# Consolidated Audit Trail > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2010-13129 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** June 8, 2010 - **Citation:** 75 FR 32556 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 242 [Release No. 34-62174; File No. S7-11-10] RIN 3235-AK51 Consolidated Audit Trail AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. SUMMARY: The Securities and Exchange Commission (“Commission”) is proposing new Rule 613 under Section 11A(a)(3)(B) of the Securities Exchange Act of 1934 (“Exchange Act”) that would require national securities exchanges and national securities associations (“self-regulatory organizations” or “SROs”) to act jointly in developing a national market system (“NMS”) plan to develop, implement, and maintain a consolidated order tracking system, or consolidated audit trail, with respect to the trading of NMS securities. The Commission preliminarily believes that with today's electronic, interconnected markets, there is a heightened need for regulators to have efficient access to a more robust and effective cross-market order and execution tracking system. Currently, many of the national securities exchanges and the Financial Industry Regulatory Authority, Inc. (“FINRA”) have audit trail rules and systems to track information relating to orders received and executed, or otherwise handled, in their respective markets. While the information gathered from these audit trail systems aids the SRO and Commission staff in their regulatory responsibility to surveil for compliance with SRO rules and the federal securities laws and regulations, the Commission preliminarily believes that existing audit trails are limited in their scope and effectiveness in varying ways. In addition, while the SRO and Commission staff also currently receive information about orders or trades through the electronic bluesheet (“EBS”) system, Rule 17a-25 under the Exchange Act, 1 or from equity cleared reports, the information is limited, to varying degrees, in detail and scope. 1 17 CFR 240.17a-25. A consolidated audit trail would significantly aid in SRO efforts to detect and deter fraudulent and manipulative acts and practices in the marketplace, and generally to regulate their markets and members. In addition, such an audit trail would benefit the Commission in its market analysis efforts, such as investigating and preparing market reconstructions and understanding causes of unusual market activity. Further, timely pursuit of potential violations can be important in seeking to freeze and recover any profits received from illegal activity. DATES: Comments should be received on or before August 9, 2010. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( http://www.sec.gov/rules/proposed.shtml ); or • Send an e-mail to rule-comments@sec.gov. Please include File No. S7-11-10 on the subject line; or • Use the Federal eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments. Paper Comments • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File No. S7-11-10. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549 on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Rebekah Liu, Special Counsel, at (202) 551-5665; Jennifer Colihan, Special Counsel, at (202) 551-5642, or Leigh W. Duffy, Attorney-Adviser, at (202) 551-5928, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-7010. SUPPLEMENTARY INFORMATION: Table of Contents I. Background II. Basis for Proposed Rule III. Description of Proposed Rule IV. Request for Comments V. Paperwork Reduction Act VI. Consideration of Costs and Benefits VII. Consideration of Burden on Competition, and Promotion of Efficiency, Competition and Capital Formation VIII. Consideration of Impact on the Economy IX. Initial Regulatory Flexibility Act Analysis X. Statutory Authority I. Background The U.S. securities markets have undergone a significant transformation over the last few decades, and particularly in the last few years. Regulatory changes and technological advances have contributed to a tremendous growth in trading volume and the further distribution of order flow across multiple trading centers. Today's markets are widely dispersed, with securities often trading on multiple markets, including over-the-counter (“OTC”). Additionally, products that are closely related in nature and objective are also traded on different markets. For example, various markets trade either options on the S&P 500 index, 2 futures on the S&P 500 index, 3 exchange traded funds (“ETFs”) based on the S&P 500 index, 4 and options and futures on those ETFs. 5 This dispersion of significant trading volume has led the Commission in the past to ask for comment on how best to enhance the capability of SROs and the Commission to effectively and efficiently conduct cross-market supervision of trading activity. 6 2 The Chicago Board Options Exchange, Incorporated (“CBOE”) lists options on the S&P 500 Index (SPX) and on the Mini-S&P 500 Index (XSP) (1/10th the value of the S&P 500 Index). 3 For example, the Chicago Mercantile Exchange Inc. (“CME”) offers S&P 500 futures and “E-Mini” futures on the S&P 500 Index ($50 × S&P 500 Index price). 4 For example, NYSE Arca, Inc. (“NYSE Arca”) lists an ETF based on the S&P 500 SPDR (SPY) and the iShares S&P 500 Index Fund (IVV). 5 For example, OneChicago, LLC lists futures on the SPY, and CBOE lists options on the iShares S&P 500 Value Index Fund. 6 See infra Section I.G. (discussing past Commission requests for comment on regulation of intermarket trading). The individual SROs are responsible for regulating their markets and their members. 7 Further, the Commission has responsibilities to oversee the SROs, the securities markets, and registered broker-dealers, and routinely conducts examinations of or investigations into trading activity as part of its oversight and enforcement programs. 8 The SROs and the Commission need tools to effectively carry out these responsibilities even when trading occurs on multiple markets. For example, it is important that the SRO and Commission staff have order and trade data sufficient to monitor cross-market trading activity, assist with investigations of potential violations of federal securities laws and exchange rules, and perform market reconstructions or other analysis necessary to understand trading activity. 9 Such information also is important to the Commission in carrying out its oversight responsibilities. 7 See, e.g., Sections 6(b)(1), 15A(b)(2), and 19(g) of the Exchange Act, 15 U.S.C. 78f(b)(1), 15 U.S.C. 78o-3(b)(2), and 15 U.S.C. 78s(g). 8 See, e.g., Sections 2, 6(b)(1), 10, 15(b)(4)(D) and (E), and 19(h) of the Exchange Act, 15 U.S.C. 78b, 15 U.S.C. 78f(b)(1), 15 U.S.C. 78j, 15 U.S.C. 78o(b)(4)(D) and (E), and 15 U.S.C. 78s(h). 9 As discussed below in Sections II and III, the Commission preliminarily believes that the proposal would improve the ability of regulators to conduct timely and accurate trading analyses for market reconstructions and complex investigations, as well as inspections and examinations. Indeed, the Commission believes that the proposed consolidated audit trail, if implemented, would have significantly enhanced the Commission's ability to quickly reconstruct and analyze the severe market disruption that occurred on May 6, 2010. If approved and implemented, the proposal also would enhance the Commission's ability to similarly respond to future severe market events. The SROs' staff currently uses both EBS 10 and SRO audit trail data to help fulfill their regulatory obligations. 11 Commission staff also uses this data to perform its regulatory oversight obligations. The Commission and SROs have depended on the bluesheet system for decades to request trading records from broker-dealers needed for regulatory inquiries. Most SROs also maintain their own specific audit trail requirements applicable to their members. As discussed more fully below, for example, the National Association of Securities Dealers (“NASD”) 12 established the Order Audit Trail System (“OATS”) 13 in 1996, and the New York Stock Exchange (“NYSE”) implemented its Order Tracking System (“OTS”) 14 in 1999. Beginning in 2000, several of the current options exchanges implemented the Consolidated Options Audit Trail System (“COATS”). 15 10 Bluesheets are trading records requested by the Commission and SROs from broker-dealers that are used in regulatory investigations to identify buyers and sellers of specific securities. 11 The Commission recently published for comment a proposal to establish a large trader reporting system. See Securities Exchange Act Release No. 61908 (April 14, 2010), 75 FR 21456 (April 23, 2010) (“Large Trader Proposal”). Under that proposal, large traders would be issued unique identifiers that they would be required to provide to the broker-dealers that execute transactions on their behalf, and the broker-dealers would be required to maintain, and provide to the Commission upon request, transaction records for each large trader customer. The large trader proposal is designed to address in the near term the Commission's current need for access to more information about large traders and their activities. As discussed below, the Commission anticipates that the proposed consolidated audit trail discussed in this release, which is much broader in scope, would take a significant amount of time to fully implement. This proposal would require that, if the Large Trader proposal is adopted, the large trader identification number be reported to the central repository as part of the identifying customer information. See proposed Rule 613(j)(2). 12 In 2007, the NASD and the member-related functions of NYSE Regulation, Inc., the regulatory subsidiary of the New York Stock Exchange LLC (“NYSE”), were consolidated. As part of this regulatory consolidation, the NASD changed its name to FINRA. See Securities Exchange Act Release No. 56146 (July 26, 2007), 72 FR 42190 (August 1, 2007). FINRA and the National Futures Association (“NFA”) are currently the only national securities associations registered with the Commission; however, the NFA has a limited purpose registration with the Commission under Section 15A(k) of the Exchange Act, 15 U.S.C. 78o-3(k). See also Securities Exchange Act Release No. 44823 (September 20, 2001), 66 FR 49439 (September 27, 2001). 13 See Securities Exchange Act Release No. 39729 (March 6, 1998), 63 FR 12559 (March 13, 1998) (order approving proposed rules comprising OATS) (“OATS Approval Order”). 14 See Securities Exchange Act Release No. 47689 (April 17, 2003), 68 FR 20200 (April 24, 2003) (order approving proposed rule change by NYSE relating to order tracking) (“OTS Approval Order”). 15 See In the Matter of Certain Activities of Options Exchanges, Administrative Proceeding File No. 3-10282, Securities Exchange Act Release No. 43268 (September 11, 2000) (Order Instituting Public Administrative Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions) (“Options Settlement Order”). See also, e.g., Securities Exchange Act Release No. 50996 (January 7, 2005), 70 FR 2436 (order approving proposed rule change by CBOE relating to Phase V of COATS). Currently, there is significant disparity in the audit trail requirements among the exchanges and FINRA, especially with respect to the information captured by each. 16 Further, the information for each must be provided in different formats. The differences result in inconsistent requirements imposed on exchange and FINRA members, and also make it difficult to view trading activity across multiple markets. The lack of uniformity in, and cross-market compatibility of, SRO audit trails can make detection of illegal trading activity carried out across multiple markets and multiple products more difficult. The Commission has voiced concern about the lack of uniformity in, and cross-market compatibility of, the audit trails in the past. 17 The Commission preliminarily believes that these differences may hinder the ability of the SROs and the Commission to effectively view and regulate trading activity across markets. 16 See infra Sections I.C, I.D, I.E, and I.F. 17 See infra Section I.G. Further, risks imposed on the markets by violative conduct can be substantially increased by automated trading, as market participants have the ability to trade numerous products and enormous volume in mere seconds. As trading venues have become more automated, and trading systems have become computerized, trading volumes have increased significantly, 18 and trading has become more dispersed across more trading centers and therefore more difficult to monitor and trace. 19 The Commission is concerned that current audit trail requirements are insufficient to capture in a timely manner all of the information necessary to efficiently and effectively monitor trading activity in today's highly automated and dispersed markets. The Commission also is concerned that the current lack of cohesive, readily available order and execution information impacts the ability of the SROs and the Commission staff to effectively perform their respective regulatory and oversight responsibilities with respect to trading activity by market participants across markets and products. 18 For example, consolidated average daily share volume and trades in NYSE-listed stocks increased from just 2.1 billion shares and 2.9 million trades in January 2005, to 5.9 billion shares (an increase of 181%) and 22.1 million trades (an increase of 662%) in September 2009. See Large Trader Proposal, supra note 11, at 21456. 19 See, e.g., Securities Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594 (January 21, 2010) (“Concept Release on Equity Market Structure”) at 3594-3596. A. Electronic Bluesheets and Rule 17a-25 The Commission and the SROs frequently request bluesheets from broker-dealers to aid in investigations of possible Federal securities law violations and to create market reconstructions. 20 Until the late 1980s, bluesheets consisted of questionnaire forms that Commission and SRO regulatory staff mailed to firms to be manually completed and returned. 21 Obtaining bluesheets in this manner was particularly onerous as there were substantial delays in the production and receipt of the requested information. Additionally, the data was submitted in a variety of formats, making analysis time-consuming, and requests could result in vast amounts of information requiring lengthy manual examination. 22 20 See Securities Exchange Act Release No. 44494 (June 29, 2001), 66 FR 35836 (July 9, 2001) (File No. S7-12-00) (“Rule 17a-25 Adopting Release”), at 35836. 