In a case with significant implications for the asset management sector, the US Court of Appeals for the Fifth Circuit has today struck down the SEC’s rules on private fund advisers, concluding that
“[the SEC] has exceeded its statutory authority in adopting the Final Rule … Because the promulgation of the Final Rule was unauthorized, no part of it can stand.”
What’s happened?
On 23 August 2023, by a 3-2 majority, the SEC published an Adopting Release, which set out a series of rules and amendments (the PFA Rules) made under the Investment Advisers Act of 1940. (See here for our summary of the Adopting Release.)
From their outset, the PFA Rules were controversial and, on 1 September 2023, just over a week after the Adopting Release was published, a number of trade associations filed a petition in the US Court of Appeals for the Fifth Circuit in an attempt to have the new rules vacated.
The Petition argued, among other things, that:
the SEC exceeded its statutory authority in making the rules
the rules are ‘arbitrary, capricious and unlawful’
the SEC failed to set out evidence of the problem it was supposedly addressing and
the public was denied a proper opportunity to comment on the draft rules published by the SEC in February 2023.
What has the Court decided? And what does this mean in practice?
After consideration of the Petitioners’ and Respondent’s cases, the Court has decided to vacate (i.e., strike down) the SEC’s final rules in full.
This, of course, means that the rules will not apply as the SEC had planned.
We will be reviewing the judgment in detail and will be monitoring whether the SEC now appeals (or introduces different rules in due course). Further reports will follow.
What are the PFA Rules?
In very broad terms, the PFA Rules consist of:
the Preferential Treatment Rule - this requires all investment advisers to disclosure certain preferential terms which are offered to prospective and current investors and, in some cases, prohibit advisers from providing certain types of preferential treatment that would have a material, negative effect on other investors
the Restricted Activities Rule - this prohibits all investment advisers from engaging in certain activities unless these have been disclosed to investors (and in some cases, investor consent has been obtained
the Quarterly Statement Rule - SEC-registered investment advisers are required to provide certain disclosures regarding fees, expenses, performance and adviser compensation in quarterly statements to fund investors
the Audit Rule - SEC-registered investment advisers must obtain a financial statement audit of each advised private fund
the GP-led Secondaries Rule - this requires SEC-registered advisers to obtain an opinion on fairness or valuation from an independent opinion provider in respect of an adviser-led secondary transaction and
the Books and Records Rule - this introduces new recordkeeping requirements in respect of of the above rules under Rule 204-2 of the Advisers Act.
