(The news featured below is a selection from the news covered in SEC Today, which is distributed to subscribers of SEC Today.)

SEC Will Not Appeal Hedge Fund Ruling But Will Conduct Rulemaking

Chairman Christopher Cox has announced that the SEC will not seek en banc review of the decision by a panel of the federal court of appeals for the District of Columbia that struck down the SEC's hedge fund adviser registration rule under the Investment Advisers Act. Cox advised that the Commission would move aggressively on an agenda of rulemaking and staff guidance to address the legal consequences flowing from the invalidation of the rule. He vowed that hedge funds are not, should not be and will not be unregulated.

In Goldstein v. SEC, the appeals panel declared arbitrary an SEC rule requiring hedge funds to register with the SEC if they have more than 14 clients and manage a specific amount of assets. The Investment Advisers Act exempts from registration those investment advisers with fewer than 15 clients. The court rejected the SEC's suggestion of counting the investors in the hedge fund as clients of the fund's adviser in order to surpass the 14-client limit.

In deciding not to appeal the ruling, Cox noted that the SEC's solicitor and general counsel have concluded that, since the appellate court's decision was based on multiple grounds and was unanimous, further appeal would be futile and would simply delay and distract from the goal of advancing investor protection.

As stated in Cox's recent testimony before the Senate Banking Committee, the SEC will propose significant new rulemaking, including a new antifraud rule under the Investment Advisers Act that will have the effect of looking through a hedge fund to its investors. The rule will reverse the side-effect of the Goldstein decision that the antifraud provisions of the Act apply only to clients as the court interpreted that term, and not to investors in the hedge fund.

In the Goldstein decision, the court held that the antifraud provisions of Investment Advisers Act sections 206(1) and (2) apply only to clients and not to investors in the hedge fund. Cox pointed out that the court itself said that section 206(4) is not limited to fraud against clients, so he believes the proposed rule will withstand judicial scrutiny. The rule will also clarify that hedge fund advisers owe duties to investors in hedge funds.

At the chairman's direction, the staff is also considering whether to increase the minimum asset and income requirements for individuals who invest in hedge funds. In addition, staff guidance can be expected to address the grandfathering, transition and other relief necessitated by the vacating of the rule. The guidance will help eliminate disincentives for voluntary registration and enable hedge fund advisers who are already registered under the rule to remain registered.

Cox also emphasized that, regardless of the Goldstein decision, hedge funds remain subject to SEC regulations and enforcement under the antifraud, civil liability and other provisions of the federal securities laws. The SEC will continue to vigorously enforce the federal securities laws against hedge funds and hedge fund advisers who violate those laws. 

Last month, Cox testified before the Banking Committee that the proposed new rules and initiatives concerning hedge funds will expand the Commission's authority to hold hedge fund advisers accountable for fraud against individual hedge fund investors, remove legal impediments that might otherwise force currently registered hedge fund advisers to deregister and update protections for unsophisticated investors by raising the thresholds to qualify for sophisticated investor status.