How the Fifth Circuit’s Decision to Vacate the SEC’s PFAR Impacts Compliance Professionals

The  U.S. Court of Appeals for the Fifth Circuit’s (“Fifth Circuit”) decision to vacate the Securities and Exchange Commission’s (“SEC”) Private Fund Adviser Rules (“PFAR”) is expected to impact the responsibilities of compliance professionals.

To assist in understanding the implications resulting from the Fifth Circuit decision, EisnerAmper hosted a General Counsel(“GC”)/Chief Compliance Officer (“CCO”) Roundtable Luncheon where over twenty GCs, CCOs, and other compliance professionals gathered to discuss the impact of the Fifth Circuit’s decision and share industry best practices.  The event took place on June 26, 2024, at Sea Fire Grill in New York City and was co-hosted by the law firm Lowenstein Sandler LLP, with guest speakers Suzan Rose, Senior Advisor to Government & Regulatory Affairs at the Alternative Investment Management Association (“AIMA”), and Michelle Noyes, Head of Americas at AIMA.

The roundtable discussion began by highlighting the Fifth Circuit’s decision to vacate the SEC’s PFAR. PFAR was adopted on August 23, 2023, with related compliance dates for the bulk of the rules scheduled to go into effect on September 14, 2024, or March 14, 2025, depending on the amount of private funds assets under management.  The final PFAR consisted of the following rules:

(1) Preferential treatment rule;
(2) Restricted activities rule;
(3) Quarterly statement rule;
(4) Adviser-led secondaries rule;
(5) Annual audit rule;
(6) Annual review rule.

The Fifth Circuit vacated PFAR in its entirety after finding that in adopting the rules, the SEC exceeded its statutory authority under Section 206(4) and Section 211(h) of the Investment Advisers Act of 1940 (the “Advisers Act”). The Fifth Circuit held that neither section granted the SEC the authority to adopt the new rules.

In its decision, the Fifth Circuit held that (1) Section 206(4), - known as the anti-fraud rule under the Advisers Act - specifically requires the SEC to define the fraud it is being used for, but the SEC applied 206(4) pretextually, failing to articulate a rational connection between PFAR and fraud, nor how PFAR would prevent the undemonstrated fraud, and (2) Section 211(h) applies to relationships between investment advisers and retail customers, not private funds as the SEC had asserted.

At present, it is unclear whether the SEC will appeal the Fifth Circuit decision. Absent successful appeal, Rose advised that “PFAR should be considered a 660-page risk alert and while advisers can put their pencils down for now, they should not throw away their workpapers.” She urged advisers to recognize the “hotspots” that are of concern to the SEC, particularly where they correlate with existing authority, such as fiduciary duty as detailed in the 2019 interpretation on Standard Conduct for Investment Advisers. Advisers also can glean best practices from PFAR on subjects such as investor transparency, distributing a fairness or valuation opinion for adviser-led secondary transactions, managing conflicts of interest, and documenting fees, expense allocations and annual compliance reviews. Investor expectations have changed as a result of PFAR, despite the outcome, and investment advisers may change certain of their practices accordingly. They also should consider the potential for further regulatory developments, such as if the SEC attempts to repropose elements of PFAR under its existing authority. In the meantime, it is likely that the SEC will more aggressively enforce existing regulation, particularly in relation to concerns it attempted to address through PFAR.

The discussions continued and covered topics such as fiduciary duty, investor expectations and due diligence practice changes since PFAR was finalized, investment adviser preparation for PFAR to date, and the Marketing Rule.