Proposed Rule2022-06960
Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer
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Published
April 18, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is proposing new rules to further define the phrase "as a part of a regular business" as used in the statutory definitions of "dealer" and "government securities dealer" under Sections 3(a)(5) and 3(a)(44), respectively, of the Securities Exchange Act of 1934 ("Exchange Act").
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<title>Federal Register, Volume 87 Issue 74 (Monday, April 18, 2022)</title>
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[Federal Register Volume 87, Number 74 (Monday, April 18, 2022)]
[Proposed Rules]
[Pages 23054-23106]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-06960]
[[Page 23053]]
Vol. 87
Monday,
No. 74
April 18, 2022
Part II
Securities and Exchange Commission
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17 CFR Part 240
Further Definition of ``As a Part of a Regular Business'' in the
Definition of Dealer and Government Securities Dealer; Proposed Rule
Federal Register / Vol. 87 , No. 74 / Monday, April 18, 2022 /
Proposed Rules
[[Page 23054]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-94524; File No. S7-12-22]
RIN 3235-AN10
Further Definition of ``As a Part of a Regular Business'' in the
Definition of Dealer and Government Securities Dealer
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing new rules to further define the phrase ``as a part of a
regular business'' as used in the statutory definitions of ``dealer''
and ``government securities dealer'' under Sections 3(a)(5) and
3(a)(44), respectively, of the Securities Exchange Act of 1934
(``Exchange Act'').
DATES: Comments should be received on or before May 27, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.htm">https://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#6614130a034b05090b0b030812152615030548010910"><span class="__cf_email__" data-cfemail="fa888f969fd7999597979f948e89ba899f99d49d958c">[email protected]</span></a>. Please include
File Number S7-12-22 on the subject line.
Paper Comments
<bullet> Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-12-22. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (<a href="https://www.sec.gov/rules/proposed.shtml">https://www.sec.gov/rules/proposed.shtml</a>). Comments also are available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. Operating conditions may limit access to the
Commission's public reference room. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Emily Westerberg Russell, Chief
Counsel; John Fahey, Deputy Chief Counsel; Joanne Rutkowski, Assistant
Chief Counsel; Shauna Sappington Vlosich, Senior Special Counsel; James
Blakemore, Special Counsel; or Katherine Lesker, Special Counsel at
202-551-5550 in the Office of Chief Counsel, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is proposing the following
new rules under the Exchange Act: (1) 17 CFR 3a5-4 (Rule 3a5-4) and (2)
17 CFR 3a44-2 (Rule 3a44-2) (collectively, the ``Proposed Rules'').
I. Introduction
Advancements in electronic trading across securities markets have
led to the emergence of certain market participants that play an
increasingly significant liquidity providing role in overall trading
and market activity--a role that has traditionally been performed by
entities regulated as dealers.\1\ However, these market participants--
despite engaging in liquidity providing activities similar to those
traditionally performed by either ``dealers'' or ``government
securities dealers'' as defined under Sections 3(a)(5) and 3(a)(44) of
the Exchange Act, respectively, and despite their significant share of
market volume \2\--may not be registered with the Commission as either
dealers or government securities dealers under Sections 15 and 15C of
the Exchange Act, respectively.\3\ Because of this, investors and the
markets lack the important protections that result from an entity's
registration and regulation under the Exchange Act. In addition,
obligations and regulatory oversight that promote market stability and
investor protection are not being consistently applied to entities
engaged in similar activities.
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\1\ See Department of the Treasury, Notice Seeking Comment on
the Evolution of the U.S. Treasury Market Structure, 81 FR 3928
(Jan. 22, 2016) (``Treasury Request for Comment''). See also Joint
Staff Report: The U.S. Treasury Market on October 15, 2014 (July 13,
2015) (``2015 Joint Staff Report''), prepared by staff of the U.S.
Department of the Treasury, Board of Governors of the Federal
Reserve System, Federal Reserve Bank of New York, U.S. Securities
and Exchange Commission, and U.S. Commodity Futures Trading
Commission, available at <a href="https://www.sec.gov/reportspubs/special-studies/treasury-market-volatility-10-14-2014-joint-report.pdf">https://www.sec.gov/reportspubs/special-studies/treasury-market-volatility-10-14-2014-joint-report.pdf</a>. The
2015 Joint Staff Report is a report of the Inter-Agency Working
Group for Treasury Market Surveillance (``IAWG''). Staff reports,
Investor Bulletins, and other staff documents (including those cited
herein) represent the views of Commission staff and are not a rule,
regulation, or statement of the Commission. The Commission has
neither approved nor disapproved the content of these staff
documents and, like all staff statements, they have no legal force
or effect, do not alter or amend applicable law, and create no new
or additional obligations for any person. See also Concept Release
Concerning Equity Market Structure, Exchange Act Release No. 61358
(Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010) (``2010 Equity Market
Structure Concept Release'') at 3594-96 (discussing the evolution
from ``a market structure with primarily manual trading to a market
structure with primarily automated trading'').
\2\ FEDS Notes, ``Principal Trading Firm Activity in Treasury
Cash Markets,'' James Collin Harkrader and Michael Puglia (Aug. 4,
2020) (``[Principal trading firms] dominate activity on the
electronic [interdealer broker] platforms (61 [percent].''). For
purposes of this release, the terms ``principal trading firms'' and
``proprietary trading firms'' (collectively, ``PTFs'') will be used
interchangeably.
\3\ As used in this release, the term ``dealer'' refers to both
dealers and government securities dealers unless explicitly noted or
the context indicates otherwise.
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The Commission believes that the identification and registration of
these market participants as dealers, including those that are not
currently regulated as dealers, would provide regulators with a more
comprehensive view of the markets through regulatory oversight and
would enhance market stability and investor protection.\4\ Accordingly,
the Commission is proposing to further define what it means to be
buying and selling securities ``as a part of a regular business''
within the definitions of ``dealer'' and ``government securities
dealer'' under Sections 3(a)(5) and 3(a)(44), respectively.
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\4\ As discussed in Section V below, the Commission believes
that the Proposed Rules would support orderly markets and protect
investors by addressing negative externalities that may arise in
relation to market participants' financial and operational risks.
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Evolution of the Market
Advancements in technology have affected securities trading across
markets and asset classes; however, regulation has not always kept
pace. This is especially true in the U.S. Treasury market in view of
the increasingly significant role played by market intermediaries that
are not registered as dealers. The U.S. Treasury market has evolved
significantly over
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recent decades in at least two important ways. First, the amount of
U.S. Treasury securities outstanding has increased substantially.\5\ At
the end of 2007, Treasury debt held by the public totaled $5.1
trillion, or 35 percent of that year's gross domestic product
(``GDP'').\6\ That number rose to $23.1 trillion, or 96.5 percent of
GDP, by the end of 2021.\7\
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\5\ See IAWG Joint Staff Report, Recent Disruptions and
Potential Reforms in the U.S. Treasury Market: A Staff Progress
Report prepared by U.S. Department of the Treasury, Board of
Governors of the Federal Reserve System, Federal Reserve Bank of New
York, U.S. Securities and Exchange Commission, U.S. Commodity
Futures Trading Commission (Nov. 8, 2021) (``2021 IAWG Joint Staff
Report'').
\6\ See id.
\7\ See Monthly Statement of the Public Debt of the United
States (Dec. 31, 2021), available at <a href="https://www.treasurydirect.gov/govt/reports/pd/mspd/2021/opds122021.pdf">https://www.treasurydirect.gov/govt/reports/pd/mspd/2021/opds122021.pdf</a>; see also U.S. Bureau of
Economic Analysis, Gross Domestic Product (GDP), FRED, Fed. Res.
Bank of St. Louis, available at <a href="https://fred.stlouisfed.org/series/GDP">https://fred.stlouisfed.org/series/GDP</a>.
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Second, a significant rise in electronic trading in the interdealer
market \8\ for U.S. Treasury securities has contributed to a dramatic
change in the overall structure of the market. In particular,
technological advances have increasingly enabled certain market
participants that are not registered as dealers to perform critical
market functions, including liquidity provision, that once were
primarily performed by regulated dealers.\9\ Since the mid-2000s,
electronic trading has come to dominate the interdealer market for U.S.
Treasury securities, gradually supplanting manual transactions made via
the telephone.\10\ The proliferation of fully electronic trading venues
has been accompanied by the rise of certain market participants who are
not registered as dealers and who today account for a majority of
trading in the Treasury interdealer market.\11\ In particular, PTFs--
businesses that often employ automated, algorithmic trading strategies
(including passive market making, arbitrage, and structural and
directional trading) \12\ that rely on speed, which allows them to
quickly execute trades, or cancel or modify quotes in response to
perceived market events \13\--account for about half of the daily
volume in the interdealer market.\14\
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\8\ The U.S. Treasury market is comprised of the cash market
(purchases and sales of securities), the repo market, and the
futures market. The U.S. Treasury cash market has been traditionally
bifurcated between the interdealer market (whereby dealers trade
with other dealers or with proprietary trading firms) and the
dealer-to-customer market (whereby dealers trade with clients).
Trading in electronic interdealer markets occurs anonymously on
electronic trading platforms known as interdealer broker platforms
(``IDBs''). Trading on the IDB platforms is similar to trading on
other highly liquid markets and where certain market participants
account for a significant trading volume. See Treasury Request for
Comment at 3928. For purposes of this release, when discussing the
U.S. Treasury market, we will be primarily focused on trading
activities occurring in the interdealer market.
\9\ 2021 IAWG Joint Staff Report at 5. A bank engaged in these
activities would not register with the Commission as a dealer. See
Exchange Act Section 3(a)(5)(C)(i)(II) (providing an exception from
dealer status when a bank buys or sells exempted securities, which
are defined in Exchange Act Section 3(a)(12)(A) to include
government securities); see also Exchange Act Section 3(a)(6)
(definition of ``bank''). As discussed infra note 41, a bank may
nonetheless be a government securities dealer required to register
under Section 15C. As such, it would not register with the
Commission but instead would provide written notice of its
government securities dealer status with the appropriate Federal
banking regulator, and comply with rules adopted by the Treasury and
the applicable Federal banking regulator.
\10\ See Treasury Request for Comment. See also Group of Thirty
Working Group on Treasury Market Liquidity, U.S. Treasury Markets:
Steps toward Increased Resilience, Group of Thirty (2021) (``G30
Report'') at <a href="https://group30.org/publications/detail/4950">https://group30.org/publications/detail/4950</a>; 2021 IAWG
Joint Staff Report at 5.
\11\ See Michael J. Fleming, Bruce Mizrach, and Giang Nguyen,
Federal Reserve Bank of New York Staff Reports, The Microstructure
of a U.S. Treasury ECN: The BrokerTec Platform, Staff Report No. 381
(July 2009, rev. May 2014); see also Treasury Request for Comment
(``Trading on these platforms [in the Treasury cash market] has
become increasingly automated, with transactions conducted using
algorithmic and other trading strategies involving little or no
human intervention . . . bear[ing] some resemblance to other highly
liquid markets, including equities and foreign exchange markets,
where PTFs and dealers transact in automated fashion, sometimes in
large volumes and at high speed.''); FEDS Notes, ``Principal Trading
Firm Activity in Treasury Cash Markets,'' James Collin Harkrader and
Michael Puglia (Aug. 4, 2020); G30 Report at 1. The Commission
separately has proposed, among other things, amendments to Exchange
Act Rule 3b-16 to include within the definition of ``exchange''
systems that offer the use of non-firm trading interest and
communication protocols to bring together buyers and sellers of
securities. See Amendments regarding the Definition of ``Exchange''
and Alternative Trading Systems (ATSs) that Trade U.S. Treasury and
Agency Securities, National Market System (NMS) Stocks, and Other
Securities, Securities Exchange Act Release No. 94062 (Jan. 26,
2022), 87 FR 15496 (Mar. 18, 2022) (``2022 ATS Proposing Release'').
\12\ See Staff Report on Algorithmic Trading in U.S. Capital
Markets As Required by Section 502 of the Economic Growth,
Regulatory Relief, and Consumer Protection Act of 2018 (Aug. 5,
2020) (``Algorithmic Trading Staff Report''), at pp. 39-41
(``Passive market-making involves submitting non-marketable orders
on both sides (buy or `bid,' and sell or `offer') of the
marketplace''; ``structural strategies attempt to exploit structural
vulnerabilities in the market or in certain market participants'';
and ``directional strategies generally involve establishing a short-
term long or short position in anticipation of a price move up or
down''); see also 2010 Equity Market Structure Concept Release.
\13\ See 2022 ATS Proposing Release at 15597. See also 2015
Joint Staff Report at 39; 2021 IAWG Joint Staff Report at 5 (``PTFs
tend to make trading decisions primarily based on immediate
profitability and the level of market risk'').
\14\ Nellie Liang and Pat Parkinson, Hutchins Center Working
Paper #72, Enhancing Liquidity of the U.S. Treasury Market Under
Stress (Dec. 16, 2020) (``Enhancing Liquidity''), at 6.
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These new market participants have established themselves as
significant market intermediaries--and critical sources of liquidity--
in the U.S. Treasury market. For example, by 2014, unregistered market
participants trading U.S. Treasury securities, including PTFs,
accounted for a majority of trading activity in the electronic
interdealer market.\15\ The 2015 Joint Staff Report on the U.S.
Treasury market found that more than 50 percent of trading volume in
benchmark U.S. Treasury securities on the major trading platforms is
attributable to PTFs.\16\ In 2020, staff at the Board of Governors of
the Federal Reserve published a paper estimating that PTFs account for
61 percent of the trading activity on interdealer broker platforms.\17\
The significant presence of market participants that are not registered
as dealers or government securities dealers in the U.S. Treasury
market, the volume of their trading, the magnitude of their impact on
the market, the regularity of their participation, and in many cases
the nature of their electronic trading strategies have all contributed
to the increasingly central role of these market participants as
liquidity providers.\18\
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\15\ See 2021 IAWG Joint Staff Report at 5.
\16\ See 2015 Joint Staff Report at 21.
\17\ FEDS Notes, ``Principal Trading Firm Activity in Treasury
Cash Markets,'' James Collin Harkrader and Michael Puglia (Aug. 4,
2020) (citing data presented at the 2019 U.S. Treasury Market
Conference showing that PTFs averaged approximately 61 percent of
total trading volume on electronic interdealer broker platforms).
\18\ 2015 Joint Staff Report; Enhancing Liquidity at 6.
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The rise of electronic trading has similarly impacted the market
structure of the securities markets generally. In the equity markets,
for example, trading in exchange-listed equities, once concentrated on
exchange floors, now largely occurs in an electronic, highly
decentralized but interconnected market that is accessed by brokers,
dealers, and other market participants using a large number and great
variety of trading venues.\19\ In the equity markets, too,
technological advances have enabled significant market participants to
take on an increasingly central role as liquidity providers, largely
replacing more traditional types of traditional liquidity providers,
such as exchange specialists on manual trading floors and over-the-
counter (``OTC'') market makers.\20\ Technological advancements
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have prompted changes to trading practices, particularly with regard to
the way in which orders are generated, routed, and executed.
Developments in securities regulation also have contributed to the
evolution of market structure and the rise of electronic trading.\21\
These technological and regulatory changes have resulted in the
development of highly automated exchange systems and trading tools that
have facilitated a business model for certain market participants,
including PTFs, that perform functions similar to registered
dealers.\22\
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\19\ See 2010 Equity Market Structure Concept Release at 3594.
\20\ See 2010 Equity Market Structure Concept Release at 3607
(stating that liquidity providers historically have been viewed as
dealers, and that ``[a]lthough [PTFs] that employ passive market
making strategies are a new type of market participant, the
liquidity providing function they perform is not new.'').
\21\ In 2005, the Commission adopted 17 CFR 242.600 through
242.614 (Regulation NMS), a series of initiatives designed to
modernize and strengthen the national market system for equity
securities through improved fairness in price execution, displaying
of quotes, and access to market data. Exchange Act Release No. 51808
(June 9, 2005), 70 FR 37495 (``Regulation NMS Release''). As these
initiatives were implemented, regulations that had protected the
manual quotes of floor exchanges from trade-throughs were rescinded.
Id. In 2006, after decades of trading predominantly on the exchange
floor, the New York Stock Exchange (``NYSE'') introduced a hybrid
market structure that incorporated an ability to transact
electronically. See 2010 Equity Market Structure Concept Release.
Today, electronic trading dominates transactions in equity
securities.
\22\ A significant portion of trading activity in the equity
markets--once estimated at 40-50 percent of the daily trading volume
in exchange-listed equities--is conducted by PTFs. See High
Frequency Trading and Networked Markets, Federico Musciotto, Jyrki
Piilo, Rosario N. Mantegna (Mar. 5, 2021); SEC Staff of the Division
of Trading and Markets, Equities Market Structure Literature Review
Part II: High Frequency Trading (Mar. 18, 2014); Do High-Frequency
Traders Anticipate Buying and Selling Pressure?, Nicholas H.
Hirschey (Nov. 2013); High-Frequency Trading and Price Discovery,
Jonathan Brogaard, Terrance Hendershott, Ryan Riordan (May 14,
2014); High Frequency Trading: An Important Conversation, available
at <a href="https://tabbforum.com/opinions/high-frequency-trading-an-important-conversation">https://tabbforum.com/opinions/high-frequency-trading-an-important-conversation</a> (Mar. 24, 2014) (illustrating the percentage
of high frequency trading of U.S. equity shares traded from 2006 to
2014 in Exhibit 1). See also Section V.B.2.
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As discussed below, the Commission has long identified liquidity
provision, including acting as a ``market maker'' or ``a de facto
market maker whereby market professionals or the public look to the
firm for liquidity,'' as a factor that indicates ``dealer'' status.\23\
Analysis indicates a number of market participants that, despite their
significant share of market volume and their central role as liquidity
providing intermediaries in the U.S. Treasury market, are not
registered with the Commission either as ``government securities
dealers'' under Section 15C of the Exchange Act or ``dealers'' under
Section 15 of the Exchange Act.\24\ This has resulted in an uneven
playing field in which some participants are subject to regulation (and
its attendant costs and benefits), and some are not. This uneven
application of regulatory oversight of significant liquidity providers
makes it difficult for regulators and market observers to detect,
investigate, understand, or address market events, such as the ``flash
rally'' in October 2014.
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\23\ Definition of Terms in and Specific Exemption for Banks,
Savings Associations, and Savings Banks Under Sections 3(a)(4) and
3(a)(5) of the Securities Exchange Act of 1934, Exchange Act Release
No. 46745 (Oct. 30, 2002), 67 FR 67496, 67498-67500 (Nov. 5, 2002)
(``2002 Release'') (stating that a person generally may satisfy the
definition, and therefore, be acting as a dealer in the securities
markets by conducting various activities, including ``acting as a
market maker or specialist on an organized exchange or trading
system'').
\24\ See Section V.B.2.a, Table 1. Section 3(a)(5) of the
Exchange Act defines the term ``dealer'' to mean ``any person
engaged in the business of buying and selling securities . . . for
such person's own account through a broker or otherwise,'' but
excludes ``a person that buys or sells securities . . . for such
person's own account, either individually or in a fiduciary
capacity, but not as a part of a regular business.'' Similarly,
Section 3(a)(44) of the Exchange Act, provides, in relevant part,
that the term ``government securities dealer'' means ``any person
engaged in the business of buying and selling government securities
for his own account, through a broker or otherwise,'' but ``does not
include any person insofar as he buys or sells such securities for
his own account, either individually or in some fiduciary capacity,
but not as part of a regular business.'' See Section II.A.
