CAT reporting woes, Reg BI, and best execution are on FINRA’s enforcement radar.
Bill St. Louis
The controversial Consolidated Audit Trail (CAT), which has already been fending off lawsuits and industry pushback, has had “instances of millions if not billions of late or inaccurately reported order events,” says Bill St. Louis, executive vice president and head of enforcement at the Financial Industry Regulatory Authority (FINRA).
The need to stay on top of CAT enforcement is a key item in a current list of enforcement priorities for FINRA’s national operations for enforcement that St. Louis and FINRA staff compiled. St. Louis recently announced the priorities via a blog posting on the FINRA website.
Announcing the priorities is intended to help FINRA-regulated firms focus their compliance efforts.
The CAT system is the result of SEC Rule 613, which requires U.S. securities exchanges and FINRA to build and maintain an electronic audit trail. The ambitious, big data, securities transaction monitoring project has a prominent place on the list of enforcement priorities of the self-regulatory organization (SRO) for the U.S. broker-dealer industry along with major concerns over Regulation Best Interest (Reg BI), the best execution requirement, and targeted exams.
Since CAT was phased in starting in 2020, the platform has given SEC officials another level of surveillance. In one case, CAT surveillance played a key role in an alleged, multi-year, insider trading scheme that yielded $47 million for the accused perpetrators: https://bit.ly/3jpRuwC
For now, St. Louis says there are some troubling CAT cases that need enforcement attention; he did not disclose the identity of the firms involved in the CAT cases.
“The overwhelming majority of firms have successfully complied with their Consolidated Audit Trail (CAT) reporting obligations. Where firms have experienced CAT reporting issues, those matters are typically resolved with no further action or Cautionary Action,” St. Louis says.
“However, there are still some CAT cases in our pipeline, including instances of millions if not billions of late or inaccurately reported order events, situations where firms are aware of CAT problems and do not reasonably respond to red flags, failure to implement a reasonable CAT system for several years, or when firms limit their supervisory reviews to data fields rejected by CAT,” he says.
Clearly, FINRA has no plans to end the CAT system despite lawsuits and industry backlash.
As Bloomberg and other media outlets have reported, the National Center for Public Policy Research began a class action legal effort last month via federal court in Waco, Texas, alleging that the SEC lacks the authority to launch the CAT surveillance system. The group wants the CAT database and system to be dismantled.
On another legal front, Citadel Securities and the American Securities Association sued the SEC this past fall attacking the funding model for the CAT system, which requires broker-dealers to pay fees to be monitored.
Some of St. Louis’s other priorities are:
- Regulation Best Interest: “The SEC’s Regulation Best Interest (Reg BI) rule establishes a ‘best interest’ standard of conduct for broker-dealers … Our department’s Reg BI-related disciplinary actions have been increasing, with the expulsion of two firms for misconduct that included Reg BI violations. We have brought cases involving the Customer Relationship Summary form (Form CRS), excessive trading, complex products, and variable annuities, with more in the pipeline. On our website, FINRA maintains a helpful chart listing disciplinary actions that include a Reg BI or Form CRS violation.”
- Recidivist behavior: “Combatting the efforts of bad actors who have a history of misconduct and repeat violations is also a major priority for our department. Plain and clear, sanctions imposed on recidivists should be more severe because a recidivist has already failed to comply with FINRA’s rules or securities laws. Firms and brokers with a history of misconduct: FINRA confronts firms and brokers with a history of misconduct to prevent them from harming investors and compromising the integrity of the financial markets. Where appropriate, we seek to bar brokers who have engaged in egregious misconduct from associating with FINRA member firms.”
- Best Execution: “FINRA’s Rule 5310 (Best Execution and Interpositioning) requires that in any transaction for or with a customer or a customer of another broker-dealer, a member firm and associated persons with a member firm should use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so the resultant price to the customer is as favorable as possible under prevailing market conditions. Our department has pursued cases focused on routing practices and execution quality, such as when firms route to their own alternative trading system, and firms receiving payment for order flow and not conducting reasonable regular and rigorous reviews of execution quality.”
- Targeted Exams: “There are a number of targeted examinations (also known as sweeps) being conducted by our regulatory operations colleagues. As those sweeps progress, they may be referred to enforcement, and we want to prioritize those related cases to ensure they are concluded in a timely manner. For instance, we recently brought the first settlement in a case that resulted from the sweep on social media influencers and customer acquisition. This is of specific importance since so much of the public receives investing advice from social media.”
“Advancing these objectives requires hard work by the talented team of professional investigators, analysts, data analysts, attorneys and operations staff at FINRA Enforcement,” St Louis says in his blog. “We are confident that by diligently pursuing the objectives and keeping our mission of investor protection and market integrity top of mind, we can achieve our goals and collectively do what is right for investors and the market.”
The full posting can be found here: https://bit.ly/4dgo0sJ
More about the latest updates on CAT compliance can be found here: https://www.catnmsplan.com/
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