June 23, 2006
Court Rejects SEC Mutual Fund Rules
In a stunning opinion, a federal circuit court has rejected the new SEC rules that require hedge fund managers to register under the Investment Adviser Act of 1940. The rules have been in effect since February of this year. The court found the regulatory distinctions "arbitrary." The SEC forces any hedge fund adviser that has more than 15 clients to register. To count clients the SEC looks through any fund to its investors if the fund invests more than $25 million. The court felt that funds with less than 14 investors could present the same regulatory problems; there was no reason to distinguish funds based on client numbers. This is a major, crushing defeat for the SEC. If the Supreme Court takes the case, I doubt the federal appeals court opinion would be affirmed. The Supreme Court may never get the case, however. In any event, the SEC must decided whether to modify its rules or drop them. Stay tuned.
I have never been a fan of the mutual fund rules (as my paper on SSRN attests) but I am surprised by the second guessing by the courts. I believe the rules are bad policy but not bad enough to be arbitrary and an abuse of agency discretion. The court's opinion is itself troubling.
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