms of the ISG Agreement.
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\453\ FINRA does receive data from certain SROs on a daily basis
and subsequently has direct access to that data.
\454\ Commission staff understands that SROs receiving
information requests from other SROs will typically provide the
information, although they are not required to do so.
\455\ See supra note 399.
\456\ See, e.g., NYSE Rule 2.A.xvi.--Jurisdiction (noting that
the exchange has jurisdiction over matters related to non-member
broker-dealers that choose to be regulated by the exchange). The
Commission may, by rule or order, subject non-members to the rules
of national securities exchanges if it deems it necessary or
appropriate in the public interest and for the protection of
investors, to maintain fair and orderly markets, or to assure equal
regulation. Section 6(f)(2) of the Act, 15 U.S.C. 78f(f)(2); see
also Sections 6(b)(1), 15A(b)(2) of the Act, 15 U.S.C. 78f(b)(1),
78o-3(b)(2) (requiring national securities exchanges and securities
associations, respectively, to have the capability to enforce
compliance by their members with applicable Exchange Act
requirements and exchange or association rules).
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The Commission has direct access only to the public data feeds and
the equity and option cleared data; it lacks direct access to
information provided in EBS or contained in trade blotters, order
tickets, order handling data, SRO audit trails, and OATS data. Unlike
the SROs, the Commission can subpoena data from entities that are not
registered with the Commission, such as professional traders that are
neither broker-dealers nor investment advisers.
If a regulator does not have direct access to data it needs, the
regulator would request it. This can result in many data requests to
broker-dealers, SROs, and others,\457\ which are burdensome to fill.
The Commission recognizes that data requests could impose burdens on
the entities responding to the request, in addition to the burden on
the regulators to put the request together. Broker-dealers, investment
advisers, and SROs responding to a data request must incur costs in
order to produce, store, and transmit the data for the Commission or
SRO.\458\ Further, as indicated above, regulators may need to request
the data needed from many different data providers because of
fragmentation in the data, and thus one analysis, such as an
investigation, can generate many data requests.
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\457\ In the context of an investigation or a court, in
litigation, the Commission can request or subpoena information from
entities, including those not registered with the Commission. See
SEC Rule of Practice 232. Pursuant to their rules, SROs can request
information from their registered entities; see also supra notes
454-456 and accompanying text (discussing how SROs request
information from other parties, including other SROs).
\458\ See, e.g., CAT NMS Plan, supra note 3, at Appendix C,
Section B.7(b)(ii)(B) (discussing the current process for broker-
dealers and SROs to respond to data requests, and stating that
broker-dealers must commit staff to respond to requests for EBS or
large trader data and may take varied approaches to fulfilling their
regulatory reporting obligations).
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Fragmentation in trade and order data can take many forms. First,
an analysis may require the same type of data from many market
participants. Second, the required data fields for an analysis may be
reflected in different types of data. Finally, an analysis may require
data on different products covered in separate data sources. The
fragmentation in the data across market participants is a function of
the fragmentation of trading and broker-dealer services. In today's
equity markets, trades execute across 12 exchanges, more than 40 ATSs,
and around 250 dealers.\459\ With its RSAs, FINRA can consolidate much
of the SRO audit trails in equities.\460\ In the options markets, 14
different exchanges trade listed options with no off-exchange trading
of standardized options and no entity aggregating each audit trail into
one dataset. The vast majority of stocks trade in more than one
location and most options trade on multiple exchanges.
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\459\ See Securities Exchange Act Release No. 76474 at 81008,
81112, ``Regulation of NMS Stocks'' (November 2015), available at
http://www.sec.gov/rules/proposed/2015/34-76474.pdf; see also Laura
Tuttle, OTC Trading: Description of Non-ATS OTC Trading in National
Market System Stocks (March 2014), available at http://www.sec.gov/dera/staff-papers/white-papers/otc-trading-white-paper-03-2014.pdf.
\460\ FINRA has access to data from OATS and each equities
exchange except CHX. See supra note 333 and accompanying text. This
reduces the data fragmentation as it relates to the number of data
requests for equities.
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Exchange SROs generally limit their data collection to securities
traded on their own exchanges, and limit the scope of their audit
trails to transactions occurring on their exchanges. While ATSs and
dealers report order events in equities to OATS, each of the 12
equities exchanges has its own audit trail. As a result of this
structure, a market reconstruction for a single security may involve
data requests to multiple exchanges. Likewise, a project involving
options data may require data from each of the 14 options exchanges.
To acquire broker-dealer order records, EBS, trade blotters, and
order tickets, regulators need to send a request to each broker-dealer
to obtain its data. In the Commission's experience requested data can
suffer from missing variables, truncations, and formatting problems due
to the way that the data is queried by the broker-dealer. These
problems can lead to substantial delays in using data and loss in
regulatory productivity. Many different broker-dealers could have
trading records in a given security on a given day of interest, so one
narrow investigation could generate many data requests. As a result, in
2014 the Commission made 3,722 EBS requests that generated 194,696
letters to broker-dealers for EBS data. Likewise, the Commission
understands that FINRA requests further generate about half this number
of letters. In addition, for examinations of investment advisers and
investment companies, the Commission makes approximately 1,200 data
requests per year. Further, an investigation that requires tracing a
single trade or a set of trades back to an investor or investors can
generate many data requests. For such investigations, regulators would
first need to request data from the exchanges or market participants
executing the trades. This data would tell the regulators which
members, subscribers, or broker-dealers sent the orders that led to the
executions. Regulators would then need to go to the members,
subscribers, and broker-dealers to get information on the orders and
repeat until they get to the broker-dealer who initiated the order to
see the customer behind the order.
Finally, some regulatory activities require data on both equities
and options. Because current data sources do not contain information
regarding both equities and options, regulators needing data on both
types of securities would need to make several data requests. Closely
related securities are sometimes traded on entirely different
exchanges, complicating cross-product analyses. For example, COATS data
covers options trades but excludes the trading of the underlying
assets. Often investigations or analyses require examining both options
and their underlying assets, creating the need for regulators to
request data from multiple sources.
This data fragmentation also results in disparate requirements for
industry members to record and report the same information in multiple
formats. Because each SRO has its own data requirements, a market
participant that is a member of multiple SROs may be required to report
audit trail data in numerous formats and interact with multiple
regulators in response to normal data queries. That said, the
Commission understands that the number of disparate formats faced by
each member may have reduced over the past several years.\461\
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\461\ For example, some exchange audit trails require floor
brokers who operated on their own systems to submit order records to
the exchange. These same floor brokers could be members of other
SROs that require different formats for submitting order reports.
The Commission understands that the volume of trading conducted on
an exchange but not on the exchange's systems has declined sharply.
Therefore, the activity generating the disparate reporting
requirements has declined.
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(4) Timeliness
In order to respond promptly to market events, regulators must be
able to obtain and analyze relevant data in a timely fashion.
Currently, obtaining trade and order data and converting the
[[Page 30673]]
data into a form in which they can be analyzed can involve a
significant delay from the time of a particular event of interest.
Indeed, in some cases the length of time from when an event occurs
until regulators can use relevant data in an investigation or analysis
can be weeks or months. This is especially true for trading data that
includes customer information.
Some of the data sources described above can be accessed by SROs
and the Commission without significant delay. For example, SROs and the
Commission have some real-time direct access to public data and,
through MIDAS, the Commission has next-day direct access to analytics
that are based on public data, such as volumes over various time
horizons. Regulators can also sometimes request and receive trade
blotter data on the same day as the trade(s) of interest because trade
blotters are generally stored in systems immediately.\462\ Further, the
Commission understands that FINRA receives audit trail data from
exchanges pursuant to RSAs at the end of each trading day. However, it
has been the Commission's experience that trade blotter data requests
can take weeks or in excess of a month depending on the scope of the
request and how accustomed the broker-dealer is with fulfilling such
requests.
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\462\ The regulated entities that respond to data requests need
to query data to respond to the request while still maintaining
normal operations. Large data requests can take significant
computing time and thus, may require the respondents to time the
queries to minimize disruptions. Further, respondents need to write
code to execute the query. More experienced respondents would have
existing code that they could modify without significant debugging
whereas less experienced respondents would need to take time to code
and debug their queries.
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Corrected FINRA OATS data may be available less than two weeks
after an event and uncorrected data on day T+1. In particular, FINRA
members submit OATS data on a daily basis, submitting end-of-day files
by 8:00 a.m. Eastern Time the following day or they are marked late by
FINRA.\463\ FINRA acknowledges receipt of the data an hour after the
member submits it, before running its validation process. FINRA then
takes approximately four hours after acknowledging receipt of OATS data
to determine if the data contain any syntax errors.\464\ In addition to
the four hours needed to identify errors within a report, it takes
another 24 hours for context checking, which identifies duplicates or
secondary events without an originating event. Once a context rejection
is available, the member has up to five business days to repair the
rejection.\465\ Reports for files that contain internally inconsistent
information about processing, linking, and routing orders may be
available within two business days. FINRA attempts to match the
inconsistent information against any additional data received up to day
T+2 for linking errors and day T+30 for routing errors. The timing for
surveillance programs varies depending on the type of surveillance
being performed; data is assumed to be completely processed and
corrected at day T+8.\466\
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\463\ FINRA currently receives exchange data from most SROs at
the end of the trading day. Information on broker-dealer data
reporting timeframes is available at OATS Reporting Technical
Specifications, supra note 357, at 8-1; see also Adopting Release,
supra note 9, at 45768 n.504.
\464\ See Section IV.D.2.b(2)A, supra (providing more detail on
the validation and error checking process for OATS and other data
sources).
\465\ See OATS Reporting Technical Specifications, supra note
357, at 6-3. Other types of errors and corrections adhere to
slightly different time-lines. See, e.g., id. at 6-12.
\466\ FINRA has the capability to query data that is not fully
corrected, processed and linked to investigate market activity at
T+1.
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Because market participants generally do not report or compile
datasets immediately after an order event, there is a delay before
regulators may access some data sources. For example, the compilation
of equity and option cleared reports occurs on day T+1 for options and
day T+3 for equities (i.e., the clearing day) and the electronic query
access for equities is available from SIAC on day T+3. Additionally,
when broker-dealers receive a request for EBS, the firm must first fill
in the EBS report and then, if it does not self-clear, pass the reports
on to its clearing firm to compile and send to SIAC. The EBS submission
process can take up to ten business days. More immediate requests for
cleared options data can be submitted to FINRA, but even this process
takes up to two days. Because EBS data do not contain order entry time
and order execution time, regulators must obtain this information from
firms and brokers using either data requests or subpoenas, and this
process generally can take from two to four weeks depending on the size
of the request.
As discussed above,\467\ the lack of direct access to most data
sources may further delay the ability of regulators to use data in
certain cases. When regulators have direct access to a data source, the
time needed to receive data is only the time it takes for a query to
run. For example, depending on the scope of the search, it can take
just a few minutes to return the results of a query of equity and
option clearing data.\468\ As a result of direct access to their own
audit trails, some SRO surveillance occurs on the same day as the
trading activity. FINRA, however, typically gets direct access to
exchange data, uncorrected OATS data, and corrected OATS data at the
time it receives it, unlike the exchanges and broker-dealers that have
some access to the data as it is generated.\469\ However, when
regulators lack direct access, their data requests can consume
significant time, including both the time required to put the request
together and response times from the SROs, broker-dealers, and others
producing the data.\470\ For example, obtaining complete responses from
each broker-dealer for an EBS request can take days or weeks depending
on the scope of the request. Likewise, responses from the ISG for SRO
audit trail data can take days or weeks.
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\467\ See Section IV.D.2.b(3), supra.
\468\ MIDAS, one example of a direct access data source, queries
return data in seconds for single ticker, intraday queries and
within hours for complex multi-ticker, multi-day queries. The data
response times from MIDAS vary depending on the format of the
resulting data and the number of other users on the system. A query
that pulls all message traffic in an equity on a single day would
take around thirty minutes.
\469\ FINRA typically collects exchange data at the end of the
trading day and, as noted above, OATS on T+1. FINRA can begin to
access each data source, but, as discussed below, FINRA has direct
access to combined data only after the completion of the OATS error
process and the processing necessary to reformat and merge the data
sources.
\470\ As discussed above, because analysis of some events
requires the collection of data from numerous sources, the time to
request and receive data may be significant. The more fragmented the
necessary data is, the longer it would take regulators to put
together the data request. Putting together an EBS request, for
example, could involve first identifying to which broker-dealers to
send the requests and then manually creating a request letter for
each broker-dealer. The Commission does recognize, however, that
regulators can request and receive trade blotter data on the same
day as the trade event if the request is for a small amount of data
from an experienced provider. In fact, two years of trade blotter
data from an experienced investment adviser can take several days
while two years of data from clearing firms can take six weeks to
several months.
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Once regulators receive requested data, the data often have to be
processed into a form in which they can be analyzed. As discussed
above,\471\ it can take considerable time for regulators to combine
data from different sources and link records from within or across data
sources. Furthermore, the lack of consistency in format adds complexity
to projects involving data from multiple data sources, even when the
project does not involve linking of these different data.\472\ For
example, the
[[Page 30674]]
Commission understands that FINRA takes approximately three days to
process exchange data to transform it into a common format and prepare
it for surveillance. Therefore, FINRA cross-market surveillances and
surveillance of the off-exchange market typically assumes data is fully
corrected and processed on T+8.\473\ Any processing that requires
linking order life-cycle events or other types of data can be time
consuming to perform, even if all of the data comes from the same data
source.\474\ In some cases, the laborious process of assembling the
data delays other critical investigative or analytical steps.
---------------------------------------------------------------------------
\471\ See Section IV.D.2.b(2)C, supra.
\472\ Because no single data source is complete, regulators
often need to combine data across sources to get a full picture. For
example, regulators may need to compile SRO audit trail records from
multiple SROs. Not all SROs collect data using the OATS format. The
different data formats implemented by SROs thus involve a
significant investment of staff time to reconcile. 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.
\473\ FINRA can access data as soon as T+1 when necessary.
\474\ The first step in linking involves finding a key to link
the records. The key can be one field or a series of fields in the
data. The second step involves designing an algorithm to use the key
to link records. If each data source formats or stores the fields in
the key differently, the algorithm can be complex. Even within a
single data source, the creation of the algorithm may be complicated
because the fields needed to build the key can change with each
market participant. For example, each member can report a different
order ID for the same order, and this order ID may even change
within the same member. The algorithm for linking needs to recognize
how order IDs change and use additional information in the order
records to piece an order lifecycle together. As noted above in
Section IV.D.2.b(2)C, linking algorithms have varying rates of
success and significant error rates in event linking are common. The
lack of success could be due to the lack of a cross-participant
error resolution process, the complexity in the linkage, or
otherwise missing key information needed for linkage. As a result,
regulators may invest significant time and resources into linking
data only to achieve a success rate significantly less than 100%.
Linking across multiple data sources makes linking even more time
consuming.
---------------------------------------------------------------------------
In addition, those who use regulatory data also typically take time
to ensure the accuracy of the data. When regulators question the
accuracy of data, they often check several alternative sources until
they are comfortable that their data are accurate. This checking of
data accuracy and augmentation process adds time to an investigation or
analysis. In some cases, regulators may filter out unreliable data or
refocus an investigation to avoid relying on data after spending time
and resources unsuccessfully attempting to ensure accuracy.
As discussed in the Adopting Release, the timely accessibility of
data to regulators also impacts the efficacy of detecting (and possibly
mitigating the effects of) some types of market manipulation.\475\ For
example, some pernicious trading schemes are designed to generate large
``quick-hit'' profits in which market 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). The timeframes currently required to acquire data generally
complicate the prevention of these asset transfers.
---------------------------------------------------------------------------
\475\ See Adopting Release, supra note 9, at 45731.
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3. Request for Comment on the Baseline
The Commission requests comment on all aspects of the Baseline for
the economic analysis of the CAT NMS Plan. In particular, the
Commission seeks responses to the following questions:
240. Do Commenters agree with the Commission's assessment of the
Baseline for the economic effects of the CAT NMS Plan? Why or why not?
241. Do Commenters believe that the Baseline appropriately
describes current market surveillance, examination, and investigation
activities by regulators? Why or why not?
242. Do Commenters believe that the Baseline appropriately
describes current market event analysis and reconstruction activities
by regulators? Why or why not?
243. Do Commenters believe that the Baseline appropriately
describes market analysis activities by regulators? Why or why not?
244. Do Commenters believe that the Baseline appropriately
describes the sources of trade and order data currently available to
regulators? Why or why not?
245. Are there additional sources of trade and order data currently
available to regulators? Please explain and describe those sources in
detail, including any limitations.
246. Do Commenters agree with the Commission's assessment of the
completeness of the trade and order data currently available to
regulators? Why or why not? Does the fragmented nature of current data
sources pose significant challenges to regulators seeking complete
data?
247. Do Commenters agree with the Commission's assessment of the
accuracy of the trade and order data currently available to regulators?
Why or why not?
248. Do Commenters agree that the error rates in current data
sources or in responses to ad hoc data requests pose significant
challenges to regulators? Why or why not? Do Commenters have additional
statistics on error rates in these data?
249. Do Commenters agree with the Commission's assessment of the
Baseline of clock synchronization for broker-dealers, exchanges, and
others in the securities industry? Please explain. Does the
Commission's analysis appropriately describe the frequency of orders
that regulators may need to sequence and the challenges to sequencing
given current clock synchronization standards? If not, do Commenters
have more appropriate analyses? How could the Commission improve the
analysis? Please explain.
250. Do Commenters believe that the Baseline appropriately
describes granularity of time stamps in the trade and order data
currently available to regulators? Please explain.
251. Do Commenters agree with the Commission's assessment of
regulators' ability to combine or link data across the sources of trade
and order data currently available to regulators? Please explain.
252. Do Commenters believe that the Baseline appropriately
describes customer and broker-dealer identifiers in the sources of
trade and order data currently available to regulators? Please explain.
253. Do Commenters believe that the Baseline appropriately
describes aggregation within the sources of trade and order data
currently available to regulators? Please explain.
254. Do Commenters agree with the Commission's assessment of the
current ability of regulators to access trade and order data? Why or
why not?
255. Do Commenters agree with the Commission's assessment of the
timeliness of the trade and order data currently available to
regulators? Why or why not?
256. Is there any other information that the Commission should
include in the Baseline? Please explain.
E. Benefits
As noted in the Framework Section above, the economic benefits of
the CAT NMS Plan would come from any expanded or more efficient
regulatory activities facilitated by improvements to the data
regulators use because the Plan would create a new consolidated data
source, CAT Data that could replace the use of some current data
sources for many regulatory activities. Therefore, the Benefits Section
first describes how CAT Data compares to data regulators currently use
for regulatory activities. Then this Section describes how the CAT Data
would improve regulatory
[[Page 30675]]
activities and how these improvements benefit investors.
The Commission preliminarily believes that the CAT NMS Plan would
produce data that would improve on current data sources, because CAT
Data would result in regulators having direct access to consolidated
audit trail data that would improve many of the regulatory activities
discussed in the Baseline Section. As summarized in Table 4, if the
Plan is approved, the Commission preliminarily believes that the Plan
would generate improvements in the quality of data that regulators
would have access to in the areas of completeness, accuracy,
accessibility, and timeliness. The Commission preliminarily believes
that the improvements in the quality of regulatory data within these
categories would significantly improve the ability of regulators to
perform a wide range of regulatory activities, which would lead to
benefits for investors and markets. In addition, the Commission
preliminarily believes that certain provisions in the Plan related to
future upgrades of the Central Repository, the promotion of the
accuracy of CAT Data, the promotion of the timeliness of CAT Data, and
the inclusion of specific governance provisions identified by the
Commission in the Adopting Release for Rule 613, increase the
likelihood that the potential benefits of the CAT NMS Plan described
below would be realized.
In the category of completeness, the ability for regulators to
access more material data elements from a consolidated source would
enable regulators to more efficiently carry out investigations,
examinations, and analyses because regulators could acquire from a
single source data that they would otherwise need to compile from many
data sources. This data source would include data elements that
regulators currently acquire with difficulty (if at all), including
customer information, allocation records, open/close position
information for equities, and certain other trade and order information
not consistently available in SRO audit trails.\476\
---------------------------------------------------------------------------
\476\ See CAT NMS Plan supra note 3, at Sections 1.1, 6.3 and
6.4; see also 17 CFR 242.613(c)(7).
---------------------------------------------------------------------------
In the category of accuracy, the Commission preliminarily believes
that the Plan would substantially improve data accuracy by requiring
CAT Data to be collected, compiled, and stored in a uniform linked
format using consistent identifiers for customers and market
participants. These requirements should over time result in fewer
inaccuracies in the data as well as fewer inaccuracies introduced in
combining data compared to the current data regime.\477\ The CAT NMS
Plan would also require that CAT Reporters' business clocks be
synchronized to within 50 milliseconds of the time maintained by the
NIST, which would increase the precision of the time stamps provided by
the 39% of broker-dealers who currently synchronize their clocks with
less precision than what is called for by the Plan. This information
may also be used to partially sequence surrounding events. However,
while the Commission preliminarily believes that the requirements in
the Plan for clock synchronization and time stamp granularity would
improve the accuracy of data with respect to the sequencing of market
events, the improvements would be modest, as regulators' would
experience improvement for a small percentage of market events relative
to all surrounding events.\478\ Independent of the potential time clock
synchronization benefits, the order linking data that would be captured
in CAT should increase the proportion of events that could be sequenced
accurately. This reflects the fact that some records pertaining to the
same order could be sequenced by their placement in an order lifecycle
(e.g., an order submission must have occurred before its execution)
without relying on time stamps.
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\477\ The Commission recognizes that the high initial Error Rate
tolerance of the CAT NMS Plan could reduce the accuracy of raw CAT
Data relative to current data sources. However, as stated in the
Plan ``the Participants expect that error rates after reprocessing
of error corrections will be de minimis.'' See CAT NMS Plan supra
note 3, at Appendix C, Section 3(b), n.102.
\478\ See FIF Clock Offset Survey, supra note 127.
---------------------------------------------------------------------------
In the category of accessibility, the Commission preliminarily
believes that the Plan would substantially improve the access of data
for regulators due to the Plan's requirement for regulators to have
direct access to CAT Data. While some elements of CAT Data can
currently be obtained from other sources, it can take regulators weeks
or months to obtain this data. As opposed to the current state of
fragmented data with indirect regulatory access, if the CAT NMS Plan is
approved, regulators would have direct access to consolidated trade and
order data from a single source. Therefore, instead of requesting data
from multiple sources, the Plan would allow regulators to log into a
single system and query data directly from the system. This direct
access for regulators would dramatically reduce the hundreds of
thousands of requests that regulators must make each year in order to
obtain data, thus reducing the burden on the industry.
In the category of timeliness, the Commission preliminarily
believes that the Plan would significantly improve the timeliness of
data acquisition and use, which could improve the timeliness of
regulatory actions that use data. CAT Data would be reported by 8:00
a.m. Eastern Time on day T+1 and made available to regulators in raw
form after it is received and passes basic formatting validations,\479\
with an error correction and linkage process that would be completed by
8:00 a.m. Eastern Time on day T+5.\480\ These requirements would ensure
that data is available to regulators faster than in the current system
and should also reduce the amount of time regulators would need to
process data prior to usage.
---------------------------------------------------------------------------
\479\ While the Plan does not specify exactly when these
validations would be complete, the requirement to link records by
12:00 p.m. Eastern Time on day T+1 gives a practical upper bound on
this timeline.
\480\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.2(a).
---------------------------------------------------------------------------
Regulatory activities expected to benefit from improved data
quality would include surveillance, investigations, examinations,
analysis and reconstruction of market events, and analysis in support
of rulemaking initiatives. Data is essential to all of these regulatory
activities and therefore substantial improvements in the quality of the
regulatory data should result in substantial improvements in the
efficiency and effectiveness of these regulatory activities, which
should translate into benefits to investors and markets. For example,
improved data could lead to more effective and efficient surveillance
that better protects investors and markets from violative behavior and
facilitates more efficient and effective risk-based investigations and
examinations that more effectively protect investors. Together, these
improved activities could better deter violative behavior of market
participants, which could improve market efficiency. Furthermore, this
increase in directly accessible data should improve regulators'
understanding of the markets, leading to more informed public policy
decisions that better address market deficiencies to the benefit of
investors and markets.
The Commission notes that the Plan lacks information regarding the
details of certain elements of the Plan, primarily because many details
likely to affect the benefits of the Plan have not yet been determined,
which creates some uncertainty about the expected economic effects. As
discussed further below, lack of specificity surrounding the processes
for converting data formats and linking related order events
[[Page 30676]]
creates uncertainty in the anticipated improvements in accuracy because
such processes have the potential to create new data inaccuracies. Lack
of specificity surrounding the process for regulators to access the CAT
Data also creates uncertainty around the expected improvements in
accessibility. For example, while the Plan indicates that regulators
would have an on-line targeted query tool and a tool for user-defined
direct queries or bulk extraction,\481\ the Plan itself does not
provide an indication for how user-friendly the tools would be or the
particular skill set needed to use the tools for user-defined direct
queries.
[[Page 30677]]
[GRAPHIC] [TIFF OMITTED] TN17MY16.328
\481\ See CAT NMS Plan, supra note 3, at Appendix D, Sections
8.1, 8.2.
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[[Page 30678]]
1. Improvements in Data Qualities
As explained above, in the Adopting Release the Commission
identified four qualities of trade and order data that impact the
effectiveness of core SRO and Commission regulatory efforts: Accuracy,
completeness, accessibility, and timeliness.\486\ In assessing the
potential benefits of the CAT NMS Plan, the Commission's economic
analysis compares the data that would be available under the Plan to
the trading and order data currently available to regulators.\487\ As
explained in detail below, the Commission preliminarily believes that
the Plan would improve data in terms of all four qualities noted above,
although uncertainty remains as to the expected degree of improvement
in some areas.
---------------------------------------------------------------------------
\486\ See Adopting Release, supra note 9, at 45727.
\487\ Changes in all four data qualities affect certain data-
driven regulatory activities. The benefits of the Plan derive from
the changes to these regulatory activities.
---------------------------------------------------------------------------
a. Completeness
The CAT NMS Plan, if approved, would result in regulators having
direct access to a single data source that would be more complete than
any current data source.\488\ The CAT Data would be more complete than
other data sources because it would contain data from a greater number
of broker-dealers on more event types, products, and data fields, when
compared to existing SRO audit trails and other data sources. As
discussed in more detail below, while some current data sources contain
many of the elements that would be included in CAT Data, the CAT Data
would consolidate that data into one source to produce a data source
much more complete than any existing source. CAT Data would also
include some elements that are not available from any current data
source. Having this data consolidated in a single source would provide
numerous benefits that are described below.
---------------------------------------------------------------------------
\488\ See Sections IV.C.1.a(1) and IV.D.2.b(1), supra for a
definition of completeness.
---------------------------------------------------------------------------
(1) Events and Products
CAT Data would be more complete than any current data source
because it combines currently fragmented information into one data
source. In particular, the Plan states that the Central Repository,
under the Plan Processor's oversight, shall receive, consolidate, and
retain all CAT Data.\489\ ``CAT Data'' is defined as ``data derived
from Participant Data, Industry Member Data, SIP Data, and such other
data as the Operating Committee may designate as CAT Data from time to
time.'' \490\ Section 6.3 of the Plan describes the data to be received
from Participants that are national securities exchanges, which would
include data for ``each NMS Security \491\ registered or listed for
trading on such exchange or admitted to unlisted trading privileges on
such exchange.'' Participants that are a national securities
association (i.e., FINRA) must report data for each ``Eligible Security
for which transaction reports are required to be submitted to that
association.'' \492\ ``Eligible Security'' is defined in the Plan as
all NMS Securities and all OTC Equity Securities,\493\ and ``OTC Equity
Security'' is defined as ``any equity security, other than an NMS
Security, subject to prompt last sale reporting rules of a registered
national securities association and reported to one of such
association's equity trade reporting facilities.'' \494\ ``Industry
Member Data'' refers to audit trail data reported by members of the
exchanges and national associations, which includes Options Market
Makers.\495\ SIP Data is defined in the Plan as information, including
size and quote condition, on quotes including the National Best Bid and
National Best Offer (``NBBO'') for each NMS Security; Last Sale Reports
and transaction reports reported pursuant to an effective transaction
reporting plan filed with the Commission pursuant to, and meeting the
requirements of Rule 601 and 608; trading halts, limit-up limit-down
(``LULD'') price bands,\496\ and LULD indicators; and summary data or
reports described in the specifications for each of the SIPs and
disseminated by the respective SIP.\497\
---------------------------------------------------------------------------
\489\ See CAT NMS Plan, supra note 3, at Section 6.5(a)(i).
\490\ See id. at Section 1.1.
\491\ An ``NMS Security'' is defined as ``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.'' See 17 CFR
242.600(b)(46).
\492\ See CAT NMS Plan, supra note 3, at Section 6.3(c)(ii).
\493\ See id. at Section 1.1. Audit trail data regarding OTC
Equity Securities was not required under Rule 613, but the
Participants, in consultation with the DAG, included OTC Equity
Securities in the CAT NMS Plan so as to permit the retirement of
OATS and thereby reduce costs to the industry. See CAT NMS Plan,
supra note 3, at Appendix C, Section C.9, Section A.1(a) n.16. The
determination to include OTC Equity Securities would also have a
positive effect on further reducing fragmentation of data sooner.
\494\ See CAT NMS Plan, supra note 3, at Section 1.1.
\495\ See id. at Section 6.4(d).
\496\ See Plan to Address Extraordinary Volatility for
information on LULD, available at http://www.finra.org/sites/default/files/regulation-NMS-plan-to-address-extraordinary-market-volatility.pdf; see also Securities Industry Automation Corporation,
Consolidated Tape System, CTS, Output Multicast Interface
Specifications, available at https://www.nyse.com/publicdocs/ctaplan/notifications/trader-update/cts_output_spec.pdf Securities
Industry Automation Corporation, Consolidated Tape System, CQS,
Output Multicast Interface Specifications, available at https://www.nyse.com/publicdocs/ctaplan/notifications/trader-update/cqs_output_spec.pdf. The UTP Plan Trade Data Feed \SM\ (UTDF\SM\),
Direct Subcriber Interface Specification, Version 14.4 available at
http://www.utpplan.com/DOC/utdfspecification.pdf.
\497\ See id. at Section 1.1 and Section 6.5(a)(ii).
---------------------------------------------------------------------------
CAT Data would include data from all SRO audit trails, combined
into a single data source. In addition, it would include some off-
exchange activity not captured on current SRO audit trails. Section
6.4(d) of the Plan requires the Participants to require their Industry
Members to record and report order events to the Central Repository.
The Commission notes that SRO audit trails currently do not include the
activity of firms that are not members of that SRO.\498\ And, currently
only FINRA requires its members to report their off-exchange activity.
While broker-dealers that trade off-exchange must be members of FINRA
unless their activity fits the terms of the exemption in Rule 15b9-
1,\499\ firms that qualify for the exemption in that rule and that are
not FINRA members do not report their off-exchange activity to
OATS.\500\ This exemption amounts to a large percentage of off-exchange
activity. Broker-dealers that are not FINRA Members accounted for 48%
of orders sent directly to ATSs in 2014, 40% of orders sent directly to
ATSs in 2013, and 32% in 2012.\501\ Because all SROs
[[Page 30679]]
are Participants in the Plan, under the Plan all broker-dealers with
Reportable Events, including off-exchange, would be required to report
the required CAT Data to the Central Repository. And, the inclusion of
these additional Reportable Events would make CAT Data more complete
than the combination of current SRO audit trails.
---------------------------------------------------------------------------
\498\ This information can sometimes be inferred through data
reported by member firms. See Securities Exchange Act Release No.
74581 (March 25, 2015), 80 FR 18036 (April 2, 2015) (``Proposed
Amendments to Rule 15b9-1''), Section V.B.2; see also CAT NMS Plan,
supra note 3, at Appendix C Section B.7(a)(ii)(A).
\499\ See id. for details on the exemption to Rule 15b9-1 and
the proposed modifications to the Exemption for Certain Exchange
Members that would require a dealer to be a member of a registered
national securities association to conduct most off-exchange
activity. If these modifications are adopted, Section IV.F.1.c(2)B.i
discusses counts of broker-dealers currently not represented in
OATS; the 15b9-1 exclusion applies to approximately 125 firms, most
of which are not expected to incur OATS reporting obligations if
15b9-1 modifications are approved.
\500\ Furthermore, not all FINRA members are obligated to report
to OATS. FINRA's rules exempt from reporting certain members that
engage in a non-discretionary order routing process; additionally,
FINRA has the authority to exempt other members who meet specific
criteria from the OATS recording and reporting requirements, and has
granted many such exemptions. See supra notes 396 and 397, and
accompanying text. Approximately 799 firms that are excluded or
exempt from OATS would incur CAT reporting obligations if the Plan
were approved; see also Section IV.F.1.c(2)B.i, infra.
\501\ See Proposed Amendments to Rule 15b9-1, supra note 498, at
n.21. If the Commission adopts the proposed amendments to Rule 15b9-
1 set out in the proposed modifications to the Exemption for Certain
Exchange Members, the percentage of off-exchange activity captured
by CAT Data that is not currently captured by another audit trail
would be smaller, and fewer broker-dealers would be excluded from
OATS, reducing the number of broker-dealers that would be added to
regulatory data if the Plan were approved. Section IV.F.1.c(2)B.ii
discusses counts of broker-dealers currently not represented in
OATS; the 15b9-1 exclusion applies to approximately 125 firms, most
of which are not expected to incur OATS reporting obligations if
15b9-1 modifications are approved. Specifically, the exemption from
FINRA membership would be limited to dealers that effect
transactions off the exchanges of which they are members solely for
the purpose of hedging the risks of their floor-based activity, and
brokers and dealers that effect transactions off the exchange
resulting from orders that are routed by a national securities
exchange of which they are members. Id. at Section II.
---------------------------------------------------------------------------
CAT Data would also include many Reportable Events such as order
origination, order routing, receipt of a routed order, order
modifications, cancellations, and executions, and trade cancellations.
Currently, OATS data contains most of these Reportable Events but does
not cover all participants and does not include options.\502\ For
example, CAT Data would contain more events than EBS data, trade
blotters, and public data. As previously noted, OATS data also do not
include proprietary orders originated by a trading desk in the ordinary
course of a member's market making activities (or ``principal
activity'').\503\ But, pursuant to Rule 613(j)(8),\504\ principal
trading would be included in CAT reporting requirements, an improvement
over OATS. This requirement significantly improves completeness because
such events are not included in current SRO audit trails, and account
for a significant portion of market activity (40.5% of all transactions
and 67% of all exchange message traffic according to a Commission
analysis).\505\ This would improve regulatory activities in which
observation of pricing information, as it relates to market activity,
is important for determining the legality and consequences of market
activity of interest as well as regulatory analysis of market behavior
in general.
---------------------------------------------------------------------------
\502\ See Section IV.D.2.b(1)A, supra.
\503\ Id.
\504\ See 17 CFR 242.613(j)(8).
\505\ See Section IV.D.2.b(1)A, supra for a description of this
analysis.
---------------------------------------------------------------------------
CAT Data also would include the information described above for
listed equities and options and OTC Equity Securities.\506\ Therefore,
the inclusion in CAT Data of all these products adds an additional
level of completeness relative to current data sources.
---------------------------------------------------------------------------
\506\ See supra note 494.
---------------------------------------------------------------------------
(2) Data Fields
The CAT NMS Plan also would improve completeness by consolidating
in a single source fields that currently may only be available from
some data sources, and by including some fields that are difficult for
regulators to compile. Not every data field that would be in CAT Data
is currently included in SRO audit trails, and very few fields are
included in all data sources.
The inclusion of consistent unique customer information, in
particular, in the CAT Data represents a significant improvement over
current SRO audit trails in terms of completeness. Rule 613(c)(7)(i)
requires that a CAT Reporter report information to the Central
Repository that uniquely identifies a customer across all broker-
dealers.\507\ As noted in the Baseline, very few current data sources
contain customer information, and those that do are largely limited in
the completeness and accuracy of this information, all of which
significantly limits regulatory efficiency.\508\ The identification of
customers underlies numerous enforcement activities and many
examination and surveillance activities of regulators. This would also
allow regulators to obtain information efficiently regarding customers,
such as issuers repurchasing their stock and short sellers.\509\
---------------------------------------------------------------------------
\507\ 17 CFR 242.613(c)(7)(i). Specifically, Sections 9.1 and
9.2 of Appendix D of the Plan require the CAT Data to include the
following Customer information, at minimum: social security number
or individual taxpayer identification number, date of birth, current
name, current address, previous name and previous address. For legal
entities, the Plan requires the reporting of the LEI (if available),
tax identifier, full legal name and address. The Plan also requires
that the following information about a Customer be reported to the
Central Repository, at a minimum: Account owner name, account owner
mailing address, account tax identifier, market identifiers, type of
account, firm identifier number, prime broker ID, bank repository
ID, and clearing broker. See CAT NMS Plan supra note 3, at Sections
9.1 and 9.2. The CAT Data must also support account structures that
have multiple account holders. See id. Relatedly, the unique
Customer-ID also improves accuracy because Rule 613 requires that it
be consistent and associated with all Reportable Events involving
that Customer. Current data sources do not provide consistent
customer identifiers. See Sections IV.D.2.b(2)D supra, and
IV.E.1.b(4), infra.
\508\ See Sections IV.D.2.a(1) and IV.D.2.b(1)B, supra. As
discussed above, the Commission notes that SRO audit trails
typically do not provide customer information but a recent FINRA
rule change would require its members to report to OATS non-FINRA
member customers who are broker-dealers. See supra note 407.
\509\ See Short Sale Reporting Study, supra note 413, for a
discussion of the benefits of being able to identify short sellers.
Because CAT Data would include a short sale mark and identify
customers, regulators could use CAT Data to identify short sellers.
---------------------------------------------------------------------------
In addition to data fields providing customer information, the Plan
would improve completeness by including other data fields not found on
current SRO audit trails. For example, CAT Data would include
allocation information, open/close information, Quote Sent Time, and
information on whether a Customer gave a modification or cancellation
instruction.
The information in the Allocation Report required by the CAT NMS
Plan represents a significant improvement in completeness over current
sources for subaccount allocation data, such as trade blotter and EBS
data. Under the Plan, an Allocation Report would include the Firm
Designated ID for any account(s), including subaccount(s), to which
executed shares are allocated, the security that has been allocated,
the identifier of the firm reporting the allocation, the price per
share of shares allocated, the side of shares allocated, the number of
shares allocated to each account, and the time of the allocation.\510\
While most of the fields required on the Allocation Report are included
on trade blotter or EBS data, their inclusion in CAT Data would
significantly reduce the time and effort expended for regulators to
acquire such information.\511\ Because it is not required on EBS or in
broker-dealer recordkeeping rules, the allocation time field on the
Allocation Report provides information that is currently even more
difficult for regulators to acquire than the other information on the
Allocation Report. These data improvements should facilitate the use of
allocation data in regulatory investigations and should result in more
effective and efficient investigative processes. Allocation data also
serves an important role in many other regulatory activities that aim
to protect investors.\512\ Indeed, allocation time is an extremely
important data field because it is critical in investigations of
violations like market manipulation and cherry-picking.\513\
---------------------------------------------------------------------------
\510\ See CAT NMS Plan, supra note 3, at Section 1.1; see also
Exemption Order, supra note 18, at 11867.
\511\ See Section IV.D.2.b(1)B, supra, for further information
on Allocation Reports.
\512\ Id.
\513\ Id.
---------------------------------------------------------------------------
In addition, while many of the elements contained in the definition
of ``Material Terms of the Order'' are
[[Page 30680]]
collected in current SRO audit trails, the CAT NMS Plan's definition of
Material Terms of the Order expands the CAT Data beyond the coverage of
current SRO audit trails and other sources. The CAT NMS Plan requires
that the Material Terms of the Order be reported for order origination,
routing, and the receipt of a routed order. And Material Terms of the
Order is defined to include the 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, open/close indicator, time in force (if applicable), and any
special handling instructions.\514\ In addition, if the order is for a
Listed Option, the Material Terms of the Order would be defined to
include option type (put/call), option symbol or root symbol,
underlying symbol, strike price, expiration date, and open/close.\515\
---------------------------------------------------------------------------
\514\ See CAT NMS Plan, supra note 3, Section 1.1; see also 17
CFR 242.613(j)(7).
\515\ Id.
---------------------------------------------------------------------------
Because data on open/close indicators are not currently included in
SRO audit trails, obtaining data on whether a trade opens or closes a
position in equities is currently very difficult. Ready access to this
information would facilitate regulators' ability to determine whether a
purchase or sale increases or decreases equity exposure, such as when a
buy covers a short position.\516\ This would help regulators
reconstruct customer positions without requiring specific position data
and would assist in analysis of rules such as Rule 105 of Regulation
M,\517\ governing when short sellers can participate in a follow-on
offering.\518\ This information is also useful in investigating short
selling abuses and short squeezes.\519\ Among other things, a build-up
of a large short position by one investor along with the spreading of
rumors may be indicative of using short selling as a tool to
potentially manipulate prices. Information on when the position
decreases is also useful for indicating potential manipulation, insider
trading, or other rule violations.\520\ The ability to determine
whether an order adds to a position, along with the timing of the
order, is particularly important in detecting and investigating
portfolio pumping or marking the close.\521\
---------------------------------------------------------------------------
\516\ The open/close indicator would help to identify buy to
cover orders because a buy order that closes a position would
presumably be a buy-to-cover order. See Proposing Release supra note
9, at 32575. The Commission notes that the accuracy of this data
field may depend on how the Plan Processor interprets when CAT
Reporters should populate the field with particular permitted
values. See infra note 537 and accompanying text.
\517\ 17 CFR 242.105.
\518\ For a discussion of additional benefits of position
information and buy to cover information, see Short Sale Reporting
Study, supra note 413; see also Press Release: SEC Charges Six Firms
for Short Selling Violations in Advance of Stock Offerings (October
14, 2015), available at http://www.sec.gov/news/pressrelease/2015-239.html.
\519\ See Proposing Release, supra note 9 at 32575.
\520\ Id.
\521\ Id.
---------------------------------------------------------------------------
The CAT Data would also include information regarding the sent time
for Options Market Maker quotes and information about whether a
modification or cancellation instruction for an order was given by a
Customer associated with an order, or was initiated by a broker-dealer
or exchange associated with the order. Neither of these data fields is
currently readily available from existing SRO audit trails.\522\ Quote
sent time is particularly informative for certain narrow market
reconstructions for enforcement investigations, and knowing whether the
member or Customer made a modification or cancellation helps regulators
understand the decisions that broker-dealers and others make in the
interest of best execution.
---------------------------------------------------------------------------
\522\ See Exemption Order, supra note 18 at 11857 and 11861.
---------------------------------------------------------------------------
The remaining data fields included in CAT Data are also included in
some or all current SRO audit trails, although no single source
contains all of them. For instance, Rule 613(c)(7)(vi)(C) requires the
collection of audit trail data that links executions to contra-side
orders and a CAT-Order-ID for the contra-side order.\523\ An order
identifier for the contra-side order(s) would help regulators better
reconstruct executions. Although some current exchange audit trails
identify counterparties to trades, this identification is sometimes
more difficult for off-exchange equity trading.\524\ Further, while all
SRO audit trails contain time stamps, as CAT Data would, some sources
of regulatory data do not currently include all the types of time
stamps that would be in CAT Data.
---------------------------------------------------------------------------
\523\ 17 CFR 613.242(c)(7)(vi)(C).
\524\ For off-exchange trading, OATS records sometimes do not
directly identify counterparties. In the case of ATS trades,
sometimes counterparty broker-dealers can only be identified through
TRF records; sometimes ATS OATS records alone suffice. For
internalized trades, the reporting broker-dealer is the
counterparty. By combining OATS with TRF data, regulators can
identify the broker-dealers representing the counterparties for over
99% of TRF reported trades, but identifying customer account
information generally requires a data request to those broker-
dealers. See Section IV.D.2.b(2)A, supra.
---------------------------------------------------------------------------
Additionally, the inclusion of order display information (i.e.,
whether the size of the order is displayed or non-displayed), and
special handling instructions in CAT Data improve completeness because
they are not always mandatory in SRO audit trail data, and therefore
may not be consistently available without data requests to broker-
dealers.\525\ Order display information is useful for examining how
hidden liquidity affects markets or how regulatory changes affect
hidden liquidity, and special order handling instructions could assist
in examinations of best execution and could allow regulators to better
understand the role and trends of these instructions in the market.
---------------------------------------------------------------------------
\525\ See supra note 412.
---------------------------------------------------------------------------
Other information required by the CAT NMS Plan includes the
security symbol, date and time of the Reportable Event, the identity of
each Industry Member or Participant accepting, routing, receiving,
modifying, canceling, or executing each order, the identity and nature
of the department or desk to which an order is routed, if an order is
routed internally within the system of an Industry Member, a CAT-Order-
ID, changes in any Material Term of the Order (if the order is
modified), execution capacity, the CAT-Order-ID of any contra-side
order(s), and the SRO-Assigned Market Participant Identifier of the
clearing broker or prime broker.\526\ Of these fields, the security
symbol and date are the only data found on all current data sources.
---------------------------------------------------------------------------
\526\ See CAT NMS Plan, supra note 3, Sections 6.3(d); 6.4(d).
---------------------------------------------------------------------------
The Commission preliminarily believes that the CAT Data would
include all data elements that would be useful and efficient to include
in a consolidated audit trail. The Commission previously considered
which fields should be reported to CAT when proposing and adopting Rule
613. The set of data fields required by Rule 613 reflected the
Commission's assessment, as informed by public comment, of the benefits
and costs of including various data elements in CAT.\527\ While the
costs and benefits of including particular fields can change due to
technological advances and/or changes in the nature of markets, the
Plan contains provisions regarding periodic reviews and upgrades to CAT
that could lead to proposing additional data fields that are deemed
important.\528\ In addition the Commission reviewed gap analyses that
examine whether the CAT Data would contain all important data elements
in current data sources.\529\ As a result of
[[Page 30681]]
this review, the Commission is aware that one data gap involves OATS
data fields that allow off-exchange transactions to be matched to their
corresponding trade reports at trade reporting facilities, and
recognizes that these fields are important to assure trade reporting
requirements are being met for off-exchange trading.\530\ Similarly,
the Commission notes that EBS includes 13 data elements that are not
required by CAT or derivable through other CAT fields and would thus
reflect some limitations of the Plan if EBS were retired before those
missing data elements were incorporated into CAT.\531\ However, as
discussed in Section 3 of Appendix D of the Plan, prior to the
retirement of existing systems, the CAT Data must contain data elements
sufficient to ensure the same regulatory coverage provided by existing
systems that are anticipated to be retired.\532\ The Commission
therefore expects that any missing elements that are material to
regulators would be incorporated into CAT Data prior to the retirement
of the systems that currently provide those data elements to
regulators. And the Commission preliminarily believes that CAT Data
would include the audit trail data elements that currently exist in
audit trail data sources and that could be retired upon implementation
of the CAT.
---------------------------------------------------------------------------
\527\ See Adopting Release, supra note 9, at 45751.
\528\ See Section IV.E.3a, infra for a discussion of adding new
data fields and other requirements for upgrading the CAT Data after
approval.
\529\ The Commission acknowledges that the Participants are
continuing to study gaps between current regulatory data sources and
the Plan as filed. CAT NMS Plan, supra note 3, at Appendix C,
Section C.9; see also SEC Rule 613--Consolidated Audit Trail (CAT)
OATS--CAT Gap Analysis and SEC Rule 613--Consolidated Audit Trail
(CAT) Revised EBS--CAT GAP Analysis, available at http://www.catnmsplan.com/gapanalyses/index.html.
\530\ The Commission notes that Rule 613 does not require the
inclusion of this information. This information did not exist at the
time the Commission adopted Rule 613 and such information on
exchange trades does not exist today. The Commission expects that
the requirements discussed in Section 3 of Appendix D of the Plan
would result in the inclusion of this information in the CAT Data.
\531\ See SEC Rule 613--Consolidated Audit Trail (CAT) Revised
EBS--CAT GAP Analysis, available at http://www.catnmsplan.com/gapanalyses/p450537.pdf.
\532\ See CAT NMS Plan, supra note 3, at Appendix D, Section 3.
---------------------------------------------------------------------------
b. Accuracy
This Section analyzes the expected effect of the CAT NMS Plan, if
approved, on the accuracy of the data available to regulators.\533\ In
general, the Commission preliminarily believes that the requirements in
the CAT NMS Plan for collecting, consolidating, and storing the CAT
Data in a uniform linked format, the use of consistent identifiers for
Customers, and the focus on sequencing would promote data accuracy.
---------------------------------------------------------------------------
\533\ As discussed above and in the Adopting Release, accuracy
refers to whether the data about a particular order or trade is
correct. See Adopting Release, supra note 9, at 45727.
---------------------------------------------------------------------------
The Commission notes that the full extent of improvement that would
result from the Plan is currently unknown, because the Plan defers many
decisions relevant to accuracy until the Plan Processor publishes the
Technical Specifications and interpretations.\534\ In particular, the
CAT NMS Plan specifies that the ``[t]echnical Specifications shall
include a detailed description of . . . each data element, including
permitted values, in any type of report submitted to the Central
Repository'' \535\ and ``the Plan Processor shall have sole discretion
to amend and publish interpretations regarding the Technical Specifica-
tions.'' \536\ This leaves open precise definitions and parameters for
the data fields to be included in CAT Data.\537\
---------------------------------------------------------------------------
\534\ See CAT NMS Plan, supra note 3, at Section 6.9.
\535\ Id. at Section 6.9(b)(v).
\536\ The CAT NMS Plan provides details regarding how the
responsibility for these decisions would be shared between the
Operating Committee and the Plan Processor, with the Plan Processor
having responsibility for data definitions and interpretations. See
CAT NMS Plan, supra note 3, at Section 6.9(c)(i).
\537\ For example, the completeness Section notes that the open/
close indicator for equities does not exist in current data sources
(see Section IV.E.1.a(2)). The accuracy of the open/close indicator
would be subject to Plan Processor discretion, because the Plan
Processor would have responsibility for defining the permitted
values and interpreting when CAT Reporters would use such permitted
values and the Plan Processor would not have guidance from previous
data sources on how to define or interpret such a field. While the
Commission would ultimately be able to correct such
misinterpretations, regulators may not detect such a
misinterpretation until the misinterpretation harms an
investigation, exam, or other analysis. Based on its experience with
short sale indicators, the Commission believes that defining and
interpreting the open/close indicator would be particularly complex.
See SEC, Division of Market Regulation: Responses to Frequently
Asked Questions Concerning Regulation SHO, Question 2.5, available
at http://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm
(``Regulation SHO FAQs'').
---------------------------------------------------------------------------
Nonetheless, the Commission preliminarily believes that the Plan
provides some procedural protections to mitigate this uncertainty and
help promote accuracy. For example, the Plan requires that, at a
minimum, the Technical Specifications be ``consistent with
[considerations and minimum standards discussed in] Appendices C and
D,'' and that the initial Technical Specifications and any Material
Amendments thereto must be provided to the Operating Committee for
approval by Supermajority Vote.\538\ Further, all non-Material
Amendments and all published interpretations must be provided to the
Operating Committee in writing at least ten days before publication,
and shall be deemed approved unless two or more unaffiliated
Participants call the matter for a vote of the full Operating
Committee.\539\
---------------------------------------------------------------------------
\538\ Id. at Section 6.9(a). The Commission notes that the
standards in Appendices C and D do not cover all decisions that
would affect the accuracy of the data.
\539\ See CAT NMS Plan, supra note 3, at Section 6.9(c)(i).
---------------------------------------------------------------------------
(1) Data Errors
The CAT NMS Plan specifies a high-level process for handling errors
that includes target Error Rates for data initially submitted by CAT
Reporters and a correction process and timeline. In particular, the
Plan specifies an initial maximum Error Rate, which measures errors by
CAT Reporters and linkage validation errors,\540\ of 5% for reports
received by the Central Repository before the error correction process
and contemplates the reduction of this Error Rate over time. It is
difficult to conclude whether the Error Rates and processes in the CAT
NMS Plan would constitute an accuracy improvement as compared to
current data sources.
---------------------------------------------------------------------------
\540\ The Commission notes that there is some uncertainty on
whether the Error Rate definition includes any additional errors
attributable to the Plan Processor because the Plan does not
explicitly state whether Plan Processor errors are included in the
Error Rate or not; it is also not clear whether Plan Processor
errors are included in linking errors. See id. at Article VI,
6.1(n)(v) n.1; Appendix C, Section A.3(b), n.102. Additional
uncertainty exists because the Operating Committee would determine
the details regarding error definitions in the Technical
Specifications after the Plan is approved.
---------------------------------------------------------------------------
The Plan states that 5% is an appropriate initial Error Rate, to
allow CAT Reporters the opportunity to get used to a new reporting
regime, and that the Error Rate should be reduced over time, with goal
of a 1% Error Rate to be achieved one year after each new category of
Reporters is required to begin reporting.\541\ This was determined
based on Participants' experience with OATS. The initial rejection
rates for OATS when it was initially implemented was 23%,\542\ although
more recent experience with OATS reporting indicates error rates below
3% following the implementation of additional OATS upgrades over the
past 10 years and a current error rate of less than 1%.\543\
---------------------------------------------------------------------------
\541\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(b).
\542\ See id. at Appendix C, Section A.3(b), n.106.
\543\ See Memorandum to File No. S7-11-10 regarding Telephone
Conferences with FINRA (April 17, 2012) available at http://www.sec.gov/comments/s7-11-10/s71110-116.pdf.
---------------------------------------------------------------------------
But, because the current OATS error rate is below 1%, the
Commission preliminarily believes that the initial
[[Page 30682]]
percentage of errors in CAT would be higher than current percentage of
errors in OATS, though the OATS error rate may not be directly
comparable to the Error Rate in the Plan.\544\ Given the magnitude of
CAT, the fact that many CAT Reporters would be new to audit trail
reporting, and that options would be covered for the first time, the
Participants believe that 5% is an appropriate initial Error Rate.\545\
And the Plan injects some uncertainty by asserting that this initial 5%
rate is subject to the quality assurance testing period to be performed
prior to launch, and then again before each new batch of CAT Reporters
are brought online.\546\ In time, the rate could be lowered, but it
also could be raised.
---------------------------------------------------------------------------
\544\ See Section IV.D.2.b(2)A, supra, for discussion of current
regulatory data error rates. It is important to note that both the
1% OATS error rate and the 5% proposed CAT Error Rate represent
error rates measured at initial data submission. Furthermore, some
situations that do not qualify as an error in OATS (i.e., a route
that cannot be linked because the routing destination is not
required to report OATS) would qualify as an error under CAT.
Furthermore, error rates after data correction are not known for
OATS, and are anticipated to be ``de minimis'' under CAT, as
discussed in note 547, infra. Finally, definitions of ``error'' for
both OATS and CAT Data are dependent on proscribed data validation
checks; if data is reported and passes validation checks, it is
assumed to be correct. When validation checks are exhaustive and
stringent, error rates are expected to be higher than when
validation checks are minimal. Consequently, the Commission is
cautious in directly comparing OATS reported and proposed CAT Error
Rates.
\545\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(b). See also Section IV.H.2.b, infra for a discussion and
solicitation of comment on alternative Error Rates.
\546\ See id. at Appendix C, Section A.3(b).
---------------------------------------------------------------------------
The Plan specifies an error correction process after initial
reports are received and indicates that practically all errors
identifiable by the validations used in the error correction process
would be corrected by 8:00 a.m. Eastern Time on day T+5, stating that
errors are expected to be ``de minimis'' after the error correction
period.\547\ Specifically, the Plan Processor must run initial
validation checks on the data by noon eastern time on day T+1 (four
hours after the submission deadline for the data). Those validation
checks must be published in the Technical Specifications (as discussed
further below) and have the objective to ensure that data is accurate,
timely, and complete as near as possible to the time of submission.
Once errors are identified, the Plan Processor must accept corrections
via manual web-based entry and via batch uploads. Although there is a
specific timeframe for performing these corrections, the Plan Processor
must accept error corrections at any time.\548\
---------------------------------------------------------------------------
\547\ See id. at Appendix C, Section A.3(b) n.102. ``De
minimis'' is not defined and no numerical Error Rate is given. The
Plan also includes a compliance program intended to help achieve
this goal.
\548\ See Section IV.E.1.d, infra. The RFP requested that
Bidders provide information on how data format and context
validations for order and quote events would be performed and how
errors would be communicated to CAT Reporters; a system flow diagram
showing how and when different types of validations would be
completed; and how Customer information would be validated. Bidders
noted that the validations would be performed via rules engines
(using standard data validation techniques like format checks, data
type checks, consistency checks, limit and logic checks, or data
validity checks), and processing would be done in real time during
data ingestion. The Plan Processor would be required to perform
validations within three specified categories, which must be set out
in the Technical Specifications document: File Validations
(confirmation that the file is received in the correct format);
Validation of CAT Data (checks of format, data type, consistency,
range/logic, data validity, completeness, and timeliness); and
Linkage Validation (checking the ``daisy chain''). See CAT NMS Plan,
supra note 3, at Appendix D, Section 7.2. If errors are found, the
data would be stored in an error database and notification sent to
the CAT Reporter.
---------------------------------------------------------------------------
Rather than providing details on the validations that would occur,
however, the Plan provides high-level requirements for the validations
and delegates the detailed design of the specific validations to the
Plan Processor (with the involvement of the Operating Committee and the
Advisory Committee).\549\ Additionally, the Plan does not provide the
level of detail necessary to verify whether the CAT validation process
would run the same validations as OATS, whether current validations
would be relevant, and what validations, if any, would be added.
---------------------------------------------------------------------------
\549\ See CAT NMS Plan, supra note 3, at Appendix D, Section 7.2
(discussing validation requirements); see also id. Appendix C at
Section A.3(b) (delegating responsibility regarding measurement of
Error Rates to the Plan Processor).
---------------------------------------------------------------------------
As noted above, it is therefore difficult to conclude whether the
Error Rates and processes in the CAT NMS Plan would constitute an
accuracy improvement as compared to current data sources. With respect
to OATS, FINRA currently performs over 152 validation checks on each
order event reported.\550\ After corrections, approximately 1-2% of
each day's recorded events remain unmatched (i.e., multi-firm events,
such as order routing that cannot be reconciled).\551\ However, the
Commission is not certain that those error rates are directly
comparable to the Error Rates permitted for CAT Data in the Plan given
the increased scope and level of linkages specified in the Plan, and
the new, large, and untested system. The Commission is not aware of
other systems that track and record similar error rates, although the
Commission does experience issues with errors contained in other
sources of data when the Commission attempts to use that data.
Accordingly, the Commission is unable to conclude whether the Error
Rates and processes in the Plan would constitute an accuracy
improvement compared to current data.
---------------------------------------------------------------------------
\550\ See Adopting Release, supra note 9, at 45729.
\551\ Id. at 45778.
---------------------------------------------------------------------------
(2) Event Sequencing
A. Clock Synchronization
Rule 613(d)(1) and (2) requires that the CAT NMS Plan require that
the business clocks of Participants and their members be synchronized
to a specified standard of precision and for protocols to be in place
for that standard to be maintained over time. Complying with this clock
synchronization standard will require that, for the purpose of
recording the date and time of Reportable Events, the business systems
of Participants and their members be synchronized consistently with
``industry standards.'' The Commission did not define the term
``industry standard'' in Rule 613, though it noted that it expected the
Plan to ``specify the time increment within which clock synchronization
must be maintained, and the reasons the plan sponsors believe this
represents the industry standard.'' \552\
---------------------------------------------------------------------------
\552\ See Adopting Release, supra note 9, at 45774.
---------------------------------------------------------------------------
The CAT NMS Plan describes the ``industry standard'' in this
context in terms of the technology adopted by the majority of the
industry.\553\ The Plan therefore bases its clock synchronization
standard on current practices of the broker-dealer industry generally
and provides that one standard would apply to all CAT Reporters.
Specifically, Section 6.8(a) of the CAT NMS Plan requires CAT Reporters
to synchronize their time clocks to the time maintained by the NIST
with an allowable clock offset of 50 milliseconds, which the Plan
determines is consistent with the current industry standards, as
defined in the Plan. The Plan further requires annual review of the
clock synchronization standard to evaluate its achievement of the
Plan's goals related to clock synchronization. Section 6.8(c) of the
Plan requires the Chief Compliance Officer to annually evaluate the
clock offset tolerance and to make recommendations to the Operating
Committee regarding whether industry standards have evolved such that
the standard in Section 6.8(a) should be shortened.\554\
---------------------------------------------------------------------------
\553\ See CAT NMS Plan, supra note 3, at Appendix C, Section
12(p).
\554\ See id. at Section 6.8.(c) and Appendix C, Section A.3.(c)
---------------------------------------------------------------------------
[[Page 30683]]
The Commission preliminarily believes that the clock
synchronization standards in the CAT NMS Plan are reasonably designed
to improve the accuracy of market activity sequencing by increasing the
percentage of order events that could be chronologically sequenced
relative to other order events,\555\ but notes that the improvements to
the percentage of sequenceable order events by Plan standards are
modest and the requirements of the Plan may not be sufficient to
completely sequence the majority of market events relative to all other
events.
---------------------------------------------------------------------------
\555\ Independent of the potential time clock synchronization
benefits, the order linking data that would be captured in CAT
should increase the proportion of events that could be sequenced
accurately. This reflects the fact that some records pertaining to
the same order could be sequenced by their placement in an order
lifecycle (e.g., an order submission must have occurred before its
execution) without relying on time stamps. This information may also
be used to partially sequence surrounding events.
---------------------------------------------------------------------------
As discussed in the Baseline Section, 39% of the broker-dealers
responding to the FIF Clock Offset Survey currently synchronize their
clocks to a clock offset tolerance of greater than 50
milliseconds.\556\ Accordingly, the 50 millisecond requirement for all
CAT Reporters (except on manual order handling systems) would result in
the availability of more precise time stamps from many broker-dealers
\557\ and would increase the number of order events that could be
accurately sequenced relative to each other.
---------------------------------------------------------------------------
\556\ See Section IV.D.2.b(2)B.i, supra (reporting results of
this survey); see also FIF Clock Offset Study, supra note 127.
\557\ As noted above, FINRA has indicated that it is considering
proposing a rule change that would require a 50 millisecond clock
offset tolerance. If this rule change is proposed and approved, more
entities would record time stamps with data at a 50 millisecond
clock offset tolerance regardless of whether the CAT NMS Plan is
approved.
---------------------------------------------------------------------------
To evaluate the proportion of order events that could be sequenced
with the clock offset tolerance specified in the CAT NMS Plan, the
Commission has conducted an analysis of the frequency of market events
occurring within 100 milliseconds of an event in a different trading
venue in the same security.\558\ Table 5 (CAT and Current Clock Offset
Tolerance) shows the percentage of events for listed equities and
options that could be accurately sequenced with one-second and 50-
millisecond clock offset tolerances.
---------------------------------------------------------------------------
\558\ The methodology to calculate these frequencies starts with
the steps described in supra note 438 and then subtracts the result
from one to get the percentage of unrelated orders that could be
sequenced. This assumes that consecutive unrelated events within
twice the clock offset tolerance cannot be sequenced. An unrelated
event is an order event at a different venue.
Table 5--CAT and Current Clock Offset Tolerance
----------------------------------------------------------------------------------------------------------------
% of Unrelated order events
----------------------------------------------------------------------------------------------------------------
Minimum time between adjacent events Clock offset tolerance Equities (%) Options (%)
----------------------------------------------------------------------------------------------------------------
2 seconds..................................... 1 second........................ 1.31 6.97
100 milliseconds.............................. 50 milliseconds................. 7.84 18.83
----------------------------------------------------------------------------------------------------------------
The analysis finds that the current FINRA one-second clock offset
tolerance allows only 1.31% of unrelated order events for listed
equities and 6.97% of unrelated order events for listed options to be
sequenced. The proposed 50-millisecond clock offset tolerance could
accurately sequence 7.84% for listed equities and 18.83% for listed
options of such events included in the MIDAS data. This analysis
overestimates the portion of unrelated events that the proposed clock
synchronization standard could sequence because the analysis includes
only trade and quote events observable in the MIDAS data. The data
currently available to the Commission provides only a rough and
upwardly-biased estimate of how many of these events could be sequenced
by the order data that would be captured by the CAT. In sum, the
results of the Commission's analysis suggest that the standards
required by the Plan do represent an improvement over current standard
but that the majority of market events would remain impossible to
sequence based on the Plan's required clock synchronization standards.
This analysis does not consider events in OTC Equity Securities.
The Commission believes that the proposed clock synchronization
standard could accurately sequence a higher proportion of unrelated
events in OTC Equity Securities because OTC Equity Securities trade
less frequently than NMS equities and unrelated order events may be
less frequent in OTC Equity Securities than in listed equities. The
Commission therefore preliminarily believes that the proposed 50
millisecond clock offset tolerance in the CAT NMS Plan could improve
accuracy by modestly increasing the number of events that could be
sequenced in OTC Equity Securities.
The Plan acknowledges that the required clock offset tolerance,
which is based on its determination of the current industry standard,
would not be sufficient to accurately sequence all order events by
their time stamps alone.\559\ In particular, the Plan states that
``[f]or unrelated events, e.g., multiple unrelated orders from
different broker-dealers, there would be no way to definitively
sequence order events within the allowable clock drift as defined in
Article 6.8.'' \560\ This in turn limits the benefits of CAT in
regulatory activities that require event sequencing, such as the
analysis and reconstruction of market events, as well as market
analysis and research in support of policy decisions, in addition to
examinations, enforcement investigations, cross-market surveillance,
and other enforcement functions.
---------------------------------------------------------------------------
\559\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c). Order events occurring within a single system using the same
time clock could be accurately sequenced by their time stamps,
assuming that their time stamps are not identical. The CAT NMS Plan
does not specify the approach that would be used to sequence events
when time stamps are identical or indicate how this decision would
be made.
\560\ Id. at n.110. Events involving the same order routed
across systems could be logically sequenced using routing-related
data, because a routed order must be sent before it can be received,
and received before it can be executed. However, the Plan would not
facilitate the accurate sequencing of events that occur in different
systems within 100 milliseconds of each other (twice the clock
offset tolerance) that are not linked using a parent-child order
relationship. The CAT NMS Plan does not provide a solution that will
sequence these events, but recognizes the issue and states that
``the Participants plan to require that the Plan Processor develop a
way to accurately track the sequence of order events without relying
entirely on time stamps.'' See CAT NMS Plan, supra note 3, at
Appendix C, Section A.3(c).
---------------------------------------------------------------------------
The Plan discusses its determination of the current industry
standard and specifies implementation requirements for the clock
synchronization standards in Appendix C.\561\ As noted above, the
[[Page 30684]]
Plan bases industry standards on current practices of the broker-dealer
industry, which are derived from a survey of broker-dealers, and on the
assumption that a change in industry standards would be premised on
``the extent existing technology that synchronizes . . . clocks with a
lower tolerance . . . becomes widespread enough throughout the industry
to constitute a new standard.'' \562\
---------------------------------------------------------------------------
\561\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\562\ Id.
---------------------------------------------------------------------------
The Commission notes however, that the current practices for
exchanges and Execution Venues may differ from the industry standard
for broker-dealers as defined in the Plan, and current practices for
certain systems within broker-dealers may vary by the system within the
broker-dealers. As noted in the Baseline Section, the Commission does
not have precise information on the clock synchronization standards on
exchange and ATS matching engines and quoting systems, but exchanges
may currently synchronize their clocks to a 100 microsecond or less
clock offset tolerance, and have an average clock offset of 36
microseconds.\563\ By defining industry standards based on practices of
the broker-dealer industry generally, the Plan does not account for
these differences. Further, defining industry standards by majority
practices may have the unintended effect of setting a standard that
delays adopting advances in technology.
---------------------------------------------------------------------------
\563\ See supra notes 435 and436.
---------------------------------------------------------------------------
Despite these limitations, it is worth noting that the Plan
requires the CCO of the Plan Processor to develop and conduct an annual
assessment of Business Clock synchronization.\564\ Moreover, Plan
Participants must require Industry Members to certify periodically that
their Business Clocks comply with the clock synchronization standard
and that any violations thereof are reported to the Plan Processor and
the Plan Participant.\565\ Thus, the Commission believes that these
provisions would help ensure that the benefits of clock synchronization
are maintained.
---------------------------------------------------------------------------
\564\ See CAT NMS Plan, supra note 3, Section 6.2(a)(v)(M).
\565\ See id. at Section 6.8(a)(ii) and (iii).
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B. Time Stamp Granularity
The Commission preliminarily believes that the minimum time stamp
granularity required by the Plan would result in some improvement in
data accuracy, but that the level of improvement could be limited.
Despite the modest level of direct improvements expected from the
Plan's minimum time stamp granularity standards, the Commission
preliminarily believes that the Plan should continue to have a time
stamp granularity standard because the Plan provides a mechanism for
making future improvements and monitoring whether more granular time
stamps would provide better quality CAT Data and be feasible given
technology improvements.
The level of precision or granularity with which time stamps are
recorded has significant implications for the usability of audit trail
data in terms of sequencing events, matching records, and linking the
data to other data sources. In some current regulatory data, the
relative lack of time stamp granularity standards for data reporters
could lead to difficulties in accurately sequencing events or linking
data with other data sources. Rule 613(d)(3) requires that CAT
Reporters record time stamps to reflect current industry standards and
be at least to the millisecond.\566\ Furthermore, the Plan requires
Participants to adopt rules requiring that CAT Reporters that use time
stamps in increments finer than milliseconds use those finer increments
when reporting to the Central Repository.\567\ Consistent with Rule
613, Section 6.8(b) of the CAT NMS Plan requires millisecond or less
time stamps. However, the Commission granted exemptive relief for
manual orders to be recorded at the granularity of one second or
better.\568\ Further, pursuant to Rule 613, if a CAT Reporter's system
already utilizes time stamps in increments less than the minimum
required by the Plan, the CAT Reporter must record time stamps in such
finer increments.\569\
---------------------------------------------------------------------------
\566\ 17 CFR 242.613(d)(3). This requirement does not apply to
certain Manual Order Events, which are exempted from the requirement
and are captured at one-second increments. Time stamp granularity on
manual order events is discussed separately in the Alternatives
Section.
\567\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\568\ See CAT NMS Plan, supra note 3, at Section 6.8(b) and
Appendix C, Section A.3(c) (explaining that recording Manual Order
Events at the millisecond level would be costly and ultimately
arbitrary or imprecise due to the human interaction); see also
Exemption Order, supra note 18, at 11868-9.
\569\ Id.
---------------------------------------------------------------------------
The Plan asserts that the millisecond increment required for CAT
Data reflects the industry standard level of granularity.\570\ As noted
in the discussion of clock synchronization, the Commission did not
define the term ``industry standard'' in Rule 613. The Plan therefore
bases its standard for time stamp granularity on current practices of
the broker-dealer industry generally, and provides that one standard
would apply to all CAT Reporters. There appears to be a wide divergence
of industry standards in practice, ranging from full seconds to
microseconds for latency-sensitive applications, and the Plan describes
the slower systems as mostly older ones that cannot support a finer
time stamp granularity.\571\ Many of the systems from which regulators
currently obtain data already capture time stamps in increments of
milliseconds or less. For example, OPRA allows for time stamps in
nanoseconds, and the other SIPs require time stamps in microseconds for
equity trades and quotes.\572\ However, OATS and EBS do not. Current
OATS rules require time stamps to be expressed to the nearest second,
unless the member's system expresses time in finer increments; and as
of September 2014, approximately 12% of OATS records contain time
stamps greater than one millisecond. EBS records either do not contain
times or express time stamps in seconds.\573\
---------------------------------------------------------------------------
\570\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\571\ Id. Because older technology cannot support finer time
stamp increments, members with older systems would incur significant
effort and cost to upgrade those systems to support reporting data
in milliseconds. The newest systems support finer increments, but
include mostly the subset of systems dealing with low latency
trading. Electronic Order Handling and Trading systems are commonly
set at the millisecond level; see, e.g., FIF Letter.
\572\ See Section IV.D.2.b(2), supra.
\573\ Id.
---------------------------------------------------------------------------
Thus, to the extent that some current data sources report time
stamps in increments coarser than a millisecond, which is the case for
12% of OATS records and all EBS records, the Commission expects the CAT
millisecond time stamp requirement to improve data, and thereby allow
regulators to more accurately determine the sequence of market events
relative to surrounding events.
The Commission preliminarily believes, however, that benefits from
the more granular time stamps could be limited by the level of clock
synchronization required by the Plan. In particular, the Commission
believes that time stamp granularity would not be the limiting factor
in sequencing accuracy, because recording events with time stamps with
resolutions of less than one millisecond cannot help to sequence events
occurring on different venues with clocks that may be 100 milliseconds
out of sync due to clock synchronization offsets.\574\ Therefore,
[[Page 30685]]
the benefits of time stamping order events at increments finer than a
millisecond would be limited without also improving the clock
synchronization standards of the Plan.
---------------------------------------------------------------------------
\574\ For example, under the requirements in the Plan, an order
event at Broker-Dealer A could have a time stamp that is 1
millisecond sooner than an order event at Broker-Dealer B even if
the event at Broker-Dealer B actually occurred 99 milliseconds
sooner. This could occur if Broker-Dealer A's systems are recording
times 50 milliseconds ahead of NIST while Broker-Dealer B's systems
are recording times 50 milliseconds behind NIST. Both broker-
dealers' systems would be within the Plan's allowable clock
synchronization tolerance.
---------------------------------------------------------------------------
(3) Linking and Combining Data
The Commission believes the requirements of Rule 613 and the Plan
related to data linking would result in improvements to the accuracy of
the data available to regulators, but the extent of the improvement
would depend on the accuracy of the linking algorithm and the
reformatting process that the Plan Processor would eventually develop.
As discussed in the Baseline, data is currently stored in multiple
formats, is difficult to merge, and results in errors during the
merging process. Moreover, in some cases, the data sources do not
capture the information necessary to link records, while in other cases
linking must be done with algorithms that accomplish the linking with
some degree of error.
Rule 613(e)(1) generally requires the creation and maintenance of a
Central Repository that would receive, consolidate, and retain
information reported to the CAT.\575\ Further, the rule requires that
the Central Repository 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 information reported to the
CAT.\576\
---------------------------------------------------------------------------
\575\ 17 CFR 242.613(e)(1); see also CAT NMS Plan, supra note 3,
at Section 6.5(a) and (b).
\576\ 17 CFR 242.613(e)(1).
---------------------------------------------------------------------------
The Commission preliminarily believes that the requirement that
data be stored in a uniform format would eliminate the need for
regulators who are accessing the data to reformat the data. As noted in
the Baseline Section above, regulators face delays and inaccuracies
when attempting to reformat and link data from multiple sources, such
as linking trade blotters from several broker dealers with SRO audit
trails. Given that the reformatting of CAT Data would be accomplished
by individuals that likely specialize in this activity and that
repetitively do so in a prescriptive and formalized way, this
requirement could reduce the errors that could be introduced in the
current regime where reformatting data is often done on an ad hoc basis
by regulatory Staff who need to work with the data.\577\ In other
words, the Plan Processor would develop a reformatting process by
working with CAT Reporters to build an expertise in harmonizing the
various formats that it receives from Reporters. The Plan Processor
could then build, test, and refine the reformatting process with the
ability to go back to the CAT Reporters for further clarification. Even
if only one Staff member at each SRO or Affiliated Participant
developed the expertise necessary to reformat each of the various
formats and ran a reformatting process on order data, this would result
in a duplication of efforts compared to one centralized entity (the
Plan Processor) developing the expertise and running the reformatting
process. Storing data in a linked format removes the need for
regulators to link information from multiple lifecycle events of an
order or orders themselves, which could further reduce errors and
increase the usability of the data. The Commission recognizes, however,
that despite the potential improvements, the CAT Data could still
contain errors introduced in the reformatting and linking processes.
---------------------------------------------------------------------------
\577\ Whether errors would decrease depends on the actual
formatting process used.
---------------------------------------------------------------------------
The process for linking orders designated in the CAT NMS Plan is
similar to the process FINRA currently uses to link OATS records across
market participants. However, the Plan would significantly improve the
ability of regulators to link order events compared to OATS, and would
link this activity to specific customers unlike current audit trail
data.\578\ CAT Reporters must report a series of unique identifiers
that are designed to allow records of events that occur over the
order's lifecycle to be linked together to determine how the order was
handled and how the order interacted with other orders.\579\ The Plan
Processor must then create the initial linkages in the submitted data;
unlike in OATS, the Plan Processor would verify these linkages as part
of its data validity checks.\580\ In general, the CAT NMS Plan would
link orders using the ``daisy chain approach,'' where CAT Reporters
assign their own identifiers to each order event that the Plan
Processor later replaces with a single identifier (the CAT Order-ID)
for all order events pertaining to the same order.\581\ The Central
Repository at a minimum must be able to create linkages between all
order events that are internalized, between the Customer execution and
a proprietary order in the case of a riskless principal transaction,
between two broker-dealers, between a broker-dealer and an exchange,
and vice versa, between executed orders and trade reports, between
various legs of option/equity complex orders, and between order events
for all equity option order handling scenarios that currently are or
could potentially be used by CAT Reporters.\582\
---------------------------------------------------------------------------
\578\ As discussed above, the Commission notes that SRO audit
trails typically do not provide customer information but a recent
FINRA rule change requires its members to report to OATS non-FINRA
member customers who are broker-dealers. See supra note 407.
\579\ See id. at Section 6.3(d)(i) through (vi).
\580\ These data validations are to be established in a
Technical Specifications document by the Plan Processor.
Consequently, it is as yet unclear precisely how that process would
occur. See id. at Appendix D, Section 7.2; Appendix C, Section
A.3(a) (validations ensure that data is submitted in required
formats and that lifecycle events can be accurately linked).
\581\ See id. at Appendix D, Section 3.
\582\ See id.
---------------------------------------------------------------------------
Unlike OATS data, CAT Data would be less prone to breaking the
order lifecycle chain when an order is sent across market participants
because the order lifecycle linking procedure across reporters would be
uniform and all industry participants would be reporters.\583\
Currently, linking procedures across SROs are not uniform, which
complicates reconstructing order lifecycles. Furthermore, because some
broker-dealers are not required to report to OATS, these broker-
dealers' activity cannot be completely reconstructed from audit trail
data, and therefore, orders that they handle cannot be traced through
their lifecycle, effectively severing the links between the order being
received and the order's final disposition. Furthermore, as covered
elsewhere, unlike other data sources, CAT Data would link orders to
Customers because the Plan requires the order lifecycle to be linked
back to the original Customer, and the Plan Processor must be able to
fix linkages when error correction files are submitted.\584\ While the
success of such a matching process is dependent on the accurate
reporting of order linkages by CAT Reporters,\585\ Appendix D directs
the Plan Processor to ensure that breaks in certain lifecycle linkages
must not cause the entire lifecycle to break or
[[Page 30686]]
cause a CAT Reporter that correctly reports information to have its
submission rejected.\586\
---------------------------------------------------------------------------
\583\ See Section IV.D.2, supra.
\584\ See id.
\585\ For example, assume two broker-dealers handle an order
that is ultimately executed on an exchange. Broker-Dealer A receives
the order, and transmits it to Broker-Dealer B, that routes it to
Exchange C where it is executed. In order for the Plan Processor to
link these three order events, Broker-Dealer A would need to report
the order and its routing to Broker-Dealer B; B would need to
correctly echo A's order ID in its CAT reporting and its route to
Exchange C, and C would need to correctly echo Broker-dealer B's
order ID in its CAT reporting.
\586\ See CAT NMS Plan, supra note 3, at Appendix D, Section
7.3. The Commission also notes that, even if all CAT Reporters
provide the required linking information, the success of the linking
process would depend in part on the approach taken by the Plan
Processor and whether or not that approach results in errors.
---------------------------------------------------------------------------
The CAT NMS Plan does not provide sufficiently detailed information
for the Commission to estimate the likely Error Rates associated with
the linking process required by the CAT NMS Plan. Indeed, the 5% Error
Rate covers data from CAT Reporters, but the Plan Processor could
create errors as well, for example, through the linking process.
Further, the Plan does not include details on how the Plan Processor
would perform the linking process, identify broken linkages, and seek
corrected reports from CAT Reporters to correct broken linkages.
Instead, the Plan defers key decisions regarding the validation process
until the selection of a Plan Processor and the development of
Technical Specifications.\587\ Accordingly, while the centralized
linking should generally promote efficiencies and accuracies in
linking, these uncertainties make it difficult for the Commission to
gauge the degree to which the process for linking orders across market
participants and SROs would improve accuracy compared to existing data,
including OATS.\588\
---------------------------------------------------------------------------
\587\ The CAT NMS Plan describes the Plan Processor's
responsibility for creating the Technical Specifications. See CAT
NMS Plan, supra note 3, at Section 6.9.
\588\ The Commission notes that the Plan Processor is required
to create a quality assurance testing environment in which, during
industry-wide testing, the Plan Processor provides linkage
processing of data submitted, the results of which are reported back
to Participants and to the Operating Committee for review. See CAT
NMS Plan, supra note 3, at Appendix D, Section 1.2. This may help
identify challenges in the linking process and allow for their early
resolution.
---------------------------------------------------------------------------
Uncertainties also prevent the Commission from determining whether
the process for converting data into a uniform format at the Central
Repository would improve the accuracy of the data over existing audit
trail accuracy rates. The Plan includes two alternative approaches to
data conversion. In the first, called Approach 1, CAT Reporters would
submit data to the Central Repository in an existing industry standard
protocol of their choice such as the Financial Information eXchange
(``FIX'') protocol. In Approach 2, CAT Reporters would submit data to
the Central Repository in single mandatory specified format, such as an
augmented version of the OATS protocol. Under Approach 1, the data must
be converted into a uniform format at the Central Repository in a
second step. Under Approach 2, the data is already in a uniform format
at the time of submission. The Plan defers the decision regarding which
approach to take until the selection of a Plan Processor and the
development of Technical Specifications.
The Commission preliminarily believes that Approach 1 would likely
result in a lower Error Rate than Approach 2. Under Approach 1, the CAT
Reporters would presumably be submitting the actual data captured in
real time without having to translate it into another format. In
addition, under Approach 1, the conversion would be performed at the
Central Repository by the Plan Processor, rather than the conversion
being performed by each of the approximately 1,800 individual CAT
Reporters or their vendors, which should reduce potential points where
errors in formatting could be introduced, and provide for economies of
scale.\589\ This would likely result in increased efficiency and
accuracy due to specialization by the Plan Processor. However, while
the Commission preliminarily believes that Approach 1 is likely to
result in greater data accuracy than Approach 2, because of
uncertainties regarding expected Error Rates and error rates in current
data, the Commission is unable to evaluate the degree to which that
approach would improve data accuracy relative to currently available
data.\590\
---------------------------------------------------------------------------
\589\ The Commission understands that a large proportion of
reports that fail OATS validation checks do so because of errors in
the translation of the data by the OATS reporter.
\590\ The Plan Processor is required to have policies and
procedures, including standards, to ensure the accuracy of the
consolidation by the Plan Processor of the data, per Rule
613(e)(4)(iii), which could mitigate errors as well. 17 CFR
242.613(e)(4)(iii).
---------------------------------------------------------------------------
Uniquely complex situations also pose a difficulty for assessing
the ability of the Plan Processor to build a complete and accurate
database of linked data that regulators could query for regulatory
purposes. First, the Plan requires the Plan Processor, in consultation
with industry, to develop a linking mechanism that would allow the
option and equity legs of multi-leg trades to be linked within the
Central Repository.\591\ Because the mechanism for this linkage is not
yet determined, the Commission cannot assess the degree of the expected
linkage error rate but, given that equities are not linked to options
in current data sources, the Commission expects this feature to
significantly improve the accuracy of linking equities to options.
---------------------------------------------------------------------------
\591\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(b).
---------------------------------------------------------------------------
Second, the Commission in the Proposing Release noted concern about
the ability of the daisy chain approach to link a Customer order and a
member's order from which the Customer is provided with an
allocation.\592\ The Plan addresses this concern in the definition of
an Allocation Report, which is a report that identifies accounts and
subaccounts to which executed shares are allocated, but that is not
required to be tied to a particular order or execution.\593\ The Report
is required to be submitted to the Central Repository,\594\ but the
lack of linkages in this case could make the resulting data less
useful. Specifically, the content of the Allocation Report and the
order lifecycles must contain content that permits regulators to draw
certain conclusions about subaccount allocations even without a clean
linkage.
---------------------------------------------------------------------------
\592\ See Proposing Release, supra note 9, at 32576.
\593\ See CAT NMS Plan, supra note 3, at Section 1.1.
\594\ See id. at Section 6.4(d)(ii).
---------------------------------------------------------------------------
While uncertainty about this issue remains, the Commission notes
that the Plan's requirement for standardized Allocation Reports that
consistently and uniquely identify Customers and reporters should
improve the linkability of allocation information compared to current
data, despite the limitation of direct linkage to order lifecycles,
particularly in scenarios where potentially violative conduct is
carried out by market participants operating through multiple broker
dealers. This moderate improvement in the linkability of allocation
data should improve regulators' ability to identify market participants
who commit violations related to improper subaccount allocations.
(4) Customer and Reporter Identifiers
The Commission preliminarily believes that the inclusion of unique
Customer and Reporter Identifiers described in the CAT NMS Plan would
increase the accuracy of customer and broker-dealer information in data
regulators use and provide benefits to a broad range of regulatory
activities that involve audit trail data.
Currently, only a few data sources, which typically cover only a
small portion of order lifecycles, include information regarding
customers.\595\ Further, the customer information in these data sources
is often incomplete
[[Page 30687]]
and inconsistent and the data is currently only obtainable by
regulators making requests to broker-dealers directly. Additionally,
although broker-dealer identifiers, in the form of MPID numbers, CRD
numbers, and clearing broker numbers, appear within the current sources
of audit trail data, because of the lack of a centralized database and
because these identifiers may vary across exchanges, the Commission
faces challenges in relying on these identifiers to accurately identify
broker-dealer activity across the market.\596\
---------------------------------------------------------------------------
\595\ See Section IV.D.2.b(1)A, supra. As discussed above, the
Commission notes that SRO audit trails typically do not provide
customer information but a recent FINRA rule change would require
its members to report to OATS non-FINRA member customers who are
broker-dealers. See supra note 407.
\596\ See Section IV.D.2.b(1)D, supra.
---------------------------------------------------------------------------
Rule 613 requires the use of a unique Customer-ID that identifies
the Customer involved in CAT Reportable Events.\597\ Based on a concern
that requiring CAT Reporters to report a Customer-ID to the Central
Repository with each order would disrupt existing business practices
and that reporting on that basis could risk the leakage of order and
Customer information into the market,\598\ the Plan requires the Plan
Processor to translate a unique Customer identifier assigned by the
firm to its Customer (the Firm Designated ID) into the Customer-ID to
be used in CAT.\599\ Specifically, the Plan requires CAT Reporters to
provide a Firm Designated ID for each Customer, which is defined as the
unique identifier designated by the broker-dealer for each trading
account for purposes of providing data to the Central Repository.\600\
Upon receipt of the Firm Designated ID, the Plan Processor would be
required to generate and associate one or more Customer-IDs for orders
received by the Customer of the CAT Reporter, which would also be
linked to the relevant Reportable Events for that Customer's order.
Pursuant to the Plan, therefore, the Customer-ID would be generated
from the Firm Designated ID,\601\ and the Plan Processor would create a
unique Customer-ID that would be consistent across that Customer's
activity regardless of the originating broker-dealer.
---------------------------------------------------------------------------
\597\ Rule 613(c)(7) specifies the event records that would
contain the Customer-ID. 17 CFR 242.613(c)(7). Event records that do
not explicitly capture the Customer-ID could be linked to a record
that does contain this information, typically using the Order-ID.
\598\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1.(a)(iii).
\599\ Id. The Firm Designated ID could be anything, provided
that it is unique across the firm for a given business date.
\600\ See id. at Section 6.3(d)(i)(A), n.2; see also id. at
Section 1.1.
\601\ See CAT NMS Plan, supra note 3, at Appendix D, Section 3.
---------------------------------------------------------------------------
To facilitate the creation of Customer-IDs, certain information
would be submitted to the Central Repository. Specifically, broker-
dealers would be required to submit an initial set of information
identifying a Customer to the Central Repository, including the Firm
Designated ID and the other biographical information associated
therewith including, for an individual, name, address, date of birth,
ITIN/SSN, and individual's role in the account (e.g., primary holder,
joint holder, guardian, trustee, person with power of attorney). With
respect to legal entities, identifying information would include: name,
address, EIN/LEI or other comparable common entity identifier.\602\
Broker-dealers must also submit to the Central Repository daily updates
for reactivated accounts, newly-established or revised Firm Designated
IDs, or other associated reportable Customer information.\603\ The Plan
also calls for periodic refreshes of all Customer information from CAT
Reporters.\604\ And the Plan Processor must have a way to periodically
receive full account lists (i.e., not just the daily changes) to ensure
the completeness and accuracy of the database.\605\
---------------------------------------------------------------------------
\602\ See id. at Appendix C, Section A.1.(a)(iii); see also id.
at Appendix D, Section 9.1. The CAT NMS Plan further provides, in
the definition of Customer Identifying Information, that where the
LEI or other comparable common identifier is provided, information
covered by such common entity identifier (e.g., name, address) would
not need to be separately submitted to the Central Repository. Id.
at Section 1.1.
\603\ See id. at Appendix C, Section A.1.(a)(iii).
\604\ See id. at Appendix C, n.33 and Appendix D, Section 9.1.
\605\ See id. at Appendix D, Section 9.1.
---------------------------------------------------------------------------
Based on this information, the Plan Processor has to ``maintain
information of sufficient detail to uniquely and consistently identify
each Customer across all CAT Reporters, and associated accounts from
each CAT Reporter.'' \606\ It is the Plan Processor's responsibility to
document and publish, with the approval of the Operating Committee, the
minimum list of data elements needed to maintain this association.
Appendix D sets forth a list of minimum data elements needed to
identify each Customer across all CAT Reporters, and associated
accounts within a CAT Reporter, including SSN or ITIN, date of birth,
current name, current address, previous name and address; and for legal
entities, the LEI (if available), tax identifier, full legal name, and
address.\607\ The Plan Processor must also support account structures
that have multiple account owners and associated Customer information
(e.g., joint accounts, managed accounts), and must be able to link
accounts that move from one CAT Reporter to another,\608\ so it is
possible that additional data fields would be necessary. Once a
database is established, it must be maintained over time, and provide
ready access to regulators to historical changes to that
information.\609\
---------------------------------------------------------------------------
\606\ See id. at Appendix C, Section A.1.(a)(iii).
\607\ See id. at Appendix D, Section 9.1.
\608\ See id.
\609\ See id. at Article VI, Section 6.5(b) and (c).
---------------------------------------------------------------------------
The Commission preliminarily believes that approval of the Plan
would likely further remedy some of the inconsistencies and other
limitations mentioned above. The Plan also contains provisions related
to the accuracy of submitted Customer information. For example, a
robust data validation process must be established for submitted
Customer and Customer Account Information.\610\ There must also be a
robust error resolution process for Customer information. The Central
Repository must be able to accommodate minor data discrepancies (e.g.,
Road versus Rd in an address) on its own, while more substantial
discrepancies (e.g., two different persons with the same SSN) would
need to be transmitted to the CAT Reporter for resolution within the
established error correction timeframe.\611\ While these elements
should help increase the accuracy of Customer identification within
CAT, there are some uncertainties, as the precise methods for
submitting Customer data to the Central Repository, along with
validations, are to be set out in Technical Specifications in the
future.\612\
---------------------------------------------------------------------------
\610\ See id. at Appendix C, Section A.1.(a)(iii); see also id.
at Appendix D, Section 9.1.
\611\ See id. at Appendix D, Section 3.
\612\ See id. at Appendix C, Section A.1.(a)(iii).
---------------------------------------------------------------------------
In addition to Customer-IDs, the CAT NMS Plan calls for the use of
CAT-Reporter-IDs. The data to be reported to the Central Repository
includes the SRO-assigned Market Participant Identifier (MPID) of the
Industry Member or Participant receiving, routing, or executing the
order.\613\ Upon receipt of the data, the Plan Processor must map the
SRO-assigned MPID to a CAT-Reporter-ID, which would be assigned by the
Plan Processor in the CAT data.\614\ Specifically, the Plan Processor
must be able to assign a CAT-Reporter-ID to all reports submitted to
the Central Repository based on SRO-assigned MPIDs. To the extent that
the different Participants assign the same MPID to different CAT
Reporters, the Plan Processor must be able to properly associate the
correct SRO-assigned
[[Page 30688]]
MPIDs with the CAT Reporters.\615\ To do this, the Plan Processor must
develop and maintain a mechanism for assigning CAT-Reporter-IDs based
on the relevant SRO-assigned identifier (MPID, ETPID, or trading
mnemonic) currently used by CAT Reporters in their order handling and
trading processes, and also to change those identifiers should that be
necessary (e.g., in the event of a merger), although changes are
expected to be infrequent.\616\ Moreover, the SROs would have an
obligation to provide all their SRO-assigned MPIDs to the Central
Repository on a daily basis to ensure the accuracy of the information
used to assign the CAT-Reporter-ID. The Plan Processor must capture,
store, and maintain this information in a master/reference database,
similar to how the Plan Processor would handle symbology changes.\617\
Finally, the validity of the SRO-assigned MPID is part of the initial
file validation process upon receipt of a submission from a CAT
Reporter, which should facilitate the accuracy of the Plan Processor's
subsequent assignment of the CAT-Reporter-ID.\618\
---------------------------------------------------------------------------
\613\ See Exemption Order, supra note 18, at 11863-11865; CAT
NMS Plan, supra note 3, at Sections 6.3(d), 6.4(d).
\614\ See CAT NMS Plan, supra note 3, at Appendix D, Section 3.
\615\ See id.
\616\ See id. at Appendix D, Section 10.1.
\617\ See id. at Appendix D, Section 2 and Section IV.E.3.b,
infra.
\618\ See id. at Appendix D, Section 7.2.
---------------------------------------------------------------------------
The Commission preliminarily believes that the Customer-ID approach
in the CAT NMS Plan would significantly improve the accuracy of
customer information available to regulators. As noted above, existing
data does not consistently capture information about the customers
involved in a trade or other market event, which negatively affects the
ability of regulators to accurately track customers' activities across
broker-dealers. Additionally, customer identities in many existing data
sources use inconsistent definitions and mappings across market
centers. Accordingly, it is difficult for regulators to identify the
trading of a single customer across multiple market participants.\619\
The Customer-ID approach specified in the CAT NMS Plan constitutes a
significant improvement because it would consistently identify the
Customer responsible for market activity, obviating the need for
regulators to collect and reconcile Customer identification information
from multiple broker-dealers. This should reduce the risk of the
introduction of errors into the data by regulators and save a
significant amount of time.
---------------------------------------------------------------------------
\619\ See Adopting Release, supra note 9, at 45730; see also
Section III.D.2.b(2)D, supra.
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Furthermore, the Commission preliminarily believes that the
Reporter ID approach specified in the CAT NMS Plan would improve the
accuracy of tracking information regarding entities with reporting
obligations, namely broker-dealers and SROs. Because the Commission
currently face challenges in using MPIDs and CRD numbers, for example,
to identify broker-dealers across the market, the Plan's requirement
for consistent unique Reporter IDs would eliminate the need for the
Commission to reconcile broker-dealer information from multiple data
sources, which can be a costly task for regulatory Staff that is often
limited in terms of accuracy by the inconsistencies and non-uniqueness
of current identifiers, and facilitate more efficient and effective
regulatory activities that protect investors from harm. Moreover,
because CAT Data would include more Industry Members in the Reporter ID
category than are currently in any current set of broker-dealer
identifiers, the Commission preliminarily believes that approval of the
Plan would likely further remedy some of the inconsistencies and other
limitations mentioned above.
(5) Aggregation
Most CAT Data would be disaggregated data, meaning that CAT Data
would not suffer from the limitations that characterize some of the
aggregated data sources that regulators must currently use. As
mentioned in the Baseline Section, subaccount allocation data and
issuer repurchase data exist in forms that are aggregated and thus
these data sources are limited for use in certain regulatory activities
and interests.\620\ In particular, neither data type may necessarily
indicate the individual executions. This data feature should promote
more effective and efficient investigation by regulators of subaccount
allocation issues and repurchase activity.
---------------------------------------------------------------------------
\620\ See Section IV.D.2.b.(2)E, supra. Item 703 of Regulation
S-K requires issuers to report aggregated issuer repurchase data to
the Commission on an annual and quarterly basis in Forms 10-K and
10-Q; see also 17 CFR 229.703 and supra note 451.
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To meet the requirements of Rule 613, the CAT NMS Plan includes a
required allocation reporting tool that would provide information on
executions that are allocated to multiple subaccounts.\621\ The
Allocation Reports required by the Plan would provide the Firm
Designated ID for any account(s), including subaccount(s) to which
executed shares are allocated, the security that has been allocated,
the identifier of the firm reporting the allocation, the price per
share of shares allocated, the side of shares allocated, the number of
shares allocated to each account, and the time of the allocation.\622\
The Firm Designated IDs could facilitate linking back to the Customer-
ID, so it may not be possible to perfectly link a Customer's aggregated
orders, executions, and allocations for a day.\623\
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\621\ See CAT NMS Plan, supra note 3, at Section
6.4(d)(ii)(A)(1).
