SEC Issues No-Action Letter on Role of Alternative Trading Systems (ATSs) in Settling Digital Asset Security Trades | Practical Law

SEC Issues No-Action Letter on Role of Alternative Trading Systems (ATSs) in Settling Digital Asset Security Trades | Practical Law

The SEC's Division of Trading and Markets issued a no-action letter to FINRA regarding the process in which alternative trading systems (ATSs) can facilitate trades of digital asset securities without violating Exchange Act Rule 15c3-3 (the Customer Protection Rule).

SEC Issues No-Action Letter on Role of Alternative Trading Systems (ATSs) in Settling Digital Asset Security Trades

by Practical Law Corporate & Securities
Published on 01 Oct 2020 • USA (National/Federal)
The SEC's Division of Trading and Markets issued a no-action letter to FINRA regarding the process in which alternative trading systems (ATSs) can facilitate trades of digital asset securities without violating Exchange Act Rule 15c3-3 (the Customer Protection Rule).
On September 25, 2020, the SEC's Division of Trading and Markets (Division) issued a no-action letter to FINRA allowing for a simpler process for alternative trading systems (ATSs) to facilitate trades of digital asset securities without violating Exchange Act Rule 15c3-3 (the Customer Protection Rule).
FINRA's no-action request specifically asked about the application to registered broker-dealers operating ATSs that trade digital asset securities of the Joint Staff Statement issued on July 8, 2019 by the staffs of the SEC and FINRA, which addressed investor protection concerns relating to the Customer Protection Rule and custody of digital asset securities (see Legal Update, SEC and FINRA Issue Joint Statement on Broker-Dealer Custody of Digital Asset Securities).
The Joint Staff Statement described several non-custodial broker-dealer business models involving digital asset securities that would draw less scrutiny from staff, including where broker-dealers operate an ATS to facilitate secondary market transactions of digital asset securities in which the trades would be settled either directly between the buyer and seller, or the buyer and seller would give instructions to their respective custodians to settle the transactions. However, this model in effect was a four-step process, as outlined in the Division's letter, that broker-dealers felt introduced operational and settlement risk.
To mitigate the operational risk, several broker-dealers proposed the following three-step process:
  • Step 1: The buyer and seller send their respective orders to the ATS, notify their respective custodians of their respective orders submitted to their respective ATSs, and instruct their respective custodians to settle transactions in accordance with the terms of their orders when their ATS notifies the custodians of a match on the ATS.
  • Step 2: The ATS matches the orders.
  • Step 3: The ATS notifies the buyer and seller and their respective custodians of the matched trade and the custodians carry out the conditional instructions.
In the three-step process, as with the model described in the Joint Staff Statement, the broker-dealer operating the ATS does not guarantee or otherwise have responsibility for settling the trades and does not at any time exercise control over the digital asset securities being sold or the cash used to make the purchase other than by notifying the custodians for the buyer and seller, and the buyer and seller, of the match.
In its no-action letter, the Division stated it would not recommend enforcement action to the SEC if a broker-dealer operating an ATS that trades digital asset securities uses the above three-step process for settling digital asset securities transactions, provided:
  • The broker-dealer operator maintains a minimum of $250,000 in net capital.
  • The agreements between the broker-dealer operator and its customers clearly state that the broker-dealer operator does not guarantee or otherwise have responsibility for settling the trades.
  • The broker-dealer operator has established and maintains reasonably designed procedures to assess whether a digital asset security was offered and sold initially pursuant to an effective registration statement or an available exemption from registration, and whether any secondary transactions of the digital asset security on or through the ATS are made pursuant to an effective registration statement or an available exemption from registration.
  • The transactions in digital asset securities otherwise comply with the federal securities laws.
The Division also made clear the letter solely addresses ATSs trading digital asset securities under the specific circumstances described above and does not otherwise address broker-dealer custody or control of digital asset securities under the Customer Protection Rule.
For more information on the Customer Protection Rule, see Practice Note, The Customer Protection Rule for Broker-Dealers.
For more on the regulation of digital asset securities, see Practice Note, SEC Regulation of Digital Assets.