June 11, 2015.
Automated Matching Systems Exchange, LLC (“AMSE”) believes that its proposed business model would qualify it as an exchange. As defined in Section 3(a)(1) of the Securities Exchange Act of 1934 (“Exchange Act” or “Act”), an “exchange” is “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.” 
Under Section 5 of the Act, it is unlawful for an exchange to effect any transaction in a security, or to report such transaction, “unless such exchange (1) is registered as a national securities exchange . . . or (2) is exempted from such registration upon application by the exchange because, in the opinion of the Commission, by reason of the limited volume of transactions effected on such exchange, it is not practicable and not necessary or appropriate in the public interest or for the protection of investors to require such registration.” 
AMSE has chosen the latter option, seeking from the Commission an exemption from registration as a national securities exchange.
After a careful review of the exemption application, however, we have determined to deny it.
Although our review leads us to identify a number of potential issues that might warrant this result (including whether AMSE would even qualify as an exchange),
we find that the application is fatally flawed because AMSE is proposing to possess the broad regulatory powers and responsibilities that are reserved for self-regulatory organizations (“SROs”), while simultaneously seeking exemption from registration as an exchange.
Under the Act, for an exchange to possess the powers and responsibilities of an SRO, it must register as a national securities exchange. An exchange that is exempt from such registration does not meet the definition of an SRO under the Act. Moreover, the Commission has never allowed an exempt exchange to possess the broad range of regulatory powers and responsibilities of an SRO. We believe that doing so here would be contrary to the Act and inconsistent with the public interest and the protection of investors.
A. Procedural History
On July 7, 2014, AMSE filed with the Commission an application seeking a limited volume exemption, under Section 5 of the Act, from the requirement to register as a national securities exchange under Section 6 of the Act.
Notice of AMSE's exemption application was published for comment in the Federal Register on July 29, 2014.
On October 23, 2014, the Commission issued an order instituting proceedings to determine whether to grant or deny AMSE's exemption application.
In that order, the Commission explained that it “is concerned that AMSE's exemption application does not meet a key threshold requirement for being granted an exemption from exchange registration—namely, that the applicant actually be an `exchange' as defined under Section 3(a)(1) of the Exchange Act and Rule 3b-16 thereunder.” 
The Commission specifically identified the fact that “it does not appear that any AMSE system would operate as an exchange by bringing together purchasers and sellers of securities.” 
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On November 10, 2014, AMSE submitted Amendment No. 1 to its exemption application. Notice of Amendment No. 1 to AMSE's exemption application was published for comment in the Federal Register on December 30, 2014.
In the notice, the Commission advised interested parties that it was considering potential “additional grounds for denial.” As the Commission explained, “AMSE's exemption application states that AMSE would operate as a self-regulatory organization that would exercise self-regulatory authority over its members,” 
but under the Act an exempt exchange is not an SRO; thus, “any attempts by AMSE to hold itself out as a self-regulatory organization while simultaneously seeking an exemption under Section 5 would be contrary to the Exchange Act.” 
On February 11, 2015, AMSE submitted Amendment Nos. 2A and 2B, along with a comment letter.
Among other things, Amendments 2A and 2B changed most of the application's references to “self-regulatory organization” to “limited volume exempt regulatory organization.” 
Notwithstanding this change in nomenclature, AMSE did not otherwise modify the accompanying description of the powers and responsibilities it contemplated possessing. In some instances, AMSE continued to refer to itself in terms that pertain only to SROs under the Act or implied that it falls generally within the category of an SRO and would exercise authority as such.
The Commission received thereafter one comment letter from 1st Trade opposing AMSE's exemption application,
to which AMSE subsequently submitted a response.
B. AMSE's Proposed Regulatory Functions
In its exemption application, AMSE proposes that it would operate a marketplace for securities processing.
According to the application, persons seeking to buy or sell securities could only enter their orders through an AMSE member.
And pursuant to AMSE's proposed rules, any person may become a member of AMSE, provided that the person submits an application and complies with any conditions imposed by AMSE.
AMSE proposes a specific application form for broker-dealer firms to become its members.