21 Id. 22 See Securities Exchange Act Release No. 25859 (June 27, 1988), 53 FR 25029 (July 1, 1988) (approving both the NYSE and the American Stock Exchange's (“Amex”) rules for the electronic submission of transaction information). In the late 1980s, as the volume of trading and securities transactions dramatically increased, the manual bluesheet system was replaced by the EBS system. 23 The EBS system allows broker-dealers to electronically submit the requested information in a specific format and transmit it to the Securities Industry Automation Corporation (“SIAC”). 24 SIAC then routes the information to the Commission or to an SRO as applicable. 23 See Rule 17a-25 Adopting Release, supra note 20, at 3-4. See also, e.g., id. and Securities Exchange Act Release Nos. 26235 (November 1, 1988), 53 FR 44688 (November 4, 1988) (approving the CBOE rule for the electronic submission of transaction information); 26539 (February 13, 1989), 54 FR 7318 (February 17, 1989) (approving the NASD's rule for the electronic submission of transaction information); and 27170 (August 23, 1989), 54 FR 37066 (September 6, 1989) (approving the Philadelphia Stock Exchange's rule for the electronic submission of transaction information). 24 See Rule 17a-25 Adopting Release, supra note 20, at 35836. SIAC is a subsidiary of NYSE Euronext and serves as the securities information processor of the Consolidated Tape Plan (“CTA Plan”), which governs the dissemination of trade information; the Consolidated Quotation Plan (“CQ Plan”), which governs the dissemination of quotation information; and the Options Price Reporting Authority Plan (“OPRA Plan”), which governs the dissemination of trade and quotation information for listed options. In this capacity, it provides real time quotation and transaction information to market participants. The EBS system, supplemented by the requirements of Rule 17a-25 under the Exchange Act, 25 currently is used by Commission and SRO regulatory staff primarily to assist the staff in the investigation of possible federal securities law violations primarily involving insider trading and other market manipulations, and to conduct market reconstructions, especially following periods of significant market volatility. 26 In its electronic format, the EBS system provides detailed execution information upon request by the Commission and the SROs' staff for specific securities during specified time frames. 27 However, because the EBS system is designed for use in narrowly-focused enforcement investigations that generally involve trading in particular securities, it is less useful for large-scale market reconstructions and analyses involving numerous stocks during peak trading volume periods. 28 25 17 CFR 240.17a-25. 26 See Rule 17a-25 Adopting Release, supra note 20, at 35836. 27 EBS data does not, however, include the time of execution, and often does not include the identity of the beneficial owner. See infra note 147. 28 A 1990 Senate Report acknowledged the immense value of the EBS system, but noted that “it is designed for use in more narrowly focused enforcement investigations that generally relate to trading in individual securities. It is not designed for use for multiple inquiries that are essential for trading reconstruction purposes.” See S. Rep. No. 300, 101st Cong., 2d Sess. 2-5 (1990), at 48. In 2000, the Commission proposed Rule 17a-25 under the Exchange Act to supplement the existing EBS system with data elements incorporating institutional and professional trading strategies, to assist regulatory staff in reviewing and analyzing EBS data. 29 Adopted in June 2001, 30 the rule codified the requirement that broker-dealers submit to the Commission, upon request, information on their customer and proprietary securities transactions in an electronic format. 31 Rule 17a-25 requires submission of the same standard customer and proprietary transaction information that SROs request through the EBS system in connection with their market surveillance and enforcement inquiries. 32 29 See Securities Exchange Act Release No. 42741 (May 2, 2000), 65 FR 26534 (May 8, 2000) (“Rule 17a-25 Proposing Release”). 30 See Rule 17a-25 Adopting Release, supra note 20. 31 Id. at 35836, and 17 CFR 240.17a-25. 32 See e.g. NYSE Rule 410A and FINRA Rule 8211. Specifically, for a proprietary transaction, Rule 17a-25 requires a broker-dealer to provide the following information electronically upon request: (1) Clearing house number or alpha symbol used by the broker-dealer submitting the information; (2) clearing house number(s) or alpha symbol(s) of the broker-dealer(s) on the opposite side to the trade; (3) security identifier; (4) execution date; (5) quantity executed; (6) transaction price; (7) account number; (8) identity of the exchange or market where the transaction was executed; (9) prime broker identifier; (10) average price account identifier; and (11) the identifier assigned to the account by a depository institution. 33 For customer transactions, the broker-dealer also is required to include the customer's name, customer's address, the customer's tax identification number, and other related account information. 34 The new data elements added by Rule 17a-25—prime broker identifiers, average price account identifiers, and depository institution account identifiers—assist the Commission in aggregating, without double-counting, securities transactions by entities trading through multiple accounts at more than one broker-dealer. 35 33 See Rule 17a-25(a)(1) and Rule 17a-25(b)(1)-(3), 17 CFR 240.17a-25(a)(1) and 17 CFR 240.17a-25(b)(1)-(3). 34 See Rule 17a-25(a)(2), 17 CFR 240.17a-25(a)(2). Rule 17a-25 also requires broker-dealers to submit, and keep current, contact person information for requests under the rule. This provision was designed to ensure that the Commission could effectively direct its data requests to broker-dealers. See Rule 17a-25 Proposing Release, supra note 29, at 26537. 35 This information was deemed especially necessary for the creation of massive market reconstructions performed by Commission staff. See Rule 17a-25 Adopting Release, supra note 20, at 35836. B. Equity Cleared Reports In addition to the EBS system and Rule 17a-25, the Commission also relies upon the National Securities Clearing Corporation's (“NSCC”) 36 equity cleared report for initial regulatory inquiries. 37 This report is generated on a daily basis by the SROs and is provided to the NSCC, in a database accessible by the Commission, and shows the number of trades and daily volume of all equity securities in which transactions took place, sorted by clearing member. The information provided is end of day data and is searchable by security name and CUSIP number. 38 Since the information made available on the report is limited to the date, the clearing firm, and the number of transactions cleared by each clearing firm on each SRO, it basically serves as a starting point for an investigation, providing a tool the Commission can use to narrow down which clearing firms to contact concerning a transaction in a certain security. 36 NSCC is a subsidiary of the Deposit Trust and Clearing Corporation and provides centralized clearing information and settlement services to broker-dealers for trades involving equities, corporate and municipal debt, American depository receipts, exchange traded funds, and unit investment trusts. 37 The Commission also uses the Options Cleared Report, with data supplied by the Options Clearing Corporation (“OCC”), for analysis of trading in listed options. OCC is an equity derivatives clearing organization that is registered as a clearing agency under Section 17A of the Exchange Act and operates under the jurisdiction of both the Commission and the Commodities Futures Trading Commission (“CFTC”). 38 A CUSIP number is a unique alphanumeric identifier assigned to a security and is used to facilitate the clearance and settlement of trades in the security. C. FINRA's Order Audit Trail System In 1996, the Commission instituted public administrative proceedings against the NASD, alleging that it failed to enforce and investigate potential misconduct by its members. 39 In settling the Commission's enforcement action, the NASD was ordered to design and implement an audit trail to enable it to reconstruct its markets promptly and effectively surveil them. 40 The Commission mandated that the audit trail at a minimum: (1) Provide an accurate time-sequenced record of orders and transactions, beginning with the receipt of an order at the first point of contact between the broker-dealer and the customer or counterparty, and further documenting the life of the order through the process including execution, modification and cancellation; and (2) provide for market-wide synchronization of clocks used in connection with the new audit trail system. 41 In response to the order, the NASD created OATS. 42 39 See In the Matter of National Association of Securities Dealers, Inc., Administrative Proceeding File No. 3-9056, Securities Exchange Act Release No. 37538 (August 8, 1996) (Order Instituting Public Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions). 40 Id. at 11-12. 41 Id. 42 See FINRA Rules 7400 to 7470. See also OATS Approval Order, supra note 13. Currently, OATS is used to capture order information reported by FINRA members in equity securities listed on the Nasdaq Stock Market, Inc. (“Nasdaq”) and OTC equity securities. 43 OATS requires reporting members 44 to record and report to FINRA 45 detailed information covering the receipt and origination of an order, 46 order terms, transmission, and modification, cancellation and execution. 47 Specifically, for each of these stages in the life of an order, FINRA Rule 7440 requires the recording and reporting of the following information, as applicable, including but not limited to: 43 FINRA defines an OTC equity security as any equity security that (1) is not listed on a national securities exchange, or (2) is listed on one or more regional stock exchanges and does not qualify for dissemination of transaction reports via the facilities of the Consolidated Tape. See FINRA Rule 7410(l). 44 A reporting member is a member that receives or originates an order and has an obligation to record and report information under FINRA Rules 7440 and 7450. A member shall not be considered a reporting member in connection with an order if the following conditions are met: (1) The member engages in a non-discretionary order routing process, pursuant to which it immediately routes, by electronic or other means, all of its orders to a single reporting member; (2) the member does not direct and does not maintain control over subsequent routing or execution by the receiving reporting member; (3) the receiving reporting member records and reports all information required under FINRA Rules 7440 and 7450 with respect to the order; and (4) the member has a written agreement with the receiving reporting member specifying the respective functions and responsibilities of each party to effect full compliance with the requirements of Rule 7440 and 7450. See FINRA Rule 7410(o). 45 Each reporting member must record each item of information required by OATS in electronic form by the end of each business day. See FINRA Rule 7440(a)(3). Reporting members must transmit to OATS a report of order information whenever an order is originated, received, transmitted to another department within the member or to another member, modified, canceled, or executed. Each report shall be transmitted on the day such event occurred if the information is available that day. Order information reports may be aggregated into one or more transmissions. See FINRA Rule 7450(b)(2). 46 OATS recording and reporting requirements apply to any oral, written, or electronic instruction to effect a transaction in an equity security listed on the Nasdaq Stock Market or an OTC equity security that is received by a member from another person for handling or execution, or that is originated by a department of a member for execution by the same or another member, other than any such instruction to effect a proprietary transaction originated by a trading desk in the ordinary course of a member's market making activities. See FINRA Rule 7410(j). 47 See FINRA Rules 7440 and 7450. • For the receipt or origination of the order, 48 the date and time the order was first originated or received by the reporting member; a unique order identifier; the market participant symbol of the receiving reporting member; and the material terms of the order; 49 48 FINRA Rule 7440 also requires reporting of the account type; the identification of the department or terminal where an order is received from a customer; the identification of the department or terminal where an order is originated by a reporting member; and the identification of a reporting agent if the agent has agreed to take on the responsibilities of a reporting member under Rule 7450. See FINRA Rule 7440(b). 49 The specific information required to be reported includes: The number of shares; designation as a buy or sell or short sale; designation of the order as market, limit, stop, or stop limit; limit or stop price; date on which the order expires and if the time in force is less than one day, the time when the order expires; the time limit during which the order is in force; any request by a customer that an order not be displayed, or that a block size be displayed, pursuant to Rule 604(b) of Regulation NMS; any special handling requests; and identification of the order as related to a program trade or index arbitrage trade. See FINRA Rule 7440(b). • For the internal or external routing of an order, the unique order identifier; the market participant symbol of the member to which the order was transmitted; the identification and nature of the department to which the order was transmitted if transmitted internally; the date and time the order was received by the market participant or department to which the order was transmitted; the material terms of the order as transmitted; 50 the date and time the order is transmitted; and the market participant symbol of the member who transmitted the order; 50 The specific information required includes the number of shares to which the transmission applies, and whether the order is an intermarket sweep order. See FINRA Rule 7440(c). • For the modification or cancellation of an order, a new unique order identifier; original unique order identifier; the date and time a modification or cancellation was originated or received; and the date and time the order was first received or originated; 51 and 51 For cancellations or modification, the following information also is required: If the open balance of an order is canceled after a partial execution, the number of shares canceled; and whether the order was canceled on the instruction of a customer or the reporting member. See FINRA Rule 7440(d). • For the execution of an order, in whole or in part, the unique order identifier; the designation of the order as fully or partially executed; the number of shares to which a partial execution applies and the number of unexecuted shares remaining; the date and time of execution; the execution price; the capacity in which the member executed the transaction; the identification of the market where the trade was reported; and the date and time the order was originally received. 