[Federal Register Volume 77, Number 148 (Wednesday, August 1, 2012)]
[Rules and Regulations]
[Pages 45721-45814]
[FR Doc No: 2012-17918]

Vol. 77

Wednesday,

No. 148

August 1, 2012

Part II

Securities and Exchange Commission

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17 CFR Part 242

Consolidated Audit Trail; Final Rule

Federal Register / Vol. 77, No. 148 / Wednesday, August 1, 2012 /
Rules and Regulations

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-67457; File No. S7-11-10]
RIN 3235-AK51

Consolidated Audit Trail

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting Rule 613 under the Securities Exchange Act of 1934 (``Exchange
Act'' or ``Act'') to require national securities exchanges and national
securities associations (``self-regulatory organizations'' or ``SROs'')
to submit a national market system (``NMS'') plan to create, implement,
and maintain a consolidated order tracking system, or consolidated
audit trail, with respect to the trading of NMS securities, that would
capture customer and order event information for orders in NMS
securities, across all markets, from the time of order inception
through routing, cancellation, modification, or execution.

DATES: Effective Date: October 1, 2012.

FOR FURTHER INFORMATION CONTACT: Rebekah Liu, Special Counsel, at (202)
551-5665; Jennifer Colihan, Special Counsel, at<PHONE_NUMBER>; Carl
Tugberk, Special Counsel, at<PHONE_NUMBER>; or Leigh Duffy, Special
Counsel, at<PHONE_NUMBER>, Division of Trading and Markets, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Executive Summary
II. Introduction
    A. Need for, and Objectives of, a Consolidated Audit Trail
    1. Use and Limitations of Current Sources of Trading Data
    2. Regulatory Improvements With a Consolidated Audit Trail
    3. Large Trader Reporting System Rule
    B. Summary of Proposed Rule 613
    C. Summary of General Comments on the Proposed Rule
    1. Industry Support for a Consolidated Audit Trail
    2. Commenters' Views on the Overall Costs of the Proposed Rule
and the Resulting Framework of the Adopted Rule
    3. Comments on the Process for Creating a Consolidated Audit
Trail
    4. Comments on Alternatives to the Proposed Consolidated Audit
Trail
III. Discussion
    A. NMS Plan
    1. Description of the Rule
    B. Elements of the NMS Plan
    1. Recording and Reporting
    2. Central Repository
    3. Other Required Provisions of the NMS Plan
    C. NMS Plan Process
    1. Comments on the NMS Plan Process
    2. Adopted Rule
    3. NMS Plan Costs
    4. Consideration of Burden on Competition and Promotion of
Efficiency, Competition, and Capital Formation
    D. Implementation of Rule 613 After Approval of the NMS Plan
IV. Paperwork Reduction Act
    A. Summary of Collection of Information Under Rule 613
    B. Use of Information
    C. Respondents
    D. Total Annual Reporting and Recordkeeping Burden for the
Creation and Filing of the NMS Plan
    1. Preliminary Burden Hour Estimates From Proposing Release
    2. Revised Burden Hour Estimates
    E. Collection of Information Is Mandatory
    F. Confidentiality
    G. Retention Period of Recordkeeping Requirements
V. Regulatory Flexibility Act Certification
VI. Statutory Authority

I. Executive Summary

    In today's high-speed electronic markets, trading is widely
dispersed across a variety of market centers, including exchanges,
Alternative Trading Systems (``ATSs''), such as dark pools and
Electronic Communication Networks (``ECNs''), and over-the-counter
broker-dealers acting as market makers or block positioners. In their
capacity as SROs, the Financial Industry Regulatory Authority
(``FINRA'') and some of the exchanges currently maintain their own
separate audit trail systems for certain segments of this trading
activity, which vary in scope, required data elements and format. In
performing their market oversight responsibilities, SRO and Commission
staffs today must rely heavily on data from these various SRO audit
trails.
    As discussed more fully in part II.A below, there are shortcomings
in the completeness, accuracy, accessibility, and timeliness of these
existing audit trail systems. Some of these shortcomings are a result
of the disparate nature of the systems, which make it impractical, for
example, to follow orders through their entire lifecycle as they may be
routed, aggregated, re-routed, and disaggregated across multiple
markets. The lack of key information in the audit trails that would be
useful for regulatory oversight, such as the identity of the customers
who originate orders, or even the fact that two sets of orders may have
been originated by the same customer, is another shortcoming.
    Though SRO and Commission staff also have access to sources of
market activity data other than SRO audit trails, these systems each
suffer their own drawbacks. For example, data obtained from the
Electronic Blue Sheet (``EBS'') \1\ system and equity cleared reports
\2\ comprise only trade executions, and not orders or quotes. In
addition, like data from existing audit trails, data from these sources
lacks key elements important to regulators, such as the time of
execution, and, in the case of equity cleared reports, the identity of
the customer. Furthermore, recent experience with implementing
incremental improvements to the EBS system has illustrated some of the

overall limitations of the current technologies and mechanisms used by
the industry to collect, record, and make available market activity
data for regulatory purposes.\3\
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    \1\ EBSs are trading records requested by the Commission and
SROs from broker-dealers that are used in regulatory investigations
to identify buyers and sellers of specific securities. See
Securities Exchange Act Release No. 44494 (June 29, 2001), 66 FR
35836 (July 9, 2001) (File No. S7-12-00) (adopting Rule 17a-25). See
also Securities Exchange Act Release Nos. 26235 (November 1, 1988),
53 FR 44688 (November 4, 1988) (approving the Chicago Board Options
Exchange's (``CBOE'') rule for the electronic submission of
transaction information); 26539 (February 13, 1989), 54 FR 7318
(February 17, 1989) (approving the National Association of
Securities Dealers' (n/k/a FINRA) rule for the electronic submission
of transaction information); and 27170 (August 23, 1989), 54 FR
37066 (September 6, 1989) (approving the Philadelphia Stock
Exchange's (n/k/a NASDAQ OMX PHLX LLC) (``Phlx'') rule for the
electronic submission of transaction information).
    To partially address some of the current limitations of the EBS
system, and to provide the Commission, in the short term, with more
detailed and timely trade information for large traders, the
Commission recently adopted new Rule 13h-1 concerning large trader
reporting. See Securities Exchange Act Release No. 61908 (July 27,
2011), 76 FR 46960 (August 3, 2011) (``Large Trader Release''). Rule
13h-1 requires ``large traders'' to identify themselves to the
Commission and make certain disclosures to the Commission on Form
13H. As adopted, Rule 13h-1 requires certain broker-dealers to
capture and report through EBS the time of execution for any trade
involving a large trader and a Commission-issued large trader
identifier that identifies the large trader. See also Section
II.A.3., infra.
    On April 20, 2012, the Commission, among other things, extended
the time by which registered broker-dealers were required to comply
with Rule 13h-1 to allow broker-dealers additional time to develop,
test, and implement enhancements to their recordkeeping and
reporting systems as required under Rule 13h-1. See Securities
Exchange Act Release No. 66839, 77 FR 25007 (April 26, 2012) (Order
Temporarily Exempting Broker-Dealers From the Recordkeeping,
Reporting, and Monitoring Requirements of Rule 13h-1 Under the
Securities Exchange Act of 1934 and Granting an Exemption for
Certain Securities Transactions) (``Large Trader Extension'').
    \2\ The Commission uses the National Securities Clearing
Corporation's (``NSCC'') equity cleared report for initial
regulatory inquiries. This report is generated on a daily basis by
the SROs and is provided to the NSCC in a database accessible by the
Commission, and shows the number of trades and daily volume of all
equity securities in which transactions took place, sorted by
clearing member. The information provided is end-of-day data and is
searchable by security name and CUSIP number.
    \3\ See Large Trader Extension, supra note 1.
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    The Commission therefore believes that the regulatory data
infrastructure on which the SROs and the Commission currently must rely
generally is outdated and inadequate to effectively oversee a complex,
dispersed, and highly automated national market system. In performing
their oversight responsibilities, regulators today must attempt to
cobble together disparate data from a variety of existing information
systems lacking in completeness, accuracy, accessibility, and/or
timeliness--a model that neither supports the efficient aggregation of
data from multiple trading venues nor yields the type of complete and
accurate market activity data needed for robust market oversight.
    To address this problem and improve the ability of the SROs and the
Commission to oversee the securities markets, on May 26, 2010, the
Commission proposed Rule 613,\4\ with the goal of creating a
comprehensive consolidated audit trail \5\ that allows regulators to
efficiently and accurately track all activity in NMS securities
throughout the U.S. markets. As proposed--and summarized in part II.B
below--Rule 613 required SROs to jointly submit an NMS plan \6\ that
would govern the creation, implementation, and maintenance of a
consolidated audit trail, including a central repository to receive and
store consolidated audit trail data. In the proposed Rule, the
Commission specified many requirements that the NMS plan, and by
extension the consolidated audit trail, must meet, ranging from details
of the data elements to be collected, to the timing of data
transmissions, to specific standards for data formatting.
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    \4\ See Securities Exchange Act Release No. 62174 (May 26,
2010), 75 FR 32556 (June 8, 2010) (``Proposing Release''). The
comment file is on the Commission's Web site at: http://www.sec.gov/comments/s7-11-10/s71110.shtml.
    \5\ In this release, ``consolidated audit trail'' means both a
system capable of capturing a complete record of all transactions
relating to an order, from origination to execution or cancellation,
and the complete record for an order generated by such a system, as
the context may require.
    \6\ NMS plan is defined in Rule 600(b)(43) to mean ``any joint
self-regulatory organization plan in connection with: (i) [t]he
planning, development, operation or regulation of a national market
system (or a subsystem thereof) or one or more facilities thereof;
or (ii) [t]he development and implementation of procedures and/or
facilities designed to achieve compliance by self-regulatory
organizations and their members with any section of [Regulation NMS]
* * *.'' 17 CFR 240.600(b)(43). Such NMS plan may be subject to
modification prior to approval by the Commission pursuant to Rule
608 of Regulation NMS, as discussed in Section III.C.2.a.v., infra.
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    Among its various requirements, the proposed Rule mandated that the
NMS plan developed by the SROs must in turn require each SRO and its
members to capture and report specified trade, quote, and order
activity in all NMS securities \7\ to the central repository in real
time, across all markets, from order inception through routing,
cancellation, modification, and execution. The proposed Rule also
mandated that the NMS plan require the creation of unique order
identifiers to facilitate the ability of regulators to view cross-
market activity, as well as unique customer identifiers to enhance the
ability of regulators to reliably and efficiently identify the
beneficial owner of the account originating an order or the person
exercising investment discretion for the account originating the order,
if different from the beneficial owner.
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    \7\ ``NMS security'' is defined in Rule 600(a)(46) of Regulation
NMS to mean ``any security or class of securities for which
transaction reports are collected, processed, and made available
pursuant to an effective transaction reporting plan, or an effective
national market system plan for reporting transactions in listed
options.'' 17 CFR 242.600(a)(46). NMS stock is defined in Rule
600(47) to mean ``any NMS security other than an option.'' 17 CFR
242.600(a)(46). A listed option is defined in Rule 600(a)(35) of
Regulation NMS to mean ``any option traded on a registered national
securities exchange or automated facility of a national securities
association.'' 17 CFR 242.600(a)(35).
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    The Commission received 64 comment letters from 56 commenters in
response to the proposed consolidated audit trail representing a wide
range of viewpoints, as summarized in part II.C below.\8\ The
commenters included national securities exchanges, a national
securities association, technology providers, academics, broker-
dealers, organizations representing industry participants, individual
investors, and members of Congress.\9\ Of the comment letters received,
13 expressed support for the proposal; \10\ 36 expressed support, but
suggested modifications to certain provisions of the proposal; \11\
five solely suggested modifications to the proposal; \12\ two opposed
the proposal; \13\ and seven neither supported nor opposed the
substance of the proposal.\14\ Concerns raised in these comment letters
included: (1) The appropriateness of real-time reporting of required
data to the central repository; \15\ (2) the scope of the required data
elements, including the use of unique order identifiers and unique
customer identifiers; \16\ and (3) the burden and costs associated with
the proposal.\17\ In addition, a number of commenters offered
alternative approaches and made suggestions regarding the creation,
implementation, and maintenance of the consolidated audit trail.\18\
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    \8\ See Exhibit A for a citation key to the comment letters
received by the Commission on the proposed rule. The Commission also
received four comment letters that do not address the substance of
the consolidated audit trail proposal. See Ericson Letter; Kondracki
Letter; Grady Letter; Deep Liquidity Letter.
    \9\ The Commission notes that, in some cases, commenters fell
into more than one such category.
    \10\ See Vannelli Letter; Beach Letter; Foothill Letter; Green
Letter; Wealth Management Letter; McCrary Letter; Anastasopoulos
Letter; Triage Letter; FTEN Letter; Middle Office Letter; Correlix
Letter; Lettieri Letter; Bean Letter.
    \11\ See ICI Letter; Thomson Reuters Letter; Scottrade Letter;
Liquidnet Letter; FINRA/NYSE Euronext Letter; BOX Letter; Nasdaq
Letter I; Nasdaq Letter II; TIAA-CREF Letter; GETCO Letter; BATS
Letter; SIFMA Letter; SIFMA February 2012 Letter; CBOE Letter;
Direct Edge Letter; Angel Letter; IAG Letter; Managed Funds
Association Letter; Mansfield Letter; Marketcore Letter; Kumaraguru
Letter; Ameritrade Letter; FINRA Letter; Wells Fargo Letter; Noetic
Partners Letters; Knight Letter; FIF Letter; FIF Letter II; Albany
Letter; Endace Letter; Ross Letter; FINRA Proposal Letter; Schumer
Letter; FIA Letter; STA Letter; Van Bokkelen Letter.
    \12\ See Belanger Letters; SIFMA Drop Copy Letter; Wachtel
Letter; High Speed Letter (recommending next steps in the
development of the consolidated audit trail).
    \13\ See BondMart Letter; Leuchtkafter Letter.
    \14\ See Broadridge Letter; FIX Letter; Know More Letter; Aditat
Letter; iSys Letter; Kaufman Letter; Berkeley Letter.
    \15\ See Scottrade Letter, p. 1; ICI Letter, p. 4-6; FINRA/NYSE
Euronext Letter, p. 4; GETCO Letter, p. 2; BATS Letter, p. 1-2;
SIFMA Letter, p. 3-8; SIFMA February 2012 Letter, p. 1; CBOE Letter,
p. 4-5; Direct Edge Letter, p. 3; FINRA Letter, p. 10-13; Wells
Fargo Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter;
Broadridge Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy Letter,
p. 1; Ross Letter, p. 1; FINRA Proposal Letter, p. 3; FIA Letter, p.
1-2.
    \16\ See Ameritrade Letter, p. 3; Kumaraguru Letter, p. 1; FINRA
Proposal Letter, p. 6-8, 13 and Appendix A.; Angel Letter, p. 2-3;
Managed Funds Association Letter, p. 2; SIFMA Letter, p. 11-12, 14;
SIFMA Drop Copy Letter, p. 2; Liquidnet Letter p. 6-7; FINRA Letter,
p. 4, 7-9; CBOE Letter, p. 2; Knight Letter, p. 2; Scottrade Letter,
p. 1; DirectEdge Letter, p. 3; FIF Letter, p. 2-3, 6-7; FIF Letter
II, p. 2; BOX Letter, p. 2; Wells Fargo Letter, p. 3; Ross Letter,
p. 1; ICI Letter, p. 3; Thomson Reuters Letter, p. 3; Endace Letter,
p. 1-2; GETCO Letter, p. 4.
    \17\ See Thomson Reuters Letter, p. 2; Liquidnet Letter, p. 1;
CBOE Letter, p. 2, 4-5; Nasdaq Letter I, p. 2; Angel Letter, p. 1-2;
IAG Letter, p. 3.; Kaufman Letter, attachment p. 3; Wells Fargo
Letter, p. 3-4; Noetic Partners Letter, p. 2; Leuchtkafer Letter, p.
1-5; Broadridge Letter, p. 3; FINRA Proposal Letter, p. 2-3.; High
Speed Letter, p. 1; Belanger Letter, p. 7-8; Correlix Letter, p. 2.;
FTEN Letter, p. 13; SIFMA Letter, p.1-8, 15-16; FINRA/NYSE Euronext
Letter, p 4, 7; FINRA Letter, p. 3, 10-13; Scottrade Letter, p. 1;
ICI Letter, p. 4-6; GETCO Letter, p. 2; BATS Letter, p. 1-2; Direct
Edge Letter, p. 3; Knight Letter, p. 2-3; Leuchtkafer Letter;
Broadridge Letter, p. 3; FIF Letter, p. 4; SIFMA Drop Copy Letter,
p. 1; Ross Letter, p. 1; SIFMA February 2012 Letter; FIA Letter, p.
1-2; Noetic Partners Letter II, p. 2; High Speed Letter, p. 1.
    \18\ See FINRA Proposal Letter; Angel Letter, p. 3; BOX Letter,
p. 2; BATS Letter, p. 2; CBOE Letter, p. 2-3; SIFMA Letter, p. 16-
18; Wells Fargo Letter, p. 2; Knight Letter, p. 3; FIF Letter, p. 5-
6; Schumer Letter, p. 1; FIF Letter, p. 1-3; FINRA Letter, p. 3, 6;
FINRA/NYSE Euronext Letter, p. 8, 14; SIFMA Drop Copy Letter.

