The Wall Street Journal reports that the appellate court said the SEC failed to justify its definition of “client” in the new rule and that its interpretation “falls outside the bounds of reasonableness” and comes close to violating “the plain language” of the 1940 Investment Advisers Act.
The rule imposed by the SEC effective February 1 requires managers that run hedge funds with at least 15 US clients to register as an investment adviser with the SEC. The rule requires advisers to give the SEC basic information about themselves and submit to spot inspections (See SEC Imposes Hedge Fund Registration ).
At issue with the appellate panel was the meaning the SEC attributed to the word “client.” (See Appellate Court Pondering SEC Hedge Fund Registration Future ) Regulation existing at the time the SEC was pondering the rule allowed hedge funds to avoid registration by defining each hedge fund they manage as a separate “client.” The new rule requires each hedge fund investor to be counted as a client, forcing most large managers to register with the SEC.
The court opinion said the SEC did not show why the new rule was needed or adequately explain “how the relationship between hedge fund investors and advisers justifies treating the former as clients of the latter,” according to the news report.
The appellate court vacated the rule and remanded it back to the SEC for review. Its opinion is here .