Rule2024-02837
Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer in Connection With Certain Liquidity Providers
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Published
February 29, 2024
Effective
April 29, 2024
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("SEC" or "Commission") is adopting 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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[Federal Register Volume 89, Number 41 (Thursday, February 29, 2024)]
[Rules and Regulations]
[Pages 14938-15010]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-02837]
[[Page 14937]]
Vol. 89
Thursday,
No. 41
February 29, 2024
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 in Connection
With Certain Liquidity Providers; Final Rule
Federal Register / Vol. 89 , No. 41 / Thursday, February 29, 2024 /
Rules and Regulations
[[Page 14938]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-99477; 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 in Connection
With Certain Liquidity Providers
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting 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:
Effective date: April 29, 2024.
Compliance date: The compliance date is discussed in section II.B
of this release.
FOR FURTHER INFORMATION CONTACT: Emily Westerberg Russell, Chief
Counsel; John Fahey, Deputy Chief Counsel; Joanne Rutkowski, Assistant
Chief Counsel; Bonnie Gauch, Senior Special Counsel; Shauna Sappington
Vlosich, Senior Special Counsel; Geeta Dhingra, Branch Chief; Katherine
Lesker, Special Counsel; and Carl Emigholz, 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 adopting the following new
rules under the Exchange Act: (1) 17 CFR 240.3a5-4 (``Rule 3a5-4''),
and (2) 17 CFR 240.3a44-2 (``Rule 3a44-2'') (collectively, ``final
rules'').
Table of Contents
I. Introduction
A. Background
B. Overview of the Final Rules and Modifications to the Proposal
II. Discussion of Final Rules
A. Component Parts
1. Qualitative Standard
a. Elimination of the Proposed First Qualitative Factor
b. Expressing Trading Interest Factor
c. Primary Revenue Factor
2. Quantitative Standard
3. Exclusions
a. Person That Has or Controls Assets of Less Than $50 Million
b. Registered Investment Companies, Private Funds, and
Registered Investment Advisers
c. Official Sector Exclusions
d. Other Requests for Exclusions
4. Definitions and Anti-Evasion
5. No Presumption
B. Compliance Date
III. Economic Analysis
A. Introduction
B. Baseline
1. Rules and Regulations That Apply to Registered Dealers
2. Affected Parties
a. Principal Traders
b. Private Funds and Advisers
c. Number of Affected Parties
3. Competition Among Significant Liquidity Providers
4. Externalities
C. Economic Effects, Including Impact on Efficiency,
Competition, and Capital Formation
1. Benefits
a. Regulatory Consistency and Competition
b. Regulations on Financial and Operational Risk-Taking
c. Regulations on Reporting
d. Regulations on Deceptive Practices
e. Regulations Related to Examinations
2. Costs
a. Compliance Costs
b. Costs Associated With the Net Capital Rule
c. Potential Implications for Private Funds and Advisers
d. Effects on Market Liquidity
3. Effects on Efficiency, Competition, and Capital Formation
a. Effects on Efficiency
b. Effects on Competition
c. Effects on Capital Formation
D. Reasonable Alternatives
1. Retain the Quantitative Standard
2. Retain the First Qualitative Standard (e.g., ``Routinely
Making Roughly Comparable Purchases and Sales of the Same or
Substantially Similar Securities [or Government Securities] in a
Day'')
3. Remove the Exclusion for Registered Investment Companies
4. Exclude Registered Investment Advisers and Private Funds
5. Require Registered Investment Advisers and Private Funds To
Report to TRACE
6. Carve Out or Narrow Application to Crypto Asset Securities
IV. Paperwork Reduction Act
V. Regulatory Flexibility Act
VI. Other Matters
Statutory Authority
I. Introduction
The dealer regulatory regime is a cornerstone of the U.S. Federal
securities laws and helps to promote the Commission's longstanding
mission to protect investors, maintain fair, orderly, and efficient
markets, and facilitate capital formation.\1\ 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.\2\ However, some of 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--are not registered with the Commission as either dealers
or government securities dealers under sections 15 and 15C of the
Exchange Act, respectively. The identification, registration, and
regulation of these market participants as dealers will provide
regulators with a more comprehensive view of the markets through
regulatory oversight and will support market stability and resiliency
and protect investors by promoting the financial responsibility and
operational integrity of market participants that are acting as
dealers.\3\ Further, the final rules will promote competition among
entities that regularly provide significant liquidity by applying
consistent regulation to these entities, thus leveling the competitive
playing field between liquidity provision conducted by entities that
are currently registered as dealers and government securities dealers
and by entities that are not.
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\1\ See, e.g., Eastside Church of Christ v. National Plan, Inc.,
391 F.2d 357 (5th Cir. 1968) (``The requirement that brokers and
dealers register is of the utmost importance in effecting the
purposes of the 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.'');
see also section 2 of the Exchange Act, 15 U.S.C. 78b (stating that
``transactions in securities as commonly conducted upon securities
exchanges and over-the-counter markets are effected with a national
public interest which makes it necessary to provide for regulation
and control of such transactions and of practices and matters
related thereto'').
\2\ See Further Definition of ``As a Part of a Regular
Business'' in the Definition of Dealer and Government Securities
Dealer, Exchange Act Release No. 94524 (Mar. 28, 2022), 87 FR 23054
(Apr. 18, 2022) (``Proposing Release'').
\3\ See section III.
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The Federal securities laws provide a comprehensive system of
regulation of securities activity, and the definition of ``dealer'' is
one of the Exchange Act's most important definitions, as it sets forth
certain activities that cause persons to fall within the Commission's
regulatory ambit.\4\ Section 3(a)(5) of the Exchange Act defines the
term ``dealer'' to mean ``any person engaged in the
[[Page 14939]]
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.'' These
statutory definitions of ``dealer'' and ``government securities
dealer,'' and the accompanying registration requirements of the
Exchange Act, were drawn broadly by Congress to encompass a wide range
of activities involving the securities markets and their
participants.\5\ Market participants that meet these statutory
definitions are required to register with the Commission and are
subject to a panoply of regulatory obligations and supervisory
oversight, unless an exemption or exception applies.\6\
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\4\ See supra note 1; see also Roth v. SEC, 22 F.3d 1108, 1109
(D.C. Cir. 1994).
\5\ 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; and references to ``security'' apply
both with respect to ``security'' and ``government security'' under
sections 3(a)(10) and 3(a)(42) of the Exchange Act, respectively.
See Proposing Release at 23057 (Congress defined ``dealer'' broadly
``to encompass a wide range of activities involving investors and
securities markets.''); Registration Requirements for Foreign Broker
Dealers, Exchange Act Release No. 27017 (July 11, 1989), 54 FR
30013, 30015 (July 18, 1989) (``Foreign Broker Dealer Adopting
Release'').
\6\ See Proposing Release at 23057; Foreign Broker Dealer
Adopting Release at 30015.
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Under the Exchange Act, the SEC has the authority to define the
terms used in the statutory definitions of ``dealer'' and ``government
securities dealer,'' and to oversee and regulate registered dealers.\7\
The Commission is adopting new Rules 3a5-4 and 3a44-2 under the
Exchange Act to further define what it means to be engaged in the
business of buying and selling securities ``as a part of a regular
business'' within the definitions of ``dealer'' and ``government
securities dealer,'' respectively.\8\ The final rules, which have been
modified to narrow the scope of the proposed rules and carefully
tailored in response to commenter concerns, will help to ensure that
market participants that take on significant liquidity-providing roles
are appropriately registered and regulated as dealers and government
securities dealers. As discussed further below, the final rules are one
way to establish that a person is a dealer or government securities
dealer; otherwise applicable court precedent and Commission
interpretations will continue to apply.\9\
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\7\ See, e.g., Exchange Act section 3(b) (authorizes the SEC to
define terms used in the Exchange Act, consistent with the
provisions and purposes of the Exchange Act. 15 U.S.C. 78c(b)).
\8\ On Mar. 28, 2022, the Commission voted to issue the proposed
17 CFR 240.3a5-4 (``proposed Rule 3a5-4'') and 240.3a44-2
(``proposed Rule 3a44-2'') (collectively, ``proposed rules'') to
further define ``as a part of a regular business'' as that phrase is
used in the statutory definitions of ``dealer'' and ``government
securities dealer.'' See Proposing Release. The release was posted
on the Commission website that day, and comment letters were
received beginning that same date. The comment period closed on May
27, 2022. Comments are available here: <a href="https://www.sec.gov/comments/s7-12-22/s71222.htm">https://www.sec.gov/comments/s7-12-22/s71222.htm</a>. We have considered all comments received since
Mar. 28, 2022.
\9\ See 17 CFR 240.3a5-4(c) (``Rule 3a5-4(c)'') and 240.3a44-
2(c) (``Rule 3a44-2(c)'') (providing that no presumption shall arise
that a person is not a dealer or government securities dealer solely
because that person does not satisfy the standards of the final
rules). As discussed in the Proposing Release and below, the courts
and the Commission look to an array of factors in determining
whether someone is a ``dealer'' within the meaning of the statute.
See, e.g., 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''); see also section II.A.5 (explaining that
otherwise applicable interpretations and precedent continue to apply
to determine whether a person is acting as a dealer, even when that
person does not fall within the requirements of the new rules);
section II.A.3 (explaining that the $50 million threshold is not an
exclusion from the ``dealer'' definition for all purposes, but only
for purposes of the new rules).
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Registration will enable more comprehensive regulatory oversight of
securities markets and those participants that take on significant
liquidity-providing roles. The final rules will support market
stability and resiliency and protect investors by promoting the
financial responsibility and operational integrity of significant
liquidity providers that are acting as dealers in the securities
markets.\10\
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\10\ Section III below describes the estimated benefits and
costs associated with registering as a dealer or government
securities dealer for those persons who meet the qualitative
standard of the final rules.
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A. Background
The statutory definition of ``dealer'' in section 3(a)(5) 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. 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.'' \11\ This statutory
exclusion from the definition of ``dealer'' is often referred to as the
``trader'' exception.\12\ 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.\13\ 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
[[Page 14940]]
regular business.'' \14\ Read together, these provisions identify a
``government securities dealer'' as a person engaged in the business of
buying and selling government securities for its own account as part of
a regular business. 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).\15\
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\11\ 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. The Dodd-Frank Act established a statutory
framework for regulating security-based swaps that includes the
registration and regulation of security-based swap dealers.
\12\ See 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'').
\13\ A bank engaged in these activities with respect to
government securities 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''). A bank may nonetheless be a
government securities dealer under section 3(a)(44). 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.
\14\ 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 (``GSA''). Public Law 99-571, 100
Stat. 3208 (Oct. 28, 1986). In addition to otherwise applicable
regulations, government securities dealers must comply with rules
adopted by the Treasury. See regulations under section 15C of the
Securities Exchange Act of 1934, 17 CFR 400.1(b), available at
<a href="https://www.govinfo.gov/content/pkg/CFR-2018-title17-vol4/pdf/CFR-2018-title17-vol4.pdf">https://www.govinfo.gov/content/pkg/CFR-2018-title17-vol4/pdf/CFR-2018-title17-vol4.pdf</a>. These regulations address financial
responsibility, protection of customer securities and funds,
recordkeeping, 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 GSA, 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); Louis Dreyfus Corp., SEC No-Action Letter
(July 23, 1987); United Savings Association of Texas, SEC No-Action
Letter (Apr. 2, 1987); Continental Grain Co., SEC No-Action Letter
(Nov. 28, 1987). 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.
Staff in the Division of Trading and Markets is reviewing its no-
action letters and other staff statements that address the Exchange
Act's definition of ``dealer'' or ``government securities dealer''
to determine which letters and other staff statements, or portions
thereof, should be withdrawn in connection with the adoption of the
final rules. Some of these letters and staff statements, or portions
thereof, may be moot, superseded, or otherwise inconsistent with the
final rules, and, therefore, may be withdrawn by the staff. A list
of the letters to be withdrawn will be available on the Commission's
website.
\15\ 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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The Commission has long identified factors that would be
informative for determining whether a person is a dealer. For example,
the Commission's 2002 Release states that ``[a] person generally may
satisfy the definition, and therefore, be acting as a dealer in the
securities markets by conducting various activities: (1) underwriting;
(2) acting as a market maker or specialist on an organized exchange or
trading system; (3) acting as a de facto market maker whereby market
professionals or the public look to the firm for liquidity; or (4)
buying and selling directly to securities customers together with
conducting any of an assortment of professional market activities such
as providing investment advice, extending credit and lending securities
in connection with transactions in securities, and carrying a
securities account.\16\ These principles demonstrate that the analysis
of whether a person meets the definition of a dealer depends upon all
of the relevant facts and circumstances.'' \17\
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\16\ 2002 Release at 67498-67500.
\17\ See id.; see also Proposing Release at 23058-59.
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In recent years, market participants regularly engaging in
significant liquidity provision have not registered, either as
``dealers'' under section 15 of the Exchange Act or ``government
securities dealers'' under section 15C of the Exchange Act.\18\ This is
particularly true in the U.S. Treasury market where certain market
participants, particularly those commonly known as proprietary or
principal trading firms (``PTFs''), account for about half of the daily
volume in the interdealer market and yet are not registered as
dealers--despite performing critical market functions, in particular
liquidity provision, that historically have been performed by
dealers.\19\ The Commission recognizes that, depending on their
business models, PTFs may not engage in certain types of dealer
activities. Some may not, for example, underwrite securities, solicit
clients, provide investment advice, carry accounts for others, or
extend credit, and so may not implicate principle (1), (2), or (4) as
discussed in the 2002 Release. The Commission is concerned, however,
that some PTFs act as de facto market makers but do so without
registration.\20\ Such a regulatory gap results in inconsistent
oversight of market participants performing similar functions (whether
in the same market or across asset classes). This limited regulatory
oversight of significant liquidity providers increases the difficulty
and complexity for regulators to investigate, understand, and address
significant market events.\21\ As a result,
[[Page 14941]]
investors and the markets currently lack important protections.
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\18\ See Proposing Release at 23081.
\19\ Nellie Liang and Pat Parkinson, Hutchins Center Working
Paper #72, Enhancing Liquidity of the U.S. Treasury Market Under
Stress (Dec. 16, 2020), at 6. The term ``PTF'' is not defined in the
securities laws. PTFs trade as principals, buying and selling for
their own accounts, and often employ automated, algorithmic trading
strategies (including passive market making, arbitrage, and
structural and directional trading) that rely on speed, which allows
them to quickly execute trades, or cancel or modify quotes in
response to perceived market events. See Proposing Release at 23055.
See also Joint Staff Report: The U.S. Treasury Market on Oct. 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/specialstudies/treasury-market-volatility-10-14-2014-joint-report.pdf">https://www.sec.gov/reportspubs/specialstudies/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''). In
contrast, many equity market participants may already be registered
in order to take advantage of certain incentives offered only to
exchange members. See Exchange Act section 6(c)(1) (requiring a
national securities exchange to deny membership to any person that
is not a registered broker or dealer or, if a natural person,
associated with a registered broker or dealer).
\20\ The significant role played by market participants not
registered as dealers distinguishes the Treasury market from other
markets where these types of participants are more typically
registered as dealers. One commenter stated that it understood
``from its member firms that one of the effects of the Market Access
Rule is that many previously unregistered PTFs operating in the
equity and options markets became registered as broker-dealers due
to their business need to submit their orders directly into the
market without having to first run them through the risk controls of
other broker-dealers,'' and that the Proposing Release did not
address this market development. See Comment Letter of Securities
Industry and Financial Markets Association (May 27, 2022) (``SIFMA
Comment Letter I''); see also 17 CFR 240.15c3-5 (``Rule 15c3-5'' or
``Market Access Rule'') (requiring broker-dealers with market access
to establish, document, and maintain a system of risk management
controls and supervisory procedures reasonably designed to manage
financial, regulatory, and other risks of this business activity).
As explained in the Proposing Release, 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. In the U.S.
Treasury market, however, where trading occurs on alternative
trading systems (``ATSs'') and other non-exchange venues, PTFs lack
this incentive to register. See Proposing Release at 23072-73. See
also Exchange Act section 6(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.'').
\21\ See, e.g., Inter-Agency Working Group for Treasury Market
Surveillance 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'')
(describing Mar. 2020 COVID-19 and Oct. 15, 2014, flash rally
disruptions to the Treasury market). See also supra note 18 and
accompanying text.
