[Federal Register Volume 89, Number 41 (Thursday, February 29, 2024)]
[Rules and Regulations]
[Pages 14938-15010]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-02837]



[[Page 14937]]

Vol. 89

Thursday,

No. 41

February 29, 2024

Part II





Securities and Exchange Commission





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17 CFR Part 240





Further Definition of ``As a Part of a Regular Business'' in the 
Definition of Dealer and Government Securities Dealer in Connection 
With Certain Liquidity Providers; Final Rule

  Federal Register / Vol. 89 , No. 41 / Thursday, February 29, 2024 / 
Rules and Regulations  

[[Page 14938]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-99477; File No. S7-12-22]
RIN 3235-AN10


Further Definition of ``As a Part of a Regular Business'' in the 
Definition of Dealer and Government Securities Dealer in Connection 
With Certain Liquidity Providers

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or 
``Commission'') is adopting new rules to further define the phrase ``as 
a part of a regular business'' as used in the statutory definitions of 
``dealer'' and ``government securities dealer'' under sections 3(a)(5) 
and 3(a)(44), respectively, of the Securities Exchange Act of 1934 
(``Exchange Act'').

DATES: 
    Effective date: April 29, 2024.
    Compliance date: The compliance date is discussed in section II.B 
of this release.

FOR FURTHER INFORMATION CONTACT: Emily Westerberg Russell, Chief 
Counsel; John Fahey, Deputy Chief Counsel; Joanne Rutkowski, Assistant 
Chief Counsel; Bonnie Gauch, Senior Special Counsel; Shauna Sappington 
Vlosich, Senior Special Counsel; Geeta Dhingra, Branch Chief; Katherine 
Lesker, Special Counsel; and Carl Emigholz, Special Counsel at 202-551-
5550 in the Office of Chief Counsel, Division of Trading and Markets, 
Securities and Exchange Commission, 100 F Street NE, Washington, DC 
20549-7010.

SUPPLEMENTARY INFORMATION: The Commission is adopting the following new 
rules under the Exchange Act: (1) 17 CFR 240.3a5-4 (``Rule 3a5-4''), 
and (2) 17 CFR 240.3a44-2 (``Rule 3a44-2'') (collectively, ``final 
rules'').

Table of Contents

I. Introduction
    A. Background
    B. Overview of the Final Rules and Modifications to the Proposal
II. Discussion of Final Rules
    A. Component Parts
    1. Qualitative Standard
    a. Elimination of the Proposed First Qualitative Factor
    b. Expressing Trading Interest Factor
    c. Primary Revenue Factor
    2. Quantitative Standard
    3. Exclusions
    a. Person That Has or Controls Assets of Less Than $50 Million
    b. Registered Investment Companies, Private Funds, and 
Registered Investment Advisers
    c. Official Sector Exclusions
    d. Other Requests for Exclusions
    4. Definitions and Anti-Evasion
    5. No Presumption
    B. Compliance Date
III. Economic Analysis
    A. Introduction
    B. Baseline
    1. Rules and Regulations That Apply to Registered Dealers
    2. Affected Parties
    a. Principal Traders
    b. Private Funds and Advisers
    c. Number of Affected Parties
    3. Competition Among Significant Liquidity Providers
    4. Externalities
    C. Economic Effects, Including Impact on Efficiency, 
Competition, and Capital Formation
    1. Benefits
    a. Regulatory Consistency and Competition
    b. Regulations on Financial and Operational Risk-Taking
    c. Regulations on Reporting
    d. Regulations on Deceptive Practices
    e. Regulations Related to Examinations
    2. Costs
    a. Compliance Costs
    b. Costs Associated With the Net Capital Rule
    c. Potential Implications for Private Funds and Advisers
    d. Effects on Market Liquidity
    3. Effects on Efficiency, Competition, and Capital Formation
    a. Effects on Efficiency
    b. Effects on Competition
    c. Effects on Capital Formation
    D. Reasonable Alternatives
    1. Retain the Quantitative Standard
    2. Retain the First Qualitative Standard (e.g., ``Routinely 
Making Roughly Comparable Purchases and Sales of the Same or 
Substantially Similar Securities [or Government Securities] in a 
Day'')
    3. Remove the Exclusion for Registered Investment Companies
    4. Exclude Registered Investment Advisers and Private Funds
    5. Require Registered Investment Advisers and Private Funds To 
Report to TRACE
    6. Carve Out or Narrow Application to Crypto Asset Securities
IV. Paperwork Reduction Act
V. Regulatory Flexibility Act
VI. Other Matters
Statutory Authority

I. Introduction

    The dealer regulatory regime is a cornerstone of the U.S. Federal 
securities laws and helps to promote the Commission's longstanding 
mission to protect investors, maintain fair, orderly, and efficient 
markets, and facilitate capital formation.\1\ Advancements in 
electronic trading across securities markets have led to the emergence 
of certain market participants that play an increasingly significant 
liquidity-providing role in overall trading and market activity--a role 
that has traditionally been performed by entities regulated as 
dealers.\2\ However, some of these market participants--despite 
engaging in liquidity-providing activities similar to those 
traditionally performed by either ``dealers'' or ``government 
securities dealers'' as defined under sections 3(a)(5) and 3(a)(44) of 
the Exchange Act, respectively, and despite their significant share of 
market volume--are not registered with the Commission as either dealers 
or government securities dealers under sections 15 and 15C of the 
Exchange Act, respectively. The identification, registration, and 
regulation of these market participants as dealers will provide 
regulators with a more comprehensive view of the markets through 
regulatory oversight and will support market stability and resiliency 
and protect investors by promoting the financial responsibility and 
operational integrity of market participants that are acting as 
dealers.\3\ Further, the final rules will promote competition among 
entities that regularly provide significant liquidity by applying 
consistent regulation to these entities, thus leveling the competitive 
playing field between liquidity provision conducted by entities that 
are currently registered as dealers and government securities dealers 
and by entities that are not.
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    \1\ See, e.g., Eastside Church of Christ v. National Plan, Inc., 
391 F.2d 357 (5th Cir. 1968) (``The requirement that brokers and 
dealers register is of the utmost importance in effecting the 
purposes of the Act. It is through the registration requirement that 
some discipline may be exercised over those who may engage in the 
securities business and by which necessary standards may be 
established with respect to training, experience, and records.''); 
see also section 2 of the Exchange Act, 15 U.S.C. 78b (stating that 
``transactions in securities as commonly conducted upon securities 
exchanges and over-the-counter markets are effected with a national 
public interest which makes it necessary to provide for regulation 
and control of such transactions and of practices and matters 
related thereto'').
    \2\ See Further Definition of ``As a Part of a Regular 
Business'' in the Definition of Dealer and Government Securities 
Dealer, Exchange Act Release No. 94524 (Mar. 28, 2022), 87 FR 23054 
(Apr. 18, 2022) (``Proposing Release'').
    \3\ See section III.
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    The Federal securities laws provide a comprehensive system of 
regulation of securities activity, and the definition of ``dealer'' is 
one of the Exchange Act's most important definitions, as it sets forth 
certain activities that cause persons to fall within the Commission's 
regulatory ambit.\4\ Section 3(a)(5) of the Exchange Act defines the 
term ``dealer'' to mean ``any person engaged in the

[[Page 14939]]

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.'' Similarly, section 3(a)(44) of the Exchange Act provides, 
in relevant part, that the term ``government securities dealer'' means 
``any person engaged in the business of buying and selling government 
securities for his own account, through a broker or otherwise,'' but 
``does not include any person insofar as he buys or sells such 
securities for his own account, either individually or in some 
fiduciary capacity, but not as part of a regular business.'' These 
statutory definitions of ``dealer'' and ``government securities 
dealer,'' and the accompanying registration requirements of the 
Exchange Act, were drawn broadly by Congress to encompass a wide range 
of activities involving the securities markets and their 
participants.\5\ Market participants that meet these statutory 
definitions are required to register with the Commission and are 
subject to a panoply of regulatory obligations and supervisory 
oversight, unless an exemption or exception applies.\6\
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    \4\ See supra note 1; see also Roth v. SEC, 22 F.3d 1108, 1109 
(D.C. Cir. 1994).
    \5\ Unless otherwise indicated, references to ``dealer'' 
activity apply both with respect to ``dealers'' and ``government 
securities dealers'' under sections 3(a)(5) and 3(a)(44) of the 
Exchange Act, respectively; and references to ``security'' apply 
both with respect to ``security'' and ``government security'' under 
sections 3(a)(10) and 3(a)(42) of the Exchange Act, respectively. 
See Proposing Release at 23057 (Congress defined ``dealer'' broadly 
``to encompass a wide range of activities involving investors and 
securities markets.''); Registration Requirements for Foreign Broker 
Dealers, Exchange Act Release No. 27017 (July 11, 1989), 54 FR 
30013, 30015 (July 18, 1989) (``Foreign Broker Dealer Adopting 
Release'').
    \6\ See Proposing Release at 23057; Foreign Broker Dealer 
Adopting Release at 30015.
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    Under the Exchange Act, the SEC has the authority to define the 
terms used in the statutory definitions of ``dealer'' and ``government 
securities dealer,'' and to oversee and regulate registered dealers.\7\ 
The Commission is adopting new Rules 3a5-4 and 3a44-2 under the 
Exchange Act to further define what it means to be engaged in the 
business of buying and selling securities ``as a part of a regular 
business'' within the definitions of ``dealer'' and ``government 
securities dealer,'' respectively.\8\ The final rules, which have been 
modified to narrow the scope of the proposed rules and carefully 
tailored in response to commenter concerns, will help to ensure that 
market participants that take on significant liquidity-providing roles 
are appropriately registered and regulated as dealers and government 
securities dealers. As discussed further below, the final rules are one 
way to establish that a person is a dealer or government securities 
dealer; otherwise applicable court precedent and Commission 
interpretations will continue to apply.\9\
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    \7\ See, e.g., Exchange Act section 3(b) (authorizes the SEC to 
define terms used in the Exchange Act, consistent with the 
provisions and purposes of the Exchange Act. 15 U.S.C. 78c(b)).
    \8\ On Mar. 28, 2022, the Commission voted to issue the proposed 
17 CFR 240.3a5-4 (``proposed Rule 3a5-4'') and 240.3a44-2 
(``proposed Rule 3a44-2'') (collectively, ``proposed rules'') to 
further define ``as a part of a regular business'' as that phrase is 
used in the statutory definitions of ``dealer'' and ``government 
securities dealer.'' See Proposing Release. The release was posted 
on the Commission website that day, and comment letters were 
received beginning that same date. The comment period closed on May 
27, 2022. Comments are available here: https://www.sec.gov/comments/s7-12-22/s71222.htm. We have considered all comments received since 
Mar. 28, 2022.
    \9\ See 17 CFR 240.3a5-4(c) (``Rule 3a5-4(c)'') and 240.3a44-
2(c) (``Rule 3a44-2(c)'') (providing that no presumption shall arise 
that a person is not a dealer or government securities dealer solely 
because that person does not satisfy the standards of the final 
rules). As discussed in the Proposing Release and below, the courts 
and the Commission look to an array of factors in determining 
whether someone is a ``dealer'' within the meaning of the statute. 
See, e.g., Definition of Terms in and Specific Exemption for Banks, 
Savings Associations, and Savings Banks Under Sections 3(a)(4) and 
3(a)(5) of the Securities Exchange Act of 1934, Exchange Act Release 
No. 46745 (Oct. 30, 2002), 67 FR 67496, 67498-67500 (Nov. 5, 2002) 
(``2002 Release''); see also section II.A.5 (explaining that 
otherwise applicable interpretations and precedent continue to apply 
to determine whether a person is acting as a dealer, even when that 
person does not fall within the requirements of the new rules); 
section II.A.3 (explaining that the $50 million threshold is not an 
exclusion from the ``dealer'' definition for all purposes, but only 
for purposes of the new rules).
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    Registration will enable more comprehensive regulatory oversight of 
securities markets and those participants that take on significant 
liquidity-providing roles. The final rules will support market 
stability and resiliency and protect investors by promoting the 
financial responsibility and operational integrity of significant 
liquidity providers that are acting as dealers in the securities 
markets.\10\
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    \10\ Section III below describes the estimated benefits and 
costs associated with registering as a dealer or government 
securities dealer for those persons who meet the qualitative 
standard of the final rules.
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A. Background

    The statutory definition of ``dealer'' in section 3(a)(5) and the 
accompanying registration requirements of the Exchange Act were drawn 
broadly by Congress in 1934 to encompass a wide range of activities 
involving the securities markets and their participants. 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.'' \11\ This statutory 
exclusion from the definition of ``dealer'' is often referred to as the 
``trader'' exception.\12\ Absent an exception or an exemption, section 
15(a)(1) of the Exchange Act makes it unlawful for a ``dealer'' to 
effect any transactions in, or to induce or attempt to induce the 
purchase or sale of, any security unless registered with the Commission 
in accordance with section 15(b) of the Exchange Act.\13\ Similarly, 
section 3(a)(44) of the Exchange Act provides, in relevant part, that 
the term ``government securities dealer'' means ``any person engaged in 
the business of buying and selling government securities for his own 
account, through a broker or otherwise,'' but ``does not include any 
person insofar as he buys or sells such securities for his own account, 
either individually or in some fiduciary capacity, but not as part of a

[[Page 14940]]

regular business.'' \14\ Read together, these provisions identify a 
``government securities dealer'' as a person engaged in the business of 
buying and selling government securities for its own account as part of 
a regular business. Section 15C of the Exchange Act makes it unlawful 
for a ``government securities dealer'' (other than a registered broker-
dealer or financial institution) to induce or attempt to induce the 
purchase or sale of any government security unless such government 
securities dealer is registered in accordance with section 
15C(a)(2).\15\
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    \11\ See sections 3(a)(5)(A) and (B) of the Exchange Act, 15 
U.S.C. 78c(a)(5)(A) and (B). The definition of ``dealer'' in the 
Exchange Act is largely unchanged from its enactment in 1934. Until 
the Gramm-Leach-Bliley Act (``GLBA'') was enacted in 1999, banks 
were excluded from the definition of ``dealer.'' The GLBA added 
section 3(a)(5)(C) of the Exchange Act to create a series of 
functional exemptions from the statutory definition of dealer. The 
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 
(``Dodd-Frank Act'') further amended section 3(a)(5)(A) of the 
Exchange Act to exclude from the dealer definition persons engaged 
in the business of buying and selling security-based swaps, other 
than security-based swaps with or for persons that are not eligible 
contract participants. The Dodd-Frank Act established a statutory 
framework for regulating security-based swaps that includes the 
registration and regulation of security-based swap dealers.
    \12\ See 2002 Release (explaining that ``a person that is buying 
securities for its own account may still not be a `dealer' because 
it is not `engaged in the business' of buying and selling securities 
for its own account as part of a regular business,'' and that 
``[t]his exclusion is often referred to as the dealer/trader 
distinction'').
    \13\ A bank engaged in these activities with respect to 
government securities would not register with the Commission as a 
dealer. See Exchange Act section 3(a)(5)(C)(i)(II) (providing an 
exception from dealer status when a bank buys or sells exempted 
securities, which are defined in Exchange Act section 3(a)(12)(A) to 
include government securities); see also Exchange Act section 
3(a)(6) (definition of ``bank''). A bank may nonetheless be a 
government securities dealer under section 3(a)(44). As such, it 
would not register with the Commission but instead would provide 
written notice of its government securities dealer status with the 
appropriate Federal banking regulator.
    \14\ 15 U.S.C. 78c(a)(44). Congress added the definition of 
``government securities dealer'' to the Exchange Act in the 
Government Securities Act of 1986 (``GSA''). Public Law 99-571, 100 
Stat. 3208 (Oct. 28, 1986). In addition to otherwise applicable 
regulations, government securities dealers must comply with rules 
adopted by the Treasury. See regulations under section 15C of the 
Securities Exchange Act of 1934, 17 CFR 400.1(b), available at 
https://www.govinfo.gov/content/pkg/CFR-2018-title17-vol4/pdf/CFR-2018-title17-vol4.pdf. These regulations address financial 
responsibility, protection of customer securities and funds, 
recordkeeping, and financial reporting and audits. Also included are 
rules concerning custodial holdings of government securities by 
depository institutions. The Commission retains broad antifraud 
authority over banks that are government securities dealers. Soon 
after enactment of the GSA, the staff issued a series of no-action 
letters to persons seeking assurances that the staff would not 
recommend enforcement action if they did not register as government 
securities dealers. See, e.g., Bankers Guarantee Title & Trust Co., 
SEC No-Action Letter (Jan. 22, 1991); Bank of America, Canada, SEC 
No-Action Letter (May 1, 1988); Citicorp Homeowners, Inc., SEC No-
Action Letter (Oct. 7, 1987); Fairfield Trading Corp., SEC No-Action 
Letter (Dec. 10, 1987); Louis Dreyfus Corp., SEC No-Action Letter 
(July 23, 1987); United Savings Association of Texas, SEC No-Action 
Letter (Apr. 2, 1987); Continental Grain Co., SEC No-Action Letter 
(Nov. 28, 1987). Staff reports, Investor Bulletins, and other staff 
documents (including those cited herein) represent the views of 
Commission staff and are not a rule, regulation, or statement of the 
Commission. The Commission has neither approved nor disapproved the 
content of these staff documents and, like all staff statements, 
they have no legal force or effect, do not alter or amend applicable 
law, and create no new or additional obligations for any person. 
Staff in the Division of Trading and Markets is reviewing its no-
action letters and other staff statements that address the Exchange 
Act's definition of ``dealer'' or ``government securities dealer'' 
to determine which letters and other staff statements, or portions 
thereof, should be withdrawn in connection with the adoption of the 
final rules. Some of these letters and staff statements, or portions 
thereof, may be moot, superseded, or otherwise inconsistent with the 
final rules, and, therefore, may be withdrawn by the staff. A list 
of the letters to be withdrawn will be available on the Commission's 
website.
    \15\ A government securities dealer that is a registered dealer 
or a financial institution must file notice with the appropriate 
regulatory agency that it is a government securities dealer. See 15 
U.S.C. 78o-5(a). Exchange Act section 3(a)(46) defines the term 
``financial institution'' to include: (i) a bank (as that term is 
defined in Exchange Act section 3(a)(6) (15 U.S.C. 38c(a)(6)); (ii) 
a foreign bank (as that term is used in the International Banking 
Act of 1978); and (iii) a savings association (as defined in section 
3(b) of the Federal Deposit Insurance Act, the deposits of which are 
insured by the Federal Deposit Insurance Corporation). See 15 U.S.C. 
78c(a)(46)(A) through (C).
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    The Commission has long identified factors that would be 
informative for determining whether a person is a dealer. For example, 
the Commission's 2002 Release states that ``[a] person generally may 
satisfy the definition, and therefore, be acting as a dealer in the 
securities markets by conducting various activities: (1) underwriting; 
(2) acting as a market maker or specialist on an organized exchange or 
trading system; (3) acting as a de facto market maker whereby market 
professionals or the public look to the firm for liquidity; or (4) 
buying and selling directly to securities customers together with 
conducting any of an assortment of professional market activities such 
as providing investment advice, extending credit and lending securities 
in connection with transactions in securities, and carrying a 
securities account.\16\ These principles demonstrate that the analysis 
of whether a person meets the definition of a dealer depends upon all 
of the relevant facts and circumstances.'' \17\
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    \16\ 2002 Release at 67498-67500.
    \17\ See id.; see also Proposing Release at 23058-59.
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    In recent years, market participants regularly engaging in 
significant liquidity provision have not registered, either as 
``dealers'' under section 15 of the Exchange Act or ``government 
securities dealers'' under section 15C of the Exchange Act.\18\ This is 
particularly true in the U.S. Treasury market where certain market 
participants, particularly those commonly known as proprietary or 
principal trading firms (``PTFs''), account for about half of the daily 
volume in the interdealer market and yet are not registered as 
dealers--despite performing critical market functions, in particular 
liquidity provision, that historically have been performed by 
dealers.\19\ The Commission recognizes that, depending on their 
business models, PTFs may not engage in certain types of dealer 
activities. Some may not, for example, underwrite securities, solicit 
clients, provide investment advice, carry accounts for others, or 
extend credit, and so may not implicate principle (1), (2), or (4) as 
discussed in the 2002 Release. The Commission is concerned, however, 
that some PTFs act as de facto market makers but do so without 
registration.\20\ Such a regulatory gap results in inconsistent 
oversight of market participants performing similar functions (whether 
in the same market or across asset classes). This limited regulatory 
oversight of significant liquidity providers increases the difficulty 
and complexity for regulators to investigate, understand, and address 
significant market events.\21\ As a result,

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investors and the markets currently lack important protections.
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    \18\ See Proposing Release at 23081.
    \19\ Nellie Liang and Pat Parkinson, Hutchins Center Working 
Paper #72, Enhancing Liquidity of the U.S. Treasury Market Under 
Stress (Dec. 16, 2020), at 6. The term ``PTF'' is not defined in the 
securities laws. PTFs trade as principals, buying and selling for 
their own accounts, and often employ automated, algorithmic trading 
strategies (including passive market making, arbitrage, and 
structural and directional trading) that rely on speed, which allows 
them to quickly execute trades, or cancel or modify quotes in 
response to perceived market events. See Proposing Release at 23055. 
See also Joint Staff Report: The U.S. Treasury Market on Oct. 15, 
2014 (July 13, 2015) (``2015 Joint Staff Report''), prepared by 
staff of the U.S. Department of the Treasury, Board of Governors of 
the Federal Reserve System, Federal Reserve Bank of New York, U.S. 
Securities and Exchange Commission, and U.S. Commodity Futures 
Trading Commission, available at https://www.sec.gov/reportspubs/specialstudies/treasury-market-volatility-10-14-2014-joint-report.pdf. The 2015 Joint Staff Report is a report of the Inter-
Agency Working Group for Treasury Market Surveillance (``IAWG''). In 
contrast, many equity market participants may already be registered 
in order to take advantage of certain incentives offered only to 
exchange members. See Exchange Act section 6(c)(1) (requiring a 
national securities exchange to deny membership to any person that 
is not a registered broker or dealer or, if a natural person, 
associated with a registered broker or dealer).
    \20\ The significant role played by market participants not 
registered as dealers distinguishes the Treasury market from other 
markets where these types of participants are more typically 
registered as dealers. One commenter stated that it understood 
``from its member firms that one of the effects of the Market Access 
Rule is that many previously unregistered PTFs operating in the 
equity and options markets became registered as broker-dealers due 
to their business need to submit their orders directly into the 
market without having to first run them through the risk controls of 
other broker-dealers,'' and that the Proposing Release did not 
address this market development. See Comment Letter of Securities 
Industry and Financial Markets Association (May 27, 2022) (``SIFMA 
Comment Letter I''); see also 17 CFR 240.15c3-5 (``Rule 15c3-5'' or 
``Market Access Rule'') (requiring broker-dealers with market access 
to establish, document, and maintain a system of risk management 
controls and supervisory procedures reasonably designed to manage 
financial, regulatory, and other risks of this business activity). 
As explained in the Proposing Release, it is the Commission's 
understanding that in the equity markets, because PTF trading 
strategies typically depend on latency and cost advantages made 
possible by trading directly (via membership) on a national 
securities exchange, and the Exchange Act limits exchange membership 
to registered broker-dealers, there is incentive for many PTFs to 
register as broker-dealers to gain these advantages. In the U.S. 
Treasury market, however, where trading occurs on alternative 
trading systems (``ATSs'') and other non-exchange venues, PTFs lack 
this incentive to register. See Proposing Release at 23072-73. See 
also Exchange Act section 6(c)(1) (``A national securities exchange 
shall deny membership to (A) any person, other than a natural 
person, which is not a registered broker or dealer or (B) any 
natural person who is not, or is not associated with, a registered 
broker or dealer.'').
    \21\ See, e.g., Inter-Agency Working Group for Treasury Market 
Surveillance Joint Staff Report, Recent Disruptions and Potential 
Reforms in the U.S. Treasury Market: A Staff Progress Report 
prepared by U.S. Department of the Treasury, Board of Governors of 
the Federal Reserve System, Federal Reserve Bank of New York, U.S. 
Securities and Exchange Commission, U.S. Commodity Futures Trading 
Commission (Nov. 8, 2021) (``2021 IAWG Joint Staff Report'') 
(describing Mar. 2020 COVID-19 and Oct. 15, 2014, flash rally 
disruptions to the Treasury market). See also supra note 18 and 
accompanying text.
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    Courts have repeatedly recognized the requirement that dealers 
register as being ``of the utmost importance in effecting the purposes 
of the Exchange Act.'' \22\ Dealers generally must register with the 
Commission and become members of a self-regulatory organization 
(``SRO''); \23\ comply with Commission and SRO rules, including certain 
financial responsibility and risk management rules,\24\ transaction and 
other reporting requirements,\25\ operational integrity rules,\26\ and 
books and records requirements,\27\ all of which help to enhance market 
stability by giving regulators increased insight into firm-level and 
aggregate trading activity and so help regulators to evaluate, assess, 
and address market risks. In addition, registered dealers and 
government securities dealers are required to comply with all 
applicable securities laws, including not only section 17(a) of the 
Securities Act of 1933 (``Securities Act'') and section 10(b) of the 
Exchange Act but also specialized anti-manipulative and other antifraud 
rules promulgated pursuant to section 15(c) of the Exchange Act.\28\ 
These regulatory requirements provide fundamental protections that 
contribute to fair and orderly markets. Firms that are government 
securities dealers (including registered broker-dealers trading 
government securities) must also comply with rules adopted by the U.S. 
Treasury, including rules relating to financial responsibility, 
recordkeeping, financial condition reporting, and risk oversight.\29\ 
Importantly, dealers are

[[Page 14942]]

subject to Commission and SRO examination and enforcement for 
compliance with applicable Federal securities laws and SRO rules.\30\
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    \22\ Proposing Release at 23060-61; see also SEC v. Benger, 697 
F. Supp. 2d 932, 944 (N.D. Ill. 2010) (quoting Celsion Corp. v. 
Stearns Mgmt. Corp., 157 F. Supp. 2d 942, 947 (N.D. Ill. 2001) 
(section 15(a)'s registration requirement is ``of the utmost 
importance in effecting the purposes of the Act'' because it enables 
the SEC ``to exercise discipline over those who may engage in the 
securities business and it establishes necessary standards with 
respect to training, experience, and records.''); Roth v. SEC, 22 
F.3d 1108, 1109 (D.C. Cir. 1994) (``The broker-dealer registration 
requirement serves as the keystone of the entire system of broker-
dealer regulation.''); Regional Properties, Inc. v. Financial and 
Real Estate Consulting Co., 678 F.2d 552, 561 (5th Cir. June 3, 
1982); Eastside Church of Christ v. National Plan, Inc., 391 F.2d 
357, 361 (5th Cir. Mar. 12, 1968).
    \23\ See sections 15(b)(8), 15C(e)(1), and 17(b) of the Exchange 
Act, 15 U.S.C. 78o(b)(8), 15 U.S.C. 78o-5(e)(1), and 15 U.S.C. 
78q(b), respectively. Section 15(b)(8) of the Exchange Act makes it 
unlawful for any registered broker or dealer to effect any 
transaction in securities (with certain exceptions) unless the 
broker or dealer is a member of a registered securities association 
or effects transactions in securities solely on a national 
securities exchange of which it is a member. Section 15C(e)(1) of 
the Exchange Act requires that a registered government securities 
broker-dealer become a member of a registered national securities 
exchange or registered national securities association. Because 
government securities are not traded on registered national 
securities exchanges, a person that registers as a government 
securities dealer under section 15C to trade only government 
securities would generally need to become a member of a registered 
national securities association (FINRA is the only registered 
national securities association). The Commission recently adopted 
amendments to 17 CFR 240.15b9-1 (``Rule 15b9-1'') to replace rule 
provisions that provide an exemption for proprietary trading with 
narrower exemptions from national securities association membership 
for any registered broker or dealer that is a member of a national 
securities exchange, carries no customer accounts, and effects 
transactions in securities otherwise than on a national securities 
exchange of which it is a member. See 17 CFR 240.15b9-1; Exemption 
for Certain Exchange Members, Exchange Act Release No. 98202, Aug. 
23, 2023), 88 FR 61850 (Sept. 7, 2023) (``Amended Rule 15b9-1 
Adopting Release''). Section 17(b) of the Exchange Act provides, 
among other things, that all records of a broker-dealer are subject 
at any time, or from time to time, to such reasonable, periodic, 
special, or other examinations by representatives of the Commission 
and the appropriate regulatory agency of the broker-dealer as the 
Commission or the appropriate regulatory agency deems necessary or 
appropriate in the public interest, for the protection of investors, 
or otherwise in furtherance of the purposes of the Exchange Act.
    \24\ See, e.g., 17 CFR 240.15c3-1 (``Rule 15c3-1'' or ``Net 
Capital Rule''); Financial Responsibility Rules for Broker-Dealers, 
Exchange Act Release No. 70072 (July 30, 2013), 78 FR 51823 at 51849 
(Aug. 21, 2013) (``The capital standard in Rule 15c3-1 is a net 
liquid assets test. This standard is designed to allow a broker-
dealer the flexibility to engage in activities that are part of 
conducting a securities business (e.g., taking securities into 
inventory) but in a manner that places the firm in the position of 
holding at all times more than one dollar of highly liquid assets 
for each dollar of unsubordinated liabilities (e.g., money owed to 
customers, counterparties, and creditors)''). The rule imposes a 
``moment to moment'' net capital requirement in that broker-dealers 
must maintain an amount of net capital that meets or exceeds their 
minimal net capital requirement at all times.
    \25\ See, e.g., FINRA Rule 6730(a)(1) (requiring FINRA members 
to report transactions in TRACE-Eligible Securities, including 
Treasury securities, which promotes transparency to the securities 
markets, including the Treasury market, by providing market 
participants with comprehensive access to transaction data); FINRA 
Rule 7200 (Trade Reporting Facilities); FINRA Rule 4530 (Reporting 
Requirements) which requires FINRA members to report among other 
things when the member or an associated person of the member has 
violated certain specified regulatory requirements, is subject to 
written customer complaints, and is denied registration or is 
expelled, enjoined, directed to cease and desist, suspended or 
disciplined by a specified regulatory body. The provision at 17 CFR 
240.17a-5(d)(1)(i)(A) (``Rule 17a-5(d)(1)(i)(A)'') requires broker-
dealers, subject to limited exceptions, to file annual reports, 
including financial statements and supporting schedules that 
generally must be audited by a Public Company Accounting Oversight 
Board (``PCAOB'') registered independent public accountant in 
accordance with PCAOB standards. See also Consolidated Audit Trail, 
Exchange Act Release No. 62174 (May 26, 2010), 75 FR 32556 (June 8, 
2010); Joint Industry Plan; Order Approving the National Market 
System Plan Governing the Consolidated Audit Trail, Exchange Act 
Release No. 79318 (Nov. 15, 2016), 81 FR 84696 (Nov. 23, 2016) 
(``CAT Approval Order''); Joint Industry Plan; Notice of Filing of a 
National Market System Plan Regarding Consolidated Equity Market 
Data, Exchange Act Release No. 77724 (Apr. 27, 2016), 81 FR 30614 
(May 17, 2016) (``CAT Notice'').
    \26\ See, e.g., Market Access Rule (promotes market integrity by 
reducing risks associated with market access by requiring financial 
and regulatory risk management controls reasonably designed to limit 
financial exposures and ensure compliance with applicable regulatory 
requirements).
    \27\ See, e.g., section 17(a) of the Exchange Act and 17 CFR 
240.17a-3 (``Rule 17a-3'') and 240.17a-4 (``Rule 17a-4''); see also, 
e.g., FINRA Rules 2268, 4510, 4511, 4512, 4513, 4514, 4515, 5340, 
and 7440(a)(4) (requiring member firms to make and preserve certain 
books and records to show compliance with applicable securities 
laws, rules, and regulations and enable Commission and FINRA staffs 
to conduct effective examinations); NYSE Rule 440 (Books and 
Records); CBOE Exchange Rule 7.1 (Maintenance, Retention and 
Furnishing of Books, Records and Other Information). Among other 
things, Commission and SRO books and records rules help to ensure 
that regulators can access information to evaluate the financial and 
operational condition of the firm, including examining compliance 
with financial responsibility rules, among other rules, as well as 
assess whether and how a firm's participation in the securities 
markets impacted a major market event. See Staff Study on Investment 
Advisers and Broker-Dealers As Required by section 913 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) at 
72. See also Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers; Capital Rule for Certain Security-Based Swaps 
Dealers, Exchange Act Release No. 71958 (Apr. 17, 2014), 79 FR 
25194, 25199 (May 2, 2014) (``The requirements are an integral part 
of the investor protection function of the Commission, and other 
securities regulators, in that the preserved records are the primary 
means of monitoring compliance with applicable securities laws, 
including antifraud provisions and financial responsibility 
standards.'').
    \28\ See, e.g., sections 15(c)(1) and (2) of the Exchange Act, 
15 U.S.C. 78o(c)(1) and (2), and rules promulgated thereunder. 
Section 15(c) of the Exchange Act prohibits broker-dealers from 
effecting any transaction in securities by means of any 
manipulative, deceptive, or other fraudulent device or contrivance.
    \29\ Under Title I of the GSA, all government securities brokers 
and government securities dealers are required to comply with the 
requirements in Treasury's GSA regulations that are set out in 17 
CFR parts 400 through 449, as well as all other applicable 
requirements. For the most part, Treasury's GSA regulations 
incorporate with some modifications: (1) Commission rules for non-
financial institution government securities brokers and government 
securities dealers; and (2) the appropriate regulatory agency rules 
for financial institutions that are required to file notice as 
government securities brokers and government securities dealers. 
See, e.g., 17 CFR part 400, Rules of general application; 17 CFR 
part 401, Exemptions; 17 CFR part 402, Financial responsibility; 17 
CFR part 403, Protection of customer securities and balances; 17 CFR 
part 404, Recordkeeping and preservation of records; 17 CFR part 
405, Reports and audit; and 17 CFR part 449, Forms, section 15C of 
the Exchange Act. The GSA regulations also include requirements for 
custodial holdings by depository institutions at 17 CFR part 450, 
which were issued under Title II of the GSA. The Treasury GSA 
regulations provide in many instances that a registered dealer can 
comply with a Commission rule to establish compliance with the 
comparable Treasury requirement. See, e.g., 17 CFR 402.1(b) (``This 
part does not apply to a registered broker or dealer . . . that is 
subject to [Rule 15c3-1].''); 17 CFR 403.1 (regarding application to 
registered brokers or dealers); 17 CFR 404.1 and 17 CFR 405.1(a) 
(same).
    \30\ See Exchange Act section 15(b) (regarding Commission 
authority to sanction brokers and dealers); section 15C(c) 
(regarding Commission authority to sanction government securities 
dealers that are registered with it); section 15C(d) (authorizing 
the Commission to examine books and records of government securities 
dealers registered with it); and section 17(b) (broker-dealer 
recordkeeping and examination). See also section 15C(g) (restricting 
the authority of the Commission with respect to government 
securities dealers that are not registered with the Commission).
---------------------------------------------------------------------------

    On March 28, 2022, the Commission proposed Rules 3a5-4 and 3a44-2 
to identify certain activities that would constitute a ``regular 
business'' requiring a person engaged in certain liquidity-providing 
activities to register as a ``dealer'' or a ``government securities 
dealer,'' absent an exception or exemption.\31\ Proposed Rules 3a5-4 
and 3a44-2 were designed to define the types of activities that would 
cause a person to be regarded as a de facto market maker and therefore 
subject to registration as a dealer under sections 15 and 15C of the 
Exchange Act. Specifically, the proposed rules would have established 
three qualitative factors, as well as a quantitative standard 
applicable only with respect to government securities. The proposed 
rules also further defined the types of entities that would be included 
in and excluded from the ambit of the rules. The proposed rules focused 
only on the de facto market maker test, as emphasized through the 
inclusion of the ``no presumption'' language, which provided that the 
further definition of ``regular business,'' if adopted, would not seek 
to address all persons that may be acting as dealers under otherwise 
applicable interpretations and precedent.
---------------------------------------------------------------------------

    \31\ See Proposing Release; see also Exchange Act section 15 
(regarding registration of dealers) and section 15C (regarding 
registration of government securities dealers).
---------------------------------------------------------------------------

    The Commission received comment letters from a variety of 
commenters including investment advisers, PTFs, private fund advisers, 
crypto asset related entities and industry groups, insurance industry 
groups, industry associations, advisory groups, retail investors, and 
other market participants.\32\ The comments addressed all aspects of 
the proposal.
---------------------------------------------------------------------------

    \32\ Comments received in response to the Proposing Release are 
available at: https://www.sec.gov/comments/s7-12-22/s71222.htm.
---------------------------------------------------------------------------

    Commenters in support of the proposal shared the Commission's 
concerns regarding the significant role of unregistered entities that 
act as liquidity providers and emphasized the benefits of registration 
and regulation.\33\ These commenters discussed specific benefits, in 
particular transparency, market integrity and investor protection, as 
well as appropriate Commission and SRO oversight of entities registered 
as dealers and government securities dealers.\34\
---------------------------------------------------------------------------

    \33\ See, e.g., Comment Letter of The Financial Industry 
Regulatory Authority, Inc. (June 23, 2022) (``FINRA Comment 
Letter''); Comment Letter of Better Markets (May 27, 2022) (``Better 
Markets Comment Letter'').
    \34\ Id.
---------------------------------------------------------------------------

    Some commenters stated that they supported the Commission's policy 
goals but expressed concerns regarding whether the proposed rules would 
achieve those goals.\35\ As discussed more fully below, these and other 
commenters raised certain common themes, which generally reflected 
concerns regarding the breadth of the proposed rules and that the 
proposed rules would inappropriately apply to persons not engaging in 
dealer activity. Specifically, many commenters stated that some of the 
terms used in the proposed qualitative factors were vague and overly 
broad.\36\ As discussed below, some commenters thought that the 
proposed first qualitative factor was overinclusive and would capture 
activity that was not dealing.\37\ Commenters also raised concerns 
about certain terms used in the proposed first qualitative factor, the 
manner in which they would be interpreted, and the compliance 
challenges that they might present.\38\ While the Commission is 
generally retaining the overall structure of the proposed rules, the 
Commission is making certain modifications to the text of the rules and 
also is providing guidance to address concerns raised during the public 
comment process.
---------------------------------------------------------------------------

    \35\ See, e.g., SIFMA Comment Letter I (``We support the policy 
goal of proposed Rule 3a44-2 to require PTFs in the government 
securities market to register as government securities dealers, but 
believe that the Commission can adequately capture trading activity 
by unregistered PTFs by adopting solely the qualitative standards 
set forth Rule 3a44-2(a)(1)(ii) and (iii), without the need to adopt 
the standard in Rule 3a44-2(a)(1)(i).''); Comment Letter of Modern 
Markets Initiative (May 27, 2022) (``MMI Comment Letter'') (``MMI 
appreciates the SEC's intent in the Proposal to further support 
transparency, market integrity, and resiliency across the U.S. 
Treasury market and other securities markets, as it relates to 
ensuring that proprietary (or principal) trading firms and other 
market participants who are acting as dealers be, in fact, 
registered as `dealers.' MMI agrees it is important that dealers or 
those who engage in buying and selling of government securities as 
registered dealers should become members of a self-regulatory 
organization, and receive the benefits and obligations under the 
existing framework of Federal securities laws.''); Comment Letter of 
Asset Management Group of Securities Industry and Financial Markets 
Association (May 27, 2022) (``SIFMA AMG Comment Letter'') (``While 
SIFMA AMG can appreciate the Commission's efforts to protect 
investors and further the public interest, we do not believe that 
the Proposal will achieve those goals with respect to money 
managers.''); Comment Letter of FIA Principal Traders Group (Dec. 
12, 2023) (``FIA PTG Comment Letter II'').
    \36\ See, e.g., Comment Letter of Association of Digital Asset 
Markets (May 27, 2022) (``ADAM Comment Letter''); Comment Letter of 
Citadel (June 7, 2022) (``Citadel Comment Letter''); Comment Letter 
of Morgan, Lewis & Bockius LLP (June 8, 2022) (``Morgan Lewis 
Comment Letter''); Comment Letter of T. Rowe Price (June 8, 2022) 
(``T. Rowe Price Comment Letter''); Comment Letter of Investment 
Company Institute (May 27, 2022) (``ICI Comment Letter''); SIFMA 
Comment Letter I; SIFMA AMG Comment Letter; Comment Letter of 
Alternative Investment Management Association (May 27, 2022) (``AIMA 
Comment Letter II''); Comment Letter of Managed Funds Association 
(May 27, 2022) (``MFA Comment Letter I''); Comment Letter of 
McIntyre & Lemon, PLLC (May 31, 2022) (``McIntyre Comment Letter 
II''); Comment Letter of FIA Principal Traders Group (May 27, 2022) 
(``FIA PTG Comment Letter I''); Comment Letter of Managed Funds 
Association (Dec. 19, 2023) (``MFA Comment Letter V''). See also 
section II.A.1.
    \37\ See, e.g., AIMA Comment Letter II; MFA Comment Letter I; 
Comment Letter of Element Capital Management LLC (May 27, 2022) 
(``Element Comment Letter''); SIFMA Comment Letter II; MFA Comment 
Letter V.
    \38\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter; 
T. Rowe Price Comment Letter.
---------------------------------------------------------------------------

    Many commenters also questioned whether the quantitative standard 
exceeds the Commission's authority under the Exchange Act and is 
consistent with historical Commission interpretations and guidance and 
Federal case law.\39\ As discussed above, the SEC has the authority to 
define the terms used in the statutory definition of ``dealer'' and 
oversee and regulate registered dealers. Further, the statutory 
definitions of ``dealer'' in section 3(a)(5) and ``government 
securities dealer'' in section 3(a)(44), and the accompanying 
registration requirements of the Exchange Act, were drawn broadly by 
Congress to encompass a wide range of activities involving the 
securities markets and their participants. PTFs and other market 
participants that engage in dealer activity in the U.S. Treasury market 
should be subject to the same regulatory requirements as other dealers.
---------------------------------------------------------------------------

    \39\ See, e.g., SIFMA AMG Comment Letter; Comment Letter of Two 
Sigma (May 27, 2022) (``Two Sigma Comment Letter I'').
---------------------------------------------------------------------------

    In addition, commenters, many of which were in the asset management 
industry, stated that the proposed definition of ``own account'' would

[[Page 14943]]

inappropriately apply the dealer regime to private funds and registered 
investment advisers, and that the proposed exclusion for registered 
investment companies should be expanded to registered investment 
advisers and to private funds managed by registered investment 
advisers.\40\ Commenters in the crypto asset industry also opposed the 
proposal, stating that the dealer framework should not apply to 
entities that transact in crypto assets that are securities.\41\
---------------------------------------------------------------------------

    \40\ See, e.g., Comment Letter of National Association of 
Private Fund Managers (May 27, 2022) (``NAPFM Comment Letter''); MFA 
Comment Letter I; AIMA Comment Letter II. See also section II.A.3.
    \41\ The Proposing Release used the phrase ``digital asset that 
is a security.'' See Proposing Release at 23057 n.36. For purposes 
of this Adopting Release, the Commission does not distinguish 
between the terms ``digital asset securities'' and ``crypto asset 
securities.''
---------------------------------------------------------------------------

    Further, many commenters believed that the economic analysis did 
not adequately address economic implications of the proposed rules.\42\ 
Commenters also stated that the proposed rules were largely unnecessary 
because of existing regulatory obligations, stating that the Commission 
has other tools to accomplish its stated goals of improving 
transparency including, for example, the Consolidated Audit Trail 
(``CAT''), the Trade Reporting and Compliance Engine (``TRACE'') and 
large trader reporting,\43\ and that the proposed rules could have a 
negative effect on liquidity.\44\
---------------------------------------------------------------------------

    \42\ See, e.g., Comment Letter of Andreessen Horowitz (May 27, 
2022) (``Andreessen Horowitz Comment Letter''); AIMA Comment Letter 
II; ADAM Comment Letter; MFA Comment Letter I; Comment Letter of 
Blockchain Association (May 27, 2022) (``Blockchain Association 
Comment Letter''); Comment letter of U.S. Representatives Patrick 
McHenry and Bill Huizenga (Apr. 18, 2022) (``U.S. Reps Comment 
Letter''); Comment Letter of Virtu Financial (May 27, 2022) (``Virtu 
Comment Letter''); Comment Letter of Alphaworks Capital Management 
(May 27, 2022) (``Alphaworks Comment Letter''); Two Sigma Comment 
Letter I; FIA PTG Comment Letter I; Comment Letter of Independent 
Dealer and Trader Association (May 27, 2022) (``IDTA Comment 
Letter''); NAPFM Comment Letter; Comment Letter of Schulte Roth & 
Zabel LLP (May 27, 2022) (``Schulte Roth Comment Letter''); SIFMA 
Comment Letter I; Comment Letter of James Overdahl (May 27, 2022) 
(``Overdahl Comment Letter''); Comment Letter of Fried, Frank, 
Harris, Shriver, & Jacobson LLP (May 27, 2022) (``Fried Frank 
Comment Letter''); Element Comment Letter; Comment Letter of Chamber 
of Digital Commerce (June 13, 2022) (Chamber of Digital Commerce 
Comment Letter''); Morgan Lewis Comment Letter; Comment Letter of 
DeFi Education Fund (May 27, 2022) (``DeFi Fund Comment Letter''); 
Comment Letter of Ranking Member, Tim Scott, U.S. Senator (Dec. 14, 
2023) (``Scott Comment Letter'').
    \43\ See, e.g., MMI Comment Letter; Virtu Comment Letter; AIMA 
Comment Letter II; ADAM Comment Letter; SIFMA AMG Comment Letter; 
SIFMA Comment Letter I; Fried Frank Comment Letter; Element Comment 
Letter; T. Rowe Price Comment Letter.
    \44\ See, e.g., AIMA Comment Letter II; FIA PTG Comment Letter 
I; Virtu Comment Letter; McIntyre Comment Letter II; Alphaworks 
Comment Letter; MMI Comment Letter; Schulte Roth Comment Letter; 
IDTA Comment Letter; NAPFM Comment Letter; Comment Letter of Federal 
Regulation of Securities Committee of the Business Law Section of 
the American Bar Association (May 27, 2022) (``ABA Comment 
Letter''); Fried Frank Comment Letter; MFA Comment Letter I; Element 
Comment Letter; Citadel Comment Letter; Morgan Lewis Comment Letter; 
DeFi Fund Comment Letter; Scott Comment Letter.
---------------------------------------------------------------------------

B. Overview of the Final Rules and Modifications to the Proposal

    After careful review of comments received and upon further 
consideration, the Commission is adopting Rules 3a5-4 and 3a44-2 as 
revised. As discussed below, while the Commission is generally 
retaining the overall structure of the proposed rules, we are making 
certain modifications to the text of the rules and also are providing 
guidance to address concerns raised during the comment process. In 
particular, the modifications we have made to more appropriately tailor 
the scope of the final rules will address various concerns raised by 
commenters and appropriately require only entities engaging in de facto 
market making activity to register as dealers.\45\ Overall, the final 
rules will achieve the Commission's important goals of protecting 
investors and supporting fair, orderly, and efficient markets.
---------------------------------------------------------------------------

    \45\ With respect to the Commission's authority to adopt the 
final rules, some commenters asserted that the major questions 
doctrine is implicated. See, e.g., Comment Letter of Consensys 
Software Inc. (May 26, 2022) (``Consensys Comment Letter''); Comment 
Letter of American Investment Council (Aug. 8, 2023) (``AIC Comment 
Letter''). In further defining what it means to be engaged in the 
business of buying and selling securities ``as a part of a regular 
business'' within the definitions of ``dealer'' and ``government 
securities dealer'' under the Exchange Act, the Commission did not 
claim an ``[e]xtraordinary grant[ ] of regulatory authority'' based 
on ``vague,'' ``cryptic,'' ``ancillary,'' or ``modest'' statutory 
language. West Virginia v. EPA, 142 S. Ct. 2587, 2608-10 (2022) 
(quotation omitted). Nor did it assert authority that falls outside 
its ``particular domain.'' Alabama Ass'n of Realtors v. HHS, 141 S. 
Ct. 2485, 2489 (2021) (per curiam). Congress granted the SEC 
authority to oversee and regulate dealers, and the Exchange Act 
empowers the SEC with authority to define statutory terms.
---------------------------------------------------------------------------

    An overview of the changes from the proposal follows:
    Modification and Streamlining of the Qualitative Standard--The 
Commission has modified the proposed qualitative factors to: (1) 
eliminate the proposed qualitative factor that would have captured 
persons engaging in liquidity provision by routinely making roughly 
comparable purchases and sales of the same or substantially similar 
securities in a day (``proposed first qualitative factor''); (2) more 
closely track the statutory language of the Exchange Act by referring 
to ``regular'' rather than the proposed ``routine'' patterns of 
behavior that have the effect of providing liquidity to other market 
participants; and (3) add the phrase ``for the same security'' to the 
factor relating to the expression of trading interests to clarify that 
it will apply only when a person is on both sides of the market for the 
same security. While the proposed first qualitative factor was intended 
to capture persons whose pattern of trading indicates that their 
liquidity provision forms a part of a regular business and to 
distinguish them from persons engaging in isolated or sporadic 
securities transactions (and therefore not engaging in such a 
regularity of participation), commenters raised a number of concerns 
with this factor, in particular that it was overinclusive and would 
capture activity that was not dealing, but rather investing in the 
ordinary course. After consideration of comments, the Commission has 
decided to eliminate this factor from the final rules. As discussed 
below, the qualitative factors as modified, together with the statutory 
definition and related precedent and interpretations, appropriately 
describe the circumstances in which a person would be deemed to engage 
in a ``regular'' pattern of buying and selling securities that has the 
effect of providing liquidity to other market participants, including 
in the U.S. Treasury market.
    Deletion of the Quantitative Standard--The Commission proposed a 
bright line test under which persons engaged in certain levels of 
activity in the U.S. Treasury market would be defined to be buying and 
selling securities ``as part of a regular business,'' regardless of 
whether they meet any of the qualitative factors. The quantitative 
standard was intended as a backstop to the qualitative factors to 
capture the most significant Treasury market participants.\46\ While 
the proposed trading volume threshold was intended to provide an easily 
measurable and non-discretionary standard, commenters raised concerns 
regarding the application of this standard, in particular with respect 
to investment activities that might trigger the quantitative threshold. 
After consideration of these comments, the Commission has decided to 
eliminate

[[Page 14944]]

the quantitative standard from the final rules. As discussed below, the 
qualitative factors as modified, and otherwise applicable court 
precedent and Commission interpretations, appropriately describe the 
circumstances in which a person would be deemed to engage in a 
``regular'' pattern of buying and selling securities that has the 
effect of providing liquidity to other market participants, including 
in the U.S. Treasury market.
---------------------------------------------------------------------------

    \46\ See Proposing Release at 23072 (stating that the 
quantitative standard was ``designed to make clear the Commission's 
view that a person engaged in this regular volume of buying and 
selling activity is engaged in the buying and selling of government 
securities for its own account as part of a regular business, and 
therefore, should be subject to the same regulatory requirements as 
other dealers'').
---------------------------------------------------------------------------

    As a result of these modifications, the final rules establish two 
non-exclusive ways in which a person will be determined to be engaged 
in a regular pattern of providing liquidity to other market 
participants ``as part of a regular business'':
     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 (``expressing trading 
interest factor''); \47\ or
---------------------------------------------------------------------------

    \47\ The proposed second qualitative factor has been modified to 
change the term ``trading interests'' to ``trading interest'' and 
the words ``are'' to ``is'' and ``they'' to ``it.'' This is a non-
substantive modification to align the term with common usage.
---------------------------------------------------------------------------

     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 (``primary revenue factor'').\48\
---------------------------------------------------------------------------

    \48\ The proposed third qualitative factor has been modified to 
change the term ``trading interests'' to ``trading interest.'' This 
is a non-substantive modification to align the term with common 
usage.
---------------------------------------------------------------------------

    Revision of ``Own Account'' Definition and Addition of Anti-Evasion 
Provision--The Commission had proposed to define ``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 aggregation provision'').\49\ Upon consideration of the 
comments, the Commission has revised the definition so that the final 
rules define ``own account'' to mean an account: (i) held in the name 
of that person; or (ii) held for the benefit of that person. The rules 
as adopted thus are consistent with the Commission's historical 
``entity'' approach to broker-dealer regulation.\50\
---------------------------------------------------------------------------

    \49\ See infra note 297 and accompanying text. Further, the 
Commission is removing the definitions of ``control'' and ``parallel 
account structure.''
    \50\ See, e.g., Foreign Broker-Dealer Adopting Release at 30017 
(``the Commission uses an entity approach with respect to registered 
broker-dealers''). See infra note 326 and accompanying text.
---------------------------------------------------------------------------

    However, with a view to deterring the establishment of multiple 
legal entities or accounts to evade appropriate regulation, the final 
rules include an anti-evasion provision that prohibits persons from 
evading the registration requirements by: (1) engaging in activities 
indirectly that would satisfy the qualitative factors; or (2) 
disaggregating accounts. The changes from the proposed rules address 
concerns about the scope of the proposed rules as raised by commenters 
while enhancing the Commission's current ability to prevent and address 
potentially evasive behavior.\51\
---------------------------------------------------------------------------

    \51\ See section II.A.4.
---------------------------------------------------------------------------

    Exclusions--The Commission is providing an exclusion for ``central 
banks,'' ``sovereign entities,'' and ``international financial 
institutions,'' all as defined in the final rules. The exclusion is 
appropriate in view of the unique roles played by these entities. The 
Commission also is adopting as proposed the exclusions from the final 
rules for registered investment companies and persons that have or 
control less than $50 million in total assets.\52\
---------------------------------------------------------------------------

    \52\ See section II.A.3. As discussed further below, the less 
than $50 million exclusion is not an exclusion from the ``dealer'' 
definition for all purposes, but only for purposes of the final 
rules that focus on de facto market making. Outside of this context, 
the question of whether any person, including a person that has or 
controls less than $50 million in total assets, is acting as a 
dealer, as opposed to a trader, will remain a facts and 
circumstances determination.
---------------------------------------------------------------------------

    The Commission is not adopting certain commenters' suggestions for 
additional exclusions. Among other things, as discussed more fully 
below, the Commission is not excluding private funds or registered 
investment advisers from the final rules because an investment adviser 
or private fund could be acting as a dealer depending upon the 
particular activities in which it is engaged. The final rules do, 
however, include several modifications and clarifications to address 
many of the compliance and other concerns raised by certain commenters, 
including those raised by private funds and registered investment 
advisers.\53\
---------------------------------------------------------------------------

    \53\ See section II.A.3.b.
---------------------------------------------------------------------------

    In addition, as discussed in more detail below, the Commission is 
not excluding certain types of securities, specifically crypto asset 
securities, from the application of the final rules.\54\ As stated in 
the Proposing Release, the proposed rules would apply to any 
``security'' as defined in section 3(a)(10) or ``government security'' 
as defined in section 3(a)(44) of the Exchange Act. The dealer 
framework is a functional analysis based on the securities trading 
activities undertaken by a person, not the type of security being 
traded. Accordingly, the final rules will apply with respect to any 
crypto asset that is a ``security'' or ``government security'' within 
the meaning of the Exchange Act.
---------------------------------------------------------------------------

    \54\ Comments requesting that the proposed rules not apply 
specifically to crypto asset securities are discussed further in 
section II.A.3.
---------------------------------------------------------------------------

    Further, the Commission disagrees with the argument that certain 
market participants, including PTFs, are not dealers because they do 
not have customers.\55\ There is no requirement in the statutory text 
of either section 3(a)(5) or section 3(a)(44) that dealers have 
customers. In comparison, the Exchange Act's definition of ``broker'' 
is ``any person in the business of effecting transactions in securities 
for the account of others,'' which includes (but is not limited to) 
customers.\56\ The dealer definition includes no such limiting language 
and, since its enactment, the dealer definition was understood to cover 
``the operations of a trader . . . who has no customers but merely 
trades for his own account through a broker'' so long as those 
operations ``are sufficiently extensive to be regarded as a regular 
business . . . .'' \57\ Likewise, many of the factors that the 
Commission identified in its 2002 Release do not presume a dealer is 
acting for a customer.\58\ Indeed, a number of Exchange Act rules 
applicable to dealers presuppose that there are dealers without 
customers and are tailored for that business model.\59\
---------------------------------------------------------------------------

    \55\ See Eastside Church of Christ v. National Plan, Inc., 391 
F.2d 357 (5th Cir. 1968).
    \56\ 15 U.S.C. 78c(a)(4)(A).
    \57\ Charles H. Meyer, Securities Exchange Act of 1934 Analyzed 
and Explained 33-34 (1934) (emphasis added).
    \58\ See 2002 Release at 67498-67500.
    \59\ See, e.g., 17 CFR 240.15c3-1(a)(6) (``Rule 15c3-1(a)(6)'') 
(requiring firms relying on this provision to transact only with 
other brokers and dealers and prohibiting such firms from carrying 
customer accounts); Rule 15b9-1 (exempting brokers-dealers from 
becoming members of a national securities association if they are a 
member of an exchange, do not carry customer accounts, and any 
securities transactions that they effect elsewhere than an exchange 
of which they are a member meet certain exceptions).
---------------------------------------------------------------------------

    Further, a helpful analogy can be drawn to the Commission's 
rulemaking further defining who is a ``security-based swap dealer''--a 
definition that closely parallels the statutory definition of 
``dealer,'' particularly with respect to the exclusion of activities 
that are not part of a regular business.\60\ In that

[[Page 14945]]

matter, in comparing ``counterparties'' with ``customers,'' the 
Commission stated that ``any interpretation of the `security-based swap 
dealer' definition that is predicated on the existence of a customer 
relationship may lead to an overly narrow construction of the 
definition.'' \61\ Accordingly, in this regard, these commenters have 
read a limitation into the statute where none exists.
---------------------------------------------------------------------------

    \60\ See Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based 
Swap Participant'' and ``Eligible Contract Participant,'' Exchange 
Act Release No. 66868 (Apr. 27, 2012), 77 FR 30596, (May 23, 2012) 
(``Entities Release'') (``Although commenters have expressed the 
view that a person that engaged in security-based swap activities on 
an organized market should not be deemed to be a dealer unless it 
engaged in those activities with customers, we do not agree.'').
    \61\ Id. at n.282.
---------------------------------------------------------------------------

    As stated above, some commenters suggested that the final rules are 
unnecessary because the SEC has other tools to accomplish the goals of 
the rulemaking, including large trader reporting, TRACE, and CAT. 
Certain commenters urged the Commission to take additional or different 
regulatory actions for entities covered by the Investment Advisers Act 
of 1940 (``Advisers Act'') than the approach we have adopted, including 
leveraging existing data from Form PF filings or making amendments to 
the existing regulatory regime under the Advisers Act. However, as 
discussed below, dealer registration is tailored to provide specific 
protections to address potential risks associated with dealer activity, 
and the aforementioned tools do not provide sufficient regulatory 
oversight and transparency into the trading activity of entities that 
are not otherwise registered as dealers.
    Commenters expressed the view that the proposed rules could have a 
negative impact on liquidity or may cause many market participants to 
cease, modify, or curtail their trading activity to avoid being 
required to register as a dealer.\62\ However, as discussed further 
below, we have made various modifications to appropriately tailor the 
scope of the final rules to address concerns raised by commenters about 
effects on liquidity. The Commission has crafted the final rules to 
draw upon established concepts and to expand upon prior Commission 
statements to identify more specifically the activities of certain 
market participants who act as dealers by ``providing liquidity'' to 
other market participants, and to establish a more level regulatory 
playing field for these types of significant liquidity providers. The 
test established in the Exchange Act to determine if a person is a 
dealer is whether the person is engaged in the business of buying and 
selling securities for its own account ``as part of a regular 
business.'' \63\ The final rules are thus intended to reflect the 
longstanding distinction between so-called ``traders''--whose liquidity 
provision is only incidental to their trading activities--and persons 
who are ``in the business'' of providing liquidity as part of a 
``regular business,'' and so are ``dealers'' and ``government 
securities dealers'' under the Exchange Act. Under the final rules, a 
person is deemed to be engaged in buying and selling securities for its 
own account as part of a regular business--and therefore within the 
definition of ``dealer'' or ``government securities dealer''--if that 
person is engaged in a ``regular pattern of buying and selling 
securities that has the effect of providing liquidity to other market 
participants.''
---------------------------------------------------------------------------

    \62\ See ABA Comment Letter at 9-12; ADAM Comment Letter at 16; 
AIMA Comment Letter II at 11-13; Comment Letter of Alternative 
Investment Management Association (Nov. 17, 2022) (``AIMA Comment 
Letter III'') at 3 and 8; Alphaworks Comment Letter at 6; Andreessen 
Horowitz Comment Letter at 10 and 13; Blockchain Association Comment 
Letter at 7; Citadel Comment Letter at 7-8; Comment Letter of 
Committee on Capital Markets (Oct. 19, 2022) (``Committee on Capital 
Markets Comment Letter'') at 3; DeFi Fund Comment Letter at 14; 
Element Comment Letter at 5; FIA PTG Comment Letter I at 2-10; Fried 
Frank Comment Letter at 8-11; Comment Letter of Gretz Consilium LLC 
(May 26, 2022) (``Gretz Comment Letter'') at 18; ICI Comment Letter 
at 7-8; McIntyre Comment Letter II at 2; MFA Comment Letter I at 12; 
Comment Letter of Managed Funds Association (Dec. 5, 2022) (``Lewis 
Study'') at 2; Morgan Lewis Comment Letter at 2 and 14; NAPFM 
Comment Letter at 5; Overdahl Comment Letter at 16-23; Schulte Roth 
Comment Letter at 2; SIFMA Comment Letter I at 8; SIFMA AMG Comment 
Letter at 16-17; Two Sigma Comment Letter at 2 and 9; Virtu Comment 
Letter at 3-4.
    \63\ See sections 3(a)(5)(A) and (B) of the Exchange Act, 15 
U.S.C. 78c(a)(5)(A) and (B); section 3(a)(44) of the Exchange Act, 
15 U.S.C. 78c(a)(44).
---------------------------------------------------------------------------

    The final rules are not the exclusive means of establishing that a 
person is a dealer or government securities dealer; otherwise 
applicable Commission interpretations and precedent will continue to 
apply.\64\ In other words, these rules address one way in which a 
person can be engaged in the regular business of buying and selling 
securities for its own account, but these rules do not displace, 
modify, or substitute for otherwise applicable Commission 
interpretations and court precedent. A person engaging in other 
activities that satisfy the definition of dealer under otherwise 
applicable interpretations and precedent, such as underwriting, will 
still be a dealer even though those activities are not addressed by the 
two qualitative factors.\65\
---------------------------------------------------------------------------

    \64\ See Rules 3a5-4(c) and 3a44-2(c) (providing that no 
presumption shall arise that a person is not a dealer or government 
securities dealer solely because that person does not satisfy the 
standards of the final rules). See also section II.A.5.
    \65\ See supra note 16.
---------------------------------------------------------------------------

    The final rules, as modified, appropriately balance the concerns of 
the various commenters in a way that will best achieve the Commission's 
important goals to protect investors and support fair, orderly, and 
resilient markets through the complete and consistent application of 
dealer regulations. Further, the modifications we have made to tailor 
the scope of the final rules, including the persons scoped into the 
final rules, will address various concerns raised by commenters and 
appropriately require only entities engaging in dealing activity to 
register as dealers.

