a favorable difference or spread between the price at which he buys and
the amount for which he sells'' \137\--and the liquidity provider whose
trading strategies generally involve frequent turnover of positions on
a short-term basis, with overnight holdings of unhedged positions that
are a fraction of their overall intraday positions.\138\
---------------------------------------------------------------------------

    \135\ See, e.g., 2002 Release (focusing, among other things, on
a ``regular turnover of inventory'' rather than requiring completely
neutral positions).
    \136\ The Proposed Rules do not provide a bright-line test to
determine ``roughly comparable'' purchases and sales. However, for
purposes of the Economic Analysis of the Proposed Rules, the
Commission assumes a daily buy-sell imbalance between two identical
or substantially similar securities, in terms of dollar volume,
below 10 percent or, alternatively, 20 percent may be indicative of
purchases and sales that are ``roughly comparable,'' as described
below in Section V.B.2.c. The Commission has requested comment on
whether this approach is appropriate and whether this standard
should include a trading threshold.
    \137\ See U.S. Securities and Exchange Commission, Report on the
Feasibility and Advisability of the Complete Segregation of the
Functions of Dealer and Broker XIV (1936).
    \138\ See 2010 Equity Market Structure Concept Release at 3607-
09. See also 2015 Joint Staff Report.

---------------------------------------------------------------------------

    The Proposed Rules reflect the statutory distinction between
``dealers'' and ``traders.'' The Commission has long distinguished
dealer activity from trader activity by focusing on, among other
things, a dealer's frequent turnover of positions--stating, for
example, that the dealer ``sells securities . . . he has purchased or
intends to purchase elsewhere or buys securities . . . with a view to
disposing of them elsewhere'' \139\--as well as the frequency with
which a person buys and sells.\140\ By targeting persons who routinely
make roughly comparable purchases and sales of the same or
substantially similar securities, the Proposed Rules identify persons
whose trading has the effect of providing liquidity that requires
dealer registration, and so distinguish those persons who are acting as
traders.\141\
---------------------------------------------------------------------------

    \139\ See U.S. Securities and Exchange Commission, Report on the
Feasibility and Advisability of the Complete Segregation of the
Functions of Dealer and Broker XIV (1936).
    \140\ See Section II.A.
    \141\ See Section I.
---------------------------------------------------------------------------

    The Proposed Rules take into account the speed at which technology
permits liquidity providers today to turn over their positions and the
fact that high-speed, anonymous trading platforms allow liquidity
providers to act as intermediaries without customers and without
holding an inventory of securities.\142\ In addition, the Proposed
Rules take into consideration the frequency with which a person buys
and sells securities, which is a factor historically considered as part
of the dealer analysis.\143\ Because they are based on activity, the
Proposed Rules would cover not only PTFs, but also any other persons
engaging in the identified activities.
---------------------------------------------------------------------------

    \142\ See, e.g., Stock Exchange Regulation: Hearing on H.R. 7852
and H.R. 8720 Before the Committee on Interstate and Foreign
Commerce, 73rd Congr. 117 (1934) (statement of Thomas Corcoran)
(discussing floor traders, which have long been viewed as dealers).
As the markets have evolved, the role of floor traders has largely
been replaced by PTFs, which play a role--albeit, electronically and
through the use of algorithmic trading strategies--similar to that
of the floor traders that traditionally have been regulated as
dealers. See 2010 Equity Market Structure Concept Release at 3607-
08.
    \143\ See Section II.A.
---------------------------------------------------------------------------

    Paragraph (a)(1)(i) of the Proposed Rules would also provide that
the securities bought and sold must be ``the same or substantially
similar'' in order to further distinguish liquidity providing dealer
activity from non-dealer trader activity. As discussed above, routinely
making roughly comparable purchases and sales of securities keeps a
liquidity provider's market positions near neutral only to the extent
that a sale or another trade offsets the risk taken on through a
purchase. For purposes of the rule, ``the same'' securities means that
the securities bought and sold are securities of the same class and
having the same terms, conditions, and rights.\144\ Securities bearing
the same Committee on Uniform Securities Identification Procedures
(``CUSIP'') number, for example, would be considered ``the same.'' In
addition, the determination of what would constitute ``substantially
similar'' securities for purposes of the rule would be based on the
facts and circumstances analysis that would take into account factors
such as, for example, whether: (1) The fair market value of each
security primarily reflects the performance of a single firm or
enterprise or the same economic factor or factors, such as interest
rates; and (2) changes in the fair market value of one security are
reasonably expected to approximate, directly or inversely, changes in,
or a fraction or a multiple of, the fair market value of the second
security. A person routinely making roughly comparable purchases and
sales of the same or substantially similar securities, such that the
sale or purchase of one security offsets the risk associated with the
sale or purchase of the other, permitting that person to maintain a
near market-neutral position, would meet this aspect of this standard.
---------------------------------------------------------------------------

    \144\ See 17 CFR 227.300(b)(2) (Rule 300(b)(2) of Regulation
Crowdfunding) (permitting an intermediary to have a financial
interest in an issuer if, among other things, the financial interest
consists of securities of the same class and having the same terms,
conditions and rights as the securities being offered and sold on
the intermediary's platform.).
---------------------------------------------------------------------------

    Applying these principles, the Commission believes that the
following are nonexclusive examples of purchases and sales of
``substantially similar'' securities:
     Selling a Treasury security and buying another Treasury
security in the same maturity range, as used by the Federal Reserve
Bank of New York's Open Market Operations.\145\ For example, selling a
4.5-year Treasury security and buying a 5-year Treasury security, or a
9.5 year Treasury security versus a 10-year Treasury security.
---------------------------------------------------------------------------

    \145\ See Federal Reserve Bank of New York, ``FAQs: Treasury
Purchases,'' https://www.newyorkfed.org/markets/treasury-reinvestments-purchases-faq.
---------------------------------------------------------------------------

     Buying an exchange traded fund and selling the underlying
securities that make up the basket of securities held by the exchange
traded fund that was purchased.
     Buying a European call option on a stock and selling a
European put option on the same stock with the same strike and
maturity.
     Buying an OTC call option on a stock and selling a listed
option on the same stock with the same strike and maturity.
    Conversely, the Commission believes that the following are examples
of purchases and sales of securities that are not ``substantially
similar'':
     Buying stock in one company (e.g., Ford) and selling stock
in another company in the same industry (e.g., Chrysler).
     Buying stock and selling bonds issued by the same company.
     Buying cash Treasury securities and selling Treasury
futures.
    Finally, the standard under paragraph (a)(1)(i) of the Proposed
Rules would apply with respect to purchases and sales made ``in a
day.'' As discussed above, dealer liquidity providers are
distinguishable, in part, from traders and other market participants by
the frequent turnover of their positions. Traditional dealers often
hold an inventory to enable them to buy from one market participant and
sell to another. Technological advancements have increased the speed at
which this process happens, eliminating in some cases the need to carry
a traditional inventory at all, as liquidity providers are able to
source and unload securities extremely rapidly. The Commission believes
that a temporal component is necessary in paragraph (a)(1)(i) to
distinguish dealer liquidity providers from other market participants
who may contribute liquidity to the market periodically but not in the
repeated, routine--and often relied upon--manner of liquidity
providers. The Commission believes that ``in a day'' is a period of
sufficient duration to capture the trading activity typical of dealer
liquidity providers that are the focus of the Proposed Rules, and still
brief enough to exclude non-dealers pursuing longer-term investment
strategies. In addition, because PTFs tend to turn over their positions
over the course of a day, ``end[ing] the day with little net
directional exposure,'' \146\ market practices support drawing the
temporal line at the end of the day.
---------------------------------------------------------------------------

    \146\ See 2021 IAWG Joint Staff Report at 5.
---------------------------------------------------------------------------

ii. Routinely Expressing Trading Interests That Are at or Near the Best
Available Prices on Both Sides of the Market and That Are Communicated
and Represented in a Way That Makes Them Accessible to Other Market
Participants
    Proposed Rules 3a44-2(a)(1)(ii) and 3a5-4(a)(1)(ii) set forth the
second

pattern of trading activity that ``has the effect of providing
liquidity to other market participants.'' Specifically, under paragraph
(a)(1)(ii), a person buying and selling for its own account that
``routinely express[es] trading interests that are at or near the best
available prices on both sides of the market and that are communicated
and represented in a way that makes them accessible to other market
participants'' would be engaged in a pattern of trading in securities
or government securities that ``has the effect of providing liquidity
to other market participants,'' and therefore would be a dealer or
government securities dealer under the Proposed Rules. As discussed
below, the Proposed Rules would update the longstanding understanding
that regular or continuous quotation is a hallmark of market making or
de facto market making (and, hence, dealer) activity,\147\ to reflect
technological changes to the ways in which buyers and sellers of
securities are brought together.
---------------------------------------------------------------------------

    \147\ The term ``market maker'' includes, among other things,
``any dealer who, with respect to a security, holds itself out (by
entering quotations in an inter-dealer quotation system or
otherwise) as being willing to buy and sell such security for its
own account on a regular or continuous basis.'' See 15 U.S.C.
78c(a)(38). Moreover, the Commission has stated previously that a
market maker engaged in bona-fide market making is a ``broker-dealer
that deals on a regular basis with other broker-dealers, actively
buying and selling the subject security as well as regularly and
continuously placing quotations in a quotation medium on both the
bid and ask side of the market.'' See, e.g., Exchange Act Release
No. 32632 (July 14, 1993), 58 FR 39072, 39074 (July 21, 1993).
---------------------------------------------------------------------------

    The Proposed Rules would apply when a person ``routinely''
expresses trading interests. Here, as well as in paragraph (a)(1)(i),
``routinely'' means that the person must express trading interests more
frequently than occasionally, but not necessarily continuously.\148\ As
discussed above in connection with paragraph (a)(1)(i), ``routinely''
relates to the frequency of the activity both intraday and across time,
and means both repeatedly within a day and on a regular basis over
time. The Commission believes it is appropriate to use ``routinely,''
rather than ``regular'' or ``continuous,'' as the latter standards may
fail to capture a number of significant firms, due to the unique
characteristics of certain liquidity providers in today's markets.
Specifically, by using ``routinely,'' the Proposed Rules are intended
to reflect market evolution to capture significant liquidity providers
who express trading interests at a high enough frequency to play a
significant role in price discovery and the provision of market
liquidity, even if their liquidity provision may not be continuous like
that of some traditional dealers. At the same time, they are very
active in the markets--their participation is very routine--as
demonstrated by the ``key role'' they play ``in price discovery and the
provision of market liquidity'' in both the interdealer U.S. Treasury
market \149\ and the equity markets.\150\
---------------------------------------------------------------------------

    \148\ See, e.g., Entities Adopting Release at 30609 (``In this
regard, `routinely' means that the person must do so more frequently
than occasionally, but there is no requirement that the person do so
continuously.'').
    \149\ 2021 IAWG Joint Staff Report at 5, 13.
    \150\ See, e.g., Algorithmic Trading Staff Report; 2010 Equity
Market Structure Concept Release.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii) would also use the term ``trading interest''
rather than ``quotations.'' The Commission has recently proposed to
define ``trading interest'' to mean ``an order, as defined in paragraph
(e) of [Rule 300 of Regulation ATS],\151\ or any non-firm indication of
a willingness to buy or sell a security that identifies at least the
security and either quantity, direction (buy or sell), or price.''
\152\ Technological advancements have proliferated methods by which
market participants hold themselves out as willing to buy or sell
securities, or otherwise communicate their willingness to trade. The
broader term ``trading interest'' would reflect the prevalence of non-
firm trading interest offered by market places today,\153\ and account
for the varied ways in which developing technologies permit market
participants to effectively make markets. The broader term
appropriately captures the traditional quoting engaged in by dealer
liquidity providers, new and developing quoting equivalents, and the
orders that actually result in the provision of liquidity that the
Commission intends the Proposed Rules to address. Using ``trading
interest,'' as defined above, rather than ``quotation'' will allow for
clear and consistent application of the definition of dealer and
government securities dealer.
---------------------------------------------------------------------------