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Courts have repeatedly recognized the requirement that dealers
register as being ``of the utmost importance in effecting the purposes
of the Exchange Act.'' \22\ Dealers generally must register with the
Commission and become members of a self-regulatory organization
(``SRO''); \23\ comply with Commission and SRO rules, including certain
financial responsibility and risk management rules,\24\ transaction and
other reporting requirements,\25\ operational integrity rules,\26\ and
books and records requirements,\27\ 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 market risks. In addition, registered dealers and
government securities dealers are required to comply with all
applicable securities laws, including not only section 17(a) of the
Securities Act of 1933 (``Securities Act'') and section 10(b) of the
Exchange Act but also specialized anti-manipulative and other antifraud
rules promulgated pursuant to section 15(c) of the Exchange Act.\28\
These regulatory requirements provide fundamental protections that
contribute to fair and orderly markets. Firms that are government
securities dealers (including registered broker-dealers trading
government securities) must also comply with rules adopted by the U.S.
Treasury, including rules relating to financial responsibility,
recordkeeping, financial condition reporting, and risk oversight.\29\
Importantly, dealers are
[[Page 14942]]
subject to Commission and SRO examination and enforcement for
compliance with applicable Federal securities laws and SRO rules.\30\
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\22\ Proposing Release at 23060-61; see also SEC v. Benger, 697
F. Supp. 2d 932, 944 (N.D. Ill. 2010) (quoting Celsion Corp. v.
Stearns Mgmt. Corp., 157 F. Supp. 2d 942, 947 (N.D. Ill. 2001)
(section 15(a)'s registration requirement is ``of the utmost
importance in effecting the purposes of the Act'' because it enables
the SEC ``to exercise discipline over those who may engage in the
securities business and it establishes necessary standards with
respect to training, experience, and records.''); 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.''); Regional Properties, Inc. v. Financial and
Real Estate Consulting Co., 678 F.2d 552, 561 (5th Cir. June 3,
1982); Eastside Church of Christ v. National Plan, Inc., 391 F.2d
357, 361 (5th Cir. Mar. 12, 1968).
\23\ 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 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 generally need to become a member of a registered
national securities association (FINRA is the only registered
national securities association). The Commission recently adopted
amendments to 17 CFR 240.15b9-1 (``Rule 15b9-1'') to replace rule
provisions that provide an exemption for proprietary trading with
narrower exemptions from national securities association membership
for any registered broker or dealer that is a member of a national
securities exchange, carries no customer accounts, and effects
transactions in securities otherwise than on a national securities
exchange of which it is a member. See 17 CFR 240.15b9-1; Exemption
for Certain Exchange Members, Exchange Act Release No. 98202, Aug.
23, 2023), 88 FR 61850 (Sept. 7, 2023) (``Amended Rule 15b9-1
Adopting Release''). 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.
\24\ See, e.g., 17 CFR 240.15c3-1 (``Rule 15c3-1'' or ``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.
\25\ 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 member has
violated certain specified regulatory requirements, is subject to
written customer complaints, 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) (``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. See also Consolidated Audit Trail,
Exchange Act Release No. 62174 (May 26, 2010), 75 FR 32556 (June 8,
2010); Joint Industry Plan; Order Approving the National Market
System Plan Governing the Consolidated Audit Trail, Exchange Act
Release No. 79318 (Nov. 15, 2016), 81 FR 84696 (Nov. 23, 2016)
(``CAT Approval Order''); Joint Industry Plan; Notice of Filing of a
National Market System Plan Regarding Consolidated Equity Market
Data, Exchange Act Release No. 77724 (Apr. 27, 2016), 81 FR 30614
(May 17, 2016) (``CAT Notice'').
\26\ See, e.g., 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).
\27\ See, e.g., section 17(a) of the Exchange Act and 17 CFR
240.17a-3 (``Rule 17a-3'') and 240.17a-4 (``Rule 17a-4''); 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.'').
\28\ 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.
Section 15(c) of the Exchange Act prohibits broker-dealers from
effecting any transaction in securities by means of any
manipulative, deceptive, or other fraudulent device or contrivance.
\29\ Under Title I of the 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, as well as all other applicable
requirements. 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; 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) (``This
part does not apply to a registered broker or dealer . . . that is
subject to [Rule 15c3-1].''); 17 CFR 403.1 (regarding application to
registered brokers or dealers); 17 CFR 404.1 and 17 CFR 405.1(a)
(same).
\30\ 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 authority of the Commission with respect to government
securities dealers that are not registered with the Commission).
---------------------------------------------------------------------------
On March 28, 2022, the Commission proposed Rules 3a5-4 and 3a44-2
to identify certain activities that would constitute a ``regular
business'' requiring a person engaged in certain liquidity-providing
activities to register as a ``dealer'' or a ``government securities
dealer,'' absent an exception or exemption.\31\ Proposed Rules 3a5-4
and 3a44-2 were designed to define the types of activities that would
cause a person to be regarded as a de facto market maker and therefore
subject to registration as a dealer under sections 15 and 15C of the
Exchange Act. Specifically, the proposed rules would have established
three qualitative factors, as well as a quantitative standard
applicable only with respect to government securities. The proposed
rules also further defined the types of entities that would be included
in and excluded from the ambit of the rules. The proposed rules focused
only on the de facto market maker test, as emphasized through the
inclusion of the ``no presumption'' language, which provided that the
further definition of ``regular business,'' if adopted, would not seek
to address all persons that may be acting as dealers under otherwise
applicable interpretations and precedent.
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\31\ See Proposing Release; see also Exchange Act section 15
(regarding registration of dealers) and section 15C (regarding
registration of government securities dealers).
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The Commission received comment letters from a variety of
commenters including investment advisers, PTFs, private fund advisers,
crypto asset related entities and industry groups, insurance industry
groups, industry associations, advisory groups, retail investors, and
other market participants.\32\ The comments addressed all aspects of
the proposal.
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\32\ Comments received in response to the Proposing Release are
available at: <a href="https://www.sec.gov/comments/s7-12-22/s71222.htm">https://www.sec.gov/comments/s7-12-22/s71222.htm</a>.
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Commenters in support of the proposal shared the Commission's
concerns regarding the significant role of unregistered entities that
act as liquidity providers and emphasized the benefits of registration
and regulation.\33\ These commenters discussed specific benefits, in
particular transparency, market integrity and investor protection, as
well as appropriate Commission and SRO oversight of entities registered
as dealers and government securities dealers.\34\
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\33\ See, e.g., Comment Letter of The Financial Industry
Regulatory Authority, Inc. (June 23, 2022) (``FINRA Comment
Letter''); Comment Letter of Better Markets (May 27, 2022) (``Better
Markets Comment Letter'').
\34\ Id.
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Some commenters stated that they supported the Commission's policy
goals but expressed concerns regarding whether the proposed rules would
achieve those goals.\35\ As discussed more fully below, these and other
commenters raised certain common themes, which generally reflected
concerns regarding the breadth of the proposed rules and that the
proposed rules would inappropriately apply to persons not engaging in
dealer activity. Specifically, many commenters stated that some of the
terms used in the proposed qualitative factors were vague and overly
broad.\36\ As discussed below, some commenters thought that the
proposed first qualitative factor was overinclusive and would capture
activity that was not dealing.\37\ Commenters also raised concerns
about certain terms used in the proposed first qualitative factor, the
manner in which they would be interpreted, and the compliance
challenges that they might present.\38\ While the Commission is
generally retaining the overall structure of the proposed rules, the
Commission is making certain modifications to the text of the rules and
also is providing guidance to address concerns raised during the public
comment process.
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\35\ See, e.g., SIFMA Comment Letter I (``We support the policy
goal of proposed Rule 3a44-2 to require PTFs in the government
securities market to register as government securities dealers, but
believe that the Commission can adequately capture trading activity
by unregistered PTFs by adopting solely the qualitative standards
set forth Rule 3a44-2(a)(1)(ii) and (iii), without the need to adopt
the standard in Rule 3a44-2(a)(1)(i).''); Comment Letter of Modern
Markets Initiative (May 27, 2022) (``MMI Comment Letter'') (``MMI
appreciates the SEC's intent in the Proposal to further support
transparency, market integrity, and resiliency across the U.S.
Treasury market and other securities markets, as it relates to
ensuring that proprietary (or principal) trading firms and other
market participants who are acting as dealers be, in fact,
registered as `dealers.' MMI agrees it is important that dealers or
those who engage in buying and selling of government securities as
registered dealers should become members of a self-regulatory
organization, and receive the benefits and obligations under the
existing framework of Federal securities laws.''); Comment Letter of
Asset Management Group of Securities Industry and Financial Markets
Association (May 27, 2022) (``SIFMA AMG Comment Letter'') (``While
SIFMA AMG can appreciate the Commission's efforts to protect
investors and further the public interest, we do not believe that
the Proposal will achieve those goals with respect to money
managers.''); Comment Letter of FIA Principal Traders Group (Dec.
12, 2023) (``FIA PTG Comment Letter II'').
\36\ See, e.g., Comment Letter of Association of Digital Asset
Markets (May 27, 2022) (``ADAM Comment Letter''); Comment Letter of
Citadel (June 7, 2022) (``Citadel Comment Letter''); Comment Letter
of Morgan, Lewis & Bockius LLP (June 8, 2022) (``Morgan Lewis
Comment Letter''); Comment Letter of T. Rowe Price (June 8, 2022)
(``T. Rowe Price Comment Letter''); Comment Letter of Investment
Company Institute (May 27, 2022) (``ICI Comment Letter''); SIFMA
Comment Letter I; SIFMA AMG Comment Letter; Comment Letter of
Alternative Investment Management Association (May 27, 2022) (``AIMA
Comment Letter II''); Comment Letter of Managed Funds Association
(May 27, 2022) (``MFA Comment Letter I''); Comment Letter of
McIntyre & Lemon, PLLC (May 31, 2022) (``McIntyre Comment Letter
II''); Comment Letter of FIA Principal Traders Group (May 27, 2022)
(``FIA PTG Comment Letter I''); Comment Letter of Managed Funds
Association (Dec. 19, 2023) (``MFA Comment Letter V''). See also
section II.A.1.
\37\ See, e.g., AIMA Comment Letter II; MFA Comment Letter I;
Comment Letter of Element Capital Management LLC (May 27, 2022)
(``Element Comment Letter''); SIFMA Comment Letter II; MFA Comment
Letter V.
\38\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter;
T. Rowe Price Comment Letter.
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Many commenters also questioned whether the quantitative standard
exceeds the Commission's authority under the Exchange Act and is
consistent with historical Commission interpretations and guidance and
Federal case law.\39\ As discussed above, the SEC has the authority to
define the terms used in the statutory definition of ``dealer'' and
oversee and regulate registered dealers. Further, the statutory
definitions of ``dealer'' in section 3(a)(5) and ``government
securities dealer'' in section 3(a)(44), and the accompanying
registration requirements of the Exchange Act, were drawn broadly by
Congress to encompass a wide range of activities involving the
securities markets and their participants. PTFs and other market
participants that engage in dealer activity in the U.S. Treasury market
should be subject to the same regulatory requirements as other dealers.
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\39\ See, e.g., SIFMA AMG Comment Letter; Comment Letter of Two
Sigma (May 27, 2022) (``Two Sigma Comment Letter I'').
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In addition, commenters, many of which were in the asset management
industry, stated that the proposed definition of ``own account'' would
[[Page 14943]]
inappropriately apply the dealer regime to private funds and registered
investment advisers, and that the proposed exclusion for registered
investment companies should be expanded to registered investment
advisers and to private funds managed by registered investment
advisers.\40\ Commenters in the crypto asset industry also opposed the
proposal, stating that the dealer framework should not apply to
entities that transact in crypto assets that are securities.\41\
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\40\ See, e.g., Comment Letter of National Association of
Private Fund Managers (May 27, 2022) (``NAPFM Comment Letter''); MFA
Comment Letter I; AIMA Comment Letter II. See also section II.A.3.
\41\ The Proposing Release used the phrase ``digital asset that
is a security.'' See Proposing Release at 23057 n.36. For purposes
of this Adopting Release, the Commission does not distinguish
between the terms ``digital asset securities'' and ``crypto asset
securities.''
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Further, many commenters believed that the economic analysis did
not adequately address economic implications of the proposed rules.\42\
Commenters also stated that the proposed rules were largely unnecessary
because of existing regulatory obligations, stating that the Commission
has other tools to accomplish its stated goals of improving
transparency including, for example, the Consolidated Audit Trail
(``CAT''), the Trade Reporting and Compliance Engine (``TRACE'') and
large trader reporting,\43\ and that the proposed rules could have a
negative effect on liquidity.\44\
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\42\ See, e.g., Comment Letter of Andreessen Horowitz (May 27,
2022) (``Andreessen Horowitz Comment Letter''); AIMA Comment Letter
II; ADAM Comment Letter; MFA Comment Letter I; Comment Letter of
Blockchain Association (May 27, 2022) (``Blockchain Association
Comment Letter''); Comment letter of U.S. Representatives Patrick
McHenry and Bill Huizenga (Apr. 18, 2022) (``U.S. Reps Comment
Letter''); Comment Letter of Virtu Financial (May 27, 2022) (``Virtu
Comment Letter''); Comment Letter of Alphaworks Capital Management
(May 27, 2022) (``Alphaworks Comment Letter''); Two Sigma Comment
Letter I; FIA PTG Comment Letter I; Comment Letter of Independent
Dealer and Trader Association (May 27, 2022) (``IDTA Comment
Letter''); NAPFM Comment Letter; Comment Letter of Schulte Roth &
Zabel LLP (May 27, 2022) (``Schulte Roth Comment Letter''); SIFMA
Comment Letter I; Comment Letter of James Overdahl (May 27, 2022)
(``Overdahl Comment Letter''); Comment Letter of Fried, Frank,
Harris, Shriver, & Jacobson LLP (May 27, 2022) (``Fried Frank
Comment Letter''); Element Comment Letter; Comment Letter of Chamber
of Digital Commerce (June 13, 2022) (Chamber of Digital Commerce
Comment Letter''); Morgan Lewis Comment Letter; Comment Letter of
DeFi Education Fund (May 27, 2022) (``DeFi Fund Comment Letter'');
Comment Letter of Ranking Member, Tim Scott, U.S. Senator (Dec. 14,
2023) (``Scott Comment Letter'').
\43\ See, e.g., MMI Comment Letter; Virtu Comment Letter; AIMA
Comment Letter II; ADAM Comment Letter; SIFMA AMG Comment Letter;
SIFMA Comment Letter I; Fried Frank Comment Letter; Element Comment
Letter; T. Rowe Price Comment Letter.
\44\ See, e.g., AIMA Comment Letter II; FIA PTG Comment Letter
I; Virtu Comment Letter; McIntyre Comment Letter II; Alphaworks
Comment Letter; MMI Comment Letter; Schulte Roth Comment Letter;
IDTA Comment Letter; NAPFM Comment Letter; Comment Letter of Federal
Regulation of Securities Committee of the Business Law Section of
the American Bar Association (May 27, 2022) (``ABA Comment
Letter''); Fried Frank Comment Letter; MFA Comment Letter I; Element
Comment Letter; Citadel Comment Letter; Morgan Lewis Comment Letter;
DeFi Fund Comment Letter; Scott Comment Letter.
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B. Overview of the Final Rules and Modifications to the Proposal
After careful review of comments received and upon further
consideration, the Commission is adopting Rules 3a5-4 and 3a44-2 as
revised. As discussed below, while the Commission is generally
retaining the overall structure of the proposed rules, we are making
certain modifications to the text of the rules and also are providing
guidance to address concerns raised during the comment process. In
particular, the modifications we have made to more appropriately tailor
the scope of the final rules will address various concerns raised by
commenters and appropriately require only entities engaging in de facto
market making activity to register as dealers.\45\ Overall, the final
rules will achieve the Commission's important goals of protecting
investors and supporting fair, orderly, and efficient markets.
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\45\ With respect to the Commission's authority to adopt the
final rules, some commenters asserted that the major questions
doctrine is implicated. See, e.g., Comment Letter of Consensys
Software Inc. (May 26, 2022) (``Consensys Comment Letter''); Comment
Letter of American Investment Council (Aug. 8, 2023) (``AIC Comment
Letter''). In further defining what it means to be engaged in the
business of buying and selling securities ``as a part of a regular
business'' within the definitions of ``dealer'' and ``government
securities dealer'' under the Exchange Act, the Commission did not
claim an ``[e]xtraordinary grant[ ] of regulatory authority'' based
on ``vague,'' ``cryptic,'' ``ancillary,'' or ``modest'' statutory
language. West Virginia v. EPA, 142 S. Ct. 2587, 2608-10 (2022)
(quotation omitted). Nor did it assert authority that falls outside
its ``particular domain.'' Alabama Ass'n of Realtors v. HHS, 141 S.
Ct. 2485, 2489 (2021) (per curiam). Congress granted the SEC
authority to oversee and regulate dealers, and the Exchange Act
empowers the SEC with authority to define statutory terms.
