Federal Appeals Court Rejects SEC Transparency Rules For Hedge Funds

A federal appeals court has dashed U.S. Securities and Exchange Commission rules requiring hedge funds and private equity firms to detail quarterly fees and expenses to investors.

The U.S. 5th Court of Appeals in New Orleans, consisting of a three-judge panel, sided with industry groups who argued that the SEC exceeded its authority and that the rules were unnecessary for “highly sophisticated” investors who invest in private funds, according to Bloomberg.

“The Commission has exceeded its statutory authority in adopting the Final Rule,” Judge Kurt D. Engelhardt wrote in a 27-page court document on Wednesday obtained by Benzinga.

The regulations were one of several rules that the SEC has been seeking to impose on hedge funds and private equity firms, Bloomberg reported.

"The staff will take a look" and respond accordingly, SEC Chair Gary Gensler said during an industry conference Wednesday in New York when asked about the court opinion. The SEC rules, which were adopted in August, also prohibited firms from allowing some favored investors to cash out more easily than others.

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The court ruling came several months after industry groups that included the Managed Funds Association and the American Investment Council filed a lawsuit in late October against the SEC, arguing that rules would “fundamentally change the way private funds are regulated in America,” Bloomberg reported.

The groups said that private equity investors are among the most sophisticated in the world and would not be funneling their money into an industry if it was in need of a "government overhaul."

"Today's ruling is a significant victory for markets, fund managers, and investors, including pensions, foundations, and endowments,” MFA President and CEO Bryan Corbett said in a statement on Wednesday. “The court affirmed that the SEC cannot expand its authority beyond what Congress intended.”

“Unfortunately, this is just one instance of SEC overreach as it looks to push through the most aggressive agenda in decades. MFA will continue to work constructively with the SEC to help improve its rushed rulemakings, and we remain focused on enabling alternative asset managers to raise capital, invest it, and generate returns for their beneficiaries," Corbett said.

The MFA and other trade groups sued the SEC in March over rules requiring firms to register as dealers in the U.S. Treasuries market.

Ahead of Wednesday's opinion, the SEC had argued that its fee disclosure rules are permitted under the 2010 Dodd-Frank Act, but Engelhardt said that, "by congressional design, private funds are exempt from federal regulation" of their internal structures, according to Bloomberg.

He also said the 2010 law expanding government oversight of the U.S. financial system is not as permissive as the SEC argued in defending the rule.

The appeals court also rejected an argument from the SEC that the rule was necessary because it would weed out fraud, ruling that the SEC is conflating a lack of disclosure with deception.

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