SEC Proposes Rule to Require Broker-Dealers Active in Off-Exchange Market to Become Members of National Securities Association

The Securities and Exchange Commission today proposed rule amendments to require that broker-dealers trading in off-exchange venues become members of a national securities association.  The amendments would enhance regulatory oversight of active proprietary trading firms, such as high frequency traders.

“This proposal embodies a simple but powerful principle of the federal securities laws – the protection of investors and the stability of our markets require that trading is overseen by both the Commission and a strong self-regulatory organization,” said SEC Chair Mary Jo White.  “Today’s proposed rules would close a regulatory gap by extending oversight to a significant portion of off-exchange trading.”

The proposed amendments to Rule 15b9-1 under the Exchange Act would narrow an exemption that currently exempts certain brokers-dealers from membership in a national securities association if they are a member of a national securities exchange, carry no customer accounts, and have annual gross income of no more than $1,000 that is derived from securities transactions effected otherwise than on a national securities exchange of which they are a member.  Income derived from proprietary trading conducted with or through another broker-dealer does not count against the $1,000 limit.  The exemption originally was designed to accommodate exchange specialists and other floor members that might need to conduct limited hedging or other off-exchange activities ancillary to their floor-based business.  Over time, the markets have undergone a substantial transformation, including the emergence of active cross-market proprietary trading firms, many of which engage in so-called high-frequency trading strategies.  Although the business of these firms may not be focused on an exchange floor, and they may be responsible for a substantial percentage of the trading volume in the off-exchange market, many are not members of a national securities association because they have been able to rely on the broad proprietary trading exemption in Rule 15b9-1.

The proposed amendments would amend the exemption to target the broker-dealers for which it was originally designed – those with a business focused on an exchange floor and over which that exchange is positioned to oversee the entirety of their trading activity.  The proposed amendments, among other things, would eliminate the current proprietary trading exemption and replace it with a more focused 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.  They also would update the exemption that permits off-exchange transactions necessary to comply with regulatory requirements restricting trade-throughs, under Rule 611 of Regulation NMS.

The SEC will seek public comment on the proposed rule amendment for 60 days following its publication in the Federal Register.

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FACT SHEET

Proposed Amendments to Rule 15b9-1 to Require Broker-Dealers that Engage in Off-Exchange Trading to Become Members of a National Securities Association

SEC Open Meeting
March 25, 2015

Highlights of the Proposed Amendments

The proposed amendments would:

• Narrow an exemption that currently allows certain broker-dealers to engage in significant off-exchange proprietary trading without becoming members of a national securities association.
• Target the exemption to broker-dealers for which it was originally designed – those with a business focused on an exchange floor.
• Update the exemption that permits off-exchange transactions necessary to comply with the regulatory requirements preventing trade-throughs.

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, and trades solely on an exchange of which it is a member (subject to the following exceptions). 

The proposal would provide for two narrow exceptions to the requirement that a broker-dealer trade solely on an exchange of which it is a member:

• 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 this exception must establish, maintain and enforce written policies and procedures reasonably designed to ensure and demonstrate that such hedging transactions reduce or otherwise mitigate the risks of the financial exposure the dealer incurs as a result 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. 
• A broker-dealer could effect transactions off the exchange that result from orders that are routed by the national securities exchange of which it is a member, to prevent trade-throughs on that national securities exchange consistent with the provisions of Rule 611 Regulation NMS.

Background

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.  However, Rule 15b9-1 was last substantively amended in 1983.  Since then, the markets have undergone a substantial transformation, and active cross-market proprietary trading firms have emerged, many of which engage in so-called high frequency trading strategies.  Although the business of these firms is not focused on an exchange floor, and they are responsible for a substantial percentage of the trading volume in the off-exchange market, many are not members of a national securities association because they have been able to rely on the broad proprietary trading exemption in Rule 15b9-1.

Comment Period for 15b9-1

If approved for publication by the Commission, the proposed amendments will be published on the Commission’s website and in the Federal Register.  The comment period for the proposed amendments will be 60 days after publication in the Federal Register.