What New Developments in the Consolidated Audit Trail Spell for Broker-Dealer Compliance

The Securities and Exchange Commission's journey toward establishing a consolidated audit trail, or CAT, has been mired in debate and delays. In late April -- almost four years after the SEC voted to create a market-wide system for tracking equity and options trades -- capital markets firms finally got a glimpse at how the CAT will operate, and how their compliance requirements will evolve because of it.

Today, the goals of the consolidated audit trail remain the same: to help market regulators better understand incidents such as the 2010 Flash Crash; to expedite the surveillance process to prevent manipulative practices; and to potentially level the playing field between trading organizations. The SEC's most recent announcement offers more detail into how broker-dealers will cooperate with the CAT, including new data-reporting and clock-synchronization guidelines.

Despite recent progress in CAT rulemaking, a fully baked, centralized trail is still years away. But in the interim, as capital markets authorities explore ways to ensure the efficacy of a CAT system, broker-dealers have to reengineer their operations for a more transparent world.

CAT Inspires More Questions Than Answers

According to the SEC's latest proposal, U.S. exchanges would not begin reporting trade data to a consolidated system until the end of 2017. Large broker-dealers would have until 2018 to start reporting, and smaller firms until 2019. This timing, of course, is contingent on any hiccups that may interfere with the plan's approval, or the selection of a vendor to build and maintain the technology.

Already, broker-dealer executives have voiced concern about the time and financial investment needed to adapt their existing systems in order to capture information for the audit trail. Even the Securities Industry and Financial Markets Association publicly questioned the mandate for brokerages to synchronize their clocks within 50 milliseconds of federal standards, suggesting that such a wide reporting gap isn't enough to match the speed of high-frequency trading.

Some critics speculate that by the time a consolidated audit trail is available, the infrastructure will be outdated (or close to it.) As industry stakeholders share their qualms about an expensive, error-prone shift to CAT, blockchain technology increasingly seems like a viable solution. On one hand, blockchain's vast storage capacity would eliminate the need for massive servers and complex data entry. However, the legwork needed to develop industry usage standards around the distributed ledger system could derail the timing of CAT adoption.

It's Harder for Small Firms to Fly Under the Radar

Any to-be consolidated audit trail can only be as strong as the data that feeds it. It's no surprise then, that broker-dealers will have to submit volumes of information to the SEC once the CAT comes to fruition. According to the SEC's latest plans, broker-dealers will need to systematically create and store an array of data, including unique customer and brokerage identifiers, the date and time of order events, and various order terms (i.e., security symbol, price and order type) so that regulators can oversee the lifecycle of every order.

Faced with intense market competition, broker-dealer leaders are more concerned (rightfully) with closing new business rather than optimizing data practices. In the near term, the CAT's looming data requirements will force smaller firms to clean up their data management practices. Manual order tagging and fragmented data storage protocol will foil any attempts to efficiently submit order details to the consolidated audit trail. Putting off this exercise could only lead to steeper CAT adoption costs down the road.

Still, the consolidated audit trail presents implications for broker-dealer compliance that go beyond data management. With order, execution and customer information unified in one market repository, there will be more illumination on trading activity -- and fewer shadows for firms to hide in. The CAT puts regulators in a better position to detect issues and pursue noncompliant broker-dealers faster. In a post-CAT era, firms will contend with additional pressure to proactively identify and self-report red flags (rather than hope questionable activity goes unnoticed).

The future of the CAT remains somewhat vague, but this is no excuse for broker-dealers to press pause on their preparation efforts. Rather than wait around to feel the impacts of this new system, firms that start planning today can ensure that -- come reporting time -- complying with the audit trail seems like business as usual.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

More from Opinion

It's Just Not Smart For Investors to Ignore the Threat of a Trade War

It's Just Not Smart For Investors to Ignore the Threat of a Trade War

To Think a Trade War's Still Just a Threat Is the Dumbest Thing on Wall Street

To Think a Trade War's Still Just a Threat Is the Dumbest Thing on Wall Street

Flashback Friday in Politics: Trade Wars, Manafort, Immigration Dominate Minds

Flashback Friday in Politics: Trade Wars, Manafort, Immigration Dominate Minds

Microsoft and Sony's Rumored Game Console Plans Bode Well for AMD

Microsoft and Sony's Rumored Game Console Plans Bode Well for AMD

Apple Supplier Jabil Is Tumbling, But Its Sales Momentum Remains Strong

Apple Supplier Jabil Is Tumbling, But Its Sales Momentum Remains Strong