The current regulatory environment, shaped by numerous recent developments including the Private Fund Adviser Rules (PFAR) having been vacated and Chevron deference struck down, among others, presents significant challenges to the SEC’s rulemaking and enforcement capabilities. Court rulings such as Loper, National Association of Private Fund Managers, Jarkesy and Corner Post have collectively restricted the SEC’s ability to interpret and enforce federal laws and enact new rules to effectuate those laws. Despite these obstacles, Silver remains committed to guiding firms by emphasizing the continued importance of SEC rulemaking for compliance programs. We recommend upholding best practice standards to maintain regulatory integrity and ensure long-term success.
The loosening of the SEC’s reins began earlier this year when the Supreme Court issued its decision in Securities and Exchange Commission v. George R. Jarkesy, Jr., et al., addressing the constitutionality of the SEC’s administrative enforcement process. The case challenged the SEC’s authority to conduct in-house proceedings and impose penalties without traditional court trials. The Supreme Court ruled in favor of Jarkesy, finding that the SEC’s administrative process violated constitutional protections.
The Court’s ruling sidestepped several key constitutional concerns, focusing instead on whether the SEC’s use of Administrative Law Judges (ALJs) violated the right to a jury trial under the Seventh Amendment. The decision did not address the non-delegation doctrine, which was raised in the lower court but not ruled upon by the Supreme Court. This doctrine involves scrutinizing the extent of the SEC’s regulatory discretion without clear Congressional guidelines.
Nor did the ruling consider the implications of the Take Care Clause, which was not part of the case, but which mandates that the President ensure laws are faithfully executed and can raise issues about the independence of ALJs and presidential oversight. Nonetheless, this decision has significant implications for the SEC’s enforcement practices, while still leaving further challenges open, and could lead to broader changes in how federal agencies conduct administrative proceedings.
The Big Hits – PFAR and Chevron
On June 5, 2024, the Fifth Circuit Court of Appeals ruled to vacate the SEC’s Private Fund Adviser Rules (PFAR), concluding that the SEC had overstepped its statutory authority. PFAR, which had been adopted on August 23, 2023, introduced several new requirements for private fund advisers, including quarterly financial statements, annual audits and limitations on certain activities. The legal challenge to PFAR, spearheaded by the Managed Funds Association (MFA), the Alternative Investment Management Association (AIMA) and other industry groups, argued that PFAR exceeded the SEC’s statutory authority.
The court’s decision was grounded in several findings. It determined that PFAR violated the Administrative Procedure Act, as the SEC lacked clear Congressional authorization to impose such comprehensive regulations. The ruling also noted that the SEC had failed to provide precise definitions of practices deemed fraudulent or manipulative under Section 206(4) of the Advisers Act. Additionally, the court found that the rule sought to regulate private funds beyond the scope intended by Congress. As a result, PFAR is no longer enforceable, creating significant implications for the regulatory framework governing private fund advisers. Industry reaction to the ruling has been mixed, with many leaders and trade groups expressing relief at the reduction in regulatory burdens.
In a notable development, the SEC decided not to pursue an appeal of the Fifth Circuit Court’s decision that invalidated PFAR. The deadline for an appeal was July 22 and the court officially vacated PFAR on July 29th. While the SEC could still seek an appeal before the Supreme Court or attempt to propose revised rules under different statutory authorities, both options present significant challenges.
Implications of the PFAR Ruling
The SEC’s decision not to appeal has introduced a degree of uncertainty regarding the SEC’s ability to implement future similar regulatory measures. This development has substantial implications for the SEC’s regulatory agenda.
PFAR was designed to impose significant changes on the private fund industry, including new requirements for private fund advisers to provide detailed disclosures about fees and expenses, stricter rules for secondary transactions and additional regulatory obligations. The ruling’s impact is profound, as it nullifies these requirements and underscores ongoing debates about the SEC’s regulatory reach and authority.
The invalidation of PFAR highlights broader uncertainties within the legal and regulatory landscape for private fund advisers, who were anticipating substantial changes under the rule. This decision signals ongoing disputes regarding the SEC’s authority and may influence future regulatory initiatives. The removal of PFAR may prompt private fund advisers to reassess certain planned actions to modify their compliance program and practices accordingly.
Financial institutions and private fund advisers are advised to remain vigilant and adaptable in response to these developments. Silver recommends that firms adopt a cautious approach to compliance, evaluating the potential risks and benefits of investing resources in measures that may be subject to future legal challenges. Staying informed about ongoing regulatory and judicial developments will be crucial for navigating this evolving environment.
