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Comment: US Court decision on hedge fund manager supervision - Timothy Spangler, Berwin Leighton Paisner

Timothy Spangler summarises last Friday's decision by a US Circuit Court of Appeal to strike down the SEC's hedge fund registration rule.

On 23 June 2006 the US Court of Appeals for the District of Columbia Circuit sent the rule bringing hedge fund managers under the supervision of the Securities and Exchange Commission back to the Commission for review.

The new rule on registration by hedge fund managers took effect on 1 February 2006. The Commission's concerns over the growth in popularity in hedge funds prompted the rule requiring certain hedge fund managers to register with the regulators. This in turn opened a fund's books to SEC examiners and other supervision. Prior to this hedge fund managers were largely unregulated.
In this case the court reviewed the Commission's regulation of "hedge funds" under the US Investment Advisers Act 1940. Previously these fund managers were exempt because they had fewer than fifteen clients.  Under the new rule most advisers were required to register with the Commission if the funds they advise have fifteen or more "shareholders, limited partners, members or beneficiaries". The petitioners, Phillip Goldstein (an investment advisory firm) and Opportunities Partners LP (a hedge fund) challenged the regulations equation of "client" with "investor".
The court summarised the previous status of the parties in a hedge fund. They indicated that the funds manager's role was completely passive and did not tell the investor how or when to invest in the funds. If the person or entity controlling the fund was not an "investment advisor" it follows that the investor cannot be the client. The court took the view that this position had not changed. In its decision, the court referred to the new rule as "arbitrary" and considered the Commission had failed to make a compelling case for the necessity of the rule or change in interpretation. The court accepted the petitioner's arguments. The petition for review was granted and the Hedge Fund rule vacated and remanded.
The Commission has indicated that following this decision it will re-evaluate its approach to hedge fund activity and will be conducting an immediate review of the court's decision as well as identifying alternatives to the rule as currently drafted. The ruling does not impact the Commission's ability to investigate any suspected securities violations.

To read the full SEC Press Release, please click here

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