SEC's Ambiguous "Dealer" Rulemaking Needs Reconsideration

On Friday, the DeFi Education Fund submitted a comment letter in response to a new proposed rule by Securities and Exchange Commission (SEC), entitled “Further Definition of ‘As a Part of a Regular Business in the Definition of Dealer and Government Securities Dealer.” Our comment letter expresses our serious concerns with the proposal.

Too Vague to Be Effective

On March 18, 2022, the SEC released a proposed rulemaking that would dramatically expand the definition of what constitutes a “dealer” under the Securities Exchange Act of 1934. If adopted, this proposal would require a host of new persons and entities to register with the SEC as a dealer and comply with the disclosure requirements that come along with registration.

The SEC’s general goals are to promote market efficiency, capital formation, and competitive capital markets while protecting investors. This proposal would have the opposite effect.

The SEC’s proposal is intended to address the emergence of significant but unregulated liquidity-providing participants in the securities markets, most notably in the markets for U.S. Treasuries and equity securities. “Dealers” in this context historically have been entities in the businesses of “making markets” in securities.

But the the proposal would adopt a new definition far less clear in its scope, much more equivocal in its implications, and decidedly over-broad in its language — and for these reasons could potentially capture certain DeFi users. But how would it do so? In what way? The SEC does not say.

A big part of the issue here is the broad and ambiguous factors the SEC proposes to use to establish who is and who is not a dealer. For example, the proposal considers whether an entity’s activity has the effect of “providing liquidity” to markets, but every participant in a market necessarily provides liquidity to it. Owing to its ambiguous definition of a dealer, the proposal will very likely have a chilling effect on innovation, market development and market competitiveness. Concerned market participants will react with fear and uncertainty to the prospect of comprehensive but unpredictable regulatory obligations.

The Exchange Act is intended to subject actual market makers to dealer regulatory standards. The proposed rulemaking departs from this original purpose, and expands the definition of a dealer to include, in part, not just actual market makers, but anyone the SEC views as a “de facto market maker or liquidity provider.” It’s not simply that this definition is vague; it is outside the scope of the Exchange Act’s plain meaning and application.

We also think this proposal was improperly written and disseminated for comment.

The Administrative Procedure Act requires both that agencies provide sufficiently detailed data supporting any and every conclusion in a proposal and that agencies provide the public with sufficient time to respond with thoughtful comments. The SEC did neither of these things.

Despite our criticisms of the SEC’s proposal, we think the SEC’s original objectives with respect to unregulated market actors in securities markets are valid. We just think the SEC is addressing that concern in the wrong way. Accordingly, we conclude our letter by suggesting the SEC come forward with a more tailored approach that falls within the SEC’s authority and that doesn’t implicate market participants it shouldn’t.

You can read our letter in full here.