SEC Rulemaking Returns After Quiet Stretch: Assessing the SEC “Reg. Flex” Agenda for BDs and Exchanges

In July 2024, the federal Office of Information and Regulatory Affairs, or “OIRA,” published the SEC’s Spring 2024 “Reg. Flex” agenda. Under Chair Gensler, the SEC has already adopted 40+ final rulemakings, has formally proposed an additional dozen-plus rulemakings that it expects to adopt soon, and plans on proposing more than a dozen fresh proposals on top of that. The 70+ total rulemakings targeted by Chair Gensler compares to a total of 43 adopted rulemakings under prior Chair Clayton and 22 adopted rulemakings under former Chair White. The anticipated dates in the agenda are merely projections, and it is possible that some of these rulemakings will not proceed. However, with the election approaching, the Chair’s sense of urgency must be high, which is only one of several reasons why the agency’s rulemaking schedule has returned after a significant lull the past several months.

Quick Take!

The SEC is advancing steps to modernize Reg. NMS (national market system) and the ATS regime along with overhauling cybersecurity, cyber incident reporting, and privacy controls and requirements for industry registrants. At the same time, the SEC is expanding the scope of activities that require registration as dealers and exchanges and is also expanding the scope of registrants included within new and existing rules and regulations. And because of course it is, the SEC is set to tackle the industry’s use of AI when interacting with investors.

What’s Already Happened?

The SEC recently expanded definitions for what it means to be a dealer and a government securities dealer (February 2024); amended Reg. NMS Rule 605 to enhance order execution disclosures (March 2024); amended Reg. S-P to modernize and enhance the privacy and cybersecurity obligations of “covered institutions” regarding their treatment of consumers’ nonpublic personal information (May 2024); and amended Reg. NMS Rules 603, 610, and 612 to decrease the minimum pricing increments for the quoting of certain NMS stocks, reduce access fee caps, and (as the SEC puts it) enhance the transparency of better-priced orders (September 2024).

What’s Coming Next?

Market Structure and ATS Modernization: The SEC still expects to adopt these December 2022 and October 2023 equity “market structure” proposals: new Regulation Best Execution (new Exchange Act Rules 1100, 1101, and 1102 establishing a best execution standard and requiring robust policies and procedures for firms engaging in certain conflicted transactions with retail customers); a proposed new Order Competition Rule (new Exchange Act Rule 616, including requiring certain retail equity orders to be exposed in auctions before being internalized); and new Exchange Act Rule 6b-1 (prohibiting national securities exchanges like NYSE and Nasdaq from charging members based on the volume of their agency and riskless principal orders). Separately, the industry can expect the SEC to propose “modernizations” to the conditions to the ATS exemption, as well as to include requirements designed to promote pre-trade transparency across asset classes.

Exchange Status (including for crypto platforms): The SEC still intends to expand the meaning of what it means to be an exchange, despite this proposal having lingered since January 2022. Applicability to the fixed income markets was the main headline of the initial proposal (really, the only headline). However, the proposed expansion goes well beyond that and would sweep in what the SEC refers to as “communication protocol systems.” In doing so, the proposal would broaden the scope of the ATS regime from a centralized construct to one in which a communication protocol system would be viewed as an exchange even if the developer merely “makes it available.” In April 2023, the SEC reopened the comment period and asked several new questions related to the proposal, much of which focused on crypto asset securities, references to which were peculiarly missing from the original proposal. The SEC finally made clear that the proposed expanded meaning would apply to any crypto asset that is a security, including under an “investment contract” analysis. The SEC noted that “it is unlikely that systems trading a large number of different crypto assets are not trading any crypto assets that are securities.” Accordingly, in the SEC’s eyes, “these systems likely meet the current criteria of Exchange Act Rule 3b-16(a)” (emphasis added) and “some amount of crypto asset securities trade on New Rule 3b-16(a) Systems.” In each case, these systems would need to register as exchanges or as broker-dealers and ATSs. A series of recent high-profile enforcement actions were in line with this view of the current Commission. Separately, the SEC confirmed it does not intend the proposed expanded exchange definition to capture order and execution management systems used by fund complexes to manage portfolio positions. Additionally, the SEC does not intend for the proposal to apply to general chat functions if they do not contain any type of structured messaging or prompts geared toward creating a securities transaction.

Cyber and SCI: The SEC also intends to amend to Reg. SCI (systems compliance and integrity) by including new requirements for and expanding the scope of covered “SCI Entities” to include all clearing agencies exempted from registration and registered broker-dealers and security-based swap data repositories that exceed certain asset and transaction thresholds. At the same time, the SEC expects to adopt new Rule 10, new Form SCIR, and related cybersecurity requirements for “Market Entities” that perform critical services to support the fair, orderly, and efficient operations of the US securities markets, including broker-dealers, FINRA, the MSRB, exchanges, TAs, and clearing agencies.

Artificial Intelligence and Conflicts: The SEC expects to repropose rules related to broker-dealer and investment adviser conflicts of interest in the use of predictive data analytics, artificial intelligence, machine learning, and similar technologies in connection with certain investor interactions. The agency originally proposed this rulemaking in July 2023. If adopted, the rulemaking would have required firms to (i) eliminate or neutralize the effect of conflicts of interest associated with the firm’s use of covered technologies in investor interactions that place the firm’s or its associated person’s interest ahead of investors’ interests; (ii) maintain reasonably designed written policies and procedures related to investor interactions using covered technology; and (iii) maintain certain records related to the proposed conflicts rules. The original proposal drew significant industry scrutiny, including because of the wildly expansive scope of “covered technologies.” Chair Gensler and other SEC leadership later hinted at a reproposal that was ultimately confirmed in the Reg. Flex agenda. While the SEC is reconsidering the proposal’s scope, one can only hope they also reconsider the name so it leads to an acronym other than PDA.

Final Thoughts

The SEC seems poised to tackle many of the Reg. Flex agenda items by the end of 2024, despite the looming election for president and, depending on those results, the potential for a new Chair to be nominated shortly thereafter. The Congressional Review Act “lookback” provides an additional element of uncertainty for the SEC and industry participants. Finally, if you are wondering why we are not discussing the SEC’s Fall 2024 agenda, OIRA likely will not publish that until the end of Q4 2024, and the election results will likely affect that timing.

 

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