Understanding the SEC Final Rules vacated by the Fifth Circuit  

On Aug. 23, 2023, the U.S. Securities and Exchange Commission (“SEC”) adopted new rules and amendments to the Investment Adviser’s Act of 1940 (“Advisers Act”) collectively know as the “Final Rules.” The Final Rules were designed to enhance the SEC’s regulation of private fund advisers and provide further protection for investors in private funds by increasing compliance requirements for the private fund advisers. These Final Rules were met with some opposition that led to a challenge in the court system as to the validity of these rules.  

Under these rules, registered fund advisers would have been required to adopt the following rules: 

• Quarterly statement rule - Provide quarterly statements to private fund investors detailing performance, fees, and expenses for each private fund it advises; 
• Private fund audit rule - Obtain an annual audit of each private fund it advises, meeting the requirements of the audit provision under Rule 206(4)-2(b)(4) (the SEC Custody Rule or the Custody Rule); and 
• Adviser-led secondaries rule - Obtain a fairness or valuation opinion from an independent opinion provider in connection with an adviser-led secondary transaction. 

In addition to the above, the following rules would have been applicable to all private fund advisers regardless of registration status: 

• Restricted activities rule – Prohibiting engaging in certain restricted activities unless appropriate disclosure is made, and in certain cases, consent is obtained. 
• Preferential treatment rule – Prohibiting providing certain types of preferential treatment that would have a material, negative effect on other investors, subject to certain exceptions; and other types of preferential treatment to any investor in a private fund, unless the adviser satisfies certain disclosure obligations. 

Ruling: 

On June 5, 2024, the U.S. Fifth Circuit Court of Appeals (Fifth Circuit) delivered a verdict that vacates the SEC’s “Final Rules” in their entirety, specifically stating that the “promulgation of the Rule was unauthorized, no part of it can stand”. 

There were two legislative foundations permitting the adoption of the Final Rules, as follows: 

• Section 913(h) of the Dodd-Frank Act, also known as Section 211(h) in the Advisers Act; and  
• The antifraud rulemaking authority in Section 206 of the Advisers Act. 

In light of the above, the Fifth Circuit concluded that the SEC exceeded its statutory authority for the following reasons: 

• Section 211(h) of the Advisers Act applied only to retail customers, not private fund investors.  
• The SEC’s reliance on the antifraud provision of Section 206(4) was inaccurate, as the SEC did not provide sufficient specificity regarding what misconduct or fraud the Final Rules were designed to prevent. 

Moving forward 

As noted above, the rules have been vacated in their entirety, meaning that their application is not required at this time. The SEC has stated that it will “determine next steps as appropriate.” In the future, the SEC may request a rehearing or file a petition seeking review before the Supreme Court of the United States. This will be worth monitoring as this continues to develop.