Hedge funds and finance industry groups are laying the groundwork for litigation that threatens to jeopardise some of the top priorities for reforming markets following the collapse of Archegos, which are being pushed by Gary Gensler, the top US securities regulator.
Gensler, chair of the Securities and Exchange Commission, has pointed to the collapse of Archegos Capital Management as evidence of the need for greater transparency in swaps markets. The family office collapsed in early 2021 after using total return swaps to build up a series of highly concentrated bets on share price moves that backfired.
In December, the commission proposed new rules that would force investors to publicly disclose swaps positions that previously allowed them to secretly build up holdings in public companies.
It followed up in February with proposals that would halve the amount of time investors have to report substantial stock holdings, and tighten the rules around multiple investors working together.
But a group of critics including hedge fund Elliott Management, the Futures Industry Association and partners at the 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 riding roughshod over the US constitution.
The criticisms provide an indication of the industry’s legal line of attack if the regulator pushes ahead with the proposals, according to lobbyists.
“If these proposals go through as is there’s going to be a lot of individual firms and trade associations pursuing the legal challenges,” said one senior lobbyist. “There’s a lot of pushback.”
The proposals have provoked particular fury among activist investors and their backers, who say the rules would hamstring the industry by allowing other investors to front-run their strategies and give companies more time to plot defences against shareholders agitating for change.
In some of the most strident submissions to the SEC, Paul Singer’s activist hedge fund Elliott wrote that the rules would protect boards of poorly-performing companies and violate laws protecting trade secrets, including a clause in the fifth amendment of 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 “secretive” and enabled “sneak activist attacks” were using “Orwellian turns of phrase . . . that should be buried once and for all”.
The prospect of a drawn-out legal battle has prompted concern among some of the SEC’s supporters too, who have urged it to strengthen its proposals to avoid a repeat of earlier instances when reform attempts were quashed by courts.
Henry Hu, a professor at University of Texas Law School and former SEC official, said the reforms were “seminal and long overdue”. But he warned that they could be subject to challenges on the strength of the commission’s cost-benefit analyses.
The SEC is legally required to consider the costs and benefits of any new rules before implementing them. In 2011, a US federal appeals court threw out proposals that would have made it easier for shareholders to eject board members after criticism of its analysis.
The SEC noted in its swaps proposals that many of the benefits and costs were “difficult to quantify” and said “much of the discussion of the 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 benefits that were already highlighted.
“I want the SEC to better justify the particular implementation of the direction they’re trying to go,” Hu said. “Unquestionably it reduces the incentives for activism, but there are also benefits . . . I suspect that one of the key areas of contention would be whether the SEC has done enough to fully explore this balance.”
Letter in response to this article: