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How important is transparency in markets? It’s not a front-of-mind thought for most investors as they place a trade — a sign that confidence in market integrity is high. But what if a lawsuit had the power to shut down a key tool in the regulatory kit to scrutinise the entire stock market?
That’s the worry of Tyler Gellasch, chief executive of the investor advocate group Healthy Markets Association, who is concerned about two challenges to the legitimacy of what is known as CAT, or Consolidated Audit Trail.
In a nutshell, CAT is a regulator’s dream, tracking all orders and trades in listed equities and options. This allows the Securities and Exchange Commission to see who trades what in the US stock market, in real time. Conceived in the wake of the 2010 flash crash when regulators struggled to pinpoint the cause of a shock $1tn market plunge, it has gone online in stages, becoming fully operational in 2024. Fans compare it to the Hubble Telescope.
Gellasch says suspending CAT would send US market surveillance capability back to the 1970s, even though trading decisions are now made in nanoseconds and there are many more of them. “Whether killed by courts or Congress, killing CAT means blocking regulators’ ability to know who’s doing what in our capital markets. That risk is unprecedented,” says Gellasch who recently wrote to the SEC urging a rethink in CAT’s structure before any changes were forced upon it.
To its detractors, CAT is an Orwellian nightmare — a huge invasion of privacy for which the SEC never sought congressional backing. And they are suing.
Billionaire Ken Griffin’s Citadel Securities filed one case in Florida last year in conjunction with the American Securities Association. The suit challenges CAT’s funding whereby the industry is on the hook for an estimated $200mn a year in running costs — on top of $1bn spent on the system. For good measure, the case warns darkly of 500bn trading records a day being stockpiled “for uses left entirely to the bureaucratic imagination”.
In April, a case in Texas took a different approach, with conservative activist groups including the National Civil Liberties Alliance calling for a halt to CAT because of its “dystopian surveillance” of individuals’ financial data. They have warned thousands of regulators could access this through what amounts to the world’s second largest database, behind that of the National Security Agency. “The Constitution expressly prohibits uncaging this CAT,” lawyers argued.
The claims are made in the dramatic style typical of court complaints. Would killing CAT really lead to gaps in spotting market miscreants? Well, there would still be what’s known as the “blue sheets” system when regulators ask brokers for particular records but that is based on someone noticing something first. It can’t spot anomalous trading patterns.
“If the CAT were taken out by the courts, we would have a big hole in our financial regulation. If you’re trying to catch people doing things like spoofing or manipulation or other sleazy stuff, you need that kind of data,” says James Angel, finance professor at Georgetown University.
In the eyes of its challengers though, CAT’s structure is illegal or unconstitutional. It grew out of long-standing systems that ran through the exchanges and the Financial Industry Regulatory Authority which oversees brokers. All are officially self-regulatory organisations, meaning they have a responsibility to set rules for their members and to oversee them. They operated CAT’s clunky predecessor, so it didn’t particularly cause a stir when the SEC initially delegated the design, funding and construction of CAT to the same group, under its supervision.
Under that system, Congress did not have to authorise CAT because while the SEC’s budget needs approval, CAT doesn’t come into it. If it did, it would eat up about a tenth of the watchdog’s funding.
Gellasch fears that the courts or Congress could decide that CAT does exceed the SEC’s authority, or question its funding structure. CAT also merited a blunt one line in Project 2025, the conservative think-tank policy blueprint supported by many allies of president-elect Donald Trump, which called for it to be terminated.
Last month a report from the SEC’s own independent internal review system noted the general worries about CAT’s privacy, security and costs, and began a deeper audit. For now in Florida, the parties are waiting for a ruling on Citadel’s request to halt any CAT fees until the case is decided. In Texas last month, the judge denied a preliminary injunction calling for CAT’s suspension on the basis that there was no back-up. “The CAT,” the judge wrote, “has been out of the bag for years.” It seems the only element uniting all parties in the CAT fight is a need to scratch an itch to pun.
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