Supplemental Information and Reopening of Comment Period for Amendments Regarding the Definition of “Exchange”

Federal RegisterMay 5, 2023

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 232, 240, 242, and 249

[Release No. 34-97309; File No. S7-02-22]

RIN 3235-AM45

Supplemental Information and Reopening of Comment Period for Amendments Regarding the Definition of “Exchange”

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule; reopening of comment period.

SUMMARY:

The Securities and Exchange Commission (“Commission”) is reopening the comment period for its proposal (“Proposed Rules”) to amend the rule under the Securities Exchange Act of 1934 (“Exchange Act”) that defines certain terms used in the statutory definition of “exchange.” The reopening provides supplemental information and economic analysis regarding trading systems that trade crypto asset securities that would be newly included in the definition of “exchange” under the Proposed Rules. The Commission is requesting further information and public comment on certain aspects of the Proposed Rules as applicable to all securities and the compliance dates and other alternatives for the Proposed Rules. The Proposed Rules were set forth in Release No. 34-94062 (“Proposing Release”), and the related comment period, which was reopened in Release No. 34-94868 on May 9, 2022, ended on June 13, 2022. The reopening of this comment period is intended to allow interested persons further opportunity to analyze and comment on the Proposed Rules in light of the supplemental information provided herein (“Reopening Release”).

DATES:

The comment period for the proposed amendments published on March 18, 2022, at 87 FR 15496, which was initially reopened on May 12, 2022, at 87 FR 29059, is again reopened. Comments should be received on or before June 13, 2023.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form (

https://www.sec.gov/regulatory-actions/how-to-submit-comments

); or

• Send an email to

rule-comments@sec.gov.

Please include File Number S7-02-22 on the subject line.

Paper Comments

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

All submissions should refer to File Number S7-02-22. 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 of submission. The Commission will post all comments on the Commission's website (

https://www.sec.gov/rules/proposed.shtml

). Comments are also 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 a.m. and 3 p.m. Operating conditions may limit access to the Commission's Public Reference Room. All comments received will be posted without change. 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 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:

Tyler Raimo, Assistant Director, Matthew Cursio, David Garcia, Eugene Hsia, Megan Mitchell, Amir Katz, Special Counsels, and Joanne Kim, Attorney Advisor, at (202) 551-5500, Office of Market Supervision, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Background

A. Exchange Regulatory Framework

Exchange Act section 3(a)(1) states that the term “exchange” means any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange.

See

15 U.S.C. 78c(a)(1).

Title 17 section 240.3b-16(a) (“Rule 3b-16(a)”) defines certain terms in the definition of “exchange” under section 3(a)(1) of the Exchange Act to include any organization, association, or group of persons that: (1) brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.

Title 17 section 240.3b-16(b) (“Rule 3b-16(b)”) explicitly excludes certain systems from the definition of “exchange.”

Title 17 section 240.3b-16 (“Rule 3b-16”) provides a functional test to assess whether a trading platform meets the definition of exchange and, if so, triggers exchange registration. Section 5 of the Exchange Act

requires an organization, association, or group of persons that meets the definition of “exchange” under section 3(a)(1) of the Exchange Act, unless otherwise exempt, to register with the Commission as a national securities exchange pursuant to section 6 of the Exchange Act.

See

17 CFR 240.3b-16(a).

See

Securities Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR 70844, 70852 (Dec. 22, 1998) (“Regulation ATS Adopting Release”). Specifically, Rule 3b-16(b) excludes from the definition of “exchange” systems that perform only traditional broker-dealer activities, including: systems that route orders to a national securities exchange, a market operated by a national securities association, or a broker-dealer for execution, or systems that allow persons to enter orders for execution against the bids and offers of a single dealer if certain additional conditions are met. 17 CFR 240.3b-16(b).

15 U.S.C. 78e. Registered national securities exchanges are also self-regulatory organizations (“SROs”), and must comply with regulatory requirements applicable to both national securities exchanges and SROs.

15 U.S.C. 78f.

Title 17 section 240.3a1-1(a)(2) (“Rule 3a1-1(a)(2)”) exempts from the Exchange Act section 3(a)(1) definition of “exchange” an organization, association, or group of persons that complies with Regulation ATS, which requires, among other things, meeting the definition of an alternative trading system (“ATS”) and registering as a broker-dealer.

As a result of the exemption, an organization, association, or group of persons that meets the definition of an exchange and complies with Regulation ATS is not required by section 5 of the Exchange Act to register

as a national securities exchange pursuant to section 6 of the Exchange Act, is not an SRO, and, therefore, is not required to comply with the regulatory requirements applicable to national securities exchanges and SROs.

“Regulation ATS” consists of 17 CFR 242.300 through 242.304 (Rules 300 through 304 under the Exchange Act).

An ATS that fails to comply with the requirements of Regulation ATS would no longer qualify for the exemption provided under Rule 3a1-1(a)(2), and thus, risks operating as an unregistered exchange in violation of section 5 of the Exchange Act.

See

Securities Exchange Act Release No. 83663 (July 18, 2018), 83 FR 38768, 38772 n.36 (Aug. 7, 2018) (“NMS Stock ATS Adopting Release”).

B. January 2022 Proposed Amendments to Exchange Act Rule 3b-16

As described more fully in the Proposing Release,

the Commission proposed to amend Exchange Act Rule 3b-16 to, among other things, replace “orders” with “trading interest” and define “trading interest”;

remove the term “multiple” before “buyers and sellers”;

add “communication protocols” as an example of an established, non-discretionary method that an organization, association, or group of persons can provide to bring together buyers and sellers of securities; simplify and align the rule text with the statutory definition of “exchange” under section 3(a)(1) of the Exchange Act; and add an exclusion under Exchange Act Rule 3b-16(b) for systems that allow an issuer to sell its securities to investors.

See

Securities Exchange Act Release No. 94062 (Jan. 26, 2022), 87 FR 15496 (Mar. 18, 2022). The Proposed Rules also: (1) re-proposed amendments to Regulation ATS for 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 (“Government Securities ATSs”); (2) proposed amendments to Form ATS-N for NMS Stock ATSs and Government Securities ATSs; (3) proposed amendments to 17 CFR 242.301(b)(5) (“Rule 301(b)(5)”) of Regulation ATS (“Fair Access Rule”) for ATSs; (4) proposed to require electronic filing of and to modernize Form ATS and Form ATS-R; and (5) re-proposed amendments to regulations regarding systems compliance and integrity to apply to 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.

As proposed, “trading interest” (defined in proposed Rule 300(q) of Regulation ATS) would include “orders,” as the term is defined under 17 CFR 240.3b-16(c) (“Rule 3b-16(c)”), or any non-firm indication of a willingness to buy or sell a security that identifies at least the security and either quantity, direction (buy or sell), or price.

See

Proposing Release at 15540.

The Commission proposed removing the word “multiple” from Exchange Act Rule 3b-16(a)(1) to mitigate confusion as to its application to non-firm trading interest, including request-for-quote (“RFQ”) systems, and align the rule more closely with the statutory definition of “exchange,” which does not contain the word “multiple” but includes the plural terms “purchasers and sellers.”

See id.

at 15506. The Commission also stated in the Proposing Release that the use of plural terms in “buyers and sellers” in Rule 3b-16(a) and “purchasers and sellers” in the statutory definition of “exchange” makes sufficiently clear that an exchange need only have more than one buyer and more than one seller participating on the system to meet this prong.

See id.

at 15506 n.105.

Specifically, the Commission proposed to amend Exchange Act Rule 3b-16(a) to include within the definition of “exchange” an organization, association, or group of persons that constitutes, maintains, or provides a market place or facilities for bringing together buyers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange if it is not subject to an exception under Rule 3b-16(b) and it: (1) brings together buyers and sellers of securities using trading interest; and (2) makes available established, non-discretionary methods (whether by providing a trading facility or communication protocols, or by setting rules) under which buyers and sellers can interact and agree to the terms of a trade. For purposes of this Reopening Release, trading systems that meet the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended (

i.e.,

offer the use of non-firm trading interest and provide non-discretionary protocols),

are referred to throughout the release as “New Rule 3b-16(a) Systems.” New Rule 3b-16(a) Systems would be subject to the definition of “exchange” and be required to register as a national securities exchange or comply with the conditions to an exemption to such registration, such as Regulation ATS.

Such systems were referred to as “Communication Protocol Systems” in the Proposing Release.

See id.

at 15497 n.5.

C. Purpose of the Reopening Release

In response to the Proposing Release, the Commission received many comments.

In particular, the Commission received requests for information about the application of the Proposed Rules to trading systems for crypto asset securities

and trading systems that use distributed ledger or blockchain technology (broadly referred to as “DLT”),

including systems commenters characterize as decentralized finance or “DeFi.”

Commenters request information about whether and how such systems can comply with existing federal securities laws and the Proposed Rules.

Given these comments, the Commission is issuing this Reopening Release regarding the potential effects of the proposed amendments to Exchange Act Rule 3b-16 on trading systems for crypto asset securities and trading systems using DLT, including systems commenters characterize as various forms of “DeFi,” and requesting further information and public comment on aspects of the Proposed Rules, more generally. This Reopening Release also supplements the economic analysis in the Proposing Release by providing additional analysis on the estimated impact of the Proposed Rules on trading systems for crypto asset securities and those using DLT, which include various so-called “DeFi” trading systems, and requests further comment.

See infra

sections II.A and II.B. Comment letters cited in this Reopening Release are comment letters received in response to the Proposing Release, which are available at

https://www.sec.gov/comments/s7-02-22/s70222.htm.

See infra

note 26.

The terms DLT and blockchain, a type of DLT, generally refer to databases that maintain information across a network of computers in a decentralized or distributed manner. Blockchain networks commonly use cryptographic protocols to ensure data integrity.

See, e.g.,

World Bank Group, “Distributed Ledger Technology (DLT) and Blockchain,” FinTech Note No. 1 (2017),

available at https://openknowledge.worldbank.org/bitstream/handle/10986/29053/WP-PUBLIC-Distributed-LedgerTechnology-and-Blockchain-Fintech-Notes.pdf?sequence=1&isAllowed=y.

Commenters vary in their definitions of “DeFi,” or what makes a product, service, arrangement or activity “decentralized.”

See generally

The Board of the International Organization of Securities Commissions, IOSCO Decentralized Finance Report (Mar. 2022) (“IOSCO Decentralized Finance Report”),

available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD699.pdf.

Trading systems for crypto assets that are colloquially referred to as “decentralized” typically combine more traditional technology (such as web-based systems that accept and display orders and servers that store orders) with distributed ledger technology (such as “smart contract” provisioned blockchains—self-executing code run on distributed ledgers that carry out “if/then” type computations).

See id.

at 1.

See also

Damien G. Scott, Deputy General Counsel, CoinList, dated Apr. 18, 2022 (“CoinList Letter”) at 1-2 (explaining that crypto asset industry needs clarity about how the rules written for traditional paper securities secured and validated by intermediaries apply in practice to new digital technology).

See

Letter from Jay H. Knight, Chair of the Federal Regulation of Securities Committee, Federal Regulation of Securities Committee of the Business Law Section of the American Bar Association, dated Apr. 18, 2022 (“ABA Letter”) at 5-6 (suggesting the Commission defer the application of the Proposed Rules to digital asset intermediaries and their underlying technology pending completion of coordination among a broad range of government agencies to develop an appropriate approach to digital assets, pursuant to the Executive Order on Ensuring the Responsible Development of Digital Assets).