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    In consideration of the views expressed, suggestions for
alternatives, and other information provided by those commenting on the
proposed Rule, the Commission is adopting Rule 613 with significant
modifications to the proposed requirements for the NMS plan submitted
to the Commission for its consideration. In certain instances these
modifications alter the data and collection requirements of the
proposed Rule. In other instances, the adopted Rule has been altered to
be less prescriptive, and hence less limiting, in the means SROs may
use to meet certain requirements. Some of the more significant changes
are as follows:
     Replacing Real-Time Reporting with a Requirement to Report
Data by 8 a.m. of the Next Trading Day. The adopted Rule no longer
requires that the NMS plan provide for the reporting of order event
data \19\ to the central repository in real time; rather, it provides
that the NMS plan must require the reporting of order event data to the
central repository by 8 a.m. Eastern Time on the trading day following
the day such information has been recorded by the SRO or the
member.\20\ The NMS plan may accommodate voluntary submissions of order
event data prior to 8 a.m. on the following trading day, but it may not
mandate a reporting deadline prior to 8 a.m.
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    \19\ As used herein, the term ``order event data'' is used to
refer to the information reported pursuant to Rule 613(c)(3) and
identified in Rule 613(c)(7)(i) through (v), generally including:
(1) The Customer-ID(s) for each customer, including the person
giving a modification or cancellation instruction; (2) the CAT-
Order-ID; (3) the CAT-Reporter-ID of the broker-dealer, national
securities exchange, or national securities association receiving,
originating, routing, modifying, cancelling or executing an order,
and to which an order is being routed; (4) the identity and nature
of the department or desk to which an order is routed, if routed
internally at the broker-dealer; (5) the date an order was received,
originated, routed, modified, cancelled, or executed; (6) the time
an order was received, originated, routed, modified, cancelled, or
executed; (7) material terms of an order and any changes of such
terms, if modified; (8) the price and remaining size of an order, if
modified; (9) execution capacity (principal, agency, riskless
principal); (10) execution price and size; and (11) whether the
execution was reported pursuant to an effective transaction
reporting plan or the Plan for Reporting of Consolidated Options
Last Sale Reports and Quotation Information (``OPRA''). See Section
III.B.1.d., infra. Information reported pursuant to Rule 613(c)(4)
and identified in Rule 613(c)(7)(vi) through (viii) is referred to
as ``supplemental data.''
    \20\ See Rule 613(c)(3); Sections II.A., III.B.1.e., infra.
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     Providing More Flexibility to Determine the Format of Data
Reported to the Central Repository. The proposed Rule mandated that the
NMS plan require the SROs and their members to collect and provide to
the central repository the required order and event information in a
uniform electronic format. The adopted Rule instead allows the SROs to
determine the details of how market participants would transmit data to
the central repository (which might include multiple electronic
formats, rather than a uniform electronic format), subject to a more
general requirement that data must be transmitted in a manner that
ultimately allows the central repository to make this data available to
regulators in a uniform electronic format.\21\
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    \21\ See Rule 613(c)(2); Sections III.B.1.f., III.B.2., infra.
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     Eliminating the Requirement to Report Orders with a Unique
Order Identifier. The proposed Rule mandated that each order reported
to the central repository be tagged with a unique identifier that is
the same throughout the order's entire lifecycle. In the adopted Rule,
this requirement is replaced with a more general requirement that once
all order events are transmitted to the central repository, the
repository must be able to efficiently and accurately link together all
lifecycle events for the same order, and make available to regulators
this linked order data.\22\
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    \22\ See Rule 613(j)(1); Section III.B.1.d.iv., infra.
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     Extending the Compliance Period for Small Broker-Dealers.
Under the adopted Rule, the NMS plan may provide that small broker-
dealers be allowed up to three years, rather than two years as
proposed, from the effectiveness of the NMS plan to provide the
required data to the consolidated audit trail.\23\
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    \23\ See Rule 613(a)(3)(vi); Section III.B.1.c., infra.
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    In addition to the above modifications, the Commission has also
added a number of new requirements to the adopted Rule in response to
general concerns expressed by commenters regarding the process for the
development and implementation of the NMS plan. Some of the more
significant of these additions are as follows:
     Considering and Explaining Choices and Available
Alternatives. The adopted Rule requires that the NMS plan describe and
discuss any reasonable alternative approaches to the creation of the
consolidated audit trail that were considered by the SROs and why the
approach set forth by the NMS plan was selected.\24\
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    \24\ See Rule 613(a)(1)(xii); Section III.C.2.a., infra.
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     Planning for Future System Efficiencies. The adopted Rule
requires that the NMS plan provide a plan to eliminate existing rules
and systems (or components thereof) that are rendered duplicative by
the consolidated audit trail, including identification of such rules
and systems (or components thereof). Further, to the extent that any
existing rules or systems related to monitoring quotes, orders, and
executions provide information that is not rendered duplicative by the
consolidated audit trail, such plan must also include an analysis of
(1) whether the collection of such information remains appropriate, (2)
if still appropriate, whether such information should continue to be
separately collected or should instead be incorporated into the
consolidated audit trail, and (3) if no longer appropriate, how the
collection of such information could be efficiently terminated.
Finally, such plan must also discuss the steps the plan sponsors
propose to take to seek Commission approval for the elimination of such
rules and systems (or components thereof); and a timetable for such
elimination, including a description of how the plan sponsors propose
to phase in the consolidated audit trail and phase out such existing
rules and systems (or components thereof).\25\
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    \25\ See Rule 613(a)(1)(ix); Section III.C.2.a., infra.
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     Considering Input. The adopted Rule requires the NMS plan
to address the process by which the plan sponsors solicited views of
their members and other appropriate parties regarding the creation,
implementation, and maintenance of the consolidated audit trail,
provide a summary of the views of such members and other parties, and
describe how the plan sponsors took such views into account in
preparing the NMS plan.\26\ In addition, the adopted Rule also requires
the NMS plan to provide for the establishment of an Advisory Committee
whose function will be to advise the plan sponsors on the
implementation, operation, and administration of the central
repository.\27\
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    \26\ See Rule 613(a)(1)(xi).
    \27\ See Rule 613(b)(7). For a further discussion of the
composition of the Advisory Committee, see Section III.B.3.b.,
infra.
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     Periodic Reviews of the Consolidated Audit Trail. To help
assure the Commission that as financial markets evolve and new
technologies emerge, the consolidated audit trail remains a useful
regulatory tool, the adopted Rule mandates that the NMS plan must
require the central repository's Chief Compliance Officer to regularly
review the operations of the consolidated audit trail, and, in light of

