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Hedge Funds are Pushing Back on SEC’s Short-Selling Rules

Industry groups representing a coalition of hedge funds havefiled a lawsuit seeking to challenge short selling rules implemented by the SEC.

Photo of the U.S. Securities and Exchange Commission Headquarters
Photo by APK via CC BY-SA 3.0

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A group of hedge funds are going to long lengths to make sure the SEC’s new short-selling rules are short-lived.

On Tuesday, three industry groups representing a coalition of hedge funds filed a lawsuit seeking to invalidate two different rules implemented by the SEC to regulate the short-selling trade, calling the agency’s tactics “arbitrary and capricious.” 

Coming up Short

Short-selling — betting against a security and cashing in when it goes down in value — has long been criticized for its lack of transparency and disclosure as well as for how it can incentivize hedge funds to drag down share prices to help their short positions. The SEC adopted two new rules in October that require more intricate reporting of short positions than previously required. 

Proponents of the new rules argued that disclosing more data allows both the public and regulators to be better equipped to respond to potential destabilizing market events. But in their lawsuit, the hedge funds say that the SEC “adopted fundamentally contradictory approaches” by instituting the two different rules:

  • The first rule requires traders to report the securities loaned to facilitate the short sale, with the SEC then publishing the information anonymously and on delay. The second rule requires short-selling activity reporting from some institutional investors, with the data also eventually published anonymously on a delayed basis.
  • The ramped-up disclosure could inadvertently end up “revealing confidential investment strategies and potentially facilitating retaliation or other manipulative activities,” the plaintiffs argued in their filing, a hat tip to the PTSD inflicted by meme-stockers driving up the share price of GameStop to undermine hedge funds’ short positions in early 2021.

British Open: When US regulators zig, the UK’s zag. Earlier this year, England’s regulators significantly decreased the disclosure requirements that hedge funds need to reveal on short positions on London-listed company stocks, arguing that more disclosure can risk both trend-setting or short squeezes. It’s amazing the impact a brigade of Redditors can have around the world.