\622\ See Exemption Order, supra note 18, at 11867.
\623\ The Commission notes, however, that there may be
allocations made by non-broker-dealers that are difficult to track
if they involve multiple broker-dealers, or are not tracked if they
involve non-CAT-reporters. See Exemptive Request Letter, supra note
16, at 26 n.61.
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The Commission preliminarily believes that the CAT NMS Plan would
improve the accuracy of allocation data compared to existing data
available to regulators. It would provide disaggregated information on
the identity of the security, the number of shares and price allocated
to each subaccount, when the allocation took place, and how each
Customer subaccount is associated with the master account. This would
more accurately reflect which Customer ultimately received the shares
that were purchased in a particular trade.
The Commission anticipates that regulators may use CAT Data for
some purposes that they use cleared data for now because CAT is
significantly less aggregated. As discussed above, regulators often
used equity and option cleared reports to identify market participants
involved in trading activity relevant to an investigation.\624\ Because
these are aggregated, regulators can use them to identify clearing
firms that may have higher volume in a particular stock on a particular
day, but the data does not identify actual trades, and, therefore,
regulators make data requests to access the underlying disaggregated
data necessary to identify broker-dealers or customers that may be
involved in the activity under investigation. If the CAT NMS Plan is
approved, CAT Data could be used to identify individual trades and
customers or other market participants who were involved in such
activity with less delay and without requiring ad hoc data requests to
clearing firms identified using equity or option cleared reports.
---------------------------------------------------------------------------
\624\ See Section IV.D.2.a(2), supra.
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Likewise, the disaggregated issuer repurchase information that
would be in the CAT data would be an improvement in the accuracy of
information available to regulators about those issuer repurchases. In
particular, the Plan would require that the Plan Processor link
Customer information to the order lifecycle and the report would
identify as Customers those issuers that are
[[Page 30689]]
repurchasing their stock in the open market.\625\ This would provide
much more granular data than what is available currently for open
market issuer repurchases, which consists of monthly aggregations of
those issuer repurchases.\626\
---------------------------------------------------------------------------
\625\ See CAT NMS Plan, supra note 3, at Section 6.4(d)(iv).
\626\ See Section IV.D.2.b(2)E, supra for baseline information
on current issuer repurchase data.
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c. Accessibility
In general, the Commission believes that the Plan, if approved,
would substantially improve the accessibility of regulatory data by
providing regulators with direct access to the consolidated CAT Data,
including some data elements that currently take weeks or months to
obtain. However, there is some uncertainty regarding the process for
regulatory access under the Plan, which creates uncertainty as to the
degree of the expected improvement.\627\
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\627\ Accessibility refers to how the data is stored, how
practical it is to assemble, aggregate, and process the data, and
whether all appropriate regulators could acquire the data they need.
---------------------------------------------------------------------------
(1) Direct Access to Data
As discussed in the Baseline Section,\628\ one of the significant
limitations of current regulatory data sources is lack of direct
access. Rule 613(e)(1) requires the Central Repository to 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 for all Reportable Events for that order.\629\
Additionally, Rule 613(a)(1)(ii) requires that the CAT NMS Plan discuss
the time and method of access by which the data would be made available
to regulators.\630\ The CAT NMS Plan implements this requirement in
Section 6.5(c) \631\ and further describes the direct access methods
and functionality in the discussion of Consideration 2 and in Appendix
D.\632\ Section 6.5(c) requires that the Participants and the
Commission have access to the Central Repository, and access to and use
of the CAT Data stored at the Central Repository, and further requires
a method of access to the data that provides for the ability to run
searches and generate reports, including complex queries. Specifically,
the Central Repository must store 6 years of CAT data in a ``convenient
and usable standard electronic format'' that is ``directly available
and searchable electronically without any manual intervention by the
Plan Processor.'' \633\ This access to the Central Repository is solely
for the purpose of performing regulatory functions and must include the
ability to run searches and generate reports; further, the Plan
requires that the Central Repository shall allow the ability to return
results of queries that are complex in nature, including market
reconstructions and the status of order books at varying time
intervals.\634\ The Central Repository must also maintain valid
Customer and Customer Account Information and permit regulators access
to ``easily obtain historical changes to that information (e.g., name
changes, address changes).'' \635\
---------------------------------------------------------------------------
\628\ See Section IV.D.2.b(3), supra.
\629\ 17 CFR 242.613(e)(1).
\630\ 17 CFR 242.613(a)(1)(ii).
\631\ See CAT NMS Plan, supra note 3, at Section 6.5(c).
\632\ See id. at Appendix C, Section A.2(b) and (c), Appendix D,
Section 8.
\633\ See id. at Section 6.5(b)(i).
\634\ See id. at Section 6.5(c)(ii), Appendix D, Section 8.1.
\635\ See id. at Appendix C, Section A.1(a)(iii).
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The Commission recognizes that improving accessibility relative to
the Baseline requires ensuring that enough SRO and Commission Staff
members are able to use the direct access system supplied by the
Central Repository when they need it. The ability to use the direct
access system depends, among other things, on how user-friendly the
system is, whether it has enough capacity for the expected use of the
system, and whether it contains the functionality that the SROs and
Commission Staff require. The Commission preliminarily believes that
the minimum requirements for the direct access system would ensure that
the Plan would improve on the Baseline of access to current data,
including the process of requesting data.
Appendix D provides minimum functional and technical requirements
that must be met by the Technical Specifications to facilitate these
methods of access, including the methods of selecting data that must be
supported, query and bulk extract performance standards, and formats in
which data could be retrieved.\636\ Specifically, CAT must be able to
support a minimum of 3,000 regulatory users within the system, 600 of
which might be accessing the system concurrently (which must be
possible without an unacceptable decline in system performance) \637\:
20% of the 3,000 users would be daily or weekly users, and 10% would
require advanced regulatory-user access.\638\ Advanced user access
includes the ability to run complex queries (versus basic users who may
only run basic queries).\639\
---------------------------------------------------------------------------
\636\ See id. at Appendix D, Section 8; see also Appendix C,
Section A.2.
\637\ See id. at Appendix D, Section 8.1.
\638\ Id.
\639\ See id. at Appendix D, Section 8.1.1. Both Basic and
Advanced Users may be established by an employee at the regulator
designated to set up access to the system, if the Plan Processor
chooses to do so versus processing it themselves. See id. at
Appendix C, Section D.12(k). However, providing access to PII must
always be done directly by the Plan Processor. Id.
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Two types of query interfacing must be supported. The first, an
online targeted query tool, must include a date or time range, or both,
and allow users to choose from a broad menu of 26 pre-defined selection
criteria (e.g., data type, listing market, size, price, CAT-Reporter-
ID, Customer-ID, or CAT-Order-ID), with more to be defined at a later
date.\640\ Results must be viewable in the tool or downloadable in a
variety of formats and support at least a result size of 5,000 or
10,000 records, respectively, with a maximum result size to be
determined by the Plan Processor.\641\ The other method for regulator
access to the data is a user-defined direct query or bulk
extraction.\642\ CAT must be able to support at least 3,000 daily
queries, including 1,800 concurrently, and up to 300 simultaneous query
requests with no performance degradation.\643\ Datasets generated by
these direct queries could run from less than 1 GB to at least 10 TB or
more of uncompressed data.\644\
---------------------------------------------------------------------------
\640\ See id. at Appendix D, Section 8.1.1. This is a broad
range of criteria from which to choose, although deferring
additional selection fields to be defined at a later date makes the
precise scope of this tool less certain.
\641\ See id.
\642\ See id. at Appendix D, Section 8.2.
\643\ See id. at Appendix D, Section 8.2.1.
\644\ See id.
---------------------------------------------------------------------------
The actual method of query support is to be determined by the Plan
Processor, but must provide an open API that allows use of regulator-
supplied common analytic tools (e.g., Python, Tableau) and ODBC/JDBC
drivers.\645\ The Plan Processor is permitted to define a ``limited set
of basic required fields (e.g., date and at least one other field such
as symbol, CAT-Reporter-ID, or CAT-Customer-ID)'' that must be used by
regulators in direct queries.\646\ Direct queries must be able to be
created, saved, and run by regulators (either directly or at a
prescheduled time), with automated delivery of scheduled query
results.\647\ Finally, the Plan Processor must provide data models and
data dictionaries for all processed and unlinked CAT Data, and
[[Page 30690]]
the Plan Processor must provide procedures and training to regulators
that would use the direct query feature (although it is up to the Plan
Processor whether to require these training sessions).\648\
Consideration was given to requiring the Plan Processor to create an
online Report Center that would provide pre-canned reports (i.e.,
recurring reports of interest to regulators), but due to the added
complexity and lack of quantifiable use cases, the decision was made
not to proceed. The Plan, however, provides that this decision would be
reassessed when broker-dealers begin submitting data to the CAT.\649\
---------------------------------------------------------------------------
\645\ See id. at Appendix D, Section 8.2. A discussion of the
types of data tools that bidders proposed to support can be found in
Appendix C, Section A.2(b).
\646\ See id. at Appendix D, Section 8.2.
\647\ See id. at Appendix D, Section 8.2.1.
\648\ See id. at Appendix D, Section 8.2.
\649\ See id. at Appendix D, Section 8.2.2.
---------------------------------------------------------------------------
All queries must be able to be run against raw (i.e., unlinked) or
processed data, or both. A variety of minimum performance metrics apply
to these queries.\650\ The Plan Processor must also provide certain
support to regulatory users. Specifically, it must ``develop a program
to provide technical, operational and business support'' to regulators,
including creating and maintaining the CAT Help Desk to provide
technical expertise to assist regulators with questions and/or
functionality about the content and structure of the CAT query
capability.\651\ The Help Desk must be available 24x7, support email
and phone communication, and be staffed to handle 2,500 calls per month
(although this resource would not be exclusive to regulators; CAT
Reporters could use it as well).\652\ The Plan Processor must also
develop tools, including an interface, to let users monitor the status
of their queries and/or reports, including all in-progress queries/
reports and estimated time to completion.\653\ In addition, the Plan
Processor must develop communication protocols regarding system status,
outages, and other issues affecting access, including access by
regulators to a secure Web site to monitor CAT System status.\654\
Furthermore, the Plan Processor must develop and maintain documentation
and other materials to train regulators, including training on building
and running queries.\655\
---------------------------------------------------------------------------
\650\ See Section IV.E.1.IV.E.1.d(3), infra, for additional for
additional information.
\651\ See CAT NMS Plan, supra note 3, at Appendix D, Section
10.2.
\652\ See id. at Appendix D, Section 10.3.
\653\ See id. at Appendix D, Section 10.2.
\654\ See id.
\655\ See id.
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The Commission preliminary believes that the direct access
facilitated by provisions of the CAT NMS Plan described above is
reasonably designed to substantially reduce the number of ad hoc data
requests and provide access to substantial data without the delays and
costly time and knowledge investments associated with the need to
create and respond to data requests. For example, regulators do not
have direct access to EBS or trade blotter data and therefore they must
request such data when needed for regulatory tasks. As a result, in
2014 the Commission made 3,722 EBS requests that generated 194,696
letters to broker-dealers for EBS data.\656\ Likewise, the Commission
understands that FINRA requests generate about half this number of
letters. In addition, for examinations of investment advisers and
investment companies, the Commission makes approximately 1,200 data
requests per year. If the Plan is approved, the Commission
preliminarily believes that the number of data requests would decline
sharply. In addition to decreasing the amount of time currently
required for regulators to access data sources, direct access to the
CAT Data should decrease the costs that many regulators and market
participants incur in either requesting data or fulfilling requests for
data, such as the time and resources that regulators and data liaisons
or back office IT staff at broker-dealers expend to understand and
access broker-dealer data collected and provided in a particular way.
---------------------------------------------------------------------------
\656\ See Section IV.D.2.b(2), supra, for discussion of ad hoc
data requests.
---------------------------------------------------------------------------
The Plan would also permit regulators to directly access customer
information, which could improve the ability of SROs to conduct
surveillance. Rule 613(e)(3) requires that the CAT provide the
capability to run searches and generate reports.\657\ The CAT NMS Plan
indicates that regulators would be able to run searches on many
variables, including Customer-IDs.\658\ Appendix D further clarifies
that both the online targeted query tool and the user-defined query/
bulk extract process would produce records that provide Customer-IDs,
but that do not themselves provide Customer PII data.\659\ Data
containing PII, however, could be obtained by regulatory personnel
specifically authorized to obtain PII access, through a process to be
documented by the Plan Processor.\660\ Currently, most regulatory data
sources do not directly link to specific customers.\661\ Instead,
regulators can use an ad-hoc data request to identify the customer and
follow up with an EBS request to identify the customer's other activity
across market participants. In this regard, CAT would provide SROs with
direct access to the data that is necessary to conduct surveillance of
the trading behavior of individual market participants in a more timely
fashion.\662\
---------------------------------------------------------------------------
\657\ 17 CFR 242.613(e)(3).
\658\ See CAT NMS Plan, supra note 3, at Appendix D, Section
8.2; See also supra note 632.
\659\ See id. at Appendix D, Section 4.1.6, Appendix D, Section
8.1.1-8.1.3.
\660\ See id. at Appendix D, Section 4.1.6.
\661\ The EBS system, trade blotters, order tickets, and trade
confirmations are the existing data sources that contain customer
information. See Section IV.D.2.b(1)A, supra; Adopting Release,
supra note 9, at 45727. Also a recent FINRA rule change would
require FINRA members to report to OATS non-FINRA member customers
who are broker-dealers. See supra note 407.
\662\ Currently, FINRA receives exchange data from SROs at the
end of the trading day. It takes approximately three days for FINRA
to process and translate this data to a common format before
surveillance programs can run. As noted in Section IV.D.1.c, this
economic analysis considers surveillance to be SROs running
automated processes on routinely collected or in-house data to
identify potential violations of rules or regulations.
---------------------------------------------------------------------------
(2) Consolidation of Data
The Commission also preliminarily believes that, if approved, the
Plan would improve accessibility by consolidating various data elements
into one combined source, reducing data fragmentation. First, Rule 613
requires that the Central Repository collect data that includes the
trading and routing of a given security from all CAT Reporters.\663\
Currently, audit trail data for securities that are traded on multiple
venues (multiple exchanges or off-exchange venues) is fragmented across
multiple data sources, with each regulator generally having direct
access only to data generated on the trading venues it regulates.\664\
If approved, the Plan would bring audit trail data related to trading
on all venues into the Central Repository where it could be accessed by
all regulators. Second, Rule 613 requires that the Plan include both
equity and options data.\665\ Currently no existing regulatory audit
trail data source includes both options and equities data, so
collecting this data and providing access would allow regulators to
monitor and run surveillance on the activity of market participants in
related instruments, such as when a market participant has activity in
both options and the options' underlying assets.
---------------------------------------------------------------------------
\663\ See 17 CFR 242.613(c).
\664\ The Commission recognizes that FINRA collects data from
exchanges for which it provides regulatory services. However, this
data is sent to FINRA by the exchanges with a delay, and the data
formats are not standardized prior to receipt at FINRA.
\665\ See 17 CFR 242.613(c)(5), (c)(6).
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The Plan would also marginally increase the accessibility of
historical exchange data. In particular, Section 6.5(b)(i) of the Plan
requires that the Central Repository make historical data available for
not less than six years, in
[[Page 30691]]
a manner that is directly accessible and searchable electronically
without manual intervention by the Plan Processor.\666\
---------------------------------------------------------------------------
\666\ See CAT NMS Plan, supra note 3, at Section 6.5(b)(i).
Currently, broker-dealers retain data for six years, but exchanges
are only required to retain data for five years. In practice, the
Commission understands that most exchanges generally retain data for
at least six years, but at least one exchange does not retain data
for six or more years. Therefore, the CAT NMS Plan would improve the
historical data available from at least one exchange.
---------------------------------------------------------------------------
In some dimensions of accessibility, the Commission notes that
uncertainties exist that could affect the degree of expected
improvement to accessibility. In particular, while the Plan provides
detail on the method of access and the types of queries that regulators
could run, many of the decisions regarding access have been deferred
until after the Plan Processor is selected and finalizes the Technical
Specifications; the Plan does not specify how regulators would access
the data beyond providing for both an online query tool and user-
defined direct queries that could do bulk extractions.\667\ For
example, while the Plan indicates that regulators would have an on-line
targeted query tool and a tool for user-defined direct queries or bulk
extraction,\668\ the Plan itself does not provide an indication for how
user-friendly the tools would be or the particular skill set needed to
use the tools for user-defined direct queries.
---------------------------------------------------------------------------
\667\ See, e.g., CAT NMS Plan, supra note 3, at Appendix D,
Section 8.2.
\668\ See CAT NMS Plan, supra note 3 at Appendix D, Sections
8.1.1, 8.1.2.
---------------------------------------------------------------------------
In addition, it is not known whether the Plan Processor would host
a server workspace that regulators could use for more complex analyses,
what software tools would be available to regulators within such a
workspace, and whether complex analyses would be able to be performed
without extracting significant data from the Central Repository's
database.
While all Bidders included certain baseline functionality, such as
some means for regulators to perform dynamic searches, data extraction,
and ``off-line analysis,'' \669\ Bidders proposed using a variety of
tools to provide regulators with access to and reports from the Central
Repository, including direct access portals, web-based applications,
and a number of different options for formatting the data provided to
regulators in response to their queries.\670\ While all of these
proposed solutions would presumably be compatible with achieving the
accessibility benefits sought to be achieved through the Plan--i.e.,
they would all involve the aggregation of data from various sources and
the provision of ready access to that data for regulators--the precise
degree of functionality of the final system is still to be determined.
Similarly, the details of system performance would depend on Service
Level Agreements to be established between the Plan Participants and
the eventual Plan Processor, which means that the details would not be
known until after the Plan Processor is selected.\671\ These
functionality and performance uncertainties create some uncertainty
regarding the degree of improvement in regulatory access that would
result from the Plan.
---------------------------------------------------------------------------
\669\ See id. at Appendix C, Section A.2(b). ``Offline-
analysis'' refers to a regulator's analysis of data extracted from
the Central Repository using the regulator's own analytical tools,
software, and hardware to perform the analysis. See id. at Appendix
C, Section A.2(b) n.77.
\670\ See id. at Appendix C, Section A.2(b).
\671\ See id. at Appendix D, Section 8.5.
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Nonetheless, the requirements included in the Plan describe a
system that, once implemented, would result in the ability to query
consolidated data sources that represents a significant improvement
over the currently available systems. This substantial reduction in
data delays and costly data investments would permit regulators to
complete market reconstructions, analyses, and research projects, as
well as investigations and examinations, more effectively and
efficiently and would lead to improved productivity in the array of
regulatory matters that rely on data, which should lead to improved
investor protection.
d. Timeliness
The Commission believes that, if approved, the CAT NMS Plan would
significantly improve the timeliness of the reporting, compiling, and
access of regulatory data, which would benefit a wide array of
regulatory activities that use or could use audit trail data.\672\ The
Commission preliminarily believes that the timeline for compiling and
reporting data pursuant to the Plan constitutes an improvement over the
processes currently in place for many existing data sources, and
relative to some data sources the improvement is dramatic.
Specifically, under the Plan, CAT Data would be compiled and made ready
for access faster than is the case today for some data, both in raw and
in corrected form; regulators would be able to query and manipulate the
CAT Data without going through a lengthy data request process; and the
data would be in a format to make it more immediately useful for
regulatory purposes.
---------------------------------------------------------------------------
\672\ Timeliness refers to when the data is available to
regulators and how long it would take to process before it could be
used for regulatory analysis.
---------------------------------------------------------------------------
(1) Timing of Initial Access to Data
The Plan would require CAT Reporters to report data to the Central
Repository at times that are on par with current audit trails that
require reporting, but the Central Repository would compile the data
for initial access sooner than some other such data.\673\ Sections
6.3(b)(ii) and 6.4(b)(ii) of the Plan require that the data required to
be collected by CAT Reporters must be reported to the Central
Repository by 8:00 a.m. Eastern Time on day T+1.\674\ These provisions
also make clear that CAT Reporters could voluntarily report the
required data prior to the deadline.\675\ As described in Table 4, the
time at which data is reported often differs significantly from the
time at which data is made available to various regulators.\676\ The
CAT Data would be made available to regulators in raw form after it is
received from reporters and passes basic formatting validations; the
Plan does not specify exactly when these validations would be complete,
but the requirement to link records by 12:00 p.m. (noon) Eastern Time
on day T+1 gives a practical upper bound on this timeline for initial
access to the data.\677\ Thus, to the extent that access to the raw
(i.e., uncorrected and unlinked) data would be useful for regulatory
purposes, the CAT NMS Plan provides a way for SROs and the Commission
to access the uncorrected and unlinked data on day T+1 by 12:00 p.m. at
the latest.
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\673\ Compiling data refers to a process that aggregates
individual data records into a data set. This could occur when
regulators request data and when the regulators receive data from
multiple providers. This is different from the act of reporting
data.
\674\ See Rules 613(c)(3), (c)(4), 17 CFR 242.613(c)(3), (c)(4).
\675\ See CAT NMS Plan, supra note 3, at Appendix D, Section
3.1.
\676\ See Table 4, supra.
\677\ See CAT NMS Plan supra note 3, at Appendix C, Section
A.2(a); Appendix C, Section A.3(e); Appendix D, Section 6.1.
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As noted in the Baseline, some current data sources compile and
report the data with delays. For example, equity and option clearing
data are not compiled and reported to the NSCC and OCC until day T+3,
and thus access to this data by the Commission cannot occur until day
T+3 at the very soonest. Under the Plan, raw data would be available
two days sooner to all regulators. In other cases such as EBS reports,
the data are not compiled and reported to a centralized database until
[[Page 30692]]
a request is received.\678\ OATS data is initially reported to FINRA by
8 a.m. on the calendar day following the reportable event, and it takes
approximately 24 hours for FINRA to run validation checks on the
file.\679\ However, SROs do not currently access OATS information for
regulatory purposes until after the error correction process is
complete, which imposes a further delay of several business days for
non-FINRA SRO regulators' use.\680\ Uncorrected OATS data is, however,
available at 8 a.m. on the calendar day following the reportable event
to FINRA (several hours more timely than CAT Data would be)--and is
available to other regulators upon request several weeks later.\681\
Uncorrected CAT Data would be available to all regulators at 12:00 p.m.
on day T+1, which is at least several days sooner than OATS is
available to non-FINRA regulators; however, the Commission notes that
because OATS is reportable on the calendar day following the OATS-
reportable event while CAT would be reported on T+1 following a
Reportable Event, regulators' access to CAT Data from a day preceding a
non-trading day (Fridays or days before market holidays) is likely to
be less timely than it is currently, if that data would be covered by
OATS. However, to the extent that the CAT would generally make CAT
Data, which would include substantially more information than OATS
data, available to all regulators, as opposed to just FINRA, in raw
form by at least 12:00 p.m. Eastern Time on day T+1, the CAT would
generally represent a significant improvement in timeliness for SROs
other than FINRA compared to OATS.
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\678\ The Commission notes, however, that broker-dealers could
compile some data sources discussed in the baseline on the day of an
event. For example, broker-dealers can compile trade blotters on the
same day as the trade. Further, regulators can compile data received
in real-time on the event day. For example, regulators can compile
direct data feeds same day. The Commission does not believe the CAT
NMS Plan would affect the timing of the compilation of such data,
nor would it reduce the number of requests for data on the day of an
event.
\679\ See Adopting Release, supra note 9, at 45729.
\680\ Id.
\681\ See OATS Reporting Technical Specifications Section 8.1,
available at https://www.finra.org/sites/default/files/OATSTechSpec_01112016.pdf.
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It is true that the Plan would not necessarily improve the
timeliness of audit trail data in every case or for every regulator, as
some kinds of audit trail data are currently timely for some
regulators. For example, exchange SROs already have real-time access to
their own audit trail data.\682\ However, regulators at other SROs or
the Commission do not have real-time access to that exchange's audit
trail, and therefore CAT Data could be more timely for these other
regulators to access and use than obtaining that exchange's audit trail
data through any means.\683\
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\682\ Under the Plan, SROs that are exchanges would still have
the same real-time access to their own audit trail data as they
currently do. The Commission does not expect that all SRO audit
trails will be retired on implementation of the Plan because
exchanges may use such audit trails to implement their CAT reporting
responsibilities. CAT reporting requirements would require that
exchanges collect and report audit trail information from their
systems even if they elect to replace their current audit trails.
However, CAT requirements may improve the completeness of real-time
exchange audit trail data if the information that exchanges collect
under the Plan is more complete than what they currently collect.
\683\ As noted, the SROs are generally currently able to access
their own audit trail data on the same day of an event and the
Commission is currently able to access some public data, like SIP
and MIDAS, on the same day as an event. Further, OATS is available
to FINRA at 8am on the day following an event. The Commission
preliminarily does not expect the CAT NMS Plan would affect these
regulators' access to most of these respective data sources.
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(2) Timeliness of Access to Error-Corrected Data
Further, the Commission preliminarily believes that the error
correction process required by the CAT NMS Plan is reasonably designed
to provide additional improvements in timeliness for corrected data.
The CAT NMS Plan specifies that the initial data validation and
communication of errors to CAT Reporters must occur by noon on day T+1,
corrections of these errors must be submitted by the CAT Reporters to
the Central Repository by 8:00 a.m. Eastern Time on day T+3, and the
corrected data made available to regulators by 8:00 a.m. Eastern Time
on day T+5.\684\ During this interim time period between initial
processing and corrected data availability, ``all iterations'' of
processed data must be available for regulatory use.\685\ The Central
Repository must be able to receive error corrections at any time, even
if late; \686\ if corrections are received after day T+5, the Plan
Processor must notify the SEC and SROs of this fact and how re-
processing of the data (to be determined in conjunction with the
Operating Committee) would be completed.\687\ Customer information
(i.e., information containing PII) is processed along a slightly
different timeline, but the outcome--corrected data available by 8:00
a.m. Eastern Time on day T+5--is the same.\688\ One exception to this
timeline is if the Plan Processor has not received a significant
portion of the data, as determined according to the Plan Processor's
monitoring, in which case the Plan Processor could determine to halt
processing pending submission of that data.\689\
---------------------------------------------------------------------------
\684\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.2(a), Appendix D, Section 6.1.
\685\ Id. at Appendix D, Section 6.2.
\686\ See id. at Appendix C, Section A.3.(b), Appendix D,
Section 7.4.
\687\ See id. at Appendix D, Section 6.2.
\688\ Id.
\689\ See id. at Appendix D, Section 6.1.
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As discussed in the Baseline Section, the error resolution process
for OATS is limited to five business days from the date a rejection
becomes available.\690\ The CAT NMS Plan requires a three-day repair
window for the Central Repository.\691\ Accordingly, if the Plan is
approved, regulators would generally be able to access partially and
fully corrected data earlier than they would for OATS.\692\
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\690\ See Section IV.D.2.b(4) and supra note 465.
\691\ Id. at Appendix C, Section A.2(a).
\692\ CAT Data being available on day T+5 may be later than for
other current SRO audit trails.
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(3) Timeliness of direct access
Improvements to timeliness would also result from the ability of
regulators to directly access CAT Data.\693\ As noted in the Baseline
Section and throughout this Section, most current data sources do not
provide direct access to most regulators, and data requests can take as
long as weeks or even months to process. Other data sources provide
direct access with queries that can sometimes generate results in
minutes--for example, running a search on all MIDAS message traffic in
one day can take up to 30 minutes \694\--but only for a limited subset
of the data to be available in CAT, and generally only for a limited
number of regulators. Accordingly, the Commission preliminarily
believes that the ability of regulators to directly access and analyze
the scope of audit trail data that would be stored in the Central
Repository should reduce the delays that are currently associated with
requesting and receiving data. For many purposes, therefore, CAT Data
could be up to many weeks more timely than current data sources.
Furthermore, direct access to CAT Data should reduce the costs of
making ad hoc data requests, including extensive interactions with data
liaisons and IT staff at broker-dealers, SROs, and vendors, developing
specialized knowledge of varied formats, data structures, and systems,
and reconciling data.
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\693\ See CAT NMS Plan, supra note 3, Section 6.5(c).
\694\ See Section IV.D.2.b(4) and supra note 468.
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As discussed above, Rule 613 generally requires that the Central
[[Page 30693]]
Repository would receive, consolidate, and retain CAT Data in a linked
uniform electronic format and the regulators would be able to directly
access the data stored in the Central Repository.\695\ Queries take
time to return data because they need to look up information across a
range of data records, process that data, and compile it into an output
dataset. Therefore, the improvements to timeliness depend on how long
the queries take to return data. The CAT NMS Plan specifies that
regulators would be able to query the Central Repository using an
online targeted query tool with response times ``measured in time
increments of less than a minute'' for targeted queries and within 24
hours for large or complex queries that either scan large amounts of
data or return large result sets (i.e., sets of over 1 million
records).\696\ That said, if the data request is limited to one
business date, and that business date is within the last 12-month
period, the query must not take more than 3 hours to run, regardless of
complexity.\697\ Specifically, searches including only equities and
options trade data must be returned within either 1 minute (events for
a specific Customer or CAT Reporter with filterable other fields); 30
minutes (events for a specific Customer or CAT Reporter in a specified
date range of less than 1 month); or 6 hours (events for a single
Customer or CAT Reporter in a specified date range of up to 12 months
within the last 24 months).\698\ Searches including equities and
options trade data, along with NBBO data, must return within 5 minutes
for all orders for a specific security from a specific Participant; and
for all orders, cancellations, and NBBO (or the protected best bid and
offer) for a specific security, and with several similar types of
searches, within a specified window not to exceed 10 minutes for a
single date.\699\
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\695\ See Section IV.E.1.c, supra.
\696\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.2(c); Appendix D, Section 8.1.2.
\697\ Id. at Appendix D, Section 8.1.2.
\698\ Id.
\699\ Id.
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Furthermore, the search tool must include a resource management
component, which could manage query requests to balance the workload,
and categorize and prioritize query requests based on the input
parameters, complexity of the query, and the volume of data to be
parsed in the query, with the details on the prioritization plan to be
provided at a later date.\700\ The database must support the estimated
600 concurrent users to ensure that there is not an unacceptable
decline in system performance.\701\ The direct query and bulk extract
features are also designed to ensure timely regulatory access to
critical data. For example, the bulk extract of an entire day's worth
of data should be able to be transferred in less than four hours
(assuming the regulator's network could support the required data
transfer speeds).\702\ The Plan Processor must have an automated
mechanism to monitor user-defined direct queries and bulk data
extracts, including automated alerts of issues with bottlenecks and
excessively long queues for queries or data extractions.\703\ Monthly
reporting on the delivery and timeliness of these tools to the
Operating Committee and regulators is required.\704\
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\700\ See id. at Appendix D, Section 8.1.2.
\701\ See id. at Appendix D, Section 8.1.
\702\ See id. at Appendix D, Section 8.2.2.
\703\ Id.
\704\ Id.
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(4) Timeliness of use of Data
The Commission also preliminarily expects the CAT NMS Plan to
reduce the time required to process data before analysis. Currently
regulators can spend days and up to months processing data they receive
into a useful format.\705\ Part of this delay is due to the need to
combine data across sources that could have non-uniform formats and to
link data about the same event both within and across data sources. As
discussed above, these kinds of linking processes can require
sophisticated data techniques and substantial assumptions, and can
result in imperfectly linked data. The Plan addresses this issue by
stating that the Plan Processor must store the data in a linked uniform
format.\706\ Specifically, the Central Repository will use a ``daisy
chain'' approach to link and reconstruct the complete lifecycle of each
Reportable Event, including all related order events from all CAT
Reporters involved in that lifecycle.\707\ Therefore, regulators
accessing the data in a linked uniform format would no longer need to
take additional time to process the data into a uniform format or to
link the data.\708\ Accordingly, the Commission preliminarily believes
that the Plan would reduce or eliminate the delays associated with
merging and linking order events within the same lifecycle. Further,
the Plan would improve the timeliness of FINRA's access to the data it
uses for much of its surveillance by several days because the corrected
and linked CAT Data would be accessible on T+5 compared to FINRA's T+8
access to its corrected and linked data combining OATS with exchange
audit trails.
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\705\ See Section IV.D.2.b(4), supra.
\706\ See CAT NMS Plan, supra note 3, at Section 6.5(b)(i). The
CAT NMS Plan does not link allocations to order events; see also 17
CFR 242.613(e)(1).
\707\ See CAT NMS Plan, supra note 3, at Appendix D, Section 3.
\708\ This does not apply if regulators choose to access raw
data before the Central Repository processed them.
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The expected improvements to data accuracy discussed above could
also result in an increase in the timeliness of data that is ready for
analysis, although uncertainty exists regarding the extent of this
benefit.\709\ As noted in the Baseline, regulators currently take
significant time to ensure data is accurate beyond the time that it
takes data sources to validate data. In some cases, data users may
engage in a lengthy iterative process involving a back and forth with
the staff of a data provider in order to obtain accurate data necessary
for a regulatory inquiry. Accordingly, to the extent that the Central
Repository's validation process is sufficiently reliable and complete,
the duration of the error resolution process regulators would perform
with CAT Data may be shorter than for current data. Further, to the
extent that the Central Repository's linking and reformatting processes
are sufficiently successful, the SROs and Commission may not need a
lengthy process to ensure the receipt of accurate data. However, as
discussed above, the Commission lacks sufficient information on the
validations, linking, and reformatting processes needed to draw a
strong conclusion as to whether users would take less time to validate
CAT Data than they take on current data.\710\ Nonetheless, the
Commission preliminarily believes that the linking and reformatting
processes at the Central Repository would be more accurate than the
current decentralized processes such that it would reduce the time that
regulators spend linking and reformatting data prior to use.
---------------------------------------------------------------------------
\709\ See Section IV.E.1.b, supra.
\710\ As discussed above, Rule 613 requires a validation process
but leaves significant flexibility on the specific validations to be
performed and the timeline for validation. The details regarding
required validations do not appear in the CAT NMS Plan and instead
would appear in the Technical Specifications, which would not be
finalized until after approval of the CAT NMS Plan. See Section
IV.E.1.b, supra.
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2. Improvements to Regulatory Activities
The Commission preliminarily believes that improvements in the
quality of available data have the potential to result in improvements
in the analysis and reconstruction of market events; market analysis
and research in support of regulatory
[[Page 30694]]
decisions; and market surveillance, examinations, investigations, and
other enforcement functions.
Regulators' abilities to perform analyses and reconstructions of
market events would likely improve, allowing regulators to more quickly
and thoroughly investigate these events. This would allow regulators to
provide investors and other market participants with more timely and
accurate explanations of market events, and to develop more effective
responses to such events. The availability of the CAT Data would
benefit market analysis and research in support of regulatory
decisions, facilitating an improved understanding of markets and
informing potential policy decisions. Regulatory initiatives that are
based on an accurate understanding of underlying events and are
narrowly tailored to address any market deficiency should improve
market quality and benefit investors.
In the Commission's preliminary view, CAT Data would substantially
improve both the efficiency and effectiveness of SRO broad market
surveillance programs, which could benefit investors and market
participants by allowing regulators to more quickly and precisely
identify and address a higher proportion of market violations that
occur, as well as prevent violative behavior through deterrence.
The Commission also preliminarily believes that CAT Data would
enhance the SROs' and the Commission's abilities to effectively target
risk-based examinations of market participants who are at elevated risk
of violating market rules, as well as their abilities to conduct those
examinations efficiently and effectively, which could also contribute
to the identification and resolution of a higher proportion of
violative behavior in the markets. The reduction of violative behaviors
in the markets should benefit investors by providing investors with a
safer environment for allocating their capital and making financial
decisions. A reduction in violative behaviors could also benefit market
participants whose business activities are harmed by the violative
behavior of other market participants. The Commission further believes
that more targeted examinations could also benefit market participants
by resulting in proportionately fewer burdensome examinations of
compliant market participants. A significant percentage of Commission
enforcement actions involve trade and order data,\711\ and the
Commission also preliminarily believes that CAT Data would
significantly improve the efficiency and efficacy of enforcement
investigations, including insider trading and manipulation
investigations.
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\711\ In 2015, the Commission filed 807 enforcement actions,
including 39 related to insider trading, 43 related to market
manipulation, 124 related to broker-dealers, 126 related to
investment advisers/investment companies, and one related to
exchange or SRO duties. In 2014, the Commission filed 755
enforcement actions, including 52 related to insider trading, 63
related to market manipulation, 166 related to broker-dealers, and
130 related to investment advisers/investment companies, many of
which involved trade and order data. See Year-by-Year SEC
Enforcement Statistics, available at https://www.sec.gov/news/newsroom/images/enfstats.pdf. The total number of actions filed is
not necessarily the same as the number of investigations. An
investigation may result in no filings, one filing, or multiple
filings. Additionally, trade and order data may be utilized in
enforcement investigations that do not lead to any filings. Based on
these numbers, the Commission estimates that 30-50% of its
enforcement actions incorporate trading or order data. A portion of
FINRA's 1,397 disciplinary actions in 2014 and 1,512 in 2015 also
involved trading or order data. See http://www.finra.org/newsroom/statistics.
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The Commission further anticipates additional benefits associated
with enhanced abilities to handle tips, complaints and referrals, and
improvements in the speed with which they could be addressed,
particularly in connection with the significant number of tips,
complaints, and referrals that relate to manipulation, insider trading,
or other trading and pricing issues.\712\ The benefits to investor
protection of an improved tips, complaints, and referrals system would
largely mirror the benefits to investor protection that would accrue
through improved surveillance and examinations efficiency.
---------------------------------------------------------------------------
\712\ In fiscal years 2014 and 2015, the Commission received
around 15,000 entries in its TCR system, approximately one third of
which related to manipulation, insider trading, market events, or
other trading and pricing issues.
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a. Analysis and Reconstruction of Market Events
The Commission preliminarily believes that, if approved, the Plan
would improve regulators' ability to perform analysis and
reconstruction of market events. As noted in the Adopting Release, the
sooner regulators can complete a market reconstruction, the sooner
regulators can begin reviewing an event to determine what happened, who
was affected and how, if any regulatory responses might be required to
address the event, and what shape such responses should take.\713\
Furthermore, the improved ability for regulators to generate prompt and
complete market reconstructions could provide improved market
knowledge, which could assist regulators in conducting retrospective
analysis of their rules and pilots.
---------------------------------------------------------------------------
\713\ See Adopting Release, supra note 9, at 45732.
---------------------------------------------------------------------------
The fragmented nature of current audit trail data and the lack of
direct access to such data renders market reconstructions cumbersome
and time-consuming. Currently, the information needed to perform these
analyses is spread across multiple audit trails, with some residing in
broker-dealer order systems and trade blotters. Requesting the data
necessary for a reconstruction of a market event often takes weeks or
months and, once received, regulators then need weeks to reconcile
disparate data formats used in different data sources. 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 indices,
such as the Dow Jones Industrial Average Index and the S&P 500 Index,
fell about 5% in five minutes, only to rebound soon after (the ``Flash
Crash'').\714\
---------------------------------------------------------------------------
\714\ See CFTC and SEC, Findings Regarding the Market Events of
May 6, 2010: Report of the Staffs of the CFTC and SEC to the Joint
Advisory Committee on Emerging Regulatory Issues (September 30,
2010), available at http://www.sec.gov/news/studies/2010/marketevents-report.pdf.
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The lack of readily available trade and order data resulted in
delays and gaps in the Commission's analysis of the events of the Flash
Crash. 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.\715\ Even then, the reconstruction only
contained an estimated 90% of trade and order activity for that day.
---------------------------------------------------------------------------
\715\ For a further explanation of the limitations data
deficiencies imposed on the Commission's investigation into the
Flash Crash, see Adopting Release, supra note 9, at 45732-33.
---------------------------------------------------------------------------
Regulators, such as the Commission and SROs on whose exchanges
events took place, faced similar challenges when reconstructing events
around the May 2012 Facebook IPO, the August 2012 Knight Securities
``glitch,'' and the August 2013 NASDAQ SIP outage.\716\ In addition,
during the financial crisis in 2008, the lack of direct access to audit
trail data resulted in the Commission being unable to quickly and
efficiently conduct analysis and reconstruction of
[[Page 30695]]
market events. The state of OATS data in 2008 also limited FINRA's
ability to analyze and reconstruct the market during the financial
crisis because FINRA could not yet augment its OATS data with exchange
data and OATS did not include market maker quotations. As a result,
regulators had little information about the role of short sellers in
market events and the identity of short sellers during the financial
crisis, for example.\717\ Some of these shortcomings in regulatory data
still apply today.\718\
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\716\ For background information on these events, see SEC Press
Release, SEC Charges NASDAQ for Failures During Facebook IPO (May
29, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171575032; In the Matter of Knight Capital Americas
LLC, Securities Exchange Release Nos. 70694 (October 16, 2013);
73639 (November 19, 2014), 79 FR 72252, 72255, n.32 (December 5,
2014) (discussing NASDAQ SIP outage); see also Adopting Release,
supra note 9, at 45732-33 (discussing difficulty of analyzing and
reconstructing market events in absence of a consolidated audit
trail).
\717\ See Short Sale Reporting Study, supra note 413. To resolve
this lack of information, the Commission issued an emergency order
creating a new filing requirement for 13f filers to report their
short positions and short sales to the Commission weekly on Form SH.
See former Rule 10a-3T; available at http://www.sec.gov/rules/other/2008/34-58591.pdf; http://www.sec.gov/rules/other/2008/34-58591a.pdf; http://www.sec.gov/rules/other/2008/34-58724.pdf; http://www.sec.gov/rules/final/2008/34-58785.pdf; http://www.sec.gov/news/press/2008/2008-209.htm; http://www.sec.gov/divisions/marketreg/shortsaledisclosurefaq.htm. This data was kept confidential. After
evaluating whether the benefits from the data justified the costs,
the Commission let this requirement expire, replacing it with
additional public data. See SEC Press Release, SEC Takes Steps to
Curtail Abusive Short Sales and Increase Market Transparency (July
27, 2009), available at http://www.sec.gov/news/press/2009/2009-172.htm. This public data did not identify the short sellers as the
Form SH data did. In addition, using data requested from SROs, the
Commission conducted two studies on short selling during September
2008. These studies required data requests to select exchanges, took
two months to complete and did not have information identifying
short sellers. See ``Analysis of a Short Sale Price Test Using
Intraday Quote and Trade Data'' available at http://www.sec.gov/comments/s7-08-09/s70809-368.pdf and ``Analysis of Short Selling
Activity during the First Weeks of September 2008'' available at
http://www.sec.gov/comments/s7-08-09/s70809-369.pdf.
\718\ For example, OATS still does not include all principal
orders or option data. See Section IV.D.2.b(1)A, supra. Because
FINRA collects some exchange data, FINRA is able to merge exchange
quotes with OATS.
And although there is a proposed FINRA rule that will require
FINRA members to report to OATS identification for their non-FINRA
member customers who are broker-dealers, even after approval of this
rule OATS will lack identification for customers who are not broker-
dealers. See Section IV.D.2.b(1)B, supra.
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More generally, regulators face significant difficulties in using
some current data sources for a thorough market reconstruction. Some of
the most detailed data sources, including sources like EBS and trade
blotters that identify customers, are impractical for broad-based
reconstructions of market events. In particular, including EBS data for
a reconstruction of trading in the market for even one security on one
day could involve many, perhaps hundreds, of requests, and would
require linking that to SRO audit trail data or public data.\719\
Further, because EBS data lacks time stamps for certain trades,\720\
use of EBS data in market reconstructions requires supplementation with
data from other sources, such as trade blotters.
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\719\ See Section IV.D.2.b(3), supra (noting that in 2014, the
SEC made 3,722 EBS requests which generated 194,696 letters to
broker-dealers requesting EBS data). The Commission understands that
FINRA makes about half this number of requests.
\720\ Large traders who file Form 13H with the Commission are
assigned a ``large trader identification number'' by the Commission
and must provide that number to their brokers for inclusion in the
EBS records that are maintained by the clearing brokers. Rule 13h-1,
subject to relief granted by the Commission, requires that execution
time be captured (to the second) for certain categories of large
traders. See Sections IV.D.2.a.(3) and IV.D.2.b, supra (discussing
the EBS system and large trader reports and the limitations of these
data sources in performing market reconstructions).
---------------------------------------------------------------------------
The Commission therefore expects that improvements in data
completeness and accuracy from the Plan would enhance regulators'
ability to perform analyses and to reach conclusions faster in the wake
of a market event by reducing the time needed to collect, consolidate
and link the data. The inclusion of Customer-IDs and consistent CAT-
Reporter-IDs in CAT would allow regulators to more effectively and
efficiently identify market participants that submit orders through
several broker-dealers and execute on multiple exchanges and whose
activity may warrant further analysis. This would be useful if
regulators were interested in determining if a particular trader or
category of traders had some role in causing the market event, or how
they might have adjusted their behavior in response to the event, which
could amplify the effects of the root cause or causes. Furthermore, the
clock synchronization requirements of the Plan would improve the
ability of regulators to sequence some events that happened in
different market centers to better identify the causes of market
events. Overall, the Commission preliminarily believes that, if the
Plan is approved, regulators would have dramatically improved ability
to identify the market participants involved in market events.
The Commission further believes that better data accessibility
would significantly improve the ability of regulators to analyze and
reconstruct market events. As noted above, CAT Data would improve data
accessibility relative to every other data source because all SROs and
the Commission would have direct access to CAT Data. If the Plan is
approved, much of this information would be housed in the Central
Repository with query capabilities that would allow regulators to
access raw data beginning the day after an event.\721\ Further, as
mentioned below in the SRO Surveillance Section, the CAT Data would
link Reportable Events, which could allow regulators to respond to
market events more rapidly because they would not need to process
corrected and linked data before starting their analyses.\722\
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\721\ While the Commission recognizes that some data sources are
currently available earlier, those data sources are so fragmented as
to make collecting them for a broad-based market reconstruction
infeasible.
\722\ Such benefits could be limited for market events that
require linked data within five days of an event or if the linking
algorithm in the Central Repository introduces data errors.
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b. Market Analysis and Research
The Commission preliminarily believes that the CAT NMS Plan would
benefit the quality of market analysis and research that is produced to
increase regulatory knowledge and support policy decisions and would
lead to a more thorough understanding of current markets and emerging
issues. These expected benefits would stem from improvements in
accessibility, accuracy, and completeness of regulatory data.
Improvements in regulatory market analysis and research aimed at
informing regulatory decisions would benefit investors and market
participants by improving regulators' understanding of the intricacies
of dynamic modern markets and how different market participants behave
in response to policies and information. These more nuanced and more
thorough insights would help regulators to identify the need for
regulation that specifically tailors policies and interventions to the
diverse landscape of market participants and conditions that
characterize current financial markets, as well as assist them in
conducting retrospective analysis of their rules and pilots.
A lack of direct access to necessary data, along with inaccuracies
in the data that are available, currently limits the types of analyses
that regulators can conduct. These data limitations constrain the
information available to regulators when they are considering the
potential effects of regulatory decisions. For example, 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.\723\ The
concept release poses a number of questions about the role and impact
of high-frequency trading
[[Page 30696]]
strategies and the movement of trading volume from the public national
securities exchanges to over-the-counter trading venues such as dark
pools. Over the past five years there has been considerable discussion
about these topics by regulators, market participants, the media, and
the general public. Nevertheless, limitations in the completeness and
accessibility of the available data have limited the research that
followed the concept release.
---------------------------------------------------------------------------
\723\ See Concept Release on Equity Market Structure, supra note
733; see also Adopting Release, supra note 9, at 45733 (discussing
the Concept Release on Equity Market Structure).
---------------------------------------------------------------------------
The Commission preliminarily believes that the CAT NMS Plan
improves this situation, benefiting market analysis and research in
support of SRO and Commission rulemaking. It would provide direct
access to data that currently requires an often lengthy and labor-
intensive effort to request, compile, and process. Additionally, the
expected improvements in accuracy and completeness could benefit
efforts to analyze the activities of particular categories of market
participants, understand order routing behavior, identify short selling
and short covering trades, issuer repurchases, and related topics. The
requirement to store the data in a uniform format in the Central
Repository is particularly important, as linking and normalizing data
from disparate sources in different formats is a major component of
completing many types of analyses and currently requires a significant
amount of time. The Plan would provide direct access to data that
regulators could use to more directly study issues such as high
frequency trading, maker-taker pricing structures, short selling,
issuer repurchases, and ETF trading.
The CAT NMS Plan could improve market analysis and research
concerning HFT by providing regulators with direct access to more
uniform and comprehensive data that identifies HFT activity more
precisely compared to existing academic research that regulators
currently utilize. Existing academic research on high frequency trading
cannot precisely identify high frequency traders or their trading
activity and more comprehensive regulatory analysis on high frequency
trading currently relies on fragmented data that is cumbersome to
collect and process.\724\ For both academics and regulators, studying
high frequency traders is currently difficult because these traders
typically trade across many exchanges, and often off-exchange as well.
NASDAQ distributes a trade and quote dataset to researchers for the
purposes of performing academic studies on high frequency trading. This
dataset identifies the trading and quoting activity of a group of high
frequency traders identified by NASDAQ, but only includes activity from
the NASDAQ exchange. Other exchanges and market centers currently do
not provide such data to academics or the public.\725\ As a result,
studies of high frequency trading have been limited in their ability to
examine thoroughly such strategies and their impact on the market.
Because data on high-frequency trading tends to be fragmented across
many data sources, it is difficult even for regulators to thoroughly
analyze their aggregate activity level, study how their activity on one
exchange affects their activity on another, and study the effect of
particular high frequency strategies on market quality.\726\
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\724\ See High Frequency Trading, literature review, available
at https://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf.
\725\ Even if other exchanges did provide such data, the NASDAQ
data fields do not include the identities of the high frequency
traders. As a result researchers would not be able to study the
activity of the same high frequency trader across exchanges.
\726\ See infra note 724.
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The Plan also would provide information on how various broker-
dealers route their customer orders and would allow regulators to study
whether access fees and rebates drive routing decisions as much as
execution quality considerations. This could inform debates about
effects of conflicts of interest created by such maker-taker pricing.
Studies of maker-taker pricing require information on routing decisions
and how routing affects execution quality. Current academic studies of
maker-taker pricing rely on data that provide imprecise information
that cannot directly link routing and execution quality, and current
similar research carried out by some regulators is often hindered by
the significant amount of time it takes to obtain the relevant data
from all market centers. However, the Plan would provide regulators
with direct access to a data source that would link order lifecycle
events together in a way that would allow regulators to more thoroughly
analyze how and where broker-dealers route various order types. This
could assist regulators in analyzing the importance of fees to the
routing decisions and the ultimate impact on investors of any conflicts
of interest in broker-dealer routing decisions. Such analysis could
inform debates regarding whether maker/taker pricing structures are
harmful to market structure.
Similarly, the Plan would provide regulators with data to better
understand the nature of short selling. Existing studies of the effects
of short selling lack the ability to associate short selling activity
with customer-level data, and also lack the ability to distinguish
buying activity that covers short positions from buying activity that
establishes new long positions. The Plan would allow regulators to
examine, for example, how long particular types of traders hold a short
position and what types of traders short around corporate events.
The Plan, in requiring information about a Customer, would also
facilitate studies of how certain entities other than natural persons
trade and the market impact of their trading. For example, existing
information on repurchases is aggregated at the monthly and quarterly
level while the CAT Data on issuer repurchases would be much more
granular. CAT Data would provide information that could determine the
size and timing of issuer repurchases, for example. In addition, CAT
Data would provide information that could help identify open market
repurchases whereas existing data does not distinguish the type of
repurchase. As such, the Plan would facilitate research that addresses
the timing of issuer repurchases around corporate events or stock
option grants and exercises, the extent to which issuers use the safe
harbor in Rule 10b-18, and how aggressively issuers trade in the
market. In addition, CAT Data on the trading of leveraged ETFs,
particularly the end of day rebalancing, could shed light on how the
leveraged ETFs relate to market volatility. In addition, Customer
information should facilitate analyses of the secondary market trading
of ETF Authorized Participants in their ETFs.\727\ This could help
regulators better understand the arbitrage process between an ETF and
its underlying securities and the limitations of that arbitrage.
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\727\ The CAT NMS Plan does not include requirements to record
or report information on the creation or redemption of ETF shares.
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The Commission preliminarily believes that CAT Data would also
better inform SROs and the Commission in rulemakings and assist them in
conducting retrospective analysis of their rules and pilots. In
particular, SROs would be able to use order data that is currently not
available to examine whether rule changes are in the interest of
investors. For example, direct access to consolidated audit trail data
that identifies trader types could help an SRO examine whether a new
rule improved market quality across the entire market and whether it
benefitted retail and institutional investors specifically. Further,
CAT Data would allow SROs to examine whether a rule
[[Page 30697]]
change on another exchange was in the interest of investors and whether
to propose a similar rule on their own exchange.
c. Surveillance and Investigations
The Commission preliminarily believes that the enhanced
surveillance and investigations made possible by the implementation of
the CAT NMS Plan could allow regulators to more efficiently identify
and investigate violative behavior in the markets and could also lead
to market participants that currently engage in violative behavior
reducing or ceasing such behavior, to the extent that such behavior is
not already deterred by current systems. The current markets are
characterized by surveillance systems that identify violators so that
regulators may address these violations. Given that violative behavior
is identifiable in current markets, and potential violators know that
there is a positive probability that they would be caught by
surveillance should they commit a violation, fewer potential violators
commit violations than would do so in markets that had no surveillance.
Potential violators' expected probability of being caught influences
their likelihood of committing a violation.\728\ It then follows that
any system change that increases the likelihood of violative behavior
detection would increase potential violators' expected probability of
being caught and thus reduce the likelihood that potential violators
would commit a violation.
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\728\ It is well established in the economics and political
science literature that common knowledge among market actors can
lead to the deterrence of behaviors; see, e.g., Schelling, Thomas,
``The Strategy of Conflict: Prospectus for a Reorientation of Game
Theory,'' Journal of Conflict Resolution, Vol. 2 No. 3 (1958) and
Ellsberg, Daniel, ``The Crude Analysis of Strategic Choices,''
American Economic Review, Vol. 51, No. 2 (1961). Therefore, market
participants with knowledge of improvements in the efficiency of
market surveillance, investigations, and enforcements, and
consequently the increased probability of incurring a costly
penalty, could be deterred from participating in violative behavior.
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Specifically, if market participants believe that the existence of
CAT, and the improved regulatory activities that result from
improvements in data and data processes, increase the likelihood of
regulators detecting violative behavior, they could reduce or eliminate
the violative activity in which they engage to avoid incurring the
costs associated with detection, such as fines, legal expenses, and
loss of reputation. Such a reduction in violative behavior would
benefit investor protection and the market as investors would no longer
bear the costs of the violative behavior that would otherwise exist in
the current system. Many of the improvements that would result from CAT
could also allow regulators to identify violative activity, such as
market manipulation, more quickly and reliably, which could improve
market efficiency by deterring market manipulation and identifying and
addressing it more quickly and more often when it occurs.\729\
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\729\ For example, as discussed in Section IV.E.2.c(1), the Plan
would allow regulators to more efficiently conduct cross-market and
cross-product surveillance relative to surveillance using current
data sources, and the requirement that data be consolidated in a
single database would assist regulators in detecting violative (but
not obvious) activity. To the extent that market participants are
aware of the current challenges to regulators in performing cross-
market surveillance and aggregating data across venues, and to the
extent that they believe that their violative behavior is more
likely to be detected if regulators' ability to perform those
activities improves, they may reduce or eliminate violative behavior
if the CAT Plan is approved.
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(1) SRO Surveillance
The Commission preliminarily believes that the CAT NMS Plan would
result in improvements in SROs' surveillance capabilities and that many
of the benefits to SRO surveillance stem from improvements to data
completeness. These benefits encompass a number of improvements to
surveillance, including: detection of insider trading; surveillance of
principal orders; cross-market and cross-product surveillance, and
other market surveillance activities.
Rule 613(f) requires SROs to implement surveillances reasonably
designed to make use of the CAT Data.\730\ Further, data improvements
resulting from the Plan would improve regulators' ability to perform
comprehensive and efficient surveillance. As a result, the market
surveillances required by Rule 613(f) could identify a broader and more
nuanced set of market participant behaviors. As such, the CAT would
also provide the opportunity for development of more effective and
efficient surveillance system. It is also possible that the CAT Data
and tools would enable further innovations in market surveillance
beyond those currently contemplated. These innovations could be in
response to new developments in the market over the next few years or
to the new capabilities for regulators.
---------------------------------------------------------------------------
\730\ 17 CFR 242.613(f).
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CAT Data would include additional fields not currently available in
data used for surveillance.\731\ The inclusion of Customer-IDs in the
CAT would significantly improve surveillance capabilities, including
surveillance designed to detect market manipulation and insider
trading. Because currently available data do not include customer
identifiers, SROs performing insider trading and manipulation
surveillance could be unable to identify some suspicious trading \732\
and must undertake multiple steps to request additional information
after identifying suspect trades. The ability to link uniquely
identified customers with suspicious trading behavior would provide
regulators with better opportunity to identify the distribution of
suspicious trading instances by a customer as well as improving
regulators' ability to utilize customer-based risk assessment. This
enhanced ability to link customers with behaviors would enable
detection of market abuses that are perpetrated by customers trading or
quoting through multiple accounts or on multiple trading venues.
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\731\ As noted in Section IV.D.1.c, this economic analysis
considers surveillance to be SROs running processing on routinely
collected or in-house data to identify potential violations of rules
or regulations.
\732\ The Commission understands that SRO surveillances on
topics such as insider trading and market manipulation do not
incorporate data that identifies customers. Based on alerts from
their surveillances, SROs may open a review that runs through
several stages of data requests before identifying a customer. As
discussed above, the Commission notes that SRO audit trails
typically do not provide customer information but a recent FINRA
rule change would require its members to report to OATS non-FINRA
member customers who are broker-dealers. See supra note 407.
---------------------------------------------------------------------------
Furthermore, having direct access to data could assist an SRO in
its surveillance activities by potentially facilitating quicker
responses to suspicious trading activity. Additionally, the inclusion
of the principal orders of members would enable regulators to better
identify rule violations by broker-dealers that have not previously had
to provide audit trail data on their unexecuted principal orders. The
evolution of the market has increased the importance of surveillance on
principal orders. Many of these principal orders originate from
algorithmic or high frequency trading firms who have been the recent
subject of regulatory interest.\733\ Further, some rules and
regulations provide for differential treatment of the principal orders
of broker-dealer market makers. Yet, some current data sources used for
SRO surveillance exclude unexecuted principal orders,\734\ limiting the
[[Page 30698]]
surveillance for issues such as wash sales. As a result, many
surveillance patterns are unable to detect certain rule violations
involving principal orders.
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\733\ See Securities Exchange Act Release No. 61358 (January 14,
2010), 75 FR 3594 (January 21, 2010) (``Concept Release on Equity
Market Structure''); Exemption for Certain Exchange Members, supra
note 394.
\734\ See Section IV.D.2.b(1), supra.
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The Plan would also improve regulators' efficiency in conducting
cross-market and cross-product surveillance. The Plan would
particularly enhance regulators' ability to perform cross-market
surveillance, across equity and options markets, by enabling any
regulator to surveil the trading activity of market participants in
both equity and options markets and across multiple trading venues
without data requests. Regulators would also have access to
substantially more information about market participants'
activity,\735\ and the requirement that the data be consolidated in a
single database would assist regulators in detecting activity that may
appear permissible without evaluating data from multiple venues.\736\
Likewise, it would assist regulators in detecting activity that may not
appear violative without evaluating data from multiple venues.
---------------------------------------------------------------------------
\735\ For example CAT Data would include Customer information,
subaccount allocation information, exchange quotes, trade and order
activity that occurs on exchanges, trade and order activity that
occurs at broker-dealers that are not FINRA members, and trade and
order activity that occurs at FINRA members who are not currently
required to report to OATS. In addition CAT Data would require
reporters to report data in milliseconds and would be directly
available to non-FINRA regulators much faster than OATS is currently
available to them. See Section IV.E.1.a, supra.
\736\ See Section IV.E.1.c(2), infra. The Commission notes that
while this is a benefit allowed by consolidation of data in the
Central Repository, linked data would not be available in the
Central Repository until T+5, which may delay the completion of
surveillance activities.
---------------------------------------------------------------------------
Increasing market complexity and fragmentation has increased the
importance of cross-market surveillance. The Commission noted in its
Regulation of NMS Stock Alternative Trading Systems proposing release
that, ``[i]n the seventeen years since the Commission adopted
Regulation ATS, the equity markets have evolved significantly,
resulting in an increased number of trading centers and a reduced
concentration of trading activity in NMS stocks.'' \737\ However,
because market data are fragmented across many data sources and because
audit trail data lacks consistent customer identifiers, regulators
cannot run cross-market surveillance tracking particular
customers.\738\ Furthermore, routine cross-product surveillance is
generally not possible with current data. The potential enhancements in
market surveillance enabled by the CAT NMS Plan are likely to result in
more capable and efficient surveillance which could reduce violative
behavior and protect investors from harm.
---------------------------------------------------------------------------
\737\ See Securities Exchange Act Release No. 76474 (November
18, 2015), 80 FR 80998 (December 28, 2015), at 81000.
\738\ As noted in the above, SROs currently do not conduct
routine surveillance that tracks particular customers because data
currently used for surveillance does not include customer
information.
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(2) Examinations
The Commission preliminarily believes that availability of the CAT
would also improve examinations and that these improvements would
benefit investor protection, and the market in general, by resulting in
more effective supervision of market participants. The Commission
conducted 493 broker-dealer examinations in 2014 and 484 in 2015, 70
exams of the national securities exchanges and FINRA in 2014 and 21 in
2015. In addition, the Commission conducted 1,237 investment adviser
and investment company examinations in 2014 and 1,358 in 2015.
Virtually all investment adviser examinations and a significant
proportion of the Commission's other examinations involve analysis of
trading and order data. Currently some data that would be useful to
conduct risk-based selection for examinations, such as trade blotters,
are not available in data sources available for pre-exam analysis.\739\
Further, data available during exams often require regulatory Staff to
link multiple data sources to analyze customer trading. For example,
some customer identities are present in EBS data, but time stamps are
not. To evaluate the execution price a customer received, it is
necessary to know the time of the trade to compare the price of the
customer's execution with the prevailing market prices at that time.
This requires linking the EBS data with another data source that
contains trades with time stamps (such as the trade blotter). These
linking processes can be labor-intensive and require the use of
algorithms that may not link with 100% accuracy. Finally, for
investment adviser examinations, examiners sometimes use non-trading
data such as Form PF, Form 13-F, Form ADV, and clearing broker reports
as a proxy for trading data when selecting investment advisers for
examinations. The CAT would improve examinations in the following
specific ways.
---------------------------------------------------------------------------
\739\ Regulators can obtain detailed equity transaction data by
requesting a trade blotter from a particular firm; however, the data
would only show the activity of that firm.
---------------------------------------------------------------------------
First, the Commission preliminarily believes that the expected
improvements in the data qualities discussed above would enhance the
ability of regulators to select market participants for focused
examinations on the basis of risk. The direct access to consolidated
data in a single location would dramatically improve regulators'
ability to efficiently conduct analyses in an attempt to select broker-
dealers and investment advisers for more intensive examinations based
on identified risk. Having CAT Data stored in the Central Repository in
a linked format would allow examiners to access much more data directly
through a query and without performing the linking process on an ad-hoc
basis than is currently available before an exam. The ability to use
Customer Account Information in the process for selecting investment
advisers for exams, for example, could allow those selection models to
incorporate trading data directly instead of imperfect proxies for
trading data. This could lead to improved outcomes for risk-based
examinations, such as more regulatory resources invested in examining
market participants who are at an elevated risk of violating federal
securities laws, rules, and regulations, and SRO rules, and a reduction
in the proportion of examinations that might not have been necessary if
a more complete view of the market participant's activity had been
available. Compliant market participants could benefit from a reduction
in the relative frequency of burdensome examinations. Improvements in
the breadth and effectiveness of risk-based examination would help
protect investors by increasing the likelihood of identifying market
participants who are violating laws, rules and regulations.
Second, the Commission preliminarily believes that with the CAT,
regulators would be able to examine market participants more
effectively. In particular, regulators would be able to conduct certain
types of exams more efficiently because of the inclusion of Customer-
IDs in CAT. In addition, direct access to CAT Data would provide
examination Staff with the ability to conduct more analysis prior to
opening an examination because data would be available without the need
to make a formal data request. In addition, the clock synchronization
provisions of the Plan could aid regulators in sequencing some events
more accurately, thereby facilitating more informed exams.\740\ In sum,
the Plan would allow the data collection portion of examinations to be
completed more quickly with fewer formal data requests. More efficient
examinations would help regulators better protect
[[Page 30699]]
investors from the violative behavior of some market participants and
could reduce examination costs for market participants who would have
otherwise faced examinations that are less focused and more lengthy.
---------------------------------------------------------------------------
\740\ See Sections IV.D.2.b(2), supra and IV.H.2.a(1), infra.
---------------------------------------------------------------------------
(3) Enforcement Investigations
Many Commission enforcement actions involve trade and order
data.\741\ The Commission preliminarily believes that the improvements
in data qualities that would result from the CAT NMS Plan \742\ would
significantly improve the efficiency and efficacy of enforcement
investigations, including insider trading and manipulation
investigations. The Commission believes that more efficient and
effective enforcement activity is beneficial to both investors and
market participants because it deters violative behavior that degrades
market quality and that imposes costs on investors and market
participants.
---------------------------------------------------------------------------
\741\ See supra note 711 and accompanying text.
\742\ See Section IV.E.1, supra.
---------------------------------------------------------------------------
Dramatic expected benefits come from improvements to the accuracy,
accessibility, timeliness, and completeness of the data. As noted
above,\743\ compiling the data to support an investigation often
requires a tremendous amount of time and resources and requires
multiple requests to multiple data sources and significant data
processing efforts, for both SROs and the Commission. While individual
SROs have direct access to the data from their own markets, their
investigations often require access to the data of other SROs because
firms trade across multiple venues. Some enforcement investigations,
including those on insider trading and manipulation, require narrow
market reconstructions that allow investigators to view actions and
reactions across the market. Currently, the data fragmentation and the
time it takes to receive requested data, makes these market
reconstructions cumbersome and time-consuming. Further, new data fields
related to Customer information and the Allocation Reports should
improve the completeness of the data available to investigators.
---------------------------------------------------------------------------
\743\ See Sections IV.D.2.b(3) and IV.D.2.b(4), supra.
---------------------------------------------------------------------------
Under the CAT NMS Plan, the data for an enforcement investigation
initiated at least five days after an event would be processed, linked,
and available for analysis within 24 hours of a query, instead of the
current timeline of weeks or longer. Further, some of the data
processing steps that are now performed on an ad-hoc basis during an
investigation would be systematically performed by the Plan Processor
in advance.\744\ The availability of uncorrected data by noon on T+1
could improve the Commission's chances of preventing asset transfers
from manipulation schemes because regulators could use the uncorrected
data to detect the manipulation and identify the suspected
manipulators.\745\ These improvements could shorten the times required
to collect the data for investigations.
---------------------------------------------------------------------------
\744\ See Section IV.E.1.d(4), supra.
\745\ See Section IV.D.2.b(4), supra.
---------------------------------------------------------------------------
Other expected benefits stem from improvements in the accuracy and
completeness of the data. The inclusion and expected improvement in the
accuracy of customer identifying data could allow regulators to review
the activity of specific market participants more efficiently;
currently, identifying the activity of a single market participant
across the market is cumbersome and prone to error.\746\ This
information would be particularly helpful in identifying insider
trading, manipulation and other potentially violative activity that
depends on the identity of market participants. Customer information
could also be helpful to regulators in more efficiently identifying
investors who qualify for disgorgement proceeds and in estimating such
disgorgement proceeds.
---------------------------------------------------------------------------
\746\ See Section IV.D.2.b(2)D, supra.
---------------------------------------------------------------------------
The Commission also believes that increasing the proportion of
market events that could be sequenced under the CAT NMS Plan could
yield some benefits in enforcement investigations, improving
investigations of insider trading, manipulation, and compliance with
Rule 201 of Regulation SHO and Rule 611 of Regulation NMS.\747\ The
expected improvements in completeness could also benefit investigations
by allowing regulators to observe in a consolidated data source
relevant data that are not available in some or all current data
sources, including time stamps, principal orders, non-member activity,
allocations, and the identification of whether a trade increases or
decreases an existing position. This data could be important, for
example, when investigating allegations of market manipulation or
cherry-picking in subaccount allocations. Having disaggregated
information about allocations and issuer repurchases also could
facilitate new ways to investigate allegations of unfair allocations
and new ways to investigate and monitor manipulation through issuer
repurchases.
---------------------------------------------------------------------------
\747\ Again, benefits associated with the ability to sequence
events may be limited in some cases because many order events would
not be able to be sequenced completely with the standards
established in the CAT NMS Plan. See Section IV.D.2.b(2)B.i, supra.
---------------------------------------------------------------------------
(4) Tips and Complaints
The Commission preliminarily believes that the CAT NMS Plan would
improve the process for evaluating tips and complaints by allowing
regulators to more effectively triage tips and complaints, which could
focus resources on behavior that is most likely to be violative.\748\
The SROs and Commission evaluate thousands of tips and complaints
regarding trading behavior each year. In fiscal years 2014 and 2015,
the Commission received around 15,000 entries in its TCR system,
approximately one third of which related to manipulation, insider
trading, market events, or other trading and pricing issues. As stated
in the Baseline Section, the analysis of tips and complaints follows
three general stages. The Commission expects that the Plan would
improve the second and third stages, the third in ways described in the
Examinations and Enforcement Investigations Sections.\749\ The second
stage in the evaluations of tips, which help regulators determine the
credibility of a tip or complaint, is limited by a lack of direct
access to the most useful data; specifically, customer information and
cross-market data.\750\ The availability of the CAT Data would
drastically increase the detail of data available to regulators for the
purposes of tip assessment. This access would assist the SROs and
Commission in identifying which tips and complaints are credible, would
help ensure that regulators open investigations or examinations on
credible tips and complaints, and would limit regulatory resources
spent on unreliable tips and complaints. Likewise, regulated market
participants would likely benefit from a reduction in unnecessary
burdens placed upon them by inquiries that are related to tips that the
CAT Data could show are not credible.
---------------------------------------------------------------------------
\748\ See SEC Office of the Whistleblower, What Happens to Tips,
https://www.sec.gov/about/offices/owb/owb-what-happens-to-tips.shtml.
\749\ See Sections IV.D.2.a(4), supra.
\750\ Cross-market data is especially key to market manipulation
complaints, because regulators may need to examine a broad range
data to see if a complaint is valid.
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3. Other Provisions of the CAT NMS Plan
The Commission notes that there are a number of provisions of the
CAT NMS Plan that provide for features that are uniquely applicable to
a consolidated audit trail or otherwise lack a direct analog in
existing data systems.
[[Page 30700]]
Therefore, rather than analyze the benefits of these provisions as
compared to existing NMS Plans or data systems, the Commission has
analyzed these provisions in comparison to a CAT NMS Plan without these
features. The Commission preliminarily believes that these provisions
of the CAT NMS Plan increase the likelihood that the potential benefits
of the CAT NMS Plan described above would be realized.
a. Future Upgrades
Several provisions in the Plan seek to ensure that the CAT Data
would continually be updated to keep pace with technological and
regulatory developments. For example, the Plan would require that the
Chief Compliance Officer review the completeness of CAT Data
periodically,\751\ that the Central Repository be scalable to
efficiently adjust for new requirements and changes in
regulations,\752\ and that Participants provide the SEC with a document
outlining how the Participants could incorporate information on select
additional products and related Reportable Events.\753\ The Commission
preliminarily believes that these provisions would allow the CAT to be
updated if and when the applicable technologies and regulations change.
---------------------------------------------------------------------------
\751\ See CAT NMS Plan supra note 3, at Sections 4.12(b)(ii),
6.2(a)(v)(E). The Chief Compliance Officer would be required to
perform reviews on matters including the completeness of information
submitted to the Plan Processor or Central Repository and report
findings periodically to the Operating Committee.
\752\ See id. at Appendix D, Section 1.1.
\753\ See id. at Section 6.11. This document is due within six
months of the Effective Date of the CAT NMS Plan.
---------------------------------------------------------------------------
Specifically, Rule 613(b)(6)(ii) and (iii) require that the Plan
include a provision requiring a report at least every two years that
details potential improvements in the CAT, such as incorporating new
technology to improve system performance. Such a report would also
include the costs of any such improvements. The CAT NMS Plan delegates
responsibility for the report to the Chief Compliance Officer.
Section 6.1(d)(iv) of the Plan, with respect to new functionality,
requires the Plan Processor to ``design and implement appropriate
policies and procedures governing the determination to develop new
functionality for the CAT including, among other requirements, a
mechanism by which changes can be suggested by Advisory Committee
members, Participants, or the SEC,'' as well as providing for the
escalation of reviews of proposed technological changes and upgrades to
the Operating Committee, and for addressing the handling of
surveillance.
With respect to upgrades to maintain existing functionality, the
Plan Processor could evaluate and implement potential system changes
and upgrades to maintain and improve the normal day-to-day operating
function of the CAT System; material system changes and upgrades are to
be performed by the Plan Processor in consultation with the Operating
Committee.\754\ The Plan Processor may on its own discretion initiate
changes or upgrades to ensure compliance with applicable legal
requirements.\755\ Regular reports on the operations and maintenance of
the CAT System are to be provided by the Plan Processor to the
Operating Committee, including reports on system improvements
contemplated in Appendix D, Upgrade Process and Development of New
Functionality.\756\
---------------------------------------------------------------------------
\754\ See id. at Section 6.1(j).
\755\ See id. at Section 6.1(k).
\756\ See id. at Section 6.1(o).
---------------------------------------------------------------------------
Section 11 of Appendix D sets out the obligations of the Plan
Processor with respect to the requirements discussed above (e.g., to
develop a process to add functionality to CAT, including reviewing
suggestions submitted by the SEC). The Plan Processor must create a
defined process for developing impact assessments, including
implementation timelines for proposed changes, and a mechanism by which
functional changes that the Plan Processor wishes to undertake could be
reviewed and approved by the Operating Committee. The Plan Processor
``shall not unreasonably withhold, condition, or delay implementation
of any changes or modifications reasonably requested by the Operating
Committee.'' \757\ There must be a similar process to govern the
changes to the Central Repository discussed above--i.e., business-as-
usual changes that could be performed by the Plan Processor with only a
summary report to the Operating Committee, versus infrastructure
changes that would require approval by the Operating Committee.\758\
Finally, a process for user testing of new changes must be developed by
the Plan Processor.\759\
---------------------------------------------------------------------------
\757\ See id. at Appendix D, Section 11.1.
\758\ See id at Appendix D, Section 11.2.
\759\ See id. at Appendix D, Section 11.3.
---------------------------------------------------------------------------
Appendix C notes that the Plan Processor must ensure that the
Central Repository's technical infrastructure is scalable (to increase
capacity to handle increased reporting volumes); adaptable (to support
future technology developments so that new requirements could be
incorporated); and current (to ensure, through maintenance and
upgrades, that technology is kept current, supported, and
operational).\760\
---------------------------------------------------------------------------
\760\ See id. at Appendix C, Section A.5(a).
---------------------------------------------------------------------------
These provisions are designed to ensure that the Participants
consider enhancing and expanding CAT Data shortly after initial
implementation of the CAT NMS Plan and that the Participants consider
improvements regularly continuing forward. The Commission preliminarily
expects that, in addition to these provisions, the CCO review would
further facilitate proactive expansion of CAT to account for a
regulatory change or change in how the market operates, or should there
be a need for regulators to have access to new order events or new
information about particular order events. To the extent that the
Participants determine that an expansion is necessary and it is
approved by the Commission, the Plan's scalability provision promotes
the efficiency of the implementation of that expansion such that it
could be completed at lower cost and/or in a timely manner.
Taken together, these provisions could also provide a means for the
Commission to ensure that improvements to CAT functionality are
considered so as to preserve its existing benefits, or that expansion
of CAT functionality is undertaken in order to create new benefits.
These methods are not certain, but the Commission does retain the
ability to modify the Plan, if such a step becomes necessary to ensure
that future upgrades are undertaken as necessary.\761\ Moreover, the
focus on scalability, adaptability, and timely maintenance and upgrades
promotes a system that could be readily adapted over time, versus one
that is difficult or costly to expand or modify. The Commission
preliminarily believes that the provisions outlined above would allow
the CAT Data to be continually updated to keep pace with technological
and regulatory developments.
---------------------------------------------------------------------------
\761\ See 17 CFR 242.608.
---------------------------------------------------------------------------
b. Promotion of Accuracy
The Commission notes that the Plan contains specific provisions
designed to generally promote the accuracy of information contained in
the Central Repository. The CCO is required, among other
responsibilities, to perform reviews related to the accuracy of
information submitted to the Central Repository and report to the
Operating Committee with regard thereto,\762\ and there is a special
Compliance Subcommittee of the Operating
[[Page 30701]]
Committee, which is established to aid the CCO with regard to, among
other things, issues involving the accuracy of information.\763\ The
Plan also contains certain other provisions intended to monitor and
address Error Rates.\764\
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\762\ See CAT NMS Plan, supra note 3, at Section 6.2(a)(v)(E).
\763\ See id. at Section 4.12(b).
\764\ See id. at Appendix C, Section A.3(b).
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The Operating Committee is responsible for adopting policies and
procedures regarding the accuracy of CAT Data, which the Plan Processor
shall be responsible to implement.\765\ The Plan Processor in turn must
provide regular reports regarding accuracy issues to the Operating
Committee, specifically Error Rates relating to the Central Repository,
including (to the extent the Operating Committee deems necessary or
advisable) Error Rates by day, changes in the Error Rates over time,
and Compliance Thresholds by CAT Reporter, by Reportable Event, by age
before resolution, by symbol, by symbol type, and by event time. The
Plan documents an initial Error Rate tolerance of 5%, but requires
that, at least annually, the Plan Processor review the Error Rates and
make recommendations to the Operating Committee for proposed changes to
the maximum Error Rate; and requires that the Operating Committee set
and periodically review the maximum Error Rate.\766\
---------------------------------------------------------------------------
\765\ See id. at Section 6.5(d).
\766\ See id. at Section 6.5(d)(i).
---------------------------------------------------------------------------
Under the Plan, the Plan Processor would also provide details to
each CAT Reporter on the number of rejected records and the reasons for
their rejection on a daily basis. And on a monthly basis, the Plan
Processor would publish report cards that would allow CAT Reporters to
compare their Error Rates with those of industry peers; this is similar
to the process used by FINRA for OATS reporting. The Plan Processor
would notify each CAT Reporter that exceeds the maximum Error Rate, and
provide the specific reporting requirements that they did not fully
meet. Participants and the SEC could request reports on Error Rates
from the Plan Processor. The Plan Processor would also provide
statistics on each CAT Reporter's Compliance Thresholds--the CAT
Reporter's specific Error Rate, which could serve as the basis for a
review or investigation into the CAT Reporter's performance by the
Participants or the SEC for failure to comply with CAT reporting
obligations--to the Participants or the SEC.
In addition to providing CAT Reporters data on their Error Rates,
the Plan states that the Participants believe that in order to meet
Error Rate targets, industry would require certain resources, including
a stand-alone testing environment, and time to test their reporting
systems and infrastructure. The Technical Specifications must also be
well-written and effectively communicated to CAT Reporters with
sufficient time to allow proper systems updates.\767\ Finally, the Plan
notes that reporters may be subject to penalties or fines for excessive
Error Rates, to be defined by the Operating Committee.\768\
---------------------------------------------------------------------------
\767\ See id. at Appendix C, Section A.3(b).
\768\ See id. at Appendix C, Section A.3(b), n.101.
---------------------------------------------------------------------------
The Commission preliminarily believes that these provisions to
document Error Rates and promote data accuracy are reasonably designed
to improve the overall accuracy of CAT Data relative to the exclusion
of such provisions; however, the Commission also preliminarily believes
that certain procedures outlined in the Plan may not incentivize all
firms to further improve the quality of the data they report. The
Commission recognizes that providing feedback to individual CAT
Reporters on their individual Error Rates and information that compares
Error Rates to industry peers could motivate firms with high Error
Rates to reduce those rates, to avoid accruing penalties and fines
associated with being a high Error Rate CAT Reporter.\769\ However, it
is not clear what incentive, if any, would be provided to firms with
median Error Rates to improve their regulatory data reporting
processes; this could collectively limit industry's incentives to
reduce Error Rates. Furthermore, the Commission notes that, under the
Plan, proposals to adjust the maximum allowable Error Rate are to
originate from the Plan Processor. The Commission preliminarily
believes that the Participants (as data users) have incentives to
pursue lower Error Rates as data errors could complicate their efforts
to perform their regulatory responsibilities. However, the Commission
preliminarily believes that the Plan Processor would also have to
allocate resources to error resolution, so could be incentivized to
pursue Error Rate reduction.
---------------------------------------------------------------------------
\769\ The Commission understands that OATS has an analogous
feedback system, but not all current data sources have such a
system.
---------------------------------------------------------------------------
The Commission notes that the Plan includes provisions requiring
the establishment of a symbology database that will also foster
accuracy. The Plan requires the Central Repository to create and
maintain a symbol history and mapping table, as well as provide a tool
to regulators and CAT Reporters showing the security's complete symbol
history, along with a start of day and end of day list of reportable
securities for use by CAT Reporters, in .csv format, by 6:00 a.m. on
each trading day.\770\ This resource will assist regulators in
accurately identifying all trading activity of securities across
venues, many of which do not natively follow listing exchange
symbology.
---------------------------------------------------------------------------
\770\ See CAT NMS Plan, supra note 3, at Appendix D, Section 2.
---------------------------------------------------------------------------
Regarding the Plan's business clock synchronization requirements,
the Plan also discusses the expectation that Participants and their
Industry Members will each be required to maintain a five-year running
log, or comparable procedure, documenting the time of each clock
synchronization performed and the result of such synchronization. These
practices would reveal the parameters of any discrepancies, between
Business Clocks and NIST, that exceed 50 milliseconds.\771\ As
mentioned above, there is currently uncertainty regarding clock
offsets, clock drift, and synchronization practices of Participants and
Industry Members and the required practice of systematically
maintaining five-year logs regarding these details should improve
regulatory and industry understanding of these dynamics, which should
provide a clearer foundation for evaluating the standards set in the
Plan upon which future improvements could be considered.
---------------------------------------------------------------------------
\771\ Id. at Appendix C, Section A.3(c).
---------------------------------------------------------------------------
c. Promotion of Timeliness
In addition to the specific timeliness benefits discussed in the
foregoing Sections, the Plan contains some provisions that promote
performance of the Central Repository, and that therefore could
indirectly improve the timeliness of regulator access to or use of the
CAT Data. These are found in capacity requirements for the Plan
Processor, disaster recovery requirements to ensure the availability of
the system, and in supervision and reporting of timeliness issues.
Specifically, first, the Plan Processor must measure and monitor
Latency within the Central Repository's systems, must establish
acceptable levels of Latency with the approval of the Operating
Committee, and must establish policies and procedures to ensure that
data feed delays are communicated to CAT Reporters, the Commission, and
Participants' regulatory Staff.\772\ The Plan further provides that
``[a]ny delays will be
[[Page 30702]]
posted for public consumption, so that CAT Reporters may choose to
adjust the submission of their data appropriately. . . .'' \773\ The
Plan Processor must also provide relevant parties, as well as to the
public, with approximate timelines provided for system
restoration.\774\ Moreover, the Central Repository is required to be
designed to meet certain capacity standards, including handling above-
peak submission volumes, storing data for a sliding 6 year window (more
than 29 petabytes of raw, uncompressed data), and the ability to add
capacity quickly and seamlessly if needed.\775\
---------------------------------------------------------------------------
\772\ See CAT NMS Plan, supra note 3, at Appendix D, Section
8.3.
\773\ Id.
\774\ Id.
\775\ See id. at Appendix D, Section 1.3.
---------------------------------------------------------------------------
Second, the Plan Processor must develop disaster recovery and
business continuity plans to support the continuation of CAT business
operations.\776\ Business continuity planning must include a secondary
site for critical staff, capable of recovery and restoration of
services within 48 hours, with the goal of next day recovery.\777\ The
secondary site must have the same level of availability, capacity,
throughput and security (physical and logical) as the primary site--
i.e., it must be fully redundant.\778\ Thus, in the event of a
widespread disruption, delays to CAT processing and regulator access to
CAT of greater than a day or two could likely be prevented.
---------------------------------------------------------------------------
\776\ See id. at Appendix D, Sections 5.3-5.4.
\777\ Id.
\778\ Id.
---------------------------------------------------------------------------
Third, the Chief Compliance Officer of the Plan Processor must
conduct regular monitoring of the CAT System for compliance, including
with respect to the reporting and linkage requirements in Appendix
D.\779\ Moreover, the Plan Processor must provide the Operating
Committee with regular reports on the CAT System's operations and
maintenance, including its capacity and performance, as set out in
Appendix D.\780\
---------------------------------------------------------------------------
\779\ See id. at Section 6.2(a)(v)(J).
\780\ See id. at Section 6.1(o)(i).
---------------------------------------------------------------------------
Finally, one caveat on the foregoing discussion is that system
performance would in part be dependent on a series of SLAs to be
negotiated between the Plan Participants and the eventual Plan
Processor, including with respect to linkage and order event processing
performance, query performance and response times, and system
availability.\781\ As these have not yet actually been negotiated, some
of the key timeliness benefits anticipated to accrue from
implementation of the Plan could be subject to the successful
negotiation on an acceptable basis of the terms of the SLAs.
---------------------------------------------------------------------------
\781\ See id. at Appendix D, Section 8.5.
---------------------------------------------------------------------------
d. Operation and Administration of the CAT NMS Plan
There are certain elements of the CAT NMS Plan's governance that,
like the other factors discussed in this subsection, are uniquely
applicable to a consolidated audit trail, and that the Commission
therefore analyzed in comparison to a CAT NMS Plan without these
features (or that implements those features in a different way). The
Commission preliminarily believes that these provisions of the CAT NMS
Plan increase the likelihood that the potential benefits of the CAT NMS
Plan described above would be realized.
(1) Introduction
In adopting Rule 613, the Commission established certain
requirements for the governance of the CAT NMS Plan, stating that those
``requirements are important to the efficient operation and practical
evolution of the [CAT], and are responsive to many commenters' concerns
about governance structure, cost allocations, and the inclusion of SRO
members as part of the planning process.'' \782\ The Commission did
not, in Rule 613, establish detailed parameters for the governance of
the CAT NMS Plan, but rather allowed the SROs to develop specific
governance provisions, subject to a small number of requirements.
Recognizing that Rule 613 left Plan Participants with wide latitude to
determine how to structure the Plan's governance, the Commission in the
Adopting Release also stated that ``[a]fter the SROs submit the NMS
plan, the Commission and the public will have more detailed information
in evaluating the NMS plan.'' \783\
---------------------------------------------------------------------------
\782\ See Adopting Release, supra note 9, at 45787.
\783\ Id. at 45787-45788.
---------------------------------------------------------------------------
The Plan's governance is described in greater detail in Section
III.A.3. above, but generally consists of a Delaware LLC, which is to
``create, implement, and maintain the CAT and the Central Repository,''
and which is to be managed by the Operating Committee, consisting of
one voting representative of each SRO Participant. The Operating
Committee acts by majority or Supermajority Vote, depending on the
issue. An Advisory Committee that includes a mix of broker-dealers, as
required by Rule 613, is to ``advise the [Operating Committee] on the
implementation, operation and administration of the central
repository.'' \784\ These features are analyzed in greater detail
below.
---------------------------------------------------------------------------
\784\ See Rule 613(b)(7). Whereas Section 4.13(b) requires that
the Operating Committee select representatives of different types of
broker-dealers, it specifies that Advisory Committee representatives
would ``serve on the Advisory Committee on behalf of himself or
herself individually and not on behalf of the entity for which the
individual is then currently employed.'' See CAT NMS Plan, supra
note 3, at Section 4.13(b).
---------------------------------------------------------------------------
The Commission preliminarily believes that the governance
provisions identified in the Adopting Release continue to be important
to the efficient operation and practical evolution of the Plan,
particularly given that there are a range of possible outcomes with
respect to both the costs and benefits of the Plan that depend on
future decisions. The way in which the identified governance provisions
have been incorporated into the Plan, as discussed in greater detail
below, could help facilitate better decision-making by the relevant
parties. This, in turn, means that the Commission could have greater
confidence that the benefits resulting from implementation of the Plan
would be achieved in an efficient manner and that costs resulting from
inefficiencies would be avoided.
The Commission notes that it can monitor whether the benefits of
CAT are being achieved. For example, certain Operating Committee
actions are subject to Commission approval.\785\ The Commission also
retains the ability to modify the Plan as it may deem necessary or
appropriate.\786\ To enable the Commission to exercise its oversight
authority in an informed manner and to make its views known,
representatives of the Commission are permitted to attend meetings of
the Operating Committee, although the Commission representatives may be
excluded from Operating Committee Executive Sessions.\787\ Moreover,
the Commission is entitled to receive information regarding the
performance of the Central Repository, including a Regular Written
Assessment of the operation of the Central Repository at least every
two years, or more frequently in connection with any review of the Plan
Processor's performance. The assessment would cover the performance
metrics specified in Rule 613(b)(6)(i).\788\ The Commission
[[Page 30703]]
is also entitled to receive any reports prepared in connection with the
Operating Committee's annual performance review of the Plan
Processor.\789\
---------------------------------------------------------------------------
\785\ See CAT NMS Plan, supra note 3, at Section 4.3 (stating
that actions authorized by Majority and Supermajority Vote of the
Operating Committee are subject to approval by the Commission
whenever such approval is required under the Exchange Act and the
rules thereunder).
\786\ See 17 CFR 242.608(b)(2).
\787\ See CAT NMS Plan, supra note 3, at Section 4.4(a).
\788\ See 17 CFR 242.613(b)(6)(i). Rule 613(b)(6) requires the
Participants to provide the Commission with a written assessment of
operation of the CAT at least every two years, along with a detailed
plan, based on the assessment, that indicates any potential
improvements to the performance of the CAT and includes an estimate
of the costs and potential impacts of such improvements on
competition, efficiency and capital formation, as well as an
estimated implementation timeline for such potential improvements.
\789\ See CAT NMS Plan, supra note 3, at Section 6.1(n). The
review may be more frequent than annually if at the request of two
non-affiliated Participants. The Commission also has other means of
accessing information (e.g., through books & records requirements).
---------------------------------------------------------------------------
(2) Key Factors Relating to Governance
Two factors identified by the Commission in the Adopting Release as
``important to the efficient operation and practical evolution of the
[CAT]'' are voting within the Operating Committee and the role and
composition of the Advisory Committee. Voting thresholds that result in
Operating Committee decision-making that balances the ability of
minority members to have alternative views considered with the need to
move forward when appropriate to implement needed policies can promote
achievement of the Plan's benefits in an efficient manner. Similarly,
an Advisory Committee that is balanced in terms of membership size and
composition, as well as in its ability to present views to the
Operating Committee, can result in better performance of its
informational role, and thus more efficient achievement of the benefits
of the Plan.
A. Voting
In adopting Rule 613, the Commission found that one Commenter's
concerns about unanimous voting in the context of the CAT NMS Plan
``have merit.'' Specifically, the Commission stated that ``an alternate
approach'' to voting involving ``the possibility of a governance
requirement other than unanimity, or even super-majority approval, for
all but the most important decisions'' should be considered, as it
``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.'' \790\ The Commission ``urge[d] the SROs to take into
account the need for efficient and fair operation of the NMS Plan
governing the consolidated audit trail'' in setting voting
thresholds.\791\
---------------------------------------------------------------------------
\790\ See Adopting Release, supra note 9, at 45787.
\791\ Id.
---------------------------------------------------------------------------
The Plan sets forth two voting thresholds for most matters to be
decided by the Operating Committee.\792\ Majority approval of the
Operating Committee is sufficient to approve routine matters, arising
in the ordinary course of business, while non-routine matters, outside
the ordinary course of business, would require a supermajority (two-
thirds) vote of the Operating Committee to be approved.\793\
---------------------------------------------------------------------------
\792\ As noted in Section IV.G.4, infra, the Plan requires
unanimous voting in only three circumstances: A decision to obligate
Participants to make a loan or capital contribution, a decision to
dissolve the Company, and a decision to take an action by written
consent instead of a meeting.
\793\ See CAT NMS Plan, supra note 3, at Section 4.3; Appendix
C, Section B.8(d). (specifying actions of the Operating Committee
that require a Supermajority Vote); see also id. at Appendix C,
Section D.11(b).
---------------------------------------------------------------------------
The Plan generally eschews a unanimous voting threshold, except for
the three clearly-defined circumstances noted above. Unanimity as a
voting threshold may confer greater influence on holders of minority
views, but it may also give a small faction the ability to extract
private benefits inconsistent with Plan objectives by acting as
holdouts.\794\ In a hold-out dynamic, one member may be able to block
action that all the other members agree should move forward. While this
dynamic may occasionally be used productively, to produce better
decision-making through fostering discussion and compromise, it also
may give one member the power to stand in the way of needed change.
---------------------------------------------------------------------------
\794\ There are other governance-related trade-offs for majority
voting versus supermajority voting; these are discussed in greater
detail in the Plan. See CAT NMS Plan, supra note 3, at Appendix C,
Sections B.8(d) and D.11(b).
---------------------------------------------------------------------------
The ability of a single member to prevent action with regard to the
Plan could be particularly troublesome if that member were motivated by
a conflict of interest.\795\ The Plan requires recusal of the member
representing such a Participant from voting in the Operating Committee
on matters that raise a conflict of interest, defined as any matter
subject to a vote that interferes, or is reasonably likely to
interfere, with the member's objective consideration of the matter, or
that is, or would reasonably likely be, inconsistent with the
regulatory purpose and objectives of CAT.\796\ Recusal of a member
could also be compelled by a supermajority of the Operating
Committee.\797\ If conflicts of interest were the cause of all
unproductive holding-out (i.e., holding out that does not contribute to
better decision-making), then a robust conflict of interest provision
could mitigate some of the negative features of unanimous voting.
---------------------------------------------------------------------------
\795\ That there are potential conflicts of interest between
Participants acting in their self-regulatory capacities and
Participants acting in the other capacities in which they serve is
well-documented; see, e.g., Peter M. DeMarzo, Michael J. Fishman,
and Kathleen M. Hagerty, ``Self-Regulation and Government
Oversight,'' 72 Review of Economic Studies 687 (2005); see also
David Reiffen and Michel Robe, ``Demutualization and Customer
Protection at Self-Regulatory Financial Exchanges,'' Journal of
Futures Markets (2011) and Securities Exchange Act Release No. 50700
(November 18, 2004), 69 FR 71256 (December 8, 2004) (Concept Release
Concerning Self-Regulation); John W. Carson, Conflicts of Interest
in Self-Regulation: Can Demutualized Exchanges Successfully Manage
Them? (World Bank Policy Research Working Paper 3183, December
2003). These conflicts could be further complicated if the
individual employee of the Participant SRO who represents the
Participant SRO on the Operating Committee sought to advance a
private gain for the individual employee that is inconsistent with
the Plan's regulatory objective or the objective of the Participant
SRO. Indeed, the idea that an agency conflict between a natural
person and the entity that the person represents has been discussed
extensively in the academic literature on the governance of
corporations; see, e.g., Jonathan Berk and Peter DeMarzo, 2011,
Corporate Finance, Second Edition, Prentice Hall (Section 2.1:
Corporate Governance and Agency Costs).
\796\ See CAT NMS Plan, supra note 3, at Section 4.3(d) (recusal
requirement) and Section 1.1 (definition of Conflict of Interest).
Section 4.3(d) also automatically recuses a member from voting with
respect to matters relating to the selection or removal of the Plan
Processor if they or their affiliates are, or are bidding to be, the
Plan Processor. Id.
\797\ See CAT NMS Plan, supra note 3, at Section 4.3(d).
---------------------------------------------------------------------------
Majority voting as a voting threshold strikes a different balance
between the rights of members than does unanimous voting. Majority
voting avoids the hold-out problem of unanimity, but can result in
decisions that bear less concern for the interests of the minority
members. Whether it does so or not may depend at least in part on
voting dynamics on the Operating Committee. Under the Plan, each member
has only one vote within the Operating Committee, and so an individual
member--and represented Participant--could not unilaterally advance a
position that benefits only the Participant under the Plan. That said,
however, some individual members could exercise more influence than
others over the outcome of the voting process. Participant SROs that
are affiliated with one another could vote as a bloc by designating a
single individual to represent them on the Committee.\798\ Individuals
who represent more than one SRO would then in principle
[[Page 30704]]
exercise more influence than other individuals on the Operating
Committee.\799\ The Chair of the Operating Committee also could
exercise more influence than other members on the Committee, even
though the Chair only has one vote, through influence over Committee
processes.\800\ Ultimately, however, no individual would have
unilateral control over vote outcomes, even at a majority voting
threshold. Whether the threshold results in adequate attention to the
rights of minority members could therefore depend on the ease with
which a majority coalition can be formed, whether those coalitions are
fluid or static, and whether in practice decision-making is collegial
or contentious. While majority voting could pose a risk of disregard
for minority positions, that risk here is mitigated in that majority
voting only applies to the less important matters that could arise in
the operations of the Plan.