52 52 For executions, the reporting member also must report its market participant symbol; its number assigned for purposes of identifying transaction data; and the identification number of the terminal where the order was executed. See FINRA Rule 7440(d). FINRA uses this information to recreate daily market activity for FINRA's market surveillance activities. 53 53 See OATS Reporting Technical Specifications, January 5, 2010, available at http://www.finra.org/web/groups/industry/@ip/@comp/@regis/documents/appsupportdocs/p120686.pdf. D. NYSE's Order Tracking System The Commission instituted public administrative proceedings against the NYSE in 1999, alleging that the exchange had failed to detect violations of federal securities laws and its own rules by its independent floor broker members, failed to police for performance-based compensation arrangements involving these members, and failed to adequately surveil them. 54 In settling the Commission's enforcement action, the NYSE was ordered to continue its development of an electronic floor system for the entry of order details prior to representation on the exchange floor, as well as to design and implement an audit trail to enable it to effectively surveil and reconstruct its market promptly, and facilitate the NYSE's effective enforcement of the federal securities laws and exchange rules. 55 Like OATS, this audit trail was required to provide an accurate, time-sequenced record of orders, quotations and transactions, documenting the life of an order from receipt through execution or cancellation. The NYSE also was required to provide for synchronization of all clocks used in connection with the audit trail. 56 54 See In the Matter of New York Stock Exchange, Inc., Administrative Proceeding File No. 3-9925, Securities Exchange Act Release No. 41574 (June 29, 1999) (Order Instituting Public Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Ordering Compliance with Undertakings), at 4-5. 55 Id. at 28-29. 56 Id. In response to the Commission's order, the NYSE created OTS. 57 OTS currently is used for the provision of audit trail data for orders 58 in NYSE and NYSE Amex-listed cash equity securities by NYSE and NYSE Amex members, including for orders in NYSE or NYSE Amex-listed cash equity securities initiated by a NYSE or NYSE Amex member or routed by a NYSE or NYSE Amex member to another market center for execution. 59 OTS is similar in scope to OATS, as detailed information is required to be recorded for the stages of an order's life, from origination and receipt and transmittal, through order modification, cancellation, and/or execution. 60 Specifically, for each of these stages in the life of an order, OTS requires the recording of the following information, as applicable, including but not limited to: 57 See NYSE Rule 132B, and OTS Approval Order, supra note 14. 58 OTS is applicable to all orders in NYSE-listed securities, regardless of account type (firm or customer). See NYSE Rule 132B(a)(1). 59 See Securities Exchange Act Release No. 59022 (November 26, 2008), 73 FR 73683 (December 3, 2008). NYSE Alternext adopted NYSE Rules 1-1004 as the NYSE Alternext Equities Rules to govern all cash equities trading on the NYSE Alternext Trading Systems and NYSE Alternext Bonds. In March 2009, NYSE Alternext changed its name to NYSE Amex LLC (“NYSE Amex”) (the successor to Amex, see infra note 73). See Securities Exchange Act Release No. 59575 (March 13, 2009), 74 FR 11803 (March 19, 2009). 60 See NYSE Rule 132B and NYSE Amex Equities Rule 132B. Each member or member organization shall, by the end of each business day, record each item of information required to be recorded under the rule in such electronic form as is prescribed by the NYSE (or NYSE Amex) from time to time. See NYSE Rule 132B(a)(3) and NYSE Amex Equities Rule 132B(a)(3). Members and member organizations shall be required to transmit to the NYSE or NYSE Amex, in such format as the applicable exchange may from time to time prescribe, such order tracking information as the exchange may request. See NYSE Rule 132C and NYSE Amex Equities Rule 132C. • For order receipt or origination, 61 the date and time the order is originated or received by a member or member organization; a unique order identifier; market participant symbol; and the material terms of the order; 62 61 Members are also required to report: The identification of the department or terminal where an order is received directly from a customer; and where the order is originated by a member or member organization, the identification of the department (if appropriate) of the member that originated the order. See NYSE Rule 132B(b) and NYSE Amex Equities Rule 132B(b). 62 The specific information required to be reported includes: Number of shares; designation of the order as a buy or sell; designation of the order as a short sale; designation of the order as a market order, limit order, auction market order, stop order, auction stop order, or ISO; security symbol; limit or stop price; type of account; the date on which the order expires, and, if the time in force is less than one day, the time when the order expires; the time limit during which the order is in force; any request by a customer that an order not be displayed pursuant to Rule 604(c) under the Exchange Act; and special handling requests. See NYSE Rule 132B(b) and NYSE Amex Equities Rule 132B(b). • For the internal or external routing of an order, the unique order identifier; the identification of the department to which an order was transmitted if transmitted internally; the date and time the order was received by the department receiving a transmitted order; the market participant symbol assigned to the member or member organization receiving the transmitted order or notation that the order was transmitted to a non-member; 63 the material terms of the order as transmitted; 64 and the date and time the order is transmitted; and 63 The information required to be reported also includes whether the order was transmitted and received manually or electronically; the date the order was first originated or received by the transmitting member or member organization; and, for each order to be included in a bunched order, the bunched order route indicator assigned to the bunched order. See NYSE Rule 132B(c) and NYSE Amex Equities Rule 132B(c). 64 The information required to be reported includes the number of shares to which the transmission applies. See NYSE Rule 132B(c) and NYSE Amex Equities Rule 132B(c). • For the modification or cancellation of an order, a new unique order identifier; the original unique order identifier; and the date and time a modification or cancellation was originated or received. 65 65 For cancellations or modifications, the following information also is required: The order identifier assigned to the order prior to modification; if the open balance of an order is canceled after a partial execution, the number of shares canceled; and whether the order was canceled on the instruction of a customer or the member or member organization. See NYSE Rule 132B(d) and NYSE Amex Equities Rule 132B(d). Additionally, the NYSE and NYSE Amex require the recording of detailed information concerning the receipt, cancellation or execution of orders in NYSE and NYSE Amex-listed cash equity securities originated on or transmitted to the exchange floor. 66 Immediately following receipt of an order on the floor, the member receiving the order must record the following information: (1) The material terms of the order; 67 (2) a unique order identifier; (3) the clearing member organization and the identification of the member or member organization recording order details; 68 and (4) modification of terms of the order or cancellation of the order. 69 66 See NYSE Rule 123 and NYSE Amex Equities Rule 123, each of which require, among other things, a record of the cancellation of an order, which must include the time the cancellation was entered, and a record of the receipt of an execution report, which must include the time of receipt of the report. 67 The specific information required includes the security symbol; quantity; side of the market; whether the order is a market, auction market, limit, stop, or auction limit order; any limit or stop price, discretionary price range, discretionary volume range, discretionary quote price, pegging ceiling price, pegging floor price and/or whether discretionary instructions are active in connection with interest displayed by other market centers; time in force; designation as held or not held; and any special conditions. See NYSE Rule 123(e) and NYSE Amex Equities Rule 123(e). 68 The required information also includes the system-generated time of recording order details. See NYSE Rule 123(e) and NYSE Amex Equities Rule 123(e). 69 See NYSE Rule 123(e) and NYSE Amex Equities Rule 123(e). Further, once an order is executed, the following information must be recorded: (1) The material terms of the execution; 70 (2) the unique order identifier; (3) the identity of the firms involved in the execution; 71 and (4) certain other information related to the execution. 72 70 The specific information required includes security symbol; quantity; transaction price; and execution time. See NYSE Rule 123(f) and NYSE Amex Equities Rule 123(f). 71 The specific information required includes the executing broker badge number or alpha symbol; the contra side executing broker badge number or alpha symbol; the clearing firm number or alpha; and the contra side clearing firm number or alpha. See NYSE Rule 123(f) and NYSE Amex Equities Rule 123(f). 72 The required information includes whether the account for which the order was executed was that of a member or member organization or non-member or non-member organization; the identification of member or member organization which recorded order details; the date the order was entered into an exchange system; an indication as to whether this is a modification to a previously submitted report; settlement instructions; special trade indication (if applicable); and the Online Comparison System control number. See NYSE Rule 123(f) and NYSE Amex Equities Rule 123(f). E. Consolidated Options Audit Trail System In September 2000, the Commission instituted public administrative proceedings against Amex, 73 CBOE, the Pacific Exchange, 74 and the Philadelphia Stock Exchange 75 for failing to uphold their obligations to enforce compliance with exchange rules and the federal securities laws, including those relating to reporting. Specifically, the Commission alleged that they had either conducted no automated surveillance, or inadequate automated surveillance, of trade reporting and consequently failed to adequately detect noncompliance with their rules. 76 In settling the Commission's enforcement action, the exchanges were required to jointly design and implement COATS to enable them to reconstruct markets promptly, surveil them, and enforce compliance with trade reporting, firm quote, order handling, and other rules. 77 The exchanges were required to complete this undertaking in five phases. 78 73 Amex was acquired by NYSE Euronext on October 1, 2008. Initially, the successor entity to Amex was established as NYSE Alternext U.S. LLC, but the name was changed in 2009 to NYSE Amex. See Securities Exchange Act Release No. 59575 (March 13, 2009), 74 FR 11803 (March 19, 2009). 74 In 2001, the Archipelago Exchange LLC (“ArcaEx”) was established as an electronic trading facility for Pacific Exchange's subsidiary PCX Equities, Inc. (“PCX Equities”). See Securities Exchange Act Release No. 44983 (October 25, 2001), 66 FR 55225 (November 1, 2001). In 2005, Archipelago Holdings, Inc., the parent company of ArcaEx, acquired PCX Holdings, Inc., which included subsidiaries Pacific Exchange (PCX) and PCX Equities. See Securities Exchange Act Release No. 52497 (September 22, 2005), 70 FR 56949 (September 29, 2005). The NYSE merged with Archipelago Holdings in 2006. See Securities Exchange Act Release No. 53382 (February 27, 2006), 71 FR 11251 (March 6, 2006). NYSE Arca is the successor to PCX. 75 The Philadelphia Stock Exchange was acquired by The NASDAQ OMX Group, Inc. in 2008, and is now called NASDAQ OMX Phlx (“Phlx”). See Securities Exchange Act Release No. 58179 (July 17, 2008), 73 FR 42874 (July 23, 2008). 76 See Options Settlement Order, supra note 15, at 12. 77 Id. at 22. 78 Id. at 22-25. In particular, each exchange was required to achieve the following through its audit trail: (1) Synchronize trading and support system clocks with all other options exchanges; (2) design and implement a method to merge all options exchanges' reported and matched transaction data on a daily basis in a common computer format; (3) incorporate its quotations and the national best bid and offer as displayed in its market with the merged transaction data so that it could be promptly retrieved and merged in the common computer format with other options exchanges' merged transactions and quotation data; (4) design and implement an audit trail readily retrievable (in the common computer format) providing an accurate, time-sequenced record of electronic orders, quotations and transactions on such exchange, beginning with the receipt of an electronic order, and further documenting the life of the order through the process of execution, partial execution, or cancellation; (5) incorporate into the audit trail all non-electronic orders so that such orders were also subject to the audit trail requirements for electronic orders; and (6) design effective surveillance systems to use this newly available data to enforce the Federal securities laws and the exchange's rules. 79 79 See Options Settlement Order, supra note 15, at 22-25. The exchanges subject to the Options Settlement Order fully implemented the requirements in 2005. In addition, the International Securities Exchange, LLC (“ISE”), Boston Options Exchange Group, LLC (“BOX”), the Nasdaq Options Market (“NOM”), and BATS Options Exchange Market (“BATS Options”) also comply with the COATS requirements. 