Regulation by Rulemaking: SEC and CFTC Continue Piecing Together a Crypto Asset Framework

On September 15, the U.S. Senate held a failed cloture vote on the Digital Asset Market Clarity Act (Clarity Act), the bipartisan bill that sought to establish a comprehensive federal regulatory framework for digital assets under the jurisdiction of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Shortly after the Clarity Act failed to advance, the SEC released an order granting the Innovation Exemption, while the CFTC issued an industry no-action letter providing exemptive relief for certain software providers. In addition, the SEC issued a series of no-action letters, supported by Lowenstein Sandler (see Lowenstein Sandler’s client alert here), giving much-needed exemptive relief from technical and operational requirements for broker-dealers with respect to cash balance transfers between accounts maintained by different regulated entities.

The industry expects to see more rulemaking and actions taken by both regulators in the upcoming weeks, as together these actions signal that the agencies intend to advance workable rules of the road for digital asset market participants through their existing administrative authority, even as comprehensive legislation remains stalled in Congress. Lowenstein Sandler will continue to monitor these actions and update the industry accordingly.

Background

On September 17, as a continuation of the SEC’s Project Crypto initiative launched by SEC Chairman Paul S. Atkins in July 2025, the SEC issued an order under Section 36(a)(1) of the Exchange Act granting exemptive relief for participants facilitating permissioned trading of tokenized NMS Stocks through AMMs and Liquidity Pools on permissionless distributed ledgers.

In the order, the SEC acknowledged that existing market-structure rules may not accommodate AMM Liquidity Pool models without forcing the implementation of burdensome changes to business models. In particular, the order discusses potential challenges under Regulation NMS Rule 611’s order-protection framework, Rule 602(a)’s quotation requirements, and Rule 612’s minimum pricing increments. Against that backdrop, the Innovation Exemption establishes a limited environment for testing blockchain-based trading while the SEC evaluates whether broader regulatory changes are appropriate. The SEC highlighted potential benefits, including self-custody, around-the-clock trading, fractional share ownership, near-instantaneous settlement, improved auditability, greater transparency, and lower operating and transaction costs.

Scope and Key Definitions

• Tokenized NMS Stock: An NMS Stock that is tokenized either by or on behalf of the issuer of the underlying NMS Stock or by an unaffiliated third party (Tokenized NMS Stock). Tokenized NMS Stocks do not include tokenized securities that provide indirect economic exposure to an underlying NMS Stock, such as a tokenized linked security or tokenized security-based swap.
• AMM Liquidity Pool: An AMM and Liquidity Pool structure in which smart contracts automate pricing and execution based on the assets committed to a Liquidity P Access to trading under the Innovation Exemption is permissioned even though the relevant smart contracts must be deployed on a public, permissionless distributed ledger.
• TSV: A TSV is an organization, association, or group of persons that brings together buyers and sellers of Tokenized NMS Stock by providing one or more AMM Liquidity Pools in which permissioned participants interact and agree to trade terms and by setting access standards. Participants may include retail investors, institutional investors, broker-dealers, and other market participants.
• Covered Firm: Under the Covered Firm Exemption, a “Covered Firm” is a liquidity provider that supplies Tokenized NMS Stock to an AMM Liquidity Pool using proprietary capital and may engage in additional activity indicative of dealing, such as quoting prices or agreeing to provide committed capital.
  
  

The TSV Exemption

A TSV that satisfies all conditions of the TSV Exemption is exempt for five years from the Exchange Act definition of “exchange.” As a result, a TSV is not treated as a trading center or market center under Regulation NMS, and Regulation NMS rules applicable to those entities do not apply to the TSV. Notably, the exemption is activity-specific, not applicable to an entity as a whole. An otherwise registered entity (e.g., an exchange) may operate a TSV through a separate affiliate, but registered activity must remain separate, and securities activities conducted outside the TSV are subject to the registration provisions and other federal securities law obligations under the Exchange Act.

