On June 5, 2024, the Fifth Circuit Court of Appeals overturned the SEC’s New Private Fund Rules introduced in August 2023 (the “Private Fund Rules”). Given that the Private Fund Rules imposed several limitations and prohibitions that ran counter to the fundamental principles of a private fund, this was a significant victory for private fund advisers.
The Fifth Circuit found that the SEC exceeded its statutory authority under Section 211(h) and Section 206(4) of the Investment Advisers Act of 1940 in adopting the Private Fund Rules and vacated them in their entirety, including:
- the quarterly statements rule;
- the audit rule;
- the restricted activities rule;
- the adviser-led secondaries rule; and
- the preferential treatment rule.
The Annual Review and Quarterly Statements Rules would have required private fund advisers to furnish investors quarterly statements of fund performance, associated fees, and expenses in much greater detail. The Private Fund Audit Rule would have required advisers to perform a costly annual audit of private fund statements and provide investors with that information.
The final SEC Rules would have also disallowed certain practices such as prohibiting private fund advisers from charging certain fees and expenses, together with borrowing funds from or extending credit to a client. Also, to curb any preferential treatment, the SEC sought to prohibit advisers from using “Side Letters,” barring them from providing certain fund investors with different or more advantageous terms than other investors in that private fund.
The Adviser Led Secondaries Rule would have required advisers to obtain a fairness or valuation opinion in connection with secondary transactions. Furthermore, advisers would have needed to disclose any material business ties with the entity providing the opinion.
When the SEC’s Private Fund Rules were finalized in August 2023, they received immediate backlash from the industry. A lawsuit was filed against the SEC in September 2023 in a coordinated legal action by business associations such the Alternative Investment Management Association (AIMA), the Managed Funds Association (MFA), and the National Association of Private Fund Managers (NAPFM).
Private fund managers argued that the new rules significantly raised the costs of meeting compliance requirements and added operational burdens, such as having to file quarterly statements. In addition, fund managers alleged that the SEC did not have the authority to enforce those rules.
The Fifth Circuit Court of Appeals ultimately agreed with the industry and held that the SEC had indeed exceeded its authority and had no basis for the rules.
According to a Reuters article on this update, the SEC said that the goal of the private fund rules was to increase transparency to protect ordinary investors who are indirectly affected by what goes on in the private fund world. However, the Circuit Judge disagreed with this and with the SEC’s use of the Dodd-Frank Law, stating that it applied to retail investors, not private fund investors, and was therefore not applicable. The SEC is yet to respond to the judgment.
With the SEC Private Fund Rules vacated, the SEC has various options including abandoning the final rules, seeking en banc review with the full Fifth Circuit, or appealing the Fifth Circuit’s decision to the Supreme Court. Given the time required for the Supreme Court to consider and act (or decline to act) on any petition by the SEC for review, it is estimated that the final rules will remain vacated for at least twelve (12) months. To the extent that the Fifth Circuit’s decision is not set aside by the full Circuit Court or overruled (or not accepted for review) by the Supreme Court, none of the elements of the Final Rule will be binding on private fund advisers.
Jacko Law Group works with private fund managers to ensure they meet compliance requirements and are aware of any updates or changes to regulation.
If you have any questions about this new decision and what it means for your compliance requirements, please call us at 619.298.2880 or email [email protected].
