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op.! MARKET OVERSIGHT SURVEILIANCE SYSTEMDescription and Justification

INTRODUCTION

Given dramatic changes in the complexityand structure of

the securities markets during the pas t five years, including

the rapid development of new productssuch as exchange traded

put an d call options, the need to accelerate progress toward

realization of a National.Market System, and theneed-to improve

oversight of the self-regulatory organizations (SRO's) in an en-

vironment of increasing trading complexity, the Con~nission seeks

to establish and proposes to implement a national market surveil-

lance system based upon the latest computer technology.

In addition to providing the Con~nission for the first time.- . , .

.with a direct surveillance capabilityover trading actiyities on

:all of th en ati on' s stock and options markets, the proposed s ys te m

willfacilitatemany existing Con~ission functions such as the

inspe ction and regulation of self, egulatory organizations and

the examinat ion of registered broker-dealers. Th e system is

expected to be implemented over a five-year period, depending

upon industry developments, the pace at which trading infor-

mationcan be standardized, and the availability of governmen t

funding. By building upon existing industry and self-regulatory

automate dsyste ms, the system co stw ill be relatively modestincomparison to communications and computer systems created in

rec ent years elsewhere in government or in private industry.

The comprehensive market surveillance system, when implemented,

will represent a substantial improvement in the industry's and

the Commission's regulatorycapabilities.

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sonnel to run the computing equipment and service the user environment.L

Some of the personnel requirements can be met with4n allotted posi-

tions presently available in the Con~ission. Other positions are new

and must be provided.

The following schedule breaks out the estimated requirements by

category by year and contains anticipated new positions in parentheses:

Users

Liaison

Year

1 2 3

16(0) 23(7) 28(12)

< 5

38(14) 42(14)

2(0) 2( 0) 2(0) 3(1) 3(1)

Sys tem Oper atio n 8(0) 9(1) 10(2) 11(3) 12(4)

26(0) 34(8) 40(14) 52(18) 57(19)

Added Positions 0 +8 +6 +4 +iby Year

The President's 1981 budget for the Con~ission is based on the

assumption that no new positions are required in the first ye ar . The

Con~ission estimates an additional 8 personnel will be required in the

second year, 6 in the third year, 4 in the fourth year, and 1 in the

fi ft h year. The costs related to the new positions have been estimated

by averaging first year GS-II/12 for users, GS-12/13 for liaison, and

GS=9/10 for syste operation.

Other Operati ng Costs - These costs are broken into outside

services (such as consolidated ticker, pricing, corporate action,

security statistics), hardware/software maintenance by a vendor,

an d uti l i t ies~supplies~miscel laneous.

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The fo llowing c har tpr ovi des es t imates by year for the implementa tion and opera-

t io of the new marke t surveil lance system. Additionally, an annual breakdown by func-

tion by year is gi ve n for one-time costs using the percentage estimates previously stated, i;

Note:

C O ST ES T IM ATE S F O R I M P L I ~ E N T I N G A N D O P E R AT I N G T H ENEW MARKET SURVEILLANCE SYST~4

5 YEAR PERIOD

Costs do not include space, or depreciation and assume annualCPI in crease of 9% from 1979 dolla rs ($000's).

Level 1 Le ve l 2 Level 3~.

Year 1 Year 2 Year 3 Year 4\ Year 5

Totalsfo r

5-Years

One-time Costs:

Computing. Equipme nt:

- Trans actio n Coll ecti on ~- 250

- Data Base/Batch Processor 350

Sof twareDeve lopmen t 600

Implementation, Training,Documentation, ProjectExpenses 500

Total One-time Costs 1700

ii 0

220

1200

77 0

2300

12 0

24 0

1 2 9 0

83 0

2480

130

26 0

1400

140

280

1 4 1 0

900 970

2690 2800

750

1350

5900

3970

11970

Oper atin 9 Cos ts (Annuail):

Personnel (NewPosi t ions)

- Users @ GS 11-12 0 (7) 162 . (12)302 (14)384 (14)419

- Liaison.@ GS 12-13

- System Operation@ GS 9-10

Non-Personnel:

0

0 (i)

0

18 (2)

0

40

(i) 33 (i)

(3) 65 4)

36

94

- Outside Services 25 0 19 0 21 0 260 280

- Hardware/S oftware Maint. 30

- Utilities, Supplies, Misc. 20

Total Operating Costs 300

Total One- time & Operating_ 2000Costs

30

20

42 0

2720

40

30

62 2

3102

50

30

82 2

3512

60

40

92 9

3729

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This schedule is intended t o break down one-time costs presented above by new

system functions byyear. .

