SEC Private Fund Rule Struck Down by US Appeals Court

A U.S. appeals court struck down a newly adopted Securities and Exchange Commission (“SEC”) rule implementing a series of new disclosure requirements and restrictions on private fund advisors. On June 5, the U.S. Court of Appeals for the Fifth Circuit in New Orleans (the “Fifth Circuit”) sided with six private equity and hedge fund groups in ruling that the SEC exceeded its authority to issue these rules under both Section 211(h) (as added by Dodd-Frank Act Section 913) and Section 206(4) of the Investment Advisers Act of 1940.¹ 

The SEC argued that Congress gave it authority through the 2010 Dodd-Frank Act to implement the rule to protect investors. The private equity and hedge fund groups challenging the new rule argued the SEC overstepped its statutory authority when enacting the rule. Ultimately, the Fifth Circuit sided with the private equity and hedge fund groups, halting the enforcement of the rule for private equity and hedge funds across the country.

Writing for the three-judge panel, Judge Kurt D. Engelhardt said, “While the Dodd-Frank Act expanded the Commission’s oversight in many respects, it did not do so to the extent the Commission argues [in this case].”

Notably, the Fifth Circuit found that the SEC also lacks the rulemaking authority under Section 206(4) of the Investment Advisors Act. A majority of rules adopted under the Investment Advisers Act are adopted on the basis of the anti-fraud rulemaking authority of Section 206(4). Thus, the Fifth Circuit’s decision, if left unchallenged, could have ramifications on current and future rulemaking.

In August 2023, the SEC adopted new rules and rule amendments to update regulations of private fund advisers and update the existing compliance rule that applies to all investment advisers. The final rules required private fund advisers registered with the SEC to provide investors with quarterly statements detailing certain information regarding fund fees, expenses, and performance. In addition, the final rules required a private fund adviser registered with the SEC to obtain and distribute to investors an annual financial statement audit of each private fund it advises and, in connection with an adviser-led secondary transaction, a fairness opinion or valuation opinion. The rule prohibited certain side letter practices used by fund managers to give some investors preferential treatment for redemptions and special access to information on portfolio holdings. This rule applied to all private equity funds, hedge funds, venture capital funds, and managers of funds for institutional investors.

A spokesperson for the SEC said the agency is reviewing the decision and will determine its next steps. The SEC can seek further review of the panel’s decision, but either the full Fifth Circuit or the Supreme Court would have to exercise discretion to hear the case. The SEC could also propose new rules or re-open the existing rulemaking, which would very likely be subject to a renewed challenge. The rules will be vacated when the Fifth Circuit issues a formal order to the SEC unless the SEC seeks emergency relief that delays the implementation of the decision. If the SEC does not obtain such relief, then the rules are expected to be vacated prior to the September compliance dates.

_{¹National Association of Private Fund Managers v. Securities and Exchange Commission, 5th Cir. No. 23-60471.}