• The SEC dropped the most controversial provisions, but still significantly expanded the reach of the “dealer” definition.
• Persons that engage in trading activity that resembles market-making may now have to register as “dealers” and be subject to the corresponding regulatory requirements, regardless of whether they have customers.
• Registered investment advisers, hedge funds and other private funds are not excluded and may also be “dealers” under the rule.

At a contentious open meeting on February 6, 2024, the Securities and Exchange Commission (Commission) voted three to two to adopt rule amendments (Final Rules) under the Securities Exchange Act of 1934, as amended (Exchange Act), that will significantly expand the scope of the definition of “dealer” and “government securities dealer.”¹ As a result of the expanded definitions, market participants that regularly engage in certain liquidity-providing activity in securities (or government securities) will have to register with the SEC as a “dealer” or “government securities dealer” under Section 15 or Section 15C, respectively.

The Commission stated in the Adopting Release that the Final Rules were designed to bring within the dealer definition proprietary trading firms and private funds (primarily hedge funds) whose activities provide liquidity to the securities markets but which previously fell under the so-called “trader” exception. The Commission stated that the Final Rules would help “enable more comprehensive regulatory oversight of securities markets and those participants that take on significant liquidity-providing roles.”

Section 3(a)(5) of the Exchange Act defines the term “dealer” to mean “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.” The Final Rules include two qualitative standards for trading activities to be deemed “as part of a regular business” and further define the meaning of “own account.”

The Commission originally proposed the amendments (Proposed Rules) on March 28, 2022.² The Final Rules did not include two of the most contentious provisions applicable to the “as part of a regular business” test: a qualitative standard designed to capture firms that trade flat each day, and a bright-line quantitative test designed to capture firms that trade large volumes in government securities. The Final Rules also removed from the “own account” definition the aggregation standard, which expanded the definition of “own account” to include accounts “held in the name of a person over whom that person exercises control or with whom that person is under common control.”

The Final Rules may bring within the definition of dealer a number of proprietary trading firms, private funds, and investment advisers (including registered investment advisers).

Background

Prior to adoption of the Final Rules, Section 3(a)(5) of the Exchange Act and the accompanying registration requirements required a person engaged in the business of buying and selling securities (or government securities) for its own account as part of a regular business to register as a dealer. This definition excepted “a person that buys or sells securities (or government securities) . . . for such person’s own account, either individually or in a fiduciary capacity, but not as a part of regular business” – otherwise referred to as the “trader” exception. The Commission asserted that with advancements in electronic trading across securities markets, certain market participants that have relied on the trader exception have become increasingly important liquidity providers in the securities markets, a function traditionally performed by dealers. The Commission adopted the Final Rules seeking to address this issue by expanding the definition of “dealer” and “government securities dealer” to “ensure that market participants that take on significant liquidity-providing roles are appropriately registered and regulated as dealers and government securities dealers.”

Summary of the Rule

For any person that owns or controls at least $50 million in total assets and is not a registered investment company, central bank, sovereign entity or international financial institution, the Final Rules deem the person’s regular pattern of trading in securities (or government securities) for its own account to be “as part of a regular business” when it has the effect of providing liquidity to other market participants in either of two ways:

• 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.
• 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 interest.

Under questioning from Commissioner Mark T. Uyeda about what constitutes “near the best available market prices,” the Staff stated that it could vary for different products or circumstances.

In a change from the Proposed Rules, the Final Rules did not include:

• The proposed qualitative standard applying to a person routinely making roughly comparable purchases and sales of the same or substantially similar securities (or government securities) in a day.
• The proposed bright-line quantitative standard for trading in government securities.³

Additionally, the Final Rules reflect a change in language from “routinely” to “regularly” as applied to a person’s expression of trading interests.

Definition of “Own Account” and the Anti-Evasion Provision

The Final Rules further define a person’s “own account” to mean any account held in the name of that person or held for the benefit of that person. In a change from the Proposed Rules, the Final Rules do not include the proposed aggregation provision, which would have expanded the definition of “own account” to include accounts “held in the name of a person over whom that person exercises control or with whom that person is under common control.”

Instead, to prevent potentially evasive behavior by persons who may be required to register as a dealer, the Final Rules include an anti-evasion provision. A person may not evade the registration requirements by:

• Engaging in activities indirectly that would satisfy the qualitative standard.
• Disaggregating accounts.

The anti-evasion provision is meant to prohibit persons from structuring activities or disaggregating accounts for the purpose of evading dealer registration requirements. During questioning by Commissioner Hester M. Peirce about the practice of separating dealer-affiliates from trading-affiliates, the Staff acknowledged that this activity may be proper in some circumstances but avoided giving meaningful guidance regarding when it would trigger the anti-evasion provisions.

No Presumption

Additionally, the Final Rules expressly adopt a “no presumption” clause, under which no presumption is established that a person is not a dealer solely because that person is not deemed a dealer by the Final Rules. That is, a person may be a dealer if it engages in a regular business of buying and selling securities (or government securities) for its own account, even if it does not meet the conditions set forth in the Final Rules. The Commission stated that the Proposed Rules did not seek to address all persons that may be acting as dealers under applicable interpretations and precedent.

Registered Investment Companies, Private Funds and Registered Investment Advisers

Investment companies registered under the Investment Company Act of 1940, as amended (Investment Company Act), are excluded from the Final Rules. In contrast, private funds and registered investment advisers are not expressly excluded. In the Final Rule's Adopting Release, the Commission explained that private funds, and the regulatory regimes that apply to registered advisers to private funds, differ from the one that applies to dealers, including with respect to leverage constraints and reporting.

In particular, private funds are not subject to the extensive regulatory framework of the Investment Company Act, and depending on the totality of the facts, a private fund may be engaged in the business of buying and selling securities (or government securities) for its own account.

Similarly, the Adopting Release states that registered investment advisers that are trading for their “own account” could implicate dealer registration requirements and should be required to register. However, in response to concerns related to separately managed accounts and investment advisers trading on behalf of their clients, including those exercising discretion, the Commission modified the definition of “own account” in the Final Rules as explained above so as not to attribute accounts over which investment advisers have discretion to the investment advisers’ proprietary activities. Thus, investment advisers will not be captured by the Final Rules due to their fiduciary activities because they would not be buying and selling for their “own account.” However, the Commission noted in the Final Rules that investment advisers may nevertheless be subject to dealer registration to the extent their proprietary activities meet either of the Final Rules’ tests.

Compliance Date

The Commission is adopting a compliance date that is one year from the effective date of the Final Rules (i.e., 60 days after publication of the Final Rules in the Federal Register) for all persons engaged in activities that trigger the new dealer registration. The Commission noted that a person who is engaged in activities that require registration as a dealer for reasons other than the criteria set forth in the Final Rules will still be required to register before the compliance date.

The authors would like to thank Pat McCarthy for his contributions.

1. Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and U. Securities Dealer, Release No. 34-99477 (Feb. 6, 2024) (Adopting Release).
2. Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer, Release No. 34-94524 (Mar. 28, 2022) (Proposing Release).
3. The Proposed Rules set out a bright-line threshold of $25 billion monthly trading volume in government securities as defined in section 3(a)(42)(A) of the Exchange Act. For purposes of the government securities dealer definition, a firm would have been deemed to be providing liquidity if it exceeded that volume in four of the six most recent months.