    \151\ 17 CFR 242.300(e) defines an ``order'' to mean ``any firm
indication of a willingness to buy or sell a security, as either
principal or agent, including any bid or offer quotation, market
order, limit order, or other priced order.''
    \152\ See 2022 ATS Proposing Release, proposed Rule 300(q). In
proposing this new term, the Commission noted the incidence of
``non-firm trading interest that includes the symbol and one of the
following: quantity, direction, or price. . . . The Commission
believes that . . . the use of a message that identifies the
security and either the quantity, direction, or price would provide
sufficient information to bring together buyers and sellers of
securities because it allows a market participant to communicate its
intent to trade and a reasonable person receiving the information to
decide whether to trade or engage in further communications with the
sender.'' Id. at 15505.
    \153\ See 2022 ATS Proposing Release at 15500-15502.
---------------------------------------------------------------------------

    Further, the Commission is proposing that the rules encompass
trading interests expressed ``at or near the best available prices on
both sides of the market.'' \154\ The phrase ``best available prices on
both sides of the market'' more specifically and clearly describes the
activity of liquidity-providing dealers, which help determine the
spread between the best available bid price and the best available ask
price for a given security. Among other market benefits, by competing
to both buy and sell at the best available prices, liquidity providers
help to narrow bid-ask spreads.\155\ The Commission further believes
that the proposed formulation helps emphasize that a liquidity
provider, to come within the rule, must both buy and sell
securities.\156\
---------------------------------------------------------------------------

    \154\ See, e.g., Regulation SHO Amendments, in which the
Commission stated that quotations near or at the market for a short
sale in a security may provide an indication of bona-fide market
making for purposes of Regulation SHO, depending on the facts and
circumstances surrounding the activity. See also supra note 131.
    \155\ See, e.g., Prohibitions and Restrictions on Proprietary
Trading, Release No. BHCA-1; File No. S7-41-11 (Dec. 10, 2013), 79
FR 5535, 5585-86 (Jan. 31, 2014), available at https://www.sec.gov/rules/final/2013/bhca-1.pdf (setting forth, among other things, the
circumstances in which a banking entity may engage market making-
related activities) (``Volcker Rule Adopting Release'') at 177.
    \156\ See, e.g., 15 U.S.C. 78c(a)(5) (``The term `dealer' means
any person engaged in the business of buying and selling
securities'' (emphasis added)); see also 15 U.S.C. 78c(a)(44).
---------------------------------------------------------------------------

    Finally, the Proposed Rules would apply only when these trading
interests that are at or near the best available prices on both sides
of the market are ``communicated and represented in a way that makes
them accessible to other market participants.'' Under the Proposed
Rules, a market participant that routinely makes these trading
interests available to other market participants would be considered to
have engaged in a routine pattern of trading that has the effect of
providing liquidity to other market participants.\157\
---------------------------------------------------------------------------

    \157\ See, e.g., Regulation SHO Amendments (``Continuous
quotations that are at or near the market on both sides and that are
communicated and represented in a way that makes them widely
accessible to investors and other broker-dealers are also an
indication that a market maker is engaged in bona-fide market making
activity.''). But see supra note 131 (explaining that the
determination of eligibility for Regulation SHO's bona-fide market-
making exceptions is distinct from the determination of whether a
person's trading activity indicates that such person is acting as a
dealer under the Proposed Rule). The Commission further notes that
the bona-fide market-making exceptions under Regulation SHO are only
available to registered broker-dealers that publish continuous
quotations for a specific security in a manner that puts the broker-
dealer at economic risk. Broker-dealers that do not publish
continuous quotations, or publish quotations that do not subject the
broker-dealer to such risk (e.g., quotations that are not publicly
accessible, are not near or at the market, or are skewed
directionally towards one side of the market), would not be eligible
for the bona-fide market-maker exceptions under Regulation SHO. In
addition, broker-dealers that publish quotations but fill orders at
different prices than those quoted would not be engaged in bona-fide
market making for purposes of Regulation SHO.

---------------------------------------------------------------------------

iii. Earning Revenue Primarily From Capturing Bid-Ask Spreads, by
Buying at the Bid and Selling at the Offer, or From Capturing Any
Incentives Offered by Trading Venues to Liquidity-Supplying Trading
Interests
    Proposed Rules 3a44-2(a)(1)(iii) and 3a5-4(a)(1)(iii) set forth the
final enumerated pattern of activity that ``has the effect of providing
liquidity to other market participants.'' Under paragraph (a)(1)(iii)
of each rule, a person that, trading for its own account, ``earn[s]
revenue primarily from capturing bid-ask spreads, by buying at the bid
and selling at the offer, or from capturing any incentives offered by
trading venues to liquidity-supplying trading interests,'' would be
engaging in a routine pattern of trading that has the effect of
providing liquidity to other market participants, and as a result,
would be a dealer under the Proposed Rules.
    As with other aspects of the Proposed Rules, this standard focuses
on activity rather than label or status. The Proposed Rules would apply
to any person regardless of whether the person labels itself, or is
commonly known as, a PTF.
    As discussed above, one fundamental characteristic typical of
market makers and liquidity providers--and one that has historically
been viewed as dealer activity--is trading in a manner designed to
profit from spreads or liquidity incentives, rather than with a view
toward appreciation in value.\158\ The Commission has previously
identified a person's seeking, through its presence in the market,
compensation through spreads or fees, or other compensation not
attributable to changes in the value of the security traded, as a
factor indicating dealer activity.\159\ Dealer liquidity providers
frequently are distinguishable from other market participants whose
trades arguably ``provide liquidity'' inasmuch as dealers seek to be
compensated for the service of contributing to a market's liquidity,
whether by bid-ask spreads or liquidity incentives. They are ``in the
business'' of providing liquidity because they routinely supply it and
the revenue they earn as a result through bid-ask spreads or liquidity
incentives is their primary source of revenue.
---------------------------------------------------------------------------

    \158\ See, e.g., U.S. Securities and Exchange Commission, Report
on the Feasibility and Advisability of the Complete Segregation of
the Functions of Dealer and Broker XIV (1936) (``The dealer . . .
receives no brokerage commission but relies for his compensation
upon a favorable difference or spread between the price at which he
buys and the amount for which he sells.''). See also Entities
Adopting Release at 30609 (``seeking to profit by providing
liquidity to the market is an indication of dealer [as opposed to
trader] activity'').
    \159\ See Entities Adopting Release at 30617 (identifying as an
indication of dealer activity which is consistent with the
definition's ``regular business'' requirement, ``seeking
compensation in connection with providing liquidity . . . by seeking
a spread, fees or other compensation not attributable to changes in
the value of the [security itself]''). With respect to bid-ask
spreads, the connection between liquidity provision and bid-ask
spreads is evident in the relationship among high volume, liquidity,
and bid-ask spreads: Because high volume can reduce a dealer's
overhead, high volume tends to make liquidity provision more
profitable; as liquidity provision becomes more profitable, more
persons compete to provide liquidity, and this increased competition
tightens bid-ask spreads, as the more competitive liquidity
providers are willing to be compensated less for the liquidity they
provide in order to compete. See Section V.C.3.c. See also Volcker
Rule Adopting Release at 177 (``[L]iquidity provides important
benefits to the financial system, as more liquid markets are
characterized by competitive market makers, narrow bid-ask spreads,
and frequent trading.''). Notably, a person may be acting as a
dealer by profiting from a spread even if they are not profiting
from ``bid-ask spreads'' under the Proposed Rules. See, e.g., River
North, 415 F. Supp. at 859 (discussing Sodorff, 1992 WL 224082, at
*5).
---------------------------------------------------------------------------

    Both forms of revenue are accounted for in the Proposed Rules. The
first--capturing bid-ask spreads--is done by buying at the bid and
selling at the offer, which would include buying at a lower price than,
and selling at a higher price than, the midpoint of the bid-ask spread.
The spread between these prices compensates them for providing the
service of liquidity--that is, of generally standing ready to buy or
sell and enabling other market participants to reliably make purchases
and sales. When a liquidity provider routinely buys and sells
securities in a manner designed to capture a spread with such frequency
and consistency that its revenue is made up primarily of this form of
compensation, it will be considered to be engaged in a routine pattern
of providing liquidity as a service and will fall within the scope of
the rules.
    The second major source of revenue for market makers and other
liquidity providers is explicit liquidity-compensation arrangements.
For example, many exchanges in the equities markets have adopted a
``maker-taker'' pricing model to compensate (and thereby attract)
liquidity providers.\160\ Under this model, non-marketable, resting
orders that offer (make) liquidity at a particular price receive a
liquidity rebate if they are executed, while incoming orders that
execute against (take) the liquidity of resting orders are charged an
access fee.\161\ When a liquidity provider, as a result of its routine
purchases and sales of securities, captures ``incentives offered by
trading venues to liquidity-supplying trading interests'' with such
frequency and consistency that its revenue is made up primarily of this
form of compensation, it will be considered to be engaged in a routine
pattern of providing liquidity as a service and generally standing
ready to buy or sell securities, so would fall within the scope of the
Proposed Rules.
---------------------------------------------------------------------------

    \160\ See 2010 Equity Market Structure Concept Release at 3599.
    \161\ See 2010 Equity Market Structure Concept Release at 3599.
Highly automated exchange systems and liquidity rebates have
contributed to the rise of PTFs that focus on liquidity provision.
Id.
---------------------------------------------------------------------------

    To come within this paragraph of the Proposed Rules, a liquidity
provider would have to earn its revenue primarily from bid-ask spreads
or trading incentives. The Proposed Rules use the phrase ``earn
revenue''--rather than, for example, ``profit from''--to make clear
that a person's trading strategies would not need to be profitable to
bring them within the rule because a market participant can provide
liquidity without being profitable. Furthermore, under the Proposed
Rules, a person whose revenue is derived ``primarily'' from capturing
bid-ask spreads or liquidity incentives, or a combination of the two,
would be a liquidity provider that is engaged in the regular business
of buying and selling securities for its own account and, as a result,
a dealer or government securities dealer. Generally speaking, although
the Proposed Rules do not provide a bright-line test in connection with
the qualitative factors, the Commission believes that if a person
derives the majority of its revenue from the sources described in
paragraph (a)(3)(iii), it would likely be in a regular business of
buying and selling securities or government securities for its own
account.
    Finally, the paragraph would apply with respect to activity on
``trading venues.'' The Commission has recently proposed to define the
term ``trading venue'' to mean ``a national securities exchange or
national securities association that operates an SRO trading facility,
an ATS, an exchange market maker, an OTC market maker, a futures or
options market, or any other broker- or dealer-operated platform for
executing trading interest internally by trading as principal or
crossing orders as agent.'' \162\
---------------------------------------------------------------------------

    \162\ 2022 ATS Proposing Release at 15540.
---------------------------------------------------------------------------

    Market evolution has given rise to a variety of venues in which
liquidity providers can express trading interests,

and the definition is designed to capture the breadth of these
different venues. For example, Communication Protocol Systems, which
are electronic systems that offer the use of non-firm trading interest
and make available communication protocols to bring together buyers and
sellers of securities but do not fall within the current definition of
an ``exchange'' under Federal securities laws, have come to perform the
function of a market place and become a preferred method for market
participants to discover prices, find counterparties, and execute
trades.\163\ The Proposed Rules are designed to capture dealer activity
wherever that activity occurs, whether on a national securities
exchange, an ATS, a Communication Protocol System, or another form of
trading venue. For purposes of the Proposed Rules, the particular
trading venue matters less than the fact that a market participant
provides liquidity on it. Using the broad term ``trading venue,'' as
defined above, will allow for clear and consistent application of the
definitions of dealer and government securities dealer.
---------------------------------------------------------------------------

