As a reminder, the Securities and Exchange Commission (SEC) and the National Association of Private Fund Managers (NAPFM) and the other Petitioners in the Private Funds Rules Litigation¹ requested that the three-judge panel of the US Court of Appeals for the Fifth Circuit (the “Panel”) issue its decision by May 31st. Of course, the Court will decide on its own terms and timeline. Regardless, when the Court decides the case, we expect to focus on the following key questions in our review of the decision from the Court (the “Decision”).

1) Does the Decision treat the Rules as a single Rule or multiple Rules?

The Petitioners sought to treat the contested Rules as a single SEC action in an effort to vacate the entire package in one case. The SEC, by contrast, argued that the Rules should all be treated separately. In other words, the Court would have the option to vacate certain aspects of the Rules but not the entire package. The Panel suggested that, if treated separately, it would be difficult to overturn the two Rules that were not individually challenged – i.e., the Private Fund Audit Rule and the Adviser-Led Secondaries Rule.

2) Does the Decision knock out both pillars on which the Rules rely?

The Petitioners focused most of their fire on whether the SEC could base the Rules on Section 211(h) of the Advisers Act (which was added by Section 913 of the Dodd-Frank Act). However, the rules were adopted under both Section 211(h) and Section 206 of the Advisers Act (the anti-fraud provision), which is the basis for most of the rules adopted under the Advisers Act. To vacate the Rules, the Court would need to find that the SEC was not able to rely on either Section in adopting these Rules.

3) Does the Decision find that the SEC lacked a factual basis for adopting the Rules under Section 206 of the Advisers Act? How high will the Decision set the bar that the SEC would need to clear in satisfying the factual basis requirements?

While much of the discussion regarding the Rules has focused on Section 211(h) of the Advisers Act/Section 913 of the Dodd-Frank Act, the key to the challenge may come down to whether the SEC could rely on its more traditional rulemaking authority under Advisers Act Section 206. At oral argument, the Panel suggested some concern with the factual basis for relying on Section 206 and whether the SEC had identified enough circumstances of “fraud” or other securities law violations to support the sweeping nature of the Rules.

The most important aspect of a holding that the SEC lacked a factual basis may be how realistic it would be for the SEC to cure those deficiencies, both with respect to the standard (if any) that the Court sets (i.e., as to how much record support is necessary) and with respect to the timing (i.e., how quickly the SEC needs to pull together that additional record support). There may also be concerns as to the types of record support the SEC was relying on, including its knowledge gained through non-public examinations and through settled administrative proceedings.

4) Does the Decision find that the SEC cannot use Section 211(h) of the Advisers Act for rulemaking that focuses solely on private fund advisers or for rulemaking that go beyond retail advisory clients?

The Petitioners devoted much of their arguments on why the SEC cannot rely on Section 211(h) of the Advisers Act/Section 913 of the Dodd-Frank Act for a rulemaking focused on private fund advisers. The argument’s premise is that Dodd-Frank Act Section 913 focuses on relationships with retail clients. While the Panel seemed to be open to such a challenge, one question would be whether this means that the SEC cannot rely on Section 211(h) with respect to a rulemaking (i) that excludes retail clients (like the Rules) or (ii) that includes both retail and non-retail clients – e.g., a generally applicable rule that covers all types of clients, including, but not limited to, retail clients.

5) Does the Decision go further in restricting rulemaking with respect to private fund advisers?

Some of the Petitioners’ arguments (in their briefs and during oral argument) broadly challenged the SEC’s ability to adopt rules regulating private funds and private fund advisers, including arguments with respect to (i) the statutory intent of Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, (ii) the ability for the Advisers Act rulemaking to cover the relationship between a private fund sponsor and a private fund investor post-Goldstein, and (iii) the application of the Major-Questions Doctrine post-West Virginia. A more expansive Decision could have a wider range of consequences on other existing rulemakings that apply to private fund advisers.

6) Who looks most likely to seek further review?

It seems likely that one (or both) of the parties will be unhappy with some or all of the Decision. A non-prevailing party can seek further review, through a request for an en banc rehearing by the Fifth Circuit (i.e., the full court, rather than just the three-judge Panel) and/or to the Supreme Court.

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We have previously covered the Private Funds Rules Litigation in more detail in our prior client alerts.²  We will continue to update following the Decision and any following proceedings.

^[1] National Association of Private Fund Managers v. Securities and Exchange Commission, 5th Cir. No. 23-60471. The “Private Funds Rules” are Rule 206(4)-10 (the “Private Fund Audit Rule”), Rule 211(h)(1)-2 (the “Quarterly Statements Rule”), Rule 211(h)(2)-1 (the “Restricted Activities Rule”), Rule 211(h)(2)-2 (the “Adviser-Led Secondaries Rule”) and Rule 211(h)(2)-3 (the “Preferential Treatment Rule”). Please see Client Alert: SEC Adopts Expansive (Albeit Slightly Softened) Private Funds Rules (Aug. 23, 2023).
^[2] Please see our Client Alert: Taking Stock of the Private Funds Rules Litigation After Oral Arguments at the Fifth Circuit (Feb. 7, 2024) and Client Alert: Reviewing the Industry Groups’ Opening Brief Challenging the Private Funds Rules (Nov. 6, 2023).

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