to avoid additional market activity that might move it to a higher fee
tier. For example, to control its tier level, a market participant
could reduce its quoting activity or cease providing services in a set
of securities. Such activity could affect liquidity and the
availability of trading services to investors. The Commission notes,
however, that because this incentive is contingent on being near a fee-
tier cutoff point, it preliminarily believes relatively few market
participants would likely be affected and thus market quality effects
would likely not be significant.\1007\ Furthermore, for those market
participants near a cutoff point, managing activity to avoid a higher
fee tier would necessarily incur costs of lost business and potential
loss of market share, and would possibly be difficult to implement,
which should mitigate any effects on market quality.
---------------------------------------------------------------------------

    \1004\ See CAT NMS Plan, supra note 3, at Section 11.3 and
Appendix C, Section B.7(b)(4)(C).
    \1005\ The CAT NMS Plan defines ``Execution Venue'' as ``. . . a
Participant or an alternative trading system (``ATS'') (as defined
in Rule 300 or Regulation ATS) that operates pursuant to Rule 301 of
Regulation ATS (excluding any such ATS that does not execute
orders).'' The Plan also defines Industry Member as ``. . . a member
of a national securities exchange or a member of a national
securities association''. See CAT NMS Plan, supra note 3, at Article
I, Section 1.1 for definitions. Classification of Execution Venues
into tiers is based on transacted volume market share of share
volume (in the case of NMS stocks and OTC Equity Securities) or
contract volume (in the case of listed options). For Industry
Members, classification into tiers is based on message traffic.
Based on conversations with Participants, the Commission
preliminarily believes message traffic would be based on CAT
Reportable Events reported to the Central Repository. See id. at
Article XI, Section 11.3 for discussion of assignment to funding
tiers.
    \1006\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(v).
    \1007\ This argument assumes that activity levels used to
determine funding tiers do not naturally cluster near cutoffs, and
that if such natural cutoff points exist, the Operating Committee
would avoid setting such funding tier cutoff levels near those
activity levels.
---------------------------------------------------------------------------

    The Commission recognizes that the tiering of fees also could
create calendar effects within markets. Although the Plan does not
detail the horizon at which CAT would measure activity levels, the
structure ultimately approved by the Operating Committee could affect
market participant behavior near the end of a measuring period. For
example, high levels of market activity during a measuring period might
cause CAT Reporters to limit their activity near the end of a
measurement period to avoid entering a higher fee tier. If this
translates into a reduction in quoting activity, market liquidity
conditions could deteriorate at the end of activity measurement
periods, and improve when a new measurement period begins, for example.
    The Commission notes that the Operating Committee has discretion
under the Plan governance structure to make the tier adjustments
discussed in Section 11.1.d for individual CAT Reporters. This
provision might mitigate incentives for individual market participants
to alter market activities to reduce their expected CAT fees.
d. Differential CAT Costs Across Execution Venues
    The funding model proposed in the Plan is a bifurcated funding
model, in which costs are first allocated between the group of all
broker-dealers and the group of all Execution Venues, then within these
groups by market activity level.\1008\ The proposed funding model
treats Execution Venues differently from broker-dealers; this
differential treatment could introduce inefficiencies to the market for
execution services. As discussed in a recent academic paper,\1009\
differential funding models in execution venues could influence how
broker-dealers route customer order flow, possibly to the detriment of
execution quality realized by investors. The Commission preliminarily
believes that the bifurcated funding model proposed in the Plan almost
certainly results in differential CAT costs between Execution Venues
because it would assess fees differently on exchanges and ATSs for two
reasons. First, message traffic to and from an ATS would generate fee
obligations on the broker-dealer that sponsors the ATS, while exchanges
incur almost no message traffic fees.\1010\ Second, broker-dealers that
internalize off-exchange order flow, generating off-exchange
transactions outside of ATSs, would face a differential funding model
compared to ATSs and exchanges.\1011\ The cost differentials that
result might create incentives for broker-dealers to route order flow
to minimize costs,\1012\ creating a potential conflict of interest with
broker-dealers' investor customers, who are likely to consider many
facets of execution quality (such as price impact of a trade and
probability of execution in a venue in which the order is exposed) in
addition to any of these costs that are passed on to them.
---------------------------------------------------------------------------

    \1008\ See CAT NMS Plan, supra note 3, at Article XI.
    \1009\ See Robert H. Battalio, Shane A. Corwin and Robert H.
Jennings, Can Brokers Have It All? On the Relation between Make-Take
Fees and Limit Order Execution Quality (2015 working paper),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2367462. (``Battalio, Corwin, and
Jennings'').
    \1010\ See CAT NMS Plan, supra note 3, at Section 11.3.(b):
``For the avoidance of doubt, the fixed fees payable by Industry
Members pursuant to this paragraph shall, in addition to any other
applicable message traffic, include message traffic generated by:
(i) an ATS that does not execute orders that is sponsored by such
Industry Member; and (ii) routing orders to and from any ATS
sponsored by such Industry Member.'' The Commission notes that
exchange broker-dealers would be subject to message traffic fees as
Industry Members under the Plan. However, the Commission notes that
based on its analysis of OATS data from September 15-19, 2014, these
broker-dealers are minor contributors to overall message traffic,
accounting for less than 0.03% of OATS ROEs.
    \1011\ See CAT NMS Plan, supra note 3, at Article XI.
    \1012\ This assumes that CAT fees would ultimately be borne by
the broker-dealers that make routing decisions. Currently, exchange
access fees are often borne by broker-dealers that make routing
decisions, as discussed in Battalio, Corwin, and Jennings. Id. If
Execution Venues were to absorb these fees rather than pass them on
to customers, broker-dealer routing decisions might not be affected.
It is also possible that some Execution Venues could incorporate
some sort of rebate for broker-dealer message fees into their fee
schedules, effectively making some venues less expensive for broker-
dealers to access.
---------------------------------------------------------------------------

    In addition to friction created by the bifurcated structure of the
funding model, the Commission preliminarily believes that the CAT NMS
Plan funding model shifts broker-dealer costs associated with the
Central Repository to all broker-dealers and away from Options Market
Makers. The CAT NMS Plan provides that broker-dealers would not report
their options quotations to the Central Repository, while equity market
makers would report their equity

quotations to the Central Repository.\1013\ This differential treatment
of market making quotes affects costs of funding the Central Repository
in two ways. First, the elimination of Options Market Maker quotes from
the message traffic of broker-dealers decreases the number of messages
that must be reported and stored, which presumably reduces the overall
cost of building and operating the Central Repository. This reduction
in the overall cost of the Central Repository reduces costs to both
broker-dealers and Execution Venues. Second, because Options Market
Maker quotes would not be in the message traffic which determines the
allocation of broker-dealer costs of the Central Repository, broker-
dealers that do not quote listed options would pay a higher share of
broker-dealer-assessed CAT fees than they would if Options Market
Makers' quotes were included in the allocation of fees. Also, Options
Market Makers would pay relatively lower fees than they would if their
quotations were included in CAT message traffic from broker-dealers.
---------------------------------------------------------------------------

    \1013\ See Section IV.H.1.a, supra for a discussion of an
alternative that would require Options Market Makers to report their
quotes.
---------------------------------------------------------------------------

    Although this differential treatment would marginally increase the
cost of providing other broker-dealers services relative to options
market making, the Commission preliminarily does not believe that this
would materially affect a market participant's willingness to provide
broker-dealer services other than options market making for several
reasons. First, many market participants participate in both equities
and options markets because activity in one market (equities or
options) could be used to hedge positions acquired in the other market.
Consequently, many firms already find it cost effective to participate
in both markets. Second, broker-dealers participating in equity markets
have significant infrastructure in place for serving that market and
switching costs to participate in options market making are high due to
the need to establish quantitative infrastructure to quote options,
market connectivity, IT infrastructure, and clearing/settlement
arrangements required to transact in options; consequently, reducing
the cost to make markets in options is unlikely to attract broker-
dealers to change their business models. Finally, the Commission
believes that the market to provide liquidity in the options market is
already a competitive one because many broker-dealers participate in
that market and market share that is sufficient to cover substantial
fixed costs of making markets in options is valuable; consequently,
options market participants have incentives to compete to win market
share. Without a market change that significantly affects profits to be
made in options market making, it seems broker-dealers would need a
competitive advantage relative to existing competitors to successfully
win market share from the existing competitors. The Commission
preliminarily believes that that broker-dealers that currently focus on
equity market making and other broker-dealer services unrelated to
options market making are likely to continue to focus on the markets in
which they participate because their competitive advantages relate to
these activities.
5. Request for Comment on the Costs
    The Commission requests comment on all aspects of the discussion of
the potential costs of the CAT NMS Plan. In particular, the Commission
seeks responses to the following questions:
    301. Do Commenters agree with the Commission's assessment of the
potential costs of the CAT NMS Plan? Why or why not?
    302. To what extent do the uncertainties related to future
decisions about Plan implementation impact the assessment of potential
costs of the Plan? Please explain.
    303. Do Commenters agree that the Plan's level of detail regarding
the drivers of the costs to build, operate, and maintain the Central
Repository is sufficient to assess the economic effects of the Plan? If
more detail is needed, how can this information be obtained?
    304. Do Commenters agree that using the cost estimates provided in
Bids from the Shortlisted Bidders provides reasonable estimates of
costs to build and operate the Central Repository? Why or why not?
    305. Estimates in the Plan suggest that the Participants' data
reporting costs will significantly increase while surveillance costs
will significantly decrease if the Plan is approved. Do Commenters
agree that these changes are likely to occur? Please explain.
    306. Do Commenters agree with the Commission's characterization of
the limitations in the cost studies? Do Commenters agree with the
Commission's assessment that the Vendors Study and Participants Study
have reliable cost estimates? Do Commenters agree that cost estimates
for large OATS Reporters and large non-OATS Reporters are reliable? Do
Commenters agree that cost estimates for small reporters are
unreliable? Why or why not? Do Commenters have more precise estimates
of the costs than provided in the cost surveys?
    307. The Commission re-estimated aggregated costs under a different
set of assumptions than the Plan. Do Commenters agree that the re-
estimated costs better represent the expected costs of the CAT NMS
Plan? Why or why not? Do Commenters agree that most broker-dealers that
report fewer than 350,000 OATS ROEs per month are likely to report this
data through a service bureau?
    308. Do Commenters agree with the estimates of annual service
bureau costs for a very small OATS-reporting firm of $50,000 to
$180,000 per year, which assumes that the service bureau provides order
routing and an order-handling system? If not, please provide alternate
estimates.
    309. Do Commenters agree that the pricing function for service
bureaus is concave (increasing at a decreasing rate)? Why or why not?
The Commission assumes in its re-estimation that service bureau cost
functions are approximately as concave as exchange pricing functions.
Do Commenters agree? Why or why not?
    310. Will the requirement to provide customer information to the
Central Repository be a significant cost-driver for Outsourcers? Why or
why not? Is the need for encryption of this data a significant cost-
driver?
    311. Will the anticipated retirement of duplicative reporting
systems such as EBS affect Outsourcer costs? Why or why not? Will the
reduction in ad hoc data requests significantly affect the costs
incurred by service bureaus in assisting their clients in responding to
these requests? Why or why not?
    312. Are there ways in which the Commission could better estimate
the aggregate costs of the CAT NMS Plan? If so, please explain.
    313. Do Commenters agree with the Commission's assumption that most
firms that report fewer than 350,000 OATS ROEs per month are self-
clearing? If not, please explain. Do Commenters believe that these
firms would have significantly higher implementation costs due to their
need to provide this information to any service bureaus they use for
regulatory data reporting?
    314. Do Commenters agree that broker-dealers that are exempt or
excluded from OATS reporting are likely to be small and should have
their costs estimated as Outsourcers? If no, how many of these broker-
dealers currently participate in more than 350,000 events that would be
OATS-reportable, were they not exempt or excluded, per month?