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As discussed below, the regulatory regime applicable to dealers is
a cornerstone of the U.S. Federal securities laws, and helps to promote
the Commission's long-standing mission to protect investors, maintain
fair, orderly, and efficient markets, and promote capital formation. As
discussed in Sections II.D, and V.C, the registration of market
participants who engage in significant dealer-like activities--but who
are not currently registered as dealers--would provide regulators with
a more comprehensive view of the markets through regulatory oversight,
as well as enhance market stability through compliance with dealer
regulations that are designed to support orderly markets, and protect
investors by minimizing the impact of market participants' potential
financial and operational risks.\25\ Accordingly, the Commission is
taking steps to ensure that these market participants are registered
and regulated,\26\ and is proposing for comment rules to further define
the regulatory status of certain participants as ``dealers'' and
``government securities dealers,'' within the meaning of Sections
3(a)(5) and 3(a)(44) of the Exchange Act, respectively.\27\
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\25\ Section V.C.2 describes the estimated costs associated with
registering as a dealer or government securities dealer for those
persons who meet the proposed standards.
\26\ In addition, earlier this year, the Commission proposed to
amend 17 CFR 242.300 through 242.304 (Regulation ATS) for
alternative trading systems (``ATSs'') that trade government
securities (as defined under Section 3(a)(42) of the Exchange Act)
or repurchase and reverse repurchase agreements on government
securities (``repos'') (such ATSs, together, ``Government Securities
ATSs'') to: (1) Eliminate the current exemption from compliance with
Regulation ATS for an ATS that limits its securities activities to
government securities or repos, and registers as a broker-dealer or
is a bank; (2) require the filing of public Form ATS-N for
Government Securities ATSs, which would be subject to Commission
review and ineffectiveness procedures, and would require a
Government Securities ATS to disclose information about its manner
of operations and the ATS-related activities of the registered
broker-dealer or government securities broker or government
securities dealer that operates the ATS and its affiliates; and (3)
apply the fair access rule under 17 CFR 242.301(b)(5) (Rule
301(b)(5) of Regulation ATS) to Government Securities ATSs that meet
certain volume thresholds in U.S. Treasury Securities or in a debt
security issued or guaranteed by a U.S. executive agency, or
government-sponsored enterprise (``Agency Securities''). See 2022
ATS Proposing Release. The 2022 ATS Proposing Release is also re-
proposing amendments to 12 CFR 242.1000 through 242.1007 (Regulation
Systems Compliance and Integrity (``Regulation SCI'')) to apply it
to Government Securities ATSs that meet certain volume thresholds in
U.S. Treasury Securities or Agency Securities.
\27\ We have consulted with the staff of the U.S. Department of
the Treasury on this proposal.
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Specifically, the Commission is proposing standards to identify
those market participants that are providing an important liquidity
provision function in today's securities markets. Any person \28\ that
meets the activity-based standards identified in the Proposed Rules
would be a dealer or government securities dealer required to register,
absent an otherwise available and applicable statutory or regulatory
exemption or exception (e.g., foreign broker-dealers exempted pursuant
to 17 CFR 240.15a-6 (Exchange Act Rule 15a-6)).\29\
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\28\ As discussed more fully below, the standards in the
Proposed Rules do not apply to a person that has or controls total
assets of less than $50 million, or an investment company registered
under the Investment Company Act of 1940 (``Investment Company
Act'') (such company a ``registered investment company''). See
proposed Rule 3a5-4(a)(2) and proposed Rule 3a44-2(a)(3). Investment
advisers are not required to aggregate accounts held in the name of
clients of the adviser under certain circumstances as described in
proposed Rule 3a5-4(b)(2)(ii) and proposed Rule 3a44-2(b)(2)(ii).
See Section III.D.
\29\ There is an analogous exemption under the Treasury rules
for certain foreign government securities dealers. See 17 CFR 401.7
(Treas. Reg. Sec. 401.7) (1987) (``Exemption for certain foreign
government securities brokers or dealers.''). The Commission is not
expressing any views concerning multilateral development banks, like
the International Bank for Reconstruction and Development (or the
World Bank) and the International Finance Corporation, or foreign
sovereigns or foreign central banks, or any other sovereign or
international bodies as to the immunities such entities may possess
under U.S. or international law. See, e.g., Security-Based Swap
Transactions Connected With a Non-U.S. Person's Dealing Activity
That Are Arranged, Negotiated, or Executed by Personnel Located in a
U.S. Branch or Office or in a U.S. Branch or Office of an Agent;
Security-Based Swap Dealer De Minimis Exception, Exchange Act
Release No. 77104 (Feb. 10, 2016), 81 FR 8598, available at <a href="https://www.govinfo.gov/content/pkg/FR-2016-02-19/pdf/2016-03178.pdf">https://www.govinfo.gov/content/pkg/FR-2016-02-19/pdf/2016-03178.pdf</a>.
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As the Proposed Rules focus on activity rather than label or
status, they would potentially scope in other market participants as
discussed below in Section V, thereby triggering a registration
requirement and subjecting those entities to dealer regulation and
oversight. As discussed further in Section V.B.2, the Commission's
analysis indicates that the Proposed Rules would primarily require
registration by PTFs, and potentially some private funds.\30\ In
addition, it is possible that the activities of some investment
advisers \31\ could meet the Proposed Rules \32\ and trigger a dealer
registration requirement. The Commission believes the scope of the
Proposed Rules is appropriate in light of the important liquidity that
these participants provide to the securities markets, which is similar
to that historically provided by regulated dealers.
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\30\ A private fund, including a hedge fund, is an issuer that
would be an investment company as defined in Section 3 of the
Investment Company Act if not for Section 3(c)(1) or 3(c)(7) of the
Investment Company Act. See 15 U.S.C. 80a-3.
\31\ ``Investment adviser'' is defined under the Investment
Advisers Act of 1940 (``Advisers Act'') as ``any person who, for
compensation, engages in the business of advising others, either
directly or through publications or writings, as to the value of
securities or as to the advisability of investing in, purchasing, or
selling securities, or who, for compensation and as part of a
regular business, issues or promulgates analyses or reports
concerning securities.'' See 15 U.S.C. 80b-2(a)(11).
\32\ See Section III.D.
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The Commission is proposing to exclude certain smaller
participants, as well as registered investment companies, from the
ambit of the Proposed Rules. As discussed in Section III.A and V.B,
these smaller participants--persons that have or control less than $50
million in total assets--are unlikely to be able to engage in the
significant liquidity provision that is the focus of the Proposed
Rules. As discussed below in Section III.A, in light of the regulatory
structure that governs registered investment companies, which
addresses, among other things, the types of concerns that we seek to
address in the Proposed Rules, the Commission is proposing to exclude
registered investment companies from the Proposed Rules.\33\
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\33\ As discussed in Section III.D, for purposes of the
definition of ``own account,'' an account held in the name of a
person that is a registered investment company would not be
attributed to a controlling person or another person under common
control.
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Conversely, the Proposed Rules would not exclude private funds
because we are proposing to take a similar approach to regulating
dealer activity across market participants and, unlike registered
investment companies, private funds are not subject to the regulatory
framework of the Investment Company Act. The Commission currently
receives information about the operations, exposures, liabilities,
liquidity, and strategies of private funds through filings of Form PF
by registered private fund advisers and has recently proposed
amendments to Form PF to enhance the reporting about private funds.\34\
If excluded from the Proposed Rules, however, private funds engaged in
dealer activity would not be subject to the dealer regulatory regime,
which includes not only registration obligations, but also
comprehensive regulatory requirements and oversight that broadly focus
on market functionality--that is, the impact of dealing activity on the
market as a whole.
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\34\ See Amendments to Form PF to Require Current Reporting and
Amend Reporting Requirements for Large Private Equity Advisers and
Large Liquidity Fund Advisers, Investment Advisers Act Release No.
5950 (Jan. 26. 2022), 87 FR 9106 (Feb. 17, 2022) (``Form PF
Proposing Release'').
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The Proposed Rules also would not exclude investment advisers
registered under the Advisers Act (``registered investment advisers'').
A registered investment adviser trading for its own proprietary
account, for example, could trigger the dealer registration
requirements under the Proposed Rules. And, under certain
circumstances, a registered investment adviser could trigger
application of the Proposed Rules because of aggregating trading in its
own account with client accounts it controls. However, as described
below in Section III.D, in determining whether its activity would be
captured by the Proposed Rules, a registered investment adviser would
not be required to aggregate its own trading activities with the
trading activities of its clients' solely based on an adviser-client
discretionary investment management relationship.\35\ This exclusion is
designed to attribute the dealer activity to the appropriate market
actor.
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\35\ Paragraph (b)(2)(ii)(B) of the Proposed Rules would not
attribute to a registered investment adviser an account held in the
name of a client of the registered investment adviser, unless the
adviser controls the client as a result of the adviser's right to
vote or direct the vote of voting securities of the client, the
adviser's right to sell or direct the sale of voting securities of
the client, or the adviser's capital contributions to or rights to
amounts upon dissolution of the client.
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II. Background
The Federal securities laws provide a comprehensive system of
regulation of securities activities, and the definition of dealer is
one of the Exchange Act's most important definitions. As discussed
below, the statutory definition of ``dealer'' in Section 3(a)(4) and
the accompanying registration requirements of the Exchange Act were
drawn broadly by Congress in 1934 to encompass a wide range of
activities involving the securities markets and their participants.\36\
Registered dealers and government securities dealers are subject to a
panoply of regulatory obligations and supervisory oversight intended to
protect investors and the securities markets. Therefore, it is
important that market participants whose securities activities fall
within the broad definitions of ``dealer'' and ``government securities
dealer'' are registered and regulated under the Exchange Act.
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\36\ Proposed Rule 3a5-4 would apply to securities as defined by
Section 3(a)(10) of the Exchange Act, and proposed Rule 3a44-2 would
apply to government securities as defined by Section 3(a)(42) of the
Exchange Act, including any digital asset that is a security or a
government security within the meaning of the Exchange Act.
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A. Definitions of ``Dealer'' and ``Government Securities Dealer''
Section 3(a)(5) of the Exchange Act defines the term ``dealer'' to
mean ``any person \37\ engaged in the business of buying and selling
securities . . . for such person's own account through a broker or
otherwise,'' but excludes ``a person that buys or sells securities . .
. for such person's own account, either individually or in a fiduciary
capacity, but not as a part of a regular business.'' \38\ This
statutory exclusion from the definition of ``dealer'' is often referred
to as the ``trader'' exception.\39\
[[Page 23058]]
As one commentator has described it, at the core of the ``dealer/
trader'' distinction is an attempt to draw a line between a dealer and
``an ordinary investor who buys and sells for his own account with some
frequency.'' \40\ Read together, these provisions identify as a
``dealer'' a person engaged in the business of buying and selling
securities for its own account as part of a regular business. Absent an
exception or an exemption, Section 15(a)(1) of the Exchange Act makes
it unlawful for a ``dealer'' to effect any transactions in, or to
induce or attempt to induce the purchase or sale of, any security
unless registered with the Commission in accordance with Section 15(b)
of the Exchange Act.
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\37\ Paragraph (b)(1) of the Proposed Rules provides that the
term ``person'' has the same meaning as prescribed in Section
3(a)(9) of the Exchange Act. Section 3(a)(9) of the Exchange Act
defines a ``person'' as ``a natural person, company, government, or
political subdivision, agency, or instrumentality of a government.''
See 15 U.S.C. 78c(a)(9).
\38\ See Sections 3(a)(5)(A) and (B) of the Exchange Act, 15
U.S.C. 78c(a)(5)(A) and (B). The definition of ``dealer'' in the
Exchange Act is largely unchanged from its enactment in 1934. Until
the Gramm-Leach-Bliley Act (``GLBA'') was enacted in 1999, banks
were excluded from the definition of ``dealer.'' The GLBA added
Section 3(a)(5)(C) of the Exchange Act to create a series of
functional exemptions from the statutory definition of dealer. The
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(``Dodd-Frank Act'') further amended Section 3(a)(5)(A) of the
Exchange Act to exclude from the dealer definition persons engaged
in the business of buying and selling security-based swaps, other
than security-based swaps with or for persons that are not eligible
contract participants.
\39\ See, e.g., 2002 Release (explaining that ``a person that is
buying securities for its own account may still not be a `dealer'
because it is not `engaged in the business' of buying and selling
securities for its own account as part of a regular business,'' and
that ``[t]his exclusion is often referred to as the dealer/trader
distinction'').
\40\ See Loss, Securities Regulation 722 (1st ed. 1951) (``One
aspect of the `business' concept is the matter of drawing the line
between a `dealer' and a trader--an ordinary investor who buys and
sells for his own account with some frequency.''), cited in Further
Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,''
``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' Exchange Act
Release No. 66868 (Apr. 27, 2012), 77 FR 30596 n.250 (May 23, 2012)
(``Entities Adopting Release'').
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Similarly, Section 3(a)(44) of the Exchange Act provides, in
relevant part, that the term ``government securities dealer'' means
``any person engaged in the business of buying and selling government
securities for his own account, through a broker or otherwise,'' but
``does not include any person insofar as he buys or sells such
securities for his own account, either individually or in some
fiduciary capacity, but not as part of a regular business.'' \41\ Read
together, these provisions identify as a ``government securities
dealer'' a person engaged in the business of buying and selling
government securities for its own account as part of a regular
business.\42\ Section 15C of the Exchange Act makes it unlawful for a
``government securities dealer'' (other than a registered broker-dealer
or financial institution) to induce or attempt to induce the purchase
or sale of any government security unless such government securities
dealer is registered in accordance with Section 15C(a)(2).\43\
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\41\ 15 U.S.C. 78c(a)(44). Congress added the definition of
``government securities dealer'' to the Exchange Act in the
Government Securities Act of 1986. Public Law 99-571, 100 Stat. 3208
(Oct. 28, 1986). To the extent a financial institution is a
government securities dealer required to register under Section 15C,
it would not register with the Commission but instead would provide
written notice of its government securities dealer status with the
appropriate Federal banking regulator, and comply with rules adopted
by the Treasury and the applicable Federal banking regulator. See
Regulations under Section 15C of the Securities Exchange Act of
1934, 17 CFR 400.1(b), available at CFR-2018-title17-vol4-chapIV.pdf
(<a href="http://treasurydirect.gov">treasurydirect.gov</a>) (the ``Treasury Rules''). The Treasury Rules
address financial responsibility, protecting customer securities and
funds, recordkeeping, large position reporting, and financial
reporting and audits. Also included are rules concerning custodial
holdings of government securities by depository institutions. The
Commission retains broad antifraud authority over banks that are
government securities dealers. Soon after enactment of the
Government Securities Act of 1986, the staff issued a series of no-
action letters to persons seeking assurances that the staff would
not recommend enforcement action if they did not register as
government securities dealers. See, e.g., Bankers Guarantee Title &
Trust Co., SEC No-Action Letter (Jan. 22, 1991); Bank of America,
Canada, SEC No-Action Letter (May 1, 1988); Citicorp Homeowners,
Inc., SEC No-Action Letter (Oct. 7, 1987); Fairfield Trading Corp.,
SEC No-Action Letter (Dec. 10, 1987); Continental Grain Co., SEC No-
Action Letter (Nov. 28, 1987); Louis Dreyfus Corp., SEC No-Action
Letter (July 23, 1987); United Savings Association of Texas, SEC No-
Action Letter (Apr. 2, 1987). Staff no-action letters, like all
staff statements, have no legal force or effect: They do not alter
or amend applicable law, and they create no new or additional
obligations for any person. Upon the adoption of any final rule,
some letters and other staff statements, or portions thereof, may be
moot, superseded, or otherwise inconsistent with the final rules
and, therefore, would be withdrawn or modified.
\42\ The legislative history relating to the enactment of the
Government Securities Act of 1986 provides that the term government
securities dealer ``would utilize key concepts from the current
definitions of . . . `dealer' and `municipal securities dealer.' ''
H.R. Rep. No. 258, 99th Cong., 1st Sess. 24 (1985). S. Rep. No. 426,
99th Cong., 2d Sess. 19 (1986).
\43\ A government securities dealer that is a registered dealer
or a financial institution must file notice with the appropriate
regulatory agency that it is a government securities dealer. See 15
U.S.C. 78o-5(a). Exchange Act Section 3(a)(46) defines the term
``financial institution'' to include: (i) A bank (as that term is
defined in Exchange Act Section 3(a)(6) (15 U.S.C. 38c(a)(6)); (ii)
a foreign bank (as that term is used in the International Banking
Act of 1978); and (iii) a savings association (as defined in section
3(b) of the Federal Deposit Insurance Act, the deposits of which are
insured by the Federal Deposit Insurance Corporation). See 15 U.S.C.
78c(a)(46)(A) through(C).
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Under both the dealer and government securities dealer definitions,
a person acts as a dealer or a government securities dealer when it is
engaged in the business of buying and selling securities or government
securities, respectively, for its own account as part of a ``regular
business.'' \44\
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\44\ Unless otherwise indicated, references to ``dealer''
activity apply both with respect to ``dealers'' and ``government
securities dealers'' under Sections 3(a)(5) and 3(a)(44) of the
Exchange Act, respectively.
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Factors Considered in Evaluating ``Regular Business''
Because the Exchange Act does not define what it means to be
engaged in a ``regular business,'' courts and the Commission have
looked to an array of factors in determining whether someone is a
``dealer'' within the meaning of the statute.\45\ In determining
whether a person is engaged in the business of buying and selling
securities for its own account as part of a ``regular business,''
courts and the Commission assess the frequency with which the person
buys and sells securities for its own account.\46\ The ``regularity''
of participation in securities transactions necessary to find that a
person is a ``dealer'' has not been quantified, but involves engaging
in ``more than a few isolated'' securities transactions.\47\
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\45\ See, e.g., Registration Requirements for Foreign Broker-
Dealers, Exchange Act Release No. 27017 (July 11, 1989), 54 FR
30013, 30015 (July 18, 1989) (stating that the definition of
``dealer'' and the registration requirements under the Exchange Act
``were broadly drawn by Congress to encompass a wide range of
activities involving investors and the securities markets'').
Recognizing that the word ``business'' is central to the dealer
definition, courts have cited to Black's Law Dictionary definition
of business: ``a commercial enterprise carried on for profit, a
particular occupation or employment habitually engaged in for
livelihood or gain.'' SEC v. Justin W. Keener d/b/a JMJ Financial,
No. 20-cv-21254, pp. 14-15 (S.D. Fla. Jan. 21, 2022) (citing SEC v.
Big Apple Consulting USA, Inc., 783 F.3d 786, 809 (11th Cir. 2015)
which was quoting Black's Law Dictionary 239 (10th ed. 2009))
(emphasis in original). The Eleventh Circuit elaborated that
``[c]entral to this definition is profit or gain.'' Id. (emphasis in
original). See also SEC v. Ibrahim Almagarby, 479 F. Supp. 3d 1266,
1272 (S.D. Fla. 2020).
