SEC Proposed Amendments Could Significantly Impact DeFi Companies — Corporate/Commercial Law

The U.S. Secu­ri­ties and Exchange Com­mis­sion (SEC) recently 
issued pro­posed amend­ments to the Secu­ri­ties Exchange Act ¹ (the “Exchange Act”) that 
would sig­nif­i­cant­ly broad­en the def­i­n­i­tion of “exchange”
for pur­pos­es of reg­u­la­tion under the Exchange Act (“Pro­posed
Rule”).² Designed to address a 
“reg­u­la­to­ry gap,“³ the 
Pro­posed Rule would cov­er “plat­forms for all kinds of asset 
class­es that bring togeth­er buy­ers and sell­ers.“⁴ Under the Pro­posed Rule, 
com­mu­ni­ca­tion pro­to­col systems—trading sys­tems that offer the 
use of non-firm trad­ing inter­est and pro­vide pro­to­cols to bring 
togeth­er buy­ers and sell­ers of securities—would have to 
reg­is­ter with the SEC as an exchange unless oth­er­wise exempt.⁵ As we pre­vi­ous­ly report­ed, this amend­ment, if passed, likely 
would have a sig­nif­i­cant impact on the decen­tral­ized finance 
(“defi”) industry.

Cur­rent Def­i­n­i­tion of “Exchange”

Sec­tion 3(a)(1) of the Exchange Act defines an 
“exchange” as “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.“⁶

The Exchange Act pro­vides a two-step test to assess whether a 
trad­ing sys­tem meets the def­i­n­i­tion of an exchange:

• does the sys­tem bring togeth­er the orders for secu­ri­ties of 
  mul­ti­ple buy­ers and sell­ers; and




• does the sys­tem 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 the trade.⁷

“Non-dis­cre­tionary meth­ods” means the platform 
“does not exer­cise any dis­cre­tion in the match­ing of buyers 
and sell­ers or their orders and buy­ers and sell­ers par­tic­i­pat­ing on 
an exchange can use their own dis­cre­tion in find­ing and select­ing a 
coun­ter­par­ty.“⁸
“Order” means “any firm indi­ca­tion of a willingness 
to buy or sell a secu­ri­ty, as either prin­ci­pal or agent, including 
any bid or offer quo­ta­tion, mar­ket order, lim­it order, or other 
priced order.“⁹

Pro­posed Rule

The pro­posed amend­ments would, among oth­ers, include 
“trad­ing inter­est”, i.e., non-firm indi­ca­tions of a 
will­ing­ness to buy or sell a secu­ri­ty, in addi­tion to orders, 
with­in the inter­pre­ta­tion, swap “uses” for “makes
avail­able,” and add “com­mu­ni­ca­tion pro­to­cols” as an 
estab­lished method for bring­ing togeth­er buy­ers and sell­ers of 
secu­ri­ties.¹⁰

Accord­ing­ly, the Pro­posed Rule would amend the two-part test of 
Exchange Act Rule 3b-16 to pro­vide that an organization, 
asso­ci­a­tion, or group of per­sons would be con­sid­ered to constitute, 
main­tain, or pro­vide an exchange if (A) it is not sub­ject to an 
excep­tion under Rule 3b-16(b) and (B) it:

• brings togeth­er buy­ers and sell­ers of secu­ri­ties using 
  trad­ing inter­est; and




• makes avail­able estab­lished, non-dis­cre­tionary methods 
  (whether by pro­vid­ing a trad­ing facil­i­ty or com­mu­ni­ca­tion
  pro­to­cols, or by set­ting rules) under which buy­ers and sellers 
  can inter­act and agree to the terms of a trade (empha­sis added).¹¹

The three ital­i­cized terms above sig­nif­i­cant­ly broad­en the 
def­i­n­i­tion of an exchange. First, the term “trad­ing
interest” includes both “orders” and any 
“non-firm indi­ca­tion of a will­ing­ness to buy or sell a 
secu­ri­ty that iden­ti­fies at least the secu­ri­ty and either
quan­ti­ty, direc­tion (buy or sell), or price” (empha­sis
added).¹² This means that trading 
inter­est could be as sim­ple as, “I am look­ing to buy token 
X”, with­out even men­tion­ing the price or quan­ti­ty of token X 
you want to buy.