Core Conditions for TSVs

• Public, auditable infrastructure and U.S. nexus. Smart contracts used by a TSV must be auditable, public, and deployed on a public, permissionless distributed ledger. Additionally, a TSV must be a U.S. person subject to applicable U.S. economic and trade sanctions requirements, including Office of Foreign Assets Control administered programs.
• Public notice and ongoing updates. At least 30 calendar days before operating, a TSV must prominently publish a plain-English notice on its public website. Within one business day after publication, it must notify the SEC in writing. The notice must address, among other things, organizational structure, permissioning and participant verification, trading procedures and pricing, fees and incentives, risks, systems safeguards, clearing and settlement, complaints and disputes, affiliated activity, and the assets available for trading. Material operational changes generally require 20 calendar days’ advance notice.
• Issuer notice and objection. Before trading Tokenized NMS Stock created by an unaffiliated third party, a TSV must provide written notice to the issuer of the underlying NMS S Trading cannot begin until at least 30 calendar days after the issuer receives notice. If the issuer objects in writing within the 30-day window, a TSV cannot make the NMS Stock available for trading and must update its public notice within five business days.
• No primary issuance; equivalent rights. A TSV may not host a primary issuance or initial offering. Offers and sales must be registered under the Securities Act or qualify for an exemption. A TSV also must verify that the tokenized security carries the same rights and privileges as the equivalent traditional class, including economic, voting, dividend, liquidation, and communication rights, as applicable.
• Symbol and volume limits. Tier 1 Tokenized NMS Stock (i.e., S&P 500 and Russell 1000 components and certain eligible exchange-traded products under the Limit Up-Limit Down Plan) is capped at 75 symbols and 0.25 percent of the relevant stock’s prior-month average daily share volume. Tier 2 (i.e., other eligible NMS Stocks) is capped at 250 symbols and 2.5 percent. Symbol counts and volume must be aggregated with affiliated TSVs.
• Stepped response to volume breaches. The first volume-threshold breach in a particular Tokenized NMS Stock requires no remedial action other than future compliance. Each subsequent breach requires a TSV and its affiliated TSVs to pause trading in that stock immediately for three months, notify participants immediately, and amend the public notice within five business days.
• Transaction transparency. A TSV must make U.S. dollar-denominated transaction data for the prior 30 days freely and publicly available in machine-readable form and update it within 10 minutes after each transaction. Required data include the traded pair, price, size, time, direction, AMM Liquidity Pool and smart contract information, daily pair volume, and end-of-day pool size.
• Trading stoppages. Trading in Tokenized NMS Stock must stop concurrently with any halt or suspension of the underlying NMS Stock on its primary listing exchange. A TSV must immediately notify participants of the stoppage and of a discretionary decision by the TSV to cease trading the stock.
• Operational-event reporting. A TSV must immediately notify participants and promptly notify the SEC of a significant operational event, including a material systems disruption or intrusion. It must remediate known significant operational events as soon as reasonably practicable and notify participants of remediation measures.
• No leverage. A TSV may not borrow securities or non-security crypto assets on the venue, hypothecate or permit hypothecation of those assets, or extend credit to a participant to purchase Tokenized NMS Stock.
• Registration disclaimer. A TSV may not suggest that it is SEC-registered or that its activities are SEC-approved or endorsed. Its public notice must affirmatively state that the TSV is not registered with the SEC.
• Books, records, and examination. The TSV must create and maintain detailed records regarding trading, permissioning and wallet verification, fees and compensation, pauses and stoppages, volume, operational events, and required notices. Records must be maintained in the United States throughout the exemption and for three years afterward, be available in human-readable and reasonably usable electronic form, and be open to SEC staff examination at any time.
• The TSV Exemption generally is unavailable if an organization, association, or person within the TSV group is subject to statutory disqualification under Section 3(a)(39) of the Exchange Act, absent specified SEC or self-regulatory organization permission.
  
  

The Covered Firm Exemption

The Covered Firm Exemption provides parallel five-year relief from the Exchange Act definition of “dealer” for qualifying proprietary liquidity providers. Section 3(a)(5) of the Exchange Act defines “dealer” to mean “any person engaged in the business of buying and selling securities ... for such person’s own account through a broker or otherwise,” but excludes “a person that buys or sells securities ... for such person’s own account, either individually or in a fiduciary capacity, but not as a part of a regular

business.” The SEC emphasized that liquidity provision alone does not necessarily constitute dealer activity. The Covered Firm Exemption is intended to address uncertainty where a provider also engages in activities indicative of dealing, such as customer pricing or committed-capital arrangements.

Conditions for Covered Firms

• Limited securities activity. A Covered Firm’s securities activities under the Covered Firm Exemption must be limited to trading Tokenized NMS Stock in an AMM Liquidity Pool operating pursuant to the TSV Exemption. A Covered Firm may participate on more than one qualifying TSV, and the relief does not limit non-securities activity.
• Proprietary activity only. A Covered Firm must provide liquidity solely for its own account and may not hold or custody customer assets.
• A Covered Firm must retain records concerning its capacity to maintain sufficient liquid assets against potential trading losses, liquidity supplied, agreements or understandings with TSVs, and fees, rebates, tokens, or other compensation associated with liquidity provision.
• Website disclosures. On any public-facing website, a Covered Firm must prominently disclose that it is not SEC-registered as a broker-dealer, that it may enter into liquidity provision or market-making arrangements with a TSV, and that it may receive fees, tokens, or other incentives.
• SEC notice and oversight. A Covered Firm must notify the SEC in writing of its role and provide specified information regarding its identity, business model, risk controls, regulatory contact, liquidity arrangements, and compensation. It also must acknowledge the absence of applicable statutory disqualification, consent to SEC information requests, and acknowledge that inconsistent operation may lead to enforcement action.
• The Covered Firm Exemption is unavailable if the Covered Firm or an affiliate is subject to statutory disqualification under Section 3(a)(39), subject to the limited permission described in the order.
  
