On November 21, 2024, a federal District Court judge in the Northern District of Texas found the Securities and Exchange Commission (SEC) acted without lawful, statutory authority in creating its new Dealer Rule. The Dealer Rule broadened the definition of dealer and would have required those with significant liquidity providing roles in the markets to register with the SEC, become members of a self-regulatory organization, and comply with federal securities laws and regulatory obligations. The ruling, in two related cases brought by industry groups from private fund management and cryptocurrency spaces, vacated the Dealer Rule in whole.
Back in February 2024, a divided SEC adopted the Dealer Rule, which requires proprietary traders and other firms that "regularly" buy and sell securities for their own accounts to register as broker-dealers. The Dealer Rule included as a "dealer" any person whose trading activity "regularly" has the effect of "providing liquidity" to the marketplace. The rule provided two tests to determine whether one is acting as a dealer when providing liquidity. At the time the SEC adopted the rule, Commissioner Hester Pierce said the rule "obliterates" the regulatory system as "the Commission and market participants have read it for decades." Chief among Commissioner Pierce's concerns was that the new rule inappropriately made the provision of liquidity the litmus test for determining whether someone was engaged in dealer activity, rather than simply one factor of many to be considered, as had been the Commission's, its staff's, and the courts' understanding for decades. Despite this pushback, the SEC voted 3-2 to adopt the rule.
Shortly after, two industry organizations representing hedge fund managers and two representing cryptocurrency advocates and users filed suit in the Northern District of Texas against the SEC to enjoin enforcement of the rule. In their suits, each group of plaintiffs argued the SEC violated the Administrative Procedures Act (APA) by creating a rule that exceeds the SEC's statutory authority to regulate. Plaintiffs argued that the text of the Exchange Act carves out the role of a trader who does not buy or sell securities as a regular part of business, but rather for personal accounts, from the traditional broker-dealer definition. This carve-out means that traders whose business is not primarily buying or selling securities do not have to register with the SEC.
In its opposition to Plaintiffs, the SEC argued that the strict textual language of the Exchange Act does not account for the dramatic increase in securities trading in the internet age, something the Dealer Rule would better address. Ultimately, though, Judge Reed O'Connor of the Northern District of Texas disagreed, finding that both the text of the Exchange Act and the historical use of the word "dealer" meant that the SEC's rule had gone too far. The court found that the SEC's proposed test to determine whether one meets the new definition of dealer appeared nowhere in the statutory text. The court also held, contrary to the SEC's position, that the terms "broker" and "dealer" must be read together, and that the statute does not regulate trading entities without customers as dealers. As a result, Judge O'Connor ordered the rule vacated in both cases.
The SEC can seek to appeal Judge O'Connor's decision, but, given the upcoming changes to the composition of the SEC after the recent presidential election, it remains to be seen whether the SEC will do so.
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