(``Even where firms were at the target clock offset, many firms
cited additional costs associated with compliance including logging
and achieving greater degrees of reliability'').
    \2658\ See Section V.F.1.d, infra, for discussion of service
bureau costs and the degree to which those costs might be passed on
to broker-dealers.
    \2659\ These are the 126 current OATS reporters that report more
than 350,000 OATS ROEs per month; the 31 options market-making
firms; and the 14 ELPs.
    \2660\ See Section VI.H.2.a(1), infra, for a discussion of how
these implementation costs might vary for different clock
synchronization standards.
    \2661\ See id., for discussion of costs attributable to the 50
millisecond clock synchronization tolerance proposed in the Plan,
including the $109,197 estimate of per-firm implementation costs of
the 50 millisecond clock synchronization requirement; see also CAT
NMS Plan, supra note 5, at Appendix C, Section B.7(b)(i)(A)(3). 171
broker-dealers x $109,197 = $18,672,687. Note also that the
Commission erroneously reported in the Notice that costs were $19.7
million in implementation costs, but these estimated costs should
have been $18.7 million in ongoing costs. See Notice, supra note 5,
at 30762-63 for further information on the Commission's estimation.
    \2662\ The CAT NMS Plan states that the Vendor Study was
distributed to 13 service bureaus or technology-providing firms
identified by the DAG. See CAT NMS Plan, supra note 5, at Appendix
C, Section B.7(b)(i)(A)(3). 13 service bureaus x $109,197 x 4.2 =
$5,962,156.2. The 4.2 multiplier is the ratio between the total
incremental ongoing charges to broker-dealers and the total
incremental ongoing costs to service bureaus derived from the cost
estimates above. See Notice, supra note 5, at 30763 n 1245. Note
that the Commission erroneously reported in the Notice that costs
were $1.4 million in implementation costs, but these estimated costs
should have been $6 million in ongoing costs. The Commission
believed clock synchronization costs are already included in cost
estimates provided in the Vendor Study. In the Notice, the
Commission explained its belief that these costs likely would
ultimately be passed on to service bureaus' broker-dealer clients.
See Notice, supra note 5 at 30726; see also Notice, supra note 5, at
30762-63 for further information on the Commission's estimation.
---------------------------------------------------------------------------

    In addition, the Commission solicited comment in the Notice on
alternatives to the Plan's one-size-fits all definition of ``industry
standard.'' \2663\ Under these alternatives, ``industry standard''
would be defined in terms of the standard practices of different
segments of the CAT Reporters. The Commission explained that these
alternative approaches could result in clock offset tolerances shorter
than the CAT NMS Plan's proposed 50 millisecond standard for some or
all CAT Reporters, Using information from a survey,\2664\ the
Commission estimated broker-dealer costs under various alternative
standards.
---------------------------------------------------------------------------

    \2663\ See Notice, supra note 5, at 30759.
    \2664\ See FIF Clock Offset Survey, supra note 247.
---------------------------------------------------------------------------

    The Commission received several comments regarding costs associated
with clock synchronization requirements. One commenter mentioned that
managing multiple clock synchronization structures across report types
would present unnecessary difficulties for broker-dealers and
unnecessary reconciliation issues for the Commission and SROs.\2665\
Another commenter stated that clock synchronization will cost the
industry $268 million for initial implementation of a 50 millisecond
clock offset and $25 million for annual monitoring/maintenance, and
that this represents a significant proportion of overall industry costs
of the CAT NMS Plan.\2666\ Furthermore, as discussed in Section
V.F.3.a.(4), the commenter also indicated that the survey of broker-
dealers used to estimate the costs of clock synchronization
requirements did not include the requirement of timestamps on
Allocation Reports.\2667\ The commenter estimated that the proposed
allocation timestamp requirement would cost the industry $88,775,000 in
initial implementation costs and $13,925,000 in ongoing annual costs
and that a modified allocation timestamp requirement, with a one second
timestamp granularity and a one second clock offset, would cost the
industry $44,050,000 in initial implementation costs and $5,035,833 in
ongoing annual costs.\2668\ Finally, this commenter highlighted several
limitations in the Commission's cost estimates that result in these
estimates understating industry cost.\2669\ First, the commenter said
that the costs in the FIF survey do not represent ``insourcer''
implementation costs as the Commission assumed because the survey was
skewed toward smaller broker-dealers. Second, the commenter said that
the Commission stated that the FIF Clock Offset Survey underestimated
the costs per firm because of the

methodology used to select a ``midpoint'' for the top cost range.
Finally, the commenter said that the Commission should not have assumed
staffing of \1/4\ full time employee (``FTE'') for initial
implementation because it is incorrect to assume that all of the costs
would be borne by a service bureau for all broker-dealers.
---------------------------------------------------------------------------

    \2665\ SIFMA Letter at 34.
    \2666\ FIF Letter at 108.
    \2667\ FIF Letter at 86.
    \2668\ FIF Letter at 88, Table 6.
    \2669\ Id. at 109.
---------------------------------------------------------------------------

    The Participants' response recommended a modification to the Plan
changing the clock synchronization to 100 microseconds with regards to
electronic systems, excluding certain manual systems; but stated that
having multiple clock synchronization standards across an order
lifecycle would complicate the linking process at the Central
Repository, implying an increase in costs.\2670\ In addition, the
Participants' response recommended a modification to the Plan that
would specify a one-second timestamp for allocation time on Allocation
Reports \2671\ and that would permit Industry Members to synchronize
their Business Clocks used solely for reporting the time of allocation
on Allocation Reports to within one second.\2672\ The Plan has been
amended to reflect each of these recommendations. The Commission is
also amending the Plan to state that the Participants should apply
industry standards based on the type of CAT Reporter or system, rather
than the industry as a whole.\2673\
---------------------------------------------------------------------------

    \2670\ Response Letter II at 5.
    \2671\ Response Letter I at 25.
    \2672\ Response Letter III at 14.
    \2673\ See CAT NMS Plan, supra note 5, at Section 6.8(c).
---------------------------------------------------------------------------

    The Commission has considered the comments received, the
Participants' response, and modifications to the Plan regarding clock
synchronization and is revising its analysis of the costs attributable
to this element of the Plan. In response to the commenter that stated
the Commission's estimate for clock synchronization costs represents a
significant portion of overall costs, the Commission did not intend to
imply in the Notice that the magnitude of the clock synchronization
costs were trivial, but instead that these costs were less significant
contributors to overall costs than other costs.
    In response to the commenter that stated the Commission's cost
estimates associated with clock synchronization requirements were
understated, the Commission recognizes the limitations in its analysis.
However, the Commission lacks sufficient information to derive a more
precise estimate. Although the participants in the FIF Clock Offset
Survey \2674\ were skewed towards smaller firms that did not match the
``insourcer'' model, as the commenter mentioned, it is unclear that the
inclusion of such firms would bias the Commission's cost estimates
downward. Also, the Commission's estimate of \1/4\ FTE for the clock
synchronization implementation costs for Outsourcers is in line with
its estimate of 1 FTE for the overall implementation costs for
Outsourcers whereas multiplying the estimate from the survey results by
the number of Outsourcers would yield a result that would be
approximately 87% of the Commission's estimates for total
implementation costs for outsourcers.\2675\ The Commission agrees,
however, that the average cost calculated in the FIF Clock Offset
Survey included an inherent downward bias due to the selection of the
minimum value in the highest cost response range when calculating the
average.\2676\ In conclusion, while the Commission recognizes a degree
of uncertainty in its clock synchronization cost estimates, which may
be downward biased, the commenter does not offer an alternative cost
estimate, and the Commission does not have enough information to change
its estimate.
---------------------------------------------------------------------------

    \2674\ See FIF Clock Offset Survey, supra note 247.
    \2675\ Compare the implied Outsourcer clock offset
implementation cost estimate of $554,348 x 1,629 = $903,032,892
($554,348 x 1,629 outsourcers) to total Outsourcer implementation
costs of $1,040,506,000 (342,026,000 + 678,111,000 + 20,369,000).
See Notice, supra note 5, at 30726.
    \2676\ See Notice, supra note 5, at n 968.
---------------------------------------------------------------------------

    The Commission agrees with the commenter that stated cost estimates
in the Plan did not include the requirement of timestamps on Allocation
Reports. In recognition of the modification to the Plan regarding
timestamp requirements of Allocation Reports, and in realization that
Allocation Time costs were not included in the cost estimates in the
Notice, the Commission is now adding the commenter's estimate of
$44,050,000 in implementation costs and $5,035,833 in ongoing costs for
the inclusion of timestamps on Allocation Reports to the estimated
costs of broker-dealers.\2677\
---------------------------------------------------------------------------

    \2677\ The total cost estimates of the CAT Plan reflect these
implementation and ongoing costs. See Section V,F.2.a, infra.
---------------------------------------------------------------------------

    The Commission is unable to update cost estimates to account for
the modifications to the clock synchronization standards for exchanges,
but the Commission does not believe that the modifications will result
in substantial cost increases for exchanges. The Commission does not
have sufficient information to estimate clock synchronization costs for
exchanges. However, based on information cited in the Notice \2678\ and
the Participants' response,\2679\ the Commission understands that
exchanges already maintain clock offsets of 100 microseconds or less.
While the Commission recognizes that exchanges may still incur costs in
additional logging and other actions to ensure they maintain clock
offsets in compliance with the Plan, the Commission does not believe
these additional costs will be substantial.
---------------------------------------------------------------------------

    \2678\ See Notice, supra note 5, at 30669.
    \2679\ Response Letter II at 4.
---------------------------------------------------------------------------

    The Commission does not agree with the Participants that having
multiple clock synchronization standards within the same order
lifecycle will complicate the linkage process at the Central
Repository. As indicated in Section V.D.2.b.(2), the industry already
operates with multiple clock synchronization standards. Therefore,
regardless of whether the clock synchronization standards apply a one-
size-fits-all definition of industry standard or apply a different
standard to exchanges, the linking process is already complicated by
the fact that exchanges and many broker-dealers already synchronize
some or all of their business systems to less than 50 milliseconds. The
Commission therefore believes that the modifications to the Plan to set
the clock synchronization standard for exchanges at 100 microseconds
and base industry standards on the type of CAT Reporter or system will
not increase the costs of the Central Repository.
    The Commission acknowledges that the requirement for the
Participants to perform an assessment of clock synchronization
standards, including consideration of industry standards based on the
type of CAT Reporter, Industry Member and type of system, will impose
additional costs on the Participants.\2680\ Furthermore, it is possible
that the requirement to base industry standards on the type of CAT
Reporter or system will ultimately lead to additional costs from more
granular clock synchronization standards for some Industry Members in
the future. However, any resulting proposed amendments to the Plan
regarding clock synchronization standards would be subject to notice
and comment.\2681\
---------------------------------------------------------------------------

    \2680\ See Section V.F.1.b, supra.
    \2681\ See Notice, supra note 5, at 30759-64.