    315. Are Commenters aware of options market making firms that are
FINRA members and report fewer than 350,000 OATS ROEs per month, or
that are exempt or excluded from OATS reporting rules? If so, are there
ways that the Commission can identify these firms to better estimate
their costs under the Plan?
    316. Are Commenters aware of ELPs that are not CBOE members that
did not trade on ATSs in 2014? If so, are there ways that the
Commission can identify these firms to better estimate their costs
under the Plan?
    317. Do Commenters agree that FINRA member broker-dealers that are
Options Market Makers are unlikely to be exempt or excluded from OATS-
reporting requirements, and are likely to report more than 350,000 OATS
ROEs per month? If not, how many FINRA member Options Market Makers
exist that are exempt or excluded from OATS reporting requirements, or
that report fewer than 350,000 OATS ROEs per month? Are there methods
by which the Commission could improve its estimates of costs these
broker-dealers are likely to face if the Plan is approved?
    318. According to survey results, Approach 1 aggregate
implementation and ongoing costs are higher than those for Approach 2
for CAT Reporters, though not statistically so.\1014\ The Commission
notes that this cost estimate does not seem intuitive because Approach
2 could result in extra data processing by CAT Reporters to translate
data into a fixed format whereas Approach 1 would require no
translation. Why is the cost of Approach 1 anticipated to be higher
than Approach 2? Can this be explained by the use of service bureaus
whom CAT Reporters expect to charge the same for either approach? Can
this be explained by the need to process data under either approach to
replace ticker symbols with listing exchange symbology?
---------------------------------------------------------------------------

    \1014\ Approach 1 assumes CAT Reporters would submit CAT Data
using their choice of industry protocols. Approach 2 assumes CAT
Reporters would submit data using a pre-specified format.
---------------------------------------------------------------------------

    319. Do Commenters believe that duplicative reporting systems will
be retired and, if so, when? What systems do Commenters expect to be
retired? \1015\ Are there any systems that cannot be retired? What are
the costs associated with retiring duplicative reporting systems? What
are the benefits of retiring duplicative reporting systems? Would there
be cost savings as a result of retiring any duplicative reporting
systems? How does the timeline for retiring duplicative reporting
systems affect the costs and benefits? Please explain.
---------------------------------------------------------------------------

    \1015\ See supra note 856.
---------------------------------------------------------------------------

    320. Do service bureaus handle EBS reporting for their clients? To
what extent would EBS reporting contribute to duplicative reporting
costs or system retirement costs and savings?
    321. The Commission's analysis discusses the Plan's timetable for
retirement of duplicative reporting systems (i.e., a maximum of 2.5
years). Is the timetable for retirement of these systems in the Plan
realistic and/or reasonable? Are there ways that the timetable for
duplicative reporting system retirement could be accelerated? If so,
how?
    322. Do Commenters believe that the period of duplicative reporting
that would precede the retirement of certain current, anticipated to be
retired, regulatory reporting systems would impose significant cost
burdens on industry? Are the Commission's estimates of those costs
accurate? Are there dimensions of these costs that the Commission has
not recognized? If so, what are they and what are their magnitudes?
    323. What milestones should CAT be required to reach before
duplicative reporting systems can be retired?
    324. What costs would service bureaus face in accomplishing a
period of duplicative reporting during which both CAT and the
regulatory data reporting systems that the Plan anticipates would be
retired are operational? How many FTEs would be involved?
    325. What costs would broker-dealers face in accomplishing a period
of duplicative reporting during which both CAT and the regulatory data
reporting systems that the Plan anticipates would be retired are
operational? How many FTEs would be involved?
    326. The CAT NMS Plan estimates that market participants would face
significant costs of approximately $2.6 billion in connection with
retiring duplicative reporting systems. What expenses does this
estimate cover, and which systems account for which costs? For some
broker-dealers, would implementation of CAT reporting accomplish the
retirement of other regulatory data reporting systems? How do system
retirement costs differ between broker-dealers that outsource their
data reporting versus those who perform this function in-house?
    327. Do Commenters believe that the CAT NMS Plan would deliver
additional cost savings from sources other than the retirement of
duplicative reporting systems and a reduction in the amount of ad-hoc
data requests to regulated entities? Are there any changes to the CAT
NMS Plan that would increase the potential cost savings?
    328. Are SROs adequately incentivized to retire current regulatory
reporting and surveillance systems that might be replaced by CAT? Do
they have incentives to resist the retirement of these systems that
this analysis fails to identify?
    329. Do Commenters agree that costs associated with the Plan
incurred by broker-dealers could be passed down to their customers? Why
or why not? If so, do Commenters have estimates regarding what fraction
of broker-dealer costs would be passed down?
    330. The Commission preliminarily believes that the Vendors Study
measures ongoing costs that would also be captured by the third-party
outsourcing costs in the other surveys. As a result, the Commission
does not add these to the aggregated cost estimates. Do Commenters
agree with this approach? Is there any double counting of costs across
the surveys, or can the individual survey estimates be aggregated into
an industry-wide estimate? Please explain.
    331. According to survey results, Approach 1 aggregate
implementation costs are higher than those for Approach 2 for vendors
and ongoing costs are lower.\1016\ The Commission notes that this
implementation cost result does not seem intuitive because Approach 2
could result in creating a whole new data translation process to
implement the Plan whereas Approach 1 would require no translation. Why
is Approach 1 costlier for vendors to implement than Approach 2? Can
this be explained by the need to process data under either approach to
replace ticker symbols with listing exchange symbology?
---------------------------------------------------------------------------

    \1016\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(iv)(A).
---------------------------------------------------------------------------

    332. The Commission assumes that cost estimates from Participants
include all costs the Participants would incur if the Plan is approved,
and that other costs related to development of the Plan are not
avoidable if the Plan is not approved. Is it reasonable for the
Commission to treat all costs related to development of the Plan that
are not included in implementation and ongoing costs as sunk costs? Why
or why not?
    333. To what degree would industry's costs to implement and
maintain CAT reporting be passed on to investors? Would competition
between broker-dealers affect the passing on of costs to investors? Why
or why not?
    334. How significant to the total industry costs of the CAT NMS
Plan are

clock synchronization requirements, the requirement that Options Market
Makers send quote times to the exchanges, the requirement that the
Central Repository maintain six years of CAT Data, and the inclusion of
OTC Equity Securities in the initial phase of the implementation of the
CAT NMS Plan? Why?
    335. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report customer information to the Central
Repository? What elements of this requirement contribute to its
significance of the potential costs of the Plan? Are there ways in
which this data can be made available to regulators that would prove
less costly to industry and investors? If so, what are they?
    336. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report certain information as part of the
material terms of the order? What elements of this requirement
contribute to its significance of the potential costs of the Plan? Are
there ways in which this data can be made available to regulators that
would prove less costly to industry and investors? If so, what are
they?
    337. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report information to the Central Repository
using listing exchange symbology? What elements of this requirement
contribute to its significance of the potential costs of the Plan? Are
there ways in which this data can be made available to regulators that
would prove less costly to industry and investors? If so, what are
they?
    338. How significant to the total industry costs of the CAT NMS
Plan is the requirement to report allocation information to the Central
Repository? What elements of this requirement contribute to its
significance of the potential costs of the Plan? Are there ways in
which this data can be made available to regulators that would prove
less costly to industry and investors? If so, what are they?
    339. Are there other requirements of the CAT NMS Plan that would be
significant sources of costs? If so, what are they? Are there ways in
which those requirements could be made less costly? If so, what are
they?
    340. Do Commenters agree that ancillary fees levied by the Plan
Processor on broker-dealers in response to late or inaccurate reporting
are unlikely to broadly levied on broker-dealers? Do Commenters believe
they would comprise a significant source of CAT costs to industry? Why
or why not?
    341. Do Commenters agree with the Commission's analysis of
potential cost savings from a reduction in the number (and ultimately
the cost) of data requests as a result of regulators having direct
access to CAT Data?
    342. Do Commenters agree with the Commission's analysis of the risk
of a security breach? Do Commenters agree with the Commission's
analysis of the potential costs of a security breach? Are there factors
not covered in the analysis? What are they? Are the security measures
outlined in the Plan appropriate and reasonable? Why or why not?
    343. Do Commenters agree with the Commission's analysis of
potential changes to CAT reporter behavior? Why or why not? Are there
additional factors that should be considered?
    344. Do Commenters agree with the Commission's analysis of the
Plan's funding model? Why or why not? Are there additional factors that
should be considered?
    345. Do Commenters agree with the Commission's analysis of
potential costs resulting from differential CAT costs across Execution
Venues? Why or why not? Are there additional factors that should be
considered?
    346. Should the Plan require the inclusion of a web-based manual
data entry option for initial CAT reporting in addition to updates and
corrections? Please explain. How would a web-based manual data entry
option affect the costs incurred by CAT Reporters? Do any current
regulatory data reporting systems have a web-based manual data entry
option? If so, which ones and how often do broker-dealers utilize that
option for data submission?

G. Efficiency, Competition, and Capital Formation

    In determining whether to approve the CAT NMS Plan, and whether the
Plan is in the public interest, Rule 613 requires the Commission to
consider the impact of the Plan on efficiency, competition and capital
formation.\1017\
---------------------------------------------------------------------------

    \1017\ See 17 CFR 242.613(a)(5); see also 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission preliminarily believes that the Plan generally
promotes competition. However, as explained below, the Commission
recognizes that the Plan could increase barriers to entry because of
the costs to comply with the Plan. Further, the Commission's analysis
identifies several limitations to competition, but the Plan contains
provisions to address some limitations and Commission oversight can
also address the limitations.
    The Commission preliminarily believes that the Plan would improve
the efficiency of regulatory activities and enhance market efficiency
by deterring violative activity that harms market efficiency. The
Commission preliminarily believes that the Plan would have modest
positive effects on capital formation and that the threat of a security
breach at the Central Repository is unlikely to significantly harm
capital formation.
    The Commission notes that the significant uncertainties discussed
earlier in this economic analysis also affect the Commission's analysis
of efficiency, competition, and capital formation. For example, the
Commission recognizes that the uncertainties around the improvements to
data qualities can affect the strength of the Commission's conclusions
on efficiency, and the uncertainty regarding how the Operating
Committee allocates the fees used to fund the Central Repository could
affect the Commission's conclusions on competition. Additionally, the
Commission recognizes that the Plan's likely effects on competition,
efficiency and capital formation are dependent to some extent on the
performance and decisions of the Plan Processor and the Operating
Committee in implementing the Plan, and thus there is necessarily some
further uncertainty in the Commission's analysis. Nonetheless, the
Commission believes that the Plan contains certain governance
provisions, as well as provisions relating to the selection and removal
of the Plan Processor, that mitigate this uncertainty by promoting
decision-making that could, on balance, have positive effects on
competition, efficiency, and capital formation.
1. Competition
    As required by Rule 613, the Plan contains an analysis of its
expected impact on competition.\1018\ The Plan's analysis considers
potential impacts of the CAT NMS Plan on competition related to
technology, cost allocation across CAT Reporters, and changes in
regulatory reporting requirements.\1019\ The Plan splits its analysis
between ``Participants and broker-dealers communities'' and concludes
that the Plan generally would avoid placing an inappropriate burden on
competition in U.S. markets.\1020\ The Plan's analysis states the
criteria for evaluating impacts on competition by outlining the channel
of potential impacts as policy changes

caused by the Plan that ``burden a group or class of CAT Reporters in a
way that would harm the public's ability to access their services'' and
states that such impacts ``should be measured relative to the economic
baseline.'' \1021\
---------------------------------------------------------------------------

    \1018\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8 (noting that Rule 613(a)(1)(viii) requires the Plan to include a
discussion of an analysis of the impact of the Plan on competition,
efficiency and capital formation).
    \1019\ See id.
    \1020\ See id.
    \1021\ See id.
---------------------------------------------------------------------------

