# Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2022-06960

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** April 18, 2022
- **Citation:** 87 FR 23054

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-94524; File No. S7-12-22]
RIN 3235-AN10
Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“Commission”) is proposing new rules to further define the phrase “as a part of a regular business” as used in the statutory definitions of “dealer” and “government securities dealer” under Sections 3(a)(5) and 3(a)(44), respectively, of the Securities Exchange Act of 1934 (“Exchange Act”).

DATES:

Comments should be received on or before May 27, 2022.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form (
https://www.sec.gov/rules/submitcomments.htm
); or

• Send an email to
rule-comments@sec.gov.
Please include File Number S7-12-22 on the subject line.

Paper Comments

• Send paper comments to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-12-22. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's internet website (
https://www.sec.gov/rules/proposed.shtml
). Comments also are available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Operating conditions may limit access to the Commission's public reference room. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly.

Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission's website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at
www.sec.gov
to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Emily Westerberg Russell, Chief Counsel; John Fahey, Deputy Chief Counsel; Joanne Rutkowski, Assistant Chief Counsel; Shauna Sappington Vlosich, Senior Special Counsel; James Blakemore, Special Counsel; or Katherine Lesker, Special Counsel at 202-551-5550 in the Office of Chief Counsel, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

The Commission is proposing the following new rules under the Exchange Act: (1) 17 CFR 3a5-4 (Rule 3a5-4) and (2) 17 CFR 3a44-2 (Rule 3a44-2) (collectively, the “Proposed Rules”).

I. Introduction

Advancements in electronic trading across securities markets have led to the emergence of certain market participants that play an increasingly significant liquidity providing role in overall trading and market activity—a role that has traditionally been performed by entities regulated as dealers.
1

However, these market participants—despite engaging in liquidity providing activities similar to those traditionally performed by either “dealers” or “government securities dealers” as defined under Sections 3(a)(5) and 3(a)(44) of the Exchange Act, respectively, and despite their significant share of market volume
2
—may

not be registered with the Commission as either dealers or government securities dealers under Sections 15 and 15C of the Exchange Act, respectively.
3

Because of this, investors and the markets lack the important protections that result from an entity's registration and regulation under the Exchange Act. In addition, obligations and regulatory oversight that promote market stability and investor protection are not being consistently applied to entities engaged in similar activities.

1

See
Department of the Treasury, Notice Seeking Comment on the Evolution of the U.S. Treasury Market Structure, 81 FR 3928 (Jan. 22, 2016) (“Treasury Request for Comment”).
See also
Joint Staff Report: The U.S. Treasury Market on October 15, 2014 (July 13, 2015) (“2015 Joint Staff Report”), prepared by staff of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission,
available at https://www.sec.gov/reportspubs/special-studies/treasury-market-volatility-10-14-2014-joint-report.pdf.
The 2015 Joint Staff Report is a report of the Inter-Agency Working Group for Treasury Market Surveillance (“IAWG”). Staff reports, Investor Bulletins, and other staff documents (including those cited herein) represent the views of Commission staff and are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content of these staff documents and, like all staff statements, they have no legal force or effect, do not alter or amend applicable law, and create no new or additional obligations for any person.
See also
Concept Release Concerning Equity Market Structure, Exchange Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010) (“2010 Equity Market Structure Concept Release”) at 3594-96 (discussing the evolution from “a market structure with primarily manual trading to a market structure with primarily automated trading”).

2
FEDS Notes, “Principal Trading Firm Activity in Treasury Cash Markets,” James Collin Harkrader and Michael Puglia (Aug. 4, 2020) (“[Principal trading firms] dominate activity on the electronic [interdealer broker] platforms (61 [percent].”). For purposes of this release, the terms “principal trading firms” and “proprietary trading firms” (collectively, “PTFs”) will be used interchangeably.

3
As used in this release, the term “dealer” refers to both dealers and government securities dealers unless explicitly noted or the context indicates otherwise.

The Commission believes that the identification and registration of these market participants as dealers, including those that are not currently regulated as dealers, would provide regulators with a more comprehensive view of the markets through regulatory oversight and would enhance market stability and investor protection.
4

Accordingly, the Commission is proposing to further define what it means to be buying and selling securities “as a part of a regular business” within the definitions of “dealer” and “government securities dealer” under Sections 3(a)(5) and 3(a)(44), respectively.

4
As discussed in Section V below, the Commission believes that the Proposed Rules would support orderly markets and protect investors by addressing negative externalities that may arise in relation to market participants' financial and operational risks.

Evolution of the Market

Advancements in technology have affected securities trading across markets and asset classes; however, regulation has not always kept pace. This is especially true in the U.S. Treasury market in view of the increasingly significant role played by market intermediaries that are not registered as dealers. The U.S. Treasury market has evolved significantly over

recent decades in at least two important ways. First, the amount of U.S. Treasury securities outstanding has increased substantially.
5

At the end of 2007, Treasury debt held by the public totaled $5.1 trillion, or 35 percent of that year's gross domestic product (“GDP”).
6

That number rose to $23.1 trillion, or 96.5 percent of GDP, by the end of 2021.
7

5

See
IAWG Joint Staff Report, Recent Disruptions and Potential Reforms in the U.S. Treasury Market: A Staff Progress Report prepared by U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, U.S. Commodity Futures Trading Commission (Nov. 8, 2021) (“2021 IAWG Joint Staff Report”).

6

See id.

7

See
Monthly Statement of the Public Debt of the United States (Dec. 31, 2021),
available at https://www.treasurydirect.gov/govt/reports/pd/mspd/2021/opds122021.pdf;

see also
U.S. Bureau of Economic Analysis, Gross Domestic Product (GDP), FRED, Fed. Res. Bank of St. Louis,
available at https://fred.stlouisfed.org/series/GDP.

Second, a significant rise in electronic trading in the interdealer market
8

for U.S. Treasury securities has contributed to a dramatic change in the overall structure of the market. In particular, technological advances have increasingly enabled certain market participants that are not registered as dealers to perform critical market functions, including liquidity provision, that once were primarily performed by regulated dealers.
9

Since the mid-2000s, electronic trading has come to dominate the interdealer market for U.S. Treasury securities, gradually supplanting manual transactions made via the telephone.
10

The proliferation of fully electronic trading venues has been accompanied by the rise of certain market participants who are not registered as dealers and who today account for a majority of trading in the Treasury interdealer market.
11

In particular, PTFs—businesses that often employ automated, algorithmic trading strategies (including passive market making, arbitrage, and structural and directional trading)
12

that rely on speed, which allows them to quickly execute trades, or cancel or modify quotes in response to perceived market events
13

—account for about half of the daily volume in the interdealer market.
14

8
The U.S. Treasury market is comprised of the cash market (purchases and sales of securities), the repo market, and the futures market. The U.S. Treasury cash market has been traditionally bifurcated between the interdealer market (whereby dealers trade with other dealers or with proprietary trading firms) and the dealer-to-customer market (whereby dealers trade with clients). Trading in electronic interdealer markets occurs anonymously on electronic trading platforms known as interdealer broker platforms (“IDBs”). Trading on the IDB platforms is similar to trading on other highly liquid markets and where certain market participants account for a significant trading volume.
See
Treasury Request for Comment at 3928. For purposes of this release, when discussing the U.S. Treasury market, we will be primarily focused on trading activities occurring in the interdealer market.

9
2021 IAWG Joint Staff Report at 5. A bank engaged in these activities would not register with the Commission as a dealer.
See
Exchange Act Section 3(a)(5)(C)(i)(II) (providing an exception from dealer status when a bank buys or sells exempted securities, which are defined in Exchange Act Section 3(a)(12)(A) to include government securities);
see also
Exchange Act Section 3(a)(6) (definition of “bank”). As discussed
infra
note 41, a bank may nonetheless be a government securities dealer required to register under Section 15C. As such, it would not register with the Commission but instead would provide written notice of its government securities dealer status with the appropriate Federal banking regulator, and comply with rules adopted by the Treasury and the applicable Federal banking regulator.

10

See
Treasury Request for Comment.
See also
Group of Thirty Working Group on Treasury Market Liquidity, U.S. Treasury Markets: Steps toward Increased Resilience, Group of Thirty (2021) (“G30 Report”) at
https://group30.org/publications/detail/4950;
2021 IAWG Joint Staff Report at 5.

11

See
Michael J. Fleming, Bruce Mizrach, and Giang Nguyen, Federal Reserve Bank of New York Staff Reports, The Microstructure of a U.S. Treasury ECN: The BrokerTec Platform, Staff Report No. 381 (July 2009, rev. May 2014);
see also
Treasury Request for Comment (“Trading on these platforms [in the Treasury cash market] has become increasingly automated, with transactions conducted using algorithmic and other trading strategies involving little or no human intervention . . . bear[ing] some resemblance to other highly liquid markets, including equities and foreign exchange markets, where PTFs and dealers transact in automated fashion, sometimes in large volumes and at high speed.”); FEDS Notes, “Principal Trading Firm Activity in Treasury Cash Markets,” James Collin Harkrader and Michael Puglia (Aug. 4, 2020); G30 Report at 1. The Commission separately has proposed, among other things, amendments to Exchange Act Rule 3b-16 to include within the definition of “exchange” systems that offer the use of non-firm trading interest and communication protocols to bring together buyers and sellers of securities.
See
Amendments regarding the Definition of “Exchange” and Alternative Trading Systems (ATSs) that Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities, Securities Exchange Act Release No. 94062 (Jan. 26, 2022), 87 FR 15496 (Mar. 18, 2022) (“2022 ATS Proposing Release”).

12

See
Staff Report on Algorithmic Trading in U.S. Capital Markets As Required by Section 502 of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (Aug. 5, 2020) (“Algorithmic Trading Staff Report”), at pp. 39-41 (“Passive market-making involves submitting non-marketable orders on both sides (buy or `bid,' and sell or `offer') of the marketplace”; “structural strategies attempt to exploit structural vulnerabilities in the market or in certain market participants”; and “directional strategies generally involve establishing a short-term long or short position in anticipation of a price move up or down”);
see also
2010 Equity Market Structure Concept Release.

13

See
2022 ATS Proposing Release at 15597.
See also
2015 Joint Staff Report at 39; 2021 IAWG Joint Staff Report at 5 (“PTFs tend to make trading decisions primarily based on immediate profitability and the level of market risk”).

14
Nellie Liang and Pat Parkinson, Hutchins Center Working Paper #72, Enhancing Liquidity of the U.S. Treasury Market Under Stress (Dec. 16, 2020) (“Enhancing Liquidity”), at 6.

These new market participants have established themselves as significant market intermediaries—and critical sources of liquidity—in the U.S. Treasury market. For example, by 2014, unregistered market participants trading U.S. Treasury securities, including PTFs, accounted for a majority of trading activity in the electronic interdealer market.
15

The 2015 Joint Staff Report on the U.S. Treasury market found that more than 50 percent of trading volume in benchmark U.S. Treasury securities on the major trading platforms is attributable to PTFs.
16

In 2020, staff at the Board of Governors of the Federal Reserve published a paper estimating that PTFs account for 61 percent of the trading activity on interdealer broker platforms.
17

The significant presence of market participants that are not registered as dealers or government securities dealers in the U.S. Treasury market, the volume of their trading, the magnitude of their impact on the market, the regularity of their participation, and in many cases the nature of their electronic trading strategies have all contributed to the increasingly central role of these market participants as liquidity providers.
18

15

See
2021 IAWG Joint Staff Report at 5.

16

See
2015 Joint Staff Report at 21.

17
FEDS Notes, “Principal Trading Firm Activity in Treasury Cash Markets,” James Collin Harkrader and Michael Puglia (Aug. 4, 2020) (citing data presented at the 2019 U.S. Treasury Market Conference showing that PTFs averaged approximately 61 percent of total trading volume on electronic interdealer broker platforms).

18
2015 Joint Staff Report; Enhancing Liquidity at 6.

