SEC Proposes Rule Amendments to Require Off-Exchange Broker-Dealers to Become Members of FINRA

The SEC proposed rule amendments to Exchange Act Rule 15b9-1 to require broker-dealers trading in off-exchange venues to become members of a national securities association (i.e., FINRA). According to the SEC, the amendments would enhance the regulatory oversight of active proprietary trading firms, such as high-frequency traders.

Currently, Rule 15b9-1 exempts certain brokers-dealers from membership in FINRA if they (i) are members of a national securities exchange, (ii) carry no customer accounts, and (iii) each have annual gross incomes in which no more than $1,000 is derived from securities transactions effected somewhere 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.

According to the SEC, many active cross-market proprietary trading firms have emerged that are not members of FINRA because they have been able to rely on the broad proprietary trading exemption in Rule 15b9-1.

The proposal would amend the Rule 15b9-1 exemption to target the broker-dealers for which it was originally designed by eliminating the current proprietary trading exemption and replacing it with a “more focused one” that would accommodate off-exchange transactions by floor-based dealers that are effected solely for the purpose of hedging the risks of the dealers’ floor-based activities. The amendments also would update the exemption that permits the off-exchange transactions that are necessary to comply with regulatory requirements restricting trade-throughs under Rule 611 of Regulation NMS.

The SEC Commissioners generally voiced support for the proposal, but some of them expressed concerns. Commissioner Gallagher stated that he is “not convinced that proprietary dealers that avail themselves of the current exemption are a threat to investors or the market.” Similarly, Commissioner Piwowar commented that he is not sure why the proposal is necessary and appropriate. Commissioner Piwowar also voiced his concern that the proposal might impose too many conditions on the exemption.

Commissioner Piwowar also wondered aloud whether FINRA could use the increased fee revenue that will be generated by an influx of membership “in a manner that would not translate to better regulatory oversight for the new members.”

Lofchie Comment: As membership in FINRA becomes a near-universal requirement for broker-dealers, the most interesting question to emerge is not whether all broker-dealers should be required to become FINRA members, but whether FINRA should be considered a government actor.

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