Fifth Circuit Sends Back SEC Short Sale Rule

Legal Alert
Baker Donelson (original publication)
By Paul Turner and Peyton Lacoste
October 1, 2024

Fifth Circuit Vacates and Remands SEC Short Sale Disclosure Rule

(Originally published by Baker Donelson.)

Summary

In a decision that could reshape how securities lending and short sale market transactions are disclosed, the U.S. Court of Appeals for the Fifth Circuit returned two key Securities and Exchange Commission (SEC) rules, citing the agency's failure to assess their cumulative economic impact. Affected entities should monitor the SEC's response and consider submitting additional comments during any reopened rulemaking period. Legal and compliance teams may also want to reassess internal reporting systems in anticipation of potential changes to disclosure requirements.

Ruling

In National Ass'n of Private Fund Mgrs. v. SEC, the Court addressed challenges to two SEC rules—the Securities Lending Rule and the Short Sale Rule (together, the Rules). The Rules sought to increase transparency within their respective markets. The Court remanded the matter to the SEC for further proceedings, finding that the agency failed to consider and quantify the cumulative economic impact of the Rules on market participants subject to both.

Background

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), Congress provided the SEC additional rulemaking authority aimed at increasing transparency in securities lending and short sale markets, including reporting of related transaction information.

On November 18, 2021, the SEC proposed the Securities Lending Rule, under which securities loan transactions must be reported contemporaneously to the Financial Industry Regulatory Authority (FINRA), with additional information about the size of each individual security loan provided later.

Shortly thereafter, the SEC proposed the Short Sale Rule, requiring institutional investment managers to report and publish aggregated short sale information monthly through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system. After notice-and-comment, the SEC adopted final rules on October 13, 2023, which became the subject of the appeal.

The Appeal

The National Association of Private Fund Managers and other petitioners challenged the Rules on multiple grounds, including statutory authority under Dodd-Frank, APA process claims, and the SEC’s decision not to evaluate cumulative economic impacts despite overlapping applicability.

The Court upheld the SEC’s authority to promulgate both rules and found the SEC provided adequate notice and comment. But because the SEC adopted the rules simultaneously and they regulate overlapping market activities, the Court treated them as interrelated rules requiring assessment of combined effects—which the SEC failed to do. The Court remanded both rules for further economic analysis.

Key Takeaways

• The Fifth Circuit’s decision focuses on the SEC’s rulemaking process and economic analysis rather than categorically rejecting short sale reporting.
• The SEC may seek to re-propose or revise the rules, potentially with additional justification or adjustments to scope and burden.
• Market participants should stay engaged in the rulemaking process and be prepared for renewed short sale reporting requirements in some form.