See, e.g.,

a16z Letter at 9 (“But even casting aside the practical challenges that DeFi protocols would confront in attempting to follow Regulation ATS, the Commission seems to overlook the fact that the purposes behind Regulation ATS would not be served by imposing its requirements on DeFi protocols.”); Letter from William C. Hughes, Senior Counsel & Director of Global Regulatory Matters, ConsenSys Software Inc., dated Apr. 14, 2022 (“ConsenSys Letter”) at 8 (“The '34 Act's requirements, tailored as they are to the centralized nature of exchanges, make no sense when applied to decentralized blockchain-based systems.”); Letter from Delphi Digital, dated Apr. 18, 2022 (“Delphi Digital Letter”) at 6 (stating that “systems lacking order-book logic, or which are sufficiently decentralized (

i.e.,

lacking any particular owner/operator who could rationally be expected to comply with the SEC's intermediaries-based regulatory regime)” have been viewed by participants in the digital asset marketplace as outside the scope of securities exchange regulation). One commenter cites a paper stating that “[s]ome characteristics of DeFi may be incompatible with the existing regulatory framework, particularly given that the current framework is designed for a system that has financial intermediaries at its core.”

See

Letter from Jake Chervinsky, Head of Policy, Blockchain Association and Miller Whitehouse-Levine, Policy Director, DeFi Education Fund, dated June 13, 2022 (“Blockchain Association/DeFi Education Fund Letter”) at 4 (citing Org. for Econ. Cooperation and Dev., Why Decentralised Finance (DeFi) Matters and the Policy Implications (2022) at 12).

Crypto assets

generally use DLT as a method to record ownership and transfers.

Further, a crypto asset that is a security is not a separate type or category of security (

e.g.,

NMS stock, corporate bond) for purposes of federal securities laws based solely on the use of DLT. The definition of “exchange” under section 3(a)(1) of the Exchange Act and

existing

Rule 3b-16 thereunder, and the requirement that an exchange register with the Commission pursuant to section 5 of the Exchange Act, apply to all securities, including crypto assets that are securities, which include investment contracts or any other type of security.

The Commission understands that currently certain trading systems for crypto assets, including so-called “DeFi” systems, operate like an exchange as defined under federal securities laws—that is, they bring together orders of multiple buyers and sellers using established, non-discretionary methods (by providing a trading facility, for example) under which such orders interact and the buyers and sellers entering such orders agree upon the terms of a trade.

Because it is unlikely that systems trading a large number of different crypto assets are not trading any crypto assets that are securities,

these

systems likely meet the current criteria of Exchange Act Rule 3b-16(a) and are subject to the exchange regulatory framework.

Indeed, the President's Executive Order on Ensuring Responsible Development of Digital Assets acknowledged that “many activities involving digital assets are within the scope of existing domestic laws and regulations” and systems trading such assets “should, as appropriate, be subject to and in compliance with regulatory and supervisory standards that govern traditional market infrastructures and financial firms.”

The proposed amendments to Exchange Act Rule 3b-16 do not change any existing obligation for these systems to register as a national securities exchange or comply with the conditions to an exemption to such registration, such as Regulation ATS.

For purposes of this Reopening Release, the Commission does not distinguish between the terms “digital asset securities” and “crypto asset securities.” The term “digital asset” refers to an asset that is issued and/or transferred using distributed ledger or blockchain technology, including, but not limited to, so-called “virtual currencies,” “coins,” and “tokens.”

See

Securities Exchange Act Release No. 90788 (Dec. 23, 2020), 86 FR 11627, 11627 n.1 (Feb. 26, 2021) (“Commission Statement on Custody of Digital Asset Securities by Special Purpose Broker-Dealers”). A digital asset may or may not meet the definition of a “security” under the federal securities laws.

See, e.g.,

Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Securities Exchange Act Release No. 81207 (July 25, 2017) (“DAO 21(a) Report”),

available at https://www.sec.gov/litigation/investreport/34-81207.pdf. See also SEC

W.J. Howey Co.,

328 U.S. 293 (1946). To the extent digital assets rely on cryptographic protocols, these types of assets also are commonly referred to as “crypto assets.”

See

Investment Advisers Act Release No. 6240 (Feb. 15, 2023), 88 FR 14672, 14676 n.25 and accompanying text (Mar. 9, 2023); Securities Exchange Act Release No. 96496 (Dec. 14, 2022), 88 FR 5440, 5448 n.94 and accompanying text (Jan. 27, 2023).

Section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder do not apply to market places or facilities that do not trade securities. This would also remain unchanged under Exchange Act Rule 3b-16, as proposed to be amended.

In addition to its exchange obligations, depending on the facts and circumstances, an organization, association, or group of persons engaging in crypto asset securities business may also have legal and regulatory obligations under the federal securities laws for broker-dealer, custodial, clearing, or lending activities, among others.

See U.S. Securities and Exchange Commission

Beaxy Digital, Ltd., et al.,

No. 23-cv-1962 (N.D. Ill. Mar. 29, 2023) (Docket Entries 1, 4) (final judgment entered on consent enjoining crypto asset trading platform from operating an unregistered exchange, broker, and clearing agency).

See

Fin. Stability Oversight Council, Report on Digital Asset Financial Stability Risks and Regulation 119 (2022) (“FSOC Report”) at 97,

available at https://home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-2022.pdf.

Each system should analyze whether the crypto assets that it offers for trading meet the definition of a security under the federal securities laws and prior Commission statements.

See supra

note 26. The Commission will continue to evaluate whether currently operating systems are acting consistent with federal securities laws and the rules thereunder.

See, e.g.,

DAO 21(a) Report at 17 (“The Platforms that traded DAO Tokens appear to have satisfied the criteria of Rule 3b-16(a) and do not appear to have been excluded from Rule 3b-16(b).”); In the Matter of Zachary Coburn, Securities Exchange Act Release No. 84553 (Nov. 8, 2018) (settled cease-and-desist order); In the Matter of Poloniex, LLC, Securities Exchange Act Release No. 92607 (Aug. 9, 2021) (settled cease-and-desist order).

See

President's Executive Order on Ensuring Responsible Development of Digital Assets, dated Mar. 9, 2022,

available at https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.

17 CFR 242.300 through 242.304.

The Commission preliminarily believes that some amount of crypto asset securities trade on New Rule 3b-16(a) Systems, and that such systems may use DLT or be “DeFi” trading systems, as described by some commenters. Depending on facts and circumstances, systems that offer the use of non-firm trading interest and provide non-discretionary protocols to bring together buyers and sellers of crypto assets securities

can perform a market place function like that of an exchange—that is, they allow participants to discover prices, find liquidity, locate counterparties, and agree upon terms of a trade for securities. The exchange regulatory framework would provide market participants that use New Rule 3b-16(a) Systems for crypto asset securities with transparency, fair and orderly markets, and investor protections that apply to today's registered exchanges or ATSs.

These benefits, in turn, promote capital formation, competition, and market efficiencies.

An organization, association, or group of persons that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of crypto asset securities or performs with respect to crypto asset securities the functions commonly performed by a stock exchange as that term is generally understood under the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended, would be an exchange under section 3(a)(1) of the Exchange Act and would be required to register as a national securities exchange or comply with the conditions of Regulation ATS.

See

Proposing Release at 15503.

See

Regulation ATS Adopting Release at 70847.

See

15 U.S.C. 78c(f).

Some commenters question the application of the proposed amendments to Exchange Act Rule 3b-16 to assets that may not be securities.

In addition, commenters indicate that many crypto asset trading systems offer pairs trading,

which typically involves two crypto assets (which may or may not be securities) that can be exchanged directly for each other using their relative price (“trading pair”).

Trading pairs consist of both a base and quote asset; the base asset is the asset quoted in terms of the value of the other (

i.e.,

quote) asset in the trading pair.

Today, trading pairs can include a combination of securities and non-securities and frequently include so-called stablecoins, bitcoin, or ether as the base asset, quote asset, or both.

Users entering a trading pair on a system can exchange one crypto asset for another without exchanging the crypto asset for U.S. dollars (or other fiat currency) by simultaneously selling one asset while buying another on the system without exchanging either crypto asset for U.S. dollars first.

See

ADAM Letter II at 9 (stating that “it is premature of the SEC to include digital assets within the scope of the exchange regulatory framework until such time as there is a better understanding regarding the appropriate regulatory approach for such assets”); LeXpunK Letter at 2 n.4 (stating “where digital asset transactions do not involve securities, U.S. securities laws (and the instant proposed rulemaking) would be inapplicable” and that “in light of the lack of clarity with respect to the Commission's classification of digital assets and transactions involving digital assets, however, there remains a looming uncertainty as to whether the same would be regarded as securities and securities transactions, respectively”); a16z Letter at 15-16 (stating that the Proposing Release “does not mention `digital asset securities' or `investment contracts,' two of the terms the Commission uses to describe digital assets believed to be securities” and that the “omissions will further compound the uncertainty over whether the Proposal was meant to cover digital assets”).

See

LeXpunK Letter at 4 and 4 n.19; Delphi Digital Letter at 7 (stating that, in the context of systems that use “technology in DeFi,” automated market makers (“AMMs”) use “liquidity pools,” which “represents assets in (and a market for) a single token pair” that are “ `locked' within smart contracts”).

See

Fan Fang, Carmine Ventre, Michail Basios et al.,

Cryptocurrency Trading: A Comprehensive Survey,

8 Fin. Innovation 13 (2022),

available at https://doi.org/10.1186/s40854-021-00321-6

(stating that in general, pairs trading involves two similar assets with a stable long-run relationship and slightly different spreads, and if the spread widens, investors short the high-priced crypto asset and buy the low-priced crypto asset).

See

A Review of Cryptoasset Market Structure and Regulation in the United States, Feb. 2023, Program on International Financial Systems,

available at https://www.pifsinternational.org/cryptoasset-market-structure-and-regulation-in-the-u-s/

(“PIFS Crypto Review”).

Crypto asset trading pairs offered by trading systems today also include other combinations (

e.g.,

crypto asset (security or non-security) for another crypto asset (security or non-security)). While some of the major crypto asset trading systems available in the U.S. allow trading in U.S. dollars, others only allow trading between different crypto assets and not fiat currencies. The main base asset used on certain of these other systems is Tether (USDT).

See

Igor Makarov & Antoinette Schoar,

Trading and Arbitrage in Cryptocurrency Markets,

135 J. Fin. Econ. 293 (2020).

See also

PIFS Crypto Review at 10-11 (stating that most global bitcoin trading is conducted with stablecoins rather than fiat currency).

Section 3(a)(1) of the Exchange Act and Rule 3b-16 state that an exchange is any organization, association, or group of persons which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of

securities

or for otherwise performing with respect to

securities

the functions commonly performed by a

stock exchange

as that term is generally understood.

An organization, association, or group of persons that meets the criteria of existing Exchange Act Rule 3b-16(a), and Rule 3b-16(a), as proposed to be amended, and makes available for trading a security and a non-security would meet the definition of “exchange” notwithstanding the fact that the entity traded non-securities. For its securities activities, the organization, association, or group of person must register as a national securities exchange or comply with the conditions of Regulation ATS.

Market places or facilities of, and the functions performed by, national securities exchanges and ATSs trade only securities quoted in and paid for in U.S. dollars.

See

15 U.S.C. 78c(a)(1).

Section 5 of the Exchange Act states that “[i]t shall be unlawful for any . . . exchange, directly or indirectly, to make use of the mails or any means or instrumentality of interstate commerce for the purpose of using any facility of an exchange within or subject to the jurisdiction of the United States to effect any transaction in a

security,

or to report any such transaction, unless such exchange (1) is registered as national securities exchange under [section 6 of the Exchange Act], or (2) is exempted from such registration . . . .”