    The Commission's evaluation of competition reorients the Plan's
approach to analyzing competition, expands upon it, and notes some
limitations in the scope and conclusions of the Plan's analysis. In
particular, the Commission's analysis of competition is organized and
segmented by the particular markets in which competition among service
providers of types of services exists. The Commission's analysis
focuses on four distinct markets: The market for trading services, the
markets for broker-dealer services, the market for regulatory services,
and the market for data reporting services. In the context of the Plan,
this allows the competition analysis to consider a more complex
interaction between all market participants in a defined market than
would be feasible by focusing solely on market participant types. This
approach allows the Commission to determine whether a differential
impact across competitors affects overall competition in the market.
Much like the Plan's criteria for evaluation, the Commission recognizes
that any effects on competition, with respect to each market, should be
compared to a Baseline that characterizes the competitive environment
without the CAT NMS Plan. In addition, the Commission considered
uncertainty in the effect of the Plan on competition in any of these
markets.
    After analyzing the discussion of competition and the other
relevant provisions of the Plan in the context of four affected
markets, the Commission preliminarily believes that, while there could
be effects on individual competitors, these effects would not lead to
changes to competition as a whole in affected markets in a way that
would generate significant adverse effects. In sum, and as discussed in
detail below, the Commission preliminarily believes that the Plan poses
a risk for competition for trading services, but provisions in the Plan
and Commission oversight could mitigate this risk. Additionally, the
Plan could have a differential impact on the ability of smaller broker-
dealers and broker-dealers subject to CAT reporting to compete in the
various markets for broker-dealer services, but these differential
impacts may not be significant enough to affect overall competition in
the markets for broker-dealer services. Moreover, the Plan generally
promotes competition to be the Plan Processor and competition for
regulatory services, but friction in those markets could limit the
competition. Finally, the Plan could have a harmful effect on
competition in the market for data reporting services, at least in the
short term, because of capacity constraints, but the prolonged
implementation for small broker-dealers could limit these harmful
effects.
a. Market for Trading Services
    The Commission analyzed the CAT NMS Plan's economic effects on
competition in the market for trading services, compared to the
Baseline of the competitive environment without the Plan, and
preliminarily believes that the Plan would not place a significant
burden on competition for trading services. The Commission recognizes
the risk for the Plan to have negative effects on competition and to
increase the barriers to entry in this market, but preliminarily
believes that Plan provisions and Commission oversight could mitigate
these risks.
    The market for trading services, which is served by exchanges,
ATSs, and liquidity providers (internalizers and others), relies on
competition to supply investors with execution services at efficient
prices. These trading venues, which compete to match traders with
counterparties, provide a framework for price negotiation and
disseminate trading information. The market for trading services in
options and equities consists of 19 national securities exchanges,
which are all Plan Participants,\1022\ and off-exchange trading venues
including broker-dealer internalizers, which execute substantial
volumes of transactions, and 44 ATSs, which are not Plan
Participants.\1023\ Since the adoption of Regulation NMS in 2005, the
market for trading services has become more fragmented and competitive,
and there has been a shift in the market share of trading volume among
trading venues. For instance, from 2005 to 2013, there was a decline in
the market share of trading volume for exchange-listed stocks on NYSE.
At the same time, there was an increase in the market share of newer
national securities exchanges such as NYSE Arca, BATS-Z, BATS-Y, EDGA
and EDGX.\1024\ During the same time period, the proportion of NMS
Stocks trading off-exchange (which includes both internalization and
ATS trading) increased; for example, during the second quarter of 2015,
NMS Stock ATSs alone comprised approximately 15 percent of consolidated
volume, and other off-exchange volume totaled 18 percent of
consolidated volume over the same period.\1025\ Aside from trading
venues, exchange market makers provide trading services in the
securities market. These firms stand ready to buy and sell a security
``on a regular and continuous basis at publicly quoted prices.'' \1026\
Exchange market makers quote both buy and sell prices in a security
held in inventory, for their own account, for the business purpose of
generating a profit from trading with a spread between the sell and buy
prices. Off-exchange market makers also stand ready to buy and sell out
of their own inventory, but they do not quote buy and sell
prices.\1027\
---------------------------------------------------------------------------

    \1022\ The Commission understands that ISE Mercury, LLC will
become a Participant in the CAT NMS Plan and thus is accounted for
as a Participant for purposes of this Notice. See supra note 3.
    \1023\ See Concept Release on Equity Market Structure, at 3598-
3560, supra note 733 (for a discussion of the types of trading
centers); see also Alternative Trading Systems with Form ATS on File
with the SEC as of April 1, 2016, available at https://www.sec.gov/foia/ats/atslist0416.pdf.
    \1024\ See Securities Exchange Act Release No. 76474 at 81112,
``Regulation of NMS Stock Alternative Trading Systems'', available
at http://www.sec.gov/rules/proposed/2015/34-76474.pdf.
    \1025\ See id. at 81124.
    \1026\ See ``Market Maker'', available at http://www.sec.gov/answers/mktmaker.htm (last visited April 18, 2016).
    \1027\ Laura Tuttle, OTC Trading: Description of Non-ATS OTC
Trading in National Market System Stocks (March 2014), available at
http://www.sec.gov/dera/staff-papers/white-papers/otc-trading-white-paper-03-2014.pdf.
---------------------------------------------------------------------------

    The Plan examined the effect of the CAT NMS Plan on the market for
trading services primarily from the perspective of the exchanges. The
Plan asserts that distribution of regulatory costs incurred by the Plan
would be distributed according to ``the Plan's funding principles,''
calibrated to avoid placing ``undue burden on exchanges relative to
their core characteristics,'' and would thus not cause any exchange to
be at a relative ``competitive disadvantage in a way that would
materially impact the respective Execution Venue marketplaces.'' \1028\
Likewise, the Plan asserts that its method of cost allocation would
avoid discouraging entry into the Participant community because a
potential entrant, like an ATS, would ``be assessed exactly the same
amount [of allocated CAT-related fees] for a given level of activity''
both before and after becoming an exchange.\1029\
---------------------------------------------------------------------------

    \1028\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(a)(i); see also id. at Section 11.2 (for a discussion of the
Plan's funding principles); Section, III.A.3.d, supra.
    \1029\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(a)(i).

---------------------------------------------------------------------------

    The Commission also examined the effect of the funding model on
competition in the market for trading services, including off-exchange
liquidity suppliers and ATSs. In addition, the Commission considered
the effect of implementation and ongoing costs of the Plan, whether
particular elements of the Plan could hinder competition, and the
effect of enhanced surveillance on competition in the market for
trading services.
(1) The Funding Model
    As noted above, the Operating Committee would fund the Central
Repository by allocating its costs across exchanges, FINRA, ATSs and
broker-dealers.\1030\ The Operating Committee would decide which
proportion of costs would be funded by exchanges, FINRA, and ATSs and
which portion would be funded by broker-dealers. The Plan does not
specify how the Operating Committee would select this allocation.
However, the portion allocated to the exchanges, FINRA, and ATSs would
be divided among them according to market share of share volume and the
portion allocated to broker-dealers would be divided among them
according to message traffic, including message traffic sent to and
from an ATS.\1031\ The Operating Committee would allocate fees for the
equities market and options market separately based on market share in
each market. The Operating Committee would file the fees resulting from
its funding model with the Commission under the Exchange Act.
---------------------------------------------------------------------------

    \1030\ See id. at Article XI.
    \1031\ Id.
---------------------------------------------------------------------------

    Any entity that becomes a new exchange would be required to join
the CAT NMS Plan as a Participant. In addition, any new Participant to
the Plan must pay a ``Participation Fee,'' to the Company ``in an
amount determined by a Majority Vote of the Operating Committee as
fairly and reasonably compensating the Company and the Participants for
costs incurred in creating, implementing, and maintaining the CAT.''
\1032\ This Participation Fee would be based on, among other potential
factors, capital expenditures paid by the Company amortized over five
years, costs incurred by the Company to accommodate the new
Participant, and Participant Fees paid by other new Participants.\1033\
---------------------------------------------------------------------------

    \1032\ See id. at Section 3.3. The Commission notes that the
Plan does not specify the Participation Fee. The Commission expects
this fee to be filed as an amendment to the CAT NMS Plan under Rule
608 of Regulation NMS. See 17 CFR 242.608.
    \1033\ The Commission notes that Section 3.3(b)(v) of the CAT
NMS Plan states, ``In the event the Company (following the vote of
the Operating Committee contemplated by Section 3.3(a)) and a
prospective Participant do not agree on the amount of the
Participation Fee, such amount shall be subject to review by the
Commission pursuant to Sec.  11A(b)(5) of the Exchange Act.'' See
CAT NMS Plan, supra note 3, at Section 3.3(b)(v); see also text
accompanying notes 1038-1039, infra.
---------------------------------------------------------------------------

    The Commission preliminarily believes that any impacts of such fees
on competition in the market for trading services would manifest either
through the model for the fees itself or through the later allocation
of the fees across market participant types, across equity or options
exchanges or, within market participant types and markets, through the
levels of fees paid by each tier. Each of the different channels
through which the Plan could have an adverse effect on competition is
discussed separately below.
A. Funding Model
    As discussed in Section IV.F.4.d, the Commission preliminarily
believes that the structure of the funding model could provide a
competitive advantage to exchanges over ATSs. The Plan states that an
entity would be assessed exactly the same amount for a given level of
activity whether it acted as an ATS or an exchange.\1034\ However,
FINRA would be charged fees based on the market share of off-exchange
trading. ATSs, which are FINRA members, would presumably pay a portion
of the FINRA fee through their broker-dealer membership fees. In
addition, ATSs would pay a fee for their market share, which is a
portion of the total off-exchange market share. Therefore, ATS volume
would effectively be charged once to the broker-dealer operating the
ATS and a second time to FINRA.\1035\ This would result in ATSs paying
more than exchanges for the same level of activity. Ultimately, if the
funding model disadvantages ATSs relative to registered exchanges,
trading volume could migrate to exchanges in response, and ATSs could
have incentives to register as exchanges as well.\1036\
---------------------------------------------------------------------------

    \1034\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(iii)(C).
    \1035\ Id. at Section 11.3(b).
    \1036\ The Commission notes that ATSs currently incur a
different set of regulatory fees than are incurred by exchanges,
because ATSs are required to be members of a national securities
association. FINRA charges its members fees to cover its regulatory
costs. See FINRA Manual: Corporate Organization: By-Laws of the
Corporation: Schedule A: Section 1--Member Regulatory Fees,
available at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=4694 (``FINRA shall, in
accordance with this Section, collect member regulatory fees that
are designed to recover the costs to FINRA of the supervision and
regulation of members, including performing examinations, financial
monitoring, and policy, rulemaking, interpretive, and enforcement
activities.'').
---------------------------------------------------------------------------

    Additionally, the Commission preliminarily believes that the
Participation Fee could discourage new entrants or the registration of
an ATS as an exchange, increasing the barriers to entry to becoming an
exchange. In particular, the factors listed in the Plan for determining
the Participation Fee consider the previous costs incurred by the
existing Participants but not the costs already incurred by the new
Participant when it acted as an ATS.\1037\ However, the Plan does not
prescribe a set formula for determining the Participation Fee and the
Plan does not preclude considering previous costs incurred by the ATS
in the Participation Fee. In addition, although amendments designated
by sponsors to an NMS plan as establishing or changing a fee may be
effective upon filing with the Commission,\1038\ the Commission may
summarily abrogate the amendment that establishes (or in the future,
changes) the Participation Fee within 60 days of its filing and require
that the fee amendment be refiled in accordance with Rule 608(a)(1) and
reviewed in accordance with Rule 608(b)(2) of Regulation NMS, if it
appears to the Commission that such action is necessary or appropriate
in the public interest, for the protection of investors, or the
maintenance of fair and orderly markets, to remove impediments to, and
perfect the mechanisms of, a national market system or otherwise in
furtherance of the purposes of the Act.\1039\
---------------------------------------------------------------------------

    \1037\ See CAT NMS Plan, supra note 3, at Section 3.3(b).
    \1038\ See 17 CFR 242.608(b)(3)(i).
    \1039\ See 17 CFR 242.608(a)(1); 608(b)(2); 608(b)(3)(i); and
608(b)(3)(iii). Pursuant to Rule 608(b)(2) of Regulation NMS, the
Commission shall approve such amendment, with such changes or
subject to such conditions as the Commission may deem necessary or
appropriate, if it finds that such amendment is necessary or
appropriate in the public interest, for the protection of investors
and the maintenance of fair and orderly markets, to remove
impediments to, and perfect the mechanisms of, a national market
system, or otherwise in furtherance of the purposes of the Act.
Approval of the amendment shall be by Commission order.
---------------------------------------------------------------------------