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

(6) Quote Sent Time and OTC Equity Securities
    In the Notice, the Commission stated its preliminarily belief that
other Plan requirements such as the requirement that Options Market
Makers report Quote Sent Time to the exchanges would cost between $36.9
million and $76.8 million over five years; \2682\ and the requirement
to maintain six years of data at the Central Repository would cost
approximately $5.59 million.\2683\ The cost to include OTC Equity
Securities in the initial phase of the implementation of the Plan could
not be estimated.\2684\ The Commission preliminarily concluded that
these requirements did not represent a significant source of costs.
---------------------------------------------------------------------------

    \2682\ See FIF, SIFMA, and Security Traders Association, Cost
Survey Report on CAT Reporting of Options Quotes by Market Makers
(November 5, 2013), available at http://www.catnmsplan.com/industryfeedback/p601771.pdf; see also CAT NMS Plan, supra note 5,
at Appendix C, Section B.7(b)(iv)(B).
    \2683\ See CAT NMS Plan, supra note 5, at Section 12(m).
    \2684\ See id. at Section 12(q). The Commission does not have
the information necessary to precisely estimate the costs that are
incurred by including OTC Equity Securities in the initial phase of
the implementation of the CAT NMS Plan, because the Plan does not
separately present the costs associated with OTC Equity Securities.
Because of low trading activity in the OTC equity markets, any
significant costs associated with including OTC Equity Securities
would be in implementation costs. Further, broker-dealers that
implement CAT Data reporting for NMS securities may not incur
significant additional costs to implement CAT Data reporting for OTC
Equity Securities.
---------------------------------------------------------------------------

    The Commission received a comment regarding the costs incurred by
Option Market Makers regarding reporting Quote Sent Times. According to
the FIF/SIFMA/STA Cost Survey Report on CAT Reporting of Options Quotes
by Market Makers, the estimated 5-year cost to Options Market Makers
for adding a timestamp to the quote times was between ``$39.9'' million
and $76.8 million.\2685\ The commenter further stated that this is
``not a trivial cost for providing one data element to the consolidated
audit trail.'' \2686\ The Commission did not receive any comments on
the requirement to retain an extra year of data in the Central
Repository and the inclusion of OTC Equity Securities in the initial
implementation phase of CAT. Furthermore, the issues were not addressed
in the Participants' response and there were no changes in the Plan
that would affect the Commission's conclusions.
---------------------------------------------------------------------------

    \2685\ FIF Letter at 65.
    \2686\ FIF Letter at 65.
---------------------------------------------------------------------------

    As such, in light of the comments received, the Commission
continues to believe that the estimates in the Notice are reliable
estimates for the costs for Option Market Makers to send the Quote Sent
Time field to exchanges. In response to the comment that the five year
costs of adding a timestamp to the quotes is not trivial, the
Commission notes that the implied annual costs would be much lower than
the five year costs and the Commission agrees that the costs of quote
sent time are large. The Commission is no longer referring to
quantified costs as significant or less significant contributors to
overall costs.
    As noted above, in response to comments, the Commission
acknowledges that the Allocation Time data field was not included in
its cost estimates in the Notice.\2687\ For similar reasons, the
Commission now also believes that the Quote Sent Time is also not
included in the cost estimates in the Notice. Therefore, the Commission
now adds these costs to the total costs to be incurred by broker-
dealers.\2688\ The Commission recognizes that Participants and the
Central Repository will also incur costs to comply with the Quote Sent
Time requirements; however the Commission lacks sufficient information
to quantify these costs, and therefore, does not add them to the cost
estimates above for Participants or the Central Repository.
---------------------------------------------------------------------------

    \2687\ See Notice, supra note 5, at Section IV.F.1.c(2).
    \2688\ See Section V.F.1.c.(2).B, supra.
---------------------------------------------------------------------------

    The Commission also recognizes that the modifications to the Plan
to require the submission of the LEI for Customers, if an Industry
Member has or acquires its Customer's LEI, and the LEI for Industry
Members, if the Industry Member has one, could be an additional source
of costs for broker-dealers. The Commission however does not believe
that these costs will be substantial, because the Plan does not require
Industry Members or others to obtain or submit an LEI if they do not
already have an LEI.
(7) Other Costs
    In the Notice, the Commission stated its preliminary belief that
there were other categories of costs in addition to the items discussed
above, but that these categories were unlikely to represent significant
contributions to the overall costs of the Plan. For example, in
addition to providing CAT Reporters data on their Error Rates, the Plan
stated that the Participants believed that in order to meet Error Rate
targets, industry would require certain resources, including a stand-
alone testing environment, and time to test their reporting systems and
infrastructure. There were also likely to be costs related to the Plan
Processor's management of PII,\2689\ as well as related compliance
costs associated with minimizing the costs and risks of a security
breach.
---------------------------------------------------------------------------

    \2689\ The Commission also acknowledges that the costs
associated with handling PII could create an incentive for service
bureaus not to offer CAT Reporting services. Nonetheless, the
Commission does not believe that this incentive would significantly
alter the services available to broker-dealers. For further
discussion, see Section V.G.1.e, infra. The Commission also notes
that, pursuant to the exemptive relief granted by the Commission,
the approach to the reporting of Customer information in the CAT NMS
Plan could allow for the bifurcation of PII reporting from the
reporting of order data. See Exemption Order, supra note 21, at
11858-63.
---------------------------------------------------------------------------

    The Commission received a comment stating that the costs associated
with the management of the PII included in the customer information
reported could increase the costs of the CAT Plan.\2690\ Another
commenter mentioned that underlying customer data is PII information
and moving this sensitive data requires extreme precaution, which could
also increase these costs.\2691\
---------------------------------------------------------------------------

    \2690\ Data Boiler Letter at 37.
    \2691\ TR Letter at 8-9; FIF Letter at 9-10, 86.
---------------------------------------------------------------------------

    The Commission considered these comments, as well as modifications
to the Plan's security provisions, and is updating its analysis. While
the Commission cannot quantify these costs, the Commission believes
that costs associated with the management of PII, and related security
costs associated with minimizing the costs and risks of a security
breach, would increase in light of modifications to the Plan discussed
above.\2692\ Specifically, the Commission believes the costs would
increase in light of the requirement that the Plan Processor adhere to
the NIST Cyber Security Framework in its entirety, the requirement that
the CAT System be AICPA SOC 2 certified and audited by a qualified
third-party auditor, the requirement that all CAT Data be encrypted,
and the requirement that Customer Identifying Information and Customer
Account Information, irrespective of whether it meets a common
understanding of the definition of PII, should be considered PII for
security purposes. The Commission believes these costs would represent
a significant proportion of the total costs of the CAT Plan.
---------------------------------------------------------------------------

    \2692\ See Section IV.D.6, supra.
---------------------------------------------------------------------------

    As discussed above,\2693\ the Participants' response provided
clarifying information on error correction timelines for customer
information and PII, and identified an errant discussion of these error
correction timelines in the Plan. The

Commission is amending the Plan to incorporate the Participants'
clarification. The Commission does not believe the clarification
regarding the timeline for communication of errors for customer and
account information would warrant any changes to its analysis and
conclusions regarding costs.
---------------------------------------------------------------------------

    \2693\ See Section V.E.1.d., supra.
---------------------------------------------------------------------------

    The Commission is also amending the Plan require that the CAT
testing environment will be made available to Industry Members on a
voluntary basis no later than six months prior to when Industry Members
are required to report and that more coordinated, structured testing of
the CAT System will begin no later than three months prior to when
Industry Members are required to report data to CAT.\2694\ These
amendments could increase the costs of the Plan as they relate to the
provision of a testing environment.
---------------------------------------------------------------------------

    \2694\ See Section IV.D.8.a, supra.
---------------------------------------------------------------------------

b. Fees
    In the Notice, the Commission discussed a source of costs due to
ancillary fees on both broker-dealers reporting to, and regulators
accessing, the Central Repository.\2695\ The Commission preliminarily
believed that ancillary fees levied on broker-dealers were unlikely to
be levied broadly, because discussion in the Plan associated these fees
with late and/or inaccurate reporting. The Plan also discussed
ancillary fees possibly levied on regulators associated with the use of
Central Repository data. The Commission recognized that costs estimated
in Bids for constructing and operating the Central Repository already
anticipate use of the CAT Data by regulators, and that additional fees
to access the data might give regulators incentives to make less use of
the data than anticipated in the Benefits Section. However, any fee
schedule proposed by the Participants would be filed with the
Commission. Consequently, the Commission preliminarily did not believe
that the provisions for ancillary fees would likely significantly
impact the costs or benefits of CAT.
---------------------------------------------------------------------------

    \2695\ See CAT NMS Plan, supra note 5, at Section 11.3(c).
---------------------------------------------------------------------------

    Three commenters supported levying fees on regulators that access
CAT Data.\2696\ One commenter mentioned that any costs imposed in
connection with a usage fee for the CAT will be offset by the costs
that the SROs will save in retiring systems. In fact, imposing a user
fee could create an incentive to eliminate those systems in a timely
fashion.\2697\ While the Participants agreed there are potential
benefits to charging a usage fee, they also stated that it is premature
to establish such a fee until the Participants gain a better
understanding of how the Plan will be used by the regulators and how
such usage will impact the operational costs of the Plan.\2698\
---------------------------------------------------------------------------

    \2696\ SIFMA Letter at 18; DAG Letter at 5; STA Letter at 1.
    \2697\ SIFMA Letter at 18.
    \2698\ Response Letter II at 15.
---------------------------------------------------------------------------

    The Commission considered these comments, but does not believe that
they would warrant changes to the Commission's preliminary analysis and
conclusions regarding the ancillary fees under the Plan. Furthermore
there were no modifications to the Plan that would warrant changes to
this aspect of the economic analysis. The Commission disagrees with the
comment that the usage fees would create an incentive for SROs to
retire their systems earlier. In fact, the Commission notes that the
usage fees could have the opposite effect--it could encourage the SROs
to not use CAT for regulatory activities other than surveillance, which
could incentivize them to retain these systems longer. The Commission
continues to believe that ancillary costs do not represent a
significant proportion of costs of the CAT NMS Plan.
4. Expected Costs of Security Breaches
    In the Notice, the Commission recognized that investors and market
participants could face significant costs if CAT Data security were
breached.\2699\ The Commission explained its belief that it is
difficult to form reliable economic expectations for the costs of
security breaches because there are few examples of security breaches
analogous to the type that could occur under the CAT NMS Plan. However,
the Commission provided a qualitative analysis of the expected costs of
security breaches in the Notice by separating the expected costs of
security breaches into two components: The risk of a security breach
and the cost resulting from a security breach.\2700\
---------------------------------------------------------------------------

    \2699\ See Notice, supra note 5, at 30732-36.
    \2700\ See Notice, supra note 5, at Section IV.F.4a(2) for the
risk of a security breach and Section IV.F.4a(1) for the costs
resulting from a security breach.
---------------------------------------------------------------------------

    The Commission acknowledged in the Notice \2701\ that because many
of the decisions that define security measures for the Central
Repository are coincident with the selection of the Plan Processor,
there is a degree of uncertainty with regards to security measures that
would be implemented by the Plan Processor.\2702\ Consequently, there
is uncertainty about the significance of the risks, the expected costs
of a breach when considering the likelihood of a data breach, and the
second-order effects.\2703\
---------------------------------------------------------------------------

    \2701\ See Notice, supra note 5, at 30733.
    \2702\ The Commission noted that, as discussed in the Plan, the
Participants collected information from the Bidders regarding
security and confidentiality during the RFP process, however, there
was considerable diversity in the approaches proposed by the Bidders
and the Participants chose to give the Plan Processor flexibility on
many implementation details and state the requirements as a set of
minimum standards. These requirements include both general security
and PII treatment requirements. General security requirements are
designed to address physical security, data security during
transmissions, transactions, and while at-rest, confidentiality, and
a cyber incident response plan. PII requirements include a separate
PII-specific workflow, PII-specific authentication and access
control, separate storage of PII data, and a full audit trail of PII
access. Id.
    \2703\ Id.
---------------------------------------------------------------------------

a. Costs of a Security Breach
    The Commission discussed its belief in the Notice \2704\ that the
form of the direct costs resulting from a security breach will vary
across market participants and could be significant. It listed the
following four types of costs. First, for broker-dealers, investment
advisers, and other similar institutions, a security breach could leak
highly-confidential information about trading strategies or
positions,\2705\ which could be deleterious for market participants'
trading profits and client relationships. Second, a data breach could
also expose proprietary information about the existence of a
significant business relationship with either a counterparty or client,
which could reduce business profits.
---------------------------------------------------------------------------

    \2704\ Id. at 30732.
    \2705\ Although the Plan does not require reporting positions,
observation of a broker-dealer's recent executions can offer
information about their change in position, or, potentially,
information about their actual position if the audit trail
information breached contains all trading activity since the
creation of the position.
---------------------------------------------------------------------------

    Third, a data breach could also potentially reveal PII of
customers. Because some of the CAT Data stored in the Central
Repository will contain PII such as names, addresses, and social
security numbers, a security breach could raise the possibility of
identity theft, which currently costs Americans billions of dollars per
year.\2706\ Because PII will be stored in a single, centralized
location rather than stored across multiple locations, a breach in the
Central Repository could leak all PII, rather than a subset of PII that
could be leaked if the information were stored in

multiple locations. As such, these costs associated with the risk of a
security breach could be substantial in aggregate.
---------------------------------------------------------------------------

