Some worry SEC's proposed system to monitor stock markets too ambitious

Skeptics have labeled the Securities and Exchange Commission's proposed plan to create a system that would monitor all trades within three years as possibly too ambitious.

SEC issued a proposal on May 26 to develop a $4 billion system that would track trades instantaneously, be fully funded by exchanges and the Financial Industry Regulatory Authority, and help avoid a repeat of the stock market meltdown that occurred in May. Market exchanges would begin reporting transactions to the central repository within a year, following approval of an implementation plan. Their member brokerages would be required to start reporting within two years.

The commission began developing the plan for a more uniform audit system last year and had it been in place in May, regulators would have been better able to quickly analyze the stock market plunge that happened on May 6, officials said. That day the Dow Jones Industrial Average fell more than 9 percent in a matter of minutes, recovering much of the loss a short time after.

Regulators still are investigating why the market dropped so sharply. Reconstructing even a few hours of unusual trading is an enormous undertaking due to the complexity of today's markets, the thousands of investment products, millions of trades and hundreds of millions of data points, SEC officials have said. Trading occurs in microseconds, but regulators do not have visibility into the transactions for days or even months without a system that can analyze all of the disparate data.

Federal regulators are seeking public input on the proposal to determine the best method of standardizing trading reports from dissimilar systems. SEC's repository would allow regulators to sort through data across every securities market, looking for activity that indicates an increased risk for large market fluctuations or for suspicious trading patterns that point to possible market manipulation. Regulators also would be better able to reconstruct market abnormalities with the information.

But some former information technology managers say the quick-hit deadlines could result in inadequate data being reported when the system goes live. "It's like everything is supposed to happen in the last quarter. Those kinds of miracles don't occur when you're managing a major systems initiative," said Alan Balutis, a former chief information officer at the Commerce Department and a founding member of the federal Chief Information Officers Council. "If you've not been doing all the things that need to be done preparatory, you're going to find that a lot of those reports are going to be flawed."

From a project management perspective, Balutis said a more efficient approach for gathering detailed information would be to require market officials to submit data over incremental periods leading up to the two deadlines so SEC officials could detect any problems before the system fully launches three years out.

He noted that one could draw an analogy between the situation SEC faces and the difficulties the White House encountered when it required economic stimulus recipients to file reports on how many jobs were created by the funds. When FederalReporting.gov, the central database for recipient filings, began collecting data last year, many recipients entered incorrect or incomplete job numbers, leading the White House to change its job calculation formula and allow extra time for corrections. Still, three quarters into the reporting process, some recipients have yet to file.

"I don't know what kind of regulatory sanctions exist if people fail to [report trades], or how prescriptive they would need to be to ensure that in fact these things are properly formatted and submitted in a required, timely fashion," said Balutis, now a director at the Cisco Internet Business Solutions Group.

One of the questions SEC asks in its proposal is whether the agency should consider requiring all exchanges and their respective brokers to begin reporting a subset of the data initially, and phase in the collection of additional data over time.

Balutis said another risk management approach would be to install a project manager to take responsibility for any slip-ups and for fixing them. As proposed, a chief compliance officer appointed by the exchanges would be required to regularly supervise the operation of the database and recommend ways to improve the quality and processing of the information. "I think whoever is managing the project ought to be someone within the government," he said.

Progress on meeting milestones should be reported to the Office of Management and Budget in the same way that agencies are required to report on their IT investments, Balutis added.

SEC spokesman John Nester said the final form of the repository will depend in part on staff analysis of the public comments, stressing that the whole plan is still only a proposal. As currently envisioned, the exchanges would be responsible for keeping the project on time and fully funding it, he added.

Regarding the $4 billion price tag for the anticipated system, aides to Senate Republicans said it is hard to assess whether the cost is realistic at this stage of planning. Previous SEC cost estimates have been wildly inaccurate, including a prediction that compliance with the 2002 Sarbanes Oxley Act -- aimed at fighting accounting fraud -- would be $91,000 for the average company, when actual costs typically ran into the millions of dollars, they said.

"I can't see any way they can get this thing up and running in three years. This is a massive undertaking," said one Senate GOP aide familiar with the proposal.

The success or failure of the project largely depends on FINRA, not SEC, the aide said. FINRA provides regulatory services to exchanges that execute the majority of trades in the United States such as the NASDAQ Stock Market, NYSE Euronext, the International Securities Exchange and the Chicago Climate Exchange. Those regulatory services include surveillance and enforcement, subject to SEC approval.

Another Republican aide noted that allowing the exchanges to design and pay for the repository makes sense, because they are more familiar with the available, effective technologies than SEC.

The government likely would not have to use taxpayer dollars if the project goes over budget or the schedule slips, according to the aides. But one area of concern is the confidentiality of customer information, they said.

When asked what expectations Sen. Christopher Dodd, D-Conn., chairman of the Banking, Housing and Urban Affairs Committee, had for the repository, a spokesman for the senator said, "Public confidence is seriously reduced when there is sudden, extreme, inexplicable volatility, and Chairman Dodd is committed to assisting regulators to determine what happened in the markets on May 6th. . . . Chairman Dodd will continue to work with the SEC and the CFTC to ensure measures are put in place to prevent the markets from experiencing such volatility in the future."