Has the SEC gone beyond its statutory mandate?

The dissenters in the 3-2 vote, Uyeda and Peirce, seemed to welcome a court challenge. But for several days that prospect hung in the air.

The new rules for private funds, approved by a 3-2 vote of the US Securities and Exchange Commission on 23 August 2023 – which we first considered in last week’s column – created a paradoxical circumstance. On the one hand, these rules did seem vulnerable to litigation in a federal court system. On the other, it was unclear who would do the challenging.

The paradox resolved itself on 1 September, when six industry associations joined in filing a petition for review with the US Court of Appeals for the fifth circuit, asking that the rules be set aside.

The petitioners are: National Association of Private Fund Managers; Alternative Investment Management Association; American Investment Council; Loan Syndications and Trading Association; Managed Funds Association; and National Venture Capital Association.

The final rule is worrisome to many, in part because it expands disclosure rules in a way that may prove costly and that look like a one-size-fits-all approach to a densely variegated industry. Indeed, the associations’ petition argues that the new rules will “curb the entrepreneurialism, flexibility and investment returns that have until now made private funds an increasingly attractive option for the world’s most sophisticated investors”.

The specifics range from a requirement for audits and fairness opinions for all adviser-led secondaries to new restrictions on the borrowing from, or receiving credit extension from, private fund clients and the prohibition of preferential treatment of certain investors on redemptions, or on the receipt of portfolio information.

The new rules say, for example, that preferential treatment is prohibited unless it is available to all. But then, is it still preferential? As commissioner Hester Peirce, an opponent of the changes, noted: “Conditioning preferential rights on offering them to everyone sounds like a ban on offering preferential rights, but the release does not characterise what we are doing as a ban.”

As Peirce and fellow commissioner Mark Uyeda contend: the rules seem to go beyond what the statutes that underlie the SEC authorise.

Robert Crea, partner and US head of fund formation at San Francisco law firm Bryan Cave Leighton Paisner, spoke to this point in a conversation subsequent to the SEC’s move: “The dissenting opinion of commissioner Hester Peirce specifically contends, that these rules, especially those that overturn commonly accepted practices in the private funds marketplace, may be vulnerable to claims that the SEC lacks a statutory basis for such rules.

“Such claims may become more compelling given the breadth and prescriptiveness of recent SEC rule proposals in light of their generic foundational statutory bases and the perception that federal courts have become less deferential than they formerly were to rulemaking by federal agencies.”

The rules in some ways change the game for private fund managers fairly fundamentally. The line of defence is becoming clear: that the SEC has overstepped the mark.

Write to the author at christopher.f@pei.group