Although AMSE's application seeks approval as an exempt exchange, its proposal reveals AMSE's aim to exist simultaneously as an SRO. Throughout its exemption application, AMSE refers to itself in terms that pertain only to SROs under the Act. For example, AMSE's exemption application refers to AMSE's rules being filed with the Commission under Section 19(b) of the Act,
which governs the filing of rules by SROs with the Commission.
AMSE's rules also state that its disciplinary decisions and access decisions would be subject to agency review under the Act,
where such review is available only for the activities of SROs under Section 19 of the Act.
AMSE's exemption application also repeatedly implies that it falls generally within the category of an SRO and that it would exercise authority as such.
AMSE also has stated in a comment letter that AMSE “will become a dedicated SRO for securities matching systems. . . .” 
Further, AMSE asserts that its members would hold a status under the Act that is only conferred on members of SROs.
In addition, throughout its exemption application, AMSE proposes to perform regulatory oversight of its members that is consistent with the powers and responsibilities of an SRO.
Start Printed Page 34767Specifically, AMSE proposes to regulate its members with respect to: training, experience, and competence; 
financial responsibility and operational capacity; 
the maintenance of books and records; 
business conduct; 
anti-money laundering compliance programs; 
extension of margin or credit; 
custody of customer funds or securities; 
fraud and manipulation; 
and compliance with broker best execution obligations.
AMSE also proposes to regulate the associated persons of its members and would require each member to establish, maintain, and enforce written supervisory procedures to enable the member to supervise the activities of its associated persons and to ensure their compliance with the securities laws, rules, regulations and statements of policy promulgated thereunder, as well as with AMSE rules.
Moreover, at times AMSE asserts that it is required to perform such functions under the Act,
implying that it will be an SRO, or acting in an equivalent, self-designated capacity it calls a “limited volume exempt regulatory organization.” 
As the 1st Trade Letter observed, AMSE appears to be “attempting to operate with the most lenient regulatory constraints possible and in this attempt are circumventing many accepted practices and regulatory requirements.” 
AMSE also proposes to require its members and their associated persons to agree to be regulated by AMSE and to recognize AMSE as being obligated to enforce their compliance with the Act and regulations thereunder.
AMSE also would require its members and associated persons to recognize AMSE as being required to discipline them for violations of the Act, including through: expulsion; suspension; limitation of activities, functions, and operation; fines; censure; suspension or bar from association with an AMSE member; or any other sanction determined in AMSE's discretion for violations of the Act.
Here again, these are powers and responsibilities exercised by an SRO.
A. AMSE Does Not Appear to Meet the Definition of an “Exchange.”
At the outset, we note that AMSE has urged the Commission to conclude that AMSE should be granted an exemption from exchange registration under the Act. Certain provisions of AMSE's amended application indicate that AMSE's members may operate multiple distinct trading systems, under an AMSE umbrella, while other provisions indicate that AMSE itself would operate the proposed trading systems.
These conflicting provisions make it difficult to ascertain the operation of the trading system. Moreover, the lack of detail and clarity in AMSE's exemption application prevents the Commission from understanding precisely how AMSE proposes to bring together the orders of multiple buyers and sellers and otherwise satisfy the definition of “exchange.” Under these circumstances, we would have grave doubts as to whether AMSE could in fact qualify as an exchange exempt from registration under the Act. We need not reach the merits of this issue, however, because as we describe below AMSE's exemption application suffers from a separate, fatal flaw.
B. It Is Contrary to the Act and Inconsistent With the Public Interest and the Protection of Investors for an Exempt Exchange To Exercise the Powers and Responsibilities of an SRO
Even assuming that AMSE were deemed to be an exchange, the Commission cannot find that AMSE should be granted an exemption from the requirement to register as a national securities exchange under Section 6 of the Act because the Commission believes that AMSE's proposal is inconsistent with the Act.
As described above, AMSE proposes to exercise extensive self-regulatory powers that are reserved under the Act for an SRO—indeed, the bulk of AMSE's rules are devoted to this proposed regulatory function, and at times AMSE even refers to itself as an SRO. But the Act does not afford the powers and responsibilities of an SRO to an exchange that is exempt from registration, nor does it require an exchange that is exempt from registration to exercise such powers and responsibilities.
Section 3(a)(26) of the Act defines an SRO, in pertinent part, as any “national Start Printed Page 34768securities exchange.” 
