Vague and overbroad rule exceeds US SEC’s statutory authority, is arbitrary and capricious, and has severe consequences for financial markets

18 March 2024 - The National Association of Private Fund Managers (NAPFM), the Alternative Investment Management Association (AIMA) and the MFA today filed a lawsuit asking the U.S. District Court for the Northern District of Texas in Fort Worth to vacate a rule recently adopted by the US Securities and Exchange Commission (US SEC) that dramatically expands the definitions of “dealer” and “government securities dealer” (the “Dealer Rule”). The petition for review can be found here.

NAPFM said: “The US SEC’s redefinition of ‘dealer’ upsets a century’s worth of understanding about the meaning of that term under the Exchange Act. As with respect to the Private Fund Adviser Rule that NAPFM recently challenged, the agency here tries to extend its reach over private funds in ways Congress never imagined. The Dealer Rule - purportedly designed to increase liquidity in trading markets - could ultimately have the effect of decreasing such liquidity.”

Jack Inglis, AIMA CEO, said: “The US SEC has exceeded its statutory authority by incorrectly concluding that customers of dealers may be dealers themselves – a clear departure from the statutory definition and understanding of what has meant to be a securities ‘dealer’ for the past 90 years. This rule will force certain hedge funds – who are not dealers and have never been considered dealers – to either register as dealers, thereby subjecting them to an unworkable regulatory framework, or force them to significantly curtail or cease altogether their trading activity. Both results will lead to unnecessary and significant harm to markets, investors, and certain funds. We do not take the decision lightly to challenge the Dealer Rule, but if left unchallenged, it threatens the future of certain funds and strategies.”

Bryan Corbett, President & CEO of MFA, said: “We were left with no choice but to challenge the Dealer Rule, because it will harm markets and create tremendous uncertainty for investors. The Dealer Rule is indeterminate and leaves certain market participants uncertain of their need to comply with the dealer regulatory framework. Alternative asset managers are not dealers. They are customers of dealers. If the rule is permitted to stand, it could mean that managers in scope and the funds they manage would lose their customer protections with their dealer counterparties and could not participate in IPOs. This would harm funds, their investors, and issuers looking to raise capital.”

The complaint asserts that the rule upends the well-understood meaning of what constitutes dealer activity under the Securities Exchange Act of 1934 and nearly a century of market practice. The Dealer Rule is indeterminate and overbroad and can be read to capture a wide variety of non-dealing activity, thereby subjecting private funds to dealer registration in what can only be described as an end-run around legislative intent. Moreover, the Dealer Rule is expressly non-exclusive, with no presumption of compliance even if a market participant falls outside the new definition, affording market participants no meaningful way to understand with certainty who counts as a dealer.

By failing to definitively and accurately define what a dealer is – even though doing so was the stated purpose of the rulemaking – the Dealer Rule may deter regulated market participants (such as registered investment advisers) from engaging in investment activity in various asset classes, including U.S. treasuries. This outcome will unnecessarily harm markets, funds, and investors by decreasing liquidity and market efficiency, while increasing volatility and costs.

The petitioners argue the Dealer Rule must be vacated and set aside in its entirety because:

• The US SEC lacks the statutory authority to adopt the definition in the Dealer Rule because the rule captures firms that are not, and have never been considered, dealers and lacks any limiting principle.
• The US SEC engaged in arbitrary and capricious decision-making, including by failing to adequately address the economic consequences of the Dealer Rule.
• The Dealer Rule is otherwise contrary to law because it imposes a burden on competition not necessary or appropriate in furtherance of the purposes of the Securities Exchange Act.

The petitioners are represented by Gene Scalia and Helgi Walker of Gibson, Dunn & Crutcher, LLP.