---------------------------------------------------------------------------
\798\ See CAT NMS Plan supra note 3, at Section 4.2(a) (``One
individual may serve as the voting member of the Operating Committee
for multiple Affiliated Participants, and such individual shall have
the right to vote on behalf of each such Affiliated Participant.'')
Even if separate representatives were appointed for each voting
member, such individuals could agree to vote in a bloc; see also
Section IV.G.1, infra, (discussing how many affiliated groups would
need to vote together to reach a majority or supermajority).
\799\ By enabling a single individual (i.e., natural person) to
vote on behalf of groups of Affiliated Participant SROs, the Plan
reduces the share and number of individuals needed to approve a
committee action below the share and number of votes required for
approval. For example, as few as two individuals (who would possess
more than one-third of member votes) may be sufficient to block an
action that requires a two-thirds (a supermajority) vote for
approval of an action of the Operating Committee under the Plan.
This casting of multiple votes by a single group is limited for some
decisions under the Plan, however. See CAT NMS Plan, supra note 3,
at Section 4.4(a) (Meetings of the Operating Committee: special and
emergency meetings); see also Section IV.G.1, infra (discussing, in
n.1077, the various affiliated exchanges among the 20 members of the
Operating Committee, which could appoint a single individual to
represent them).
\800\ Specifically, see CAT NMS Plan, supra note 3, Section
4.2(b) which establishes that there shall be elected a Chair from
among the members of the Operating Committee, and states that the
Chair's powers are those that the Operating Committee may from time
to time prescribe. For example, the Chair may be granted the power
to set the agenda of Operating Committee meetings, and thereby
advance agenda items favorable to the Chair. Id. Section 4.2(b) also
specifies that the Chair is not entitled to a tie-breaking vote and
that the Chair may be removed by Supermajority Vote of the Operating
Committee.
---------------------------------------------------------------------------
The Plan's supermajority voting requirement for more important
matters represents an intermediate ground between majority and
unanimous voting, requiring more than a bare majority of members to
agree to support a position, which therefore enhances the ability of
members of the minority to seek to have their views reflected in the
ultimate decision, while limiting the ability of minority members to
act as holdouts. That said, the supermajority voting requirement may
also have some disadvantages: To the extent that rules and practices
already in place require correction, a supermajority voting requirement
may make it more difficult to assemble the votes necessary to make
needed changes. For example, supermajority voting could have the
indirect effect of locking in the preferred business practices of the
inaugural members of the Operating Committee. For decisions later in
the Plan implementation, this lock-in effect of supermajority voting
could make it more difficult for the Operating Committee to take non-
routine actions, such as replacing the Plan Processor after the initial
selection decision.\801\
---------------------------------------------------------------------------
\801\ See id. at Section 4.3(i). Supermajority voting as a
governance mechanism in the CAT NMS plan is distinct from an
analysis of supermajority voting rules in other settings.
---------------------------------------------------------------------------
B. Advisory Committee
Rule 613(b)(7) requires that the Plan designate an Advisory
Committee.\802\ Specifically, Rule 613(b)(7) calls for the formation of
an Advisory Committee to advise the plan sponsors on the
implementation, operation, and administration of the Central
Repository, as detailed above in Section III.A.3 of this Notice.\803\
Under Rule 613(b)(7)(i), the Advisory Committee must include
representatives of member firms of the plan sponsors (broker-dealers),
acting in their own capacities as individuals on the Committee. Under
Rule 613(b)(7)(ii), plan sponsors must give members of the Committee
access to information and permit them to express their views and attend
meetings of the Operating Committee. Also under Rule 613(b)(7)(ii), the
Operating Committee has the right to exclude members of the Advisory
Committee from its deliberations by meeting in Executive Session by a
Majority Vote of its members.
---------------------------------------------------------------------------
\802\ 17 CFR 242.613(b)(7).
\803\ See Section III.A.3 (Requirements Pursuant to Rule
608(a)), supra; see also Section IV.G.4.a, infra, for a discussion
of the effects of the Advisory Committee on the efficiency of the
Plan.
---------------------------------------------------------------------------
The Adopting Release states that the ``provision requiring the
creation of an Advisory Committee, composed at least in part by
representatives of the plan sponsors,'' was ``[i]n response to the
comment requesting that the broker-dealer industry receive a `seat at
the table' regarding governance of the NMS plan.'' \804\ In addition,
the Commission ``encourage[d] 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.'' Rule 613 does not
give broker-dealers a vote on the Operating Committee itself. In the
Adopting Release, the Commission stated that the structure of Rule 613
as adopted ``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 [CAT] 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.''
---------------------------------------------------------------------------
\804\ See Adopting Release, supra note 9, at 45786.
---------------------------------------------------------------------------
In implementing these provisions of Rule 613, the Plan requires the
Advisory Committee to have diverse membership.\805\ Section 4.13 of the
Plan requires an Advisory Committee with a minimum of six broker-
dealers of diverse types and six representatives of entities that are
not broker-dealers.\806\ That is, five of twelve seats on the initial
Advisory Committee would be filled by representatives, respectively, of
the client of a registered broker or dealer, two types of institutional
investors, and two others with academic and regulatory expertise. Terms
of Advisory Committee members would not exceed three years, and
memberships would be staggered so that a third of the Committee would
be replaced each year.\807\
---------------------------------------------------------------------------
\805\ See CAT NMS Plan, supra note 3, Section 4.13(b).
\806\ See id. at Section 4.13(b)(i) through (xii).
\807\ See id. at Section 4.13(c).
---------------------------------------------------------------------------
The Commission believes that the Plan's provisions regarding the
Advisory Committee advance the goals of the Advisory Committee
articulated in the Adopting Release: To allow the Operating Committee
to receive the benefit of members' expertise with respect to ``expected
or unexpected operational or technical issues'' and ``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
burdens on SRO members.''
Given the primary purpose of the Advisory Committee as a forum to
communicate important information to the Operating Committee, which the
Operating Committee could then use to ensure its decisions are fully-
informed, the Plan's choices in implementing Rule 613 do reflect some
trade-offs. One factor in the ability of the Advisory Committee to
collect relevant information for the Operating Committee is the quality
and depth of the expertise, and the diversity of viewpoints, of the
Advisory
[[Page 30705]]
Committee's membership.\808\ A larger and more diverse Advisory
Committee may have better access to expertise and diversity of
viewpoints from among members for use in advising the Operating
Committee.\809\ But, members of a larger and more diverse Advisory
Committee would face potentially greater difficulties in working among
themselves to identify and convey the information that is available to
them. The Plan balances these considerations by providing the Advisory
Committee with sufficient membership to be able to generate useful
information and advice for the Operating Committee, while being at a
sufficiently low size and diversity level to permit the members to be
able to work together without undue obstacles that could otherwise
limit the Advisory Committee's effectiveness in conveying their
views.\810\
---------------------------------------------------------------------------
\808\ In a role similar to that of the Advisory Committee,
outsiders on corporate boards of directors can bring expertise and
independence to board actions, thereby enhancing board
effectiveness. Trade-offs in determining the optimum size and
composition of boards is the subject of extensive academic research.
For example, Lehn, Kenneth, Sukesh Patro, and Mengxin Zhao, 2009,
``Determinants of the size and structure of corporate boards: 1935-
2000,'' Financial Management, 747-780, consider the size and
composition of the board to be determined by trade-offs associated
with the information the directors bring to boards, which facilitate
their monitoring and advisory role, and the coordination costs and
free-rider problems associated with their presence. Harris, Milton
and Raviv, Artur, 2008, ``A Theory of Corporate Control and Size,''
21 Review of Financial Studies, 1797-1832, model the trade-off
between benefits of greater expertise that outside directors bring
versus the costs of an aggravated free-rider problem to arrive at
the optimum number of outside directors on the board. Collective-
action and communication problems can limit the effectiveness of a
board as it gains members as explored by Harris and Raviv (2008) and
Lehn, Patro, and Zhao (2009), in addition to Raheja, Charu, 2005.
``Determinants of Board Size and Composition: A Theory of Corporate
Boards,'' 40 Journal of Financial and Quantitative Analysis, 283-
306, and Yermack, David, ``Higher Market Valuation for Firms with a
Small Board of Directors,'' Journal of Financial Economics, XL
(1996), 185-211; see also Jerayr Haleblian and Sydney Finkelstein,
``Top Management Team Size, CEO Dominance, and Firm Performance: The
Moderating Roles of Environmental Turbulence and Discretion,'' The
Academy of Management Journal, Vol. 36, No. 4 (August, 1993), 844-
863.
\809\ For related literature that expressly examines trade-offs
and consequences of ``diverse'' boards, see Baranchuk, Nina, and
Phil Dybvig, 2009, ``Consensus in diverse corporate boards,'' Review
of Financial Studies 22(2), 715-747; and Malenko, Nadya, 2014,
``Communication and Decision-Making in Corporate Boards,'' Review of
Financial Studies 27(5), 1486-1532.
\810\ Another factor that may bear on the Advisory Committee's
ability to assemble a diverse range of views is the Plan's
provisions that Advisory Committee members sit in their individual
capacity, rather than as a representative of their employer. This
may give Advisory Committee members greater freedom to speak to
issues common to similarly-situated entities (e.g., large broker-
dealers), rather than potentially-idiosyncratic views of the
individuals' employers, which broader views in turn could better
inform the Operating Committee about issues or impacts associated
with the operation of the CAT.
---------------------------------------------------------------------------
Another factor in the ability of the Advisory Committee to advise
the Operating Committee is whether the Advisory Committee, having
assembled a diverse set of views, could effectively communicate those
views to the Operating Committee. Two Plan provisions, relating to the
staggering of member terms and the limits on participation of the
Advisory Committee under Rule 613(b)(7)(ii), bear on this
communication.\811\
---------------------------------------------------------------------------
\811\ See CAT NMS Plan, supra note 3, at Section 4.13(b) and
(c).
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First, the Plan provides for Advisory Committee members to serve
for staggered three-year terms in order to provide ``improved
continuity given the complexity of CAT processing.'' \812\ Staggering
of terms would prevent the entire Advisory Committee or large numbers
of its members from turning over in any given year, which could enhance
the cohesion of the Advisory Committee, and thereby its effectiveness
in communicating member viewpoints to the Operating Committee. Second,
the Plan gives the Advisory Committee varying roles with respect to the
different actions to be taken by the Operating Committee. While the
Advisory Committee members may attend meetings and submit views to the
Operating Committee on matters prior to a decision by the Operating
Committee, the Operating Committee may exclude Advisory Committee
members from Executive Sessions.\813\
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\812\ See id. at Section 4.13(c); Appendix C, Section D.11(b)
(``Governance of the CAT . . . Industry Members also recommended a
three-year term with one-third turnover per year . . . to provide
improved continuity given the complexity of CAT processing.'').
\813\ See CAT NMS Plan, supra note 3, at Section 4.13(d).
---------------------------------------------------------------------------
An additional factor that bears on the ability of the Advisory
Committee to advise the Operating Committee is a feedback loop: Whether
the Advisory Committee could receive sufficiently detailed information
on the operations of the Plan so that the Advisory Committee members
can, in turn, provide decision-useful information to the Operating
Committee. Here, the Plan specifies that the Advisory Committee has the
right to receive from the Operating Committee information necessary and
appropriate to the fulfillment of its functions, but that the scope and
content of the information is to be determined by the Operating
Committee.\814\ Thus, the Commission notes that the Operating Committee
could act to limit the effectiveness of the Advisory Committee--for
example, if the Operating Committee were to fail to provide Advisory
Committee members with notice of the items to be deliberated and voted
upon by the Operating Committee with sufficient time and particularity
for the Advisory Committee to be able to adequately fulfill its
function, or fail to provide other pathways for Advisory Committee
members to become aware of topics of interest or concern to the
Operating Committee.
---------------------------------------------------------------------------
\814\ Id. at Section 4.13(e).
---------------------------------------------------------------------------
One other determinant bears on the effectiveness of the Advisory
Committee in ensuring that the Operating Committee makes decisions in
light of diverse information--whether the Operating Committee actually
takes into account the facts and views of the Advisory Committee before
making a decision. Although the Plan expressly provides for Advisory
Committee input, it does not contain a mechanism--such as requiring the
Operating Committee to respond to the Advisory Committee's views,
formally or informally, in advance of or following a decision by the
Operating Committee--to ensure that the Operating Committee considers
the views of the Advisory Committee as a part of the Operating
Committee's decision-making process.
(3) Conclusion
The Commission preliminarily believes that the governance
provisions discussed above, which the Commission identified as being
``important to the efficient operation and practical evolution of the
[CAT], and . . . responsive to many commenters' concerns about
governance structure, cost allocations, and the inclusion of SRO
members as part of the planning process,'' could help promote better
decision-making by the relevant parties. These provisions thus could
mitigate concerns about potential uncertainty in the economic effects
of the Plan by giving the Commission greater confidence that its
expected benefits would be achieved in an efficient manner and that
costs resulting from inefficiencies would be avoided.
4. Request for Comment on the Benefits
The Commission requests comment on all aspects of the discussion of
the potential benefits of the CAT NMS Plan. In particular, the
Commission seeks responses to the following questions:
257. Do Commenters agree with the Commission's assessment of the
potential benefits of the CAT NMS Plan? Why or why not?
258. To what extent do the uncertainties related to future
decisions about Plan implementation impact the
[[Page 30706]]
assessment of potential benefits of the Plan? Please explain.
259. Do Commenters agree that the inclusion of the data fields in
one centralized data source in the CAT NMS Plan described above would
result in more complete data than what is currently available to
regulators? Which elements of the Plan would deliver improvements to
completeness? Are there any elements of the Plan that would degrade the
completeness of regulatory data? Please explain.
260. The Commission reviewed gap analyses that examine whether the
CAT Data would contain all important data elements in current data
sources \815\ and concluded that certain information is not included
(e.g., OATS data fields that allow off-exchange transactions to be
matched to their corresponding trade reports at trade reporting
facilities and certain EBS elements). Please identify any such data
elements that are missing under the Plan.
---------------------------------------------------------------------------
\815\ See SEC Rule 613--Consolidated Audit Trail (CAT) OATS--CAT
Gap Analysis and SEC Rule 613--Consolidated Audit Trail (CAT)
Revised EBS--CAT GAP Analysis, available at http://www.catnmsplan.com/gapanalyses/index.html. The Commission
acknowledges that the Participants are continuing to study gaps
between current regulatory data sources and the Plan as filed. CAT
NMS Plan, supra note 3, at Appendix C, Section C.9
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261. The Commission also seeks comment on the significance of the
gaps identified in the analyses. If there are particular fields that
are identified in the gap analyses that should not be incorporated into
CAT, please identify them and explain.
262. The Commission expects that, pursuant to the requirements of
the Plan,\816\ any missing elements that are material to regulators
would be incorporated into CAT Data prior to the retirement of the
systems that currently provide those data elements to regulators. Do
you agree? Why or why not? Do you agree that CAT Data would include the
audit trail data elements that currently exist in audit trail data
sources? Why or why not?
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\816\ The Plan requires that, prior to the retirement of
existing systems, the CAT Data must contain data elements sufficient
to ensure the same regulatory coverage provided by existing systems
that are anticipated to be retired. See CAT NMS Plan, supra note 3,
at Appendix D, Section 3.
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263. Do Commenters agree that the CAT NMS Plan would improve the
accuracy of the data available to regulators? Which elements of the
Plan would deliver these improvements? Are there any elements of the
Plan that would degrade the accuracy of regulatory data relative to
today? Are there any elements of the Plan that would prevent or limit
improvements in the accuracy of regulatory data? Are the provisions of
the Plan related to accuracy appropriate and reasonable in light of the
goal of improving data quality? Please explain.
264. Do Commenters believe that procedural protections in the Plan,
such as the requirement that the Technical Specifications be
``consistent with [considerations and minimum standards discussed in]
Appendices C and D,'' the requirement to provide the initial Technical
Specifications and any Material Amendments thereto to the Operating
Committee for approval by Supermajority Vote,\817\ and the requirement
that all non-Material Amendments and all published interpretations be
provided to the Operating Committee in writing at least ten days before
publication,\818\ can mitigate uncertainty regarding future decisions
and help promote accuracy? Please explain.
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\817\ Id. at Section 6.9(a). The Commission notes that the
standards in Appendices C and D do not cover all decisions that
would affect the accuracy of the data.
\818\ See CAT NMS Plan, supra note 3, at Section 6.9(c)(i).
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265. Do Commenters believe that the Error Rate, validations, and
error resolution processes described in the CAT NMS Plan would provide
improvements in accuracy? Are these processes appropriate and
reasonable in light of the goal of improving data quality? Please
explain.
266. The Plan specifies an error correction process after initial
reports are received and indicates that practically all errors
identifiable by the validations used in the error correction process
would be corrected by 8:00 a.m. Eastern Time on day T+5, stating that
errors are expected to be ``de minimis'' after the error correction
period.\819\ Do Commenters believe that this is a reasonable
conclusion? Please explain.
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\819\ See id. at Appendix C, Section A.3(b) n.102. ``De
minimis'' is not defined and no numerical Error Rate is given. The
Plan also includes a compliance program intended to help achieve
this goal.
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267. Do Commenters believe that the provisions in the CAT NMS Plan
related to event sequencing would provide improvements in accuracy? To
what degree does the 50 millisecond clock synchronization requirement
enable or prevent regulators' ability to sequence events that occur in
different Execution Venues? Are the provisions of the Plan related to
event sequencing appropriate and reasonable in light of the goal of
improving data quality? Please explain.
268. The Plan does not specify the approach that would be used to
sequence events when time stamps are identical. Do Commenters believe
that there is a way for the Plan Processor to sequence events with
identical time stamps? How would this process, or the lack of a
process, affect the quality of the CAT Data?
269. The Plan states that ``the Participants plan to require that
the Plan Processor develop a way to accurately track the sequence of
order events [of a particular order] without relying entirely on time
stamps.'' \820\ Do Commenters believe it is feasible to properly
sequence the events of a simple or complex order without relying
entirely on time stamps? Please explain. If such a procedure could be
developed, how accurate would it be?
---------------------------------------------------------------------------
\820\ See CAT NMS Plan supra note 3 at Appendix C, Section
A.3(c).
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270. The Plan further states, ``For unrelated events, e.g.,
multiple unrelated orders from different broker-dealers, there would be
no way to definitively sequence order events within the allowable clock
drift as defined in Article 6.8.'' \821\ Do Commenters believe it would
be feasible for the Plan Processor to develop a way to accurately
sequence such unrelated orders given the time stamp and clock
synchronization requirements of the Plan? Please explain. If such a
procedure could be developed, how accurate would it be?
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\821\ See id. at Appendix C, Section A.3(c) n.110.
---------------------------------------------------------------------------
271. Do Commenters agree with the Commission's data analysis of the
clock synchronization improvements from the Plan? If not, how could the
Commission improve the data analysis? Do Commenters have their own data
analysis that informs on the expected improvements from the Plan? If
so, please provide. Do Commenters agree that the improvements to the
percentage of sequenceable order events by Plan standards are modest
and the requirements of the Plan may not be sufficient to completely
sequence the majority of market events relative to all other events?
272. Do Commenters agree with the Plan's assessment of the industry
standard for clock synchronization? Does this reflect the standards for
all CAT Reporters, including exchanges, ATSs, and other broker-dealers?
If not, what would be a more appropriate way to define the industry
standard for clock synchronization?
273. Do Commenters believe that the provisions in the CAT NMS Plan
related to linking data would result in improvements to the accuracy of
the data available to regulators? Would the process for linking orders
across market participants and SROs improve accuracy compared to
existing data? Would the Plan Processor be able to
[[Page 30707]]
develop expertise in linking data more efficiently than the regulatory
staff members from each entity could on their own? Please explain.
274. Would the Error Rates associated with the linking process
represent improvements to data accuracy? Would Approach 1 to data
conversion result in a lower Error Rate than Approach 2? Would the
Approach affect the Plan Processor's ability to build a complete and
accurate database of linked data? Are the Error Rates associated with
the linking process appropriate and reasonable in light of the goal of
improving data quality? Please explain.
275. Do Commenters believe that the inclusion of unique Customer
and Reporter Identifiers would increase the accuracy of information in
data regulators use and provide benefits to a broad range of regulatory
activities that involve audit trail data? Please explain.
276. Do Commenters agree that the CAT Data would provide less
aggregated allocation information and less aggregated issuer repurchase
information? Why or why not? Would these changes significantly affect
regulatory activities?
277. Do Commenters agree that the CAT NMS Plan would improve the
accessibility of the data available to regulators? Which elements of
the Plan would deliver these improvements? Are there any elements of
the Plan that would degrade the accessibility of regulatory data
relative to today? Are there any elements of the Plan that would
prevent or limit improvements in the accessibility of regulatory data?
278. Do Commenters believe that the minimum requirements for direct
access ensure that the Plan would improve access to current data,
including the process of requesting data? Would the direct access
facilitated by the Plan provide sufficient capacity and functionality?
Would direct access reduce the number of ad hoc data requests?
279. Do Commenters agree that the CAT NMS Plan would improve the
timeliness of the data available to regulators? Which elements of the
Plan would deliver these improvements? Are there any elements of the
Plan that would degrade the timeliness of regulatory data relative to
today? Are there any elements of the Plan that would prevent or limit
improvements in the timeliness of regulatory data?
280. Do Commenters believe that the CAT NMS Plan will facilitate
the ability of each national securities exchange and national
securities association to comply with the requirement in Rule 613(f)
that they 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? If
not, why not?
281. Do Commenters agree that the CAT NMS Plan will facilitate the
ability of regulators to conduct risk-based examinations? Why or why
not? How significantly would the Plan improve risk-based examinations?
Please explain.
282. Do Commenters agree that the CAT NMS Plan will improve the
efficiency of regulators' enforcement activities? Why or why not? Which
specific regulatory activities would be most improved by the CAT NMS
Plan? Please explain.
283. Do Commenters agree that the CAT NMS Plan will improve the
ability for regulators to determine the credibility of tips and
complaints? Please explain.
284. Overall, do Commenters agree that the surveillance,
examination, and enforcement activities of regulators would improve
with the CAT NMS Plan? Please explain. Would these improvements be
significant enough to deter violative behavior? Please explain. What
would be the economic effect of this deterrence?
285. Would such improvements reduce the percentage of activities
that generate false positives (i.e., detection of behaviors that are
not violative) and/or reduce the percentage of activities that are
false negatives (i.e., not detecting behaviors that are violative)?
Please explain. What would be the economic effect of any changes in
false positives or false negatives?
286. Do Commenters agree with the Commission's assessment of the
economic effects of the improvements to surveillance, examinations, and
enforcement from the CAT NMS Plan? Please explain.
287. Do Commenters agree that the CAT NMS Plan would improve the
efficiency and effectiveness of regulators conducting analysis and
reconstruction of market events? Please explain. Do Commenters agree
with the Commission's assessment of the benefits to investors and the
market of more efficient and effective analysis and reconstruction of
market events? Please explain.
288. Do Commenters agree that the CAT NMS Plan would facilitate
market analysis and research that would improve regulators'
understanding of securities markets? Please explain. Do Commenters
agree with the Commission's assessment of the benefits to investors and
the markets from regulators having a better understanding of the
markets? Please explain.
289. Do Commenters believe that there are other features of the CAT
NMS Plan uniquely applicable to a consolidated audit trail that
increase the likelihood that the potential benefits of the CAT NMS Plan
would be realized? Please identify these features and explain.
290. Do Commenters agree that provisions of the Plan related to
future upgrades, promoting accuracy, and promoting timeliness increase
the likelihood that the potential benefits of the CAT NMS Plan would be
realized? Do current regulatory data sources have provisions similar to
ones the Commission analyzed? If so, please describe such provisions.
291. Do Commenters believe that provisions of the Plan provide
incentives to reduce reporting errors for a CAT Reporter that has an
Error Rate that does not exceed the thresholds that would trigger fines
under the Plan or possible enforcement actions by regulators? If so,
what are the incentives? Could the Plan provide different incentives to
reduce reporting errors? Please explain.
292. Under the Plan, proposals to adjust the maximum allowable
Error Rate are to originate from the Plan Processor. Do Commenters
agree with this approach? Please explain. Should others, such as the
Operating Committee, or Advisory Committee be able to originate changes
to the Error Rate? Please explain.
293. Do Commenters agree that communication of data feed delays for
public consumption is beneficial to the operation and effectiveness of
the CAT? If so, in what ways? What are the benefits and costs of such
public disclosure?
294. Do Commenters agree that the governance provisions identified
in the Rule 613 Adopting Release continue to be important to the
efficient operation and practical evolution of the Plan, and therefore
to the achievement of the Plan's benefits? Are there other aspects of
the Plan's governance that might enhance (or detract from) the Plan's
ability to achieve its intended benefits? Are there other governance
aspects that the Plan does not address that might enhance, if included
(or detract from, if not remedied) the Plan's ability to achieve its
intended benefits? Please identify these other features and explain how
they enhance (or detract from) the Plan's ability to achieve its
intended benefits.
295. The Commission's analysis of the provisions of the Plan
relating to voting assumes that these provisions will
[[Page 30708]]
promote the benefits sought to be achieved by the Plan because, by
assigning different voting thresholds to different actions, the Plan
seeks to address potential conflict of interest and holdout problems,
balancing dissenters' rights with the need to move forward with needed
changes. Is this a complete and accurate list of the factors that could
bear on whether the voting provisions of the Plan will promote the
benefits sought to be achieved by the Plan, and did the Commission
correctly weigh these factors in preliminarily concluding that the
Plan's voting provisions could help promote better Plan decision-making
and, thus, improve achievement of the Plan's goals? If the Commission
should have considered other factors or weighed the identified factors
differently, please explain how, and what the costs and benefits of an
alternative approach would be.
296. The Plan provides that ``[a]ll votes by the Selection
Committee shall be confidential and non-public.'' \822\ What are the
effects of confidential voting as a means of limiting conflicts of
interest and promoting accountability? Would expanding confidentiality
in voting to other situations help or hinder the effectiveness of the
Operating Committee and its Subcommittees in achieving the regulatory
objectives of the Plan? Please explain and provide supporting examples
and evidence, if available.
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\822\ See CAT NMS Plan, supra note 3, at Section 5.1(b)(v).
---------------------------------------------------------------------------
297. Do Commenters believe that the size, membership, and tenure of
Advisory Committee members is appropriately tailored to encourage the
effective accumulation and communication of Advisory Committee member
views to the Operating Committee, thereby improving Plan decision-
making? If not, why not? Are there other factors that could bear on
whether the provisions of the Plan relating to the Advisory Committee
will promote better decision-making? If so, what other factors?
298. Are there any alternatives for Advisory Committee involvement
that could increase the effectiveness of its involvement? What benefits
would these achieve in terms of improving the Operating Committee's
efficiency? Would these alternatives increase or decrease costs?
299. What obstacles to information-sharing between individual
members of the Operating Committee and the Commission, if any, are
likely to limit the Plan's effectiveness in meeting its regulatory
objectives? Is there any information, such as regarding individual SRO
clock synchronization standards, that members would need to share
within the Operating Committee to achieve plan regulatory objectives
but may be uncomfortable sharing with one another (or more comfortable
sharing with the Commission than with one another)? Please be specific
and explain what, if any, changes to the plan could mitigate obstacles
from inadequate information-sharing.
300. Are there any other factors relating to the operation and
administration of the Plan that the Commission should consider as part
of determining whether to approve the Plan? If so, what are those
factors and how could they influence the costs and benefits of the
Plan? Does the Plan currently address these factors? If not, how could
the Plan address these factors and what would be the relative costs and
benefits of any changes to the Plan?
F. Costs
As noted above, at the time of the Adopting Release the Commission
deferred its economic analysis of the creation, implementation, and
maintenance of CAT until after submission of the CAT NMS Plan.\823\
Accordingly, the Commission deferred its detailed analysis of costs
associated with CAT. In light of the SROs having submitted the CAT NMS
Plan, this Section sets forth the Commission's preliminary analysis of
the expected costs for creating, implementing, and maintaining the CAT,
as well as the associated reporting of data.
---------------------------------------------------------------------------
\823\ See Adopting Release, supra note 9, at 45789.
---------------------------------------------------------------------------
As discussed in detail below, the Commission has preliminarily
estimated current costs related to regulatory data reporting,
anticipated costs associated with building and maintaining the Central
Repository, and the anticipated costs to report CAT Data to the Central
Repository. These preliminary estimates are calculated from information
provided in the CAT NMS Plan as well as supplemental information.
Currently, the 20 Participants spend $154.1 million annually on
reporting regulatory data and performing surveillance.\824\ The
approximately 1,800 broker-dealers anticipated to have CAT reporting
responsibilities currently spend $1.6 billion annually on regulatory
data reporting.\825\ If the Plan is approved, the Commission
preliminarily estimates that the cost of the Plan would be
approximately $2.4 billion in initial aggregate implementation costs
and $1.7 billion in ongoing annual costs.\826\ Furthermore, the Plan
anticipates that market participants would have duplicative audit trail
data reporting responsibilities for a period of up to a maximum of 2.5
years, preceding the retirement of potentially duplicative regulatory
data reporting schemes.\827\ Duplicative audit trail data reporting
could cost broker-dealers $1.6 billion per year or more and could cost
the Participants up to $6.9 million per year. The Commission
preliminarily believes that the primary component of costs for CAT's
estimated annual costs would be the estimated aggregate broker-dealer
data reporting costs of $1.5 billion per year, whereas the Central
Repository build costs are preliminarily estimated by the Participants
to be no more than $92 million, with annual operating costs of no more
than $135 million.
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\824\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(ii)(B)(1).
\825\ See Section IV.F.1.c(2), infra.
\826\ See Section IV.F.2, infra.
\827\ See id.
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As explained in detail below, the Commission believes, however,
that there is significant uncertainty surrounding the actual
implementation costs of CAT and the actual ongoing broker-dealer data
reporting costs if the Plan were approved. Methodology and data
limitations used to develop these preliminary cost estimates could
result in imprecise estimates that may significantly differ from actual
costs. The Commission has used its best judgment, however, in obtaining
and assessing available information and data to provide the analysis
and estimates included in this Notice. The Commission is also
requesting comment on the methodology and any additional data
Commenters believe should be considered.
Furthermore, the Commission notes that because some CAT design
decisions (such as setting forth detailed Technical Specifications)
have been deferred until the selection of the Plan Processor, the
associated cost uncertainties could cause the actual costs to vary
significantly from the estimates set forth in this analysis.
The Commission notes that the cost estimates set forth in this
analysis are updated from the cost estimates provided in the Proposing
Release. In the Proposing Release, the Commission estimated $4.3
billion in initial implementation costs and $2.3 billion in ongoing
annual costs.\828\ The
[[Page 30709]]
Commission has now updated its analysis and estimates $2.4 billion in
initial implementation costs and $1.7 billion in ongoing annual costs.
The Commission believes that several factors drive differences in cost
estimates from the Proposing Release to the current cost estimates in
this analysis. First, the scope of CAT as contemplated in the Proposing
Release is different than the scope of CAT Data as would be implemented
by the CAT NMS Plan.\829\ For example, the Commission notes that,
unlike CAT Data envisioned in the Proposing Release, the proposed Plan
includes OTC Equity Securities, which if included in CAT would
facilitate the possible retirement of OATS as an audit trail data
reporting system at a relatively earlier date. While the Commission's
cost estimates do not explicitly incorporate cost savings from systems
retirement, cost estimates provided in the Plan and based on surveys of
broker-dealers, participants and service providers may reflect some of
these savings. For example, because respondents anticipate
incorporating resources that would be devoted to OTC equity data
reporting to CAT reporting, cost estimates may be lower than they would
be if OTC equity data were excluded from CAT but were still reported to
OATS on an ongoing basis. Thus, after all CAT Reporters start reporting
to the Central Repository and the resolution of any data gaps between
OATS and CAT, FINRA would not need to maintain OATS solely to fulfill
its regulatory responsibilities relating to OTC Equity Securities.\830\
Additionally, the Commission's updated cost estimates are based on data
submitted with the Plan, which was unavailable when the Commission
first estimated the costs of CAT in the Proposing Release,\831\ as well
as certain additional information obtained by Commission Staff.\832\
Furthermore, the Plan also integrates exemptive relief extended to the
Participants regarding (1) Options Market Maker quotes; (2) Customer-
IDs; (3) CAT-Reporter-IDs; (4) linking of executions to specific
subaccount allocations on Allocation Reports; and (5) time stamp
granularity for Manual Order Events. The Commission preliminarily
believes that this exemptive relief contributes to reductions in cost
of the Plan relative to those estimated in the Proposing Release. The
Commission has incorporated this additional information into its
current cost analysis.\833\
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\828\ See Proposing Release supra note 9, at 32596-602. The $4.3
billion and $2.3 billion cost estimates can be calculated using
individual cost estimates from the Proposing Release. The Proposing
Release expressed some cost estimates on a per-Participant basis.
The Plan, however, breaks out costs to Participants by (i) single-
exchange-operating Participants and (ii) Affiliated Participants
that operate multiple exchanges. To validly compare the Commission's
preliminary cost estimates to the cost estimates set forth in the
Plan, the Commission's analysis aggregates costs to all Participants
for these cost estimates. The Proposing Release anticipated 1,114
SRO members would report data to the Central Repository directly,
and 3,006 broker-dealers would report data through a service
provider. The Plan anticipates that approximately 1,800 broker-
dealers would have CAT reporting obligations; the Commission
preliminarily believes that the majority of these broker-dealers
would rely on service bureaus to perform their regulatory data
reporting. Again, to validly compare the different cost estimates,
the Commission aggregates the cost estimates across all broker-
dealer CAT Reporters.
\829\ Similarly, in the Adopting Release, the Commission
explained that ``the methodology that the Commission used in the
Proposing Release to estimate the costs of creating, implementing,
and maintaining a consolidated audit trail may no longer be
suitable'' and that certain ``assumptions may no longer be valid
since several of the specific technical requirements underlying the
Proposing Release's approach have been substantially modified.'' See
Adopting Release, supra note 9, at 45781.
\830\ If FINRA were unable to retire OATS, the costs of
duplicative reporting (discussed in Section IV.F.2, infra), would
continue indefinitely. The Commission preliminarily believes this
outcome is unlikely because the Plan discusses the Participants'
plans to retire OATS if the Plan is approved. See CAT NMS Plan,
supra note 3, at Appendix C, Section C.9.
\831\ See Proposing Release, supra note 9, at 32601-02.
\832\ As discussed further below, the Commission's analysis also
incorporates data obtained from FINRA and information from
discussions with broker-dealers and service bureaus arranged by FIF
and staff. See infra notes 880 and 899.
\833\ The Commission's revised cost estimates are generally
substantially lower than those presented in the Proposing Release.
See Proposing Release, supra note 9, at 32601-02. The Proposing
Release's estimate of total industry implementation costs is 40.45%
higher than the current estimate, and the Proposing Release's
estimate of ongoing total industry costs is 57.99% higher than the
current estimate. Reductions in cost estimates are primarily driven
by lower broker-dealer implementation and ongoing reporting costs
that are largely attributable to a reduction in the number of
broker-dealers anticipated to incur CAT reporting responsibilities,
as the Proposing Release assumed that all 4,120 broker-dealers would
be CAT Reporters but the Plan estimates that only 1,800 broker-
dealers would incur CAT reporting responsibilities. The Proposing
Release also presented higher estimates of the number of broker-
dealers that are likely to be insourcers; these broker-dealers have
significantly higher implementation and ongoing costs that
outsourcing broker-dealers. The Proposing Release estimated Central
Repository implementation costs that are 23.33% higher than current
estimates; ongoing Central Repository costs were lower by 33.56%;
SRO implementation costs were 82.21% higher in the proposing
release; SRO ongoing costs were estimated to be 31.79% lower than
current estimates. The Proposing Release did not recognize costs to
Service Bureaus related to CAT.
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1. Analysis of Expected Costs
The Plan provides estimates of the expected costs associated with
the Plan, including costs to build and operate the Central Repository
and costs to Participants and CAT Reporters to implement and maintain
CAT reporting.\834\ As explained below, the Commission has thoroughly
reviewed the cost estimates contained in the Plan and other relevant
information to develop the Commission's preliminary estimate of
expected costs of the Plan. The Commission preliminarily believes that
in some cases the estimates provided in the Plan are reliable estimates
of the potential costs of certain aspects of the Plan. The Commission
preliminarily believes, however, that in other cases the data and
methodology underlying certain Plan estimates are unreliable and, in
such cases, the Commission has preliminarily evaluated and provided
separate estimates based on alternative data or a different
methodology.\835\
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\834\ Because the Plan does not provide data that permit
partitioning costs associated with the Central Repository between
Participants and broker-dealer CAT Reporters, this analysis
discusses the Central Repository costs separately.
\835\ For example, the Commission preliminarily believes that
cost estimates in the Plan relating to the costs that would be borne
by broker-dealers are unreliable due to limitations of certain
survey response data. These limitations and the Commission's
alternative cost estimate are discussed in detail below. See Section
IV.F.1.c, infra.
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In this Section, the Commission provides preliminary estimates of
the individual elements that constitute the estimated expected total
cost associated with implementing and maintaining the CAT, including
the costs of operating and building the Central Repository, the costs
to Participants, the costs to broker-dealers, and other costs
considered in the CAT NMS Plan.
a. Costs of Building and Operating the Central Repository
The Plan's estimates of the costs to build the Central Repository
are based on Bids that vary in a range as high as $92 million. The
Plan's estimates of annual operating costs are based on Bids that vary
in a range up to $135 million. The eventual magnitude of Central
Repository costs is dependent on the Participants' selection of the
Plan Processor, and may ultimately differ from estimates discussed in
the Plan if Bids are revised as the bidding process progresses. The
Plan discusses these costs both as (i) one-time and ongoing costs as
well as (ii) a five-year total cost, to help evaluate economic trade-
offs between initial build costs and operating costs. The Plan
anticipates that Participants and their members would bear the costs of
building and operating the Central Repository. The Commission
preliminarily believes that these estimates are reliable because they
are the result of a competitive bidding process, although the
Commission recognizes that the Bids are not legally binding on bidders.
In particular, the Commission preliminarily believes that a Bidder
would not likely decline a
[[Page 30710]]
contract to be Plan Processor that was based on the Bid it submitted
because that Bidder might lose future business due to reputational
consequences of its actions. Furthermore, Bidders have invested
considerable time and effort in evaluating the RFP and preparing their
Bids and thus if a Bidder were unwilling to serve as Plan Processor
according to the terms outlined in its Bid, the time and effort
expended to prepare the Bid would be wasted resources. As explained
further below, however, the Commission believes that these cost
estimates associated with building and operating the Central Repository
are subject to a number of uncertainties.
To estimate the one-time total cost to build the Central
Repository, the Plan uses the Bids of the final six Shortlisted
Bidders.\836\ The Bidders' implementation cost estimates range from $30
million to $91.6 million, with a mean of $53 million and a median of
$46.1 million.\837\ The Plan also estimates the ongoing costs of the
Central Repository. The Bids of the final six Shortlisted Bidders
estimate annual costs to operate and maintain the Central Repository
range from $27 million to $135 million, with a mean of $51.1 million
and a median of $42.2 million.\838\ The Plan's summary statistics show
that annual costs are not expected to be constant year-over-year for
all Bidders, but the Plan does not provide further details on how the
costs are expected to evolve over time or how many of the Bids have
time-varying annual costs.\839\ Although the Commission preliminarily
believes that costs provided by Bidders are reliable, the Commission
recognizes that these ongoing costs could increase over time due to
inflation or changes in market structure such as a significant increase
in message traffic. It is also possible these costs could decrease due
to improvements in technology, reductions in message traffic, and
innovation by the Plan Processor.
---------------------------------------------------------------------------
\836\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B). The Plan does not reflect any more specific cost
ranges that result from narrowing the range of Bidders from six to
three. See supra note 35.
\837\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B).
\838\ Id.
\839\ Id.
---------------------------------------------------------------------------
The Plan also provides information based on the Bids on the total
five-year operating costs for the Central Repository because the annual
costs to operate and maintain the Central Repository are not
independent of the build cost. In particular, it is plausible that the
Bidders with the lowest build costs trade off lower build costs for
higher recurring annual costs. To account for this possibility, the
Plan presents the range of total five-year costs across Bidders using
the Bids of the final six Shortlisted Bidders.\840\ The methodology
takes the sum of the annual recurring costs over the first five years
(discounted to the present with a discount rate of 2%) and adds the
upfront investment. Across the six Shortlisted Bidders, the total five-
year costs to build and maintain CAT range from $159.8 million to
$538.7 million.\841\ This information is less granular than other
Bidder cost information provided in the Plan, and no mean or median is
provided or can be calculated with the information provided.
---------------------------------------------------------------------------
\840\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B). The five-year presentation of Central Repository costs
is converted into implementation and annual costs by using the
maximum build cost and maximum annual operating cost over the five
year period in the Bids. The Commission preliminarily believes that
this presentation is conservative in the sense that it avoids
underestimating the Central Repository costs that must be borne by
industry. However, the Commission preliminarily believes that it is
likely that this presentation overestimates the actual Central
Repository costs because most individual Bids forecast variation in
operating expenses year by year, with costs in some years lower than
the maximum used in this presentation. Because the Central
Repository costs are, in aggregate, significantly lower than the
aggregate costs broker-dealers would incur in reporting CAT Data,
the Commission preliminarily believes that this overestimation would
not materially affect the magnitude of aggregate costs for the Plan
to industry.
\841\ See supra note 836, and CAT NMS Plan, supra note 3, at
Appendix C, Section B.7(b)(i)(B).
---------------------------------------------------------------------------
The Plan provides that costs associated with building and operating
the Central Repository would be borne by both Participants and their
members.\842\ In particular, the Plan provides for fixed-tiered fees
based on ranges of activity levels to be levied on Execution Venues
(i.e., the Participants (including a national securities association
with trade reporting facilities, and ATSs)) based upon the Execution
Venue's market share of share volumes, with options and equity venue
fees determined by separate schedules set by CAT's Operating
Committee.\843\ Furthermore, the Plan provides for fixed-tiered fees
for Industry Members (broker-dealers) based on the message traffic
generated by the member, including message traffic associated with an
ATS operated by the member.\844\ The Plan also provides for the
establishment of other fees for activities such as late, inaccurate, or
corrected data submission by CAT Reporters.\845\ The Plan does not
present information on the potential magnitude of these fees, but the
Commission preliminarily believes they are likely to be a minor expense
for CAT reporters, who should be able to avoid these fees by fulfilling
their normal reporting responsibilities under the Plan. The Plan does
not provide information on the relative allocation of these fees
between transaction-based fees, message traffic-based fees, and other
fees.\846\
---------------------------------------------------------------------------
\842\ See CAT NMS Plan, supra note 3, at Section 11.
\843\ See id. at Section 11.3.
\844\ See id. at Section 11.3(b).
\845\ See id. at Section 11.3(c).
\846\ The economic analysis treats estimates of costs associated
with building and operating the Central Repository separately from
estimates of costs to Participants and other CAT Reporters to report
CAT Data. While the costs of building and operating the Central
Repository would be borne by the Participants and Industry Members,
the allocation of the costs between and among those entities would
be determined by the CAT Funding Model, which has not yet been
finalized. See Section IV.C.2, supra. However, these costs are
included in the Commission's estimate of the total costs to industry
if the Plan is approved.
---------------------------------------------------------------------------
The Commission believes that a range of factors would drive the
ultimate costs associated with building and operating the Central
Repository and who would bear those costs. The Plan explains that the
major cost drivers identified by Bidders are (1) transactional volume,
(2) technical environments, (3) likely future growth in transactional
volumes, (4) data archival requirements, and (5) user support/help desk
resource requirements.\847\ The Plan does not present information on
how sensitive the cost estimates are to each of these factors. Further,
how Bidders propose to satisfy the RFP requirements could materially
affect the ultimate cost to the industry to operate the Central
Repository and who would bear those costs. For instance, some Bids may
provide more extensive user support from the Plan Processor than
others, effectively shifting user support costs from CAT Reporters to
the Plan Processor, where such support might be more efficiently
provided. However, the Plan does not provide information about how the
Bidders propose to address each of the RFP requirements; thus,
uncertainties exist around who would bear certain costs and how such
costs could change if each Bidder's proposal related to these factors
change.
---------------------------------------------------------------------------
\847\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B).
---------------------------------------------------------------------------
The Commission is mindful that the cost estimates associated with
building and operating the Central Repository are subject to a number
of additional uncertainties. First, the Participants have not yet
selected a Plan Processor, and the Shortlisted Bidders have submitted a
wide range of cost estimates for building and operating the Central
[[Page 30711]]
Repository. Second, the Bids submitted by the Shortlisted Bidders are
not yet final. Participants could allow Bidders to revise their Bids
before the final selection of the Plan Processor. Third, neither the
Bidders nor the Commission can anticipate the evolution of technology
and market activity with complete prescience. Available technologies
could improve such that the Central Repository would be built and
operated at a lower cost than is currently anticipated. On the other
hand, if anticipated market activity levels are materially
underestimated, the Central Repository's capacity could need to
increase sooner, increasing the actual costs to operate the Central
Repository than currently anticipated in the Bids. The Commission notes
that costs to build and operate the Central Repository are relatively
small compared to total industry costs if the CAT NMS Plan were
approved; consequently, the Commission preliminarily believes that
these uncertainties are unlikely to materially affect the final cost of
the Plan to industry, if it is approved.
b. Costs to Participants
The Commission preliminarily believes that the Plan's estimates for
Participants to report CAT Data are reliable because all of the SROs
provided cost estimates, and most SROs have experience collecting audit
trail data as well as expertise in the both the requirements of CAT as
well as their current business practices. The Plan provides estimated
costs for the Participants to report CAT Data.\848\ These estimates are
based on Participant responses to the Costs to Participants Study
(``Participants Study'') \849\ that the Participants collected to
estimate SRO CAT-related costs for hardware and software, full-time
employee staffing (``FTE costs''), and third-party providers.\850\
Respondents to the Participants Study also estimated the costs
associated with retiring current regulatory data reporting systems that
would be rendered redundant by CAT.\851\
---------------------------------------------------------------------------
\848\ See id. at Appendix C, Section B.7(b)(iii)(B)(2). In
addition to the costs the Participants would incur implementing and
maintaining CAT, the Participants would also incur and would
continue to incur costs associated with developing the CAT NMS Plan.
The Participants estimate such costs to be $8,800,000. The
Commission does not include these costs in its estimates of the
costs associated with CAT if the CAT NMS Plan is approved because
these costs have already been incurred and would not change
regardless of whether the Commission approves or disapproves the CAT
NMS Plan. Further, the Commission assumes that the CAT NMS Plan's
implementation cost estimates include any additional CAT NMS Plan
development costs that would be incurred by Participants if the CAT
NMS Plan were approved.
\849\ The Participants Study delineates Participant responses
into two groups. The first group consists of affiliated
Participants, which includes single entities that hold self-
regulatory licenses for multiple exchanges. The second group
consists of Participants that hold a single self-regulatory license,
including FINRA, the sole national securities association. Id. at
Appendix C, Section B.7(b)(i)(A)(1).
\850\ Third-party provider costs are generally legal and
consulting costs but may include other outsourcing. The template
used by respondents is available at http://catnmsplan.com/PastEvents/ under the Section titled ``6/23/14'' at the ``Cost Study
Working Template'' link.
\851\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(B)(2).
---------------------------------------------------------------------------
The Plan estimates costs for the Participants as an aggregate
across all Participants (the six single-license Participants and the
five Affiliated Participant Groups).\852\ The implementation cost
estimate for Participants is $17.9 million, including $770,000 in legal
and consulting costs and $10.3 million in full-time employee costs for
operational, technical/development, and compliance-type functions.\853\
Annual ongoing costs are estimated to be $14.7 million, including
$720,000 in legal and consulting costs and $7.3 million in full-time
employee costs.\854\ Other than legal and consulting costs and full-
time employee costs, the Plan does not specify the other categories of
implementation and ongoing costs, but based on discussion with the
Participants, the Commission preliminarily believes that much of the
remaining costs would be attributed to IT infrastructure, including
hardware and software costs.
---------------------------------------------------------------------------
\852\ Id. at Appendix C, Section B.7(b)(iii)(B)(2).
\853\ Id.
\854\ Id.
---------------------------------------------------------------------------
The Plan also provides estimates of the costs Participants
currently face in reporting regulatory data.\855\ The Plan anticipates
that some, but not all, of these reporting systems would be retired
after implementation of the Plan.\856\ The Plan reports that aggregate
annual costs for current regulatory data reporting systems are $6.9
million across all Participants.\857\
---------------------------------------------------------------------------
\855\ Id.
\856\ Id. As required by Rule 613(a)(1)(ix), 17 CFR
242.613(a)(1)(ix), the CAT NMS Plan includes a plan to eliminate
existing rules and systems that would be rendered duplicative under
CAT. Id. at Appendix C, Section C.9. Among other things, this plan
requires that within 18 months after Industry Members are required
to begin reporting data to the Central Repository, each Participant
will complete an analysis of whether its rules and systems related
to monitoring quotes, orders, and executions collect information
that is not rendered duplicative by CAT. Id. Each Participant must
also analyze whether any such non-duplicative information should
continue to be separately collected, incorporated into CAT, or
terminated. Id. Therefore, depending on the results of these
analyses, some existing regulatory reporting systems may continue to
be in place after the implementation of CAT.
\857\ Id. at Appendix C, Section B.7(b)(ii)(B)(1).
---------------------------------------------------------------------------
In addition to data reporting costs, Participants face costs
associated with developing and implementing a surveillance system
reasonably designed to make use of the information contained in CAT
Data as required by Rule 613(f).\858\ The Plan provides estimates of
the costs to Participants to implement surveillance programs using data
stored in the Central Repository. Participants would incur expenses,
including full-time employee (``FTE''), legal, consulting and other
costs to adapt their surveillance systems to utilize data in the
Central Repository. The Plan provides an estimate of $23.2 million to
implement surveillance systems for CAT, and ongoing annual costs of
$87.7 million.\859\ The Plan does not provide information on why
Participants' data reporting costs would substantially increase if the
Plan were approved, nor does it provide information on why surveillance
costs would decrease.
---------------------------------------------------------------------------
\858\ See 17 CFR 242.613(f).
\859\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(B)(2). Rule 613 requires the SROs to file updated
surveillance plans within 14 months of CAT implementation. 17 CFR
242.613(f). The Commission assumes that the CAT NMS Plan's estimate
is limited to adapting current surveillance programs to the Central
Repository. The Commission believes this is a conservative
assumption because if other expenses were included in the estimate,
the Commission would be overestimating the costs Participants would
incur to implement and operate CAT if the CAT NMS Plan is approved.
---------------------------------------------------------------------------
The Commission preliminarily believes the data reporting cost
estimates are reasonable because the Commission expects that
Participants would be required to implement new technology
infrastructure to report data to the Central Repository and support
specialized personnel to maintain this infrastructure and respond to
inquiries from the Plan Processor and users of CAT Data. The Commission
likewise preliminarily believes that the surveillance cost estimates
are reasonable, even though the annual estimate of $87.7 million is
lower than the $147.2 million Participants, in aggregate, currently
spend on surveillance programs annually \860\ because Participants
could realize efficiencies from having data standardized and centrally
hosted that could allow them to handle fewer ad hoc data requests. In
addition, the Plan could allow Participants to automate some
surveillance processes that may currently be labor intensive or
processed on legacy systems, which
[[Page 30712]]
could reduce costs because the primary driver of these costs is FTE
costs.
---------------------------------------------------------------------------
\860\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(ii)(B)(1).
---------------------------------------------------------------------------
Table 6 summarizes the Participants' estimated costs, both current
and CAT-related, that are set forth in the Plan. Currently,
Participants spend approximately $154 million per year on data
reporting and surveillance activities. The Participants estimate that
they would incur $41 million in CAT implementation costs, and $102
million annually in ongoing costs to report CAT Data and perform
surveillance as mandated under Rule 613.
Table 6--Participants' Cost Estimates
----------------------------------------------------------------------------------------------------------------
Current CAT implementation CAT ongoing
----------------------------------------------------------------------------------------------------------------
Data Reporting................................ $6,900,000 $17,900,000 $14,700,000
Surveillance.................................. 147,200,000 23,200,000 87,700,000
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr
Total..................................... 154,100,000 41,100,000 102,400,000
----------------------------------------------------------------------------------------------------------------
c. Costs to Broker-Dealers
(1) Estimates in the Plan
The Plan estimates total costs for those broker-dealers expected to
report to CAT. In particular, the Plan relies on the Costs to CAT
Reporters Study (``Reporters Study''), which gathered from broker-
dealers the same categories of cost estimates used in the Participants
Study--i.e., the hardware and software costs, full-time employee
staffing costs, and third-party provider costs that CAT Reporters would
incur if the Commission approves the Plan.\861\ The Reporters Study
surveyed broker-dealers to respond to two distinct approaches for
reporting CAT Data to the Central Repository.\862\ Approach 1 assumes
CAT Reporters would submit CAT Data using their choice of industry
protocols. Approach 2 assumes CAT Reporters would submit data using a
pre-specified format. The Participants distributed the Reporters Study
to 4,406 broker-dealers and received 422 responses, of which the
Participants excluded 180 deemed materially incomplete and 75
determined to be erroneous.\863\ The Plan's cost estimate calculations
are based on the remaining 167 responses. In aggregating the cost
estimates across all broker-dealers expected to report CAT Data to the
Central Repository, the Plan assumed that the characteristics of survey
respondents (firm size and OATS reporting status) were representative
of the approximately 1,800 broker-dealers expected to have CAT
reporting obligations.\864\
---------------------------------------------------------------------------
\861\ See id. at Appendix C, Section B.7(b)(i)(A)(2).
\862\ See id.
\863\ See id.
\864\ Not all broker-dealers are expected to have CAT reporting
obligations; the Participants report that approximately 1,800
broker-dealers currently quote or execute transactions in NMS
Securities, Listed Options or OTC Equity Securities and would likely
have CAT reporting obligations. The Commission understands that the
remaining 2,338 registered broker-dealers either trade in asset
classes not currently included in the definition of Eligible
Security or do not trade at all (e.g., broker-dealers for the
purposes of underwriting, advising, private placements). The Plan
describes the process of determining that 1,800 broker-dealers would
report to the Central Repository in Appendix C. See CAT NMS Plan,
supra note 3, at Appendix C, Section B.7(b)(ii)(B)(2).
---------------------------------------------------------------------------
Based on the Reporters Study survey data, the Plan estimates
implementation costs of less than $740 million for small firms \865\
and approximately $2.6 billion for large firms, for a total of $3.34
billion in implementation costs for broker-dealers.\866\ For annual
ongoing costs, the Plan estimates costs of $739 million for small firms
and $2.3 billion for large firms, for a total of $3.04 billion in
annual ongoing costs for broker-dealers.\867\ For both large and small
broker-dealers, the Plan suggests that the primary cost driver for
projected CAT reporting costs for broker-dealers is costs associated
with full-time employees.\868\ For the reasons discussed below, the
Commission preliminarily believes that the broker-dealer cost estimates
in the Plan are in part unreliable, based on limitations with the
Plan's underlying data in estimating costs. As discussed below, the
Commission preliminarily believes that cost estimates in the Plan for
large broker-dealers may be reliable, and the Commission has
incorporated large firm data from the Plan into the Commission's
estimates outlined below.\869\
---------------------------------------------------------------------------
\865\ Survey respondents were instructed to classify themselves
as ``small'' if their Total Capital (defined as net worth plus
subordinated liabilities) was less than $500,000. See CAT NMS Plan,
supra note 3, at Appendix C, Section B.7(b)(ii)(C) n.188. This is
consistent with the definition of ``small business'' or ``small
organization'' used with reference to a broker or dealer for
purposes of Commission rulemaking in accordance with provisions of
Chapter Six of the Administrative Procedure Act (5 U.S.C. 601 et
seq.). See 17 CFR 240.0-10(c).
\866\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iv)(A)(3).
\867\ Id.
\868\ See id. at Appendix C, Section B.7(b)(iii)(C)(2).
\869\ While the estimates presented in the Plan assume that the
proportion of large versus small broker-dealers that responded to
the Reporters Study is representative of the relative number of
large versus small broker-dealers that are expected to incur CAT
reporting obligations, the Commission's cost estimates do not embed
this assumption. Instead, the Commission relies on data from FINRA
to determine which firms are likely to outsource, and models those
firms' costs based on information gleaned from FIF-organized
discussions with industry. This is discussed further below, but this
estimation results in relatively fewer firms' costs being estimated
using ``large'' firm cost estimates presented in the Plan.
---------------------------------------------------------------------------
The Commission preliminarily believes, however, that the cost
estimates for small broker-dealers provided in the Plan, which are
based upon responses set forth in the Reporters Study, do not prove
reliable estimates of smaller CAT Reporter costs for a number of
reasons. First, some respondents classified as small in the Reporters
Study appear to have responded numerically with incorrect units, with
such responses resulting in annual estimated cost figures that would be
1,000 times too large. Second, maximum responses in certain categories
of costs suggest that some large broker-dealers may have misclassified
themselves as small broker-dealers.\870\ Third, methods used to remove
outliers are likely to have introduced significant biases. Finally, the
response rate to the Reporters Study survey was low and is likely to
have oversampled small broker-dealers who currently have no OATS
reporting obligations.\871\
---------------------------------------------------------------------------
\870\ The Plan presents summary statistics such as average,
median and maximum for each survey response. See CAT NMS Plan supra
note 3, at Appendix C, Section B(7)(b)(ii)(C), Table 5. In the left
most column, $14 million is the maximum response for ``Hardware/
Software Current Cost.''
\871\ In reaching these preliminary conclusions, the Commission
reviewed the detailed discussions of the Reporters Study survey
methodology in the Plan and the survey form and instructions
provided to respondents. See 6/23/14 entry on CAT NMS Plan Web site,
available at http://www.catnmsplan.com/pastevents/index.html. The
Commission staff also discussed with the Participants potential
methodology adjustments in aggregating the CAT Reporters Study data.
After Commission staff discussions with the Participants, the
Commission concluded that no methodology could address these
fundamental issues with the survey data.
---------------------------------------------------------------------------
First, the Commission preliminarily believes that the respondents
to the Reporters Study survey are likely to have used different units
in their responses and that the survey precision is materially affected
because
[[Page 30713]]
inconsistent use of reporting units across respondents introduces an
upward bias to the Reporters Study's findings. The survey collected
cost estimates in $1,000 increments; however, there is evidence that
some respondents did not provide estimates in $1,000 increments as
requested. Rather, survey results in the Plan reveal, for example, that
one small firm reported current annual hardware/software costs for
current regulatory data reporting to be $14,000,000 per year.\872\
Because small firms responding to the survey by definition have no more
than $500,000 in total capital, an annual $14,000,000 estimate for
hardware/software costs for current data reporting seems
unreasonable.\873\ Furthermore, a small survey respondent cited
$3,500,000 in hardware/software retirement of systems costs, which
seems unreasonable for a broker-dealer with less than $500,000 in total
capital. These are only a few examples, but they raise the question of
how many other respondents recorded incorrect units in their responses,
particularly if screening methodologies have difficulty detecting such
incorrect units. In light of these unreasonable results, the Commission
preliminarily believes that the Plan's cost estimates for small broker-
dealers reporting data to CAT has an upward bias because some firms did
not correctly respond to the survey in $1,000 increments.
---------------------------------------------------------------------------
\872\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.(7)(b)(ii)(C), Table 5.
\873\ The Plan notes that it is possible that the firm intended
to report that it had $14,000 in annual expenses for hardware/
software. See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(ii)(C), n.193.
---------------------------------------------------------------------------
Because of errant responses of this type, the Plan recommends using
medians instead of averages; \874\ however, for nearly all estimated
cost categories in the Reporters Study, the median response was zero,
which the Commission believes underestimates the costs that CAT
Reporters are likely to face in most categories of costs. Consequently,
the Commission is unable to adjust for these biases.
---------------------------------------------------------------------------
\874\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7.(b)(ii)(C), n.194.
---------------------------------------------------------------------------
In addition, the Commission preliminarily believes that the small
firm cost survey information in the Reporters Study is unlikely to be
representative of the small broker-dealers that would have CAT
reporting responsibilities in part because the Commission also believes
preliminarily that some survey respondents misclassified their firm's
size, which renders the Plan's separate presentation of results for
large and small broker-dealers imprecise. In particular, the Commission
believes that at least one large firm misclassified itself as a small
firm. The CAT NMS Plan Table 6 reveals that one firm designated as a
small firm responded to the Reporters Study survey with it having 68
full-time employees dedicated to performing regulatory data reporting
activities for a yearly cost of $27,300,000.\875\ The Commission
believes, however, that a firm with 68 full-time employees reporting
regulatory data could not be small (again, as defined by the survey to
include firms with less than $500,000 in total capital) because such a
firm would lack the working capital to support that level of employee
expense.\876\ The presence of large-firms with significantly higher
costs in the small-firm sample significantly biases the small-firm cost
estimates upward.
---------------------------------------------------------------------------
\875\ See id. at Appendix C, Section B.(7)(b)(ii)(C), Table 6.
\876\ See id. at Appendix C, Section B.7.(b)(i)(C), n.188.
---------------------------------------------------------------------------
Moreover, the Commission preliminarily believes that the
methodologies implemented to remove outliers in the Reporters Study
introduce cost estimate biases.\877\ Based on discussions with the
Participants, the Commission understands that to identify and remove
outliers, the Participants first determined if each survey item's
maximum response was a potential outlier because it was more than twice
the value of the next highest response; the Participants then
individually reviewed potential outliers and omitted those deemed
errant. While the Commission recognizes that this methodology may
mitigate the precision bias discussed above by removing a single
response that is 1,000 times too high, it may not remove such outliers
when two or more firms errantly report values 1,000 times too high, in
which case an upward bias to the cost estimates would remain.
Furthermore, if one firm genuinely incurs expenses that are more than
twice those of the next highest respondent, such survey response might
be removed under this methodology, even though such a response may
accurately identify expenses expected by the respondent, which in turn
introduces a downward bias to the cost estimates. For example, only 21
large OATS reporting firms are represented in the Reporters Study
survey responses. If most of these 21 firms perform the majority of
their regulatory data reporting functions in house, but one firm
outsources all of its regulatory data reporting, that single firm could
have outsourcing costs far higher than its peers. Under the Plan's cost
estimate methodology, this outsourcing response in the Reporters Study
might be removed as an outlier, unless another large, OATS reporting
firm responded to the Reporters Study with at least half of the
outsourcing costs. The Commission considered whether to request that
the Participants provide updated cost estimates under a methodology
that did not remove Reporters Study outlier responses, but the
Commission preliminarily believes that this approach would exacerbate
the precision problem discussed above and possibly increase the number
of errant responses that are 1,000 times too high to the cost estimate
data set.
---------------------------------------------------------------------------
\877\ See id. at Appendix C, Section B.7.(b)(i)(B)(ii)(C).
---------------------------------------------------------------------------
Finally, the Commission believes that the Reporters Study response
rate is not adequate to be representative of the population of broker-
dealers that would report to CAT. The survey was delivered to 4,025
broker-dealers. After removing erroneous and materially incomplete
responses, only 167 responses remained of the 4,025 broker-dealers who
were sent the survey. To be representative of the broker-dealers that
would report to CAT, a final response rate of 4.15% seems low
considering the diversity of these broker-dealers. The majority of
broker-dealers are small and smaller broker-dealers are diverse along
many dimensions relevant to the likely magnitude of their expected CAT
costs, including business practices; tendency to centralize technology;
specialization in market segments, such as options versus equities; and
the range of products and markets in which individual broker-dealers
participate. Because broker-dealer diversity is great, a survey of
expected broker-dealer costs would ideally have a higher response rate
to ensure a representative sample. Furthermore, of the 167 responses
incorporated into the Plan's cost estimates, 118 respondent firms were
classified as small in the Reporters Study, and 88 of these 118 small
firms were identified as having no current OATS reporting
responsibilities.\878\ The Commission preliminarily believes that small
firms that anticipate limited CAT reporting responsibilities may have
been oversampled by the Reporters Study survey because for nearly all
categories of cost estimates, the median small firm response was zero,
suggesting that they do not expect to have CAT reporting
responsibilities. Consequently, the
[[Page 30714]]
Commission preliminarily believes that the small firms that responded
to the study cannot be statistically representative of the small firms
that would incur CAT reporting obligations, because the Commission
believes that most small broker-dealers would incur significant costs
in reporting to CAT.\879\ These costs are estimated below.
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\878\ Small firms may have no OATS reporting responsibilities
because they do not engage in activities that would incur OATS
reporting obligations, or they may be excluded or exempted under
FINRA's OATS reporting rules. See Section IV.D.2.b(1)A, supra.
\879\ The Commission notes that small firms currently excluded
from OATS reporting due to their size would have CAT reporting
responsibilities under the Plan because the Plan makes no provision
to exempt or exclude them, as FINRA does with OATS reporting. The
Commission preliminarily believes that these firms are likely to
experience higher implementation costs than other small firms
because CAT reporting would likely necessitate establishing business
relationships with service providers if they do not already have
such relationships. The Commission preliminarily believes that most
small firms that would have CAT reporting obligations but do not
currently have OATS reporting obligations would not have the IT and
regulatory personnel infrastructure to accomplish this reporting in-
house. The Commission's estimation of these firms' costs to
implement CAT includes higher estimates of employee costs to
implement CAT to account for this increased burden.
---------------------------------------------------------------------------
Although the Commission has preliminarily concluded that the small
broker-dealer cost estimates presented in the Plan are unreliable, the
Commission also preliminarily believes that the cost estimates in the
Plan for large broker-dealers may be reliable. The Commission
preliminarily believes that problems with the Reporters Study data are
less likely to affect the Plan's large broker-dealer cost estimates for
several reasons. First, if a large broker-dealer were to respond to the
Reporter Study survey with the incorrect level of units (resulting in
estimates that were 1,000 times too large as was the case for some
small broker-dealer responses), then these errant cost survey responses
would result in estimates that likely would be denominated in billions
of dollars. The maximums presented in the Plan's tables describing the
Reporters Study data do not include responses denominated in billions;
notably, under the Plan's cost estimate methodology, if such responses
were generated, these responses likely would have been removed as
outliers. Second, although it is possible that small broker-dealers
misclassified themselves as large broker-dealers in the Reporters Study
data, such misclassification does not seem to have biased the cost
estimate results for large broker-dealers to the degree that the
Commission preliminarily believes has occurred for the small broker-
dealer Reporters Study data. Cost estimates for large broker-dealers,
particularly those that do not have current OATS reporting obligations,
are not inconsistent with information gathered by the Commission in
discussions with broker dealers and service providers,\880\ although
the Commission preliminarily believes that averages presented in the
Plan generally fall between the expenses that a very large and complex
broker-dealer would experience and those of a more typical broker-
dealer in the same category. For example, the Plan estimates that the
average large OATS-reporting broker-dealer currently spends $8.7
million annually to comply with current data reporting
requirements.\881\ The Commission preliminarily believes that this
estimate is likely to be substantially lower than the actual data
reporting costs incurred by the largest and most complex broker-dealers
that currently report to OATS; these very large and complex firms are
assumed to spend far more than this estimate. There are, however, only
a limited number of exceptionally large OATS-reporting broker-dealers.
Similarly, the Plan's estimate is likely to significantly overestimate
the costs incurred by the majority of firms classified as large by the
Plan because most large firms are not as large or as complex as these
limited number of exceptionally large broker-dealers. Summary
statistics on activity levels of OATS reporting firms are discussed in
detail below.
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\880\ FIF arranged a group discussion with a small number of
broker-dealers whose identities were not provided to Commission
staff and individual discussions with five service bureaus whose
identities were not provided to Commission staff. Also, staff
arranged individual discussions with five additional broker-dealers.
When market participant identities were unknown, FIF provided
demographic information that allowed Commission staff to gauge a
firm's size, complexity, and general market activities. Broker-
dealers outside of the group discussion and service bureaus were
asked for specific cost information that related to their regulatory
data reporting costs; most broker-dealers and some service bureaus
shared general estimates, particularly of staffing levels, and
provided information on cost drivers and obstacles that firms face
in accomplishing their regulatory data reporting, particularly
challenges that they face in implementing changes to these
requirements. Most, but not all, firms participating in discussions
with Commission staff discussed OATS as their most challenging data
reporting requirement. Some firms named LOPR and EBS as additional
sources of regular challenges and significant costs. It is our
understanding from these discussions, that some data reporting
requirements, such as Rule 605 and Rule 606 reporting, are nearly
always outsourced.
\881\ See infra note 882.
---------------------------------------------------------------------------
The Plan presents cost estimates for large broker-dealers' current
regulatory data reporting costs and costs they would incur to implement
and maintain CAT Data reporting. The Plan estimates that an OATS-
reporting large broker-dealer has current data reporting costs of $8.7
million per year.\882\ A non-OATS reporting large broker-dealer is
estimated to spend approximately $1.4 million annually.\883\ The Plan
estimates that OATS-reporting large broker-dealers would spend
approximately $7.2 million to implement CAT Data reporting, and $4.8
million annually for ongoing costs.\884\ For non-OATS reporting large
broker-dealers, the Plan estimates $3.9 million in implementation costs
and $3.2 million in annual ongoing costs.\885\ According to the Plan,
the magnitude of each of these cost estimates is primarily driven by
FTE costs.
---------------------------------------------------------------------------
\882\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.(7)(b)(ii)(C), Table 3. The $8.7 million figure was calculated by
summing the average hardware/software cost, third party/outsourcing
cost, and full-time employee costs using the Commission's estimated
cost per employee of $424,350.
\883\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.(7)(b)(ii)(C), Table 4. The $1.4 million figure was calculated by
summing the average hardware/software cost, third party/outsourcing
cost, and full-time employee costs using the Commission's estimated
cost per employee of $424,350.
\884\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.(7)(b)(iii)(C)(2)a., Table 9; and at Appendix C, Section
B.(7)(b)(iii)(C)(2)b., Table 15.
\885\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.(7)(b)(iii)(C)(2)a., Table 10; and at Appendix C, Section
B.(7)(b)(iii)(C)(2)b., Table 16.
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(2) Commission Cost Estimates
The Commission's broker-dealer cost estimates incorporate some
broker-dealer data from the Plan, but to address issues in the Plan's
Reporters Study data, the Commission's cost estimates also include
other data sources.\886\ As previously discussed, the Commission
preliminarily believes that the small firm cost estimates presented in
the Reporters Study are unreliable. As a result, the Commission has re-
estimated the costs that broker-dealers likely would incur for CAT
implementation and ongoing reporting. As with the Plan's cost
estimates, the Commission's re-estimation relies on classifying broker-
dealers based on whether they currently report OATS data. However, the
re-estimation further classifies broker-dealers, as in the Commission's
cost estimates presented in the Proposing Release, based on whether the
firm is likely to use a service bureau to report its regulatory data,
or, alternatively, whether the firm might choose to self-report its
regulatory data. In this updated analysis, the Commission preliminarily
estimates that the 1,800 broker-dealers expected to incur CAT reporting
obligations currently spend approximately $1.6 billion annually to
report regulatory data.\887\ If the CAT NMS Plan is
[[Page 30715]]
approved, the Commission preliminarily believes that these broker-
dealers would incur approximately $2.2 billion in implementation costs
and $1.5 billion in ongoing data reporting costs.\888\
---------------------------------------------------------------------------
\886\ Discussions below present information on data obtained
from FINRA and gleaned from discussions with broker-dealers and
service bureaus arranged by FIF and staff. See supra notes 880 and
899.
\887\ To the extent that the CAT NMS Plan underestimates the
number of broker-dealers that would incur CAT reporting obligations,
the Commission's updated estimates understate the actual costs
Reporters would face if the CAT NMS Plan is approved.
\888\ These figures cover only broker-dealer costs. Industry-
wide costs are summarized below in Section IV.F.2.
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The Commission preliminarily believes classifying broker-dealers
based on their manner of reporting provides a more accurate estimate of
the costs firms will incur because, as noted below, costs differ based
on whether the firm insources or outsources reporting responsibilities
and insourcing/outsourcing does not necessarily correlate with firm
size. Accordingly, the Commission begins its estimation of costs using
the number of OATS Reportable Order Events (``ROEs'') reported by firms
that report to OATS. The Commission preliminarily believes that because
OATS reportable events, such as order originations, routes, and
executions are also CAT Reportable Events, these two measures are
likely to be highly correlated, making the number of OATS records a
proxy for the anticipated level of CAT reporting.\889\ Based on
discussions with broker dealers and service providers, however, the
Commission preliminarily believes that firms that report high numbers
of OATS ROEs decide to either self-report their regulatory data or
outsource their regulatory data reporting based on a number of
criteria, including potential costs.\890\ Thus, simply using the number
of OATS ROEs as a proxy for firm size may not provide an accurate
picture of the reporting costs for such firms. As a result, the
Commission goes a step further in its estimation of costs by segmenting
firms into two groups--those that insource and those that outsource
their regulatory data reporting--and estimates costs separately for
each group. Empirical evidence supporting this approach is detailed
further below.\891\
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\889\ In other words, the Commission preliminarily believes that
the higher the number of OATS ROEs reported, the higher the
anticipated number of CAT records to report. As noted below,
however, the Commission anticipates that the number of CAT records
would exceed the number of OATS ROEs.
\890\ As explained further below, the Commission believes that
firms reporting relatively few OATS ROEs would be unlikely to have
the infrastructure and specialized employees necessary to insource
regulatory data reporting and would almost certainly outsource their
regulatory data reporting functions.
\891\ The Commission in its cost calculation uses the number of
OATS ROEs as a measure of firm size, rather than traditional
measures of firm size based on a single metric, such as capital
level, or OTC dollar volume. The Commission preliminarily believes
that the use of OATS ROEs provides a more accurate predictor of firm
reporting behavior. Data provided by FINRA, for example, reveals
that some firms with extremely high levels of OATS reporting
activity have relatively low capital levels; furthermore, many firms
that report exceptionally high numbers of OATS ROEs have no OTC
dollar-volume. See infra note 893.
---------------------------------------------------------------------------
The Plan also separates industry costs of current OATS reporting
firms from those that currently have no OATS reporting obligations,
recognizing that the group of non-OATS reporting firms are diverse in
size and scope of activities. The Commission maintains this approach in
its re-estimation, as firms that do not currently report to OATS would
face a different range of costs to implement and maintain CAT reporting
because firms that currently do not report to OATS may have little to
no regulatory data infrastructure in place. Broker-dealers that do not
currently report to OATS may have higher or lower costs than firms that
do report to OATS, depending on whether they do not report because of
SRO membership status or lack of equity market activity or because of
size and scope of activity within equity markets. For example, an
electronic liquidity provider (``ELP'') may trade extensively both on
and off-exchange, yet not report to OATS because it is not a FINRA
member; such a firm could incur high data reporting costs under CAT
because it has a high volume of records to report. Conversely, a small
equity trading firm might be excluded or exempted from OATS reporting
due to its size and scope of activities; such a firm could have
relatively low CAT reporting costs, although still higher than its
existing regulatory reporting costs, because it has few Reportable
Events and is assumed to outsource its reporting responsibilities.
Recognizing this diversity in non-OATS firms, the Commission's re-
estimation anticipates a large range of firm activity levels in non-
OATS CAT reporters and treats them differently when estimating their
costs.\892\ This is discussed further below.
---------------------------------------------------------------------------
\892\ The Commission's re-estimation of costs assumes that firms
that are currently excluded or exempted from OATS reporting are
Outsourcers. By definition, OATS-reporting Outsourcers report fewer
than 350,000 OATS ROEs per month. However, firms that are not FINRA
members are not assumed to be Outsourcers; many of these firms are
in the business of proprietary trading as ELPs or are Options Market
Makers, which are assumed to be typical of large non-OATS reporters
discussed in the Plan. The identification of these firms and their
estimated costs of CAT reporting are discussed further in Section
IV.F.1.c(2)B.i, infra.
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In sum, the framework for the Commission's re-estimation is as
follows. First, the Commission identifies those OATS-reporting firms
that insource (``Insourcers'') and those that outsource based on an
analysis of the number of OATS reporting ROEs combined with specific
data provided by FINRA on how firms report. Furthermore, the Commission
identifies firms that do not currently report to OATS but are likely to
insource based on their expected activity level by identifying Options
Market Makers and ELPs. Based on that analysis, the Commission
preliminarily estimates that there are 126 OATS-reporting Insourcers
and 45 non-OATS reporting Insourcers; these estimates are discussed
further below. The Commission's re-estimation classifies the remaining
1,629 broker-dealers that the Plan anticipates would have CAT Data
reporting obligations as ``Outsourcers,'' based on outsourcing
practices observed in data obtained from FINRA and discussed further
below. The Commission preliminarily believes that most of these firms
would accomplish their CAT Data reporting through a service bureau.
Next, to determine costs for Insourcers, the Commission relies upon
cost estimates for firms classified as ``large'' in the Reporters
Study. For Outsourcers, the Commission uses a model of ongoing
outsourcing costs (``Outsourcing Cost Model'') to estimate both current
regulatory data reporting costs and CAT-related data reporting costs
Outsourcers would incur if the CAT NMS Plan were approved.
A. Broker-Dealer Reporting Practices
Although the Commission's analysis segregates broker-dealers into
two groups (Insourcers and Outsourcers), within those groups, broker-
dealer data reporting methods currently vary widely across firms, and
these varied methods affect the data reporting costs that broker-
dealers incur. As discussed previously, depending on the business in
which broker-dealers participate, broker-dealers can have a wide range
of reporting responsibilities.
There are two primary methods by which broker-dealers accomplish
data reporting: Insourcing, where the firm reports data to regulators
directly; and outsourcing, where a third-party service provider
performs the data reporting, usually as part of a service agreement
that includes other services. Firms that outsource retain
responsibility for complying with rules related to outsourced activity.
Based on data from FINRA and conversations with market participants,
the Commission preliminarily believes that the vast majority of broker-
dealers outsource most of their regulatory data reporting
[[Page 30716]]
functions to third-party firms. Data provided by FINRA shows that 932
broker-dealers reported at least one OATS ROE between June 15 and July
10, 2015.\893\ Of these 932 firms, 799 reported at least 90% of their
OATS ROEs through a service bureau. Broker-dealers generally used a
single service bureau (497 firms) to report OATS, but some broker-
dealers used multiple service bureaus (up to 9 service bureaus).
---------------------------------------------------------------------------
\893\ The Commission analyzed data on broker-dealer OATS
reporting received from FINRA. This data source included the number
of OATS ROEs reported by each individual broker-dealer, as well as
counts of how many ROEs were reported by the firm directly and how
many ROEs were reported through service bureaus, and the number of
service bureaus that reported data for the firm. The dataset
includes the firms' minimum net capital required and actual net
capital as well as the number of registered persons associated with
the firm. Factors that affect broker-dealers' insourcing/outsourcing
decision are discussed below. Because market activity is highly
correlated with volatility, this four-week period was chosen to have
a typical level of volatility (as measured by VIX level) for the
period September 16, 2010 through September 15, 2015.
---------------------------------------------------------------------------
Often, service bureaus bundle regulatory data reporting services
with an order-handling system service that provides broker-dealers with
market access and order routing capabilities. Sometimes regulatory data
reporting services are bundled with trade clearing services. A broker-
dealer's decision to insource/outsource these functions and services
can be complex, and different broker-dealers reach different solutions
based on their business characteristics. To illustrate, some broker-
dealers self-clear trades but outsource regulatory data reporting
functions; some broker-dealers have proprietary order handling systems,
self-clear trades, and outsource regulatory data reporting functions.
Other broker-dealers outsource order-handling, outsource clearing
trades, and self-report regulatory data. The most common insource/
outsource service configuration, however, for all but the most active-
in-the-market broker-dealers is to use one or more service bureaus to
handle all of these functions.
In most, but not all, cases, service bureaus host their client
broker-dealer's order-handling system on the service bureau's servers
while the broker-dealer has software serving as a ``front end'' for
this system running on the broker-dealers' local IT infrastructure. For
broker-dealers whose order-handling systems are thus hosted on their
service bureau's servers, their service bureaus would handle many
elements of CAT implementation, including clock synchronization. These
broker-dealers would still incur some CAT implementation costs because
some CAT Data, such as Customer information (including PII), is likely
to reside outside of the broker-dealer's order handling system;
consequently, such broker-dealers would need to develop technical and
regulatory infrastructure to provide such CAT Data to its service
bureaus. Further, broker-dealers that outsource could still need to
adapt their in-house software systems to address order-management
system changes. In addition to the resources needed to reprogram the
system, any order-handling system change is likely to require
significant staff training. Furthermore, broker-dealers that outsource
would need to update their internal monitoring of their service
bureau's reporting to ensure it meets the requirements of the Plan.
In discussions arranged by FIF, broker-dealers cited a number of
factors that influence a broker-dealer's decision on whether to handle
regulatory data reporting in-house. Generally, smaller broker-dealers
(with relatively few registered persons and limited capital) do not
have the business volume required to support the IT infrastructure and
specialized staff that is necessary to perform in-house regulatory data
reporting; these broker-dealers may have no business choice but to rely
upon third-party service providers to provide order handling and market
connectivity, as well as clearing services.\894\ For larger broker-
dealers, outsourcing is more likely to be a discretionary business
decision. In discussions with staff, larger broker-dealers cited a
number of reasons to outsource. First, it may be a strategic choice;
some broker-dealers view regulatory data reporting as a function that
offers no competitive advantages and a costly distraction from other
business activities, as long as an alternative solution satisfies
reporting requirements. For these firms, compliance might be achieved
at a lower-cost in-house, but the firms prefer to outsource the data
reporting function to focus key resources on business functions.
Second, some broker-dealers outsource these functions to reduce costs
associated with demonstrating regulatory compliance. Multiple broker-
dealers stated that using a regulatory reporting service that was
familiar to regulators allowed more efficient regulatory examinations,
because an in-house regulatory reporting system might require more
staff time invested in facilitating examinations and demonstrating
compliance. Third, some broker-dealers cited that keeping current with
regulatory requirements drove their decision to outsource. These
broker-dealers may have insourced initially, but they relayed that over
time they experienced accelerating regulatory rule changes, which led
to an escalation in their compliance costs. For these firms, the pace
of regulatory rule changes drove the decision to outsource where they
had at one time insourced, because the firm could fulfill its
regulatory responsibilities at a lower cost by outsourcing and
monitoring the service bureau's compliance.\895\
---------------------------------------------------------------------------
\894\ In conversations with market participants, several broker-
dealers suggested that for very small firms, establishing these
service bureau relationships could be difficult. These firms might
``piggy back'' on another broker-dealer's infrastructure,
essentially relying on them to act as an introducing broker. This
would generally add another cost layer for these very small firms
but could be more cost effective than establishing stand-alone
service bureau relationships.
\895\ The Commission notes that an Industry Member CAT Reporter
remains responsible for compliance with the requirements of the CAT
NMS Plan and Rule 613, as reflected in the Compliance Rule of the
SRO(s) of which it is a member, regardless of whether it has
outsourced some or all of its regulatory data reporting functions to
a third party.
---------------------------------------------------------------------------
On the other hand, some broker-dealers choose to insource their
regulatory data reporting functions. In discussions arranged by FIF,
broker-dealers cited a number of reasons supporting their decision to
self-report. First, some broker-dealers cited ancillary benefits to
constructing the IT infrastructure necessary to accomplish their
regulatory data reporting. Data collected in a central location for
regulatory data reporting and the software necessary to manipulate the
regulatory data facilitates self-monitoring and business reporting,
providing other benefits to the firm. Second, some broker-dealers cited
protecting their proprietary strategies as a motivator to self-report
regulatory data. These broker-dealers felt that sharing their trading
data with a service bureau was potentially too revealing of their
proprietary trading strategies. Third, some broker-dealers cited
operational complexity as a driver of their insourcing decision. For
these very large broker-dealers that traded in a wide range of assets,
outsourcing would involve multiple service provider contracts. At least
one broker-dealer stated that it did not believe service bureaus could
meet all of its requirements due to its complexity. Finally, while some
broker-dealers preferred to outsource to reduce the costs of
demonstrating compliance, others stated that outsourcing would increase
compliance costs because they could not conduct their own compliance
checks to ensure the reports comply with relevant regulations.
[[Page 30717]]
Current costs of outsourcing regulatory data reporting vary widely
across broker-dealers. Whether data reporting is provided on behalf of
a broker-dealer by the provider of an order-management system or
another third-party firm, a broker-dealer generally enters into long-
term agreements with its service provider to obtain a bundle of
services that includes regulatory data reporting, and costs to change
service bureaus are high. Furthermore, based on discussions with
service providers, the Commission understands that switching service
bureaus can be costly and involve complex onboarding processes and
requirements, and that systems between service bureaus may be
disparate; furthermore, changing service bureaus may require different
or updated client documentation.\896\ The Commission preliminarily
believes that annual costs for provision of an order-handling system
(including market connectivity, routing and regulatory data reporting)
range from $50,000 to $180,000 annually for very small broker-dealers.
Costs for very large broker-dealers that outsource these functions
begin at $1 million to 2.4 million annually.\897\
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\896\ See Section IV.G.1.d, infra, for a discussion of the
potential effects of the Plan on the market to report regulatory
data.
\897\ These estimates are based on Staff discussions with
service bureaus that were arranged by FIF. See supra note 895 and
accompanying text. The $1 million per year figure contemplated a
very large broker-dealer that provided its own order management
system and market connectivity, so it likely represents a rough
estimate of the regulatory data reporting costs of a very large
firm. Because service bureaus did not provide an OATS activity level
corresponding to ``very large,'' the Commission relies on an
analysis of FINRA data on OATS reporting to calibrate its definition
of ``very large'' in terms of OATS activity level and seeks comment
on what activity level should correspond to cost estimates for
``very large'' broker-dealers. The Commission notes that because
there are relatively few broker-dealers that report at medium
activity levels, the Commission's estimation of outsourcing costs is
not particularly sensitive to this definition because most broker-
dealers whose costs are estimated using the Outsourcing Cost Model
have very low OATS reporting levels. Finally, estimates of total
reporting costs include provision of an order-management system and
market connectivity.
---------------------------------------------------------------------------
For broker-dealers that perform regulatory data reporting in-house,
implementation costs are likely to vary widely. Some very large broker-
dealers that self-report regulatory data have a centralized IT
infrastructure and trade in relatively few asset classes. Some of these
broker-dealers carry no customer accounts, simplifying their regulatory
data reporting obligations. The Commission preliminarily believes that
such broker-dealers could incur relatively low CAT implementation costs
because they have a centralized IT infrastructure that captures all
broker-dealer activity and specialized personnel who are dedicated to
broker-dealer-wide data reporting. At the other end of the spectrum,
large broker-dealers may be very complex, facilitating complex multi-
leg transactions and operating within a non-centralized structure.
These broker-dealers would be likely to experience CAT implementation
costs far higher than broker-dealers with less complex structures for
several reasons. First, some of these broker-dealers do not have a
centralized IT infrastructure; instead, orders could originate from
many locations in the broker-dealer and may be handled by diverse
legacy systems, each of which the broker-dealer would need to adapt for
CAT Data reporting.\898\ Second, broker-dealers that accommodate more
complex transactions that involve multiple asset classes would likely
need to invest more time in understanding new regulatory requirements.
In discussions with market participants, several broker-dealers noted,
among other concerns, that determining the correct regulatory treatment
for unusual trades can be a significant cost-driver in implementing
regulatory rule changes and can delay implementation of system changes
or precipitate a second round of changes once regulatory treatment of
these trades is clarified. Third, broker-dealers that lack a
centralized IT infrastructure would likely incur higher costs to comply
with clock synchronization requirements because more servers may be
handling orders than in firms with a more centralized IT
infrastructure.
---------------------------------------------------------------------------
\898\ In discussions with market participants, some broker-
dealers indicated that they operate more than a dozen instances of a
third-party's order handling system, suggesting they originate
orders at more than a dozen places within the broker-dealer, yet
they handle data reporting in-house. Firms such as these are likely
to incur far higher costs to implement CAT compared to broker-
dealers with a centralized IT infrastructure and fewer legacy
systems because there are more systems that require changes to
comply with new data reporting requirements.
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B. Re-Estimation
i. Count of Firms Likely To Rely Upon Service Bureaus for Data
Reporting
To separately examine the costs to broker-dealers that outsource
and to aggregate those costs across all broker-dealers, Commission
Staff first established a count of CAT Reporters likely to outsource
their regulatory data reporting functions. For this, the Commission
analyzed data provided by FINRA.\899\
---------------------------------------------------------------------------
\899\ See supra note 893 and accompanying text.
---------------------------------------------------------------------------
The FINRA data allows the Commission to examine how broker-dealers'
current outsourcing activities vary with the number of ROEs reported to
OATS. Figure 1 shows the percentage of OATS ROEs that are self-reported
for five size categories of broker-dealers with the following OATS
reporting activity levels for a four-week period from June 15-July 10,
2015: More than 1 billion records; 1 million to 1 billion records;
350,000 to 1 million records; 100,000 to 350,000 records; and 100,000
records or fewer.\900\ The bars for each category represent the
percentage of total OATS ROEs reported by broker-dealers in the
category that were reported directly by the broker-dealers.
---------------------------------------------------------------------------
\900\ The group that reports one billion records or more
comprises 77.90% of OATS records; the group that reports one million
records to one billion comprises an additional 22.05% of OATS
records. The remaining three groups comprise just 0.05% of all OATS
records. Overall, firms self-report 65.44% of OATS ROEs.
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[[Page 30718]]
[GRAPHIC] [TIFF OMITTED] TN17MY16.329
Based on this analysis of FINRA data, the Commission preliminarily
believes that the 126 broker-dealers that reported more than 350,000
OATS ROEs between June 15 and July 10, 2015 make the insourcing-
outsourcing decision strategically based on the broker-dealer's
characteristics and preferences, while the remaining OATS reporters are
likely to utilize a service bureau to accomplish their regulatory data
reporting.\901\ The categories of broker-dealers assumed to outsource
their data reporting are marked with an asterisk (*) in Figure 1.
---------------------------------------------------------------------------
\901\ The Commission preliminarily believes this decision is
strategic and discretionary because FINRA data reveals that while
many broker-dealers at these activity levels self-report most or all
of their regulatory data, other broker-dealers outsource most or all
of their regulatory reporting at these activity levels. At lower
activity levels, most, but not all, broker-dealers outsource most if
not all of their regulatory data reporting. The Commission is
cognizant that some broker-dealers reporting fewer than 350,000 OATS
ROEs per month can and do opt to self-report their regulatory data.
However, based on conversations with broker-dealers, the Commission
preliminarily believes that most broker-dealers at these activity
levels do not have the infrastructure and specialized staff that
would be required to report directly to the Central Repository, and
electing to self-report would be cost-prohibitive in most but not
all cases. See Section IV.F.1.c(2)A, supra.
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As seen in Figure 1, broker-dealers in the highest OATS-reporting
category insourced reporting for more than 60% of the OATS ROEs
reported. More specifically, the FINRA data shows that 16 broker-
dealers reported more than a billion OATS ROEs each between June 15 and
July 10, 2015; most of these broker-dealers (11) self-reported nearly
all of their regulatory data, but 3 used service bureaus for 100% of
their OATS reporting.
Figure 1 also shows that broker-dealers that report between 1
million and 1 billion OATS ROEs during the four-week period insourced
reporting for more than 70% of the OATS ROEs they reported in
aggregate. Thirty-six of these 89 broker-dealers used service bureaus
to report at least 90% of their OATS data while 42 of these 89 broker-
dealers self-reported over 99% of their regulatory data.
For the 21 broker-dealers that reported more than 350,000 but fewer
than 1 million OATS ROEs during the sample period, Figure 1 shows that
they insource approximately 27% of their aggregate OATS ROEs reporting.
Thirteen of these broker-dealers use service bureaus for more than 99%
of their OATS reporting while 7 of these 21 broker-dealers self-
reported more than 98% of their OATS data.
For the 806 broker-dealers that reported fewer than 350,000 OATS
ROEs during the sample period, approximately 88.9% of those OATS ROEs
were reported through service bureaus, with 730 broker-dealers
reporting more than 99% of their OATS ROEs through one or more service
bureaus.\902\ These broker-dealers are represented in the two right-
most bars in Figure 1 that are identified with asterisks (*) in their
labels. Because of the extensive use of service bureaus in these
categories of broker-dealers, the Commission assumes that these broker-
dealers are likely to use service bureaus to accomplish their CAT Data
reporting.
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\902\ Although most of these broker-dealers report nearly all of
their ROEs through a service bureau, there are broker-dealers, both
large and small, that self-report nearly all of their OATS data at
all activity levels, including a broker-dealer that self-reported
two OATS ROEs during the sample. Despite this variation, the
Commission believes that its assumptions regarding which firms are
likely to outsource and which firms have discretion are appropriate
because (1) small firms that insource likely do so because it is
less costly so the assumption simplifies the analysis and
overestimates costs and (2) the cost information for the other firms
already accounts for both insourcing and outsourcing.
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ii. Estimation of Outsourcing Costs
The Commission has estimated ongoing costs for outsourcing firms
using a model based on data gleaned from discussions with service
bureaus and broker-dealers and implementation costs using information
learned in conversations with industry.\903\ Service bureaus that
provide order-handling systems, market connectivity and regulatory data
reporting services estimated that a very small broker-dealer was likely
to currently spend $50,000-$180,000 per year for these services; they
suggested that current annual costs for very large broker-dealers would
likely be $1,000,000-$2,400,000 but could be greater in some
cases.\904\ The Commission assumes that a very small broker-dealer
would report a single OATS ROE per month and a very large broker-dealer
would report 100 million OATS ROEs per month.\905\
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\903\ See supra note 880.
\904\ Estimates are based on FIF-arranged conversations with
service bureaus. See supra note 880.
\905\ The Commission preliminarily believes that firms that
report more than 350,000 OATS ROEs per month outsource on a
discretionary basis. If the estimate of activity level for very
large firms is too large (100 million ROEs is used in the model
estimation), the Commission's model would underestimate the costs of
all firms that report fewer than 350,000 OATS ROEs per month
currently. The Commission preliminarily believes the 100 million
ROEs per year size estimate to be reliable because although most
firms at activity levels between 40 million and 300 million OATS
ROEs (15 firms) self-report, several use service bureaus.
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[[Page 30719]]
[GRAPHIC] [TIFF OMITTED] TN17MY16.330
Based on discussions with market participants, the Commission
assumes that the cost function for outsourcing is concave.\906\ This
type of function is appropriate when costs increase as activity level
increases, but the cost per unit of activity (e.g., cost per report)
declines as activity increases. Volume discounts can create such cost
functions. Alternatively, if the Commission estimates outsourcing costs
as a linear function using the two point-estimates (very small firms
and very large firms) obtained from service bureaus, that outsourcing
cost model would underestimate the costs of broker-dealers that are
neither very large nor very small due to the concavity of the function.
As shown in Figure 2, a concave function is greater than the linear
function that connects its endpoints. To illustrate the underestimation
concern, if the estimated pricing function was a straight line but the
actual pricing function was concave, the estimates would be too low.
Lacking data on outsourcing costs faced by broker-dealers with activity
levels that are neither very small nor very large, which would assist
the Commission in estimating the degree of concavity of the pricing
function, the Commission's estimation assumes that service bureau
pricing functions are similar in concavity to equity exchange pricing
functions.\907\
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\906\ The Commission preliminarily believes that service bureau
pricing functions are concave based on discussions with service
bureaus arranged by FIF. See supra note 897.
\907\ The Commission relies on exchange pricing functions
because the data is publicly available and because a broker-dealer's
activity level on exchanges is correlated with the quantity of
regulatory data it generates. If the pricing function for service
bureau services is more concave than exchange pricing functions, the
Commission's preliminary model would underestimate costs for broker-
dealers that are neither very small nor very large because an
increase in concavity would increase the distance between the
concave and linear functions in Figure 2.
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The Commission relies on a schedule of average charges to access
liquidity and rebates to provide liquidity from four non-inverted
exchanges to estimate the concavity of the exchange pricing function,
which the Commission uses to approximate the concavity of the
outsourcing cost model.\908\ On such exchanges, the party receiving
liquidity in the transaction generally pays a fixed fee to do so; the
party providing liquidity receives a rebate from the exchange. This
rebate often marginally increases with the market participant's
aggregate volume on the exchange.\909\ For liquidity providing firms,
this pricing scheme would imply a concave function of the cost
differential between taking and providing liquidity, which informs the
Commission's estimation of the degree of concavity of the outsourcing
cost model. The Commission preliminarily believes that estimating the
shape of the function \910\ using exchange pricing functions is a
reasonable approach because the same
[[Page 30720]]
activities that determine a broker-dealer's access fees on exchanges--
such as executing orders and the activities such as order submission
that are requisite to those executions--would affect the broker-
dealer's impact on a service bureau's infrastructure and thus the fee
that a service bureau is likely to charge to provide services to the
broker-dealer.
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\908\ On many exchanges, the party posting a resting order earns
a rebate when his order is executed. His counterparty, whose order
immediately executes, pays a fee to the exchange, which exceeds the
rebate the liquidity-providing party earned. The difference between
the rebate and the fee represents the cost a market participant
would incur to fill a resting order on the exchange, then
immediately trade out of the position--a so-called ``round-trip''
cost. The magnitude of this round-trip cost is often a function of
the market participant's trading activity on the exchange, with more
active traders paying lower round-trip costs. On ``inverted''
exchanges, the party with the resting order pays a fee while her
counterparty that receives immediate execution earns a rebate. The
Commission's estimate of concavity relies on data from exchanges
that do not feature inverted pricing.