    \163\ See 2022 ATS Proposing Release at 15496 n.5 and 15501.
This is particularly true for government securities and other fixed
income securities. Id.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on these provisions of
the Proposed Rules. In addition, the Commission requests comments on
the following specific issues:
    9. Is there sufficient specificity provided for the terms used in
the qualitative standards? Are there any terms that should be defined
in rule text or addressed in the release?
     Is there sufficient specificity provided for the term
``pattern''? If not, what additional specificity should the Commission
provide and please provide specific examples on the types of
specificity. Should the rule text define what is meant by ``pattern''?
Why or why not? Is the Proposed Rules' use of ``pattern'' appropriate?
Would ``manner'' or another word be more appropriate? Why or why not?
     Is there sufficient specificity provided for the term
``effect of providing liquidity''? If not, what additional specificity
should the Commission provide and please provide specific examples on
the types of specificity. Should the rule text define what is meant by
``effect of providing liquidity''? Why or why not? Is the Proposed
Rules' use of ``effect of providing liquidity'' appropriate? Would
replacing ``effect of providing liquidity'' with ``market making'' be
more appropriate? Are there other words that would more appropriate?
Why or why not?
     Is there sufficient specificity provided for the term
``primarily''? Should the rule text define what is meant by
``primarily''? Why or why not? Is the Proposed Rules' use of
``primarily'' appropriate? Would ``mostly'' or another word be more
appropriate? Why or why not?
     Is there sufficient specificity provided for the term
``trading venue''? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Should the rule text define what is meant by ``trading
venue''? Why or why not? Is the Proposed Rules' use of ``trading
venue'' appropriate? Are there other words that would be more
appropriate? Why or why not?
    10. Is liquidity provision an appropriate factor to use in defining
which buying and selling activity for one's own account qualifies as
``regular business''? Are there other factors the Commission should
include? If so, which factors and why? Are there trading activities or
investment strategies that should not be considered providing
liquidity? If so, please describe why.
    11. Are the three qualitative factors identified in the Proposed
Rules as having the ``effect of providing liquidity to other market
participants'' that would qualify as ``regular business'' appropriate?
Are there any other forms of liquidity provision, or any other factors,
that the Commission should include or exclude instead or in addition to
those proposed? Are the factors over or under-inclusive? If so, please
provide specific examples of any alternative suggestions.
     For example, should the Commission include as an example
of a ``liquid market,'' ``a market in which participants have the
ability to readily trade at a predictable price and in a desired size
without materially moving the market''? Why or why not?
     In addition to passive ``liquidity providing'' trading
strategies, the Proposed Rules would capture certain aggressive
``liquidity demanding'' strategies as having the ``effect of providing
liquidity to other market participants''? Is this appropriate? Why or
why not?
    12. Under the Proposed Rules, a person routinely making roughly
comparable purchases and sales of the same or substantially similar
securities in a day would have the effect of providing liquidity to
other market participants, and therefore would be a dealer. Is this an
appropriate measure or illustration of liquidity provision? Why or why
not? Would the provision capture persons that should not be dealers? If
so, who and why?
     For example, would the Proposed Rules capture private
funds and other persons pursing investment strategies such as relative
value fixed income arbitrage or share class arbitrage? If so, should
such strategies be included or excluded? Why or why not?
     Is there sufficient specificity to determine which
securities would be considered ``same'' or ``substantially similar''?
Why or why not? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Should additional or different factors be considered? Are
there other words that would be more appropriate? Why or why not?
     Should the rule text define what is meant by ``same'' or
``substantially similar''? Why or why not?
     Are there other types of purchase and sale transactions
that would be examples of purchases and sales of securities that are
``substantially similar'' (i.e., other types of roughly comparable
purchases and sales of substantially similar securities, such that the
sale or purchase of one security offsets the risk associated with the
sale or purchase of the other, permitting a person to maintain a near
market-neutral position)? Are there examples of types of purchase and
sale transactions involving derivatives, or other products that
represent the economic equivalent of another security, that would be
purchases and sales of securities that are ``substantially similar''?
Please explain.
    13. Although the Proposed Rules do not provide a bright-line test
to determine ``roughly comparable'' purchases and sales, depending on
the facts and circumstances, the Commission believes a daily buy-sell
imbalance, as described below in Section V.B.2.c., between two
identical or substantially similar securities, in terms of dollar
volume below 20 percent may be indicative of purchases and sales that
are ``roughly comparable.'' Is this an appropriate measurement of
``roughly comparable''? Why or why not? Would another measurement be
more appropriate? Should there be a minimum trading volume or dollar
amount threshold as part of the qualitative standard under paragraph
(a)(1)(i), daily buy-sell imbalance, or other measurement?
     Is there sufficient specificity provided for the term
``roughly comparable''? Why or why not? If not,

what additional specificity should the Commission provide and please
provide specific examples on the types of specificity. Is the Proposed
Rules' use of ``roughly comparable'' appropriate? Are there other words
that would be more appropriate? Why or why not?
     Should the rule text define, as opposed to the release
addressing, what is meant by ``roughly comparable''? Why or why not?
     Does there need to be more specificity provided as to how
many transactions must be executed (or positions opened and/or closed)
in a day to be ``roughly comparable''?
     Is ``in a day'' an appropriate period of time during which
to measure whether a person has made roughly comparable purchases and
sales of the same or substantially similar securities? If not, what is
an appropriate time period?
     If an institutional investor seeks to rebalance its
portfolio, would the institutional investor typically ``routinely make
roughly comparable purchases and sales of the same or substantially
similar securities in a day,'' or otherwise trigger the Proposed Rules?
    14. Under the Proposed Rules, a person that ``routinely express[es]
trading interests that are at or near the best available prices on both
sides of the market and that are communicated and represented in a way
that makes them accessible to other market participants'' would have
the effect of providing liquidity to other market participants, and
thus would be a dealer. Is this an appropriate measure or illustration
of liquidity provision? Why or why not? Would the provision capture
persons that should not be dealers? If so, who and why?
     Is the Proposed Rules' use of ``routinely'' appropriate?
Would ``regularly'' or ``continuously'' or another word be more
appropriate? Why or why not?
     Is there sufficient specificity provided for the term
``routinely''? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Should the rule text define what is meant by
``routinely''? Why or why not?
     Is the Proposed Rules' use of ``trading interest''
appropriate? Would ``quotations'' or another term be more appropriate?
Why or why not?
     Is there sufficient specificity provided for the term
``trading interest''? Should the rule text define what is meant by
``trading interest''? Why or why not? If not, what additional
specificity should the Commission provide and please provide specific
examples on the types of specificity.
     The Proposed Rules would require that trading interests be
communicated and represented in a way that makes them accessible to
other market participants in order to come within the rule. Should the
Commission require that the trading interests be communicated
``widely''? Why or why not?
    15. Under the Proposed Rules, a person that ``earn[s] revenue
primarily from capturing bid-ask spreads, by buying at the bid and
selling at the offer, or from capturing any incentives offered by
trading venues to liquidity-supplying trading interest,'' would have
the effect of providing liquidity to other market participants. Is this
an appropriate measure or illustration of liquidity provision? Why or
why not? Would the provision capture persons that should not be
dealers? If so, who and why?
     Is there sufficient specificity provided for the term
``earn revenue''? If not, what additional specificity should the
Commission provide and please provide specific examples on the types of
specificity. Is the Proposed Rules' use of ``earn revenue''
appropriate? Are there other words that would be more appropriate? Why
or why not? Should the rule text define what is meant by ``earn
revenue''? Why or why not?
     Should the Proposed Rules include additional or other
forms of revenue?
     Should the Proposed Rules include other measures of
liquidity provision? If so, what measures and why?
     As explained above, buying at the bid and selling at the
offer would include buying at lower than, and selling at higher than,
the midpoint of the bid-ask spread. Should the rule text define
``capturing bid-ask spread'' to expressly include buying at lower than,
and selling at higher than, the midpoint of the bid-ask spread?
    16. Do the Proposed Rules provide sufficient specificity to permit
market participants to distinguish between revenue derived from
capturing bid-ask spreads and revenue derived from realization of
appreciation of the underlying asset?

C. Quantitative Standard

    In addition to the qualitative standards described above, proposed
Rule 3a44-2 would also include a quantitative standard that would
establish a bright-line test under which persons engaging in certain
specified levels of activity in the U.S. Treasury market would be
defined to be buying and selling securities ``as a part of a regular
business,'' regardless of whether they meet any of the qualitative
standards. Specifically, proposed Rule 3a44-2(a)(2) would provide that
a person \164\ that is engaged buying and selling government securities
for its own account is engaged in such activity ``as a part of a
regular business'' if that person in each of four out of the last six
calendar months, engaged in buying and selling more than $25 billion of
trading volume in government securities as defined in Section
3(a)(42)(A) of the Exchange Act.\165\
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    \164\ In light of the statutory definition of ``person,'' in
conjunction with the proposed definitions of ``own account'' and
``control,'' as discussed in Section III.D, trading volume would be
determined by aggregating volume at the firm or legal-entity level
(rather than market participant identifier (``MPID'') or global firm
level). See 15 U.S.C. 78c(a)(9).
    \165\ Proposed Rule 3a44-2(a)(2) only applies to government
securities as defined in Section 3(a)(42)(A) of the Exchange Act.
Accordingly, the trading volume threshold set forth in the proposed
rule does not apply to all government securities as defined by
Section 3(a)(42); but rather, it is limited to ``securities which
are direct obligations of, or obligations guaranteed as to principal
or interest by, the United States'' (``U.S. Treasury Securities'').
See 15 U.S.C. 78c(a)(42)(A). For purposes of determining whether the
trading volume threshold is met, a person would include transactions
in U.S. Treasury Securities--that is, Treasury bills, notes,
floating rate notes, bonds, inflation-protected securities
(``TIPS''), and Separate Trading of Registered Interest and
Principal Securities (``STRIPS'')--and would exclude auction awards
and repurchase or reverse repurchase transactions in U.S. Treasury
Securities. See 2022 ATS Proposing Release at 15542 nn. 512-517
(describing U.S. Treasury Securities). Additionally, for purposes of
determining whether the trading volume threshold is met, Treasury
when-issued transactions would be included.
---------------------------------------------------------------------------

    The Commission believes that four out of the last six calendar
months is an appropriate range of time to evaluate the trading volume
of a market participant and should help to ensure the proposed
quantitative standard does not capture market participants with
relatively low trading volume that may have had an anomalous increase
in trading. The proposed time measurement period would smooth monthly
variations by reducing the effect of trading fluctuations in a
particular month that could misrepresent or distort a market
participant's overall trading pattern.\166\ A shorter period of time
could potentially cause a market participant to fall within the scope
of the quantitative standard solely as a result of an atypical, short-
term increase in trading, which

potentially could discourage participation in the U.S. Treasury market
by a new market participant that has not had as long of a time period
to develop its business prior to having to incur compliance costs
associated with being subject to dealer registration. In addition, the
Commission does not believe that a longer period of time is necessary
to identify those market participants that play a significant role, and
regularly transact, in U.S. Treasury Securities. The Commission
believes that the proposed time measurement period provides sufficient
trading history data so as to indicate a market participant's
significance to the market, and that the structure of the measurement
(i.e., requiring a market participant to meet the threshold for four
out of the last six calendar months) identifies regularity of such
significant trading levels.
---------------------------------------------------------------------------

    \166\ This Commission has adopted regulations that use the four
out of the last six calendar months metric in Regulation ATS, Rules
301(b)(5) and (6), and Regulation SCI Rule 1000. See 17 CFR
242.301(b)(5)-(6) (definition of an SCI alternative trading system
or SCI ATS); see also Regulation Systems Compliance and Integrity,
Exchange Act No. 73639 (Nov. 19, 2014), 79 FR 72251 (Dec. 5, 2014)
(noting that time measurement period of four of the preceding six
months is consistent with the current standard under Regulation
ATS).
---------------------------------------------------------------------------

    As discussed below, the Commission's analysis of market
participants that are not members of FINRA in the U.S. Treasury market
found that these participants accounted for approximately 19 percent of
the aggregate Treasury trading volume in July 2021, with PTFs
representing the highest volumes of trading among these
participants.\167\ In addition, PTFs dominate the interdealer U.S.
Treasury market, representing 61 percent of the trading activity on the
electronic IDB platforms and 48 percent of the total interdealer
market.\168\
---------------------------------------------------------------------------

