Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer in Connection With Certain Liquidity Providers

Federal RegisterFeb 29, 2024

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-99477; File No. S7-12-22]

RIN 3235-AN10

Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer in Connection With Certain Liquidity Providers

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

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

DATES:

Effective date:

April 29, 2024.

Compliance date:

The compliance date is discussed in section II.B of this release.

FOR FURTHER INFORMATION CONTACT:

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

SUPPLEMENTARY INFORMATION:

The Commission is adopting the following new rules under the Exchange Act: (1) 17 CFR 240.3a5-4 (“Rule 3a5-4”), and (2) 17 CFR 240.3a44-2 (“Rule 3a44-2”) (collectively, “final rules”).

Table of Contents

I. Introduction

A. Background

B. Overview of the Final Rules and Modifications to the Proposal

II. Discussion of Final Rules

A. Component Parts

1. Qualitative Standard

a. Elimination of the Proposed First Qualitative Factor

b. Expressing Trading Interest Factor

c. Primary Revenue Factor

2. Quantitative Standard

3. Exclusions

a. Person That Has or Controls Assets of Less Than $50 Million

b. Registered Investment Companies, Private Funds, and Registered Investment Advisers

c. Official Sector Exclusions

d. Other Requests for Exclusions

4. Definitions and Anti-Evasion

5. No Presumption

B. Compliance Date

III. Economic Analysis

A. Introduction

B. Baseline

1. Rules and Regulations That Apply to Registered Dealers

2. Affected Parties

a. Principal Traders

b. Private Funds and Advisers

c. Number of Affected Parties

3. Competition Among Significant Liquidity Providers

4. Externalities

C. Economic Effects, Including Impact on Efficiency, Competition, and Capital Formation

1. Benefits

a. Regulatory Consistency and Competition

b. Regulations on Financial and Operational Risk-Taking

c. Regulations on Reporting

d. Regulations on Deceptive Practices

e. Regulations Related to Examinations

2. Costs

a. Compliance Costs

b. Costs Associated With the Net Capital Rule

c. Potential Implications for Private Funds and Advisers

d. Effects on Market Liquidity

3. Effects on Efficiency, Competition, and Capital Formation

a. Effects on Efficiency

b. Effects on Competition

c. Effects on Capital Formation

D. Reasonable Alternatives

1. Retain the Quantitative Standard

2. Retain the First Qualitative Standard (

e.g.,

“Routinely Making Roughly Comparable Purchases and Sales of the Same or Substantially Similar Securities [or Government Securities] in a Day”)

3. Remove the Exclusion for Registered Investment Companies

4. Exclude Registered Investment Advisers and Private Funds

5. Require Registered Investment Advisers and Private Funds To Report to TRACE

6. Carve Out or Narrow Application to Crypto Asset Securities

IV. Paperwork Reduction Act

V. Regulatory Flexibility Act

VI. Other Matters

Statutory Authority

I. Introduction

The dealer regulatory regime is a cornerstone of the U.S. Federal securities laws and helps to promote the Commission's longstanding mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

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

However, some of these market participants—despite engaging in liquidity-providing activities similar to those traditionally performed by either “dealers” or “government securities dealers” as defined under sections 3(a)(5) and 3(a)(44) of the Exchange Act, respectively, and despite their significant share of market volume—are not registered with the Commission as either dealers or government securities dealers under sections 15 and 15C of the Exchange Act, respectively. The identification, registration, and regulation of these market participants as dealers will provide regulators with a more comprehensive view of the markets through regulatory oversight and will support market stability and resiliency and protect investors by promoting the financial responsibility and operational integrity of market participants that are acting as dealers.

Further, the final rules will promote competition among entities that regularly provide significant liquidity by applying consistent regulation to these entities, thus leveling the competitive playing field between liquidity provision conducted by entities that are currently registered as dealers and government securities dealers and by entities that are not.

See, e.g., Eastside Church of Christ

National Plan, Inc.,

391 F.2d 357 (5th Cir. 1968) (“The requirement that brokers and dealers register is of the utmost importance in effecting the purposes of the Act. It is through the registration requirement that some discipline may be exercised over those who may engage in the securities business and by which necessary standards may be established with respect to training, experience, and records.”);

see also

section 2 of the Exchange Act, 15 U.S.C. 78b (stating that “transactions in securities as commonly conducted upon securities exchanges and over-the-counter markets are effected with a national public interest which makes it necessary to provide for regulation and control of such transactions and of practices and matters related thereto”).

See

Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer, Exchange Act Release No. 94524 (Mar. 28, 2022), 87 FR 23054 (Apr. 18, 2022) (“Proposing Release”).

See

section III.

The Federal securities laws provide a comprehensive system of regulation of securities activity, and the definition of “dealer” is one of the Exchange Act's most important definitions, as it sets forth certain activities that cause persons to fall within the Commission's regulatory ambit.

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

business of buying and selling securities . . . for such person's own account through a broker or otherwise,” but excludes “a person that buys or sells securities . . . for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business.” Similarly, section 3(a)(44) of the Exchange Act provides, in relevant part, that the term “government securities dealer” means “any person engaged in the business of buying and selling government securities for his own account, through a broker or otherwise,” but “does not include any person insofar as he buys or sells such securities for his own account, either individually or in some fiduciary capacity, but not as part of a regular business.” These statutory definitions of “dealer” and “government securities dealer,” and the accompanying registration requirements of the Exchange Act, were drawn broadly by Congress to encompass a wide range of activities involving the securities markets and their participants.

Market participants that meet these statutory definitions are required to register with the Commission and are subject to a panoply of regulatory obligations and supervisory oversight, unless an exemption or exception applies.

See supra

note 1;

see also

section II.A.5 (explaining that otherwise applicable interpretations and precedent continue to apply to determine whether a person is acting as a dealer, even when that person does not fall within the requirements of the new rules); section II.A.3 (explaining that the $50 million threshold is not an exclusion from the “dealer” definition for all purposes, but only for purposes of the new rules).

Registration will enable more comprehensive regulatory oversight of securities markets and those participants that take on significant liquidity-providing roles. The final rules will support market stability and resiliency and protect investors by promoting the financial responsibility and operational integrity of significant liquidity providers that are acting as dealers in the securities markets.

Section III below describes the estimated benefits and costs associated with registering as a dealer or government securities dealer for those persons who meet the qualitative standard of the final rules.

A. Background

The statutory definition of “dealer” in section 3(a)(5) and the accompanying registration requirements of the Exchange Act were drawn broadly by Congress in 1934 to encompass a wide range of activities involving the securities markets and their participants. Section 3(a)(5) of the Exchange Act defines the term “dealer” to mean “any person engaged in the business of buying and selling securities . . . for such person's own account through a broker or otherwise,” but excludes “a person that buys or sells securities . . . for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business.”

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

Absent an exception or an exemption, section 15(a)(1) of the Exchange Act makes it unlawful for a “dealer” to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security unless registered with the Commission in accordance with section 15(b) of the Exchange Act.

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

regular business.”

Read together, these provisions identify a “government securities dealer” as a person engaged in the business of buying and selling government securities for its own account as part of a regular business. Section 15C of the Exchange Act makes it unlawful for a “government securities dealer” (other than a registered broker-dealer or financial institution) to induce or attempt to induce the purchase or sale of any government security unless such government securities dealer is registered in accordance with section 15C(a)(2).

See

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

See

2002 Release (explaining that “a person that is buying securities for its own account may still not be a `dealer' because it is not `engaged in the business' of buying and selling securities for its own account as part of a regular business,” and that “[t]his exclusion is often referred to as the dealer/trader distinction”).

A bank engaged in these activities with respect to government securities would not register with the Commission as a dealer.

See

Exchange Act section 3(a)(5)(C)(i)(II) (providing an exception from dealer status when a bank buys or sells exempted securities, which are defined in Exchange Act section 3(a)(12)(A) to include government securities);

see also

Exchange Act section 3(a)(6) (definition of “bank”). A bank may nonetheless be a government securities dealer under section 3(a)(44). As such, it would not register with the Commission but instead would provide written notice of its government securities dealer status with the appropriate Federal banking regulator.

15 U.S.C. 78c(a)(44). Congress added the definition of “government securities dealer” to the Exchange Act in the Government Securities Act of 1986 (“GSA”). Public Law 99-571, 100 Stat. 3208 (Oct. 28, 1986). In addition to otherwise applicable regulations, government securities dealers must comply with rules adopted by the Treasury.

See

regulations under section 15C of the Securities Exchange Act of 1934, 17 CFR 400.1(b),

available at https://www.govinfo.gov/content/pkg/CFR-2018-title17-vol4/pdf/CFR-2018-title17-vol4.pdf.

These regulations address financial responsibility, protection of customer securities and funds, recordkeeping, and financial reporting and audits. Also included are rules concerning custodial holdings of government securities by depository institutions. The Commission retains broad antifraud authority over banks that are government securities dealers. Soon after enactment of the GSA, the staff issued a series of no-action letters to persons seeking assurances that the staff would not recommend enforcement action if they did not register as government securities dealers.

See, e.g.,

Bankers Guarantee Title & Trust Co., SEC No-Action Letter (Jan. 22, 1991); Bank of America, Canada, SEC No-Action Letter (May 1, 1988); Citicorp Homeowners, Inc., SEC No-Action Letter (Oct. 7, 1987); Fairfield Trading Corp., SEC No-Action Letter (Dec. 10, 1987); Louis Dreyfus Corp., SEC No-Action Letter (July 23, 1987); United Savings Association of Texas, SEC No-Action Letter (Apr. 2, 1987); Continental Grain Co., SEC No-Action Letter (Nov. 28, 1987). Staff reports, Investor Bulletins, and other staff documents (including those cited herein) represent the views of Commission staff and are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content of these staff documents and, like all staff statements, they have no legal force or effect, do not alter or amend applicable law, and create no new or additional obligations for any person. Staff in the Division of Trading and Markets is reviewing its no-action letters and other staff statements that address the Exchange Act's definition of “dealer” or “government securities dealer” to determine which letters and other staff statements, or portions thereof, should be withdrawn in connection with the adoption of the final rules. Some of these letters and staff statements, or portions thereof, may be moot, superseded, or otherwise inconsistent with the final rules, and, therefore, may be withdrawn by the staff. A list of the letters to be withdrawn will be available on the Commission's website.

A government securities dealer that is a registered dealer or a financial institution must file notice with the appropriate regulatory agency that it is a government securities dealer.

See

15 U.S.C. 78

-5(a). Exchange Act section 3(a)(46) defines the term “financial institution” to include: (i) a bank (as that term is defined in Exchange Act section 3(a)(6) (15 U.S.C. 38c(a)(6)); (ii) a foreign bank (as that term is used in the International Banking Act of 1978); and (iii) a savings association (as defined in section 3(b) of the Federal Deposit Insurance Act, the deposits of which are insured by the Federal Deposit Insurance Corporation).

See

15 U.S.C. 78c(a)(46)(A) through (C).

The Commission has long identified factors that would be informative for determining whether a person is a dealer. For example, the Commission's 2002 Release states that “[a] person generally may satisfy the definition, and therefore, be acting as a dealer in the securities markets by conducting various activities: (1) underwriting; (2) acting as a market maker or specialist on an organized exchange or trading system; (3) acting as a

de facto

market maker whereby market professionals or the public look to the firm for liquidity; or (4) buying and selling directly to securities customers together with conducting any of an assortment of professional market activities such as providing investment advice, extending credit and lending securities in connection with transactions in securities, and carrying a securities account.

These principles demonstrate that the analysis of whether a person meets the definition of a dealer depends upon all of the relevant facts and circumstances.”

2002 Release at 67498-67500.

See id.; see also

Proposing Release at 23058-59.

In recent years, market participants regularly engaging in significant liquidity provision have not registered, either as “dealers” under section 15 of the Exchange Act or “government securities dealers” under section 15C of the Exchange Act.

This is particularly true in the U.S. Treasury market where certain market participants, particularly those commonly known as proprietary or principal trading firms (“PTFs”), account for about half of the daily volume in the interdealer market and yet are not registered as dealers—despite performing critical market functions, in particular liquidity provision, that historically have been performed by dealers.

The Commission recognizes that, depending on their business models, PTFs may not engage in certain types of dealer activities. Some may not, for example, underwrite securities, solicit clients, provide investment advice, carry accounts for others, or extend credit, and so may not implicate principle (1), (2), or (4) as discussed in the 2002 Release. The Commission is concerned, however, that some PTFs act as

de facto

market makers but do so without registration.

Such a regulatory gap results in inconsistent oversight of market participants performing similar functions (whether in the same market or across asset classes). This limited regulatory oversight of significant liquidity providers increases the difficulty and complexity for regulators to investigate, understand, and address significant market events.

As a result,

investors and the markets currently lack important protections.

See

Proposing Release at 23081.

Nellie Liang and Pat Parkinson, Hutchins Center Working Paper #72, Enhancing Liquidity of the U.S. Treasury Market Under Stress (Dec. 16, 2020), at 6. The term “PTF” is not defined in the securities laws. PTFs trade as principals, buying and selling for their own accounts, and often employ automated, algorithmic trading strategies (including passive market making, arbitrage, and structural and directional trading) that rely on speed, which allows them to quickly execute trades, or cancel or modify quotes in response to perceived market events.

