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A DC Circuit Court of Appeals has struck down the SEC's new rule requiring many hedge fund managers to register as investment advisers.

In a unanimous decision last Friday, the Court ultimately found that the SEC's new definition of 'client' was unreasonable and, as such, the registration rule was an invalid regulation.

The Court focused on the relationships and fiduciary duties owed by investment advisers to their clients.  After analyzing these obligations, the Court flatly rejected the SEC's attempt to classify a fund's investors as the adviser's client.  The Court aptly recognized that the adviser's obligations run only to the fund in the same manner that a lawyer's obligations run only to the corporation it serves, not the individual shareholders of the corporation.

While courts typically provide federal agencies wide latitude in enacting regulations, the DC Circuit wasn't so accommodating to the SEC.  The court seemed unconvinced of the need for registration of fund managers and cited the SEC for trying to define the word 'client' 'by a manipulation of meaning'. 

The question on everyone's mind, of course, is what does this mean for fund managers?  The answer, unfortunately, is that only time will tell.  The court's ruling, however, will make it difficult for the SEC to revise the rule since the ruling, in essence, foreclosed the possibility of re-defining the word 'client'.

Indeed, the court inferred that if registration of fund managers is required due to the size of the industry and potential impact they have on the markets, the proper way to do so is for Congress to provide an exemption to advisers based on their AUM rather than the number of its clients. 

The battle is not over and the SEC will likely seek permission to appeal to the Supreme Court.  A stay of the Circuit Court's ruling pending any such appeal will likely also be sought.  Since Commissioner Cox is viewed as being more business-friendly, it's no guarantee that a revised rule would even make it through the Commission.

This US regulatory  update was provided by Sadis & Goldberg LLC


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