On November 21, 2024, a Northern District of Texas court ruled[1] that the Securities and Exchange Commission had overstepped its authority when the agency had implemented a rule (the “Dealer Rule”) requiring a broader group to register as “Dealers” or “Government Securities Dealers” under the Securities Exchange Act of 1934 (the “Exchange Act”).[2]
The rule, intended to improve regulation of high-frequency traders (“HFT”s) and give the SEC greater visibility into market liquidity, sought to modify the SEC’s definition of “dealer” to include market participants who engage “in a routine pattern of buying and selling securities that has the effect of providing liquidity to other market participants.”[3]
We previewed the rule back in 2022 in SEC Proposes a Revised Definition of “Dealer,” when SEC Chair Gary Gensler pointed out that “electronification and the use of algorithmic trading have made transacting in this market faster than ever before,” which has led to “a number of high-profile events in markets with significant participation by” high-frequency traders or HFTs. [4] HFTs drew scrutiny following the 2010 “Flash Crash” in which an HFT’s trading algorithm triggered a wave of selling in the market for eMini S&P500 futures, contracts that are based on projected values of the S&P 500 index. The ensuing wave of selling across markets forced the Dow Jones Industrial Average down nearly 9 percent in just four minutes.[5] Similar events in markets for U.S. Treasury Bonds and individual securities led to abrupt declines and concerns about market stability.[6]
Plaintiffs Claimed Overbroad, Inconsistent
The case was brought by a group of three “nonprofit membership organizations whose members include hedge fund managers adversely affected by the Dealer Rule.”[7]
In their briefing, Plaintiffs asserted a number of challenges, including that “the costs of the [Dealer] Rule are enormous, and there are no corresponding benefits” and that the Dealer Rule is overbroad.[8]
Plaintiffs’ reasoning rested in part on the idea that the Dealer Rule would improperly allow the SEC to expand the definition of dealer to include traders who do not act on behalf of customers. Citing recent decisions from within both the District and the Second Circuit, Plaintiffs argued that “dealers” were understood to act on behalf of customers not only in judicial precedent, but also prior to the Exchange Act as shown in the Act’s language and structure.[9]
Plaintiffs’ motion for summary judgment was supported by amicus curiae briefs submitted by two industry associations, the Futures Industry Association and the Committee on Capital Markets Regulation. Among other challenges, both amici argued that the Dealer Rule ran contrary to the SEC’s own longstanding interpretation of the Exchange Act, presenting a significant expansion of the SEC’s regulatory regime.[10]
SEC Touted Uniformity and Tailored Application
The SEC described its rationale for the Dealer Rule, pointing to a “regulatory gap” in which some proprietary trading firms perform critical market functions, such as providing liquidity—an important element in the flash-crash episodes, but these firms are not registered with the SEC as dealers. This led to “inconsistent oversight of market participants performing similar functions” and increased the “difficulty and complexity for regulators to investigate, understand, and address significant market events.”[11]
Among its defenses of its rule, the SEC pointed out that the agency reviewed comments submitted over the course of almost two years, and made significant modifications to its initial proposed text in an effort to “more appropriately tailor the scope of the final rule to ensure that only entities engaging in de facto market making activity are required to register as dealers under the rule.”[12]
These changes included:
- Doing away with one qualitative standard entirely that would have looked at whether a market participant “routinely [made] roughly comparable purchases and sales of the same or substantially similar securities”; and
- Removing a provision that would have aggregated accounts controlled by a single entity.[13]
Other safeguards against overbroad application in the final rule were an exclusion of any market participant with less than $50 million, and traditional dealer activities such as underwriting.[14]
The final version of the Dealer Rule sought to require registration by those who – “as a part of a regular business” – met one of two specific qualitative standards related to market liquidity: (1) “regularly expressing trading interest at or near the best available prices on both sides of the market for the same security,” or (2) “earning revenue primarily from capturing bid-ask spreads.” [15]
