Cost worries dog "CAT" plan to monitor U.S. stock market

Mon Jun 17, 2013 2:01pm EDT

* Audit system spawned by 2010 "Flash Crash"

* Bidding for consolidated audit trail pushed back from June 30

* FINRA seen as front-runner, but many details unresolved

By Herbert Lash

NEW YORK, June 17 (Reuters) - Concerns about how much it will cost to build a new surveillance system for the U.S. stock market hang over a project regulators demanded after it took months to pull together the data needed to investigate the "flash crash" of May 2010.

A June 30 deadline for turning in bids to build and manage the Consolidated Audit Trail, or CAT, was pushed back on Friday to mid-August at the earliest because the selection process still must be approved by the U.S. Securities and Exchange Commission.

The delay is a procedural issue, but worries about the cost - vague estimates now hover around $1 billion instead of earlier suggestions of as much as $4 billion - have created anxiety within the securities industry about the audit trail.

"People who have looked at this have become fairly skeptical about the project because they're looking at how much it's going to cost," said Manoj Narang, founder and chief executive of Tradeworx, a high-frequency trading firm and hedge fund in Red Bank, New Jersey, that intends to bid on the project.

The audit trail is considered crucial for regulators to be able to monitor the market and to build confidence among both the industry and public that regulators have this capability. It is expected to capture information from broad swath of the market, including trading, order management and routing, compliance, risk management and the back office.

Two sessions about the CAT are scheduled for Tuesday at the two-day "SIFMA Tech" conference on technology sponsored by the Securities Industry and Financial Markets Association, the industry's largest trade group.

Discussion of cost estimates take up much of the Securities and Exchange Commission's 351-page rule that mandated the CAT. But Narang believes the estimates are probably not valid and that the CAT will likely end up costing a fraction of $1 billion. Tradeworx has a $2.5 million contract to supply a high-speed data feed to the SEC.

The exchanges overseeing the CAT will determine the cost of the project, which they will share with their members. The lack of a market-wide database delayed regulators examining the flash crash in May 2010 and led the SEC to approve Rule 613 a year ago to create an audit trail to capture all orders and executions.

"We're much more optimistic that this thing can get done," Narang said.

SIFMA last year said that the cost of capturing options quotes in real time could alone exceed the SEC's $2.1 billion estimate for the audit trail's annualized cost.

Another concern is whether the CAT will require an entirely new reporting system or if the linkage brokers already have to an existing tracking system run by the Financial Industry Regulatory Authority can be incorporated to reduce costs.

The retirement of legacy systems would provide significant cost savings and allow both broker/dealers and regulators to tap into current sources of funding for the CAT, SIFMA said in March in a letter to the exchanges overseeing the project.

Many people say FINRA has an advantage in winning the bid because of its existing order audit trail system, or OATS, which does not track all the data required of the CAT, such as information on the customer behind an order.

Thirty-one firms in March expressed interest in bidding for the project, but four companies have withdrawn their intention to be the primary bidder.

"From an industry standpoint, we get a lot of feedback that we're the right people to do it," Richard Ketchum, chairman and chief executive of FINRA, told Reuters two weeks ago.

"I do believe we are probably the favorites at this point, but of course, so was Orb for the Preakness," Ketchum said, referring to this year's Kentucky Derby champion, which was the favored horse in the Preakness Stakes but failed to win.

Some proposals will likely include retrofitting new data onto FINRA's system. But it is unclear if that would be cheaper or provide all the capabilities the CAT requires, Narang said.

"It's basically a technology issue. Sometimes it's easier to build new systems from scratch, rather than force-fit new capabilities onto legacy infrastructure," he said.

There are other outstanding considerations, such as whether the CAT will be cloud-based or use hardware to store data. Hardware requires a large up-front expenditure, while the cloud is cheaper and capacity can be augmented as needed.

Cost, however, remains the biggest issue for a securities industry faced with compliance to Dodd-Frank regulations and tighter profit margins because of a decline in transactions.

There are many service providers that could support CAT on an annual basis for between $50 million and $250 million, depending on the plan's final specifications, said Ted Myerson, former head of global access services at Nasdaq OMX.

"At the end of the day the industry can't support a $1 billion-a-year price tag. Not just to set it up, but also to manage and operate it," said Myerson. "If the industry had to bear a $1 billion-a-year project, it would almost bankrupt it."

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