See

Proposing Release at 23055.

See also

Joint Staff Report: The U.S. Treasury Market on Oct. 15, 2014 (July 13, 2015) (“2015 Joint Staff Report”), prepared by staff of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission,

available at https://www.sec.gov/reportspubs/specialstudies/treasury-market-volatility-10-14-2014-joint-report.pdf.

The 2015 Joint Staff Report is a report of the Inter-Agency Working Group for Treasury Market Surveillance (“IAWG”). In contrast, many equity market participants may already be registered in order to take advantage of certain incentives offered only to exchange members.

See

Exchange Act section 6(c)(1) (requiring a national securities exchange to deny membership to any person that is not a registered broker or dealer or, if a natural person, associated with a registered broker or dealer).

The significant role played by market participants not registered as dealers distinguishes the Treasury market from other markets where these types of participants are more typically registered as dealers. One commenter stated that it understood “from its member firms that one of the effects of the Market Access Rule is that many previously unregistered PTFs operating in the equity and options markets became registered as broker-dealers due to their business need to submit their orders directly into the market without having to first run them through the risk controls of other broker-dealers,” and that the Proposing Release did not address this market development.

See

Comment Letter of Securities Industry and Financial Markets Association (May 27, 2022) (“SIFMA Comment Letter I”);

see also

17 CFR 240.15c3-5 (“Rule 15c3-5” or “Market Access Rule”) (requiring broker-dealers with market access to establish, document, and maintain a system of risk management controls and supervisory procedures reasonably designed to manage financial, regulatory, and other risks of this business activity). As explained in the Proposing Release, it is the Commission's understanding that in the equity markets, because PTF trading strategies typically depend on latency and cost advantages made possible by trading directly (via membership) on a national securities exchange, and the Exchange Act limits exchange membership to registered broker-dealers, there is incentive for many PTFs to register as broker-dealers to gain these advantages. In the U.S. Treasury market, however, where trading occurs on alternative trading systems (“ATSs”) and other non-exchange venues, PTFs lack this incentive to register.

See

Proposing Release at 23072-73.

See also

Exchange Act section 6(c)(1) (“A national securities exchange shall deny membership to (A) any person, other than a natural person, which is not a registered broker or dealer or (B) any natural person who is not, or is not associated with, a registered broker or dealer.”).

See, e.g.,

Inter-Agency Working Group for Treasury Market Surveillance Joint Staff Report, Recent Disruptions and Potential Reforms in the U.S. Treasury Market: A Staff Progress Report

prepared by U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, U.S. Commodity Futures Trading Commission (Nov. 8, 2021) (“2021 IAWG Joint Staff Report”) (describing Mar. 2020 COVID-19 and Oct. 15, 2014, flash rally disruptions to the Treasury market).

See also

Consolidated Audit Trail, Exchange Act Release No. 62174 (May 26, 2010), 75 FR 32556 (June 8, 2010); Joint Industry Plan; Order Approving the National Market System Plan Governing the Consolidated Audit Trail, Exchange Act Release No. 79318 (Nov. 15, 2016), 81 FR 84696 (Nov. 23, 2016) (“CAT Approval Order”); Joint Industry Plan; Notice of Filing of a National Market System Plan Regarding Consolidated Equity Market Data, Exchange Act Release No. 77724 (Apr. 27, 2016), 81 FR 30614 (May 17, 2016) (“CAT Notice”).

See, e.g.,

Market Access Rule (promotes market integrity by reducing risks associated with market access by requiring financial and regulatory risk management controls reasonably designed to limit financial exposures and ensure compliance with applicable regulatory requirements).

See, e.g.,

section 17(a) of the Exchange Act and 17 CFR 240.17a-3 (“Rule 17a-3”) and 240.17a-4 (“Rule 17a-4”);

See also

Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers; Capital Rule for Certain Security-Based Swaps Dealers, Exchange Act Release No. 71958 (Apr. 17, 2014), 79 FR 25194, 25199 (May 2, 2014) (“The requirements are an integral part of the investor protection function of the Commission, and other securities regulators, in that the preserved records are the primary means of monitoring compliance with applicable securities laws, including antifraud provisions and financial responsibility standards.”).

See, e.g.,

sections 15(c)(1) and (2) of the Exchange Act, 15 U.S.C. 78

(c)(1) and (2), and rules promulgated thereunder. Section 15(c) of the Exchange Act prohibits broker-dealers from effecting any transaction in securities by means of any manipulative, deceptive, or other fraudulent device or contrivance.

Under Title I of the GSA, all government securities brokers and government securities dealers are required to comply with the requirements in Treasury's GSA regulations that are set out in 17 CFR parts 400 through 449, as well as all other applicable requirements. For the most part, Treasury's GSA regulations incorporate with some modifications: (1) Commission rules for non-financial institution government securities brokers and government securities dealers; and (2) the appropriate regulatory agency rules for financial institutions that are required to file notice as government securities brokers and government securities dealers.

See, e.g.,

17 CFR part 400, Rules of general application; 17 CFR part 401, Exemptions; 17 CFR part 402, Financial responsibility; 17 CFR part 403, Protection of customer securities and balances; 17 CFR part 404, Recordkeeping and preservation of records; 17 CFR part 405, Reports and audit; and 17 CFR part 449, Forms, section 15C of the Exchange Act. The GSA regulations also include requirements for custodial holdings by depository institutions at 17 CFR part 450, which were issued under Title II of the GSA. The Treasury GSA regulations provide in many

instances that a registered dealer can comply with a Commission rule to establish compliance with the comparable Treasury requirement.

See, e.g.,

17 CFR 402.1(b) (“This part does not apply to a registered broker or dealer . . . that is subject to [Rule 15c3-1].”); 17 CFR 403.1 (regarding application to registered brokers or dealers); 17 CFR 404.1 and 17 CFR 405.1(a) (same).

See

Exchange Act section 15(b) (regarding Commission authority to sanction brokers and dealers); section 15C(c) (regarding Commission authority to sanction government securities dealers that are registered with it); section 15C(d) (authorizing the Commission to examine books and records of government securities dealers registered with it); and section 17(b) (broker-dealer recordkeeping and examination).

See also

section 15C(g) (restricting the authority of the Commission with respect to government securities dealers that are not registered with the Commission).

On March 28, 2022, the Commission proposed Rules 3a5-4 and 3a44-2 to identify certain activities that would constitute a “regular business” requiring a person engaged in certain liquidity-providing activities to register as a “dealer” or a “government securities dealer,” absent an exception or exemption.

Proposed Rules 3a5-4 and 3a44-2 were designed to define the types of activities that would cause a person to be regarded as a

de facto

market maker and therefore subject to registration as a dealer under sections 15 and 15C of the Exchange Act. Specifically, the proposed rules would have established three qualitative factors, as well as a quantitative standard applicable only with respect to government securities. The proposed rules also further defined the types of entities that would be included in and excluded from the ambit of the rules. The proposed rules focused only on the

de facto

market maker test, as emphasized through the inclusion of the “no presumption” language, which provided that the further definition of “regular business,” if adopted, would not seek to address all persons that may be acting as dealers under otherwise applicable interpretations and precedent.

See

Proposing Release;

see also

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

The Commission received comment letters from a variety of commenters including investment advisers, PTFs, private fund advisers, crypto asset related entities and industry groups, insurance industry groups, industry associations, advisory groups, retail investors, and other market participants.

The comments addressed all aspects of the proposal.

Comments received in response to the Proposing Release are available at:

https://www.sec.gov/comments/s7-12-22/s71222.htm.

Commenters in support of the proposal shared the Commission's concerns regarding the significant role of unregistered entities that act as liquidity providers and emphasized the benefits of registration and regulation.

These commenters discussed specific benefits, in particular transparency, market integrity and investor protection, as well as appropriate Commission and SRO oversight of entities registered as dealers and government securities dealers.

See, e.g.,

Comment Letter of The Financial Industry Regulatory Authority, Inc. (June 23, 2022) (“FINRA Comment Letter”); Comment Letter of Better Markets (May 27, 2022) (“Better Markets Comment Letter”).

Id.

Some commenters stated that they supported the Commission's policy goals but expressed concerns regarding whether the proposed rules would achieve those goals.

As discussed more fully below, these and other commenters raised certain common themes, which generally reflected concerns regarding the breadth of the proposed rules and that the proposed rules would inappropriately apply to persons not engaging in dealer activity. Specifically, many commenters stated that some of the terms used in the proposed qualitative factors were vague and overly broad.

As discussed below, some commenters thought that the proposed first qualitative factor was overinclusive and would capture activity that was not dealing.

Commenters also raised concerns about certain terms used in the proposed first qualitative factor, the manner in which they would be interpreted, and the compliance challenges that they might present.

While the Commission is generally retaining the overall structure of the proposed rules, the Commission is making certain modifications to the text of the rules and also is providing guidance to address concerns raised during the public comment process.

See, e.g.,

SIFMA Comment Letter I (“We support the policy goal of proposed Rule 3a44-2 to require PTFs in the government securities market to register as government securities dealers, but believe that the Commission can adequately capture trading activity by unregistered PTFs by adopting solely the qualitative standards set forth Rule 3a44-2(a)(1)(ii) and (iii), without the need to adopt the standard in Rule 3a44-2(a)(1)(i).”); Comment Letter of Modern Markets Initiative (May 27, 2022) (“MMI Comment Letter”) (“MMI appreciates the SEC's intent in the Proposal to further support transparency, market integrity, and resiliency across the U.S. Treasury market and other securities markets, as it relates to ensuring that proprietary (or principal) trading firms and other market participants who are acting as dealers be, in fact, registered as `dealers.' MMI agrees it is important that dealers or those who engage in buying and selling of government securities as registered dealers should become members of a self-regulatory organization, and receive the benefits and obligations under the existing framework of Federal securities laws.”); Comment Letter of Asset Management Group of Securities Industry and Financial Markets Association (May 27, 2022) (“SIFMA AMG Comment Letter”) (“While SIFMA AMG can appreciate the Commission's efforts to protect investors and further the public interest, we do not believe that the Proposal will achieve those goals with respect to money managers.”); Comment Letter of FIA Principal Traders Group (Dec. 12, 2023) (“FIA PTG Comment Letter II”).

See, e.g.,

Comment Letter of Association of Digital Asset Markets (May 27, 2022) (“ADAM Comment Letter”); Comment Letter of Citadel (June 7, 2022) (“Citadel Comment Letter”); Comment Letter of Morgan, Lewis & Bockius LLP (June 8, 2022) (“Morgan Lewis Comment Letter”); Comment Letter of T. Rowe Price (June 8, 2022) (“T. Rowe Price Comment Letter”); Comment Letter of Investment Company Institute (May 27, 2022) (“ICI Comment Letter”); SIFMA Comment Letter I; SIFMA AMG Comment Letter; Comment Letter of Alternative Investment Management Association (May 27, 2022) (“AIMA Comment Letter II”); Comment Letter of Managed Funds Association (May 27, 2022) (“MFA Comment Letter I”); Comment Letter of McIntyre & Lemon, PLLC (May 31, 2022) (“McIntyre Comment Letter II”); Comment Letter of FIA Principal Traders Group (May 27, 2022) (“FIA PTG Comment Letter I”); Comment Letter of Managed Funds Association (Dec. 19, 2023) (“MFA Comment Letter V”).

See also

section II.A.1.

See, e.g.,

AIMA Comment Letter II; MFA Comment Letter I; Comment Letter of Element Capital Management LLC (May 27, 2022) (“Element Comment Letter”); SIFMA Comment Letter II; MFA Comment Letter V.

See, e.g.,

MFA Comment Letter I; SIFMA AMG Comment Letter; T. Rowe Price Comment Letter.

Many commenters also questioned whether the quantitative standard exceeds the Commission's authority under the Exchange Act and is consistent with historical Commission interpretations and guidance and Federal case law.

As discussed above, the SEC has the authority to define the terms used in the statutory definition of “dealer” and oversee and regulate registered dealers. Further, the statutory definitions of “dealer” in section 3(a)(5) and “government securities dealer” in section 3(a)(44), and the accompanying registration requirements of the Exchange Act, were drawn broadly by Congress to encompass a wide range of activities involving the securities markets and their participants. PTFs and other market participants that engage in dealer activity in the U.S. Treasury market should be subject to the same regulatory requirements as other dealers.

See, e.g.,

SIFMA AMG Comment Letter; Comment Letter of Two Sigma (May 27, 2022) (“Two Sigma Comment Letter I”).

In addition, commenters, many of which were in the asset management industry, stated that the proposed definition of “own account” would

inappropriately apply the dealer regime to private funds and registered investment advisers, and that the proposed exclusion for registered investment companies should be expanded to registered investment advisers and to private funds managed by registered investment advisers.

Commenters in the crypto asset industry also opposed the proposal, stating that the dealer framework should not apply to entities that transact in crypto assets that are securities.