    Further, because the funding model seems to charge ATSs more for
their market share than exchanges, ATSs could pay relatively less for
their market share as an exchange than as an ATS, countering this
barrier to entry depending on the magnitudes of the two fee types.
B. Allocation of Fees
    The Plan discusses the allocation of fees among market participants
of different sizes within the same market participant type (Execution
Venues versus broker-dealers), but does not

discuss the allocation of fees across the different market participant
types or markets. The Operating Committee would determine this
allocation and would submit a filing to the Commission, which would be
subject to Commission review and public comment.\1040\ The Commission
recognizes the potential for the Operating Committee to influence the
market for trading services either by coordinating to favor one segment
over another, or through an imbalance in the voting rights on the
Operating Committee. The Commission also preliminarily believes that
the Plan contains governance provisions that could mitigate such
potential burdens on competition.
---------------------------------------------------------------------------

    \1040\ See supra notes 78 and 79 (describing how fee schedules
for CAT could be filed and noting that they could take effect upon
filing with the Commission).
---------------------------------------------------------------------------

    The Commission recognizes that the potential for a burden on
competition and effects on competitors in the market for trading
services could arise from provisions relating to the allocation and
exercise of voting rights. In particular, a concentration of influence
over Committee decisions could directly and indirectly affect
competition. The potential for concentration of influence over vote
outcomes arises from proposed provisions to give one vote to each Plan
Participant \1041\ in an environment where some Participants are
Affiliated SROs.\1042\ Indeed, supermajority approval could be achieved
through five of the 10 groups of Affiliated SROs and majority approval
could be achieved with just four such groups.\1043\ In light of this
potential for concentration, voters could weigh some particular
interests more than others. For example, the Participant groups with
options exchanges could have the incentive to allocate a
disproportionately low level of fees for options market share than for
equity market share. Such an allocation could disadvantage competing
Participants with only equities exchanges.
---------------------------------------------------------------------------

    \1041\ See CAT NMS Plan, supra note 3, at Section 4.3.
    \1042\ The CAT NMS Plan states that the Operating Committee
shall consist of one voting member representing each Participant and
that one individual may serve as the voting member of the Operating
Committee for multiple Affiliated Participants and shall have the
right to vote on behalf of each such Affiliated Participant. See id.
at Section 4.2(a).
    \1043\ The twenty SROs that are Participants in the CAT NMS Plan
include five sets of affiliated SROs (New York Stock Exchange LLC,
NYSE Arca, Inc., and NYSE MKT LLC (the ``NYSE Group''); The NASDAQ
Stock Market LLC, NASDAQ OMX BX, Inc., and NASDAQ OMX PHLX LLC (the
``NASDAQ Group''); BATS Exchange, Inc., BATS Y-Exchange, Inc., EDGX
Exchange, Inc., and EDGA Exchange, Inc. (the ``BATS Group'');
Chicago Board Options Exchange, Incorporated and C2 Options
Exchange, Incorporated (the ``Chicago Options Group'');
International Securities Exchange, LLC, ISE Gemini, LLC, and ISE
Mercury, LLC (the ``ISE Group''); and five independent SROs
(National Stock Exchange, Inc.; Chicago Stock Exchange, Inc.; BOX
Options Exchange LLC; Miami International Securities Exchange LLC;
and Financial Industry Regulatory Authority, Inc.). The BATS Group
has four votes, the NYSE Group, the NASDAQ Group and the ISE Group
each have three votes, and the Chicago Options Group has two votes.
See CAT NMS Plan, supra note 3, at Appendix C, Section D.11(b)
(Affiliated Participant Groups and Participants without
Affiliations). A majority approval requires eleven votes. This could
include as few as four of the SROs and sets of affiliated SROs: the
affiliated SROs that have four votes, two sets of affiliated SROs
that have three votes, and one other SRO or set of affiliated SROs.
Supermajority approval requires fourteen votes. This could include
as few as five SROs and sets of affiliated SROs: the affiliated SROs
that have four votes, three sets of affiliated SROs with three
votes, and any additional SRO. Note also that as few as two sets of
affiliated SROs could block a Supermajority approval by casting
seven ``no'' votes: the affiliated SROs with four votes and any one
of the affiliated SROs with three votes.
---------------------------------------------------------------------------

    The inclusion of all exchanges on the Operating Committee could
give the Plan Participants opportunities and incentives to share
information and coordinate strategies in ways that could reduce the
competition among exchanges or could create a competitive advantage of
exchange trading over off-exchange trading.\1044\ However, the
Commission preliminarily believes that the Plan would limit these
potential burdens on competition. In particular, the Plan includes
provisions designed to limit the flow of information between the
employees of the Plan Participants who serve as members of the
Operating Committee and other employees of the Plan Participants.\1045\
Additionally, the Plan includes provisions that guide the Operating
Committee to set fees between exchanges and ATSs in a tiered fashion,
based upon market share.\1046\ Finally, Commission oversight could also
mitigate any concerns that burdens on competition might arise as a
result of this approach.
---------------------------------------------------------------------------

    \1044\ See infra note 1272. The Commission notes that FINRA
could represent the perspectives of the off-exchange portion of the
market, but FINRA would have only one vote and exchanges would have
nineteen.
    \1045\ See CAT NMS Plan, supra note 3, at Section 9.6(a)
(Participants may share Plan information with their employees and
other Representatives on a need-to-know basis; their use of Plan
information is restricted to what is needed to achieve plan
regulatory objectives). Details on the implementation of these
confidentiality provisions are not stated. However, see also id. at
Section 9.6(c) (Participants may share information among themselves
without Operating Committee approval in some instances).
    \1046\ See id. at Section 11.3; Appendix C, Section
B.7(b)(iv)(C).
---------------------------------------------------------------------------

    Additionally, the Commission agrees with the Plan's assessment that
some governance features of the Plan would limit adverse effects on
competition in the market for trading services. The governance
structure of the Plan contains provisions to limit the incentive and
ability of Operating Committee members to serve the private interests
of their employers, such as rules regulating conflicts of
interest.\1047\ Such governance provisions could mitigate the potential
for members of the Operating Committee to use their influence over the
fee schedule to benefit their own enterprise in a way that unfairly
harms the customers of competing exchanges and ATSs and places a burden
on competition. Moreover, as discussed above, the Commission may
summarily abrogate and require the filing of Plan amendments that
establish or change a fee in accordance with Rule 608(a)(1) and review
such amendments in accordance with Rule 608(b)(2) of Regulation NMS, if
it appears to the Commission that such action is necessary or
appropriate in the public interest, for the protection of investors, or
the maintenance of fair and orderly markets, to remove impediments to,
and perfect the mechanisms of, a national market system or otherwise in
furtherance of the purposes of the Act.\1048\ In such a case, if the
Commission chooses to approve such amendment, it would be by order and,
with such changes or subject to such conditions as the Commission may
deem necessary or appropriate.
---------------------------------------------------------------------------

    \1047\ See supra note 796.
    \1048\ See supra note 1039.
---------------------------------------------------------------------------

(2) Costs of Compliance
    Because all Participants but one compete in the market for trading
services, the ability of affiliates to vote as a group could in
principle allow a few large Participant groups to influence the outcome
of competition in the market for trading services by making various
decisions that can alter the costs of one set of competitors more than
another set. Further, the Plan would allocate profits and losses from
operating the Central Repository equally across Participants, which
could advantage small exchanges in the event of a profit and
disadvantage small exchanges in the event of a loss. This could
negatively impact competition if the cost differentials are unnecessary
in light of the cost-benefit trade-offs of alternatives and if the cost
differentials are significant enough to alter the set of services that
some Participants offer.
    Generally, smaller competitors could have implementation and
ongoing costs of compliance that are disproportionate

relative to their size. Any choices that could exacerbate these
differences could potentially result in the exit of smaller
competitors. To lessen the impact of funding the Central Repository on
smaller exchanges and ATSs, the Plan would apply a tiered funding model
that charges the smallest exchanges and ATSs the lowest fees. Likewise,
the Plan would apply a tiered funding model that would charge the
smallest broker-dealers, including liquidity suppliers, the lowest
fees. However, the Commission notes that the Plan does not indicate
whether off-exchange liquidity providers would pay fees similar to
similarly-sized ATSs and exchanges.
    In addition, as noted above, the Plan provides that the Technical
Specifications would not be finalized until after the selection of a
Plan Processor, which would not occur until after any decision by the
Commission to approve the Plan.\1049\ The Commission recognizes that
the costs of compliance associated with future technical choices or the
selection of the Plan Processor could exacerbate the relative cost
differential across competitors. For example, the Affiliated
Participants on the Selection Committee could favor a Plan Processor
that employs technology that would make implementation costs relatively
higher for the exchanges that do not have affiliates. In addition, the
Affiliated Participants, who have more votes on the Operating
Committee, could be amenable to adding particular CAT Data items in the
future that could expose violations on other exchanges, but not be
amenable to CAT Data items that could expose violations on their own
exchanges. While those groups could still use such data to surveil
their own exchanges, if not in CAT Data, the data items would not be
available for cross-market surveillance or efficient Commission
examinations and enforcement. As such, the independent exchanges, which
have only one vote on the Operating Committee, could face higher
regulatory costs than exchanges of the Affiliated Participants.
However, for the same reasons as stated above, the Commission
preliminarily believes that the governance provisions of the Plan and
Commission oversight could help to mitigate such effects on these
competitors in the market for trading services.
---------------------------------------------------------------------------

    \1049\ See Section IV.C.2, supra.
---------------------------------------------------------------------------

(3) Enhanced Surveillance and Deterrence
    The Commission also preliminarily believes that the CAT NMS Plan
could promote competition in the market for trading services through
enhanced surveillance and the deterrence of violative behavior that
could inhibit competition.\1050\ Should the Plan deter violative
behavior, passive liquidity suppliers, such as on or off-exchange
market makers could increase profits as a result of reduced losses from
others' violative behavior. This increase in profits could encourage
new entrants or could spark greater competition, which reduces
transaction costs for investors. For example, spoofing, which involves
building up the apparent depth of the market to trigger particular
trading patterns and then trading against those patterns, could cause
confusion about bona-fide supply and demand for a particular security.
Liquidity providers could compete less than is optimal to provide
liquidity in that security out of fear that they could suffer a decline
in profitability if they trade at inopportune times as a result of
others' spoofing behavior. If the Plan facilitates surveillance
improvements that deter spoofing, it could increase incentives to
provide liquidity and promote lower transaction costs for investors,
particularly in stocks that may lack a critical mass of competing
liquidity providers or that could be targets for violative trading
behavior.
---------------------------------------------------------------------------

    \1050\ See Section IV.E.2.c, supra, for a discussion of how the
CAT NMS Plan would enhance surveillance and deter violative
behavior.
---------------------------------------------------------------------------

b. Market for Broker-Dealer Services
    The Commission analyzed the effect of the CAT NMS Plan on the
market for broker-dealer services. For simplification, the Commission
presents its analysis as if the market for broker-dealer services
encompasses one broad market with multiple segments even though, in
terms of competition, it actually may be more realistic to think of it
as numerous inter-related markets. The market for broker-dealer
services covers many different markets for a variety of services,
including, but not limited to, managing orders for customers and
routing them to various trading venues, holding customer funds and
securities, handling clearance and settlement of trades, intermediating
between customers and carrying/clearing brokers, dealing in government
bonds, private placements of securities, and effecting transactions in
mutual funds that involve transferring funds directly to the issuer.
Some broker-dealers may specialize in just one narrowly defined
service, while others may provide a wide variety of services.
    The market for broker-dealer services relies on competition among
broker-dealers to provide the services listed above to their customers
at efficient levels of quality and quantity. The broker-dealer industry
is highly competitive, with most business concentrated among a small
set of large broker-dealers and thousands of small broker-dealers
competing for niche or regional segments of the market. To limit costs
and make business more viable, small broker-dealers often contract with
larger broker-dealers or service bureaus to handle certain functions,
such as clearing and execution, or to update their technology.\1051\
Large broker-dealers typically enjoy economies of scale over small
broker-dealers and compete with each other to service the smaller
broker-dealers, who are both their competitors and their customers.
---------------------------------------------------------------------------

