July 25, 2024
What happened?
July 22, 2024, was the deadline for the SEC to petition the Fifth U.S. Circuit Court of Appeals to review its landmark decision that vacated the Private Fund Rules, and the SEC let this deadline pass. It appears the SEC will not attempt to relitigate the decision.
The Fifth Circuit decision held that the SEC exceeded its statutory authority when it adopted the package of Private Fund Rules which included: the Preferential Treatment Rule; the Restricted Activities Rule; the Quarterly Statement Rule; the Adviser-Led Secondaries Rule; and the Mandatory Fund Financial Statement Audit Rule.
The SEC still has the option of appealing to the U.S. Supreme Court to pursue this rulemaking. However the court’s conservative lean and recent decisions against the SEC make that option challenging. The SEC also has to endure the recent loss of Chevron Deference and the limitations on administrative proceedings in Jaresky. The loss of Chevron Deference could lead to more industry-backed efforts to weaken the SEC’s regulatory authority and curb future rulemaking through court challenges.
Even though the SEC was found to have exceeded its Congressional mandate in making the Private Fund Rules, there are still tools that the SEC can use to regulate advisers of private funds.
What does this mean for me?
First, the requirement for all registered investment advisers to document a written annual review under 206(4)-7 of the Advisers Act still stands. While the rules for private fund advisers were vacated, the consensus is that this Adviser Act amendment remains intact. The SEC has plenty of authority under the Advisers Act, and the written review requirement was not mentioned alongside the Private Fund Rules in the Fifth Circuit decision.
Second, the SEC made it abundantly clear that it takes issue with private fund activities that involve conflicts of interest or compensation schemes the SEC deems contrary to the public interest. If it is restrained from making new rules, this could mean a shift to regulate by enforcement.
Remember that the SEC declined to adopt two rules from the original proposal. The reasons for leaving these out could be a picture of things to come. Rules on Fees for Unperformed Services and Adviser Limitations on Liability were proposed but not adopted. The SEC staff stated that advisers have a fiduciary duty to private fund clients and the antifraud provisions apply to an adviser’s dealings with clients and fund investors. Rather than make those rules, the SEC would simply litigate such behavior under existing law.
The good news is that the Private Fund Rules appear to be dead. The bad news is that the SEC may bring more enforcements against private fund advisers for the same activities. Even though the rules were vacated, we may see the SEC lean on existing requirements for registered investment advisers to regulate private fund activities.
We will continue to monitor legal challenges, proposed rules, and agency actions that impact compliance programs. If you have any questions, or if you would like to speak with one of our regulatory experts, let us know.
