Fairness and integrity are critical to the development of deep and liquid securities markets. A strong, honest, and stable market attracts investors; conversely, without the confidence of investors in the integrity of a marketplace, investors are likely to seek investment opportunities elsewhere. COSRA members agree that regulatory mechanisms designed to promote the fairness and integrity of the marketplace contribute to the growth and development of strong, liquid securities markets. Market regulators, governmental and non-governmental market authorities alike, must provide soundly constructed regulatory tools to enhance market integrity. One regulatory tool that COSRA members find effective in promoting honesty and fairness is the use of automated audit trails to monitor securities market activity so as to detect unusual trading activity or market conditions that may indicate violations of laws or rules.

An audit trail is a time-sequenced record of market transactions. It is a regulatory tool that facilitates surveillance systems and the investigation of potential wrongful conduct. Audit trail data is generally composed of two streams or types of data: (l) transaction and quotation data disseminated to the public; and (2) data transmitted for settlement between the parties to the trade. Audit trail systems should capture all material elements of trade information and should be produced in a timely and accurate fashion. A market authority should strive to automate the various facets of audit trail systems in order to maximize the usefulness of such systems.

COSRA members generally agree that a market authority should design its audit trail systems to capture and store trading information in a manner that is consistent with applicable recordkeeping, reporting, settlement, and market trading rules, regulations, and practices. Although the particular elements of audit trail systems may vary depending on differences in market structures, certain basic principles may be applied in constructing such systems.

1. FACILITATION OF SURVEILLANCE AND INVESTIGATIONS

Audit trails should be designed to facilitate the efficient surveillance and investigation of market transactions that may violate a market authority's rules and regulations.

The nature and complexity of market trading abuses vary widely. Violations of some market trading rules, such as rules governing the execution of orders or position limits, may be easily detected and investigated because clearly delineated standards of wrongful conduct may be established by a market authority. On the other hand, violations involving fraudulent or manipulative schemes may be difficult to detect and investigate because the standards or violative conduct are not as clearly defined or may not involve readily discernible patterns of deceit or omissions of fact.

Market authorities should carefully consider the information needed to detect and investigate the full range of violations and should facilitate the efficiency of surveillance systems and investigations by gathering as much trade data as possible. For example, in order to facilitate the detection of complex patterns of fraud or manipulation involving more than one market participant and broker, an audit trail must contain information identifying all clearing and executing brokers for the parties to the trade. In addition, care should be taken that markets trading the same security cooperate to ensure that there can be effective surveillance and, where necessary, enforcement of relevant laws and regulations. Similarly, in order to detect a technical floor trading violation, such as a prohibition of acting as principal and agent during the same day, an audit trail system should capture information regarding the capacity in which all parties to a trade acted.

2. ELEMENTS OF AUDIT TRAIL INFORMATION

Audit trails should contain all material elements of trade information that may be relevant to the detection and investigation of wrongful trading activity.

The trade information that is commonly deemed to be relevant for market surveillance and investigative purposes, includes: (1) trade date; (2) settlement date; (3) security identifier; (4) trade price; (5) trade quantity; (6) market quotations and time thereof; (7) parties to the trade; (8) the capacity of each party to the trade; and (9) time of the trade.

The information identifying the parties to the trade should include all clearing brokers and executing brokers for the parties to the trade. Depending on the nature of a market's structure and practices, the information regarding the parties to the trade also may include the account numbers of the buyers and the sellers.

The information regarding the capacity of the parties to the trade should identify whether the party is acting for its own account as principal, or as an agent for the account of another. Capacity information also may identify whether a party to the trade is a market professional or public investor.

The time of the trade should include the actual time that the trade was executed. The time that a trade is entered or reported as executed also may be useful to help detect, or provide relevant information about, possible wrongful trading activity. For example, in a market that employs a manual system for delivering orders to a specific location for physical negotiation and execution, it should be a market requirement that the time that an order is entered and reported as executed should be time stamped by an appropriate person involved in the trade or in supervising such trading activity. Similarly, in a market that employs an automated system that electronically handles orders and automatically executes trades, the system itself should be programmed to ensure that the time that orders are entered and reported is noted in the system database.

3. TIMELY AND ACCURATE PRODUCTION OF AUDIT TRAILS

Audit trails should be produced on a timely basis and should be reasonably accurate in order to effectively support market surveillance and investigatory functions.

Inaccurate or untimely audit trail data may be of little use to a market authority and can contribute to the waste of scarce regulatory resources. On the other hand, while completely acclimate and instantaneous audit trails are desirable and should be the ultimate regulatory goal, COSRA members recognize that such a goal may be difficult to achieve. Accordingly, audit trails should be reasonably accurate and should be produced on a reasonably timely basis that effectively supports a market authority's regulatory programs.

In order to assure the timeliness of audit trail information, market authorities should carefully evaluate market trading rules and practices, the quantity of data associated with overall market activity, and the characteristics of market abuses, when establishing the appropriate reporting and retention time frames for audit trail data. In most cases, an overnight or next-day reporting time frame would be sufficient for supporting market surveillance and investigatory functions. The length of time required to detect and investigate complex violations would necessitate that market participants be required to retain the information reported to a market authority's audit trail systems for a period of no less than three years.

To assure the reliability of its audit trail, a market authority should develop systems for monitoring the accuracy and completeness of information reported to, and contained in, its audit trail systems. Many audit trail inaccuracies may result from careless reporting by market participants. Accordingly, a market authority should develop examination or oversight programs that monitor and assure compliance with audit trail reporting requirements by market participants.

4. AUTOMATION OF AUDIT TRAILS

A market authority should strive to automate the various facets of audit trail systems in order to maximize the efficiency and usefulness of such systems.

The components of audit trail systems that may be automated include data capture and reporting by market participants as well as data processing by market authorities. The automated capture and reporting of audit trail data by market participants enhances the timeliness of audit tray systems. The automated capture and reporting of audit trail data also improves accuracy by reducing the normal occurrence of human error that is attendant to manual information capture and reporting by market participants.

The automation of audit trail databases enhance their functionality by facilitating more efficient processing and sorting of information by market authorities. For example, the effective detection and investigation of a particular market trading abuse may require that audit trail information be simultaneously sorted by time, broker, and capacity. Without significant automation, sorting trade data in this fashion may be excessively cumbersome or may generate unreliable results.

The benefits of audit trail automation increase exponentially as the volume of activity captured by a market authority's audit trail system increases. When evaluating the costs and benefits of automation, a market authority should quantify current activity and should estimate future growth in activity. Nevertheless, even when current market activity is not great, automated audit trail systems provide significant benefits to the surveillance and investigatory systems and provide a sound foundation to expand upon as market activity grows.