The rise of electronic trading has similarly impacted the market structure of the securities markets generally. In the equity markets, for example, trading in exchange-listed equities, once concentrated on exchange floors, now largely occurs in an electronic, highly decentralized but interconnected market that is accessed by brokers, dealers, and other market participants using a large number and great variety of trading venues.
19

In the equity markets, too, technological advances have enabled significant market participants to take on an increasingly central role as liquidity providers, largely replacing more traditional types of traditional liquidity providers, such as exchange specialists on manual trading floors and over-the-counter (“OTC”) market makers.
20

Technological advancements

have prompted changes to trading practices, particularly with regard to the way in which orders are generated, routed, and executed. Developments in securities regulation also have contributed to the evolution of market structure and the rise of electronic trading.
21

These technological and regulatory changes have resulted in the development of highly automated exchange systems and trading tools that have facilitated a business model for certain market participants, including PTFs, that perform functions similar to registered dealers.
22

19

See
2010 Equity Market Structure Concept Release at 3594.

20

See
2010 Equity Market Structure Concept Release at 3607 (stating that liquidity providers historically have been viewed as dealers, and that “[a]lthough [PTFs] that employ passive market making strategies are a new type of market participant, the liquidity providing function they perform is not new.”).

21
In 2005, the Commission adopted 17 CFR 242.600 through 242.614 (Regulation NMS), a series of initiatives designed to modernize and strengthen the national market system for equity securities through improved fairness in price execution, displaying of quotes, and access to market data. Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37495 (“Regulation NMS Release”). As these initiatives were implemented, regulations that had protected the manual quotes of floor exchanges from trade-throughs were rescinded.
Id.
In 2006, after decades of trading predominantly on the exchange floor, the New York Stock Exchange (“NYSE”) introduced a hybrid market structure that incorporated an ability to transact electronically.
See
2010 Equity Market Structure Concept Release. Today, electronic trading dominates transactions in equity securities.

22
A significant portion of trading activity in the equity markets—once estimated at 40-50 percent of the daily trading volume in exchange-listed equities—is conducted by PTFs.
See
High Frequency Trading and Networked Markets, Federico Musciotto, Jyrki Piilo, Rosario N. Mantegna (Mar. 5, 2021); SEC Staff of the Division of Trading and Markets, Equities Market Structure Literature Review Part II: High Frequency Trading (Mar. 18, 2014); Do High-Frequency Traders Anticipate Buying and Selling Pressure?, Nicholas H. Hirschey (Nov. 2013); High-Frequency Trading and Price Discovery, Jonathan Brogaard, Terrance Hendershott, Ryan Riordan (May 14, 2014); High Frequency Trading: An Important Conversation,
available at https://tabbforum.com/opinions/high-frequency-trading-an-important-conversation
(Mar. 24, 2014) (illustrating the percentage of high frequency trading of U.S. equity shares traded from 2006 to 2014 in Exhibit 1).
See also
Section V.B.2.

As discussed below, the Commission has long identified liquidity provision, including acting as a “market maker” or “a
de facto
market maker whereby market professionals or the public look to the firm for liquidity,” as a factor that indicates “dealer” status.
23

Analysis indicates a number of market participants that, despite their significant share of market volume and their central role as liquidity providing intermediaries in the U.S. Treasury market, are not registered with the Commission either as “government securities dealers” under Section 15C of the Exchange Act or “dealers” under Section 15 of the Exchange Act.
24

This has resulted in an uneven playing field in which some participants are subject to regulation (and its attendant costs and benefits), and some are not. This uneven application of regulatory oversight of significant liquidity providers makes it difficult for regulators and market observers to detect, investigate, understand, or address market events, such as the “flash rally” in October 2014.

23
Definition of Terms in and Specific Exemption for Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934, Exchange Act Release No. 46745 (Oct. 30, 2002), 67 FR 67496, 67498-67500 (Nov. 5, 2002) (“2002 Release”) (stating that a person generally may satisfy the definition, and therefore, be acting as a dealer in the securities markets by conducting various activities, including “acting as a market maker or specialist on an organized exchange or trading system”).

24

See
Section V.B.2.a, Table 1. Section 3(a)(5) of the Exchange Act defines the term “dealer” to mean “any person engaged in the business of buying and selling securities . . . for such person's own account through a broker or otherwise,” but excludes “a person that buys or sells securities . . . for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business.” Similarly, Section 3(a)(44) of the Exchange Act, provides, in relevant part, that the term “government securities dealer” means “any person engaged in the business of buying and selling government securities for his own account, through a broker or otherwise,” but “does not include any person insofar as he buys or sells such securities for his own account, either individually or in some fiduciary capacity, but not as part of a regular business.”
See
Section II.A.

As discussed below, the regulatory regime applicable to dealers is a cornerstone of the U.S. Federal securities laws, and helps to promote the Commission's long-standing mission to protect investors, maintain fair, orderly, and efficient markets, and promote capital formation. As discussed in Sections II.D, and V.C, the registration of market participants who engage in significant dealer-like activities—but who are not currently registered as dealers—would provide regulators with a more comprehensive view of the markets through regulatory oversight, as well as enhance market stability through compliance with dealer regulations that are designed to support orderly markets, and protect investors by minimizing the impact of market participants' potential financial and operational risks.
25

Accordingly, the Commission is taking steps to ensure that these market participants are registered and regulated,
26

and is proposing for comment rules to further define the regulatory status of certain participants as “dealers” and “government securities dealers,” within the meaning of Sections 3(a)(5) and 3(a)(44) of the Exchange Act, respectively.
27

25
Section V.C.2 describes the estimated costs associated with registering as a dealer or government securities dealer for those persons who meet the proposed standards.

26
In addition, earlier this year, the Commission proposed to amend 17 CFR 242.300 through 242.304 (Regulation ATS) for alternative trading systems (“ATSs”) that trade government securities (as defined under Section 3(a)(42) of the Exchange Act) or repurchase and reverse repurchase agreements on government securities (“repos”) (such ATSs, together, “Government Securities ATSs”) to: (1) Eliminate the current exemption from compliance with Regulation ATS for an ATS that limits its securities activities to government securities or repos, and registers as a broker-dealer or is a bank; (2) require the filing of public Form ATS-N for Government Securities ATSs, which would be subject to Commission review and ineffectiveness procedures, and would require a Government Securities ATS to disclose information about its manner of operations and the ATS-related activities of the registered broker-dealer or government securities broker or government securities dealer that operates the ATS and its affiliates; and (3) apply the fair access rule under 17 CFR 242.301(b)(5) (Rule 301(b)(5) of Regulation ATS) to Government Securities ATSs that meet certain volume thresholds in U.S. Treasury Securities or in a debt security issued or guaranteed by a U.S. executive agency, or government-sponsored enterprise (“Agency Securities”).
See
2022 ATS Proposing Release. The 2022 ATS Proposing Release is also re-proposing amendments to 12 CFR 242.1000 through 242.1007 (Regulation Systems Compliance and Integrity (“Regulation SCI”)) to apply it to Government Securities ATSs that meet certain volume thresholds in U.S. Treasury Securities or Agency Securities.

27
We have consulted with the staff of the U.S. Department of the Treasury on this proposal.

Specifically, the Commission is proposing standards to identify those market participants that are providing an important liquidity provision function in today's securities markets. Any person
28

that meets the activity-based standards identified in the Proposed Rules would be a dealer or government securities dealer required to register, absent an otherwise available and applicable statutory or regulatory exemption or exception (
e.g.,
foreign broker-dealers exempted pursuant to 17 CFR 240.15a-6 (Exchange Act Rule 15a-6)).
29

28
As discussed more fully below, the standards in the Proposed Rules do not apply to a person that has or controls total assets of less than $50 million, or an investment company registered under the Investment Company Act of 1940 (“Investment Company Act”) (such company a “registered investment company”).
See
proposed Rule 3a5-4(a)(2) and proposed Rule 3a44-2(a)(3). Investment advisers are not required to aggregate accounts held in the name of clients of the adviser under certain circumstances as described in proposed Rule 3a5-4(b)(2)(ii) and proposed Rule 3a44-2(b)(2)(ii).
See
Section III.D.

29
There is an analogous exemption under the Treasury rules for certain foreign government securities dealers.
See
17 CFR 401.7 (Treas. Reg. § 401.7) (1987) (“Exemption for certain foreign government securities brokers or dealers.”). The Commission is not expressing any views concerning multilateral development banks, like the International Bank for Reconstruction and Development (or the World Bank) and the International Finance Corporation, or foreign sovereigns or foreign central banks, or any other sovereign or international bodies as to the immunities such entities may possess under U.S. or international law.
See, e.g.,
Security-Based Swap Transactions Connected With a Non-U.S. Person's Dealing Activity That Are Arranged, Negotiated, or Executed by Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent;

Security-Based Swap Dealer De Minimis Exception, Exchange Act Release No. 77104 (Feb. 10, 2016), 81 FR 8598,
available at https://www.govinfo.gov/content/pkg/FR-2016-02-19/pdf/2016-03178.pdf.

As the Proposed Rules focus on activity rather than label or status, they would potentially scope in other market participants as discussed below in Section V, thereby triggering a registration requirement and subjecting those entities to dealer regulation and oversight. As discussed further in Section V.B.2, the Commission's analysis indicates that the Proposed Rules would primarily require registration by PTFs, and potentially some private funds.
30

In addition, it is possible that the activities of some investment advisers
31

could meet the Proposed Rules
32

and trigger a dealer registration requirement. The Commission believes the scope of the Proposed Rules is appropriate in light of the important liquidity that these participants provide to the securities markets, which is similar to that historically provided by regulated dealers.

30
A private fund, including a hedge fund, is an issuer that would be an investment company as defined in Section 3 of the Investment Company Act if not for Section 3(c)(1) or 3(c)(7) of the Investment Company Act.
See
15 U.S.C. 80a-3.

31
“Investment adviser” is defined under the Investment Advisers Act of 1940 (“Advisers Act”) as “any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”
See
15 U.S.C. 80b-2(a)(11).

32

See
Section III.D.

The Commission is proposing to exclude certain smaller participants, as well as registered investment companies, from the ambit of the Proposed Rules. As discussed in Section III.A and V.B, these smaller participants—persons that have or control less than $50 million in total assets—are unlikely to be able to engage in the significant liquidity provision that is the focus of the Proposed Rules. As discussed below in Section III.A, in light of the regulatory structure that governs registered investment companies, which addresses, among other things, the types of concerns that we seek to address in the Proposed Rules, the Commission is proposing to exclude registered investment companies from the Proposed Rules.
33

33
As discussed in Section III.D, for purposes of the definition of “own account,” an account held in the name of a person that is a registered investment company would not be attributed to a controlling person or another person under common control.

Conversely, the Proposed Rules would not exclude private funds because we are proposing to take a similar approach to regulating dealer activity across market participants and, unlike registered investment companies, private funds are not subject to the regulatory framework of the Investment Company Act. The Commission currently receives information about the operations, exposures, liabilities, liquidity, and strategies of private funds through filings of Form PF by registered private fund advisers and has recently proposed amendments to Form PF to enhance the reporting about private funds.
34

If excluded from the Proposed Rules, however, private funds engaged in dealer activity would not be subject to the dealer regulatory regime, which includes not only registration obligations, but also comprehensive regulatory requirements and oversight that broadly focus on market functionality—that is, the impact of dealing activity on the market as a whole.

34

See
Amendments to Form PF to Require Current Reporting and Amend Reporting Requirements for Large Private Equity Advisers and Large Liquidity Fund Advisers, Investment Advisers Act Release No. 5950 (Jan. 26. 2022), 87 FR 9106 (Feb. 17, 2022) (“Form PF Proposing Release”).

The Proposed Rules also would not exclude investment advisers registered under the Advisers Act (“registered investment advisers”). A registered investment adviser trading for its own proprietary account, for example, could trigger the dealer registration requirements under the Proposed Rules. And, under certain circumstances, a registered investment adviser could trigger application of the Proposed Rules because of aggregating trading in its own account with client accounts it controls. However, as described below in Section III.D, in determining whether its activity would be captured by the Proposed Rules, a registered investment adviser would not be required to aggregate its own trading activities with the trading activities of its clients' solely based on an adviser-client discretionary investment management relationship.
35

This exclusion is designed to attribute the dealer activity to the appropriate market actor.

