11th Circuit Strikes Down SEC CAT Funding Rule: Implications for Broker-Dealers, Dark Pools, and Market Participants

Posted on July 25, 2025 by De Silva Law Offices

The Eleventh Circuit Court of Appeals today vacated the SEC's 2023 Funding Order for the Consolidated Audit Trail (CAT). Judges ruled unanimously that the order violates the Administrative Procedure Act (APA). This decision, in American Securities Association v. SEC (No. 23-13396), disrupts the SEC's plan to fund its vast trade-tracking system.  Opinion can be read here.

Background on the CAT and Regulatory Framework

Congress passed the Securities Exchange Act of 1934 after the 1929 stock market crash and the Great Depression. This law created a system to regulate the securities industry. The SEC oversees private self-regulatory organizations (SROs). These groups handle day-to-day market regulation. SROs include 24 national securities exchanges, such as NASDAQ and the New York Stock Exchange. They also include the Financial Industry Regulatory Authority (FINRA), a non-profit. SROs enforce compliance. Broker-dealers must follow federal securities laws, rules, and additional SRO guidelines.

Audit systems evolved over time. Early ones relied on manual reviews of trading tapes and audits. By the 1990s, electronic systems emerged. The NYSE's system, for example, reconstructed trades with details like time, firms, and brokers. But these systems fragmented across SROs. They proved inadequate for modern, dispersed markets.

The SEC addressed this in 2012. It adopted a rule requiring SROs to create a unified CAT. This system consolidates trade data, including time and broker identity. Regulators use it for auditing, surveillance, and enforcement. The SEC justified the CAT as a way to enhance oversight. It promotes efficiency and fulfills statutory duties. See Consolidated Audit Trail, 77 Fed. Reg. 45722 (Aug. 1, 2012).

SROs submitted a National Market System (NMS) Plan in 2015. The SEC approved it in 2016. See Joint Industry Plan; Order Approving the National Market System Plan Governing the Consolidated Audit Trail, 81 Fed. Reg. 84696 (Nov. 23, 2016). The CAT operates through CAT NMS, LLC, owned by SROs. Broker-dealers serve in a non-voting advisory role. The plan required cost-sharing between SROs and broker-dealers. The SEC's 2016 economic analysis estimated build costs at $37.5–$65 million. Annual operating costs ranged from $36.5–$55 million. It concluded positive effects on competition, efficiency, and capital formation.

Implementation brought surprises. The CAT went live in 2020. Legacy systems shut down in 2022. Costs ballooned. Building it cost $518 million—eight times the high estimate. Annual operations hit nearly $200 million—nearly four times the projection. SROs funded it initially through loans to CAT LLC.

Bar chart comparing SEC's 2016 CAT cost estimates ($37.5–$65M build, $36.5–$55M annual) to actuals ($518M build, $200M annual).

How Does the CAT Handle Dark Pools and Retail Trades?

Retail investors typically have their orders executed outside of public “lit” exchanges, in venues commonly known as dark pools or through wholesale market makers. These private trading venues match buyers and sellers away from the open market, providing anonymity and often lower transaction costs.

Prominent firms such as the Petitioner, Citadel Securities. operate off-exchange trading services that internalize a huge portion of retail order flow. However, while dark pools and internalizers can offer price improvements for small trades, they substantially limit market transparency since the orders are not visible on public order books.

The majority of retail stock trades bypass public exchanges entirely. Over 90% of individual investors’ marketable orders are routed to off-exchange dealers (wholesalers or dark pool operators) instead of the lit markets. This high volume of off-exchange retail trading has raised concerns about fairness and visibility in the market.

The CAT expands oversight here. It requires reports from broker-dealers, exchanges, and dark pool operators. By tracking the full lifecycle of every order and trade, the CAT also helps identify potential instances of market manipulation, insider trading, or other illicit activities.

Regulatory advocates like Better Markets have emphasized that a fully functioning CAT is essential to market surveillance. In an April 2025 comment letter, they argued that scaling back the CAT’s customer data collection undermines the SEC’s enforcement capabilities and increases the risk of manipulation going undetected.

