SEC’s Enhanced Regulations for Hedge Funds and Private Equity Firms Struck Down by Appeals Court
In a recent ruling, the U.S. Fifth Circuit Court of Appeals declared that the Securities and Exchange Commission (SEC) had exceeded its authority in implementing enhanced regulations for hedge funds and private equity firms. The court’s decision was based on the finding that the SEC’s promulgation of the Final Rule was unauthorized. As a result, the court vacated the entire rule. This ruling came in response to a lawsuit filed by a coalition of industry groups, arguing that the rule was arbitrary, capricious, and unlawful.
The SEC had adopted these regulations in August 2023 with the aim of increasing transparency, competition, and efficiency in the private funds market. The rules included requirements for private fund advisers to detail quarterly fees and expenses to investors, restrictions on favored investors’ ability to redeem investments more easily than others, and the need for annual audits and fairness opinions for each private fund. The regulations also prohibited certain activities deemed contrary to the public interest unless proper disclosures were made.
However, industry groups opposed these rules and took legal action against them. The coalition of industry groups, including the Managed Funds Association (MFA), the American Investment Council (AIC), and others, argued for the rules to be voided on several grounds. They contended that the SEC exceeded its statutory authority by attempting to regulate exempted relationships between private funds and investors. The groups also claimed that the SEC did not provide adequate opportunity for public comment on the final rule and failed to present evidence of the industry problem it aimed to address. Additionally, they criticized the SEC for not conducting a sufficient cost-benefit analysis.
The court sided with the industry groups, stating that the SEC had indeed exceeded its authority in setting the rule. However, it did not evaluate the remaining issues raised in the lawsuit. Industry groups praised the court’s decision, emphasizing the protection of market participants against regulatory overreach. They argued that the ruling would spare the private funds industry and investors unnecessary costs and disruption.
On the other hand, critics of the ruling expressed concern about the impact on investor protection. Stephen Hall, legal director and security specialist at Better Markets, called the decision a setback that would deprive investors in private funds of protections against unfair practices. He also accused the 5th Circuit Court of Appeals of being overly sympathetic to industry claims and suggested that the ruling would encourage the industry to continue seeking courts that support their interests.
This ruling comes at a time when the Biden administration has been implementing new regulations targeting big business, such as the Federal Trade Commission ban on noncompete agreements. The ruling raises questions about the balance between regulation and market efficiency and highlights the ongoing tension between regulatory bodies and industry groups.