35
Paragraph (b)(2)(ii)(B) of the Proposed Rules would not attribute to a registered investment adviser an account held in the name of a client of the registered investment adviser, unless the adviser controls the client as a result of the adviser's right to vote or direct the vote of voting securities of the client, the adviser's right to sell or direct the sale of voting securities of the client, or the adviser's capital contributions to or rights to amounts upon dissolution of the client.

II. Background

The Federal securities laws provide a comprehensive system of regulation of securities activities, and the definition of dealer is one of the Exchange Act's most important definitions. As discussed below, the statutory definition of “dealer” in Section 3(a)(4) and the accompanying registration requirements of the Exchange Act were drawn broadly by Congress in 1934 to encompass a wide range of activities involving the securities markets and their participants.
36

Registered dealers and government securities dealers are subject to a panoply of regulatory obligations and supervisory oversight intended to protect investors and the securities markets. Therefore, it is important that market participants whose securities activities fall within the broad definitions of “dealer” and “government securities dealer” are registered and regulated under the Exchange Act.

36
Proposed Rule 3a5-4 would apply to securities as defined by Section 3(a)(10) of the Exchange Act, and proposed Rule 3a44-2 would apply to government securities as defined by Section 3(a)(42) of the Exchange Act, including any digital asset that is a security or a government security within the meaning of the Exchange Act.

A. Definitions of “Dealer” and “Government Securities Dealer”

Section 3(a)(5) of the Exchange Act defines the term “dealer” to mean “any person
37

engaged in the business of buying and selling securities . . . for such person's own account through a broker or otherwise,” but excludes “a person that buys or sells securities . . . for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business.”
38

This statutory exclusion from the definition of “dealer” is often referred to as the “trader” exception.

39

As one commentator has described it, at the core of the “dealer/trader” distinction is an attempt to draw a line between a dealer and “an ordinary investor who buys and sells for his own account with some frequency.”
40

Read together, these provisions identify as a “dealer” a person engaged in the business of buying and selling securities for its own account as part of a regular business. Absent an exception or an exemption, Section 15(a)(1) of the Exchange Act makes it unlawful for a “dealer” to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security unless registered with the Commission in accordance with Section 15(b) of the Exchange Act.

37
Paragraph (b)(1) of the Proposed Rules provides that the term “person” has the same meaning as prescribed in Section 3(a)(9) of the Exchange Act. Section 3(a)(9) of the Exchange Act defines a “person” as “a natural person, company, government, or political subdivision, agency, or instrumentality of a government.”
See
15 U.S.C. 78c(a)(9).

38

See
Sections 3(a)(5)(A) and (B) of the Exchange Act, 15 U.S.C. 78c(a)(5)(A) and (B). The definition of “dealer” in the Exchange Act is largely unchanged from its enactment in 1934. Until the Gramm-Leach-Bliley Act (“GLBA”) was enacted in 1999, banks were excluded from the definition of “dealer.” The GLBA added Section 3(a)(5)(C) of the Exchange Act to create a series of functional exemptions from the statutory definition of dealer. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) further amended Section 3(a)(5)(A) of the Exchange Act to exclude from the dealer definition persons engaged in the business of buying and selling security-based swaps, other than security-based swaps with or for persons that are not eligible contract participants.

39

See, e.g.,
2002 Release (explaining that “a person that is buying securities for its own account may still not be a `dealer' because it is not `engaged in the business' of buying and selling securities for its own account as part of a regular business,” and

that “[t]his exclusion is often referred to as the dealer/trader distinction”).

40

See
Loss,
Securities Regulation
722 (1st ed. 1951) (“One aspect of the `business' concept is the matter of drawing the line between a `dealer' and a trader—an ordinary investor who buys and sells for his own account with some frequency.”),
cited in
Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” Exchange Act Release No. 66868 (Apr. 27, 2012), 77 FR 30596 n.250 (May 23, 2012) (“Entities Adopting Release”).

Similarly, Section 3(a)(44) of the Exchange Act provides, in relevant part, that the term “government securities dealer” means “any person engaged in the business of buying and selling government securities for his own account, through a broker or otherwise,” but “does not include any person insofar as he buys or sells such securities for his own account, either individually or in some fiduciary capacity, but not as part of a regular business.”
41

Read together, these provisions identify as a “government securities dealer” a person engaged in the business of buying and selling government securities for its own account as part of a regular business.
42

Section 15C of the Exchange Act makes it unlawful for a “government securities dealer” (other than a registered broker-dealer or financial institution) to induce or attempt to induce the purchase or sale of any government security unless such government securities dealer is registered in accordance with Section 15C(a)(2).
43

41
15 U.S.C. 78c(a)(44). Congress added the definition of “government securities dealer” to the Exchange Act in the Government Securities Act of 1986. Public Law 99-571, 100 Stat. 3208 (Oct. 28, 1986). To the extent a financial institution is a government securities dealer required to register under Section 15C, it would not register with the Commission but instead would provide written notice of its government securities dealer status with the appropriate Federal banking regulator, and comply with rules adopted by the Treasury and the applicable Federal banking regulator.
See
Regulations under Section 15C of the Securities Exchange Act of 1934, 17 CFR 400.1(b),
available at
CFR-2018-title17-vol4-chapIV.pdf (
treasurydirect.gov
) (the “Treasury Rules”). The Treasury Rules address financial responsibility, protecting customer securities and funds, recordkeeping, large position reporting, and financial reporting and audits. Also included are rules concerning custodial holdings of government securities by depository institutions. The Commission retains broad antifraud authority over banks that are government securities dealers. Soon after enactment of the Government Securities Act of 1986, the staff issued a series of no-action letters to persons seeking assurances that the staff would not recommend enforcement action if they did not register as government securities dealers.
See, e.g., Bankers Guarantee Title & Trust Co.,
SEC No-Action Letter (Jan. 22, 1991);
Bank of America, Canada,
SEC No-Action Letter (May 1, 1988);
Citicorp Homeowners, Inc.,
SEC No-Action Letter (Oct. 7, 1987);
Fairfield Trading Corp.,
SEC No-Action Letter (Dec. 10, 1987);
Continental Grain Co.,
SEC No-Action Letter (Nov. 28, 1987);
Louis Dreyfus Corp.,
SEC No-Action Letter (July 23, 1987);
United Savings Association of Texas,
SEC No-Action Letter (Apr. 2, 1987). Staff no-action letters, like all staff statements, have no legal force or effect: They do not alter or amend applicable law, and they create no new or additional obligations for any person. Upon the adoption of any final rule, some letters and other staff statements, or portions thereof, may be moot, superseded, or otherwise inconsistent with the final rules and, therefore, would be withdrawn or modified.

42
The legislative history relating to the enactment of the Government Securities Act of 1986 provides that the term government securities dealer “would utilize key concepts from the current definitions of . . . `dealer' and `municipal securities dealer.' ” H.R. Rep. No. 258, 99th Cong., 1st Sess. 24 (1985). S. Rep. No. 426, 99th Cong., 2d Sess. 19 (1986).

43
A government securities dealer that is a registered dealer or a financial institution must file notice with the appropriate regulatory agency that it is a government securities dealer.
See
15 U.S.C. 78o-5(a). Exchange Act Section 3(a)(46) defines the term “financial institution” to include: (i) A bank (as that term is defined in Exchange Act Section 3(a)(6) (15 U.S.C. 38c(a)(6)); (ii) a foreign bank (as that term is used in the International Banking Act of 1978); and (iii) a savings association (as defined in section 3(b) of the Federal Deposit Insurance Act, the deposits of which are insured by the Federal Deposit Insurance Corporation).
See
15 U.S.C. 78c(a)(46)(A) through(C).

Under both the dealer and government securities dealer definitions, a person acts as a dealer or a government securities dealer when it is engaged in the business of buying and selling securities or government securities, respectively, for its own account as part of a “regular business.”
44

44
Unless otherwise indicated, references to “dealer” activity apply both with respect to “dealers” and “government securities dealers” under Sections 3(a)(5) and 3(a)(44) of the Exchange Act, respectively.

Factors Considered in Evaluating “Regular Business”

Because the Exchange Act does not define what it means to be engaged in a “regular business,” courts and the Commission have looked to an array of factors in determining whether someone is a “dealer” within the meaning of the statute.
45

In determining whether a person is engaged in the business of buying and selling securities for its own account as part of a “regular business,” courts and the Commission assess the frequency with which the person buys and sells securities for its own account.
46

The “regularity” of participation in securities transactions necessary to find that a person is a “dealer” has not been quantified, but involves engaging in “more than a few isolated” securities transactions.
47

45

See, e.g.,
Registration Requirements for Foreign Broker-Dealers, Exchange Act Release No. 27017 (July 11, 1989), 54 FR 30013, 30015 (July 18, 1989) (stating that the definition of “dealer” and the registration requirements under the Exchange Act “were broadly drawn by Congress to encompass a wide range of activities involving investors and the securities markets”). Recognizing that the word “business” is central to the dealer definition, courts have cited to Black's Law Dictionary definition of business: “a commercial enterprise carried on
for profit,
a particular occupation or employment habitually engaged in for
livelihood or gain.” SEC
v.
Justin W. Keener d/b/a JMJ Financial,
No. 20-cv-21254, pp. 14-15 (S.D. Fla. Jan. 21, 2022) (citing
SEC
v.
Big Apple Consulting USA, Inc.,
783 F.3d 786, 809 (11th Cir. 2015) which was quoting Black's Law Dictionary 239 (10th ed. 2009)) (emphasis in original). The Eleventh Circuit elaborated that “[c]entral to this definition is
profit
or gain.”
Id.
(emphasis in original).
See also SEC
v.
Ibrahim Almagarby,
479 F. Supp. 3d 1266, 1272 (S.D. Fla. 2020).

46

See Massachusetts Financial Services, Inc.
v.
Securities Investor Protection Corp.,
411 F. Supp. 411, 415 (D. Mass.),
aff'd,
545 F.2d 754 (1st Cir. 1976),
cert. denied,
431 U.S. 904 (1977) (noting that the dealer definition: “connote[s] a certain regularity of participation in securities transactions at key points in the chain of distribution.”);
see also Eastside Church of Christ
v.
National Plan, Inc.,
391 F.2d at 361-362 (an entity that purchased many securities for its own account as part of its regular business and sold some of them was deemed a dealer);
SEC
v.
Century Inv. Transfer Corp.,
1971 U.S. Dist. LEXIS 11364, at *14 (S.D.N.Y. Oct. 5, 1971) (a limited partnership that bought and sold securities for its own account on numerous occasions was deemed a dealer);
SEC
v.
Corporate Rels. Group, Inc.,
2003 U.S. Dist. LEXIS 24925, at *60-61 (M.D. Fla. Mar. 28, 2003) (an unregistered stock promotion company that was operating as a broker was also operating as a dealer because it bought securities on more than a dozen occasions and sold those securities in hundreds of transactions through accounts it maintained or in which it had an interest).

47

See SEC
v.
Am. Inst. Counselors, Inc.,
Fed. Sec. L. Rep. (CCH) ¶ 95388 (D.D.C. 1975) (citing Loss, Securities Regulation (2d ed. 1961)).

In addition to frequency of activity, the nature of the trading activity is a factor in determining whether a person is a dealer.
48

Over time, the Commission has identified activities that, in context and when engaged in with regularity, may be indicative of being a dealer.
49

For example, the Commission has identified certain factors that would be indicators of dealer activity, including,

among other things: (1) Acting as a market maker or specialist on an organized exchange or trading system; (2) acting as a de facto market maker or liquidity provider;
50

and (3) holding oneself out as buying or selling securities at a regular place of business.
51

48

See
2002 Release at 67498.