See

15 U.S.C. 78e.

The Commission is soliciting additional comment on Rule 3b-16, as proposed to be amended, and in

particular responses to the following questions:

1. Should a New Rule 3b-16(a) System that trades crypto asset securities have the choice of registering as a national securities exchange or complying with the conditions of Regulation ATS? Why or why not?

2. Please describe any trading systems that currently offer the use of non-firm trading interest and provide non-discretionary protocols to bring together buyers and sellers of crypto asset securities, including a description of trading interest used, functionalities or protocols, requirements, limitations, types of market participants that use the systems, transaction volume, crypto asset securities offered for trading, and any other services offered by the system. Please provide any data, literature, or other information that you consider relevant to the Commission's analysis of New Rule 3b-16(a) Systems for crypto asset securities, including but not limited to, the types of systems, the amount of trading volume on such systems, the number of participants on such systems (as well as the participant types, such as institutional and retail), and the types of crypto asset securities they trade.

3. Do organizations, associations, or groups of persons that meet the criteria of New Rule 3b-16(a) Systems and trade crypto asset securities quote a security in an asset other than in U.S. dollars, such as a non-security crypto asset, and provide for the purchase or sale of that asset on the system or off-system? How do investors and trading systems use pairs trading involving non-security crypto assets and crypto asset securities? Are there significant differences between investors' use of pairs trading on centralized trading systems versus trading systems that commenters describe as “DeFi”? Please explain. For example, approximately how much trading volume for crypto asset securities is executed using trading pairs on various types of platforms discussed above? What percentage of trading in crypto asset securities, in terms of volume executed, is in exchange for U.S. dollars? Please provide any data, literature, or other information that you consider relevant to the Commission's analysis.

B. Exchange Activity Using DLT, Including “DeFi” Systems

1. Technology Neutral and Functional Test of the “Exchange” Definition

The Commission received comments regarding whether the proposed amendments to Exchange Act Rule 3b-16 were intended to apply to what commenters characterize as “DeFi,” and comments stating that the Proposed Rules could be interpreted to cover a broad range of technologies, including technologies used by so-called “DeFi” trading systems.

Some commenters state that so-called “DeFi” trading systems should be excluded from Exchange Act Rule 3b-16(a), as proposed to be amended.

See, e.g.,

ConsenSys Letter at 8-9 (requesting that any final rule make clear that “blockchain-based systems” would not be exchanges); a16z Letter at 1, 2, 28 (stating, among other things, that the Proposed Rules could be interpreted as applying to a broad array of technologies, including “DeFi systems and protocols”); Crypto Council Letter at 2, 4 (stating, in part, that the Proposed Rules could apply to the “crypto and decentralized finance markets”); LeXpunK Letter at 3 (stating, in part, its belief that many “DeFi protocols and applications” would meet the definition of a “communication protocol system” under the Proposed Rules); Global Digital Asset & Cryptocurrency Association, dated Apr. 18, 2022 (“GDCA Letter II”) at 11 (questioning whether “decentralized exchanges” would fall under the definition of “exchange”); Letter from Miller Whitehouse-Levine, Policy Director, DeFi Education Fund, dated Apr. 18, 2022 (“DeFi Education Fund Letter”) at 3, 15 (stating, in part, that, without clarification, the Proposed Rules could be interpreted to regulate certain “DeFi protocols”); Letter from Dante Disparte, Chief Strategy Officer and Head of Global Policy, Circle internet Financial, LLC, dated Apr. 18, 2022 (“Circle Letter”) at 3; Letter from Michelle Bond, Chief Executive Officer, Association for Digital Asset Markets, dated Feb. 2, 2022 (“ADAM Letter I”) at 1-2 (stating that the Proposed Rules could expand Commission authority over “spot digital asset markets and peer-to-peer decentralized networks” in ways not discussed in the Proposing Release); Letter from Kimberly Unger, The Security Traders Association of New York, dated Feb. 3, 2022 (“STANY Letter”) at 2; Letter from Andrew Vollmer, Mercatus Center at George Mason University, dated Mar. 11, 2022 (“Vollmer Letter”) at 2. Two commenters also state their belief that there is a lack of clarity as to the application of the Proposed Rules to “decentralized finance” or “DeFi protocols” that raises administrative due process concerns for industry participants.

See

ConsenSys Letter at 18; DeFi Education Fund Letter at 19. The foregoing commenters describe systems that use DLT with varying definitions and terminology (some of which the commenters do not define). As discussed above, there is no generally agreed upon definition of “DeFi” or decentralization.

See

IOSCO Decentralized Finance Report at 1, 9. Nonetheless, as discussed below, the Proposed Rules, like the existing exchange framework, regulate exchange activity, and not the technology underlying such activity.

See, e.g.,

a16z Letter at 3 (stating that “DeFi protocols eliminate the need for a central operator that could implement regulatory requirements applicable to traditional securities exchanges or broker-dealers” and therefore the Commission should “clarify that the [p]roposal does not apply to DeFi systems by explicitly excluding them”); LeXpunK Letter at 2 (stating that the Proposed Rules would improperly expand the Commission's authority to regulate “technologists with neither the resources nor the reasonable expectation of being so regulated, who `make available' peer-to-peer `communication protocols' used in DeFi”); ConsenSys Letter at 8-12 (stating its belief that the term “communication protocols” does not cover “blockchain-based systems”); Delphi Digital Letter at 6 (stating that, unless “decentralized-in-actuality software systems—including `automatic market-making' smart contract systems” are carved out of the term “communication protocols,” the Proposed Rules would impose “impossible compliance obligations on persons who may merely write open-source `communications protocol' code or publish information about the contents of communications systems which they do not control”); Blockchain Association Letter II at 3 (stating that application of the Proposed Rules to “decentralized exchange protocols through which digital assets may be traded, [and] operate[d] autonomously and automatically through smart contracts and the participation of their users” would exceed the Commission's statutory authority under the Exchange Act); Letter from Spence Purnell, Director of Technology Policy, Reason Foundation, dated Feb. 23, 2022 at 2 (stating that the Proposed Rules should not apply to “technologies such as decentralized finance and smart-contracts” because they were not explicitly considered in the Proposing Release); Letter from Bryant Eisenbach, dated Feb. 2, 2022 (“Eisenbach Letter”).

See also

Letter from Rep. Patrick McHenry, Ranking Member, and Rep. Bill Huizenga, Ranking Member Subcommittee on Investor Protection, Entrepreneurship and Capital Markets, House Committee on Financial Services, dated Apr. 18, 2022 (“McHenry/Huizenga Letter”) (expressing concern that the Proposed Rules “can be interpreted to expand the SEC's jurisdiction beyond its existing statutory authority to regulate market participants in the digital asset ecosystem, including in decentralized finance”).

When adopting Exchange Act Rule 3b-16, the Commission stated that the exchange framework is based on the functions performed by a trading system, not on its use of technology.

Notwithstanding how an entity may characterize itself or the technology it uses, a functional approach (taking into account the relevant facts and circumstances) will be applied when assessing whether the activities of a trading system meet the definition of an exchange. These principles continue to apply today under existing Rule 3b-16 and would equally apply under Rule 3b-16, as proposed to be amended.

Accordingly, an organization, association, or group of persons that uses any form or forms of technology (

e.g.,

DLT, including technologies used by so-called “DeFi” trading systems, computers, networks, the internet, cloud, telephones, algorithms, a

physical trading floor) that constitutes, maintains, or provides a market place for bringing together purchasers and sellers of securities, including crypto asset securities, or for otherwise performing with respect to securities the functions commonly performed by a stock exchange under the current criteria of Exchange Act Rule 3b-16(a), or Exchange Act Rule 3b-16(a), as proposed to be amended, would be an exchange and would be required to register as a national securities exchange or comply with the conditions of Regulation ATS.

See

Regulation ATS Adopting Release at 70902.

See, e.g.,

DAO 21(a) Report (stating that “any entity or person engaging in the activities of an exchange, such as bringing together the orders for securities of multiple buyers and sellers using established non-discretionary methods under which such orders interact with each other and buyers and sellers entering such orders agree upon the terms of the trade, must register as a national securities exchange or operate pursuant to an exemption from such registration,” “the automation of certain functions through this technology, `smart contracts,' or computer code, does not remove conduct from the purview of the U.S. federal securities laws,” and that the requirements of the U.S. federal securities laws “apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology”).

2. So-Called “DeFi” Systems and Exchange Act Rule 3b-16

Several commenters state their belief that the Proposed Rules could cause what they describe as “DeFi” trading systems to meet the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended.

So-called “DeFi” trading systems can be used to allow investors to discover prices, find liquidity, locate counterparties, and agree upon terms of a trade for securities, including crypto asset securities, thereby performing market place activities or functions commonly performed by a stock exchange. Today, many systems, some of which are described as “DeFi” by commenters, bring together buyers and sellers of securities, including crypto asset securities, and could meet the existing criteria of Exchange Act Rule 3b-16(a). The Commission understands that so-called “DeFi” trading systems often rely on electronic messages that are exchanged between buyers and sellers so that they can agree upon the terms of a trade without negotiations.

If these electronic messages constitute a firm willingness to buy or sell a security, including a crypto asset security, the messages would meet the definition of orders under existing Rule 3b-16(c).

And if established, non-discretionary method(s) under which orders of multiple buyers and sellers interact with each other are provided, such as through the provision of certain smart contract functionality, the activities would be covered under existing Rule 3b-16(a). Accordingly, depending on the facts and circumstances, activities performed today using so-called “DeFi” trading systems could meet the criteria of existing Rule 3b-16 and thus constitute exchange activity. The proposed amendments to Rule 3b-16(a) would not, in any way, change whether such activities constitute exchange activity under section 3(a)(1) and Rule 3b-16(a).

See

DeFi Education Fund Letter at 15; Circle Letter at 3; ADAM Letter I at 1-2; STANY Letter at 2; Vollmer Letter at 2; Crypto Council Letter at 2; LeXpunK Letter at 7-8.

For example, AMM is a mechanism designed to create liquidity for others seeking to effectuate trades.

See

President's Working Group on Financial Markets, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency, Report on Stablecoins (Nov. 2021),

available at https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.

Liquidity pools of so-called “DeFi” trading systems rely on AMM protocols which typically use preset mathematical equations (

e.g.,

x*y=k, where x and y represent the values of tokens in a liquidity pair and k is a constant) to ensure the ratio of assets in the liquidity pools remains balanced and determine prices based on trading volumes.

See

U.S. Department of the Treasury, Crypto-Assets: Implications for Consumers, Investors, and Businesses (Sept. 2022) (“Crypto-Assets Treasury Report”),

available at https://home.treasury.gov/system/files/136/CryptoAsset_EO5.pdf.

Some commenters argue that systems that use AMMs do not use trading interest as described in the Proposed Rules.

See

LeXpunK Letter at 12-13; Delphi Digital Letter at 9-10. One commenter states that AMM users do not interact with each other but with a pool of liquidity resting in a smart contract.

See

LeXpunK Letter at 12-13. This commenter states that forms of non-firm trading interest—conditional orders and indications of interest—discussed in the Proposing Release, “do not align with AMMs provision of automated liquidity through the smart contract-based deterministic mechanisms,” where no party imposes such conditions or communicates such interest.

See id.

One commenter states that there are no “orders” on an AMM because, in contrast to a “centralized” platform which permits makers and takers to agree upon a price, an AMM sets the price.

See

Delphi Digital Letter at 9-10.

See

17 CFR 240.3b-16(c).

As discussed above, the Commission preliminarily believes that New Rule 3b-16(a) Systems, including some so-called “DeFi” systems, trade some amount of crypto asset securities, and would, under the proposed amendments to Exchange Act Rule 3b-16(a), be required to register as a national securities exchange or comply with the conditions of Regulation ATS.