See, e.g.,

Comment Letter of National Association of Private Fund Managers (May 27, 2022) (“NAPFM Comment Letter”); MFA Comment Letter I; AIMA Comment Letter II.

See also

section II.A.3.

The Proposing Release used the phrase “digital asset that is a security.”

See

Proposing Release at 23057 n.36. For purposes of this Adopting Release, the Commission does not distinguish between the terms “digital asset securities” and “crypto asset securities.”

Further, many commenters believed that the economic analysis did not adequately address economic implications of the proposed rules.

Commenters also stated that the proposed rules were largely unnecessary because of existing regulatory obligations, stating that the Commission has other tools to accomplish its stated goals of improving transparency including, for example, the Consolidated Audit Trail (“CAT”), the Trade Reporting and Compliance Engine (“TRACE”) and large trader reporting,

and that the proposed rules could have a negative effect on liquidity.

See, e.g.,

Comment Letter of Andreessen Horowitz (May 27, 2022) (“Andreessen Horowitz Comment Letter”); AIMA Comment Letter II; ADAM Comment Letter; MFA Comment Letter I; Comment Letter of Blockchain Association (May 27, 2022) (“Blockchain Association Comment Letter”); Comment letter of U.S. Representatives Patrick McHenry and Bill Huizenga (Apr. 18, 2022) (“U.S. Reps Comment Letter”); Comment Letter of Virtu Financial (May 27, 2022) (“Virtu Comment Letter”); Comment Letter of Alphaworks Capital Management (May 27, 2022) (“Alphaworks Comment Letter”); Two Sigma Comment Letter I; FIA PTG Comment Letter I; Comment Letter of Independent Dealer and Trader Association (May 27, 2022) (“IDTA Comment Letter”); NAPFM Comment Letter; Comment Letter of Schulte Roth & Zabel LLP (May 27, 2022) (“Schulte Roth Comment Letter”); SIFMA Comment Letter I; Comment Letter of James Overdahl (May 27, 2022) (“Overdahl Comment Letter”); Comment Letter of Fried, Frank, Harris, Shriver, & Jacobson LLP (May 27, 2022) (“Fried Frank Comment Letter”); Element Comment Letter; Comment Letter of Chamber of Digital Commerce (June 13, 2022) (Chamber of Digital Commerce Comment Letter”); Morgan Lewis Comment Letter; Comment Letter of DeFi Education Fund (May 27, 2022) (“DeFi Fund Comment Letter”); Comment Letter of Ranking Member, Tim Scott, U.S. Senator (Dec. 14, 2023) (“Scott Comment Letter”).

See, e.g.,

MMI Comment Letter; Virtu Comment Letter; AIMA Comment Letter II; ADAM Comment Letter; SIFMA AMG Comment Letter; SIFMA Comment Letter I; Fried Frank Comment Letter; Element Comment Letter; T. Rowe Price Comment Letter.

See, e.g.,

AIMA Comment Letter II; FIA PTG Comment Letter I; Virtu Comment Letter; McIntyre Comment Letter II; Alphaworks Comment Letter; MMI Comment Letter; Schulte Roth Comment Letter; IDTA Comment Letter; NAPFM Comment Letter; Comment Letter of Federal Regulation of Securities Committee of the Business Law Section of the American Bar Association (May 27, 2022) (“ABA Comment Letter”); Fried Frank Comment Letter; MFA Comment Letter I; Element Comment Letter; Citadel Comment Letter; Morgan Lewis Comment Letter; DeFi Fund Comment Letter; Scott Comment Letter.

B. Overview of the Final Rules and Modifications to the Proposal

After careful review of comments received and upon further consideration, the Commission is adopting Rules 3a5-4 and 3a44-2 as revised. As discussed below, while the Commission is generally retaining the overall structure of the proposed rules, we are making certain modifications to the text of the rules and also are providing guidance to address concerns raised during the comment process. In particular, the modifications we have made to more appropriately tailor the scope of the final rules will address various concerns raised by commenters and appropriately require only entities engaging in

de facto

market making activity to register as dealers.

Overall, the final rules will achieve the Commission's important goals of protecting investors and supporting fair, orderly, and efficient markets.

With respect to the Commission's authority to adopt the final rules, some commenters asserted that the major questions doctrine is implicated.

See, e.g.,

Comment Letter of Consensys Software Inc. (May 26, 2022) (“Consensys Comment Letter”); Comment Letter of American Investment Council (Aug. 8, 2023) (“AIC Comment Letter”). In further defining what it means to be engaged in the business of buying and selling securities “as a part of a regular business” within the definitions of “dealer” and “government securities dealer” under the Exchange Act, the Commission did not claim an “[e]xtraordinary grant[ ] of regulatory authority” based on “vague,” “cryptic,” “ancillary,” or “modest” statutory language.

West Virginia

EPA,

142 S. Ct. 2587, 2608-10 (2022) (quotation omitted). Nor did it assert authority that falls outside its “particular domain.”

Alabama Ass'n of Realtors

HHS,

141 S. Ct. 2485, 2489 (2021) (per curiam). Congress granted the SEC authority to oversee and regulate dealers, and the Exchange Act empowers the SEC with authority to define statutory terms.

An overview of the changes from the proposal follows:

Modification and Streamlining of the Qualitative Standard

—The Commission has modified the proposed qualitative factors to: (1) eliminate the proposed qualitative factor that would have captured persons engaging in liquidity provision by routinely making roughly comparable purchases and sales of the same or substantially similar securities in a day (“proposed first qualitative factor”); (2) more closely track the statutory language of the Exchange Act by referring to “regular” rather than the proposed “routine” patterns of behavior that have the effect of providing liquidity to other market participants; and (3) add the phrase “for the same security” to the factor relating to the expression of trading interests to clarify that it will apply only when a person is on both sides of the market for the same security. While the proposed first qualitative factor was intended to capture persons whose pattern of trading indicates that their liquidity provision forms a part of a regular business and to distinguish them from persons engaging in isolated or sporadic securities transactions (and therefore not engaging in such a regularity of participation), commenters raised a number of concerns with this factor, in particular that it was overinclusive and would capture activity that was not dealing, but rather investing in the ordinary course. After consideration of comments, the Commission has decided to eliminate this factor from the final rules. As discussed below, the qualitative factors as modified, together with the statutory definition and related precedent and interpretations, appropriately describe the circumstances in which a person would be deemed to engage in a “regular” pattern of buying and selling securities that has the effect of providing liquidity to other market participants, including in the U.S. Treasury market.

Deletion of the Quantitative Standard

—The Commission proposed a bright line test under which persons engaged in certain levels of activity in the U.S. Treasury market would be defined to be buying and selling securities “as part of a regular business,” regardless of whether they meet any of the qualitative factors. The quantitative standard was intended as a backstop to the qualitative factors to capture the most significant Treasury market participants.

While the proposed trading volume threshold was intended to provide an easily measurable and non-discretionary standard, commenters raised concerns regarding the application of this standard, in particular with respect to investment activities that might trigger the quantitative threshold. After consideration of these comments, the Commission has decided to eliminate

the quantitative standard from the final rules. As discussed below, the qualitative factors as modified, and otherwise applicable court precedent and Commission interpretations, appropriately describe the circumstances in which a person would be deemed to engage in a “regular” pattern of buying and selling securities that has the effect of providing liquidity to other market participants, including in the U.S. Treasury market.

See

Proposing Release at 23072 (stating that the quantitative standard was “designed to make clear the Commission's view that a person engaged in this regular volume of buying and selling activity is engaged in the buying and selling of government securities for its own account as part of a regular business, and therefore, should be subject to the same regulatory requirements as other dealers”).

As a result of these modifications, the final rules establish two non-exclusive ways in which a person will be determined to be engaged in a regular pattern of providing liquidity to other market participants “as part of a regular business”:

• Regularly expressing trading interest that is at or near the best available prices on both sides of the market for the same security, and that is communicated and represented in a way that makes it accessible to other market participants (“expressing trading interest factor”);

The proposed second qualitative factor has been modified to change the term “trading interests” to “trading interest” and the words “are” to “is” and “they” to “it.” This is a non-substantive modification to align the term with common usage.

• Earning revenue primarily from capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interest (“primary revenue factor”).

The proposed third qualitative factor has been modified to change the term “trading interests” to “trading interest.” This is a non-substantive modification to align the term with common usage.

Revision of “Own Account” Definition and Addition of Anti-Evasion Provision

—The Commission had proposed to define “own account” to include accounts “held in the name of a person over whom that person exercises control or with whom that person is under common control” (“the aggregation provision”).

Upon consideration of the comments, the Commission has revised the definition so that the final rules define “own account” to mean an account: (i) held in the name of that person; or (ii) held for the benefit of that person. The rules as adopted thus are consistent with the Commission's historical “entity” approach to broker-dealer regulation.

See infra

note 297 and accompanying text. Further, the Commission is removing the definitions of “control” and “parallel account structure.”

See, e.g.,

Foreign Broker-Dealer Adopting Release at 30017 (“the Commission uses an entity approach with respect to registered broker-dealers”).

See infra

note 326 and accompanying text.

However, with a view to deterring the establishment of multiple legal entities or accounts to evade appropriate regulation, the final rules include an anti-evasion provision that prohibits persons from evading the registration requirements by: (1) engaging in activities indirectly that would satisfy the qualitative factors; or (2) disaggregating accounts. The changes from the proposed rules address concerns about the scope of the proposed rules as raised by commenters while enhancing the Commission's current ability to prevent and address potentially evasive behavior.

See

section II.A.4.

Exclusions

—The Commission is providing an exclusion for “central banks,” “sovereign entities,” and “international financial institutions,” all as defined in the final rules. The exclusion is appropriate in view of the unique roles played by these entities. The Commission also is adopting as proposed the exclusions from the final rules for registered investment companies and persons that have or control less than $50 million in total assets.

See

section II.A.3. As discussed further below, the less than $50 million exclusion is not an exclusion from the “dealer” definition for all purposes, but only for purposes of the final rules that focus on

de facto

market making. Outside of this context, the question of whether any person, including a person that has or controls less than $50 million in total assets, is acting as a dealer, as opposed to a trader, will remain a facts and circumstances determination.

The Commission is not adopting certain commenters' suggestions for additional exclusions. Among other things, as discussed more fully below, the Commission is not excluding private funds or registered investment advisers from the final rules because an investment adviser or private fund could be acting as a dealer depending upon the particular activities in which it is engaged. The final rules do, however, include several modifications and clarifications to address many of the compliance and other concerns raised by certain commenters, including those raised by private funds and registered investment advisers.

See

section II.A.3.b.

In addition, as discussed in more detail below, the Commission is not excluding certain types of securities, specifically crypto asset securities, from the application of the final rules.

As stated in the Proposing Release, the proposed rules would apply to any “security” as defined in section 3(a)(10) or “government security” as defined in section 3(a)(44) of the Exchange Act. The dealer framework is a functional analysis based on the securities trading activities undertaken by a person, not the type of security being traded. Accordingly, the final rules will apply with respect to any crypto asset that is a “security” or “government security” within the meaning of the Exchange Act.

Comments requesting that the proposed rules not apply specifically to crypto asset securities are discussed further in section II.A.3.

Further, the Commission disagrees with the argument that certain market participants, including PTFs, are not dealers because they do not have customers.

There is no requirement in the statutory text of either section 3(a)(5) or section 3(a)(44) that dealers have customers. In comparison, the Exchange Act's definition of “broker” is “any person in the business of effecting transactions in securities for the account of others,” which includes (but is not limited to) customers.

The dealer definition includes no such limiting language and, since its enactment, the dealer definition was understood to cover “the operations of a trader . . .

who has no customers

but merely trades for his own account through a broker” so long as those operations “are sufficiently extensive to be regarded as a regular business . . . .”

Likewise, many of the factors that the Commission identified in its 2002 Release do not presume a dealer is acting for a customer.

Indeed, a number of Exchange Act rules applicable to dealers presuppose that there are dealers without customers and are tailored for that business model.

See Eastside Church of Christ

National Plan, Inc.,

391 F.2d 357 (5th Cir. 1968).

15 U.S.C. 78c(a)(4)(A).

Charles H. Meyer, Securities Exchange Act of 1934 Analyzed and Explained 33-34 (1934) (emphasis added).

See

2002 Release at 67498-67500.

See, e.g.,

17 CFR 240.15c3-1(a)(6) (“Rule 15c3-1(a)(6)”) (requiring firms relying on this provision to transact only with other brokers and dealers and prohibiting such firms from carrying customer accounts); Rule 15b9-1 (exempting brokers-dealers from becoming members of a national securities association if they are a member of an exchange, do not carry customer accounts, and any securities transactions that they effect elsewhere than an exchange of which they are a member meet certain exceptions).

Further, a helpful analogy can be drawn to the Commission's rulemaking further defining who is a “security-based swap dealer”—a definition that closely parallels the statutory definition of “dealer,” particularly with respect to the exclusion of activities that are not part of a regular business.

In that

matter, in comparing “counterparties” with “customers,” the Commission stated that “any interpretation of the `security-based swap dealer' definition that is predicated on the existence of a customer relationship may lead to an overly narrow construction of the definition.”