The 2023 Funding Order: What Went Wrong?

The SEC issued the 2023 order to allocate CAT costs. It replaced an old model with the "Executed Share Model." This splits expenses equally: one-third to the buyer's broker-dealer, one-third to the seller's, and one-third to the SRO.

SROs can pass their share fully to broker-dealers via fees. This setup lets broker-dealers, and ultimately investors, bear up to 100% of costs. The SEC approved it in a 3-2 vote. Dissenters warned of misaligned incentives. SROs control budgets but can shift expenses.

Petitioners challenged it. The American Securities Association and Citadel Securities claimed violations. The court agreed on APA grounds. It avoided broader Exchange Act issues.

Detailed Analysis of the Court's Ruling and Rationale

Judge Brasher wrote the opinion. Judges Jordan and Geraghty joined. The court vacated the order as arbitrary and capricious. It cited two core APA flaws. Agencies must explain decisions reasonably. They cannot ignore key problems.

Petitioners' Challenges

The petitioners argued three main points. First, they claimed the CAT itself violates the Exchange Act. The SEC called this untimely. Second, they attacked the cost allocation. They said it acts arbitrarily by allowing 100% pass-through. This conflicts with prior shared-cost mandates. It creates misaligned incentives, turning SROs into free riders. Third, they criticized the economic analysis. It failed to update 2016 estimates despite huge cost jumps and a new structure. This breaches APA reasonableness.

The court skipped the CAT's legality. It practiced judicial minimalism. It also ignored Exchange Act claims. Instead, it resolved everything on APA grounds.

Court's Analysis and Holding

The court held that the 2023 Funding Order violates the APA. It fails to deliver a "reasonable and reasonably explained" decision. See FCC v. Prometheus Radio Project, 592 U.S. 414, 423 (2021).

A central flaw identified by the Eleventh Circuit is the SEC’s internal contradiction regarding cost allocation. On one hand, the SEC repeatedly emphasized that both self-regulatory organizations (SROs) and broker-dealers must share the costs of the Consolidated Audit Trail (CAT). Yet, in a puzzling move, the same order permitted SROs to shift all these costs exclusively onto broker-dealers. The court was troubled by this inconsistency and found no meaningful justification for the SEC’s sudden reversal. By quietly discarding the original shared-cost approach, the Commission undermined the fairness and transparency mandated by the Administrative Procedure Act.

Moreover, the SEC overlooked important aspects of the problem, especially misaligned incentives. Under the new order, SROs manage the CAT budgets yet could fully shift the associated costs to broker-dealers. This creates a classic free-rider problem. The SEC’s response—that SROs will control costs because they pay one-third, fails, as it incorrectly assumes no pass-through will occur. Yet the order explicitly permits pass-through. The dissenting commissioners highlighted this flaw, pointing out that broker-dealers would lack input into budgetary decisions even as they potentially bear the full financial burden.

The Eleventh Circuit was particularly concerned about the misalignment of incentives created by the SEC's funding structure. Under the new order, SROs control the Consolidated Audit Trail’s budgets. They decide how much money to spend, how the system runs, and what costs to incur. At the same time, these SROs can pass every cent of the cost onto broker-dealers. This sets up a classic free-rider scenario: SROs have no real motivation to limit spending because they aren't footing the bill. Instead, broker-dealers must pay the tab, even though they get no meaningful say in budget decisions.

The court also dismissed the SEC’s defenses. The SEC had argued that Exchange Act safeguards and assumptions of future compliance would sufficiently protect broker-dealers. The court viewed these arguments as post-hoc rationalizations, which the law expressly forbids. See SEC v. Chenery Corp., 318 U.S. 80, 87 (1943).

The court concluded by carefully choosing an appropriate judicial remedy. Rather than simply remanding the matter back to the SEC, the Eleventh Circuit determined that vacating the 2023 Funding Order was the right course. The court viewed the SEC's failure to justify its cost-shifting decision as a serious procedural defect. Allowing SROs to pass all costs to broker-dealers represented a fundamental shift from previous policy. Because broker-dealers might face substantial financial consequences without adequate legal protections or meaningful input, the court saw no other remedy as adequate. Simple remand, without vacating the order, would leave broker-dealers exposed and potentially without recourse.

