SEC Rules 3a5-4 and 3a44-2

On February 6, 2024, the Securities and Exchange Commission adopted new Rules 3a5-4 and 3a44-2 (“Final Rules”) that interpret Sections 3(a)(5) and 3(a)(44) of the Securities Exchange Act of 1934 (“Exchange Act”) which provide the definitions of “dealer” and “government securities dealer,” respectively.

For any person that owns or controls at least $50 million in total assets and is not a registered investment company, central bank, sovereign entity or international financial institution, if that person engages in the following activities for its own account as part of a regular business, it would be deemed under the Exchange Act as a “dealer” or “government securities dealer:”

• 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.

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. 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. Note that there is no requirement in the statutory text of either Section 3(a)(5) or Section 3(a)(44) that dealers have customers.

The Final Rules are not the exclusive means of establishing that a person is a dealer or government securities dealer; otherwise applicable SEC interpretations and precedent will continue to apply.

Other commentators note that: “Hedge funds and other [proprietary trading funds] PTFs that use high-volume trading strategies will need to review this standard and the SEC’s guidance carefully to determine whether their activities will now result in a dealer registration obligation.  The SEC noted in particular that market participants 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 this standard if they have established themselves as “significant market intermediaries” and “critical sources of liquidity.””

If a client is determined to fall within the definitions, it will be required to:

• Register with the SEC under Section 15(a) or Section 15C, as applicable;
• Become a member of a Self Regulatory Organization (i.e., FINRA); and
• Comply with federal securities laws and regulatory obligations and applicable SRO and Treasury rules and requirements.

The Final Rules will be effective on or about April 8, 2024 (60 days following the date of publication of the adopting release in the Federal Register).

See the Final Rules here: https://www.sec.gov/files/rules/final/2024/34-99477.pdf

See the SEC Fact Sheet here: https://www.sec.gov/files/34-99477-fact-sheet.pdf