On February 6, 2024, by a 3-2 vote, the US Securities and Exchange Commission adopted new rules that expand the definition of “dealer” under the federal securities laws. Ostensibly adopted to provide the SEC with greater oversight over the market for Treasury bonds, the new rules are not limited to any particular asset class, and may impact the operations of firms that regularly trade in cryptocurrencies or other digital assets that are securities.

The Securities Exchange Act defines “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 the definition 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.” Decades of SEC interpretations help to lay out the frontier between dealers, who must register with the SEC and FINRA, and “traders” who need not register because they do not buy and sell securities as part of a regular business. Registration as a dealer subjects the registrant to ongoing SEC and FINRA regulation, which entails complex bookkeeping and customer protection rules, as well as a requirement to maintain minimum net capital. Many hedge funds and other professional asset managers have structured their securities trading operations to rely on the trader exception.

The SEC’s new rules narrow the trader exception by setting out two standards that would be deemed dealing “as part of a regular business.” Specifically, the new rules provide that a person buying and selling securities “for its own account” is engaged in that activity “as a regular business” if that person engages in a regular pattern of buying and selling securities that has the effect of providing liquidity to other market participants by either (1) regularly expressing trading interest that is at or near the best available prices on both sides of the market for the same security that is communicated and represented in a way that makes it accessible to other market participants or (2) 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. The new rules exclude registered investment companies, central banks, sovereign entities, certain international financial institutions and persons who control total assets of less than $50 million.

Trade associations and other commenters representing the crypto industry sought a broad exemption from the new rules for digital assets that are securities, but the SEC declined to grant such an exemption. Instead, according to the SEC, the “dealer framework is a functional analysis based on the securities trading activities undertaken by a person, not the type of security traded.” In the adopting release for the new rules, the SEC observed that “certain persons engaging in crypto asset securities transactions may be operating as dealers as defined under the Exchange Act.” The SEC noted that the new rules apply “irrespective of where, or the technology through which, the security or government security trades.” Thus, the SEC determined that “regardless of the technology used, if a person meets the expressing trading and primary revenue factors in the final rules, the application of the dealer regulatory regime to that person’s activities will be beneficial and critical to promoting the Commission’s mission.”

Because the SEC asserts that most digital assets are securities, parties transacting in cryptocurrencies who previously relied on the trader exemption will need to review their business models to determine whether the new rules apply. The SEC and FINRA have sparingly granted approvals to digital asset trading businesses seeking to become licensed as brokers-dealers, which may present challenges to crypto businesses seeking to register as dealers in light of the new rules. The new rules also declined to provide an exemption for decentralized finance, or DeFi, trading protocols, and it is also unclear who bears the burden of registration on a decentralized platform.

The new rules take effect 60 days after publication in the Federal Register, with compliance required one year after that date.

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