Sec­ond, the term “makes avail­able” is
designed to cap­ture estab­lished, non-dis­cre­tionary meth­ods that a 
plat­form pro­vides, either direct­ly or indi­rect­ly, for
buy­ers and sell­ers to inter­act and agree upon terms of a trade. ¹³ This means that, if a platform 
out­sources a func­tion of an exchange to a third par­ty, or provides 
a means to access and com­mu­ni­cate with oth­er buy­ers and sellers, 
the plat­form would still be con­sid­ered an exchange under Rule 
3b-16.¹⁴

Third, the term “com­mu­ni­ca­tion pro­to­cols”
would cov­er “[s]ystems that bring togeth­er buy­ers and sellers 
of secu­ri­ties [that] func­tion as exchange mar­ket places of 
secu­ri­ties with­out orders or a trad­ing facil­i­ty for orders to 
inter­act.“¹⁵ The term 
“com­mu­ni­ca­tion pro­to­cols” applies to “tech­nolo­gies
and con­nec­tiv­i­ty” that “gen­er­al­ly use non-firm trading 
inter­est as opposed to orders to prompt and guide buy­ers and 
sell­ers to com­mu­ni­cate, nego­ti­ate, and agree to the terms of the 
trade.” ¹⁶ For exam­ple, a 
plat­form that pro­vides a chat fea­ture that requires certain 
infor­ma­tion to be includ­ed in a chat mes­sage (e.g., price,
quan­ti­ty) and sets para­me­ters and struc­ture for users to 
com­mu­ni­cate about buy­ing and sell­ing secu­ri­ties “would have 
estab­lished com­mu­ni­ca­tion pro­to­cols.“¹⁷ Even if the com­mu­ni­ca­tion protocol 
sys­tem itself does not match coun­ter­par­ties’ trad­ing interests, 
if it pro­vides the plat­form where buy­ers and sell­ers are brought 
togeth­er to “inter­act … and agree to the terms of the 
trade,” the SEC would deem this an exchange under the Proposed 
Rule.¹⁸

As pro­posed, the SEC would take an “expan­sive view” of 
what would con­sti­tute “com­mu­ni­ca­tion pro­to­cols” with­in a 
sys­tem, including:

• set­ting min­i­mum cri­te­ria for what mes­sages must contain;




• set­ting time peri­ods under which buy­ers and sell­ers must 
  respond to messages;




• restrict­ing the num­ber of per­sons a mes­sage can be sent 
  to;




• lim­it­ing the types of secu­ri­ties about which buy­ers and sellers 
  can communicate;




• set­ting min­i­mums on the size of the trad­ing inter­est to be 
  nego­ti­at­ed; or




• orga­niz­ing the pre­sen­ta­tion of trad­ing inter­est, whether firm 
  or non-firm, to par­tic­i­pants.¹9

On the oth­er hand, the Pro­posed Rule would specif­i­cal­ly exclude 
“sys­tems that only pro­vide gen­er­al con­nec­tiv­i­ty for per­sons to 
com­mu­ni­cate with­out pro­to­cols, such as util­i­ties or elec­tron­ic web 
chat providers … because such providers are not specifically 
designed to bring togeth­er buy­ers and sell­er of secu­ri­ties or 
pro­vide pro­ce­dures or para­me­ters for buy­ers and sell­ers for 
secu­ri­ties to inter­act.“²²
Accord­ing to the SEC, cov­ered “com­mu­ni­ca­tions protocols” 
would not include sys­tems that pas­sive­ly dis­play trad­ing interest, 
such as indus­try “bul­letin boards,” but do not provide 
means for buy­ers and sell­ers to con­tact each oth­er and agree to the 
terms of the trade on the sys­tem.²⁰ Nor would they include a system 
that dis­plays trad­ing inter­est but no trad­ing facil­i­ty to match 
orders or pro­to­cols for par­tic­i­pants to com­mu­ni­cate and interact 
because such sys­tem “would not be con­sid­ered to be making 
avail­able estab­lished, non-dis­cre­tionary meth­ods.“²¹

Poten­tial Impacts on DeFi Companies

Although not specif­i­cal­ly called out in the Pro­posed Rule, the 
amend­ments are broad enough to include defi plat­forms and 
cryp­tocur­ren­cy exchanges. For exam­ple, the tran­si­tion from 
“uses” to “makes avail­able” would arguably 
encap­su­late plat­forms using blockchain tech­nol­o­gy and soft­ware to 
effec­tu­ate trans­ac­tions on a blockchain (e.g. smart 
con­tracts, min­ers, val­ida­tors), and even com­pa­nies that merely 
pro­vide the plat­form on which buy­ers and sell­ers of 
cryp­tocur­ren­cies can con­nect and trade amongst themselves.

