Buy-side associations take legal action against SEC over short-sale disclosure
13 December 2023 US
Image: AdobeStock/William A. Morgan
Three buy-side trade associations have launched legal action against the Securities and Exchange Commission (SEC), asking for the US Court of Appeals to invalidate rules on reporting and public disclosure of securities lending and short selling.
The Alternative Investment Management Association (AIMA), the Managed Funds Association (MFA) and the National Association of Private Fund Managers (NAPFM) argue in their petition that the SEC rules apply “contradictory and incoherent approaches” to two aspects of the same underlying transaction, specifically the short-sale and the stock borrow.
In one rule, the SEC protects the anonymity of the short seller, claim the trade associations. In the other, it exposes confidential securities lending and position information on a granular basis.
Despite finalising these two closely related rules on the same day, the SEC has disregarded how the two rules are connected and has applied very different reporting requirements, the associations claim.
In their petition, the joint associations refer to the SEC’s final rule in Reporting of Securities Loans, Release No 34-98737. The other rule is the SEC’s final rule in Short Position and Short Activity Reporting by Institutional Investment Managers, Release No 34-98738.
“The SEC entirely disregarded the impact of one rule on the other, including by failing to conduct a sufficient cost-benefit analysis of both rules’ cumulative impact,” say the trade associations.
In the Short Position Reporting Rule, the SEC recognised that “frequent, detailed disclosures relating to short-sale activity can impose substantial harms on markets” — including by compromising price discovery, liquidity and the ability to detect corporate waste or misconduct — the petitioners say.
In trying to avoid these “harms”, the SEC has adopted a delayed public disclosure regime for short-sale activity based on aggregate data.
“Yet the Commission then contradicted and undermined those very same considerations in the Securities Loan Reporting Rule by requiring daily disclosure of individual transaction information pertaining to loans of securities in a manner that effectively serves as a proxy for short-sale activity,” says the petition.
“The Commission did not even attempt to explain its starkly different approaches, and it inexplicably refused to consider the rules’ cumulative economic impact despite adopting them on the same day,” it continues.
Given these shortcomings, the trade associations suggest that these rules present a “particularly stark example of arbitrary and capricious rulemaking in violation of the Administrative Procedure Act” and run counter to the SEC’s stated mission to protect investors and maintain fair, orderly and efficient markets.
The trade associations contend that the SEC’s rules are also invalid for additional reasons: they will impose substantial costs that outweigh the benefits of the new rules; they will conflict with the SEC’s statutory authority; and they fail to comply fully with procedural rulemaking requirements under the Administrative Procedure Act (APA).
The Short Position Reporting Rule also purports, impermissibly, to apply extraterritorially to securities traded outside the United States, the associations claim.
Commenting on the petition, AIMA chief executive Jack Inglis says: “These two rules underscore how the SEC has ignored calls from industry, market participants and Congress to consider the interconnectedness and aggregate impact of its rulemakings. The rules follow inconsistent approaches with broad extraterritorial scope and contain conflicting analyses and rationale, even though they both address similar markets.”
“The rules will impair market efficiency and price discovery and harm market participants and investors,” Inglis adds. “The SEC should instead take into account their connected nature and apply consistent reporting and disclosure frameworks for these positions, which are designed to protect both market efficiency and market participants.”
MFA president and CEO Bryan Corbett says: “Despite our best efforts, the SEC decided to ignore the interconnected nature of these two rulemakings and failed to apply a consistent approach or principle to regulating these related markets...The SEC needs to go back to the drawing board and develop a consistent, coherent approach that will protect investors and avoid undermining the resilience of our capital markets.”
The associations indicate that they have “worked constructively to raise these issues during the rulemaking process” and have only chosen to litigate “as a last resort”.
For these, and other reasons, they ask the US Court of Appeals to “hold unlawful, vacate, and set aside both rules” and to grant additional relief as may be appropriate.
The Alternative Investment Management Association (AIMA), the Managed Funds Association (MFA) and the National Association of Private Fund Managers (NAPFM) argue in their petition that the SEC rules apply “contradictory and incoherent approaches” to two aspects of the same underlying transaction, specifically the short-sale and the stock borrow.
In one rule, the SEC protects the anonymity of the short seller, claim the trade associations. In the other, it exposes confidential securities lending and position information on a granular basis.
Despite finalising these two closely related rules on the same day, the SEC has disregarded how the two rules are connected and has applied very different reporting requirements, the associations claim.
In their petition, the joint associations refer to the SEC’s final rule in Reporting of Securities Loans, Release No 34-98737. The other rule is the SEC’s final rule in Short Position and Short Activity Reporting by Institutional Investment Managers, Release No 34-98738.
“The SEC entirely disregarded the impact of one rule on the other, including by failing to conduct a sufficient cost-benefit analysis of both rules’ cumulative impact,” say the trade associations.
In the Short Position Reporting Rule, the SEC recognised that “frequent, detailed disclosures relating to short-sale activity can impose substantial harms on markets” — including by compromising price discovery, liquidity and the ability to detect corporate waste or misconduct — the petitioners say.
In trying to avoid these “harms”, the SEC has adopted a delayed public disclosure regime for short-sale activity based on aggregate data.
“Yet the Commission then contradicted and undermined those very same considerations in the Securities Loan Reporting Rule by requiring daily disclosure of individual transaction information pertaining to loans of securities in a manner that effectively serves as a proxy for short-sale activity,” says the petition.
“The Commission did not even attempt to explain its starkly different approaches, and it inexplicably refused to consider the rules’ cumulative economic impact despite adopting them on the same day,” it continues.
Given these shortcomings, the trade associations suggest that these rules present a “particularly stark example of arbitrary and capricious rulemaking in violation of the Administrative Procedure Act” and run counter to the SEC’s stated mission to protect investors and maintain fair, orderly and efficient markets.
The trade associations contend that the SEC’s rules are also invalid for additional reasons: they will impose substantial costs that outweigh the benefits of the new rules; they will conflict with the SEC’s statutory authority; and they fail to comply fully with procedural rulemaking requirements under the Administrative Procedure Act (APA).
The Short Position Reporting Rule also purports, impermissibly, to apply extraterritorially to securities traded outside the United States, the associations claim.
Commenting on the petition, AIMA chief executive Jack Inglis says: “These two rules underscore how the SEC has ignored calls from industry, market participants and Congress to consider the interconnectedness and aggregate impact of its rulemakings. The rules follow inconsistent approaches with broad extraterritorial scope and contain conflicting analyses and rationale, even though they both address similar markets.”
“The rules will impair market efficiency and price discovery and harm market participants and investors,” Inglis adds. “The SEC should instead take into account their connected nature and apply consistent reporting and disclosure frameworks for these positions, which are designed to protect both market efficiency and market participants.”
MFA president and CEO Bryan Corbett says: “Despite our best efforts, the SEC decided to ignore the interconnected nature of these two rulemakings and failed to apply a consistent approach or principle to regulating these related markets...The SEC needs to go back to the drawing board and develop a consistent, coherent approach that will protect investors and avoid undermining the resilience of our capital markets.”
The associations indicate that they have “worked constructively to raise these issues during the rulemaking process” and have only chosen to litigate “as a last resort”.
For these, and other reasons, they ask the US Court of Appeals to “hold unlawful, vacate, and set aside both rules” and to grant additional relief as may be appropriate.
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