September 6, 2023
On September 1, 2023, six private equity and hedge fund trade groups sued the SEC to block new private fund reforms adopted in August. The suit was filed in the Fifth Circuit Court of Appeals and argued that the SEC overstepped its statutory authority by adopting sweeping changes with these new rules for private funds. For more on the private fund reforms see the SEC press release and our prior coverage.
These reforms faced headwinds from the beginning. It was a divided SEC that voted to adopt them: two dissenting commissioners pointed to the harm these reforms would cause to investors, competition, and the ability to contractually negotiate terms. Bryan Corbett, CEO of the Managed Funds Association (MFA) pointed to the increased costs for investors, undermining of competition, and reduction of investment opportunities as well.
The new rules for registered private fund advisers include providing quarterly statements to fund investors; completing annual audit requirements for each private fund; a requirement for adviser-led secondary transactions to obtain a fairness opinion or valuation opinion in connection with the transaction; and strict disclosure and consent requirements for a number of activities. Though the proposed prohibitions were softened in the final rules to “restricted activities” which could still be done with proper disclosure and meeting strict requirements, this softening was not enough to avoid a suit. The suit seeks to vacate the rules because they “exceed the Commission’s statutory authority, were adopted without compliance with notice-and-comment requirements, and are otherwise arbitrary, capricious, an abuse of discretion, and contrary to law, all in violation of the Administrative Procedure Act.”
SEC Chair Gary Gensler cited the rapid growth and increased influence of the private fund industry as the need for reforms that bring more transparency and competition. In response to the suit, an agency spokesperson said the Commission “undertakes rulemaking consistent with its authorities and laws governing the administrative process, and we will vigorously defend the challenged rule in court.”
What does this mean for me?
These reforms are in keeping with the SEC’s trend of increased regulatory attention to private funds, and the SEC’s quick pace of new rulemaking. The Fifth Circuit has been a friendly judicial venue for the industry. While the suit may or may not succeed in vacating all or a portion of these new rules, given the record of prior rulemakings, regulatory attention to private funds is not likely slow down.
An 18-month transition gives plenty of time to prepare and react to any changes that the outcome of this suit may bring. Compliance programs should start preparing now to be ready when the compliance date arrives.
Contact us if you have any questions or would like additional information about maintaining your compliance program.