    \2706\ According to survey data, the Bureau of Justice
Statistics reported $24.7 billion in identity theft costs in 2012,
available at http://www.bjs.gov/content/pub/press/vit12pr.cfm.
---------------------------------------------------------------------------

    Fourth, a breach that reveals the activities of regulators within
the Central Repository, such as data on the queries and processes run
on query results, could compromise regulatory efforts or lead to
speculation that could falsely harm the reputation of market
participants and investors.
    The Commission received several comments regarding the costs of a
security breach, which are summarized in more detail in Section IV.D.6.
Some commenters asserted that the potential costs of a breach exceed
those described by the Commission in the Notice because a breach could
negatively affect not just individual firms and investors but also the
broader financial markets. One commenter wrote that a bad actor gaining
access to the Central Repository ``may pose tremendous threat to the
U.S. financial stability.'' \2707\ Another wrote that a breach could be
a ``threat to market stability or national security'' and ``would have
serious impacts on the global economy.'' \2708\ The same commenter
stated that ``we believe the CAT Data is on par with, and meets, the
standards for classified information as set in Executive Order 13526 on
Classified National Security Information. . . . We think that
unauthorized disclosure or use of CAT Data could destabilize the U.S.
and world financial markets by causing investor panic, mass selling and
runs on financial institutions. The potential extent of damage to the
U.S. markets and economy would be a matter of national security.''
Another commenter cited the Government Accountability Office, stating
``the ineffective protection of cyber assets can result in the loss or
unauthorized disclosure or alteration of information, [which] could
lead to serious consequences and result in substantial harm to
individuals and to the federal government.'' \2709\
---------------------------------------------------------------------------

    \2707\ Data Boiler Letter at 26.
    \2708\ MFA Letter at 2, 5.
    \2709\ FSR Letter at 5, which references the ``High-Risk Series:
An Update'' a publication issued by the Government Accountability
Office, GAO-15-290 at 235 (Feb. 2015).
---------------------------------------------------------------------------

    Commenters also asserted that the potential costs of a breach
exceed those described by the Commission in the Notice because the
Notice did not discuss costs related to breach management. One
commenter stated that ``the Proposal fails to address who is
responsible for the cost of the breach that occurs at the Central
Repository,'' \2710\ and another commenter suggested that ``[because]
the Plan Processor is responsible for constructing and operating the
CAT . . . the Plan Processor should bear responsibility in the event of
a data breach.'' \2711\ One commenter wrote that ``the cost of
complying with the notification requirements under the Privacy Laws may
be exorbitant.'' \2712\ Two commenters recommended the purchase of
insurance by the Plan Processor or CAT NMS, LLC to cover the costs of a
breach.\2713\ One commenter argued that the Plan Processor must
promptly notify a customer of security breaches of his data because ``a
security breach of a customer's trading data could compromise the
customer's investment strategies even if the customer's PII was not
compromised.'' \2714\ Another commenter observed that breach
notification may take longer if the data breach happens at the site of
a Participant, ``which could greatly harm registered funds and other
victims of the breach.\2715\
---------------------------------------------------------------------------

    \2710\ FSR Letter at 7.
    \2711\ FSI Letter at 4.
    \2712\ FSR Letter at 8.
    \2713\ FSR Letter at 8; SIFMA Letter at 22.
    \2714\ MFA Letter at 9.
    \2715\ ICI Letter at 7.
---------------------------------------------------------------------------

    The Commission acknowledges that the costs of a breach, including
breach management, could be quite high, especially during periods of
market stress. Furthermore, the Commission understands that a breach
could seriously harm not only investors and institutions but also the
broader financial markets. The Commission is unable to provide
quantitative estimates of those costs because there are few examples of
security breaches analogous to the type that could occur under the Plan
and because the Plan Processor has some discretion in developing its
breach management plan.\2716\ The Commission notes, however, that the
Plan Processor is responsible for CAT Data,\2717\ and it will develop a
breach protocol and cyber incident response plan that will include
notification of breach victims such as Customers, insurance coverage
and liability, and details about the distribution of costs.\2718\
---------------------------------------------------------------------------

    \2716\ See CAT NMS Plan, supra note 5, at Appendix D, Section
4.1.5.
    \2717\ See Section III.26, supra.
    \2718\ See Section IV.D.6.j, supra.
---------------------------------------------------------------------------

b. Risk of a Security Breach
    The Commission discussed in the Notice \2719\ its belief that the
risks of a security breach may not be significant because certain
provisions of Rule 613 and the CAT NMS Plan appear reasonably designed
to mitigate these risks. However, the Commission noted that the
considerable diversity in the potential security approaches of the
Bidders creates some uncertainty about the effectiveness of the
eventual security procedures and hence, the risk of a security
breach.\2720\
---------------------------------------------------------------------------

    \2719\ See Notice, supra note 5, at 30732-34.
    \2720\ The Commission notes that, at a minimum, the security of
the CAT Data must be consistent with Reg SCI. 17 CFR 242.1000 to
1007.
---------------------------------------------------------------------------

    In the Notice,\2721\ the Commission discussed the provisions of
both Rule 613 and the Plan that provide safeguards designed to prevent
security breaches.\2722\ First, governance provisions of the CAT NMS
Plan could mitigate the risk of a security breach.\2723\ Second, the
Plan includes specific provisions designed to ensure the security of
data in-flight.\2724\ Third, Section 6.7(g) of the Plan requires that
the Participants establish, maintain, and enforce written policies and
procedures reasonably designed to (1) ensure the confidentiality of the
CAT Data obtained from the Central Repository; and (2) limit the use of
CAT Data obtained from the Central Repository solely for surveillance
and regulatory purposes. Finally, the Plan includes further provisions
designed to provide security for PII.\2725\
---------------------------------------------------------------------------

    \2721\ See Notice, supra note 5, at 30733.
    \2722\ The Commission noted that ``Rule 613(e)(4) requires
policies and procedures that are designed to ensure the rigorous
protection of confidential information collected by the Central
Repository, and Rule 613(iv) requires that the Plan contain a
discussion of the security and confidentiality of the information
reported to the Central Repository. Rule 613 also restricts access
to use only for regulatory purposes, and requires certain provisions
that are designed to mitigate these security risks such as the
appointment of a Chief Compliance Officer and annual audits of Plan
Processor operating procedures.'' Id.
    \2723\ The Notice, supra note 5, at 30733 lists the following
three governance mechanisms: Activities of the Compliance
Subcommittee that could reduce the risk that information is released
to unauthorized entities; the requirement that the Plan Processor
submit a comprehensive security plan to the Operating Committee and
update this security plan annually; and the establishment of a Chief
Information Security Officer who is responsible for monitoring and
addressing data security issues for the Plan Processor.
    \2724\ The Commission noted that ``the Plan requires that bulk
extract data be encrypted, password protected and sent via secure
methods of transmission.'' Id.
    \2725\ The Commission noted that regulators authorized to access
PII would be required to complete additional authentications, and
PII would be masked unless users have permissions to view PII. Id.
---------------------------------------------------------------------------

    Commenters made four types of comments about the Notice's economic
analysis of the risk of a security breach. The first type of comment
relates to protecting CAT Data that are extracted or downloaded from
the Central Repository. Several commenters expressed strong concerns
about allowing any entity, including

regulators, to extract or download data from the Central Repository
because the risk of any data breach would greatly increase as the data
are maintained at more sites.\2726\ One commenter suggested that
allowing anyone to download the entire CAT database might threaten U.S.
financial stability.\2727\ Some commenters also objected to excluding
the Commission or its Staff from certain security-related parts of the
CAT NMS Plan.\2728\
---------------------------------------------------------------------------

    \2726\ SIFMA Letter at 20; Fidelity Letter at 4; FIF Letter at
134; ICI Letter at 7.
    \2727\ Data Boiler Letter at 26.
    \2728\ FIF Letter at 134; NYSE Letter at 2-4 (noting also that
``[i]f employees of the Commission with access to the data stored in
the Central Repository or other CAT systems are subject to security
standards less stringent than those applicable to other authorized
users, the data obtained and held by those individuals may be
subject to heightened risk of a data breach''); Garrett Letter at 1-
2.
---------------------------------------------------------------------------

    The second type of comment relates to tailoring security
requirements to the security risk of the particular data element.
Several commenters argued that at-rest data and in-use data needs to
have some of the same security measures that are required for in-flight
data in order to keep risk at an acceptable level.\2729\ Another
commenter wrote that maintaining different security standards for PII
data and non-PII data ``creates the misimpression that all non-PII data
merits less information security protection than PII data'' and
recommended more accurately matching security requirements to the
underlying risk through the imposition of ``additional levels of data
classification to protect adequately commercially sensitive non-PII
data.'' \2730\
---------------------------------------------------------------------------

    \2729\ SIFMA Letter at 20; MFA Letter at 8; FSR Letter at 4-8;
Data Boiler Letter at 8.
    \2730\ ICI Letter at 6.
---------------------------------------------------------------------------

    The third type of comment relates to the overall risks of the
system due to the unique nature of the database. Several commenters
suggested that the Commission impose additional security requirements
beyond what appears in the Notice because the scale and scope of the
Central Repository will make it a particularly attractive target for
well-funded hackers, individuals, and nation-states with objectives
ranging from theft to insider trading to market disruption.\2731\
Additionally, a number of commenters recommended that the Plan include
additional detail concerning the security of CAT Data.\2732\
---------------------------------------------------------------------------

    \2731\ ICI Letter at 3; Fidelity Letter at 3; FSI Letter at 4;
SIFMA Letter at 19; MFA Letter at 5.
    \2732\ SIFMA Letter at 20; ICI Letter at 4; FSR Letter at 6; TR
Letter at 8; FIF Letter at 131-132; Fidelity Letter at 4. The
Commission responds to these comments in detail in Section IV.D.6.a,
supra.
---------------------------------------------------------------------------

    The fourth type of comment relates to data governance. One
commenter stated that the proposal for the CCO and CISO to be officers
of the Company as well as employees of the Plan Processor creates a
conflict of interest that would undermine the ability of these officers
to carry out their responsibilities effectively under the Plan because
they would owe a fiduciary duty to the Plan Processor rather than the
CAT LLC.\2733\ The same commenter noted that the Notice did not specify
the entity liable in the event of a data breach.\2734\ The commenter
suggested that because the Plan Processor is responsible for
constructing and operating the CAT, with the oversight of the Operating
Committee, and will be solely in control of the system's information
security, the Plan Processor should bear responsibility in the event of
a data breach.\2735\
---------------------------------------------------------------------------

    \2733\ FSI Letter at 3. As discussed above in Section IV.D.6,
the CCO and CISO each have responsibilities related the security of
CAT Data.
    \2734\ FSI Letter at 4-5.
    \2735\ FSI Letter at 4-5.
---------------------------------------------------------------------------

    The Participants have responded to these comments. In response to
the commenters that expressed concern about allowing any entity to
extract or download CAT Data, the Participants noted that Rule 613
requires regulators to develop and implement a surveillance system, or
enhance existing surveillance systems to make use of CAT Data.\2736\
The Participants stated that ``eliminating or limiting bulk data
extracts of the CAT Data may significantly and adversely impact the
Participants' ability to effectively surveil their markets using CAT
Data.'' \2737\ The Participants further noted that the Plan also
requires that Participants have appropriate policies and procedures in
place to protect all of the CAT Data they extract or download.\2738\ In
response to the comments about excluding the Commission or its Staff
from certain security requirements of the Plan, the Participants stated
that they agreed that the Plan's security program must take into
consideration all users with access to CAT Data, including the SEC, and
they recommended removing the exclusions.\2739\
---------------------------------------------------------------------------

    \2736\ Response Letter I at 56.
    \2737\ Response Letter III at 10.
    \2738\ Response Letter III at 11.
    \2739\ Response Letter I at 60-61.
---------------------------------------------------------------------------

