NEW YORK – A federal appeals court on Friday struck down the Securities and Exchange Commission’s attempt to boost its oversight of lightly regulated hedge funds, labeling a new SEC rule as “arbitrary” and sending it back to the agency to be reworked.
The ruling was a blow to the SEC, which contends greater scrutiny is needed to ferret out fraud and head off risks to the global economy. More than 8,000 hedge funds manage a combined $1 trillion; the funds are estimated to account for as much as one-fifth of U.S. stock-trading volume.
The decision by the Court of Appeals for the District of Columbia Circuit turned on a technical point. But it raised broader questions about whether federal regulators have the legal authority to patrol the hedge-fund industry.
“It is a stunning setback for the SEC,” said Mitch Nichter, a hedge-fund lawyer at Paul, Hastings, Janofsky &Walker in San Francisco. “It’s unlikely the SEC is going to be able to fix this rule to withstand legal challenge, and it’s unlikely that the SEC will be able to convince this Congress that further hedge-fund regulation and registration is needed.”
Hedge funds typically pool money from wealthy individuals and institutional investors such as pension plans. They often pursue sophisticated and potentially risky investment strategies in hopes of outsized returns for their clients.