80 80 See Securities Exchange Act Release Nos. 61154 (December 11, 2009), 74 FR 67278 (December 18, 2009), at 67280 (stating “ISE and the other options exchanges are required to populate a consolidated options audit trail (“COATS”) system in order to surveil member activities across markets”); 61388 (January 20, 2010), 75 FR 4431 (January 27, 2010), at 4433 (Nasdaq OMX BX filing amending BOX's fee schedule, with similar language as Release No. 61154); and 61419 (January 26, 2010), 75 FR 5157 (February 1, 2010) (BATS Exchange, Inc. (“BATS”) represented that BATS Options would comply with the specifications of COATS in submitting data to create a consolidated audit trail, as well as receiving COATS data for its own surveillance purposes). A majority of options exchanges require their members to provide the following information with respect to orders entered onto their exchange: (1) The material terms of the order; 81 (2) order receipt time; 82 (3) account type; (4) the time a modification is received; (5) the time a cancellation is received; (6) execution time; and (7) the clearing member identifier of the parties to the transaction. 83 81 The specific information required includes option symbol; underlying security; expiration month; exercise price; contract volume; call/put; buy/sell; opening/closing transaction; price or price limit; and special instructions. 82 The required information also includes identification of the terminal or individual completing the order ticket. 83 See e.g. BATS Rule 20.7; BOX Chapter V, Section 15; CBOE Chapter VI, Rules 6.24 and 6.51; NOM Rule Chapter V, Section 7; NYSE Amex Rules 153, Commentary .01, and 962; NYSE Arca Rules 6.67, 6.68, and 6.69; and Phlx Rules 1063 and 1080. F. Other Audit Trail Requirements SRO audit trail rules regarding information on orders for NMS stocks to be recorded by their members, and in some cases provided to the SRO, tend to be less uniform than SRO audit trail rules relating to listed options. 84 Some exchanges and FINRA have detailed audit trail data submission requirements for their members covering order entry, transmittal, and execution. 85 For example, the rules of one exchange require the recording of the following information for each order originating with an exchange participant that is given to or received from another participant for execution, transmitted by an exchange participant to another market, or originating off the exchange and transmitted to an exchange participant, and subsequent execution of any such orders: 86 84 For purposes of this release, the Commission does not consider SRO EBS rules to be audit trail rules. 85 See Chicago Stock Exchange (“CHX”) Article 11, Rule 3(b); FINRA Rules 7400 to 7470 (the OATS rules); Nasdaq Rules 6950 to 6958 (substantially similar to the OATS rules); BX Rules 6950 to 6958 (substantially similar to OATS rules); NYSE Rule 123 and 132B; and NYSE Amex Equities Rule 123 and 132B (OTS rules). See supra Sections I.C. and I.D. for a discussion of FINRA's OATS rules and the NYSE and NYSE Amex's OTS rules, respectively. 86 See CHX Article 11, Rule 3(b). • Information relating to receipt or transmission of the order, including the material terms of the order; 87 a unique order identifier; the identification of the clearing participant and the participant recording the order details; the date and time of order receipt or transmission (if applicable); the market or participant to which the order was transmitted or from which the order was received (if applicable); 87 Id. The specific information required includes the symbol; number or shares or quantity of security; side of the market; order type; limit and/or stop price; whether the order is agency or proprietary; whether an order is a bona fide arbitrage order; whether the order is short; time in force; designation as held or not held; any special conditions or instructions (including any customer display instructions and any all-or-none conditions); and the date and time of any order expiration. • Information relating to modifications to or cancellation of the order, including any modifications to the order, any cancellation of all or part of the order; the date and time of receipt and transmission of any modifications to the order or cancellations; and the identification of the party canceling or modifying the order; 88 88 Id. • For executions of the order, 89 in whole or in part, the transaction price; the number of shares or quantity executed; the date and time of execution; the contra party to the execution; and any settlement instructions. 90 89 Id. 90 Id. The participant also must record the system-generated times of recording this required information. This information must be recorded immediately after the information is received or becomes available. CHX Article 11, Rule 3(c). Additionally, before any such orders are executed, exchange participants must record the name or designation of the account for which the order is being executed. CHX Article 11, Rule 3(d). This rule does not apply to orders sent or received through the exchange's matching system or any other electronic systems the exchange recognizes as providing the required information in a format acceptable to the exchange. See CHX Article 11, Rule 3, Interpretations and Policies .03. The audit trail rules of the other exchanges incorporate only standard books and records requirements in accordance with Section 17 of the Exchange Act. 91 91 See e.g. National Stock Exchange (“NSX”) Chapter VI, Rule 4.1.; BATS Chapter IV, Rule 4.1; CBOE Rule 15.1 (applicable to CBSX); ISE Stock Exchange Rule 1400; NYSE Arca Equities Rule 2.24; 15 U.S.C. 78q et seq. For example, one exchange only requires its members to make and keep books and records and other correspondence in conformity with Section 17 of the Exchange Act and the rules thereunder, with all other applicable laws and the rules, regulations and statements of policy promulgated thereunder, and with the exchange's rules. See NSX Chapter VI, Rule 4.1. G. Prior Commission Request for Comment The Commission has previously requested comment regarding cross- market regulation, including whether changes should be made to existing audit trail rules, in two concept releases in 2003 and 2004. 92 92 See Securities Exchange Act Release Nos. 47849 (May 14, 2003), 68 FR 27722 (May 20, 2003) (File No. S7-11-03) (“Intermarket Trading Concept Release”) and 50700 (November 18, 2004), 69 FR 71256 (December 8, 2004) (File No. S7-40-04) (“Concept Release Concerning Self-Regulation”). In 2003, the Commission sought public comment on a petition submitted by Nasdaq that raised concerns about the impact of market fragmentation on the trading in, and regulation of trading in, Nasdaq-listed securities. 93 Nasdaq, through OATS, collected data from its members trading Nasdaq-listed securities, which the NASD then used to surveil for potential rule violations. 94 Nasdaq requested that the Commission require all SROs trading Nasdaq-listed securities to implement an electronic audit trail identical to OATS. 95 Nasdaq also noted that the available cross-market audit trail information provided by the Intermarket Surveillance Group (“ISG”) 96 was comprised of audit trail information from each of the exchanges and provided two day delayed data at the clearing firm level, with time data from non-synchronized clocks. 97 Nasdaq believed that the information provided by ISG was insufficient to identify potentially violative activity. 98 93 See letter to Jonathan G. Katz, Secretary, Commission, from Edward Knight, Executive Vice President and General Counsel, Nasdaq, dated April 11, 2003 (File No. 4-479) (“Nasdaq Petition”). In particular, Nasdaq was concerned over what it deemed “unequal and inadequate regulation” by other markets trading Nasdaq-listed securities. Id. at 2. See also Intermarket Trading Concept Release, supra note 92, at 27223. 94 See Nasdaq Petition, supra note 93, at 10, and Intermarket Trading Concept Release, supra note 92, at 27224. 95 See Nasdaq Petition, supra note 93, at 11, and Intermarket Trading Concept Release, supra note 92, at 27224. 96 The ISG was created in 1983 and its members include all of the registered national securities exchanges and FINRA. ISG states that its goals are to enhance intermarket surveillance, assure the integrity of trading, and provide investor protection. To achieve these goals, ISG members share data such as audit trail information and short interest data among themselves. ISG provides surveillance tools to supplement its participant members' existing surveillance systems, such as the ISG Unusual Activity Report and the Consolidated Equity Audit Trail. These reports are made available from SIAC to members of ISG and are intended to provide a consolidated view across all markets of trade, quote, and clearing activity. See comment letter from Brian F. Colby, Chairman, Intermarket Surveillance Group, to Jonathan G. Katz, Secretary, Commission, dated June 18, 2003 (“ISG 2003 Comment Letter”) (commenting in response to the Intermarket Trading Concept Release). 97 See Nasdaq Petition, supra note 93, at 10, and Intermarket Trading Concept Release, supra note 92, at 27224. 98 See Nasdaq Petition, supra note 93, at 10-11, and Intermarket Trading Concept Release, supra note 92, at 27224. In response to the Intermarket Trading Concept Release, the Commission received a variety of comments on intermarket surveillance and order audit trail issues. 99 Of those commenters that addressed the general concept of creating a uniform electronic audit trail, some supported the concept while others did not. 100 99 See comment letters from Darla C. Stuckey, Corporate Secretary, NYSE, to Jonathan G. Katz, Secretary, Commission, dated June 19, 2003 (“NYSE Comment Letter”); Jeffrey T. Brown, General Counsel, Cincinnati Stock Exchange, to Jonathan G. Katz, Secretary, Commission, dated June 19, 2003 (“CSE Comment Letter”); Michael J. Simon, Senior Vice President and Secretary, International Securities Exchange, Inc., to Jonathan G. Katz, Secretary, Commission, dated June 19, 2003 (“ISE Comment Letter”); William O'Brien, Chief Operating Officer, Brut, LLC, to Jonathan G. Katz, Secretary, Commission, dated June 19, 2003 (“Brut Comment Letter”); Kim Bang, President, Bloomberg Tradebook LLC, to Jonathan G. Katz, Secretary, Commission, dated June 20, 2003 (“Bloomberg Tradebook Comment Letter”); Donald D. Kittell, Executive Vice President, Securities Industry Association, to Jonathan G. Katz, Secretary, Commission, dated June 27, 2003 (“SIA Comment Letter”); Edward J. Joyce, President and Chief Operating Officer, CBOE, to Jonathan G. Katz, Secretary, Commission, dated June 30, 2003 (“CBOE Comment Letter”); W. Hardy Callcott, Senior Vice President and General Counsel, Charles Schwab & Co., Inc., to Jonathan G. Katz, Secretary, Commission, dated July 7, 2003 (“Schwab Comment Letter”); Richard Ketchum, General Counsel, Citigroup, to Jonathan G. Katz, Secretary, Commission, dated July 8, 2003 (“Citigroup Comment Letter”); John S. Markle, Associate General Counsel, Ameritrade Holding Corp., to Jonathan G. Katz, Secretary, Commission, dated July 10, 2003 (“Ameritrade Comment Letter”); and Eric Schwartz, Managing Director, Goldman Sachs, and Duncan Niederauer, Co-Chief Executive Officer, Spear, Leeds & Kellogg, to Jonathan G. Katz, Secretary, Commission, dated July 25, 2003 (“Goldman Sachs and Spear, Leeds & Kellogg Comment Letter”). 100 Of the commenters that clearly commented on the creation of a uniform intermarket audit trail, Citigroup and Goldman Sachs and Spear, Leeds & Kellogg were in favor of the idea, and Bloomberg supported a consolidated audit trail for those SROs trading Nasdaq-listed securities. See Citigroup Comment Letter, supra note 99, at 6; Goldman Sachs and Spear, Leeds & Kellogg Comment Letter, supra note 99, at 3-4; and Bloomberg Tradebook Comment Letter, supra note 99, at 3. Brut, CBOE, and the NYSE did not appear to be in favor of a standardized intermarket audit trail. See Brut Comment Letter, supra note 99, at 5 (arguing for addressing improvements to surveillances falling short of Exchange Act requirements individually instead of “costly and comprehensive technology overhauls”); CBOE Comment Letter, supra note 99, at 2 (explaining that it “supports expanding the use of existing tools and enhancing [SRO] and Commission coordination to strengthen surveillance and to achieve more uniform regulation * * *” and noting that the Commission could “play a significant role in achieving uniform SRO regulation [by] establishing guiding principles on a variety of areas that affect all SROs.” CBOE also noted that there should be enhanced coordination of SRO regulatory efforts through ISG and through 17d-2 agreements); and NYSE Comment Letter, supra note 99, at 5 (suggesting linking SRO audit trails in the manner of the ISG Consolidated Audit Trail). One commenter expressed the view that once broker-dealers have implemented systems necessary to comply with audit trail requirements, it would not be incrementally significant from a cost perspective to supply the same data in a common format to additional SROs, but that there would be a significant cost if the data to be captured and the methods of encoding and delivering the data differed from market to market. 101 This commenter urged the Commission, if it were to require all market centers to adopt audit trail requirements, to ensure that the requirements are uniform and standardized. This commenter recommended a single standard for real time electronic trade and audit trail reporting, which would be applicable to all equity securities traded in the national market regardless of where listed or traded, and where data would be captured in a central depository, aggregated and made immediately available to each relevant market center, possibly through direct electronic data feeds. 102 Likewise, another commenter stated that it would be preferable for there to be one uniform audit trail system, rather than each SRO adopting its own audit trail requirements and systems, to reduce the potential for conflicting rules and regulations and duplicative systems and technology requirements. 103 Another commenter recommended that if the Commission determined that the need for a particular SRO to have enhanced audit trail information outweighs costs to member firms, SROs be required to coordinate efforts so as to reduce duplication of systems and regulatory efforts. 