In the press, this regulation has been presented as not applying to normal consumers and merchants who use bitcoin. For instance, this interview with Benjamin Lawsky:
http://www.bbc.co.uk/programmes/p023dgg1
(statement starting at 11:20)
So I believe we can consider it a requirement for this regulation to actually not apply to consumers or merchants, and any deviation can be considered a "bug", and should be fixed.
I am particularly worried that consumers and/or merchants may be performing a "Virtual Currency Business Activity" if they exchange virtual currencies against fiat currencies, through section 200.2 (n) 4. If one consumer or merchant exchanges virtual currency for fiat currency with another consumer or merchant (or any other entity), they can be thought of as providing conversion services to each other. On sites like localbitcoins.com, this is a normal consumer activity, and as such it should not be regulated, as stated above.
It it not clear how to distinguish consumers and merchants from other entities that somehow, for some reason, should be regulated. The root cause may be that a solid justification is missing why those other entities (whatever they may be) should be regulated, and consumers and merchants should not.
My proposed solution would be to remove any regulation requirements, for which it can not be proven that they cannot apply to consumers or merchants. 200.2 (n) 4 would be one candidate for removal.
Any other suggestions?