Court Overturns SEC Hedge Fund Rule

A federal judge sends the SEC back to the drawing board, saying its hedge fund registration rule is "arbitrary" and based on fuzzy definitions.

A federal appeals court has vacated a new Securities and Exchange Commission requirement that hedge funds register with the commission, calling the rule “arbitrary.”

The U.S. Court of Appeals for the District of Columbia Circuit sent the rule back to the regulator to be reviewed, according to the Associated Press.

The controversial SEC rule took effect on February 1 amid widespread industry opposition. It required hedge funds with at least $30 million under management to register, and nearly 1,000 funds did so. However, funds that require investors to “lock up” their money for at least two years or refuse to take new money were exempt from the rule.

“‘Hedge funds’ are notoriously difficult to define,” U.S. Circuit Court Judge A. Raymond Randolph wrote in the 19-page opinion. “The term appears nowhere in the federal securities laws, and even industry participants do not agree upon a single definition.” The judge also said it was difficult to define a client of a hedge fund.

In a statement, SEC chairman Christopher Cox said: “The SEC takes seriously its responsibility to make rules in accordance with our governing laws.” Acknowledging that the court’s finding requires that the SEC reevaluate its approach to hedge fund activity, he added, “I have instructed the SEC’s professional staff to promptly evaluate the court’s decision, and to provide to the Commission a set of alternatives for our consideration. The SEC will use the court’s decision as a spur to improvement in both our rulemaking process and the effectiveness of our programs to protect investors, maintain fair and orderly markets, and promote capital formation. And we will continue to work with the other members of the President’s Working Group on Financial Markets, including the Treasury, the CFTC, and the Federal Reserve, to evaluate both the systemic market risks and retail investment issues associated with the growing presence of hedge funds in the world’s capital markets.”

Idaho Sen. Mike Crapo, a member of the Senate Banking Committee and a strong critic of the rule, fired off a statement that “strongly supports” the court decision. “I agree with the Court that the SEC rule is arbitrary, a significant departure from the current regulatory framework, and lacks statutory authority,” he said. “I am glad that the Court affirmed the concerns of many of us in Congress that the SEC never adequately explained the basis for its dramatic re-interpretation of its statute.”

Crapo also asserted that the SEC “does not have — nor should it have — the authority to make law where Congress never intended.”

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