U.S. Court of Appeals Invalidates SEC’s Private Fund Adviser Rules

On June 5, the U.S. Court of Appeals for the Fifth Circuit vacated the U.S. Securities and Exchange Commission’s (“SEC”) 2023 Private Fund Advisers Rule (“Final Rules”), agreeing with petitioners that the SEC exceeded its statutory authority.

As background, on August 23, 2023, the SEC adopted new rules and amendments under the Investment Advisers Act of 1940 designed to increase the SEC’s ability to regulate private fund advisers [see here]. The Final Rules dramatically increased the compliance burdens on private fund advisers and called into question the legal distinction between regulated investment companies and private funds.

In its unanimous decision, the Court noted that “the Commission relies on preexisting anti-fraud rulemaking authority found in section 206 of the Advisers Act, [and also] cites section 913(h) of the Dodd Frank Act…” After extensive analysis, the Court noted that, “section 913 of the Dodd-Frank Act—the section the Commission relies on—applies to “retail customers,” not private fund investors.” Turning to and quickly dismissing the anti-fraud basis as “pretextual”, the Court stated that “the Commission cannot rely on section 206(4) for the authority to adopt the Final Rule.”

Finally, while there was speculation that the Court could split the difference, allowing certain provisions to stand while striking down the more specious provisions, the Court concluded by stating that, “[u]nder section 706 of the [Administrative Procedures Act, “APA”] , when a court holds that an agency rule violates the APA, it “‘shall’—not may—‘hold unlawful and set aside’ [the] agency action.” …. Because the promulgation of the Final Rule was unauthorized, no part of it can stand. Accordingly, we VACATE the Final Rule.”

What does this mean?

An SEC spokesperson said the Commission is reviewing the decision and will determine its next steps. It must be noted that this decision is only binding in the states of Louisiana, Mississippi and Texas (the Fifth Circuit) and that the SEC’s is free to enforce the rules elsewhere. We continue to cover this decision and its implications as events unfold. That said, whether binding or not, certain provisions in the Final Rules should be deemed best practices, and investment managers should evaluate accordingly.

On a final note, given that a number of proposed SEC rules rely, at least in part, on section 913(h) of the Dodd Frank Act (upon which the SEC relied in adopting the Final Rules) it remains to be seen what will become of these proposed rules.

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06.05.2024  |  PUBLICATION: BulletPoint  |  TOPICS: Investment Management

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