104 101 See Goldman Sachs and Spear, Leeds & Kellogg Comment Letter, supra note 99, at 3. 102 Id at 4. 103 See Citigroup Comment Letter, supra note 99, at 6. 104 See SIA Comment Letter, supra note 99, at 4. One commenter agreed that the Commission would be justified in requiring all SROs trading Nasdaq-listed securities to coordinate electronic audit trail systems with the NASD. See Bloomberg Tradebook Comment Letter, supra note 99. On the other hand, one commenter stated its belief that if there is a legitimate need to improve on the ISG audit trail, the markets should act jointly to do so, without being forced to adopt Nasdaq's proprietary audit trail. See ISE Comment Letter, supra note 99. Several commenters urged the Commission to consider the costs to broker-dealer firms of supplying the audit trail data when considering the appropriateness of extending OATS-like audit trail requirements to other market centers. 105 One commenter stated the belief that firms already are required to maintain all of the customer and transaction information that regulators would want under their current books and records requirements and that most firms do not believe there is a justification for requiring firms to spend the money necessary to send this information to every market center where an order may be routed. 106 Another commenter was concerned about the impact on each individual market's structure of mandating uniformity. 107 105 See SIA Comment Letter, supra note 99, at 4; Goldman Sachs and Spear, Leeds & Kellogg Comment Letter, supra note 99, at 3 (stating that any decision about extending OATS to other markets should take into account the costs imposed on SROs, market intermediaries and the markets); and Ameritrade Comment Letter, supra note 99, at 3. 106 See SIA Comment Letter, supra note 99, at 4. 107 See CSE Comment Letter, supra note 99, at 6-7 (noting that the data formats among exchanges may vary due to structural needs and system designs; thus, while this commenter advocated that exchanges should be required to have internal audit trails tracking orders from inception to execution, it argued that design flexibility be maintained so that exchanges could create the audit trail systems best suited to monitor their markets). Some commenters supported the ISG as a facilitator of a coordinated regulation. 108 One commenter noted that the ISG Consolidated Equity Audit Trail was a valuable supplement to existing SRO market data. 109 One commenter also endorsed the ISG audit trail as well as CSE's Firm Order Submission system, 110 stating that it was preferable to enhance these systems rather than conduct a “mass migration” to OATS. 111 The ISG itself stated that no other market had reported any problems with ISG's timing of the incorporation of the clearing data into the Consolidated Equity Audit Trail, nor with the delivery of its audit trail information. 112 108 See Ameritrade Comment Letter, supra note 99, at 2; CSE Comment Letter, supra note 99, at 13; ISE Comment Letter, supra note 99, at 4; and NYSE Comment Letter, supra note 99, at 3. 109 See NYSE Comment Letter, supra note 99. 110 In its comment letter, CSE stated that its Firm Order Submission system (“FOS”) was more comprehensive than OATS and that the exchange had pioneered order audit trail development. See CSE Comment Letter, supra note 99. In its petition, Nasdaq argued that FOS was used voluntarily for settling commercial disputes between traders and was not meant for surveillance. See Nasdaq Petition, supra note 93, at 4. 111 See Brut Comment Letter, supra note 99, at 6. 112 See ISG 2003 Comment Letter, supra note 99. In 2004, in a release seeking comment on a variety of issues relating to self-regulation, the Commission again sought public comment on intermarket surveillance. 113 The Commission discussed the individual audit trails developed by several equity markets, COATS, and ISG's clearing level audit trail. 114 The Commission suggested that a more robust intermarket order audit trail for options and equity markets could enhance the surveillance of order flow and requested comment on the issue. 115 113 See Concept Release Concerning Self-Regulation, supra note 92, at Sections IV.C and V.A.2. 114 Id. 115 Id. at 71277. One commenter on the Concept Release Concerning Self-Regulation stated that, because trading in most liquid securities now occurs on multiple markets, no single SRO could capture a complete picture of all the trading in each product, all trading by one broker-dealer, and even all the trading related to a single order. 116 This commenter stated its belief that the lack of uniform order and transaction data creates regulatory gaps and may provide incentives for market participants to conduct activities on markets where less regulatory data is collected on an automated basis. 117 This commenter believed that minimum data-collection standards should be required to ensure adequate regulation across all markets, and that consolidating that data would permit effective intermarket regulation while ensuring that no single market has a competitive advantage. 118 116 See comment letter from Robert R. Glauber, Chairman and Chief Executive Officer, NASD, to Jonathan G. Katz, Secretary, Commission, dated March 15, 2005 (“NASD Comment Letter”), at 10. 117 Id. at 11. 118 Id. Another commenter gave an example of how it believed the lack of real time reporting across markets was detrimental to surveillances relating to certain illegal activities. This commenter stated its belief that “effective surveillances relating to insider trading, market manipulation and stock or options frontrunning in multiple markets can be hindered because away-market data such as order information, position limit reports and large position reports (for options) are not available electronically on a real time or near real time basis to the SRO that has generated an alert or flag in the course of its routine surveillance. 119 This commenter suggested that consolidating this type of data in real time or near real time would permit SROs to immediately detect and review all aberrational activity in the multiple market centers, which could significantly deter or prevent violative conduct. 120 119 See comment letter from Mary Yeager, Secretary, NYSE, to Jonathan G. Katz, Secretary, Commission, dated March 8, 2005, at 8. 120 Id. Another commenter stated its belief that the lack of a coordinated surveillance system is potentially one of the more significant problems facing the markets, and that as trading strategies become more sophisticated across multiple markets and national borders, the potential for sophisticated fraud also increases. 121 One commenter recommended a consolidated information base that all regulators could access, stating that “having separate and uncoordinated regulatory data is inefficient and detracts from the quality of regulation.” 122 Further, another commenter suggested a voluntary regulatory cooperative, jointly owned by participant exchanges, that would be the central regulator for surveillance, investigations and examinations and would include an electronic interface with the SEC; this commenter believed that the costs of developing an intermarket consolidated order audit trail system should be justified by the regulatory value of the data to be captured. 123 121 See comment letter from Rebecca T. McEnally, Director, and Linda L. Rittenhouse, Senior Policy Analyst, Centre for Financial Market Integrity, to Nancy M. Morris, Secretary, Commission, dated July 14, 2006, at 6. 122 See comment letter from Kim Bang, Chief Executive Officer, Bloomberg L.P., to Jonathan G. Katz, Secretary, Commission, dated March 8, 2005, at 4. 123 See comment letter from Meyer S. Frucher, Chairman and Chief Executive Officer, Philadelphia Stock Exchange, to Jonathan G. Katz, Secretary, Commission, dated March 9, 2005, at 3. II. Basis for Proposed Rule As noted above, the U.S. securities markets have experienced a dynamic transformation in recent years. Rapid technological advances and regulatory developments have produced fundamental changes in the structure of the securities markets, the types of market participants, the trading strategies employed, and the array of products traded. Trading of securities has become more dispersed among exchanges and various other trading venues, including the OTC market. The markets have become even more competitive, with exchanges and other trading centers aggressively competing for order flow by offering innovative order types, new data products and other services, and through fees charged or rebates provided by the markets. The Commission preliminarily believes that with today's fast, electronic and interconnected markets, there is a heightened need for a single uniform electronic cross-market order and execution tracking system that includes more information than is captured by the existing SRO audit trails, and in a uniform format. Such a system would enable SROs to better fulfill their regulatory responsibilities to monitor for and investigate illegal activity in their markets and by their members. Further, the Commission preliminarily believes that such a system would enable the Commission staff to better carry out its oversight of the NMS for securities and to perform market analysis in a more timely fashion, whether on one market or across markets. Each national securities exchange and national securities association must be organized and have the capacity to comply, and enforce compliance by its members, with its rules, and with the federal securities laws, rules, and regulations. 124 The Commission preliminarily believes that the exchanges and FINRA could more effectively and efficiently fulfill these statutory obligations if the SROs had direct, electronic real time access to consolidated and more detailed order and execution information across all markets. 125 Likewise, the Commission has the statutory obligation to oversee the exchanges and associations, 126 and to enforce compliance by the members of exchanges and associations with the respective exchange's or association's rules, and the federal securities laws and regulations. 127 The Commission also preliminarily believes that electronic real time access to consolidated information and more detailed cross-market order and execution information also would aid the Commission in carrying out its statutory obligations. 124 See, e.g., Sections 6(b)(1), 19(g)(1) and 15A(b)(2) of the Exchange Act, 15 U.S.C. 78f(b)(1), 78s(g)(1), and 78o-3(b)(2). 125 The Commission notes that, if adopted as proposed, its Large Trader Proposal would not amend or impact the scope of any of the existing SRO audit trail rules. See Large Trader Proposal, supra note 11. 126 See, e.g., Sections 2, 6(b), 15A(b), and 19(h)(1) of the Exchange Act, 15 U.S.C. 78b, 15 U.S.C. 78f(b), 15 U.S.C. 78o-3(b), and 15 U.S.C. 78s(h)(1). 127 See, e.g., Section 19(h)(1) of the Exchange Act, 15 U.S.C. 78s(h)(1). Section 11A(a)(3)(B) of the Exchange Act provides in part that the Commission may, by rule, require SROs to act jointly with respect to matters as to which they share authority under the Exchange Act in regulating an NMS for securities. 128 Pursuant to this authority, the Commission today is proposing a rule that would require all national securities exchanges and national securities associations to jointly submit to the Commission an NMS plan to create, implement, and maintain a consolidated audit trail that would be more comprehensive than any audit trail currently in existence. 129 The proposed Rule would require the consolidated audit trail to capture certain information about each order for an NMS security, including the identity of the customer placing the order and the routing, modification, cancellation or execution of the order, in real time. In effect, the proposal would create a time-stamped “electronic audit trail record or report” for every order, and each market participant that touches the order would be required to report information about certain reportable events, such as routing or execution of the order. 128 See Section 11A(a)(3)(B) of the Exchange Act, 15 U.S.C. 78k-1(a)(3)(B). 129 See infra Section III for a description of proposed Rule 613. The Commission preliminarily believes that a consolidated order audit trail, such as the one proposed today, could enhance the ability of the SROs to carry out their obligations to regulate their markets and their members. The Commission also preliminarily believes that the proposed consolidated order audit trail could aid the Commission in fulfilling its statutory obligations to oversee SROs, 130 monitor for the manipulation of security prices, 131 and detect the use of manipulative or deceptive devices in the purchase or sale of a security, 132 as well as to perform market reconstructions. 130 See, e.g., Sections 6(b)(1) and 19(h) of the Exchange Act, 15 U.S.C. 78f(b)(1) and 78s(h). 131 See Section 9 of the Exchange Act, 15 U.S.C. 78i. 132 See Section 10 of the Exchange Act, 15 U.S.C. 78j. The Commission preliminarily believes that proposed Rule 613 would benefit the industry, through potential cost reductions, by eliminating the need for certain SRO and Commission rules that currently mandate the collection and provision of information, at least with respect to NMS securities. 133 The Commission also preliminarily believes that the proposal would benefit SROs, as well as the NMS for NMS securities, by ultimately reducing some regulatory costs, which may result in a more effective re-allocation of overall costs. 134 133 See infra Section VI.A (discussion of benefits of the proposed Rule). 134 Id. The Commission recognizes that SRO rules requiring members to capture and disclose audit trail information already exist, and considered whether more modest improvements to existing rules, and corresponding SRO and member systems, would achieve the proposed Rule's objective at lower cost. For example, the Commission considered whether to standardize and expand the order information collected by existing audit trails, the EBS system, Rule 17a-25 and equity cleared reports. Without centralization of the trading data in a uniform electronic format, however, the Commission's goals of cross-market comparability and ready access could not be achieved. Additionally, this approach would not resolve concerns over how long it takes to obtain order and execution information because the data is often not available in real time and is provided only upon request. 