By Suzanne Cosgrove
By a 3-to-2 vote, the SEC on Friday reopened a comment period and provided supplemental information on proposed amendments to the definition of “exchange” under Exchange Act Rule 3b-16. The reopening release requests information and public comment on alternative trading systems (ATS), including crypto asset securities trading systems, and how various aspects of the proposed amendments apply.
“Make no mistake: many crypto trading platforms already come under the current definition of an exchange and thus have an existing duty to comply with the securities laws,” said SEC Chairman Gary Gensler, in a statement.
During its prior comment period on the proposals, which ended on June 13, 2022, the Commission received a significant number of comments from crypto market participants, and the SEC’s review of the revised proposals at an open meeting on Friday spurred an often contentious discussion by the commissioners of new technology and terms -- and how they relate to crypto platforms.
The Commission first suggested an amendment to Exchange Act Rule 3b-16 in January 2022 that would amend certain terms used in the statutory definition of “exchange” to include systems that offer the use of non-firm trading interest and communication protocols to bring together buyers and sellers of securities.
As initially proposed, the amendments would require these systems to register as national securities exchanges or as broker-dealers and comply with Regulation ATS. The amendment also proposed changes to Form PF that would require more immediate reporting of stressors that could harm investors or create systemic risk.
“I believe this supplemental release would help address (prior) comments on the proposal from various market participants, particularly those in the crypto markets,” Gensler said. “Given how crypto trading platforms operate, many of them currently are exchanges, regardless of the reopening release we’re considering today.”
“Exchange” redefined. “These platforms match orders of multiple buyers and sellers of crypto securities using established, non-discretionary methods. That’s the definition of an exchange—and today, most crypto trading platforms meet it,” Gensler said. “That’s the case regardless of whether they call themselves centralized or decentralized.”
Standing firmly against the proposed amendment, Commissioner Hester Pierce argued, “We stretch the statutory definition of ‘exchange’ beyond a reasonable reading to reach a poorly defined set of activities with no evidence that investors will benefit. Rather than embracing the promise of new technology as we have done in the past, here we propose to embrace stagnation, force centralization, urge expatriation, and welcome extinction of new technology.”
Addressing “crypto-specific concerns” raised by the reopening release, Pierce said it “articulates confusing and unworkable standards for decentralized activity.” Its definition of “group” is so expansive as to drain the word of any meaning, she said.
“Given commenters’ concerns over the ambiguity and scope of the proposed rule and our still limited understanding of the area we are regulating (which the release repeatedly acknowledges), we should have gone back to square one and issued a concept release instead,” Pierce said.
SEC Commissioner Mark Uyeda, who voted against the reopening along with Pierce, questioned the need for more entities to be included in the regulatory framework for exchanges.
“It does not follow that regulations designed to cover exchanges—that is, facilities where securities orders are placed and matched in terms of established, non-discretionary methods—should necessarily be extended and applied to innovative platforms that facilitate open-ended communication processes where market participants may find and recognize a mutual interest in specific trading,” he said in a statement.
Compliance sought. Taking a more focused view, Commissioner Caroline Crenshaw said some crypto asset securities currently trade on entities that do not meet the current definition of exchange under Rule 3b-16, but would meet the updated criteria in the proposal.
“However, there is significant trading activity in crypto asset securities that may be occurring in non-compliance with the federal securities laws, and certain other trading systems for crypto assets likely already meet the definition of an exchange,” Crenshaw said.
“For those entities, the proposed amendments would not change any existing obligation to register as a national securities exchange or comply with the conditions to an exemption to such registration, such as Regulation ATS,” she said.
“The existing definition of ‘exchange’ does not have an exception or carve-out for entities that trade crypto asset securities, and the updated definition would not include one, either,” Crenshaw said. “This is consistent with the principle I emphasized when we proposed the amendments: that there should be a level playing field for entities performing similar functions.”
Interdealer brokers affected. While most SEC officials emphasized the impact of the reopening on the digital asset trading community in their comments on Friday, the proposal’s primary goal, at least at inception, was to require interdealer brokers (IDBs) in the government securities markets to comply with Regulation ATS and Regulation Systems Compliance and Integrity.
These IDBs function like exchanges but still are not regulated like exchanges, Gensler noted. “In closing this regulatory gap, this proposal would promote resiliency and greater access in our $24 trillion Treasury markets as well as in other marketplaces for government securities,” he said.
The public comment period for the proposed amendments to Exchange Act Rule 3b-16 will remain open for 30 days after their publication in the Federal Register.