    \1051\ See Securities Exchange Act Release No. 63241 (November
3, 2010), 75 FR 69791, 69822 (November 15, 2010) (Risk Management
Controls for Brokers or Dealers with Market Access).
---------------------------------------------------------------------------

    There are approximately 1,800 broker-dealers likely to be CAT
Reporters, while approximately 2,338 broker-dealers would not be CAT
Reporters because their businesses do not involve reportable events in
securities covered by the Plan.\1052\ Further, broker-dealers that are
anticipated to have CAT reporting obligations could compete with the
broker-dealers that would not have CAT reporting responsibilities in
various broker-dealer market segments that are unrelated to CAT
reporting. Some broker-dealers may offer specialized services in one
line of business mentioned above, while other broker-dealers may offer
diversified services across many different lines of businesses. As
such, the competitive dynamics within each of these specific lines of
business for broker-dealers is different, depending on the number of
broker-dealers that operate in the given segment and the market share
that the broker-dealers occupy.
---------------------------------------------------------------------------

    \1052\ Examples of these business activities include
underwriting and advising. See supra note 864.
---------------------------------------------------------------------------

    The Commission preliminarily believes costs of compliance incurred
by broker-dealers to comply with the Plan, particularly to report order
events to the Central Repository, will differ substantially between
broker-dealers and may affect competition between smaller and larger
broker-dealers. As discussed previously in the Commission's analysis of
Costs, broker-dealers that outsource regulatory data reporting
activities are expected to see their costs of regulatory data reporting
increase, while broker-dealers that Insource may see a decrease in
their regulatory data reporting costs.\1053\ The Commission
preliminarily believes this

dynamic may affect competition between Outsourcers (that tend to be
smaller) and Insourcers (that tend to be larger), and may increase
barriers to entry in some segments of this market.
---------------------------------------------------------------------------

    \1053\ See Section IV.F.1.c(2)C, supra.
---------------------------------------------------------------------------

    The Plan discusses certain aspects of competition pertaining to
broker-dealers that relate to costs and the allocation of fees. The
Plan states, ``[b]roker-dealer competition could be impacted if the
direct and indirect costs associated with meeting the CAT NMS Plan's
requirements materially impact the provision of their services to the
public. Further, competition may be harmed if a particular class or
group of broker-dealers bears the costs disproportionately . . . .''
The Plan asserts that it would have little to no adverse effect on
competition between large broker-dealers, and would not materially
disadvantage small broker-dealers relative to large broker-dealers.
Regarding small broker-dealers, the Plan states, ``. . . . [the
allocation of costs on broker-dealers based on their contribution to
market activity] may be significant for some small firms, and may even
impact their business models materially . . . .'' and that the
Participants were sensitive to the burdens the Plan could impose on
small broker-dealers, noting that such broker-dealers could incur
minimal costs under their existing regulatory reporting requirements
``because they are OATS-exempt or excluded broker-dealers or limited
purpose broker-dealers.'' The CAT NMS Plan attempts to mitigate its
impact on these broker-dealers by proposing to follow a cost allocation
formula that (in expectation) charges lower fees to smaller broker-
dealers; furthermore, Rule 613 provides them additional time to
commence their reporting requirements.
    The Commission preliminarily agrees with the Plan's general
assessment of competition among broker-dealers, and also with the
Plan's assessment of differential effects on small versus large broker-
dealers. The Commission agrees that the Plan's funding model is an
explicit source of financial obligation for broker-dealers and
therefore an important feature to evaluate when considering potential
differential effects of the Plan on competition in the market for
broker-dealers. The Commission understands that the tiered funding
model should result in the smallest broker-dealers paying the smallest
fees, but the Plan does not outline how the magnitudes of fees would
differ across the tiers. The Commission also recognizes that the
potentially greater level of service specialization that may
characterize small broker dealers and the potentially non-linear
economies of scale may result in the compliance costs associated with
the Plan competitively disadvantaging small broker-dealers, on average,
relative to large broker-dealers.
    However, the Commission preliminarily believes that the segments of
the market most likely to experience higher barriers to entry are those
that currently have no data reporting requirements of the type the Plan
requires and those that would involve more CAT Reporting obligations,
such as the part of the broker-dealer market that involves connecting
to exchanges, because of the technology infrastructure requirements and
the potential to have to report several types of order events.\1054\
The opportunity to rely on service bureaus or other solutions to reduce
the costs of complying with the Plan could limit any increases in the
barriers to entry in this market. Nonetheless, the Commission
preliminarily believes that any increases in the barriers to entry are
justified because they are necessary in order for the CAT Data to
include data from small broker-dealers. In the Adopting Release, the
Commission explained that excluding small broker-dealers from reporting
requirements would ``eliminate the collection of audit trail
information from a segment of the broker-dealer community and would
thus result in an audit trail that does not capture all orders by all
participants in the securities markets.'' \1055\ The Commission further
noted that ``illegal activity, such as insider trading and market
manipulation, can be conducted through accounts at small broker-dealers
just as readily as it can be conducted through accounts at large
broker-dealers'' and that ``granting an exemption to certain broker-
dealers might create incentives for prospective wrongdoers to utilize
such firms to evade effective regulatory oversight through the
consolidated audit trail.'' \1056\
---------------------------------------------------------------------------

    \1054\ The majority of broker-dealers do not directly engage in
exchange trading, and most broker-dealers are not expected to have
CAT reporting obligations. See supra note 864.
    \1055\ See Adopting Release supra note 9, at 45749.
    \1056\ See id.
---------------------------------------------------------------------------

    The Commission also recognizes that the Plan could affect the
current relative competitive positions of broker-dealers in the market
for broker-dealer services. To varying degrees, the economic impacts
resulting from the Plan could benefit some broker-dealers and adversely
affect others. The magnitude of these effects on broker-dealers could
vary across and within categories of broker-dealers and classes of
securities. However, there is no clear reason to expect these impacts,
should they occur, to decrease the current state of overall competition
in the market for broker-dealer services so as to materially burden the
price or quality of services received by investors on average.
    Regardless of the differential effects of the CAT NMS Plan on small
versus large broker-dealers, it is the Commission's preliminary view
that the CAT NMS Plan, in aggregate, would likely not reduce
competition and efficiency in the overall market for broker-dealer
services. Even if small broker-dealers potentially face a burden, this
may not necessarily have an adverse effect on competition as a whole in
the overall market for broker-dealer services. Under the CAT NMS Plan,
broker-dealers would have greater reporting responsibilities than they
would otherwise have. Broker-dealers could face high upfront
infrastructure costs to set up a processing environment to meet
reporting responsibilities. Because these infrastructure costs are
upfront, fixed costs, the burden to bear these costs could be
potentially greater for small broker-dealers. Instead of bearing these
costs in-house, small broker-dealers could contract with outside
technology vendors for reporting services. This outcome could lead to
lower costs relative to not using a vendor for reporting services. For
these reasons, even firms that currently do not report to OATS, but
will be CAT Reporters under the Plan, could face manageable upfront
costs that permit them to continue in their line of business without a
severe setback in their profitability.
    The Commission notes that a difficulty in assessing the likely
impacts of the CAT NMS Plan on competition among broker-dealers is that
competition in the markets for different broker-dealer services could
be affected in different ways. As mentioned above, there is great
diversity in the business activities of broker-dealers. Broker-dealer
services that are likely to incur CAT reporting responsibilities
include: executing orders, whether it be as an ATS or acting as a
carrying broker-dealer; intermediating between customers and carrying/
clearing brokers; effecting transactions in mutual funds that involve
transferring funds directly to the issuer; writing options; and acting
as an exchange floor broker. As noted above, these broker-dealers may
also compete with the approximately 2,338 other broker-dealers in
market segments that are not related to CAT reporting, such as dealing
in municipal bonds or arranging

private placements of securities.\1057\ If CAT costs represent a
significant increase in overall costs, the Plan could disadvantage
broker-dealers who are CAT Reporters in the market segments that do not
require CAT reporting. For example, broker-dealers that, in addition to
providing services related to market transactions that are reportable
to CAT, also compete to provide fixed-income order entry as a line of
business may be at a relative disadvantage to competitors in the fixed-
income market who do not provide broker-dealer services that are
related to market activity that is reportable to CAT. Whether this
disadvantage amounts to a substantial reduction in competition in
various markets depends on the magnitude of the disadvantage and
whether it affects the price and level of services available to
investors.
---------------------------------------------------------------------------

    \1057\ See Section IV.F.1.c, supra.
---------------------------------------------------------------------------

    The Commission recognizes that the CAT NMS Plan could result in
fewer broker-dealers providing specialized services that trigger CAT
reporting obligations. The Commission preliminarily believes that this
potential effect on broker-dealer specialization depends on whether
three key conditions are met. First, the effect requires that, compared
to large broker-dealers, small broker-dealers disproportionately
specialize in providing regional or niche services to a particular
market segment of clients. Second, the effect requires that this
specialization is correlated with business risk associated with changes
in marginal cost. Finally, the effect requires that the compliance
costs of the CAT NMS Plan could affect the ability for some small
broker-dealers to provide these specialized services. This effect, in
which fewer broker-dealers compete in specialized market segments,
could thereby negatively affect the competitive dynamics in these
market segments, especially if these segments currently contain
relatively few broker-dealers. The Commission preliminarily believes
that these conditions could hold, particularly for smaller broker-
dealers, and result in fewer broker-dealers operating in specialized or
niche markets if the Plan is approved.
    The Commission recognizes, however, that fewer broker-dealers in a
specialized segment of the market may not necessarily harm competition
in that segment. In particular, the costs of compliance with the Plan
may be less of a relative burden for large broker-dealers who may,
compared to small broker-dealers, provide a larger portfolio of
specialized services to clients. This portfolio may buffer large
broker-dealers from business risk associated with specialization.
Because of the lower relative burden, large broker-dealers are more
likely to maintain their presence in specialized market segments. If a
sufficient number of large broker-dealers, or all broker-dealers more
generally, maintain their presence in specialized market segments, a
net decrease in broker-dealers may not affect the competition in such
market segments to a level in which the market segment offers fewer or
lower quality services or higher prices. However, the Commission
recognizes that negative effects on competition in specialized market
segments could result if broker-dealers achieve a level of market
concentration necessary to adversely affect prices for investors.
c. Market for Regulatory Services
    SROs compete in the market for regulatory services.\1058\
Regulatory functions include market surveillance, cross-market
surveillance, oversight, compliance, investigation, and enforcement, as
well as the registration, testing, and examination of broker-dealers.
Although the Commission oversees exchange SROs' supervision of trading
on their respective venues, the responsibility for direct supervision
of trading on an exchange resides in the SRO that operates the
exchange. Currently, SROs compete to provide regulatory services in at
least two ways. First, because SROs are responsible for regulating
trading within venues they operate, their regulatory services are
bundled with their operation of the venue. Consequently, for a broker-
dealer, selecting a trading venue also entails the selection of a
provider of regulatory services surrounding the trading activity.
Second, SROs could provide this supervision not only for their own
venues, but for other SROs' venues as well through the use of
Regulatory Service Agreements or a plan approved pursuant to Rule 17d-2
under the Exchange Act.\1059\ Consequently, SROs compete to provide
regulatory services to venues they do not operate. Because providing
trading supervision is characterized by high fixed costs (such as
significant IT infrastructure and specialized personnel), some SROs
could find that another SRO could provide some regulatory services at a
lower cost than it would incur to provide this service in-house. Until
recently, nearly all the SROs that operate equity and option exchanges
contracted with FINRA for some or much of their trading surveillance
and routine inspections of members' activity.\1060\
---------------------------------------------------------------------------

