Consolidated Audit Trail: Those Messy Data Linkages

US brokerage operations managers are quickly turning their attention to how they will meet the cumbersome requirements for data linkages now that the Financial Industry Regulatory Authority (FINRA) has been stepped in at the eleventh hour to operate the new consolidated audit trail (CAT).

The initial phase-in of CAT — 2a and 2b– starting in April and May 2020 isn’t as far away as it sounds given the extensive work firms have to do tweaking their front office order management and execution management sysems, their back-office systems and data repositories. By 8AM EST on T+1, or the day after the trade is executed, US brokerages have to submit tons of data on executed equity and options orders.

That’s the easy part. Even harder will be their need to tie in received customer orders, with executed orders, and executed block orders with child orders, executed orders with underlying client accounts and orders routed to another broker for execution. Just one mistake can lead to an erroneous report which will be rejected and must be resubmitted correctly by 8AM EST on T+3.

“The data linkages mandated by CAT are similar to those already included in the Electronic Blue Sheets Reporting with the notable exception that they are required, rather than requested,” say Sandeep Kumar, managing director for global financial services consultancy Synechron in New York. The US Securities and Exchange Commission can ask clearing firms, broker-dealers and market-makers for detailed information on executed trades. However, as Kumar notes, the regulator’s request is certainly not nearly as stressful to brokerage operations and compliance managers as the required frequent reporting and quick deadline imposed by CAT.

FINRA’s selection as the new CAT processor to replace Thesys Technologies appears to be the one saving grace for brokerage operations managers who are hoping for a successful conclusion to what has been a lengthy arduous process. The SEC ordered the creation of an audit trail system back in 2012 under Reg NMS Rule 613 after it had trouble accessing the data it needed to analyze the sudden decline in US stocks that took place on May 20, 2010, otherwise known as the “flash crash.” The US regulatory agency then asked self-regulatory agencies and FINRA to come up with a gameplan on how to create, implement and maintain CAT.

It took another four years for Thesys Technologies to finally be selected as the data repository manager in 2017 winning out over FINRA and FIS. However, any sighs of relief were dashed late last year after Thesys was ejected from the project. FINRA’s selection earlier this week now seems like a sound decision as it aleady operates a trade reporting system Order Audit Trail System (OATS), considered CAT’s predecessor. OATS is set to be decommissioned at a yet-to-be determined date.

Although CAT’s operating committee recently reassured US brokerages that there would be no substantive changes to existing technical requirements regardless of the new service provider, operations managers are still a bit concerned about a potential high number of reporting errors. Too many mistakes can cost their firms either warnings or fines from FINRA.

Changes to current specifications including error corrections will be issued in March and April of this year with the hopes of testing for the largest broker dealers beginning in December 2019. That leaves sufficient time for the CAT system to actually go into full production for equities in April 2020 and May 2020 for options.

Other than the dates, the main change between the previous CAT program plan and the new one can be explained as follows: the original plan called for a conformance period where all validations would be applied by the plan processor to events being reported; however, the T+3 requirement for corrections would not be applied. The new plan will layer in validations over the course of 2020 and will require that from April 2020 firms meet their T+3 correction requirements. Smaller brokerages will have until 2022 to file reports on both options and equities.

Full production means that large brokerages must be able to correct any errors on linkages by that time. The April 2020 date only applies to basic data validation not data linkages which come in the subsequent months. Intra-firm validations will go live for equities in July 2020 and in August 2020 for options. Inter-firm or brokerage to brokerage linkages follow for both equities and options in October 2020. The final set of validations related to keeping track of the exchanges on which trades are executed go live in October 2020 for equities and December 2020 for options.

The extensive testing and drawn-out validation process will certainly be a big help for broker-dealers, but isn’t a panacea. Unfortunately, practically-speaking they will have less than two days to fix an error from the time they did any reporting because it is expected that the CAT operator will provide feedback on any errors by 12 PM EST on T+1. US brokerage operations managers tell FinOps Report that the process for correcting errors on the CAT system is far harder than the current one for FINRA’s OATS and the extra data linkages won’t help matters.

Synechron’s Kumar recommends that US brokerages consider artificial intelligence and machine learning technologies as a way to quickly analyze data quality, fill gaps and potentially handle data extraction. However, for now brokerages seem to be focused on working with the basics of what they have on hand. “Operations managers need to turn their attention to finding where all of the data required by CAT is located and whether their order management and execution management systems are correctly integrated,” recommends Joanna Fields. managing principal of New York-based regulatory consultancy Aplomb Strategies.

That’s just for starters.

“Even if the order and execution management systems would generate correct information on executed orders, tying those orders to the underlying customers of the broker-dealers could become tricky,” says David Campbell, vice president of strategy for business operations outsourcing giant Broadridge Financial Solutions in New York. “The ultimate client allocations may need to be sourced from a back-office system for reporting and if any changes are made in this platform they may not be registered in the OMS and EMS platforms.”

The result: “orphan” events that produce linkage errors at the CAT repository.

Campbell recommends that firms verify that order management, execution management, back office and reporting systems all be correctly integrated. In some cases, firms might even decide to rely on a data repository which takes in all of the data before it is submitted for reporting.

However, a brokerage’s accuracy rate in reporting will only be as good as the systems and data it is using. “While brokerages are focused on finding ways to link data across multiple systems they must also consider reviewing the data integrity controls of their OMS and EMS platforms,” says Fields. “To reduce their chance of reporting errors, brokerages need to identify missing, duplicative or corrupted data.” Some OMS and EMS systems do not include the exchange on which a trade is executed, instead citing the type of algorithm used. Yet other factors brokerage operations managers must consider, says Fields are: whether their OMS and EMS systems have independent technology certifications, whether they notify their clients of material changes; whether they offer an audit trail of technology changes and whether they provide updated books and records for all products and trade flows.

For some brokerages, outsourcing the reporting for CAT to a third-party service provider, such as Broadridge Financial, makes sense. Campbell says that his firm can eliminate the potential for reporting errors by tying in all the necessary data or flagging any missing data that must be found prior to reporting.

However, even the best managed internal operational integration or effective third-party service provider can’t solve every glitch. “There could still be mistakes with inter-broker trades or those which one brokerage must send to another to execute because of discrepancies in transaction codes between brokerages,” says Campbell. During its webinar, the CAT operating committee says that such linkages will also be part of the test process to take place in the summer of 2020.

Brokerage operations managers say they have no choice but to take CAT’s operating committee at its word and hope that FINRA’s assumption of the audit trail process will give them an annoying headache rather than a full-blown migraine. In the meantime, operations managers have plenty of work to do on their own to reduce the intensity of their headaches.

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