SEC Expands Dealer Definition and Details Mobile Impact on Crypto Trading Compliance

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In early February 2024, the U.S. Securities and Exchange Commission released new rules, expanding its definition of who should be registered as a dealer or a government securities dealer.

The move is significant since many market participants, including crypto traders, will now have to register with the regulator as broker-dealers.

Further, they must register with the Financial Industry Regulatory Authority (FINRA), along with demonstrating compliance with relevant federal securities regulations as per Section 15(a) of the Exchange Act.

Notably, as part of the changes, the SEC has planned to put in place broad standards to determine whether a person’s buying or selling is part of a regular business that necessitates registration as a broker-dealer.

Highlights from the SEC announcements

The regulator’s focus is on market participants engaged in regular buying and selling of securities, with the effect of creating liquidity in the equities, treasuries, fixed income, and the crypto markets as well for other participants.

Under the new rule, individuals, private funds, and firms controlling assets amounting to at least $50 million and qualifying under either one of the regulator’s two qualitative standards are supposed to register as dealers:

  • The crypto market participant or another security trader regularly expresses trading interest that is at or near the “best available prices on both sides of the market for the same security that is communicated and represented in a way that makes it accessible to other market participants”
  • The market participant primarily earns revenue by “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 SEC has reiterated via an Adopting Release that the framework for defining a dealer was based on their security trading activity and not the security being traded, meaning the new rules apply to crypto asset securities.

As a result, crypt traders would qualify as dealers if their primary revenue was from buying and selling securities for their own account. Aside from that, the market participant would be considered a regular participant if they engage in trading on a frequent enough basis to demonstrate that it is a “regular business”. Regularity will also depend on the liquidity and depth of the security’s market. The regulator went on to clarify that “expressing trading interest” means that the individual trader expressed interest in trading to more than one market participant and that whether a person qualifies as a dealer does not hinge on any particular method of communication.

Moreover, the regulator has made the compliance date clear for its new rules; firms and individuals who qualify have a year and 60 days to comply after the publication of the new rules in the Federal Register, meaning they have to register as broker-dealers by that date.

Once the crypto trader is registered as a broker-dealer, their trading strategies do not even need to be profitable for the new rules to apply to them.

Implications for newly regulated entities

Essentially, the market participants, including crypto firms who begin to qualify as dealers will be required to become FINRA members. As a requirement of membership with FINRA and being regulated by the SEC, crypto trading entities must meet their strict communication compliance guidelines that require the retention and recordkeeping of business-related messages sent by employees. The records are to be kept in an easily accessible and tamper-proof storage system that can allow these dealers to comply with review requests.

The employees at broker-dealer firms will also be subject to increased scrutiny, given that they are now registered representatives. Transparency is expected when it comes to employees’:

  • Disciplinary action
  • Lawsuits
  • Outside business activity
  • Private securities transactions
  • Bankruptcies, etc.

In addition to supervising employee communication, they also are required to have in place qualified personnel who have passed FINRA-mandated exams, including;

  • A principal financial officer
  • Two general securities principals
  • One financial and operations principal
  • One principal operations officer
  • A chief compliance officer

They will also be subject to net capital requirements to meet financial obligations, as per SEC Rule 15c3-1.

Other requirements include the Regulation of Short Sales, which requires the newly registered broker-dealers to locate securities for delivery before short selling. Apart from that, broker-dealers providing “market access” by facilitating trading via an exchange or other trading system have to demonstrate they have sound measures in place to mitigate risk, including the execution of erroneous orders, orders exceeding pre-set capital limits, etc.

Conclusion

The SEC’s rules modification to broaden the definition of dealer, which will now include crypto traders who meet certain criteria, has also gotten some backlash from market participants. Two crypto industry trade associations even took the SEC to court, claiming the new rules to be “arbitrary and capricious”. While the direction of the lawsuit remains to be seen, it is prudent for entities that may end up being considered dealers in the near term to be prepared, especially since the regulator hands out hundreds of millions worth of fines for non-compliance.

Being classified as a dealer once the new rules kick in means that regulated firms will have to contend with a whole host of compliance challenges. One of the most proven ways regulated firms can take charge of the rising compliance requirements is by implementing a system to archive text messages and other communication that the SEC and FINRA want to be documented, so there is accountability and transparency throughout the firm when it comes to how trades happen.

If you need more convincing, look no further than the notorious WhatsApp fines enforced by the SEC that saw financial firms losing hundreds of millions of dollars in penalties. All this was because employees were communicating about their trading activity via non-approved channels that were not being recorded as per the regulator’s norms.

Taken together with the other compliance requirements mandated by the regulator, a system to capture digital communications will go a long way in ensuring that employees are aligned with the expanded compliance requirements expected from broker-dealers.

To get an overview of how the archiving system helps with communication compliance, contact us for a demo.

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