US Appeals Court Overturns SEC Rule on Private Equity and Hedge Fund Oversight

On June 5, a US appeals court struck down a Securities and Exchange Commission (SEC) rule designed to increase transparency for investors in private funds. This ruling came as a major blow to the SEC’s efforts to regulate the nearly $27 trillion private fund industry.

US Appeals Court Verdict Disregards the Dodd-Frank Act

In a three-judge decision, the New Orleans-based 5th US Circuit Court of Appeals ruled in favor of six private equity and hedge fund groups, determining that the US SEC had overstepped its authority by adopting a rule in August 2023.

Judge Kurt Engelhardt, writing on behalf of the three judges, stated,

“The SEC exceeded its statutory authority. The promulgation of the Final Rule was unauthorized; no part of it can stand.”

The decision specifically addressed the US regulator’s rules governing private equity funds, hedge funds, venture capital funds, and managers of institutional investor funds such as pension funds and endowments.

These rules required fund managers to issue quarterly performance and fee reports, conduct annual audits, and refrain from giving preferential treatment to some investors regarding redemptions and portfolio holdings.

The intention behind these rules was to improve transparency, fairness, and accountability in an industry often criticized for its opaqueness, and the SEC cited the Dodd-Frank Act, enacted to reform the financial sector following the 2008 financial crisis.

The US government introduced the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, which was in response to the financial crisis. The Act aimed to prevent the excessive risk-taking that led to the financial meltdown by implementing comprehensive reforms in the financial industry.

One of the Dodd-Frank Act’s provisions was to grant the SEC additional authority to regulate private funds, including private equity and hedge funds, and reduce the risk of another financial downtrend.

However, the US appeals court ruled that the SEC had overreached its authority with these rules, indicating that the specific sections of the Dodd-Frank Act cited by the SEC did not provide the necessary legal basis for such extensive regulations.

Crypto Enthusiasts Praises US Appeals Court’s Verdict

In response to the US appeals court verdict, Drew Maloney, chief executive of the American Investment Council, one of the six groups involved in the lawsuit, expressed satisfaction with the ruling.

Additionally, Consensys senior counsel Bill Hughes stated that this ruling exemplifies the SEC’s recent trend of overreach, which has been a recurring issue over the past three-plus years.

The SEC loses in court again, and another rulemaking is vacated.

The question presented was whether the SEC had the authority from Congress under an existing statute to make the rule directed at private funds advisors. The court found that, no, it did not.

The court found… pic.twitter.com/R6D3eAgxmk

— Bill Hughes : wchughes.eth 🦊 (@BillHughesDC) June 5, 2024

In stark contrast, Healthy Markets Association CEO Tyler Gellasch, whose group represents institutional investors, warned that the ruling will fuel concerns about a market where large investors get more information and better deals, leaving others to “take whatever they get.”

It should be noted the SEC has been facing backlash over its crackdown on the activities of crypto firms, even as these companies are reacting that the regulatory body does not have the power to regulate crypto without due approval from Congress.

This claim may have a foothold with the passage of the Financial Innovation and Technology for the 21st Century Act (FIT21) in the House, which could largely shift regulatory authority over the crypto industry to the Commodity Futures Trading Commission (CFTC). However, the White House faults the bill with the concerns that investors will not be protected. Hence, planning to work with Congress to make new laws for the crypto market.