II. Discussion of Final Rules

A. Component Parts

1. Qualitative Standard
    The qualitative standard in the proposed rules was intended to 
build on existing statements by the Commission and the courts regarding 
``dealer'' activity to further define certain factors for determining 
when a person is engaged in buying and selling securities for its own 
account ``as part of a regular business'' as that phrase is used in 
sections 3(a)(5) and 3(a)(44) of the Exchange Act. Under paragraph 
(a)(1) of the proposed rules, a person would be engaged in buying and 
selling securities for its own account ``as a part of a regular 
business'' and so would be a dealer or a government securities dealer, 
if that person engages in a routine pattern of buying and selling 
securities (or government securities) that has the effect of providing 
liquidity to other market participants. Under this standard, as 
supplemented by the qualitative factors, when the frequency and nature 
of a person's securities trading is such that the person assumes a 
role--whether described as market-making, de facto market-making, or 
liquidity-providing--similar to the role that historically has been 
performed by a registered dealer, that person would be deemed to be a 
dealer or government securities dealer.\66\ The proposed rules would 
have further defined three types of activities that would be considered 
to have the effect of providing liquidity to other market participants: 
(i) routinely making roughly comparable purchases and sales of the same 
or substantially similar securities (or government securities) in a 
day; or (ii) 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 (iii) earning

[[Page 14946]]

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.
---------------------------------------------------------------------------

    \66\ See, e.g., 2002 Release at 67499.
---------------------------------------------------------------------------

    Commenters stated that the terms ``routine'' and ``routinely'' in 
the proposed rules were unclear and would lead to inconsistent 
interpretations.\67\ In response to the comments and upon further 
consideration, the Commission has replaced the term ``routine'' with 
``regular'' in 17 CFR 240.3a5-4(a)(1) and 240.3a44-2(a)(1) so that a 
person will be engaged in buying and selling securities for its own 
account ``as a part of a regular business''--and so be a dealer or a 
government securities dealer--if that person engages in a regular 
pattern of buying and selling securities (or government securities) 
that has the effect of providing liquidity to other market 
participants. As discussed more fully below, ``regular'' participation 
in the securities markets is part of the statutory definition of 
``dealer'' in the Exchange Act and therefore is a concept that should 
be familiar to market participants.\68\
---------------------------------------------------------------------------

    \67\ See, e.g., ADAM Comment Letter; Element Comment Letter; 
Morgan Lewis Comment Letter; Consensys Comment Letter; MFA Comment 
Letter I; NAPFM Comment Letter; SIFMA AMG Comment Letter.
    \68\ See 15 U.S.C. 78c(a)(5) and 78c(a)(44).
---------------------------------------------------------------------------

    In addition, as discussed below, after further consideration, the 
Commission has revised the qualitative standard by eliminating the 
proposed first qualitative factor and modifying the remaining two 
qualitative factors. These changes are designed to more appropriately 
tailor the rule to the nature of dealing in today's securities 
markets.\69\ As a result of these modifications, the final rules 
establish two non-exclusive ways in which a person will be deemed to be 
engaged in providing liquidity as part of a regular business:
---------------------------------------------------------------------------

    \69\ As discussed below, the Commission is adding the phrase 
``for the same security'' so that the proposed second qualitative 
factor applies to expressing trading interest on both sides of the 
market for the same security. The Commission has also modified, as 
appropriate, the remaining qualitative factors to replace the term 
``routinely'' with ``regularly.''
---------------------------------------------------------------------------

     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; 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 
interest.
a. Elimination of the Proposed First Qualitative Factor
    As discussed in the Proposing Release, the proposed first 
qualitative factor was intended to capture a person's pattern of 
trading, the consistency and regularity of which indicate that its 
liquidity provision forms a part of a regular business.\70\ 
Specifically, under proposed 17 CFR 240.3a5-1(a)(1)(i) and 240.3a44-
2(a)(1)(i), a person that, trading for its own account, ``routinely 
mak[es] roughly comparable purchases and sales of the same or 
substantially similar securities in a day'' would be engaged in a 
pattern of trading that ``has the effect of providing liquidity to 
other market participants,'' and therefore engaged in buying and 
selling securities or government securities ``as part of a regular 
business'' as a dealer or government securities dealer.\71\ The 
proposed first qualitative factor was intended to separate persons 
engaging in isolated or sporadic securities transactions from persons 
whose regularity of participation in securities transactions 
demonstrates that they are acting as dealers.
---------------------------------------------------------------------------

    \70\ See Proposing Release at 23066.
    \71\ See id.
---------------------------------------------------------------------------

    Commenters raised a number of concerns about the proposed first 
qualitative factor.\72\ As a general matter, commenters contended that 
the proposed first qualitative factor would capture activity that was 
not dealing, but rather investing in the ordinary course.\73\ One 
commenter recommended that certain specific activities be explicitly 
excluded from the rule, including asset liability management, liquidity 
and collateral management, and activities ancillary to exempt dealer 
activity.\74\ As discussed further below, commenters also expressed 
concerns about certain terms used in the proposed first qualitative 
factor, the manner in which they would be interpreted, and the 
compliance challenges that they might present, focusing in particular 
on the use of the terms ``routinely,'' ``substantially similar,'' 
``roughly comparable,'' and ``in a day.'' \75\ As a result of these 
concerns, some commenters stated that the Commission should remove the 
first proposed qualitative factor.\76\
---------------------------------------------------------------------------

    \72\ See also supra notes 37-38 and accompanying text.
    \73\ See, e.g., AIMA Comment Letter II; MFA Comment Letter I; 
Element Comment Letter; SIFMA Comment Letter II; FIA PTG Comment 
Letter II; MFA Comment Letter V. For example, one commenter stated 
that ``[w]ithout revision to, and clarification of, these vague 
terms, this Qualitative Standard will clearly capture many short-
term investment strategies engaged in by traders that are not 
indicative of dealer functions.'' Element Comment Letter. Another 
stated that ``Qualitative Standard 1 would capture many common hedge 
fund strategies that have never been, and should not now be, 
considered dealing, including fixed-income arbitrage, convertible 
bond arbitrage and capital structure arbitrage, as well as a number 
of relative value or quantitative strategies.'' AIMA Comment Letter 
II.
    \74\ SIFMA Comment Letter II.
    \75\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter; 
T. Rowe Price Comment Letter; MFA Comment Letter V.
    \76\ MFA Comment Letter I (``We have considered this proposed 
test and strongly believe that it will be unworkable for market 
participants--as described in detail below--and we therefore urge 
the Commission not to include Qualitative Test 1 in any final 
rule.''). See also AIMA Comment Letter II (``We believe the 
Commission should limit its qualitative standards to only 
Qualitative Standard 3.''). In addition, one commenter suggested 
that the Commission replace the first and second proposed 
qualitative factors with a test defining a person acting as a bona 
fide market maker under Regulation SHO as a dealer. See MFA Comment 
Letter I. As discussed below, the Commission is removing the 
proposed first qualitative standard and declines to replace the 
proposed second qualitative factor with a test defining a person 
acting as a bona fide market maker under Regulation SHO. See section 
II.A.1.b.
---------------------------------------------------------------------------

    After further consideration and in light of commenters' concerns, 
the Commission has decided to eliminate the proposed first qualitative 
factor. The Commission agrees with commenters that the proposed first 
qualitative factor could capture more than dealing activity intended to 
be captured by the rule. Accordingly, the Commission is not adopting 
the first factor.
    The Commission emphasizes that the elimination of this factor does 
not mean that the conduct that would have been captured by the proposed 
factor is not dealing activity. This conduct may be de facto market 
making under the other two qualitative factors or dealer activity under 
otherwise applicable precedent. In this regard, as discussed in section 
II.A.5, no presumption shall arise that a person is not a dealer or 
government securities dealer as defined by the Exchange Act solely 
because that person does not satisfy the standard set forth in the 
final rules.
b. Expressing Trading Interest Factor
    The Commission proposed a second qualitative factor to identify 
activity that ``has the effect of providing liquidity to other market 
participants'' focused on the expression of trading interests. 
Specifically, under proposed 17 CFR 240.3a5-4(a)(1)(ii) and 240.3a44-
2(a)(1)(ii), a person that, trading for its own account, ``routinely 
express[es] 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

[[Page 14947]]

accessible to other market participants'' would be engaging in a 
routine pattern of trading that has the effect of providing liquidity 
to other market participants, and as a result, would be a dealer under 
the proposed rules.\77\ As the Commission stated in the Proposing 
Release, this factor ``would update the longstanding understanding that 
regular or continuous quotation is a hallmark of market making or de 
facto market making (and, hence, dealer) activity, to reflect 
technological changes to the ways in which buyers and sellers of 
securities are brought together.'' \78\
---------------------------------------------------------------------------

    \77\ As discussed below, the Commission is adding the phrase 
``for the same security'' to the expressing trading interest factor 
to specify that this factor applies to expressing trading interest 
on both sides of the market for the same security.
    \78\ Proposing Release at 23068.
---------------------------------------------------------------------------

    The Commission explained in the Proposing Release the meanings of 
certain key terms used in the proposed second qualitative factor.\79\ 
Specifically, as discussed in more detail below, the Commission 
explained the terms ``routinely,'' ``trading interests'' and ``best 
available prices on both sides of the market.'' \80\
---------------------------------------------------------------------------

    \79\ Id.
    \80\ Id.
---------------------------------------------------------------------------

    The Commission received a range of comments on the proposed second 
qualitative factor. One commenter explicitly supported the proposed 
second qualitative factor, voicing support for the policy goal of 
requiring PTFs in the government securities market to register as 
government securities dealers.\81\ The commenter stated that it 
believed that the second qualitative factor would achieve this 
goal.\82\ As discussed below, a number of commenters opposed the 
proposed second qualitative factor, contending that the factor would 
capture activity that was not dealing,\83\ and expressing concerns 
about certain terms used in this factor (i.e., ``routinely,'' ``trading 
interests,'' ``both sides of the market,'' ``accessible to other market 
participants''), as well as addressing other issues.\84\
---------------------------------------------------------------------------

    \81\ SIFMA Comment Letter I.
    \82\ Id.
    \83\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter; 
AIMA Comment Letter II.
    \84\ See, e.g., MFA Comment Letter I; McIntyre Comment Letter 
II; Consensys Comment Letter; Gretz Comment Letter; FIA PTG Comment 
Letter I; Blockchain Comment Letter; NAPFM Comment Letter; ADAM 
Comment Letter; SIFMA AMG Comment Letter; Comment Letter of Managed 
Funds Association (July 21, 2023) (``MFA Comment Letter II''); 
Element Comment Letter; Morgan Lewis Comment Letter; ABA Comment 
Letter.
---------------------------------------------------------------------------

    Advancements in the securities markets have altered the way in 
which market participants interact with the markets. Certain market 
participants continue to perform important dealer functions as 
providers of liquidity to other market participants by expressing 
trading interest on both sides of the market for a security to other 
market participants. The expressing trading interest factor takes these 
changes into account, while also allowing for flexibility in its 
application in the markets for different securities, based on the wide 
variance in liquidity, depth, or other traits.
    In adopting the proposed second qualitative factor as the 
expressing trading interest factor, the Commission is replacing the 
term ``routinely'' with ``regularly.'' The Commission is also revising 
the rule text to explicitly provide that the test applies with respect 
to the expression of trading interest in the ``same'' security. Other 
than these changes, and certain non-substantive changes, for the 
reasons set forth below, the Commission is adopting this factor as 
proposed. Accordingly, under the expressing trading interest factor, a 
person ``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'' is engaged in buying and 
selling securities for its own account ``as a part of a regular 
business'' as the phrase is used in sections 3(a)(5)(B) and 3(a)(44)(A) 
of the Exchange Act. The expressing trading interest factor will 
appropriately capture those market participants who are engaging in 
liquidity-providing activities similar to those traditionally performed 
by dealers or government securities dealers as defined under sections 
3(a)(5) and 3(a)(44) of the Exchange Act.\85\
---------------------------------------------------------------------------

    \85\ See 15 U.S.C. 78c(a)(5) and 78c(a)(44).
---------------------------------------------------------------------------

Regularly
    The Proposing Release stated that the term ``routinely'' as used in 
the proposed second qualitative factor meant that a person must express 
trading interests more frequently than occasionally, but not 
necessarily continuously, both intraday and across time.\86\ The use of 
the term ``routinely'' in the proposed second qualitative factor was 
thus intended to capture significant liquidity providers who express 
trading interests at a high enough frequency to play a significant role 
in price discovery and the provision of market liquidity, even if their 
liquidity provision may not be continuous like that of some traditional 
dealers.\87\ The Proposing Release stated that the liquidity providers 
that would be covered by the proposed second qualitative factor are 
very active in the markets--their participation is very routine--as 
demonstrated by the ``key role'' they play ``in price discovery and the 
provision of market liquidity'' in both the interdealer U.S. Treasury 
market and the equity markets.\88\
---------------------------------------------------------------------------

    \86\ Proposing Release at 23068.
    \87\ Id.
    \88\ Id.
---------------------------------------------------------------------------

    A number of commenters expressed concerns related to the use of the 
term ``routinely.'' \89\ Several commenters stated that the term 
``routinely'' was unclear, which would make it difficult or impossible 
for market participants to determine whether their activities would be 
captured by the proposed second qualitative factor.\90\ For example, 
one commenter stated that the term ``routinely'' is ``unclear, defined 
with reference to another undefined concept (`occasional') and 
distinguished from a concept (`continuous') that market participants 
actually understand and have experience applying.'' \91\ As a result, 
the commenter stated this factor ``would ultimately be unworkable for 
market participants who will have to make subjective determinations, on 
at least a daily basis, about whether they are `routinely' engaging in 
the activity described in [the proposed rules].'' \92\ Another 
commenter asserted that use of the term ``routinely'' ``will lead to 
inconsistent application across market participants.'' \93\ Commenters 
also raised questions about the Proposing Release's analogy to the 
approach in the Commission's joint rulemaking with the Commodity 
Futures Trading Commission regarding, among other things, the 
definitions of ``swap dealer'' and ``security-based swap dealer.'' \94\ 
In particular, commenters stated that the reference was inappropriate 
because of the different nature of the markets for

[[Page 14948]]

cash securities and security-based swaps.\95\
---------------------------------------------------------------------------

    \89\ See, e.g., MFA Comment Letter I; McIntyre Comment Letter 
II; Consensys Comment Letter; Gretz Comment Letter; FIA PTG Comment 
Letter I; Blockchain Comment Letter; NAPFM Comment Letter; ADAM 
Comment Letter; SIFMA AMG Comment Letter; MFA Comment Letter II; 
Element Comment Letter; Morgan Lewis Comment Letter; ABA Comment 
Letter.
    \90\ See, e.g., MFA Comment Letter I; Element Comment Letter; 
ADAM Comment Letter; Morgan Lewis Comment Letter; SIFMA AMG Comment 
Letter.
    \91\ MFA Comment Letter I.
    \92\ Id. See also Element Comment Letter (```routine' trading 
can indicate market making, which implies a dealer function, but can 
also indicate the day-to-day activity of a private fund's trading 
desk.'').
    \93\ ADAM Comment Letter. See also SIFMA AMG Comment Letter.
    \94\ See, e.g., ADAM Comment Letter; Morgan Lewis Comment 
Letter; SIFMA AMG Comment Letter; see also Proposing Release at 
n.132.
    \95\ See, e.g., ADAM Comment Letter; Morgan Lewis Comment 
Letter; SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    As an alternative to ``routinely,'' some commenters suggested using 
a different term, with most such commenters suggesting ``continuous.'' 
\96\ Some commenters asked whether the Commission had considered using 
``regularly,'' stating that the statute uses the term ``regular.'' \97\
---------------------------------------------------------------------------

    \96\ SIFMA AMG Comment Letter; Comment Letter of BlackRock (Mar. 
16, 2023) (``BlackRock Comment Letter'').
    \97\ MFA Comment Letter I (``. . .but query, was `nearly 
continuous' considered? Or `regular'?''); McIntyre Comment Letter II 
(stating that the Proposed Rule ``replaces the statutory text of 
``regular'' and ``continuous'' with an amorphous notion of 
``routine'' patterns of providing liquidity.'').
---------------------------------------------------------------------------

    After further consideration, the Commission has replaced the term 
``routinely'' with ``regularly.'' As with the term ``routinely'' in the 
Proposing Release, the term ``regularly'' in the final rules will apply 
to a person's expression of trading interest both within a trading day 
and over time.\98\ This requirement distinguishes persons engaging in 
isolated or sporadic expressions of trading interest from persons whose 
regularity of expression of trading interest demonstrates that they are 
acting as dealers. As some commenters expressly stated,\99\ the term 
``regular'' is part of the statutory definition of ``dealer'' in the 
Exchange Act.\100\ The term ``regular'' captures persons operating as 
dealers through their expression of trading interest on both sides of 
the market for the same security in a manner consistent with this 
statutory text.
---------------------------------------------------------------------------

    \98\ As proposed, the term ``routinely'' would have meant both 
repeatedly within a day and repeatedly over time. See Proposing 
Release at 23068.
    \99\ See supra note 97.
    \100\ 15 U.S.C. 78c(a)(5).
---------------------------------------------------------------------------

    A market participant does not need to be continuously expressing 
trading interest to be engaging in a ``regular'' business. The Exchange 
Act's definitions of ``dealer'' and ``government securities dealer'' do 
not include a requirement of continuous participation. The ordinary 
meaning of ``continuous'' is ``characterized by continuity; extending 
in space without interruption of substance; having not interstices or 
breaks; having its parts in immediate connection; connected, unbroken'' 
and ``marked by uninterrupted extension in space, time, or sequence,'' 
as defined by the Oxford English and the Merriam-Webster dictionaries, 
respectively.\101\ While such ``continuous'' expression of trading 
interest would be indicative of dealer activity, a continuous standard 
would not be appropriate because it would be too limited in markets for 
securities that exhibit varying degrees of depth and liquidity.\102\
---------------------------------------------------------------------------

    \101\ See, e.g., Iqbal v. United States Citizenship & Immigr. 
Servs., 397 F. Supp. 3d 273, 283 (W.D.N.Y. 2019) (quoting Merriam-
Webster, https://www.merriam-webster.com/dictionary/continuous (Aug. 
22, 2019)); see also Axia Inc. v. Jarke Corp., No. 87 C 8024, 1989 
WL 39722, at *3 (N.D. Ill. Apr. 20, 1989) (explaining that 
``continuous'' is commonly understood as ``uninterrupted'' in the 
context of an interpretation of a patent claim).
    \102\ See Remarks of Lorie K. Logan, Executive Vice President of 
the Federal Reserve Bank of New York, at the Brookings-Chicago Booth 
Task Force on Financial Stability, available at https://www.newyorkfed.org/newsevents/speeches/2020/log201023; Remarks of 
Deputy Secretary Justin Muzinich at the 2020 U.S. Treasury Market 
Conference [verbar] U.S. Department of the Treasury; see also 
Treasury Market Liquidity during the COVID-19 Crisis--Liberty Street 
Economics (newyorkfed.org). See also 2015 IAWG Report (when 
conducting an algorithm-level analysis from the event window on Oct. 
15, 2014, the IAWG found ``the analysis suggests that multiple types 
of trading strategies were deployed by PTFs during the event window. 
Some PTF algorithms appear to explain the considerable amount of net 
passive market making activity that was witnessed across cash and 
futures over the event window and likely was an important 
contributing factor to the absence of price gapping despite the 
unprecedented large price swings. Another, and equally significant, 
group of PTF strategies appears to have aggressively traded in the 
direction of price moves during the event window, accounting for the 
bulk of the overall aggressive trading imbalance observed.'').
---------------------------------------------------------------------------

    Whether a person's activity is ``regular'' will depend on the 
liquidity and depth of the relevant market for the security. For 
example, in markets that have significant liquidity and market depth, 
and have experienced advancements in technology and electronic trading, 
like the U.S. Treasury market,\103\ expressing trading interest on both 
sides of the market for the same security as part of an investment 
strategy on a one-off basis would not be sufficiently regular to be 
caught by the expressing trading interest factor. Rather, ``regular'' 
in the most liquid markets would mean more frequent periods of 
expressing trading interest on both sides of the market both intraday 
and across days given the efficiency in which securities can be bought 
and sold and the market's ability to absorb orders without 
significantly impacting the price of the security.\104\ In contrast, if 
the market for a security is less liquid, and it is difficult to 
execute orders in that security or large orders can dramatically affect 
the price of the security, the term ``regular'' would account for the 
possibility of more interruptions or wider spreads for the best 
available prices.
---------------------------------------------------------------------------

    \103\ See Proposing Release at 23055.
    \104\ See Proposing Release at 23058 (stating ``[t]he 
`regularity' of participation in securities transactions necessary 
to find that a person is a `dealer' '' has not been quantified, but 
involves engaging in `more than a few isolated' securities 
transactions.'') (citing SEC v. Am. Inst. Counselors, Inc., Fed. 
Sec. L. Rep. (CCH) ] 95388 (D.D.C. 1975)); see also supra note 98.
---------------------------------------------------------------------------

    The expressing trading interest factor captures the hallmark de 
facto market making activity in which dealers make a market in a 
security, standing ready to trade on both sides of the market on the 
same security on a regular ongoing basis.\105\ Those market 
participants that have established themselves as significant market 
intermediaries--and critical sources of liquidity--in a market by 
employing automated, algorithmic trading strategies that rely on high 
frequency trading strategies to generate a large volume of orders and 
transactions would be captured by the expressing trading interest 
factor.\106\ This would include market participants that, for example, 
employ passive market making strategies involving the submission of 
non-marketable resting orders (bids and offers) that provide liquidity 
to the marketplace at specified prices.\107\ Accordingly, the term 
``regularly'' will capture those market participants that engage in the 
activity described in the expressing trading interest factor on a 
frequent enough basis (both within a trading day and over time) that 
they do so as part of a regular business.
---------------------------------------------------------------------------

    \105\ See Concept Release on Equity Market Structure, Exchange 
Act Release No. 61358 (Jan. 14, 2010), 75 FR 3594 (Jan. 21, 2010) 
(``2010 Equity Market Structure Concept Release'') at 3607-08.
    \106\ See Amended Rule 15b9-1 Adopting Release at n.8.
    \107\ 2010 Equity Market Structure Concept Release at 3607-08.
---------------------------------------------------------------------------

Trading Interest
    The proposed second qualitative factor in the proposed rules would 
have applied to ``trading interests.'' The Proposing Release stated 
that the use of the broader term ``trading interests'' in the proposed 
second qualitative factor, rather than the term ``quotations,'' would 
reflect the prevalence of non-firm trading interest offered by 
marketplaces today, and account for the varied ways in which developing 
technologies permit market participants to hold themselves out as 
willing to buy or sell securities, or otherwise communicate their 
willingness to trade, and to effectively make markets.\108\ As 
explained in the Proposing Release, the broader term was intended to 
capture the traditional quoting engaged in by dealer liquidity 
providers, new and developing quoting equivalents, and the orders that 
actually result in the provision of liquidity.\109\ In other words,

[[Page 14949]]

the proposed use of the term ``trading interests'' was intended to 
update the Commission's longstanding understanding that regular or 
continuous ``quotation'' is a hallmark of market making or de facto 
market making (and, hence, dealer) activity, to reflect the various and 
evolving ways in which buyers and sellers of securities are brought 
together.\110\ Using the term ``trading interests,'' rather than 
``quotations,'' the Commission stated, would also allow for clear and 
consistent application of the definition of ``dealer'' and ``government 
securities dealer.'' \111\
---------------------------------------------------------------------------

    \108\ Proposing Release at 23068.
    \109\ Id.
    \110\ Id. The Commission has stated previously that a market 
maker engaged in bona-fide market making is a ``broker-dealer that 
deals on a regular basis with other broker-dealers, actively buying 
and selling the subject security as well as regularly and 
continuously placing quotations in a quotation medium on both the 
bid and ask side of the market.'' See, e.g., Exchange Act Release 
No. 32632 (July 14, 1993), 58 FR 39072, 39074 (July 21, 1993).
    \111\ Proposing Release at 23068.
---------------------------------------------------------------------------

    A number of commenters objected to the use of the term ``trading 
interests'' on various grounds including, among others, the difficulty 
in applying the term and the breadth of the term purportedly causing 
non-dealing trading activity to be captured.\112\ One commenter 
explained that it would be challenging for firms to assess whether non-
firm trading interest actually is at or near the best available price 
because non-firm trading interest often is not executed given that 
firms are not required to execute non-firm trading interest, even if 
matched.\113\ The commenter also stated that nearly any active investor 
or trader might express trading interests on both sides of the market 
to get best execution, and suggested limiting the factor instead to 
``firm two-sided quotations'' expressed on a ``continuous or near 
continuous basis.'' \114\ Another commenter similarly requested that 
the term ``trading interest'' be replaced with a quotation and order-
based standard.\115\
---------------------------------------------------------------------------

    \112\ See, e.g., MFA Comment Letter I; SIFMA AMG Comment Letter; 
AIMA Comment Letter II. A number of other commenters objected to the 
Proposing Release's use of the term ``trading interests'' on the 
grounds that the term is the subject of another proposed rule. See, 
e.g., ABA Comment Letter; SIFMA AMG Comment Letter; SIFMA Comment 
Letter I; MFA Comment Letter I. As discussed below, it is 
appropriate for the final rules to use the term ``trading 
interest.'' The Commission is adopting the term ``trading interest'' 
as explained herein for purposes of the final rules.
    \113\ MFA Comment Letter I.
    \114\ MFA Comment Letter II; see also MFA Comment Letter I.
    \115\ SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Two commenters stated that applying the proposed second qualitative 
factor to investment advisers would inappropriately subject them to 
potential dealer status simply for exercising their fiduciary 
duties.\116\ For example, one commenter stated that an investment 
adviser may have to submit trading interests throughout a trading day 
in order to obtain best execution and meet other fiduciary obligations 
acting for their clients, or to use specific trading protocols 
available in the market, such as the order book.\117\
---------------------------------------------------------------------------

    \116\ Id.; MFA Comment Letter I.
    \117\ SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Similarly, other commenters stated that the proposed second 
qualitative factor could require firms, including unregistered funds 
excluded from the Investment Company Act and registered investment 
advisers, to register as dealers for engaging in activity that has not 
historically been considered to be dealer activity.\118\ One commenter, 
for example, questioned whether portfolio managers, by taking long/
short positions or seeking arbitrage opportunities, would be required 
to register as dealers under the proposed second qualitative 
factor.\119\ Another commenter stated that some asset managers have 
funds with active fixed-income trading strategies involving indications 
of interest to trade bonds, as well as swaps, on similar or even 
identical underlying issuers in order to take advantage of mispricing 
or to create a unique non-directional risk profile in a trade.\120\ 
According to this commenter, although this activity entails 
communicating and indicating interest on such trades to a number of 
counterparties, it has never been considered dealing.\121\ Yet another 
commenter stated that firms that, as a primary element of their trading 
strategy, simultaneously and continuously post bids and offers in a 
specific instrument at or near the national best bid and offer, have 
not historically been treated as having engaged in dealer activity 
where the firm posting quotes did not hold itself out to 
customers.\122\ One commenter asked for clarity on how the proposed 
second qualitative factor would apply in the digital assets space, and 
in particular whether participants in a digital asset liquidity pool, 
by leaving their assets in the pool and thereby exposing those assets 
to sale at the pool's prevailing exchange rate, are expressing a 
``trading interest.'' \123\
---------------------------------------------------------------------------

    \118\ Id.; AIMA Comment Letter II.
    \119\ McIntyre Comment Letter II.
    \120\ See AIMA Comment Letter II (explaining, for example, that 
some asset managers may have funds with active fixed-income 
strategies that may be captured by the proposed second qualitative 
factor).
    \121\ AIMA Comment Letter II.
    \122\ Fried Frank Comment Letter. As discussed below, whether a 
person meets the definition of ``dealer'' is not contingent upon 
whether that person has customers.
    \123\ DeFi Fund Comment Letter.
---------------------------------------------------------------------------

    After consideration of the comments, the Commission has determined 
to adopt the proposed second qualitative factor with minor, non-
substantive modifications to the term ``trading interest.'' The term 
``trading interest'' means: (i) an ``order'' as the term is defined 
under 17 CFR 240.3b-16(c) (``Rule 3b-16(c)''); \124\ or (ii) any non-
firm indication of a willingness to buy or sell a security that 
identifies the security and at least one of the following: quantity, 
direction (buy or sell), or price. A standard of ``firm two-sided 
quotations'' expressed on a ``continuous or near continuous basis,'' 
while captured by the existing understanding of ``dealer'' under 
Exchange Act section 3(a)(5), does not account for the full range of 
liquidity-providing dealer activity undertaken in today's security 
markets.\125\ The term ``trading interest'' accounts for the varied 
mechanisms that permit market participants to effectively make markets. 
These include, but are not limited to, the use of streaming quotes, 
request for quotes (``RFQs''), or order books. To be captured by the 
expressing trading interest factor depends less on the method used to 
communicate trading interest, and more on whether the person is 
expressing trading interest on both sides of the market for the same 
security that has the effect of providing liquidity in the same 
security to other market participants.
---------------------------------------------------------------------------

    \124\ Rule 3b-16(c) states that ``the term order means any firm 
indication of a willingness to buy or sell a security, as either 
principal or agent, including any bid or offer quotation, market 
order, limit order, or other priced order.'' The Proposing Release 
previously referenced the definition of ``order'' under 17 CFR 
242.300. Proposing Release at 23068. This release refers to Rule 3b-
16(c), which defines the term ``order'' identically and is further 
discussed in the release adopting 17 CFR 242.300 through 242.304 
(``Regulation ATS''). See Regulation of Exchanges and Alternative 
Trading Systems, Exchange Act Release No. 40760 (Dec. 8, 1998), 63 
FR 70844 (Dec. 22, 1998).
    \125\ See Proposing Release at 23068.
---------------------------------------------------------------------------

    At the same time, expressing trading interest is not, standing 
alone, enough to demonstrate engaging in a ``regular pattern of buying 
and selling securities that has the effect of providing liquidity to 
other market participants'' under the final rules. Specifically, under 
the final rules, a person will be engaged in activity as part of a 
regular business if that person ``[e]ngages in a regular pattern of 
buying and selling securities that has the effect of providing 
liquidity to other market participants by . . . [r]egularly expressing 
trading interest that is at or near the best available prices on both 
sides of the market for

[[Page 14950]]

the same security and that is communicated and represented in a way 
that makes it accessible to other market participants (emphasis 
added).'' \126\ A market participant seeking price information by 
requesting quotes on a security, without including prices, on both 
sides of the market would generally not satisfy this qualitative factor 
because that trading interest, absent more, would not be ``at or near 
the best available price.'' With respect to the commenter's statement 
that investment advisers' fiduciary duties may require them to submit 
``trading interests'' throughout a trading day, the final rules have 
been modified so that the definition of ``own account'' applies to 
accounts in which the person holds the account in its name or the 
account is held for the benefit of that person.\127\ As such, the 
trading interest expressed by investment advisers for purposes of their 
fiduciary duty to their clients and their clients' accounts, such as 
when investment advisers place orders or request quotations on behalf 
of their clients, would not be activity captured by the expressing 
trading interest factor, unless the investment adviser itself is the 
account holder or the account is held for the benefit of the investment 
adviser.\128\ Moreover, as discussed above, persons engaging in the 
activity described in the qualitative standard are acting as dealers 
regardless of whether the person engaging in such dealer activity has 
or holds itself out to customers.\129\ The statutory definitions of 
``dealer'' and ``government securities dealer'' distinguish between a 
dealer and a trader on the basis of whether a person is in the 
``regular business'' of buying and selling securities for one's own 
account--not whether the person is doing so to effectuate customer 
orders.\130\
---------------------------------------------------------------------------

    \126\ See Rules 3a5-4(a)(1)(ii) and 3a44-2(a)(1)(ii).
    \127\ See SIFMA AMG Comment Letter. See also section II.A.4.
    \128\ Furthermore, as discussed in section II.A.3, the 
Commission declines to include an exclusion from the final rules for 
registered investment advisers and private funds and continues to 
believe that when engaged in dealer activity, including by 
expressing trading interest as set forth in the factor, registered 
investment advisers and private funds should be subject to the 
dealer regulatory regime, which includes not only registration 
obligations, but also comprehensive regulatory requirements and 
oversight that broadly focus on market functionality--that is, the 
impact of dealing activity on the market as a whole.
    \129\ See supra notes 55-59 and accompanying text.
    \130\ See id.; 15 U.S.C. 78c(a)(5); 15 U.S.C. 78c(a)(44)(A). In 
fact, the definition of ``broker'' presumes that a person is 
effectuating securities transactions on behalf of customers. See 15 
U.S.C. 78c(a)(4) (stating that a broker means ``any person engaged 
in the business of effecting transactions in securities for the 
account of others'') (emphasis added).
---------------------------------------------------------------------------

    One commenter questioned how to apply the term ``trading interest'' 
to certain types of products, structures, or activities in the so-
called decentralized finance (``DeFi'') market to provide crypto asset 
securities liquidity.\131\ Whether a particular activity in the crypto 
asset securities market, including in the so-called DeFi market, gives 
rise to dealer activity requires an analysis of the totality of the 
particular circumstances against all elements of the expressing trading 
interest factor.\132\ Commenters argued that crypto assets should not 
be covered by the final rules.\133\ However, the Commission is not 
excluding any particular type of securities, including crypto asset 
securities, from the application of the final rules. The dealer 
framework is a functional analysis based on the securities trading 
activities undertaken by a person, not the type of security being 
traded. Persons, including persons using so-called ``automated market 
makers,'' that are engaged in buying and selling securities for their 
own account must consider whether they are dealers under the final 
rules, and thus subject to dealer registration requirements.\134\ As 
discussed below, the final rules build off existing legal standards 
and, as discussed throughout this release, are designed to address 
where market participants are engaging in de facto market making and 
required to register as dealers or government securities dealers, 
regardless of which such technology is used.\135\ As explained 
throughout this release, the application of the dealer regulatory 
regime to such persons will promote the Commission's longstanding 
mission.
---------------------------------------------------------------------------

    \131\ DeFi Fund Comment Letter.
    \132\ A threshold question in determining the applicability of 
the final rules is whether a person engaging with products, 
structures, or activities in the so-called DeFi market has or 
controls total assets of less than $50 million. See 17 CFR 240.3a5-
4(a)(2)(i) (``Rule 3a5-4(a)(2)(i)''); 17 CFR 240.3a44-2(a)(2)(i) 
(``Rule 3a44-2(a)(2)(i)''); section II.A.3. If so, that person would 
not be captured by the final rules. See also 17 CFR 240.3a5-4(d); 17 
CFR 240.3a44-2(d) (providing that a person not meeting the 
conditions set forth in the final rules may nonetheless be a dealer 
if it otherwise engages in a regular business of buying and selling 
securities for its own account); infra note 284 and accompanying 
text (citing examples where persons engaging in crypto asset 
securities transactions are operating as dealers as defined under 
section 3(a)(5)). If this exclusion cannot be relied upon, then the 
expressing trading interest factor could apply. Furthermore, as 
discussed in section II.A.3.a, the exclusion for persons having or 
controlling less than $50 million in total assets applies to the 
final rules and does not modify existing applicable court precedent 
and Commission interpretations.
    \133\ See, e.g., ADAM Comment Letter (stating ``the blanket 
application of the dealer and government securities dealer 
regulatory framework to digital assets would be premature and 
imprudent.''); see also Consensys Comment Letter; DeFi Fund Comment 
Letter; Chamber of Digital Commerce Comment Letter; Blockchain 
Association Comment Letter.
    \134\ The application of the final rules turns on whether a 
particular crypto asset is a security, as defined under the U.S. 
Federal securities laws. The term ``security'' includes an 
``investment contract,'' as well as other instruments. To the extent 
there is a question as to whether a particular crypto asset is an 
investment contract that is a security, the analysis is governed by 
the test first articulated by the Supreme Court in SEC v. W.J. Howey 
Co., 328 U.S. 293, 301 (1946). See, e.g., SEC v. Terraform Labs PTE, 
Ltd., No. 23-cv-1346, 2023 WL 8944860 (S.D.N.Y. Dec. 28, 2023 
(stating that Howey was and remains a binding statement of law and 
that there was no genuine dispute that the elements of the Howey 
test had been met)); SEC v. Kik Interactive Inc., 492 F. Supp. 3d 
169, 177-180 (S.D.N.Y. 2020) (applying Howey in granting the 
Commission's motion for summary judgment finding Kik's sale of Kin 
tokens to the public was a sale of a security and required a 
registration statement); SEC v. LBRY, No. 21-CV-260-PB, 2022 WL 
16744741 (D.N.H. Nov. 7, 2022) (applying Howey in granting the 
Commission's motion for summary judgment finding ``no reasonable 
trier of fact could reject the SEC's contention that LBRY offered 
LBC [a crypto asset] as a security.''); Report of Investigation 
Pursuant to Section 21(a) of the Securities Exchange Act of 1934: 
The DAO, Exchange Act Release No. 81207 (July 25, 2017) (``DAO 21(a) 
Report'') (describing how DAO tokens were securities under Howey).
    \135\ See sections II.A.3, III.D.6; see also Policy 
Recommendations for Crypto and Digital Asset Markets Final Report, 
Board of the International Organization of Securities Commissions 
(Nov. 2023) (stating that ``the regulatory frameworks (existing or 
new) should seek to achieve regulatory outcomes for investor 
protection and market integrity that are the same as, or consistent 
with, those required in traditional financial markets in order to 
facilitate a level-playing field between crypto-assets and 
traditional financial markets and help reduce the risk of regulatory 
arbitrage''), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD747.pdf; Final Report with Policy Recommendations for 
Decentralized Finance (DeFi), Board of the International 
Organization of Securities Commissions (Dec. 2023), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD754.pdf.
---------------------------------------------------------------------------

Both Sides of the Market
    Under the proposed rules, in order to come within the proposed 
second qualitative factor, the expression of trading interests would 
need to be ``at or near the best available prices on both sides of the 
market.'' \136\ As discussed in the Proposing Release, the phrase ``at 
or near the best available prices on both sides of the market'' 
describes ``the activity of liquidity-providing dealers, which help 
determine the spread between the best available bid price and the best 
available ask price for a given security.'' \137\ The Proposing Release 
further explained that, by competing to both buy and sell at the best 
available prices, liquidity providers help to narrow bid-ask 
spreads.\138\ The Commission also stated that the proposed second 
qualitative factor helped to emphasize that a liquidity

[[Page 14951]]

provider, to come within the rules, must both buy and sell 
securities.\139\
---------------------------------------------------------------------------

    \136\ Proposing Release at 23068.
    \137\ Id. (emphasis added).
    \138\ Id.
    \139\ Id.
---------------------------------------------------------------------------

    Several commenters requested clarification as to how to apply the 
phrase ``on both sides of the market,'' particularly, with regard to 
what period of time to use when evaluating orders placed on both sides 
of the market, and as to whether the phrase applies to the market for a 
single security or related instruments.\140\ Some commenters asserted 
that the absence of a time limitation could prevent market participants 
from using all available trading strategies in a market, including 
active trading strategies where a person would post resting offers and 
bids on a central limit order book (``CLOB''), without registering as a 
dealer.\141\ Two of these commenters urged the Commission to modify the 
proposed second qualitative factor to clarify that the trading interest 
must be expressed on both sides of the market simultaneously.\142\ 
According to one commenter, if the proposed second qualitative factor 
does not require that the trading interest be expressed on both sides 
of the market simultaneously, it ``would result in this test capturing 
trading that is not consistent with dealer activity.'' \143\ Commenters 
also urged the Commission to clarify that the phrase ``both sides of 
the market'' applied to the same security.\144\ One commenter suggested 
that the Commission modify the proposed second qualitative factor to 
add the phrase ``for the same security.'' \145\
---------------------------------------------------------------------------

    \140\ See, e.g., SIFMA AMG Comment Letter; AIMA Comment Letter 
II; MFA Comment Letter I; Citadel Comment Letter.
    \141\ Id. For instance, according to one commenter, there are 
examples of where market participants using a CLOB routinely express 
trading interests on both sides of the market in various instruments 
over the course of a trading day, and CLOBs can benefit both market 
liquidity and competition. See Citadel Comment Letter.
    \142\ See MFA Comment Letter I; Citadel Comment Letter.
    \143\ MFA Comment Letter I.
    \144\ See, e.g., Citadel Comment Letter; Lewis Study; MFA 
Comment Letter I; MFA Comment Letter II.
    \145\ MFA Comment Letter II.
---------------------------------------------------------------------------

    Consistent with the Proposing Release which explained that the 
proposed second qualitative factor applies to persons expressing 
trading interests on both sides of the market in a given security, the 
Commission is modifying the rule text to add the phrase ``for the same 
security'' to the second qualitative factor.\146\
---------------------------------------------------------------------------

    \146\ Proposing Release at 23068 (stating ``[t]he phrase `best 
available prices on both sides of the market' more specifically and 
clearly describes the activity of liquidity-providing dealers, which 
help determine the spread between the best available bid price and 
the best available ask price for a given security'') (emphasis 
added). The phrase ``same security'' is to be interpreted as that 
phrase is used in the Proposing Release. See Proposing Release at 
23067 (stating `` `the same' securities means that the securities 
bought and sold are securities of the same class and having the same 
terms, conditions, and rights [, and] securities bearing the same 
Committee on Uniform Securities Identification Procedures (`CUSIP') 
number, for example, would be considered `the same.' '').
---------------------------------------------------------------------------

    The Commission is not adopting a requirement that the trading 
interest be expressed simultaneously on both sides of the market. 
Limiting the expressing trading interest factor to the simultaneous 
expression of trading interests could exclude other regular expressions 
of trading interest that constitute dealer activity by providing 
liquidity to other market participants. While simultaneously expressing 
trading interest on both sides of the market in the same security is 
indicative of dealer activity, market participants also can be acting 
as dealers by regularly providing liquidity even where the expressions 
of trading interest on both sides of the market for the same security 
are not simultaneous, particularly because the markets for different 
securities have varying structures, trading volume, and liquidity.\147\ 
Further, adding a simultaneity condition could lead to behavior where a 
dealer might, for example, express trading interest to buy and sell in 
alternate moments in time to evade the requirement to register. 
Accordingly, the Commission is not conditioning the application of the 
expressing trading interest factor on trading interests being expressed 
simultaneously. Due to the differences between markets, participants 
will need to assess the totality of their trading activity to determine 
if they are expressing trading interests on both sides of the market 
for the same security sufficiently close in time to have the effect of 
providing liquidity in the same security to other market participants.
---------------------------------------------------------------------------

    \147\ See 2010 Equity Market Structure Concept Release at 3608 
(stating that ``proprietary traders are analogous to OTC [over-the-
counter] market makers in that they have considerable flexibility in 
trading without significant negative or affirmative obligations for 
overall market quality'').
---------------------------------------------------------------------------

    The Commission recognizes that non-firm trading interest (and firm 
quotations for that matter) need not be executed, even if matched. 
Nonetheless, it will be possible to assess whether a non-firm trading 
interest is actually ``at or near the best available price,'' using the 
similar information that market participants use to make bids and 
offers, including recently completed purchases and sales and the 
totality of indications of willingness to buy or sell at specified 
prices.\148\ For example, market participants can use similar 
information to that used by registered broker-dealers to assess whether 
a customer order was executed at the best available price.\149\
---------------------------------------------------------------------------

    \148\ See, e.g., Disclosure of Order Execution and Routing 
Practices, Exchange Act Release No. 43590 (Nov. 17, 2000), 65 FR 
75414, 75418 (Dec. 1, 2000) (stating that quotation information 
contained in the public quotation system must be considered in 
seeking best execution of customer orders).
    \149\ Id.
---------------------------------------------------------------------------

    Finally, as discussed above in connection with the term ``trading 
interest,'' to come within this factor, a person expressing trading 
interest (including through a CLOB) must be buying and selling 
securities, and it must engage in such activity ``regularly.''
Accessible to Other Market Participants
    Under the proposed rules, market participants would have had to 
routinely express trading interests accessible to other market 
participants to be considered to have engaged in a routine pattern of 
trading that has the effect of providing liquidity to other market 
participants.\150\ In the Proposing Release, the Commission explained 
that the proposed second qualitative factor would apply only when the 
expressed trading interests that are at or near the best available 
prices on both sides of the market are ``communicated and represented 
in a way that makes them accessible to other market participants.'' 
\151\
---------------------------------------------------------------------------

    \150\ Proposing Release at 23068.
    \151\ Id.
---------------------------------------------------------------------------

    One commenter objected to the proposed second qualitative factor's 
phrase ``communicated and represented in a way that makes them 
accessible to other market participants,'' stating that the Proposing 
Release does not make clear whether trading interests made available to 
a limited group of participants via a RFQ would trigger the factor, 
versus trading interests published on a broadly accessible order book. 
The commenter stated further that the vagueness of the standard would 
prevent market participants from applying it with confidence and might 
encourage market participants to choose execution venues and order 
types that are not transparent or accessible.\152\ This commenter 
recommended adopting a test defining a person acting as a bona fide 
market maker under 17 CFR 242.200 through 242.204 (``Regulation SHO'') 
as a dealer, in lieu of the first and second proposed qualitative 
factors.\153\
---------------------------------------------------------------------------

    \152\ MFA Comment Letter I.
    \153\ Id.
---------------------------------------------------------------------------

    The phrase ``accessible to other market participants'' reflects the 
plain

[[Page 14952]]

meaning that a person expresses trading interests to more than one 
market participant. For example, where a person makes a trading 
interest available (such as streaming two-way indicative quotes) to 
more than one market participant, even if the person made that trading 
interest available through individual communications, that person would 
be expressing trading interest accessible to other market 
participants.\154\ Again, the expressing trading interest factor does 
not hinge on any particular method of communication and representation 
(e.g., RFQ, indications of interest, or streaming quotes); it depends 
on the totality of the trading activity to determine if the person is 
expressing trading interests on both sides of the market for the same 
security to have the effect of providing liquidity in the same security 
to other market participants.
---------------------------------------------------------------------------

    \154\ On the other hand, when an investor seeking liquidity 
sends a single, one-sided RFQ to a number of potential liquidity 
providers, this action by itself does not generally trigger the 
expressing trading interest factor because it is on one side of the 
market in an isolated instance.
---------------------------------------------------------------------------

    The Commission is not adopting the suggestion to replace this 
factor with a test defining a dealer as a person engaging in bona fide 
market making activities under Regulation SHO. The bona fide market 
making exception under Regulation SHO applies to a specific subset of 
dealer activity. As the Commission previously stated when proposing 
Regulation SHO, ``a narrow exception for market makers and specialists 
engaged in bona fide market making activities is necessary because they 
may need to facilitate customer orders in a fast moving market without 
possible delays associated with complying with the proposed `locate' 
rule.'' \155\ For example, a broker-dealer must claim the bona fide 
market making exception from the locate requirement of Regulation SHO 
at the time of the short sale in a particular security.\156\ 
Accordingly, limiting the applicability of the final rules to those 
persons eligible for Regulation SHO's bona-fide market-making exception 
would exclude persons engaged in other liquidity-providing dealer 
activity.
---------------------------------------------------------------------------

    \155\ Short Sales, Exchange Act Release No. 48709 (Oct. 28, 
2003), 68 FR 62972, 62977 (Nov. 6, 2003); see also Short Position 
and Short Activity Reporting by Institutional Investment Managers, 
Exchange Act Release No. 98738 (Oct. 13, 2023), 88 FR 75100, 75136 
(Nov. 1, 2023) (stating ``a market maker must also be a market maker 
in the security being sold, and must be engaged in bona-fide market 
making in that security at the time of the short sale.'').
    \156\ The determination of eligibility for the bona-fide market-
making exceptions in Regulation SHO is distinct from the 
determination of whether the effect of a person's trading activity 
indicates that such person is acting as a dealer. Proposing Release 
at n.131.
---------------------------------------------------------------------------

    One commenter stated that the proposed second qualitative factor 
would impact the Commission's Order Competition Rule proposal.\157\ On 
December 14, 2022, the Commission proposed a rule that would require 
certain orders of individual investors to be exposed to competition in 
fair and open auctions before such orders could be executed internally 
by any trading center that restricts order-by-order competition.\158\ 
As discussed below, the Commission has considered the current 
regulatory landscape in presenting the baseline. To the extent the 
proposed Order Competition Rule is adopted, the baseline in that 
rulemaking will reflect the regulatory landscape that is current at 
that time.\159\
---------------------------------------------------------------------------

    \157\ Comment Letter of Two Sigma (Mar. 31, 2023) (``Two Sigma 
Comment Letter II'').
    \158\ Order Competition Rule, Exchange Act Release No. 96495 
(Dec. 14, 2022), 88 FR 128 (Jan. 3, 2023).
    \159\ See section III.B.
---------------------------------------------------------------------------

    In sum, the Commission has determined to replace the term 
``routinely'' with ``regularly,'' add the phrase ``for the same 
security,'' and make non-substantive modifications to this factor, but 
otherwise is adopting this factor as proposed.
c. Primary Revenue Factor
    Finally, the Commission proposed a third qualitative factor 
encompassing activity that ``has the effect of providing liquidity to 
other market participants.'' Specifically, under proposed 17 CFR 
240.3a5-4(a)(1)(iii) and 240.3a44-2(a)(1)(iii), a person that, trading 
for its own account, ``earn[ed] 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,'' would have been engaging in a routine 
pattern of trading that has the effect of providing liquidity to other 
market participants, and as a result, would have been a dealer under 
the proposed rules.
    The Commission explained in the Proposing Release that one 
fundamental characteristic typical of market makers and liquidity 
providers--and one that has historically been viewed as dealer 
activity--is trading in a manner designed to profit from bid-ask 
spreads or liquidity incentives rather than with a view toward 
appreciation in value.\160\ We stated that persons engaged in such 
activity are ``in the business'' of providing liquidity because (1) 
they routinely supply it and (2) the revenue they earn through bid-ask 
spreads or liquidity incentives is their primary source of 
revenue.\161\
---------------------------------------------------------------------------

    \160\ Proposing Release at 23069.
    \161\ Id.
---------------------------------------------------------------------------

    The proposed third qualitative factor accounted for both forms of 
revenue. As to the first--capturing bid-ask spreads--the Commission 
stated that when a liquidity provider routinely buys and sells 
securities in a manner designed to capture a spread with such frequency 
and consistency that its revenue is made up primarily of this form of 
compensation, it would be considered to be engaged in a routine pattern 
of providing liquidity as a service and would fall within the scope of 
the rules.\162\ As to the second, the Commission stated that when a 
liquidity provider, as a result of its routine purchases and sales of 
securities, captures ``incentives offered by trading venues to 
liquidity-supplying trading interests'' with such frequency and 
consistency that its revenue is made up primarily of this form of 
compensation, it would be considered to be engaged in a routine pattern 
of providing liquidity as a service and generally standing ready to buy 
or sell securities, and so would fall within the scope of the proposed 
rules.\163\
---------------------------------------------------------------------------

    \162\ Id.
    \163\ Id.
---------------------------------------------------------------------------

    In the Proposing Release, the Commission explained the meaning of 
certain key terms in the proposed third qualitative factor. The 
Commission stated that the factor used the phrase ``earn revenue''--
rather than, for example, ``profit from''--to make clear that a 
person's trading strategies would not need to be profitable to bring 
them within the rule.\164\ Dealer activity is dealer activity 
regardless of whether it is profitable. With respect to the term 
``primarily,'' the Commission further stated that, generally speaking, 
although the Commission has not established a bright-line test, if a 
person derives the majority of its revenue from either of the sources 
described in the proposed third qualitative standard, it would likely 
be in a regular business of buying and selling securities or government 
securities for its own account.\165\
---------------------------------------------------------------------------

    \164\ Id.
    \165\ Id.
---------------------------------------------------------------------------

    Finally, with respect to the term ``trading venues,'' the 
Commission stated that market evolution has given rise to a variety of 
venues in which liquidity providers can express trading interests, and 
the term ``trading venues'' is designed to capture the breadth of these 
different venues.\166\ In explaining

[[Page 14953]]

the term ``trading venue'' the Proposing Release referenced a 
definition of ``trading venue'' that described it to mean ``a national 
securities exchange or national securities association that operates an 
SRO trading facility, an ATS, an exchange market maker, an OTC market 
maker, a futures or options market, or any other broker- or dealer-
operated platform for executing trading interest internally by trading 
as principal or crossing orders as agent.'' \167\ The Commission 
further stated that the third proposed qualitative standard was 
designed to capture dealer activity wherever that activity occurs, 
``whether on a national securities exchange, an ATS . . . or another 
form of trading venue.'' \168\ The Commission also stated that for 
purposes of the proposed rules, the particular venue mattered less than 
the fact that a market participant provides liquidity on it.\169\
---------------------------------------------------------------------------

    \166\ Id. at 23069-70. As discussed in the Proposing Release, 
the term ``trading venue'' was designed to capture the variety and 
breadth of different venues resulting from market evolution. Id. To 
the extent new systems develop as a result of technological 
advancements that offer market participants the ability to provide 
liquidity in a security for other market participants, the term 
``trading venue'' would apply to such systems. Id.
    \167\ Id. Whether an entity is or is not registered with the 
Commission does not affect the determination of whether that entity 
is a trading venue for purposes of the final rules. For example, a 
person operating a platform for executing trading interest 
internally would likely be operating as a broker or dealer, 
regardless of whether that person is registered as such, and the 
receipt of incentives from that person could be captured by the 
factor. See 15 U.S.C. 78o(a)(1) (absent an exemption, persons 
meeting the definition of broker or dealer must register with the 
Commission).
    \168\ Proposing Release at 23070 (emphasis added).
    \169\ Id.
---------------------------------------------------------------------------

    Of the three proposed qualitative factors, this factor received the 
fewest comments. Two commenters supported the third qualitative factor 
as proposed.\170\ According to one of the commenters, capturing bid-ask 
spreads or earning revenue from liquidity incentives have traditionally 
been indicative of dealing activity and the proposed third qualitative 
standard would be less likely to capture certain funds, advisers, and 
trading strategies that the commenter believed would be inappropriately 
captured by the first and second qualitative factors.\171\
---------------------------------------------------------------------------

    \170\ SIFMA Comment Letter I (stating that ``[s]ubject to our 
additional comments on the application of the proposed rules to bank 
holding companies, we believe that the qualitative standard in 
proposed . . . Rule 3a44-2(iii) [is] generally a good step forward 
to address this long-standing asymmetric regulatory treatment for 
similar [dealing] activities.''); see also AIMA Comment Letter II 
(requesting the Commission to limit the qualitative standard to the 
third factor alone).
    \171\ AIMA Comment Letter II.
---------------------------------------------------------------------------

    Another commenter stated the proposed third qualitative factor was 
``workable,'' assuming two modifications.\172\ First, the commenter 
stated that the proposed third qualitative factor should turn on 
``profit,'' rather than ``revenue.'' \173\ In the commenter's view, 
because dealers are in the business of profiting from their market-
making activities, they are unlikely to be (or stay) engaged in markets 
if they are not profiting from their dealer activities.\174\ As a 
result, the commenter believed that a person otherwise meeting the 
factor but failing to earn profits in doing so is better viewed as a 
trader than a dealer.\175\ Second, the commenter stated that the 
proposed third qualitative factor should be limited to ``national 
securities exchanges and ATSs,'' rather than ``trading venues.'' \176\ 
In the commenter's view, to reduce the compliance burdens on market 
participants while capturing the most significant trading activity, the 
rule should be limited to the most liquid trading venues, including 
those where liquidity incentives are most likely to be offered and 
where trading to profit from the spread occurs most often.\177\ The 
commenter stated that this change would avoid difficult and unworkable 
line-drawing questions, such as when pricing offered by an OTC market 
maker to its customer would constitute an ``incentive'' captured by the 
rule.\178\
---------------------------------------------------------------------------

    \172\ See MFA Comment Letter I; see also MFA Comment Letter II. 
Another commenter stated it shared many of the comments raised by 
MFA with respect to the proposed third qualitative test. See 
BlackRock Comment Letter. See also ICI Comment Letter (stating 
``[t]o avoid unintentionally capturing ordinary investment and 
trading strategies, the Commission should limit the qualitative test 
to capture persons trading only in the same securities--where this 
purpose is clear--rather than trading in merely similar 
securities.'').
    \173\ See MFA Comment Letter I.
    \174\ See id.
    \175\ See id.
    \176\ Id. See also ABA Comment Letter (``the proposed tests for 
the definition of ``dealer'' requires interpreting terms that are 
not yet settled because they are concurrently being commented on in 
a proposed form.''); DeFi Fund Comment Letter (stating ``whether a 
DeFi protocol constitutes a `trading venue' is likely to turn on the 
outcome of the Commission's pending proposal to expand its 
`exchange' definition, which we strongly oppose.''). As discussed 
below, the Commission believes it is appropriate for the final rules 
to use the term ``trading venues.'' The Commission has proposed an 
amendment to Form ATS-N to change the term ``Trading Centers'' to 
``trading venue'' and has proposed the term to mean a national 
securities exchange or national securities association that operates 
an SRO trading facility, an ATS, an exchange market maker, an OTC 
market maker, a futures or options market, or any other broker- or 
dealer-operated platform for executing trading interest internally 
by trading as principal or crossing orders as agent. See Amendments 
regarding the Definition of ``Exchange'' and Alternative Trading 
Systems (ATSs) that Trade U.S. Treasury and Agency Securities, 
National Market System (NMS) Stocks, and Other Securities, Exchange 
Act Release No. 94062 (Jan. 26, 2022), 87 FR 15496, 15539-40 (Mar. 
18, 2022). Although the term ``trading venue'' is used in the final 
rules and the proposed amendment to Form ATS-N, the adoption of the 
term as discussed above is appropriate for the final rules.
    \177\ MFA Comment Letter I.
    \178\ Id.
---------------------------------------------------------------------------

    Some commenters objected to the proposed third qualitative 
factor,\179\ expressing concerns about the lack of clarity as to, and 
breadth of, its application.\180\ One of these commenters stated that 
the term ``primarily'' is potentially vague because a person might earn 
more revenue from appreciation in the value of its inventory of 
securities than from capturing bid-ask spreads or trading 
incentives.\181\ Another commenter explained that certain portfolio 
management and trading strategies, like hedging and arbitrage 
strategies, among other things, seek to derive value, positive fund 
performance, and portfolio-trading revenues by taking advantage of 
pricing differentials in bid-ask spreads.\182\ The commenter stated 
that such strategies have not traditionally been viewed as dealer 
activity and questioned whether they would be captured by the proposed 
third qualitative factor.\183\ Another commenter stated that trading 
incentives are often organized in a manner that allows traders or their 
investment advisers to reduce overall commissions and fees paid by 
directing liquidity-providing trades to specific venues.\184\ In the 
commenter's view, the ``optimization of commission costs by an 
investment adviser on behalf of investors, or by a trader acting on his 
or her own behalf, should not by itself require registration as a 
dealer for a person who is otherwise a trader.'' \185\ Finally, some 
commenters objected that the proposed third qualitative factor's 
application in the crypto asset securities market may not be clear, 
including how the factor applies to so-called DeFi market products, 
structures, and activities such as so-called decentralized exchange 
(``DEX'') and ``automated market maker'' activities, as well as 
activities related to blockchain consensus and validation.\186\
---------------------------------------------------------------------------

    \179\ See, e.g., FIA PTG Comment Letter II.
    \180\ See, e.g., Gretz Comment Letter; McIntyre Comment Letter 
II; Element Comment Letter; SIFMA AMG Comment Letter; ICI Comment 
Letter; MFA Comment Letter I.
    \181\ Gretz Comment Letter.
    \182\ McIntyre Comment Letter II.
    \183\ Id.
    \184\ Element Comment Letter.
    \185\ Id.
    \186\ See, e.g., ADAM Comment Letter (stating that ``the third 
qualitative factor does not account for `staking' and the way in 
which some blockchains use the proof-of-stake consensus mechanism to 
validate transactions, leaving unclear whether certain `validators' 
might be captured by the third qualitative factor.''); DeFi Fund 
Comment Letter (questioning if the ``liquidity provider tokens'' 
participants in digital asset liquidity pools receive in proportion 
to the amount of liquidity they contribute to the pool constitute an 
``incentive . . . for liquidity-supplying trading interests'').

