# Consolidated Audit Trail

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2012-17918

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** August 1, 2012
- **Citation:** 77 FR 45722

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-67457; File No. S7-11-10]
RIN 3235-AK51
Consolidated Audit Trail

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (“Commission”) is adopting Rule 613 under the Securities Exchange Act of 1934 (“Exchange Act” or “Act”) to require national securities exchanges and national securities associations (“self-regulatory organizations” or “SROs”) to submit a national market system (“NMS”) plan to create, implement, and maintain a consolidated order tracking system, or consolidated audit trail, with respect to the trading of NMS securities, that would capture customer and order event information for orders in NMS securities, across all markets, from the time of order inception through routing, cancellation, modification, or execution.

DATES:

Effective Date:
October 1, 2012.

FOR FURTHER INFORMATION CONTACT:

Rebekah Liu, Special Counsel, at (202) 551-5665; Jennifer Colihan, Special Counsel, at (202) 551-5642; Carl Tugberk, Special Counsel, at (202) 551-6049; or Leigh Duffy, Special Counsel, 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. Executive Summary

II. Introduction

A. Need for, and Objectives of, a Consolidated Audit Trail

1. Use and Limitations of Current Sources of Trading Data

2. Regulatory Improvements With a Consolidated Audit Trail

3. Large Trader Reporting System Rule

B. Summary of Proposed Rule 613

C. Summary of General Comments on the Proposed Rule

1. Industry Support for a Consolidated Audit Trail

2. Commenters' Views on the Overall Costs of the Proposed Rule and the Resulting Framework of the Adopted Rule

3. Comments on the Process for Creating a Consolidated Audit Trail

4. Comments on Alternatives to the Proposed Consolidated Audit Trail

III. Discussion

A. NMS Plan

1. Description of the Rule

B. Elements of the NMS Plan

1. Recording and Reporting

2. Central Repository

3. Other Required Provisions of the NMS Plan

C. NMS Plan Process

1. Comments on the NMS Plan Process

2. Adopted Rule

3. NMS Plan Costs

4. Consideration of Burden on Competition and Promotion of Efficiency, Competition, and Capital Formation

D. Implementation of Rule 613 After Approval of the NMS Plan

IV. Paperwork Reduction Act

A. Summary of Collection of Information Under Rule 613

B. Use of Information

C. Respondents

D. Total Annual Reporting and Recordkeeping Burden for the Creation and Filing of the NMS Plan

1. Preliminary Burden Hour Estimates From Proposing Release

2. Revised Burden Hour Estimates

E. Collection of Information Is Mandatory

F. Confidentiality

G. Retention Period of Recordkeeping Requirements

V. Regulatory Flexibility Act Certification

VI. Statutory Authority

I. Executive Summary

In today's high-speed electronic markets, trading is widely dispersed across a variety of market centers, including exchanges, Alternative Trading Systems (“ATSs”), such as dark pools and Electronic Communication Networks (“ECNs”), and over-the-counter broker-dealers acting as market makers or block positioners. In their capacity as SROs, the Financial Industry Regulatory Authority (“FINRA”) and some of the exchanges currently maintain their own separate audit trail systems for certain segments of this trading activity, which vary in scope, required data elements and format. In performing their market oversight responsibilities, SRO and Commission staffs today must rely heavily on data from these various SRO audit trails.

As discussed more fully in part II.A below, there are shortcomings in the completeness, accuracy, accessibility, and timeliness of these existing audit trail systems. Some of these shortcomings are a result of the disparate nature of the systems, which make it impractical, for example, to follow orders through their entire lifecycle as they may be routed, aggregated, re-routed, and disaggregated across multiple markets. The lack of key information in the audit trails that would be useful for regulatory oversight, such as the identity of the customers who originate orders, or even the fact that two sets of orders may have been originated by the same customer, is another shortcoming.

Though SRO and Commission staff also have access to sources of market activity data other than SRO audit trails, these systems each suffer their own drawbacks. For example, data obtained from the Electronic Blue Sheet (“EBS”)
1

system and equity cleared reports
2

comprise only trade executions, and not orders or quotes. In addition, like data from existing audit trails, data from these sources lacks key elements important to regulators, such as the time of execution, and, in the case of equity cleared reports, the identity of the customer. Furthermore, recent experience with implementing incremental improvements to the EBS system has illustrated some of the

overall limitations of the current technologies and mechanisms used by the industry to collect, record, and make available market activity data for regulatory purposes.
3

1
EBSs 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.
See
Securities Exchange Act Release No. 44494 (June 29, 2001), 66 FR 35836 (July 9, 2001) (File No. S7-12-00) (adopting Rule 17a-25).
See also
Securities Exchange Act Release Nos. 26235 (November 1, 1988), 53 FR 44688 (November 4, 1988) (approving the Chicago Board Options Exchange's (“CBOE”) rule for the electronic submission of transaction information); 26539 (February 13, 1989), 54 FR 7318 (February 17, 1989) (approving the National Association of Securities Dealers' (n/k/a FINRA) 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 (n/k/a NASDAQ OMX PHLX LLC) (“Phlx”) rule for the electronic submission of transaction information).

To partially address some of the current limitations of the EBS system, and to provide the Commission, in the short term, with more detailed and timely trade information for large traders, the Commission recently adopted new Rule 13h-1 concerning large trader reporting.
See
Securities Exchange Act Release No. 61908 (July 27, 2011), 76 FR 46960 (August 3, 2011) (“Large Trader Release”). Rule 13h-1 requires “large traders” to identify themselves to the Commission and make certain disclosures to the Commission on Form 13H. As adopted, Rule 13h-1 requires certain broker-dealers to capture and report through EBS the time of execution for any trade involving a large trader and a Commission-issued large trader identifier that identifies the large trader.
See also
Section II.A.3.,
infra.

On April 20, 2012, the Commission, among other things, extended the time by which registered broker-dealers were required to comply with Rule 13h-1 to allow broker-dealers additional time to develop, test, and implement enhancements to their recordkeeping and reporting systems as required under Rule 13h-1.
See
Securities Exchange Act Release No. 66839, 77 FR 25007 (April 26, 2012) (Order Temporarily Exempting Broker-Dealers From the Recordkeeping, Reporting, and Monitoring Requirements of Rule 13h-1 Under the Securities Exchange Act of 1934 and Granting an Exemption for Certain Securities Transactions) (“Large Trader Extension”).

2
The Commission uses the National Securities Clearing Corporation's (“NSCC”) equity cleared report for initial regulatory inquiries. 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.

3

See
Large Trader Extension,
supra
note 1.

The Commission therefore believes that the regulatory data infrastructure on which the SROs and the Commission currently must rely generally is outdated and inadequate to effectively oversee a complex, dispersed, and highly automated national market system. In performing their oversight responsibilities, regulators today must attempt to cobble together disparate data from a variety of existing information systems lacking in completeness, accuracy, accessibility, and/or timeliness—a model that neither supports the efficient aggregation of data from multiple trading venues nor yields the type of complete and accurate market activity data needed for robust market oversight.

To address this problem and improve the ability of the SROs and the Commission to oversee the securities markets, on May 26, 2010, the Commission proposed Rule 613,
4

with the goal of creating a comprehensive consolidated audit trail
5

that allows regulators to efficiently and accurately track all activity in NMS securities throughout the U.S. markets. As proposed—and summarized in part II.B below—Rule 613 required SROs to jointly submit an NMS plan
6

that would govern the creation, implementation, and maintenance of a consolidated audit trail, including a central repository to receive and store consolidated audit trail data. In the proposed Rule, the Commission specified many requirements that the NMS plan, and by extension the consolidated audit trail, must meet, ranging from details of the data elements to be collected, to the timing of data transmissions, to specific standards for data formatting.

4

See
Securities Exchange Act Release No. 62174 (May 26, 2010), 75 FR 32556 (June 8, 2010) (“Proposing Release”). The comment file is on the Commission's Web site at:
http://www.sec.gov/comments/s7-11-10/s71110.shtml.

5
In this release, “consolidated audit trail” means both a system capable of capturing a complete record of all transactions relating to an order, from origination to execution or cancellation, and the complete record for an order generated by such a system, as the context may require.

6
NMS plan is defined in Rule 600(b)(43) to mean “any joint self-regulatory organization plan in connection with: (i) [t]he planning, development, operation or regulation of a national market system (or a subsystem thereof) or one or more facilities thereof; or (ii) [t]he development and implementation of procedures and/or facilities designed to achieve compliance by self-regulatory organizations and their members with any section of [Regulation NMS] * * *.” 17 CFR 240.600(b)(43). Such NMS plan may be subject to modification prior to approval by the Commission pursuant to Rule 608 of Regulation NMS, as discussed in Section III.C.2.a.v.,
infra.

Among its various requirements, the proposed Rule mandated that the NMS plan developed by the SROs must in turn require each SRO and its members to capture and report specified trade, quote, and order activity in all NMS securities
7

to the central repository in real time, across all markets, from order inception through routing, cancellation, modification, and execution. The proposed Rule also mandated that the NMS plan require the creation of unique order identifiers to facilitate the ability of regulators to view cross-market activity, as well as unique customer identifiers to enhance the ability of regulators to reliably and efficiently identify the beneficial owner of the account originating an order or the person exercising investment discretion for the account originating the order, if different from the beneficial owner.

7
“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).

The Commission received 64 comment letters from 56 commenters in response to the proposed consolidated audit trail representing a wide range of viewpoints, as summarized in part II.C below.
8

The commenters included national securities exchanges, a national securities association, technology providers, academics, broker-dealers, organizations representing industry participants, individual investors, and members of Congress.
9

Of the comment letters received, 13 expressed support for the proposal;
10

36 expressed support, but suggested modifications to certain provisions of the proposal;
11

five solely suggested modifications to the proposal;
12

two opposed the proposal;
13

and seven neither supported nor opposed the substance of the proposal.
14

Concerns raised in these comment letters included: (1) The appropriateness of real-time reporting of required data to the central repository;
15

(2) the scope of the required data elements, including the use of unique order identifiers and unique customer identifiers;
16

and (3) the burden and costs associated with the proposal.
17

In addition, a number of commenters offered alternative approaches and made suggestions regarding the creation, implementation, and maintenance of the consolidated audit trail.
18

8

See
Exhibit A for a citation key to the comment letters received by the Commission on the proposed rule. The Commission also received four comment letters that do not address the substance of the consolidated audit trail proposal.
See
Ericson Letter; Kondracki Letter; Grady Letter; Deep Liquidity Letter.

9
The Commission notes that, in some cases, commenters fell into more than one such category.

10

See
Vannelli Letter; Beach Letter; Foothill Letter; Green Letter; Wealth Management Letter; McCrary Letter; Anastasopoulos Letter; Triage Letter; FTEN Letter; Middle Office Letter; Correlix Letter; Lettieri Letter; Bean Letter.

11

See
ICI Letter; Thomson Reuters Letter; Scottrade Letter; Liquidnet Letter; FINRA/NYSE Euronext Letter; BOX Letter; Nasdaq Letter I; Nasdaq Letter II; TIAA-CREF Letter; GETCO Letter; BATS Letter; SIFMA Letter; SIFMA February 2012 Letter; CBOE Letter; Direct Edge Letter; Angel Letter; IAG Letter; Managed Funds Association Letter; Mansfield Letter; Marketcore Letter; Kumaraguru Letter; Ameritrade Letter; FINRA Letter; Wells Fargo Letter; Noetic Partners Letters; Knight Letter; FIF Letter; FIF Letter II; Albany Letter; Endace Letter; Ross Letter; FINRA Proposal Letter; Schumer Letter; FIA Letter; STA Letter; Van Bokkelen Letter.