---------------------------------------------------------------------------
An overview of the changes from the proposal follows:
Modification and Streamlining of the Qualitative Standard--The
Commission has modified the proposed qualitative factors to: (1)
eliminate the proposed qualitative factor that would have captured
persons engaging in liquidity provision by routinely making roughly
comparable purchases and sales of the same or substantially similar
securities in a day (``proposed first qualitative factor''); (2) more
closely track the statutory language of the Exchange Act by referring
to ``regular'' rather than the proposed ``routine'' patterns of
behavior that have the effect of providing liquidity to other market
participants; and (3) add the phrase ``for the same security'' to the
factor relating to the expression of trading interests to clarify that
it will apply only when a person is on both sides of the market for the
same security. While the proposed first qualitative factor was intended
to capture persons whose pattern of trading indicates that their
liquidity provision forms a part of a regular business and to
distinguish them from persons engaging in isolated or sporadic
securities transactions (and therefore not engaging in such a
regularity of participation), commenters raised a number of concerns
with this factor, in particular that it was overinclusive and would
capture activity that was not dealing, but rather investing in the
ordinary course. After consideration of comments, the Commission has
decided to eliminate this factor from the final rules. As discussed
below, the qualitative factors as modified, together with the statutory
definition and related precedent and interpretations, appropriately
describe the circumstances in which a person would be deemed to engage
in a ``regular'' pattern of buying and selling securities that has the
effect of providing liquidity to other market participants, including
in the U.S. Treasury market.
Deletion of the Quantitative Standard--The Commission proposed a
bright line test under which persons engaged in certain levels of
activity in the U.S. Treasury market would be defined to be buying and
selling securities ``as part of a regular business,'' regardless of
whether they meet any of the qualitative factors. The quantitative
standard was intended as a backstop to the qualitative factors to
capture the most significant Treasury market participants.\46\ While
the proposed trading volume threshold was intended to provide an easily
measurable and non-discretionary standard, commenters raised concerns
regarding the application of this standard, in particular with respect
to investment activities that might trigger the quantitative threshold.
After consideration of these comments, the Commission has decided to
eliminate
[[Page 14944]]
the quantitative standard from the final rules. As discussed below, the
qualitative factors as modified, and otherwise applicable court
precedent and Commission interpretations, appropriately describe the
circumstances in which a person would be deemed to engage in a
``regular'' pattern of buying and selling securities that has the
effect of providing liquidity to other market participants, including
in the U.S. Treasury market.
---------------------------------------------------------------------------
\46\ See Proposing Release at 23072 (stating that the
quantitative standard was ``designed to make clear the Commission's
view that a person engaged in this regular volume of buying and
selling activity is engaged in the buying and selling of government
securities for its own account as part of a regular business, and
therefore, should be subject to the same regulatory requirements as
other dealers'').
---------------------------------------------------------------------------
As a result of these modifications, the final rules establish two
non-exclusive ways in which a person will be determined to be engaged
in a regular pattern of providing liquidity to other market
participants ``as part of a regular business'':
<bullet> Regularly expressing trading interest that is at or near
the best available prices on both sides of the market for the same
security, and that is communicated and represented in a way that makes
it accessible to other market participants (``expressing trading
interest factor''); \47\ or
---------------------------------------------------------------------------
\47\ The proposed second qualitative factor has been modified to
change the term ``trading interests'' to ``trading interest'' and
the words ``are'' to ``is'' and ``they'' to ``it.'' This is a non-
substantive modification to align the term with common usage.
---------------------------------------------------------------------------
<bullet> 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
interest (``primary revenue factor'').\48\
---------------------------------------------------------------------------
\48\ The proposed third qualitative factor has been modified to
change the term ``trading interests'' to ``trading interest.'' This
is a non-substantive modification to align the term with common
usage.
---------------------------------------------------------------------------
Revision of ``Own Account'' Definition and Addition of Anti-Evasion
Provision--The Commission had proposed to define ``own account'' to
include accounts ``held in the name of a person over whom that person
exercises control or with whom that person is under common control''
(``the aggregation provision'').\49\ Upon consideration of the
comments, the Commission has revised the definition so that the final
rules define ``own account'' to mean an account: (i) held in the name
of that person; or (ii) held for the benefit of that person. The rules
as adopted thus are consistent with the Commission's historical
``entity'' approach to broker-dealer regulation.\50\
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\49\ See infra note 297 and accompanying text. Further, the
Commission is removing the definitions of ``control'' and ``parallel
account structure.''
\50\ See, e.g., Foreign Broker-Dealer Adopting Release at 30017
(``the Commission uses an entity approach with respect to registered
broker-dealers''). See infra note 326 and accompanying text.
---------------------------------------------------------------------------
However, with a view to deterring the establishment of multiple
legal entities or accounts to evade appropriate regulation, the final
rules include an anti-evasion provision that prohibits persons from
evading the registration requirements by: (1) engaging in activities
indirectly that would satisfy the qualitative factors; or (2)
disaggregating accounts. The changes from the proposed rules address
concerns about the scope of the proposed rules as raised by commenters
while enhancing the Commission's current ability to prevent and address
potentially evasive behavior.\51\
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\51\ See section II.A.4.
---------------------------------------------------------------------------
Exclusions--The Commission is providing an exclusion for ``central
banks,'' ``sovereign entities,'' and ``international financial
institutions,'' all as defined in the final rules. The exclusion is
appropriate in view of the unique roles played by these entities. The
Commission also is adopting as proposed the exclusions from the final
rules for registered investment companies and persons that have or
control less than $50 million in total assets.\52\
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\52\ See section II.A.3. As discussed further below, the less
than $50 million exclusion is not an exclusion from the ``dealer''
definition for all purposes, but only for purposes of the final
rules that focus on de facto market making. Outside of this context,
the question of whether any person, including 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.
---------------------------------------------------------------------------
The Commission is not adopting certain commenters' suggestions for
additional exclusions. Among other things, as discussed more fully
below, the Commission is not excluding private funds or registered
investment advisers from the final rules because an investment adviser
or private fund could be acting as a dealer depending upon the
particular activities in which it is engaged. The final rules do,
however, include several modifications and clarifications to address
many of the compliance and other concerns raised by certain commenters,
including those raised by private funds and registered investment
advisers.\53\
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\53\ See section II.A.3.b.
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In addition, as discussed in more detail below, the Commission is
not excluding certain types of securities, specifically crypto asset
securities, from the application of the final rules.\54\ As stated in
the Proposing Release, the proposed rules would apply to any
``security'' as defined in section 3(a)(10) or ``government security''
as defined in section 3(a)(44) of the Exchange Act. The dealer
framework is a functional analysis based on the securities trading
activities undertaken by a person, not the type of security being
traded. Accordingly, the final rules will apply with respect to any
crypto asset that is a ``security'' or ``government security'' within
the meaning of the Exchange Act.
---------------------------------------------------------------------------
\54\ Comments requesting that the proposed rules not apply
specifically to crypto asset securities are discussed further in
section II.A.3.
---------------------------------------------------------------------------
Further, the Commission disagrees with the argument that certain
market participants, including PTFs, are not dealers because they do
not have customers.\55\ There is no requirement in the statutory text
of either section 3(a)(5) or section 3(a)(44) that dealers have
customers. In comparison, the Exchange Act's definition of ``broker''
is ``any person in the business of effecting transactions in securities
for the account of others,'' which includes (but is not limited to)
customers.\56\ The dealer definition includes no such limiting language
and, since its enactment, the dealer definition was understood to cover
``the operations of a trader . . . who has no customers but merely
trades for his own account through a broker'' so long as those
operations ``are sufficiently extensive to be regarded as a regular
business . . . .'' \57\ Likewise, many of the factors that the
Commission identified in its 2002 Release do not presume a dealer is
acting for a customer.\58\ Indeed, a number of Exchange Act rules
applicable to dealers presuppose that there are dealers without
customers and are tailored for that business model.\59\
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\55\ See Eastside Church of Christ v. National Plan, Inc., 391
F.2d 357 (5th Cir. 1968).
\56\ 15 U.S.C. 78c(a)(4)(A).
\57\ Charles H. Meyer, Securities Exchange Act of 1934 Analyzed
and Explained 33-34 (1934) (emphasis added).
\58\ See 2002 Release at 67498-67500.
\59\ See, e.g., 17 CFR 240.15c3-1(a)(6) (``Rule 15c3-1(a)(6)'')
(requiring firms relying on this provision to transact only with
other brokers and dealers and prohibiting such firms from carrying
customer accounts); Rule 15b9-1 (exempting brokers-dealers from
becoming members of a national securities association if they are a
member of an exchange, do not carry customer accounts, and any
securities transactions that they effect elsewhere than an exchange
of which they are a member meet certain exceptions).
---------------------------------------------------------------------------
Further, a helpful analogy can be drawn to the Commission's
rulemaking further defining who is a ``security-based swap dealer''--a
definition that closely parallels the statutory definition of
``dealer,'' particularly with respect to the exclusion of activities
that are not part of a regular business.\60\ In that
[[Page 14945]]
matter, in comparing ``counterparties'' with ``customers,'' the
Commission stated that ``any interpretation of the `security-based swap
dealer' definition that is predicated on the existence of a customer
relationship may lead to an overly narrow construction of the
definition.'' \61\ Accordingly, in this regard, these commenters have
read a limitation into the statute where none exists.
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\60\ See 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, (May 23, 2012)
(``Entities Release'') (``Although commenters have expressed the
view that a person that engaged in security-based swap activities on
an organized market should not be deemed to be a dealer unless it
engaged in those activities with customers, we do not agree.'').
\61\ Id. at n.282.
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As stated above, some commenters suggested that the final rules are
unnecessary because the SEC has other tools to accomplish the goals of
the rulemaking, including large trader reporting, TRACE, and CAT.
Certain commenters urged the Commission to take additional or different
regulatory actions for entities covered by the Investment Advisers Act
of 1940 (``Advisers Act'') than the approach we have adopted, including
leveraging existing data from Form PF filings or making amendments to
the existing regulatory regime under the Advisers Act. However, as
discussed below, dealer registration is tailored to provide specific
protections to address potential risks associated with dealer activity,
and the aforementioned tools do not provide sufficient regulatory
oversight and transparency into the trading activity of entities that
are not otherwise registered as dealers.
Commenters expressed the view that the proposed rules could have a
negative impact on liquidity or may cause many market participants to
cease, modify, or curtail their trading activity to avoid being
required to register as a dealer.\62\ However, as discussed further
below, we have made various modifications to appropriately tailor the
scope of the final rules to address concerns raised by commenters about
effects on liquidity. The Commission has crafted the final rules to
draw upon established concepts and to expand upon prior Commission
statements to identify more specifically the activities of certain
market participants who act as dealers by ``providing liquidity'' to
other market participants, and to establish a more level regulatory
playing field for these types of significant liquidity providers. The
test established in the Exchange Act to determine if a person is a
dealer is whether the person is engaged in the business of buying and
selling securities for its own account ``as part of a regular
business.'' \63\ The final rules are thus intended to reflect the
longstanding distinction between so-called ``traders''--whose liquidity
provision is only incidental to their trading activities--and persons
who are ``in the business'' of providing liquidity as part of a
``regular business,'' and so are ``dealers'' and ``government
securities dealers'' under the Exchange Act. Under the final rules, a
person is deemed to be engaged in buying and selling securities for its
own account as part of a regular business--and therefore within the
definition of ``dealer'' or ``government securities dealer''--if that
person is engaged in a ``regular pattern of buying and selling
securities that has the effect of providing liquidity to other market
participants.''
---------------------------------------------------------------------------
\62\ See ABA Comment Letter at 9-12; ADAM Comment Letter at 16;
AIMA Comment Letter II at 11-13; Comment Letter of Alternative
Investment Management Association (Nov. 17, 2022) (``AIMA Comment
Letter III'') at 3 and 8; Alphaworks Comment Letter at 6; Andreessen
Horowitz Comment Letter at 10 and 13; Blockchain Association Comment
Letter at 7; Citadel Comment Letter at 7-8; Comment Letter of
Committee on Capital Markets (Oct. 19, 2022) (``Committee on Capital
Markets Comment Letter'') at 3; DeFi Fund Comment Letter at 14;
Element Comment Letter at 5; FIA PTG Comment Letter I at 2-10; Fried
Frank Comment Letter at 8-11; Comment Letter of Gretz Consilium LLC
(May 26, 2022) (``Gretz Comment Letter'') at 18; ICI Comment Letter
at 7-8; McIntyre Comment Letter II at 2; MFA Comment Letter I at 12;
Comment Letter of Managed Funds Association (Dec. 5, 2022) (``Lewis
Study'') at 2; Morgan Lewis Comment Letter at 2 and 14; NAPFM
Comment Letter at 5; Overdahl Comment Letter at 16-23; Schulte Roth
Comment Letter at 2; SIFMA Comment Letter I at 8; SIFMA AMG Comment
Letter at 16-17; Two Sigma Comment Letter at 2 and 9; Virtu Comment
Letter at 3-4.
\63\ See sections 3(a)(5)(A) and (B) of the Exchange Act, 15
U.S.C. 78c(a)(5)(A) and (B); section 3(a)(44) of the Exchange Act,
15 U.S.C. 78c(a)(44).
---------------------------------------------------------------------------
The final rules are not the exclusive means of establishing that a
person is a dealer or government securities dealer; otherwise
applicable Commission interpretations and precedent will continue to
apply.\64\ In other words, these rules address one way in which a
person can be engaged in the regular business of buying and selling
securities for its own account, but these rules do not displace,
modify, or substitute for otherwise applicable Commission
interpretations and court precedent. A person engaging in other
activities that satisfy the definition of dealer under otherwise
applicable interpretations and precedent, such as underwriting, will
still be a dealer even though those activities are not addressed by the
two qualitative factors.\65\
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\64\ See Rules 3a5-4(c) and 3a44-2(c) (providing that no
presumption shall arise that a person is not a dealer or government
securities dealer solely because that person does not satisfy the
standards of the final rules). See also section II.A.5.
\65\ See supra note 16.
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The final rules, as modified, appropriately balance the concerns of
the various commenters in a way that will best achieve the Commission's
important goals to protect investors and support fair, orderly, and
resilient markets through the complete and consistent application of
dealer regulations. Further, the modifications we have made to tailor
the scope of the final rules, including the persons scoped into the
final rules, will address various concerns raised by commenters and
appropriately require only entities engaging in dealing activity to
register as dealers.
II. Discussion of Final Rules
A. Component Parts
1. Qualitative Standard
The qualitative standard in the proposed rules was intended to
build on existing statements by the Commission and the courts regarding
``dealer'' activity to further define certain factors for determining
when a person is engaged in buying and selling securities for its own
account ``as part of a regular business'' as that phrase is used in
sections 3(a)(5) and 3(a)(44) of the Exchange Act. 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 would be a dealer or a government securities dealer,
if 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. Under this standard, as
supplemented by the qualitative factors, when the frequency and nature
of a person's securities trading is such that the person assumes a
role--whether described as market-making, de facto market-making, or
liquidity-providing--similar to the role that historically has been
performed by a registered dealer, that person would be deemed to be a
dealer or government securities dealer.\66\ The proposed rules would
have further defined 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
[[Page 14946]]
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.
---------------------------------------------------------------------------
\66\ See, e.g., 2002 Release at 67499.
---------------------------------------------------------------------------
Commenters stated that the terms ``routine'' and ``routinely'' in
the proposed rules were unclear and would lead to inconsistent
interpretations.\67\ In response to the comments and upon further
consideration, the Commission has replaced the term ``routine'' with
``regular'' in 17 CFR 240.3a5-4(a)(1) and 240.3a44-2(a)(1) so that a
person will be engaged in buying and selling securities for its own
account ``as a part of a regular business''--and so be a dealer or a
government securities dealer--if that person engages in a regular
pattern of buying and selling securities (or government securities)
that has the effect of providing liquidity to other market
participants. As discussed more fully below, ``regular'' participation
in the securities markets is part of the statutory definition of
``dealer'' in the Exchange Act and therefore is a concept that should
be familiar to market participants.\68\
---------------------------------------------------------------------------
\67\ See, e.g., ADAM Comment Letter; Element Comment Letter;
Morgan Lewis Comment Letter; Consensys Comment Letter; MFA Comment
Letter I; NAPFM Comment Letter; SIFMA AMG Comment Letter.
\68\ See 15 U.S.C. 78c(a)(5) and 78c(a)(44).
---------------------------------------------------------------------------
In addition, as discussed below, after further consideration, the
Commission has revised the qualitative standard by eliminating the
proposed first qualitative factor and modifying the remaining two
qualitative factors. These changes are designed to more appropriately
tailor the rule to the nature of dealing in today's securities
markets.\69\ As a result of these modifications, the final rules
establish two non-exclusive ways in which a person will be deemed to be
engaged in providing liquidity as part of a regular business:
---------------------------------------------------------------------------
\69\ As discussed below, the Commission is adding the phrase
``for the same security'' so that the proposed second qualitative
factor applies to expressing trading interest on both sides of the
market for the same security. The Commission has also modified, as
appropriate, the remaining qualitative factors to replace the term
``routinely'' with ``regularly.''