\46\ See Massachusetts Financial Services, Inc. v. Securities
Investor Protection Corp., 411 F. Supp. 411, 415 (D. Mass.), aff'd,
545 F.2d 754 (1st Cir. 1976), cert. denied, 431 U.S. 904 (1977)
(noting that the dealer definition: ``connote[s] a certain
regularity of participation in securities transactions at key points
in the chain of distribution.''); see also Eastside Church of Christ
v. National Plan, Inc., 391 F.2d at 361-362 (an entity that
purchased many securities for its own account as part of its regular
business and sold some of them was deemed a dealer); SEC v. Century
Inv. Transfer Corp., 1971 U.S. Dist. LEXIS 11364, at *14 (S.D.N.Y.
Oct. 5, 1971) (a limited partnership that bought and sold securities
for its own account on numerous occasions was deemed a dealer); SEC
v. Corporate Rels. Group, Inc., 2003 U.S. Dist. LEXIS 24925, at *60-
61 (M.D. Fla. Mar. 28, 2003) (an unregistered stock promotion
company that was operating as a broker was also operating as a
dealer because it bought securities on more than a dozen occasions
and sold those securities in hundreds of transactions through
accounts it maintained or in which it had an interest).
\47\ See SEC v. Am. Inst. Counselors, Inc., Fed. Sec. L. Rep.
(CCH) ] 95388 (D.D.C. 1975) (citing Loss, Securities Regulation (2d
ed. 1961)).
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In addition to frequency of activity, the nature of the trading
activity is a factor in determining whether a person is a dealer.\48\
Over time, the Commission has identified activities that, in context
and when engaged in with regularity, may be indicative of being a
dealer.\49\ For example, the Commission has identified certain factors
that would be indicators of dealer activity, including,
[[Page 23059]]
among other things: (1) Acting as a market maker or specialist on an
organized exchange or trading system; (2) acting as a de facto market
maker or liquidity provider; \50\ and (3) holding oneself out as buying
or selling securities at a regular place of business.\51\
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\48\ See 2002 Release at 67498.
\49\ See Entities Adopting Release, 77 FR 30617 (discussing
application of the dealer/trader distinction in the context of
security-based swap dealers); see also 2002 Release at 67499.
\50\ For example, a person may be acting as a dealer if they
``turned a profit not from selling only after market prices
increased (like a trader), but rather from quickly reselling at a
marked-up price.'' River North, 415 F. Supp. 3d at 859; see also SEC
v. Big Apple Consulting USA, Inc., 783 F.3d 786, 809-10 (11th Cir.
2015); In re Sodorff, 50 SEC. 1249, 1992 WL 224082, at *5 (Sep. 2,
1992).
\51\ See 2002 Release. These factors were confirmed by the
Commission in 2012 when it defined certain terms, including
``security-based swap dealer,'' in accordance with Title VII of the
Dodd-Frank Act. See Entities Adopting Release at 30607
(distinguishing traders from dealers by noting that a trader, among
other things, does not make a market). These indicia have been
developed in a range of contexts over time as the markets and dealer
activity have evolved, and do not represent an exclusive or
exhaustive list of activities relevant for determining whether
registration as a dealer is required. Further, a person not meeting
the standards in the Proposed Rules may still be a dealer under
otherwise applicable dealer precedent. Whether or not a person is a
``dealer'' is based on the facts and circumstances, where various
factors are ``neither exclusive, nor function as a checklist,'' and
meeting any one factor may be sufficient to establish dealer status.
SEC v. River North Equity LLC, 415 F. Supp. 3d 853, 858 (N.D. Ill.
2019); accord SEC v. Fierro, No. 20-cv-2104, 2020 WL 7481773, at *3
(D.N.J. Dec. 18, 2020); SEC v. Keener, No. 20-cv-21254, 2020 WL
4736205, at *3-*4 (S.D. Fla. Aug. 14, 2020); SEC v. Almagarby, 479
F. Supp. 3d 1266, 1272-73 (S.D. Fla. 2020); SEC v. Benger, 697 F.
Supp. 2d 932, 945 (N.D. Ill. 2010).
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Trader Exclusion
The Exchange Act excludes from the definition of dealer any
``person that buys or sells securities . . . for such person's own
account, either individually or in a fiduciary capacity, but not as a
part of a regular business.'' \52\ While traders and dealers engage in
the same core activity--buying and selling securities for their own
account--their level of activity varies in absolute terms and in
regularity.\53\ The Commission has stated that dealers include those
who are willing to buy and sell contemporaneously and often quickly
enter into offsetting transactions to minimize the risk associated with
a position.\54\ In contrast, traders are ``market participants who
provide capital investment and are willing to accept the risk of
ownership in listed companies for an extended period of time,'' and the
Commission has stated that ``it makes little sense to refer to someone
as `investing' in a company for a few seconds, minutes, or hours.''
\55\ The purpose of the ``trader'' exception is to ``exclude from the
definition of `dealer' members of the public who buy and sell
securities for their own account as ordinary traders.'' \56\
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\52\ Sections 3(a)(5)(B) and 3(a)(44)(A) of the Exchange Act.
\53\ See Loss, supra note 40, at 720 (noting that the
distinction between a trader and a dealer seeks to separate the
``ordinary investor who buys and sells for his own account with some
frequency'' by establishing that dealers engage in the business of
buying and selling securities as part of a regular business).
\54\ 2002 Release.
\55\ 2010 Equity Market Structure Concept Release at 3603, n. 52
(citing Regulation NMS Release, 70 FR 37500).
\56\ See SEC v. Am. Inst. Counselors, Inc., Fed. Sec. L. Rep.
(CCH) ] 95,388 (D.D.C. 1975) (citing Loss, Securities Regulation (2d
ed. 1961)). See also 2002 Release (``[A] person that is buying
securities for its own account may still not be a `dealer' because
it is not `engaged in the business' of buying and selling securities
for its own account as part of a regular business''); River North,
415 F. Supp. at 859 (traders purchase securities already in the
marketplace and turn a profit from selling them after they
appreciate in value); Sodorff, 1992 WL 224082, at *5 (same).
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B. 2010 Equity Market Structure Concept Release
The Commission raised the issue of broker-dealer registration for
PTFs in its 2010 Equity Market Structure Concept Release.\57\
Specifically, as part of its discussion relating to the potential risks
to the markets posed by PTFs, the Commission requested comment on
whether all PTFs should be required to register as broker-dealers.\58\
Comments were mixed.\59\ A number of commenters explicitly supported
registration as an effective means for providing oversight of trading
activity.\60\ Others commenters opposed registration, citing costs,
burdens, and barriers to competition.\61\
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\57\ See 2010 Equity Market Structure Concept Release at 3612.
\58\ Id.
\59\ See Letter from Donald R. Wilson, Jr., DRW Trading, LLC
(Apr. 21, 2010); Letter from Peter Kovac, Chief Operating Officer
and Financial and Operations Principal, EWT (Feb. 22, 2010); Letter
from Senator Edward Kaufman (Aug. 5, 2010); Article from Stephen M.
Barnes, J.D., Regulating High-Frequency Trading: An Examination of
U.S. Equity Market Structure in Light of the May 6, 2010 Flash Crash
(Dec. 2010); Letter from R.T. Leuchtkafer (Apr. 16, 2010); Letter
from R.T. Leuchtkafer (July 15, 2010); Letter from Micah Hauptman,
Financial Services Counsel, Consumer Federation of America (Sept. 9,
2014); Letter from Berkowitz, Trager & Trager, LLC (Apr. 21, 2010);
Letter from Alston Trading, LLC, RGM Advisors, LLC, Hudson River
Trading, LLC, and Quantlab Financial, LLC (Apr. 23, 2010); Letter
from Marcia E. Asquith, Senior Vice President and Corporate
Secretary, Financial Industry Regulatory Authority (Apr. 23, 2010);
Letter from James J. Angel, Associate Professor, McDonough School of
Business, Georgetown University, Lawrence E. Harris, Fred V. Keenan
Chair in Finance, Professor of Finance and Business Economics,
Marshall School of Business, University of Southern California, and
Chester S. Spatt, Pamela R. and Kenneth B. Dunn Professor of
Finance, Director, Center for Financial Markets, Tepper School of
Business, Carnegie Mellon University, Equity Trading in the 21st
Century (Feb. 23, 2010); and Letter from Kurt N. Schacht, Managing
Director and Linda L. Rittenhouse, Director, Capital Markets Policy,
CFA Institute (June 22, 2010).
\60\ See Letter from Peter Kovac, Chief Operating Officer and
Financial and Operations Principal, EWT (Feb. 22, 2010); Letter from
Senator Edward Kaufman (Aug. 5, 2010); Article from Stephen M.
Barnes, J.D., Regulating High-Frequency Trading: An Examination of
U.S. Equity Market Structure in Light of the May 6, 2010 Flash Crash
(Dec. 2010); Letter from R.T. Leuchtkafer (Apr. 16, 2010); Letter
from R.T. Leuchtkafer (July 15, 2010); Letter from Micah Hauptman,
Financial Services Counsel, Consumer Federation of America (Sept. 9,
2014). See also Letter from Donald R. Wilson, Jr., DRW Trading, LLC
(Apr. 21, 2010), pp 3-4 (supporting registration only for those
firms that engage in high-volume and high-speed trading).
\61\ See Letter from Berkowitz, Trager & Trager, LLC (Apr. 21,
2010); Letter from Alston Trading, LLC, RGM Advisors, LLC, Hudson
River Trading, LLC, and Quantlab Financial, LLC (Apr. 23, 2010).
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C. Department of the Treasury Request for Comment
In 2016, Treasury published notice seeking public comment on the
evolution of the U.S. Treasury market structure and the implications
for market functions, trading and risk management practices across the
U.S. Treasury market, considerations with respect to more comprehensive
official sector access to U.S. Treasury market data, and the benefits
and risks of increased public disclosure of U.S. Treasury market
activity.\62\ In that Request for Comment, Treasury raised the issue of
registration for certain market participants, including those persons
engaging in automated trading or conducting a certain volume of
trading.\63\ Specifically, concerning its continued monitoring of
trading and risk management practices across the U.S. Treasury market
and reviewing regulatory requirements applicable to the government
securities market and its participants, Treasury requested comment on:
(1) Aligning standards between U.S. securities, commodities, and
derivatives markets and the U.S. Treasury cash market; (2) the
implications of a registration requirement for certain market
participants, including those persons engaging in automated trading or
conducting a certain volume of trading; and (3) whether such firms
should be subject to capital requirements, examinations and
supervision, conduct rules, and/or other standards.\64\ A number of
comment letters were submitted directly or indirectly responding to
these questions.\65\ Most
[[Page 23060]]
commenters explicitly supported consistent regulatory standards to be
applied to certain market participants, including those persons
engaging in automated trading or conducting a certain volume of
trading,\66\ with some commenters explicitly supporting the
registration of market participants that are not currently registered
as dealers.\67\ One commenter was opposed to the registration of
certain market participants citing disapproval of the ``application of
arbitrary thresholds when determining the applicability of
regulation.'' \68\ Another commenter stated that ``principal trading
firms have played an increasingly larger role in offering liquidity in
these markets, and have become de facto market makers.'' \69\
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\62\ See Treasury Request for Comment.
\63\ See Treasury Request for Comment at 3930.
\64\ See Treasury Request for Comment at 3931 (Questions 2.6,
2.6(a) and 2.6(b)).
\65\ See Letter from Deirdre K. Dunn, Managing Director--Head of
NA G10 Rates, Citi Global Markets (Apr. 22, 2016) (``Citi Global'');
Letter from Shane O'Cuinn, Managing Director, Credit Suisse/Global
Markets (Apr. 22, 2016) (``Credit Suisse''); Letter from Joanna
Mallers, Secretary, FIA Principal Traders Group (Apr. 22, 2016)
(``FIA PTG''); Comment from Kermit Kubitz (Apr. 22, 2016); Letter
from William Harts, Modern Market Initiative (Apr. 22, 2016)
(``MMI''); Letter from Prudential Fixed Income (Apr. 21, 2016)
(``Prudential''); Letter from Alan Mittleman, Managing Director,
Head of USD Rates Trading, RBS Securities Inc. (Apr. 22, 2016)
(``RBS Securities''); Letter from Reserve Bank of India (Apr. 22,
2016); Letter from Mike Zolik, Nate Kalich, and Larry Magargal,
Ronin Capital, LLC (Mar. 19, 2016) (``Ronin Capital''); Letter from
Timothy W. Cameron, Esq., Asset Management Group--Head and Lindsey
Weber Keljo, Vice President and Assistant General Counsel, Asset
Management Group, Securities Industry and Financial Markets
Association (Apr. 22, 2016) (``SIFMA-AMG''); Letter from Greg Moore,
Managing Director and Head of FICM New York, TD Securities (USA) LLC
(Apr. 22, 2016) (``TD Securities''); and Letter from C. Thomas
Richardson, Managing Director, Head of Market Structure, Head of
Electronic Trading Services, and Cronin McTigue, Managing Director,
Head of Liquid Products, Wells Fargo Securities (Apr. 21, 2016)
(``Wells Fargo'').
\66\ See Letter from Citi Global; Letter from Credit Suisse;
Comment from Kermit Kubitz; Letter from MMI; Letter from Prudential;
Letter from RBS Securities; Letter from Reserve Bank of India;
Letter from Ronin Capital; Letter from SIFMA-AMG; Letter from TD
Securities; and Letter from Wells Fargo.
\67\ See Letter from Prudential; Letter from MMI; Letter from TD
Securities; Letter from Reserve Bank of India; Letter Citi Global;
and Letter from Ronin Capital.
\68\ See Letter from FIA PTG.
\69\ See Letter from Stuart Kaswell, Executive Vice President
and Managing Director, General Counsel, and Ji[rcaron][iacute]
Kr[oacute]l, Deputy CEO, Global Head of Government Affairs,
Alternative Investment Management Association (Apr. 22, 2016) at 2
(describing the evolution of market structure generally).
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D. Need for Commission Action
While the participation of these PTFs and other significant market
participants that are not registered as dealers may have positive
effects, such as through increased competition, there are risks that
accompany such market participants' trading activities and the
accompanying lack of regulatory obligations or oversight relating to
such activity.\70\ Among other things, scrutiny of the U.S. Treasury
market, in light of recent market disruptions,\71\ has identified a
regulatory gap in terms of the registration status and regulation of
significant market participants in the U.S. Treasury market. Not only
does such a regulatory gap mean inconsistent oversight of market
participants performing similar functions either in the same market or
across asset classes but, as described below, the activity of
significant market participants that are not registered may pose
certain risks to the markets.
---------------------------------------------------------------------------
\70\ See Section V for discussion of competition; see also
Algorithmic Trading Staff Report.
\71\ See 2021 IAWG Report.
---------------------------------------------------------------------------
In particular, certain market participants, such as PTFs that are
not registered as dealers, play an increasingly significant role as
major liquidity providers across asset classes in the U.S. securities
markets, including the U.S. Treasury market. These market participants
engage in a significant volume of trading across many trading platforms
for their own accounts, generally ending the day with a relatively
small position. In the U.S. Treasury market, in particular, market
commenters and financial regulators have stated that the rise of
electronic trading and emergence of unregulated significant market
participants over the years could be a contributing factor to the more
frequent market disruptions, specifically stating that these changes
are directly affecting liquidity provision.\72\
---------------------------------------------------------------------------
\72\ See 2021 IAWG Joint Staff Report (stating that the October
15, 2014 market disruption made clear that, among other things,
``electronic trading permitted rapid increases in orders that
removed liquidity'') at 18, and G30 Report.
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The Commission believes that, although the Proposed Rules will not
by themselves necessarily prevent future market disruptions, the
operation of the rules will support transparency; market integrity and
resiliency; and investor protection; across the U.S. Treasury and other
securities markets by closing the regulatory gap that currently exists
and ensuring consistent regulatory oversight of persons engaging in the
type of activities described in the Proposed Rules.\73\ The requirement
that dealers register has been repeatedly recognized as being ``of the
utmost importance in effecting the purposes of the [Exchange] Act. It
is through the registration requirement that some discipline may be
exercised over those who may engage in the securities business and by
which necessary standards may be established with respect to training,
experience, and records.'' \74\ For example, as described below in
Section V.C, dealers and government securities dealers must register
with the Commission and become members of a self-regulatory
organization (``SRO''); \75\ comply with Commission and SRO rules,
including certain financial responsibility and risk management
rules,\76\ transaction and
[[Page 23061]]
other reporting requirements,\77\ operational integrity rules,\78\ and
books and records requirements,\79\ all of which help to enhance market
stability by giving regulators increased insight into firm-level and
aggregate trading activity and so help regulators to evaluate, assess,
and address, as appropriate, market risks. In addition, registered
dealers and government securities dealers are required to comply with
specific anti-manipulative and other anti-fraud rules that are
promulgated pursuant to Section 15(c) of the Exchange Act, thereby
contributing to fair and orderly markets.\80\ Firms that are government
securities dealers (including registered broker-dealers trading
government securities) must also comply with rules adopted by Treasury,
including but not limited to rules relating to financial
responsibility, recordkeeping, financial condition reporting, risk
oversight, and large trader reporting.\81\ Importantly, dealers and
government securities dealers are subject to Commission and SRO
examination, inspection, and enforcement for compliance with applicable
Federal securities laws and SRO rules.\82\
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\73\ See Section V.
\74\ River North, 415 F. Supp. 3d 853, 858 (citing Benger, 697
F. Supp. 2d at 944 (quoting Celsion Corp. v. Stearns Mgmt. Corp.,
157 F. Supp. 2d 942, 947 (N.D. Ill. 2001)); see also Roth v. SEC, 22
F.3d 1108, 1109 (D.C. Cir. 1994) (``The broker-dealer registration
requirement serves as the keystone of the entire system of broker-
dealer regulation.''); see Section 15(b)(7) of the Exchange Act, 15
U.S.C. 78o(b)(7), and 17 CFR 240.15b7-1 (Rule 15b7-1 thereunder)
(requiring natural persons associated with a broker-dealer to be
registered or approved ``in accordance with the standards of
training, experience, competence, and other qualification
standards''); see also Financial Industry Regulatory Authority
(``FINRA'') Rule 1210 (Registration Requirements) and FINRA Rule
1220 (Registration Categories), which require, for example, an
associated person of a member broker-dealer of FINRA who is
primarily responsible for the design, development, or significant
modification of an algorithmic trading strategy, or who is
responsible for supervising or directing such activities, to pass
the Series 57 exam, register as a Securities Trader, and comply with
continuing education requirements.
\75\ See Sections 15(b)(8), 15C(e)(1), and 17(b) of the Exchange
Act, 15 U.S.C. 78o(b)(8), 15 U.S.C. 78o-5(e)(1), and 15 U.S.C.
78q(b), respectively. Section 15(b)(8) of the Exchange Act makes it
unlawful for any registered broker or dealer to effect any
transaction in securities (with certain exceptions) unless the
broker or dealer is a member of a registered securities association
or effects transactions in securities solely on a national
securities exchange of which it is a member. Section 15C(e)(1) of
the Exchange Act requires that a registered government securities
broker-dealer, other than certain financial institutions, become a
member of a registered national securities exchange or registered
national securities association. Because government securities are
not traded on registered national securities exchanges, a person
that registers as a government securities dealer under Section 15C
to trade only government securities would need to become a member of
a registered national securities association (FINRA is the only
registered national securities association). Currently, however, a
person that is engaged in a regular business of buying and selling
both government securities and other securities for its own account,
and therefore registers as a dealer under Section 15, could
potentially be exempt from Section 15(b)(8)'s national securities
association membership requirement if it is or becomes a member of a
national securities exchange and satisfies other requirements. See
17 CFR 240.15b9-1. Section 17(b) of the Exchange Act provides, among
other things, that all records of a broker-dealer are subject at any
time, or from time to time, to such reasonable, periodic, special,
or other examinations by representatives of the Commission and the
appropriate regulatory agency of the broker-dealer as the Commission
or the appropriate regulatory agency deems necessary or appropriate
in the public interest, for the protection of investors, or
otherwise in furtherance of the purposes of the Exchange Act.
