US Appeals Court Says SEC Overstepped Authority in New Rules for Hedge Funds

The US Fifth Circuit Court of Appeals has invalidated an SEC rule mandating private equity firms and hedge funds to declare their fees and expenses. The court says such oversight exceeds the Securities and Exchanges Commission’s congressional authority.

The court’s ruling marks a major setback for the SEC, challenging its interpretation of its regulatory powers under existing financial reform laws.

US Appeals Court Overturns SEC’s Rule

The controversy began with the SEC introducing a new rule in August 2023. This rule mainly required hedge funds and private equity firms to adhere to stricter reporting and auditing standards.

It demanded that these funds conduct annual audits, release quarterly reports detailing their performance and fees, and eliminate preferential treatment for certain investors.

The SEC argued that these measures were necessary to enhance transparency and protect investors. The commission cited the Dodd-Frank Act as the foundation for its expanded regulatory authority. 

In context, the Dodd-Frank Act, passed following the 2008 financial crisis, aimed to reform the financial sector and included provisions for increased oversight of private funds.

This newly introduced SEC rule faced immediate opposition from industry groups. Six prominent hedge fund and private equity organizations filed a lawsuit, challenging the regulator. They asserted that the new requirements would impose significant compliance costs and disrupt their operations.

Also, they contended that the SEC had overstepped its statutory authority, a point that the Fifth Circuit Court of Appeals supported. The three-judge panel, including Edith Jones and Judges Kurt Engelhardt and Andrew Oldham, unanimously agreed on June 5 to overturn the SEC’s rule.

In the court’s written opinion, Judge Engelhardt stated that the SEC had undoubtedly gone past its statutory authority. He clarified that the SEC’s sections of the Dodd-Frank Act cited did not grant it the extensive regulatory powers it claimed.

Notably, the ruling has received several positive reactions from SEC critics. This is particularly true for those in the crypto industry who have long accused the regulator of overreach.

Bill Hughes, senior counsel at Consensys, supported the decision on social media. He described the SEC’s actions over the past few years as “off-key,” indicating a broader pattern of overstepping its bounds.

Disputes Between Crypto and the US SEC

This case is part of the ongoing dispute between digital assets and the SEC, which has always centered on classifying cryptocurrencies as securities. The SEC maintains that many crypto assets fall under this category, subjecting them to its regulatory oversight.

To support this position, the SEC pointed to the Howey test, a legal framework used to determine whether an asset qualifies as a security. However, crypto firms vigorously oppose this assertion, arguing that the commission lacks Congress’s explicit mandate to regulate the cryptocurrency sector.

The situation has attracted the attention of Congress, which is deliberating on the Financial Innovation and Technology for the 21st Century Act (FIT21). This proposed legislation seeks to transfer much of the regulatory authority over cryptocurrencies from the SEC to the Commodity Futures Trading Commission.