The End of Chevron Deference and Its Implications for the SEC
On June 28, 2024 – just three days after its 40th anniversary – the United States Supreme Court overruled Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., effectively ending Chevron deference, which mandated judicial deference to federal agencies’ interpretations of ambiguous statutes they administer.
Originally promulgated on June 25, 1984, Chevron introduced a two-step test with the Court first determining whether the statute was ambiguous. If the statute was clear, the Court gave effect to Congress’s unambiguously expressed intent. Step two noted that if the statute was ambiguous, the Court then considered whether the agency’s interpretation was “reasonable.” If it was reasonable, the Court deferred to that agency’s expertise. The Chevron decision stemmed from a dispute over the EPA’s interpretation of the Clean Air Act, where the EPA allowed states to treat entire industrial plants as a single “stationary source” of pollution under certain conditions, a move contested by environmental groups.
Chevron deference had empowered agencies to interpret and implement statutes more flexibly, acknowledging an agency’s expertise in specialized fields and promoting regulatory adaptability. However, it had also faced criticism for potentially undermining the separation of powers by allowing executive agencies significant interpretative leeway and leading to inconsistent judicial rulings.
The Supreme Court’s recent ruling in Loper Bright Enterprises v. Raimondo signifies a shift toward greater judicial scrutiny of agency actions, eliminating automatic judicial deference and mandating courts to independently interpret statutory ambiguities.
Impact of Chevron Deference Reduction
The recent decision alters the preexisting dynamic that allowed for considerable leeway in interpreting statutes that were ambiguous, introducing a more stringent standard of judicial review. Courts are no longer obligated to accept agency interpretations of ambiguous laws at face value, leading to increased vulnerability for agency rules and guidance to judicial challenges.
For environmental regulation, this change poses challenges, as many key environmental programs are based on statutes that have historically been considered ambiguous, and thus have benefited from Chevron deference. This deference allowed agencies to implement and enforce regulations with a degree of flexibility in interpreting these unclear provisions. With the reduction in Chevron deference, agencies are now required to provide more precise and well-defined interpretations of such statutes.
This shift will likely slow down the regulatory process as agencies must navigate the increased demands for clarity and justification. Consequently, addressing complex issues such as climate change could become more difficult, as the ability to swiftly and effectively implement regulatory measures may be hindered by the need to meet this new, rigorous standard of review.
In addition to the Chevron deference reduction, the July 1, 2024 decision in Corner Post, Inc. v. Board of Governors of the Federal Reserve System has further complicated the regulatory landscape, as it allows newly established businesses to challenge long-standing regulations, effectively eliminating the statute of limitations to challenge federal laws. This ruling has modified the statute of limitations for challenging federal regulations.
Previously, under the Administrative Procedure Act (APA), parties had six years from the issuance of a regulation to initiate a challenge, which provided a stable framework for regulatory compliance and protection. The new ruling shifts the statute of limitations to begin from the moment a party is adversely affected by a regulation, rather than from the date of its issuance. The implications of this ruling, combined with recent decisions such as Loper Bright Enterprises, may embolden entities to challenge regulations that were once considered settled.
This increased potential for litigation could undermine the predictability of the regulatory environment and complicate the enforcement of established protections. The decision’s impact extends beyond environmental regulations, affecting a wide range of regulatory fields and potentially leading to significant disruptions in the enforcement of various standards.
Key Takeaway(s):
- All rules and regulations enacted prior to the overturn of the Chevron doctrine will remain in effect.
- SEC proposed rules (such as Rule 206(4)-2 under the Advisers Act, also referred to as the “Safeguarding Advisory Client Assets Rule”) that have yet to be finalized may be called into question as to whether the SEC has rulemaking or interpretive authority in the wake of Chevron being overturned.
- Investment advisers should be prepared for a more stringent judicial review of agency interpretations and proposed rulemaking, which may lead to increased legal challenges from interested parties designed to block or narrow the rulemaking ability of the SEC.
- Investment advisers should ensure that their compliance frameworks are flexible, yet comprehensive, anticipating a potential shift towards more court-centric interpretations of regulatory statutes.
Silver is actively monitoring how this decision will impact the proposed Safeguarding Advisory Client Assets Rule, the stayed Climate Disclosure Regulation and the proposed ESG Disclosure Regulation and whether the SEC will reconsider whether it has the authority to enact such rules.