    In response to the commenter that suggested adding additional
levels of data classification, the Participants determined that ``it is
[not] necessary to expand the categories of other CAT Data.'' \2740\ In
response to commenters that requested more detail regarding the
security controls for CAT Data, the Participants noted that in the
Adopting Release for Rule 613, the Commission stated that ``an outline
or overview description of the policies and procedures that would be
implemented under the NMS plan submitted to the Commission for its
consideration would be sufficient to satisfy the requirement of the
Rule.'' \2741\ In their response, the Participants also provided
additional information about security procedures, including a high
level description of the security requirements for the CAT System and
additional details concerning certain security controls and protocols
required of the Plan Processor.\2742\ The Participants also stated that
they believe that ``publicly releasing too many details about the data
security and information policies and procedures of the CAT System
presents its own security concerns and is not advisable.'' \2743\ In
response to comments about governance, the Participants agreed that the
Plan should explicitly state that the CCO and CISO of the LLC should
have fiduciary duties to the LLC in the same manner and extent as an
officer of a Delaware corporation and recommended the Plan be amended
accordingly.\2744\ Additionally, the Participants stated that they are
``in the process of negotiating an agreement with potential Plan
Processors. This agreement will cover liability, insurance, and
indemnification.'' \2745\
---------------------------------------------------------------------------

    \2740\ Response Letter I at 57.
    \2741\ Response Letter I at 53-54.
    \2742\ Response Letter III at 7-8.
    \2743\ Response Letter I at 53-54.
    \2744\ Response Letter I at 17-19.
    \2745\ Response Letter I at 59.
---------------------------------------------------------------------------

    The Commission has considered the comment letters and the
Participants' response letters. In response to the commenters that
expressed concern about allowing any entity to extract or download CAT
Data, the Commission notes that it believes that regulators need access
to CAT Data outside the Central Repository to perform their duties
effectively. As discussed above in Section IV.D.6.d, Participants that
choose to extract or download CAT Data must have policies and
procedures regarding CAT Data security that are equivalent to those of
the Plan Processor for the Central Repository. And as discussed in
Section IV.D.6.o, the rules and policies applicable to the Commission
and its Staff will be different yet substantively as rigorous as those
applicable to the Participants and their personnel. The Commission
therefore believes that, due to these precautions, the regulatory use
of CAT Data outside the Central Repository

should not increase the security risks to the CAT system.
    In response to the commenters that expressed concern about the
security requirements for particular data elements, the Commission
notes that it believes that the best use of limited resources is to
tailor security requirements to the security risk of the particular
data element. No commenter quantified the relative risk of a breach
that comes from in-flight data versus at-rest data or in-use data, and
the Commission continues to believe that the largest risk of a breach
comes from in-flight data. Thus, the adopted Plan will maintain higher
security standards for in-flight data than for at-rest data or in-use
data. The Commission also continues to believe that PII data warrants
more security considerations than non-PII data, but it disagrees with
the one commenter that recommended multiple levels of security for non-
PII data.\2746\ In this case, the Commission does not believe that the
benefits justify the costs of creating additional levels of data
classification within non-PII data.
---------------------------------------------------------------------------

    \2746\ ICI Letter at 6.
---------------------------------------------------------------------------

    In response to the commenters that expressed concern about the
risks of aggregating confidential data from disparate sources into one
location, the Commission notes that it agrees that the CAT Data will be
a particularly attractive target for bad actors. However, the
Commission believes that the extensive, robust security requirements in
the adopted Plan, as outlined in Section IV.D.6, provide appropriate,
adequate protection for the CAT Data.
    In response to the comments regarding the lack of security details
in the Plan, the Commission continues to believe that, as discussed in
the Notice, there is a degree of uncertainty with respect to the
security measures that would be implemented by the Plan Processor, and
consequently, uncertainty about the risk of a data breach.\2747\ As
discussed in more detail above,\2748\ the Commission notes that the
Participants have provided some additional information regarding
security procedures. Additionally, as discussed above, the Commission
is amending the Plan to require that the Participants conduct
background checks for the employees and contractors of the Participants
that will use the CAT System,\2749\ and to require that the
Participants provide the Commission with an evaluation of the
information security program to ensure that the program is consistent
with the highest industry standards for the protection of data.\2750\
The Commission believes that this additional information mitigates some
of the uncertainty, but continues to believe that there is significant
uncertainty with respect to the risk of a breach. However, the
Commission also recognizes that publicly releasing too many details
about security requirements could create additional risk, and as
discussed in Section IV.D.6, believes a reasonable level of detail has
been provided.\2751\
---------------------------------------------------------------------------

    \2747\ See Notice, supra note 5, at 30733.
    \2748\ See Section IV.D.6.a, supra.
    \2749\ See Section IV.D.6.c, supra.
    \2750\ See Section IV.H, supra.
    \2751\ See CAT NMS Plan, supra note 5, at Appendix C, Section
A.1(b) (discussing the manner in which the Central Repository will
receive, extract, transform, load, and retain data); Section 6.10(c)
(discussing the CAT user help desk).
---------------------------------------------------------------------------

    In response to comments about governance, the Commission notes that
it has modified the Plan to address the concern regarding potential
conflicts of interest on the part of the CCO and CISO. Specifically, as
discussed in more detail above in Section IV.B.3, the CCO and CISO will
have fiduciary duties to the CAT LLC in the same manner and extent as
an officer of a Delaware corporation, and to the extent those duties
conflict with duties the CCO and CISO have to the Plan Processor, the
duties to the CAT LLC will control.\2752\ As discussed above in Section
IV.D.6, the CCO and CISO each have responsibilities related the
security of CAT Data, and the potential for a conflict of interest
could create uncertainty as to whether these responsibilities will be
carried out in a way that will minimize the risk of a security breach.
The Commission believes that the modifications to the Plan should
reduce this uncertainty.
---------------------------------------------------------------------------

    \2752\ Response Letter I at 17-19.
---------------------------------------------------------------------------

    In response to the commenter who noted that the Notice did not
specify the entity liable in the event of a data breach, the Commission
notes that the Plan requires the Plan Processor's cyber incident
response plan to address insurance issues related to security breaches,
and that as part of the discussions on insurance coverage and
liability, further detail about the distribution of costs will be
undertaken, including details about who might bear the cost of a breach
and under what specific circumstances. The Commission believes that
these provisions in the Plan should provide incentives for the Plan
Processor to manage security risks. However, because the cyber incident
response plan will not be developed until after the Plan Processor has
been selected, the Commission does not know whether or under what
circumstances the Plan Processor will bear the cost of a breach. While
the Commission recognizes that this creates some uncertainty with
respect to the incentives on the Plan Processor to minimize the risk of
a security breach, the Commission is approving the Plan without further
modification for the reasons discussed in Section IV.D.6.j, above.
5. Second Order Effects
    In the Notice, the Commission recognized that a number of second-
order effects could result from the approval of the Plan.\2753\ These
included market-participant actions designed to avoid direct costs of a
security breach; changes to CAT Reporter behavior due to increased
surveillance; changes in CAT Reporter behavior to switch from one
funding tier to another to qualify for lower fees; and changes in
broker-dealer routing practices related to fee differentials across
execution venues.
---------------------------------------------------------------------------

    \2753\ See Notice, supra note 5, at 30733-34.
---------------------------------------------------------------------------

a. Security-Related Second Order Effects
    In the Notice, the Commission recognized that the desire to avoid
direct costs of a security breach could motivate actions that would
cause second order effects.\2754\ The Commission illustrated this in
the Notice by considering two specific examples of actions that
Participants might take. First, if service bureaus perceive the costs
and risks of a security breach to be great enough because of the
addition of PII in the data, which is not included in current data,
some could decide not to provide CAT Data reporting services.\2755\
Second, investors or other market participants could move their
activity off-shore or cease market participation altogether to avoid
having sensitive information stored in the Central Repository.\2756\
The Commission stated that it did not believe that the effect of the
Plan on the risk or costs of a data breach would be great enough to
result in significant second order effects.\2757\
---------------------------------------------------------------------------

    \2754\ Id.
    \2755\ The Commission noted that this could increase the
potential for a short term strain on capacity and exacerbate the
costs. Id. at 30733.
    \2756\ The Commission noted that consequences of changes in
investor behavior in response to the threat of a breach include:
Investors holding suboptimal portfolios; lost profits to the
securities industry; and higher costs of raising capital for U.S.-
based securities issuers, if the public's willingness to participate
in capital markets is sufficiently reduced. Id. at 30734.
    \2757\ Id.
---------------------------------------------------------------------------

    The Commission received two comments on this issue. Both comments
suggested that industry members would have to purchase insurance or
cease domestic operations if the Plan Processor was not required to
purchase

an insurance policy that covers potential security breaches and extends
to industry members to reimburse them for costs related to the
breach.\2758\ Comments on another potential second order effect related
to capital formation are addressed in more detail below in Section
V.G.3.b.\2759\
---------------------------------------------------------------------------

    \2758\ FSR Letter at 2; SIFMA Letter at 22.
    \2759\ An analysis related to Capital Formation can be found in
Section V.G.3., infra.
---------------------------------------------------------------------------

    In their response to comments, the Participants indicated that they
are working on an agreement between themselves and the potential Plan
Processors to cover liability, insurance, and indemnification, which
would also make it less likely that industry members would move off-
shore or cease operations.\2760\
---------------------------------------------------------------------------

    \2760\ Response Letter I at 59.
---------------------------------------------------------------------------

    The Commission recognizes that the purchase of insurance to cover
these costs is a potential second order effect. As such, the Commission
is revising its economic analysis to acknowledge this additional second
order effect, but otherwise continues to believe that the security-
related second order effects will be as anticipated in the Notice.
b. Changes to CAT Reporter Behavior
    In the Notice, the Commission also acknowledged that increased
surveillance could impose some costs by altering the behavior of market
participants. The Commission stated that benefits could accrue to the
extent that improved surveillance, investigation, and enforcement
capabilities allow for regulators to better identify and address
violative behavior when it occurs, and to the extent that common
knowledge of improved capabilities deters violative behavior.\2761\ In
particular, the Commission acknowledged that some market participants
could reduce economically beneficial behavior if those market
participants believe that, because of enhanced surveillance, their
activities would increase the level of regulatory scrutiny that they
bear. Furthermore, the Commission stated that costs could accrue to the
extent that some forms of market activity, which are permissible and
economically beneficial to the market and investors, could come under
greater scrutiny, which could create a disincentive to engage in that
activity. For example, regulators could increase the number of
inspections, examinations and enforcement proceedings that they
initiate. To the extent that these activities result in a reduction in
violative behavior, the market benefits by avoiding the costs of this
behavior. To the extent, however, the additional regulatory activity
increases the number of inspections, examinations and enforcement on
permissible activities, market participants would incur the increased
costs of facilitating these regulatory inquiries.
---------------------------------------------------------------------------

    \2761\ See Notice, supra note 5, at 30734.
---------------------------------------------------------------------------

    Although the Commission did not receive any comments on the second
order effects it discussed in the Notice, it did receive two comments
on a second order effect related to the granularity of timestamps. As
discussed in the Notice, the Plan requires CAT reporters to report sub-
millisecond timestamps when the CAT reporter uses such timestamps
internally.\2762\ Two commenters noted that this requirement may
discourage CAT reporters from using sub-millisecond timestamps
internally, since this would require finer timestamp resolution in CAT
reporting.\2763\ The Commission also received a comment on a second-
order effect that could result from the tiered fee structure of broker-
dealers based on message traffic.\2764\ The commenter suggested that
the structure of the funding model might cause second-order effects
related to the differential message traffic of different activities,
and these effects may vary across securities based on their liquidity.
---------------------------------------------------------------------------

    \2762\ Id. at 30764-65.
    \2763\ FIF Letter at 12; SIFMA Letter at 35.
    \2764\ SIFMA Letter at 16-17.
---------------------------------------------------------------------------

    In response to comments on the granularity of timestamps, the
Participants state that the quality of CAT Data would improve if the
Plan required such timestamps to be reported by CAT reporters that use
such timestamps internally.\2765\ Furthermore, in response to the
comment that the imposition of a fee on message traffic would
discourage liquidity provision, the Participants note that they
actively considered the market quality concerns in devising the
proposed funding model, and one of the reasons for proposing a tiered,
fixed fee funding model was to limit the disincentives to providing
liquidity to the market. In particular, the Participants believed that
a funding model based on message volume was far more likely to affect
market behavior.\2766\
---------------------------------------------------------------------------

