Broker-dealers have been encouraged by the efforts of CAT NMS — a consortium of 22 self-regulatory organizations — to extend the effective date for implementation of the SEC's Rule 613 consolidated audit trail reporting. By replacing a variety of regulatory reporting systems with a comprehensive CAT system, the Securities and Exchange Commission and the SROs are seeking to more efficiently and accurately track all activity in National Market System securities.
The SEC has not yet approved exemptive relief, but the publication in January of the SROs' implementation timeline included an extension date, sending a strong signal to the SEC that large broker-dealers would be unlikely to start reporting on CAT before 2020. This lack of clarity around the CAT implementation has created an uncertain environment for broker-dealers of all sizes.
The current confusion may also serve to delay the industry's much-needed focus on two important structural issues: establishing internal accountabilities for the regulatory reporting function and ensuring the integrity of the data management process. For many broker-dealers, unless these two longstanding shortcomings are resolved, the CAT transition will create even greater compliance risk. For the SEC, the industry's management and operational issues will greatly limit achievement of its strategic objectives for CAT.
Over the past two decades, implementation of regulatory reporting to address Finra's Order Audit Trail System or the self-regulatory organization's Electronic Blue Sheet-related requirements has frequently been considered a back-office function. Responsibility has been pushed onto the plates of the IT department, an isolated trading desk or operations professionals, who possess neither a complete understanding of the data nor an appreciation of the associated reporting risks. There's been a lack of funding as well as the senior-level oversight necessary to ensure proper and consistent reporting compliance.
Well in advance of CAT implementation, broker-dealers must resolve the issue of ownership and accountability for regulatory reporting within their firm. Ideally, this involves the creation of an integrated team, led by a member of senior management and consisting of internal (or external) subject matter experts in technology, operations, data analysis, financial products and regulatory risks. Allocation of funds to support these compliance units should be weighed against potential regulatory sanctions and the reputation risks associated with noncompliance.
The second industry challenge involves the fundamental steps necessary to maintain data integrity. This has always been at the heart of the reporting issue and difficult for most broker-dealers to manage because of the failure to update reporting applications, the volume and complexity of the data that need to be generated and inadvertent changes to data sources caused by day-to-day business activity. In fact, the root cause of most regulatory fines related to OATS, EBS and Large Options Positions Reporting has been missing and inaccurate data.
With its cross-functional reporting team in place, a broker-dealer's preparations for transition to CAT reporting should include a robust, side-by-side comparison between its existing OATS and EBS records against the new technical specifications of CAT. These test scripts will identify any differences in formatting, as well as missing and inaccurate data across all the fields. If there are deviations from CAT requirements in the firm's current OATS or EBS reports, those issues should be proactively addressed, for three reasons:
• FINRA and the SEC will continue to monitor and enforce existing reporting requirements until they are retired;
• Similar data sources and feeds may be used to address a significant number of CAT requirements; and
• These comparisons can uncover existing risks in the complex interplay of data sources that has caused so many problems and enforcement actions related to OATS, EBS and LOPR.
In addition to this platform comparison, firms should conduct in-depth data mapping to validate the accuracy of their records of transactions and account files, so that any systemic reporting issues can be addressed. The testing and validation cannot be point in time. Just as firms now test core net capital and reserve calculations, often with assistance from independent sources, such testing should be bolstered to include CAT and legacy OATS, EBS and LOPR regulatory reporting.
Alternatively, broker-dealers can respond to these mission-critical structural requirements by throttling back on their CAT project plans with the expectation that the SROs' implementation calendar will be adopted and that additional extensions are likely. Or they might seek to take advantage of the fact that SROs may be somewhat forgiving initially as the industry struggles to meet the CAT requirements. Those procrastinating broker-dealers will most likely to be targets of future regulatory action.
John Ivan Esq. is a managing director at Chicago-based Capital Forensics Inc., a regulatory consulting firm.