---------------------------------------------------------------------------

[[Page 14954]]

    After consideration of the comments, the Commission has determined 
to adopt, as the primary revenue factor, the third qualitative factor 
as proposed, with a non-substantive change. The final rules continue to 
use the phrase ``earn revenue'' rather than ``earn profit.'' While the 
Commission acknowledges the possibility that persons whose liquidity 
provision fails to turn a profit may ultimately seek out more 
profitable lines of business, dealer status requires only that a person 
be ``in the business,'' not that that business be profitable.\187\
---------------------------------------------------------------------------

    \187\ See Proposing Release at 23069.
---------------------------------------------------------------------------

    The term ``trading venues'' is intended to accommodate the variety 
of venues in which market participants today engage in liquidity-
providing dealer activity. In addition, the use of this term is 
intended to capture venues as they evolve, wherever that activity 
occurs, whether on a national securities exchange, an ATS, any other 
broker- or dealer-operated platform for executing trading interest 
internally by trading as principal or crossing orders as agent, or any 
other platform performing a similar function.\188\ The particular venue 
matters less than the fact that a market participant provides liquidity 
on it.\189\ As discussed in the Proposing Release, there have been 
notable technological enhancements affecting securities trading across 
markets and asset classes.\190\ Accordingly, the term ``trading 
venues'' is designed to capture current trading venues that use a 
variety of technologies, as well as trading venues that use 
technologies and venues that may develop over time. The term ``trading 
venues'' is designed to help ensure that, as innovation and technology 
used by such venues evolve, the final rules remain effective at 
supporting market stability and resiliency, protecting investors, and 
promoting competition across the U.S. Treasury and other securities 
markets. For these reasons, the Commission declines to limit the scope 
of this factor to trading venues that are national securities exchanges 
or ATSs.
---------------------------------------------------------------------------

    \188\ Whether a particular structure or activity in the crypto 
asset securities market, including the so-called DeFi market, 
involves a trading venue is a facts and circumstances determination.
    \189\ See Proposing Release at 23069.
    \190\ See Proposing Release at 23055.
---------------------------------------------------------------------------

    Regarding the term ``primarily'' as used in the primary revenue 
factor, the Proposing Release stated that if a person derives the 
majority of its revenue from the sources described in paragraph 
(a)(3)(iii), it would likely be in a regular business of buying and 
selling securities or government securities for its own account.\191\ 
Further, in response to one commenter's example,\192\ while the 
analysis of this specific scenario would depend on the totality of 
circumstances, as a general matter, it is unlikely that a person who 
regularly earns more revenue from an appreciation in the value of its 
inventory of securities than from capturing bid-ask spreads or 
incentive payment for liquidity provision, would be considered to earn 
revenue ``primarily'' from capturing bid-ask spreads or trading 
incentives.
---------------------------------------------------------------------------

    \191\ Proposing Release at 23069.
    \192\ See Gretz Comment Letter (stating `` `Primarily' might be 
a bit vague. Technically, an entity could earn more revenues by 
price increases on the securities being held in stock for trading 
than by catching bid-ask spreads.'').
---------------------------------------------------------------------------

    A commenter stated that the Proposing Release did not account for 
how the primary revenue factor would apply to market participants 
transacting in the crypto asset securities market; as commenters have 
pointed out, the crypto asset securities market has structures, 
products and activities that may implicate dealer registration.\193\ 
Whether a particular activity in the crypto asset securities market, 
including in the so-called DeFi market, gives rise to dealer activity 
will require an analysis of the totality of the particular facts and 
circumstances. As discussed above, any person engaged in buying and 
selling securities for its own account must consider whether it is a 
dealer, including under the final rules, and so subject to dealer 
registration requirements.\194\ Accordingly, the primary revenue factor 
will capture market participants that are primarily earning revenue 
from capturing spreads or liquidity incentives offered by trading 
venues, including trading venues that support transacting in crypto 
asset securities.\195\
---------------------------------------------------------------------------

    \193\ See DeFi Fund Comment Letter; ADAM Comment Letter. A 
commenter explained that ``a blockchain utilizing proof-of-stake 
validation lets users participate in verifying the blockchain by 
staking the native token, providing a reward if they propose and 
approve valid smart contracts.'' ADAM Comment Letter.
    \194\ See section II.A.1.b.
    \195\ As discussed above, a threshold question is whether the 
person has or controls total assets of less than $50 million, and if 
so, the person would not be captured by the final rules. See supra 
note 132 and accompanying text.
---------------------------------------------------------------------------

    With respect to portfolio management and trading strategies that 
for varying reasons may seek to take advantage of pricing differentials 
in bid-ask spreads, as stated above, persons who engage in a pattern of 
trading for their own account having the effect of providing liquidity 
to other market participants should be subject to the dealer regulatory 
regime, even if they are also registered investment advisers or private 
funds. As discussed below, the important protections provided by the 
dealer regulatory framework differ from those under the private fund 
and private fund advisers regulatory scheme established by the Advisers 
Act.\196\ The primary revenue factor, as with the expressing trading 
interest standard, focuses on activity rather than label or status. 
Market participants will need to determine, based on their trading 
activities, whether their portfolio management and trading strategies 
meet this standard.
---------------------------------------------------------------------------

    \196\ See section II.A.3.
---------------------------------------------------------------------------

    To summarize, one fundamental and historically recognized view of 
dealer activity is trading in a manner designed to profit from spreads 
or liquidity incentives.\197\ Under the final rules, persons providing 
liquidity because they regularly supply it and the revenue they earn as 
a result through bid-ask spreads or liquidity incentives as their 
primary source of revenue are ``in the business'' of dealing, and such 
persons regularly undertaking this liquidity-providing role for their 
own account in overall trading and market activity must register as 
dealers and be subject to the dealer regulatory regime.
---------------------------------------------------------------------------

    \197\ Proposing Release at 23069. The Commission has previously 
identified a person's seeking, through its presence in the market, 
compensation through spreads or fees, or other compensation not 
attributable to changes in the value of the security traded, as a 
factor indicating dealer activity. See Entities Release at 30609.
---------------------------------------------------------------------------

2. Quantitative Standard
    The Commission proposed a quantitative standard that would 
establish a bright-line test under which persons engaging in certain 
specified levels of activity in the U.S. Treasury market would be 
defined to be buying and selling government securities ``as a part of a 
regular business,'' regardless of whether they meet any of the 
qualitative factors.\198\ Specifically, proposed 17 CFR 240.3a44-
2(a)(2) (proposed ``Rule 3a44-2(a)(2)'') provided that a person engaged 
in buying and selling government securities for its own account would 
be engaged in such activity ``as a part of a regular business'' if that 
person in each of four out of the last six calendar months, engaged in 
buying and selling more than $25 billion of trading volume in 
government

[[Page 14955]]

securities as defined in section 3(a)(42)(A) of the Exchange Act.\199\
---------------------------------------------------------------------------

    \198\ See Proposing Release at 23071, n.165.
    \199\ Proposed Rule 3a44-2(a)(2); Proposing Release at 23071.
---------------------------------------------------------------------------

    Some commenters generally supported inclusion of the quantitative 
standard.\200\ One commenter stated that ``quantitative standard[ ] 
build[s] upon and [is] consistent with past Commission regulations and 
case law for defining a dealer.'' \201\ The majority of commenters, 
however, urged that the Commission remove the quantitative standard, 
raising various issues and concerns with establishing a test based 
solely on trading volume.\202\
---------------------------------------------------------------------------

    \200\ See Better Markets Comment Letter (stating that the 
``quantitative standards for government securities markets, coupled 
with the proposed qualitative standards, will help to capture the 
high-frequency trading firms trading in significant volumes of U.S. 
Treasury bonds that are not currently registered with the 
Commission.''); see also FINRA Comment Letter.
    \201\ Better Markets Comment Letter.
    \202\ See, e.g., Element Comment Letter; MMI Comment Letter; Two 
Sigma Comment Letter I; FIA PTG Comment Letter I; NAPFM Comment 
Letter; AIMA Comment Letter II; ADAM Comment Letter; SIFMA AMG 
Comment Letter; McIntyre Comment Letter II; SIFMA Comment Letter I; 
Overdahl Comment Letter; Fried Frank Comment Letter; MFA Comment 
Letter I; ICI Comment Letter; Morgan Lewis Comment Letter; T. Rowe 
Price Comment Letter; Citadel Comment Letter; DeFi Fund Comment 
Letter; Comment Letter of Investment Advisers Association (June 6, 
2022) (``IAA Comment Letter I''); BlackRock Comment Letter; FIA PTG 
Comment Letter II; Comment Letter of Darrell Duffie (Jan. 10, 2024) 
(``Duffie Comment Letter'').
---------------------------------------------------------------------------

    Many commenters maintained that the quantitative standard was 
arbitrary and overly broad, and opined that a volume standard alone 
could not distinguish between a dealer and a trader.\203\ Several 
commenters stated that the quantitative standard would capture persons 
engaging in non-dealing trading activity.\204\ Some commenters also 
stated that the trading volume threshold was too low in light of the 
size of the U.S. Treasury market and that the Proposing Release failed 
to provide sufficient detail on how the proposed trading volume would 
be measured and implemented.\205\
---------------------------------------------------------------------------

    \203\ See, e.g., AIMA Comment Letter II; ICI Comment Letter; T. 
Rowe Price Comment Letter.
    \204\ See, e.g., FIA PTG Comment Letter I; SIFMA AMG Comment 
Letter; Morgan Lewis Comment Letter; MMI Comment Letter; Two Sigma 
Comment Letter I; NAPFM Comment Letter; AIMA Comment Letter II; MFA 
Comment Letter I; McIntyre Comment Letter II; Element Comment 
Letter; ICI Comment Letter; Citadel Comment Letter; T. Rowe Price 
Comment Letter; Fried Frank Comment Letter; Consensys Comment 
Letter; ADAM Comment Letter; SIFMA Comment Letter I; Overdahl 
Comment Letter.
    \205\ See, e.g., Two Sigma Comment Letter I; FIA PTG Comment 
Letter I; Element Comment Letter; MFA Comment Letter II. One 
commenter agreed that repurchase and reverse repurchase transactions 
should be excluded from counting towards the quantitative standard 
threshold. See ACLI Comment Letter.
---------------------------------------------------------------------------

    After consideration of the comments, the Commission has decided to 
eliminate the quantitative standard from the final rules. While a 
trading volume threshold could provide a bright-line test under which 
persons engaging in certain specified levels of activity in the U.S. 
Treasury market would be defined to be buying and selling securities 
``as a part of a regular business,'' the Commission has concluded such 
a bright-line test is unnecessary. The modified qualitative factors and 
otherwise applicable court precedent and Commission interpretations 
will appropriately address when market participants are acting as 
government securities dealers in the U.S. Treasury market by engaging 
in a ``regular'' pattern of buying and selling securities that has the 
effect of providing liquidity to other market participants. Therefore, 
the Commission has decided to delete the quantitative standard from the 
final rules.
    In addition, as discussed in section II.A.5, no presumption shall 
arise that a person is not a government securities dealer as defined by 
the Exchange Act solely because that person does not satisfy Rule 3a44-
2(a).\206\ Thus, market participants acting similarly to traditional 
dealers that are buying and selling U.S. Treasuries as part of a 
regular business may still meet the definition of government securities 
dealer even absent the activity identified in the qualitative standard.
---------------------------------------------------------------------------

    \206\ See section II.A.5.
---------------------------------------------------------------------------

3. Exclusions
    The proposed rules provided exclusions for certain market 
participants that the Commission determined do not provide liquidity to 
the markets in a manner requiring dealer registration or are subject to 
a comparable regulatory structure which addresses the types of concerns 
that the proposed rules were intended to address. The Commission is 
adopting these exclusions as proposed. In addition, the Commission is 
adding exclusions for central banks, sovereign entities, and 
international financial institutions, as defined in the final rules. 
Each of these exclusions is discussed in more detail below.\207\
---------------------------------------------------------------------------

    \207\ The Commission has determined to create bright-line 
exclusions for certain persons from the scope of the final rules for 
policy reasons specific to these types of persons as further defined 
below. This is in contrast to various exclusions requested by 
commenters related to, among other things, specific securities 
activities that market participants may engage in (such as certain 
trading strategies or asset classes). Because these specific 
securities activities and specific types of securities cannot be 
viewed in isolation, and could constitute in whole or in part 
liquidity-providing activity that these rules are designed to 
address, the Commission is not adding these categorical exclusions. 
Rather, as with any other securities activities, whether these 
specific securities activities result in triggering the provisions 
of the final rules requires a facts and circumstances analysis of 
the totality of a person's activities. The Commission, however, has 
significantly refined its proposal (including, notably, the 
aggregation provision) so that persons whose securities activities 
may have been captured may no longer be within the scope of the 
rules as adopted.
---------------------------------------------------------------------------

a. Person That Has or Controls Assets of Less Than $50 Million
    In the Proposing Release, the Commission proposed to exclude from 
the proposed rules ``[a] person \208\ that has or controls total assets 
of less than $50 million.'' The Commission stated that providing an 
exception was appropriate because, even though a person that has or 
controls less than $50 million in assets may be engaged in the 
activities identified in the qualitative standard, the frequency and 
nature of such a person's securities trading are less likely to pose 
the types of financial and operational risks to the market that may be 
associated with the significant dealer activity that the rules were 
designed to address.\209\
---------------------------------------------------------------------------

    \208\ As noted below, the term ``person'' has the same meaning 
as prescribed in section 3(a)(9) of the Exchange Act: ``a natural 
person, company, government, or political subdivision, agency, or 
instrumentality of a government.''
    \209\ Proposing Release at 23062.
---------------------------------------------------------------------------

    Commenters that addressed this exclusion raised a number of 
concerns.\210\ Some commenters stated that it was arbitrary or 
inconsistent with the plain reading of the ``dealer'' definition.\211\ 
A few commenters stated that the threshold was too low.\212\ However, 
one of those commenters also said that the threshold could be too high 
for some securities.\213\
---------------------------------------------------------------------------

    \210\ One commenter also raised practical issues about how the 
exclusion would operate in connection with the proposed aggregation 
provision; however, these concerns have been mooted with the removal 
of the aggregation provision. See ICI Comment Letter.
    \211\ See, e.g., MMI Comment Letter; SIFMA AMG Comment Letter; 
Consensys Comment Letter.
    \212\ See Defi Fund Comment Letter; Element Comment Letter; 
Gretz Comment Letter; Consensys Comment Letter. See also section 
III.B.2.
    \213\ See Gretz Comment Letter.
---------------------------------------------------------------------------

    After consideration of comments, the Commission is adopting this 
exclusion as proposed. While we appreciate commenters' concerns, as 
indicated in the Proposing Release, the final rules are intended to 
capture market participants not registered as dealers that serve a 
critical dealer role in the securities and government securities 
markets through their liquidity provision or significant and regular 
trading activity in the market. These smaller market participants are 
unlikely to engage in the significant liquidity provision that is

[[Page 14956]]

the focus of the final rules.\214\ Importantly, we disagree that the 
$50 million threshold is arbitrary or too low or too high because, as 
stated in the Proposing Release, this exception parallels an 
established and well understood standard for distinguishing between 
``retail'' and ``institutional'' accounts for purposes of broker-dealer 
regulation.\215\ In the context of the final rules, persons that have 
or control assets of $50 million or more--so-called ``institutional'' 
accounts--are more likely to have a significant impact on the market as 
opposed to ``retail'' accounts of smaller market participants who are 
less likely to pose financial and operational risks to the markets. 
Further, in response to the commenter who raised practical issues about 
how the exclusion would operate in connection with investment advisers' 
separately managed accounts, as discussed in more detail below, the 
Commission has removed the aggregation provision, which should address 
those concerns.\216\ Finally, we reiterate that this is not an 
exclusion from the ``dealer'' definition for all purposes, but only for 
purposes of the final rules, which focus on de facto market making. 
Outside of the context of these rules, the question of whether any 
person, including a person that has or controls less than $50 million 
in total assets, is acting as a dealer, as opposed to a trader, will 
remain a facts and circumstances determination. For example, an 
underwriter with assets below $50 million could still be required to 
register as a dealer.
---------------------------------------------------------------------------

    \214\ See Proposing Release at 23062.
    \215\ Under FINRA rules, a ``retail'' account is distinguished 
from an ``institutional'' account that is defined, in part, as 
belonging to ``a person (whether a natural person, corporation, 
partnership, trust, or otherwise) with total assets of at least $50 
million.'' FINRA Rule 4512(c)(3); see also Business Conduct 
Standards for Security-Based Swap Dealers and Major Security-Based 
Swap Participants, Exchange Act Release No. 77617 (Apr. 14, 2016), 
81 FR 29959, 29995 n.462 (May 13, 2016) (adopting a similar 
threshold in connection with security-based swap dealers, for 
purposes of 17 CFR 240.15Fh-3(f)(4). The Commission considered but 
is not using the definition of ``retail customer'' adopted as part 
of Regulation Best Interest, as the policy considerations behind 
that definition are different than those presented here: the focus 
of Regulation Best Interest is the regulatory protections provided 
to customers who receive recommendations from broker-dealers, 
whereas the focus of this rulemaking is the regulation of persons 
engaging in certain dealer-like activities. See Regulation Best 
Interest: The Broker-Dealer Standard of Conduct, Exchange Act 
Release No. 86031 (June 5, 2019), 84 FR 33318 (July 12, 2019).
    \216\ See supra note 254 and accompanying text.
---------------------------------------------------------------------------

b. Registered Investment Companies, Private Funds, and Registered 
Investment Advisers
    The Commission also proposed to exclude registered investment 
companies registered under the Investment Company Act from the 
application of the rules.\217\ In proposing the exclusion, the 
Commission cited to the comprehensive regulatory framework under the 
Investment Company Act and its extensive oversight and broad insight 
into the operations and activities of registered investment 
companies.\218\ In contrast, the proposed rules did not exclude private 
funds, instead discussing differences between the regulatory regime 
that applies to registered advisers to private funds, and the one that 
applies to dealers, including leverage constraints and reporting.\219\ 
As explained in the Proposing Release, private funds are not subject to 
the extensive regulatory framework of the Investment Company Act.\220\ 
Further, the Commission did not propose to create a blanket exclusion 
for registered investment advisers because a registered investment 
adviser trading for its ``own account'' could nevertheless meet the 
definition of a ``dealer'' and therefore should be required to 
register.\221\
---------------------------------------------------------------------------

    \217\ See proposed 17 CFR 240.3a5-4(a)(2)(ii) and 240.3a44-
2(a)(3)(ii).
    \218\ Registered investment companies are subject to a 
regulatory framework under the Investment Company Act and rules 
thereunder, which imposes requirements regarding capital structure, 
custody of assets, investment activities, transactions with 
affiliates and other conflicts of interest, and the duties and 
independence of boards of directors, among other things. Moreover, 
registered investment companies are subject to statutory limits on 
indebtedness and rules that limit leverage risk. In addition, 
registered investment companies must adopt, implement, and review at 
least annually written policies and procedures reasonably designed 
to prevent violations of the Federal securities laws by the fund. 
Proposing Release at 23063.
    \219\ Proposing Release at 23083.
    \220\ Id.
    \221\ Proposing Release at 23073-74.
---------------------------------------------------------------------------

    Many commenters agreed with the proposed exclusion for registered 
investment companies.\222\ However, most of these commenters also 
stated that the exclusion should be expanded to registered investment 
advisers \223\ and private funds managed by registered investment 
advisers.\224\ Commenters cited to the regulatory regime under the 
Advisers Act.\225\ Some commenters stated that some of the reasons 
supporting an exclusion for registered investment companies also would 
support an exclusion for registered advisers,\226\ or an exclusion for 
private funds.\227\
---------------------------------------------------------------------------

    \222\ See, e.g., ICI Comment Letter; MFA Comment Letter II; 
Element Comment Letter; McIntyre Comment Letter II; IAA Comment 
Letter I.
    \223\ See, e.g., SIFMA Comment Letter I; SIFMA AMG Comment 
Letter; IAA Comment Letter I; Comment Letter of Investment Adviser 
Association (Oct. 17, 2023) (``IAA Comment Letter II'').
    \224\ See, e.g., MFA Comment Letter I (recommending that the 
exclusion for registered investment companies be expanded ``to cover 
any person registered as an investment adviser (or exempt or 
excluded from registration other than as a family office), as well 
as any private fund client of such adviser (and any affiliated 
general partner, managing member, or similar control person of the 
private fund client), with respect to trading done by the person 
with or through a registered broker-dealer''); Element Comment 
Letter; McIntyre Comment Letter II; IAA Comment Letter I; T. Rowe 
Price Comment Letter; IAA Comment Letter II.
    \225\ See, e.g., MFA Comment Letter I (``Advisers and the 
private funds they manage are already subject, directly or 
indirectly, to comprehensive regulation, which is sufficient to 
address the objectives of the Proposal without subjecting them to 
dealer registration.'').
    \226\ See, e.g., T. Rowe Price Comment Letter (``It appears the 
SEC's rationale for excluding registered investment companies is 
that they are subject to various requirements, including those 
related to custody, conflicts of interest, books and records, 
policies and procedures, and designation of a chief compliance 
officer. RIAs should also be excluded as they are subject to similar 
requirements, as well as a robust registration regime, and must act 
in accordance with their fiduciary duties.''); McIntyre Comment 
Letter II (``[T]he Commission notes that the `regulatory framework' 
to which registered investment companies are subject justifies the 
exclusion of these entities. However, [we believe] that the current 
regulatory environment and framework for registered investment 
advisers is also very robust. . .''). See also Scott Comment Letter.
    \227\ See, e.g., Citadel Comment Letter (``The disparate 
treatment of private funds and mutual funds . . . further highlights 
the lack of justification for requiring private funds to register as 
dealers . . . Moreover, the Commission's logic for exempting RICs 
equally applies to private funds.'').
---------------------------------------------------------------------------

    In addition, many commenters stated that imposing dealer 
requirements--and in particular net capital requirements \228\--on 
private funds would be inappropriate and untenable,\229\ and could in 
turn significantly and negatively affect liquidity if private funds 
were to modify or cease their trading activity.\230\ As support for an 
exclusion for private funds, many commenters cited to Form PF, which 
requires certain registered advisers that have at least $150 million in 
private fund assets under

[[Page 14957]]

management to report certain confidential information about their 
private funds.\231\
---------------------------------------------------------------------------

    \228\ See, e.g., MFA Comment Letter I (stating that the Net 
Capital Rule functions more like a restriction on the types of 
investments and trading a firm can engage in than a restriction on 
leverage and that the requirements would impede investors' highly 
negotiated liquidity rights); Citadel Comment Letter (stating that 
the Net Capital Rules would impose substantial costs and finding 
``the absurdity of applying these rules to private funds, which do 
not hold customer securities''). See also AIMA Comment Letter II; 
Morgan Lewis Comment Letter; Fried Frank Comment Letter; T. Rowe 
Price Comment Letter; IAA Comment Letter I; Element Comment Letter.
    \229\ See, e.g., Two Sigma Comment Letter I; MFA Comment Letter 
I; NAPFM Comment Letter; AIMA Comment Letter II.
    \230\ See, e.g., Schulte Roth Comment Letter.
    \231\ See, e.g., MFA Comment Letter I; T. Rowe Price Comment 
Letter; AIMA Comment Letter II; see also 17 CFR 279.9.
---------------------------------------------------------------------------

    Some commenters described potential practical difficulties with 
applying the dealer regulatory framework to private fund advisers and 
private funds \232\ and with having a managed account register as a 
dealer.\233\ One comment letter suggested that if a fund or separately 
managed account was required to register as a dealer, a conflict could 
arise between the fund's or separately managed account's adviser's 
fiduciary duty to achieve best execution and a best execution 
obligation to a counterparty ``when participating in all-to-all trading 
protocols where they may match with another end-user.'' \234\ We do not 
believe that such a conflict would arise in this scenario.\235\
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    \232\ See, e.g., AIMA Comment Letter II; see also ABA Comment 
Letter.
    \233\ See, e.g., ICI Comment Letter; SIFMA AMG Comment Letter 
(``In addition, the Proposal fails to consider how the principal 
trading prohibitions in the Advisers Act would impact an investment 
adviser that comes within the meaning of the term dealer solely 
because of its managed accounts.'').
    \234\ See BlackRock Comment Letter.
    \235\ Rather than ``counterparty,'' FINRA Rule 5310 applies to 
``any transaction for or with a customer or a customer of another 
broker-dealer'' (emphases added). The commenter did not specify what 
would constitute an ``all-to-all trading protocol.'' However, a 
dealer simply posting an order on a fully anonymous platform or 
providing a price in response to a bid request or bid list presented 
to the dealer or other competitive bidding process would likely not 
be subject to a best execution obligation since the dealer has not 
accepted a customer order for the purpose of facilitating the 
handling and execution of such order; this situation is analogous to 
Supplementary Material .04 to FINRA Rule 5310 which draws a 
distinction between those situations in which a firm acts solely as 
the buyer or seller in connection with an order presented against 
the firm's quote as opposed to accepting an order for handling and 
execution. See FINRA Regulatory Notice 15-46. See also infra notes 
599-601 and accompanying text.
---------------------------------------------------------------------------

    As support for such potential practical difficulties, some 
commenters stated that private funds are merely pools of assets that 
rely on fund managers for all functions and therefore do not have 
personnel or infrastructure to meet the dealer regulatory 
requirements.\236\ A few commenters questioned the Commission's concern 
\237\ that exempting private funds and private fund advisers from the 
proposed rules would produce negative outcomes with respect to 
PTFs,\238\ with one of these commenters citing to ``leverage 
constraints and reporting'' as the ``only two differences'' between the 
private funds and dealer regulatory framework as noted in the Proposing 
Release.\239\ Another commenter identified possible exceptions from the 
application of certain SEC and FINRA rules that may be necessary if 
registered investment advisers and/or the private funds they advise 
were required to register as dealers.\240\ Some commenters identified 
issues with imposing a dealer regulatory framework on investment 
advisers,\241\ with one commenter stating that the ``unsuitability of 
the dealer regime for advisers is highlighted by the inconsistency of 
an adviser needing to stand ready as a dealer to provide liquidity to, 
i.e., trade as principal with, the market, potentially through its 
clients' accounts, while being prohibited from acting in that capacity 
with its clients.'' \242\
---------------------------------------------------------------------------

    \236\ See, e.g., ABA Comment Letter; MFA Comment Letter I; AIMA 
Comment Letter II.
    \237\ Proposing Release at 23096 (``Excluding these funds would 
guarantee that the dealer regime would fail to capture this type of 
securities dealing activity. Furthermore, a blanket exclusion for 
hedge funds may provide an opportunity for regulatory arbitrage. For 
example, PTFs may seek to restructure themselves as private funds, 
thus preempting the intended benefits of the proposed rules.'').
    \238\ See AIMA Comment Letter II; MFA Comment Letter I; IAA 
Comment Letter I; see also T. Rowe Price Comment Letter.
    \239\ See AIMA Comment Letter II (``Indeed, the Commission's 
view expressed in the Proposal is that the only differences between 
the regulatory regime for private fund advisers and securities 
dealers are leverage constraints and reporting, yet the Commission 
has chosen to include both private funds and their advisers within 
the scope of the Proposal.'').
    \240\ See Element Comment Letter (identifying, in part, 
licensing of personnel who structure private placements on behalf of 
Required Registrants with the Series 79 license; application of Reg 
NMS Rule 611 to cross-trades effected on behalf of a Required 
Registrant by its investment adviser; application of the Net Capital 
Rule to Required Registrants; and application of the possession and 
control requirements of the customer protection rule, 17 CFR 
240.15c3-3 (``Rule 15c3-3''), in situations where hypothecation of 
securities may be in the best interests of an investment advisory 
client).
    \241\ See, e.g., IAA Comment Letter I (``Unlike brokers or 
dealers, advisers are prohibited from holding client assets or from 
taking client assets onto their balance sheets. To the extent that 
advisers trade securities, they do so through a broker or dealer 
intermediary, generally on behalf of and for the benefit of their 
clients''); see also T. Rowe Price Comment Letter (``We also are 
concerned that the SEC has not adequately assessed the feasibility 
and impact of an RIA being regulated as a dealer while also being 
subject to the [Advisers Act] for the same activities, nor does the 
Proposal detail how an entity could practically comply with both 
regimes.'').
    \242\ See IAA Comment Letter I.
---------------------------------------------------------------------------

    After consideration of the comments and for the reasons stated here 
and in the Proposing Release,\243\ the Commission is adopting the 
exclusion for registered investment companies as proposed. As stated 
above, many commenters generally supported the exclusion and did not 
suggest specific changes for registered investment companies but 
instead requested that the Commission expand the scope of the 
exclusions to include registered investment advisers and private funds.
---------------------------------------------------------------------------

    \243\ See supra note 218 and accompanying text.
---------------------------------------------------------------------------

    The Commission, however, is not including an express exclusion for 
private funds or registered investment advisers. Depending on the 
totality of the facts, a private fund may be engaged in the business of 
buying and selling securities for its own account.\244\ Similarly, a 
registered investment adviser that is trading for its ``own account'' 
could implicate dealer registration requirements. Further, as stated in 
the Proposing Release, market actors that are engaged in dealing 
activity should be subject to the dealer regulatory regime, which 
includes not only registration obligations, but also regulatory 
requirements specific to dealer activity and oversight that broadly 
focus on the dealer market functionality--that is, the impact of 
dealing activity on the market as a whole.\245\
---------------------------------------------------------------------------

    \244\ See, e.g., In the Matter of Murchinson Ltd., Marc 
Bistricer, and Paul Zogala, Exchange Act Release No. 92684 (Aug. 17, 
2021) (settled matter). In Murchinson, the Commission charged the 
principals of a hedge fund with causing dealer violations under 
section 15(a).
    \245\ Proposing Release at 23078-79.
---------------------------------------------------------------------------

    Entities engaging in dealing activity that meet the qualitative 
standard are required to register as dealers and comply with regulatory 
requirements that are applicable to dealer activity. Dealer regulatory 
requirements address related but distinct concerns from investment 
adviser regulation. In addition, dealer registration enhances 
regulatory oversight \246\ of market participants' trading activities 
and interactions with the market overall. In this regard, dealer 
regulatory requirements focus broadly on market functionality (along 
with protecting investors under principles of fair dealing between 
parties).\247\
---------------------------------------------------------------------------

    \246\ Dealers and government securities dealers are subject to 
extensive regulation and oversight and generally must: (i) register 
with the Commission and become members of an SRO; and (ii) comply 
with Commission and SRO rules, including certain financial 
responsibility and risk management rules, transaction and other 
reporting requirements, operational integrity rules, and books and 
records requirements, all of which help to enhance market stability 
by giving regulators increased insight into firm-level and aggregate 
trading activity. See section I.A.
    \247\ Proposing Release at 23056. See also id. at 23078-79 
(describing the regulatory requirements of registered dealers and 
government securities dealers).
---------------------------------------------------------------------------

    However, the Commission is mindful of concerns raised by commenters 
regarding the application of the dealer regime to registered investment 
advisers and private funds and as such has made significant changes to 
the definition of ``own account'' to remove the

[[Page 14958]]

aggregation standard in order to appropriately tailor the scope of 
persons captured by the final rules.
    Further, there are material differences between the private fund 
and dealer regulatory frameworks, and dealer registration offers 
important benefits and regulatory protections to address the risks 
related to dealing activities.\248\ As explained in the Proposing 
Release, registered private fund advisers are regulated under the 
Advisers Act and information on private fund activities is reported by 
registered private fund advisers on Form PF. The information the 
Commission obtains on certain private funds through its regulation of 
registered investment advisers, however, differs from that the 
Commission collects for the purposes of dealer regulation.\249\ Private 
funds also do not have the same level of reporting of their securities 
transactions. For example, fixed income transactions between private 
funds are not directly reported in TRACE. If their fixed-income trade 
is with a broker-dealer and reported by the broker-dealer, private 
funds appear anonymously in TRACE.\250\
---------------------------------------------------------------------------

    \248\ Proposing Release at 23083.
    \249\ Id.
    \250\ Id.
---------------------------------------------------------------------------

    Although, as commenters noted, the Commission collects some 
information about certain private funds through Form PF, this reporting 
alone is not a sufficient substitute for the comprehensive dealer 
requirements because the dealer requirements are specific to dealer 
activity. For example, Form PF only requires reporting related to a 
subset of the private fund industry and does not include individual 
trade reporting details, which would give regulators greater insight 
into securities trading patterns, including the ability to more 
efficiently match trades to market participants.\251\
---------------------------------------------------------------------------

    \251\ 17 CFR 279.9. See section III.C.1.c for a discussion of 
the benefits of additional regulatory reporting.
---------------------------------------------------------------------------

    In response to commenters who stated that private funds are merely 
pools of assets that rely on fund managers for all functions and 
therefore do not have personnel or infrastructure to meet the dealer 
regulatory requirements, to the extent that a private fund engages in 
activities that trigger dealer registration under the final rules, such 
private funds would need similarly to establish means, whether by 
contract or otherwise, of complying with the obligations for registered 
dealers, just as the fund must do to comply with any other regulatory 
obligation.
    In response to the commenter who suggested there were ``only two 
differences'' between the dealer and private fund regulatory regimes, 
the examples provided in the Proposing Release (i.e., leverage 
constraints and reporting requirements) were non-exhaustive 
examples.\252\ As discussed in the Proposing Release, registered 
dealers' leverage is limited by net capital requirements, which must be 
maintained at all times, while private funds have no formal leverage 
constraints.\253\ Further, in response to commenters who raised 
concerns about the application of certain SEC and FINRA rules or stated 
that certain dealer requirements were untenable or inappropriate, while 
the Commission acknowledges that complying with a new rule set may 
require market participants to revise their business models, as 
discussed further in the economic analysis, appropriate regulation of 
dealer activities, and the benefits associated with enhancements to 
investor protection and orderly markets, justifies these associated 
costs and difficulties associated with registration.\254\
---------------------------------------------------------------------------

    \252\ See section I.A (citing to the benefits of dealer 
registration).
    \253\ Proposing Release at 23083. See also section III.B.2.b 
(stating that private funds and investment advisers do not have to 
comply with the Net Capital Rule or with any other direct, 
regulatory constraint on leverage).
    \254\ See section III.C.
---------------------------------------------------------------------------

    Finally, while not excluding registered investment advisers and 
private funds, the Commission is, however, modifying the definition of 
``own account'' to mean an account held in the name of, or for the 
benefit of, that person and removing the proposed first qualitative 
factor. These changes will respond to concerns related to separately 
managed accounts and investment advisers trading on behalf of their 
clients, including those exercising discretion; these investment 
advisers generally will not be captured by the final rules because they 
would not be buying and selling for their ``own account.'' Private 
funds that are buying and selling for their ``own account'' in a way 
that meets the qualitative standard could be captured by the final 
rules. To the extent that private funds or investment advisers trigger 
application of the final rules, they would need to comply with the 
dealer registration requirements or cease engaging in dealer activity.
c. Official Sector Exclusions
    The Commission is adopting express exclusions for central banks, 
sovereign entities, and international financial institutions, as 
defined in the final rules. Together, these exclusions are referred to 
as the ``Official Sector Exclusions.''
    The Official Sector Exclusions are designed to permit central 
banks, sovereign entities, and international financial institutions to 
continue to pursue important policy goals, and to be consistent with 
principles of international comity and the privileges and immunities 
granted to foreign central banks, foreign sovereigns and sovereign 
entities, and certain international financial institutions under U.S. 
Federal law.\255\
---------------------------------------------------------------------------

    \255\ See, e.g., Standards for Covered Clearing Agencies for 
U.S. Treasury Securities and Application of the Broker-Dealer 
Customer Protection Rule With Respect to U.S. Treasury Securities, 
Exchange Act Release No. 99149 (Dec. 13, 2023).
---------------------------------------------------------------------------

    For purposes of the Official Sector Exclusion, the final rules 
define a ``central bank'' as a reserve bank or monetary authority of a 
central government (including the Board of Governors of the Federal 
Reserve System or any of the Federal Reserve Banks). This definition 
also includes the Bank for International Settlements (``BIS''). The BIS 
is owned by central banks,\256\ so it is appropriate to include the BIS 
in the final rules' definition of central bank. The final rules define 
a ``sovereign entity'' as a central government (including the U.S. 
Government), or an agency, department, or ministry of a central 
government. Finally, the final rules define an ``international 
financial institution'' by identifying specific entities and providing 
that an ``international financial institution'' also includes any other 
entity that provides financing for national or regional development in 
which the United States government is a shareholder or contributing 
member.\257\ The following entities are specifically identified as an 
``international financial institution'' under the final rule: (1) 
African Development Bank; (2) African Development Fund; (3) Asian 
Development Bank; (4) Banco Centroamericano de Integraci[oacute]n 
Econ[oacute]mica; (5) Bank for Economic Cooperation and Development in 
the Middle East and North Africa; (6) Caribbean Development Bank; (7) 
Corporaci[oacute]n Andina de Fomento; (8) Council of Europe Development 
Bank; (9) European Bank for Reconstruction

[[Page 14959]]

and Development; (10) European Investment Bank; (11) European 
Investment Fund; (12) European Stability Mechanism; (13) Inter-American 
Development Bank; (14) Inter-American Investment Corporation; (15) 
International Bank for Reconstruction and Development; (16) 
International Development Association; (17) International Finance 
Corporation; (18) International Monetary Fund; (19) Islamic Development 
Bank; (20) Multilateral Investment Guarantee Agency; (21) Nordic 
Investment Bank; (22) North American Development Bank.
---------------------------------------------------------------------------

    \256\ See BIS, About BIS--Overview, https://www.bis.org/about/index.htm (noting that ``the BIS is owned by 63 central banks, 
representing countries from around the world that together account 
for about 95% of world GDP.'').
    \257\ Cf. 17 CFR 50.76(b) (the Commodity Futures Trading 
Commission (``CFTC'') definition of international financial 
institution for purposes of exemptions from swap clearing 
requirement).
---------------------------------------------------------------------------

    The exclusion is appropriate for the Federal Reserve System--the 
central bank of the United States--both because excluding the Federal 
Reserve System will not contravene any of the Commission's goals in 
adopting the final rules and because of the Federal Reserve System's 
unique role in the U.S. Treasury market and the U.S. economy. Entities 
that constitute part of the Federal Reserve System should be excluded 
from dealer registration because requiring them to register as dealers 
would not address the primary concerns animating the final rules.\258\ 
Moreover, transactions in U.S. Treasury securities are an important 
tool in the fiscal and monetary policy of the United States.\259\ In 
particular, cash and repo transactions in U.S. Treasury securities are 
one of the primary tools used by the Federal Reserve Bank of New York 
to conduct open market transactions at the direction of the Federal 
Open Market Committee.\260\ The System Open Market Account, which is 
managed by the Federal Reserve Bank of New York's System Open Market 
Trading Desk, is ``the largest asset on the Federal Reserve's balance 
sheet.'' \261\ In light of the key role of open market operations 
conducted by the Federal Reserve Bank of New York in the monetary 
policy of the United States, an exemption from the final rules is 
appropriate for the Federal Reserve System.\262\
---------------------------------------------------------------------------

    \258\ Regulators already have insight into the activities of the 
Federal Reserve System, and the Federal Reserve Banks already 
consider market integrity and resiliency issues. See, e.g., 
Enhancing the Resilience of the U.S. Treasury Market 2022 Staff 
Progress Report (Nov. 10, 2022) at 1, available at https://home.treasury.gov/system/files/136/2022-IAWG-Treasury-Report.pdf 
(stating that the Inter-Agency Working Group for Treasury Market 
Surveillance ``was formed by the Treasury Department, SEC, and 
Federal Reserve Board in 1992 to improve monitoring and surveillance 
and strengthen interagency coordination with respect to the Treasury 
markets . . .'').
    \259\ 12 U.S.C. 225a (defining goals of monetary policy); see 
also Federal Reserve Bank; Monetary Policy: What Are Its Goals? How 
Does It Work? available at https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm.
    \260\ See Federal Reserve Bank; Monetary Policy Implementation, 
available at https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation.
    \261\ Id.
    \262\ See Order Exempting the Federal Reserve Bank of New York, 
Maiden Lane LLC, Exchange Act Release No. 61884 (Apr. 9, 2010) 
(granting exemptions to the Federal Reserve Bank of New York, Maiden 
Lane LLC and the Maiden Lane Commercial Mortgage Backed Securities 
Trust 2008-1 in connection with restructuring of debt instruments 
acquired by the Federal Reserve Bank of New York when it facilitated 
the acquisition of the Bear Stearns Companies Inc. by JP Morgan 
Chase & Co., including permitting receipt of compensation that is 
calculated by reference to underwriting fees received by other 
parties to the restructuring). Congress similarly exempted 
transactions in which one counterparty is a member of the Federal 
Reserve System from the regulation of swaps and security-based swaps 
in Title VII of the Dodd-Frank Act. See 15 U.S.C. 78c(a)(68)(A) 
(stating that a security-based swap is a swap, as defined in 7 
U.S.C. 1a(47), subject to certain other conditions); 7 U.S.C. 
1a(47)(B)(ix) (excluding from the definition of swap any transaction 
in which one counterparty ``is a Federal Reserve bank, the Federal 
Government, or a Federal agency that is expressly backed by the full 
faith and credit of the United States'').
---------------------------------------------------------------------------

    With respect to central banks generally, central banks are 
typically created by statute and are part of, or aligned with, a 
central government.\263\ Further, as with the Federal Reserve System in 
the United States, the purpose of a central bank is generally to 
effectuate monetary policy for its respective nation.\264\ In light of 
ongoing expectations that Federal Reserve Banks and agencies of the 
Federal government would not be subject to foreign regulatory 
requirements in their transactions in the sovereign debt of other 
nations, the principles of international comity counsel in favor of 
exempting foreign central banks--as well as sovereign entities and 
international financial institutions.\265\
---------------------------------------------------------------------------

    \263\ The authorizing statutes generally provide that the 
government owns all or part of the capital stock or equity interest 
of the central bank. See, e.g., Capital of the ECB Protocol on the 
Statute of the European System of Central Banks and of the European 
Central Bank (``ECB Protocol''), Article 28.2, available at https://www.ecb.europa.eu/ecb/legal/pdf/en_statute_2.pdf.
    \264\ See, e.g., ECB Protocol, supra note 263, Article 3.1; Bank 
of Japan Act, Articles 1 and 2, available at https://www.boj.or.jp/en/about/boj_law/index.htm/#p01.
    \265\ For similar reasons, the CFTC has similarly determined to 
exempt swap transactions involving foreign central banks, sovereign 
entities, and international financial institutions from the 
statutory requirement that swap transactions be cleared with a 
Derivatives Clearing Organization. See 17 CFR 50.75, 50.76; Swap 
Clearing Exemptions, 85 FR 76428, 76429-30, 76432 (Nov. 30, 2020).
---------------------------------------------------------------------------

    Finally, Congress has granted foreign central banks, other foreign 
sovereign entities, and certain international financial institutions 
special privileges and immunities under U.S. Federal law,\266\ and thus 
in these circumstances the Commission is not including these entities 
in the final rules.
---------------------------------------------------------------------------

    \266\ The United States has taken actions to implement 
international obligations with respect to such immunities and 
privileges. See, e.g., International Bank for Reconstruction and 
Development (``World Bank'') and International Monetary Fund (22 
U.S.C. 286g and 22 U.S.C. 286h), the European Bank for 
Reconstruction and Development (22 U.S.C. 290l-6), the Multilateral 
Investment Guarantee Agency (22 U.S.C. 290k-10), the Africa 
Development Bank (22 U.S.C. 290-8), the African Development Fund (22 
U.S.C. 290g-7), the Asian Development Bank (22 U.S.C. 285g), the 
Inter-American Development Bank (22 U.S.C. 283g), the Bank for 
Economic Cooperation and Development in the Middle East and North 
Africa (22 U.S.C. 290o), and the Inter-American Investment 
Corporation (22 U.S.C. 283hh). See also the International 
Organization and Immunities Act (22 U.S.C. 288) and the Foreign 
Sovereign Immunities Act (28 U.S.C. 1602) (``FSIA'') (the FSIA is an 
exception from the general principle of sovereign immunity, which 
derives from customary international law).
---------------------------------------------------------------------------

d. Other Requests for Exclusions
    The Commission received a number of comments about how the proposed 
rules would apply to crypto assets. In the Proposing Release, the 
Commission explained that the definition of ``dealer'' and the 
accompanying registration requirements of the Exchange Act were drawn 
broadly by Congress to encompass a wide range of activities involving 
securities markets and participants in those markets.\267\ The 
Commission further stated that proposed Rules 3a5-4 and 3a44-2 would 
apply to any crypto asset that is a ``security'' as defined by section 
3(a)(10) of the Exchange Act or a ``government security'' as defined by 
section 3(a)(42) of the Exchange Act, respectively.\268\
---------------------------------------------------------------------------

    \267\ See Proposing Release at 23057.
    \268\ See id. at n.36.
---------------------------------------------------------------------------

    The Commission received several comments concerning the application 
of the proposed rules to crypto assets that are securities that trade 
through centralized trading platforms or trade in the so-called DeFi 
market, and to persons who trade crypto asset securities. Many opposed 
applying the proposed rules to persons transacting in crypto asset 
securities.\269\ Commenters

[[Page 14960]]

expressed their concern that they do not understand which crypto assets 
are securities under the Federal securities laws and believe it would 
be inappropriate for the dealer regulatory framework to apply to 
persons transacting in crypto assets that are securities.\270\ In 
addition, certain of these commenters expressed their view that there 
were aspects of the dealer regulatory framework, including 
registration, that could substantially raise the costs, or would be 
unworkable, for crypto asset security participants, and could hinder 
U.S. innovation in the crypto asset market.\271\ For example, some 
commenters contended that the Commission has provided no viable path 
forward by which a Commission-registered broker-dealer can custody 
digital assets.\272\ Commenters requested that if the Commission were 
to move forward with adopting the proposed rules, the Commission revise 
the final rules to carve out or tailor the application to persons 
transacting in crypto assets that are securities.\273\
---------------------------------------------------------------------------

    \269\ See, e.g., Consensys Comment Letter; ADAM Comment Letter; 
Andreessen Horowitz Comment Letter; Blockchain Comment Letter; 
Comment Letter of Global Digital Asset and Cryptocurrency 
Association (May 27, 2022) (``GDCA Comment Letter''); U.S. Reps 
Comment Letter; Chamber of Digital Commerce Comment Letter; DeFi 
Fund Comment Letter. In addition to the comments discussed in 
section II.A.1, many of the commenters that represent participants 
of the crypto asset industry expressed concerns that mirror those of 
other commenters. For example, compare GDCA Comment Letter (stating 
that the ``the proposed one-year compliance period is wholly 
impractical'') with MFA Comment Letter I. In these circumstances, 
those comments are addressed in their respective section in this 
Adopting Release. See, e.g., section II.B.
    \270\ See, e.g., ADAM Comment Letter; Chamber Digital Commerce 
Comment Letter; Blockchain Comment Letter; Andreessen Horowitz 
Comment Letter.
    \271\ See, e.g., GDCA Comment Letter; ADAM Comment Letter; DeFi 
Fund Comment Letter; Consensys Comment Letter; Blockchain Comment 
Letter; U.S. Reps Comment Letter; American Blockchain PAC Comment 
Letter; Andreessen Horowitz Comment Letter; ABA Comment Letter.
    \272\ See, e.g., GDCA Comment Letter; ABA Comment Letter.
    \273\ See, e.g., Andreessen Horowitz Comment Letter; DeFi 
Foundation Comment Letter; ADAM Comment Letter. Similarly, one 
commenter recommended that the application to businesses in crypto 
assets be narrow. See also Gretz Comment Letter (stating ``based on 
the principle of `same business, same risks, same rules' we'd 
recommend to have the applicability on digital asset related 
businesses in narrow scope'').
---------------------------------------------------------------------------

    One commenter supported applying the proposed rules to all 
securities, including crypto asset securities, and asked the Commission 
to resist suggestions from other commenters to carve out any types of 
assets that are securities from the ``dealer'' definition.\274\ The 
commenter urged that the Commission apply securities regulation 
``equally to all securities regardless of how novel, `innovative,' 
popular, or profitable such offerings may be.'' \275\
---------------------------------------------------------------------------

    \274\ See Better Markets Comment Letter.
    \275\ See id.
---------------------------------------------------------------------------

    The Commission also received comments about the application of the 
proposed rules to so-called DeFi products, structures, and activities, 
and users and participants thereof.\276\ One commenter asserted that it 
is unreasonable for the proposed rules to apply to so-called DeFi 
products, structures and activities because they assert that these do 
not have a central controlling body and are just software, and that 
they do not raise the concerns identified by Congress when enacting the 
Exchange Act.\277\ Other commenters questioned whether the proposed 
rules would apply to participants in so-called DeFi products, 
structures and activities, including those involving the use of smart 
contracts, automated market makers, or other ``all-to-all'' or peer-to-
peer execution protocols.\278\ Commenters expressed concerns that the 
uncertainty of whether the proposed rules applied to such users or 
participants could lead to less liquidity in the crypto asset 
markets.\279\ Commenters requested that the Commission clarify that the 
adopted rules would not apply to so-called DeFi products, structures or 
activities, or users or participants thereof.\280\ One commenter also 
asserted that crypto assets were currency, and not securities, and 
asked that the Commission clarify that the proposed rules would not 
apply to ``retailers'' or ``merchants'' that accept payment for goods 
and services in crypto assets and exchange that crypto asset for fiat 
currency.\281\
---------------------------------------------------------------------------

    \276\ See, e.g., Andreessen Horowitz Comment Letter; DeFi Fund 
Comment Letter; Consensys Comment Letter.
    \277\ See Consensys Comment Letter.
    \278\ See, e.g., DeFi Fund Comment Letter; Andreessen Horowitz 
Comment Letter.
    \279\ See, e.g., DeFi Fund Comment Letter; Andreessen Horowitz 
Comment Letter.
    \280\ See, e.g., Consensys Comment Letter; Andreessen Horowitz 
Comment Letter.
    \281\ See Consensys Comment Letter (stating that the rules might 
apply to ``retailers'' or ``merchants'' that accept crypto assets as 
payment for goods and as an ancillary part of their business, 
exchange the crypto assets for more traditional forms of currency). 
The final rules apply only to trading activities involving crypto 
assets that are securities. As the rules apply only to crypto assets 
that are securities, commenter's view as to the treatment of trading 
in crypto assets that are not securities are not relevant to the 
analysis.
---------------------------------------------------------------------------

    As stated in the Proposing Release, as a threshold matter, the 
definitions of ``dealer'' and ``government securities dealer'' under 
sections 3(a)(5) and 3(a)(44) of the Exchange Act, and the requirement 
that dealers and government securities dealers register with the 
Commission pursuant to sections 15 and 15C of the Exchange Act, apply 
with respect to the buying and selling of all securities or government 
securities.\282\ Therefore, Rules 3a5-4 and 3a44-2 as adopted apply to 
any person transacting in securities or government securities, 
regardless of where the security or government security trades.
---------------------------------------------------------------------------

    \282\ Proposing Release at 23057, n.36.
---------------------------------------------------------------------------

    The dealer framework is a functional analysis based on the 
securities trading activities undertaken by a person, not the type of 
security being traded. The final rules apply to the buying and selling 
of all securities, including crypto assets that are securities or 
government securities within the meaning of the Exchange Act. While 
some commenters stated that the proposed rules should not apply to so 
called DeFi, whether there is a dealer involved in any particular 
transaction or structure (whether or not referred to as so-called DeFi) 
is a facts and circumstances analysis. There is nothing about the 
technology used, including distributed ledger technology-based 
protocols using smart contracts, that would preclude crypto asset 
securities activities from falling within the scope of dealer 
activity.\283\ Accordingly, certain persons engaging in crypto asset 
securities transactions may be operating as dealers as defined under 
the Exchange Act.\284\
---------------------------------------------------------------------------

    \283\ See supra note 135.
    \284\ See, e.g., SEC v. Beaxy Digital, Ltd., et al., No. 23-cv-
1962 (N.D. Ill. Mar. 29, 2023) (Docket Entries 1, 4) (final judgment 
entered on consent enjoining crypto asset trading platform from 
operating an unregistered exchange, broker, dealer, and clearing 
agency). The President's Executive Order on Ensuring Responsible 
Development of Digital Assets recognized that ``many activities 
involving digital assets are within the scope of existing domestic 
laws and regulations'' and ``[d]igital asset . . . intermediaries 
whose activities may increase risks to financial stability, should, 
as appropriate, be subject to and in compliance with regulatory and 
supervisory standards that govern traditional market infrastructures 
and financial firms.'' See President's Executive Order on Ensuring 
Responsible Development of Digital Assets, dated Mar. 9, 2022, 
available at https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/. As discussed below, these 
intermediaries perform a wide range of functions, many of which may 
already qualify them as dealers under the Exchange Act. See section 
III.B.2.c.
---------------------------------------------------------------------------

    Rules 3a5-4 and 3a44-2 apply to persons transacting in crypto 
assets that meet the definition of ``securities'' or ``government 
securities'' under the Exchange Act. If a person's trading activities 
in crypto asset securities, including products, structures and 
activities involved in the so-called DeFi market, meet the definition 
of ``as part of a regular business'' as set forth in the final rules 
(i.e., the person engages in a regular pattern of buying and selling 
crypto asset securities that has the effect of providing liquidity to 
other market participants as stated in the qualitative standard), and 
no exception or exclusion applies, that person would be required to 
register as a dealer or government securities dealer under the Exchange 
Act and comply with the requirements applicable to dealers and 
government securities dealers. Contrary

[[Page 14961]]

to what some commenters have stated, unless an exemption or exception 
applies, the Exchange Act requires the Commission to register and 
regulate persons acting as dealers in securities.\285\ Regardless of 
the technology used to engage in crypto asset securities trading and 
transactions, if a person meets the qualitative standard in the final 
rule, or otherwise meets the definition of dealer under the Exchange 
Act, that person is subject to registration as a dealer, and the 
application of the dealer regulatory regime to its activities.\286\
---------------------------------------------------------------------------

    \285\ See 15 U.S.C. 78o(a); see generally DAO 21(a) Report, 
available at https://www.sec.gov/litigation/investreport/34-81207.pdf (addressing the obligation to comply with the registration 
provisions of the Federal securities laws with respect to products 
and platforms involving emerging technologies and new investor 
interfaces).
    \286\ See section III.C.1 (discussing benefits of dealer 
regulatory framework).
---------------------------------------------------------------------------

    In addition to the commenters requesting additional exclusions for 
private funds and advisers and for market participants transacting in 
crypto asset securities, a commenter stated that the Commission should 
exclude from the scope of the proposed rules inter-affiliate 
transactions used by banking institutions to centrally manage cash or 
risk throughout their organizations.\287\ In the context of discussing 
its concerns with the proposed aggregation provision, the commenter 
stated that, consistent with exclusions for inter-affiliate 
transactions in the security-based swaps context, as well as with the 
language of the proposed rules, which focus on transactions that have 
``the effect of providing liquidity to other market participants,'' 
inter-affiliate transactions should be excluded.\288\
---------------------------------------------------------------------------

    \287\ See SIFMA Comment Letter I.
    \288\ Id. SIFMA suggested that the Commission modify the text of 
the proposed second qualitative factor to clarify the treatment of 
inter-affiliate transactions by adding that the relevant expressions 
of trading interests are those made to other market participants 
``not controlling, controlled by or under common control with the 
person.'' See Comment Letter of Securities Industry and Financial 
Markets Association (Oct. 5, 2022) (``SIFMA Comment Letter III'').
---------------------------------------------------------------------------

    The Commission is not adding an exclusion for inter-affiliate 
transactions because the Commission is removing the aggregation 
provision, and the final rules have been modified to focus on the 
trading activity of a person for an account in the name of, or for the 
benefit of, that person.\289\ In the context of whether a person is 
acting as a dealer, the Commission continues to believe each person 
must independently consider its own trading activities to determine 
whether its activities require dealer registration.\290\ Accordingly, 
the Commission is not excluding inter-affiliate transactions.\291\
---------------------------------------------------------------------------

    \289\ See section II.A.4 (discussing the deletion from the 
definition of ``own account'' any accounts held in the name of a 
person over whom that person exercises control or with whom that 
person is under common control and corresponding exclusions).
    \290\ In addition, the Commission analyzes the activities of 
each entity in determining broker-dealer registration status. See, 
e.g., Foreign Broker-Dealer Adopting Release at 30017 (stating ``the 
Commission uses an entity approach with respect to registered 
broker-dealers. Under this approach, if a foreign broker-dealer 
physically operates a branch in the United States, and thus becomes 
subject to U.S. registration requirements, the registration 
requirements and the regulatory system governing U.S. broker-dealers 
would apply to the entire foreign broker-dealer entity.'')
    \291\ Id.
---------------------------------------------------------------------------

    Further, some commenters requested clarification that the proposed 
rules would not apply to a governmental plan, including public 
pensions, nor to state administrators managing state funds or to city 
administrators managing the city pension funds through an exclusion 
from the proposed rules.\292\ One of these commenters specifically 
raised concerns that the proposed quantitative standard could subject 
state boards and similar investment fiduciaries and/or administrators 
of state pension funds to the rules.\293\ The Commission is not adding 
an exclusion for such arrangements because the rules have been 
significantly modified, including by removal of the quantitative 
standard and the proposed first qualitative standard, such that the 
final rules should not capture these arrangements.\294\
---------------------------------------------------------------------------

    \292\ Comment Letter of Marcie Frost, Chief Executive Officer, 
California Public Employees Retirement System; Anastasia Titarchuk, 
Chief Investment Officer and Deputy Comptroller for Pension 
Investment & Cash Management, New York State Common Retirement Fund; 
Jase R. Auby, Chief Investment Officer, Teacher Retirement System of 
Texas; and Steven Meier, Chief Investment Officer and Deputy 
Comptroller for Asset Management, Office of the Comptroller of the 
City of New York (Nov. 3, 2023) (``Public Pension Fund Comment 
Letter''); Comment Letter of Lamar Taylor, Interim Executive 
Director & CIO, State Board of Administration of Florida (Nov. 1, 
2023) (``Florida State Board Comment Letter'').
    \293\ Florida State Board Comment Letter.
    \294\ See section I.B.
---------------------------------------------------------------------------

4. Definitions and Anti-Evasion
    As noted in the Proposing Release, the Exchange Act defines a 
``dealer'' or ``government securities dealer'' as a person engaged in 
the business of buying and selling securities for its ``own account.'' 
\295\ The proposed rules included definitions for the terms ``person,'' 
\296\ ``own account,'' ``control,'' and ``parallel account structure.''
---------------------------------------------------------------------------

    \295\ 15 U.S.C. 78c(a)(5) (``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.'') 
(emphasis added); 15 U.S.C. 78c(a)(44) (``The term `government 
securities dealer' means any person engaged in the business of 
buying and selling government securities for his own account, 
through a broker or otherwise . . .'') (emphasis added).
    \296\ Paragraph (b)(1) of the proposed rules provided that the 
term ``person'' has the same meaning as prescribed in section 
3(a)(9) of the Exchange Act. Section 3(a)(9) of the Exchange Act 
defines a ``person'' as ``a natural person, company, government, or 
political subdivision, agency, or instrumentality of a government.'' 
See 15 U.S.C. 78c(a)(9).
---------------------------------------------------------------------------

    The proposed rules would have broadly defined a person's ``own 
account'' to mean any account that is: ``held in the name of that 
person,'' or ``held in the name of a person over whom that person 
exercises control or with whom that person is under common control,'' 
\297\ or ``held for the benefit of those persons,'' subject to certain 
exclusions.\298\
---------------------------------------------------------------------------

    \297\ When using the terms ``aggregation provision'' and 
``aggregation,'' the Commission is referring to the following 
language in the definition of ``own account'' that was included in 
the proposed rules: ``held in the name of a person over whom that 
person exercises control or with whom that person is under common 
control.'' The removal of this provision eliminated the inclusion of 
entities under control or common control as set forth in the 
definition of ``own account'' under the proposed rules.
    \298\ Proposing Release at 23062. For purposes of paragraph 
(b)(2)(ii), the proposed rules incorporated the definition of 
``control'' under 17 CFR 240.13h-1 (``Rule 13h-l'').
---------------------------------------------------------------------------

    The proposed rules would have excluded from the definition of ``own 
account'': (A) an account in the name of a registered broker, dealer, 
or government securities dealer, or an investment company registered 
under the Investment Company Act of 1940; \299\ (B) with respect to an 
investment adviser registered under the Investment Advisers Act of 
1940, an account held in the name of a client of the adviser unless the 
adviser controlled the client as a result of the adviser's right to 
vote or direct the vote of voting securities of the client, the 
adviser's right to sell or direct the sale of voting securities of the 
client, or the adviser's capital contributions to or rights to amounts 
upon dissolution of the client; \300\ and (C) with respect to any 
person, an account in the name of another person that was under common 
control with that person solely because both persons are clients of an 
investment adviser registered under the Advisers Act unless those 
accounts constituted a parallel account structure.\301\
---------------------------------------------------------------------------

    \299\ Proposed 17 CFR 240.3a5-4(b)(2)(ii)(A) and 240.3a44-
2(b)(2)(ii)(A).
    \300\ Proposed 17 CFR 240.3a5-4(b)(2)(ii)(B) and 240.3a44-
2(b)(2)(ii)(B).
    \301\ Proposed 17 CFR 240. 3a5-4(b)(2)(ii)(C) and 240.3a44-
2(b)(2)(ii)(C). The Commission proposed to define parallel account 
structure to mean ``a structure in which one or more private funds 
(each a `parallel fund'), accounts, or other pools of assets (each a 
`parallel managed account') managed by the same investment adviser 
pursue substantially the same investment objective and strategy and 
invest side-by-side in substantially the same positions as another 
parallel fund or parallel managed account.'' See Proposing Release 
at 23075.