    \1058\ FINRA is the SRO responsible for supervision of trading
off-exchange, which includes trading occurring on ATSs.
    \1059\ 17 CFR 240.17d-2.
    \1060\ Every equity exchange except CHX and NSX has an RSA with
FINRA which allows FINRA to provide cross-market surveillance for
nearly 100% of the equity markets. These RSAs differ in scope, but
in every case these contracts represent a partnership between FINRA
and the other SROs to provide a full set of effective regulatory
services. Recently NYSE Group and NASDAQ OMX decided to
significantly scale back their RSA with FINRA and directly resume
most of their market surveillance and investigation regulatory
obligations.
---------------------------------------------------------------------------

    As a result, the market for regulatory services in the equity and
options markets currently has one dominant competitor, FINRA. This may
provide relatively uniform levels of surveillance across trading
venues. One SRO having a competitive advantage in providing such
services could also limit the incentives to innovate in surveillance.
Hypothetically, increases in the competition to provide regulatory
services could promote regulatory oversight of exchanges and investor
protection for investors. To the extent that a regulator could improve
on current regulatory oversight, this could result in a better
functioning, more liquid, financial market. However, it is possible
that increased competition between SROs to provide regulatory services
could have negative effects on the market if SROs compete on the basis
of providing light-touch regulation, which might be less likely to
detect violative activity.
    The Commission preliminarily believes that the Plan could provide
opportunities for increased competition in the market to provide
regulatory services. In particular, designated regulatory Staff from
all of the SROs would have access to CAT Data, which would reduce the
differences in data access across SROs.\1061\ This could reduce
barriers to entry in providing regulatory services because data would
be centralized and standardized, possibly reducing economies of scale
in performing surveillance activities.\1062\ Furthermore, because some
types of

previously infeasible surveillance would become possible with the
availability of additional data,\1063\ SROs would have greater
opportunities to innovate in the type of surveillance that is
performed, and the efficiency with which it is performed. In addition,
when as Rule 613(a)(3)(iv) requires, SROs implement new or updated
surveillance within 14 months after effectiveness of the CAT NMS
Plan,\1064\ any SRO could reconsider its approach to outsourcing its
own regulation and whether it wants to compete for regulatory service
agreements.
---------------------------------------------------------------------------

    \1061\ Without a Central Repository, an SRO wishing to compete
as a regulatory services provider would need to invest in the IT
infrastructure and enter into the data access agreements necessary
to surveil broadly beyond its exchanges' data resources. By
providing access to consolidated trade and order data to all SROs,
CAT may reduce barriers to entry for this market. See Exemption for
Certain Exchange Members, supra note 394, at 18057-58 (describing
the barriers to entry of potential new national securities
associations).
    \1062\ The Commission recognizes that efficient access to data
is not the only prerequisite for entering the market to provide
regulatory services and that high barriers to entry may still
characterize this market.
    \1063\ See Section IV.G.2.a, infra, for a discussion of the
efficiency improvements for surveillance.
    \1064\ 17 CFR 242.613(a)(3)(iv).
---------------------------------------------------------------------------

d. Market for Regulatory Data Reporting Services
    The Commission analyzed the effect of the CAT NMS Plan on
competition in the market for data reporting services with a focus on
its impact on the costs incurred by broker-dealers to comply with the
Plan. As discussed in the Costs Section above, the Commission
preliminarily believes that many broker-dealers, particularly smaller
broker-dealers, would fulfill their CAT Reporting obligations by
outsourcing to service bureaus and that the fees charged by the service
bureaus would be a major cost driver for these broker-dealers. Further,
these fees would factor into the increase in barriers to entry in the
market for broker-dealer services.\1065\ Therefore, the Commission
preliminarily believes that any effects on competition in the market
for regulatory data reporting services could have a significant effect
on the costs incurred by broker-dealers in complying with the CAT NMS
Plan.
---------------------------------------------------------------------------

    \1065\ See Section IV.G.1.b, supra.
---------------------------------------------------------------------------

    The Plan provides information on broker-dealers' use of third-party
service providers to accomplish current regulatory data reporting. The
Plan notes that while some broker-dealers perform their regulatory data
reporting in-house, others outsource this activity. The Plan does not
state what proportion of broker-dealers currently outsources their
regulatory data reporting work. However, the Commission interviewed a
variety of broker-dealers and service bureaus in order to gain insight
into the scope of broker-dealers' use of data reporting services. As
noted in the Costs Section,\1066\ the Commission understands that most
firms outsource the bulk of their regulatory data reporting to third-
party firms. The Commission preliminarily believes that the competition
in the market to provide data reporting services is a product of firms
choosing to perform this activity in-house or to outsource it based on
a number of considerations including cost, with some firms choosing to
outsource this activity across multiple service providers.
---------------------------------------------------------------------------

    \1066\ See Section IV.F.1.c(2)A, supra.
---------------------------------------------------------------------------

    The market for regulatory data reporting services is characterized
by bundling, high switching costs, and barriers to entry. The high IT
infrastructure costs of regulatory data reporting creates economies of
scale that give rise to the data reporting services provided by service
bureaus. Broker-dealers, instead of investing in the IT infrastructure
necessary for regulatory data reporting, could share the costs of the
IT infrastructure with other broker-dealers by paying for a service
bureau to report for them. Often, service bureaus bundle regulatory
data reporting services with an order-handling system service that
provides broker-dealers with market access and order routing
capabilities.\1067\ Sometimes service bureaus bundle regulatory data
reporting services with trade clearing services.
---------------------------------------------------------------------------

    \1067\ See Section IV.F.1.c(2)A, supra, for more information on
broker-dealer use of service bureaus.
---------------------------------------------------------------------------

    In discussions with Staff, service bureaus stated that switching
service bureaus can be costly and involve complex onboarding processes
and requirements, that systems between service bureaus may be
disparate, and switching service providers may require different or
updated client documentation. However, service bureaus stated that on-
boarding operations were infrequent and that it was rare for broker-
dealers to switch between service providers. Difficulty switching
between service providers could limit the competition among service
bureaus to provide data reporting services, and impact the costs that
Outsourcers incur to secure regulatory data reporting services.
Furthermore, the high IT infrastructure costs also give rise to
barriers to entry, which could slow the entry of new market
participants into the market. Despite this, the trend in the market is
toward expansion.\1068\
---------------------------------------------------------------------------

    \1068\ See supra note 920.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the Plan could alter the
competitive landscape in the market for data reporting services in
several ways. It is not clear whether demand for regulatory data
reporting services would increase or decrease; although more broker-
dealers would be required to report regulatory data, it is possible
that flexible reporting options allowed by the Plan could make
preparing data for reporting less onerous, leading to fewer firms
choosing to outsource this activity.
    It is possible that the Plan would increase the demand for data
reporting services by requiring regulatory data reporting by broker-
dealers that may have previously been exempt due to size under
individual SRO rules.\1069\ Because more broker-dealers would be
required to report regulatory data under the Plan, the Commission
preliminarily believes there could be an opportunity for increased
competition in this market which might benefit all broker-dealers that
outsource their regulatory data reporting activity. However, it is also
possible that the increase in demand for data reporting services could
serve to entrench existing providers if they capture a large share of
newly created demand; this could lead to relatively higher costs for
broker-dealers than they would face in a more competitive market. The
potential increase in demand for data reporting services could impact
the capacity of already existing data reporting services to meet this
increase in demand, and this in turn could have implications for
competition and pricing in the market for data reporting services.
Considering the barriers to entry that characterize the market for data
reporting services and this potential increase in demand, service
bureaus could have less incentive to compete for broker-dealer clients
because these clients are no longer scarce, and as such, the CAT NMS
Plan could result in a decline in the competition for data reporting
services. It is possible that broker-dealers seeking to establish
relationships with service bureaus could have trouble securing them
because of the limited on-boarding capacity and need to on-board many
broker-dealers at once. In the short-run these capacity constraints and
the high demand could increase the costs of reporting through a service
bureau. However, the two year implementation period for large broker-
dealers and three year period for small broker-dealers could alleviate
the reduction in competition due to the onboarding capacity strain
because current service bureaus have time to increase their on-boarding
capacity and new entrants have time to build the necessary IT
infrastructure and a client base.
---------------------------------------------------------------------------

    \1069\ See, e.g., FINRA Rule 7470.
---------------------------------------------------------------------------

    The CAT NMS Plan could also dramatically change the pool of firms
demanding data reporting services, which would be skewed toward firms
that are smaller and on average costlier to service, which could result
in higher

prices, which could eventually be passed onto investors. In addition to
small and medium sized broker-dealers that previously self-reported,
the CAT NMS plan would result in more broker-dealers having data
reporting responsibilities and the Commission preliminarily believes
that these broker-dealers would predominantly be small. For example,
very small broker-dealers that are currently exempt from OATS reporting
requirements could seek to establish service bureau relationships. In
addition, because the Plan would require additional elements in
regulatory data, particularly customer data, some broker-dealers that
currently self-report could no longer find it economically feasible to
continue to do so.
    In addition to possibly increasing demand for data reporting
services, the CAT NMS Plan may have a mixed effect on the number of
firms offering data reporting services. This can impact the
competitiveness of this market, and affect the costs broker-dealers
bear in securing these services. On one hand, the number of firms
offering data reporting services could decrease, because the need to
secure PII might increase the likelihood of liability and litigation
risks in the event of a security breach.\1070\ On the other hand, it is
possible that the number of service bureaus offering data reporting
services would increase. New reporting requirements for numerous
broker-dealers could create opportunities for new entrants to meet this
demand. This could increase capacity and result in innovation in
providing these services, which could benefit broker-dealers needing
data reporting services by potentially reducing reporting costs, or at
least reducing the potential for cost increases. Lower reporting costs
for broker-dealers could in turn benefit the investors who are serviced
by these broker-dealers, through reduced costs.
---------------------------------------------------------------------------

    \1070\ See Section IV.F.4.a(3), supra for a discussion of the
potential exit of service bureau resulting from the risk of a
security breach.
---------------------------------------------------------------------------

    It is also possible that the Plan would decrease the demand for
data reporting services. Many broker-dealers currently pay another firm
(such as a service bureau) to fulfill their regulatory data reporting;
this may be because these broker-dealers find it would be more
expensive to handle the translation of their order management system
data into fixed formats, such as is required for OATS. If the Plan
Processor allows broker-dealers to send data to the Central Repository
in the formats that they use for normal operations, in drop copies for
example, these broker-dealers may no longer see a cost advantage in
engaging the services of a regulatory data reporting service provider
because one of the costs associated with regulatory data reporting--
having to translate data into a fixed format--will have been
eliminated.\1071\ Without the cost of having to translate data, some
broker-dealers that currently outsource OATS reporting could choose, at
the margin, to insource their regulatory data reporting.
---------------------------------------------------------------------------

    \1071\ The Plan does not mandate the data ingestion format. See
CAT NMS Plan, supra note 3, at Appendix C, at Section A.1(b). The
Commission recognizes that the CAT Reporters Study found no
difference in expected costs for a fixed format, but requests
comment on why the costs may be similar when it would seem logical
that allowing flexible data reporting formats would reduce costs for
broker-dealers. See Request for Comment Nos. 318 and 331 in Section
IV.F.5, supra.
---------------------------------------------------------------------------

    The Commission preliminarily believes that this reduction in demand
would not likely be realized and, if realized, would be unlikely to
offset the increase in demand that would come from CAT reporters not
subject to OATS reporting. As noted in the Costs Section, of the 1,800
expected CAT Reporters, 868 do not currently report to OATS.\1072\ This
means that the Commission expects a large proportion of CAT Reporters
may be broker-dealers that currently do not have a service bureau for
regulatory data reporting but would choose to engage one to manage
their CAT reporting responsibilities. This is more than the
Commission's estimate of 806 current outsourcing broker-dealers.\1073\
Therefore, it is unlikely that the number of current Outsourcers that
choose to become Insourcers would be larger than the number of non-OATS
reporters that would elect to outsource. As a result, demand is more
likely to increase. Further, the requirement for CAT reports to use
listing exchange symbology could require pre-report data processing
even if the Plan Processor allows for the receipt of reports in the
formats that broker-dealers use for normal operations.\1074\ As a
result, the CAT NMS Plan is unlikely to eliminate the costs of
processing data prior to reporting that data to the Central Repository.
---------------------------------------------------------------------------

