US Court Ruling: Private Funds Win Exemption from SEC Oversight

The United States Court of Appeals for the Fifth Circuit made a significant decision on June 5, 2024, by vacating new rules applicable to advisers to private funds. US Court ruled in favor of National Association of Private Fund Managers (NAPFM), The Alternative Investment Management Association (AIMA) , National Venture Capital Association (NCVA) , Managed Fund Association (MFA) and others who challenged the regulations. Please read the complete trade associations' petition.

Why Did Court Overturns Entire SEC private Fund Rule?

This decision drew attention to the distinction between retail investors and sophisticated private fund investors, emphasizing the historical need to safeguard retail investors who may not possess the same level of knowledge, experience, or sophistication as their counterparts in the private fund sector.

In the face of this ruling, it's clear that there has always been a recognized discrepancy between retail investors and accredited or qualified investors in the eyes of Congress and the SEC. The court's detailed decision underscored the intent of Congress in regulating private funds under Dodd Frank, shedding light on the differences between these two investor categories.

Ultimately, the court's ruling concluded that sophisticated investors permitted to invest in private funds do not require the same level of oversight and protection as retail investors. This was accompanied by a finding that the SEC had overstepped its authority in this regard.

This decision sets a significant precedent and is likely to have far-reaching implications within the financial and investment sector. It underscores the importance of recognizing and respecting the divergence between various types of investors and the necessity of tailored regulations to ensure appropriate protection for each group. 

Which Part of the Private Fund Rule Was Overturned?

The U.S. Court of Appeals for the Fifth Circuit unanimously stated that no part of the private funds rule adopted by the SEC on August 23, 2023, can stand. As a refresher, the rule included:

  • Additional quarterly reporting. The rule required statements to disclose fees, expenses, standardized performance information, along with criteria used and assumptions made to calculate this information in tabular format.
  • Required annual audits. This applied to all private funds advised by registered investment advisers (RIAs), even those funds historically covered by exemptions under the custody rule.
  • Required fairness/valuation opinions. These were required to be obtained from independent providers for adviser-led secondary transactions and distributed to investors.
  • Restricted ability for the adviser to charge certain fees or expenses. Fees or expenses associated with regulatory or governmental investigations or adviser exams to the private fund’s investors would be limited.
  • Restricted ability to give preferential treatment to certain investors. The ability to give discounted, or to waive, management and/or incentive fees, would be limited if it could negatively impact other investors that do not have such terms.
  • Annual requirement to document compliance in writing.

SEC May Appeal the Court Ruling

We expect the SEC will carefully review this court ruling in detail and weigh the concerns of market participants before taking next steps. In the meantime, we will continue to monitor the developments on this ruling and its impact to those in the industry.