The Commission obtained public fee schedule data from Web sites
for NASDAQ, PSX, NYSE, and ARCA during October, 2015. For NASDAQ,
the differential between access fees and liquidity rebates was
calculated using the universal ``take fee,'' and rebates were for
shares trading at greater than $1.00 per share (http://www.nasdaqtrader.com/Trader.aspx?id=PriceListTrading2. For PSX,
calculations used the Tape C remove charge less rebate to add
displayed liquidity (http://www.nasdaqtrader.com/Trader.aspx?id=PSX_Pricing). For NYSE, calculations used the
``Providing Tier 3/2/1'' rebates versus the universal ``take fee''
(NYSE Trading Fees). For ARCA, calculations used charges and rebates
for midpoint passive liquidity orders available at https://www.nyse.com/publicdocs/nyse/markets/nyse-arca/NYSE_Arca_Marketplace_Fees.pdf.
\909\ See supra note 908 for examples of exchange pricing
schedules.
\910\ This estimation affects the shape of the function, and
thus the relative prices that are estimated for each broker-dealer;
the absolute level of prices is determined through the function's
calibration, which is described below.
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The Commission's estimation of the outsourcing cost model begins
with construction of a tiered function based on the exchange pricing
function; the incorporation of the exchange pricing function is the
source of the concavity in the model.\911\ The Commission's estimation
of exchange pricing assumes four activity level categories.\912\ The
Commission preliminarily mapped OATS reporting activity levels to
exchange fee break points, with the assumptions that only a very small
minority of firms would qualify for the lowest-fee tier of services and
all of the firms that reported so few OATS ROEs to be assumed to be
Outsourcers would be at the highest-cost tier of service.\913\
Consequently, the Commission assumed the first fee break-point to be
350,000 OATS messages per month. A firm with 1 million messages per
month is assumed to qualify for the third pricing tier. To qualify for
the most favorable pricing tier, a firm would need to report more than
100 million OATS messages per month. The model is fitted by adding a
constant to the implied cost of message traffic to bring firms with a
single OATS ROE to the minimum $50,000 annual fee discussed by service
bureaus. The fee for very large firms (for purposes of this model, 100
million plus records per month) is calibrated by multiplying the
estimated exchange fee tiered function by a constant scale factor of
30. With these adjustments, the tiered function implies a firm with
20,000 OATS ROEs per month would incur a service bureau fee of $50,705
annually; a firm with 100 million OATS ROEs per month would incur a
service bureau fee of $1.175 million annually; and a firm with 1
billion OATS ROEs per month firm would incur a service bureau fee of
$11.3 million annually.\914\
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\911\ A tiered function often looks like a set of steps with
points of discontinuity where the function appears to suddenly move
up or down. Often, a tiered function's behavior is determined by the
range of its independent variable (input value). For example, a firm
that charges $1 per unit for orders of 100 units or less, or $.80
per unit for orders of more than 100 units prices according to a
step function, with the number of units ordered being the
independent variable. On exchanges, the round trip cost (access fee
less rebate) is often a step function based on the firm's activity
level during a given calendar period.
\912\ The Commission chose four tiers to strike a balance
between incorporating as much information from exchange pricing
models and having to extrapolate information from them. NASDAQ and
PSX have five activity level tiers, while NYSE and ARCA have three
activity level tiers. Building a model with only three tiers would
ignore potentially significant information from NASDAQ and PSX while
building a model with five tiers would require extrapolating
information on nonexistent tiers on NYSE and ARCA, which adds
imprecision to the function. For NASDAQ and PSX, the Commission used
prices for the four most active tiers in the analysis; for NYSE and
ARCA, the Commission used all three, with the middle activity level
assumed constant over the two middle activity tiers in the
outsourcing cost model. The aggregate exchange price function
averages prices on those four exchanges.
\913\ The Commission preliminarily believes that this is a
conservative assumption because all of the firms assumed to be
outsourcing are assumed to be at the highest priced service level on
a per record reported basis. This causes the Commission's estimate
of their costs to be higher than other possible assumptions.
\914\ Estimates are outputs of the calibrated step function
based on exchange pricing. Calculations are as follows: Outsourcing
Cost = Fixed Fee ($50,000) + Monthly OATS ROEs x Fee per ROE.
$50,705 = $50,000 + 20,000 x $0.03525; $1.175 million = $50,000 +
100MM x $0.01125; $11.3MM = $50,000 + 1B x $0.01125.
---------------------------------------------------------------------------
The final step in estimating the Outsourcing Cost Model is to
smooth the tiered function by fitting it to a polynomial. As discussed
previously, tiered functions are not continuous; the behavior of the
function can change dramatically at a discontinuity, such as happens
when moving from one activity level category to another. In the earlier
illustrative example, a vendor offered pricing that would be
characterized by a tiered function, in which the firm charges $1 per
unit for orders of 100 units or less, or $.80 per unit for orders up to
400 units. In this example, a purchase of 100 units is more expensive
than a purchase of 120 units.\915\ On exchanges, the pricing
discontinuities may be acceptable to broker-dealers because the broker-
dealers can more easily estimate a range of volume rather than actual
volume, and thus pricing discontinuities may allow the broker-dealers
to better forecast their expected exchange fees based on those volume
ranges. For the Outsourcing Cost Model, however, such discontinuities
are undesirable because service bureaus negotiate the contract with
each customer individually and contracts generally cover a period of
several years. Consequently, service providers provide custom
quotations in consideration of the firm's business activities and
likely capacity impact upon the provider's infrastructure. The
Commission preliminarily believes that there are unlikely to be
instances in which a service bureau's costs to service a customer would
decrease if the customer were to become more active, and because the
contract has a fixed cost, there is unlikely to be incentives to price
with a tiered function to ease billing. To smooth the Outsourcing Cost
Model, the Commission estimates a second degree polynomial to points
imputed across the tiered function.\916\ This step essentially involves
finding a smooth curve that closely tracks the tiered function, but
smoothes its discontinuities.
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\915\ In this illustrative example, 100 units would cost $100
(100 units x $1 per unit), while 120 units would cost $96 (120 units
x $.80).
\916\ A first degree polynomial is linear; a second-degree
polynomial includes a term raised to the power of two and defines a
quadratic function. The Commission did not consider higher degree
polynomials because they include inflection points, which would be
undesirable in this model because there is unlikely to be a range in
which costs per unit would be expected to increase with volume.
Quadratic functions are characterized by curves with a single
minimum or maximum and include concave curves that would be typical
of cost curves with volume discounts. The estimated functional form
of the outsourcing cost model used in cost estimates is based on
OATS ROE activity levels expressed in millions of ROEs per month.
The estimated function is: Cost estimate = -1.3939 ROEs \2\ + 12,473
ROEs + 124,005. Model fit statistics, used to measure how well a
model fits its underlying data, are not meaningful for this model
because points used for the estimation are imputed rather than
observed. This function is not monotonic (always increasing or
always decreasing); it has a maximum at 4.47 billion ROEs. The
Commission believes this is not a serious concern because the model
is not used to provide cost estimates for firms that report more
than 350,000 OATS ROEs per month.
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[[Page 30721]]
[GRAPHIC] [TIFF OMITTED] TN17MY16.331
The model's output in Figure 3 is an estimate of a broker-dealer's
current cost to outsource data reporting services as part of a bundle
of services from a service bureau; for smaller broker-dealers, it is
assumed to include provision of an order management system and market
connectivity.\917\
---------------------------------------------------------------------------
\917\ In conversations with Commission staff, service bureaus
related that some very large clients provide their own order-
handling system and market connectivity. See supra note 880.
---------------------------------------------------------------------------
To estimate costs of CAT Data reporting by the service bureaus, the
Commission preliminarily assumes that the current pricing function
would apply for CAT Data reporting, but the costs in relation to the
number of ROEs would increase because some events that are excluded
from OATS (like proprietary orders originated by a trading desk in the
ordinary course of a member's market making activities), would be
included in CAT.\918\ The Commission estimates the expected increase in
broker-dealer data by estimating the ratio of all SRO audit trail data
(OATS and exchange data) to OATS data; with this methodology, the
Commission estimates CAT Data ROEs reported by broker-dealers would
increase from those reported to OATS by a factor of 1.9431.\919\ The
Commission preliminarily believes that the assumption of the same cost
function is reasonable for several reasons. First, the service bureaus
that provide market access for broker-dealers already process the
exchange traffic for most of these broker-dealers. Although the number
of ROEs reported would increase, service bureaus already host most of
the data that broker-dealers would report to the Central Repository.
Second, although some broker-dealers would have to establish a process
of hosting or processing their customer information at their service
bureau, many broker-dealers already do so to allow their service bureau
to prepare information for clearing.\920\
[[Page 30722]]
Consequently, most service bureaus have already established the
infrastructure to host or process customer information. Third, the Plan
requires broker-dealers to update customer information files, one of
the additional data sources that broker-dealers would need to report to
the Central Repository. While the costs of ensuring the appropriate
security could be significant, these updates occur at a much lower
frequency than the rate of a service bureau customer's market activity,
and thus such updating activity would be unlikely to provide a
technological stress on a service bureau's infrastructure.
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\918\ Although the pricing function is assumed constant, broker-
dealer costs would increase because the number of ROEs they report
through their service bureaus would increase under the Plan. It is
possible that, if the Plan is approved, data under CAT might be
reported in a form other than ROEs; however, if a ROE is equivalent
to a Reportable Event, the number of Reportable Events--regardless
of the form of the event report--would increase by approximately the
same adjustment factor.
\919\ To approximate the increase in reporting activity that
broker-dealers would likely experience if the Plan were approved,
the Commission relied on equity data from the week of September 15-
19, 2014, previously provided by FINRA. This FINRA data includes all
OATS data reported to FINRA, as well as SRO audit trail data from
all equity exchanges effecting trades that week except the Chicago
Stock Exchange. The adjustment factor was estimated by dividing the
number of ROEs in SRO audit trail data hosted by FINRA for all
exchanges and OATS, by the number of ROEs in OATS; this methodology
is equivalent to assuming that all exchange message traffic would
become reportable by broker-dealers. Because some exchange message
traffic is already reported through OATS, this is a conservative
assumption in the sense that it increases the adjustment factor and
consequently increases estimates of broker-dealer reporting costs.
To adjust for the missing exchange, data for the NASDAQ OMX BX (the
lowest volume exchange with trading volume exceeding that of the
Chicago Stock Exchange, based on trades reported through NYSE TAQ)
was double-counted in the exchange activity total. Although this
adjustment factor does not capture options data, the Commission
preliminarily believes that the underestimation is not material in
this application because the Plan assumes that Options Market Maker
quotes (the most frequent option event) would not be reported by
broker-dealers. Furthermore, the Commission notes that the largest
group of events excluded by OATS but reportable under CAT's
reporting rules (proprietary orders originated by a trading desk in
the ordinary course of a member's market making activities)
predominantly originate from insourcing firms for which the service-
bureau model does not provide estimates of reporting costs.
Consequently, the adjustment factor is likely to overestimate the
increased regulatory data volume of outsourcing firms under CAT to a
degree that should encompass the limited option activity reported by
outsourcing broker-dealers.
\920\ Broker-dealers that self-clear but rely on a service
bureau to perform their regulatory data reporting may not have
infrastructure in place to share customer information with their
service providers. However, service bureaus that provide regulatory
data reporting services would need customer information to perform
CAT reporting. The Commission preliminarily believes that service
bureaus that do not currently collect customer information but
provide regulatory data reporting services would need to change
their business processes to continue to offer regulatory data
reporting services; the Commission further assumes that the cost
estimates presented in the Vendors Study encompass the expenses
these service bureaus would incur to continue providing their
current service offerings. In discussions with service bureaus
arranged by FIF, some service bureaus that do not offer clearing
services discussed additional costs, some related to security, that
accompany hosting customer information. If these service bureaus
were to stop offering regulatory data reporting services due to
unwillingness to host customer information, their customers would be
forced to establish new service bureau relationships or undertake
self-reporting. The Commission cannot rule out that one or more
service bureaus may choose to exit the market to provide data
reporting services rather than change their business practices to
satisfy their clients' responsibilities under the Plan. Any such
event would potentially be very costly to the broker-dealer clients
of the exiting service bureaus due to the switching costs that
broker-dealers incur to change service bureaus. Such an event could
also contribute to crowded entrances problems. See infra note 934.
The Commission preliminarily believes that such service bureau exit
events are unlikely because service bureaus should be able to pass
costs associated with handling customer information on to their
clients as part of a more comprehensive bundle of services.
Furthermore, based on information from broker-dealer discussions
arranged by FIF, the Commission preliminarily believes that the
market for regulatory data reporting services is generally expanding
and the trend is for more, not less, outsourcing. Consequently, the
Commission believes that market share in this market is valuable and
existing competitors are unlikely to voluntarily exit the market
abruptly. The Commission preliminarily believes that most firms that
report fewer than 350,000 OATS ROEs per month do not self-clear;
smaller firms that do not self-clear are likely to already have
relationships with service bureaus that host their customer
information. It is possible that some of these firms have clearing
arrangements that do not include regulatory data reporting; these
firms may be forced to seek new service bureau relationships to
satisfy their CAT reporting obligations, but it is also possible
these clearing firms may either add CAT reporting as a service or
establish a relationship with a service bureau to perform the
function of providing customer information for CAT on behalf of its
clients.
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The Commission preliminarily believes this activity is unlikely to
result in a service bureau pricing structure that significantly differs
from the Commission's current outsourcing cost model. The Commission
recognizes, however, that these new data sources create implementation
costs for both broker-dealers and service bureaus, and preliminarily
believes that these costs are reflected in cost estimates provided by
service bureaus because service providers that responded to the Service
Providers Study were presumably familiar with the requirements of CAT
when they estimated the costs they could likely incur if the CAT NMS
Plan is approved. The number of ROEs broker-dealers would report would
likely increase because, for example, proprietary orders originated by
a trading desk in the ordinary course of a member's market-making
activities, currently excluded from OATS, would be included in a
broker-dealer's audit trail data under the Plan.\921\ The increase in
ROEs would drive an increase in service bureau costs that the
Commission's model anticipates for broker-dealers that would outsource
CAT Data reporting obligations.\922\ For illustration, consider two
firms: Firm A reports the median number of OATS ROEs per month in the
Outsourcers sample (1,251) and Firm B reports the maximum number of
OATS ROEs per month (348,636). After CAT implementation, the estimation
would assume that Firm A would report 2,431 ROEs of audit trail data
per month and Firm B would report 677,435 ROEs of audit trail data per
month.\923\ Using the outsourcing cost model discussed above, Firm A's
annual cost would increase from $124,021 to $124,035. Firm B's average
annual cost would increase from $128,353 to $132,454.\924\
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\921\ The Commission recognizes that OATS does not include
options market activity. Because option quotes are not reportable by
broker-dealers under the Plan, the Commission preliminarily believes
that option related events would not significantly increase the
number of events that would be included in regulatory data reporting
for broker-dealers whose costs are estimated by the Outsourcing Cost
Model. The Outsourcing Cost Model predicts costs only for broker-
dealers that the Commission expects to outsource CAT reporting
responsibilities. Because exchanges would report Options Market
Maker quotes, the Outsourcing Cost Model would not predict the costs
of reporting Options Market Maker quotes. See Exemption Order, supra
note 18, at 11857-58.
In addition, the Commission recognizes that larger and more
complex broker-dealers are likely to have significant regulatory
reporting responsibilities related to their options activities, but
the Commission preliminarily believes that these broker-dealers are
likely to be included in the broker-dealers reporting more than
350,000 OATS ROEs per month. The Commission estimates these broker-
dealers' costs using information from the Reporters Study in the
Plan as opposed to the Outsourcing Cost Model, and those cost
estimates presumably include costs related to options activity.
\922\ The Outsourcing Cost Model assumes that other CAT
reporting tasks like providing customer information to the Central
Repository are handled by the firms' service bureaus. In practice,
some Outsourcers may have a service bureau that provides an order
handling system and market connectivity, but does not currently host
broker-dealers' customer information, while another service provider
provides clearing services and hosts customer information. For
broker-dealers with multiple service provider relationships, the
clearing broker-dealer is assumed to provide services that include
providing the Central Repository with the customer information for
its broker-dealer clients. The Commission recognizes that not all
clearing firms may plan to provide this service to their customers,
and this may result in additional costs for broker-dealers that do
not have relationships with service providers that will provide all
services they need to comply with CAT, if it is approved. This is
discussed further below in Section IV.G.1.d, infra.
\923\ Firm A: 2,431 = 1,251 x 1.9431. Firm B: 677,435 = 348,636
x 1.9431.
\924\ Firm A: $124,021 = -1.3939 x (0.001251) \2\ + 12,473 x
0.001251 + 124005; $124,035 = -1.3939 x (0.002431) \2\ + 12,473 x
0.002431 + 124,005. Firm B: $128,353 = -1.3939 x (0.348636) \2\ +
12,473 x 0.348636 + 124,005; $132,454 = -1.3939 x (0.677435) \2\ +
12,473 x 0.677435 + 124,005. The Commission notes that, as set
forth, the outsourcing cost model's output is dominated by the fixed
cost of maintaining service at low reporting levels. But if the
service bureau cost model estimated a very large firm's outsourcing
cost, a very large firm's cost increase due to CAT would be far more
significant. For example, a firm that reported 1.05 billion OATS
ROEs per month would have estimated current costs of $11.7 million
annually; after CAT implementation, its costs would be estimated to
be $19.8 million. However, the Commission does not assume that firms
that report more than 350,000 OATS ROEs per month are Outsourcers
nor does the Commission assume that they are necessarily Insourcers;
instead, their costs are estimated using data from the Reporters
Study.
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Application of the model to data provided by FINRA allows the
Commission to estimate current outsourcing costs for broker-dealers, as
well as projected costs under the CAT NMS Plan.\925\ The Commission
estimates that the 806 broker-dealers that monthly each currently
report fewer than 350,000 OATS ROEs currently spend an aggregate $100.1
million on annual outsourcing costs.\926\ Under the CAT NMS Plan, the
Commission estimates these 806 broker-dealers would spend $100.2
million on annual outsourcing costs. The Commission recognizes that the
magnitude of this increase is quite small, but this is driven by the
fact that the vast majority of firms that are assumed to outsource have
very low regulatory data reporting levels currently. As mentioned
previously, the median firm in this group reports 1,251 OATS ROEs per
month; only 39 of these 806 firms currently reports more than 100,000
OATS ROEs per month. The Outsourcing Cost Model also does not include
additional staffing costs that the broker-dealer is likely to incur for
implementation and maintenance of CAT reporting; these are discussed
further below, and are the primary cost driver of costs that
Outsourcers are expected to incur if the Plan is approved. Furthermore,
the Commission is cognizant that data reporting is
[[Page 30723]]
normally part of a bundle of services provided by a service bureau;
many of those services, including the provision of market access and an
order handling system, are likely to contribute substantially to the
costs service bureaus bear to service their clients. The Commission is
cognizant that while the volume of transactions reported by broker-
dealers assumed to be Outsourcers are unlikely to dramatically increase
under CAT, the service bureaus would incur significant costs to
implement changes required by CAT reporting. Those costs are discussed
below.\927\ Assuming service bureaus pass those implementation costs on
to their broker-dealer clients eventually, the Outsourcing Cost Model
would change.\928\
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\925\ This data is described above. See supra note 893.
\926\ The average broker-dealer in this category reported 15,185
OATS ROEs from June 15-July 10, 2015; the median broker-dealer
reported 1,251 OATS ROEs. Of these broker-dealers, 39 reported more
than 100,000 OATS ROEs during the sample period.
\927\ See Section IV.F.1.d, infra.
\928\ This would constitute a transfer of costs between market
participants, but would not affect the Commission's estimate of the
total costs to industry. In particular, the Commission preliminarily
believes that if service bureaus pass their implementation costs on
to their broker-dealer clients, it would appear as higher ongoing
costs for those clients, but the overall costs would not change.
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Firms that outsource their regulatory data reporting still incur
internal staffing costs associated with this activity. These employees
perform activities directly related to regulatory data reporting such
as answering inquiries from their service bureaus, investigating
reporting exceptions, maintaining any systems that transmit data to
their service providers, and overseeing their service bureaus' data
reporting to ensure compliance.\929\ Based on conversations with market
participants, the Commission estimates that these firms currently have
0.5 full-time employees devoted to regulatory data reporting
activities. The Commission further estimates these firms would need one
full-time employee for one year to implement CAT reporting
requirements, and 0.75 full-time employees on an ongoing basis to
maintain CAT reporting.\930\
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\929\ Other employees perform other compliance duties such as
supervising associated persons, and creating and enforcing internal
regulatory policies (e.g., personal trading, churning reviews, sales
practice reviews, SEC filings and net capital compliance). Because
these regulatory activities are not part of regulatory data
reporting directly affected by the Plan, they are not included in
activities that contribute to current regulatory data reporting
costs in the Commission's analysis.
\930\ As previously discussed, the Commission preliminarily
believes that small broker-dealer cost data in the Reporters Study
is unreliable. Based on discussions with broker-dealers, the
Commission preliminarily believes that very small broker-dealers are
unlikely to have employees entirely dedicated to regulatory data
reporting. Instead, other employees have duties that include dealing
with service bureau matters and answering regulatory inquiries. The
Commission assumes a full-time employee costs $424,350 per year. See
Section V.D.2(2)A.i, infra.
---------------------------------------------------------------------------
In addition to broker-dealers that currently report to OATS, the
Commission estimates there are 799 broker-dealers that are currently
excluded from OATS reporting rules due to firm size, or exempt because
all of their order flow is routed to a single OATS reporter, such as a
clearing broker, that would have CAT reporting responsibilities.\931\
The Commission assumes these broker-dealers would have low levels of
CAT reporting, similar to those of the typical Outsourcers that
currently report to OATS.\932\ For these firms, the Commission assumes
that under CAT they would incur the average estimated outsourcing cost
of firms that currently report fewer than 350,000 OATS ROEs per month,
which is $124,373 annually. Furthermore, because these firms have more
limited data reporting requirements than other firms, the Commission
assumes these firms currently have only 0.1 full-time employees
currently dedicated to regulatory data reporting activities. The
Commission assumes that these firms would require 2 full-time employees
for one year to implement the CAT NMS Plan and 0.75 full-time employees
annually to maintain CAT Data reporting.\933\
---------------------------------------------------------------------------
\931\ In discussions with Commission Staff, FINRA has stated
that there are currently 54 OATS-exempt broker-dealers and 691 OATS-
excluded firms. The Commission's estimate of 799 new CAT-reporting
broker-dealers is based on the counts of other broker-dealer types
(current OATS reporters, ELPs, Options Market Makers, and floor
brokers) and the 1,800 broker-dealer estimate provided in the Plan.
Based on the FINRA information on OATS-excluded or OATS-exempt
broker-dealers, there are 54 remaining broker-dealers in the 1,800
with an unknown type. The Commission preliminarily assumes that
these broker-dealers are small and new reporters, although it is
possible that they are floor brokers on exchanges other than the
CBOE (CBOE floor brokers are accounted for directly as discussed
below.) Floor brokers are assumed to have the same costs as new
reporting small firms, so there would be no impact on the
Commission's cost estimate if these firms were reclassified as
options floor brokers.
\932\ Exemption or exclusion from OATS may be based on firm size
or type of activity. Broker-dealers with exemptions or exclusions
that relate to firm size are presumably relatively inactive.
However, some firms may be exempted or excluded because they route
only to a single OATS-reporting broker-dealer; this could encompass
large firms that would be more similar to Insourcers.
\933\ The Commission assumes that these very small firms already
have established service bureau relationships to provide an order
handling system, market access, and clearing services. If any of
these firms would have to establish these relationships to comply
with CAT, they would likely face greater costs associated with
implementing these relationships. Furthermore, the Commission notes
that conversations with market participants revealed that
establishing these relationships can be difficult for very small
firms because their relatively low activity levels results in
service bureau fees that may not make the relationship economically
feasible for service providers. Faced with this constraint, some
very small firms currently resort to establishing ``piggy back''
relationships with larger broker-dealers, essentially using another
firm as its introducing broker. Such a relationship may add an
additional layer of costs to those discussed here, but such an
agreement may actually prove less costly for these small firms than
establishing the service bureau relationships assumed in the cost
estimation because the process of onboarding with a service bureau
is costly.
---------------------------------------------------------------------------
The Commission recognizes that some broker-dealers that are
categorized in its estimation as Outsourcers in fact currently self-
report their regulatory data; there are 36 firms that the Commission
categorized as Outsourcers that self-report more than 95% of their OATS
ROEs. Some of these broker-dealers could find that the costs associated
with adapting their systems to the CAT NMS Plan reporting would render
self-reporting (insourcing) CAT Data reporting infeasible or
undesirable; others could continue to self-report regulatory data. The
Commission preliminarily believes that the estimated cost of
outsourcing for these broker-dealers is reliable, but recognizes that
some of these broker-dealers could choose to self-report for other
reasons at costs that could exceed these estimates. If some of these
broker-dealers choose to outsource under CAT, these broker-dealers
would likely incur additional costs associated with establishing or re-
negotiating service bureau relationships.\934\ The Commission does
[[Page 30724]]
not have information on existing service bureau relationships for firms
that currently self-report OATS data, so cannot estimate the costs
these firms might face in aggregate. It would be, however, unlikely
that many firms of this size do not have relationships with service
bureaus that would provide this service because firms with limited OATS
reporting are unlikely to be large enough to self-clear and support the
IT infrastructure necessary to provide a proprietary order handling
system and market access.
---------------------------------------------------------------------------
\934\ In addition to the 36 broker-dealers discussed above, it
is possible that many of the 799 broker-dealers that are currently
exempt or excluded from OATS reporting may seek to establish service
bureau relationships to accomplish their regulatory reporting
required under the Plan if it were approved. It is possible that
this could precipitate a ``crowded entrances'' problem in the market
for regulatory data reporting services, in which more broker-dealers
wished to establish relationships than the market could accommodate.
As discussed previously, the onboarding process for service bureaus
is onerous and time-consuming, both for the broker-dealer and the
service bureau. If a large number of broker-dealers seek
relationships simultaneously, service bureaus might not accommodate
them in time to meet CAT reporting requirements. In such a
situation, smaller broker-dealers are more likely to fail to
establish service bureau relationships because they are presumably
less profitable for service bureaus to serve and so are likely to be
seen as lower-priority when onboarding resources are constrained.
Some small broker-dealers could be forced to establish relationships
with larger broker-dealers and rely on their infrastructure,
essentially using the larger partner as an introducing broker. This
could add an additional layer of costs for the smaller broker-
dealer. The Commission preliminarily believes that significant
crowded entrances problems with service bureaus are unlikely for two
reasons. First, in discussions with service bureaus arranged by FIF,
several service bureaus stated that onboarding resources were not
difficult to scale up. Consequently, it seems likely that service
bureaus could deploy additional onboarding resources to accommodate
new demand for their services. Second, the Commission preliminarily
believes that most of the OATS exempt or excluded broker-dealers
already have service bureau relationships which provide them with
order handling systems and market access; it is likely that these
service bureaus could add regulatory data reporting packages to
their current bundle of services. Finally, the implementation
timelines may help alleviate strained capacity because it would
allow some time for expanding onboarding capacity and new entrants
and would spread out onboarding somewhat. See Section IV.G.1.d,
infra.
---------------------------------------------------------------------------
C. Aggregate Broker-Dealer Cost Estimate
The Commission's methodology to estimate costs to broker-dealers of
implementing and maintaining CAT reporting varies by the type of
broker-dealer. As discussed previously,\935\ the Commission
preliminarily believes that the survey of small broker-dealers used in
the Reporters Study is unreliable. The Commission does, however, rely
on the Reporters Study's large broker-dealer cost estimates in
estimating costs for Insourcers. Consequently, for broker-dealers that
are FINRA members, the Commission relies on the Reporters Study data to
estimate costs for broker-dealers that report more than 350,000 OATS
ROEs per month (using estimates from the Reporters Study for large,
OATS-reporting broker-dealers).\936\ For lower activity FINRA-member
broker-dealers (including those that do not currently report to OATS
due to exclusions and exemptions to OATS reporting requirements), the
Commission relies on the Outsourcing Cost Model to estimate costs for
CAT Data reporting.
---------------------------------------------------------------------------
\935\ See Section IV.F.1.c(1), supra.
\936\ The Commission's cost estimates assume that broker-dealers
that currently reporter fewer than 350,000 OATS ROEs per month are
likely to use one or more service bureaus to report their regulatory
data. This is discussed further in Section IV.F.1.c(2)B.i, supra.
---------------------------------------------------------------------------
The Commission, however, preliminarily believes that there are
three other categories of broker-dealers not reflected in the above
detailed cost estimates that do not currently report OATS data but
could be CAT Reporters. First, there are at least 14 ELPs that do not
carry customer accounts; these firms are not FINRA members and thus
have no regular OATS reporting obligations.\937\ The Commission
preliminarily believes that it is likely that these broker-dealers
already have self-reporting capabilities in place because each is a
member of an SRO that requires the ability to report OATS on request.
The second group of broker-dealers that are not encompassed by the cost
estimates of FINRA member broker-dealers discussed above are those that
make markets in options and not equities. Although not required by the
CAT NMS Plan to report their option quoting activity to the Central
Repository,\938\ these broker-dealers may have customer orders and
other activity that would cause them to incur a CAT Data reporting
obligation. Based on CBOE membership data, the Commission believes
there are 31 options market-making firms that are members of multiple
SROs but not FINRA.\939\ The third group comprises 24 broker-dealers
that have SRO memberships only with CBOE; the Commission believes this
group is comprised primarily of CBOE floor brokers and, further,
preliminarily believes these firms would incur CAT implementation and
ongoing reporting costs similar in magnitude to small equity broker-
dealers that currently have no OATS reporting responsibilities because
they would face similar tasks to implement and maintain CAT reporting.
The Commission assumes the 31 options market-making firms and 14 ELPs
would be typical of the Reporters Study's large, non-OATS reporting
firms because this group encompasses large broker-dealers that are not
FINRA members, a category that would exclude any broker-dealer that
carries customer accounts and trades in equities. For these 45 firms,
the Commission relies on cost estimates from the Reporters Study.\940\
---------------------------------------------------------------------------
\937\ The category of Insourcers that do not currently report
OATS data includes firms that have multiple SRO memberships that
exclude FINRA. This category includes Options Market Makers and at
least 14 ELPs; these are firms that carry no customer accounts and
directly route proprietary orders to Alternative Trading Systems;
further information on these firms including the methodology by
which they are identified can be found in the 15b9-1 Proposing
Release. See Proposed Amendments to Rule 15b9-1, supra note 498, at
18052. Because the Commission has identified at least 14 ELPs, it
can consider these firms separately from Options Market Makers for
analysis. However, the Commission recognizes that some firms that
are classified as Options Market Makers may actually be ELPs, if
they were not identified as ELPs previously and are members of CBOE;
because the same cost estimates are used for these groups, this
misclassification does not affect the Commission's aggregate cost
estimates for broker-dealers. The Commission recognizes that some
FINRA member firms also make markets in options; if these firms
report more than 350,000 OATS ROEs per month, the Commission's
estimate of these firms' costs would be based on the estimates for
OATS-reporting large firms based on data in the Reporters Study,
which are higher than estimates for non-OATS reporting large firms
(which include Options Market Makers that do not currently report
OATS). If FINRA member Options Market Makers report fewer than
350,000 OATS ROEs per month or are exempt or excluded from
reporting, they would be incorrectly classified as Outsourcers.
Furthermore, ELPs that were not included in the analysis for the
15b9-1 Proposing Release and are not CBOE members would be
incorrectly classified as new Outsourcers.
Most if not all ELPs have SRO memberships that require them to
report OATS data upon request. Consequently, these firms are likely
to have infrastructure in place that would reduce their
implementation costs for CAT. The Commission preliminarily believes
that this is reflected in the lower CAT implementation costs that
the Plan estimates for large firms that do not currently report
OATS; these estimates form the basis of the Commission's estimates
of costs that ELPs would face if CAT were approved.
\938\ See Section III.B.9, supra; see also Exemption Order,
supra note 18, at 11857-58.
\939\ The Commission identified 39 CBOE-member broker-dealers
that are not FINRA members, but are members of multiple SROs; 8 of
these broker-dealers were previously identified as ELPs, leaving 31
firms with multiple SRO memberships that are unlikely to be CBOE
floor brokers. These 31 firms are likely to include some ELPs. This
methodology implicitly assumes that there are no Options Market
Makers that are not members of the CBOE. Because the Commission uses
the same cost estimates for ELPs and options market making firms,
uncertainty in the classification of the 31 Non-FINRA member CBOE
member firms does not impact the Commission's cost estimates. The
Commission recognizes that Options Market Makers may be FINRA
members, but preliminarily believes these broker-dealers would be
identified as Insourcers using FINRA data discussed in Section
IV.F.1.c(2)B.i and thus would not fall under cost estimates produced
by the Outsourcing Cost Model.
\940\ The Commission recognizes that additional broker-dealers
may be members of neither FINRA nor CBOE, yet may incur CAT
reporting obligations if the Plan is approved. Indeed, the Plan
estimates that 100 CAT Reporters are not currently FINRA members
(B.7.(b)(ii)(B)(2)), while the Commission estimates 69 (24 floor
brokers, 31 Options Market Makers, and 14 ELPs). The Commission has
determined that categorizing additional broker-dealers that are
currently classified as exempt or excluded FINRA members as non-
FINRA members would not change the cost estimates because these
groups have identical estimated per-firm costs.
---------------------------------------------------------------------------
The estimated costs in the Reporters Study for non-OATS reporting
firms are lower than the Reporters Study's estimated costs for large
OATS-reporting firms; in reviewing the Reporters Study data, the
Commission considered the possibility that firms that do not currently
report OATS may systematically underestimate the costs they would incur
to initiate and maintain the type of comprehensive regulatory data
reporting that OATS entails or the CAT NMS Plan would entail. After
discussions with multiple broker-dealers, the Commission, however,
preliminarily believes that large non-OATS reporting firms would likely
have lower CAT Data reporting costs than current OATS reporting large
[[Page 30725]]
firms because large non-OATS reporting firms tend to be cutting-edge
technology firms that already have a centralized IT infrastructure;
they are unlikely to have a fragmented structure with multiple legacy
systems. A centralized IT infrastructure with cutting-edge technology
would likely simplify their implementation of the CAT NMS Plan, as
fewer of their systems would need altering and fewer servers would be
subject to clock synchronization requirements.
The Commission presents cost estimates for individual broker-
dealers in Table 7 that include estimates of current costs, CAT
implementation costs, and ongoing CAT reporting costs. In addition,
Table 7 presents cost estimates for three categories of costs:
Hardware/software; staffing; and outsourcing.\941\ Table 7 also
presents a total across these three categories.\942\ Current data
reporting cost estimates range from $167,000 annually for floor broker
and firms that are currently exempt from OATS reporting requirements to
$8.7 million annually for firms that currently report more than 350,000
OATS ROEs per month (``Insourcers''). One-time implementation costs
range from $424,000 for current OATS reporters that are assumed to
outsource (``OATS Outsourcers'') to $7.2 million for Insourcers.
Ongoing annual costs range from $443,000 annually for firms that are
assumed to outsource (OATS Outsourcers, New Outsourcers and Floor
Brokers) to $4.8 million for Insourcers.
---------------------------------------------------------------------------
\941\ The Commission preliminarily believes that ``Hardware/
Software'' costs include technology such as servers and
telecommunications infrastructure necessary to report data to the
Central Repository, as well as software that must be acquired or
costs to alter existing software. ``Staffing'' includes the costs of
employees assigned to regulatory data reporting, and includes
existing staff as well as staff that would need to be hired if the
CAT NMS Plan is approved. ``Outsourcing'' includes costs of service
bureau relationships, legal and technical consulting, as well as
other services that firms would need to acquire from service vendors
to accomplish CAT reporting.
\942\ Rounding may cause totals to vary from the sum of
individual elements in Table 7.
Table 7--Cost Estimates for Individual Broker-Dealers by Type
----------------------------------------------------------------------------------------------------------------
Costs
---------------------------------------------------------------
Broker-dealer type Hardware/
software Staffing Outsourcing Total
----------------------------------------------------------------------------------------------------------------
Current Costs:
Insourcers.................................. $720,000 $7,587,000 $400,000 $8,707,000
ELPs........................................ 3,000 1,409,000 22,000 1,433,000
Options Market Makers....................... 3,000 1,409,000 22,000 1,433,000
OATS Outsourcers \1\........................ 0 212,000 124,000 336,000
New Outsourcers \1\......................... 0 42,000 124,000 167,000
Floor Brokers \1\........................... 0 42,000 124,000 167,000
CAT Implementation:
Insourcers.................................. 750,000 6,331,000 150,000 7,231,000
ELPs........................................ 450,000 3,416,000 10,000 3,876,000
Options Market Makers....................... 450,000 3,416,000 10,000 3,876,000
OATS Outsourcers \1\........................ 0 424,000 0 424,000
New Outsourcers \1\......................... 0 849,000 0 849,000
Floor Brokers \1\........................... 0 849,000 0 849,000
CAT Ongoing:
Insourcers.................................. 380,000 4,256,000 120,000 4,756,000
ELPs........................................ 80,000 3,144,000 1,000 3,226,000
Options Market Makers....................... 80,000 3,144,000 1,000 3,226,000
OATS Outsourcers \1\........................ 0 318,000 124,000 443,000
New Outsourcers \1\......................... 0 318,000 124,000 443,000
Floor Brokers \1\........................... 0 318,000 124,000 443,000
----------------------------------------------------------------------------------------------------------------
\1\ Outsourcing costs are modelled on an individual broker-dealer basis. Category averages are presented here.
Table 8 presents aggregate total costs to broker-dealers by broker-
dealer type. The Commission estimates that broker-dealers spend
approximately $1.6 billion annually on current regulatory data
reporting activities. The Commission estimates approximate one-time
implementation costs of $2.1 billion, and annual ongoing costs of CAT
reporting of $1.5 billion. The Commission notes that estimates of
ongoing CAT reporting costs of $1.5 billion are slightly lower than
current data reporting costs of $1.6 billion. This differential is
driven by reductions in data reporting costs reported by large OATS-
reporting broker-dealers in the Reporters Study survey.\943\ The
Commission estimates that all other categories of broker-dealers would
face significant increases in annual data reporting costs.
---------------------------------------------------------------------------
\943\ In the Reporters Study, Large OATS Reporters cite average
current data reporting costs of $8.32 million and Approach 1
maintenance costs of $4.5 million annually.
Table 8--Aggregate Broker-Dealer Cost Estimates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Costs
--------------------------------------- Individual
Broker-dealer type Hardware/ Count total Aggregate total
software Staffing Outsourcing
--------------------------------------------------------------------------------------------------------------------------------------------------------
Current Data Reporting Costs:
Insourcers................................................ $720,000 $7,587,000 $400,000 126 $8,707,000 $1,097,130,000
ELPs...................................................... 3,000 1,409,000 22,000 14 1,433,000 20,068,000
Options Market Makers..................................... 3,000 1,409,000 22,000 31 1,433,000 44,437,000
OATS Outsourcers \1\...................................... 0 212,000 124,000 806 336,000 271,113,000
New Outsourcers \1\....................................... 0 42,000 124,000 799 167,000 133,137,000
[[Page 30726]]
Floor Brokers \1\......................................... 0 42,000 124,000 24 167,000 3,999,000
------------------------
Total................................................. ........... ........... ........... 1,800 ........... 1,569,884,000
CAT Implementation Costs:
Insourcers................................................ 750,000 6,331,000 150,000 126 7,231,000 911,144,000
ELPs...................................................... 450,000 3,416,000 10,000 14 3,876,000 54,257,000
Options Market Makers..................................... 450,000 3,416,000 10,000 31 3,876,000 120,141,000
OATS Outsourcers \1\...................................... 0 424,000 0 806 424,000 342,026,000
New Outsourcers \1\....................................... 0 849,000 0 799 849,000 678,111,000
Floor Brokers \1\......................................... 0 849,000 0 24 849,000 20,369,000
------------------------
Total................................................. ........... ........... ........... ........... ........... 2,126,048,000
CAT Ongoing Costs:
Insourcers................................................ 380,000 4,256,000 120,000 126 4,756,000 599,285,000
ELPs...................................................... 80,000 3,144,000 1,000 14 3,226,000 45,160,000
Options Market Makers..................................... 80,000 3,144,000 1,000 31 3,226,000 99,998,000
OATS Outsourcers \1\...................................... 0 318,000 124,000 806 443,000 356,764,000
New Outsourcers \1\....................................... 0 318,000 124,000 799 443,000 353,666,000
Floor Brokers \1\......................................... 0 318,000 124,000 24 443,000 10,623,000
------------------------
Total................................................. ........... ........... ........... ........... ........... 1,465,496,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Outsourcing costs are modeled on an individual broker-dealer basis. Category averages are presented here.
d. Costs to Service Bureaus
The Plan discusses costs that service bureaus would face to
implement the CAT NMS Plan and maintain ongoing CAT reporting.\944\ The
CAT NMS Plan's cost estimates for service bureaus are based on the
Participant's Costs to Vendors Study (``Vendors Study''), which
gathered data from third-party vendors.\945\ The Vendors Study
requested information from thirteen (13) service providers about their
potential costs for reporting CAT Data--five (5) service providers
responded. The CAT NMS Plan cites aggregate implementation costs of
$51.6 million to $118.2 million for service bureaus, depending on
whether Approach 1 or Approach 2 is selected, where Approach 1 would be
more costly to vendors.\946\ Aggregate ongoing annual cost estimates
ranged from $38.6 million to $48.7 million.
---------------------------------------------------------------------------
\944\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(D), Appendix C, Section B.7(b)(iv)(A)(4).
\945\ See id. at Appendix C, Section B.7(b)(i)(A)(3); Appendix
C, Section B.7(b)(iii)(D). The Commission preliminarily believes
that most if not all market participants that responded to the
Vendors Survey are service bureaus, but it is possible that some
respondents are firms providing technology rather than service
bureau services.
\946\ Approach 1 allows broker-dealers to submit data to the
Central Repository using their choice of existing industry messaging
protocols while Approach 2 would specify a pre-defined format. See
Section IV.E.1.b(3), supra.
---------------------------------------------------------------------------
The Commission preliminarily believes that costs that service
bureaus would face to implement CAT should be included as part of the
aggregate costs of CAT. While the CAT NMS Plan does not require the use
of service bureaus to report CAT Data, the Commission recognizes that
the most cost effective manner to implement the CAT NMS Plan likely
would be for most market participants to continue their current
practice of outsourcing their regulatory data reporting to one or more
service bureaus. By doing so, the roughly 1,600 broker-dealers
predicted to outsource would avoid incurring a significant fraction of
CAT implementation costs; instead, service bureaus would incur
implementation costs on their behalf. Based on conversations with
market participants, the Commission preliminarily believes that these
implementation costs are likely to pass-through to broker-dealers that
outsource data reporting, because service contracts between broker-
dealers and service bureaus are renegotiated periodically, and approval
of the CAT NMS Plan might trigger renegotiation as the bundle of
services provided would materially change. Consequently, service
bureaus likely would renegotiate their client agreements during the
period of implementation of the CAT NMS Plan. The Commission
preliminarily recognizes that service bureaus may, when re-negotiating
these service contracts factor in the CAT implementation costs the
service bureaus incurred; consequently, broker-dealers could see
increases in costs that reflect a service bureau's efforts to recoup
those costs. In its analysis of costs, the Commission includes these
service bureau costs and separately identifies them as service bureau
implementation costs, but the Commission recognizes that they are
likely to ultimately be borne by broker-dealers.\947\
---------------------------------------------------------------------------
\947\ Although the Commission preliminarily believes that
service bureau implementation costs would ultimately be passed on to
broker-dealers, the Commission believes these costs are not double-
counted in this analysis because re-negotiation of service bureau's
contracts with their clients is not explicitly factored in to the
Outsourcing Cost Model. Instead, the Commission recognizes these
costs as being borne by the service bureaus initially, and does not
identify a specific mechanism by which they will ultimately be
passed onto broker-dealers.
---------------------------------------------------------------------------
The Commission, however, preliminarily believes that the ongoing
costs of CAT Data reporting by service bureaus would be duplicative of
costs incurred by broker-dealers. The aggregate fees paid by
outsourcing broker-dealers to service bureaus cover the service
bureaus' costs of ongoing data reporting. To include ongoing service
bureau costs as a cost of CAT would double-count the costs that broker-
dealers incur for CAT Data reporting; thus, in aggregating the cost
estimates for CAT, the Commission includes only the maximum
implementation cost that vendors would likely face of $118.2 million.
2. Aggregate Costs to Industry
The Sections above provide four sets of cost estimates that
together encompass the costs of the Plan. This Section discusses
aggregation of these costs into the total costs of the Plan. The Plan
provides estimates of the total costs to industry if the Commission
approves the Plan. The Plan estimates initial aggregate costs to
industry of $3.2 billion to $3.6 billion and annual ongoing costs of
$2.8 billion to $3.4
[[Page 30727]]
billion, with system retirement costs of $2.6 billion.\948\ The
Commission estimates that industry would spend $2.4 billion to
implement CAT, and $1.7 billion per year in ongoing annual costs.
---------------------------------------------------------------------------
\948\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iv)(A)(5).
---------------------------------------------------------------------------
Using estimates discussed above, the Commission recalculated total
implementation and ongoing annual costs, partitioned across market
participant types as possible. Because the Plan does not discuss how
Central Repository costs would be partitioned across Participants and
CAT Reporters, the analysis here presents Central Repository costs
separately from costs to Participants and costs to CAT Reporters. The
Plan presents some costs related to constructing and operating the
Central Repository as ranges; in these cases, the Commission uses range
maximums in the total cost calculation. Where costs differ for Approach
1 and Approach 2, the Commission uses estimates for the approach that
is more costly in aggregate.\949\
---------------------------------------------------------------------------
\949\ Approach 1 aggregate costs are higher than those for
Approach 2 for all market participants except in one case where
service bureaus have lower ongoing costs for Approach 1. In its
discussion of industry (broker-dealer) costs, the Plan states that
the cost differences between these two approaches are not
statistically significant and that there would likely be no
incremental costs associated with either approach. See CAT NMS Plan,
supra note 3, at Appendix C, Section B.7(b)(iii)(C)(2)e.
---------------------------------------------------------------------------
Table 9 presents estimates of aggregate current, implementation,
and ongoing costs to the industry. The Commission notes that costs to
broker-dealers are much greater than the costs of building and
maintaining the Central Repository. In terms of magnitudes of aggregate
costs, costs to the 126 largest broker-dealers that currently report
OATS data is the largest driver of implementation costs, accounting for
38.3% of CAT implementation costs. Although these firms would face
significant costs in implementing CAT, the Reporters Study survey
results suggest that they anticipate lower ongoing reporting costs than
they currently incur ($599 million annually in expected aggregate costs
versus $1.1 billion annually in current aggregate regulatory data
reporting costs).\950\ For all other categories of broker-dealers, the
Commission estimates ongoing annual costs to be higher than currently
reporting costs.
---------------------------------------------------------------------------
\950\ As discussed in Section IV.F.1.c(1), supra, the Commission
preliminarily believes that cost estimates for Large Broker-Dealers
presented in the Plan are reliable.
Table 9--Aggregate Data Reporting Costs to Industry
----------------------------------------------------------------------------------------------------------------
CAT
Number Current costs ---------------------------------
Implementation Ongoing
----------------------------------------------------------------------------------------------------------------
Central Repository............................ 1 $0 $92,000,000 $134,900,000
Participants (all)............................ 1 154,100,000 41,100,000 102,400,000
Service Bureaus (all, 13)..................... 1 Unknown 118,200,000 Excluded
Broker Dealers:...............................
Insourcers (126).............................. 126 1,097,130,000 911,144,052 599,285,000
Outsourcers (806)............................. 806 271,113,000 342,026,100 356,764,000
New Small Firms (799)......................... 799 133,137,000 678,111,300 353,666,000
ELPs (14)..................................... 14 20,068,000 54,257,245 45,160,000
Options Market Makers (31).................... 31 44,437,000 120,141,043 99,998,000
Options Floor Brokers (24).................... 24 3,999,000 20,368,800 10,623,000
-------------------------------------------------
Total BD.................................. 1800 1,569,884,000 2,126,048,540 1,465,496,000
-------------------------------------------------
Total Industry............................ .............. 1,723,984,000 2,377,348,540 1,702,796,000
----------------------------------------------------------------------------------------------------------------
Although the Commission relied on an alternative to the Reporters
Study data to estimate costs for most broker-dealers, the Commission's
aggregate cost estimate is consistent with information presented in the
Plan that suggests that ongoing costs under CAT would likely be lower
than ongoing costs for current reporting systems.\951\ The Plan,
however, also discusses significant costs ($2.6 billion) for retirement
of current regulatory reporting systems.\952\
---------------------------------------------------------------------------
\951\ See CAT NMS Plan, supra note 3, at Appendix C.
\952\ Id. at Appendix C, Section B.7(b)(iv)(A)(5).
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The Commission has not included those costs in its estimate of the
aggregate costs of the Plan for several reasons. First, for reasons
discussed below, the Commission preliminarily believes that cost
estimates provided in the Plan are unlikely to accurately represent the
actual costs industry will face in retiring duplicative reporting
systems. Second, the retirement of current regulatory reporting systems
is not a requirement of the Plan and the timeline and process for their
retirement is uncertain.\953\ While the Commission's cost estimates do
not recognize explicit system retirement expenses, it also does not
explicitly recognize savings from elimination of these systems, though
they are recognized qualitatively as additional benefits of the Plan.
The Commission preliminarily believes that this approach is
conservative in the sense that (for reasons that are discussed below)
system retirement costs are likely to be mitigated by incorporation of
current reporting infrastructure into CAT reporting infrastructure,
while cost savings associated with industry's need to maintain fewer
regulatory data reporting systems are not explicitly recognized.
Finally, while the Commission does not include explicit system
retirement costs, the Commission does recognize that industry will
experience a costly period of duplicative reporting if the CAT NMS Plan
is approved, and the Commission believes it is possible that these
costs may be conflated with actual retirement costs estimated in the
Plan. These reasons are discussed further below. As discussed above,
the Commission preliminarily believes that retirement costs are
unlikely to reflect actual costs to industry in eliminating duplicative
reporting systems for several reasons. First, for the majority of
broker-dealers that outsource, system retirement would affect few in-
house systems; these broker-dealers are likely to adapt the systems
that interface with service bureaus for current regulatory data
reporting to interface for CAT Data reporting. Consequently, the
Commission believes that, for these broker-dealers, costs to implement
CAT reporting are likely to implicitly
[[Page 30728]]
accomplish the retirement of older regulatory data reporting systems
because these older systems will be transformed--in whole or in part--
into systems that accomplish CAT reporting. Second, for broker-dealers
that self-report regulatory data, the Commission cannot determine the
source of the costs of system retirement that are estimated in the
Plan. At its simplest level, ceasing reporting activities would include
scrapping IT hardware dedicated to the endeavor and terminating the
employees responsible for such regulatory data reporting.\954\ The
Commission recognizes that there are costs associated with those
activities, but does not preliminarily believe their magnitude
(estimated in the Plan as $2.6 billion) should approach or exceed the
magnitude of costs of CAT implementation (estimated in this analysis as
$2.4 billion). Although the Commission is uncertain what estimates were
included in system retirement costs and the Commission recognizes that
different survey respondents may have interpreted the question
differently, the Commission preliminarily believes that the system
retirement costs cited in the Plan might include industry estimates of
an extended period of duplicative reporting costs, during which
industry would report data to both CAT and to the systems that CAT
would likely replace.
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\953\ Id. at Appendix C, Section C.9.
\954\ Based on discussions with industry, the Commission
believes that industry is likely to implement the CAT NMS Plan by
repurposing systems and employees currently assigned to other
regulatory data reporting. The cost of eliminating these resources,
however, should provide an upper bound to what actual system
retirement costs would be, because eliminating these resources is an
available and effective means of retiring these systems; market
participants could choose other methods if they are preferable in
terms of reducing costs of system retirement or CAT implementation.
See supra note 880.
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The Commission preliminarily believes that the period of
duplicative reporting would likely constitute a major cost to industry
for several reasons. These reasons include the length of the
duplicative reporting period; constraints on the capacity of industry
to implement changes to regulatory reporting infrastructure that might
cause market participants to implement changes using less cost-
effective resources; and the inability of some market participants to
implement duplicative reporting in house, necessitating that they seek
service bureau relationships to accomplish their CAT reporting
requirements.
Based on data provided in the Plan, the Commission believes that
the period of duplicative reporting anticipated by the Participants is
likely to last for 2 to 2.5 years. The Commission preliminarily
believes that these estimates are reliable because they reflect the
Participants' experience with their historical rulemaking activity,
although the Commission preliminarily believes that some steps outlined
by the Participants might happen concurrently with Commission
rulemaking required to facilitate ending some duplicative reporting.
The Plan outlines a timeline for eliminating duplicative
reporting.\955\ The timeline begins when Industry Members (other than
Small Industry Members) are required to begin reporting to the Central
Repository. The elimination of duplicative reporting would require
several steps: (1) The SROs would identify their respective duplicative
SRO rules and systems; (2) the SROs would file with the Commission the
relevant rule modifications or eliminations; (3) the Commission would
review and consider such rule modification or elimination filings; and
(4) subject to the requisite Commission approval, the SROs would then
implement such SRO rule changes.
---------------------------------------------------------------------------
\955\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.9. The elimination of duplicative reporting may or may not involve
actually retiring IT systems. If current regulatory data reporting
systems are adapted to report CAT Data, some of these systems may
continue to also report duplicative data during the period of
duplicative reporting. In such a case, system retirement would
involve no longer using these systems to report the duplicative data
and any savings may be associated with no longer requiring staff to
maintain the software and systems that support the duplicative
reporting.
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According to the Plan, step (1)--SRO identification of duplicative
SRO rules and systems--of the process could take 12 to 18 months from
implementation. SROs have 12 months (in the case of duplicative rules
and systems) or 18 months (in the case of partially duplicative rules
and systems) to complete their analysis of existing rules and systems
to identify which systems should continue collecting data, or whether
data in the Central Repository could substitute for the information
collected through rules and systems in place.\956\
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\956\ The Plan notes that if a Participant determines that
sufficient data is not available to complete the analysis, a
subsequent date could be identified for such a determination to be
made.
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Certain SRO rules or systems identified by the SROs in step (1)
might first necessitate an SEC rule change before the SROs can properly
modify or eliminate such SRO rule or system. If so, Commission
rulemaking may be required.\957\ This step (1)--even for those SRO rule
and system changes requiring Commission rulemaking--could still
feasibly take less than 18 months total because the SRO's analysis of
their rules and their corresponding SRO rule filings could be
undertaken in parallel with any such related Commission rulemaking
during this period.
---------------------------------------------------------------------------
\957\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.9. For example, Commission rules that require broker-dealers to be
able to report Large Trader or EBS data would prevent SROs from
changing their rules to eliminate this capability. See id.
Consequently, the timeframe for retirement of these systems may also
be dependent on Commission rulemaking. The Commission recognizes
that during the comment period of any SEC rulemaking, SROs might
begin their analysis of their own rules and preparation of potential
filings, possibly compressing this timeline further.
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According to the Plan, step (2) of the process could take 6 months.
After identifying the rules to eliminate or modify, the Plan provides
the Participants with six months to file the proposed rule change with
the Commission. It is possible for the Participants to file these
sooner if their rule changes are not complex, but the Plan places an
upper bound on this. Under this timeline, it could take 18 months to
two years after the first broker-dealers start reporting to the Central
Repository for Participants to file rules to eliminate duplicative
reporting.\958\
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\958\ It could also take longer if the Participant determines
that sufficient data is not available to complete such analysis by
12 or 18 months after Industry Member reporting to the Central
Repository commences.
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According to the Plan, step (3) of the process could take another 3
months to a year. The Commission recognizes that the approval process
for Participant rule changes can take time. In particular, for the
Commission to approve such rules could take another 3 to 12 months
depending on how complex the rule change. However, the Commission
preliminarily expects that as long as such rule changes would be fairly
straight forward, approval would likely take 3 months or less. As such,
the first three steps add up to 21 months to 27 months.
Step (4) involves implementing the Participant rule changes, which
would eliminate duplicative reporting. The Plan states that
Participants would, upon Commission approval of rule changes, implement
the ``. . . most appropriate and expeditious timeline . . . for
eliminating such rules and systems.'' \959\ The Commission
preliminarily believes that the elimination of duplicative reporting
will require significant planning and implementation, but believes that
much of the required planning is likely to happen concurrently with the
Commission approval process of the
[[Page 30729]]
underlying SRO rules. Consequently, the Commission preliminarily
believes that actual implementation could occur as soon as 90 days
after approval, and is not likely to occur more than six months after
approval. The Plan also states that Participants should consider in
setting an implementation timeline, when the quality of CAT Data would
be sufficient to meet surveillance needs. In addition, reducing some
duplicative reporting could require changing Participant rules in
response to the elimination or modification of Commission Rules.
---------------------------------------------------------------------------
\959\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.9.
---------------------------------------------------------------------------
Based on the timelines for all four steps and the Commission's
analysis of how this timeline would be affected by the need in some
cases for Commission rulemaking, the Commission preliminarily believes
that the period of duplicative reporting could last at least 2 years,
and the period of system retirement could extend for up to 2.5 years
after Industry Members begin reporting data, assuming SROs are not
limited in their initial analysis by problems such as delays in
Commission rulemaking or excessive Error Rates, and Commission approval
of SRO rules is completed within 90 days of submission.
Second, industry-wide resources to update order-handling systems
are limited. Based on conversations with market participants, the
Commission preliminarily believes that while most Insourcers and
service bureaus have permanent staff that specialize in these
activities, some would rely on hiring additional staff or utilizing
contractors to increase their capacity to implement changes to order
handling and data reporting systems and support of duplicative
reporting systems. Furthermore, multiple broker-dealers and service
providers cited access to specialized staff as a constraint that limits
their ability to implement regulatory rule changes, stating that while
current and newly hired staff might be able to implement the CAT NMS
Plan and continue supporting OATS, they would be unlikely to be able to
continue to implement changes to both systems. Consequently, Insourcers
and service bureaus would likely incur significant costs associated
with hiring additional employees to implement the CAT NMS Plan and
accomplish regulatory data reporting during any duplicative reporting
period.
Third, the Commission preliminarily believes that some firms that
are currently challenged to maintain their self-reporting of data may
not have the resources to implement the CAT NMS Plan at the same time
as current reporting absent a service bureau relationship. It is
possible that a number of relatively large firms would seek to
establish service bureau relationships to accomplish both CAT reporting
and current reporting even as a number of very small firms that
currently do not report OATS could seek to establish such
relationships. This could precipitate a ``crowded entrances'' situation
in the market to provide data reporting services. The establishment of
these relationships would pose a significant cost to industry.\960\
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\960\ See supra note 934 and Section IV.G.1.d, infra.
---------------------------------------------------------------------------
The Commission expects that there would be some cost efficiencies
with respect to current data reporting costs and CAT reporting costs
during any period of duplicative reporting. For example, servers
hosting software to produce records for CAT could possibly also host
software to produce records for OATS during the duplicative reporting
period because these regulatory reporting systems rely upon much of the
same underlying data. However, the Commission does not currently have
the necessary data to determine the extent of these efficiencies, which
would vary across market participants. Therefore, the Commission cannot
estimate duplicative reporting costs. The Commission preliminarily
believes, however, that the current data reporting costs of $1.7
billion per year constitutes an estimate of the cost per year to
industry of duplicative reporting requirements, as it represents the
cost of duplicative reporting to industry if there are no efficiencies.
The Commission notes, however, that staff required to implement changes
to order handling systems are a limited resource. If market
participants do not have adequate staffing to implement the changes
required by CAT and maintain duplicative reporting, costs for
duplicative reporting could exceed current reporting costs because
market participants could have to rely on external staff (such as
consultants) or contract through service bureaus to accomplish this
reporting; this is likely to be more expensive than staff used for
current reporting.
Further, the Commission does not believe that duplicative reporting
costs should be added to the estimated aggregate costs of the CAT NMS
Plan. The Commission believes that the aggregate costs above represent
the total costs of the Plan and do not account for the differential
between these costs and the costs the industry currently incurs for
regulatory data reporting and maintenance. During the period of
duplicative reporting, industry would incur the aggregate costs of
accomplishing CAT reporting described above, plus the costs of current
data reporting, which the Commission uses as an estimate of duplicative
reporting costs. The Commission notes that market participants will
incur costs equal to current data reporting costs if the Plan were not
approved (because current regulatory data reporting would continue), or
as duplicative reporting costs if the Plan were approved. Consequently,
the Commission preliminarily believes these costs should not be
considered as costs attributable to approval of the Plan, because
market participants would bear these costs whether the Plan is approved
or disapproved.
While broker-dealers are anticipated to bear the burden of the
costs associated with CAT, including implementation costs, ongoing
costs and duplicative reporting costs, the Commission does not know
whether these costs would be passed on to investors, or whether these
costs would be absorbed by the broker-dealers themselves. On one hand,
it could be assumed that broker-dealers could pass on the costs
associated with CAT to investors because broker-dealers currently
already pass on certain regulatory fees to their customers. For
instance, the SROs have adopted rules that require broker-dealer to pay
Section 31 transaction fees,\961\ and some of these broker-dealers have
in turn imposed fees on their customers in order to provide funds to
pay for the fees owed to the SROs. However on the other hand, if the
passing on of these costs is associated with higher fees, a given
broker-dealer could decide to absorb these costs and not increase their
fees, and by doing so, they may attract more customer order flow. The
incremental order flow that the broker-dealer attracts from having
lower fees relative to their competitors may indeed offset the costs
associated with CAT that they incur by not passing these on to their
customers. Other broker-dealers, cognizant that they could lose order
flow to other broker-dealers that do not pass on the costs to their
customers could strategically respond and thus, could also absorb these
costs. Ultimately, the Commission does not know which situation is more
likely to eventuate,
[[Page 30730]]
primarily because the Commission generally does not know the cost
structure of broker-dealers.
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\961\ Under Section 31 of the Securities Exchange Act of 1934,
SROs and all the national securities exchanges must pay transaction
fees to the Commission based on the volume of securities that are
sold on their markets. These fees are designed to recover the costs
incurred by the government, including the Commission, for
supervising and regulating the securities market and securities
professionals. See ``SEC Fee--Section 31 Transaction Fees,''
available at https://www.sec.gov/answers/sec31.htm.
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3. Further Analysis of Costs
a. Costs Included in the Estimates
In general, the CAT NMS Plan does not break down its cost estimates
as a function of particular CAT NMS Plan requirements, although it does
provide some cost information for certain requirements in the Plan.
However, the Commission has considered which elements of the CAT NMS
Plan are likely to be among the most significant contributors to CAT
costs. The Commission preliminarily believes that significant sources
of costs would include the requirement to report customer information,
the requirement to report certain information as part of the material
terms of the order, the requirement to use listing exchange symbology,
and possibly, the inclusion of Allocation Reports. The Commission
preliminarily believes that the clock synchronization requirements, the
requirement that Options Market Makers send quote times to the
exchanges, the requirement that the Central Repository maintain six
years of CAT Data, and the inclusion of OTC Equity Securities in the
initial phase of the implementation of the CAT NMS Plan are unlikely to
be significant contributors to the overall costs of the Plan. Notably,
the Commission believes that its estimates of the implementation costs
and ongoing costs to industry above include each of the costs discussed
in this Section because these provisions encapsulate major parts of the
Plan.
The Commission preliminarily believes that the requirement in the
CAT NMS Plan to report customer information for each transaction
represents a significant source of costs.\962\ In particular, the
adapting of systems to report customer information that is not included
in current regulatory data on a routine basis could require significant
and potentially difficult reprogramming because current audit trail
data does not routinely provide this information. Consequently, this
reprogramming could require gathering information from separate systems
within a broker-dealer's infrastructure and consolidating it in one
location, and redesigning an IT infrastructure to satisfy this
requirement could interrupt other workflows within the broker-dealer,
expanding the scope of systems that must be altered to accomplish CAT
reporting. While the Commission preliminarily believes that the
requirement to report customer information would be a significant
source of costs, the Commission lacks the necessary information to
estimate what proportion of the costs of the Plan are attributable to
this requirement. The Plan does not provide information on the costs
attributable to the reporting of customer information, and the
Commission has no other data from which it can independently estimate
these costs, because the Commission is not aware of any data currently
available to it regarding the number of broker-dealers that would need
to engage in significant reprogramming in order to report customer
information as required in the Plan, or the costs of doing so. The
Commission therefore seeks comment on the costs that would be
attributable to the requirement to report customer information as set
out in the CAT NMS Plan. The Commission also notes that the Plan
reflects exemptive relief granted by the Commission in connection with
this requirement. Specifically, as discussed further in the
Alternatives Section, the Commission granted exemptive relief from
certain requirements of Rule 613 to allow the alternative approach to
customer information that leverages existing identifiers to be included
in the Plan and subject to notice and comment.\963\ Based on cost
survey data provided by the Participants, this approach would reduce
quantifiable costs to the top three tiers of CAT Reporters by at least
$195 million as compared to an approach that followed requirements of
Rule 613 as adopted.\964\
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\962\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1.a.iii.
\963\ See Exemption Order, supra note 18.
\964\ Id. at 17-18.
---------------------------------------------------------------------------
Similarly, the Commission preliminarily believes that the
requirement to report material terms of the order that include an open/
close indicator, order display information, and special handling
instructions represents a significant source of costs.\965\ Not all
broker-dealers are currently required to report these elements on every
order and no market participants report an open/close indicator on
orders to buy or sell equities. Thus, the adapting of some market
participants' systems to report this information for each transaction
could require significant and potentially difficult reprogramming that
requires centralizing or copying information from multiple IT systems
within the broker-dealer. As discussed above, redesigning a broker-
dealer's IT infrastructure could disrupt multiple workflows and
dramatically increase the costs associated with implementing the
changes required by CAT. While the Commission preliminarily believes
that this reprogramming would be a significant source of implementation
costs, the Commission lacks the necessary information to estimate what
proportion of the costs of the Plan are attributable to this
requirement. The Plan does not provide information on the costs
attributable to these elements of the Plan, and the Commission has no
other data from which it can independently estimate the costs, because
the Commission is not aware of any data currently available to it
regarding the number of broker-dealers that would need to engage in
significant reprogramming in order to report this information as
required in the Plan, or the costs of doing so. The Commission
therefore seeks comment on the costs that would be attributable to
reporting the material terms of the order as set out in the CAT NMS
Plan, including an open/close indicator, order display information, and
special handling instructions.
---------------------------------------------------------------------------
\965\ See CAT NMS Plan, supra note 3, at Article I.
---------------------------------------------------------------------------
The Commission also preliminarily believes that the requirement to
use listing exchange symbology in the CAT NMS Plan could represent a
significant source of costs. The Plan requires CAT Reporters to report
CAT Data using the listing exchange symbology format,\966\ which would
also be used in the display of linked data; because broker-dealers do
not necessarily use listing exchange symbology when placing orders on
other exchanges or off-exchange, this requirement could require broker-
dealers to perform a translation process on their data before they
submit CAT Data to the Central Repository.\967\ The translation process
could be costly to design and perform and result in errors that would
be costly for the broker-dealers to correct. If other elements of the
Plan were to necessitate a translation, then the listing exchange
symbology could be fairly low cost because it would be just another
step in the translation. However, if the Plan has no other requirement
that would necessitate a translation, the costs of including listing
exchange symbology on all CAT reports would include the costs of
designing and performing the
[[Page 30731]]
translation as well as the costs of correcting any errors caused by the
translation. While the Commission preliminarily believes that the
requirement to use listing exchange symbology could be a significant
source of costs, the Commission lacks the necessary information to
estimate what proportion of the costs of the Plan are attributable to
this requirement. The Plan does not provide information on the costs
attributable to this particular element of the Plan, and the Commission
has no other data from which it can independently estimate these costs,
because the Commission is not aware of any data currently available to
it regarding the number of broker-dealers that would need to undertake
the translation process, either as a result of this or other elements
of Plan, or the costs of doing so. The Commission seeks comment on the
costs that would be attributable to the requirement to report CAT Data
using listing exchange symbology format as set out in the CAT NMS Plan.
---------------------------------------------------------------------------
\966\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1.a.
\967\ For example, class A shares of ABC Company might be traded
using ticker symbol ``ABC A'' on one exchange, ``ABC_A'' on another
exchange, and ``ABC.A'' on a third. As written, the Plan would
require all broker-dealers to use the listing exchange's symbol for
its Central Repository reporting, regardless of the symbol in the
order messages received or acted upon at the broker-dealer or
exchange.
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The Commission recognizes that industry would bear certain costs
associated with Allocation Reports, particularly the requirement that
the reports include allocation times. The Commission understands that
some broker-dealers already record allocation times; broker-dealers
that do not currently record these times will face implementation costs
associated with changing their business processes to record these
times. Implementation costs for allocation reporting may include
significant costs associated with incorporating additional systems into
their regulatory data reporting infrastructure to facilitate this
reporting, if such systems would not already be involved in recording
or reporting order events. Furthermore, Outsourcers could face
significant implementation and ongoing costs associated with reporting
Allocation Reports if their service bureaus do not extend their
services to manage the servers that handle allocations. Because
implementation costs for Allocation Reports would vary widely across
broker-dealers and because the Plan does not break out costs associated
with reporting allocation information, the Commission cannot separately
estimate costs attributable to this reporting.
The Commission preliminarily believes that the clock
synchronization requirements in the Plan represent a less significant
source of costs. The CAT NMS Plan estimates industry costs associated
with the 50 millisecond clock synchronization requirement, based on the
FIF Clock Offset Survey.\968\ The FIF Clock Offset Survey states that
broker-dealers currently spend $203,846 per year on clock
synchronization activities, including documenting clock synchronization
events.\969\ The FIF Clock Offset Survey states that firms expect the
50 millisecond requirement to increase those costs by $109,197 per
firm.\970\
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\968\ See CAT NMS Plan, supra notes 3, at Section D.12, and note
127. The Commission notes that the survey has two limitations
pertinent to specific cost estimates provided in the summary of
survey results. First, cost estimates are likely to be significantly
downward biased. Individual responses to cost data were gathered
within a range; for example, a firm would quantify its expected
costs as ``Between $500K and less than $1M'' or ``$2.5M and over''.
When aggregating these responses, FIF generally used the range
midpoint as a point estimate; however, for the highest response, the
range minimum was used (i.e., ``$2.5M and over'' was summarized as
$2.5M.) This is likely to have produced a significant downward bias
in aggregate survey responses. Second, the survey includes only
broker-dealers and service bureaus, thus the data excludes
exchanges. The Commission preliminarily believes this limitation
would not significantly impact industry costs because all exchanges
currently maintain clock synchronization standards finer than those
discussed as alternatives.
\969\ See FIF Clock Offset Survey, supra note 127. This is based
on the current practice of the broker-dealers who responded to the
survey.
\970\ See id. at 16. The $109,197 figure is obtained by
subtracting the cost of maintaining current clock offsets of
$203,846 annually from the estimated per-firm annual cost of
maintaining a 50 millisecond clock offset of $313,043; see also id.
at 7 (``Even where firms were at the target clock offset, many firms
cited additional costs associated with compliance including logging
and achieving greater degrees of reliability'').
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Based on discussions with industry, the Commission preliminarily
believes that the majority of broker-dealers (Outsourcers) would not
face significant direct costs for clock synchronization because time
stamps for CAT Data reporting would be applied by service bureaus.\971\
However, the Commission preliminarily estimates there are 171 firms
that make the insourcing-outsourcing decision on a discretionary basis;
\972\ if these firms decide to insource their data reporting under CAT,
each of these firms is likely to face costs associated with complying
with new clock synchronization requirements. The Commission
preliminarily estimates that industry-wide implementation costs for the
50 millisecond clock synchronization requirement would be $268 million,
with $25 million annually in ongoing costs.\973\ The Commission
preliminarily believes that approximately $19.7 million in broker-
dealer implementation costs would be attributable to clock
synchronization requirements.\974\ The Commission also preliminarily
believes that service bureaus would face similar clock synchronization
costs if the CAT NMS Plan is approved. Using 13 as an estimate of the
number of service bureaus, approximately $1.4 million in service bureau
implementation costs would be attributable to clock synchronization
requirements in the Plan.\975\
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\971\ See Section IV.F.1.d for discussion of service bureau
costs and the degree to which those costs might be passed on to
broker-dealers.
\972\ These are the 126 current OATS reporters that report more
than 350,000 OATS ROEs per month; the 31 options market-making
firms; and the 14 ELPs.
\973\ See Section IV.H.2.a(1), infra, for a discussion of how
these implementation costs might vary for different clock
synchronization standards.
\974\ See id., for discussion of costs attributable to the 50
millisecond clock synchronization tolerance proposed in the Plan,
including the $109,197 estimate of per-firm implementation costs of
the 50 millisecond clock synchronization requirement; see also CAT
NMS Plan, supra note 3, at Appendix C, Section B.7(b)(i)(A)(3). 171
broker-dealers x $109,197 = $18,672,687.
\975\ The CAT NMS Plan states that the Vendor Study was
distributed to 13 service bureaus or technology-providing firms
identified by the DAG. See CAT NMS Plan, supra note 3, at Appendix
C, Section B.7(b)(i)(A)(3). 13 service bureaus x $109,197 =
$1,419,561. The Commission believes clock synchronization costs are
already included in cost estimates provided in the Vendor Study. As
discussed above (see Section IV.F.1.d), the Commission believes it
is likely that these costs would ultimately be passed on to service
bureaus' broker-dealer clients.
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Other Plan requirements that the Commission preliminarily believes
are unlikely to represent major contributions to the overall costs of
the Plan include the requirement that Options Market Makers report the
quote times sent to the exchanges,\976\ which the Plan estimates would
cost between $36.9 million and $76.8 million over five years; the
requirement to maintain six years of data at the Central Repository,
which the Plan estimates would cost $5.59 million,\977\ and the
inclusion of OTC Equity Securities in the initial phase of the
implementation of the CAT NMS Plan.\978\
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\976\ See FIF, SIFMA, and Security Traders Association, Cost
Survey Report on CAT Reporting of Options Quotes by Market Makers
(November 5, 2013), available at http://catnmsplan.com/web/groups/catnms/@catnms/documents/appsupportdocs/p601771.pdf; see also CAT
NMS Plan, supra note 3, at Appendix C, Section B.7(b)(iv)(B).
\977\ See CAT NMS Plan, supra note 3, Section 12(m).
\978\ See id. at Section 12(q). The Commission does not have the
information necessary to precisely estimate the costs that are
incurred by including OTC Equity Securities in the initial phase of
the implementation of the CAT NMS Plan, because the Plan does not
separately present the costs associated with OTC Equity Securities.
Because of low trading activity in the OTC equity markets, any
significant costs associated with including OTC Equity Securities
would be in implementation costs. Further, broker-dealers that
implement CAT Data reporting for NMS securities may not incur
significant additional costs to implement CAT Data reporting for OTC
Equity Securities.
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[[Page 30732]]
There are many other categories of costs that contribute to the
aggregated estimates of the costs of the Plan in addition to the items
discussed above. For example, in addition to providing CAT Reporters
data on their Error Rates, the Plan states that the Participants
believe that in order to meet Error Rate targets, industry would
require certain resources, including a stand-alone testing environment,
and time to test their reporting systems and infrastructure. There are
also likely to be costs related to the Plan Processor's management of
PII.\979\ As noted above, the Commission does not have sufficient
information to analyze each individual category of costs, because the
available cost estimates do not reflect a detailed breakdown of the
expected cost of each element of the CAT NMS Plan. However, the
Commission preliminarily believes that its estimates of implementation
costs and the ongoing costs of the CAT NMS Plan reflect all relevant
costs to industry.
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\979\ The Commission also acknowledges that the costs associated
with handling PII could create an incentive for service bureaus not
to offer CAT Reporting services. The Commission does not believe
that this incentive would significantly alter the services available
to broker-dealers. For further discussion, see supra note 920 and
Section IV.G.1.e, infra. The Commission also notes that, pursuant to
the exemptive relief granted by the Commission, the approach to the
reporting of Customer information in the CAT NMS Plan could allow
for the bifurcation of PII reporting from the reporting of order
data. See Exemption Order, supra note 18, at 11858-63.
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b. Fees
The Plan states that the Operating Committee would have the
authority to levy ancillary fees on both broker-dealers reporting to,
and regulators accessing, the Central Repository.\980\ The Commission
believes that ancillary fees levied on broker-dealers are unlikely to
be levied broadly, because discussion in the Plan associates these fees
with late and/or inaccurate reporting. The Plan also discusses
ancillary fees possibly levied on regulators associated with the use of
Central Repository data. The Commission recognizes that costs estimated
in Bids for constructing and operating the Central Repository already
anticipate use of the CAT Data by regulators, and that additional fees
to access the data might give regulators incentives to make less use of
the data than anticipated in the Benefits Section. However, any fee
schedule proposed by the Participants would be filed with the
Commission. Consequently, the Commission does not believe that the
provisions for ancillary fees would likely significantly impact the
costs or benefits of CAT.
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\980\ See CAT NMS Plan, supra note 3, at Section 11.3(c).
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4. Second-Order Effects and Other Security-Related Costs
a. Security
As noted in the Adopting Release, Commenters have expressed
concerns regarding the risk of failing to maintain appropriate controls
over the privacy and security of CAT Data.\981\ The Commission
recognizes that investors and market participants could face
significant costs if CAT Data security were breached.
---------------------------------------------------------------------------
\981\ See Adopting Release, supra note 9, at 45725, 45756-58.
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The Commission believes that it is difficult to form reliable
economic expectations for the costs of security breaches, because there
are few examples of security breaches analogous to the type that could
occur under the CAT NMS Plan. However, the Commission can break down
the expected costs of security breaches into two components: The risk
of a security breach and the cost resulting from a security breach.
Therefore, the Commission separates its discussion of the expected
costs of security breaches into these two components. The Commission
recognizes that security risks could give rise to second order costs as
well where the costs come not directly from the security breach but
rather from the actions of market participants attempting to avoid
security risks.
(1) Costs of a Security Breach
The form of the direct costs resulting from a security breach would
vary across market participants and could be significant. For broker-
dealers, investment advisers, and other similar institutions, a
security breach could leak highly-confidential information about
trading strategies or positions,\982\ which could be deleterious for
market participants' trading profits and client relationships. A data
breach could also expose the proprietary information about the
existence of a significant business relationship with either a
counterparty or client, which could reduce business profits.
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\982\ Although the Plan does not require reporting positions,
observation of a broker-dealer's recent executions can offer
information about their change in position, or, potentially,
information about their actual position if the audit trail
information breached contains all trading activity since the
creation of the position.
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A data breach could also potentially reveal PII of Customers.
Because some of the CAT Data that would be stored in the Central
Repository would contain PII such as names, addresses and social
security numbers, a security breach could raise the possibility of
identity theft, which currently costs Americans billions of dollars per
year.\983\ Because PII would be stored in a single, centralized
location rather than stored across multiple locations, a breach in the
Central Repository could leak all PII, rather than a subset of PII that
could be leaked if the information was stored in multiple locations. As
such, these costs associated with the risk of a security breach could
be substantial in aggregate.\984\
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\983\ According to survey data, the Bureau of Justice Statistics
reported $24.7 billion in identity theft costs in 2012, available at
http://www.bjs.gov/content/pub/press/vit12pr.cfm.
\984\ At a June 23, 2015 congressional hearing titled,
``Government Personnel Data Security Review'', Office of Personnel
Management (OPM) Director Katherine Archuleta estimated the direct
costs of the OPM data breach at $19 to $21 million. Available at
http://www.c-span.org/video/?326710-1/opm-director-katherine-archuleta-testimony-spending-data-security&start=3304. This breach
of PII of current and former federal employees exposed PII for
approximately 4 million individuals. Available at http://www.federaltimes.com/section/OPM-Cyber-Report/. The Commission
recognizes that the number of individuals whose PII would be stored
in the Central Repository far exceeds the number of federal
employees whose data was exposed in the OPM breach, and that these
costs include only the direct costs (such as the provision of credit
monitoring services to affected individuals) incurred by OPM and do
not reflect the total costs that these individuals may face as a
result of the data breach, which could be far larger than the direct
costs faced by OPM. These indirect costs may include the
consequences of the breach as well as costs of credit fraud and
legal services to address consequences of the data breach. There may
also be second-order effects to such a breach, if investors reduce
their engagement with the securities industry to avoid these costs.
See Section IV.F.4.a(3), infra.
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A breach that reveals the activities of regulators within the
Central Repository, such as data on the queries and processes run on
query results, could compromise regulatory efforts or lead to
speculation that could falsely harm the reputation of market
participants and investors. For example, a breach could result in an
article that reports on regulators querying trading information of
certain individuals or broker-dealers, which could harm those
individuals or broker-dealers even if no regulators open
investigations. Further, perpetrators of a breach could attempt to
trade on information on regulatory queries to try to profit ahead of
public information of an action, to the disadvantage of other
investors.
(2) Risk of a Security Breach
The Commission preliminarily believes that the risks of a security
breach may not be significant because certain provisions of Rule 613
and the
[[Page 30733]]
CAT NMS Plan appear reasonably designed to mitigate these risks.
However, the Commission notes that the considerable diversity in the
potential security approaches of the bidders creates some uncertainty
about the effectiveness of the eventual security procedures and hence,
the risk of a security breach.\985\
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\985\ The Commission notes that, at a minimum, the security of
the CAT Data must be consistent with Regulation Systems Compliance
and Integrity under the Exchange Act (``Reg SCI'') (17 CFR 242.1000
to 1007).
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Provisions of Rule 613 provide safeguards designed to prevent
security breaches. Rule 613(e)(4) requires policies and procedures that
are designed to ensure the rigorous protection of confidential
information collected by the Central Repository, and Rule 613(iv)
requires that the Plan contain a discussion of the security and
confidentiality of the information reported to the Central Repository.
Rule 613 also restricts access to use only for regulatory purposes, and
requires certain provisions that are designed to mitigate these
security risks such as the appointment of a Chief Compliance Officer
and annual audits of Plan Processor operating procedures.
The Plan also includes provisions designed to prevent security
breaches. First, governance provisions of the CAT NMS Plan could
mitigate the risk of a security breach. Section 4.12 of the CAT NMS
Plan provides for a Compliance Subcommittee whose activities could
reduce the risk that information is released to unauthorized
entities.\986\ Among the Subcommittee's responsibilities is ``the
maintenance of the confidentiality of information submitted to the Plan
Processor or Central Repository.'' Furthermore, the Plan Processor is
required to submit a comprehensive security plan to the Operating
Committee and update this security plan annually.\987\ The security
plan must cover all components of CAT, including physical assets and
personnel; the plan ``must document how the Plan Processor would
protect, monitor and patch the environment; assess it for
vulnerabilities as part of a managed process, as well as the process
for response to security incidents and reporting of such
incidents.''\988\ In addition, Section 6.2(b) of the Plan establishes a
Chief Information Security Officer who is responsible for monitoring
and addressing data security issues for the Plan Processor. Second, the
Plan includes specific provisions designed to ensure the security of
data in flight. For instance, the Plan requires that bulk extract data
be encrypted, password protected and sent via secure methods of
transmission.\989\ Third, Section 6.7(g) of the Plan requires that the
Participants establish, maintain, and enforce written policies and
procedures reasonably designed to (1) ensure the confidentiality of the
CAT Data obtained from the Central Repository; and (2) limit the use of
CAT Data obtained from the Central Repository solely for surveillance
and regulatory purposes. Finally, the Plan makes further provisions
designed to provide security for PII. For example, regulators
authorized to access PII would be required to complete additional
authentications, and PII would be masked unless users have permissions
to view PII.\990\
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\986\ See CAT NMS Plan, supra note 3, at Section 4.12.
\987\ Id. at Section 6.12.
\988\ See id. at Appendix D, Section 4.
\989\ See id. at Appendix D, Section 8.2.2.
\990\ See id. at Appendix C, Section A.2(c).
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As discussed in the Plan,\991\ the Participants collected
information from the Bidders regarding security and confidentiality
during the RFP process, however, there was considerable diversity in
the approaches proposed by the Bidders and the Participants chose to
give the Plan Processor flexibility on many implementation details and
state the requirements as a set of minimum standards. These
requirements include both general security and PII treatment
requirements. General security requirements are designed to address
physical security, data security during transmissions, transactions,
and while at-rest, confidentiality, and a cyber-incident response plan.
PII requirements include a separate PII-specific workflow, PII-specific
authentication and access control, separate storage of PII data, and a
full audit trail of PII access.\992\ Because many of the decisions that
define security measures for the Central Repository are coincident with
the selection of the Plan Processor, there is a degree of uncertainty
with regards to security measures that would be implemented by the Plan
Processor. Consequently, there is uncertainty about the significance of
the risks, the expected costs of a breach when considering the
likelihood of a data breach,\993\ and the second-order effects.
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\991\ See id. at Appendix C, Section A.4; Appendix D, Section 4.
\992\ See CAT NMS Plan, supra note 3, at Appendix D, Section
4.1.2-4.1.6.
\993\ One study of 62 U.S. companies experiencing data breaches
in 2015 puts the average cost per stolen record containing personal
or sensitive information at $217; the average number of breached
records per incident was 28,070. See Ponemon Institute, 2015 Cost of
Data Breach Study: United States (May 2015) (noting, however, that
the study specifically excluded breaches of over 100,000 records as
not representative of ``typical'' data breaches). As one example of
a large data breach, Target Corporation's 2013 data breach affecting
40 million credit card numbers and 70 million other records
containing PII had, as of January 2015, resulted in $252 million of
related expenses for Target. See Target Corporation, Form 10-K for
the Fiscal Year ended January 31, 2015 (March 13, 2015). Because it
is not clear what the risk of a breach would be for CAT, in terms of
either likelihood or magnitude, these types of numbers are simply
indicative; it is impossible to estimate with any precision what the
cost of a breach might be. For example, a complete breach of the CAT
System, including the PII storage, might expose records an order of
magnitude larger than the Target breach; however the types of
records stored in CAT could be more difficult to exploit than credit
card information, but their exploitation might prove far more
damaging to individuals and entities whose trading information, for
example, were compromised.
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The Commission preliminarily believes the Plan marginally increases
the threat of breach of broker-dealer trading and business strategies
because although SROs currently receive this data from their own
members, SROs are expected to have access to other SROs data more
readily within the Central Repository. There is some risk that SROs
could use this data improperly to gain information on how broker-
dealers interact with other SROs' trading platforms. The Plan includes
certain measures that mitigate this risk, however, by restricting the
use of CAT Data reported by other entities for business purposes.\994\
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\994\ Rule 613(e)(4)(1)(A) states that Participants and the Plan
Processor ``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.'' Similar language
appears in the CAT NMS Plan. The Commission preliminarily believes
this provision does not increase security risks because the data
reported to the Central Repository by a Participant is already
available to that Participant. See CAT NMS Plan, note 3, supra, at
Section 6.5(f)(i)(A).
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(3) Second Order Effects
The desire to avoid direct costs of a security breach could
motivate actions that would result in second order effects of security
breaches. For example, if service bureaus perceive the costs and risks
of a security breach to be great enough because of the addition of PII
in the data, which is not included in current data, some could decide
not to provide CAT Data reporting services. This could increase the
potential for a short term strain on capacity and exacerbate the costs
of this strain described above and below.\995\ Further, investors or
other market participants could move their activity off-shore or cease
market participation altogether to
[[Page 30734]]
avoid having sensitive information stored in the Central Repository.
Consequences of changes in investor behavior in response to the threat
of a breach include: Investors holding suboptimal portfolios; lost
profits to the securities industry; and higher costs of raising capital
for U.S.-based securities issuers, if the public's willingness to
participate in capital markets is sufficiently reduced.\996\
---------------------------------------------------------------------------
\995\ See supra note 934 and Section IV.G.1.d, infra.
\996\ See Section IV.G.3, infra.
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Nonetheless, the Commission preliminarily does not believe that the
effect of the Plan on the risk or costs of a data breach would be great
enough to result in significant second order effects. As discussed
above, the Commission preliminarily believes the Plan marginally
increases the threat of breach of broker-dealer trading and business
strategies. However, the Plan includes certain measures that mitigate
this risk. In light of these provisions, the Commission preliminarily
believes that the Plan is unlikely to significantly deter broker-
dealers from participating in markets. In addition, in deciding whether
to trade in the U.S. markets or abroad, investors and other market
participants would continue to assess a multitude of potential trade-
offs. While the expected costs of a security breach may factor in, so
would the level of investor protections, which the Commission
preliminarily believes would increase if it approved the Plan.\997\
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\997\ See Section IV.E.2, supra.
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Another possible second order effect of avoiding the risk and cost
of a security breach event could be the risk that one or more service
bureaus could choose to exit the market in providing data reporting
services rather than change their business practices to report PII to
the Central Repository, in order to assist their client(s) in meeting
their reporting responsibilities under the Plan. Specifically, while
some service bureaus currently handle PII for their broker-dealer
clients, others do not or do so only on an occasional and limited
basis. To the extent service bureaus that do not already handle such
PII were to stop offering regulatory data reporting services due to an
unwillingness to host such customer information, their customers would
be forced to establish new service bureau relationships, or undertake
self-reporting. This potentially would be very costly to the broker-
dealer clients of the exiting service bureaus due to the switching
costs that broker-dealers incur to change service bureaus. Such an
event could also contribute to crowded entrances problems.\998\ As
noted above, however, the approach in the Plan to the reporting of
customer information could allow for the bifurcation of PII reporting
from the reporting of order data, which could affect a service bureau's
decision whether to exit the market for reporting services to a broker-
dealer client.\999\ While the Commission cannot rule out that one or
more service bureaus could choose to exit the data reporting services
market to avoid the costs of a potential security breach, the
Commission preliminarily believes that such exits are unlikely. In
addition, the Commission preliminarily believes that security breach
risks are unlikely to result in service bureau exit because the market
for regulatory data reporting services is generally expanding and the
trend is for more, not less, outsourcing.\1000\ Consequently, the
Commission preliminarily believes that market share in this market is
valuable and existing competitors are unlikely to voluntarily exit the
market abruptly.
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\998\ See supra note 934.
\999\ See supra note 979.
\1000\ See Section IV.G.1.d, infra.
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b. Changes to CAT Reporter Behavior
The Commission acknowledges that increased surveillance could
potentially impose some costs by altering the behavior of market
participants. Benefits could accrue to the extent that improved
surveillance, investigation, and enforcement capabilities allow for
regulators to better identify and address violative behavior when it
occurs; and to the extent that common knowledge of improved
capabilities deters violative behavior.\1001\ Costs could accrue to the
extent that some forms of market activity, which are permissible and
economically beneficial to the market and investors, could come under
higher scrutiny, which could create a disincentive to engage in that
activity.
---------------------------------------------------------------------------
\1001\ See Section IV.E.2.c, supra.
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In particular, the Commission acknowledges that some market
participants could reduce economically beneficial behavior if those
market participants believe that, because of enhanced surveillance,
their activities would increase the level of regulatory scrutiny that
they bear. In other words, if market participants engaging in non-
violative activity believe that such activity could increase the
likelihood of examinations, inspections, and other interactions with
regulators, those market participants could reduce or cease such
activity to reduce the frequency and costs of interactions with
regulators, including staff time to accommodate inspections, facilitate
examinations and answer regulatory inquiries. Because facilitating
regulatory inquiries is costly to firms, such a firm might conclude
that certain permissible activities generate insufficient profits to
offset costs associated with the regulatory scrutiny generated by these
activities, even if the firm's behavior is permissible and no fines or
other penalties result from these inquiries. To the extent that market
participants could reduce activity that benefits the market, this could
impose costs on investors and the market in the form of a reduction in
the economic value of such activity.
Additionally, in an environment of improved surveillance,
regulators could increase the number of inspections, examinations and
enforcement proceedings that they initiate.\1002\ To the extent that
these activities result in a reduction in violative behavior, the
market benefits in not bearing the costs of this behavior. To the
extent, however, the additional regulatory activity increases the
number of inspections, examinations and enforcement on permissible
activities,\1003\ market participants would incur the increased costs
of facilitating these regulatory inquiries. The Commission
preliminarily believes, however, that these costs would be offset by
other effects of CAT such as fewer ad hoc data requests, improvement in
regulators' precision in selecting firms for risk-based exams, and
other efficiency improvements, and that the related savings would
likely be greater than such costs in aggregate.
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\1002\ See Section IV.E.2.c, supra.
\1003\ For example, the Commission preliminarily believes that
the Plan would improve the efficiency and effectiveness of risk-
based exams. However, because the efficiency could increase the
total number of risk-based exams, the total number of exams on
permissible activity could go up even if the percentage of exams on
permissible activity goes down.
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c. Tiered Funding Model
The Commission preliminarily believes that establishing a small
number of discrete fee tiers, as occurs under the Plan, could create
incentives for CAT Reporters to alter their behavior to switch from one
tier to another, thereby qualifying for lower fees. Specifically, in
the discussion of Consideration 7, the Plan states that CAT Reporters
would be classified into a number of groups based on reporter type and
market share of share volume or message traffic and assessed a fixed
fee that is determined by this classification.\1004\ The higher-
activity groups would be assessed higher fees.
[[Page 30735]]
Equity Execution Venues would be classified into 2-5 fee tiers based on
market share of share volume, option Execution Venues would be
classified into a separate set of 2-5 fee tiers based on market share
of share volume, and Industry Members would be classified into another
set of 5-9 fee tiers based on message traffic.\1005\ That is, the Plan
describes a funding policy with a tiered funding model that places
market participants who fall into the lower tiers at a fee advantage
over the market participants that fall into the higher tiers.\1006\ The
Plan states that this funding model is designed to reward the
characteristics--small market share of share volume in the case of
Execution Venues, low message traffic in the case of broker-dealers--
that would enable CAT Reporters to qualify for the lower tiers. The
potential effect of rewarding these characteristics is to incent market
participants at the margins to reconfigure their operations so as to
qualify for smaller tiers than would otherwise apply. The potential for
such an effect would be greater among those CAT Reporters that fall at
the low end of a tier and could most easily alter their operations to
qualify for a smaller tier. Similarly, the funding model could create
incentives for a firm that has an activity level near the top of a tier
to avoid additional market activity that might move it to a higher fee
tier. For example, to control its tier level, a market participant
could reduce its quoting activity or cease providing services in a set
of securities. Such activity could affect liquidity and the
availability of trading services to investors. The Commission notes,
however, that because this incentive is contingent on being near a fee-
tier cutoff point, it preliminarily believes relatively few market
participants would likely be affected and thus market quality effects
would likely not be significant.\1007\ Furthermore, for those market
participants near a cutoff point, managing activity to avoid a higher
fee tier would necessarily incur costs of lost business and potential
loss of market share, and would possibly be difficult to implement,
which should mitigate any effects on market quality.
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\1004\ See CAT NMS Plan, supra note 3, at Section 11.3 and
Appendix C, Section B.7(b)(4)(C).
\1005\ The CAT NMS Plan defines ``Execution Venue'' as ``. . . a
Participant or an alternative trading system (``ATS'') (as defined
in Rule 300 or Regulation ATS) that operates pursuant to Rule 301 of
Regulation ATS (excluding any such ATS that does not execute
orders).'' The Plan also defines Industry Member as ``. . . a member
of a national securities exchange or a member of a national
securities association''. See CAT NMS Plan, supra note 3, at Article
I, Section 1.1 for definitions. Classification of Execution Venues
into tiers is based on transacted volume market share of share
volume (in the case of NMS stocks and OTC Equity Securities) or
contract volume (in the case of listed options). For Industry
Members, classification into tiers is based on message traffic.
Based on conversations with Participants, the Commission
preliminarily believes message traffic would be based on CAT
Reportable Events reported to the Central Repository. See id. at
Article XI, Section 11.3 for discussion of assignment to funding
tiers.
\1006\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(v).
\1007\ This argument assumes that activity levels used to
determine funding tiers do not naturally cluster near cutoffs, and
that if such natural cutoff points exist, the Operating Committee
would avoid setting such funding tier cutoff levels near those
activity levels.
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The Commission recognizes that the tiering of fees also could
create calendar effects within markets. Although the Plan does not
detail the horizon at which CAT would measure activity levels, the
structure ultimately approved by the Operating Committee could affect
market participant behavior near the end of a measuring period. For
example, high levels of market activity during a measuring period might
cause CAT Reporters to limit their activity near the end of a
measurement period to avoid entering a higher fee tier. If this
translates into a reduction in quoting activity, market liquidity
conditions could deteriorate at the end of activity measurement
periods, and improve when a new measurement period begins, for example.
The Commission notes that the Operating Committee has discretion
under the Plan governance structure to make the tier adjustments
discussed in Section 11.1.d for individual CAT Reporters. This
provision might mitigate incentives for individual market participants
to alter market activities to reduce their expected CAT fees.
d. Differential CAT Costs Across Execution Venues
The funding model proposed in the Plan is a bifurcated funding
model, in which costs are first allocated between the group of all
broker-dealers and the group of all Execution Venues, then within these
groups by market activity level.\1008\ The proposed funding model
treats Execution Venues differently from broker-dealers; this
differential treatment could introduce inefficiencies to the market for
execution services. As discussed in a recent academic paper,\1009\
differential funding models in execution venues could influence how
broker-dealers route customer order flow, possibly to the detriment of
execution quality realized by investors. The Commission preliminarily
believes that the bifurcated funding model proposed in the Plan almost
certainly results in differential CAT costs between Execution Venues
because it would assess fees differently on exchanges and ATSs for two
reasons. First, message traffic to and from an ATS would generate fee
obligations on the broker-dealer that sponsors the ATS, while exchanges
incur almost no message traffic fees.\1010\ Second, broker-dealers that
internalize off-exchange order flow, generating off-exchange
transactions outside of ATSs, would face a differential funding model
compared to ATSs and exchanges.\1011\ The cost differentials that
result might create incentives for broker-dealers to route order flow
to minimize costs,\1012\ creating a potential conflict of interest with
broker-dealers' investor customers, who are likely to consider many
facets of execution quality (such as price impact of a trade and
probability of execution in a venue in which the order is exposed) in
addition to any of these costs that are passed on to them.