\76\ See, e.g., 17 CFR 240.15c3-1 (Exchange Act Rule 15c3-1)
(the ``Net Capital Rule''; Financial Responsibility Rules for
Broker-Dealers, Exchange Act Release No. 70072 (July 30, 2013), 78
FR 51823 at 51849 (Aug. 21, 2013) (``The capital standard in Rule
15c3-1 is a net liquid assets test. This standard is designed to
allow a broker-dealer the flexibility to engage in activities that
are part of conducting a securities business (e.g., taking
securities into inventory) but in a manner that places the firm in
the position of holding at all times more than one dollar of highly
liquid assets for each dollar of unsubordinated liabilities (e.g.,
money owed to customers, counterparties, and creditors)''). The rule
imposes a ``moment to moment'' net capital requirement in that
broker-dealers must maintain an amount of net capital that meets or
exceeds their minimal net capital requirement at all times.
\77\ See, e.g., FINRA Rule 6730(a)(1) (requiring FINRA members
to report transactions in TRACE-Eligible Securities, including
Treasury securities, which promotes transparency to the securities
markets, including the Treasury market, by providing market
participants with comprehensive access to transaction data); FINRA
Rule 7200 (Trade Reporting Facilities); FINRA Rule 4530 (Reporting
Requirements) which requires FINRA members to report among other
things when the member or an associated person of the members has
violated certain specified regulatory requirements, is subject to
written customer complaint, and is denied registration or is
expelled, enjoined, directed to cease and desist, suspended or
disciplined by a specified regulatory body. The provision at 17 CFR
240.17a-5(d)(1)(i)(A) (Exchange Act Rule 17a-5(d)(1)(i)(A)) requires
broker-dealers, subject to limited exceptions, to file annual
reports, including financial statements and supporting schedules
that generally must be audited by a Public Company Accounting
Oversight Board (PCAOB)-registered independent public accountant in
accordance with PCAOB standards.
\78\ See, e.g., 17 CFR 240.15c3-5 (Exchange Act Rule 15c3-5)--
Risk Management Controls for Brokers or Dealers with Market Access
(the ``Market Access Rule'') promotes market integrity by reducing
risks associated with market access by requiring financial and
regulatory risk management controls reasonably designed to limit
financial exposures and ensure compliance with applicable regulatory
requirements.
\79\ See, e.g., Section 17(a) of the Exchange Act and 17 CFR
240.17a-3 and 240.17a-4 (Rules 17a-3 and 17a-4 thereunder); see
also, e.g., FINRA Rules 2268, 4510, 4511, 4512, 4513, 4514, 4515,
5340 and 7440(a)(4) (requiring member firms to make and preserve
certain books and records to show compliance with applicable
securities laws, rules, and regulations and enable Commission and
FINRA staffs to conduct effective examinations); NYSE Rule 440
(Books and Records); CBOE Exchange Rule 7.1 (Maintenance, Retention
and Furnishing of Books, Records and Other Information). Among other
things, Commission and SRO books and records rules help to ensure
that regulators can access information to evaluate the financial and
operational condition of the firm, including examining compliance
with financial responsibility rules, among other rules, as well as
assess whether and how a firm's participation in the securities
markets impacted a major market event. See Staff Study on Investment
Advisers and Broker-Dealers As Required by Section 913 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) at
72. See also Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers; Capital Rule for Certain Security-Based Swaps
Dealers, Exchange Act Release No. 71958 (Apr. 17, 2014), 79 FR
25194, 25199 (May 2, 2014) (``The requirements are an integral part
of the investor protection function of the Commission, and other
securities regulators, in that the preserved records are the primary
means of monitoring compliance with applicable securities laws,
including antifraud provisions and financial responsibility
standards.'').
\80\ See, e.g., Sections 15(c)(1) and (2) of the Exchange Act,
15 U.S.C. 78o(c)(1) and (2), and rules promulgated thereunder.
\81\ Under Title I of the Government Securities Act (``GSA''),
all government securities brokers and government securities dealers
are required to comply with the requirements in Treasury's GSA
regulations that are set out in 17 CFR parts 400 through 449. For
the most part, Treasury's GSA regulations incorporate with some
modifications: (1) Commission rules for non-financial institution
government securities brokers and government securities dealers; and
(2) the appropriate regulatory agency rules for financial
institutions that are required to file notice as government
securities brokers and government securities dealers. See, e.g., 17
CFR part 400, Rules of general application; 17 CFR part 401,
Exemptions; 17 CFR part 402, Financial responsibility; 17 CFR part
403, Protection of customer securities and balances; 17 CFR part
404, Recordkeeping and preservation of records; 17 CFR part 405,
Reports and audit; 17 CFR part 420, Large position reporting; and 17
CFR part 449, Forms, Section 15C of the Exchange Act. The GSA
regulations also include requirements for custodial holdings by
depository institutions at 17 CFR part 450, which were issued under
Title II of the GSA. The Treasury GSA regulations provide in many
instances that a registered dealer can comply with a Commission rule
to establish compliance with the comparable Treasury requirement.
See, e.g., 17 CFR 402.1(b) (Treas. Reg. Sec. 402.1(b)) (``This part
does not apply to a registered broker or dealer . . . that is
subject to [Exchange Act Rule 15c3-1].''); 17 CFR 403.1 (Treas. Reg.
Sec. 403.1) (regarding application to registered brokers or
dealers); 17 CFR 404.1 and 405.1(a) (Treas. Reg. Sec. Sec. 404.1
and 405.1(a)) (same).
\82\ See Exchange Act Section 15(b) (regarding Commission
authority to sanction brokers and dealers); Section 15C(c)
(regarding Commission authority to sanction government securities
dealers that are registered with it); Section 15C(d) (authorizing
the Commission to examine books and records of government securities
dealers registered with it); and Section 17(b) (broker-dealer
recordkeeping and examination). See also Section 15C(g) (restricting
the ability of the Commission with respect to government securities
dealers that are not registered with the Commission).
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III. Overview of Proposed Rules
The operative concept in the definitions of ``dealer'' and
``government securities dealer''--that distinguishes the regulated
entity from the unregulated trader--is that the dealer is engaged in
buying and selling securities for its own account ``as part of a
regular business.'' \83\ The Commission is proposing two rules--
proposed Rules 3a5-4 and 3a44-2--to further define these terms to
identify certain activities that would constitute a ``regular
business'' requiring a person engaged in those activities to register
as a ``dealer'' or a ``government securities dealer,'' absent an
exception or exemption.\84\ A person (as defined below) who engages in
any one of the activities identified in either proposed Rule 3a5-4 or
3a44-2 would be considered a dealer under that rule.\85\
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\83\ As discussed above, the definitions of ``dealer'' and
``government securities dealer'' under the Exchange Act exclude from
dealer status a person that buys or sells securities for such
person's own account ``but not as a part of a regular business.''
See 15 U.S.C. 78c(a)(5)(A) and (B) and 15 U.S.C. 78c(a)(44)(A).
\84\ See Exchange Act Section 15 (regarding registration of
dealers) and Section 15C (regarding registration of government
securities dealers).
\85\ Status as a securities ``dealer'' or ``government
securities dealer'' as a result of engaging in securities or
government securities transactions ``as part of a regular business''
under proposed Rules 3a5-4 or 3a44-2 is not determinative of a
person's status for purposes of the exclusions in Section 3(c)(2) of
the Investment Company Act. Although that exclusion uses some
terminology that is similar to that in the Proposed Rules, Section
3(c)(2) includes a number of conditions in addition to the
requirement that a person regularly engage in transactions on both
sides of the market, each of which an entity would have to satisfy
to be able to rely on the investment company exclusion.
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As explained above, over the years the Commission and the courts
have identified a number of qualitative factors, including acting as a
market maker, de facto market maker, or liquidity provider, that might
indicate a person may be engaged in a regular business of buying and
selling securities for its own account.\86\ The Proposed Rules would
expand upon these statements to further define three qualitative
standards designed to more specifically identify activities of certain
market participants who assume dealer-like roles, specifically, persons
whose trading activity in the market ``has the effect of providing
liquidity'' to other
[[Page 23062]]
market participants.\87\ While all market participants who buy or sell
securities in the marketplace arguably contribute to a market's
liquidity, the Proposed Rules focus on market participants who engage
in a routine pattern of buying and selling securities for their own
account that has the effect of providing liquidity. Said differently,
for market participants engaging in any of the activities identified by
the qualitative standards of the Proposed Rules, liquidity provision is
not incidental to their trading activities. Rather, these persons are
``in the business'' of buying and selling securities for their own
account and providing liquidity as part of a regular business.\88\ The
Proposed Rules would set forth three standards that the Commission
believes would appropriately distinguish and identify such liquidity
provision as a ``regular business.''
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\86\ See 2002 Release (stating that a person generally may
satisfy the definition, and therefore, be acting as a dealer in the
securities markets, by conducting various activities, including
``acting as a market maker or specialist on an organized exchange or
trading system'' or ``acting as a de facto market maker whereby
market professionals or the public look to the firm for
liquidity'').
\87\ As noted below, the Proposed Rules are not the exclusive
means of establishing that a person is a dealer or government
securities dealer--to the extent consistent with the Proposed Rules,
existing Commission interpretations and precedent will continue to
apply. See above Section II.A. For example, facts indicating a
person may be acting as a ``dealer'' include underwriting, as well
as buying and selling directly to securities customers together with
conducting any of an assortment of professional market activities
such as providing investment recommendations, extending credit, and
lending securities in connection with transactions in securities,
and carrying a securities account. See 2002 Release. See also SEC v.
Justin W. Keener d/b/a JMJ Financial, No. 20-cv-21254 (S.D. Fla.
Jan. 21, 2022). Accordingly, a person may still be acting as a
dealer even if they do not, under the Proposed Rules, engage in a
routine pattern of buying and selling securities that has the effect
of providing liquidity to other market participants. See proposed
Rule 3a5-4(c) and proposed Rule 3a44-2(c), discussed below in
Section III.E.
\88\ PTFs engaging in passive market making, for example, earn
revenue primarily from the provision of liquidity, specifically ``by
buying at the bid and selling at the offer and capturing any
liquidity rebates offered by trading centers to liquidity supplying
orders.'' See, e.g., 2010 Equity Market Structure Concept Release at
3607.
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In addition, proposed Rule 3a44-2, which would apply only to
government securities dealers, would include a quantitative
standard.\89\ This quantitative standard would establish a bright-line
test, under which a person engaging in certain specified levels of
activity would be deemed to be buying and selling government securities
``as a part of a regular business,'' regardless of whether it meets any
of the qualitative standards.\90\
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\89\ See Section III.C.
\90\ See id.
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A person whose activity meets the quantitative or any of the
qualitative standards would be a dealer and so subject to the Exchange
Act registration requirements, regardless of whether the liquidity
provision is a chosen consequence of its activities.\91\
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\91\ The Proposed Rules focus on effect regardless of a person's
intention. The fact that the provision of liquidity is a fundamental
aspect of the activities captured by the qualitative standards does
not mean that such liquidity provision need be deliberate to come
within the Proposed Rules. Intent is not required by the statutory
language, nor is it relevant in every circumstance.
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To account for variations in corporate structure and ownership, the
Proposed Rules additionally would define the terms ``own account'' and
``control.'' The Proposed Rules would define a person's ``own account''
to mean, subject to certain exceptions, any account: (i) Held in the
name of that person; (ii) held in the name of a person, over whom that
person exercises control or with whom that person is under common
control; \92\ or (iii) held for the benefit of those persons identified
in (i) and (ii). In addition, the Proposed Rules would give ``control''
the ``same meaning as prescribed in Sec. 240.13h-l (Rule 13h-l), under
the Exchange Act.''
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\92\ The Proposed Rules would exclude from aggregation under
paragraph (b)(2)(ii): (A) An account in the name of a registered
broker, dealer, government securities dealer, or an investment
company registered under the Investment Company Act; (B) with
respect to an investment adviser registered under the Advisers Act,
an account held in the name of a client of the adviser unless the
adviser controls the client as a result of the adviser's right to
vote or direct the vote of voting securities of the client, the
adviser's right to sell or direct the sale of voting securities of
the client, or the adviser's capital contributions to or rights to
amounts upon dissolution of the client; or (C) with respect to any
person, an account in the name of another person that is under
common control with that person solely because both persons are
clients of an investment adviser registered under the Advisers Act
unless those accounts constitute a parallel account structure.
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While the Proposed Rules would establish standards that identify
when a person is acting as a dealer or government securities dealer,
whether a person's activities meet these standards would remain a facts
and circumstances determination.\93\ Importantly, the Proposed Rules
are not the exclusive means of establishing that a person is a dealer
or government securities dealer--to the extent consistent with the
Proposed Rules, existing Commission interpretations and precedent will
continue to apply.\94\
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\93\ Cf. 2002 Release (``[T]he analysis of whether a person
meets the definition of a dealer depends upon all of the relevant
facts and circumstances.'').
\94\ See Section II.A. For example, a person generally may
satisfy the statutory definition of ``dealer'' by underwriting, or
buying and selling directly to securities customers together with
conducting any of an assortment of professional market activities
such as providing investment recommendations, extending credit, and
lending securities in connection with transactions in securities,
and carrying a securities account. See 2002 Release.
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A market participant that is not registered as a dealer that comes
within the scope of the Proposed Rules would need to register with the
Commission as a dealer or government securities dealer and become a
member of an SRO. This would involve filing Form BD with the Commission
and completing the SRO's processes for new members.\95\ The Commission
is proposing to provide such market participants a one-year compliance
period from the effective date of any final rules. The proposed
compliance period is designed to provide adequate time for persons
captured by the Proposed Rules at the time of adoption, if adopted, to
apply for dealer registration, and for the relevant SROs to conduct
their review of the new member applications, without disrupting the
markets or the participants' market activities. The proposed compliance
period would not cover market participants whose activities following
the effective date of any final rules require registration as dealers
under those rules.
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\95\ After receiving a substantially complete application
package, FINRA, for instance, must review and process it within 180
calendar days. See ``How to Become a Member--Member Application Time
Frames,'' available at <a href="https://www.finra.org/registration-exams-ce/broker-dealers/how-become-member-membership-application-time-frames">https://www.finra.org/registration-exams-ce/broker-dealers/how-become-member-membership-application-time-frames</a>.
See also FINRA Rule 1014.
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A. Persons Excluded From the Proposed Rules
Under the Proposed Rules, the term ``person'' would have the same
meaning as prescribed in Section 3(a)(9) of the Exchange Act.\96\ As a
threshold matter, the Proposed Rules would not apply to: (i) ``[a]
person that has or controls total assets of less than $50 million;''
\97\ or (ii) ``[an] investment company registered under the Investment
Company Act.'' \98\
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\96\ See proposed Rule 3a5-4(b)(1) and proposed Rule 3a44-
2(b)(1).
\97\ See proposed Rule 3a5-4(a)(2)(i) and proposed Rule 3a44-
2(a)(3)(i). While a person who has or controls less than $50 million
in total assets would not be subject to the Proposed Rules, that
person's trading volume or activities may still be aggregated with
those of another person under the Proposed Rules definitions of
``own account'' and ``control.'' See Section III.D.
\98\ See proposed Rule 3a5-4(a)(2)(ii) and proposed Rule 3a44-
2(a)(3)(ii).
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As discussed above, the Proposed Rules are intended to capture
market participants not registered as dealers that serve a critical
dealer-like role in the securities and government securities markets
through their liquidity provision or significant and regular trading
activity in the market. By providing an exception for persons that have
or control total assets of less than $50 million, the Proposed Rules
would parallel an established standard for distinguishing between
``retail'' and ``institutional'' investors in other
[[Page 23063]]
contexts.\99\ The Commission believes that this threshold is
appropriate in the context of the Proposed Rules because, even though a
person that has or controls less than $50 million in assets may be
engaged in the activities identified in the Proposed Rules' qualitative
standards,\100\ the frequency and nature of its securities trading are
less likely to pose the types of financial and operational risks to the
market that may be associated with the significant dealer-like activity
engaged in by certain PTFs and other institutional market participants,
that the Proposed Rules are designed to address.\101\ This is not an
exclusion from the dealer definition for all purposes. Rather, as with
other persons not within the ambit of the Proposed Rules, the question
of whether a person that has or controls less than $50 million in total
assets is acting as a dealer, as opposed to a trader, will remain a
facts and circumstances determination, and to the extent consistent
with the Proposed Rules, existing applicable interpretations and
precedent will continue to apply.\102\
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\99\ Under FINRA rules, a ``retail'' account is distinguished
from an ``institutional'' account by defining, in part, an
institutional account as belonging to ``a person (whether a natural
person, corporation, partnership, trust, or otherwise) with total
assets of at least $50 million.'' FINRA Rule 4512(c)(3); see also
Business Conduct Standards for Security-Based Swap Dealers and Major
Security-Based Swap Participants, Exchange Act Release No. 77617
(Apr. 14, 2016), 81 FR 29959, 29995 n.462 (May 13, 2016) (adopting a
similar threshold for purposes of 17 CFR 240.15Fh-3(f)(4) (Exchange
Act Rule 15Fh-3(f)(4))). The Proposed Rules do not use the
definition of ``retail customer'' adopted as part of Regulation Best
Interest, as the policy considerations behind that definition are
different than those presented here: The focus of Regulation Best
Interest is the regulatory protections provided to customers who
receive recommendations from broker-dealers, whereas the focus of
this proposed rulemaking is the regulation of persons engaging in
certain dealer-like activities. See Regulation Best Interest: The
Broker-Dealer Standard of Conduct, Exchange Act Release No. 86031
(June 5, 2019), 84 FR 33318 (July 12, 2019).
\100\ As discussed in Section III.C, to meet the quantitative
standard set forth in proposed Rule 3a44-2(a)(2) a person must, in
each of four out of the last six calendar months, engage in buying
and selling more than $25 billion of trading volume in government
securities as defined in Section 3(a)(42)(A) of the Exchange Act.
The Commission believes that there will not be any instances where a
person who has or controls less than $50 million in total assets
will meet this quantitative standard.
\101\ Depending on the scope and nature of its activities, such
a person could come within the definition of ``pattern day trader''
under FINRA rules. See FINRA Rule 4210. Notably, among other
requirements, a pattern day trader must maintain a minimum amount of
equity in its margin account on any day that the customer day trades
and this minimum equity must be in the account prior to engaging in
any day-trading activities. Id. If the account falls below the
minimum requirement, the pattern day trader will not be permitted to
day trade until the account is restored to the minimum equity level.
Id.
\102\ As discussed above, dealer status involves engaging in
``more than a few isolated'' securities transactions. See supra note
47 and accompanying text.
