Private Funds Associations Sue SEC to Vacate New "Dealer Rule"
Commentary by Steven Lofchie
The Alternative Investment Management Association, the Managed Funds Association and the National Association of Private Fund Managers (collectively, the Associations) filed a complaint against the SEC to vacate the agency's recently adopted rule to change the definitions of "dealer" and "government securities dealer" (the "Dealer Rule"). (See related coverage.)
In the Complaint, filed with the U.S. District Court for the Northern District of Texas in Fort Worth, the Associations argued, among other things, that:
- the SEC lacks the statutory authority to adopt the definition of "dealer" in the Dealer Rule because the expanded definition captures firms that are not within the statutory definition and have never been considered to be "dealers";
- the SEC claims, without basis, that imposing dealer regulations on private funds "would make them less likely to discontinue trading in turbulent markets";
- the SEC was not justified in asserting that market participants require more comprehensive regulatory oversight because it already has substantial data, and market participants are already subject to anti-fraud and anti-manipulation rules;
- the SEC engaged in arbitrary and capricious decision-making, including by failing to adequately address the economic consequences of the Dealer Rule; and
- the Dealer Rule is otherwise contrary to law because it imposes a burden on competition not necessary or appropriate to the furtherance of the purposes of the SEA.
The Associations asked that the Court (i) declare that the Dealer Rule was promulgated in excess of the SEC's statutory authority under the SEA and is arbitrary and capricious, (ii) vacate and set aside the Rule, (iii) enjoin the SEC from implementing the Rule and (iv) do whatever is required to postpone the effective date of the Rule.
Commentary
There are a good number of reasons to believe that the Associations' legal challenges to the new "Dealer Rule" rule will be successful. These reasons include those set forth in the Complaint: absence of statutory authority, failure to properly consider costs, claims of benefits that cannot be proved and inadequate time to comply. (These and others are described in some detail in a recent Memorandum on the subject. Note: stay tuned for an update.)
Perhaps the most fundamental weakness of the Dealer Rule is the complete ambiguity of the terms used in its key definitions. As stated in the Memorandum:
If one takes the SEC at its word, that the term "trading interest" includes any indication of a willingness to trade a security that identifies the security and at least one of the "quantity, direction or price" of the statement, it would result in conclusions that seem surprising. Compare these two examples:
(i) "I am open to trading in Security X," would not be expressing trading interest because there is not a firm order and none of quantity, direction or price has been indicated, even though the phrasing suggests that the speaker could be on either side of the market; but
(ii) "I am interested in buying Security X; what price will you give me" would be expressing trading interest that could render the speaker a dealer, even though the speaker is only on one side of the market, and has not indicated either price or quantity.
[Further] the Release goes on to say that requesting quotes on both sides of the market as to a security would not be an expression of trading interest because that trading interest would not be "at or near the best available price." This example is inconsistent with the Release's statement that expressing direction brings a firm within the scope of the term "trading interest."
The combination of this level of ambiguity and the potential severity of the sanctions, should require the Court to force the SEC to explain in detail just what activities are encompassed by the Dealer Rule, why the SEC believes it has authority to expand statutory terms in place for 90 years, and how the SEC conducted its cost-benefit analysis. None of this will be easy for the SEC.
It is notable that two of the Commissioners denounced the Dealer Rule as not founded on statutory authority and as the product of a materially deficient rulemaking process. Rather than treating these and the other concerns about the Rule as worthy of serious consideration, Chair Gensler's response was to post a video on X in which he asks, "What do dealers and traders have in common with Top Gun," the Tom Cruise movie. In non-celluloid reality, the answer to his question is: "not much." Nor will anything in that video be likely to prove useful to the SEC in Court.
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