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\1008\ See CAT NMS Plan, supra note 3, at Article XI.
\1009\ See Robert H. Battalio, Shane A. Corwin and Robert H.
Jennings, Can Brokers Have It All? On the Relation between Make-Take
Fees and Limit Order Execution Quality (2015 working paper),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2367462. (``Battalio, Corwin, and
Jennings'').
\1010\ See CAT NMS Plan, supra note 3, at Section 11.3.(b):
``For the avoidance of doubt, the fixed fees payable by Industry
Members pursuant to this paragraph shall, in addition to any other
applicable message traffic, include message traffic generated by:
(i) an ATS that does not execute orders that is sponsored by such
Industry Member; and (ii) routing orders to and from any ATS
sponsored by such Industry Member.'' The Commission notes that
exchange broker-dealers would be subject to message traffic fees as
Industry Members under the Plan. However, the Commission notes that
based on its analysis of OATS data from September 15-19, 2014, these
broker-dealers are minor contributors to overall message traffic,
accounting for less than 0.03% of OATS ROEs.
\1011\ See CAT NMS Plan, supra note 3, at Article XI.
\1012\ This assumes that CAT fees would ultimately be borne by
the broker-dealers that make routing decisions. Currently, exchange
access fees are often borne by broker-dealers that make routing
decisions, as discussed in Battalio, Corwin, and Jennings. Id. If
Execution Venues were to absorb these fees rather than pass them on
to customers, broker-dealer routing decisions might not be affected.
It is also possible that some Execution Venues could incorporate
some sort of rebate for broker-dealer message fees into their fee
schedules, effectively making some venues less expensive for broker-
dealers to access.
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In addition to friction created by the bifurcated structure of the
funding model, the Commission preliminarily believes that the CAT NMS
Plan funding model shifts broker-dealer costs associated with the
Central Repository to all broker-dealers and away from Options Market
Makers. The CAT NMS Plan provides that broker-dealers would not report
their options quotations to the Central Repository, while equity market
makers would report their equity
[[Page 30736]]
quotations to the Central Repository.\1013\ This differential treatment
of market making quotes affects costs of funding the Central Repository
in two ways. First, the elimination of Options Market Maker quotes from
the message traffic of broker-dealers decreases the number of messages
that must be reported and stored, which presumably reduces the overall
cost of building and operating the Central Repository. This reduction
in the overall cost of the Central Repository reduces costs to both
broker-dealers and Execution Venues. Second, because Options Market
Maker quotes would not be in the message traffic which determines the
allocation of broker-dealer costs of the Central Repository, broker-
dealers that do not quote listed options would pay a higher share of
broker-dealer-assessed CAT fees than they would if Options Market
Makers' quotes were included in the allocation of fees. Also, Options
Market Makers would pay relatively lower fees than they would if their
quotations were included in CAT message traffic from broker-dealers.
---------------------------------------------------------------------------
\1013\ See Section IV.H.1.a, supra for a discussion of an
alternative that would require Options Market Makers to report their
quotes.
---------------------------------------------------------------------------
Although this differential treatment would marginally increase the
cost of providing other broker-dealers services relative to options
market making, the Commission preliminarily does not believe that this
would materially affect a market participant's willingness to provide
broker-dealer services other than options market making for several
reasons. First, many market participants participate in both equities
and options markets because activity in one market (equities or
options) could be used to hedge positions acquired in the other market.
Consequently, many firms already find it cost effective to participate
in both markets. Second, broker-dealers participating in equity markets
have significant infrastructure in place for serving that market and
switching costs to participate in options market making are high due to
the need to establish quantitative infrastructure to quote options,
market connectivity, IT infrastructure, and clearing/settlement
arrangements required to transact in options; consequently, reducing
the cost to make markets in options is unlikely to attract broker-
dealers to change their business models. Finally, the Commission
believes that the market to provide liquidity in the options market is
already a competitive one because many broker-dealers participate in
that market and market share that is sufficient to cover substantial
fixed costs of making markets in options is valuable; consequently,
options market participants have incentives to compete to win market
share. Without a market change that significantly affects profits to be
made in options market making, it seems broker-dealers would need a
competitive advantage relative to existing competitors to successfully
win market share from the existing competitors. The Commission
preliminarily believes that that broker-dealers that currently focus on
equity market making and other broker-dealer services unrelated to
options market making are likely to continue to focus on the markets in
which they participate because their competitive advantages relate to
these activities.
5. Request for Comment on the Costs
The Commission requests comment on all aspects of the discussion of
the potential costs of the CAT NMS Plan. In particular, the Commission
seeks responses to the following questions:
301. Do Commenters agree with the Commission's assessment of the
potential costs of the CAT NMS Plan? Why or why not?
302. To what extent do the uncertainties related to future
decisions about Plan implementation impact the assessment of potential
costs of the Plan? Please explain.
303. Do Commenters agree that the Plan's level of detail regarding
the drivers of the costs to build, operate, and maintain the Central
Repository is sufficient to assess the economic effects of the Plan? If
more detail is needed, how can this information be obtained?
304. Do Commenters agree that using the cost estimates provided in
Bids from the Shortlisted Bidders provides reasonable estimates of
costs to build and operate the Central Repository? Why or why not?
305. Estimates in the Plan suggest that the Participants' data
reporting costs will significantly increase while surveillance costs
will significantly decrease if the Plan is approved. Do Commenters
agree that these changes are likely to occur? Please explain.
306. Do Commenters agree with the Commission's characterization of
the limitations in the cost studies? Do Commenters agree with the
Commission's assessment that the Vendors Study and Participants Study
have reliable cost estimates? Do Commenters agree that cost estimates
for large OATS Reporters and large non-OATS Reporters are reliable? Do
Commenters agree that cost estimates for small reporters are
unreliable? Why or why not? Do Commenters have more precise estimates
of the costs than provided in the cost surveys?
307. The Commission re-estimated aggregated costs under a different
set of assumptions than the Plan. Do Commenters agree that the re-
estimated costs better represent the expected costs of the CAT NMS
Plan? Why or why not? Do Commenters agree that most broker-dealers that
report fewer than 350,000 OATS ROEs per month are likely to report this
data through a service bureau?
308. Do Commenters agree with the estimates of annual service
bureau costs for a very small OATS-reporting firm of $50,000 to
$180,000 per year, which assumes that the service bureau provides order
routing and an order-handling system? If not, please provide alternate
estimates.
309. Do Commenters agree that the pricing function for service
bureaus is concave (increasing at a decreasing rate)? Why or why not?
The Commission assumes in its re-estimation that service bureau cost
functions are approximately as concave as exchange pricing functions.
Do Commenters agree? Why or why not?
310. Will the requirement to provide customer information to the
Central Repository be a significant cost-driver for Outsourcers? Why or
why not? Is the need for encryption of this data a significant cost-
driver?
311. Will the anticipated retirement of duplicative reporting
systems such as EBS affect Outsourcer costs? Why or why not? Will the
reduction in ad hoc data requests significantly affect the costs
incurred by service bureaus in assisting their clients in responding to
these requests? Why or why not?
312. Are there ways in which the Commission could better estimate
the aggregate costs of the CAT NMS Plan? If so, please explain.
313. Do Commenters agree with the Commission's assumption that most
firms that report fewer than 350,000 OATS ROEs per month are self-
clearing? If not, please explain. Do Commenters believe that these
firms would have significantly higher implementation costs due to their
need to provide this information to any service bureaus they use for
regulatory data reporting?
314. Do Commenters agree that broker-dealers that are exempt or
excluded from OATS reporting are likely to be small and should have
their costs estimated as Outsourcers? If no, how many of these broker-
dealers currently participate in more than 350,000 events that would be
OATS-reportable, were they not exempt or excluded, per month?
[[Page 30737]]
315. Are Commenters aware of options market making firms that are
FINRA members and report fewer than 350,000 OATS ROEs per month, or
that are exempt or excluded from OATS reporting rules? If so, are there
ways that the Commission can identify these firms to better estimate
their costs under the Plan?
316. Are Commenters aware of ELPs that are not CBOE members that
did not trade on ATSs in 2014? If so, are there ways that the
Commission can identify these firms to better estimate their costs
under the Plan?
317. Do Commenters agree that FINRA member broker-dealers that are
Options Market Makers are unlikely to be exempt or excluded from OATS-
reporting requirements, and are likely to report more than 350,000 OATS
ROEs per month? If not, how many FINRA member Options Market Makers
exist that are exempt or excluded from OATS reporting requirements, or
that report fewer than 350,000 OATS ROEs per month? Are there methods
by which the Commission could improve its estimates of costs these
broker-dealers are likely to face if the Plan is approved?
318. According to survey results, Approach 1 aggregate
implementation and ongoing costs are higher than those for Approach 2
for CAT Reporters, though not statistically so.\1014\ The Commission
notes that this cost estimate does not seem intuitive because Approach
2 could result in extra data processing by CAT Reporters to translate
data into a fixed format whereas Approach 1 would require no
translation. Why is the cost of Approach 1 anticipated to be higher
than Approach 2? Can this be explained by the use of service bureaus
whom CAT Reporters expect to charge the same for either approach? Can
this be explained by the need to process data under either approach to
replace ticker symbols with listing exchange symbology?
---------------------------------------------------------------------------
\1014\ Approach 1 assumes CAT Reporters would submit CAT Data
using their choice of industry protocols. Approach 2 assumes CAT
Reporters would submit data using a pre-specified format.
---------------------------------------------------------------------------
319. Do Commenters believe that duplicative reporting systems will
be retired and, if so, when? What systems do Commenters expect to be
retired? \1015\ Are there any systems that cannot be retired? What are
the costs associated with retiring duplicative reporting systems? What
are the benefits of retiring duplicative reporting systems? Would there
be cost savings as a result of retiring any duplicative reporting
systems? How does the timeline for retiring duplicative reporting
systems affect the costs and benefits? Please explain.
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\1015\ See supra note 856.
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320. Do service bureaus handle EBS reporting for their clients? To
what extent would EBS reporting contribute to duplicative reporting
costs or system retirement costs and savings?
321. The Commission's analysis discusses the Plan's timetable for
retirement of duplicative reporting systems (i.e., a maximum of 2.5
years). Is the timetable for retirement of these systems in the Plan
realistic and/or reasonable? Are there ways that the timetable for
duplicative reporting system retirement could be accelerated? If so,
how?
322. Do Commenters believe that the period of duplicative reporting
that would precede the retirement of certain current, anticipated to be
retired, regulatory reporting systems would impose significant cost
burdens on industry? Are the Commission's estimates of those costs
accurate? Are there dimensions of these costs that the Commission has
not recognized? If so, what are they and what are their magnitudes?
323. What milestones should CAT be required to reach before
duplicative reporting systems can be retired?
324. What costs would service bureaus face in accomplishing a
period of duplicative reporting during which both CAT and the
regulatory data reporting systems that the Plan anticipates would be
retired are operational? How many FTEs would be involved?
325. What costs would broker-dealers face in accomplishing a period
of duplicative reporting during which both CAT and the regulatory data
reporting systems that the Plan anticipates would be retired are
operational? How many FTEs would be involved?
326. The CAT NMS Plan estimates that market participants would face
significant costs of approximately $2.6 billion in connection with
retiring duplicative reporting systems. What expenses does this
estimate cover, and which systems account for which costs? For some
broker-dealers, would implementation of CAT reporting accomplish the
retirement of other regulatory data reporting systems? How do system
retirement costs differ between broker-dealers that outsource their
data reporting versus those who perform this function in-house?
327. Do Commenters believe that the CAT NMS Plan would deliver
additional cost savings from sources other than the retirement of
duplicative reporting systems and a reduction in the amount of ad-hoc
data requests to regulated entities? Are there any changes to the CAT
NMS Plan that would increase the potential cost savings?
328. Are SROs adequately incentivized to retire current regulatory
reporting and surveillance systems that might be replaced by CAT? Do
they have incentives to resist the retirement of these systems that
this analysis fails to identify?
329. Do Commenters agree that costs associated with the Plan
incurred by broker-dealers could be passed down to their customers? Why
or why not? If so, do Commenters have estimates regarding what fraction
of broker-dealer costs would be passed down?
330. The Commission preliminarily believes that the Vendors Study
measures ongoing costs that would also be captured by the third-party
outsourcing costs in the other surveys. As a result, the Commission
does not add these to the aggregated cost estimates. Do Commenters
agree with this approach? Is there any double counting of costs across
the surveys, or can the individual survey estimates be aggregated into
an industry-wide estimate? Please explain.
331. According to survey results, Approach 1 aggregate
implementation costs are higher than those for Approach 2 for vendors
and ongoing costs are lower.\1016\ The Commission notes that this
implementation cost result does not seem intuitive because Approach 2
could result in creating a whole new data translation process to
implement the Plan whereas Approach 1 would require no translation. Why
is Approach 1 costlier for vendors to implement than Approach 2? Can
this be explained by the need to process data under either approach to
replace ticker symbols with listing exchange symbology?
---------------------------------------------------------------------------
\1016\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(iv)(A).
---------------------------------------------------------------------------
332. The Commission assumes that cost estimates from Participants
include all costs the Participants would incur if the Plan is approved,
and that other costs related to development of the Plan are not
avoidable if the Plan is not approved. Is it reasonable for the
Commission to treat all costs related to development of the Plan that
are not included in implementation and ongoing costs as sunk costs? Why
or why not?
333. To what degree would industry's costs to implement and
maintain CAT reporting be passed on to investors? Would competition
between broker-dealers affect the passing on of costs to investors? Why
or why not?
334. How significant to the total industry costs of the CAT NMS
Plan are
[[Page 30738]]
clock synchronization requirements, the requirement that Options Market
Makers send quote times to the exchanges, the requirement that the
Central Repository maintain six years of CAT Data, and the inclusion of
OTC Equity Securities in the initial phase of the implementation of the
CAT NMS Plan? Why?
335. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report customer information to the Central
Repository? What elements of this requirement contribute to its
significance of the potential costs of the Plan? Are there ways in
which this data can be made available to regulators that would prove
less costly to industry and investors? If so, what are they?
336. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report certain information as part of the
material terms of the order? What elements of this requirement
contribute to its significance of the potential costs of the Plan? Are
there ways in which this data can be made available to regulators that
would prove less costly to industry and investors? If so, what are
they?
337. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report information to the Central Repository
using listing exchange symbology? What elements of this requirement
contribute to its significance of the potential costs of the Plan? Are
there ways in which this data can be made available to regulators that
would prove less costly to industry and investors? If so, what are
they?
338. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report allocation information to the Central
Repository? What elements of this requirement contribute to its
significance of the potential costs of the Plan? Are there ways in
which this data can be made available to regulators that would prove
less costly to industry and investors? If so, what are they?
339. Are there other requirements of the CAT NMS Plan that would be
significant sources of costs? If so, what are they? Are there ways in
which those requirements could be made less costly? If so, what are
they?
340. Do Commenters agree that ancillary fees levied by the Plan
Processor on broker-dealers in response to late or inaccurate reporting
are unlikely to broadly levied on broker-dealers? Do Commenters believe
they would comprise a significant source of CAT costs to industry? Why
or why not?
341. Do Commenters agree with the Commission's analysis of
potential cost savings from a reduction in the number (and ultimately
the cost) of data requests as a result of regulators having direct
access to CAT Data?
342. Do Commenters agree with the Commission's analysis of the risk
of a security breach? Do Commenters agree with the Commission's
analysis of the potential costs of a security breach? Are there factors
not covered in the analysis? What are they? Are the security measures
outlined in the Plan appropriate and reasonable? Why or why not?
343. Do Commenters agree with the Commission's analysis of
potential changes to CAT reporter behavior? Why or why not? Are there
additional factors that should be considered?
344. Do Commenters agree with the Commission's analysis of the
Plan's funding model? Why or why not? Are there additional factors that
should be considered?
345. Do Commenters agree with the Commission's analysis of
potential costs resulting from differential CAT costs across Execution
Venues? Why or why not? Are there additional factors that should be
considered?
346. Should the Plan require the inclusion of a web-based manual
data entry option for initial CAT reporting in addition to updates and
corrections? Please explain. How would a web-based manual data entry
option affect the costs incurred by CAT Reporters? Do any current
regulatory data reporting systems have a web-based manual data entry
option? If so, which ones and how often do broker-dealers utilize that
option for data submission?
G. Efficiency, Competition, and Capital Formation
In determining whether to approve the CAT NMS Plan, and whether the
Plan is in the public interest, Rule 613 requires the Commission to
consider the impact of the Plan on efficiency, competition and capital
formation.\1017\
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\1017\ See 17 CFR 242.613(a)(5); see also 15 U.S.C. 78c(f).
---------------------------------------------------------------------------
The Commission preliminarily believes that the Plan generally
promotes competition. However, as explained below, the Commission
recognizes that the Plan could increase barriers to entry because of
the costs to comply with the Plan. Further, the Commission's analysis
identifies several limitations to competition, but the Plan contains
provisions to address some limitations and Commission oversight can
also address the limitations.
The Commission preliminarily believes that the Plan would improve
the efficiency of regulatory activities and enhance market efficiency
by deterring violative activity that harms market efficiency. The
Commission preliminarily believes that the Plan would have modest
positive effects on capital formation and that the threat of a security
breach at the Central Repository is unlikely to significantly harm
capital formation.
The Commission notes that the significant uncertainties discussed
earlier in this economic analysis also affect the Commission's analysis
of efficiency, competition, and capital formation. For example, the
Commission recognizes that the uncertainties around the improvements to
data qualities can affect the strength of the Commission's conclusions
on efficiency, and the uncertainty regarding how the Operating
Committee allocates the fees used to fund the Central Repository could
affect the Commission's conclusions on competition. Additionally, the
Commission recognizes that the Plan's likely effects on competition,
efficiency and capital formation are dependent to some extent on the
performance and decisions of the Plan Processor and the Operating
Committee in implementing the Plan, and thus there is necessarily some
further uncertainty in the Commission's analysis. Nonetheless, the
Commission believes that the Plan contains certain governance
provisions, as well as provisions relating to the selection and removal
of the Plan Processor, that mitigate this uncertainty by promoting
decision-making that could, on balance, have positive effects on
competition, efficiency, and capital formation.
1. Competition
As required by Rule 613, the Plan contains an analysis of its
expected impact on competition.\1018\ The Plan's analysis considers
potential impacts of the CAT NMS Plan on competition related to
technology, cost allocation across CAT Reporters, and changes in
regulatory reporting requirements.\1019\ The Plan splits its analysis
between ``Participants and broker-dealers communities'' and concludes
that the Plan generally would avoid placing an inappropriate burden on
competition in U.S. markets.\1020\ The Plan's analysis states the
criteria for evaluating impacts on competition by outlining the channel
of potential impacts as policy changes
[[Page 30739]]
caused by the Plan that ``burden a group or class of CAT Reporters in a
way that would harm the public's ability to access their services'' and
states that such impacts ``should be measured relative to the economic
baseline.'' \1021\
---------------------------------------------------------------------------
\1018\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8 (noting that Rule 613(a)(1)(viii) requires the Plan to include a
discussion of an analysis of the impact of the Plan on competition,
efficiency and capital formation).
\1019\ See id.
\1020\ See id.
\1021\ See id.
---------------------------------------------------------------------------
The Commission's evaluation of competition reorients the Plan's
approach to analyzing competition, expands upon it, and notes some
limitations in the scope and conclusions of the Plan's analysis. In
particular, the Commission's analysis of competition is organized and
segmented by the particular markets in which competition among service
providers of types of services exists. The Commission's analysis
focuses on four distinct markets: The market for trading services, the
markets for broker-dealer services, the market for regulatory services,
and the market for data reporting services. In the context of the Plan,
this allows the competition analysis to consider a more complex
interaction between all market participants in a defined market than
would be feasible by focusing solely on market participant types. This
approach allows the Commission to determine whether a differential
impact across competitors affects overall competition in the market.
Much like the Plan's criteria for evaluation, the Commission recognizes
that any effects on competition, with respect to each market, should be
compared to a Baseline that characterizes the competitive environment
without the CAT NMS Plan. In addition, the Commission considered
uncertainty in the effect of the Plan on competition in any of these
markets.
After analyzing the discussion of competition and the other
relevant provisions of the Plan in the context of four affected
markets, the Commission preliminarily believes that, while there could
be effects on individual competitors, these effects would not lead to
changes to competition as a whole in affected markets in a way that
would generate significant adverse effects. In sum, and as discussed in
detail below, the Commission preliminarily believes that the Plan poses
a risk for competition for trading services, but provisions in the Plan
and Commission oversight could mitigate this risk. Additionally, the
Plan could have a differential impact on the ability of smaller broker-
dealers and broker-dealers subject to CAT reporting to compete in the
various markets for broker-dealer services, but these differential
impacts may not be significant enough to affect overall competition in
the markets for broker-dealer services. Moreover, the Plan generally
promotes competition to be the Plan Processor and competition for
regulatory services, but friction in those markets could limit the
competition. Finally, the Plan could have a harmful effect on
competition in the market for data reporting services, at least in the
short term, because of capacity constraints, but the prolonged
implementation for small broker-dealers could limit these harmful
effects.
a. Market for Trading Services
The Commission analyzed the CAT NMS Plan's economic effects on
competition in the market for trading services, compared to the
Baseline of the competitive environment without the Plan, and
preliminarily believes that the Plan would not place a significant
burden on competition for trading services. The Commission recognizes
the risk for the Plan to have negative effects on competition and to
increase the barriers to entry in this market, but preliminarily
believes that Plan provisions and Commission oversight could mitigate
these risks.
The market for trading services, which is served by exchanges,
ATSs, and liquidity providers (internalizers and others), relies on
competition to supply investors with execution services at efficient
prices. These trading venues, which compete to match traders with
counterparties, provide a framework for price negotiation and
disseminate trading information. The market for trading services in
options and equities consists of 19 national securities exchanges,
which are all Plan Participants,\1022\ and off-exchange trading venues
including broker-dealer internalizers, which execute substantial
volumes of transactions, and 44 ATSs, which are not Plan
Participants.\1023\ Since the adoption of Regulation NMS in 2005, the
market for trading services has become more fragmented and competitive,
and there has been a shift in the market share of trading volume among
trading venues. For instance, from 2005 to 2013, there was a decline in
the market share of trading volume for exchange-listed stocks on NYSE.
At the same time, there was an increase in the market share of newer
national securities exchanges such as NYSE Arca, BATS-Z, BATS-Y, EDGA
and EDGX.\1024\ During the same time period, the proportion of NMS
Stocks trading off-exchange (which includes both internalization and
ATS trading) increased; for example, during the second quarter of 2015,
NMS Stock ATSs alone comprised approximately 15 percent of consolidated
volume, and other off-exchange volume totaled 18 percent of
consolidated volume over the same period.\1025\ Aside from trading
venues, exchange market makers provide trading services in the
securities market. These firms stand ready to buy and sell a security
``on a regular and continuous basis at publicly quoted prices.'' \1026\
Exchange market makers quote both buy and sell prices in a security
held in inventory, for their own account, for the business purpose of
generating a profit from trading with a spread between the sell and buy
prices. Off-exchange market makers also stand ready to buy and sell out
of their own inventory, but they do not quote buy and sell
prices.\1027\
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\1022\ The Commission understands that ISE Mercury, LLC will
become a Participant in the CAT NMS Plan and thus is accounted for
as a Participant for purposes of this Notice. See supra note 3.
\1023\ See Concept Release on Equity Market Structure, at 3598-
3560, supra note 733 (for a discussion of the types of trading
centers); see also Alternative Trading Systems with Form ATS on File
with the SEC as of April 1, 2016, available at https://www.sec.gov/foia/ats/atslist0416.pdf.
\1024\ See Securities Exchange Act Release No. 76474 at 81112,
``Regulation of NMS Stock Alternative Trading Systems'', available
at http://www.sec.gov/rules/proposed/2015/34-76474.pdf.
\1025\ See id. at 81124.
\1026\ See ``Market Maker'', available at http://www.sec.gov/answers/mktmaker.htm (last visited April 18, 2016).
\1027\ Laura Tuttle, OTC Trading: Description of Non-ATS OTC
Trading in National Market System Stocks (March 2014), available at
http://www.sec.gov/dera/staff-papers/white-papers/otc-trading-white-paper-03-2014.pdf.
---------------------------------------------------------------------------
The Plan examined the effect of the CAT NMS Plan on the market for
trading services primarily from the perspective of the exchanges. The
Plan asserts that distribution of regulatory costs incurred by the Plan
would be distributed according to ``the Plan's funding principles,''
calibrated to avoid placing ``undue burden on exchanges relative to
their core characteristics,'' and would thus not cause any exchange to
be at a relative ``competitive disadvantage in a way that would
materially impact the respective Execution Venue marketplaces.'' \1028\
Likewise, the Plan asserts that its method of cost allocation would
avoid discouraging entry into the Participant community because a
potential entrant, like an ATS, would ``be assessed exactly the same
amount [of allocated CAT-related fees] for a given level of activity''
both before and after becoming an exchange.\1029\
---------------------------------------------------------------------------
\1028\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(a)(i); see also id. at Section 11.2 (for a discussion of the
Plan's funding principles); Section, III.A.3.d, supra.
\1029\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(a)(i).
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[[Page 30740]]
The Commission also examined the effect of the funding model on
competition in the market for trading services, including off-exchange
liquidity suppliers and ATSs. In addition, the Commission considered
the effect of implementation and ongoing costs of the Plan, whether
particular elements of the Plan could hinder competition, and the
effect of enhanced surveillance on competition in the market for
trading services.
(1) The Funding Model
As noted above, the Operating Committee would fund the Central
Repository by allocating its costs across exchanges, FINRA, ATSs and
broker-dealers.\1030\ The Operating Committee would decide which
proportion of costs would be funded by exchanges, FINRA, and ATSs and
which portion would be funded by broker-dealers. The Plan does not
specify how the Operating Committee would select this allocation.
However, the portion allocated to the exchanges, FINRA, and ATSs would
be divided among them according to market share of share volume and the
portion allocated to broker-dealers would be divided among them
according to message traffic, including message traffic sent to and
from an ATS.\1031\ The Operating Committee would allocate fees for the
equities market and options market separately based on market share in
each market. The Operating Committee would file the fees resulting from
its funding model with the Commission under the Exchange Act.
---------------------------------------------------------------------------
\1030\ See id. at Article XI.
\1031\ Id.
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Any entity that becomes a new exchange would be required to join
the CAT NMS Plan as a Participant. In addition, any new Participant to
the Plan must pay a ``Participation Fee,'' to the Company ``in an
amount determined by a Majority Vote of the Operating Committee as
fairly and reasonably compensating the Company and the Participants for
costs incurred in creating, implementing, and maintaining the CAT.''
\1032\ This Participation Fee would be based on, among other potential
factors, capital expenditures paid by the Company amortized over five
years, costs incurred by the Company to accommodate the new
Participant, and Participant Fees paid by other new Participants.\1033\
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\1032\ See id. at Section 3.3. The Commission notes that the
Plan does not specify the Participation Fee. The Commission expects
this fee to be filed as an amendment to the CAT NMS Plan under Rule
608 of Regulation NMS. See 17 CFR 242.608.
\1033\ The Commission notes that Section 3.3(b)(v) of the CAT
NMS Plan states, ``In the event the Company (following the vote of
the Operating Committee contemplated by Section 3.3(a)) and a
prospective Participant do not agree on the amount of the
Participation Fee, such amount shall be subject to review by the
Commission pursuant to Sec. 11A(b)(5) of the Exchange Act.'' See
CAT NMS Plan, supra note 3, at Section 3.3(b)(v); see also text
accompanying notes 1038-1039, infra.
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The Commission preliminarily believes that any impacts of such fees
on competition in the market for trading services would manifest either
through the model for the fees itself or through the later allocation
of the fees across market participant types, across equity or options
exchanges or, within market participant types and markets, through the
levels of fees paid by each tier. Each of the different channels
through which the Plan could have an adverse effect on competition is
discussed separately below.
A. Funding Model
As discussed in Section IV.F.4.d, the Commission preliminarily
believes that the structure of the funding model could provide a
competitive advantage to exchanges over ATSs. The Plan states that an
entity would be assessed exactly the same amount for a given level of
activity whether it acted as an ATS or an exchange.\1034\ However,
FINRA would be charged fees based on the market share of off-exchange
trading. ATSs, which are FINRA members, would presumably pay a portion
of the FINRA fee through their broker-dealer membership fees. In
addition, ATSs would pay a fee for their market share, which is a
portion of the total off-exchange market share. Therefore, ATS volume
would effectively be charged once to the broker-dealer operating the
ATS and a second time to FINRA.\1035\ This would result in ATSs paying
more than exchanges for the same level of activity. Ultimately, if the
funding model disadvantages ATSs relative to registered exchanges,
trading volume could migrate to exchanges in response, and ATSs could
have incentives to register as exchanges as well.\1036\
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\1034\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(iii)(C).
\1035\ Id. at Section 11.3(b).
\1036\ The Commission notes that ATSs currently incur a
different set of regulatory fees than are incurred by exchanges,
because ATSs are required to be members of a national securities
association. FINRA charges its members fees to cover its regulatory
costs. See FINRA Manual: Corporate Organization: By-Laws of the
Corporation: Schedule A: Section 1--Member Regulatory Fees,
available at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=4694 (``FINRA shall, in
accordance with this Section, collect member regulatory fees that
are designed to recover the costs to FINRA of the supervision and
regulation of members, including performing examinations, financial
monitoring, and policy, rulemaking, interpretive, and enforcement
activities.'').
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Additionally, the Commission preliminarily believes that the
Participation Fee could discourage new entrants or the registration of
an ATS as an exchange, increasing the barriers to entry to becoming an
exchange. In particular, the factors listed in the Plan for determining
the Participation Fee consider the previous costs incurred by the
existing Participants but not the costs already incurred by the new
Participant when it acted as an ATS.\1037\ However, the Plan does not
prescribe a set formula for determining the Participation Fee and the
Plan does not preclude considering previous costs incurred by the ATS
in the Participation Fee. In addition, although amendments designated
by sponsors to an NMS plan as establishing or changing a fee may be
effective upon filing with the Commission,\1038\ the Commission may
summarily abrogate the amendment that establishes (or in the future,
changes) the Participation Fee within 60 days of its filing and require
that the fee amendment be refiled in accordance with Rule 608(a)(1) and
reviewed in accordance with Rule 608(b)(2) of Regulation NMS, if it
appears to the Commission that such action is necessary or appropriate
in the public interest, for the protection of investors, or 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.\1039\
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\1037\ See CAT NMS Plan, supra note 3, at Section 3.3(b).
\1038\ See 17 CFR 242.608(b)(3)(i).
\1039\ See 17 CFR 242.608(a)(1); 608(b)(2); 608(b)(3)(i); and
608(b)(3)(iii). Pursuant to Rule 608(b)(2) of Regulation NMS, the
Commission shall approve such amendment, with such changes or
subject to such conditions as the Commission may deem necessary or
appropriate, if it finds that such 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.
Approval of the amendment shall be by Commission order.
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Further, because the funding model seems to charge ATSs more for
their market share than exchanges, ATSs could pay relatively less for
their market share as an exchange than as an ATS, countering this
barrier to entry depending on the magnitudes of the two fee types.
B. Allocation of Fees
The Plan discusses the allocation of fees among market participants
of different sizes within the same market participant type (Execution
Venues versus broker-dealers), but does not
[[Page 30741]]
discuss the allocation of fees across the different market participant
types or markets. The Operating Committee would determine this
allocation and would submit a filing to the Commission, which would be
subject to Commission review and public comment.\1040\ The Commission
recognizes the potential for the Operating Committee to influence the
market for trading services either by coordinating to favor one segment
over another, or through an imbalance in the voting rights on the
Operating Committee. The Commission also preliminarily believes that
the Plan contains governance provisions that could mitigate such
potential burdens on competition.
---------------------------------------------------------------------------
\1040\ See supra notes 78 and 79 (describing how fee schedules
for CAT could be filed and noting that they could take effect upon
filing with the Commission).
---------------------------------------------------------------------------
The Commission recognizes that the potential for a burden on
competition and effects on competitors in the market for trading
services could arise from provisions relating to the allocation and
exercise of voting rights. In particular, a concentration of influence
over Committee decisions could directly and indirectly affect
competition. The potential for concentration of influence over vote
outcomes arises from proposed provisions to give one vote to each Plan
Participant \1041\ in an environment where some Participants are
Affiliated SROs.\1042\ Indeed, supermajority approval could be achieved
through five of the 10 groups of Affiliated SROs and majority approval
could be achieved with just four such groups.\1043\ In light of this
potential for concentration, voters could weigh some particular
interests more than others. For example, the Participant groups with
options exchanges could have the incentive to allocate a
disproportionately low level of fees for options market share than for
equity market share. Such an allocation could disadvantage competing
Participants with only equities exchanges.
---------------------------------------------------------------------------
\1041\ See CAT NMS Plan, supra note 3, at Section 4.3.
\1042\ The CAT NMS Plan states that the Operating Committee
shall consist of one voting member representing each Participant and
that one individual may serve as the voting member of the Operating
Committee for multiple Affiliated Participants and shall have the
right to vote on behalf of each such Affiliated Participant. See id.
at Section 4.2(a).
\1043\ The twenty SROs that are Participants in the CAT NMS Plan
include five sets of affiliated SROs (New York Stock Exchange LLC,
NYSE Arca, Inc., and NYSE MKT LLC (the ``NYSE Group''); The NASDAQ
Stock Market LLC, NASDAQ OMX BX, Inc., and NASDAQ OMX PHLX LLC (the
``NASDAQ Group''); BATS Exchange, Inc., BATS Y-Exchange, Inc., EDGX
Exchange, Inc., and EDGA Exchange, Inc. (the ``BATS Group'');
Chicago Board Options Exchange, Incorporated and C2 Options
Exchange, Incorporated (the ``Chicago Options Group'');
International Securities Exchange, LLC, ISE Gemini, LLC, and ISE
Mercury, LLC (the ``ISE Group''); and five independent SROs
(National Stock Exchange, Inc.; Chicago Stock Exchange, Inc.; BOX
Options Exchange LLC; Miami International Securities Exchange LLC;
and Financial Industry Regulatory Authority, Inc.). The BATS Group
has four votes, the NYSE Group, the NASDAQ Group and the ISE Group
each have three votes, and the Chicago Options Group has two votes.
See CAT NMS Plan, supra note 3, at Appendix C, Section D.11(b)
(Affiliated Participant Groups and Participants without
Affiliations). A majority approval requires eleven votes. This could
include as few as four of the SROs and sets of affiliated SROs: the
affiliated SROs that have four votes, two sets of affiliated SROs
that have three votes, and one other SRO or set of affiliated SROs.
Supermajority approval requires fourteen votes. This could include
as few as five SROs and sets of affiliated SROs: the affiliated SROs
that have four votes, three sets of affiliated SROs with three
votes, and any additional SRO. Note also that as few as two sets of
affiliated SROs could block a Supermajority approval by casting
seven ``no'' votes: the affiliated SROs with four votes and any one
of the affiliated SROs with three votes.
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The inclusion of all exchanges on the Operating Committee could
give the Plan Participants opportunities and incentives to share
information and coordinate strategies in ways that could reduce the
competition among exchanges or could create a competitive advantage of
exchange trading over off-exchange trading.\1044\ However, the
Commission preliminarily believes that the Plan would limit these
potential burdens on competition. In particular, the Plan includes
provisions designed to limit the flow of information between the
employees of the Plan Participants who serve as members of the
Operating Committee and other employees of the Plan Participants.\1045\
Additionally, the Plan includes provisions that guide the Operating
Committee to set fees between exchanges and ATSs in a tiered fashion,
based upon market share.\1046\ Finally, Commission oversight could also
mitigate any concerns that burdens on competition might arise as a
result of this approach.
---------------------------------------------------------------------------
\1044\ See infra note 1272. The Commission notes that FINRA
could represent the perspectives of the off-exchange portion of the
market, but FINRA would have only one vote and exchanges would have
nineteen.
\1045\ See CAT NMS Plan, supra note 3, at Section 9.6(a)
(Participants may share Plan information with their employees and
other Representatives on a need-to-know basis; their use of Plan
information is restricted to what is needed to achieve plan
regulatory objectives). Details on the implementation of these
confidentiality provisions are not stated. However, see also id. at
Section 9.6(c) (Participants may share information among themselves
without Operating Committee approval in some instances).
\1046\ See id. at Section 11.3; Appendix C, Section
B.7(b)(iv)(C).
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Additionally, the Commission agrees with the Plan's assessment that
some governance features of the Plan would limit adverse effects on
competition in the market for trading services. The governance
structure of the Plan contains provisions to limit the incentive and
ability of Operating Committee members to serve the private interests
of their employers, such as rules regulating conflicts of
interest.\1047\ Such governance provisions could mitigate the potential
for members of the Operating Committee to use their influence over the
fee schedule to benefit their own enterprise in a way that unfairly
harms the customers of competing exchanges and ATSs and places a burden
on competition. Moreover, as discussed above, the Commission may
summarily abrogate and require the filing of Plan amendments that
establish or change a fee in accordance with Rule 608(a)(1) and review
such amendments in accordance with Rule 608(b)(2) of Regulation NMS, if
it appears to the Commission that such action is necessary or
appropriate in the public interest, for the protection of investors, or
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.\1048\ In such a case, if the
Commission chooses to approve such amendment, it would be by order and,
with such changes or subject to such conditions as the Commission may
deem necessary or appropriate.
---------------------------------------------------------------------------
\1047\ See supra note 796.
\1048\ See supra note 1039.
---------------------------------------------------------------------------
(2) Costs of Compliance
Because all Participants but one compete in the market for trading
services, the ability of affiliates to vote as a group could in
principle allow a few large Participant groups to influence the outcome
of competition in the market for trading services by making various
decisions that can alter the costs of one set of competitors more than
another set. Further, the Plan would allocate profits and losses from
operating the Central Repository equally across Participants, which
could advantage small exchanges in the event of a profit and
disadvantage small exchanges in the event of a loss. This could
negatively impact competition if the cost differentials are unnecessary
in light of the cost-benefit trade-offs of alternatives and if the cost
differentials are significant enough to alter the set of services that
some Participants offer.
Generally, smaller competitors could have implementation and
ongoing costs of compliance that are disproportionate
[[Page 30742]]
relative to their size. Any choices that could exacerbate these
differences could potentially result in the exit of smaller
competitors. To lessen the impact of funding the Central Repository on
smaller exchanges and ATSs, the Plan would apply a tiered funding model
that charges the smallest exchanges and ATSs the lowest fees. Likewise,
the Plan would apply a tiered funding model that would charge the
smallest broker-dealers, including liquidity suppliers, the lowest
fees. However, the Commission notes that the Plan does not indicate
whether off-exchange liquidity providers would pay fees similar to
similarly-sized ATSs and exchanges.
In addition, as noted above, the Plan provides that the Technical
Specifications would not be finalized until after the selection of a
Plan Processor, which would not occur until after any decision by the
Commission to approve the Plan.\1049\ The Commission recognizes that
the costs of compliance associated with future technical choices or the
selection of the Plan Processor could exacerbate the relative cost
differential across competitors. For example, the Affiliated
Participants on the Selection Committee could favor a Plan Processor
that employs technology that would make implementation costs relatively
higher for the exchanges that do not have affiliates. In addition, the
Affiliated Participants, who have more votes on the Operating
Committee, could be amenable to adding particular CAT Data items in the
future that could expose violations on other exchanges, but not be
amenable to CAT Data items that could expose violations on their own
exchanges. While those groups could still use such data to surveil
their own exchanges, if not in CAT Data, the data items would not be
available for cross-market surveillance or efficient Commission
examinations and enforcement. As such, the independent exchanges, which
have only one vote on the Operating Committee, could face higher
regulatory costs than exchanges of the Affiliated Participants.
However, for the same reasons as stated above, the Commission
preliminarily believes that the governance provisions of the Plan and
Commission oversight could help to mitigate such effects on these
competitors in the market for trading services.
---------------------------------------------------------------------------
\1049\ See Section IV.C.2, supra.
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(3) Enhanced Surveillance and Deterrence
The Commission also preliminarily believes that the CAT NMS Plan
could promote competition in the market for trading services through
enhanced surveillance and the deterrence of violative behavior that
could inhibit competition.\1050\ Should the Plan deter violative
behavior, passive liquidity suppliers, such as on or off-exchange
market makers could increase profits as a result of reduced losses from
others' violative behavior. This increase in profits could encourage
new entrants or could spark greater competition, which reduces
transaction costs for investors. For example, spoofing, which involves
building up the apparent depth of the market to trigger particular
trading patterns and then trading against those patterns, could cause
confusion about bona-fide supply and demand for a particular security.
Liquidity providers could compete less than is optimal to provide
liquidity in that security out of fear that they could suffer a decline
in profitability if they trade at inopportune times as a result of
others' spoofing behavior. If the Plan facilitates surveillance
improvements that deter spoofing, it could increase incentives to
provide liquidity and promote lower transaction costs for investors,
particularly in stocks that may lack a critical mass of competing
liquidity providers or that could be targets for violative trading
behavior.
---------------------------------------------------------------------------
\1050\ See Section IV.E.2.c, supra, for a discussion of how the
CAT NMS Plan would enhance surveillance and deter violative
behavior.
---------------------------------------------------------------------------
b. Market for Broker-Dealer Services
The Commission analyzed the effect of the CAT NMS Plan on the
market for broker-dealer services. For simplification, the Commission
presents its analysis as if the market for broker-dealer services
encompasses one broad market with multiple segments even though, in
terms of competition, it actually may be more realistic to think of it
as numerous inter-related markets. The market for broker-dealer
services covers many different markets for a variety of services,
including, but not limited to, managing orders for customers and
routing them to various trading venues, holding customer funds and
securities, handling clearance and settlement of trades, intermediating
between customers and carrying/clearing brokers, dealing in government
bonds, private placements of securities, and effecting transactions in
mutual funds that involve transferring funds directly to the issuer.
Some broker-dealers may specialize in just one narrowly defined
service, while others may provide a wide variety of services.
The market for broker-dealer services relies on competition among
broker-dealers to provide the services listed above to their customers
at efficient levels of quality and quantity. The broker-dealer industry
is highly competitive, with most business concentrated among a small
set of large broker-dealers and thousands of small broker-dealers
competing for niche or regional segments of the market. To limit costs
and make business more viable, small broker-dealers often contract with
larger broker-dealers or service bureaus to handle certain functions,
such as clearing and execution, or to update their technology.\1051\
Large broker-dealers typically enjoy economies of scale over small
broker-dealers and compete with each other to service the smaller
broker-dealers, who are both their competitors and their customers.
---------------------------------------------------------------------------
\1051\ See Securities Exchange Act Release No. 63241 (November
3, 2010), 75 FR 69791, 69822 (November 15, 2010) (Risk Management
Controls for Brokers or Dealers with Market Access).
---------------------------------------------------------------------------
There are approximately 1,800 broker-dealers likely to be CAT
Reporters, while approximately 2,338 broker-dealers would not be CAT
Reporters because their businesses do not involve reportable events in
securities covered by the Plan.\1052\ Further, broker-dealers that are
anticipated to have CAT reporting obligations could compete with the
broker-dealers that would not have CAT reporting responsibilities in
various broker-dealer market segments that are unrelated to CAT
reporting. Some broker-dealers may offer specialized services in one
line of business mentioned above, while other broker-dealers may offer
diversified services across many different lines of businesses. As
such, the competitive dynamics within each of these specific lines of
business for broker-dealers is different, depending on the number of
broker-dealers that operate in the given segment and the market share
that the broker-dealers occupy.
---------------------------------------------------------------------------
\1052\ Examples of these business activities include
underwriting and advising. See supra note 864.
---------------------------------------------------------------------------
The Commission preliminarily believes costs of compliance incurred
by broker-dealers to comply with the Plan, particularly to report order
events to the Central Repository, will differ substantially between
broker-dealers and may affect competition between smaller and larger
broker-dealers. As discussed previously in the Commission's analysis of
Costs, broker-dealers that outsource regulatory data reporting
activities are expected to see their costs of regulatory data reporting
increase, while broker-dealers that Insource may see a decrease in
their regulatory data reporting costs.\1053\ The Commission
preliminarily believes this
[[Page 30743]]
dynamic may affect competition between Outsourcers (that tend to be
smaller) and Insourcers (that tend to be larger), and may increase
barriers to entry in some segments of this market.
---------------------------------------------------------------------------
\1053\ See Section IV.F.1.c(2)C, supra.
---------------------------------------------------------------------------
The Plan discusses certain aspects of competition pertaining to
broker-dealers that relate to costs and the allocation of fees. The
Plan states, ``[b]roker-dealer competition could be impacted if the
direct and indirect costs associated with meeting the CAT NMS Plan's
requirements materially impact the provision of their services to the
public. Further, competition may be harmed if a particular class or
group of broker-dealers bears the costs disproportionately . . . .''
The Plan asserts that it would have little to no adverse effect on
competition between large broker-dealers, and would not materially
disadvantage small broker-dealers relative to large broker-dealers.
Regarding small broker-dealers, the Plan states, ``. . . . [the
allocation of costs on broker-dealers based on their contribution to
market activity] may be significant for some small firms, and may even
impact their business models materially . . . .'' and that the
Participants were sensitive to the burdens the Plan could impose on
small broker-dealers, noting that such broker-dealers could incur
minimal costs under their existing regulatory reporting requirements
``because they are OATS-exempt or excluded broker-dealers or limited
purpose broker-dealers.'' The CAT NMS Plan attempts to mitigate its
impact on these broker-dealers by proposing to follow a cost allocation
formula that (in expectation) charges lower fees to smaller broker-
dealers; furthermore, Rule 613 provides them additional time to
commence their reporting requirements.
The Commission preliminarily agrees with the Plan's general
assessment of competition among broker-dealers, and also with the
Plan's assessment of differential effects on small versus large broker-
dealers. The Commission agrees that the Plan's funding model is an
explicit source of financial obligation for broker-dealers and
therefore an important feature to evaluate when considering potential
differential effects of the Plan on competition in the market for
broker-dealers. The Commission understands that the tiered funding
model should result in the smallest broker-dealers paying the smallest
fees, but the Plan does not outline how the magnitudes of fees would
differ across the tiers. The Commission also recognizes that the
potentially greater level of service specialization that may
characterize small broker dealers and the potentially non-linear
economies of scale may result in the compliance costs associated with
the Plan competitively disadvantaging small broker-dealers, on average,
relative to large broker-dealers.
However, the Commission preliminarily believes that the segments of
the market most likely to experience higher barriers to entry are those
that currently have no data reporting requirements of the type the Plan
requires and those that would involve more CAT Reporting obligations,
such as the part of the broker-dealer market that involves connecting
to exchanges, because of the technology infrastructure requirements and
the potential to have to report several types of order events.\1054\
The opportunity to rely on service bureaus or other solutions to reduce
the costs of complying with the Plan could limit any increases in the
barriers to entry in this market. Nonetheless, the Commission
preliminarily believes that any increases in the barriers to entry are
justified because they are necessary in order for the CAT Data to
include data from small broker-dealers. In the Adopting Release, the
Commission explained that excluding small broker-dealers from reporting
requirements 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.'' \1055\ The Commission further
noted 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'' and that ``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.'' \1056\
---------------------------------------------------------------------------
\1054\ The majority of broker-dealers do not directly engage in
exchange trading, and most broker-dealers are not expected to have
CAT reporting obligations. See supra note 864.
\1055\ See Adopting Release supra note 9, at 45749.
\1056\ See id.
---------------------------------------------------------------------------
The Commission also recognizes that the Plan could affect the
current relative competitive positions of broker-dealers in the market
for broker-dealer services. To varying degrees, the economic impacts
resulting from the Plan could benefit some broker-dealers and adversely
affect others. The magnitude of these effects on broker-dealers could
vary across and within categories of broker-dealers and classes of
securities. However, there is no clear reason to expect these impacts,
should they occur, to decrease the current state of overall competition
in the market for broker-dealer services so as to materially burden the
price or quality of services received by investors on average.
Regardless of the differential effects of the CAT NMS Plan on small
versus large broker-dealers, it is the Commission's preliminary view
that the CAT NMS Plan, in aggregate, would likely not reduce
competition and efficiency in the overall market for broker-dealer
services. Even if small broker-dealers potentially face a burden, this
may not necessarily have an adverse effect on competition as a whole in
the overall market for broker-dealer services. Under the CAT NMS Plan,
broker-dealers would have greater reporting responsibilities than they
would otherwise have. Broker-dealers could face high upfront
infrastructure costs to set up a processing environment to meet
reporting responsibilities. Because these infrastructure costs are
upfront, fixed costs, the burden to bear these costs could be
potentially greater for small broker-dealers. Instead of bearing these
costs in-house, small broker-dealers could contract with outside
technology vendors for reporting services. This outcome could lead to
lower costs relative to not using a vendor for reporting services. For
these reasons, even firms that currently do not report to OATS, but
will be CAT Reporters under the Plan, could face manageable upfront
costs that permit them to continue in their line of business without a
severe setback in their profitability.
The Commission notes that a difficulty in assessing the likely
impacts of the CAT NMS Plan on competition among broker-dealers is that
competition in the markets for different broker-dealer services could
be affected in different ways. As mentioned above, there is great
diversity in the business activities of broker-dealers. Broker-dealer
services that are likely to incur CAT reporting responsibilities
include: executing orders, whether it be as an ATS or acting as a
carrying broker-dealer; intermediating between customers and carrying/
clearing brokers; effecting transactions in mutual funds that involve
transferring funds directly to the issuer; writing options; and acting
as an exchange floor broker. As noted above, these broker-dealers may
also compete with the approximately 2,338 other broker-dealers in
market segments that are not related to CAT reporting, such as dealing
in municipal bonds or arranging
[[Page 30744]]
private placements of securities.\1057\ If CAT costs represent a
significant increase in overall costs, the Plan could disadvantage
broker-dealers who are CAT Reporters in the market segments that do not
require CAT reporting. For example, broker-dealers that, in addition to
providing services related to market transactions that are reportable
to CAT, also compete to provide fixed-income order entry as a line of
business may be at a relative disadvantage to competitors in the fixed-
income market who do not provide broker-dealer services that are
related to market activity that is reportable to CAT. Whether this
disadvantage amounts to a substantial reduction in competition in
various markets depends on the magnitude of the disadvantage and
whether it affects the price and level of services available to
investors.
---------------------------------------------------------------------------
\1057\ See Section IV.F.1.c, supra.
---------------------------------------------------------------------------
The Commission recognizes that the CAT NMS Plan could result in
fewer broker-dealers providing specialized services that trigger CAT
reporting obligations. The Commission preliminarily believes that this
potential effect on broker-dealer specialization depends on whether
three key conditions are met. First, the effect requires that, compared
to large broker-dealers, small broker-dealers disproportionately
specialize in providing regional or niche services to a particular
market segment of clients. Second, the effect requires that this
specialization is correlated with business risk associated with changes
in marginal cost. Finally, the effect requires that the compliance
costs of the CAT NMS Plan could affect the ability for some small
broker-dealers to provide these specialized services. This effect, in
which fewer broker-dealers compete in specialized market segments,
could thereby negatively affect the competitive dynamics in these
market segments, especially if these segments currently contain
relatively few broker-dealers. The Commission preliminarily believes
that these conditions could hold, particularly for smaller broker-
dealers, and result in fewer broker-dealers operating in specialized or
niche markets if the Plan is approved.
The Commission recognizes, however, that fewer broker-dealers in a
specialized segment of the market may not necessarily harm competition
in that segment. In particular, the costs of compliance with the Plan
may be less of a relative burden for large broker-dealers who may,
compared to small broker-dealers, provide a larger portfolio of
specialized services to clients. This portfolio may buffer large
broker-dealers from business risk associated with specialization.
Because of the lower relative burden, large broker-dealers are more
likely to maintain their presence in specialized market segments. If a
sufficient number of large broker-dealers, or all broker-dealers more
generally, maintain their presence in specialized market segments, a
net decrease in broker-dealers may not affect the competition in such
market segments to a level in which the market segment offers fewer or
lower quality services or higher prices. However, the Commission
recognizes that negative effects on competition in specialized market
segments could result if broker-dealers achieve a level of market
concentration necessary to adversely affect prices for investors.
c. Market for Regulatory Services
SROs compete in the market for regulatory services.\1058\
Regulatory functions include market surveillance, cross-market
surveillance, oversight, compliance, investigation, and enforcement, as
well as the registration, testing, and examination of broker-dealers.
Although the Commission oversees exchange SROs' supervision of trading
on their respective venues, the responsibility for direct supervision
of trading on an exchange resides in the SRO that operates the
exchange. Currently, SROs compete to provide regulatory services in at
least two ways. First, because SROs are responsible for regulating
trading within venues they operate, their regulatory services are
bundled with their operation of the venue. Consequently, for a broker-
dealer, selecting a trading venue also entails the selection of a
provider of regulatory services surrounding the trading activity.
Second, SROs could provide this supervision not only for their own
venues, but for other SROs' venues as well through the use of
Regulatory Service Agreements or a plan approved pursuant to Rule 17d-2
under the Exchange Act.\1059\ Consequently, SROs compete to provide
regulatory services to venues they do not operate. Because providing
trading supervision is characterized by high fixed costs (such as
significant IT infrastructure and specialized personnel), some SROs
could find that another SRO could provide some regulatory services at a
lower cost than it would incur to provide this service in-house. Until
recently, nearly all the SROs that operate equity and option exchanges
contracted with FINRA for some or much of their trading surveillance
and routine inspections of members' activity.\1060\
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\1058\ FINRA is the SRO responsible for supervision of trading
off-exchange, which includes trading occurring on ATSs.
\1059\ 17 CFR 240.17d-2.
\1060\ Every equity exchange except CHX and NSX has an RSA with
FINRA which allows FINRA to provide cross-market surveillance for
nearly 100% of the equity markets. These RSAs differ in scope, but
in every case these contracts represent a partnership between FINRA
and the other SROs to provide a full set of effective regulatory
services. Recently NYSE Group and NASDAQ OMX decided to
significantly scale back their RSA with FINRA and directly resume
most of their market surveillance and investigation regulatory
obligations.
---------------------------------------------------------------------------
As a result, the market for regulatory services in the equity and
options markets currently has one dominant competitor, FINRA. This may
provide relatively uniform levels of surveillance across trading
venues. One SRO having a competitive advantage in providing such
services could also limit the incentives to innovate in surveillance.
Hypothetically, increases in the competition to provide regulatory
services could promote regulatory oversight of exchanges and investor
protection for investors. To the extent that a regulator could improve
on current regulatory oversight, this could result in a better
functioning, more liquid, financial market. However, it is possible
that increased competition between SROs to provide regulatory services
could have negative effects on the market if SROs compete on the basis
of providing light-touch regulation, which might be less likely to
detect violative activity.
The Commission preliminarily believes that the Plan could provide
opportunities for increased competition in the market to provide
regulatory services. In particular, designated regulatory Staff from
all of the SROs would have access to CAT Data, which would reduce the
differences in data access across SROs.\1061\ This could reduce
barriers to entry in providing regulatory services because data would
be centralized and standardized, possibly reducing economies of scale
in performing surveillance activities.\1062\ Furthermore, because some
types of
[[Page 30745]]
previously infeasible surveillance would become possible with the
availability of additional data,\1063\ SROs would have greater
opportunities to innovate in the type of surveillance that is
performed, and the efficiency with which it is performed. In addition,
when as Rule 613(a)(3)(iv) requires, SROs implement new or updated
surveillance within 14 months after effectiveness of the CAT NMS
Plan,\1064\ any SRO could reconsider its approach to outsourcing its
own regulation and whether it wants to compete for regulatory service
agreements.
---------------------------------------------------------------------------
\1061\ Without a Central Repository, an SRO wishing to compete
as a regulatory services provider would need to invest in the IT
infrastructure and enter into the data access agreements necessary
to surveil broadly beyond its exchanges' data resources. By
providing access to consolidated trade and order data to all SROs,
CAT may reduce barriers to entry for this market. See Exemption for
Certain Exchange Members, supra note 394, at 18057-58 (describing
the barriers to entry of potential new national securities
associations).
\1062\ The Commission recognizes that efficient access to data
is not the only prerequisite for entering the market to provide
regulatory services and that high barriers to entry may still
characterize this market.
\1063\ See Section IV.G.2.a, infra, for a discussion of the
efficiency improvements for surveillance.
\1064\ 17 CFR 242.613(a)(3)(iv).
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d. Market for Regulatory Data Reporting Services
The Commission analyzed the effect of the CAT NMS Plan on
competition in the market for data reporting services with a focus on
its impact on the costs incurred by broker-dealers to comply with the
Plan. As discussed in the Costs Section above, the Commission
preliminarily believes that many broker-dealers, particularly smaller
broker-dealers, would fulfill their CAT Reporting obligations by
outsourcing to service bureaus and that the fees charged by the service
bureaus would be a major cost driver for these broker-dealers. Further,
these fees would factor into the increase in barriers to entry in the
market for broker-dealer services.\1065\ Therefore, the Commission
preliminarily believes that any effects on competition in the market
for regulatory data reporting services could have a significant effect
on the costs incurred by broker-dealers in complying with the CAT NMS
Plan.
---------------------------------------------------------------------------
\1065\ See Section IV.G.1.b, supra.
---------------------------------------------------------------------------
The Plan provides information on broker-dealers' use of third-party
service providers to accomplish current regulatory data reporting. The
Plan notes that while some broker-dealers perform their regulatory data
reporting in-house, others outsource this activity. The Plan does not
state what proportion of broker-dealers currently outsources their
regulatory data reporting work. However, the Commission interviewed a
variety of broker-dealers and service bureaus in order to gain insight
into the scope of broker-dealers' use of data reporting services. As
noted in the Costs Section,\1066\ the Commission understands that most
firms outsource the bulk of their regulatory data reporting to third-
party firms. The Commission preliminarily believes that the competition
in the market to provide data reporting services is a product of firms
choosing to perform this activity in-house or to outsource it based on
a number of considerations including cost, with some firms choosing to
outsource this activity across multiple service providers.
---------------------------------------------------------------------------
\1066\ See Section IV.F.1.c(2)A, supra.
---------------------------------------------------------------------------
The market for regulatory data reporting services is characterized
by bundling, high switching costs, and barriers to entry. The high IT
infrastructure costs of regulatory data reporting creates economies of
scale that give rise to the data reporting services provided by service
bureaus. Broker-dealers, instead of investing in the IT infrastructure
necessary for regulatory data reporting, could share the costs of the
IT infrastructure with other broker-dealers by paying for a service
bureau to report for them. Often, service bureaus bundle regulatory
data reporting services with an order-handling system service that
provides broker-dealers with market access and order routing
capabilities.\1067\ Sometimes service bureaus bundle regulatory data
reporting services with trade clearing services.
---------------------------------------------------------------------------
\1067\ See Section IV.F.1.c(2)A, supra, for more information on
broker-dealer use of service bureaus.
---------------------------------------------------------------------------
In discussions with Staff, service bureaus stated that switching
service bureaus can be costly and involve complex onboarding processes
and requirements, that systems between service bureaus may be
disparate, and switching service providers may require different or
updated client documentation. However, service bureaus stated that on-
boarding operations were infrequent and that it was rare for broker-
dealers to switch between service providers. Difficulty switching
between service providers could limit the competition among service
bureaus to provide data reporting services, and impact the costs that
Outsourcers incur to secure regulatory data reporting services.
Furthermore, the high IT infrastructure costs also give rise to
barriers to entry, which could slow the entry of new market
participants into the market. Despite this, the trend in the market is
toward expansion.\1068\
---------------------------------------------------------------------------
\1068\ See supra note 920.
---------------------------------------------------------------------------
The Commission preliminarily believes that the Plan could alter the
competitive landscape in the market for data reporting services in
several ways. It is not clear whether demand for regulatory data
reporting services would increase or decrease; although more broker-
dealers would be required to report regulatory data, it is possible
that flexible reporting options allowed by the Plan could make
preparing data for reporting less onerous, leading to fewer firms
choosing to outsource this activity.
It is possible that the Plan would increase the demand for data
reporting services by requiring regulatory data reporting by broker-
dealers that may have previously been exempt due to size under
individual SRO rules.\1069\ Because more broker-dealers would be
required to report regulatory data under the Plan, the Commission
preliminarily believes there could be an opportunity for increased
competition in this market which might benefit all broker-dealers that
outsource their regulatory data reporting activity. However, it is also
possible that the increase in demand for data reporting services could
serve to entrench existing providers if they capture a large share of
newly created demand; this could lead to relatively higher costs for
broker-dealers than they would face in a more competitive market. The
potential increase in demand for data reporting services could impact
the capacity of already existing data reporting services to meet this
increase in demand, and this in turn could have implications for
competition and pricing in the market for data reporting services.
Considering the barriers to entry that characterize the market for data
reporting services and this potential increase in demand, service
bureaus could have less incentive to compete for broker-dealer clients
because these clients are no longer scarce, and as such, the CAT NMS
Plan could result in a decline in the competition for data reporting
services. It is possible that broker-dealers seeking to establish
relationships with service bureaus could have trouble securing them
because of the limited on-boarding capacity and need to on-board many
broker-dealers at once. In the short-run these capacity constraints and
the high demand could increase the costs of reporting through a service
bureau. However, the two year implementation period for large broker-
dealers and three year period for small broker-dealers could alleviate
the reduction in competition due to the onboarding capacity strain
because current service bureaus have time to increase their on-boarding
capacity and new entrants have time to build the necessary IT
infrastructure and a client base.
---------------------------------------------------------------------------
\1069\ See, e.g., FINRA Rule 7470.
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The CAT NMS Plan could also dramatically change the pool of firms
demanding data reporting services, which would be skewed toward firms
that are smaller and on average costlier to service, which could result
in higher
[[Page 30746]]
prices, which could eventually be passed onto investors. In addition to
small and medium sized broker-dealers that previously self-reported,
the CAT NMS plan would result in more broker-dealers having data
reporting responsibilities and the Commission preliminarily believes
that these broker-dealers would predominantly be small. For example,
very small broker-dealers that are currently exempt from OATS reporting
requirements could seek to establish service bureau relationships. In
addition, because the Plan would require additional elements in
regulatory data, particularly customer data, some broker-dealers that
currently self-report could no longer find it economically feasible to
continue to do so.
In addition to possibly increasing demand for data reporting
services, the CAT NMS Plan may have a mixed effect on the number of
firms offering data reporting services. This can impact the
competitiveness of this market, and affect the costs broker-dealers
bear in securing these services. On one hand, the number of firms
offering data reporting services could decrease, because the need to
secure PII might increase the likelihood of liability and litigation
risks in the event of a security breach.\1070\ On the other hand, it is
possible that the number of service bureaus offering data reporting
services would increase. New reporting requirements for numerous
broker-dealers could create opportunities for new entrants to meet this
demand. This could increase capacity and result in innovation in
providing these services, which could benefit broker-dealers needing
data reporting services by potentially reducing reporting costs, or at
least reducing the potential for cost increases. Lower reporting costs
for broker-dealers could in turn benefit the investors who are serviced
by these broker-dealers, through reduced costs.
---------------------------------------------------------------------------
\1070\ See Section IV.F.4.a(3), supra for a discussion of the
potential exit of service bureau resulting from the risk of a
security breach.
---------------------------------------------------------------------------
It is also possible that the Plan would decrease the demand for
data reporting services. Many broker-dealers currently pay another firm
(such as a service bureau) to fulfill their regulatory data reporting;
this may be because these broker-dealers find it would be more
expensive to handle the translation of their order management system
data into fixed formats, such as is required for OATS. If the Plan
Processor allows broker-dealers to send data to the Central Repository
in the formats that they use for normal operations, in drop copies for
example, these broker-dealers may no longer see a cost advantage in
engaging the services of a regulatory data reporting service provider
because one of the costs associated with regulatory data reporting--
having to translate data into a fixed format--will have been
eliminated.\1071\ Without the cost of having to translate data, some
broker-dealers that currently outsource OATS reporting could choose, at
the margin, to insource their regulatory data reporting.
---------------------------------------------------------------------------
\1071\ The Plan does not mandate the data ingestion format. See
CAT NMS Plan, supra note 3, at Appendix C, at Section A.1(b). The
Commission recognizes that the CAT Reporters Study found no
difference in expected costs for a fixed format, but requests
comment on why the costs may be similar when it would seem logical
that allowing flexible data reporting formats would reduce costs for
broker-dealers. See Request for Comment Nos. 318 and 331 in Section
IV.F.5, supra.
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The Commission preliminarily believes that this reduction in demand
would not likely be realized and, if realized, would be unlikely to
offset the increase in demand that would come from CAT reporters not
subject to OATS reporting. As noted in the Costs Section, of the 1,800
expected CAT Reporters, 868 do not currently report to OATS.\1072\ This
means that the Commission expects a large proportion of CAT Reporters
may be broker-dealers that currently do not have a service bureau for
regulatory data reporting but would choose to engage one to manage
their CAT reporting responsibilities. This is more than the
Commission's estimate of 806 current outsourcing broker-dealers.\1073\
Therefore, it is unlikely that the number of current Outsourcers that
choose to become Insourcers would be larger than the number of non-OATS
reporters that would elect to outsource. As a result, demand is more
likely to increase. Further, the requirement for CAT reports to use
listing exchange symbology could require pre-report data processing
even if the Plan Processor allows for the receipt of reports in the
formats that broker-dealers use for normal operations.\1074\ As a
result, the CAT NMS Plan is unlikely to eliminate the costs of
processing data prior to reporting that data to the Central Repository.
---------------------------------------------------------------------------
\1072\ The Plan estimates that 1,800 broker-dealers are expected
to have CAT reporting obligations. Based on data from FINRA, 932
broker-dealers currently report OATS data. 1,800-932=868. See
Section IV.F.1.c(2)A, supra.
\1073\ Id.
\1074\ See supra note 949.
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2. Efficiency
The Commission has analyzed the potential impact of the Plan on
efficiency. The Plan includes a discussion of certain efficiency
effects anticipated if the Plan is approved; as part of its economic
analysis, the Commission discusses these effects, as well as additional
effects on efficiency anticipated by the Commission. The Commission
preliminarily believes that the Plan as proposed is likely to result in
significant improvements in efficiency related to how regulatory data
is collected and used. The Plan also has the potential to result in
improvements in market efficiency by deterring violative activity that
could reduce market efficiency.\1075\ The Commission notes, however,
that efficiency gains from the retirement of duplicative and outdated
reporting systems would be delayed for up to two and a half years and
the interim period of increased duplicative reporting would impose
significant financial burden on Industry Members.\1076\
---------------------------------------------------------------------------
\1075\ The Commission has also analyzed the likely effect of the
Plan on allocative efficiency of existing capital within the
industry. These potential effects are discussed in Section IV.G.3,
infra.
\1076\ See Section IV.F.2, supra.
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a. Effect of the Plan on Efficiency
The Commission has analyzed the possible effects of the CAT NMS
Plan on efficiency. Specifically, building off the discussion in the
Plan, the Commission analyzed the effect of the Plan on the efficiency
of detecting violative behavior through examinations and enforcement,
on the efficiency of surveillance, on market efficiency through
deterrence of violative behavior, on operational efficiency of CAT
Reporters, and on efficiencies through reduced ad hoc data requests and
quicker access to data.
The current state of regulatory data collection and use provides
ample opportunity for efficiency improvements. First, regulators'
ability to efficiently perform cross-market surveillance is hindered by
data fragmentation.\1077\ Second, regulators' ability to efficiently
supervise and surveil market participants and carry out their
enforcement responsibilities is hindered by limitations in current
regulatory data.\1078\ Finally, there are a number of other
inefficiencies associated with the current system of regulatory data
collection. These include: Delays in data availability to regulators;
lack of direct access to data collected by other regulators results in
numerous ad-hoc data requests; and the need for regulatory Staff to
invest
[[Page 30747]]
significant time and resources to reconciling disparate data
sources.\1079\
---------------------------------------------------------------------------
\1077\ See Section IV.E.2.c, supra.
\1078\ See Section IV.E.2.c, supra.
\1079\ See Section IV.D.2.b, supra. These other inefficiencies
are discussed above in the Baseline and Benefits Sections.
---------------------------------------------------------------------------
The Plan discusses a number of expected efficiency effects
associated with the Plan, including both positive and negative
effects.\1080\ The Commission preliminarily agrees with the Plan's
assessment and has identified additional efficiency effects as well.
The Plan outlines several positive effects relating to efficiency in:
Monitoring for rule violations; performing surveillance; and supporting
fewer reporting systems. Some of these efficiencies are also discussed
in the Benefits Section of this analysis.\1081\
---------------------------------------------------------------------------
\1080\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
\1081\ See Section IV.E, supra.
---------------------------------------------------------------------------
The Plan concludes SROs would experience improved efficiency in the
detection of rule violations, particularly for violations that involve
trading in multiple markets.\1082\ The Plan states an expectation that
SROs would need to expend fewer resources to detect violative cross-
market activity, and such activity would be detected more
quickly.\1083\ The Commission agrees that the Plan would result in
improvements in efficiency in the performance of examinations of market
participants by SROs and the Commission. Improvements to data
availability and access through the Central Repository could allow SROs
and the Commission to more efficiently identify market participants for
examination.\1084\ The Commission also agrees that the Plan would
improve the efficiency of enforcement investigations. If regulatory
data access improves, the quality and quantity of enforcement
investigations could increase through improvements to the
comprehensiveness and timeliness of data used to support
investigations. As mentioned previously, it can take months for
regulators to assemble the data necessary to comprehensively
investigate a regulatory inquiry.\1085\ To the extent that the Plan
allows regulators to access more comprehensive data directly from the
Central Repository, regulators would be able to collect data faster and
start processing it sooner, resulting in a more efficient data analysis
portion of an investigation. As a result, follow-up enforcement
inquiries could be avoided entirely in situations where data from the
Central Repository allows regulators to conclude an initial inquiry
without initiating an enforcement investigation.\1086\ This benefit
would be observable to both regulators and subjects of investigations,
for whom ongoing enforcement investigations can be costly and the
source of uncertainty.
---------------------------------------------------------------------------
\1082\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b); see also Section IV.E.2, supra.
\1083\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
\1084\ See Section IV.E.2.c, supra.
\1085\ See Section IV.E.2.c, supra.
\1086\ The Commission notes that this does not preclude an
increase in total enforcement investigations, but rather that some
enforcement investigations may determine earlier in the
investigation that no violation occurred.
---------------------------------------------------------------------------
The Plan states that the Participants believe that the CAT NMS Plan
could improve the efficiency of surveillance.\1087\ According to the
Plan, this improvement is due to a number of factors including:
Increased surveillance capacity; improved system speed, which would
result in more efficient data analysis; and a reduction in surveillance
system downtime.\1088\ The Plan also cites reduced monitoring
costs,\1089\ but the Commission notes that estimates in the Costs
Section of the Plan predict increased surveillance costs if the Plan is
approved. The increased surveillance costs predicted in the Plan could
reflect more effective surveillance under the Plan. Although the Plan
does not discuss the cost-benefit trade-off of increased surveillance
directly, the Commission notes that achieving the level of surveillance
that would be possible if the Plan is approved would likely be more
expensive using currently available data sources, if it is achievable
at all, due to the inefficiencies that currently exist in delivering
regulatory supervision, discussed previously.\1090\
---------------------------------------------------------------------------
\1087\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b) (stating that the CAT NMS Plan could reduce monitoring costs,
enable regulators to detect cross-market violative activity more
quickly, provide regulators more fulsome access to unprocessed data
and timely and accurate information on market activity, and provide
CAT Reporters with long term efficiencies resulting from the
increase in surveillance capabilities); see also IV.E.2.c, supra.
\1088\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b). The Participants surveyed the 10 exchange-operating SRO
groups on surveillance downtime. In conversations with Staff, the
Participants informed Staff that average surveillance downtime was
0.03% from August 1, 2014 to August 31, 2015, and ranges from 0 to
0.21% across SROs.
\1089\ See id.
\1090\ See Section IV.E.2, supra.
---------------------------------------------------------------------------
The Commission preliminarily believes that CAT may reduce violative
behavior.\1091\ The Plan states that CAT may serve a deterrent effect,
thereby reducing investor losses attributable to such behavior.\1092\
Improvements in the efficiency of market surveillance, investigations,
and enforcement could directly reduce the amount of violative behavior
by identifying and penalizing market participants who violate rules and
who would more easily go undetected in the current regime. Furthermore,
market participants' awareness regarding improvements in the efficiency
of market surveillance, investigations, and enforcement (or perceptions
thereof), and the resultant increase in the probability of incurring a
costly penalty for violative behavior, could deter violative
behavior.\1093\ Reductions in violative behavior through both of these
economic channels could improve market efficiency, assuming violative
behavior receives diminishing marginal gains and generates increasing
marginal harm.\1094\
---------------------------------------------------------------------------
\1091\ See Section IV.E.2.c, supra.
\1092\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
\1093\ See, e.g., Schelling, Thomas, ``The Strategy of Conflict:
Prospectus for a Reorientation of Game Theory,'' Journal of Conflict
Resolution, Vol. 2 No.3 (1958); Ellsberg, Daniel, ``The Crude
Analysis of Strategic Choices,'' American Economic Review, Vol. 51,
No. 2 (1961).
\1094\ See, e.g., Becker, Gary and William Landes, ``Essays in
the Economics of Crime and Punishment,'' Columbia University Press,
(1974).
---------------------------------------------------------------------------
The Plan discusses increased efficiency due to reductions in
redundant reporting systems.\1095\ The Plan also discusses increases in
system standardization, which would allow consolidation of resources,
including the sunsetting of legacy reporting systems and processes, as
well as consolidated data processing envisioned from the Plan.\1096\
However, the Commission is aware that the Plan, as proposed, calls for
a period of years during which Industry Members would face duplicative
reporting systems before older regulatory data reporting systems are
retired.\1097\ This period of duplicative reporting would impose a
considerable financial burden on Industry Members.\1098\
---------------------------------------------------------------------------
\1095\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(C) (discussing benefits of CAT to broker-dealers).
\1096\ See id. at Appendix C, Section B.8(b).
\1097\ See id. at Appendix C, Section B.9.
\1098\ See Section IV.F.2, supra for a discussion of duplicative
reporting and whether broker-dealers would pass costs on to
investors.
---------------------------------------------------------------------------
The Plan discusses two other efficiency improvements: a reduction
in ad-hoc data requests and more fulsome access to raw data. The Plan
predicts a reduction in ad-hoc data requests, which would free up
resources previously used to service such requests.\1099\ However,
while the Plan anticipates a decrease in ad-hoc data requests as a
result of Plan-related data improvements, the Commission notes that it
is possible that some types of ad-hoc data requests might increase. For
instance, even if enforcement
[[Page 30748]]
investigations initially use CAT Data, later-stage investigations may
involve requests for data not included in CAT Data, such as commissions
paid or a locate identifier for a short sale. An increase in the
efficiency of enforcement investigations could increase the total
number of later-stage investigations.\1100.\ Such investigations could
produce additional ad-hoc data requests and require other interactions
with market participants.\1101\ The Commission recognizes that these
data request increases would partially offset the efficiency
improvements from the reduction in data requests noted above, but the
Commission preliminarily believes that the Plan would improve
efficiency by reducing the total number of data requests. The
Commission, however, acknowledges that this decrease in data requests
may be partially offset in an increase in the number of investigations
in general, because enhanced surveillance is likely to detect more
potentially violative activity that would need to be investigated.
---------------------------------------------------------------------------
\1099\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
\1100\ This does not preclude regulators determining sooner if
the actions they are investigating are not violative. Rather, an
increase in the total number of enforcement investigations due to
efficiency improvements can result in more later-stage
investigations even if regulators are better able to conclude some
investigations earlier.
\1101\ See Section IV.D.1.c, supra.
---------------------------------------------------------------------------
Furthermore, the Plan anticipates more robust access to unprocessed
regulatory data, which could improve the efficiency with which SROs
could respond to market events where they previously had to submit data
requests and wait for data validation procedures to be completed before
accessing data collected by other regulators.\1102\ The Commission
recognizes that unprocessed data may contain errors that would later be
fixed.\1103\ The Commission preliminarily believes the benefits of the
greater timeliness of the unprocessed data may justify the lack of
validations and corrections in such unprocessed data.\1104\
---------------------------------------------------------------------------
\1102\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
\1103\ See Section III.B.10, supra.
\1104\ See Section IV.E.2.c, supra, for an example of benefits
from regulators accessing uncorrected data on T+1.
---------------------------------------------------------------------------
b. Effects of Certain Costs of the Plan on Efficiency
The Plan discusses several sources of inefficiency due to costs of
the Plan that are difficult to quantify, and are transient in nature.
First, the Plan anticipates that implementation would introduce new
costs related to data mapping and data dictionary creation.\1105\
Second, the Plan discusses needs for expenditures, such as staff time
for compliance with encryption requirements associated with the
transmission of PII.\1106\ While the Commission recognizes that these
are additional activities and costs that the Plan would require, it
views these as additional costs rather than inefficiencies and, though
the Commission cannot quantify the magnitude, these costs are likely to
have relatively minor contributions to overall costs of the Plan
because they impose technical requirements on systems that industry
will need to significantly alter to comply with other provisions in the
Plan.\1107\ Furthermore, the Commission notes that the costs of data
mapping and encryption requirements are likely to be included in costs
covered by surveys conducted by the Participants while preparing the
Plan because these requirements were known publicly at the time the
surveys were conducted, and are anticipated to be small relative to
other costs entailed in potentially complying with the Plan if it is
approved.\1108\
---------------------------------------------------------------------------
\1105\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
\1106\ See id.
\1107\ See Section IV.G.2.a, supra.
\1108\ See Section IV.F.1, supra.
---------------------------------------------------------------------------
The Plan notes that there could be a market inefficiency effect
related to the funding proposal for the Plan. For example, the cost
allocation methodology for the Plan could create disincentives for the
provision of liquidity, which could impair market quality and increase
the costs to investors to transact.\1109\ The Plan notes that the
funding principles set forth in the Plan \1110\ seek to mitigate the
risk of reduction in market quality resulting from allocation of costs
from building and operating the Central Repository.\1111\ The
Commission preliminarily recognizes that negative effects on efficiency
could result from the CAT Funding Model.\1112\ First, data reporters
could respond to the Funding Model by taking actions to limit their fee
payments, such as exiting the market or reducing their activity levels.
Second, the funding policy of the CAT NMS Plan of aligning fees closely
with the amounts that are required to cover costs could create
incentives for the Plan Processor or Operating Committee to propose a
cost schedule for the CAT that matches a given fee schedule, but is not
the most efficient cost schedule for meeting the CAT regulatory
objectives.\1113\
---------------------------------------------------------------------------
\1109\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
\1110\ See id. at Section 11.2, Appendix C, Section
B.7(b)(iv)(C).
\1111\ See id. at Appendix C, Section B.7.(b)(iv)(C).
\1112\ See id. at Appendix C, Section B.7(b)(v)(B).
\1113\ Economics research that dates back to Averch, Harvey, and
Johnson, Leland L. (1962) (``Behavior of the Firm Under Regulatory
Constraint,'' American Economic Review 52 (5): 1052-1069)
characterizes an incentive of regulated utilities to inflate their
costs in order to establish larger rate bases and justify higher
rates. An opposite effect would arise if the regulated utility were
unable to justify sufficient fee revenue to pay the fixed cost of
expanding the base.
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3. Capital Formation
a. Enhanced Investor Protection
The Commission has examined the potential effects on capital
formation discussed in the Plan in addition to other potential effects
on capital formation that the Commission believes could result if the
Plan is approved. The Commission preliminarily believes that the Plan
would have a modest positive effect on capital formation.
The Plan's analysis regarding capital formation concludes that the
Plan would generally not have a deleterious effect on capital formation
and could bolster capital formation that could lead to increased
investor participation in capital markets.\1114\ The Plan's analysis
provides several reasons why the Plan would not adversely affect
capital formation. Specifically, it asserts that the Plan would not
place any undue burden on primary issuances; would not pass along CAT
related costs to ``investors in a way that would limit their access to
or participation in capital markets''; and would not discourage market
participation as a result of data security concerns given the data
security safeguards outlined in the Plan.\1115\ The Commission
preliminarily agrees with the rationale of the Plan's analysis, but
addresses some additional considerations regarding the scope of the
Plan's effects on capital formation, as well as the channels through
which these effects could accrue.
---------------------------------------------------------------------------
\1114\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.8(c).
\1115\ See id.
---------------------------------------------------------------------------
The Plan's analysis states that the Plan may improve capital
formation by improving investor confidence in the market due to
improvements in surveillance. As discussed previously,\1116\ the
Commission believes that the Plan would provide substantial
enhancements to investor protection through improvements to
surveillance, particularly for cross-market trading.\1117\
[[Page 30749]]
As discussed throughout, improved surveillance, as well as other
regulatory activities, could decrease the rate of violative activity in
the market, reducing investor losses due to violative activity, to the
extent that such behavior is not already deterred by current
systems.\1118\ If improved surveillance leads to expectations of fewer
losses due to violative activity, this may increase capital formation
by facilitating a market where investors could be more likely to
mobilize capital into securities markets.\1119\
---------------------------------------------------------------------------
\1116\ See Section IV.E.2.c, supra and CAT NMS Plan, supra note
3, at Appendix C, Section B.7(b)(ii)(B)(1) and (2), B.7(b)(iii)(C).
\1117\ FINRA currently provides cross-market surveillance, but
limitations in the data (e.g. reliable cross-market linkages,
customer identification, parent order identification) limit the
scope and reliability of this surveillance.
\1118\ For example, as discussed in Section IV.E.2.c, the Plan
would allow regulators to more efficiently conduct cross-market and
cross-product surveillance relative to surveillance using current
data sources, and the requirement that data be consolidated in a
single database would assist regulators in detecting activity that
does not appear clearly violative until data is linked and evaluated
from multiple venues. To the extent that market participants are
aware of the current challenges to regulators in performing cross-
market surveillance and aggregating data across venues, and to the
extent that they believe that their violative behavior is more
likely to be detected if regulators' ability to perform those
activities improves, they may reduce or eliminate violative behavior
if the CAT Plan is approved.
\1119\ There is evidence in the academic finance literature that
countries with weaker investor protections, considering both the
character of rules as well as the quality of enforcement, have
smaller and narrower capital markets in terms of investor
participation. See La Porta, R. et al, ``Legal Determinants of
External Finance,'' Journal of Finance, Vol. 52 No. 3 (1997).
---------------------------------------------------------------------------
The Commission preliminarily believes there could be additional
increases in capital formation in the form of improvements in
allocative efficiency of existing capital within the industry. If
investors perceive an environment of improved surveillance, they could
be willing to allocate additional capital to liquidity provision or
other activities that increase market efficiency. Furthermore, an
environment of improved surveillance efficiency could result in the
reduction of capital allocated to violative activities that impose
costs on other market participants, because these market participants
may no longer find it possible to engage in such behavior that exposes
them to regulatory action. In this scenario, this reallocation of
capital could improve market quality and efficiency even if net capital
formation changes little. In addition to the potential reallocation of
capital currently mobilized toward violative activities, investor
capital that may currently be diverted because of the risk of loss to
violative activities could also be reallocated should the violative
activities decrease. If the CAT NMS Plan reduces manipulative quoting
activities, either through improved detection/enforcement or through
deterrence of such activities, then investors are less likely to make
capital allocation decisions in response to manipulative quoting
activities. In this scenario, because manipulative quoting activities
have been reduced, the contribution of manipulation to prices has been
reduced and prices should therefore better reflect fundamentals. It
would follow that, to the extent that displayed prices better reflect
fundamentals rather than manipulation, investors could allocate capital
more efficiently for their purposes. The Commission notes, however,
that market participants engaging in allowable activity that might risk
additional regulatory scrutiny under the Plan regime could allocate
capital to other activities to avoid this scrutiny, because even when
activity is not violative, interacting with regulators can be costly
for market participants.\1120\ This reallocation away from allowable
activity to avoid regulatory interactions could result in capital
allocations that are less efficient.\1121\
---------------------------------------------------------------------------
\1120\ See Section IV.F.4.b, supra, for a discussion of the
potential for the efficiencies in surveillance, examinations, and
investigations to increase the number of regulatory activities,
including the number of regulatory activities on conduct that turns
out not to violate regulations.
\1121\ The Commission is unable to estimate the magnitude of
allowable economic activity that does not occur when market
participants anticipate relatively high costs of demonstrating
regulatory compliance in the course of normal regulatory
interactions such as exams and inquiries because this activity is
not observable. However, Section IV.F.1.c(2) discusses how some
broker-dealers avoid self-reporting regulatory data because of
expectations of higher costs to demonstrate compliance, providing an
example of an allowable activity that is perceived as costly due to
the risk of compliance costs. See Section IV.F.1.c(2), supra.
---------------------------------------------------------------------------
The Plan states that the costs from CAT are unlikely to deter
investor participation in the capital markets.\1122\ The Commission
notes, however, that the final costs of the Plan and the funding
mechanism for CAT are not wholly certain at this time; thus, it is the
Commission's view that there is uncertainty concerning the extent to
which investors would bear Plan costs and consequently to what extent
Plan costs could affect investors' allocation of capital. As mentioned
above in the Costs Section,\1123\ the Commission preliminarily does not
know whether Plan costs incurred by the industry are likely to be
passed on to investors. Competition in the market for broker-dealer
services could mitigate some of these costs, but it may not minimize
costs passed on to retail investors. Despite these potential costs to
investors, investors could believe that the additional benefits they
receive from the potential of a market that is more effectively
regulated justify any additional costs they pay to access capital
markets.
---------------------------------------------------------------------------
\1122\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(c).
\1123\ See Section IV.F.2, supra.
---------------------------------------------------------------------------
b. Data Security
The Commission preliminarily agrees with the Plan's assessment that
data security concerns are unlikely to materially affect capital
formation. In its discussion of capital formation, the Plan recognizes
that data security concerns could potentially impact capital formation
through market participants' perception that sensitive proprietary data
might be vulnerable in case of a data breach at the Central Repository.
The Plan's analysis discusses the security measures that are required
by Rule 613 and the manner in which they have been implemented in the
Plan. It concludes that these security measures are sufficient and that
it is unlikely market participants would reduce their participation in
markets in a manner that would affect capital formation.
As noted above, the Commission agrees that concerns regarding data
security are unlikely to substantially affect capital formation, but
that some uncertainty about the risks exist because of the variations
in the potential security solutions and their resulting
effectiveness.\1124\ The Commission notes that the consequences of a
data breach, nonetheless, could be quite severe. It is inherently
difficult to form reliable economic expectations given that security
breaches of the form that could occur under the CAT NMS Plan occur
infrequently. Therefore, as described in Section IV.F above, even if a
CAT Data security breach is unlikely with the safeguards required by
the Plan, the scope of the potential consequences of such a breach in
the event that one should occur is important to evaluating the risk to
capital formation.\1125\
---------------------------------------------------------------------------
\1124\ See Section IV.F.4.a, supra.
\1125\ See id. for a more thorough discussion of the costs and
risks of security breaches of the Central Repository.
---------------------------------------------------------------------------
A data breach could also substantially harm market participants by
exposing proprietary information, such as a proprietary trading
strategy or the existence of a significant business relationship with
either a counterparty or client. The Commission notes, however, that
broker-dealers already bear such risks in transmitting regulatory data
to SROs. The Commission preliminarily believes that the marginal
increase in the risks to broker-dealers associated with a data breach
would be unlikely to deter
[[Page 30750]]
broker-dealers from participating in markets.
A data breach could potentially reveal PII of investors. To address
the potential for harm to the investing public and the health of
capital markets through such a breach, the Plan has enhanced
requirements for security around PII. Those requirements include a
separate PII-specific workflow, PII-specific authentication and access
control, separate storage of PII data, and a full audit trail of PII
access.\1126\ The Commission preliminarily believes that these risks
will not materially affect investors' willingness to participate in
markets because they already face these risks with PII shared with
broker-dealers, though not in one centralized location.\1127\ However,
the risk and costs of a security breach would be only one factor that
market participants would consider in deciding whether to participate
in the market. Another consideration would be investor protection,
which the Commission preliminarily believes would increase under the
CAT NMS Plan.\1128\
---------------------------------------------------------------------------
\1126\ See CAT NMS Plan, supra note 3, at Appendix D, Sections
4.1.1-4.1.6. The Commission notes that there is considerable
diversity in the approaches proposed by the Bidders. Further, the
Participants chose to give the Plan Processor flexibility on many
implementation details and the Plan states the requirements as a set
of minimum standards. Consequently, the final PII security solution
cannot be evaluated--only the minimum standards specified in the
Plan.
\1127\ See Section IV.F.2, supra.
\1128\ See Section IV.E.2, supra.
---------------------------------------------------------------------------
4. Related Considerations Affecting Competition, Efficiency and Capital
Formation
The Commission recognizes that the Plan's likely effects on
competition, efficiency and capital formation are dependent to some
extent on the performance and decisions of the Plan Processor and the
Operating Committee in implementing the Plan, and thus there is
necessarily some uncertainty in the Commission's analysis. Nonetheless,
the Commission believes that the Plan contains certain governance
provisions, as well as provisions relating to the selection and removal
of the Plan Processor, that mitigate this uncertainty by promoting
decision-making that could, on balance, have positive effects on
competition, efficiency, and capital formation.
a. The Efficiency of Plan Decision-Making
As noted in several places above,\1129\ future decisions of the
Operating Committee could significantly alter the economic effects of
the Plan. As a result, this economic analysis also considered whether
the process by which the Operating Committee would make such decisions
promotes efficiency. According to the Plan, the inability of the
Operating Committee to act in a timely manner could create consequences
for efficiency, competition, and capital formation.\1130\ On the other
hand, the Commission notes that consequences also could arise if the
Operating Committee makes decisions so quickly that it does not
consider all relevant information. This Section analyzes whether the
decision-making processes in the Plan promote timely decisions that
consider all relevant information of value. While the Plan considers
the potential for inefficiencies in the decision-making process, the
Commission preliminarily believes that certain governance provisions in
the Plan could create some inefficiencies in the decision-making
process, but that these inefficiencies are limited or exist to promote
better decision-making. The Plan discusses two areas where the proposed
governance structure impacts the efficiency of the decision-making
process: (1) Voting protocols and (2) the role of industry
advisers.\1131\ The Commission also considered the efficiency
implications of the level of detail included in the Plan and the
scalability of the Plan.
---------------------------------------------------------------------------
\1129\ See, e.g., Section IV.C.2, supra.
\1130\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(d).
\1131\ See id.
---------------------------------------------------------------------------
The Plan specified three types of voting protocols and determines
when each protocol applies.\1132\ The Plan requires unanimous voting in
only three circumstances: A decision to obligate Participants to make a
loan or capital contribution, a decision to dissolve the Company, and a
decision to take an action by written consent instead of a
meeting.\1133\ Further, the Plan requires supermajority voting in
instances considered by the Participants to have a direct and
significant impact on the functioning, management, and financing of the
CAT System,\1134\ such as selection and removal of the Plan Processor
and key officers, approving the initial Technical Specifications,
approving Material Amendments to the Technical Specifications proposed
by the Plan Processor, and approving direct amendments to the Technical
Specifications proposed by the Operating Committee.\1135\ The Plan
considers other matters as routine matters that arise in the ordinary
course of business and would be subject to majority voting. As a
practical matter, Majority Vote is the default standard for decisions
other than those requiring supermajority or unanimous voting.
---------------------------------------------------------------------------
\1132\ See Section III.A.3.a(3), supra, for a discussion of the
management of the Company, including the definitions of the voting
protocols and details on their application.
\1133\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.11(b), Voting Criteria of the Operating Committee.
\1134\ See id. at Appendix C, Section D.11(b).
\1135\ See id. at Appendix C, Section D.11(b). The Plan also
requires supermajority voting on matters outside the ordinary course
of business, such as modifications to a Material Contract, incurring
debt, making distributions or tax elections, or changing the fee
schedules.
---------------------------------------------------------------------------
The Plan balanced the efficiency of the decision-making process
against the value of considering minority and dissenting opinions in
proposing these voting protocols.\1136\ In particular, the Plan
recognizes that some voting protocols might impede the effective
administration of the CAT System.\1137\ From a mechanical perspective,
voting protocols determine a threshold for a passing vote. Unanimity
requires a threshold of 100% yes votes while majority voting requires a
threshold of more than 50% yes votes and Supermajority requires two-
thirds or more. The Plan explains that too-high a threshold for
decision-making, such as may be the case in applying unanimity to all
voting matters, could limit the ability of the Operating Committee to
adopt broadly agreed upon provisions.\1138\ For example, in the
extreme, requiring unanimity in voting could result in one dissenting
opinion holding up the entire decision-making process. Conversely, the
Plan explains that a threshold that is set too low might limit the
opportunities for the consideration of dissenting or minority opinions
and alternative approaches.\1139\ For example, if voting thresholds
were too low, a set of Participants could potentially adopt provisions
that might provide them a competitive advantage over other
Participants.
---------------------------------------------------------------------------
\1136\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(d).
\1137\ See id.
\1138\ See id.
\1139\ See id.
---------------------------------------------------------------------------
The Commission preliminarily agrees with the discussion on the need
to balance efficiency in the voting protocols in the Plan. The
Commission notes that the speed and ability to make a decision are key
components of whether the Plan promotes efficiency in its operations.
High-vote thresholds may result in an increase in the effort needed to
obtain enough votes to make a decision. Further, in addition to the
drawn out discussions necessary to obtain a unanimous vote, a unanimous
[[Page 30751]]
vote might also require compromises that reduce the efficiency of the
decision-making process. This could be particularly costly in
situations in which the Operating Committee must make a decision by a
particular date. It could also result in inaction for decisions related
to making discretionary changes that could improve data qualities, such
as updates, if the Participants disagree among the various
alternatives.
Furthermore, while the decision-making processes with a very low
voting threshold would be faster, the resulting decisions might not
consider all relevant information.\1140\ As a result, the Commission
preliminarily agrees that the inefficiencies in the voting protocols in
the Plan are limited enough to strike a balance between the
inefficiencies of the decision-making process and the quality of the
decisions.
---------------------------------------------------------------------------
\1140\ See Section IV.E.3.d, supra, for a discussion of how
certain governance provisions could help promote better decision-
making by the relevant parties.
---------------------------------------------------------------------------
The Plan also discusses the role of industry representation as part
of the governance structure.\1141\ Section 4.13 of the Plan requires an
Advisory Committee that contains twelve members, including
representatives from 7 types of broker-dealers, 2 institutional
investors, and 3 individuals.\1142\ In addition, the Plan says that the
Advisory Committee is ``intended to support the Operating Committee and
to promote continuing efficiency in meeting the objective of the CAT.''
\1143\ The Plan also indicates that it is important to include industry
representation to assure that all affected parties have representation.
---------------------------------------------------------------------------
\1141\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(d).
\1142\ See id. at Section 4.13 (Advisory Committee).
\1143\ See id. at Appendix C, Section B.8(d).
---------------------------------------------------------------------------
The Commission preliminarily agrees with the discussion in the Plan
that including industry representation might result in a more
efficiently designed CAT, but adds that an Advisory Committee also adds
operational inefficiencies. As discussed above, the Commission
preliminarily believes that an Advisory Committee could add more
diverse viewpoints to the debates surrounding Operating Committee
decisions and thus reduce the risk that members of the Operating
Committee could make decisions without first obtaining a full
understanding of the underlying facts or the likely impact of its
decisions.\1144\ The Commission also recognizes, however, that
including an Advisory Committee in the decision-making process might
add complexity to the process and decisions might require more time
relative to allowing the Operating Committee to make decisions without
the input of an Advisory Committee. The inclusion of an Advisory
Committee could thereby potentially adversely affect the efficiency of
the Plan's operation. In general, the Commission preliminarily believes
that as long as the Advisory Committee adds sufficiently useful
information, the benefits from the Advisory Committee would justify any
operational inefficiencies from the inclusion of the Advisory
Committee.
---------------------------------------------------------------------------
\1144\ See Section IV.E.3.d(2)B, supra.
---------------------------------------------------------------------------
The Commission considered an additional source of potential
efficiencies in the decision-making process. The Plan specifies minimum
standards for particular provisions or solutions in Appendix D of the
Plan instead of specifying the solutions themselves in the Plan.\1145\
While this creates uncertainty in the costs and benefits of the Plan
and reduces the transparency for the bidders, the Commission recognizes
that decisions to not specify certain solutions in the Plan could
promote efficiency in the decision-making process of the Operating
Committee. The Operating Committee and/or Selection Committee would
effectively decide upon the unspecified details when selecting the Plan
Processor and when approving the Technical Specifications.\1146\ As
such, certain technical details may not appear in the Plan and may not
be subject to Commission approval or, potentially, to public comment.