---------------------------------------------------------------------------

[[Page 14962]]

    The Proposing Release explained that the proposed definitions were 
intended to avoid incentivizing market participants to change their 
corporate structures for the purpose of avoiding registration.\302\ The 
Proposing Release sought comment generally on this aspect of the 
proposed rules, and also asked whether the Commission should include an 
anti-evasion provision similar to Rule 13h-1(c)(2) under the Exchange 
Act.\303\
---------------------------------------------------------------------------

    \302\ Proposing Release at 23074.
    \303\ 17 CFR 240.13h-1(c)(2) (``Rule 13h-1(c)(2)''). Rule 13h-
1(c)(2) provides that under no circumstances shall a person 
disaggregate accounts to avoid the identification requirements of 
the section.
---------------------------------------------------------------------------

    The Commission received extensive comment on the definitions 
included in the Proposing Release.\304\ Most commenters did not support 
the definitions, and in particular, suggested eliminating the 
aggregation provision set forth in the definitions of ``own account'' 
and ``control.'' \305\ Commenters stated that the proposed rules 
represented a departure from the Commission's historical ``entity'' 
approach to broker-dealer regulation.\306\
---------------------------------------------------------------------------

    \304\ While we received letters from a variety of commenters, 
these letters primarily represented the asset management industry.
    \305\ See, e.g., SIFMA Comment Letter I; Fried Frank Comment 
Letter; Two Sigma Comment Letter I; ICI Comment Letter; AIMA Comment 
Letter II; ADAM Comment Letter; FIA PTG Comment Letter I; MFA 
Comment Letter I; T. Rowe Price Comment Letter. See also IAA Comment 
Letter I; SIFMA AMG Comment Letter; AIMA Comment Letter II (``If the 
Commission is going to subject private funds and private fund 
advisers to the Proposal, it should provide some clarity regarding 
its application and remove the aggregation requirements (including 
the `under common control' element)''). While many commenters raised 
concerns with the definitions of ``own account'' and ``control,'' 
most commenters did not specifically address the definition of 
``person.'' But see MFA Comment Letter I (``The Commission should 
define the term `person' to recognize disaggregation by independent 
portfolio managers. The Proposal appears based on an assumption that 
all trading activity taking place within a single legal entity or 
commonly controlled group of legal entities takes place on an 
integrated and coordinated basis. However, it is quite common that a 
single entity (including a fund) or group of entities engage in 
trading through substantially (for all relevant purposes) 
independent portfolio managers. . . . To avoid this issue, the 
Commission should adopt a definition of `person' that treats 
separately trading activity conducted by separate decision-makers 
without coordination of trading or cooperation among or between 
them. This treatment would be consistent with the treatment of truly 
separate accounts for other securities law purposes.'').
    \306\ See, e.g., ADAM Comment Letter; SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Many commenters stated that the Commission should maintain an 
entity approach to registration, focusing on activity on an entity-by-
entity basis,\307\ and suggested that instead of aggregating the 
trading activities of entities within a corporate structure, the 
Commission should adopt an anti-evasion standard.\308\ In particular, 
one commenter stated that the Commission should apply the principles of 
the entity approach to broker-dealer registration that it articulated 
in the adopting release to 17 CFR 240. 15a-6 (``Rule 15a-6'') where 
registration activities are assessed on an entity-by-entity basis, 
rather than across affiliated entities.\309\ Another commenter also 
cited to Rule 15a-6, stating that, in assessing whether a person has to 
register as a government securities dealer, such commenter believed 
that Congress intended that the Commission should focus on activity on 
an entity-by-entity basis rather than on an aggregated basis.\310\
---------------------------------------------------------------------------

    \307\ See, e.g., Morgan Lewis Comment Letter; ADAM Comment 
Letter; SIFMA AMG Comment Letter.
    \308\ See SIFMA Comment Letter I (``Instead of the Aggregation 
Rule, the Commission should adopt a targeted anti-evasion standard 
prohibiting a person from willfully evading dealer or government 
securities dealer status (under the existing definition and 
guidance) through coordinated trading activity across commonly 
controlled entities over which the person exercises investment 
discretion.''). See also ICI Comment Letter (``[I]nstead of a 
blanket exclusion for parallel account structures from the exception 
for commonly managed accounts, we believe a general anti-evasion 
provision similar to Rule 13h-1(c)(2) under the Exchange Act is more 
appropriate.''); IAA Comment Letter I (``The Commission should focus 
on general anti-evasion principles rather than imposing dealer 
regulation on advisers and their clients out of concern that some 
persons could theoretically evade regulation.''); T. Rowe Price 
Comment Letter (``A better way to address potential abusive 
situations is to simply have an anti-evasion clause.''); MFA Comment 
Letter I; Two Sigma Comment Letter I; IAA Comment Letter II.
    \309\ SIFMA AMG Comment Letter.
    \310\ Morgan Lewis Comment Letter.
---------------------------------------------------------------------------

    Regarding the proposed aggregation standard, many commenters raised 
concerns that trading activities of entities, including banks and bank 
holding companies, that may be excepted or exempted from dealer 
registration would nonetheless need to be aggregated with, and 
potentially trigger registration of, commonly controlled persons under 
the proposed rules, contrary to policy decisions Congress and the 
Commission has made to not require these entities to register as 
dealers.\311\ One commenter stated that the proposed aggregation 
provisions would force market participants to constantly monitor their 
trading activities and their volume (for government securities) across 
all subsidiaries and clients to determine whether either the 
qualitative or quantitative standards are triggered.\312\ One commenter 
questioned why the Commission's aggregation approach departs 
substantially from established Commission precedent under Regulation M 
and section 13 reporting requirements.\313\
---------------------------------------------------------------------------

    \311\ See SIFMA Comment Letter I (``In addition, the Aggregation 
Rule would undermine statutory and regulatory limits on the scope of 
dealer and government securities dealer registration.''); Committee 
on Capital Markets Regulation Comment Letter. See also ICI Comment 
Letter; SIFMA AMG Comment Letter; Morgan Lewis Comment Letter; MFA 
Comment Letter I.
    \312\ AIMA Comment Letter II.
    \313\ See Comment Letter of Managed Funds Association (Apr. 6, 
2023) (``MFA Comment Letter IV'').
---------------------------------------------------------------------------

    One commenter stated that the Commission has not explained how 
dealer registration would work if unrelated client accounts needed to 
be aggregated.\314\ One commenter specifically raised concerns with the 
``common control'' provision stating that: ``Combining the securities 
buying of one entity and the securities selling of another entity when 
they are under common control is plainly not indicative of dealing 
activity when it is not coordinated or integrated.'' \315\
---------------------------------------------------------------------------

    \314\ See IAA Comment Letter I.
    \315\ See MFA Comment Letter IV.
---------------------------------------------------------------------------

    As noted above, many commenters did not support the definitions, 
specifically the definition of ``own account,'' which they stated was 
overbroad.\316\ One of these commenters stated that there is no 
connection between controlling--but not owning--an account and that 
account being the party's ``own account.'' \317\ Some commenters stated 
that all managed accounts should be excluded from the definition.\318\
---------------------------------------------------------------------------

    \316\ See, e.g., ADAM Comment Letter; Schulte Roth Comment 
Letter; SIFMA AMG Comment Letter; McIntyre Comment Letter II; MFA 
Comment Letter I; Andreessen Horowitz Comment Letter; Morgan Lewis 
Comment Letter; BlackRock Comment Letter. See also IAA Comment 
Letter I (``We are concerned that these overbroad provisions would 
sweep in separately-managed accounts and pooled investment vehicles 
managed in the ordinary course by the same adviser but that have no 
relationship with one another other than having the same adviser''); 
McIntyre Comment Letter II (``The proposals construct a complex 
regime of aggregation and attribution principles in order to address 
a manufactured concern of avoidance structuring, which has the 
effect of casting a wide net to capture accounts at the `legal-
entity level,' presumably meaning accounts under common control in a 
fund complex.'').
    \317\ See Schulte Roth Comment Letter.
    \318\ See SIFMA AMG Comment Letter; BlackRock Comment Letter 
(``As discussed in SIFMA AMG's and ICI's respective comment letters, 
we are concerned that the Proposal's definition of `own account' is 
overly broad and could require that separately managed accounts 
(`SMAs') register as dealers based on the activity of their 
unaffiliated advisers acting as their agents.'').
---------------------------------------------------------------------------

    Similarly, many commenters also did not support the definition of 
``control''

[[Page 14963]]

because they believed the definition was too broad by capturing too 
many types of arrangements.\319\ One commenter stated that the 
Commission should make clear that advisers do not control their clients 
merely because they manage those clients' accounts on a discretionary 
or other basis.\320\ Many commenters also opposed the ``parallel 
account structure'' definition, also finding that it was overbroad and 
impractical.\321\ While commenters generally did not comment on the 
definition of ``person,'' one commenter suggested adopting a definition 
that treats separately trading activity conducted by separate decision-
makers without coordination of trading or cooperation among or between 
them, stating that this treatment would be consistent with the 
treatment of separate accounts for other securities law purposes.\322\
---------------------------------------------------------------------------

    \319\ See, e.g., ADAM Comment Letter; Schulte Roth Comment 
Letter; T. Rowe Price Comment Letter; SIFMA Comment Letter I; MFA 
Comment Letter I; AIMA Comment Letter II; McIntyre Comment Letter 
II; IAA Comment Letter I. See also SIFMA AMG Comment Letter (``The 
Commission's definition of `own account,' and the reference to the 
definition of `control' in the large trader reporting regime is 
inappropriate, exceedingly broad, and will capture a number of 
accounts and arrangements that were otherwise not contemplated as 
encompassing traditional dealer activity.'').
    \320\ See IAA Comment Letter I; IAA Comment Letter II.
    \321\ See, e.g., ICI Comment Letter (``The Commission's proposed 
definition of a `parallel account structure' in this context is 
overly broad and would inappropriately result in aggregation among 
separately owned client accounts that follow substantially the same 
investment objectives and strategies but are managed by the same 
registered investment adviser in the ordinary course of business, 
rather than for purposes of evading dealer registration 
requirements.''). See also ABA Comment Letter; SIFMA AMG Comment 
Letter; IAA Comment Letter I; T Rowe Price Comment Letter.
    \322\ MFA Comment Letter I.
---------------------------------------------------------------------------

    After careful review of these comments and upon further 
consideration, the Commission acknowledges the concerns raised by 
commenters and has determined that for the purpose of assessing dealer 
status under the final rules, an anti-evasion approach is appropriate. 
The Commission is revising the rule text to delete from the definition 
of ``own account'' any accounts held in the name of a person over whom 
that person exercises control or with whom that person is under common 
control and corresponding exclusions. Accordingly, under the rules as 
adopted, ``own account'' thus means any account: (a) held in the name 
of that person; or (b) held for the benefit of that person.\323\ At the 
same time, in order to prevent potentially evasive behavior and in 
response to comments, the Commission is adding an anti-evasion 
provision providing that no person shall evade the registration 
requirements of this section by: (1) engaging in activities indirectly 
that would satisfy the qualitative standard; or (2) disaggregating 
accounts.
---------------------------------------------------------------------------

    \323\ As discussed below, the Commission has not made changes to 
the definition of ``person,'' but has made conforming edits to 
delete the definitions of ``control'' and ``parallel account 
structure'' due to deletion of the aggregation standard.
---------------------------------------------------------------------------

    Each of these changes is discussed in more detail below.
Definition of ``Person''
    The Commission is adopting the definition of ``person'' as 
proposed. Removal of the aggregation provision adequately addresses the 
comment mentioned above \324\ suggesting adoption of a definition of 
``person'' that treats separately trading activity conducted by 
separate decision-makers without coordination of trading or cooperation 
among or between them. Further, the adopted definition of ``person'' is 
well-established and has the same meaning as prescribed in section 
3(a)(9) of the Exchange Act and under applicable dealer precedent.\325\
---------------------------------------------------------------------------

    \324\ See MFA Comment Letter I.
    \325\ Section 3(a)(9) of the Exchange Act defines a ``person'' 
as ``a natural person, company, government, or political 
subdivision, agency, or instrumentality of a government.'' See 15 
U.S.C. 78c(a)(9). Under section 3(a)(19) of the Exchange Act, the 
term ``company'' has the same meaning as in the Investment Company 
Act of 1940. See 15 U.S.C. 78c(a)(19).
---------------------------------------------------------------------------

Definition of ``Own Account''
    As stated above, the Commission is adopting the definition of ``own 
account'' under paragraph (b)(2) to mean any account: (i) held in the 
name of that person; or (ii) held for the benefit of that person. 
Further, the Commission is removing the definitions of ``control'' and 
``parallel account structure'' as the corresponding language in the 
aggregation provisions of the proposed rules has been removed, and the 
definitions are no longer relevant.
    In response to concerns raised by commenters related to, among 
other things, the breadth of the proposed rule's aggregation approach, 
the Commission has determined to focus in the first instance on an 
analysis of activity on an entity-by-entity basis, rather than 
aggregating accounts across entities that are controlled by or are 
under common control with an entity.\326\
---------------------------------------------------------------------------

    \326\ See supra note 290.
---------------------------------------------------------------------------

Anti-Evasion Provision
    Although the Commission has determined to eliminate the proposed 
rule's aggregation provision, the Commission nevertheless remains 
concerned that some persons may seek to structure their business for 
the purpose of evading dealer registration. Accordingly, the Commission 
is adopting an anti-evasion provision in the final rules, consistent 
with suggestions from commenters. This anti-evasion provision prohibits 
structuring activities or disaggregating accounts for the purpose of 
evading the dealer registration requirements.\327\ Specifically, the 
anti-evasion provision provides that ``no person shall evade the 
registration requirements of this section by'' either ``engaging in 
activities indirectly that would satisfy paragraph (a) of this 
section'' (``first anti-evasion prong''); or ``disaggregating 
accounts'' (``second anti-evasion prong'' and together, the ``anti-
evasion provision'').
---------------------------------------------------------------------------

    \327\ The use of an anti-evasion approach was also suggested by 
commenters. See supra note 308 and accompanying text.
---------------------------------------------------------------------------

    The first anti-evasion prong prohibits a person from evading the 
registration requirements by engaging indirectly in activity that would 
meet the qualitative standard. This prong makes clear that persons are 
prohibited from evading the dealer registration requirements under the 
final rules by, among other things, using another person or entity to 
indirectly engage in activity that would meet the qualitative 
standard.\328\
---------------------------------------------------------------------------

    \328\ Nothing in these final rules or this release affects the 
Commission's ability to pursue unlawful unregistered dealer activity 
under any other applicable provision of the Federal securities laws.
---------------------------------------------------------------------------

    The final rules also include a second anti-evasion prong. This 
prong, which is modeled on Rule 13h-1(c)(2),\329\ would make it 
unlawful for a person to evade registration by disaggregating accounts. 
For purposes of this second anti-evasion prong, ``disaggregate'' means 
separating or breaking up accounts for the purpose of evading the 
dealer registration requirements. This prong is intended to address 
persons who seek to evade the requirements of this rule--not by 
reducing or changing their activity to avoid triggering the rules--but 
by spreading the activity across entities or accounts such that the 
level of activity is the same, with no real change with respect to 
liquidity provision. The second anti-evasion prong thus is intended to 
address market participants who disaggregate their existing business 
for the purpose of evading the final rules, but not limit the ordinary 
course business activities of persons who have no such intent or 
purpose. For instance, the Commission would generally consider 
management by a registered investment adviser of separately owned

[[Page 14964]]

client accounts that follow substantially the same investment 
objectives and strategies to be ordinary course business activities, 
and so would not impute the trading in the clients' accounts to the 
adviser's ``own account,'' absent intent to evade the dealer 
registration requirements.
---------------------------------------------------------------------------

    \329\ See Proposing Release at 23078. See, e.g., ICI Comment 
Letter; T. Rowe Price Comment Letter.
---------------------------------------------------------------------------

    The anti-evasion provision is intended to capture persons dividing 
or structuring their activity to evade the application of the final 
rules. Potentially evasive activity would include but is not limited 
to, coordinating and integrating trading across commonly controlled 
groups of legal entities such that it would not meet the qualitative 
standard, including by switching which legal entity is engaged in 
trading to evade the ``regular'' requirement of the qualitative 
standard. Other specific examples of potentially evasive behavior 
include: (i) a person that uses two legal entities to separately 
purchase and sell securities; \330\ or (ii) a person that uses several 
legal entities to purchase and sell securities, but ``rotates'' the 
activity across or among entities in a way that none of the legal 
entities trades frequently enough to satisfy the ``regular'' test under 
either factor.
---------------------------------------------------------------------------

    \330\ The separation of purchases and sales in distinct legal 
entities could also indicate evasive behavior with respect to the 
expressing trading interest qualitative factor, which requires 
expressing trading interest on both sides of the market.
---------------------------------------------------------------------------

    In determining whether or not a person is evading the dealer 
registration requirements in violation of the anti-evasion provision, 
the Commission may consider, for example, whether there are: (i) 
information barriers to prevent sharing of information or sufficiently 
segregated trading,\331\ (ii) overlapping personnel across accounts or 
entities, or (iii) separate account statements for each account. Other 
relevant factors could include, for example, the identification of 
personnel with oversight or managerial responsibility over multiple 
accounts in a single entity or affiliated entities, and account owners 
of multiple accounts, that do not have authority to execute trades or 
pre-approve trading decisions for accounts or entities; \332\ or a 
business purpose that demonstrates that there is no coordinated buying 
and selling between accounts or entities.
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    \331\ See Citadel Comment Letter (``The Commission should not 
aggregate trading activities across independent entities, portfolio 
managers, or trading strategies when assessing whether the proposed 
qualitative criteria are met, particularly if there are information 
barriers in place.'').
    \332\ See Exchange Act Release No. 56206 (Aug. 6, 2007), 72 FR 
45094 (Aug. 10, 2007).
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    While the Commission has identified a number of non-exhaustive 
examples of potentially evasive behavior and described factors that 
weigh against a conclusion that a person's intent is evasive, it is 
important to recognize that whether a person has violated the anti-
evasion provision will depend on an evaluation of the totality of the 
facts and circumstances.
5. No Presumption
    In the Proposing Release, the Commission proposed to include a ``no 
presumption'' clause to clarify that a person may be a dealer if it 
engages in a regular business of buying and selling securities for its 
own account, even if it does not meet the conditions set forth in the 
proposed rules. The Commission explained that the proposed rules did 
not seek to address all persons that may be acting as dealers under 
otherwise applicable interpretations and precedent (for example, by 
acting as an underwriter, regardless of whether such person has or 
controls assets of less than $50 million).\333\
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    \333\ See Proposing Release at 23077.
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    No commenters suggested changes to the proposed no presumption 
clause. For the reasons discussed in the Proposing Release, we are 
adopting this provision as proposed. We also reiterate, consistent with 
our adoption of the no presumption clause, that the final rules do not 
modify existing court precedent and Commission interpretations, which 
continue to apply to determine whether a person is a dealer, even if 
such person would not qualify as a dealer under the final rules.

B. Compliance Date

    In the Proposing Release, the Commission proposed and sought 
comment on a compliance date of one year from the effective date of the 
adoption of the final rules.\334\ The Commission explained that the 
compliance period was designed to provide adequate time for persons 
captured by the proposed rules, if adopted, to apply for dealer 
registration, and for the relevant SROs to review new member 
applications, without disrupting the markets or the participants' 
existing market activities. The Proposing Release explained that the 
proposed compliance period would not cover market participants whose 
activities following the effective date of the final rules would 
require registration under those rules.
---------------------------------------------------------------------------

    \334\ See Proposing Release at 23062.
---------------------------------------------------------------------------

    The Commission received a few comments relating to the compliance 
date.\335\ Some of the letters expressed concerns that the compliance 
period would not be long enough to allow for new dealers or government 
securities dealers to prepare to register as well as complete the SRO 
registration process.\336\ One of the commenters recommended that the 
Commission provide the same transition period for market participants 
whose activities would require registration following the effective 
date.\337\ Another commenter, FINRA, commented that although the 
current FINRA rule set currently provides for a 180-day review period 
for a new member application, FINRA has ``ways to help expedite the 
processing of applications for persons captured by the [final rules] 
and is committed to ensuring an application review process that is 
thorough and efficient while promoting investor protection.'' \338\
---------------------------------------------------------------------------

    \335\ GDCA Comment Letter at 3; MFA Comment Letter I at 33-34; 
FINRA Comment Letter (explaining that ``FINRA membership is key to 
facilitate effective oversight of such entities, and to provide for 
enhanced regulatory audit trails and market integrity, among other 
benefits. . .''). In addition, with respect to the compliance 
period, several commenters requested the Commission to consider 
interactions between the proposed rule and other recent Commission 
rules. In determining compliance periods, the Commission considers 
the benefits of the rules, as well as the costs of delayed 
compliance dates and potential overlapping compliance periods. For 
the reasons discussed throughout this release, to the extent that 
there are costs from overlapping compliance periods, the benefits of 
the rules justify such costs. See infra section III.C.2.a.vi for a 
discussion of the interactions of the final rule with certain other 
Commission rules.
    \336\ See GDCA Comment Letter (``If firms were required to 
register, the proposed one year compliance period is wholly 
impractical. In our experience, for a firm that is not currently 
registered to prepare to register as a broker-dealer, including 
implementing email, invoicing, and other operations related 
technology, hiring appropriate personnel, and completing relevant 
examinations takes at least six months. While FINRA is expected to 
approve registrations within six months, in the best circumstances 
that is often not the case. For firms with unusual or complex 
business plans, such as digital asset focused firms, this process 
could take years.''); MFA Comment Letter I (``We strongly urge the 
Commission to extend the proposed one-year compliance period. The 
Proposal's requirements are complex and we understand that firms 
will need to expend significant time, resources, and effort to 
understand and apply them. Firms that determine that registration is 
necessary after an analysis of their trading activity will then need 
additional time to prepare a Form BD and otherwise prepare to comply 
with the Commission's dealer regulations. We believe that a 36-month 
transition period following the effectiveness of any final rule 
would be more appropriate.'').
    \337\ See MFA Comment Letter I (noting that ``[i]t will be far 
easier and fairer to provide a common transition period for all 
market participants'').
    \338\ FINRA Comment Letter (further stating that FINRA ``looks 
forward to the opportunity to work with the Commission and affected 
market participants to facilitate a review process that can achieve 
this balance without disrupting the markets.'').
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    After further consideration, the Commission is adopting a one-year

[[Page 14965]]

compliance date from the effective date of the final rules for all 
persons who engage in activities that meet the dealer registration 
requirements under the final rules. In light of the significant 
benefits afforded by dealer registration to investors and the markets, 
it is important for persons engaging in activities that meet the dealer 
registration requirements to register as soon as possible. Considering 
FINRA's expressed commitment to expedite the application process,\339\ 
a compliance date of one year from the effective date of the final 
rules will provide a sufficient period of time for affected market 
participants to comply with the final rules. However, the one-year 
compliance period will be applicable to all affected market 
participants, as we agree that a common transition period will be 
easier to administer and more equitable.\340\
---------------------------------------------------------------------------

    \339\ FINRA Comment Letter.
    \340\ See MFA Comment Letter I.
---------------------------------------------------------------------------

    However, we emphasize that the one-year compliance period only 
applies to market participants who are engaging in activities covered 
by the final rules prior to the compliance date, and does not apply to 
persons whose activities otherwise satisfy the definition of dealer 
under applicable Commission interpretations and court precedent. It is 
incumbent here, as with questions of ``dealer'' status generally, for 
market participants to analyze and monitor their trading activities to 
understand their registration obligations.

III. Economic Analysis

A. Introduction

    The Commission is sensitive to the economic effects of its rules, 
including the costs and benefits and effects on efficiency, 
competition, and capital formation. Section 3(f) of the Exchange Act 
requires the Commission, whenever it engages in rulemaking pursuant to 
the Exchange Act and is required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action would 
promote efficiency, competition, and capital formation.\341\ In 
addition, section 23(a)(2) of the Exchange Act requires the Commission, 
when making rules under the Exchange Act, to consider the effect such 
rules would have on competition.\342\ Exchange Act section 23(a)(2) 
prohibits the Commission from adopting any rule that would impose a 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act.\343\
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    \341\ 15 U.S.C. 78c(f).
    \342\ 15 U.S.C. 78w(a)(2).
    \343\ Id.
---------------------------------------------------------------------------

    The final rules will promote competition among entities that 
regularly provide significant liquidity by applying consistent 
regulation to these entities, thus leveling the playing field between 
liquidity provision conducted by entities that are currently registered 
as dealers and government securities dealers and by entities that are 
not. The final rules will also promote the financial responsibility and 
operational integrity of significant liquidity providers that are 
acting as dealers in securities markets by subjecting them to the Net 
Capital Rule and to other Commission and SRO rules and oversight. The 
financial responsibility and operational integrity of these significant 
liquidity providers, in turn, will support the resilience of securities 
markets. In addition, the final rules will improve the Commission's 
ability to analyze market events and detect manipulation and fraud. 
Although the final rules may have small negative effects on market 
liquidity and efficiency, due to increases in costs for affected 
parties, the final rules may also promote liquidity and efficiency by 
limiting the probability that significant liquidity providers fail.

B. Baseline

    The baseline against which the costs, benefits, and the effects on 
efficiency, competition, and capital formation of the final rules are 
measured consists of the current state of the securities markets, 
current practice as it relates to dealers and other significant 
liquidity providers in securities markets, and the current regulatory 
framework. The economic analysis considers existing regulatory 
requirements, including recently adopted rules, as part of its economic 
baseline against which the costs and benefits of the final rules are 
measured.\344\ Several commenters requested the Commission to consider 
interactions between the economic effects of the proposed rules and 
other recent Commission rules.\345\ The Commission recently adopted 
seven of the rules mentioned as potentially impacting the economic 
effects of the final rules,\346\ namely the May 2023 SEC Form PF 
Amending Release,\347\ the Treasury Clearing Adopting Release,\348\

[[Page 14966]]

the Private Fund Advisers Adopting Release,\349\ the Beneficial 
Ownership Amending Release,\350\ the 17 CFR 240.10c-1a (``Rule 10c-
1a'') Adopting Release,\351\ the Short Position Reporting Adopting 
Release,\352\ and the Securitizations Conflicts Adopting Release.\353\ 
These adopted rules were not included as part of the baseline in the 
Proposing Release because they were not adopted at that time.\354\ In 
response to commenters, this economic analysis considers potential 
economic effects arising from any overlap between the compliance period 
for the final amendments and each of these recently adopted rules.\355\
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    \344\ See, e.g., Nasdaq v. SEC, 34 F.4th 1105, 1111-15 (D.C. 
Cir. 2022). This approach also follows SEC staff guidance on 
economic analysis for rulemaking. See Staff's ``Current Guidance on 
Economic Analysis in SEC Rulemaking'' (Mar. 16, 2012), available at 
https://www.sec.gov/divisions/riskfin/rsfi_guidance_econ_analy_secrulemaking.pdf (``The economic 
consequences of proposed rules (potential costs and benefits 
including effects on efficiency, competition, and capital formation) 
should be measured against a baseline, which is the best assessment 
of how the world would look in the absence of the proposed 
action.''); id. at 7 (``The baseline includes both the economic 
attributes of the relevant market and the existing regulatory 
structure.''). The best assessment of how the world would look in 
the absence of the proposed or final action typically does not 
include recently proposed actions, because doing so would improperly 
assume the adoption of those proposed actions.
    \345\ See, e.g., ICI Comment Letter (``The Commission has issued 
a wide range of interconnected rule proposals . . . [that] in the 
aggregate warrant further analysis by the Commission. The 
Commission's failure to consider the Interconnected Rules 
holistically is a widespread concern among other market 
participants.'').
    \346\ Short Position and Short Activity Reporting by 
Institutional Investment Managers, Exchange Act Release No. 94313 
(Feb. 25, 2022), 87 FR 14950 (Mar. 16, 2022) (see, e.g., Overdahl 
Comment Letter at 24 n.113; MFA Comment Letter I at 15-16); 
Modernization of Beneficial Ownership Reporting, Securities Act 
Release No. 11030, Exchange Act Release No. 94211 (Feb. 10, 2022), 
87 FR 13846 (Mar. 10, 2022) (see, e.g., Element Comment Letter at 
10; Overdahl Comment Letter at 24 n.113; MFA Comment Letter I at 14-
16); Private Fund Advisers; Documentation of Registered Investment 
Adviser Compliance Reviews, Investment Advisers Act Release No. 5955 
(Feb. 9, 2022), 87 FR 16886 (Mar. 24, 2022) (see, e.g., MFA Comment 
Letter I at 20; Element Comment Letter at 10; Overdahl Comment 
Letter at 24 n.113; AIC Comment Letter at 1 n.3, 8); Amendments to 
Form PF to Require Event Reporting for Large Hedge Fund Advisers and 
Private Equity Fund Advisers and to Amend Reporting Requirements for 
Large Private Equity Fund Advisers, Investment Advisers Act Release 
No. 5950 (Jan. 26, 2022), 87 FR 9106 (Feb. 17, 2022) (see Overdahl 
Comment Letter at 24 n.113; AIC Comment Letter at 1 n.3, 8; MFA 
Comment Letter I at 20 n.21); Prohibition Against Conflicts of 
Interest in Certain Securitizations, Securities Act Release No. 
11151 (Jan. 25, 2023), 88 FR 9678 (Feb. 14, 2023) (see MFA Comment 
Letter I at 21-22); Reporting of Securities Loans, Exchange Act 
Release No. 93613 (Nov. 18, 2021), 86 FR 69802 (Dec. 8, 2021) (see, 
e.g., Overdahl Comment Letter at 24 n.113); Standards for Covered 
Clearing Agencies for U.S. Treasury Securities and Application of 
the Broker-Dealer Customer Protection Rule With Respect to U.S. 
Treasury Securities, Exchange Act Release No. 95763 (Sept. 14, 
2022), 87 FR 64610 (Oct. 25, 2022) (see AIMA Comment Letter III at 
4; MFA Comment Letter II at 6 n.13).
    \347\ Form PF; Event Reporting for Large Hedge Fund Advisers and 
Private Equity Fund Advisers; Requirements for Large Private Equity 
Fund Adviser Reporting, Investment Advisers Act Release No. 6297 
(May 3, 2023), 88 FR 38146 (June 12, 2023) (``May 2023 SEC Form PF 
Amending Release''). The Form PF amendments adopted in May 2023 
require large hedge fund advisers and all private equity fund 
advisers to file reports upon the occurrence of certain reporting 
events. The May 2023 SEC Form PF Amending Release revised Form PF to 
(i) add new current reporting requirements for large hedge fund 
advisers to qualifying hedge funds upon the occurrence of key events 
(new section 5); (ii) add new quarterly reporting requirements for 
all private equity fund advisers upon the occurrence of key events 
(new section 6); and (iii) add and revise new regular reporting 
questions for large private equity fund advisers. The compliance 
dates are Dec. 11, 2023, for the event reports in Form PF sections 5 
and 6, and June 11, 2024, for the remainder of the Form PF 
amendments in the May 2023 SEC Form PF Amending Release.
    \348\ Standards for Covered Clearing Agencies for U.S. Treasury 
Securities and Application of the Broker-Dealer Customer Protection 
Rule With Respect to U.S. Treasury Securities, Exchange Act Release 
No. 99149 (Dec. 13, 2023), 89 FR 2714 (Jan. 16, 2024) (``Treasury 
Clearing Adopting Release''). Among other things, the Treasury 
Clearing Adopting Release requires covered clearing agencies for 
U.S. Treasury securities to have written policies and procedures 
reasonably designed to require that every direct participant of the 
covered clearing agency submit for clearance and settlement all 
eligible secondary market transactions in U.S. Treasury securities 
to which it is a counterparty. The compliance dates are 60 days 
following Jan. 16, 2024, for each covered clearing agency to file 
any proposed rule changes pursuant to 17 CFR 240.17ad-22(e)(6)(i) 
and (e)(18)(iv)(C) (``final Rule 17ad-22(e)(6)(i) and 
(e)(18)(iv)(C)'') and final Rule 15c3-3, and the rule changes must 
be effective by Mar. 31, 2025. With respect to the changes to Rule 
17ad-22(e)(18)(iv)(A) and (B), each covered clearing agency will be 
required to file any proposed rule changes regarding those 
amendments no later than 150 days following Jan. 16, 2024, and the 
proposed rule changes must be effective by Dec. 31, 2025, for cash 
market transactions encompassed by paragraph (ii) of the definition 
of an eligible secondary market transaction, and by June 30, 2026, 
for repo transactions encompassed by paragraph (i) of the definition 
of an eligible secondary market transactions. Compliance by the 
direct participants of a U.S. Treasury securities covered clearing 
agency with the requirement to clear eligible secondary market 
transactions would not be required until Dec. 31, 2025, and June 30, 
2026, respectively, for cash and repo transactions.
    \349\ Private Fund Advisers; Documentation of Registered 
Investment Adviser Compliance Reviews, Investment Advisers Act 
Release No. 6383 (Aug. 23, 2023), 88 FR 63206 (Sept. 14, 2023) 
(``Private Fund Advisers Adopting Release''). The Commission adopted 
five new rules and two rule amendments as part of the reforms. The 
compliance date for the quarterly statement rule and the audit rule 
is Mar. 14, 2025, for all advisers. For the adviser-led secondaries 
rule, the preferential treatment rule, and the restricted activities 
rule, the Commission adopted staggered compliance dates that provide 
for the following compliance periods: for advisers with $1.5 billion 
or more in private funds assets under management, a 12-month 
compliance period (ending on Sept. 14, 2024) and for advisers with 
less than $1.5 billion in private funds assets, an 18-month 
compliance period (ending on Mar 14, 2025). The amended Advisers Act 
compliance provision for registered investment advisers has a Nov. 
13, 2023, compliance date. See Private Fund Advisers Adopting 
Release, sections IV, VI.C.1.
    \350\ Modernization of Beneficial Ownership Reporting, 
Securities Act Release No. 11253, Exchange Act Release No. 98704 
(Oct. 10, 2023), 88 FR 76896 (Nov. 7, 2023) (``Beneficial Ownership 
Amending Release''). Among other things, the amendments generally 
shorten the filing deadlines for initial and amended beneficial 
ownership reports filed on Schedules 13D and 13G, and require that 
Schedules 13D and 13G filings be made using a structured, machine-
readable data language. The new disclosure requirements and filing 
deadlines for Schedule 13D are effective on Feb. 5, 2024. The new 
filing deadline for Schedule 13G takes effect on Sept 30, 2024, and 
the rule's structured data requirements have a one-year 
implementation period ending Dec. 18, 2024. See Beneficial Ownership 
Amending Release, section II.G.
    \351\ Reporting of Securities Loans, Exchange Act Release No. 
98737 (Oct. 13, 2023), 88 FR 75644 (Nov. 3, 2023) (``Rule 10c-1a 
Adopting Release''). The securities loan reporting rule requires any 
person who loans a security on behalf of itself or another person to 
report information about securities loans to a registered national 
securities association (namely, FINRA) and requires FINRA to make 
certain information it receives available to the public. The covered 
persons will include market intermediaries, securities lenders, 
broker-dealers, and reporting agents. The final rule's compliance 
dates require that FINRA propose its rules within four months of the 
effective date of final Rule 10c-1a, or approximately May 2024, and 
finalize them no later than 12 months after the effective date of 
final Rule 10c-1a, or approximately Jan. 2025; that FINRA implement 
data retention and availability requirements for reporting 24 months 
after the effective date of final Rule 10c-1a, or approximately Jan. 
2026; that covered persons report Rule 10c-1a information to FINRA 
starting on the first business day thereafter; and that FINRA 
publicly report Rule 10c-1a information within 90 calendar days 
thereafter, or approximately May 2026. See Rule 10c-1a Adopting 
Release, section VIII.
    \352\ Short Position and Short Activity Reporting by 
Institutional Investment Managers, Exchange Act Release No. 98738 
(Oct. 13, 2023), 88 FR 75100 (Nov. 1, 2023) (``Short Position 
Reporting Adopting Release''). The new rule and related form are 
designed to provide greater transparency through the publication of 
short sale-related data to investors and other market participants. 
Under the new rule, institutional investment managers that meet or 
exceed certain specified reporting thresholds are required to 
report, on a monthly basis using the related form, specified short 
position data and short activity data for equity securities. The 
compliance date for the rule is Jan. 2, 2025. In addition, the Short 
Position Reporting Adopting Release amends the national market 
system plan governing CAT to require the reporting of reliance on 
the bona-fide market-making exception in the Commission's short sale 
rules. The compliance date for the CAT amendments is July 2, 2025.
    \353\ Prohibition Against Conflicts of Interest in Certain 
Securitizations, Securities Act Release No. 11254 (Nov. 27, 2023), 
88 FR 85396 (Dec. 7, 2023) (``Securitizations Conflicts Adopting 
Release''). The new rule prohibits an underwriter, placement agent, 
initial purchaser, or sponsor of an asset-backed security (including 
a synthetic asset-backed security), or certain affiliates or 
subsidiaries of any such entity, from engaging in any transaction 
that would involve or result in certain material conflicts of 
interest. The compliance date for securitization participants to 
comply with the prohibition is June 9, 2025.
    \354\ Since proposing these rules, the Commission adopted rules 
to prohibit fraud and prevent undue influence over chief compliance 
officers in security-based swaps entities that were proposed in 
another proposal identified by a commenter, the Security-Based Swaps 
Proposal. See Overdahl Comment Letter; Prohibition Against Fraud, 
Manipulation, or Deception in Connection with Security-Based Swaps; 
Prohibition Against Undue Influence over Chief Compliance Officers, 
Exchange Act Release No. 97656 (June 7, 2023), 88 FR 42546 (June 20, 
2023). However, the Commission believes that there are no potential 
significant effects from overlapping requirements to comply with the 
final rules. Specifically, the new security-based swaps rules were 
effective Aug. 29, 2023--before the effective date of the final 
rules and over a year before compliance with the final rules is 
required for persons engaging in activities that meet the dealer 
registration requirements--and were expected to have minimal 
compliance costs because they solely identified prohibited actions.
    \355\ In addition, commenters indicated there could also be 
overlapping compliance costs between the final amendments and 
proposals that have not been adopted. See, e.g., ICI Comment Letter; 
Overdahl Comment Letter; MFA Comment Letter I; MFA Comment Letter 
II; Element Comment Letter; AIC Comment Letter; Consensys Comment 
Letter; AIMA Comment Letter II. To the extent those proposals are 
adopted, the baseline in those subsequent rulemakings will reflect 
the existing regulatory requirements at that time.
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    Dealers perform important market functions, such as absorbing order 
imbalances and providing liquidity to buyers and sellers who may not 
arrive at the same time, and a regulatory regime exists to govern their 
activities.\356\ However, market participants that do not register as 
dealers--and so do not comply with the dealer regulatory regime--
increasingly perform critical market functions that historically have 
been performed by dealers. This difference in regulatory treatment 
creates the potential for negative externalities, as described below. 
Furthermore, the unevenness of regulation potentially gives less-
regulated entities an unfair advantage over registered dealers that 
engage in similar activities.
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    \356\ Order imbalances exist when a market receives more buy 
orders than sell orders, or vice versa, at a point in time. Dealers 
may absorb these imbalances by buying when there are more sell 
orders (and temporarily holding inventory) and by selling when there 
are more buy orders (by liquidating inventory). A dealer that 
absorbs imbalances in this way can effectively facilitate a 
transaction between a person who wishes to sell at time X and a 
person who wishes to buy at time Y.
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1. Rules and Regulations That Apply to Registered Dealers
    Persons engaged in the business of buying and selling securities 
for such person's own account are generally dealers pursuant to section 
3(a)(5) of the Exchange Act and are required to register as dealers 
with the Commission in accordance with section 15(b) of the Exchange 
Act, become members of an SRO, and adhere to a comprehensive regulatory 
regime, unless their activities fall within an exception,\357\ or 
unless they limit their dealing activity to excluded or exempted 
securities.
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    \357\ See supra notes 5 and 11.
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    Dealers that are also government securities dealers are further 
subject to rules issued by the Treasury that concern financial 
responsibility, capital requirements, recordkeeping, and

[[Page 14967]]

reports and audits. However, while not required to register as dealers, 
market participants (other than registered dealers and financial 
institutions) that limit their dealing activities to government 
securities generally have to register with the Commission as government 
securities dealers under section 15C of the Exchange Act, and similarly 
must comply with Treasury rules.
    The regulatory regime for registered dealers includes provisions 
that limit risk (e.g., the Net Capital Rule \358\ and rules promoting 
operational integrity \359\), provisions that require certain books and 
records,\360\ provisions that require various reporting and disclosure 
(including audited financial statements \361\ and the identities of 
owners, directors, and managers \362\), and antifraud and anti-
manipulation provisions.\363\ The Net Capital Rule requires registered 
dealers to maintain minimum amounts of net liquid assets at all times, 
even intraday, thus constraining dealer leverage.\364\ In addition to 
the financial and regulatory risk management controls required by the 
Market Access Rule, dealers with market access must comply with a 
number of underlying regulatory requirements when conducting their 
business.\365\ Registered dealers are also subject to the Commission's 
authority to conduct examinations and impose sanctions \366\ and to the 
rules, examination authority, and enforcement authority of the relevant 
SRO.\367\ Section 6(b)(5) and section 15A(b)(6) of the Exchange Act, 
respectively, require that the rules of a national securities exchange 
and the rules of a national securities association be designed to 
prevent fraudulent and manipulative acts and practices; promote just 
and equitable principles of trade; foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities; remove impediments to and perfect the mechanisms of a free 
and open market and a national market system, and in general protect 
investors and the public interest.\368\ SROs can review their members' 
supervisory procedures, including requiring internal controls on 
algorithmic trading.\369\ For most securities dealers that trade on 
more than one exchange, the relevant SRO is currently FINRA.\370\ 
Commission-registered brokers or dealers must also become members of 
the Securities Investor Protection Corporation (``SIPC'').\371\
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    \358\ The Net Capital Rule requires dealers to hold liquid 
assets in excess of their unsubordinated liabilities. See section 
III.C.2.b for a more complete discussion of the Net Capital Rule.
    \359\ See supra note 26.
    \360\ See supra note 27.
    \361\ See 17 CFR 240.17a-5(d)(1)(i)(A) (``Rule 17a-
5(d)(1)(i)(A)'').
    \362\ See Form BD.
    \363\ See supra note 28 and surrounding text. See also, e.g., 
FINRA Rule 2010 (Standards of Commercial Honor and Principles of 
Trade); FINRA Rule 2020 (Use of Manipulative, Deceptive, or Other 
Fraudulent Devices); FINRA Rule 4510 Series (Books and Records 
Requirements). Other SROs have comparable and sometimes equivalent 
rules. See, e.g., NYSE, NYSE Rules, available at https://nyseguide.srorules.com/rules; Nasdaq, Rulebook--The Nasdaq Stock 
Market, available at https://listingcenter.nasdaq.com/rulebook/nasdaq/rules.
    \364\ See section III.C.2.b for a discussion of the Net Capital 
Rule.
    \365\ These regulatory requirements include, for example, pre-
trade requirements such as exchange-trading rules relating to 
special order types, trading halts, odd-lot orders, and SEC rules 
under Regulation SHO and Regulation NMS, as well as post-trade 
obligations to monitor for manipulation and other illegal activity. 
See also supra note 26 on the Market Access Rule.
    \366\ See supra note 30.
    \367\ Exchange Act section 17(b) subjects broker-dealers to 
inspections and examinations by Commission staff and by the relevant 
SRO. In addition, 17 CFR 240.15b2-2 (``Exchange Act Rule 15b2-2'' or 
``Rule 15b2-2'') generally requires the SRO that has responsibility 
for examining a dealer member to inspect a newly registered dealer 
for compliance with applicable financial responsibility rules within 
six months of registration, and for compliance with all other 
regulatory requirements within 12 months of registration. See also 
17 CFR 240.17d-1 (``Rule 17d-1'') (examination for compliance with 
applicable financial responsibility rules). Thereafter, FINRA or 
another SRO, as applicable, continues to inspect each firm 
periodically, based on the firm's risk profile.
    \368\ 15 U.S.C. 78f(b)(5) and 15 U.S.C. 78o-3(b)(6).
    \369\ For instance, see FINRA Rules 2010, 3110, 5210, and 6140, 
which establish conduct rules that may apply to algorithmic trading 
and which give FINRA supervisory authority. FINRA Notice 15-09 
describes how ``FINRA staff has conducted a number of examinations 
and investigations . . . that were prompted by the detection of 
systems-related issues at firms engaged in algorithmic strategies, 
and several of these investigations have resulted in settlements of 
formal actions.'' The FINRA notice provides guidance on best 
practices for keeping algorithmic trading compliant with FINRA and 
Commission rules.
    \370\ See supra note 23.
    \371\ Exceptions to the SIPC membership requirement exist for 
(a) persons whose principal business is conducted outside the United 
States and its territories and possessions; (b) persons whose 
business as a broker or dealer consists exclusively of (i) the 
distribution of shares of registered open end investment companies 
or unit investment trusts, (ii) the sale of variable annuities, 
(iii) the business of insurance, or (iv) the business of rendering 
investment advisory services to one or more registered investment 
companies or insurance company separate accounts; and (c) persons 
who are registered as a broker or dealer with respect to 
transactions in security futures products, pursuant to 15 U.S.C. 
78o(b)(11)(A).
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    The regulatory regime differs somewhat for entities that transact 
only in government securities, especially with respect to requirements 
on SIPC membership and capitalization.\372\ Such persons engaged in the 
business of buying and selling government securities for such person's 
own account are generally dealers pursuant to section 3(a)(44) of the 
Exchange Act and have to register with the Commission as government 
securities dealers under section 15C of the Exchange Act. These 
government securities dealers are not required to be members of 
SIPC,\373\ and they are required to comply with the capital 
requirements set forth in 17 CFR 402.2 rather than with the Net Capital 
Rule that applies to dealers. They are further subject to rules issued 
by the Treasury on financial responsibility, capital requirements, 
recordkeeping, and reports and audits.\374\
---------------------------------------------------------------------------

    \372\ See supra note 29.
    \373\ See 15 U.S.C. 78ccc(a)(2).
    \374\ See 17 CFR 402.2. See also supra note 14 and accompanying 
text.
---------------------------------------------------------------------------

    The SEC's recently-adopted Treasury Clearing rule requires that any 
direct participant of a covered clearing agency submit all eligible 
secondary market transactions in U.S. Treasury securities for clearance 
and settlement, including transactions where the counterparty is 
another member of a covered clearing agency.\375\
---------------------------------------------------------------------------

    \375\ See Treasury Clearing Adopting Release.
---------------------------------------------------------------------------

    As explained in section I.A, courts have repeatedly recognized the 
requirement that dealers and government securities dealers register as 
being ``of the utmost importance in effecting the purposes of the 
Exchange Act.'' \376\ Among other things, these regulations promote 
dealers' financial responsibility, including adequate capitalization 
(liquidity held against risky assets) and internal controls. The dealer 
regulations also give the Commission and the SROs tools to help them 
detect manipulation or fraud by analyzing transaction reports and 
examining other records kept by dealers.
---------------------------------------------------------------------------

    \376\ Proposing Release at 23060-61; see also SEC v. Benger, 697 
F. Supp. 2d 932, 944 (N.D. Ill. 2010) (quoting Celsion Corp. v. 
Stearns Mgmt. Corp., 157 F. Supp. 2d 942, 947 (N.D. Ill. 2001) 
(section 15(a)'s registration requirement is ``of the utmost 
importance in effecting the purposes of the Act'' because it enables 
the SEC ``to exercise discipline over those who may engage in the 
securities business and it establishes necessary standards with 
respect to training, experience, and records.''); Roth v. SEC, 22 
F.3d 1108, 1109 (D.C. Cir. 1994) (``The broker-dealer registration 
requirement serves as the keystone of the entire system of broker-
dealer regulation.''); Regional Properties, Inc. v. Financial and 
Real Estate Consulting Co., 678 F.2d 552, 561 (5th Cir. June 3, 
1982); Eastside Church of Christ v. National Plan, Inc., 391 F.2d 
357, 361 (5th Cir. Mar. 12, 1968).
---------------------------------------------------------------------------

2. Affected Parties
    The Commission believes that some entities who are not registered 
as dealers or government securities dealers perform a significant role 
in providing liquidity in markets, including entities

[[Page 14968]]

commonly known as PTFs and potentially other market participants such 
as private funds. The final rules exclude market participants who have 
or control assets of less than $50 million.\377\ This threshold 
excludes small market participants, some of whom are natural persons, 
who are unlikely to pose financial and operational risks to the 
markets.\378\ Similarly, for the reasons discussed above in section 
II.A.3, the final rules exclude investment companies that are 
registered under the Investment Company Act and central banks, 
sovereign entities, and international financial institutions, as 
defined in the final rules. The following two sub-sections describe 
PTFs, as well as private funds and advisers, which are the entities 
most likely to be affected. The third sub-section below analyzes data 
from TRACE and Form PF to identify up to 43 entities that the final 
rules may affect.
---------------------------------------------------------------------------

    \377\ As noted in section II.A.3, outside of the context of 
these rules, whether a person who has or controls less than $50 
million in assets must register as a dealer will remain a facts and 
circumstances determination.
    \378\ Most U.S. investors are households, and most household 
investors have far less than $50 million in assets. The 2019 Survey 
of Consumer Finance, sponsored by the Federal Reserve Board of 
Governors and the U.S. Treasury, shows that 68 million U.S. families 
owned stocks and bonds, either directly or indirectly, and that 93% 
own less than $1 million. The survey also showed that the mean 
(median) U.S. household had total assets of $858,000 ($227,000). 
This number of household investors is much larger than the number of 
institutional investors. For example, there are currently 3,963 
registered investment companies and 15,562 registered investment 
advisers.
---------------------------------------------------------------------------

a. PTFs
    PTFs, who trade only for their own account without customers, have 
emerged as de facto market makers, especially in the U.S. Treasury 
market.\379\ While some such firms have registered with the Commission 
as dealers, many others have not. This section discusses the baseline 
for PTFs in the current market, and a later section will estimate the 
number of PTFs that may be affected by the final rules due to their 
activities in the market for U.S. Treasury securities.
---------------------------------------------------------------------------

    \379\ See FINRA Comment Letter.
    \380\ The analysis is limited to a subsection of TRACE data 
where the identity of trading counterparties is known. Non-FINRA 
member participants generally appear anonymously when they trade 
with FINRA members, who report their activity to TRACE but maintain 
the anonymity of the non-FINRA member counterparties. When non-FINRA 
member participants trade on an ATS that is covered by FINRA Rule 
6730.07, the ATS reports the transaction to TRACE along with a 
unique, non-anonymous MPID for each counterparty. For FINRA Rule 
6730.07, a ``covered ATS'' is an ATS, as that term is defined in 
Rule 300 of SEC Regulation ATS (17 CFR 242.300), that executed 
transactions in U.S. Treasury securities against non-FINRA member 
subscribers of $10 billion or more in monthly par value, computed by 
aggregating buy and sell transactions, for any two months in the 
preceding calendar quarter. In 2022, approximately 58% of the non-
FINRA member volume in TRACE belonged to anonymous market 
participants.
    \381\ Our classification of TRACE entities includes an 
assessment of non-FINRA firms in the data as ``PTFs,'' ``hedge 
funds,'' etc. A small number of non-FINRA firms are registered with 
the Commission as broker-dealers, and these are included with the 
FINRA firms as ``SEC-registered broker-dealers'' in Table 1.
    \382\ James Collin Harkrader and Michael Puglia, ``Principal 
Trading Firm Activity in Treasury Cash Markets,'' FEDS Notes (Aug. 
4, 2020) (``[Principal trading firms] dominate activity on the 
electronic [interdealer broker] platforms (61%).''). See also Doug 
Brain et al., ``Unlocking the Treasury Market Through TRACE,'' FEDS 
Notes (Sept. 28, 2018).
---------------------------------------------------------------------------

    Table 1 summarizes the number and type of identifiable market 
participants in TRACE, by average monthly trading volume in 2022.\380\ 
Many of the most active participants are classified in the data as 
``PTFs'' who are not registered with the Commission as broker-
dealers.\381\ The 231 firms in Table 1 that were not SEC-registered 
broker-dealers accounted for approximately 13% of the aggregate 
Treasury trading volume of all identifiable firms in 2022. The PTFs had 
by far the highest volumes among the non-broker-dealer firms, and the 
most active PTFs had trading volumes roughly comparable to those of the 
most active registered dealers. A Federal Reserve staff analysis 
concluded that PTFs were particularly active in the interdealer segment 
of the U.S. Treasury market in 2019, accounting for 61% of the volume 
on automated interdealer broker platforms and 48% of the interdealer 
broker volume overall.\382\ Figure 1 also shows that in the U.S. 
Treasury market, some participants who are not SEC-registered dealers 
trade very high volumes comparable to the most active registered 
dealers. The very high trading volumes and large share of trading in 
the interdealer Treasury market suggest that at least some PTFs may be 
regularly acting as significant liquidity providers.

                Table 1--Count of Active Firms in the Treasury Market by Type: Calendar Year 2022
----------------------------------------------------------------------------------------------------------------
                                                    # Firms, by average monthly (buy + sell) volume
              Firm type              ---------------------------------------------------------------------------
                                          all firms           >$10 bn            >$50 bn            >$100 bn
----------------------------------------------------------------------------------------------------------------
SEC-registered broker-dealers.......                854                 83                 46                 34
Other firms.........................                231                 54                 15                 10
    Dealers.........................                110                 23                  *                  0
    Hedge Funds.....................                 62                  7                  *                  0
    PTFs............................                 40                 23                 13                 10
    Others..........................                 19                  1                  *                  0
----------------------------------------------------------------------------------------------------------------
* Suppressed to protect confidentiality.


[[Page 14969]]

[GRAPHIC] [TIFF OMITTED] TR29FE24.000

    PTFs that are engaged in dealing activities without registering 
with the Commission as dealers do not have the same regulatory 
responsibilities as registered dealers or government securities 
dealers. These responsibilities include compliance with regulations 
regarding capitalization, operational controls, book-keeping, and 
record-keeping.\383\ These PTFs also do not submit annual reports or 
financial statements to the Commission and are not subject to 
examination, thus limiting regulators' insight into their internal 
risk-management or record-keeping practices.
---------------------------------------------------------------------------

    \383\ See supra notes 358-363.
---------------------------------------------------------------------------

    PTFs that are not registered as dealers do face constraints on 
risk-taking, but they face fewer constraints than registered dealers or 
government securities dealers. When they trade through a bank or 
broker-dealer, 12 CFR parts 220, 221, and 224 (``Federal Reserve 
Regulations T, U, and X'') require the bank or broker-dealer to limit 
the PTFs' risk by imposing margin requirements on loans that use 
securities as collateral.\384\ If they trade through a broker-dealer 
that is a FINRA member, FINRA Rule 4210 may apply, since the rule 
specifies margins for securities that FINRA members hold in their 
customers' accounts, including initial margin requirements on 
securities transactions and commitments and maintenance margin.\385\ If 
they trade directly in the market using a broker-dealer's market 
access, the Market Access Rule requires the broker-dealer offering its 
market access to establish, document, and maintain a system of controls 
and supervision designed to limit the risk--e.g., financial, 
regulatory, operational, or legal--of the PTFs' activities related to 
that market access.\386\ However, entities that are not registered as 
dealers do not have to comply with the Net Capital Rule.\387\
---------------------------------------------------------------------------

    \384\ See Federal Reserve Regulation T (12 CFR part 220); 
Regulation U (12 CFR part 221); Regulation X (12 CFR part 224).
    \385\ See FINRA Rule 4210.
    \386\ See supra note 26.
    \387\ See supra note 24 and accompanying text.
---------------------------------------------------------------------------

    PTFs that are not registered as dealers do not have reporting 
obligations to CAT or to TRACE, though these data sources contain 
certain information on PTFs' trading.\388\ CAT generally includes all 
PTFs' orders in NMS securities, OTC equities, and listed options 
because they are reported by other registered parties. Broker-dealers, 
including those through whom PTFs currently trade, are required to 
report orders and order events to CAT for NMS Securities or OTC 
equities.\389\ Consequently, the receipt of such principal orders from 
PTFs and the execution of such orders (as well as all other order 
events) are included in CAT data. However, customers of the broker-
dealers, including such PTFs, are only identified in the CAT system 
with Customer-IDs.\390\ Regulators must then go to a separate database 
to obtain customer identifying information associated with a Customer-
ID.\391\
---------------------------------------------------------------------------

    \388\ See Fried Frank Comment Letter; IAA Comment Letter I; 
McIntyre Comment Letter II; MMI Comment Letter; SIFMA Comment Letter 
I.
    \389\ Many broker-dealers contract with third-party service 
providers to fulfill their reporting requirements to CAT.
    \390\ Pursuant to the CAT NMS Plan, each customer is required to 
be assigned a unique Customer-ID that can be used to link all orders 
and reportable events from a specific customer.
    \391\ Pursuant to the CAT NMS Plan, the customer information 
data must be stored separately from the order data (see Appendix D-
14 and D-33 of the CAT NMS Plan) with different access protocols 
(see Appendix D-14 and D-29 of the CAT NMS Plan). The purpose of 
these requirements is to secure Personally Identifiable Information 
(``PII''). According to the CAT NMS Plan, ``[a] subset of authorized 
regulators . . . will have permission to access and view PII data.'' 
See Appendix D-29 of the CAT NMS Plan.
---------------------------------------------------------------------------

    Pursuant to the CAT NMS Plan, the CAT must capture and store 
Customer and Customer Account Information in a secure database 
physically separated from the transactional database. ``CAIS'' refers 
to the Customer and Account Information System within the CAT System 
that collects and links Customer-ID(s) to Customer and Account 
Attributes and other identifiers for queries by regulatory staff.\392\ 
When the CAIS system becomes fully operational, authorized regulators 
will

[[Page 14970]]

be able to identify in the CAIS database all the customers associated 
with orders and related events captured and stored in the transactional 
database, including any PTFs that are engaging in dealer activities but 
that are not registered as dealers. Unlike the identification of 
customers, regulators can identify registered broker-dealers (who have 
reporting obligations) by their unique identifiers in CAT transactional 
data without having to access CAIS. Therefore, analysis requiring the 
identification of customers (such as PTFs) takes more time because 
accessing CAIS involves enhanced security measures and requires 
necessary additional steps that are not required for identifying 
broker-dealers associated with CAT reported trading activities in the 
CAT transactional database.
---------------------------------------------------------------------------

    \392\ See ``Consolidated Audit Trail, Customer and Account 
Information System (CAIS): Specification for Firm Designated ID 
(FDID) and Large Trader ID (LTID)'' (Dec. 18, 2019), available at 
https://www.catnmsplan.com/sites/default/files/2020-01/FDID-LTID-Specification-Publication-12-18-v1.pdf, for background information 
on the CAIS system. See also CAT NMS Plan 6.5(c)(i) (stating that 
access is for regulatory use only) and CAT NMS Plan Appendix D 9.1 
at p. D-33 (stating that customer information will be stored 
separately from other data).
---------------------------------------------------------------------------

    Additionally, broker-dealers and ATSs report transactions in U.S. 
Government securities to TRACE. However, TRACE data include the 
identities of unregistered entities only when the trades occur on an 
ATS covered by FINRA Rule 6730.07 (generally, the ATSs with higher 
volume).\393\ When PTFs that are not registered as dealers trade U.S. 
Government securities and other fixed-income securities through a 
broker-dealer or on an ATS that is not covered by FINRA Rule 6730.07, 
the broker-dealer or ATS reports the transaction to TRACE, but the 
identity of the PTF remains anonymous. PTFs that are not registered as 
dealers are always anonymous in the TRACE database for corporate bond 
transactions.
---------------------------------------------------------------------------

    \393\ See supra note 380.
---------------------------------------------------------------------------

    PTFs with high volumes or large portfolios in equities markets may 
also have to report to the Commission on Form 13F \394\ or Form 
13H.\395\ On Form 13F, institutional investment managers report the 
details of their holdings of section 13(f) securities--e.g., CUSIP, 
fair market value. On Form 13H, among other things, large traders 
provide details of their organization, governance, and relationships.
---------------------------------------------------------------------------

    \394\ Every manager which exercises investment discretion with 
respect to accounts holding section 13(f) securities, as defined in 
Rule 13f-1(c), having an aggregate fair market value on the last 
trading day of any month of any calendar year of at least 
$100,000,000, shall file a report on Form 13F with the Commission 
within 45 days after the last day of such calendar year and within 
45 days after the last day of each of the first three calendar 
quarters of the subsequent calendar year.
    \395\ Each large trader--defined as a person whose transactions 
in NMS securities equal or exceed 2 million shares or $20 million 
during any calendar day, or 20 million shares or $200 million during 
any calendar month--is required to identify itself to the Commission 
by filing a Form 13H and submitting annual updates, as well as 
updates on as frequently as a quarterly basis when necessary to 
correct information previously disclosed that has become inaccurate. 
See 17 CFR 240.13h-1.
---------------------------------------------------------------------------

    PTFs are subject to the anti-manipulation and antifraud provisions 
under Securities Act section 17(a) and Exchange Act section 10(b), but 
they are not subject to Exchange Act section 15(c). Exchange Act 
section 15(c) authorizes the Commission to issue, for registered 
entities, specific rules and regulations that ``define, and prescribe 
means reasonably designed to prevent, such acts and practices as are 
fraudulent, deceptive, or manipulative and such quotations as are 
fictitious.'' \396\ They are also not subject to examinations, net 
capital requirements, or any record-keeping or reporting requirements.
---------------------------------------------------------------------------

    \396\ 15 U.S.C. 78o(c)(2)(D). For example, the Net Capital Rule 
and the Market Access Rule are both tied to section 15(c) of the 
Exchange Act.
---------------------------------------------------------------------------

b. Private Funds and Advisers
    Private funds \397\ are also prominent participants in U.S. 
securities markets. This section discusses the baseline for private 
funds and advisers in the current market, and in section III.B.2.c we 
will estimate the number of hedge funds that may be affected by the 
final rules.
---------------------------------------------------------------------------

    \397\ A private fund, including a hedge fund, is an issuer that 
would be an investment company as defined in section 3 of the 
Investment Company Act if not for section 3(c)(1) or 3(c)(7) of the 
Investment Company Act. See 15 U.S.C. 80a-3.

                                  Table 2--Private Fund Statistics as of 2022Q4
----------------------------------------------------------------------------------------------------------------
                                                         Gross asset value                Net asset value
            Fund type                  Count     ---------------------------------------------------------------
                                                    Total ($B)       Avg ($mm)      Total ($B)       Avg ($mm)
----------------------------------------------------------------------------------------------------------------
Hedge Fund......................           9,783           9,347             955           4,811             492
Private Equity Fund.............          20,860           6,710             322           6,030             289
Venture Capital Fund............           2,978             375             126             342             115
Liquidity Fund..................              71             321           4,521             318           4,479
Other Private Fund..............           6,688           1,622             243           1,397             209
Real Estate Fund................           4,226           1,137             269             857             203
Securitized Asset Fund..........           2,482             935             377             272             110
----------------------------------------------------------------------------------------------------------------
Note: These statistics rely on Form PF. Only SEC-registered advisers with at least $150 million in private fund
  assets under management must report to the Commission on Form PF; SEC-registered investment advisers with less
  than $150 million in private fund assets under management, SEC exempt reporting advisers, and state-registered
  investment advisers are not required to file Form PF.

    Table 2 shows the number of private funds as of the fourth quarter 
of 2022.\398\ Of the 9,783 hedge funds reported on Form PF during this 
period, there were 2,069 qualifying hedge funds that reported 
information on their positions, and these held $2.4 trillion in listed 
equities and $1.8 trillion in U.S. Government securities.\399\ Certain 
hedge fund strategies, such as those that involve automated or high-
frequency trading (``HFT''), could meet the final rules' definition of 
dealing.
---------------------------------------------------------------------------

    \398\ See SEC Division of Investment Management Analytics 
Office, Private Fund Statistics: Fourth Calendar Quarter 2022 (July 
18, 2023) (``Private fund Statistics''), available at https://www.sec.gov/files/investment/private-funds-statistics-2022-q4.pdf.
    \399\ Large hedge fund advisers have at least $1.5 billion in 
hedge fund assets under management. A large hedge fund adviser is 
required to file Form PF quarterly and provide data about each hedge 
fund it managed during the reporting period (irrespective of the 
size of the fund). Large hedge fund advisers must report more 
information on Form PF about Qualifying Hedge Funds than other hedge 
funds they manage during the reporting period. A Qualifying Hedge 
Fund is any hedge fund advised by a large hedge fund adviser that 
had a NAV (individually or in combination with any feeder funds, 
parallel funds, and/or dependent parallel managed accounts) of at 
least $500 million as of the last day of any month in the fiscal 
quarter immediately preceding the adviser's most recently completed 
fiscal quarter.
---------------------------------------------------------------------------

    The business models of private equity funds \400\ and liquidity 
funds \401\ are

[[Page 14971]]

unlikely to engage in activities that meet the final rules' definition 
of dealing, because they are generally long-only investors that are not 
likely to regularly communicate trading interests on both sides of the 
market or earn revenue primarily from capturing bid-ask spreads.
---------------------------------------------------------------------------

    \400\ See Investor.gov, Private Equity Funds, available at 
https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/private-equity.
    \401\ See Daniel Hiltgen, ``Private liquidity Funds: 
Characteristics and Risk Indicators,'' DERA White Paper (Jan. 27, 
2017), available at https://www.sec.gov/files/2017-03/Liquidity%20Fund%20Study.pdf.
---------------------------------------------------------------------------

    Investment advisers are subject to the Advisers Act and the 
Commission oversees private fund advisers, many of which are registered 
with the SEC or report to the SEC as exempt reporting advisers.\402\ 
Advisers may also trade for their own account subject to certain 
restrictions.\403\ When trading through a bank or broker-dealer, 
private funds and investment advisers are indirectly constrained by the 
same limitations on risk-taking as are PTFs, as described in the 
previous section--i.e., the Market Access Rule, FINRA Rule 4210, and 
Federal Reserve Regulations T, U, and X. Investment advisers are 
subject to a Federal fiduciary duty, which comprises a duty of care and 
a duty of loyalty,\404\ and are subject to the antifraud provisions in 
section 206 of the Advisers Act. Private funds and investment advisers 
are also subject to section 10(b) of the Exchange Act and section 17(a) 
of the Securities Act. Registered investment advisers are further 
subject to specific substantive requirements related to various areas, 
including principal trading, agency cross transactions, custody of 
client assets, and marketing.\405\ The Commission also recently adopted 
new rules and rule amendments to enhance the regulation of private fund 
advisers.\406\
---------------------------------------------------------------------------

    \402\ Section 203(l) of the Advisers Act provides that an 
investment adviser that solely advises venture capital funds is 
exempt from registration, and section 203(m) exempts from 
registration any investment adviser that solely advises private 
funds if the adviser has assets under management in the U.S. of less 
than $150 million. Advisers that rely on the venture capital and 
private fund adviser exemptions are generally referred to as 
``exempt reporting advisers,'' because sections 203(l) and 203(m) 
provide that the Commission shall require the advisers to maintain 
such records and to submit such reports as the Commission determines 
necessary or appropriate in the public interest or for the 
protection of investors.
    \403\ See 17 CFR 275.206(3) (``Rule 206(3)'').
    \404\ See Commission Interpretation Regarding Standard of 
Conduct for Investment Advisers, Investment Advisers Act Release No. 
5248 (June 5, 2019) 84 FR 33669 (July 12, 2019), at 24-25.
    \405\ See 17 CFR 275.206(4)-1 (``Rule 206(4)-1''); 17 CFR 
275.206(4)-2 (``Rule 206(4)-2''); 17 CFR 275.206(4)-7 (``Rule 
206(4)-7'').
    \406\ See Private Fund Advisers; Documentation of Registered 
Investment Adviser Compliance, Investment Advisers Act Release No. 
6383 (Aug. 28, 2023) 88 FR 63206 (Sept. 14, 2023) (adopting 17 CFR 
275.206(4)-10; 275.211(h)(1)-1, 275.211(h)(1)-2; 275.211(h)(2)-1; 
275.211(h)(2)-2; 275.211(h)(2)-3).
---------------------------------------------------------------------------

    The Advisers Act establishes reporting and recordkeeping 
requirements for registered advisers to private funds. For example, 
section 204 requires registered investment advisers to keep certain 
books and records (records of the advised private funds are considered 
records of the adviser for these purposes). Registered investment 
advisers and exempt reporting advisers must also disclose information 
on Form ADV. Registered private fund advisers report certain 
information on the private funds they manage to the Commission annually 
(and, for certain large advisers of certain large hedge funds, 
quarterly) on Form PF. Specifically, large hedge fund advisers 
currently file quarterly periodic reports and--within 72 hours of the 
occurrence of certain events including extraordinary investment losses 
and large margin increases--current reports to the Commission on Form 
PF and are subject to books and records rules and examinations.\407\ 
Advisers are also subject to Commission examinations. Advisers and 
funds with high trading volumes or large portfolios may also have to 
report to the Commission on Form 13F or Form 13H, on which they would 
disclose details of their securities holdings, organization, 
governance, and relationships.\408\
---------------------------------------------------------------------------

    \407\ These periodic and current reporting obligations of large 
hedge fund advisers on Form PF reflect recently adopted amendments. 
See supra note 347.
    \408\ See supra notes 394 and 395. See also Fried Frank Comment 
Letter; IAA Comment Letter I; McIntyre Comment Letter II; SIFMA AMG 
Comment Letter.
---------------------------------------------------------------------------

    However, private funds and investment advisers do not have to 
comply with the Net Capital Rule or with any other direct regulatory 
constraint on leverage. They also are not required to report their 
transactions (though their broker-dealer may be required to report the 
transactions), and they are not subject to section 15(c) of the 
Exchange Act.\409\ Regulators may be able to obtain complete data on 
private funds' and advisers' securities transactions through 
examinations, but such information is currently more readily available 
for registered dealers or government securities dealers.
---------------------------------------------------------------------------

    \409\ See supra note 396.
---------------------------------------------------------------------------

c. Number of Affected Parties
    In this section, we provide estimates of the number of entities 
that may satisfy the qualitative standard, as adopted. These estimates 
are subject to significant caveats that we also describe below. We use 
TRACE data on U.S. Treasury transactions to provide an estimate of the 
number of identifiable Treasury-market participants that could be 
affected. We use data from Form PF \410\ to approximate the number of 
possibly affected private funds, under the assumption that, to the 
extent private funds employ trading strategies that would qualify under 
the final rules' qualitative standard, they would most likely report 
those as HFT strategies. The analysis focuses on U.S. Treasury markets 
where market participants not registered as dealers are significant 
liquidity providers.\411\ Natural persons are unlikely to be dealing in 
U.S. Government securities, and we do not observe any natural persons 
trading U.S. Government securities in the interdealer market.
---------------------------------------------------------------------------

    \410\ Commenters said the proposed rules would have had a much 
larger impact on private funds than suggested by the economic 
analysis and asked that the Commission analyze Form PF data to 
estimate the number of affected funds. See AIMA Comment Letter II; 
IAA Comment Letter I; Fried Frank Comment Letter; T. Rowe Price 
Comment Letter. In consideration of these comments, we have 
supplemented this economic analysis with estimations based on Form 
PF.
    \411\ See supra note 20. See also SIFMA Comment Letter I. The 
letter describes how the Commission's Market Access Rule, beginning 
in 2010, may have encouraged previously unregistered equity or 
options dealers to register with the Commission.
---------------------------------------------------------------------------

    Using TRACE data for U.S. Treasury securities, we estimate the 
number of affected parties by identifying firms that appear to meet the 
primary revenue factor by earning revenue from capturing bid-ask 
spreads in the market for U.S. Treasury securities. We do not estimate 
the number of entities that appear to meet the expressing trading 
interest factor because the Commission does not have sufficient data on 
quoting activities. TRACE data identify specific parties in the 
Treasury market that are not registered broker-dealers who trade on 
certain ATSs.\412\ In other markets, post-trade data do not identify 
entities that are not registered as broker-dealers. In all markets, 
when entities transact on ATSs for or on behalf of other market 
participants that are not registered broker-dealers, data limitations 
prevent us from identifying the ultimate buyer or seller. It is the 
Commission's understanding that significant liquidity providers are 
more likely to be registered broker-dealers in other markets such as 
those for equities and options than they are in the market for

[[Page 14972]]

U.S. Treasury securities.\413\ We acknowledge that this lack of 
transparency may affect our estimates.
---------------------------------------------------------------------------

    \412\ See FINRA Rule 6730--Transaction Reporting, Supplementary 
Material .07--ATS Identification of Non-FINRA Member Counterparties 
for Transactions in U.S. Treasury Securities (among other things, 
defining the term ``covered ATS'' as an ATS that executed 
transactions in U.S. Treasury securities against non-FINRA member 
subscribers of $10 billion or more in monthly par value, computed by 
aggregating buy and sell transactions, for any two months in the 
preceding calendar quarter).
    \413\ See supra note 20.
---------------------------------------------------------------------------

    The Commission does not necessarily observe all revenue sources for 
the most active participants in the U.S. Treasury market. Thus, for the 
purpose of estimating the number of affected entities, we consider that 
firms potentially meet the primary revenue factor if they trade at 
least 4 of the 10 highest-volume U.S. Government securities on at least 
15 different trading days in a given month and if they realize, on 
average across the month, a positive intraday trading spread on each of 
those securities.\414\ We consider such trading characteristics for 
this analysis because (1) TRACE data cannot determine whether any 
spread apparently earned is a ``primary'' source of revenue,\415\ and 
(2) the calculation of intraday spreads does not distinguish between 
trades that capture the bid-ask spread and trades that profit from 
intraday price movements.\416\ A firm that earns its revenue primarily 
from dealing in U.S. Government securities will likely trade at least 
one of the highest-volume securities on most trading days and will also 
tend to profit from those trades. This analysis reflects the 
requirement that dealing be regular by requiring the firm to trade the 
security on at least 15 trading days in a month (the ``day'' threshold) 
and by counting the number of months in which a firm appears to deal. 
We only consider a 15-day threshold here, rather than a lower threshold 
of 10 trading days or a higher threshold of 20 trading days 
(effectively every trading day in a month), because a firm that is not 
dealing--even a hypothetical firm that trades randomly--might earn a 
positive spread in a given security on a few trading days each month; 
likewise, a firm acting as a dealer might suffer a negative spread on a 
few trading days each month. Although we rely on a proxy definition of 
dealing for the purpose of this analysis, we stress that the 
determination of whether an entity is engaged in regular dealing 
activity depends on the facts and circumstances. The empirical proxy of 
dealing used for the purpose of this analysis--trading a security for 
at least 15 days in a month with a positive average trading spread--may 
not be necessary or sufficient for determining whether an activity 
constitutes dealing according to the final rules.
---------------------------------------------------------------------------

    \414\ For each firm and for each CUSIP, we calculate the daily 
spread as the volume-weighted average sell price minus the volume-
weighted average buy price. We then take the simple average of this 
number across days within each firm-CUSIP-month.
    \415\ The final rules' primary revenue factor says, ``earning 
revenue primarily from capturing bid-ask spreads.''
    \416\ See Lewis Study for a description of some trades that may 
profit from intraday price movements without intending to capture 
bid-ask spreads.
---------------------------------------------------------------------------

    Figure 2 counts the number of identifiable non-broker-dealers that 
appear to meet the primary revenue factor for 1+, 2+, etc. months 
during 2022 in the market for U.S. Government securities. Figure 2, 
using the empirical measures described above, identifies as potential 
significant liquidity providers a total of 31 non-broker-dealers in 
TRACE that would have met the primary revenue factor for at least one 
month in 2022,\417\ and 15 that would have done so for at least 6 
months. Depending upon the number of months considered in Figure 2, 
these numbers include from 13 to 22 entities classified as PTFs and up 
to 4 entities classified as hedge funds.\418\
---------------------------------------------------------------------------

    \417\ These 31 non-broker-dealers represent 13% of the 231 non-
broker-dealers shown in Table 1.
    \418\ In Figure 2, the 31 non-broker dealers that appear to meet 
the primary revenue factor in 2022 for at least 1 month include 22 
PTFs, 4 hedge funds, 4 entities classified as ``dealers'' (though 
they are not FINRA members and do not appear to be registered with 
the Commission), and 1 entity classified as ``other.'' A higher 
alternative threshold of 20 days would show up to 12 firms, 
including 9 PTFs and 1 hedge fund. A lower alternative threshold of 
10 days would show up to 40 firms, including 27 PTFs and 7 hedge 
funds.
[GRAPHIC] [TIFF OMITTED] TR29FE24.001

    Several commenters \419\ cited the relevance of Form PF data for 
identifying market participants that could be captured by the final 
rules. We use Form PF to provide an estimate of the number of possibly 
affected hedge funds. Form PF filers provide information on hedge 
funds' trading strategies in two ways: (1) Question 20 asks about the 
breakdown of funds' reliance on several categories of strategy--e.g., 
``Equity, Market Neutral'' or ``Equity, Long/Short''--and (2) Question 
21 asks how much of the funds' assets are dedicated to HFT 
strategies.\420\ Based on our

[[Page 14973]]

understanding of the trading objectives that hedge funds report 
pursuant to Questions 20 and 21, we believe that any hedge funds 
employing trading strategies that would fit the final rules' 
qualitative standard, as adopted, would likely report them as HFT.
---------------------------------------------------------------------------

    \419\ See, e.g., AIMA Comment Letter II; IAA Comment Letter I; 
Fried Frank Comment Letter; T. Rowe Price Comment Letter.
    \420\ The question does not provide a definition for the term 
high frequency trading strategies. The Commission has proposed to 
remove Question 21 from Form PF because the form's question on 
portfolio turnover, with proposed revisions, would better inform our 
and FSOC's understanding of the extent of trading by large hedge 
fund advisers and would better show how larger hedge funds interact 
with the markets and provide trading liquidity. See Form PF; 
Reporting Requirements for All Filers and Large Hedge Fund Advisers, 
Investment Advisers Act Release No. 6083 (Aug. 10, 2022), 87 FR 
53832 at 53850 (Sept. 1, 2022), as corrected 87 FR 54641 (Sept. 7, 
2022). The proposed amendments to the form's question on portfolio 
turnover would not provide information on the number of funds that 
would meet the definition of dealer under the final rules because 
the proposed portfolio turnover question asks about aggregate value 
of turnover in a month, for specific asset classes. While responses 
to the question could indicate potentially high trading activity by 
private funds, they would not indicate the number of trades or the 
securities traded. In contrast, responses to current Question 21, 
which asks about HFT strategies at the fund level, are more directly 
informative for this release. Based on our understanding of private 
fund activity, self-reported HFT is more relevant for estimating 
which entities may be affected by these final rules than the 
proposed portfolio turnover question.
---------------------------------------------------------------------------

    Table 3 describes the number of hedge funds that used at least some 
HFT strategies, as reported by their advisers in the advisers' most 
recent Form PF filing between 2021-Q4 and 2022-Q3. Using Form PF, 
advisers report their use of HFT strategies as a range of percentages 
of net asset value (``NAV''), such as ``less than 10%'' of NAV, ``10%-
25%,'' etc. We calculate a range of dollar values for each fund by 
multiplying the high and low values of the reported range by the fund's 
NAV. For example, if an adviser reports that a fund engages in HFT 
using ``Less than 10%'' of the fund's NAV, and if the fund's NAV is 
$100, then we conclude that the fund uses HFT to manage between $0 and 
$10 (10% of $100). For reported HFT use of ``100% or more'' of NAV, we 
use 500% of NAV as the high end of the range. The third row of Table 3 
shows the total range of HFT use that we obtain by summing the low and 
the high estimates across funds. The left column provides statistics 
for funds with reported HFT use that is less than 10% of NAV, and the 
right column provides statistics for funds with reported HFT use that 
is 10% or more of NAV.

