February 7, 2024 - A three-judge panel of the U.S. Circuit Court for the Fifth Circuit heard oral argument this week in a case brought in September 2023 by the LSTA and several other trade associations (the “Joint Trades”) against the Securities and Exchange Commission (“SEC”) seeking to vacate the Private Fund Advisers Rule (“the PFA Rule”). The case reflects the Joint Trades’ belief that the SEC exceeded its statutory authority and acted arbitrarily and capriciously in adopting the PFA Rule.

The oral argument focused primarily on whether the SEC has the statutory authority to impose the PFA Rule on private funds. Reorg reported that Eugene Scalia of Gibson Dunn, representing the Joint Trades, “characterized the final rule as a “brazen attempt” and “hostile takeover” by the SEC to exercise “plenary authority” over private fund advisors.”  He argued that the SEC “incorrectly interprets section 913 of the Dodd-Frank Act as enabling the agency to regulate private fund advisors in addition to retail investors.” Scalia highlighted the context of the SEC’s purported statutory authority, suggesting that Congress would not have relied on an obscure provision of section 913 (entitled “Other Matters”) for such sweeping “plenary” authority over private funds. Stated differently, “Congress does not hide elephants in mouseholes.”  In contrast, Jefferey Berger, representing the SEC, argued that the plain language in the provision of section 913 was clear, was not limited to retail investors and, to the contrary, gave the SEC authority to regulate managers of all “investors,” not just retail investors. The Wall Street Journal noted that the Fifth Circuit panel sounded “skeptical” about the SEC’s claims for broader power and Reorg noted that the panel “grilled” the SEC on whether the agency had “sufficient authority to implement the new regulations.”

Counsel also sparred about whether the SEC had justified the need for the rule and whether it had done an adequate cost-benefit analysis, with Scalia arguing that the private fund advisory business was robust, growing in popularity and providing outsized returns to investors and Berger contending that the rule was meant to address the lack of transparency and conflicts of interest in the private fund industry. Berger pointed to the disadvantages experienced by some investors such as small pension funds and the fact that the SEC had settled a small number of enforcement actions against private fund advisers over the years.

One of the more interesting discussions at the argument was whether, even if the court rules for the Joint Trades, it should limit the ruling to only the three (of five) components of the PFA Rule addressed in the Joint Trades’ briefs. Scalia urged the court to consider the rule in its entirety since the lack of statutory authority and other flaws identified by the Joint Trades pertain to the entire rule, not just the three components they briefed. Berger, in contrast, urged the court to treat the PFA Rule as five different rules and leave the two “uncontested” rules in place. At the end of the oral argument the court took the rule under advisement. Given that the court is handling this litigation on an expedited basis (and has moved remarkably quickly so far) it would not be surprising to see a decision from the court in the near future.

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