Adios, Private Fund Rules
-- by Molly Tranbaugh
You know all those new private fund rules the SEC threw at us last year? The Fifth Circuit recently struck down the rules in their entirety. Let’s talk about what this means for you and your fund.
The Rules. In August 2023, the SEC adopted sweeping new rules governing private fund advisers. The rules would have subjected advisers to significant new requirements, such as heightened disclosures to investors (including some side letter provisions and detailed expenses), prevented advisers from granting certain redemption rights and information rights to LPs, and imposed further requirements around reporting, audits, secondary transactions, and recordkeeping. Most of the rules would have required compliance by March 2025, with some as soon as September 2024 for advisers with over $1.5 billion assets under management.
The Decision. The rules were immediately and widely criticized by investment advisers and industry groups who argued that they were overly burdensome and that compliance would be too expensive for private funds. A group of trade associations challenged the rules in the U.S. Court of Appeals for the Fifth Circuit (that’s Texas), mainly arguing that the rules exceeded the SEC’s authority. Last month, the Fifth Circuit issued its decision. The Court agreed with the challengers and unanimously vacated the rules in their entirety. The Court found that the statutory authority claimed by the SEC when adopting the rules did not actually give the SEC the right to regulate private funds, holding that section 211(h) of the Advisers Act “has nothing to do with private funds” because it only applies to “retail customers.” Nor could the SEC rely on its general antifraud authority under section 206(4). The SEC would have had to show fraudulent activity among private fund advisers before adopting rules regulating that activity. Instead, the SEC presented almost no evidence of fraud (the SEC had only observed misconduct in roughly 0.05% of advisers).
What Happens Next? The SEC has a few options from here. The Fifth Circuit’s decision was unanimous, making it unlikely to grant a request for a rehearing, but the SEC can appeal the decision to the Supreme Court within 90 days of the Fifth Circuit’s decision. We could hear from the Supreme Court in the fall on whether it will take the case, depending on when the SEC files its petition in that 90-day period. The SEC may also try to address the conduct that the rules were designed to prevent through examination and enforcement efforts or by proposing new rules. However, given the Fifth Circuit’s unanimous and decisive ruling, any new rules would likely be much narrower than those adopted last year.
What Does This Mean For Your Fund? Although the SEC may appeal the decision, for now, the rules have been vacated in their entirety and are no longer in effect, providing fund advisers with a reprieve from compliance. We have yet to see the impact the vacated rules will have on market practices, particularly while any appeals are pending, and investors may request that certain provisions of the rules are incorporated into fund documents regardless of the outcome in the courts. Funds may also consider adopting some of the requirements that the rules would have imposed as best practice or to reduce the risk of SEC enforcement actions. On the other hand, advisers currently negotiating their documents with investors will have a good argument to hold off on incorporating the rules given the possibility of an appeal and potential new proposed rules from the SEC. These decisions will need to be assessed with fund counsel in light of the provisions at issue, investor dynamics, and the best interests of the fund. Ultimately this is a developing area while litigation is pending and the SEC regroups after the Fifth Circuit’s decision.
