The Securities and Exchange Commission’s (SEC or the Commission) Division of Trading and Markets yesterday released a Staff statement (the Statement) outlining conditions under which providers of certain crypto asset securities user interfaces may operate without registering as broker-dealers under Section 15(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act). The Statement reflects Commission Staff’s views as an interim measure while the Commission considers broader regulatory issues and, absent further action, will automatically be considered withdrawn five years after its release date. Commissioner Hester M. Peirce issued a statement, rightly observing that the Statement requires the Commission to “confront its inner demons” on evaluating what constitutes being a “broker” under the Exchange Act.
The Statement is the latest in a string of federal regulatory developments aimed at reconciling crypto industry practices within the existing securities (and derivatives) regulatory framework. Last month, the SEC and Commodity Futures Trading Commission (CFTC) issued joint guidance addressing the status of certain crypto assets under the federal securities and commodities laws,[1] and the CFTC granted no-action relief allowing a crypto wallet technology service vendor to facilitate user access to derivatives markets without registering as an introducing broker.[2] Together, these steps reflect a push by federal regulators to create workable paths for technology providers that connect users to crypto markets without full intermediary registration.
What Is a ‘Covered User Interface’?
The Statement focuses on what it calls “Covered User Interfaces,” used in connection with user-initiated crypto asset securities transactions on blockchain protocols or blockchain-based smart contracts. These are interfaces provided by websites, browser extensions, or other software applications (including mobile applications) that may be embedded in a self-custodial wallet or be available for download separately.
In practice, these Covered User Interfaces convert a user’s chosen transaction parameters (such as buy or sell, volume, crypto asset security, and price) into blockchain-legible commands for signature and transmission through the user’s self-custodial wallet. They facilitate these user-initiated transactions but, under the Staff’s framework, are not themselves permitted to exercise discretion over the user’s trading decisions. They may also provide users with market data, including potential execution routes, asset prices, and estimated transaction costs. The emphasis throughout is on the Covered User Interface as a user-driven tool, one that allows users to set their own parameters, obtain and evaluate their own data, and make their own decisions as a result, including choosing their own execution paths. The concept bears some resemblance to long-standing no-action relief from investment adviser registration for technology platforms that allow investors to independently sort through and analyze readily available market data that is not highly selective.[3]
Key Conditions for Operating Without Registration
The Staff’s position is that it will not object, for purposes of Section 15(a) of the Exchange Act, to a Covered User Interface operating without registering as a broker-dealer, provided the provider satisfies a detailed set of conditions. Among the most significant of these conditions is that, the Covered User Interface must (i) permit users to customize any default transaction parameters; and (ii) provide educational materials on setting their desired parameters. The provider of the Covered User Interface must refrain from soliciting investors to engage in any specific crypto asset securities transactions.
With respect to execution routing, if only one potential execution route is displayed, the Covered User Interface must give the user the ability to view additional routes. Where multiple routes are displayed, the Covered User Interface must offer filtering or sorting tools based on objective, pre-disclosed factors, such as alphabetical order, lowest or highest price, or speed. The Covered User Interface may not provide commentary on execution routes, such as labeling a particular route as offering the “best price” or being the “most reliable.” Again, the focus is on the user making their own decisions based on objectively presented information.
The compensation that the provider of the Covered User Interface must be limited to a fixed charge to the user, which may be a flat fee or a percentage of the transaction; however, it must be product-, execution route-, execution venue-, and counterparty-agnostic. Presumably, this is the Staff’s attempt to separate the Covered User Interface Provider’s activity from the “engaged in the business of effecting transactions” prong of the definition of a “broker” under the Exchange Act.[4]
The Statement also imposes detailed disclosure obligations on the provider of the Covered User Interface. Specifically, the provider must disclose prominently to users all material facts related to its role, fees, material conflicts of interest, limitations of the interface, cybersecurity policies, and the parameters used in its software for preparing trading instructions and displaying market data. The provider must also disclose any affiliations with trading venues or distributed ledger trading systems and must interact with affiliated venues on the same terms and conditions as any unaffiliated interface.
What Falls Outside the Statement
The Staff made clear that its position does not extend to Covered User Interface providers that engage in certain activities with respect to securities, including negotiating transaction terms, making investment recommendations, providing advice, arranging financing, holding or accessing user funds or securities (including stablecoins used to settle transactions), executing or settling transactions, taking or routing orders or otherwise arranging or effecting securities transactions. Providers of custodial wallets with an associated Covered User Interface are also outside the scope of the Staff’s non-objection position. In some ways, this is similar to restrictions on extending credit or custodying securities in the former M&A Brokers No-Action letter, now codified in the Exchange Act.[5]
It is important to note that the Statement is not a rule or regulation and does not carry the force of law. It reflects only the views of the Division of Trading and Markets Staff and does not bind the Commission or the courts. The Staff has invited public comments on all aspects of the Statement. Commissioner Peirce has reiterated the need for “public feedback to inform future rulemaking to assess terms like ‘broker’ against the backdrop of new technologies.”
Questions Worth Watching
The Statement raises at least two questions that market participants should keep in mind. First, the five-year sunset is notable. The Staff has created what amounts to a temporary regulatory framework, but it has done so outside the formal rulemaking process. That is likely to invite the familiar criticism from some commentators that a Staff statement of this scope constitutes de facto rulemaking without complying with the Administrative Procedures Act.
Second, there is a conceptual tension at the heart of the Statement. The SEC has consistently treated crypto asset securities as securities. If that is the case, it is fair to ask why this relief is expressly limited to interfaces that facilitate transactions in crypto asset securities and does not extend to interfaces that facilitate transactions in traditional, non-crypto securities under comparable conditions. Commissioner Peirce addressed this concern head-on, asking the Commission to “address its inner demons” across all aspects of the “broker” definition, not just its application to crypto asset securities.
Firms and individuals operating or developing crypto asset securities interfaces should review the Statement carefully to assess how it may apply to their business activities. Our team is available to discuss its implications.
[1] See Katten’s coverage of the joint guidance here.
[2] See Katten’s coverage of the CFTC’s no-action relief here.
[4] Section 3(a)(4)(A) of the Exchange Act provides that “[t]he term ‘broker’ means any person engaged in the business of effecting transactions in securities for the account of others.” See 15 U.S.C. § 78c(a)(4)(A).
[5] See 15 U.S.C. § 78o(b)(13).
