On February 6, 2024, the Securities and Exchange Commission (SEC) released a final rule that significantly expands the definitions of “dealer” and “government securities dealer.” This expansion covers additional market participants engaged in liquidity-providing activities, such as hedge funds or proprietary trading firms. This blog post aims to provide a brief background on who has been considered a dealer prior to the final rule, the changes introduced by the final rule, and the potential impacts of these changes on the securities markets.
Who are “dealers” and “government securities dealers”?
Sections 3(a)(5) and 3(a)(44) of the Securities Exchange Act of 1934 (Exchange Act) outline activities that classify persons as “dealers” or “government securities dealers.” Consequently, such persons must adhere to the registration requirements of Sections 15 and 15C of the Act, respectively.
A “dealer” is broadly defined as “any person engaged in the business of buying and selling securities… for such person’s own account through a broker or otherwise.” However, there are exceptions to this definition, such as the “trader” exception. This exception 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” from the term “dealer”. The final rule expands the previous definitions to include qualitative standards in determining whether an individual or entity buys and sells securities as part of its regular business.
Similarly, the Exchange Act only requires a person to register as a “government securities dealer” if such person buys and sells government securities for its own account “as a part of a regular business.”
Key Highlights of the Final Rule
Below are some key takeaways from the final rule, including who is now classified a dealer or government securities dealer:
- Qualitative Standards: The rules establish standards to identify market participants who take on significant liquidity-providing roles. A person falls under the new rules if they engage in a regular pattern of buying and selling securities or government securities that has the effect of providing liquidity to other market participants by either:
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- 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; or
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- 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.
- Asset Threshold: Entities with total assets under $50 million are excluded from the definition.
- Exemptions: Registered investment companies, central banks, sovereign entities, and international financial institutions are exempt. However, registered investment advisors are not exempt.
What is the Impact of the Final Rule?
The final rule creates and adopts Rules 3a5-4 and 3a44-2 under the Exchange Act. These rules further define the phrase “as a part of a regular business” as used in the statutory definitions of “dealer” and “government securities dealer”, and will require market participants who fall within the new, expanded definitions to be subject to heightened regulatory scrutiny. This includes registration requirements with the SEC, becoming members of a self-regulatory organization (SRO), such as FINRA, adherence to record-keeping and reporting standards as well as adherence with other regulatory standards and federal securities laws, and compliance with other regulatory obligations that were previously not applicable. Some compliance and strategic considerations also include:
- Assessing Dealer Status: Firms must thoroughly evaluate their trading activities to determine whether they fall within the expanded definitions. This assessment should include an analysis of trading patterns, the frequency and volume of transactions, and the nature of their market activities.
- Operational Adjustments: Firms may need to implement significant changes to their operations, including enhancing compliance programs, training staff on new regulatory requirements, and potentially restructuring their business models to align with dealer regulations.
- Legal and Financial Advice: Seeking legal counsel and financial advisory services is crucial to understand the full scope of the rule’s impact and to develop a comprehensive compliance strategy. Law firms specializing in securities regulation, such as Austin Legal Group, can provide valuable guidance on navigating the complexities of the new rule.
Other Important Details
The final rule was published in the Federal Register on February 29, 2024. The rule has an effective date of April 29, 2024, and a compliance deadline of one year thereafter (April 29, 2025).
The new rules could affect principal trading firms, proprietary trading firms, and some private funds engaged in significant trading activities, especially through electronic and algorithmic systems in the U.S. Treasury markets. However, there remains uncertainty for small-cap investors and lenders who don’t meet the new thresholds but may still be considered dealers based on other legal standards.
The SEC clarifies that “no presumption shall arise that a person is not a dealer or government securities dealer solely because that person does not engage in the activities identified in the final rules.” Thus, the final rule applies if a person acts like a dealer or government securities dealer, even if their specific circumstances are not covered by the rule. Provisions also exist to prevent evasion of registration requirements by engaging in activities indirectly or by disaggregating accounts.
Moving Forward and Why This Matters
The SEC’s action addresses the substantial market volume attributed to unregistered entities that provide liquidity. The new rule aims to ensure consistent oversight and investor protection across various securities markets.
However, the rule could introduce a chilling effect on market participation. By broadening the definition of a dealer, it imposes registration and compliance requirements on a wider array of market participants. This could reduce the number of liquidity providers, potentially affecting trade execution efficiency, pricing, and market confidence. Stakeholders, from individual investors to large institutions, could face increased capital costs and disruptions in market operations.
The SEC’s expanded definitions of “dealer” and “government securities dealer” represent a significant regulatory shift with far-reaching implications. Firms must proactively address these changes to ensure compliance and maintain their competitive edge in the market. While the rule seeks to enhance oversight and investor protection, it also risks unintended consequences that could impact the dynamism and accessibility of U.S. markets. We will monitor these impacts closely to advise clients on navigating the new legal landscape for potential dealers.
More Information
Austin Legal Group, APC (ALG) represents the legal interests of businesses and individuals across the country. The firm was founded on a desire to deliver excellent legal services in a personalized and economical manner. We represent public and private companies in a variety of corporate transactions including strategic planning, public offerings, private equity, debt offerings, mergers and acquisitions, and other general corporate services. Our clients include companies from various sectors, including: technology, health and wellness, agriculture, real estate development, manufacturing, cannabis, renewable energy and digital assets/crypto currencies. For more information or to schedule a consultation, please call our office at (619) 924-9600 and ask to speak with one of our attorneys.
Disclaimer
ALG does not make any representations or warranties, expressed or implied, as to the accuracy, completeness or fitness for a particular purpose of this or any article. This article is meant for general informational purposes only and should not be construed as, and does not constitute, legal advice. No one should take any action regarding the information in this article without first seeking the advice of an attorney. This article does not create an attorney-client relationship. No attorney-client relationship will exist with ALG or any attorney affiliated with it unless a written contract is signed by all parties and any conditions in such contract are satisfied.