  

Continuing Requirements and Regulatory Gaps

The Innovation Exemption is targeted relief, not a comprehensive tokenized securities regime. The Innovation Exemption does not exempt offers or sales from Securities Act registration, provide Investment Company Act relief, or determine the regulatory status of TSV participants. Depending on their activities, participants may remain subject to SEC and self-regulatory organization registration and rules, transaction reporting requirements, and AML/CFT obligations.

CFTC Expanded No-Action Relief for Passive Software Providers

In parallel with the SEC’s Innovation Exemption, the CFTC’s Market Participants Division issued Staff Letter No. 26-25 on September 17, expanding the no-action position originally granted to Phantom Technologies Inc. in Letter 26-09 (dated March 17, 2026) to all similarly situated PSPs. The expanded relief provides relief from the registration obligations of software developers whose applications passively enable users to trade CFTC-regulated derivatives products, including through self-custodial crypto asset wallet software. The substantive conditions of the expanded relief are substantially similar to those in the previous limited no-action, with the sole exception that this relief added a provision (in footnote 23) acknowledging that some PSPs may be affiliated with a state or tribal government and therefore are protected by sovereign immunity.

Under the expanded no-action position, the Market Participants Division confirmed it will not recommend enforcement action against a PSP for failure to register as an IB under Section 4d(g) of the Commodity Exchange Act or against PSP personnel involved in soliciting users (and supervisors thereof) for failure to register as APs under Section 4k(1) solely as a result of engaging in “Covered Activities.” These Covered Activities include developing and distributing front-end interface software that enables users to review market data, view product offerings, and submit orders for CFTC-regulated derivatives directly to registered futures commission merchants (FCMs), IBs, or designated contract markets (DCMs). Critically, the PSP’s involvement must remain passive. At no point may the PSP hold or custody user assets, generate express buy or sell signals, or exercise discretion over order routing or execution. The no-action relief is conditioned on several requirements, including that the PSP and its principals are not subject to statutory disqualification, that users are onboarded directly as customers of registered entities, that the PSP adopts compliance policies consistent with applicable CFTC and NFA rules regarding communications with the public, that each PSP and its collaborating registrants execute joint-and-several liability undertakings, that each PSP consents to CFTC jurisdiction, and that the PSP maintains records regarding its compliance and regulated activities consistent with CFTC Regulation 1.31. The relief applies until the effective date of any future CFTC rulemaking or guidance addressing the IB registration requirement for software developers.

Practical Takeaways

• Build out the notice and disclosure packages. In light of the Innovation Exemption’s extensive notice and disclosure requirements, entities seeking to operate as a TSV or Covered Firm should begin preparing their respective notice and disclosures immediately. For prospective TSVs, the 30-calendar day advance notice requirement before commencing operations means that any delay in drafting and publishing the required public notice directly postpones the date on which the TSV can begin trading Tokenized NMS Stock. Given the breadth of the required disclosures, which span more than 30 categories covering everything from AMM Liquidity Pool trading procedures and pricing models to smart contract addresses, systems safeguards, risk disclosures, and permissioning criteria, the preparation of a compliant notice will require substantial coordination across legal, technical, compliance, and operations teams. Similarly, Covered Firms should promptly prepare their written notifications to the SEC and public-facing website disclosures, including descriptions of their business models, risk controls, liquidity provision arrangements, and compensation structures. Entities should also establish processes for the ongoing notice revision obligations, which require updated disclosures on timelines as short as five business days for certain triggering events. Proactive preparation of these materials will help ensure that TSVs and Covered Firms are positioned to commence operations as expeditiously as possible once the Innovation Exemption’s conditions are met.
• Issuer engagement as a gating workstream. For third-party tokenized stock, proof of delivery, the 30-day waiting period, objection intake, and public-notice updates should be embedded into asset-onboarding controls. Commercial or technical readiness cannot override a timely issuer objection.
• Design surveillance around aggregated limits. Real-time or near-real-time controls should aggregate symbols and volume across affiliated TSVs and distinguish the one-time volume grace from strict symbol limits and subsequent three-month pauses. Firms should also model how a pause affects pool withdrawals, liquidity-provider obligations, participant communications, and orderly resumption.
• Separate exempt and regulated activities. The relief does not extend beyond the qualifying TSV or Covered Firm activity. Broker-dealers, affiliates, custodians, transfer agents, and other regulated entities should document legal-entity boundaries, information flows, shared systems, customer touchpoints, and the basis for each entity’s registration posture.
• Custody and operational risks. Self-custody may benefit investors, but wallet permissioning, sanctions screening, smart-contract governance, cybersecurity, incident response, trade-halting logic, and equivalent shareholder-rights delivery remain substantial implementation challenges. Covered Firms must avoid customer custody altogether.
• Broker-dealer role remains uncertain. The Innovation Exemption does not definitively resolve the role of broker-dealers in Tokenized NMS Stock trading on TSVs. However, the structure of the relief—particularly the TSV Exemption from the “exchange” definition and the Covered Firm Exemption from the “dealer” definition—suggests that the SEC envisions a framework in which AMM Liquidity Pools may facilitate trading without requiring traditional broker-dealer intermediation.
• AML/KYC compliance burden on AMMs. The Innovation Exemption does not relieve TSVs or their participants of anti-money laundering and know-your-customer (AML/KYC) obligations, which remain fully applicable under existing law. Implementing effective AML/KYC programs within AMM Liquidity Pool structures presents a significant operational challenge. Unlike traditional intermediated venues, AMMs execute trades through automated smart contracts and permissionless liquidity provision, and it remains unclear whether these decentralized applications are operationally suited to perform the identity verification, transaction monitoring, and suspicious activity reporting functions that AML/KYC compliance demands. Market participants considering TSV operations should carefully evaluate how to integrate these compliance requirements into AMM architectures and anticipate that the compliance burden may be a material barrier to scalability and institutional participation.
  