49

See
Entities Adopting Release, 77 FR 30617 (discussing application of the dealer/trader distinction in the context of security-based swap dealers);
see also
2002 Release at 67499.

50
For example, a person may be acting as a dealer if they “turned a profit not from selling only after market prices increased (like a trader), but rather from quickly reselling at a marked-up price.”
River North,
415 F. Supp. 3d at 859;
see also SEC
v.
Big Apple Consulting USA, Inc.,
783 F.3d 786, 809-10 (11th Cir. 2015);
In re Sodorff,
50 SEC. 1249, 1992 WL 224082, at *5 (Sep. 2, 1992).

51

See
2002 Release. These factors were confirmed by the Commission in 2012 when it defined certain terms, including “security-based swap dealer,” in accordance with Title VII of the Dodd-Frank Act.
See
Entities Adopting Release at 30607 (distinguishing traders from dealers by noting that a trader, among other things, does not make a market). These indicia have been developed in a range of contexts over time as the markets and dealer activity have evolved, and do not represent an exclusive or exhaustive list of activities relevant for determining whether registration as a dealer is required. Further, a person not meeting the standards in the Proposed Rules may still be a dealer under otherwise applicable dealer precedent. Whether or not a person is a “dealer” is based on the facts and circumstances, where various factors are “neither exclusive, nor function as a checklist,” and meeting any one factor may be sufficient to establish dealer status.
SEC
v.
River North Equity LLC,
415 F. Supp. 3d 853, 858 (N.D. Ill. 2019);
accord SEC
v.
Fierro,
No. 20-cv-2104, 2020 WL 7481773, at *3 (D.N.J. Dec. 18, 2020);
SEC
v.
Keener,
No. 20-cv-21254, 2020 WL 4736205, at *3-*4 (S.D. Fla. Aug. 14, 2020);
SEC
v.
Almagarby,
479 F. Supp. 3d 1266, 1272-73 (S.D. Fla. 2020);
SEC
v.
Benger,
697 F. Supp. 2d 932, 945 (N.D. Ill. 2010).

Trader Exclusion

The Exchange Act excludes from the definition of dealer any “person that buys or sells securities . . . for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business.”
52

While traders and dealers engage in the same core activity—buying and selling securities for their own account—their level of activity varies in absolute terms and in regularity.
53

The Commission has stated that dealers include those who are willing to buy and sell contemporaneously and often quickly enter into offsetting transactions to minimize the risk associated with a position.
54

In contrast, traders are “market participants who provide capital investment and are willing to accept the risk of ownership in listed companies for an extended period of time,” and the Commission has stated that “it makes little sense to refer to someone as `investing' in a company for a few seconds, minutes, or hours.”
55

The purpose of the “trader” exception is to “exclude from the definition of `dealer' members of the public who buy and sell securities for their own account as ordinary traders.”
56

52
Sections 3(a)(5)(B) and 3(a)(44)(A) of the Exchange Act.

53

See
Loss,
supra
note 40, at 720 (noting that the distinction between a trader and a dealer seeks to separate the “ordinary investor who buys and sells for his own account with some frequency” by establishing that dealers engage in the business of buying and selling securities as part of a regular business).

54
2002 Release.

55
2010 Equity Market Structure Concept Release at 3603, n. 52 (citing Regulation NMS Release, 70 FR 37500).

56

See SEC
v.
Am. Inst. Counselors, Inc.,
Fed. Sec. L. Rep. (CCH) ¶ 95,388 (D.D.C. 1975) (citing Loss, Securities Regulation (2d ed. 1961)).
See also
2002 Release (“[A] person that is buying securities for its own account may still not be a `dealer' because it is not `engaged in the business' of buying and selling securities for its own account as part of a regular business”);
River North,
415 F. Supp. at 859 (traders purchase securities already in the marketplace and turn a profit from selling them after they appreciate in value);
Sodorff,
1992 WL 224082, at *5 (same).

B. 2010 Equity Market Structure Concept Release

The Commission raised the issue of broker-dealer registration for PTFs in its 2010 Equity Market Structure Concept Release.
57

Specifically, as part of its discussion relating to the potential risks to the markets posed by PTFs, the Commission requested comment on whether all PTFs should be required to register as broker-dealers.
58

Comments were mixed.
59

A number of commenters explicitly supported registration as an effective means for providing oversight of trading activity.
60

Others commenters opposed registration, citing costs, burdens, and barriers to competition.
61

57

See
2010 Equity Market Structure Concept Release at 3612.

58

Id.

59

See
Letter from Donald R. Wilson, Jr., DRW Trading, LLC (Apr. 21, 2010); Letter from Peter Kovac, Chief Operating Officer and Financial and Operations Principal, EWT (Feb. 22, 2010); Letter from Senator Edward Kaufman (Aug. 5, 2010); Article from Stephen M. Barnes, J.D.,
Regulating High-Frequency Trading: An Examination of U.S. Equity Market Structure in Light of the May 6, 2010 Flash Crash
(Dec. 2010); Letter from R.T. Leuchtkafer (Apr. 16, 2010); Letter from R.T. Leuchtkafer (July 15, 2010); Letter from Micah Hauptman, Financial Services Counsel, Consumer Federation of America (Sept. 9, 2014); Letter from Berkowitz, Trager & Trager, LLC (Apr. 21, 2010); Letter from Alston Trading, LLC, RGM Advisors, LLC, Hudson River Trading, LLC, and Quantlab Financial, LLC (Apr. 23, 2010); Letter from Marcia E. Asquith, Senior Vice President and Corporate Secretary, Financial Industry Regulatory Authority (Apr. 23, 2010); Letter from James J. Angel, Associate Professor, McDonough School of Business, Georgetown University, Lawrence E. Harris, Fred V. Keenan Chair in Finance, Professor of Finance and Business Economics, Marshall School of Business, University of Southern California, and Chester S. Spatt, Pamela R. and Kenneth B. Dunn Professor of Finance, Director, Center for Financial Markets, Tepper School of Business, Carnegie Mellon University, Equity Trading in the 21st Century (Feb. 23, 2010); and Letter from Kurt N. Schacht, Managing Director and Linda L. Rittenhouse, Director, Capital Markets Policy, CFA Institute (June 22, 2010).

60

See
Letter from Peter Kovac, Chief Operating Officer and Financial and Operations Principal, EWT (Feb. 22, 2010); Letter from Senator Edward Kaufman (Aug. 5, 2010); Article from Stephen M. Barnes, J.D.,
Regulating High-Frequency Trading: An Examination of U.S. Equity Market Structure in Light of the May 6, 2010 Flash Crash
(Dec. 2010); Letter from R.T. Leuchtkafer (Apr. 16, 2010); Letter from R.T. Leuchtkafer (July 15, 2010); Letter from Micah Hauptman, Financial Services Counsel, Consumer Federation of America (Sept. 9, 2014).
See also
Letter from Donald R. Wilson, Jr., DRW Trading, LLC (Apr. 21, 2010), pp 3-4 (supporting registration only for those firms that engage in high-volume and high-speed trading).

61

See
Letter from Berkowitz, Trager & Trager, LLC (Apr. 21, 2010); Letter from Alston Trading, LLC, RGM Advisors, LLC, Hudson River Trading, LLC, and Quantlab Financial, LLC (Apr. 23, 2010).

C. Department of the Treasury Request for Comment

In 2016, Treasury published notice seeking public comment on the evolution of the U.S. Treasury market structure and the implications for market functions, trading and risk management practices across the U.S. Treasury market, considerations with respect to more comprehensive official sector access to U.S. Treasury market data, and the benefits and risks of increased public disclosure of U.S. Treasury market activity.
62

In that Request for Comment, Treasury raised the issue of registration for certain market participants, including those persons engaging in automated trading or conducting a certain volume of trading.
63

Specifically, concerning its continued monitoring of trading and risk management practices across the U.S. Treasury market and reviewing regulatory requirements applicable to the government securities market and its participants, Treasury requested comment on: (1) Aligning standards between U.S. securities, commodities, and derivatives markets and the U.S. Treasury cash market; (2) the implications of a registration requirement for certain market participants, including those persons engaging in automated trading or conducting a certain volume of trading; and (3) whether such firms should be subject to capital requirements, examinations and supervision, conduct rules, and/or other standards.
64

A number of comment letters were submitted directly or indirectly responding to these questions.
65

Most

commenters explicitly supported consistent regulatory standards to be applied to certain market participants, including those persons engaging in automated trading or conducting a certain volume of trading,
66

with some commenters explicitly supporting the registration of market participants that are not currently registered as dealers.
67

One commenter was opposed to the registration of certain market participants citing disapproval of the “application of arbitrary thresholds when determining the applicability of regulation.”
68

Another commenter stated that “principal trading firms have played an increasingly larger role in offering liquidity in these markets, and have become de facto market makers.”
69

62

See
Treasury Request for Comment.

63

See
Treasury Request for Comment at 3930.

64

See
Treasury Request for Comment at 3931 (Questions 2.6, 2.6(a) and 2.6(b)).

65

See
Letter from Deirdre K. Dunn, Managing Director—Head of NA G10 Rates, Citi Global

Markets (Apr. 22, 2016) (“Citi Global”); Letter from Shane O'Cuinn, Managing Director, Credit Suisse/Global Markets (Apr. 22, 2016) (“Credit Suisse”); Letter from Joanna Mallers, Secretary, FIA Principal Traders Group (Apr. 22, 2016) (“FIA PTG”); Comment from Kermit Kubitz (Apr. 22, 2016); Letter from William Harts, Modern Market Initiative (Apr. 22, 2016) (“MMI”); Letter from Prudential Fixed Income (Apr. 21, 2016) (“Prudential”); Letter from Alan Mittleman, Managing Director, Head of USD Rates Trading, RBS Securities Inc. (Apr. 22, 2016) (“RBS Securities”); Letter from Reserve Bank of India (Apr. 22, 2016); Letter from Mike Zolik, Nate Kalich, and Larry Magargal, Ronin Capital, LLC (Mar. 19, 2016) (“Ronin Capital”); Letter from Timothy W. Cameron, Esq., Asset Management Group—Head and Lindsey Weber Keljo, Vice President and Assistant General Counsel, Asset Management Group, Securities Industry and Financial Markets Association (Apr. 22, 2016) (“SIFMA-AMG”); Letter from Greg Moore, Managing Director and Head of FICM New York, TD Securities (USA) LLC (Apr. 22, 2016) (“TD Securities”); and Letter from C. Thomas Richardson, Managing Director, Head of Market Structure, Head of Electronic Trading Services, and Cronin McTigue, Managing Director, Head of Liquid Products, Wells Fargo Securities (Apr. 21, 2016) (“Wells Fargo”).

66

See
Letter from Citi Global; Letter from Credit Suisse; Comment from Kermit Kubitz; Letter from MMI; Letter from Prudential; Letter from RBS Securities; Letter from Reserve Bank of India; Letter from Ronin Capital; Letter from SIFMA-AMG; Letter from TD Securities; and Letter from Wells Fargo.

67

See
Letter from Prudential; Letter from MMI; Letter from TD Securities; Letter from Reserve Bank of India; Letter Citi Global; and Letter from Ronin Capital.

68

See
Letter from FIA PTG.

69

See
Letter from Stuart Kaswell, Executive Vice President and Managing Director, General Counsel, and Jiří Król, Deputy CEO, Global Head of Government Affairs, Alternative Investment Management Association (Apr. 22, 2016) at 2 (describing the evolution of market structure generally).

D. Need for Commission Action

While the participation of these PTFs and other significant market participants that are not registered as dealers may have positive effects, such as through increased competition, there are risks that accompany such market participants' trading activities and the accompanying lack of regulatory obligations or oversight relating to such activity.
70

Among other things, scrutiny of the U.S. Treasury market, in light of recent market disruptions,
71

has identified a regulatory gap in terms of the registration status and regulation of significant market participants in the U.S. Treasury market. Not only does such a regulatory gap mean inconsistent oversight of market participants performing similar functions either in the same market or across asset classes but, as described below, the activity of significant market participants that are not registered may pose certain risks to the markets.