 Table 3--Private Funds' Use of HFT, Latest Form PF Filing Between 2021-
                             Q4 and 2022-Q3
------------------------------------------------------------------------
                               Funds with HFT <10%  Funds with HFT >=10%
                                     of NAV                of NAV
------------------------------------------------------------------------
# Funds.....................  40..................  12.
Average NAV.................  $3.2 bn.............  $0.9 bn.
Total $s dedicated to HFT *.  $0-$12.7 bn.........  $8.9 bn-$40.4 bn.
# Advisers..................  21..................  10.
------------------------------------------------------------------------
* Form PF includes a range of reported HFT--e.g., ``less than 10%'' of
  NAV, ``10%-25%,'' etc. For funds reporting ``100% or more,'' we use
  500% of NAV as the high end of the range.

    The use of HFT strategies is, however, an imperfect proxy for 
whether these funds would qualify under the qualitative standard, as 
adopted. We are unable to determine whether the HFT activities that 
these funds report would satisfy the expressing trading interest factor 
or the primary revenue factor because we do not observe individual 
transactions in Form PF. The use of HFT strategies, to the extent it 
may be dealing, is more likely to be a primary source of revenue when 
it accounts for a larger percentage of a fund's NAV. Accordingly, the 
12 hedge funds with HFT of at least 10% of NAV in Table 3 are the more 
likely to meet the final rules' primary revenue factor. However, since 
reported HFT may apply to a broader set of activities than the final 
rules' qualitative factors, the actual number of affected funds may be 
less than 12.
    Our empirical analyses of likely affected parties face other 
limitations. In the current stage of implementation of CAT, we do not 
have comprehensive statistics on option or equity market activity 
stemming from entities engaging in dealing activity that are not 
registered as dealers, such as those known as PTFs in other 
markets.\421\ Similarly, because our TRACE analysis is limited to U.S. 
Government securities, it does not cover markets for equities, options, 
or other fixed-income markets. Our TRACE data also cannot establish 
whether firms primarily earn revenue from capturing bid-ask spreads. 
Further, and specifically for Treasury market participants, our counts 
of identifiable firms in TRACE may be low because TRACE data on U.S. 
Government securities transactions does not identify all market 
participants.\422\ The TRACE analysis also relies on empirical proxies 
to estimate the number of firms--i.e., the range of values for 
``regular'' and the ``at least 15 days'' distinction--and uses observed 
intraday trading spreads rather than the (unobserved) revenue earned 
from bid-ask spreads. As explained above, the analysis also does not 
estimate the number of entities described by the final rules' 
expressing trading interest factor because of data limitations. Whether 
or not a person is a securities dealer or government securities dealer 
under the final rules would be, in part, a question of facts and 
circumstances not observed in the data, such as whether and to whom 
trading interests are expressed, whether they are on both sides of the 
market, and whether they are at or near the best available prices.
---------------------------------------------------------------------------

    \421\ As described in section III.B.2.a, the CAIS system in CAT 
will allow the Commission to identify individual non-broker-dealers 
in equity and options markets, including any PTFs not currently 
registered as broker-dealers, but CAIS is not yet fully operational. 
Notably, because CAIS is not fully operational, the transactional 
data does not contain unique customer identifiers needed to track 
the same customer across broker-dealers. This prevents us from 
analyzing CAT to identify entities engaging in dealing activity that 
are not registered as dealers.
    \422\ See supra note 380.
---------------------------------------------------------------------------

    Commenters said that the number of hedge funds affected by the 
Proposed Rules would be much higher than the Proposing Release 
suggested, potentially numbering into the hundreds.\423\ However, the 
changes to the final rules described in section I.B largely respond to 
commenters' concerns by reducing the number of entities that the final 
rules would potentially require to newly register as dealers.
---------------------------------------------------------------------------

    \423\ See, e.g., AIMA Comment Letter II; Consensys Comment 
Letter; Fried Frank Comment Letter; ICI Comment Letter; McIntyre 
Comment Letter II; MFA Comment Letter I; NAPFM Comment Letter; SIFMA 
Comment Letter I; SIFMA AMG Comment Letter; Two Sigma Comment Letter 
I.
---------------------------------------------------------------------------

    One commenter stated that the Commission did not estimate the 
number of affected parties based on trading in other asset classes, 
such as corporate bonds, municipal securities, and asset- or mortgage-
backed securities.\424\ Transaction data in these markets do not permit 
such estimations because non-broker-dealers are generally labeled as 
``customer'' without name attribution in trade reports. However, with 
regard to PTFs, it is the Commission's understanding that these market 
participants are most active in on-the-run Treasury markets, where they 
provide a substantial amount of liquidity, but are less active in off-
the-run Treasury securities and play only a small role in the market 
for agency securities.\425\ Similarly, the Commission

[[Page 14974]]

does not believe that PTFs are active in municipal securities markets, 
which are characterized by a high level of retail investors. One 
commenter to the ATS-G Proposing Release noted that approximately 15% 
of daily dollar volume in municipal bonds is executed electronically, 
further indicating that PTFs--which rely on electronic platforms--may 
not play a significant role in this market.\426\ Finally, recent 
research finds that non-dealer liquidity providers are present in 
corporate bond markets, though they account for a small share of 
overall volume. Looking at a particular electronic platform, the 
authors of one study find that all-to-all trading makes up 12% of all 
trades on the platform; of this, new liquidity providers acting as 
dealers account for 7%.\427\ However, this platform accounts for 
approximately 10% of trading reported to TRACE, so that the overall 
share of non-dealer liquidity providers or PTFs in the corporate bond 
market is relatively small. Other anecdotal evidence suggests that PTFs 
have begun to enter the corporate bond market using RFQ platforms, 
possibly driven by the growth of corporate bond ETFs.\428\
---------------------------------------------------------------------------

    \424\ See SIFMA Comment Letter I.
    \425\ See the Commission's proposed amendments to Regulation ATS 
for ATSs that trade government securities (``ATS-G Proposing 
Release''), 85 FR 87106 (Dec. 31, 2020), available at https://www.federalregister.gov/documents/2020/12/31/2020-21781/regulation-ats-for-atss-that-trade-us-government-securities-nms-stock-and-other-securities. In particular, Table X.2 highlights that PTFs 
accounted for 31.4% of on-the-run volume share from July 1, 2019, to 
Dec. 31, 2019, while Table X.3 shows that PTFs accounted for only 
1.5% of off-the-run volume. Table X.4 shows that PTFs were 
essentially not active in agency securities during the same period.
    \426\ See Bond Dealers of America comment letter to ATS-G 
Proposing Release, available at https://www.sec.gov/comments/s7-12-20/s71220-8426431-229605.pdf.
    \427\ See Terrence Hendershott, Livdan Dmitry, and Norman 
Sch[uuml]rhoff, ``All-to-All Liquidity in Corporate Bonds,'' Swiss 
Finance Institute Research Paper No. 21-43 (Oct. 27, 2021), 
available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3895270.
    \428\ See Kevin McPartland, What's Next for High Frequency 
Traders? Not Calling Them High Frequency Traders, Coalition 
Greenwich (Sept. 27, 2019), available at https://www.greenwich.com/blog/what%E2%80%99s-next-high-frequency-traders (noting that one PTF 
has begun to trade using corporate bond RFQs).
---------------------------------------------------------------------------

    Because crypto asset platforms transacting in crypto assets for 
their own account may already be dealers under current law--i.e., with 
respect to crypto assets that are securities or government securities 
within the meaning of the Exchange Act--the final rules might affect 
only a few of the entities that provide significant liquidity in crypto 
asset markets. We understand that the rules may affect some PTFs in 
crypto asset markets, however. We are unable to estimate the number of 
crypto asset market participants who would be affected by the rules, 
because data do not allow us to match crypto asset security 
transactions to individual traders, especially across platforms.\429\
---------------------------------------------------------------------------

    \429\ We would have to match entities' trades in crypto asset 
securities across platforms in order to determine whether or not 
their trading activity meets the final rules' definition of regular 
liquidity provision.
---------------------------------------------------------------------------

3. Competition Among Significant Liquidity Providers
    The previous sections highlight important differences in regulatory 
treatment among competing significant liquidity providers. 
Specifically, registered dealers and the unregistered market 
participants that perform similar functions operate under different 
regulations--i.e., unregistered market participants have fewer 
constraints on risk-taking and are subject to fewer reporting 
requirements--even as they perform a similar role as dealers in 
markets. The requirement that dealers register is of the utmost 
importance in effecting the purposes of the Exchange Act (see section 
I.A). In this section, we provide some data on current concentration in 
the market for U.S. Government securities and also discuss the 
competitive implications of differences in regulatory treatment.
    Our analysis of TRACE data suggests that liquidity provision in the 
interdealer market for U.S. Government securities is not 
concentrated.\430\ Table 4 displays measures of market concentration 
among entities that are potentially dealing in U.S. Government 
securities across months in 2022.\431\ This table categorizes firms as 
potential significant liquidity providers in three ways, and we display 
two measures of concentration for each. In column 1, the list of 
potential significant liquidity providers includes only firms currently 
classified as dealers in our TRACE data. In column 2, the list also 
includes identifiable PTFs. In column 3, the list expands again to 
include identifiable hedge funds. The two measures of concentration are 
the volume share of the 5 highest-volume firms and the Herfindahl-
Hirschman index (``HHI'').\432\ The inverse of the HHI provides some 
intuition by giving the number of equally sized competitors a market 
would need to produce such an HHI. The first column of Table 4 shows 
that between 445 and 714 dealers were active in the U.S. Treasury 
market in 2022, and that the 5 highest-volume of these firms accounted 
for approximately 40% of the group's total volume each month. Across 
months, the HHI in column 1 ranged between 0.047 and 0.056, comparable 
to a market with 18 to 21 equally sized competitors.\433\ If we also 
consider identifiable PTFs to be significant liquidity providers 
(column 2), then 479 to 748 significant liquidity providers were active 
each month during 2022, and the five highest-volume firms accounted for 
approximately one-third of the group's total. The HHI in this case 
averages approximately 0.0385, comparable to a market with 26 equally 
sized competitors. If we further consider identifiable hedge funds in 
TRACE to be significant liquidity providers (column 3), then 517 to 799 
significant liquidity providers were active in the U.S. Treasury market 
in each month during 2022, the concentration metrics are nearly the 
same as in column 2. The narrow differences between columns 2 and 3 
suggest that the hedge funds that we can identify in TRACE are not 
major competitors in the market for liquidity provision against either 
registered broker-dealers or PTFs.
---------------------------------------------------------------------------

    \430\ We consider all dealer-to-dealer trades and all trades on 
covered ATSs (see supra note 380) to be the interdealer market. For 
the purposes of this table, we consider all registered broker-
dealers to be potential liquidity providers, though it may be the 
case that some broker-dealers do not regularly seek to provide 
liquidity in the market for U.S. Government securities.
    \431\ As of Oct. 2023, there were 3,490 active broker-dealers 
registered with the Commission. See SEC, Data: Company Information 
About Active Broker-Dealers (updated Oct. 2, 2023), available at 
https://www.sec.gov/help/foiadocsbdfoiahtm.html.
    \432\ HHI is equal to the sum of squared market shares. An index 
of 1 would indicate a completely concentrated market with a single 
significant liquidity provider.
    \433\ A Federal Reserve analysis from 2020 finds that activity 
on electronic interdealer platforms is slightly more concentrated, 
with an HHI of 0.082. See James Collin Harkrader and Michael Puglia, 
``Principal Trading Firm Activity in Treasury Cash Markets,'' FEDS 
Notes (Aug. 4, 2020).

[[Page 14975]]



             Table 4--Competition Among Significant Liquidity Providers in the Treasury Market, 2022
                    [The largest 5 firms in this table overall are registered broker-dealers]
----------------------------------------------------------------------------------------------------------------
                                                                                          Significant liquidity
                                        Significant liquidity    Significant liquidity    providers: registered
                                        providers: registered    providers: registered      BDs + PTFs + hedge
                                                 BDs                   BDs + PTFs                 funds
----------------------------------------------------------------------------------------------------------------
No. of firms.........................  445-714................  479-748................  517-799.
Share of interdealer market *........  72.7%-83.7%............  93.7%-97.4%............  95.0%-98.5%.
Concentration measures:
    Share of top 5 firms.............  37.3%-43.1%............  32.0%-35.4%............  31.7%-35.0%.
    HHI..............................  0.047-0.056............  0.036-0.041............  0.036-0.047.
    HHI comparable to market with __   18-21..................  24-28..................  24-28.
     equal-size competitors.
----------------------------------------------------------------------------------------------------------------
* Source: TRACE data. Our sample contains all transactions in the interdealer market, including direct dealer-to-
  dealer trades and trades that occur on ATSs covered by FINRA Rule 6730.07.

    The Commission also understands that many firms compete to provide 
liquidity in the markets for corporate bonds and for equities (not 
necessarily the same firms). Research has documented that, as of the 
first quarter of 2020, about 600 dealers intermediated in the market 
for corporate bonds, but that the top 10 broker-dealers controlled 
approximately 70% of the volume.\434\ Another analysis by the 
Commission \435\ found that of the 3,972 broker-dealers that filed Form 
X-17a-5 (FOCUS report) in 2016, 430 were also members of U.S. equities 
exchanges, and the largest 20 broker-dealers controlled approximately 
75% of the total assets of all broker-dealers.
---------------------------------------------------------------------------

    \434\ Maureen O'Hara and Alex Zhou, Anatomy of a Liquidity 
Crisis: Corporate Bonds in the Covid-19 Liquidity Crisis, 142 J. 
Fin. Econ. 46 (2021), 46-68.
    \435\ Transaction Fee Pilot for NMS Stocks, Exchange Act Release 
No. 82873 (Mar. 14, 2018), 83 FR 13008 (Mar. 26, 2018).
---------------------------------------------------------------------------

    The current competitive landscape among significant liquidity 
providers is shaped by the difference in regulatory treatment between 
registered dealers and the unregistered market participants that 
perform a similar role in the markets. Competition among significant 
liquidity providers in U.S. capital markets, described above, puts 
pressure on firms' ability to profit from these activities, meaning 
that even small regulatory differences across significant liquidity 
providers can be important. The compliance costs of the additional 
requirements to which registered dealers are subject may currently 
allow less-regulated firms such as PTFs to increase (or continue to 
increase) their share of dealing activity at registered dealers' 
expense. These dynamics may especially apply to the electronic 
interdealer segment of the Treasury market, where PTFs now account for 
a majority of trading activity (as of 2019).\436\
---------------------------------------------------------------------------

    \436\ See supra note 382.
---------------------------------------------------------------------------

4. Externalities
    Externalities arise in a market when a market participant engages 
in activity that impacts participants not otherwise directly related to 
the activity and the market participant does not take this impact into 
account. In this analysis, externalities can arise with regard to 
activities, such as risk taking and abusive trading, that are taken by 
market participants who act as regular significant liquidity providers 
(i.e., dealers). The dealer regulatory regime promotes dealers' 
financial responsibility, including adequate capitalization (liquidity 
held against risky assets) and internal controls, which can help 
address externalities--above and beyond any other existing regulatory 
or industry practices. Subjecting unregistered market participants that 
perform as dealers to this regime, similarly to all currently 
registered dealers, will therefore enhance oversight by regulators and 
help limit externalities by helping prevent spillovers that may broadly 
harm investors.
    Market participants that act as regular significant liquidity 
providers, whether registered with the Commission as dealers or not, 
can not only harm their counterparties but also cause wider harm 
throughout securities markets if they fail financially.
    Failed liquidity providers can become unable to meet short-term 
obligations to trading counterparties, repo lenders and other lenders, 
and clearing firms. Negative effects can be transmitted further through 
creditors or counterparties to other market entities who are not 
directly related. For instance, a lender that suffers a loss due to the 
bankruptcy of one of its borrowers may reduce its willingness to lend 
(i.e., it may increase the price of credit) more generally, especially 
when the lender is uncertain about whether the bankruptcy is due to 
idiosyncratic events or to events that have also negatively impacted 
other potential borrowers. Prior to or during a failure, a significant 
liquidity provider may have to liquidate an unexpectedly large 
position--perhaps acquired because offsetting trades were unavailable 
for a time or because of errors in trading algorithms or other systems 
(including human errors). Rapid liquidation of the position may cause 
detrimental price volatility or a temporary drop in market liquidity.
    If the failed liquidity provider is a substantial market 
participant, then its disorderly exit from the market or from a 
securities position may push market prices away from fundamental value 
and harm traders across the markets. Because a significant liquidity 
provider can harm others to whom it is not directly related--and who 
may not be able to contract to bear those costs--its failure can impose 
negative externalities. These externalities may ensue whether the 
failed liquidity provider is registered as a dealer or not. However, 
the next paragraph explains how the dealer regime's limitations on 
financial risk, including the Net Capital Rule, reduce the risk for 
registered dealers.
    Dealer regulations are designed to mitigate the magnitude of these 
externalities and to limit the probability that they occur at all. For 
example, the Net Capital Rule requires dealers to maintain sufficient 
liquid assets to meet all unsubordinated liabilities--including 
obligations to counterparties and other creditors--and to have adequate 
additional resources to wind down their business in an orderly manner 
if they fail financially. PTFs that are not registered as dealers 
currently face fewer regulations restricting their operational or 
financial risk,\437\ and they are also not subject to additional SRO 
rules that promote financial

[[Page 14976]]

responsibility and operational capability. Private funds can place 
limits on investor withdrawals, and the fund adviser's fiduciary 
obligations may also deter private funds' excessive risk-taking. 
However, qualifying hedge funds have no regulatory leverage constraints 
and tend to have more secured debts than assets that could be 
liquidated within a day or even within a year.\438\
---------------------------------------------------------------------------

    \437\ See discussion of risk limitations in section III.B.2.a.
    \438\ See Private Fund Statistics, Tables 4, 49, and 51. As of 
the fourth quarter of 2022, qualifying hedge funds had $1.2 trillion 
(32%*$3.8 trillion) in assets that could be liquidated within a day, 
$2.9 trillion (78%*3.8 trillion) in assets that could be liquidated 
within a year, and $3.5 trillion in secured debts. In the Proposing 
Release, we estimated that ``qualifying hedge funds are more 
leveraged than registered dealers.'' A commenter disagreed with our 
use of the word ``leverage'' in that statement, citing statistics 
showing that the average hedge fund has a lower ratio of assets to 
equity--a more traditional measure of leverage--than registered 
dealers (see MFA Comment Letter I). However, we believe the 
comparison in the proposal and here is apt because the Net Capital 
Rule constrains a form of leverage--not book leverage, but a more 
``liquid'' notion of leverage equal to liquid assets minus 
unsubordinated liabilities. To avoid misunderstanding, we refer to 
``having more secured debts than assets that could be liquidated 
within a day or even within a year'' instead of ``leverage.'' See 
also supra note 399 for a definition of ``qualifying hedge fund.''
---------------------------------------------------------------------------

    Some commenters disagreed that traders without customers pose risks 
to investors, since they do not interact directly with the investing 
public.\439\ A dealer's insolvency can also harm other counterparties 
and creditors even in the absence of customers. Any entity that 
effectively and regularly provides significant liquidity to markets, 
regardless of whether that entity has customers or not, has the 
potential to harm markets if it fails, as discussed above.
---------------------------------------------------------------------------

    \439\ See AIMA Comment Letter II; Blockchain Association Comment 
Letter; FIA PTG Comment Letter I; MFA Comment Letter I; SIFMA 
Comment Letter I.
---------------------------------------------------------------------------

    Some commenters questioned the proposal's premise that market 
participants who are not registered dealers can have important 
externalities, or stated that any such externalities manifest 
themselves so infrequently that the proposed rules are 
unnecessary.\440\ Market participants engaged in dealing activities but 
without being registered as dealers create the potential for serious 
externalities if they fail, regardless of the historical frequency of 
such failure. Two examples illustrate such externalities: the failure 
of Drysdale Government Securities and the Treasury market illiquidity 
in March 2020. In 1982, Drysdale Government Securities--a firm that was 
not registered as a dealer but was actively dealing in the U.S. 
Treasury market for its own account--failed when it became unable to 
pay interest due on securities it had acquired in reverse repo 
agreements with 30 brokers.\441\ Drysdale had acquired a $4 billion 
securities portfolio supported by only $20-30 million in capital--far 
in excess of the leverage that the Net Capital Rule would have allowed 
for a registered dealer. Even though Chase Bank (Drysdale's agent) 
supported market confidence by making Drysdale's payments and markets 
eventually return to normal, Drysdale's failure harmed market 
functioning for several days. For as long as a week, ``according to 
dealers, the secondary markets in government securities continue[d] to 
be very thin, with few deals being done. And . . . the repo market was 
virtually dead.'' \442\
---------------------------------------------------------------------------

    \440\ See AlphaWorks Comment Letter; FIA PTG Comment Letter I; 
McIntyre Comment Letter I; Overdahl Comment Letter.
    \441\ Drysdale Government Securities was very active in the U.S. 
Treasury market, and the firm had acquired a large portfolio of U.S. 
Government securities through reverse repurchase agreements. Those 
agreements required Drysdale to pass along any interest received to 
the banks from whom it had borrowed the securities. The firm 
collapsed when it was unable to pass along those interest payments. 
See Ron Scherer, ``How Drysdale Affair Almost Stymied US Securities 
Market,'' Christian Science Monitor (May 27, 1982), available at 
https://www.csmonitor.com/1982/0527/052737.html; James L. Rowe Jr. 
and Merrill Brown, ``Through Abrupt Personality Change, Tiny Wall 
Street Firm Demonstrates the Allure, and Danger, in Speculative 
Trading,'' Wash. Post (May 23, 1982), available at https://www.washingtonpost.com/archive/politics/1982/05/23/through-abrupt-personality-change-tiny-wall-street-firm-demonstrates-the-allure-and-danger-in-speculative-trading/532bf4ea-bdf2-4248-924b-d6a682907aba/ https://www.washingtonpost.com/archive/politics/1982/05/23/through-abrupt-personality-change-tiny-wall-street-firm-demonstrates-the-allure-and-danger-in-speculative-trading/532bf4ea-bdf2-4248-924b-d6a682907aba/ (retrieved from Factiva database).
    \442\ See Ron Scherer, ``How Drysdale Affair Almost Stymied US 
Securities Market,'' Christian Science Monitor (May 27, 1982), 
available at https://www.csmonitor.com/1982/0527/052737.html.
---------------------------------------------------------------------------

    In addition, the 2021 IAWG Joint Staff Report showed that PTFs in 
particular (many of whom were not registered as dealers) appeared to 
pull back from providing liquidity in the Treasury markets relative to 
dealers during the market volatility in March 2020, possibly because 
``their lower capitalization relative to dealers may [have left] them 
with less capacity to absorb adverse shocks.'' \443\ Higher 
capitalization may have given PTFs more capacity to absorb the shock, 
which may have increased their ability to provide liquidity as well as 
increasing the resiliency of the market itself. While PTFs may not have 
been the primary cause of the volatility,\444\ this episode illustrates 
that PTFs' market withdrawal can contribute to stress in the overall 
U.S. Treasury market. One commenter disagreed with the IAWG's 
characterization of March 2020, and said that ``price moves reflected 
rapidly shifting outlooks for the world economy, and the spreads were 
narrower than might be expected given the price moves.'' \445\ Research 
has shown that Treasury market liquidity in March 2020 was considerably 
lower than might be expected given the price volatility.\446\ 
Consistent with this research, we disagree with the commenter that 
spreads were narrower than might be expected. However, we do not 
necessarily conclude that PTFs always exacerbate market instability, 
since PTFs' share of market trading appeared to increase during the 
uncertainty in March 2023.\447\
---------------------------------------------------------------------------

    \443\ See 2021 IAWG Joint Staff Report, supra note 21. 
Initially, PTFs increased trading activity, but they pulled back 
from market making several days later when volatility reached very 
high levels. See id. at 13 (``In the first week of Mar., a large 
share of the increased trading volume came from PTFs, and on Mar. 9, 
PTFs' share of trading on electronic IDB platforms was just over 
60%, a typical level. But as heavy net investor sales continued, the 
balance of activity in the interdealer market shifted . . . PTFs' 
total share of activity fell to a low of 45% on Mar. 16. Dealers' 
total volumes on electronic IDB platforms also declined, but less 
sharply than PTFs' volumes.''). See also infra note 460 and 
surrounding text.
    \444\ See Overdahl Comment Letter.
    \445\ See Alphaworks Comment Letter.
    \446\ See Darrell Duffie, et al., Oct. 2023, ``Dealer Capacity 
and U.S. Treasury Market Function,'' Federal Reserve Bank of New 
York Staff Reports, no. 1070, available at https://doi.org/10.59576/sr.1070.
    \447\ See Nellie Liang, ``Remarks by Under Secretary for 
Domestic Finance Nellie Liang at the 2023 Treasury Market 
Conference'' (Nov. 16, 2023), available at https://home.treasury.gov/news/press-releases/jy1917.
---------------------------------------------------------------------------

    Negative externalities can also derive from market misconduct by 
unregistered dealers. Several elements of the dealer regulatory regime 
address misconduct risks and regulators can examine regulated dealers. 
Under that regime, financial statement reporting, transaction 
reporting,\448\ and examinations help regulators detect manipulation or 
fraud and determine whether firms comply with applicable regulations. 
If unregistered dealers engage in market misconduct, it could result in 
negative externalities by distorting market prices and adversely 
impacting market participants.\449\
---------------------------------------------------------------------------

    \448\ See section III.B.2.a for a discussion on transactions 
reporting by registered dealers versus other entities.
    \449\ In 2020 and 2021, FINRA identified non-member firms in 17% 
of the alerts generated by its surveillance of manipulative trading 
patterns in U.S. Treasury market, despite limitations on its 
surveillance of non-members--FINRA can only identify trades as 
involving non-FINRA members when the trades take place on certain 
ATSs (see supra note 380). See Sept. 27, 2022, letter from FINRA 
responding to SEC Release No. 95388 (15b9-1), pp. 9-10, available at 
https://www.sec.gov/comments/s7-05-15/s70515-20144330-309240.pdf. 
FINRA staff later clarified that some of that 17% may be due to SEC-
registered broker-dealers who are not FINRA members (see memorandum 
of telephone conversation between Commission staff and FINRA 
available at https://www.sec.gov/comments/s7-05-15/s70515-226580-474322.pdf).

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[[Page 14977]]

    Some commenters said that requiring more Treasury security 
transactions to be centrally cleared would address the same 
externalities that are described above.\450\ The SEC recently adopted 
the Treasury Clearing Adopting Release, which, among other things, 
amends 17 CFR 240.17Ad-22(e)(18) to require covered clearing agencies 
that provide central counterparty (``CCP'') services for U.S. Treasury 
securities to establish, implement, maintain and enforce written 
policies and procedures reasonably designed, as applicable, to 
establish objective, risk-based and publicly disclosed criteria for 
participation, which require that any direct participant of such a 
covered clearing agency submit for clearance and settlement all the 
eligible secondary market transactions in U.S. Treasury securities to 
which such direct participant is a counterparty.\451\ The Treasury 
Clearing Adopting Release lowers overall systemic risk in the U.S. 
Treasury market by bringing the benefits of central clearing to more 
transactions involving U.S. Treasury securities.\452\ The amendments 
that the Commission adopted in the Treasury Clearing Adopting Release 
will likely yield benefits associated with increased levels of central 
clearing in the secondary market for U.S. Treasury securities.\453\ 
These benefits could be particularly significant in times of market 
stress, as CCPs will mitigate the potential for a single market 
participant's failure to destabilize other market participants, 
destabilize the financial system more broadly, and/or reduce the 
effects of misinformation and rumors.\454\ A CCP also will address 
concerns about counterparty risk by substituting the creditworthiness 
and liquidity of the CCP for the creditworthiness and liquidity of 
counterparties.\455\
---------------------------------------------------------------------------

    \450\ See AIMA Comment Letter III; Lewis Study; MFA Comment 
Letter II; Overdahl Comment Letter.
    \451\ See Treasury Clearing Adopting Release, 89 FR 2717-22.
    \452\ See id. at 2716.
    \453\ See id. at 2798.
    \454\ See id.
    \455\ See id. at 2798-99.
---------------------------------------------------------------------------

    Accordingly, the Commission acknowledges that the Treasury Clearing 
Adopting Release addresses some of the externalities discussed above 
stemming from the failure of large firms, which the final rules are 
also intended to address. However, given that the Treasury Clearing 
Adopting Release and the final rules address these externalities 
through different mechanisms, the final rules would serve to further 
reduce the externalities in the market for U.S. Government securities. 
This, in turn, further reduces the probability that a significant 
liquidity provider fails and thus promotes the stability and resiliency 
of the government securities market. By limiting the risk of failure, 
the final rules limit the probability that such failure could harm 
creditors or lead to price volatility as a troubled firm rapidly 
deleverages. The final rules may also limit the probability of failure 
for all PTFs and hedge funds who are engaged in dealing activity. The 
Treasury Clearing Adopting Release, in contrast, would not require 
central clearing for hedge funds' cash trades or for any transaction 
between a PTF who is not a member of a clearing agency and another non-
member counterparty. In addition, benefits of the final rules such as 
the consistent application of dealer regulations across significant 
liquidity providers, operational and financial requirements designed to 
mitigate risks, deterrence of abusive and deceptive trading practices, 
extension of SROs' examination authority to significant liquidity 
providers for U.S. financial markets, and increased transparency into 
the identities of significant liquidity providers in the Treasury 
market, are largely unaffected by the adoption of the Treasury Clearing 
Adopting Release.

C. Economic Effects, Including Impact on Efficiency, Competition, and 
Capital Formation

    As described in section II, the Commission believes that the final 
rules will promote the stability and transparency of U.S. Treasury and 
other securities markets by closing the regulatory gap that currently 
exists and ensuring consistent regulatory oversight of persons engaging 
in regular liquidity provision in securities markets. Specifically, the 
final rules will increase the share of liquidity provision that is 
undertaken by persons who are subject to the dealer regime's limits on 
financial risk-taking, reporting requirements, regulation against 
abusive practices, and examinations. The greatest benefits come from 
applying these dealer regulations to entities that are currently not 
registered at all--i.e., unregistered PTFs. While the Commission 
already has some insight into private funds and investment advisers, to 
the extent that certain private funds or registered investment advisers 
perform the functions of dealers, it would be beneficial to extend 
dealer risk limitations and transaction reporting responsibilities to 
them. These benefits, as well as the costs described in this section, 
may differ for registered government securities dealers, since they 
have different capital requirements and are not required to join SIPC 
as discussed in section III.B.1.
    Costs of the final rules include registration and membership fees, 
costs of recordkeeping and reporting, and costs associated with net 
capital requirements. Additionally, the final rules may influence 
patterns of market participation, which may in turn affect competition 
among significant liquidity providers, market liquidity and efficiency, 
and capital formation.
1. Benefits
    The final rules would subject all market participants that perform 
similar dealer functions to a common regulatory regime. This regime 
includes provisions that limit risk (e.g., the Net Capital Rule and 
rules promoting operational integrity), provisions that require certain 
books and records, provisions that require various reporting and 
disclosure (including audited financial statements and the identities 
of owners, directors, and managers), and antifraud and anti-
manipulation provisions. Subjecting currently unregistered (as dealers) 
market participants to dealer requirements will thus enable oversight 
by regulators,\456\ limit externalities by helping prevent spillovers 
that may broadly harm investors, and ensure that the competitive 
landscape among significant liquidity providers is not shaped by a 
difference in regulatory treatment.\457\
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    \456\ One commenter stated that ``[t]he Regulation ATS proposal 
may well result in coverage of some of the same market participants 
as would be covered by the [proposed rules] and may therefore 
address some of the needs that the Commission claims warrant the 
[proposed rules].'' See Consensys Comment Letter (discussing 
Amendments Regarding the Definition of ``Exchange'' and Alternative 
Trading Systems (ATSs) That Trade U.S. Treasury and Agency 
Securities, National Market System (NMS) Stocks, and Other 
Securities, Exchange Act Release No. 94062 (87 FR 15496, Mar. 18, 
2022) (``Regulation ATS Proposal'')). The Regulation ATS Proposal 
has not been adopted and is therefore not part of the baseline for 
this economic analysis. See supra note 355. In any event, the final 
rules and the Regulation ATS Proposal differ in scope and impact, as 
the rules would apply to market participants engaging in different 
types of market activities if Regulation ATS is adopted as proposed.
    \457\ In a comment letter, FINRA agreed that ``requiring such 
entities to register with the SEC . . . would close regulatory 
gaps,'' and stated that ``current regulatory disparities are 
especially pronounced in the market for U.S. Treasury securities.'' 
See FINRA Comment Letter.
---------------------------------------------------------------------------

    As previously discussed, PTFs and hedge funds would be the primary 
affected parties, and registering PTFs that are dealing would provide 
the

[[Page 14978]]

largest benefits. Some investment advisers may also be affected if they 
engage in dealing activities on their own account, and these entities' 
dealer registration would also provide benefits.
    In response to a related initiative in 2010,\458\ at least one 
principal trading firm told the Commission that the costs of 
registering PTFs as dealers were not justified because equity markets 
worked well during the autumn of 2008 (then the most-recent crisis) and 
because the commenter believed that principal trading firms in general 
help market integrity by providing liquidity during difficult 
situations.\459\ However, the 2021 IAWG Joint Staff Report showed that, 
during the U.S. Treasury market volatility of March 2020, PTFs' share 
of market intermediation fell considerably more than did dealers' 
share.\460\ The Joint Staff Report's conclusion suggests that PTFs do 
not always promote stability in securities markets.
---------------------------------------------------------------------------

    \458\ See 2010 Equity Market Structure Concept Release.
    \459\ See Comment Letter of Berkowitz, Trager & Trager, LLC 
(Apr. 21, 2010) (``Berkowitz Comment Letter''). See also supra note 
20.
    \460\ See supra notes 21 and 443 and accompanying text for 
further discussion of changes in trading activity of principal 
trading firms during the U.S. Treasury market volatility of Mar. 
2020. The market share of PTFs declined from approximately 62% at 
the beginning of Mar. 2020 to a low of 45% on Mar. 16, 2020.
---------------------------------------------------------------------------

a. Regulatory Consistency and Competition
    Currently, large market participants that are not registered as 
dealers (or government securities dealers) perform critical market 
functions, in particular liquidity provision, akin to those performed 
by dealers (or government securities dealers). For example, in the U.S. 
Treasury market, PTFs account for about half of the daily volume in the 
interdealer market and yet are not registered as dealers. The final 
rules will help ensure that all market participants that take on 
significant liquidity-providing roles are appropriately registered as 
dealers and government securities dealers. The final rules will thereby 
promote competition among entities that regularly provide significant 
liquidity by applying consistent regulation to these entities, thus 
leveling the competitive playing field between liquidity provision 
conducted by entities that are currently registered as dealers and 
government securities dealers and by entities that are not.
    The regulatory consistency under the final rules is expected to 
benefit currently registered dealers by ensuring that all of their 
competitors, including currently unregistered market participants that 
perform the same function as dealers, are subject to common regulatory 
requirements.\461\ As stated above in section III.B.3, even small 
differences across significant liquidity providers in regulatory costs 
could be enough to give important advantages to the firms bearing the 
smallest regulatory burdens.
---------------------------------------------------------------------------

    \461\ See section III.B.3.
---------------------------------------------------------------------------

    Some commenters stated that the final rules would negatively impact 
competition by especially harming small PTFs and creating barriers to 
entry against small liquidity providers.\462\ We agree that the final 
rules could impose proportionally greater costs on small-volume 
liquidity providers for two reasons. First, FINRA's Gross Income 
Assessment \463\ generally declines as a percentage of revenue for 
larger firms, so that firms with smaller revenues pay proportionally 
larger fees. Second, fees associated with reporting to TRACE \464\ are 
proportionally lower for trades with larger dollar par value. To the 
extent that larger firms also tend to place larger trades, on average, 
TRACE reporting might be proportionally more costly for small firms. 
However, the final rules will exclude market participants who have or 
control assets less than $50 million.\465\ Also, currently registered 
dealers include smaller market participants, and under the final rules 
smaller unregistered market participants would be subject to the same 
rules as smaller registered market participants, thereby creating a 
level competitive landscape amongst smaller market participants.
---------------------------------------------------------------------------

    \462\ See Alphaworks Comment Letter; MMI Comment Letter; FIA PTG 
Comment Letter I.
    \463\ See infra Table 6.
    \464\ See infra note 543.
    \465\ This discussion of the potential negative economic impact 
on smaller liquidity providers for purposes of the economic analysis 
does not impact the regulatory flexibility analysis discussed later 
in section V because the final rules include a $50 million 
exclusion. As a result, any of the ``small liquidity providers'' 
discussed in the economic analysis would not meet the Commission's 
definition of a ``small business'' or ``small organization'' in 17 
CFR 240.0-10 (``Rule 0-10''), which defines an ``issuer'' or 
``person'' other than an investment company as having total assets 
less than $5 million on the last day of its fiscal year for purposes 
of the Regulatory Flexibility Act.
---------------------------------------------------------------------------

b. Regulations on Financial and Operational Risk-Taking
    The final rules will mitigate externalities to liquidity and 
stability, discussed in section III.B.3, by applying the Net Capital 
Rule and SRO requirements to additional significant liquidity 
providers. These final rules will reduce the risk that a significant 
liquidity provider fails and harms its counterparties and the broader 
functioning of the markets, by promoting the financial stability of 
individual significant liquidity providers. SRO supervision may also 
reduce the risks that errors in algorithms lead to trading activities 
that violate Commission or SRO rules.\466\
---------------------------------------------------------------------------

    \466\ See supra note 369 and accompanying text.
---------------------------------------------------------------------------

    The Net Capital Rule will make risk-taking more costly for affected 
parties because the final rules will require them to maintain a greater 
supply of liquid assets when they are exposed to more risk. In the 
event that a significant liquidity provider fails, the Net Capital Rule 
will ensure that it has sufficient liquid assets to meet all its 
liabilities to unsubordinated creditors. In addition, qualifying hedge 
funds,\467\ on average, have fewer liquid assets than the Net Capital 
Rule would allow.\468\ Markets in which significant liquidity providers 
are required to hold some amount of liquid assets and face constraints 
on leverage may be less sensitive to sudden market disruptions that 
could otherwise reduce their capacity to provide liquidity. Such 
liquidity providers are better able to withstand adverse events without 
compromising their ability to remain engaged in the market.\469\
---------------------------------------------------------------------------

    \467\ See supra note 399.
    \468\ See supra note 438 and accompanying text.
    \469\ See supra notes 21 and 443 (referring to the Treasury 
market events of 2020).
---------------------------------------------------------------------------

    The benefit of the Net Capital Rule's constraints on risk-taking 
may be smaller for certain affected parties. Some persons may meet the 
final rules' definition of dealing but also keep their gross exposure 
small at any moment. Such persons would operate with very little 
leverage and would have few short-term obligations at any moment. The 
benefit of the Net Capital Rule may also be smaller when applied to 
persons whose creditors and counterparties have rigorous risk 
management practices and are capable of calculating and managing their 
exposure to that person. Such creditors and counterparties may not be 
seriously harmed by a dealer's failure. As noted above, registered 
government securities dealers are subject to minimum liquid capital 
requirements as set forth in 17 CFR 402.2. These requirements would 
generally serve the same risk-limiting purpose as the Net Capital Rule. 
Also, the Net Capital Rule would not necessarily make affected persons 
more willing to provide liquidity in times of market stress; solvent 
firms could still decide not to provide liquidity if it were not 
profitable to do so.
    The final rules require affected persons to become FINRA members 
and comply with FINRA rules designed to

[[Page 14979]]

facilitate the orderly and robust execution of algorithmic and HFT 
operations.\470\ Applying these rules would address the risk that a 
significant liquidity provider's failure could cause market 
disruptions, and these rules are also designed to limit the duration of 
any such market disruptions that may occur. We understand that 
algorithmic HFT is a primary feature of the PTFs and private funds who 
are most likely to meet the final rules' qualitative factors, since 
such trading can involve regularly expressing trading interests on both 
sides of the market (the expressing trading interest factor) or earning 
revenue from bid-ask spreads or incentives offered for liquidity-
providing trades (the primary revenue factor). The application of these 
rules to affected parties engaged in such algorithmic trading activity 
will accordingly promote the stability and resilience of U.S. 
securities markets.
---------------------------------------------------------------------------

    \470\ See supra note 369.
---------------------------------------------------------------------------

    A few commenters agreed that the proposed rules would provide 
benefits of market stability, integrity, and resiliency.\471\ Other 
commenters asked how the final rules would prevent or mitigate harm 
from future market disruptions and one said that having more market 
participants registered as dealers would not have improved the market 
structure in March 2020.\472\ We acknowledge that dealer registration 
does not obligate an entity to provide liquidity in the secondary 
market, and that even registered dealers may pull back from the market 
at times for business reasons. We also acknowledge that even registered 
dealers can fail. However, we emphasize that the dealer regime, 
including the Net Capital Rule, seeks to limit financial risk that may 
make entities more likely to fail or to need to pull back from the 
market. We believe that compliance with the dealer regime would make 
significant liquidity providers less likely to contribute to market 
instability.\473\
---------------------------------------------------------------------------

    \471\ See Better Markets Comment Letter; FINRA Comment Letter; 
Gretz Comment Letter.
    \472\ See Alphaworks Comment Letter; Consensys Comment Letter; 
FIA PTG Comment Letter I; McIntyre Comment Letter II; Morgan Lewis 
Comment Letter.
    \473\ See supra section I.A for a discussion on how dealer 
registration enhances market stability by giving regulators 
increased insight into firm-level and aggregate trading activity and 
so helps regulators to evaluate, assess, and address market risks 
and to contribute to fair and orderly markets.
---------------------------------------------------------------------------

    Many commenters stated that market participants who are not 
registered as dealers are already subject to regulatory risk limits, 
because the market participants typically trade through registered 
entities (e.g., banks and broker-dealers), and therefore it is not 
necessary for such participants to comply with the Net Capital 
Rule.\474\ Other commenters questioned the benefits of regulating 
private fund advisers as dealers, since existing rules and regulations 
already limit advisers' risk and protect their investors through rules 
on custody of assets, fiduciary duty, and reporting, and record-
keeping.\475\ Another commenter added that professional equity trading 
firms are also subject to the Market Access Rule, which is designed to 
promote market integrity, and to the Commission's large trader program, 
which may impose reporting obligations on unregistered as well as 
registered entities.\476\ The Commission acknowledges that market 
participants currently have direct and indirect constraints on their 
trading activity and risk-taking.\477\ However, as discussed in section 
III.B.3.a, the Net Capital Rule is another important constraint on 
risk-taking and helps promote the stability of markets. Unlike the 
various margin requirements, the Net Capital Rule directly ensures that 
dealers are sufficiently liquid so that they can quickly satisfy 
creditors and counterparties. With respect to direct market access, the 
Market Access Rule does not directly impose obligations on all trading 
firms. Rather, the Market Access Rule requires a broker or dealer with 
market access to establish, document, and maintain a system of risk 
management controls and supervisory procedures reasonably designed to 
manage financial, regulatory, and other risks of this business 
activity.
---------------------------------------------------------------------------

    \474\ See Alphaworks Comment Letter; ADAM Comment Letter; MFA 
Comment Letter I; Lewis Study; Element Comment Letter; ICI Comment 
Letter; Letter from the Hedge Fund Association (May 27, 2022) (``HFA 
Comment Letter''); IAA Comment Letter I; IDTA Comment Letter; Morgan 
Lewis Comment Letter; NAPFM Comment Letter; SIFMA Comment Letter; T. 
Rowe Price Comment Letter; Virtu Comment Letter. See supra notes 
384-386 and accompanying text for a discussion of existing risk 
limits.
    \475\ See AIMA Comment Letter II; ABA Comment Letter; Citadel 
Comment Letter; Committee on Capital Markets Regulation Comment 
Letter; Element Comment Letter; MFA Comment Letter I; MFA Comment 
Letter II; Fried Frank Comment Letter; HFA Comment Letter; IAA 
Comment Letter I; ICI Comment Letter; Lewis Study; McIntyre Comment 
Letter II; T. Rowe Price Comment Letter; Two Sigma Comment Letter I.
    \476\ See Lewis Study; McIntyre Comment Letter II.
    \477\ See sections III.B.2.a and III.B.2.b.
---------------------------------------------------------------------------

    Some commenters questioned the benefits of applying the Net Capital 
Rule to entities without customers--e.g., PTFs, investment advisers, or 
private funds.\478\ However another commenter stated that even entities 
without customers may still engage in a significant amount of trading 
activity, and so their financial and operational condition can present 
risks to the markets.\479\ Two commenters said that the Net Capital 
Rule was designed to protect creditors and counterparties, in addition 
to customers.\480\ Such creditors and counterparties may include repo 
counterparties and clearing firms. If a significant liquidity provider 
were to fail, these other parties could become unable to complete 
trades or lose control of assets, either permanently or temporarily 
during bankruptcy proceedings. Even if the losses were eventually 
recovered, the significant liquidity provider could be temporarily 
unable to deliver securities or cash, forcing the counterparties to 
quickly enter new trades, put on new hedges, replace frozen collateral, 
or find new sources of liquidity. If market prices were volatile during 
this period, even a temporary freeze could cause serious stress to 
these counterparties and creditors. If a liquidity provider with large 
enough positions were to fail, the cumulative harm to counterparties 
and creditors, even if temporary, could cause substantial market 
disorder. Even if it does not fail, a highly leveraged significant 
liquidity provider may exacerbate market instability during times of 
market stress or volatility. For example, the entity may receive margin 
calls at a time of volatility, requiring it to reduce its leverage by 
closing positions instead of continuing to provide liquidity the 
market.
---------------------------------------------------------------------------

    \478\ See AIMA Comment Letter; Blockchain Association Comment 
Letter; Consensys Comment Letter; FIA PTG Comment Letter I; IAA 
Comment Letter I; MFA Comment Letter I; T. Rowe Price Comment 
Letter.
    \479\ See FINRA Comment Letter.
    \480\ See FIA PTG Comment Letter I; AIMA Comment Letter II.
---------------------------------------------------------------------------

    The final rules may also increase the benefits associated with 
increased central clearing. Under the recent Treasury Clearing 
amendments,\481\ registered dealers and government securities dealers 
that are direct participants of a covered clearing agency will be 
required to centrally clear all of their eligible secondary market 
transactions; such transactions of dealers and government securities 
dealers that are not direct participants of a covered clearing agency 
will still be subject to central clearing requirements if those 
transactions are with members of a covered clearing agency. 
Accordingly, the final rules may increase the number of transactions 
subject to central clearing requirements to the extent they result in 
registration of new dealers or government securities dealers whose 
eligible secondary market

[[Page 14980]]

transactions with a direct participant of a covered clearing agency 
will need to be centrally cleared.\482\ This increase in central 
clearing will confer benefits as discussed in the Treasury Clearing 
Adopting Release.\483\
---------------------------------------------------------------------------

    \481\ See supra notes 348 and 375 and accompanying text.
    \482\ Such transactions would not have been cleared under the 
baseline unless the transaction was with direct participant that 
brought together multiple buyers and sellers using a trading 
facility (such as a limit order book) and is a counterparty to both 
the buyer and seller in two separate transactions. See Treasury 
Clearing Adopting Release.
    \483\ See Treasury Clearing Adopting Release; see also supra 
section III.B.4.
---------------------------------------------------------------------------

    Entities that register as dealers, other than registered government 
securities dealers, will be required to become members of SIPC. Some 
commenters questioned whether dealers registered under the final rules 
that do not have customers would benefit from SIPC membership.\484\ We 
acknowledge that not every registered dealer has customers. However, in 
the Securities Investor Protection Act of 1970 (``SIPA''), Congress 
mandated that a broad range of dealers, including those without 
customers, are required to become members of SIPC.\485\ In fact, there 
are many firms that are current broker-dealers and have no customers 
that are members of SIPC.\486\ The requirement for dealers to become 
SIPC members is intended to place the financial support of the SIPC 
program on all firms that made their livelihood in the securities 
business, regardless of whether they had public customers or not.\487\ 
Accordingly, we believe that expanding SIPC membership will enhance the 
ability of SIPC to carry out its investor protection mission, 
consistent with SIPA, which will have positive effects on the 
securities markets overall. In addition, we note that entities that 
choose to comply with the final rules by registering as government 
securities dealers under section 78o-5(a) of the Exchange Act are not 
required to become SIPC members.
---------------------------------------------------------------------------

    \484\ See Citadel Comment Letter; Overdahl Comment Letter.
    \485\ See 15 U.S.C. 78ccc(a)(2).
    \486\ See SIPC, List of Members, available at https://www.sipc.org/list-of-members/ (listing SIPC members, including 
multiple firms that do not have customers).
    \487\ See SIPC, Member FAQs, available at https://www.sipc.org/for-members/member-faqs#my-firm-has-no-public-customers-why-do-i-have-to-be-a-member (``When Congress passed the Securities Investor 
Protection Act, it made all SIPC members subject to its provisions, 
including the obligation to pay assessments into the SIPC Fund. The 
objective was to instill confidence in the investing public and to 
place the financial support of the SIPC program on all firms that 
made their livelihood in the securities business, regardless of 
whether they had public customers or not.'').
---------------------------------------------------------------------------

c. Regulations on Reporting
    The final rules would enhance regulators' oversight of significant 
liquidity providers and of individual securities trades. Entities that 
register as dealers under the final rules will have new reporting 
obligations to CAT (if they transact in CAT-reportable securities) and 
to TRACE (if they transact in TRACE-eligible securities). The 
additional reporting would give regulators greater insight into 
securities trading patterns, including the ability to more efficiently 
match trades to market participants.\488\ PTFs who register as dealers 
or as government securities dealers would also begin submitting annual 
reports, including financial statements, for the first time. This 
additional information, especially the financial reporting and the 
transaction reporting, would help address the Commission's concerns 
described in sections III.B.3. and III.B.4. The information would 
enable regulators to better analyze markets--including reconstructing 
markets and detecting abusive trading behaviors--respond to market 
events and inform investors.\489\ Improved regulatory oversight would, 
in turn, promote the efficiency and stability of the markets as well as 
investor confidence, which would support capital formation by 
increasing demand for securities issued in U.S. markets and lowering 
yields.
---------------------------------------------------------------------------

    \488\ See section III.B.2.a for a discussion of limitations that 
exist when market participants do not have reporting obligations--
reduced efficiency in identifying market participants in CAT, and 
limited ability to identify market participants in TRACE.
    \489\ For example, regulators' lack of insight into the market 
for U.S. Treasury securities became especially apparent during the 
instability of Mar. 2020. The 2021 IAWG Joint Staff Report on Nov. 
8, 2021, noted that ``In Mar. 2020 . . . there was a [particular] 
need for timely information on the positions and transactions of 
institutions other than dealers.'' See supra note 21. Wider TRACE 
reporting would have provided more of such information.
---------------------------------------------------------------------------

    Comment letters argued that dealer registration would not provide 
an information benefit because transactions are already reported to 
TRACE or CAT,\490\ because investment advisers are already subject to 
Commission oversight, and because PTFs and investment advisers are 
potentially subject to reporting on Forms 13F or 13H.\491\ Section 
III.B.2 describes the differences in the information available to 
regulators for registered dealers compared to PTFs and private funds. 
Specifically, registered dealers who become FINRA members will be 
required to report fixed income transactions to TRACE, which will 
expand the ability to identify the new registered dealers and 
potentially result in more trades being reported. We believe this 
information would be useful for surveillance and for market 
reconstruction.\492\ Forms 13F and 13H also contain valuable 
information, but they do not contain the detailed transaction data that 
registered dealers are responsible for submitting.\493\
---------------------------------------------------------------------------

    \490\ See Fried Frank Comment Letter; McIntyre Comment Letter 
II; MMI Comment Letter; Morgan Lewis Comment Letter; SIFMA Comment 
Letter I; Virtu Comment Letter.
    \491\ See Fried Frank Comment Letter; IAA Comment Letter I; 
McIntyre Comment Letter II; SIFMA AMG Comment Letter.
    \492\ See FINRA Comment Letter; Gretz Comment Letter.
    \493\ See supra notes 394 and 395 and surrounding text.
---------------------------------------------------------------------------

d. Regulations on Deceptive Practices
    The final rules would help the Commission and the SROs to detect 
and deter abusive behaviors such as fraud or manipulation by subjecting 
significant liquidity providers to section 15(c) of the Exchange Act 
\494\ and to SRO rules and oversight.\495\ As described in section 
III.B.2, registering affected parties as dealers would subject them to 
Commission examinations and would expand the Commission's ability to 
issue specific rules and regulations designed to deter misbehavior 
under Exchange Act section 15(c). The persons whom the final rules 
would require to register would be those with the ability to 
significantly impact markets, whether in pursuit of legitimate trading 
strategies or possibly through market manipulation. Therefore, 
subjecting them--particularly the highly active but unregistered PTFs 
shown in Table 1--to the additional anti-fraud regulations that apply 
to registered dealers, as well as to additional regulatory oversight, 
would contribute to fair and orderly markets.
---------------------------------------------------------------------------

    \494\ See supra note 396.
    \495\ See supra notes 367-369.
---------------------------------------------------------------------------

e. Regulations Related to Examinations
    Registered dealers and government securities dealers are subject to 
examinations by the Commission and by the relevant SRO, and they are 
also required to comply with certain books and records 
requirements.\496\ PTFs that are not registered as dealers are not 
subject to examinations or to books and records rules, but registered 
private fund advisers are currently subject to recordkeeping 
requirements and Commission examinations. Examinations help regulators 
detect manipulative or fraudulent activities, as well as verify more 
generally that persons comply with all relevant

[[Page 14981]]

regulations. Books and records requirements facilitate examinations by 
ensuring that data entries are defined, recorded, and preserved in a 
consistent manner across all dealers. The final rules would allow 
regulators to examine firms that currently are not registered, 
including PTFs, who are not currently subject to examinations but whose 
activity contributes significantly to market liquidity or to price 
discovery. Since examinations help ensure compliance with other rules, 
and since the Commission already has authority to examine registered 
investment advisers, subjecting PTFs to examination would support the 
other benefits that would come from registering PTFs as dealers.
---------------------------------------------------------------------------

    \496\ Id.
---------------------------------------------------------------------------

    Examinations also help regulators analyze market disruptions and 
inform subsequent regulatory changes. Since the final rules will give 
regulators the ability to conduct targeted examinations of entities 
that provide substantial market liquidity and price formation, 
regulators will be able to better determine the causes of market 
disruptions and implement regulatory reforms designed to mitigate and 
prevent future similar disruptions.\497\ For instance, following the 
market disruptions caused by Knight Capital in 2012,\498\ FINRA 
conducted targeted examinations on member firms' HFT operations and 
then updated its guidance on supervision and control practices for 
algorithmic trading strategies.\499\ While FINRA oversight did not 
prevent Knight Capital's disruptions--Knight was a registered broker-
dealer--FINRA oversight did give the regulator authority to examine 
other firms engaged in activities similar to Knight and to inform its 
guidance.\500\
---------------------------------------------------------------------------

    \497\ The Commission currently can examine registered investment 
advisers and private funds, but it has no authority to examine PTFs 
who are not registered as dealers.
    \498\ On Aug. 1, 2012, an error in Knight Capital's trading 
software caused the firm to purchase $7 billion in equities in the 
first hour of trading, and the firm later tried to reverse some of 
the unintentional purchases. The buying and selling caused price 
volatility in approximately 150 different equities, and nearly 
bankrupting the firm. See Henrico Dolfing, ``Case Study 4: The $440 
Million Software Error at Knight Capital,'' available at https://www.henricodolfing.com/2019/06/project-failure-case-study-knight-capital.html. For FINRA's response, see Targeted Examination Letter 
on High Frequency Trading, FINRA, available at https://www.finra.org/rules-guidance/guidance/targeted-exam-letter/high-frequency-trading.
    \499\ See FINRA Regulatory Notice 15-09, available at https://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regulatory_15-09.pdf.
    \500\ Id. The notice states, in part, ``FINRA staff has 
conducted a number of examinations and investigations over the past 
several years that were prompted by the detection of systems-related 
issues at firms engaged in algorithmic strategies . . . As a result 
of these reviews and working with member firms engaged in 
algorithmic strategies, FINRA has developed the following list of 
suggested effective practices for such firms.''
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2. Costs
a. Compliance Costs
    The final rules will impose compliance costs on certain market 
participants, including costs of registering with the Commission and 
with an SRO, recordkeeping and reporting costs, direct costs that may 
stem from meeting net capital requirements (i.e., continuously 
monitoring capitalization), and self-evaluation as to whether one is a 
dealer or not.\501\ These potential compliance costs can be broadly 
organized into five categories:
---------------------------------------------------------------------------

    \501\ Registered dealers would be subject to requirements, such 
as Exchange Act Rules 15c3-1, 17 CFR 240.17a-1 (``Rule 17a-1''), 
17a-3, 17a-4, and 17 CFR 240.17a-5 (``Rule 17a-5'').
---------------------------------------------------------------------------