market and technological developments, make appropriate recommendations
for enhancements to the consolidated audit trail.\28\
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    \28\ See Section III.B.2., infra.
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    The Commission has also added certain requirements to the adopted
Rule in response to specific concerns expressed by commenters with
respect to the use of consolidated audit trail data. Some of the more
significant of these additions are as follows:
     Enhancing Security and Privacy Requirements. Commenters
have expressed concerns regarding the risk of failing to maintain
appropriate controls over the privacy and security of consolidated
audit trail data. Accordingly, the adopted Rule requires the NMS plan
to include additional policies and procedures that are designed to
ensure the rigorous protection of confidential information collected by
the central repository.\29\
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    \29\ See Rule 613(e)(4).
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     Addressing and Limiting Errors. Commenters have also
expressed concerns about the potential for errors in the consolidated
audit trail; the adopted Rule requires the SROs to provide in their NMS
plan detailed information regarding anticipated error rates as well as
the plan's proposed error correction process.\30\
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    \30\ See Rule 613(e)(6); Section III.B.2., infra.
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    The Commission generally believes that the collective effect of the
modifications and additions described above will be to significantly
expand the set of solutions that could be considered by the SROs for
creating, implementing, and maintaining a consolidated audit trail and
to provide the SROs with increased flexibility in how they choose to
meet the requirements of the adopted Rule, relative to the alternatives
that would have been available under the requirements of the proposed
Rule. The Commission further believes that these changes address or
mitigate the principal concerns raised by commenters--including
concerns regarding the extent and cost of the systems changes required
by the SROs and their members--while continuing to enable the SROs and
the Commission to achieve significant benefits from the consolidated
audit trail.\31\ Each of the modifications and additions noted above is
described and explained in detail in part III below.
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    \31\ See Section II.A., infra, for a discussion of the
objectives of the consolidated audit trail.
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    Given these changes and the wide array of commenters' views on how
to best create, implement, and maintain a consolidated audit trail, the
Commission expects that the SROs will seriously consider various
options as they develop the NMS plan to be submitted to the Commission
for its consideration.\32\ Indeed, some commenters recognized that a
consolidated audit trail could be created, implemented, and maintained
in a number of ways, and thus recommended that the Commission replace
the specific systems requirements of the proposed Rule with more
general ``end-user'' requirements, perform an analysis of how existing
audit trail systems do and do not meet the needs of regulators, and
perhaps even engage in a formal request-for-proposal (``RFP'')
process.\33\
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    \32\ See, e.g., FINRA Letter, p. 14 (advocating that SROs build
off existing audit trails to develop a consolidated audit trail) and
Nasdaq Letter I, p. 11-12 (arguing against building off existing
audit trail systems and supporting the development of new system to
establish a consolidated audit trail).
    \33\ See Nasdaq Letter I, p. 12; FIF Letter II, p. 2-3; STA
Letter, p. 1-3; Direct Edge Letter, p. 2-3, 5.
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    In light of the expanded solution set that should be available
under the changes described above and commenter views on the NMS plan
development process, the adopted Rule now requires the SROs to provide
much more information and analysis to the Commission as part of their
NMS plan submission. These requirements have been incorporated into the
adopted Rule as ``considerations'' that the SROs must address, and
generally mandate that the NMS plan discuss: (1) The specific features
and details of the NMS plan (e.g., how data will be transmitted to the
central repository, when linked data will be available to regulators);
(2) the SROs' analysis of NMS plan costs and impact on competition,
efficiency, and capital formation; (3) the process followed by the SROs
in developing the NMS plan (e.g., the requirement to solicit input from
members of the SROs and other appropriate parties); and (4) information
about the implementation plan and milestones for the creation of the
consolidated audit trail.
    These requirements are intended to ensure that the Commission and
the public have sufficiently detailed information to carefully consider
all aspects of the NMS plan ultimately submitted by the SROs,
facilitating an analysis of how well the NMS plan would allow
regulators to effectively and efficiently carry out their
responsibilities. To help elicit the most appropriate information and
analysis from the SROs in response to these requirements, the
Commission is furnishing further details about how it envisions
regulators would use, access, and analyze consolidated audit trail data
through a number of ``use cases.'' These use cases and accompanying
questions should help the SROs prepare an NMS plan that better
addresses the requirements of the adopted Rule, as well as aid the
Commission and the public in gauging how well the NMS plan will address
the need for a consolidated audit trail.\34\
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    \34\ See Section III.C.2.b., infra.
---------------------------------------------------------------------------

    Because the Commission believes the adopted Rule permits a wider
array of solutions to be considered by the SROs than the proposed Rule
did and because the Commission and the public will be able to avail
themselves of much more information and analysis in connection with the
NMS plan submission, the Commission is also making significant
modifications to the process by which it will consider the costs and
benefits of the creation, implementation, and maintenance of a
consolidated audit trail, as well as the potential impacts on
efficiency, competition, and capital formation. In particular, the
methodology that the Commission used in the Proposing Release to
estimate the costs of creating, implementing, and maintaining a
consolidated audit trail may be no longer suitable. As discussed in the
Proposing Release, the approximately $4 billion cost estimate for the
creation and implementation of a consolidated audit trail was primarily
based on averages for the development from scratch of new, very large-
scale market systems.\35\ However, the Commission's rationale for this
approach was predicated on some of the specific technical requirements
of the proposed Rule, especially those related to the real-time
collection and standard formatting of all data. As such, the approach
assumed that the consolidated audit trail would not be able to build on
existing trade, order, and audit trail systems. As noted above, these
assumptions may no longer be valid since several of the specific
technical requirements underlying the Proposing Release's approach have
been substantially modified. The Commission believes these changes
would now permit a wider array of solutions to be considered by the
SROs, including solutions that could capitalize on existing systems and
standards.\36\
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    \35\ The methodology in the Proposing Release assumed that the
scope of the required systems changes would be comparable to those
made in connection with Regulation NMS. See Proposing Release, supra
note 4, at 32597, n. 352.
    \36\ See, e.g, FINRA Letter, p. 14; SIFMA Letter, p. 16-18.
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    In light of these changes, the Commission believes that the
economic consequences of the consolidated audit trail now will become
apparent only over the course of the multi-step process

for developing and approving an NMS plan that will govern the creation,
implementation, and maintenance of a consolidated audit trail. In
particular, the Commission believes that the costs and benefits of
creating a consolidated audit trail, and the consideration of specific
costs as related to specific benefits, is more appropriately analyzed
once the SROs narrow the expanded array of choices they have under the
adopted Rule and develop a detailed NMS plan. The Commission therefore
is focusing its economic analysis in this Release on the actions the
SROs are required to take upon approval of the adopted Rule--
specifically the requirement that the SROs develop an NMS plan,
utilizing their own resources and undertaking their own research, that
addresses the specific details, cost estimates, considerations, and
other requirements of the Rule.\37\ A robust economic analysis of the
next step--the actual creation and implementation of a consolidated
audit trail itself--requires information on the plan's detailed
features (and their associated cost estimates) that will not be known
until the SROs submit their NMS plan to the Commission for its
consideration. Accordingly, the Commission is deferring this analysis
until such time as it may approve any NMS plan--that is, after the NMS
plan, together with its detailed information and analysis, has been
submitted by the SROs and there has been an opportunity for public
comment.
---------------------------------------------------------------------------

    \37\ See Rule 613(a)(1).
---------------------------------------------------------------------------

    To that end, the adopted Rule requires that the SROs: (1) Provide
an estimate of the costs associated with creating, implementing, and
maintaining the consolidated audit trail under the terms of the NMS
plan submitted to the Commission for its consideration; (2) discuss the
costs, benefits, and rationale for the choices made in developing the
NMS plan submitted; and (3) provide their own analysis of the submitted
NMS plan's potential impact on competition, efficiency and capital
formation. The Commission believes that these estimates and analyses
will help inform public comment regarding the NMS plan and will help
inform the Commission as it evaluates whether to approve the NMS plan.
In this way, the Commission can develop estimates of the costs for the
creation, implementation, and maintenance of the consolidated audit
trail that benefit from cost data and information provided by the SROs.
    The Commission notes that this approach is suited for the multi-
step nature of the particular process for developing and approving an
NMS plan that will govern the creation, implementation, and maintenance
of a consolidated audit trail. Further, because the Commission is
deferring its final analysis of the consolidated audit trail until
after a detailed NMS plan has been submitted to the Commission for its
consideration and the public has had an opportunity to comment, the
adopted Rule has been modified to include a mandate that in determining
whether to approve the NMS plan and whether the NMS plan is in the
public interest, the Commission must consider the impact of the NMS
plan on efficiency, competition, and capital formation of creating,
implementing, and maintaining the NMS plan.\38\ The Commission also
will consider the costs and benefits of the creation, implementation,
and maintenance of the consolidated audit trail pursuant to the details
proposed in the NMS plan submitted to the Commission for its
consideration.
---------------------------------------------------------------------------

    \38\ See Rule 613(a)(5).
---------------------------------------------------------------------------

    As a result of the new requirements for SROs to provide additional
information about costs and a number of other aspects of the NMS plan
they submit, the Commission is extending the timeframe for the
submission of the NMS plan from 90 days from the date of approval of
Rule 613 to 270 days from the date of publication of the adopting
release for Rule 613 (``Adopting Release'') in the Federal Register.
The Commission also is altering the timeframe within which SROs must
submit proposed rule changes to require their members to comply with
the requirements of the Rule and the NMS plan approved by the
Commission \39\ and the deadline for submitting the document required
by Rule 613(i) regarding the possible expansion of the scope of the NMS
plan.\40\
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    \39\ The proposed Rule would have required SROs to submit such
proposed rule changes on or before from 120 days from approval of
the Rule. Because the adopted Rule permits the SROs up to 270 days
from the date of publication of the Adopting Release in the Federal
Register to submit NMS plans, the Commission believes that the more
appropriate deadline for SROs to submit rule changes is 60 days from
the date the Commission approves an NMS plan.
    \40\ Specifically, the adopted Rule provides SROs six months,
instead of two months, after effectiveness of the NMS plan to submit
this document to the Commission.
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II. Introduction

A. Need for, and Objectives of, a Consolidated Audit Trail

    The Commission believes that the Rule adopted today is an
appropriate step in the creation of a consolidated audit trail which,
when implemented, should substantially enhance the ability of the SROs
and the Commission to oversee today's securities markets and fulfill
their responsibilities under the federal securities laws. Rule 613
requires the submission of an NMS plan to create, implement, and
maintain the first comprehensive audit trail for the U.S. securities
markets, which will allow for the prompt and accurate recording of
material information about all orders in NMS securities, including the
identity of customers, as these orders are generated and then routed
throughout the U.S. markets until execution, cancellation, or
modification. This information will be consolidated and made readily
available to regulators in a uniform electronic format.
    This section reviews the current status and limitations of
existing, discrete audit trails and discusses how a consolidated audit
trail could address those limitations and improve the ability of the
SROs and the Commission to perform their regulatory functions. To
perform this review, the Commission is, in part, drawing upon its own
experiences in using existing audit trails to carry out its regulatory
duties.\41\ The Commission also is relying on information provided to
the Commission from other regulators who use existing audit trail
systems, broker-dealers and organizations representing industry
participants, and those with expertise in data management and
technology solutions that may be applicable to the adopted
requirements.
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    \41\ See Proposing Release, supra note 4, at 32558-61.
---------------------------------------------------------------------------

1. Use and Limitations of Current Sources of Trading Data
    It has become increasingly challenging for SROs and the Commission
to oversee the U.S. securities markets across the multitude of trading
venues, given the huge volume of orders and trades that are generated,
routed, transformed, and then re-routed across dozens of venues every
day. Among the challenges is the fact that there is no single,
comprehensive audit trail available to regulators.\42\ At present, the
SROs and the Commission must use a variety of data sources, including
EBS,\43\ equity cleared reports,\44\ and SRO audit trail data to help
fulfill their regulatory obligations. As a result, among other issues,
regulatory authorities face many challenges in obtaining, reconciling,
and making effective use of even the limited

order and execution data that is available, thereby hindering the
conduct of market surveillance, investigation and enforcement
activities, and market reconstructions and analyses.\45\
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    \42\ See FINRA/NYSE Euronext Letter, p. 1-3; Nasdaq Letter I, p.
1-5.
    \43\ See note 1, supra; Proposing Release, supra note 4, at
32557-58.
    \44\ See note 2, supra.
    \45\ The term ``market reconstruction'' is used to refer to the
efforts by SRO and Commission staff to collect and process detailed
trade and order data, often from multiple and varied data sources
(e.g., market participants, trading venues, and other SROs) to
recreate the sequence of events and market conditions that existed
over a given period of time. A recent example of this occurred
following the ``Flash Crash'' of May 6, 2010, with the market
reconstruction analysis undertaken by Commission and the Commodity
Futures Trading Commission (``CFTC'') staff, which can be found in
the ``Findings Regarding the Market Events of May 6, 2010: Report of
the Staffs of the CFTC and the SEC to the Joint Advisory Commission
Emerging Regulatory Issues.'' See http://www.sec.gov/news/studies/2010/marketevents-report.pdf.
---------------------------------------------------------------------------

