SEC Open Meeting on Proposed Amendments to Definition of “Exchange”
U.S. Securities and Exchange Commission
Open Meeting
Friday, April 14, 2023
Topline
- Commissioners voted 3-2 to reopen the comment period for proposed amendments to the definition of “exchange.”
ITEM 1: Reopening of Comment Period for Amendments to Rule 3b-16 under the Exchange Act Regarding the Definition of “Exchange”
The Commission will consider whether to reopen the comment period for proposed amendments to Rule 3b-16 under the Securities Exchange Act of 1934 regarding the definition of “exchange” as set forth in Securities Exchange Act Release No. 94062.
Staff Discussion
Haoxiang Zhu, Division of Trading and Markets
Zhu began by explaining that in January 2022, the SEC proposed to amend the Exchange Act definition of exchange. He stated that the amendment would help ensure that markets that perform marketplace functions are subject to the same regulatory requirements. After proposing the amendment, the SEC received many comments about the potential impacts of the proposed change. Some commenters raised questions about how the proposed amendments would apply to decentralized finance (defi) systems. Zhu said that after reviewing the comments, the Commission staff recommends reopening the release to provide interested persons the opportunity to submit additional comments.
Tyler Raimo, Division of Trading and Markets
Raimo further explained the reopening. He noted that the proposed amendments would require government securities alternative trading systems (ATS) to file Form ATS-N, and would also amend the definition of an exchange to include systems that offer the use of non-firm trading systems. He also said that a large subset of comments focused on crypto asset securities and the systems that trade them, including how the proposed changes would apply to crypto assets and systems that are characterized as defi. Raimo added that there were other questions about the impact of the proposed rule on non-cryptocurrency platforms. While explaining the reopening, he noted several issues for the Commission to consider/highlight. First, the proposed changes would apply to all trading systems for crypto asset securities. Second, the definition of exchange depends on the activities performed, not the technology used to perform those activities. Third, activities performed using defi systems can use the existing criteria or the criteria as proposed to be amended. Fourth, if the activities constitute a marketplace for buyers/sellers of securities, those actors could today be considered a group of persons and thus an exchange. Fourth, the staff received comments from market participants on all types of securities, some of which thought the changes are vague and too broad. He recommended the commissioners solicit comments on alternative rule text, as the proposed amendments were not designed to capture brokers, dealers, or investment advisors. Finally, Raimo recommended the Commission solicit further comment on any compliance dates for the proposed rules.
Jessica Wachter, Division of Economic and Risk Analysis
Wachter said the Commission received comments stating that it had not considered the economic effects on platforms that may be covered. She noted that the reopening would supplement the original proposal with new analysis of such effects. She also said that crypto asset securities trade on limit order books and platforms without firm orders, and platforms without firm orders may bring together buyer and sellers, serving the economic function of an exchange. These amendments, Wachter argued, would bring platforms that use non-trading interest under the framework for exchanges. She noted that the benefits of these regulations would accrue to participants trading crypto asset securities, just as they have for those trading non-crypto asset securities. Finally, she said it is possible that compliance could reduce the ability of platforms to operate in a manner commonly referred to as defi.
Commissioner Discussion
Commissioner Hester Peirce
Peirce began by stating that the Commission is embracing stagnation and centralization instead of the promise of new technology. She said that today’s comment reopener shows that the Commission no longer considers the real-world effects of its authority or thinks about regulatory alternatives to advance innovation. Instead, today’s SEC aggressively expands its regulatory reach to solve problems that do not exist. Furthermore, she said that today’s SEC tells entrepreneurs to come in and register, and treats the notice and comment rulemaking process as a threat.
On the specific topic of discussion, Peirce said the reopener doubles down on the defects identified by commenters and sends a message that they are not interested in facilitating innovation in financial markets. She highlighted a few specific problems. First, it does not propose to define communication protocol system (CPS), which numerous commenters asked for. The release also does not grapple with the possibility that CPS may capture hundreds of systems, and does not analyze this concern. Third, Peirce said the release articulates confusing standards for decentralized activity, and the ambiguity undermines relevant first amendment protections as well. Finally, she said that the release does not really consider whether compliance is possible.
On crypto, Peirce argued that a Commission serious about regulating, and not destroying, the crypto market would reflect on its regulatory failure in this area and think about how regulations might need some tweaking to allow for new innovations. Instead, she said this release takes the view that any business model that does not meet the current regulatory regime does not belong in the markets.
Peirce also asked multiple questions of the staff, including whether the Commission has thought about how forcing centralization would benefit the American public. Wachter responded that they recognize that compliance may reduce the ability to operate in a manner consistent with defi and added that she looks forward to hearing comments on this point. However, she also mentioned that there are clear benefits of the proposed rulemaking, such as regulating similar economic functions similarly. Peirce said that it does not seem like the economic analysis fully accounts for the cost of taking away peer-to-peer.
Commissioner Caroline Crenshaw
Crenshaw said that if adopted, the amendments should help ensure a level playing field among entities performing similar functions and also provide investor protections. She added that entities that bring together buyers and sellers of securities would be required to register as exchanges, regardless of whether they are crypto asset securities or traditional securities. She reiterated that there should be a level playing field, and noted that any updated definition would not include a carveout for crypto assets. Finally, Crenshaw said that the proposed amendments would not change any obligation to register for crypto exchanges that are already required to do so under securities law.
Commissioner Mark Uyeda
Uyeda opened by stating that the supplement, along with original proposal, raises more questions than it addresses about definitional terms of what is and is not an exchange. He noted that historically, the SEC has carefully defined what constitutes an exchange, and argued that the Commission has a responsibility to demonstrate that an extension of the definition will benefit investors. Uyeda continued by stating that innovation and technological change have created new methods for buyers and sellers to interact, but that does not mean those methods constitute an exchange under the Exchange Act. He said it is notable how expansive and ambiguous the combined changes are, and added that under current law, many communication platforms are not deemed exchanges. Finally, Uyeda said that there is a distinct danger that expanding the scope of the definition might depress further beneficial innovation, and much of the supplement’s commentary on crypto assets is insufficiently supported.
Commissioner Jaime Lizarraga
Lizarraga stated that the proposed amendments were designed to close a regulatory gap, strengthen oversight, protect investors, and promote fair and orderly markets. He said reopening the release will allow the public to offer additional comment on the scope of the proposal. Furthermore, he argued that the Commission must consider how the proposed amendments would apply to all unregistered trading systems, regardless of technology, as investors that use similar systems should benefit from the same protections. He closed by stating that he looks forward to receiving public feedback on these proposals to help close the regulatory gap between registered and unregistered trading systems.
Chair Gary Gensler
Gensler said that he supports reopening the January 2022 proposal. He said that the supplemental release will help address comments, including those from the crypto market. The chair explained that the proposal would require certain entities in the government securities markets to comply with the regulations from the 1998 period, including Reg ATS, as these brokers function like exchanges but currently are not regulated like them. He added that the proposal would modernize rules regarding the definition of exchange to account for the evolving nature of trading platforms. In particular, it would require communication protocols to comply with rules for exchanges, which will benefit investors and exchanges alike. Gensler noted that many crypto trading platforms already come under the definition of exchange and thus have an obligation under the securities laws. He added that “calling yourself a crypto or defi platform is not an excuse to defy our securities laws.” Finally, Gensler said that he welcomes additional public comment on all aspects of the proposal, which he thinks will promote resilience, access, and fairness in the markets.
Vote
The item was approved 3-2.
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