FINRA’s Consolidated Audit Trail reporting requirements are steadily moving forward. In this episode of our Oyster Stew podcast, Oyster experts provide an overview of the Consolidated Audit Trail requirements, discuss FINRA’s CAT priorities, sweeps, and pitfalls firms should avoid.
Transcript provided by Temi transcript services
Jeff Gearhart: Hi, everyone. This is Oyster’s Trading and Markets Team here to talk about CAT reporting, an exciting topic. I’m Jeff Gearhart, here with me are Frank Childress and Ralph McGee. We would like to share our perspective on the topic. We’ve been actively engaged with multiple clients, both through those using our CAT Reporting tool, as well as those inquiring, just for help on solving problems, implementing policies, procedures, controls, and whatnot. With that, I’ll turn it over to Frank to get started.
Frank Childress: Great. Thanks Jeff. Why don’t we get right into it? We’ve got with us today Oyster Consulting’s resident subject matter expert on CAT or the Consolidated Audit Trail, Ralph McGee. Ralph, CAT’s been out for a little while now. Why don’t you give us an assessment of where we currently stand?
Ralph Magee: Sure. Thanks Frank, and thanks, Jeff. I think we’ll backtrack a little bit to the start of the implementation of CAT, which goes back to 2020. We saw the industry entered, do phases 2A and 2B, which are for equity and options order flow, respectively. We progressed throughout that year to introduce linkage both from an intra firm and inter firm basis. So within the firm, linking the events that happen on an audit trail of an order, and then externally of the firm to other firms that order flow has been sent to and also the exchanges and the trade reporting facilities. That implementation continued as an industry into 2021 with phases 2C, large trader identification reporting, and also phase 2D with the addition of complex options order reporting to CAT. So with all of that being said, that really completed the transactional CAT reporting implementation as an industry. And that has led us to currently where we are as that last implementation happened in December of 2021.
Frank Childress: All that’s great. Great overview. So the CAT issue kind of alluded to is very, sort of, calendar specific. What are we looking forward to in terms of the forward-looking calendar with respect to other implementations and what industry members need to focus on?
Ralph Magee: So the plan provider FINRA CAT has three industry releases that are planned for this year 2022. The first of those is coming up here the end of the month on 3/21, where they’ll do a schema release and some additional validations and some 2D cleanup work as an industry. That will progress into release two, which is in coordination with something we’ll talk about a bit later, I’m sure, which is the customer and account information phased in implementation, which will be phase 2E that comes in July 11th. And then the third release that is planned is for December 7th, 2022, which will introduce a new reporting event from the multi leg or complex options order flow, which is the MLOE, which is the order effective date for those multi leg options. In addition, we, as I mentioned, the case, the customer and account information phase 2E comes into compliance in July. That is what will allow the regulators to link all of the trading activity that’s being reported from a transactional perspective to CAT to the actual end clients for that workflow.
Frank Childress: Great. I certainly couldn’t help to notice that FINRA’s recent exam priorities letter for 2022 in the market integrity section, CAT was number one on their list; or Consolidated Audit Trail was number one on their list. What can you tell us about where FINRA’s focus is going to be? And are there any specific releases or documents that industry members should be thinking about?
Ralph Magee: Certainly the one you just mentioned, the 2022 FINRA report on examinations and risk monitoring. There are some bolded sections in there for CAT specifically, which are new adds this year that give industry members an insight as to what FINRA CAT will be focusing on in their reviews and their sweeps. We’re starting to see regular sweeps that are being performed by their rapid remediation team. And we’re seeing clients get those inquiries more regularly each day and each week that we get into 2022. In terms of reference material, I think, you have got to go back to Notice to Members 20-31, which just reminds industry members of their requirements from a supervisory perspective for CAT reporting. And I also think that folks need to review the FINRA sanction guidelines that were published last October 2021, which has specific information in there in terms of what the fines and sanctions and potential suspensions, bars, and other sanctions, that industry members will face for violations.
Jeff Gearhart: Hey, Ralph, if I could just interject one quick question there. If there’s a sweep, is there any special guidance or anything unique people should know about responding to these sweeps or these inquiries?
Ralph Magee: Well, I think what we are seeing is that if folks have good answers to this rapid remediation process, the inquiry really stops there. It doesn’t become a formalized event or a finding or an open case with FINRA. So you know, the focus certainly should be there to get those answers out to them quickly. We have seen some ability for firms to ask for a slight extension to that rapid remediation team that has been granted in several instances. So I think just putting that focus in, getting the answers to them quickly, and moving on, in most cases, if you could answer their questions adequately.
Jeff Gearhart: Good, good to know.
Frank Childress: That’s great. That’s really helpful guidance, Ralph. So as someone who’s been deeply engaged with clients in the field and working with them, what are some of the observations, pitfalls, and challenges that you’re seeing within our client base?
