Ding, Dong! The Dealer/Trader Distinction is Dead. HFTs and DEX AMMs Should Take Notice

The SEC recently proposed rules that would greatly expand the Exchange Act definition of “dealer” and essentially kill the existing dealer/trader distinction long-recognized by the SEC.  The likely outcome is that most proprietary trading firms will need to register with the SEC as dealers and become members of FINRA or a national securities exchange (more on this later).  The scope of the proposal is vast—all securities, including equities, fixed income, govys, and, wait for it…digital asset securities.  Coupled with the SEC’s recent proposal to amend the definition of “exchange,” this dealer proposal is central to the SEC’s plans to regulate additional market participants (like “communication protocol systems” and this broader universe of securities dealers), both in traditional financial markets and beyond (including crypto and DeFi).

The Exchange Act definition of “dealer” currently excludes a trader who “buys or sells securities…for such person’s own account…but not as a part of a regular business.”  Under the proposal, however, any person or firm that has or controls total assets of at least $50 million and satisfies certain quantitative standards that are “dealer-like” will need to register.  The proposal generally identifies firms that have such a high degree of activity that, even though on a proprietary basis, they play a significant role in providing liquidity to the overall market. The SEC’s focus is on “market participants who engage in a routine pattern of buying and selling securities for their own account that has the effect of providing liquidity. Said differently, for market participants engaging in any of the activities identified by the qualitative standards…, liquidity provision is not incidental to their trading activities. Rather, these persons are ‘in the business’ of buying and selling securities for their own account and providing liquidity as part of a regular business.”  The proposed qualitative standards are:

  • Routinely making roughly comparable purchases and sales of the same or substantially similar securities in a day; or
  • 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.

Market participants are sure to comment vociferously. While the proposed amendments may make sense from a policy and soundness standpoint for some markets and participants (U.S. Treasuries, for example), the proposal is not scoped in that way.  The introduction of “qualitative” standards also essentially gives the SEC limitless ability to subjectively determine who’s in and who’s out.  Lack of clear guidelines is always a bad idea in a regulatory context and that will be the likely industry view here.

Given the push to expand its regulatory reach, it would also come as no surprise to see the SEC re-propose amendments to Exchange Act Rule 15b9-1, which currently exempts from FINRA membership brokers-dealers that are members of a national securities exchange (like NYSE or Nasdaq), carry no customer accounts, and meet other requirements.  The exemption was created to accommodate exchange specialists and floor-traders.  In 2015, the SEC sought to narrow the 15b9-1 exemption by “eliminat[ing] the current proprietary trading exemption and replac[ing] it with a more focused one that would accommodate off-exchange transactions by a floor-based dealer that are solely for the purpose of hedging the risks of its floor-based activities.”