---------------------------------------------------------------------------
<bullet> Regularly expressing trading interest that is at or near
the best available prices on both sides of the market for the same
security, and that is communicated and represented in a way that makes
it accessible to other market participants; or
<bullet> 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
interest.
a. Elimination of the Proposed First Qualitative Factor
As discussed in the Proposing Release, the proposed first
qualitative factor was intended to capture a person's pattern of
trading, the consistency and regularity of which indicate that its
liquidity provision forms a part of a regular business.\70\
Specifically, under proposed 17 CFR 240.3a5-1(a)(1)(i) and 240.3a44-
2(a)(1)(i), 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 engaged in buying and
selling securities or government securities ``as part of a regular
business'' as a dealer or government securities dealer.\71\ The
proposed first qualitative factor was intended to 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.
---------------------------------------------------------------------------
\70\ See Proposing Release at 23066.
\71\ See id.
---------------------------------------------------------------------------
Commenters raised a number of concerns about the proposed first
qualitative factor.\72\ As a general matter, commenters contended that
the proposed first qualitative factor would capture activity that was
not dealing, but rather investing in the ordinary course.\73\ One
commenter recommended that certain specific activities be explicitly
excluded from the rule, including asset liability management, liquidity
and collateral management, and activities ancillary to exempt dealer
activity.\74\ As discussed further below, commenters also expressed
concerns about certain terms used in the proposed first qualitative
factor, the manner in which they would be interpreted, and the
compliance challenges that they might present, focusing in particular
on the use of the terms ``routinely,'' ``substantially similar,''
``roughly comparable,'' and ``in a day.'' \75\ As a result of these
concerns, some commenters stated that the Commission should remove the
first proposed qualitative factor.\76\
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\72\ See also supra notes 37-38 and accompanying text.
\73\ See, e.g., AIMA Comment Letter II; MFA Comment Letter I;
Element Comment Letter; SIFMA Comment Letter II; FIA PTG Comment
Letter II; MFA Comment Letter V. For example, one commenter stated
that ``[w]ithout revision to, and clarification of, these vague
terms, this Qualitative Standard will clearly capture many short-
term investment strategies engaged in by traders that are not
indicative of dealer functions.'' Element Comment Letter. Another
stated that ``Qualitative Standard 1 would capture many common hedge
fund strategies that have never been, and should not now be,
considered dealing, including fixed-income arbitrage, convertible
bond arbitrage and capital structure arbitrage, as well as a number
of relative value or quantitative strategies.'' AIMA Comment Letter
II.
\74\ SIFMA Comment Letter II.
\75\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter;
T. Rowe Price Comment Letter; MFA Comment Letter V.
\76\ MFA Comment Letter I (``We have considered this proposed
test and strongly believe that it will be unworkable for market
participants--as described in detail below--and we therefore urge
the Commission not to include Qualitative Test 1 in any final
rule.''). See also AIMA Comment Letter II (``We believe the
Commission should limit its qualitative standards to only
Qualitative Standard 3.''). In addition, one commenter suggested
that the Commission replace the first and second proposed
qualitative factors with a test defining a person acting as a bona
fide market maker under Regulation SHO as a dealer. See MFA Comment
Letter I. As discussed below, the Commission is removing the
proposed first qualitative standard and declines to replace the
proposed second qualitative factor with a test defining a person
acting as a bona fide market maker under Regulation SHO. See section
II.A.1.b.
---------------------------------------------------------------------------
After further consideration and in light of commenters' concerns,
the Commission has decided to eliminate the proposed first qualitative
factor. The Commission agrees with commenters that the proposed first
qualitative factor could capture more than dealing activity intended to
be captured by the rule. Accordingly, the Commission is not adopting
the first factor.
The Commission emphasizes that the elimination of this factor does
not mean that the conduct that would have been captured by the proposed
factor is not dealing activity. This conduct may be de facto market
making under the other two qualitative factors or dealer activity under
otherwise applicable precedent. In this regard, as discussed in section
II.A.5, no presumption shall arise that a person is not a dealer or
government securities dealer as defined by the Exchange Act solely
because that person does not satisfy the standard set forth in the
final rules.
b. Expressing Trading Interest Factor
The Commission proposed a second qualitative factor to identify
activity that ``has the effect of providing liquidity to other market
participants'' focused on the expression of trading interests.
Specifically, under proposed 17 CFR 240.3a5-4(a)(1)(ii) and 240.3a44-
2(a)(1)(ii), a person that, trading for its own account, ``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
[[Page 14947]]
accessible to other market participants'' 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.\77\ As the Commission stated in the Proposing
Release, this factor ``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, to reflect
technological changes to the ways in which buyers and sellers of
securities are brought together.'' \78\
---------------------------------------------------------------------------
\77\ As discussed below, the Commission is adding the phrase
``for the same security'' to the expressing trading interest factor
to specify that this factor applies to expressing trading interest
on both sides of the market for the same security.
\78\ Proposing Release at 23068.
---------------------------------------------------------------------------
The Commission explained in the Proposing Release the meanings of
certain key terms used in the proposed second qualitative factor.\79\
Specifically, as discussed in more detail below, the Commission
explained the terms ``routinely,'' ``trading interests'' and ``best
available prices on both sides of the market.'' \80\
---------------------------------------------------------------------------
\79\ Id.
\80\ Id.
---------------------------------------------------------------------------
The Commission received a range of comments on the proposed second
qualitative factor. One commenter explicitly supported the proposed
second qualitative factor, voicing support for the policy goal of
requiring PTFs in the government securities market to register as
government securities dealers.\81\ The commenter stated that it
believed that the second qualitative factor would achieve this
goal.\82\ As discussed below, a number of commenters opposed the
proposed second qualitative factor, contending that the factor would
capture activity that was not dealing,\83\ and expressing concerns
about certain terms used in this factor (i.e., ``routinely,'' ``trading
interests,'' ``both sides of the market,'' ``accessible to other market
participants''), as well as addressing other issues.\84\
---------------------------------------------------------------------------
\81\ SIFMA Comment Letter I.
\82\ Id.
\83\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter;
AIMA Comment Letter II.
\84\ See, e.g., MFA Comment Letter I; McIntyre Comment Letter
II; Consensys Comment Letter; Gretz Comment Letter; FIA PTG Comment
Letter I; Blockchain Comment Letter; NAPFM Comment Letter; ADAM
Comment Letter; SIFMA AMG Comment Letter; Comment Letter of Managed
Funds Association (July 21, 2023) (``MFA Comment Letter II'');
Element Comment Letter; Morgan Lewis Comment Letter; ABA Comment
Letter.
---------------------------------------------------------------------------
Advancements in the securities markets have altered the way in
which market participants interact with the markets. Certain market
participants continue to perform important dealer functions as
providers of liquidity to other market participants by expressing
trading interest on both sides of the market for a security to other
market participants. The expressing trading interest factor takes these
changes into account, while also allowing for flexibility in its
application in the markets for different securities, based on the wide
variance in liquidity, depth, or other traits.
In adopting the proposed second qualitative factor as the
expressing trading interest factor, the Commission is replacing the
term ``routinely'' with ``regularly.'' The Commission is also revising
the rule text to explicitly provide that the test applies with respect
to the expression of trading interest in the ``same'' security. Other
than these changes, and certain non-substantive changes, for the
reasons set forth below, the Commission is adopting this factor as
proposed. Accordingly, under the expressing trading interest factor, a
person ``regularly expressing trading interest that is at or near the
best available prices on both sides of the market for the same security
and that is communicated and represented in a way that makes it
accessible to other market participants'' is engaged in buying and
selling securities for its own account ``as a part of a regular
business'' as the phrase is used in sections 3(a)(5)(B) and 3(a)(44)(A)
of the Exchange Act. The expressing trading interest factor will
appropriately capture those market participants who are engaging in
liquidity-providing activities similar to those traditionally performed
by dealers or government securities dealers as defined under sections
3(a)(5) and 3(a)(44) of the Exchange Act.\85\
---------------------------------------------------------------------------
\85\ See 15 U.S.C. 78c(a)(5) and 78c(a)(44).
---------------------------------------------------------------------------
Regularly
The Proposing Release stated that the term ``routinely'' as used in
the proposed second qualitative factor meant that a person must express
trading interests more frequently than occasionally, but not
necessarily continuously, both intraday and across time.\86\ The use of
the term ``routinely'' in the proposed second qualitative factor was
thus intended 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.\87\ The Proposing Release stated that the liquidity providers
that would be covered by the proposed second qualitative factor 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 and the equity markets.\88\
---------------------------------------------------------------------------
\86\ Proposing Release at 23068.
\87\ Id.
\88\ Id.
---------------------------------------------------------------------------
A number of commenters expressed concerns related to the use of the
term ``routinely.'' \89\ Several commenters stated that the term
``routinely'' was unclear, which would make it difficult or impossible
for market participants to determine whether their activities would be
captured by the proposed second qualitative factor.\90\ For example,
one commenter stated that the term ``routinely'' is ``unclear, defined
with reference to another undefined concept (`occasional') and
distinguished from a concept (`continuous') that market participants
actually understand and have experience applying.'' \91\ As a result,
the commenter stated this factor ``would ultimately be unworkable for
market participants who will have to make subjective determinations, on
at least a daily basis, about whether they are `routinely' engaging in
the activity described in [the proposed rules].'' \92\ Another
commenter asserted that use of the term ``routinely'' ``will lead to
inconsistent application across market participants.'' \93\ Commenters
also raised questions about the Proposing Release's analogy to the
approach in the Commission's joint rulemaking with the Commodity
Futures Trading Commission regarding, among other things, the
definitions of ``swap dealer'' and ``security-based swap dealer.'' \94\
In particular, commenters stated that the reference was inappropriate
because of the different nature of the markets for
[[Page 14948]]
cash securities and security-based swaps.\95\
---------------------------------------------------------------------------
\89\ See, e.g., MFA Comment Letter I; McIntyre Comment Letter
II; Consensys Comment Letter; Gretz Comment Letter; FIA PTG Comment
Letter I; Blockchain Comment Letter; NAPFM Comment Letter; ADAM
Comment Letter; SIFMA AMG Comment Letter; MFA Comment Letter II;
Element Comment Letter; Morgan Lewis Comment Letter; ABA Comment
Letter.
\90\ See, e.g., MFA Comment Letter I; Element Comment Letter;
ADAM Comment Letter; Morgan Lewis Comment Letter; SIFMA AMG Comment
Letter.
\91\ MFA Comment Letter I.
\92\ Id. See also Element Comment Letter (```routine' trading
can indicate market making, which implies a dealer function, but can
also indicate the day-to-day activity of a private fund's trading
desk.'').
\93\ ADAM Comment Letter. See also SIFMA AMG Comment Letter.
\94\ See, e.g., ADAM Comment Letter; Morgan Lewis Comment
Letter; SIFMA AMG Comment Letter; see also Proposing Release at
n.132.
\95\ See, e.g., ADAM Comment Letter; Morgan Lewis Comment
Letter; SIFMA AMG Comment Letter.
---------------------------------------------------------------------------
As an alternative to ``routinely,'' some commenters suggested using
a different term, with most such commenters suggesting ``continuous.''
\96\ Some commenters asked whether the Commission had considered using
``regularly,'' stating that the statute uses the term ``regular.'' \97\
---------------------------------------------------------------------------
\96\ SIFMA AMG Comment Letter; Comment Letter of BlackRock (Mar.
16, 2023) (``BlackRock Comment Letter'').
\97\ MFA Comment Letter I (``. . .but query, was `nearly
continuous' considered? Or `regular'?''); McIntyre Comment Letter II
(stating that the Proposed Rule ``replaces the statutory text of
``regular'' and ``continuous'' with an amorphous notion of
``routine'' patterns of providing liquidity.'').
---------------------------------------------------------------------------
After further consideration, the Commission has replaced the term
``routinely'' with ``regularly.'' As with the term ``routinely'' in the
Proposing Release, the term ``regularly'' in the final rules will apply
to a person's expression of trading interest both within a trading day
and over time.\98\ This requirement distinguishes persons engaging in
isolated or sporadic expressions of trading interest from persons whose
regularity of expression of trading interest demonstrates that they are
acting as dealers. As some commenters expressly stated,\99\ the term
``regular'' is part of the statutory definition of ``dealer'' in the
Exchange Act.\100\ The term ``regular'' captures persons operating as
dealers through their expression of trading interest on both sides of
the market for the same security in a manner consistent with this
statutory text.
---------------------------------------------------------------------------
\98\ As proposed, the term ``routinely'' would have meant both
repeatedly within a day and repeatedly over time. See Proposing
Release at 23068.
\99\ See supra note 97.
\100\ 15 U.S.C. 78c(a)(5).
---------------------------------------------------------------------------
A market participant does not need to be continuously expressing
trading interest to be engaging in a ``regular'' business. The Exchange
Act's definitions of ``dealer'' and ``government securities dealer'' do
not include a requirement of continuous participation. The ordinary
meaning of ``continuous'' is ``characterized by continuity; extending
in space without interruption of substance; having not interstices or
breaks; having its parts in immediate connection; connected, unbroken''
and ``marked by uninterrupted extension in space, time, or sequence,''
as defined by the Oxford English and the Merriam-Webster dictionaries,
respectively.\101\ While such ``continuous'' expression of trading
interest would be indicative of dealer activity, a continuous standard
would not be appropriate because it would be too limited in markets for
securities that exhibit varying degrees of depth and liquidity.\102\
---------------------------------------------------------------------------
\101\ See, e.g., Iqbal v. United States Citizenship & Immigr.
Servs., 397 F. Supp. 3d 273, 283 (W.D.N.Y. 2019) (quoting Merriam-
Webster, <a href="https://www.merriam-webster.com/dictionary/continuous">https://www.merriam-webster.com/dictionary/continuous</a> (Aug.
22, 2019)); see also Axia Inc. v. Jarke Corp., No. 87 C 8024, 1989
WL 39722, at *3 (N.D. Ill. Apr. 20, 1989) (explaining that
``continuous'' is commonly understood as ``uninterrupted'' in the
context of an interpretation of a patent claim).
\102\ See Remarks of Lorie K. Logan, Executive Vice President of
the Federal Reserve Bank of New York, at the Brookings-Chicago Booth
Task Force on Financial Stability, available at <a href="https://www.newyorkfed.org/newsevents/speeches/2020/log201023">https://www.newyorkfed.org/newsevents/speeches/2020/log201023</a>; Remarks of
Deputy Secretary Justin Muzinich at the 2020 U.S. Treasury Market
Conference [verbar] U.S. Department of the Treasury; see also
Treasury Market Liquidity during the COVID-19 Crisis--Liberty Street
Economics (<a href="http://newyorkfed.org">newyorkfed.org</a>). See also 2015 IAWG Report (when
conducting an algorithm-level analysis from the event window on Oct.
15, 2014, the IAWG found ``the analysis suggests that multiple types
of trading strategies were deployed by PTFs during the event window.
Some PTF algorithms appear to explain the considerable amount of net
passive market making activity that was witnessed across cash and
futures over the event window and likely was an important
contributing factor to the absence of price gapping despite the
unprecedented large price swings. Another, and equally significant,
group of PTF strategies appears to have aggressively traded in the
direction of price moves during the event window, accounting for the
bulk of the overall aggressive trading imbalance observed.'').
---------------------------------------------------------------------------
Whether a person's activity is ``regular'' will depend on the
liquidity and depth of the relevant market for the security. For
example, in markets that have significant liquidity and market depth,
and have experienced advancements in technology and electronic trading,
like the U.S. Treasury market,\103\ expressing trading interest on both
sides of the market for the same security as part of an investment
strategy on a one-off basis would not be sufficiently regular to be
caught by the expressing trading interest factor. Rather, ``regular''
in the most liquid markets would mean more frequent periods of
expressing trading interest on both sides of the market both intraday
and across days given the efficiency in which securities can be bought
and sold and the market's ability to absorb orders without
significantly impacting the price of the security.\104\ In contrast, if
the market for a security is less liquid, and it is difficult to
execute orders in that security or large orders can dramatically affect
the price of the security, the term ``regular'' would account for the
possibility of more interruptions or wider spreads for the best
available prices.
---------------------------------------------------------------------------
\103\ See Proposing Release at 23055.
\104\ See Proposing Release at 23058 (stating ``[t]he
`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.'') (citing SEC v. Am. Inst. Counselors, Inc., Fed.
Sec. L. Rep. (CCH) ] 95388 (D.D.C. 1975)); see also supra note 98.