    \2765\ Response Letter I at 28-29.
    \2766\ Response Letter II at 16.
---------------------------------------------------------------------------

    With regards to comments on sub-millisecond timestamps, the
Commission acknowledges that this requirement may prove to be a
disincentive for market participants to use sub-millisecond timestamps
internally; however, the Commission believes that for many market
participants, capturing timestamps at a finer resolution supports
analysis of the firm's data for business purposes that provide benefits
such as improvement to trading strategies and measurement of execution
costs, and the benefits of these business purposes may exceed the costs
of reporting regulatory data with finer timestamps. However, the
Commission acknowledges that for firms that do not perform such
analyses, this requirement may prove to be a disincentive to adopting
technologies that capture finer resolution timestamps.
    The Commission agrees with the comment about second order effects
related to the tiering of broker-dealer fees based on message traffic
and is adding this second-order effect to its analysis. The funding
model anticipates Central Repository costs being spread across broker-
dealers according to activity tiers based on message traffic. This may
cause broker-dealers to alter their behavior to avoid being assigned to
a higher fee tier. For example, trading strategies that involve
providing liquidity might be expected to generate more message traffic
than strategies that take liquidity because providing liquidity
generally requires posting many quotes on many venues. Furthermore,
while a broker-dealer is seeking to provide liquidity, market prices
may change causing the broker-dealer to have to update its quotes on
many venues multiple times as it seeks to trade. Consequently, the
funding model may create an incentive to take rather than provide
liquidity, which could reduce levels of market liquidity. Furthermore,
these effects may vary across securities based on the liquidity of the
security. As the commenter noted, ``the quote-to-trade ratio for
exchange-traded-products (``ETPs'') can be ten times greater than that
for corporate stocks. This implies that market makers in ETPs may
generate ten times the amount of message traffic per executed trade
than market makers in corporate stock.'' \2767\ Consequently, the
Commission also agrees that the tiered funding model for broker-dealers
may create disincentives to provide liquidity in less liquid
securities, possibly resulting in less liquid markets for securities
that are already considered illiquid. As discussed below, the
Commission recognizes the potential differential effect on those
broker-dealers that engage in market making in liquid stocks versus
illiquid stocks and on those broker-dealers that engage in liquidity
taking strategies versus those that engage in other strategies.

Nonetheless, as explained above in Section IV.D.13.b, the Commission
believes that the timestamp requirements contained in the CAT NMS Plan,
including the requirement that a CAT Reporter report timestamps in
increments finer than milliseconds if they do so in other systems, are
reasonable and will improve regulators' ability to sequence events.
---------------------------------------------------------------------------

    \2767\ SIFMA Letter at 17.
---------------------------------------------------------------------------

c. Tiered Funding Model
    In the Notice, the Commission stated its preliminary belief that
establishing a small number of discrete fee tiers, as occurs under the
Plan, could create incentives for CAT Reporters to alter their behavior
to switch from one tier to another, thereby qualifying for lower
fees.\2768\ Specifically, the Plan states that CAT Reporters would be
classified into a number of groups based on reporter type and market
share of share volume or message traffic and assessed a fixed fee that
is determined by this classification. The higher-activity groups would
be assessed higher fees such that market participants who fall into the
lower tiers have a fee advantage over the market participants that fall
into the higher tiers. The Commission noted, however, that because this
incentive is contingent on being near a fee-tier cutoff point,
relatively few market participants will likely be affected and thus
market quality effects will likely not be significant. Furthermore, for
those market participants near a cutoff point, managing activity to
avoid a higher fee tier would necessarily incur costs of lost business
and potential loss of market share, and would possibly be difficult to
implement, which should mitigate any effects on market quality.
---------------------------------------------------------------------------

    \2768\ See Notice, supra note 5, at 30734-35.
---------------------------------------------------------------------------

    The Commission also recognized that the tiering of fees could
create calendar effects within markets. That is, the structure
ultimately approved by the Operating Committee could affect market
participant behavior near the end of a measuring period. For example,
high levels of market activity during a measuring period might cause
CAT Reporters to limit their activity near the end of a measurement
period to avoid entering a higher fee tier. The Commission noted that
the Operating Committee has discretion under the Plan governance
structure to make the tier adjustments discussed in Section 11.1.d for
individual CAT Reporters. This provision might mitigate incentives for
individual market participants to alter market activities to reduce
their expected CAT fees.
    The Commission did not receive any comments related to its economic
analysis regarding the market quality effects, calendar effects, or
other effects due to the tiered structure of the funding model. While
the Commission is making certain modifications to the funding model, as
described in Section IV.F above, the funding model will continue to
utilize a tiered structure. Consequently, the Commission continues to
believe that the tiered fee structure could create incentives for CAT
Reporters to alter their behavior, but that market quality effects
would likely not be significant. Nonetheless, the Commission expects
that the required report by the Participants to study the impact of
tiered-fees on market liquidity should provide insights into whether
the fee model affects liquidity provision and ultimately market
quality. This will assist the Commission's oversight of the Plan and
assist the Operating Committee in understanding whether it needs to
make adjustments to the Funding Model. Furthermore, for those market
participants near a cutoff point, managing activity to avoid a higher
fee tier would necessarily incur costs of lost business and potential
loss of market share, and would possibly be difficult to implement,
which should mitigate any effects on market quality.
    The Commission is also updating its analysis based on the amendment
to the Plan to clarify that the Operating Committee may only change the
tier to which a Person is assigned in accordance with a fee schedule
filed with the Commission.\2769\ Consequently, the Commission no longer
believes that this provision would mitigate incentives for individual
market participants to alter market activities to reduce their expected
CAT fees. The Commission continues to recognize that CAT Reporters may
have incentives to alter their behavior to switch from one tier to
another.
---------------------------------------------------------------------------

    \2769\ See CAT NMS Plan, supra note 5, at Section 11.1(d).
---------------------------------------------------------------------------

d. Differential CAT Fees Across Market Participants
    In the Notice, the Commission discussed the funding model proposed
in the Plan, which is a bifurcated funding model in which costs are
first allocated between the group of all broker-dealers and the group
of all Execution Venues, then within these groups by market activity
level.\2770\ The Commission discussed its preliminary belief that the
bifurcated funding model proposed in the Plan almost certainly would
result in differential CAT costs between Execution Venues because it
will assess fees differently on exchanges and ATSs. First, message
traffic to and from an ATS would generate fee obligations on the
broker-dealer that sponsors the ATS, while exchanges would incur almost
no message traffic fees.\2771\ Second, broker-dealers that internalize
off-exchange order flow, generating off-exchange transactions outside
of ATSs, would face a differential funding model compared to ATSs and
exchanges.\2772\ Specifically, broker-dealers internalizing orders
would only pay fees based on message traffic, whereas orders routed to
ATSs and exchanges would lead to broker-dealer fees based on message
traffic and ATS or exchange fees based on market share. If these fees
are even partially passed on to customers, then the cost differentials
that result might create incentives for broker-dealers to route order
flow to those broker-dealers who internalize in order to minimize
costs, creating a potential conflict of interest with broker-dealers'
investor customers.
---------------------------------------------------------------------------

    \2770\ See Notice, supra note 5, at 30735-36.
    \2771\ See CAT NMS Plan, supra note 5, at Section 11.3.
    \2772\ Id.
---------------------------------------------------------------------------

    In addition, the Commission discussed its preliminary belief that
the funding model shifts broker-dealer costs associated with the
Central Repository to all broker-dealers and away from Options Market
Makers. The Plan provides that broker-dealers would not report their
options quotations, while equity market makers would report their
equity quotations to the Central Repository. This differential
treatment of market making quotes would affect funding costs by (a)
decreasing the number of messages that must be reported and stored by
Options Market Makers, and (b) charging broker-dealers that do not
quote listed options a higher share of broker-dealer-assessed CAT fees
than they would if Options Market Makers' quotes were included in the
allocation of fees.
    Although this differential treatment would marginally increase the
cost of providing other broker-dealer services relative to options
market making, the Commission discussed its belief that this would not
materially affect a market participant's willingness to provide broker-
dealer services other than options market making because (a) many
market participants participate in both equities and options markets,
and (b) broker-dealers participating in equity markets have significant
infrastructure in place for serving that market and switching costs to
participate in options market making are high.

    In the Notice, the Commission also discussed the allocation of
costs between the Execution Venues and the other Industry Members
(i.e., broker-dealers) and solicited comment on alternative funding
models.\2773\ Specifically, the Commission noted that the CAT NMS Plan
does not detail the proportions of fees to be borne by Execution Venues
versus Industry Members. The Notice also pointed out that Execution
Venues would be tiered by market share to determine their fees while
Industry Members would be tiered by message traffic. In its analysis,
the Commission noted that assessing CAT costs on market participants by
message traffic may have the benefit of aligning market participants'
incentives with the Participants' stated goal of minimizing costs. The
Commission also explained that while a broker-dealer's choice of
business model is likely to determine its level of message activity,
the majority of an exchange's message traffic is passive receipt of
quote updates.\2774\ Further, because quotes must be updated on all
exchanges when prices change, exchanges with low market share are
likely to have more message traffic (incurring CAT fees) per executed
transaction (generating revenue).\2775\ The Commission further
explained that bifurcated fee approaches, such as the one in the Plan,
may cause one Execution Venue to be relatively cheaper if Execution
Venues pass costs on to members and subscribers and may exacerbate
conflicts of interest for broker-dealers routing customer orders.
---------------------------------------------------------------------------

    \2773\ See Notice, supra note 5, at 30766-69.
    \2774\ Using MIDAS data, Commission Staff analyzed the number of
equity exchange proprietary feed messages and trades during the week
of October 12, 2015 and provided the results in the Notice. The
message per trade ratio varied across exchanges from 38.46 to
987.17, with a median of 57.21.
    \2775\ The Commission's data analysis as reported in the Notice
confirmed this for the smallest exchanges. Except for the smallest
exchanges, the trade-to-message ratios range from about 0.016 trades
for every quote update to about 0.026 trades for every quote update
and appear constant across market share levels. However, the
smallest exchanges by market share have only about 0.001 trades for
every quote update to about 0.009 trades for every quote update.
---------------------------------------------------------------------------

    The Commission received comments that inform its analysis of
differential fees across market participants, particularly focusing on
the allocation to Participants versus broker-dealers. One commenter
questioned why Participants were tiered by market share while broker-
dealers were treated differently (by message traffic), and noted this
could place a larger burden on market makers of liquid securities. The
commenter explicitly stated that it is not suggesting that market-share
tiers are wrong, but believes there should be a reason why Participant
tiers are based on one metric (market share) while broker-dealer tiers
are based on another metric (message traffic).\2776\ The Commission
received several comments on issues related to cost differentials
between Participants and broker-dealers that were not discussed in the
Notice. One commenter noted that the profits from the fees would only
be distributed among the Participants and suggested these should be at
least partially returned to broker-dealers.\2777\ Another commenter was
concerned that SROs would use CAT profits to fund other SRO
operations.\2778\ There were comments regarding the lack of
transparency over fee calculations and metrics used to determine tiers,
as well as the determination of the allocation split between broker-
dealers and Participants--all of which increases uncertainty in cost
estimates.\2779\ Finally, there were a number of comments that
described the potential for a conflict of interest in the allocation of
fees, and discussing the relative burden of funding on broker-dealers
to SROs, estimating that at least 88% of costs will be borne by broker-
dealers.\2780\
---------------------------------------------------------------------------

    \2776\ SIFMA Letter at 16-17.
    \2777\ KCG Letter at 5.
    \2778\ DAG Letter at 5.
    \2779\ SIFMA Letter at 16; FSI Letter at 6.
    \2780\ KCG Letter; SIFMA Letter; Fidelity Letter; FSR Letter;
DAG Letter; Data Boiler Letter; Wachtel Letter; FSI Letter; STA
Letter.
---------------------------------------------------------------------------

    There were no comments related to the economic analysis regarding a
double charging of ATSs.\2781\ In addition, there were no comments
regarding the economic analysis related to differences in costs between
option market makers and equity market makers.\2782\
---------------------------------------------------------------------------

