Opening Statement at SEC Open Meeting: Consolidated Audit Trail
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
July 11, 2012
Good morning. This is an open meeting of the Securities and Exchange Commission on July 11, 2012.
Today, we will consider a recommendation to significantly enhance our ability to regulate the nation’s equity markets.
From virtually the day I arrived at the SEC three-and-a-half years ago, I have talked about the importance of a consolidated audit trail and I am enormously pleased that we are moving ahead to make it a reality.
In particular, we will consider whether to adopt a rule, Rule 613, which would require the nation’s securities exchanges and FINRA to develop a detailed, comprehensive plan for creating, implementing, and operating a single, market-wide consolidated audit trail system.
This system will collect and accurately identify – among other things – every order, cancellation, and trade execution for all exchange-listed equities and options across all U.S. markets.
In today’s competitive marketplace, trading is dispersed across a variety of market centers ranging from public venues, to private dark pools, to individual broker-dealers.
And the vast majority of trading is now performed by automated computer algorithms used by many different kinds of market participants.
This includes electronic market makers and high-frequency traders seeking to capture small profits from thousands of individual trades. It includes large institutions seeking to accumulate large amounts of securities without affecting the market. And it includes broker-dealers seeking to provide individual retail investors with the best execution for their order.
As a result of this automation, market activity is now measured in milliseconds and microseconds – increments so small that only the speed of light becomes a limiting factor. In addition, automation means it is not uncommon for hundreds – and sometimes thousands – of orders to be generated, modified, cancelled, aggregated, disaggregated, and routed across a dozen venues, all before even a single trade is executed.
In carrying out their responsibilities, regulators must be able to corral this vast amount of disparate data in a way that allows us to monitor, correlate, and analyze a vast stream of market events and transactions. The availability and quality of trading data are central to the SEC’s ability to protect investors, and to maintain fair, orderly, and efficient markets.
Though FINRA and some of the exchanges currently maintain their own separate audit trail systems, there are numerous shortcomings regarding their accuracy, completeness, accessibility, and timeliness. These limitations make it impractical for regulators to readily follow orders as they are routed, aggregated, re-routed, and disaggregated across multiple markets.
For instance, after the Flash Crash of May 6, 2010, it took dozens of highly-trained economists, financial professionals, and data technologists four months to aggregate and process the information required to fully analyze just a few hours of trading on a single day. While that process was remarkable considering our limitations, and while we were able to identify the various causes of that event, efficient and effective market regulation requires that future analyses not take nearly that long.
In fact, it is even more difficult to perform some other types of market analyses because certain key information is never collected by audit trails – information such as the identity of the customers who originate orders, or the fact that two sets of orders may have originated with the same customer.
A consolidated audit trail that accurately tracks orders throughout their lifecycle and identifies the broker-dealers handling them will provide us with an unprecedented ability to effectively oversee the markets we regulate.
First, a consolidated audit trail will increase the data available to regulators investigating illegal activities such as insider trading, wash sales, and market manipulation. In particular, increased data will facilitate risk-based examinations, allow more accurate and faster surveillance, improve the process for evaluating tips, complaints, and referrals, and promote innovation in cross-market and principal order surveillance.
Second, a consolidated audit trail will significantly improve the ability of regulators to reconstruct broad-based market events in an accurate and timely manner. The sooner regulators can reconstruct the event, the sooner we can inform the public and determine what, if any, responses might be required.
Third, a consolidated audit trail will significantly increase the ability of regulators to monitor overall market structure, so that both the Commission and the SROs can be better informed about how our rules are affecting the markets. For example, having more precise data on the trading patterns of different types of market participants would help us better understand the impact of high frequency trading on the quality and fairness of our markets.
Finally, a consolidated audit trail will reduce the regulatory data production burdens on SROs and broker-dealers by reducing the number and types of ad hoc requests that regulators submit today. A consolidated audit trail that covers the entire market may also eliminate the need for multiple other, less efficient, reporting requirements that market participants must current comply with.
The rule the Commission is considering today is the result of careful information gathering and thoughtful deliberation. Since the rule was first proposed in 2010, the Commission received many comments and our staff have met frequently with interested parties about the proposal. This has helped us identify strengths and address weaknesses.
As a result, there are some aspects of the rule we are considering today that differ from what the Commission had originally proposed. For example, the rule will now require broker-dealers to report their activity by 8 a.m. the next trading day. I believe that all of the most important regulatory benefits of a consolidated audit trail are just as achievable with a next-morning deadline as they are with a real-time reporting requirement.
However, many other aspects of the rule have not changed. For instance, the rule continues to require customer identifiers that will be assigned to every order and trade – something I believe is critical to achieving the regulatory benefits of a consolidated audit trail. This is not only necessary, but also given the many advanced technologies used by the market to route, re-route, aggregate, and disaggregate customer orders across dozens of venues in the space of a few milliseconds, I am confident that it is achievable as well.
Today’s rule ultimately will lead to better protections for investors, and fairer, more orderly, and more efficient markets. I look forward to the Commission receiving a plan that meets the extensive requirements we set forth in this rule, and, that is capable of evolving over time to match the needs of regulators of dynamic markets.
Today’s action adds to a growing list of significant measures we have put in place to make our financial markets safer and more efficient. In the past two years alone, we have put rules in place for revised market-wide circuit breakers and a new limit-up/limit-down mechanism to pause trading when markets move too far, too fast. We have clarified up front when erroneous trades are to be broken. We have effectively prohibited stub quotes and barred naked access to the market.
And, we have adopted a large trader reporting system that will allow us to better identify large market participants to collect information and analyze their trading activity. More recently, we’ve procured new technological capabilities and systems designed to collect and analyze the mounds of trade and order data that many public exchanges currently disseminate.
In sum, the rule we are considering today represents a great leap forward in providing the SROs and the Commission with the data and means to exponentially enhance our abilities to oversee a highly complex market structure.
Before turning the discussion over to Robert Cook, the Director of the Division of Trading and Markets, to more fully describe the details of the rule, I would like to acknowledge the exceptional efforts of David Shillman, Gregg Berman, David Hsu, Jennifer Colihan, Leigh Duffy, Rebekah Liu, Carl Tugberk, and Nathaniel Stankard in the Division of Trading and Markets … Steve Cohen, Bruce Karpati, Hugh Beck, and many other contributors in the Division of Enforcement … John Polise, Mark Donohue, Connie Kiggins and the many contributors in the Office of Compliance Inspections and Examinations … Amy Edwards, Adam Glass, Vanessa Countryman, and Chuck Dale in the Division of Risk, Strategy, and Financial Innovation … And Meridith Mitchell, Debby Flynn, Cynthia Ginsberg, and Robert Teply in the Office of the General Counsel. I would also like to thank the other Commissioners and their counsel for their work and comments on the proposed rule.
Now I’ll turn the meeting over to Robert to hear more about the Division’s recommendations.