Securities and Exchange Commission: Regulation of NMS Stock Alternative Trading Systems

(j) Commercial paper shall mean any note, draft, or bill of exchange which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited. (3) In the case of a partnership, has contributed, or has the right to receive upon dissolution, 25 percent or more of the capital of the broker-dealer of the alternative trading system. The NYSE had been insulated for a time by Rule 390, but in 1999, losing market share and under alternative trading systems examples heavy pressure from the SEC, it repealed the Rule with “a tremendous amount of cajoling,” as Annette Nazareth, then Senior Counsel to Chairman Arthur Levitt, put it. 43 By the time of Reg ATS, the NASDAQ was emerging from a period of vulnerability and was able to more effectively compete in the new institutional and regulatory landscape. Registered representatives can fulfill Continuing Education requirements, view their industry CRD record and perform other compliance tasks.

What Is the Difference Between an Exchange and an ATS?

If adopted as proposed, the proposed https://www.xcritical.com/ changes would require that a Communication Protocol System either register as a national securities exchange or register as a broker-dealer and comply with the requirements of Regulation ATS. The SEC stated its expectation that most Communication Protocol Systems would prefer to be regulated as broker-dealers and be subject to Regulation ATS rather than exchange registration, but explained the implications under both options. Better Markets filed a comment letter in response to the proposal of the Securities and Exchange Commission (SEC) to eliminate the exemption for Government Securities alternative trading systems (ATS) from compliance with Regulation ATS and update its rule on the definition of an exchange to include Communication Protocol Systems.

SEC Proposes Changes to Regulation ATS for Communication Protocol Systems

• Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.
• One of the challenges for registering an ATS is that the SEC and FINRA currently lack sufficient experience and technical understanding of the digital assets and trading platforms, which requires back-to-back communication and meetings with FINRA throughout the registration process.
• An ATS must file the Securities and Exchange Commission (SEC) Form ATS-R within 30 days of the end of each calendar quarter.
• FINRA Data provides non-commercial use of data, specifically the ability to save data views and create and manage a Bond Watchlist.

In support of removing this exemption for banks, the SEC notes the importance of SRO membership for ATSs, and because banks typically operate in reliance on exemptions from broker or dealer status, they are not required to become a member of FINRA. Accordingly, bank-operated ATSs trading only government securities would not be able to rely on the exemption from exchange registration provided by Regulation ATS. The SEC believes a bank in such a situation may adopt a registered affiliate structure for government securities operations by moving its ATS operations into a new or existing broker-dealer affiliate of the bank. For banks currently trading government securities pursuant to an exemption without a registered broker-dealer affiliate, they will need to either register a broker-dealer and ATS or cease the activity.

Types of Tokenized Securities that Can Be Traded on ATS Platforms

It also shows that the share of trading in large companies typically is proportional to their share of total market capitalisation. The US Regulation National Market System (Regulation NMS) adopted in 2005 is a collection of existing and new rules issued by the US Securities and Exchange Commission (US SEC). The Commission also stated market participants could receivepotential benefits from more information on the operation of ATSs that would bestandardized, reducing search costs. The Commission further statedbroker-dealers could face potential benefits due to increased competitionleading to innovation which could attract more trading volume. SIFMA generally supports increased operational transparency related to the basic rules of operation of fixed income and government securities ATSs. There is value in operational transparency related to the basic rules of operation of the venue, the ability of priority or preferential treatment (if any) for certain desks or clients and information on risk controls.

Resources for Registering/Operating ATS:

Many of these platforms may already be subject to Reg ATS if they use firm orders in respect of trading digital assets that are securities. As a result, the incremental expansion of Reg ATS to cover the broader category of “trading interest” (rather than just “orders”) would not newly ensnare such platforms using firm orders. Given the difficulties with analysing the trading data in Europe, potentially double-counted trades have been excluded, based on the explanations provided for each trading category in the dataset, including give up/give in trades. In the Securities Exchange Act of 1934, Congress intentionally adopted a broad definition of what constitutes an “exchange” to enable the SEC to adapt to changes in the markets.

