SEC Should Shut Down Big Brother Database for Stock Traders

The financial regulators in this country have been on a streak of encouraging moves recently, and the Securities and Exchange Commission (SEC) now has a golden opportunity to keep the good times rolling. The agency just closed the comment window on its review of the Consolidated Audit Trail (CAT), the master database it established to track every order, cancellation, modification, and executed trade across U.S. equity and options markets. 

Since the SEC first proposed the CAT in 2010, critics have identified a long list of deficiencies and problems associated with the program. The agency has now received hundreds of comment letters to inform its “comprehensive review.” When the staff is done with its analysis, they should do the right thing: Shut down CAT entirely. 

As part of the concept release that the SEC issued in April, commissioners specifically solicited comments on whether changes should be made to the CAT that respond to “civil liberty, privacy, and confidentiality concerns; cost-efficient technology solutions; and cybersecurity considerations.” They have now received an earful of comments related to just those concerns. 

Even a short summary should cause anyone who cares about limited government some alarm. For starters, the CAT has First Amendment issues that were present in Supreme Court cases like Americans for Prosperity Foundation v. Bonta (2021) and NAACP v. Alabama (1958). In those cases, mandated government disclosure of financial data from individuals — who were not suspected of any crime — was considered to have a chilling effect on free speech and association because such information could be weaponized by motivated government officials. In Bonta, the Supreme Court reiterated that “protected association furthers ‘a wide variety of political, social, economic, educational, religious, and cultural ends,’ and ‘is especially important in preserving political and cultural diversity and in shielding dissident expression from suppression by the majority.’” 

When it comes to First Amendment protections, investment choices may not be as obviously expressive conduct as writing a newspaper op-ed or protesting in front of a government building. But the SEC’s own commissioner Hester Peirce has argued persuasively that these are indeed expressive acts, writing that “economic transactions offer a window into a person’s deepest thoughts and core values” and “are a rich form of value expression.” If investment decisions are as important for making the world a better place as the environment, social, and governance (ESG) crowd insists, surely they also count as protected expression.

An Orwellian database of every stock and option transaction is a treasure trove of information for deep-state operators committed to causing mischief. Could such a serious violation actually happen, or is it a fanciful hypothetical? Maybe we should ask the former IRS contractor who is currently serving time in federal prison for leaking President Trump’s tax returns and the private information of thousands of Americans.

But that’s just the beginning. The CAT has major Fourth Amendment problems as well. The comprehensive nature of the audit trail data represents a shift from surveilling specific suspects to surveilling everyone, as my colleague Wayne Crews put it. The current SEC practice for populating CAT gathers data on everyone all the time, then allows the staff to search it for anything that might be slightly incriminating. This practice should be considered equally illegal as the police searching every home in a given area without a warrant and obtaining the names of the owners only after discovering evidence of possible crime.

Commissioner Peirce has warned about the problems here too, asking us to consider what this theory would look like if applied to any other industry. “Imagine that every time you went to the grocery store, convenience store, bookstore, or hardware store, those stores — under government orders — sent a complete, itemized list of what you bought and when you bought it to the government and organizations working on its behalf that could challenge you to explain any purchase that catches their interest,” she said. No one who cares about civil liberty would agree to such an absurdly unconstitutional premise. It’s not clear if even the Communist Party of China would demand such lists. 

And we can’t let the previous SEC leadership off easy, since the CAT also has Fifth Amendment concerns relating to property takings. The trade data scooped up by the agency, including order timing and execution details, can reveal highly valuable proprietary trading strategies. Being forced to yield up intangible trade secrets without compensation can be considered a regulatory taking, as the Supreme Court found when Monsanto sued the Environmental Protection Agency in the 1980s. Attorney Jay Khurana, in the University of Chicago Business Law Review, recently made a similar point in response to calls demanding additional regulations on hedge funds and short selling.

The CAT may similarly run afoul of the Fifth Amendment’s protection against self-incrimination. The Cato Institute’s Thomas Berry, for example, has written: “The SEC, without a warrant and absent a showing of even reasonable suspicion, is acquiring and searching massive amounts of investors’ and brokers’ personal information and transactions stretching back years. By compelling the production of potentially incriminating records, the CAT violates the Fifth Amendment rights of investors and brokers not to be forced to testify against themselves.” Again, we would not tolerate this level of overreach in any normal law enforcement framework.  

Even if you aren’t afraid of being prosecuted for securities fraud, there are more prosaic privacy concerns that should worry anyone whose data has ever been captured by the CAT. Maintaining a giant database full of information on millions of presumptively innocent Americans presents significant cybersecurity problems. The SEC has had its own issues maintaining its EDGAR database and locking down other digital properties, like a former chairman’s social-media account. And these concerns aren’t limited to regulation of financial transactions. Smart analysts like Shoshana Weissmann have written about the dangers posed by huge, unwieldy government databases in the context of issues like age verification for digital media. Her concerns are relevant to the SEC as well. 

Read the full article on National Review.