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Private Fund Advisors, Breathe Easier: Fifth Circuit Strikes Down Private Fund Rules | Knowledge

Private Fund Advisors, Breathe Easier: Fifth Circuit Strikes Down Private Fund Rules |  Knowledge
Private Fund Advisors, Breathe Easier: Fifth Circuit Strikes Down Private Fund Rules |  Knowledge


The United States Court of Appeals for the Fifth Circuit (Court), based in New Orleans, on June 5, 2024, released the new Private Fund Rules adopted by the SEC in August 2023, resulting in a significant victory for private fund advisors.1 The Private Funds Rules made fundamental changes to the activities and operations of private fund advisors by creating 1) the Preferential Treatment Rule, 2) the Restricted Activities Rule, 3) the Quarterly Statements Rule, 4) the advisor-led secondaries and 5) the audit rule.2 In September 2023, a group of private fund managers (the petitioners) filed a petition against the SEC claiming, among other things, that the SEC exceeded its statutory authority in formulating the Private Fund Rules to regulate private fund advisors and that the SEC is not authorized. to adopt the regulations for private funds.

The Court's opinion

In a unanimous opinion written by Justice Kurt D. Engelhardt, the Court's three-judge panel agreed with the petitioners' assertions and struck down the private fund rules entirely. The Court's decision relied on the interpretation of Sections 211(h) and 206(4) of the Investment Advisers Act of 1940 (Advisers Act) to determine that the SEC exceeded its authority in promulgating the rules of private funds.

The Court first considered whether the SEC had the authority under Section 211(h) to regulate private fund advisers. Section 211(h) was added to the Advisers Act by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) following the 2008 financial crisis It authorized the SEC to “promulgate rules prohibiting or restricting certain sales practices, conflicts of interest and compensation schemes for broker-dealers, broker-dealers and investment advisers that the SEC determines to be contrary to the public interest and the protection of investors. The court distinguished Section 211(h) from other sections of the Dodd-Frank Act that amended the Advisers Act to expand the SEC's regulatory authority over private fund advisers, including requiring the registration and imposing record-keeping requirements. The Court held that the Dodd-Frank Act “took only one step toward regulating the relationships between advisors and the private funds they advise” and that Congress decided not to impose specific regulations on private fund advisors like those imposed on funds that serve retail clients. The Court concluded that the SEC could not rely on Section 211(h) to promulgate the private fund rules because that section applies only to “retail customers.”

The Court also considered Section 206(4) of the Advisers Act, which authorizes the SEC to “define and prescribe means reasonably designed to prevent commercial acts, practices, and activities that are fraudulent, deceptive, or manipulative” in matters investment. advisors. The Court found that the SEC's reliance on Section 206(4) was “pretextual” and that it failed to establish a rational relationship between the private funds rules and how they would prevent fraud. . The Court explained that Section 206(4) does not authorize the SEC to impose information and reporting obligations on private fund advisors, which were exempt from the “prescriptive framework.” The Court reasoned that if Congress had wanted to impose these regulations on private fund advisors, it would have done so in law. Rather, the Court concluded generally that “by Congressional design,” private funds are exempt from regulation of their internal “governance structure.”

What happens next?

This Court decision came as a relief to private fund advisors who were rushing to understand the practical implications of the private fund rules and to implement policies to comply with the new rules. As the Court noted, the private fund rules would have cost $5.4 billion and required millions of employee hours. An SEC spokesperson said the SEC is reviewing the decision and will determine its next steps. The SEC could request a new hearing in bench before the whole Court. The SEC could also file a petition for certiorari before the U.S. Supreme Court.

Key takeaways

Despite the Court's decision, the overturned private fund rules may still have a significant impact on the operations of private fund advisors, for several important reasons:

  • First, the rules for private funds had important support from some sectors of the investment community, including state pension plans and some industry groups who filed an amicus brief in support of the rules. Some investors may seek, in their negotiations with private fund advisors, to obtain rights that would otherwise have been granted under the private fund rules. As a result, private fund rules could yet herald a significant change in market practices in the sector.
  • Additionally, private funds are expected to remain a continuing priority of the SEC. The SEC Division of Examinations has included private funds in its Priorities for the 2024 exams. Although the Court's general ruling may limit the tools available to the SEC to regulate certain market practices, the SEC indicated in the Rule Adoption Statement that certain practices contained in the Private Funds Rules may be necessary to comply with the fiduciary duties of an investment adviser under the Advisers Act. For example, the SEC indicated that the Quarterly Reporting Rule was intended to prevent fraudulent, deceptive, or manipulative practices observed by the SEC, including charging monitoring fees and other similar fees to portfolio companies without disclosing the fees. to investors. Going forward, it may be prudent for private fund advisors to continue to review their own policies and procedures in light of the principles reflected in the now vacant private fund rules.

The SECond Opinions blog will continue to monitor activity in this area and provide updates. If you need additional information on this topic – or any topic related to law enforcement or securities investigations – please contact the authors or other members of the defense team. securities application from Holland & Knight or the private equity team.


1 Nat'l Assoc. private fund managers. vs. DRYNo. 23-60471, 2024 WL 2836655 (5th Cir. June 5, 2024).

2 For a detailed summary of the private funds rules, see “Summary and Preliminary Analysis of the SEC's New Private Funds Rules.” Holland & Knight AlertSeptember 18, 2023.




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