Legal Action Aims to Halt SEC’s Decade-Long Attack on Investment Data and Rights

The Securities and Exchange Commission unconstitutionally mandated the seizure of data of every purchase or sale of securities in the U.S. markets, a lawsuit filed Tuesday in a Texas federal court alleged.

The lawsuit, Davidson v. SEC, challenges the Consolidated Audit Trail, or CAT, which the SEC has been quietly working to implement for over a decade. Here’s what you need to know about CAT and the lawsuit.

Decade in the Works

CAT’s origins date back to 2010 and the Obama administration. That year, under the guise of preventing another “flash crash,” in which market indices dropped some 15 percent before quickly rebounding, the SEC first promulgated Rule 613. That rule directed the creation of CAT, a database that, as the SEC explained in a press release, would track “every order, cancellation, modification and trade execution for all exchange-listed equities and equity options across all U.S. markets.”

Rather than create the desired database itself, however, the SEC, by regulation, mandated that various “self-regulated organizations” (SRO), namely the Financial Industry Regulatory Authority (FINRA) and a dozen or so national securities exchanges, create CAT. Rule 613 specified the parameters for CAT and required the collection of data sufficient to identify the individuals conducting the trades, the dates and times of any orders placed, any material terms of the order, and details concerning the broker proceeding with the order.

Under CAT, the SEC will have access to the data to conduct later searches at will. It isn’t merely the SEC with access to the data either — an estimated 3,000 people, including private individuals working for the exchanges, will likewise have access to CAT.

A Private Army of Taxing Agents

In 2010, the SEC estimated it would cost $4 billion to implement Rule 613 and an additional $2.1 billion in annual costs to maintain CAT. The SEC, whose entire annual budget for fiscal year 2010 totaled only $1.1 billion, didn’t finance its CAT mandate, however.

Instead, the SEC required the SROs, such as FINRA, to cover the cost of CAT, with the various exchanges passing the cost on to brokers or dealers and, in turn, to investors. Further, the costs passed on to Americans are already far exceeding the initial cost estimates, with costs projected to be some five times higher than originally forecast.

SEC Starts Collecting Americans’ Financial Information

In June 2020, some 10 years after the SEC first proposed CAT, it began requiring broker-dealers to submit retail investors’ information to “the CAT Central Depository.” The required reporting was at first limited to national market systems and over-the-counter equity securities but later expanded to include data related to options. By December 2021, all FINRA members, including small broker-dealers, were required to report data from these categories. Then, in July 2022, the SEC delayed full implementation of CAT until 2024.

With CAT on the cusp of full implementation, two Texas investors, Erik Davidson and John Restivo, joined by the National Center for Public Policy Research, which invests in U.S. securities, filed suit on Tuesday, in a Waco federal district court. The plaintiffs seek certification of the case as a class-action lawsuit and challenge Rule 613 on multiple fronts.

Vesting Clause and Power of the Purse

The plaintiffs’ complaint first alleges the SEC exceeded its authority in promulgating Rule 613, with count one alleging a violation of the vesting clause of Article I of the Constitution. The vesting clause provides that “[a]ll legislative Powers” are vested “in the Congress.”

Here, the plaintiffs maintain that “[t]he CAT scheme represents an emerging and disturbing pattern whereby federal agencies unconstitutionally regulate matters clearly outside the scope of their statutory authority.” In short, because Congress never authorized the SEC to adopt CAT, and because the Constitution holds “the lawmaking function belongs to Congress,” count one of the complaint argues Rule 613 is unconstitutional.

Count two further alleges the SEC violated the Constitution’s vesting of the power of the purse in Congress. “Executive agencies may spend funds on a program only if they can convince Congress to appropriate the money,” the plaintiffs allege, stressing that “[t]his applies not only to the direct use of funds raised by the government or through SEC’s self-appropriation through FINRA.”

“Bluntly put,” the complaint continues, “No agency has the power to direct the seizing of Americans’ private financial records or to fund this unlegislated and unfunded project by requiring regulated SROs to raise revenues for the project.”

First, Fourth, and Fifth Amendments

In counts three, four, and five, the complaint alleges violations of the Fourth, Fifth, and First Amendments respectively. Specifically, count three alleges the SEC’s adoption of CAT violates the Fourth Amendment, which protects against unreasonable searches and seizures. The data collected consists of private papers in electronic form and personal effects, and Rule 613 mandates such collection without cause. This scheme, the complaint alleges, represents an unconstitutional seizure of the data. And when that data is later mined by the SEC, the government executes an unconstitutional search.

Here, the complaint highlights the difference between CAT and the SEC’s historical practices. While the SEC could long obtain information about securities transactions via subpoena and a “blue sheet” process, both procedures require the SEC to have an articulable basis to investigate a possible violation of securities laws. The SEC can then only obtain data related to those trades where there is an individualized suspicion of wrongdoing.

The complaint does not challenge the blue sheet or subpoena process, arguing instead that the wholesale collection — without any suspicion — of the trading data of every American constitutes an unreasonable seizure under the Fourth Amendment. Later searches of that data further violate the Fourth Amendment’s prohibition on unreasonable searches, the plaintiffs allege.

The next count alleges CAT violates the Fifth Amendment by depriving plaintiffs of their “personal information and business records” and “private papers and records” without due process. Additionally, CAT violates the First Amendment, the plaintiffs allege, arguing that the SEC unconstitutionally requires plaintiffs to disclose the companies with which they seek to associate through securities purchases and further requires the disclosure of organizations to whom they seek to donate stock.

The First Amendment protects freedom of association, including the right to keep private those organizations. Rule 613 requires plaintiffs and every American trading on U.S. exchanges to inform the government of the entities with whom they seek to associate, in violation of the First Amendment.

Additional Counts

The legal challenge to CAT adds two more claims under the Administrative Procedure Act, one alleging the SEC exceeded its constitutional authority and the second alleging the SEC acted beyond its legislative authority. Plaintiffs also include a count under the Mandamus Act, 28 U.S.C. § 1361, seeking an injunction directing the SEC to abrogate all rules related to CAT.

Finally, the complaint alleges one count against defendant CAT LLC — the corporate entity created by FINRA and the other exchanges to hold ownership of the CAT database. Here, the plaintiffs allege an “unjust enrichment count,” asserting that “CAT LLC has no legitimate claim to” the data provided it, and therefore, CAT LLC should be ordered to expunge all data from CAT.

Constitution Doesn’t Care If CAT Is Too Big to Fail

Administrative overreach is nothing new. However, today’s lawsuit in Davidson v. SEC exposes a new extreme and multifaceted disregard for the Constitution by the administrative state.

It isn’t merely that the SEC regulated beyond its authority. The SEC also considered itself able to privately raise revenues to further its ultra vires goal of implementing CAT, ignoring the commands of the Fourth, Fifth, and First Amendments in the process. So while a court may pause at the thought of dismantling the billion-dollar-plus CAT scheme that has been in the making for over a decade, the Constitution should quickly overcome any such hesitation.

Margot Cleveland is Of Counsel for NCLA.