Photographer: Michael Nagle/Bloomberg

Wall Street Wins Round in Fight With Exchanges Over Audit System

  • SEC is reviewing exchanges’ plan to pay for surveillance tech
  • System meant to catch cheaters, diagnose mysterious crashes

The long effort to make it easier to catch cheaters and diagnose the causes of mysterious crashes in the U.S. stock market just suffered another setback.

The Securities and Exchange Commission is reviewing how exchanges plan to pay for the massive database, known as the Consolidated Audit Trail, with fees from brokers, banks and other traders. The decision came after financial firms complained that their concerns were ignored by the exchanges.

It’s the latest twist in the multi-year struggle to build something regulators say is critical to keeping tabs on computerized markets where trading happens in tiny fractions of a second. The May 2010 flash crash underscored the need for such a system -- which needs to process billions of records a day -- yet the details were only finished in the past year. The SEC’s review may push the matter up the agenda of the regulator’s new chairman, Jay Clayton.

“It’s not surprising that the funding structure is under scrutiny,” said Tyler Gellasch, a former SEC official who’s now at the Healthy Markets Association, a market-structure advisory group with members including OppenheimerFunds and Janus Capital Group. “It is surprising that it’s taken this long for the SEC to show any inclination that it appreciates the conflicts of interest posed by having one set of for-profit entities setting the costs for other market participants, including some of their competitors.”

The SEC declined to comment.

Slow Tech

Today when the SEC wants to probe trading, it can take days with current technology because it often has to collect the data from different systems. The CAT aims to change that. Its design was approved in November, and Thesys Technologies LLC was picked to build the database in January.

Exchanges wanted traders to cover about three-quarters of the CAT’s operating costs. The more trading data they create, the more they pay.

The Securities Industry and Financial Markets Association, a trade group for brokers and money managers, argued a month ago that their voices had been ignored and that the SEC should review whether to approve or reject the fee plan. On June 30, the regulator did just that and temporarily suspended the levies. Sifma members include finance giants like Goldman Sachs Group Inc. and JPMorgan Chase & Co., as well as Bloomberg News parent Bloomberg LP.

The exchanges and the Financial Industry Regulatory Authority, the industry-funded Wall Street regulator that also oversees the CAT, say they didn’t ignore critiques when deciding how much to charge.

“Broker-dealers and other market participants had ample opportunity to provide input into the CAT funding model,” they said in a June 29 comment letter.

‘That’s Anticompetitive’

OTC Markets Group Inc. runs a trading system where investors can buy or sell mostly tiny stocks -- typically companies not eligible for listing by the New York Stock Exchange or Nasdaq Stock Market. Its chief executive officer says his firm is being asked to contribute too much to the CAT, even though it’s far smaller than most exchanges.

“That’s anticompetitive,” said Cromwell Coulson, CEO of OTC Markets Group. “The SEC has an obligation to make sure CAT fees are fairly allocated.”

Much like setting rates for public utilities, “everyone makes the case that someone else should bear the cost,” said James Angel, a Georgetown University finance professor who studies trading. “We have a very complex market structure and need a complex information system. The question is: How cost effective is that system going to be?”

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