* Audit system spawned by 2010 "Flash Crash"
* Bidding for consolidated audit trail pushed back from June
* FINRA seen as front-runner, but many details unresolved
By Herbert Lash
NEW YORK, June 17 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
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,"
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."