Rules Are Arbitrary and Capricious and Will Harm Investors and Markets
WASHINGTON, December 12, 2023 – The National Association of Private Fund Managers (NAPFM), Alternative Investment Management Association (AIMA), and Managed Funds Association (MFA) have filed a lawsuit asking the U.S. Court of Appeals for the Fifth Circuit to invalidate two rules recently adopted by the Securities and Exchange Commission (SEC) that require reporting and public disclosure of securities loans and short selling activity. The petition for review can be found here.
As noted in the petition, despite finalizing the two closely related rules on the same day, the SEC disregarded the interconnectedness of the rules and adopted vastly different reporting requirements. As a result, the rules would apply contradictory and incoherent approaches to two aspects of the same underlying transaction: the short sales themselves and the loans of securities to facilitate those short sales. In particular, the SEC protects the value of anonymity for short sellers in one rule, —where it acknowledges short sellers’ contributions to liquidity and price efficiency—but then in the other rule exposes short sellers’ confidential securities lending and position information on a granular basis. The SEC entirely disregarded the impact of one rule on the other, including by failing to conduct a sufficient cost-benefit analysis of both rules’ cumulative impact.
Because of these and other flaws, the petitioners argue the rules are arbitrary and capricious under the Administrative Procedure Act and run counter to the SEC’s stated mission to protect investors and maintain fair, orderly, and efficient markets. The petitioners worked constructively to raise these issues during the rulemaking process and chose to litigate only as a last resort.
“Despite our best efforts, the SEC decided to ignore the interconnected nature of these two rulemakings and failed to apply a consistent approach or principle to regulating these related markets. The resulting rules are arbitrary and capricious. The SEC needs to go back to the drawing board and develop a consistent, coherent approach that will protect investors and avoid undermining the resilience of our capital markets,” said Bryan Corbett, MFA President and CEO.
“These two rules underscore how the SEC has ignored calls from industry, market participants, and Congress to consider the interconnectedness and aggregate impact of its rulemakings. The rules follow inconsistent approaches with broad extraterritorial scope and contain conflicting analyses and rationale even though they both address similar markets. The rules will impair market efficiency and price discovery and harm market participants and investors. The SEC should instead take into account their connected nature and apply consistent reporting and disclosure frameworks for these positions, which are designed to protect both market efficiency and market participants,” said AIMA’s CEO Jack Inglis.
Securities lending and short selling are foundational practices for investment and portfolio management. Mutual funds, pension plans, central banks, insurance companies, private funds, broker-dealers, and other sophisticated investors are involved in the lending and borrowing of securities. Securities lending improves investor returns by providing additional portfolio income. Borrowing securities is a necessary component of effecting short sales, which support price discovery, promote market stability, and reduce market risks.
The newly adopted rules create inconsistent and burdensome reporting regimes that will increase the frequency and detail of disclosure of securities loan and short positions data, allowing market participants to imitate or trade against the underlying position holder, harming investors. In effect, the rules will discourage short selling.
The petitioners are represented by Jeff Wall and Judd Littleton of Sullivan & Cromwell LLP.
About the National Association of Private Fund Managers
The National Association of Private Fund Managers is a non-profit organization whose members include investment advisers in the private fund management industry. NAPFM was founded for, among other things, providing education to its members and representing their legal and economic interests before the government and in the courts. As part of this mission, NAPFM has submitted comments on behalf of its members in rulemaking proceedings and participated as amicus curiae in Federal court. NAPFM represents firms with total net assets under management of over $600 billion as of July 2023.
About the Managed Funds Association
Managed Funds Association (MFA), based in Washington, DC, New York, Brussels, and London, represents the global alternative asset management industry. MFA’s mission is to advance the ability of alternative asset managers to raise capital, invest, and generate returns for their beneficiaries. MFA advocates on behalf of its membership and convenes stakeholders to address global regulatory, operational, and business issues. MFA has more than 170 member firms, including traditional hedge funds, credit funds, and crossover funds, that collectively manage over $3.2 trillion across a diverse group of investment strategies. Member firms help pension plans, university endowments, charitable foundations, and other institutional investors to diversify their investments, manage risk, and generate attractive returns over time.
About the Alternative Investment Management Association
The Alternative Investment Management Association (AIMA) is the global representative of the alternative investment industry, with around 2,200 corporate members in over 60 countries. AIMA’s fund manager members collectively manage more than US$3 trillion in hedge fund and private credit assets.
AIMA draws upon the expertise and diversity of its membership to provide leadership in industry initiatives such as advocacy, policy and regulatory engagement, educational programmes and sound practice guides. AIMA works to raise media and public awareness of the value of the industry.
AIMA set up the Alternative Credit Council (ACC) to help firms focused in the private credit and direct lending space. The ACC currently represents over 250 members that manage over US$1 trillion of private credit assets globally.
AIMA is committed to developing skills and education standards and is a co-founder of the Chartered Alternative Investment Analyst designation (CAIA) – the first and only specialised educational standard for alternative investment specialists. AIMA is governed by its Council (Board of Directors).