12

See
Belanger Letters; SIFMA Drop Copy Letter; Wachtel Letter; High Speed Letter (recommending next steps in the development of the consolidated audit trail).

13

See
BondMart Letter; Leuchtkafter Letter.

14

See
Broadridge Letter; FIX Letter; Know More Letter; Aditat Letter; iSys Letter; Kaufman Letter; Berkeley Letter.

15

See
Scottrade Letter, p. 1; ICI Letter, p. 4-6; FINRA/NYSE Euronext Letter, p. 4; GETCO Letter, p. 2; BATS Letter, p. 1-2; SIFMA Letter, p. 3-8; SIFMA February 2012 Letter, p. 1; CBOE Letter, p. 4-5; Direct Edge Letter, p. 3; FINRA Letter, p. 10-13; Wells Fargo Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter; Broadridge Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy Letter, p. 1; Ross Letter, p. 1; FINRA Proposal Letter, p. 3; FIA Letter, p. 1-2.

16

See
Ameritrade Letter, p. 3; Kumaraguru Letter, p. 1; FINRA Proposal Letter, p. 6-8, 13 and Appendix A.; Angel Letter, p. 2-3; Managed Funds Association Letter, p. 2; SIFMA Letter, p. 11-12, 14; SIFMA Drop Copy Letter, p. 2; Liquidnet Letter p. 6-7; FINRA Letter, p. 4, 7-9; CBOE Letter, p. 2; Knight Letter, p. 2; Scottrade Letter, p. 1; DirectEdge Letter, p. 3; FIF Letter, p. 2-3, 6-7; FIF Letter II, p. 2; BOX Letter, p. 2; Wells Fargo Letter, p. 3; Ross Letter, p. 1; ICI Letter, p. 3; Thomson Reuters Letter, p. 3; Endace Letter, p. 1-2; GETCO Letter, p. 4.

17

See
Thomson Reuters Letter, p. 2; Liquidnet Letter, p. 1; CBOE Letter, p. 2, 4-5; Nasdaq Letter I, p. 2; Angel Letter, p. 1-2; IAG Letter, p. 3.; Kaufman Letter, attachment p. 3; Wells Fargo Letter, p. 3-4; Noetic Partners Letter, p. 2; Leuchtkafer Letter, p. 1-5; Broadridge Letter, p. 3; FINRA Proposal Letter, p. 2-3.; High Speed Letter, p. 1; Belanger Letter, p. 7-8; Correlix Letter, p. 2.; FTEN Letter, p. 13; SIFMA Letter, p.1-8, 15-16; FINRA/NYSE Euronext Letter, p 4, 7; FINRA Letter, p. 3, 10-13; Scottrade Letter, p. 1; ICI Letter, p. 4-6; GETCO Letter, p. 2; BATS Letter, p. 1-2; Direct Edge Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter; Broadridge Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy Letter, p. 1; Ross Letter, p. 1; SIFMA February 2012 Letter; FIA Letter, p. 1-2; Noetic Partners Letter II, p. 2; High Speed Letter, p. 1.

18

See
FINRA Proposal Letter; Angel Letter, p. 3; BOX Letter, p. 2; BATS Letter, p. 2; CBOE Letter,

p. 2-3; SIFMA Letter, p. 16-18; Wells Fargo Letter, p. 2; Knight Letter, p. 3; FIF Letter, p. 5-6; Schumer Letter, p. 1; FIF Letter, p. 1-3; FINRA Letter, p. 3, 6; FINRA/NYSE Euronext Letter, p. 8, 14; SIFMA Drop Copy Letter.

In consideration of the views expressed, suggestions for alternatives, and other information provided by those commenting on the proposed Rule, the Commission is adopting Rule 613 with significant modifications to the proposed requirements for the NMS plan submitted to the Commission for its consideration. In certain instances these modifications alter the data and collection requirements of the proposed Rule. In other instances, the adopted Rule has been altered to be less prescriptive, and hence less limiting, in the means SROs may use to meet certain requirements. Some of the more significant changes are as follows:

•
Replacing Real-Time Reporting with a Requirement to Report Data by 8 a.m. of the Next Trading Day.
The adopted Rule no longer requires that the NMS plan provide for the reporting of order event data
19

to the central repository in real time; rather, it provides that the NMS plan must require the reporting of order event data to the central repository by 8 a.m. Eastern Time on the trading day following the day such information has been recorded by the SRO or the member.
20

The NMS plan may accommodate voluntary submissions of order event data prior to 8 a.m. on the following trading day, but it may not mandate a reporting deadline prior to 8 a.m.

19
As used herein, the term “order event data” is used to refer to the information reported pursuant to Rule 613(c)(3) and identified in Rule 613(c)(7)(i) through (v), generally including: (1) The Customer-ID(s) for each customer, including the person giving a modification or cancellation instruction; (2) the CAT-Order-ID; (3) the CAT-Reporter-ID of the broker-dealer, national securities exchange, or national securities association receiving, originating, routing, modifying, cancelling or executing an order, and to which an order is being routed; (4) the identity and nature of the department or desk to which an order is routed, if routed internally at the broker-dealer; (5) the date an order was received, originated, routed, modified, cancelled, or executed; (6) the time an order was received, originated, routed, modified, cancelled, or executed; (7) material terms of an order and any changes of such terms, if modified; (8) the price and remaining size of an order, if modified; (9) execution capacity (principal, agency, riskless principal); (10) execution price and size; and (11) whether the execution was reported pursuant to an effective transaction reporting plan or the Plan for Reporting of Consolidated Options Last Sale Reports and Quotation Information (“OPRA”).
See
Section III.B.1.d.,
infra.
Information reported pursuant to Rule 613(c)(4) and identified in Rule 613(c)(7)(vi) through (viii) is referred to as “supplemental data.”

20

See
Rule 613(c)(3); Sections II.A., III.B.1.e.,
infra.

•
Providing More Flexibility to Determine the Format of Data Reported to the Central Repository.
The proposed Rule mandated that the NMS plan require the SROs and their members to collect and provide to the central repository the required order and event information in a uniform electronic format. The adopted Rule instead allows the SROs to determine the details of how market participants would transmit data to the central repository (which might include multiple electronic formats, rather than a uniform electronic format), subject to a more general requirement that data must be transmitted in a manner that ultimately allows the central repository to make this data available to regulators in a uniform electronic format.
21

21

See
Rule 613(c)(2); Sections III.B.1.f., III.B.2.,
infra.

•
Eliminating the Requirement to Report Orders with a Unique Order Identifier.
The proposed Rule mandated that each order reported to the central repository be tagged with a unique identifier that is the same throughout the order's entire lifecycle. In the adopted Rule, this requirement is replaced with a more general requirement that once all order events are transmitted to the central repository, the repository must be able to efficiently and accurately link together all lifecycle events for the same order, and make available to regulators this linked order data.
22

22

See
Rule 613(j)(1); Section III.B.1.d.iv.,
infra.

•
Extending the Compliance Period for Small Broker-Dealers.
Under the adopted Rule, the NMS plan may provide that small broker-dealers be allowed up to three years, rather than two years as proposed, from the effectiveness of the NMS plan to provide the required data to the consolidated audit trail.
23

23

See
Rule 613(a)(3)(vi); Section III.B.1.c.,
infra.

In addition to the above modifications, the Commission has also added a number of new requirements to the adopted Rule in response to general concerns expressed by commenters regarding the process for the development and implementation of the NMS plan. Some of the more significant of these additions are as follows:

•
Considering and Explaining Choices and Available Alternatives.
The adopted Rule requires that the NMS plan describe and discuss any reasonable alternative approaches to the creation of the consolidated audit trail that were considered by the SROs and why the approach set forth by the NMS plan was selected.
24

24

See
Rule 613(a)(1)(xii); Section III.C.2.a.,
infra.

•
Planning for Future System Efficiencies.
The adopted Rule requires that the NMS plan provide a plan to eliminate existing rules and systems (or components thereof) that are rendered duplicative by the consolidated audit trail, including identification of such rules and systems (or components thereof). Further, to the extent that any existing rules or systems related to monitoring quotes, orders, and executions provide information that is not rendered duplicative by the consolidated audit trail, such plan must also include an analysis of (1) whether the collection of such information remains appropriate, (2) if still appropriate, whether such information should continue to be separately collected or should instead be incorporated into the consolidated audit trail, and (3) if no longer appropriate, how the collection of such information could be efficiently terminated. Finally, such plan must also discuss the steps the plan sponsors propose to take to seek Commission approval for the elimination of such rules and systems (or components thereof); and a timetable for such elimination, including a description of how the plan sponsors propose to phase in the consolidated audit trail and phase out such existing rules and systems (or components thereof).
25

25

See
Rule 613(a)(1)(ix); Section III.C.2.a.,
infra.

•
Considering Input.
The adopted Rule requires the NMS plan to address the process by which the plan sponsors solicited views of their members and other appropriate parties regarding the creation, implementation, and maintenance of the consolidated audit trail, provide a summary of the views of such members and other parties, and describe how the plan sponsors took such views into account in preparing the NMS plan.
26

In addition, the adopted Rule also requires the NMS plan to provide for the establishment of an Advisory Committee whose function will be to advise the plan sponsors on the implementation, operation, and administration of the central repository.
27

26

See
Rule 613(a)(1)(xi).

27

See
Rule 613(b)(7). For a further discussion of the composition of the Advisory Committee,
see
Section III.B.3.b.,
infra.

•
Periodic Reviews of the Consolidated Audit Trail.
To help assure the Commission that as financial markets evolve and new technologies emerge, the consolidated audit trail remains a useful regulatory tool, the adopted Rule mandates that the NMS plan must require the central repository's Chief Compliance Officer to regularly review the operations of the consolidated audit trail, and, in light of

market and technological developments, make appropriate recommendations for enhancements to the consolidated audit trail.
28

28

See
Section III.B.2.,
infra.

The Commission has also added certain requirements to the adopted Rule in response to specific concerns expressed by commenters with respect to the use of consolidated audit trail data. Some of the more significant of these additions are as follows:

•
Enhancing Security and Privacy Requirements.
Commenters have expressed concerns regarding the risk of failing to maintain appropriate controls over the privacy and security of consolidated audit trail data. Accordingly, the adopted Rule requires the NMS plan to include additional policies and procedures that are designed to ensure the rigorous protection of confidential information collected by the central repository.
29

29

See
Rule 613(e)(4).

•
Addressing and Limiting Errors.
Commenters have also expressed concerns about the potential for errors in the consolidated audit trail; the adopted Rule requires the SROs to provide in their NMS plan detailed information regarding anticipated error rates as well as the plan's proposed error correction process.
30

30

See
Rule 613(e)(6); Section III.B.2.,
infra.

The Commission generally believes that the collective effect of the modifications and additions described above will be to significantly expand the set of solutions that could be considered by the SROs for creating, implementing, and maintaining a consolidated audit trail and to provide the SROs with increased flexibility in how they choose to meet the requirements of the adopted Rule, relative to the alternatives that would have been available under the requirements of the proposed Rule. The Commission further believes that these changes address or mitigate the principal concerns raised by commenters—including concerns regarding the extent and cost of the systems changes required by the SROs and their members—while continuing to enable the SROs and the Commission to achieve significant benefits from the consolidated audit trail.
31

Each of the modifications and additions noted above is described and explained in detail in part III below.