Accordingly, in this regard, these commenters have read a limitation into the statute where none exists.

See

Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” Exchange Act Release No. 66868 (Apr. 27, 2012), 77 FR 30596, (May 23, 2012) (“Entities Release”)

(“Although commenters have expressed the view that a person that engaged in security-based swap activities on an organized market should not be deemed to be a dealer unless it engaged in those activities with customers, we do not agree.”).

Id.

at n.282.

As stated above, some commenters suggested that the final rules are unnecessary because the SEC has other tools to accomplish the goals of the rulemaking, including large trader reporting, TRACE, and CAT. Certain commenters urged the Commission to take additional or different regulatory actions for entities covered by the Investment Advisers Act of 1940 (“Advisers Act”) than the approach we have adopted, including leveraging existing data from Form PF filings or making amendments to the existing regulatory regime under the Advisers Act. However, as discussed below, dealer registration is tailored to provide specific protections to address potential risks associated with dealer activity, and the aforementioned tools do not provide sufficient regulatory oversight and transparency into the trading activity of entities that are not otherwise registered as dealers.

Commenters expressed the view that the proposed rules could have a negative impact on liquidity or may cause many market participants to cease, modify, or curtail their trading activity to avoid being required to register as a dealer.

However, as discussed further below, we have made various modifications to appropriately tailor the scope of the final rules to address concerns raised by commenters about effects on liquidity. The Commission has crafted the final rules to draw upon established concepts and to expand upon prior Commission statements to identify more specifically the activities of certain market participants who act as dealers by “providing liquidity” to other market participants, and to establish a more level regulatory playing field for these types of significant liquidity providers. The test established in the Exchange Act to determine if a person is a dealer is whether the person is engaged in the business of buying and selling securities for its own account “as part of a regular business.”

The final rules are thus intended to reflect the longstanding distinction between so-called “traders”—whose liquidity provision is only incidental to their trading activities—and persons who are “in the business” of providing liquidity as part of a “regular business,” and so are “dealers” and “government securities dealers” under the Exchange Act. Under the final rules, a person is deemed to be engaged in buying and selling securities for its own account as part of a regular business—and therefore within the definition of “dealer” or “government securities dealer”—if that person is engaged in a “regular pattern of buying and selling securities that has the effect of providing liquidity to other market participants.”

See

ABA Comment Letter at 9-12; ADAM Comment Letter at 16; AIMA Comment Letter II at 11-13; Comment Letter of Alternative Investment Management Association (Nov. 17, 2022) (“AIMA Comment Letter III”) at 3 and 8; Alphaworks Comment Letter at 6; Andreessen Horowitz Comment Letter at 10 and 13; Blockchain Association Comment Letter at 7; Citadel Comment Letter at 7-8; Comment Letter of Committee on Capital Markets (Oct. 19, 2022) (“Committee on Capital Markets Comment Letter”) at 3; DeFi Fund Comment Letter at 14; Element Comment Letter at 5; FIA PTG Comment Letter I at 2-10; Fried Frank Comment Letter at 8-11; Comment Letter of Gretz Consilium LLC (May 26, 2022) (“Gretz Comment Letter”) at 18; ICI Comment Letter at 7-8; McIntyre Comment Letter II at 2; MFA Comment Letter I at 12; Comment Letter of Managed Funds Association (Dec. 5, 2022) (“Lewis Study”) at 2; Morgan Lewis Comment Letter at 2 and 14; NAPFM Comment Letter at 5; Overdahl Comment Letter at 16-23; Schulte Roth Comment Letter at 2; SIFMA Comment Letter I at 8; SIFMA AMG Comment Letter at 16-17; Two Sigma Comment Letter at 2 and 9; Virtu Comment Letter at 3-4.

See

sections 3(a)(5)(A) and (B) of the Exchange Act, 15 U.S.C. 78c(a)(5)(A) and (B); section 3(a)(44) of the Exchange Act, 15 U.S.C. 78c(a)(44).

The final rules are not the exclusive means of establishing that a person is a dealer or government securities dealer; otherwise applicable Commission interpretations and precedent will continue to apply.

In other words, these rules address one way in which a person can be engaged in the regular business of buying and selling securities for its own account, but these rules do not displace, modify, or substitute for otherwise applicable Commission interpretations and court precedent. A person engaging in other activities that satisfy the definition of dealer under otherwise applicable interpretations and precedent, such as underwriting, will still be a dealer even though those activities are not addressed by the two qualitative factors.

See

Rules 3a5-4(c) and 3a44-2(c) (providing that no presumption shall arise that a person is not a dealer or government securities dealer solely because that person does not satisfy the standards of the final rules).

See also

section II.A.5.

See supra

note 16.

The final rules, as modified, appropriately balance the concerns of the various commenters in a way that will best achieve the Commission's important goals to protect investors and support fair, orderly, and resilient markets through the complete and consistent application of dealer regulations. Further, the modifications we have made to tailor the scope of the final rules, including the persons scoped into the final rules, will address various concerns raised by commenters and appropriately require only entities engaging in dealing activity to register as dealers.

II. Discussion of Final Rules

A. Component Parts

1. Qualitative Standard

The qualitative standard in the proposed rules was intended to build on existing statements by the Commission and the courts regarding “dealer” activity to further define certain factors for determining when a person is engaged in buying and selling securities for its own account “as part of a regular business” as that phrase is used in sections 3(a)(5) and 3(a)(44) of the Exchange Act. Under paragraph (a)(1) of the proposed rules, a person would be engaged in buying and selling securities for its own account “as a part of a regular business” and so would be a dealer or a government securities dealer, if that person engages in a routine pattern of buying and selling securities (or government securities) that has the effect of providing liquidity to other market participants. Under this standard, as supplemented by the qualitative factors, when the frequency and nature of a person's securities trading is such that the person assumes a role—whether described as market-making,

de facto

market-making, or liquidity-providing—similar to the role that historically has been performed by a registered dealer, that person would be deemed to be a dealer or government securities dealer.

The proposed rules would have further defined three types of activities that would be considered to have the effect of providing liquidity to other market participants: (i) routinely making roughly comparable purchases and sales of the same or substantially similar securities (or government securities) in a day; or (ii) routinely expressing trading interests that are at or near the best available prices on both sides of the market and that are communicated and represented in a way that makes them accessible to other market participants; or (iii) earning

revenue primarily from capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interests.

See, e.g.,

2002 Release at 67499.

Commenters stated that the terms “routine” and “routinely” in the proposed rules were unclear and would lead to inconsistent interpretations.

In response to the comments and upon further consideration, the Commission has replaced the term “routine” with “regular” in 17 CFR 240.3a5-4(a)(1) and 240.3a44-2(a)(1) so that a person will be engaged in buying and selling securities for its own account “as a part of a regular business”—and so be a dealer or a government securities dealer—if that person engages in a regular pattern of buying and selling securities (or government securities) that has the effect of providing liquidity to other market participants. As discussed more fully below, “regular” participation in the securities markets is part of the statutory definition of “dealer” in the Exchange Act and therefore is a concept that should be familiar to market participants.

See, e.g.,

ADAM Comment Letter; Element Comment Letter; Morgan Lewis Comment Letter; Consensys Comment Letter; MFA Comment Letter I; NAPFM Comment Letter; SIFMA AMG Comment Letter.

See

15 U.S.C. 78c(a)(5) and 78c(a)(44).

In addition, as discussed below, after further consideration, the Commission has revised the qualitative standard by eliminating the proposed first qualitative factor and modifying the remaining two qualitative factors. These changes are designed to more appropriately tailor the rule to the nature of dealing in today's securities markets.

As a result of these modifications, the final rules establish two non-exclusive ways in which a person will be deemed to be engaged in providing liquidity as part of a regular business:

As discussed below, the Commission is adding the phrase “for the same security” so that the proposed second qualitative factor applies to expressing trading interest on both sides of the market for the same security. The Commission has also modified, as appropriate, the remaining qualitative factors to replace the term “routinely” with “regularly.”

a. Elimination of the Proposed First Qualitative Factor

As discussed in the Proposing Release, the proposed first qualitative factor was intended to capture a person's pattern of trading, the consistency and regularity of which indicate that its liquidity provision forms a part of a regular business.

Specifically, under proposed 17 CFR 240.3a5-1(a)(1)(i) and 240.3a44-2(a)(1)(i), a person that, trading for its own account, “routinely mak[es] roughly comparable purchases and sales of the same or substantially similar securities in a day” would be engaged in a pattern of trading that “has the effect of providing liquidity to other market participants,” and therefore engaged in buying and selling securities or government securities “as part of a regular business” as a dealer or government securities dealer.

The proposed first qualitative factor was intended to separate persons engaging in isolated or sporadic securities transactions from persons whose regularity of participation in securities transactions demonstrates that they are acting as dealers.

See

Proposing Release at 23066.

See id.

Commenters raised a number of concerns about the proposed first qualitative factor.

As a general matter, commenters contended that the proposed first qualitative factor would capture activity that was not dealing, but rather investing in the ordinary course.

One commenter recommended that certain specific activities be explicitly excluded from the rule, including asset liability management, liquidity and collateral management, and activities ancillary to exempt dealer activity.

As discussed further below, commenters also expressed concerns about certain terms used in the proposed first qualitative factor, the manner in which they would be interpreted, and the compliance challenges that they might present, focusing in particular on the use of the terms “routinely,” “substantially similar,” “roughly comparable,” and “in a day.”

As a result of these concerns, some commenters stated that the Commission should remove the first proposed qualitative factor.

See also

AIMA Comment Letter II (“We believe the Commission should limit its qualitative standards to only Qualitative Standard 3.”). In addition, one commenter suggested that the Commission replace the first and second proposed qualitative factors with a test defining a person acting as a

bona fide

market maker under Regulation SHO as a dealer.

See

MFA Comment Letter I. As discussed below, the Commission is removing the proposed first qualitative standard and declines to replace the proposed second qualitative factor with a test defining a person acting as a

bona fide

market maker under Regulation SHO.

See

section II.A.1.b.

After further consideration and in light of commenters' concerns, the Commission has decided to eliminate the proposed first qualitative factor. The Commission agrees with commenters that the proposed first qualitative factor could capture more than dealing activity intended to be captured by the rule. Accordingly, the Commission is not adopting the first factor.

The Commission emphasizes that the elimination of this factor does not mean that the conduct that would have been captured by the proposed factor is not dealing activity. This conduct may be

de facto

market making under the other two qualitative factors or dealer activity under otherwise applicable precedent. In this regard, as discussed in section II.A.5, no presumption shall arise that a person is not a dealer or government securities dealer as defined by the Exchange Act solely because that person does not satisfy the standard set forth in the final rules.

b. Expressing Trading Interest Factor

The Commission proposed a second qualitative factor to identify activity that “has the effect of providing liquidity to other market participants” focused on the expression of trading interests. Specifically, under proposed 17 CFR 240.3a5-4(a)(1)(ii) and 240.3a44-2(a)(1)(ii), a person that, trading for its own account, “routinely express[es] trading interests that are at or near the best available prices on both sides of the market and that are communicated and represented in a way that makes them

accessible to other market participants” would be engaging in a routine pattern of trading that has the effect of providing liquidity to other market participants, and as a result, would be a dealer under the proposed rules.

As the Commission stated in the Proposing Release, this factor “would update the longstanding understanding that regular or continuous quotation is a hallmark of market making or

de facto

market making (and, hence, dealer) activity, to reflect technological changes to the ways in which buyers and sellers of securities are brought together.”

As discussed below, the Commission is adding the phrase “for the same security” to the expressing trading interest factor to specify that this factor applies to expressing trading interest on both sides of the market for the same security.

Proposing Release at 23068.

The Commission explained in the Proposing Release the meanings of certain key terms used in the proposed second qualitative factor.

Specifically, as discussed in more detail below, the Commission explained the terms “routinely,” “trading interests” and “best available prices on both sides of the market.”

Id.

The Commission received a range of comments on the proposed second qualitative factor. One commenter explicitly supported the proposed second qualitative factor, voicing support for the policy goal of requiring PTFs in the government securities market to register as government securities dealers.

The commenter stated that it believed that the second qualitative factor would achieve this goal.

As discussed below, a number of commenters opposed the proposed second qualitative factor, contending that the factor would capture activity that was not dealing,

and expressing concerns about certain terms used in this factor (

i.e.,

“routinely,” “trading interests,” “both sides of the market,” “accessible to other market participants”), as well as addressing other issues.

SIFMA Comment Letter I.

Id.

See, e.g.,

MFA Comment Letter I; SIFMA AMG Comment Letter; AIMA Comment Letter II.

See, e.g.,

MFA Comment Letter I; McIntyre Comment Letter II; Consensys Comment Letter; Gretz Comment Letter; FIA PTG Comment Letter I; Blockchain Comment Letter; NAPFM Comment Letter; ADAM Comment Letter; SIFMA AMG Comment Letter; Comment Letter of Managed Funds Association (July 21, 2023) (“MFA Comment Letter II”); Element Comment Letter; Morgan Lewis Comment Letter; ABA Comment Letter.