Based on these and other factors, the SEC asserted that the Dealer Rule fell “squarely within the Commission’s statutory authority to define terms used in the Exchange Act” and promoted the uniform treatment of those who performed a role similar to that “historically [done] by a registered dealer.”[16]
And while neither Plaintiffs nor the Court explicitly raised the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo[17] in which that Court overruled its long-standing precedent of judicial deference to agency statutory interpretation first set forth in Chevron v. Natural Resources Defense Council,[18] the SEC did offer its analysis under Loper’s “best reading” standard.[19] Citing the Exchange Act’s definitions of “dealer” and “government securities dealer,” the SEC argued that its Dealer Rule “further defines what it means to be engaged in the business of buying and selling securities ‘as a part of a regular business’”[20] by:
“identifying two trading patterns tailored to how a market participant provides liquidity by acting as a de facto market maker in today’s securities markets: (1) regularly communicating trading interest on both sides of the market for the same security, or (2) earning revenue primarily from capturing bid-ask spreads or trading incentives.”[21]
Vacated by the Court
The court’s opinion focused on the text and structure of the Exchange Act and the history of how the term “dealer” has been defined. Pointing to a “rich common law history” and “pre-Exchange Act treatises,” the court adopted Plaintiffs’ position that a dealer must be in the business of effecting transactions for customers.[22] The court explained its reasoning, stating:
- The structure of the Exchange Act defines “dealer” and “broker” in related ways that must work together;
- The Exchange Act “only makes sense if dealers are in the business of customer-order facilitation”; and
- The SEC’s Dealer Rule failed to maintain an appropriate connection between these terms.
Based on these factors and the history of the definition of “dealer,” the court concluded that the SEC’s “attempt to change the definition, when the statutory language has not changed, is in excess of its statutory authority.”[23]
An SEC spokesperson reportedly said the agency is reviewing the decision.[24] The agency has 60 days to appeal the ruling to the Fifth Circuit Court of Appeals.[25]
The case is National Association of Private Fund Managers v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024).
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[1] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 46 at 20.
[2] 15 U.S.C. § 78a et seq.
[3] S.E.C., Further Definition of “As a Part of a Regular Business” in the Definition of Dealer and Government Securities Dealer, Release No. 34-94524; File No. S7-12-22 (Mar. 28, 2022).
[4] Statement on the Further Definition of a Dealer-Trader, S.E.C. Chair G. Gensler (Mar. 28, 2022) available at https://www.sec.gov/news/statement/gensler-statement-further-definition-dealer-trader-032822.
[5] See, e.g., Findings Regarding the Market Events of May 6, 2010, Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issues, S.E.C. and C.F.T.C. (Sept. 30, 2010) available at https://www.sec.gov/files/marketevents-report.pdf.
For a more technical discussion, see Nanex Flash Crash Summary Report, Nanex (Sept. 27, 2010) and related reports, available at http://www.nanex.net/FlashCrashFinal/FlashCrashSummary.html.
[6] See Levine, Z., et al., The October 2014 United States Treasury bond flash crash and the contributory effect of mini flash crashes, PloS One (Nov. 1, 2017) available at doi:10.1371/journal.pone.0186688; Golub, A., et al., High Frequency Trading and Mini Flash Crashes, SSRN Electronic J. (Nov. 2012) at 3 (Fig. 1) available at DOI:10.2139/ssrn.2182097.
[7] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 1 at 4.
[8] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 29 at 9.
[9] Id. at 11-14.
[10] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. Nos. 34, 36.
[11] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 38 at 9 (internal quotations omitted).
[12] Id. at 8.
[13] Id. at 10.
14] Id. at 11.
[15] Id. at 13-14.
[16] Id. at 14.
[17] Loper Bright Enterprises v. Raimondo, 603 U.S. —; 144 S. Ct. 2244 (2024).
[18] Chevron U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).
[19] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 43 at 2-3.
[20] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 43 at 3.
[21] Id.
[22] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 46 at 10-11.
[23] Nat’l Ass’n of Private Fund Mgrs. v. SEC, No. 4:24-cv-00250 (N.D. Tex. 2024), Dkt. 46 at 12-13.
[24] M. Mekelburg & L. Beyoud, Judge Tosses SEC Treasury Dealer Rule in Hedge Fund Win, Bloomberg, Nov. 21, 2024.
[25] See Fed. R. App. Proc. 4(a)(1)(b).