    \167\ See Section V.B.2. Specifically, the analysis identified
174 market participants who were active in the U.S. Treasury market
in July 2021 and that were not members of FINRA. Although FINRA
membership is not synonymous with dealer registration status, the
Commission believes that many of the market participants who are not
FINRA members are also likely not registered as government
securities dealers. These 174 identified non-FINRA member market
participants accounted for approximately 19 percent of aggregate
Treasury trading volume in July 2021. PTFs had the highest volumes
among these identified non-FINRA member U.S. Treasury market
participants. See Section V.B.2.
    \168\ See supra note 2.
---------------------------------------------------------------------------

    Although, as noted previously, the Proposed Rules alone will not
necessarily prevent future market disruptions, the operation of
proposed Rule 3a44-2 will support transparency; market integrity and
resiliency; and investor protection across the U.S. Treasury market by
helping to close the regulatory gap that currently exists and by
ensuring consistent regulatory oversight.\169\ The lack of consistent
visibility across the market today constrains the ability of regulators
to understand and respond to significant market events. The proposed
quantitative standard is intended to capture the most significant
market participants that are regularly buying and selling U.S. Treasury
Securities, and subject these participants that are not already
registered as dealers or government securities dealers to a regulatory
regime designed to minimize the risks they may pose to the U.S.
Treasury market and provide regulators with appropriate oversight of
their activities.
---------------------------------------------------------------------------

    \169\ For example, regulators do not have the same insight into
the trading activities of unregistered PTFs because, unlike
registered dealers, they do not report their U.S. Treasury
Securities transactions to FINRA's Trading Reporting and Compliance
Engine (``TRACE''), do not file annual reports with the Commission,
and are not subject to Commission examinations. See Section V.B.3.
Market participants that are private funds are generally managed by
registered investment advisers that file regular financial reports
with the Commission on Form PF, and are subject to examination
concerning their private fund clients, but private funds do not
report securities transactions such as those required by the rules
governing registered dealers. See id. Transactions in fixed income
securities, such as U.S. Treasury Securities, are not currently
reported to the Consolidated Audit Trail (``CAT''). See Section
V.B.2 (explaining the type of transactions reported to CAT).
---------------------------------------------------------------------------

    As described below in Section V, the proposed trading volume
threshold was derived from analysis of historical U.S. Treasury
Securities transactions reported to TRACE.\170\ Based on this analysis,
the Commission is proposing a trading volume amount of $25 billion;
this quantitative standard would likely capture mostly unregistered
PTFs, but also may capture certain other significant market
participants not currently registered as government securities
dealers.\171\ In determining whether the trading volume threshold is
met, a market participant would include transactions in U.S. Treasury
Securities that are currently reported to TRACE-- that is, Treasury
bills, notes, floating rate notes, bonds, TIPS, and STRIPS--and would
exclude auction awards and repurchase or reverse repurchase
transactions in U.S. Treasury Securities.\172\ The proposed
quantitative standard is intended to be a straightforward threshold
identifying those market participants that, as a result of their
regularly high trading volume in government securities, serve dealer-
like roles significantly impacting the U.S. Treasury market. In this
regard, the Commission believes that setting forth a trading volume
threshold would provide an easily measurable and observable standard.
---------------------------------------------------------------------------

    \170\ TRACE reporting requirements apply to all marketable U.S.
Treasury Securities, including Treasury bills, notes, floating rate
notes, bonds, TIPS, and STRIPS. See FINRA Rule 6700 series. Under
FINRA Rules, ``Bona fide repurchase and reverse repurchase
transactions involving TRACE-Eligible Securities'' and ``Auction
Transactions'' are not reported to TRACE. See FINRA Rule 6730(e).
    \171\ As described in Section V.B.2, the analysis found 46 non-
FINRA member firms with trading volumes of at least $25 billion in
July 2021. Based on classifications (further explained infra note
218), of these 46 non-FINRA member firms, 22 are classified as PTFs
and 20 are classified as dealers. See Section V.B.2, Table 1. To the
extent a non-FINRA member firm is a financial institution, it would
not register with the Commission but instead would provide written
notice of its government securities dealer status with the
appropriate Federal banking regulator. See Section II; 17 CFR 400.1.
Additionally, a non-FINRA member firm may be operating in reliance
on an exception or exemption. See supra note 29 and accompanying
text.
    \172\ See supra notes 165, 170.
---------------------------------------------------------------------------

    As discussed above, the market structure for U.S. Treasury
securities has evolved, with PTFs accounting for a large percent of
trading volume.\173\ In some ways, PTFs have displaced the role of
traditional dealers in the interdealer U.S. Treasury market, and the
Commission believes that PTFs, and other market participants that
similarly have a significantly large, and regular, amount of trading
volume and have a significant impact on the U.S. Treasury market,
should register as government securities dealers.\174\ Proposed Rule
3a44-2(a)(2) is designed to make clear the Commission's view that a
person engaging in this regular volume of buying and selling activity
is engaged in the buying and selling of government securities for its
own account as a part of a regular business, and therefore, should be
subject to the same regulatory requirements as other dealers.
---------------------------------------------------------------------------

    \173\ See Section II.
    \174\ 2010 Equity Market Structure Concept Release at 3607.
---------------------------------------------------------------------------

    The Commission believes the need for a quantitative rule is most
acute in the U.S. Treasury market. Thus, while proposed Rules 3a5-4 and
3a44-2 share common qualitative standards, the Commission is proposing
a quantitative standard only with respect to the U.S. Treasury market
at this time. As explained more fully in Section V, the quantitative
standard is derived from trading data related to the U.S. Treasury
market, and is intended to identify significant market participants not
registered as dealers that are performing dealer-like activities in the
U.S. Treasury market.\175\
---------------------------------------------------------------------------

    \175\ The Commission believes that due to the varying
characteristics of the other securities markets, setting a
quantitative standard would be more complicated and each market
would need to be separately assessed before a quantitative threshold
is set. Accordingly, the Proposed Rules do not set forth a
comparable quantitative standard for proposed Rule 3a5-4. The
Commission is seeking comment, however, on whether proposed Rule
3a5-4 should include a quantitative standard, and if so, how it
should be established. See Question 26.
---------------------------------------------------------------------------

    The recent disruptions in the U.S. Treasury market referenced
above, together with the significant role played

by market participants not registered as dealers, distinguishes that
market from other markets where these types of participants are more
typically registered as dealers. Indeed, it is the Commission's
understanding that in the equity markets, because PTF trading
strategies typically depend on latency and cost advantages made
possible by trading directly (via membership) on a national securities
exchange, and the Exchange Act limits exchange membership to registered
broker-dealers, there is incentive for many PTFs to register as broker-
dealers to gain these advantages.\176\ In the U.S. Treasury market,
however, where trading occurs on ATSs and other non-exchange venues,
PTFs lack this incentive to register.
---------------------------------------------------------------------------

    \176\ See 15 U.S.C. 78f(c)(1) (``A national securities exchange
shall deny membership to (A) any person, other than a natural
person, which is not a registered broker or dealer or (B) any
natural person who is not, or is not associated with, a registered
broker or dealer.'').
---------------------------------------------------------------------------

Request for Comments
    The Commission generally requests comment on this aspect of
proposed Rule 3a44-2. In addition, the Commission requests comment on
the following specific issues:
    17. Is there sufficient specificity provided for the terms used in
the quantitative standard? Are there any terms that should be defined
in rule text or addressed in the release?
    18. Is the threshold of more than $25 billion of trading volume in
each of four out of the last six calendar months an appropriate proxy
for determining whether a person is engaged in buying and selling U.S.
Treasury Securities for its own account is engaged in such activity as
a part of a regular business? Why or why not? If not, what thresholds
would be appropriate? For example, should the quantitative standard
include a separate trading volume threshold for: (1) Buying; (2)
selling; and (3) both buying and selling U.S. Treasury Securities, all
three of which would be required to be satisfied in order to meet the
quantitative standard? Commenters should provide data to support their
views.
    19. Should the Commission apply a different look-back period for
applying the quantitative threshold from four out of the preceding six
months to something different? Is the time period measurement of four
out of the last six calendar months an appropriate metric to evaluate a
market participant's trading volume? Should the time period be a weekly
measurement or is there another measurement that would better determine
whether a person is engaged in buying and selling U.S. Treasury
Securities for its own account is engaged in such activity as a part of
a regular business?
    20. Should the look-back period for the quantitative standard take
into consideration the general auction schedule for U.S. Treasury
securities? Should the look-back period correspond with the schedule of
any particular U.S. Treasury security? Why or why not? For example, the
10-year U.S. Treasury note auctions are usually announced in the first
half of February, May, August, and November and generally auctioned
during the second week of these months and are issued on the 15th of
the same month.\177\ Should the look-back period take into
consideration these particular months for purposes of the quantitative
standard? Why or why not? How could the look-back period incorporate
the auction schedule? Please explain.
---------------------------------------------------------------------------

    \177\ See TreasuryDirect, General Auction Timing, available at
https://www.treasurydirect.gov/instit/auctfund/work/auctime/auctime.htm.
---------------------------------------------------------------------------

    21. Are there persons that would meet the quantitative standard
under the proposed rule but that should not be classified as government
securities dealers (i.e., is the quantitative standard over-
inclusive?). If so, who are they and why should the Commission not
classify them as government securities dealers?
    22. Are there persons that would not meet the quantitative standard
under the proposed rule--and would not be otherwise captured by the
qualitative factors--but that should be classified as government
securities dealers based on their trading volume (i.e., is the
quantitative standard under-inclusive)? If so, who are they and why
should they be classified as government securities dealers?
    23. Should the quantitative standard include an additional standard
related to routinely expressing trading interests? For example,
activity related to resting orders on a central-limit order book, or
expressing trading interest on Communication Protocol Systems? If so,
what measure of activity, including sources of data and calculation
methodology, would appropriately identify market participants as
government securities dealers?
    24. Are there other ways of calculating a quantitative standard,
such as using a measurement based on turnover (e.g., a turnover ratio)
rather than volume, or other measurements of significance (e.g., a
trading volume ratio, net/gross ratio) that would appropriately
identify market participants as government securities dealers? If so,
what are they, and why are they relevant in the context of analyzing
dealer status? Commenters should provide any data or information to
support their views.
    25. Should the quantitative standard be a dynamic trading volume
threshold that changes with the market over time, such as percentage of
transactions reported to TRACE, a percentage of U.S. Treasury
Securities outstanding or issued, or other inflation-adjusted
threshold? Why or why not?
    26. Should a quantitative standard be included in proposed Rule
3a5-4? To the extent a quantitative standard should be included, are
there ways of calculating the standard for other securities markets? Is
a trading volume threshold suitable for other types of securities
markets?
    27. In determining whether the trading volume threshold is met, the
Commission has indicated that market participants should exclude
auction awards and repurchase or reverse repurchase transactions. Is
this exclusion appropriate? Should some or all of these transactions be
included? Are there other transactions that should be excluded (e.g.,
Treasury when-issued transactions)? Please explain. Should any excluded
transactions be specifically addressed in rule text? Should there be a
similar exclusion of these types of transactions for purposes of
evaluating whether a market participant has met the qualitative
standards? Are there any types of transactions that should be included
in calculating the trading volume amount?
    28. Are there market participants that would fluctuate between
meeting or not meeting the quantitative standard (or qualitative
standard) (e.g., initially meet the standard, a few months later no
longer meet the standard, and later meet the standard again)? Would
this pattern be associated with a particular type of trading such that
there may be periods in which the participant meets neither the
quantitative standard nor any qualitative standard?
    29. Are there circumstances in which a person triggering the
quantitative threshold would not also trigger the proposed qualitative
standards? Please describe those circumstances in detail. In such case,
would firms implement compliance systems to monitor trading volumes? Do
firms have systems in place that already or could easily be programmed
to monitor for the proposed quantitative threshold? What are the costs
of implementing such systems or updating existing systems? Would firms
be incentivized to trade below the proposed quantitative standard to
avoid registration?

