After much anticipation from the private funds market, earlier this week on June 5, 2024, the U.S. Court of Appeals for the Fifth Circuit (the Court) reached a decision in respect of the litigation challenging the Private Fund Adviser Rules (the PFA Rules) which were adopted by the Securities and Exchange Commission (the SEC) in August of 2023—and struck down the PFA Rules entirely.
The PFA Rules would have increased disclosure requirements and imposed strict compliance standards on private fund managers managing funds in the United States. Under the PFA Rules, private fund managers were required to obtain audited financial statements on behalf of their funds, provide investors with quarterly statements detailing fees, expenses and performance of each fund, and obtain an independent fairness opinion prior to any GP-led secondary transaction. The PRA Rules would have also changed the practice and process for the negotiation of side letters with investors, by restricting preferential treatment and requiring full disclosure of any special rights. Given the extensive compliance obligations which would have ensued, the news comes as a relief to private fund managers who can generally continue to operate in the U.S. as they have done so traditionally.
The lawsuit, National Association of Private Fund Managers et. al. v Securities and Exchange Commission, was brought by various industry associations including the National Association of Private Fund Managers, the Alternative Investment Management Association and the National Venture Capital Association (the Associations). On behalf of like-minded players in the private funds industry, the Associations challenged the legitimacy and enforceability of the PFA Rules.
The Associations focused their arguments on SEC overreach and lack of authority by the SEC to adopt the PFA Rules to begin with. The Court ultimately found that the SEC did not have authority to adopt such rules under the U.S. Investment Advisers Act of 1940 or the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was intended for the protection of retail investors and not investors in private funds.
What Happens Next?
The SEC has not indicated what its next steps might be. The Commission could seek an en banc rehearing by the full Fifth Circuit or it could petition the U.S. Supreme Court to review the decision. We will continue to monitor this matter and provide updates as they come.
While the PFA Rules have been vacated, they have set a stage for many productive conversations that have emanated in recent years regarding what is important to the private funds industry and what is important to the SEC. The content of the PFA Rules reinforced the SEC's support for adequate disclosure, the fair treatment of investors, and careful management of conflicts. These are standards that are also very important to private fund managers. The fact that the Court has set aside the PFA Rules will not erase the values they intended to promote. As a result of the process, private fund managers have a current account of the SEC's view which they can take into account when managing funds in the absence of onerous regulations, which is key to the appeal of private markets.
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