As many of our clients will already be aware, yesterday a unanimous panel of the U.S. Court of Appeals for the Fifth Circuit (the “Panel”) struck down all of the so-called “Private Fund Adviser Rules” (the “Rules”) recently promulgated by the U.S. Securities and Exchange Commission (the “SEC”). The full opinion is available here.
The Panel considered both bases the SEC had asserted for their rulemaking authority, Section 206(4) of the Investment Advisers Act of 1940 (the “Advisers Act”) and Section 211(h) of the Advisers Act added by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), and concluded that the SEC exceeded its statutory authority. The Panel considered Section 211(h) in the context of the Dodd-Frank Act and the Advisers Act and concluded that Section 211(h) applies to “retail customers." Further, the Panel considered the SEC’s reliance on Section 206(4) “pretextual” as the SEC did not sufficiently articulate a connection between the Rules and fraud and distinguished between the regulatory framework designed by Congress under the Investment Company Act of 1940 and the framework under the Advisers Act applicable to private funds. Should the SEC determine to litigate further, we expect the next step would be for the SEC to file a Petition for Rehearing En Banc in front of the full U.S. Court of Appeals for the Fifth Circuit.
Notwithstanding the vacatur of the Rules, we believe the rulemaking process (and in particular the SEC’s adopting release, available here) provides important insight into the SEC’s examination and enforcement priorities on a go-forward basis. As we have discussed with many of our clients, although the SEC had declined to adopt a prohibition on limitation of liability and indemnification for simple negligence in the Rules, some of the commentary in the SEC’s adopting release seemed to expand the positions expressed by the SEC in their 2019 guidance on fiduciary duties (available here). On this topic, and a number of aspects of the Rules, views expressed by the SEC throughout the rulemaking process as well as through the substance of the Rules as adopted provide a helpful roadmap for investment advisers in anticipating and preparing for SEC examinations. Based on these recent learnings, we believe there are areas of clarification in limited partnership agreements (and similar fund operating documents) as well as enhancements to private placement memoranda and other private fund offering documents and Form ADV disclosures that will be helpful for private investment fund managers to consider on a proactive basis in order to position themselves most effectively for ongoing regulatory scrutiny.
If you have questions concerning the matters discussed in this memorandum, or would like more detailed information, please reach out to your regular firm contact or one of the following attorneys: Reed W. Balmer, Zachary Moore, Claire Stevens, and Andrew M. Calamari.
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