Judges on the U.S. Court of Appeals in Washington on Friday took lawyers for the Securities and Exchange Commission to task over some language included in the regulator's controversial hedge fund registration rule and it might be good news for the plaintiff.

Phillip Goldstein, managing partner of the New York hedge fund Opportunity Partners, is suing to have the rule overturned. Goldstein claims the SEC is overstepping its jurisdictional boundaries by making it mandatory that hedge funds to register like any other investment adviser. He also believes that the SEC misunderstood a law that places hedge funds under exemption in regards to registering, and furthermore, he claims that the SEC made procedural mistakes when adopting the rule.

Deadline for compliance with the rule, which also gives the SEC new authority to examine the operations of hedge funds, is Feb. 6, 2006. Hedge funds can still get out of registering if they manage less than $25 million or have fewer than 15 investors. They can also skirt the rule if they "lock-up" investors' funds for a minimum of two years.

In court last week, however, two judges scrutinized the SEC's attorneys over the legal definition of the word "client," Reuters reported. The new SEC rule closes a registration loophole, where hedge funds would count each fund under management as a client, versus each individual investor as a client. The distinction is important because Congress, as the New York Sun observed, has never authorized the SEC to register hedge funds, but it has instructed it to police investment advisers with more than 15 investors.

"You can't just come in here and say we're going to make 'client' mean whatever we want because we're the [SEC]," Judge Harry Edwards told the defense. "We have to test your thesis and your thesis doesn't stand up."

The SEC says the individual is the client.

Leaving the courtroom, Goldstein said, "I thought it went pretty well."

Eugene Scalia, who is representing the U.S. Chamber of Commerce in its fight to overturn the SEC's equally controversial independent chairman rule, said, "My sense of this case was that if the court homed in on the definition of 'client,' that could mean trouble for the SEC and that's what the court did."

An opinion on the rule is expected in the next four to six weeks.

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