Securities Regulation Daily Wrap Up, SEC NEWS AND SPEECHES—Commission adopts new rules that broaden its definition of ‘dealers’, (Feb 6, 2024)

By Suzanne Cosgrove

“Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others,” said SEC Chairman Gensler.

The SEC on Tuesday adopted final rules by a 3-2 vote that require market participants who perform dealer functions—in particular those who take on significant market liquidity-providing roles—to register with the SEC, become members of a self-regulatory organization (SRO) and comply with U.S. securities laws and obligations. The rule changes are expected to significantly impact Treasury securities trading.

“Absent an exemption or exception, if anyone trades in a manner consistent with de facto market making, it must register with us as a dealer,” said SEC Chairman Gary Gensler in a release. “These measures are common sense.”

However, Gensler’s view was actively challenged in Tuesday’s SEC Open Meeting by Commissioner Mark Uyeda, who called the rules “problematic.” Uyeda and Commissioner Hester Peirce both voted against the rule changes.

“Today’s action may reduce liquidity in the Treasury markets, make them more volatile, reduce the number of liquidity providers, and increase debt costs to taxpayers,” Uyeda said.

The dealer-trader distinction. “The Commission and Commission staff repeatedly have issued guidance on what we have called the dealer-trader distinction,” said Peirce. “The rule the Commission is considering today obliterates this distinction by extending the definition of ‘dealer’ to market participants that run investing and trading businesses, not dealing businesses.”

“This rule turns traders, many of whom are customers, into dealers,” Peirce added. “Doing so runs counter to the statute, as the Commission and market participants have read it for decades.” Further, traders lose the protections they held as customers, she said.

Peirce also questioned meeting participants whether investment advisers were included in the new dealer definition and how cryptocurrencies trading firms fit into the picture. According to a SEC fact sheet, the final rules exclude any person that has -- or controls -- total assets of less than $50 million. That limit, or “de minimis,” applies whether a firm is in the crypto or non-crypto space, Gensler replied.

A two-year debate. The Commission initially proposed expanding the definition of “dealers” in March 2022. The final rules, Exchange Act Rules 3a5-4 and 3a44-2, further define the phrase “as a part of a regular business” in Sections 3(a)(5) and 3(a)(44) of the Securities Exchange Act of 1934 to identify activities that would cause persons engaging in such activities to be “dealers” or “government securities dealers” and be subject to the registration requirements of Sections 15 and 15C of the Act, respectively, in connection with liquidity-providing roles.

“The Exchange Act defines a dealer as any person engaged in the business of buying or selling securities for their own account,” said Commissioner Caroline Crenshaw, who voted in favor of the new rules, along with Gensler and Commissioner Jaime Lizárraga. “The Commission has long identified the provision of liquidity, including acting as a ‘market maker’ or ‘a de facto market maker,’ as a factor that indicates ‘dealer’ status.”

“When dealers register, they become subject to a variety of important laws and rules that help protect the public, promote market integrity, and facilitate capital formation,” Gensler noted. Those requirements include meeting minimum capital requirements, reporting data to regulators, and keeping books and records.

“The final rules promote an important cornerstone of the SEC’s work to oversee the markets,” he said.

Treasuries’ exemptive status. Foundational securities laws written in the 1930s exempted Treasury securities—and therefore government securities dealers—from the provisions. That changed in the 1980s, when a number of firms, including Drysdale Government Securities, failed. In response, then-President Ronald Reagan signed the Government Securities Act into law in 1986, Gensler noted. The Act granted the SEC and other regulators the authority to oversee dealers and brokers. Working with the SEC, the U.S. Department of Treasury put in place rules for government securities dealers.

The markets also evolved in other ways, including electronification, the use of algorithmic trading, and market participants transacting faster than ever before, Gensler said. “Some market participants, such as principal-trading firms (PTFs) that use high-frequency trading strategies, started participating significantly in the Treasury cash market,” and in 2019, PTFs represented around 60 percent of the volume on the inter-dealer broker (IDB) platforms in the Treasury markets, he said.

However, Gensler added that in 2021, “when I arrived at the SEC, I was told that though numerous firms have registered with the SEC as government securities dealers, some market participants have not,” Gensler added. “I think that leaves potential regulatory gaps and risk in the system,” he said.

As reported by Securities and Regulation Daily in March 2022, a series of high-profile market events that involved principal trading firms, including “tremors” in the Treasuries markets in 2014, 2019 and at the beginning of the COVID crisis in 2020, fueled the SEC’s drive to fill those “gaps.”

The rules help close regulatory loopholes and “level the playing field by subjecting market participants that perform similar dealer functions to a common regulatory regime,” Crenshaw said.

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