Com­pa­nies that met the new def­i­n­i­tion would then be required to 
reg­is­ter with the SEC either as an exchange or, more like­ly, as an 
alter­na­tive trad­ing sys­tem (“ATS”). Both would require 
the com­pa­ny to adopt and main­tain a suite of com­pli­ance programs 
cov­er­ing dis­clo­sure oblig­a­tions, trade report­ing, anti-financial 
crimes and sus­pi­cious activ­i­ty report­ing, as well as passing 
qual­i­fi­ca­tion exams.

The SEC has rec­og­nized that, if adopt­ed, com­pli­ance with the 
Pro­posed Rule would be a sig­nif­i­cant under­tak­ing for unregistered 
exchanges. The SEC would grant cov­ered exchanges a grace period, 
dur­ing which they can oper­ate pro­vi­sion­al­ly until the ear­li­er of 
either: (1) the date the enti­ty reg­is­ters as a bro­ker-deal­er and 
becomes a mem­ber of a nation­al secu­ri­ties asso­ci­a­tion, or (2) 210 
cal­en­dar days after the effec­tive date of any final rule.²³ The pro­posed 210 cal­en­dar day 
tran­si­tion peri­od would pro­vide time for a cov­ered enti­ty to submit 
its bro­ker-deal­er reg­is­tra­tion appli­ca­tion, for FINRA to conduct 
its review of the appli­ca­tion, and for the enti­ty to otherwise 
com­ply with the nec­es­sary bro­ker-deal­er reg­is­tra­tion requirements 
under Reg­u­la­tion ATS with­out dis­rupt­ing its mar­ket or its 
par­tic­i­pants.²⁴

The notice and com­ment peri­od for the Pro­posed Rule is set to 
expire on Feb­ru­ary 25, 30 days after pub­li­ca­tion in the Federal 
Reg­is­ter. Giv­en the heft of the rule (over 650 pages) and critiques 
by some com­men­ta­tors, includ­ing SEC Com­mis­sion­er Peirce, fault­ing the SEC for 
set­ting an unrea­son­able dead­line to respond to over 220 unique 
com­ment requests, this peri­od may be extend­ed fur­ther. Once the SEC 
has reviewed ini­tial com­ments, it may reopen the peri­od and request 
addi­tion­al com­ments, which would fur­ther extend the process. Once 
all com­ments are received, the SEC will review and incor­po­rate the 
com­ments into the pro­posed rule, as it deems appro­pri­ate. Once 
sat­is­fied, the SEC will pub­lish the final rule, which would become 
effec­tive 30 days after pub­li­ca­tion in the Fed­er­al Reg­is­ter. In 
this case, it is unlike­ly the SEC would pub­lish a final rule before 
Octo­ber 2022, if then.

Foot­notes

1. 15 U.S. Code §§ 
78a-78qq.

2. U.S. Secu­ri­ties and Exchange 
Com­mis­sion, “Amend­ments to Exchange Act Rule 3b-16 Regarding 
the Def­i­n­i­tion of “Exchange,” Jan. 26, 2022, https://www.sec.gov/rules/proposed/2022/34–94062.pdf
(“Pro­posed Rule”).

3. U.S. Secu­ri­ties and Exchange 
Com­mis­sion, “Investor Pro­tec­tions in Com­mu­ni­ca­tion Protocol 
Sys­tems and ATSs,” Fact Sheet, 34–94062-fact-sheet.pdf (sec.gov).

4. See SEC Chair Gary 
Gensler, “State­ment on Gov­ern­ment Secu­ri­ties Alternative 
Trad­ing Sys­tems,” Jan. 26, 2022, https://www.sec.gov/news/statement/gensler-ats-20220126.

5. See Pro­posed Rule at 
33.

6. 15 U.S. Code § 
78c(a)(1).

7. 17 CFR § 
240.3b-16(a).

8. See Pro­posed Rule at 
42.

9. 17 CFR § 
240.3b-16©.

10. Pro­posed Rule at 
34.

11. Id.

12. Id.

13. Id. at 
42.

14. Id. at 
40.

15. Id. at 
43.

16. Id.

17. Id. at 
34.

18. Id. at 
35.

19. Id. at 
44.

22. Id. at 
46.

20. Id. at 
45.

21. Id.

23. Id. at 
60.

24. Id.

The con­tent of this arti­cle is intend­ed to pro­vide a general 
guide to the sub­ject mat­ter. Spe­cial­ist advice should be sought 
about your spe­cif­ic circumstances.