On June 5, the U.S. Court of Appeals for the Fifth Circuit vacated in its entirety the Securities and Exchange Commission’s (SEC) final “private fund adviser rule” under the Investment Advisers Act of 1940. In unanimously determining to vacate the rule, the three-judge panel held that the SEC exceeded its statutory authority by promulgating the rule and that the anti-fraud rationale is “pretextual.”

The rule, adopted on August 23, 2023, subjected private fund advisers to several onerous new obligations and restrictions, including mandated quarterly disclosures to investors, required annual audits, and prohibitions on restricted activities and transactions – many of which would have been required beginning in September 2024. A group of private fund industry trade association plaintiffs brought suit against the SEC challenging the rule on several grounds, including that 1) it exceeded the scope of the SEC’s statutory authority and 2) there was no rational connection between the requirements imposed by the rule and the supposed fraud it seeks to prevent.

The plaintiffs argued the provisions in the Advisers Act relied upon by the SEC to promulgate the rule are not intended to expand the SEC’s authority to regulate private fund advisers, the funds they advise and the investors in those funds. In addition, the plaintiffs argued that the SEC’s claim that the rule was authorized under the anti-fraud provisions of Section 206(4) was “pretextual,” and the rule was not “reasonably designed” to prevent fraud and lacked a “close nexus” to the fraud it purports to prevent. The Fifth Circuit agreed on both grounds and vacated the rule in its entirety. 

This decision represents a major win for the industry groups and investment advisers who challenged the rule. Striking down the rule in its entirety allows advisers to avoid a significant increase in compliance obligations and related costs, which these industry groups argued would have been substantial and unnecessary. Additionally, the Fifth Circuit’s interpretation of the Advisers Act may have implications on previous SEC rulemaking and limit future action by the SEC.

The SEC has not indicated what additional steps it will take, which may include appealing and filing a petition for certiorari for review of the Fifth Circuit’s decision by the U.S. Supreme Court.