Hedge funds and financial industry groups are laying the groundwork for litigation that threatens to jeopardize some of the top markets reform priorities after the collapse of Archegos, which are being pushed by Gary Gensler, the top US securities regulator .
Gensler, chairman of the Securities and Exchange Commission, pointed to the collapse of Archegos Capital Management as evidence of the need for greater transparency in swap markets. The family office collapsed in early 2021 after using total return swaps to build a series of highly concentrated bets on stock price movements that backfired.
In December, the commission proposed new rules that would require investors to publicly disclose swap positions that previously allowed them to secretly build stakes in public companies.
He followed in February with proposals that would halve the time investors have to report substantial stock holdings and tighten rules around multiple investors collaborating.
But a group of critics, including hedge fund Elliott Management, the Futures Industry Association and partners at law firm Ropes & Gray, have submitted public responses to the proposals that accuse the SEC of breaking its own rules and even the law. .
Their complaints range from suggestions that the SEC has not done enough to assess the costs and benefits of the proposals to accusations that it is trampling on the US Constitution.
The critics give an indication of the industry’s legal line of attack if the regulator goes ahead with the proposals, lobbyists say.
“If these proposals are accepted as is, there will be plenty of individual companies and trade associations pursuing legal challenges,” said a seasoned lobbyist. “There’s a lot of pushback.”
The proposals have caused particular furor among activist investors and their supporters, who say the rules would cripple the industry by allowing other investors to direct their strategies and give companies more time to prepare defenses against shareholders who agitate for change.
In some of the most strident submissions to the SEC, Paul Singer’s activist hedge fund Elliott wrote that the rules would shield the boards of underperforming companies and violate laws protecting trade secrets, including a clause in the fifth amendment to the US constitution that prevents the government from taking private property.
Richard Zabel, Elliott’s general counsel, said critics who said the existing rules were “secret” and allowed for “sneak attacks by activists” were using “Orwellian turns of phrase . . . that should be buried once for all “.
The prospect of a lengthy legal battle has also raised concerns among some of the SEC’s supporters, who have urged it to strengthen its proposals to avoid a repeat of past cases when reform attempts were struck down by the courts.
Henry Hu, a professor at the University of Texas School of Law and a former SEC official, said the reforms were “seminal and long overdue.” But he warned they could be challenged based on the commission’s cost-benefit analyses.
The SEC is legally required to review the costs and benefits of any new rule before implementing it. In 2011, a US federal appeals court rejected proposals that would have made it easier for shareholders to eject board members after criticizing its analysis.
The SEC noted in its proposed exchanges that many of the benefits and costs were “difficult to quantify” and said “much of the discussion is about anticipated economic effects. . . is qualitative and descriptive in nature. The regulator declined to comment further.
Hu also pointed out that the analysis missed some benefits and could have provided more evidence of the benefits already highlighted.
“I want the SEC to better justify the particular implementation of the direction it’s trying to go,” Hu said. “Without a doubt, this reduces the incentives for activism, but there are also advantages. . . I suspect that one of the main areas of contention would be whether the SEC has done enough to fully explore this balance.