---------------------------------------------------------------------------
The expressing trading interest factor captures the hallmark de
facto market making activity in which dealers make a market in a
security, standing ready to trade on both sides of the market on the
same security on a regular ongoing basis.\105\ Those market
participants that have established themselves as significant market
intermediaries--and critical sources of liquidity--in a market by
employing automated, algorithmic trading strategies that rely on high
frequency trading strategies to generate a large volume of orders and
transactions would be captured by the expressing trading interest
factor.\106\ This would include market participants that, for example,
employ passive market making strategies involving the submission of
non-marketable resting orders (bids and offers) that provide liquidity
to the marketplace at specified prices.\107\ Accordingly, the term
``regularly'' will capture those market participants that engage in the
activity described in the expressing trading interest factor on a
frequent enough basis (both within a trading day and over time) that
they do so as part of a regular business.
---------------------------------------------------------------------------
\105\ See Concept Release on Equity Market Structure, Exchange
Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010)
(``2010 Equity Market Structure Concept Release'') at 3607-08.
\106\ See Amended Rule 15b9-1 Adopting Release at n.8.
\107\ 2010 Equity Market Structure Concept Release at 3607-08.
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Trading Interest
The proposed second qualitative factor in the proposed rules would
have applied to ``trading interests.'' The Proposing Release stated
that the use of the broader term ``trading interests'' in the proposed
second qualitative factor, rather than the term ``quotations,'' would
reflect the prevalence of non-firm trading interest offered by
marketplaces today, and account for the varied ways in which developing
technologies permit market participants to hold themselves out as
willing to buy or sell securities, or otherwise communicate their
willingness to trade, and to effectively make markets.\108\ As
explained in the Proposing Release, the broader term was intended to
capture 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.\109\ In other words,
[[Page 14949]]
the proposed use of the term ``trading interests'' was intended to
update the Commission's longstanding understanding that regular or
continuous ``quotation'' is a hallmark of market making or de facto
market making (and, hence, dealer) activity, to reflect the various and
evolving ways in which buyers and sellers of securities are brought
together.\110\ Using the term ``trading interests,'' rather than
``quotations,'' the Commission stated, would also allow for clear and
consistent application of the definition of ``dealer'' and ``government
securities dealer.'' \111\
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\108\ Proposing Release at 23068.
\109\ Id.
\110\ Id. 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).
\111\ Proposing Release at 23068.
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A number of commenters objected to the use of the term ``trading
interests'' on various grounds including, among others, the difficulty
in applying the term and the breadth of the term purportedly causing
non-dealing trading activity to be captured.\112\ One commenter
explained that it would be challenging for firms to assess whether non-
firm trading interest actually is at or near the best available price
because non-firm trading interest often is not executed given that
firms are not required to execute non-firm trading interest, even if
matched.\113\ The commenter also stated that nearly any active investor
or trader might express trading interests on both sides of the market
to get best execution, and suggested limiting the factor instead to
``firm two-sided quotations'' expressed on a ``continuous or near
continuous basis.'' \114\ Another commenter similarly requested that
the term ``trading interest'' be replaced with a quotation and order-
based standard.\115\
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\112\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter;
AIMA Comment Letter II. A number of other commenters objected to the
Proposing Release's use of the term ``trading interests'' on the
grounds that the term is the subject of another proposed rule. See,
e.g., ABA Comment Letter; SIFMA AMG Comment Letter; SIFMA Comment
Letter I; MFA Comment Letter I. As discussed below, it is
appropriate for the final rules to use the term ``trading
interest.'' The Commission is adopting the term ``trading interest''
as explained herein for purposes of the final rules.
\113\ MFA Comment Letter I.
\114\ MFA Comment Letter II; see also MFA Comment Letter I.
\115\ SIFMA AMG Comment Letter.
---------------------------------------------------------------------------
Two commenters stated that applying the proposed second qualitative
factor to investment advisers would inappropriately subject them to
potential dealer status simply for exercising their fiduciary
duties.\116\ For example, one commenter stated that an investment
adviser may have to submit trading interests throughout a trading day
in order to obtain best execution and meet other fiduciary obligations
acting for their clients, or to use specific trading protocols
available in the market, such as the order book.\117\
---------------------------------------------------------------------------
\116\ Id.; MFA Comment Letter I.
\117\ SIFMA AMG Comment Letter.
---------------------------------------------------------------------------
Similarly, other commenters stated that the proposed second
qualitative factor could require firms, including unregistered funds
excluded from the Investment Company Act and registered investment
advisers, to register as dealers for engaging in activity that has not
historically been considered to be dealer activity.\118\ One commenter,
for example, questioned whether portfolio managers, by taking long/
short positions or seeking arbitrage opportunities, would be required
to register as dealers under the proposed second qualitative
factor.\119\ Another commenter stated that some asset managers have
funds with active fixed-income trading strategies involving indications
of interest to trade bonds, as well as swaps, on similar or even
identical underlying issuers in order to take advantage of mispricing
or to create a unique non-directional risk profile in a trade.\120\
According to this commenter, although this activity entails
communicating and indicating interest on such trades to a number of
counterparties, it has never been considered dealing.\121\ Yet another
commenter stated that firms that, as a primary element of their trading
strategy, simultaneously and continuously post bids and offers in a
specific instrument at or near the national best bid and offer, have
not historically been treated as having engaged in dealer activity
where the firm posting quotes did not hold itself out to
customers.\122\ One commenter asked for clarity on how the proposed
second qualitative factor would apply in the digital assets space, and
in particular whether participants in a digital asset liquidity pool,
by leaving their assets in the pool and thereby exposing those assets
to sale at the pool's prevailing exchange rate, are expressing a
``trading interest.'' \123\
---------------------------------------------------------------------------
\118\ Id.; AIMA Comment Letter II.
\119\ McIntyre Comment Letter II.
\120\ See AIMA Comment Letter II (explaining, for example, that
some asset managers may have funds with active fixed-income
strategies that may be captured by the proposed second qualitative
factor).
\121\ AIMA Comment Letter II.
\122\ Fried Frank Comment Letter. As discussed below, whether a
person meets the definition of ``dealer'' is not contingent upon
whether that person has customers.
\123\ DeFi Fund Comment Letter.
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After consideration of the comments, the Commission has determined
to adopt the proposed second qualitative factor with minor, non-
substantive modifications to the term ``trading interest.'' The term
``trading interest'' means: (i) an ``order'' as the term is defined
under 17 CFR 240.3b-16(c) (``Rule 3b-16(c)''); \124\ or (ii) any non-
firm indication of a willingness to buy or sell a security that
identifies the security and at least one of the following: quantity,
direction (buy or sell), or price. A standard of ``firm two-sided
quotations'' expressed on a ``continuous or near continuous basis,''
while captured by the existing understanding of ``dealer'' under
Exchange Act section 3(a)(5), does not account for the full range of
liquidity-providing dealer activity undertaken in today's security
markets.\125\ The term ``trading interest'' accounts for the varied
mechanisms that permit market participants to effectively make markets.
These include, but are not limited to, the use of streaming quotes,
request for quotes (``RFQs''), or order books. To be captured by the
expressing trading interest factor depends less on the method used to
communicate trading interest, and more on whether the person is
expressing trading interest on both sides of the market for the same
security that has the effect of providing liquidity in the same
security to other market participants.
---------------------------------------------------------------------------
\124\ Rule 3b-16(c) states that ``the term order means 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.'' The Proposing Release
previously referenced the definition of ``order'' under 17 CFR
242.300. Proposing Release at 23068. This release refers to Rule 3b-
16(c), which defines the term ``order'' identically and is further
discussed in the release adopting 17 CFR 242.300 through 242.304
(``Regulation ATS''). See Regulation of Exchanges and Alternative
Trading Systems, Exchange Act Release No. 40760 (Dec. 8, 1998), 63
FR 70844 (Dec. 22, 1998).
\125\ See Proposing Release at 23068.
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At the same time, expressing trading interest is not, standing
alone, enough to demonstrate engaging in a ``regular pattern of buying
and selling securities that has the effect of providing liquidity to
other market participants'' under the final rules. Specifically, under
the final rules, a person will be engaged in activity as part of a
regular business if that person ``[e]ngages in a regular pattern of
buying and selling securities that has the effect of providing
liquidity to other market participants by . . . [r]egularly expressing
trading interest that is at or near the best available prices on both
sides of the market for
[[Page 14950]]
the same security and that is communicated and represented in a way
that makes it accessible to other market participants (emphasis
added).'' \126\ A market participant seeking price information by
requesting quotes on a security, without including prices, on both
sides of the market would generally not satisfy this qualitative factor
because that trading interest, absent more, would not be ``at or near
the best available price.'' With respect to the commenter's statement
that investment advisers' fiduciary duties may require them to submit
``trading interests'' throughout a trading day, the final rules have
been modified so that the definition of ``own account'' applies to
accounts in which the person holds the account in its name or the
account is held for the benefit of that person.\127\ As such, the
trading interest expressed by investment advisers for purposes of their
fiduciary duty to their clients and their clients' accounts, such as
when investment advisers place orders or request quotations on behalf
of their clients, would not be activity captured by the expressing
trading interest factor, unless the investment adviser itself is the
account holder or the account is held for the benefit of the investment
adviser.\128\ Moreover, as discussed above, persons engaging in the
activity described in the qualitative standard are acting as dealers
regardless of whether the person engaging in such dealer activity has
or holds itself out to customers.\129\ The statutory definitions of
``dealer'' and ``government securities dealer'' distinguish between a
dealer and a trader on the basis of whether a person is in the
``regular business'' of buying and selling securities for one's own
account--not whether the person is doing so to effectuate customer
orders.\130\
---------------------------------------------------------------------------
\126\ See Rules 3a5-4(a)(1)(ii) and 3a44-2(a)(1)(ii).
\127\ See SIFMA AMG Comment Letter. See also section II.A.4.
\128\ Furthermore, as discussed in section II.A.3, the
Commission declines to include an exclusion from the final rules for
registered investment advisers and private funds and continues to
believe that when engaged in dealer activity, including by
expressing trading interest as set forth in the factor, registered
investment advisers and private funds should 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.
\129\ See supra notes 55-59 and accompanying text.
\130\ See id.; 15 U.S.C. 78c(a)(5); 15 U.S.C. 78c(a)(44)(A). In
fact, the definition of ``broker'' presumes that a person is
effectuating securities transactions on behalf of customers. See 15
U.S.C. 78c(a)(4) (stating that a broker means ``any person engaged
in the business of effecting transactions in securities for the
account of others'') (emphasis added).
---------------------------------------------------------------------------
One commenter questioned how to apply the term ``trading interest''
to certain types of products, structures, or activities in the so-
called decentralized finance (``DeFi'') market to provide crypto asset
securities liquidity.\131\ Whether a particular activity in the crypto
asset securities market, including in the so-called DeFi market, gives
rise to dealer activity requires an analysis of the totality of the
particular circumstances against all elements of the expressing trading
interest factor.\132\ Commenters argued that crypto assets should not
be covered by the final rules.\133\ However, the Commission is not
excluding any particular type of securities, including crypto asset
securities, from the application of the final rules. The dealer
framework is a functional analysis based on the securities trading
activities undertaken by a person, not the type of security being
traded. Persons, including persons using so-called ``automated market
makers,'' that are engaged in buying and selling securities for their
own account must consider whether they are dealers under the final
rules, and thus subject to dealer registration requirements.\134\ As
discussed below, the final rules build off existing legal standards
and, as discussed throughout this release, are designed to address
where market participants are engaging in de facto market making and
required to register as dealers or government securities dealers,
regardless of which such technology is used.\135\ As explained
throughout this release, the application of the dealer regulatory
regime to such persons will promote the Commission's longstanding
mission.
---------------------------------------------------------------------------
\131\ DeFi Fund Comment Letter.
\132\ A threshold question in determining the applicability of
the final rules is whether a person engaging with products,
structures, or activities in the so-called DeFi market has or
controls total assets of less than $50 million. See 17 CFR 240.3a5-
4(a)(2)(i) (``Rule 3a5-4(a)(2)(i)''); 17 CFR 240.3a44-2(a)(2)(i)
(``Rule 3a44-2(a)(2)(i)''); section II.A.3. If so, that person would
not be captured by the final rules. See also 17 CFR 240.3a5-4(d); 17
CFR 240.3a44-2(d) (providing that a person not meeting the
conditions set forth in the final rules may nonetheless be a dealer
if it otherwise engages in a regular business of buying and selling
securities for its own account); infra note 284 and accompanying
text (citing examples where persons engaging in crypto asset
securities transactions are operating as dealers as defined under
section 3(a)(5)). If this exclusion cannot be relied upon, then the
expressing trading interest factor could apply. Furthermore, as
discussed in section II.A.3.a, the exclusion for persons having or
controlling less than $50 million in total assets applies to the
final rules and does not modify existing applicable court precedent
and Commission interpretations.
\133\ See, e.g., ADAM Comment Letter (stating ``the blanket
application of the dealer and government securities dealer
regulatory framework to digital assets would be premature and
imprudent.''); see also Consensys Comment Letter; DeFi Fund Comment
Letter; Chamber of Digital Commerce Comment Letter; Blockchain
Association Comment Letter.
\134\ The application of the final rules turns on whether a
particular crypto asset is a security, as defined under the U.S.
Federal securities laws. The term ``security'' includes an
``investment contract,'' as well as other instruments. To the extent
there is a question as to whether a particular crypto asset is an
investment contract that is a security, the analysis is governed by
the test first articulated by the Supreme Court in SEC v. W.J. Howey
Co., 328 U.S. 293, 301 (1946). See, e.g., SEC v. Terraform Labs PTE,
Ltd., No. 23-cv-1346, 2023 WL 8944860 (S.D.N.Y. Dec. 28, 2023
(stating that Howey was and remains a binding statement of law and
that there was no genuine dispute that the elements of the Howey
test had been met)); SEC v. Kik Interactive Inc., 492 F. Supp. 3d
169, 177-180 (S.D.N.Y. 2020) (applying Howey in granting the
Commission's motion for summary judgment finding Kik's sale of Kin
tokens to the public was a sale of a security and required a
registration statement); SEC v. LBRY, No. 21-CV-260-PB, 2022 WL
16744741 (D.N.H. Nov. 7, 2022) (applying Howey in granting the
Commission's motion for summary judgment finding ``no reasonable
trier of fact could reject the SEC's contention that LBRY offered
LBC [a crypto asset] as a security.''); Report of Investigation
Pursuant to Section 21(a) of the Securities Exchange Act of 1934:
The DAO, Exchange Act Release No. 81207 (July 25, 2017) (``DAO 21(a)
Report'') (describing how DAO tokens were securities under Howey).
\135\ See sections II.A.3, III.D.6; see also Policy
Recommendations for Crypto and Digital Asset Markets Final Report,
Board of the International Organization of Securities Commissions
(Nov. 2023) (stating that ``the regulatory frameworks (existing or
new) should seek to achieve regulatory outcomes for investor
protection and market integrity that are the same as, or consistent
with, those required in traditional financial markets in order to
facilitate a level-playing field between crypto-assets and
traditional financial markets and help reduce the risk of regulatory
arbitrage''), <a href="https://www.iosco.org/library/pubdocs/pdf/IOSCOPD747.pdf">https://www.iosco.org/library/pubdocs/pdf/IOSCOPD747.pdf</a>; Final Report with Policy Recommendations for
Decentralized Finance (DeFi), Board of the International
Organization of Securities Commissions (Dec. 2023), <a href="https://www.iosco.org/library/pubdocs/pdf/IOSCOPD754.pdf">https://www.iosco.org/library/pubdocs/pdf/IOSCOPD754.pdf</a>.
---------------------------------------------------------------------------
Both Sides of the Market
Under the proposed rules, in order to come within the proposed
second qualitative factor, the expression of trading interests would
need to be ``at or near the best available prices on both sides of the
market.'' \136\ As discussed in the Proposing Release, the phrase ``at
or near the best available prices on both sides of the market''
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.'' \137\ The Proposing Release
further explained that, by competing to both buy and sell at the best
available prices, liquidity providers help to narrow bid-ask
spreads.\138\ The Commission also stated that the proposed second
qualitative factor helped to emphasize that a liquidity
[[Page 14951]]
provider, to come within the rules, must both buy and sell
securities.\139\
---------------------------------------------------------------------------
\136\ Proposing Release at 23068.
\137\ Id. (emphasis added).
\138\ Id.
\139\ Id.
---------------------------------------------------------------------------
Several commenters requested clarification as to how to apply the
phrase ``on both sides of the market,'' particularly, with regard to
what period of time to use when evaluating orders placed on both sides
of the market, and as to whether the phrase applies to the market for a
single security or related instruments.\140\ Some commenters asserted
that the absence of a time limitation could prevent market participants
from using all available trading strategies in a market, including
active trading strategies where a person would post resting offers and
bids on a central limit order book (``CLOB''), without registering as a
dealer.\141\ Two of these commenters urged the Commission to modify the
proposed second qualitative factor to clarify that the trading interest
must be expressed on both sides of the market simultaneously.\142\
According to one commenter, if the proposed second qualitative factor
does not require that the trading interest be expressed on both sides
of the market simultaneously, it ``would result in this test capturing
trading that is not consistent with dealer activity.'' \143\ Commenters
also urged the Commission to clarify that the phrase ``both sides of
the market'' applied to the same security.\144\ One commenter suggested
that the Commission modify the proposed second qualitative factor to
add the phrase ``for the same security.'' \145\
---------------------------------------------------------------------------
\140\ See, e.g., SIFMA AMG Comment Letter; AIMA Comment Letter
II; MFA Comment Letter I; Citadel Comment Letter.
