Although not included in the SEC's release on its vote or on the proposed rule amendment, it appears that the SEC is also considering seeking congressional approval of amendments to the definition of the term "dealer" contained in Section 3(a)(5) of the Exchange Act.
As the result of a recent series of proposed new and amended rules and regulations, firms whose business is proprietary trading in the financial markets—such as so-called "high frequency traders" (HFT)—may become subject to an entirely new substantive regulatory landscape, including registration as a broker/dealer with the U.S. Securities and Exchange Commission (SEC) and membership in the Financial Industry Regulatory Authority (FINRA).
Although most, but not all, proprietary trading firms are already required to register as broker-dealers (BD) with the SEC, they have historically been exempt from the requirement that they also become members of a "national securities association," of which there is only one: FINRA. Rule 15b9-1 under the Securities Exchange Act of 1934, as amended, (the "Exchange Act") exempts BDs that are members of one or more national securities exchanges and whose business is conducted entirely on such exchanges (other than a very small amount of non-exchange business) from having to join FINRA. Most proprietary trading firms have no customers and are able to conduct their business in a way to take advantage of that exemption.
On March 25, 2015, the SEC voted to amend Rule 15b9-1 in a manner that would require broker-dealers whose business is proprietary trading to become members of FINRA. While an exemption would remain for a limited number of firms that truly engage in no other substantive business than trading on exchanges of which they are a member and in limited trading elsewhere solely for the purpose of hedging their exchange-traded positions, the intent of the amendment would be to require proprietary trading firms to join FINRA—thereby becoming subject to its rules and regulations, as well as its examination, inspection and disciplinary processes.
Although not included in the SEC's release on its vote or on the proposed rule amendment, it appears that the SEC is also considering seeking congressional approval of amendments to the definition of the term "dealer" contained in Section 3(a)(5) of the Exchange Act. That definition currently provides: "The term 'dealer' means any person engaged in the business of buying and selling securities … for such person's own account through a broker or otherwise."
However, a distinction has been made for persons who trade for their own account in securities as a "trader" but who are not engaged "in the business of" buying and selling securities. Although several bright-line tests can determine whether one is a dealer and required to register, or a trader and not required to register, the most common one is membership on one or more securities exchanges or other trading and/or execution facilities.
The SEC may determine that the definition does not require amendment in order to conclude that all firms that trade for their own accounts and are HFT fall within the definition of "dealer" under the existing section. In that event, the SEC could issue an interpretation to that effect or adopt a conforming rule. Regardless, it appears the intention of the SEC is to ensure that all persons and entities that engage in proprietary trading through HFT register as a BD and become members of FINRA and subject to its regulatory jurisdiction.
At virtually the same time that the SEC announced its proposed rule amendments, FINRA issued a number of notices of proposed or amended rulemaking that would likely impact proprietary trading firms.
In Regulatory Notice 15-09 (March 26, 2015), FINRA issued guidance on what it deems to be minimum standards of "Supervision and Control Practices for Algorithmic Trading Systems." Among the subjects covered by the notice are:
- General Risk Assessment and Response,
- Software/Code Development and Implementation,
- Software Testing and System Validation,
- Trading Systems and
Each subject, in turn, covers a number of regulatory requirements and proposed standards.
On March 19, 2015, FINRA solicited comments on a proposed rule amendment that would require specific registration (including an examination requirement) of associated persons of a BD "Involved in the Development or Significant Modification of Algorithmic Trading Systems." That amendment would require substantially all IT personnel and firm proprietary traders who develop, review, customize or otherwise employ algorithmic trading programs or systems to register as such with FINRA.
If adopted and approved, the proposed regulatory actions described above may significantly impact how proprietary trading firms conduct and manage their businesses.
For Further Information
If you have any questions about this Alert, please contact Robert P. Bramnik, any member of our Broker-Dealer & Securities Regulation Practice Group or the attorney in the firm with whom you are regularly in contact.
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