31

See
Section II.A.,
infra,
for a discussion of the objectives of the consolidated audit trail.

Given these changes and the wide array of commenters' views on how to best create, implement, and maintain a consolidated audit trail, the Commission expects that the SROs will seriously consider various options as they develop the NMS plan to be submitted to the Commission for its consideration.
32

Indeed, some commenters recognized that a consolidated audit trail could be created, implemented, and maintained in a number of ways, and thus recommended that the Commission replace the specific systems requirements of the proposed Rule with more general “end-user” requirements, perform an analysis of how existing audit trail systems do and do not meet the needs of regulators, and perhaps even engage in a formal request-for-proposal (“RFP”) process.
33

32

See, e.g.,
FINRA Letter, p. 14 (advocating that SROs build off existing audit trails to develop a consolidated audit trail) and Nasdaq Letter I, p. 11-12 (arguing against building off existing audit trail systems and supporting the development of new system to establish a consolidated audit trail).

33

See
Nasdaq Letter I, p. 12; FIF Letter II, p. 2-3; STA Letter, p. 1-3; Direct Edge Letter, p. 2-3, 5.

In light of the expanded solution set that should be available under the changes described above and commenter views on the NMS plan development process, the adopted Rule now requires the SROs to provide much more information and analysis to the Commission as part of their NMS plan submission. These requirements have been incorporated into the adopted Rule as “considerations” that the SROs must address, and generally mandate that the NMS plan discuss: (1) The specific features and details of the NMS plan (
e.g.,
how data will be transmitted to the central repository, when linked data will be available to regulators); (2) the SROs' analysis of NMS plan costs and impact on competition, efficiency, and capital formation; (3) the process followed by the SROs in developing the NMS plan (
e.g.,
the requirement to solicit input from members of the SROs and other appropriate parties); and (4) information about the implementation plan and milestones for the creation of the consolidated audit trail.

These requirements are intended to ensure that the Commission and the public have sufficiently detailed information to carefully consider all aspects of the NMS plan ultimately submitted by the SROs, facilitating an analysis of how well the NMS plan would allow regulators to effectively and efficiently carry out their responsibilities. To help elicit the most appropriate information and analysis from the SROs in response to these requirements, the Commission is furnishing further details about how it envisions regulators would use, access, and analyze consolidated audit trail data through a number of “use cases.” These use cases and accompanying questions should help the SROs prepare an NMS plan that better addresses the requirements of the adopted Rule, as well as aid the Commission and the public in gauging how well the NMS plan will address the need for a consolidated audit trail.
34

34

See
Section III.C.2.b.,
infra.

Because the Commission believes the adopted Rule permits a wider array of solutions to be considered by the SROs than the proposed Rule did and because the Commission and the public will be able to avail themselves of much more information and analysis in connection with the NMS plan submission, the Commission is also making significant modifications to the process by which it will consider the costs and benefits of the creation, implementation, and maintenance of a consolidated audit trail, as well as the potential impacts on efficiency, competition, and capital formation. In particular, the methodology that the Commission used in the Proposing Release to estimate the costs of creating, implementing, and maintaining a consolidated audit trail may be no longer suitable. As discussed in the Proposing Release, the approximately $4 billion cost estimate for the creation and implementation of a consolidated audit trail was primarily based on averages for the development from scratch of new, very large-scale market systems.
35

However, the Commission's rationale for this approach was predicated on some of the specific technical requirements of the proposed Rule, especially those related to the real-time collection and standard formatting of all data. As such, the approach assumed that the consolidated audit trail would not be able to build on existing trade, order, and audit trail systems. As noted above, these assumptions may no longer be valid since several of the specific technical requirements underlying the Proposing Release's approach have been substantially modified. The Commission believes these changes would now permit a wider array of solutions to be considered by the SROs, including solutions that could capitalize on existing systems and standards.
36

35
The methodology in the Proposing Release assumed that the scope of the required systems changes would be comparable to those made in connection with Regulation NMS.
See
Proposing Release,
supra
note 4, at 32597, n. 352.

36

See, e.g,
FINRA Letter, p. 14; SIFMA Letter, p. 16-18.

In light of these changes, the Commission believes that the economic consequences of the consolidated audit trail now will become apparent only over the course of the multi-step process

for developing and approving an NMS plan that will govern the creation, implementation, and maintenance of a consolidated audit trail. In particular, the Commission believes that the costs and benefits of creating a consolidated audit trail, and the consideration of specific costs as related to specific benefits, is more appropriately analyzed once the SROs narrow the expanded array of choices they have under the adopted Rule and develop a detailed NMS plan. The Commission therefore is focusing its economic analysis in this Release on the actions the SROs are required to take upon approval of the adopted Rule—specifically the requirement that the SROs develop an NMS plan, utilizing their own resources and undertaking their own research, that addresses the specific details, cost estimates, considerations, and other requirements of the Rule.
37

A robust economic analysis of the next step—the actual creation and implementation of a consolidated audit trail itself—requires information on the plan's detailed features (and their associated cost estimates) that will not be known until the SROs submit their NMS plan to the Commission for its consideration. Accordingly, the Commission is deferring this analysis until such time as it may approve any NMS plan—that is, after the NMS plan, together with its detailed information and analysis, has been submitted by the SROs and there has been an opportunity for public comment.

37

See
Rule 613(a)(1).

To that end, the adopted Rule requires that the SROs: (1) Provide an estimate of the costs associated with creating, implementing, and maintaining the consolidated audit trail under the terms of the NMS plan submitted to the Commission for its consideration; (2) discuss the costs, benefits, and rationale for the choices made in developing the NMS plan submitted; and (3) provide their own analysis of the submitted NMS plan's potential impact on competition, efficiency and capital formation. The Commission believes that these estimates and analyses will help inform public comment regarding the NMS plan and will help inform the Commission as it evaluates whether to approve the NMS plan. In this way, the Commission can develop estimates of the costs for the creation, implementation, and maintenance of the consolidated audit trail that benefit from cost data and information provided by the SROs.

The Commission notes that this approach is suited for the multi-step nature of the particular process for developing and approving an NMS plan that will govern the creation, implementation, and maintenance of a consolidated audit trail. Further, because the Commission is deferring its final analysis of the consolidated audit trail until after a detailed NMS plan has been submitted to the Commission for its consideration and the public has had an opportunity to comment, the adopted Rule has been modified to include a mandate that in determining whether to approve the NMS plan and whether the NMS plan is in the public interest, the Commission must consider the impact of the NMS plan on efficiency, competition, and capital formation of creating, implementing, and maintaining the NMS plan.
38

The Commission also will consider the costs and benefits of the creation, implementation, and maintenance of the consolidated audit trail pursuant to the details proposed in the NMS plan submitted to the Commission for its consideration.

38

See
Rule 613(a)(5).

As a result of the new requirements for SROs to provide additional information about costs and a number of other aspects of the NMS plan they submit, the Commission is extending the timeframe for the submission of the NMS plan from 90 days from the date of approval of Rule 613 to 270 days from the date of publication of the adopting release for Rule 613 (“Adopting Release”) in the
Federal Register
. The Commission also is altering the timeframe within which SROs must submit proposed rule changes to require their members to comply with the requirements of the Rule and the NMS plan approved by the Commission
39

and the deadline for submitting the document required by Rule 613(i) regarding the possible expansion of the scope of the NMS plan.
40

39
The proposed Rule would have required SROs to submit such proposed rule changes on or before from 120 days from approval of the Rule. Because the adopted Rule permits the SROs up to 270 days from the date of publication of the Adopting Release in the
Federal Register
to submit NMS plans, the Commission believes that the more appropriate deadline for SROs to submit rule changes is 60 days from the date the Commission approves an NMS plan.

40
Specifically, the adopted Rule provides SROs six months, instead of two months, after effectiveness of the NMS plan to submit this document to the Commission.

II. Introduction

A. Need for, and Objectives of, a Consolidated Audit Trail

The Commission believes that the Rule adopted today is an appropriate step in the creation of a consolidated audit trail which, when implemented, should substantially enhance the ability of the SROs and the Commission to oversee today's securities markets and fulfill their responsibilities under the federal securities laws. Rule 613 requires the submission of an NMS plan to create, implement, and maintain the first comprehensive audit trail for the U.S. securities markets, which will allow for the prompt and accurate recording of material information about all orders in NMS securities, including the identity of customers, as these orders are generated and then routed throughout the U.S. markets until execution, cancellation, or modification. This information will be consolidated and made readily available to regulators in a uniform electronic format.

This section reviews the current status and limitations of existing, discrete audit trails and discusses how a consolidated audit trail could address those limitations and improve the ability of the SROs and the Commission to perform their regulatory functions. To perform this review, the Commission is, in part, drawing upon its own experiences in using existing audit trails to carry out its regulatory duties.
41

The Commission also is relying on information provided to the Commission from other regulators who use existing audit trail systems, broker-dealers and organizations representing industry participants, and those with expertise in data management and technology solutions that may be applicable to the adopted requirements.

41

See
Proposing Release,
supra
note 4, at 32558-61.

1. Use and Limitations of Current Sources of Trading Data

It has become increasingly challenging for SROs and the Commission to oversee the U.S. securities markets across the multitude of trading venues, given the huge volume of orders and trades that are generated, routed, transformed, and then re-routed across dozens of venues every day. Among the challenges is the fact that there is no single, comprehensive audit trail available to regulators.
42

At present, the SROs and the Commission must use a variety of data sources, including EBS,
43

equity cleared reports,
44

and SRO audit trail data to help fulfill their regulatory obligations. As a result, among other issues, regulatory authorities face many challenges in obtaining, reconciling, and making effective use of even the limited

order and execution data that is available, thereby hindering the conduct of market surveillance, investigation and enforcement activities, and market reconstructions and analyses.
45

42

See
FINRA/NYSE Euronext Letter, p. 1-3; Nasdaq Letter I, p. 1-5.

43

See
note 1,
supra;
Proposing Release,
supra
note 4, at 32557-58.

44

See
note 2,
supra.

45
The term “market reconstruction” is used to refer to the efforts by SRO and Commission staff to collect and process detailed trade and order data, often from multiple and varied data sources (
e.g.,
market participants, trading venues, and other SROs) to recreate the sequence of events and market conditions that existed over a given period of time. A recent example of this occurred following the “Flash Crash” of May 6, 2010, with the market reconstruction analysis undertaken by Commission and the Commodity Futures Trading Commission (“CFTC”) staff, which can be found in the “Findings Regarding the Market Events of May 6, 2010: Report of the Staffs of the CFTC and the SEC to the Joint Advisory Commission Emerging Regulatory Issues.”
See http://www.sec.gov/news/studies/2010/marketevents-report.pdf
.

The ultimate effectiveness of core SRO and Commission regulatory efforts depends on the following four qualities of trade and order (collectively “market”) data:

• Accuracy. Is the data about a particular order or trade correct?

• Completeness. Does the data represent all market activity of interest, or just a subset? Is the data sufficiently detailed to provide the required information?

• Accessibility. How is the data stored? How practical is it to assemble, aggregate, reconcile, and process the data? Can all appropriate regulators acquire the data they need?

• Timeliness. When is the data available to regulators? How long will it take to process before it can be used for regulatory analyses?

