The SEC's Setback in the CAT Funding Rule and Its Implications for Market Structure and Investor Costs

The U.S. Securities and Exchange Commission's (SEC) recent legal defeat in its attempt to fund the Consolidated Audit Trail (CAT) has ignited a broader debate about regulatory overreach, market efficiency, and the long-term costs of financial oversight. The 11th Circuit Court's July 2025 ruling, which declared the SEC's 2023 funding model “arbitrary and capricious,” has forced regulators to reconsider how the CAT—a $200+ million-a-year surveillance system—is paid for. While the CAT was designed to enhance market transparency, its funding model has become a flashpoint for tensions between regulatory ambition, investor privacy, and market structure.

The CAT: A System Too Big to Justify?

The CAT, mandated in 2012 to track every equity and options trade in the U.S., was conceived as a tool to prevent another “flash crash” by giving regulators real-time visibility into market activity. But its implementation has been plagued by delays, cost overruns, and legal challenges. The 2023 funding model sought to spread costs across exchanges, broker-dealers, and investors, but critics argued it lacked transparency and fairness. The court's decision highlighted a critical flaw: the SEC failed to justify why certain market participants should bear the brunt of the costs without meaningful influence over the system's design.

The ruling underscores a recurring theme in modern regulation—ambitious mandates often outpace practical considerations. The CAT's budget ballooned from $51 million in 2016 to over $223 million in 2025, with cloud hosting alone consuming $135 million in 2022. Such opaque spending raises questions about whether the system's benefits outweigh its costs. For investors, the implications are stark: if costs are passed down to retail and institutional clients, trading fees could rise, and smaller broker-dealers may struggle to absorb the burden, potentially stifling competition.

Regulatory Overreach and Market Incentives

The CAT funding model's flaws reveal a deeper problem: regulatory overreach in a system where incentives are misaligned. Broker-dealers and self-regulatory organizations (SROs), which now cover 100% of the CAT's costs, have little say in how the system is managed. This creates a perverse dynamic: those footing the bill lack the power to control spending, while the SEC—free from financial risk—can expand the CAT's scope without accountability.

The misalignment of incentives has real-world consequences. For example, the SEC has used CAT data to justify sweeping rule changes, such as the 2022 proposal to overhaul equity market structure. Yet, the data underpinning these decisions is not publicly accessible—even in anonymized form. This lack of transparency undermines the legitimacy of regulatory actions and erodes trust in the market's fairness.

Investor Costs and Privacy Risks

The CAT's collection of personally identifiable information (PII) on every investor has also sparked privacy concerns. While regulators argue that the data is essential for detecting fraud and market manipulation, critics warn that the system's scale and lack of safeguards make it a prime target for cyberattacks. FINRA's call to stop collecting PII highlights the growing unease: investors may be paying higher fees without commensurate protections.

For investors, the cost implications are twofold. First, higher fees could deter participation, particularly among retail investors, reducing liquidity in markets. Second, the privacy risks associated with the CAT could lead to reputational damage for firms handling sensitive data, potentially affecting their stock valuations. Firms like Charles Schwab and Robinhood, which rely heavily on low-cost retail trading, may face margin pressures if the SEC's revised funding model increases operational costs.

Legal Pushback and the Path Forward

The court's decision is part of a broader trend of judicial scrutiny of regulatory actions. With a Republican-majority SEC now reviewing the funding model, the agency faces pressure to adopt a more equitable and transparent approach. One potential solution is to split costs more evenly between exchanges and SROs, aligning financial responsibility with influence over the system. Another is to establish an independent oversight body to audit the CAT's budget and ensure cost-effectiveness.

However, any new funding model must address the core issue: who should pay for regulatory surveillance? If the SEC insists on maintaining the CAT's current scope, it may need to justify the costs through congressional appropriations rather than shifting the burden to market participants. This would align with the principle that regulators should bear the costs of their own oversight, rather than imposing a de facto tax on investors.

Investment Implications

For investors, the CAT saga underscores the importance of monitoring regulatory developments and their market impacts. Here's how to position portfolios:
1. Sector Diversification: Firms exposed to regulatory costs, such as broker-dealers and fintechs, may face margin pressures. Consider hedging with defensive sectors like utilities or healthcare.
2. Privacy-Focused Stocks: As data security becomes a priority, companies specializing in cybersecurity (e.g., CrowdStrike, Palantir) could benefit from increased demand for data protection solutions.
3. Market Structure Plays: If the SEC's rulemaking process becomes more transparent, firms that provide compliance technology (e.g., Fiserv, Fidelity National Information Services) may see growth.

The SEC's CAT funding debacle is a cautionary tale about the risks of regulatory overreach. While market surveillance is essential, it must be funded in a way that balances oversight with fairness. As the agency rethinks its approach, investors should remain vigilant—both about the costs of regulation and the opportunities it creates.