Advancements in the securities markets have altered the way in which market participants interact with the markets. Certain market participants continue to perform important dealer functions as providers of liquidity to other market participants by expressing trading interest on both sides of the market for a security to other market participants. The expressing trading interest factor takes these changes into account, while also allowing for flexibility in its application in the markets for different securities, based on the wide variance in liquidity, depth, or other traits.

In adopting the proposed second qualitative factor as the expressing trading interest factor, the Commission is replacing the term “routinely” with “regularly.” The Commission is also revising the rule text to explicitly provide that the test applies with respect to the expression of trading interest in the “same” security. Other than these changes, and certain non-substantive changes, for the reasons set forth below, the Commission is adopting this factor as proposed. Accordingly, under the expressing trading interest factor, a person “regularly expressing trading interest that is at or near the best available prices on both sides of the market for the same security and that is communicated and represented in a way that makes it accessible to other market participants” is engaged in buying and selling securities for its own account “as a part of a regular business” as the phrase is used in sections 3(a)(5)(B) and 3(a)(44)(A) of the Exchange Act. The expressing trading interest factor will appropriately capture those market participants who are engaging in liquidity-providing activities similar to those traditionally performed by dealers or government securities dealers as defined under sections 3(a)(5) and 3(a)(44) of the Exchange Act.

See

15 U.S.C. 78c(a)(5) and 78c(a)(44).

Regularly

The Proposing Release stated that the term “routinely” as used in the proposed second qualitative factor meant that a person must express trading interests more frequently than occasionally, but not necessarily continuously, both intraday and across time.

The use of the term “routinely” in the proposed second qualitative factor was thus intended to capture significant liquidity providers who express trading interests at a high enough frequency to play a significant role in price discovery and the provision of market liquidity, even if their liquidity provision may not be continuous like that of some traditional dealers.

The Proposing Release stated that the liquidity providers that would be covered by the proposed second qualitative factor are very active in the markets—their participation is very routine—as demonstrated by the “key role” they play “in price discovery and the provision of market liquidity” in both the interdealer U.S. Treasury market and the equity markets.

Proposing Release at 23068.

Id.

A number of commenters expressed concerns related to the use of the term “routinely.”

Several commenters stated that the term “routinely” was unclear, which would make it difficult or impossible for market participants to determine whether their activities would be captured by the proposed second qualitative factor.

For example, one commenter stated that the term “routinely” is “unclear, defined with reference to another undefined concept (`occasional') and distinguished from a concept (`continuous') that market participants actually understand and have experience applying.”

As a result, the commenter stated this factor “would ultimately be unworkable for market participants who will have to make subjective determinations, on at least a daily basis, about whether they are `routinely' engaging in the activity described in [the proposed rules].”

Another commenter asserted that use of the term “routinely” “will lead to inconsistent application across market participants.”

Commenters also raised questions about the Proposing Release's analogy to the approach in the Commission's joint rulemaking with the Commodity Futures Trading Commission regarding, among other things, the definitions of “swap dealer” and “security-based swap dealer.”

In particular, commenters stated that the reference was inappropriate because of the different nature of the markets for

cash securities and security-based swaps.

See, e.g.,

MFA Comment Letter I; McIntyre Comment Letter II; Consensys Comment Letter; Gretz Comment Letter; FIA PTG Comment Letter I; Blockchain Comment Letter; NAPFM Comment Letter; ADAM Comment Letter; SIFMA AMG Comment Letter; MFA Comment Letter II; Element Comment Letter; Morgan Lewis Comment Letter; ABA Comment Letter.

See, e.g.,

MFA Comment Letter I; Element Comment Letter; ADAM Comment Letter; Morgan Lewis Comment Letter; SIFMA AMG Comment Letter.

MFA Comment Letter I.

Id. See also

Element Comment Letter (“`routine' trading can indicate market making, which implies a dealer function, but can also indicate the day-to-day activity of a private fund's trading desk.”).

ADAM Comment Letter.

See also

SIFMA AMG Comment Letter.

See, e.g.,

ADAM Comment Letter; Morgan Lewis Comment Letter; SIFMA AMG Comment Letter;

see also

Proposing Release at n.132.

See, e.g.,

ADAM Comment Letter; Morgan Lewis Comment Letter; SIFMA AMG Comment Letter.

As an alternative to “routinely,” some commenters suggested using a different term, with most such commenters suggesting “continuous.”

Some commenters asked whether the Commission had considered using “regularly,” stating that the statute uses the term “regular.”

SIFMA AMG Comment Letter; Comment Letter of BlackRock (Mar. 16, 2023) (“BlackRock Comment Letter”).

MFA Comment Letter I (“. . .but query, was `nearly continuous' considered? Or `regular'?”); McIntyre Comment Letter II (stating that the Proposed Rule “replaces the statutory text of “regular” and “continuous” with an amorphous notion of “routine” patterns of providing liquidity.”).

After further consideration, the Commission has replaced the term “routinely” with “regularly.” As with the term “routinely” in the Proposing Release, the term “regularly” in the final rules will apply to a person's expression of trading interest both within a trading day and over time.

This requirement distinguishes persons engaging in isolated or sporadic expressions of trading interest from persons whose regularity of expression of trading interest demonstrates that they are acting as dealers. As some commenters expressly stated,

the term “regular” is part of the statutory definition of “dealer” in the Exchange Act.

100

The term “regular” captures persons operating as dealers through their expression of trading interest on both sides of the market for the same security in a manner consistent with this statutory text.

As proposed, the term “routinely” would have meant both repeatedly within a day and repeatedly over time.

See

Proposing Release at 23068.

See supra

note 97.

100

15 U.S.C. 78c(a)(5).

A market participant does not need to be continuously expressing trading interest to be engaging in a “regular” business. The Exchange Act's definitions of “dealer” and “government securities dealer” do not include a requirement of continuous participation. The ordinary meaning of “continuous” is “characterized by continuity; extending in space without interruption of substance; having not interstices or breaks; having its parts in immediate connection; connected, unbroken” and “marked by uninterrupted extension in space, time, or sequence,” as defined by the Oxford English and the Merriam-Webster dictionaries, respectively.

101

While such “continuous” expression of trading interest would be indicative of dealer activity, a continuous standard would not be appropriate because it would be too limited in markets for securities that exhibit varying degrees of depth and liquidity.

102

101

See, e.g., Iqbal

United States Citizenship & Immigr. Servs.,

397 F. Supp. 3d 273, 283 (W.D.N.Y. 2019) (quoting Merriam-Webster,

https://www.merriam-webster.com/dictionary/continuous

(Aug. 22, 2019));

see also

Treasury Market Liquidity during the COVID-19 Crisis—Liberty Street Economics (newyorkfed.org).

See also

2015 IAWG Report (when conducting an algorithm-level analysis from the event window on Oct. 15, 2014, the IAWG found “the analysis suggests that multiple types of trading strategies were deployed by PTFs during the event window. Some PTF algorithms appear to explain the considerable amount of net passive market making activity that was witnessed across cash and futures over the event window and likely was an important contributing factor to the absence of price gapping despite the unprecedented large price swings. Another, and equally significant, group of PTF strategies appears to have aggressively traded in the direction of price moves during the event window, accounting for the bulk of the overall aggressive trading imbalance observed.”).

Whether a person's activity is “regular” will depend on the liquidity and depth of the relevant market for the security. For example, in markets that have significant liquidity and market depth, and have experienced advancements in technology and electronic trading, like the U.S. Treasury market,

103

expressing trading interest on both sides of the market for the same security as part of an investment strategy on a one-off basis would not be sufficiently regular to be caught by the expressing trading interest factor. Rather, “regular” in the most liquid markets would mean more frequent periods of expressing trading interest on both sides of the market both intraday and across days given the efficiency in which securities can be bought and sold and the market's ability to absorb orders without significantly impacting the price of the security.

104

In contrast, if the market for a security is less liquid, and it is difficult to execute orders in that security or large orders can dramatically affect the price of the security, the term “regular” would account for the possibility of more interruptions or wider spreads for the best available prices.

103

See

Proposing Release at 23055.

104

See

Proposing Release at 23058 (stating “[t]he `regularity' of participation in securities transactions necessary to find that a person is a `dealer' ” has not been quantified, but involves engaging in `more than a few isolated' securities transactions.”) (citing

SEC

Am. Inst. Counselors, Inc.,

Fed. Sec. L. Rep. (CCH) ¶ 95388 (D.D.C. 1975));

see also

MFA Comment Letter I.

115

SIFMA AMG Comment Letter.

Two commenters stated that applying the proposed second qualitative factor to investment advisers would inappropriately subject them to potential dealer status simply for exercising their fiduciary duties.

116

For example, one commenter stated that an investment adviser may have to submit trading interests throughout a trading day in order to obtain best execution and meet other fiduciary obligations acting for their clients, or to use specific trading protocols available in the market, such as the order book.

117

116

Id.;

MFA Comment Letter I.

117

SIFMA AMG Comment Letter.

Similarly, other commenters stated that the proposed second qualitative factor could require firms, including unregistered funds excluded from the Investment Company Act and registered investment advisers, to register as dealers for engaging in activity that has not historically been considered to be dealer activity.

118

One commenter, for example, questioned whether portfolio managers, by taking long/short positions or seeking arbitrage opportunities, would be required to register as dealers under the proposed second qualitative factor.

119

Another commenter stated that some asset managers have funds with active fixed-income trading strategies involving indications of interest to trade bonds, as well as swaps, on similar or even identical underlying issuers in order to take advantage of mispricing or to create a unique non-directional risk profile in a trade.

120

According to this commenter, although this activity entails communicating and indicating interest on such trades to a number of counterparties, it has never been considered dealing.

121

Yet another commenter stated that firms that, as a primary element of their trading strategy, simultaneously and continuously post bids and offers in a specific instrument at or near the national best bid and offer, have not historically been treated as having engaged in dealer activity where the firm posting quotes did not hold itself out to customers.

122

One commenter asked for clarity on how the proposed second qualitative factor would apply in the digital assets space, and in particular whether participants in a digital asset liquidity pool, by leaving their assets in the pool and thereby exposing those assets to sale at the pool's prevailing exchange rate, are expressing a “trading interest.”

123

118

Id.;

AIMA Comment Letter II.

119

McIntyre Comment Letter II.

120

See

AIMA Comment Letter II (explaining, for example, that some asset managers may have funds with active fixed-income strategies that may be captured by the proposed second qualitative factor).

121

AIMA Comment Letter II.

122

Fried Frank Comment Letter. As discussed below, whether a person meets the definition of “dealer” is not contingent upon whether that person has customers.

123

DeFi Fund Comment Letter.

After consideration of the comments, the Commission has determined to adopt the proposed second qualitative factor with minor, non-substantive modifications to the term “trading interest.” The term “trading interest” means: (i) an “order” as the term is defined under 17 CFR 240.3b-16(c) (“Rule 3b-16(c)”);

124

or (ii) any non-firm indication of a willingness to buy or sell a security that identifies the security and at least one of the following: quantity, direction (buy or sell), or price. A standard of “firm two-sided quotations” expressed on a “continuous or near continuous basis,” while captured by the existing understanding of “dealer” under Exchange Act section 3(a)(5), does not account for the full range of liquidity-providing dealer activity undertaken in today's security markets.

125

The term “trading interest” accounts for the varied mechanisms that permit market participants to effectively make markets. These include, but are not limited to, the use of streaming quotes, request for quotes (“RFQs”), or order books. To be captured by the expressing trading interest factor depends less on the method used to communicate trading interest, and more on whether the person is expressing trading interest on both sides of the market for the same security that has the effect of providing liquidity in the same security to other market participants.

124

Rule 3b-16(c) states that “the term order means any firm indication of a willingness to buy or sell a security, as either principal or agent, including any bid or offer quotation, market order, limit order, or other priced order.” The Proposing Release previously referenced the definition of “order” under 17 CFR 242.300. Proposing Release at 23068. This release refers to Rule 3b-16(c), which defines the term “order” identically and is further discussed in the release adopting 17 CFR 242.300 through 242.304 (“Regulation ATS”).

See

Regulation of Exchanges and Alternative Trading Systems, Exchange Act Release No. 40760 (Dec. 8, 1998), 63 FR 70844 (Dec. 22, 1998).

125

See

Proposing Release at 23068.

At the same time, expressing trading interest is not, standing alone, enough to demonstrate engaging in a “regular pattern of buying and selling securities that has the effect of providing liquidity to other market participants” under the final rules. Specifically, under the final rules, a person will be engaged in activity as part of a regular business if that person “[e]ngages in a regular pattern of

buying and selling securities

that has the effect of providing liquidity to other market participants by . . . [r]egularly expressing trading interest that is at or near the best available prices on both sides of the market for

the same security and that is communicated and represented in a way that makes it accessible to other market participants (emphasis added).”

126

A market participant seeking price information by requesting quotes on a security, without including prices, on both sides of the market would generally not satisfy this qualitative factor because that trading interest, absent more, would not be “at or near the best available price.” With respect to the commenter's statement that investment advisers' fiduciary duties may require them to submit “trading interests” throughout a trading day, the final rules have been modified so that the definition of “own account” applies to accounts in which the person holds the account in its name or the account is held for the benefit of that person.

