On June 5, the Fifth Circuit Court of Appeals issued an opinion fully vacating a Securities and Exchange Commission (SEC) rule that would have significantly increased the regulatory obligations of private fund advisors in relation to fund investors. The SEC’s Private Fund Adviser Rules were adopted last August before being challenged by several private equity and hedge fund groups.
The Fifth Circuit determined that the SEC “exceeded its statutory authority” in adopting the rules and sided with the industry groups that argued the rules were not necessary for “highly sophisticated” private fund investors.
As we discussed in our alert last year, the Private Fund Adviser Rules imposed the following:
- Requirements to prepare and distribute quarterly statements
- Audit requirements
- Conditions to adviser-led secondary transactions
- Restrictions on certain activities, including recovery of expenses and borrowing arrangements with funds
- Restrictions on preferential treatment of fund investors
In rejecting the SEC’s argument that it had the authority to adopt these rules under Sections 206(4) and 211(h) of the Advisers Act, the Court determined that those provisions only apply to retail customers, that the rules’ anti-fraud measures were merely “pretextual,” and that the SEC failed to articulate a “rational connection” between fraud and any part of the final rules.
It is unclear whether the SEC will appeal the decision to the U.S. Supreme Court.