70

See
Section V for discussion of competition;
see also
Algorithmic Trading Staff Report.

71

See
2021 IAWG Report.

In particular, certain market participants, such as PTFs that are not registered as dealers, play an increasingly significant role as major liquidity providers across asset classes in the U.S. securities markets, including the U.S. Treasury market. These market participants engage in a significant volume of trading across many trading platforms for their own accounts, generally ending the day with a relatively small position. In the U.S. Treasury market, in particular, market commenters and financial regulators have stated that the rise of electronic trading and emergence of unregulated significant market participants over the years could be a contributing factor to the more frequent market disruptions, specifically stating that these changes are directly affecting liquidity provision.
72

72

See
2021 IAWG Joint Staff Report (stating that the October 15, 2014 market disruption made clear that, among other things, “electronic trading permitted rapid increases in orders that removed liquidity”) at 18, and G30 Report.

The Commission believes that, although the Proposed Rules will not by themselves necessarily prevent future market disruptions, the operation of the rules will support transparency; market integrity and resiliency; and investor protection; across the U.S. Treasury and other securities markets by closing the regulatory gap that currently exists and ensuring consistent regulatory oversight of persons engaging in the type of activities described in the Proposed Rules.
73

The requirement that dealers register has been repeatedly recognized as being “of the utmost importance in effecting the purposes of the [Exchange] Act. It is through the registration requirement that some discipline may be exercised over those who may engage in the securities business and by which necessary standards may be established with respect to training, experience, and records.”
74

For example, as described below in Section V.C, dealers and government securities dealers must register with the Commission and become members of a self-regulatory organization (“SRO”);
75

comply with Commission and SRO rules, including certain financial responsibility and risk management rules,
76

transaction and

other reporting requirements,
77

operational integrity rules,
78

and books and records requirements,
79

all of which help to enhance market stability by giving regulators increased insight into firm-level and aggregate trading activity and so help regulators to evaluate, assess, and address, as appropriate, market risks. In addition, registered dealers and government securities dealers are required to comply with specific anti-manipulative and other anti-fraud rules that are promulgated pursuant to Section 15(c) of the Exchange Act, thereby contributing to fair and orderly markets.
80

Firms that are government securities dealers (including registered broker-dealers trading government securities) must also comply with rules adopted by Treasury, including but not limited to rules relating to financial responsibility, recordkeeping, financial condition reporting, risk oversight, and large trader reporting.
81

Importantly, dealers and government securities dealers are subject to Commission and SRO examination, inspection, and enforcement for compliance with applicable Federal securities laws and SRO rules.
82

73

See
Section V.

74

River North,
415 F. Supp. 3d 853, 858 (citing
Benger,
697 F. Supp. 2d at 944 (quoting
Celsion Corp.
v.
Stearns Mgmt. Corp.,
157 F. Supp. 2d 942, 947 (N.D. Ill. 2001));
see also Roth
v.
SEC,
22 F.3d 1108, 1109 (D.C. Cir. 1994) (“The broker-dealer registration requirement serves as the keystone of the entire system of broker-dealer regulation.”);
see
Section 15(b)(7) of the Exchange Act, 15 U.S.C. 78o(b)(7), and 17 CFR 240.15b7-1 (Rule 15b7-1 thereunder) (requiring natural persons associated with a broker-dealer to be registered or approved “in accordance with the standards of training, experience, competence, and other qualification standards”);
see also
Financial Industry Regulatory Authority (“FINRA”) Rule 1210 (Registration Requirements) and FINRA Rule 1220 (Registration Categories), which require, for example, an associated person of a member broker-dealer of FINRA who is primarily responsible for the design, development, or significant modification of an algorithmic trading strategy, or who is responsible for supervising or directing such activities, to pass the Series 57 exam, register as a Securities Trader, and comply with continuing education requirements.

75

See
Sections 15(b)(8), 15C(e)(1), and 17(b) of the Exchange Act, 15 U.S.C. 78o(b)(8), 15 U.S.C. 78o-5(e)(1), and 15 U.S.C. 78q(b), respectively. Section 15(b)(8) of the Exchange Act makes it unlawful for any registered broker or dealer to effect any transaction in securities (with certain exceptions) unless the broker or dealer is a member of a registered securities association or effects transactions in securities solely on a national securities exchange of which it is a member. Section 15C(e)(1) of the Exchange Act requires that a registered government securities broker-dealer, other than certain financial institutions, become a member of a registered national securities exchange or registered national securities association. Because government securities are not traded on registered national securities exchanges, a person that registers as a government securities dealer under Section 15C to trade only government securities would need to become a member of a registered national securities association (FINRA is the only registered national securities association). Currently, however, a person that is engaged in a regular business of buying and selling both government securities and other securities for its own account, and therefore registers as a dealer under Section 15, could potentially be exempt from Section 15(b)(8)'s national securities association membership requirement if it is or becomes a member of a national securities exchange and satisfies other requirements.
See
17 CFR 240.15b9-1. Section 17(b) of the Exchange Act provides, among other things, that all records of a broker-dealer are subject at any time, or from time to time, to such reasonable, periodic, special, or other examinations by representatives of the Commission and the appropriate regulatory agency of the broker-dealer as the Commission or the appropriate regulatory agency deems necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act.

76

See, e.g.,
17 CFR 240.15c3-1 (Exchange Act Rule 15c3-1) (the “Net Capital Rule”; Financial Responsibility Rules for Broker-Dealers, Exchange Act Release No. 70072 (July 30, 2013), 78 FR 51823 at 51849 (Aug. 21, 2013) (“The capital standard in

Rule 15c3-1 is a net liquid assets test. This standard is designed to allow a broker-dealer the flexibility to engage in activities that are part of conducting a securities business (
e.g.,
taking securities into inventory) but in a manner that places the firm in the position of holding at all times more than one dollar of highly liquid assets for each dollar of unsubordinated liabilities (
e.g.,
money owed to customers, counterparties, and creditors)”). The rule imposes a “moment to moment” net capital requirement in that broker-dealers must maintain an amount of net capital that meets or exceeds their minimal net capital requirement at all times.

77

See, e.g.,
FINRA Rule 6730(a)(1) (requiring FINRA members to report transactions in TRACE-Eligible Securities, including Treasury securities, which promotes transparency to the securities markets, including the Treasury market, by providing market participants with comprehensive access to transaction data); FINRA Rule 7200 (Trade Reporting Facilities); FINRA Rule 4530 (Reporting Requirements) which requires FINRA members to report among other things when the member or an associated person of the members has violated certain specified regulatory requirements, is subject to written customer complaint, and is denied registration or is expelled, enjoined, directed to cease and desist, suspended or disciplined by a specified regulatory body. The provision at 17 CFR 240.17a-5(d)(1)(i)(A) (Exchange Act Rule 17a-5(d)(1)(i)(A)) requires broker-dealers, subject to limited exceptions, to file annual reports, including financial statements and supporting schedules that generally must be audited by a Public Company Accounting Oversight Board (PCAOB)-registered independent public accountant in accordance with PCAOB standards.

78

See, e.g.,
17 CFR 240.15c3-5 (Exchange Act Rule 15c3-5)—Risk Management Controls for Brokers or Dealers with Market Access (the “Market Access Rule”) promotes market integrity by reducing risks associated with market access by requiring financial and regulatory risk management controls reasonably designed to limit financial exposures and ensure compliance with applicable regulatory requirements.

79

See, e.g.,
Section 17(a) of the Exchange Act and 17 CFR 240.17a-3 and 240.17a-4 (Rules 17a-3 and 17a-4 thereunder);
see also, e.g.,
FINRA Rules 2268, 4510, 4511, 4512, 4513, 4514, 4515, 5340 and 7440(a)(4) (requiring member firms to make and preserve certain books and records to show compliance with applicable securities laws, rules, and regulations and enable Commission and FINRA staffs to conduct effective examinations); NYSE Rule 440 (Books and Records); CBOE Exchange Rule 7.1 (Maintenance, Retention and Furnishing of Books, Records and Other Information). Among other things, Commission and SRO books and records rules help to ensure that regulators can access information to evaluate the financial and operational condition of the firm, including examining compliance with financial responsibility rules, among other rules, as well as assess whether and how a firm's participation in the securities markets impacted a major market event.
See
Staff Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) at 72.
See also
Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers; Capital Rule for Certain Security-Based Swaps Dealers, Exchange Act Release No. 71958 (Apr. 17, 2014), 79 FR 25194, 25199 (May 2, 2014) (“The requirements are an integral part of the investor protection function of the Commission, and other securities regulators, in that the preserved records are the primary means of monitoring compliance with applicable securities laws, including antifraud provisions and financial responsibility standards.”).

80

See, e.g.,
Sections 15(c)(1) and (2) of the Exchange Act, 15 U.S.C. 78o(c)(1) and (2), and rules promulgated thereunder.

81
Under Title I of the Government Securities Act (“GSA”), all government securities brokers and government securities dealers are required to comply with the requirements in Treasury's GSA regulations that are set out in 17 CFR parts 400 through 449. For the most part, Treasury's GSA regulations incorporate with some modifications: (1) Commission rules for non-financial institution government securities brokers and government securities dealers; and (2) the appropriate regulatory agency rules for financial institutions that are required to file notice as government securities brokers and government securities dealers.
See, e.g.,
17 CFR part 400, Rules of general application; 17 CFR part 401, Exemptions; 17 CFR part 402, Financial responsibility; 17 CFR part 403, Protection of customer securities and balances; 17 CFR part 404, Recordkeeping and preservation of records; 17 CFR part 405, Reports and audit; 17 CFR part 420, Large position reporting; and 17 CFR part 449, Forms, Section 15C of the Exchange Act. The GSA regulations also include requirements for custodial holdings by depository institutions at 17 CFR part 450, which were issued under Title II of the GSA. The Treasury GSA regulations provide in many instances that a registered dealer can comply with a Commission rule to establish compliance with the comparable Treasury requirement.
See, e.g.,
17 CFR 402.1(b) (Treas. Reg. § 402.1(b)) (“This part does not apply to a registered broker or dealer . . . that is subject to [Exchange Act Rule 15c3-1].”); 17 CFR 403.1 (Treas. Reg. § 403.1) (regarding application to registered brokers or dealers); 17 CFR 404.1 and 405.1(a) (Treas. Reg. §§ 404.1 and 405.1(a)) (same).

82

See
Exchange Act Section 15(b) (regarding Commission authority to sanction brokers and dealers); Section 15C(c) (regarding Commission authority to sanction government securities dealers that are registered with it); Section 15C(d) (authorizing the Commission to examine books and records of government securities dealers registered with it); and Section 17(b) (broker-dealer recordkeeping and examination).
See also
Section 15C(g) (restricting the ability of the Commission with respect to government securities dealers that are not registered with the Commission).

III. Overview of Proposed Rules

The operative concept in the definitions of “dealer” and “government securities dealer”—that distinguishes the regulated entity from the unregulated trader—is that the dealer is engaged in buying and selling securities for its own account “as part of a regular business.”
83

The Commission is proposing two rules—proposed Rules 3a5-4 and 3a44-2—to further define these terms to identify certain activities that would constitute a “regular business” requiring a person engaged in those activities to register as a “dealer” or a “government securities dealer,” absent an exception or exemption.
84

A person (as defined below) who engages in any one of the activities identified in either proposed Rule 3a5-4 or 3a44-2 would be considered a dealer under that rule.
85

83
As discussed above, the definitions of “dealer” and “government securities dealer” under the Exchange Act exclude from dealer status a person that buys or sells securities for such person's own account “but not as a part of a regular business.”
See
15 U.S.C. 78c(a)(5)(A) and (B) and 15 U.S.C. 78c(a)(44)(A).

84

See
Exchange Act Section 15 (regarding registration of dealers) and Section 15C (regarding registration of government securities dealers).