Recalibrating Compliance Strategies
In response to these significant shifts in the regulatory environment, Silver suggests financial institutions should reassess certain aspects of their compliance strategies. The reduction in Chevron deference and the potential increase in legal challenges necessitate a careful evaluation of how firms approach compliance with new SEC regulations. Silver suggests that institutions should weigh the potential risks associated with its internal efforts related to compliance, particularly for rules that might be vulnerable to judicial scrutiny. Given the heightened regulatory uncertainty, it is advisable for firms to adopt a cautious and flexible approach to compliance.
Additionally, the anticipated increase in lawsuits against federal regulators could elevate the chances of successful litigation challenging regulatory measures. Although not every legal challenge will succeed, the changed legal landscape enhances the probability of favorable outcomes for plaintiffs. This shift in the judicial environment is likely to impact the broader framework of financial regulation, affecting not only the SEC but also the entire regulatory structure governing financial institutions.
Industry Reactions: Challenges to SEC Proposals
Joint Comment Letter from Industry Groups
On July 9, 2024, a coalition of private fund industry groups, including AIMA, the National Association of Private Fund Managers, the American Investment Council, the Loan Syndications and Trading Association, the National Venture Capital Association and the Managed Funds Association, submitted a joint comment letter to the SEC. The letter expressed substantial concerns regarding three significant proposed rules and requested that the SEC either withdraw these proposals or clarify that they do not apply to private funds, especially considering recent judicial rulings.
Proposed Rules Under Scrutiny
- The “Cybersecurity Proposal” mandates enhanced cybersecurity disclosures for registered investment advisers, registered investment companies and business development companies to provide more detailed information on their cybersecurity measures.
- The “Outsourcing Proposal” seeks to regulate how registered investment advisers outsource services to third parties, imposing stricter oversight and control requirements.
- The “Predictive Data Analytics Proposal” addresses potential conflicts of interest that arise from the use of data analytics technology by registered broker-dealers and investment advisers, aiming to manage the impact of these technologies on investor interactions.
The coalition of industry groups argues that these proposed rules exceed the SEC’s regulatory authority in a manner similar to the recently overturned PFAR. They contend that the SEC has overstepped its statutory powers, which could have significant industry ramifications.
SEC’s Proposed Rulemaking Agenda Post-Rulings
New Rulemaking Agenda
In the aftermath of the Fifth Circuit’s invalidation of PFAR and just a week following the Supreme Court’s decision in Loper Bright Enterprises v. Raimondo, the SEC introduced the following new agenda of proposed rulemaking:
| Initial Proposal Date | Status | |
| The Safeguarding Advisory Client Assets Rule | February 2023 | Reproposed by October 2024 |
| The Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers Rule | July 2023 | Reproposed by October 2024 |
| The Enhanced Disclosures by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices Rule | October 2023 | To be finalized by October 2024 |
| The Cybersecurity Risk Management for Investment Advisers, Registered Investment Companies, and Business Development Companies Rule | February 2022 | To be finalized by October 2024 |
| Fund Fee Disclosure and Reform | N/A | To be initially proposed by April 2025 |
The timing of the SEC’s announcement reflects its stance that it retains the authority and capability to advance and enforce new regulations despite recent judicial setbacks. The SEC appears resolute in its belief that it can continue to regulate effectively, demonstrating confidence in its regulatory powers and commitment to its regulatory objectives.
Although the proposed rules outlined in the new agenda could have significant implications for clients, there remains a possibility that they might be withdrawn or altered depending on potential legal or congressional action. The outcome of the upcoming elections in November will also play a critical role in determining the future trajectory of these regulatory measures.
Conclusion
Considering these recent developments, Silver advises financial institutions to approach compliance with heightened caution and adaptability. It is crucial for firms to maintain awareness of ongoing changes in both judicial decisions and regulatory actions, carefully assessing the risks linked to new compliance measures. Firms will need to reassess and adjust their strategies related to their compliance programs to effectively handle emerging challenges and uphold regulatory standards. To navigate this landscape successfully, Silver recommends that firms remain agile to ongoing regulatory shifts, ensuring their compliance strategies are robust and flexible enough to accommodate future developments.
Please feel free to contact us at [email protected] with any questions or concerns you might have regarding the information outlined above and how Silver can support your firm in navigating these changes.