Instead, the Operating Committee could implement such decisions much
more quickly and at a potentially lower cost. The Commission believes
that the Commission and public review process could add value to the
decision-making process, particularly in assuring that the decisions
consider costs and benefits. However, a notice and comment process for
certain technical changes could be cumbersome and time-consuming, and
may not therefore be justified in the context of certain technical
issues. The Plan therefore may be more agile and efficient in its
ability to upgrade and improve systems quickly. On the other hand, the
cost of this efficiency comes in the form of the significant
uncertainties surrounding the economic effects of the Plan during the
approval process.
---------------------------------------------------------------------------
\1145\ For example, the Plan provides minimum standards for
regulator access to CAT Data but does not propose any particular
method for regulatory access. Nor does the Plan specify whether the
regulators would have work space on servers at the Central
Repository or whether regulators would have to download the results
of every query before being able to process such results.
\1146\ For example, the Selection Committee would decide on the
details of regulator access in conjunction with selecting the Plan
Processor or in subsequent negotiations with the selected Plan
Processor.
---------------------------------------------------------------------------
Provisions of the Plan should also promote efficiently implementing
expansions to the CAT Data. Appendix C of the Plan notes that the Plan
Processor must ensure that the Central Repository's technical
infrastructure is scalable and adaptable.\1147\ These provisions should
reduce the costs and time needed for expansions to the Central
Repository.
---------------------------------------------------------------------------
\1147\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.5(a).
---------------------------------------------------------------------------
b. Selection and Removal of the Plan Processor
The CAT NMS Plan uses a request for proposal (``RFP'') to select
the Plan Processor that would design, build, and operate the Central
Repository. The winning bidder becomes the sole supplier of the
operation of the Central Repository. The Commission preliminarily
believes this is necessary to achieve the benefits of a single
consolidated source of regulatory data.
The competitiveness of the selection process influences the
ultimate economic effect of the Plan because those effects depend in
large part on the efficiency and effectiveness of the Plan Processor.
In particular, many of the details of the Plan would be determined
either by the winning bid or in negotiations with the Plan Processor
after selection. The Plan Processor exercises control over the future
costs of operating and maintaining the Central Repository in this
context and the Plan Processor chooses its performance level, subject
to the minimum standards in the Plan and with oversight from the
Operating Committee.
Given the effects associated with the selection process for the
Plan Processor, the Commission considered whether the Plan promotes a
competitive process and whether the Plan contains provisions that would
create incentives for the chosen Plan Processor to set costs and
performance competitively. As explained below, the Commission
preliminarily believes that the selection process generally promotes
competition but that there are also a few potential limitations on
competition. Moreover, the Commission recognizes that a competitive
bidding process does not necessarily mean that the selected bidder
would behave competitively after being selected as the Plan
Processor.\1148\
[[Page 30752]]
But the Commission preliminarily believes that the Plan could control
the costs of the Central Repository and the performance of the Plan
Processor if the Plan included sufficient competitive incentives for
the selected Plan Processor. While the Commission preliminarily
believes that threat of replacement of the Plan Processor could
incentivize them to set costs and performance competitively, the high
cost of replacement could limit these incentives.\1149\
---------------------------------------------------------------------------
\1148\ See Goldfine and Vorrasi, ``The Fall of the Kodak
Aftermarket Doctrine: Dying A Slow Death in the Lower Courts,'' 74
Antitrust Law Journal No. 1 (2004), p. 209 (stating that
``competition in the primary market, as a matter of law, does not
necessarily preclude the possibility of market power (and
anticompetitive conduct) in the aftermarkets for parts and
services,'' and citing Eastman Kodak Co. v. Image Technical
Services, Inc., 504 U.S. 451 (1992)). Economic theories of the
relation between primary markets and aftermarket are the focus of
other literature as well; see infra note 1149. (In the context of
the Plan, the ``primary market'' would be the initial selection of
the Plan Processor while in the ``aftermarket,'' the selected Plan
Processor would supply a performance level for the given revenues
received from the Company.)
\1149\ Under the theory of contestable markets, it is possible
for the sole supplier of a service to behave as if there multiple
suppliers, and thus not exercise monopoly power. Necessary
conditions include the absence of entry and exit costs. William J.
Baumol, John C. Panzar, Robert D. Willig (1982), Contestable Markets
and the Theory of Industry Structure. When the conditions needed to
support contestable markets are not met, the presence of alternative
suppliers may not be sufficient to prevent the costly exercise of
monopoly power, post-selection. For example, if the supplier cannot
make complete and binding commitments to the price and quality of
its post-selection services, and the buyer becomes locked into the
sole supplier (e.g., due to switching costs or other sources of
friction), a competitive selection process may lead to monopoly
outcomes, post-selection; see, e.g., Carl Shapiro, 1995,
``Aftermarkets and Consumer Welfare: Making Sense of Kodak,''
Antitrust Law Journal, and Borenstein, Severin, Jeffrey K. Mackie-
Mason, and Janet S. Netz, 1995, Antitrust Policy in Aftermarkets,
Antitrust Law Journal 63: 455-82. For a recent survey of alternative
theories, see section 3.1, Dennis W. Carlton and Michael Waldman,
2014. ``Robert Bork's Contributions to Antitrust Perspectives on
Tying Behavior,'' Journal of Law & Economics.
---------------------------------------------------------------------------
(1) Competitiveness of the Plan Processor Selection Process
The Commission believes that two elements determine the
competitiveness of the bidding process. The first relates to the voting
process and the second relates to the degree of transparency in the
bidding process. The Commission preliminarily believes that the Plan
provisions relevant to these two factors could promote competition in
the bidding process and limit the risk that selection of the Plan
Processor would be affected by a conflict of interest, thereby
promoting better decision-making.
The CAT NMS Plan outlines a bidding process whereby a Selection
Committee votes on bidders during several rounds of voting that each
narrow the potential bidders until one bidder is selected.\1150\
Pursuant to the Plan, the bidders compete to be selected by proposing
solutions to comply with Rule 613 and documenting the anticipated costs
of doing so. The Plan also contains provisions for revising Bids if the
Commission approves the Plan.\1151\
---------------------------------------------------------------------------
\1150\ See CAT NMS Plan, supra note 3, at Section 5.2 (Bid
Evaluation and Initial Plan Processor Selection).
\1151\ Id. at Section 5.2(e).
---------------------------------------------------------------------------
The Participants received 31 Intent to Bid forms during the RFP
process; 13 of the potential bidders withdrew before January 30, 2014;
the Participants reported receiving 10 Bids by April 2, 2014.\1152\ Six
of these Bidders were shortlisted through the selection process in July
2014, including one SRO that is also a Bidder. In November 2015, the
shortlist was further narrowed to three Bidders.\1153\
---------------------------------------------------------------------------
\1152\ For details on the progression of the CAT RFP process,
see RFP Process, SEC Rule 613: Consolidated Audit Trail (CAT),
available at http://catnmsplan.com/process/ (last visited November
19, 2015).
\1153\ See supra note 35.
---------------------------------------------------------------------------
In considering how competitive the voting process is, the
Commission has considered whether conflicts of interest could limit
competition in the bidding process through the proposed participation
of a bidder representative on the Selection Committee. The Plan
includes provisions that mitigate this conflict but that have not
eliminated it completely. In particular, the Plan requires recusal of
an SRO from any selection round if that SRO or its affiliate has
submitted a bid--or is included as a material subcontractor as part of
a bid--that is still under consideration in such round.\1154\
Similarly, the Plan creates information barriers between the Staff at
the SRO selecting the bidder and the Staff undertaking the
bidding.\1155\ These provisions promote a level playing field for all
bidders because the SRO bidder does not know any more than a non-SRO
bidder and so has no informational advantage in submitting a bid that
the Selection Committee may find favorable. Further, the information
barriers prevent those working on the bid from attempting to persuade
members of the Selection Committee toward their bid in a way that other
bidders cannot. The Commission recognizes, however, that there is a
residual risk in having an SRO among the bidders; it is possible that
voting Participants would be biased for or against that SRO either
because they compete with that SRO in another market (and could gain a
competitive advantage in that market by acting as Plan Processor) or
because of repeated interactions with that SRO.
---------------------------------------------------------------------------
\1154\ See CAT NMS Plan, supra note 3, at Section 4.3(d), at
Section 5.1(b).
\1155\ See id. at Section 5.1(d).
---------------------------------------------------------------------------
The Commission also recognizes that, to the extent the Operating
Committee has specific preferred solutions as to how the Plan should be
implemented, the degree to which the Committee is transparent about
those preferences in the bidding process would affect the
competitiveness of that process. For example, if the Commission were to
approve the Plan and bidders were thereafter given the opportunity to
revise their bids, the Operating Committee could promote
competitiveness in the bidding process by outlining its preferences.
Transparency into the Operating Committee's views regarding potential
optimal solutions could assist a bidder in revising its bid to inform
how that bidder could supply those optimal solutions, and the Selection
Committee could then compare all bidders on those particular solutions.
To the extent that the Operating Committee has strong preferences
toward particular solutions but did not specify those preferences
directly in the Plan, the bidder may not know that it could improve its
chances of winning the bid by proposing a different solution and the
Selection Committee would not know whether the bidder is capable of
delivering the preferred solution more efficiently than the other
bidders. On the other hand, the Commission notes that specifying a
preferred solution also has the potential to discourage bidders from
competing on innovation by proposing novel approaches that may deliver
superior outcomes.
The Commission has no reason to believe that the Operating
Committee has preferred solutions beyond what is in the Plan that would
significantly impact the competitiveness of the Plan Processor
selection process. Indeed, Appendix D of the Plan details numerous
minimum standards not included in the RFP. In addition, the Plan also
provides details on the range of solutions proposed by bidders and why
the Operating Committee may not have a preference and therefore did not
select a particular solution. This provides transparency to the bidders
on the criteria the Selection Committee may use to compare bidders.
(2) Competitive Incentives of the Selected Plan Processor
The Plan could create competitive incentives for the selected Plan
Processor by detailing strong requirements for the Plan Processor and
providing an efficient mechanism to
[[Page 30753]]
remove the selected Plan Processor and introducing an alternative Plan
Processor in the event of underperformance. As described below, the
Commission preliminarily believes that the Plan provides the selected
Plan Processor with competitive incentives because the Plan contains
defined procedures for monitoring and removing the Plan Processor for
failure to perform functions adequately or otherwise. However, the ease
with which the Operating Committee could remove the Plan Processor and
the costs of switching to another Plan Processor could limit these
competitive incentives.
The Plan contains several provisions that would allow the Operating
Committee to remove the Plan Processor.\1156\ By Supermajority Vote,
the Operating Committee could remove the Plan Processor for any reason.
The Operating Committee may, by Majority Vote, remove the Plan
Processor if it determines that the Plan Processor has failed to
perform its functions ``in a reasonably acceptable manner'' or if the
Plan Processor's expenses ``have become excessive or are not
justified.'' The consideration of such poor performance or excessive
expenses would include (1) responsiveness to requests for technological
changes or enhancements, (2) results of assessments performed pursuant
to Section 6.6 of the Plan, (3) staying up-to-date on reliability and
security of operations, (4) compliance with the requirements of
Appendix D, and (5) other factors the Operating Committee may determine
to be appropriate.
---------------------------------------------------------------------------
\1156\ See CAT NMS Plan, supra note 3, at Section 6.1(q), (r),
(s).
---------------------------------------------------------------------------
The Commission preliminarily believes that the ability of the
Operating Committee to remove the Plan Processor for poor performance
with only a Majority Vote incentivizes the Plan Processor to perform
well enough to avoid being removed. The Commission further
preliminarily believes that the performance of the Plan Processor would
depend significantly on strong oversight by the Operating
Committee.\1157\
---------------------------------------------------------------------------
\1157\ See Section IV.E.3.d, supra, for a discussion of the
incentives of the Operating Committee in overseeing the Plan
Processor.
---------------------------------------------------------------------------
The Commission recognizes that the effort required to remove a Plan
Processor could be significant, which would limit the incentives of the
Plan Processor to perform well. To subject a removal to a Majority
Vote, the Operating Committee would presumably need to demonstrate the
Plan Processor's performance and determine that it was not ``reasonably
acceptable.'' If not, the removal would be subject to Supermajority
Vote, which could also take significant effort and a removal would be
less likely to pass.
In addition, significant switching costs could influence whether
removing a Plan Processor despite poor performance makes economic
sense. In other words, the Operating Committee could wait for
significant performance issues before initiating a vote to remove the
Plan Processor. Additionally, before removing a Plan Processor, the
Operating Committee would need to select a new Plan Processor. This
would likely be a lengthy process taking significant time and effort by
the Operating Committee. Moreover, switching Plan Processors could
entail a complete rebuild of the Central Repository and significant
implementation costs for CAT Reporters and Participants, potentially
amounting to the initial implementation costs of the Plan. These costs
would be higher if the Plan Processor's solutions include proprietary
technologies that no other potential replacement (competitor) could
supply. The costs would be lower if the new Plan Processor could
implement the existing Technical Specifications. The benefits of
switching could also depend on the benefits from technological
advancements that these competitors could supply. In light of these
costs, the competitive incentives of the Plan Processor to maintain top
performance could be limited. Specifically, the Plan Processor may only
need to perform well enough to keep the inefficiencies associated with
their performance from exceeding the cost to switch to another Plan
Processor. Despite the limitations on competitive incentives due to
switching costs, however, the Commission preliminarily believes that
the threat of replacement still provides an incentive to stay
relatively current on technology advancements to avoid falling
significantly behind potential competitors.
5. Request for Comment on Efficiency, Competition, and Capital
Formation
The Commission requests comment on all aspects of the discussion of
the effects of the CAT NMS Plan on efficiency, competition, and capital
formation. In particular, the Commission seeks responses to the
following questions:
347. The Participants state in the Plan that they believe the Plan
would avoid disincentives such as placing an inappropriate burden on
competition in the U.S. securities markets. In its analysis, the
Commission concludes that competition is unlikely to be harmed to a
degree that would affect investors. Do Commenters agree with the
conclusions discussed in the Plan? Why or why not? Do Commenters agree
with the Commission's conclusion regarding the Plan's impact on
competition? Why or why not?
348. Do Commenters agree with the Commission's characterization of
the relevant markets that the CAT NMS Plan affect? Why or why not? Do
Commenters agree with the identified level of competition in each of
the relevant markets in the Commission's analysis? Why or why not?
349. Do Commenters agree with the Commission's discussion of the
Baseline for the market for trading services? Why or why not?
350. Do Commenters agree with the Commission's analysis of
competition in the market for trading services under the Plan? Why or
why not?
351. Do Commenters agree with the Commission's analysis of effects
of the Plan's funding model on competition? Why or why not? Would the
funding model as outlined in the Plan affect competition in the market
for trading services between exchanges and ATSs? If so, how? Do
Commenters agree with the Commission's analysis of the effects on
competition of the Plan's allocation of CAT fees across market
participants? Why or why not? Would the Participation Fee outlined in
the Plan serve as a barrier to entry for ATSs that might otherwise
register as exchanges? Why or why not?
352. Do Commenters believe that the allocation of voting rights
among the Participants may serve to affect competition between
Participants that operate options exchanges and those that do not? Why?
Do governance provisions outlined in the Plan provide controls that
could prevent burdens on competition due to the allocation of voting
rights among Participants? If not, are there controls that could
achieve this?
353. Do Commenters believe that the allocation of voting rights
among the Participants may serve to affect competition between
exchanges and ATSs in the market for trading services? Why or why not?
354. Do Commenters agree with the Commission's analysis of the
effects on competition of costs of compliance with the Plan? Why or why
not?
355. Do Commenters agree with the Commission's analysis of the
effects on competition of the Plan's enhanced surveillance and
deterrence? Why or why not?
356. Do Commenters agree with the Commission's analysis of the
Baseline
[[Page 30754]]
for competition in the market for broker-dealer services? Why or why
not?
357. Do Commenters agree with the Commission's analysis of the
effects on competition in the market for broker-dealer services of the
Plan? Why or why not? Are these effects different for smaller broker-
dealers? How? How significant are these impacts?
358. Do Commenters agree with the Commission's analysis of the
competition to be Plan Processor? Why or why not?
359. Do Commenters believe that any elements of the CAT NMS Plan
may affect competition among the bidders? Do Commenters believe that
any decisions by the Operating Committee that are allowable or likely
under the proposed Plan may affect competition among the bidders in the
market to be Plan Processor? If so, how would these competitive
dynamics affect CAT as outlined in the Plan?
360. Do Commenters agree with the Commission's analysis of
competition in the market to be Plan Processor post-selection? Why or
why not?
361. Do Commenters agree with the Commission's analysis of the
Baseline for competition in the market for regulatory services? Why or
why not?
362. Do Commenters agree with the Commission's analysis of
competition in the market for regulatory services of the Plan? Why or
why not?
363. Do Commenters agree with the Commission's analysis of the
Baseline for competition in the market for data reporting services? Why
or why not? Do Commenters believe that capacity constraints in this
market may affect broker-dealers' ability to comply with data reporting
requirements under the Plan?
364. Do Commenters agree with the Commission's analysis of
competition in the market for data reporting services under the Plan?
Why or why not?
365. If some or all of the Participants decide to share the Raw
Data they collect pursuant to the CAT NMS Plan and use the combined
data for commercial purposes, how do Commenters believe that might
affect competition in the markets described above?
366. In the Plan, the Participants state that they believe the Plan
would have a net positive effect on efficiency. The Commission's
analysis states that the Commission preliminarily believes the Plan
would have a significant positive effect on efficiency. Do Commenters
agree with the conclusions stated in the Plan? Why or why not? Do
Commenters agree with the Commission's analysis? Why or why not?
367. Do Commenters agree that costs related to the Plan's
requirements for data mapping, data dictionary creation, and encryption
associated with the transmission of PII would not significantly affect
efficiency? Why or why not?
368. Do Commenters agree with the Commission's analysis of the
Plan's effects on the efficiency of market regulation and oversight?
Why or why not?
369. Do Commenters agree with the Commission's analysis of the
Plan's effects on market efficiency due to reductions in violative
behavior? Why or why not?
370. Do Commenters agree with the Commission's analysis of the
Plan's effect on efficiency related to reductions in ad hoc data
requests from regulators? Why or why not?
371. Do Commenters agree with the Commission's analysis of the
Plan's effect on efficiency due to reductions in duplicative reporting
systems? Why or why not?
372. Do Commenters believe that the period of duplicative reporting
that would precede the retirement of certain current, anticipated to be
retired, regulatory reporting systems would significantly affect
efficiency? Why or why not?
373. Do Commenters agree with the Commission's analysis of
inefficiencies related to the funding model? Why or why not?
374. Do Commenters agree with the Commission's analysis of the
likelihood of CAT fees being passed on to investors under the Plan? Why
or why not?
375. Do Commenters agree with the Commission's analysis of the
efficiency of Plan operations? Why or why not?
376. Do Commenters agree with the Commission's analysis of the
effects of voting thresholds for Operating Committee decisions on
efficiency? Why or why not?
377. Do Commenters agree with the Commission's analysis of the
Advisory Committee's effect on efficiency under the Plan? Why or why
not?
378. Do Commenters agree with the Commission's analysis of the
effects on efficiency of the Participants' decision to specify or not
specify certain aspects of CAT in the RFP? Why or why not?
379. Do Commenters believe that the CAT NMS Plan would impact
investor confidence? If so, how? Do investors currently lack confidence
because of the current state of regulatory data? Would the expected
improvements to investor protection result in increased investor
confidence? Please explain. What would be the expected effects of
changes in investor confidence on allocative efficiency and capital
formation? What would be the magnitude of the economic effects from
expected changes to investor confidence? Please provide analysis.
380. The Plan states that the Participants believe that the Plan
would have no deleterious effect on capital formation. Do Commenters
agree with the Participants' conclusions stated in the Plan? Do
Commenters agree with the Commission's preliminary belief that the Plan
would not have a deleterious effect on capital formation? Why or why
not?
381. Do Commenters agree with the Commission's analysis of the
Plan's effects on capital formation due to enhanced market surveillance
and regulatory activities? Why or why not?
382. Do Commenters agree with the Commission's analysis of effects
on capital formation due to data security provisions of the Plan? Why
or why not?
H. Alternatives
As a part of its economic analysis, the Commission is considering
and soliciting comment on alternatives to certain approaches or
elements of the CAT NMS Plan. The Commission analyzes alternatives that
could have a direct and significant impact on costs or benefits
deriving from at least one of the four data qualities discussed above:
accuracy, completeness, accessibility, and timeliness. While the
discussed alternatives are not the only alternatives that could
significantly impact costs, benefits, or data quality, they are an
attempt to identify reasonable options. Each has the potential to alter
the Commission's preliminary conclusions regarding the economic effects
of the CAT NMS Plan.
The analysis of alternatives is divided into three categories.
First, the Commission analyzes alternatives to the approaches the
Exemption Order permitted the Participants to include in the
Plan.\1158\ As noted in the Exemption Order, the Commission was
persuaded to grant exemptive relief to provide flexibility such that
the proposed approaches described in the Exemption Request can be
included in the CAT NMS Plan and subject to notice and comment.\1159\
Second, the Commission analyzes alternatives to certain specific
approaches in the CAT NMS Plan, including alternative approaches to
clock synchronization, time stamps, Error Rates, error correction
timelines, the funding model, listing exchange symbology, data
accessibility standards, and the intake capacity levels. Third,
[[Page 30755]]
the Commission analyzes alternatives to the scope of certain specific
elements of the Plan. Specifically, the Commission analyzes the impact
of changing the scope of the CAT to exclude certain data fields. The
Commission also analyzes alternatives to exclude OTC Equity Securities
and the requirement to periodically refresh all customer information.
Finally, the Commission solicits comment on the broad alternative of
modifying OATS and/or another existing system to meet the requirements
of Rule 613 instead of approving the Plan.
---------------------------------------------------------------------------
\1158\ See Exemption Order, supra note 18.
\1159\ Id.
---------------------------------------------------------------------------
1. Alternatives to the Approaches the Exemption Order Permitted To Be
Included in the Plan
The Commission is soliciting additional comment on alternatives to
the approaches the Exemption Order permitted the SROs to include in the
CAT NMS Plan.\1160\ Specifically, the Commission is soliciting comment
on how the following alternatives (the ``Rule 613 approach''),
described in further detail below, would affect the costs and benefits
of the CAT: (a) Requiring both Options Market Makers and Options
Exchanges to report Options Market Maker quotations to the Central
Repository, (b) requiring CAT Reporters to report a Customer-ID for
each Customer upon the original receipt or origination of an order, (c)
requiring CAT Reporters to report a universal CAT-Reporter-ID to the
Central Repository for orders and certain Reportable Events, (d)
requiring the reporting of the account number for any subaccount to
which an execution is allocated, and (e) requiring that Manual Order
Events be reported with a time stamp granularity of one millisecond.
---------------------------------------------------------------------------
\1160\ Id.
---------------------------------------------------------------------------
a. Options Market Maker Quotes
The Commission is soliciting comment on how an alternative
approach--the Rule 613 approach--to the reporting of Options Market
Maker quotations might impact the costs and benefits of the Plan. Rule
613(c)(7) provides that the CAT NMS Plan must 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 the routing and modification or cancellation of an
order.\1161\ Rule 613(j)(8) defines ``order'' to include ``any bid or
offer'' so that the details for each Options Market Maker quotation
must be reported to the Central Repository by both the Options Market
Maker and the exchange to which it routes its quote.\1162\ The SROs
requested an exemption from Rules 613(c)(7)(ii) and (iv) and proposed
an approach whereby only Options Exchanges--but not Options Market
Makers--would be required to report information to the Central
Repository regarding Options Market Maker quotations.\1163\ The
Commission granted exemptive relief to the SROs to allow the approach
to collecting Options Market Maker quotations described in the
Exemption Request to be included in the CAT NMS Plan and subject to
notice and comment.\1164\
---------------------------------------------------------------------------
\1161\ See 17 CFR 242.613(c)(7).
\1162\ See 17 CFR 242.613(j)(8).
\1163\ See Exemptive Request Letter, supra note 16, at 2-5.
\1164\ See Exemption Order, supra note 18.
---------------------------------------------------------------------------
Pursuant to the exemptive relief granted by the Commission, the CAT
NMS Plan provides that only Options Exchanges--but not Options Market
Makers--would be required to report information to the Central
Repository regarding Options Market Maker quotations.\1165\ On the
other hand, the Rule 613 approach would require that each Options
Market Maker quotation be reported to the Central Repository by both
the Options Market Maker and the exchange to which it routes its quote.
The Commission preliminarily believes that the Rule 613 approach would
increase certain costs associated with the implementation and operation
of CAT as compared to the Plan as filed without providing any
additional material information.
---------------------------------------------------------------------------
\1165\ See CAT NMS Plan, supra note 3, at Appendix C, Background
Section.
---------------------------------------------------------------------------
Under the Rule 613 approach, the reports from the Options Exchanges
would be virtually identical to the reports coming from the Options
Market Makers, with the exception that reports from the Options Market
Makers would indicate the time that the Options Market Maker routes its
quote, or any modification or cancellation thereof, to the exchange
(``Quote Sent Time''). However, to ensure that regulators would receive
all of the information contemplated by Rule 613(c)(7), the CAT NMS Plan
requires that (1) Options Market Makers report to the relevant Options
Exchange the Quote Sent Time along with any quotation, or any
modification or cancellation thereof; and (2) Options Exchanges submit
the quotation data received from Options Market Makers, including the
Quote Sent Time, to the Central Repository without change.\1166\ Under
the CAT NMS Plan, therefore, regulators would have access to all the
material information in CAT that would be provided under the Rule 613
approach. As such, the Commission preliminarily does not believe that
there would be any additional benefits to using the Rule 613 approach.
---------------------------------------------------------------------------
\1166\ Id. at Section 6.4(d)(iii).
---------------------------------------------------------------------------
Furthermore, the CAT NMS Plan estimates that the Rule 613 approach
would increase the amount of records that must be handled by the
Central Repository by 18 billion records per day, at an additional cost
of between $2 million and $16 million for data storage and technical
infrastructure over a five year period.\1167\ A cost survey estimates
the Rule 613 approach would cost all Options Market Makers between
$307.6 million and $382 million over five years.\1168\ Under the
approach taken in the CAT NMS Plan, these costs would be avoided but
the Options Market Makers surveyed would spend approximately $8.5
million to send Quote Sent Times to the exchanges and all Options
Market Makers would spend $36.9M to $76.8M.\1169\ In aggregate, the
estimates provided suggest that the Rule 613 approach would add between
$230.80 million and $345.10 million to industry costs over five
years.\1170\ The Exemption Request also notes that the additional costs
would be disproportionately borne by smaller broker-dealers relative to
their market share.\1171\
---------------------------------------------------------------------------
\1167\ Id. at Appendix C, Section B.7(b)(iv)(B).
\1168\ See FIF, SIFMA, and Security Traders Association, Cost
Survey Report on CAT Reporting of Options Quotes by Market Makers
(November 5, 2013), available at http://www.catnmsplan.com/industryfeedback/p601771.pdf; see also CAT NMS Plan, supra note 3,
at Appendix C, Section B.7(b)(iv)(B).
\1169\ See FIF, SIFMA, and Security Traders Association, Cost
Survey Report on CAT Reporting of Options Quotes by Market Makers 3-
4 (November 5, 2013), available at http://www.catnmsplan.com/industryfeedback/p601771.pdf.
\1170\ To be conservative, the Commission estimates the lower
end of the range to be the lower cost to comply with a CAT NMS Plan
without the exemption minus the higher cost to comply with a CAT NMS
Plan with the exemption ($230.8M = $307.6 - $76.8M). Likewise, the
higher end of the range is the higher cost to comply with a CAT NMS
Plan without the exemption minus the lower cost to comply with a CAT
NMS Plan with the exemption ($345.1M = $382M - $36.9M).
\1171\ See Exemptive Request Letter, supra note 16, at 7.
---------------------------------------------------------------------------
The Commission notes that there are limitations to the cost
estimation methodology presented in the Exemption Request. These
limitations include the lack of quantified cost estimates for
additional indirect cost savings associated with the exemption.
However, the Commission preliminarily believes that the Rule 613
approach would increase certain costs associated with the
implementation and operation of CAT as compared to the Plan as filed
[[Page 30756]]
without providing any additional material information.
b. Customer-ID
The Commission is soliciting comment on how an alternative
approach--the Rule 613 approach--to the reporting of customer
information might impact the costs and benefits of the Plan. Rule
613(c)(7)(i)(A) requires that for the original receipt or origination
of an order, a CAT Reporter report the ``Customer-ID(s) for each
Customer.'' \1172\ ``Customer-ID'' is defined in Rule 613(j)(5) 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.'' \1173\ Rule 613(c)(8) further requires that ``[a]ll plan
sponsors and their members shall use the same Customer-ID and CAT-
Reporter-ID for each customer and broker-dealer.'' \1174\ The SROs
requested an exemption from the requirements in Rule 613(c)(7)(i)(A)
and Rule 613(c)(8), and proposed an approach whereby each broker-dealer
would assign a unique Firm Designated ID to each trading account, which
would be linked to a set of identifying information (the ``Customer
Information Approach'').\1175\ Using the Firm Designated ID and the
other information identifying the Customer that would be reported to
the Central Repository, the Plan Processor would then assign a unique
Customer-ID to each Customer. Upon original receipt or origination of
an order, broker-dealers would only be required to report the Firm
Designated ID on each new order, rather than using the Customer-ID. The
Commission granted exemptive relief to the SROs to allow the
alternative approach to Customer-IDs described in the Exemption Request
to be included in the CAT NMS Plan and subject to notice and
comment.\1176\
---------------------------------------------------------------------------
\1172\ See 17 CFR 242.613(c)(7)(i)(A).
\1173\ See 17 CFR 242.613(j)(5).
\1174\ See 17 CFR 242.613(c)(8).
\1175\ See Exemptive Request Letter, supra note 16, at 9.
Because the Plan Processor would still assign a Customer-ID to each
Customer under the Customer Information Approach, the SROs did not
request an exemption from Rule 613(j)(5).
\1176\ See Exemption Order, supra note 18, at 11863.
---------------------------------------------------------------------------
Pursuant to the exemptive relief granted by the Commission, the CAT
NMS Plan provides for the use of the Customer Information
Approach.\1177\ The Commission is soliciting comment on the Rule 613
approach, which would require that broker-dealers report Customer
information using a consistent, unique Customer-ID, as set out in in
Rule 613(c)(7)(i)(A) and Rule 613(c)(8). The Commission preliminarily
believes that the Rule 613 approach would increase certain costs
associated with the implementation and operation of CAT as compared to
the Customer Information Approach while providing substantially
identical data.
---------------------------------------------------------------------------
\1177\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(a)(iii).
---------------------------------------------------------------------------
The Commission also preliminarily believes that the Rule 613
approach would have no significant impact on the benefits of the CAT
NMS Plan. The Participants maintain that, under the Rule 613 approach,
there would be no gains in terms of accuracy or reliability, no effect
on the ability to link records, and no effect on the time the data
would be made available to regulators, as compared to the Customer
Information Approach.\1178\ The Participants also believe that there
may be accuracy gains under the Customer Information Approach if it
reduces errors that may otherwise occur if broker-dealers must adapt
their systems and business processes to manage Customer-IDs.\1179\
---------------------------------------------------------------------------
\1178\ See Exemptive Request Letter, supra note 16, at 15-18.
\1179\ Id.
---------------------------------------------------------------------------
The Commission also preliminarily believes that the Rule 613
approach would increase the costs of the CAT NMS Plan. In their
Exemption Request, the Participants discussed a number of reasons why
the Customer Information Approach is less burdensome than the Rule 613
approach. First, it reduces the CAT implementation burden on market
participants by eliminating the need for changes to their current
customer identification systems.\1180\ Currently, market participants
have individual formats for their customer identifiers; under the
Customer Information Approach, no standardization of form would be
required. Second, the Customer Information Approach eliminates the need
for centrally-assigned Customer-IDs to be assigned at the Central
Repository and communicated back to market participants.\1181\ Third,
it allows the Plan Processor to implement modifications and technical
upgrades to the Customer-ID generation process and infrastructure
without the involvement of CAT Reporters.\1182\ Fourth, the Customer
Information Approach eliminates the need to train CAT Reporters on the
Customer-ID management process and provide related technical support.
Fifth, it potentially reduces delays faced by investors opening new
accounts, who might not be able to transact until the Central
Repository has assigned a Customer-ID and communicated it to the
broker-dealer representing the Customer.\1183\
---------------------------------------------------------------------------
\1180\ See id. at 17.
\1181\ See id.
\1182\ See id.
\1183\ See id. at 16-17.
---------------------------------------------------------------------------
Based on cost survey data provided by the Participants, the Rule
613 approach would increase quantifiable costs to the top three tiers
of CAT Reporters by at least $195 million.\1184\ The Commission notes
that this likely underestimates the increased costs to all CAT
Reporters because the Rule 613 approach would likely increase costs to
CAT Reporters outside the top three tiers also. Furthermore, the
Bidders have indicated that the costs of building and operating the
Central Repository under the Rule 613 approach would not be lower than
the costs of the Customer Information Approach.\1185\ The Commission
therefore preliminarily believes that the Rule 613 approach would
increase the costs of the CAT NMS Plan relative to the Plan's Customer
Information Approach, while providing substantially identical data.
---------------------------------------------------------------------------
\1184\ Id. at 17-18.
\1185\ Id. at 17.
---------------------------------------------------------------------------
c. CAT-Reporter-ID
The Commission is soliciting comment on how an alternative
approach--the Rule 613 approach--to the reporting of CAT Reporter
information might impact the costs and benefits of the Plan. A CAT-
Reporter-ID is ``a code that uniquely and consistently identifies [a
CAT Reporter] for purposes of providing data to the central
repository.'' \1186\ Subparagraphs (c)(7)(i)(C), (ii)(D), (ii)(E),
(iii)(D), (iii)(E), (iv)(F), (v)(F), (vi)(B), and (c)(8) of Rule 613
provide that the CAT NMS Plan must require CAT Reporters to report CAT-
Reporter-IDs to the Central Repository for orders and certain
Reportable Events.\1187\ Additionally, Rule 613(c)(8) requires that CAT
Reporters use the same CAT-Reporter-ID for each broker-dealer.\1188\ To
leverage existing infrastructure and business processes, the
Participants requested an exemption from Rule 613(c)(7) and (c)(8) to
allow a different approach to be included in the Plan; CAT Reporters
would report existing SRO-assigned market participant identifiers when
submitting data to the Central Repository (``SRO-Assigned Market
Participant Identifiers'').\1189\ The Central Repository would then
generate a corresponding CAT-Reporter-ID for internal use to identify
CAT Reporters.
[[Page 30757]]
This approach--called the ``Existing Identifier Approach''--allows the
CAT-Reporter-IDs to be managed at the Central Repository by the Plan
Processor without the involvement of the Reporters.\1190\ The
Commission granted exemptive relief to the SROs to allow the Existing
Identifier Approach to be included in the CAT NMS Plan and subject to
notice and comment.\1191\
---------------------------------------------------------------------------
\1186\ 17 CFR 242.613(j)(2).
\1187\ 17 CFR 242.613(c)(7)(i)(C), (ii)(D), (ii)(E), (iii)(D),
(iii)(E), (iv)(F), (v)(F), (vi)(B), and (c)(8).
\1188\ 17 CFR 242.613(c)(8).
\1189\ See Exemptive Request Letter, supra note 16, at 19.
\1190\ Id.
\1191\ See Exemption Order, supra note 18, at 11866.
---------------------------------------------------------------------------
Pursuant to the exemptive relief granted by the Commission, the CAT
NMS Plan provides for the use of the Existing Identifier
Approach.\1192\ The Commission is soliciting additional comment on the
Rule 613 approach, which would require that CAT Reporters use a
consistent, unique CAT-Reporter-ID, as set out in in Rule 613(c)(7) and
Rule 613(c)(8). The Commission preliminarily believes that the Rule 613
approach would increase certain costs associated with the
implementation and operation of CAT as compared to the Existing
Identifier Approach while providing substantially identical data.
---------------------------------------------------------------------------
\1192\ See, e.g., CAT NMS Plan, supra note 3, at Sections 6.3(d)
and (e), 6.4(d).
---------------------------------------------------------------------------
The Commission preliminarily believes that the Rule 613 approach
would not result in more reliable or accurate data as compared to the
Existing Identifier Approach. The Exemption Request states that ``the
proposed approach would not compromise the goal of Rule 613 to record
and link Reportable Events to the CAT Reporter associated with the
event.'' \1193\ The processed CAT Data would contain the CAT-Reporter-
ID fields, and the Participants maintain that there would be no loss of
accuracy or reliability, no effect on the ability to link records, and
no effect on the time the data would be made available to
regulators.\1194\
---------------------------------------------------------------------------
\1193\ See Exemptive Request Letter, supra note 16, at 21.
\1194\ Id. at 22-23.
---------------------------------------------------------------------------
In fact, the Commission preliminarily believes that the Rule 613
approach would reduce the quality of data obtained as compared to the
Existing Identifier Approach. Specifically, the Rule 613 approach would
reduce the granularity of information on departments, trading desks,
and other business units within CAT Reporters, which would be captured
under the Existing Identifier Approach. This additional granularity
would be possible under the Existing Identifier Approach because
identifiers currently in use are often assigned to entities that are
defined more granularly than the CAT-Reporter-ID level. The Commission
also preliminarily believes that the ability to leverage existing
infrastructure and business processes may reduce the potential for
delays and errors that could be associated with requiring CAT Reporters
to modify their systems and workflows to handle the CAT-Reporter-IDs.
The Commission preliminarily believes that the Rule 613 approach
would increase the costs of the CAT NMS Plan relative to the Existing
Identifier Approach. The Participants estimate implementation costs for
the top three tiers of CAT Reporters for the Rule 613 approach of $78
to $244 million, depending on how report types have to use the CAT-
Reporter-IDs.\1195\ The Exemption Request does not compare these costs
to the Existing Identifier Approach allowed by the exemption and
included in the Plan.\1196\ The Participants note that these estimates
are conservative because they are based on only 11% of broker-
dealers.\1197\ The Participants indicated that they have consulted with
the bidders and the industry in compiling this analysis.\1198\
---------------------------------------------------------------------------
\1195\ Id. at 24.
\1196\ Id. at 24.
\1197\ Id. at 25.
\1198\ Id. at 22.
---------------------------------------------------------------------------
While the Commission preliminarily believes that the Rule 613
approach would increase certain costs associated with the
implementation and operation of CAT as compared to the Existing
Identifier Approach, the Commission notes that there are limitations
associated with the cost estimation methodology presented in the
Exemption Request. These limitations include the exclusion of SROs and
smaller CAT Reporters from the survey, no apparent differentiation
between initial, deferred, and recurring costs, and lack of support for
the method used to extrapolate the estimates for large broker-dealers
to the industry. Nor do the cost estimates address the broker-dealers
who would be CAT Reporters but are currently not OATS reporters,
including those that are currently not registered with FINRA, which may
have a very different cost structure. However, it is likely that the
dominant effect would be the exclusion of many CAT Reporters from the
cost estimates, which would tend to underestimate the cost increases.
The Commission currently has no data from which it can independently
estimate the cost differential because it depends on information
internal to each of a heterogeneous group of CAT Reporters, which is
not compiled or stored anywhere and to which the Commission therefore
does not have ready access. The Commission believes that these effects
are not likely to alter its preliminary conclusion that the Rule 613
approach would significantly increase the costs of the CAT NMS Plan as
compared to the Plan's Existing Identifier Approach. The Commission is
requesting comment on this preliminary conclusion and any additional
data Commenters believe should be considered.
d. Linking Order Executions to Allocations
The Commission is soliciting comment on how an alternative approach
to the reporting of allocation information--the Rule 613 approach--
might impact the costs and benefits of the Plan. Rule 613(c)(7)(vi)(A)
requires each CAT Reporter to record and report to the Central
Repository ``the account number for any subaccounts to which the
execution is allocated (in whole or part).'' \1199\ This information
would allow regulators to link the subaccount to which an allocation
was made to the original order placed and its execution. In the
Exemptive Request Letter and April 2015 Supplement, the SROs requested
an exemption from Rule 613(c)(7)(vi)(A) to include in the Plan an
approach whereby CAT Reporters would instead submit information to the
Central Repository that would allow regulators to link subaccount
information to the Customer that submitted the original order.\1200\
The Commission granted exemptive relief to the SROs to allow this
approach to be included in the CAT NMS Plan and subject to notice and
comment.\1201\
---------------------------------------------------------------------------
\1199\ See 17 CFR 242.613(c)(7)(vi)(A).
\1200\ See Exemptive Request Letter, supra note 16, at 28-29;
April 2015 Supplement, supra note 16, at 2.
\1201\ See Exemption Order, supra note 18, at 11868.
---------------------------------------------------------------------------
Pursuant to the exemptive relief granted by the Commission, the CAT
NMS Plan provides that, rather than providing the account number for
any subaccounts to which the execution is allocated, CAT Reporters
would submit information to the Central Repository in the form of an
Allocation Report, in order to allow regulators to link subaccount
information to the Customer that submitted the original order.\1202\
The Allocation Report would include the Firm Designated ID for any
account(s), including subaccount(s), to which executed shares are
allocated, and provide the security that has been allocated, the
identifier of the firm
[[Page 30758]]
reporting the allocation, the price per share of shares allocated, the
side of shares allocated, the number of shares allocated to each
account, and the time of the allocation, which is information that is
not currently required to be reported and/or retained by broker-
dealers.\1203\ There would not be a direct link in the Central
Repository between the subaccounts to which an execution is allocated
and the execution itself. However, CAT Reporters would be required to
report each allocation to the Central Repository on an Allocation
Report, and the Firm Designated ID of the relevant subaccount provided
to the Central Repository as part of the Allocation Report could be
used by the Central Repository to link the subaccount holder to those
with authority to trade on behalf of the account.\1204\ Further, the
Allocation Reports used in conjunction with order lifecycle information
in CAT would assist regulators in identifying, through additional
investigation, the probable group of orders that led to
allocations.\1205\
---------------------------------------------------------------------------
\1202\ See CAT NMS Plan, supra note 3, at Section
6.4(d)(ii)(A)(1).
\1203\ See id. at Section 1.1; see also Exemption Order, supra
note 18, at 44-45.
\1204\ See Exemption Order, supra note 18, at 45.
\1205\ Id.
---------------------------------------------------------------------------
The Commission is soliciting comment on the Rule 613 approach,
which would require CAT Reporters to record and report the account
number for any subaccounts to which the execution is allocated, as
described above. The Commission preliminarily believes that that the
Rule 613 approach could provide the Central Repository with a way to
link allocations to order lifecycles.\1206\ This linkage would not be
available under the current approach. However, based on estimates
provided by the Participants, the Commission preliminarily believes
that the Rule 613 approach would increase certain costs associated with
the implementation and operation of CAT as compared to the Plan as
filed by roughly $525 million.\1207\
---------------------------------------------------------------------------
\1206\ In the Exemption Request, the SROs explained that under
the Rule 613 approach allocations made from an average price account
would not reflect a true one-to-one relationship between an
execution and an allocation, and therefore the information provided
would not directly link a single order execution and the subaccount
to which an allocation was made. See Exemptive Request Letter, supra
note 16, at 28. However, the Commission believes that under the Rule
613 approach, regulators would receive information that would
identify each execution resulting from the original order placed, as
well as the identity of all the subaccounts to which those
executions were allocated. This information would provide regulators
a finite list of executions from which the subaccount allocations
could have been made.
\1207\ The Participants estimate that the Plan's approach to
allocation information would result in a reduction in implementation
cost for the top three tiers of CAT Reporters of $525 million as
compared to the Rule 613 approach. See Exemptive Request Letter,
supra note 16, at 31.
---------------------------------------------------------------------------
The Commission preliminarily believes that either approach would
allow regulators to link specific allocations, and the prices received
on those allocations, with the aggregated executions that resulted in
the allocations and their execution prices. Industry feedback received
by the Participants indicates that existing business practices
typically involve aggregating executions in an average price account
before making allocations, and forcing a precise matching between
orders and executions ex-post would be misleading.\1208\ The Exemption
Request maintains that, under the approach in the Plan, there would be
no loss of accuracy or reliability, no effect on the ability to link
order records, and no effect on the time the data would be made
available to regulators as compared to the Rule 613 approach.\1209\ The
Exemption Request also states that there may be accuracy and
reliability gains if the exemption reduces errors that may otherwise
occur if broker-dealers were required to re-engineer their allocation
handling systems and business processes to meet the requirements of
Rule 613.\1210\
---------------------------------------------------------------------------
\1208\ See Exemptive Request Letter, supra note 16, at 28
(``[T]his approach . . . introduces an artificial relationship
between any one execution and one allocation. . . . Although, . . .
the ultimate allocation of the shares executed that result from [an]
aggregated order may be useful for regulatory surveillance purposes,
tying these allocations to multiple different executions is of
little regulatory benefit.'').
\1209\ Id. at 30.
\1210\ Id.
---------------------------------------------------------------------------
However, the Rule 613 approach would provide regulators access to
allocations linked to specific disaggregated orders, which is not
possible under the approach in the Plan. The Exemption Request notes
that linking particular allocations to particular order lifecycles
would be inaccurate in some circumstances, such as when many orders are
allocated to many customers.\1211\ The Commission is soliciting comment
on whether such information would necessarily be inaccurate, and
whether requiring the linking of allocations to order lifecycles would
reduce accuracy for several reasons. First, in cases in which one order
is allocated to one customer, the Rule 613 approach would provide an
improvement in accuracy over the approach proposed in the CAT NMS Plan
because the Rule 613 approach would allow the Central Repository to
accurately link such allocations to order lifecycles whereas the
approach proposed in the CAT NMS Plan might not. Under the CAT NMS
Plan, for regulators to link the allocations to the order lifecycles,
they would need to construct an algorithm that would rely on less
information than the Central Repository would have under the Rule 613
approach. As a result, these regulator linkages would likely be less
accurate than a Central Repository linkage. The Commission
preliminarily believes that this is true for cases in which one order
is allocated to many customers and when many orders are linked to one
customer. For the many-to-many allocations, in which many customer
orders are grouped and worked by the market participant using many
orders to acquire the aggregate position ultimately used to fill the
customer orders, the Commission notes that broker-dealers likely
already maintain records that allow them to ensure that the allocations
receive fair prices based on market executions. The Commission is
soliciting comment on whether such information might be sufficient to
link the many allocations to the many orders executed in an accurate
manner. Such information would greatly aid investigations of fair
allocations because it would allow regulators to reconstruct the manner
in which allocations occur.
---------------------------------------------------------------------------
\1211\ See id. at 28-30.
---------------------------------------------------------------------------
The Commission preliminarily believes that the Rule 613 approach
would increase the costs of compliance with the CAT NMS Plan. According
to industry feedback collected by the Participants, the Rule 613
approach would require broker-dealers to undertake a major re-
engineering of their middle and back office systems and
processes.\1212\ The Participants estimate a reduction in
implementation cost over the Rule 613(c)(7)(vi) Baseline for the top
three tiers of CAT Reporters of $525 million; consequently, the
Commission preliminarily believes that this alternative would cost at
least $525 million more than the estimated costs of the CAT NMS Plan to
implement.\1213\ The Participants indicated that they have consulted
with the bidders and the industry in compiling this analysis.\1214\
---------------------------------------------------------------------------
\1212\ Id. at 27.
\1213\ Id. at 31.
\1214\ See id. at 30-31.
---------------------------------------------------------------------------
e. Time Stamp Granularity
The Commission is soliciting comment on how an alternative
approach--the Rule 613 approach--to time stamps on ``Manual Order
Events'' might impact the costs and benefits of
[[Page 30759]]
the Plan.\1215\ Rule 613(c)(7) and Rule 613(d)(3) require time stamps
with a minimum granularity of one millisecond on all order
events.\1216\ The Participants requested an exemption from the
requirement in Rule 613(d)(3) that for Manual Order Events each CAT
Reporter record and report details for Reportable Events with time
stamps that ``reflect current industry standards and [are] at least to
the millisecond.'' \1217\ The Commission granted exemptive relief to
the SROs to allow the approach to recording and reporting time stamps
for Manual Order Events described in the Exemption Request to be
included in the CAT NMS Plan and subject to notice and comment.\1218\
---------------------------------------------------------------------------
\1215\ ``Manual Order Events'' are defined to mean ``non-
electronic communication[s] of order-related information for which
CAT Reporters must record and report the time of the event.'' See
CAT NMS Plan, supra note 3, at Section 1.1.
\1216\ See 17 CFR 242.613(c)(7) (requiring use of time stamps
pursuant to 17 CFR 242.613(d)(3)); 17 CFR 242.613(d)(3) (requiring
time stamp granularity be ``at least to the millisecond'').
\1217\ See 17 CFR 242.613(d)(3); Exemptive Request Letter, supra
note 16, at 32.
\1218\ See Exemption Order, supra note 18, at 11869.
---------------------------------------------------------------------------
Pursuant to the exemptive relief granted by the Commission, the CAT
NMS Plan provides that: (1) Each CAT Reporter would record and report
Manual Order Event time stamps to the second; (2) Manual Order Events
would be identified as such when reported to the CAT; and (3) CAT
Reporters would report in millisecond time stamp increments when a
Manual Order Event is captured electronically in the relevant order
handling and execution system of the CAT Reporter (``Electronic Capture
Time'').\1219\ On the other hand, the Rule 613 approach would require
that CAT Reporters record and report details for Manual Order Events
with time stamps that are at least to the millisecond, as required by
Rule 613(c)(7) and Rule 613(d)(3). The Commission preliminarily
believes that the Rule 613 approach would increase the costs of
implementing the CAT NMS Plan while providing little regulatory benefit
relative to the current approach.
---------------------------------------------------------------------------
\1219\ See CAT NMS Plan, supra note 3, at Section 6.8.
---------------------------------------------------------------------------
The Participants maintain in the Exemption Request that there would
be little benefit, and possibly some adverse consequences, of capturing
Manual Order Event time stamps in milliseconds.\1220\ They note that
determining the time of a manual event is inherently imprecise, due to
the limits of human reaction time in completing a transaction and the
time required to manually record the event.\1221\ They claim human
reaction time to visual stimulus is on the order of 400-500
milliseconds, making millisecond time stamps imprecise.\1222\ The
Commission preliminarily agrees that attempting to record the precise
millisecond in which a manual event occurred would necessarily be
imprecise. The Commission also preliminarily agrees that potential
adverse consequences could arise from relying on time stamps with a
misleading level of precision.\1223\
---------------------------------------------------------------------------
\1220\ See Exemptive Request Letter, supra note 16, at 33.
\1221\ Id. at 37.
\1222\ Id.
\1223\ The Commission notes that Manual Order Events are not
clearly and exhaustively defined, and the definitions may not be
available until the Technical Specifications are published. It may
be possible for the Plan Processor to classify some types of order
events as Manual Order Events that were not considered to be a
Manual Order Event for the purposes of this analysis. This creates a
degree of uncertainty as to whether the Rule 613 approach might
yield some regulatory benefit.
---------------------------------------------------------------------------
The Participants discussed the costs and benefits of the proposed
exemption in their Exemption Request. They estimated a minimum total
cost to the industry of $10.5 million based on the cost of advanced
OATS-compliant clocks with granularity of one second, and noted that
clocks with millisecond granularity would likely be more expensive if
available.\1224\ The Participants also noted that the industry was
consulted through the DAG and an unsuccessful attempt was made to find
a commercially available time stamping device with millisecond
granularity.\1225\ Based on this information, the Commission
preliminarily believes the Rule 613 approach to Manual Order Events
would increase certain costs associated with the implementation and
operation of CAT as compared to the Plan as filed without providing any
significant additional benefit.
---------------------------------------------------------------------------
\1224\ See Exemptive Request Letter, supra note 16, at 36-37.
\1225\ Id. at 35.
---------------------------------------------------------------------------
2. Alternatives to Certain Specific Approaches in the CAT NMS Plan
The Commission has analyzed alternatives to specific approaches in
the CAT NMS Plan with respect to clock synchronization, time stamps,
error rates, the time within which errors must be corrected, the
funding model, requirements regarding listing exchange symbology, data
accessibility standards, and intake capacity levels.
a. Clock Synchronization
The Commission is soliciting comments on alternate approaches to
clock synchronization as compared to those proposed in the CAT NMS
Plan. First, the Commission is soliciting comment on alternatives to
the Plan's one-size-fits-all definition of ``industry standard.'' Under
these alternatives, ``industry standard'' would be defined in terms of
the standard practices of different segments of the CAT Reporters, or
by looking at information other than current industry practices. These
alternative approaches could result in clock offset tolerances shorter
than the CAT NMS Plan's proposed 50 millisecond standard for some or
all CAT Reporters. The Commission preliminarily believes that these
alternatives could substantially increase the benefits of CAT in
regulatory activities that require event sequencing, such as analysis
and reconstruction of market events, as well as market analysis and
research in support of policy decisions, and cross-market surveillance,
examinations, investigations, and other enforcement functions.\1226\
---------------------------------------------------------------------------
\1226\ See Section IV.E.1.b(2), supra.
---------------------------------------------------------------------------
Second, the Commission is soliciting comment on two additional
alternatives that could allow for more cost-effective clock
synchronization standards. In particular, the Commission is soliciting
comment on modifying the requirement to document clock synchronization
activities such that only events that require clock adjustment would be
required to be documented, and modifying the clock synchronization
requirement such that clocks would not have to be synchronized at times
when systems are not recording time-sensitive CAT Reportable Events,
such as orders originated outside of market hours when they are not
immediately actionable. The Commission preliminarily believes that
reduced clock synchronization logging requirements might significantly
reduce ongoing costs associated with clock synchronization compliance
as compared to the Plan as filed, without losing any additional
material information. In addition, the Commission preliminarily
believes that more flexible clock synchronization standards outside of
regular and extended trading hours may also reduce costs without a
material loss to the ability of regulators to sequence order events as
compared to the Plan as filed, without losing any additional material
information. Each of these alternatives is outlined below.
(1) Alternative Clock Synchronization Standards
Rule 613(d)(1) requires synchronization of business clocks for the
purposes of recording the date and time of Reportable Events consistent
[[Page 30760]]
with industry standards.\1227\ The CAT NMS Plan describes the
``industry standard'' in terms of the technology adopted by the
majority in the industry.\1228\ The Plan therefore bases its clock
synchronization standard on current practices of the broker-dealer
industry generally, and provides that one standard would apply to all
CAT Reporters. The Commission is soliciting comment on an alternative
interpretation of ``industry standard'' that would consider the
standard practices of different segments of the CAT Reporters for the
purposes of setting the clock synchronization requirements. The
Commission is also soliciting comment on an alternative that would
define industry standard by looking at information other than current
industry practice; for example, the most accurate technology currently
available in the industry, or the standard recommended by a particular
authority or industry group.
---------------------------------------------------------------------------
\1227\ The Commission did not define the term ``industry
standard'' in Rule 613. In the Adopting Release, the Commission
noted that it expected the Plan to ``specify the time increment
within which clock synchronization must be maintained, and the
reasons the plan sponsors believe this represents the industry
standard.'' See Adopting Release, supra note 9, at 45774.
The benefits of alternative clock offset tolerances discussed
in this Section may be dependent on time stamp granularity
requirements. Related alternatives are discussed in Section
IV.H.2.b, infra.
\1228\ See CAT NMS Plan, supra note 3, at Appendix C, Section
12(p).
---------------------------------------------------------------------------
First, the Commission is soliciting comment on an alternative
definition of industry standard that would consider the standard
practices of different segments of CAT Reporters. Under this
alternative, all systems within market participants that process CAT-
Reportable Events would be required to comply with a clock
synchronization requirement reflecting an industry standard particular
to that market participant's segment of the industry. Currently, the
Commission lacks the information necessary to reach a preliminary
conclusion regarding the appropriate industry standards for all subsets
of the industry. Specifically, neither the FIF Clock Offset Survey nor
the Plan provides comprehensive data on the clock synchronization
practices of firms within each of the relevant subsets of the industry,
and the Commission has no data from which it can independently estimate
the cost differential because the Commission is not aware of any such
data available to it at this time. However, the Commission is
soliciting comment on this approach, which it believes would result in
a clock offset tolerance of less than 50 milliseconds for some market
participants. The Commission seeks comment on the current practices for
clock synchronization in various segments of the industry, including
but not limited to broker-dealers that are introducing firms,
institutional firms, retail firms that accept customer orders
electronically, registered market makers and principal trading firms,
as well as service bureaus hosting order management systems, exchanges
and ATSs, and branches of broker-dealers that predominantly handle
manual orders. The Commission also seeks comment on the costs and
benefits of requiring varying clock offset tolerances within the
industry.
The Commission notes that the current practices for exchanges and
Execution Venues may differ from the industry standard for broker-
dealers as defined by the Plan, and current practices for certain
systems within broker-dealers may vary by the system within the broker-
dealers. For example, a small clock offset tolerance may be nearly
universally adopted for systems like ATSs that operate a matching
engine, while systems involved in manual entry of orders may typically
have larger clock offset tolerances. By defining industry standard
based on practices of the broker-dealer industry generally, the Plan
does not account for these differences.
Other information now available for the Commission and the public
to study, particularly information from the FIF Clock Offset Survey,
shows that several of the survey respondents that have a current clock
offset tolerance of one second are clearing firms or service
bureaus.\1229\ According to the same survey, current clock offset
tolerances vary from one second to five microseconds among the broker-
dealers surveyed with 22% of respondents having multiple clock offset
tolerances across their systems.\1230\ Further, the FIF Clock Offset
Survey shows that the firms with multiple clock offset tolerances
typically engage in multiple lines of business. The fact that some
broker-dealers maintain clock offset tolerances at different levels
within the firm suggests that these broker-dealers believe that clock
precision is more important for some systems; furthermore, based on
conversations with market participants,\1231\ the Commission
preliminarily believes that market participants strategically upgrade
certain systems and reallocate older technology within the firm to
applications where up-to-date technology is less critical.\1232\
---------------------------------------------------------------------------
\1229\ See FIF Clock Offset Survey, supra note 127.
\1230\ See Section IV.D.2.b(2)B.i, supra for more information
regarding the distribution of broker-dealer clock offset tolerances.
\1231\ Based on FIF-organized conversations with broker-dealers
and service bureaus. See supra note 880.
\1232\ Systems that have greater clock offset tolerances may
have technology that is too old to support smaller clock offset
tolerances. The Commission preliminarily believes that if a shorter
clock offset tolerance is important to these broker-dealers, they
would update their systems to support newer technology capable of
smaller clock offset tolerances.
---------------------------------------------------------------------------
Finally, exchanges and ATSs, as well as the SIPs, may have current
clock offset tolerances that are significantly different from the clock
offset tolerances at broker-dealers and could therefore achieve finer
clock offset tolerances at lower cost than broker-dealers.\1233\
According to FIF, all exchange matching engines meet a clock offset
tolerance of 50 milliseconds or less while NASDAQ states that all
exchanges that trade NASDAQ securities have clock offset tolerances of
100 microseconds or less.\1234\ In conversations with Commission Staff,
the Participants stated that absolute clock offset on exchanges
averages 36 microseconds, further suggesting that certain business
activities warrant smaller clock synchronization tolerances.\1235\
---------------------------------------------------------------------------
\1233\ See supra notes 441 and 442. Specifically, the NASDAQ SIP
Web site implies that exchanges reporting to the NASDAQ SIP
synchronize their systems to 100 microseconds.
\1234\ See Section IV.D.2.b(2)B.i, supra for more information on
clock offset tolerances of exchanges and the SIPs.
\1235\ See supra note 436.
---------------------------------------------------------------------------
Given this information, the Commission recognizes the possibility
that some business systems and some CAT Reporter types would rarely be
responsible for recording the date and time of reportable events and
also recognizes that the time stamp precision of such rare events might
not be as critical as for other events. For example, a system that
routes customer orders to market centers may be considered critical for
sequencing market events, while a system that facilitates manual input
of orders received by telephone may not. Conversely, the clock
synchronization practices of some CAT Reporters may be more critical to
the overall benefits of CAT or could be less costly to implement. For
example, a service bureau that provides an order-handling system hosted
on its own servers is likely to route orders for many market
participants and its clock synchronization practices would, thus, be
critical to event sequencing. On the other hand, the precision of time
stamps from systems of an isolated broker-dealer that routes customer
orders to its service bureau or another broker-dealer for market access
and conducts no
[[Page 30761]]
proprietary trading may be less critical to event sequencing,
especially if the receiving system at the service bureau would record a
high-precision time stamp when the order is received. Furthermore,
instituting higher clock precision at a single service bureau would be
less costly than instituting that same level of clock precision at the
service bureau and all of its broker-dealer customers as is required by
the Plan as filed.
Relative to the proposed clock synchronization standard, the
Commission preliminarily believes that an alternative approach that
would consider the standard practices of different segments of the
industry for the purposes of setting the clock synchronization
requirements, and would require a smaller clock offset tolerance than
in the Plan for certain business systems that are more critical to
being able to accurately sequence order events, could have significant
benefits. In other words, the Commission preliminarily believes that
some business systems may be responsible for time stamping more time-
sensitive order events than others, where more time-sensitive orders
are those for which precise time stamps are more critical for event
sequencing.
The Commission does not currently have the information necessary to
specify which particular types of business system handle more time-
sensitive orders because neither the FIF Clock Offset Survey nor the
Plan provides this data. The Commission has no data from which it can
independently estimate this because the Commission is not aware of any
such data available to it. However, the Commission recognizes the
potential for such an approach. For example, it is possible that almost
all of the order origination events, routing events, modification
events, and execution events, which are likely to be more time-
sensitive than other CAT Reportable Events, occur on systems at broker-
dealers that conduct certain types of businesses. The businesses that
seem most likely to record these time-sensitive events include:
Introducing broker-dealers; institutional broker-dealers; retail
broker-dealers that accept customer orders electronically; registered
market makers; principal trading firms; service bureaus that host order
management systems; exchanges; and ATSs.
Further, some systems collect order events that either do not
require a granular time stamp; other systems would not be required to
record order events in real time. An example would be regional branches
of broker-dealers that only handle manual orders which require a time
stamp to the second until the broker enters the order into an
electronic system. If the order entry hits a centralized system
quickly, then perhaps the clock precision of the centralized system may
be sufficient for sequencing.
The Commission is also soliciting comment on an alternative
approach that would define industry standard by looking at information
other than current industry practices; for example, by considering the
most accurate technology currently available in the industry, or the
standard recommended by a particular industry group or authority.
Defining industry standards by majority practices may have the
unintended effect of setting a standard that delays adopting advances
in technology. The Commission preliminarily believes that this
alternative approach could result in defining an industry standard for
clock synchronization that would require a clock offset tolerance for
all CAT Reporters that is lower than the 50 millisecond standard
required by the Plan. The Commission seeks comment on any appropriate
definitions of ``industry standard'' with respect to clock
synchronization, including the costs and benefits of using any
alternative definitions of ``industry standard'' for the purposes of
setting clock synchronization requirements. The Commission also seeks
comment on whether a definition of ``industry standard'' could set a
maximum clock offset tolerance with an expectation that each CAT
Reporter would be responsible for smaller clock offsets if the CAT
Reporter is technically capable of such clock offsets.
The Commission conducted an analysis to assess the benefits of
alternative approaches to defining industry standard that would result
in smaller clock offset tolerances for some or all segments of CAT
Reporters. The Commission evaluated the percentage of unrelated events
that can potentially be sequenced under various clock offset
tolerances, including the 50 millisecond tolerance outlined in the CAT
NMS Plan. The Commission estimates that approximately 7.84% of
unrelated orders for listed equities and 18.83% of unrelated orders for
listed options can be accurately sequenced using a clock offset
tolerance of 50 milliseconds.\1236\ The Commission augmented this
analysis by conducting a clock synchronization analysis to examine
certain alternative clock offset tolerances from those examined in the
FIF Clock Offset Survey.\1237\ Table 10 shows the results of the
Commission's analysis as a percentage of unrelated order events for
equities that could be sequenced under various alternative clock offset
tolerance.
---------------------------------------------------------------------------
\1236\ See Section IV.E.1.b(2)A, supra. In general, events occur
with such frequency that a 50 millisecond clock synchronization
standard would not be sufficient to sequence all orders; see also
CAT NMS Plan, supra note 3, at Appendix C, Section A.3(c) n.110
(``Events occurring within a single system that uses the same clock
to time stamp those events should be able to be accurately sequenced
based on the time stamp. For unrelated events, e.g., multiple
unrelated orders from different broker-dealers, there would be no
way to definitively sequence order events within the allowable clock
drift as defined in Article 6.8 [of the CAT NMS Plan].'').
\1237\ See Section IV.D.2.b(2)B, supra, for information on the
Commission's clock offset tolerance analysis. Specifically, the
analysis says that an order event can be sequenced if its time stamp
is at least twice the clock offset tolerance from any other event on
another venue.
Table 10--Sequencing Accuracy of Unrelated Events by Clock Offset
Tolerance
------------------------------------------------------------------------
Percentage of unrelated events
that can be sequenced
Clock offset tolerance -----------------------------------
Equities (%) Options (%)
------------------------------------------------------------------------
50 milliseconds..................... 7.84 18.83
5 milliseconds...................... 16.51 35.54
1 millisecond....................... 22.08 50.70
100 microseconds.................... 42.47 78.42
------------------------------------------------------------------------
[[Page 30762]]
The Commission's analysis suggests that approximately 16.51% of
unrelated order events for equities and 35.54% of unrelated order
events for options could be sequenced under a clock offset tolerance of
5 milliseconds, 22.08% of orders events for equities and 50.70% of
order events for options could be sequenced under a clock offset
tolerance of 1 millisecond, and 42.47% of order events for equities and
78.42% of orders events for options could be sequenced under a clock
offset tolerance of 100 microseconds. Given these results, the
Commission believes that requiring a smaller clock offset tolerance
than the Plan's proposed 50 milliseconds for some segments of the
industry could improve the accuracy of event sequencing.
Relative to the Plan's proposed universal 50 millisecond clock
offset tolerance, the Commission preliminarily believes that requiring
a smaller clock offset tolerance for some segments of the industry
would likely increase the costs of the CAT NMS Plan. Table 11 is from
page C-126 of the CAT NMS Plan, and it provides the costs of the Plan's
proposed clock offset tolerance (50 milliseconds) and alternative
tolerances (100 microseconds, 5 milliseconds, and 1 millisecond).\1238\
These costs assume that each clock offset tolerance is applied to all
business systems. However, as noted above, the alternative the
Commission is soliciting comment on is to require smaller clock offset
tolerance for certain segments of the industry. So, the estimates below
provide an upper bound on the potential cost if the Commission requires
smaller clock offset tolerances in some cases.
---------------------------------------------------------------------------
\1238\ Table 11 is from the CAT NMS Plan, supra note 3, at
Appendix C, Section D.12(p) and it draws its numbers from the FIF
Clock Offset Survey. See supra note 127.
Table 11--Implementation and Annual Ongoing Cost Estimates per Firm by
Clock Offset Tolerance
------------------------------------------------------------------------
Estimated Estimated annual
Clock offset tolerance implementation ongoing cost
cost (per firm) (per firm)
------------------------------------------------------------------------
50 milliseconds..................... $554,348 $313,043
5 milliseconds...................... 887,500 482,609
1 millisecond....................... 1,141,667 534,783
100 microseconds.................... 1,550,000 783,333
------------------------------------------------------------------------
The Commission understands that the cost figures in Table 11 do not
net out the current ongoing costs of clock synchronization, which are
$203,846.\1239\ Table 12 shows the preliminary estimated annual ongoing
cost increase (ongoing costs minus current costs) to comply with
various alternative clock offset tolerances as well as the clock offset
tolerance specified in the Plan.
---------------------------------------------------------------------------
\1239\ See FIF Clock Offset Survey, supra note 127, at 16. This
is based on current practice of the broker-dealers who responded to
the survey.
Table 12--Annual Ongoing Cost Increases per Firm by Clock Offset
Tolerance
------------------------------------------------------------------------
Estimated
annual ongoing
Clock offset tolerance cost increases
(per firm)
------------------------------------------------------------------------
50 milliseconds....................................... $109,197
5 milliseconds........................................ 278,763
1 millisecond......................................... 330,937
100 microseconds...................................... 579,487
------------------------------------------------------------------------
Based on these estimates, the Commission estimated aggregate clock
synchronization costs for broker-dealers consistent with the estimation
of their total CAT compliance costs as detailed in the Costs Section
above.\1240\ The Commission assumed that 171 broker-dealers would incur
the full ongoing costs and full implementation costs indicated in the
FIF Clock Offset Survey.\1241\ Conversely, the remaining 1,629 broker-
dealers that are already assumed to use service bureaus would rely on
the 13 service bureaus to facilitate their clock synchronization, and
therefore would pay lower implementation and ongoing costs than those
in the FIF Clock Offset Survey. The Commission understands that broker-
dealers that rely on service bureaus for order management systems and
regulatory reporting usually use servers operated by their service
bureaus and most would therefore not directly bear the costs to
implement and comply with clock synchronization standards.\1242\ For
the implementation costs for those relying on service bureaus for clock
synchronization, the Commission assumes \1/4\ FTE for 50 milliseconds,
\1/2\ FTE for 5 milliseconds, \3/4\ FTE for 1 millisecond, and 1 FTE
for 100 microseconds. Under these assumptions, broker-dealers that
outsource their order management and regulatory reporting obligations
would incur costs (shown in Table 13) that are significant relative to
the estimated implementation costs for broker-dealers that handle order
management and reporting obligations in-house.\1243\
---------------------------------------------------------------------------
\1240\ See Section IV.F.3.a, supra.
\1241\ The 171 broker-dealers comes from the total of
Insourcers, ELPs, and Options Market Makers.
\1242\ See Section IV.F.1.d, supra for a discussion of service
bureaus passing costs on to clients.
\1243\ As in the Costs Section above (see Section IV.F.1.c(2)C),
monetizing the FTE costs involves multiplying the number of FTEs by
$424,350. See infra note 1487.
Table 13--Implementation Cost Estimates per Firm for Outsourcing Firms
by Clock Offset Tolerance
------------------------------------------------------------------------
Estimated
implementation
Clock offset tolerance costs (per firm)
for outsourcing
firms
------------------------------------------------------------------------
50 milliseconds....................................... $106,000
5 milliseconds........................................ 212,000
1 millisecond......................................... 318,000
100 microseconds...................................... 424,000
------------------------------------------------------------------------
With these implementation costs, the Commission aggregated
implementation and ongoing costs as indicated in Table 14.
[[Page 30763]]
Table 14--Aggregated Implementation and Annual Ongoing Cost Estimates by
Clock Offset Tolerance
------------------------------------------------------------------------
Estimated Estimated
aggregate aggregate annual
Clock offset tolerance implementation ongoing cost
cost \1244\ \1245\
------------------------------------------------------------------------
50 milliseconds..................... $268 million $25 million.
5 milliseconds...................... 497 million 63 million.
1 millisecond....................... 714 million 75 million.
100 microseconds.................... 956 million 131 million.
------------------------------------------------------------------------
Table 14 suggests that the Plan's clock synchronization costs for
the approximately 1,800 expected CAT Reporters would be approximately
$268 million in estimated implementation costs and about $25 million in
ongoing costs. To estimate the relative costs of each alternative
compared to the Plan, the Commission subtracted the costs of the Plan
from the costs of each alternative.
---------------------------------------------------------------------------
\1244\ $268 million [ap] 171*$554,348 + 1,629*0.25*$424,350.
$497 million [ap] 171*$887,500 + 1,629*0.5*$424,350. $714 million
[ap] 171*$1,141,667 + 1,629*0.75*$424,350. $956 million [ap]
171*$1,550,000 + 1,629*$424,350.
\1245\ $25 million [ap] 171*$109,197 + 13*4.2*$109,197. $63
million [ap] 171*$278,763 + 13*4.2*$278,763. $75 million [ap]
171*$330,937 + 13*4.2*$330,937. $131 million [ap] 171*$579,487 +
13*4.2*$579,487. 13 is the number of service bureaus and 4.2 is the
ratio between the total incremental ongoing charges to broker-
dealers and the total incremental ongoing costs to service bureaus
derived from the cost estimates above. See Section IV.F.2, supra.
---------------------------------------------------------------------------
Table 15 provides estimates for how the costs of alternative clock
offset tolerances applied to all business systems would be greater than
those of the CAT NMS Plan if a different clock offset tolerance applied
to all CAT Reporters.
Table 15--Aggregated Implementation and Annual Ongoing Cost Increases by
Clock Offset Tolerance
------------------------------------------------------------------------
Estimated Estimated
increase in increase in
Clock offset tolerance implementation annual ongoing
cost cost
(aggregate) (aggregate)
------------------------------------------------------------------------
5 milliseconds...................... $229 million $38 million.
1 millisecond....................... 446 million 50 million.
100 microseconds \1246\............. 688 million 106 million.
------------------------------------------------------------------------
The Commission does not have information on the implementation and
ongoing costs to exchanges or ATSs of various alternative clock offset
tolerances because trading venues were not included in the FIF Clock
Offset Survey. The Plan does not provide this data, and the Commission
has no other data from which it can independently estimate this,
because the Commission is not aware of any such data available to it.
However, exchanges may currently synchronize their clocks to within 100
microseconds.\1247\ Consequently, the Commission preliminarily believes
that any of the alternative clock offset tolerances discussed above
would not materially increase costs to Participants relative to the
costs they would incur under the Plan because their current clock
synchronization procedures seem to satisfy any of the proposed clock
offset tolerances. In the case of ATSs, these systems tend to be
operated by large and complex broker-dealers that are unlikely to rely
upon service bureaus to perform their clock synchronization
responsibilities. Consequently, the Commission preliminarily believes
that cost estimates for the broker-dealers surveyed by FIF are likely
to include broker-dealers that operate ATSs and already reflect any
additional clock synchronization costs attributable to operating ATSs.
However, if Execution Venues (including ATSs) were to have smaller
clock offset tolerances than other broker-dealer systems, broker-
dealers operating ATSs would be expected to incur higher clock
synchronization costs than other broker-dealers.
---------------------------------------------------------------------------
\1246\ The Commission recognizes that the benefits of clock
synchronization of less than one millisecond are limited unless the
time stamps are also more granular. Requiring more granular time
stamps than the 1 millisecond in the Plan would increase the costs
relative to those in Table 15.
\1247\ See Section IV.D.2.b(2)B.i, supra; see also supra notes
435 and 436.
---------------------------------------------------------------------------
As noted above, the Commission is soliciting comment on both an
alternative that would consider the standard practices of different
segments of the CAT Reporters for the purposes of setting the clock
synchronization requirements, and an alternative that would define
industry standard by looking at information other than current industry
practice. The Commission preliminarily believes that if the CAT NMS
Plan used an alternative interpretation of ``industry standard'' that
considered the standard practices of different segments of the CAT
Reporters for the purposes of setting the clock synchronization
requirements, the cost increases associated with smaller clock offset
tolerances might be lower than estimates presented in the tables above.
In particular, if the clock synchronization requirements were only
applied to the most time-sensitive systems, the costs increases would
be lower than those presented.\1248\ In addition, if the only broker-
dealers required to comply with clock synchronization requirements were
the ones accepting, routing, and executing orders, the costs could be
lower than those presented above. The Commission does not have the
information necessary to quantify how much lower the costs would be
under an alternative that applied different clock offset tolerances to
different segments of the CAT Reporters, because neither the Plan nor
[[Page 30764]]
the FIF Clock Offset Survey break the cost estimates for changes in
clock synchronization requirements down by business system types, and
the Commission has no data from which it can independently estimate
this, because the Commission is not aware of any such data available to
it.
---------------------------------------------------------------------------
\1248\ This belief is also consistent with information in the
FIF Clock Offset Survey. See supra note 127, at 20. Specifically,
the survey found that respondents would save on costs if the
alternative clock offset tolerance were applied only to ``server-
side trading systems.''
---------------------------------------------------------------------------
The Commission recognizes that a clock offset tolerance smaller
than 50 milliseconds would have differential cost across market
participants. An alternate approach to defining ``industry standard''
that took into account the standard practices of different segments of
CAT Reporters could mitigate those costs. All FIF Clock Offset Survey
respondents that provided technology information use technology capable
of 50 millisecond clock offset tolerances, but 36% of those respondents
do not employ a technology capable of clock offset tolerances smaller
than 50 milliseconds. Some survey respondents indicated that they
employ software that is not capable of clock offset tolerances of less
than 50 milliseconds or that desktop PCs would be a challenge with such
clock offset tolerances. An alternative definition of ``industry
standard'' that considered the practices of various segments of the
industry could apply smaller clock offset tolerances to a subset of
business systems; the Commission expects that applying smaller clock
offset tolerances to a subset of systems would cost less than applying
such clock offset tolerances to all systems. However, the benefits
could also be limited in terms of the percentage of unrelated events
that could potentially be sequenced, as compared to a definition of
``industry standard'' that a set a lower clock offset tolerance for all
CAT Reporters.
(2) Alternative Logging Procedures
Rule 613(d)(1) requires synchronizing business clocks that are used
for the purposes of recording the date and time of any Reportable
Event. The CAT NMS Plan further requires that Participants and other
CAT Reporters maintain a log recording the time of each clock
synchronization that is performed and the result of such
synchronization, specifically identifying any synchronization initiated
in response to an observed discrepancy between the CAT Reporter's
business clock and the time maintained by the NIST exceeding 50
milliseconds.\1249\ According to the FIF Clock Offset Survey, costs in
logging the synchronization events is a significant driver of overall
clock synchronization costs.\1250\
---------------------------------------------------------------------------
\1249\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\1250\ Other cost drivers include hardware and software costs
and costs in ensuring reliability.
---------------------------------------------------------------------------
A few survey respondents indicated that the number of logged events
would go up significantly with a shorter clock offset, which requires a
costly logging system.\1251\ Therefore, the Commission is soliciting
comment on an alternative that would require logging only exceptions to
the clock offset (i.e., events in which a market participant checks the
clock offset and applies changes to the clock).\1252\ While logging
every event, including clock offset checks, may be cost effective with
longer clock synchronization tolerances, the Commission questions
whether logging each event is cost efficient with finer clock offset
tolerances, given the large number of events expected for the proposed
and alternative clock synchronization standards. For example, if an
investigation is relying on properly sequenced events, the
investigation only would need to examine exception files to ensure the
precision of the time stamps. The FIF Clock Offset Survey suggests that
relaxing the logging requirement could reduce the burdens associated
with clock synchronization.
---------------------------------------------------------------------------
\1251\ See FIF Clock Offset Survey, supra note 127, at 19. One
survey respondent noted that a log file for a one second clock
offset would require 1 gigabyte of compressed storage each day but
clock offset log files for 50 millisecond clock offset would
increase the daily data storage 10 fold. Another survey respondent
noted that its current system logs 86,000 events per day and that
the proposed clock offset would require logging 35 million events
per day; see also CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\1252\ This is one of the alternatives suggested in the FIF
Clock Offset Survey. See supra note 127.
---------------------------------------------------------------------------
The Commission cannot quantify the reduction in costs from this
alternative because it lacks data on the proportion of clock
synchronization costs that are associated with event logging and the
proportion of those costs that could be avoided by alternative event
logging requirements. The Commission preliminarily believes that any
reduction in benefits from this alternative, as compared to the CAT NMS
Plan's approach for clock synchronization, would be minor because the
inclusion of clock synchronization checks that required no clock
adjustment would not improve regulators' ability to sequence events.
The Commission notes, however, that enforcement of clock
synchronization requirements may be more difficult without
comprehensive logging requirements that document firms' actions to
comply with requirements; consequently, relaxing the logging
requirement may also reduce incentives to comply with the clock
synchronization requirements.
(3) Alternative Clock Synchronization Hours
The Commission is soliciting comment on alternative requirements
for the times during which clock synchronization is required that would
provide more flexibility than the requirements of the Plan. The clock
synchronization requirement presented in the CAT NMS Plan makes no
provision for reduced clock synchronization requirements at times
during which systems are not performing tasks that produce time-
sensitive CAT Reportable Events; in the FIF Clock Offset Survey,
respondents identified that there were certain times during which
maintaining clock synchronization is more costly. Survey respondents
noted they would incur additional costs in maintaining clock offset
``99.9% of the time'' or with ``100% reliability'' and costs associated
with managing ``clock synch instability . . . after server reboot.''
The Commission notes that maintaining 99.9% or 100% reliability may be
unnecessary during times when the system does not record Reportable
Events. Further, the Commission understands that generally a system
does not record Reportable Events during server reboots. Therefore, the
Commission preliminarily believes that an alternative that does not
require synchronizing clocks when servers are not recording Reportable
Events or when precise time stamps are not as important to sequencing,
such as outside of normal trading hours, would not materially reduce
benefits. Given the responses to the FIF Clock Offset Survey, the
Commission preliminarily believes that this alternative could reduce
costs because synchronization activities and log entries related to
those events would not be as beneficial outside of normal trading
hours. The Commission does not have information necessary to quantify
the cost reduction because cost information available to the Commission
is not broken down by time of day or server status.
b. Time Stamp Granularity
The Commission is soliciting comment on the benefits and costs of
an alternative time stamp granularity requirement of less than one
millisecond. Rule 613(d)(3) requires time stamp granularity consistent
with industry standards and, as discussed above, the Plan requires time
stamps that reflect industry standards and are at
[[Page 30765]]
least to the millisecond.\1253\ Furthermore, the Plan requires
Participants to adopt rules requiring that CAT Reporters that use time
stamps in increments finer than milliseconds use those finer increments
when reporting to the Central Repository.\1254\ As discussed in the
Commission's analysis of alternative clock offset tolerance
requirements, millisecond time stamps may be inadequate to allow
sequencing of the majority of unrelated Reportable Events across
markets.\1255\ In addition, as discussed below, the Commission
recognizes that the benefits of more granular time stamps would be
limited unless the Plan were to require a clock offset tolerance far
lower than is proposed in the Plan.
---------------------------------------------------------------------------
\1253\ See Section IV.H.1.e, supra.
\1254\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(c).
\1255\ See Section IV.E.1.b(2)B, supra.
---------------------------------------------------------------------------
The Commission recognizes that regulators' ability to sequence
events is dependent on both clock offset tolerance and time stamp
granularity. If the Plan requires any or all CAT Reporters to implement
clock offset tolerances of less than a millisecond, time stamps
reported at the millisecond level would not capture the additional
precision of the smaller clock offset tolerance and much of the
benefits of this smaller clock offset requirement would be lost if time
stamps were rounded or truncated due to a millisecond time stamp
granularity requirement. The Commission notes that provisions in the
Plan require that any Participant that utilizes time stamps in
increments finer than the minimum required to be reported under the
Plan utilize such increments in reporting data to the Central
Repository. Also, the Commission notes that a sub-millisecond clock
offset tolerance would not in itself require the reporting of sub-
millisecond time stamps to the Central Repository.\1256\
---------------------------------------------------------------------------
\1256\ See CAT NMS Plan, supra note 3, at Section 6.8(b).
---------------------------------------------------------------------------
A requirement for time stamps at resolutions finer than 1
millisecond would entail certain costs. Because some market
participants already use time stamps at the sub-millisecond level and
will be required to report this information under the Plan, such a
requirement is unlikely to create significant additional costs for CAT
Reporters. Furthermore, while some exchanges and broker-dealers are
already required to report time stamps at the sub-millisecond level,
implementation costs are likely to vary across CAT Reporters. The Plan
does not provide data on the cost of requiring sub-millisecond time
stamps, and the Commission has no other data from which it can
independently estimate this, because the Commission is not aware of any
such data currently available to it.
Requiring sub-millisecond time stamp reporting would bring certain
benefits. However, the Commission preliminarily believes these benefits
may be limited without requiring clock offset tolerances of less than
one millisecond as well. For example, with a 50 millisecond clock
offset tolerance, a time stamp can only pinpoint the time of an event
to a 100 millisecond range.\1257\ In this case, sub-millisecond time
stamps provide little benefit to regulators attempting to determine the
order of events occurring in venues with separate clocks. However, even
with a 1 millisecond clock offset tolerance, a sub-millisecond time
stamp granularity requirement could provide some benefit for regulators
attempting to sequence events. For example, two events recorded at
times 12:00:00.0001 and 12:00:00.0021 on different venues can be
sequenced with a 1 millisecond clock offset, while if these time stamps
were rounded or truncated to 12:00:00.000 and 12:00:00.002, they could
not be sequenced with certainty, because it would be possible that both
events occurred at 12:00:00.001. If the Plan were to require sub-
millisecond clock offset tolerances, the additional benefits of this
sub-millisecond clock offset tolerance would be significantly limited
without time stamps that were similarly granular.
---------------------------------------------------------------------------
\1257\ See Section IV.H.2.a(1), supra.
---------------------------------------------------------------------------
c. Error Rate
The Commission is soliciting comment on the benefits and costs of
alternative maximum Error Rates. The Commission does not possess
sufficient data to quantitatively assess the costs and benefits of an
alternative to the maximum Error Rates specified in the CAT NMS Plan.
However, the Commission is using information provided in the CAT NMS
Plan to perform a qualitative assessment of the proposed maximum Error
Rates.\1258\
---------------------------------------------------------------------------
\1258\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.3(b).
---------------------------------------------------------------------------
The potential benefits from a lower maximum Error Rate than
proposed in the CAT NMS Plan could be improved accuracy in the data,
and a quicker retirement of OATS and other regulatory data reporting
systems.\1259\ However, the CAT NMS Plan states that errors would be de
minimis by the morning of day T+5, therefore the improvement in
accuracy does not seem to affect the data available to regulators
starting on day T+5.\1260\ Accordingly, the benefit of improved
accuracy as a result of a lower maximum Error Rate comes primarily from
regulatory use of the data prior to day T+5. While the Commission
believes that most regulatory uses would involve data after day T+5,
regulators also have essential needs for uncorrected data prior to day
T+5. For example, as discussed in the Benefits Section, the
availability of unprocessed data within three days of an event could
improve the Commission's chances of preventing asset transfers from
manipulation schemes.\1261\ Therefore, a lower Error Rate in data
available before day T+5 could, in certain regulatory contexts, be
meaningful.
---------------------------------------------------------------------------
\1259\ The Commission recognizes that a lower Error Rate could
also lead to the same accuracy level as the proposed Error Rate, but
more violations and consequences from those violations. This is
likely to occur if the Error Rates in the Plan are lower than what
every broker-dealer could reasonably obtain on the timeline; as a
consequence, because broker-dealers are reporting the most accurate
data they are currently able to report, a lower Error Rate cannot
improve data quality, but it can produce additional costs in the
form of penalties levied by the Plan Processor. However, as long as
at least one broker dealer can reasonably obtain lower Error Rates
than those in the Plan, a lower Error Rate would improve accuracy
because the lower Error Rate would incentivize that broker-dealer to
reduce its initial errors.
\1260\ See id. at Appendix C, Section A.3(b), n.102.
\1261\ See Section IV.E.3.d(3), supra.
---------------------------------------------------------------------------
Second, because OATS currently has a lower observed error rate than
the CAT NMS Plan, a reduction in CAT Error Rates may accelerate the
retirement of OATS because the SROs may find it advantageous to retain
OATS until CAT Data is at least as accurate as OATS data. However, the
CAT NMS Plan does not require a particular target Error Rate before
OATS can be retired and the Plan does not estimate any cost savings
associated with the retirement of OATS or other systems, beyond those
resulting from the end of a period of costly duplicative reporting.
Therefore, any acceleration in the retirement of OATS would not provide
a direct benefit resulting from a lower Error Rate. Further, the error
rates in OATS may not be comparable to the Error Rates in CAT Data
because the algorithm that identifies errors in CAT Data is unlikely to
be identical to the algorithm that identifies errors in OATS. In
particular, the Plan requires some types of validation checks on CAT
Data that OATS data does not go through. These additional validation
checks will help to ensure the accuracy of information types not
currently collected by OATS such as Customer Account Information, Firm
Designated
[[Page 30766]]
ID, and options information, or to ensure the accuracy of information
necessary for the order lifecycle linking process.\1262\ Consequently,
the Commission cannot be sure of the specific CAT Error Rate that would
accelerate retirement of OATS. In addition, the Commission does not
have cost estimates for different maximum Error Rates because such
information was not provided in the CAT NMS Plan.
---------------------------------------------------------------------------
\1262\ See CAT NMS Plan, supra note 3, at Appendix C, Sections
A.1(a)(iii) and A.3(a) and Appendix D, Section 7.2 for a discussion
of the types of required validations of CAT Data.
---------------------------------------------------------------------------
While reducing error rates may have these potential benefits, the
Commission recognizes that it would also come at a cost. In particular,
reducing Error Rates could increase the implementation and ongoing
costs incurred by CAT Reporters and the Central Repository as compared
to costs estimated in the Plan, as filed. To achieve lower Error Rates,
some CAT Reporters might have to run additional validation checks on
their data before sending their data to the Central Repository. Such
CAT Reporters would incur additional costs to code and test any
additional validation checks prior to implementation. CAT Reporters
might also have to monitor and adjust their validation checks to
respond to Error Rate reports from the Central Repository, incurring
additional ongoing costs. However, the CAT Reporters already achieving
lower Error Rates might not require additional checks, adjustments, or
monitoring. Additionally, the Commission preliminarily believes that
costs incurred by CAT Reporters to reduce error rates prior to sending
data to the Central Repository may ultimately result in lower costs
associated with correcting errors after the data is sent. The
Commission also notes that the costs incurred would depend in part on
the format in which data is reported to the Central Repository, which
has yet to be determined. If a solution is chosen that requires the
reformatting of data, and this reformatting results in errors, then the
costs could be higher. Conversely, a solution that does not require
data reformatting could result in a lower Error Rate with lower costs
to CAT Reporters.
Additionally, the Plan contains provisions that require the Plan
Processor to monitor and address Error Rates. For example, the Plan
Processor is required to notify each CAT Reporter that exceeds the
maximum Error Rate, and provide the specific reporting requirements
that they did not fully meet. Requiring a lower Error Rate could
increase the costs of these provisions, as compared to the costs
estimated in the Plan as filed, because more CAT Reporters would exceed
the Error Rate at which penalties are levied by the Plan Processor.
d. Error Correction Timeline
The Commission is soliciting comment on an alternative error
correction timeline to that proposed in the CAT NMS Plan. The CAT NMS
Plan proposes a deadline of T+3 for submission of corrected data to the
Central Repository.\1263\ The CAT NMS Plan also discusses
recommendations from FIF and SIFMA to impose a day T+5 deadline, which
is the current standard for OATS.\1264\ The Participants state in the
CAT NMS Plan that they believe it is important to retain the day T+3
deadline in order to make data available to regulators as soon as
possible.\1265\
---------------------------------------------------------------------------
\1263\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(a)(iv).
\1264\ Id.
\1265\ Id.
---------------------------------------------------------------------------
The Commission is soliciting comment on whether the CAT NMS Plan
should impose a day T+5 deadline rather than the day T+3 deadline. In
comment letters submitted to the Participants, FIF and SIFMA maintain
that the day T+3 deadline may not be feasible and would prove costly to
market participants.\1266\ The alternative of a day T+5 deadline could
reduce the costs relative to the CAT NMS Plan for CAT Reporters. The
Commission preliminarily believes that the delays in regulatory access
from a day T+5 deadline would significantly reduce regulators' ability
to conduct surveillance and slow the response to market events relative
to the CAT NMS Plan. However, the Commission also believes that day T+5
error correction may reduce costs to industry relative to the CAT NMS
Plan, although the Commission is unaware of any cost estimates that
have been provided to date.
---------------------------------------------------------------------------
\1266\ See Letter from Manisha Kimmel, Managing Director, FIF,
to the Participants, dated November 19, 2014, available at http://www.catnmsplan.com/industryfeedback/p601972.pdf; Industry
Recommendations for the Creation of a Consolidated Audit Trail
(CAT), SIFMA, March 28, 2013, available at http://www.catnmsplan.com/industryfeedback/p242319.pdf.
---------------------------------------------------------------------------
e. Funding Model
The mechanism by which CAT fees are allocated is important because
it can potentially disadvantage particular business models. Although
the Plan does not discuss the final details of the CAT funding model,
it does provide some details, including a set of funding principles
that the Participants have discussed with the Development Advisory
Group. The Commission is soliciting comment on alternative mechanisms
for allocating fees across Execution Venues and across Industry
Members.
The CAT NMS Plan presents details regarding an allocation of costs
between the Execution Venues and the other Industry Members (i.e.,
broker-dealers), but does not detail the proportions of fees to be
borne by each group. Under the CAT NMS Plan, fees would be tiered by
activity levels, with market participants within a given tier incurring
a fixed fee.\1267\ In the case of Execution Venues (exchanges and
ATSs), market share of share volume would determine the tier of the
Execution Venue. In the case of broker-dealers, fees would be allocated
by message traffic. The Commission is cognizant that ATSs are operated
by broker-dealers, complicating this division of fees between broker-
dealers and Execution Venues. This is discussed further below.
---------------------------------------------------------------------------
\1267\ For a discussion of the economic effect of the tiered
structure, see IV.F.4.c, supra.
---------------------------------------------------------------------------
(1) Unified Funding Models
The Commission is soliciting comment on several unified funding
models as alternatives to the Plan's bifurcated funding model. One of
the alternative funding models the Commission is soliciting comment on
is a unified funding model in which Central Repository costs are
allocated across all market participants (including Execution Venues)
by message traffic. The Commission expects that message traffic will be
a primary cost driver for the Central Repository, because transactional
volume (which is cited by the Plan as a primary cost driver for the
Central repository) is highly correlated with message traffic.
Consequently, assessing CAT costs on market participants by message
traffic may have the benefit of aligning market participants'
incentives with the Participants' stated goal of minimizing costs.
However, the Commission is also aware that while a broker-dealer's
choice of business model is likely to determine its level of message
activity, the majority of an exchange's message traffic is passive
receipt of quote updates.\1268\ Because quotes must be updated on all
exchanges when prices change, exchanges with low market share are
likely to have more message
[[Page 30767]]
traffic (incurring CAT fees) per executed transaction (generating
revenue).\1269\ Consequently, a model that charges exchanges for the
passive receipt of messages from broker-dealers is likely to
disadvantage the smaller exchanges relative to a model that charges for
market share of executions.
---------------------------------------------------------------------------
\1268\ Using MIDAS data, Commission staff analyzed the number of
equity exchange proprietary feed messages and trades during the week
of October 12, 2015. The message per trade ratio varied across
exchanges from 38.46 to 987.17, with a median of 57.21.
\1269\ Commission staff data analysis confirms this for the
smallest exchanges. Except for the smallest exchanges, the trade to
message ratios range from about 0.016 trades for every quote update
to about 0.026 trades for every quote update and appear constant
across market share levels. However, the smallest exchanges by
market share have only about 0.001 trades for every quote update to
about 0.009 trades for every quote update.
---------------------------------------------------------------------------
The Commission is also soliciting comment on an alternative
approach to reporting market maker quotations on exchanges that could
address this concern. In this approach, market makers (both equity and
options) would not need to report their quotation updates. Exchanges
(both equity and options) would report quotation sent times (as
detailed in the Plan with regard to Options Market Makers and the
Exemption Request \1270\). Exchanges would not be assessed message
traffic fees for these quotation updates; the broker-dealers who sent
the quotes would be assessed for this message traffic. All other
message traffic, regardless of which market participant initiated it,
would be assessed fees associated with CAT using a common rate formula.
---------------------------------------------------------------------------
\1270\ See Exemption Order, supra note 18, at 7-8.
---------------------------------------------------------------------------
The Commission is soliciting comment on this alternative for a
number of reasons. First, it ties CAT costs to a primary driver of the
magnitude of Central Repository costs: message traffic.\1271\ Second,
it substantially reduces the number of messages stored in the Central
Repository. Third, it avoids disadvantaging smaller exchanges whose
message traffic may be relatively large compared to their execution
volume. Finally, this alternative avoids bifurcated fee approaches that
may cause one Execution Venue to be relatively cheaper than another due
to the manner in which CAT fees are assessed and may cause conflicts of
interest for broker-dealers routing customer orders.\1272\ However,
this alternative assesses CAT fees based on messages rather than the
revenue-generating activity of trades. This may provide market
participants with incentives to change their business models to reduce
CAT fees, which could lead to reduced quotation activity that could be
detrimental to market liquidity levels. Furthermore, because the vast
majority of message activity originates with broker-dealers, this
approach necessarily shifts most of the ultimate CAT funding burden to
broker-dealers.
---------------------------------------------------------------------------
\1271\ See Section IV.F.1.a, supra, stating that transactional
volume is a primary driver of the costs of the Central Repository.
The Commission preliminarily believes that transactional volume is
highly correlated with message traffic.
\1272\ For example, if the CAT funding model were set to make
ATS trades significantly more costly relative to exchange trades,
the exchanges might benefit from increased market share because ATSs
might be compelled to increase their access fees to offset the
proportionately higher CAT charges that they would incur. In the
extreme, some ATSs might cease operations or seek to register as
exchanges. Most ATSs do not disseminate quotation information;
exchanges are required to do so. Reorganizing an ATS as an exchange
therefore involves significant changes to its business model.
Consequently, the Commission believes it unlikely that many ATSs
would register as exchanges to avoid proportionately higher CAT
charges. If certain types of trades have lower costs when their
trades execute on an ATS, their trading costs would increase if they
are forced onto exchanges. If some trades would not happen in the
absence of an ATS, this would drive down overall trading volumes (as
opposed to a shift from ATS to exchange). Lower overall trading
volumes would be considered welfare-reducing, as they indicate
foregone gains from trade.
