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  • L Higgins and M Bacina

SEC marks its territory with expanded "dealer" definition

The US Securities and Exchange Commission (SEC) has broadened its definition of a "dealer" to encompass a wider range of financial activities. The rules require that anyone who meets the expanded "dealer" definition must register with the SEC and become a member of a self-regulatory organisation. The broadening of the definition could capture high frequency traders and target crypto and DeFi platforms which industry advocates say are unable to register with the SEC owing to a lack of compatible regulations and regulatory stonewalling.

In short, the new framework puts forward two new qualitative and non-exhaustive criteria to establish "dealer" status for persons providing liquidity in securities markets (including what the SEC calls "crypto securities"):

  1. Expressing Trading Interest Factor: regularly expressing trading interest that is at or near the best 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

  2. Primary Revenue Factor: earning revenue primarily from capturing bid-ask, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interest.

According to the SEC's description, the new dealer framework focuses on the functional analysis of securities trading activities, irrespective of the type of security being traded, and while purporting to be technologically neutral, ignores those elements of crypto-assets and DeFi which are incompatible with existing regulation.

The SEC's decision comes amidst a backdrop of broader regulatory efforts by US agencies targeting crypto assets, including measures proposed by the Internal Revenue Service (IRS). While previous regulatory discussions may have garnered more attention, the implications of the SEC's expanded dealer definition could be far greater, particularly for DeFi projects who may further limit access to US users while pushing innovation offshore.

SEC Chair Gary Gensler emphasised his views on the reform, stating:

Absent an exemption or exception, if anyone trades in a manner consistent with de facto market making, it must register with us as a dealer – consistent with Congress’s intent.

Unfortunately, the SEC's stance reaffirms its attempts to extend existing regulatory regimes to novel technologies. In other words, it may amount to a shadow-ban on DeFi platforms and underscore Mr Gensler's true view: that only traditional models of financial services should be offered to US customers.

Despite objections and confusion from industry insiders, including those in DeFi, the SEC position has remained unchanging. The agency emphasised that the application of dealer rules is contingent upon a thorough examination of the facts and circumstances surrounding each transaction or structure, irrespective of the technology used, but fails to accommodate fundamental technological differences in DeFi.

The commission's decision not to carve out a specific exemption for crypto activities was motivated by concerns regarding negative competitive effects. While the rules initially targeted electronic participants in the US Treasuries market, they will apply uniformly to any business falling under the expanded definition of a dealer.

Critics, including SEC Commissioners Mark Uyeda and Hester Peirce, voiced dissenting opinions, citing regulatory confusion and problems in the practical application of the existing rules to crypto products. Peirce, a vocal advocate for tailored regulations for crypto, expressed disappointment in the lack of nuanced consideration for DeFi operations:

...the [new] rule[s] reflects little thought regarding its practical application in the crypto markets

The DeFi Education Fund and other crypto groups echoed these concerns, denouncing the final rules as misguided and unworkable. Max Bernstein, Communications & Operations Senior Manager at DeFi Education Fund, posted the group's thoughts via X:

For crypto industry participants, this is another regulatory blow which highlights the absence of a clear compliance pathway for DeFi platforms in the US. The final rules will become effective 60 days after being published in the Federal Register. The compliance date will be one year after the effective date of the final rules. 

It is curious that the SEC has been raising concerns around negative competitive effects for traditional operators, in stark contrast to the early 2000s when SEC Commissioners embraced technology which created efficiency and broader access to information and did not suggest online trading posted a negative competitive effect for then traditional operators.

As the regulatory landscape continues to evolve, stakeholders in the crypto industry must navigate these changes while advocating for a regulatory model that allows US enterprise and users to build and access DeFi technology.

By Luke Misthos , Steven Pettigrove and Michael Bacina


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