Hedge funds are suing the SEC over its 'contradictory' short-selling regulations

• A group of hedge fund organizations filed a lawsuit against the Securities and Exchange Commission.
• It argues that the SEC's new rules concerning short-selling activity are "contradictory."

A group of three hedge fund organizations has filed a lawsuit against the Securities and Exchange Commission over recent regulations pertaining to short-selling transparency.

The coalition is asking the 5th US Circuit Court of Appeals to invalidate two rules the SEC introduced in October, saying that they are arbitrary and potentially confusing.

"As noted in the petition, despite finalizing the two closely related rules on the same day, the SEC disregarded the interconnectedness of the rules and adopted vastly different reporting requirements," a press release said. "As a result, the rules would apply contradictory and incoherent approaches to two aspects of the same underlying transaction: the short sales themselves and the loans of securities to facilitate those short sales."

Essentially, one rule requires individual reporting for securities loaned to short sellers, with the data then made public the following business day.

The other rule asks some institutional investors to report their short-selling activity, which is then publicized in an aggregated and delayed form with involved names kept anonymous.

The lawsuit also argued that the frequent disclosures could reveal confidential investment strategies, and potentially lead to retaliation against market participants.

"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," said Bryan Corbett, president of the Managed Funds Association, in the press release.

In a statement to Business Insider, the SEC said, "the Commission undertakes rulemaking consistent with its authorities and laws governing the administrative process, and we will vigorously defend challenged rules in court."

Short sellers, or investors who bet that an asset's price will drop, have long generated controversy in financial markets. More recently, scrutiny of the practice flared up in 2021, when retail investors decided to pump up meme stocks such as GameStop to disrupt short positions.