PRIVATE FUND RULE
National Association of Private Fund Managers v SEC
Date: June 5, 2024
Issue: Whether the Securities and Exchange Commission (SEC) exceeded its statutory authority when adopting the Investment Adviser Act of 1940’s (Advisers Act) rules applicable to private fund advisers (Private Fund Rules).
Case Summary: In a unanimous 3-0 decision, a Fifth Circuit panel vacated the SEC’s Private Fund Rule, concluding the commission exceeded its statutory authority.
On Aug. 23, 2023, a divided SEC voted 3-2 to amend the Adviser Act’s rules to require private fund advisers to provide their investors with detailed disclosures regarding performances and fees. Under the Private Fund Rule, the SEC required private fund advisers to disclose when they granted preferential terms to certain investors. The Private Fund Rule also required fund advisers to provide quarterly statements disclosing to investors their performance and costs. Additionally, the Private Fund Rule required funds to undergo annual audits and obtain a fairness or valuation opinion before offering their investors an opportunity to sell their interests through secondary transactions.
A coalition of trade associations sued the SEC to enjoin the Private Fund Rule, arguing it would fundamentally change the way private funds are regulated in the United States. The trades also argued the rules exceeded the commission’s statutory authority, were adopted without compliance with notice and comment requirements, and were otherwise arbitrary, capricious, an abuse of discretion, and contrary to law under the Administrative Procedure Act (APA). At the outset, the Fifth Circuit determined the trades have Article III standing to sue because the Private Fund Rule regulates advisers, and each petitioner represents private fund advisers. The panel then ruled the SEC exceeded its statutory authority under the Advisers Act.
The Firth Circuit observed that the SEC enacted the Private Fund Rule citing Sections 206(4) and 211(h) of the Advisers Act as its rulemaking authority. On Section 211(h), the Fifth Circuit concluded that Congress purposely limited the SEC’s rulemaking authority, granted under Title IX of the Dodd-Frank Act, to relationships between investment advisers and “retail customers.” Because private fund investors are not “retail investors” due to their heightened level of sophistication, the Fifth Circuit found that Section 211(h) of the Advisers Act does not apply to private fund investors. In the Fifth Circuit’s view, Section 211(h) “has nothing to do with private funds,” and thus the SEC could not rely on it to regulate private fund advisers.
On Section 206(4), the Fifth Circuit concluded the SEC failed to adequately state a connection between the Private Fund Adviser Rules and fraud. The Fifth Circuit determined that: the new rules failed to define the fraud that they supposedly addressed; the SEC was aware of misconduct by only 0.05% of investment advisers; and a failure to provide the disclosures required by the new rules could not be fraud without an associated duty to disclose, which extends only to a fund and not to investors in a fund. Further, the Fifth Circuit reasoned the new rules were not “reasonably designed” because they failed to fit within the statutory design of the Advisers Act and the Investment Company Act of 1940.
Bottom Line: The SEC has not indicated whether it will seek a full panel rehearing (en banc), file a certiorari petition, or pursue a new rulemaking.
Documents: Opinion
