Hedge Funds Battle SEC: Three hedge fund associations have taken legal action against the U.S. Securities and Exchange Commission (SEC) in an attempt to overturn two recently implemented rules designed to enhance transparency in short-selling practices. Issued in October, these rules pertain to both short selling and securities lending, interconnected financial activities.
The hedge fund groups argue that the SEC’s approach to these rules is inconsistent, allowing aggregated transaction reports for investor protection while simultaneously mandating individual disclosure for others. This lawsuit, filed in the 5th U.S. Circuit Court of Appeals, marks the second legal challenge by hedge fund associations against the SEC in recent months, reflecting Wall Street’s resistance to new financial regulations.
In their legal complaint, the hedge fund groups contend that the SEC failed to consider the interconnected nature of the two rules, adopting contradictory approaches that could adversely affect investors. Additionally, the groups assert that these rules violate the Administrative Procedure Act, requiring regulatory agencies to justify their rules and take public feedback into account.
Bryan Corbett, President and CEO of the Managed Funds Association, expressed frustration, stating, “Despite our best efforts, the SEC decided to ignore the interconnected nature of these two rulemakings and failed to apply a consistent approach or principle to regulating these related markets.”
Also Read: Hedge Funds Strike a Bearish Chord in Financial Markets
The SEC responded, stating it will “vigorously defend challenged rules in court.” Short selling involves borrowing stocks to sell with the expectation of a price decline, allowing investors to buy them back at a lower price and profit from the difference. The October short-selling rule mandates hedge funds to report short positions to the SEC, which publishes them on an aggregate basis with individual traders remaining anonymous. The second rule requires financial firms to submit daily reports on individual securities loans supporting their short positions, with the data disclosed on a delayed basis.
Fund managers oppose increased transparency around their trades, fearing it could expose confidential investment strategies and potentially lead to retaliation or manipulative activities. The lawsuit includes the Alternative Investment Management Association and the National Association of Private Fund Managers as petitioners. Short selling gained renewed attention during the 2021 GameStop saga when retail investors drove up the stock price, causing significant losses for hedge funds with short positions.
SEC Chair Gary Gensler, when introducing the rules, emphasized the importance of transparency in short sale activity, especially during times of market stress or volatility. In a related legal move, the same hedge fund groups, along with other associations, sued the SEC in September over new private funds rules.
Our Reader’s Queries
Do hedge funds report to the SEC?
New SEC regulations now mandate that hedge funds and other major investors must disclose their gross short positions in specific stocks at the end of every month. Additionally, they must provide more frequent updates on their trading activity, including derivatives. These rules aim to increase transparency and accountability in the financial industry.
Are hedge funds exempt from SEC?
Unlike mutual funds, hedge funds are not registered with the SEC, which means they are subject to minimal regulatory controls. Furthermore, many hedge fund managers are not obligated to register with the SEC, resulting in a lack of regular oversight from the regulatory body.
Who is suing the SEC?
Hedge funds have taken legal action against the Securities and Exchange Commission over new rules regarding short sales. The funds claim that the agency acted unlawfully when implementing the regulations, which were designed to gather data on these types of transactions.
What is the largest hedge fund failure?
In 2008, the Madoff Investment Scandal came to light when Madoff confessed to his sons, who were also employed at the firm, that the asset management business was a complete sham. The estimated fraud amount was a staggering $65 billion.