All for nothing?

A court of appeals decision in the US this week to render null and void the SEC’s private fund rule doesn’t signal the end of efforts to better protect investors.

Does freedom of contract – the ability of a fund and an investor to reach terms that they deem to be mutually acceptable – trump efforts designed to protect those same investors from the fund managers they invest with? According to a US federal appeals court this week, it does.

That was the matter at the heart of a lawsuit to overturn the biggest changes to the private funds industry since the global financial crisis. On Wednesday, the Fifth Circuit Court of Appeals smacked down the US Securities and Exchange Commission’s attempts to radically change how the private funds industry operates.

To recap, the SEC had wanted, among other things, to address preferential terms by requiring GPs to disclose to all newly committing LPs the various different economic terms other LPs in the fund are subject to pre-closing. It also required them to produce quarterly statements on fees and expenses, compensation and fund performance.

There are several reasons behind the appeals court’s decision; if you haven’t yet read it, here’s a debrief.

So, after countless hours and what is likely millions of dollars’ worth of consultancy and legal experts’ fees, was it all for nothing?

“I don’t see this as a waste, because there are a lot of parts of the rule that have been in discussion even before the rule came out,” says Barbara Niederkofler, a partner at Akin Gump. The conversations about fiduciary duty and conflicts of interest in the private funds industry are going to continue, she adds.

Still, LPs are clearly licking their wounds. The Institutional Limited Partners Association’s chief executive, Jennifer Choi, said her group was “disappointed” by the decision. With the ruling, the “absence of minimum mandated standards, private funds will be under no obligation to provide critical information related to the fees and expenses charged to fund investors and meaningful performance information, leaving LPs to negotiate for terms that should be common sense”, Choi said in a statement.

On the fund management side, there will be jubilation. Jack Inglis – chief executive of the Alternative Investment Management Association, which was one of the industry bodies that sued the SEC – had referred to the SEC’s rules as “very simply unlawful” and warned that private funds were at risk of being treated more like publicly offered investment vehicles such as mutual funds.

As far as GP-led secondaries – a key part of the private fund advisers rule – are concerned, market sources tell us the court’s decision is likely to have little impact on how this part of the industry operates. Third-party valuations or fairness opinions, made mandatory under the rules, have become standard market practice in many GP-led transactions already. And the 60-day reporting requirement for GP-led processes was part of the SEC’s separate Form PF requirements, which were not up for appeal and which still stand.

This is likely not the last we’ll hear from the SEC when it comes to enhancing protections for private fund investors. There’s a “definite expansion” in interest and capabilities by the regulator when it comes to private equity, Niederkofler says. There’s also the possibility the regulator will use existing rules, particularly the marketing rule, to crack down on some of the practices the voided rules targeted. The Commission could also still appeal the decision to the Supreme Court, and a spokesperson for the regulator told affiliate title Private Funds CFO that the SEC was reviewing the decision and “will determine next steps as appropriate”.

For the private funds industry, the case may well continue.