85
Status as a securities “dealer” or “government securities dealer” as a result of engaging in securities or government securities transactions “as part of a regular business” under proposed Rules 3a5-4 or 3a44-2 is not determinative of a person's status for purposes of the exclusions in Section 3(c)(2) of the Investment Company Act. Although that exclusion uses some terminology that is similar to that in the Proposed Rules, Section 3(c)(2) includes a number of conditions in addition to the requirement that a person regularly engage in transactions on both sides of the market, each of which an entity would have to satisfy to be able to rely on the investment company exclusion.

As explained above, over the years the Commission and the courts have identified a number of qualitative factors, including acting as a market maker, de facto market maker, or liquidity provider, that might indicate a person may be engaged in a regular business of buying and selling securities for its own account.
86

The Proposed Rules would expand upon these statements to further define three qualitative standards designed to more specifically identify activities of certain market participants who assume dealer-like roles, specifically, persons whose trading activity in the market “has the effect of providing liquidity” to other

market participants.
87

While all market participants who buy or sell securities in the marketplace arguably contribute to a market's liquidity, the Proposed Rules focus on market participants who engage in a routine pattern of buying and selling securities for their own account that has the effect of providing liquidity. Said differently, for market participants engaging in any of the activities identified by the qualitative standards of the Proposed Rules, liquidity provision is not incidental to their trading activities. Rather, these persons are “in the business” of buying and selling securities for their own account and providing liquidity as part of a regular business.
88

The Proposed Rules would set forth three standards that the Commission believes would appropriately distinguish and identify such liquidity provision as a “regular business.”

86

See
2002 Release (stating that a person generally may satisfy the definition, and therefore, be acting as a dealer in the securities markets, by conducting various activities, including “acting as a market maker or specialist on an organized exchange or trading system” or “acting as a
de facto
market maker whereby market professionals or the public look to the firm for liquidity”).

87
As noted below, the Proposed Rules are not the exclusive means of establishing that a person is a dealer or government securities dealer—to the extent consistent with the Proposed Rules, existing Commission interpretations and precedent will continue to apply.
See above
Section II.A. For example, facts indicating a person may be acting as a “dealer” include underwriting, as well as buying and selling directly to securities customers together with conducting any of an assortment of professional market activities such as providing investment recommendations, extending credit, and lending securities in connection with transactions in securities, and carrying a securities account.
See
2002 Release.
See also SEC
v.
Justin W. Keener d/b/a JMJ Financial,
No. 20-cv-21254 (S.D. Fla. Jan. 21, 2022). Accordingly, a person may still be acting as a dealer even if they do
not,
under the Proposed Rules, engage in a routine pattern of buying and selling securities that has the effect of providing liquidity to other market participants.
See
proposed Rule 3a5-4(c) and proposed Rule 3a44-2(c), discussed below in Section III.E.

88
PTFs engaging in passive market making, for example, earn revenue primarily from the provision of liquidity, specifically “by buying at the bid and selling at the offer and capturing any liquidity rebates offered by trading centers to liquidity supplying orders.”
See, e.g.,
2010 Equity Market Structure Concept Release at 3607.

In addition, proposed Rule 3a44-2, which would apply only to government securities dealers, would include a quantitative standard.
89

This quantitative standard would establish a bright-line test, under which a person engaging in certain specified levels of activity would be deemed to be buying and selling government securities “as a part of a regular business,” regardless of whether it meets any of the qualitative standards.
90

89

See
Section III.C.

90

See id.

A person whose activity meets the quantitative or any of the qualitative standards would be a dealer and so subject to the Exchange Act registration requirements, regardless of whether the liquidity provision is a chosen consequence of its activities.
91

91
The Proposed Rules focus on effect regardless of a person's intention. The fact that the provision of liquidity is a fundamental aspect of the activities captured by the qualitative standards does not mean that such liquidity provision need be deliberate to come within the Proposed Rules. Intent is not required by the statutory language, nor is it relevant in every circumstance.

To account for variations in corporate structure and ownership, the Proposed Rules additionally would define the terms “own account” and “control.” The Proposed Rules would define a person's “own account” to mean, subject to certain exceptions, any account: (i) Held in the name of that person; (ii) held in the name of a person, over whom that person exercises control or with whom that person is under common control;
92

or (iii) held for the benefit of those persons identified in (i) and (ii). In addition, the Proposed Rules would give “control” the “same meaning as prescribed in § 240.13h-l (Rule 13h-l), under the Exchange Act.”

92
The Proposed Rules would exclude from aggregation under paragraph (b)(2)(ii): (A) An account in the name of a registered broker, dealer, government securities dealer, or an investment company registered under the Investment Company Act; (B) with respect to an investment adviser registered under the Advisers Act, an account held in the name of a client of the adviser unless the adviser controls the client as a result of the adviser's right to vote or direct the vote of voting securities of the client, the adviser's right to sell or direct the sale of voting securities of the client, or the adviser's capital contributions to or rights to amounts upon dissolution of the client; or (C) with respect to any person, an account in the name of another person that is under common control with that person solely because both persons are clients of an investment adviser registered under the Advisers Act unless those accounts constitute a parallel account structure.

While the Proposed Rules would establish standards that identify when a person is acting as a dealer or government securities dealer, whether a person's activities meet these standards would remain a facts and circumstances determination.
93

Importantly, the Proposed Rules are not the exclusive means of establishing that a person is a dealer or government securities dealer—to the extent consistent with the Proposed Rules, existing Commission interpretations and precedent will continue to apply.
94

93

Cf.
2002 Release (“[T]he analysis of whether a person meets the definition of a dealer depends upon all of the relevant facts and circumstances.”).

94

See
Section II.A. For example, a person generally may satisfy the statutory definition of “dealer” by underwriting, or buying and selling directly to securities customers together with conducting any of an assortment of professional market activities such as providing investment recommendations, extending credit, and lending securities in connection with transactions in securities, and carrying a securities account.
See
2002 Release.

A market participant that is not registered as a dealer that comes within the scope of the Proposed Rules would need to register with the Commission as a dealer or government securities dealer and become a member of an SRO. This would involve filing Form BD with the Commission and completing the SRO's processes for new members.
95

The Commission is proposing to provide such market participants a one-year compliance period from the effective date of any final rules. The proposed compliance period is designed to provide adequate time for persons captured by the Proposed Rules at the time of adoption, if adopted, to apply for dealer registration, and for the relevant SROs to conduct their review of the new member applications, without disrupting the markets or the participants' market activities. The proposed compliance period would not cover market participants whose activities following the effective date of any final rules require registration as dealers under those rules.

95
After receiving a substantially complete application package, FINRA, for instance, must review and process it within 180 calendar days.
See
“How to Become a Member—Member Application Time Frames,”
available at https://www.finra.org/registration-exams-ce/broker-dealers/how-become-member-membership-application-time-frames. See also
FINRA Rule 1014.

A. Persons Excluded From the Proposed Rules

Under the Proposed Rules, the term “person” would have the same meaning as prescribed in Section 3(a)(9) of the Exchange Act.
96

As a threshold matter, the Proposed Rules would not apply to: (i) “[a] person that has or controls total assets of less than $50 million;”
97

or (ii) “[an] investment company registered under the Investment Company Act.”
98

96

See
proposed Rule 3a5-4(b)(1) and proposed Rule 3a44-2(b)(1).

97

See
proposed Rule 3a5-4(a)(2)(i) and proposed Rule 3a44-2(a)(3)(i). While a person who has or controls less than $50 million in total assets would not be subject to the Proposed Rules, that person's trading volume or activities may still be aggregated with those of another person under the Proposed Rules definitions of “own account” and “control.”
See
Section III.D.

98

See
proposed Rule 3a5-4(a)(2)(ii) and proposed Rule 3a44-2(a)(3)(ii).

As discussed above, the Proposed Rules are intended to capture market participants not registered as dealers that serve a critical dealer-like role in the securities and government securities markets through their liquidity provision or significant and regular trading activity in the market. By providing an exception for persons that have or control total assets of less than $50 million, the Proposed Rules would parallel an established standard for distinguishing between “retail” and “institutional” investors in other

contexts.
99

The Commission believes that this threshold is appropriate in the context of the Proposed Rules because, even though a person that has or controls less than $50 million in assets may be engaged in the activities identified in the Proposed Rules' qualitative standards,
100

the frequency and nature of its securities trading are less likely to pose the types of financial and operational risks to the market that may be associated with the significant dealer-like activity engaged in by certain PTFs and other institutional market participants, that the Proposed Rules are designed to address.
101

This is not an exclusion from the dealer definition for all purposes. Rather, as with other persons not within the ambit of the Proposed Rules, the question of whether a person that has or controls less than $50 million in total assets is acting as a dealer, as opposed to a trader, will remain a facts and circumstances determination, and to the extent consistent with the Proposed Rules, existing applicable interpretations and precedent will continue to apply.
102

99
Under FINRA rules, a “retail” account is distinguished from an “institutional” account by defining, in part, an institutional account as belonging to “a person (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of at least $50 million.” FINRA Rule 4512(c)(3);
see also
Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 77617 (Apr. 14, 2016), 81 FR 29959, 29995 n.462 (May 13, 2016) (adopting a similar threshold for purposes of 17 CFR 240.15Fh-3(f)(4) (Exchange Act Rule 15Fh-3(f)(4))). The Proposed Rules do not use the definition of “retail customer” adopted as part of Regulation Best Interest, as the policy considerations behind that definition are different than those presented here: The focus of Regulation Best Interest is the regulatory protections provided to customers who receive recommendations from broker-dealers, whereas the focus of this proposed rulemaking is the regulation of persons engaging in certain dealer-like activities.
See
Regulation Best Interest: The Broker-Dealer Standard of Conduct, Exchange Act Release No. 86031 (June 5, 2019), 84 FR 33318 (July 12, 2019).

100
As discussed in Section III.C, to meet the quantitative standard set forth in proposed Rule 3a44-2(a)(2) a person must, in each of four out of the last six calendar months, engage in buying and selling more than $25 billion of trading volume in government securities as defined in Section 3(a)(42)(A) of the Exchange Act. The Commission believes that there will not be any instances where a person who has or controls less than $50 million in total assets will meet this quantitative standard.

101
Depending on the scope and nature of its activities, such a person could come within the definition of “pattern day trader” under FINRA rules.
See
FINRA Rule 4210. Notably, among other requirements, a pattern day trader must maintain a minimum amount of equity in its margin account on any day that the customer day trades and this minimum equity must be in the account prior to engaging in any day-trading activities.
Id.
If the account falls below the minimum requirement, the pattern day trader will not be permitted to day trade until the account is restored to the minimum equity level.
Id.

102
As discussed above, dealer status involves engaging in “more than a few isolated” securities transactions.
See supra
note 47 and accompanying text.

The Commission is proposing to exclude registered investment companies from the application of the Proposed Rules.
103

Registered investment companies are subject to a regulatory framework under the Investment Company Act and rules thereunder, which imposes requirements regarding capital structure,
104

custody of assets,
105

investment activities,
106

transactions with affiliates and other conflicts of interest,
107

and the duties and independence of boards of directors, among other things.
108

Moreover, registered investment companies are subject to statutory limits on indebtedness and rules that limit leverage risk.
109

In addition, registered investment companies must adopt, implement, and review at least annually written policies and procedures reasonably designed to prevent violations of the Federal securities laws by the fund.
110

These policies and procedures must be approved by the fund's board of directors, including a majority of independent directors, and are administered by a designated chief compliance officer.
111

Registered investment companies are required to register under the Investment Company Act and offer their shares under the Securities Act of 1933 (“Securities Act”).
112

They also must report to the Commission on many aspects of their operations and their portfolio holdings.
113

Registered investment companies must maintain certain books and records and make them available for examination by the Commission.
114

As a result, the Commission has extensive oversight of registered investment companies and broad insight into their operations and activities. In light of the regulatory structure that governs registered investment companies, which addresses, among other things, the types of concerns that we seek to address in the Proposed Rules, the Commission is proposing to exclude registered investment companies from the application of the Proposed Rules.
115

103
A registered investment company includes any issuer which is or holds itself out as being primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities. 15 U.S.C. 80a-3(a)(1)(A). The Investment Company Act generally prohibits a domestic registered investment company from offering or selling any security unless the company is registered under Section 8 of the Investment Company Act. 15 U.S.C. 80a-7(a).

