The SEC's Mild-Mannered, but Tough CAT

Hester Peirce discusses the negative effects the SEC's proposed Consolidated Audit Trail (CAT) would have on the market.

Believe it or not, the Securities and Exchange Commission (SEC) has never really had a good way to monitor market activity. In 2010, the agency proposed to remedy that, but the proposal was so heavy-handed that it would have done more harm than good. Last week, the SEC took what appears to be an encouraging step towards getting the data it needs without unnecessarily weighing down the markets. The plan the SEC set in motion for developing a Consolidated Audit Trail (CAT) relies on careful rulemaking backed by input from all affected parties and economic analysis.

The purpose of the CAT is to ensure that the SEC has the comprehensive, uniform, timely, cross-market data it needs to understand what is happening in the securities markets. Right now, it is very difficult for the SEC to gather data from multiple market sources, consolidate it, and transform it into a usable, meaningful data set. This data gap complicates the SEC's ability to monitor the securities markets and write effective rules. The difficulty it had in assessing the May 6, 2010, flash crash, for example, is partly attributable to the agency's lack of ready access to market data.

The CAT will allow the SEC to observe how, when, and where orders were submitted, modified, cancelled, and executed. This information will help the regulator to perform all of its core functions more effectively. The SEC will be able to more easily reconstruct and analyze market events such as the flash crash. It will be better able to predict the effects of rules and recognize developing market trends. Finally, the SEC's enforcement and examination abilities will be enhanced by easy access to accurate, complete, and uniform data from across the securities markets.

The SEC's rule adoption is just one step in a long process. Next, the so-called self-regulatory organizations (SROs)-the stock exchanges and the Financial Industry Regulatory Authority, which is the front-line regulator for broker-dealers-must develop a joint plan for bringing the CAT to life. In devising this plan, these SROs must employ sound rulemaking procedures. Among other things, the SROs must solicit the input of their members, estimate the costs and benefits of their proposal and reasonable alternatives, and explain why they made the choices they did. The SEC, when it receives the proposal, will publish it for public comment and conduct economic analysis.

The SEC already made some adjustments to its approach to the CAT based on an assessment of costs and benefits. It rejected the proposal's real time reporting element. Real time reporting would have required firms to incur great costs, even though the SEC would not be able to use the data immediately. The adopted rule instead requires that data be in to the central data repository by 8 a.m. the next morning, which will be much cheaper for firms, but won't harm the ability of the SEC to do its job. The SEC also lengthened the compliance period from the proposed two to three years for small broker-dealers.

We can hope that the SEC will apply the principles from CAT-informed rulemaking backed by public comment and careful economic analysis-to its many forthcoming rulemakings under Dodd-Frank. By doing so, it might avoid some of those pesky court defeats that have dogged its rulemaking over recent years