This summer has been tumultuous for the SEC, with potentially significant short- and long-term implications for the investment management sector.
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 makes 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 disclosure 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 stared 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 interpretations 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.
Impact on 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. Throughout 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 regulations. While Jarkesy limited the SEC’s ability to use administrative proceedings 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 of what types of enforcement it takes because often the justification for such enforcement is based on its 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 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.
Conclusion
In conclusion, the SEC faces a challenging landscape post-summer, with reduced rulemaking abilities and a potentially stronger focus on enforcement actions. For investment managers, adapting to these changes will be crucial in navigating the evolving regulatory environment. If you have any questions or require support, the Zeidler’s Team are here to assist. Our global team of professionals stays current on the latest legal, regulatory, and compliance changes affecting the asset management industry. For additional information or assistance, please get in touch with us.