SROs generally use market data in the form of audit trails to identify potential misconduct in the markets they oversee, including attempts to manipulate market quotations, inflate trading or order volume artificially, or profit from non-public information. When these surveillance efforts identify suspicious trading activity, SROs have a responsibility to open investigations in which they assemble and review additional market data to assess the nature and scope of the potential misconduct. When an SRO detects persistent problems in the market it oversees, it may write new rules for its members to address the problems. To inform these rulemaking efforts, SROs frequently gather and analyze significant amounts of market data. The effectiveness of such efforts is largely determined by the qualities of the data available.
46

46
The Commission recognizes that the accuracy of the data available may also be subject to occasional errors, including errors caused by rare and unexpected events.

The qualities of such market data are also primary determinants of the Commission's ability to fulfill its statutory mission. The Commission uses market data in most of its investigations of potential securities law violations. In many of these investigations, market data analysis frames the issues for investigation and is a primary means of identifying relationships between individuals and entities whose activities may threaten the integrity of the securities markets or create substantial and unnecessary investor losses. The Commission also uses audit trails and other sources of market data to: (1) Inform its priorities for examinations of broker-dealers, investment advisers and SROs; (2) supplement the data and information it collects during those examinations; and (3) determine the nature and scope of any potential misconduct the examinations identify. The Commission also relies heavily on market data to identify patterns of trading and order activity that pose risks to the securities markets and to inform regulatory initiatives, as well as to perform market reconstructions. In addition, the Commission relies on market data to improve its understanding of how markets operate and evolve, including with respect to the development of new trading practices, the reconstruction of atypical or novel market events, and the implications of new markets or market rules. As is the case for the SROs, the effectiveness of such efforts by the Commission is largely determined by the qualities of the data available.
47

47
The effectiveness of such efforts with respect to cross-market activities within the Commission's jurisdiction depends on the qualities of data from multiple sources, such as separate SRO audit trails used for equities and equity options.
See
Section II.A.1.c.,
infra.
This dependency also exists with respect to market activities that involve other products outside the Commission's jurisdiction, such as futures and certain swaps.
See
note 239,
infra.

As described in the following sections, each of the present sources of market data available to regulators suffers from deficiencies limiting its effective use.

a. The EBS System

The EBS system is currently the only available source of data that allows regulators to obtain the identity of customers of broker-dealers who have executed trades. The SROs and the Commission have depended on this system for decades to request trading records from broker-dealers. The EBS system, supplemented by the requirements of Rule 17a-25 under the Exchange Act,
48

is generally used by SRO and Commission staff to assist in the investigation of possible securities law violations, typically involving insider trading and market manipulations.
49

In its electronic format, the EBS system provides certain detailed execution information, upon request by SRO or Commission staff, for specific securities during specified timeframes. However, EBS data, which is currently sourced from the so-called back-office records of clearing brokers, are limited to executed trades and do not contain information on orders or quotes (and thus no information on routes, modifications, and cancellations). Also, in frequent cases where brokers utilize average-price accounts to execute and aggregate multiple trades for one or more customers, the details of each individual trade execution are typically lost when reported through the EBS system because it is only the average aggregate price and volume of a series of executed trades that are transmitted to the clearing systems for processing.
50

48
17 CFR 240.17a-25. Rule 17a-25 codified the requirement that broker-dealers submit to the Commission, upon request, information on their customer and proprietary securities transactions in an electronic format. The rule 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.

49

See
Rule 17a-25;
supra
note 1, and accompanying text.

50

See
FIF Letter I, p. 3; SIFMA Letter, p. 18-19.

Furthermore, the EBS data currently includes only the dates, but not the times, of each trade execution (regardless of whether or not the trade represents an average-price series of executions).
51

Since there could be many broker-dealers trading a given security on a given day of interest, to reconstruct trading on the market for one security on one day could involve many, perhaps hundreds, of EBS requests. Consequently, EBS data, alone, are not generally useful for price or short sale manipulations analysis, order flow analysis, depth-of-book analysis, or any large-scale market reconstructions in which the timing of events is required to build a useful picture of the market.
52

51
As adopted, Rule 13h-1 requires certain broker-dealers to capture and report through EBS the time of execution for any trade involving a large trader and a Commission-issued large trader identifier that identifies the large trader.
See
Large Trader Release and Large Trader Extension,
supra
note 1.

52
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 addition, though the EBS system provides the names associated with each account in which a trade has been

placed, these names are based on the separate records of each broker-dealer providing data to the EBS system, and the same party may be identified by a different name across multiple broker-dealers. Experience of staff at the Commission has shown
53

that it is difficult to perform cross-broker customer analysis of trading since the same customer may be known by different names depending on the account and broker-dealer through which it traded.

53

See, generally,
Sections II.A.1. and II.A.2.,
infra.

The EBS system also typically requires SRO and Commission staff needing EBS data to request the information from each broker-dealer, and complete responses from each broker-dealer may take days or weeks depending upon the scope of the request. As a result of these various limitations, the EBS system is generally only used by regulators in narrowly-focused enforcement investigations that generally involve trading in particular securities on particular dates or with specific broker-dealers.

b. Equity Cleared Reports

In addition to the EBS system and Rule 17a-25, the SROs and the Commission also rely upon the NSCC
54

equity cleared report for initial regulatory inquiries.
55

This report is generated on a daily basis by the SROs, is provided to the NSCC, 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.
56

This information is also provided to the Commission upon request. 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, its use for regulatory purposes is quite limited—equity cleared reports basically serve as a starting point for certain types of investigations, providing a tool the Commission can use to narrow down the clearing firms to contact concerning transactions in a certain security.

54

See
note 2,
supra,
and accompanying text.

55
The Commission also uses the Options Cleared Report, with data supplied by the Options Clearing Corporation (“OCC”), for analysis of trading in listed options. The OCC is an equity derivatives clearing organization that is registered as a clearing agency under Section 17A, 15 U.S.C. 78q-1, of the Exchange Act, and operates under the jurisdiction of both the Commission and the CFTC.

56
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. SRO Audit Trails

In addition to EBS data and equity cleared reports, the SROs and the Commission rely on data collected through individual SRO audit trails. Most SROs maintain their own specific audit trails applicable to their members. For example, the National Association of Securities Dealers (“NASD”)
57

established its Order Audit Trail System (“OATS”)
58

in 1996, which required NASD (n/k/a FINRA) members to report certain trade and order data on Nasdaq-listed equity securities. OATS was later expanded to include OTC equity securities. Similarly, the NYSE implemented its Order Tracking System (“OTS”)
59

in 1999 under which its members were required to report certain trade and order data on NYSE-listed securities. Beginning in 2000, several of the current options exchanges implemented the Consolidated Options Audit Trail System (“COATS”).
60

In addition, many of the exchanges have created their own audit trails to assist in surveillance activities.

57
In 2007, NASD and the member-related functions of NYSE Regulation, Inc., the regulatory subsidiary of 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).

58

See In the Matter of National Association of Securities Dealers, Inc.,
Order Instituting Public Proceedings Pursuant to Section 19(h)(1) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions, Exchange Act Release No. 37538 (August 8, 1996), Administrative Proceeding File No. 3-9056 and Report Pursuant to Section 21(a) of the Securities Exchange Act of 1934 Regarding the NASD and The Nasdaq Stock Market LLC (“Nasdaq”).
See also
Securities Exchange Act Release No. 39729 (March 6, 1998), 63 FR 12559 (March 13, 1998) (order approving proposed rules comprising OATS) (“OATS Approval Order”).

59

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”).

60

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, 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).

Recently, FINRA expanded its OATS requirements from covering only Nasdaq-listed and OTC equity securities to covering all NMS stocks.
61

To avoid duplicative reporting requirements, the NYSE, NYSE Amex LLC (n/k/a “NYSE MKT LLC”) (“NYSE Amex”), and NYSE ARCA, Inc. (“NYSE Arca”) subsequently replaced their OTS audit trail requirements for members who are also members of either FINRA or Nasdaq (and therefore subject to OATS requirements) with rules that allow these members to satisfy their reporting obligations by meeting the new OATS requirements.
62

61

See
Securities Exchange Act Release No. 63311 (November 12, 2010), 75 FR 70757 (November 18, 2010) (SR-FINRA-2010-044) (order approving proposed rule change by FINRA relating to the expansion of OATS to all NMS stocks).

62

See
Securities Exchange Act Release Nos. 65523 (October 7, 2011), 76 FR 64154 (October 17, 2011) (SR-NYSE-2011-49); 65524 (October 7, 2011), 76 FR 64151 (October 17, 2011) (SR-NYSEAmex-2011-74); 65544 (October 12, 2011), 76 FR 64406 (October 18, 2011) (SR-NYSEArca-2011-69).

Although these developments with respect to the scope of FINRA's OATS rules reduce the number of audit trails with disparate requirements, they still do not result in a comprehensive audit trail that provides regulators with accurate, complete, accessible, and timely data on the overall markets for which regulators have oversight responsibilities. In particular, data collected by FINRA pursuant to FINRA's Rule 7400 series (“OATS data”) does not provide a complete picture of the market because though OATS collects data from FINRA members with respect to orders and trades involving NMS stocks, OATS does not include trade or order activity that occurs on exchanges, or at broker-dealers that are not FINRA or Nasdaq members. Nor does OATS include exchange quotes, principal orders submitted by FINRA members registered as market makers, or options data.
63

In

performing its own regulatory oversight of the markets, FINRA has chosen to create an internal process in which it augments the data it collects via OATS with trade execution data from other exchanges with which it has a regulatory services agreement. This process provides FINRA with a wider view of the markets than that provided by OATS alone, but linking data in this fashion does not yield fully accurate results.
64

For these reasons, the Commission believes that the augmented OATS data currently falls short of providing an efficient source of data for analyzing cross-market activities, or tracking an order through its entire cycle from generation through routing to execution, modification or cancellation.

63

See
FINRA Rule 7410(j) (defining
“
Order
”
for purposes of OATS, to mean “any oral, written, or electronic instruction to effect a transaction in an NMS stock 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.” Additionally, Nasdaq, Nasdaq OMX BX, Inc. (“BX”) and Phlx equities (“PSX”) members that are registered as market makers in a certain security are similarly exempted from recording OATS audit trail data for the security in which they are registered to make a market.
See
Nasdaq and BX Rules 6951(i); PSX Rule 3401(i).

The Commission notes that members of Nasdaq, BX and PSX, that are not also members of FINRA, are required by those exchanges to record the audit trail data required by OATS; however, they are only required to report that data through OATS upon request by their respective exchanges. See Nasdaq

and BX Rules 6955(b); PSX Rule 3405(b). Additionally, as of October 17, 2011, members of NYSE and NYSE Amex, who are not also FINRA members, are required to record their trade and order activity. These non-FINRA members are not required to report this data through OATS unless requested.
See
NYSE and NYSE Amex Equities Rules 7450(b);
see, e.g.,
Securities Exchange Act Release Nos. 65523 (October 7, 2011), 76 FR 64154 (October 17, 2011); 65524 (October 7, 2011), 76 FR 64151 (October 17, 2011); 65544 (October 12, 2011), 76 FR 64406 (October 18, 2011) (notice of immediate effectiveness of proposed rule change to adopt the FINRA Rule 7400 series, the OATS rules, and making certain conforming changes to the NYSE and NYSE Amex Equities rules). Members of NYSE Arca, who are not also FINRA members, were required to record their trade and order activity as of March 31, 2012.
See
NYSE Arca Equities Rule 7450(b); see Securities Exchange Act Release No. 65544 (October 12, 2011), 76 FR 64406 (October 18, 2011) (notice of immediate effectiveness of proposed rule change to adopt the FINRA Rule 7400 series, the OATS rules, and making certain conforming changes to the NYSE Arca Equities rules).
See also
Securities Exchange Act 66094 (January 4, 2012), 77 FR 1545 (January 10, 2012) (notice of immediate effectiveness to extend the implementation date of the NYSE Arca Equities Rule 7400 Series, the OATS rules, for Equity Trading Permit Holders that are not FINRA members from January 31, 2012 to March 31, 2012).