    1. Costs related to registration as a dealer or government 
securities dealer.
    2. Costs related to FINRA membership or membership with another 
SRO.
    3. Costs related to TRACE reporting for firms that trade fixed 
income securities.
    4. Costs related to CAT reporting for firms that trade NMS 
securities or OTC equities.
    5. Costs related to SIPC membership for firms that register as 
dealers under section 15(b) of the Exchange Act.
    The costs of registration as a dealer or government securities 
dealer will apply to all firms. Likewise, the cost of FINRA membership 
or membership with another SRO will apply to all firms. However, the 
costs of TRACE reporting will only apply to firms that trade fixed 
income securities. The costs of CAT reporting will only apply to firms 
that trade NMS securities, OTC equity securities, or options. The costs 
of SIPC membership will apply only to firms that register as dealers 
under section 15(b) of the Exchange Act and not firms that register as 
government securities dealers under section 15C of the Exchange Act.
    The Commission has itemized and updated its cost estimates for 
affected parties in response to commenters.\502\ The following 
subsections present itemized compliance cost estimates for affected 
parties that register as dealers under section 15(b) of the Exchange 
Act after the rules' adoption or register as government securities 
dealers under section 15C of the Exchange Act. The compliance cost 
estimates reported in the following subsections are reported on a per 
firm basis. Some compliance costs in the following subsections are 
approximately proportional to trading activity or revenue. For these 
compliance costs, we report both how these costs scale with trading 
activity or firm revenue, and quantitative estimates of these costs for 
the large firm sample from the Amended Rule 15b9-1 Adopting Release.
---------------------------------------------------------------------------

    \502\ The TRACE analysis identifies up to 22 PTFs, 4 hedge fund, 
4 entities classified as ``dealers'' (though they are not FINRA 
members and do not appear to be registered with the Commission), and 
1 entity classified as ``other.'' The Form PF analysis identifies 12 
hedge funds as the most likely to be affected. See supra note 418.
---------------------------------------------------------------------------

    The cost estimates in the following subsections are subject to 
several assumptions, uncertainties, and other factors. In particular, 
the cost estimates are for firms the Commission expects to register as 
dealers or government securities dealers because the firms meet either 
the expressing trading interest factor or the primary revenue factor in 
the final rule. Since estimates of the number of affected parties are 
subject to some uncertainty, the following cost estimates are subject 
to similar uncertainty and limitations.\503\ Other sources of 
uncertainty are discussed within individual subsections. Additionally, 
some firms may already own a registered dealer or government securities 
dealer. If an affected party already owns a registered dealer, then the 
party may choose to migrate operations satisfying the expressing 
trading interest factor or primary revenue factor into the registered 
dealer instead of registering additional entities as dealers. If an 
affected party chooses to migrate operations into an existing 
registered dealer after the rules' adoption, then its compliance costs 
will likely be less than the cost estimates reported in the following 
subsections. PTFs, since they do not have clients or customers, would 
bear the costs of registration and compliance themselves. Private 
funds, however, may either bear the costs themselves (i.e., the funds' 
investors would bear the cost) or the costs may be borne by their 
investment adviser.
---------------------------------------------------------------------------

    \503\ See, e.g., section III.B.2.c for a discussion of the 
affected entity estimates and uncertainty regarding the affected 
entity estimates.
---------------------------------------------------------------------------

i. Dealer Registration
    This section discusses the Commission's estimates of the costs 
associated with dealer registration under section 15(b) of the Exchange 
Act and government securities dealer registration under section 15C of 
the Exchange Act with the Commission for the final rules' affected 
parties. The Commission expects the costs of registration to be similar 
for dealer registration under section 15(b) and government securities 
dealer registration under section 15C because

[[Page 14982]]

of the registrations' similarity, e.g., both registrations require 
completing and amending Form BD, maintaining dealer-related policies 
and procedures, record-keeping, and filing annual reports.
    The Commission estimates the initial cost of the final rules for 
affected parties that register as dealers is approximately 
$700,000.\504\ The Commission estimates the cost of the final rules for 
parties that self-evaluate but do not register as dealers is 
approximately $60,000.\505\ The initial costs to register as a dealer 
with the Commission would include costs associated with filing Form BD, 
filing Form ID, any related legal or consulting costs that may be 
needed to ensure compliance with rules, including drafting policies and 
procedures as may be required, and an initial self-evaluation of the 
final rules' applicability to the affected party.\506\ If a firm has a 
large number of employees, has several lines of business, or relatively 
complicated trading operations, then the firm may incur greater 
expenses relative to other firms when registering as a dealer.\507\
---------------------------------------------------------------------------

    \504\ Exchange Act Release No. 76324 (Oct. 30, 2015), 80 FR 
71388, 71509 n.1487 (Nov. 16, 2015) (``Regulation Crowdfunding 
Adopting Release''), estimates the upper bound on the costs of 
registering as a broker-dealer and complying with associated 
regulations would be $500,000. Most of these costs involve personnel 
hours and legal services. Since the cost of legal services and 
nominal wages paid to administrative and financial operations 
employees have approximately risen with the consumer price index 
since 2015, we adjust these estimates for inflation of 27.31% 
between Oct. 2015 and May 2023, based on the CPI-U as recorded by 
the Bureau of Labor Statistics (see U.S. Bureau of Labor Statistics, 
Consumer Price Index, available at https://www.bls.gov/cpi/data.htm). $500,000 x 1.2731 = $636,550. We add an additional 
$60,000 self-evaluation cost suggested by commenters discussed in 
infra note 517. $636,550 + $60,000 = $696,550. We round this figure 
to $700,000 to reflect uncertainty in our estimate. As in previous 
releases, this is an estimated upper bound on the range of 
registration costs incurred by broker-dealers; it is possible that 
certain affected parties--for example, smaller firms with relatively 
simple trading operations--could incur lower registration costs.
    \505\ See infra note 517 for the calculation of the $60,000 
self-evaluation cost.
    \506\ See section III.B.1 for a detailed description of the 
filings and regulations associated with dealer registration and 
maintaining dealer registration.
    \507\ See Regulation Crowdfunding Adopting Release.
---------------------------------------------------------------------------

    The Commission estimates the ongoing cost of registering with the 
Commission as a dealer is approximately $600,000.\508\ The Commission's 
estimate of the annual cost for an affected party to maintain its 
status as a registered dealer includes several items: filing form BD 
amendments, risk management system maintenance, information collection, 
information storage, financial reporting, audits by an independent 
PCAOB-registered accounting firm, and claiming an exemption from 
treatment as a dealer pursuant to 17 CFR 240.15c3-3 (``Rule 15c3-
3'').\509\
---------------------------------------------------------------------------

    \508\ The Regulation Crowdfunding Adopting Release estimated the 
ongoing cost of broker-dealer registration with the Commission is 
approximately $230,000. Most of these costs involve personnel hours 
and legal services, so we adjust this cost estimate for inflation by 
a factor of 1.2731. The inflation adjusted cost estimate is $230,000 
x 1.2731 = $292,831. We add a $300,000 estimate for the cost of an 
annual audit by an independent PCAOB-registered account firm to this 
figure to construct the final cost estimate. See Private Fund 
Advisers; Documentation of Registered Investment Adviser Compliance 
Reviews, Investment Advisers Act Release No. 6383 (Aug. 2023), 88 FR 
63206 (Sept. 14, 2023) (``Registered Investment Adviser Compliance 
Reviews Adopted Rule''). $292,831 + $300,000 = $592,831. We round 
$592,831 to the nearest hundred thousand to reflect uncertainty in 
the cost estimate. We have added an additional auditing expense to 
the Commission's revised cost estimates in response to comment 
letters that stated that the original expense estimates for broker-
dealer registration were underestimated because they omitted 
compliance, clerical, and accounting related costs associated with 
preparing and verifying financial statements required to comply with 
broker-dealer related regulations. See, e.g., AlphaWorks Comment 
Letter; AIMA Comment Letter II; Citadel Comment Letter; Fried Frank 
Comment Letter.
    \509\ See the Proposed Rule for estimates of labor hour 
requirements for completing tasks associated with ongoing broker-
dealer registration-related expenses and filing related fees. The 
hourly wage rates are based on: (1) SIFMA's Management & 
Professional Earnings in Securities Industry 2013, modified by SEC 
staff to account for an 1,800-hour work-year and inflation, and 
multiplied by 5.35 to account for bonuses, firm size, employee 
benefits, and overhead; and (2) SIFMA's Office Salaries in the 
Securities Industry 2013, modified by SEC staff to account for an 
1,800-hour work-year and inflation, and multiplied by 2.93 to 
account for bonuses, firm size, employee benefits, and overhead. The 
final estimates are based on the preceding SIFMA data sets, which 
SEC staff have updated since the Proposing Release to account for 
current inflation rates.
---------------------------------------------------------------------------

    A dealer registered under section 15(b) of the Exchange Act is 
subject to the compliance requirements of the customer protection rule, 
Rule 15c3-3, unless the dealer's operations satisfy certain criteria 
that exempt the dealer from the rule.\510\ The Commission believes that 
the affected parties would generally claim they are exempt from Rule 
15c3-3 because they do not carry brokerage accounts for customers.\511\ 
If an affected party does not claim an exemption, then the affected 
party may incur additional costs to comply with Rule 15c3-3. Several 
commenters suggested that dealers registered under the final rules 
would lose protections under Rule 15c3-3.\512\ However, we do not 
believe the final rules will significantly impact registered dealers 
with respect to the customer protection rule. In particular, Rule 15c3-
3 requires a carrying broker-dealer to take steps to protect both 
customer accounts and also proprietary accounts of other brokers or 
dealers (``PAB Accounts''). Therefore, a registered dealer that holds 
accounts at another broker-dealer would benefit from the protections 
for PAB Accounts under Rule 15c3-3.\513\
---------------------------------------------------------------------------

    \510\ See Rule 15c3-3(k).
    \511\ See section IV.A.8.
    \512\ See, e.g., AIMA Comment Letter II; AIMA Comment Letter 
III; BlackRock Comment Letter; Citadel Comment Letter at 5; 
Committee on Capital Markets Comment Letter; Lewis Study; Element 
Comment Letter; Fried Frank Comment Letter; Hagerty-Hill Comment 
Letter; MFA Comment Letter I; NAPFM Comment Letter; Two Sigma 
Comment Letter.
    \513\ See Rule 15c3-3(e) (requiring carrying broker-dealers to 
maintain a special reserve bank account for brokers and dealers, 
which must be separate from any other bank account of the carrying 
broker-dealer).
---------------------------------------------------------------------------

    The initial and ongoing compliance costs include financial 
reporting, recording keeping, and net capital requirement compliance 
operations. The costs associated with the reporting, record keeping, 
and net capital requirements of dealer registration will depend on the 
scope of the firm's dealer activities, capital structure, existing 
compliance-related activity, and jurisdiction. If a firm trades 
securities belonging to several different asset classes, then the firm 
may incur greater dealer related compliance costs because different 
types of securities are subject to different reporting, record keeping, 
and net capital requirements.\514\ If a firm is already a registered 
investment adviser or affiliated with an investment adviser, then the 
firm may incur fewer dealer related compliance costs because the firm 
has prior experience implementing and maintaining compliance-related 
operations.\515\ Firms already conducting reporting and recordkeeping 
related activities for compliance purposes may incur somewhat lower 
costs because these firms have already established recordkeeping 
practices, internal controls, and related business processes. For 
example, if some of a private fund adviser's existing compliance-
related records, internal controls, and other processes overlap with 
dealer compliance requirements, then the private fund might use its 
adviser's existing compliance infrastructure to satisfy dealer related 
compliance requirements. However, these potential cost reductions are 
limited only to situations where a private fund's existing compliance 
operations can be re-used to comply with dealer requirements.
---------------------------------------------------------------------------

    \514\ Regulation ATS Proposal at 15629.
    \515\ Id.

---------------------------------------------------------------------------

[[Page 14983]]

    An additional compliance cost of the rules is the cost of self-
evaluation.\516\ The self-evaluation cost applies to firms whose 
trading operations may satisfy the final rules' expressing trading 
interest factor or primary revenue factor. The Commission estimates the 
initial costs of self-evaluation for one firm will add up to 
approximately $60,000.\517\ This expense includes costs incurred by a 
firm to determine whether the firm should register as a dealer 
following the final rules' adoption from an initial review of the 
firm's trading operations through the potential preparation of an 
opinion letter by outside counsel stating the firm does not need to 
register as a dealer. The self-evaluation process may begin with a 
review of a firm's trading operations by internal personnel or 
consultants to assess a firm's likelihood of satisfying the expressing 
trading interest factor or primary revenue factor. If a firm finds its 
trading operations are very unlikely to meet either criteria, then the 
firm may conclude its self-evaluation after this initial review at a 
cost much less than the $60,000 estimate.\518\
---------------------------------------------------------------------------

    \516\ See Blockchain Association Comment Letter II; AIMA Comment 
Letter II; HFA Comment Letter; Morgan Lewis Comment Letter; NAPFM 
Comment Letter; SIFMA Comment Letter I; SIFMA Comment Letter II; 
Schulte Roth Comment Letter.
    \517\ The Regulation Crowdfunding Adopting Release estimated a 
lower bound on the cost of registration as a broker-dealer with the 
SEC is $50,000. See Regulation Crowdfunding Adopting Release at 
71509 n.1487. We use this lower bound to approximate the cost of the 
self-evaluation process, including, if necessary, the use of outside 
consultants and legal counsel to evaluate a firm's trading 
operations and the possible preparation of an opinion letter stating 
a firm does not need to register as a dealer to comply with the 
final rule. Because the cost of consulting and legal services has 
approximately risen with the consumer price index since 2015, we 
adjust this estimate for inflation of 27.31% between Oct. 2015 and 
May 2023, based on the CPI-U as recorded by the Bureau of Labor 
Statistics. See Consumer Price Index, U.S. Bureau of Labor 
Statistics, available at https://www.bls.gov/cpi/data.htm. The 
inflation adjusted cost of the opinion letter is $63,655.46 = 
$50,000 x 1.2731. We round this figure to $60,000 to the nearest ten 
thousand to reflect uncertainty in our estimate of the cost of the 
opinion letter.
    \518\ See supra note 517 for the calculation of the $60,000 
cost.
---------------------------------------------------------------------------

    If a firm finds its trading operations might satisfy the criteria 
for the trading interest factor or primary revenue factor, then the 
firm will likely hire legal counsel to conduct an independent review of 
a firm's trading operations. The review will produce one of two 
outcomes. The first possible outcome is the preparation of an opinion 
letter stating that the legal counsel believes a firm's trading 
operations do not satisfy the trading interest or primary revenue 
factors and therefore the firm does not need to register as a dealer. 
The second possible outcome is that the external legal counsel finds 
that the firm should register as a dealer following the final rules' 
adoption, in which case the firm will not incur the costs associated 
with the preparation of an opinion letter.
    The Commission is unable to provide quantitative estimates of the 
number of firms that would incur the cost of self-evaluation but 
determine they are not required to register. The Commission is unable 
to provide a quantitative estimate because of the same data limitations 
that constrain the Commission's ability to estimate the number of firms 
that will ultimately register as dealers.\519\ Our analyses observe 
several entities whose activities may constitute dealing according to 
the final rules.\520\ However, the lack of transparency in TRACE 
conceals the identities of other non-FINRA entities that may also be 
dealing or near enough to dealing to require careful self-
evaluation.\521\ In addition, some firms engaged in HFT activity as 
reported on Form PF may determine that they do not meet the final 
rules' qualitative factors. It is also possible, though unlikely, that 
some hedge fund activity that is not reported as HFT may nevertheless 
be dealing or near enough to dealing to require self-evaluation. 
Because of the limitations of TRACE data, we are unable to estimate the 
number of entities that would need to self-evaluate. As discussed 
above, section I.B explains modifications made to the rules that tailor 
the scope of the final rules. These changes largely respond to 
commenters' concerns regarding the number of affected parties by 
narrowing the scope of the final rules in a way that reduces that 
number. These changes would likewise reduce the number of firms that 
would incur the cost of self-evaluation.
---------------------------------------------------------------------------

    \519\ See section III.B.2.c.
    \520\ Id.
    \521\ See supra notes 380 and 422 and surrounding discussion.
---------------------------------------------------------------------------

ii. FINRA or Other SRO Membership
    Affected parties that register as dealers after the final rules' 
adoption must become members of FINRA or another appropriate SRO.\522\ 
The Commission expects affected parties who choose to register as 
government securities dealers to become members of FINRA.\523\
---------------------------------------------------------------------------

    \522\ The Commission has revised its estimate of affected firms' 
FINRA-related costs in response to comment letters. See, e.g., 
Citadel Comment Letter; Fried Frank Comment Letter; Overdahl Comment 
Letter; MFA Comment Letter II; Morgan Lewis Comment Letter; NAPFM 
Comment Letter; Virtu Comment Letter.
    \523\ See supra note 23.
---------------------------------------------------------------------------

    The initial costs for an affected party to become a member of FINRA 
are composed of FINRA membership application fees and any legal or 
consulting costs necessary for an affected party to complete the FINRA 
membership application and comply with FINRA rules.\524\ Table 5 
summarizes the initial costs associated with FINRA membership for an 
affected firm. The small firm column in Table 5 reports initial costs 
for FINRA membership for a firm with one to ten registered employees. 
The large firm column in Table 5 reports initial costs for FINRA 
membership for a firm with 101-150 employees.
---------------------------------------------------------------------------

    \524\ Initial and ongoing cost estimates associated with FINRA 
membership are from section V.C.2 of Amended Rule 15b9-1 Adopting 
Release.

     Table 5--Initial Cost of FINRA Membership in Dollars per Firm *
------------------------------------------------------------------------
                                                      Small      Large
                       Cost                            firm       firm
------------------------------------------------------------------------
Application.......................................     $7,500    $20,000
Consulting........................................     40,000    125,000
                                                   ---------------------
    Total **......................................     50,000    150,000
------------------------------------------------------------------------
* Cost estimates are from the Amended Rule 15b9-1 Adopting Release. A
  small firm has 1-10 registered employees. A large firm has 101-150
  registered employees.
** Totals are rounded to the nearest ten thousand to reflect uncertainty
  in the cost estimates.

    The fees associated with a FINRA membership application can 
vary.\525\ The application fee itself depends on the number of 
registered persons associated with the affected party. If an affected 
party employs ten or fewer registered persons, then the application fee 
is $7,500. For an affected party with 11 to 100 registered persons the 
application fee is $12,5000. The application fee is $20,000 for an 
affected party affiliated with 101 to 150 registered persons.\526\
---------------------------------------------------------------------------

    \525\ The application fee ranges from $7,500 for a small new 
member applicant (i.e., 1-10 employees, Tier 1) to $55,000 for a 
large new member applicant (i.e., 5,000+ employees, Tier 3). See 
FINRA, Schedule of Registration and Exam Fees, available at https://www.finra.org/registration-exams-ce/classic-crd/fee-schedule.
    \526\ See FINRA, Schedule of Registration and Exam Fees, 
available at https://www.finra.org/registration-exams-ce/classic-crd/fee-schedule, for application fees when an applicant has more 
than 150 registered persons.
---------------------------------------------------------------------------

    The other initial cost associated with FINRA membership is a 
consulting expense, which accounts for the legal and other advisory 
work necessary for an affected party to successfully complete a FINRA 
membership application. Some affected parties may decide to perform 
this work internally, while others may use outside counsel. When making 
this choice, an affected party will likely consider factors, such as 
the size and resources of the affected party, the complexity of the 
affected

[[Page 14984]]

party's trading operations, and the affected party's previous use of 
outside counsel. The Commission's estimate of these consulting costs 
ranges from $40,000 to $125,000 with a midpoint of $82,500.\527\ 
Additionally, if an affected party is affiliated with a firm that is 
already a registered member of FINRA and the affiliated firm retains 
legal personnel with FINRA-related experience, then the affected party 
may incur fewer expenses during the FINRA membership application 
process because the affiliated firm's legal staff may provide services 
at a lower cost than a third party.
---------------------------------------------------------------------------

    \527\ See Amended Rule 15b9-1 Adopting Release section V.C.2 for 
the consulting cost estimates and methodology.
---------------------------------------------------------------------------

    Affected parties will incur ongoing annual costs to maintain FINRA 
membership after completing their initial application. The ongoing 
annual costs include the Gross Income Assessment (``GIA''), the Trading 
Activity Fee (``TAF''), the FINRA section 3 fee, FINRA-related 
compliance activities, and the personnel assessment. Table 6 summarizes 
these ongoing annual expenses for the final rules' affected parties. 
The Commission estimates that the ongoing annual cost of FINRA 
membership for an affected entity will range from approximately $61,000 
for a relatively small firm to $1,130,000 for a relatively large firm. 
We will discuss each of these costs and our estimates below.

     Table 6--Ongoing Cost of FINRA Membership in Dollars per Firm *
------------------------------------------------------------------------
                                                      Small      Large
                       Cost                            firm       firm
------------------------------------------------------------------------
Trading Activity Fee **...........................     $7,000   $120,000
Gross Income Assessment...........................     30,000    330,000
Section 3 Fee.....................................      3,000    560,000
Compliance Activities.............................     20,000    100,000
Personnel Assessment..............................      1,000     20,000
                                                   ---------------------
  Total ***.......................................     61,000  1,130,000
------------------------------------------------------------------------
* Cost estimates are from the Amended Rule 15b9-1 Adopting Release. A
  small firm has 1-10 registered employees. A large firm has 101-150
  registered employees.
** FINRA recently implemented an amendment to TAF that exempts PTFs
  belonging to FINRA from TAF for trades on exchanges of which the firm
  is a member. This may cause affected parties to incur lower TAF fees
  than those reported in the table.
*** Totals are rounded to the nearest thousand to reflect uncertainty in
  the cost estimates.

    The Commission estimates the TAF cost for an affected party 
registering as a dealer following the final rules' adoption will range 
from approximately $7,000 for a small firm conducting few trades in 
securities subject to TAF to $120,000 for a large firm conducting many 
trades subject to TAF.\528\
---------------------------------------------------------------------------

    \528\ The small firm TAF estimate corresponds to the $6,746.92 
median annual TAF for the 64 non-FINRA member firms in the Amended 
Rule 15b9-1 Adopting Release. The large firm TAF estimate 
corresponds to the $119,255.85 median annual TAF for the 12 largest 
non-FINRA member firms. We round both figures to the nearest 
thousand to reflect uncertainty in the estimates. We use data from 
the Amended Rule 15b9-1 Adopting Release to estimate FINRA costs for 
affected firms because the Commission does not observe the financial 
or trading data necessary to directly calculate the TAF or GIA costs 
associated with FINRA membership for firms affected by these rules.
---------------------------------------------------------------------------

    The TAF is a transaction-based fee that is usually assessed on 
member firm transactions in covered equity securities, options, 
security futures, TRACE-eligible bonds, and asset-backed 
securities.\529\ Table 7 summarizes the fees associated with specific 
classes of securities under TAF.\530\ Most security fees assessed via 
TAF are subject to one or more conditions and one or more possible 
exemptions. The covered equity security fee, TRACE-eligible bond fee, 
and asset-backed security fee are subject to maximum fees per trade. 
The security future fee is subject to a minimum fee per trade. Some 
transactions are exempt from TAF, which may reduce firms' TAF related 
expenses.\531\ Potentially relevant exemptions from TAF for firms 
registering under the rules include transactions in U.S. Treasury 
securities, transactions in options and futures involving narrow and 
broad indices, transactions made by a firm in their capacity as a 
market specialist or market maker, and transactions executed outside 
the United States not requiring reporting to a transaction reporting 
association. Additionally, a recently implemented TAF Amendment exempts 
PTFs from TAF for trades occurring on exchanges of which the firm is a 
member.\532\ If the firms joining FINRA because of the final rules 
execute trades that qualify for exemption from TAF under the recent TAF 
amendment, then the firms' TAF-related expenses may be less than our 
TAF cost estimates.
---------------------------------------------------------------------------

    \529\ We have revised our TAF cost estimates in response to 
comment letters. See Blockchain Association Comment Letter; Overdahl 
Comment Letter. See also FINRA, Trading Activity Fee, available at 
https://www.finra.org/rules-guidance/guidance/trading-activity-fee.
    \530\ See FINRA, Schedule A to the By-Laws of the Corporation, 
Section 1--Member Regulatory Fees (footnote on Trading Activity Fee 
rates), available at https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-1-member-regulatory-fees.
    \531\ See id., section 1(b)(2) (transactions exempt from the 
Trading Activity Fee).
    \532\ See Self-Regulatory Organizations; Financial Industry 
Regulatory Authority, Inc.; Notice of Filing and Immediate 
Effectiveness of a Proposed Rule Change To Amend FINRA's Trading 
Activity Fee, Exchange Act Release No. 97798 (June 26, 2023), 88 FR 
42404 (June 30, 2023), available at https://www.govinfo.gov/content/pkg/FR-2023-06-30/pdf/2023-13894.pdf.

Table 7--Trading Activity Fee Rates for Specific Securities in Dollars *
------------------------------------------------------------------------
            Security                      Fee                Rate
------------------------------------------------------------------------
Covered Equity Security.........  0.000166..........  per share sale.**
Option..........................  0.00279...........  per option sale.
Security Future.................  0.00011...........  per round turn
                                                       transaction.***
TRACE-eligible bond.............  0.00105...........  per bond sale.****
Asset-Backed Security...........  sale price x        per security
                                   0.00000105.         sale.****
------------------------------------------------------------------------
* FINRA recently implemented an amendment to TAF that exempts PTFs
  belonging to FINRA from TAF for trades on exchanges of which the firm
  is a member. Additionally, FINRA is currently implementing annual
  increases in its TAF rates until 2024. This table reports the fees
  that will be in effect for 2024 and future years.
** Up to $7.27 per trade.
*** Minimum charge is $0.012 per round turn transaction.
**** Up to $0.92 per trade.

    The GIA is an annual expense determined by a firm's annual gross 
revenue, which is defined as a firm's total income as reported on FOCUS 
form Part II or Part IIA excluding commodities income.\533\ We estimate

[[Page 14985]]

the annual GIA for an affected party joining FINRA after the final 
rules' adoption will range from approximately $30,000 for a small firm 
with relatively little annual gross revenue to $330,000 for a large 
firm with a relatively large annual gross revenue.\534\ Since FOCUS 
forms are not available for the final rules' affected parties, we use 
GIA estimates from Amended Rule 15b9-1 to estimate the affected 
parties' GIA.\535\
---------------------------------------------------------------------------

    \533\ We are adding GIA to our estimate of the rules' cost for 
an effected firm in response comment letters. See Blockchain 
Association Comment Letter; Overdahl Comment Letter. For the 
definition of gross revenue, see FINRA, Schedule A to the By-Laws of 
the Corporation, Section 2--Gross Revenue for Assessment Purposes, 
available at https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-2-gross-revenue-assessment-purposes.
    \534\ The small firm GIA estimate corresponds to the $33,655.65 
median GIA estimate for the 64 non-member firms from the Amended 
Rule 15b9-1 Adopting Release. The large firm GIA estimate 
corresponds to the $327,870 median GIA estimate for the 12 largest 
non-member firms from the Amended Rule 15b9-1 Adopting Release. We 
round both figures to the nearest ten thousand to reflect 
uncertainty in the estimates.
    \535\ See supra note 533.
---------------------------------------------------------------------------

    A firm's GIA is the greater of the expense calculated per the 
schedule in Table 8 below or the firm's average GIA over the previous 
three years. Table 8 reports the schedule used to calculate a firm's 
GIA given its gross revenue. The table reports the assessment for the 
portion of a firm's gross revenue within a given range. For instance, 
suppose a firm's gross revenue is $100M. The firm's Gross Income 
Assessment is $172,293. This assessment is the sum of the following 
items: The firm owes $1,200 on its first million dollars of gross 
revenue. The firm owes an additional $41,568 = ($24M x 0.1732%) on its 
gross revenue between $1M and $25M. The firm also owes $92,625 = ($25M 
x 0.3705%) on its gross revenue between $25M and $50M. And the firm 
owes $36,900 = ($50M x 0.0738%) on its gross revenue between $50M and 
$100M.

                   Table 8--Gross Income Assessment *
------------------------------------------------------------------------
                     Gross income range                          Cost
------------------------------------------------------------------------
$0 to $1M...................................................      $1,200
$1M to $25M.................................................     0.1732%
$25M to $50M................................................     0.3705%
$50M to $100M...............................................     0.0738%
$100M to $5B................................................     0.0520%
$5B to $25B.................................................     0.0566%
$25B or more................................................     0.1219%
------------------------------------------------------------------------
* FINRA is currently implementing annual increases in the rates for its
  Gross Income Assessment until 2024. This table reports the rates that
  will be in effect for 2024 and future years.

    FINRA charges an annual personnel assessment of $210 for each of 
the first five registered representatives at a firm, $200 for each of 
the sixth through 25th registered representatives at a firm, and $190 
for each of the 26th and subsequent representatives at a firm.\536\ 
Registered individuals include salespersons, branch managers, 
department supervisors, partners, officers, and directors involved in a 
firm's securities business.\537\ The Commission does not have the 
information necessary to estimate the personnel fees the affected 
parties will likely incur to maintain FINRA membership.\538\ Table 6 
reports personnel fees for the midpoints of a small firm with 1-10 
registered employees and a large firm with 101-150 registered 
employees.\539\ The personnel fee estimate for a small firm is $1,000. 
The personnel fee estimate for a large firm is $20,000.
---------------------------------------------------------------------------

    \536\ For the personnel assessment, see FINRA Fee Increase 
Schedule, available at https://www.finra.org/rules-guidance/rule-filings/sr-finra-2020-032/fee-increase-schedule.
    \537\ See FINRA, Individual Registration, available at https://www.finra.org/registration-exams-ce/individuals.
    \538\ See section III.B.2 for a discussion of the data 
limitations associated with the Commission's estimates of the final 
rules' affected parties.
    \539\ For a small firm with 1-10 registered employees the 
midpoint is 5 employees. 5 x $210 = $1,050. We round $1,050 to the 
nearest thousand to reflect uncertainty in our cost estimate. For a 
large firm with 101-150 employees the midpoint is 125 employees. 5 x 
$210 + 25 x $200 + 95 x $190 = $24,100. We round $24,100 to the 
nearest ten thousand ($20,000) to reflect uncertainty in our 
estimate.
---------------------------------------------------------------------------

    FINRA also charges an annual branch office fee of $75 for each 
office, excluding one office, operated by a firm and registered by 
FINRA.\540\
---------------------------------------------------------------------------

    \540\ See FINRA, Schedule A to the By-Laws of the Corporation, 
Section 4--Fees, available at https://www.finra.org/rules-guidance/rulebooks/corporate-organization/section-4-fees.
---------------------------------------------------------------------------

    Finally, registered dealers are subject to an annual renewal fee 
that applies for each SRO or jurisdiction where the dealer is 
registered. Renewal fees vary by SRO and jurisdiction, as well as by 
the number of registered representatives and branch offices at a 
dealer. Given our estimate that entities that register as a result of 
the final rules will not have registered representatives or branch 
offices, we focus on the fee that applies at the level of the dealer. 
At the jurisdiction level, renewal fees range between $40 and $600, 
depending on the state, with most between $250 and $300. If the newly 
registered dealer chooses to also register with another SRO, renewal 
fees range between $0 and $10,000, depending on the SRO.\541\ We assume 
that the final rules would require membership at only one SRO.
---------------------------------------------------------------------------

    \541\ See FINRA, SRO/Jurisdiction Fee and Setting Schedule, 
available at https://www.finra.org/sites/default/files/srojurisdiction-fee-and-setting-schedule.pdf.
---------------------------------------------------------------------------

    The discussion above may overstate the final rules' costs to 
affected firms to the extent that already registered broker-dealers 
pass regulatory costs through to the affected firms. For example, the 
Commission understands that FINRA member brokers and dealers can pass 
at least some of the burden of regulatory costs including the TAF to 
their customers, so that the parties who will be affected by the final 
rules may already bear these costs indirectly to the extent that they 
trade with FINRA members. If the affected party were to register as a 
dealer and become a FINRA member, some of the regulatory costs incurred 
by its trading partners may fall. For instance, when a PTF who is not a 
broker-dealer places a sell order on an ATS and matches with a FINRA 
member broker-dealer, the TAF is assessed on the FINRA member executing 
the cross.\542\ However, if the PTF were a FINRA member, then it would 
bear the TAF costs directly and the other member executing the cross 
would not, because the TAF is assessed on the selling FINRA member 
broker-dealer.
---------------------------------------------------------------------------

    \542\ See FINRA, Trading Activity Fee Frequently Asked 
Questions, available at https://www.finra.org/rules-guidance/guidance/faqs/trading-activity-fee.
---------------------------------------------------------------------------

iii. TRACE Reporting
    Firms joining FINRA will also incur the costs of reporting their 
fixed-income transactions (other than municipal securities) to 
TRACE.\543\ We estimate that the initial implementation cost associated 
with TRACE reporting is $2,000 and that the ongoing annual cost 
associated with TRACE reporting $100,000.\544\ Firms that do not trade 
fixed-income securities will not incur TRACE reporting costs. In 
addition, FINRA Rule 7730(b) excludes transactions in U.S. Treasury 
securities from the TRACE transaction reporting fees.
---------------------------------------------------------------------------

    \543\ TRACE fees include system fees of between $20 and $260 per 
month plus transaction reporting fees, which are one of: (i) $0.475 
per trade for trades with par value up to $200,000, (ii) $2.375 per 
million dollars par value for trades with par value more than 
$200,000 but less than $1 million, or (iii) $2.375 per trade for 
trades with par value of at least $1 million or $1.50 per trade for 
agency pass-through MBS that are traded TBA or SBA-backed ABS that 
are traded TBA. See FINRA Rule 7730 (Trade Reporting and Compliance 
Engine), available at https://www.finra.org/rules-guidance/rulebooks/finra-rules/7730.
    \544\ See Amended Rule 15b9-1 Adopting Release, Tables 5 and 6. 
We have rounded the implementation cost estimate and ongoing annual 
cost estimate to reflect uncertainty in the estimates.
---------------------------------------------------------------------------

iv. Consolidated Audit Trail Reporting
    In this section, we estimate costs from CAT-related reporting, 
should an affected party trade CAT-eligible securities. However, the 
Commission believes few, if any, of the 43 potentially affected parties 
identified in section III.B.2.c will incur CAT-related reporting costs. 
If an affected party does

[[Page 14986]]

not trade NMS stocks, OTC equities, or listed options, then the 
affected party will not incur CAT-related reporting costs because the 
affected party does not trade securities that must be reported to CAT. 
For instance, if an affected party that only trades government 
securities only registers as a government securities dealer under 
section 15C, then that affected party will not incur CAT-reporting 
related expenses because it will not trade securities associated with 
CAT-reporting obligations. Affected parties that newly register as 
dealers under section 15(b) and trade NMS stocks, OTC equities, or 
listed options will incur the cost of reporting their transactions in 
these securities to CAT.\545\
---------------------------------------------------------------------------

    \545\ See Exchange Act Release No. 79318 (Nov. 15, 2016), 81 FR 
84696 (Nov. 23, 2016) (``CAT NMS Plan Approval Order''), for 
additional information about CAT. We note that the Commission 
recently approved the CAT Funding Plan. See Securities Exchange Act 
Release No. 98290 (Sept. 6, 2023), 88 FR 62628 (Sept. 12, 2023) 
(``CAT Funding Plan'') for additional information about the CAT 
Funding Plan.
---------------------------------------------------------------------------

    The Commission estimates the initial cost of CAT reporting for an 
affected party that trades CAT-reportable securities will range from a 
lower value of approximately $1,100,000 for a small firm with 
relatively few reportable trades to an upper value of approximately 
$4,900,000 for a large firm with many reportable trades. Our estimates 
for the initial costs of CAT compliance for an affected party 
registered as a dealer and trading CAT-reportable securities are based 
on inflation-adjusted cost estimates from the CAT NMS Plan Approval 
Order.\546\
---------------------------------------------------------------------------

    \546\ See section V.F of the CAT NMS Plan Approval Order for 
information about the construction of the estimates of CAT reporting 
for different types of firms. See supra note 504 for information 
about the sources for the inflation adjustments. The inflation 
factor for CAT-related costs is 1.25 = 303 (May 2023 CPI-U)/238 
(Nov. 2016 CPI-U) after rounding to the nearest hundredths place. 
The lower value estimate is the inflation adjusted initial 
implementation cost for an options floor broker from Table 4 of the 
CAT NMS Plan Approval Order. $848,700 (Implementation cost for one 
options floor broker) x 1.25 = $1,062,487.53. We round this value to 
the nearest $100,000 to reflect uncertainty in our cost estimate. 
The upper value estimate is the inflation adjusted initial 
implementation cost for an electronic liquidity provider in Table 4 
of the CAT NMS Plan Approval Order. $3,875,517 (Implementation cost 
for one electronic liquidity provider) x 1.25 = $4,851,760. We round 
this figure to the nearest $100,000 to reflect uncertainty in our 
cost estimate. We use an options floor broker and an electronic 
liquidity provider to estimate the range of CAT costs for the 
affected parties because both types of firms' primary business is 
liquidity provision and both types of firms do not carry customer 
accounts.
---------------------------------------------------------------------------

    The Commission estimates the ongoing cost of CAT reporting for an 
affected party that trades CAT-reportable securities will range from a 
lower value of approximately $600,000 annually for a small firm with 
relatively few CAT-related trades to an upper value of approximately 
$4,000,000 annually for a relatively large firm reporting many trades 
to CAT. The Commission's estimates for the annual costs of CAT 
compliance of an affected party registered as a dealer and trading CAT-
reportable securities are based on inflation-adjusted cost estimates 
from the CAT NMS Plan Approval Order.\547\
---------------------------------------------------------------------------

    \547\ See supra note 546 for a discussion of the inflation 
adjustments used for the initial and ongoing CAT reporting costs. 
The lower value estimate is the inflation adjusted ongoing cost for 
an options floor broker from Table 4 of the CAT NMS Plan Approval 
Order. $442,625 (Ongoing cost for one options floor broker) x 1.25 = 
$554,122. We round this value to the nearest $100,000 to reflect 
uncertainty in our ongoing cost estimate. The upper value estimate 
is the inflation adjusted ongoing cost for an electronic liquidity 
provider in Table 4 of the CAT NMS Plan Approval Order. $3,22,5714 
(Ongoing cost for one electronic liquidity provider) x 1.25 = 
$4,038,271. We round this figure to the nearest $100,000 to reflect 
uncertainty in our ongoing cost estimate.
---------------------------------------------------------------------------

    CAT reporting costs also vary depending on security type, order 
size, and trading venue, among other factors.\548\ An affected party 
that trades more types of securities, that trades a greater variety of 
order sizes, or that trades at more venues will see higher CAT-related 
expenses. Affected parties that have a smaller number of registered 
persons, that conduct less brokerage activity, or that trade smaller 
volumes of securities will see lower CAT-related reporting costs. 
Affected parties that only trade U.S. Government securities will not 
incur CAT-related reporting costs because government securities are not 
CAT-reportable securities.
---------------------------------------------------------------------------

    \548\ See CAT NMS Plan Approval Order section V.F for a 
discussion of how CAT reporting costs may vary across firms.
---------------------------------------------------------------------------

    In addition to the costs for reporting data to CAT, affected 
parties that register as dealers and trade NMS stocks, OTC equities, or 
listed options may be assessed CAT fees under the CAT Funding 
Plan.\549\ These CAT fees would depend on the extent to which an 
affected party is the executing broker-dealer for its transactions 
reported to CAT and the type of securities involved in its transactions 
reported to CAT.\550\ The Commission cannot estimate the magnitude of 
these costs because the amounts of the CAT fees to be charged to 
broker-dealers pursuant to the funding model must be established 
through rule filings pursuant to section 19(b) of the Exchange 
Act.\551\ However, the CAT fees allocated in accordance with the 
funding model borne by the affected parties are not a new cost to 
industry, but at least partially represent a transfer of costs from 
current broker-dealers with CAT reporting responsibilities, who would 
have higher CAT fees in the absence of the final rules, to affected 
parties. Furthermore, the Commission believes that other broker-dealers 
with CAT reporting responsibilities or CAT NMS Plan participants that 
have previously reported data related to the orders of affected parties 
to CAT would have likely passed on such costs to the affected parties 
in the absence of the amendments because the affected parties are 
customers of existing broker-dealers with CAT reporting obligations.
---------------------------------------------------------------------------

    \549\ The CAT NMS Plan requires both the Participants and 
broker-dealers to fund CAT. The CAT NMS Plan includes a funding 
model that sets for the methodology for allocating fees to recover 
those costs, including certain costs previously paid by the 
Participants, among the Participants and broker-dealers. See CAT 
Funding Plan. Specifically, the CAT NMS Plan sets forth a one-third 
allocation of CAT fees to the applicable Participant in a 
transaction, to the CAT Executing Broker for the buyer in a 
transaction, and to the CAT Executing Broker for the seller in a 
transaction. See CAT NMS Plan Approval Order Section 11.3.
    \550\ See CAT Funding Plan Section III.3 for the CAT fees 
associated with NMS stocks, OTC equities, and listed options.
    \551\ Such filings have been filed and noticed but are not 
effective because the Commission temporarily suspended them and 
instituted proceedings to determine whether to approve or disapprove 
the proposed rule changes. For example, on Jan. 3, 2024, New York 
Stock Exchange LLC filed a proposed rule change to establish fees on 
behalf of CAT LLC for broker-dealers relating to certain historical 
costs. On Jan. 17, 2024, pursuant to section 19(b)(3)(C) of the 
Exchange Act, the Commission temporarily suspended the rule change 
and instituted proceedings to determine whether to approve or 
disapprove the proposed rule change. See Self-Regulatory 
Organizations; New York Stock Exchange LLC; Notice of Filing of a 
Proposed Rule Change to Amend the NYSE Price List to Establish Fees 
for Industry Members Related to Certain Historical Costs of the 
National Market System Plan Governing the Consolidated Audit Trail; 
Suspension of and Order Instituting Proceedings to Determine Whether 
to Approve or Disapprove the Proposed Rule Change, Exchange Act 
Release No. 99380 (Jan. 17, 2024), available at https://www.sec.gov/files/rules/sro/nyse/2024/34-99380.pdf.
---------------------------------------------------------------------------

v. SIPC Membership
    Commenters said that the costs of joining SIPC should also be 
considered in addition to the costs discussed in the Proposing 
Release.\552\ Under SIPA, all dealers registered under section 15(b) of 
the Exchange Act in the U.S. are automatically members of SIPC except 
for certain subsets of dealers. The Commission acknowledges that if an 
affected party registers as a dealer under section 15(b) of the 
Exchange Act, then the affected party will become a member of SIPC and 
incur the costs discussed in this section.\553\ However, government 
securities dealers registered under section 15C of the Exchange Act do 
not

[[Page 14987]]

need to join SIPC, and thus if an affected party registers as a 
government securities dealer under section 15C, the party will not 
incur the costs discussed in this section. If an affected party trades 
only government securities, then the Commission expects the party to 
register as a government securities dealer under section 15C of the 
Exchange Act.
---------------------------------------------------------------------------

    \552\ See Overdahl Comment Letter; Citadel Comment Letter; AIMA 
Comment Letter II.
    \553\ See 15 U.S.C. 78ccc(2)(A)(i) through (iii).
---------------------------------------------------------------------------

    The Commission estimates the annual cost of SIPC membership for an 
affected party registered as a dealer is approximately $3,000 plus 
0.15% of gross operating revenues generated by the affected party's 
securities business minus interest expense and dividends. This annual 
expense is the sum of two separate annual costs associated with SIPC 
membership. The first annual expense is approximately $3,000 and 
represents costs associated with preparing and filing annual reports 
with SIPC.\554\ The second annual expense is an assessment equal to 
0.15% of gross operating revenues generated by a dealer's securities 
business minus interest expense and dividends, which SIPC collects for 
the SIPC Fund from all SIPC members.\555\ We estimate that an affected 
firm's annual SIPC assessment will be approximately $700,000 for larger 
firms and $30,000 for smaller firms, although costs will vary depending 
on each firm's actual gross operating revenues.\556\ The annual SIPC 
assessment of an affected party registered as a dealer may differ from 
the above two estimates for a larger firm and a smaller firm if the 
SIPC assessment rate changes from 0.15% to a different value in the 
future.\557\
---------------------------------------------------------------------------

    \554\ $3,234 = $431 Compliance Attorney x 0.5 hours (Annual 
Report to SIPC Filing) + $431 Compliance Attorney x 5 hours + $1 
Postage (Annual SIPC Membership Filing) + $431 Compliance Attorney x 
2 + $1 Postage (Filing Annual Statement from Independent Accounting 
Firm). We round $3,234 to $3,000 to reflect uncertainty in our 
estimate.
    \555\ For the current assessment rate, see Securities Investor 
Protection Corporation, Assessment Rate, available at https://www.sipc.org/for-members/assessment-rate. For the assessment rate 
calculation, see Article 6 of the SIPC Bylaws, available at https://www.sipc.org/about-sipc/statute-and-rules/bylaws.
    \556\ We use firms from the Amended Rule 15b9-1 Adopting Release 
to approximate the gross revenue of affected parties that register 
as dealers. We use the 12 largest firms, which have a median gross 
revenue of approximately $491 million, from the Amended Rule 15b9-1 
Adopting Release to estimate the SIPC assessment for large firms. We 
use the remaining firms from the Amended Rule 15b9-1 Adopting 
Release, which have a median gross revenue of approximately $20 
million, to estimate the SIPC assessment for small firms. See 
Amended Rule 15b9-1 Adopting Release, section V.C.2.b. Based on 
those median revenues: $491 million x 0.0015 = $736,500; and $20 
million x 0.0015 = $30,000. We round $736,000 to the nearest hundred 
thousand, $700,000, to reflect the estimate's uncertainty. We cannot 
calculate with precision the total SIPC-related costs for all 
affected firms because of data limitations regarding estimating the 
number of firms that will ultimately register. See sections 
III.B.2.c and III.C.2.a.i and gross operating revenues of those 
firms.
    \557\ See supra note 555.
---------------------------------------------------------------------------

vi. Other Compliance Costs
    One commenter stated that the Commission should consider that ``the 
sheer number and complexity of the Proposals, when considered in their 
totality, if adopted, would impose staggering aggregate costs, as well 
as unprecedented operational and other practical challenges.'' \558\ 
But, consistent with its long-standing practice, the Commission's 
economic analysis in each adopting release considers the incremental 
benefits and costs for the specific rule--i.e., the benefits and costs 
stemming from that rule compared to the baseline. In doing so, the 
Commission acknowledges that in some cases resource limitations can 
lead to higher compliance costs when the compliance period of the rule 
being considered overlaps with the compliance period of other rules. In 
determining compliance periods, the Commission considers the benefits 
of the rules as well as the costs of delayed compliance periods and 
potential overlapping compliance periods.
---------------------------------------------------------------------------

    \558\ MFA Comment Letter II; see also ICI Comment Letter 
(stating that the Commission should consider ``practical realities 
such as the implementation timelines as well as operational and 
compliance requirements''); Overdahl Comment Letter (``direct costs 
associated with registering as a government securities dealers will 
aggregate with the direct costs of compliance with other proposed 
rules which impact that fund'').
---------------------------------------------------------------------------

    In this regard, some commenters mentioned the proposals which 
culminated in the recent adoptions of the May 2023 SEC Form PF Amending 
Release, the Private Fund Advisers Adopting Release, the Treasury 
Clearing Release, the Beneficial Ownership Amending Release, the Rule 
10c-1a Adopting Release, the Short Position Reporting Adopting Release, 
and the Securitizations Conflicts Adopting Release.\559\ The Commission 
acknowledges that there are compliance dates for certain requirements 
of these rules that overlap in time with the final rules, which may 
impose costs on resource constrained entities affected by multiple 
rules.\560\
---------------------------------------------------------------------------

    \559\ See supra note 346. As stated above, commenters also 
specifically suggested the Commission consider potential overlapping 
compliance costs between the final rules and certain proposing 
releases. See supra note 345 (identifying proposals other than those 
that have been adopted). These proposals have not been adopted and 
thus have not been considered as part of the baseline here. To the 
extent those proposals are adopted in the future, the baseline in 
those subsequent rulemakings will reflect the regulatory landscape 
that is current at that time.
    \560\ See supra notes 347-353 (summarizing compliance dates).
---------------------------------------------------------------------------

    However, we think these increased costs from overlapping compliance 
periods will be limited for several reasons. First, the number of newly 
registered dealers that will be subject to each of the recently adopted 
rules identified by commenters will be limited based on whether those 
newly registered dealers' activities fall within the scope of the other 
rules.\561\ Second, commenters' concerns about the costs of overlapping 
compliance periods were raised in response to the proposal and, as 
discussed above, we have taken steps to reduce costs of the final 
rules.\562\ Third, although the compliance periods for these rules 
overlap in part, the compliance dates adopted by the Commission are 
generally spread out over more than a two-year period from 2023 to 
2026.\563\ As discussed above, the Commission is adopting a compliance 
date of one year from the effective date of the final rules for persons 
engaging in activities that meet the dealer registration requirements 
to register.\564\
---------------------------------------------------------------------------

    \561\ The Beneficial Ownership Amending Release amends 
disclosure requirements that apply to only those persons who 
beneficially own more than five percent of a covered class of equity 
securities. The Rule 10c-1a Adopting Release will require only 
persons who agree to a covered securities loan to report that 
activity. The Short Position Reporting Adopting Release will require 
only institutional investment managers that meet or exceed certain 
reporting thresholds to report short position and short activity 
data for equity securities. And the Securitizations Conflicts 
Adopting Release will affect only certain entities--and their 
affiliates and subsidiaries--that participate in securitization 
transactions. In addition, principal trading firms will not have to 
comply with the final rules in the May 2023 SEC Form PF Amending 
Release or the Private Fund Advisers Adopting Release. See id.
    \562\ The final rules mitigate costs relative to the proposal. 
As discussed above, the Commission is deleting the proposed 
quantitative and aggregation standards, which would have required 
persons to establish robust controls to monitor and analyze trading 
across their corporate structure to determine whether registration 
was required, and if so, which entities would register. 
Additionally, we expect FINRA's expressed commitment to expedite the 
application process will generally ease the compliance burdens 
raised by commenters. See supra section II.B.
    \563\ For example, the effective date of the amended deadline 
for filing Schedule 13D will be early 2024. By contrast, compliance 
deadlines for reporting securities loans under the Rule 10c-1a 
Adopting Release will be approximately two years later. See supra 
notes 347-353.
    \564\ See section II.B.
---------------------------------------------------------------------------

    As discussed above, the final rules may result in certain 
transactions of newly registered dealers or government securities 
dealers being subject to central clearing requirements under the recent 
Treasury Clearing amendments.\565\ Such newly registered

[[Page 14988]]

dealers or government securities dealers may incur costs associated 
with these central clearing requirements, as discussed in the Treasury 
Clearing Adopting Release.\566\
---------------------------------------------------------------------------

    \565\ See discussion on benefits in section III.C.1.
    \566\ See Treasury Clearing Adopting Release, 89 FR 2811-18.
---------------------------------------------------------------------------

b. Costs Associated With the Net Capital Rule
    Affected persons who are not currently in compliance with the Net 
Capital Rule would need to decrease the charges to their net capital or 
raise additional capital. This may particularly impact private funds, 
as their investors generally have withdrawal rights and the Net Capital 
Rule requires a broker-dealer to subtract from net worth when 
calculating net capital any contribution of capital to the broker-
dealer: (1) under an agreement that provides the investor with the 
option to withdraw the capital; or (2) that is intended to be withdrawn 
within a period of one year of the contribution.\567\ Therefore, 
commenters said that funds registering as dealers may have to amend 
their contractual agreements with investors and that those investors 
may lose substantial liquidity rights.\568\ However, we estimate that 
the final rules will only affect a small percentage of private 
funds.\569\ We acknowledge that affected private funds may have to 
limit investor withdrawals if they want to continue dealing 
securities.\570\ Alternatively, an affected private fund may choose to 
separate its dealing activities into a separate entity.\571\
---------------------------------------------------------------------------

    \567\ See 17 CFR 240.15c3-1(c)(2)(i)(G) (``Rule 15c3-
1(c)(2)(i)(G)''). The Net Capital Rule states that ``[any] 
withdrawal of capital made within one year of its contribution is 
deemed to have been intended to be withdrawn within a period of one 
year, unless the withdrawal has been approved in writing by the 
Examining Authority for the broker or dealer.'' Id. See AIMA Comment 
Letter II; Citadel Comment Letter; FIA-PTG Comment Letter; Fried 
Frank Comment Letter; Hagerty-Hill Comment Letter; IAA Comment 
Letter I; MFA Comment Letter I; NAPFM Comment Letter; Two Sigma 
Comment Letter.
    \568\ See AIMA Comment Letter II; Citadel Comment Letter; 
Element Comment Letter; Fried Frank Comment Letter; NAPFM Comment 
Letter; Two Sigma Comment Letter I; MFA Comment Letter I; FIA PTG 
Comment Letter I; IAA Comment Letter I; Overdahl Comment Letter; 
McIntyre Comment Letter II. See also Hagerty-Hill Comment Letter.
    \569\ Table 2 shows 47,088 private funds reported on Form PF as 
of 2022Q4, but section III.B.2.c explains why the final rules may 
only affect a small percentage of those funds.
    \570\ At least some investor capital would need to remain off-
limits to withdrawal for at least one year. For example, funds who 
wish to continue dealing activities may need to renegotiate 
contracts with investors to provide for a one-year lockup period.
    \571\ For example, a fund that engages in both dealing and non-
dealing activities could divide its activities into two new funds: 
one that engages in dealing and offers different (lower) liquidity 
rights for investors, and another than continues to operate the non-
dealing strategies and offers the same liquidity rights as the 
original fund.
---------------------------------------------------------------------------

    For market participants engaging in dealing activity, other than 
private funds, the Net Capital Rule may require additional capital. We 
anticipate the costs associated with the Net Capital Rule to vary 
according to the type of investment. For example, less liquid 
investments and derivatives positions are subject to greater haircuts 
(see below), and will thus require more capital.\572\ Crypto assets 
that are not securities would be subject to a 100% deduction when 
computing net capital and so affected persons that hold more of such 
assets would likely need more net capital.\573\ The cost of complying 
with increased capital requirements arises because an entity is 
required to either shift the composition of its portfolio to hold more 
liquid assets--which typically earn lower rates of return--than it 
would otherwise, or to fund its positions with a greater amount of 
equity or subordinated debt, which is typically costlier than 
unsubordinated debt. However, entities that take less financial risk 
tend to have better credit with investors or lenders, other things 
equal, so more favorable borrowing terms for affected parties may 
partially offset the costs of increasing their net capital.
---------------------------------------------------------------------------

    \572\ See MFA Comment Letter I.
    \573\ See DeFi Fund Comment Letter at 9; GDCA Comment Letter. 
The Net Capital Rule's AI standard requires net capital to exceed 1/
15 of aggregate indebtedness. Any crypto assets that are not 
securities would not contribute to net capital, but borrowing to 
fund those holdings may contribute to AI. Thus, if an entity were to 
acquire non-security crypto assets using proportionally the same 
amount of leverage as for the entity's securities holdings, the non-
security crypto assets would reduce the entity's ratio of net 
capital to AI. Crypto assets that are securities and that have a 
``ready market,'' as defined in section (c)(11) of the Net Capital 
Rule, would likely contribute to net capital, subject to haircuts. 
See 17 CFR 240.15c3-1(c)(2)(vi)(K). Because the Net Capital Rule's 
AI standard requires net capital to exceed a fraction (1/15) of AI, 
entities would not necessarily need to fund holdings of non-security 
crypto assets with 100% equity.
---------------------------------------------------------------------------

    One comment letter stated that the proposed rule would greatly 
increase the cost of certain trading strategies and provided numerical 
estimates.\574\ These estimates appeared to rely on position sizes and 
existing margin requirements which the commenter did not provide. We 
can nevertheless ascertain that the commenter's estimates rest on two 
assumptions. First, the commenter said that, under the proposed rule, 
the futures margin requirement would increase by 50% and cited to a 
CFTC rule describing ``Minimum financial requirements for futures 
commission merchants and introducing brokers.'' \575\ Registration with 
the SEC as a dealer--by itself--does not create a requirement to also 
register with the CFTC as a futures commission merchant or introducing 
broker, so the final rules would not necessarily increase affected 
parties' futures margin. Registered broker-dealers--as is the case with 
futures commission merchants--are subject to requirements to take 
capital charges for proprietary futures positions.\576\ However, they 
need not take a charge if the position is a covered futures 
position.\577\ Second, the commenter calculated margin costs based on a 
5-day, 99% confidence, portfolio value at risk (``VaR'') that 
recognizes offsets between futures and bonds positions.\578\ VaR 
calculation methods vary, and they may depend on several assumptions--
among other things, the relevant historical time period, the precise 
assets in a portfolio, covariance between those assets, and methods for 
modelling future returns. We are uncertain of some of the details of 
the sample strategies identified by the commenter, such as which 
precise assets may be involved in the butterfly strategies. Under this 
uncertainty, rather than make the assumptions needed to calculate VaR, 
we assume a flat 2% margin cost that does not necessarily recognize 
offsets. For entities with margin costs lower (or, respectively, 
higher) than 2%, the actual increases in minimum capital would be 
higher (lower) than the estimates we report in Table 9. Because the 
final rules will not include the proposed first qualitative factor, we 
do not expect the strategies in the letter to necessarily constitute 
dealing under the final rules.
---------------------------------------------------------------------------

    \574\ See FIA PTG Comment Letter I. The letter listed 18 
``typical types of trading activity that PTFs, and many others in 
the market, often employ,'' along with quantitative estimates of how 
much the required equity would have increased under the proposed 
rules.
    \575\ CFTC Reg. Sec.  1.17(c)((5)(x)(B). See also Morgan Lewis 
Comment Letter.
    \576\ See 17 CFR 240.15c3-1b (``Rule 15c3-1b'').
    \577\ See 17 CFR 240.15c3-1b(a)(3)(ix)(A) (``Rule 15c3-
1b(a)(3)(ix)(A)'') (providing that there is no charge for inventory 
which is currently registered as deliverable on a contract market 
and covered by an open futures contract or by a commodity option on 
a physical). We assume that futures positions involved in the 
strategies listed in the letter are covered, but see infra notes 587 
and 588 for how our calculations may change if they are not.
    \578\ See FIA PTG Comment Letter I.
---------------------------------------------------------------------------

    In this context, in response to the commenter's letter, we 
undertake our own estimations of how much the final rules may increase 
affected parties' required capital for different position sizes under 
17 of the 18 strategies listed in the comment letter.\579\
---------------------------------------------------------------------------

    \579\ The FIA PTG Comment Letter I did not provide sufficient 
information to enable us to assume details for strategy 10 ``Two 
offsetting butterfly positions in bonds.''
---------------------------------------------------------------------------

    Estimates of increases in required equity: In Table 9, the left 
column lists the strategies as given in the comment

[[Page 14989]]

letter, and the right column lists the contracts and transactions that 
we assume the strategies involve. Dollar amounts such as $P or $0.5P 
indicate position sizes.

       Table 9--Sample Strategies From the FIA-PTG Comment Letter
------------------------------------------------------------------------
                   Strategy listed in      Contracts and transactions
                   the comment letter              involved *
------------------------------------------------------------------------
1................  Two year futures    short $P futures position with
                    vs On the Run       2yr Treasury deliverable, long
                    cash.               $P Treasury note that will be
                                        deliverable against the futures
                                        contract.
2................  Five year futures   short $P futures position with
                    vs On the Run       5yr Treasury deliverable, long
                    cash.               $P Treasury note that will be
                                        deliverable against the futures
                                        contract.
3................  Ten year futures    short $P futures position with
                    vs On the Run       10yr Treasury deliverable, long
                    cash.               $P Treasury bond that will be
                                        deliverable against the futures
                                        contract.
4................  Ultra Bond futures  short $P futures position with
                    vs Deliverable      25+yr Treasury deliverable, long
                    bonds.              $P Treasury bond that will be
                                        deliverable against the futures
                                        contract.
5................  Two Year futures    short $P futures position with
                    vs Off the Run 2s.  2yr Treasury deliverable, long
                                        $P off-the-run Treasury note
                                        that will be deliverable against
                                        the futures contract.
6................  Ultra Bond futures  short $P futures position with
                    vs On the Run 30s.  25+yr Treasury deliverable, long
                                        $P 30yr on-the-run Treasury
                                        bond.
7................  Off-the-run Bond    long $P 5yr Treasury note, short
                    Butterfly.          $0.5P 2yr Treasury note and
                                        short $0.5P 10yr Treasury note.
8................  US/20yr/WN          long $P 20yr Treasury bond, short
                    Butterfly.          $0.5P futures position with 10yr
                                        Treasury deliverable, short
                                        $0.5P futures position with 30yr
                                        Treasury deliverable.
9................  TY futures vs. Off  short $P futures position with
                    the Run cash.       10yr Treasury deliverable, long
                                        $P off-the-run Treasury bond
                                        that will be deliverable against
                                        the futures position.
10...............  Two offsetting      We did not have sufficient
                    butterfly           information to analyze this
                    positions in        strategy.
                    bonds.
11...............  On the Run vs Off   short $P on-the-run 20yr Treasury
                    the Run 20yrs.      bond, long $P off-the-run 20yr
                                        Treasury bond.
12...............  5s30s Flattener...  short $P 5yr Treasury note, long
                                        $P 30yr Treasury bond.
13...............  TY Cash futures     short $0.5P futures position with
                    basis vs TU Cash    10yr Treasury deliverable and
                    futures basis.      long $0.5P Treasury bond that
                                        will be deliverable against the
                                        futures contract; long $0.5P
                                        futures position with 2yr
                                        Treasury deliverable, short
                                        $0.5P Treasury note that will be
                                        deliverable against the futures
                                        contract.
14...............  Ultrabond futures   short $P futures position with
                    vs. CTD Cash        25+yr Treasury deliverable, long
                    bonds.              $P Treasury bond that will be
                                        deliverable against the futures
                                        contract.
15...............  On the Run 30 Year  long $P Treasury bond maturing
                    vs. Aug47s.         Aug. 2047 (assume maturity
                                        >25yrs), $P short on-the-run **
                                        30yr Treasury bond.
16...............  On the Run 30 Year  long $P Treasury bond maturing
                    vs. Feb42s.         Feb. 2042 (assume maturity
                                        <20yrs), short $P on-the-run **
                                        30yr Treasury bond.
17...............  On the Run 30 Year  long $P Treasury bond maturing
                    vs. Feb36s.         Feb. 2036 (assume maturity
                                        <14yrs), short $P on-the-run **
                                        30yr Treasury bond.
18...............  Low Risk Tight 3    (a) long $P 5yr Treasury note,
                    Year Micro RV ***.  short $P 2yr Treasury note.
                                       (b) long $P 10yr Treasury note,
                                        short $P 7yr Treasury note.
                                       (c) Long $P 25yr Treasury bond,
                                        short $P 22yr Treasury bond.
------------------------------------------------------------------------
* Based on the Commission's understanding of what these strategies mean.
** Analyses performed in Aug. 2022 (calculations of net capital
  requirements are not sensitive to changes in interest rates since Aug.
  2022).
*** We consider three possible versions of this strategy.

