In a unanimous decision on June 5, 2024, the Fifth U.S. Circuit Court of Appeals (the (“Court”) vacated the new rule and compliance requirements that the SEC imposed on private investment funds in August 2023.
Background
On August 23, 2023, the United States Securities and Exchange Commission (“SEC”) adopted new rules and amendments under the Investment Advisers Act of 1940 (“Advisers Act”) including the preferential treatment rule, the restricted activities rule, quarterly statement rule, adviser-led secondaries rule, audit rule, and the amendment to compliance procedures and practices (the “Final Rule”). The SEC relied on its authority under the Advisers Act in adopting the Final Rule in an effort to protect private fund investors and make the private funds market more transparent, competitive and efficient. See https://www.apm.law/new-sec-rules-aim-to-protect-private-fund-investors.
Court’s Decision
In the June 5th decision, the Court reasoned that the SEC lacks statutory authority to issue the revised rules under the Advisers Act since the fund itself is the client (and not the individual investors). Therefore, in the context of a private fund the adviser owes a fiduciary duty to the fund, and not to any individual investor.1 In order to pass the Final Rule, the SEC relied on Section 206(4) and Section 211(h) of the Advisers Act for authority. The Court held that Section 206(4) did not provide the SEC with statutory authority to promulgate the Final Rule because the SEC did not sufficiently prove how the Final Rule would prevent fraudulent, deceptive, or manipulative acts by investment advisers. Furthermore, the Court determined that the SEC lacked authority under Section 211(h) because the definition of the term “investor” in Section 211(h) is limited to “retail customers” (non-professional investors) and fund investors do not qualify as “retail customers” since, per se private fund investments are restricted to qualified high net-worth individuals or institutions, and private funds are not accessible to non-professional investors.2
What this Means for Funds and Fund Investors
It is uncertain whether the SEC will challenge the Court’s decision or file a petition with the U.S. Supreme Court. In the meantime, the Final Rule’s compliance deadlines, which were set to begin in September 2024, have been vacated entirely by the Court together with the entirety of the Final Rule.3
This document is intended to provide only a general background regarding this matter. This document should not be regarded as binding legal advice, but rather a practical overview based on our understanding. APM & Co. is not licensed to practice law outside of Israel.
[1][2][3] National Association of Private Fund Managers et al. v. Securities and Exchange Commission, 23-60471, US Fifth Circuit Court of Appeals (New Orleans) https://www.ca5.uscourts.gov/opinions/pub/23/23-60471CV0.pdf
