That rule sought to enhance regulation of private fund advisers, and to guard against fraud or manipulation by those firms, ostensibly to protect small investors that are exposed to private fund advisers through their pension funds and other vehicles that may invest in hedge funds and other private funds.
“The need for oversight, according to the commission, stems from investor protection risks and harms, such as the lack of transparency, conflicts of interest, and lack of governance mechanisms,” the court noted in its decision.
However, the rule was challenged by a collection of trade groups — including the Alternative Investment Management Association (AIMA), the Managed Funds Association, and the National Venture Capital Association — which argued the SEC exceeded its authority by seeking to sharply step up oversight of private funds.
The commission argued the Dodd-Frank Act, which was developed in response to the global financial crisis, expanded its rulemaking authority to cover private fund advisers and investors.
The court disagreed, ruling that U.S. lawmakers have specifically exempted private funds from the kind of prescriptive oversight deemed necessary in the public markets, and that Dodd-Frank didn’t erase that distinction.
“By congressional design, private funds are exempt from federal regulation of their internal ‘governance structure’,” the court said. It added that, unlike retail-focused funds, private funds are free to negotiate their fees, redemption terms and financial reporting.
“The Dodd-Frank Act only stepped towards regulating the relationship between the advisers and the private funds they advise,” the court said, in concluding that the SEC exceeded its authority.
The court also rejected the SEC’s argument that its authority to regulate against fraud gave it the scope to create the new rule, saying the SEC conflated a “lack of disclosure” with “fraud.”
The court vacated the rule entirely.
“We are very pleased by the court’s ruling, which will spare the private funds industry and investors a lot of unnecessary costs and disruption, as a result of the U.S. SEC’s unlawful action,” said AIMA CEO Jack Inglis.
Inglis added that the ruling, “rewards our decision to file suit, which was taken to protect the interests of our members against regulatory overreach and improper rulemaking by the U.S. SEC that would have had severe and adverse impacts on a wide variety of market participants.”