By Bill Alpert

In the past year, fraud investigations at the U.S. Securities and Exchange Commission started to benefit from a trade-tracking system that took 15 years and cost $1 billion to build.

The SEC's new bosses are considering killing or impairing the system, calling it an unwarranted invasion of investors' privacy and too costly to operate.

The Consolidated Audit Trail, or CAT, gives the agency a timestamped record of every stock and option order as it makes its way from brokers to any of the country's roughly 50 exchanges and trading pools. It has already helped uncover insider-trading schemes and market manipulations that older surveillance systems would have missed.

Nobody likes a tattler, but that isn't the main reason that CAT is unpopular on Wall Street. In addition to paying development costs, the securities industry will be on the hook for the approximately $250 million required annually to operate CAT.

The Republican commissioners now calling the shots at the agency say CAT has too much personal information on investors, including names and birth year. "The CAT is a system that one would expect to find in a dystopian surveillance state, not the shining beacon for liberty and the free world," said commissioners Hester Peirce and Mark Uyeda in December.

Within weeks of Donald Trump's inauguration, those commissioners said Wall Street could start withholding personal information about its customers.

The newly confirmed SEC Chairman Paul Atkins might go further. He helped draft the conservative manifesto, Project 2025, which calls for the CAT's termination.

Some investor advocates see it otherwise. "The purpose of the CAT is to make it easier for the SEC to identify and catch crooks that are perpetrating market disruptions and manipulations," says Ben Schiffrin, the director of Securities Policy at the investor advocacy group Better Markets. "I can't understand why the industry wouldn't be a fan of the CAT."

There weren't a lot of objections when the SEC began thinking about creating market surveillance tools in the wake of the May 6, 2010, "Flash Crash," when the Dow Jones Industrial Average lost 1,000 points in 10 minutes.

It took months for the agency to reconstruct why stocks had plunged that day, then rebounded minutes later. Agency analysts had to cobble together trading records from many exchanges, as well as the off-exchange "dark pools" that didn't report on suspicious trades.

The SEC proposed CAT in 2012. It wanted to track every trade -- timestamped from its start as customer order, through submission to a trading venue, and then execution or cancellation.

It wasn't until 2016 that the SEC accepted the exchanges' plan for a system that would gather the audit data. The first contractor hired to build and run the system was fired, after missing deadlines. In 2019 a new CAT processing organization was formed by 25 exchanges and the brokerage industry's self-regulator Finra.

Even before the CAT had its full complement of data, the SEC credited it with busts. In 2023, an employee at the retirement manager TIAA pleaded guilty to front-running that firm's trades and reaping $47 million in illicit profits. Investigators traced his multiyear scheme in CAT data.

In November 2024, a Federal Reserve Bank examiner pleaded guilty to trading in stock and options, using nonpublic information about the banks he supervised. In December, a Florida trader settled without admitting SEC charges that he manipulated the bid and offer in thinly traded stocks, with "spoof" orders that he retracted after cashing out of previous positions.

CAT is now the world's biggest repository of securities data, with a trillion new reportable events flowing in a day.

But it has turned out to be far more expensive than expected.

When development began in 2017, Finra estimated that the CAT would cost $37 million to build and $50 million a year to run. Development costs have since topped $1 billion. Annual operating costs are expected to approach $250 million in 2025 -- 73% going to Amazon.com for cloud hosting -- and are growing 10% to 15% a year.

"The costs to the industry just keep going up," says Thomas Jordan, an attorney who chairs the CAT advisory committee at the Financial Information Forum, an industry working group for trading data.

As the audit trail's costs rose, so did fighting over the bill.

The system's costs are split between two groups: broker-dealers and those Wall Street entities with self-regulatory status -- Finra and the exchanges. Under rules agreed upon by the SEC and the self-regulators, the latter bunch can pass their portion on to the brokers.

Finra already does that -- leaving broker-dealers with some 80% of the CAT's cost. That could rise to 100%, if the exchanges follow suit.

About half of all trades get executed by off-exchange dealers like Virtu Financial and Citadel Securities, the firm founded by billionaire Ken Griffin. Facing a tidal wave of CAT costs, Citadel has battled the audit plan in court.

Appearing in February before the U.S. Court of Appeals for the 11th Circuit in Atlanta, Citadel argued that the SEC unlawfully hid CAT's cost from Congress, by sticking industry with the tab. The SEC also gave Citadel's competitors -- the stock exchanges like Nasdaq and NYSE-owner Intercontinental Exchange -- the power to pass their costs on to Citadel.

At the moment, the CAT fee works out to about two cents per 1,000 shares traded. Ultimately, of course, everyone probably passes the costs to investors.

"The SEC has created a massive unprecedented surveillance tool that tracks every investor and trade from cradle to grave," said Noel Francisco, the Jones Day lawyer representing Citadel. "All funded through a tax on every trade in America."

SEC lawyers told the judges that the agency has had the power to investigate stock trades since it was created, after the 1929 crash.

Neither the SEC or Citadel would comment.

But outside of court, the Commission's new Republican majority is already backtracking on the audit trail. A few days after the court hearing, the Commission exempted the industry from submitting the name, address and birth year of the individual behind a trade. Acting Chair Mark Uyeda said that a coded identifier will still allow investigators to track traders.

A group of Republican senators and members of Congress wrote Uyeda at the end of February, asking if the Commission wanted to continue defending the audit system in court.

Then in March, CAT's industry operators asked the SEC to make the personal info exemption permanent, and to let them expunge the personal information accumulated in past years.

That proposal would frustrate CAT's purpose and handcuff the SEC, says the Better Markets group, in a comment letter submitted Thursday. Without personal information, says the group, "the SEC will not be able to quickly investigate abusive trading and identify the parties responsible."

It isn't really possible to shut down the CAT program altogether, says Financial Information Forum advisor Jordan. That is because the industry has decommissioned its prior system for reporting suspicious trades to the SEC.

"I think the CAT lives," Jordan says. "But it has to be run more efficiently."

The newly confirmed SEC Chair Paul Atkins arrives as a CAT skeptic.

At his March 27 confirmation hearing, he was asked about Project 2025's call to terminate the audit program.

"It needs to be reviewed," said Atkins. "We need to look to see if it's going to be focused on the mission that it's trying to solve."

Write to Bill Alpert at william.alpert@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

April 11, 2025 14:11 ET (18:11 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.