3. Custodial Services Is Generally Not Relevant to Exchange Analysis

Some commenters state that because so-called “DeFi” trading systems do not custody assets, they should not be subject to exchange regulation.

One commenter states that trading conducted using “DeFi” trading systems does not involve users depositing assets with a central authority.

Another commenter states that “custody” with reference to “DeFi” means self-custody, which the commenter states does not fit “the Commission's model, under which all exchanges are centralized.”

Neither existing Exchange Act Rule 3b-16 nor Rule 3b-16, as proposed to be amended, requires an organization, association, or group of persons to provide custodial services to be considered an exchange under section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder.

Thus, custodial services generally is not a relevant factor to the exchange analysis.

See

a16z Letter at 8-9; GDCA Letter II at 11; DeFi Education Fund Letter at 6.

See also

LeXpunK Letter at 4 n.18 (stating that no “ `custody' or `transfer' actually occurs” in the context of a “smart contract-based platform”).

See

a16z Letter at 8-9. The commenter cites a paper stating “one of the main advantages of decentralized exchanges over centralized exchanges is the ability for users to keep control of their private keys.”

See id.

at 8 n.41 (citing Igor Makarov & Antoinette Schoar,

Cryptocurrencies and Decentralized Finance (DeFi)

23 (Brookings Paper on Econ. Activity, Conference Draft, 2022)).

See

GDCA Letter II at 11.

See also

DeFi Education Fund Letter at 6 (stating “DeFi protocols” present “no financial risk for users from broker activity or custody”). One commenter also states that the Commission has provided no public guidance regarding how a digital asset communication protocol system could arrange for custody and settlement to the Commission's satisfaction, in order to operate as an exchange.

See

GDCA Letter II at 10. Further, some commenters question how exchange regulation will apply to trading activities that use “DeFi” and do not involve an intermediary for trading or to custody securities.

See supra

note 52 and

infra

note 56.

The Customer Protection Rule requires a broker-dealer to promptly obtain and thereafter maintain physical possession or control of all fully-paid and excess margin securities it carries for the account of customers.

See

17 CFR 240.15c3-3(b). In 2020, the Commission issued a statement describing its position that, for a period of five years, special purpose broker-dealers operating under the circumstances set forth in the statement will not be subject to a Commission enforcement action on the basis that the broker-dealer deems itself to have obtained and maintained physical possession or control of customer fully-paid and excess margin crypto asset securities for purposes of 17 CFR 240.15c3-3(b)(1) (“Rule 15c3-3(b)(1)”) under the Exchange Act.

See

Commission Statement on Custody of Digital Asset Securities by Special Purpose Broker-Dealers. To date, no person has been approved to act as a special purpose broker-dealer custodying crypto asset securities.

4. Group of Persons as the Exchange

Some commenters ask that the Commission explain which actor or group of actors would be responsible for compliance and how so-called “DeFi” trading systems should comply with exchange regulatory requirements.

Some commenters express concerns that the proposed amendments to Exchange Act Rule 3b-16(a) would inappropriately apply to systems that purport not to involve intermediaries.

One commenter states that providers of rule sets on how messages should be formed, stored, and relayed on a network are not like “intermediaries of the traditional financial system” because “all they are doing is

publishing particular arrangements of 0s and 1s.”

In addition, some commenters state that “DeFi” trading systems may be unable to comply with exchange regulatory requirements because they lack a central operator.

Some commenters interpret Exchange Act Rule 3b-16(a), as proposed to be amended, to mean that each entity that performs any exchange function would need to register as a national securities exchange or comply with the conditions of Regulation ATS.

For example, some commenters state that, under the proposed amendments to Exchange Act Rule 3b-16(a), exchange regulation could extend to persons including open source developers who contribute code to the software repositories where software for so-called “DeFi” trading systems is first published, persons who republish and share this information, and persons who connect to the peer-to-peer networks on which “DeFi” activities takes place.

One commenter states that the group of persons involved in a “DeFi” trading system—including developers, AMMs, and miners—could all comprise essential components of the market infrastructure.

This commenter further states that the fact that these roles might be “decentralized” does not change that they would be considered a group of persons who constitutes, maintains, or provides facilities for bringing together purchasers and sellers of securities.

See

Letter from Paul Grewal, Chief Legal Officer, Coinbase Global, Inc., dated Apr. 18, 2022 (“Coinbase Letter”) at 7; a16z Letter at 3; Blockchain Association Letter II at 8.

See

a16z Letter at 10; ConsenSys Letter at 8; DeFi Education Fund Letter at 3, 11; Blockchain Association Letter II at 3, 5; CoinList Letter at 2; Eisenbach Letter at 2. For example, one commenter states that what it calls “decentralized” systems allow anyone to participate rather than rely on gatekeepers.

See

ConsenSys Letter at 8.

See

Letter from Coin Center, dated Apr. 14, 2022 (“Coin Center Letter”) at 13. Another commenter states that developers of “DeFi protocols” would not qualify as a “group of persons” because they “merely make tools available for parties to communicate.”

See

DeFi Education Fund Letter at 15.

See, e.g.,

a16z Letter at 3; Coin Center Letter at 12; CoinList Letter at 2; GDCA Letter II at 11; Blockchain Association/DeFi Education Fund Letter at 5.

See, e.g.,

Letter from Robert Toomey, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, dated June 13, 2022 (“SIFMA Letter II”) at 8.

See

Coin Center Letter at 25.

See also

Delphi Digital Letter at 9 (stating that participants could “number in the hundreds or thousands and be distributed all over the world”).

See

Letter from James F. Tierney, Assistant Professor of Law, University of Nebraska College of Law, dated June 13, 2022 (“Tierney Letter”) at 2 (stating that these participants in “blockchain and other DeFi applications” all “might play analogous roles to in-house counsel, market makers, and back-office clearance roles in a traditional exchange setup”).

See id.

The existence of smart contracts on a blockchain does not materialize in the absence of human activity or a machine (or code) controlled or deployed by humans. The Commission understands that, typically, including for so-called “DeFi” trading systems, a single organization constitutes, maintains, or provides the market place or facilities for bringing together buyers and sellers of securities or otherwise performs with respect to securities the functions commonly performed by a stock exchange under section 3(a)(1) and Exchange Act Rule 3b-16 thereunder.

See

IOSCO Decentralization Finance Report at 8 n.13 (stating that “claims about decentralization for many projects may not hold up to scrutiny of the technical reality of what can be changed in the system, who can be involved in the decisions, and who actually is involved”).

While it is common today for a single organization to provide a market place or facilities to bring together buyers and sellers of securities and meet the definition of an exchange, an exchange can also exist where a market place or facilities are provided by a group of persons, rather than a single organization.

Under section 3(a)(1), and Exchange Act Rule 3b-16(a), the term exchange “means any organization, association, or

group of persons,

whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together buyers and sellers of securities or perform with respect to securities the functions commonly performed by a stock exchange.”

Thus, a group of persons, whether incorporated or unincorporated, can together constitute, maintain, or provide a market place or facilities or perform with respect to securities the functions commonly performed by a stock exchange. In determining which persons would be included in the group of persons that constitutes, maintains, or provides an exchange or performs with respect to securities the functions commonly performed by a stock exchange, important factors would generally include whether the persons act in concert in establishing, maintaining, or providing a market place or facilities for bringing together buyers and sellers of securities or in performing with respect to securities the functions commonly performed by a stock exchange, or exercise control, or share control, over aspects of such market place or facilities or the performance of functions commonly performed by a stock exchange. In particular, when a group of persons exercises control, or shares control, over the organizational, financial, or operational aspects of a market place or facilities for bringing together buyers and sellers of securities, they are a group of persons that can be deemed to constitute, maintain, or provide the market place or facilities.

The term “person” means a natural person, company, government, or political subdivision, agency, or instrumentality of a government. 15 U.S.C. 78c(a)(9).

In a recent decision, the United States Court of Appeals for the District of Columbia Circuit held that the term “group of persons” “certainly includes closely connected corporate affiliates” and noted that “[w]hether two or more persons are or may be acting in concert is likely the key consideration” in determining whether two or more entities may constitute a “group of persons” for purposes of the statute.

Intercontinental Exch., Inc.

SEC,

23 F.4th 1013, 1024 (D.C. Cir. 2022). In addition, the court stated that it was “not suggest[ing] the term `group of persons' is synonymous with corporate affiliation” and that “one corporation that is affiliated with but not controlled by another may or may not, depending upon the circumstances, be considered a `group of persons' ” for the purposes of section 3(a)(1) of the Exchange Act.

See id.

In the Proposing Release, the Commission explained that, depending on the activities of the persons involved with the market place or facilities, a group of persons, who may each perform a function of the market place that meets the criteria of Exchange Act Rule 3b-16, can together provide, constitute, or maintain a market place or facilities for bringing together buyers and sellers of securities and together meet the definition of exchange.

See

Proposing Release at 15506 n.109.

See also

Regulation ATS Adopting Release at 70891 (“. . . any subsidiary or affiliate of a registered exchange could not integrate, or otherwise link the alternative trading system with the exchange, including using the premises or property of such exchange for effecting or reporting a transaction, without being considered a `facility of the exchange.' ”). In determining whether affiliated persons would be a “group of persons” for the purposes of section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder, an important factor is whether the operations and management of the affiliated persons are separate. For example, an affiliated entity of an exchange might not be considered a group of persons with that exchange if there is independent governance, management, and oversight between affiliated entities; prevention of strategic coordination or information sharing between the affiliated entities by way of information barriers and other procedures; separation of functions relating to technology, operations and infrastructure, sales and marketing, branding, and staffing; and avoidance of business links, such as routing, fees, billing, and membership.

Whether persons act in concert or exercise control, or share control, requires an analysis of the activities of each person and the totality of facts and circumstances. In assessing whether a person would be acting in concert with a group of persons, one factor to consider, depending on other facts and circumstances, would be the extent to which a person acts with an agreement (formal or informal) to constitute, maintain, or provide a market place or facilities for bringing together buyers and sellers of securities or to perform with respect to securities a function commonly performed by a stock exchange. For example, if one entity agrees with another entity to combine aspects of each other's market places or facilities (

e.g.,

order books, display functionalities, or matching engines) to bring together buyers and sellers of securities, both entities could be considered part of the group and thus an exchange.

Control could occur through several means, including, among other things, ownership interest, corporate organizational structure and management, significant financial interest, or the ability to determine or modify participant access, securities traded, operations or trading policies, or non-discretionary methods of the market place or facilities. For example, a person that can determine or modify, either individually or with others, the entering, storing, matching, or display of trading interest (

e.g.,

a matching engine, a smart contract) would be exercising control over the operations of the market place or facilities. In addition, a person that can determine or modify, or grant or limit access to, for example, either individually or with others, the market or other data about the securities and securities transactions available on the market place or facility, order types, order interaction procedures (

e.g.,

counterparty selection, segmentation), the priority or price at which trading interest will execute, or protocols for negotiation, would have the ability to determine trading policies or methods and exercise control over the market place or facilities.

The ability to exercise control over a market place or facilities is not limited solely to the operational control.

Also, a person that, for example, either individually or with others, can determine or modify, with respect to the market place or facilities, the securities made available for trading or the access requirements and conditions for participation would be exercising control. In addition, a person could exercise control by determining who can, and in what amount, share in profits or revenues derived from the market place or facilities, or by having the ability to enter into legal or financial agreements or arrangements on behalf of or in the name of the market place or facilities. Depending on the facts and circumstances, significant holders of governance or other tokens, for example, could also be considered part of the group of persons and thus an exchange if they can control certain aspects of it.

See, e.g.,

Regulation ATS Adopting Release at 78052 (stating that a system that standardizes the material terms of instruments traded on the system will be considered to use established, non-discretionary methods).

