By Chris Montagnino, Managing Director of Compliance Services, Jordan & Jordan
On April 20, 2020, FINRA CAT LLC officially opened the CAT production portal for firms who are ready to begin reporting, although reporting to production is not required until June due to a recent SEC extension – see below.
You have worked with your vendor or internal technology team over the past two-three years and have made it through the FINRA CAT testing phase and may be one of the 363 firms that has been certified by FINRA (as of 4/21/20) to report to the production environment, so what do you do now?
· First the obvious, there are four remaining phases of implementation still to go for CAT including options, complex equities, complex options and customer information; thus, there is still plenty of development work to do for future phases.
· Next, the implementation of procedures and controls to monitor daily reporting statistics and rejections that require repair within the required timeframe (T+3).
· Finally, there should be routine testing of the CAT reporting process (whether proprietary or vendor) to verify that the reporting is both comprehensive and accurate.
If you are not one of the 363 already certified firms, you may not want to read further but perhaps continue to focus on certification. Or, as you do on Zoom video now, raise your hand for help.
The next phase (Phase 2B) of CAT reporting scheduled for production covers simple options, however, do not let the name fool you, there is absolutely nothing simple about the reporting of options to CAT. Unlike equities, which have been reportable to FINRA via OATS for almost 20 years, options orders and events have NEVER been reportable to any regulatory agency by any firms. The moral of the story is that this is a new and challenging undertaking for all firms that accept options orders. This includes obtaining data and files from systems that may not have been developed with reporting in mind and feeding such data to databases that were not developed with the criteria inherent to options in mind. This phase of CAT will incur significant testing and evaluation before being production ready.
Further development is also required for the next phase (Phase 2C) of equities reporting particularly for firms that employ composite or representative orders. These are orders that are bunched or aggregated from multiple smaller orders, executed and then allocated to fill the smaller orders. Although, one-for-one representative orders (where the representative order is directly linked to a single order) are reportable in Phase 2A, the more complicated scenario of multiple aggregated orders linked to one representative order follows in the subsequent phase. The CAT technical specification has very specific requirements for the reporting of representative orders including the type of representative orders as well as the linking and reporting of the related, aggregated orders. This can be particularly challenging when aggregated and representative orders are handled via separate, unlinked systems.
The remaining phases of CAT cover the reporting of complex options orders (Phase 2D) and, eventually, the reporting of customer information in 2022 (Phase 2E). Again, as with options, the daily reporting/updating of customer related information is a new endeavor for the entire industry. Many of the aspects of options and allocation events are well represented in the FIX protocol, so it would be worthwhile to include FIX expertise on the implementation team. As you can see, much research and development work is still required over the next few years until full CAT implementation.
As mentioned above, once firms begin reporting to CAT, there must be supervisory and monitoring procedures in place to identify potential reporting issues and repair any rejected events. The repair window for CAT is a much tighter one than for OATS and provides firms with less than 48 hours to repair rejections after they are notified of them. As an example, for an event that occurs on Monday before 4:15PM and is reported to CAT by Tuesday at 8AM (the reporting deadline), FINRA CAT generally expects to report rejections back to the firm by around noon on Tuesday at the latest. The firm will then have to investigate the issue and repair the event by 8AM on Thursday. This requires having staff knowledgeable of the CAT requirements, equity systems/data and repair mechanisms to resolve the rejections on such an aggressive timetable.
In addition, firms should establish expected baselines for their CAT reporting in order to identify potential, systemic issues that could impact the veracity of their reporting. This entails setting daily metrics concerning event levels based upon historical activity with respect to total number of events and total numbers for different types of events. By doing so and monitoring the reporting statistics daily, firms can quickly investigate when they identify activity levels that fall short of or exceed the expected ranges.
Finally, every firm should have a regular (at least annual) process in place to test their CAT reporting whether or not they are utilizing proprietary systems or a vendor system. Regulators will expect that firms are adequately performing due diligence over their vendor to evidence supervision/oversight of the process for which the firm has ultimate responsibility. This can be accomplished by engaging external parties that perform independent validations and assessments. Firms can also conduct such reviews internally by comparing the raw data of order events from their OMS/EMS systems to the CAT generated files to confirm that appropriate events are being generated based upon the activity in the raw data and that the field values being populated reflect the correct values based upon the firm’s business activity. This is what the regulators will do during examinations so it would be prudent for firms to undertake this work first, rather than the regulators.
On April 20th, the SEC granted an extension of the requirements for firms to report to the production environment of CAT until June 22, 2020 for Phase 2a and until July 20, 2020 for Phase 2b. This allows firms additional testing time to validate their processes prior to production as well as implement the necessary supervisory procedures and controls discussed above.