104

See
15 U.S.C. 80a-18.

105

See
15 U.S.C. 80a-17(f); 17 CFR 270.17f-1 through 270.17f-7.

106

See, e.g.,
15 U.S.C. 80a-12(d)(1), 12(d)(3).

107

See
15 U.S.C. 80a-17(a), (d), (e); 17 CFR 270.17d-1, 270.17e-1.

108

See, e.g.,
15 U.S.C. 80a-2(a)(41), 15, 17(f), 17 CFR 270.17(j), 270.31(a); 17 CFR 270.2a-4, 270.2a-5, 270.10f-3, 270.12b-1, 270.17a-7, 270.17e-1, 270.22c-1, 270.38a-1.

109

See
15 U.S.C. 80a-18 (Section 18 prohibits closed-end funds from issuing or selling senior securities that represent indebtedness unless it has at least 300 percent asset coverage, and open-end funds from issuing or selling a senior security other than borrowing from a bank, also subject to 300 percent asset coverage and defines “senior security,” in part, as “any bond, debenture, note, or similar obligation or instrument constituting a security and evidencing indebtedness.”); 17 CFR 270.18f-4 (generally requiring investment companies that use derivatives to adopt a derivatives risk management program that includes a limitation on leverage risk based on Value-at-Risk (VaR)).
See also
Use of Derivatives by Registered Investment Companies and Business Development Companies, Investment Company Act Release No. 34084 (Nov. 2, 2021), 85 FR 83162 (Dec. 21, 2020).

110
17 CFR 270.38a-1. The fund's policies and procedures also must provide for the oversight of compliance by the fund's advisers, principal underwriters, administrators, and transfer agents.
See also
15 U.S.C. 80a-47(a) (“It shall be unlawful for any person, directly or indirectly, to cause to be done any act or thing through or by means of any other person which it would be unlawful for such person to do under the provisions of this subchapter or any rule, regulation, or order thereunder.”).

111
17 CFR 270.38a-1.

112
Depending on the organizational form, investment companies register under the Investment Company Act and offer their shares under the Securities Act on Forms N-1A (open-end management investment companies), N-2 (closed-end management investment companies), N-3 (separate accounts organized as management companies), N-4 (separate accounts organized as unit investment trusts), N-5 (small business investment companies), and N-6 (separate accounts organized as unit investment trusts that offer variable life insurance products).

113
Registered investment companies report certain census information annually to the Commission on Form N-CEN. Registered investment companies also are required to report monthly portfolio-wide and position-level holdings data to the Commission on Form N-PORT. This includes information regarding repurchase agreements, securities lending activities, and counterparty exposures, terms of derivatives contracts, and discrete portfolio level and position level risk measures to better understand fund exposure to changes in market conditions.

114
15 U.S.C. 80a-30.

115
As discussed in Section III.D, for purposes of the definition of “own account,” an account held in the name of a person that is a registered investment company would not be attributed to a controlling person or another person under common control.

The Proposed Rules would not exclude private funds because we are taking a similar approach to regulating dealer activity across market participants and, unlike registered investment companies, private funds are not subject to the extensive regulatory framework of the Investment Company Act. The Commission is mindful that registered private fund advisers are regulated under the Advisers Act and that information on private fund activities is reported by registered

private fund advisers on Form PF.
116

The information the Commission obtains on private funds through its regulation of registered investment advisers, however, differs from that the Commission collects for the purposes of dealer regulation. In addition, dealer registration enhances regulatory oversight of market participants' trading activities and interactions with the market overall and dealer regulatory requirements focus broadly on market functionality (along with protecting investors under principles of fair dealing between parties).

116
The Commission recently has issued a proposal to amend Form PF, which would provide the SEC and the Financial Stability Oversight Counsel (“FSOC”) with additional confidential information about private funds. Information reported on Form PF has helped establish a baseline picture of the private fund industry for use in assessing systemic risk. These proposed amendments would apply to large hedge fund advisers, private equity advisers, and large liquidity fund advisers and are designed to enhance FSOC's and the Commission's ability to monitor systemic risk, bolster the Commission's regulatory oversight of private fund advisers, and enhance investor protection efforts.
See
Form PF Proposing Release,
supra
note 34.

Similarly, the Proposed Rules would not apply a blanket exclusion for registered investment advisers. A registered investment adviser trading for its “own account” as defined in the Proposed Rules could implicate dealer registration requirements.
117

The Commission is mindful, however, that with some clients, a registered investment adviser only exercises investment discretion over the client's account, while with some other clients, the adviser also may control the client through an ownership interest. The Proposed Rules take into account a registered investment adviser's role in determining what client trading activity should be attributed to the adviser for purpose of the rules.
118

117

See
proposed Rule 3a5-2(b)(2) and proposed Rule 3a44-2(b)(2).

118

See infra
note 185 and accompanying text.

Request for Comments

The Commission generally requests comment on this aspect of the Proposed Rules. In addition, the Commission requests comment on the following specific issues:

1. Should the Proposed Rules exclude persons that have or control less than $50 million in total assets? Are there instances in which persons that have or control less than $50 million in total assets that are buying and selling securities or government securities for their own accounts provide liquidity to the markets or have a significant impact on the markets that would warrant regulation as dealers or government securities dealers? Please explain.

2. Does the proposed $50 million in total assets threshold sufficiently distinguish persons whose activity should not be captured for purposes of the Proposed Rules? If not, is there another amount or measurement that would better distinguish these smaller market participants and achieve the purposes of the Proposed Rules? Please explain.

3. Would persons that would be captured by the Proposed Rules (
i.e.,
have or control more than $50 million in total assets) restructure their activities or change their corporate structures for the purpose of avoiding registration, including withdrawing or reducing their trading activities or ceasing investment strategies that trigger the application of the Proposed Rules? What would be the effects of such restructuring, withdrawal, or cessation? Please explain.

4. Should the Commission exclude registered investment companies from the scope of the Proposed Rules? Why or why not? If they are not excluded, do registered investment companies engage in activities that would be captured by the Proposed Rules? Could a registered investment company comply with the requirements applicable to dealers? What would be the potential costs and/or benefits of requiring registered investment companies to register as dealers or government securities dealers? Could the registered investment companies restructure their activities to avoid dealer registration? What would be the effects of such restructuring? Please explain.

5. The Proposed Rules do not exclude private funds, that is, pooled investment vehicles that are exempted from the definition of “investment company” under Section 3(c)(1) or 3(c)(7) of the Investment Company Act. Should the Commission except or exclude private funds from the scope of the Proposed Rules? Why or why not? Should the Commission except or exclude private funds advised by registered investment advisers from the scope of the Proposed Rules? Do some private funds engage in activities that would be captured by the Proposed Rules? Could a private fund comply with the requirements applicable to dealers? What would be the potential costs and/or benefits of requiring private funds to register as dealers or government securities dealers? Would private funds restructure their activities to avoid registration as a dealer? What would be the effects of such restructuring? Would private funds cease or reduce investment strategies captured by the Proposed Rules to avoid registration as a dealer? If so, what would be the effects of removing or reducing these investment strategies from the markets? Please explain.

6. Should registered investment advisers trading for their own accounts be excluded partially or entirely from the Proposed Rules? Why or why not? Could some registered investment advisers engage in activities that meet the proposed qualitative standards and trigger the application of the Proposed Rules? Could some registered investment advisers engage in trading volume in government securities that could exceed the quantitative threshold in proposed Rule 3a44-2? If registered investment advisers were captured by the Proposed Rules, how would they comply with the requirements applicable to dealers? Would the registered investment advisers restructure their activities to avoid registration as a dealer, including withdrawing or reducing their trading activities or ceasing or reducing investment strategies that trigger the application of the Proposed Rules? What would be the effects of such restructuring, withdrawal, or cessation? Please explain.

7. Instead of addressing investment adviser and private fund dealer concerns under the framework of existing dealer regulation, should the Commission consider a proposed rulemaking under the Advisers Act to address these concerns? What elements should be included in such a rulemaking? For example, should it include transaction reporting and/or capital requirements?

8. Should the Commission except or exclude any other categories of persons from the scope of the Proposed Rules? If so, what persons, and why? If not, why not?

B. Qualitative Standards

The qualitative standards in the Proposed Rules would build on existing statements by the Commission and the courts regarding “dealer” activity to further define certain standards for determining when a person that is engaged in buying and selling securities for its own account is engaged in that activity “as a part of a regular business,” as that phrase is used in Sections 3(a)(5) and 3(a)(44)(B) of the Exchange Act. Specifically, under paragraph (a)(1) of the Proposed Rules, a person would be engaged in buying and selling securities for its own account “as a part of a regular business” and so a dealer or a government securities dealer, if that person engages in a routine pattern of buying and selling securities (or

government securities) that has the effect of providing liquidity to other market participants.

The Proposed Rules further identify three types of activities that would be considered to have the effect of providing liquidity to other market participants: (i) Routinely making roughly comparable purchases and sales of the same or substantially similar securities (or government securities) in a day; or (ii) routinely expressing trading interests that are at or near the best available prices on both sides of the market and that are communicated and represented in a way that makes them accessible to other market participants; or (iii) earning revenue primarily from capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interests. The following discussion of the proposed qualitative standards is applicable to both rules, and references to “dealer” activity apply equally to both “dealers” and “government securities dealers” under Sections 3(a)(5) and 3(a)(44) of the Exchange Act, respectively, unless otherwise indicated.

Under the Proposed Rules, a person's securities trading activity would form a “part of a regular business” when that person “engages in a routine pattern of buying and selling securities [or government securities] that has the effect of providing liquidity to other market participants.”
119

Under this qualitative standard, when the frequency and nature of a person's securities trading is such that the person assumes a role—described as either market-making, de facto market-making, or liquidity-providing—similar to the role that historically has been performed by a set of registered dealers, that person would be deemed to be acting as a dealer or government securities dealer.
120

As elaborated below, the Proposed Rules identify three patterns of buying and selling that the Commission views as having the effect of providing liquidity—any one of which is sufficient to require a person to register as a dealer. As discussed below, no presumption shall arise that a person is not a dealer solely because that person does not engage in the activities described in the Proposed Rules.
121

Other patterns of buying and selling may have the effect of providing liquidity to other market participants or otherwise require a person to register under the Proposed Rules in accordance with applicable precedent.

119

See
proposed Rule 3a5-4(a)(1) and proposed Rule 3a44-2(a)(1).

120

See, e.g.,
2002 Release at 67499.

121

See
proposed Rule 3a5-4(c) and proposed Rule 3a44-2(c), discussed in Section III.E.

The Commission has long identified activities related to liquidity provision as factors that would indicate a person is “ `engaged in the business' of buying and selling securities.”
122

Historically, persons who provide liquidity in securities markets in exchange for compensation, earning revenue from the act of buying and selling itself, have registered as dealers.
123

And, from the enactment of the Exchange Act, the term “dealer” has included a class of liquidity providers that includes but is broader than market makers, encompassing, for example, professional floor traders who trade “in and out,” effect “about half of the transactions on the floor of the stock exchange,” and whose “profits depend upon . . . running along and playing with the trends and not getting caught taking positions.”
124

As securities markets have evolved, and new market participants have increasingly taken on market-making and liquidity-providing roles, the Commission has stated that dealer activity includes not only “acting as a market maker” but also “acting as a
de facto
market maker whereby market professionals or the public look to the firm for liquidity.”
125

Traders, by contrast, the Commission indicated, do “not mak[e] a market in securities.”
126

122
2002 Release at 67498-500. In addition, the staff has stated that, while “the practical distinction between a `trader' and a `dealer' is often difficult to make and depends substantially upon the facts, . . . [a]s a general matter, a trader does not[, among other things,] . . . furnish the services which are usually provided by dealers, such as quoting the market in one or more securities.” National Council of Savings Inst., SEC No-Action Letter, 1986 WL 67129 (July 27, 1986) (the staff declined to take a no-action position with respect to national trade association's members as “a determination of a Member's status under the [Exchange] Act would depend upon an analysis of all of that Member's securities activities, and not just” the activities described in the request).