---------------------------------------------------------------------------
The Commission also is soliciting comment on a second alternative
approach to CAT funding, a unified funding approach where the tiers in
the funding model are based on market share of share volume. Under this
approach, all market participants (both exchanges and broker-dealers)
would qualify for a tier based on reported share volumes. Share volume
would count equally toward the tier regardless of the Execution Venue
selected by the broker-dealer originating the order. However, this
approach does not align the costs of operating and maintaining the
Central Repository, which would largely depend on message traffic, with
the fees charged to market participants. Furthermore, it is possible
that some Execution Venues could compete for order flow by not passing
this fee on to their customers, generating the same limitations as
discussed above for the funding model in the Plan.\1273\
---------------------------------------------------------------------------
\1273\ See Section IV.F.4.c, supra.
---------------------------------------------------------------------------
A third alternative would be for the funding model to impose fees
on every individual trade instead of imposing a fixed fee by tier. This
approach has several benefits. First, the Commission preliminarily
believes that implementation costs for this approach are likely to be
lower than other alternatives because infrastructure already exists to
levy fees on each trade (this is the mechanism by which Section 31 fees
are levied).\1274\ Second, it ties fees to the revenue-generating
activity of trading, rather than quoting activity, which results in
those more likely to afford high fees paying the higher fees. Quoting
activity provides liquidity to the market, but often does not
necessarily result in an execution that can bring revenue to the market
participant placing the quote; consequently, levying CAT fees on trades
avoids making a generally desirable activity (posting liquidity) more
costly.\1275\ Third, it avoids the problems that may accompany a
bifurcated approach to CAT cost allocation. Because the fee is levied
regardless of where the trade occurs, it limits incentives of market
participants to route to exchanges to avoid message traffic fees within
broker-dealers or to avoid exposing an order in multiple venues to try
to find non-displayed liquidity. These liquidity-seeking activities
might reduce a client's trading costs, but they also potentially incur
message traffic fees, creating a conflict of interest for broker-
dealers.
---------------------------------------------------------------------------
\1274\ Under Section 31 of the Act, 15 U.S.C. 78ee, and Rule 31
thereunder, 17 CFR 240.31, SROs such as FINRA and the national
securities exchanges must pay transaction fees to the SEC based on
the volume of securities that are sold on their markets. These fees
are designed to recover the costs incurred by the government,
including the SEC, for supervising and regulating the securities
markets and securities professionals. The SROs have adopted rules
that require their broker-dealer members to pay a share of these
fees. Broker-dealers, in turn, may impose fees on their customers
that provide the funds to pay the fees owed to their SROs. See SEC,
Section 31 Transaction Fees (September 25, 2013), available at
http://www.sec.gov/answers/sec31.htm.
\1275\ Some quoting behavior may be costly to the market, for
example spoofing or layering. This analysis assumes that message
traffic fees associated with this undesirable behavior would not be
sufficient to reduce that behavior. If that assumption is false,
funding models that assign fees to quotes have the additional
benefit of reducing disruptive activity. The Commission
preliminarily believes that the benefits of reducing disruptive
quoting activity via levying fees on quotes would not justify the
costs of reducing beneficial quoting activity through the same fees.
---------------------------------------------------------------------------
Assessing fees directly on trades entails certain costs as well.
First, it does not provide incentives for market participants to limit
their message traffic, which is a primary cost-driver for the Central
Repository. Second, it does not provide the benefits of a tiered
approach, which the CAT NMS Plan lists as including transparency,
predictability and ease of calculation.\1276\
---------------------------------------------------------------------------
\1276\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(v)(B).
---------------------------------------------------------------------------
(2) Bifurcated Funding Models
The Commission is also soliciting comment on alternatives to the
funding model proposed in the CAT NMS Plan that would also be
bifurcated. One alternative would be to allocate CAT costs to broker-
dealers by market share of share volume while retaining the Plan's
funding model for Execution
[[Page 30768]]
Venues.\1277\ A benefit of this alternative would be to avoid
disincentives to liquidity provision operations, particularly for
infrequently traded securities and high volatility securities. A
disadvantage of this approach would be that it does not align the fees
charged to a CAT Reporter with the costs those CAT Reporters impose on
the Central Repository in terms of message traffic, potentially
resulting in disproportionate charges to CAT Reporters because high
message traffic broker-dealers would pay no more than low message-
traffic broker-dealers with the same level of trading activity.
---------------------------------------------------------------------------
\1277\ SROs currently fund their regulatory data collection
through a number of mechanisms. The Commission notes that FINRA does
not charge its members for OATS directly. Rather, it is funded from
FINRA's regulatory budget, which is collected from its members
through various membership fees. The options exchanges charge an
Options Regulatory Fee (``ORF''), which is a pass-through exchange
fee collected by OCC clearing members on behalf of the U.S. option
exchanges. The stated purpose of the fee is to assist in offsetting
exchange costs relating to the supervision and regulation of the
options market (e.g., routine surveillance, investigations, and
policy, rule-making, interpretive and enforcement activities). The
fee was first adopted by CBOE in 2008. See Securities Exchange Act
Release No. 58817 (October 20, 2008), 73 FR 63744 (October 27,
2008). Subsequently, PHLX (Securities Exchange Act Release No. 61133
(December 9, 2009), 74 FR 66715 (December 16, 2009), ISE (Securities
Exchange Act Release No. 61154 (December 11, 2010, 74 FR 67278
(December 18, 2009)), BOX (See Securities Exchange Act Release No.
61388 (January 20, 2010), 75 FR 4431(January 27, 2010)), NYSEAmex
(Securities Exchange Act Release No. 64400 (May 4, 2011), 76 FR
27114 (May 10, 2011), NYSE Arca (Securities Exchange Act Release No.
64399 (May 4, 2011), 76 FR 27114 (May 10, 2011), NASDAQ (Securities
Exchange Act Release No. 66158 (January 13, 2012), 77 FR 3024
(January 20, 2012, C2 (Securities Exchange Act Release No. 67596
(August 6, 2012), 77 FR 47902 (August 10, 2012)), MIAX (Securities
Exchange Act Release No. 68711 (January 23, 2013), 78 FR 6155
(January 29, 2013)), ISE Gemini (Securities Exchange Act Release No.
70200 (August 14, 2013), 78 FR 51242 (August 20, 2013)), and BATS
(Securities Exchange Act Release No. 74214 (February 5, 2105), 80 FR
7665 (February 11, 2015)) also adopted an ORF. The OFR is currently
assessed to customer orders at a rate of $0.0417 per U.S. exchange
listed option contract. The ORF is assessed on all trades, both buys
and sells. Further, FINRA charges fees for reporting to TRACE.
Certain fees are based on the number of users and type of connection
a firm has to the system, and others are based on size of the
transaction. See FINRA Rule 7730.
---------------------------------------------------------------------------
The Commission is further soliciting comment on the alternative of
requiring the CAT NMS Plan to treat ATSs only as broker-dealers for
funding purposes, instead of treating ATSs as Execution Venues. Under
this alternative, firms that operate ATSs would not be charged for both
their ATS's market share of share volume (like an exchange) and its
message traffic (as a broker-dealer).\1278\ Instead, the firm operating
the ATS would pay fees based on the ATS's message traffic as part of
its operations as a broker-dealer, rather than as an Execution Venue as
well, for fee purposes. As described in Section IV.F.4.d, the
Commission preliminarily believes that under the current funding model
in the CAT NMS Plan, the cost differentials that result might create
incentives for broker-dealers to route order flow to minimize costs,
creating a potential conflict of interest with broker-dealers' investor
customers, who are likely to consider many facets of execution quality
(such as price impact of a trade and probability of execution in a
venue in which the order is exposed) in addition to any of these costs
that are passed on to them.\1279\ The Commission is aware that this
alternative would, in effect, shift part of the Central Repository
funding costs from broker-dealers to Execution Venues because volume
transacted on ATSs would not be assessed a portion of the Execution
Venue funding burden and this portion would instead be allocated to
exchanges. Furthermore, the Commission is aware that it is possible
that under this alternative approach, ATSs might pay less in fees than
similarly situated exchanges, which could disadvantage exchanges
relative to ATSs.
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\1278\ As explained in Section IV.F.4.c, supra, the Commission
preliminarily believes that the bifurcated funding model proposed in
the Plan results in differential CAT costs between Execution Venues
because it would assess fees differently on exchanges and ATSs for
two reasons. First, message traffic to and from an ATS would
generate fee obligations on the broker-dealer that sponsors the ATS,
while exchanges incur no message traffic fees. Second, broker-
dealers that internalize off-exchange order flow, generating off-
exchange transactions outside of ATSs, would face a differential
funding model compared to ATSs and exchanges.
\1279\ See CAT NMS Plan, supra note 3, at Article VIII.
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The Commission is also soliciting comment on the alternative
approach of not charging broker-dealers for message traffic to and from
their ATSs while still assessing fees to ATSs as Execution Venues or
exchange broker-dealers for their message traffic. Under this
alternative, broker-dealers that operate ATSs would pay trading volume
based fees on their ATSs volume in the same manner as exchanges' fees
are assessed. However, the message traffic to and from the ATS would
not be included in the message traffic used to calculate fees assessed
to the broker-dealer that sponsors the ATS. The Commission
preliminarily believes this alternative would help mitigate the broker-
dealer routing incentives discussed above. The Commission is aware that
because the volume executed on ATSs would be included in the portion of
Central Repository funding assigned to Execution Venues, this funding
approach would not shift part of the funding burden assigned to
Execution Venues away from ATSs (and the broker-dealers that operate
them) to exchanges as the previous alternative would.
The Commission preliminarily believes that either of these ATS-
related funding alternative approaches would avoid disadvantaging ATSs
relative to similarly situated exchanges, and would be less likely to
result in the conflicts of interest in routing described above.
Currently, the Commission lacks sufficient details on the fee structure
to make this determination, because the fee structure has not yet been
finalized.
The Commission is also soliciting comment on the alternative of
excluding ATS volume from TRF volume for purposes of allocating fees
across Execution Venues. Under this alternative, SROs that operate TRFs
(currently only FINRA) would not pay Execution Venue fees for volume
that originated from an ATS execution. This alternative would avoid the
problem of double-counting ATS volume as share volume, which originates
because each ATS trade is counted for fee-levying purposes as share
volume associated with an ATS, then counted again as share volume when
the trade is printed to a TRF. However, the Commission notes that other
over the counter volume, such as occurs when orders are executed off-
exchange against a broker-dealer's inventory, would be assessed share
volume fees while the message traffic that resulted in this execution
would also be subject to fees through the broker-dealers that had order
events related to these transactions. This contrasts to executions that
occur on exchanges, where the venue that facilitates the execution does
not pay fees for message traffic that led to the execution.
The Commission is also soliciting comment on the alternative of not
treating the Trade Reporting Facilities (``TRFs'') as FINRA Execution
Venues. TRFs capture ATS share volume, which is already subject to fees
allocated to Execution Venues, and non-ATS off-exchange share volume,
which is subject to CAT fees allocated to broker-dealer message
traffic. Consequently, under the approach in the Plan, the activity
that generates a TRF trade report is already assessed CAT fees through
the broker-dealers that facilitate the trade, or the ATSs that served
as the Execution Venue. Under this alternative approach, FINRA would
not pay any fees directly into the Central Repository, and broker-
dealers would only incur fees directly levied on them by the Operating
Committee, rather than also
[[Page 30769]]
indirectly paying the TRF fees passed on to them by FINRA. If FINRA
does not pay fees directly to the Central Repository, this could alter
its incentives with respect to matters of cost voted on by the
Operating Committee. However, it is possible that, since FINRA
represents the viewpoints of its broker-dealer members, its incentives
would be similar under either approach.
The CAT NMS Plan would allocate net profit or net loss from the
operation of the CAT equally among the Participants, regardless of
size, which could advantage small exchanges in the event of a profit
and disadvantage small exchanges in the event of a loss. This could
negatively impact competition if the cost differentials are significant
enough to alter the set of services that some competitors offer. As an
alternative, the Commission is soliciting comment on whether the profit
or loss from operating CAT should be allocated across Participants by
market share of share volume, consistent with how the CAT costs would
be allocated under the Plan.\1280\ The Commission preliminarily
believes that this alternative would limit the possibility of
extraordinary profits or losses from CAT resulting in a
disproportionate advantage or disadvantage to exchanges with low
trading volume.
---------------------------------------------------------------------------
\1280\ Id.
---------------------------------------------------------------------------
Finally, the Commission is soliciting comment on requiring a
strictly variable funding model, rather than the fixed-tiered model in
the CAT NMS Plan. Under a variable funding model, each trade or message
is subject to a fee, rather than a broker-dealer incurring a fixed fee
that depends on that broker-dealer's volume tier.\1281\ The Commission
preliminarily believes that this alternative might increase
administrative costs of the CAT NMS Plan as compared to an approach
that uses the fixed-tiered funding model. However, the Commission also
preliminarily believes that the fixed-tiered funding model can create
incentives for market participants to change their behavior to avoid
fees when their activity is near the boundary between two tier
levels.\1282\ The Commission preliminarily believes that a strictly
variable funding model could reduce inefficiencies resulting from
market participants changing their behavior to move into a lower fee
tier.
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\1281\ For example, under a fixed-tiered funding approach, any
broker-dealer with no more than 10,000 CAT Reportable Events in a
given month might pay $100 in fees, even a broker-dealer reporting a
single event. Under a strictly variable funding approach, every
broker-dealer CAT message might be assessed one cent in fees. For a
broker-dealer reporting 10,000 CAT Reportable Events in a given
month, the same fee burden would be incurred, but a broker-dealer
reporting a single CAT reportable event would pay only one cent.
\1282\ See Section IV.F.3.b, supra.
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f. Requiring Listing Exchange Symbology
The Commission is soliciting comment on an alternative to the CAT
NMS Plan that would allow CAT Reporters to report using their existing
symbologies, rather than listing exchange symbology. The Plan requires
the Plan Processor maintain a complete symbology database, including
the historical symbology. The CAT NMS Plan also requires CAT Reporters
to report data using the listing exchange symbology format, which would
be used in the display of linked data. The CAT NMS Plan also requires
Participants to provide the Plan Processor with the issue symbol
information, and validation of symbology would be part of data
validation performed by the Plan Processor.\1283\
---------------------------------------------------------------------------
\1283\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(a).
---------------------------------------------------------------------------
The Commission preliminarily believes that, in light of the
proposed requirement for the Plan Processor to maintain a complete
symbology database, the requirement that CAT Reporters report using
listing exchange symbology may result in unnecessary costs to CAT
Reporters. Therefore, the Commission preliminarily believes that the
alternative of allowing CAT Reporters to use their existing symbologies
for reporting purposes could significantly reduce the costs for
exchanges and broker-dealers to report order events to the Central
Repository, as compared to the approach in the CAT NMS as filed,
without a significant impact on the expected benefits of the Plan or
the costs to operate the Central Repository.
Currently, Execution Venues handle complex symbology in different
fashions. Some common stocks, for example, have multiple classes of
shares. Exactly specifying the issue to be traded involves identifying
the ticker symbol and sometimes a share class. On some venues, the
convention is that these security types are reported without a
delimiter in the symbol; other venues use a delimiter, and delimiters
can vary across venues. For example, assume a firm has a listing symbol
of ABC, and has two classes of shares, A and B. An issue might be ``ABC
A'' on one venue, ``ABC_A'' on another, and ``ABCA'' on a third. This
can cause numerous problems for analyses that extend beyond a single
trading venue, particularly if ``ABCA'' is the complete listing symbol
for an unrelated security. As mentioned in the Benefits Section, the
inclusion of the complete symbol history of a security and the
requirement for queries, reports, and searches to automatically collect
the appropriate data despite symbol changes promotes accurate query
responses by ensuring the inclusion of order events that might have
been excluded because of symbology differences and by excluding order
events in unrelated securities. The Commission preliminarily believes
that the CAT NMS Plan can achieve these benefits without requiring CAT
Reporters to report using listing exchange symbology.
As discussed in the Costs Section, one potential cost driver to CAT
Reporters is the need to process reports before submitting them to the
Central Repository.\1284\ If reports can contain drop copies from an
order management system, CAT Reporters can aggregate their drop copies
and send them without further processing the reports. If, on the other
hand, CAT Reporters need to transform or add any fields to the report,
those CAT Reporters would need to develop, test, and maintain code to
run the transformation, and they would need to actually transform the
data at least once a day. If CAT Reporters do not need to run this
transformation at all, they could save money. The Commission
preliminarily believes that the requirement to report in listing
exchange symbology could be the only requirement that necessitates that
CAT Reporters transform data before reporting it to the Central
Repository.\1285\ Therefore, the Commission preliminarily believes that
eliminating this requirement could reduce costs relative to the CAT NMS
Plan as filed.
---------------------------------------------------------------------------
\1284\ See Section IV.F.3.a, supra.
\1285\ See id.
---------------------------------------------------------------------------
Some broker-dealers may already have adequate computational
resources to run the transformation, whether at once, in batches, or in
real-time; others could have to invest in such resources--an investment
that would be saved by eliminating the requirement to use listing
exchange symbology. The degree of cost savings would depend on any
requirements to transform the data prior to reporting, which depends on
the allowable formats for transmission. The CAT NMS Plan does not
specify the allowable formats or whether the Central Repository would
require a fixed format. If the Technical Specifications require a fixed
format, broker-dealers would most likely have
[[Page 30770]]
to transform their data prior to reporting it to the Central Repository
regardless of the requirement to use listing exchange symbology, and
the listing exchange symbol requirement could add very little to the
reporting costs. Therefore, the Commission recognizes significant
uncertainty in the cost savings associated with this alternative.
Further, the Commission cannot estimate the degree to which
eliminating this requirement could reduce costs as compared to those in
the CAT NMS Plan as filed, because it lacks the data to do so. The Plan
assumes the need to transform the data to match exchange symbologies
and therefore does not separately itemize the cost for transformation
as a separate step in the reporting process. The Commission has no data
from which it can independently estimate the cost differential because
it depends on information internal to each of a heterogeneous group of
CAT Reporters (e.g., the symbologies their current systems use and
whether those are readily transformed to match listing exchange
symbologies), which information is not compiled or stored anywhere and
to which the Commission therefore does not have ready access.
g. Data Accessibility Standards
The Commission is soliciting comment on alternative approaches to
the manner in which the CAT NMS Plan provides data access to
regulators. Section IV.E.1.c of the CAT NMS Plan summarizes the Central
Repository's requirements to provide access to regulators. This access
would include both an online targeted query tool and a user-defined
direct query or bulk extract.\1286\ The CAT NMS Plan also specifies
minimum standards the Central Repository must meet, such as capacity to
support 3,000 minimum regulatory users and minimum acceptable response
times for queries of varying complexity and size.\1287\ The CAT NMS
Plan also requires that the Plan Processor provide an open API that
allows use of regulator-supplied common analytic tools. As discussed
above, the CAT NMS Plan could result in many improvements to regulatory
activities such as surveillance, examinations, and enforcement, but
these benefits may not be fully realized if access to data is
cumbersome or inefficient.\1288\ The Commission does not have
information on the incremental benefits and costs of each aspect of
regulator access as would be necessary to analyze specific alternatives
to the many data access standards in the CAT NMS Plan.
---------------------------------------------------------------------------
\1286\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.2(c).
\1287\ Id. at Appendix C, Section A.1(b).
\1288\ See Section IV.E.2, supra.
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The Commission is generally soliciting comment on alternatives to
each minimum data accessibility standard required in the CAT NMS Plan.
With multiple standards that could each be adjusted in countless ways,
the set of possibilities is infinite, which precludes their enumeration
and discussion within this analysis. Instead, this Section discusses
several examples and requests comment on alternative standards that
might be adopted. Because query response time standards provide exact
limits, the Commission uses those to illustrate how changing the
standards could affect benefits and costs. The CAT NMS Plan requires
query responses for various types of queries of 5 minutes, 10 minutes,
3 hours, and 24 hours, where the simplest queries involving scanning
narrow sets of data would be required to return in 5 minutes and
complex queries scanning multiple days of data and returning large
datasets would be required to return within 24 hours.
The Commission notes that particularly large and complex data
queries can take extensive computing resources. While the benefits of
direct access to CAT Data depend on reasonably fast query responses,
the Commission recognizes that faster query response times come at a
cost. The Commission does not have detailed information on significant
breakpoints in those costs to judge whether slightly longer response
times than those in the Plan could significantly reduce the costs of
developing, maintaining, and operating the Central Repository. For
example, the Commission does not know whether a 48-hour response time
on a query of 5 years of data is significantly less expensive than a 24
hour response time, but either maximum response time would provide a
significant improvement in timeliness over current data. Likewise, the
Commission does not know whether the response times could be faster
without a significant increase in costs. The Commission recognizes that
the detailed information on numerous other minimum standards regarding
access to regulators is similarly unclear. Therefore, the Commission
requests comment regarding all standards for regulatory access and
whether technology creates natural breakpoints in costs such that a
particular alternative could reduce the costs of the Plan without
significantly reducing benefits or could increase benefits without
significantly increasing costs.
h. Intake Capacity Levels
The Commission is soliciting comment on alternatives to the intake
capacity level required in the CAT NMS Plan. The CAT NMS Plan requires
that the Central Repository have an intake capacity of twice historical
peak daily volume measured over the most recent six years and the
ability to handle peaks beyond this Baseline level for short
periods.\1289\ In setting this requirement, the Participants could have
selected any number of alternative intake capacity standards.
---------------------------------------------------------------------------
\1289\ See CAT NMS Plan, supra note 3, at Appendix D, Section
1.1.
---------------------------------------------------------------------------
The Commission performed an analysis using MIDAS data and
determined that, for equities, the daily message traffic volume would
exceed two times the maximum daily message volume from the previous six
years (2010 through 2015) with a probability of 0.033%, which amounts
to the intake exceeding capacity levels about once every 8\1/3\ years.
Message volume measures all equity messages, including orders, order
updates, executions and cancellations, from MIDAS exchange direct
feeds, consolidated SIP feeds, and a small portion of the FINRA ATS
feed.\1290\
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\1290\ The Commission collected daily message volume from MIDAS
for six years (January 1, 2010 through November 19, 2015) and found
that August 10, 2011 generated the highest message traffic with 8.6
billion messages. A Box-Cox transformation was applied to the data
to fit it into a normal distribution. Using a probability density
function to fit the transformed data into a normal distribution, the
Commission found the probability that the daily message volume would
exceed 17.2 billion (twice the maximum) messages is 0.033%. The
MIDAS data used are all equity messages between 4 a.m. and 7 p.m. on
trading days--including orders, order updates, executions, and
cancellations--from exchange direct feeds, consolidated SIP feeds,
and a small portion of the FINRA ATS feed. MIDAS does not receive
messages before 4 a.m. and after 7 p.m. from its feed sources. The
data is missing AMEX feeds from January 1, 2010 through October 4,
2010; however, on average AMEX messages represent only 0.26% of
daily message volume from all feeds.
---------------------------------------------------------------------------
The Commission preliminarily believes that intake capacity level is
likely to be a primary cost driver for the Central Repository.\1291\ In
selecting a standard, there is a trade-off between additional cost for
constructing and operating the Central Repository and the risk that
increased volume could exceed the Central Repository's capacity. If the
capacity were exceeded, the Commission preliminarily believes that
regulators' access to CAT Data could be
[[Page 30771]]
significantly delayed. The Commission is cognizant that periods of
heavy market activity are more likely to be periods with market events
that would require regulatory investigation, so the risk that the
Central Repository might not be able to provide timely access to data
when it is most needed is concerning.
---------------------------------------------------------------------------
\1291\ Transactional volume and the growth in transactional
volume is likely a primary driver of the costs of the Central
Repository. See Section IV.F.1.a, supra. The Commission believes
that higher transactional volumes require higher intake capacity
levels, higher storage capacity, and higher processing capacity.
---------------------------------------------------------------------------
The Commission is soliciting comment on requiring a different
intake capacity level. Alternative intake capacity levels would result
in costs and benefits that depend on the specific alternative capacity
level and whether it is higher or lower than the proposed level. For an
alternative with a lower intake capacity level, such as 1.5 times the
historic peak capacity level, the cost of creating and operating the
Central Repository might be lower, but the risk that the Central
Repository would be unable to meet regulator's data needs would be
higher than under the CAT NMS Plan, particularly following events
similar to the Flash Crash and August 24th, which created both a high
volume of trading records and a high demand for timely regulatory
analysis.
An alternative with a higher required intake capacity level, such
as 3 times the historic peak capacity level, would likely entail higher
costs than the CAT NMS Plan, but higher intake capacity levels would
reduce the risk of the Central Repository being unable to meet
regulators' data needs and thus increase the benefits of the Plan.
The CAT NMS Plan does not provide sufficient information for the
Commission to quantify the cost difference between alternative intake
capacities and the intake capacity in the CAT NMS Plan and there are no
analogous projects of this scope with publicly-available data from
bidding or otherwise from which the Commission could extrapolate.
3. Alternatives to the Scope of Certain Specific Elements in the CAT
NMS Plan
The Commission notes that Rule 613 sets forth the minimum elements
the Commission believes are necessary for an effective consolidated
audit trail.\1292\ The Commission also notes that it adopted these
elements after notice and comment, including analyzing comment letters
submitted in response to the Rule 613 Proposing Release.\1293\
Moreover, the Participants, pursuant to Rule 613, analyzed and proposed
for inclusion in the CAT NMS Plan certain elements after consultation
with their members, the Bidders and the DAG.\1294\
---------------------------------------------------------------------------
\1292\ See Adopting Release, supra note 9.
\1293\ See id.
\1294\ See CAT NMS Plan, supra note 3.
---------------------------------------------------------------------------
While the Commission and the SROs have previously analyzed Rule
613, including the elements to be included in the CAT NMS Plan, the
Commission now has the Plan, together with the cost and alternatives
analysis provided by the Participants. The Commission has reviewed the
Plan, including the cost estimates, and has performed its own economic
analysis of the Plan. With the benefit of having reviewed and analyzed
the Plan, the Commission believes that it is reasonable to solicit
comment on alternatives to the scope of certain elements of the CAT NMS
Plan because these alternatives could impact the cost and benefits of
CAT, and given the passage of time, there may be market developments
that could affect those costs and benefits that should be evaluated.
These alternatives include: (1) Not requiring certain data fields that
are currently required by the Plan; (2) requiring the Operating
Committee to consider including more primary market transactions than
it would otherwise be required to consider under the Plan; (3) removing
from the Plan the OTC Equity Securities recording and reporting
requirements; and (4) excluding certain Customer information periodic
update requirements.
a. Data Fields
Rule 613 provides that the Plan must require the reporting of
certain data fields.\1295\ It also gives discretion to the Participants
to require the reporting of data fields beyond the minimum set of
fields mandated by Rule 613.\1296\ The Commission is soliciting comment
on whether there should be changes to the data fields that would be
subject to CAT reporting. Specifically, the Commission is soliciting
comment on whether any data fields that would be subject to CAT
reporting under the Plan should be excluded.
---------------------------------------------------------------------------
\1295\ See 17 CFR 242.613(c)(7).
\1296\ Id.
---------------------------------------------------------------------------
The Commission is soliciting comment on whether any data fields
that would be subject to CAT reporting under the Plan should be
excluded. For example, Rule 613 required the Plan to include a unique
customer identifier. As discussed further in Section IV.H.1 above the
Commission granted the Participants an exemption from certain
requirements in Rule 613 so that the Plan could include an approach
whereby each broker-dealer would assign a unique Firm Designated ID to
each trading account, which would be linked to a set of identifying
information.\1297\ The Commission preliminarily believes that this
approach would reduce the costs of requiring the customer identifier as
compared to the Rule 613 approach.\1298\
---------------------------------------------------------------------------
\1297\ Using the Firm Designated ID and the other information
identifying the Customer that would be reported to the Central
Repository, the Plan Processor would then assign a unique Customer-
ID to each Customer. Upon original receipt or origination of an
order, broker-dealers would only be required to report the Firm
Designated ID on each new order, rather than using the Customer-ID.
See Exemption Order, supra note 18, at 14-15. Because the Plan
Processor would still assign a Customer-ID to each Customer under
the Customer Information Approach, the SROs are not requesting an
exemption from Rule 613(j)(5).
\1298\ See Section IV.H.1.b, supra.
---------------------------------------------------------------------------
As an alternative, the Commission could eliminate the requirement
to report customer identifiers. In the Adopting Release, the Commission
recognized that the implementation of the unique customer identifier
requirement might be complex and costly, and that the reporting of a
unique customer identifier would require SROs and their members to
modify their systems to comply with the Rule's requirements.\1299\
While the Commission preliminarily believes that eliminating the
customer identifier would reduce certain costs to industry associated
with the implementation and operation of CAT as compared to the Plan as
filed, without providing any additional material information, the
Commission preliminarily believes that such a change would limit the
benefits of the Plan significantly. As the Commission noted in the
Adopting Release for Rule 613, unique customer identifiers are vital to
the effectiveness of the consolidated audit trail, and the inclusion of
unique customer identifiers would 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. Further,
without the inclusion of unique customer identifiers, many of the
potential benefits of a consolidated audit trail would not be
achievable.\1300\
---------------------------------------------------------------------------
\1299\ See Adopting Release, supra note 9, at 45756.
\1300\ Id.
---------------------------------------------------------------------------
The Commission could also consider the alternative of excluding the
allocation time field from reporting requirements in the Allocation
Reports. Although this field is not currently required for
recordkeeping, some broker-dealers do already retain allocation time
information at the subaccount level in their trade blotters, though the
Commission does not have precise information on the prevalence of this
practice. The Commission preliminarily believes that removing
allocation time would significantly
[[Page 30772]]
reduce the benefits of the Plan because regulators currently undergo
significant difficulties to obtain allocation times and the allocation
times would be useful for enforcement investigations.\1301\ At the same
time, given the uncertainty in the current practices and the lack of
information on the costs of this field in the Plan, the Commission is
not sure how significant the cost savings of excluding the allocation
time field would be. The Commission preliminarily believes that the
substantial benefits of having allocation time at the subaccount level
available and relatively accessible for regulatory activities warrants
the costs associated with requiring CAT Reporters to include this field
in CAT Data and that these costs would be significantly mitigated to
the extent that CAT Reporters already retain this information.
---------------------------------------------------------------------------
\1301\ See Section IV.E.1.a, supra.
---------------------------------------------------------------------------
The Plan requires both the CAT-Reporter-ID for the broker-dealer
routing an order and the CAT-Reporter-ID for the broker-dealer
receiving a routed order to be reported to the Central Repository, both
when the order is routed and again when the routed order is received.
The Commission could eliminate the requirement to report the CAT-
Reporter-IDs when the routed order is received. However, while the
Commission preliminarily believes this might reduce the CAT Reporting
burden on some broker-dealers as compared to the Plan as filed, without
providing any additional material information, the Commission noted in
the Adopting Release that it does not believe the information reported
when the order is received would be duplicative. Instead, the
Commission noted that 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.\1302\ In addition, the Commission notes that 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.\1303\ The Commission also noted that it relies on such
data to improve its understanding of how markets operate and evolve,
including with respect to the development of new trading practices, the
analysis and reconstruction of atypical or novel market events, and the
implications of new market dynamics.\1304\
---------------------------------------------------------------------------
\1302\ See Adopting Release, supra note 9, at 45763.
\1303\ Id.
\1304\ Id.
---------------------------------------------------------------------------
The Commission preliminarily believes that, with respect to the
reporting of data fields required by Rule 613, the analysis in the
Adopting Release is still applicable and the elimination of these data
fields from the Plan would result in a failure to achieve many of the
significant potential benefits of the Plan. However, as noted above,
the costs or benefits of including particular fields in the Plan as
filed, may have changed due to technological advances and/or changes in
the nature of markets since Rule 613 was adopted. The Commission is
therefore soliciting comment on the benefits and drawbacks of
eliminating these and any other required data fields from the Plan.
b. Primary Market Transactions
The CAT NMS Plan does not require the reporting of any primary
market information to the Central Repository. However, as required by
Rule 613(i), the CAT NMS Plan commits to incorporating a discussion of
how and when to implement the inclusion of some primary market
information into a document outlining how additional Eligible
Securities could be reported to the Central Repository (the
``Discussion Document''), which would be jointly provided to the
Commission within six months after effectiveness of the Plan.\1305\
Additionally, as required by Rule 613(a)(1)(vi), the Plan includes a
discussion of the feasibility, benefits and costs of including primary
market transactions in the CAT NMS Plan.\1306\
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\1305\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.9. Section 6.11 of the Plan satisfies a requirement in 17 CFR
242.613(i) to plan for expansion.
\1306\ 17 CFR 242.613(a)(1)(vi); CAT NMS Plan, supra note 3, at
Appendix C, Section A.6.
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In its discussion of primary market transactions, the CAT NMS Plan
states that including some primary market allocation information in the
CAT NMS Plan would provide significant benefits without unreasonable
costs, while other allocation information would provide marginal
benefits at significantly higher cost.\1307\ Specifically, the
discussion in the CAT NMS Plan divides the primary market allocation
information into two categories: Top-account allocations and subaccount
allocations. Top-account allocations refer to allocations during the
book-building process to institutional clients and retail broker-
dealers. These allocations are conditional and can fluctuate until the
offering syndicate terminates. Top-account institutions and broker-
dealers make the subsequent subaccount allocations to the actual
accounts receiving the shares. The Plan concludes that, with respect to
primary market information, only the subaccount allocations would
provide significant benefits without unreasonable costs if they were to
be incorporated into the CAT.
---------------------------------------------------------------------------
\1307\ See id. at Appendix C, Section A.6(b)-(c).
---------------------------------------------------------------------------
Based on that discussion, the Plan states that ``the Participants
are supportive of considering the reporting of Primary Market
Transactions, but only at the subaccount level, and would incorporate
analysis of this requirement, including how and when to implement such
a requirement, into their document outlining how additional Eligible
Securities could be reported to the Central Repository, in accordance
with SEC Rule 613(i) and Section 6.11 of the Plan.'' \1308\ The Plan
therefore would limit the discussion of reporting primary market
transactions in the Discussion Document to the subaccount level. As an
alternative to the approach in the Plan, the Commission is soliciting
comment on whether to broaden the required scope of the discussion of
primary market allocation information in the Discussion Document to
include an analysis of incorporating both top-account and subaccount
information for primary market transactions into the CAT. The
Commission preliminarily believes that the potential benefits of
including top-account information in the CAT could be significant and
that the costs of including top-account information could be lower than
what is described in the CAT NMS Plan and appropriate in light of
significant potential benefits. For these reasons, the Commission
preliminarily believes that top-account information should not be
excluded from the Discussion Document.
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\1308\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.6(c).
---------------------------------------------------------------------------
Some primary market information is currently available to
regulators. FINRA collects primary market allocation information on the
initial and final list of distribution participants in their
Distribution Manager. Based on discussions with Participants, the
Commission understands that issuers of IPOs are required to report
primary market allocations to broker-dealers within the Distribution
Manager, but reported information does not contain broker-dealer
customer information on those allocations. Primary market allocations
to market participants other than broker-dealers can be voluntarily
reported to the system. FINRA uses this system in the course of
investigations in response to complaints and in normal
[[Page 30773]]
examinations of broker-dealers. The Commission can request data from
the Distribution Manager. When the Commission or an SRO needs
additional primary market information, they request it from
underwriters and other broker-dealers in the offering process. These ad
hoc data requests can take weeks for underwriters to process and, if
requesting data from multiple underwriters or other broker-dealers,
each could submit the data in a different format or with different data
definitions, adding time to the process of combining the data across
underwriters.
Primary market information currently assists regulators in
examining underwriting practices and surveilling for violations of
regulations regarding allocations in primary offerings. The information
also is useful for conducting market analysis and research on policy
issues such as allocation decisions, flipping, and secondary market
price support and the analysis and reconstruction of market events such
as the Facebook IPO or the Vonage IPO.\1309\
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\1309\ See Reena Aggarwal, Allocation of Initial Public Offering
and Flipping Activity, 68(1) Journal of Financial Economics 111-135
(2003); Reena Aggarwal, Manju Puri and N. Prabhala, Institutional
Allocation in Initial Public Offerings: Empirical Evidence 57 (3)
Journal of Finance 1421-1442 (2002); Raymond P. Fishe, How Stock
Flippers Affect IPO Pricing and Stabilization, Journal of Financial
and Quantitative Analysis 319-339 (2002); and Raymond P. Fishe,
Ekkehart Boehmer, Underwriter Short Covering in the IPO Aftermarket:
A Clinical Study, Journal of Corporate Finance, 575-594 (2004). For
background information on the Facebook IPO, see SEC Press Release,
SEC Charges NASDAQ for Failures During Facebook IPO (May 29, 2013),
available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171575032. For background information on the Vonage
IPO, see FINRA, FINRA Fines Citigroup Global Markets, UBS and
Deutsche Bank $425,000, Orders Customer Restitution for Supervisory
Failures in Vonage IPO (September 22, 2009), available at http://www.finra.org/newsroom/2009/finra-fines-citigroup-global-markets-ubs-and-deutsche-bank-425000-orders-customer.
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The Commission preliminarily believes that including both top-
account and subaccount allocation information for primary market
transactions in CAT would make primary market information that
identifies customers directly accessible to regulators, which would be
beneficial. In particular, top-account information in addition to
subaccount information would be necessary to surveil, without
requesting data from underwriters, for prohibited activities in the
book-building process and would improve the efficiency of
investigations into such prohibited activities. For example, including
top-account information in CAT Data would provide regulators efficient
access to data relevant for investigations into tie-in arrangements
because regulators would be able to correlate treatment in the primary
offering with other trading activity to see if, for example, those who
trade more in the aftermarket receive more of the initial public
offering shares they request than others. Including such information in
CAT Data would also provide efficient access to data that could
identify potential allocations that preference some customers over
others in the IPO allocation process because the SROs and Commission
could examine the relationship between IPO initial allocations, initial
indications of interest, and fluctuations in allocations and
indications of interest during the book-building process. In the
Adopting Release, the Commission noted several additional benefits of
collecting top-account information in addition to subaccount
information for primary market transactions. For example, examinations
of ``spinning,'' ``laddering,'' and other ``quid pro quo'' arrangements
would benefit from efficient access to such CAT Data, which would
facilitate a comparison of those customers allocated shares in an
offering to those who are not allocated shares in an offering and how
the conditional allocations change during the book-building process.
Book-building information, which is currently very difficult for
regulators to assemble, would provide very useful insights into IPO and
follow-on allocations in market analysis. Such insights would better
inform rulemaking and other policy decisions.
The CAT NMS Plan estimates that for broker-dealers to implement a
system to record and report top-account and subaccount allocation
information for primary market transactions would take 36 months of
staff time per firm at a cost of $234.8 million whereas just subaccount
information would take 12 months of staff time per firm at a cost of
$58.7 million.\1310\ The inclusion of top-account allocation
information accounts for the difference of $176.1 million. The CAT NMS
Plan explains that including top-account information in the CAT would
result in higher implementation costs because the top-account
information is maintained in book-building systems in investment
banking divisions of broker-dealers that differ fundamentally from
secondary market systems.\1311\
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\1310\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.6(c). The estimated costs reflect the implementation cost of
systems development needed to support top-account and subaccount
information for primary market transactions to CAT. The $234.8
million figure assumes 36 months of staff time, with 21.741 days per
month at a $1200 daily FTE rate for 250 firms. The $58.7 million
figure assumes 9 months of staff time, with 21.741 days per month at
a $1200 daily FTE rate for 250 firms. The estimates do not include
any ongoing annual costs to maintain the reporting; the Commission
assumes that these systems would be supported by staff already
engaged to support CAT reporting.
\1311\ Id. at Appendix C, Section A.6(a).
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However, the Commission preliminarily believes that the costs of
adding top-account allocation information may be lower than those
estimated in the CAT NMS Plan, for several reasons. First, in
combination with an alternative that would require less granular time
stamps or a larger allowable clock offset on less time-sensitive
systems, the costs for top-account information would be lower than
indicated in the Plan. The Commission recognizes that the benefits from
time stamp granularity and clock synchronization in the systems for
reporting top-account information may be lower than those for secondary
market systems because activity occurs far less frequently than it does
on exchanges and regulators may not need to sequence primary market
transactions relative to secondary market transactions within a second.
The Commission is unable to estimate cost savings from alternative
clock synchronization requirements because estimates presented in the
Plan do not cite these specific costs. Second, the Plan's estimate is
sensitive to the number of underwriters. In particular, the estimates
assume 250 underwriters would need to implement changes to provide for
top-account allocation information for primary market
transactions.\1312\ This is also the same number of underwriters
assumed to need to implement subaccount allocation information.
However, the Commission suspects that the number of underwriters that
would need to implement changes for top-account information may be
lower than the number that implement subaccount information for primary
market transactions because the lead underwriters could have all of the
information necessary to report the top-account information. If so,
then only those underwriters that expect to lead an offering would need
to implement systems changes to report top-account allocation
information. Estimating costs only for lead underwriters could result
in a much smaller estimate.
---------------------------------------------------------------------------
\1312\ See Cost Estimate for Adding Primary Market Transactions
into CAT (February 17, 2015), available at http://www.catnmsplan.com/industryfeedback/p602480.pdf.
---------------------------------------------------------------------------
The Commission does not have an estimate of the ongoing costs of
underwriters reporting top-account information. However, the Commission
preliminarily estimates an average of
[[Page 30774]]
approximately 120 IPOs each year and 340 follow-on offerings each year
from 2001 to 2014. Assuming each offering contains approximately 260
initial allocations, including all indications of interest, with 10
amendments from initial allocation to final allocation, each offering
would generate 2,600 CAT Reportable Events for a total of 1.2 million
per year.\1313\ This total is much smaller than the number of
Reportable Events in the secondary market (trillions). Therefore, while
the Commission cannot estimate the costs of ongoing primary market
reporting, the Commission believes the ongoing costs of reporting
primary market transactions would be a fraction of the ongoing costs of
secondary market reporting and would likely be supported by staff
already engaged to maintain CAT reporting.
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\1313\ The Commission estimated the number of allocations per
offering by averaging the data for the 11 IPOs made public along
with an academic paper. See Jay R. Ritter and Donghang Zhang,
Affiliated Mutual Funds and the Allocation of Initial Public
Offerings, 86(2) Journal of Financial Economics 337-368 (2007) and
http://bear.warrington.ufl.edu/ritter/Allocation08282012.xls. If the
Commission assumes that each offering would generate 10 amendments
to allocations prior to the subaccount allocations, there would be
2,600 reports per offering and 1.2 million reports per year using
the number of offerings in 2014. If each offering instead generates
5 or 20 amendments, the number of reports per year would be 0.6
million or 2.4 million.
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The Commission also recognizes that including top-account
information in the CAT NMS Plan could change the competitive landscape
of the market for underwriting services. In particular, some
underwriters may choose to exit the market instead of report top-
account information. The Commission preliminarily believes that the
compliance costs themselves would be low compared to underwriting
fees.\1314\ Nonetheless, the Commission recognizes that some
underwriters may exit rather than comply with the CAT NMS Plan
requirements. Likewise, the Commission recognizes that the costs to
implement CAT reporting of top-account allocation information could
increase barriers to entry.
---------------------------------------------------------------------------
\1314\ The primary market issued about $450 billion in common
stock in 2014 and underwriters earned $5.2 billion in underwriting
fees in 2014. This is high relative to the $176 million cost
estimate above. The value of issuances comes from the Securities
Data Corporation and information regarding the aggregate
underwriting fees comes from FOCUS reports.
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Finally, the Commission recognizes that requiring top-account
information in the CAT NMS Plan could alter the way underwriters
conduct their book-building activities. The Commission is not sure if
these changes would be beneficial or harmful to issuers and investors.
For example, issuers and investors could benefit if including top-
account information in CAT deters book-building activity that violates
Regulation M or FINRA Rule 5110, 5130 or 5131, though some particular
investors may lose any gains from preferential treatment. However, the
Commission is uncertain whether investors and issuers would benefit if
underwriters altered their book-building activity in an effort to
reduce their reporting burden. For example, if reporting every change
to a conditional allocation proved cumbersome, underwriters may choose
to update preliminary allocations less often. This could change the way
that underwriters and investors interact with each other in the book-
building process with implications for the potential success of the
offering or investors' satisfaction with the outcome.
c. OTC Equity Securities
The CAT NMS Plan requires the reporting of data regarding OTC
Equity Securities upon implementation of the CAT NMS Plan. The
Commission is soliciting comment on the alternative of eliminating the
requirement to report activity in OTC Equity Securities from the CAT
NMS Plan, and instead requiring only that the SROs include a discussion
of how OTC Equity Securities could be incorporated into the CAT in the
Discussion Document that they are required to provide within six months
after the effective date of the Plan pursuant to Rule 613(i).\1315\
This was the approach taken with respect to OTC Equity Securities in
Rule 613, because the Commission believed that limiting the scope of
the CAT to NMS securities was a reasonable first step in implementing
the CAT.\1316\ Under this approach, the CAT NMS Plan would require each
national securities exchange and national securities association,
within six months after effectiveness of the national market system
plan, to jointly provide to the Commission a document outlining in
detail how OTC Equity Securities (along with certain other categories
of securities) could be incorporated into the CAT information,
including an implementation timeline and a cost estimate. The
Commission preliminarily believes that excluding OTC Equity Securities
from the CAT upon implementation would reduce costs of the CAT NMS
Plan. But, the Commission also preliminarily believes that removing the
requirement to report activity in OTC Equity Securities from the CAT
NMS Plan would limit the regulatory benefits of the CAT NMS Plan
significantly.
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\1315\ 17 CFR 242.613(i).
\1316\ Id.; see also Adopting Release, supra note 9 at 45744.
The Plan states that ``[e]ven though SEC Rule 613 does not require
reporting of OTC Equity Securities, the Participants have agreed to
expand the reporting requirements to include OTC Equity Securities
to facilitate the elimination of OATS.'' See CAT NMS Plan, supra
note 3, at Appendix C, Section C.9.
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Under the alternative approach, OTC Equity Securities would be
excluded from the Plan upon implementation. While they could still be
incorporated into the Plan following the submission of the Discussion
Document, the alternative approach would create uncertainty as to
whether or not OTC Equity Securities would ultimately be incorporated
into CAT NMS Plan and the timeline for that process.
Excluding OTC Equity Securities from the CAT NMS Plan could limit
oversight of the OTC equity market relative to the oversight obtainable
under the Plan.\1317\ FINRA currently collects reports on OTC equity
markets in its OATS data.\1318\ The primary difference between OATS and
CAT Data for OTC Equity Securities would be in completeness, due to the
additional data fields in CAT Data that are not in OATS, particularly
Customer-ID; in any accuracy improvements relative to OATS; in direct
access for the Commission; and in the timeliness relative to OATS,
particularly in having linked data that requires less time to process.
Relative to the Plan, therefore, excluding OTC Equity Securities could
reduce the efficiency and effectiveness of regulators overseeing the
OTC market, conducting investigations of manipulation, pump and dumps,
and improper penny stock sales. It could also reduce the efficiency of
estimating disgorgement payments to harmed investors relative to the
Plan.
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\1317\ The Commission has discussed the potential for fraudulent
activity in the OTC market. See SEC, Microcap Fraud, available at
http://www.sec.gov/spotlight/microcap-fraud.shtml.
\1318\ See supra note 351 and related text.
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The CAT NMS Plan states that including OTC Equity Securities could
facilitate the retirement of OATS.\1319\ If OTC Equity Securities are
not included in the CAT NMS Plan upon implementation, including OTC
Equity Securities at a later time would require an amendment to the CAT
NMS Plan, which could take significant time and potentially delay the
retirement of OATS.\1320\ The Commission is cognizant
[[Page 30775]]
that the period of duplicative reporting, during which both CAT and
OATS would be reported by market participants, is likely to impose a
significant cost on industry.\1321\ The CAT NMS Plan states that the
inclusion of OTC Equity Securities at CAT implementation is generally
supported by industry to facilitate the retirement of OATS.\1322\
---------------------------------------------------------------------------
\1319\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(a) n.16.
\1320\ The Commission notes, however, that the incorporation of
OTC Equity Securities is not the only hurdle needed to retire OATS,
and other hurdles may remain open even after any approval of the CAT
NMS Plan. For example, the Plan anticipates a period of 12-18 months
during which the SROs would analyze rules and systems to determine
which require duplicative information. The process and timeline for
elimination of duplicative reporting systems is discussed in Section
IV.F.2, supra.
\1321\ See Section IV.F.2, supra.
\1322\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.9.
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The Commission preliminarily believes that excluding OTC Equity
Securities from the CAT upon implementation would reduce certain costs
associated with implementation and operation of CAT as compared to the
Plan as filed, without providing any additional material information,
because less data would be reported,\1323\ therefore requiring fewer
resources to implement and maintain the CAT. The Commission further
preliminarily believes that CAT Reporters and the Central Repository
would avoid certain compliance costs if OTC equities were excluded. To
the extent that market participants rely on separate IT infrastructure
to handle activity in OTC as opposed to listed securities, delaying the
inclusion of OTC Equity Securities in CAT postpones costs associated
with updating these systems. Postponing these system modifications may
allow these modifications to be more efficiently integrated into other
planned system upgrades, reducing costs to industry. The Commission
notes that, even under this alternative approach, market participants
still may incur these costs eventually, because the approach
contemplates that the CAT NMS Plan could be expanded to require the
reporting of order events in OTC Equities following the submission of
the Discussion Document.
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\1323\ For example, in February, 2016, the average daily number
of trades in OTC securities is approximately 98,300, on an average
of approximately 18,500 issues over that same period. While that
volume of trades is not large, the number of distinct issues is.
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Furthermore, the Commission preliminarily believes that the cost
savings from delaying incorporating OTC Equity Securities in the CAT
NMS Plan are likely to be lower than the increase in costs of
duplicative reporting that result from a delay to OATS retirement. Any
broker-dealers that trade both OTC Equity Securities and listed equity
or option securities would have to comply with the Plan regardless of
the inclusion of OTC equities, so the cost savings to these broker-
dealers from the exclusion of OTC Equity Securities may not be
significant. The Commission preliminarily believes that the number of
broker-dealers that trade only OTC Equity Securities is small. Finally,
the Commission expects that the duplicative reporting costs would be
fairly significant and that extending the time until the retirement of
OATS would be a significant additional cost.
The Commission cannot estimate the amount of the cost reduction
from excluding OTC Equity Securities because it lacks the data to do
so. The CAT NMS Plan presents data only on the aggregate costs of on-
exchange and OTC equity reporting; it does not present data on the
costs specifically attributable to OTC equity reporting. The Commission
has no data from which it can independently estimate the cost
differential because it depends on information internal to each CAT
Reporter (e.g., how their systems would change for the alternative
compared to the Plan), which is not compiled or stored anywhere, and to
which the Commission therefore does not have ready access, and it
depends on when OTC Equity Securities would otherwise be included and
the status of OATS and other systems in the interim.
d. Periodic Updates to Customer Information
As noted above in Section IV.E.1.b(4), the Plan Processor is
required to create a Customer-ID and map Firm Designated IDs to this
Customer-ID so that records stored in the CAT Data link to the
Customers. To facilitate this, the Plan requires CAT Reporters to
submit an initial set of Customer information to the Central Repository
and subsequent daily updates and changes to that Customer
information.\1324\ In addition to daily updates to reflect changes in
Customer information required in Rule 613, the CAT NMS Plan also
requires members to submit periodic full refreshes of all Customer
information to the CAT.\1325\ The Commission is soliciting comment on
an alternative that would eliminate the requirement for periodic full
refreshes.
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\1324\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(a)(iii); Appendix D, Section 9.1.
\1325\ See id., at Appendix C, Section A.1(a)(iii) n.33.
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The CAT NMS Plan states that the purpose of these refreshes is to
``ensure the completeness and accuracy of Customer information and
associations.'' \1326\ Although the Commission believes that the
Participants should ensure that customer information in the Central
Repository is complete and accurate, the requirement for periodic full
refreshes seems redundant if the initial list and daily updates are
complete and accurate and would, therefore, provide no additional
benefit. Further, not requiring these periodic refreshes could reduce
the risk of a security breach of personally identifiable information.
However, the Commission recognizes that periodic full refreshes of
customer information could address any errors that are introduced in
the daily update process, although the Commission preliminarily
believes that such problems are likely to be quite rare. In addition,
the Commission recognizes that not requiring the periodic full
refreshes could reduce certain costs associated with implementation and
operation of CAT as compared to the Plan as filed for CAT Reporters,
although the Commission preliminarily believes that these cost
reductions would be minor for two reasons. First, the quantity of data
required to refresh the customer information table is very small
compared to the size of market data files submitted regularly by most
market participants. Second, because market participants would need to
develop software and procedures to initially populate the customer
information table, that software and procedure should be available to
refresh the table periodically. Therefore, the Commission preliminarily
believes that removing the requirements for periodic full refreshes of
customer information could minimally reduce the cost of the Plan
without materially reducing the benefits.
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\1326\ Id.
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4. Alternatives to the CAT NMS Plan
The Commission is soliciting comment on the broad set of
alternatives of modifying existing systems to reduce the data
limitations described above instead of approving the CAT NMS Plan.
When it adopted Rule 613, the Commission noted that ``the costs and
benefits of creating a consolidated audit trail, and the consideration
of specific costs as related to specific benefits, are more
appropriately analyzed once the SROs narrow the expanded array of
choices they have under the adopted Rule and develop a detailed NMS
plan.'' \1327\ The Commission also noted that a ``robust economic
analysis of . . . the actual creation and implementation of a
consolidated audit trail itself . . .
[[Page 30776]]
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.'' \1328\
Accordingly, the Commission deferred its economic analysis of the
actual creation, implementation, and maintenance of the CAT until after
submission of an NMS plan.
---------------------------------------------------------------------------
\1327\ See Adopting Release, supra note 9, at 45725-26.
\1328\ Id. at 45726.
---------------------------------------------------------------------------
The Commission recognizes that approving the CAT NMS Plan is not
the only available means of improving the completeness, accuracy,
accessibility, and timeliness of the data used in regulatory
activities. Alternatively, the Commission could mandate improvements to
one or more existing data sources to address the data limitations noted
in the Baseline Section. The Commission previously considered this set
of alternatives when considering whether to adopt Rule 613.\1329\ The
Commission has now reviewed the CAT NMS Plan, including the cost
estimates, and has performed its own economic analysis of the Plan.
With the benefit of having reviewed and analyzed the Plan, the
Commission is now soliciting comment on this set of alternatives.
---------------------------------------------------------------------------
\1329\ Id. at 45739-41.
---------------------------------------------------------------------------
As an alternative to the CAT NMS Plan, the Commission could require
modifications to OATS. In the Adopting Release, the Commission noted
that it had received comments suggesting various ways that the OATS
system could be modified to serve as the central repository for the
consolidated audit trail.\1330\ However, the Commission also noted that
OATS would require significant modifications in order to provide the
attributes that the Commission deems crucial to an effective audit
trail. In particular, OATS excludes some exchange-based and other types
of non-member activity; it does not collect market-making quotes
submitted by registered market makers (in those stocks for which they
are registered); it 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; it does not
presently collect options data; it does not afford regulators an
opportunity to perform cross-product surveillance and monitoring; and
it does not collect information on the identities of the customers of
broker-dealers from whom an order is received.\1331\
---------------------------------------------------------------------------
\1330\ Id.
\1331\ Id. at 45741.
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The Commission preliminarily believes that, as stated in the
Adopting Release, the missing attributes identified above are crucial
to improving the completeness, accuracy, accessibility, and timeliness
of the data used in regulatory activities. Thus, any alternative to CAT
based on OATS that does not address those deficiencies would limit the
potential benefits of the alternative significantly. Given the
modifications necessary, the Commission cannot estimate the potential
cost savings, if any, from mandating an OATS-based approach as an
alternative to the CAT NMS Plan, because the Commission does not have
sufficient information to estimate the cost of modifying OATS to
address some or all of these deficiencies, either separately or in
combination. The Plan does not provide data on the cost of making each
relevant modification to OATS, and the Commission has no other data
from which it can independently estimate this, because the Commission
is not aware of any such data currently available to it. The Commission
notes, however, that Rule 613 provided flexibility to the SROs to
propose an approach based on OATS and/or other existing data
sources.\1332\ Given that Rule 613 provided this flexibility to the
SROs, the Commission preliminarily believes that the SROs could have
utilized an OATS-based approach if that approach would have represented
significant cost savings relative to the Plan's approach, and the SROs
that operate those reporting systems had presented such a solution as a
Bid. Furthermore, the Commission notes that an approach that modifies
and expands OATS to satisfy the requirements of the CAT NMS Plan
remains feasible under the current bidding process. The Commission
seeks comment on the costs and benefits of requiring modifications to
OATS as an alternative to the CAT NMS Plan.
---------------------------------------------------------------------------
\1332\ Id. The Commission also notes that the current Plan could
allow the Plan Processor to leverage some elements of the existing
OATS infrastructure and/or other existing data sources in the
implementation of the CAT.
---------------------------------------------------------------------------
Another alternative would be for the Commission to modify other
data sources instead of, or in combination with, OATS. However, like
OATS, all of the current data sources have limitations that would need
to be addressed in order to provide the attributes that the Commission
deems crucial to an effective audit trail.\1333\ Furthermore, the
Commission preliminarily believes that modifying any other single data
source would be more costly than modifying OATS, which is currently the
most comprehensive audit trail. While the Commission could require the
modification of multiple data sources in combination, the Commission
preliminarily believes that an alternative to the CAT NMS Plan that
relied on multiple data sources, such as a combination of OATS, COATS,
other SRO audit trail data and/or publicly available data, would
eliminate the benefits associated with having a single, complete
consolidated source from which regulators can access trade and order
data, which the Commission considers to be very significant.\1334\
---------------------------------------------------------------------------
\1333\ The limitations of the various data sources are discussed
in Section IV.D, supra.
\1334\ These benefits are discussed in Section IV.E, supra.
---------------------------------------------------------------------------
In summary, the Commission cannot estimate the potential cost
savings, if any, from modifying one or more other data sources instead
of, or in combination with, OATS, because the Commission does not have
sufficient information to estimate the cost of modifying each of the
currently available data sources to address their current limitations,
separately or in combination. The Plan does not provide data on the
cost of making each relevant modification to each current data source,
and the Commission has no other data from which it can independently
estimate this, because the Commission is not aware of any such data
currently available to it.
However, the Commission preliminarily believes that mandating
improvements to the completeness, accuracy, accessibility, and
timeliness of current data sources without an NMS Plan that requires
the consolidation of data and increased coverage across markets and
broker-dealers would likely significantly limit the potential benefits,
possibly without providing significant cost savings. The Commission
seeks comment on the costs and benefits of modifying one or more
currently available data sources, separately or in combination, as an
alternative to the CAT NMS Plan.
5. Request for Comment on the Alternatives
a. Generally
383. Are there any other alternatives that the Plan should require?
If so, please describe the alternative and the costs and benefits of
the alternative relative to the Plan.
[[Page 30777]]
b. Alternatives to the Approaches Permitted by the Exemption Order
\1335\
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\1335\ See also Sections III.B.5-III.B.9, supra, for additional
requests for comment on the alternative Rule 613 approaches to the
approaches the Exemption Order allowed to be included in the CAT NMS
Plan.
---------------------------------------------------------------------------
384. Should the CAT NMS Plan require Options Market Makers to
report their quotes to the Central Repository? Please explain. Do
Commenters believe that the costs of the Rule 613 approach would be
disproportionately borne by smaller broker-dealers? Why or why not?
Please provide data supporting your position.
385. Should the Plan treat equity market makers the same as Options
Market Makers for purposes of quotation reporting--i.e., equity market
makers report only Quote Sent Time and exchanges to which the quote is
routed report the other information? Why or why not? What are the
relative costs and benefits of this alternative? Please provide cost
estimates.
386. Should the Plan require an alternative approach to reporting
market maker quotes on exchanges where both equity and Options Market
Makers would not need to report their quotation updates, and instead
the exchanges would report Quote Sent Times in their reports of
receiving these quotation updates? Why or why not? How would such an
alternative affect the costs of building and operating the Central
Repository? How would such an alternative affect market-maker costs of
implementing and continuing CAT reporting?
387. Should the CAT NMS Plan require that Allocation Reports
provide sufficient information for the Central Repository to be able to
link those allocations to order lifecycles? What are the costs and
benefits of providing this information? Please explain and provide cost
estimates.
388. How do broker-dealers currently track which customers should
receive allocations from which set of orders and how do broker-dealers
ensure that those orders receive the correct average price? Can these
same systems provide a key that could accurately link the allocations
to lifecycles in many-to-many allocations? Please explain.
389. Should the CAT NMS Plan require an alternative to the Customer
Information Approach? If so, what alternative should the Commission
require and what are the relative costs and benefits of the
alternative? Please explain.
390. Should the CAT NMS Plan require an alternative approach to
assigning CAT-Reporter-IDs? If so, what alternative should the
Commission require and what are the relative costs and benefits of the
alternative? Please explain.
391. Should the CAT NMS Plan provide for the use of the LEI or
another unique identification code as an alternative to the CAT-
Reporter-ID? What are the advantages and disadvantages of this
approach?
392. Should the CAT NMS Plan require an alternative to the
requirement to time stamp manual orders to the second? If so, what
alternative should the Commission require? For example, should the Plan
require millisecond time stamps or one-minute time stamps? Please
explain and provide information on the relative costs and benefits of
the alternatives.
c. Alternatives to Certain Specific Approaches in the CAT NMS Plan
\1336\
---------------------------------------------------------------------------
\1336\ See also Sections III.B.2, III.B.4, III.B.10, III.B.11,
supra, for additional requests for comment related to alternatives
to certain specific approaches in the CAT NMS Plan.
---------------------------------------------------------------------------
393. Should the ``industry standard'' for the purposes of the clock
synchronization and time stamping be ``one-size-fits-all''? Please
explain. If not, how should the CAT NMS Plan structure variations in
clock synchronization and time stamp requirements that are based on
industry practices?
394. Should the ``industry standard'' for the purposes of the clock
synchronization and time stamping requirements be defined based on
industry practice? Please explain. If not, how should ``industry
standard'' be defined? Should the ``industry standard'' consider
information other than current industry practice, such as the most
accurate technology currently available in the industry, or the
standard recommended by a particular industry group or authority? Could
a definition of ``industry standard'' set a maximum clock offset
threshold with an expectation that each CAT Reporter would be
responsible for smaller clock offsets if the CAT Reporter is
technically capable of such clock offsets? Please explain and include
information on the relative costs and benefits of such alternative
definitions.
395. What benefits, if any, would derive from applying the same
uniform clock synchronization standards to all market participants
versus applying different standards to different participant types?
Which approach is preferable? If applying different standards to
different participant types, which participant types should have
smaller clock offset tolerances and which should have larger clock
offset tolerances and what are the industry standards for those
participant types? Please explain and provide any supporting data.
396. Do Commenters agree with the Commission's cost estimates for
clock synchronization alternatives? Are there CAT Reporters other than
broker-dealers that would incur significant costs from increasing clock
synchronization standards to allowable clock drifts of less than 50
milliseconds, such as 1 millisecond or 100 microseconds? At what level
of clock synchronization would these costs become material? Please
explain. Do Commenters have estimates of these costs?
397. Does the FIF Clock Offset Survey reflect the operational
capabilities of all potential CAT Reporters? Please explain.
398. Do Commenters agree that an alternative that would relax the
logging requirements such that CAT Reporters would only need to log
exceptions and resulting synchronization events (and not every
synchronization event) would reduce costs of the CAT NMS Plan without
materially reducing its benefits? Why or why not? Do Commenters have an
estimate of how much such an alternative would reduce costs, either in
isolation or in combination with the alternative to not require
synchronization outside of event recording times? Please provide
supporting documentation for these estimates.
399. Is there a need for clock synchronization standards outside of
regular and extended trading hours? Is clock synchronization beneficial
for retail orders that come in overnight? Are there examples of times
or events outside of regular and extended trading hours when clock
synchronization is more beneficial? Do Commenters agree that an
alternative that would not require synchronizing clocks outside of
times when servers record Reportable Events would reduce costs of the
Plan without materially reducing its benefits? Do Commenters have an
estimate of how much such an alternative would reduce costs? Please
explain and provide supporting documentation if possible.
400. Are some CAT Reportable Events more time-sensitive than other
events? If so, what events are more time-sensitive and why? What
systems are more likely to process these events, and where are those
systems located (i.e., within broker-dealers, service bureaus,
Execution Venues)? Please explain.
401. What market participant systems, if any, should have smaller
clock offset tolerances? Why? What clock
[[Page 30778]]
synchronization standard should these systems have? Why? What market
participant systems, if any, should have smaller clock offset
tolerances? Why? What clock offset tolerances should these systems
have? Why?
402. Should the Plan require time stamps to be reported more
granularly than the one millisecond required in the Plan? If so, what
standard should be required? Do Commenters agree with the Commission's
analysis of the costs and benefits of requiring finer time stamp
resolution than 1 millisecond? Please explain.
403. Should the CAT NMS Plan require different Error Rates in CAT?
For example, should the Plan require a lower initial Error Rate? If so,
what initial Error Rate should the Plan require and why? What would be
the costs and benefits of requiring a lower initial Error Rate? Should
the Plan require a lower Error Rate at some time period after
implementation? If so, what Error Rate should the Plan require and why
and when? What would be the costs and benefits of requiring a lower
Error Rate?
404. Should the CAT NMS Plan require a day T+5 error correction
deadline instead of a day T+3 error correction deadline? What are the
relative costs and benefits of different error correction deadlines?
Please explain and provide cost estimates.
405. Should the CAT NMS Plan require an alternative to the funding
model in which broker-dealers and Execution Venues pay fees on the same
fee schedule? If so, how would that funding model be structured and
what metric would determine the fee level? How would that funding model
affect the costs and benefits of the Plan, including the effect on
competition? Please explain.
406. The Plan cites ``transactional volume'' as a cost driver for
the Central Repository, but uses ``message traffic'' to allocate
Central Repository costs across Industry Members. Do Commenters agree
with the Commission's assumption that these two metrics are highly
correlated? Is one of these metrics preferable for allocating costs
across Industry Members? Please explain.
407. Should the CAT NMS Plan require alternative metrics to the
message traffic and market share metrics required by the Plan for
determining the tiers of the funding model but still place Execution
Venues on a different fee schedule than broker-dealers? If so, which
metrics? How would these alternative metrics affect the costs and
benefits of the Plan, including effects on competition? Could these
alternative metrics create conflicts of interest? Please explain.
408. Do Commenters agree with the Commission's analysis of unified
versus bifurcated funding models? Why or why not?
409. Should the Plan require a unified funding model wherein
Central Repository costs are allocated across all market participants
by message traffic? Why or why not?
410. Should the Plan require a unified funding model wherein the
tiers of the funding model for all CAT Reporters would be based on
market share of share volume? Why or why not?
411. Should the Plan require a unified funding model wherein a
fixed fee is levied on every trade? Why or why not? Could such a
funding model reduce implementation costs by utilizing infrastructure
already in place to assess Section 31 fees?
412. Should the Plan require a bifurcated funding model wherein
Central Repository costs are allocated across broker-dealers by market
share of share volume? Why or why not?
413. Should the Plan require a bifurcated funding model wherein
Central Repository costs treat ATSs as part of broker-dealers only,
instead of including them as Execution Venues? Why or why not?
414. Should the Plan require a bifurcated funding model wherein
broker-dealer message traffic to and from an ATS are not included in
message traffic measures used to assess fees on broker-dealers? Why or
why not?
415. Should the Plan require a bifurcated funding model wherein ATS
volume is excluded from TRF volume for the purposes of assessing
Execution Venue fees to operators of TRFs? Why or why not?
416. Should the Plan require a bifurcated funding model wherein
TRFs are not counted as Execution Venues for purposes of assessing fees
on Execution Venues? Why or why not?
417. Should the Plan require that profits or losses from operating
the Central Repository be allocated across Participants by market share
of share volume? Why or why not?
418. Should the Plan require a strictly variable, rather than
tiered, funding model? Why or why not?
419. Should the CAT NMS Plan require any funding model alternatives
that could result in ATSs and exchanges paying equivalent fees? If so,
how should that funding model be structured and what metrics should
determine the funding tiers? How would that funding model affect the
costs and benefits of this alternative, including effects on
competition? Could these alternatives create conflicts of interest and,
if so, to what extent? Please explain.
420. How should the CAT NMS Plan distribute the profits and losses
of the Company among Participants? What are the relative costs and
benefits of alternative ways to divide the profits and losses among the
Participants? Please explain.
421. Should the CAT NMS Plan require a strictly variable funding
model in which the fees paid are a set percentage of message traffic or
share volume instead of a tiered funding model in which fees are fixed
for a tier that is determined by message traffic or market share of
share volume? If so, how would that funding model be structured? What
are the relative costs and benefits of that funding model, including
the effect on competition? Please explain.
422. Should the CAT NMS Plan exclude the requirement to report
listing exchange symbology and instead allow CAT Reporters to use
existing symbologies? Please explain. Would excluding this requirement
allow broker-dealers to report data to CAT without processing the data
ahead of the report? Please explain. What would be the relative costs
and benefits of removing this requirement from the Plan? Please provide
any cost estimates.
423. Should the CAT NMS Plan require alternative minimum standards
for access to the CAT Data to those proposed in the CAT NMS Plan? If
so, what alternative minimum standards should the Commission require?
For example, should the response time on the largest queries be longer
or shorter than 24 hours? How would changes to the alternative minimum
standards affect the costs and benefits of the Plan? Please be specific
and provide cost estimates.
424. Should the CAT NMS Plan require an intake capacity level
different from twice historical peak daily volume measured over the
most recent six years? If so, what intake capacity level should the
Plan require? What are the relative costs and benefits of this
alternative intake capacity level?
425. The Plan proposes using a ``daisy chain'' approach for linking
order events within the Central Repository.\1337\ This approach was
chosen in favor of an approach that would require a unique order ID to
be assigned by the first market participant that receives an order, and
that order ID to be passed to and used by any market participant that
handles the order afterward (the ``unique order ID''
[[Page 30779]]
approach). Do Commenters believe that a unique order ID approach or any
other alternative approach would produce more accurate linkages than a
daisy chain approach or any other benefits? Please explain. According
to the Plan, the daisy chain approach would minimize impact on existing
OATS reporters because OATS already uses this type of linkage.\1338\ Do
Commenters believe that a unique order ID approach or any other
alternative approach would increase the costs for CAT Reporters who
currently report to OATS or have any other effect on the costs of the
Plan? Please explain and provide estimates. Given that the Bids from
potential Plan Processors all utilize the ``daisy chain'' approach,
would adopting a unique order ID approach at this stage cause a
significant disruption in the progress toward the implementation of a
consolidated audit trail? Please explain. What would the costs of such
a disruption be?
---------------------------------------------------------------------------
\1337\ See CAT NMS Plan, supra note 3, at Appendix C, Section
A.1(b).
\1338\ Id.
---------------------------------------------------------------------------
426. The CAT NMS Plan requires that the Plan Processor make use of
a commercially available file management tool. What are the benefits to
CAT Reporters from this requirement? Does this requirement have any
effects on the competition between bidders? For example, are any
bidders, such as those that could more efficiently use a proprietary
file management tool, disadvantaged by this requirement? Please
explain. Does this requirement affect the ability of the Operating
Committee to replace an under-performing Plan Processor? Are there
other costs or benefits of this requirement? Please explain.
d. Alternatives to the Scope of Certain Specific Approaches in the CAT
NMS Plan
427. Should the CAT NMS Plan require excluding any data fields
currently required to be included in the CAT Data (e.g., unique
customer identification, allocation time, and CAT-Reporter-IDs at both
order routing and receipt)? If so, which ones? Please explain and
provide information on the relative costs and benefits of excluding
those data fields, including any cost estimates.
428. Should the CAT NMS Plan exclude primary market information?
Why or why not?
429. Do Commenters agree with the analysis in the Plan of the
feasibility, benefits, and costs of the inclusion of primary market
information (including primary market transactions) in the CAT NMS
Plan? Please explain.
430. Do Commenters have additional analysis relevant to the
decision to include primary market information (including primary
market transactions) in the CAT NMS Plan? If so, please describe that
analysis, including any data.
431. Do Commenters agree with the Plan's decision to include
subaccount allocation information for primary market transactions in
the Discussion Document, which commits the Operating Committee to
consider the implementation of this subaccount allocation information
in the CAT NMS Plan? Please explain.
432. Do Commenters agree with the Commission's assessment of the
costs and benefits of requiring top-account allocation information for
primary market transactions? Please explain. Should the Operating
Committee consider requiring top-account information? Please explain.
433. What are the implications of the SROs decision not to include
top-account information for primary market transactions in the
Discussion Document? Please explain.
434. Should the CAT NMS Plan exclude OTC Equity Securities? Please
explain. Would the exclusion of OTC Equity Securities in the CAT NMS
Plan delay the retirement of OATS? If so, by how long and what would be
the added cost be? Please provide an estimate. What are the other costs
and benefits of excluding OTC Equity Securities from the CAT NMS Plan?
435. The CAT NMS Plan requires that CAT Reporters provide periodic
refreshes of all customer information to the Central Repository to
maintain an accurate database of customer information. What intervals
for updates would be appropriate and reasonable, and what information
should be required to be updated? Should the CAT NMS Plan remove the
requirement for periodic full submission of customer information beyond
the daily updates sent when customer information changes? Please
explain. Would broker-dealers reduce their costs if they did not have
to report all customer information periodically? Would the removal of
this requirement significantly reduce the risk of a security breach of
personally identifiable information? Please explain.
e. Alternatives to the CAT NMS Plan
436. Do Commenters agree with the Commission's analysis of the
broad alternatives to approving the CAT NMS Plan, such as modifying
OATS and/or other data sources to meet the objectives of Rule 613?
Please explain. Are there other alternative approaches that the
Commission has not identified that it should consider? Please explain.
f. Alternatives Discussed in the CAT NMS Plan
The Commission recognizes that the Plan discusses many alternatives
that the Commission does not analyze above, including alternatives in
Consideration 12 therein. This Consideration (Rule 613(a)(1)(xii))
requires the Participants to discuss in the Plan any reasonable
alternative approaches that the plan sponsors considered in developing
the Plan, including 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 CAT NMS Plan. Such discussions appear in Section 12 of Appendix
C. The Commission reviewed these alternatives and has not included
above a discussion of all of the specific alternatives addressed in the
Plan. In some cases, the Commission, at this time, has no analysis to
add beyond the analysis in the Plan. In other cases, the Plan does not
require any specific alternative, so the Commission cannot analyze the
effect on the Plan of selecting a different alternative. The Commission
is soliciting comment on the alternatives discussed by the Participants
in the Plan but not discussed above. The Commission requests comment on
each of these alternatives, both in isolation and in combination, as
well as any data that would assist the Commission in evaluating the
costs and trade-offs associated with these alternatives.
437. Organizational Structure. According to the CAT NMS Plan, the
Participants considered various organizational structures of the
Bidders.\1339\ The CAT NMS Plan notes that the Bidders have three
general organizational structures: (1) Consortiums or partnerships
(i.e., the Plan Processor would consist of more than one unaffiliated
entity that would operate the CAT), (2) single firms (i.e., one entity
would be the Plan Processor and that entity would operate the CAT as
part of its other ongoing business operations), and (3) dedicated legal
entities (i.e., Plan operations would be conducted in a separate legal
entity that would perform no other business activities). The CAT NMS
Plan notes that each type of organizational structure has strengths and
weaknesses but does not discuss those strengths and
[[Page 30780]]
weaknesses. The CAT NMS Plan concludes that the organizational
structure should not be a material factor in selecting a bidder and
does not mandate any specific organizational structure for the Plan
Processor.\1340\ The Commission requests comment on whether the CAT NMS
Plan should mandate a particular organizational structure. Why or why
not? How can the organizational structure of the Plan Processor affect
the costs and benefits of the CAT NMS Plan? What are the relative
strengths and weaknesses of the different organizational structures?
---------------------------------------------------------------------------
\1339\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(b).
\1340\ Id.
---------------------------------------------------------------------------
438. Primary Storage. The CAT NMS Plan states that bidders proposed
two methods of primary data storage: traditionally-hosted storage
architecture and infrastructure-as-a-service.\1341\ The CAT NMS Plan
does not mandate a specific method for primary storage, but does
indicate that the storage solution would meet the security,
reliability, and accessibility requirements for the CAT, including
storage of PII data, separately. The CAT NMS Plan also indicates
several considerations in the selection of a storage solution including
maturity, cost, complexity, and reliability of the storage method. The
Commission requests comment on whether the CAT NMS Plan should mandate
a particular data storage method. Why or why not? How can the storage
method affect the costs and benefits of the Plan? What are the relative
strengths and weaknesses of the different primary storage methods?
---------------------------------------------------------------------------
\1341\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(c). Traditionally-hosted storage architecture is a model in
which an organization would purchase and maintain proprietary
servers and other hardware to store CAT Data. Infrastructure-as-a-
service is a provisioning model in which an organization outsources
the equipment used to support operations, including storage,
hardware, servers, and networking components, to a third party who
charges for the service on a usage basis.
---------------------------------------------------------------------------
439. Personally Identifiable Information. The CAT NMS Plan
discusses several requirements to reduce the risk of misuse of PII,
such as multi-factor authentication \1342\ and Role Based Access
Control for access to PII; \1343\ separation of PII from other CAT
Data; restricted access to PII; and an auditable record of all access
to PII data contained in the Central Repository.\1344\ The CAT NMS Plan
notes that all bidders proposed some of these requirements, but only
some bidders proposed others. The Commission requests comment on
whether the Plan should mandate any/all of these requirements. The
Commission further requests comment on the alternatives to these
requirements. What are the potential alternative ways to protect PII?
What are the costs and benefits of those alternatives compared to the
Plan? Please provide estimates or other data to support answers.
---------------------------------------------------------------------------
\1342\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(e). Multifactor authentication is a mechanism that requires the
user to provide more than one factor (e.g., biometrics/personal
information in addition to a password) in order to be validated by
the system. Id.
\1343\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(e). Role Based Access Control (``RBAC'') is a mechanism for
authentication in which users are assigned to one or many roles, and
each role is assigned a defined set of permissions. Id.
\1344\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(e). Appendix D provides additional discussion of these PII
requirements. See id. at Appendix D, Section 4.1-4.2.
---------------------------------------------------------------------------
440. Data Ingestion Format. The Plan discusses the trade-offs
between requiring that the CAT Reporters report data to CAT in a
uniform defined format or in existing messaging protocols.\1345\ The
Plan does not require either method. A uniform defined format would
include the current process for reporting data to OATS. This is
Approach 2 in the CAT Reporters Study.\1346\ Several bidders proposed
to leverage the OATS format and enhance it to meet the requirements of
Rule 613. The Plan states that this could reduce the burden on certain
CAT Reporters (i.e., current OATS Reporters) and simplify the process
for those CAT Reporters to implement the CAT.\1347\ Accepting existing
messaging protocols would allow CAT Reporters to submit copies of their
order handling messages that are typically used across the order
lifecycle and within order management processes, such as FIX. This is
Approach 1 in the CAT Reporters' Survey.\1348\ The Plan states that
using existing messaging protocols could result in quicker
implementation times and simplify data aggregation.\1349\ The Plan
further notes that the surveys revealed no cost difference between the
two approaches,\1350\ but that FIF members prefer using the FIX
protocol.\1351\ Should the Plan specify a particular approach? Please
explain.
---------------------------------------------------------------------------
\1345\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(A)(2); Section D.12(f). These are also called ``Approach
1'' and ``Approach 2'' in the Costs Section herein.
\1346\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(A)(2).
\1347\ Id. at Appendix C, Section D.12(f).
\1348\ Id. at Appendix C, Section B.7(b)(i)(A)(2).
\1349\ Id. at Appendix C, Section D.12(f).
\1350\ Id.
\1351\ Id.
---------------------------------------------------------------------------
441. The Commission requests further information on the relative
costs and benefits and strengths and weaknesses of these two data
ingestion format approaches. Would either of these approaches produce
more accurate data? For example, would using existing messaging
protocols such as FIX be more accurate because CAT Reporters would send
their messages without the possibility of adding errors when
translating them to a different format? Alternatively, would using
existing messaging protocols such as FIX be less accurate because the
Central Repository would have to translate too many different and
possibly bespoke formats into a uniform format for the CAT data? Would
a hybrid approach produce the most accurate data? \1352\ How else would
the benefits of the CAT NMS Plan differ between these approaches?
---------------------------------------------------------------------------
\1352\ A hybrid approach would allow data to be submitted in
either a uniform defined format or using existing messaging
protocols.
---------------------------------------------------------------------------
442. The Commission requests comment on the implementation costs of
these two data ingestion format approaches. The Commission expects that
broker-dealers would need to modify existing messaging protocols to
implement CAT regardless of which approach the Plan requires for
reporting order events. What additional implementation costs would CAT
Reporters incur to report using existing messaging protocols? What
additional implementation costs would CAT Reporters, both OATS and non-
OATS reporters, incur to report using a uniform defined format such as
a modification of OATS format? In what ways would the implementation
costs incurred at the Central Repository differ for the two approaches?
What is the estimated cost of implementing each approach for CAT
Reporters, Participants, and the Central Repository?
443. The Commission requests comment on the ongoing costs of these
two data ingestion format approaches. How would ongoing costs be
different for the two approaches? Would CAT Reporters need to process
the order messages before reporting using existing messaging protocols
to comply with requirements such as using the listing exchange
symbology? If so, how costly is that processing? How costly is the
processing required to translate order messages into a uniform defined
format such as OATS format? What other ongoing costs associated with
these approaches would CAT Reporters incur and how would they differ
for the two approaches? How do the ongoing costs incurred by the
Central Repository differ for the two approaches? Would the translation
process from existing messaging protocols into a uniform format be more
costly for the Central
[[Page 30781]]
Repository relative to putting reports submitted in a uniform defined
format in a single dataset? Would the validation process associated
with existing messaging protocols be more costly for the Central
Repository than uniform defined format because of the complexity of
validating data from many different and possibly bespoke messaging
protocols? What are the estimated ongoing costs of each approach for
CAT Reporters, Participants, and the Central Repository?
444. Process to Develop the CAT. Bidders proposed, and the Plan
describes, several processes for development of the CAT: The agile or
iterative development model, the waterfall model, and hybrid
models.\1353\ The CAT NMS Plan does not mandate a particular
development process because any of the options could be utilized to
manage the development of CAT.\1354\ The CAT NMS Plan notes that the
agile model is more flexible and more susceptible to the early delivery
of software for testing and feedback, but that the agile model makes it
more difficult to accurately estimate the effort and time required for
development. The waterfall model would also facilitate longer-term
planning and coordination among multiple vendors or project
streams.\1355\ The Commission requests comment on the strengths and
weaknesses of each development process. The Commission further requests
comment on whether the CAT NMS Plan should mandate a particular process
and the impact on the relative costs and benefits of the mandating a
particular process.
---------------------------------------------------------------------------
\1353\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(g). An agile methodology is an iterative model in which
development is staggered and provides for continuous evolution of
requirements and solutions. A waterfall model is a sequential
process of software development with dedicated phases for
Conception, Initiation, Analysis, Design, Construction, Testing,
Production/Implementation and Maintenance. Id.
\1354\ Id.
\1355\ Id.
---------------------------------------------------------------------------
445. Industry Testing. The CAT NMS Plan requires a dedicated test
environment that is functionally equivalent to the production
environment and available 24 hours a day, six days a week.\1356\ The
CAT NMS Plan discusses alternative approaches for industry
testing.\1357\ Using the production environment for scheduled testing
events on weekends or on specific dates would allow for realistic
testing because multiple users are likely to test at the same time.
However, CAT Reporters would not be able to test when it might be more
convenient or less costly for them to test. The Commission requests
comment on whether the Plan should mandate particular industry testing
processes and the benefits and costs of these alternatives compared to
the requirements of the CAT NMS Plan. How would either of these
alternatives lead to more accurate data than the Plan? Would the
alternatives otherwise affect the benefits of the CAT NMS Plan? How
would either of these alternatives affect the costs of the CAT NMS Plan
for CAT Reporters, Participants, and the Central Repository? Please
provide estimates, if available.
---------------------------------------------------------------------------
\1356\ See CAT NMS Plan, supra note 3, at Appendix D, Section
1.2.
\1357\ See id, at Appendix C, Section D.12(h).
---------------------------------------------------------------------------
446. Quality Assurance (QA). The CAT NMS Plan mentions several
alternative approaches to quality assurance, but does not select a
particular approach.\1358\ In particular, the CAT NMS Plan states that
the Participants considered many approaches, including continuous
integration, test automation, and industry standards such as ISO 20000/
ITIL. Although the Plan does not mandate a particular approach, certain
requirements were detailed in the RFP.\1359\ In addition, the CAT NMS
Plan discusses the trade-offs associated with the QA staffing
level.\1360\ The Commission requests comment on whether the CAT NMS
Plan should mandate a particular QA approach. Why or why not? If so,
which approach should the Plan mandate? How can the QA approach affect
the costs and benefits of the CAT NMS Plan? For example, how does the
QA approach affect the accuracy and accessibility of the CAT Data? What
are the relative strengths and weaknesses of the different quality
assurance approaches?
---------------------------------------------------------------------------
\1358\ See id., at Appendix C, Section D.12(i).
\1359\ See RFP, supra note 29, at 31. Specifically, the RFP
requires that Bidders' responses include both the functional and
non-functional testing that includes the following: System testing,
integration testing, regression testing, software performance
testing, system performance testing, application programming
interface (API) testing, user acceptance testing, industry testing,
interoperability, security, load and performance testing, and CAT
Reporter testing.
\1360\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(i). Bidder QA staffing levels range from 2 to 90. Id.
---------------------------------------------------------------------------
447. User Support and Help Desk. The CAT NMS Plan discusses several
alternatives related to how the Plan Processor provides a CAT Help Desk
that would be available 24 hours a day, 7 days a week and be able to
manage 2,500 calls per month.\1361\ Specifically, alternatives relate
to the number of user support staff members, the degree to which the
support team is dedicated to CAT, and whether the help desk is located
in the US or offshore. The CAT NMS Plan discusses the benefit and cost
trade-offs,\1362\ but does not mandate any of the particular
alternatives. Instead, the CAT NMS Plan commits to considering each
bidder's user support proposals in the context of the overall bid. The
Commission requests comment on whether the CAT NMS Plan should specify
the standards for user support. How would the various alternatives
affect the benefits of CAT? How would the various alternatives affect
the implementation costs of CAT? How would the various alternatives
affect the ongoing costs of CAT for CAT Reporters, Participants, and
the Central Repository? Please explain and provide estimates, if
available.
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\1361\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(j). The RFP specified these standards. Id.
\1362\ See id. The Plan states that a larger support staff could
be more effective, but would be more costly. Further, a dedicated
CAT support team would have a deeper knowledge of CAT but would be
more costly. Finally, a U.S.-based help desk could facilitate
greater security and higher quality service, but would be more
costly. Id.
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448. CAT User Management. The CAT NMS Plan discusses several
alternatives to manage users, but does not require a specific approach
or standards.\1363\ Specifically, the CAT NMS Plan discusses help desk
creation of accounts, user creation (by broker-dealers or regulators),
and multi-role solutions. Generally, there are trade-offs in terms of
convenience and security in the approaches.\1364\ The Commission
requests comments on whether the CAT NMS Plan should specify an
approach for user management. How would the various alternatives affect
the benefits of CAT, such as accessibility? How would the various
alternatives affect the implementation costs of CAT? How would the
various alternatives affect the ongoing costs of CAT for CAT Reporters,
Participants, and the Central Repository? How would the various
alternatives affect the risk of a security breach or misuse of the CAT
Data? Please explain and provide estimates, if available.
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\1363\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(k). User management is a business function that grants,
controls, and maintains user access to a system. Id. at n.253.
\1364\ See id. for more specific information on the relative
strengths and weaknesses of each approach.
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449. Required Reportable Events. The CAT NMS Plan states that the
Participants considered requiring the reporting of multiple additional
order event types, such as the ``results order event'' and the ``CAT
feedback order
[[Page 30782]]
event.'' \1365\ According to the CAT NMS Plan, a ``results order
event'' type would not provide additional value over a ``daisy chain''
linkage method and a ``CAT feedback order event'' can be generated by
the Plan Processor, making reporting by others unnecessary.\1366\ The
Commission requests comments on these additional order event types and
any other order event types that the Plan might require. Should the CAT
NMS Plan require additional order event types? What are these order
event types and what distinguishes them from the required order event
types? What would be the purpose of these order event types? Would they
make the CAT Data more complete or more accurate? How would regulators
use these event types? How much would these additional order event
types cost to report, to validate, and/or to store? Are there any other
costs associated with these additional order event types? Please
provide estimates, if available.
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\1365\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(l).
\1366\ Id.
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450. Data Feed Connectivity. The Plan discusses requiring the
collection of SIP data in real-time as opposed to through an end-of-day
batch process.\1367\ According to the Plan, real-time data would
provide for more rapid access to SIP Data, but may require additional
processing support to deal with out-of- sequence or missing
records.\1368\ Because CAT Reporters are only required to report order
information on a next-day basis, the Plan does not require the Plan
Processor to have real-time SIP connectivity. The Commission requests
comments on whether the Plan should require a particular SIP
connectivity. The Commission requests comment on the costs and benefits
of requiring real-time SIP connectivity, or conversely, the costs and
benefits of requiring end-of-day batch SIP connectivity (and not allow
real-time). What would the Plan Processor do with real-time SIP data?
Would the real-time SIP data be available to regulators, and if so,
what would regulators do with that data? Do all regulators currently
receive real-time SIP data? How much would the various SIP connectivity
alternatives cost? How much processing would each alternative require
to be of use to the Plan Processor or regulators?
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\1367\ See CAT NMS Plan, supra note 3, at Appendix C, Section
D.12(n).
\1368\ See id.
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I. Request for Comment on the Economic Analysis
The Commission has identified above the economic effects associated
with the proposed CAT NMS Plan and requests comment on all aspects of
its preliminary economic analysis. The Commission encourages Commenters
to identify, discuss, analyze, and supply relevant data, information,
or statistics regarding any such economic effects. Commenters should,
when possible, provide the Commission with data to support their views.
Commenters suggesting alternative approaches should provide
comprehensive proposals, including any conditions or limitations that
they believe should apply, the reasons for the suggested approaches,
their analysis of the cost-benefit trade-offs of suggested approaches
compared to the Plan, and their analysis regarding why their suggested
approaches would satisfy the objectives of Rule 613. In particular, the
Commission seeks comment on the following:
451. Do Commenters agree with the Commission's analysis of the
potential economic effects of the Plan? Why or why not?
452. Has the Commission considered all relevant economic effects?
If not, what other economic effects should the Commission consider?
453. Do Commenters have information that could help the Commission
fill in gaps in the economic analysis related to a lack of information
on details in the plan that could significantly affect the economic
analysis? If so, please provide this information and explain how it
could affect the economic analysis.
454. Do Commenters have data that could help the Commission fill in
gaps in the economic analysis related to a lack of available data? If
so, please provide this information and explain how it could affect the
economic analysis.
455. Do Commenters believe that there are additional categories of
benefits or costs that could be quantified or otherwise monetized? If
so, please identify these categories and, if possible, provide specific
estimates or data.
456. Do Commenters believe that the CAT NMS Plan would change the
behavior of any market participant in such a way as to create
unintended effects? For example, would requirements to report certain
data elements or events change the activities of market participants in
ways other than deterrence but that create second-order economic
effects? If so, please explain. Would such effects be economic benefits
or economic costs? Please explain.
V. Paperwork Reduction Act
Certain provisions of Rule 613 contain ``collection of information
requirements'' within the meaning of the Paperwork Reduction Act of
1995 (``PRA'') \1369\ and the Commission has submitted them 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 title of
the collection of information is ``Creation of a Consolidated Audit
Trail Pursuant to Section 11A of the Securities Exchange Act of 1934
and Rules Thereunder.''
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\1369\ 44 U.S.C. 3501 et. seq.
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As noted above, Rule 613 of Regulation NMS (17 CFR part 242)
requires the Participants to jointly submit to the Commission the CAT
NMS Plan to govern the creation, implementation, and maintenance of the
consolidated audit trail and Central Repository for the collection of
information for NMS securities. The CAT NMS Plan must require each
Participant and its respective members to provide certain data to the
Central Repository in compliance with Rule 613. When it adopted Rule
613, the Commission discussed the burden hours associated with the
development and submission of the CAT NMS Plan.\1370\ In doing so, the
Commission noted that the
[[Page 30783]]
development and submission of the CAT NMS Plan that would govern the
creation, implementation and maintenance of a consolidated audit trail
is a multi-step process and accordingly that the Commission was
deferring its discussion of the burden hours associated with the other
paperwork requirements required by Rule 613 and ongoing burdens since
they would only be incurred if the Commission approves the CAT NMS
Plan.\1371\
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\1370\ See Adopting Release, supra note 9, at 45804. On
September 25, 2015, the Commission submitted to OMB a request for
approval of an extension of the collection of information related to
the development and submission of the CAT NMS Plan. The Commission
stated that, although that collection of information pertained to
the development and submission of an NMS plan, and that such NMS
plan had already been developed and submitted, the Commission
believed it was prudent to extend the collection of information
during the pendency of the Commission's review of the NMS plan. The
Commission provided estimates for 19 SROs, stating that they would
spend a total of 2,760 burden hours of internal legal, compliance,
information technology, and business operations time to comply with
the existing collection of information, calculated as follows: (880
programmer analyst hours) + (880 business analyst hours) + (700
attorney hours) + (300 compliance manager hours) = 2,760 burden
hours to prepare and file an NMS plan, or approximately 52,440
burden hours in the aggregate, calculated as follows: (2,760 burden
hours per SRO) x (19 SROs) = 52,440 burden hours. Amortized over
three years, the annualized burden hours would be 920 hours per SRO,
or a total of 17,480 for all 19 SROs. The Commission further
estimated that the aggregate one-time reporting burden for preparing
and filing an NMS plan would be approximately $20,000 in external
legal costs per SRO, calculated as follows: 50 legal hours x $400
per hour = $20,000, for an aggregate burden of $380,000, calculated
as follows: ($20,000 in external legal costs per SRO) x (19 SROs) =
$380,000. Amortized over three years, the annualized capital
external cost would be $6,667 per SRO, or a total of $126,667 for
the 19 SROs. See Submission for OMB Review; Comment Request for
Extension of Rule 613; SEC File No. 270-616, OMB Control No. 3235-
0671 (September 25, 2015), 80 FR 59209 (October 1, 2015).
\1371\ Id.
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The Commission is now publishing its preliminary estimates of the
paperwork burdens of the CAT NMS Plan. These estimates are based on the
requirements of Rule 613 and take into account the Exemption Order
discussed above.\1372\ Information and estimates contained in the CAT
NMS Plan that was submitted by the Participants also informed these
estimates because they provide a useful, quantified point of reference
regarding potential burdens and costs. The Commission acknowledges that
the CAT NMS Plan as filed contains provisions in addition to those
required by Rule 613 (e.g., requiring the inclusion of OTC Equity
Securities; \1373\ the availability of historical data for not less
than six years in a manner that is directly available and searchable
without manual intervention from the Plan Processor; \1374\ a complete
symbology database to be maintained by the Plan Processor, including
the historical symbology; as well as issue symbol information and data
using the listing exchange symbology format \1375\).
---------------------------------------------------------------------------
\1372\ See Exemption Order, supra note 18.
\1373\ See CAT NMS Plan, supra note 3, at Section 1.1 (defining
``Eligible Security'' as all NMS securities and all OTC Equity
Securities); Appendix C, Section A.1(a).
\1374\ See id. at Section 6.5(b)(i).
\1375\ See CAT NMS Plan, supra note 3 at Appendix C, Section
A.1(a); Appendix D, Section 2.
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A. Summary of Collection of Information Under Rule 613
Rule 613 requires that the CAT NMS Plan must provide for an
accurate, time-sequenced record of an order's life, from receipt or
origination, through the process of routing, modification, cancellation
and execution.\1376\ The Central Repository, created by the
Participants, would be required to receive, consolidate and retain the
data required under the Rule.\1377\ Such data must be accessible to
each Participant, as well as the Commission, for purposes of performing
regulatory and oversight responsibilities.\1378\
---------------------------------------------------------------------------
\1376\ See 17 CFR 242.613(c)(1).
\1377\ See 17 CFR 242.613(e)(1).
\1378\ See 17 CFR 242.613(e)(1), (e)(2).
---------------------------------------------------------------------------
Rule 613 provides that the CAT NMS Plan must require that all
Participants that are exchanges, and their members, record and report
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 each Participant that is a
national securities association, and its members, record and report for
each NMS security for which transaction reports are required to be
submitted to the national securities association 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. This data must be recorded contemporaneously
with the Reportable Event and reported to the Central Repository in no
event later than 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.\1379\
---------------------------------------------------------------------------
\1379\ See 17 CFR 242.613(c)(3).
---------------------------------------------------------------------------
Rule 613 also provides that the CAT NMS Plan must require each
member of a Participant to record and report to the Central Repository
other information which may not be available until later in the
clearing process no later than 8:00 a.m. Eastern Time on the trading
day following the day the member receives such information.\1380\ The
CAT NMS Plan also requires the Participants to provide to the
Commission, at least every two years after the effectiveness of the CAT
NMS Plan, a written assessment of the operation of the consolidated
audit trail.\1381\
---------------------------------------------------------------------------
\1380\ See 17 CFR 242.613(c)(4).
