On June 5, 2024, a unanimous panel of the U.S. Court of Appeals for the Fifth Circuit issued an opinion in National Association of Private Fund Managers v. SEC (NAPFM),[1] a challenge to the SEC’s recent Private Fund Rules[2] brought by six trade associations. The Fifth Circuit’s opinion vacated the Private Fund Rules entirely, finding that the SEC had “exceeded its statutory authority” in promulgating the Rules and that “no part of [the Private Fund Rules] can stand.”[3]
Background
Issued last August, the Private Fund Rules would have significantly expanded reporting, disclosure and recordkeeping requirements for advisers to private funds and prohibited certain types of preferential treatment of investors in private funds (absent disclosure and other requirements).[4] The SEC relied on two authorities in promulgating the Private Fund Rules[5]—the authority under section 913 Dodd-Frank Wall Street Reform Act and Consumer Protection Act of 2010 (Dodd-Frank) to enact rules and require disclosures for the protection of “investors”[6] and its general antifraud rulemaking authority under section 206 of the Investment Advisers Act of 1940, as amended (the Advisers Act).[7] The NAPFM petitioners challenged both of these authorities, arguing that the SEC had exceeded its statutory authority, and also raised a number of administrative law challenges.
The Fifth Circuit’s Opinion
The Fifth Circuit agreed with the NAPFM petitioners, holding that the broader language of Dodd-Frank made clear that section 913 “applies to ‘retail customers,’ not private fund investors” and “has nothing to do with private funds.”[8] The Fifth Circuit also held that the Private Fund Rules were not authorized by the SEC’s antifraud authority. It found the SEC’s antifraud rationale “pretextual”[9] and observed that, in any event, the general antifraud provisions of the Advisers Act do not empower the SEC to require disclosure and reporting.[10] Finally, the Fifth Circuit observed that an absence of disclosure by private fund advisers “‘cannot be deceptive’ without a ‘duty to disclose’” and that in the case of private funds, this duty “extends to the client alone, which is the fund, not the investors in the fund.”[11]
Immediate Impact
The decision to vacate the Private Fund Rules, which were set to begin phasing into effect later this year and by the SEC’s own estimates would have cost $5.4 billion and required millions of hours of employee time,[12] provides significant relief to private fund managers. While the panel’s decision cannot undo the significant time and resources already expended by private fund managers in preparing for the implementation of the Private Fund Rules, it substantially reduces the prospect of significant ongoing compliance costs that would likely be passed on to private funds’ investors and is a major step in restoring the status quo ante for relationships between private fund managers and their investors.
The decision in NAPFM does not prevent the SEC from continuing to prioritize the issues addressed by the Private Fund Rules in supervisory and enforcement contexts. Private fund advisers should expect SEC examiners to continue to carefully review practices and procedures identified in the Private Fund Rule as presenting conflict-of-interest risks and pursue action where practices are fraudulent or procedures inadequate to prevent violations of the securities laws.
What’s Next?
Focus now turns to how the SEC will react to the decision. The SEC has indicated that it is reviewing the decision and “will determine next steps as appropriate.” The Commission may petition for rehearing by the full Fifth Circuit or appeal to the U.S. Supreme Court. The SEC could also seek to impose portions of the Private Fund Rules through alternative means even if it does not further contest the panel’s decision. These could include another rulemaking that purports to resolve the issues noted in the Fifth Circuit’s opinion or, perhaps more likely, imposing new compliance standards through examination of private fund managers and related deficiency findings and enforcement efforts based on the Commission’s existing disclosure, fiduciary, and antifraud authorities under the Advisers Act and the rules promulgated thereunder. While the portions of the Fifth Circuit’s decision finding a limited relation between the practices regulated in the Private Fund Rules and any “fraudulent, deceptive, or manipulative” acts, practices, or courses of business and its narrow reading of the SEC’s antifraud rulemaking authority could constrain these authorities.[13]
More broadly, NAPFM is the second recent case in which the Fifth Circuit has substantially curtailed SEC powers. The previous case—SEC v. Jarkesy,[14] in which the Fifth Circuit held that the Constitution significantly curtails the SEC’s power to use administrative law judges to try enforcement actions—is currently pending before the Supreme Court, and the Fifth Circuit’s opinion is expected by many to be at least partially upheld. The Fifth Circuit’s reasoning in NAPFM opens the door for further challenges along these lines. For example, the SEC’s proposed Predictive Data Analytics Rule,[15] which is authorized in part by the SEC’s authorities under section 913 of Dodd-Frank, could be challenged to the extent that its provisions are for the protection of “investors” who are not “retail customers.”[16] Rulemakings that purported to be authorized pursuant to the SEC’s general antifraud authorities under the Advisers Act, such as the Marketing Rule,[17] likewise could be subject to challenge where the SEC has not defined the specific fraudulent practice a regulation is designed to prevent or where the SEC has sought to regulate practices that cannot be connected to a breach of duty to an investment adviser’s direct client, especially where that client is a fund, rather than an investor.[18] Finally, the antifraud authority under the Advisers Act closely resembles antifraud provisions in other statutes administered by the SEC, suggesting that disclosure requirements pursuant to those provisions may be vulnerable to similar attacks in Fifth Circuit courts.[19]
We will continue to monitor developments and provide updates as warranted.
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[1] Nat’l Ass’n of Priv. Fund Managers v. Sec. and Exch. Comm’n, No. 23-60471 (5th Cir. June 6, 2024), available at https://www.ca5.uscourts.gov/opinions/pub/23/23-60471CV0.pdf
[2] Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, 88 Fed. Reg. 63206 (Sept. 14, 2023).
[3] NAPFM, at 25.
[4] See Private Fund Rules. For additional detail about the now-vacated rules, please see our blog post from last August.
[5] Private Fund Rules, at 63213; NAPFM, at 5.
[6] 15 U.S.C. § 80b-11(h).
[7] 15 U.S.C. § 80b-6.
[8] NAPFM, at 21.
[9] Id., at 23.
[10] Id., at 23–24.
[11] Id., at 24–25.
[12] Id., at 13.
[13] See Id., at 23–25.
[14] SJarkesy v. Sec. & Exch. Comm’n, 34 F.4th 446 (5th Cir. 2022).
[15] Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers, 88 Fed. Reg. 53960 (proposed Aug. 9, 2023).
[16] See supra, note 8
[17] Investment Adviser Marketing, 86 Fed. Reg. 13024 (Mar. 5, 2021) (codified at 17 CFR 275.206(4)-1, 275.204-2, 279.1, and 275.206(4)-3).
[18] See supra, notes 9–11.
[19] See supra, note 10.