64
FINRA has represented to Commission staff that, as part of its own surveillance activities, FINRA acquires some of this order handling system data from non-FINRA members to supplement the data it receives from its members via OATS, but that matching data across the audit trails yields varying levels of success and accuracy due to the disparate methods used by the different order handling systems to collect and store data. FINRA represented that, during the period from November 28, 2011 to February 24, 2012, approximately 2% of reportable OATS data related to exchange orders could not be linked with matching exchange data.
See
Commission Staff Memorandum to File No. S7-11-10 regarding telephone conversations with FINRA, dated April 17, 2012 (“Commission Staff Memorandum”). Also, since this process only involves acquiring trade and order data from select sources, it still does not produce a complete record of all market activity. The Commission notes that, when considering data covering a time period of approximately 26 months, the percentage of reportable OATS data related to exchange orders that could not be linked with matching exchange data remained at approximately 2%.
Id.

OATS data also suffers from a lack of timeliness, partly as a result of the problems with the accuracy of the data as collected, and partly because of its lack of completeness. When FINRA receives an end-of-day OATS file from a member, it takes an hour for FINRA to acknowledge receipt of the report and approximately another 24 hours to determine if there is a syntax error
65

in the report.
66

During this time, FINRA performs over 152 validation checks on each order event reported to OATS. Thus, FINRA performs over 40 billion separate checks each day to ensure OATS data conforms to all applicable specifications.
67

Each of these checks can result in OATS data submissions being rejected and generating an error message.
68

As a result of these validation checks, almost 425,000 reports per day, on average, are rejected and must be corrected.
69

In addition to the 24 hours needed to identify errors within a report, it takes another two business days to determine whether a file that is syntactically correct nevertheless contains errors in content related to internally-inconsistent information about processing, linking, and routing orders. Once a member is advised of such errors, the member has up to five business days to re-submit a corrected file. However, error corrections are limited to only those that are required to remedy internal inconsistencies within a given member's submission. Cross-firm inconsistencies in which, for example, one member reports routing an order to a second member, but the second member does not report receiving or processing such an order, are identified as unmatched or unlinkable data records, but neither firm corrects these types of reporting errors. The net result yields a historical data record of market activity that contains a small but permanent number of incorrect or irreconcilable trade and order events.
70

65
Common reasons given by FINRA for syntax rejections include: Missing mandatory fields, invalid fields, and invalid field combinations (
e.g.,
a Limit Price without a Time in Force Code). OATS will reject records as duplicates if more than one record is submitted with the same Order Receiving Firm Market Participant Identifier, Order Received Date, and Order Identifier or if more than one record contains all of the same information.
http://www.finra.org/Industry/Compliance/MarketTransparency/OATS/FAQ/P085542
(last viewed on May 23, 2012).

66

See
Commission Staff Memorandum,
supra
note 64. FINRA estimates that, from the period November 28, 2011 to February 24, 2012 approximately 0.10% of the intra-firm data reported daily by broker-dealers were rejected for errors.
Id.
The Commission notes that, when considering data covering a time period of approximately 26 months, the percentage of the intra-firm data reported daily by broker-dealers rejected for errors was more than double this amount.
Id.

67

See
FINRA Letter, p. 11. FINRA represented to Commission staff that many of the validation errors result from problems encountered in translating order information from broker-dealer formats into OATS format.
See
Commission Staff Memorandum,
supra
note 64.

68

Id.

69

Id.

70
FINRA estimates that during the period from November 28, 2011 to February 24, 2012 approximately 0.5% of each day's reportable events remained unmatched (
i.e.,
multi-firm events, such as routes, that cannot be reconciled).
See
Commission Staff Memorandum,
supra
note 64. When considering data covering a time period of approximately 26 months, the percentage of each day's reportable events remaining unmatched was more than double this amount.
Id.

Given the time it takes to process each OATS file, and the nature of the process in which errors are detected, reported back to members, and then corrected, inter-firm surveillance by FINRA typically does not begin until 5 business days after receipt of OATS data. In addition, the final product of the FINRA process is available to FINRA, but is not stored in a market-wide database or a central repository that is readily accessible to other regulators. This is because SROs do not typically have access to the internal systems of another SRO, though they may share some sources of underlying data.
71

71
For example, FINRA has been given access to order audit trail information from certain SROs pursuant to Regulatory Services Agreements.

Because the Commission does not have direct access to OATS data and other SRO audit trails and because each SRO only has direct access to its own audit trails, requests must be made to the Intermarket Surveillance Group (“ISG”)
72

or SROs to conduct an analysis on order data. It can take days or weeks, depending on the scope of the information requested, to receive responses to requests. Once the responses to its requests for information are received, the Commission, or any SRO undertaking the same task, must commit a significant amount of time and resources to process and cross-link the data from the various formats used by different SROs before it can be analyzed and used for regulatory purposes. Whether or not this process is successful depends on the accuracy, completeness, and format of the data received, as well as how readily data from different SROs can be reliably linked. For example, staff at the Commission working on the analysis of the May 6, 2010 “Flash-Crash” found it was not possible to use the data from existing audit trails to accurately or comprehensively reconstruct exchange

and ATS equity limit order books for NMS securities as required to fully analyze the events of that day.
73

72
ISG is an international group of exchanges, market centers, and regulators that perform market surveillance in their respective jurisdictions. The organization provides a forum for its members to share information and coordinate regulatory efforts to address potential intermarket manipulation and trading abuses.

73

See
Section II.A.2.b.,
infra.

A further difficulty in using existing audit trails to conduct cross-market surveillance is the lack of consistency in both format and content among the various audit trails. Not all SROs collect data using the OATS format. In addition, each options exchange maintains its own COATS audit trail in a different format and includes different supplemental data items in its audit trail. These differences make it difficult and labor intensive for regulators to view options trading activity across multiple markets, and the lack of any combined equity and options audit trail is a significant impediment to regulators performing cross-product investigations and analyses.

An additional shortcoming of existing SRO audit trails is the lack of customer identifiers. In general, existing SRO audit trails only identify the broker-dealer handling the order and not the account holder or the person exercising investment discretion for the account holder, if different. This limitation makes the process of identifying the customers involved in unusual trading patterns or market events very difficult. Even determining whether or not an unusual trading pattern exists is challenging if the data does not identify trades by a single customer at multiple broker-dealers. Requests therefore must be made to one or more broker-dealers to obtain information about the customer or customers behind an order. Multiple requests may be necessary before the information is obtained. EBS data may have to be requested as a supplement. A further challenge arises in any type of customer-based cross-market analysis because there is no standard convention for how customers are identified at different broker-dealers—the same party directing trades across multiple venues, or through different broker-dealers, can be known by many different names.

Not having customer information at the early stage of surveillance can also impair the accuracy, and thus efficacy, of certain surveillances. The patterns that emerge when trade and order activity is aggregated across all customers of a broker-dealer often exhibit characteristics that can be quite different from the (initially) unobservable patterns of trade and order activity of each individual customer at that broker-dealer. This could result in what are known as “false positive signals,” in which market activities that initially are flagged as being potentially manipulative by a surveillance system are later found not to be potentially manipulative once more detailed customer data from the broker-dealer is requested and analyzed. In contrast, potentially manipulative activities may be missed by a surveillance system that cannot identify the customers behind each order or trade if those activities are otherwise obscured by non-manipulative activities of other customers of the same broker-dealer such that the aggregate patterns of trading do not appear potentially manipulative.

Given the various limitations described above, the Commission does not believe that existing audit trails, with their current features, provide regulators with an efficient or adequate method of monitoring and surveilling the market for NMS securities. The Commission notes, for example, that FINRA summarizes the current cross-market systems as follows: “The current systems in place to achieve effective cross-market surveillance, such as the ISG, are incomplete. For example, the ISG audit trail data has numerous shortcomings, including: (1) It does not capture quote/orders away from a market's inside market (i.e., those quotes/orders below the best bid or above the best offer); (2) it currently identifies participants of a trade only to the clearing broker, not down to the executing broker level; (3) data submitted by participants is not validated; (4) certain data fields are not mandatory; and (5) there are no service level agreements to ensure that participants submit timely and accurate information.”
74

74

See
FINRA/NYSE Euronext Letter, p. 3.

2. Regulatory Improvements With a Consolidated Audit Trail

The NMS plan required by the Rule, if approved by the Commission, will improve the quality of audit trail data by, among other things: (1) Identifying with a unique “Customer-ID” the account holder(s) with respect to an account at a registered broker-dealer and, if different, any person authorized to give the broker-dealer trading instructions for such account; (2) identifying the time of each key event in the life of an order according to synchronized business clocks; (3) requiring the reporting of comprehensive order lifecycle data; and (4) including all NMS securities in one audit trail. As discussed below, the Commission believes that these improvements should have the potential to result in the following: (1) Improved market surveillance and investigations; (2) improved analysis and reconstruction of broad-based market events; and (3) improved market analysis. In addition, a consolidated audit trail has the potential to result in a reduction in disparate reporting requirements and data requests.

a. Improved Market Surveillance and Investigations

A consolidated audit trail will expand the data available for regulators to perform surveillance and investigations for illegal activities such as insider trading, wash sales, or manipulative practices. In particular, a consolidated audit trail will help surveillance and investigations by facilitating risk-based examinations, allowing more accurate and faster surveillance for manipulation, improving the process for evaluating tips, complaints, and referrals (“TCRs”), and promoting innovation in cross-market and principal order surveillance.

i. Risk-Based Examinations

A consolidated audit trail will facilitate risk-based examinations. Risk-based examinations require access to accurate and timely data so that the scope of the examination can be properly set to cover the areas of identified risks. Regulators currently may request audit trail data directly from the broker-dealer, work with the broker-dealer to understand the format and definitions in the data, validate that information with a third party, and analyze the data to determine whether the initial assumptions concerning risk were valid. This effort requires significant resources from both the regulator and the broker-dealer, all of which may be wasted if the resulting analysis shows that the assumptions of risk justifying the examination of a particular subject were not founded. Thus, this resource-intensive process does not necessarily reveal the subjects most worthy of examination, and does not permit an effective pre-examination review of a subject's trading practices.

In contrast, a consolidated audit trail would permit regulators, for example, to identify risks and appropriate subjects for examinations relating to certain types of trading by creating and comparing metrics based on the complete (and possibly cross-market) activities of a broker-dealer or customer. Signals based on such metrics could, for example, identify outlier patterns in the ratio of order activity to execution, which may be an indication of potentially manipulative practices. Currently, this method is impractical because, as described above, it requires the consolidation of many audit trails

that store data in non-uniform formats, participant information in SRO audit trails often does not consistently identify the executing broker-dealer, and there is no uniform method of identifying customers.

