A federal appeals court on Wednesday struck down a Securities and Exchange Commission rule that forced hedge funds to disclose more about their fees to investors and prevented them from allowing some other forms of preferential treatment.
It’s a victory for hedge fund associations such as the Managed Funds Association, whose members include behemoths Bridgewater, Millennium Management, and Renaissance Technologies. But in a bigger sense, the agency’s loss could portend trouble for a broad part of SEC Chair Gary Gensler’s legacy.
The decision Wednesday concerned a rule the SEC adopted in August that required private funds and advisors to give investors regular account statements, standardized fee information, and conflict-of-interest disclosures. The rule also prevented funds from giving some investors preferential treatment for redemptions.
Hedge fund industry groups, including the MFA and the National Association of Private Fund Managers, sued the SEC in the U.S. Fifth Circuit Court of Appeals in New Orleans. They were joined by associations representing other types of private funds, including the private-equity-focused American Investment Council and the National Venture Capital Association.
The appellate court said that the SEC had exceeded its authority and vacated the rule. With the loss, the SEC can request an “en banc” hearing in front of the rest of the appellate judges in the Fifth Circuit. It could also seek a review from the Supreme Court.
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An SEC spokesperson said the agency is reviewing the decision and will determine next steps.
“Today’s ruling is a significant victory for markets, fund managers, and investors, including pensions, foundations, and endowments,” said Managed Funds Association President Bryan Corbett in a statement. “The court affirmed that the SEC cannot expand its authority beyond what Congress intended.”
Some proponents of the rule said the court’s reasoning seemed to threaten other SEC-required disclosures, including ones that have been on the books for years.
“The debate now isn’t about whether new obligations can withstand legal challenge, but rather what longstanding disclosure and reporting requirements might survive,” said Tyler Gellasch, who is president of the Healthy Markets Association and had supported the rule.
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The court ruling is likely just a glimpse of the challenges the SEC under Gensler will face as his ambitious regulatory agenda hits a conservative judiciary that has expressed growing discomfort with how federal agencies are interpreting laws to write new rules. Gensler and other agency heads have said they believe their rules fall within the bounds of the law.
In addition to the private-fund-advisor rule, hedge fund groups have sued the SEC over rules that require greater disclosures around short sales, and that could make some funds have to register as Treasury dealers. The U.S. Chamber of Commerce has sued to prevent the SEC from requiring companies to disclose their climate impact. Crypto firms are suing the agency to require it to write new rules to govern digital assets and are fighting the SEC’s allegations that they are breaking existing rules.
Many of those battles are taking place in the Fifth Circuit, which has a concentration of conservative judges who the funds and other firms think are most likely to rebuff the SEC. The Supreme Court has also lately expressed skepticism that agencies are remaining within the bounds of the law in making rules.
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“Given how aggressive the Fifth Circuit was in interpreting the statute, it makes sense for the SEC to appeal to the Supreme Court,” said Americans for Financial Reform senior policy analyst Andrew Park, who supported the rule.
There’s at least some question around whether Gensler will be able to see through any challenges to the Fifth Circuit’s decision and those on the way. If President Donald Trump wins reelection, a new SEC chair could choose not to fight judgments striking down rules passed under Gensler. A Republican SEC could also rewrite rules that do survive.
Gensler has managed to push through an agenda that’s won plaudits from investor advocacy groups and ire from much of the investment-management industry. The next few years will be about how much of it survives.
Write to Joe Light at joe.light@barrons.com