Recent SEC Rule Adoptions Expand Registration Requirements

Is your firm prepared to operate as a broker-dealer?

By the PKF O’Connor Davies Financial Services Team and Oyster Consulting LLC

The Securities and Exchange Commission (SEC) adopted two new rules, Rules 3a5-4 and 3a44-2 (collectively “The New SEC Rules”). These new rules were adopted on February 6, 2024 and greatly expand on entities that may be required to register as dealers or government securities dealers. The New SEC Rules redefine the term “as a part of a regular business” within the definitions of “dealer” and “government securities dealer” under the Securities Exchange Act of 1934.

Many firms operating under the “trader” exemption will now be required to register with the SEC and become a member of the Financial Industry Regulatory Authority (FINRA) and be subject to broker-dealer compliance requirements. The compliance date is one year and 60 days after publication in the Federal Register, which is anticipated to be in mid-April 2025.

The New SEC Rules introduce two qualitative standards to determine if an entity is in fact acting “as a part of a regular business” and thus needs to register as a dealer: (1) Trading Interest Factor and (2) Primary Revenue Factor.

  • The Trading Interest Factor considers whether an entity regularly expresses trading interest at or near the best available prices for both sides of the market, making it accessible to other market participants. It is important to note that “regularly” does not imply “continually” expressing trading interest.

  • The Primary Revenue Factor assesses whether an entity’s primary revenue comes from capturing bid-ask spreads or trading venue incentives for providing liquidity.

Exemptions to the New SEC Rules are provided for registered investment companies, central banks, sovereign entities, international financial institutions and persons with less than $50 million in total assets. Notably, private funds are not exempt, meaning any private fund engaging in activities described in the rules may need to register as a broker-dealer. The final New SEC Rules include an anti-evasion provision that prohibits persons from evading the registration requirements by: (1) engaging in activities indirectly that would satisfy the qualitative factors or (2) disaggregating accounts.

Absent an exemption, entities will be required to register with the SEC as a broker-dealer, become a member of FINRA and comply with federal securities laws and regulatory requirements of a broker-dealer. For firms accustomed to operating outside the scope of these regulations, this introduces a host of new challenges that must be addressed, a few of which are discussed below.

FINRA Membership

This is a thorough process that can take up to six months or more, depending on the complexity of the business activities. The application must include detailed information about the entity’s business plan, financials, ownership structure, compliance systems and supervisory procedures.

Prior to submitting an application, the applicant must clearly define its operating structure. This includes the designation of key supervisory personnel (e.g., Chief Executive Officer, Chief Compliance Officer, Financial and Operations Principal, Trading Principals), completed written supervisory procedures and the ability to provide a working demonstration of core trading and operations platforms.

In addition, prior to FINRA approval, an engagement letter from an Independent Registered Public Accounting Firm will be required. FINRA approval will be documented in a Membership Agreement that defines the business activities for which an entity is authorized. Additional approval for any expansion of business activities must be sought.

Once approved, members are subject to periodic examinations and audits by FINRA to assess compliance with industry regulations.

Compliance with FINRA and SEC Rules and Regulations

FINRA rules and regulations cover broad topics, including trading practices, communications with the public, financial reporting and the conduct of associated persons.

SEC rules and regulations require oversight of electronic communications, evaluation of external business engagements, licensing and continuing education programs and examination of social media interactions, among others. In addition, firms must maintain minimum net capital based on their business activities and must always meet capital standards. Further, broker-dealers are required to ensure regulatory compliance and effective risk management in key areas such as:

  • Compliance with trading practices and financial reporting requirements.
  • Adherence to net capital requirements.
  • Effectiveness of cybersecurity measures.

Firms providing access to an exchange, or an alternative trading system, must comply with the Market Access Rule (15c3-5), a complex set of rules requiring financial and risk management controls. Firms trading in NMS securities are subject to Reg SHO and the order marking rules and locate requirements.

Firms will also be subject to financial statement audits from a PCAOB-registered independent public accounting firm. Such audits have defined timelines, generally 60 to 90 days after the fiscal year end, and require consideration of a quality audit firm, as such audits are subject to the inspection of the PCAOB who have consistently noted high deficiency rates in the audit and attestation engagements reviewed (covered in our previous article found here).

Implementation of Controls and Processes

Unregulated trading firms have controls and processes to govern trading activities and deployment of capital that they consider appropriate for their risk profile and ownership structure. As a broker-dealer, these firms will now be subject to more stringent regulations governing financial reporting and the use of capital that many will find restrictive. There are restrictions and notice requirements on the movement of capital out of the firm limiting the ability to distribute proceeds to owners.

Capital requirements may also curtail certain business activities given the haircut requirements and capital charges for open commitments. Regulatory reporting requirements include monthly/quarterly FOCUS filings, real time monitoring of net capital and books and records standards. Controls are necessary to ensure compliance with regulatory reporting, capital requirements, etc. among many of the other new rules and regulations these firms will become subject to.

From Trader to Broker-Dealer

Navigating the compliance landscape of the New SEC Rules represents a complex and resource-intensive undertaking for entities transitioning from the “trader” exemption to registered broker-dealer status. The process demands not only a significant investment in infrastructure and technology but also a strategic approach to regulatory compliance and risk management. Risk management and regulatory compliance are paramount in leveraging expertise in the application process.

Given the deficiencies in audit and attestation engagements of registered broker-dealers, it’s also important that firms engage a Registered Public Accounting Firm with the necessary resources, skills and industry experience. Firms benefit immensely from engaging with advisors and independent auditors who specialize in navigating the intricacies of FINRA and SEC regulations. Achieving and maintaining compliance not only upholds integrity and investor confidence but also contributes to the broader objective of ensuring a transparent, competitive and fair financial landscape.

Contact Us

If you believe you may be affected by the New SEC Rules and need to assess the impact to you and your firm, consider consulting with experienced professionals to assist in navigating the new requirements. Our experts are actively following the updates, including potential legal challenges to the new rules. If you would like more information on the New SEC Rules, contact your client service team at PKF O’Connor Davies or Oyster Consulting LLC or:

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