The U.S. Securities and Exchange Commission has proposed to amend Rule 3b-16 under the Securities Exchange Act of 1934 to expand the definition of “exchange” in a way that could be an effort by the Commission to try to make it easier for the Commission to argue that cryptocurrency exchange platforms, decentralized exchanges, and even developers must register as alternative trading systems or exchanges. See Exchange Act Release No. 94,062 (Jan. 22, 2022).

Section 3(a)(1) of the Exchange Act defines the term “exchange” to mean “any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange.” The Commission adopted Rule 3b-16 to define and elaborate on terms used in the statutory definition of “exchange” contained in Section 3(a)(1).

Rule 3b-16 currently states that an organization, association, or group of persons shall be considered to constitute, maintain, or provide “a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange” if they:

1. bring together the orders for securities of multiple buyers and sellers; and
2. use established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.

The Commission proposes to expand Rule 3b-16 to treat any system performing the function of a market place as an “exchange” by, inter alia, including in the definition what it calls “Communication Protocol Systems.” Of interest here, some developers and platforms that operate in the digital asset space could be viewed as falling within the proposed definition of “Communication Protocol Systems.” 

How does this affect you? Although the Commission’s proposal contains no references to cryptocurrency, blockchain or decentralized finance, the proposed amendment of Rule 3b-16 could have far reaching consequences for the broader network of ecosystem participants who could be required to register as alternative trading systems or exchanges. Our team works with participants across the industry--from issuers, to exchanges, to developers, to markets--to provide clear assessments that help our clients address risk and take advantage of opportunities. Contact us here.

What you should do: The Commission is seeking public comment until February 26,2022 on the proposal and is required to take such comments into account in determining whether or not to adopt the proposal into law. Crypto and blockchain industry participants should let the Commission know that without a reasoned basis, practical guidance or timelines to allow for compliance, this proposal could cause significant confusion in the industry. Our team can help you assess the impact of this rule on your business and customers. Contact us here.

The proposed amendments could be challenged under Section 25 of the Exchange Act in a United States Court of Appeals on the basis that the Commission lacked statutory authority to engage in this rulemaking at all, did not adequately address the evidence before it, or otherwise acted “arbitrarily and capriciously” under the Administrative Procedure Act. We are working with other industry participants and groups to assess the validity of the proposed rule and the bases under which it can be challenged. We can help you develop a strategy to help protect and preserve your business model. Contact us here.