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The Commission is proposing to exclude registered investment
companies from the application of the Proposed Rules.\103\ Registered
investment companies are subject to a regulatory framework under the
Investment Company Act and rules thereunder, which imposes requirements
regarding capital structure,\104\ custody of assets,\105\ investment
activities,\106\ transactions with affiliates and other conflicts of
interest,\107\ and the duties and independence of boards of directors,
among other things.\108\ Moreover, registered investment companies are
subject to statutory limits on indebtedness and rules that limit
leverage risk.\109\ In addition, registered investment companies must
adopt, implement, and review at least annually written policies and
procedures reasonably designed to prevent violations of the Federal
securities laws by the fund.\110\ These policies and procedures must be
approved by the fund's board of directors, including a majority of
independent directors, and are administered by a designated chief
compliance officer.\111\ Registered investment companies are required
to register under the Investment Company Act and offer their shares
under the Securities Act of 1933 (``Securities Act'').\112\ They also
must report to the Commission on many aspects of their operations and
their portfolio holdings.\113\ Registered investment companies must
maintain certain books and records and make them available for
examination by the Commission.\114\ As a result, the Commission has
extensive oversight of registered investment companies and broad
insight into their operations and activities. In light of the
regulatory structure that governs registered investment companies,
which addresses, among other things, the types of concerns that we seek
to address in the Proposed Rules, the Commission is proposing to
exclude registered investment companies from the application of the
Proposed Rules.\115\
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\103\ A registered investment company includes any issuer which
is or holds itself out as being primarily, or proposes to engage
primarily, in the business of investing, reinvesting, or trading in
securities. 15 U.S.C. 80a-3(a)(1)(A). The Investment Company Act
generally prohibits a domestic registered investment company from
offering or selling any security unless the company is registered
under Section 8 of the Investment Company Act. 15 U.S.C. 80a-7(a).
\104\ See 15 U.S.C. 80a-18.
\105\ See 15 U.S.C. 80a-17(f); 17 CFR 270.17f-1 through 270.17f-
7.
\106\ See, e.g., 15 U.S.C. 80a-12(d)(1), 12(d)(3).
\107\ See 15 U.S.C. 80a-17(a), (d), (e); 17 CFR 270.17d-1,
270.17e-1.
\108\ See, e.g., 15 U.S.C. 80a-2(a)(41), 15, 17(f), 17 CFR
270.17(j), 270.31(a); 17 CFR 270.2a-4, 270.2a-5, 270.10f-3, 270.12b-
1, 270.17a-7, 270.17e-1, 270.22c-1, 270.38a-1.
\109\ See 15 U.S.C. 80a-18 (Section 18 prohibits closed-end
funds from issuing or selling senior securities that represent
indebtedness unless it has at least 300 percent asset coverage, and
open-end funds from issuing or selling a senior security other than
borrowing from a bank, also subject to 300 percent asset coverage
and defines ``senior security,'' in part, as ``any bond, debenture,
note, or similar obligation or instrument constituting a security
and evidencing indebtedness.''); 17 CFR 270.18f-4 (generally
requiring investment companies that use derivatives to adopt a
derivatives risk management program that includes a limitation on
leverage risk based on Value-at-Risk (VaR)). See also Use of
Derivatives by Registered Investment Companies and Business
Development Companies, Investment Company Act Release No. 34084
(Nov. 2, 2021), 85 FR 83162 (Dec. 21, 2020).
\110\ 17 CFR 270.38a-1. The fund's policies and procedures also
must provide for the oversight of compliance by the fund's advisers,
principal underwriters, administrators, and transfer agents. See
also 15 U.S.C. 80a-47(a) (``It shall be unlawful for any person,
directly or indirectly, to cause to be done any act or thing through
or by means of any other person which it would be unlawful for such
person to do under the provisions of this subchapter or any rule,
regulation, or order thereunder.'').
\111\ 17 CFR 270.38a-1.
\112\ Depending on the organizational form, investment companies
register under the Investment Company Act and offer their shares
under the Securities Act on Forms N-1A (open-end management
investment companies), N-2 (closed-end management investment
companies), N-3 (separate accounts organized as management
companies), N-4 (separate accounts organized as unit investment
trusts), N-5 (small business investment companies), and N-6
(separate accounts organized as unit investment trusts that offer
variable life insurance products).
\113\ Registered investment companies report certain census
information annually to the Commission on Form N-CEN. Registered
investment companies also are required to report monthly portfolio-
wide and position-level holdings data to the Commission on Form N-
PORT. This includes information regarding repurchase agreements,
securities lending activities, and counterparty exposures, terms of
derivatives contracts, and discrete portfolio level and position
level risk measures to better understand fund exposure to changes in
market conditions.
\114\ 15 U.S.C. 80a-30.
\115\ As discussed in Section III.D, for purposes of the
definition of ``own account,'' an account held in the name of a
person that is a registered investment company would not be
attributed to a controlling person or another person under common
control.
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The Proposed Rules would not exclude private funds because we are
taking a similar approach to regulating dealer activity across market
participants and, unlike registered investment companies, private funds
are not subject to the extensive regulatory framework of the Investment
Company Act. The Commission is mindful that registered private fund
advisers are regulated under the Advisers Act and that information on
private fund activities is reported by registered
[[Page 23064]]
private fund advisers on Form PF.\116\ The information the Commission
obtains on private funds through its regulation of registered
investment advisers, however, differs from that the Commission collects
for the purposes of dealer regulation. In addition, dealer registration
enhances regulatory oversight of market participants' trading
activities and interactions with the market overall and dealer
regulatory requirements focus broadly on market functionality (along
with protecting investors under principles of fair dealing between
parties).
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\116\ The Commission recently has issued a proposal to amend
Form PF, which would provide the SEC and the Financial Stability
Oversight Counsel (``FSOC'') with additional confidential
information about private funds. Information reported on Form PF has
helped establish a baseline picture of the private fund industry for
use in assessing systemic risk. These proposed amendments would
apply to large hedge fund advisers, private equity advisers, and
large liquidity fund advisers and are designed to enhance FSOC's and
the Commission's ability to monitor systemic risk, bolster the
Commission's regulatory oversight of private fund advisers, and
enhance investor protection efforts. See Form PF Proposing Release,
supra note 34.
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Similarly, the Proposed Rules would not apply a blanket exclusion
for registered investment advisers. A registered investment adviser
trading for its ``own account'' as defined in the Proposed Rules could
implicate dealer registration requirements.\117\ The Commission is
mindful, however, that with some clients, a registered investment
adviser only exercises investment discretion over the client's account,
while with some other clients, the adviser also may control the client
through an ownership interest. The Proposed Rules take into account a
registered investment adviser's role in determining what client trading
activity should be attributed to the adviser for purpose of the
rules.\118\
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\117\ See proposed Rule 3a5-2(b)(2) and proposed Rule 3a44-
2(b)(2).
\118\ See infra note 185 and accompanying text.
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Request for Comments
The Commission generally requests comment on this aspect of the
Proposed Rules. In addition, the Commission requests comment on the
following specific issues:
1. Should the Proposed Rules exclude persons that have or control
less than $50 million in total assets? Are there instances in which
persons that have or control less than $50 million in total assets that
are buying and selling securities or government securities for their
own accounts provide liquidity to the markets or have a significant
impact on the markets that would warrant regulation as dealers or
government securities dealers? Please explain.
2. Does the proposed $50 million in total assets threshold
sufficiently distinguish persons whose activity should not be captured
for purposes of the Proposed Rules? If not, is there another amount or
measurement that would better distinguish these smaller market
participants and achieve the purposes of the Proposed Rules? Please
explain.
3. Would persons that would be captured by the Proposed Rules
(i.e., have or control more than $50 million in total assets)
restructure their activities or change their corporate structures for
the purpose of avoiding registration, including withdrawing or reducing
their trading activities or ceasing investment strategies that trigger
the application of the Proposed Rules? What would be the effects of
such restructuring, withdrawal, or cessation? Please explain.
4. Should the Commission exclude registered investment companies
from the scope of the Proposed Rules? Why or why not? If they are not
excluded, do registered investment companies engage in activities that
would be captured by the Proposed Rules? Could a registered investment
company comply with the requirements applicable to dealers? What would
be the potential costs and/or benefits of requiring registered
investment companies to register as dealers or government securities
dealers? Could the registered investment companies restructure their
activities to avoid dealer registration? What would be the effects of
such restructuring? Please explain.
5. The Proposed Rules do not exclude private funds, that is, pooled
investment vehicles that are exempted from the definition of
``investment company'' under Section 3(c)(1) or 3(c)(7) of the
Investment Company Act. Should the Commission except or exclude private
funds from the scope of the Proposed Rules? Why or why not? Should the
Commission except or exclude private funds advised by registered
investment advisers from the scope of the Proposed Rules? Do some
private funds engage in activities that would be captured by the
Proposed Rules? Could a private fund comply with the requirements
applicable to dealers? What would be the potential costs and/or
benefits of requiring private funds to register as dealers or
government securities dealers? Would private funds restructure their
activities to avoid registration as a dealer? What would be the effects
of such restructuring? Would private funds cease or reduce investment
strategies captured by the Proposed Rules to avoid registration as a
dealer? If so, what would be the effects of removing or reducing these
investment strategies from the markets? Please explain.
6. Should registered investment advisers trading for their own
accounts be excluded partially or entirely from the Proposed Rules? Why
or why not? Could some registered investment advisers engage in
activities that meet the proposed qualitative standards and trigger the
application of the Proposed Rules? Could some registered investment
advisers engage in trading volume in government securities that could
exceed the quantitative threshold in proposed Rule 3a44-2? If
registered investment advisers were captured by the Proposed Rules, how
would they comply with the requirements applicable to dealers? Would
the registered investment advisers restructure their activities to
avoid registration as a dealer, including withdrawing or reducing their
trading activities or ceasing or reducing investment strategies that
trigger the application of the Proposed Rules? What would be the
effects of such restructuring, withdrawal, or cessation? Please
explain.
7. Instead of addressing investment adviser and private fund dealer
concerns under the framework of existing dealer regulation, should the
Commission consider a proposed rulemaking under the Advisers Act to
address these concerns? What elements should be included in such a
rulemaking? For example, should it include transaction reporting and/or
capital requirements?
8. Should the Commission except or exclude any other categories of
persons from the scope of the Proposed Rules? If so, what persons, and
why? If not, why not?
B. Qualitative Standards
The qualitative standards in the Proposed Rules would build on
existing statements by the Commission and the courts regarding
``dealer'' activity to further define certain standards for determining
when a person that is engaged in buying and selling securities for its
own account is engaged in that activity ``as a part of a regular
business,'' as that phrase is used in Sections 3(a)(5) and 3(a)(44)(B)
of the Exchange Act. Specifically, under paragraph (a)(1) of the
Proposed Rules, a person would be engaged in buying and selling
securities for its own account ``as a part of a regular business'' and
so a dealer or a government securities dealer, if that person engages
in a routine pattern of buying and selling securities (or
[[Page 23065]]
government securities) that has the effect of providing liquidity to
other market participants.
The Proposed Rules further identify three types of activities that
would be considered to have the effect of providing liquidity to other
market participants: (i) Routinely making roughly comparable purchases
and sales of the same or substantially similar securities (or
government securities) in a day; or (ii) routinely expressing trading
interests that are at or near the best available prices on both sides
of the market and that are communicated and represented in a way that
makes them accessible to other market participants; or (iii) earning
revenue primarily from capturing bid-ask spreads, by buying at the bid
and selling at the offer, or from capturing any incentives offered by
trading venues to liquidity-supplying trading interests. The following
discussion of the proposed qualitative standards is applicable to both
rules, and references to ``dealer'' activity apply equally to both
``dealers'' and ``government securities dealers'' under Sections
3(a)(5) and 3(a)(44) of the Exchange Act, respectively, unless
otherwise indicated.
Under the Proposed Rules, a person's securities trading activity
would form a ``part of a regular business'' when that person ``engages
in a routine pattern of buying and selling securities [or government
securities] that has the effect of providing liquidity to other market
participants.'' \119\ Under this qualitative standard, when the
frequency and nature of a person's securities trading is such that the
person assumes a role--described as either market-making, de facto
market-making, or liquidity-providing--similar to the role that
historically has been performed by a set of registered dealers, that
person would be deemed to be acting as a dealer or government
securities dealer.\120\ As elaborated below, the Proposed Rules
identify three patterns of buying and selling that the Commission views
as having the effect of providing liquidity--any one of which is
sufficient to require a person to register as a dealer. As discussed
below, no presumption shall arise that a person is not a dealer solely
because that person does not engage in the activities described in the
Proposed Rules.\121\ Other patterns of buying and selling may have the
effect of providing liquidity to other market participants or otherwise
require a person to register under the Proposed Rules in accordance
with applicable precedent.
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\119\ See proposed Rule 3a5-4(a)(1) and proposed Rule 3a44-
2(a)(1).
\120\ See, e.g., 2002 Release at 67499.
\121\ See proposed Rule 3a5-4(c) and proposed Rule 3a44-2(c),
discussed in Section III.E.
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The Commission has long identified activities related to liquidity
provision as factors that would indicate a person is `` `engaged in the
business' of buying and selling securities.'' \122\ Historically,
persons who provide liquidity in securities markets in exchange for
compensation, earning revenue from the act of buying and selling
itself, have registered as dealers.\123\ And, from the enactment of the
Exchange Act, the term ``dealer'' has included a class of liquidity
providers that includes but is broader than market makers,
encompassing, for example, professional floor traders who trade ``in
and out,'' effect ``about half of the transactions on the floor of the
stock exchange,'' and whose ``profits depend upon . . . running along
and playing with the trends and not getting caught taking positions.''
\124\ As securities markets have evolved, and new market participants
have increasingly taken on market-making and liquidity-providing roles,
the Commission has stated that dealer activity includes not only
``acting as a market maker'' but also ``acting as a de facto market
maker whereby market professionals or the public look to the firm for
liquidity.'' \125\ Traders, by contrast, the Commission indicated, do
``not mak[e] a market in securities.'' \126\
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\122\ 2002 Release at 67498-500. In addition, the staff has
stated that, while ``the practical distinction between a `trader'
and a `dealer' is often difficult to make and depends substantially
upon the facts, . . . [a]s a general matter, a trader does not[,
among other things,] . . . furnish the services which are usually
provided by dealers, such as quoting the market in one or more
securities.'' National Council of Savings Inst., SEC No-Action
Letter, 1986 WL 67129 (July 27, 1986) (the staff declined to take a
no-action position with respect to national trade association's
members as ``a determination of a Member's status under the
[Exchange] Act would depend upon an analysis of all of that Member's
securities activities, and not just'' the activities described in
the request).
\123\ See, e.g., Exchange Act Section 3(a)(38), 15 U.S.C.
78c(a)(38) (``The term `market maker' means any specialist permitted
to act as a dealer, any dealer acting in the capacity of block
positioner, and any dealer who, with respect to a security, holds
himself out (by entering quotations in an inter-dealer
communications system or otherwise) as being willing to buy and sell
such security for his own account on a regular or continuous
basis.'') (emphasis added). See also Stock Exchange Regulation:
Hearing on H.R. 7852 and H.R. 8720 Before the Committee on
Interstate and Foreign Commerce, 73rd Congr. 117 (1934) (statement
of Thomas Corcoran) (``The term `dealer' is broad enough to include
. . . the floor trader . . . [whose] profits depend upon his running
along and playing with the trends and not getting caught taking
positions.''); 2002 Release at 67499 (``A person generally may
satisfy the definition, and therefore, be acting as a dealer in the
securities markets by . . . acting as a market maker or specialist
on an organized exchange or trading system [or] acting as a de facto
market maker whereby market professionals or the public look to the
firm for liquidity . . . .'').
\124\ See Stock Exchange Regulation: Hearing on H.R. 7852 and
H.R. 8720 Before the Committee on Interstate and Foreign Commerce,
73rd Congr. 117 (1934) (statement of Thomas Corcoran). See also U.S.
Securities and Exchange Commission, Report on the Feasibility and
Advisability of the Complete Segregation of the Functions of Dealer
and Broker 21, 25, 85, 109 (1936).
\125\ See 2002 Release at 67499.
\126\ Id.
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In the context of the Proposed Rules, and as discussed further
below, a ``pattern'' of trading means buying and selling repetitively.
For a pattern to come within the Proposed Rules, both purchases and
sales would have to be ``routine'' and have ``the effect of providing
liquidity'' to other market participants. Further, as discussed below,
the Proposed Rules would set forth three standards that the Commission
believes would appropriately distinguish and identify such liquidity
provision as a ``regular business'' as opposed to non-dealer, or
trader, activity.
In this respect, the Proposed Rules focus on activity rather than
label or status. The Proposed Rules by their terms would cover any
person (as defined above) who ``engages in a routine pattern of buying
and selling securities [or government securities] that has the effect
of providing liquidity to other market participants,'' regardless of
whether the person labels itself, or is commonly known as, a PTF.
The liquidity-providing activity captured by the Proposed Rules
would include not only passive liquidity-providing activity \127\ but
also aggressive trading strategies, including structural or directional
trading \128\ that similarly
[[Page 23066]]
permit a person to earn revenue from the act of buying and selling
itself. In this regard, the Proposed Rules would cover persons who
trade, as part of a regular business,\129\ ``in and out'' and whose
``profits depend upon . . . running along and playing with the trends
and not getting caught taking positions''--activity understood from the
enactment of the Exchange Act to be a form of dealer activity--as well
as more traditional forms of liquidity provision, such as market
making.\130\
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\127\ See Algorithmic Trading Staff Report at 39 (``Passive
market-making involves submitting non-marketable orders on both
sides (buy or `bid,' and sell or `offer') of the marketplace.'').
\128\ See id. at 39-41 (citing 2010 Equity Market Structure
Concept Release and SEC Staff of the Division of Trading and
Markets, Equities Market Structure Literature Review Part II: High
Frequency Trading (Mar. 18, 2014)) (describing broad types of short-
term high frequency trading strategies). Market participants of the
kind that this release addresses, including PTFs, may carry out
passive market making strategies. They may also engage in a range of
trading strategies that involve submitting aggressive orders, or a
combination of passive and aggressive orders, ``sometimes rapidly
demanding liquidity, in order to quickly liquidate positions
accumulated through providing liquidity.'' See Algorithmic Trading
Staff Report at 39-40; see also ``Making,'' ``taking'' and the
material political economy of algorithmic trading, Donald MacKenzie,
Economy and Society, 47:4, 501-23 (2018); High-Frequency Trading
Strategies Michael Goldstein, Babson College, Amy Kwan, University
of Sydney, Richard Philip, University of Sydney (Dec. 8, 2016);
Exploring Market Making Strategy for High Frequency Trading: An
Agent-Based Approach, Yibing Xiong, Takashi Yamada, Takao Terano
(2015); SEC Staff of the Division of Trading and Markets, Equities
Market Structure Literature Review Part II: High Frequency Trading
(Mar. 18, 2014). These passive and aggressive strategies are often
referred to as ``liquidity providing'' and ``liquidity demanding''
or ``liquidity taking'' strategies respectively. See, e.g.,
Algorithmic Trading Staff Report. Under the Proposed Rules, both
passive and aggressive trading strategies would be considered forms
of liquidity provision.
\129\ See supra note 39.
\130\ Stock Exchange Regulation: Hearing on H.R. 7852 and H.R.
8720 Before the Committee on Interstate and Foreign Commerce, 73rd
Congr. 117 (1934) (statement of Thomas Corcoran). For a discussion
of ``liquidity providing'' versus ``liquidity demanding'' trading
strategies, see supra note 128.
