Introduction

The Securities and Exchange Commission (“SEC”) recently proposed two new rules (the “Proposed Rules”)¹ that would require market participants (including proprietary trading firms and potentially some private funds) who engage in buying and selling securities for their own accounts while assuming certain dealer functions and acting as liquidity providers in the market to register as a dealer with the SEC and become members of a self-regulatory organization. In the release relating to the Proposed Rules (the “Release”),² the SEC noted that “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.” The Proposed Rules would establish activity-based standards to identify market participants who would meet an expanded definition of “dealer” or “government securities dealer” and would be required to register with the SEC.

Background

The Federal securities laws currently define a dealer as “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.”³ This statutory exclusion from the definition of “dealer” is often referred to as the “trader exception.”⁴ The Proposed Rules seek to further define what it means to trade securities⁵ for one’s own account “as part of a regular business” in a manner that would require many market participants who previously relied on the trader exception to register as a dealer or a government securities dealer.

The Proposed Rules establish three activity-based standards to help identify activities of market participants who “assume dealer-like roles, specifically, persons whose trading activity in the market has the effect of providing liquidity to other market participants” and would be considered dealers. The Proposed Rules list some activities that may be considered “as a part of a regular business.”

Qualitative Standards and Government Securities Dealer Quantitative Test

Under the Proposed Rules, a person would be engaged in buying and selling securities (or government securities) for its own account “as part of a regular business” if that person engages in a routine pattern of buying and selling securities (and government securities) that has the effect of providing liquidity to other market participants by:

• routinely making roughly comparable purchases and sales⁶ of the same or substantially similar securities or government securities, as the case may be, in a day;
• 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
• 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.

There would be an additional quantitative standard for persons buying and selling government securities that, if met, would automatically consider the person to be engaging in the activity as “part of a regular business,” regardless of whether any of the qualitative standards are met. Under this test, a person engaged in buying and selling more than $25 billion of trading volume in government securities in each of four of the last six calendar months would be considered to be doing so “as part of a regular business.”

Certain Definitions

In order to be considered a dealer or government securities dealer under the Proposed Rules, a person⁷ would need to be engaged in the business of buying and selling securities for its “own account”. A person’s “own account” is defined to mean, with some exceptions, any account: (i) held in the name of that person; (ii) held in the name of a person, over whom that person exercises control⁸ or with whom that person is under common control; or (iii) held for the benefit of those persons identified in (i) and (ii). This definition would require the aggregation of certain accounts.

The definition of “own account” does not include an account held in the name of a client of an SEC-registered investment adviser unless the adviser controls the client as a result of the adviser’s right to vote or direct the vote of voting securities of the client, the adviser’s right to sell or direct the sale of voting securities of the client, or the adviser’s capital contributions to or rights to amounts upon dissolution of the client. The Release confirms that the Proposed Rules would exclude SEC-registered advisers from aggregating their trading activities with those of other clients when the client and adviser only have a discretionary investment management relationship.

Excluded Persons

The Proposed Rules provide an exclusion for the following categories of persons:

• any person that has or controls total assets of less than $50 million; or
• an investment company registered under the Investment Company Act of 1940

Non-Exclusive Nature of Proposed Rules

The Proposed Rules do not establish a presumption that a person who does not meet the criteria established would not be a dealer or government securities dealer. Accordingly, market participants, including proprietary trading firms and private funds, would still be required to analyze relevant activity in light of existing SEC interpretations and precedent.

Observations

The scope of the Proposed Rules is broad and includes terms that are not defined and will require consideration of SEC “facts and circumstances” guidance to assess. It will require dealer registration of market participants not previously considered dealers. The Release specifically notes that the Proposed Rules would not exclude private funds because, unlike registered investment companies, private funds are not subject to an extensive regulatory framework. In addition, the SEC requests comments on numerous aspects of the Proposed Rules and specific issues, including whether the SEC should except or exclude private funds from the scope of the Proposed Rules.

The Release and Proposed Rules were published in the Federal Register on April 18, 2022. The SEC will accept comments up until May 27, 2022. Please contact your primary Seward & Kissel attorney if you have any questions regarding the Proposal.