    The ultimate effectiveness of core SRO and Commission regulatory
efforts depends on the following four qualities of trade and order
(collectively ``market'') data:
     Accuracy. Is the data about a particular order or trade
correct?
     Completeness. Does the data represent all market activity
of interest, or just a subset? Is the data sufficiently detailed to
provide the required information?
     Accessibility. How is the data stored? How practical is it
to assemble, aggregate, reconcile, and process the data? Can all
appropriate regulators acquire the data they need?
     Timeliness. When is the data available to regulators? How
long will it take to process before it can be used for regulatory
analyses?
    SROs generally use market data in the form of audit trails to
identify potential misconduct in the markets they oversee, including
attempts to manipulate market quotations, inflate trading or order
volume artificially, or profit from non-public information. When these
surveillance efforts identify suspicious trading activity, SROs have a
responsibility to open investigations in which they assemble and review
additional market data to assess the nature and scope of the potential
misconduct. When an SRO detects persistent problems in the market it
oversees, it may write new rules for its members to address the
problems. To inform these rulemaking efforts, SROs frequently gather
and analyze significant amounts of market data. The effectiveness of
such efforts is largely determined by the qualities of the data
available.\46\
---------------------------------------------------------------------------

    \46\ The Commission recognizes that the accuracy of the data
available may also be subject to occasional errors, including errors
caused by rare and unexpected events.
---------------------------------------------------------------------------

    The qualities of such market data are also primary determinants of
the Commission's ability to fulfill its statutory mission. The
Commission uses market data in most of its investigations of potential
securities law violations. In many of these investigations, market data
analysis frames the issues for investigation and is a primary means of
identifying relationships between individuals and entities whose
activities may threaten the integrity of the securities markets or
create substantial and unnecessary investor losses. The Commission also
uses audit trails and other sources of market data to: (1) Inform its
priorities for examinations of broker-dealers, investment advisers and
SROs; (2) supplement the data and information it collects during those
examinations; and (3) determine the nature and scope of any potential
misconduct the examinations identify. The Commission also relies
heavily on market data to identify patterns of trading and order
activity that pose risks to the securities markets and to inform
regulatory initiatives, as well as to perform market reconstructions.
In addition, the Commission relies on market data to improve its
understanding of how markets operate and evolve, including with respect
to the development of new trading practices, the reconstruction of
atypical or novel market events, and the implications of new markets or
market rules. As is the case for the SROs, the effectiveness of such
efforts by the Commission is largely determined by the qualities of the
data available.\47\
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    \47\ The effectiveness of such efforts with respect to cross-
market activities within the Commission's jurisdiction depends on
the qualities of data from multiple sources, such as separate SRO
audit trails used for equities and equity options. See Section
II.A.1.c., infra. This dependency also exists with respect to market
activities that involve other products outside the Commission's
jurisdiction, such as futures and certain swaps. See note 239,
infra.
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    As described in the following sections, each of the present sources
of market data available to regulators suffers from deficiencies
limiting its effective use.
a. The EBS System
    The EBS system is currently the only available source of data that
allows regulators to obtain the identity of customers of broker-dealers
who have executed trades. The SROs and the Commission have depended on
this system for decades to request trading records from broker-dealers.
The EBS system, supplemented by the requirements of Rule 17a-25 under
the Exchange Act,\48\ is generally used by SRO and Commission staff to
assist in the investigation of possible securities law violations,
typically involving insider trading and market manipulations.\49\ In
its electronic format, the EBS system provides certain detailed
execution information, upon request by SRO or Commission staff, for
specific securities during specified timeframes. However, EBS data,
which is currently sourced from the so-called back-office records of
clearing brokers, are limited to executed trades and do not contain
information on orders or quotes (and thus no information on routes,
modifications, and cancellations). Also, in frequent cases where
brokers utilize average-price accounts to execute and aggregate
multiple trades for one or more customers, the details of each
individual trade execution are typically lost when reported through the
EBS system because it is only the average aggregate price and volume of
a series of executed trades that are transmitted to the clearing
systems for processing.\50\
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    \48\ 17 CFR 240.17a-25. Rule 17a-25 codified the requirement
that broker-dealers submit to the Commission, upon request,
information on their customer and proprietary securities
transactions in an electronic format. The rule requires submission
of the same standard customer and proprietary transaction
information that SROs request through the EBS system in connection
with their market surveillance and enforcement inquiries.
    \49\ See Rule 17a-25; supra note 1, and accompanying text.
    \50\ See FIF Letter I, p. 3; SIFMA Letter, p. 18-19.
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    Furthermore, the EBS data currently includes only the dates, but
not the times, of each trade execution (regardless of whether or not
the trade represents an average-price series of executions).\51\ Since
there could be many broker-dealers trading a given security on a given
day of interest, to reconstruct trading on the market for one security
on one day could involve many, perhaps hundreds, of EBS requests.
Consequently, EBS data, alone, are not generally useful for price or
short sale manipulations analysis, order flow analysis, depth-of-book
analysis, or any large-scale market reconstructions in which the timing
of events is required to build a useful picture of the market.\52\
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    \51\ As adopted, Rule 13h-1 requires certain broker-dealers to
capture and report through EBS the time of execution for any trade
involving a large trader and a Commission-issued large trader
identifier that identifies the large trader. See Large Trader
Release and Large Trader Extension, supra note 1.
    \52\ A 1990 Senate Report acknowledged the immense value of the
EBS system, but noted that ``it is designed for use in more narrowly
focused enforcement investigations that generally relate to trading
in individual securities. It is not designed for use for multiple
inquiries that are essential for trading reconstruction purposes.''
See S. Rep. No. 300, 101st Cong., 2d Sess. 2-5 (1990), at 48.
---------------------------------------------------------------------------

    In addition, though the EBS system provides the names associated
with each account in which a trade has been

placed, these names are based on the separate records of each broker-
dealer providing data to the EBS system, and the same party may be
identified by a different name across multiple broker-dealers.
Experience of staff at the Commission has shown \53\ that it is
difficult to perform cross-broker customer analysis of trading since
the same customer may be known by different names depending on the
account and broker-dealer through which it traded.
---------------------------------------------------------------------------

    \53\ See, generally, Sections II.A.1. and II.A.2., infra.
---------------------------------------------------------------------------

    The EBS system also typically requires SRO and Commission staff
needing EBS data to request the information from each broker-dealer,
and complete responses from each broker-dealer may take days or weeks
depending upon the scope of the request. As a result of these various
limitations, the EBS system is generally only used by regulators in
narrowly-focused enforcement investigations that generally involve
trading in particular securities on particular dates or with specific
broker-dealers.
b. Equity Cleared Reports
    In addition to the EBS system and Rule 17a-25, the SROs and the
Commission also rely upon the NSCC \54\ equity cleared report for
initial regulatory inquiries.\55\ This report is generated on a daily
basis by the SROs, is provided to the NSCC, and shows the number of
trades and daily volume of all equity securities in which transactions
took place, sorted by clearing member. The information provided is end-
of-day data and is searchable by security name and CUSIP number.\56\
This information is also provided to the Commission upon request. Since
the information made available on the report is limited to the date,
the clearing firm, and the number of transactions cleared by each
clearing firm, its use for regulatory purposes is quite limited--equity
cleared reports basically serve as a starting point for certain types
of investigations, providing a tool the Commission can use to narrow
down the clearing firms to contact concerning transactions in a certain
security.
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    \54\ See note 2, supra, and accompanying text.
    \55\ The Commission also uses the Options Cleared Report, with
data supplied by the Options Clearing Corporation (``OCC''), for
analysis of trading in listed options. The OCC is an equity
derivatives clearing organization that is registered as a clearing
agency under Section 17A, 15 U.S.C. 78q-1, of the Exchange Act, and
operates under the jurisdiction of both the Commission and the CFTC.
    \56\ A CUSIP number is a unique alphanumeric identifier assigned
to a security and is used to facilitate the clearance and settlement
of trades in the security.
---------------------------------------------------------------------------

c. SRO Audit Trails
    In addition to EBS data and equity cleared reports, the SROs and
the Commission rely on data collected through individual SRO audit
trails. Most SROs maintain their own specific audit trails applicable
to their members. For example, the National Association of Securities
Dealers (``NASD'') \57\ established its Order Audit Trail System
(``OATS'') \58\ in 1996, which required NASD (n/k/a FINRA) members to
report certain trade and order data on Nasdaq-listed equity securities.
OATS was later expanded to include OTC equity securities. Similarly,
the NYSE implemented its Order Tracking System (``OTS'') \59\ in 1999
under which its members were required to report certain trade and order
data on NYSE-listed securities. Beginning in 2000, several of the
current options exchanges implemented the Consolidated Options Audit
Trail System (``COATS'').\60\ In addition, many of the exchanges have
created their own audit trails to assist in surveillance activities.
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    \57\ In 2007, NASD and the member-related functions of NYSE
Regulation, Inc., the regulatory subsidiary of New York Stock
Exchange LLC (``NYSE''), were consolidated. As part of this
regulatory consolidation, the NASD changed its name to FINRA. See
Securities Exchange Act Release No. 56146 (July 26, 2007), 72 FR
42190 (August 1, 2007). FINRA and the National Futures Association
(``NFA'') are currently the only national securities associations
registered with the Commission; however, the NFA has a limited
purpose registration with the Commission under Section 15A(k) of the
Exchange Act, 15 U.S.C. 78o-3(k). See also Securities Exchange Act
Release No. 44823 (September 20, 2001), 66 FR 49439 (September 27,
2001).
    \58\ See In the Matter of National Association of Securities
Dealers, Inc., Order Instituting Public Proceedings Pursuant to
Section 19(h)(1) of the Securities Exchange Act of 1934, Making
Findings and Imposing Remedial Sanctions, Exchange Act Release No.
37538 (August 8, 1996), Administrative Proceeding File No. 3-9056
and Report Pursuant to Section 21(a) of the Securities Exchange Act
of 1934 Regarding the NASD and The Nasdaq Stock Market LLC
(``Nasdaq''). See also Securities Exchange Act Release No. 39729
(March 6, 1998), 63 FR 12559 (March 13, 1998) (order approving
proposed rules comprising OATS) (``OATS Approval Order'').
    \59\ See Securities Exchange Act Release No. 47689 (April 17,
2003), 68 FR 20200 (April 24, 2003) (order approving proposed rule
change by NYSE relating to order tracking) (``OTS Approval Order'').
    \60\ See In the Matter of Certain Activities of Options
Exchanges, Administrative Proceeding File No. 3-10282, Securities
Exchange Act Release No. 43268 (September 11, 2000) (Order
Instituting Public Administrative Proceedings Pursuant to Section
19(h)(1) of the Securities Exchange Act of 1934, Making Findings and
Imposing Remedial Sanctions) (``Options Settlement Order''). See,
e.g., Securities Exchange Act Release No. 50996 (January 7, 2005),
70 FR 2436 (order approving proposed rule change by CBOE relating to
Phase V of COATS).
---------------------------------------------------------------------------

    Recently, FINRA expanded its OATS requirements from covering only
Nasdaq-listed and OTC equity securities to covering all NMS stocks.\61\
To avoid duplicative reporting requirements, the NYSE, NYSE Amex LLC
(n/k/a ``NYSE MKT LLC'') (``NYSE Amex''), and NYSE ARCA, Inc. (``NYSE
Arca'') subsequently replaced their OTS audit trail requirements for
members who are also members of either FINRA or Nasdaq (and therefore
subject to OATS requirements) with rules that allow these members to
satisfy their reporting obligations by meeting the new OATS
requirements.\62\
---------------------------------------------------------------------------

    \61\ See Securities Exchange Act Release No. 63311 (November 12,
2010), 75 FR 70757 (November 18, 2010) (SR-FINRA-2010-044) (order
approving proposed rule change by FINRA relating to the expansion of
OATS to all NMS stocks).
    \62\ See Securities Exchange Act Release Nos. 65523 (October 7,
2011), 76 FR 64154 (October 17, 2011) (SR-NYSE-2011-49); 65524
(October 7, 2011), 76 FR 64151 (October 17, 2011) (SR-NYSEAmex-2011-
74); 65544 (October 12, 2011), 76 FR 64406 (October 18, 2011) (SR-
NYSEArca-2011-69).
---------------------------------------------------------------------------