This analysis would depend on facts and circumstances. Whether a token holder can exercise control over a market place or facilities and be considered part of a “group of persons” would depend, for example, on the number of total token holders, or, if a holder's votes are weighted proportionally to the size of their holdings of tokens, the size of their holdings, as well as what parameters the governance tokens are set to control (

e.g.,

fundamental operational decisions, strategic direction of the company, budgetary decisions, and ability to change the underlying code), among other things.

Generally, an entity that engages a service provider or vendor to operate a market place or facilities for bringing together buyers and sellers of securities directs, manages, and oversees the activities of the service provider or vendor. In this instance, the entity, not the service provider or vendor, controls the market place or facilities, and the entity is responsible for compliance with federal securities laws. In certain circumstances, however, a service provider or vendor could exercise control, or share control, over aspects of the market place or facilities along with the entity that procured the service provider or vendor. In that case, the service provider or vendor would be considered a person within a group of persons that constitutes, maintains, or provides the market place or facilities for bringing together buyers and sellers of securities.

See

Proposing Release at 15548. This would not encompass purely administrative items, such as human resources support, or basic overhead items, such as phone services, electricity, and other utilities. In the Proposing Release, the Commission recognized that an ATS may engage an entity other than the broker-dealer operator to perform an operation or function of the ATS or a subscriber may be directed to use an entity to access a service of the ATS, such as order entry, disseminating market data, or display, for example.

See

Proposing Release at 15548. In such instances, the ATS must ensure that the entity performing the ATS function complies with Regulation ATS with respect to the ATS activities performed.

See id.

The group of persons that constitutes, maintains, or provides a market place or facilities for bringing together buyers and sellers of securities or performs with respect to securities the functions commonly performed by a stock exchange, and is thus an exchange, would collectively have the responsibility for compliance with federal securities laws. A group of persons must consider how they will comply with the Exchange Act registration requirements given their activities, which can include, but are not limited to, designating a member of the group,

to register the group or forming an organization to register as an exchange or, to operate as an ATS, registering as a broker-dealer and becoming a member of Financial Industry Regulatory Authority (“FINRA”) to ensure compliance with the requirements of the Exchange Act, Commission rules, and FINRA rules.

The group of persons would be collectively responsible for ensuring that the designated member of the group fulfills its regulatory responsibilities.

An ATS that complies with Regulation ATS and registers as a broker-dealer would be required to, among other things, comply with the anti-money laundering and countering the financing of terrorism (AML/CFT) obligations under the Bank Secrecy Act. 31 CFR 1023.210; 31 CFR 1023.320. The Bank Secrecy Act is codified at 31 U.S.C. 5311-5314; 5316-5332 and 12 U.S.C. 1829b, 1951-1959. Additionally, sections 5(a) and 5(c) of the Securities Act of 1933 (“Securities Act”) generally prohibit any person, including broker-dealers, from selling a security unless a registration statement is in effect or has been filed with the Commission as to the offer and sale of such security.

See

15 U.S.C. 77e(a) and (c). A New Rule 3b-16(a) System that operates as an ATS, which is a registered broker-dealer, could be subject to liability under section 5 of the Securities Act for facilitating the sale of a security by its customer on the ATS if the sale of such security is not registered or an exemption from the registration provisions does not apply. Section 4(a)(4) of the Securities Act provides an exemption for “brokers' transactions, executed upon customers' orders on any exchange or in the over-the-counter market but not the solicitation of such orders.”

See

15 U.S.C. 77d(a)(4). To rely on this exemption, a broker-dealer is required to conduct a “reasonable inquiry” into the facts surrounding a proposed unregistered sale of securities before selling the securities to form reasonable grounds for believing that a selling customer's part of the transaction is exempt from section 5 of the Securities Act. The Commission has stated that broker-dealers “have a responsibility to be aware of the requirements necessary to establish an exemption from the registration requirements of the Securities Act and should be reasonably certain such an exemption is available.”

In the Matter of World Trade Financial Corp.,

Securities Exchange Act Release No. 66114, 13 (Jan. 6, 2012) (quoting

Stone Summers & Co.,

Securities Exchange Act Release No. 9839, 3 (Nov. 3, 1972)).

5. Group of Persons and So-Called “DeFi” Systems

One commenter states users of what it characterizes as “DeFi” protocols should not be considered part of a group of persons as they act independently of each other.

The commenter states that developers and users of “DeFi” protocols would not qualify as a “group of persons” because the developers have no ongoing relationship with either market participants or other financial providers and merely make tools available for parties to communicate, and users are acting independently of each other.

Another commenter describes that the “DeFi protocols” deploying AMM functionality rely on many distinct groups or participants, which may not be “affiliated or extrinsically coordinated” with one another.

See

DeFi Education Fund Letter at 15.

See id.

See

Delphi Digital Letter at 9 (describing that “[t]hey do not co-own assets or operate a single enterprise for profit, do not know each other's identities, and have diverse (and often competing) motivations”).

Trading on so-called “DeFi” systems can involve multiple actors. These actors can include, for example, the provider(s) of the DeFi application or user interface, developers of AMMs or other DLT code, decentralized autonomous organizations (“DAO”),

validators or miners,

and issuers or holders of governance or other tokens. Often, a single organization constitutes, maintains, or provides a DLT-based market place or facilities for bringing together buyers and sellers of securities or performs with respect to securities the functions commonly performed by a stock exchange; however, a group of persons can likewise do so. As indicated above, one possible avenue for determining which persons comprise a group of persons can include whether such persons act in concert to establish, provide, or maintain a market place or facilities for securities or to perform with respect to securities the functions commonly performed by a stock exchange, or exercise control, or share control, over aspects of the market place or facilities or the performance of functions commonly performed by a stock exchange.

These actors can form a group of persons if they act in concert to perform, or exercise control or share control over, different functions of a market place or facilities for bringing together buyers and sellers of securities that, taken together, satisfy the elements of existing Exchange Act Rule 3b-16(a) or Rule 3b-16(a), as proposed to be amended.

Validators and miners verify transactions on the underlying blockchain and the function they perform is not only with respect to a particular trading system. Validators and miners use a consensus mechanism (

e.g.,

proof-of-stake or proof-of-work) to verify and add transactions to a distributed ledger in exchange for crypto assets.

See

Crypto-Assets Treasury Report at 11-12.

See supra

note 66.

As discussed above, in assessing whether a person would be acting in concert with a group of persons, one factor to consider, depending on other facts and circumstances, would be the extent to which a person acts with an agreement (formal or informal) to perform a function of a market place or facilities for bringing together buyers and sellers of securities.

A software developer who, acting independently and separate from an organization, publishes or republishes code without any agreement (formal or informal) with any person for that code to be used for a function of a market place or facilities for bringing together buyers and sellers of securities may be less likely to be acting in concert to provide a market place or facilities for bringing together buyers and sellers.

This could be the case even if the software developer's code is subsequently adopted and implemented into a market place or facilities for securities by an unrelated person. Whether the activities of actors amount to a group of persons requires an analysis of the totality of facts and circumstances and the activities of each actor. If the activities of any combination of actors constitute, maintain, or provide, together, a market place or facilities for bringing together buyers and sellers for securities or perform with respect to securities a function commonly performed by a stock exchange, they could today be considered a group of persons and thus an exchange under section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder and therefore be required to register as an exchange under section 5 of the Exchange Act.

See supra

section II.B.4.

See, e.g.,

LeXpunK Letter at 15 (requesting that the Commission clarify that persons who “write and publish smart contract code as a hobby or business, whether to an open-source repository otherwise, and may not otherwise be subject to the jurisdiction of the U.S.” are not intended to be captured by the Proposed Rules). If a software developer receives compensation for publishing, independently from an organization, code for a trading facility to match orders or a protocol for buyers and sellers to negotiate a trade, the software developer could be acting in concert with a group of persons to provide a market place or facilities for bringing together buyers and sellers.

See, e.g.,

Regulation ATS Adopting Release at 70852 (“[I]f an organization arranges for separate entities to provide different pieces of a trading system, which together meet the definition contained in paragraph (a) of Rule 3b-16, the organization responsible for arranging the collective efforts will be deemed to have established a trading facility.”).

See also

Proposing Release at 15506 (stating the proposed change to use the phrase “makes available” is intended to make clear that, in the event that a party other than the organization, association, or group of persons performs a function of the exchange, the function performed by that party would still be captured for purposes of

determining the scope of the exchange

under Exchange Act Rule 3b-16). The Proposing Release also stated that, “[d]epending on the activities of the persons involved with the market place, a group of persons, who may each perform a part of the 3b-16 system, can together provide, constitute, or maintain a market place or facilities for bringing together purchasers and sellers of securities and together meet the definition of exchange. In such a case, the group of persons would have the regulatory responsibility for the exchange.”

See id.

at 15506 n.109.

See also

DeFi Education Fund Letter at 9-10 (stating that “systems providing communication and other financial technology adjacent to trading, such as bespoke direct messaging or market information services, could be captured under the overbroad `makes available' standard”).

109

See

Letter from Corinna Mitchell, General Counsel, Symphony Communication Services, dated Apr. 18, 2022 at 4.

See also

DeFi Education Fund Letter at 9-10 (stating the “makes available” language could subject software developers to exchange regulation “solely on the basis of having lines of their code subsequently used by unrelated parties”); Tradeweb Letter at 5 (stating that the proposed language might affect various forms of software tools widely used in the securities industry).

110

See

Blockchain Association Letter II at 4-5 (quoting the Proposing Release at 15506).

111

See

Aditum Letter at 2.

Request for Comment

10. In the Regulation ATS Adopting Release, the Commission stated that it would “attribute the activities of a trading facility to a system if that facility is offered by the system directly or indirectly (such as where a system arranges for a third party or parties to offer the trading facility).”

112

In explaining the term “makes available” in the Proposing Release, the Commission stated that it was “designed to capture established, non-discretionary methods that an organization, association or groups of person may provide, whether directly or indirectly.”

113

To ensure that an exchange function performed by a party is appropriately captured under Exchange Act Rule 3b-16, should the Commission adopt alternative language to “makes available”? Please explain. For example, should the Commission adopt “Uses established, non-discretionary methods (whether by providing,

directly or indirectly,

a trading facility. . .)”? Would the addition of the phrase “directly or indirectly” align Rule 3b-16 more closely with prior Commission statements in the Regulation ATS Adopting Release

114

and focus the rule text on a function that a party performs in the provision of an established, non-discretionary method to bring together buyers and sellers? Would the phrase “directly or indirectly” reduce commenters' concerns about the proposed “makes available” language being overbroad? Why or why not? What, if any, limiting principles should be applied to determining when a person provides “directly or indirectly” a trading facility or communication protocols (or “negotiation protocols”)?

115

Please explain.

112

See

Regulation ATS Adopting Release at 70852.

113

See

Proposing Release at 15506.

114

See id.

(citing Regulation ATS Adopting Release at 70852).

115

See infra

Request for Comment #13.

11. The Commission proposed to remove the term “uses” and insert the term “makes available” before “established, non-discretionary methods” because the Commission proposed to include as an established, non-discretionary method communication protocols under which buyers and sellers can interact and agree to the terms of a trade. Communication protocols would be in addition to a trading facility, which is an existing established, non-discretionary method under existing Exchange Act Rule 3b-16(a)(2) and is used by the provider of the exchange to match buyers and sellers. Instead of the terms “uses” and “makes available,” should the Commission adopt amendments to Exchange Act Rule 3b-16(a)(2) that state “

[E]stablishes

non-discretionary methods (whether by providing, directly or indirectly, a trading facility or . . .)”? The addition of the term “establishes” would adhere to the concept of “established” in existing Exchange Act Rule 3b-16(a)(2) and be consistent with the Commission's explanation in the Regulation ATS Adopting Release that the person who

establishes

non-discretionary methods is dictating the terms of trading among buyers and sellers on the system.