D. Definitions of ``Own Account'' and ``Control''

    The Exchange Act defines a ``dealer'' or ``government securities
dealer'' as a person engaged in the business of buying and selling
securities for its ``own account.'' \178\ The Proposed Rules define a
person's ``own account'' in a way that recognizes that corporate
families and entities may be organized in various structures. The
proposed definitions of ``own account'' and ``control'' are designed to
focus on the trading activity occurring at the firm or legal-entity
level or the trading activity that is being employed on behalf of, or
for the benefit of, the entity, and limit the registration burden to
those entities engaged in dealer activity. In addition, the proposed
definitions are intended to avoid incentivizing market participants to
change their corporate structures for the purpose of avoiding
registration.
---------------------------------------------------------------------------

    \178\ 15 U.S.C. 78c(a)(5) (``The term `dealer' means any person
engaged in the business of buying and selling securities . . . for
such person's own account through a broker or otherwise.'')
(emphasis added); 15 U.S.C. 78c(a)(44) (``The term `government
securities dealer' means any person engaged in the business of
buying and selling government securities for his own account,
through a broker or otherwise . . .'') (emphasis added).
---------------------------------------------------------------------------

    Under paragraph (b)(2) of the Proposed Rules, a person's ``own
account'' means any account that is: ``held in the name of that
person''; or ``held in the name of a person over whom that person
exercises control or with whom that person is under common control,
provided that this paragraph (b)(2)(ii) does not include [the accounts
described in paragraphs (b)(2)(ii)(A)-(C)]''; or ``held for the benefit
of those persons identified in paragraphs (b)(2)(i) and (ii).'' \179\
Paragraphs (b)(2)(ii)(A)-(C) excludes an account in the name of a
registered broker, dealer, or government securities dealer, or an
investment company registered under the Investment Company Act of 1940;
with respect to an investment adviser registered under the Investment
Advisers Act of 1940, an account held in the name of a client of the
adviser unless the adviser controls the client as a result of the
adviser's right to vote or direct the vote of voting securities of the
client, the adviser's right to sell or direct the sale of voting
securities of the client, or the adviser's capital contributions to or
rights to amounts upon dissolution of the client; and with respect to
any person, an account in the name of another person that is under
common control with that person solely because both persons are clients
of an investment adviser registered under the Investment Advisers Act
of 1940 unless those accounts constitute a parallel account
structure.\180\
---------------------------------------------------------------------------

    \179\ See proposed Rule 3a5-4(b)(2) and proposed Rule 3a44-
2(b)(2).
    \180\ See proposed Rule 3a5-4(b)(2)(ii)(A)-(C) and proposed Rule
3a44-2(b)(2)(ii)(A)-(C).
---------------------------------------------------------------------------

    With respect to which accounts should be aggregated for purposes of
paragraph (b)(2)(ii), the Proposed Rules would incorporate the
definition of ``control'' under Exchange Act Rule 13h-l.\181\ The
Commission believes that incorporating the established definition of
``control'' under Exchange Act Rule 13h-l into the Proposed Rules would
promote consistency and assist persons in applying the definition. The
Commission further believes that the proposed definition of ``control''
is sufficiently limited to capture only those market participants with
a significant enough controlling interest to warrant registration as a
dealer.\182\ The proposed definition of ``control'' used in Rule 13h-l
is appropriate because it is less burdensome than other Commission
rules defining control, but still achieves the goal of identifying
persons who exert direct or indirect control over significant market
participants.\183\ In addition, the Commission believes that this
definition of control would appropriately deter the structuring of
corporate relationships or establishment of multiple legal entities to
avoid the Proposed Rules.
---------------------------------------------------------------------------

    \181\ Exchange Act Rule 13h-l(a)(3) provides that control
(including the terms controlling, controlled by and under common
control with) means the possession, direct or indirect, of the power
to direct or cause the direction of the management and policies of a
person, whether through the ownership of securities, by contract, or
otherwise. For purposes of Rule 13h-l only, any person that directly
or indirectly has the right to vote or direct the vote of 25 percent
or more of a class of voting securities of an entity or has the
power to sell or direct the sale of 25 percent or more of a class of
voting securities of such entity, or in the case of a partnership,
has the right to receive, upon dissolution, or has contributed, 25
percent or more of the capital, is presumed to control that entity.
17 CFR 240.13h-l(a)(3). The definition of ``control'' in Rule 13h-l
is based on the definition of ``control'' in Form 1 (Application for
the Registration or Exemption from Registration as a National
Securities Exchange) and Form BD (Uniform Application for Broker-
Dealer Registration).
    \182\ As noted above, the Commission has applied this standard
in other contexts. See Large Trader Reporting, Exchange Act Release
No. 61908 (Apr. 14, 2010), 75 FR 21456, 21461 (Apr. 23, 2010) (``The
Commission preliminarily believes that the proposed definition of
control is sufficiently limited to capture only those persons with a
significant enough controlling interest to warrant identification as
a large trader.''). The definition of ``control'' in Rules 13h-l and
on Forms 1 and BD is less expansive than the definition of control
as used in 17 CFR 240.19h-1 (Rule 19h-1), for example. In Rule 19h-
1(f)(2), the definition of ``control'' features a 10 percent
threshold with respect to the right to vote 10 percent or more of
the voting securities or receive 10 percent or more of the net
profits.
    \183\ The Commission is not incorporating the provision
contained in the Form 1 and Form BD relating to directors, general
partners, or officers that exercise executive responsibility.
Instead, the proposed definition of ``control'' focuses on the
existence of a corporate control relationship over significant
market participants.
---------------------------------------------------------------------------

    The Proposed Rules exclude three types of accounts from being
aggregated with another account for purposes of the definition of ``own
account.'' First, under paragraph (b)(2)(ii)(A), where an account is
held in the name of a person who is a registered broker, dealer,
government securities dealer, or registered investment company
(collectively, ``registered person''), the Commission believes that it
would be inappropriate to attribute the registered person's accounts to
controlling persons or persons under common control, because the
registered person is already subject to the broker-dealer regulatory
regime or the investment company regulatory regime.\184\ Thus, the
definition of ``own account'' would not include those types of
accounts.
---------------------------------------------------------------------------

    \184\ As discussed in Section II.A, the Proposed Rules would
exclude registered investment companies in light of the regulatory
framework that applies under the Investment Company Act and rules
thereunder.
---------------------------------------------------------------------------

    Second under paragraph (b)(2)(ii)(B), the Proposed Rules would not
attribute to a registered investment adviser an account held in the
name of a client of the adviser, unless the adviser controls the client
as a result of the adviser's right to vote or direct the vote of voting
securities of the client, the adviser's right to sell or direct the
sale of voting securities of the client, or the adviser's capital
contributions to or rights to amounts upon dissolution of the
client.\185\
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    \185\ Registered investment advisers typically have investment
discretion over the assets of the accounts of their clients,
including private funds and other client accounts that are managed
separately (``separately managed accounts''). Each of these clients
has its own independent investment objectives and strategies, which
the registered investment adviser implements as agent for the
client. Moreover, investors in different private funds typically
differ in their investment objectives and strategies, as do owners
of the assets in separately managed accounts. A registered
investment adviser has a duty to provide investment advice in the
best interest of its client, based on the client's investment
objectives, see Investment Advisers Act Release No. 5248 (June 5,
2019), 84 FR 33669, 33671 (July 12, 2019), and so the Proposed Rules
would not require aggregation solely because a registered investment
adviser exercises discretion.
---------------------------------------------------------------------------

    Under the aggregation provisions of the Proposed Rules, a
registered investment adviser that has an investment advisory
relationship and is determined to control the client would be required
to aggregate its trading activities with those of the client.\186\ The

Proposed Rules' aggregation provisions are designed to account for
trading activity within a corporate family in which trading activity at
a firm or legal-entity level is employed on behalf of or for the
benefit of another legal entity. In the case of registered investment
advisers that have no controlling ownership interest in an entity for
which they are solely managing client assets, the trading activities of
the adviser and each client are independent of each other and are not
for the benefit of the adviser or any other client. Nevertheless, the
Commission recognizes, in the absence of the proposed exclusion for
such accounts, questions could arise whether the Proposed Rules could
require the aggregation of client trading activities with those of the
registered investment adviser. Because some clients may have similar
trading strategies, their trading activities in the aggregate could
meet the proposed qualitative or quantitative standards. This would
result in the application of the Proposed Rules to the activities of a
registered investment adviser and those of its clients even when none
of the entities is engaged in dealer activity for the economic benefit
of another. To reduce the potential for capturing registered investment
advisers and their clients in these circumstances, we are proposing to
exclude registered investment advisers from aggregating their trading
activities with those of their clients when the adviser and client only
have a discretionary investment management relationship (i.e., where
the registered investment adviser does not control the client as a
result of the adviser's right to vote or direct the vote of voting
securities of the client, the adviser's right to sell or direct the
sale of voting securities of the client, or the adviser's capital
contributions to or rights to amounts upon dissolution of the
client).\187\
---------------------------------------------------------------------------

    \186\ For purposes of the Proposed Rules ``control'' is defined
to include ``the possession, direct or indirect, of the power to
direct or cause the direction of the management and policies whether
through the ownership of securities, by contract or otherwise.'' See
supra note 181; 17 CFR 240.13h-l(a)(3).
    \187\ See text in 3a5-4(b)(2)(ii)(B) and 3a44-2(b)(2)(ii)(B) of
the Proposed Rules.
---------------------------------------------------------------------------

    The Proposed Rules, however, are designed to address situations in
which a registered investment adviser might use the proposed exclusion
to avoid the application of the Proposed Rules. For example, a
registered investment adviser that has a controlling ownership interest
in a client could attempt to divide trading activities among several
clients it controls to avoid dealer registration by any individual
client whose trading activities would meet either of the Proposed
Rules. In those circumstances, the aggregate trading activities of each
client could be designed to economically benefit the registered
investment adviser and, if aggregated, the activities would fall within
the intended scope of the Proposed Rules. To prevent such potentially
evasive structures, the proposed exclusion from aggregation does not
apply to any registered investment adviser that controls the client as
a result of the registered investment adviser's right to vote or direct
the vote of voting securities of the client, the registered investment
adviser's right to sell or direct the sale of voting securities of the
client, or the adviser's capital contributions to or rights to amounts
upon dissolution of the client.\188\
---------------------------------------------------------------------------

    \188\ Id. Paragraph (b)(2)(ii)(B) reflects the definition of
control under Exchange Act Rule 13h-l. See 17 CFR 240.13h-l(a)(3).
---------------------------------------------------------------------------

    Third, under paragraph (b)(2)(ii)(C), a person under common control
with another person solely because both persons are clients of a
registered investment adviser would not aggregate their trading
activities and volume to determine if each meet the Proposed Rules,
unless those accounts constitute a parallel account structure. The
Proposed Rules would define parallel account structure to mean ``a
structure in which one or more private funds (each a `parallel fund'),
accounts, or other pools of assets (each a `parallel managed account')
managed by the same investment adviser pursue substantially the same
investment objective and strategy and invest side by side in
substantially the same positions as another parallel fund or parallel
managed account.'' \189\ The aggregation provisions would require
clients of a registered investment adviser that are determined to be
under ``common control'' of the registered investment adviser to
aggregate their trading activities under certain circumstances. As
noted above, in many instances, a registered investment adviser's
clients are engaged in independent investment objectives and strategies
and no individual client is engaged in trading activities for the
benefit of any other client. As a result, in the absence of the
proposed exclusion, questions could arise whether clients who would not
otherwise be scoped into the Proposed Rules either because of their
individual trading activities or their trading activities for the
economic benefit of any other client, could nevertheless be captured by
the Proposed Rules as a result of having to aggregate their trading
activities with those of other clients. To reduce the potential for
capturing these registered investment adviser clients in these
circumstances, we are proposing to exclude from the proposed
requirement to aggregate trading activities of clients of a registered
investment adviser that are under common control solely because both
are clients of the same registered investment adviser.\190\
---------------------------------------------------------------------------

    \189\ See proposed Rule 3a5-4(b)(4) and proposed Rule 3a44-
2(b)(4). The proposed definition of ``parallel account structure''
corresponds to definitions of ``parallel fund structure'' and
``parallel managed account'' under Form PF. See Form PF Glossary of
Terms, available at https://www.sec.gov/files/formpf.pdf.
    \190\ See proposed Rule 3a5-4(b)(2)(ii)(C) and proposed Rule
3a44-2(b)(2)(ii)(C).
---------------------------------------------------------------------------

