New SEC private fund disclosure rules rejected by US court

By Sean Cole, James Kanabar, Hannah O'Flynn
Private Capital Private Equity Superannuation

What Australian sponsors and investors need to know 3 min read

In our previous Insight, we discussed the adoption of new Rules by the US Securities and Exchange Commission (SEC), which sought to regulate the private fund industry under the US Investment Advisers Act of 1940, and the potential effects of those Rules on Australian sponsors and investors. The new Rules, designed to increase transparency and provide additional investor protections, had presented the biggest change to the regulation of US private fund advisers in over a decade.

A US appeals court has now thrown out those Rules in their entirety, finding that the SEC exceeded its statutory authority in adopting the Rules in August 2023 (given it was not empowered under either of provisions it relied upon to adopt the Rules), and that the SEC had failed to 'rationally connect' the Rules to its fraud-prevention powers.1

How might this affect you?

US private fund advisers and non-US advisers captured by these Rules will be relieved to hear that the burdensome restrictions and new requirements under the Rules will no longer take effect.

Australian LP investment teams, however, will no longer be able to receive the benefit of the Rules (see our previous Insight) when investing with advisers subject to the Rules. LPs will instead need to rely (as they are currently doing) on the usual route of seeking to negotiate their required position with the GP on a bilateral basis.

It was anticipated that the Rules would significantly change the private funds market in the US and the expectations of investors in private funds, however without any strict requirement on private fund advisers to agree to those positions, it would seem that, for now at least, we are back to the status quo.

Next steps

It is reported that the SEC is reviewing the decision and determining its next steps. While the SEC could appeal to the US Supreme Court, it would face a conservative majority which has been progressively trying to weaken the authority of administrative agencies, including the SEC. Alternatively, the SEC could seek a rehearing before the full bench of the court which has just passed this judgment, but we understand there is a remote possibility of this in practice. The court's decision not only raises questions more generally about the SEC's powers to impose other rules it is working on, but could restrict future SEC rulemakings that specifically regulate private fund advisers.

As investment managers and APRA-regulated investors in Australia prepare for the incoming implementation of Prudential Standard CPS 230 (Operational Risk Management)—which will further regulate, amongst a range of other reforms, the outsourcing activities of impacted investment managers—the SEC's proposed rules to regulate outsourcing by regulated Investment Advisers now look vulnerable to litigation and challenge.

We expect that investors and sponsors will follow the SEC's response and other developments closely, given the potential impact on both regulatory approaches and market practices across the wholesale funds management industry globally.