As we updated in our previous Client Update, in August 2023 the U.S. Securities and Exchange Commission (SEC) adopted final rules that sought to implement sweeping changes to the private funds industry by aiming to give investors more transparency into private funds as advocated by the SEC. However, these regulations faced staunch opposition from the multi-trillion-dollar private fund industry, which argued that they were unduly burdensome and costly and threatened to fundamentally change how the industry does business whilst significantly boosting regulatory and compliance costs and thereby reducing profits.
On June 5, 2024, the U.S. Court of Appeals for the Fifth Circuit based in New Orleans issued a 3-0 decision which vacated the final rules in their entirety on the grounds that the SEC overstepped its statutory rulemaking authority under the U.S. Investment Advisers Act of 1940 in adopting the final rules. The U.S. court ruled in favor of six private equity and hedge fund groups that challenged the regulations.
As a reminder, the SEC final rules included, among others:
- The Preferential Treatment Rule – which prohibits investment advisers from providing preferential treatment to investors in a private fund with respect to either preferential redemption rights or information rights with respect to portfolio holdings or exposure, where the investment adviser reasonably expects that such preferential treatment would have a material, negative effect on other investors in the fund or in other funds with similar portfolios and includes certain disclosure requirements.
- The Restricted Activities Rule – which restricts certain activities by requiring disclosure and prior written consent of investors such as an adviser borrowing from a private fund and causing a fund to bear fees/expenses relating to government or regulatory investigations of the investment adviser.
- The Quarterly Statement Rule – which requires advisers to prepare and distribute to investors a quarterly statement.
- The Adviser-Led Secondaries Rule – which requires a registered adviser to a private fund to distribute to fund investors, in connection with an adviser-led secondary, (i) a fairness opinion or a valuation opinion from an independent opinion provider and (ii) a written summary of any material business relationships the adviser (or any of its related persons) has, or has had, within the past two years with the independent opinion provider.
- The Audit Rule– which requires advisers to cause each private fund it advises to undergo an annual financial statement audit.
The SEC has not yet indicated what action, if any, it will take in light of the court’s decision, although any further review by the full court of the Fifth Circuit or an appeal to the U.S. Supreme Court or any proposed changes to the current form of the rules would likely be lengthy and extend well past the first set of compliance dates that are set to activate the rules in September 2024.
We will continue to monitor new developments.
This document is intended to provide only a general background regarding this matter. It should not be regarded as setting out binding legal advice but rather as a practical overview based on our understanding of applicable regulations.