    \2781\ See Section VI.G.1.a.(1)A., supra.
    \2782\ While FIF recommends exempting equity market makers, they
did not provide information that suggests revising the Commission's
OMM vs equity market maker analysis. See FIF Letter at 65-66.
Specifically, the letter says that equity market makers would get
the same benefits as OMMs for the quotes that are not paired with
orders.
---------------------------------------------------------------------------

    The Participants' response contains information that is relevant to
the economic analysis with regards to transparency in funding and the
allocation of costs. Specifically, the Participants commented that the
Plan provides the Advisory Committee with the right to receive
information concerning the operation of the CAT,\2783\ and that the
Participants plan to provide the Advisory Committee with minutes of
Operating Committee meetings.\2784\ The response addressed the concerns
over transparency in decision making; however, the concerns regarding
uncertainty in the metrics used to determine tiers and the final cost
allocation split will not be resolved until the Plan Processor is
chosen.
---------------------------------------------------------------------------

    \2783\ See CAT NMS Plan, supra note 5, at Section 4.13(d)-(e).
    \2784\ Response Letter I at 17.
---------------------------------------------------------------------------

    The Participants' supplemental response also contained information
that is relevant to the economic analysis with respect to second order
effects of the funding model. With regards to determining fees via
message traffic for broker-dealers and market share for Participants,
the Participants noted that message traffic is a key component of CAT
operating costs, and that message traffic is strongly correlated with
broker-dealer size. However, there is little correlation between
message traffic and Execution Venue size, so charging large and small
Execution Venues with similar message traffic would be inequitable. The
Plan treats ATSs in the same manner as exchanges because their business
models and anticipated burden on CAT are similar.\2785\
---------------------------------------------------------------------------

    \2785\ Response Letter II at 11, 13.
---------------------------------------------------------------------------

    On this topic, the Participants proposed one modification to the
plan. The Participants proposed to amend the manner in which market
share will be calculated for a national securities association that has
trades reported by its members to its trade reporting facility or
facilities for reporting transactions effected otherwise than on an
exchange in NMS Stock or OTC Equity Securities. For such an
association, its market share for purposes of the funding model would
not include the share volume reported to the national securities
association by an ATS, as such share volume will be included in the
market share calculation for that ATS.\2786\
---------------------------------------------------------------------------

    \2786\ Response Letter II at 12.
---------------------------------------------------------------------------

    The Participants also responded that they expect to operate the CAT
on a break-even basis--that is, the fees imposed and collected would be
intended to cover CAT costs and an appropriate reserve for CAT costs,
and any surpluses would be treated as an operational reserve to offset
fees in future payment. In addition, the Participants subsequently
stated that the CAT LLC will seek to qualify for tax exempt status as a
``business league.'' \2787\
---------------------------------------------------------------------------

    \2787\ Participants' Letter at 1; Section IV.B.4, supra.
---------------------------------------------------------------------------

    With regards to fee transparency, the Participants noted that the
details regarding the tiers are important considerations and are
actively developing the tiers. Once the Plan

Processor is selected, the Operating Committee will work with the
Processor to finalize the tiers, and broker-dealers and other
participants will have the opportunity to comment on the proposal as
part of the approval process for an immediately effective rule
filing.\2788\
---------------------------------------------------------------------------

    \2788\ Response Letter II at 14. See supra note 1709.
---------------------------------------------------------------------------

    With regards to the allocation of costs between Participants and
broker-dealers and the potential for a conflict of interest in
determining this allocation, the Participants noted that the proposed
funding model is designed to recover costs associated with creating,
implementing, and operating CAT as opposed to addressing costs of
compliance, which might be incurred regardless of the funding model. In
addition, there are over 100 times more broker-dealers expected to
report to CAT than Participants. Therefore, the 88% aggregate cost
figure quoted in the comments is less than what broker-dealers would be
expected to pay in aggregate on a per-CAT reporter basis.\2789\ With
regard to the potential conflict of interest, the Participants noted
that broker-dealers and the public will have the opportunity to comment
on fees, the SEC will be required to evaluate the fees for consistency
with the Exchange Act, the funding proposal expects that CAT will
operate on a break-even basis, and Participants are prohibited from
using regulatory fees for commercial purposes.\2790\
---------------------------------------------------------------------------

    \2789\ Response Letter II at 10-11.
    \2790\ Response Letter II at 17.
---------------------------------------------------------------------------

    The Commission is revising its economic analysis in light of
comments, the Participants' response, and Plan modifications. First,
the Commission recognizes the validity of the comment that the funding
tiers would place a larger burden on market makers of liquid securities
relative to illiquid securities and place a lower burden on liquidity
takers relative to those who provide liquidity. This could increase the
incentive to broker-dealers to transact in more illiquid securities and
reduce the incentive to provide liquidity. In response to the comment
seeking the rationale behind the bifurcation in the funding model, the
Commission notes that the Notice provided a rationale that the
Commission continues to believe makes economic sense. Specifically, as
summarized above, the Commission continues to believe that because
message traffic is passive for exchanges and a business decision for
Broker-Dealers, the bifurcated funding model will help align the
incentives of market participants with the Participants' stated goal of
minimizing costs. More broadly, the Commission continues to believe
that because the CAT NMS Plan does not detail the proportions of fees
to be borne by Execution Venues versus Industry Members, its economic
analysis contains uncertainty regarding the differential fees to be
borne by Execution Venues versus Industry Members.
    With regards to the distribution of profits among SROs, the
Commission is revising its economic analysis to incorporate the
clarification in the Plan to the effect that profits from fees will go
toward funding future costs instead of being redistributed among the
SROs except in the two instances described above, as well as the
modification to the Plan that reflects that the CAT LLC will seek to
qualify for tax exempt status as a ``business league.'' \2791\ Broadly
speaking, the Commission had been concerned about the competitive
effects of distributing profits equally among SROs because, in
profitable years, an equal distribution of profits would advantage
smaller exchanges (larger exchanges in the case of losses). However,
with the clarification and modification to the Plan, the Commission
believes there will be little or no competitive effects resulting from
distributions among SROs. The Commission also believes that this
clarification and modification address commenter concerns about the
distribution of CAT profits.
---------------------------------------------------------------------------

    \2791\ Participants' Letter at 1.
---------------------------------------------------------------------------

    The Commission is updating its analysis of the differential fees on
exchanges and ATSs to incorporate Plan modifications that would change
the way national securities associations are treated in the Funding
Model. The modified Plan would no longer double-count ATS volume as
share volume for the purposes of placing both ATSs and FINRA in tiers
in the Funding Model. However, because of the uncertainty in the
ultimate Funding Model, the Commission recognizes that this
modification may not impact the fees paid by either ATSs or FINRA and
may not alleviate any fee differentials between ATSs and exchanges. As
described earlier in this Section, these fee differentials may arise
because message traffic to and from an ATS would generate fee
obligations on the broker-dealer that sponsors the ATS, while exchanges
incur almost no message traffic fees.\2792\
---------------------------------------------------------------------------

    \2792\ See CAT NMS Plan, supra note 5 at Section 11.3.(b):
(``For the avoidance of doubt, the fixed fees payable by Industry
Members pursuant to this paragraph shall, in addition to any other
applicable message traffic, include message traffic generated by:
(i) An ATS that does not execute orders that is sponsored by such
Industry Member; and (ii) routing orders to and from any ATS
sponsored by such Industry Member.'') The Commission notes that
exchange broker-dealers would be subject to message traffic fees as
Industry Members under the Plan. However, the Commission notes that
based on its analysis of OATS data from September 15-19, 2014, these
broker-dealers are minor contributors to overall message traffic,
accounting for less than 0.03% of OATS ROEs.
---------------------------------------------------------------------------

    In addition, the Commission notes that other over-the-counter
volume, such as occurs when orders are executed off-exchange against a
broker-dealer's inventory, will still be assessed share volume fees
while the message traffic that resulted in the executions will also be
subject to fees through the broker-dealers that had order events
related to the transactions. This contrasts to executions that occur on
exchanges, where the venue that facilitates the execution does not pay
fees for message traffic that led to the execution. This difference in
treatment could still result in costs that are passed on to investors
because broker-dealers have the incentive to route orders in a way that
results in less order flow to those who pay higher CAT fees.
    The Commission is not changing the economic analysis with respect
to the allocation of costs between SROs and Broker-Dealers. As
discussed in detail previously,\2793\ in response to the comments that
suggested that Plan allocates 88% of the costs to broker-dealers, the
Commission believes that the 88% figure cited is in reference to
compliance costs, which are not ``allocated'' by the Plan. Fees to pay
for the maintenance and operation of the Central Repository will be
allocated via the funding model, and the current allocation of fees
between broker-dealers and exchanges has not been determined.
---------------------------------------------------------------------------

    \2793\ See Section IV.E, infra.
---------------------------------------------------------------------------

    The Commission is updating the Economic Analysis to reflect some
improvements in financial transparency as a result of amendments to the
Plan. Specifically, the Commission's amendment to the Plan to require
that CAT LLC financial statements be prepared in accordance with GAAP
and audited by an independent public accounting firm may substitute to
a certain extent for the added financial transparency sought by
commenters.\2794\ Additionally, as per the Participants' response, all
meeting minutes will be made available, and in addition, the Funding
Model will be filed with the Commission and subject to public
comment.\2795\ However, the Commission

continues to recognize uncertainty in the ultimate allocation of fees.
---------------------------------------------------------------------------

    \2794\ See CAT NMS Plan, supra note 5, at Section 9.2; see also
Section IV.B.4; Participants' Letter II.
    \2795\ See supra note 1709 for further details on fee proposals.
---------------------------------------------------------------------------

G. Efficiency, Competition, and Capital Formation

    In determining whether to approve the CAT NMS Plan, and whether the
Plan is in the public interest, Rule 613 requires the Commission to
consider the impact of the Plan on efficiency, competition and capital
formation.\2796\
---------------------------------------------------------------------------

    \2796\ 17 CFR 242.613(a)(5); see also 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    In the Notice, the Commission's analysis supported the preliminary
belief that the Plan generally promotes competition.\2797\ However, the
Commission recognized that the Plan could increase barriers to entry
because of the costs to comply with the Plan. Further, the Commission's
analysis in the Notice identified several limitations to competition,
but stated that the Plan contains provisions to address some
limitations and Commission oversight can also address the
limitations.\2798\
---------------------------------------------------------------------------

    \2797\ See Notice, supra note 5, at 30738.
    \2798\ Id. at 30738-46.
---------------------------------------------------------------------------

    The Commission's analysis in the Notice also supported the
preliminary belief that the Plan would improve the efficiency of
regulatory activities and enhance market efficiency by deterring
violative activity that harms market efficiency. Further, the analysis
in the Notice supported the Commission's preliminary belief that the
Plan would have modest positive effects on capital formation and that
the threat of a security breach at the Central Repository would be
unlikely to significantly harm capital formation.\2799\
---------------------------------------------------------------------------

    \2799\ Id. at 30748-50.
---------------------------------------------------------------------------

    At the same time, however, the Notice stated that the significant
uncertainties discussed elsewhere in its economic analysis also affect
the Commission's analysis of efficiency, competition, and capital
formation.\2800\ Additionally, the Commission recognized that the
Plan's likely effects on competition, efficiency and capital formation
were dependent to some extent on the performance and decisions of the
Plan Processor and the Operating Committee in implementing the Plan,
and thus there was necessarily some further uncertainty in the
Commission's analysis. Nonetheless, the Notice stated that the
Commission preliminarily believed that the Plan contained certain
governance provisions, as well as provisions relating to the selection
and removal of the Plan Processor, that mitigate this concern regarding
uncertainty by promoting decision-making that could, on balance, have
positive effects on competition, efficiency, and capital formation.
---------------------------------------------------------------------------

    \2800\ Id. at 30738. As examples, the Commission recognized that
the uncertainties around the improvements to data qualities could
affect the conclusions on efficiency and the uncertainty regarding
how the Operations Committee allocated the fees used to fund the
Central Repository could affect the conclusions on competition.
---------------------------------------------------------------------------

