In a further challenge to the U.S. Securities and Exchange Commission’s rules related to private fund advisors, industry groups are leaning in on the agency’s authority to impose regulatory oversight.
The Managed Funds Association (MFA), National Association of Private Fund Managers (NAPFM), Alternative Investment Management Association (AIMA), Alternative Investment Council (AIC), Loan Syndications and Trading Association (LSTA) and National Venture Capital Association (NVCA) have drafted a joint letter highlighting the Fifth Circuit Court’s recent decision to vacate the Private Fund Advisor (PFA) rule last month.
There are three new rules under fire. The first is a proposal is related to Predictive Data Analytics, which requires require broker-dealers and investment advisers to take certain steps to address conflicts of interest associated with their use of predictive data analytics and similar technologies to interact with investors to prevent firms from placing their interests ahead of investors’ interests. The rule was proposed last year under section 211 of the Investment Advisers Act of 1940 (the Act).
The second rule being challenged relates to outsourcing, and it would require advisers to conduct due diligence prior to engaging a service provider to perform certain services or functions. It would further require advisers to periodically monitor the performance and reassess the retention of the service provider in accordance with due diligence requirements to reasonably determine that it is appropriate to continue to outsource those services or functions to that service provider. The rule was proposed in 2022 and falls under both section 206 and 211 of the Act.
Also facing opposition is a proposed cybersecurity rule that would, among other things, require registered investment advisers and investment companies to adopt and implement written cybersecurity policies and procedures reasonably designed to address cybersecurity risks, report information confidentially to the SEC about certain cybersecurity incidents and maintain related records. The rule was also proposed in 2022 and falls under section 206 and 211 of the Act.
According to the industry groups, the Fifth Circuit Court’s decision that struck down the Private Fund Adviser rule found that neither section of the Investment Advisers Act allows for the SEC to have rulemaking authority over private fund advisers or their investors.
According to legal scholars, the decision last month settled an ongoing debate as to whether the agency needed to have Congress draft new laws to grant SEC additional oversight with respect to the issues raised by the proposed rules.
“The Private Fund Adviser decision reaffirmed that the SEC cannot finalize rules that exceed its statutory authority. As drafted, the Predictive Data Analytics, Outsourcing, and Cybersecurity proposals exceed the Commission’s authority in the same way as the recently vacated Private Fund Adviser Rule,” said MFA President and CEO Bryan Corbett. “The SEC needs to withdraw these rules that are based on an improper reading of the relevant statutes.”
The letter sent by the industry bodies the SEC echoes the same forceful language. They add, however, that the commission needs to make clear that the newly proposed rules are only applicable to advisors with retail clients, which would be in line with the Court’s ruling that section 211 of the Advisers Act applied only to retail customers.
Congressional action?
With respect to the Outsourcing and Cybersecurity proposals, the private fund manager groups agree that “by congressional design, private funds are exempt from federal regulation of their internal ‘governance structure’ and that includes oversight of vendors and other operational matters.”
“By prohibiting private fund managers from retaining service providers unless they adhere to the strict conditions set forth in the Outsourcing and the Cybersecurity Proposals, the Commission seeks to affect the internal affairs of private funds, thereby undoing Congress’s deliberate decision to exempt private funds from precisely that sort of intrusive regulation,” the letter states.
The letter also strikes a nuance between decisions of Congress granting oversight of publicly traded companies vs. private fund managers.
At the end of the day, the groups in their four-page letter said they were appreciative of the opportunity to provide insight. It remains uncertain whether additional legal action will be warranted on behalf of the group’s members that include some of the largest private market managers in the world.