In a setback to the Securities and Exchange Commission, a federal appeals court on Friday overturned a rule bringing hedge funds under new supervision by the agency.

The decision by the U.S. Court of Appeals for the District of Columbia Circuit sent the rule — which bitterly divided the five-member SEC when it was adopted in October 2004 — back to the agency to be reviewed.

The SEC rule for hedge funds, which are high-risk, largely unregulated and secretive investment pools, took effect on Feb. 1.

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Hedge funds have traditionally been the investment domain of the wealthy but have become popular with smaller investors in recent years. Today some 7,000 hedge funds in the United States command an estimated $750 billion to $1 trillion in assets and leave a wide footprint in the financial markets, as they are believed to account for as much as 20 percent of all U.S. stock trading.

Regulators' concern about the funds' explosive growth and virtually unbridled operations prompted the SEC rule, which requires most hedge-fund managers to register with the agency. That opens the funds' books to SEC examiners.

But the appeals court, in its decision Friday, called the SEC rule "arbitrary." The agency failed to make a compelling case for the necessity of the rule, the court said.

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