On January 10, 2022, the Securities and Exchange Commission (“Commission”) entered a settled order against tZERO ATS LLC (“tZERO”) for making late disclosures under Regulation ATS and violating Regulation ATS’s “Fair Access Rule.”¹ tZERO is a New York-based broker dealer specializing in digital assets and tokenized securities that operates an alternative trading system (“ATS”) with trading in both national market system (“NMS”) stocks and digital securities. Starting in October 2019, tZERO operated a separate ATS for NMS stock trading after regular market hours, while continuing to offer trading in digital securities during regular market hours through its original ATS. Under the terms of the Order, tZERO was censured and required to pay an $800,000 penalty.

An ATS is a trading venue that is subject to fewer restrictions and regulations than a national securities exchange. An ATS that does not publicly display unfilled orders is called a “dark market” or “dark pool,” while an ATS that does display such orders, similar to a registered exchange, is considered “lit.” Order display provides buyers and sellers the expectation of liquidity and execution in the ATS. Regulation ATS provides for an exemption from registration as a national securities exchange if certain rules are followed. Rule 301(b)(2) of Regulation ATS requires an ATS to file information with the Commission about its operations, such as its order entry procedures, how it displays orders and quotes, and the role of any entity involved in its operations, and to maintain the accuracy of those disclosures.

According to the Order, starting in December 2014, tZERO and its affiliated broker-dealer had an arrangement with an unregistered foreign entity to facilitate trading in certain NMS stocks and ETFs after U.S. markets had closed. tZERO shared order information from its after-hours NMS stock order book with the broker-dealer, the foreign entity, and Blue Ocean Technologies, LLC (“Blue Ocean”), a tZERO affiliate that acquired the foreign entity in early 2017. tZERO did not disclose until September 2017 that it was displaying ATS subscriber orders to other ATS subscribers and customers of the broker-dealer, and it did not disclose Blue Ocean’s involvement until June 2018. In addition, the broker-dealer entered digital security orders on the ATS starting in January 2019, but it did not disclose until April 2019 that those orders were being displayed to its customers. These disclosure failures violated Rule 301(b)(2).

tZERO also violated Rule 301(b)(5) of Regulation ATS. Rule 301(b)(5) requires an ATS with at least 5% of the average daily volume for a security in at least four of the previous six months to comply with “fair access” requirements, including establishing written standards for granting access to the ATS. An ATS cannot unreasonably deny or limit access to its platform by, for example, applying minimum capital or credit requirements in a discriminatory manner. By exceeding the 5% threshold, tZERO was subject to Rule 301(b)(5) with respect to trading in Overstock’s Series A Blockchain Preferred Securities (OSTKP) in June 2017, its own Preferred Securities (TZROP) beginning in February 2020, and Overstock’s Series A Digitally Enhanced Preferred Securities (OSTKO) in March 2020. tZERO failed to maintain written supervisory procedures (“WSPs”) establishing its fair access obligations and did not update its WSPs to establish fair-access standards until June 2020, after Enforcement staff requested its standards.

S&K Observations:

This enforcement proceeding underscores the importance of broker-dealers observing disclosure requirements, especially in operating alternative trading systems. We recommend that broker-dealers regularly review their disclosures to ensure they are accurate and current.

Please contact your primary attorney at Seward & Kissel if you have any questions or require assistance with respect to Regulation ATS.