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The Proposed Rules further define three patterns of buying and
selling that the Commission views as having the effect of providing
liquidity, which are discussed in turn below.
i. Routinely Making Roughly Comparable Purchases and Sales of the Same
or Substantially Similar Securities in a Day
Under the first enumerated pattern, in proposed Rules 3a44-
2(a)(1)(i) and 3a5-4(a)(1)(i) respectively, a person that, trading for
its own account, ``routinely mak[es] roughly comparable purchases and
sales of the same or substantially similar securities in a day'' would
be engaged in a pattern of trading that ``has the effect of providing
liquidity to other market participants,'' and therefore be a dealer or
government securities dealer.\131\
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\131\ See, e.g., Amendments to Regulation SHO, Exchange Act
Release No. 58775, 73 FR 61690, 61699 (Oct. 17, 2008) (``Regulation
SHO Amendments''), in which the Commission stated that ``[a] pattern
of trading that includes both purchases and sales in roughly
comparable amounts to provide liquidity to customers or other
broker-dealers'' would be one indicia of bona-fide market-making
activity for purposes of the exceptions in 17 CFR 242.200 through
242.204 (Regulation SHO) to the locate and close-out requirements.
The determination of eligibility for the bona-fide market-making
exceptions is distinct from the determination of whether a person's
trading activity indicates that such person is acting as a dealer
under the Proposed Rule. Under the Regulation SHO exception, for
instance, the broker-dealer must also be providing widely
disseminated quotations near or at the market and put itself at
market risk. As the Commission has stated on numerous occasions, the
determination of whether a particular short sale qualifies for the
bona-fide market-making exception depends on the particular facts
and circumstances surrounding the transaction(s). See infra note
157. Importantly, under the Proposed Rules, a person's intent is
irrelevant; the Proposed Rules focus on the ``effect'' of a person's
activity, and where a person's activity ``has the effect of
providing liquidity,'' whether or not that effect is intended, the
person would fall within the scope of the Proposed Rules.
---------------------------------------------------------------------------
``Routinely'' as used in this standard relates to the frequency
with which a person engages in making roughly comparable purchases and
sales of the same or substantially similar securities in a day. Here,
``routinely'' means more frequent than occasional but not necessarily
continuous,\132\ such that a person's transactions in roughly
comparable positions, throughout the day and routinely over time,
constitute ``[engaging] in a routine pattern of buying and selling
securities that has the effect of providing liquidity for market
participants'' under the Proposed Rules. The Commission believes that
this interpretation of ``routinely'' will separate persons engaging in
isolated or sporadic securities transactions from persons whose
regularity of participation in securities transactions demonstrates
that they are acting as dealers.
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\132\ As discussed below in Section III.A.ii, the Commission
believes it is appropriate to use ``routine,'' rather than
``regular'' or ``continuous,'' as these standards may fail to
capture a number of significant firms, due to the unique
characteristics of certain liquidity providers in today's markets.
Unlike many traditional types of liquidity providers, there are
liquidity providers in today's markets, such as PTFs, that despite
routine participation in the market, may at times interrupt their
market activity so that it is not always ``continuous.'' The
Commission adopted a similar approach in connection with its joint
rulemaking with the Commodity Futures Trading Commission regarding,
among other things, the definitions of ``swap dealer'' and
``security-based swap dealer.'' See Entities Adopting Release at
30609 (``making a market in swaps is appropriately described as
routinely standing ready to enter into swaps at the request or
demand of a counterparty. In this regard, `routinely' means that the
person must do so more frequently than occasionally, but there is no
requirement that the person do so continuously.'').
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As discussed above, the frequency with which a person buys and
sells securities for its own account is a common component of the
dealer analysis: More frequent buying and selling is indicative of
dealer activity.\133\ The first qualitative standard of the Proposed
Rules describes a regularity of participation far beyond the isolated
transactions of non-dealers,\134\ and focuses on a pattern of trading
because the consistency and regularity of their participation indicates
that their liquidity provision forms a part of a regular business.
---------------------------------------------------------------------------
\133\ See Section II.A.
\134\ See SEC v. Justin W. Keener d/b/a JMJ Financial, No. 1:20-
CV-21254 (S.D. Fla. Jan. 21, 2022) (``Case law has established that
the primary indicia in determining that a person has `engaged in the
business' within the meaning of the term `dealer' is that the level
of participation in purchasing and selling securities involves more
than a few isolated transactions.'' (emphasis added) (quoting
Sodorff, 1992 WL 224082, at *4)).
---------------------------------------------------------------------------
Under the Proposed Rules, ``roughly comparable'' would generally
capture purchases and sales similar enough, in terms of dollar volume,
number of shares, or risk profile, to permit liquidity providers to
maintain near market-neutral positions by netting one transaction
against another transaction. To be ``roughly comparable,'' the dollar
volume or number of shares of, or risk offset by, the purchases and
sales need not be exactly the same, as requiring a full netting of
positions may fail to capture a number of significant firms, due to the
unique characteristics of certain liquidity providers in today's
markets.\135\ Instead, ``roughly comparable'' purchases and sales would
fall within a reasonable range that generally would have the effect of
offsetting one transaction against the other. Generally speaking,
although the Proposed Rules do not provide a bright-line test in
connection with the qualitative factors, the Commission believes that a
person that closes or offsets, in the same day, the overwhelming
majority of the positions it has opened, has likely made ``roughly
comparable purchases and sales.'' \136\ This proposed standard would
capture a fundamental aspect of both the traditional dealer--who ``buys
securities . . . with a view to disposing them elsewhere'' and
``receives no brokerage commission but relies for his compensation upon
a favorable difference or spread between the price at which he buys and
the amount for which he sells'' \137\--and the liquidity provider whose
trading strategies generally involve frequent turnover of positions on
a short-term basis, with overnight holdings of unhedged positions that
are a fraction of their overall intraday positions.\138\
---------------------------------------------------------------------------
\135\ See, e.g., 2002 Release (focusing, among other things, on
a ``regular turnover of inventory'' rather than requiring completely
neutral positions).
\136\ The Proposed Rules do not provide a bright-line test to
determine ``roughly comparable'' purchases and sales. However, for
purposes of the Economic Analysis of the Proposed Rules, the
Commission assumes a daily buy-sell imbalance between two identical
or substantially similar securities, in terms of dollar volume,
below 10 percent or, alternatively, 20 percent may be indicative of
purchases and sales that are ``roughly comparable,'' as described
below in Section V.B.2.c. The Commission has requested comment on
whether this approach is appropriate and whether this standard
should include a trading threshold.
\137\ See U.S. Securities and Exchange Commission, Report on the
Feasibility and Advisability of the Complete Segregation of the
Functions of Dealer and Broker XIV (1936).
\138\ See 2010 Equity Market Structure Concept Release at 3607-
09. See also 2015 Joint Staff Report.
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[[Page 23067]]
The Proposed Rules reflect the statutory distinction between
``dealers'' and ``traders.'' The Commission has long distinguished
dealer activity from trader activity by focusing on, among other
things, a dealer's frequent turnover of positions--stating, for
example, that the dealer ``sells securities . . . he has purchased or
intends to purchase elsewhere or buys securities . . . with a view to
disposing of them elsewhere'' \139\--as well as the frequency with
which a person buys and sells.\140\ By targeting persons who routinely
make roughly comparable purchases and sales of the same or
substantially similar securities, the Proposed Rules identify persons
whose trading has the effect of providing liquidity that requires
dealer registration, and so distinguish those persons who are acting as
traders.\141\
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\139\ See U.S. Securities and Exchange Commission, Report on the
Feasibility and Advisability of the Complete Segregation of the
Functions of Dealer and Broker XIV (1936).
\140\ See Section II.A.
\141\ See Section I.
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The Proposed Rules take into account the speed at which technology
permits liquidity providers today to turn over their positions and the
fact that high-speed, anonymous trading platforms allow liquidity
providers to act as intermediaries without customers and without
holding an inventory of securities.\142\ In addition, the Proposed
Rules take into consideration the frequency with which a person buys
and sells securities, which is a factor historically considered as part
of the dealer analysis.\143\ Because they are based on activity, the
Proposed Rules would cover not only PTFs, but also any other persons
engaging in the identified activities.
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\142\ See, e.g., Stock Exchange Regulation: Hearing on H.R. 7852
and H.R. 8720 Before the Committee on Interstate and Foreign
Commerce, 73rd Congr. 117 (1934) (statement of Thomas Corcoran)
(discussing floor traders, which have long been viewed as dealers).
As the markets have evolved, the role of floor traders has largely
been replaced by PTFs, which play a role--albeit, electronically and
through the use of algorithmic trading strategies--similar to that
of the floor traders that traditionally have been regulated as
dealers. See 2010 Equity Market Structure Concept Release at 3607-
08.
\143\ See Section II.A.
---------------------------------------------------------------------------
Paragraph (a)(1)(i) of the Proposed Rules would also provide that
the securities bought and sold must be ``the same or substantially
similar'' in order to further distinguish liquidity providing dealer
activity from non-dealer trader activity. As discussed above, routinely
making roughly comparable purchases and sales of securities keeps a
liquidity provider's market positions near neutral only to the extent
that a sale or another trade offsets the risk taken on through a
purchase. For purposes of the rule, ``the same'' securities means that
the securities bought and sold are securities of the same class and
having the same terms, conditions, and rights.\144\ Securities bearing
the same Committee on Uniform Securities Identification Procedures
(``CUSIP'') number, for example, would be considered ``the same.'' In
addition, the determination of what would constitute ``substantially
similar'' securities for purposes of the rule would be based on the
facts and circumstances analysis that would take into account factors
such as, for example, whether: (1) The fair market value of each
security primarily reflects the performance of a single firm or
enterprise or the same economic factor or factors, such as interest
rates; and (2) changes in the fair market value of one security are
reasonably expected to approximate, directly or inversely, changes in,
or a fraction or a multiple of, the fair market value of the second
security. A person routinely making roughly comparable purchases and
sales of the same or substantially similar securities, such that the
sale or purchase of one security offsets the risk associated with the
sale or purchase of the other, permitting that person to maintain a
near market-neutral position, would meet this aspect of this standard.
---------------------------------------------------------------------------
\144\ See 17 CFR 227.300(b)(2) (Rule 300(b)(2) of Regulation
Crowdfunding) (permitting an intermediary to have a financial
interest in an issuer if, among other things, the financial interest
consists of securities of the same class and having the same terms,
conditions and rights as the securities being offered and sold on
the intermediary's platform.).
---------------------------------------------------------------------------
Applying these principles, the Commission believes that the
following are nonexclusive examples of purchases and sales of
``substantially similar'' securities:
<bullet> Selling a Treasury security and buying another Treasury
security in the same maturity range, as used by the Federal Reserve
Bank of New York's Open Market Operations.\145\ For example, selling a
4.5-year Treasury security and buying a 5-year Treasury security, or a
9.5 year Treasury security versus a 10-year Treasury security.
---------------------------------------------------------------------------
\145\ See Federal Reserve Bank of New York, ``FAQs: Treasury
Purchases,'' <a href="https://www.newyorkfed.org/markets/treasury-reinvestments-purchases-faq">https://www.newyorkfed.org/markets/treasury-reinvestments-purchases-faq</a>.
---------------------------------------------------------------------------
<bullet> Buying an exchange traded fund and selling the underlying
securities that make up the basket of securities held by the exchange
traded fund that was purchased.
<bullet> Buying a European call option on a stock and selling a
European put option on the same stock with the same strike and
maturity.
<bullet> Buying an OTC call option on a stock and selling a listed
option on the same stock with the same strike and maturity.
Conversely, the Commission believes that the following are examples
of purchases and sales of securities that are not ``substantially
similar'':
<bullet> Buying stock in one company (e.g., Ford) and selling stock
in another company in the same industry (e.g., Chrysler).
<bullet> Buying stock and selling bonds issued by the same company.
<bullet> Buying cash Treasury securities and selling Treasury
futures.
Finally, the standard under paragraph (a)(1)(i) of the Proposed
Rules would apply with respect to purchases and sales made ``in a
day.'' As discussed above, dealer liquidity providers are
distinguishable, in part, from traders and other market participants by
the frequent turnover of their positions. Traditional dealers often
hold an inventory to enable them to buy from one market participant and
sell to another. Technological advancements have increased the speed at
which this process happens, eliminating in some cases the need to carry
a traditional inventory at all, as liquidity providers are able to
source and unload securities extremely rapidly. The Commission believes
that a temporal component is necessary in paragraph (a)(1)(i) to
distinguish dealer liquidity providers from other market participants
who may contribute liquidity to the market periodically but not in the
repeated, routine--and often relied upon--manner of liquidity
providers. The Commission believes that ``in a day'' is a period of
sufficient duration to capture the trading activity typical of dealer
liquidity providers that are the focus of the Proposed Rules, and still
brief enough to exclude non-dealers pursuing longer-term investment
strategies. In addition, because PTFs tend to turn over their positions
over the course of a day, ``end[ing] the day with little net
directional exposure,'' \146\ market practices support drawing the
temporal line at the end of the day.
---------------------------------------------------------------------------
\146\ See 2021 IAWG Joint Staff Report at 5.
---------------------------------------------------------------------------
ii. Routinely Expressing Trading Interests That Are at or Near the Best
Available Prices on Both Sides of the Market and That Are Communicated
and Represented in a Way That Makes Them Accessible to Other Market
Participants
Proposed Rules 3a44-2(a)(1)(ii) and 3a5-4(a)(1)(ii) set forth the
second
[[Page 23068]]
pattern of trading activity that ``has the effect of providing
liquidity to other market participants.'' Specifically, under paragraph
(a)(1)(ii), a person buying and selling for its own account that
``routinely express[es] trading interests that are at or near the best
available prices on both sides of the market and that are communicated
and represented in a way that makes them accessible to other market
participants'' would be engaged in a pattern of trading in securities
or government securities that ``has the effect of providing liquidity
to other market participants,'' and therefore would be a dealer or
government securities dealer under the Proposed Rules. As discussed
below, the Proposed Rules would update the longstanding understanding
that regular or continuous quotation is a hallmark of market making or
de facto market making (and, hence, dealer) activity,\147\ to reflect
technological changes to the ways in which buyers and sellers of
securities are brought together.
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\147\ The term ``market maker'' includes, among other things,
``any dealer who, with respect to a security, holds itself out (by
entering quotations in an inter-dealer quotation system or
otherwise) as being willing to buy and sell such security for its
own account on a regular or continuous basis.'' See 15 U.S.C.
78c(a)(38). Moreover, the Commission has stated previously that a
market maker engaged in bona-fide market making is a ``broker-dealer
that deals on a regular basis with other broker-dealers, actively
buying and selling the subject security as well as regularly and
continuously placing quotations in a quotation medium on both the
bid and ask side of the market.'' See, e.g., Exchange Act Release
No. 32632 (July 14, 1993), 58 FR 39072, 39074 (July 21, 1993).
---------------------------------------------------------------------------
The Proposed Rules would apply when a person ``routinely''
expresses trading interests. Here, as well as in paragraph (a)(1)(i),
``routinely'' means that the person must express trading interests more
frequently than occasionally, but not necessarily continuously.\148\ As
discussed above in connection with paragraph (a)(1)(i), ``routinely''
relates to the frequency of the activity both intraday and across time,
and means both repeatedly within a day and on a regular basis over
time. The Commission believes it is appropriate to use ``routinely,''
rather than ``regular'' or ``continuous,'' as the latter standards may
fail to capture a number of significant firms, due to the unique
characteristics of certain liquidity providers in today's markets.
Specifically, by using ``routinely,'' the Proposed Rules are intended
to reflect market evolution to capture significant liquidity providers
who express trading interests at a high enough frequency to play a
significant role in price discovery and the provision of market
liquidity, even if their liquidity provision may not be continuous like
that of some traditional dealers. At the same time, they are very
active in the markets--their participation is very routine--as
demonstrated by the ``key role'' they play ``in price discovery and the
provision of market liquidity'' in both the interdealer U.S. Treasury
market \149\ and the equity markets.\150\
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\148\ See, e.g., Entities Adopting Release at 30609 (``In this
regard, `routinely' means that the person must do so more frequently
than occasionally, but there is no requirement that the person do so
continuously.'').
\149\ 2021 IAWG Joint Staff Report at 5, 13.
\150\ See, e.g., Algorithmic Trading Staff Report; 2010 Equity
Market Structure Concept Release.
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Paragraph (a)(1)(ii) would also use the term ``trading interest''
rather than ``quotations.'' The Commission has recently proposed to
define ``trading interest'' to mean ``an order, as defined in paragraph
(e) of [Rule 300 of Regulation ATS],\151\ or any non-firm indication of
a willingness to buy or sell a security that identifies at least the
security and either quantity, direction (buy or sell), or price.''
\152\ Technological advancements have proliferated methods by which
market participants hold themselves out as willing to buy or sell
securities, or otherwise communicate their willingness to trade. The
broader term ``trading interest'' would reflect the prevalence of non-
firm trading interest offered by market places today,\153\ and account
for the varied ways in which developing technologies permit market
participants to effectively make markets. The broader term
appropriately captures the traditional quoting engaged in by dealer
liquidity providers, new and developing quoting equivalents, and the
orders that actually result in the provision of liquidity that the
Commission intends the Proposed Rules to address. Using ``trading
interest,'' as defined above, rather than ``quotation'' will allow for
clear and consistent application of the definition of dealer and
government securities dealer.
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\151\ 17 CFR 242.300(e) defines an ``order'' to mean ``any firm
indication of a willingness to buy or sell a security, as either
principal or agent, including any bid or offer quotation, market
order, limit order, or other priced order.''
\152\ See 2022 ATS Proposing Release, proposed Rule 300(q). In
proposing this new term, the Commission noted the incidence of
``non-firm trading interest that includes the symbol and one of the
following: quantity, direction, or price. . . . The Commission
believes that . . . the use of a message that identifies the
security and either the quantity, direction, or price would provide
sufficient information to bring together buyers and sellers of
securities because it allows a market participant to communicate its
intent to trade and a reasonable person receiving the information to
decide whether to trade or engage in further communications with the
sender.'' Id. at 15505.
\153\ See 2022 ATS Proposing Release at 15500-15502.
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Further, the Commission is proposing that the rules encompass
trading interests expressed ``at or near the best available prices on
both sides of the market.'' \154\ The phrase ``best available prices on
both sides of the market'' more specifically and clearly describes the
activity of liquidity-providing dealers, which help determine the
spread between the best available bid price and the best available ask
price for a given security. Among other market benefits, by competing
to both buy and sell at the best available prices, liquidity providers
help to narrow bid-ask spreads.\155\ The Commission further believes
that the proposed formulation helps emphasize that a liquidity
provider, to come within the rule, must both buy and sell
securities.\156\
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\154\ See, e.g., Regulation SHO Amendments, in which the
Commission stated that quotations near or at the market for a short
sale in a security may provide an indication of bona-fide market
making for purposes of Regulation SHO, depending on the facts and
circumstances surrounding the activity. See also supra note 131.
\155\ See, e.g., Prohibitions and Restrictions on Proprietary
Trading, Release No. BHCA-1; File No. S7-41-11 (Dec. 10, 2013), 79
FR 5535, 5585-86 (Jan. 31, 2014), available at <a href="https://www.sec.gov/rules/final/2013/bhca-1.pdf">https://www.sec.gov/rules/final/2013/bhca-1.pdf</a> (setting forth, among other things, the
circumstances in which a banking entity may engage market making-
related activities) (``Volcker Rule Adopting Release'') at 177.
