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CAT: FINRA’s Exams, Deadlines Won’t Be a Virtual Breeze


Alexandra Hamer

Alexandra Hamer

Peter Gargone, chief executive of n-Tier, comments on FINRA’s latest decision on CAT reporting.

Trade compliance, regulatory operations, and technology managers at US broker-dealers will need to quickly cross their Ts and dot their I’s when it comes to documentation, data and IT if they want to pass muster with the Financial Industry Regulatory Authority’s examiners for reporting to the new Consolidated Audit Trail (CAT) and survive one of the trickiest milestones — interfirm linkage reporting– just around the corner.

FINRA’s examiners are starting to show up at broker-dealers’ doorsteps — virtually that is– checking up on the entire reporting lifecycle and its accuracy. As of June 22, large and small broker-dealers had to report information on trades executed for customers — including institutional investors– if they had already reported on the Order Audit Trail System (OATS), a predecessor to CAT. The date was July 20 for simple options trades. By December 13, all broker-dealers must start reporting on equities and options trades to the CAT, a single large database storing information on equities and options transactions executed on exchanges and over-the-counter. Of the estimated 1,700 brokers that must file CAT reports, about 800 have never even filed OATS reports. That is because OATS reporting only applies to FINRA members, whereas CAT reporting applies to all broker-dealers registered with the Securities and Exchange Commission. The goal of CAT is to help regulators track illegal or manipulative trades more quickly in the wake of May 2010 flash crash whose cause took months to unravel. Although the SEC agreed to the creation of CAT back in 2012, its launch was marred by multiple delays with FINRA finally replacing Thesys Technologies as the CAT processor in February 2019. The processor is responsible for developing and operating CAT.

Trade compliance managers at several broker-dealers who spoke with FinOps Report are worried FINRA will crack down heavily on consistent offenders — or those who make too many CAT reporting mistakes too often– with warnings and hefty penalties. FINRA has not disclosed the methodology it will use to fine firms who can’t get their reporting in order which means less than a five percent error rate for initial submissions and two percent error rate for resubmissions. Based on FINRA’s track record of fines for poor OATS reporting, broker-dealers should expect to fork over at least US$1 million for not meeting individual CAT thresholds. The threat of fines could help FINRA decommission OATS by mid-2021, if the broker-dealer community meets multiple litmus tests which include an average error rate of less than five percent over 180 days for initial submissions and of less than two percent for post-correction resubmissions. A single outlier won’t affect the thresholds, but too many will. Given the vast amount of data and the large number of trades that must be reported, the percentages are low. The three days firms have to correct any errors flagged by FINRA isn’t that much time. It actually comes down to less than two days because FINRA doesn’t provide feedback on any errors until 12 PM EST on T+1 (the day after the trade is executed) and firms don’t have to report trades until 8AM EST on T+1. All firms need are a few mistakes each day and within a few weeks the backlog of errors could easily become too difficult to fix quickly. Correcting mistakes on CAT reports is harder than on OATS reports. So far, broker-dealers seem to be on track to meet FINRA’s timeline to shutter OATS, but future deadlines could change the momentum. As of August 15, FINRA’s report card for CAT indicated an average error rate of 3.12 percent for equity events compared to 1.29 percent for options events based on 63.5 billion average weekly events for equities and 6.5 billion events for options.

FINRA’s examiners will expect broker-dealers complying with CAT reporting to answer the who, what, when, where, how and why in their written policies, procedures, controls, and governance, including the names of any reporting agents and third-party order management and smart-order routing systems along with their delivery models. “Policies and procedures refer to where the data is accessed from, how it is migrated to the reporting system, and who touches the data if anyone,” says Peter Gargone, chief executive of n-Tier, a New York-based software firm focused on data management for regulatory reporting. “Controls refer to how data completeness and accuracy are ensured to guarantee all of the right information is reported for events and in data fields.” The name and title of the person in charge of the CAT reporting process, likely a principal with a Series 24 license from FINRA, must be listed in the governance section along with the process used to escalate mistakes. As is typically the case with documentation, multiple departments will be involved. “Compliance departments should take charge of drafting the language explaining the policies, procedures and governance with input from the regulatory reporting department which will explain the sources of the data and data verification measures,” recommends Steven Goune, practice head of finance, risk, regulatory and compliance at Capital Markets Advisors, a regulatory compliance, risk and financial services IT consultancy in New York. “The process for data validation will likely be left to the IT department.”

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