116

For example, an organization that establishes a non-discretionary method would be providing a trading facility or providing communication protocols (or “negotiation protocols”

117

) or setting rules for buyers and sellers to interact and agree upon the terms of a trade.

116

See

Regulation ATS Adopting Release at 70850.

117

See infra

Request for Comment #13.

C. Non-Discretionary Method: Communication Protocols

In the Proposed Rules, the Commission proposed to add “communication protocols” to Exchange Act Rule 3b-16(a) as a non-discretionary method that an

organization, association, or group of persons could provide for buyers and sellers to interact and agree upon the terms of a trade.

118

In the Proposing Release, the Commission explained that communication protocols, which can be applied to various technologies and connectivity, are provided along with the use of non-firm trading interest (as opposed to firm orders) to prompt and guide buyers and sellers to communicate, negotiate, and agree to the terms of the trade.

119

The Commission also provided examples of trading systems that function as market places or facilities for securities by providing communication protocols.

120

The Commission provided an example of an entity making available a chat feature that has the additional requirement that certain information be included in a chat message (

e.g.,

price, quantity) and also setting parameters and structure designed for participants to communicate about buying or selling securities as a system that would have established communication protocols.

121

The Commission also explained what would not be a communication protocol system for purposes of the Proposed Rules.

122

118

See

Proposing Release at 15507.

119

Id.

120

See id.

at 15500-01. These trading systems could include, among others, RFQ systems, stream axes, conditional order systems, and bilateral negotiation systems.

121

See id.

at 15507.

122

See, e.g., id.

For example, the Commission stated that it did not intend for communication protocols to include systems that only provide the connectivity or technology that allows buyers and sellers to communicate (such as utilities or providers of stand-alone electronic web chat) without also establishing non-discretionary methods that govern how the communications are allowed to proceed as participants agree to the terms of a trade.

See id.

The Commission received comment that the term “communication protocol” is too broad and vague and that it is unclear what activities or entities would be classified as communication protocol systems.

123

Commenters suggest that the Commission should define the term “communication protocol system” to avoid uncertainty as to who is included or not included under its scope.

124

Commenters state that the broad concept of a communication protocol system could capture various types of technologies used by market places for securities, including, for example, front-end graphical user interfaces (“GUIs”), web chat providers,

125

primary market communication systems,

126

software solutions,

127

or trading desks of a broker-dealer.

128

Commenters state that the uncertainty could give the impression that employing the term expands the scope of exchange regulation to all communication methods.

129

123

See, e.g.,

Letter from Lindsey Weber Keljo, Head of Asset Management Group, William C. Thum, Managing Director and Assistant General Counsel, Securities Industry and Financial Market Association, dated Apr. 18, 2022 (“SIFMA AMG Letter”) at 6; Letter from Charles V. Callan, Broadridge Financial Solutions, Inc., dated Apr. 18, 2022 (“Broadridge Letter”) at 2; Letter from Douglas A. Cifu, Chief Executive Officer, Virtu Financial, Inc., dated Apr. 18, 2022 (“Virtu Letter”) at 11; Letter from Jennifer W. Han, Managed Funds Association, dated Apr. 18, 2022 (“MFA Letter”) at 7-10; Letter from David R. Burton, Senior Fellow in Economic Policy, The Heritage Foundation, dated Apr. 18, 2022 (“Burton Letter”) at 2.

124

See, e.g.,

Healthy Markets Letter at 6; Letter from Scott Pintoff, General Counsel, MarketAxess, dated Apr. 18, 2022 (“MarketAxess Letter”) at 5; Broadridge Letter at 2; Virtu Letter at 11. Another commenter, in expressing concern about the scope of the Proposed Rules, describes that the Proposed Rules did not define “communication protocol system.”

See

McHenry/Huizenga Letter at 2.

125

See, e.g.,

GDCA Letter II at 9; Coin Center Letter at 19-20.

126

See

Letter from Scott Eisenberg, Head of Legal, DirectBooks LLC, dated Apr. 18, 2022.

127

See

SIFMA Letter II at 9.

128

See

Letter from Christopher A. Iacovella, Chief Executive Officer, American Securities Association, dated Apr. 18, 2022 (“ASA Letter”) at 3.

129

See, e.g.,

Bloomberg Letter I at 19; Chia Network Letter at 2 (stating that “the Commission's proposed amendments [put] the entire internet and connectivity businesses in jeopardy of tripping over the [Exchange Act]”).

Request for Comment

12. In existing Exchange Act Rule 3b-16(a)(2), non-discretionary methods include providing a trading facility or setting rules governing the interaction of orders. “Trading facility” and “setting rules” are not defined in the rule text but are explained in the Regulation ATS Adopting Release and the Commission provided examples of each.

130

The Commission proposed “communication protocols” as another non-discretionary method for trading interest in the Proposing Release. Should the Commission adopt Exchange Act Rule 3b-16(a)(2), as proposed to be amended, to include “communication protocols” as an example of a non-discretionary method under which buyers and sellers can interact and agree to the terms of a trade? Why or why not? In addition to the guidance provided in the Regulation ATS Adopting Release, should the Commission provide guidance on what “non-discretionary methods” means under Exchange Act Rule 3b-16?

130

See

Regulation ATS Adopting Release at 70851-52. The Regulation ATS Adopting Release stated that the Commission intended for “ `established, non-discretionary methods' to include any methods that dictate the terms of trading among the multiple buyers and sellers entering orders into the system.”

Id.

at 70850.

13. To reflect systems that provide non-discretionary methods under which buyers and sellers negotiate terms of a trade, should the Commission adopt amendments to Exchange Act Rule 3b-16(a)(2) that replace the proposed term “communication protocols” with the term “negotiation protocols” and adopt the following definition under a new Rule 3b-16(f):

For purposes of this section, the term “negotiation protocols” means a non-discretionary method that sets requirements or limitations designed for multiple buyers and sellers of securities using trading interest to interact and negotiate terms of a trade.

14. As discussed above, some commenters state that the term “communication protocol” is too broad and vague and that it is unclear what activities or entities would be classified as communication protocol systems.

131

The term “negotiation protocols” could better focus the non-discretionary methods that the Commission intended to capture in the proposed amendments to Exchange Act 3b-16(a)(2) than the term “communication protocols.” The term “negotiation protocols” would be another example, in addition to directly or indirectly providing a trading facility or setting rules, of a non-discretionary method established by an exchange under which buyers and sellers can negotiate and agree to the terms of a trade. What are commenters' views of the term “negotiation protocols”? Are there any terms that should be added, deleted, or modified in the definition of “negotiation protocol” to make the definition more precise or appropriate? Are there other non-discretionary methods under which buyers and sellers can interact and agree to the terms of a trade that the Commission should add to Rule 3b-16(a)(2)? If so, please explain. What other types of protocols under which buyers and sellers can interact and agree to the terms of a trade exist or can be provided?

131

See supra

note 123.

15. The definition of “negotiation protocols” described above would set

requirements or limitations

designed to govern how the trading interest is used by participants to interact and negotiate a trade. Should a definition of “negotiation protocols” specify both requirements and limitations that would constitute a non-discretionary method? Why or why not?

16. As an alternative to adopting a definition of “negotiation protocols” in the rule text, should the Commission provide an explanation and examples of what negotiation protocols are and are not in any adopting release, similar to what the Commission did in the Regulation ATS Adopting Release when

analyzing the application of Rule 3b-16 to hypothetical Systems A through T?

132

In the Proposing Release, the Commission provided examples of trading systems that offer the use of non-firm trading interest and established protocols that would meet the criteria of Exchange Act 3b-16, as proposed to be amended (

e.g.,

RFQ, conditional order systems, indication of interest systems).

133

Should the Commission adopt those examples as hypotheticals that would meet the criteria of Rule 3b-16 similar to the hypotheticals in the Regulation ATS Adopting Release? Please explain. Should the examples that the Commission provided in the Proposing Release change in any way? Are there any other examples that the Commission should adopt to describe New Rule 3b-16(a) Systems? Please describe any such examples.

132

See

Regulation ATS Adopting Release at 70854-56.

133

See

Proposing Release at 15500-01.

17. As discussed above, whether an organization, association, or group of persons meets the definition of an exchange depends on the activities performed and not the technology used. The Commission received comments requesting the Commission clarify that order management systems, order execution systems, and order execution management systems (collectively referred to as “OEMS” technology) do not meet the criteria of Rule 3b-16, as proposed to be amended.

134

The Commission understands that brokers, dealers, and investment advisers use OEMS technology to carry out their respective Commission-regulated activities. The proposed amendments to Rule 3b-16 were not designed to capture within the definition of exchange the activities of brokers, dealers, and investment advisers who use an OEMS to carry out their functions (

e.g.,

organizing and routing trading interest). The use of OEMS technology, however, like other types of technology, could be used, in certain circumstances, to perform exchange activities (

e.g.,

crossing orders of multiple buyers and sellers using established non-discretionary methods). The Commission requests comment on what activities are performed today using OEMS technology and how the use of OEMS technology might change in the future. The Commission requests comment on whether and how activities performed through the use of OEMS technology could meet the criteria of Rule 3b-16(a), as proposed to be amended. Please explain why or why not.

134

See

Bloomberg Letter I at 16; SIFMA AMG Letter at 11; Broadridge Letter at 3; MFA Letter at 9; Letter from Kelvin To, Founder and President, Data Boiler Technologies, LLC, dated Apr. 18, 2022 at 9. Several commenters express general concerns about and set forth policy arguments against including OEMSs within the Commission's exchange regulation.

See, e.g.,

SIFMA AMG Letter at 6 (asserting that “the Commission's drafting risks moving too far beyond trading venues and is potentially capturing a broad range of OEMS, ETF portal, and single user systems carefully developed by a diverse group of market participants to introduce efficiencies and costs savings into the market, but which do not allow for separate users to interact and do not directly connect with multiple brokers to confirm the non-discretionary execution of orders”); Letter from Sarah Bessin, Associate General Counsel, Investment Company Institute, dated Apr. 18, 2022 (“ICI Letter”) at 9 (arguing that there are no perceived regulatory benefits from applying the ATS or broker-dealer regulatory framework to internalized trading activity on OEMSs, which is independently regulated, and stating that it may “frustrate advisers' ability to seek best execution on behalf of their clients”).

18. In light of comments that the concept of a communication protocol system could capture various types of technologies used by market participants for securities (

e.g.,

GUIs, web chat providers, primary market communication systems, software solutions, or trading desks of a broker-dealer), please explain in detail and provide examples of the specific activities performed through the use of such technology identified by commenters.

19. In response to the Proposing Release, the Commission received several comments expressing concern that the expansion of Exchange Act Rule 3b-16 might encompass general internet chat services, such as WhatsApp, Twitter, and Reddit.

135

As stated in the Proposing Release, systems that provide general connectivity for persons to communicate without protocols containing requirements and limitations to negotiate trades for securities (

e.g.,

utilities or electronic web chat providers) would not fall within the definition of exchange, as proposed to be amended.

