The rule requiring most hedge funds to register with the SEC was struck down today by the U.S. Court of Appeals for the District of Columbia, which called it "arbitrary." The SEC did not adequately justify the need for new regulations, according to the court's 19-page decision.
Phillip Goldstein, portfolio manager at hedge fund Opportunity Partners, sued the SEC in December 2004, claiming the agency didn't have the authority to change the Investment Advisers Act of 1940's definition of a client to apply to every investor in a hedge fund. Under the new rules, which took effect Feb. 1, registration was required for hedge fund managers with more than 15 clients, more than $30 million under management and lockups of less than two years. The new rule also required hedge fund advisers to count each of the underlying investors in its hedge funds as an investor. Under the old rules, hedge fund managers were permitted to count each hedge fund managed as one client. Attempts to reach Mr. Goldstein were unsuccessful.
SEC staff will re-evaluate hedge fund regulations in light of the appellate court decision and will "provide to the commission a set of alternatives," SEC Chairman Christopher Cox, said in a statement today. "The SEC will use the court's decision as a spur to improvement in both our rule-making process and the effectiveness of our programs to protect investors, maintain fair and orderly markets and promote capital formation."
John Heine, an SEC spokesman, said he could not provide additional details.
Hedge fund attorneys said it was too early to know how fund managers will react. "It's hard to say now whether hedge fund managers that spent millions and hired many people to bring themselves into compliance will choose to de-register. Everyone needs to take a deep breath and really think this through," said attorney Nir Yarden, partner, Greenberg Traurig.
As far as the general trend in the hedge fund industry toward institutionalization, Michael Tannenbaum, founding partner of law firm Tannenbaum, Helpern, Syracuse & Hirschtritt, said: "Registration is an important issue for hedge fund managers who want to manage pension assets. Registration is valuable apart from the mere change of client definitions. The marketplace itself will continue to push hedge funds toward voluntary registration."