A federal judge on Nov. 21 struck down a Securities and Exchange Commission rule that broadened the definition of a dealer, ruling that the agency exceeded its statutory authority.
“Because the promulgation of the final rule was unauthorized, no part of it can stand,” Judge Reed O’Connor wrote in his decision, agreeing with plaintiffs’ claims that the SEC rule runs afoul of the Administrative Procedures Act.
The dealer rule, which the SEC finalized in February in a 3-2 vote with the agency’s two Republican commissioners dissenting, expanded the definitions of a dealer and government securities dealer to include traders that engage in one of two activities "as part of a regular business." Those activities are regularly expressing trading interest that is at or near the best available prices on both sides of the market, and collecting revenue chiefly from "capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity supplying trading interest," according to an SEC fact sheet.
In March, the National Association of Private Fund Managers, the Managed Funds Association and the Alternative Investment Management Association filed a lawsuit in U.S. District Court in Fort Worth, Texas, alleging the rule is indeterminate, overbroad and can be read to capture a wide variety of non-dealing activity.
Oral arguments were held Nov. 14.
“Because there is no genuine dispute regarding any material facts and statutory interpretation is a question of law, the court concludes that the SEC exceeded its statutory authority by expanding definition of dealer, untethered from the text, history, and structure” of the Securities Exchange Act of 1934.
The judge opened his opinion by citing a line from SEC Commissioner Hester M. Peirce when she dissented from the rule’s adoption in February.
“A regulator’s temptation may be to put every corner of the market under a regulatory spotlight,” the judge wrote referencing Peirce. He then added, “When engaging in that temptation causes an agency to act beyond its authority, the judiciary is obligated to thwart that action.”
In response, an SEC spokesperson said by email that the agency was reviewing the decision and "will determine next steps as appropriate.”
Jack Inglis, CEO of the Alternative Investment Management Association, said in a statement that the court’s decision was correct.
“This outcome spares many hedge fund managers from facing the unenviable task of either attempting to comply with dealer registration in whatever form or curtailing their trading strategies that may have triggered one of the dealer rule’s arbitrary tests,” he said. “Today’s ruling validates our decision to challenge the rule to protect the interests of our members and a wide variety of market participants from what would otherwise have been severe and adverse consequences.”
Managed Funds Association President and CEO Bryan Corbett said in a statement that the court's ruling affirms that alternative asset managers are not dealers.
"The SEC’s rushed rule-making resulted in a final rule that was unworkable, ignored that dealers have customers and exceeded the commission’s statutory authority," he said. “MFA looks forward to working with the next SEC chair to pursue policies that support robust capital markets, change the adversarial relationship between policymakers and market participants, and embrace alternative asset managers as drivers of economic growth.”
