On July 29, 2022, the U.S. Securities and Exchange Commission (SEC) unanimously proposed amendments to Rule 15b9-1 (the Proposal) under the Securities Exchange Act of 1934 (Exchange Act) that, if adopted, would substantially narrow an exemption for broker-dealers from the requirement to become a member of the Financial Industry Regulatory Authority (FINRA).1 The Proposal is designed to require broker-dealers that engage in securities transactions over the counter (OTC) to be subject to oversight by FINRA, the primary regulator of the OTC markets for securities.2

The Proposal closely relates to the SEC’s separate proposal in late March 2022 to significantly expand the scope of firms that must register as dealers (the Dealer-Trader Proposal).3 If the both the Proposal and the Dealer-Trader Proposal are adopted, then most of the estimated 97 firms that would be required to register as dealers with the SEC would also be required to become FINRA members. As we noted in our Dealer-Trader Proposal client alert, proposed amendments to Rule 15b9-1 appeared likely in order to ensure that FINRA would be able to supervise the OTC trading of such firms — particularly with respect to transactions in U.S. Treasury securities that all occur OTC.4

The Proposal’s comment deadline is the later of (i) Tuesday, September 27, 2022 (60 days after issuance of the Proposal), or (ii) 30 days after publication of the Proposal in the Federal Register.

Background

Section 15(b)(8) of the Exchange Act requires a broker-dealer to register with a national securities association (i.e., FINRA) unless it effects transactions solely on a national securities exchange of which it is a member.5 Currently, Rule 15b9-1 further exempts a broker-dealer from FINRA membership if the broker-dealer (1) is a member of a national securities exchange, (2) does not carry customer accounts, and (3) derives an annual gross income of $1,000 or less from securities transactions that are not effected on the national securities exchange of which it is a member (the de minimis allowance).6 However, excluded from the de minimis allowance is all income derived from a broker-dealer’s proprietary transactions conducted with or through another registered broker-dealer.7 As a result, broker-dealers today are effectively able to engage in an unlimited number of proprietary transactions OTC without being a FINRA member provided the broker-dealer is an exchange member, does not carry customer accounts, and effects its OTC trades with or through another broker-dealer. 

Rule 15b9-1 was initially adopted to allow for exchange specialists and other floor traders to receive a portion of commissions on occasional off-exchange transactions referred to other broker-dealers or to hedge positions arising from on-exchange trading. In making the Proposal, the SEC is indicating that the current use of the Rule 15b9-1 exemption by proprietary trading firms that trade actively OTC is not consistent with the original purpose of Rule 15b9-1.8

Proposed Changes to Rule 15b9-1

The Proposal would amend Rule 15b9-1 by eliminating the de minimis allowance and establishing a more narrow exemption from Section 15(b)(8). Specifically, under the Proposal a broker-dealer would be required to join FINRA if it effects securities transactions other than on an exchange of which it is a member unless it

  • is a member of a national securities exchange
  • carries no customer accounts
  • limits its OTC trading to transactions that are solely for the purpose of
    1. routing orders by an exchange of which the broker or dealer is a member to comply with Rule 611 of Regulation NMS or the Options Order Protection and Locked/Crossed Market Plan (Options Linkage Plan) or
    2. executing the stock leg of a stock-option order9

As a result of this proposed narrowing, the only purpose for which a broker-dealer relying on the exemption could transact OTC would be to prevent trade-throughs or for the purpose of hedging an options transaction through the use of a stock-option order.10 Notably, broker-dealers relying on the exemption for routing to avoid trade-throughs would be required to use the exchange’s affiliated routing broker-dealer rather than a broker-dealer of their choosing.

The SEC estimates that if adopted, the Proposal would affect approximately 65 broker-dealers that are not FINRA members that routinely transact in the OTC securities market. As noted above, the impact of the Proposal would be much greater if the Dealer-Trader Proposal is also adopted.