    At the same time, however, the Proposed Rules are designed to
prevent a registered investment adviser from dividing trading
activities among multiple clients to avoid the application of the
Proposed Rules. A registered investment adviser could, for example,
create a parallel fund structure in which one or more private funds
pursue substantially the same investment objective and strategy and
invest side by side in substantially the same positions as another
private fund. The registered investment adviser could limit the trading
activity of each ``parallel fund'' so that individually it does not
meet the qualitative or quantitative standards, even though the funds'
trading activities in the aggregate are part of a single trading
strategy. To prevent such potential structuring of funds to avoid
dealer registration, the proposed exclusion would not apply to client
accounts that constitute a parallel account structure.\191\
---------------------------------------------------------------------------

    \191\ Id.
---------------------------------------------------------------------------

    Finally, it is important to note that, as discussed above, while a
person that meets the qualitative or quantitative standards in
paragraph (a) is not subject to the Proposed Rules if that person has
or controls total assets less than $50 million,\192\ the accounts of
such under-$50-million persons must be considered for purposes of
determining whether another person's trading activities or volume falls
within the qualitative or quantitative standards set forth in paragraph
(a). In particular, a person must consider for aggregation purposes any
accounts (including those under $50 million) that are controlled by, or
under common control with, that person. The Commission believes that
requiring aggregation of accounts of those persons that have or control
less than $50 million in total assets would prevent the organizing of
corporate

structures for the purpose of avoiding dealer registration.
---------------------------------------------------------------------------

    \192\ See Section III.A; proposed Rule 3a5-4(a)(2)(i) and
proposed Rule 3a44-2(a)(3)(i).
---------------------------------------------------------------------------

    The following examples illustrate the application of the Proposed
Rules' definition of ``own account'' as discussed above. In these
examples, whether any of the firms' relationship and activities meet
the definition of ``control'' would remain a facts and circumstances
determination. Additionally, as discussed in Section III.E, although a
firm may not meet the Proposed Rule's definition of dealer or
government securities dealer in the examples, the firm may be a dealer
or government securities dealer pursuant to existing Commission
interpretations and precedent to the extent consistent with the
Proposed Rules.
Example 1
     A, B, and C are under common control; all are controlled
by D. A, B, C, and D are all limited liability companies. None of the
firms are registered brokers, dealers, government securities dealers,
or registered investment companies.
Aggregation by Parent D
    [cir] D would aggregate the trading activities and volume of A, B,
C, and D to determine if D would be captured by paragraph (a) of the
Proposed Rules. If as a result of this aggregation, D meets the
quantitative or qualitative standards of paragraph (a), and it has or
controls more than $50 million in total assets, it would be captured by
the Proposed Rules.
Aggregation by D's Subsidiaries
    [cir] A, B, and C would also need to aggregate each other's trading
activities and volume to determine if they would individually be
captured by the qualitative or quantitative standards of paragraph (a)
of the Proposed Rules. If, as a result of aggregation A, B, and C each
meet the qualitative or quantitative standards of paragraph (a), but A
has or owns less than $50 million in total assets, A would be excluded
from the Proposed Rules under paragraph (a). A's activities and volume,
however, would still be considered for purposes of B, C, and D.
    [cir] If B registers as a dealer, its trading activities and volume
would no longer be considered by A, C, or D.
Example 2
     A is a registered investment adviser with clients B, C, D,
E, F, and G. A has an investment advisory contract with each of B and C
under which A exercises investment discretion with respect to B's and
C's assets each in an account separately managed by A. D and E are
hedge funds. A is the general partner of both D and E, and controls D
and E as a result of its capital contributions to and rights to amounts
upon dissolution of each fund. F and G are also hedge funds. A has an
investment advisory contract with each of F and G under which A
exercises investment discretion with respect to F's and G's assets. F
and G pursue substantially the same investment objective and strategy
and invest side by side in substantially the same positions. Neither A
nor any of its clients is a registered broker, dealer, government
securities dealer, or registered investment company.
Aggregation by A
    [cir] A would not need to aggregate its trading activities with the
trading activities of B, C, F, or G unless A controls B, C, F, or G as
a result of the right to vote or direct the vote of the voting
securities issued by these clients, the right to sell or direct the
sale of the voting securities issued by these clients, or the amount of
capital contributions to or rights to amounts upon these clients'
dissolution.
    [cir] A would need to aggregate its trading activities with the
trading activities of both D and E because A has control over each fund
as a result of its capital contributions to and rights to amounts upon
dissolution of each fund.
Aggregation by A's Clients
    [cir] B and C would not need to aggregate their trading activities
even if B and C were determined to be under common control (which would
be a facts and circumstances determination), because common control
would be solely because both are clients of A.
    [cir] D and E would need to aggregate their trading activities
because they are under common control of A, which has the right to
direct the vote of the voting securities of each fund and the right to
capital contributions upon dissolution of the fund and not solely
because each fund is a client of A.
    [cir] Each of F and G would need to aggregate the trading
activities of the other fund. F and G's activities would constitute a
parallel account structure (even if they are under common control
solely because both F and G are clients of A) because F and G are
managed by the same investment adviser, pursue substantially the same
investment objective and strategy and invest side by side in
substantially the same positions as another parallel fund or parallel
managed account.
    The Commission believes that the definitions of own account and
control are appropriate and will help to ensure that there is no
circumvention of the Proposed Rules through, for example, the
establishment of multiple legal entities whose activities may not
separately rise to a level of engagement that qualifies for dealer or
government dealer status, but, when aggregated, does demonstrate that
the entities are selling and buying securities or government securities
as a part of a regular business.
Request for Comments
    The Commission generally requests comment on this aspect of the
Proposed Rules. In addition, the Commission requests comment on the
following specific issues:
    30. Does the proposed definition of ``own account'' appropriately
reflect complexities and differences in corporate structures and
business models of proprietary trading firms, investment advisers,
private funds, and other market participants, and the ownership
structures of their trading accounts? Why or why not? Commenters should
provide descriptions to support their responses.
    31. Except as described in paragraph (b)(2)(ii), are there
instances when an account of a controlled person, or person under
common control, should not be considered a person's ``own account'' for
purposes of the Proposed Rules? For example, should an account held in
the name of a bank be excluded from the definition of ``own account''?
Commenters should provide descriptions of any such instances.
    32. Is the proposed definition of ``control'' appropriate? What is
the effect of using the Exchange Act definition of ``control'', as
opposed to the Investment Company Act definition? Please describe
potential alternative definitions and why they are more appropriate.
    33. Are there instances where two entities may meet the proposed
definition of ``control'' and where these entities are in different
lines of business and/or unaware of the other's trading strategies? Are
there any situations where two entities may meet the proposed
definition of ``control'' but communications between two entities would
be prohibited?
    34. Under the Proposed Rules, a registered investment adviser would
aggregate its account with its client accounts (private funds and
separately managed accounts), except as described in paragraph
(b)(2)(ii).
     Should registered investment advisers be included only
with respect to their own proprietary trading activities (i.e., not
with respect to activities that could be attributed to

them by the aggregation contemplated by the definitions of ``own
account'' and ``control'')? Why or why not?
     How would such aggregated accounts comply with the
requirements for dealer registration?
     In these cases, would the investment adviser registering
itself avoid registering a private fund or separately managed account
client? If not, are there other actions these accounts would seek to
take to avoid all such accounts either registering as dealers or
ceasing investment strategies that trigger the Proposed Rules
application? Would any of such accounts avoid certain investment
strategies to prevent application of the Proposed Rules? If so, which
investment strategies and at which types of accounts?
     Would the registered investment adviser restructure its
activities or those of its private fund or separately managed account
clients to avoid registering a private fund or separately managed
account client as a dealer? For example, would a registered investment
adviser create an affiliated broker-dealer to avoid registering itself
and/or any clients as dealers? What would be the effects of any
restructuring? Please explain.
    35. Should the Proposed Rules require registered investment
advisers to aggregate client accounts when the adviser controls a
person other than through an ownership interest? Why or why not? We
understand that, for tax and other purposes, hedge fund offshore
companies are often controlled by boards of directors or legal entities
that are separate from the hedge fund's adviser. Should the aggregation
provisions of the Proposed Rules cover those arrangements? Will the
exclusion in paragraph (b)(2)(ii)(B) have different impacts on
registered investment adviser client funds that are organized
domestically as general partnerships and funds that are organized
offshore as companies with independent directors? If so, could
registered investment advisers restructure certain funds to avoid
application of the Proposed Rules? What would be the effects of any
restructuring? Would a registered investment adviser's use of an
omnibus account to trade client securities on an aggregate basis
present particular interpretative questions or raise operational issues
for these purposes?
    36. Should registered investment adviser clients that are under
common control solely because they are clients of the same registered
investment adviser be required to aggregate accounts? Why or why not?
Does the definition of ``parallel control structure'' adequately
capture ways in which a registered investment adviser could seek to
separate trading activities among accounts to avoid registration by
their clients? Would the aggregation provisions of the Proposed Rules
appropriately capture activity that would raise the concerns that the
Proposed Rules are designed to address? Would the aggregation
provisions of the Proposed Rules capture activity that it should not?
If so, please explain.
    37. Are there any incentives created by the aggregation provisions
that may cause market participants to reevaluate or restructure their
corporate structures? What costs and benefits are there associated with
restructuring?
    38. Would market participants exit certain strategies or exit the
market to avoid registration? If so, what would be the effects?

E. No Presumption

    The Proposed Rules would further define the phrase ``as a part of a
regular business'' by identifying certain activities that would cause
persons engaging in such activities to be ``dealers'' or ``government
securities dealers'' within the meaning of Sections 3(a)(5) and
3(a)(44) of the Exchange Act.\193\ They would not seek to address all
persons that may be acting as dealers or government securities dealers
under otherwise applicable interpretations and precedent.\194\ A person
that does not meet the conditions set forth in the Proposed Rules may
nonetheless be a dealer if it is otherwise engaged in a regular
business of buying and selling securities for its own account by, for
example, acting as an underwriter.\195\
---------------------------------------------------------------------------

    \193\ As discussed above, each qualitative standard in proposed
Rules 3a5-4 and 3a44-2 is a separate definition that further defines
when a person is acting as a dealer or government securities dealer.
See Section III.B. Accordingly, a person would register with the
Commission if it satisfied any one of the three qualitative
standards. Id. Similarly, the quantitative standard in proposed Rule
3a44-2(a)(2) is a discrete definition and a person would register as
a government securities dealer upon meeting this standard even if it
did not satisfy any of the qualitative standards in proposed Rule
3a44-2(a)(1). See Section III.C.
    \194\ See supra note 87; see, e.g., 2002 Release at 67499
(stating that ``[a]s developed over the years, the dealer/trader
distinction recognizes that dealers normally . . . hold themselves
our as buying and selling securities at a regular place of
business'').
    \195\ See 2002 Release at 67499.
---------------------------------------------------------------------------

    To emphasize this point, the Proposed Rules would state that no
presumption shall arise that a person is not a dealer or government
securities dealer as defined by the Exchange Act solely because that
person does not satisfy paragraph (a) of the Proposed Rules. Proposed
Rules 3a5-4(c) and 3a44-2(c) thus would provide that a person may still
meet the statutory definition of dealer and government securities
dealer even absent the activity identified in paragraph (a) of the
Proposed Rules if the person is otherwise engaged in buying and selling
securities or government securities for its own account as a part of a
regular business.\196\
---------------------------------------------------------------------------

    \196\ See proposed Rule 3a5-4(c) and proposed Rule 3a44-2(c).
---------------------------------------------------------------------------