Crypto Exchanges & the SEC’s Proposed Redefinition of an “Exchange”

While ATS is so far the best suited model for creating digital asset marketplaces for real estate, NFTs and operating businesses, registration and operation of ATS platforms that facilitate trading of tokenized securities involves novel issues and challenges. (k) NMS Stock ATS means an alternative trading system, as defined in paragraph (a) of this section, that trades NMS stocks, as defined in paragraph (g) of this section. (ii) Separately file the information required by Form ATS-R for transactions in NMS stocks and transactions in securities other than NMS stocks within 10 calendar days after an alternative trading system ceases to operate. Nonetheless, the SEC waited only a weekend before bringing a new enforcement action against a centralized crypto exchange for acting as an unregistered exchange, broker-dealer, and clearing agency. Further, the reopening comes on the heels of an announcement that the SEC issued a Wells Notice to one of the world’s largest centralized crypto exchanges covering a wide array of potential violations that also could implicate unregistered “exchange” activity. One exemption from registration as an NSE allows a company to conduct a digital asset platform business if such company is registered as an ATS.

SEC Proposes Broad Expansion of Regulation ATS, Regulation SCI, and Exchange Definition

An exchange-run system must deal with multiple buyers and sellers in contrast to systems operated by a single dealer who acts as a counterparty to all trades. Similarly, systems that do not provide for order interaction, such as those that route orders to order-execution facilities, will not qualify as exchanges. In addition, exchanges must use “established, non-discretionary methods” for order interaction. Orders include “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,” and are executable without further meaningful negotiation. Having experience in digital assets, including security tokens, and traditional securities, we represent our clients before the SEC and FINRA throughout the whole ATS registration process to achieve the result. Our partners are in the constant process of communicating with the SEC and FINRA representatives regarding the most efficient ways of registering and operating an ATS.

Institutional investors may use an ATS to find counterparties for transactions, instead of trading large blocks of shares on national stock exchanges. These actions may be designed to conceal trading from public view since ATS transactions do not appear on national exchange order books. The benefit of using an ATS to execute such orders is that it reduces the domino effect that large trades might have on the price of an equity. They are known as multilateral trading facilities in Europe, ECNs, cross networks, and call networks. Most ATSs are registered as broker-dealers rather than exchanges and focus on finding counterparties for transactions.

ALTERNATIVE TRADING SYSTEMS (ATS) FOR TOKENIZED SECURITIES

In line with the SEC’s recent barrage of enforcement actions targeting the crypto industry, the reopening validated concerns voiced in comments to the initial proposal. The SEC notes in the reopening release that its purpose is to address the potential effects of the proposed amendments to Rule 3b-16 on trading systems for crypto asset securities and trading systems using distributed ledger technology (“DLT”), including various DeFi systems such as automated market makers (“AMMs”) and DeFi exchanges (“DEXs”). On April 14, 2023, the Securities and Exchange Commission (“SEC”) reopened the comment period and provided supplemental information on proposed amendments to Rule 3b-16 under the Securities Exchange Act of 1934 (“Exchange Act”), which defines certain terms used in the definition of “exchange” in Section 3(a)(1) of the Exchange Act. The reopening is primarily intended to address the significant comments received by the SEC in response to the initial proposal, many of which questioned the proposal’s application to trading systems that enable trading of crypto asset securities. The reopening comment period will end 30 days after its publication in the Federal Register or June 13, 2023, whichever is later.

Rule 3b-16 currently also requires that a system bring together the orders of multiple buyers and sellers. The alternative trading system shall register as a broker-dealer under section 15 of the Act, (15 U.S.C. 78o). As a result, dark pools, along with high-frequency trading (HFT), are oft-criticized by those in the finance industry; some traders believe that these elements convey an unfair advantage to certain players in the stock market. Over the past 30 years, the SEC has examined how to apply the term “exchange” to systems that have been variously called proprietary trading systems (PTSs), broker-dealer trading systems, and most recently, ATSs. While expanding Regulation ATS to Government Securities ATSs and layering on Regulation SCI requirements was the main headline, all existing ATS operators should carefully review the proposal, as its reach and effects go far beyond government securities. (B) During at least 4 of the preceding 6 calendar months, had an average daily trading volume of 5 percent or more of the aggregate average daily share volume for such NMS stock as reported by an effective transaction reporting plan.