    Overall, after considering comments, the Participants' response,
and modifications to the Plan, the Commission is updating and revising
its economic analysis of competition, efficiency, and capital
formation. However, the revisions in the analysis do not impact the
Commission's broad conclusions. The Commission continues to believe
that the Plan generally will promote competition, improve the
efficiency of regulatory activities, promote market efficiency, and
have modest positive effects on capital formation. Further, the
Commission continues to recognize the significant uncertainty and that
certain provisions of the Plan could promote efficient decisions and
implementation and could provide competitive incentives to the Plan
Processor to promote good performance.
1. Competition
a. Market for Trading Services
    In the Notice, the Commission analyzed the CAT NMS Plan's likely
economic effects on competition in the market for trading services, as
compared to the Baseline of the competitive environment without the
Plan. The Commission stated that it preliminarily believed that the
Plan would not place a significant burden on competition for trading
services.\2801\ The Commission also examined the effect of the funding
model on competition in the market for trading services, including off-
exchange liquidity suppliers and ATSs. In addition, the Commission
considered the effect of implementation and ongoing costs of the Plan,
whether particular elements of the Plan could hinder competition, and
the effect of enhanced surveillance on competition in the market for
trading services. The Commission recognized the risk that the Plan
would have negative effects on competition and increase the barriers to
entry in this market, but discussed how the Plan provisions and
Commission oversight could mitigate these risks.
---------------------------------------------------------------------------

    \2801\ Id. at 30739-42.
---------------------------------------------------------------------------

    The Commission discussed how the market for trading services--which
is served by exchanges, ATSs, and liquidity providers (internalizers
and others)--relies on competition to supply investors with execution
services at efficient prices. These trading venues, which compete to
match traders with counterparties, provide a framework for price
negotiation and disseminating trading information. The Commission
observed that, since the adoption of Regulation NMS in 2005, there has
been a shift in the market share of trading volume among trading
venues. From 2005 to 2013, there was an increase in the market share of
newer national securities exchanges and a decline in market share on
NYSE. In addition, the proportion of NMS Stocks trading off-exchange
(which includes both internalization and ATS trading) increased.
    The Commission noted that the Plan examines the effect of the CAT
NMS Plan on the market for trading services primarily from the
perspective of the exchanges. The Plan asserts that distribution of
regulatory costs incurred by the Plan would be distributed according to
``the Plan's funding principles,'' calibrated to avoid placing ``undue
burden on exchanges relative to their core characteristics,'' and would
thus not cause any exchange to be at a relative ``competitive
disadvantage in a way that would materially impact the respective
Execution Venue marketplaces.'' \2802\ Likewise, the Plan asserts that
its method of cost allocation would avoid discouraging entry into the
Participant community because a potential entrant, like an ATS, would
``be assessed exactly the same amount [of allocated CAT-related fees]
for a given level of activity'' both before and after becoming an
exchange.\2803\
---------------------------------------------------------------------------

    \2802\ See CAT NMS Plan, supra note 5, at Appendix C, Section
B.8(a)(i); see also id. at Section 11.2 (for a discussion of the
Plan's funding principles).
    \2803\ See CAT NMS Plan, supra note 5, at Appendix C, Section
B.8(a)(i).
---------------------------------------------------------------------------

    In addition, in its final analysis described below, the Commission
examines each of the issues in relation to competition in the market
for trading services and revises its economic analysis in response to
comments, the Participants' response, and modifications to the Plan.
(1) Funding
    The Commission noted that the Operating Committee will fund the
Central Repository by allocating its costs across exchanges, FINRA,
ATSs (``Execution Venues'') and broker-dealers (``Industry Members''),
and will decide which proportion of costs would be funded by exchanges,
FINRA, and ATSs and which portion would be funded by broker-dealers.
The Commission observed that the Plan does not specify how the
Operating Committee would select the method of allocation. The
Commission believed

that any impacts of such fees on competition in the market for trading
services will manifest either through the model for the fees itself or
through the later allocation of the fees across market participant
types, across equity or options exchanges, or within market participant
types and markets, through the levels of fees paid by each tier.
A. Funding Model
    In the Notice, the Commission discussed its preliminary belief that
the structure of the funding model could provide a competitive
advantage to exchanges.\2804\ Specifically, the Commission noted that
the Plan states that an entity would be assessed exactly the same
amount for a given level of activity whether it acted as an ATS or an
exchange. However, FINRA would be charged fees based on the market
share of off-exchange trading. ATSs, which are FINRA members, would
presumably pay a portion of the FINRA fee through their broker-dealer
membership fees. In addition, ATSs would pay a fee for their market
share, which is a portion of the total off-exchange market share.
Therefore, ATS volume would effectively be charged once to the broker-
dealer operating the ATS and a second time to FINRA, which would result
in ATSs paying more than exchanges for the same level of activity.
Ultimately, if the funding model disadvantages ATSs relative to
exchanges, trading volume could migrate to exchanges in response, and
ATSs could have incentives to register as exchanges as well.
Additionally, the Commission discussed its belief that the
Participation Fee \2805\ could discourage new exchange entrants or the
registration of an ATS as an exchange, increasing the barriers to entry
to becoming an exchange. However, the Commission also explained that
because the funding model seems to charge ATSs more for their market
share than exchanges, ATSs could pay relatively less for their market
share as an exchange than as an ATS, countering this barrier to entry
depending on the magnitudes of the two fee types.
---------------------------------------------------------------------------

    \2804\ See Notice, supra note 5, at 30740.
    \2805\ The Participation Fee would be determined by the
Operating Company and paid by national securities exchanges and
national securities associations currently registered with the
Commission (``Participants'') to fund costs incurred in creating,
implementing and maintaining the CAT.
---------------------------------------------------------------------------

    As described earlier,\2806\ the Participants propose to amend the
manner in which market share will be calculated for a national
securities association that has trades reported by its members to its
trade reporting facility or facilities for reporting transactions
effected otherwise than on an exchange in NMS Stock or OTC Equity
Securities.\2807\ For such an association, its market share for
purposes of qualifying for a particular tier in the funding model would
not include the share volume reported to the national securities
association by an ATS, as such share volume will be included in the
market share calculation for that ATS.\2808\ As discussed above in
Section IV.F, the Commission is modifying the Plan as the Participants
suggested.
---------------------------------------------------------------------------

    \2806\ See Section V.F.5.d, supra.
    \2807\ Response Letter II at 12.
    \2808\ Response Letter II at 12.
---------------------------------------------------------------------------

    This modification reduces the potential for the Plan to charge ATSs
more than similarly situated exchanges, but it may not alleviate all
the fee differentials between ATSs and exchanges. As described above,
\2809\ these fee differentials may arise because message traffic to and
from an ATS would generate fee obligations on the broker-dealer that
sponsors the ATS, while exchanges incur almost no message traffic fees.
Even with this modification, the Commission continues to believe that
the Funding Model could provide a competitive advantage to exchanges
over ATSs. However, the Commission is approving the Plan without
further modification for the reasons discussed in Section IV.F, above.
---------------------------------------------------------------------------

    \2809\ See Section V.F.5.d, supra.
---------------------------------------------------------------------------

B. Allocation of Voting Rights and Fees
    In the Notice, the Commission recognized that the potential for a
burden on competition and effects on competitors in the market for
trading services could arise from provisions relating to the allocation
and exercise of voting rights.\2810\ The Commission noted that the
potential for concentration of influence over vote outcomes arises from
proposed provisions to give one vote to each Plan Participant[thinsp]in
an environment where some Participants are Affiliated SROs. Indeed,
supermajority approval could be achieved through four of the 10 groups
of Affiliated SROs and individual SROs, and majority approval could be
achieved with just three such groups or individual SROs.\2811\ For
example, the Participant groups with options exchanges could have the
incentive to allocate a disproportionately low level of fees for
options market share than for equity market share. The Commission noted
that such an allocation could disadvantage competing Participants with
only equities exchanges.
---------------------------------------------------------------------------

    \2810\ See Notice, supra note 5, at 30740-41.
    \2811\ At the time of the Notice, the twenty SROs that were
Participants in the CAT NMS Plan included five sets of affiliated
SROs (New York Stock Exchange LLC, NYSE Arca, Inc., and NYSE MKT LLC
(the ``NYSE Group''); The NASDAQ Stock Market LLC, NASDAQ OMX BX,
Inc., and NASDAQ OMX PHLX LLC (the ``NASDAQ Group''); BATS Exchange,
Inc., BATS Y-Exchange, Inc., EDGX Exchange, Inc., and EDGA Exchange,
Inc. (the ``BATS Group''); Chicago Board Options Exchange, Inc. and
C2 Options Exchange, Inc. (the ``Chicago Options Group'');
International Securities Exchange, LLC, ISE Gemini, LLC, and ISE
Mercury, LLC (the ``ISE Group''); and five independent SROs
(National Stock Exchange, Inc.; Chicago Stock Exchange, Inc.; BOX
Options Exchange LLC; Miami International Securities Exchange LLC;
and Financial Industry Regulatory Authority, Inc.). The BATS Group
would have had four votes, the NYSE Group, the NASDAQ Group and the
ISE Group each would have had three votes, and the Chicago Options
Group would have had two votes. See CAT NMS Plan, supra note 5, at
Appendix C, Section D.11(b). A majority approval would have required
eleven votes. This could have included as few as four of the SROs
and sets of affiliated SROs: The affiliated SROs that would have had
four votes, two sets of affiliated SROs that would have had three
votes, and one other SRO or set of affiliated SROs. Supermajority
approval would have required fourteen votes. This could have
included as few as five SROs and sets of affiliated SROs: The
affiliated SROs that would have had four votes, three sets of
affiliated SROs with three votes, and any additional SRO. Note also
that as few as two sets of affiliated SROs could have blocked a
Supermajority approval by casting seven ``no'' votes: The affiliated
SROs with four votes and any one of the affiliated SROs with three
votes.
---------------------------------------------------------------------------

    The Commission also noted that the inclusion of all exchanges on
the Operating Committee could give the Plan Participants opportunities
and incentives to share information and coordinate strategies in ways
that could reduce the competition among exchanges or could create a
competitive advantage for exchanges over venues for off-exchange
trading.\2812\ However, the Commission stated that it preliminarily
believed that certain provisions of the Plan would limit these
potential burdens on competition. In particular, the Plan includes
provisions designed to limit the flow of information between the
employees of the Plan Participants who serve as members of the
Operating Committee and other employees of the Plan Participants.\2813\
---------------------------------------------------------------------------

    \2812\ The Commission also noted that FINRA could represent the
perspectives of the off-exchange portion of the market, but FINRA
would have only one vote and exchanges would have twenty.
    \2813\ See CAT NMS Plan, supra note 5, at Section 9.6; see also
Section III.24, supra.
---------------------------------------------------------------------------

    Additionally, the Commission agreed with the Plan's assessment that
some governance features of the Plan will limit adverse effects on
competition in the market for trading services. These include
provisions limiting the incentive and ability of Operating Committee
members to serve the private interests of their employers, such as the
rules regulating conflicts of interest. Moreover, the Commission
explained

that it may summarily abrogate and require the filing of Plan
amendments that establish or change a fee in accordance with Rule
608(a)(1) and review such amendments in accordance with Rule 608(b)(2)
of Regulation NMS, if it appears to the Commission that such action is
necessary or appropriate in the public interest, for the protection of
investors, or the maintenance of fair and orderly markets, to remove
impediments to, and perfect the mechanisms of, a national market system
or otherwise in furtherance of the purposes of the Act.\2814\ In such a
case, if the Commission chooses to approve such amendment, it would be
by order and with such changes or subject to such conditions as the
Commission may deem necessary or appropriate.\2815\
---------------------------------------------------------------------------

    \2814\ 17 CFR 242.608(a)(1); 608(b)(2); 608(b)(3)(i); and
608(b)(3)(iii). Pursuant to Rule 608(b)(2) of Regulation NMS, the
Commission shall approve such amendment, with such changes or
subject to such conditions as the Commission may deem necessary or
appropriate, if it finds that such amendment is necessary or
appropriate in the public interest, for the protection of investors
and the maintenance of fair and orderly markets, to remove
impediments to, and perfect the mechanisms of, a national market
system, or otherwise in furtherance of the purposes of the Act.
Approval of the amendment shall be by Commission order.
    \2815\ See Notice, supra note 5, at 30741; supra note 1709 for
further details on fee proposals.
---------------------------------------------------------------------------

