On August 23, 2023, the U.S. Securities and Exchange Commission (SEC or Commission), in a 3-2 split along party lines, adopted amendments (the Amendments) to Rule 15b9-1 under the Securities Exchange Act of 1934 (Exchange Act) that substantially narrow an exemption for broker-dealers from the requirement to become a member of the Financial Industry Regulatory Authority (FINRA).1 Under the Amendments’ narrower exemption, nearly all broker-dealers that engage in securities transactions over the counter (OTC) will now be subject to oversight by FINRA, the primary regulator of the OTC markets for securities and currently the only registered national securities association.
The SEC estimates the Amendments will affect approximately 64 broker-dealers that are not currently FINRA members but routinely transact in the OTC securities market.2 These firms will need to become FINRA members through its new membership application process and comply with all applicable FINRA rules based on their business. Additionally, such firms will become newly subject to reporting obligations for trading in U.S. Treasury securities and other fixed-income securities subject to reporting to FINRA’s Trade Reporting and Compliance Engine (TRACE).3 In FINRA’s comment letter on the rulemaking, it stated that given the types of proprietary trading firms that will need to join as a result of the Rule 15b9-1 amendments, FINRA intends to implement an expedited membership application process for such firms to process their applications within 60 days.
Even more market participants may soon be required to become FINRA members if the SEC also adopts a related March 2022 proposal to significantly expand the scope of firms that must register as dealers (the Dealer-Trader Proposal).4 The SEC’s office of Information and Regulatory Affairs indicated in June that the agency may take final action to adopt that rulemaking as soon as October 2023.
Background
Section 15(b)(8) of the Exchange Act requires a broker-dealer to register with a national securities association (i.e., FINRA) unless it effects transactions solely on a national securities exchange of which it is a member.5 Exchange Act Rule 15b9-1 provides an exemption to certain proprietary trading dealers that effect securities transactions other than on an exchange where they are members. Under the current rule, broker-dealers are exempted from FINRA membership if they (1) are a member of a national securities exchange, (2) do not carry customer accounts, and (3) derive an annual gross income of $1,000 or less from securities transactions that are not effected on the national securities exchange of which they are a member (the de minimis allowance).6 Because the de minimis allowance excludes all income derived from a broker-dealer’s proprietary transactions conducted with or through another registered broker-dealer, broker-dealers could effectively engage in an unlimited number of proprietary transactions OTC without being a FINRA member, provided that the broker-dealer was an exchange member, did not carry customer accounts, and effected its OTC trades with or through another broker-dealer.
Amendments to Rule 15b9-1
The Amendments eliminate the de minimis allowance and establish a more narrow exemption from Section 15(b)(8). Specifically, the Amendments will require a broker-dealer to join FINRA if it effects securities transactions other than on an exchange of which it is a member unless it
- is a member of a national securities exchange
- carries no customer accounts
- limits its OTC trading to transactions that are solely for the purpose of
- routing orders by an exchange of which the broker or dealer is a member to comply with Rule 611 of Regulation NMS or the Options Order Protection and Locked/Crossed Market Plan (Options Linkage Plan) or
- executing the stock leg of a stock-option order7
Under the Amendments, the only purpose for which a broker-dealer relying on the exemption could transact OTC would be to prevent trade-throughs or for the purpose of hedging an options transaction through the use of a stock-option order.8 Notably, broker-dealers relying on the exemption for routing to avoid trade-throughs will be required under the Amendments to use the exchange’s affiliated routing broker-dealer rather than a broker-dealer of their choosing.
Effective Date
The Amendments will become effective 60 days after the date of publication of the adopting release in the Federal Register. The compliance date will be 365 days from the date of publication of the adopting release in the Federal Register, meaning that firms affected by the final rules must become FINRA members within one year of the final rules’ being published in the Federal Register.
1 Exemption for Certain Exchange Members, Rel. No. 34-98202 (Aug. 23, 2023), available at https://www.sec.gov/files/rules/final/2023/34-98202.pdf.
2 Id. at 14.
3 See FINRA Rule 6700 series.
4 For additional information about the Dealer-Trader Proposal, see the following Sidley client alert: https://www.sidley.com/en/insights/newsupdates/2022/04/sec-proposes-significant-expansion-of-firms-that-must-register-as-dealers.
5 15 U.S.C. 78o(b)(8).
6 17 CFR 240.15b9-1.
7 In addition, under the Amendments, a broker-dealer relying on the exception for stock-option orders will be required to establish, maintain, and enforce written policies and procedures reasonably designed to ensure and demonstrate that such transactions are solely for the purpose of executing the stock leg of a stock-option order as well as preserve copies of such policies and procedures consistent with Rule 17a-4 until three years after the date the policies and procedures are replaced with updated policies and procedures.
8 Rule 611 of Regulation NMS and the Options Linkage Plan are designed to prevent a transaction from occurring at a price that would “trade through” a better-priced quotation in that same security. See 17 CFR 242.611 and Exchange Act Release No. 60405, 74 FR 39362 (August 6, 2009). As a result, Rule 611 and the Options Linkage Plan generally require that broker-dealers route to execute against the full size of any better-priced displayed quotation unless an exception applies.
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