In sum, consolidated audit trail data that meets the minimum requirements for the NMS plan specified in the Rule would allow regulators to create a process that focuses much more of their resources on those firms for which specific activities over specific time periods warrant follow up. The subsequent examinations would thus be more precise, resulting in more efficient use of regulatory resources, potentially reducing the need for multiple document requests, and ultimately reducing the sometimes significant compliance burden on a broker-dealer or other subject.

ii. Market Manipulation

In addition to helping regulators focus their resources and better identify areas in which potentially manipulative trading activity may be occurring, a consolidated audit trail will greatly aid the analysis of the potential manipulation itself. The current methodology to analyze order and trade data requires a tremendous amount of time and resources to construct an accurate picture of when trades are actually executed. Typically, this includes: (1) Broker-dealers and other registrants responding to multiple requests from the Commission and SROs; (2) SROs devoting regulatory resources to obtaining, analyzing, and reporting data requested by the Commission; and (3) Commission staff reconciling inconsistent order data provided by different SROs with respect to different markets.

In addition, while SRO audit trail data identifies the dates and times of trades by a particular broker-dealer, SRO audit trail data does not reveal the identities of the customers initiating the trades executed by the broker-dealers. Accordingly, to identify customers placing trades through a broker-dealer, regulatory staff must obtain EBS data and integrate such data with SRO audit trail data. This is a cumbersome process because there is no automated process to link the two data sources. To determine the exact execution time for trades by a particular customer, regulatory staff must obtain a third set of data from the broker-dealer's trading and order handling system. These processes can take many months. In some cases, the laborious process of assembling the data delays other critical investigative or analytical steps. In other cases, investigators or analysts forego the process of determining when trades occurred, limiting their analysis to more accessible information. As a result, SRO and Commission staffs may fail to ascertain the full scope of misconduct under investigation or the causes of unusual market events at issue.

Even more critically, the absence of reliable information about who initiated which orders makes detection of schemes that involve repeat instances of activity through accounts at multiple broker-dealers difficult. Schemes of this sort may be among the most harmful and difficult to police, but without a customer identifier that consistently and uniquely identifies responsibility for orders across all broker-dealers, no amount of technical sophistication and securities market insight can produce a data query or analysis to detect them.
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75
Examples of schemes that typically rely on orders from accounts at multiple brokers include: (1) “Network” insider trading schemes in which the participants cultivate multiple sources of non-public information and trade on the information they receive over an extended period of time and through accounts at a large number of broker-dealers; (2) wash trading; and (3) order layering. Unlike insider trading, for example, which is neither defined nor expressly prohibited in the Act, wash trading is specifically prohibited in the statute. The entering of matched orders for the purpose of creating the illusion of market activity or to artificially affect the price is one of the oldest and most difficult to detect manipulative practices. Technology that permits the routing of thousands of orders to different venues in micro seconds has made cross market surveillance for this activity extremely difficult. “Order layering” is similar to wash trading. In this practice, a market participant can enter numerous non-bona fide market moving orders, often in substantial size relative to a security's legitimate volume to create the false impression of buy or sell side pressure. When such orders induce others to execute against profitable limit orders, the market participants immediately cancel the pending orders that manipulated the price. As with wash sales, multiple traders can enter orders on different venues, impacting the NBBO and making the activity difficult to detect.

With the data provided by the consolidated audit trail, regulatory staff would be able to conduct such analyses in a much shorter period of time. In addition, the process of analysis with a consolidated audit trail would be inherently more reliable than the manual reconstruction process currently available, reducing the risk of inaccuracies. Furthermore, the ability to process and meaningfully analyze audit trail data more quickly would allow regulatory staff to employ proactive methods of identifying potentially manipulative activities. The Commission therefore believes a consolidated audit trail would make the overall process of identifying and analyzing potentially manipulative trading practices much more focused, accurate, and efficient.
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For example, implementation of a consolidated audit trail also will help regulators monitor reliance on the use of the safe harbor provision for issuer repurchases in Rule 10b-18 under the Exchange Act. 17 CFR 240.10b-18. Rule 10b-18 under the Exchange Act provides issuers with a safe harbor from liability for manipulation under Sections 9(a)(2) and 10(b) of the Exchange Act, and Rule 10b-5 under the Exchange Act, when they repurchase their common stock in the market in accordance with the Rule's manner, timing, price, and volume conditions. The data required to be included in the consolidated audit trail will assist regulators in monitoring issuer repurchases that rely on Rule 10b-18's safe harbor protections to ensure that they comply with all required criteria.

The timely availability of data to regulators also impacts the efficacy of detecting (and possibly mitigating the effects of) some types of market manipulation. For example, some pernicious trading schemes are designed to generate large “quick-hit” profits in which participants attempt to transfer the proceeds from the activity to accounts outside of the reach of domestic law enforcement as soon as the offending transactions have settled in the brokerage account (typically three days after execution). If the SROs detect such schemes and promptly report them to the Commission, the Commission potentially could seek asset freezes that limit the transfer of funds until charges against the account holder are resolved. The Commission believes that a consolidated audit trail in which uniform data about market activities are efficiently collected and processed soon after such activities occur, and in which data are available to regulators in a timely manner, would more frequently and effectively allow regulators to use this approach.

iii. Tips and Complaints

A consolidated audit trail also would significantly improve the processes used by the SROs and the Commission for evaluating tips and complaints about trading activity.
77

It is not uncommon for market participants or those with experience in market data to sometimes note atypical trading or quoting patterns in publicly-available market data. A consolidated audit trail would allow regulatory staff to quickly determine whether a particular instance of an atypical activity (regardless of how it was originally identified), such as an abnormally high level of quote traffic, is worthy of further investigation.

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The Commission receives an average of over 200 market-related TCRs each month.

Today, such an analysis of TCRs is difficult and cumbersome. Even a preliminary review requires analysis by each exchange or ATS to identify the activity in question and to determine its scope. Regulators then must consolidate the analyses from each such market center to determine the identities of those responsible for the atypical

activity in question. To the extent that the activity originates from several market participants, regulators must conduct additional analysis on each of those participants, and possibly other participants, to discover information that could identify the customer(s) originating the orders that created the atypical activity. Without a unique customer identifier included in the order and trade data, this may not be possible. The consolidated audit trail would significantly improve the multi-stage process, enabling regulatory staff to make efficient queries on orders and more quickly determine whether the TCR can be “closed” or if further analysis and investigation are warranted.

iv. Cross-Market and Principal Order Surveillance

Investigations of cross-market activity may be more efficient with a consolidated audit trail as such an audit trail may provide regulators with data not currently consolidated across markets and/or data not currently available to regulators such as broker-dealer principal orders, including market maker quotes. For example, in an attempt to manipulate the market, a broker-dealer could use numerous principal sell orders across multiple venues to give the misleading appearance of broad sell-side pressure, and then send a buy principal order at a favorable price to take advantage of the market momentum created by the misleading sell orders. This type of activity would be difficult to readily identify with current audit trails, but it could be the target of a routine surveillance of a consolidated audit trail. The Commission notes, for example, the statement of FINRA and NYSE Euronext that, “[p]articularly since the implementation of Regulation NMS in 2007, there has been a significant increase in market linkages, the result of which is that trading activity on one market can have a profound effect on other markets. This, in turn, has led to the realization that market manipulation, by its very nature, is facilitated cross-market where, for example, trading on one market is used to affect a security's price while trading on another market is used to take advantage of that price change.”
78

78

See
FINRA/NYSE Euronext Letter, p. 2.

In addition, the consolidation of order data with direct access for all relevant regulators may create opportunities for regulators to develop entirely new methods of surveillance, and to keep existing forms of surveillance up to date as new market practices and new market technologies continue to rapidly evolve. In fact, as described more fully below, SROs are required by the Rule to incorporate the expanded audit trail data into their surveillance systems.
79

79

See
Rule 613(f).

b. Improved Analysis and Reconstruction of Broad-Based Market Events

A consolidated audit trail will significantly improve the ability of regulators to reconstruct broad-based market events so that they and the public may be informed by an accurate and timely accounting of what happened, and possibly why. The sooner a reconstruction can be completed, the sooner regulators can begin reviewing an event to determine what, if any, regulatory responses might be required to address the event in an effective manner.

For example, on the afternoon of May 6, 2010, the U.S. equity and equity futures markets experienced a sudden breakdown of orderly trading, when broad-based indices, such as the Dow Jones Industrial Average Index and the S&P 500 Index, fell about 5% in just five minutes, only to rebound soon after (the “Flash Crash”). Many individual equities suffered even worse declines, with prices in over 300 stocks and exchange-traded funds falling more than 60%. In many of these cases, trades were executed at a penny or less in stocks that were trading at prices of $30 or more only moments earlier before prices recovered to their pre-Flash Crash levels.
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80

See
note 45,
supra.

The Commission immediately formed an interdisciplinary team from across the Commission to analyze the events of May 6, 2010, identify possible causes, inform the public of what happened, and aid in formation of regulatory responses. The CFTC took similar steps. Within a few weeks, staff at the Commission and the CFTC released a joint preliminary report that described the event and, in general terms, the market conditions prior to and during the rapid decline.
81

However, at that time the staffs were unable to definitively identify the specific conditions or circumstances that could have caused, contributed to, or exacerbated the event. Though the SROs and the Commission quickly implemented a single-stock circuit breaker pilot program as an initial response, a more complete regulatory response required a full and robust analysis of additional data.

81

See
“Preliminary Findings Regarding the Market Events of May 6, 2010: Report of the Staffs of the CFTC and the SEC to the Joint Advisory Commission Emerging Regulatory Issues.” (May 18, 2010).
See http://www.sec.gov/sec-cftc-prelimreport.pdf.

From the start of the investigation, many market participants had suggested that the sudden withdrawal of liquidity in the equity markets may have resulted in the rapid decline of prices as orders to immediately sell (many from retail investors) found no interest on the buy side (from market professionals).
82

To fully understand how such conditions could occur, Commission economists needed to analyze the order books for thousands of equities. Commission staff requested order book data from several exchanges that sell such data or could readily put such data together, but this data did not represent the whole market. Commission staff attempted to use order data from OATS and several SRO audit trails to reconstruct order books for thousands of equities traded on exchanges that do not maintain or could not provide order book data. Although it was possible to link the data from different sources to show trading activity for a particular stock over a specific period of time, the accuracy, completeness, and content of the combined data sets were not sufficient to allow for an accurate reconstruction of the order books. This hindered staff in determining what happened to liquidity before, during, and after the Flash Crash. Two major problems were the inability to identify and eliminate duplicate orders from the data and the inability to accurately sequence events across the multiple data sources.

82
For detailed discussions and chronologies of the investigation into the events of May 6, 2010,
see
SEC (
http://www.sec.gov/spotlight/sec-cftcjointcommittee.shtml
) and CFTC (
http://www.cftc.gov/PressRoom/Events/AdvisoryCommitteeMeetings/index.htm
) webcasts and minutes of public meetings held with the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues on May 24, 2010, June 22, 2010, August 11, 2010, November 5, 2010, and February 18, 2011.

As described in the final joint report issued by the staffs of the CFTC and the Commission on September 30, 2010, Commission staff were only able to create a comprehensive view of the order books by acquiring, processing, and aggregating four distinct data sets that each contained a subset of order book information from each of the four exchanges that could provide such information: Nasdaq ModelView, NYSE Openbook Ultra, NYSE ARCABook, and BATS Exchange.
83

Given the enormous volume of data that needed to be processed (more than 5.3 billion records), even small changes to the integration and aggregation process took

significant computer time to test and implement.

83

See
note 45,
supra,
at p. 11.