    In each strategy, the entity in question simultaneously (i) takes a 
long position of $P (in total) in one or more securities or futures and 
a short position of $P (in total) in one or more securities or futures; 
(ii) posts margin; and (iii) keeps no additional cash on its balance 
sheet, so that its equity equals the value of its margin account.
    The net capital calculation begins with computing Tentative Net 
Capital (``TNC''), which is equal to book equity minus assets not 
readily convertible to cash (e.g., fixed or intangible assets), minus 
certain operational charges, plus qualified subordinated liabilities. 
Because the comment letter discussed these trading strategies in 
isolation, our calculations correspondingly assume that the entity in 
question has no assets that are not readily convertible to cash, no 
relevant operational charges, and no qualified subordinated 
liabilities, so that TNC always equals book equity. Net Capital 
(``NC'') equals TNC minus a haircut. Haircuts are standardized by 
security,\580\ but dealers can seek regulatory approval to instead 
compute net capital using the market risk standards of appendix E.\581\ 
Our calculations rely on the standardized haircuts.
---------------------------------------------------------------------------

    \580\ See SEC Rule 15c3-1(c)(2)(vi).
    \581\ Dealers approved to calculate net capital in this manner 
must also maintain at all times TNC of at least $5 billion and NC of 
at least $1 billion.
---------------------------------------------------------------------------

    NC must equal or exceed the greater of a fixed-dollar minimum 
requirement and a ratio-based minimum requirement. The aggregate 
indebtedness (AI) standard requires NC to exceed the greater of (i) 
one-fifteenth of AI (or one-eighth for 12 months after commencing 
business as a broker or dealer) and (ii) a fixed dollar amount that 
varies by broker-dealer type.\582\ We assume that the relevant fixed 
dollar amount is $100,000 for parties affected by the final rules, as 
that is the fixed dollar minimum for a dealer. We assume that all loans 
involved in the sample strategies in Table 9 would be ``adequately 
collateralized by securities which are carried long by the broker or 
dealer and which have not been sold''

[[Page 14990]]

and that securities borrowed would also be adequately collateralized. 
AI is thus equal to zero in our analysis, and NC under the AI standard 
must therefore exceed the fixed dollar amount of $100,000.\583\ An 
alternative standard requires NC to exceed the greater of (i) 2% of 
customer debit items or (ii) $250,000. Our calculations assume that, 
similarly to the PTFs to which the comment letter refers,\584\ the 
trader in question has no customers. Therefore, in the absence of 
customer debit items, this alternative standard requires at least 
$250,000 of NC, which is higher than the $100,000 fixed-dollar minimum 
under the AI standard.
---------------------------------------------------------------------------

    \582\ For example, the fixed dollar amount equals $5,000 for a 
broker-dealer that does not receive, directly or indirectly, or hold 
funds or securities for, or owe funds or securities to, customers; 
$50,000 for an introducing broker dealer that receives but does not 
hold securities; $100,000 for a dealer (defined as a broker-dealer 
that, among other things, ``effects more than ten transactions in 
any one calendar year for its own investment account''); $250,000 
for a carrying broker-dealer; $20 million for an OTC derivatives 
dealer; or $1 billion for a broker-dealer that has been approved to 
use models to compute net capital.
    \583\ Paragraph (c)(1) of the Net Capital Rule defines AI as 
``the total money liabilities of a broker or dealer arising in 
connection with any transaction whatsoever,'' subject to several 
exclusions. Paragraphs (c)(1)(i) and (ii) describe two exclusions 
that apply to the trading strategies provided by FIA-PTG for 
``indebtedness adequately collateralized by securities which are 
carried long by the broker or dealer and which have not been sold,'' 
and for ``amounts payable against securities loaned, which 
securities are carried long by the broker or dealer and which have 
not been sold.''
    \584\ See FIA PTG Comment Letter I.
---------------------------------------------------------------------------

    Certain dealers \585\ engaged in activities as market makers can 
avoid calculating a haircut (so NC=TNC) if they maintain liquidating 
equity above a threshold equal to a percentage of their securities or 
derivatives positions.\586\ We consider this provision in our analysis, 
but we find that the capital requirement for market makers is not the 
binding constraint for any of the sample strategies.
---------------------------------------------------------------------------

    \585\ See paragraph (a)(6) of the Net Capital Rule. The market 
maker exception is available to a dealer ``who does not effect 
transactions with other than brokers or dealers, who does not carry 
customer accounts, who does not effect transactions in options not 
listed on a registered national securities exchange or facility of a 
registered national securities association, and whose market maker 
or specialist transactions are effected through and carried in a 
market maker or specialist account cleared by another broker or 
dealer.''
    \586\ See Rule 15c3-1(c)(6)(iii). For these strategies, the 
thresholds are generally 5% of the value of long positions in U.S. 
Treasury securities plus 25% of the value of long positions in U.S. 
Treasury futures plus 30% of the value of short positions.
---------------------------------------------------------------------------

    OTC derivatives dealers must also maintain TNC of $100 million, and 
dealers that are approved to calculate haircuts using their own 
internal risk models must maintain TNC of $5 billion. Our calculations 
are for affected parties to which these TNC requirements do not apply, 
however.
    Lastly, as described above, our calculations assume that the entity 
in question, whether registered as a dealer or not, faces a margin 
requirement of 2%, so that its book equity equals $0.02P.
    To summarize, we estimate the increased capital requirement for 
affected parties under the following conditions: (i) TNC equals book 
equity; (ii) affected parties would use the standardized haircuts 
specified in the Net Capital Rule; (iii) the fixed amount under the AI 
standard is $100,000 and AI equals zero so that the AI standard 
requires $100,000 of NC; (iv) the alternative standard requires NC of 
$250,000, therefore it would not be adopted by affected parties in lieu 
of the $100,000 fixed dollar minimum required under the AI standard; 
(v) certain entities can claim a market maker exception that allows 
them to avoid calculating a haircut (so NC=TNC) if they maintain 
capital above a certain threshold; (vi) all futures positions are 
covered; and (vii) the entity in question must maintain capital of 
$0.02P even if it does not register with the Commission.
    Under these conditions, the AI standard requires that book equity 
minus any haircut exceeds $100,000--i.e., book equity must exceed 
$100,000 plus any haircut--so that the percentage increase in required 
equity is equal to: [(haircut + $100k)/non-broker-dealer margin]-1, or 
[(haircut + $100k)/$0.02P]-1. The AI standard under the market maker 
exception requires instead that book equity exceed the greater of 
$100,000 and a percentage of the position size P that depends on the 
exposures involved. We now turn to our findings.
    Eleven of the 17 strategies for which we provide estimates have no 
haircuts under the Net Capital Rule, because the securities and/or 
futures positions offset each other--the 11 strategies are strategy 1, 
2, 3, 4, 5, 6, 9, 11, 13, 14, and 15--and six strategies do have 
haircuts--these strategies are 7, 8, 12, 16, 17, and 18. To illustrate 
the calculations involved, Box 1 describes the calculation details for 
a strategy with no haircut, and Box 2 describes the calculation details 
for a strategy with a haircut.

               Box 1--Calculation Details for Strategy 1: ``Two Year Futures vs On the Run Cash''
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
Description: short $P futures position with 2yr Treasury deliverable, long $P Treasury note that will be
 deliverable against the futures contract.
Transactions assumed: borrow $P, buy $P 2yr notes, enter $P short futures position with 2yr Treasury
 deliverable, deposit $x in margin.
----------------------------------------------------------------------------------------------------------------
                                                  Balance Sheet
----------------------------------------------------------------------------------------------------------------
Assets...............................  $P 2yr note............  Liabilities............  $P loan.
                                       $x receivable (margin).  Equity.................  $x.
                                                                Off balance sheet......  short $P notional 2yr
                                                                                          futures.
----------------------------------------------------------------------------------------------------------------
Calculations                           Notes
----------------------------------------------------------------------------------------------------------------
Haircut *............................  0......................  futures and note positions offset.
----------------------------------------------------------------------------------------------------------------
Capital Requirement (minimum required x)
----------------------------------------------------------------------------------------------------------------
Non-dealer...........................  0.02P..................  margin requirement.
Dealer...............................  max(0.02P, 100k).......  max(margin requirement, dealer capital).
% Change.............................  (100k/0.02P)-1.........  if P < 100k/0.02 = $5 million,
                                       or
                                       0......................  if P >= $5 million (margin is binding
                                                                 constraint).
----------------------------------------------------------------------------------------------------------------


                    Box 2--Calculation Details for Strategy 7: ``Off-the-Run Bond Butterfly''
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
Description: long $P 5yr Treasury note, short $0.5P 2yr Treasury note and short $0.5P 10yr Treasury note.

[[Page 14991]]

 
Transactions: borrow $P, buy $P 5yr notes, use 5yr notes as collateral to borrow $0.5P of 10yr notes and $0.5P
 of 2yr notes, sell them and use proceeds to repay loan, deposit $x in margin.
----------------------------------------------------------------------------------------------------------------
                                                  Balance Sheet
----------------------------------------------------------------------------------------------------------------
Assets...............................  $x receivable (margin).  Liabilities............  $0.
                                                                Equity.................  $x.
                                                                Off Balance sheet......  $0.5P stock borrowed
                                                                                          (10yr note).
                                                                                         $0.5P stock borrowed
                                                                                          (2yr note).
                                                                                         $P 5yr note posted as
                                                                                          collateral.
----------------------------------------------------------------------------------------------------------------
                         Calculations  Note
----------------------------------------------------------------------------------------------------------------
Haircut *............................  P*7.25%................  (P*4% for 5yr note) + (0.5P*2% for 2yr note) +
                                                                 (0.5P*4.5% for 10yr note).
----------------------------------------------------------------------------------------------------------------
Capital Requirement (minimum required x)
----------------------------------------------------------------------------------------------------------------
Non-dealer...........................  0.02P..................  margin requirement.
Dealer...............................  max(0.02P,100k+0.0725P)  under regular AI standard.
                                       or
                                       max(100k, 0.35P) **....  if acting as market maker (0.35P = 5% of long +
                                                                 30% of short positions).
% Change.............................  (100k/0.02P)-1.........  if P < 100k/(0.35-0.0725) = 360k.
                                       or
                                       (100k+0.0725P)/0.02P-1.  if P > $360k.
----------------------------------------------------------------------------------------------------------------
* See 17 CFR 240.15c3-1, paragraph (c)(2)(vi)(A) (``Rule 240.15c3-1(c)(2)(vi)(A)'').
** See 17 CFR 240.15c3-1, paragraph (c)(6)(iii) (``Rule 240.I3-1(c)(6)(iii)'').

    For strategies with no haircuts, such as in Box 1, the percentage 
change in capital is equal to ($100,000/0.02P)-1, which converges to 
zero as the position size P grows, since as P gets large the 2% margin 
requirement already requires more capital than would the Net Capital 
Rule.\587\
---------------------------------------------------------------------------

    \587\ The increase for strategies with uncovered futures would 
be higher. For example, if the additional futures margin meant the 
entity's overall margin requirement increased from 2% of P to 3% of 
P, then the percentage increase would be [max(0.03, $100k)/$0.02P]-
1. The smallest value of P we consider is $50 million (see infra 
Table 10 and related discussion). Under the assumption that higher 
futures margin raises overall margin costs from 2% to 3%, the 
increase in required capital for strategies with no margin would be 
50% at P=$50 million.
---------------------------------------------------------------------------

    For strategies with haircuts, such as in Box 2, the AI standard 
with the market maker exemption is the easiest to meet when the 
position size P is small enough because the market maker exemption 
allows the entity to avoid taking a haircut. As P grows, the market 
maker exemption becomes more binding, and the regular AI standard is 
the easiest to meet. As P grows arbitrarily large, the increase in 
equity converges to (haircut/0.02)-1.\588\ If the haircut is greater 
than the margin requirement, the Net Capital Rule will always require 
an increase in minimum capital. If the haircut is less than the margin 
requirement, then a large enough P will make the margin requirement the 
binding constraint.
---------------------------------------------------------------------------

    \588\ The increase for strategies with uncovered futures would 
be higher. For example, if the additional futures margin meant the 
entity's overall margin requirement increased from 2% of P to 3% of 
P, then the percentage increase would be [max(0.03, haircut)/
$0.02P]-1. All but one of the 17 strategies with haircuts have 
haircuts larger than 0.03 except for strategy 8, for which we 
calculate a haircut of 2.875%. Under the assumption that higher 
futures margin raises overall margin costs from 2% to 3%, then, our 
calculations are nearly the same whether the futures positions are 
covered or not.
---------------------------------------------------------------------------

    Table 10 reports our findings. The first column shows the estimated 
increase in required capital that the commenter provided for each 
strategy included in the comment letter. Columns 2 shows our estimated 
increases in required minimum capital for a position size of $50 
million (i.e., at P = $50mm), because the final rules will exclude 
persons that have or control less than $50 million in total assets. 
Column 3 shows our estimated increases in required minimum capital for 
very large position sizes (i.e., as P [rarr] infinity). We estimate 
that in 10 out of the 17 strategies provided by the commenter the Net 
Capital Rule would not increase affected parties' minimum capital 
requirements, and in another four strategies the capital requirements 
would increase by less than 100%. Our estimates are generally lower 
than the commenter's estimates. As described above, our calculations 
may differ because (i) we do not agree that futures margin requirement 
would necessarily increase by 50% and (ii) we use a flat 2% margin 
rather than calculating a risk-based margin using VaR.
    The values shown in Table 10 may also overstate or understate the 
actual costs of the Net Capital Rule for the following reasons. For 
affected parties that pursue more than one trading strategy, we expect 
that the actual increase in minimum net capital would be lower than the 
values shown in column 2, and perhaps even lower than the values shown 
in column 3, because net capital applies to the entire portfolio and 
not just to a single strategy. The increases shown in Table 10 are 
therefore not additive--e.g., trading P=$50 million of, Strategy 7 and 
$50 million of Strategy 8 will not cause minimum net capital to 
increase by 273% + 54%, but by a smaller amount. Holding many 
securities or futures positions for many different strategies may allow 
additional offsets when calculating standardized haircuts according to 
the Net Capital Rule, so the total increase in capital required for a 
$100 million multi-strategy portfolio could be even lower than the 
increase associated with $100 million in a single strategy.

[[Page 14992]]



                            Table 10--Estimated Increase in Required Minimum Capital
----------------------------------------------------------------------------------------------------------------
                                                                             Commission-estimated increases in
                                                       Estimated capital                  capital
                      Strategy                         increase reported ---------------------------------------
                                                       by the commenter                        Large P (P [rarr]
                                                              (%)            P = $50mm (%)       infinity) (%)
----------------------------------------------------------------------------------------------------------------
1...................................................                 828                   0                   0
2...................................................                 595                   0                   0
3...................................................                 718                   0                   0
4...................................................               1,117                   0                   0
5...................................................                  34                   0                   0
6...................................................                 645                   0                   0
7...................................................                 580                 273                 263
8...................................................                 718                  54                  44
9...................................................                 171                   0                   0
10..................................................                 913           * unknown             unknown
11..................................................                 530                   0                   0
12..................................................                 207                 410                 400
13..................................................                 742                  80                   0
14..................................................                 612                   0                   0
15..................................................                 615                   0                   0
16..................................................                 315                  85                  75
17..................................................                 173                  98                  88
18 (a) **...........................................                 522                 210                 200
18 (b) **...........................................                 522                 335                 325
18 (c) **...........................................                 522                  73                  63
----------------------------------------------------------------------------------------------------------------
* For strategy 10, the Commission was unable to find, under its analysis, a position size that corresponded to
  the commenter's estimate of 913%.
** The Commission estimated three potential versions of strategy 18, ``Low Risk Tight 3 Year Micro RV.''

    The values shown in Table 10 may understate the actual costs of the 
Net Capital Rule because this analysis does not consider the ``lock-
up'' requirement that capital be held for at least a period of one 
year.\589\ As one commenter described, this requirement may be more 
restrictive for some corporate structures than for others.\590\ For 
example, consider a dealer trading in both Treasury securities and 
equities for whom, on day 1, its Treasury positions require net capital 
of $70 and its equity positions require net capital of $30, for total 
required net capital of $100. On day 2, the dealer's activities shift 
such that its Treasury positions now require net capital of $30 and its 
equity positions require $70. If a single entity engages in these 
activities, the shift in activities on day 2 will not require any 
change in net capital. However, the shift may require additional net 
capital if different activities are conducted by separate subsidiary 
entities. Since the Net Capital Rule requires capital to be held for at 
least one year, the entity trading Treasury securities would still have 
$70 of net capital on day 2, while the entity trading equities would 
need to increase its net capital from $30 to $70, for a total required 
net capital of $140 across both entities. For a dealer organized in 
this way, shifts in the distribution of activities across subsidiaries 
may result in a higher net capital requirement than would otherwise 
apply to the aggregate activities. In this simple example, a dealer 
that engaged 100% in equities one day (through its equity-focused 
subsidiary) and 100% in Treasury securities on another day (through its 
Treasury-focused subsidiary) may have to hold twice as much net capital 
as it would if it were organized as a single consolidated entity. 
Affected parties may respond to this capital lock-up by limiting the 
amount of capital they deploy toward dealing activities, with the 
result that affected parties may become less likely to commit capital 
to dealing activities, even in times when the returns to dealing may be 
high. However, currently-registered dealers and their investors must 
already consider these consequences of the Net Capital Rule.
---------------------------------------------------------------------------

    \589\ The Net Capital Rule allows for exceptions from the one-
year lockup for withdrawals that are approved in writing by the 
examining authority. Based on staff experience, FINRA--in its 
capacity as an examining authority--has on rare occasions provided 
such approvals to address extraordinary circumstances. See supra 
note 567.
    \590\ See Duffie Comment Letter.
---------------------------------------------------------------------------

    We acknowledge that in instances where the Net Capital Rule may 
increase affected parties' minimum capital requirements, these parties 
may need to raise capital or reduce leverage. Several commenters 
suggested that affected parties could respond to the final rules by 
changing or curtailing their trading to avoid the revised dealer 
definition.\591\ Or, as discussed above, affected parties could respond 
by reorganizing their activities--e.g., to consolidate subsidiaries--in 
order to avoid the capital lock-up problem described in the previous 
paragraph. We cannot quantify the costs to these affected parties and 
their investors of scaling back trading activities or reorganizing 
since we do not know the scope of their current activities, how 
profitable those activities may be, or how market participants may 
allocate trading across different legal entities. An affected party's 
costs of increased net capital requirements under the application of 
the Net Capital Rule could be partially offset by reductions in its 
cost of capital as higher levels of net capital may reduce the affected 
party's probability of default.
---------------------------------------------------------------------------

    \591\ See supra note 62.
---------------------------------------------------------------------------

c. Potential Implications for Private Funds and Advisers
    Commenters mentioned other potential conflicts between private 
funds' business and the dealer rules and regulations beyond the 
challenge of reconciling fund investors' withdrawal rights with 
dealers' capital requirements.\592\ As explained above, the Commission 
expects that only a limited number of private funds will be affected by 
the final rules.\593\ For the

[[Page 14993]]

limited number of affected funds under the final rules, we discuss 
below potential costs to those funds and their advisers and investors. 
Depending on the specific conflict between private funds' business and 
the dealer rules and regulations, a fund may respond by revising its 
organizational documents and agreements with third parties, such as 
prime brokers and executing brokers; modifying its investing strategies 
(which can require investor consent and also trigger investors' 
redemption rights) to avoid dealing; or accommodating investors that 
withdraw from the fund. Although these costs may be significant for 
individual funds, in aggregate we do not expect that their combined 
impact will be significant because of the limited number of funds 
likely to be affected by the final rules.
---------------------------------------------------------------------------

    \592\ See supra notes 230, 233, 242, and 254.
    \593\ See sections II.A.3.b, III.B.2.c.
---------------------------------------------------------------------------

    One potential conflict is that private funds that register as 
dealers may face restrictions against participating in the IPO 
market.\594\ Hedge funds that buy IPO shares and also engage in dealing 
strategies may have to withdraw from one set of activities when the 
final rules go into effect. We expect that funds will choose the 
activity that adds more value to the fund and its investors; some may 
choose to register and stay out of the IPO market, while others may 
forgo dealing to be able to invest in IPOs. Because hedge funds are 
important players in the IPO market,\595\ any large-scale exit of hedge 
funds from this market could impact the ability of issuers to raise new 
capital, as well as reduce efficient pricing in new issues. Similarly, 
any large-scale exit from dealing could impact liquidity. The magnitude 
of these costs depends on the extent to which there are hedge funds 
that engage in both activities simultaneously, as well as on hedge 
funds' total share of aggregate IPO and dealing activity.
---------------------------------------------------------------------------

    \594\ A broker-dealer registered with FINRA is subject to Rule 
5130, which prohibits member firms from selling new issues (e.g., 
IPOs) to restricted persons. Generally, a broker-dealer, along with 
the owners that would be listed on Form BD (e.g., 5% direct owners, 
25% indirect owners) would be considered ``restricted persons'' and 
subject to the new issue restrictions. FINRA member firms are also 
prohibited from purchasing new issue securities. See AIMA Comment 
Letter II; AIMA Comment Letter III; Citadel Comment Letter; 
Committee on Capital Markets Comment Letter; Element Comment Letter; 
Lewis Study; MFA Comment Letter I.
    \595\ See Hong Qian and Zhaodong (Ken) Zhong, 2017, ``Do Hedge 
Funds Possess Private Information about IPO Stocks? Evidence from 
Post-IPO Holdings,'' Review of Asset Pricing Studies 8(1), p. 117-
152. These authors observe that hedge funds hold about 80% of the 
average IPO firm's shares as of the first reporting date after the 
IPO.
---------------------------------------------------------------------------

    Several commenters stated that registering as dealers would cause 
funds to lose the benefit of various customer protection regulations 
that govern their relations with their broker-dealers.\596\ Funds that 
register as dealers may incur costs to the extent that they need to 
revise their organizational documents and agreements with third parties 
because certain customer protection regulations would no longer apply. 
And insofar as the applicability of these customer protections affect 
investors' decisions to invest, funds may also incur costs from 
investors withdrawing or choosing not to invest.
---------------------------------------------------------------------------

    \596\ See, e.g., Citadel Comment Letter; Lewis Study.
---------------------------------------------------------------------------

    One commenter suggested that the proposed rules' impact may be 
costly for private funds because funds and broker-dealers are treated 
differently for tax purposes.\597\ This different treatment may result 
in costs for some of the affected funds. But given the limited number 
of affected funds, we do not believe that tax consequences for those 
funds will harm market liquidity and efficiency.
---------------------------------------------------------------------------

    \597\ See Two Sigma Comment Letter I.
---------------------------------------------------------------------------

    One commenter said that ``many investment funds (e.g., pension 
plans) may not be permitted to register as a dealer under their 
organizational charters'' and also that ``many potential fund investors 
may not be permitted to invest in the equity of a broker-dealer.'' 
\598\ If any affected funds are prohibited from registering as dealers 
or have investors that are prohibited from investing in a dealer, then 
we agree that those affected funds may incur additional costs, 
including costs of revising organizational documents, splitting dealing 
and non-dealing activities into separate legal entities, or changing 
investment strategies and withdrawal of investors, whichever option is 
least costly.
---------------------------------------------------------------------------

    \598\ See Blackrock Comment Letter.
---------------------------------------------------------------------------

    A commenter suggested one scenario in the context of all-to-all 
trading in which a fund's best execution obligation as a dealer under 
FINRA Rule 5310 may conflict with the fund adviser's fiduciary duty to 
achieve best execution for its client, the fund.\599\ The adviser's 
fiduciary duty to achieve best execution is informed by applicable 
legal requirements,\600\ and, as stated above, we do not believe a 
conflict between these legal obligations will arise in the scenario 
raised by the commenter.\601\ The fund may nevertheless incur costs 
because of best execution obligations as a newly registered dealer, 
including costs for amending its organizational agreements to 
facilitate compliance with FINRA Rule 5310. To the extent they face 
these costs, some affected persons may consider ceasing any behavior 
that constitutes dealing.
---------------------------------------------------------------------------

    \599\ Id.
    \600\ See Commission Interpretation Regarding Standard of 
Conduct for Investment Advisers, Investment Advisers Act Release No. 
5248 (June 5, 2019), 84 FR 33669, 33674-75 (July 12, 2019).
    \601\ See supra note 235 and accompanying text.
---------------------------------------------------------------------------

    Another commenter said that FINRA rules may restrict investment 
advisers who are also dealers from receiving carried interest from 
their private fund clients.\602\ The comment letter cited to FINRA Rule 
2150, which contains prohibitions against FINRA members sharing in the 
profits of customers' accounts. The commenter said that the proposed 
rules' aggregation provision, which would have combined advisers' 
trading on behalf of their clients together with advisers' proprietary 
trading, would also have meant that adviser-client relationships could 
be treated like dealer-customer relationships for the purposes of FINRA 
Rule 2150. We have removed the aggregation standard from the definition 
of ``own account,'' as discussed previously, and these changes mean the 
final rules are not likely to prevent advisers who are also dealers 
from receiving carried interest from their private fund clients.
---------------------------------------------------------------------------

    \602\ See McIntyre Comment Letter II.
---------------------------------------------------------------------------

d. Effects on Market Liquidity
    Studies on HFT are mixed on whether affected firms' activities may 
improve or worsen market liquidity.\603\ Recent experience is also 
mixed on the role of PTFs during market events. PTFs' share of market 
intermediation fell considerably more than did dealers' share did 
during 2020,\604\ but their share actually increased during the 2014 
flash rally \605\ and again during March 2023.\606\ Many commenters 
said that the final rules would reduce market liquidity, especially in 
the market for

[[Page 14994]]

U.S. Government securities.\607\ These commenters said that affected 
parties would curtail or cease the trading activities described in the 
final rule rather than submit to dealer registration.\608\ Two 
commenters also said that the costs of dealer registration, especially 
the Net Capital Rule, would lead affected parties to curtail their 
trading even if they were to register as dealers and continue 
dealing.\609\ Also, if affected parties experience rapid changes in 
their amounts of liquid assets or unsubordinated liabilities, the 
requirement to maintain minimum net capital could prevent them from 
providing liquidity even if it would be profitable to do so.\610\ One 
commenter said that the costs of dealer registration are a barrier to 
participation in the U.S. Treasury market.\611\ Another commenter said 
that the costs of the Net Capital Rule might make it more costly for 
firms to employ capital in trading U.S. Government securities.\612\ For 
instance, when a ``parent'' firm has the option to contribute capital 
to any of its trading businesses (``subsidiaries''), one commenter 
added that the effects of applying the Net Capital Rule to these 
entities might directly harm liquidity in government securities by 
making it more costly for the parent entity to ``opportunistically'' 
deploy capital internally.\613\
---------------------------------------------------------------------------

    \603\ See section III.B.2.b for why we believe HFT is the most 
likely private fund activity to fit the final rules' factors. See 
also 2015 Joint Staff Report, stating that low latency trading--
i.e., HFT--is ``typically [a] key element of trading strategies'' 
for PTFs. For a survey of the literature on HFT, see Albert J., 
2016, The Economics of High-Frequency Trading: Taking Stock, Annual 
Review of Financial Economics (8), 1-24. See also Brogaard, 
Jonathan, Allen Carrion, Thibaut Moyaert, Ryan Riordan, Andriy 
Shkilko, Konstantin Sokolov, 2018, High Frequency Trading and 
Extreme Price Movements, Journal of Financial Economics 128(2), 253-
265; ``Fast and Furious,'' 11/20/2018, J.P. Morgan North America 
Fixed Income Strategy; ``Revisiting the Ides of March, Part I: A 
Thousand Year Flood,'' Council on Foreign Relations (July 20, 2020), 
available at https://www.cfr.org/blog/revisiting-ides-march-part-i-thousand-year-flood; Better Markets Comment Letter.
    \604\ See supra notes 21 and 443.
    \605\ See 2015 Joint Staff report.
    \606\ See supra note 447.
    \607\ See AIMA Comment Letter II; BlackRock Comment Letter; 
Duffie Comment Letter, FIA-PTG Comment Letter; Hagerty-Hill Comment 
Letter; IDTA Comment Letter; Lewis Study; MMI Comment Letter; Morgan 
Lewis Comment Letter; Virtu Comment Letter. See also section 
III.C.2.b for a discussion of the Duffie Comment Letter, including 
the Net Capital Rule's potential impact on market participants' 
trading activity.
    \608\ See supra note 62.
    \609\ See MFA Comment Letter II; Citadel Comment Letter.
    \610\ Dealers that violate the Net Capital Rule by having too 
few liquid assets relative to unsubordinated liabilities, at any 
moment, must immediately cease taking on new positions.
    \611\ See Overdahl Comment Letter.
    \612\ See Duffie Comment Letter.
    \613\ See Duffie Comment Letter.
---------------------------------------------------------------------------

    We acknowledge that the final rules could have the effect of 
reducing liquidity. Affected parties may respond by curtailing their 
liquidity-providing activities. If the final rules reduce affected 
parties' profitability, then investors in those entities may reduce 
their market participation as well.\614\ A decrease in the activities 
of liquidity-providing entities and their investors would harm market 
liquidity. Because some PTFs have become especially prominent 
intermediaries in the market for U.S. Government securities, any harm 
to market liquidity may be more pronounced in that market.\615\
---------------------------------------------------------------------------

    \614\ See Two Sigma Comment Letter I.
    \615\ This potential reduction in liquidity may occur despite 
the improvement to the liquidity of the U.S. Treasury securities 
market that may result from increased central clearing. See section 
III.C.1.b.
---------------------------------------------------------------------------

    We conclude that any potential harm to market liquidity is likely 
to be smaller than commenters suggested because the final rules will 
likely affect fewer entities than the proposed rule, due to the 
elimination of the proposed first qualitative factor \616\ and the 
elimination of aggregation.\617\ We also believe that any harm to 
liquidity is likely to be limited for the following reasons. First, if 
affected persons reduce their trading and bid-ask spreads meaningfully 
widen, then other registered dealers may compete with one another to 
trade on the wider spreads. The additional buying and selling by these 
other dealers would offset some of the liquidity lost as the affected 
persons withdrew from dealing. Second, if significant liquidity 
providers that are better capitalized are also less volatile during 
times of crisis, then the final rules may promote the stability and 
resiliency of market liquidity by consistently applying the Net Capital 
Rule. Third, section III.B.4 describes how the failure of a significant 
liquidity provider can harm market functioning. These final rules will 
reduce the risk that a significant liquidity provider fails, and so 
they should also limit the harm such failure may have on market 
liquidity.
---------------------------------------------------------------------------

    \616\ See section II.A.1.a.
    \617\ See section II.A.4.
---------------------------------------------------------------------------

    The following analysis of Form PF data sheds light on how the final 
rules' effect on private funds might, in turn, reduce market 
liquidity.\618\ Registered investment advisers report the monthly 
turnover \619\ across all their funds, in each of 10 different asset 
classes. As discussed in section III.B.2.b, private fund activities 
reported as HFT are the most likely to be affected by the final rules. 
Table 11 describes the turnover for the advisers associated with funds 
that use HFT for the most recently reported month between 2021-Q4 and 
2022-Q3 (see also Table 3). The left column describes the advisers for 
the 40 funds listed in Table 3 as using less than 10% of NAV for HFT, 
and the right column describes the advisers for the 12 funds listed as 
using more than 10%. The second row lists the total number of funds 
with these advisers (including funds that do not have any reported 
HFT), and the third row lists the total NAV of all of these funds. As 
described above in the context of Table 3, we use Form PF data to 
translate each fund's HFT use (reported as a percentage of NAV) into 
dollar amounts. The fourth row of Table 11 divides the total HFT use 
across these advisers by the total NAV of all the advisers' funds, to 
express an adviser-level percentage use of HFT. The remaining rows 
report the total turnover for these advisers during the most recent 
month in their most recent filings between 2021-Q4 and 2022-Q3. No 
adviser appears in both columns.
---------------------------------------------------------------------------

    \618\ The Overdahl Comment Letter recommended that the 
Commission examine the liquidity contribution made by persons who 
would be affected by the proposed rule (esp. see paragraph 43).
    \619\ Question 27 of Form PF defines turnover as ``the sum of 
the absolute values of transactions in the relevant asset class 
during the period.''

 Table 11--Turnover for Advisers of Funds Using HFT Strategies, for Most
                Recent Month Between 2021-Q4 and 2022-Q3
------------------------------------------------------------------------
                                    Funds with HFT      Funds with HFT
                                     <=10% of NAV         >10% of NAV
------------------------------------------------------------------------
Advisers over funds using HFT...                  21                  10
Total funds with these advisers.                 178                  23
Total NAV ($ billions)..........              $210.6               $63.2
HFT (as % of adviser total NAV).             0%-6.1%         14.1%-64.0%
Turnover ($ billions):
    Listed equity...............            $1,511.3              $193.8
    Corp. bonds (other than                     66.3                 7.6
     convertible)...............
    Convertible bonds...........                 4.3                 1.3
    U.S. Treasury securities....               423.1                78.6
    Agency securities...........                11.0                 3.4

[[Page 14995]]

 
    GSE bonds...................                15.7                 9.6
    Sov. bonds (non-U.S. G10)...               119.6                41.6
    Other sovereign bonds.......                50.6                 2.4
    U.S. state & local bonds....                 0.8                 0.6
    Futures.....................             2,709.3             1,366.1
------------------------------------------------------------------------

    As described in section III.B.2.c, the advisers in the left column 
may be less likely than those in the right column to have funds that 
meet the final rules' definition of dealing. To put the turnover 
numbers in context, total equity trading volume across all U.S. 
exchanges averaged about $12 trillion per month in 2022,\620\ and total 
U.S. Treasury market volume was approximately $17 trillion in October 
2023.\621\ Therefore, the advisers in the left column may account for 
approximately 12.6% of equity market volume and 1.6% of Treasury market 
volume, and the advisers in the right column may account for another 
2.5% of equity volume and 0.5% of Treasury volume. For the following 
reasons, we expect any curtailing of affected activities to reduce 
trading volumes by much less than these numbers. First, for the 
advisers in the left column that may be less likely to have any 
affected funds, only 0%-6% of the advisers' total NAV was used for HFT. 
Second, for the advisers in both columns, the final rules may not apply 
to all the activities that advisers report as HFT on Form PF. Third, 
affected private funds that do cease certain HFT activities may 
redeploy their capital to alternate trading strategies and thus keep 
the capital engaged in the markets. Fourth, if falling trading volumes 
were to cause bid-ask spreads to meaningfully widen, other registered 
dealers might increase their own buying and selling and so replace some 
of the lost activity.
---------------------------------------------------------------------------

    \620\ See Cboe, Historical Market Volume Data, available at 
https://www.cboe.com/us/equities/market_statistics/historical_market_volume/.
    \621\ See FINRA, Treasury Monthly Aggregate Statistics, 
available at https://www.finra.org/finra-data/browse-catalog/about-treasury/monthly-data.
---------------------------------------------------------------------------

    We also analyze entities' trading volumes in TRACE data to estimate 
how much liquidity affected parties may provide in the market for U.S. 
Government securities. For each government security CUSIP in TRACE in 
2022, we calculate trading volume in the interdealer market \622\ and 
calculate the share of that volume attributable to identifiable \623\ 
non-broker-dealers. Figure 3 shows, for each CUSIP, what the 
interdealer volume was in 2022 along with the share of that volume 
attributable to (i) all non-broker-dealers and (ii) the subset of non-
broker-dealers identified in TRACE as PTFs. We do not show the shares 
for firms identified as hedge funds because the shares are generally 
quite low.
---------------------------------------------------------------------------

    \622\ See supra note 430.
    \623\ See supra note 380.
    [GRAPHIC] [TIFF OMITTED] TR29FE24.002
    
    The values for ``% interdealer volume'' in Figure 3 may be biased 
downwards by any non-broker-dealers that trade on Treasury ATSs by 
submitting orders through broker-dealers, because TRACE would attribute 
such trades to the broker-dealer and the ultimate buyer or seller would 
remain anonymous. However, this bias will be

[[Page 14996]]

smaller for CUSIPs that PTFs are most likely to trade on the most 
active Treasury ATSs--generally the higher-volume CUSIPs--because PTFs 
involved in such trades are not anonymous in our data. Identifiable 
non-broker-dealer PTFs account for more than 10% of interdealer volume 
in approximately 11% of CUSIPs and for more than 25% of volume in 1.6% 
of CUSIPs, but for no CUSIPs do they account for more than 40% of the 
volume in 2022.
    The TRACE analysis is limited by the large volume of trading where 
the counterparty to the reporting broker-dealer is anonymous.\624\ 
However, we understand that entities that regularly provide liquidity 
in U.S. Government securities markets are likely to appear in our data, 
because they are likely to trade on the ATSs that report to TRACE.
---------------------------------------------------------------------------

    \624\ See id.
---------------------------------------------------------------------------

    Commenters said that the proposed rules would harm liquidity in 
markets for crypto assets.\625\ We acknowledge that the final rules may 
affect PTFs in crypto asset markets, but some significant liquidity 
providers in these markets may already be dealers under the Exchange 
Act.\626\ If affected PTFs curtail their crypto asset trading 
activities, then trading volumes in crypto asset markets could fall, 
harming the liquidity and efficiency of these markets.
---------------------------------------------------------------------------

    \625\ See Blockchain Association Comment Letter; American 
Blockchain PAC Comment Letter; Andreessen Horowitz Comment Letter; 
ADAM Comment Letter; U.S. Reps. Comment Letter.
    \626\ See section III.B.2.c.
---------------------------------------------------------------------------

3. Effects on Efficiency, Competition, and Capital Formation
a. Effects on Efficiency
    The previous section explains why we believe the final rules could 
have a small negative effect on market liquidity. More liquid markets 
tend to be more efficient markets since they allow new information to 
influence securities prices more quickly. Therefore, we also expect 
that the final rules could have a small negative effect on market 
efficiency, especially in the market for U.S. Government 
securities.\627\ However, as discussed in section III.C.1.b, adequately 
capitalized firms \628\ may be less sensitive to market disruptions 
that could otherwise reduce their capacity to provide liquidity. 
Therefore, to the extent that the final rules lead to better 
capitalization for significant liquidity providers, the final rules 
could also promote market efficiency.
---------------------------------------------------------------------------

    \627\ By ``efficiency,'' here we mean price discovery, or the 
speed with which new information or developments impact the market 
price of a security.
    \628\ PTFs' risk-taking is currently less constrained than that 
of registered broker-dealers (see section III.B.2.a). For evidence 
that hedge funds may have less capital than the Net Capital Rule 
allows, see supra notes 438 and 468 and accompanying text.
---------------------------------------------------------------------------

b. Effects on Competition
    Section III.C.1.a describes how the final rules will promote 
competition among entities that regularly provide significant liquidity 
by applying consistent regulation to these entities, thus leveling the 
competitive playing field between liquidity provision conducted by 
entities that are currently registered as dealers and government 
securities dealers and by entities that are not. The section also 
discusses how the final rules' costs may be proportionally greater for 
smaller affected parties, which may reduce the overall benefits to 
competition. Commenters also raised concerns that the final rules could 
harm competition. We respond to these concerns in the paragraphs below, 
but, in general, any negative effect on the competitiveness of 
liquidity provision in U.S. securities markets would likely be small 
because, as discussed in section III.B.3 (including Table 4 for the 
U.S. Treasury market), liquidity provision in securities markets is not 
concentrated, even among currently registered broker-dealers. The final 
rules may also affect some PTFs who conduct smaller trading volumes but 
nevertheless fit the final rules' qualitative factor, and such PTFs may 
choose to cease their liquidity-providing activities. Because such PTFs 
would be less significant liquidity providers on account of their 
smaller volumes, and because currently registered broker-dealers are 
not concentrated, we expect that any exit of theirs from the market 
would have a negligible effect on the competitiveness of liquidity 
provision in U.S. securities markets.
    One commenter said that the final rules could put U.S. liquidity 
providers at a disadvantage versus foreign firms.\629\ However, other 
than central banks, foreign sovereign entities, and international 
financial institutions (as defined in the final rules), foreign firms 
that deal in U.S. markets are not excluded from the final rules. 
Therefore, we do not expect the final rules to create competitive 
disadvantages for U.S. liquidity providers. Finally, any competitive 
disadvantages that these final rules may create would already be borne 
by currently registered dealers.
---------------------------------------------------------------------------

    \629\ See Overdahl Comment Letter.
---------------------------------------------------------------------------

    One commenter said that the final rules would harm competition by 
requiring some private funds to register but not others.\630\ The final 
rules would apply a similar regulatory treatment to persons conducting 
similar activities in securities markets, regardless of the persons' 
legal organization or structure. The final rules may treat some private 
funds differently from others, but only in cases where those private 
funds engage in activities that have different characteristics than 
other funds' activities.
---------------------------------------------------------------------------

    \630\ See Citadel Comment Letter.
---------------------------------------------------------------------------

    Another commenter said that the proposed rules would not have 
leveled the playing field because too many non-dealing entities would 
have been swept up by the proposed quantitative factor, by ambiguity in 
the proposed qualitative factors (e.g., ``the same or substantially 
similar securities'') and by the aggregation language.\631\ The 
Commission has responded to these concerns by removing the proposed 
quantitative factor and the proposed first qualitative factor and by 
removing the aggregation provisions. With these changes, the final 
rules are more appropriately targeted to persons who are effectively 
dealers.
---------------------------------------------------------------------------

    \631\ See Virtu Comment Letter.
---------------------------------------------------------------------------

    Two commenters said that the proposed rules would harm competition 
in crypto asset markets.\632\ The effect on competition in crypto asset 
markets would be similar to the effects on competition already 
discussed for other markets.\633\
---------------------------------------------------------------------------

    \632\ See Andreessen Horowitz Comment Letter; Consensys Comment 
Letter.
    \633\ We believe that some primary liquidity providers in crypto 
asset markets may already be dealers under the Exchange Act. See 
section III.B.2.c and supra note 626 and accompanying text.
---------------------------------------------------------------------------

    In addition, as stated above, some commenters requested that the 
Commission consider interactions between the economic effects of the 
proposed rules and other recent Commission rules, as well as practical 
realities such as implementation timelines.\634\ As discussed above, 
the Commission acknowledges that overlapping compliance periods may in 
some cases increase costs.\635\ This may be particularly true for 
smaller entities with more limited compliance resources.\636\ This 
effect can negatively impact some competitors because these entities 
may be less able to absorb or pass on these additional costs, making it 
more difficult for them to remain in business or compete. However, the 
final rules mitigate overall costs relative to

[[Page 14997]]

the proposal,\637\ and we do not believe these increased compliance 
costs will be significant for most affected parties subject to the 
final rules.\638\ We therefore do not expect the risk of negative 
competitive effects from increased compliance costs due to simultaneous 
compliance periods to be significant.
---------------------------------------------------------------------------

    \634\ See supra section III.C.2.a.v.
    \635\ Id.
    \636\ But see infra section V (stating that the final rules will 
not have a significant economic impact on a substantial number of 
small entities for purposes of the Regulatory Flexibility Act).
    \637\ See supra section II.A.3.
    \638\ See supra section III.C.2.a.v.
---------------------------------------------------------------------------

c. Effects on Capital Formation
    We expect the final rules' effect on capital formation to be mixed. 
As described above in sections III.C.2.d and III.C.3.a, we agree with 
commenters \639\ that the final rules could have small negative effects 
on market liquidity and efficiency. Lower liquidity and efficiency 
would tend to harm capital formation by reducing security prices and 
raising yields.
---------------------------------------------------------------------------

    \639\ See supra note 607.
---------------------------------------------------------------------------

    The final rules will also promote market stability, resiliency, and 
investor confidence by helping to ensure that dealing activity is 
adequately capitalized, subject to regulatory oversight, and 
accompanied by regulated internal controls and deterrents to deceptive 
behaviors. More stable markets and strengthened investor confidence in 
U.S. markets may promote capital formation by increasing demand for 
securities issued in U.S. markets, raising security prices, and 
lowering yields. One commenter agreed that the ``overall effects [on 
market participation, market liquidity, price efficiency, competition 
among liquidity providers, and capital formation] are positive.'' \640\
---------------------------------------------------------------------------

    \640\ See Gretz Comment Letter.
---------------------------------------------------------------------------

D. Reasonable Alternatives

    The Commission considered several alternatives to the final rules: 
(1) retain the quantitative factor; (2) add a quantitative threshold to 
the proposed first qualitative factor; (3) remove the exclusion for 
registered investment companies; (4) exclude registered investment 
advisers and private funds; (5) require registered investment advisers 
and private funds to report to TRACE (rather than comply with the full 
set of dealer rules and regulations); and (6) revise the final rules to 
carve out or narrow the application to crypto asset securities.
1. Retain the Quantitative Standard
    Proposed Rule 3a44-2 would have required dealer registration of 
persons who purchased and/or sold a total of at least $25 billion in 
U.S. Government securities in each of 4 out of the last 6 months. The 
Commission proposed the particular threshold value because available 
data suggested that $25 billion would appear to strike a balance 
between low values, which may affect many small-volume traders who are 
not dealing, and high values, which may miss entities whose activities 
provide significant liquidity in the market.\641\ Some commenters said 
the analysis behind the proposed quantitative factor was flawed due to 
the limitations of TRACE data and the assumptions the Commission 
used.\642\ In section III.B.2.d, we discuss the limitations of TRACE 
data. Based on comments received, we acknowledge that identifiable 
TRACE data may not represent trading patterns in the dealer-to-customer 
market. This conclusion heightens the already high uncertainty around 
where to set the value of such a threshold.
---------------------------------------------------------------------------

    \641\ See Proposing Release at 23092-93.
    \642\ See Citadel Comment Letter; MFA Comment Letter I; NAPFM 
Comment Letter; Overdahl Comment Letter.
---------------------------------------------------------------------------

    Market participants who would meet the quantitative standard by 
regularly conducting large volumes of securities trading activity would 
likely also meet the expressing trading interest and primary revenue 
factors. The overlap may exist either because large trading volumes 
accompany expressions of trading interest in line with the expressing 
trading interest factor or because significant liquidity-providers that 
earn revenue from capturing bid-ask spreads or from capturing any 
incentives offered by trading venues (primary revenue factor) also tend 
to have large trading volumes.
    Table 12 approximates the overlap between the proposed quantitative 
factor and the primary revenue factor by sorting identifiable firms 
based on their average monthly Treasury-trading volume in 2022 and then 
showing how many firms in each volume bucket appear to meet or not meet 
the primary revenue factor (i.e., firms that appear in the left-most 
bar in Figure 2). This table counts firms based on their average 
monthly volume--which does not precisely match the ``4 out of the past 
6 months'' in the proposed quantitative factor--but average monthly 
volume is sufficient to indicate the extent to which firms whose 
activities meet the primary revenue factor also have large trading 
volumes.

   Table 12--Overlap Between Quantitative Standard and Primary Revenue
                                 Factor
------------------------------------------------------------------------
                                     # firms meeting      # firms not
 Average monthly trading volume in   primary revenue    meeting primary
               2022                       factor         revenue factor
------------------------------------------------------------------------
<$10 billion......................                  4                174
$10-25 billion....................                  8                 18
$25-50 billion....................                  7                  6
$50-100 billion...................                  2                  3
$100 billion or higher............                 10                  0
------------------------------------------------------------------------

    The quantitative factor could support the final rules in applying 
dealer registration to entities that provide significant liquidity, by 
specifically including the most active market participants (unless 
excluded). The bright-line test in the quantitative factor also could 
reduce self-evaluation costs for persons who regularly surpass the 
threshold, but it would not reduce the self-evaluation costs of persons 
who do not regularly surpass the threshold because such persons would 
still have to consider the expressing trading interest and primary 
revenue factors.
    The quantitative factor would potentially increase the costs of the 
final rules because the quantitative standard may apply to a greater 
number of entities.\643\ This factor would have the potential to affect 
persons who are not dealing, because it would not consider any other 
facts and circumstances other than total transaction volume. For 
example, a hypothetical long-only investor that regularly purchased $25 
billion Treasuries in a month and held them to maturity, would be 
defined as a dealer under this alternative. Many commenters said that 
the $25 billion

[[Page 14998]]

quantitative factor had a threshold that was too low or was otherwise 
not indicative of dealing.\644\ We agree that the $25 billion threshold 
could capture persons who are not dealing. This alternative would 
potentially burden non-dealers with the costs of registration and 
compliance, could harm their investors by lowering returns, and could 
potentially harm market liquidity, efficiency, competition, and capital 
formation if affected persons were to reduce their trading below the 
$25 billion threshold to avoid becoming dealers.
---------------------------------------------------------------------------

    \643\ See supra notes 203-204.
    \644\ See AIMA Comment Letter II; AIMA Comment Letter III; 
Citadel Comment Letter; Committee on Capital Markets Comment Letter; 
Element Comment Letter; FIA PTG Comment Letter I; Fried Frank 
Comment Letter; ICI Comment Letter; Lewis Study; MFA Comment Letter 
I; MFA Comment Letter II; NAPFM Comment Letter; Overdahl Comment 
Letter; SIFMA Comment Letter I; T. Rowe Price Comment Letter; Two 
Sigma Comment Letter I. A few commenters calculated that $25 
billion, as a fraction of average daily activity in the U.S. 
Treasury market, may be as small as approximately 0.2%.
---------------------------------------------------------------------------

    Given that the quantitative factor is unlikely to capture dealing 
activity that is not also captured by the expressing trading interest 
and primary revenue factors, and given the additional costs of 
requiring entities who are not dealing to register as dealers, the 
Commission has removed the quantitative standard from the final 
rules.\645\
---------------------------------------------------------------------------

    \645\ The MFA Comment Letter I said that the quantitative factor 
would be redundant with the qualitative factors.
---------------------------------------------------------------------------

2. Retain the First Qualitative Standard (e.g., ``Routinely Making 
Roughly Comparable Purchases and Sales of the Same or Substantially 
Similar Securities [or Government Securities] in a Day'')
    The Commission has long distinguished dealer activity from trader 
activity by focusing on, among other things, a dealer's frequent 
turnover of positions--stating, for example, that the dealer ``sells 
securities . . . he has purchased or intends to purchase elsewhere or 
buys securities . . . with a view to disposing of them elsewhere'' 
\646\ The proposed first qualitative factor was intended to describe 
activities that include such frequent turnover, and also to separate 
persons engaging in isolated or sporadic securities transactions from 
persons whose regularity of transacting demonstrates that they are 
acting as dealers.
---------------------------------------------------------------------------

    \646\ See U.S. Securities and Exchange Commission, Report on the 
Feasibility and Advisability of the Complete Segregation of the 
Functions of Dealer and Broker XIV (1936).
---------------------------------------------------------------------------

    Commenters raised concerns about the proposed first qualitative 
factor, saying that the factor's language was vague and that the factor 
could potentially capture significant non-dealing activities.\647\ 
Commenters suggested that the Commission modify the factor, limit it 
with exclusions, or eliminate it from the final rules.\648\ The 
Commission considered changes to the rule, including revising the terms 
``routinely,'' ``roughly comparable,'' or ``in a day, or changing the 
factor to require that dealing mean trading in the same security 
instead of in ``the same or substantially similar'' securities. Upon 
consideration, the Commission agrees with commenters' that the proposed 
first qualitative factor could capture more than dealing activity. The 
Commission also does not believe that modifications to this factor 
could appropriately limit its application to dealing activity, and 
dealing activity that would be captured by the factor would also likely 
be captured by at least one of the final rules' qualitative factors--
the trading interest factor and the primary revenue factor.
---------------------------------------------------------------------------

    \647\ See section II.A.1.a.
    \648\ See supra notes 74-76.
---------------------------------------------------------------------------

    Retaining the proposed first qualitative factor may improve 
regulators' ability to analyze data on market activity,\649\ if persons 
who would not otherwise be affected by the final rules (including 
persons who may not be dealing) were to submit to dealer registration. 
However, retaining this factor may also substantially increase the 
final rules' costs by capturing activities that are not dealing. To the 
extent that this factor would capture non-dealing, retaining it would 
require persons who are not dealing to either register as dealers and 
incur the costs described in section III.C.2, or else to cease certain 
non-dealing activities.
---------------------------------------------------------------------------

    \649\ See section III.C.1.c.
---------------------------------------------------------------------------

3. Remove the Exclusion for Registered Investment Companies
    The final rules exclude registered investment companies from the 
application of the rules, even if their activities meet the final 
rules' definition of dealing. The Commission could adopt the final 
rules without this exclusion, extending the rationale that all market 
participants engaged in activities that meet the final rules' 
definition of dealing, including registered investment companies, ought 
to register as dealers.
    Including investment companies in the application of the rule would 
provide additional benefits by applying dealer regulation to more 
significant liquidity providers. First, we believe that standardizing 
the regulatory treatment of all significant liquidity providers would 
be beneficial because, as discussed previously, the uneven regulation 
potentially gives less-regulated entities an unfair advantage over 
registered dealers that engage in similar activities. Specifically, 
this alternative would further standardize regulatory treatment of 
significant liquidity providers in terms of capitalization, transaction 
reporting, books and records requirements, and anti-manipulation and 
anti-fraud provisions.\650\ However, the benefits of registering 
investment companies that are engaged in dealing activity as dealers 
would be less than the benefits of registering PTFs that are engaged in 
dealing activity, because the existing regulation that applies to 
registered investment companies under the Investment Company Act 
overlaps with the regulation that applies to dealers on several 
points.\651\ For example, registered investment companies are subject 
to rules that limit leverage risk; \652\ they must maintain certain 
books and records; \653\ and they must report to the Commission on many 
aspects of their operations and their portfolio holdings.\654\ As 
discussed above and in the Proposing Release, the benefits of 
registering investment companies engaged in the rules' dealing activity 
as dealers would also be less than the benefits of registering private 
funds engaged in the rules' dealing activity, because private funds are 
not subject to the extensive regulatory

[[Page 14999]]

framework of the Investment Company Act.\655\
---------------------------------------------------------------------------

    \650\ See section III.B.4 for a discussion of the market 
externalities that such rules seek to address; see also section 
III.C.1 for a discussion on the benefits of such rules.
    \651\ See ICI Comment Letter.
    \652\ See 15 U.S.C. 80a-18 (Section 18 prohibits closed-end 
funds from issuing or selling senior securities that represent 
indebtedness unless it has at least 300% asset coverage, and open-
end funds from issuing or selling a senior security other than 
borrowing from a bank, which are also subject to 300% asset 
coverage, and defines ``senior security,'' in part, as ``any bond, 
debenture, note, or similar obligation or instrument constituting a 
security and evidencing indebtedness.''); 17 CFR 270.18f-4 (``Rule 
18f-4'') (generally requiring investment companies that use 
derivatives to adopt a derivatives risk management program that 
includes a limitation on leverage risk based on VaR). See also Use 
of Derivatives by Registered Investment Companies and Business 
Development Companies, Investment Company Act Release No. 34084 
(Nov. 2, 2021), 85 FR 83162 (Dec. 21, 2020).
    \653\ 15 U.S.C. 80a-30.
    \654\ Registered investment companies report certain census 
information annually to the Commission on Form N-CEN. Registered 
investment companies also are required to report monthly portfolio-
wide and position-level holdings data to the Commission on Form N-
PORT. This includes information regarding repurchase agreements, 
securities lending activities, and counterparty exposures, terms of 
derivatives contracts, and discrete portfolio-level and position-
level risk measures to better understand fund exposure to changes in 
market conditions.
    \655\ See supra notes 218-220 and accompanying text.
---------------------------------------------------------------------------

    Removing the exclusion for registered investment companies would 
increase the costs of the final rules. Affected investment companies 
would bear the costs of registering with the Commission as dealers, 
joining FINRA or another SRO, reporting to TRACE and CAT, and becoming 
a member of SIPC.\656\ They would also be required to comply with 
dealer rules on financial responsibility and risk management, 
operational integrity, and books and records.\657\ Complying with these 
rules may be inefficient in cases where elements of the Investment 
Company Act overlap with dealer regulation--i.e., where segments of the 
investment company rules and the dealer rules serve the same purpose 
but may entail different disclosure, recordkeeping, or other such 
actions.\658\ The regulatory regime that has evolved around dealers 
might also be inadequate or inappropriate for affected investment 
companies. For example, investment companies may be unable to comply 
with the Net Capital Rule without substantially reducing their 
investors' withdrawal rights.\659\
---------------------------------------------------------------------------

    \656\ See section III.C.2.a for a discussion of these costs.
    \657\ See supra notes 24, 26, and 27.
    \658\ See supra note 218.
    \659\ See supra notes 567 and 568 and accompanying text for a 
discussion of why the Net Capital Rule may necessarily restrict 
withdrawal rights of investors in a registered dealer.
---------------------------------------------------------------------------

    Instead of registering as dealers, affected investment companies 
could respond by curtailing or ceasing certain trading activities.\660\ 
Such a response would reduce the number of investment companies 
registering as dealers, and so would reduce or eliminate the benefits 
discussed above on net capital, transactions reporting, etc. The 
curtailing of profitable trading activities would also harm the 
affected investment companies and their investors. The changes in 
aggregate securities trading activity could also reduce market 
efficiency and liquidity, thus harming investors of all sizes 
throughout the markets. However, if the changes in market activity were 
to increase the profitability of certain activities (such as by 
increasing certain bid-ask spreads), then other registered dealers may 
increase their own trading activity and so offset at least some of the 
harm to market efficiency and liquidity.
---------------------------------------------------------------------------

    \660\ Commenters suggested that affected private funds would 
respond to the final rules' adoption in this way. See supra note 62.
---------------------------------------------------------------------------

    Commenters generally agreed with the exclusion for registered 
investment companies,\661\ and did not suggest any changes to the final 
rules' treatment of investment companies.
---------------------------------------------------------------------------

    \661\ See supra note 222.
---------------------------------------------------------------------------

4. Exclude Registered Investment Advisers and Private Funds
    Registered investment advisers and private funds may engage in 
activities that meet the final rules' definition of dealing. If so, the 
final rules would require them to register as dealers and comply with 
dealer regulations. Some commenters said that the Commission should 
exclude registered investment advisers, along with any private funds 
they may advise, from the final rules because the advisers are already 
subject to an extensive regulatory framework under the Advisers Act and 
because elements of the dealer regime--e.g., the Net Capital Rule, 
restrictions on participating in the IPO market--may be inappropriate 
or untenable for advisers and adviser-led funds.\662\ However, as 
stated in the Proposing Release, market participants that are engaged 
in dealing activity should be subject to dealer regulations. The 
Commission is mindful of concerns raised by commenters regarding the 
application of the dealer regime to investment advisers and private 
funds, and it has made significant changes to the definition of ``own 
account'' to remove the aggregation standard in order to appropriately 
tailor the scope of advisers and funds captured by the final 
rules.\663\
---------------------------------------------------------------------------

    \662\ See supra notes 223-229.
    \663\ See discussion of registered investment advisers and 
private funds in section II.A.3.b.
---------------------------------------------------------------------------

    Excluding registered investment advisers and their private fund 
clients could reduce many of the final rules' benefits by applying 
dealer regulation to fewer significant liquidity providers.\664\ 
Advisers or private funds whose activities have the effect of providing 
liquidity would not have to report transactions to TRACE or comply with 
the Net Capital Rule or other dealer rules that govern internal 
controls and are designed to prevent fraud or manipulation. Advisers 
would continue to be subject to the adviser regulations described in 
the baseline, including conduct rules, books and records requirements, 
reporting requirements, and examinations. If advisers and private funds 
would have responded to the final rules by curtailing their trading 
instead of registering as dealers, then excluding them from the rules 
may not substantially reduce the benefits described in section III.C.1.
---------------------------------------------------------------------------

    \664\ In section III.B.2.c, we identify up to 12 hedge funds 
that may be dealing under the final rules.
---------------------------------------------------------------------------

    This alternative would also reduce the final rules' benefit to 
competition, by failing to level the playing field between significant 
liquidity providers who are registered as dealers and significant 
liquidity providers who may be investment advisers or private funds. 
However, if the final rules would have a net negative impact on 
competition by deterring private funds and advisers from providing 
liquidity,\665\ then this alternative could reduce that negative impact 
by not deterring such liquidity provision.
---------------------------------------------------------------------------

    \665\ See section III.C.2.d.
---------------------------------------------------------------------------

    Excluding registered investment advisers and private funds would 
reduce the final rules' costs. Advisers and private funds who would 
otherwise be affected would not be required to register with the 
Commission as dealers, join FINRA or another SRO, report to TRACE and 
CAT, and become a member of SIPC.\666\ They would also not be required 
to comply with dealer rules on financial responsibility and risk 
management, operational integrity, and books and records.\667\ Since 
they would not be registered as dealers, they would not face dealer-
specific restrictions against participating in the IPO market. Since 
they would not be subject to the Net Capital Rule, they would also not 
need to consider restricting their investors' withdrawal rights in 
order to comply with that rule.\668\ If the costs of dealer 
registration and compliance would have lowered returns for investors in 
private funds, then this alternative would also reduce the harm to 
investors.
---------------------------------------------------------------------------

    \666\ See section III.C.2 for a discussion of these costs.
    \667\ See supra note 27.
    \668\ See supra notes 567 and 570.
---------------------------------------------------------------------------

    Excluding private funds would also limit the final rules' effects 
on market liquidity, efficiency, competition, and capital formation, 
since it would affect fewer parties who could respond by curtailing 
their trading activities. Section III.C.2.d describes how such a 
response could harm market liquidity and efficiency as well as how 
reductions in funds' profitability could reduce investor participation 
in the market. If advisers and private funds were excluded, then they 
would not respond in this way, and so any potential negative impact of 
such curtailing on market functioning or investor participation could 
be less than under the final rules.
    Excluding advisers and private funds may allow current or future 
significant liquidity providers to avoid the dealer regime by 
registering as advisers. Commenters argued that principal

[[Page 15000]]

trading firms are unlikely to attempt to avoid the dealer regime in 
this way.\669\ Though firms would incur significant costs to reorganize 
their business and register as advisers, an exclusion would 
nevertheless allow for the possibility. The possibility concerns us 
because, as discussed above and in the Proposing Release, registered 
investment advisers and private funds that are engaged in dealing 
activity should be subject to the dealer regulatory regime.\670\
---------------------------------------------------------------------------

    \669\ See IAA Comment Letter I; AIMA Comment Letter II; MFA 
Comment Letter I; T. Rowe Price Comment Letter.
    \670\ See sections II.A.3, III.B.3, and III.C.1; Proposing 
Release at 23078-79.
---------------------------------------------------------------------------

5. Require Registered Investment Advisers and Private Funds To Report 
to TRACE
    As described above, private funds and private fund advisers not 
registered as dealers are not subject to the requirement to report 
transactions to TRACE. Rather than requiring liquidity-providing 
investment advisers and private funds to register as dealers, the 
Commission could instead require them to report their transactions to 
TRACE as if they were members of FINRA, without submitting to the other 
requirements of the dealer regime.\671\ This alternative would fall 
short of applying other important elements of the dealer regime that 
mitigate the problems discussed in sections III.B.3 and III.B.4. These 
important elements of the dealer regime include the Net Capital 
Rule,\672\ Exchange Act section 15(c),\673\ and SRO membership.\674\ 
Therefore, this alternative would not adequately address the potential 
for negative externalities discussed in section III.B.3 in the 
baseline. However, the alternative would eliminate, for affected 
registered investment advisers and private funds, the final rules' 
registration and compliance costs other than the costs of self-
evaluation and of reporting to TRACE.\675\
---------------------------------------------------------------------------

    \671\ See Overdahl Comment Letter (stating ``To the extent that 
the SEC does identify any material informational gaps, the SEC could 
explore whether additional recordkeeping requirements are 
appropriate.'').
    \672\ See section III.C.1.a.
    \673\ See supra note 396 and surrounding text.
    \674\ See sections III.C.1.a and III.C.1.d. See also FINRA 
Comment Letter.
    \675\ See cost discussions in section III.C.2 for a detailed 
discussion of TRACE, self-evaluation, and other costs. The 
Commission estimates the initial combined cost of self-evaluation 
and TRACE reporting is at most approximately $600,000. This estimate 
is the sum of the initial cost estimate for TRACE reporting, which 
is $2,000, and the initial cost estimate for self-evaluation, which 
is up to $600,000. The combined initial costs' sum is $602,000, 
which we round to $600,000 to reflect uncertainty in our estimate of 
these combined costs. The Commission estimates the ongoing costs for 
TRACE reporting and self-evaluation are approximately $100,000. This 
ongoing cost estimate is the sum of the $100,000 annual expense 
estimate for TRACE reporting and a $0 annual expense for self-
evaluation. The Commission expects few firms' trading operations to 
change sufficiently to merit ongoing self-evaluations because of the 
substantial investments in human-, technological-, and financial 
capital necessary to start a trading operation that satisfies the 
criteria necessary for registration as a dealer under the adopted 
rules.
---------------------------------------------------------------------------

6. Carve Out or Narrow Application to Crypto Asset Securities
    As described in section II.A.3 above, the Commission received 
comments regarding the application of the proposed rules to crypto 
asset securities. Commenters requested that if the Commission were to 
move forward with adopting the proposed rules, the Commission revise 
the final rules to carve out or narrow the application to crypto asset 
securities.\676\ For example, one commenter asserted that without an 
exclusion for digital assets, the proposed rules would hinder 
innovation, competition, and capital formation in the U.S.\677\ Another 
commenter stated that the Commission should limit the scope of the 
proposed rules to persons transacting in the U.S. Treasury and listed 
equity markets, for which the Commission has adequate data, and that to 
the extent the Commission intends to address digital assets, it should 
do so as part of a multi-agency approach and in consultation with 
Congress.\678\ Consistent with the comments received, the Commission 
has considered an alternative that would treat crypto asset securities 
differently from other types of securities under the final rules.
---------------------------------------------------------------------------

    \676\ See, e.g., Andreessen Horowitz Comment Letter; DeFi 
Foundation Comment Letter; ADAM Comment Letter; Gretz Comment 
Letter.
    \677\ See ADAM Comment Letter.
    \678\ See DeFi Fund Comment Letter.
---------------------------------------------------------------------------

    As noted in section II.A.3, the definitions of ``dealer'' and 
``government securities dealer'' under sections 3(a)(5) and 3(a)(44) of 
the Exchange Act, and the requirement that dealers and government 
securities dealers register with the Commission pursuant to sections 15 
and 15C of the Exchange Act, apply to dealers in all securities or 
government securities, including crypto asset securities. Rules 3a5-4 
and 3a44-2, as adopted, apply to any person transacting in securities 
or government securities, irrespective of where, or the technology 
through which, the security or government security trades.
    The Commission is not changing this longstanding historical 
application of the Federal securities laws to securities, including 
crypto assets that are securities. After consideration of comments, the 
Commission continues to believe that Rules 3a5-4 and 3a44-2 apply to 
persons transacting in crypto assets that meet the definition of 
``securities'' or ``government securities'' under the Exchange Act. As 
discussed above, certain persons engaging in crypto asset securities 
transactions may be operating as dealers as defined under the Exchange 
Act.\679\ The dealer framework is a functional analysis based on the 
securities trading activities undertaken by a person, not the type of 
security being traded.\680\ Regardless of the technology used, if a 
person meets the expressing trading interest and primary revenue 
factors in the final rules, the application of the dealer regulatory 
regime to that person's activities \681\ will be beneficial and 
critical to promoting the Commission's mission.
---------------------------------------------------------------------------

    \679\ See section II.A.3.
    \680\ Id.
    \681\ See section III.C.1.
---------------------------------------------------------------------------

    If the Commission were to revise the final rules to carve out or 
narrow the application to market participants who transact in crypto 
asset securities, that alternative would reduce costs for such market 
participants who are not dealers under current law and who, absent an 
exemption, would be required to register as dealers under the final 
rules. The alternative would also reduce the benefits of the final 
rules, discussed in section III.C.1, since it would not apply the 
dealer regime to market participants that provide liquidity in crypto 
asset securities markets.
    The alternative could also have negative competitive effects, since 
certain market participants that deal in crypto asset securities would 
be exempted from registering as dealers, while market participants that 
deal in other types of securities would not enjoy such an exemption.