\156\ See, e.g., 15 U.S.C. 78c(a)(5) (``The term `dealer' means
any person engaged in the business of buying and selling
securities'' (emphasis added)); see also 15 U.S.C. 78c(a)(44).
---------------------------------------------------------------------------
Finally, the Proposed Rules would apply only when these trading
interests that are at or near the best available prices on both sides
of the market are ``communicated and represented in a way that makes
them accessible to other market participants.'' Under the Proposed
Rules, a market participant that routinely makes these trading
interests available to other market participants would be considered to
have engaged in a routine pattern of trading that has the effect of
providing liquidity to other market participants.\157\
---------------------------------------------------------------------------
\157\ See, e.g., Regulation SHO Amendments (``Continuous
quotations that are at or near the market on both sides and that are
communicated and represented in a way that makes them widely
accessible to investors and other broker-dealers are also an
indication that a market maker is engaged in bona-fide market making
activity.''). But see supra note 131 (explaining that the
determination of eligibility for Regulation SHO's bona-fide market-
making exceptions is distinct from the determination of whether a
person's trading activity indicates that such person is acting as a
dealer under the Proposed Rule). The Commission further notes that
the bona-fide market-making exceptions under Regulation SHO are only
available to registered broker-dealers that publish continuous
quotations for a specific security in a manner that puts the broker-
dealer at economic risk. Broker-dealers that do not publish
continuous quotations, or publish quotations that do not subject the
broker-dealer to such risk (e.g., quotations that are not publicly
accessible, are not near or at the market, or are skewed
directionally towards one side of the market), would not be eligible
for the bona-fide market-maker exceptions under Regulation SHO. In
addition, broker-dealers that publish quotations but fill orders at
different prices than those quoted would not be engaged in bona-fide
market making for purposes of Regulation SHO.
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[[Page 23069]]
iii. Earning Revenue Primarily From Capturing Bid-Ask Spreads, by
Buying at the Bid and Selling at the Offer, or From Capturing Any
Incentives Offered by Trading Venues to Liquidity-Supplying Trading
Interests
Proposed Rules 3a44-2(a)(1)(iii) and 3a5-4(a)(1)(iii) set forth the
final enumerated pattern of activity that ``has the effect of providing
liquidity to other market participants.'' Under paragraph (a)(1)(iii)
of each rule, a person that, trading for its own account, ``earn[s]
revenue primarily from capturing bid-ask spreads, by buying at the bid
and selling at the offer, or from capturing any incentives offered by
trading venues to liquidity-supplying trading interests,'' would be
engaging in a routine pattern of trading that has the effect of
providing liquidity to other market participants, and as a result,
would be a dealer under the Proposed Rules.
As with other aspects of the Proposed Rules, this standard focuses
on activity rather than label or status. The Proposed Rules would apply
to any person regardless of whether the person labels itself, or is
commonly known as, a PTF.
As discussed above, one fundamental characteristic typical of
market makers and liquidity providers--and one that has historically
been viewed as dealer activity--is trading in a manner designed to
profit from spreads or liquidity incentives, rather than with a view
toward appreciation in value.\158\ The Commission has previously
identified a person's seeking, through its presence in the market,
compensation through spreads or fees, or other compensation not
attributable to changes in the value of the security traded, as a
factor indicating dealer activity.\159\ Dealer liquidity providers
frequently are distinguishable from other market participants whose
trades arguably ``provide liquidity'' inasmuch as dealers seek to be
compensated for the service of contributing to a market's liquidity,
whether by bid-ask spreads or liquidity incentives. They are ``in the
business'' of providing liquidity because they routinely supply it and
the revenue they earn as a result through bid-ask spreads or liquidity
incentives is their primary source of revenue.
---------------------------------------------------------------------------
\158\ See, e.g., U.S. Securities and Exchange Commission, Report
on the Feasibility and Advisability of the Complete Segregation of
the Functions of Dealer and Broker XIV (1936) (``The dealer . . .
receives no brokerage commission but relies for his compensation
upon a favorable difference or spread between the price at which he
buys and the amount for which he sells.''). See also Entities
Adopting Release at 30609 (``seeking to profit by providing
liquidity to the market is an indication of dealer [as opposed to
trader] activity'').
\159\ See Entities Adopting Release at 30617 (identifying as an
indication of dealer activity which is consistent with the
definition's ``regular business'' requirement, ``seeking
compensation in connection with providing liquidity . . . by seeking
a spread, fees or other compensation not attributable to changes in
the value of the [security itself]''). With respect to bid-ask
spreads, the connection between liquidity provision and bid-ask
spreads is evident in the relationship among high volume, liquidity,
and bid-ask spreads: Because high volume can reduce a dealer's
overhead, high volume tends to make liquidity provision more
profitable; as liquidity provision becomes more profitable, more
persons compete to provide liquidity, and this increased competition
tightens bid-ask spreads, as the more competitive liquidity
providers are willing to be compensated less for the liquidity they
provide in order to compete. See Section V.C.3.c. See also Volcker
Rule Adopting Release at 177 (``[L]iquidity provides important
benefits to the financial system, as more liquid markets are
characterized by competitive market makers, narrow bid-ask spreads,
and frequent trading.''). Notably, a person may be acting as a
dealer by profiting from a spread even if they are not profiting
from ``bid-ask spreads'' under the Proposed Rules. See, e.g., River
North, 415 F. Supp. at 859 (discussing Sodorff, 1992 WL 224082, at
*5).
---------------------------------------------------------------------------
Both forms of revenue are accounted for in the Proposed Rules. The
first--capturing bid-ask spreads--is done by buying at the bid and
selling at the offer, which would include buying at a lower price than,
and selling at a higher price than, the midpoint of the bid-ask spread.
The spread between these prices compensates them for providing the
service of liquidity--that is, of generally standing ready to buy or
sell and enabling other market participants to reliably make purchases
and sales. When a liquidity provider routinely buys and sells
securities in a manner designed to capture a spread with such frequency
and consistency that its revenue is made up primarily of this form of
compensation, it will be considered to be engaged in a routine pattern
of providing liquidity as a service and will fall within the scope of
the rules.
The second major source of revenue for market makers and other
liquidity providers is explicit liquidity-compensation arrangements.
For example, many exchanges in the equities markets have adopted a
``maker-taker'' pricing model to compensate (and thereby attract)
liquidity providers.\160\ Under this model, non-marketable, resting
orders that offer (make) liquidity at a particular price receive a
liquidity rebate if they are executed, while incoming orders that
execute against (take) the liquidity of resting orders are charged an
access fee.\161\ When a liquidity provider, as a result of its routine
purchases and sales of securities, captures ``incentives offered by
trading venues to liquidity-supplying trading interests'' with such
frequency and consistency that its revenue is made up primarily of this
form of compensation, it will be considered to be engaged in a routine
pattern of providing liquidity as a service and generally standing
ready to buy or sell securities, so would fall within the scope of the
Proposed Rules.
---------------------------------------------------------------------------
\160\ See 2010 Equity Market Structure Concept Release at 3599.
\161\ See 2010 Equity Market Structure Concept Release at 3599.
Highly automated exchange systems and liquidity rebates have
contributed to the rise of PTFs that focus on liquidity provision.
Id.
---------------------------------------------------------------------------
To come within this paragraph of the Proposed Rules, a liquidity
provider would have to earn its revenue primarily from bid-ask spreads
or trading incentives. The Proposed Rules use the phrase ``earn
revenue''--rather than, for example, ``profit from''--to make clear
that a person's trading strategies would not need to be profitable to
bring them within the rule because a market participant can provide
liquidity without being profitable. Furthermore, under the Proposed
Rules, a person whose revenue is derived ``primarily'' from capturing
bid-ask spreads or liquidity incentives, or a combination of the two,
would be a liquidity provider that is engaged in the regular business
of buying and selling securities for its own account and, as a result,
a dealer or government securities dealer. Generally speaking, although
the Proposed Rules do not provide a bright-line test in connection with
the qualitative factors, the Commission believes that if a person
derives the majority of its revenue from the sources described in
paragraph (a)(3)(iii), it would likely be in a regular business of
buying and selling securities or government securities for its own
account.
Finally, the paragraph would apply with respect to activity on
``trading venues.'' The Commission has recently proposed to define the
term ``trading venue'' to mean ``a national securities exchange or
national securities association that operates an SRO trading facility,
an ATS, an exchange market maker, an OTC market maker, a futures or
options market, or any other broker- or dealer-operated platform for
executing trading interest internally by trading as principal or
crossing orders as agent.'' \162\
---------------------------------------------------------------------------
\162\ 2022 ATS Proposing Release at 15540.
---------------------------------------------------------------------------
Market evolution has given rise to a variety of venues in which
liquidity providers can express trading interests,
[[Page 23070]]
and the definition is designed to capture the breadth of these
different venues. For example, Communication Protocol Systems, which
are electronic systems that offer the use of non-firm trading interest
and make available communication protocols to bring together buyers and
sellers of securities but do not fall within the current definition of
an ``exchange'' under Federal securities laws, have come to perform the
function of a market place and become a preferred method for market
participants to discover prices, find counterparties, and execute
trades.\163\ The Proposed Rules are designed to capture dealer activity
wherever that activity occurs, whether on a national securities
exchange, an ATS, a Communication Protocol System, or another form of
trading venue. For purposes of the Proposed Rules, the particular
trading venue matters less than the fact that a market participant
provides liquidity on it. Using the broad term ``trading venue,'' as
defined above, will allow for clear and consistent application of the
definitions of dealer and government securities dealer.
---------------------------------------------------------------------------
\163\ See 2022 ATS Proposing Release at 15496 n.5 and 15501.
This is particularly true for government securities and other fixed
income securities. Id.
---------------------------------------------------------------------------
Request for Comment
The Commission generally requests comment on these provisions of
the Proposed Rules. In addition, the Commission requests comments on
the following specific issues:
9. Is there sufficient specificity provided for the terms used in
the qualitative standards? Are there any terms that should be defined
in rule text or addressed in the release?
<bullet> Is there sufficient specificity provided for the term
``pattern''? If not, what additional specificity should the Commission
provide and please provide specific examples on the types of
specificity. Should the rule text define what is meant by ``pattern''?
Why or why not? Is the Proposed Rules' use of ``pattern'' appropriate?
Would ``manner'' or another word be more appropriate? Why or why not?
<bullet> Is there sufficient specificity provided for the term
``effect of providing liquidity''? If not, what additional specificity
should the Commission provide and please provide specific examples on
the types of specificity. Should the rule text define what is meant by
``effect of providing liquidity''? Why or why not? Is the Proposed
Rules' use of ``effect of providing liquidity'' appropriate? Would
replacing ``effect of providing liquidity'' with ``market making'' be
more appropriate? Are there other words that would more appropriate?
Why or why not?
<bullet> Is there sufficient specificity provided for the term
``primarily''? Should the rule text define what is meant by
``primarily''? Why or why not? Is the Proposed Rules' use of
``primarily'' appropriate? Would ``mostly'' or another word be more
appropriate? Why or why not?
<bullet> Is there sufficient specificity provided for the term
``trading venue''? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Should the rule text define what is meant by ``trading
venue''? Why or why not? Is the Proposed Rules' use of ``trading
venue'' appropriate? Are there other words that would be more
appropriate? Why or why not?
10. Is liquidity provision an appropriate factor to use in defining
which buying and selling activity for one's own account qualifies as
``regular business''? Are there other factors the Commission should
include? If so, which factors and why? Are there trading activities or
investment strategies that should not be considered providing
liquidity? If so, please describe why.
11. Are the three qualitative factors identified in the Proposed
Rules as having the ``effect of providing liquidity to other market
participants'' that would qualify as ``regular business'' appropriate?
Are there any other forms of liquidity provision, or any other factors,
that the Commission should include or exclude instead or in addition to
those proposed? Are the factors over or under-inclusive? If so, please
provide specific examples of any alternative suggestions.
<bullet> For example, should the Commission include as an example
of a ``liquid market,'' ``a market in which participants have the
ability to readily trade at a predictable price and in a desired size
without materially moving the market''? Why or why not?
<bullet> In addition to passive ``liquidity providing'' trading
strategies, the Proposed Rules would capture certain aggressive
``liquidity demanding'' strategies as having the ``effect of providing
liquidity to other market participants''? Is this appropriate? Why or
why not?
12. Under the Proposed Rules, a person routinely making roughly
comparable purchases and sales of the same or substantially similar
securities in a day would have the effect of providing liquidity to
other market participants, and therefore would be a dealer. Is this an
appropriate measure or illustration of liquidity provision? Why or why
not? Would the provision capture persons that should not be dealers? If
so, who and why?
<bullet> For example, would the Proposed Rules capture private
funds and other persons pursing investment strategies such as relative
value fixed income arbitrage or share class arbitrage? If so, should
such strategies be included or excluded? Why or why not?
<bullet> Is there sufficient specificity to determine which
securities would be considered ``same'' or ``substantially similar''?
Why or why not? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Should additional or different factors be considered? Are
there other words that would be more appropriate? Why or why not?
<bullet> Should the rule text define what is meant by ``same'' or
``substantially similar''? Why or why not?
<bullet> Are there other types of purchase and sale transactions
that would be examples of purchases and sales of securities that are
``substantially similar'' (i.e., other types of roughly comparable
purchases and sales of substantially similar securities, such that the
sale or purchase of one security offsets the risk associated with the
sale or purchase of the other, permitting a person to maintain a near
market-neutral position)? Are there examples of types of purchase and
sale transactions involving derivatives, or other products that
represent the economic equivalent of another security, that would be
purchases and sales of securities that are ``substantially similar''?
Please explain.
13. Although the Proposed Rules do not provide a bright-line test
to determine ``roughly comparable'' purchases and sales, depending on
the facts and circumstances, the Commission believes a daily buy-sell
imbalance, as described below in Section V.B.2.c., between two
identical or substantially similar securities, in terms of dollar
volume below 20 percent may be indicative of purchases and sales that
are ``roughly comparable.'' Is this an appropriate measurement of
``roughly comparable''? Why or why not? Would another measurement be
more appropriate? Should there be a minimum trading volume or dollar
amount threshold as part of the qualitative standard under paragraph
(a)(1)(i), daily buy-sell imbalance, or other measurement?
<bullet> Is there sufficient specificity provided for the term
``roughly comparable''? Why or why not? If not,
[[Page 23071]]
what additional specificity should the Commission provide and please
provide specific examples on the types of specificity. Is the Proposed
Rules' use of ``roughly comparable'' appropriate? Are there other words
that would be more appropriate? Why or why not?
<bullet> Should the rule text define, as opposed to the release
addressing, what is meant by ``roughly comparable''? Why or why not?
<bullet> Does there need to be more specificity provided as to how
many transactions must be executed (or positions opened and/or closed)
in a day to be ``roughly comparable''?
<bullet> Is ``in a day'' an appropriate period of time during which
to measure whether a person has made roughly comparable purchases and
sales of the same or substantially similar securities? If not, what is
an appropriate time period?
<bullet> If an institutional investor seeks to rebalance its
portfolio, would the institutional investor typically ``routinely make
roughly comparable purchases and sales of the same or substantially
similar securities in a day,'' or otherwise trigger the Proposed Rules?
14. Under the Proposed Rules, a person that ``routinely express[es]
trading interests that are at or near the best available prices on both
sides of the market and that are communicated and represented in a way
that makes them accessible to other market participants'' would have
the effect of providing liquidity to other market participants, and
thus would be a dealer. Is this an appropriate measure or illustration
of liquidity provision? Why or why not? Would the provision capture
persons that should not be dealers? If so, who and why?
<bullet> Is the Proposed Rules' use of ``routinely'' appropriate?
Would ``regularly'' or ``continuously'' or another word be more
appropriate? Why or why not?
<bullet> Is there sufficient specificity provided for the term
``routinely''? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Should the rule text define what is meant by
``routinely''? Why or why not?
<bullet> Is the Proposed Rules' use of ``trading interest''
appropriate? Would ``quotations'' or another term be more appropriate?
Why or why not?
<bullet> Is there sufficient specificity provided for the term
``trading interest''? Should the rule text define what is meant by
``trading interest''? Why or why not? If not, what additional
specificity should the Commission provide and please provide specific
examples on the types of specificity.
<bullet> The Proposed Rules would require that trading interests be
communicated and represented in a way that makes them accessible to
other market participants in order to come within the rule. Should the
Commission require that the trading interests be communicated
``widely''? Why or why not?
15. Under the Proposed Rules, a person that ``earn[s] revenue
primarily from capturing bid-ask spreads, by buying at the bid and
selling at the offer, or from capturing any incentives offered by
trading venues to liquidity-supplying trading interest,'' would have
the effect of providing liquidity to other market participants. Is this
an appropriate measure or illustration of liquidity provision? Why or
why not? Would the provision capture persons that should not be
dealers? If so, who and why?
<bullet> Is there sufficient specificity provided for the term
``earn revenue''? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Is the Proposed Rules' use of ``earn revenue''
appropriate? Are there other words that would be more appropriate? Why
or why not? Should the rule text define what is meant by ``earn
revenue''? Why or why not?
<bullet> Should the Proposed Rules include additional or other
forms of revenue?
<bullet> Should the Proposed Rules include other measures of
liquidity provision? If so, what measures and why?
<bullet> As explained above, buying at the bid and selling at the
offer would include buying at lower than, and selling at higher than,
the midpoint of the bid-ask spread. Should the rule text define
``capturing bid-ask spread'' to expressly include buying at lower than,
and selling at higher than, the midpoint of the bid-ask spread?
16. Do the Proposed Rules provide sufficient specificity to permit
market participants to distinguish between revenue derived from
capturing bid-ask spreads and revenue derived from realization of
appreciation of the underlying asset?
C. Quantitative Standard
In addition to the qualitative standards described above, proposed
Rule 3a44-2 would also include a quantitative standard that would
establish a bright-line test under which persons engaging in certain
specified levels of activity in the U.S. Treasury market would be
defined to be buying and selling securities ``as a part of a regular
business,'' regardless of whether they meet any of the qualitative
standards. Specifically, proposed Rule 3a44-2(a)(2) would provide that
a person \164\ that is engaged buying and selling government securities
for its own account is engaged in such activity ``as a part of a
regular business'' if that person in each of four out of the last six
calendar months, engaged in buying and selling more than $25 billion of
trading volume in government securities as defined in Section
3(a)(42)(A) of the Exchange Act.\165\
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\164\ In light of the statutory definition of ``person,'' in
conjunction with the proposed definitions of ``own account'' and
``control,'' as discussed in Section III.D, trading volume would be
determined by aggregating volume at the firm or legal-entity level
(rather than market participant identifier (``MPID'') or global firm
level). See 15 U.S.C. 78c(a)(9).
\165\ Proposed Rule 3a44-2(a)(2) only applies to government
securities as defined in Section 3(a)(42)(A) of the Exchange Act.
Accordingly, the trading volume threshold set forth in the proposed
rule does not apply to all government securities as defined by
Section 3(a)(42); but rather, it is limited to ``securities which
are direct obligations of, or obligations guaranteed as to principal
or interest by, the United States'' (``U.S. Treasury Securities'').