\141\ Id. For instance, according to one commenter, there are
examples of where market participants using a CLOB routinely express
trading interests on both sides of the market in various instruments
over the course of a trading day, and CLOBs can benefit both market
liquidity and competition. See Citadel Comment Letter.
\142\ See MFA Comment Letter I; Citadel Comment Letter.
\143\ MFA Comment Letter I.
\144\ See, e.g., Citadel Comment Letter; Lewis Study; MFA
Comment Letter I; MFA Comment Letter II.
\145\ MFA Comment Letter II.
---------------------------------------------------------------------------
Consistent with the Proposing Release which explained that the
proposed second qualitative factor applies to persons expressing
trading interests on both sides of the market in a given security, the
Commission is modifying the rule text to add the phrase ``for the same
security'' to the second qualitative factor.\146\
---------------------------------------------------------------------------
\146\ Proposing Release at 23068 (stating ``[t]he 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'') (emphasis
added). The phrase ``same security'' is to be interpreted as that
phrase is used in the Proposing Release. See Proposing Release at
23067 (stating `` `the same' securities means that the securities
bought and sold are securities of the same class and having the same
terms, conditions, and rights [, and] securities bearing the same
Committee on Uniform Securities Identification Procedures (`CUSIP')
number, for example, would be considered `the same.' '').
---------------------------------------------------------------------------
The Commission is not adopting a requirement that the trading
interest be expressed simultaneously on both sides of the market.
Limiting the expressing trading interest factor to the simultaneous
expression of trading interests could exclude other regular expressions
of trading interest that constitute dealer activity by providing
liquidity to other market participants. While simultaneously expressing
trading interest on both sides of the market in the same security is
indicative of dealer activity, market participants also can be acting
as dealers by regularly providing liquidity even where the expressions
of trading interest on both sides of the market for the same security
are not simultaneous, particularly because the markets for different
securities have varying structures, trading volume, and liquidity.\147\
Further, adding a simultaneity condition could lead to behavior where a
dealer might, for example, express trading interest to buy and sell in
alternate moments in time to evade the requirement to register.
Accordingly, the Commission is not conditioning the application of the
expressing trading interest factor on trading interests being expressed
simultaneously. Due to the differences between markets, participants
will need to assess the totality of their trading activity to determine
if they are expressing trading interests on both sides of the market
for the same security sufficiently close in time to have the effect of
providing liquidity in the same security to other market participants.
---------------------------------------------------------------------------
\147\ See 2010 Equity Market Structure Concept Release at 3608
(stating that ``proprietary traders are analogous to OTC [over-the-
counter] market makers in that they have considerable flexibility in
trading without significant negative or affirmative obligations for
overall market quality'').
---------------------------------------------------------------------------
The Commission recognizes that non-firm trading interest (and firm
quotations for that matter) need not be executed, even if matched.
Nonetheless, it will be possible to assess whether a non-firm trading
interest is actually ``at or near the best available price,'' using the
similar information that market participants use to make bids and
offers, including recently completed purchases and sales and the
totality of indications of willingness to buy or sell at specified
prices.\148\ For example, market participants can use similar
information to that used by registered broker-dealers to assess whether
a customer order was executed at the best available price.\149\
---------------------------------------------------------------------------
\148\ See, e.g., Disclosure of Order Execution and Routing
Practices, Exchange Act Release No. 43590 (Nov. 17, 2000), 65 FR
75414, 75418 (Dec. 1, 2000) (stating that quotation information
contained in the public quotation system must be considered in
seeking best execution of customer orders).
\149\ Id.
---------------------------------------------------------------------------
Finally, as discussed above in connection with the term ``trading
interest,'' to come within this factor, a person expressing trading
interest (including through a CLOB) must be buying and selling
securities, and it must engage in such activity ``regularly.''
Accessible to Other Market Participants
Under the proposed rules, market participants would have had to
routinely express trading interests accessible to other market
participants to be considered to have engaged in a routine pattern of
trading that has the effect of providing liquidity to other market
participants.\150\ In the Proposing Release, the Commission explained
that the proposed second qualitative factor would apply only when the
expressed 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.''
\151\
---------------------------------------------------------------------------
\150\ Proposing Release at 23068.
\151\ Id.
---------------------------------------------------------------------------
One commenter objected to the proposed second qualitative factor's
phrase ``communicated and represented in a way that makes them
accessible to other market participants,'' stating that the Proposing
Release does not make clear whether trading interests made available to
a limited group of participants via a RFQ would trigger the factor,
versus trading interests published on a broadly accessible order book.
The commenter stated further that the vagueness of the standard would
prevent market participants from applying it with confidence and might
encourage market participants to choose execution venues and order
types that are not transparent or accessible.\152\ This commenter
recommended adopting a test defining a person acting as a bona fide
market maker under 17 CFR 242.200 through 242.204 (``Regulation SHO'')
as a dealer, in lieu of the first and second proposed qualitative
factors.\153\
---------------------------------------------------------------------------
\152\ MFA Comment Letter I.
\153\ Id.
---------------------------------------------------------------------------
The phrase ``accessible to other market participants'' reflects the
plain
[[Page 14952]]
meaning that a person expresses trading interests to more than one
market participant. For example, where a person makes a trading
interest available (such as streaming two-way indicative quotes) to
more than one market participant, even if the person made that trading
interest available through individual communications, that person would
be expressing trading interest accessible to other market
participants.\154\ Again, the expressing trading interest factor does
not hinge on any particular method of communication and representation
(e.g., RFQ, indications of interest, or streaming quotes); it depends
on the totality of the trading activity to determine if the person is
expressing trading interests on both sides of the market for the same
security to have the effect of providing liquidity in the same security
to other market participants.
---------------------------------------------------------------------------
\154\ On the other hand, when an investor seeking liquidity
sends a single, one-sided RFQ to a number of potential liquidity
providers, this action by itself does not generally trigger the
expressing trading interest factor because it is on one side of the
market in an isolated instance.
---------------------------------------------------------------------------
The Commission is not adopting the suggestion to replace this
factor with a test defining a dealer as a person engaging in bona fide
market making activities under Regulation SHO. The bona fide market
making exception under Regulation SHO applies to a specific subset of
dealer activity. As the Commission previously stated when proposing
Regulation SHO, ``a narrow exception for market makers and specialists
engaged in bona fide market making activities is necessary because they
may need to facilitate customer orders in a fast moving market without
possible delays associated with complying with the proposed `locate'
rule.'' \155\ For example, a broker-dealer must claim the bona fide
market making exception from the locate requirement of Regulation SHO
at the time of the short sale in a particular security.\156\
Accordingly, limiting the applicability of the final rules to those
persons eligible for Regulation SHO's bona-fide market-making exception
would exclude persons engaged in other liquidity-providing dealer
activity.
---------------------------------------------------------------------------
\155\ Short Sales, Exchange Act Release No. 48709 (Oct. 28,
2003), 68 FR 62972, 62977 (Nov. 6, 2003); see also Short Position
and Short Activity Reporting by Institutional Investment Managers,
Exchange Act Release No. 98738 (Oct. 13, 2023), 88 FR 75100, 75136
(Nov. 1, 2023) (stating ``a market maker must also be a market maker
in the security being sold, and must be engaged in bona-fide market
making in that security at the time of the short sale.'').
\156\ The determination of eligibility for the bona-fide market-
making exceptions in Regulation SHO is distinct from the
determination of whether the effect of a person's trading activity
indicates that such person is acting as a dealer. Proposing Release
at n.131.
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One commenter stated that the proposed second qualitative factor
would impact the Commission's Order Competition Rule proposal.\157\ On
December 14, 2022, the Commission proposed a rule that would require
certain orders of individual investors to be exposed to competition in
fair and open auctions before such orders could be executed internally
by any trading center that restricts order-by-order competition.\158\
As discussed below, the Commission has considered the current
regulatory landscape in presenting the baseline. To the extent the
proposed Order Competition Rule is adopted, the baseline in that
rulemaking will reflect the regulatory landscape that is current at
that time.\159\
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\157\ Comment Letter of Two Sigma (Mar. 31, 2023) (``Two Sigma
Comment Letter II'').
\158\ Order Competition Rule, Exchange Act Release No. 96495
(Dec. 14, 2022), 88 FR 128 (Jan. 3, 2023).
\159\ See section III.B.
---------------------------------------------------------------------------
In sum, the Commission has determined to replace the term
``routinely'' with ``regularly,'' add the phrase ``for the same
security,'' and make non-substantive modifications to this factor, but
otherwise is adopting this factor as proposed.
c. Primary Revenue Factor
Finally, the Commission proposed a third qualitative factor
encompassing activity that ``has the effect of providing liquidity to
other market participants.'' Specifically, under proposed 17 CFR
240.3a5-4(a)(1)(iii) and 240.3a44-2(a)(1)(iii), a person that, trading
for its own account, ``earn[ed] 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 have been engaging in a routine
pattern of trading that has the effect of providing liquidity to other
market participants, and as a result, would have been a dealer under
the proposed rules.
The Commission explained in the Proposing Release that 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 bid-ask
spreads or liquidity incentives rather than with a view toward
appreciation in value.\160\ We stated that persons engaged in such
activity are ``in the business'' of providing liquidity because (1)
they routinely supply it and (2) the revenue they earn through bid-ask
spreads or liquidity incentives is their primary source of
revenue.\161\
---------------------------------------------------------------------------
\160\ Proposing Release at 23069.
\161\ Id.
---------------------------------------------------------------------------
The proposed third qualitative factor accounted for both forms of
revenue. As to the first--capturing bid-ask spreads--the Commission
stated that 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 would be considered to be engaged in a routine pattern
of providing liquidity as a service and would fall within the scope of
the rules.\162\ As to the second, the Commission stated that 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 would be considered to be engaged in a routine pattern
of providing liquidity as a service and generally standing ready to buy
or sell securities, and so would fall within the scope of the proposed
rules.\163\
---------------------------------------------------------------------------
\162\ Id.
\163\ Id.
---------------------------------------------------------------------------
In the Proposing Release, the Commission explained the meaning of
certain key terms in the proposed third qualitative factor. The
Commission stated that the factor used 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.\164\ Dealer activity is dealer activity
regardless of whether it is profitable. With respect to the term
``primarily,'' the Commission further stated that, generally speaking,
although the Commission has not established a bright-line test, if a
person derives the majority of its revenue from either of the sources
described in the proposed third qualitative standard, it would likely
be in a regular business of buying and selling securities or government
securities for its own account.\165\
---------------------------------------------------------------------------
\164\ Id.
\165\ Id.
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Finally, with respect to the term ``trading venues,'' the
Commission stated that market evolution has given rise to a variety of
venues in which liquidity providers can express trading interests, and
the term ``trading venues'' is designed to capture the breadth of these
different venues.\166\ In explaining
[[Page 14953]]
the term ``trading venue'' the Proposing Release referenced a
definition of ``trading venue'' that described it 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.'' \167\ The Commission
further stated that the third proposed qualitative standard was
designed to capture dealer activity wherever that activity occurs,
``whether on a national securities exchange, an ATS . . . or another
form of trading venue.'' \168\ The Commission also stated that for
purposes of the proposed rules, the particular venue mattered less than
the fact that a market participant provides liquidity on it.\169\
---------------------------------------------------------------------------
\166\ Id. at 23069-70. As discussed in the Proposing Release,
the term ``trading venue'' was designed to capture the variety and
breadth of different venues resulting from market evolution. Id. To
the extent new systems develop as a result of technological
advancements that offer market participants the ability to provide
liquidity in a security for other market participants, the term
``trading venue'' would apply to such systems. Id.
\167\ Id. Whether an entity is or is not registered with the
Commission does not affect the determination of whether that entity
is a trading venue for purposes of the final rules. For example, a
person operating a platform for executing trading interest
internally would likely be operating as a broker or dealer,
regardless of whether that person is registered as such, and the
receipt of incentives from that person could be captured by the
factor. See 15 U.S.C. 78o(a)(1) (absent an exemption, persons
meeting the definition of broker or dealer must register with the
Commission).
\168\ Proposing Release at 23070 (emphasis added).
\169\ Id.
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Of the three proposed qualitative factors, this factor received the
fewest comments. Two commenters supported the third qualitative factor
as proposed.\170\ According to one of the commenters, capturing bid-ask
spreads or earning revenue from liquidity incentives have traditionally
been indicative of dealing activity and the proposed third qualitative
standard would be less likely to capture certain funds, advisers, and
trading strategies that the commenter believed would be inappropriately
captured by the first and second qualitative factors.\171\
---------------------------------------------------------------------------
\170\ SIFMA Comment Letter I (stating that ``[s]ubject to our
additional comments on the application of the proposed rules to bank
holding companies, we believe that the qualitative standard in
proposed . . . Rule 3a44-2(iii) [is] generally a good step forward
to address this long-standing asymmetric regulatory treatment for
similar [dealing] activities.''); see also AIMA Comment Letter II
(requesting the Commission to limit the qualitative standard to the
third factor alone).
\171\ AIMA Comment Letter II.
---------------------------------------------------------------------------
Another commenter stated the proposed third qualitative factor was
``workable,'' assuming two modifications.\172\ First, the commenter
stated that the proposed third qualitative factor should turn on
``profit,'' rather than ``revenue.'' \173\ In the commenter's view,
because dealers are in the business of profiting from their market-
making activities, they are unlikely to be (or stay) engaged in markets
if they are not profiting from their dealer activities.\174\ As a
result, the commenter believed that a person otherwise meeting the
factor but failing to earn profits in doing so is better viewed as a
trader than a dealer.\175\ Second, the commenter stated that the
proposed third qualitative factor should be limited to ``national
securities exchanges and ATSs,'' rather than ``trading venues.'' \176\
In the commenter's view, to reduce the compliance burdens on market
participants while capturing the most significant trading activity, the
rule should be limited to the most liquid trading venues, including
those where liquidity incentives are most likely to be offered and
where trading to profit from the spread occurs most often.\177\ The
commenter stated that this change would avoid difficult and unworkable
line-drawing questions, such as when pricing offered by an OTC market
maker to its customer would constitute an ``incentive'' captured by the
rule.\178\
---------------------------------------------------------------------------
\172\ See MFA Comment Letter I; see also MFA Comment Letter II.
Another commenter stated it shared many of the comments raised by
MFA with respect to the proposed third qualitative test. See
BlackRock Comment Letter. See also ICI Comment Letter (stating
``[t]o avoid unintentionally capturing ordinary investment and
trading strategies, the Commission should limit the qualitative test
to capture persons trading only in the same securities--where this
purpose is clear--rather than trading in merely similar
securities.'').
\173\ See MFA Comment Letter I.
\174\ See id.
\175\ See id.
\176\ Id. See also ABA Comment Letter (``the proposed tests for
the definition of ``dealer'' requires interpreting terms that are
not yet settled because they are concurrently being commented on in
a proposed form.''); DeFi Fund Comment Letter (stating ``whether a
DeFi protocol constitutes a `trading venue' is likely to turn on the
outcome of the Commission's pending proposal to expand its
`exchange' definition, which we strongly oppose.''). As discussed
below, the Commission believes it is appropriate for the final rules
to use the term ``trading venues.'' The Commission has proposed an
amendment to Form ATS-N to change the term ``Trading Centers'' to
``trading venue'' and has proposed the term 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. 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, Exchange
Act Release No. 94062 (Jan. 26, 2022), 87 FR 15496, 15539-40 (Mar.
18, 2022). Although the term ``trading venue'' is used in the final
rules and the proposed amendment to Form ATS-N, the adoption of the
term as discussed above is appropriate for the final rules.
\177\ MFA Comment Letter I.
\178\ Id.
