Court rejects hedge-fund disclosure rule

A federal Appeals Court yesterday struck down a disputed hedge-fund disclosure rule, calling it ``arbitrary" and ill-conceived by the Securities and Exchange Commission.

The blunt decision marked a victory for some in the world of private investments who had opposed the rule issued under a former SEC chairman, even as opposition has died down more recently. The rule was meant to provide more disclosure about advisers who manage hedge funds, loosely regulated investment vehicles whose popularity has soared to around $1.5 trillion in assets worldwide in recent years.

Massachusetts in particular has become a center for hedge funds, according to recent filings resulting from the rule that showed more than $150 billion of such ``private investments" are managed here.

Those filings might cease if the defeated rule isn't revived or the court's decision appealed by the current SEC chairman Christopher Cox and other commissioners. The former Republican congressman already must determine what to do with several other disputes left over by his predecessor William H. Donaldson.

In their unanimous decision, a three-judge panel of the US Court of Appeals for the District of Columbia agreed that hedge funds are ``notoriously difficult to define" but wrote the SEC had incorrectly analyzed the relationship between hedge fund advisers and investors.

Specifically, the decision scrutinized the SEC's goal of protecting small investors now tempted by the hedge funds' potentially big returns. Unlike more common mutual funds, hedge funds often use risky strategies like short-selling and charge big management fees. Previously their advisers were exempt from disclosing much about themselves if they had fewer than 15 clients and didn't advertise.

The new rule stated that investors in a particular fund could be counted as clients of the adviser, making it harder to claim the exemption. But the SEC had no data to back up its view that the rise of hedge funds had changed the relationship between advisers and investors, the court wrote. Without evidence, the judges wrote, ``there is a disconnect between the factors the commission cited and the rule it promulgated."

The SEC's Cox and the four other commissioners must now decide whether to revise the rule, drop it, or appeal the decision. Cox said in a statement he has told the agency's staff to review the decision. In previous interviews he has spoken of trying to reach more consensus decisions by the agency, but that will be difficult in this case where the body still includes both a strong past supporter of the rule, Democrat Roel C. Campos, and a vocal opponent, Republican Paul S. Atkins.

The court's action came in response to a suit filed by New York investment adviser Phillip Goldstein, and the industry's main trade group, the Managed Funds Association, had actively lobbied against the rule at the time.

Not all hedge fund advisers opposed it, however, and in an interview yesterday the group's president, John G. Gaine, declined to praise or criticize the ruling. He said the association is now focused on other issues. Even if the SEC manages to revive the rule, Gaine said, ``This is something we could live with either way."

Ross Kerber can be reached at kerber@globe.com.