UPDATE 1-US SEC approves database plan to audit stock trades

Wed Jul 11, 2012 12:40pm EDT

* Exchanges have 270 days to submit plan for database

* Database to have trade orders, executions, cancellations

* SEC's Aguilar, Walter dissent, call rule weak

* Rule will not require real-time reporting of data

* Smaller brokers will get more time to comply

By Sarah N. Lynch

WASHINGTON, July 11 (Reuters) - A divided Securities and Exchange Commission on Wednesday adopted a rule designed to bolster its surveillance of the equities markets by establishing a central database that stores every trade order, execution and cancellation.

The rule will bring the SEC one step closer to having a consolidated audit trail to better police for market manipulation and insider trading, though the new database will not be operational in the near term.

The rule would give U.S. exchanges 270 days to jointly submit a plan for establishing a consolidated audit trail. The exchanges and the Financial Industry Regulatory Authority (FINRA), as well as their broker members, would be required to provide detailed information to the database.

The exchanges' plan will be subject to SEC approval. If approved, the parties would need to start reporting data within one year.

Though the SEC's five commissioners all supported the concept of a consolidated audit trail, not everyone agreed on Wednesday with how the final rule was drafted.

The rule was approved on a 3-2 vote, with Democrats Luis Aguilar and Elisse Walter voting no amid concerns it gives exchanges too much flexibility.

"I believe that the rule should not require that all the SROs (self-regulatory organizations) jointly submit a single plan. Rather, the rule should provide the commission with the ability to consider a fulsome discussion of competing solutions," Aguilar said.

"This assumes that all SROs will have equal weight and negotiation power, which is just not realistic."

Walter's no vote marked a rare public disagreement with SEC Chairman Mary Schapiro. The two are close personal friends and previously worked together at FINRA.

"I believe that the rule before us today falls far short of where we need to be in terms of bringing market oversight into the 21st century," she said, calling the rule "disappointingly weak."

She added that she hoped exchanges will go "above and beyond" the minimum requirements of the rule, proving her concerns unfounded.

Schapiro sought to reassure both Walter and Aguilar, saying the SEC will "push and pull" to ensure the final plan will meet the agency's needs.

The idea of establishing a consolidated audit trail gained momentum after the May 6, 2010, "flash crash" that temporarily wiped out roughly $1 trillion in shareholder equity in a matter of minutes.

The fragmented nature of the U.S. equities markets made it difficult for the SEC to piece together exactly what happened, and it took months for the SEC to gather and analyze all of the data.

"A consolidated audit trail will significantly increase the ability of regulators to monitor overall market structure, so that both the commission and the SROs can be better informed about how our rules are affecting the markets," Schapiro said.

"Having more precise data on the trading patterns of different types of market participants would help us better understand the impact of high frequency trading on the quality and fairness of our markets."

As expected, the final rule has been scaled back from the original 2010 proposal by removing a key provision that would have required the trade data to be submitted in real time.

Exchanges like NYSE Euronext and brokers like TD Ameritrade had balked at that provision, saying it was too costly to implement and would not provide much benefit.

Under the final rule, they will need to submit the data by 8 a.m. the following morning.

Gregg Berman, a senior official in the SEC's trading and markets division, said the switch from real-time to next-day reporting will not be a disadvantage to the SEC.

"Virtually all of the benefits of a (consolidated audit trail) can be achieved using an 8 a.m. reporting deadline," he said.

The rule will also require the information to be tagged and stored in such a way that the SEC will be able to follow an order "through its entire life cycle."

Each broker-dealer and exchange will also be assigned a unique identifying number.

The final rule gives more deference to exchanges than the original proposal, allowing them to determine the specifics of how market players report the data to the central repository.

The SEC also said it will give smaller broker-dealers up to three years, rather than the two previously proposed, to begin reporting the data.

Questions about the final costs of the consolidated audit trail were still a bit unclear. Initially, the SEC estimated it could cost $4 billion for the industry collectively to create the database and have real-time reporting.

The SEC decided to kick a cost-benefit analysis of the final rule down the road and wait until after the exchanges submit their plan before proceeding with a cost study.

As part of the plan that exchanges must submit to regulators, they will be required to describe in detail the costs for creating, implementing and maintaining the consolidated audit trail.