123

See, e.g.,
Exchange Act Section 3(a)(38), 15 U.S.C. 78c(a)(38) (“The term `market maker' means any specialist permitted to act as a
dealer,
any
dealer
acting in the capacity of block positioner, and any
dealer
who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis.”) (emphasis added).
See also
Stock Exchange Regulation: Hearing on H.R. 7852 and H.R. 8720 Before the Committee on Interstate and Foreign Commerce, 73rd Congr. 117 (1934) (statement of Thomas Corcoran) (“The term `dealer' is broad enough to include . . . the floor trader . . . [whose] profits depend upon his running along and playing with the trends and not getting caught taking positions.”); 2002 Release at 67499 (“A person generally may satisfy the definition, and therefore, be acting as a dealer in the securities markets by . . . acting as a market maker or specialist on an organized exchange or trading system [or] acting as a de facto market maker whereby market professionals or the public look to the firm for liquidity . . . .”).

124

See
Stock Exchange Regulation: Hearing on H.R. 7852 and H.R. 8720 Before the Committee on Interstate and Foreign Commerce, 73rd Congr. 117 (1934) (statement of Thomas Corcoran).
See also
U.S. Securities and Exchange Commission, Report on the Feasibility and Advisability of the Complete Segregation of the Functions of Dealer and Broker 21, 25, 85, 109 (1936).

125

See
2002 Release at 67499.

126

Id.

In the context of the Proposed Rules, and as discussed further below, a “pattern” of trading means buying and selling repetitively. For a pattern to come within the Proposed Rules, both purchases and sales would have to be “routine” and have “the effect of providing liquidity” to other market participants. Further, as discussed below, the Proposed Rules would set forth three standards that the Commission believes would appropriately distinguish and identify such liquidity provision as a “regular business” as opposed to non-dealer, or trader, activity.

In this respect, the Proposed Rules focus on activity rather than label or status. The Proposed Rules by their terms would cover any person (as defined above) who “engages in a routine pattern of buying and selling securities [or government securities] that has the effect of providing liquidity to other market participants,” regardless of whether the person labels itself, or is commonly known as, a PTF.

The liquidity-providing activity captured by the Proposed Rules would include not only passive liquidity-providing activity
127

but also aggressive trading strategies, including structural or directional trading
128

that similarly

permit a person to earn revenue from the act of buying and selling itself. In this regard, the Proposed Rules would cover persons who trade, as part of a regular business,
129

“in and out” and whose “profits depend upon . . . running along and playing with the trends and not getting caught taking positions”—activity understood from the enactment of the Exchange Act to be a form of dealer activity—as well as more traditional forms of liquidity provision, such as market making.
130

127

See
Algorithmic Trading Staff Report at 39 (“Passive market-making involves submitting non-marketable orders on both sides (buy or `bid,' and sell or `offer') of the marketplace.”).

128

See id.
at 39-41 (citing 2010 Equity Market Structure Concept Release and SEC Staff of the Division of Trading and Markets, Equities Market Structure Literature Review Part II: High Frequency Trading (Mar. 18, 2014)) (describing broad types of short-term high frequency trading strategies). Market participants of the kind that this release addresses, including PTFs, may carry out passive market making strategies. They may also engage in a range of trading strategies that involve submitting aggressive orders, or a combination of passive and aggressive orders, “sometimes rapidly demanding liquidity, in order to quickly liquidate positions accumulated through providing liquidity.”
See
Algorithmic Trading Staff Report at 39-40;
see also
“Making,” “taking” and the material political economy of algorithmic trading, Donald MacKenzie, Economy and Society, 47:4, 501-23 (2018); High-Frequency Trading Strategies Michael Goldstein, Babson College, Amy Kwan, University of Sydney, Richard Philip, University of Sydney (Dec. 8, 2016); Exploring Market Making Strategy for High Frequency Trading: An Agent-Based Approach, Yibing Xiong, Takashi Yamada, Takao Terano (2015); SEC Staff of the Division of Trading and Markets, Equities Market Structure Literature

Review Part II: High Frequency Trading (Mar. 18, 2014). These passive and aggressive strategies are often referred to as “liquidity providing” and “liquidity demanding” or “liquidity taking” strategies respectively.
See, e.g.,
Algorithmic Trading Staff Report. Under the Proposed Rules, both passive and aggressive trading strategies would be considered forms of liquidity provision.

129

See supra
note 39.

130
Stock Exchange Regulation: Hearing on H.R. 7852 and H.R. 8720 Before the Committee on Interstate and Foreign Commerce, 73rd Congr. 117 (1934) (statement of Thomas Corcoran). For a discussion of “liquidity providing” versus “liquidity demanding” trading strategies,
see supra
note 128.

The Proposed Rules further define three patterns of buying and selling that the Commission views as having the effect of providing liquidity, which are discussed in turn below.

i. Routinely Making Roughly Comparable Purchases and Sales of the Same or Substantially Similar Securities in a Day

Under the first enumerated pattern, in proposed Rules 3a44-2(a)(1)(i) and 3a5-4(a)(1)(i) respectively, a person that, trading for its own account, “routinely mak[es] roughly comparable purchases and sales of the same or substantially similar securities in a day” would be engaged in a pattern of trading that “has the effect of providing liquidity to other market participants,” and therefore be a dealer or government securities dealer.
131

131

See, e.g.,
Amendments to Regulation SHO, Exchange Act Release No. 58775, 73 FR 61690, 61699 (Oct. 17, 2008) (“Regulation SHO Amendments”), in which the Commission stated that “[a] pattern of trading that includes both purchases and sales in roughly comparable amounts to provide liquidity to customers or other broker-dealers” would be one indicia of bona-fide market-making activity for purposes of the exceptions in 17 CFR 242.200 through 242.204 (Regulation SHO) to the locate and close-out requirements. The determination of eligibility for the bona-fide market-making exceptions is distinct from the determination of whether a person's trading activity indicates that such person is acting as a dealer under the Proposed Rule. Under the Regulation SHO exception, for instance, the broker-dealer must also be providing widely disseminated quotations near or at the market and put itself at market risk. As the Commission has stated on numerous occasions, the determination of whether a particular short sale qualifies for the bona-fide market-making exception depends on the particular facts and circumstances surrounding the transaction(s).
See infra
note 157. Importantly, under the Proposed Rules, a person's intent is irrelevant; the Proposed Rules focus on the “effect” of a person's activity, and where a person's activity “has the effect of providing liquidity,” whether or not that effect is intended, the person would fall within the scope of the Proposed Rules.

“Routinely” as used in this standard relates to the frequency with which a person engages in making roughly comparable purchases and sales of the same or substantially similar securities in a day. Here, “routinely” means more frequent than occasional but not necessarily continuous,
132

such that a person's transactions in roughly comparable positions, throughout the day and routinely over time, constitute “[engaging] in a routine pattern of buying and selling securities that has the effect of providing liquidity for market participants” under the Proposed Rules. The Commission believes that this interpretation of “routinely” will separate persons engaging in isolated or sporadic securities transactions from persons whose regularity of participation in securities transactions demonstrates that they are acting as dealers.

132
As discussed below in Section III.A.ii, the Commission believes it is appropriate to use “routine,” rather than “regular” or “continuous,” as these standards may fail to capture a number of significant firms, due to the unique characteristics of certain liquidity providers in today's markets. Unlike many traditional types of liquidity providers, there are liquidity providers in today's markets, such as PTFs, that despite routine participation in the market, may at times interrupt their market activity so that it is not always “continuous.” The Commission adopted a similar approach in connection with its joint rulemaking with the Commodity Futures Trading Commission regarding, among other things, the definitions of “swap dealer” and “security-based swap dealer.”
See
Entities Adopting Release at 30609 (“making a market in swaps is appropriately described as routinely standing ready to enter into swaps at the request or demand of a counterparty. In this regard, `routinely' means that the person must do so more frequently than occasionally, but there is no requirement that the person do so continuously.”).

As discussed above, the frequency with which a person buys and sells securities for its own account is a common component of the dealer analysis: More frequent buying and selling is indicative of dealer activity.
133

The first qualitative standard of the Proposed Rules describes a regularity of participation far beyond the isolated transactions of non-dealers,
134

and focuses on a pattern of trading because the consistency and regularity of their participation indicates that their liquidity provision forms a part of a regular business.

133

See
Section II.A.

134

See SEC
v.
Justin W. Keener d/b/a JMJ Financial,
No. 1:20-CV-21254 (S.D. Fla. Jan. 21, 2022) (“Case law has established that the primary indicia in determining that a person has `engaged in the business' within the meaning of the term `dealer' is that the level of participation in purchasing and selling securities involves
more than a few isolated transactions.
” (emphasis added) (
quoting Sodorff,
1992 WL 224082, at *4)).

Under the Proposed Rules, “roughly comparable” would generally capture purchases and sales similar enough, in terms of dollar volume, number of shares, or risk profile, to permit liquidity providers to maintain near market-neutral positions by netting one transaction against another transaction. To be “roughly comparable,” the dollar volume or number of shares of, or risk offset by, the purchases and sales need not be exactly the same, as requiring a full netting of positions may fail to capture a number of significant firms, due to the unique characteristics of certain liquidity providers in today's markets.
135

Instead, “roughly comparable” purchases and sales would fall within a reasonable range that generally would have the effect of offsetting one transaction against the other. Generally speaking, although the Proposed Rules do not provide a bright-line test in connection with the qualitative factors, the Commission believes that a person that closes or offsets, in the same day, the overwhelming majority of the positions it has opened, has likely made “roughly comparable purchases and sales.”
136

This proposed standard would capture a fundamental aspect of both the traditional dealer—who “buys securities . . . with a view to disposing them elsewhere” and “receives no brokerage commission but relies for his compensation upon a favorable difference or spread between the price at which he buys and the amount for which he sells”
137

—and the liquidity provider whose trading strategies generally involve frequent turnover of positions on a short-term basis, with overnight holdings of unhedged positions that are a fraction of their overall intraday positions.
138

135

See, e.g.,
2002 Release (focusing, among other things, on a “regular turnover of inventory” rather than requiring completely neutral positions).

136
The Proposed Rules do not provide a bright-line test to determine “roughly comparable” purchases and sales. However, for purposes of the Economic Analysis of the Proposed Rules, the Commission assumes a daily buy-sell imbalance between two identical or substantially similar securities, in terms of dollar volume, below 10 percent or, alternatively, 20 percent may be indicative of purchases and sales that are “roughly comparable,” as described below in Section V.B.2.c. The Commission has requested comment on whether this approach is appropriate and whether this standard should include a trading threshold.

137

See
U.S. Securities and Exchange Commission, Report on the Feasibility and Advisability of the Complete Segregation of the Functions of Dealer and Broker XIV (1936).

138

See
2010 Equity Market Structure Concept Release at 3607-09.
See also
2015 Joint Staff Report.

The Proposed Rules reflect the statutory distinction between “dealers” and “traders.” The Commission has long distinguished dealer activity from trader activity by focusing on, among other things, a dealer's frequent turnover of positions—stating, for example, that the dealer “sells securities . . . he has purchased or intends to purchase elsewhere or buys securities . . . with a view to disposing of them elsewhere”
139

—as well as the frequency with which a person buys and sells.
140

By targeting persons who routinely make roughly comparable purchases and sales of the same or substantially similar securities, the Proposed Rules identify persons whose trading has the effect of providing liquidity that requires dealer registration, and so distinguish those persons who are acting as traders.
141

139

See
U.S. Securities and Exchange Commission, Report on the Feasibility and Advisability of the Complete Segregation of the Functions of Dealer and Broker XIV (1936).

140

See
Section II.A.

141

See
Section I.

The Proposed Rule

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2022-06960. Public record. Not legal advice.