A federal appeals court on Wednesday struck down a Securities and Exchange Commission rule that was intended to make hedge funds, private equity funds and venture capital firms provide investors with more information about fees and expenses.
The unanimous decision by the New Orleans-based U.S. Court of Appeals for the Fifth Circuit ruled in favor of a group of organizations representing the private fund industry that the SEC had overstepped its authority through the rule implemented in August.
In its decision, the appeals court agreed with their argument, saying the regulator had violated its own rules, which are based on a law designed to protect ordinary investors who typically invest in mutual funds and other public securities, rather than investors in hedge funds and private equity firms.
The SEC said in a statement that it is reviewing the decision and will “determine next steps as appropriate.”
Hedge funds, private equity firms, and venture capital firms manage about $27 trillion in client assets for pension funds, universities, charitable groups, and wealthy individuals. About a decade ago, large investment funds were required to register with the SEC and subject themselves to basic regulatory oversight.
The SEC's August rule created new requirements for private fund managers – to provide quarterly disclosures to investors about fees and expenses and to treat all investors in the fund equally, no matter how big the investor is. The SEC said its goal was to bring more uniformity to the information private funds provide to investors.
SEC Chair Gary Gensler said at the time that the rule would promote greater transparency and competition in the private fund industry. Rules adopted In a 3-2 vote, all Democratic commissioners voted in favor and the Republican commissioners voted against it.
Private fund managers objected to the rule, arguing that quarterly disclosures, in particular, would increase operating costs. A group of organizations representing the private fund industry immediately filed a lawsuit challenging the rule.
The appeals court's decision was criticized by advocates for greater transparency in financial markets.
“While the federal securities laws were designed to provide investors with necessary information, the Court is saying the SEC cannot do the same for investors in private funds,” said Tyler Gellasch, president of the Healthy Markets Association.
The decision could set the stage for other legal challenges involving the private fund business.
“The court has confirmed that the SEC cannot extend its authority beyond what Congress intended,” said Brian Corbett, president of the Managed Funds Association, one of the industry groups that brought the suit. “Unfortunately, this is just one example of the SEC doing that.”
The Fifth Circuit become one of the more conservative federalists There are appellate benches in the country. Because of their business-friendly nature, industry groups have filed lawsuits challenging the regulations in federal courts in Texas and Louisiana in hopes of getting a hearing before an appellate court. All three judges on the appellate panel were appointed by Republican presidents.