Victory For Private Fund Managers: SEC’s Private Fund Rules Vacated by Fifth Circuit Appeals Court

Posted on Jun 6, 2024 by Kamden Crawford

Yesterday, a significant win for private fund managers emerged from the U.S. Court of Appeals for the Fifth Circuit (“Fifth Circuit“) when a three-judge panel unanimously overruled the Security and Exchange Commission’s (“SEC“) private fund rules passed in August (“Private Fund Rules“). These rules expanded oversight over private funds by restricting certain activities, prohibiting preferential treatment, requiring quarterly statements and annual audits, and adding requirements for adviser led secondary transactions. A summary of the Private Fund Rules can be found here.  

Key Points from the Ruling

The Fifth Circuit grouped all five of the Private Fund Rules together to overrule them in their entirety. Here are the main takeaways of the opinion: 

  1. Improper Authority: The SEC adopted the Private Fund Rules under Section 913(h) of the Dodd-Frank Act (embedded in Section 211(h) of the Advisers Act) and the antifraud rulemaking authority in Section 206 of the Advisers Act. However, the Fifth Circuit found that these sections have “nothing to do with private funds”. The Fifth Circuit based its decision on interpretation of Section 211(h) which they found applies to retail customers, not private fund investors. 
  2. Lack of Basis: The Fifth Circuit found the Private Fund Rules to be pretextual and that the SEC lacked factual basis for the Private Fund Rules. This is because the SEC failed to establish a rational connection or close nexus between any fraud and the Private Fund Rules.
  3. Misalignment with Congressional Intent: The Fifth Circuit found that the Private Fund Rules do not fit within the current statutory design. This is because the Investment Company Act exempts private funds from registration, such as under Sections 3(c)(1) and 3(c)(7). Accordingly, the Fifth Circuit concluded that the SEC cannot regulate the internal governance of private funds, as this contradicts congressional intent.
  4. Misconception of Fraud: Furthermore, the Fifth Circuit determined that the SEC conflates nondisclosure with fraud, finding that nondisclosure cannot be fraudulent without a duty to disclose. The Fifth Circuit clarified that an adviser’s duty to disclose extends to the fund alone and not to the investors in the fund.
What does this mean moving forward?

 The Fifth Circuit’s opinion signals a significant roadblock in the SEC’s attempt to expand its oversight over private funds, handing a notable victory to private fund managers. However, this is far from the end of the Private Fund Rules. First, the decision only applies to the Fifth Circuit, meaning private fund managers outside of the Fifth Circuit should continue to exercise caution. Second, the SEC can ask Fifth Circuit to rehear the case en banc or can petition the Supreme Court to consider the case. The SEC has not commented at this time and has yet to indicate which, if any, action it will take in response to the decision. 

This ruling underscores ongoing legal debates surrounding regulation of private funds and could shape the future landscape of oversight in the future. We will continue to monitor any further developments. Stay tuned for further updates.