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U.S. Court of Appeals Strikes Down S.E.C.’s New Fee Disclosure Rule for Private Funds

June 5, 2024

On June 5, 2024, the U.S. Court of Appeals for the Fifth Circuit ruled to vacate the Securities and Exchange Commission’s (“SEC”) new rules that targeted private fund advisers (the “Rule”). The Rule, adopted by the SEC on August 23, 2023, requires hedge funds and private equity firms to detail quarterly fees and expenses to investors. The unanimous decision from the Fifth Circuit sided with a group of associations representing the private fund industry in ruling that the SEC exceeded its authority with the Rule.


The SEC stated at the time of adoption that the Rule was designed to increase investor transparency into the practices of advisers to private funds in which third parties invest. In addition to mandating fee disclosure, the Rule established new obligations for private fund managers, such as requiring private fund audits, ensuring equal treatment of all investors regardless of their investment size, and prohibiting firms from allowing certain preferred investors to cash out more easily than others. The SEC said the goal of the Rule was to bring more uniformity to the information private funds provide to investors. Many industry participants have objected to the Rule and argued that the Rule significantly, and unnecessarily, increases compliance obligations and costs of private fund advisers.


The SEC had based its rulemaking authority on Section 206(4) and 211(h) of the Investment Advisers Act of 1940 (the “Advisers Act”). The Fifth Circuit found that Section 211(h) of the Advisers Act does not expand the SEC’s authority to regulate the relationships between private fund advisers, their private funds and the funds’ third-party investors to the extent cited by the SEC. In addition, the Fifth Circuit ruled that the SEC’s reliance on the anti-fraud provisions of Section 206(4) of the Advisers Act to adopt the Rule was “pretextual” and that the SEC had failed to articulate a “rational connection” between fraud and any part of the adopted Rule. The Fifth Circuit also rejected an argument from the SEC that the Rule was necessary because it would weed out fraud, ruling that the SEC is conflating a lack of disclosure with deception. For these reasons, the Fifth Circuit concluded that the SEC “exceeded its statutory authority in adopting” the Rule and that, because the adoption of the Rule was unauthorized in its entirety, “no part of it can stand.”  Accordingly, the Fifth Circuit fully vacated the Rule.


The Fifth Circuit’s ruling is a significant victory for private fund advisers and the private fund industry. In addition, the Fifth Circuit’s interpretation of the scope of Section 206(4) may have implications for other rulemaking adopted by the SEC in reliance on Section 206(4) in the past and may constrain the ability of the SEC to adopt certain regulatory measures in the future. 


The SEC said in a statement that it was reviewing the decision and would “determine next steps as appropriate.” It remains to be seen whether the SEC will petition for a rehearing by the Fifth Circuit or appeal to the U.S. Supreme Court.

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