  

Looking Ahead: Anticipated SEC and CFTC Rulemaking

The coordinated actions by the SEC and CFTC on September 17 represent only the beginning. Both agencies have signaled that additional rulemaking, guidance, and no-action relief are forthcoming as they seek to construct a regulatory framework for digital assets through existing administrative authority.

While the Innovation Exemption represents a meaningful step forward in providing regulatory clarity for blockchain-based trading of NMS Stocks, the five-year duration of the exemptive relief—effective September 17, 2026, through September 17, 2031—underscores the provisional nature of the framework. The temporary window is a constructive signal that the SEC is willing to engage with tokenized securities markets through existing administrative authority, but significant structural barriers are likely to limit real institutional adoption during the exemption period. In particular, the volume caps (0.25 percent of average daily share volume for tier 1 and 2.5 percent for tier 2) may be too restrictive to support the depth of liquidity institutional participants require. The Innovation Exemption also does not relieve TSVs or their participants of AML/KYC obligations, which remain applicable under existing law. Implementing robust AML/KYC compliance within AMM Liquidity Pool structures—which operate through automated smart contracts rather than traditional intermediated order flow—presents substantial operational challenges that AMMs may not be well suited to address. Taken together, these constraints suggest that the Innovation Exemption may function primarily as a proof-of-concept regulatory sandbox rather than a catalyst for near-term institutional-scale adoption of Tokenized NMS Stock trading.

On the SEC side, the Innovation Exemption order itself solicits public comment on potential modifications and future steps, including whether the TSV Exemption should be made permanent, whether volume and symbol limitations should be adjusted, and whether additional types of securities should be eligible for trading on TSVs. The SEC’s Spring 2026 Regulatory Flexibility Agenda also indicates that the Division of Trading and Markets is considering recommending amendments regarding the scope of, and exceptions from, the term “dealer” under the Exchange Act, a development that could affect the long-term status of the Covered Firm Exemption. Additionally, the SEC’s Crypto Task Force continues to host roundtables and solicit written input on topics including tailored disclosure frameworks, registration pathways for crypto asset intermediaries, and the potential rescission of Regulation NMS Rule 611’s trade-through requirements for NMS Stocks, which was separately proposed on June 11.

On the CFTC side, the expansion of the no-action relief to all PSPs indicates potential future rulemaking or guidance addressing the application of IB registration requirements to software developers. Market participants should expect the CFTC to propose formal rules governing the regulatory status of passive technology intermediaries in the derivatives markets, potentially establishing a permanent exemption or tailored relief therefrom. Additionally, as the CFTC continues to develop its approach to digital commodity regulation, further guidance on the treatment of decentralized finance protocols, perpetual contracts, and event contracts in the regulated derivatives framework is expected.

Market participants in the digital asset space should closely monitor these developments, actively participate in comment periods, and begin contingency planning for multiple regulatory scenarios. Lowenstein Sandler will continue to track these regulatory actions and provide timely updates as new rules, guidance, and no-action letters are issued.

Lowenstein Sandler has significant experience advising crypto asset issuers, trading platforms, broker-dealers, and other financial institutions regulated by the SEC, FINRA, the CFTC, the NFA, and other federal and state regulators on a wide variety of regulatory matters, including the application of the federal securities and commodity derivative laws to digital assets and tokenized securities. Please reach out to one of the listed authors of this Client Alert or your regular Lowenstein Sandler contact if you have any questions regarding the Innovation Exemption or its implications for your business.