SEC's New Short-Selling Rules Face Court Challenge, Accusations They 'Harm Market Participants And Investors'

Three hedge fund associations are suing the Securities and Exchange Commission in a bid to overturn that they say “impair price discovery.”

The National Association of Private Fund Managers (NAPFM), Alternative Investment Management Association (AIMA) and the Managed Funds Association (MFA) have jointly filed a lawsuit asking the U.S. Court of Appeals for the Fifth Circuit to “invalidate” two rules recently adopted by the SEC requiring hedge funds to report details of securities loans and short selling activity.

Two new rules were approved by the SEC in October that require:

1. Certain fund managers to report their short sales to the SEC within 14 days of month end. The agency publishes the data on a delayed basis, keeping fund manager information confidential.
2. Financial companies that facilitate securities loans disclose information about those transactions to FINRA on a daily basis.

Exec: SEC Rules ‘Impair Market Efficiency’

The petitioners argued the rules would apply contradictory and incoherent approaches to two aspects of the same underlying transaction and run counter to the SEC’s stated mission to protect investors and maintain fair, orderly and efficient markets.

“The rules will impair market efficiency and price discovery and harm market participants and investors,” said Jack Inglis, CEO at AIMA.

He added: “The SEC should instead take into account their connected nature and apply consistent reporting and disclosure frameworks for these positions.”

Also Read: Supreme Court Vs. SEC: A Potential Game-Changer For Investors And Regulators’ In-House Courts

Short selling is a common trading strategy of hedge funds and involves borrowing a certain security and selling it on in the expectation its price will fall, then buying it from the vendor at the lower price, thus pocketing the difference.

Hedge funds tend to be largely private companies, but investors can back a number of hedge fund exchange traded funds. The biggest listed in the U.S. is the IQ Hedge Multi-Strategy Tracker ETF QAI, which tracks the top strategies of hedge fund managers. It has gained 8.1% in 2023.

Meanwhile, there are plenty of ETFs that track short-selling strategies. The biggest of these is the ProShares UltraPro Short QQQ SQQQ which inversely tracks the tech-heavy NASDAQ 100 index. Given the performance of tech stocks this year, it’s safe to say the SQQQ has performed badly — down 72%.

Regulator Faces Further Challenges

The SEC has come under increasing scrutiny from the investment community in recent months and has been the subject of several filings in U.S. courts.

Benzinga reported last month that the regulator was being heard in the Supreme Court in relation to the use of its own internal courts when prosecuting financial wrongdoers.

In emailed responses to media requests for comment on the new short selling rules, the SEC said it would “vigorously defend challenged rules in court.”

Now Read: Short Selling Rout: 92% Of ETF Shorts Were Unprofitable In The Last Month

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