(Bloomberg) — The US Securities and Exchange Commission is trying to fend off a legal challenge to agency rules requiring hedge funds and private equity firms to detail quarterly fees and expenses to investors.
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The regulator faced tough questioning from a three-judge panel as it faced off Monday against the Managed Funds Association and other trade groups in a hearing at the US Fifth Circuit Court of Appeals in New Orleans.
In addition to fee disclosures, the rules adopted by the SEC in August would prohibit firms from allowing some favored investors to cash out more easily than others. The SEC under Chair Gary Gensler has been tightening its grip on private funds, and the rules would bring increased transparency to a burgeoning industry known for its opaque and complex layers of fees.
The industry groups, including the American Investment Council, argued in the lawsuit they filed a week after the rules were adopted that they would “fundamentally change the way private funds are regulated in America.” 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.”
Lawyers for the industry also contend the SEC exceeded its authority in adopting the rules. But the SEC claims it’s working within its authority under the 2010 Dodd-Frank Act. The agency has said in court filings that the rules “are a flexible and measured approach to resolve problems affecting investors and their stakeholders.”
At the hearing, the two judges appointed by former President Donald Trump and one by George W. Bush appeared more sympathetic to the private funds’ arguments than to the SEC.
“I perceived a healthy dose of skepticism of the SEC’s rulemaking authority at least under the new Dodd-Frank Act,” David Blass, a former SEC official who’s now a partner at the law firm Simpson Thacher & Bartlett, said after listening to the arguments.
The judges’ comments suggested they viewed the economics of the fast growth of the private funds industry as a sign of market success rather than failure. They appeared to be considering whether to strike down the new rules in their entirety or just the provisions that the industry attacked most forcefully in court filings.
The industry groups are represented by former Trump administration Labor Secretary Eugene Scalia, son of the late Supreme Court Justice Antonin Scalia.
The appeal has been on a fast-track schedule at the request of Scalia, who argued to the court in September that the “commission’s edicts will soon take effect; compliance build-out has already started, and the industry is now hurtling toward a multi-billion-dollar-a-year financial cliff.”
The panel didn’t indicate when it will rule. If the court ends up striking down the rules, the SEC could ask for review by a larger panel of judges or the US Supreme Court.
The case is National Association of Fund Managers v. Securities and Exchange Commission, 23-60471, US Fifth Circuit Court of Appeals (New Orleans).
–With assistance from Dawn Lim.
(Updates with judges’ comments at hearing.)
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