By early July 2010, staff at the CFTC had completed a very detailed analysis of the full order book of the S&P 500 E-Mini futures contract and were able to show how liquidity in that contract had been eroding for most of the day. The CFTC's detailed second-by-second analysis of trading during the Flash Crash itself revealed how buy-side depth in the S&P 500 E-Mini futures virtually evaporated as broad market indices rapidly fell 5%.
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However, until a similar analysis could be completed in the equity markets, neither regulators nor the public would know whether an evaporation of liquidity was also present in the equity markets, and whether the timing of such an event preceded or followed the liquidity event in the futures market. Ultimately, it took Commission staff nearly five months to complete an accurate representation of the order books of the equity markets for May 6, 2010. Even then, the reconstruction was not fully complete and only contained an estimated 90% of trade and order activity for that day.
85

However, it was sufficiently comprehensive to allow staff to perform a robust analysis of the equity markets revealing how “the decline in full-depth buy-side liquidity for the E-Mini precede[d] that of the SPY and [the stocks composing] the S&P 500,” and how “drops in [stock] prices [became] increasingly more severe with ever-larger drops in liquidity.”
86

84

Id.

85

Id.

86

Id.
at p. 18, 80.

Had there been a consolidated audit trail in place on May 6, 2010, regulators would likely have been able to much more quickly and efficiently perform these types of detailed analyses. This in turn could have dramatically shortened the time during which regulators, as well as the public, remained uncertain about what actually happened during the Flash Crash.

c. Improved Market Analysis

In addition to the surveillance and reconstruction benefits described above, a consolidated audit trail would also significantly improve the ability of regulators to monitor overall market structure, so that both the Commission and the SROs can be better informed in their rulemakings. In January 2010 the Commission published a concept release on equity market structure that discusses how the markets have rapidly evolved from trading by floor-based specialists to trading by high-speed computers. The concept release poses a number of questions about the role and impact of high-frequency trading strategies and the movement of trading volume from the public national securities exchanges to dark pools.
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87

See
Securities Exchange Act Release No. 61358 (January 14, 2010), 75 FR 3594 (January 21, 2010) (“Concept Release on Equity Market Structure”).

Over the past two years there has been considerable discussion about these topics by regulators, market participants, the media, and the general public. Nevertheless, numerous open questions remain because of a lack of consolidated market data, making certain types of market-wide analysis impractical. For example, existing research on high frequency trading cannot precisely identify high frequency traders. As a result, studies of high frequency trading have been limited in their ability to thoroughly examine such strategies and their impact on the market, leaving many open questions. Having more precise data on who is trading (and from which general patterns of order submission could be inferred) would help regulators better understand the impact of high frequency trading on markets. Similar analyses also could be performed for other aspects of general market structure, such as those discussed in the concept release related to dark pools and internalization. In addition, having access to a consolidated audit trail will provide the Commission and SROs with better data to conduct retrospective analyses of rules and pilots. Informed analysis of these topics requires consolidating audit trails so that quotes and trades across multiple exchanges can be linked (either by customer type or by specific customer) with order flow and trades from the many dozens of over-the-counter venues.

d. Potential Reduction in Disparate Reporting Requirements and Data Requests

The Commission believes that a consolidated audit trail will reduce the burdens on SROs and broker-dealers associated with producing regulatory data. In particular, the consolidated audit trail may reduce burdens from ad hoc data requests.

The Commission believes that the creation of a consolidated audit trail may reduce the number and types of ad hoc requests made by regulators to market participants for data concerning their trading activities. In particular, regulators could use direct access to data in the consolidated audit trail for investigations or analyzing trends or broad market activities instead of requesting data from market participants. In addition, regulators could use this direct access to analyze the activities of a single trader across multiple markets, which today requires requests for data from multiple market participants. Regulators would therefore likely make fewer ad hoc requests. The Commission, however, does not believe that all ad hoc requests for data from market participants will be replaced by obtaining data from the consolidated audit trail. A detailed investigation of a particular firm may require types of data from that firm that are not stored in the consolidated audit trail, or that relate to periods prior to the implementation of the consolidated audit trail. In addition, in cases in which there are discrepancies, or even suspected discrepancies, between a firm's actual trading activities and what is stored in the consolidated audit trail's central repository, regulators are likely to request data directly from market participants for verification and investigative purposes.

3. Large Trader Reporting System Rule

The Commission believes that a consolidated audit trail will be able to build upon various aspects of the large trader reporting system that was recently adopted by the Commission.
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Rule 13h-1, which establishes the large trader reporting system, requires large traders to identify themselves to the Commission and make certain disclosures to the Commission on Form 13H. Upon receipt of Form 13H, the Commission issues a unique identification number to the large trader, which the large trader then will be required to provide to those broker-dealers through which the large trader trades. Registered broker-dealers will be required to maintain specified transaction records for each large trader and to report that information to the Commission upon request. The Large Trader Rule requirements are designed to enable the Commission to promptly and efficiently identify significant market participants and collect data on their trading activity so that Commission staff can reconstruct market events, conduct investigations and bring enforcement actions as appropriate.

88

See
note 1,
supra.

Several commenters noted that portions of the requirements of Rule 13h-1 overlapped with certain provisions of proposed Rule 613 and requested that the Commission harmonize the rules.
89

One commenter

stated that the Commission should consider implementing only those portions of Rule 13h-1 that would not be affected by, or be redundant to, the implementation of the consolidated audit trail proposal.
90

Another commenter suggested that the Commission mandate compliance only with those aspects of Rule 13h-1 that would operate as part of the consolidated audit trail—the large trader identifier in particular—so they could be leveraged in the creation of the consolidated audit trail.
91

Yet another commenter believed that, upon implementation of the consolidated audit trail, it would not be necessary for large traders to identify themselves to their broker-dealers pursuant to Rule 13h-1, because the consolidated audit trail already would require broker-dealers to include a customer identifier for every order.
92

The commenter explained that, if customer information is collected as part of the consolidated audit trail, the Commission and SROs could run queries to identify customers with significant trading volume.
93

89

See
ICI Letter, p. 6-7; Liquidnet Letter, p. 4-5; SIFMA Letter, p. 18-19; CBOE Letter, p. 6

(questioning the need for a large trader reporting system if a consolidated audit trail is implemented).

90

See
FINRA/NYSE Euronext letter, p. 7.

91

See
SIFMA Letter, p. 18.

92

See
Liquidnet Letter, p. 5.

93

Id.

The Commission believes that both Rules are necessary to enhance regulatory oversight of the markets and its members. Key aspects of Rule 13h-1 define the types of entities that are large traders, and who must register with the Commission and file and keep current certain background information on Form 13H. These aspects of Rule 13h-1 are not addressed by Rule 613 and would not be superseded by it. Rather, the information collected by the registration of large traders would further complement the data collected for a consolidated audit trail. To this end, Rule 613 requires that large trader identifiers also be reported to the central repository as part of any large trader's customer account information.
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94

See
Rule 613(j)(4).

The Commission does note, however, that other aspects of Rule 13h-1 may be superseded by Rule 613. Specifically, the trade reporting requirements of Rule 13h-1 are built upon the existing EBS system. To the extent that, as described in Section II.A.2.iv.d., data reported to the central repository under Rule 613 obviates the need for the EBS system, the Commission expects that the separate reporting requirements of Rule 13h-1 related to the EBS system would be eliminated.
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95
Though certain reporting requirements of Rule 13h-1 may eventually be unnecessary due to Rule 613, the Commission notes that Rule 13h-1 will be implemented much more expeditiously compared to the consolidated audit trail, and therefore will address the Commission's near-term need for access to more information about large traders and their activities.

B. Summary of Proposed Rule 613

Proposed Rule 613 would have required that the SROs propose an NMS plan that included provisions regarding: (1) The operation and administration of the NMS plan; (2) the creation, operation and oversight of a central repository; (3) the data required to be provided by SROs and their members
96

to the central repository; (4) clock synchronization; (5) compliance by national securities exchanges, FINRA, and their members with Rule 613 and the NMS plan; and (6) a plan for the possible expansion of the NMS plan to products other than NMS securities.

96
Section 3(a)(3)(A) of the Exchange Act defines the term “member” to mean: “(i) Any natural person permitted to effect transactions on the floor of the exchange without the services of another person acting as broker; (ii) any registered broker or dealer with which such a natural person is associated; (iii) any registered broker or dealer permitted to designate as a representative such a natural person; and (iv) any other registered broker or dealer which agrees to be regulated by such exchange and with respect to which the exchange undertakes to enforce compliance with the provisions of the [Exchange Act], the rules and regulations thereunder, and its own rules.” Section 3(a)(3)(A) further provides that, “[f]or purposes of Sections 6(b)(1), 6(b)(4), 6(b)(6), 6(b)(7), 6(d), 17(d), 19(d), 19(e), 19(g), 19(h), and 21 of [the Exchange Act], the term `member' when used with respect to a national securities exchange also means, to the extent of the rules of the exchange specified by the Commission, any person required by the Commission to comply with such rules pursuant to Section 6(f) of this title.” Finally, Section 3(a)(3)(B) provides that “[t]he term `member' when used with respect to a registered securities association means any broker or dealer who agrees to be regulated by such association and with respect to whom the association undertakes to enforce compliance with the provisions of [the Exchange Act].”
See
15 U.S.C. 78c(a)(3)(A) and 15 U.S.C. 78c(a)(3)(B).

Specifically, proposed Rule 613 would have required the SROs to jointly file an NMS plan with the Commission to govern the creation, implementation, and maintenance of a consolidated audit trail and a central repository.
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The NMS plan would have been required to provide for an accurate, time-sequenced record of an order's life, from receipt or origination, through cancellation or execution. In particular, the proposed Rule would have required the NMS plan to require that the SROs and their respective members collect and provide to the central repository data for each “reportable event,” defined to include the receipt, origination, modification, cancellation, routing, and execution (in whole or in part) of an order, with respect to any NMS security. This data would have been required to be collected and provided to the central repository in a uniform electronic format on a real-time basis.

97
The proposed Rule would have explicitly required 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). “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).

Under the proposed Rule, the data collected upon the receipt or origination of an order would have included: a unique order identifier; a unique customer identifier;
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a unique identifier for the broker-dealer receiving or originating the order; the date and time of receipt or origination of the order; and the “material terms of the order.”
99

For orders that are modified or cancelled, the data collected in real time would have included: The date and time the modification or cancellation was received or originated; the price and remaining size of the order; changes in the material terms of the order (if the order is modified); and the identity of the person giving the modification or cancellation.

98
Proposed Rule 613(j)(1) would have defined the term “customer” to mean the beneficial owner(s) of the account originating the order and the person exercising investment discretion for the account originating the order, if different from the beneficial owner(s).

99
The proposed Rule would have defined “material terms of the order” to include, but not be limited to: The NMS security symbol; security type; price (if applicable); size (displayed and non-displayed); side (buy/sell); order type; if a sell order, whether the order is long, short, or short exempt; if a short sale, the locate identifier, open/close indicator, time in force (if applicable), whether the order is solicited or unsolicited, and whether the account has a prior position in the security; if the order is for a listed option, option type (put/call), option symbol or root symbol, underlying symbol, strike price, expiration date, and open/close; and any special handling instructions.
See
proposed Rule 613(j)(3).

For orders that are routed, data collected in real time would have included: The unique order identifier, the date and time the order was routed; The unique identifier of the broker-dealer or national securities exchange routing the order; the unique identifier of the broker-dealer or national securities exchange receiving the order; if routed internally at a broker-dealer, the identity and nature of the department and desk to which the order was routed; and the material terms of the order.

For orders received that were routed, data collected in real time would have included all the information for orders that are routed, except the identity and nature of the department and desk to which the order was routed, if routed internally at a broker-dealer; however,

the date and time the order was routed would be replaced by the date and time the order was received.