    Several commenters provided information relevant to the
Commission's analysis of the potential impact of the allocation of fees
on competition. In particular, three commenters suggested that there
was an inherent conflict of interest as the SROs were the only ones
with votes, yet will be involved in the decision to allocate funding
responsibility across SROs and broker-dealers.\2816\ Such comments
relate to the influence of voting rights on the allocation of fees to
exchanges (SROs) compared to ATSs and internalizers (broker-dealers).
The Commission notes also that certain EMSAC discussions recognized
conflicts in the market for trading services.\2817\
---------------------------------------------------------------------------

    \2816\ Fidelity Letter at 5, SIFMA Letter at 27 and KCG Letter
at 4.
    \2817\ See ``Recommendations Relating to Trading Venues
Regulation'', Equity Market Structure Advisory Committee (``EMSAC'')
Trading Venues Regulation Subcommittee, April 19, 2016, at 1,
available at https://www.sec.gov/spotlight/emsac/emsac-trading-venues-subcommittee-recommendations-041916.pdf (describing four
recommendations relating to the regulation of trading venues); see
also EMSAC April 26, 2016 Transcript, available at https://www.sec.gov/spotlight/emsac/emsac-042616-transcript.txt.
---------------------------------------------------------------------------

    The Commission believes that the concerns expressed in the comments
and the EMSAC discussions are consistent with the Commission's
discussion and analysis of the potential impacts in the Notice. The
Commission recognized in the Notice that bloc voting could create a
competitive advantage for exchanges over trading venues for off-
exchange trading. The commenters did not address the Commission's
discussion in the Notice of certain provisions in the Plan that would
limit potential burdens on competition or of the role of the Commission
in approving NMS Plan fee filings. The Commission notes that changes in
the number of exchanges and in exchange groups since the Notice \2818\
affect the potential influence of bloc voting because fewer SRO groups
will be needed for approval or to block an approval.\2819\ Nonetheless,
the Commission continues to believe that provisions in the Plan and
Commission oversight of the allocation of fees could mitigate these
concerns.\2820\
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    \2818\ Since the time of the Notice, the Commission approved a
new exchange, the Investors' Exchange, LLC (``IEX''), which is an
independent SRO, and two sets of affiliated SROs merged, the NASDAQ
Group and the ISE Group.
    \2819\ The Plan now includes twenty-one SROs with votes on the
Operating Committee, including four sets of affiliated SROs and six
independent SROs. Compared to the time of the Notice (see supra note
2811), the number of votes required for majority or Supermajority
approval remains the same, but the number of SRO blocks required for
approval or to block an approval has changed. Now, the NASDAQ-ISE
Group has six votes instead of separate blocs of three votes each. A
majority approval still requires eleven votes. This could include as
few as three of the SROs and sets of affiliated SROs instead of the
former four: The affiliated SROs that have six votes, the affiliated
SROs that have four votes, and one other SRO or set of affiliated
SROs. Supermajority approval still requires fourteen votes. This
could include as few as four SROs and sets of affiliated SROs
instead of the former five: The affiliated SROs that have six votes,
the affiliated SROs that have four votes, the affiliated SROs that
have three votes, and any additional SRO or group of affiliated
SROs. Note also that, now, as few as two sets of affiliated SROs,
instead of the former three, could block a Supermajority approval by
casting eight ``no'' votes: The affiliated SROs with six votes, and
the affiliated SRO with two votes.
    \2820\ See supra note 1709 for further details on fee proposals.
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(2) Costs of Compliance
    In the Notice, the Commission explained that because all
Participants but one compete in the market for trading services, the
ability of affiliates to vote as a group could in principle allow a few
large Participant groups to influence the outcome of competition in the
market for trading services by making various decisions that can alter
the costs of one set of competitors more than another set.\2821\ In
addition, the Commission discussed the fact that the Plan calls for
profits to be distributed equally among Participants, which could
advantage smaller exchanges during profitable years and disadvantage
smaller exchanges during loss years.\2822\
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    \2821\ See Notice, supra note 5, at 30741-42.
    \2822\ Generally, smaller exchanges will have smaller fees. So,
if there are profits, and each exchange receives the same nominal
reimbursement amount, then the percentage reduction in fees from the
redistributed profit will be greater for smaller exchanges, as they
are starting with a smaller denominator in the ratio. This does not
speak to the relative burden of compliance costs, however, which may
still disadvantage smaller exchanges.
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    The Commission explained that generally, smaller competitors could
have implementation and ongoing costs of compliance that are
disproportionate relative to their size. It noted that, to lessen the
impact of funding the Central Repository on smaller exchanges and ATSs,
the Plan would apply a tiered funding model that charges the smallest
exchanges and ATSs the lowest fees. Likewise, the Plan would apply a
tiered funding model that would charge the smallest broker-dealers,
including liquidity suppliers, the lowest fees. However, the Commission
noted that the Plan does not indicate whether off-exchange liquidity
providers would pay fees similar to similarly-sized ATSs and exchanges.
This is important because, as described earlier, broker-dealers
internalizing orders off exchanges would only be allocated fees based
on message traffic, whereas orders routed to ATSs and exchanges lead to
broker-dealer fees based on message traffic and ATS or exchange fees
based on market share. If these fees are even partially passed on to
customers, then the cost differentials that result might create
incentives for broker-dealers to route order flow to those broker-
dealers who internalize in order to minimize costs, creating a
potential conflict of interest with broker-dealers' investor
customers.\2823\
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    \2823\ See Section V.F.5.d, supra.
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    The Commission discussed the fact that the Plan provides that the
Technical Specifications will not be finalized until after the
selection of a Plan Processor, which will not occur until after any
decision by the Commission to approve the Plan. The Commission
recognized that the costs of compliance associated with future
technical choices or the selection of the Plan Processor could
exacerbate the relative cost differential across competitors. However,
the Commission preliminarily believed that the governance provisions of
the Plan and Commission oversight could help to mitigate such effects
in the market for trading services.
    The Commission received several comments relevant to its analysis
of the

potential impact of the costs of compliance on competition in the
market for trading services. Specifically, as described earlier,\2824\
several commenters had concerns about the distribution of CAT profits
among SROs, though none specifically discussed the potential
differential impact on small versus large exchanges.\2825\ Further, the
concerns of commenters and the EMSAC discussed in the Allocation of
Fees section above also have implications for the Commission's
analysis.
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    \2824\ Id.
    \2825\ SIFMA Letter at 19; KCG Letter at 5; DAG Letter at 5.
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    Regarding the distribution of CAT profits among SROs, as described
earlier,\2826\ the Participants responded with a clarification that
they expect to operate the CAT on a break-even basis and any surpluses
would be treated as an operational reserve to offset fees in future
payment. In addition, the Participants subsequently stated that the CAT
LLC will seek to qualify for tax exempt status as a ``business
league.'' \2827\
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    \2826\ See Section V.F.5.d, supra.
    \2827\ Participants' Letter at 1; Section IV.B.4, supra.
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    The Commission has considered the comments and the EMSAC discussion
regarding voting blocs and believes that these concerns do not alter
the analysis in the Notice for the same reasons as described
above.\2828\ Overall, the Commission continues to believe that the
ability of affiliates to vote as a group could in principle allow a few
large Participant groups to influence the outcome of competition in the
market for trading services by making various decisions that alter the
costs of one set of competitors more than another set, but that
Commission oversight and the governance provisions of the Plan and
could help to mitigate these effects.\2829\ Also, in light of amendment
to the Plan to reflect that the CAT LLC will seek to qualify for tax
exempt status as a ``business league,'' \2830\ the Commission now
believes that neither CAT profits or losses should affect competition
in the market for trading services. The Commission maintains its
conclusions regarding the impact of compliance costs on competition in
the market for trading services, specifically, that compliance costs
may be relatively more burdensome for small SROs, but that the tiered
aspect of the funding model should serve to mitigate this. However, the
Commission notes that the funding model continues to have
uncertainties, and depends on the decisions of the Operating Committee.
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    \2828\ See Section V.G.1.a(1)B, supra.
    \2829\ See supra note 2814.
    \2830\ Participants' Letter at 1. See also Section V.F.5.d,
supra. for more detail on these modifications and the resulting
economic effects.
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(3) Enhanced Surveillance and Deterrence
    In the Notice, the Commission also discussed its preliminary belief
that the CAT NMS Plan could promote competition in the market for
trading services through enhanced surveillance and the deterrence of
violative behavior that could inhibit competition.\2831\ Should the
Plan deter violative behavior, passive liquidity suppliers, such as on
or off-exchange market makers could increase profits as a result of
reduced losses from others' violative behavior. This increase in
profits could encourage new entrants or could spark greater
competition, which would reduce transaction costs for investors. For
example, if the Plan facilitates surveillance improvements that deter
spoofing, the Commission stated that it could increase incentives to
provide liquidity and promote lower transaction costs for investors,
particularly in stocks that may lack a critical mass of competing
liquidity providers or that could be targets for violative trading
behavior.
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    \2831\ See Section V.E.2.c, supra, for a discussion of how the
CAT NMS Plan would enhance surveillance and deter violative
behavior.
---------------------------------------------------------------------------

    The Commission did not receive comments related to its economic
analysis on enhanced surveillance and deterrence of violative behavior
affecting competition in the market for trading services. Therefore,
the Commission continues to believe that the CAT NMS Plan could promote
competition in the market for trading services through enhanced
surveillance and the deterrence of violative behavior that could
inhibit competition.
b. Market for Broker-Dealer Services
    In the Notice, the Commission analyzed the effect of the CAT NMS
Plan on the market for broker-dealer services.\2832\ The Commission
stated that it preliminarily believed that the costs of broker-dealers'
compliance, particularly the cost to report order events to the Central
Repository, would differ substantially between broker-dealers and might
affect competition between smaller and larger broker-dealers. The
Commission also noted that broker-dealers that outsource regulatory
data reporting activities are expected to see their costs of regulatory
data reporting increase, while broker-dealers that insource may see a
decrease in their regulatory data reporting costs.\2833\ The Commission
stated that it preliminarily believed this dynamic might affect
competition between Outsourcers (that tend to be smaller) and
Insourcers (that tend to be larger), and might increase barriers to
entry in some segments of this market.
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    \2832\ The market for broker-dealer services is described in the
Notice, supra note 5, at 30742-44.
    \2833\ See Section V.E.2.c., supra.
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    The Notice discussed the Plan's assertion that it will have little
to no adverse effect on competition between large broker-dealers, and
will not materially disadvantage small broker-dealers relative to large
broker-dealers.\2834\ Regarding small broker-dealers, the Plan states,
``. . . [the allocation of costs to broker-dealers based on their
contribution to market activity] may be significant for some small
firms, and may even impact their business models materially . . .'' and
that the Participants were sensitive to the burdens the Plan could
impose on small broker-dealers, noting that such broker-dealers could
incur minimal costs under their existing regulatory reporting
requirements ``because they are OATS-exempt or excluded broker-dealers
or limited purpose broker-dealers.'' The Commission noted that the CAT
NMS Plan attempts to mitigate its impact on these broker-dealers by
proposing to follow a cost allocation formula that should charge lower
fees to smaller broker-dealers; \2835\ furthermore, Rule 613 provides
them additional time to commence their reporting requirements.
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    \2834\ See CAT NMS Plan, supra note 5, at Appendix C
B.8.(a)(ii).
    \2835\ See CAT NMS Plan, supra note 5, at Appendix C
B.7.(b)(iv)(C) (``The fees to be assessed at each tier are
calculated so as to recoup a proportion of costs appropriate to the
message traffic from firms in each tier. Therefore, larger broker-
dealers, generating the majority of message traffic, will be in the
higher tiers, and therefore be charged a higher fee. Smaller broker-
dealers with low levels of message traffic will be in lower tiers
and will be assessed a minimal fee for the CAT. The Participants
estimate that up to 75% of broker-dealers will be in the lower tiers
of the Funding Model.'').