IV. General Request for Comments

    The Commission generally requests comment on all aspects of the
Proposed Rules. In addition, the Commission requests comment on the
following specific issues:
    39. Are there standards of activity other than the standards under
the Proposed Rules that the Commission should apply in the context of
analyzing dealer status? If so, which standards and why?
    40. Would the Proposed Rules capture persons that should not be
regulated as dealers? If so, who? Why would they be captured under the
Proposed Rules, and why is that not appropriate?
    41. Are there any categories of persons that would not meet the
Proposed Rules, yet should be registered as dealers? Commenters should
identify any such categories of persons and describe why they should be
registered despite not meeting the proposed thresholds.
    42. Would the Proposed Rules cause market participants to
reevaluate or restructure their activities to avoid registration as a
dealer or cease investment strategies that trigger the application of
the Proposed Rules? What would be the effects of such restructuring,
withdrawal, or cessation? Please explain.
    43. For purposes of determining whether a person is a dealer, are
there significant differences between equity securities, government
securities, or other securities that should be addressed by the
Proposed Rules? Commenters should identify and discuss any such
differences.
    44. Would the Proposed Rules appropriately apply the requirements
applicable to dealers (e.g., capital, margin, and business conduct
requirements) to the entities that would be subject to those
requirements? Is the scope of the Proposed Rules appropriate in light
of the costs and benefits associated with those substantive rules?
    45. How are each of PTFs, hedge funds, and investment advisers
typically capitalized? Would the requirement of the Net Capital Rule
(Exchange Act Rule 15c3-1) deter any of these entities from

registering? Would the Net Capital Rule cause these entities to alter
trading activity that would trigger the rules' application?
    46. Would a pension plan or other institutional investor that
rebalances its portfolio be captured by the Proposed Rules? Please
explain how. If so, should the rule specifically exclude periodic
portfolio rebalancing (e.g., on a monthly or quarterly basis) from the
concept of ``as a part of a regular business?'' Why or why not?
    47. Should the Commission view rebalancing differently if it occurs
only at a certain frequency or by certain institutional investors? Why
or why not?
    48. Are there any other terms used in the Proposed Rules that the
Commission should define? Why or why not? Please identify what term(s)
and how the term(s) should be defined.
    49. Should the Proposed Rules include an anti-evasion provision
similar to Rule 13h-l(c)(2), and why?
    50. Will the Proposed Rules appropriately account for trading
activity occurring through sponsored access arrangements? Is there
anything more that the Commission should address regarding how such
Proposed Rules will interrelate with such arrangements?
    51. If the Proposed Rules are adopted, which staff letters, if any,
should or should not be withdrawn, and why?
    52. Are there additional standards, consistent with the
Commission's objectives, that should be incorporated into the Proposed
Rules? Commenters should identify and discuss any such standards.
    53. Are there any additional factors that the Commission should
address in relation to the Proposed Rules?
    54. Are there any alternative approaches to the Proposed Rules that
the Commission should propose? Commenters should identify any such
alternative approach and describe the advantages and disadvantages of
the alternative approach.
    55. Other than what is discussed herein, are there any costs of
compliance with the Proposed Rules that the Commission has not
addressed? Commenters should describe any additional costs of
compliance with the proposed rule and include any empirical data, to
the extent available.
    56. The Commission is proposing a one-year compliance period from
the effective date of any final rules if adopted. Would the proposed
compliance period provide sufficient time for market participants to
comply with the Proposed Rules? Why or why not?

V. Economic Analysis

A. Introduction

    The Commission is sensitive to the economic effects of its rules,
including the costs and benefits and effects on efficiency,
competition, and capital formation. Section 3(f) of the Exchange Act
requires the Commission, whenever it engages in rulemaking pursuant to
the Exchange Act and is required to consider or determine whether an
action is necessary or appropriate in the public interest, to consider,
in addition to the protection of investors, whether the action would
promote efficiency, competition, and capital formation.\197\ In
addition, Section 23(a)(2) of the Exchange Act requires the Commission,
when making rules under the Exchange Act, to consider the effect such
rules would have on competition.\198\ Exchange Act Section 23(a)(2)
prohibits the Commission from adopting any rule that would impose a
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act.\199\
---------------------------------------------------------------------------

    \197\ 15 U.S.C. 78c(f).
    \198\ 15 U.S.C. 78w(a)(2).
    \199\ Id.
---------------------------------------------------------------------------

    The Commission believes the Proposed Rules will support orderly
markets and protect investors by addressing negative externalities that
may arise in relation to market participants' financial and operational
risks. The Proposed Rules would also improve transparency in markets.
Specifically, the Commission believes the Proposed Rules would promote
the financial and operational resilience of individual liquidity
providers in securities markets and would improve the Commission's
ability to monitor market activity, conduct research, and detect
manipulation and fraud. The Proposed Rules would have uncertain impacts
on efficiency, competition, and capital formation, due to the
likelihood of offsetting effects. As discussed further below, the
Proposed Rules may create a more level competitive landscape by
applying similar rules to all activities that meet the proposed
standards, and they may also promote market efficiency and capital
formation by strengthening market stability and investor protection.
However, offsetting effects could arise due to costs that the Proposed
Rules would impose on activities that provide liquidity.
    Any person whose activities satisfy the qualitative or quantitative
standards would be affected by the Proposed Rules. The list of affected
parties would primarily include PTFs, but private funds may also be
affected. Registered investment advisers may be affected if their own
proprietary trading activity triggers the application of the Proposed
Rules or if they have certain control over client accounts (including
private funds and separately managed accounts) that, individually or
collectively, engage in activities that satisfy the Proposed Rules.
However, the Proposed Rules' aggregation provisions exclude an account
held in the name of a client of the registered investment adviser
unless the adviser controls the client as a result of the adviser's
right to vote or direct the vote of voting securities of the client,
the adviser's right to sell or direct the sale of voting securities of
the client, or the adviser's capital contributions to or rights to
amounts upon dissolution of the client.\200\ Registered investment
companies would be excluded from the Proposed Rules, along with all
persons that have or control assets of less than $50 million, as
described below. Other parties who may be indirectly affected include
the competitors, customers or clients (if any), and creditors (if any)
of the above-mentioned affected parties.
---------------------------------------------------------------------------

    \200\ See supra note 185 and associated text.
---------------------------------------------------------------------------

B. Baseline

    Dealers perform an important market function, absorbing order
imbalances and providing liquidity to buyers and sellers who may not
arrive at the same time, and a regulatory regime exists to govern their
activities. However, market participants that do not register as
dealers--and so are not required to comply with the dealer regulatory
regime--increasingly perform similar economic functions as dealers.
This difference in regulatory treatment creates the potential for
negative externalities, as described below. Furthermore, the unevenness
of regulation potentially places a greater burden on registered dealers
than on other market participants that engage in similar activities,
which may allow market participants not registered as dealers to gain
market share from registered dealers.
1. Regulatory Baseline
    Dealers, unless excepted or exempted, are required to register with
the Commission,\201\ join an SRO, and adhere to a comprehensive
regulatory regime. As discussed above in Section II, this regime
includes provisions that limit risk (e.g., the Net Capital Rule and
rules promoting operational integrity),

books and records requirements,\202\ various reporting and disclosure
requirements,\203\ and dealer-specific anti-manipulative and other
anti-fraud rules.\204\ The Net Capital Rule (Rule 15c3-1) requires
registered dealers to maintain minimum amounts of net liquid assets at
all times, even intraday, thus constraining dealer leverage.\205\ In
addition to the financial and regulatory risk management controls
required by the Market Access Rule, broker-dealers with market access
must comply with a number of underlying regulatory requirements when
conducting their business.\206\ Registered dealers are also subject to
the Commission's authority to conduct examinations and impose
sanctions,\207\ and to the examination and enforcement authority of the
relevant SRO.\208\ Government securities dealers are further subject to
rules issued by the Treasury that concern financial responsibility,
capital requirements, recordkeeping, reports and audits, and large
position reporting.\209\ Finally, since registered dealers must join an
SRO, they are bound by additional rules set by the SROs.\210\
---------------------------------------------------------------------------

    \201\ As of August 2, 2021, 3,559 firms were registered with the
Commission as broker-dealers. See Data: Company Information About
Active Broker-Dealers, SEC (updated Feb. 1, 2022), available at
https://www.sec.gov/help/foiadocsbdfoiahtm.html.
    \202\ See supra note 79.
    \203\ See supra note 77.
    \204\ See supra note 80.
    \205\ See supra note 76. Rule 15c3-1 requires dealers to
maintain, at all times, net capital above the greater of: A
percentage of debt (6.25 percent, or 11.1 percent for 12 months
after commencing business as a broker or dealer), or a fixed minimum
amount based on the types of business in which the dealer engages
(the general amount for dealers without customers is $100,000).
    \206\ These regulatory requirements include, for example, pre-
trade requirements such as exchange-trading rules relating to
special order types, trading halts, odd-lot orders, and SEC rules
under Regulation SHO and Regulation NMS, as well as post-trade
obligations to monitor for manipulation and other illegal activity.
Also see supra note 78 on the Market Access Rule (15c3-5).
    \207\ See supra note 82 and Section II.D.
    \208\ Exchange Act Section 17(b) subjects broker-dealers to
inspections and examinations by Commission staff and by the relevant
SRO. In addition, 17 CFR 240.15b2-2 (Exchange Act Rule 15b2-2)
generally requires the SRO that has responsibility for examining a
dealer member to inspect a newly registered dealer for compliance
with applicable financial responsibility rules within six months of
registration, and for compliance with all other regulatory
requirements within 12 months of registration. See also 17 CFR
240.17d-1 (Exchange Act Rule 17d-1), Examination for compliance with
applicable financial responsibility rules. Thereafter, FINRA or
another SRO, as applicable, continues to inspect each firm
periodically, based on the firm's risk profile.
    \209\ See supra note 81.
    \210\ For example, see FINRA Rule 2010 (Standards of Commercial
Honor and Principles of Trade); FINRA Rule 2020 (Use of
Manipulative, Deceptive, or Other Fraudulent Devices); and FINRA
Rule 4510 Series (Books and Records Requirements). Other SROs have
comparable and sometimes equivalent rules. See, e.g., NYSE Rules,
NYSE, available at https://nyseguide.srorules.com/rules, Rulebook--
The Nasdaq Stock Market, Nasdaq, available at https://listingcenter.nasdaq.com/rulebook/nasdaq/rules.
---------------------------------------------------------------------------

    Among other things, these rules help to ensure that dealers are
financially responsible, including adequately capitalized, that they
maintain internal controls, and that the Commission and the SROs have
tools to help them detect manipulation or fraud by analyzing
transaction reports and examining other records kept by the dealer.
2. Other Market Participants
    Market participants who are not registered as dealers also conduct
significant activity in securities markets,\211\ and the Commission
believes that some of these entities nevertheless perform the economic
function of dealers. Because the Proposed Rules would apply to
activities rather to persons' legal descriptions or other
characteristics, they could potentially capture a wide array of
persons.\212\
---------------------------------------------------------------------------

    \211\ For fixed income securities, where TRACE data allow us to
observe some of the activity of non-dealers, we estimate that in
July 2021 the combined volume of non-FINRA firms accounted for
approximately 45 percent of the volume of U.S. Treasury securities,
approximately 44 percent of the total corporate bond volume, and
approximately 42 percent of the volume of agency pass-through
mortgage backed securities (including securities traded in specified
pool transactions and securities traded to be announced). While
FINRA membership is not synonymous with dealer registration status,
the Commission believes that many non-FINRA entities are also not
registered as dealers.
    \212\ Upon the adoption of any final rule, some letters and
other staff statements, or portions thereof, may be moot,
superseded, or otherwise inconsistent with the final rules and,
therefore, would be withdrawn or modified. See supra note 41.
---------------------------------------------------------------------------

    The list of affected parties would not include persons who have or
control assets less than $50 million, and we estimate that this
provision would exclude the majority of investors.\213\ Established
FINRA rules distinguish retail investors from institutional investors,
in part, based on a threshold of $50 million in assets, and we follow
that standard to exclude small investors who are unlikely to conduct a
significant degree of dealer-like activity.\214\ Certain financial
institutions may also be exempt from the Proposed Rules.\215\
---------------------------------------------------------------------------

