The SEC's proposal for a revolutionary, breakthrough system that can monitor high-speed stock trading is inching closer toward reality.  U.S. regulators now expect to issue a detailed blueprint for the Consolidated Audit Trail, or CAT, within the next few months. The CAT would give regulators a window into a market driven by computer trading that occurs at speeds too fast for the human eye to track.  Average daily trading volume has doubled since 2005 to 8.8 billion shares in 2011, according to Tabb Group, which tracks electronic trading.  And, as market speeds have exploded, so have concerns that some firms may hide manipulative activity inside the blur of trading. Enormous Cost Projections. The project faces enormous challenges, led by the enormous cost.  Many billions of dollars will go into build a system that's capable of monitoring high-speed stock trading in real time.  But in the eyes of the SEC and others, there is no viable alternative. The catch is that the SEC won't pay for the project.  Instead, the cost will be borne by the stock exchanges, brokerage firms and FINRA.  That cost, in turn, would most likely be passed along to investors and traders, industry observers believe. Industry critics claim that such costs could damage the market because the added costs could cause high-volume traders to pull back from trading, or worse, move overseas.  That's because imposing such fees would make their activities so expensive.  And, while some may not realize it, many trading orders currently aren't charged a fee. The impact to the markets - i.e., the loss of significant liquidity - could be devastating, though estimating specific numbers is next to impossible - at least until we move closer to a launch date. Regulatory Capabilities Drawn from The CAT. The CAT will provide regulators with a new sense of stock market dynamics.  For the first time, regulators would be able to monitor with enormous clarity the stock markets that now are driven by computer trading that occurs at speeds too fast for the human eye to track.  Average daily trading volume has doubled since 2005 to 8.8 billion shares in 2011, according to Tabb Group, which tracks electronic trading. As market speeds have exploded, so have concerns that some firms may hide manipulative activity inside the blur of trading.  The difference is impressive, as illustrated by the following chart from WSJ Research:

Now: Regulators see only a slice of orders. Orders available a day or weeks later. Sudden "flash crash" events difficult to explain. Manipulative computer trades hard to catch.

With new system: All orders captured. Orders instantly available. Volatile moves quickly explained. SEC polices entire market in real time.

Current Limitations in Regulators' Own Words. SEC Chairman Mary Schapiro told Congress in March that the SEC's ability to collect trading data is "wholly inadequate to the task of overseeing the largest equity markets in the world."  The Commission often must rely on data from FINRA, exchanges as well as firms - e.g., mutual funds and bank-trading desks - to track the market.  FINRA and the exchanges report irregular trading activity to the SEC, which is responsible for enforcing securities laws. The means that the SEC is essentially flying blind because it's unable to track a large amount of trading every day.  With a consolidated audit trail, the SEC would be able to directly monitor the market and create systems to catch suspicious activity.  The CAT also could let the SEC see all orders placed on all exchanges, and identify which firms originated and placed particular orders. The audit trail, which will likely track stock-option trading, as well, would enable regulators to more quickly understand and explain such events. The CAT also could catch manipulative trading activity, the agency said.  Proponents of the system said it will boost investor confidence in the market, which itself could pull in more trading activity in the long run. Naysayers. Several financial players, including FINRA have disagreed with certain elements of the SEC's plan. For example, FINRA supports many of the goals of a CAT but has said the SEC's push for a real-time tracking system is misguided.  FINRA Vice Chairman Stephen Luparello, for one, said the benefit of gathering information in real time doesn't justify the cost, because there would be few instances in which the system would capture information the SEC could immediately act on.

He added:   "What benefit you get by getting that information at three o'clock versus getting it the next day is a little hard to put one's finger on."

Critics, however, still return to the project's price tag.  When the idea was first broached, the SEC originally estimated the cost at about $4 billion upfront, and $2.1 billion annually.  Both numbers far exceed the Commission's 2011 budget of $1.2 billion.  The agency said the cost likely will be lower, but still could run into the billions of dollars. One way the industry could reduce the cost is by upgrading its own systems, such as FINRA's OATS system.  But these and other expenses would likely be passed on through trading fees.  Some observers say the fees could be assessed on a per-order basis, such as a fraction of a cent per order, because the CAT system would be designed to track order flow.  That is where the trading companies see trouble. After all, some high-frequency trading firms, which probably account for more than half of all trading in U.S. stocks, place tens of millions of orders every day, canceling the bulk of them, and make profits measured in pennies per trade.  Order fees could make their activities far less profitable or even unprofitable.  That ultimately could affect regular investors, critics of the project said, because high-speed trading is seen by some as the grease that makes the market's wheels spin. Stay tuned.   [WSJ, 9/21/11]