IV. Paperwork Reduction Act

    The new definitions adopted in this document do not, in and of 
themselves, contain ``collection of information'' requirements within 
the meaning of the Paperwork Reduction Act of 1995 (``PRA'').\682\ 
However, they may increase the number of respondents for collection of 
information requirements in other Commission rules. Specifically, the 
rules may increase the number of respondents for fourteen Commission 
rules with existing collections of information. These are explained in 
more detail below. An agency may not conduct or sponsor, and a person 
is not required to respond to, a collection of information unless the 
agency displays a currently valid control number. The

[[Page 15001]]

Commission has submitted change requests to the Office of Management 
and Budget (``OMB'') to update the number of respondents for these 
fourteen rules. The titles of these existing collections of information 
are:
---------------------------------------------------------------------------

    \682\ 44 U.S.C. 3501 et seq.

------------------------------------------------------------------------
                                                             OMB control
               Rule                       Rule title             No.
------------------------------------------------------------------------
17 CFR 240.15b1-1 (``Rule 15b1-    Application for             3235-0012
 1'') and 17 CFR 249.501 (``Form    registration of brokers
 BD'').                             or dealers.
17 CFR 240.15Ca1-1 (``Rule 15Ca1-  Notice of government
 1'') and Form BD.                  securities broker-
                                    dealer activities.
17 CFR 240.15Ca2-1 (``Rule 15Ca2-  Application for
 1'') and Form BD.                  registration of
                                    government securities
                                    brokers or government
                                    securities dealers.
17 CFR 240.15b3-1 (``Rule 15b3-    Amendments to
 1'') and 17 CFR 400.5 (``Rule      application.
 400.5'').
17 CFR 240.15b6-1 (``Rule 15b6-    Withdrawal from             3235-0018
 1'') and 17 CFR 249.501a (``Form   registration.
 BDW'').
17 CFR 240.15Cc1-1 (``Rule 15Cc1-  Withdrawal from
 1'') and Form BDW.                 registration of
                                    government securities
                                    brokers or government
                                    securities dealers.
17 CFR 240.15c2-7 (``Rule 15c2-    Identification of           3235-0479
 7'').                              quotations.
17 CFR 240.15c3-1 (``Rule 15c3-    Net capital requirements    3235-0200
 1'').                              for brokers and dealers.
17 CFR 240.15c3-5 (``Rule 15c3-    Risk management controls    3235-0673
 5'').                              for brokers or dealers
                                    with market access.
17 CFR 240.17a-3 (``Rule 17a-3'')  Records to be made by       3235-0033
                                    certain exchange
                                    members, brokers, and
                                    dealers.
17 CFR 240.17a-4 (``Rule 17a-4'')  Records to be preserved     3235-0279
                                    by certain members,
                                    brokers, and dealers.
17 CFR 240.17a-5 (``Rule 17a-5'')  Reports to be made by       3235-0123
                                    certain exchange
                                    members, brokers and
                                    dealers.
17 CFR 240.17a-11 (``Rule 17a-     Notification provisions     3235-0085
 11'').                             for brokers and dealers.
17 CFR 242.613 (``Rule 613'')....  Consolidated audit trail    3235-0671
------------------------------------------------------------------------

A. Purpose and Use of the Collections of Information

    As stated above, new definitions adopted in this document do not 
create any new collections of information, but we believe they will add 
respondents to the 14 existing collections of information noted above. 
The collections of information applicable to the additional 
respondents,\683\ and the use of the information collected are 
summarized below.
---------------------------------------------------------------------------

    \683\ See section III.B above for a description of the 
categories of respondents.
---------------------------------------------------------------------------

1. Rules 15b1-1, 15Ca1-1, 15Ca2-1, 15b3-1, and 400.5 and Form BD
    Section 15(a)(1) of the Exchange Act provides that it is unlawful 
for persons who meet the definition of the term ``broker'' or 
``dealer'' to solicit or effect transactions in most securities unless 
they are registered as broker-dealers with the Commission pursuant to 
section 15(b) of the Exchange Act. Similarly, section 15C(a)(1) of the 
Exchange Act provides that it is unlawful for persons who meet the 
definition of the term government securities broker or government 
securities dealer, other than persons registered with the Commission as 
broker-dealers and certain financial institutions, to solicit or effect 
transactions in government securities unless they are registered with 
the Commission as government securities broker-dealers pursuant to 
section 15C(a)(2) of the Exchange Act. To implement these provisions, 
the Commission adopted Rules 15b1-1, 15Ca1-1, and 15Ca2-1 and Form BD. 
In addition, Rules 15b3-1 and 400.5 require that registered broker-
dealers and government securities broker-dealers submit an amended Form 
BD when information originally reported on Form BD changes or becomes 
inaccurate.
    The Commission uses the information disclosed by applicants in Form 
BD: (1) to determine whether the applicant meets the standards for 
registration set forth in the provisions of the Exchange Act; (2) to 
develop a central information resource where members of the public may 
obtain relevant, up-to-date information about broker-dealers and 
government securities broker-dealers, and where the Commission, other 
regulators, and SROs may obtain information for investigatory purposes 
in connection with securities litigation; and (3) to develop 
statistical information about broker-dealers and government securities 
broker-dealers. In addition, all information collected on Forms BD is 
public. The public may use this information to assist in determining 
whether to engage in business with a particular broker-dealer.
2. Rules 15b6-1 and 15Cc1-1 and Form BDW
    Section 15(b)(5) of the Exchange Act provides that any broker-
dealer may, upon such terms and conditions as the Commission deems 
necessary or appropriate in the public interest or for the protection 
of investors, withdraw from registration by filing a written notice of 
withdrawal with the Commission. Similarly, section 15C(c)(1)(B) of the 
Exchange Act provides that any registered government securities broker 
or government securities dealer may, upon such terms and conditions as 
the Commission may deem necessary in the public interest or for the 
protection of investors, withdraw from registration by filing a written 
notice of withdrawal with the Commission. To implement these statutory 
provisions of the Exchange Act, the Commission promulgated Rules 15b6-1 
and 15Cc1-1 and Form BDW (the uniform request for broker-dealer 
withdrawal).
    The Commission uses the information disclosed by applicants in Form 
BDW, as required by Rules 15b6-1, 15Bc3-1, and 15Cc1-1 to: (1) 
determine whether it is in the public interest to permit broker-dealers 
and notice-registered broker-dealers to withdraw from registration; (2) 
develop central information resources where the Commission and other 
government agencies and SROs may obtain information for investigatory 
purposes in connection with securities litigation; and (3) develop 
statistical information about broker-dealers, notice-registered broker-
dealers, municipal securities dealers, and government securities 
broker-dealers.

[[Page 15002]]

3. Rule 15c2-7
    The Commission adopted Rule 15c2-7 in 1964 to improve the 
reliability and transparency of the quotations broker-dealers submit to 
inter-dealer quotation systems. To ensure that an inter-dealer 
quotation system clearly reveals where two or more quotations in 
different names for a particular security represent a single quotation 
or where one broker-dealer appears as a correspondent of another, Rule 
15c2-7 sets forth certain criteria that must be met for broker-dealers 
to furnish, or submit directly or indirectly, any quotation for a 
security (other than a municipal security) to an inter-dealer quotation 
system. More specifically, to furnish or submit any such quotation Rule 
15c2-7 requires that:
     Broker-dealers that are correspondents for other broker-
dealers for a particular security and enter quotations inform the 
inter-dealer quotation system of both the existence of the arrangement 
and the identity of the correspondent;
     Where two or more broker-dealers place quotations pursuant 
to any other arrangement between or among other broker-dealers, the 
identity of each broker-dealer participating in any such 
arrangement(s), and the fact that an arrangement exists, must be 
disclosed;
     The inter-dealer quotation systems to which the quotation 
is furnished or submitted must make it a general practice to disclose, 
with each published quotation, these arrangements, along with the 
identities of all other broker-dealers that were disclosed to the 
inter-dealer quotation system; and
     When a broker-dealer enters into any correspondent or 
other arrangement in which two or more broker-dealers furnish or submit 
quotations for a particular security, the broker-dealer must inform all 
broker-dealers furnishing or submitting such quotations of the 
existence of such correspondent or other arrangement and the identity 
of the parties thereto.
    The information required by Rule 15c2-7 is designed to help the 
Commission prevent fraud, manipulation, and deceptive acts and 
practices. When Rule 15c2-7 was adopted in 1964, the information it 
required was critical to the Commission's role in monitoring broker-
dealers and protecting the integrity of over-the-counter markets. The 
disclosures required by Rule 15c2-7 help assure that inter-dealer 
quotation systems reflect the demand for, and market activity related 
to, the securities quoted on their systems.
4. Rule 15c3-1
    Rule 15c3-1 is designed to ensure that broker-dealers registered 
with the Commission at all times have sufficient liquid capital to 
protect the assets of customers and to meet their responsibilities to 
other broker-dealers.\684\ Rule 15c3-1 is an integral part of the 
Commission's financial responsibility program for broker-dealers. In 
particular, Rule 15c3-1 facilitates the monitoring of the financial 
condition of broker-dealers by the Commission and the broker-dealer's 
designated examining authority (or ``DEA'').
---------------------------------------------------------------------------

    \684\ See Net Capital Rule, Exchange Act Release No. 39455 (Dec. 
17, 1997), 62 FR 67996 (Dec. 30, 1997).
---------------------------------------------------------------------------

    Various provisions of Rule 15c3-1 require that broker-dealers 
provide written notification to the Commission and/or their DEA under 
certain circumstances. For example, no equity capital of a broker-
dealer may be withdrawn if the amount withdrawn exceeds specified 
levels unless notice is provided to the broker-dealer's DEA and the 
Commission within prescribed timeframes.\685\ In addition, a broker-
dealer carrying the account of an options market maker must file a 
notice with the Commission and the DEA of both the carrying firm and 
the market maker prior to effecting transactions in the account.\686\
---------------------------------------------------------------------------

    \685\ See 17 CFR 240.15c3-1(e)(1).
    \686\ See 17 CFR 240.15c3-1(a)(6)(vi).
---------------------------------------------------------------------------

    There are also certain recordkeeping requirements under Rule 15c3-
1. For example, a broker-dealer must keep a record of who is acting as 
an agent in a securities loan transaction and records with respect to 
obtaining DEA approval prior to withdrawing capital within one year of 
a contribution.\687\ The regulation at 17 CFR 240.15c3-1c (``appendix C 
to Rule 15c3-1'') requires registered broker-dealers that consolidate 
their financial statements with a subsidiary or affiliate to submit, 
under certain circumstances, an opinion of counsel to their DEA.\688\
---------------------------------------------------------------------------

    \687\ See 17 CFR 240.15c3-1(c)(2)(iv)(B).
    \688\ See 17 CFR 240.15c3-1(c).
---------------------------------------------------------------------------

    These recordkeeping and reporting requirements are designed to 
inform the Commission and a broker-dealer's DEA of certain financial 
situations involving broker-dealers' financial situations.
5. Rule 15c3-5
    Rule 15c3-5 requires that broker-dealers with access to trading 
directly on an exchange or ATS, including those providing sponsored or 
direct market access to customers or other persons, implement risk 
management controls and supervisory procedures reasonably designed to 
manage the financial, regulatory, and other risks of this business 
activity. More specifically, these broker-dealers must establish, 
document, and maintain certain risk management controls and supervisory 
procedures; regularly review those controls and procedures and document 
the review; and remediate issues discovered to assure overall 
effectiveness of such controls and procedures. These broker-dealers 
also must preserve a copy of their supervisory procedures and a written 
description of their risk management controls as part of their books 
and records. In addition, the Chief Executive Officer (or equivalent 
officer) is required to certify annually that the broker or dealer's 
risk management controls and supervisory procedures comply with Rule 
15c3-5, and that the broker-dealer conducted the required review. These 
documents are required to be preserved by the broker-dealer as part of 
its books and records.
    Rule 15c3-5 is generally designed to ensure that broker-dealers 
(which, under the current regulatory structure, are the only entities 
that may be members of exchanges or provide access to trading in 
securities on an ATS to non-broker-dealers) appropriately control the 
risks associated with market access, so as not to jeopardize their own 
financial condition, that of other market participants, the integrity 
of trading on the securities markets, and the stability of the 
financial system.
6. Rules 17a-3 and 17a-4
    The Commission adopted Rules 17a-3 and 17a-4 (``Recordkeeping 
Rules'') in 1939 to standardize recordkeeping practices by establishing 
minimum standards with respect to business records that broker-dealers 
registered with the Commission must create and maintain. Rule 17a-3 
requires broker-dealers to make and keep current certain records 
relating to their financial condition, communications, customer 
information, and employees. Rule 17a-4 requires broker-dealers to 
preserve, for prescribed periods of time, the records required to be 
created under Rule 17a-3 and certain other Commission rules. In 
addition, Rule 17a-4 requires broker-dealers to preserve other records 
that may be created or received by the broker-dealer in the ordinary 
course of its business for prescribed periods of time. Rule 17a-4 also 
specifies the manner in which these records should be maintained. The 
Commission has periodically modified these rules to include additional 
records and to

[[Page 15003]]

recognize new methods to maintain records.
    The records and the information created and maintained in 
accordance with Rules 17a-3 and 17a-4 are used by examiners and other 
representatives of the Commission, State securities regulatory 
authorities, and the self-regulatory organizations (e.g., FINRA, CBOE) 
(``SROs'') to determine whether broker-dealers are in compliance with 
the Commission's antifraud and anti-manipulation rules, financial 
responsibility program, and other Commission, SRO, and State laws, 
rules, and regulations.
7. Rule 17a-5
    Rule 17a-5 requires that broker-dealers create, submit, and make 
available various reports. Paragraph (a)(1) of Rule 17a-5 requires 
broker-dealers to file quarterly or monthly (depending on a broker-
dealer's business) reports on Form X-17A-5, the Financial and 
Operational Combined Uniform Single Report (``FOCUS Report'').\689\ The 
FOCUS Report was designed to eliminate the overlapping regulatory 
reports required by various SROs and the Commission and to reduce 
reporting burdens. Paragraph (c) of Rule 17a-5 requires that certain 
broker-dealers furnish specified financial information to their 
customers.\690\ Paragraph (d) of Rule 17a-5 requires broker-dealers, 
subject to limited exceptions, to file annual reports prepared by an 
accountant registered with the PCAOB.\691\ The annual reports generally 
must be filed with the Commission, the SROs of which the broker-dealer 
is a member, and SIPC. Rule 17a-5 also requires additional 
notifications if an accountant identifies a material weakness in a 
broker-dealer's internal control over compliance during the most recent 
fiscal year.\692\
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    \689\ See 17 CFR 240.17a-5(a)(1).
    \690\ See 17 CFR 240.17a-5(c).
    \691\ See 17 CFR 240.17a-5(d).
    \692\ See 17 CFR 240.17a-5(h).
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    Reports required to be filed under Rule 17a-5 are used, among other 
things, to monitor the financial and operational condition of a broker-
dealer by Commission staff and by the broker-dealer's DEA. The reports 
required under Rule 17a-5 are one of the primary means of ensuring 
compliance with the broker-dealer financial responsibility rules. In 
addition, FOCUS Report data are used in preparation for broker-dealer 
examinations. The completed forms also are used to determine which 
firms are engaged in various securities-related activities, the extent 
to which they are engaged in those activities, and how economic events 
and government policies might affect various segments of the securities 
industry.
8. Rule 17a-11
    Rule 17a-11 requires broker-dealers that are experiencing financial 
or operational difficulties to provide notice to the Commission, the 
broker-dealer's DEA, and the CFTC (if the broker-dealer is registered 
with the CFTC as a futures commission merchant). For example, if a 
registered broker-dealer determines that the net capital it has on hand 
has fallen below the amount it must maintain (as calculated under Rule 
15c3-1), it must immediately notify the Commission and its DEA (and, if 
applicable, the CFTC).\693\ Rule 17a-11 is an integral part of the 
Commission's financial responsibility program, which enables the 
Commission, a broker-dealer's DEA, and the CFTC to increase 
surveillance of a broker-dealer experiencing difficulties and to obtain 
any additional information necessary to gauge the broker-dealer's 
financial or operational condition. The real-time information contained 
in these notices alerts the Commission, the DEA, and the CFTC of the 
need to increase surveillance of the broker-dealer's financial and 
operational condition.
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    \693\ See 17 CFR 240.17a-11(g).
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9. Rule 613
    Rule 613 requires FINRA and the national securities exchanges 
(``Participants'') to submit an NMS plan to create, implement, and 
maintain the CAT to capture order event information for orders in NMS 
securities, across all markets, from the time of order inception 
through routing, cancellation, modification, or execution in a single, 
consolidated data source.\694\ The term ``NMS Security'' is defined as 
``any security or class of securities for which transaction reports are 
collected, processed, and made available pursuant to an effective 
transaction reporting plan, or an effective national market system plan 
for reporting transactions in listed options.'' \695\ In general, the 
term ``NMS Security'' refers to exchange-listed equity securities and 
standardized options, but does not include exchange-listed debt 
securities, securities futures, or open-end mutual funds, which are not 
currently reported pursuant to an effective transaction reporting plan. 
Rule 613 requires that each Participant and its member broker-dealers 
to record, and electronically report to the central repository, details 
for each order documenting the life of an order through the process of 
original receipt or origination, routing, modification, cancellation, 
and execution (in whole or in part) for each NMS security.\696\
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    \694\ See 17 CFR 242.613(a)(1) and (c)(1) and (7).
    \695\ See 17 CFR 242.600(b)(54).
    \696\ See 17 CFR 242.613(a)(1) and (c)(1), (6), and (7).
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    This audit trail information is designed to allow regulators to 
efficiently and accurately monitor and surveil the securities markets 
and detect and investigate activity in NMS securities throughout the 
U.S. markets, whether on one market or across markets. The data 
collected and reported to the central repository can also be used by 
regulators to evaluate tips and complaints and for complex enforcement 
inquiries or investigations, as well as inspections and examinations. 
Further, regulators can use the data collected and reported to conduct 
more timely and accurate analysis of market activity for reconstruction 
of broad-based market events in support of regulatory policy decisions.

B. Respondents

    As discussed above, new Rules 3a5-4 and 3a44-2 would further define 
activities that would cause a person engaged in a regular business of 
buying and selling securities for its own account within the meaning of 
the Exchange Act. A person who satisfies the factors described in the 
amended definitions would be considered a ``dealer'' or ``government 
securities dealer,'' and thus would be required to register as such 
with the Commission, absent an exception or exemption. As detailed in 
section III.B.2.c, the TRACE analysis identifies as potential 
significant liquidity providers a total of 31 firms that are not 
currently registered as dealers; including 22 entities classified as 
PTFs, 4 entities classified as hedge funds, and another 5 
entities.\697\ Further, the Form PF analysis identifies 12 hedge funds 
that are the most likely to meet the final rules' factors due to their 
reported HFT activities.\698\ For purposes of this PRA, we will 
calculate the burdens based on an estimated 31 liquidity providers plus 
12 hedge funds, or 43 respondents. This

[[Page 15004]]

estimate of 43 respondents differs from the estimate of 105 respondents 
used in the Proposing Release. As discussed more fully in the Economic 
Analysis, changes made to the proposed rule text to address commenters' 
concerns (described in section I.B above), have decreased the number of 
persons that will likely need to register under the final rules.\699\ 
These respondents would be subject to some or all of the following 
collections of information described below.
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    \697\ See supra note 418.
    \698\ Based on staff analysis (see section III.B.2.c), the 12 
entities were identified through Form PF since we believe that any 
private funds employing trading strategies that would fit the final 
rules' qualitative standard, as adopted, would likely report them as 
HFT. However, since reported HFT may apply to a broader set of 
activities than the final rules' qualitative factors, the actual 
number of affected funds may be less than 12. However, for purposes 
of this PRA, we conservatively estimate that up to 12 entities could 
be required to register as dealers and submit order information to 
CAT. See infra note 766 and accompanying text.
    \699\ Section III.B above includes a discussion of commenters' 
concerns.
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C. Paperwork Reduction Act Burdens

1. Paperwork Burdens Associated With Rules 15b1-1, 15Ca1-1, 15Ca2-1, 
and 15b3-1 and Form BD
    As discussed above, section 15C of the Exchange Act requires that 
government securities dealers register with the Commission.\700\ A 
government securities dealer has the flexibility to either register as 
a dealer pursuant to Rule 15b1-1 and file notice as a government 
securities dealer under Rule 15Ca1-1, or register as a government 
securities dealer under Rule 15Ca2-1.\701\ In either case, the 
respondent is required to complete a Form BD.\702\ The Commission 
believes that new Rules 3a5-4 and 3a44-2 would impose the same burden 
on these respondents irrespective of whether the respondent registers 
as a dealer or a government securities dealer. Once registered, a 
broker-dealer must file an amended Form BD when information it 
originally reported on Form BD changes or becomes inaccurate.\703\ The 
Commission estimates an initial burden of 2.75 hours for completing a 
Form BD and an annual burden of .90 hours per respondent for amending 
Form BD,\704\ resulting in a total initial burden of approximately 118 
hours \705\ and a total annual burden of approximately 39 hours \706\ 
associated with the amendments to the definitions.
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    \700\ See 15 U.S.C. 78o-5(a).
    \701\ Compare section 15(a) with section 15C. A government 
securities dealer that registers under section 15C(a)(l)(A) will be 
limited to conducting a government securities business only.
    \702\ Compare 17 CFR 240.15b1-1(a) (``Rule 15b1-1(a)'') (``An 
application for registration of a broker or dealer that is filed 
pursuant to section 15(b) of the Act (15 U.S.C. 78o(b)) shall be 
filed on Form BD (249.501 of this chapter) in accordance with the 
instructions to the form'') and 17 CFR 240.15Ca1-1(a) (``Rule 15Ca1-
1(a)'') (``Every government securities broker or government 
securities dealer that is a broker or dealer registered pursuant to 
section 15 or 15B of the Act (other than a financial institution as 
defined in section 3(a)(46) of the Act) shall file with the 
Commission written notice on Form BD (249.501 of this chapter) in 
accordance with the instructions contained therein that it is a 
government securities broker or government securities dealer.'') 
with 17 CFR 240.15Ca2-1(a) (``Rule 15Ca2-1(a)'') (``An application 
for registration pursuant to section 15C(a)(1)(A) of the Act, of a 
government securities broker or government securities dealer that is 
filed on or after January 25, 1993, shall be filed with the Central 
Registration Depository (operated by the Financial Industry 
Regulatory Authority, Inc.) on Form BD in accordance with the 
instructions contained therein.'').
    \703\ See Rule 15b3-1.
    \704\ For the previously approved estimates, see ICR Reference 
No. 202306-3235-010 (conclusion date June 13, 2023), available at 
https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202306-
3235-010 (``Form BD PRA Supporting Statement''). The Commission's 
currently approved burden associated with filing an amendment to 
Form BD is .33 hours. From 2019 through 2021, the Commission 
received, on average, 2.72 amendments per broker-dealer (see Form BD 
PRA Supporting Statement at 5). Thus, we extrapolate that each new 
broker-dealer would submit approximately 2.72 amendments. 2.72 
amendments x .33 hours = .90 hours per respondent.
    \705\ 43 respondents multiplied by 2.75 hours per respondent.
    \706\ 43 respondents multiplied by .90 hours per respondent.
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2. Paperwork Burdens Associated With Rules 15b6-1 and 15Cc1-1 and Form 
BDW
    The time necessary to complete and file Form BDW will vary 
depending on the nature and complexity of the applicant's securities 
business. On average, the Commission estimates that it would take a 
broker-dealer approximately one hour \707\ per respondent to complete 
and file a Form BDW to withdraw from Commission registration. For 
purposes of estimating this paperwork burden, the Commission posits 
that at least one of the 43 respondents may withdraw as a dealer each 
year, resulting in a total annual burden of one hour.\708\ It is not 
anticipated that respondents will have to incur any capital or start-up 
costs, nor any additional operational or maintenance costs, to comply 
with the collection of information.\709\
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    \707\ For the previously approved estimates, see ICR Reference 
No. 202306-3235-014 (conclusion date Aug. 11, 2023), available at 
https://www.reginfo .gov/public/do/PRAViewDocument?ref_nbr =202306-
3235-014 (``Form BDW PRA Supporting Statement'').
    \708\ 1 respondent multiplied by 1 hour per respondent.
    \709\ Form BDW PRA Supporting Statement at 5.
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3. Paperwork Burdens Associated With Rule 15c2-7
    Any broker-dealer could be a potential respondent for Rule 15c2-7. 
Only quotations entered into through an inter-dealer quotation system, 
such as OTC Link and Global OTC, are covered by Rule 15c2-7. According 
to representatives of OTC Link and Global OTC, none of those entities 
has recently received, nor anticipates receiving, any Rule 15c2-7 
notices.\710\ However, because a respondent may be required to submit 
such notices, to estimate this paperwork burden the Commission posits 
that one filing, in the aggregate, by one broker-dealer, is made 
annually pursuant to Rule 15c2-7.\711\ Based on prior industry 
estimates, the time required to enter a notice pursuant to Rule 15c2-7 
is 45 seconds, or .75 minutes.\712\ The Commission believes that none 
of the respondents that are required to register as a result of the 
amended definitions will be required to file a Rule 15c2-7 notice. 
Accordingly, the Commission estimates that there will be no internal 
compliance cost associated with the burden hours for Rule 15c2-7.
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    \710\ For the previously approved estimates, see ICR Reference 
No. 202008-3235-005 (conclusion date Feb. 1, 2021), available at 
https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202008-
3235-005 (``Rule 15c2-7 PRA Supporting Statement'').
    \711\ Rule 15c2-7 PRA Supporting Statement at 3.
    \712\ Id.
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4. Paperwork Burdens Associated With Rule 15c3-1
    The respondents that must register with the Commission as a result 
of the new final rules may incur a collection of information burden to 
comply with Rule 15c3-1. The Commission estimates the hour burdens of 
the requirements associated with Rule 15c3-1 as follows.
    Notices: Based on the number of notices filed under Rule 15c3-1 
between November 1, 2021, and October 31, 2022, the Commission 
estimated that broker-dealers annually file approximately 1,216 notices 
under Rule 15c3-1.\713\ 3,528 broker-dealers submitted annual audit 
reports for the year ending December 31, 2021.\714\ Thus, approximately 
35% of broker-dealer respondents submitted a Rule 15c3-1 notice during 
this timeframe. Based on this percentage, the Commission estimates that 
at least approximately 15 of the 43 respondents would likely file one 
notice under Rule 15c3-1 annually.\715\ In addition, the Commission 
estimated that a broker-dealer will spend approximately 30

[[Page 15005]]

minutes preparing and filing these notices.\716\ Accordingly, the 
Commission estimates a total additional annual burden associated with 
submitting these Rule15c3-1 notices of approximately 7.5 hours.\717\
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    \713\ For the previously approved estimates, see ICR Reference 
No. 202301-3235-012 (conclusion date June 2, 2023), available at 
https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202301-3235-012 
(``Rule 15c3-1 PRA Supporting Statement'') at 4. This justification 
also describes other collections of information associated with Rule 
15c3-1, however the Commission determined that the business model of 
the firms expected to register as broker-dealers as a result of 
these new definitions would likely not require that they comply with 
those provisions (see supra section III.B (discussing types of 
entities that could be captured by the final rules)).
    \714\ Based on FOCUS data.
    \715\ 43 respondents x 35% = 15.05.
    \716\ Rule 15c3-1 PRA Supporting Statement at 4.
    \717\ 15 respondents multiplied by 0.5 hours per respondent.
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    Capital Withdrawal Liability: Paragraph (c)(2)(i)(G)(2) of Rule 
15c3-1 requires that a broker-dealer treat as a liability any capital 
contribution that is intended to be withdrawn within one year of its 
contribution. The paragraph also includes the presumption that capital 
withdrawn within one year of contribution was intended to be withdrawn 
within one year, unless the broker-dealer receives permission in 
writing for the withdrawal from its DEA. For purposes of this PRA, the 
Commission estimates that approximately three respondents would likely 
seek permission in writing to withdraw capital \718\ and that it will 
take each of those firms approximately one hour to prepare and submit 
the request to their DEAs.\719\ Accordingly, the Commission estimates 
that the total annual reporting burden will be approximately three 
hours.\720\
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    \718\ In its 2023 PRA, the Commission estimated that broker-
dealers would submit approximately 238 notices annually. Rule 15c3-1 
PRA Supporting Statement at 5. According to FOCUS data, 3,528 
broker-dealers submitted annual audit reports for the year ending 
Dec. 31, 2021. Thus, approximately 7% of the active broker-dealers 
submitted a notice annually as of 2021. 43 respondents x 7% = 3.01.
    \719\ Rule 15c3-1 PRA Supporting Statement at 5.
    \720\ 3 respondents multiplied by 1 hour per respondent.
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5. Paperwork Burdens Associated With Rule 15c3-5
    To comply with Rule 15c3-5, a respondent must maintain its risk 
management system by monitoring its effectiveness and updating its 
systems to address any issues detected.\721\ In addition, a respondent 
is required to preserve a copy of its written description of its risk 
management controls as part of its books and records in a manner 
consistent with Rule 17a-4(e)(7).\722\ The Commission estimates that 
the ongoing annualized burden for a respondent to maintain its risk 
management system will be approximately 115 burden hours.\723\ The 
Commission believes the ongoing burden of complying with the rule's 
collection of information will include, among other things, updating 
systems to address any issues detected, updating risk management 
controls to reflect any change in its business model, and documenting 
and preserving a broker-dealer's written description of its risk 
management controls.\724\ In addition, the Commission estimates that a 
broker-dealer's legal and compliance burden of complying with Rule 
15c3-5 will require approximately 45 hours per year.\725\ Accordingly, 
the Commission estimates the annual aggregate information burden per 
respondent would be 160 hours,\726\ for a total annual burden of 6,880 
hours.\727\
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    \721\ See 17 CFR 240.15c3-5.
    \722\ Id.
    \723\ For the previously approved estimates, see ICR Reference 
No. 201907-3235-022 (conclusion date Dec. 10, 2019), available at 
https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=201907-
3235-022 (``Rule 15c3-5 PRA Supporting Statement''). See Rule 15c3-5 
PRA Supporting Statement at 4.
    \724\ Id.
    \725\ Id. at 5. Specifically, compliance attorneys who review, 
document, and update written compliance policies and procedures are 
expected to require an estimated 20 hours per year; a compliance 
manager who reviews, documents, and updates written compliance 
policies and procedures is expected to require 20 hours per year; 
and the Chief Executive Officer, who certifies the policies and 
procedures, is expected to require another 5 hours per year. Id.
    \726\ 115 hours for technology + 45 hours for legal and 
compliance.
    \727\ 43 respondents multiplied by 160 hours.
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6. Paperwork Burdens Associated With Rule 17a-3
    As discussed above, the respondents that must register as dealers 
or government securities as a result of these new definitions will 
incur a burden associated with the collections of information necessary 
to comply with Rule 17a-3.
(i) Rule 17a-3 Generally
    While recordkeeping requirements will vary based on the size and 
complexity of the broker-dealer, the Commission estimates that one hour 
a day \728\ is the average amount of time needed by a broker-dealer to 
comply with the overall requirements of Rule 17a-3, in addition to the 
separate burdens described below. The number of working days per year 
is 249, and as a result the total annual estimated burden for 
respondents with respect to Rule 17a-3 generally would be 10,707 
hours.\729\
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    \728\ For the previously approved estimates, see ICR Reference 
No. 202107-3235-019 (conclusion date Dec. 1, 2021), available at 
https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202107-
3235-019 (``Rule 17a-3 PRA Supporting Statement''). Rule 17a-3 PRA 
Supporting Statement at 6.
    \729\ 43 respondents multiplied by 249 hours per respondent a 
year.
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(ii) Rule 17a-3(a)(12) and (19)
    In addition to the hour burden estimate for Rule 17a-3 generally, 
the Commission also believes that paragraphs (a)(12) and (19) of Rule 
17a-3 will impose specific burdens on respondents. Paragraphs (a)(12) 
and (19) of Rule 17a-3 require that a broker-dealer create certain 
records regarding its associated persons.\730\ The Commission estimates 
that each broker-dealer spends, on average, approximately 30 minutes 
each year \731\ to ensure that it is in compliance with these 
requirements, resulting in a total annual compliance burden of 
approximately 21.5 hours for the respondents.\732\
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    \730\ These records that a broker-dealer is required to make 
regarding the broker-dealer's associated persons include: (1) all 
agreements pertaining to the associated person's relationship with 
the broker-dealer and a summary of each associated person's 
compensation arrangement (17 CFR 240.17a-3(a)(19)(ii)), (2) a record 
delineating all identification numbers relating to each associated 
person (17 CFR 240.17a-3(a)(12)(ii)), (3) a record of the office at 
which each associated person regularly conducts business (17 CFR 
240.17a-3(a)(12)(iii)), and (4) a record as to each associated 
person listing transactions for which that person will be 
compensated (17 CFR 240.17a3(a)(19)(i)).
    \731\ Rule 17a-3 PRA Supporting Statement at 6.
    \732\ 43 respondents multiplied by 0.5 hours per respondent.
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(iii) Rule 17a-3(a)(20) Through (22)
    Paragraphs (a)(20) through (22) of Rule 17a-3 require broker-
dealers to make, among other things, records documenting the broker-
dealer's compliance, or that the broker-dealer has adopted policies and 
procedures reasonably designed to establish compliance, with applicable 
Federal regulations and SRO rules that require approval by a principal 
of the broker-dealer of any advertisements, sales literature, or other 
communications with the public.\733\ Moreover, these rules require 
broker-dealers to create a record of the personnel responsible for 
establishing compliance policies and procedures and of the personnel 
capable of explaining the types of records the broker-dealer must 
maintain and the information contained in those records.\734\ The 
Commission estimates that, on average, each broker-dealer will spend 10 
minutes each year \735\ to ensure compliance with these requirements, 
resulting in a total annual burden for the respondents of about 
approximately 7.2 hours.\736\
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    \733\ See 17 CFR 240.17a-3(a)(20).
    \734\ See 17 CFR 240.17a-3(a)(21) and (22).
    \735\ Rule 17a-3 PRA Supporting Statement at 6.
    \736\ (43 respondents multiplied by 10 minutes per respondent) 
divided by 60 minutes.
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7. Paperwork Burdens Associated With Rule 17a-4
    The respondents that registered as dealers or government securities 
would incur a collection of information burden to comply with Rule 17a-
4. Rule 17a-4 establishes the records that must be

[[Page 15006]]

preserved by broker-dealers.\737\ The Commission estimates that, on 
average, each broker-dealer spends 254 hours each year \738\ to ensure 
that it preserves the records Rule 17a-4 requires all broker-dealers to 
preserve. Accordingly, the Commission estimates that there will be a 
total annual burden of 10,922 hours to comply with the Rule 17a-4 
requirements applicable to the respondents.\739\
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    \737\ See 17 CFR 240.17a-4.
    \738\ For the previously approved estimates, see ICR Reference 
No. 202107-3235-021 (conclusion date Oct. 1, 2021), available at 
https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202107-
3235-021 (``Rule 17a-4 PRA Supporting Statement''). Rule 17a-4 PRA 
Supporting Statement at 7.
    \739\ 43 respondents multiplied by 254 hours per respondent.
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8. Paperwork Burdens Associated With Rule 17a-5
    This section summarizes the burdens associated with Rule 17a-
5.\740\
---------------------------------------------------------------------------

    \740\ Registered government securities dealers are required to 
comply with Rule 17a-5, subject to the modifications enumerated in 
17 CFR 405.1 (``Rule 405.1'') and 405.2 (``Rule 405.2''). See 17 CFR 
405.1 and 405.2.
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    FOCUS Report for Broker-Dealers that do not Clear Transactions or 
Carry Customer Accounts: Paragraph (a)(2)(iii) of Rule 17a-5 requires 
that broker-dealers that do not clear transactions or carry customer 
accounts and do not use ANC models to calculate net capital are 
required to file FOCUS Report Part IIA on a quarterly basis.\741\ The 
Commission believes that, based on their business models (as PTFs and 
hedge funds), the 43 respondents that would be required to register 
with the Commission would need to comply with this provision of Rule 
17a-5. The Commission estimates that each FOCUS Report Part IIA takes 
approximately 12 hours to prepare and file.\742\ As a result, each 
respondent is estimated to have an annual reporting burden of 48 
hours,\743\ resulting in an annual burden of 2,064 hours.\744\
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    \741\ See 17 CFR 240.17a-5(a)(2)(iii).
    \742\ For the previously approved estimates, see ICR Reference 
No. 202107-3235-022 (conclusion date Oct. 1, 2021), available at 
https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202107-
3235-022 (``Rule 17a-5 PRA Supporting Statement''). Rule 17a-5 PRA 
Supporting Statement at 6.
    \743\ These filings must be made quarterly. Rule 17a-5 PRA 
Supporting Statement at 6.
    \744\ 43 respondents multiplied by 48 hours per respondent.
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    Annual Reports: Paragraph (d)(1)(i)(A) of Rule 17a-5 requires 
broker-dealers, subject to limited exception, to file annual reports, 
including financial statements and supporting schedules that generally 
must be audited by a PCAOB-registered independent public accountant in 
accordance with PCAOB standards.\745\ The Commission believes that each 
of the 43 respondents that would be required to register with the 
Commission would need to file an annual report. The Commission 
estimates that each respondent is estimated to have an annual reporting 
burden of 12 hours under this provision of Rule 17a-5,\746\ resulting 
in an annual burden of 516 hours for the respondents.\747\
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    \745\ See 17 CFR 240.17a-5(d)(1)(i)(A).
    \746\ Rule 17a-5 PRA Supporting Statement at 7.
    \747\ 43 respondents multiplied by 12 hours per respondent.
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    Exemption Report: Paragraph (d)(1)(i)(B) of Rule 17a-5 requires a 
broker-dealer that claims it was exempt from Rule 15c3-3 throughout the 
most recent fiscal year to file an exemption report with the Commission 
on an annual basis.\748\ The Commission believes, based on their 
business models (as PTFs and hedge funds), that the respondents 
generally would claim exemptions from Rule 15c3-3 and be required to 
file an exemption report. The Commission estimates that it takes a 
broker-dealer claiming an exemption from Rule 15c3-3 approximately 7 
hours to complete the exemption report,\749\ resulting in an annual 
burden of 301 hours.\750\
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    \748\ See 17 CFR 240.17a-5(d)(1)(i)(B).
    \749\ Rule 17a-5 PRA Supporting Statement at 8.
    \750\ 43 respondents multiplied by 7 hours per respondent.
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    SIPC Annual Reports: Paragraph (d)(6) of Rule 17a-5 requires that 
each SIPC member broker-dealer file a copy of its annual report with 
SIPC.\751\ The Commission estimates that it takes a broker-dealer 
approximately 30 minutes to file the annual report with SIPC.\752\ As a 
result, each firm is estimated to have an annual burden of .5 hour, 
resulting in an annual burden of 21.5 hours for the respondents.\753\
---------------------------------------------------------------------------

    \751\ See 17 CFR 240.17a-5(d)(6).
    \752\ Rule 17a-5 PRA Supporting Statement at 8.
    \753\ 43 respondents multiplied by 0.5 hours per respondent.
---------------------------------------------------------------------------

    SIPC Annual General Assessment Reconciliation Report or Exclusion 
from Membership Forms: Paragraph (e)(4) of Rule 17a-5 requires broker-
dealers to file with SIPC a report on the SIPC annual general 
assessment reconciliation or exclusion from membership forms.\754\ The 
Commission estimates that it takes a broker-dealer approximately 5 
hours to complete and submit its SIPC annual assessment reconciliation 
form or certification of exclusion from membership form,\755\ resulting 
in an estimated annual burden of about 215 hours for the 
respondents.\756\
---------------------------------------------------------------------------

    \754\ See 17 CFR 240.17a-5(e)(4).
    \755\ Rule 17a-5 PRA Supporting Statement at 9.
    \756\ 43 respondents multiplied by 5 hours per respondent.
---------------------------------------------------------------------------

    Statement Regarding Independent Public Accountant: Paragraph (f)(2) 
of Rule 17a-5 requires broker-dealers to prepare a statement providing 
information regarding the broker-dealer's independent public accountant 
and to file it each year with the Commission and its DEA (except that 
if the engagement is of a continuing nature, no further filing is 
required).\757\ The Commission estimates that it takes a broker-dealer 
that neither carries customer accounts nor clears transactions 
approximately 2 hours to file the Statement Regarding Independent 
Public Accountant with the Commission.\758\ As a result, each broker-
dealer that neither carries nor clears transactions is estimated to 
have an annual burden of 2 hours, resulting in an annual burden of 86 
hours for the respondents.\759\
---------------------------------------------------------------------------

    \757\ 17 CFR 240.17a-5(f)(2).
    \758\ Rule 17a-5 PRA Supporting Statement at 9.
    \759\ 43 respondents multiplied by 2 hours per respondent.
---------------------------------------------------------------------------

9. Paperwork Burdens Associated With Rule 17a-11 \760\
---------------------------------------------------------------------------

    \760\ Registered government securities dealers are required to 
comply with Rule 17a-11, subject to the modifications enumerated in 
17 CFR 405.3. See 17 CFR 405.3.
---------------------------------------------------------------------------

    In 2019, the Commission received 343 Rule 17a-11 notices from 
broker-dealers.\761\ Approximately 3,679 broker-dealers filed annual 
audited financial statements for fiscal year 2019.\762\ Thus, 
approximately 9% of registered broker-dealers submitted Rule 17a-11 
notices. The Commission estimated that it will take approximately one 
hour to prepare and transmit each notice.\763\ Based on this, the 
Commission believes that 9% of the respondents may need to submit 17a-
11 notices, resulting in a burden of four hours.\764\
---------------------------------------------------------------------------

    \761\ For the previously approved estimates, see ICR Reference 
No. 202107-3235-023 (conclusion date Oct. 1, 2021), available at 
https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202107-
3235-023 (``Rule 17a-11 PRA Supporting Statement'').
    \762\ Rule 17a-5 PRA Supporting Statement at 7.
    \763\ Rule 17a-11 PRA Supporting Statement at 4.
    \764\ 43 respondents multiplied by 9% = approximately 4 
respondents. 4 respondents multiplied by 1 hour per respondent.
---------------------------------------------------------------------------

10. Paperwork Burdens Associated With Rule 613
    Paragraph (c) of Rule 613 provides that certain requirements are 
placed upon broker-dealers to record and report CAT information to the 
central repository in accordance with specified

[[Page 15007]]

timelines.\765\ The CAT is designed to capture customer and order event 
information for orders in NMS securities, across all markets, from the 
time of order inception through routing, cancellation, modification, or 
execution in a single, consolidated data source. If an affected party 
does not trade NMS stocks, OTC equities, or listed options, then the 
affected party will not incur CAT-related reporting costs because the 
affected party does not trade securities that must be reported to CAT. 
Based on staff analysis (see section III.B.2.c), the 12 entities were 
identified through Form PF since we believe that any private funds 
employing trading strategies that would fit the final rules' 
qualitative standard, as adopted, would likely report them as HFT. 
However, since reported HFT may apply to a broader set of activities 
than the final rules' qualitative factors, the actual number of 
affected funds may be less than 12. However, for purposes of this PRA, 
we conservatively estimate that up to 12 entities could be required to 
submit order information to CAT.\766\
---------------------------------------------------------------------------

    \765\ See 17 CFR 242.613(c).
    \766\ Additionally, we acknowledge that fewer entities may 
actually need to report to CAT because some entities identified in 
the data as engaging in equity strategies could be effecting 
transactions in futures rather than transactions in NMS securities.
---------------------------------------------------------------------------

    The Commission recognizes that broker-dealers may insource or 
outsource CAT data reporting obligations.\767\ The Commission believes 
all 12 of the respondents that may be required to submit order 
information to CAT would likely strategically decide to insource their 
data reporting functions as a result of their high level of trading 
activity.\768\ The Commission estimates that the average initial burden 
associated with implementing regulatory data reporting to capture the 
required information and transmit it to the central repository in 
compliance with Rule 613 for each respondent to be approximately 14,490 
initial burden hours,\769\ totaling an initial burden of 173,880 hours 
for these respondents.\770\
---------------------------------------------------------------------------

    \767\ For the previously approved estimates, see ICR Reference 
No. 202306-3235-008 (Oct. 13, 2023), available at https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=202306-3235-008 
(``2023 CAT PRA Supporting Statement'').
    \768\ See 2023 CAT PRA Supporting Statement at 37.
    \769\ The 2023 CAT PRA Supporting Statement largely eliminated 
the initial burden estimate; stating that as the CAT reporting 
obligations have been in place for some time, the Commission assumes 
that the initial one-time hour burdens associated with 
implementation of the system have already been incurred. However, 
the 12 respondents may incur these initial burdens. The prior burden 
estimates (which include a description of the initial burdens) can 
be found at https://www.reginfo.gov/public/do/
PRAViewDocument?ref_nbr=201911-3235-003 (``2020 CAT Supporting 
Statement'').
    \770\ 12 respondents multiplied by 14,490 hours.
---------------------------------------------------------------------------

    After a respondent establishes the appropriate systems and 
processes required for collection and transmission of the required 
information, the Commission estimates that Rule 613 imposes ongoing 
annual burdens associated with, among other things, personnel time to 
monitor each respondent's reporting of the required data, maintenance 
of the systems to report the required data, and implementing changes to 
trading systems that might result in additional reports.\771\ The 
Commission believes that it would take each respondent approximately 
13,338 burden hours per year \772\ to continue to comply with Rule 613, 
totaling an annual ongoing burden of 160,056 hours for the 
respondents.\773\
---------------------------------------------------------------------------

    \771\ See 2020 CAT PRA Supporting Statement at 39.
    \772\ Id. at 39-40.
    \773\ 12 respondents multiplied by 13,338 hours.
---------------------------------------------------------------------------

C. Paperwork Reduction Act Costs

    In addition to the hour burdens associated with these rules, there 
may also be external costs associated with the paperwork burdens 
imposed by these rules.
1. Costs Associated With Rule 15c3-1 Paperwork Burden
    Broker-dealers that file consolidated financial reports must obtain 
an opinion of counsel in accordance with appendix C to Rule 15c3-
1.\774\ The Commission indicated, when this rule was proposed, that it 
believed there will not be any respondents that are required to 
register as a result of the proposed rules that will obtain an opinion 
of counsel to file the consolidated financial reports as required under 
appendix C to Rule 15c3-1. We received no comment on this issue, and 
the Commission does not anticipate that respondents will incur any 
capital or start-up costs, nor any additional operational or 
maintenance costs, to comply with the collection of information under 
Rule 15c3-1.
---------------------------------------------------------------------------

    \774\ Rule 15c3-1 PRA Supporting Statement at 11.
---------------------------------------------------------------------------

2. Costs Associated With Rule 15c3-5 Paperwork Burden
    The Commission estimates that the average ongoing external hardware 
and software expenses relating to the paperwork burden associated with 
Rule 15c3-5 would be approximately $20,500 per respondent,\775\ for a 
total annualized external cost for all respondents of $881,500.\776\
---------------------------------------------------------------------------

    \775\ Rule 15c3-5 PRA Supporting Statement at 6.
    \776\ 43 respondents multiplied by $20,500 per respondent.
---------------------------------------------------------------------------

3. Costs Associated With Rule 17a-4 Paperwork Burden
    The Commission estimates that the average broker-dealer spends 
approximately $5,000 each year to store documents required to be 
retained under Rule 17a-4.\777\ Accordingly, the Commission estimates 
that the annual reporting and recordkeeping cost burden for the 
respondents to be $215,000.\778\
---------------------------------------------------------------------------

    \777\ Rule 17a-4 PRA Supporting Statement at 13. Costs include 
the cost of physical space, computer hardware and software, etc., 
which vary widely depending on the size of the broker-dealer and the 
type of storage media employed. Id.
    \778\ 43 respondents multiplied by $5,000 per respondent.
---------------------------------------------------------------------------

4. Costs Associated With Rule 17a-5 Paperwork Burden
    The Commission estimates that Rule 17a-5 causes a broker-dealer to 
incur an annual dollar cost to meet its reporting obligations. Those 
requirements that are anticipated to impose an annual cost are 
discussed below.
    Annual Reports: The Commission estimates that postage costs to 
comply with paragraph (d) of Rule 17a-5, impose on broker-dealers an 
annual dollar cost of $7.75 per firm,\779\ resulting in a total annual 
cost for the respondents of approximately $333.\780\
---------------------------------------------------------------------------

    \779\ Rule 17a-5 PRA Supporting Statement at 15.
    \780\ 43 respondents multiplied by $7.75 per respondent.
---------------------------------------------------------------------------

    Exemption Report: A broker-dealer that claims it was exempt from 
Rule 15c3-3 throughout the most recent fiscal year must file an 
exemption report with the Commission on an annual basis.\781\ The cost 
associated with an independent public accountant's review of the 
exemption report is estimated to create an ongoing cost of $3,000 per 
non-carrying broker-dealer per year,\782\ for a total annual reporting 
cost of approximately $129,000.\783\
---------------------------------------------------------------------------

    \781\ See 17 CFR 240.17a-5(d)(1)(i)(B).
    \782\ Rule 17a-5 PRA Supporting Statement at 16.
    \783\ 43 respondents multiplied by $3,000 per respondent.
---------------------------------------------------------------------------

    SIPC Annual Reports: The Commission estimates that postage costs to 
comply with paragraph (d)(6) of Rule

[[Page 15008]]

17a-5 impose an annual dollar cost of 50 cents per firm registered with 
SIPC as a SIPC member broker-dealer \784\ totaling, an estimated cost 
burden for the respondents of $21.50.\785\
---------------------------------------------------------------------------

    \784\ Rule 17a-5 PRA Supporting Statement at 16.
    \785\ 43 respondents multiplied by $0.50 per respondent.
---------------------------------------------------------------------------

    SIPC Annual General Assessment Reconciliation Report or Exclusion 
from Membership Forms: The Commission estimates that postage costs to 
comply with paragraph (e)(4) of Rule 17a-5 impose an annual dollar cost 
of 50 cents per firm.\786\ The Commission estimates that the 
respondents will file with SIPC a report on the SIPC annual general 
assessment reconciliation or exclusion from membership form, such that 
the estimated annual cost burden totals $21.50.\787\
---------------------------------------------------------------------------

    \786\ Rule 17a-5 PRA Supporting Statement at 16.
    \787\ 43 respondents multiplied by $0.50 per respondent.
---------------------------------------------------------------------------

    Statement Regarding Independent Public Accountant: The Commission 
estimates that postage costs to comply with paragraphs (f)(2) and (3) 
of Rule 17a-5, impose an annual dollar cost of 50 cents per firm.\788\ 
Accordingly, the Commission estimates that a cumulative total cost of 
$21.50 per year.\789\
---------------------------------------------------------------------------

    \788\ Rule 17a-5 PRA Supporting Statement at 17.
    \789\ 43 respondents multiplied by $0.50 per respondent.
---------------------------------------------------------------------------

5. Costs Associated With Rule 613 Paperwork Burden
    The Commission estimates that each of the 12 respondents that may 
engage in effecting transactions in NMS securities will, on average, 
incur approximately $450,000 in initial costs for hardware and software 
to implement the systems changes needed to capture the required 
information and transmit it to the central repository, an additional 
$9,500 in initial third party costs, and an additional $250,000 in 
costs to implement the modified allocation timestamp requirement,\790\ 
totaling a cumulative initial cost of $8,514,000 for the 
respondents.\791\
---------------------------------------------------------------------------

    \790\ See 2020 CAT PRA Supporting Statement at 63-64.
    \791\ 12 respondents multiplied by (($450,000 in external 
hardware and software costs) + ($250,000 to implement the modified 
allocation timestamp requirement) + ($9,500 initial third party/
outsourcing costs) = $709,500).
---------------------------------------------------------------------------

    After each respondent has established the appropriate systems and 
processes, the Commission believes that Rule 613 imposes ongoing annual 
burdens associated with, among other things, personnel time to monitor 
each respondent's reporting of the required data, maintenance of the 
systems to report the required data, and implementing changes to 
trading systems that might result in additional reports to the central 
repository.\792\ The Commission estimates costs for each respondent, on 
average, of approximately $80,000 per year to maintain systems 
connectivity to the central repository and purchase any necessary 
hardware, software, and other materials, an additional $1,300 per year 
in third party costs, and an additional $29,167 per year to maintain 
the modified allocation timestamp requirement,\793\ totaling an 
estimated a cumulative annual ongoing cost of $1,325,604 for the 
respondents.\794\
---------------------------------------------------------------------------

    \792\ See 2020 CAT PRA Supporting Statement at 66.
    \793\ Id.
    \794\ 12 respondents multiplied by (($80,000 in external 
hardware and software costs) + ($29,167 to maintain the modified 
allocation timestamp requirement) + ($1,300 ongoing external third 
party/outsourcing costs) = $110,467).
---------------------------------------------------------------------------

V. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires Federal agencies, 
in promulgating rules, to consider the impact of those rules on small 
entities. Section 603(a) of the Administrative Procedures Act 
(``APA''),\795\ as amended by the RFA, generally requires the 
Commission to undertake a regulatory flexibility analysis of all 
proposed rules, or proposed rule amendments, to determine the impact of 
the rulemaking on ``small entities.'' \796\ Section 605(b) of the RFA 
\797\ states that this requirement shall not apply to any proposed rule 
or proposed rule amendment which, if adopted, would not have a 
significant economic impact on a substantial number of small 
entities.\798\
---------------------------------------------------------------------------

    \795\ 5 U.S.C. 603(a).
    \796\ Although section 601(b) of the RFA defines the term 
``small entity,'' the statute permits agencies to formulate their 
own definitions. The Commission has adopted definitions for the term 
``small entity'' for the purposes of Commission rulemaking in 
accordance with the RFA. Those definitions, as relevant to this 
rulemaking, are set forth in Rule 0-10 under the Exchange Act. See 
also Exchange Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 
(Feb. 4, 1982) (File No. AS-305).
    \797\ 5 U.S.C. 605(b).
    \798\ Id.
---------------------------------------------------------------------------

    The Commission received one comment on this certification.\799\ The 
commenter stated that the Commission should consider as part of its 
regulatory flexibility analysis that requiring a new category of 
registrants (i.e., funds) to register as dealers under the proposed 
rules would require FINRA to provide new registration categories.\800\ 
For the reasons described below, the final rules will not have a 
significant economic impact on a substantial number of small entities; 
nor does the Commission believe that there is a correlation between the 
regulatory flexibility analysis and the particular issue that the 
commenter raised.
---------------------------------------------------------------------------

    \799\ See ABA Comment Letter.
    \800\ See supra section II.B.3.
---------------------------------------------------------------------------

    As stated in the Proposing Release, the RFA defines ``small 
entity'' to mean ``small business,'' ``small organization,'' or ``small 
governmental jurisdiction.'' \801\ The Commission's rules define 
``small business'' and ``small organization'' for purposes of the RFA 
for each of the types of entities regulated by the Commission.\802\ A 
``small business'' and ``small organization,'' when used in reference 
to a person other than an investment company, generally means a person 
with total assets of $5 million or less on the last day of its most 
recent fiscal year.\803\
---------------------------------------------------------------------------

    \801\ 5 U.S.C. 601(6).
    \802\ Exchange Act Rule 0-10 contains applicable definitions.
    \803\ Id.
---------------------------------------------------------------------------

    The final rules would not apply to persons that have or control 
total assets of less than $50 million.\804\ Therefore, because small 
businesses and small organizations with total assets of $50 million or 
less would not meet the requirements of the final rules, the final 
rules would not have a significant economic impact on a substantial 
number of small entities.
---------------------------------------------------------------------------

    \804\ See Rules 3a5-4(a)(2)(i) and 3a44-2(a)(2)(i). See also 
section II.B.3.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission certifies, pursuant to 
section 605(b), that the final rules will not have a significant 
economic impact on a substantial number of small entities for purposes 
of the RFA.

VI. Other Matters

    Pursuant to the Congressional Review Act,\805\ the Office of 
Information and Regulatory Affairs has designated these rules as a 
``major rule,'' as defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------

    \805\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

    If any of the provisions of these final rules, or the application 
thereof to any person or circumstance, is held to be invalid, such 
invalidity shall not affect other provisions or application of such 
provisions to other persons or circumstances that can be given effect 
without the invalid provision or application.

Statutory Authority

    The Commission is adopting Rules 3a5-4 and 3a44-2 pursuant to 
authority set forth in sections 3 and 23 of the Exchange Act (15 U.S.C. 
78c and 78w).

[[Page 15009]]

Text of Final Rules

List of Subjects in 17 CFR Part 240

    Securities dealers, Government securities dealers.

    For the reasons set out in the preamble, the Commission is amending 
title 17, chapter II, of the Code of Federal Regulations as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The general authority citation for part 240 continues to read as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78j-4, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 
78o-4, 78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 
78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et 
seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 
1350; and Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 
112-106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise 
noted.
* * * * *

0
2. Add Sec.  240.3a5-4 to read as follows:


Sec.  240.3a5-4  Further definition of ``as a part of a regular 
business'' in connection with certain liquidity providers.

    (a) A person that is engaged in buying and selling securities for 
its own account is engaged in such activity ``as a part of a regular 
business'' as the phrase is used in section 3(a)(5)(B) of the Act (15 
U.S.C. 78c(a)(5)(B)) if that person:
    (1) Engages in a regular pattern of buying and selling securities 
that has the effect of providing liquidity to other market participants 
by:
    (i) 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; or
    (ii) 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; and
    (2) Is not:
    (i) A person that has or controls total assets of less than $50 
million;
    (ii) An investment company registered under the Investment Company 
Act of 1940; or
    (iii) A central bank, sovereign entity, or international financial 
institution.
    (b) For purposes of this section:
    (1) The term person has the same meaning as prescribed in section 
3(a)(9) of the Act (15 U.S.C. 78c(a)(9)).
    (2) A person's own account means any account:
    (i) Held in the name of that person; or
    (ii) Held for the benefit of that person.
    (3) The term central bank means a reserve bank or monetary 
authority of a central government (including the Board of Governors of 
the Federal Reserve System or any of the Federal Reserve Banks) and the 
Bank for International Settlements.
    (4) The term international financial institution means the African 
Development Bank; African Development Fund; Asian Development Bank; 
Banco Centroamericano de Integraci[oacute]n Econ[oacute]mica; Bank for 
Economic Cooperation and Development in the Middle East and North 
Africa; Caribbean Development Bank; Corporaci[oacute]n Andina de 
Fomento; Council of Europe Development Bank; European Bank for 
Reconstruction and Development; European Investment Bank; European 
Investment Fund; European Stability Mechanism; Inter-American 
Development Bank; Inter-American Investment Corporation; International 
Bank for Reconstruction and Development; International Development 
Association; International Finance Corporation; International Monetary 
Fund; Islamic Development Bank; Multilateral Investment Guarantee 
Agency; Nordic Investment Bank; North American Development Bank; and 
any other entity that provides financing for national or regional 
development in which the U.S. Government is a shareholder or 
contributing member.
    (5) The term sovereign entity means a central government (including 
the U.S. Government), or an agency, department, or ministry of a 
central government.
    (c) No person shall evade the registration requirements of this 
section by:
    (1) Engaging in activities indirectly that would satisfy paragraph 
(a) of this section; or
    (2) Disaggregating accounts.
    (d) No presumption shall arise that a person is not a dealer within 
the meaning of section 3(a)(5) of the Act solely because that person 
does not satisfy paragraph (a) of this section.

0
3. Add Sec.  240.3a44-2 to read as follows:


Sec.  240.3a44-2  Further definition of ``as a part of a regular 
business'' in connection with certain liquidity providers.

    (a) A person that is engaged in buying and selling government 
securities for its own account is engaged in such activity ``as a part 
of a regular business'' as the phrase is used in section 3(a)(44)(A) of 
the Act (15 U.S.C. 78c(a)(44)(A)) if that person:
    (1) Engages in a regular pattern of buying and selling government 
securities that has the effect of providing liquidity to other market 
participants by:
    (i) 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; or
    (ii) 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; and
    (2) Is not:
    (i) A person that has or controls total assets of less than $50 
million; or
    (ii) An investment company registered under the Investment Company 
Act of 1940; or
    (iii) A central bank, sovereign entity, or international financial 
institution.
    (b) For purposes of this section:
    (1) The term person has the same meaning as prescribed in section 
3(a)(9) of the Act (15 U.S.C. 78c(a)(9)).
    (2) A person's own account means any account:
    (i) Held in the name of that person; or
    (ii) Held for the benefit of that person.
    (3) The term central bank means a reserve bank or monetary 
authority of a central government (including the Board of Governors of 
the Federal Reserve System or any of the Federal Reserve Banks) and the 
Bank for International Settlements.
    (4) The term international financial institution means the African 
Development Bank; African Development Fund; Asian Development Bank; 
Banco Centroamericano de Integraci[oacute]n Econ[oacute]mica; Bank for 
Economic Cooperation and Development in the Middle East and North 
Africa; Caribbean Development Bank; Corporaci[oacute]n Andina de 
Fomento; Council of Europe Development Bank; European Bank for 
Reconstruction and Development; European Investment Bank; European 
Investment Fund; European Stability Mechanism; Inter-American 
Development Bank; Inter-American Investment Corporation; International 
Bank for Reconstruction and Development; International Development 
Association; International Finance Corporation; International Monetary 
Fund; Islamic Development Bank; Multilateral Investment Guarantee 
Agency; Nordic Investment Bank; North American Development Bank; and 
any other entity that provides financing for national or regional 
development in

[[Page 15010]]

which the U.S. Government is a shareholder or contributing member.
    (5) The term sovereign entity means a central government (including 
the U.S. Government), or an agency, department, or ministry of a 
central government.
    (c) No person shall evade the registration requirements of this 
section by:
    (1) Engaging in activities indirectly that would satisfy paragraph 
(a) of this section; or
    (2) Disaggregating accounts.
    (d) No presumption shall arise that a person is not a government 
securities dealer within the meaning of section 3(a)(44) of the Act (15 
U.S.C. 78c(a)(44)) solely because that person does not satisfy 
paragraph (a) of this section.

    By the Commission.

    Dated: February 6, 2024.
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2024-02837 Filed 2-28-24; 8:45 am]
BILLING CODE 8011-01-P