135 Similarly, the Commission considered whether assuring access to existing audit trails to other SROs and the Commission would sufficiently advance its goals. Even if SROs could view order activity on a real time basis on other exchanges, this would not eliminate the need for SROs to check multiple repositories to view and obtain order information. Moreover, the information may be captured, stored and displayed in a variety of formats, making comparisons more difficult. The Commission, therefore, preliminarily does not believe that “retrofitting” existing rules and systems would be a more effective way to achieve the goals of the proposed consolidated audit trail than having the requirements contained in a single Commission rule, and a single NMS plan. 135 See infra note 149. As discussed below, the Commission preliminarily believes that existing audit trails are limited in their scope and effectiveness in varying ways. SRO and Commission staff also currently obtain information about orders or trades through the EBS system, Rule 17a-25, 136 and from equity cleared reports. 137 However, as discussed below, the information provided pursuant to the EBS system, Rule 17a-25, and the equity cleared reports also is limited, to varying degrees, in detail and scope. 136 17 CFR 240.17a-25. 137 See supra Sections I.A. and I.B. for a description of the EBS system, Rule 17a-25, and equity cleared reports. A. Lack of Uniformity of, and Gaps in, Current Required Audit Trail Information As noted above, the type of information relating to orders and executions currently collected by the exchanges and FINRA differs widely. For example, FINRA's OATS rules and NYSE/NYSE Amex's OTS rules (as supplemented by the requirements of NYSE and NYSE Amex Rule 123) both set forth in relative detail the information required to be recorded by a FINRA, NYSE or NYSE Amex member upon receipt or origination of an order; following transmission of an order to another FINRA, NYSE or NYSE Amex member; and following modification, cancellation or execution of such order. 138 In contrast, some other exchanges' rules only require their members to keep records in compliance with the member's recordkeeping obligations under Section 17(a) of the Exchange Act and rules thereunder, 139 rather than requiring that specific information be captured for orders sent to and executed on the exchange. 140 Although Rule 17a-3 under the Exchange Act 141 requires that a member make and keep detailed information with respect to each brokerage order, it does not, for instance, require information with respect to the routing of the order, or that each order be assigned a unique order identifier. 142 Similarly, the scope of securities covered by existing audit trail rules also differs among the exchanges and FINRA. FINRA's OATS rules, for instance, apply to orders for equity securities listed on Nasdaq and OTC securities, while OTS captures information for orders in NYSE and NYSE Amex-listed cash equity securities. 143 138 See FINRA Rules 7400 through 7470, NYSE Rules 123 and 132B, NYSE Amex Equities Rule 123 and 132B, and supra Sections I.C. and I.D. See also CHX Article II, Rule 3; Nasdaq Rules 6950 to 6958; and BX Rules 6950 to 6958. 139 15 U.S.C. 78q(a). 140 See, e.g., NSX Rules 4.1 and 4.2, NYSE Arca Equities Rule 9.17, and BATS Rule 4.1. 141 17 CFR 240.17a-3. 142 Rule 17a-3(a)(6)(i) under the Exchange Act requires that a member keep a memorandum of each brokerage order given or received for the purchase or sale of securities, whether executed or not, showing the terms and conditions of the order and any modification or cancellation thereof; the account for which it was entered; the time the order was received; the time of entry; the execution price; the identity of each associated person, if any, responsible for the account; the identity of any other person who entered or accepted the order on behalf of the customer, or, if a customer entered the order on an electronic system, a notation of that entry; and, to the extent feasible, the time of execution or cancellation. See 17 CFR 240.17a-3(a)(6)(i). 143 See supra Sections I.C. and I.D. See also supra the discussion in the introduction to Section II relating to the Commission's consideration of whether “retrofitting” existing SRO audit trail rules and systems would achieve the goals of the proposed consolidated audit trail. While there is no current requirement that all SROs record the same information for orders and executions in the same or different securities, each SRO has a statutory obligation to regulate its market and its members. The Commission is concerned that the lack of uniformity as to the type of audit trail information gathered by the different exchanges and FINRA, and the lack of compatibility in the format of each SRO's audit trail data, may hinder the ability of SRO and Commission staff to effectively and efficiently monitor for, detect, and deter illegal trading that occurs across markets. If a market participant is engaging in manipulative behavior across various markets, but the rules of one market do not require its members to provide detailed information regarding the orders sent to its market, it may be difficult for regulators to determine that trading activity on one market was related to trading activity on another market. For example, Section 9 of the Exchange Act expressly prohibits “wash sales.” 144 A trader could attempt to disguise such trading by executing various legs of wash transactions on different markets. Individual market surveillance based on individual SRO audit trail data would not always be able to detect this kind of cross-market abuse. 144 See Section 9(a)(1) of the Exchange Act, 15 U.S.C. 78i(a)(1). Wash sales are transactions involving no change in beneficial ownership. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 205 n. 25 (1976). Further, while current order audit trail rules provide a framework for capturing order information, the Commission is concerned that certain information about orders and executions that would be useful to efficient and effective regulation of inter-market trading activity and prevention of manipulative practices is not captured by existing audit trails. Most importantly, the existing audit trails do not require members to provide information identifying the customer submitting an order, the person with investment discretion for the order, or the beneficial owner. The identity of this “ultimate customer,” however, often is necessary to tie together potential manipulative activity that occurs across markets and through multiple accounts at various broker-dealers. While the Commission notes that exchange and FINRA regulatory staff, as well as Commission staff, eventually can obtain identifying customer or beneficial account information by submitting requests for information through ISG or to various broker-dealers involved in potentially wrongful activities, this process can result in significant delays in investigating market anomalies or potentially manipulative behavior. The Commission preliminarily believes that gaps such as this in required audit trail information may hinder the ability of regulatory authorities to enforce compliance with SRO rules and the federal securities laws, rules, and regulations in a timely manner. In addition, an exchange's audit trail information effectively ends when an order is routed to another exchange. For example, although the NYSE's OTS rule requires a NYSE member or member organization to record the fact that an order was transmitted to a non-member, the rules do not require the recording of what subsequently happens to the order. 145 Likewise, FINRA's OATS data collection effectively ends if an order is routed from a member of FINRA to an exchange. 146 As a result, key pieces of information about the life of an order may not be captured, or easily tracked, if an order is routed from one exchange to another, or from one broker-dealer to an exchange. For example, the name, or identifier, of a broker-dealer that initially received an order may be captured by the audit trail of the exchange of which that broker-dealer is a member when the broker-dealer sends the order to the exchange. However, if the order is routed to and executed on a second exchange, the identifying information for that initial broker-dealer may not be captured by the second exchange's audit trail requirements. 145 See NYSE Rule 132B(c)(3). 146 See FINRA Rule 7440(c)(6). The Commission understands that FINRA is able to link OATS order information to Nasdaq order and execution data. Similarly, under current audit trail rules, an incoming order may be assigned an order identifier by the initial receiving exchange; however, if the order is routed to a second exchange, there is no requirement that this order identifier be passed along to or maintained by the second exchange. Thus, one order that is routed across markets can have multiple order identifiers, each unique to one exchange. The Commission preliminarily believes that, from a regulatory standpoint, the lack of standardized cross-market order identifiers can pose significant obstacles and delays in effectively detecting and deterring manipulative behavior because SRO and Commission staff cannot readily collect the necessary data (that is, they cannot readily piece together activity related to the same order or the same customer occurring across several markets) to determine whether violative behavior has occurred. Additionally, the Commission is concerned that the data generated by the EBS system or that is available through the equity cleared reports also lacks items of information needed to match up order and trade information across markets to fully understand a particular trading pattern or to reconstruct a certain type of trading activity. EBS data does not include the time of execution, and often does not include the identity of the beneficial owner. 147 The equity cleared data also lacks the time of execution, as well as time of order receipt, often the identity of the beneficial owner, the identity of the broker-dealer(s) that received and/or executed the order (if different from the clearing broker-dealer), and short sale borrow and fails information. In order to obtain the time an order was received or the identity of the beneficial owner, therefore, SRO or Commission staff may take the additional step of submitting an electronically generated blue sheet request to the clearing broker-dealer identified in the equity cleared report to ask that broker-dealer to identify the beneficial ownership of the account(s) effecting the relevant transactions and/or the introducing broker, 148 and this may take a few steps if the clearing broker-dealer does not know the introducing broker, but only the executing broker (if different). If the beneficial ownership of the account(s) was not specified in the clearing broker-dealer's response, the staff could then ask the introducing broker-dealer for the time an order was received and the beneficial account holder information. Often, additional steps are required to identify the beneficial account holder, such as when the “customer” is an omnibus account. Furthermore, the equity cleared data could be duplicative. For example, one side of a trade can appear multiple times in the equity cleared reports because it may be reported by a specialist, a clearing broker-dealer, and the broker-dealer holding the customer's allocation account and the customer's trading account. 147 If a customer has an account directly with a clearing firm, or if an introducing firm clears its customers' transactions on a fully disclosed basis with the clearing firm, the clearing firm should be able to identify the beneficial owner of the account on its EBS response. 148 For purposes of this discussion, introducing broker means the broker-dealer that received or originated the order, and that is not also the clearing broker. The lack of cohesive, readily available order and execution information creates significant hurdles for investigators at both the SROs and at the Commission. In order for SROs to investigate potential violations of their rules and the federal securities laws and rules by their members, the SROs should have the ability to analyze the activities of their members taking place across different market centers. This requires the accumulation and interpretation of data from numerous, disparate sources sometimes presenting inconsistent information. Similarly, the experience of the Commission staff shows that the lack of a consolidated audit trail results in the investment of significant resources to investigate potential market abuses. For example, when investigating potential insider trading and other market manipulations, Commission staff first obtains an equity cleared report to identify the clearing broker-dealers for trades involving the stock under investigation and the trading volume for a particular period of time. Then staff sends document requests to those clearing broker-dealers to identify the broker-dealers that executed trades in the stock over that period of time. This process can be complicated further by potential market manipulators that trade through small introducing brokers or use offshore corporate accounts and prime brokerage or other arrangements to conduct transactions. Commission staff also may request trade data for additional time periods identified during the course of the investigation, resulting in further delays. Commission staff thus often must make multiple requests to broker-dealers to obtain sufficient order information about the purchase or sale of a specific security to be able to adequately analyze trading. These multiple requests and responses can take a significant amount of time and delay the Commission's efforts to analyze the data on an expedited basis. 149 While the investigative protocols of each SRO may differ from those used by the Commission, in each case, collecting, interpreting and analyzing diverse data sources is labor intensive and time consuming. 