Level 1 Level 2 Level 3

Year 1 Year 2 Year 3 Ye ar 4 Year 5

Totals

for5-Years

One-time Costs by Function:

Trade/Transact ionWatch 1280

Audit Trail/TradeReconstruction 350

Analysis and MIS 50

Investigation Coordinationand Tracking 0

Inspection Enhancem ent 20

Total 0he-timeCo sts (as 1700previously stated)

1700

540

20

i0

30

2300

680 73 0 690 5080

1220

120

ii0

35 0

2480

1330

25 0

740

14 0

4180

58 0

0 0 12 0

380 1230 2010

26 90 2800 11970

THE ROLE OF THE PILOT PROJECT

As an initial step in implementing the proposed market

surveillance system, the Conmission is undertaking a pilot

project in order to begin creating the dat a base and testingi"

Certain basic components required for the trade/transaction

watch and marke t reconstruction functions. This pilot pro-

je ct is being undertaken through a service contract with a

contractor.

The arrangement has been structured to provide

Surveill ance-rela ted b enefits to the Con~nission using con-

tractor hardwa re syst ems and contractor-developed software,

some of which can be transplanted to the final system opera-

tion at the Commission. The initial operati on of the pilot

in, ed ia te

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system will be done by the contractor.

A sun~nary of th e salien t fe athres of the pilot are as

follows:

- All t rades and NASDA Qqu ote s wi l l be received and

stored on comput er files in real-time, i.e., as they

occur;

- Trade and option clearing data will be received and

stored on computer fi les; .

- A set of off-l ine alert tests will be made on a daily

basis esulting in certain exce ption reports being

produced and transmitted to the SEC in Washington.

These reports will f lag aberrations in price, plus/minus

ticks, closing transactions, OTC bids, block trades, and

certain option trading patterns; and

- To suppor t the preliminary analysis wor k done to qualify

an alert , an off ' l ine print capabili ty will be provided

to list selected single transaction streams on a request

basis.

This is a particularly crit ical t ime in the surveillance

activi ties of the Conm~issi0n. Wit h the eminent re scissi on of ~

the options moratorium which will undoubtedly result in heavier

rading across options and equiti es markets, the need for more

sophi sticat ed moni tori ng methods is in~nediate. No single self-

regul atory organi zati on (SRO) is respons ible for, nor has the

information necessary for, Cross-market surveillance. The recent

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Commission Optio ns Study Report highlighted deficiencies in present

Isurvei ilance me th od san d made reco~nendations for SRO Procedural

chang es to enhan ce both SRO and the Con~nission's role of over sigh t

and regulation of various market participants. The Con~ission

must continue to work in con cer t with the implementation of

these improved procedures by utilizing advanced con~nunication

and computer techniques to effectively keep abreast of the changing

state Of trading technology.

Market surveillance is very complex in today's securities

~nvironment and requires the conduct of a multi-million dollar,

multi-yea r p roje ct to obtain the level of sophistication necessary

to meet increasing regulatory demands. In anticipation of a

lengthy budget approval, RFP (Request for Proposal), and procure-

ment cycle, the Commission elected to proceed with the pilot

project to begin collecting and analyzing data on a limited

scal e. Such activities are felt to be worthwhile in terms of

producing short-range benefits while laying the basic foundation

of the fin als yst em. The pilot project is expected to achieve

in the Short-term, at least as percei ved b y the industry, wha t

~e full system will achieve in the long-term, and its mo nt h- to -

month remote operation will easily and directly dovetail into

~e first level of full system implementa tion.

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S [ 3 M M A RY O F F I R S T- Y E A R P R O G R A M

TheConmlission is requesting $1,700,000 inon e= tim e development

costs in 1981 for the first year of the system's life, consisting of:

Computing Equipment

Software Development

Implementation, Trainingand Project Expenses

Total One-time Costs

$600,000

600,000

500,000

$1,700,000

During the f irs tye ar, the Con~aission will relocate approxi-

matelyS200,000 worth of software componentsdeveloped and imple-

mented by thecontractor during the pilot project. This software

Will provid e the basis upon which additional develo pment will be per-

formed creating the schedule of benefits mentioned previously for

Level 1 of the overall project.

At the com pletion of the firs t year, the Con~nission will have

in place the principal hardware components and essential software

ingredients to sustain the initial thrust of in-house surveillance.

Additionally, the internal organiz ation nece ssary to operate the

system and utilize the early system outputs will be trained and

operative with over a year's experience in dealing with the more

s0phisticated surveillance methods.

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