    Although these developments with respect to the scope of FINRA's
OATS rules reduce the number of audit trails with disparate
requirements, they still do not result in a comprehensive audit trail
that provides regulators with accurate, complete, accessible, and
timely data on the overall markets for which regulators have oversight
responsibilities. In particular, data collected by FINRA pursuant to
FINRA's Rule 7400 series (``OATS data'') does not provide a complete
picture of the market because though OATS collects data from FINRA
members with respect to orders and trades involving NMS stocks, OATS
does not include trade or order activity that occurs on exchanges, or
at broker-dealers that are not FINRA or Nasdaq members. Nor does OATS
include exchange quotes, principal orders submitted by FINRA members
registered as market makers, or options data.\63\ In

performing its own regulatory oversight of the markets, FINRA has
chosen to create an internal process in which it augments the data it
collects via OATS with trade execution data from other exchanges with
which it has a regulatory services agreement. This process provides
FINRA with a wider view of the markets than that provided by OATS
alone, but linking data in this fashion does not yield fully accurate
results.\64\ For these reasons, the Commission believes that the
augmented OATS data currently falls short of providing an efficient
source of data for analyzing cross-market activities, or tracking an
order through its entire cycle from generation through routing to
execution, modification or cancellation.
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    \63\ See FINRA Rule 7410(j) (defining ``Order'' for purposes of
OATS, to mean ``any oral, written, or electronic instruction to
effect a transaction in an NMS stock or an OTC equity security that
is received by a member from another person for handling or
execution, or that is originated by a department of a member for
execution by the same or another member, other than any such
instruction to effect a proprietary transaction originated by a
trading desk in the ordinary course of a member's market making
activities.'' Additionally, Nasdaq, Nasdaq OMX BX, Inc. (``BX'') and
Phlx equities (``PSX'') members that are registered as market makers
in a certain security are similarly exempted from recording OATS
audit trail data for the security in which they are registered to
make a market. See Nasdaq and BX Rules 6951(i); PSX Rule 3401(i).
    The Commission notes that members of Nasdaq, BX and PSX, that
are not also members of FINRA, are required by those exchanges to
record the audit trail data required by OATS; however, they are only
required to report that data through OATS upon request by their
respective exchanges. See Nasdaq and BX Rules 6955(b); PSX Rule
3405(b). Additionally, as of October 17, 2011, members of NYSE and
NYSE Amex, who are not also FINRA members, are required to record
their trade and order activity. These non-FINRA members are not
required to report this data through OATS unless requested. See NYSE
and NYSE Amex Equities Rules 7450(b); see, e.g., Securities Exchange
Act Release Nos. 65523 (October 7, 2011), 76 FR 64154 (October 17,
2011); 65524 (October 7, 2011), 76 FR 64151 (October 17, 2011);
65544 (October 12, 2011), 76 FR 64406 (October 18, 2011) (notice of
immediate effectiveness of proposed rule change to adopt the FINRA
Rule 7400 series, the OATS rules, and making certain conforming
changes to the NYSE and NYSE Amex Equities rules). Members of NYSE
Arca, who are not also FINRA members, were required to record their
trade and order activity as of March 31, 2012. See NYSE Arca
Equities Rule 7450(b); see Securities Exchange Act Release No. 65544
(October 12, 2011), 76 FR 64406 (October 18, 2011) (notice of
immediate effectiveness of proposed rule change to adopt the FINRA
Rule 7400 series, the OATS rules, and making certain conforming
changes to the NYSE Arca Equities rules). See also Securities
Exchange Act 66094 (January 4, 2012), 77 FR 1545 (January 10, 2012)
(notice of immediate effectiveness to extend the implementation date
of the NYSE Arca Equities Rule 7400 Series, the OATS rules, for
Equity Trading Permit Holders that are not FINRA members from
January 31, 2012 to March 31, 2012).
    \64\ FINRA has represented to Commission staff that, as part of
its own surveillance activities, FINRA acquires some of this order
handling system data from non-FINRA members to supplement the data
it receives from its members via OATS, but that matching data across
the audit trails yields varying levels of success and accuracy due
to the disparate methods used by the different order handling
systems to collect and store data. FINRA represented that, during
the period from November 28, 2011 to February 24, 2012,
approximately 2% of reportable OATS data related to exchange orders
could not be linked with matching exchange data. See Commission
Staff Memorandum to File No. S7-11-10 regarding telephone
conversations with FINRA, dated April 17, 2012 (``Commission Staff
Memorandum''). Also, since this process only involves acquiring
trade and order data from select sources, it still does not produce
a complete record of all market activity. The Commission notes that,
when considering data covering a time period of approximately 26
months, the percentage of reportable OATS data related to exchange
orders that could not be linked with matching exchange data remained
at approximately 2%. Id.
---------------------------------------------------------------------------

    OATS data also suffers from a lack of timeliness, partly as a
result of the problems with the accuracy of the data as collected, and
partly because of its lack of completeness. When FINRA receives an end-
of-day OATS file from a member, it takes an hour for FINRA to
acknowledge receipt of the report and approximately another 24 hours to
determine if there is a syntax error \65\ in the report.\66\ During
this time, FINRA performs over 152 validation checks on each order
event reported to OATS. Thus, FINRA performs over 40 billion separate
checks each day to ensure OATS data conforms to all applicable
specifications.\67\ Each of these checks can result in OATS data
submissions being rejected and generating an error message.\68\ As a
result of these validation checks, almost 425,000 reports per day, on
average, are rejected and must be corrected.\69\ In addition to the 24
hours needed to identify errors within a report, it takes another two
business days to determine whether a file that is syntactically correct
nevertheless contains errors in content related to internally-
inconsistent information about processing, linking, and routing orders.
Once a member is advised of such errors, the member has up to five
business days to re-submit a corrected file. However, error corrections
are limited to only those that are required to remedy internal
inconsistencies within a given member's submission. Cross-firm
inconsistencies in which, for example, one member reports routing an
order to a second member, but the second member does not report
receiving or processing such an order, are identified as unmatched or
unlinkable data records, but neither firm corrects these types of
reporting errors. The net result yields a historical data record of
market activity that contains a small but permanent number of incorrect
or irreconcilable trade and order events.\70\
---------------------------------------------------------------------------

    \65\ Common reasons given by FINRA for syntax rejections
include: Missing mandatory fields, invalid fields, and invalid field
combinations (e.g., a Limit Price without a Time in Force Code).
OATS will reject records as duplicates if more than one record is
submitted with the same Order Receiving Firm Market Participant
Identifier, Order Received Date, and Order Identifier or if more
than one record contains all of the same information.  http://www.finra.org/Industry/Compliance/MarketTransparency/OATS/FAQ/P085542 (last viewed on May 23, 2012).
    \66\ See Commission Staff Memorandum, supra note 64. FINRA
estimates that, from the period November 28, 2011 to February 24,
2012 approximately 0.10% of the intra-firm data reported daily by
broker-dealers were rejected for errors. Id. The Commission notes
that, when considering data covering a time period of approximately
26 months, the percentage of the intra-firm data reported daily by
broker-dealers rejected for errors was more than double this amount.
Id.
    \67\ See FINRA Letter, p. 11. FINRA represented to Commission
staff that many of the validation errors result from problems
encountered in translating order information from broker-dealer
formats into OATS format. See Commission Staff Memorandum, supra
note 64.
    \68\ Id.
    \69\ Id.
    \70\ FINRA estimates that during the period from November 28,
2011 to February 24, 2012 approximately 0.5% of each day's
reportable events remained unmatched (i.e., multi-firm events, such
as routes, that cannot be reconciled). See Commission Staff
Memorandum, supra note 64. When considering data covering a time
period of approximately 26 months, the percentage of each day's
reportable events remaining unmatched was more than double this
amount. Id.
---------------------------------------------------------------------------

    Given the time it takes to process each OATS file, and the nature
of the process in which errors are detected, reported back to members,
and then corrected, inter-firm surveillance by FINRA typically does not
begin until 5 business days after receipt of OATS data. In addition,
the final product of the FINRA process is available to FINRA, but is
not stored in a market-wide database or a central repository that is
readily accessible to other regulators. This is because SROs do not
typically have access to the internal systems of another SRO, though
they may share some sources of underlying data.\71\
---------------------------------------------------------------------------

    \71\ For example, FINRA has been given access to order audit
trail information from certain SROs pursuant to Regulatory Services
Agreements.
---------------------------------------------------------------------------

    Because the Commission does not have direct access to OATS data and
other SRO audit trails and because each SRO only has direct access to
its own audit trails, requests must be made to the Intermarket
Surveillance Group (``ISG'') \72\ or SROs to conduct an analysis on
order data. It can take days or weeks, depending on the scope of the
information requested, to receive responses to requests. Once the
responses to its requests for information are received, the Commission,
or any SRO undertaking the same task, must commit a significant amount
of time and resources to process and cross-link the data from the
various formats used by different SROs before it can be analyzed and
used for regulatory purposes. Whether or not this process is successful
depends on the accuracy, completeness, and format of the data received,
as well as how readily data from different SROs can be reliably linked.
For example, staff at the Commission working on the analysis of the May
6, 2010 ``Flash-Crash'' found it was not possible to use the data from
existing audit trails to accurately or comprehensively reconstruct
exchange

and ATS equity limit order books for NMS securities as required to
fully analyze the events of that day.\73\
---------------------------------------------------------------------------

    \72\ ISG is an international group of exchanges, market centers,
and regulators that perform market surveillance in their respective
jurisdictions. The organization provides a forum for its members to
share information and coordinate regulatory efforts to address
potential intermarket manipulation and trading abuses.
    \73\ See Section II.A.2.b., infra.
---------------------------------------------------------------------------

    A further difficulty in using existing audit trails to conduct
cross-market surveillance is the lack of consistency in both format and
content among the various audit trails. Not all SROs collect data using
the OATS format. In addition, each options exchange maintains its own
COATS audit trail in a different format and includes different
supplemental data items in its audit trail. These differences make it
difficult and labor intensive for regulators to view options trading
activity across multiple markets, and the lack of any combined equity
and options audit trail is a significant impediment to regulators
performing cross-product investigations and analyses.
    An additional shortcoming of existing SRO audit trails is the lack
of customer identifiers. In general, existing SRO audit trails only
identify the broker-dealer handling the order and not the account
holder or the person exercising investment discretion for the account
holder, if different. This limitation makes the process of identifying
the customers involved in unusual trading patterns or market events
very difficult. Even determining whether or not an unusual trading
pattern exists is challenging if the data does not identify trades by a
single customer at multiple broker-dealers. Requests therefore must be
made to one or more broker-dealers to obtain information about the
customer or customers behind an order. Multiple requests may be
necessary before the information is obtained. EBS data may have to be
requested as a supplement. A further challenge arises in any type of
customer-based cross-market analysis because there is no standard
convention for how customers are identified at different broker-
dealers--the same party directing trades across multiple venues, or
through different broker-dealers, can be known by many different names.
    Not having customer information at the early stage of surveillance
can also impair the accuracy, and thus efficacy, of certain
surveillances. The patterns that emerge when trade and order activity
is aggregated across all customers of a broker-dealer often exhibit
characteristics that can be quite different from the (initially)
unobservable patterns of trade and order activity of each individual
customer at that broker-dealer. This could result in what are known as
``false positive signals,'' in which market activities that initially
are flagged as being potentially manipulative by a surveillance system
are later found not to be potentially manipulative once more detailed
customer data from the broker-dealer is requested and analyzed. In
contrast, potentially manipulative activities may be missed by a
surveillance system that cannot identify the customers behind each
order or trade if those activities are otherwise obscured by non-
manipulative activities of other customers of the same broker-dealer
such that the aggregate patterns of trading do not appear potentially
manipulative.
    Given the various limitations described above, the Commission does
not believe that existing audit trails, with their current features,
provide regulators with an efficient or adequate method of monitoring
and surveilling the market for NMS securities. The Commission notes,
for example, that FINRA summarizes the current cross-market systems as
follows: ``The current systems in place to achieve effective cross-
market surveillance, such as the ISG, are incomplete. For example, the
ISG audit trail data has numerous shortcomings, including: (1) It does
not capture quote/orders away from a market's inside market (i.e.,
those quotes/orders below the best bid or above the best offer); (2) it
currently identifies participants of a trade only to the clearing
broker, not down to the executing broker level; (3) data submitted by
participants is not validated; (4) certain data fields are not
mandatory; and (5) there are no service level agreements to ensure that
participants submit timely and accurate information.'' \74\
---------------------------------------------------------------------------