Yeah, that’s a great question, Frank. As always the emphasis from FINRA is going to be on the clock sync. That’s the very nature of the audit trail and in tracking client orders from their initiation all the way through their completion and execution and allocation even. So we are seeing some significant focus there as always on the audit trail and validating that the clients are monitoring their clock sync and how often, and who’s responsible for doing so and how it’s evidenced. There’s significant focus on firm policy, WSPs. What is the firm’s surveillance system? How is it being used? You know, what are the minimal requirements? And are you doing what policy says that you’re doing? How is that being evidenced? All of those things are important factors that FINRA is really focused on. We’re also seeing some additional scrutiny for firms that are using a CAT reporting agent.
And I think that because there’s just an uptick in risk. They want to make sure at firms, that though they can contract the reporting away from the firm’s direct control. They can’t; they cannot ever outsource the compliance or surveillance of the reporting that’s actually being done on their behalf. So we’re seeing some significant focus there for firms that are using CAT reporting agents. And then there’s the obvious data field validations – account holder type, department type, manual flag, representative indicators. Those are new items to CAT reporting that they’ve pretty much called out, that they’re looking at those fields and making sure that they’re valid and accurate. We’ve also seen fractional shares be a focus for CAT reporting. How those are being done, how those are being reported to CAT. And then finally, I would say books and records comparisons have been a strong focus of the regulatory body, making sure that your books and records match the information that is being ultimately reported to FINRA CAT.
Jeff Gearhart: Ralph, I was thinking since you’ve been in this really since the beginning, and you’ve helped a lot of clients and have engaged with FINRA, are you seeing a change in tone from FINRA in terms of being patient with the industry and working with the industry while everybody adapts to the new standards and reporting requirements? Are they moving heavier to an enforcement stage or becoming less forgiving, more diligent in their efforts?
Ralph Magee: Yeah, Jeff, there’s definitely been a shift. Now that we have completed CAT, the transactional CAT reporting aspect in the implementation, we are seeing a strong shift to the regulatory sweeps. We are seeing an increased amount of data validation expectations from their team. I anticipate that will do nothing but increase. But I will mention something that I believe is important for all of our listeners to hear. And that is that – if firms are being proactive in reviewing their CAT reporting and doing the data validations that they need to, and they find a defect with their CAT reporting agent or within their own reporting, or find something that may have been reported inaccurately, the self-reporting process has been something that FINRA CAT has offered to the industry members. And all of our clients that have found themselves in that scenario, have been treated very well by the regulatory body. In doing that self-report, it has been something that has been well received by FINRA CAT and FINRA reg. And we have yet to have a client that has gone through that process, end in a monetary fine as a result of that self-report.
Jeff Gearhart: Oh, that’s actually really good to know. I’m not surprised FINRA is moving more into the enforcement stage. What do you think some of the main drivers are with firms complying? Is it simply because, quite frankly, it can be complicated. Or is it just not being prepared and taking it seriously, or not having the right resources or maybe something else?
Ralph Magee: Yeah, I think it’s an interesting question. I think what we have noticed is it depends a lot on where CAT reporting is actually owned within the firm. We have some firms that it’s owned within the operational group, others – trading groups and others – the compliance group. And from a risk perspective, you can probably make an assumption that the firms that have CAT reporting that’s owned by their compliance group take this a little bit more seriously than if it’s owned in operations and/or trading. So I think that’s an important distinction that we can make to our listeners here today.
Frank Childress: So now that you’ve identified some of the challenges that firms are having, how would you suggest that firms actually tackle these challenges?
Ralph Magee: It’s really about awareness. It differs from firm to firm and the way that they’re reporting to CAT. They really need to take a step back and look at all of their policies, all their procedures. Make sure that they’re in line with what the expectation is from FINRA and making sure that they’re doing all of what they say that they’re doing in their firm policies. And then deep dive into the actual CAT reporting, validate the data fields that are being populated for accuracy, using source files whenever possible. Those are the things that I would say need to be their primary focus. It is something that I think that we’re going to see FINRA take very seriously going forward. There’s a lot of expenses that are associated with this implementation of CAT, some of that burden will be carried by FINRA CAT as the plan provider and the industry members will certainly share a lot of that burden in paying for the cost of what will be the largest financial database ever established.
Frank Childress: Well, Ralph, this has been great. I know I’ve learned quite a bit. The CAT calendar is moving right along. FINRA’s approach will be, we’ll learn a lot as the year goes on and how they address some of these issues. But certainly we appreciate you being on the front lines of this and understanding all the intricacies within CAT and being able to help our clients tackle.
Ralph Magee: No problem. Thanks, Frank. Thanks for the opportunity. Really appreciate it.
Oyster: Thanks everyone for listening. If you’d like to learn more about the consulting services we offer around CAT reporting or our proprietary CAT reporting software, visit our website at oysterllc.com. If you like what you heard today, follow us on whatever platform you listen to and give us a review. Reviews make it easier for other people to find us. Have a great day.