An entity may only become a “national securities exchange” by registering under Section 6(a) of the Act,
as the Commission has previously explained.
And, although Section 5 of the Act permits an exempt exchange to operate lawfully without registering as a national securities exchange,
an exempt exchange is, by definition, not a national securities exchange,
and, thus, does not fall within the definition of “self-regulatory organization” under the Act. It necessarily follows that, were we to grant AMSE the exemption it seeks, AMSE would not be entitled, much less required by the Act, to hold itself out as an SRO or to exercise the self-regulatory authority that is statutorily afforded to SROs.
Nevertheless, there remains the question whether, in our discretion, we could allow AMSE to exercise the powers and responsibilities of an SRO, notwithstanding the fact that AMSE, as an exempt exchange, would not meet the definition of an SRO. Although the statutory language does not unambiguously forbid such a result, we conclude that we lack the authority under the Act to permit an exempt exchange to exercise the powers and responsibilities reserved for an SRO. In our view, the Act reflects a deliberate balance between, on the one hand, granting SROs the broad, quasi-governmental authority that AMSE proposes to exercise, and, on the other hand, ensuring that an SRO's exercise of this authority is carefully checked by close Commission oversight.
Indeed, we believe this understanding is further supported by a primary Congressional purpose underlying the 1975 amendments to the Act,
through which “Congress specifically and importantly modified [the system of self-regulation in the securities industry] to enhance the SEC's oversight of self-regulatory organizations.” 
As the Senate Report accompanying the 1975 amendments explained, “[t]he SEC is charged with supervising the exercise of this self-regulatory power in order to assure that it is used effectively to fulfill the responsibilities assigned to the self-regulatory agencies, and that it is not used in a manner inimical to the public interest or unfair to private interests.” 
Yet were we to allow AMSE to exercise the powers and responsibilities of an SRO without actually qualifying as such under the Act—i.e., without registering as a national securities exchange—we would be deprived of many of the means that Congress thought were critical for our effective oversight of the exercise of self-regulatory powers. By its express terms, the Act affords us such oversight authority only over an entity that qualifies as an SRO, which AMSE would not have done. Accordingly, if we allowed an exempt exchange to exercise the broad powers and responsibilities of an SRO, we would lack the authority over that exempt entity that we would normally have possessed over SROs to, among other things, “approve or disapprove the proposed rule change[s],” 
“abrogate, add to, [or] delete from” an exchange rule,
review a final disciplinary sanction imposed by the exchange or any denial of access,
“suspend for a period not exceeding twelve months . . . or to censure or impose limitations upon the activities, functions, and operations” of the exchange for specified misconduct,
or “remove from office or censure” any officer or director of the exchange for specified misconduct.
We do not believe that such a result would be consistent with the Congressional desire, as revealed through the statutory language and the legislative history, that the Commission closely oversee the exercise of self-regulatory authority.
This conclusion is consistent with our prior reading of the Act. As the Commission has previously stated, “any system exercising self-regulatory powers, such as regulating its members' or subscribers' conduct when engaged in activities outside of that trading system, must register as an exchange or be operated by a national securities association [which is also an SRO under the statutory definition]. This is because self-regulatory activities in the securities markets must be subject to Commission oversight under Section 19 of the Exchange Act.” 
As we have explained, under our view of the Act, “any system that uses its market power to regulate its participants should be regulated as an SRO.” 
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Accordingly, as we read the Act, an exempt exchange is relieved of the statutory obligations of a registered SRO but also forfeits the ability to exercise the statutory authority of an SRO. To the extent that AMSE desires to perform the extensive range of self-regulatory responsibilities described in its exemption application, it must qualify and register as a national securities exchange (or a national securities association).
In any event, even if we possessed the authority to grant AMSE an exemption notwithstanding its intention to exercise the powers and responsibilities reserved for SROs, we do not believe that doing so would be consistent either with investor protection or the public interest. In our view, when an exchange wants to exercise the broad powers and responsibilities that AMSE is seeking here, an exemption from registration is not appropriate because the Commission would lack sufficient oversight mechanisms to ensure that the self-regulatory authority is not exercised in a manner inimical to the public interest or unfair to private interests. The Commission's oversight responsibilities towards SROs has been a cornerstone of self-regulation from its inception.