    \74\ See FINRA/NYSE Euronext Letter, p. 3.
---------------------------------------------------------------------------

2. Regulatory Improvements With a Consolidated Audit Trail
    The NMS plan required by the Rule, if approved by the Commission,
will improve the quality of audit trail data by, among other things:
(1) Identifying with a unique ``Customer-ID'' the account holder(s)
with respect to an account at a registered broker-dealer and, if
different, any person authorized to give the broker-dealer trading
instructions for such account; (2) identifying the time of each key
event in the life of an order according to synchronized business
clocks; (3) requiring the reporting of comprehensive order lifecycle
data; and (4) including all NMS securities in one audit trail. As
discussed below, the Commission believes that these improvements should
have the potential to result in the following: (1) Improved market
surveillance and investigations; (2) improved analysis and
reconstruction of broad-based market events; and (3) improved market
analysis. In addition, a consolidated audit trail has the potential to
result in a reduction in disparate reporting requirements and data
requests.
a. Improved Market Surveillance and Investigations
    A consolidated audit trail will expand the data available for
regulators to perform surveillance and investigations for illegal
activities such as insider trading, wash sales, or manipulative
practices. In particular, a consolidated audit trail will help
surveillance and investigations by facilitating risk-based
examinations, allowing more accurate and faster surveillance for
manipulation, improving the process for evaluating tips, complaints,
and referrals (``TCRs''), and promoting innovation in cross-market and
principal order surveillance.
i. Risk-Based Examinations
    A consolidated audit trail will facilitate risk-based examinations.
Risk-based examinations require access to accurate and timely data so
that the scope of the examination can be properly set to cover the
areas of identified risks. Regulators currently may request audit trail
data directly from the broker-dealer, work with the broker-dealer to
understand the format and definitions in the data, validate that
information with a third party, and analyze the data to determine
whether the initial assumptions concerning risk were valid. This effort
requires significant resources from both the regulator and the broker-
dealer, all of which may be wasted if the resulting analysis shows that
the assumptions of risk justifying the examination of a particular
subject were not founded. Thus, this resource-intensive process does
not necessarily reveal the subjects most worthy of examination, and
does not permit an effective pre-examination review of a subject's
trading practices.
    In contrast, a consolidated audit trail would permit regulators,
for example, to identify risks and appropriate subjects for
examinations relating to certain types of trading by creating and
comparing metrics based on the complete (and possibly cross-market)
activities of a broker-dealer or customer. Signals based on such
metrics could, for example, identify outlier patterns in the ratio of
order activity to execution, which may be an indication of potentially
manipulative practices. Currently, this method is impractical because,
as described above, it requires the consolidation of many audit trails

that store data in non-uniform formats, participant information in SRO
audit trails often does not consistently identify the executing broker-
dealer, and there is no uniform method of identifying customers.
    In sum, consolidated audit trail data that meets the minimum
requirements for the NMS plan specified in the Rule would allow
regulators to create a process that focuses much more of their
resources on those firms for which specific activities over specific
time periods warrant follow up. The subsequent examinations would thus
be more precise, resulting in more efficient use of regulatory
resources, potentially reducing the need for multiple document
requests, and ultimately reducing the sometimes significant compliance
burden on a broker-dealer or other subject.
ii. Market Manipulation
    In addition to helping regulators focus their resources and better
identify areas in which potentially manipulative trading activity may
be occurring, a consolidated audit trail will greatly aid the analysis
of the potential manipulation itself. The current methodology to
analyze order and trade data requires a tremendous amount of time and
resources to construct an accurate picture of when trades are actually
executed. Typically, this includes: (1) Broker-dealers and other
registrants responding to multiple requests from the Commission and
SROs; (2) SROs devoting regulatory resources to obtaining, analyzing,
and reporting data requested by the Commission; and (3) Commission
staff reconciling inconsistent order data provided by different SROs
with respect to different markets.
    In addition, while SRO audit trail data identifies the dates and
times of trades by a particular broker-dealer, SRO audit trail data
does not reveal the identities of the customers initiating the trades
executed by the broker-dealers. Accordingly, to identify customers
placing trades through a broker-dealer, regulatory staff must obtain
EBS data and integrate such data with SRO audit trail data. This is a
cumbersome process because there is no automated process to link the
two data sources. To determine the exact execution time for trades by a
particular customer, regulatory staff must obtain a third set of data
from the broker-dealer's trading and order handling system. These
processes can take many months. In some cases, the laborious process of
assembling the data delays other critical investigative or analytical
steps. In other cases, investigators or analysts forego the process of
determining when trades occurred, limiting their analysis to more
accessible information. As a result, SRO and Commission staffs may fail
to ascertain the full scope of misconduct under investigation or the
causes of unusual market events at issue.
    Even more critically, the absence of reliable information about who
initiated which orders makes detection of schemes that involve repeat
instances of activity through accounts at multiple broker-dealers
difficult. Schemes of this sort may be among the most harmful and
difficult to police, but without a customer identifier that
consistently and uniquely identifies responsibility for orders across
all broker-dealers, no amount of technical sophistication and
securities market insight can produce a data query or analysis to
detect them.\75\
---------------------------------------------------------------------------

    \75\ Examples of schemes that typically rely on orders from
accounts at multiple brokers include: (1) ``Network'' insider
trading schemes in which the participants cultivate multiple sources
of non-public information and trade on the information they receive
over an extended period of time and through accounts at a large
number of broker-dealers; (2) wash trading; and (3) order layering.
Unlike insider trading, for example, which is neither defined nor
expressly prohibited in the Act, wash trading is specifically
prohibited in the statute. The entering of matched orders for the
purpose of creating the illusion of market activity or to
artificially affect the price is one of the oldest and most
difficult to detect manipulative practices. Technology that permits
the routing of thousands of orders to different venues in micro
seconds has made cross market surveillance for this activity
extremely difficult. ``Order layering'' is similar to wash trading.
In this practice, a market participant can enter numerous non-bona
fide market moving orders, often in substantial size relative to a
security's legitimate volume to create the false impression of buy
or sell side pressure. When such orders induce others to execute
against profitable limit orders, the market participants immediately
cancel the pending orders that manipulated the price. As with wash
sales, multiple traders can enter orders on different venues,
impacting the NBBO and making the activity difficult to detect.
---------------------------------------------------------------------------

    With the data provided by the consolidated audit trail, regulatory
staff would be able to conduct such analyses in a much shorter period
of time. In addition, the process of analysis with a consolidated audit
trail would be inherently more reliable than the manual reconstruction
process currently available, reducing the risk of inaccuracies.
Furthermore, the ability to process and meaningfully analyze audit
trail data more quickly would allow regulatory staff to employ
proactive methods of identifying potentially manipulative activities.
The Commission therefore believes a consolidated audit trail would make
the overall process of identifying and analyzing potentially
manipulative trading practices much more focused, accurate, and
efficient.\76\
---------------------------------------------------------------------------

    \76\ For example, implementation of a consolidated audit trail
also will help regulators monitor reliance on the use of the safe
harbor provision for issuer repurchases in Rule 10b-18 under the
Exchange Act. 17 CFR 240.10b-18. Rule 10b-18 under the Exchange Act
provides issuers with a safe harbor from liability for manipulation
under Sections 9(a)(2) and 10(b) of the Exchange Act, and Rule 10b-5
under the Exchange Act, when they repurchase their common stock in
the market in accordance with the Rule's manner, timing, price, and
volume conditions. The data required to be included in the
consolidated audit trail will assist regulators in monitoring issuer
repurchases that rely on Rule 10b-18's safe harbor protections to
ensure that they comply with all required criteria.
---------------------------------------------------------------------------

    The timely availability of data to regulators also impacts the
efficacy of detecting (and possibly mitigating the effects of) some
types of market manipulation. For example, some pernicious trading
schemes are designed to generate large ``quick-hit'' profits in which
participants attempt to transfer the proceeds from the activity to
accounts outside of the reach of domestic law enforcement as soon as
the offending transactions have settled in the brokerage account
(typically three days after execution). If the SROs detect such schemes
and promptly report them to the Commission, the Commission potentially
could seek asset freezes that limit the transfer of funds until charges
against the account holder are resolved. The Commission believes that a
consolidated audit trail in which uniform data about market activities
are efficiently collected and processed soon after such activities
occur, and in which data are available to regulators in a timely
manner, would more frequently and effectively allow regulators to use
this approach.
iii. Tips and Complaints
    A consolidated audit trail also would significantly improve the
processes used by the SROs and the Commission for evaluating tips and
complaints about trading activity.\77\ It is not uncommon for market
participants or those with experience in market data to sometimes note
atypical trading or quoting patterns in publicly-available market data.
A consolidated audit trail would allow regulatory staff to quickly
determine whether a particular instance of an atypical activity
(regardless of how it was originally identified), such as an abnormally
high level of quote traffic, is worthy of further investigation.
---------------------------------------------------------------------------

    \77\ The Commission receives an average of over 200 market-
related TCRs each month.
---------------------------------------------------------------------------

    Today, such an analysis of TCRs is difficult and cumbersome. Even a
preliminary review requires analysis by each exchange or ATS to
identify the activity in question and to determine its scope.
Regulators then must consolidate the analyses from each such market
center to determine the identities of those responsible for the
atypical

activity in question. To the extent that the activity originates from
several market participants, regulators must conduct additional
analysis on each of those participants, and possibly other
participants, to discover information that could identify the
customer(s) originating the orders that created the atypical activity.
Without a unique customer identifier included in the order and trade
data, this may not be possible. The consolidated audit trail would
significantly improve the multi-stage process, enabling regulatory
staff to make efficient queries on orders and more quickly determine
whether the TCR can be ``closed'' or if further analysis and
investigation are warranted.
iv. Cross-Market and Principal Order Surveillance
    Investigations of cross-market activity may be more efficient with
a consolidated audit trail as such an audit trail may provide
regulators with data not currently consolidated across markets and/or
data not currently available to regulators such as broker-dealer
principal orders, including market maker quotes. For example, in an
attempt to manipulate the market, a broker-dealer could use numerous
principal sell orders across multiple venues to give the misleading
appearance of broad sell-side pressure, and then send a buy principal
order at a favorable price to take advantage of the market momentum
created by the misleading sell orders. This type of activity would be
difficult to readily identify with current audit trails, but it could
be the target of a routine surveillance of a consolidated audit trail.
The Commission notes, for example, the statement of FINRA and NYSE
Euronext that, ``[p]articularly since the implementation of Regulation
NMS in 2007, there has been a significant increase in market linkages,
the result of which is that trading activity on one market can have a
profound effect on other markets. This, in turn, has led to the
realization that market manipulation, by its very nature, is
facilitated cross-market where, for example, trading on one market is
used to affect a security's price while trading on another market is
used to take advantage of that price change.'' \78\
---------------------------------------------------------------------------

    \78\ See FINRA/NYSE Euronext Letter, p. 2.
---------------------------------------------------------------------------

    In addition, the consolidation of order data with direct access for
all relevant regulators may create opportunities for regulators to
develop entirely new methods of surveillance, and to keep existing
forms of surveillance up to date as new market practices and new market
technologies continue to rapidly evolve. In fact, as described more
fully below, SROs are required by the Rule to incorporate the expanded
audit trail data into their surveillance systems.\79\
---------------------------------------------------------------------------

    \79\ See Rule 613(f).
---------------------------------------------------------------------------

b. Improved Analysis and Reconstruction of Broad-Based Market Events
    A consolidated audit trail will significantly improve the ability
of regulators to reconstruct broad-based market events so that they and
the public may be informed by an accurate and timely accounting of what
happened, and possibly why. The sooner a reconstruction can be
completed, the sooner regulators can begin reviewing an event to
determine what, if any, regulatory responses might be required to
address the event in an effective manner.
    For example, on the afternoon of May 6, 2010, the U.S. equity and
equity futures markets experienced a sudden breakdown of orderly
trading, when broad-based indices, such as the Dow Jones Industrial
Average Index and the S&P 500 Index, fell about 5% in just five
minutes, only to rebound soon after (the ``Flash Crash''). Many
individual equities suffered even worse declines, with prices in over
300 stocks and exchange-traded funds falling more than 60%. In many of
these cases, trades were executed at a penny or less in stocks that
were trading at prices of $30 or more only moments earlier before
prices recovered to their pre-Flash Crash levels.\80\
---------------------------------------------------------------------------

