Private Fund Rule Strikedown Puts More SEC Rules in Peril

What You Need to Know

A three-judge panel said the SEC lacked the authority to use two rulemaking statutes in its private funds rules.
One of the statutes has been the go-to authority for virtually all of the SEC’s rules, according to IAA’s Gail Bernstein.
SEC officials are now busy mulling how the ruling will affect new and existing rules.

Two of the Securities and Exchange Commission’s main rulemaking statutes hang in the balance after the U.S. Court of Appeals for the Fifth Circuit struck down on June 5 the agency’s Private Fund Adviser Rules.

The ruling “is a very broad Fifth Circuit decision,” Gail Bernstein, general counsel for the Investment Adviser Association in Washington, told me in a recent interview. The court “ended up treating all the rules as a package, including the [RIA] compliance program rule, which was under a different provision all together. It was sweeping.”

A three-judge panel found that the SEC lacked the rulemaking authority to issue the rules, which were adopted on Aug. 23, 2023, under both Section 211(h) and Section 206(4) of the Investment Advisers Act of 1940.

Section 211(h), added under the Dodd-Frank Act after the financial crisis, authorizes the SEC to restrict certain sales practices to protect investors. Section 206(4) is an antifraud statute.

Under 211(h), the court ruled “investors” includes only retail investors, not private fund investors, Bernstein explained. The court also ruled that the securities regulator had abused its antifraud authority under 206(4), which ”had been relied on by the SEC … for several of its rules for a very long time now.”

SEC officials are now mulling how the ruling will affect new and existing rules, according to Bernstein.

“Even more challenging for the SEC will be trying to figure out what [the court ruling] means for 206(4) because so many existing rules and proposed rules are based on it,” Bernstein relayed. “It’s been the go-to authority for virtually all of the SEC’s rules.”

Those rules include the proposed rules on advisor outsourcing, predictive data analytics and custody of assets, as well as the new Marketing Rule, Bernstein said.