A U.S. appeals court rejected a Securities and Exchange Commission rule intended to give investors more transparency into private funds, but which the nearly $27 trillion industry said threatened to fundamentally change how it does business.
The New Orleans-based 5th U.S. Circuit Court of Appeals decided that the SEC exceeded its authority by adopting the rule in August 2023. It ruled in favor of six private equity and hedge fund groups that challenged the regulations.
A request for comment to the SEC was not immediately returned.
Wednesday’s decision is a victory for U.S. financial services companies and trade groups that have gone to court increasingly often to challenge rules they have argued would boost compliance costs and reduce profits.
Recent fights involving the SEC concerned regulations requiring more transparency surrounding short positions, and that firms that routinely deal in government bonds and other securities register as broker-dealers.
The latest decision addressed rules covering private equity funds, hedge funds, venture capital funds and managers of funds for institutional investors such as pension funds and endowments, among others.
These rules required fund managers to issue quarterly performance and fee reports, perform annual audits, and stop giving some investors preferential treatment over redemptions and preferential information about portfolio holdings.
They were intended to increase transparency, fairness and accountability in an industry known for opacity.
Industry critics said this lack of transparency has hurt ordinary investors with indirect exposure to private funds, such as through pension and retirement plans.
The SEC voted 3-2 to adopt the rules, with Democratic-appointed commissioners in favor and Republican-appointed commissioners opposed.
Big Costs Cited
Groups that sued to challenge the rules are the National Association of Private Fund Managers, the Alternative Investment Management Association, the American Investment Council, the Loan Syndications and Trading Association, the Managed Funds Association and the National Venture Capital Association.
They said the rules were “unduly burdensome,” and would harm investors by forcing them to sift through “mountains” of new information to find what they want, while footing the estimated compliance costs of nearly $500 million a year.
The groups also said the rules could suppress capital formation, and make it harder for smaller advisers to compete.
Private funds often attract well-heeled, sophisticated investors, and as a result have received less federal regulatory oversight than investments geared toward ordinary investors.
The funds’ assets under management swelled to $26.6 trillion in 2022 from $9.8 trillion in 2022, as the number of private funds more than tripled to about 101,000, according to the SEC.
In announcing the new rules, SEC Chair Gary Gensler said they would benefit “all investors, big or small, institutional or retail, sophisticated or not.”
The 5th Circuit has become a favored court for conservative and business groups to challenge federal regulatory powers.
All three judges involved in Wednesday’s decision were appointed by Republican presidents.
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