Meme Stocks Alert: Hedge Funds Are Suing the SEC Over Short-Selling Rules

A coalition of three hedge fund associations, including The Managed Funds Association, the Alternative Investment Management Association, and the National Association of Private Fund Managers, has filed a lawsuit against the Securities and Exchange Commission (SEC) challenging two new short-selling rules implemented in October. They argue that the rules are "arbitrary and capricious," conflicting, and violate the Administrative Procedure Act.

Short-Selling Rules in Question
The first rule requires securities lenders to report individual loans to the Financial Industry Regulatory Authority (FINRA). Simultaneously, the second rule mandates certain institutional investors to disclose short-selling information, to be publicly released on an aggregate basis 14 days after each month.
The group claims that the SEC, in one rule, acknowledges and protects the anonymity of short sellers, recognizing their role in liquidity and price efficiency. However, in the other rule, it exposes confidential securities lending and position information on a detailed level.

Background on Short Selling and Meme Stocks
The surge in GameStop's stock in early 2021 brought short selling into the mainstream. With GME's short interest peaking at 140%, retail investors questioned the possibility of naked short selling. This event heightened interest in meme stocks, those gaining popularity on social media.

Market Efficiency Concerns
The hedge fund associations argue that these rules could hinder market efficiency and price discovery. Market efficiency, the belief that current prices reflect all available information, is facilitated by short selling, allowing for effective price discovery.

SEC's Response
In response, the SEC defends its rulemaking authority, stating that it acts consistently with governing laws and will vigorously defend the challenged rules in court.

Legal Venue and Potential Implications
The lawsuit was filed in the 5th U.S. Circuit Court of Appeals, known for its conservative stance. This choice may be influenced by the National Association of Private Fund Managers operating in Texas, covered by the 5th circuit.