US District Court Strikes Down SEC "Dealer Rule"
Commentary by Steven Lofchie and Gage Raju-Salicki
A US District Court "vacated in its entirety" the SEC's "Dealer Rule." The rule would have expanded the definitions of "dealer" and "government securities dealer" to entities that had historically been considered "traders" outside the scope of the broker-dealer registration requirement.
In National Association of Private Fund Managers v. SEC, the District Court for the Northern District of Texas rejected the SEC's request to limit the or modify the scope of its decision, saying "Complete vacatur is warranted because . . . the very promulgation of the Rule was in excess of [the SEC's] statutory authority." The Court derided the SEC for falling victim to a "temptation [that] causes an agency to act beyond its authority" and stated that it was the obligation of the Court to "thwart" the agency's power play. The Court found:
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An Excess of Statutory Authority. The Court said that the SEC's expanded definition of "dealer" was "in excess of the Commission's authority based on the text, history and structure of the Exchange Act."
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Historical and Structural Inconsistencies. The Court stated that the SEC's interpretation was inconsistent with the Exchange Act's history and purpose, which was primarily to protect customers. The Court dismissed the SEC's argument that an entity could be a dealer in securities even where it had no customers.
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Absurd Implications. The Court noted that the rule was so broad that it would have required the Federal Reserve to register with the SEC as a dealer in securities, absent the fact that the rule grants the Federal Reserve a specific exemption. The Court indicated that it seemed unlikely that the Federal Reserve had been acting as an unregistered dealer since 1934, and that it needed the special exemption created by the SEC in order to avoid the requirement to subject itself to the SEC's authority.
Commentary
This is the second major loss for the SEC in the last several months that has resulted in a finding that the SEC exceeded its authority. (See "Private Fund Advisors"). As a result, another major rulemaking effort must be vacated in full. Still to come, challenges to rulemaking efforts related to securities lending, short selling and greenhouse gas disclosures. If the SEC does not lose these cases in court, they are likely to be overturned by the next Congress.
Notably, these judicial findings follow other major losses by the SEC, where the Courts considered the regulator's acts "arbitrary and capricious." (See, e.g. Court Vacates SEC Refusal to Allow Exchange-Listing of Bitcoin Trusts.)
What should the SEC do with its remaining rule proposals that have not yet been adopted, and with adopted rules that are the subject of current court challenges? It may be prudent—even graceful—for the SEC to (i) announce that it will leave its rule proposals to be taken up (or not) by the next Chair, and/or (ii) seek a stay on its court cases so that the next SEC Chair can decide whether to continue with the litigation. There is no benefit to the SEC further disrupting the markets with regulatory uncertainty for the next several months in order to push forward rulemakings that are unlikely ever to become effective.
Taking additional losses in the courts simply further damages the reputation of the SEC as an agency that itself abides by the law.
Commentary
The National Association of Private Fund Managers v. SEC case was brought by private funds associations. A related case was brought by the Crypto Freedom Alliance of Texas ("Crypto Freedom Alliance") and the Blockchain Association ("BA") and decided by the same District Court on the same day. (See related coverage.)
These plaintiffs alleged that the SEC Dealer Rule was "arbitrary and capricious" because there was no required economic analysis with respect to cryptocurrencies, and, as such, the rulemaking was not properly transparent under the Administrative Procedures Act. In its Opinion, (which incorporated the ruling in Private Fund Managers), the Court explained that "[t]he Rule as it currently stands de facto removes the distinction between 'trader' and 'dealer' as they have commonly been defined for nearly 100 years."
Striking down the Dealer Rule vindicates a concern raised by SEC Commissioner Hester Peirce when the rule was finalized: that "the rule reflects little thought regarding its practical application in the crypto markets." This District Court decision is a victory for the crypto industry as it safeguards innovation and ensures ongoing transparency for any SEC future rulemaking.
Related Articles
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Two crypto industry trade associations sued to vacate the SEC's recently adopted "Dealer Rule." The rule expanded the definitions of "dealer" and "government securities dealer" as it applies to participants in decentralized finance.
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