By Jonathan Stempel and Carolina Mandl
(Reuters) -A U.S. appeals court threw out a Securities and Exchange Commission rule intended to give investors more transparency into private funds, handing a victory to the nearly $27 trillion industry.
In a 3-0 decision on Wednesday, the New Orleans-based 5th U.S. Circuit Court of Appeals ruled in favor of six private equity and hedge fund groups, finding that the SEC exceeded its authority by adopting the rule last August.
An SEC spokeswoman said the regulator is reviewing the decision and will determine its next steps.
Industry opponents said the rule was unduly burdensome and costly, and threatened to fundamentally change how they did business. They praised the appeals court for curtailing the SEC.
“The ruling is a victory for thousands of businesses across America that need capital to grow and millions of workers who depend on private equity and credit to strengthen their retirements,” said Drew Maloney, chief executive of the American Investment Council, one of the six groups.
Wednesday’s decision is a fresh blow for the SEC and Chair Gary Gensler, as industry groups turn often to conservative-leaning courts to challenge rules that they say saddle them with needless red tape and compliance costs.
Some hedge fund groups are also suing the SEC over short-selling disclosure rules and changes to their trading practices in the U.S. Treasury market, while business groups in March sued the SEC over climate change rules.
‘NOTHING TO DO’ WITH PRIVATE FUNDS
The rule overturned on Wednesday required fund managers to issue quarterly performance and fee reports, perform annual audits, and stop giving some investors preferential treatment over redemptions and special access to portfolio holdings.
It applied to private equity funds, hedge funds, venture capital funds and managers of funds for institutional investors such as pension funds and endowments, among others.
Such funds typically attract well-heeled, sophisticated investors, and as a result have received less federal regulatory oversight than investments geared toward ordinary investors.
The SEC said the rules aimed to increase transparency, fairness and accountability in an industry known for opacity.
But the industry said it would ultimately hurt ordinary investors who frequently have indirect exposure to private funds through pension and retirement plans.
Circuit Judge Kurt Engelhardt rejected the SEC’s argument that Congress gave it authority through the 2010 Dodd-Frank law to implement the rule, saying the applicable provision “has nothing to do with private funds.”
Private 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.
“The decision makes it clear that investors can’t rely on the SEC or the courts to protect them from private fund abuses,” said Tyler Gellasch, chief executive of nonprofit Healthy Markets Association.
OPPONENTS SAW INVESTOR HARM
Other groups challenging the rule were the National Association of Private Fund Managers, the Alternative Investment Management Association, the Loan Syndications and Trading Association, the Managed Funds Association and the National Venture Capital Association.
They said the rule would harm investors by forcing them to sift through “mountains” of new information to find what they want, and foot nearly $500 million of annual compliance costs.
The groups also said the rule could suppress capital formation, and make it harder for smaller advisers to compete.
In announcing the rule, Gensler said it would benefit “all investors, big or small, institutional or retail, sophisticated or not.”
The SEC voted 3-2 to adopt the rule, with Democratic-appointed commissioners in favor and Republican-appointed commissioners opposed.
All three judges involved in Wednesday’s decision were appointed by Republican presidents.
The 5th Circuit has become a favored court for conservative and business groups to challenge federal regulatory powers.