SEC Proposes Expanding "Dealer" Registration Requirement
Commentary by Steven Lofchie
The SEC proposed two new rules that would expand the scope of the term "as part of a regular business" used in SEA Sections 3(a)(5) ("Dealer"), and 3(a)(44) ("Government Securities Dealer"). The rules define entities that are engaged in the activity of "buying and selling securities" in a manner (or amount) that subjects them to registration.
The expanded definitions of dealer and government securities dealer would apply to a firm that (i) routinely engages in day trading, (ii) puts out bids and offers on both sides of the market and (iii) earns revenue "primarily" from capturing the bid-ask spread or from capturing incentives offered by trading venues to supply liquidity. In addition, the definition of government securities dealer would include a firm that had, within a six-calendar-month period, bought and sold more than $25 billion of government securities.
The definitions would exclude persons that own or control assets of less than $50 million (note that this is an asset test, not an equity test) and SEC-registered investment companies.
The definitions would include an investment adviser that either controls 25% of the voting securities of an advisee or that has contributed 25% of the capital of an advisee. Further, the rules include certain aggregation requirements between, for example, funds that engage in parallel trading strategies.
Absent an exception or exemption, any market participant that engages in the activities described in the new rules would be considered a "dealer" or "government securities dealer" and would, therefore, be required to:
- register with the SEC under Section 15(a) or 15C as applicable;
- become a member of an SRO; and
- comply with broker-dealer regulations.
Comments on the proposed new rules are due 30 days after publication in the Federal Register or May 27, 2022, whichever is later.
Commissioner Statements
SEC Chair Gary Gensler supported the proposed new rules, stating that "[this proposal] reflects Congress’s statutory intent that firms engaging in important liquidity-providing roles in the securities markets, including in the U.S. Treasury market, be registered with the Commission." He stated that the rule aims to capture, among others, principal trading firms whose participation in the market has become significant due to the "electronification and the use of algorithmic trading" in the markets in the last couple of decades.
SEC Commissioner Hester M. Pierce stated, "[W]hile I have deep reservations about the breadth of today’s proposal, it addresses some important issues on which public comment will be valuable." She also provided a list of questions that she would like to see be addressed in response to the proposed new rules.
Commentary
Commissioner Gensler states that the rule changes are consistent with Congressional intent. That assertion seems curious; as the proposing release observes, the securities markets of 2022 don't much resemble the securities markets of 1934.
The proposing release is very short as to the benefits that the expanded definitions would provide. The primary benefit to which the SEC points is that the registration of more firms would allow the SEC to collect more data. With more data, the SEC argues it might be able to determine what had caused the so called "flash rally" in October 2014 (see page 10 of the release). It is difficult to imagine that SEC rulemaking on this scale can really be justified on the basis of allowing the SEC to collect more information. (Side note, the CFTC once tried to pin the 2010 flash crash on a small trader engaged in spoofing activities. While the trader was guilty of spoofing, the notion that he caused the flash crash always seemed unlikely. This example is more of a lesson that an overzealous search for bad guys to explain highly eccentric market-wide aberrations may lead regulators on a search for causes that are not really comprehensible. See, generally, news on Navinder Sarao.)
Just as the benefits of the rulemaking seem a little thin, the costs (at least to the extent that an outside lawyer is capable of assessing them) seem significantly understated. For example, the SEC estimates the cost of completing a Form BD to register with the SEC at $1,000 (but ignores the likely $100,000 or more expense of initially becoming a member of FINRA with all of the requesting bells and whistles) and estimates that firms spend only an hour a day on recordkeeping, and 30 minutes a year on recordkeeping as to its associated persons. These estimates may be understated by many, many multiples.
Beyond the questions of whether these proposed rules are within the bounds of the statute, or whether the rules can be justified on a cost-benefit basis, there are broader questions. The SEC has proposed a torrent of new rules in the last few months. The interactions among that are impossible to anticipate. Do all these rules relate in some way? Is there a big picture here? Are there any priorities? Is there a point at which the costs of rulemaking simply overwhelm any potential benefits? Is there a point at which the pace of rulemaking simply overwhelms any possibility of reasoned consideration of those rules?