According to Politico, three members of the House Financial Services Committee, Rep.Hensarling (R-TX), Rep. Huizenga (R-MI) and Rep. Hultgren (R-IL), have asked the SEC to delay the Consolidated Audit Trail (CAT). We are not surprised to hear this since industry insiders have been setting this up for the past few weeks.  When the industry decides to go after something, they usually leave Sasquatch-sized footprints for everyone to see like yesterday’s WSJ op-ed titled “The SEC Plans to Collect Too Much Information” .  The piece was co-written by Harvard’s Hal Scott who has also been very busy defending HFT over the past few years:

• In July 2014, Scott offered testimony before U.S. Senate in defense of HFT firms. Scott testified, “Let me be clear at the outset, that I believe the net effect of HFT activity in our equity markets has been positive.”

• By December 2014, Scott was  involved in the public policy Capital Markets Committee on Regulation which released a paper that was highly critical of Michael Lewis’ Flash Boys, Nothing but the Facts Statement on High Frequency Trading.

• In Jan 2016, Prof. Hal Scott published an article attacking IEX and encouraging the SEC to decline IEX’s application to become an Exchange,Why U.S. investors are better off today stating that the SEC should not approve IEX without a proper rule change.

Rather than try to scare investors into demanding that the CAT be scrapped because their personal identifiable information could be compromised, FINRA CEO Robert Cook gave a much better analysis of the pros and cons of the CAT.  In a must read speech from September 20 titled “Equity Market Surveillance Today and the Path Ahead”, Cook explained the current state of FINRA market surveillance and how this would look after the CAT is rolled out (if it ever gets that far).  Cook seemed to make the case that FINRA would have been much better suited to run the CAT because of their experience with market surveillance which has been stepped up over the past few years.

FINRA’s surveillance starts by the collection of data through OATS but then goes much further. They utilize sophisticated computer programs and “machine learning” to identify patterns in the data to detect misconduct.   FINRA combs the data every day to look for the “proverbial needle in a haystack”.  The needles they are looking for include front running, wash sales, layering, spoofing and algo gaming.  When they find something, they refer it to the SEC and last year they made 500 referrals.

In his speech,  Cook said that FINRA supports the CAT and explained the difference between the current surveillance system and the CAT:

1) Thesys Technologies, not FINRA, will now collect and hold all trading information.

2) CAT will require the submission of additional information “including certain information related to listed options and orders originated by market makers, and in some cases will better tie together the details of how customer orders work their way through the market.”

3) CAT will include personally identifiable information (PII) which is not available today to any SRO.

Cook has some words of advice for market surveillance in a post-CAT world.  He noted that it needs to be comprehensive and oversight must reach across all venues.  He also recommends that futures market data should be incorporated into the CAT.  Cook said:

“In short, as we transition to a post-CAT world, we must not lose sight of the benefits that can be achieved when FINRA and the exchanges work closely to achieve coordinated cross-market and cross-product surveillance, examination and enforcement coverage of the U.S. securities markets, while minimizing regulatory duplication and unnecessary costs or burdens on market participants.”

After reading Robert Cook’s speech and hearing all the recent industry complaints about the cybersecurity, we think that the SRO’s made a colossal mistake in selecting Thesys Technologies to administer the CAT.  But was it a mistake or was it intentional?  Maybe the SRO’s never wanted the CAT because their largest customers would come under greater scrutiny?

FINRA already was doing the market surveillance job and had been increasing their technology rapidly.  They not only had most of the data already but they understood how to interpret the data. In our opinion, they were the logical choice to run the CAT.  There were reports that one of the reasons that the SEC selected Thesys over FINRA was because of their strong cybersecurity presence and yet ironically it looks like this issue is what will end up delaying and possibly killing the CAT.