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SEC Proposes Rule Changes that Would Tighten Regulation of High Frequency Traders
Practical Law Legal Update 8-606-3365 (Approx. 3 pages)
SEC Proposes Rule Changes that Would Tighten Regulation of High Frequency Traders
by Practical Law Corporate & Securities
| Published on 26 Mar 2015 • USA (National/Federal) |
The SEC proposed amendments to Exchange Act Rule 15b9-1 that, if adopted, would require broker-dealers that are high-frequency trading firms to join FINRA and be subject to the full panoply of its rules and its examination process.
On March 25, 2015, the SEC issued proposed amendments to Exchange Act Rule 15b9-1, which provides an exemption from the requirement to join a national securities association for broker-dealers that are engaged primarily in activities on the floor of an exchange. The amendments, if adopted, would effectively require broker-dealers which are high-frequency trading firms (HFTs) to join FINRA, the sole national securities association, and be subject to its rules, examination process and enforcement authority.
History of Rule 15b9-1
Rule 15b9-1 exempts broker-dealers from the statutory requirement to become a member of a national securities association under Section 15(b)(8) of the Exchange Act. Rule 15b9-1 was originally intended to allow exchange-based specialists and other floor members to conduct limited activities off the exchange of which they were a member without requiring them to become members of a national securities association. Although the rule was intended to apply to floor brokers and specialists with minimal off-exchange trading activities, the exclusion of trades done on behalf of a firm's proprietary account has resulted in a number of HFTs that are registered as broker-dealers relying on the exemption, despite engaging in minimal exchange trading activities and significant off-exchange trading activities.
Current Rule 15b9-1
Rule 15b9-1 currently exempts certain brokers-dealers from membership in a national securities association if they:
- Are members of a national securities exchange.
- Carry no customer accounts.
- Have annual gross income of no more than $1,000 that is derived from securities transactions effected other than on a national securities exchange of which they are members.
Income derived from proprietary trading conducted with or through another broker-dealer does not count against the $1,000 limit.
Proposed Amendments
The proposed amendments would modify the exemption to apply only to broker-dealers whose business focuses on an exchange floor for which the exchange can oversee their entire trading activity. The proposed amendments would eliminate the current proprietary trading exemption and replace it with one that would accommodate off-exchange transactions by a floor-based dealer that are solely for the purpose of hedging the risks of its floor-based activities. The proposed amendments also would update the exemption that permits off-exchange transactions necessary to comply with regulatory requirements restricting trade-throughs under Regulation NMS.
Under the proposal, a broker-dealer would be exempt from having to become a member of a national securities association if it:
- Is a member of a national securities exchange.
- Carries no customer accounts.
- Trades solely on an exchange of which it is a member, except for hedging activities as follows:
- a dealer that conducts business on the floor of a national securities exchange could effect transactions off the exchange, for the dealer's own account, with or through another registered broker-dealer, that are solely for the purpose of hedging the risks of its floor-based activities;
- a dealer seeking to rely on the hedging exception must establish, maintain and enforce written policies and procedures reasonably designed to ensure and demonstrate that its hedging transactions reduce or otherwise mitigate the risks of the financial exposure of its floor-based activity;
- a dealer must preserve a copy of its policies and procedures for three years after the date the policies and procedures are replaced with updated policies and procedures; and
- a broker-dealer could effect transactions off the exchange that result from orders that are routed by its exchange, to prevent trade-throughs on that national securities exchange consistent with the provisions of Rule 611 of Regulation NMS.
Implications of Proposal
While the proposed amendments to Rule 15b9-1, if adopted, would modernize the rule to bring it back within its original purpose, the broader result would be that HFTs would be subject to tighter regulatory requirements and a more costly and burdensome regulatory regime under FINRA. The SEC and FINRA also are reviewing potential changes to the equity market structure rules, and any rules adopted are likely to apply more directly to HFTs as members of FINRA.