By Suzanne Cosgrove
The SEC’s reopening of the comment period for its proposal to amend its definition of an exchange drew a flood of responses this week ahead of its closing. Numerous individuals and crypto industry firms weighed in with sharp criticism of the SEC’s amendment reopening and supplemental information, and a group of U.S. House members charged the SEC with attempting to “front-run” Congress while House committee members worked on crypto legislation.
“Last year, the Committee on Financial Services sent a letter to Chair Gensler expressing our concern that the Commission’s attempt to expand the definition of an exchange to include ‘Communication Protocol Systems’ exceeded its statutory authority,” wrote Patrick McHenry (R-N.C.), chairman of the House Committee on Financial Services, and French Hill (R-Ark.), the committee vice chairman. “With this re-opening, it is clear that the Committee’s initial concerns were valid,” they said.
“Given the questions included in the Proposed Rule, it is incredibly problematic that the SEC is attempting to propose amendments on a topic that it is still seeking to understand without direction from Congress. … we respectfully request that the SEC withdraw this rulemaking,” the congressmen concluded.
Industry response. In a letter dated June 13, the Crypto Council for Innovation noted it had previously requested that the Commission clarify whether its original proposal covered crypto and DeFi protocols, and, if it did, to re-propose it in accordance with the Commission’s statutory requirements under the Administrative Procedure Act (APA), the Exchange Act, and the Paperwork Reduction Act.
“However, we remain very strongly of the view that the Re-Proposal (the subsequent amendment submitted this year) continues to suffer from significant, and even potentially fatal flaws under the APA and the Exchange Act,” the Council stated. The group called the re-proposal “impermissibly vague,” neglecting to provide clarity for crypto trading platforms and market participants. In particular, the Council said the re-proposal failed to give fair notice of what conduct is subject to liability and did not provide sufficient guidance on when a person would be a member of a group operating an exchange.
Keeping pace. Amid a wave of criticism from the crypto industry, the SEC’s proposal found support from the non-profit organization Better Markets. “We believe the Commission has developed a strong proposal that would represent another important enhancement and incremental step in the oversight of exchanges and ATSs,” Better Markets said. “If adopted, it will help the Commission’s regulatory framework keep pace with the increased use of electronic trading venues and innovations in facilitating the purchasing and selling of securities in our markets.”
Further, Better Markets noted the proposal reiterates the standing position of the Commission, “expressed on numerous occasions,” that trading systems that bring together multiple buyers and sellers of cryptocurrency securities using established, non-discretionary methods meet the definition of an “exchange” under Section 3(a)(1) of the Exchange Act and Exchange Act Rule 3b-16(a) and are subject to the exchange regulatory framework.
The group also observed the 2023 proposal acknowledged that the amendments to Regulation ATS in the 2022 proposal would potentially require additional cryptocurrency securities exchanges to register as national exchanges, specifically those that “offer the use of non-firm trading interest and provide non-discretionary protocols to bring together buyers and sellers of crypto assets securities.”
Criticism redux. While the SEC’s amendments drew fire from crypto affiliates, other groups took issue with elements of the Commission’s initial focus. Market maker and stock exchange member Virtu Financial, for example, said the Commission failed to consider the economic consequences of the proposal – both the benefits and the costs – in the original amendment and in its recent supplement. Virtu called the proposed amendments to Reg ATS and Reg ATS-N “unwarranted,” and alleged the changes would harm the marketplace.
As reported in January 2022, the Commission re-proposed amendments to Regulation ATS that would include significant Treasury market platforms within the regulation's coverage. Amendments eliminating the Regulation ATS exemption for alternative trading systems trading U.S. government securities were first proposed in September 2020.
Mixed review. The Securities Industry and Financial Markets Association (SIFMA) said it supported the SEC’s goal of ensuring that its rules keep pace with technological and market developments, and its proposal to extend existing regulatory requirements to government securities ATSs.
But SIFMA added that the group and its members continued to have significant concerns with aspects of the proposal, especially the far-reaching implications of the proposed amendments to Rule 3b-16 and the inclusion of the amorphous term “communication protocol systems” within the definition of “exchange.”
SIFMA also said it opposes requiring ATSs operated by the same or affiliated broker-dealers to aggregate their transaction volume for purposes of calculating fair access volume thresholds.
The proposed rule presents “significant” compliance challenges for newly designated ATSs that cross certain volume thresholds, and for some existing government securities ATSs, the group said. “Moreover … the Commission has indicated that there may be additional changes in store for the Regulation SCI regime, which will have further consequences for the ability of affected entities to come into and remain in compliance with this challenging set of requirements.”
According to the SEC, Regulation SCI aims to reduce the occurrence of systems issues, improve resiliency when systems problems occur, and enhance the Commission’s oversight of securities market technology infrastructure. Reg SCI applies to the systems of SCI entities—SROs, stock and options exchanges and alternative trading systems—that support any one of six securities market functions: trading, clearance and settlement, order routing, market data, market regulation and market surveillance.