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SEC 'exceeded' authority on fee disclosures, US appeals court rules

Jun. 6, 2024

The Fifth Circuit Court of Appeals unanimously rules that the SEC exceeded authority in requiring fee disclosure.

three judges signing ruling on SEC authority abuse

In a blow to the SEC’s claimed authority over the hedge fund sector, a United States appeals court has struck down a rule that required hedge funds and private equity firms to increase transparency regarding their fees and expenses.

The Fifth Circuit Court of Appeals issued a unanimous decision on June 5, with a three-judge panel ruling that the SEC exceeded its statutory authority in implementing the measure.

The court’s ruling came in response to a challenge brought by six industry groups, who argued that the SEC’s 656-page rule would significantly alter the sector’s operations and increase compliance costs. The rule mandated quarterly performance and fee reports, annual audits, and the elimination of preferential treatment for certain investors.

Writing on behalf of the panel, Judge Kurt Engelhardt rejected the SEC’s assertion that the Dodd-Frank Act, passed in the wake of the 2008 financial crisis to reform the financial sector, had expanded its authority to oversee private funds. Engelhardt emphasized that the two sections of the Act cited by the SEC did not grant the Commission such authority, stating:

“The promulgation of the Final Rule was unauthorized, no part of it can stand.”

The court’s decision has resonated with critics of the SEC within the crypto industry, who have raised similar concerns about the regulator’s claimed authority in recent years. In a series of lawsuits against crypto firms, the SEC has argued that many cryptocurrencies qualify as securities under its jurisdiction, relying on the Howey test as a legal framework. However, crypto firms have pushed back, asserting that the SEC lacks the authority to regulate crypto without explicit congressional approval.

The SEC now faces potential action from Congress that could alter its claimed authority over the US crypto industry. The Financial Innovation and Technology for the 21st Century Act (FIT21), which would primarily transfer authority over the crypto industry to the Commodity Futures Trading Commission, recently passed the House with strong bipartisan support.

Additionally, the SEC narrowly avoided a Congressional resolution aimed at repealing its Staff Accounting Bulletin (SAB) 121, which prevented banks from owning crypto, thanks to a veto by President Joe Biden.

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