Statement on the Joint Industry Plan on the Consolidated Audit Trail (“CAT”)
Commissioner Kara M. Stein
Nov. 15, 2016
I would like to thank the staff for all of their work on this Order. There was a very large cross-divisional team who worked on this matter. But in particular, I would like to thank David Hsu, Jennifer Colihan, Amy Edwards, Claire O’Sullivan, Rebekah Liu, John Lee, Ted Uliassi, Leigh Duffy, Meridith Mitchell, Tracey Hardin, Maureen Johansen, Daniel Matro, and Devin Ryan. Also, I would like to thank Garry Goldsholle and David Shillman for heading up this effort. In addition, I want to thank all of the staff who worked on this issue from the Division of Trading and Markets, DERA, the Office of the General Counsel, the Office of Compliance Inspections and Examinations, the Division of Enforcement, and the Chief Information Security Officer.
Today, we are considering whether to approve a plan to create and maintain a consolidated audit trail (“CAT”). The purpose of the CAT, as envisioned over four years ago, was to store financial transaction information from a variety of equity markets in a data warehouse. This would allow regulators and ultimately market participants to better understand what was happening in the computerized marketplace and to better address market disruptions. It would also help to more quickly identify and eliminate misconduct and to formulate more effective and efficient rules. In sum, it would improve the equity markets by giving us a clear view of what is happening. The CAT would essentially be the Hubble Telescope for the securities markets.
In a computerized and fragmented marketplace, the need for the CAT has become increasingly clear. On May 6, 2010, trading in the futures market triggered a cascade of steep price declines in interrelated financial products overseen by multiple regulators. When all was said and done, over the course of 20 minutes, 2 billion shares were traded for over $56 billion. Twenty thousand trades were executed at prices that were more than 60 percent away from their prices at the start of the twenty minutes. And then, almost as quickly as it started, it was over. But it took regulators four months, and thousands of employee hours, to reconstruct what happened that day.
With the speed of today’s capital markets, the Commission and market participants cannot afford such a delay in comprehension. We have to understand what the computers are doing in order to respond quickly and effectively to disruptions. Failure to do so can create additional risk to the financial system. Indeed, as was made clear during yesterday’s Fintech Forum, the financial industry’s technical sophistication is rapidly evolving. We must keep pace. And, the CAT is foundational to those efforts.
In order for the CAT to be effective, it must be accurate, complete, accessible, and timely. The governance of the CAT must be fair. It must also appropriately address participants’ conflicts of interest. The Order amends the CAT Plan in several ways to address some of these issues. For example, the amended CAT Plan has enhanced the CAT Advisory Committee, required additional transparency regarding the CAT’s governance and finances, and clarified that fees paid by industry members must be reasonable, equitable, and not unfairly discriminatory.
The amended CAT Plan also makes some changes to address issues of accuracy. For instance, the amended CAT Plan requires the exchanges to synchronize their clocks to within 100 microseconds. This is certainly better than the proposed plan, which would have allowed all reporting entities’ clocks to be out of sync by up to 50 milliseconds. Indeed, the 100 microsecond standard is 500 times more stringent than the 50 millisecond standard.
Unfortunately, the revisions do not go far enough because only the exchanges are subject to the more stringent standard. At a minimum, alternative trading venues and high speed algorithmic traders need to have a similar standard. Imagine if the traffic lights at an intersection changed color at slightly different times—the signal would not be very useful and it would cause confusion.
Today’s trading is done at incredibly fast speeds—microseconds matter. The market is dominated by computerized or automated trading. Hundreds of transactions occur in the blink of an eye. Small mistakes can become big problems very quickly. And events that occur in well less than a second can have a major impact on the market.
In an attempt to further address this issue, the amended CAT Plan requires the exchanges and FINRA to conduct a study on clock synchronization within the next 6 months and to propose appropriate amendments to the CAT Plan. This is an area the Commission needs to constantly monitor going forward to ensure that appropriate and timely amendments are made. Failure to do so could drastically impact both the accuracy and effectiveness of the CAT. A flawed mirror on the Hubble Space Telescope meant that the telescope was initially unable to provide much needed focus and image quality. A clock synchronization flaw in the CAT Plan could similarly degrade the CAT’s effectiveness, leaving regulators blind to what is actually happening in the market. We must fix this flaw as soon as possible so that a complex and expensive repair does not become essential later.
Another area of concern related to accuracy is the failure to require the use of legal entity identifiers (“LEIs”). An LEI is a number that allows financial firms and other entities participating in the global financial markets to be uniquely identified. When Lehman Brothers failed in 2008, its counterparties struggled to understand how Lehman’s failure would affect them because they could not identify all of their exposures to the firm. Financial regulators were also unclear about the consequences of a Lehman failure. At the time, no global standards existed for identifying financial entities or financial instruments and how they were interconnected. A public-private partnership ultimately created the idea of the LEI. Much like the Dewey Decimal System, it would allow people to categorize and understand financial entities and financial instruments no matter where they originate in the world.
Under the amended CAT Plan, LEIs for industry members and customers are not required. This will leave regulators and industry participants near-sighted and unable to figure out important interconnections or identify exposures between financial firms. I had requested that at a minimum, the exchanges and FINRA be required to provide a report on the feasibility of requiring LEIs for industry members and customers. Unfortunately such a report was not included in the CAT Plan. This is a mistake, which I hope will be remedied by the exchanges and FINRA going forward.
We all know that high quality and accurate data is essential for understanding our markets and fulfilling the promise of the CAT. Failure to require LEIs undermines the CAT’s ultimate usefulness. Adoption of the CAT was a unique opportunity to modernize our market data by including LEIs. We have failed to seize that opportunity, and I fear that it will put our markets at increased risk. I strongly encourage the Commission to continue looking at this area lest we be doomed to repeat history.
Similarly, I strongly encourage the Commission to remain vigilant regarding the other necessary attributes of the CAT Plan—completeness, accessibility, timeliness, and data security. The amended CAT Plan is merely the beginning. Whether it is effective and efficient will depend largely on how it is implemented going forward. The Commission must ensure that the CAT is appropriately monitored and updated. The world will not stand still and neither can the CAT.
 17 CFR 242.613(a)(1), (c)(1), (c)(7).
 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 (Sep. 30, 2010), available at https://www.sec.gov/news/studies/2010/marketevents-report.pdf.
 See Securities Exc. Act Rel. No. 77724, available at https://www.sec.gov/rules/sro/nms/2016/34-77724.pdf.
 See, e.g., Comments on Investors’ Exchange LLC; Notice of Filing of Application, as Amended, for Registration as a National Securities Exchange under Section 6 of the Securities Exchange Act of 1934, Release No. 34-75925, File No. 10-222, available at https://www.sec.gov/comments/10-222/10-222.shtml.