Hedge funds win review of SEC’s short sale disclosure rule

A federal appeals court ordered a review of US Securities and Exchange Commission rules that required investors to reveal far more about short selling and related stock lending.

A three-judge panel of the 5th US Circuit Court of Appeals issued a ruling Monday stating that the SEC failed to consider the cumulative economic impact of the disclosure rules before approving them. The court sent the matter back to the commission to reconsider.

The New Orleans-based 5th Circuit has repeatedly sided with industry groups challenging SEC regulations. The court struck down rules requiring more fee transparency from hedge funds and a separate rule requiring some firms to register as dealers.

Hedge funds and trade groups sued to block the rules in 2023, arguing that they were inconsistent and exceeded the agency’s authority. While short selling has long been a fixture in US equity markets, it’s drawn more scrutiny from regulators since the 2008 financial crisis prompted Congress to ask for more public disclosure on holdings.

An SEC spokesperson said the commission is reviewing the decision and will determine next steps as appropriate. SEC Chair Paul Atkins, the Trump administration appointee who took over in April, has said that the agency’s rulemaking must take into account a thorough cost benefit analysis. The rules were adopted during Joe Biden’s presidency.

“It is gratifying to see the court, yet again, remand the Biden administration’s ill-conceived rulemakings for the SEC’s new leadership to fix,” said Bryan Corbett, president and chief executive officer of the Managed Funds Association, one of the groups that sued over the rule. “These regulations were fatally flawed from the start when the SEC adopted highly-related rules on the same day without analyzing the impact one would have on the other.”

Calls for more transparency increased after the meme-stock mania of 2021, when retail traders took to social media to promote buying of shares of companies like GameStop Corp. in a successful bid to boost costs for hedge funds to maintain their short positions. An SEC report in 2021 said more disclosure of short positions would allow regulators to better track the market dynamics of short sales.

The SEC’s new rules for short sellers require private funds to report their transactions on a monthly basis. Pension funds, banks and institutional money managers that lend their stocks would have to report the transactions the next day.

In addition to the Managed Funds Association, the Alternative Investment Management Association and the National Association of Private Fund Managers sued to block the rules, arguing that they have “fundamentally inconsistent requirements” and that the agency failed to calculate the economic impact of both rules on short sellers and markets.

The appellate court agreed. “In this case, the commission erred by failing to consider the economic impact the Short Sale Rule would have on the Securities Lending Rule when the rules were promulgated in tandem and were adopted concurrently,” Judge Cory Wilson wrote for the panel.

In court filings, lawyers for the SEC said the agency facilitated thorough discussion of the rules’ economic impacts and “reasonably balanced competing concerns.”

The case is National Association of Private Fund Managers v. SEC, 23-60626, 5th US Circuit Court of Appeals.

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