149 Rule 17a-25 (as well as the SRO EBS rules) does not specify a definitive deadline by which such information must be furnished to the Commission and, in the Commission's experience, data collected through the EBS system often is subject to lengthy delays, particularly with respect to files involving a large number of transactions over an extended period of time. The Commission is concerned that inadequacies in the current audit trail rules, EBS system, and equity cleared reports also impede the ability of SRO or Commission staff to promptly analyze trading patterns, particularly to prepare market reconstructions. For example, if Commission staff wants to undertake an analysis of an extreme market movement over a limited period of time, Commission staff would need to analyze audit trail information and EBS submissions of trading data to determine if specific trading strategies, techniques or participants appeared to be associated with the movement. Because of difficulties in linking trades in the audit trails with aggregate day-end trading data in EBS submissions, conducting this analysis is difficult and time-consuming. While the audit trail data could identify the precise execution times of trades by particular clearing broker-dealers, it would not identify the specific customers or beneficial owners involved in the trades. On the other hand, while EBS submissions provide summary trading information for particular accounts at the clearing broker-dealers, they lack execution times for these trades. Further complications can arise due to the common practice for large traders to route their orders through multiple accounts at multiple clearing firms, as well as practices at some firms that use “average price accounts” to effect trades that are eventually settled in multiple proprietary and/or customer accounts. While these practices are not, in themselves, improper, their use makes it more challenging to establish with certainty when trading on behalf of a particular trader was effected during the trading session. The Commission preliminarily believes that the proposed consolidated audit trail would help alleviate the difficulties faced by Commission staff in performing market reconstructions, such as those described in the above example, by requiring that national securities exchanges, national securities associations, and their members provide order and execution data to one central location, largely on a real time basis, in a uniform electronic format. Having this information readily available in a central location would reduce the need for staff to request and collect such information from multiple broker-dealers and then examine, analyze and reconcile the disparate information provided to accurately “reconstruct” the market. 150 150 As discussed, the Commission preliminarily believes that the proposal would improve the ability of regulators to conduct timely and accurate trading analyses for market reconstructions and complex investigations, as well as inspections and examinations. Indeed, the Commission believes that the proposed consolidated audit trail, if implemented, would have significantly enhanced the Commission's ability to quickly reconstruct and analyze the severe market disruption that occurred on May 6, 2010. If approved and implemented, the proposal also would enhance the Commission's ability to similarly respond to future severe market events. B. Books and Records Requirements Because brokers-dealers often are members of several exchanges and FINRA, they are subject to and must comply with the differing audit trail rules. Brokers and dealers also have a statutory obligation to maintain records in compliance with Commission and SRO rules. 151 As a result of the differing audit trail rules, brokers and dealers may be required to keep records to comply with each audit trail rule relating to trading in a certain security. Thus, some broker-dealers may now face significant costs to comply with varying audit trail rules. 152 151 See Section 17(a)(1) of the Exchange Act, 15 U.S.C. 78q(a)(1), and Rules 17a-3 and 17a-4 under the Exchange Act, 17 CFR 240.17a-3 and 17a-4. 152 See Goldman Sachs and Spear, Leeds & Kellogg Comment Letter, supra note 99, at 3, and SIA Comment Letter, supra note 99, at 3 (each commenting on the Nasdaq Petition and Intermarket Trading Concept Release). C. Time Lags Current audit trail rules require that an SRO's members submit order and execution information by the end of each business day (in the case of OATS), or in certain cases, upon request by the regulating entity (for instance, like OTS). 153 End-of-day or upon request reporting, by definition, limits regulators' ability to carry out real time cross-market surveillance and investigations of market anomalies. The Commission preliminarily believes that end-of-day reporting, coupled with the current laborious process of identifying the ultimate customer responsible for a particular securities transaction that may take several days, weeks or even months, can impact effective oversight by hindering the ability of SRO regulatory staff to identify manipulative activity close in time to when it is occurring, and respond to instances of potential manipulation quickly. This process also hinders the Commission's ability to detect and investigate potentially manipulative behavior. Manipulative activity by some market participants can result in other market participants, such as retail investors, losing money. The longer that manipulative behavior goes undetected over time, the greater the potential harm to investors. Further, timely pursuit of potential violations can be important in seeking to freeze and recover any profits received from illegal activity. 153 See supra Sections I.C. and I.D. D. Access to Audit Trail Information While each SRO has direct access to audit trail information received from its members, as well as its own data relating to orders received and executed on its market, one SRO cannot directly or easily access the audit trail information collected by other SROs, despite the interconnectedness of today's securities markets and the fact that orders are often routed from one marketplace to another marketplace for execution. In addition, Commission staff itself does not have immediate access to the exchanges' and FINRA's audit trail information, and instead must specifically request that an exchange or FINRA produce its audit trail information. 154 154 The different data fields and unique formats of each SRO audit trail present difficulties for Commission examinations and investigations, where time constraints can make it impractical to manually consolidate diverse data sets. The Commission notes that ISG provides a framework for the voluntary sharing of information and coordination of regulatory efforts among the exchanges and FINRA to address potential intermarket manipulations and trading abuses. The Commission believes that ISG plays an important role in information sharing among markets that trade the same securities, as well as related securities or futures on the same products. 155 However, the information provided to ISG, which is drawn from each individual exchange's audit trail and books and records, is not in any uniform or comparable format. In addition, information is only submitted to ISG upon a request by one of its members, and the information is not provided by ISG members in real time. Further, the operation of ISG is not subject to the Commission's oversight, including approval of what, and how, information is collected from and shared across SROs. The Commission preliminarily believes that it is now appropriate to mandate a structure whereby the regulatory staff of all exchanges and FINRA, as well as the Commission, can directly access comprehensive uniform cross-market order and execution information in real time pursuant to Commission rule, rather than through an information-sharing cooperative governed only by contract. 155 See supra note 96. E. Scalability of the EBS System and Rule 17a-25 Although the EBS system and Rule 17a-25 can be used to obtain information in conjunction with the SRO audit trail information, the Commission is concerned with the ability of the EBS system, as enhanced by Rule 17a-25, to keep pace with changes in the securities markets over recent years. Various changes in market dynamics have affected the utility of the EBS system and Rule 17a-25. For example, decimal trading has increased the number of price points for securities, and the volume of quotations and orders has correspondingly dramatically increased. Thus, the volume of transaction data subject to reporting under the EBS system can be significantly greater than the EBS system was intended to accommodate in a typical request for data. As a request-based system that is most useful when targeting trading in a specific security for a specific time, the EBS system is not well-suited as a broad-based tool to detect illegal or manipulative activity. The increased use of sponsored access (or other indirect access to an exchange) also has made it more difficult to use the EBS system and Rule 17a-25 to identify the ultimate customer that originates an order because the member broker-dealer through whom an order is sent to an exchange may not know the identity of the underlying customer. 156 156 Indirect access is when a non-member of an exchange accesses an exchange through a member. For example, to comply with regulatory obligations such as Rule 611 of Regulation NMS (17 CFR 242.611), exchanges increasingly rely on indirect access to other exchanges through member broker-dealers of the other exchanges, so called “private linkage” access. Sponsored access is one type of indirect access and is governed by exchange rules. See, e.g., Nasdaq Rule 4611(d). The Commission recently proposed rules that would address sponsored access to exchanges. See Securities Exchange Act Release No. 61379 (January 26, 2010), 75 FR 4713 (January 29, 2010). In addition, the increasing number of alternative trading venues creates more opportunities for orders to be routed to other markets and thus can result in delays in producing EBS data as requests must be made to several broker-dealers in the “chain” of an order. Finally, the increased trading of derivative instruments and products also has affected the ongoing effectiveness of the EBS system and Rule 17a-25. A market participant can use derivative instruments and products as a substitute for trading in a particular equity, and likewise engage in illegal trading activity in derivative instruments and products. However, because information related to some derivative instruments over which the Commission has anti-fraud authority (such as security-based swaps) is not included within the EBS data or provided pursuant to Rule 17a-25, the EBS system and Rule 17a-25 are not effective tools for ascertaining activity in those markets or how that activity may be affecting the underlying equity market. 157 157 See infra Section III.A for a discussion of the scope of products to be covered by the proposed Rule and the intent to expand the scope to cover other products and transactions. In the Commission staff's experience, the EBS is most effective when investigating or analyzing trading in a small sample of securities over a limited period of time. But even under those circumstances, Commission staff often must make multiple requests to broker-dealers to obtain sufficient order information about the purchase or sale of a specific security to be able to adequately analyze the suspect trading. These multiple requests and responses can take a significant amount of time. The Commission preliminarily believes that the EBS system may no longer be able to fully support the regulatory challenges currently facing SRO and Commission regulatory staff. The consolidated audit trail that the Commission is proposing today would provide significant improvements in the order and execution information available to SRO and Commission staff in several discrete ways. Among other things, the proposed audit trail would require that national securities exchanges and national securities associations and their members submit uniform order and execution information to a central repository on a real time basis, where possible. National securities exchanges and associations, and their member firms, would be required to identify the person with investment discretion for the order, and beneficial account holder, if different, along with other key information about the customer or proprietary desk that placed or originated the order. The proposed consolidated audit trail also would cover any action taken with respect to the order through execution, or cancellation, as applicable, and thus would allow regulators to more easily trace the order from inception to cancellation or execution. 158 158 The proposed Rule also would require the reporting of certain post-trade information. See infra Section III.D.2. The Commission preliminarily believes that the proposed audit trail information would greatly enhance the ability of SRO staff to effectively monitor and surveil the securities markets on a real time basis, and thus to detect and investigate illegal activity in a more timely fashion, whether on one market or across markets. The Commission also preliminarily believes that the proposal would improve the ability of Commission and SRO staff to conduct more timely and accurate trading analysis, as well as to conduct more timely and accurate market reconstructions, complex enforcement inquiries or investigations, and inspections and examinations of regulated entities and SROs. III. Description of Proposed Rule To help address the deficiencies described above, the Commission is proposing to adopt a rule that would require national securities exchanges 159 and national securities associations 160 to create and implement a consolidated audit trail that captures customer and order event information, in real time, for all orders in NMS securities, across all markets, from the time of order inception through routing, cancellation, modification, or execution. 159 National securities exchange is defined in Rule 600(a)(45) of Regulation NMS as any exchange registered pursuant to Section 6 of the Exchange Act (15 U.S.C. 78f). 17 CFR 242.600(a)(45). 160 National securities association is defined in Rule 600(a)(44) of Regulation NMS as any association of brokers and dealers registered pursuant to Section 15A of the Exchange Act (15 U.S.C. 78o-3). 17 CFR 242.600(a)(44). As noted above, see supra note 12, FINRA currently is the only national securities association to which the proposal would apply, as the NFA is restricted to regulating its members who are registered as broker-dealers in security futures products due to its limited purpose registration with the Commission under Section 15A(k) of the Exchange Act, 15 U.S.C. 78o-3(k). The NFA could, of course, seek to expand its current registration. Thus, for ease of reference, this proposal refers to FINRA but the proposed requirements would apply to any national securities association registered with the Commission. If adopted, the proposed Rule would require each national securities exchange and national securities association to file jointly with the Commission on or before 90 days from approval of this proposed Rule an NMS plan to govern the creation, implementation, and maintenance of a consolidated audit trail and a central repository. 