Hedge Funds Challenge SEC Over Short-Selling Regulations

Hedge fund groups file a lawsuit against the SEC over new short-selling disclosure rules.

What are the SEC's new short-selling rules?

A coalition of hedge fund groups has initiated legal action against the US Securities and Exchange Commission (SEC), contesting new short-selling regulations. The industry argues that these rules, which were adopted hastily, have not adequately considered their overall impact on the securities markets.

Lawsuit Against SEC's Dual Short-Selling Rules

Three major industry groups have approached the US federal appeals court, alleging that the SEC's approach in implementing two short-selling disclosure measures was "arbitrary and capricious." These rules, both adopted on the same day in October, have been criticized for their potential to expose investors' positions and for conflicting in their approach to market transparency.

Gary Gensler
Chair of the US SEC Gary Gensler's popularity is declining rapidly

The Controversial SEC Measures

The first measure mandates securities lenders to individually report each loan, including lending rates, daily, with the data becoming public the next business day. Loan sizes are revealed 20 business days later. The second rule obligates some institutional investors to report short-selling activity, which is then shared publicly in an aggregated and delayed manner. The controversy stems from the differing levels of disclosure these rules enforce, with industry groups highlighting the contradictory nature of requiring detailed daily loan disclosures while allowing delayed, aggregated short position reporting.

Broader Regulatory And Market Implications

The lawsuit underscores the ongoing debate around the transparency of short selling, a practice scrutinized during the 2021 meme-stock boom. The Dodd-Frank financial reforms post-2008 crisis mandated the SEC to collect more information on short selling, culminating in these October rules. The plaintiffs, including the Managed Funds Association and the Alternative Investment Management Association, criticize the SEC for not considering the interconnected nature of the securities market in its rulemaking. They argue that the rules impose significant costs and conflict with the SEC's statutory authority. Conversely, SEC chair Gary Gensler defends the importance of understanding short-sale activities in equity markets, particularly during volatile periods.

Strategic Choice Of Court

In a strategic legal move, the lawsuit was filed in one of the country's most conservative courts, the fifth circuit, as one of the plaintiffs is Texas-based. This choice contrasts with the usual Washington-based appeals for SEC-related cases and comes amid the UK government's move to reduce transparency in short selling, indicating a divergent approach to financial market regulation on either side of the Atlantic.

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