136

However, the determination as to whether a given system would meet the criteria under Rule 3b-16(a), as proposed to be amended, must be based on the facts and circumstances surrounding the operation of the system, not the market name or categorization (

i.e.,

simply because a program is called a “chat” or “messaging” service, it does not mean the service is per se outside the scope of Rule 3b-16(a), as proposed to be amended). For example, if a chat or messaging service was provided with a display functionality for trading interest in securities, an execution facility for securities, or protocols for participants to negotiate, the mere fact that the system contains a chat feature or message service would not necessarily preclude it from meeting the criteria of Rule 3b-16 as proposed to be amended. What features of a chat or message service could be considered protocols (

i.e.,

requirements or limitations) under Rule 3b-16, as proposed to be amended, that would allow buyers and sellers to interact and negotiate a trade for securities? Are there currently any types of chat services that are solely used for discussing securities but are not used for negotiating a securities trade? Are there any types of chat services that are currently designed for buyers and sellers to interact and negotiate a trade for securities? Please explain why or why not.

135

See, e.g.,

Chia Network Letter at 4-7 (stating that the expansion to parties that “make available” established, non-discretionary methods could capture large numbers of internet and telecommunications providers, including any company that makes any sort of messaging system available to internet users such as Twitter and Reddit, and creates regulatory uncertainty for all such entities); GDCA Letter II at 10 (stating that the term trading interest “sweeps up dialogue that otherwise would be outside the rules,” such as “ `inadvertent' or `incidental' exchange activity” through protocols “with a primary social or business use unrelated to trading” that are “used secondarily or incidentally for trading”).

136

See

Proposing Release at 15502 n.72.

20. Do commenters believe that there are other technologies, such as social networking websites, business communication platforms, financial information systems, blockchain technology nodes and smart contracting platforms,

137

that could be used to perform activities that meet the criteria of Exchange Act Rule 3b-16(a), as proposed to be amended? Are there any features of these systems that could be considered protocols (

i.e.,

requirements or limitations) that allow buyers and sellers to interact and negotiate a trade for securities? Please explain.

137

See infra

note 278.

21. Form ATS is designed to enable the Commission to determine whether an ATS subject to Regulation ATS is in compliance with Regulation ATS and other federal securities laws.

138

Form ATS provides disclosures about, among other things, classes of subscribers, securities traded, manner of operation, and procedures governing the execution, reporting, clearance, and settlement of transactions. Proposed Item 3(c) of Form ATS (current Form ATS Exhibit B) requires an ATS to disclose a list of securities the ATS trades or expects to trade, and requires disclosure of all securities, which includes crypto asset securities.

139

138

See

Form ATS Instruction A.6.

139

See

Proposing Release at 15653.

22. Form ATS-N is designed to provide market participants with information to, among other things, help them make informed decisions about whether to participate on an NMS Stock ATS (and, as proposed, on a Government Securities ATS).

140

Proposed Part I, Item 8 of Form ATS-N would require an NMS Stock ATS or Government Securities ATS to disclose information about the NMS stocks and government securities that it makes available for trading, which would include any NMS stocks or government securities that are crypto asset securities.

141

Should the Commission adopt an amendment to proposed Item 3(c) of Form ATS or proposed Part I, Item 8 of Form ATS-N to require ATSs and NMS Stock ATSs and Government Securities ATSs to specifically identify the securities that are crypto asset securities? Why or why not? Should the Commission make any other changes to Form ATS and Form ATS-N in light of the Proposing Release and the information provided in this Reopening Release?

140

See

Form ATS-N Instruction D.

141

See

Proposing Release at 15542.

23. Form ATS-R, which is filed on a quarterly basis and deemed confidential when filed, is designed to enable the Commission to more effectively track the growth and development of ATSs, as well as to more effectively comply with its statutory obligations with respect to ATSs, and improve investor protection.

142

Among other things, Form ATS-R requires ATSs to list all securities that were traded on the ATS at any time during the period covered by the report

143

and to report total unit and dollar volume of transactions for certain categories of securities.

144

Should Form ATS-R be amended to require ATSs to indicate whether any of the types of securities traded on the ATS are crypto asset securities? For example, should Form ATS-R include a checkbox for each type of security listed on Form ATS-R for the ATS to indicate whether any of the securities transacted are crypto asset securities? Why or why not? Should Form ATS-R be amended to require an ATS to report the total unit and dollar volume of transactions in crypto asset securities for each category of securities? Why or why not? Should the Commission make any other changes to Form ATS-R in light of the Proposing Release and the information provided in this Reopening Release?

142

See

Form ATS-R Instruction A.7.

143

See

Form ATS-R Item 3. Form ATS-R also requires a list of all subscribers that were participants of the ATS during each calendar quarter.

See

Form ATS-R Item 2.

144

See

Form ATS-R Item 4. For example, Form ATS-R requires NMS Stock ATSs to report the total unit and dollar volume of transactions in NMS stocks that are reported to the consolidated tape in “Listed Equity Securities” (Item 4A), “Nasdaq National Market Securities” (Item 4B), or “Nasdaq SmallCap Market Securities” (Item 4C). In the Proposing Release, the Commission proposed to delete the categories “Nasdaq National Market Securities” and “Nasdaq SmallCap Market Securities” and require ATSs to report the total volume previously reported under these categories under “Listed Equity Securities.”

See

Proposing Release at 15580.

24. Information about a New Rule 3b-16(a) System's operations, including operations related to non-firm trading interest and protocols provided for buyers and sellers to interact and negotiate the terms of a trade, would be responsive to proposed Item 3(g) of Form ATS, which requires a description of the manner of operation of the ATS. To assist New Rule 3b-16(a) Systems in responding to Form ATS, should the Commission adopt an amendment to proposed Item 3 of Form ATS to add the following requirement as a disclosure: “any display of trading interest” and “protocols provided for buyers and sellers to interact and negotiate the terms of a trade”? Please explain why or why not. Although this information would be responsive to current Form ATS Item 8(a) and would be required to be included in current Form ATS Exhibit F, the explicit references would make clear to ATSs that such information is responsive to the form and must be provided.

25. Proposed Item 3(j) of Form ATS (current Form ATS Item 8(d), which is required to be disclosed on Exhibit F) would require an ATS to provide “a description of the procedures governing execution, reporting, clearance, and settlement of transactions effected through the [ATS].”

145

Should the Commission adopt an amendment to the Item to include a reference to the use of DLT among the procedures so that the Item would state that the ATS must include “a description of the procedures, including through use of DLT, governing execution, reporting, clearance, and settlement of transactions effected through the alternative trading system”? Please explain why or why not. Although a description of the use of DLT, or any other technology, in these processes is currently required by the term “procedures,” the explicit reference to DLT would make clear that a description of its use would be required to be provided in Form ATS.

145

See id.

at 15654.

26. As discussed above, several commenters ask questions about how so-called “DeFi” systems could comply with the requirements of Regulation ATS.

146

Form ATS-N, which provides operational transparency and regulatory oversight of NMS Stock ATSs and, as proposed, of Government Securities ATSs, is technology neutral and asks questions designed to apply to ATSs that vary in structure and offer many different functionalities and trading processes and procedures. However, Form ATS-N provides examples of specific functionalities and procedures that would be responsive to particular questions. To assist subject systems in responding to Form ATS-N, should the Commission adopt any changes, particularly to the examples provided in Form ATS-N, to clarify and highlight the applicability of certain items in Form ATS-N to NMS Stock ATSs and Government Securities ATSs that use DLT? Should, for example, the Commission adopt amendments to proposed Part II, Item 5 to provide examples of other products and services that the operator of a system that uses DLT may provide for the purpose of effecting transactions or submitting, disseminating, or displaying trading interest on the ATS?

147

Should the Commission adopt amendments to Part III, Item 5(a) to provide web-based systems as an example of means by which the NMS Stock ATS or Government Securities ATS permits trading interest to be entered directly into the ATS?

148

Should the Commission adopt amendments to Part III, Item 15 to provide examples of blockchain-based means by which trading interest can be displayed or made known to the ATS subscribers or the public?

149

Should the Commission adopt amendments to proposed Part III, Item 21 to provide examples of blockchain-based procedures to manage the post-trade processing, clearance, and/or settlement on the ATS?

150

Should the Commission adopt amendments to proposed Part III, Item 22 to provide examples of blockchain-based market data sources?

151

146

See, e.g., supra

note 55.

147

See

Proposing Release at 15546-48.

148

See id.

at 15552-53.

149

See id.

at 15563-65. Such amendments could provide examples of blockchain-based means by which: an ATS may display trading interest to its subscribers or the public; a subscriber can display or make known trading interest through the ATS; and trading interest bound for the ATS is made known to any person.

See id.

150

See id.

at 15568-69.

151

See id.

at 15569.

D. Exclusion From Exchange Act Rule 3b-16(a)

In the Proposing Release, the Commission proposed to amend Rule 3b-16(b) to add an exclusion from Rule 3b-16(a) for systems that allow an issuer

to sell its securities to investors.

152

The Commission stated in the Proposing Release that the exclusion was merely codifying in Rule 3b-16(b)(3) an example the Commission provided in the Regulation ATS Adopting Release for systems that have a single seller of its securities.

153

While such systems have multiple buyers (

i.e.,

investors), they have only one seller for each security (

i.e.,

issuers) and, therefore, do not meet the criteria of Rule 3b-16(a) because the systems do not bring together multiple buyers and multiple sellers.

154

152

See

proposed Rule 3b-16(b)(3).

153

See

Regulation ATS Adopting Release at 70849.

154

Id.

One commenter states that it is unclear whether the issuer exclusion would cover portals on which multiple issuers offer securities.

155

Another commenter suggests that the exclusion for issuer systems should be revised to state that it applies to a system that “allows one or more issuers to sell their securities to investors, either directly or through placement agents or underwriters.”

156

This commenter states that a system that allows more than one issuer to sell its own securities is a single counterparty system because for any particular security, there is only one counterparty, the issuer of the securities.

157

This commenter further states that including the phrase “or through placement agents or underwriters” is needed to make clear that the issuer exclusion may continue to be applied if the system permits an issuer to use brokers or underwriters, and this approach is desirable because it permits the interposition of registered brokers, who provide a multitude of services protective of the rights of investors.

158

155

See

SIFMA AMG Letter at 8.

156

See

ABA Letter at 8.

157

Id.

at 9.

158

Id.

Two commenters request that the Commission confirm that a system or portal that an exchange-traded fund (“ETF”) sponsor uses to facilitate ETF primary market operations (

i.e.,

creation and redemption of ETF shares) (“ETF Portal”) is not a communication protocol system, as defined in the Proposing Release, and otherwise does not meet the definition of “exchange,” as proposed to be amended.

159

The commenters state that ETF Portals enable registered broker-dealers that serve as an ETF's authorized participants (“APs”) to communicate creation or redemption requests for an ETF.

160

One of the commenters states that ETF Portals do not create a market place for secondary market trading activity (

i.e.,

trading of the actual ETF shares among individual investors) because they are used by ETF sponsors for the specific purpose of creating and redeeming their own issued securities.

161

In this respect, this commenter believes that ETF Portals are similar to a system that allows issuers to sell their own securities to investors.

162

Another commenter similarly agrees that ETF Portals should not be included in the definition of an “exchange” and does not believe there would be any public benefit to treating such portals as exchanges and requiring ATS registration.

163

159

See

SIFMA AMG Letter at 8; ICI Letter at 13. The commenters state that they do not believe that the Commission intended to classify ETF Portals as exchanges under Rule 3b-16, as proposed to be amended.

See id.

160

See id.

161

See

ICI Letter at 14. This commenter also states that an ETF Portal's activities are limited in the following respects: “(1) the scope of ETFs involved in the creation or redemption process is confined to those offered by the ETF sponsor; (2) only registered broker-dealers that have an established agreement with an ETF sponsor's ETF to act as an AP can submit creation or redemption requests to the ETF; and (3) the system or portal does not directly facilitate secondary market activity in the ETF (

i.e.,

trading of the actual ETF shares among individual investors), nor does it provide access for individual investors that are not registered broker-dealers.”

Id.

at 13.