127

As such, the trading interest expressed by investment advisers for purposes of their fiduciary duty to their clients and their clients' accounts, such as when investment advisers place orders or request quotations on behalf of their clients, would not be activity captured by the expressing trading interest factor, unless the investment adviser itself is the account holder or the account is held for the benefit of the investment adviser.

128

Moreover, as discussed above, persons engaging in the activity described in the qualitative standard are acting as dealers regardless of whether the person engaging in such dealer activity has or holds itself out to customers.

129

The statutory definitions of “dealer” and “government securities dealer” distinguish between a dealer and a trader on the basis of whether a person is in the “regular business” of buying and selling securities for one's own account—not whether the person is doing so to effectuate customer orders.

130

126

See

Rules 3a5-4(a)(1)(ii) and 3a44-2(a)(1)(ii).

127

See

SIFMA AMG Comment Letter.

See also

section II.A.4.

128

Furthermore, as discussed in section II.A.3, the Commission declines to include an exclusion from the final rules for registered investment advisers and private funds and continues to believe that when engaged in dealer activity, including by expressing trading interest as set forth in the factor, registered investment advisers and private funds should be subject to the dealer regulatory regime, which includes not only registration obligations, but also comprehensive regulatory requirements and oversight that broadly focus on market functionality—that is, the impact of dealing activity on the market as a whole.

129

See supra

notes 55-59 and accompanying text.

130

See id.;

15 U.S.C. 78c(a)(5); 15 U.S.C. 78c(a)(44)(A). In fact, the definition of “broker” presumes that a person is effectuating securities transactions on behalf of customers.

See

15 U.S.C. 78c(a)(4) (stating that a broker means “any person engaged in the business of effecting transactions in securities

for the account of others”

) (emphasis added).

One commenter questioned how to apply the term “trading interest” to certain types of products, structures, or activities in the so-called decentralized finance (“DeFi”) market to provide crypto asset securities liquidity.

131

Whether a particular activity in the crypto asset securities market, including in the so-called DeFi market, gives rise to dealer activity requires an analysis of the totality of the particular circumstances against all elements of the expressing trading interest factor.

132

Commenters argued that crypto assets should not be covered by the final rules.

133

However, the Commission is not excluding any particular type of securities, including crypto asset securities, from the application of the final rules. The dealer framework is a functional analysis based on the securities trading activities undertaken by a person, not the type of security being traded. Persons, including persons using so-called “automated market makers,” that are engaged in buying and selling securities for their own account must consider whether they are dealers under the final rules, and thus subject to dealer registration requirements.

134

As discussed below, the final rules build off existing legal standards and, as discussed throughout this release, are designed to address where market participants are engaging in

de facto

market making and required to register as dealers or government securities dealers, regardless of which such technology is used.

135

As explained throughout this release, the application of the dealer regulatory regime to such persons will promote the Commission's longstanding mission.

131

DeFi Fund Comment Letter.

132

A threshold question in determining the applicability of the final rules is whether a person engaging with products, structures, or activities in the so-called DeFi market has or controls total assets of less than $50 million.

See

17 CFR 240.3a5-4(a)(2)(i) (“Rule 3a5-4(a)(2)(i)”); 17 CFR 240.3a44-2(a)(2)(i) (“Rule 3a44-2(a)(2)(i)”); section II.A.3. If so, that person would not be captured by the final rules.

See also

17 CFR 240.3a5-4(d); 17 CFR 240.3a44-2(d) (providing that a person not meeting the conditions set forth in the final rules may nonetheless be a dealer if it otherwise engages in a regular business of buying and selling securities for its own account);

infra

note 284 and accompanying text (citing examples where persons engaging in crypto asset securities transactions are operating as dealers as defined under section 3(a)(5)). If this exclusion cannot be relied upon, then the expressing trading interest factor could apply. Furthermore, as discussed in section II.A.3.a, the exclusion for persons having or controlling less than $50 million in total assets applies to the final rules and does not modify existing applicable court precedent and Commission interpretations.

133

See, e.g.,

ADAM Comment Letter (stating “the blanket application of the dealer and government securities dealer regulatory framework to digital assets would be premature and imprudent.”);

see also

Consensys Comment Letter; DeFi Fund Comment Letter; Chamber of Digital Commerce Comment Letter; Blockchain Association Comment Letter.

134

The application of the final rules turns on whether a particular crypto asset is a security, as defined under the U.S. Federal securities laws. The term “security” includes an “investment contract,” as well as other instruments. To the extent there is a question as to whether a particular crypto asset is an investment contract that is a security, the analysis is governed by the test first articulated by the Supreme Court in

SEC

W.J. Howey Co.,

328 U.S. 293, 301 (1946).

See, e.g., SEC

Terraform Labs PTE, Ltd.,

No. 23-cv-1346, 2023 WL 8944860 (S.D.N.Y. Dec. 28, 2023 (stating that

Howey

was and remains a binding statement of law and that there was no genuine dispute that the elements of the

Howey

test had been met));

SEC

Kik Interactive Inc.,

492 F. Supp. 3d 169, 177-180 (S.D.N.Y. 2020) (applying

Howey

in granting the Commission's motion for summary judgment finding Kik's sale of Kin tokens to the public was a sale of a security and required a registration statement);

SEC

LBRY,

No. 21-CV-260-PB, 2022 WL 16744741 (D.N.H. Nov. 7, 2022) (applying

Howey

in granting the Commission's motion for summary judgment finding “no reasonable trier of fact could reject the SEC's contention that LBRY offered LBC [a crypto asset] as a security.”); Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Exchange Act Release No. 81207 (July 25, 2017) (“DAO 21(a) Report”) (describing how DAO tokens were securities under

Howey

135

See

sections II.A.3, III.D.6;

see also

Policy Recommendations for Crypto and Digital Asset Markets Final Report, Board of the International Organization of Securities Commissions (Nov. 2023) (stating that “the regulatory frameworks (existing or new) should seek to achieve regulatory outcomes for investor protection and market integrity that are the same as, or consistent with, those required in traditional financial markets in order to facilitate a level-playing field between crypto-assets and traditional financial markets and help reduce the risk of regulatory arbitrage”),

https://www.iosco.org/library/pubdocs/pdf/IOSCOPD747.pdf;

Final Report with Policy Recommendations for Decentralized Finance (DeFi), Board of the International Organization of Securities Commissions (Dec. 2023),

https://www.iosco.org/library/pubdocs/pdf/IOSCOPD754.pdf.

Both Sides of the Market

Under the proposed rules, in order to come within the proposed second qualitative factor, the expression of trading interests would need to be “at or near the best available prices on both sides of the market.”

136

As discussed in the Proposing Release, the phrase “at or near the best available prices on both sides of the market” describes “the activity of liquidity-providing dealers, which help determine the spread between the best available bid price and the best available ask price for

a given security.

”

137

The Proposing Release further explained that, by competing to both buy and sell at the best available prices, liquidity providers help to narrow bid-ask spreads.

138

The Commission also stated that the proposed second qualitative factor helped to emphasize that a liquidity

provider, to come within the rules, must both buy and sell securities.

139

136

Proposing Release at 23068.

137

Id.

(emphasis added).

138

Id.

139

Id.

Several commenters requested clarification as to how to apply the phrase “on both sides of the market,” particularly, with regard to what period of time to use when evaluating orders placed on both sides of the market, and as to whether the phrase applies to the market for a single security or related instruments.

140

Some commenters asserted that the absence of a time limitation could prevent market participants from using all available trading strategies in a market, including active trading strategies where a person would post resting offers and bids on a central limit order book (“CLOB”), without registering as a dealer.

141

Two of these commenters urged the Commission to modify the proposed second qualitative factor to clarify that the trading interest must be expressed on both sides of the market simultaneously.

142

According to one commenter, if the proposed second qualitative factor does not require that the trading interest be expressed on both sides of the market simultaneously, it “would result in this test capturing trading that is not consistent with dealer activity.”

143

Commenters also urged the Commission to clarify that the phrase “both sides of the market” applied to the same security.

144

One commenter suggested that the Commission modify the proposed second qualitative factor to add the phrase “for the same security.”

145

140

See, e.g.,

SIFMA AMG Comment Letter; AIMA Comment Letter II; MFA Comment Letter I; Citadel Comment Letter.

141

Id.

For instance, according to one commenter, there are examples of where market participants using a CLOB routinely express trading interests on both sides of the market in various instruments over the course of a trading day, and CLOBs can benefit both market liquidity and competition.

See

Citadel Comment Letter.

142

See

MFA Comment Letter I; Citadel Comment Letter.

143

MFA Comment Letter I.

144

See, e.g.,

Citadel Comment Letter; Lewis Study; MFA Comment Letter I; MFA Comment Letter II.

145

MFA Comment Letter II.

Consistent with the Proposing Release which explained that the proposed second qualitative factor applies to persons expressing trading interests on both sides of the market in a given security, the Commission is modifying the rule text to add the phrase “for the same security” to the second qualitative factor.

146

Proposing Release at 23068 (stating “[t]he phrase `best available prices on both sides of the market' more specifically and clearly describes the activity of liquidity-providing dealers, which help determine the spread between the best available bid price and the best available ask price for a

given

security”) (emphasis added). The phrase “same security” is to be interpreted as that phrase is used in the Proposing Release.

See

Proposing Release at 23067 (stating “ `the same' securities means that the securities bought and sold are securities of the same class and having the same terms, conditions, and rights [, and] securities bearing the same Committee on Uniform Securities Identification Procedures (`CUSIP') number, for example, would be considered `the same.' ”).

The Commission is not adopting a requirement that the trading interest be expressed simultaneously on both sides of the market. Limiting the expressing trading interest factor to the simultaneous expression of trading interests could exclude other regular expressions of trading interest that constitute dealer activity by providing liquidity to other market participants. While simultaneously expressing trading interest on both sides of the market in the same security is indicative of dealer activity, market participants also can be acting as dealers by regularly providing liquidity even where the expressions of trading interest on both sides of the market for the same security are not simultaneous, particularly because the markets for different securities have varying structures, trading volume, and liquidity.

147

Further, adding a simultaneity condition could lead to behavior where a dealer might, for example, express trading interest to buy and sell in alternate moments in time to evade the requirement to register. Accordingly, the Commission is not conditioning the application of the expressing trading interest factor on trading interests being expressed simultaneously. Due to the differences between markets, participants will need to assess the totality of their trading activity to determine if they are expressing trading interests on both sides of the market for the same security sufficiently close in time to have the effect of providing liquidity in the same security to other market participants.

147

See

2010 Equity Market Structure Concept Release at 3608 (stating that “proprietary traders are analogous to OTC [over-the-counter] market makers in that they have considerable flexibility in trading without significant negative or affirmative obligations for overall market quality”).

The Commission recognizes that non-firm trading interest (and firm quotations for that matter) need not be executed, even if matched. Nonetheless, it will be possible to assess whether a non-firm trading interest is actually “at or near the best available price,” using the similar information that market participants use to make bids and offers, including recently completed purchases and sales and the totality of indications of willingness to buy or sell at specified prices.

148

For example, market participants can use similar information to that used by registered broker-dealers to assess whether a customer order was executed at the best available price.

149

148

See, e.g.,

Disclosure of Order Execution and Routing Practices, Exchange Act Release No. 43590 (Nov. 17, 2000), 65 FR 75414, 75418 (Dec. 1, 2000) (stating that quotation information contained in the public quotation system must be considered in seeking best execution of customer orders).

149

Id.

Finally, as discussed above in connection with the term “trading interest,” to come within this factor, a person expressing trading interest (including through a CLOB) must be buying and selling securities, and it must engage in such activity “regularly.”

Accessible to Other Market Participants

Under the proposed rules, market participants would have had to routinely express trading interests accessible to other market participants to be considered to have engaged in a routine pattern of trading that has the effect of providing liquidity to other market participants.

150

In the Proposing Release, the Commission explained that the proposed second qualitative factor would apply only when the expressed trading interests that are at or near the best available prices on both sides of the market are “communicated and represented in a way that makes them accessible to other market participants.”

151

150

Proposing Release at 23068.

151

Id.

One commenter objected to the proposed second qualitative factor's phrase “communicated and represented in a way that makes them accessible to other market participants,” stating that the Proposing Release does not make clear whether trading interests made available to a limited group of participants via a RFQ would trigger the factor, versus trading interests published on a broadly accessible order book. The commenter stated further that the vagueness of the standard would prevent market participants from applying it with confidence and might encourage market participants to choose execution venues and order types that are not transparent or accessible.

152

This commenter recommended adopting a test defining a person acting as a

bona fide

market maker under 17 CFR 242.200 through 242.204 (“Regulation SHO”) as a dealer, in lieu of the first and second proposed qualitative factors.

153

152

MFA Comment Letter I.

153

Id.

The phrase “accessible to other market participants” reflects the plain

meaning that a person expresses trading interests to more than one market participant. For example, where a person makes a trading interest available (such as streaming two-way indicative quotes) to more than one market participant, even if the person made that trading interest available through individual communications, that person would be expressing trading interest accessible to other market participants.