    \80\ See note 45, supra.
---------------------------------------------------------------------------

    The Commission immediately formed an interdisciplinary team from
across the Commission to analyze the events of May 6, 2010, identify
possible causes, inform the public of what happened, and aid in
formation of regulatory responses. The CFTC took similar steps. Within
a few weeks, staff at the Commission and the CFTC released a joint
preliminary report that described the event and, in general terms, the
market conditions prior to and during the rapid decline.\81\ However,
at that time the staffs were unable to definitively identify the
specific conditions or circumstances that could have caused,
contributed to, or exacerbated the event. Though the SROs and the
Commission quickly implemented a single-stock circuit breaker pilot
program as an initial response, a more complete regulatory response
required a full and robust analysis of additional data.
---------------------------------------------------------------------------

    \81\ See ``Preliminary Findings Regarding the Market Events of
May 6, 2010: Report of the Staffs of the CFTC and the SEC to the
Joint Advisory Commission Emerging Regulatory Issues.'' (May 18,
2010). See http://www.sec.gov/sec-cftc-prelimreport.pdf.
---------------------------------------------------------------------------

    From the start of the investigation, many market participants had
suggested that the sudden withdrawal of liquidity in the equity markets
may have resulted in the rapid decline of prices as orders to
immediately sell (many from retail investors) found no interest on the
buy side (from market professionals).\82\ To fully understand how such
conditions could occur, Commission economists needed to analyze the
order books for thousands of equities. Commission staff requested order
book data from several exchanges that sell such data or could readily
put such data together, but this data did not represent the whole
market. Commission staff attempted to use order data from OATS and
several SRO audit trails to reconstruct order books for thousands of
equities traded on exchanges that do not maintain or could not provide
order book data. Although it was possible to link the data from
different sources to show trading activity for a particular stock over
a specific period of time, the accuracy, completeness, and content of
the combined data sets were not sufficient to allow for an accurate
reconstruction of the order books. This hindered staff in determining
what happened to liquidity before, during, and after the Flash Crash.
Two major problems were the inability to identify and eliminate
duplicate orders from the data and the inability to accurately sequence
events across the multiple data sources.
---------------------------------------------------------------------------

    \82\ For detailed discussions and chronologies of the
investigation into the events of May 6, 2010, see SEC (http://www.sec.gov/spotlight/sec-cftcjointcommittee.shtml) and CFTC (http://www.cftc.gov/PressRoom/Events/AdvisoryCommitteeMeetings/index.htm)
webcasts and minutes of public meetings held with the Joint CFTC-SEC
Advisory Committee on Emerging Regulatory Issues on May 24, 2010,
June 22, 2010, August 11, 2010, November 5, 2010, and February 18,
2011.
---------------------------------------------------------------------------

    As described in the final joint report issued by the staffs of the
CFTC and the Commission on September 30, 2010, Commission staff were
only able to create a comprehensive view of the order books by
acquiring, processing, and aggregating four distinct data sets that
each contained a subset of order book information from each of the four
exchanges that could provide such information: Nasdaq ModelView, NYSE
Openbook Ultra, NYSE ARCABook, and BATS Exchange.\83\ Given the
enormous volume of data that needed to be processed (more than 5.3
billion records), even small changes to the integration and aggregation
process took

significant computer time to test and implement.
---------------------------------------------------------------------------

    \83\ See note 45, supra, at p. 11.
---------------------------------------------------------------------------

    By early July 2010, staff at the CFTC had completed a very detailed
analysis of the full order book of the S&P 500 E-Mini futures contract
and were able to show how liquidity in that contract had been eroding
for most of the day. The CFTC's detailed second-by-second analysis of
trading during the Flash Crash itself revealed how buy-side depth in
the S&P 500 E-Mini futures virtually evaporated as broad market indices
rapidly fell 5%.\84\ However, until a similar analysis could be
completed in the equity markets, neither regulators nor the public
would know whether an evaporation of liquidity was also present in the
equity markets, and whether the timing of such an event preceded or
followed the liquidity event in the futures market. Ultimately, it took
Commission staff nearly five months to complete an accurate
representation of the order books of the equity markets for May 6,
2010. Even then, the reconstruction was not fully complete and only
contained an estimated 90% of trade and order activity for that
day.\85\ However, it was sufficiently comprehensive to allow staff to
perform a robust analysis of the equity markets revealing how ``the
decline in full-depth buy-side liquidity for the E-Mini precede[d] that
of the SPY and [the stocks composing] the S&P 500,'' and how ``drops in
[stock] prices [became] increasingly more severe with ever-larger drops
in liquidity.'' \86\
---------------------------------------------------------------------------

    \84\ Id.
    \85\ Id.
    \86\ Id. at p. 18, 80.
---------------------------------------------------------------------------

    Had there been a consolidated audit trail in place on May 6, 2010,
regulators would likely have been able to much more quickly and
efficiently perform these types of detailed analyses. This in turn
could have dramatically shortened the time during which regulators, as
well as the public, remained uncertain about what actually happened
during the Flash Crash.
c. Improved Market Analysis
    In addition to the surveillance and reconstruction benefits
described above, a consolidated audit trail would also significantly
improve the ability of regulators to monitor overall market structure,
so that both the Commission and the SROs can be better informed in
their rulemakings. In January 2010 the Commission published a concept
release on equity market structure that discusses how the markets have
rapidly evolved from trading by floor-based specialists to trading by
high-speed computers. The concept release poses a number of questions
about the role and impact of high-frequency trading strategies and the
movement of trading volume from the public national securities
exchanges to dark pools.\87\
---------------------------------------------------------------------------

    \87\ See Securities Exchange Act Release No. 61358 (January 14,
2010), 75 FR 3594 (January 21, 2010) (``Concept Release on Equity
Market Structure'').
---------------------------------------------------------------------------

    Over the past two years there has been considerable discussion
about these topics by regulators, market participants, the media, and
the general public. Nevertheless, numerous open questions remain
because of a lack of consolidated market data, making certain types of
market-wide analysis impractical. For example, existing research on
high frequency trading cannot precisely identify high frequency
traders. As a result, studies of high frequency trading have been
limited in their ability to thoroughly examine such strategies and
their impact on the market, leaving many open questions. Having more
precise data on who is trading (and from which general patterns of
order submission could be inferred) would help regulators better
understand the impact of high frequency trading on markets. Similar
analyses also could be performed for other aspects of general market
structure, such as those discussed in the concept release related to
dark pools and internalization. In addition, having access to a
consolidated audit trail will provide the Commission and SROs with
better data to conduct retrospective analyses of rules and pilots.
Informed analysis of these topics requires consolidating audit trails
so that quotes and trades across multiple exchanges can be linked
(either by customer type or by specific customer) with order flow and
trades from the many dozens of over-the-counter venues.
d. Potential Reduction in Disparate Reporting Requirements and Data
Requests
    The Commission believes that a consolidated audit trail will reduce
the burdens on SROs and broker-dealers associated with producing
regulatory data. In particular, the consolidated audit trail may reduce
burdens from ad hoc data requests.
    The Commission believes that the creation of a consolidated audit
trail may reduce the number and types of ad hoc requests made by
regulators to market participants for data concerning their trading
activities. In particular, regulators could use direct access to data
in the consolidated audit trail for investigations or analyzing trends
or broad market activities instead of requesting data from market
participants. In addition, regulators could use this direct access to
analyze the activities of a single trader across multiple markets,
which today requires requests for data from multiple market
participants. Regulators would therefore likely make fewer ad hoc
requests. The Commission, however, does not believe that all ad hoc
requests for data from market participants will be replaced by
obtaining data from the consolidated audit trail. A detailed
investigation of a particular firm may require types of data from that
firm that are not stored in the consolidated audit trail, or that
relate to periods prior to the implementation of the consolidated audit
trail. In addition, in cases in which there are discrepancies, or even
suspected discrepancies, between a firm's actual trading activities and
what is stored in the consolidated audit trail's central repository,
regulators are likely to request data directly from market participants
for verification and investigative purposes.
3. Large Trader Reporting System Rule
    The Commission believes that a consolidated audit trail will be
able to build upon various aspects of the large trader reporting system
that was recently adopted by the Commission.\88\ Rule 13h-1, which
establishes the large trader reporting system, requires large traders
to identify themselves to the Commission and make certain disclosures
to the Commission on Form 13H. Upon receipt of Form 13H, the Commission
issues a unique identification number to the large trader, which the
large trader then will be required to provide to those broker-dealers
through which the large trader trades. Registered broker-dealers will
be required to maintain specified transaction records for each large
trader and to report that information to the Commission upon request.
The Large Trader Rule requirements are designed to enable the
Commission to promptly and efficiently identify significant market
participants and collect data on their trading activity so that
Commission staff can reconstruct market events, conduct investigations
and bring enforcement actions as appropriate.
---------------------------------------------------------------------------

    \88\ See note 1, supra.
---------------------------------------------------------------------------

    Several commenters noted that portions of the requirements of Rule
13h-1 overlapped with certain provisions of proposed Rule 613 and
requested that the Commission harmonize the rules.\89\ One commenter

stated that the Commission should consider implementing only those
portions of Rule 13h-1 that would not be affected by, or be redundant
to, the implementation of the consolidated audit trail proposal.\90\
Another commenter suggested that the Commission mandate compliance only
with those aspects of Rule 13h-1 that would operate as part of the
consolidated audit trail--the large trader identifier in particular--so
they could be leveraged in the creation of the consolidated audit
trail.\91\ Yet another commenter believed that, upon implementation of
the consolidated audit trail, it would not be necessary for large
traders to identify themselves to their broker-dealers pursuant to Rule
13h-1, because the consolidated audit trail already would require
broker-dealers to include a customer identifier for every order.\92\
The commenter explained that, if customer information is collected as
part of the consolidated audit trail, the Commission and SROs could run
queries to identify customers with significant trading volume.\93\
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    \89\ See ICI Letter, p. 6-7; Liquidnet Letter, p. 4-5; SIFMA
Letter, p. 18-19; CBOE Letter, p. 6 (questioning the need for a
large trader reporting system if a consolidated audit trail is
implemented).
    \90\ See FINRA/NYSE Euronext letter, p. 7.
    \91\ See SIFMA Letter, p. 18.
    \92\ See Liquidnet Letter, p. 5.
    \93\ Id.
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    The Commission believes that both Rules are necessary to enhance
regulatory oversight of the markets and its members. Key aspects of
Rule 13h-1 define the types of entities that are large traders, and who
must register with the Commission and file and keep current certain
background information on Form 13H. These aspects of Rule 13h-1 are not
addressed by Rule 613 and would not be superseded by it. Rather, the
information collected by the registration of large traders would
further complement the data collected for a consolidated audit trail.
To this end, Rule 613 requires that large trader identifiers also be
reported to the central repository as part of any large trader's
customer account information.\94\
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    \94\ See Rule 613(j)(4).
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    The Commission does note, however, that other aspects of Rule 13h-1
may be superseded by Rule 613. Specifically, the trade reporting
requirements of Rule 13h-1 are built upon the existing EBS system. To
the extent that, as described in Section II.A.2.iv.d., data reported to
the central repository under Rule 613 obviates the need for the EBS
system, the Commission expects that the separate reporting requirements
of Rule 13h-1 related to the EBS system would be eliminated.\95\
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    \95\ Though certain reporting requirements of Rule 13h-1 may
eventually be unnecessary due to Rule 613, the Commission notes that
Rule 13h-1 will be implemented much more expeditiously compared to
the consolidated audit trail, and therefore will address the
Commission's near-term need for access to more information about
large traders and their activities.
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B. Summary of Proposed Rule 613

