We argued against both the original “execution venue” concept and the proposed “message traffic” concept for the Consolidated Audit Trail (CAT) funding model. If CAT is meant to prevent future flash crashes, curb suspicious trading behavior and unusual market events, then why should those who are doing things fairly and squarely be subjected to regulatory scrutiny and CAT cost burden? Since CAT is an attempt to protect investors from market manipulation, flash crashes, etc. We believe the CAT funding model should be driven mainly by fines and settlements coming from CAT investigations, which deem acceptable revenue streams to cover CAT LLC costs satisfying the §11.2 funding principles.
If fines and settlements are insufficient to cover all CAT costs, then the SEC and CAT operating committee may consider imposing a negotiable portion of the cost which we mentioned in point (A)4 of our last article, to those based on materiality and number of suspicious activities reported on the Suspicious Activity Reports (SAR). Those who under report on SAR should get increased fines. We think those who “operate at the edge” and have higher risks for potential conflicts of interest, should bear much of CAT cost given the extra efforts in deciphering their complex activities as compared to firms with a simpler business model. Indeed, smaller players who do not accept or pay payment for order flow (PFOF) and who are not entitled to access fee rebates deserve appropriate subsidies, so there will be a sustainable pipeline of emerging broker-dealers to participate in the markets.
a) Categorization of ATS, Market Making Discount, and Maximum are Unjust
Regarding Alternative Trading Systems (ATS), we think Dark pools introduce higher implicit risks due to their lack of transparency and vulnerability to potential conflicts of interest than Lit venues. Therefore, dark pools should bear higher CAT cost than SROs. That being said, internalizers / market makers may post higher risks and be more vulnerable to potential conflicts of interest than Dark Pools. Equity / Option Market Makers whom business models derive from paying substantial rebates to others should not get a CAT discount. Whereas Tier 2 and smaller Market-Makers whom do not pay or receive any rebate have a simpler business model and deserve appropriate subsidies to encourage their participation.
The SEC should scrutinize industry members who are owners/ affiliates with ATS, or sponsors to an Exchange to avoid potential exploitation of their economy of scope or alleged trading cartel in price setting or allocation of disproportional incentives. Again, more CAT cost should be allocated to those requiring regulators extra efforts in deciphering their complex activities as compared to firms with a simpler business model. SAR would be a good basis for easier administration in determining CAT fees.
b) Capitalize on ‘Historical Assessment’ (Thesys past development work) or is it a sunk cost
Why should the public (industry members would ultimately pass down the cost to end investors) pay for anything (recover 75% or ~$145 million incurred in Period 1) that may be allowed to capitalize on as the CAT LLC/ FINRA/ CAT Operating Committee’s “private asset”? If past development work by Thesys is considered as “public asset”, then why wasn’t there a full disclosure of all CAT’s budgeted building and operating costs for the public to review before the incurrence? If it is a “sunk cost”, why should industry members bear consequences of procurement decisions that they were NOT part of the approval process, and are NOT and will NOT be ‘users’ of the CAT system?
c) Troubles in excluding OTC in Equity/ Listed Option Group Spit for CAT Participants
We acknowledge that FINRA being a non-profit trade association managing the trade reporting facility (TRF) for Over the Counter (OTC) products rather than a for-profit Exchange may have a harder time to shoulder CAT burden. Yet, FINRA replaced a private vendor Thesys as the CAT processor and should NOT get preferential treatment based on its non-profit or SRO status. Although we acknowledge that the nature of OTC trading in penny level may inherently be different from the proposed message traffic measurement use in Equity / Listed Option Group Split, similar arguments may apply to thinly traded securities, ESG stocks, etc., which SEC rule should avoid “craft-out”.
Historically, OTC has high implicit risks due to its lack of transparency and vulnerability to potential conflicts of interest than Equity and Listed Option asset classes. And for the fact that FINRA would receive explicit benefit from CAT (from perspectives of being the CAT processor, may capitalize prior development works by Thesys, and CAT will enhance FINRA’s technology), FINRA as a direct recipient of CAT benefits must bear higher portion of CAT costs than other SROs whom do not own or affiliate with a surveillance business. Indeed, FINRA and its cloud vendor – FINRA and Amazon Web Services (AWS) should fend off any public concerns about too big to fail by voluntarily providing full disclosure, and the SEC should scrutinize, to ensure CAT funding won’t be mixed-in cross-subsidizing existing surveillance and cloud processing business. There is a thin line between synergy and potential conflicts of interest (especially, FINRA also holds the SRO power to fine broker-dealers over surveillance system deficiencies). We oppose the proposed FINRA-related cap allocation/ reallocation “Adjustment” and any Equity/ listed option Market Makers Discounts.
It is worth mentioning that CAT participants included Listed Options Venues and is missing Futures and SWAP data is one of CAT’s biggest flaws. Thus, making this “gigantic vault” useless for meaningful market analysis.
We oppose the proposed Market Share approach to replace/ eliminate tiered fixed fees. The CAT operating committee’s proposals if adopted will put undue burden on good industry members and is not a deterrent to those industry members who introduce risk and detriment to the public interest. It will have an adverse impact on the incentives of the CAT participants to ensure the security of CAT and CAT data. It will NOT remove impediments to, and will NOT perfect the mechanisms of the NMS, will NOT furtherance of the purpose of the Exchange Act, but would exacerbate the potential exploitation of powers allegedly by the CAT Participants leading to inequitable, biased, unfair, discriminatory situations harming smaller industry members, putting burden on competition, and may destabilize the fairness and orderly markets.
To preserve the equitable, non-biased, fair, and non-discriminatory principles and fend off any public concerns or potential negative impression of CAT being a “private party” among elite CAT participants with fee cap, maximum, and adjustments, we again suggest adding a new CAT funding principle 11.2(g) about CAT costs allocation should be in proportion with specific public benefits received, i.e. not private benefits of CAT participants; and those that have higher implicit risk and vulnerability to potential conflicts of interest must be charged higher fees than others, to cover what is not already funded by fines and settlements from abuse or other securities law violation cases.
