SEC narrows securities association membership exemptions for firms trading off exchange
24 August 2023 US
Image: AdobeStock/qingwa
The Securities and Exchange Commission (SEC) has introduced rule changes that seek to limit exemptions for US broker-dealer firms from the requirement to register with a national securities association.
Outlining the need for these amendments, SEC chair Gary Gensler indicates that some broker-dealers continue to rely on exemptions from national securities association registration that are “older than the cell phone era”.
“This has led to a regulatory gap where a number of firms that have cross-market, monthly trading volume valued in hundreds of billions of dollars are exempt from national securities association oversight,” Gensler adds.
The amendments aim to tighten and update the conditions where broker-dealers do not need to register with a national securities association — particularly for proprietary trading firms that are trading off-exchange.
These provisions relate particularly to Section 15(b)(8) of the Securities Exchange Act of 1934, which requires broker-dealers to become NSA members to conduct off-exchange trades.
However, exemptions exist under Section 15b9-1 of the 1934 Act where broker-dealers may engage in unlimited proprietary trading off exchange or on a US exchange where they do not hold membership.
Under the rule changes, the SEC will introduce a narrower set of exemptions. This will apply to broker-dealers that do not carry customer accounts and for trade orders that are posted solely to execute the stock leg of a stock option order. This will also apply to orders routed via a national securities exchange to fulfil order protection regulatory requirements.
Opinion appears to be divided across SEC Commissioners regarding the potential value of these changes.
Commissioner Hester M. Peirce says that the release fails to make a persuasive case that the best way to address the SEC’s concerns is “to subject firms that have no customers and that provide valuable liquidity to the same SRO that oversees broker-dealers that perform very different functions in these markets”.
“It is tautologically true that subjecting these firms to FINRA oversight will make it easier for FINRA to oversee them,” says Peirce. However, this does not explain why these firms should be regulated by FINRA, as opposed to direct regulation and oversight by the SEC.
“The release asserts that FINRA has expertise in overseeing off-member-exchange activity of broker-dealers, but it never offers any convincing explanation why the Commission itself cannot perform this oversight function,” says Peirce.
Commissioner Mark T. Uyeda suggests that non-FINRA member firms may have lower regulatory costs than FINRA member firms, which may give non-FINRA member firms a competitive advantage in providing liquidity in equities, options, and fixed income markets.
“As such, non-FINRA member firms may be able to provide liquidity at a lower cost than FINRA member firms, given that non-FINRA member firms have a lower variable cost, all else equal, for trading compared to FINRA member firms,” says Uyeda.
Commissioner Caroline A. Crenshaw observes that changes are needed to ensure regulatory oversight keeps pace with the changing personality of the US securities trading. “Today, little trading in US securities markets is floor-based and broker-dealer firms no longer trade primarily on a single exchange,” she says.
“To the contrary, securities trading has evolved to be highly automated, significantly more complex, and to take place across many trading centres — this includes trading across 24 registered exchanges as well as a multitude of off-exchange venues such as alternative trading systems and over-the-counter market makers.”
Nevertheless, Crenshaw argues, Rule 15b9-1 has remained static as these types of firms have multiplied and securities trading has proliferated off-member exchange. “As a result, firms effecting significant securities transaction volume off-member-exchange have continued to rely on this historic carve out — now functioning as more of a loophole — to avoid being subject to FINRA’s jurisdiction and, thus, its rules.”
To address this discrepancy, Crenshaw proposes that the amendments will help to ensure that FINRA has direct, membership-based oversight over broker-dealers that effect securities transactions off-member-exchange, as well as the jurisdiction to directly enforce their compliance with federal securities laws, SEC and FINRA rules.
Outlining the need for these amendments, SEC chair Gary Gensler indicates that some broker-dealers continue to rely on exemptions from national securities association registration that are “older than the cell phone era”.
“This has led to a regulatory gap where a number of firms that have cross-market, monthly trading volume valued in hundreds of billions of dollars are exempt from national securities association oversight,” Gensler adds.
The amendments aim to tighten and update the conditions where broker-dealers do not need to register with a national securities association — particularly for proprietary trading firms that are trading off-exchange.
These provisions relate particularly to Section 15(b)(8) of the Securities Exchange Act of 1934, which requires broker-dealers to become NSA members to conduct off-exchange trades.
However, exemptions exist under Section 15b9-1 of the 1934 Act where broker-dealers may engage in unlimited proprietary trading off exchange or on a US exchange where they do not hold membership.
Under the rule changes, the SEC will introduce a narrower set of exemptions. This will apply to broker-dealers that do not carry customer accounts and for trade orders that are posted solely to execute the stock leg of a stock option order. This will also apply to orders routed via a national securities exchange to fulfil order protection regulatory requirements.
Opinion appears to be divided across SEC Commissioners regarding the potential value of these changes.
Commissioner Hester M. Peirce says that the release fails to make a persuasive case that the best way to address the SEC’s concerns is “to subject firms that have no customers and that provide valuable liquidity to the same SRO that oversees broker-dealers that perform very different functions in these markets”.
“It is tautologically true that subjecting these firms to FINRA oversight will make it easier for FINRA to oversee them,” says Peirce. However, this does not explain why these firms should be regulated by FINRA, as opposed to direct regulation and oversight by the SEC.
“The release asserts that FINRA has expertise in overseeing off-member-exchange activity of broker-dealers, but it never offers any convincing explanation why the Commission itself cannot perform this oversight function,” says Peirce.
Commissioner Mark T. Uyeda suggests that non-FINRA member firms may have lower regulatory costs than FINRA member firms, which may give non-FINRA member firms a competitive advantage in providing liquidity in equities, options, and fixed income markets.
“As such, non-FINRA member firms may be able to provide liquidity at a lower cost than FINRA member firms, given that non-FINRA member firms have a lower variable cost, all else equal, for trading compared to FINRA member firms,” says Uyeda.
Commissioner Caroline A. Crenshaw observes that changes are needed to ensure regulatory oversight keeps pace with the changing personality of the US securities trading. “Today, little trading in US securities markets is floor-based and broker-dealer firms no longer trade primarily on a single exchange,” she says.
“To the contrary, securities trading has evolved to be highly automated, significantly more complex, and to take place across many trading centres — this includes trading across 24 registered exchanges as well as a multitude of off-exchange venues such as alternative trading systems and over-the-counter market makers.”
Nevertheless, Crenshaw argues, Rule 15b9-1 has remained static as these types of firms have multiplied and securities trading has proliferated off-member exchange. “As a result, firms effecting significant securities transaction volume off-member-exchange have continued to rely on this historic carve out — now functioning as more of a loophole — to avoid being subject to FINRA’s jurisdiction and, thus, its rules.”
To address this discrepancy, Crenshaw proposes that the amendments will help to ensure that FINRA has direct, membership-based oversight over broker-dealers that effect securities transactions off-member-exchange, as well as the jurisdiction to directly enforce their compliance with federal securities laws, SEC and FINRA rules.
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