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Some commenters objected to the proposed third qualitative
factor,\179\ expressing concerns about the lack of clarity as to, and
breadth of, its application.\180\ One of these commenters stated that
the term ``primarily'' is potentially vague because a person might earn
more revenue from appreciation in the value of its inventory of
securities than from capturing bid-ask spreads or trading
incentives.\181\ Another commenter explained that certain portfolio
management and trading strategies, like hedging and arbitrage
strategies, among other things, seek to derive value, positive fund
performance, and portfolio-trading revenues by taking advantage of
pricing differentials in bid-ask spreads.\182\ The commenter stated
that such strategies have not traditionally been viewed as dealer
activity and questioned whether they would be captured by the proposed
third qualitative factor.\183\ Another commenter stated that trading
incentives are often organized in a manner that allows traders or their
investment advisers to reduce overall commissions and fees paid by
directing liquidity-providing trades to specific venues.\184\ In the
commenter's view, the ``optimization of commission costs by an
investment adviser on behalf of investors, or by a trader acting on his
or her own behalf, should not by itself require registration as a
dealer for a person who is otherwise a trader.'' \185\ Finally, some
commenters objected that the proposed third qualitative factor's
application in the crypto asset securities market may not be clear,
including how the factor applies to so-called DeFi market products,
structures, and activities such as so-called decentralized exchange
(``DEX'') and ``automated market maker'' activities, as well as
activities related to blockchain consensus and validation.\186\
---------------------------------------------------------------------------
\179\ See, e.g., FIA PTG Comment Letter II.
\180\ See, e.g., Gretz Comment Letter; McIntyre Comment Letter
II; Element Comment Letter; SIFMA AMG Comment Letter; ICI Comment
Letter; MFA Comment Letter I.
\181\ Gretz Comment Letter.
\182\ McIntyre Comment Letter II.
\183\ Id.
\184\ Element Comment Letter.
\185\ Id.
\186\ See, e.g., ADAM Comment Letter (stating that ``the third
qualitative factor does not account for `staking' and the way in
which some blockchains use the proof-of-stake consensus mechanism to
validate transactions, leaving unclear whether certain `validators'
might be captured by the third qualitative factor.''); DeFi Fund
Comment Letter (questioning if the ``liquidity provider tokens''
participants in digital asset liquidity pools receive in proportion
to the amount of liquidity they contribute to the pool constitute an
``incentive . . . for liquidity-supplying trading interests'').
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[[Page 14954]]
After consideration of the comments, the Commission has determined
to adopt, as the primary revenue factor, the third qualitative factor
as proposed, with a non-substantive change. The final rules continue to
use the phrase ``earn revenue'' rather than ``earn profit.'' While the
Commission acknowledges the possibility that persons whose liquidity
provision fails to turn a profit may ultimately seek out more
profitable lines of business, dealer status requires only that a person
be ``in the business,'' not that that business be profitable.\187\
---------------------------------------------------------------------------
\187\ See Proposing Release at 23069.
---------------------------------------------------------------------------
The term ``trading venues'' is intended to accommodate the variety
of venues in which market participants today engage in liquidity-
providing dealer activity. In addition, the use of this term is
intended to capture venues as they evolve, wherever that activity
occurs, whether on a national securities exchange, an ATS, any other
broker- or dealer-operated platform for executing trading interest
internally by trading as principal or crossing orders as agent, or any
other platform performing a similar function.\188\ The particular venue
matters less than the fact that a market participant provides liquidity
on it.\189\ As discussed in the Proposing Release, there have been
notable technological enhancements affecting securities trading across
markets and asset classes.\190\ Accordingly, the term ``trading
venues'' is designed to capture current trading venues that use a
variety of technologies, as well as trading venues that use
technologies and venues that may develop over time. The term ``trading
venues'' is designed to help ensure that, as innovation and technology
used by such venues evolve, the final rules remain effective at
supporting market stability and resiliency, protecting investors, and
promoting competition across the U.S. Treasury and other securities
markets. For these reasons, the Commission declines to limit the scope
of this factor to trading venues that are national securities exchanges
or ATSs.
---------------------------------------------------------------------------
\188\ Whether a particular structure or activity in the crypto
asset securities market, including the so-called DeFi market,
involves a trading venue is a facts and circumstances determination.
\189\ See Proposing Release at 23069.
\190\ See Proposing Release at 23055.
---------------------------------------------------------------------------
Regarding the term ``primarily'' as used in the primary revenue
factor, the Proposing Release stated 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.\191\
Further, in response to one commenter's example,\192\ while the
analysis of this specific scenario would depend on the totality of
circumstances, as a general matter, it is unlikely that a person who
regularly earns more revenue from an appreciation in the value of its
inventory of securities than from capturing bid-ask spreads or
incentive payment for liquidity provision, would be considered to earn
revenue ``primarily'' from capturing bid-ask spreads or trading
incentives.
---------------------------------------------------------------------------
\191\ Proposing Release at 23069.
\192\ See Gretz Comment Letter (stating `` `Primarily' might be
a bit vague. Technically, an entity could earn more revenues by
price increases on the securities being held in stock for trading
than by catching bid-ask spreads.'').
---------------------------------------------------------------------------
A commenter stated that the Proposing Release did not account for
how the primary revenue factor would apply to market participants
transacting in the crypto asset securities market; as commenters have
pointed out, the crypto asset securities market has structures,
products and activities that may implicate dealer registration.\193\
Whether a particular activity in the crypto asset securities market,
including in the so-called DeFi market, gives rise to dealer activity
will require an analysis of the totality of the particular facts and
circumstances. As discussed above, any person engaged in buying and
selling securities for its own account must consider whether it is a
dealer, including under the final rules, and so subject to dealer
registration requirements.\194\ Accordingly, the primary revenue factor
will capture market participants that are primarily earning revenue
from capturing spreads or liquidity incentives offered by trading
venues, including trading venues that support transacting in crypto
asset securities.\195\
---------------------------------------------------------------------------
\193\ See DeFi Fund Comment Letter; ADAM Comment Letter. A
commenter explained that ``a blockchain utilizing proof-of-stake
validation lets users participate in verifying the blockchain by
staking the native token, providing a reward if they propose and
approve valid smart contracts.'' ADAM Comment Letter.
\194\ See section II.A.1.b.
\195\ As discussed above, a threshold question is whether the
person has or controls total assets of less than $50 million, and if
so, the person would not be captured by the final rules. See supra
note 132 and accompanying text.
---------------------------------------------------------------------------
With respect to portfolio management and trading strategies that
for varying reasons may seek to take advantage of pricing differentials
in bid-ask spreads, as stated above, persons who engage in a pattern of
trading for their own account having the effect of providing liquidity
to other market participants should be subject to the dealer regulatory
regime, even if they are also registered investment advisers or private
funds. As discussed below, the important protections provided by the
dealer regulatory framework differ from those under the private fund
and private fund advisers regulatory scheme established by the Advisers
Act.\196\ The primary revenue factor, as with the expressing trading
interest standard, focuses on activity rather than label or status.
Market participants will need to determine, based on their trading
activities, whether their portfolio management and trading strategies
meet this standard.
---------------------------------------------------------------------------
\196\ See section II.A.3.
---------------------------------------------------------------------------
To summarize, one fundamental and historically recognized view of
dealer activity is trading in a manner designed to profit from spreads
or liquidity incentives.\197\ Under the final rules, persons providing
liquidity because they regularly supply it and the revenue they earn as
a result through bid-ask spreads or liquidity incentives as their
primary source of revenue are ``in the business'' of dealing, and such
persons regularly undertaking this liquidity-providing role for their
own account in overall trading and market activity must register as
dealers and be subject to the dealer regulatory regime.
---------------------------------------------------------------------------
\197\ Proposing Release at 23069. 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. See Entities Release at 30609.
---------------------------------------------------------------------------
2. Quantitative Standard
The Commission proposed 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 government securities ``as a part of a
regular business,'' regardless of whether they meet any of the
qualitative factors.\198\ Specifically, proposed 17 CFR 240.3a44-
2(a)(2) (proposed ``Rule 3a44-2(a)(2)'') provided that a person engaged
in buying and selling government securities for its own account would
be 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
[[Page 14955]]
securities as defined in section 3(a)(42)(A) of the Exchange Act.\199\
---------------------------------------------------------------------------
\198\ See Proposing Release at 23071, n.165.
\199\ Proposed Rule 3a44-2(a)(2); Proposing Release at 23071.
---------------------------------------------------------------------------
Some commenters generally supported inclusion of the quantitative
standard.\200\ One commenter stated that ``quantitative standard[ ]
build[s] upon and [is] consistent with past Commission regulations and
case law for defining a dealer.'' \201\ The majority of commenters,
however, urged that the Commission remove the quantitative standard,
raising various issues and concerns with establishing a test based
solely on trading volume.\202\
---------------------------------------------------------------------------
\200\ See Better Markets Comment Letter (stating that the
``quantitative standards for government securities markets, coupled
with the proposed qualitative standards, will help to capture the
high-frequency trading firms trading in significant volumes of U.S.
Treasury bonds that are not currently registered with the
Commission.''); see also FINRA Comment Letter.
\201\ Better Markets Comment Letter.
\202\ See, e.g., Element Comment Letter; MMI Comment Letter; Two
Sigma Comment Letter I; FIA PTG Comment Letter I; NAPFM Comment
Letter; AIMA Comment Letter II; ADAM Comment Letter; SIFMA AMG
Comment Letter; McIntyre Comment Letter II; SIFMA Comment Letter I;
Overdahl Comment Letter; Fried Frank Comment Letter; MFA Comment
Letter I; ICI Comment Letter; Morgan Lewis Comment Letter; T. Rowe
Price Comment Letter; Citadel Comment Letter; DeFi Fund Comment
Letter; Comment Letter of Investment Advisers Association (June 6,
2022) (``IAA Comment Letter I''); BlackRock Comment Letter; FIA PTG
Comment Letter II; Comment Letter of Darrell Duffie (Jan. 10, 2024)
(``Duffie Comment Letter'').
---------------------------------------------------------------------------
Many commenters maintained that the quantitative standard was
arbitrary and overly broad, and opined that a volume standard alone
could not distinguish between a dealer and a trader.\203\ Several
commenters stated that the quantitative standard would capture persons
engaging in non-dealing trading activity.\204\ Some commenters also
stated that the trading volume threshold was too low in light of the
size of the U.S. Treasury market and that the Proposing Release failed
to provide sufficient detail on how the proposed trading volume would
be measured and implemented.\205\
---------------------------------------------------------------------------
\203\ See, e.g., AIMA Comment Letter II; ICI Comment Letter; T.
Rowe Price Comment Letter.
\204\ See, e.g., FIA PTG Comment Letter I; SIFMA AMG Comment
Letter; Morgan Lewis Comment Letter; MMI Comment Letter; Two Sigma
Comment Letter I; NAPFM Comment Letter; AIMA Comment Letter II; MFA
Comment Letter I; McIntyre Comment Letter II; Element Comment
Letter; ICI Comment Letter; Citadel Comment Letter; T. Rowe Price
Comment Letter; Fried Frank Comment Letter; Consensys Comment
Letter; ADAM Comment Letter; SIFMA Comment Letter I; Overdahl
Comment Letter.
\205\ See, e.g., Two Sigma Comment Letter I; FIA PTG Comment
Letter I; Element Comment Letter; MFA Comment Letter II. One
commenter agreed that repurchase and reverse repurchase transactions
should be excluded from counting towards the quantitative standard
threshold. See ACLI Comment Letter.
---------------------------------------------------------------------------
After consideration of the comments, the Commission has decided to
eliminate the quantitative standard from the final rules. While a
trading volume threshold could provide 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,'' the Commission has concluded such
a bright-line test is unnecessary. The modified qualitative factors and
otherwise applicable court precedent and Commission interpretations
will appropriately address when market participants are acting as
government securities dealers in the U.S. Treasury market by engaging
in a ``regular'' pattern of buying and selling securities that has the
effect of providing liquidity to other market participants. Therefore,
the Commission has decided to delete the quantitative standard from the
final rules.
In addition, as discussed in section II.A.5, no presumption shall
arise that a person is not a government securities dealer as defined by
the Exchange Act solely because that person does not satisfy Rule 3a44-
2(a).\206\ Thus, market participants acting similarly to traditional
dealers that are buying and selling U.S. Treasuries as part of a
regular business may still meet the definition of government securities
dealer even absent the activity identified in the qualitative standard.
---------------------------------------------------------------------------
\206\ See section II.A.5.
---------------------------------------------------------------------------
3. Exclusions
The proposed rules provided exclusions for certain market
participants that the Commission determined do not provide liquidity to
the markets in a manner requiring dealer registration or are subject to
a comparable regulatory structure which addresses the types of concerns
that the proposed rules were intended to address. The Commission is
adopting these exclusions as proposed. In addition, the Commission is
adding exclusions for central banks, sovereign entities, and
international financial institutions, as defined in the final rules.
Each of these exclusions is discussed in more detail below.\207\
---------------------------------------------------------------------------
\207\ The Commission has determined to create bright-line
exclusions for certain persons from the scope of the final rules for
policy reasons specific to these types of persons as further defined
below. This is in contrast to various exclusions requested by
commenters related to, among other things, specific securities
activities that market participants may engage in (such as certain
trading strategies or asset classes). Because these specific
securities activities and specific types of securities cannot be
viewed in isolation, and could constitute in whole or in part
liquidity-providing activity that these rules are designed to
address, the Commission is not adding these categorical exclusions.
Rather, as with any other securities activities, whether these
specific securities activities result in triggering the provisions
of the final rules requires a facts and circumstances analysis of
the totality of a person's activities. The Commission, however, has
significantly refined its proposal (including, notably, the
aggregation provision) so that persons whose securities activities
may have been captured may no longer be within the scope of the
rules as adopted.
---------------------------------------------------------------------------
a. Person That Has or Controls Assets of Less Than $50 Million
In the Proposing Release, the Commission proposed to exclude from
the proposed rules ``[a] person \208\ that has or controls total assets
of less than $50 million.'' The Commission stated that providing an
exception was appropriate because, even though a person that has or
controls less than $50 million in assets may be engaged in the
activities identified in the qualitative standard, the frequency and
nature of such a person's 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 activity that the rules were
designed to address.\209\
---------------------------------------------------------------------------
\208\ As noted below, the term ``person'' has the same meaning
as prescribed in section 3(a)(9) of the Exchange Act: ``a natural
person, company, government, or political subdivision, agency, or
instrumentality of a government.''
\209\ Proposing Release at 23062.
---------------------------------------------------------------------------
Commenters that addressed this exclusion raised a number of
concerns.\210\ Some commenters stated that it was arbitrary or
inconsistent with the plain reading of the ``dealer'' definition.\211\
A few commenters stated that the threshold was too low.\212\ However,
one of those commenters also said that the threshold could be too high
for some securities.\213\
---------------------------------------------------------------------------
\210\ One commenter also raised practical issues about how the
exclusion would operate in connection with the proposed aggregation
provision; however, these concerns have been mooted with the removal
of the aggregation provision. See ICI Comment Letter.
\211\ See, e.g., MMI Comment Letter; SIFMA AMG Comment Letter;
Consensys Comment Letter.
\212\ See Defi Fund Comment Letter; Element Comment Letter;
Gretz Comment Letter; Consensys Comment Letter. See also section
III.B.2.
\213\ See Gretz Comment Letter.
---------------------------------------------------------------------------
After consideration of comments, the Commission is adopting this
exclusion as proposed. While we appreciate commenters' concerns, as
indicated in the Proposing Release, the final rules are intended to
capture market participants not registered as dealers that serve a
critical dealer role in the securities and government securities
markets through their liquidity provision or significant and regular
trading activity in the market. These smaller market participants are
unlikely to engage in the significant liquidity provision that is
[[Page 14956]]
the focus of the final rules.\214\ Importantly, we disagree that the
$50 million threshold is arbitrary or too low or too high because, as
stated in the Proposing Release, this exception parallels an
established and well understood standard for distinguishing between
``retail'' and ``institutional'' accounts for purposes of broker-dealer
regulation.\215\ In the context of the final rules, persons that have
or control assets of $50 million or more--so-called ``institutional''
accounts--are more likely to have a significant impact on the market as
opposed to ``retail'' accounts of smaller market participants who are
less likely to pose financial and operational risks to the markets.
Further, in response to the commenter who raised practical issues about
how the exclusion would operate in connection with investment advisers'
separately managed accounts, as discussed in more detail below, the
Commission has removed the aggregation provision, which should address
those concerns.\216\ Finally, we reiterate that this is not an
exclusion from the ``dealer'' definition for all purposes, but only for
purposes of the final rules, which focus on de facto market making.
Outside of the context of these rules, the question of whether any
person, including 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. For example, an
underwriter with assets below $50 million could still be required to
register as a dealer.
---------------------------------------------------------------------------
\214\ See Proposing Release at 23062.
\215\ Under FINRA rules, a ``retail'' account is distinguished
from an ``institutional'' account that is defined, in part, 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 in connection with security-based swap dealers, for
purposes of 17 CFR 240.15Fh-3(f)(4). The Commission considered but
is not using 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 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).
\216\ See supra note 254 and accompanying text.