162

See id.

at 14. This commenter further states that applying the Regulation ATS and broker-dealer regulatory frameworks to ETF Portals would impose unnecessary additional costs and burdens to the ETF creation and redemption process, lead to unintended consequences, and would not further the Commission's regulatory objectives.

See id.

at 4.

163

See

SIFMA AMG Letter at 8.

Request for Comment

27. Should the Commission adopt Rule 3b-16(b)(3), as proposed to be amended? Why or why not? Should the Commission adopt the proposed Rule 3b-16(b)(3) exclusion but with certain revisions? If so, please identify those revisions and explain. For example, should the Commission adopt, as suggested by one commenter, the proposed issuer exclusion with revisions to state that it applies to a system that “allows one or more issuers to sell their securities to investors, either directly or through placement agents or underwriters”? In particular, should the Commission add “one or more issuers” to the proposed issuer exclusion? What types of systems would be covered under the revised issuer exclusion example above? Please explain. Is the inclusion of “either directly or through placement agents or underwriters” in the revised issuer exclusion example above necessary or appropriate to clarify its application? If so, why?

28. How do ETF Portals operate for the creation and redemption of securities? Who are the participants in ETF Portals and how do they interact? Are there any trading activities conducted as part of the creation and redemption process through an ETF Portal that are exchange activities or necessitate further clarification by the Commission as to whether such activities are exchange activities? Do an ETF Portal's activities facilitate secondary market activity in the ETF? Why or why not? Does trading in ETF Portals involve multiple buyers and sellers of securities? Why or why not? What non-discretionary methods are generally used by ETF Portals?

29. Do ETF Portals fall within the criteria of existing Exchange Act Rule 3b-16(a) or Rule 3b-16(a), as proposed to be amended? Why or why not? If the activities conducted through ETF Portals fall within the criteria of existing Exchange Act Rule 3b-16(a) or Rule 3b-16(a), as proposed to be amended, should the Commission adopt an exclusion under Exchange Act Rule 3b-16(b)(3) for ETF Portals? If yes, please explain why and explain what the exclusion should apply to. How should an ETF Portal be defined for purposes of the exclusion? For example, should the Commission expressly adopt an exclusion that applies only to ETF Portals that fall within this definition: “a system that allows one or more issuers from the same sponsoring entity to solicit creation or redemption requests for their own securities submitted by authorized participants for those securities”? Should the Commission adopt an exclusion that applies only to platforms that solely support primary market transactions in investment company securities, where the issuer of the security participates in each transaction either as the sole buyer, or as the sole seller? If so, should the exclusion be available only for securities issued by ETFs or also for securities issued by other investment companies? Should the exclusion specify that it is available only for transactions that take place at a price based on the current net asset value of the security, as required by 17 CFR 270.22c-1 (Rule 22c-1 under the Investment Company Act of 1940)? What ETF Portals should not be excluded from Exchange Act Rule 3b-16(a)? Please explain.

E. Compliance Date for Implementation of Proposed Amendments to Rule 3b-16

Exchange Act Rule 3b-16, as proposed to be amended, would require, if adopted, New Rule 3b-16(a) Systems to comply with federal securities laws applicable to national securities exchanges and ATSs. These systems may trade securities that are crypto asset securities, or specific types of securities, including NMS stock, over-the-counter (“OTC”) equity securities, corporate bonds, municipal securities, government securities, foreign sovereign debt, asset-backed securities, restricted securities, or options. New Rule 3b-16(a) Systems provide access to numerous and diverse market participants (

e.g.,

retail investors, institutional investors, broker-dealers, issuers) seeking to perform different trading strategies and investment objectives in various types of securities. To facilitate these market participants' trading strategies and investment objectives, providers of these trading systems employ assorted technology and protocols (

e.g.,

internet, DLT, cloud) and apply a variety of methods to bring together buyers and sellers in securities (

e.g.,

RFQ, indication of interest, negotiation, conditional orders, bid wanted in competition, streaming axes).

Several commenters express concern that New Rule 3b-16(a) Systems would not be provided enough time to comply with their new regulatory obligations.

164

As stated in the Proposing Release, the Commission expects that many New Rule 3b-16(a) Systems would elect to register as broker-dealers and comply with Regulation ATS;

165

however, they can also elect to register as exchanges.

166

The Commission recognizes that New Rule 3b-16(a) Systems are operating today and would seek to comply with the Proposed Rules without disrupting their current business and their participants. To facilitate the trading system operators' compliance with the Proposed Rules, the Commission is soliciting further public comment on any compliance dates for the Proposed Rules.

164

See, e.g.,

MarketAxess Letter at 5; Letter from Teana Baker-Taylor, Chief Policy Officer, Chamber of Digital Commerce, dated Mar. 24, 2022 (“Chamber Letter”) at 5; Letter from Elisa Hirschmann, Executive Director, Chief Compliance Officer, BrokerTec Americas LLC, CME Group, Inc., dated Apr. 18, 2022 at 4; Bloomberg Letter I at 4-5; Letter from Scot J. Halvorsen, Associate General Counsel, Cboe Global Markets, Inc., dated Apr. 18, 2022 (“Cboe Letter”) at 2; Crypto Council Letter at 7.

165

See

Proposing Release at 15502.

166

See id.

at 15617-18.

Request for Comment

30. Should the Commission adopt a compliance date to delay implementation for New Rule 3b-16(a) Systems? Why or why not? Should the Commission adopt the same compliance date for all New Rule 3b-16(a) Systems or different compliance dates depending on certain factors, such as the type of securities the system trades? Please explain. For example, should the Commission adopt separate compliance dates to implement the proposed amendments to Exchange Act Rule 3b-16 for trading systems that trade one or more of the following: NMS stock, OTC equity securities, corporate bonds, municipal securities, government securities, foreign sovereign debt, asset-backed securities, restricted securities, or options? Please explain.

31. As indicated above, crypto assets generally use DLT as a method to record ownership and transfers, and a crypto asset that is a security is not a separate type or category of security for purposes of federal securities laws based solely on the use of DLT.

167

Should the Commission adopt a separate compliance date for New Rule 3b-16(a) Systems that trade crypto asset securities?

168

Please explain. If the Commission adopts a different compliance date for New Rule 3b-16(a) Systems that trade crypto asset securities, for purposes of ascribing such compliance date, should “crypto asset securities” be defined to mean securities that are also issued and/or transferred using distributed ledger or blockchain technology, including, but not limited to, so-called “virtual currencies,” “coins,” and “tokens,” to the extent they rely on cryptographic protocols?

169

Please explain.

167

See supra

note 27 and accompanying text.

168

Such a delayed compliance date for New Rule 3b-16(a) Systems would not impact the obligation of systems that meet the existing criteria of Rule 3b-16 to comply with existing rules.

169

In the past, the Commission used this definition for “digital asset securities” in the Commission Statement on Custody of Digital Asset Securities by Special Purpose Broker-Dealers.

See supra

note 26.

32. Should the Commission adopt a uniform compliance period for all categories of securities that is one year? Or would a shorter or longer time period than one year be sufficient or necessary? If commenters believe the Commission should adopt different compliance dates for trading systems that trade a category of security, what compliance date should the Commission adopt for such trading systems? Please explain.

33. Should the Commission adopt different compliance dates for New Rule 3b-16(a) Systems based on the types of participants that trade on the system? For example, should the Commission adopt a delayed compliance date for trading systems that have predominately retail, institutional, or broker-dealer participants? Please explain. What compliance date should the Commission adopt for these types of trading systems? Please explain.

34. Should the Commission adopt different compliance dates for New Rule 3b-16(a) Systems based on the different means by which participants enter trading interest into the system? For example, should the Commission adopt a delayed compliance date for trading systems that perform intermediary services, such as entering trading interest into the trading system on behalf of users or offering users services other than trading? Should the Commission adopt a delayed compliance date for trading systems that allow buyers and sellers to enter trading interest into the system directly without an intermediary? Please explain. What compliance date should the Commission adopt for these types of trading systems? Please explain.

35. Should the Commission adopt different compliance dates for New Rule 3b-16(a) Systems based on different trading protocols that bring together buyers and sellers to negotiate a trade? For example, should the Commission adopt different compliance dates for trading systems that provide RFQs, indications of interest, bids wanted in competition, or streaming axes? Should the Commission adopt a delayed compliance date for trading systems that use AMMs for buyers and sellers to enter trading interest into the system and negotiate a trade? What compliance date should the Commission adopt for these types of trading systems? Please explain.

36. Should the Commission adopt different compliance dates for New Rule 3b-16(a) Systems based on the technology supporting its exchange activity (

e.g.,

internet, DLT, cloud)? For example, should the Commission adopt a delayed compliance date for trading systems that use DLT to bring together buyers and sellers using trading interest and establish protocols that allow participants to negotiate a trade? Please explain. What compliance date should the Commission adopt for these types of trading systems? Please explain.

37. Should the Commission adopt different compliance dates for New Rule 3b-16(a) Systems based on the volume that trading systems transact? For example, should the Commission adopt a delayed compliance date for a trading system that transacts a certain level of dollar volume or share volume, and if

so, what should that volume be? Should the Commission adopt different compliance dates for trading systems based on all of their transaction volume or only transaction volume in a category of security or in a crypto asset security? Please explain. What compliance date should the Commission adopt for these types of trading systems? Please explain.

38. Should the Commission adopt different compliance dates for New Rule 3b-16(a) Systems based on a combination of factors described above or any other factors? Please explain.

IV. Paperwork Reduction Act

In the analysis of the proposed rule amendments under the Paperwork Reduction Act of 1995 (“PRA”) of the Proposing Release, the Commission estimated 22 Communication Protocol Systems

170

would be impacted by the Proposed Rules. This estimate included systems that offer trading of OTC equity securities and restricted securities, some of which trade crypto asset securities.

170

The Proposing Release referred to systems that would newly meet the definition of “exchange” under the Proposed Rules as “Communication Protocol Systems.”

See

Proposing Release at 15496 n.5.

See also

SIFMA Letter II at 8-9 (stating that “[t]he broad concept of communication protocol systems could theoretically capture hundreds, if not thousands, of systems across asset classes” and there is a disconnect with the Commission's estimate that 22 systems would be affected by the Proposed Rules). As discussed above, systems would constitute a single exchange and be responsible for compliance as a single entity.

See supra

section II.B.

177

The original 22 Newly Designated ATSs the Commission estimated in the Proposing Release may include ATSs that trade crypto asset securities.

178

In the Proposing Release, the Commission certified that the proposed amendments to Regulation ATS would not, if adopted, have a significant economic impact on a substantial number of small entities pursuant to section 3(a) of the Regulatory Flexibility Act of 1980 (5 U.S.C. 603(a)).

See

Proposing Release at 15645. The Commission did not receive any comment regarding its certification. Although the Commission is now revising its estimate of the number of respondents that would be subject to the proposed rules, the Commission continues to certify that the proposed amendments would not, if adopted, have a significant economic impact on a substantial number of small entities. As in the Proposing Release, the Commission encourages written comments regarding this certification.

179

The estimates presented here relate only to those collections of information for which the burdens will change as a result of increasing the estimated total number of Newly Designated ATSs. For the complete estimated burden associated with the proposed amendments, the estimates here for Newly Designated ATSs should be considered together with those originally included in the Proposing Release for Communication Protocol Systems,

see

Proposing Release at section VII, with any burden identified by the identical combination of Collection of Information and rule number replaced and superseded by that contained here.

180

The estimated respondents for the Rule 304/Form ATS-N collection of information is based on the assumption that systems that operate multiple market places that are affiliated with a new or existing broker-dealer will all be operated by such broker-dealer, and that such systems will not register multiple broker-dealers to operate multiple affiliated ATSs.

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