161 The NMS plan would be required to be filed with the Commission pursuant to, and subject to the requirements of, Rule 608 of Regulation NMS. 162 As such, the proposed NMS plan would be published in the Federal Register and subject to public notice and comment in accordance with Rule 608(b). Further, the NMS plan filed pursuant to the proposed Rule, or any amendment to such a plan, would not become effective unless approved by the Commission or otherwise permitted in accordance with Rule 608. 163 161 See infra Section III.F. for a discussion of the central repository. The proposed Rule would explicitly require each national securities exchange and national securities association to be a sponsor of the NMS plan submitted pursuant to the Rule and approved by the Commission. See proposed Rule 613(a)(4). 162 17 CFR 242.608. See proposed Rule 613(a)(2). 163 See proposed Rule 613(a)(5) and 17 CFR 242.608. The Commission would expect the exchanges and FINRA to cooperate with each other and to take joint action as necessary to develop, file, and ultimately implement a single NMS plan to fulfill this requirement. The Commission requests comment on this approach. Specifically, the Commission requests comment on whether requiring the exchanges and associations to act jointly by filing an NMS plan that would contain the requirements for a consolidated audit trail is the most effective and efficient way to achieve the objectives of a consolidated audit trail. Or, should the Commission require the exchanges and associations to standardize or otherwise enhance their existing rules? What approach would be most efficient in improving the ability to monitor cross-market trading, or undertake market analysis or reconstructions, and why? As discussed in further detail below, the proposed Rule would require that the NMS plan include provisions regarding: (1) The operation and administration of the NMS plan; (2) the creation and oversight of a central repository; (3) the data required to be provided by SROs and their members to the central repository; (4) clock synchronization; (5) compliance by national securities exchanges, FINRA, and their members with the proposed Rule and the NMS plan; and (6) the possible expansion of the NMS plan to products other than NMS securities. The proposed Rule is designed to allow the national securities exchanges and national securities associations to develop the details of the NMS plan that they believe should govern the creation, implementation and maintenance of the central repository and consolidated audit trail, within the parameters set forth in the proposed Rule. The Commission believes that the national securities exchanges and national securities associations working jointly are in the best position to propose for themselves and their members the specifics of how the consolidated audit trail should be structured and administered. To this end, the proposed Rule contains a broad framework within which the exchanges and associations would provide the details that they believe would result in a functional, cooperative mechanism to create and maintain a consolidated audit trail, as well as certain explicit requirements the NMS plan must meet. As noted above, the proposed NMS plan developed by the exchanges and FINRA would be subject to public comment and approval by the Commission. A. Products and Transactions Covered Proposed Rule 613 would apply to secondary market transactions in all NMS securities, which means NMS stocks and listed options. 164 The Commission ultimately intends for the consolidated audit trail to cover secondary market transactions in other securities, including equity securities 165 that are not NMS securities, corporate bonds, municipal bonds, and asset-backed securities and other debt instruments; 166 credit default swaps, equity swaps, and other security-based swaps; and any other products that may come under the Commission's jurisdiction in the future. Further, the Commission preliminarily believes that it would be beneficial to provide for the possible expansion of the consolidated audit trail to include information on primary market transactions in NMS stocks and other equity securities that are not NMS stocks, as well as primary market transactions in debt securities. 167 Such information could be used to monitor for violations of certain rules under the Exchange Act, such as Regulation M and Rule 10b-5 under the Exchange Act. 168 Further, FINRA's transaction reporting requirements for debt securities already cover primary market transactions in debt securities, 169 and thus FINRA members should already be recording information relating to such transactions that could be included in an audit trail. The Commission proposes that the scope of the Rule initially be limited to secondary market transactions in NMS securities, however, to allow for a manageable implementation of the proposed consolidated audit trail, and because market participants already have experience with audit trails for these types of transactions in these securities. 164 NMS security is defined in Rule 600(a)(46) of Regulation NMS to mean any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options. 17 CFR 242.600(a)(46). NMS stock is defined in Rule 600(47) to mean any NMS security other than an option. 17 CFR 242.600(a)(46). A listed option is defined in Rule 600(a)(35) of Regulation NMS to mean any option traded on a registered national securities exchange or automated facility of a national securities association. 17 CFR 242.600(a)(35). 165 Equity security is defined in Section 3(a)(11) of the Exchange Act to include any stock or similar security; or any security future on any such security; or any security convertible, with or without consideration, into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any other security which the Commission shall deem to be of similar nature and consider necessary or appropriate, by such rules and regulations as it may prescribe in the public interest or for the protection of investors, to treat as an equity security. See 15 U.S.C. 78c(a)(11). Rule 3a11-1 under the Exchange Act defines equity security to include any stock or similar security, certificate of interest or participation in any profit sharing agreement, preorganization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, limited partnership interest, interest in a joint venture, or certificate of interest in a business trust; any security future on any such security; or any security convertible, with or without consideration into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any put, call, straddle, or other option or privilege of buying such a security from or selling such a security to another without being bound to do so. See 17 CFR 240.3a11-1. 166 Asset-backed security means a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases. See 17 CFR 229.1101(c)(1). 167 A primary market transaction is any transaction other than a secondary market transaction and refers to any transaction where a person purchases securities in an offering. See, e.g., FINRA Rule 6710 (defining two types of primary market transactions for TRACE-eligible securities, a List or Fixed Offering Price Transaction or a Takedown Transaction). 168 See 17 CFR 242.100 et. seq. and 17 CFR 240.10b-5. Rule 105 prohibits the short selling of equity securities that are the subject of a public offering for cash and the subsequent purchase of the offered securities from an underwriter or broker or dealer participating in the offering if the short sale was effected during a period that is the shorter of the following: (i) Beginning five business days before the pricing of the offered securities and ending with such pricing; or (ii) beginning with the initial filing of such registration statement or notification on Form 1-A or Form 1-E and ending with the pricing. Thus, Rule 105 prohibits any person from selling short an equity security immediately prior to an offering and purchasing the security by participating in the offering. The primary market transaction data would allow for the ability to more quickly identify whether any participant in the offering sold short prior to the offering. Rule 10b-5 prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security. The primary market transaction data for bonds would allow for identification of the cost basis for bond purchases by intermediaries and make it easier to assess whether subsequent mark-ups to retail investors in primary offerings are fair and reasonable and, if not, whether there has been a violation of the antifraud provisions of the federal securities laws. 169 See FINRA Rule 6730(a)(5). As discussed above, the Commission believes that implementing a consolidated audit trail for NMS securities would aid the SROs in more effectively and efficiently carrying out their regulatory responsibilities. It would also assist the Commission in carrying out its statutory responsibilities. The Commission further preliminarily believes that a timely expansion of the scope of the consolidated audit trail beyond NMS securities would be beneficial, as illegal trading strategies that the consolidated audit trail would be designed to help detect and deter, such as insider trading, may involve trading in multiple related products other than NMS securities across multiple markets. For example, the Commission routinely receives information relating to possible upward manipulation of security prices in violation of Sections 9(a) and 10(b) of the Exchange Act, 170 and alleged abusive short selling in the over-the-counter market, which includes FINRA's Bulletin Board and Pink Sheets. If the consolidated audit trail were expanded to cover these securities, it would be possible for SROs and the Commission to make comparisons between current and historical data in a more timely manner than is currently possible, to more quickly determine whether or not a complaint merits additional attention and the corresponding commitment of enforcement resources. Similarly, to the extent that instruments currently not considered NMS securities can be substitutes for long or short positions in NMS securities, having access to an audit trail that documents trading activity in such securities would improve the Commission's ability to make a risk assessment as to information it has received about possibly manipulative activity. 171 Having ready access to this information in an audit trail also would improve the Commission's inspection process because it would enhance risk assessment and allow for better selection as to which broker-dealers to examine. For example, the information would allow for better trend analysis and outlier identification. It also would improve pre-examination work and the asset verification process, 172 and focus document requests, making the examination process more efficient for the Commission staff and the registrants subject to the process. 170 15 U.S.C. 78i(a) and 78j(b). 171 The Commission's Division of Enforcement has recently established an Office of Market Intelligence. This Office, among other things, conducts intake and triage of investor and industry referrals that are received by the Commission each year. Currently, a thorough review of referrals requires extensive resource allocation as the primary source for evaluating trading data in the EBS system. Expansion of the consolidated audit trail to non-NMS securities would allow that Office to evaluate the merits of each referral faster and more effectively, and more efficiently allocate enforcement resources to appropriate cases. 172 Asset verification is an exam process that attempts to locate independent information to verify certain customer positions, transactions, and balances at broker-dealers. To help ensure that such an expansion would occur in a reasonable time and that the systems and technology that would be used to implement the Rule as proposed are designed to be easily scalable, proposed Rule 613(i) would require that the NMS plan contain a provision requiring each national securities exchange and national securities association that is a sponsor of the plan 173 to jointly provide the Commission a document outlining how the sponsors could incorporate into the consolidated audit trail information with respect to: (1) Equity securities that are not NMS securities; (2) debt securities, including asset-backed securities; and (3) primary market transactions in NMS stocks, equity securities that are not NMS securities, and debt securities. The sponsors specifically would be required to address, among other things, details for each order and reportable event that they would recommend requiring to be provided; which market participants would be required to provide the data; an implementation timeline; and a cost estimate. 173 Sponsor, when used with respect to an NMS plan, is defined in Rule 600(a)(70) of Regulation NMS to mean any self-regulatory organization which is a signatory to such plan and has agreed to act in accordance with the terms of the plan. See 17 CFR 242.600(a)(70). The Commission requests comment on the proposed scope of products to be covered by the consolidated audit trail. Should the consolidated audit trail initially cover securities other than NMS securities? Why or why not? The Commission also requests comment on whether the approach to expand the consolidated audit trail to include the products and transactions specified above represents an appropriate expansion of the consolidated audit trail, and what additional capital commitment would be required by the various market participants to implement such an expansion. Please be specific in your response with respect to different products or transactions ( e.g. security-based swaps, or primary market transactions in NMS stocks). Are there other securities or products that should be identified and included in a future expansion? What would be the challenges to any expansion to the products and transactions listed above? Are there any other actions that the Commission or SROs would need to take to be able to expand the audit trail to certain products or transactions? Should the Commission consider expansion to certain products or transactions before others? The Commission also requests comment on an appropriate and realistic time frame for including these other products and transactions in the c [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2010-13129. Public record. Not legal advice.