Yet, acknowledging practical realities, the court softened its decision slightly. It chose to stay the vacatur for 60 days after issuing its mandate. This brief stay gives the SEC time to revisit and fix its order, performing the economic analysis it had previously avoided. The stay aims to prevent immediate disruption to CAT operations and gives regulators room to put fairer and clearer rules in place.

Economic Analysis (APA Violation)

The court also took issue with the SEC’s reliance on an outdated economic analysis from 2016. At that time, the SEC justified the Consolidated Audit Trail (CAT) by balancing projected costs and benefits. Since then, the costs have skyrocketed—exceeding the original estimates by hundreds of millions of dollars. Yet the SEC made no meaningful updates to its earlier assessment. The court criticized this omission as unreasonable and inadequate under the Administrative Procedure Act. Agencies must respond reasonably when faced with dramatically changed circumstances. Here, the SEC failed that test.

The court rejected the SEC’s defenses as unpersuasive. The Commission argued that updating its analysis wasn't necessary since it wasn't reconsidering the CAT itself. It further claimed to have relied on the "best information available" at the time. But these arguments fell short. The substantial new facts on costs and the revised allocation structure demanded a fresh, careful reassessment. The court found it unreasonable for the SEC to lean so heavily on a flawed and outdated 2016 economic analysis.

Remedy

The court chose vacatur, the ordinary APA remedy for serious, central flaws—such as the unexplained policy shift and the SEC’s failure to address misaligned incentives. See Black Warrior Riverkeeper, Inc. v. U.S. Army Corps of Eng'rs, 781 F.3d 1271, 1290 (11th Cir. 2015). The court found that vacating the rule would not cause significant disruption, since the CAT had operated without a funding order since 2016. In contrast, a remand without vacatur could expose broker-dealers to unrecoverable fees, and SRO immunity would likely prevent them from seeking relief.

The court concluded that the agency’s errors “incurably tainted” the rulemaking process. On balance, equitable considerations favored vacatur. To reduce uncertainty, the court stayed the vacatur for 60 days following issuance of the mandate. This stay gives the SEC time to conduct a new economic analysis and reconsider cost allocation, modeled after remedial approaches in cases like N. Pipeline Const. Co. v. Marathon Pipe Line Co., 458 U.S. 50, 88 (1982).

A Post-Chevron Era: Heightened Scrutiny for Agencies

This ruling aligns with post-Chevron trends. The Supreme Court formally ended Chevron deference in 2024. See Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024). Courts no longer defer to agency interpretations of ambiguous statutes. Instead, they apply independent judgment, shifting interpretive power from agencies to the judiciary.

The Eleventh Circuit’s decision reflects that shift. The court demanded rigor from the SEC and found the agency’s reasoning and treatment of the record lacking.

More challenges to agency rulemaking may follow, especially in complex areas like financial regulation. Agencies must now justify their decisions with clarity and substance, as courts apply independent judgment and heightened scrutiny under Loper Bright.

What Happens Next? Implications for Your Business

The court vacated the SEC’s CAT funding order but paused enforcement for 60 days, giving the agency time to revise its approach. A new economic analysis and a revised cost-sharing model are likely on the way.

For broker-dealers, the decision offers short-term relief from funding obligations. However, the long-term cost structure remains uncertain and could shift significantly once the SEC reissues its plan. For investors, the ruling may help prevent higher trading costs that broker-dealers might otherwise pass down, though future impacts depend on how the revised funding framework is shaped. And for dark pool operators like Citadel, the outcome maintains CAT oversight while avoiding immediate increases in financial responsibility.

De Silva Law Offices advises stakeholders, including broker-dealers on navigating securities regulation and challenging administrative rules under the APA and the Exchange Act. Contact us to discuss how this decision may affect your compliance strategy.

This post provides general information only. It does not offer legal advice. Reach out for personalized guidance.