154

Again, the expressing trading interest factor does not hinge on any particular method of communication and representation (

e.g.,

RFQ, indications of interest, or streaming quotes); it depends on the totality of the trading activity to determine if the person is expressing trading interests on both sides of the market for the same security to have the effect of providing liquidity in the same security to other market participants.

154

On the other hand, when an investor seeking liquidity sends a single, one-sided RFQ to a number of potential liquidity providers, this action by itself does not generally trigger the expressing trading interest factor because it is on one side of the market in an isolated instance.

The Commission is not adopting the suggestion to replace this factor with a test defining a dealer as a person engaging in

bona fide

market making activities under Regulation SHO. The

bona fide

market making exception under Regulation SHO applies to a specific subset of dealer activity. As the Commission previously stated when proposing Regulation SHO, “a narrow exception for market makers and specialists engaged in bona fide market making activities is necessary because they may need to facilitate customer orders in a fast moving market without possible delays associated with complying with the proposed `locate' rule.”

155

For example, a broker-dealer must claim the

bona fide

market making exception from the locate requirement of Regulation SHO at the time of the short sale in a particular security.

156

Accordingly, limiting the applicability of the final rules to those persons eligible for Regulation SHO's bona-fide market-making exception would exclude persons engaged in other liquidity-providing dealer activity.

155

Short Sales, Exchange Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972, 62977 (Nov. 6, 2003);

see also

Short Position and Short Activity Reporting by Institutional Investment Managers, Exchange Act Release No. 98738 (Oct. 13, 2023), 88 FR 75100, 75136 (Nov. 1, 2023) (stating “a market maker must also be a market maker in the security being sold, and must be engaged in bona-fide market making in that security at the time of the short sale.”).

156

The determination of eligibility for the bona-fide market-making exceptions in Regulation SHO is distinct from the determination of whether the effect of a person's trading activity indicates that such person is acting as a dealer. Proposing Release at n.131.

One commenter stated that the proposed second qualitative factor would impact the Commission's Order Competition Rule proposal.

157

On December 14, 2022, the Commission proposed a rule that would require certain orders of individual investors to be exposed to competition in fair and open auctions before such orders could be executed internally by any trading center that restricts order-by-order competition.

158

As discussed below, the Commission has considered the current regulatory landscape in presenting the baseline. To the extent the proposed Order Competition Rule is adopted, the baseline in that rulemaking will reflect the regulatory landscape that is current at that time.

159

157

Comment Letter of Two Sigma (Mar. 31, 2023) (“Two Sigma Comment Letter II”).

158

Order Competition Rule, Exchange Act Release No. 96495 (Dec. 14, 2022), 88 FR 128 (Jan. 3, 2023).

159

See

section III.B.

In sum, the Commission has determined to replace the term “routinely” with “regularly,” add the phrase “for the same security,” and make non-substantive modifications to this factor, but otherwise is adopting this factor as proposed.

c. Primary Revenue Factor

Finally, the Commission proposed a third qualitative factor encompassing activity that “has the effect of providing liquidity to other market participants.” Specifically, under proposed 17 CFR 240.3a5-4(a)(1)(iii) and 240.3a44-2(a)(1)(iii), a person that, trading for its own account, “earn[ed] revenue primarily from capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interests,” would have been engaging in a routine pattern of trading that has the effect of providing liquidity to other market participants, and as a result, would have been a dealer under the proposed rules.

The Commission explained in the Proposing Release that one fundamental characteristic typical of market makers and liquidity providers—and one that has historically been viewed as dealer activity—is trading in a manner designed to profit from bid-ask spreads or liquidity incentives rather than with a view toward appreciation in value.

160

We stated that persons engaged in such activity are “in the business” of providing liquidity because (1) they routinely supply it and (2) the revenue they earn through bid-ask spreads or liquidity incentives is their primary source of revenue.

161

160

Proposing Release at 23069.

161

Id.

The proposed third qualitative factor accounted for both forms of revenue. As to the first—capturing bid-ask spreads—the Commission stated that when a liquidity provider routinely buys and sells securities in a manner designed to capture a spread with such frequency and consistency that its revenue is made up primarily of this form of compensation, it would be considered to be engaged in a routine pattern of providing liquidity as a service and would fall within the scope of the rules.

162

As to the second, the Commission stated that when a liquidity provider, as a result of its routine purchases and sales of securities, captures “incentives offered by trading venues to liquidity-supplying trading interests” with such frequency and consistency that its revenue is made up primarily of this form of compensation, it would be considered to be engaged in a routine pattern of providing liquidity as a service and generally standing ready to buy or sell securities, and so would fall within the scope of the proposed rules.

163

162

Id.

163

Id.

In the Proposing Release, the Commission explained the meaning of certain key terms in the proposed third qualitative factor. The Commission stated that the factor used the phrase “earn revenue”—rather than, for example, “profit from”—to make clear that a person's trading strategies would not need to be profitable to bring them within the rule.

164

Dealer activity is dealer activity regardless of whether it is profitable. With respect to the term “primarily,” the Commission further stated that, generally speaking, although the Commission has not established a bright-line test, if a person derives the majority of its revenue from either of the sources described in the proposed third qualitative standard, it would likely be in a regular business of buying and selling securities or government securities for its own account.

165

164

Id.

165

Id.

Finally, with respect to the term “trading venues,” the Commission stated that market evolution has given rise to a variety of venues in which liquidity providers can express trading interests, and the term “trading venues” is designed to capture the breadth of these different venues.

166

In explaining

the term “trading venue” the Proposing Release referenced a definition of “trading venue” that described it to mean “a national securities exchange or national securities association that operates an SRO trading facility, an ATS, an exchange market maker, an OTC market maker, a futures or options market, or any other broker- or dealer-operated platform for executing trading interest internally by trading as principal or crossing orders as agent.”

167

The Commission further stated that the third proposed qualitative standard was designed to capture dealer activity wherever that activity occurs, “whether on a national securities exchange, an ATS . . .

or another form of trading venue.”

168

The Commission also stated that for purposes of the proposed rules, the particular venue mattered less than the fact that a market participant provides liquidity on it.

169

166

Id.

at 23069-70. As discussed in the Proposing Release, the term “trading venue” was designed to capture the variety and breadth of different venues resulting from market evolution.

Id.

To the extent

new systems develop as a result of technological advancements that offer market participants the ability to provide liquidity in a security for other market participants, the term “trading venue” would apply to such systems.

Id.

167

Id.

Whether an entity is or is not registered with the Commission does not affect the determination of whether that entity is a trading venue for purposes of the final rules. For example, a person operating a platform for executing trading interest internally would likely be operating as a broker or dealer, regardless of whether that person is registered as such, and the receipt of incentives from that person could be captured by the factor.

See

15 U.S.C. 78

(a)(1) (absent an exemption, persons meeting the definition of broker or dealer must register with the Commission).

168

Proposing Release at 23070 (emphasis added).

169

Id.

Of the three proposed qualitative factors, this factor received the fewest comments. Two commenters supported the third qualitative factor as proposed.

170

According to one of the commenters, capturing bid-ask spreads or earning revenue from liquidity incentives have traditionally been indicative of dealing activity and the proposed third qualitative standard would be less likely to capture certain funds, advisers, and trading strategies that the commenter believed would be inappropriately captured by the first and second qualitative factors.

171

170

SIFMA Comment Letter I (stating that “[s]ubject to our additional comments on the application of the proposed rules to bank holding companies, we believe that the qualitative standard in proposed . . . Rule 3a44-2(iii) [is] generally a good step forward to address this long-standing asymmetric regulatory treatment for similar [dealing] activities.”);

see also

AIMA Comment Letter II (requesting the Commission to limit the qualitative standard to the third factor alone).

171

AIMA Comment Letter II.

Another commenter stated the proposed third qualitative factor was “workable,” assuming two modifications.

172

First, the commenter stated that the proposed third qualitative factor should turn on “profit,” rather than “revenue.”

173

In the commenter's view, because dealers are in the business of profiting from their market-making activities, they are unlikely to be (or stay) engaged in markets if they are not profiting from their dealer activities.

174

As a result, the commenter believed that a person otherwise meeting the factor but failing to earn profits in doing so is better viewed as a trader than a dealer.

175

Second, the commenter stated that the proposed third qualitative factor should be limited to “national securities exchanges and ATSs,” rather than “trading venues.”

176

In the commenter's view, to reduce the compliance burdens on market participants while capturing the most significant trading activity, the rule should be limited to the most liquid trading venues, including those where liquidity incentives are most likely to be offered and where trading to profit from the spread occurs most often.

177

The commenter stated that this change would avoid difficult and unworkable line-drawing questions, such as when pricing offered by an OTC market maker to its customer would constitute an “incentive” captured by the rule.

178

172

See

MFA Comment Letter I;

see also

MFA Comment Letter II. Another commenter stated it shared many of the comments raised by MFA with respect to the proposed third qualitative test.

See

BlackRock Comment Letter.

See also

ICI Comment Letter (stating “[t]o avoid unintentionally capturing ordinary investment and trading strategies, the Commission should limit the qualitative test to capture persons trading only in the same securities—where this purpose is clear—rather than trading in merely similar securities.”).

173

See

MFA Comment Letter I.

174

See id.

175

See id.

176

Id. See also

ABA Comment Letter (“the proposed tests for the definition of “dealer” requires interpreting terms that are not yet settled because they are concurrently being commented on in a proposed form.”); DeFi Fund Comment Letter (stating “whether a DeFi protocol constitutes a `trading venue' is likely to turn on the outcome of the Commission's pending proposal to expand its `exchange' definition, which we strongly oppose.”). As discussed below, the Commission believes it is appropriate for the final rules to use the term “trading venues.” The Commission has proposed an amendment to Form ATS-N to change the term “Trading Centers” to “trading venue” and has proposed the term to mean a national securities exchange or national securities association that operates an SRO trading facility, an ATS, an exchange market maker, an OTC market maker, a futures or options market, or any other broker- or dealer-operated platform for executing trading interest internally by trading as principal or crossing orders as agent.

See

Amendments regarding the Definition of “Exchange” and Alternative Trading Systems (ATSs) that Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities, Exchange Act Release No. 94062 (Jan. 26, 2022), 87 FR 15496, 15539-40 (Mar. 18, 2022). Although the term “trading venue” is used in the final rules and the proposed amendment to Form ATS-N, the adoption of the term as discussed above is appropriate for the final rules.

177

MFA Comment Letter I.

178

Id.

Some commenters objected to the proposed third qualitative factor,

179

expressing concerns about the lack of clarity as to, and breadth of, its application.

180

One of these commenters stated that the term “primarily” is potentially vague because a person might earn more revenue from appreciation in the value of its inventory of securities than from capturing bid-ask spreads or trading incentives.

181

Another commenter explained that certain portfolio management and trading strategies, like hedging and arbitrage strategies, among other things, seek to derive value, positive fund performance, and portfolio-trading revenues by taking advantage of pricing differentials in bid-ask spreads.

182

The commenter stated that such strategies have not traditionally been viewed as dealer activity and questioned whether they would be captured by the proposed third qualitative factor.

183

Another commenter stated that trading incentives are often organized in a manner that allows traders or their investment advisers to reduce overall commissions and fees paid by directing liquidity-providing trades to specific venues.

184

In the commenter's view, the “optimization of commission costs by an investment adviser on behalf of investors, or by a trader acting on his or her own behalf, should not by itself require registration as a dealer for a person who is otherwise a trader.”

185

Finally, some commenters objected that the proposed third qualitative factor's application in the crypto asset securities market may not be clear, including how the factor applies to so-called DeFi market products, structures, and activities such as so-called decentralized exchange (“DEX”) and “automated market maker” activities, as well as activities related to blockchain consensus and validation.

186

179

See, e.g.,

FIA PTG Comment Letter II.

180

See, e.g.,

Gretz Comment Letter; McIntyre Comment Letter II; Element Comment Letter; SIFMA AMG Comment Letter; ICI Comment Letter; MFA Comment Letter I.

181

Gretz Comment Letter.

182

McIntyre Comment Letter II.

183

Id.

184

Element Comment Letter.

185

Id.

186

See, e.g.,

ADAM Comment Letter (stating that “the third qualitative factor does not account for `staking' and the way in which some blockchains use the proof-of-stake consensus mechanism to

validate transactions, leaving unclear whether certain `validators' might be captured by the third qualitative factor.”); DeFi Fund Comment Letter (questioning if the “liquidity provider tokens” participants in digital asset liquidity pools receive in proportion to the amount of liquidity they contribute to the pool constitute an “incentive . . . for liquidity-supplying trading interests”).

After consideration of the comments, the Commission has determined to adopt, as the primary revenue factor, the third qualitative factor as proposed, with a non-substantive change. The final rules continue to use the phrase “earn revenue” rather than “earn profit.” While the Commission acknowledges the possibility that persons whose liquidity provision fails to turn a profit may ultimately seek out more profitable lines of business, dealer status requires only that a person be “in the business,” not that that business be profitable.

187

See

Proposing Release at 23069.

