Checking in with AIFMD II; Sustainable finance; Investment monitoring changes in the UK; SEC's new private fund rules

In a development which may impact investment advisers’ compliance processes, the SEC’s recently enacted Private Fund Adviser reforms are facing scrutiny from the U.S. Court of Appeals, which on February 5th heard oral arguments. Having faced questions about its authority on a number of fronts in recent years (for example under the “major questions” doctrine and climate-related disclosures), the SEC is now defending its authority under the Investment Advisers Act. Influential trade bodies such as the Managed Funds Association (as a petitioner) and the American Chamber of Commerce (which filed a third-party brief) are leading the charge against the rules. Lead counsel for the petitioners is Eugene Scalia, a former Secretary of Labor in the Trump Administration and the son of late Supreme Court Justice Antonin Scalia.

But procedurally, the most important actor is a little-known entity created recently: the National Association of Private Fund Managers (NAPFM). Formed by hedge funds shortly after the SEC proposed its reforms in 2022, and citing Fort Worth, Texas as its place of business, NAPFM is the legal entity through which the industry brought its claims to the particular Court of Appeals most likely to be hostile to government rulemaking: the Fifth Circuit, encompassing the federal courts of Texas, Mississippi and Louisiana.

While often seen (and of late, criticized) as a target for legal forum shopping, the Fifth Circuit here wouldn’t be alone in viewing the SEC’s new framework with some skepticism. Adopted by the SEC last August in a 3-2 decision, the Private Fund Adviser reforms have already taken flak from within the Commission itself (agree with her or not, Commissioner Peirce’s dissents can make for fun reading). And the public comments submitted to the SEC during the rulemaking process showed that many private fund groups oppose the new rules, while public pensions and unions largely support them.

With respect to one key requirement set to affect adviser compliance operations — new quarterly disclosures — the issue largely boils down to this sentence in the Investment Advisers Act (Sec. 211(h)(1), added by the Dodd-Frank Act in 2010):

“(h) OTHER MATTERS. —The Commission shall— (1) facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with brokers, dealers, and investment advisers, including any material conflicts of interest; . . . ”

The question is whether that statement from Congress granted the SEC the authority to issue its relevant disclosure rule 211(h)(1)-2, which starting in March 2025 requires advisers to submit quarterly statements containing information on fees, expenses and performance. Competing briefs argue over the meaning of the statutory language (e.g. “investors”, “terms”, “relationships”), the interpretation of which by the Fifth Circuit could seal the fate of these requirements.

Other aspects of the SEC’s reforms (covered in our November edition) are also targeted, relating to certain restricted activities and preferential treatment. Additional requirements, on audits and adviser-led secondary transactions, were not addressed by the petitioners in their opening brief, and hence are more likely to survive — unless the Fifth Circuit decides to vacate the entire SEC Final Rule. A useful summary of the written as well as oral arguments before the Fifth Circuit is found here.

The first compliance date for the reforms arrives in September 2024 (relating to restricted activities, preferential treatment, and registered adviser-led secondary transactions). Without a decision from the Fifth Circuit before then, it’s possible that SEC’s reforms could be delayed pending a court decision (of the Fifth Circuit, or perhaps ultimately of the Supreme Court).

– Greg Hotaling, Regulatory Content Manager at Confluence