In a significant ruling that has sent shockwaves through the financial industry, the 5th U.S. Circuit Court of Appeals has overturned a Securities and Exchange Commission (SEC) rule aimed at increasing transparency in the nearly $27 trillion private fund sector. The decision, handed down recently by a 3-0 vote, marks a major victory for private equity and hedge fund groups who challenged the rule, arguing that it exceeded the SEC’s authority. 

The rule, which was adopted by the SEC last August, required private fund managers to provide quarterly performance and fee reports, conduct annual audits, and treat all investors equally in terms of redemptions and access to portfolio information. It applied to a wide range of private funds, including those catering to institutional investors such as pension funds and endowments. 

Industry groups, including the American Investment Council, praised the court’s decision, contending that the SEC rule was unnecessarily burdensome, expensive, and threatened to fundamentally alter their business practices. They argued that the rule would ultimately harm ordinary investors who are often indirectly exposed to private funds through their retirement and pension plans. 

However, investor advocates have criticized the ruling, with Better Markets’ legal director Stephen Hall calling it a “terrible setback.” Hall argued that the decision strips ordinary Americans of protections against unfair and opaque practices in private funds, undermining the SEC’s ability to safeguard investors, financial stability, and market integrity. 

The court’s decision hinged on the interpretation of the 2010 Dodd-Frank law, with Circuit Judge Kurt Engelhardt rejecting the SEC’s claim that Congress had granted it the authority to implement the rule. Engelhardt stated that the relevant provision “has nothing to do with private funds.” 

This ruling could have far-reaching implications for SEC rulemaking, potentially impacting other proposed regulations such as those related to broker-dealer technology and climate change disclosures. Legal experts suggest that the SEC will need to carefully consider this decision to avoid similar vulnerabilities in future rules. 

As the private fund industry continues to grow, with assets under management surging from $9.8 trillion to $26.6 trillion over the past decade, the debate over transparency and regulation is likely to persist. While the court’s decision is a setback for the SEC and investor advocates, it remains to be seen how this ruling will shape the future of private fund oversight and investor protection.