SEC Rule Requiring Registration of Hedge Fund Advisers Struck Down
A challenge to the SEC's rulemaking authority was recently successful in Goldstein v. Securities and Exchange Comm'n, No. 04-1434 (D.C. Cir. June 23, 2006). http://pacer.cadc.uscourts.gov/docs/common/opinions/200606/04-1434a.pdf.
In that case, the Federal Court of Appeals for the D.C. Circuit vacated the SEC's rule requiring most hedge fund advisers to register with the SEC under the Investment Advisors Act of 1940. The SEC's "hedge fund rule" (Rule 203(b)(3)-2) required most hedge fund advisers to register with the SEC if the funds they advise have fifteen or more shareholders, limited partners or beneficiaries. Prior to this rule, hedge fund managers were often exempt from registration under the Act's "private adviser exemption," which allows advisers with less than fifteen "clients" over the past 12 months to avoid registration, and the SEC had interpreted "client" to refer to the fund entity itself rather than individual investors. Through its hedge fund rule, however, the SEC changed from its prior position by equating "client" with "investor", thereby requiring most all hedge fund managers to register.
In vacating the rule, the Court rejected the SEC's argument that it had authority to impose any susceptible meaning on the term "client" where the term had not been defined in the Advisers Act. The court emphasized that under the Advisers Act and elsewhere, the adviser's duties run to the fund and not to the individual investors. In electing to vacate the rule, the Court determined that the SEC did not adequately explain "how the relationship between hedge fund investors and advisers justifies treating the former as clients of the latter."
The Goldstein decision demonstrates that at least the D.C. Circuit takes seriously the substantive limits on agency rule-making power. It also demonstrates the importance of industry involvement in creating a record at the rulemaking stage. The regulatory road regarding hedge funds, however, will not end here. As demonstrated by the SEC's recent testimony in Senate committee hearings on the regulation of hedge funds, there will be increased efforts to regulate hedge funds and their advisers either through new rulemaking efforts or legislation. http://banking.senate.gov/index.cfm.
So Hedge funds, this very important sector of the Securities business, can't be regulated (at lest this way); but they are not too big to be resccued from their own failures. Nice work, if you can get it I guess.
Apples and oranges. SEC-style regulation has nothing to do with Long Term Capital Management or Niederhoffer type blowups. These funds could have had 10 SEC examiners in their offices 24 hours a day and it would have made no difference since they violated no laws. They just hit a perferct storm while being overleveraged. I say don't bail them out but whether or not you agree, it is a non sequiter to link it to SEC regulation which is designed to deter and punish fraud.
Has anyone looked at the implications for state registration laws - e.g., CA's law piggy-backed off the SEC law and assumed that larger funds would go SEC so they exempted them... the way I read it only funds domiciled in CA and under $25MM are now required to register in CA...