The term “trading venues” is intended to accommodate the variety of venues in which market participants today engage in liquidity-providing dealer activity. In addition, the use of this term is intended to capture venues as they evolve, wherever that activity occurs, whether on a national securities exchange, an ATS, any other broker- or dealer-operated platform for executing trading interest internally by trading as principal or crossing orders as agent, or any other platform performing a similar function.

188

The particular venue matters less than the fact that a market participant provides liquidity on it.

189

As discussed in the Proposing Release, there have been notable technological enhancements affecting securities trading across markets and asset classes.

190

Accordingly, the term “trading venues” is designed to capture current trading venues that use a variety of technologies, as well as trading venues that use technologies and venues that may develop over time. The term “trading venues” is designed to help ensure that, as innovation and technology used by such venues evolve, the final rules remain effective at supporting market stability and resiliency, protecting investors, and promoting competition across the U.S. Treasury and other securities markets. For these reasons, the Commission declines to limit the scope of this factor to trading venues that are national securities exchanges or ATSs.

188

Whether a particular structure or activity in the crypto asset securities market, including the so-called DeFi market, involves a trading venue is a facts and circumstances determination.

189

See

Proposing Release at 23069.

190

See

Proposing Release at 23055.

Regarding the term “primarily” as used in the primary revenue factor, the Proposing Release stated that if a person derives the majority of its revenue from the sources described in paragraph (a)(3)(iii), it would likely be in a regular business of buying and selling securities or government securities for its own account.

191

Further, in response to one commenter's example,

192

while the analysis of this specific scenario would depend on the totality of circumstances, as a general matter, it is unlikely that a person who regularly earns more revenue from an appreciation in the value of its inventory of securities than from capturing bid-ask spreads or incentive payment for liquidity provision, would be considered to earn revenue “primarily” from capturing bid-ask spreads or trading incentives.

191

Proposing Release at 23069.

192

See

Gretz Comment Letter (stating “ `Primarily' might be a bit vague. Technically, an entity could earn more revenues by price increases on the securities being held in stock for trading than by catching bid-ask spreads.”).

A commenter stated that the Proposing Release did not account for how the primary revenue factor would apply to market participants transacting in the crypto asset securities market; as commenters have pointed out, the crypto asset securities market has structures, products and activities that may implicate dealer registration.

193

Whether a particular activity in the crypto asset securities market, including in the so-called DeFi market, gives rise to dealer activity will require an analysis of the totality of the particular facts and circumstances. As discussed above, any person engaged in buying and selling securities for its own account must consider whether it is a dealer, including under the final rules, and so subject to dealer registration requirements.

194

Accordingly, the primary revenue factor will capture market participants that are primarily earning revenue from capturing spreads or liquidity incentives offered by trading venues, including trading venues that support transacting in crypto asset securities.

195

193

See

DeFi Fund Comment Letter; ADAM Comment Letter. A commenter explained that “a blockchain utilizing proof-of-stake validation lets users participate in verifying the blockchain by staking the native token, providing a reward if they propose and approve valid smart contracts.” ADAM Comment Letter.

194

See

section II.A.1.b.

195

As discussed above, a threshold question is whether the person has or controls total assets of less than $50 million, and if so, the person would not be captured by the final rules.

See supra

note 132 and accompanying text.

With respect to portfolio management and trading strategies that for varying reasons may seek to take advantage of pricing differentials in bid-ask spreads, as stated above, persons who engage in a pattern of trading for their own account having the effect of providing liquidity to other market participants should be subject to the dealer regulatory regime, even if they are also registered investment advisers or private funds. As discussed below, the important protections provided by the dealer regulatory framework differ from those under the private fund and private fund advisers regulatory scheme established by the Advisers Act.

196

The primary revenue factor, as with the expressing trading interest standard, focuses on activity rather than label or status. Market participants will need to determine, based on their trading activities, whether their portfolio management and trading strategies meet this standard.

196

See

section II.A.3.

To summarize, one fundamental and historically recognized view of dealer activity is trading in a manner designed to profit from spreads or liquidity incentives.

197

Under the final rules, persons providing liquidity because they regularly supply it and the revenue they earn as a result through bid-ask spreads or liquidity incentives as their primary source of revenue are “in the business” of dealing, and such persons regularly undertaking this liquidity-providing role for their own account in overall trading and market activity must register as dealers and be subject to the dealer regulatory regime.

197

Proposing Release at 23069. The Commission has previously identified a person's seeking, through its presence in the market, compensation through spreads or fees, or other compensation not attributable to changes in the value of the security traded, as a factor indicating dealer activity.

See

Entities Release at 30609.

2. Quantitative Standard

The Commission proposed a quantitative standard that would establish a bright-line test under which persons engaging in certain specified levels of activity in the U.S. Treasury market would be defined to be buying and selling government securities “as a part of a regular business,” regardless of whether they meet any of the qualitative factors.

198

Specifically, proposed 17 CFR 240.3a44-2(a)(2) (proposed “Rule 3a44-2(a)(2)”) provided that a person engaged in buying and selling government securities for its own account would be engaged in such activity “as a part of a regular business” if that person in each of four out of the last six calendar months, engaged in buying and selling more than $25 billion of trading volume in government

securities as defined in section 3(a)(42)(A) of the Exchange Act.

199

198

See

Proposing Release at 23071, n.165.

199

Proposed Rule 3a44-2(a)(2); Proposing Release at 23071.

Some commenters generally supported inclusion of the quantitative standard.

200

One commenter stated that “quantitative standard[ ] build[s] upon and [is] consistent with past Commission regulations and case law for defining a dealer.”

201

The majority of commenters, however, urged that the Commission remove the quantitative standard, raising various issues and concerns with establishing a test based solely on trading volume.

202

200

See

Better Markets Comment Letter (stating that the “quantitative standards for government securities markets, coupled with the proposed qualitative standards, will help to capture the high-frequency trading firms trading in significant volumes of U.S. Treasury bonds that are not currently registered with the Commission.”);

see also

FINRA Comment Letter.

201

Better Markets Comment Letter.

202

See, e.g.,

Element Comment Letter; MMI Comment Letter; Two Sigma Comment Letter I; FIA PTG Comment Letter I; NAPFM Comment Letter; AIMA Comment Letter II; ADAM Comment Letter; SIFMA AMG Comment Letter; McIntyre Comment Letter II; SIFMA Comment Letter I; Overdahl Comment Letter; Fried Frank Comment Letter; MFA Comment Letter I; ICI Comment Letter; Morgan Lewis Comment Letter; T. Rowe Price Comment Letter; Citadel Comment Letter; DeFi Fund Comment Letter; Comment Letter of Investment Advisers Association (June 6, 2022) (“IAA Comment Letter I”); BlackRock Comment Letter; FIA PTG Comment Letter II; Comment Letter of Darrell Duffie (Jan. 10, 2024) (“Duffie Comment Letter”).

Many commenters maintained that the quantitative standard was arbitrary and overly broad, and opined that a volume standard alone could not distinguish between a dealer and a trader.

203

Several commenters stated that the quantitative standard would capture persons engaging in non-dealing trading activity.

204

Some commenters also stated that the trading volume threshold was too low in light of the size of the U.S. Treasury market and that the Proposing Release failed to provide sufficient detail on how the proposed trading volume would be measured and implemented.

205

203

See, e.g.,

AIMA Comment Letter II; ICI Comment Letter; T. Rowe Price Comment Letter.

204

See, e.g.,

FIA PTG Comment Letter I; SIFMA AMG Comment Letter; Morgan Lewis Comment Letter; MMI Comment Letter; Two Sigma Comment Letter I; NAPFM Comment Letter; AIMA Comment Letter II; MFA Comment Letter I; McIntyre Comment Letter II; Element Comment Letter; ICI Comment Letter; Citadel Comment Letter; T. Rowe Price Comment Letter; Fried Frank Comment Letter; Consensys Comment Letter; ADAM Comment Letter; SIFMA Comment Letter I; Overdahl Comment Letter.

205

See, e.g.,

Two Sigma Comment Letter I; FIA PTG Comment Letter I; Element Comment Letter; MFA Comment Letter II. One commenter agreed that repurchase and reverse repurchase transactions should be excluded from counting towards the quantitative standard threshold.

See

ACLI Comment Letter.

After consideration of the comments, the Commission has decided to eliminate the quantitative standard from the final rules. While a trading volume threshold could provide a bright-line test under which persons engaging in certain specified levels of activity in the U.S. Treasury market would be defined to be buying and selling securities “as a part of a regular business,” the Commission has concluded such a bright-line test is unnecessary. The modified qualitative factors and otherwise applicable court precedent and Commission interpretations will appropriately address when market participants are acting as government securities dealers in the U.S. Treasury market by engaging in a “regular” pattern of buying and selling securities that has the effect of providing liquidity to other market participants. Therefore, the Commission has decided to delete the quantitative standard from the final rules.

In addition, as discussed in section II.A.5, no presumption shall arise that a person is not a government securities dealer as defined by the Exchange Act solely because that person does not satisfy Rule 3a44-2(a).

206

Thus, market participants acting similarly to traditional dealers that are buying and selling U.S. Treasuries as part of a regular business may still meet the definition of government securities dealer even absent the activity identified in the qualitative standard.

206

See

section II.A.5.

3. Exclusions

The proposed rules provided exclusions for certain market participants that the Commission determined do not provide liquidity to the markets in a manner requiring dealer registration or are subject to a comparable regulatory structure which addresses the types of concerns that the proposed rules were intended to address. The Commission is adopting these exclusions as proposed. In addition, the Commission is adding exclusions for central banks, sovereign entities, and international financial institutions, as defined in the final rules. Each of these exclusions is discussed in more detail below.

207

The Commission has determined to create bright-line exclusions for certain persons from the scope of the final rules for policy reasons specific to these types of persons as further defined below. This is in contrast to various exclusions requested by commenters related to, among other things, specific securities activities that market participants may engage in (such as certain trading strategies or asset classes). Because these specific securities activities and specific types of securities cannot be viewed in isolation, and could constitute in whole or in part liquidity-providing activity that these rules are designed to address, the Commission is not adding these categorical exclusions. Rather, as with any other securities activities, whether these specific securities activities result in triggering the provisions of the final rules requires a facts and circumstances analysis of the totality of a person's activities. The Commission, however, has significantly refined its proposal (including, notably, the aggregation provision) so that persons whose securities activities may have been captured may no longer be within the scope of the rules as adopted.

a. Person That Has or Controls Assets of Less Than $50 Million

In the Proposing Release, the Commission proposed to exclude from the proposed rules “[a] person

208

that has or controls total assets of less than $50 million.” The Commission stated that providing an exception was appropriate because, even though a person that has or controls less than $50 million in assets may be engaged in the activities identified in the qualitative standard, the frequency and nature of such a person's securities trading are less likely to pose the types of financial and operational risks to the market that may be associated with the significant dealer activity that the rules were designed to address.

209

208

As noted below, the term “person” has the same meaning as prescribed in section 3(a)(9) of the Exchange Act: “a natural person, company, government, or political subdivision, agency, or instrumentality of a government.”

209

Proposing Release at 23062.

Commenters that addressed this exclusion raised a number of concerns.

210

Some commenters stated that it was arbitrary or inconsistent with the plain reading of the “dealer” definition.

211

A few commenters stated that the threshold was too low.

212

However, one of those commenters also said that the threshold could be too high for some securities.

213

210

One commenter also raised practical issues about how the exclusion would operate in connection with the proposed aggregation provision; however, these concerns have been mooted with the removal of the aggregation provision.

See

ICI Comment Letter.

211

See, e.g.,

MMI Comment Letter; SIFMA AMG Comment Letter; Consensys Comment Letter.

212

See

Defi Fund Comment Letter; Element Comment Letter; Gretz Comment Letter; Consensys Comment Letter.

See also

section III.B.2.

213

See

Gretz Comment Letter.

After consideration of comments, the Commission is adopting this exclusion as proposed. While we appreciate commenters' concerns, as indicated in the Proposing Release, the final rules are intended to capture market participants not registered as dealers that serve a critical dealer role in the securities and government securities markets through their liquidity provision or significant and regular trading activity in the market. These smaller market participants are unlikely to engage in the significant liquidity provision that is

the focus of the final rules.

214

Importantly, we disagree that the $50 million threshold is arbitrary or too low or too high because, as stated in the Proposing Release, this exception parallels an established and well understood standard for distinguishing between “retail” and “institutional” accounts for purposes of broker-dealer regulation.

215

In the context of the final rules, persons that have or control assets of $50 million or more—so-called “institutional” accounts—are more likely to have a significant impact on the market as opposed to “retail” accounts of smaller market participants who are less likely to pose financial and operational risks to the markets. Further, in response to the commenter who raised practical issues about how the exclusion would operate in connection with investment advisers' separately managed accounts, as discussed in more detail below, the Commission has removed the aggregation provision, which should address those concerns.

216

Finally, we reiterate that this is not an exclusion from the “dealer” definition for all purposes, but only for purposes of the final rules, which focus on

de facto

market making. Outside of the context of these rules, the question of whether any person, including a person that has or controls le

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