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Three associations have filed a lawsuit to vacate the recently adopted Dealer Rule by the US Securities and Exchange Commission (SEC) that aims to expand the definitions of a “dealer” and “government securities dealer”.
The National Association of Private Fund Managers (NAPFM), the Alternative Investment Management Association (AIMA) and the Managed Funds Association (MFA) filed a lawsuit to the US District Court for the Northern District of Texas in Fort Worth.
This is the second time the buy-side Associations have challenged rulings by the US SEC in recent months. In December 2023, they launched legal action against the Commission to invalidate rules on reporting and public disclosure of securities lending and short selling.
According to the Associations, by “failing to definitively and accurately define what a dealer is” the Dealer Rule may deter regulated market participants — such as registered investment advisers — from engaging in investment activity in various asset classes, including US treasuries.
The three entities indicate this adopted definition will unnecessarily harm markets, funds and investors by decreasing liquidity and market efficiency, while increasing volatility and costs.
Adopted in February, the rules will further define what it means to be engaged in a business of buying and selling securities “as a part of a regular business”.
It will do so for both dealers and government securities dealers by requiring entities engaging in “de facto market making” activity to register as dealers or government securities dealers.
Market participants that engage in certain dealer roles — in particular, those that take on significant liquidity-providing roles in the markets — are now required to register with the SEC.
These participants will need to become members of a self-regulatory organisation (SRO) and comply with federal securities laws and regulatory obligations.
According to the SEC, principal-trading firms (PTFs) and other institutions are “acting in a manner consistent with dealers in the securities markets”.
At the time of adoption, SEC chair Gary Gensler said: “These measures are common sense. Congress did not intend for registration and regulatory requirements to apply to some dealers and not to others. Absent an exemption or exception, if anyone trades in a manner consistent with de facto market making, it must register with us as a dealer — consistent with Congress’s intent.”
The Associations’ complaint asserts that the rule upends the meaning of what constitutes dealer activity under the Securities Exchange Act of 1934 and “nearly a century of market practice”.
NAPFM, AIMA and MFA indicate that the Dealer Rule is “indeterminate” and “overbroad” in its definition, suggesting that it can capture a wide variety of non-dealing activity.
As a result, the three entities believe it could subject private funds to dealer registration to “an end-run around legislative intent”.
The Associations argue that the rule must be rescinded under the pretence that the US SEC engaged in “arbitrary and capricious decision-making”, including by failing to adequately address the economic consequences of the Dealer Rule.
In addition, the entities say that the US 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”.
Commenting on the lawsuit, president and CEO of MFA Bryan Corbett says: “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.”
He adds: “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.”
AIMA CEO Jack Inglis comments: “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 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.”
