Amendments to SEA Rule 15b9-1: Potential Increase in FINRA Membership
By Vic Peña, Partner; Harley Aronoff, Partner; Rachel DiDio, Partner; and Samveg Punamiya, Manager
The Securities and Exchange Commission (SEC) adopted rule amendments to SEA Rule 15b9-1 that narrow the exemption from Section 15(b)(8) of the Securities Exchange Act (SEA) of 1934. The amendments eliminated a long-standing proprietary trading exclusion that had allowed certain proprietary trading firms, options market makers and other broker-dealers to operate as brokers or dealers without incurring the potential costs and burdens of Financial Industry Regulatory Authority Inc. (FINRA) membership.
“Some of today’s broker-dealers continue to rely on an exemption from national securities association registration that’s older than the cell phone era,” said SEC Chair Gary Gensler. “This has led to a regulatory gap whereby a number of firms that have cross-market, monthly trading volume valued in the hundreds of billions of dollars are exempt from national securities association oversight. These amendments update and narrow the circumstances in which broker-dealers do not need to register with a national securities association. National securities association membership will help enhance robust and consistent oversight, particularly with regard to cross-market and off-exchange oversight.”
Earlier Rule
Prior to the amendments, SEA Rule 15b9-1 provided an exemption from Section 15(b)(8). Under the exemption, certain SEC-registered brokers or dealers could engage in unlimited proprietary trading of securities on any national securities exchange of which they were not a member or in an off-exchange market without triggering the national securities association membership requirement if it:
- Were a member of an exchange;
- Carried no customer accounts; and
- Had annual gross income derived from securities transactions otherwise than on a national securities exchange of which it was a member in an amount no greater than $1,000. However, income derived from transactions for the broker-dealer’s own account with or through another registered broker-dealer did not count toward the $1,000 limitation.
Amendment
With this amendment, the SEC has replaced the third bullet above with two narrower exemptions that apply. Specifically, the amendments will require a broker-dealer that carried no customer accounts to join FINRA if it affects securities transactions other than on an exchange of which it is a member unless it:
- Results solely from orders that are routed by a national securities exchange to comply with order protection regulatory requirements (e.g., Rule 611 of Regulation NMS and the Options Order Protection and Locked/Crossed Market Plan); or
- Is solely for the purpose of executing the stock leg of a stock-option order.
These amendments drastically limit the scope of the exemption previously provided by SEA Rule 15b9-1 and effectively render the exemption unavailable for the vast majority of proprietary broker-dealer firms. The FINRA membership requirement would apply regardless of whether the proprietary trading broker-dealer trades exclusively with other SEC-registered broker-dealers on alternative trading systems or other markets (including exchanges of which it is not a member), or some combination of the two.
The SEC notes in release No. 34-98202 that direct membership-based jurisdiction by a national securities association over broker-dealers that are not FINRA members cannot be achieved through existing oversight mechanisms such as joint self-regulatory organization plans pursuant to SEA Rule 17d-2, regulatory service agreements or through reliance on the Consolidated Audit Trail (CAT). However, there’s an argument that the SEC, with its tools like the CAT, can fully oversee these firms without requiring FINRA membership.
Industry concerns have been raised about the lack of a hedging exception, which could decrease liquidity in options markets. A narrow exemption for the stock leg of a stock-option trade has been included in the amendments, but its adequacy remains in question.
The final rule will become effective 60 days after the publication of the adoption release in the Federal Register. As a result, these firms will be required to become FINRA members within 365 days after the publication of the amended rules in the Federal Register.
Broker-dealers, in particular proprietary trading broker-dealers that met the previous exemptions, should take this opportunity to carefully assess and consider seeking the help of a specialist to assist in determining how this rule change will affect the broker-dealer and to ascertain if FINRA registration will be required.
Contact Us
If you would like to discuss how our specialists can assist you with regulatory compliance or with an audit, contact your client service team at PKF O’Connor Davies or:
Vic Peña, Partner
Broker-Dealer Practice Leader
vpena@pkfod.com | 646.449.6380
Harley Aronoff, Partner
PCAOB Quality Assurance Leader
haronoff@pkfod.com | 212.986.4650
Rachel DiDio, Partner
Broker-Dealer Specialist
rdidio@pkfod.com | 646.965.7780
Samveg Punamiya, Manager
spunamiya@pkfod.com | 914.421.5689