    \1072\ The Plan estimates that 1,800 broker-dealers are expected
to have CAT reporting obligations. Based on data from FINRA, 932
broker-dealers currently report OATS data. 1,800-932=868. See
Section IV.F.1.c(2)A, supra.
    \1073\ Id.
    \1074\ See supra note 949.
---------------------------------------------------------------------------

2. Efficiency
    The Commission has analyzed the potential impact of the Plan on
efficiency. The Plan includes a discussion of certain efficiency
effects anticipated if the Plan is approved; as part of its economic
analysis, the Commission discusses these effects, as well as additional
effects on efficiency anticipated by the Commission. The Commission
preliminarily believes that the Plan as proposed is likely to result in
significant improvements in efficiency related to how regulatory data
is collected and used. The Plan also has the potential to result in
improvements in market efficiency by deterring violative activity that
could reduce market efficiency.\1075\ The Commission notes, however,
that efficiency gains from the retirement of duplicative and outdated
reporting systems would be delayed for up to two and a half years and
the interim period of increased duplicative reporting would impose
significant financial burden on Industry Members.\1076\
---------------------------------------------------------------------------

    \1075\ The Commission has also analyzed the likely effect of the
Plan on allocative efficiency of existing capital within the
industry. These potential effects are discussed in Section IV.G.3,
infra.
    \1076\ See Section IV.F.2, supra.
---------------------------------------------------------------------------

a. Effect of the Plan on Efficiency
    The Commission has analyzed the possible effects of the CAT NMS
Plan on efficiency. Specifically, building off the discussion in the
Plan, the Commission analyzed the effect of the Plan on the efficiency
of detecting violative behavior through examinations and enforcement,
on the efficiency of surveillance, on market efficiency through
deterrence of violative behavior, on operational efficiency of CAT
Reporters, and on efficiencies through reduced ad hoc data requests and
quicker access to data.
    The current state of regulatory data collection and use provides
ample opportunity for efficiency improvements. First, regulators'
ability to efficiently perform cross-market surveillance is hindered by
data fragmentation.\1077\ Second, regulators' ability to efficiently
supervise and surveil market participants and carry out their
enforcement responsibilities is hindered by limitations in current
regulatory data.\1078\ Finally, there are a number of other
inefficiencies associated with the current system of regulatory data
collection. These include: Delays in data availability to regulators;
lack of direct access to data collected by other regulators results in
numerous ad-hoc data requests; and the need for regulatory Staff to
invest

significant time and resources to reconciling disparate data
sources.\1079\
---------------------------------------------------------------------------

    \1077\ See Section IV.E.2.c, supra.
    \1078\ See Section IV.E.2.c, supra.
    \1079\ See Section IV.D.2.b, supra. These other inefficiencies
are discussed above in the Baseline and Benefits Sections.
---------------------------------------------------------------------------

    The Plan discusses a number of expected efficiency effects
associated with the Plan, including both positive and negative
effects.\1080\ The Commission preliminarily agrees with the Plan's
assessment and has identified additional efficiency effects as well.
The Plan outlines several positive effects relating to efficiency in:
Monitoring for rule violations; performing surveillance; and supporting
fewer reporting systems. Some of these efficiencies are also discussed
in the Benefits Section of this analysis.\1081\
---------------------------------------------------------------------------

    \1080\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
    \1081\ See Section IV.E, supra.
---------------------------------------------------------------------------

    The Plan concludes SROs would experience improved efficiency in the
detection of rule violations, particularly for violations that involve
trading in multiple markets.\1082\ The Plan states an expectation that
SROs would need to expend fewer resources to detect violative cross-
market activity, and such activity would be detected more
quickly.\1083\ The Commission agrees that the Plan would result in
improvements in efficiency in the performance of examinations of market
participants by SROs and the Commission. Improvements to data
availability and access through the Central Repository could allow SROs
and the Commission to more efficiently identify market participants for
examination.\1084\ The Commission also agrees that the Plan would
improve the efficiency of enforcement investigations. If regulatory
data access improves, the quality and quantity of enforcement
investigations could increase through improvements to the
comprehensiveness and timeliness of data used to support
investigations. As mentioned previously, it can take months for
regulators to assemble the data necessary to comprehensively
investigate a regulatory inquiry.\1085\ To the extent that the Plan
allows regulators to access more comprehensive data directly from the
Central Repository, regulators would be able to collect data faster and
start processing it sooner, resulting in a more efficient data analysis
portion of an investigation. As a result, follow-up enforcement
inquiries could be avoided entirely in situations where data from the
Central Repository allows regulators to conclude an initial inquiry
without initiating an enforcement investigation.\1086\ This benefit
would be observable to both regulators and subjects of investigations,
for whom ongoing enforcement investigations can be costly and the
source of uncertainty.
---------------------------------------------------------------------------

    \1082\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b); see also Section IV.E.2, supra.
    \1083\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
    \1084\ See Section IV.E.2.c, supra.
    \1085\ See Section IV.E.2.c, supra.
    \1086\ The Commission notes that this does not preclude an
increase in total enforcement investigations, but rather that some
enforcement investigations may determine earlier in the
investigation that no violation occurred.
---------------------------------------------------------------------------

    The Plan states that the Participants believe that the CAT NMS Plan
could improve the efficiency of surveillance.\1087\ According to the
Plan, this improvement is due to a number of factors including:
Increased surveillance capacity; improved system speed, which would
result in more efficient data analysis; and a reduction in surveillance
system downtime.\1088\ The Plan also cites reduced monitoring
costs,\1089\ but the Commission notes that estimates in the Costs
Section of the Plan predict increased surveillance costs if the Plan is
approved. The increased surveillance costs predicted in the Plan could
reflect more effective surveillance under the Plan. Although the Plan
does not discuss the cost-benefit trade-off of increased surveillance
directly, the Commission notes that achieving the level of surveillance
that would be possible if the Plan is approved would likely be more
expensive using currently available data sources, if it is achievable
at all, due to the inefficiencies that currently exist in delivering
regulatory supervision, discussed previously.\1090\
---------------------------------------------------------------------------

    \1087\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b) (stating that the CAT NMS Plan could reduce monitoring costs,
enable regulators to detect cross-market violative activity more
quickly, provide regulators more fulsome access to unprocessed data
and timely and accurate information on market activity, and provide
CAT Reporters with long term efficiencies resulting from the
increase in surveillance capabilities); see also IV.E.2.c, supra.
    \1088\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b). The Participants surveyed the 10 exchange-operating SRO
groups on surveillance downtime. In conversations with Staff, the
Participants informed Staff that average surveillance downtime was
0.03% from August 1, 2014 to August 31, 2015, and ranges from 0 to
0.21% across SROs.
    \1089\ See id.
    \1090\ See Section IV.E.2, supra.
---------------------------------------------------------------------------

    The Commission preliminarily believes that CAT may reduce violative
behavior.\1091\ The Plan states that CAT may serve a deterrent effect,
thereby reducing investor losses attributable to such behavior.\1092\
Improvements in the efficiency of market surveillance, investigations,
and enforcement could directly reduce the amount of violative behavior
by identifying and penalizing market participants who violate rules and
who would more easily go undetected in the current regime. Furthermore,
market participants' awareness regarding improvements in the efficiency
of market surveillance, investigations, and enforcement (or perceptions
thereof), and the resultant increase in the probability of incurring a
costly penalty for violative behavior, could deter violative
behavior.\1093\ Reductions in violative behavior through both of these
economic channels could improve market efficiency, assuming violative
behavior receives diminishing marginal gains and generates increasing
marginal harm.\1094\
---------------------------------------------------------------------------

    \1091\ See Section IV.E.2.c, supra.
    \1092\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
    \1093\ See, e.g., Schelling, Thomas, ``The Strategy of Conflict:
Prospectus for a Reorientation of Game Theory,'' Journal of Conflict
Resolution, Vol. 2 No.3 (1958); Ellsberg, Daniel, ``The Crude
Analysis of Strategic Choices,'' American Economic Review, Vol. 51,
No. 2 (1961).
    \1094\ See, e.g., Becker, Gary and William Landes, ``Essays in
the Economics of Crime and Punishment,'' Columbia University Press,
(1974).
---------------------------------------------------------------------------

    The Plan discusses increased efficiency due to reductions in
redundant reporting systems.\1095\ The Plan also discusses increases in
system standardization, which would allow consolidation of resources,
including the sunsetting of legacy reporting systems and processes, as
well as consolidated data processing envisioned from the Plan.\1096\
However, the Commission is aware that the Plan, as proposed, calls for
a period of years during which Industry Members would face duplicative
reporting systems before older regulatory data reporting systems are
retired.\1097\ This period of duplicative reporting would impose a
considerable financial burden on Industry Members.\1098\
---------------------------------------------------------------------------

    \1095\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.7(b)(iii)(C) (discussing benefits of CAT to broker-dealers).
    \1096\ See id. at Appendix C, Section B.8(b).
    \1097\ See id. at Appendix C, Section B.9.
    \1098\ See Section IV.F.2, supra for a discussion of duplicative
reporting and whether broker-dealers would pass costs on to
investors.
---------------------------------------------------------------------------

    The Plan discusses two other efficiency improvements: a reduction
in ad-hoc data requests and more fulsome access to raw data. The Plan
predicts a reduction in ad-hoc data requests, which would free up
resources previously used to service such requests.\1099\ However,
while the Plan anticipates a decrease in ad-hoc data requests as a
result of Plan-related data improvements, the Commission notes that it
is possible that some types of ad-hoc data requests might increase. For
instance, even if enforcement

investigations initially use CAT Data, later-stage investigations may
involve requests for data not included in CAT Data, such as commissions
paid or a locate identifier for a short sale. An increase in the
efficiency of enforcement investigations could increase the total
number of later-stage investigations.\1100.\ Such investigations could
produce additional ad-hoc data requests and require other interactions
with market participants.\1101\ The Commission recognizes that these
data request increases would partially offset the efficiency
improvements from the reduction in data requests noted above, but the
Commission preliminarily believes that the Plan would improve
efficiency by reducing the total number of data requests. The
Commission, however, acknowledges that this decrease in data requests
may be partially offset in an increase in the number of investigations
in general, because enhanced surveillance is likely to detect more
potentially violative activity that would need to be investigated.
---------------------------------------------------------------------------

    \1099\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
    \1100\ This does not preclude regulators determining sooner if
the actions they are investigating are not violative. Rather, an
increase in the total number of enforcement investigations due to
efficiency improvements can result in more later-stage
investigations even if regulators are better able to conclude some
investigations earlier.
    \1101\ See Section IV.D.1.c, supra.
---------------------------------------------------------------------------

    Furthermore, the Plan anticipates more robust access to unprocessed
regulatory data, which could improve the efficiency with which SROs
could respond to market events where they previously had to submit data
requests and wait for data validation procedures to be completed before
accessing data collected by other regulators.\1102\ The Commission
recognizes that unprocessed data may contain errors that would later be
fixed.\1103\ The Commission preliminarily believes the benefits of the
greater timeliness of the unprocessed data may justify the lack of
validations and corrections in such unprocessed data.\1104\
---------------------------------------------------------------------------

    \1102\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
    \1103\ See Section III.B.10, supra.
    \1104\ See Section IV.E.2.c, supra, for an example of benefits
from regulators accessing uncorrected data on T+1.
---------------------------------------------------------------------------

b. Effects of Certain Costs of the Plan on Efficiency
    The Plan discusses several sources of inefficiency due to costs of
the Plan that are difficult to quantify, and are transient in nature.
First, the Plan anticipates that implementation would introduce new
costs related to data mapping and data dictionary creation.\1105\
Second, the Plan discusses needs for expenditures, such as staff time
for compliance with encryption requirements associated with the
transmission of PII.\1106\ While the Commission recognizes that these
are additional activities and costs that the Plan would require, it
views these as additional costs rather than inefficiencies and, though
the Commission cannot quantify the magnitude, these costs are likely to
have relatively minor contributions to overall costs of the Plan
because they impose technical requirements on systems that industry
will need to significantly alter to comply with other provisions in the
Plan.\1107\ Furthermore, the Commission notes that the costs of data
mapping and encryption requirements are likely to be included in costs
covered by surveys conducted by the Participants while preparing the
Plan because these requirements were known publicly at the time the
surveys were conducted, and are anticipated to be small relative to
other costs entailed in potentially complying with the Plan if it is
approved.\1108\
---------------------------------------------------------------------------