\1381\ See 17 CFR 242.613(b).
---------------------------------------------------------------------------
Rule 613 requires all Participants to make use of the consolidated
information, either by each developing and implementing new
surveillance systems, or by enhancing existing surveillance
systems.\1382\ The Rule also requires the CAT NMS Plan to require
Participants to submit to the Commission a document outlining the
manner in which non-NMS securities and primary market transactions in
NMS and non-NMS securities can be incorporated into the consolidated
audit trail.\1383\
---------------------------------------------------------------------------
\1382\ See 17 CFR 242.613(a)(3)(iv).
\1383\ See 17 CFR 242.613(i).
---------------------------------------------------------------------------
1. Central Repository
Rule 613 provides that the CAT NMS Plan must require the creation
and maintenance of a Central Repository that would be responsible for
the receipt, consolidation, and retention of all data submitted by the
Participants and their members.\1384\ The Rule also requires that the
CAT NMS Plan require the Central Repository to retain the information
reported pursuant to subparagraphs (c)(7) and (e)(7) of the Rule for a
period of not less than five years in a convenient and usable standard
electronic data format that is directly available and searchable
electronically without any manual intervention.\1385\ The Plan
Processor is responsible for operating the Central Repository in
compliance with the Rule and the CAT NMS Plan. In addition, the Rule
provides that the CAT NMS Plan must include: Policies and procedures to
ensure the security and confidentiality of all information submitted to
the Central Repository,\1386\ including safeguards to ensure the
confidentiality of data; \1387\ information barriers between regulatory
and non-regulatory staff with regard to access and use of data; \1388\
a mechanism to confirm the identity of all persons permitted to use the
data; \1389\ a comprehensive information security program for the
Central Repository that is subject to regular reviews by the CCO;\1390\
and penalties for non-compliance with policies and procedures of the
Participants or the Central Repository with respect to information
security.\1391\ Further, the Rule provides that the CAT NMS Plan must
include policies and procedures to be used by the Plan Processor to
ensure the timeliness, accuracy, integrity, and completeness of the
data submitted to the Central Repository,\1392\ as well as policies and
procedures to ensure the accuracy of the consolidation by the Plan
Processor of the data.\1393\
---------------------------------------------------------------------------
\1384\ See 17 CFR 242.613(e)(1).
\1385\ See 17 CFR 242.613(e)(8). The Commission notes that the
CAT NMS Plan proposes to require that the Central Repository retain
data reported in a convenient and usable standard electronic data
format that is directly available and searchable electronically
without any manual intervention for six years. See CAT NMS Plan,
supra note 3, at Section 6.5(b)(i).
\1386\ See 17 CFR 242.613(e)(4)(i).
\1387\ See 17 CFR 242.613(e)(4)(i)(A).
\1388\ See 17 CFR 242.613(e)(4)(i)(B).
\1389\ See 17 CFR 242.613(e)(4)(i)(C).
\1390\ Id.
\1391\ See 17 CFR 242.613(e)(4)(i)(D).
\1392\ See 17 CFR 242.613(e)(4)(ii).
\1393\ See 17 CFR 242.613(e)(4)(iii).
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2. Data Collection and Reporting
Rule 613 provides that the CAT NMS Plan must require each
Participant, and any member of such Participant, to record and
electronically report to the
[[Page 30784]]
Central Repository details for each order and Reportable Event
documenting the life of an order through the process of original
receipt or origination, routing, modification, cancellation, and
execution (in whole or part) for each NMS security.\1394\ For national
securities exchanges, Rule 613 requires the CAT NMS Plan to 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 an exchange,
or admitted to unlisted trading privileges on such exchange.\1395\ Rule
613 provides that the CAT NMS Plan must require each Participant that
is a national securities association, and its members, to record and
report to the Central Repository the information required by Rule
613(c)(7) for each NMS security for which transaction reports are
required to be submitted to the Participant.\1396\ The Rule requires
each Participant and any member of a Participant to record the
information required by Rule 613(c)(7)(i) through (v) contemporaneously
with the Reportable Event, and to report this information 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 Participant
or member of the Participant.\1397\ The Rule requires each Participant
and any member of a Participant to record and report the information
required by Rule 613(c)(7)(vi) through (viii) to the Central Repository
by 8:00 a.m. Eastern Time on the trading day following the day the
Participant or member receives such information.\1398\ The Rule
requires each Participant and any member of such Participant to report
information required by Rule 613(c)(7) 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.\1399\
---------------------------------------------------------------------------
\1394\ See 17 CFR 242.613(c)(1), (c)(5), (c)(6), (c)(7).
\1395\ See 17 CFR 242.613(c)(1), (c)(5).
\1396\ See 17 CFR 242.613(c)(1), (c)(6).
\1397\ See 17 CFR 242.613(c)(3).
\1398\ See 17 CFR 242.613(c)(4).
\1399\ See 17 CFR 242.613(c)(2).
---------------------------------------------------------------------------
Such information must also be reported to the Central Repository
with a time stamp of a granularity that is at least to the millisecond
or less to the extent that the order handling and execution systems of
a Participant or a member utilize time stamps in finer
increments.\1400\ The Commission understands that any changes to
broker-dealer recording and reporting systems to comply with Rule 613
may also include changes to comply with the millisecond time stamp
requirement.
---------------------------------------------------------------------------
\1400\ See 17 CFR 242.613(d)(3).
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3. Collection and Retention of NBBO, Last Sale Data and Transaction
Reports
Rule 613(e)(7) provides that the CAT NMS Plan must require the
Central Repository to collect and retain on a current and continuing
basis: (i) Information on the NBBO for each NMS Security; (ii)
transaction reports reported pursuant to a transaction reporting plan
filed with the Commission pursuant to, and meeting the requirements of,
Rule 601 of Regulation NMS; and (iii) Last Sale Reports reported
pursuant to the OPRA Plan.\1401\ The Central Repository must retain
this information for no less than five years.\1402\
---------------------------------------------------------------------------
\1401\ See 17 CFR 242.613(e)(7); 17 CFR 242.601.
\1402\ See 17 CFR 242.613(e)(8).
---------------------------------------------------------------------------
4. Surveillance
Rule 613(f) provides that the CAT NMS Plan must require that every
Participant 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.
Rule 613(a)(3)(iv) provides that the CAT NMS Plan must require that the
surveillance systems be implemented within fourteen months after
effectiveness of the CAT NMS Plan.
5. Participant Rule Filings
Rule 613(g)(1) requires each Participant to file with the
Commission, pursuant to Section 19(b)(2) of the Exchange Act and Rule
19b-4 thereunder,\1403\ a proposed rule change to require its members
to comply with the requirements of Rule 613 and the CAT NMS Plan
approved by the Commission.\1404\ The burden of filing such a proposed
rule change is already included under the collection of information
requirements contained in Rule 19b-4 under the Exchange Act.\1405\
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\1403\ 15 U.S.C. 78s(b)(2) and 17 CFR 240.19b-4.
\1404\ See 17 CFR 242.613(g)(1).
\1405\ See Securities Exchange Act Release No. 50486 (October 5,
2004), 69 FR 60287, 60293 (October 8, 2004) (File No. S7-18-04)
(describing the collection of information requirements contained in
Rule 19b-4 under the Exchange Act). The Commission has submitted
revisions to the current collection of information titled ``Rule
19b-4 Filings with Respect to Proposed Rule Changes by Self-
Regulatory Organizations'' (OMB Control No. 3235-0045). According to
the last submitted revision, for Fiscal Year 2012 SROs submitted
1,688 Rule 19b-4 proposed rule changes.
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6. Written Assessment of Operation of the Consolidated Audit Trail
Rule 613(b)(6) provides that the CAT NMS Plan must require the
Participants to provide the Commission a written assessment of the
consolidated audit trail's operation at least every two years, once the
CAT NMS Plan is effective.\1406\ Such written assessment shall include,
at a minimum, with respect to the CAT: (i) An evaluation of its
performance; (ii) a detailed plan for any potential improvements to its
performance; (iii) an estimate of the costs associated with any such
potential improvements; and (iv) an estimated implementation timeline
for any such potential improvements, if applicable.\1407\
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\1406\ See 17 CFR 242.613(b)(6).
\1407\ See id.
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7. Document on Expansion to Other Securities
Rule 613(i) provides that the CAT NMS Plan must require the
Participants to jointly provide to the Commission, within six months
after the CAT NMS Plan is effective, a document outlining how the
Participants could incorporate into the CAT information regarding: (1)
Equity securities that are not NMS securities; \1408\ (2) debt
securities; and market transactions in equity securities that are not
NMS securities and debt securities.\1409\
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\1408\ As noted above, the CAT NMS Plan would require the
inclusion of OTC Equity Securities, while Rule 613 does not include
such a requirement. See supra note 1373.
\1409\ See 17 CFR 242.613(i).
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B. Proposed Use of Information
1. Central Repository
Rule 613 states that the Central Repository is required to receive,
consolidate and retain the data required to be submitted by the
Participants and their members.\1410\ Participant and Commission Staff
would have access to the data for regulatory purposes.\1411\
---------------------------------------------------------------------------
\1410\ See 17 CFR 242.613(e)(1).
\1411\ See 17 CFR 242.613(e)(2).
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2. Data Collection and Reporting
The Commission believes that the data collected and reported
pursuant to the requirements of Rule 613 would be used by regulators to
monitor and surveil the securities markets and detect and investigate
activity, whether on one market or across markets.\1412\ The data
collected and reported pursuant to Rule 613 would also be used by
regulators for the evaluation of tips and complaints and for complex
enforcement inquiries or investigations, as well as inspections and
examinations. Further, the Commission believes that regulators would
use the data collected and reported to conduct timely and accurate
analysis of market activity for reconstruction of broad-based market
[[Page 30785]]
events in support of regulatory decisions.
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\1412\ See Section IV.E.2, supra.
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3. Collection and Retention of NBBO, Last Sale Data and Transaction
Reports
The CAT NMS Plan must require the Central Repository to collect and
retain NBBO information, transaction reports, and Last Sale Reports in
a format compatible with the order and event information collected
pursuant to Rule 613(c)(7).\1413\ Participant and Commission Staff
could use this data to easily search across order, NBBO, and
transaction databases. The Commission believes that having the NBBO
information in a uniform electronic format compatible with order and
event information would assist Participants in enforcing compliance
with federal securities laws, rules, and regulations, as well as their
own rules.\1414\ The Commission also believes that a CAT NMS Plan
requiring the Central Repository to collect and retain the transaction
reports and Last Sale Reports in a format compatible with the order
execution information would aid regulators in monitoring for certain
market manipulations.\1415\
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\1413\ See 17 CFR 242.613(e)(7).
\1414\ The Commission and Participants use the NBBO to, among
other things, evaluate members for compliance with numerous
regulatory requirements, such as the duty of best execution or Rule
611 of Regulation NMS. See 17 CFR 242.611; see also, e.g., ISE Rule
1901 and Phlx Rule 1084.
\1415\ Rules 613(e)(7)(ii) and (iii) require that transaction
reports reported pursuant to an effective transaction reporting plan
and Last Sale Reports reported pursuant to the OPRA Plan be reported
to the Central Repository. This requirement should allow regulators
to evaluate certain trading activity. For example, trading patterns
of reported and unreported trades may cause Participant or
Commission staff to make further inquiries into the nature of the
trading to ensure that the public was receiving accurate and timely
information regarding executions and that market participants were
continuing to comply with trade reporting obligations under
Participant rules. Similarly, patterns in the transactions that are
reported and unreported to the consolidated tape could be indicia of
market abuse, including failure to obtain best execution for
customer orders or possible market manipulation. The Commission and
the Participants would be able to review information on trades not
reported to the tape to determine whether they should have been
reported, whether Section 31 fees should have been paid, and/or
whether the trades are part of a manipulative scheme.
---------------------------------------------------------------------------
4. Surveillance
The requirement in Rule 613(f) that the Participants develop and
implement a surveillance system, or enhance existing surveillance
systems, reasonably designed to make use of the consolidated
information in the consolidated audit trail,\1416\ is intended to
position regulators to make full use of the consolidated audit trail
data in order to carry out their regulatory obligations. In addition,
because trading and potentially manipulative activities could take
place across multiple markets, and the consolidated audit trail data
would trace the entire lifecycle of an order from origination to
execution or cancellation, new or enhanced surveillance systems may
also enable regulators to investigate potentially illegal activity that
spans multiple markets more efficiently.
---------------------------------------------------------------------------
\1416\ 17 CFR 242.613(f).
---------------------------------------------------------------------------
5. Written Assessment of Operation of the Consolidated Audit Trail
Rule 613(b)(6) requires the CAT NMS Plan to require the
Participants to provide the Commission a written assessment of the
CAT's operation at least every two years, once the CAT NMS Plan is
effective.\1417\ These assessments would aid Participant and Commission
Staff in understanding and evaluating any deficiencies in the operation
of the consolidated audit trail and to propose potential improvements
to the CAT NMS Plan. The Commission believes the written assessments
would allow Participants and Commission Staff to periodically assess
whether such potential improvements would enhance market oversight.
Moreover, the Commission believes these assessments would help inform
the Commission regarding the likely feasibility, costs, and impact of,
and the Participants' approach to, the consolidated audit trail
evolving over time.
---------------------------------------------------------------------------
\1417\ 17 CFR 242.613(b)(6).
---------------------------------------------------------------------------
6. Document on Expansion to Other Securities
Rule 613(i) requires the CAT NMS Plan to require the Participants
to jointly provide to the Commission, within six months after the CAT
NMS Plan is effective, a document outlining how the SROs could
incorporate into the CAT information regarding certain products that
are not NMS securities.\1418\ A document outlining a possible expansion
of the consolidated audit trail could help inform the Commission about
the SROs' strategy for potentially accomplishing such an expansion over
a reasonable period of time. Moreover, such document would aid the
Commission in assessing the feasibility and impact of possible future
proposals by the SROs to include such additional securities and
transactions in the consolidated audit trail.
---------------------------------------------------------------------------
\1418\ See 17 CFR 242.613(i). See also supra note 1408.
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C. Respondents
1. National Securities Exchanges and National Securities Associations
Rule 613 applies to the 20 Participants (the 19 national securities
exchanges and the one national securities association (FINRA))
currently registered with the Commission.\1419\
---------------------------------------------------------------------------
\1419\ The Participants are: BATS Exchange, Inc., BATS-Y
Exchange, Inc., BOX Options Exchange LLC, C2 Options Exchange,
Incorporated, Chicago Board Options Exchange, Incorporated, Chicago
Stock Exchange, Inc., EDGA Exchange, Inc., EDGX Exchange, Inc.,
Financial Industry Regulatory Authority, Inc., International
Securities Exchange, LLC, ISE Gemini, LLC, ISE Mercury, LLC, Miami
International Securities Exchange LLC, NASDAQ OMX BX, Inc., NASDAQ
OMX PHLX LLC, The NASDAQ Stock Market LLC, National Stock Exchange,
Inc., New York Stock Exchange LLC, NYSE MKT LLC, and NYSE Arca, Inc.
The Commission understands that ISE Mercury, LLC will become a
Participant in the CAT NMS Plan and thus is accounted for as a
Participant for purposes of this Section. See supra note 3.
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2. Members of National Securities Exchanges and National Securities
Association
Rule 613 also applies to the Participants' members, that is,
broker-dealers. The Commission believes that Rule 613 applies to 1,800
broker-dealers. The Commission understands that there are currently
4,138 broker-dealers; however, not all broker-dealers are expected to
have CAT reporting obligations. The Participants report that
approximately 1,800 broker-dealers currently quote or execute
transactions in NMS Securities, Listed Options or OTC Equity Securities
and would likely have CAT reporting obligations.\1420\
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\1420\ The Commission understands that the remaining 2,338
registered broker-dealers either trade in asset classes not
currently included in the definition of Eligible Security or do not
trade at all (e.g., broker-dealers for the purposes of underwriting,
advising, private placements). See supra note 864.
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D. Total Initial and Annual Reporting and Recordkeeping Burden
1. Burden on National Securities Exchanges and National Securities
Associations
a. Central Repository
Rule 613 requires the Participants to jointly establish a Central
Repository tasked with the receipt, consolidation, and retention of the
reported order and execution information. The Participants issued an
RFP soliciting Bids from entities to act as the consolidated audit
trail's Plan Processor.\1421\ Bidders were asked to provide total one-
year and annual recurring cost estimates to estimate the costs to the
Participants for implementing and maintaining the
[[Page 30786]]
Central Repository.\1422\ There are currently three remaining Bidders,
any of which could be selected to be the Plan Processor. The Plan
Processor would be responsible for building, operating, administering
and maintaining the Central Repository.
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\1421\ See Section III.A.1, supra.
\1422\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B). The CAT NMS Plan listed the following as primary
drivers of Bid costs: (1) Reportable volumes of data ingested into
the Central Repository; (2) number of technical environments that
would be have to be built to report to the Central Repository; (3)
likely future rate of increase of reportable volumes; (4) data
archival requirements; and (5) user support and/or help desk
resource requirements. See id. at Section B.7(b)(i)(B).
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The Plan's Operating Committee, which consists of one voting
representative of each Participant,\1423\ would be responsible for the
management of the LLC, including the Central Repository, acting by
Majority or Supermajority Vote, depending on the issue.\1424\ In
managing the Central Repository, among other things, the Operating
Committee would have the responsibility to authorize the following
actions of the LLC: (1) Interpreting the Plan; \1425\ (2) determining
appropriate funding-related policies, procedures and practices
consistent with Article XI of the CAT NMS Plan; \1426\ (3) terminating
the Plan Processor; (4) selecting a successor Plan Processor (including
establishing a Plan Processor Selection Subcommittee to evaluate and
review Bids and make a recommendation to the Operating Committee with
respect to the selection of the successor Plan Processor); \1427\ (5)
entering into, modifying or terminating any Material Contract; \1428\
(6) making any Material Systems Change; \1429\ (7) approving the
initial Technical Specifications or any Material Amendment to the
Technical Specifications proposed by the Plan Processor; \1430\ (8)
amending the Technical Specifications on its own motion; \1431\ (9)
approving the Plan Processor's appointment or removal of the CCO, CISO,
or any Independent Auditor in accordance with Section 6.1(b) of the CAT
NMS Plan; \1432\ (10) approving any recommendation by the CCO pursuant
to Section 6.2(a)(v)(A); \1433\ (11) selecting the members of the
Advisory Committee; \1434\ (12) selecting the Operating Committee
chair; \1435\ and (13) determining to hold an Executive Session of the
Operating Committee.\1436\
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\1423\ See id. at Section 4.2(a).
\1424\ See Section IV.E.3.d(1), supra.
\1425\ See CAT NMS Plan, supra note 3, at Section 4.3(a)(iii).
\1426\ See id. at Section 4.3(a)(vi).
\1427\ See id. at Section 4.3(b)(i).
\1428\ See id. at Section 4.3(b)(iv).
\1429\ See id. at Section 4.3(b)(v).
\1430\ See id. at Section 4.3(b)(vi).
\1431\ See id. at Section 4.3(b)(vii).
\1432\ See id. at Section 4.3(b)(iii).
\1433\ See id. at Section 4.3(a)(iv).
\1434\ See id. at Section 4.3(a)(ii).
\1435\ See id. at Section 4.3(a)(i).
\1436\ See id. at Section 4.3(a)(v).
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Additionally, in managing the Central Repository, the Operating
Committee would have the responsibility and authority, as appropriate,
to: (1) Direct the LLC to enter into one or more agreements with the
Plan Processor obligating the Plan Processor to perform the functions
and duties contemplated by the Plan to be performed by the Plan
Processor, as well as such other functions and duties the Operating
Committee deems necessary or appropriate; \1437\ (2) appoint as an
Officer of the Company the individual who has direct management
responsibility for the Plan Processor's performance of its obligations
with respect to the CAT; \1438\ (3) approve policies, procedures, and
control structures related to the CAT System that are consistent with
Rule 613(e)(4), Appendix C and Appendix D of the CAT NMS Plan that have
been developed and will be implemented by the Plan Processor; \1439\
(4) approve any policy, procedure or standard (and any material
modification or amendment thereto) applicable primarily to the
performance of the Plan Processor's duties as the Plan Processor;
\1440\ (5) for both the CCO and CISO, render their annual performance
reviews and review and approve their compensation; \1441\ (6) review
the Plan Processor's performance under the Plan at least once each
year, or more often than once each year upon the request of two
Participants that are not Affiliated Participants; \1442\ (7) in
conjunction with the Plan Processor, approve and regularly review (and
update as necessary) SLAs governing the performance of the Central
Repository; \1443\ (8) maintain a Compliance Subcommittee for the
purpose of aiding the CCO as necessary; \1444\ and (9) designate by
resolution one or more Subcommittees it deems necessary or desirable in
furtherance of the management of the business and affairs of the
Company.\1445\
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\1437\ See id. at Section 6.1(a).
\1438\ See id. at Section 4.6(b).
\1439\ See id. at Section 6.1(c).
\1440\ See id. at Section 6.1(e).
\1441\ See id. at Section 6.2(a)(iv) and Section 6.2(b)(iv).
\1442\ See id. at Section 6.1(n).
\1443\ See id. at Section 6.1(h).
\1444\ See id. at Section 4.12(b).
\1445\ See id. at Section 4.12(a).
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The CAT NMS Plan also proposes to establish a Selection Committee
comprised of one Voting Senior Officer from each Participant,\1446\
which is tasked with the review and evaluation of Bids and the
selection of the initial Plan Processor.\1447\ The Selection Committee
would determine, by Majority Vote, whether Shortlisted Bidders will
have the opportunity to revise their Bids.\1448\ The Selection
Committee would review and evaluate all Shortlisted Bids, including any
permitted revisions submitted by Shortlisted Bidders, and in doing so,
may consult with the Advisory Committee (or the DAG until the Advisory
Committee is formed) and such other Persons as the Selection Committee
deems appropriate.\1449\ After receipt of any permitted revisions, the
Selection Committee would select the Initial Plan Processor from the
Shortlisted Bids in two rounds of voting where each Participant has one
vote via its Voting Senior Officer in each round.\1450\ Following the
selection of the Initial Plan Processor, the Participants would file
with the Commission a statement identifying the Initial Plan Processor
and including the information required by Rule 608.\1451\
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\1446\ See id. at Section 5.1(a).
\1447\ See id. at Section 5.1.
\1448\ See id. at Section 5.1(d)(i).
\1449\ See id. at Section 5.1(d)(ii).
\1450\ See id. at Section 5.1(e).
\1451\ See id. at Section 6.7(a)(i).
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For its initial and ongoing internal burden and cost estimates
associated with the management of the Central Repository, the
Commission is relying on estimates provided in the CAT NMS Plan for the
development of the CAT NMS Plan, which the Participants ``have accrued,
and will continue to accrue,'' \1452\ and have described in the CAT NMS
Plan as ``reasonably associated with creating, implementing, and
maintaining the CAT upon the Commission's adoption of the CAT NMS
Plan.'' \1453\
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\1452\ See id. at Appendix C, Section B.7(b)(iii).
\1453\ See id.
---------------------------------------------------------------------------
The Commission believes that the activities of the Operating
Committee and the Selection Committee overlap with those undertaken by
the Participants to develop the CAT NMS Plan. The CAT NMS Plan
describes the costs incurred by the Participants to develop the CAT NMS
Plan as including ``staff time contributed by each Participant to,
among other things, determine the technological requirements for the
Central Repository, develop the RFP, evaluate Bids received, design and
collect the data necessary to evaluate costs and other economic
impacts, meet with Industry
[[Page 30787]]
Members to solicit feedback, and complete the CAT NMS Plan submitted to
the Commission for consideration.'' \1454\ For the building and
management of the Central Repository, the Selection Committee and the
Operating Committee would have comparable responsibilities. The
Selection Committee would be required to review and evaluate all
Shortlisted Bids, including any permitted revisions submitted by
Shortlisted Bidders, and then to select the initial Plan Processor from
those Bids. As part of its overall management of the Central
Repository, the Operating Committee would have responsibility for
decisions associated with the technical requirements of the Central
Repository.\1455\ Furthermore, the Operating Committee would be
required to establish a Selection Subcommittee to evaluate Bids
received to select a successor Plan Processor,\1456\ and would also be
required to authorize the selection of the members of the Advisory
Committee,\1457\ comprising members of the Industry, to advise the
Participants on the implementation, operation, and administration of
the Central Repository.\1458\ Because the responsibilities of the
Operating Committee and the Selection Committee are similar to those
described in the CAT NMS Plan for the development of the CAT NMS Plan
itself, the Commission believes that it is reasonable to use the CAT
NMS Plan estimates as the basis for its burden and cost estimates for
the initial and ongoing management of the Central Repository.
---------------------------------------------------------------------------
\1454\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii).
\1455\ For example, the Operating Committee would be required to
authorize the following actions of the LLC: Entering into, modifying
or terminating any Material Contract (see id. at Section
4.3(b)(iv)); making any Material Systems Change (see id. at Section
4.3(b)(v)); amending the Technical Specifications on its own motion
(see id. at Section 4.3(b)(vii)); and approving the initial
Technical Specifications or any Material Amendment to the Technical
Specifications proposed by the Plan Processor (see id. at Section
4.3(b)(vi)). Further, the Operating Committee would be able to
approve policies, procedures, and control structures related to the
CAT System that are consistent with Rule 613(e)(4), Appendix C and
Appendix D of the CAT NMS Plan that have been developed and will be
implemented by the Plan Processor (see id. at Section 6.1(c)); and
in conjunction with the Plan Processor, approve and regularly review
(and update as necessary) SLAs governing the performance of the
Central Repository (see id. at Section 6.1(h)).
\1456\ See id. at Section 4.3(b)(i).
\1457\ See id. at Section 4.3(a)(ii).
\1458\ See id. at Section 4.13(d).
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(1) Initial Burden and Costs To Build the Central Repository
As proposed, each Participant would contribute an employee and a
substitute for the employee to serve on the Operating Committee that
would oversee the Central Repository.\1459\ Additionally, each
Participant would select a Voting Senior Officer to represent the
Participant as a member of the Selection Committee responsible for the
selection of the Plan Processor of the Central Repository.\1460\
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\1459\ In the case of Affiliated Participants, one individual
may be the primary representative for all or some of the Affiliated
Participants, and another individual may be the substitute for all
or some of the Affiliated Participants. See id. at Section 4.2(a).
\1460\ In the case of Affiliated Participants, one individual
may be (but is not required to be) the Voting Senior Officer for
more than one or all of the Affiliated Participants. Where one
individual serves as the Voting Senior Officer for more than one
Affiliated Participant, such individual will have the right to vote
on behalf of each such Affiliated Participant. See id. at Section
5.1(a).
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The Commission preliminarily estimates that, over the 12-month
period after the effectiveness of the CAT NMS Plan within which the
Participants would be required to select an initial Plan Processor
\1461\ and begin reporting to the Central Repository,\1462\ each
Participant would incur an initial internal burden of 720 burden hours
associated with the management of the creation of the Central
Repository and the selection of the Plan Processor (including filing
with the Commission the statement identifying the Initial Plan
Processor and including the information required by Rule 608), for an
aggregate initial estimate of 14,407 burden hours.\1463\
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\1461\ Rule 613(a)(3)(i) requires the selection of the Plan
Processor within 2 months after effectiveness of the CAT NMS Plan.
See 17 CFR 242.613(a)(3)(i).
\1462\ Rule 613(a)(3)(iii) requires the Participants to provide
to the Central Repository the data required by Rule 613(c) within
one year after effectiveness of the CAT NMS Plan. See 17 CFR
242.613(a)(3)(iii).
\1463\ The Commission is basing this estimate on the internal
burden estimate provided in the CAT NMS Plan related to the
development of the CAT NMS Plan. See CAT NMS Plan, supra note 3, at
Appendix C, Section B.7(b)(iii) (stating ``. . . the Participants
have accrued, and will continue to accrue, direct costs associated
with the development of the CAT NMS Plan. These costs include staff
time contributed by each Participant to, among other things,
determine the technological requirements for the Central Repository,
develop the RFP, evaluate Bids received, design and collect the data
necessary to evaluate costs and other economic impacts, meet with
Industry Members to solicit feedback, and complete the CAT NMS Plan
submitted to the Commission for consideration. The Participants
estimate that they have collectively contributed 20 FTEs in the
first 30 months of the CAT NMS Plan development process''). The
Commission believes the staff time incurred for the development of
the CAT NMS Plan would be comparable to the staff time incurred for
the activities required of the Operating Committee and the Selection
Committee for the creation and management of the Central Repository
once the Plan is effective). (20 FTEs/30 months) = 0.667 FTEs per
month for all of the Participants to develop the CAT NMS Plan.
Converting this into burden hours, (0.667 FTEs) x (12 months) x
(1,800 burden hours per year) =14,407 initial burden hours for all
of the Participants to develop the CAT NMS Plan. (14,407 burden
hours for all Participants/20 Participants) = 720 initial burden
hours for each Participant to develop the CAT NMS Plan.
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Additionally, the Commission preliminarily estimates that the
Participants will collectively spend $2,400,000 on external public
relations, legal and consulting costs associated with the building of
the Central Repository and the selection of the Plan Processor for the
Central Repository, or $120,000 per Participant.\1464\ The Commission
is basing this estimate on the estimate provided in the CAT NMS Plan
for public relations, legal and consulting costs incurred in
preparation of the CAT NMS Plan. Because the Participants described
such costs as ``reasonably associated with creating, implementing and
maintaining the CAT,'' \1465\ the Commission preliminarily believes
these external cost estimates should also be applied to the creation
and implementation of the Central Repository.
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\1464\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii) (stating ``the Participants have incurred public
relations, legal and consulting costs in preparation of the CAT NMS
Plan. The Participants estimate the costs of these services to be
$8,800,000''). $2,400,000 for all Participants over 12 months =
($8,800,000/44 months between the adoption of Rule 613 and the
filing of the CAT NMS Plan) x (12 months). ($2,400,000/20
Participants) = $120,000 per Participant over 12 months.
\1465\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii).
---------------------------------------------------------------------------
The CAT NMS Plan provides the estimates given by the Shortlisted
Bidders \1466\ for the one-time total cost associated with the Plan
Processor that would build the Central Repository.\1467\
[[Page 30788]]
The CAT NMS Plan states that this includes internal technological,
operational, administrative and ``any other material costs.'' \1468\
Using the estimates in the CAT NMS Plan, which are based on the Bids of
the six Shortlisted Bidders, the Commission preliminarily estimates
that the initial one-time cost to develop the Central Repository would
be an aggregate initial external cost to the Participants of $91.6
million,\1469\ or $4.6 million per Participant.\1470\ Therefore, the
Commission preliminarily estimates that each Participant would incur
initial one-time external costs of $7 million \1471\ to build the
Central Repository, or an aggregate initial one-time external cost
across all Participants of $140 million.\1472\
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\1466\ The Selection Committee narrowed the list of Shortlisted
Bidders from six to three Shortlisted Bidders. See ``Participants,
SROs Reduce Short List Bids from Six to Three for Consolidated Audit
Trail'' (November 16, 2015), available at http://www.catnmsplan.com/pastevents/catnms_release_downselect_111615.pdf. However, the costs
provided by the SROs in the CAT NMS Plan are based on the Bids of
the six Shortlisted Bidders.
\1467\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B). See also id. at Appendix C, Section B.7(b)(iv)(A)(1).
The Commission notes that the cost associated with the build and
maintenance of the Central Repository includes compliance with the
requirement in Rule 613(e)(8) that the Central Repository retain
information collected pursuant to Rule 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. See id. at
Section 6.1(d)(i) (requiring the Plan Processor to comply with the
recordkeeping requirements of Rule 613(e)(8)). See also id. at
Appendix C, Section D.12(l) (stating that Rule 613(e)(8) requires
data to be available and searchable for a period of not less than
five years, that broker-dealers are currently required to retain
data for six years under Rule 17a-4(a), and that the Participants
are requiring CAT Data to be kept online in an easily accessible
format for regulators for six years, though this may increase the
cost to run the CAT). The Commission notes that a Shortlisted Bidder
may be permitted to revise its Bid prior to approval of the CAT NMS
Plan if the CAT Selection Committee determines by Majority Vote that
such revisions are necessary or appropriate, so the estimates
provided in the CAT NMS Plan may be subject to change. See id. at
Section 5.2(c)(ii). In addition, changes in technology between the
time the Bids were submitted and the time the Central Repository is
built could result in changes to the costs to build and operate the
Central Repository.
\1468\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B).
\1469\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B) (describing the minimum, median, mean and maximum
Bidder estimates for the build and maintenance costs of the Central
Repository).
\1470\ Id. The Bidders provided a range of estimates. For
purposes of this Paperwork Burden Act analysis, the Commission is
using the build cost of the maximum Bidder estimate. $4,580,000 =
$91,600,000/20 SROs.
\1471\ $7 million for each Participant to build the Central
Repository = ($4.6 million per Participant in initial one-time costs
to compensate the Plan Processor to build the Central Repository) +
($2.4 million per Participant in initial one-time public relations,
legal and consulting costs associated with the building of the
Central Repository and the selection of the initial Plan Processor).
\1472\ $140 million for all of the Participants to build the
Central Repository = $7 million per Participant to build the Central
Repository) x (20 Participants). Id.
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(2) Ongoing, Annual Burden Hours and Costs for the Central Repository
After the Central Repository has been developed and implemented,
there would be ongoing costs for operating and maintaining the Central
Repository, including the cost of systems and connectivity upgrades or
changes necessary to receive, consolidate, and store the reported order
and execution information from Participants and their members; the
costs to store data, and make it 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; \1473\ the cost,
including storage costs, of collecting and maintaining the NBBO and
transaction data in a format compatible with the order and event
information collected pursuant to the Rule; the cost of monitoring the
required validation parameters, which would allow the Central
Repository to automatically check the accuracy and completeness of the
data submitted and reject data not conforming to these parameters
consistent with the requirements of the proposed Rule; and the cost of
paying the CCO. The CAT NMS Plan provides that the Plan Processor would
be responsible for the ongoing operations of the Central
Repository.\1474\ The Operating Committee would continue to be
responsible for the management of the Central Repository. In addition,
the CAT NMS Plan states that the Participants would incur costs for
public relations, legal, and consulting costs associated with
maintaining the CAT upon approval of the CAT NMS Plan.\1475\
---------------------------------------------------------------------------
\1473\ See supra note 1469.
\1474\ See CAT NMS Plan, supra note 3, at Section 6.1.
\1475\ See id. at Appendix C, Section B.7(b)(iii).
---------------------------------------------------------------------------
The Commission preliminarily estimates that the Participants would
incur an ongoing annual internal burden of 720 burden hours associated
with the continued management of the Central Repository, for an
aggregate annual estimate of 14,407 burden hours across the
Participants.\1476\
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\1476\ The Commission is basing this estimate on the internal
burden estimate provided in the CAT NMS Plan for the development of
the CAT NMS Plan. The Commission notes that the CAT NMS Plan
describes the internal burden estimate for the development of the
CAT NMS Plan as a cost the Participants will continue to accrue;
therefore, the Commission preliminarily believes that it is
reasonable to use this burden estimate as the basis for its ongoing
internal burden estimate for the maintenance of the Central
Repository, particularly as the Commission believes the reasons for
the staff time incurred for the development of the CAT NMS Plan
would be comparable to those of the staff time to be incurred by the
Operating Committee and the Selection Committee for the continued
management of the Central Repository. See CAT NMS Plan, supra note
3, at Appendix C, Section B.7(b)(iii) (stating `` . . . the
Participants have accrued, and will continue to accrue, direct costs
associated with the development of the CAT NMS Plan. These costs
include staff time contributed by each Participant to, among other
things, determine the technological requirements for the Central
Repository, develop the RFP, evaluate Bids received, design and
collect the data necessary to evaluate costs and other economic
impacts, meet with Industry Members to solicit feedback, and
complete the CAT NMS Plan submitted to the Commission for
consideration. The Participants estimate that they have collectively
contributed 20 FTEs in the first 30 months of the CAT NMS Plan
development process''). (20 FTEs/30 Participants) = 0.667 FTEs per
month for all of the Participants to continue management of the
Central Repository. Converting this into burden hours, (0.667 FTEs)
x (12 months) x (1,800 burden hours per year) = 14,407 ongoing
annual burden hours for all of the Participants to continue
management of the Central Repository. (14,407 ongoing annual burden
hours for all Participants/20 Participants) = 720 ongoing annual
burden hours for each Participant to continue management of the
Central Repository.
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Additionally, the Commission estimates that the Participants will
collectively spend $800,000 annually on external public relations,
legal and consulting costs associated with the continued management of
the Central Repository, or $40,000 per Participant.\1477\
---------------------------------------------------------------------------
\1477\ The Commission is basing this external cost estimate on
the public relations, legal and consulting external cost estimate
provided in the CAT NMS Plan associated with the preparation of the
CAT NMS Plan (which the Participants consider ``reasonably
associated with creating, implementing, and maintaining the CAT upon
the Commission's adoption of the CAT NMS Plan''). See CAT NMS Plan,
supra note 3, at Appendix C, Section B.7(b)(iii) (stating ``the
Participants have incurred public relations, legal and consulting
costs in preparation of the CAT NMS Plan. The Participants estimate
the costs of these services to be $8,800,000''). $2,400,000 for all
Participants over 12 months = ($8,800,000/44 months between the
adoption of Rule 613 and the filing of the CAT NMS Plan) x (12
months). Because the Central Repository will have already been
created, the Commission believes it is reasonable to assume that the
Participants will have a lesser need for public relations, legal and
consulting services. The Commission is estimating that the
Participants will incur one-third of the external cost associated
with development and implementation of the Central Repository to
maintain the Central Repository. $800,000 = (0.333) x ($2,400,000).
($800,000/20 Participants) = $40,000 per Participant over 12 months.
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The CAT NMS Plan includes the estimates the six Shortlisted Bidders
provided for the annual ongoing costs to the Participants to operate
the Central Repository.\1478\ The CAT NMS Plan did not categorize the
costs included in the ongoing costs, but the Commission believes they
would comprise external technological, operational and administrative
costs, as the Participants described the costs included in the initial
one-time external cost to build the Central Repository.\1479\ Using
these estimates, the Commission preliminarily estimates that the annual
ongoing cost to the Participants \1480\ to compensate the Plan
Processor for building, operating and maintaining the Central
Repository would be an aggregate ongoing external cost of $93
million,\1481\ or approximately $4.7 million per
[[Page 30789]]
Participant.\1482\ Therefore, the Commission preliminarily estimates
that each Participant would incur ongoing annual external costs of
$4,740,000 \1483\ to maintain the Central Repository, or aggregate
ongoing annual external costs across all Participants of
$94,800,000.\1484\
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\1478\ See Section IV.F.1.a, supra, for a discussion of the
total five-year operating costs for the Central Repository presented
in the CAT NMS Plan. See also CAT NMS Plan, supra note 3, at
Appendix C, Section B.7(b)(i)(B); supra note 840; supra note 1467.
\1479\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B).
\1480\ See supra note 1469.
\1481\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(B).
\1482\ The Bidders provided a range of estimates. For purposes
of this Paperwork Burden Act analysis, the Commission is using the
maximum operation and maintenance cost estimate. $4,650,000 =
$93,000,000/20 Participants. See also Section IV.F.1.a, supra. The
Commission noted several uncertainties that may affect the Central
Repository cost estimates, including (1) that the Participants have
not yet selected a Plan Processor and the Shortlisted Bidders have
submitted a wide range of cost estimates for building and operating
the Central Repository; (2) the Bids submitted by the Shortlisted
Bidders may not be final because they may be revised before the
final selection of the CAT Processor; and (3) neither the Bidders
nor the Commission can anticipate the evolution of technology and
market activity with precision, as improvements in available
technology may allow the Central Repository to be built and operated
at a lower cost than is currently anticipated, but if levels of
anticipated market activity are materially underestimated, the
capacity of the Central Repository may need to be increased,
resulting in an increase in costs.
\1483\ $4,740,000 for each Participant to build the Central
Repository = ($4.7 million per Participant in ongoing annual costs
to build the Central Repository) + ($40,000 per Participant in
ongoing annual public relations, legal and consulting costs
associated with the maintenance of the Central Repository).
\1484\ $94,800,000 for all of the Participants to maintain the
Central Repository = ($4,740,000 per Participant to compensate the
Plan Processor and for external public relations, legal and
consulting costs associated with the maintenance of the Central
Repository) x (20 Participants). Id.
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b. Data Collection and Reporting
Rule 613(c)(1) requires the CAT NMS Plan to provide for an
accurate, time-sequenced record of orders beginning with the receipt or
origination of an order by a Participant, and further to document the
life of the order through the process of routing, modification,
cancellation and execution (in whole or in part) of the order. Rule
613(c) requires the CAT NMS Plan to impose requirements on Participants
to record and report CAT information to the Central Repository in
accordance with specified timelines.
Rule 613(c) would require the collection and reporting of some
information that Participants already collect to operate their business
and are required to maintain in compliance with Section 17(a) of the
Exchange Act and Rule 17a-1 thereunder.\1485\ For instance, the
Commission believes that the national securities exchanges keep records
pursuant to Section 17(a) of the Exchange Act and Rule 17a-1 thereunder
in electronic form, of the receipt of all orders entered into their
systems, as well as records of the routing, modification, cancellation,
and execution of those orders. However, Rule 613 requires the
Participants to collect and report additional and more detailed
information, and to report the information to the Central Repository 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.
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\1485\ 15 U.S.C. 78q(a); 17 CFR 240.17a-1.
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The CAT NMS Plan provides estimated costs for the Participants to
report CAT Data. These estimates are based on Participant responses to
the Participants Study that the Participants collected to estimate CAT-
related costs for hardware and software, FTE costs, and third-party
providers, if the Commission approves the CAT NMS Plan.\1486\ For these
estimates, the Commission is relying on the cost data provided by the
Participants because it believes that the Plan's estimates for
Participants to report CAT Data are reliable since all of the
Participants provided cost estimates, and most Participants have
experience collecting audit trail data, as well as knowledge of both
the requirements of Rule 613 as well as their current business
practices. The Commission is providing below its paperwork burden
estimates for the initial burden hours and external costs, and ongoing,
annual burden hours and external costs to be incurred by the
Participants to comply with the data reporting requirements of Rule
613.
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\1486\ Third-party provider costs are generally legal and
consulting costs, but may include other outsourcing. The template
used by respondents is available at http://catnmsplan.com/PastEvents/ under the Section titled ``6/23/14'' at the ``Cost Study
Working Template'' link.
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The Commission notes that throughout this Paperwork Reduction Act
analysis, it is categorizing the FTE cost estimates for the
Participants, as well as the broker-dealer respondents, that were
provided in the CAT NMS Plan as an internal burden. To convert the FTE
cost estimates into internal burden hours, the Commission: (1) Divided
the FTE cost estimates by a divisor of $424,350, which is the
Commission's estimated average salary for a full-time equivalent
employee in the securities industry in a job category associated with
regulatory data reporting; \1487\ and then (2) multiplied the quotient
by 1,800 (the number of hours a full-time equivalent employee is
estimated to work per year).
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\1487\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(ii)(C) at n.192. The Participants represented that the cost
per FTE is $401,440. The $401,440 figure used in the CAT NMS plan
was based on a Programmer Analyst's salary ($193 per hour) from
SIFMA's Management & Professional Earnings in the Securities
Industry 2008, multiplied by 40 hours per week, then multiplied by
52 weeks per year. The Commission has updated this number to include
recent salary data for other job categories associated with
regulatory data reporting in the securities industry, using the hour
and multiple methodology used by the Commission in its paperwork
burden analyses. The Commission is using $424,350 as its annual cost
per FTE for purposes of its cost estimates. The $424,350 FTE cost =
25% Compliance Manager + 75% Programmer Analyst (0.25) x ($283 per
hour x 1,800 working hours per year) + (0.75) x ($220 per hour x
1,800 working hours per year). The $282 per hour figure for a
Compliance Manager and the $220 per hour figure for a Programmer
Analyst are from SIFMA's Management & Professional Earnings in the
Securities Industry 2013, modified by the Commission to account for
an 1800-hour work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead.
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(1) Initial Burden Hours and External Cost
The CAT NMS Plan provides the following average costs that the
Participants would expect to incur to adopt the systems changes needed
to comply with the data reporting requirements of the consolidated
audit trail: $10,300,000 in aggregate FTE costs for internal
operational, technical/development, and compliance functions; $770,000
in aggregate third party legal and consulting costs; and $17,900,000 in
aggregate total costs.\1488\
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\1488\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(B)(2). Of the $17,900,000 in aggregate total costs,
$11,070,000 is identified (subtotal of FTE costs and outsourcing),
but the remaining $6,830,000 is not identified in the CAT NMS Plan.
The Commission believes that the $6,830,000 may be attributed to
hardware costs because the Participants have not provided any
hardware costs associated with data reporting elsewhere and the
Commission believes that the Participants will likely incur external
costs to purchase upgraded hardware to report data to the Central
Repository.
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Based on estimates provided in the CAT NMS Plan, the Commission
preliminarily estimates that the initial internal burden hours to
develop and implement the needed systems changes to capture the
required information and transmit it to the Central Repository in
compliance with the Rule for each Participant would be approximately
2,185 burden hours.\1489\ The Commission also estimates that each
Participant would, on average, incur approximately $38,500 in initial
third party legal and consulting costs \1490\ for
[[Page 30790]]
a total of $380,000 in initial external costs.\1491\ Therefore, the
Commission preliminarily estimates that, for all Participants, the
estimated aggregate one-time burden would be 43,690 hours \1492\ and
the estimated aggregate initial external cost would be
$7,600,000.\1493\
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\1489\ ($10,300,000 anticipated initial FTE costs)/(20 SROs) =
$515,000 in anticipated initial FTE costs per Participant. ($515,000
in anticipated initial FTE costs per Participant)/($424,350 FTE
costs per Participant) = 1.214 anticipated FTEs per Participant for
the implementation of data reporting. (1.214 FTEs) x (1,800 working
hours per year) = 2,184.5 initial burden hours per Participant to
implement CAT Data reporting.
\1490\ ($770,000 anticipated initial third party costs)/(20
Participants) = $38,500 in initial anticipated third party costs per
Participant.
\1491\ To determine the total initial external cost per
Participant, the Commission subtracted the anticipated initial FTE
cost estimates for the Participants as provided in the Plan from the
total aggregate initial costs to the Participants and divided the
remainder by 20 Participants. ($17,900,000 total aggregate initial
cost to Participants) - ($10,300,000 initial FTE cost to
Participants) = $7,600,000. ($7,600,000)/20 Participants = $380,000
in initial external costs per Participant. See CAT NMS Plan, supra
note 3, at Appendix C, Section B.7(b)(iii)(B)(1) for the
Participants' anticipated costs associated with the implementation
of regulatory reporting to the Central Repository.
\1492\ 43,690 initial burden hours = (20 Participants) x
(2,184.5 initial burden hours).
\1493\ $7,600,000 = ($380,000 in initial external costs) x (20
Participants).
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(2) Ongoing, Annual Burden Hours and External Cost
Once a Participant has established the appropriate systems and
processes required for collection and transmission of the required
information to the Central Repository, the Commission preliminarily
estimates that Rule 613 would impose on each Participant ongoing annual
burdens associated with, among other things, personnel time to monitor
each Participant's reporting of the required data and the maintenance
of the systems to report the required data; and implementing changes to
trading systems that might result in additional reports to the Central
Repository. The CAT NMS Plan provides the following average aggregate
costs that the Participants would expect to incur to maintain data
reporting systems to be in compliance with Rule 613: $7,300,000 in
anticipated annual FTE costs for operational, technical/development,
and compliance functions related to data reporting; $720,000 in annual
third party legal, consulting, and other costs; \1494\ and $14,700,000
total annual costs.\1495\
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\1494\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(B)(2). The CAT NMS Plan did not identify the other
costs.
\1495\ Of the $14,700,000 in aggregate total annual costs,
$8,020,000 is identified (subtotal of FTE costs and outsourcing),
but the remaining $6,680,000 is not identified in the CAT NMS Plan.
The Commission believes that this amount may be attributed to
hardware costs because the Participants have not provided any
hardware costs associated with data reporting elsewhere and the
Commission believes that the Participants will likely incur costs to
upgrade their hardware to report data to the Central Repository.
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Based on estimates provided in the CAT NMS Plan, the Commission
believes that it would take each Participant 1,548 ongoing burden hours
per year \1496\ to continue compliance with Rule 613. The Commission
preliminarily estimates that it would cost, on average, approximately
$36,000 in ongoing third party legal and consulting and other costs
\1497\ and $370,000 in total ongoing external costs per
Participant.\1498\ Therefore, the Commission preliminarily estimates
that the estimated aggregate ongoing burden for all Participants would
be approximately 30,966 hours \1499\ and an estimated aggregate ongoing
external cost of $7,400,000.\1500\
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\1496\ ($7,300,000 in anticipated Participant annual FTE costs)/
(20 Participants) = $365,000 in anticipated per Participant annual
FTE costs. ($365,000 in anticipated per Participant FTE costs)/
($424,350 FTE cost per Participant) = 0.86 anticipated FTEs per
Participant. (0.86 FTEs) x (1,800 working hours per year) = 1,548.3
burden hours per Participant to maintain CAT Data reporting.
\1497\ ($720,000 in annual third party costs)/(20 Participants)
= $36,000 per Participant in anticipated annual third party costs.
\1498\ To determine the total external annual cost per
Participant, the Commission subtracted the anticipated annual FTE
cost estimates for the Participants as provided in the Plan from the
total aggregate annual costs to the Participants and divided the
remainder by 20 Participants. ($14,700,000 total aggregate annual
cost to Participants) - ($7,300,000 annual FTE cost to Participants)
= $7,400,000. ($7,400,000)/20 Participants = $370,000 in annual
external costs per Participant. See CAT NMS Plan, supra note 3, at
Appendix C, Section B.7(b)(iii)(B)(1) for the Participants'
anticipated maintenance costs associated with regulatory reporting
to the Central Repository.
\1499\ 30,966 annual burden hours = (20 Participants) x (1,548.3
annual burden hours).
\1500\ $7,400,000 = ($370,000 in total annual external costs) x
(20 Participants).
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c. Collection and Retention of NBBO, Last Sale Data and Transaction
Reports
Rule 613(e)(7) provides that the CAT NMS Plan must require the
Central Repository to collect and retain on a current and continuous
basis NBBO information for each NMS security, transaction reports
reported pursuant to an effective transaction reporting plan, and Last
Sale Reports reported pursuant to the OPRA Plan.\1501\ Additionally,
the CAT NMS Plan must require the Central Repository to maintain this
data in a format compatible with the order and event information
consolidated and stored pursuant to Rule 613(c)(7).\1502\ Further, the
CAT NMS Plan must require the Central Repository to retain the
information collected pursuant to paragraphs (c)(7) and (e)(7) of Rule
613 for a period of not less than five years in a convenient and usable
uniform electronic format that is directly available and searchable
electronically without any manual intervention.\1503\ The Commission
notes that the CAT NMS Plan includes these data as ``SIP Data'' to be
collected by the Central Repository.\1504\ The Commission believes the
burden associated with SIP Data is included in the burden to the
Participants associated with the implementation and maintenance of the
Central Repository.
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\1501\ See 17 CFR 242.613(e)(7).
\1502\ Id.
\1503\ See 17 CFR 242.613(e)(8).
\1504\ See CAT NMS Plan, supra note 3, at Section 6.5(a)(ii).
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d. Surveillance
Rule 613(f) provides that the CAT NMS Plan must require that every
national securities exchange and national securities association
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.
Rule 613(a)(3)(iv) provides that the CAT NMS Plan must require that the
surveillance systems be implemented within fourteen months after
effectiveness of the CAT NMS Plan.
(1) Initial Burden Hours and External Cost
The CAT NMS Plan states that the estimated total cost to the
Participants to implement surveillance programs within the Central
Repository is $23,200,000.\1505\ This amount includes legal,
consulting, and other costs of $560,000, as well as $17,500,000 in FTE
costs for operational, technical/development, and compliance Staff to
be engaged in the creation of surveillance programs.\1506\
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\1505\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(B)(2).
\1506\ Id. The Commission also notes that based upon the data
provided by the Participants, the source of the remaining $5,140,000
in initial costs to implement new or enhanced surveillance systems
is unspecified. The Commission believes that this amount may be
attributed to hardware costs because the Participants have not
provided any hardware costs associated with surveillance elsewhere
and the Commission believes that the Participants will likely incur
costs to implement new or enhanced surveillance systems reasonably
designed to make use of the consolidated audit trail data.
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Based on the estimates provided in the CAT NMS Plan, the Commission
preliminarily estimates that the initial internal burden hours to
implement new or enhanced surveillance systems reasonably designed to
make use of the consolidated audit trail data for each Participant
would be approximately 3,711.6 burden hours,\1507\ for an
[[Page 30791]]
aggregate initial burden hour amount of 74,232 burden hours.\1508\ The
Commission also estimates that each Participant would, on average,
incur an initial external cost of approximately $28,000 \1509\ for
outsourced legal, consulting and other costs in order to implement new
or enhanced surveillance systems, for a total of $285,000 in initial
external costs,\1510\ for an aggregate one-time initial external cost
of $5,700,000 across the 20 Participants to implement new or enhanced
surveillance systems.\1511\
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\1507\ ($17,500,000 in anticipated initial FTE costs)/(20
Participants) = $875,000 in anticipated FTE costs per Participant.
($875,000 in anticipated initial FTE costs per Participant)/
($424,350 FTE cost per Participant) = 2.06 anticipated initial FTEs
per Participant. (2.06 FTEs) x (1,800 working hours per year) =
3,711.6 initial burden hours per Participant to implement new or
enhanced surveillance systems.
\1508\ (3,711.6 initial burden hours per Participant to
implement new or enhanced surveillance systems) x (20 Participants)
= 74,232 aggregate initial burden hours.
\1509\ $28,000 = $560,000/20 Participants.
\1510\ $285,000 = ($23,200,000 in total initial surveillance
costs--$17,500,000 in FTE costs)/(20 Participants).
\1511\ $5,700,000 = $285,000 x 20 Participants.
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(2) Ongoing, Annual Burden Hours and External Cost
The CAT NMS Plan states that the estimated total annual cost
associated with the maintenance of surveillance programs for the
Participants is $87,700,000.\1512\ This amount includes annual legal,
consulting, and other costs of $1,000,000, as well as $66,700,000 in
annual FTE costs for internal operational, technical/development, and
compliance Staff to be engaged in the maintenance of surveillance
programs.\1513\ Based on the estimates provided in the CAT NMS
Plan,\1514\ the Commission preliminarily estimates that the ongoing
internal burden hours to maintain the new or enhanced surveillance
systems reasonably designed to make use of the consolidated audit trail
data for each Participant would be approximately 14,146 annual burden
hours,\1515\ for an aggregate annual burden hour amount of 282,920
burden hours.\1516\ The Commission also estimates that each Participant
would, on average, incur an annual external cost of approximately
$50,000 \1517\ for outsourced legal, consulting and other costs in
order to maintain the new or enhanced surveillance systems, for a total
estimated ongoing external cost of $1,050,000,\1518\ for an estimated
aggregate ongoing external cost of $21,000,000 across the 20
Participants to maintain the surveillance systems.\1519\
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\1512\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(B)(2).
\1513\ Id. The Commission also notes that based upon the data
provided by the Participants, the source of the remaining
$21,000,000 in ongoing costs to maintain the new or enhanced
surveillance systems is unspecified. The Commission believes that
this amount may be attributed to hardware costs because the
Participants have not provided any hardware costs associated with
surveillance elsewhere and the Commission believes that the
Participants would likely incur costs associated with maintaining
the new or enhanced surveillance systems.
\1514\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(B)(2).
\1515\ ($66,700,000 in anticipated ongoing FTE costs)/(20
Participants) = $3,335,000 in anticipated ongoing FTE costs per
Participant. ($3,335,000 in anticipated ongoing FTE costs per
Participant)/($424,350 FTE cost per Participant) = 7.86 anticipated
FTEs per Participant. (7.86 FTEs) x (1,800 working hours per year) =
14,146 ongoing burden hours per Participant to maintain the new or
enhanced surveillance systems.
\1516\ (14,146 annual burden hours per Participant to maintain
new or enhanced surveillance systems) x (20 Participants) = 282,920
aggregate annual burden hours.
\1517\ $50,000 = $1,000,000 for ongoing legal, consulting and
other costs associated with maintenance of surveillance programs/20
Participants.
\1518\ $1,050,000 = ($87,700,000 in total ongoing surveillance
costs-$66,700,000 in ongoing FTE costs)/20 Participants
\1519\ $21,000,000 = $1,050,000 x 20 Participants.
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e. Written Assessment of Operation of the Consolidated Audit Trail
Rule 613(b)(6) provides that the CAT NMS Plan must require the
Participants to provide the Commission a written assessment of the
CAT's operation at least every two years, once the CAT NMS Plan is
effective.\1520\ The assessment must address, at a minimum, with
respect to the consolidated audit trail: (i) An evaluation of its
performance; (ii) a detailed plan for any potential improvements to its
performance; (iii) an estimate of the costs associated with any such
potential improvements; and (iv) an estimated implementation timeline
for any such potential improvements, if applicable.\1521\ Thus, the
Participants must, among other things, undertake an analysis of the
consolidated audit trail's technological and computer system
performance.
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\1520\ 17 CFR 242.613(b)(6). See also Section IV.E.3.a, supra.
\1521\ See 17 CFR 242.613(b)(6).
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The CAT NMS Plan states that the CCO would oversee the assessment
required by Rule 613(b)(6), and would allow the Participants to review
and comment on the assessment before it is submitted to the
Commission.\1522\ The CCO would be an employee of the Plan Processor
and would be compensated by the Plan Processor.\1523\ The Commission
assumes that the overall cost and associated burden on the Participants
to implement and maintain the Central Repository includes both the
compensation for the Plan Processor as well as its employees for the
implementation and maintenance of the Central Repository.
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\1522\ See CAT NMS Plan, supra note 3, at Section 6.6.
\1523\ Id. at Section 6.2(a).
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The Commission preliminarily estimates that it would take each
Participant approximately 45 annual burden hours of internal legal,
compliance, business operations, and information technology staff time
to review and comment on the assessment prepared by the CCO of the
operation of the consolidated audit trail as required by Rule
613(b)(6).\1524\ The Commission preliminarily estimates that on
average, each Participant would outsource 1.25 hours of legal time
annually to assist in the review of the assessment, for an ongoing
annual external cost of approximately $500.\1525\ Therefore, the
[[Page 30792]]
Commission preliminarily estimates that the ongoing annual burden of
submitting a written assessment at least every two years, as required
by Rule 613(b)(6), would be 45 ongoing burden hours per SRO plus $500
of external costs for outsourced legal counsel per Participant per
year, for an estimated aggregate annual ongoing burden of 900 hours
\1526\ and an estimated aggregate ongoing external cost of
$10,000.\1527\
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\1524\ The Commission calculated the total estimated burden
hours based on a similar formulation used for calculating the total
estimated burden hours of Rule 613(i)'s requirement for a document
addressing expansion of the CAT to other securities. See Section
V.D.1.f., infra. The Commission assumes that the review and
potential revision of the written assessment required by Rule
613(b)(6) would be approximately one-half as burdensome as the
document required by Rule 613(i) as the Participants are delegating
the responsibility to prepare the written assessment required by
Rule 613(b)(6) to the CCO and the Participants would only need to
review the written assessment and revise it as necessary. As noted
in note 1530, infra, to estimate the Rule 613(i) burden, the
Commission is applying the internal burden estimate provided in the
CAT NMS Plan for Plan development over a 6-month period, and
dividing the result in half. See CAT NMS Plan, supra note 3, at
Appendix C, Section B.7(b)(iii). To estimate the Rule 613(b)(6)
written assessment burden, the Commission is dividing the result
further by half. 0.667 FTEs required for all Participants per month
to develop the CAT NMS Plan = (20 FTEs/30 months). 0.667 FTEs x 6
months = 4 FTEs. 4 FTEs/2 = 2 FTEs needed for all of the
Participants to create and submit the Rule 613(i) document. 2 FTEs/2
= 1 FTE needed for all of the Participants to review and comment on
the written assessment. (1 FTE x 1,800 working hours per year) =
1,800 ongoing annual burden hours per year for all of the
Participants to review and comment on the written assessment. (1,800
burden hours/20 Participants) = 90 ongoing annual burden hours per
Participant to review and comment on the written assessment prepared
by the CCO. The Commission notes that this assessment must be filed
with the Commission every two years and is providing an annualized
estimate of the burden associated with the assessment as required
for its Paperwork Reduction Act analysis. To provide an estimate of
the annual burden associated with the assessment as required for its
Paperwork Reduction Act analysis, Commission is dividing the 90
ongoing burden hours in half (over two years) = 45 ongoing annual
burden hours per Participant to review and comment on the written
assessment prepared by the CCO.
\1525\ $500 = ($400 per hour rate for outside legal services) x
(1.25 hours). The Commission based this estimate on the assumption
that the written assessment required by Rule 613(b)(6) would require
approximately one-half the effort of drafting and submitting the
document required by Rule 613(i) regarding the expansion of the CAT
to other securities because the Participants have delegated the
responsibility to draft the written assessment on the CCO, rather
than having to draft it themselves (as with the expansion report),
but would also have to review the written assessment and revise it
as necessary. See Section V.D.1.f., infra. Because the written
assessment is a biennial requirement, the Commission is further
dividing the cost of the written assessment in half (over two years)
to estimate the annual ongoing external cost per Participant for
outside legal services to review and comment on the written
assessment prepared by the CCO.
\1526\ 900 ongoing annual burden hours = (45 ongoing annual
burden hours) x (20 Participants).
\1527\ $10,000 = 20 Participants x ($400 per hour rate for
outside legal services) x (1.25 hours).
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f. Document on Expansion to Other Securities
Rule 613(i) provides that the CAT NMS Plan must require the
Participants to jointly provide to the Commission, within six months
after the CAT NMS Plan is effective, a document outlining how the
Participants could incorporate into the consolidated audit trail
information regarding: (1) Equity securities that are not NMS
securities; \1528\ (2) debt securities; and (3) primary market
transactions in equity securities that are not NMS securities and debt
securities.\1529\ The document must also detail the order and
Reportable Event data that each market participant may be required to
provide, which market participants may be required to provide such
data, an implementation timeline, and a cost estimate. Thus, the
Participants must, among other things, undertake an analysis of
technological and computer system acquisitions and upgrades that would
be required to incorporate such an expansion.
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\1528\ As noted above, the CAT NMS Plan would require the
inclusion of OTC Equity Securities, while Rule 613 does not include
such a requirement. See supra note 1408.
\1529\ See 17 CFR 242.613(i).
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The Commission preliminarily estimates that it would take each
Participant approximately 180 burden hours of internal legal,
compliance, business operations and information technology staff time
to create a document addressing expansion of the consolidated audit
trail to additional securities as required by Rule 613(i).\1530\ The
Commission preliminarily estimates that on average, each Participant
would outsource 25 hours of external legal time to create the document,
for an aggregate one-time external cost of approximately $10,000.\1531\
Therefore, the Commission preliminarily estimates that the one-time
initial burden of drafting the document required by Rule 613 would be
180 initial burden hours plus $10,000 in initial external costs for
outsourced legal counsel per Participant, for an estimated aggregate
initial burden of 3,600 hours and an estimated aggregate initial
external cost of $200,000.\1532\
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\1530\ The Commission is basing this estimate on the internal
burden provided in the CAT NMS Plan related to the development of
the CAT NMS Plan. See CAT NMS Plan, supra note 3, at Appendix C,
Section B.7(b)(iii) (stating ``[t]he Participants estimate that they
have collectively contributed 20 FTEs in the first 30 months of the
CAT NMS Plan development process''). Because this document is much
more limited in scope than the CAT NMS Plan, and because the
Commission assumes that in drafting the CAT NMS Plan, the
Participants have already contributed time toward considering how
the CAT can be expected to be expanded in accordance with Rule
613(i), the Commission is applying the CAT NMS Plan development
internal burden over a 6-month period (Rule 613(i) requires this
document to be submitted to the Commission within six months after
effectiveness of the CAT NMS Plan), divided by half. 0.667 FTEs
required for all Participants per month to develop the CAT NMS Plan
= (20 FTEs/30 months). 0.667 FTEs x 6 months = 4 FTEs. 4 FTEs/2 = 2
FTEs needed for all of the Participants to create and submit the
document. 2 FTEs x 1,800 working hours per year = 3,600 burden
hours. 3,600 burden hours/20 Participants = 180 burden hours per
Participant to create and file the document.
\1531\ $10,000 = (25 hours of outsourced legal time per
Participant) x ($400 per hour rate for outside legal services). The
Commission derived the total estimated cost for outsourced legal
counsel based on the assumption that the report required by Rule 613
would require approximately fifteen percent of the Commission's
approximated burden of drafting and filing the CAT NMS Plan. This
assumption is based on the Participants leveraging their knowledge
gained from their drafting and filing of the CAT NMS Plan and
applying it to efficiently preparing the report required by Rule 613
with respect to other securities' order and Reportable Events,
implementation timeline and cost estimates.
\1532\ The initial burden hour estimate is based on: (20
Participants) x (180 initial burden hours to draft the report). The
initial external cost estimate is based on: (20 Participants) x
($10,000 for outsourced legal counsel).
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2. Burden on Members of National Securities Exchanges and National
Securities Associations
a. Data Collection and Reporting
Rule 613(c)(1) requires the CAT NMS Plan to provide for an
accurate, time-sequenced record of orders beginning with the receipt or
origination of an order by a broker-dealer member of a Participant, 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. Rule 613(c) requires the CAT NMS Plan to impose
requirements on broker-dealer members to record and report CAT
information to the Central Repository in accordance with specified
timelines.
The Commission acknowledges the inherent difficulty in establishing
precise burden estimates because the Commission does not know the exact
method of data reporting the Participants would decide for broker-
dealers. For these estimates, the Commission is relying, in part, on
the cost data provided by the Participants in the CAT NMS Plan,\1533\
and, as noted earlier, on its own estimates of the costs that broker-
dealers are likely to face for CAT implementation and ongoing reporting
in compliance with Rule 613.\1534\
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\1533\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b).
\1534\ See Sections IV.F.1.c(1) and IV.F.1.c(2), supra.
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The Commission's estimates delineate broker-dealer firms by whether
they insource or outsource, or are likely to insource or outsource, CAT
Data reporting obligations.\1535\ The Commission preliminarily believes
that firms that currently report high numbers of OATS ROEs
strategically would decide to either self-report their CAT Data or
outsource their CAT Data reporting functions, while the firms with the
lowest levels of activity would be unlikely to have the infrastructure
and specialized employees necessary to insource CAT Data reporting and
would almost certainly outsource their CAT Data reporting
functions.\1536\ The Commission recognizes that more active firms that
will likely be CAT Reporters and insource regulatory data reporting
functions may not have current OATS reporting obligations because they
either are not FINRA members, or because they do not trade in NMS
equity securities.\1537\
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\1535\ See Section IV.F.1.c(2)B, supra.
\1536\ Id.
\1537\ The Commission also preliminarily recognizes as discussed
above that some broker-dealer firms may strategically choose to
outsource despite the Plan's working assumption that these broker-
dealers would insource their regulatory data reporting functions.
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The Commission preliminarily estimates that there are 126 OATS-
reporting Insourcers and 45 non-OATS reporting Insourcers.\1538\ The
Commission's estimation categorizes the remaining 1,629 broker-dealers
that the Plan anticipates would have CAT Data reporting obligations as
Outsourcers.\1539\
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\1538\ See Section IV.F.1.c(2)B, infra.
\1539\ Id.
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[[Page 30793]]
(1) Insourcers
A. Large Non-OATS Reporting Broker-Dealers
i. Initial Burden Hours and External Cost
The Commission relies on the Reporters Study's large broker-dealer
cost estimates in estimating costs for large broker-dealers that can
practicably decide between insourcing or outsourcing their regulatory
data reporting functions. The Commission estimates that there are 14
large broker-dealers that are not OATS reporters currently in the
business of electronic liquidity provision that would be classified as
Insourcer firms.\1540\
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\1540\ These broker-dealers are not FINRA members and thus have
no regular OATS reporting obligations. See supra note 937.
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Additionally, the Commission estimates that there are 31 broker-
dealers that may transact in options but not in equities that can be
classified as Insourcer firms.\1541\ Although the Exemptive Relief may
relieve these firms of the obligation to report their option quoting
activity to the Central Repository, these firms may have customer
orders and other activity off-exchange that would cause them to incur a
CAT reporting obligation.
---------------------------------------------------------------------------
\1541\ See supra note 939.
---------------------------------------------------------------------------
The Commission assumes the 31 options firms and 14 ELPs would be
typical of the Reporters Study's large, non-OATS reporting firms; for
these firms, the Commission relies on the cost estimates provided under
Approach 1 \1542\ for large, non-OATS reporting firms in the CAT NMS
Plan.
---------------------------------------------------------------------------
\1542\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(i)(A)(2). The Reporters Study requested broker-dealer
respondents to provide estimates to report to the Central Repository
under two approaches. Approach 1 assumes CAT Reporters would submit
CAT Data using their choice of industry protocols. Approach 2
assumes CAT Reporters would submit data using a pre-specified
format. Approach 1's aggregate costs are higher than those for
Approach 2 for all market participants except in one case where
service bureaus have lower Approach 1 costs. See supra note 946. For
purposes of this Paperwork Reduction Act analysis, the Commission is
not relying on the cost estimates for Approach 2 because overall the
Approach 1 aggregate estimates represent the higher of the proposed
approaches. The Commission believes it would be more comprehensive
to use the higher of the two estimates for its Paperwork Reduction
Act analysis estimates.
---------------------------------------------------------------------------
The CAT NMS Plan provides the following average initial external
cost and FTE count figures that a large non-OATS reporting broker-
dealer would expect to incur to adopt the systems changes needed to
comply with the data reporting requirements of Rule 613 under Approach
1: $450,000 in external hardware and software costs; 8.05 internal
FTEs; \1543\ and $9,500 in external third party/outsourcing
costs.\1544\ Based on this information, the Commission preliminarily
estimates that the average initial burden associated with implementing
regulatory data reporting to capture the required information and
transmit it to the Central Repository in compliance with the Rule for
each large, non-OATS reporting broker-dealer would be approximately
14,490 initial burden hours.\1545\
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\1543\ Approach 1 also provided $3,200,000 in initial internal
FTE costs. The Commission believes the $3,200,000 in internal FTE
costs is the Participants' estimated cost of the 8.05 FTEs. (8.05
FTEs) x ($401,440 Participants' assumed annual cost per FTE provided
in the CAT NMS Plan) = $3,231,592. See CAT NMS Plan, supra note 3,
at n. 192. See also supra note 1487.
\1544\ See CAT NMS Plan, supra note 3, at Section
B.7(b)(iii)(c)(2)(a). The Commission believes that the third party/
outsourcing costs may be attributed to the use of service bureaus
(potentially), technology consulting, and legal services.
\1545\ 14,490 initial burden hours = (8.05 FTEs for implementing
CAT Data reporting systems) x (1,800 working hours per year).
---------------------------------------------------------------------------
The Commission also preliminarily estimates that these broker-
dealers would, on average, incur approximately $450,000 in initial
costs for hardware and software to implement the systems changes needed
to capture the required information and transmit it to the Central
Repository, and an additional $9,500 in initial third party/outsourcing
costs.\1546\ Therefore, the Commission preliminarily estimates that the
average one-time initial burden per ELP and options market-making firm
would be 14,490 internal burden hours and external costs of
$459,500,\1547\ for an estimated aggregate initial burden of 652,050
hours \1548\ and an estimated aggregate initial external cost of
$20,677,500.\1549\
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\1546\ See supra note 1544.
\1547\ ($450,000 in initial hardware and software costs) +
($9,500 initial third party/outsourcing costs) = $459,500 in initial
external costs to implement data reporting systems.
\1548\ The Commission preliminarily estimates that 45 large non-
OATS reporting broker-dealers would be impacted by this information
collection. (45 large non-OATS reporting broker-dealers) x (14,490
burden hours) = 652,050 initial burden hours to implement data
reporting systems.
\1549\ ($450,000 in hardware and software costs) + ($9,500 third
party/outsourcing costs) x 45 large, non-OATS reporting broker-
dealers = $20,677,500 in initial external costs to implement data
reporting systems.
---------------------------------------------------------------------------
ii. Ongoing, Annual Burden Hours in External Cost
Once a large non-OATS reporting broker-dealer has established the
appropriate systems and processes required for collection and
transmission of the required information to the Central Repository, the
Commission preliminarily estimates that the Rule would impose ongoing
annual burdens associated with, among other things, personnel time to
monitor each large non-OATS reporting broker-dealer's reporting of the
required data and the maintenance of the systems to report the required
data; and implementing changes to trading systems that might result in
additional reports to the Central Repository. The CAT NMS Plan provides
the following average ongoing external cost and internal FTE count
figures that a large non-OATS reporting broker-dealer would expect to
incur to maintain data reporting systems to be in compliance with Rule
613: $80,000 in external hardware and software costs; 7.41 internal
FTEs; \1550\ and $1,300 in external third party/outsourcing
costs.\1551\ Based on this information, the Commission preliminarily
believes that it would take a large non-OATS reporting broker-dealer
13,338 burden hours per year \1552\ to continue to comply with the
Rule. The Commission also preliminarily estimates that it would cost,
on average, approximately $80,000 per year per large non-OATS reporting
broker-dealer to maintain systems connectivity to the Central
Repository and purchase any necessary hardware, software, and other
materials, and an additional $1,300 in third party/outsourcing
costs.\1553\
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\1550\ Approach 1 also provided $3,000,000 in internal FTE costs
related to maintenance. The Commission believes the $3,000,000 in
ongoing internal FTE costs is the Participants' estimated cost of
the 7.41 FTEs. (7.41 FTEs) x ($401,440 Participants' assumed annual
cost per FTE provided in the CAT NMS Plan) = $2,974,670. See CAT NMS
Plan, supra note 3, at n.192. See also supra note 1487.
\1551\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(C)(2)(b). The CAT NMS Plan did not break down these
third party costs into categories.
\1552\ 13,338 ongoing burden hours = (7.41 ongoing FTEs to
maintain CAT data reporting systems) x (1,800 working hours per
year).
\1553\ See supra note 1544; CAT NMS Plan, supra note 3, at
Appendix C, Section B.7(b)(iii)(C)(2)(b).
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Therefore, the Commission preliminarily estimates that the average
ongoing annual burden per large non-OATS reporting broker-dealer would
be approximately 13,338 hours, plus $81,300 in external costs \1554\ to
maintain the systems necessary to collect and transmit information to
the Central Repository, for an estimated aggregate ongoing burden of
600,210
[[Page 30794]]
hours \1555\ and an estimated aggregate ongoing external cost of
$3,658,500.\1556\
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\1554\ ($80,000 in ongoing external hardware and software costs)
+ ($1,300 ongoing external third party/outsourcing costs) = $81,300
in ongoing external costs per large non-OATS reporting broker-
dealer.
\1555\ The Commission estimates that 45 large non-OATS reporting
broker-dealers would be impacted by this information collection. (45
large non-OATS reporting broker-dealers) x (13,338 burden hours) =
600,210 aggregate ongoing burden hours.
\1556\ ($80,000 in ongoing external hardware and software costs)
+ ($1,300 ongoing external third party/outsourcing costs) x (45
large non-OATS reporting broker-dealers) = $3,658,500 in aggregate
ongoing external costs.
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B. Large OATS-Reporting Broker-Dealers
i. Initial Burden Hours and External Cost
Based on the Commission's analysis of data provided by FINRA and
discussions with market participants, the Commission estimates that 126
broker-dealers, which reported more than 350,000 OATS ROEs between June
15 and July 10, 2015, would strategically decide to either self-report
CAT Data or outsource their CAT data reporting functions.\1557\ To
conduct its Paperwork Burden Analysis for the 126 broker-dealers, the
Commission is relying on the Reporters Study estimates used by the CAT
NMS Plan of expected costs that a large OATS-reporting broker-dealer
would incur as a result of the implementation of the consolidated audit
trail under Approach 1.\1558\
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\1557\ See Section IV.F.1.c.2.B and Section IV.F.1.c(2)B.i,
supra. See also supra note 901, stating that the Commission believes
that broker-dealers that report fewer than 350,000 OATS ROEs per
month are unlikely to be large enough to support the infrastructure
required for insourcing data reporting activities.
\1558\ See supra note 1544.
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The CAT NMS Plan provides the following average initial external
cost and internal FTE count figures that a large OATS-reporting broker-
dealer would expect to incur as a result of the implementation of the
consolidated audit trail under Approach 1: $750,000 in hardware and
software costs; 14.92 internal FTEs; \1559\ and $150,000 in external
third party/outsourcing costs.\1560\ Based on this information the
Commission preliminarily estimates that the average initial burden to
develop and implement the needed systems changes to capture the
required information and transmit it to the Central Repository in
compliance with the Rule for large OATS-reporting broker-dealers would
be approximately 26,856 internal burden hours.\1561\ The Commission
also preliminarily estimates that these large OATS-reporting broker-
dealers would, on average, incur approximately $750,000 in initial
external costs for hardware and software to implement the systems
changes needed to capture the required information and transmit it to
the Central Repository, and an additional $150,000 in initial external
third party/outsourcing costs.\1562\
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\1559\ Approach 1 also provided $6,000,000 in initial internal
FTE costs. The Commission preliminarily believes the $6,000,000 in
initial internal FTE costs is the Participants' estimated cost of
the 14.92 FTEs. (14.92 FTEs) x ($401,440 Participants' assumed
annual cost per FTE provided in the CAT NMS Plan) = $5,989,485. See
CAT NMS Plan, supra note 3, at n. 192. See also supra note 1487.
\1560\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(C)(2)(a). The CAT NMS Plan did not break down these
third party costs into categories. The Commission preliminarily
believes that these costs may be attributed to the use of service
bureaus, technology consulting, and legal services.
\1561\ 26,856 initial burden hours per large OATS-reporting
broker-dealer = (14.92 FTEs for implementation of CAT data reporting
systems) x (1,800 working hours per year).
\1562\ See CAT NMS Plan, supra note 3, at Section
B.7(b)(iii)(C)(2)(a).
---------------------------------------------------------------------------
Therefore, the Commission preliminarily estimates that the average
one-time initial burden per large OATS-reporting broker-dealer would be
26,856 burden hours and external costs of $900,000,\1563\ for an
estimated aggregate initial burden of 3,383,856 hours \1564\ and an
estimated aggregate initial external cost of $113,400,000.\1565\
---------------------------------------------------------------------------
\1563\ ($750,000 in initial external hardware and software
costs) + ($150,000 initial external third party/outsourcing costs) =
$900,000 in initial external costs per large OATS-reporting broker-
dealer to implement CAT data reporting systems.
\1564\ The Commission preliminarily estimates that 126 large
OATS-reporting broker-dealers would be impacted by this information
collection. 126 large OATS-reporting broker-dealers x 26,856 burden
hours = 3,383,856 initial burden hours to implement data reporting
systems.
\1565\ ($750,000 in initial external hardware and software
costs) + ($150,000 initial external third party/outsourcing costs) x
126 large OATS-reporting broker-dealers = $113,400,000 in initial
external costs to implement data reporting systems.
---------------------------------------------------------------------------
ii. Ongoing, Annual Burden Hours and External Cost
Once a large OATS-reporting broker-dealer has established the
appropriate systems and processes required for collection and
transmission of the required information to the Central Repository, the
Commission preliminarily estimates that the Rule would impose on each
broker-dealer ongoing annual burdens and costs associated with, among
other things, personnel time to monitor each broker-dealer's reporting
of the required data and the maintenance of the systems to report the
required data; and implementing changes to trading systems which might
result in additional reports to the Central Repository.
The CAT NMS Plan provides the following average ongoing external
cost and FTE count figures that a large OATS-reporting broker-dealer
would expect to incur to maintain data reporting systems to be in
compliance with Rule 613: $380,000 in ongoing external hardware and
software costs; 10.03 internal FTEs; \1566\ and $120,000 in ongoing
external third party/outsourcing costs.\1567\ Based on this information
the Commission preliminarily believes that it would take a large OATS-
reporting broker-dealer 18,054 ongoing burden hours per year \1568\ to
continue compliance with the Rule. The Commission preliminarily
estimates that it would cost, on average, approximately $380,000 per
year per large OATS-reporting broker-dealer to maintain systems
connectivity to the Central Repository and purchase any necessary
hardware, software, and other materials, and an additional $120,000 in
external ongoing third party/outsourcing costs.\1569\
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\1566\ Approach 1 also provided $4,000,000 in internal FTE costs
related to maintenance. The Commission believes the $4,000,000 in
ongoing internal FTE costs is the Participants' estimated cost of
the 10.03 FTEs. (10.03 FTEs) x ($401,440 Participants' assumed
annual cost per FTE provided in the CAT NMS Plan) = $4,026,443. See
CAT NMS Plan, supra note 3, at n. 192. See also supra note 1487.
\1567\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(C)(2)(b). The CAT NMS Plan did not categorize these
third party costs. The Commission preliminarily believes that these
costs may be attributed to the use of service bureaus, technology
consulting, and legal services.
\1568\ 18,054 ongoing burden hours = (10.03 ongoing FTEs for
maintenance of CAT data reporting systems) x (1,800 working hours
per year).
\1569\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(C)(2)(b).
---------------------------------------------------------------------------
Therefore, the Commission preliminarily estimates that the average
ongoing annual burden per large OATS-reporting broker-dealer would be
approximately 18,054 burden hours, plus $500,000 in external costs
\1570\ to maintain the systems necessary to collect and transmit
information to the Central Repository, for an estimated aggregate
burden of 2,274,804 hours \1571\ and an estimated aggregate ongoing
external cost of $63,000,000.\1572\
---------------------------------------------------------------------------
\1570\ ($380,000 in ongoing external hardware and software costs
+ $120,000 in ongoing external third party/outsourcing costs) =
$500,000 in ongoing external costs per large OATS-reporting broker-
dealer.
\1571\ The Commission preliminarily estimates that 126 large
OATS-reporting broker-dealers would be impacted by this information
collection. (126 large OATS-reporting broker-dealers) x (18,054
burden hours) = 2,274,804 aggregate ongoing burden hours.
\1572\ ($380,000 in ongoing external hardware and software costs
+ $120,000 in ongoing external third party/outsourcing costs) x 126
large OATS-reporting broker-dealers = $63,000,000 in aggregate
ongoing external costs.
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[[Page 30795]]
(2) Outsourcing Firms
A. Small OATS-Reporting Broker-Dealers
i. Initial Burden Hours and External Cost
Based on data provided by FINRA, the Commission estimates that
there are 806 broker-dealers that report fewer than 350,000 OATS ROEs
monthly. The Commission preliminarily believes that these broker-
dealers generally outsource their regulatory reporting obligations
because during the period June 15-July 10, 2015, approximately 88.9% of
their 350,000 OATS ROEs were reported through service bureaus, with 730
of these broker-dealers reporting more than 99% of their OATS ROEs
through one or more service bureaus.\1573\ The Commission estimates
that these firms currently spend an aggregate of $100.1 million on
annual outsourcing costs.\1574\ The Commission estimates these 806
broker-dealers would spend $100.2 million in aggregate to outsource
their regulatory data reporting to service bureaus to report in
accordance with Rule 613,\1575\ or $124,373 per broker-dealer.\1576\
These external outsourcing cost estimates are calculated using the
information from Staff discussions with service bureaus and other
market participants, as applied to data provided by FINRA.\1577\
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\1573\ See Section IV.F.1.c(2)B.i, supra. Because of the
extensive use of service bureaus in these categories of broker-
dealers, the Commission assumes that these broker-dealers are likely
to use service bureaus to accomplish their CAT data reporting.
\1574\ The average broker-dealer in this category reported
15,185 OATS ROEs from June 15-July 10, 2015; the median reported
1,251 OATS ROEs. Of these broker-dealers, 39 reported more than
100,000 OATS ROEs during the sample period. See Section
IV.F.1.c(2)B.ii, supra.
\1575\ Id.
\1576\ $124,373 = $100,200,000/806 broker-dealers. This amount
is the average estimated annual outsourcing cost to firms that
currently report fewer than 350,000 OATS ROEs per month. Id.
\1577\ See Section IV.F.1.c(2)B.ii, supra.
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Firms that outsource their regulatory data reporting still face
internal staffing burdens associated with this activity. These
employees perform activities such as answering inquiries from their
service bureaus, and investigating reporting exceptions. Based on
conversations with market participants, the Commission estimates that
these firms currently have 0.5 full-time employees devoted to these
activities.\1578\ The Commission estimates that these firms would need
to hire one additional full-time employee for one year to implement CAT
reporting requirements.\1579\
---------------------------------------------------------------------------
\1578\ Id.
\1579\ Id.
---------------------------------------------------------------------------
Based on this information, the Commission preliminarily estimates
that the average initial burden to implement the needed systems changes
to capture the required information and transmit it to the Central
Repository in compliance with the CAT NMS Plan for small OATS-reporting
broker-dealers would be approximately 1,800 burden hours.\1580\ The
Commission believes the burden hours would be associated with work
performed by internal technology, compliance and legal staff in
connection with the implementation of CAT data reporting. The
Commission also preliminarily estimates that each small OATS-reporting
broker-dealer would incur approximately
---------------------------------------------------------------------------
\1580\ This estimate assumes that, based on the expected FTE
count provided, a small OATS-reporting broker-dealer would have to
hire 1 new FTE for implementation. The salary attributed to the 1
FTE would be (1 x $424,350 FTE cost) = $424,350 per year. To
determine the number of burden hours to be incurred by the current
0.5 FTE for implementation, multiply 0.5 FTE by 1,800 hours per year
= 900 initial burden hours.
---------------------------------------------------------------------------
$124,373 in initial external outsourcing costs.\1581\ Therefore,
the Commission preliminarily estimates that the average one-time
initial burden per small OATS-reporting broker-dealer would be 1,800
burden hours and external costs of $124,373, for an estimated aggregate
initial burden of 1,450,800 hours \1582\ and an estimated aggregate
initial external cost of $100,244,638.\1583\
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\1581\ See Section IV.F.1.c(2)B.ii, supra. The Commission
preliminarily believes the outsourcing cost would be the cost of the
service bureau, which would include the compliance and legal costs
associated with changing to CAT Data reporting. The Commission
assumes these costs of changing to CAT would be included in the cost
of the service bureau because the broker-dealers would be relying on
the expertise of the service bureau to report their data to CAT on
their behalf. See supra note 941.
\1582\ The Commission preliminarily estimates that 806 small
OATS-reporting broker-dealers would be impacted by this information
collection. (806 small OATS-reporting broker-dealers x 1,800 burden
hours) = 1,450,800 aggregate initial burden hours.
\1583\ ($124,373 in outsourcing costs) x (806 small OATS-
reporting broker-dealers) = $100,244,638 in aggregate initial
external costs.
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ii. Ongoing, Annual Burden Hours and External Cost
Small OATS-reporting broker-dealers that outsource their regulatory
data reporting would likely face internal staffing burdens and external
costs associated with ongoing activity, such as maintaining any systems
that transmit data to their service providers. Based on conversations
with market participants, the Commission estimates these firms would
need 0.75 FTEs on an ongoing basis to maintain CAT reporting.\1584\
---------------------------------------------------------------------------
\1584\ See Section IV.F.1.c(2)B.ii, supra.
---------------------------------------------------------------------------
Based on this information the Commission preliminarily believes
that it would take a small OATS-reporting broker-dealer 1,350 ongoing
burden hours per year \1585\ to continue compliance with the Rule. The
Commission believes the burden hours would be associated with work
performed by internal technology, compliance and legal staff in
connection with the ongoing operation of CAT Data reporting. The
Commission preliminarily estimates that it would cost, on average,
approximately $124,373 in ongoing external outsourcing costs \1586\ to
ensure ongoing compliance with Rule 613.
---------------------------------------------------------------------------
\1585\ 1,350 ongoing burden hours = (0.75 FTE for maintenance of
CAT Data reporting systems) x (1,800 working hours per year).
\1586\ See Section IV.F.1.c(2)B.ii, supra. See supra note 1581.
---------------------------------------------------------------------------
Therefore, the Commission preliminarily estimates that the average
ongoing annual burden per small OATS-reporting broker-dealer would be
approximately 1,350 hours, plus $124,373 in external costs, for an
estimated aggregate ongoing burden of 1,088,100 hours \1587\ and an
estimated aggregate ongoing external cost of $100,244,638.\1588\
---------------------------------------------------------------------------
\1587\ The Commission preliminarily estimates that 806 small
OATS-reporting broker-dealers would be impacted by this information
collection. (806 small OATS-reporting broker-dealers x 1,350 burden
hours) = 1,088,100 aggregate ongoing burden hours to ensure ongoing
compliance with Rule 613.
\1588\ $100,244,638 = $124,373 in ongoing outsourcing costs x
806 broker-dealers.
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B. Non-OATS Reporters
i. Initial Burden Hours and External Cost
In addition to firms that currently report to OATS, the Commission
estimates there are 799 broker-dealers that are currently exempt from
OATS reporting rules due to firm size, or excluded because all of their
order flow is routed to a single OATS reporter, such as a clearing
firm, that would incur CAT reporting obligations.\1589\ A further 24
broker-dealers have SRO memberships only with one Participant; \1590\
the Commission believes this group is comprised mostly of floor brokers
and further preliminarily believes these firms would experience CAT
implementation and ongoing reporting costs similar in magnitude to
small equity broker-
[[Page 30796]]
dealers that currently have no OATS reporting responsibilities.\1591\
---------------------------------------------------------------------------
\1589\ See Section IV.F.1.c(2)B.ii, supra. Rule 613 does not
exclude from data reporting obligations SRO members that quote or
execute transactions in NMS Securities and Listed Options that route
to a single market participant. See also CAT NMS Plan, supra note 3,
at Appendix C, Section B.7(b)(ii)(B)(2).
\1590\ See Section IV.F.1.c(2)B.ii, supra.
\1591\ Id.
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The Commission assumes these broker-dealers would have very low
levels of CAT reporting, similar to those of the lowest activity firms
that currently report to OATS. For these firms, the Commission assumes
that under CAT they would incur the average estimated service bureau
cost of broker-dealers that currently report fewer than 350,000 OATS
ROEs per month, which is $124,373 annually.\1592\ Furthermore, because
these firms have more limited data reporting requirements than other
firms, the Commission assumes these firms currently have only 0.1 full-
time employees currently dedicated to regulatory data reporting
activities.\1593\ The Commission assumes these firms would require 2
full-time employees for one year to implement CAT.\1594\
---------------------------------------------------------------------------
\1592\ Id.
\1593\ Id.
\1594\ Id.
---------------------------------------------------------------------------
Based on this information, the Commission preliminarily estimates
that the average initial burden to develop and implement the needed
systems changes to capture the required information and transmit it to
the Central Repository in compliance with the Rule for small, non-OATS-
reporting broker-dealers would be approximately 3,600 initial burden
hours.\1595\ The Commission believes the burden hours would be
associated with work performed by internal technology, compliance and
legal staff in connection with the implementation of CAT Data
reporting. The Commission also preliminarily estimates that each small
non-OATS-reporting broker-dealer would incur approximately $124,373 in
initial external outsourcing costs.\1596\
---------------------------------------------------------------------------
\1595\ 3,600 initial burden hours = (2 FTEs for implementation
of CAT Data reporting systems) x (1,800 working hours per year).
\1596\ See supra note 1590.
---------------------------------------------------------------------------
Therefore, the Commission preliminarily estimates that the average
one-time initial burden per small OATS-reporting broker-dealer would be
3,600 burden hours and external costs of $124,373 for an estimated
aggregate initial burden of 2,962,800 hours \1597\ and an estimated
aggregate initial external cost of $102,358,979.\1598\
---------------------------------------------------------------------------
\1597\ The Commission preliminarily estimates that 823 small
non-OATS-reporting broker-dealers would be impacted by this
information collection. (823 small non-OATS-reporting broker-dealers
x 3,600 burden hours) = 2,962,800 aggregate initial burden hours.
\1598\ ($124,373 in outsourcing costs) x (823 small non-OATS-
reporting broker-dealers) = $102,358,979 in aggregate initial
external costs.
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ii. Ongoing, Annual Burden Hours and External Cost
Small non-OATS-reporting broker-dealers that outsource their
regulatory data reporting would likely face internal staffing burdens
and costs associated with ongoing activity, such as maintaining any
systems that transmit data to their service providers. Based on
conversations with market participants, the Commission estimates these
firms would need 0.75 full-time employees annually to maintain CAT
reporting.
Based on this information the Commission preliminarily believes
that it would take a small non-OATS-reporting broker-dealer 1,350
ongoing burden hours per year \1599\ to continue compliance with the
Rule. The Commission preliminarily estimates that it would cost, on
average, approximately $124,373 in ongoing external outsourcing costs
\1600\ to ensure ongoing compliance with Rule 613. Therefore, the
Commission preliminarily estimates that the average ongoing annual
burden per small non-OATS-reporting broker-dealer would be
approximately 1,350 hours, plus $124,373 in external costs, for an
estimated aggregate ongoing burden of 1,111,050 hours \1601\ and an
estimated aggregate ongoing external cost of $102,358,979.\1602\
---------------------------------------------------------------------------
\1599\ 1,350 ongoing burden hours = (0.75 FTEs for maintenance
of CAT data reporting systems) x (1,800 working hours per year).
\1600\ The Commission assumes these firms would have very low
levels of CAT reporting, similar to those of the lowest activity
firms that currently report to OATS. For these firms, the Commission
assumes that under CAT they would incur the average estimated
service bureau cost of firms that currently OATS report fewer than
350,000 OATS ROEs per month of $124,373 annually.
\1601\ The Commission preliminarily estimates that 823 small
non-OATS-reporting broker-dealers would be impacted by this
information collection. (823 small non-OATS-reporting broker-dealers
x 1,350 burden hours) = 1,111,050 aggregate ongoing burden hours to
ensure ongoing compliance with Rule 613.
\1602\ ($124,373 in ongoing external outsourcing costs) x 823 =
$102,358,979 in aggregate ongoing external costs to ensure ongoing
compliance with Rule 613.
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E. Collection of Information is Mandatory
Each collection of information discussed above would be a mandatory
collection of information.
F. ConfidentialityC
Rule 613 requires that the information to be collected and
electronically provided to the Central Repository would only be
available to the national securities exchanges, national securities
association, and the Commission for the purpose of performing their
respective regulatory and oversight responsibilities pursuant to the
federal securities laws, rules and regulations. Further, the CAT NMS
Plan 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 SROs and their employees, as
well as all employees of the Central Repository, shall 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. The Commission will receive confidential
information. To the extent that the Commission does receive
confidential information pursuant to this collection of information,
such information will be kept confidential, subject to the provisions
of applicable law.
G. Recordkeeping Requirements
National securities exchanges and national securities associations
would be required to retain records and information pursuant to Rule
17a-1 under the Exchange Act.\1603\ Broker-dealers would be required to
retain records and information in accordance with Rule 17a-4 under the
Exchange Act.\1604\ The Plan Processor would be required to retain the
information reported to Rule 613(c)(7) and (e)(6) for a period of not
less than five years.\1605\
---------------------------------------------------------------------------
\1603\ 17 CFR 240.17a-1.
\1604\ 17 CFR 240.17a-4.
\1605\ 17 CFR 242.613(c)(7) and (e)(6).
---------------------------------------------------------------------------
H. Request for Comments
Pursuant to 44 U.S.C. 3506(c)(2)(A), the Commission solicits
comment to:
(1) Evaluate whether the proposed collections are necessary for the
proper performance of our functions, including whether the information
shall have practical utility;
(2) Evaluate the accuracy of our estimate of the burden of each
collection of information;
(3) Determine whether there are ways to enhance the quality,
utility, and clarity of the information to be collected; and
(4) Evaluate whether there are ways to minimize the burden of each
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs,
[[Page 30797]]
Washington, DC 20503, and should also send a copy of their comments to
Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F
Street NE., Washington, DC 20549-1090, with reference to File No. 4-
698. Requests for materials submitted to OMB by the Commission with
regard to these collections of information should be in writing, with
reference to File No. 4-698, and be submitted to the Securities and
Exchange Commission, Office of FOIA/PA Services, 100 F Street NE.,
Washington, DC 20549-2736. As OMB is required to make a decision
concerning the collections of information between 30 and 60 days after
publication in the Federal Register, a comment to OMB is best assured
of having its full effect if OMB receives it within 30 days of
publication.
VI. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the CAT NMS Plan
is consistent with the Act. Comments may be submitted by any of the
following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number 4-698 on the subject line.
Paper Comments
Send paper comments in triplicate to Brent J. Fields,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number 4-698. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the CAT NMS Plan that are filed with the
Commission, and all written communications relating to the CAT NMS Plan
between the Commission and any person, other than those that may be
withheld from the public in accordance with the provisions of 5 U.S.C.
552, will be available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street NE., Washington, DC
20549 on official business days between 10:00 a.m. and 3:00 p.m. Copies
of the submission will also be available for inspection and copying at
the Participants' principal offices. All comments received will be
posted without change; the Commission does not edit personal
identifying information from submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number 4-698 and should be submitted on or before
July 18, 2016.
By the Commission.
Brent J. Fields,
Secretary.
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[FR Doc. 2016-10461 Filed 5-16-16; 8:45 am]
BILLING CODE 8011-01-P