    Proposed Rule 613 would have required that the SROs propose an NMS
plan that included provisions regarding: (1) The operation and
administration of the NMS plan; (2) the creation, operation and
oversight of a central repository; (3) the data required to be provided
by SROs and their members \96\ to the central repository; (4) clock
synchronization; (5) compliance by national securities exchanges,
FINRA, and their members with Rule 613 and the NMS plan; and (6) a plan
for the possible expansion of the NMS plan to products other than NMS
securities.
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    \96\ Section 3(a)(3)(A) of the Exchange Act defines the term
``member'' to mean: ``(i) Any natural person permitted to effect
transactions on the floor of the exchange without the services of
another person acting as broker; (ii) any registered broker or
dealer with which such a natural person is associated; (iii) any
registered broker or dealer permitted to designate as a
representative such a natural person; and (iv) any other registered
broker or dealer which agrees to be regulated by such exchange and
with respect to which the exchange undertakes to enforce compliance
with the provisions of the [Exchange Act], the rules and regulations
thereunder, and its own rules.'' Section 3(a)(3)(A) further provides
that, ``[f]or purposes of Sections 6(b)(1), 6(b)(4), 6(b)(6),
6(b)(7), 6(d), 17(d), 19(d), 19(e), 19(g), 19(h), and 21 of [the
Exchange Act], the term `member' when used with respect to a
national securities exchange also means, to the extent of the rules
of the exchange specified by the Commission, any person required by
the Commission to comply with such rules pursuant to Section 6(f) of
this title.'' Finally, Section 3(a)(3)(B) provides that ``[t]he term
`member' when used with respect to a registered securities
association means any broker or dealer who agrees to be regulated by
such association and with respect to whom the association undertakes
to enforce compliance with the provisions of [the Exchange Act].''
See 15 U.S.C. 78c(a)(3)(A) and 15 U.S.C. 78c(a)(3)(B).
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    Specifically, proposed Rule 613 would have required the SROs to
jointly file an NMS plan with the Commission to govern the creation,
implementation, and maintenance of a consolidated audit trail and a
central repository.\97\ The NMS plan would have been required to
provide for an accurate, time-sequenced record of an order's life, from
receipt or origination, through cancellation or execution. In
particular, the proposed Rule would have required the NMS plan to
require that the SROs and their respective members collect and provide
to the central repository data for each ``reportable event,'' defined
to include the receipt, origination, modification, cancellation,
routing, and execution (in whole or in part) of an order, with respect
to any NMS security. This data would have been required to be collected
and provided to the central repository in a uniform electronic format
on a real-time basis.
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    \97\ The proposed Rule would have explicitly required each
national securities exchange and national securities association to
be a sponsor of the NMS plan submitted pursuant to the Rule and
approved by the Commission. See proposed Rule 613(a)(4).
``Sponsor,'' when used with respect to an NMS plan, is defined in
Rule 600(a)(70) of Regulation NMS to mean any self-regulatory
organization which is a signatory to such plan and has agreed to act
in accordance with the terms of the plan. See 17 CFR 242.600(a)(70).
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    Under the proposed Rule, the data collected upon the receipt or
origination of an order would have included: a unique order identifier;
a unique customer identifier; \98\ a unique identifier for the broker-
dealer receiving or originating the order; the date and time of receipt
or origination of the order; and the ``material terms of the order.''
\99\ For orders that are modified or cancelled, the data collected in
real time would have included: The date and time the modification or
cancellation was received or originated; the price and remaining size
of the order; changes in the material terms of the order (if the order
is modified); and the identity of the person giving the modification or
cancellation.
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    \98\ Proposed Rule 613(j)(1) would have defined the term
``customer'' to mean the beneficial owner(s) of the account
originating the order and the person exercising investment
discretion for the account originating the order, if different from
the beneficial owner(s).
    \99\ The proposed Rule would have defined ``material terms of
the order'' to include, but not be limited to: The NMS security
symbol; security type; price (if applicable); size (displayed and
non-displayed); side (buy/sell); order type; if a sell order,
whether the order is long, short, or short exempt; if a short sale,
the locate identifier, open/close indicator, time in force (if
applicable), whether the order is solicited or unsolicited, and
whether the account has a prior position in the security; if the
order is for a listed option, option type (put/call), option symbol
or root symbol, underlying symbol, strike price, expiration date,
and open/close; and any special handling instructions. See proposed
Rule 613(j)(3).
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    For orders that are routed, data collected in real time would have
included: The unique order identifier, the date and time the order was
routed; The unique identifier of the broker-dealer or national
securities exchange routing the order; the unique identifier of the
broker-dealer or national securities exchange receiving the order; if
routed internally at a broker-dealer, the identity and nature of the
department and desk to which the order was routed; and the material
terms of the order.
    For orders received that were routed, data collected in real time
would have included all the information for orders that are routed,
except the identity and nature of the department and desk to which the
order was routed, if routed internally at a broker-dealer; however,

the date and time the order was routed would be replaced by the date
and time the order was received.
    For the execution of an order, data collected in real time would
have included: the unique order identifier; the date and time of
execution; the execution size and price; the unique identifier of the
SRO or broker-dealer executing the order; the capacity of the broker-
dealer executing the order (i.e., principal, agency, riskless
principal); and whether the execution was reported pursuant to an
effective transaction reporting plan or the OPRA Plan.\100\
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    \100\ ``The OPRA Plan'' is the Plan for Reporting of
Consolidated Options Last Sale Reports and Quotation Information
filed with the Commission pursuant to, and meeting the requirements
of, Rule 608 of Regulation NMS. The OPRA Plan governs the
dissemination of trade and quotation information for listed options.
In this capacity, it provides real-time quotation and transaction
information to market participants. See 17638 (March 18, 1981), 22
SEC Docket 484 (March 31, 1981) (order approving the OPRA Plan).
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    Because certain information may not be readily available at the
time of the reportable event, the proposed Rule would have required the
NMS plan to require each SRO and its members to collect and provide to
the central repository certain information, in a uniform electronic
format, promptly after receipt of such information, but in no instance
later than midnight of the day that the reportable event occurred or
when the SRO or its member receives such information. Under the
proposed Rule, this data would have included: The account number for
any subaccounts to which the execution is allocated (in whole or part);
the unique identifier of the clearing broker or prime broker, if
applicable; the unique order identifier of any contra-side order;
special settlement terms, if applicable; short sale borrow information
and identifier; the amount of a commission, if any, paid by the
customer, and the unique identifier of the broker-dealer(s) to whom the
commission is paid; and, if the execution is cancelled, a cancelled
trade indicator.
    The proposed Rule would have required that the SROs jointly file an
NMS plan with the Commission within 90 days after approval of the Rule.
In addition, the SROs would have been required to select a plan
processor within two months of the effectiveness of the NMS plan, as
well as provide the Commission a document outlining how the SROs would
propose to expand the audit trail to include non-NMS securities and
additional transactions. The proposed Rule also would have required the
SROs to file proposed rule changes to require their members to comply
with the requirements of the proposed Rule and the NMS plan within 120
days of the effectiveness of the NMS plan. The SROs would have been
required to begin reporting data to the central repository within one
year after the effectiveness of the NMS plan, and their members would
have been required to begin reporting data to the central repository
within two years after the effectiveness of the NMS plan.
    As proposed, the NMS plan would have been required to include
specific plan provisions, detailing: The plan governance structure, the
processes of admission and withdrawal of plan sponsors, the percentage
of votes required to effectuate amendments to the plan, the allocation
of central repository costs among the plan sponsors, and the
appointment of a Chief Compliance Officer (``CCO'') of the central
repository. The proposed Rule would have required all plan sponsors to
develop and implement a surveillance system, or enhance existing
surveillance systems, reasonably designed to make use of the
information contained in the consolidated audit trail. This information
would be available to the Commission and the SROs for regulatory and
oversight purposes only. The proposed Rule also would have required the
NMS plan to require information be collected in a convenient and usable
standard electronic data format, directly available and searchable
electronically without any manual intervention for a period of not less
than five years. This information would have been required to be
available immediately, or, if immediate availability was not reasonably
and practically achieved, any search query would have to begin
operating on the data not later than one hour after the search query
was made. Additionally, the proposed Rule would have required the NMS
plan to include policies and procedures, including standards, to be
utilized by the plan processor to ensure the security and
confidentiality of all information submitted to the central repository,
and all SROs and their employees, as well as all employees of the
central repository, would have been required to agree to use
appropriate safeguards to ensure the confidentiality of such data. The
proposed Rule also would have required SROs and their members to
synchronize their business clocks that are used for the purposes of
recording the date and time of any event that must be reported under
the proposed Rule consistent with industry standards. Further, the
proposed Rule would have required the central repository to collect and
retain, on a current and continuing basis, and in a format compatible
with the other information collected pursuant to the proposed Rule, the
national best bid and national best offer (``NBBO'') information for
each NMS security. Transaction reports reported pursuant to an
effective transaction reporting plan filed with the Commission pursuant
to, and meeting the requirements of, Rule 601 of Regulation NMS under
the Exchange Act,\101\ and last sale reports reported pursuant to the
OPRA Plan filed with the Commission pursuant to, and meeting the
requirements of, Rule 608 of Regulation NMS under the Exchange Act also
would have been required to be collected and retained.
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    \101\ The effective transaction reporting plans include the
Consolidated Tape Association Plan (``CTA Plan'') and the Joint
Self-Regulatory Organization Plan Governing the Collection,
Consolidation and Dissemination of Quotation and Transaction
Information for Nasdaq-listed Securities Traded on Exchanges on an
Unlisted Trading Privilege Basis (``UTP Plan'').
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C. Summary of General Comments on the Proposed Rule

    The Commission requested comments on all aspects of the proposed
Rule, including the potential costs and benefits.\102\ In particular,
the Commission encouraged commenters to identify, discuss, analyze, and
supply relevant data regarding any such costs or benefits.\103\ In
response, commenters provided views and opinions regarding the
regulatory usefulness of a consolidated audit trail; the overall costs
of the proposed Rule, focusing on those requirements that commenters
believed would be the most costly or burdensome to implement; \104\ the
process for creating and implementing a consolidated audit trail; and
alternatives to the proposed Rule's approach to creating, implementing,
and maintaining a consolidated audit trail. These comments are
discussed below.
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    \102\ See Proposing Release, supra note 4, at 32586 and 32594.
    \103\ Id.
    \104\ For comments on general costs of the proposed Rule, see,
e.g., Thomson Reuters Letter, p. 2; Liquidnet Letter, p. 1; CBOE
Letter, p. 2; Nasdaq Letter I, p. 2; Angel Letter, p. 1-2; IAG
Letter, p. 3.; Kaufman Letter, attachment p. 3; Wells Fargo Letter,
p. 4; Noetic Partners Letter, p. 2; Leuchtkafer Letter, p. 1-5;
Broadridge Letter, p. 3; SIFMA Letter, p. 1-2, FINRA Letter, p. 3;
FINRA Proposal Letter, p. 2.; High Speed Letter, p. 1; Belanger
Letter, p. 7-8.
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1. Industry Support for a Consolidated Audit Trail
    Commenters provided a wide range of opinions, and shared their
concerns, regarding specific aspects of the proposed Rule.\105\
However, many of the

commenters and their representatives who are involved with regulating
and operating securities markets--as well as many of the commenters who
otherwise populate data for, or make use of, existing audit trail
systems (such as broker-dealers)--expressed support for the creation of
a single consolidated audit trail.
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    \105\ See Section II.C., infra, for a discussion of specific
concerns raised by commenters.
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    FINRA and NYSE Euronext, filed a joint letter, ``vigorously
support[ing] the establishment of a consolidated audit trail,'' and
stating, among other things, that ``the evolution of the U.S. equity
markets and the technological advancements that have recently taken
place have created an environment where a consolidated audit trail is
now essential to ensuring the proper surveillance of the securities
markets and maintaining the confidence of investors in those markets.''
\106\
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    \106\ See FINRA/NYSE Euronext Letter, p. 1. NYSE Euronext is the
publicly traded parent of a number of subsidiaries, including three
SROs, NYSE, NYSE Amex, and NYSE Arca.
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    The NASDAQ OMX Group, Inc. similarly states that ``[m]arket
developments and fragmentation of market centers with varying market
structures and levels of transparency have created inefficiencies and
potential gaps in cross-market regulation,'' and that ``[c]omplete
transparency is the only way to ensure fair and orderly markets.''
\107\
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    \107\ See Nasdaq Letter I, p. 2. The NASDAQ OMX Group, Inc. is
the publicly traded parent of a number of subsidiaries, including
three SROs, Nasdaq, Phlx, and BX.