Three leading associations have filed a lawsuit to the US Court of Appeals following the US Securities and Exchange Commission’s (SEC) recent ruling which expanded the definition of “dealer” and “government securities dealer”.
Jack Inglis
“[The] vague and overbroad rule exceeds US SEC’s statutory authority, is arbitrary and capricious, and has severe consequences for financial markets,” said the National Association of Private Fund Managers (NAPFM), Managed Funds Association (MFA), and Alternative Investment Management Association (AIMA), jointly.
The two adopted rules require certain hedge funds, among other market participants, to register if they meet one of two qualitative standards, with the final rule set to inflict more scrutiny and compliance burdens on market players.
NAPFM, MFA, and AIMA are aiming to have the rule be vacated in its entirety due to three key reasons: that the SEC lacks the statutory authority to adopt the new definition; that the decision-making is “arbitrary and capricious”; that the rule is “contrary to law” due to its imposing a burden on competition which is outside the scope of the SEC’s purposes.
NAPFM asserted that the redefinition could ultimately lead to a decrease in liquidity: “The US SEC’s redefinition of ‘dealer’ upsets a century’s worth of understanding about the meaning of that term under the Exchange Act […] the agency here tries to extend its reach over private funds in ways Congress never imagined. The Dealer Rule – purportedly designed to increase liquidity in trading markets – could ultimately have the effect of decreasing such liquidity.”
Under the final rules, an entity would qualify as a dealer or government securities dealer if they regularly express trading interest as close to the best price on both sides of the market for the same security, or earn revenue primarily from capturing bid-ask spreads or from capturing incentives offered by trading venues.
If applicable, the new rule requires the market participants in question to register with the commission, become members of a self-regulatory organisation (SRO), and comply with federal securities laws and regulatory obligations.
Jack Inglis, AIMA CEO, said: “The US SEC has exceeded its statutory authority by incorrectly concluding that customers of dealers may be dealers themselves – a clear departure from the statutory definition and understanding of what has meant to be a securities ‘dealer’ for the past 90 years.
“This rule will force certain hedge funds – who are not dealers and have never been considered dealers – to either register as dealers, thereby subjecting them to an unworkable regulatory framework, or force them to significantly curtail or cease altogether their trading activity.”
He added that both of these results are set to result in unnecessary and significant harm to markets, investors, and certain funds.
The SEC has also confirmed that the final rules exclude: any person that has (or controls) assets that total less than $50 million, investment companies registered under the Investment Company Act of 1940, central banks, sovereign entities, and international financial institutions (as defined in the final rules).
Read more: SEC tags hedge funds trading Treasuries as ‘dealers’ under new rule change
Bryan Corbett, president and chief executive of MFA, added: “We were left with no choice but to challenge the Dealer Rule, because it will harm markets and create tremendous uncertainty for investors.
“[…] Alternative asset managers are not dealers. They are customers of dealers. If the rule is permitted to stand, it could mean that managers in scope and the funds they manage would lose their customer protections with their dealer counterparties and could not participate in IPOs. This would harm funds, their investors, and issuers looking to raise capital.”