    \213\ Most U.S. investors are households, and most household
investors have less than $50 million in assets. The 2019 Survey of
Consumer Finance, sponsored by the Federal Reserve Board of
Governors and the U.S. Treasury, shows that 68 million U.S. families
owned stocks and bonds, either directly or indirectly, and that 93
percent own less than $1 million. The survey also showed that the
mean (median) U.S. household had total assets of $858,000
($227,000). This number of household investors is much larger than
the number of institutional investors. For example, there are
currently 16,127 registered investment companies and 14,874
registered investment advisers.
    \214\ See supra note 99.
    \215\ See supra notes 9 and 29.
---------------------------------------------------------------------------

    The first two subsections below explain why we preliminarily
believe that PTFs and private funds, particularly hedge funds, are the
most likely firms other than registered dealers to be engaged in
activities that would satisfy the Proposed Rules. As discussed above,
the activities of clients would not be attributed to a registered
investment adviser for purposes of determining whether the adviser
would fall under the Proposed Rules, except in cases where (i) the
adviser controls the clients as a result of voting rights, capital
contributions, or the rights to amounts upon dissolution and (ii) the
clients over which the registered adviser has such control collectively
engage in activities that satisfy the Proposed Rules. Therefore,
registered investment advisers would not fall under the Proposed Rules
solely due to client activities over which the adviser has investment
discretion. Advisers may still fall under the Proposed Rules on the
basis of their own proprietary trading. The third subsection below
discusses evidence regarding the number of persons whose activities may
satisfy the Proposed Rules. The final subsection covers the Proposed
Rules' exclusion for registered investment companies.

a. Proprietary Trading Firms
    PTFs have emerged as consequential players in securities markets.
While some PTFs have registered with the Commission, many others have
not. Some studies of high-frequency trading--a primary feature of PTF
activity, according to the 2015 Joint Staff Report--show that this
activity may have positive effects on transaction costs and
competition, while other studies show that the net effects may be
negative.\216\ PTFs that are not registered with the Commission are
subject to the anti-manipulation and anti-fraud provisions under
Securities Act Section 17(a) and to Exchange Act Section 10(b), but
they are not subject to the more targeted provisions under Exchange Act
Section 15(c), to examinations, to net capital requirements, or to
various reporting requirements that apply to dealers.
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    \216\ For a survey of the literature, see, Albert J., 2016, The
Economics of High-Frequency Trading: Taking Stock, Annual Review of
Financial Economics (8), 1-24. See also Baron, Matthew, Jonathan
Brogaard, Bj[ouml]rn Hagstr[ouml]mer, and Andrei Kirilenko, 2019,
Risk and Return in High-Frequency Trading, Journal of Financial and
Quantitative Analysis 54(3), 993-1024.
    \217\ The analysis is limited to a subsection of TRACE data
where the identity of trading counterparties is known. In July 2021,
approximately 58 percent of the non-FINRA member volume in TRACE
belonged to anonymous market participants. Non-FINRA member
participants generally appear anonymously when they trade with FINRA
members, who report their activity to TRACE but maintain the
anonymity of the non-FINRA member counterparties. When non-FINRA
member participants trade on an ATS that is covered by FINRA Rule
6730.07, the ATS reports the transaction to TRACE along with a
unique, non-anonymous MPID for each counterparty.
    \218\ TRACE identifies counterparties by MPIDs, of which an
individual firm may have many. The firm classification is based on
an understanding of the individual firms' businesses (see also the
2015 Joint Staff Report at 50).
    \219\ The analysis does not aggregate affiliated firms, but
counts them separately, even though they may be controlled by a
common corporate parent. For example, if a firm were to have a
FINRA-member broker-dealer affiliate and a non-FINRA hedge fund
affiliate, the analysis would consider the broker-dealer and the
hedge fund as separate firms.
    \220\ See supra note 2. See also FEDS Notes, ``Unlocking the
Treasury Market Through TRACE'' (Sept. 28, 2018).
---------------------------------------------------------------------------

    Because regulatory TRACE data pertaining to Treasury securities
reported by certain ATSs contains the identity of non-FINRA member
trading parties, we are able to analyze PTFs' importance in the U.S.
Treasury market during July 2021 \217\ and summarize the number and
type of market participants by monthly trading volume in Table 1
below.\218\ The analysis included 626 firms \219\ who were active in
the U.S. Treasury market in July 2021, of which 452 were FINRA members
and 174 were not. While FINRA membership is not synonymous with dealer
registration status, we believe that many of the large participants in
the U.S. Treasury market who are not FINRA members are also not
registered as dealers. The 174 identified non-FINRA member firms in
Table 1 accounted for approximately 19 percent of aggregate Treasury
trading volume in July 2021. PTFs had by far the highest volumes among
identified non-FINRA member participants in the U.S. Treasury market,
and the largest PTFs had trading volumes that were roughly comparable
to the volumes of the largest dealers. A Federal Reserve staff analysis
found that PTFs were particularly active in the interdealer segment of
the U.S. Treasury market in 2019, accounting for 61 percent of the
volume on automated interdealer broker platforms and 48 percent of the
interdealer broker volume overall.\220\ Figure 1 also shows that non-
FINRA member firms in the U.S. Treasury market (most of which we
believe are not dealers) have a volume distribution that is comparable
to the volume distribution of FINRA-members (most of whom are dealers).
Based on PTFs' high trading volumes, and on the Federal Reserve staff
finding that PTFs are particularly active in the interdealer segment of
the U.S. Treasury market, we believe that PTFs have emerged as de facto
liquidity providers in the U.S. Treasury market.

                                        Table 1--Count of Active Firms in the Treasury Market by Type: July 2021
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                # Firms with (buy + sell) volume >
                        Firm type                        -----------------------------------------------------------------------------------------------
                                                                $0             $1 bn          $10 bn          $25 bn          $50 bn          $100 bn
--------------------------------------------------------------------------------------------------------------------------------------------------------
FINRA-member firms......................................             452             126              74              53              38              32
    Dealers.............................................             420             101              51              35              25              21
Non-FINRA member firms..................................             174              95              46              23              14               9
    Asset Managers......................................      ([dagger])             (*)             (*)             (*)             (*)             (*)
    Dealers.............................................              80              42              20             (*)             (*)             (*)
    Hedge Funds.........................................              41              17             (*)             (*)             (*)             (*)
    Others..............................................      ([dagger])             (*)             (*)             (*)             (*)             (*)
    PTFs................................................              38              30              22              18              13               9
    Sum of *s...........................................              15               6               4               5               1               0
--------------------------------------------------------------------------------------------------------------------------------------------------------
[dagger] Suppressed; strictly greater than zero.
* Suppressed; greater than or equal to zero.

[GRAPHIC] [TIFF OMITTED] TP18AP22.036

    Since the analysis behind Table 1 is limited to the subset of TRACE
data where we can identify the individual firms,\221\ the numbers of
firms with trading volume above the various thresholds may be greater
than shown in the table. This is also to say that, were the data to
include all market participants, we would need higher thresholds to be
able to report numbers of firms similar to what are shown in the table.
We make this adjustment as follows. In July 2021, the analysis was able
to determine the firm identity and FINRA membership status of 42
percent of the non-FINRA member volume; the remaining 58 percent of
non-FINRA member volume was anonymous.\222\ Under the assumption that
all non-FINRA member market participants are equally represented in
both the anonymous and identified subsets of TRACE, the analysis
equally undercounts the volume of all firms--i.e., we assume that our
analysis only contains 42 percent of identified non-FINRA member firms'
volume. We acknowledge considerable uncertainty regarding this
assumption. The assumption of equal representation in the observed and
non-observed data suggests dividing the thresholds shown in Table 1 by
0.42 (or multiplying them by approximately 2.5). For example, Table 1
shows that our analysis counted 46 non-FINRA member firms with trading
volumes of at least $10 billion in July 2021; the adjustment would
suggest that those 46 firms actually had trading volumes of above $25
billion. However, firms in the various categories may not be equally
represented in the identified and anonymous data. If, for example, PTFs
are overrepresented in the identified data, then the actual number of
PTFs with volumes over $25 billion will be closer to 18 than to 22. We
preliminarily estimate that approximately 46 non-FINRA member firms
would surpass the $25 billion volume threshold given in the
quantitative standard of the Proposed Rules. Although the analysis
behind Table 1 only uses data from July 2021, we find that the number
of firms that would have surpassed the $25 billion volume threshold in
four out of the last six calendar months remained relatively steady
between 39 and 50 from September 2019 to July 2021, or the entire
period for which data was available. Non-FINRA member counterparties
are first identified in TRACE beginning in April 2019, so September
2019 is the first month in which we can count how many non-FINRA member
firms would surpass the quantitative threshold in four out of the last
six calendar months.
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    \221\ See supra note 217.
    \222\ For each transaction, we consider each counterparty to be
responsible for half of the volume. Therefore, for a transactions
where we observe the identity of only one counterparty, we consider
that we have only determined the firm identity and FINRA membership
for half of the transaction's volume. We observe the identity of at
least one counterparty for all transactions in TRACE, since trades
between non-FINRA member firms are not reported to TRACE.
---------------------------------------------------------------------------

b. Private Funds
    Private funds \223\ are prominent participants in U.S. securities
markets. As of the second quarter of 2021, the Commission observed the
following

types of private funds reported on Form PF:\224\
---------------------------------------------------------------------------

    \223\ See supra note 30.
    \224\ See Division of Investment Management Analytics Office,
SEC, Private Fund Statistics: Second Calendar Quarter 2021 (Jan. 14,
2022), available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q2.pdf

                                  Table 2--Private Fund Statistics as of 2021Q2
----------------------------------------------------------------------------------------------------------------
                                                         Gross asset value                Net asset value
            Fund type                  Count     ---------------------------------------------------------------
                                                    Total  ($B)     Avg   ($mm)    Total   ($B)     Avg  ($mm)
----------------------------------------------------------------------------------------------------------------
Hedge Fund......................           9,613           9,584             997           5,132             534
Private Equity Fund.............          15,861           4,825             304           4,270             269
Venture Capital Fund............           1,424             222             156             214             150
Liquidity Fund..................              76             330           4,342             319           4,197
Other Private Fund..............          10,557           3,041             288           2,167             205
----------------------------------------------------------------------------------------------------------------
Note: These statistics rely on Form PF. Only SEC-registered advisers with at least $150 million in private fund
  assets under management must report to the Commission on Form PF; SEC-registered investment advisers with less
  than $150 million in private fund assets under management, SEC exempt reporting advisers, and state-registered
  investment advisers are not required to file Form PF.

    Of the 9,613 hedge funds reported on Form PF, there were 1,968
qualifying hedge funds that reported information on their positions,
and these held $3.2 trillion in listed equities and $1.7 trillion in
U.S. Government securities. Of the 76 liquidity funds, 56 liquidity
funds reported information on their positions, and these held $94.8
billion in U.S. Government securities and $21.7 billion in asset-backed
securities.
    Among private funds, hedge funds are the most likely to be engaged
in activities that meet the Proposed Rules. As reported on Form PF,
hedge funds and private equity funds are the largest by count and
aggregate assets, and hedge funds and liquidity funds are the largest
by average fund assets. However, the business models of private equity
funds \225\ and liquidity funds \226\ are unlikely to fall under the
Proposed Rules' qualitative factors, since they are generally long-only
investors that are not likely to routinely make roughly comparable
purchases and sales of the same or substantially similar securities in
a day or to routinely quote markets to capture bid-ask spreads. As
described above, ``routinely'' in the Proposed Rules means both
repeatedly within a day (multiple times in a single day) and repeatedly
over time (on the majority of days in a calendar month). Regarding the
quantitative volume standard, liquidity funds may trade large volumes
of U.S. Treasury securities, but the average reporting liquidity fund,
as of the second quarter of 2021, held only $1.7 billion of Treasury
securities and held the average positions for 40-50 days.\227\ Such a
fund is unlikely to regularly trade $25 billion in U.S. Treasury
securities in a month.
---------------------------------------------------------------------------

    \225\ See Investor.gov, Private Equity Funds, available at
https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/private-equity.
    \226\ See D. Hiltgen, ``Private Liquidity Funds: Characteristics
and Risk Indicators,'' DERA White Paper (Jan. 2017).
    \227\ See supra note 224, figures 18-19.
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    An important similarity between private funds and PTFs is the
incentives involved for those making trading and investment decisions.