Indeed, due to the potential harm to capital formation, investors, and the public interest that could result from the misuse of the securities markets, as noted above, Congress intentionally created a highly regulated environment in which SROs must be subject to close oversight by the Commission. Put simply, an entity seeking to establish and enforce a comprehensive regulatory structure with respect to the securities business of its broker-dealer members—including the full range of business conduct, financial condition, and regulatory compliance matters—could have a substantial impact on the way those members engage in the securities business and comply with the federal securities laws.
In our view, any such entity should be subject to full Commission oversight to assure its performance of such functions is consistent with the protection of investors and the public interest. For these additional reasons, in the exercise of our discretion under Section 5 of the Act, we would deny the exemption application.
Our conclusion today is not inconsistent with prior Commission practice. At the outset, we think it is important to observe that the Commission has rarely exercised its exemptive authority under Section 5—indeed, it has granted a limited volume exemption, as sought by AMSE here, on only two prior occasions in the past 79 years.
And while the Commission imposed certain conditions upon exemptions from exchange registration when it granted them, the exemptions and conditions thereto neither allowed nor required the exercise of the extensive SRO authority that AMSE is seeking.
Moreover, although the Commission acknowledged in the Regulation ATS Adopting Release that an exemption under Section 5 could be available for an exchange that has self-regulatory attributes,
the Commission has never granted an exemption to an exchange seeking to carry out the broad range of self-regulatory functions performed by registered SROs, as proposed by AMSE.
Rather, the Commission has granted an exemption only once to an exchange with “self-regulatory attributes” 
and, in that case, the exchange sought only to impose financial and operational standards as a condition for eligibility Start Printed Page 34770for trading.
The limited self-regulatory attributes in that case stand in stark contrast to the full scope of self-regulatory powers sought by AMSE here.
C. AMSE Is Mistaken in Its Interpretation of the Relevant Procedural Requirements Relating to Its Exemption Application
AMSE has labored under certain misunderstandings of the relevant procedures throughout its interactions with the staff on this matter. To the extent that there is any ambiguity in these procedures, we take this opportunity to provide clarification. AMSE erroneously reads Rule 202.3(b)(2) of the Commission's procedural rules as establishing an enforceable right on the part of AMSE to require the Commission's staff to confer with AMSE. Rule 202.3(b)(2) provides, in relevant part:
Applications for registration as national securities exchanges, or exemption from registration as exchanges by reason of such exchanges' limited volume of transactions filed with the Commission are routed to the Division of Market Regulation, which examines these applications to determine whether all necessary information has been supplied and whether all required financial statements and other documents have been furnished in proper form. . . . The staff confers with applicants and makes suggestions in appropriate cases for amendments and supplemental information. Where it appears appropriate in the public interest and where a basis therefore exists, denial proceedings may be instituted.
AMSE appears to construe the second sentence in the quoted language above to establish a binding obligation on the Commission staff to work with AMSE to achieve Commission approval of its exemption application.
But the rule contains no such requirement; indeed, it does not prescribe any procedure that the Commission staff must follow when working with applicants on applications for registration or exemption from registration. To the contrary, when the rule refers to Commission staff conferring with applicants, it is expressly descriptive, rather than prescriptive, as to the staff's actions. And, critically, it provides only that the staff will “confer with applicants and make suggestions in appropriate cases . . . .” 
The rule thus explicitly leaves it to the staff to identify the situations in which it would be appropriate to confer with applicants.
It certainly does not (as AMSE appears to believe) entitle applicants to obtain guidance from the staff so that the applicants can repeatedly amend their applications before the Commission issues its final order.
In any event, as noted above, Commission staff in fact consulted with AMSE and provided views and input to AMSE about its application.
The Commission has reviewed AMSE's application for a limited volume exemption from registration as a national securities exchange and has determined, for the reasons described above, to deny AMSE's application.
It is therefore ordered, pursuant to Section 5 of the Act, that AMSE's application for an exemption from registration as a national securities exchange be, and hereby is, denied.
By the Commission.
Brent J. Fields,
[FR Doc. 2015-14807 Filed 6-16-15; 8:45 am]
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