    \1105\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
    \1106\ See id.
    \1107\ See Section IV.G.2.a, supra.
    \1108\ See Section IV.F.1, supra.
---------------------------------------------------------------------------

    The Plan notes that there could be a market inefficiency effect
related to the funding proposal for the Plan. For example, the cost
allocation methodology for the Plan could create disincentives for the
provision of liquidity, which could impair market quality and increase
the costs to investors to transact.\1109\ The Plan notes that the
funding principles set forth in the Plan \1110\ seek to mitigate the
risk of reduction in market quality resulting from allocation of costs
from building and operating the Central Repository.\1111\ The
Commission preliminarily recognizes that negative effects on efficiency
could result from the CAT Funding Model.\1112\ First, data reporters
could respond to the Funding Model by taking actions to limit their fee
payments, such as exiting the market or reducing their activity levels.
Second, the funding policy of the CAT NMS Plan of aligning fees closely
with the amounts that are required to cover costs could create
incentives for the Plan Processor or Operating Committee to propose a
cost schedule for the CAT that matches a given fee schedule, but is not
the most efficient cost schedule for meeting the CAT regulatory
objectives.\1113\
---------------------------------------------------------------------------

    \1109\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(b).
    \1110\ See id. at Section 11.2, Appendix C, Section
B.7(b)(iv)(C).
    \1111\ See id. at Appendix C, Section B.7.(b)(iv)(C).
    \1112\ See id. at Appendix C, Section B.7(b)(v)(B).
    \1113\ Economics research that dates back to Averch, Harvey, and
Johnson, Leland L. (1962) (``Behavior of the Firm Under Regulatory
Constraint,'' American Economic Review 52 (5): 1052-1069)
characterizes an incentive of regulated utilities to inflate their
costs in order to establish larger rate bases and justify higher
rates. An opposite effect would arise if the regulated utility were
unable to justify sufficient fee revenue to pay the fixed cost of
expanding the base.
---------------------------------------------------------------------------

3. Capital Formation
a. Enhanced Investor Protection
    The Commission has examined the potential effects on capital
formation discussed in the Plan in addition to other potential effects
on capital formation that the Commission believes could result if the
Plan is approved. The Commission preliminarily believes that the Plan
would have a modest positive effect on capital formation.
    The Plan's analysis regarding capital formation concludes that the
Plan would generally not have a deleterious effect on capital formation
and could bolster capital formation that could lead to increased
investor participation in capital markets.\1114\ The Plan's analysis
provides several reasons why the Plan would not adversely affect
capital formation. Specifically, it asserts that the Plan would not
place any undue burden on primary issuances; would not pass along CAT
related costs to ``investors in a way that would limit their access to
or participation in capital markets''; and would not discourage market
participation as a result of data security concerns given the data
security safeguards outlined in the Plan.\1115\ The Commission
preliminarily agrees with the rationale of the Plan's analysis, but
addresses some additional considerations regarding the scope of the
Plan's effects on capital formation, as well as the channels through
which these effects could accrue.
---------------------------------------------------------------------------

    \1114\ See CAT NMS Plan, supra note 3, at Appendix C, Section
C.8(c).
    \1115\ See id.
---------------------------------------------------------------------------

    The Plan's analysis states that the Plan may improve capital
formation by improving investor confidence in the market due to
improvements in surveillance. As discussed previously,\1116\ the
Commission believes that the Plan would provide substantial
enhancements to investor protection through improvements to
surveillance, particularly for cross-market trading.\1117\

As discussed throughout, improved surveillance, as well as other
regulatory activities, could decrease the rate of violative activity in
the market, reducing investor losses due to violative activity, to the
extent that such behavior is not already deterred by current
systems.\1118\ If improved surveillance leads to expectations of fewer
losses due to violative activity, this may increase capital formation
by facilitating a market where investors could be more likely to
mobilize capital into securities markets.\1119\
---------------------------------------------------------------------------

    \1116\ See Section IV.E.2.c, supra and CAT NMS Plan, supra note
3, at Appendix C, Section B.7(b)(ii)(B)(1) and (2), B.7(b)(iii)(C).
    \1117\ FINRA currently provides cross-market surveillance, but
limitations in the data (e.g. reliable cross-market linkages,
customer identification, parent order identification) limit the
scope and reliability of this surveillance.
    \1118\ For example, as discussed in Section IV.E.2.c, the Plan
would allow regulators to more efficiently conduct cross-market and
cross-product surveillance relative to surveillance using current
data sources, and the requirement that data be consolidated in a
single database would assist regulators in detecting activity that
does not appear clearly violative until data is linked and evaluated
from multiple venues. To the extent that market participants are
aware of the current challenges to regulators in performing cross-
market surveillance and aggregating data across venues, and to the
extent that they believe that their violative behavior is more
likely to be detected if regulators' ability to perform those
activities improves, they may reduce or eliminate violative behavior
if the CAT Plan is approved.
    \1119\ There is evidence in the academic finance literature that
countries with weaker investor protections, considering both the
character of rules as well as the quality of enforcement, have
smaller and narrower capital markets in terms of investor
participation. See La Porta, R. et al, ``Legal Determinants of
External Finance,'' Journal of Finance, Vol. 52 No. 3 (1997).
---------------------------------------------------------------------------

    The Commission preliminarily believes there could be additional
increases in capital formation in the form of improvements in
allocative efficiency of existing capital within the industry. If
investors perceive an environment of improved surveillance, they could
be willing to allocate additional capital to liquidity provision or
other activities that increase market efficiency. Furthermore, an
environment of improved surveillance efficiency could result in the
reduction of capital allocated to violative activities that impose
costs on other market participants, because these market participants
may no longer find it possible to engage in such behavior that exposes
them to regulatory action. In this scenario, this reallocation of
capital could improve market quality and efficiency even if net capital
formation changes little. In addition to the potential reallocation of
capital currently mobilized toward violative activities, investor
capital that may currently be diverted because of the risk of loss to
violative activities could also be reallocated should the violative
activities decrease. If the CAT NMS Plan reduces manipulative quoting
activities, either through improved detection/enforcement or through
deterrence of such activities, then investors are less likely to make
capital allocation decisions in response to manipulative quoting
activities. In this scenario, because manipulative quoting activities
have been reduced, the contribution of manipulation to prices has been
reduced and prices should therefore better reflect fundamentals. It
would follow that, to the extent that displayed prices better reflect
fundamentals rather than manipulation, investors could allocate capital
more efficiently for their purposes. The Commission notes, however,
that market participants engaging in allowable activity that might risk
additional regulatory scrutiny under the Plan regime could allocate
capital to other activities to avoid this scrutiny, because even when
activity is not violative, interacting with regulators can be costly
for market participants.\1120\ This reallocation away from allowable
activity to avoid regulatory interactions could result in capital
allocations that are less efficient.\1121\
---------------------------------------------------------------------------

    \1120\ See Section IV.F.4.b, supra, for a discussion of the
potential for the efficiencies in surveillance, examinations, and
investigations to increase the number of regulatory activities,
including the number of regulatory activities on conduct that turns
out not to violate regulations.
    \1121\ The Commission is unable to estimate the magnitude of
allowable economic activity that does not occur when market
participants anticipate relatively high costs of demonstrating
regulatory compliance in the course of normal regulatory
interactions such as exams and inquiries because this activity is
not observable. However, Section IV.F.1.c(2) discusses how some
broker-dealers avoid self-reporting regulatory data because of
expectations of higher costs to demonstrate compliance, providing an
example of an allowable activity that is perceived as costly due to
the risk of compliance costs. See Section IV.F.1.c(2), supra.
---------------------------------------------------------------------------

    The Plan states that the costs from CAT are unlikely to deter
investor participation in the capital markets.\1122\ The Commission
notes, however, that the final costs of the Plan and the funding
mechanism for CAT are not wholly certain at this time; thus, it is the
Commission's view that there is uncertainty concerning the extent to
which investors would bear Plan costs and consequently to what extent
Plan costs could affect investors' allocation of capital. As mentioned
above in the Costs Section,\1123\ the Commission preliminarily does not
know whether Plan costs incurred by the industry are likely to be
passed on to investors. Competition in the market for broker-dealer
services could mitigate some of these costs, but it may not minimize
costs passed on to retail investors. Despite these potential costs to
investors, investors could believe that the additional benefits they
receive from the potential of a market that is more effectively
regulated justify any additional costs they pay to access capital
markets.
---------------------------------------------------------------------------

    \1122\ See CAT NMS Plan, supra note 3, at Appendix C, Section
B.8(c).
    \1123\ See Section IV.F.2, supra.
---------------------------------------------------------------------------

b. Data Security
    The Commission preliminarily agrees with the Plan's assessment that
data security concerns are unlikely to materially affect capital
formation. In its discussion of capital formation, the Plan recognizes
that data security concerns could potentially impact capital formation
through market participants' perception that sensitive proprietary data
might be vulnerable in case of a data breach at the Central Repository.
The Plan's analysis discusses the security measures that are required
by Rule 613 and the manner in which they have been implemented in the
Plan. It concludes that these security measures are sufficient and that
it is unlikely market participants would reduce their participation in
markets in a manner that would affect capital formation.
    As noted above, the Commission agrees that concerns regarding data
security are unlikely to substantially affect capital formation, but
that some uncertainty about the risks exist because of the variations
in the potential security solutions and their resulting
effectiveness.\1124\ The Commission notes that the consequences of a
data breach, nonetheless, could be quite severe. It is inherently
difficult to form reliable economic expectations given that security
breaches of the form that could occur under the CAT NMS Plan occur
infrequently. Therefore, as described in Section IV.F above, even if a
CAT Data security breach is unlikely with the safeguards required by
the Plan, the scope of the potential consequences of such a breach in
the event that one should occur is important to evaluating the risk to
capital formation.\1125\
---------------------------------------------------------------------------

    \1124\ See Section IV.F.4.a, supra.
    \1125\ See id. for a more thorough discussion of the costs and
risks of security breaches of the Central Repository.
---------------------------------------------------------------------------

    A data breach could also substantially harm market participants by
exposing proprietary information, such as a proprietary trading
strategy or the existence of a significant business relationship with
either a counterparty or client. The Commission notes, however, that
broker-dealers already bear such risks in transmitting regulatory data
to SROs. The Commission preliminarily believes that the marginal
increase in the risks to broker-dealers associated with a data breach
would be unlikely to deter

broker-dealers from participating in markets.
    A data breach could potentially reveal PII of investors. To address
the potential for harm to the investing public and the health of
capital markets through such a breach, the Plan has enhanced
requirements for security around PII. Those requirements include a
separate PII-specific workflow, PII-specific authentication and access
control, separate storage of PII data, and a full audit trail of PII
access.\1126\ The Commission preliminarily believes that these risks
will not materially affect investors' willingness to participate in
markets because they already face these risks with PII shared with
broker-dealers, though not in one centralized location.\1127\ However,
the risk and costs of a security breach would be only one factor that
market participants would consider in deciding whether to participate
in the market. Another consideration would be investor protection,
which the Commission preliminarily believes would increase under the
CAT NMS Plan.\1128\
---------------------------------------------------------------------------

    \1126\ See CAT NMS Plan, supra note 3, at Appendix D, Sections
4.1.1-4.1.6. The Commission notes that there is considerable
diversity in the approaches proposed by the Bidders. Further, the
Participants chose to give the Plan Processor flexibility on many
implementation details and the Plan states the requirements as a set
of minimum standards. Consequently, the final PII security solution
cannot be evaluated--only the minimum standards specified in the
Plan.
    \1127\ See Section IV.F.2, supra.
    \1128\ See Section IV.E.2, supra.