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Consolidated Audit Trail - Bifurcated Cost Allocation Is Inequitable, By Kelvin To, Founder And President At Data Boiler Technologies

Date 22/06/2021


Regarding the Consolidated Audit Trail (CAT)’s funding model, both the original and the revised proposal are like the Financial Transaction Tax. The plan is simply tolling everyone in the industry, which will ultimately be passed-down to the end-investors. We question why the CAT operating committee, a CAT governing body composed of ONLY representatives of the SROs, would hold concentrated power on the Funding Authority as set out in the CAT NMS Plan Exhibit A Article XI §11.1?  

We challenged the §11.2 Funding Principles as being insufficient to check against the CAT operating committee’s legislative power to (a) approve budget of CAT and (b) establish fees for themselves as well as for all industry members, the committee’s executive power in (c) imposing and collecting of all CAT Funding Fees, and the judicial right to (d) assign and change the tier assigned to any particular Person, resolution of disputes upon reasonable notice to such Person. 

Even though the SROs are required to file the fee schedules with the Commission, such unchecked power of the CAT operating committee would not ease the public or the industry community’s concerns for potential biases. If the CAT operating committee’s funding authority under §11.1 is a delegated power conferred by the SEC to perform a public duty, then we have the following concerns and/or questions: 

(A) Why are the CAT fees not imposed on the direct recipients of those that receive benefits from such services but rather a ‘tax’ on all industry members? 
  1. If the CAT fee is related to supporting the SEC to “rapidly reconstruct market events/ trading activity” beyond using the public available data, then the Commission may subscribe to the SROs’ proprietary feeds for any non-public data, or seek expressed consent to voluntarily share, or use of its permissible authority to summon the relevant private information. 
  2. If the CAT fee is related to “facilitating risk-based examinations” and/or “improving abilities for evaluating tips, complaints and referrals of potential misconduct made to regulators, monitoring and evaluating changes to market structure”, then the SEC and SROs may go back to the Congress for funding or pay for it using collected fines, penalties, and intragovernmental fees, but not “user fees”. 
  3. If the CAT fee is related to “better identification of potentially manipulative trading activity, increased efficiency of cross-market and principal order surveillance”, then private surveillance businesses affiliated with Exchange Groups stand to receive benefits from CAT, hence they should pay the most if not all of such CAT costs. The SEC and other SROs shall have choice to use peers’ surveillance system, or build their own or buy from other private vendors.
  4. If the CAT fee is related to “improving efficiencies from a potential reduction in disparate reporting requirements and data requests”, then it should be segregated into the regulators’ portion and the users’ portion. If CAT is constituted as one of the “user fees” imposed by the SEC and/or SROs, then according to the Government Accountability Office, these “fees assessed to users for goods or services provided by the Federal Government are deposited to the Treasury as miscellaneous receipts and are generally not available to the agency.” Fees assessed under the authority of the Independent Offices Appropriation Act of 1952 (codified at 31 U.S.C. § 9701), rather than under a specific authorizing statute, must be deposited to the Treasury as miscellaneous receipts and are not available to the agency or program that collected the fees, unless otherwise authorized by law.

If the SROs argue that CAT fee setting, collection, and dispute resolution are common commercial practices that they should have full discretion, then, CAT would not be part of their arbitral and prosecutorial authority. Hence, the SROs should not enjoy immunity related to their private businesses and the industry members shall then have choice (under antitrust laws), including rights to opt-out of CAT given they are not even users of the CAT system. If CAT fee/ minimum is a “pay to play” bundled cost to participate in a market, then this “tax” is a barrier of entry inconsistent with the competition, capital formation, and other goals of the Exchange Act.

Other than a negotiable portion of point “(A)4” as mentioned above, CAT has no reason to allocate an inequitable 75% of CAT cost to Industry Members because it contrasted with the SEC's staff guidance on SRO rule filing relating to feesThe proposed $125 per quarter ($500/ annum) minimum to Industry Members hits 225 industry members in the bottom population (18.2% of 1237). There will be 792 industry members (64%) paying 1 penny to 86 cents above the minimum per quarter under the proposal. If counting from industry members #37 to the #1237 (97.1%), they generate 3.33% of message traffic, but will be required to pay for 4.26% of aggregated industry member fees under the proposal. It is a huge wastage in CAT billing and other administrative functions to collect these “de Minimis” fees or minimums from small industry members; it proves that the proposed funding model is inconsistent with funding principle §11.2(d). 

(B) Why should smaller firms subsidize the top 36 elites whom generate 96.67% of message traffic but will pay 95.74% of aggregated industry member fees after the discounts? 

Some of the top elites already receive 32 mil super-tier rebates and other favorite treatments to compensate for their market making efforts and order flow contributions in the price discovery process. The CAT operating committee’s proposal with discount, maximum cap, minimum, and other adjustments would further exacerbate the inequalities in the market. Establishment of a funding model without involvement of industry members and the public may raise public concerns or potential negative impression that CAT being a “private party” among elites to seek unfair advantages over others. The proposed funding model will cause undue burden on Industry Members. 

Rulemaking to seek sole benefit for the government agency or the affiliated SROs should be prohibited. Therefore, we 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.

Published by

Founder and President at Data Boiler Technologies
Whether it is the SEC’s 25%/75% revised funding model or the NYSE’s 33.3%/66.7% counter proposal, the bifurcated cost allocation approach for the Consolidated Audit Trail (CAT) is inequitable. This article probes into various what-if scenarios to question the CAT Operating Committee’s funding authority. IMHO, the unchecked power to impose CAT cost like a Financial Transaction Tax may will hurt all industry members like “Sh*t hit the fan” and ultimately be passed down to all investors.