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Simply put, this is not a summer to remember for the SEC and there could be both short- and long-term impacts to the investment management community.
What Happened?
It began on June 5th when the 5th Circuit Court took a chainsaw to the SEC’s Private Fund Rules by vacating the rules in their entirety. What make the ruling extra painful is the court’s legal justification. The court ruled that the entire promulgation of the rules –including the SEC’s legal basis for how it could regulate private funds – exceeded the SEC’s statutory authority under the Advisers Act. Ouch…
The SEC Private Fund Rules were supposed to be one of Chairman Gensler’s crowning achievements by imposing retail-like disclosures requirements to private funds – the rules being characterized as an attempt to protect investors from riskier investments in hedge funds, private equity funds, etc. While there was much rejoicing from the private fund industry, the SEC was staring at their first real limitation on regulating private funds in a long time.
Fast forward a few weeks and the Supreme Court was prepared to issue its rulings on a variety of high-profile cases. The first came on June 27th when the Supreme Court ruled in favor of Mr. Jarkesy in SEC v. Jarkesy. While this case did not get the same media attention as Chevron or others, this ruling was a long-awaited result for people involved in SEC enforcement issues. From a very high level, the ruling gutted the SEC’s ability to use administrative proceedings when seeking civil penalties for securities fraud. The immediate impact to an investment manager is meaningless unless you are caught up in a securities fraud finding by the SEC, but the ruling is another example of the SEC’s historical methods of operations being fundamentally altered.
Lastly (at least at the time of writing this) is Chevron. The Supreme Court’s ruling in Loper Bright Enterprises v. Raimondo, where it overturned Chevron and eliminated the so-called Chevron Deference, is an unparalleled change to administrative law that had existed for over 40 years (40 years and 3 days to be precise). In layman’s terms, Chevron Deference allowed agencies like the SEC to have authority for interpreting ambiguities in the regulation it writes and courts must defer to their interpretation.
What Does This Mean?
The impacts of this decision will be felt for decades, at least, and will touch every aspect of how US federal agencies operate. For the SEC in particular, it is not known what the impacts will be tomorrow. There are endless examples of SEC decisions and interpretation of its rules whereby Chevron would be relied on if challenged. Agencies do no state they are using Chevron when implementing or interpreting their rules, but they know they have (well, had) the protection of Chevron in the background.
So, what does this all mean for Investment Managers? I think everyone can agree that the SEC is weaker today than it was before the summer and it is likely these rulings will slow, if not significantly limit, the SEC’s future rulemaking.
Even if some of the rulings, particularly the vacating of the Private Fund rules, were expected, the SEC likely needs to proceed with more caution than before. While none of the rulings change the SEC’s legislative obligation to regulate the securities market, if the SEC wants to propose new rules, they must be careful. The SEC knows that for any new rule market participants – now emboldened by the Private Fund rules result – will challenge the rules in court or challenge the SEC’s interpretation and enforcement of it. It’s akin to a pre- and post-trade investment compliance check. Any new rule will be at risk before and after adoption.
While less rulemaking is typically good for the investment management community, there is a flip side to this regulatory coin. Through the SEC’s history, there have been periods where, instead of rulemaking, it focused on “regulation by enforcement”. This is the concept where the SEC uses enforcement proceedings to change existing regulation. While Jarkesy limited the SEC’s ability to use administrative proceeding instead of civil trials, the SEC’s authority to enforce securities law has not been limited.
Enforcement may be slower when there are civil trials instead of administrative proceedings, but it is enforcement all the same. In a post-Chevron world, the SEC will need to be mindful what types of enforcement it takes because often the justification for such enforcement is based on its own interpretation of securities regulation.
While Jarkesy and Loper Bright severely limited the SEC’s enforcement and interpretive abilities, the ruling on the Private Fund rules may have the most immediate impact to by slowing rulemaking and therefore pushing the SEC to use “regulation by enforcement”. It is a highly probable outcome that SEC enforcement actions increase going forward to further the current SEC’s agenda. But alas, as such is the case in America, the upcoming election could drastically change that agenda.
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Scott G. Parkin is the Head of US for Zeidler Group.
Zeidler Group is a boutique asset management law firm and legal technology firm with newly opened US offices in New York City and Phoenix. Serving over 250 asset managers globally across 70+ jurisdictions, Zeidler Group specializes in cross-border distribution. As well as research-driven legal guidance, we offer various digital solutions for fund managers’ legal and compliance needs, including a Marketing Material Review Tool (MMR-Tool) that uses Large Language Models for reviewing investment fund marketing materials against the laws of multiple countries as well as a customizable Vendor Due Diligence solution to efficiently manage questionnaire distribution, completion and rating as well as mitigate risk. Zeidler Group provides future-proofed solutions in navigating regulatory landscapes.
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Any views expressed in this article are those of the author and do not necessarily represent the view of EFSI