For the execution of an order, data collected in real time would have included: the unique order identifier; the date and time of execution; the execution size and price; the unique identifier of the SRO or broker-dealer executing the order; the capacity of the broker-dealer executing the order (
i.e.,
principal, agency, riskless principal); and whether the execution was reported pursuant to an effective transaction reporting plan or the OPRA Plan.
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100
“The OPRA Plan” is the Plan for Reporting of Consolidated Options Last Sale Reports and Quotation Information filed with the Commission pursuant to, and meeting the requirements of, Rule 608 of Regulation NMS. The OPRA Plan 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.
See
17638 (March 18, 1981), 22 SEC Docket 484 (March 31, 1981) (order approving the OPRA Plan).

Because certain information may not be readily available at the time of the reportable event, the proposed Rule would have required the NMS plan to require each SRO and its members to collect and provide to the central repository certain information, in a uniform electronic format, promptly after receipt of such information, but in no instance later than midnight of the day that the reportable event occurred or when the SRO or its member receives such information. Under the proposed Rule, this data would have included: The account number for any subaccounts to which the execution is allocated (in whole or part); the unique identifier of the clearing broker or prime broker, if applicable; the unique order identifier of any contra-side order; special settlement terms, if applicable; short sale borrow information and identifier; the amount of a commission, if any, paid by the customer, and the unique identifier of the broker-dealer(s) to whom the commission is paid; and, if the execution is cancelled, a cancelled trade indicator.

The proposed Rule would have required that the SROs jointly file an NMS plan with the Commission within 90 days after approval of the Rule. In addition, the SROs would have been required to select a plan processor within two months of the effectiveness of the NMS plan, as well as provide the Commission a document outlining how the SROs would propose to expand the audit trail to include non-NMS securities and additional transactions. The proposed Rule also would have required the SROs to file proposed rule changes to require their members to comply with the requirements of the proposed Rule and the NMS plan within 120 days of the effectiveness of the NMS plan. The SROs would have been required to begin reporting data to the central repository within one year after the effectiveness of the NMS plan, and their members would have been required to begin reporting data to the central repository within two years after the effectiveness of the NMS plan.

As proposed, the NMS plan would have been required to include specific plan provisions, detailing: The plan governance structure, the processes of admission and withdrawal of plan sponsors, the percentage of votes required to effectuate amendments to the plan, the allocation of central repository costs among the plan sponsors, and the appointment of a Chief Compliance Officer (“CCO”) of the central repository. The proposed Rule would have required all plan sponsors to develop and implement a surveillance system, or enhance existing surveillance systems, reasonably designed to make use of the information contained in the consolidated audit trail. This information would be available to the Commission and the SROs for regulatory and oversight purposes only. The proposed Rule also would have required the NMS plan to require information be collected in a convenient and usable standard electronic data format, directly available and searchable electronically without any manual intervention for a period of not less than five years. This information would have been required to be available immediately, or, if immediate availability was not reasonably and practically achieved, any search query would have to begin operating on the data not later than one hour after the search query was made. Additionally, the proposed Rule would have required the NMS plan to include policies and procedures, including standards, to be utilized by the plan processor to ensure the security and confidentiality of all information submitted to the central repository, and all SROs and their employees, as well as all employees of the central repository, would have been required to agree to use appropriate safeguards to ensure the confidentiality of such data. The proposed Rule also would have required SROs and their members to synchronize their business clocks that are used for the purposes of recording the date and time of any event that must be reported under the proposed Rule consistent with industry standards. Further, the proposed Rule would have required the central repository to collect and retain, on a current and continuing basis, and in a format compatible with the other information collected pursuant to the proposed Rule, the national best bid and national best offer (“NBBO”) information for each NMS security. Transaction reports reported pursuant to an effective transaction reporting plan filed with the Commission pursuant to, and meeting the requirements of, Rule 601 of Regulation NMS under the Exchange Act,
101

and last sale reports reported pursuant to the OPRA Plan filed with the Commission pursuant to, and meeting the requirements of, Rule 608 of Regulation NMS under the Exchange Act also would have been required to be collected and retained.

101
The effective transaction reporting plans include the Consolidated Tape Association Plan (“CTA Plan”) and the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation and Dissemination of Quotation and Transaction Information for Nasdaq-listed Securities Traded on Exchanges on an Unlisted Trading Privilege Basis (“UTP Plan”).

C. Summary of General Comments on the Proposed Rule

The Commission requested comments on all aspects of the proposed Rule, including the potential costs and benefits.
102

In particular, the Commission encouraged commenters to identify, discuss, analyze, and supply relevant data regarding any such costs or benefits.
103

In response, commenters provided views and opinions regarding the regulatory usefulness of a consolidated audit trail; the overall costs of the proposed Rule, focusing on those requirements that commenters believed would be the most costly or burdensome to implement;
104

the process for creating and implementing a consolidated audit trail; and alternatives to the proposed Rule's approach to creating, implementing, and maintaining a consolidated audit trail. These comments are discussed below.

102

See
Proposing Release,
supra
note 4, at 32586 and 32594.

103

Id.

104
For comments on general costs of the proposed Rule,
see, e.g.,
Thomson Reuters Letter, p. 2; Liquidnet Letter, p. 1; CBOE Letter, p. 2; Nasdaq Letter I, p. 2; Angel Letter, p. 1-2; IAG Letter, p. 3.; Kaufman Letter, attachment p. 3; Wells Fargo Letter, p. 4; Noetic Partners Letter, p. 2; Leuchtkafer Letter, p. 1-5; Broadridge Letter, p. 3; SIFMA Letter, p. 1-2, FINRA Letter, p. 3; FINRA Proposal Letter, p. 2.; High Speed Letter, p. 1; Belanger Letter, p. 7-8.

1. Industry Support for a Consolidated Audit Trail

Commenters provided a wide range of opinions, and shared their concerns, regarding specific aspects of the proposed Rule.
105

However, many of the

commenters and their representatives who are involved with regulating and operating securities markets—as well as many of the commenters who otherwise populate data for, or make use of, existing audit trail systems (such as broker-dealers)—expressed support for the creation of a single consolidated audit trail.

105

See
Section II.C.,
infra,
for a discussion of specific concerns raised by commenters.

FINRA and NYSE Euronext, filed a joint letter, “vigorously support[ing] the establishment of a consolidated audit trail,” and stating, among other things, that “the evolution of the U.S. equity markets and the technological advancements that have recently taken place have created an environment where a consolidated audit trail is now essential to ensuring the proper surveillance of the securities markets and maintaining the confidence of investors in those markets.”
106

106

See
FINRA/NYSE Euronext Letter, p. 1. NYSE Euronext is the publicly traded parent of a number of subsidiaries, including three SROs, NYSE, NYSE Amex, and NYSE Arca.

The NASDAQ OMX Group, Inc. similarly states that “[m]arket developments and fragmentation of market centers with varying market structures and levels of transparency have created inefficiencies and potential gaps in cross-market regulation,” and that “[c]omplete transparency is the only way to ensure fair and orderly markets.”
107

107

See
Nasdaq Letter I, p. 2. The NASDAQ OMX Group, Inc. is the publicly traded parent of a number of subsidiaries, including three SROs, Nasdaq, Phlx, and BX.

Other commenters also stated their general support for the creation of a consolidated audit trail. According to Direct Edge Holdings, LLC (“Direct Edge”), “[t]he proposed consolidated audit trail (`CAT') system would significantly enhance the capabilities of regulators to police trading across asset classes; replace existing audit trails and consolidate trading and execution data for the asset classes under the Commission's jurisdiction * * * enable regulators to create a more complete timeline of an order's lifecycle; and facilitate large-scale market reconstructions * * * .”
108

108

See
Direct Edge Letter, p. 1. Direct Edge is the parent of two SROs, EDGA Exchange, Inc. and EDGX Exchange, Inc.

Although CBOE expressed some concerns in its comment letter about the “breadth, expense, and timetable of the Proposal”
109

(concerns that were shared by other commenters),
110

it “recognizes there are potential benefits to be obtained from CAT, and agrees that a central repository with uniform data submitted by all markets could enhance SRO and SEC oversight of the markets.”
111

CBOE further stated that, “[i]n particular, a CAT that contains a customer identifier on an order by order basis would enhance significantly the audit trails of the markets.”
112

109

See
CBOE Letter, p. 2.

110

See, e.g.,
Scottrade Letter, p. 1; ICI Letter, p. 4-6; FINRA/NYSE Euronext Letter, p. 4; GETCO Letter, p. 2; BATS Letter, p. 1-2; SIFMA Letter, p. 3-8; Direct Edge Letter, p. 3; FINRA Letter, p. 10-13; Wells Fargo Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter; Broadridge Letter, p. 3; SIFMA Proposal Letter, p. 1; FINRA Proposal Letter, p. 3.; Liquidnet Letter, p. 3 & p. 5-6; Ameritrade Letter, p. 2-3

111

Id.

112

Id.

BATS Exchange, Inc. (“BATS”) expressed general support for the Commission's proposal, stating, “[o]ver the last several years, liquidity has dispersed across multiple interconnected venues, such that no one market center can claim a majority share of equity securities transactions. However, regulatory tools have not evolved to keep pace with these changes, and the limited existing processes and data available to analyze inter-market trading are inadequate. As a consequence, regulators rely on inefficient processes to reconstruct inter-market trading activity, including ad hoc requests to members for trading data when a potential problem is identified.”
113

113

See
BATS Letter, p. 1.

Liquidnet, Inc. (“Liquidnet”), an ATS, generally stated that, “[i]n the long run, a properly-designed system that provides for centralized reporting of data should be more cost-efficient than the current patchwork system for collecting audit trail data.”
114

Liquidnet outlined seven specific benefits of a consolidated audit trail, ranging from “[reducing] the time that regulatory personnel must expend to request and collect data from market participants on a case-by-case basis,” to “[reducing] the cost of reconstructing, analyzing, and reporting on significant market events such as those that occurred on May 6, 2010.”
115

114

See
Liquidnet Letter, p. 1.

115

Id.
at p. 1-2.

The Securities Industry and Financial Markets Association (“SIFMA”), an industry group that represents, among other entities, hundreds of securities firms that could be impacted by the creation of a consolidated audit trail, “believes that a centralized and comprehensive audit trail would enable the SEC and securities self-regulatory organizations (`SROs') to perform their monitoring, enforcement, and regulatory activities more effectively.”
116

SIFMA further states that, “[i]n the current era of electronic trading, regulators need efficient access to order and execution data from both broker-dealers and exchanges. Indeed, a consolidated audit trail is a much-needed improvement over today's fragmented audit trail platforms.”
117

As did a number of other commenters,
118

SIFMA also expressed concerns about, and suggested alternatives to, some specific aspects of the proposed Rule, which will be further discussed below.

116

See
SIFMA Letter, p. 1-2.

117

Id.
at p. 2.

118

See, e.g.,
FINRA/NYSE Euronext Letter, p. 7, FINRA Letter, p. 3, FINRA Proposal Letter, p. 1-16, FTEN Letter, p. 1, 4-5, Correlix Letter, p. 2-3; BOX Letter, p. 2; BATS Letter, p. 2.; CBOE Letter, p. 2; Angel Letter, p. 2; Wells Fargo Letter, p. 2; Knight Letter, p. 3; FIF Letter, p. 5-6; Schumer Letter, p. 1.

Finally, th

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2012-17918. Public record. Not legal advice.