WASHINGTON (HedgeWorld.com)–Laying great stress, in the manner of Sherlock Holmes, on the issue of silence–as in that of a certain dog in the night–the petitioners in a lawsuit seeking to have the Securities and Exchange Commission’s hedge fund registration rule vacated have filed a reply to the SEC’s brief defending the lawfulness of its rule.

There are three petitioners: Phillip Goldstein; Kimball & Winthrop Inc., of which Mr. Goldstein is president and 50% shareholder; and the hedge fund Opportunity Partners LP, Pleasantville, N.Y., of which Kimball & Goldstein is general partner.

Their latest brief asserts that the issue has narrowed, because the SEC, in its brief, conceded an important point, or, perhaps, two important points, by its tactical silence.

The petitioners argue in the June 3, 2005 filing, as they have before, to the U.S. Court of Appeals for the District of Columbia, that the hedge fund rule requiring most managers to register as investment advisers as of Feb. 6, 2006, is invalid because it requires the registration of private investment entities that Congress has exempted from that obligation. They also respond to the SEC claim, in a brief filed May 18, that the statutory exemption at issue, which covers entities with fewer than 15 clients, is ambiguous as to how to count clients, and that the ambiguity justifies the agency in a rule clarifying its meaning.

The SEC rule imposes the registration requirement on most hedge funds by “looking through” a pooled investment vehicle as the “client” of an adviser and counts each contributor to that pool as one.

The petitioners, in their latest filing, write that they had expected the SEC’s brief to argue that the holders of securities in the pooled investment funds are, in fact, the clients of the advisers of those funds. But, to borrow from the Sherlock Holmes tale “Silver Blaze,” that dog didn’t bark, and petitioners perceive great significance in its silence.

The SEC “effectively concedes that security holders are not clients, emphasizing, among other things, that hedge fund advisers do not owe fiduciary duties to the security holders of the fund,” the petitioners argue. The SEC contends, instead, that the agency is authorized to count certain investors “as if” they are clients of certain advisers, for policy reasons, even though in fact they aren’t. “The SEC’s clarification of its position has sharply narrowed the legal issue before this Court,” the petitioners assert.

On that narrow issue, the brief contends, the court should take the side of plain language and understand client to mean “client” without any as ifs. Counting “is not an inherently ambiguous process,” and the SEC claims no “special expertise in counting.”

In the adopting release, the SEC described a supposed loophole that it believed it needed to close, with this scenario: “an adviser with, for example, 15 clients and $100 million in assets under management can take those client assets, move them into a hedge fund it advises and, because the adviser now has but one client, withdraw its Advisers Act registration.” That sentence was followed by a footnote citation to SEC v. Gary Smith (1995). That case was an enforcement action over events in which the defendant had persuaded a client to place assets into trusts so the defendant could avoid registration. The Goldstein petitioners view the case as irrelevant; they argur that no one ever created a hedge fund for that reason.

The petitioners’ reply brief (in another of its Conan Doylesque moments) says that the SEC brief before the appeals court differs from the adopting release in one important aspect: it neglects to mention the Gary Smith case at all. Apparently, the brief argues, the SEC has realized “that the Gary Smith case had nothing to do with an investment entity or herding clients into an investment entity” and has “abandoned any suggestion now that such herding has ever occurred?? 1/2 .”

CFaille@HedgeWorld.com

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.