---------------------------------------------------------------------------
b. Registered Investment Companies, Private Funds, and Registered
Investment Advisers
The Commission also proposed to exclude registered investment
companies registered under the Investment Company Act from the
application of the rules.\217\ In proposing the exclusion, the
Commission cited to the comprehensive regulatory framework under the
Investment Company Act and its extensive oversight and broad insight
into the operations and activities of registered investment
companies.\218\ In contrast, the proposed rules did not exclude private
funds, instead discussing differences between the regulatory regime
that applies to registered advisers to private funds, and the one that
applies to dealers, including leverage constraints and reporting.\219\
As explained in the Proposing Release, private funds are not subject to
the extensive regulatory framework of the Investment Company Act.\220\
Further, the Commission did not propose to create a blanket exclusion
for registered investment advisers because a registered investment
adviser trading for its ``own account'' could nevertheless meet the
definition of a ``dealer'' and therefore should be required to
register.\221\
---------------------------------------------------------------------------
\217\ See proposed 17 CFR 240.3a5-4(a)(2)(ii) and 240.3a44-
2(a)(3)(ii).
\218\ Registered investment companies are subject to a
regulatory framework under the Investment Company Act and rules
thereunder, which imposes requirements regarding capital structure,
custody of assets, investment activities, transactions with
affiliates and other conflicts of interest, and the duties and
independence of boards of directors, among other things. Moreover,
registered investment companies are subject to statutory limits on
indebtedness and rules that limit leverage risk. 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.
Proposing Release at 23063.
\219\ Proposing Release at 23083.
\220\ Id.
\221\ Proposing Release at 23073-74.
---------------------------------------------------------------------------
Many commenters agreed with the proposed exclusion for registered
investment companies.\222\ However, most of these commenters also
stated that the exclusion should be expanded to registered investment
advisers \223\ and private funds managed by registered investment
advisers.\224\ Commenters cited to the regulatory regime under the
Advisers Act.\225\ Some commenters stated that some of the reasons
supporting an exclusion for registered investment companies also would
support an exclusion for registered advisers,\226\ or an exclusion for
private funds.\227\
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\222\ See, e.g., ICI Comment Letter; MFA Comment Letter II;
Element Comment Letter; McIntyre Comment Letter II; IAA Comment
Letter I.
\223\ See, e.g., SIFMA Comment Letter I; SIFMA AMG Comment
Letter; IAA Comment Letter I; Comment Letter of Investment Adviser
Association (Oct. 17, 2023) (``IAA Comment Letter II'').
\224\ See, e.g., MFA Comment Letter I (recommending that the
exclusion for registered investment companies be expanded ``to cover
any person registered as an investment adviser (or exempt or
excluded from registration other than as a family office), as well
as any private fund client of such adviser (and any affiliated
general partner, managing member, or similar control person of the
private fund client), with respect to trading done by the person
with or through a registered broker-dealer''); Element Comment
Letter; McIntyre Comment Letter II; IAA Comment Letter I; T. Rowe
Price Comment Letter; IAA Comment Letter II.
\225\ See, e.g., MFA Comment Letter I (``Advisers and the
private funds they manage are already subject, directly or
indirectly, to comprehensive regulation, which is sufficient to
address the objectives of the Proposal without subjecting them to
dealer registration.'').
\226\ See, e.g., T. Rowe Price Comment Letter (``It appears the
SEC's rationale for excluding registered investment companies is
that they are subject to various requirements, including those
related to custody, conflicts of interest, books and records,
policies and procedures, and designation of a chief compliance
officer. RIAs should also be excluded as they are subject to similar
requirements, as well as a robust registration regime, and must act
in accordance with their fiduciary duties.''); McIntyre Comment
Letter II (``[T]he Commission notes that the `regulatory framework'
to which registered investment companies are subject justifies the
exclusion of these entities. However, [we believe] that the current
regulatory environment and framework for registered investment
advisers is also very robust. . .''). See also Scott Comment Letter.
\227\ See, e.g., Citadel Comment Letter (``The disparate
treatment of private funds and mutual funds . . . further highlights
the lack of justification for requiring private funds to register as
dealers . . . Moreover, the Commission's logic for exempting RICs
equally applies to private funds.'').
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In addition, many commenters stated that imposing dealer
requirements--and in particular net capital requirements \228\--on
private funds would be inappropriate and untenable,\229\ and could in
turn significantly and negatively affect liquidity if private funds
were to modify or cease their trading activity.\230\ As support for an
exclusion for private funds, many commenters cited to Form PF, which
requires certain registered advisers that have at least $150 million in
private fund assets under
[[Page 14957]]
management to report certain confidential information about their
private funds.\231\
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\228\ See, e.g., MFA Comment Letter I (stating that the Net
Capital Rule functions more like a restriction on the types of
investments and trading a firm can engage in than a restriction on
leverage and that the requirements would impede investors' highly
negotiated liquidity rights); Citadel Comment Letter (stating that
the Net Capital Rules would impose substantial costs and finding
``the absurdity of applying these rules to private funds, which do
not hold customer securities''). See also AIMA Comment Letter II;
Morgan Lewis Comment Letter; Fried Frank Comment Letter; T. Rowe
Price Comment Letter; IAA Comment Letter I; Element Comment Letter.
\229\ See, e.g., Two Sigma Comment Letter I; MFA Comment Letter
I; NAPFM Comment Letter; AIMA Comment Letter II.
\230\ See, e.g., Schulte Roth Comment Letter.
\231\ See, e.g., MFA Comment Letter I; T. Rowe Price Comment
Letter; AIMA Comment Letter II; see also 17 CFR 279.9.
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Some commenters described potential practical difficulties with
applying the dealer regulatory framework to private fund advisers and
private funds \232\ and with having a managed account register as a
dealer.\233\ One comment letter suggested that if a fund or separately
managed account was required to register as a dealer, a conflict could
arise between the fund's or separately managed account's adviser's
fiduciary duty to achieve best execution and a best execution
obligation to a counterparty ``when participating in all-to-all trading
protocols where they may match with another end-user.'' \234\ We do not
believe that such a conflict would arise in this scenario.\235\
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\232\ See, e.g., AIMA Comment Letter II; see also ABA Comment
Letter.
\233\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter
(``In addition, the Proposal fails to consider how the principal
trading prohibitions in the Advisers Act would impact an investment
adviser that comes within the meaning of the term dealer solely
because of its managed accounts.'').
\234\ See BlackRock Comment Letter.
\235\ Rather than ``counterparty,'' FINRA Rule 5310 applies to
``any transaction for or with a customer or a customer of another
broker-dealer'' (emphases added). The commenter did not specify what
would constitute an ``all-to-all trading protocol.'' However, a
dealer simply posting an order on a fully anonymous platform or
providing a price in response to a bid request or bid list presented
to the dealer or other competitive bidding process would likely not
be subject to a best execution obligation since the dealer has not
accepted a customer order for the purpose of facilitating the
handling and execution of such order; this situation is analogous to
Supplementary Material .04 to FINRA Rule 5310 which draws a
distinction between those situations in which a firm acts solely as
the buyer or seller in connection with an order presented against
the firm's quote as opposed to accepting an order for handling and
execution. See FINRA Regulatory Notice 15-46. See also infra notes
599-601 and accompanying text.
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As support for such potential practical difficulties, some
commenters stated that private funds are merely pools of assets that
rely on fund managers for all functions and therefore do not have
personnel or infrastructure to meet the dealer regulatory
requirements.\236\ A few commenters questioned the Commission's concern
\237\ that exempting private funds and private fund advisers from the
proposed rules would produce negative outcomes with respect to
PTFs,\238\ with one of these commenters citing to ``leverage
constraints and reporting'' as the ``only two differences'' between the
private funds and dealer regulatory framework as noted in the Proposing
Release.\239\ Another commenter identified possible exceptions from the
application of certain SEC and FINRA rules that may be necessary if
registered investment advisers and/or the private funds they advise
were required to register as dealers.\240\ Some commenters identified
issues with imposing a dealer regulatory framework on investment
advisers,\241\ with one commenter stating that the ``unsuitability of
the dealer regime for advisers is highlighted by the inconsistency of
an adviser needing to stand ready as a dealer to provide liquidity to,
i.e., trade as principal with, the market, potentially through its
clients' accounts, while being prohibited from acting in that capacity
with its clients.'' \242\
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\236\ See, e.g., ABA Comment Letter; MFA Comment Letter I; AIMA
Comment Letter II.
\237\ Proposing Release at 23096 (``Excluding these funds would
guarantee that the dealer regime would fail to capture this type of
securities dealing activity. Furthermore, a blanket exclusion for
hedge funds may provide an opportunity for regulatory arbitrage. For
example, PTFs may seek to restructure themselves as private funds,
thus preempting the intended benefits of the proposed rules.'').
\238\ See AIMA Comment Letter II; MFA Comment Letter I; IAA
Comment Letter I; see also T. Rowe Price Comment Letter.
\239\ See AIMA Comment Letter II (``Indeed, the Commission's
view expressed in the Proposal is that the only differences between
the regulatory regime for private fund advisers and securities
dealers are leverage constraints and reporting, yet the Commission
has chosen to include both private funds and their advisers within
the scope of the Proposal.'').
\240\ See Element Comment Letter (identifying, in part,
licensing of personnel who structure private placements on behalf of
Required Registrants with the Series 79 license; application of Reg
NMS Rule 611 to cross-trades effected on behalf of a Required
Registrant by its investment adviser; application of the Net Capital
Rule to Required Registrants; and application of the possession and
control requirements of the customer protection rule, 17 CFR
240.15c3-3 (``Rule 15c3-3''), in situations where hypothecation of
securities may be in the best interests of an investment advisory
client).
\241\ See, e.g., IAA Comment Letter I (``Unlike brokers or
dealers, advisers are prohibited from holding client assets or from
taking client assets onto their balance sheets. To the extent that
advisers trade securities, they do so through a broker or dealer
intermediary, generally on behalf of and for the benefit of their
clients''); see also T. Rowe Price Comment Letter (``We also are
concerned that the SEC has not adequately assessed the feasibility
and impact of an RIA being regulated as a dealer while also being
subject to the [Advisers Act] for the same activities, nor does the
Proposal detail how an entity could practically comply with both
regimes.'').
\242\ See IAA Comment Letter I.
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After consideration of the comments and for the reasons stated here
and in the Proposing Release,\243\ the Commission is adopting the
exclusion for registered investment companies as proposed. As stated
above, many commenters generally supported the exclusion and did not
suggest specific changes for registered investment companies but
instead requested that the Commission expand the scope of the
exclusions to include registered investment advisers and private funds.
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\243\ See supra note 218 and accompanying text.
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The Commission, however, is not including an express exclusion for
private funds or registered investment advisers. Depending on the
totality of the facts, a private fund may be engaged in the business of
buying and selling securities for its own account.\244\ Similarly, a
registered investment adviser that is trading for its ``own account''
could implicate dealer registration requirements. Further, as stated in
the Proposing Release, market actors that are engaged in dealing
activity should be subject to the dealer regulatory regime, which
includes not only registration obligations, but also regulatory
requirements specific to dealer activity and oversight that broadly
focus on the dealer market functionality--that is, the impact of
dealing activity on the market as a whole.\245\
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\244\ See, e.g., In the Matter of Murchinson Ltd., Marc
Bistricer, and Paul Zogala, Exchange Act Release No. 92684 (Aug. 17,
2021) (settled matter). In Murchinson, the Commission charged the
principals of a hedge fund with causing dealer violations under
section 15(a).
\245\ Proposing Release at 23078-79.
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Entities engaging in dealing activity that meet the qualitative
standard are required to register as dealers and comply with regulatory
requirements that are applicable to dealer activity. Dealer regulatory
requirements address related but distinct concerns from investment
adviser regulation. In addition, dealer registration enhances
regulatory oversight \246\ of market participants' trading activities
and interactions with the market overall. In this regard, dealer
regulatory requirements focus broadly on market functionality (along
with protecting investors under principles of fair dealing between
parties).\247\
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\246\ Dealers and government securities dealers are subject to
extensive regulation and oversight and generally must: (i) register
with the Commission and become members of an SRO; and (ii) comply
with Commission and SRO rules, including certain financial
responsibility and risk management rules, transaction and other
reporting requirements, operational integrity rules, and books and
records requirements, all of which help to enhance market stability
by giving regulators increased insight into firm-level and aggregate
trading activity. See section I.A.
\247\ Proposing Release at 23056. See also id. at 23078-79
(describing the regulatory requirements of registered dealers and
government securities dealers).
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However, the Commission is mindful of concerns raised by commenters
regarding the application of the dealer regime to registered investment
advisers and private funds and as such has made significant changes to
the definition of ``own account'' to remove the
[[Page 14958]]
aggregation standard in order to appropriately tailor the scope of
persons captured by the final rules.
Further, there are material differences between the private fund
and dealer regulatory frameworks, and dealer registration offers
important benefits and regulatory protections to address the risks
related to dealing activities.\248\ As explained in the Proposing
Release, registered private fund advisers are regulated under the
Advisers Act and information on private fund activities is reported by
registered private fund advisers on Form PF. The information the
Commission obtains on certain private funds through its regulation of
registered investment advisers, however, differs from that the
Commission collects for the purposes of dealer regulation.\249\ Private
funds also do not have the same level of reporting of their securities
transactions. For example, fixed income transactions between private
funds are not directly reported in TRACE. If their fixed-income trade
is with a broker-dealer and reported by the broker-dealer, private
funds appear anonymously in TRACE.\250\
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\248\ Proposing Release at 23083.
\249\ Id.
\250\ Id.
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Although, as commenters noted, the Commission collects some
information about certain private funds through Form PF, this reporting
alone is not a sufficient substitute for the comprehensive dealer
requirements because the dealer requirements are specific to dealer
activity. For example, Form PF only requires reporting related to a
subset of the private fund industry and does not include individual
trade reporting details, which would give regulators greater insight
into securities trading patterns, including the ability to more
efficiently match trades to market participants.\251\
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\251\ 17 CFR 279.9. See section III.C.1.c for a discussion of
the benefits of additional regulatory reporting.
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In response to commenters who stated that private funds are merely
pools of assets that rely on fund managers for all functions and
therefore do not have personnel or infrastructure to meet the dealer
regulatory requirements, to the extent that a private fund engages in
activities that trigger dealer registration under the final rules, such
private funds would need similarly to establish means, whether by
contract or otherwise, of complying with the obligations for registered
dealers, just as the fund must do to comply with any other regulatory
obligation.
In response to the commenter who suggested there were ``only two
differences'' between the dealer and private fund regulatory regimes,
the examples provided in the Proposing Release (i.e., leverage
constraints and reporting requirements) were non-exhaustive
examples.\252\ As discussed in the Proposing Release, registered
dealers' leverage is limited by net capital requirements, which must be
maintained at all times, while private funds have no formal leverage
constraints.\253\ Further, in response to commenters who raised
concerns about the application of certain SEC and FINRA rules or stated
that certain dealer requirements were untenable or inappropriate, while
the Commission acknowledges that complying with a new rule set may
require market participants to revise their business models, as
discussed further in the economic analysis, appropriate regulation of
dealer activities, and the benefits associated with enhancements to
investor protection and orderly markets, justifies these associated
costs and difficulties associated with registration.\254\
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\252\ See section I.A (citing to the benefits of dealer
registration).
\253\ Proposing Release at 23083. See also section III.B.2.b
(stating that private funds and investment advisers do not have to
comply with the Net Capital Rule or with any other direct,
regulatory constraint on leverage).
\254\ See section III.C.
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Finally, while not excluding registered investment advisers and
private funds, the Commission is, however, modifying the definition of
``own account'' to mean an account held in the name of, or for the
benefit of, that person and removing the proposed first qualitative
factor. These changes will respond to concerns related to separately
managed accounts and investment advisers trading on behalf of their
clients, including those exercising discretion; these investment
advisers generally will not be captured by the final rules because they
would not be buying and selling for their ``own account.'' Private
funds that are buying and selling for their ``own account'' in a way
that meets the qualitative standard could be captured by the final
rules. To the extent that private funds or investment advisers trigger
application of the final rules, they would need to comply with the
dealer registration requirements or cease engaging in dealer activity.
c. Official Sector Exclusions
The Commission is adopting express exclusions for central banks,
sovereign entities, and international financial institutions, as
defined in the final rules. Together, these exclusions are referred to
as the ``Official Sector Exclusions.''
The Official Sector Exclusions are designed to permit central
banks, sovereign entities, and international financial institutions to
continue to pursue important policy goals, and to be consistent with
principles of international comity and the privileges and immunities
granted to foreign central banks, foreign sovereigns and sovereign
entities, and certain international financial institutions under U.S.
Federal law.\255\
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\255\ See, e.g., Standards for Covered Clearing Agencies for
U.S. Treasury Securities and Application of the Broker-Dealer
Customer Protection Rule With Respect to U.S. Treasury Securities,
Exchange Act Release No. 99149 (Dec. 13, 2023).
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For purposes of the Official Sector Exclusion, the final rules
define a ``central bank'
[…truncated; see source link]Indexed from Federal Register on February 29, 2024.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.