On June 5, 2024, the U.S. Court of Appeals for the Fifth Circuit issued its opinion on National Association of Private Fund Managers et. al. vs. Securities and Exchange Commission, the lawsuit brought by a group of trade associations representing the private funds industry against the Securities and Exchange Commission (“SEC” or the “Commission”) challenging the validity and enforceability of the SEC’s Private Fund Adviser Rules (“PFAR”). 

The SEC released the final version of PFAR, along with an adopting release, in August 2023.  Within a matter of days, the group of six trade associations  (the “Petitioners”) filed with the Fifth Circuit a Petition for Review, requesting that the court vacate and set aside the final order of the SEC in Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, Release No. IA-6383. 

The core of the Petitioners’ argument was that the new rules “exceed the Commission’s statutory authority, were adopted without compliance with notice-and-comment requirements, and are otherwise arbitrary, capricious, an abuse of discretion, and contrary to law,” and therefore amounted to a violation both of the Administrative Procedure Act and the SEC’s obligation to consider as part of its rulemaking process the likely effects on “efficiency, competition, and capital formation.”  The Petitioners focused on the SEC’s lack of authority under Section 206(4), the anti-fraud provision, of the Investment Advisers Act of 1940 (the “Advisers Act”), or Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which focused on the SEC’s authority to enact rules for the protection of retail investors and under which Section 211(h) of the Advisers Act was added.

The Fifth Circuit agreed with the Petitioners on all issues, and considered all of the rules comprising PFAR as one “Final Rule” for purposes of its opinion.  The Court held that the Commission lacked the necessary authority under Section 206(4) of the Advisers Act and Section 913 of Dodd-Frank/Section 211(h) of the Advisers Act to adopt the Final Rule, and that the Final Rule is therefore vacated.  In the opinion, the Fifth Circuit emphasized that “section 913 of Dodd-Frank…  applies to ‘retail customers,’ not private fund investors.  It has nothing to do with private funds.”

Counsel for the Petitioners had emphasized in oral arguments that PFAR is flawed “from root to branch,” and urged the Fifth Circuit panel not to sever and thereby preserve any of the individual rules—notwithstanding a lack of focus in the Petitioners’ briefs on the Audit Rule or the Adviser-Led Secondaries Rule.  The Annual Review/Recordkeeping rule, which went into effect for all advisers on November 12, 2023, was not specifically addressed in the Petitioners’ challenge but was also vacated as part of the Fifth Circuit’s ruling.

With the rules all vacated, private fund managers should feel a huge sense of relief at avoiding burdensome compliance obligations such as producing the new quarterly statements, as well as having to revisit long-standing relationships and dynamics with existing and prospective fund investors.

That said, we expect the SEC to look for other ways to raise the bar for the industry, even if it means relying only on established fiduciary duty and anti-fraud obligations.  First, the SEC has the right to request that the Fifth Circuit re-hear the case en banc; if the Fifth Circuit grants an en banc rehearing, a stay of the PFAR rules’ effectiveness would automatically go into effect while their validity remains in question.  If the Fifth Circuit declines the rehearing, then the SEC may petition the Supreme Court to review the decision and may request a stay of the Fifth Circuit’s mandate to vacate the rules.  Second, even without the force of law, the PFAR Adopting Release will continue to offer valuable insights into the SEC’s views and interpretations of fundamental concepts such as an adviser’s obligations to treat investors fairly and equitably and to manage conflicts of interests, as well as what disclosures are necessary to avoid misleading current or prospective investors.  These views will likely make their way into SEC examinations and enforcement investigations.  And third, the SEC may take the opportunity to release other versions of some or all of the vacated rules with modifications aimed at curing the deficiencies noted by the Fifth Circuit.