A consortium of groups representing the hedge fund industry and other investment companies has filed a lawsuit against the U.S. Securities and Exchange Commission (SEC) regarding new rules that mandate the disclosure of information related to securities short sales and lending. The lawsuit claims that the rules will discourage short selling and harm market participants.

The rules approved by the SEC in October require certain fund managers to report their short sales to the SEC within 14 days of the end of the month. The agency would then aggregate and publish the data on a delayed basis, while keeping the fund manager information confidential. Additionally, the rules require financial companies facilitating securities loans to disclose transaction information to the Financial Industry Regulatory Authority (FINRA) on a daily basis.

According to the lawsuit, the disclosure rules would reveal confidential trading strategies and enable market participants to imitate or trade against funds employing a short-selling strategy. The plaintiffs argue that these rules will impair market efficiency, hinder price discovery, and ultimately harm market participants and investors.

Jack Inglis, CEO of the Alternative Investment Management Association, one of the groups involved in the lawsuit, expressed concern about the potential negative impact of the rules. Inglis stated, "The rules will impair market efficiency and price discovery and harm market participants and investors."

The lawsuit highlights a perceived contradiction between the two rules. While one acknowledges the potential harm of frequent and detailed disclosures about short sale activity, the other requires daily public disclosure of individual transaction information, which could be used to identify funds holding a specific short position.

The lack of transparency surrounding short selling has been a contentious issue, exemplified by the meme-stock craze of 2021. The market frenzy around GameStop Corp. was fueled by data revealing heavy shorting by institutional investors. The situation attracted attention when it was discovered that more than 140% of all outstanding shares of the company were being shorted, leading to accusations of illegal "naked" short selling.

MarketWatch reported in January that while naked short selling is mostly banned in the U.S., some brokers find ways to circumvent regulations to lend out shares they don't own, as the securities lending business can be lucrative. The issue of naked short selling has also made headlines earlier this year, with small-cap companies raising concerns about their share prices being artificially suppressed by illegal trading activity.

The outcome of the lawsuit filed by the consortium against the SEC will be closely monitored by market participants and investment firms as it could have significant implications for short-selling strategies and the disclosure of related information.