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Appeals Court Hears Challenge to SEC Private Funds Rule

S.J. Steinhardt
Published Date:
Feb 6, 2024

A three-judge panel of the U.S. Court of Appeals for the Fifth Circuit in New Orleans heard a case that challenges the limits of the Securities and Exchange Commission (SEC)’s authority over the $26 trillion private-funds industry, The Wall Street Journal reported.

The plaintiffs, a group of trade associations for private equity, venture capital and other types of asset managers, seek to invalidate an August 2023 SEC rule requiring private-fund managers to give their customers more information about fees and conflicts of interest.

The new rules and rule amendments are intended “to enhance the regulation of private fund advisers and update the existing compliance rule that applies to all investment advisers and “are designed to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market,” the SEC said at the time.

Eugene Scalia, a partner at Gibson, Dunn & Crutcher who leads the plaintiffs’ case, told the judges in the 45-minute hearing that Congress only intended the SEC to write rules for firms that take money from so-called retail investors, or ordinary people. “For no good reason, the SEC here is attempting to subvert the statutory exemption provided to private funds, and to conduct a hostile takeover of private funds,” he said.

The SEC argued that Scalia’s distinction between retail and sophisticated customers doesn’t appear in the language in which Congress gave the agency authority to write the rule. “Simply because investors are sophisticated, because they have a lot of wealth, does not mean they don’t enjoy the protection of the securities laws,” said SEC senior litigation counsel Jeffrey Berger at the hearing.

Judge Leslie Southwick said that the rule needs to be challenged in its entirety, but that the industry group’s argument worries him because it might not be broad enough to justify blocking the rule in full.

Judge Cory Wilson suggested that the private-funds industry is healthy and does not need new regulations. “All the economics seem to suggest that there isn’t a market failure at all; there’s a market success” in private funds, he said. 

The Fifth Circuit has in recent years developed a reputation for taking a limited view of the role of government agencies such as the SEC, the Journal reported.

The three judges hearing this case “have been in support of court decisions that did not simply accept the stated justifications of a federal agency,” said Marc Elovitz, co-managing partner of Schulte Roth & Zabel, who advises private-fund managers on legal and regulatory issues, in an interview with the Journal. He said that courts have, over the past decade, taken a more skeptical view toward government regulators.

“A decision on this set of rules will set precedent for all the other rulemaking the SEC is doing,” he said. “If they find this rulemaking is improper, it’s not just this one set of rules that will be impacted.”

The Journal reported that investors in private equity such as public pension funds, along with groups that support a tighter rein on Wall Street, support the SEC’s regulatory efforts. The Institutional Limited Partners Association, a trade group for pension funds and other private-equity investors, said in a December court filing that the SEC’s rules are within its authority and will protect pension beneficiaries such as teachers, firefighters and police officers.

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