Hedge funds win with Texas court decision scrapping SEC Treasury Dealer rule

The Securities and Exchange Commission suffered another setback in efforts to tighten its oversight of Wall Street, after a federal judge in Texas struck down new rules that would have required some firms to register as dealers in the US Treasuries market.

US District Judge Reed O’Connor in Fort Worth sided with hedge funds that sued in March to block the regulations, which they claimed were too broad and could harm the market by causing some firms to pull back from trading. The SEC “engaged in unlawful agency action taken in excess of its authority,” O’Connor said in the ruling Thursday.

The regulator could still appeal, but the ruling is the latest legal setback for SEC Chair Gary Gensler, who announced Thursday he plans to step down in January. President-elect Donald Trump had pledged to fire him. Some critics claim Gensler sought to stretch the agency’s enforcement powers far beyond its jurisdiction, including for cryptocurrencies and private funds.

To challenge O’Connor’s decision, the SEC would need to take its case to the 5th US Circuit Court of Appeals in New Orleans, which recently struck down a separate SEC rule requiring more fee transparency from hedge funds and private equity firms. The SEC abandoned its legal fight over that rule. 

An SEC spokesperson said the agency is reviewing the decision.

Earlier this year, the SEC approved rules that would require certain hedge funds and other trading firms to be labeled as dealers, which would mean increased scrutiny from the regulator and likely higher compliance costs.

The Managed Funds Association, Alternative Investment Management Association and National Association of Private Fund Managers sued, one of several complaints filed by groups pushing back on the SEC’s attempts to regulate the private-funds industry.

“Today’s decision will benefit markets, fund managers, and investors, including pensions, foundations, and endowments,” Bryan Corbett, president and chief executive officer of MFA, said in a statement. “The SEC’s rushed rulemaking resulted in a final rule that was unworkable, ignored that dealers have customers, and exceeded the Commission’s statutory authority.”

Corbett said his organization is eager to work with new leadership at the SEC under the incoming administration to “change the adversarial relationship between policymakers and market participants.”

In court filings, the SEC defended the dealer registration requirement, arguing the rules would ensure that high-frequency traders receive the same level of scrutiny as other firms active in the market that are already labeled as dealers.

But the hedge fund industry says the rules are too vague and compliance would result in excessive costs and fees to firms. Plus, they said different types of trading strategies could fall under the regulations, causing some groups to pull back from the Treasuries trading and reducing liquidity for the overall market.

“This outcome spares many hedge fund managers from facing the unenviable task of either attempting to comply with dealer registration in whatever form or curtailing their trading strategies that may have triggered one of the Dealer Rule’s arbitrary tests,” said Jack Inglis, the AIMA’s chief executive officer in a statement.

The case is National Association of Private Fund Managers v. SEC, 4:24-cv-00250, US District Court, Northern District of Texas (Fort Worth).