An operator of an order and execution management system ("OEMS") that facilitates electronic trading settled SEC charges for failing to register as a broker-dealer. According to the SEC, this is the first ever SEC enforcement action against an OEMS provider for operating without registering as a broker-dealer.

In the Order, the SEC stated that the entity running the platform had been originally registered as a broker-dealer, but withdrew its broker-dealer registration after being acquired by another company. The SEC found that the platform continued to charge its customer-selected broker-dealers with transaction fees. The SEC stated that the platform replicated its authentication database to set up a local server for one of its most active and longstanding customers, suggesting that this may have created a loss of customer privacy.

The SEC concluded that the platform's customers were deprived of the protections derived from regulation over a registered entity, including (i) increased supervision, (ii) written policies and procedures with respect to the protection of customer information and (iii) SEC or other self-regulatory organization inspection or examination. As a result of its findings, the SEC determined that the platform violated Section  15(a) ("Registration of all persons utilizing exchange facilities to effect transactions; exemptions") of the Exchange Act.

To settle the charges, the platform agreed to (i) cease and desist from future violations, (ii) a censure and (iii) a $2.75 million civil money penalty.

In a statement on the outcome of the matter, SEC Commissioner Hester M. Peirce dissented, asserting that the findings were not sufficient to establish a violation under SEA Section  15(a)(1). Ms. Peirce stated that the Order failed to explain how (i) the platform's services effected securities transactions or (ii) how the platform engaged in solicitation of securities transactions. She further criticized the action for providing "little in the way of legal analysis" and failing to assess the platform's OEMS to determine whether it could be considered broker activity. Applying the logic to other data services vendors, Ms. Peirce pointed out that under the Order, internet service providers or vendors providing direct connectivity to a securities exchange could be considered as firms engaged in the business of effecting securities transactions on behalf of others.

Ms. Peirce expressed additional concerns, particularly with respect to the increased weight given to transaction-based compensation as a determinative factor in the action. She stated that the action introduces novel uncertainty with respect to whether OEMS can engage in marketing activities without the SEC determining that such activities constitute solicitation. Ms. Peirce explained that the action will probably lead to potential innovators deciding against entering the securities industry without hiring counsel, spending months communicating with SEC staff and agreeing to inflexible conditions as to their activities.

Commentary Steven Lofchie

It is well-settled law that the receipt of transaction-based compensation related to securities makes a firm a "broker."

In the face of this well-settled law, Ms. Peirce is arguing that while a firm that collects transaction-based compensation is clearly in a "business," that does not mean it is in the business of being a "broker." Whether a firm is a "broker" must depend on the activities that the firm actually conducts. If a firm does not conduct brokerage activities, the manner in which the firm is compensated ought not to require the firm to register as a broker.

The disciplinary finding does not address Commissioner Peirce's legal challenge. The conclusion that the firm is a "broker" is based on the following premises:

  • the firm had been historically registered as a broker (which is true, but says nothing about whether it should have been required to register);
  • the firm charged transaction compensation (which is not disputed, but does not answer the question of whether the firm was engaged in brokerage);
  • the firm was less regulated than a registered broker (which is true, but does not answer the question of whether the firm is required to be registered); and
  • the firm was engaged in marketing its services (which is true, but says nothing about whether those services constituted brokerage).

According to the disciplinary action, the firm was engaged in two activities: (i) providing an order execution and management system and (ii) providing real-time market data. The second activity should not require registration, regardless of the method of compensation. It also is reasonably established that the first activity does not require registration where the provider is paid on a flat-fee basis, rather than on a transaction basis. But if the activity does not require registration, then why should the method of payment be relevant?

Turns out that Commissioner Peirce's questions regarding established assumptions are not easy to answer.

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