See 15 U.S.C. 78c(a)(42)(A). For purposes of determining whether the
trading volume threshold is met, a person would include transactions
in U.S. Treasury Securities--that is, Treasury bills, notes,
floating rate notes, bonds, inflation-protected securities
(``TIPS''), and Separate Trading of Registered Interest and
Principal Securities (``STRIPS'')--and would exclude auction awards
and repurchase or reverse repurchase transactions in U.S. Treasury
Securities. See 2022 ATS Proposing Release at 15542 nn. 512-517
(describing U.S. Treasury Securities). Additionally, for purposes of
determining whether the trading volume threshold is met, Treasury
when-issued transactions would be included.
---------------------------------------------------------------------------
The Commission believes that four out of the last six calendar
months is an appropriate range of time to evaluate the trading volume
of a market participant and should help to ensure the proposed
quantitative standard does not capture market participants with
relatively low trading volume that may have had an anomalous increase
in trading. The proposed time measurement period would smooth monthly
variations by reducing the effect of trading fluctuations in a
particular month that could misrepresent or distort a market
participant's overall trading pattern.\166\ A shorter period of time
could potentially cause a market participant to fall within the scope
of the quantitative standard solely as a result of an atypical, short-
term increase in trading, which
[[Page 23072]]
potentially could discourage participation in the U.S. Treasury market
by a new market participant that has not had as long of a time period
to develop its business prior to having to incur compliance costs
associated with being subject to dealer registration. In addition, the
Commission does not believe that a longer period of time is necessary
to identify those market participants that play a significant role, and
regularly transact, in U.S. Treasury Securities. The Commission
believes that the proposed time measurement period provides sufficient
trading history data so as to indicate a market participant's
significance to the market, and that the structure of the measurement
(i.e., requiring a market participant to meet the threshold for four
out of the last six calendar months) identifies regularity of such
significant trading levels.
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\166\ This Commission has adopted regulations that use the four
out of the last six calendar months metric in Regulation ATS, Rules
301(b)(5) and (6), and Regulation SCI Rule 1000. See 17 CFR
242.301(b)(5)-(6) (definition of an SCI alternative trading system
or SCI ATS); see also Regulation Systems Compliance and Integrity,
Exchange Act No. 73639 (Nov. 19, 2014), 79 FR 72251 (Dec. 5, 2014)
(noting that time measurement period of four of the preceding six
months is consistent with the current standard under Regulation
ATS).
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As discussed below, the Commission's analysis of market
participants that are not members of FINRA in the U.S. Treasury market
found that these participants accounted for approximately 19 percent of
the aggregate Treasury trading volume in July 2021, with PTFs
representing the highest volumes of trading among these
participants.\167\ In addition, PTFs dominate the interdealer U.S.
Treasury market, representing 61 percent of the trading activity on the
electronic IDB platforms and 48 percent of the total interdealer
market.\168\
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\167\ See Section V.B.2. Specifically, the analysis identified
174 market participants who were active in the U.S. Treasury market
in July 2021 and that were not members of FINRA. Although FINRA
membership is not synonymous with dealer registration status, the
Commission believes that many of the market participants who are not
FINRA members are also likely not registered as government
securities dealers. These 174 identified non-FINRA member market
participants accounted for approximately 19 percent of aggregate
Treasury trading volume in July 2021. PTFs had the highest volumes
among these identified non-FINRA member U.S. Treasury market
participants. See Section V.B.2.
\168\ See supra note 2.
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Although, as noted previously, the Proposed Rules alone will not
necessarily prevent future market disruptions, the operation of
proposed Rule 3a44-2 will support transparency; market integrity and
resiliency; and investor protection across the U.S. Treasury market by
helping to close the regulatory gap that currently exists and by
ensuring consistent regulatory oversight.\169\ The lack of consistent
visibility across the market today constrains the ability of regulators
to understand and respond to significant market events. The proposed
quantitative standard is intended to capture the most significant
market participants that are regularly buying and selling U.S. Treasury
Securities, and subject these participants that are not already
registered as dealers or government securities dealers to a regulatory
regime designed to minimize the risks they may pose to the U.S.
Treasury market and provide regulators with appropriate oversight of
their activities.
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\169\ For example, regulators do not have the same insight into
the trading activities of unregistered PTFs because, unlike
registered dealers, they do not report their U.S. Treasury
Securities transactions to FINRA's Trading Reporting and Compliance
Engine (``TRACE''), do not file annual reports with the Commission,
and are not subject to Commission examinations. See Section V.B.3.
Market participants that are private funds are generally managed by
registered investment advisers that file regular financial reports
with the Commission on Form PF, and are subject to examination
concerning their private fund clients, but private funds do not
report securities transactions such as those required by the rules
governing registered dealers. See id. Transactions in fixed income
securities, such as U.S. Treasury Securities, are not currently
reported to the Consolidated Audit Trail (``CAT''). See Section
V.B.2 (explaining the type of transactions reported to CAT).
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As described below in Section V, the proposed trading volume
threshold was derived from analysis of historical U.S. Treasury
Securities transactions reported to TRACE.\170\ Based on this analysis,
the Commission is proposing a trading volume amount of $25 billion;
this quantitative standard would likely capture mostly unregistered
PTFs, but also may capture certain other significant market
participants not currently registered as government securities
dealers.\171\ In determining whether the trading volume threshold is
met, a market participant would include transactions in U.S. Treasury
Securities that are currently reported to TRACE-- that is, Treasury
bills, notes, floating rate notes, bonds, TIPS, and STRIPS--and would
exclude auction awards and repurchase or reverse repurchase
transactions in U.S. Treasury Securities.\172\ The proposed
quantitative standard is intended to be a straightforward threshold
identifying those market participants that, as a result of their
regularly high trading volume in government securities, serve dealer-
like roles significantly impacting the U.S. Treasury market. In this
regard, the Commission believes that setting forth a trading volume
threshold would provide an easily measurable and observable standard.
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\170\ TRACE reporting requirements apply to all marketable U.S.
Treasury Securities, including Treasury bills, notes, floating rate
notes, bonds, TIPS, and STRIPS. See FINRA Rule 6700 series. Under
FINRA Rules, ``Bona fide repurchase and reverse repurchase
transactions involving TRACE-Eligible Securities'' and ``Auction
Transactions'' are not reported to TRACE. See FINRA Rule 6730(e).
\171\ As described in Section V.B.2, the analysis found 46 non-
FINRA member firms with trading volumes of at least $25 billion in
July 2021. Based on classifications (further explained infra note
218), of these 46 non-FINRA member firms, 22 are classified as PTFs
and 20 are classified as dealers. See Section V.B.2, Table 1. To the
extent a non-FINRA member firm is a financial institution, it would
not register with the Commission but instead would provide written
notice of its government securities dealer status with the
appropriate Federal banking regulator. See Section II; 17 CFR 400.1.
Additionally, a non-FINRA member firm may be operating in reliance
on an exception or exemption. See supra note 29 and accompanying
text.
\172\ See supra notes 165, 170.
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As discussed above, the market structure for U.S. Treasury
securities has evolved, with PTFs accounting for a large percent of
trading volume.\173\ In some ways, PTFs have displaced the role of
traditional dealers in the interdealer U.S. Treasury market, and the
Commission believes that PTFs, and other market participants that
similarly have a significantly large, and regular, amount of trading
volume and have a significant impact on the U.S. Treasury market,
should register as government securities dealers.\174\ Proposed Rule
3a44-2(a)(2) is designed to make clear the Commission's view that a
person engaging in this regular volume of buying and selling activity
is engaged in the buying and selling of government securities for its
own account as a part of a regular business, and therefore, should be
subject to the same regulatory requirements as other dealers.
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\173\ See Section II.
\174\ 2010 Equity Market Structure Concept Release at 3607.
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The Commission believes the need for a quantitative rule is most
acute in the U.S. Treasury market. Thus, while proposed Rules 3a5-4 and
3a44-2 share common qualitative standards, the Commission is proposing
a quantitative standard only with respect to the U.S. Treasury market
at this time. As explained more fully in Section V, the quantitative
standard is derived from trading data related to the U.S. Treasury
market, and is intended to identify significant market participants not
registered as dealers that are performing dealer-like activities in the
U.S. Treasury market.\175\
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\175\ The Commission believes that due to the varying
characteristics of the other securities markets, setting a
quantitative standard would be more complicated and each market
would need to be separately assessed before a quantitative threshold
is set. Accordingly, the Proposed Rules do not set forth a
comparable quantitative standard for proposed Rule 3a5-4. The
Commission is seeking comment, however, on whether proposed Rule
3a5-4 should include a quantitative standard, and if so, how it
should be established. See Question 26.
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The recent disruptions in the U.S. Treasury market referenced
above, together with the significant role played
[[Page 23073]]
by market participants not registered as dealers, distinguishes that
market from other markets where these types of participants are more
typically registered as dealers. Indeed, it is the Commission's
understanding that in the equity markets, because PTF trading
strategies typically depend on latency and cost advantages made
possible by trading directly (via membership) on a national securities
exchange, and the Exchange Act limits exchange membership to registered
broker-dealers, there is incentive for many PTFs to register as broker-
dealers to gain these advantages.\176\ In the U.S. Treasury market,
however, where trading occurs on ATSs and other non-exchange venues,
PTFs lack this incentive to register.
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\176\ See 15 U.S.C. 78f(c)(1) (``A national securities exchange
shall deny membership to (A) any person, other than a natural
person, which is not a registered broker or dealer or (B) any
natural person who is not, or is not associated with, a registered
broker or dealer.'').
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Request for Comments
The Commission generally requests comment on this aspect of
proposed Rule 3a44-2. In addition, the Commission requests comment on
the following specific issues:
17. Is there sufficient specificity provided for the terms used in
the quantitative standard? Are there any terms that should be defined
in rule text or addressed in the release?
18. Is the threshold of more than $25 billion of trading volume in
each of four out of the last six calendar months an appropriate proxy
for determining whether a person is engaged in buying and selling U.S.
Treasury Securities for its own account is engaged in such activity as
a part of a regular business? Why or why not? If not, what thresholds
would be appropriate? For example, should the quantitative standard
include a separate trading volume threshold for: (1) Buying; (2)
selling; and (3) both buying and selling U.S. Treasury Securities, all
three of which would be required to be satisfied in order to meet the
quantitative standard? Commenters should provide data to support their
views.
19. Should the Commission apply a different look-back period for
applying the quantitative threshold from four out of the preceding six
months to something different? Is the time period measurement of four
out of the last six calendar months an appropriate metric to evaluate a
market participant's trading volume? Should the time period be a weekly
measurement or is there another measurement that would better determine
whether a person is engaged in buying and selling U.S. Treasury
Securities for its own account is engaged in such activity as a part of
a regular business?
20. Should the look-back period for the quantitative standard take
into consideration the general auction schedule for U.S. Treasury
securities? Should the look-back period correspond with the schedule of
any particular U.S. Treasury security? Why or why not? For example, the
10-year U.S. Treasury note auctions are usually announced in the first
half of February, May, August, and November and generally auctioned
during the second week of these months and are issued on the 15th of
the same month.\177\ Should the look-back period take into
consideration these particular months for purposes of the quantitative
standard? Why or why not? How could the look-back period incorporate
the auction schedule? Please explain.
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\177\ See TreasuryDirect, General Auction Timing, available at
<a href="https://www.treasurydirect.gov/instit/auctfund/work/auctime/auctime.htm">https://www.treasurydirect.gov/instit/auctfund/work/auctime/auctime.htm</a>.
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21. Are there persons that would meet the quantitative standard
under the proposed rule but that should not be classified as government
securities dealers (i.e., is the quantitative standard over-
inclusive?). If so, who are they and why should the Commission not
classify them as government securities dealers?
22. Are there persons that would not meet the quantitative standard
under the proposed rule--and would not be otherwise captured by the
qualitative factors--but that should be classified as government
securities dealers based on their trading volume (i.e., is the
quantitative standard under-inclusive)? If so, who are they and why
should they be classified as government securities dealers?
23. Should the quantitative standard include an additional standard
related to routinely expressing trading interests? For example,
activity related to resting orders on a central-limit order book, or
expressing trading interest on Communication Protocol Systems? If so,
what measure of activity, including sources of data and calculation
methodology, would appropriately identify market participants as
government securities dealers?
24. Are there other ways of calculating a quantitative standard,
such as using a measurement based on turnover (e.g., a turnover ratio)
rather than volume, or other measurements of significance (e.g., a
trading volume ratio, net/gross ratio) that would appropriately
identify market participants as government securities dealers? If so,
what are they, and why are they relevant in the context of analyzing
dealer status? Commenters should provide any data or information to
support their views.
25. Should the quantitative standard be a dynamic trading volume
threshold that changes with the market over time, such as percentage of
transactions reported to TRACE, a percentage of U.S. Treasury
Securities outstanding or issued, or other inflation-adjusted
threshold? Why or why not?
26. Should a quantitative standard be included in proposed Rule
3a5-4? To the extent a quantitative standard should be included, are
there ways of calculating the standard for other securities markets? Is
a trading volume threshold suitable for other types of securities
markets?
27. In determining whether the trading volume threshold is met, the
Commission has indicated that market participants should exclude
auction awards and repurchase or reverse repurchase transactions. Is
this exclusion appropriate? Should some or all of these transactions be
included? Are there other transactions that should be excluded (e.g.,
Treasury when-issued transactions)? Please explain. Should any excluded
transactions be specifically addressed in rule text? Should there be a
similar exclusion of these types of transactions for purposes of
evaluating whether a market participant has met the qualitative
standards? Are there any types of transactions that should be included
in calculating the trading volume amount?
28. Are there market participants that would fluctuate between
meeting or not meeting the quantitative standard (or qualitative
standard) (e.g., initially meet the standard, a few months later no
longer meet the standard, and later meet the standard again)? Would
this pattern be associated with a particular type of trading such that
there may be periods in which the participant meets neither the
quantitative standard nor any qualitative standard?
29. Are there circumstances in which a person triggering the
quantitative threshold would not also trigger the proposed qualitative
standards? Please describe those circumstances in detail. In such case,
would firms implement compliance systems to monitor trading volumes? Do
firms have systems in place that already or could easily be programmed
to monitor for the proposed quantitative threshold? What are the costs
of implementing such systems or updating existing systems? Would firms
be incentivized to trade below the proposed quantitative standard to
avoid registration?
[[Page 23074]]
D. Definitions of ``Own Account'' and ``Control''
The Exchange Act defines a ``dealer'' or ``government securities
dealer'' as a person engaged in the business of buying and selling
securities for its ``own account.'' \178\ The Proposed Rules define a
person's ``own account'' in a way that recognizes that corporate
families and entities may be organized in various structures. The
proposed definitions of ``own account'' and ``control'' are designed to
focus on the trading activity occurring at the firm or legal-entity
level or the trading activity that is being employed on behalf of, or
for the benefit of, the entity, and limit the registration burden to
those entities engaged in dealer activity. In addition, the proposed
definitions are intended to avoid incentivizing market participants to
change their corporate structures for the purpose of avoiding
registration.
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\178\ 15 U.S.C. 78c(a)(5) (``The term `dealer' means any person
engaged in the business of buying and selling securities . . . for
such person's own account through a broker or otherwise.'')
(emphasis added); 15 U.S.C. 78c(a)(44) (``The term `government
securities dealer' means any person engaged in the business of
buying and selling government securities for his own account,
through a broker or otherwise . . .'') (emphasis added).
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Under paragraph (b)(2) of the Proposed Rules, a person's ``own
account'' means any account that is: ``held in the name of that
person''; or ``held in the name of a person over whom that person
exercises control or with whom that person is under common control,
provided that this paragraph (b)(2)(ii) does not include [the accounts
described in paragraphs (b)(2)(ii)(A)-(C)]''; or ``held for the benefit
of those persons identified in paragraphs (b)(2)(i) and (ii).'' \179\
Paragraphs (b)(2)(ii)(A)-(C) excludes an account in the name of a
registered broker, dealer, or government securities dealer, or an
investment company registered under the Investment Company Act of 1940;
with respect to an investment adviser registered under the Investment
Advisers Act of 1940, an account held in the name of a client of the
adviser unless the adviser controls the client as a result of the
adviser's right to vote or direct the vote of voting securities of the
client, the adviser's right to sell or direct the sale of voting
securities of the client, or the adviser's capital contributions to or
rights to amounts upon dissolution of the client; and with respect to
any person, an account in the name of another person that is under
common control with that person solely because both persons are clients
of an investment adviser registered under the Investment Advisers Act
of 1940 unless those accounts constitute a parallel account
structure.\180\
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\179\ See proposed Rule 3a5-4(b)(2) and proposed Rule 3a44-
2(b)(2).
\180\ See proposed Rule 3a5-4(b)(2)(ii)(A)-(C) and proposed Rule
3a44-2(b)(2)(ii)(A)-(C).
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With respect to which accounts should be aggregated for purposes of
paragraph (b)(2)(ii), the Proposed Rules would incorporate the
definition of ``control'' under Exchange Act Rule 13h-l.\181\ The
Commission believes that incorporating the established definition of
``control'' under Exchange Act Rule 13h-l into the Proposed Rules would
promote consistency and assist persons in applying the definition. The
Commission further believes that the proposed definition of ``control''
is sufficiently limited to capture only those market participants with
a significant enough controlling interest to warrant registration as a
dealer.\182\ The proposed definition of ``control'' used in Rule 13h-l
is appropriate because it is less burdensome than other Commission
rules defining control, but still achieves the goal of identifying
persons who exert direct or indirect control over significant market
participants.\183\ In addition, the Commission believes that this
definition of control would appropriately deter the structuring of
corporate relationships or establishment of multiple legal entities to
avoid the Proposed Rules.
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\181\ Exchange Act Rule 13h-l(a)(3) provides that control
(including the terms controlling, controlled by and under common
control with) means the possession, direct or indirect, of the power
to direct or cause the direction of the management and policies of a
person, whether through the ownership of securities, by contract, or
otherwise. For purposes of Rule 13h-l only, any person that directly
or indirectly has the right to vote or direct the vote of 25 percent
or more of a class of voting securities of an entity or has the
power to sell or direct the sale of 25 percent or more of a class of
voting securities of such entity, or in the case of a partnership,
has the right to receive, upon dissolution, or has contributed, 25
percent or more of the capital, is presumed to control that entity.
17 CFR 240.13h-l(a)(3). The definition of ``control'' in Rule 13h-l
is based on the definition of ``control'' in Form 1 (Application for
the Registration or Exemption from Registration as a National
Securities Exchange) and Form BD (Uniform Application for Broker-
Dealer Registration).
\182\ As noted above, the Commission has applied this standard
in other contexts. See Large Trader Reporting, Exchange Act Release
No. 61908 (Apr. 14, 2010), 75 FR 21456, 21461 (Apr. 23, 2010) (``The
Commission preliminarily believes that the proposed definition of
control is sufficiently limited to capture only those persons with a
significant enough controlling interest to warrant identification as
a large trader.''). The definition of ``control'' in Rules 13h-l and
on Forms 1 and BD is less expansive than the definition of control
as used in 17 CFR 240.19h-1 (Rule 19h-1), for example. In Rule 19h-
1(f)(2), the definition of ``control'' features a 10 percent
threshold with respect to the right to vote 10 percent or more of
the voting securities or receive 10 percent or more of the net
profits.
\183\ The Commission is not incorporating the provision
contained in the Form 1 and Form BD relating to directors, general
partners, or officers that exercise executive responsibility.
Instead, the proposed definition of ``control'' focuses on the
existence of a corporate control relationship over significant
market participants.
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[…truncated; see source link]Indexed from Federal Register on April 18, 2022.
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