A lot of platforms providing a marketplace for digital tokens fall squarely within the definition of an ATS. Every ATS must still be registered with the SEC, provide multiple disclosures, implement security measures and comply with the federal reporting requirements, as well as state laws in each state where the ATS operates. Rule 301(b)(5) requires an ATS with at least 5% of the average daily volume for a security in at least four of the previous six months to comply with “fair access” requirements, including establishing written standards for granting access to the ATS. An ATS cannot unreasonably deny or limit access to its platform by, for example, applying minimum capital or credit requirements in a discriminatory manner. By exceeding the 5% threshold, tZERO was subject to Rule 301(b)(5) with respect to trading in Overstock’s Series A Blockchain Preferred Securities (OSTKP) in June 2017, its own Preferred Securities (TZROP) beginning in February 2020, and Overstock’s Series A Digitally Enhanced Preferred Securities (OSTKO) in March 2020. TZERO failed to maintain written supervisory procedures (“WSPs”) establishing its fair access obligations and did not update its WSPs to establish fair-access standards until June 2020, after Enforcement staff requested its standards.

(vii) The reports provided for in paragraph (b)(2) of this section shall be considered filed upon receipt by the Division of Trading and Markets, at the Commission’s principal office in Washington, DC. Duplicate originals of the reports provided for in paragraphs (b)(2)(i) through (v) of this section must be filed with surveillance personnel designated as such by any self-regulatory organization that is the designated examining authority for the alternative trading system pursuant to § 240.17d-1 of this chapter simultaneously with filing with the Commission. Duplicates of the reports required by paragraph (b)(9) of this section shall be provided to surveillance personnel of such self-regulatory authority upon request. All reports filed pursuant to this paragraph (b)(2) and paragraph (b)(9) of this section shall be deemed confidential when filed.

Moreover, different types of DEXs may involve other market participants or technology that may provide order books, utilize automated market maker algorithms, and liquidity providers. If the “group of persons” threshold can be met for a DEX, and if a crypto asset available to be exchanged through the DEX is a “security,” there is a question of whether a DEX could be an “exchange” under the current rules and, given the expansion to passive communication protocol systems, a much higher risk of that designation under the proposed rule. This overlap between dark trading volume across off-exchange trading venues and exchange trading is identified in Figure 4.5. Adding the volume of dark trading in exchanges to the dark trading in off‐exchange trading venues (including ATS and non-ATS OTC volume) shows that about 42% of the total trading volume in US equity markets in 2015 was in the form of dark trading. As mentioned above, the fragmentation of trading into multiple venues has been accompanied by an increase in dark trading in the last decade.

Thus, the SEC’s dedication to transparency, that drove the order handling rules, has taken a significant step further. These methods include rules governing trading conduct and trading facilities that standardize the manner of order interaction, such as computer algorithms. The agency has revised its interpretation of the term exchange to apply to ATSs through new rule 3b-16.

While anonymity is great for companies that trade on ATS platforms, it is obviously a double-edged sword for the remainder of the market. Modern ATSs are a product of the rapid technological advances that have revolutionized the way stocks are bought and sold. There are many types of ATSs, and they facilitate the purchase and sale of all types of securities ranging from equities to corporate bonds to Treasuries, and more. Unlike an exchange, which must disclose publicly quotes and prices at which securities transactions occur, an ATS can operate in the dark with only limited information about its operations. The new scheme requires an ATS either to register as a national securities exchange or as a broker dealer and comply with new requirements under Regulation ATS.

Treasury Securities or in a debt security issued or guaranteed by a U.S. executive agency, as defined in 2 U.S.C. 622(8). Finally, the Commission issued a concept release on the regulatory framework for electronic platforms that trade corporate debt and municipal securities. An ATS is a trading venue that is subject to fewer restrictions and regulations than a national securities exchange. An ATS that does not publicly display unfilled orders is called a “dark market” or “dark pool,” while an ATS that does display such orders, similar to a registered exchange, is considered “lit.” Order display provides buyers and sellers the expectation of liquidity and execution in the ATS. Regulation ATS provides for an exemption from registration as a national securities exchange if certain rules are followed.

The emergence of ATS has reshaped the landscape of financial markets, introducing enhanced liquidity, transparency, and accessibility. Understanding the nuances of ATS is paramount for investors and market participants navigating the complexities of modern trading environments. Comparing the fragmentation between exchange and off-exchange trading in the United States and Europe is not straightforward. It is because trading conducted on ATS is not publicly available and does not appear on national exchange order books. Many different explanations have been proposed for the decline in non-financial company IPOs in advanced economies (Isaksson and Çelik, 2013).

A trade that is executed bilaterally off the order book of an exchange, but executed subject to the exchange’s rules and reported to the exchange, is classified as an off-order book on exchange trade. From a company’s perspective, there are two characteristics that make equity capital different from other forms of capital that the company can use. First, providers of equity capital (the shareholders) are not guaranteed any fixed interest rate or any given rate of return on the money that they invest.