Tip for Updating Your Compliance Program: SEC Focus on Hedge Clauses


Jaqueline Hummel

Publish Date



  • Compliance

As Form ADV season descends upon us, we are reminded that compliance officers face the thankless task each year of reviewing compliance policies and procedures to determine their adequacy and effectiveness, as required by Advisers Act Rule 206(4)-7. This review entails updating the firm's compliance program to reflect changes to relevant regulations and new regulatory guidance, and confirming the program is appropriately followed by the firm.  

We’ve compiled a series of tips to help understand the U.S. Securities and Exchange Commission (SEC) focus areas for 2023. 

Tip #1 - Get ready for SEC focus on hedge clauses in advisory agreements 

It’s no secret that the SEC does not like to see provisions in investment management agreements that limit an adviser’s liability, more commonly known as “hedge clauses.” Generally, the SEC frowns on hedge clauses because it believes they mislead less sophisticated clients into thinking they cannot exercise their legal rights against an adviser under federal or state law. Based on recent SEC activity, it may be time to review and reconsider the use of hedge clauses in advisory agreements, not just for retail clients but also for private funds.  

In 2019, the SEC issued its Commission Interpretation Regarding Standard of Conduct for Investment Advisers (the Interpretation), where it maintained that although an adviser can limit the scope of its duties to its client by contract, it cannot waive its fiduciary duties. In the Interpretation, the SEC prohibited the use of hedge clauses in retail client agreements because they are inherently misleading:  

"In our view, however, there are few (if any) circumstances in which a hedge clause in an agreement with a retail client would be consistent with those anti-fraud provisions, where the hedge clause purports to relieve the adviser from liability for conduct as to which the client has a non-waivable cause of action against the adviser provided by state or federal law. Such a hedge clause generally is likely to mislead those retail clients into not exercising their legal rights, in violation of the anti-fraud provisions, even where the agreement otherwise specifies that the client may continue to retain its non-waivable rights." 

The Interpretation also withdrew a no-action letter which held that hedge clauses did not per se violate Section 206(1) and 206(2) of the Advisers Act.  

More recently, the SEC settled charges against a registered investment adviser (RIA) because the hedge clause in the firm's standard investment management agreement violated its fiduciary duty to its clients. Significantly, the adviser included language stating that nothing in the agreement constitutes a waiver or limitation of any rights the client or the adviser may have under federal securities laws. This language, known as a "savings clause," is routinely used by advisers to notify clients of their rights. In this case, the SEC found that this non-waiver disclosure did not undo the damage done by the hedge clause. Shortly after this settlement, the SEC Division of Examinations (EXAMS) issued a Risk Alert where hedge clauses were again addressed. This time EXAMS targeted hedge clauses in the private fund space, observing that private fund managers used potentially misleading hedge clauses that were inconsistent with the anti-fraud provisions of Section 206 of the Advisers Act.   

In addition to this regulatory trend, ACA’s recent experiences with SEC examiners indicate that they are getting more aggressive in its stance against using hedge clauses. As a result, advisers should carefully consider any language in their investment management agreements that may be viewed as an impermissible hedge clause.  

Our guidance 

Review all hedge clauses and limitations of liability in fund private placement memoranda, limited partnership agreements, and investment management agreements. 

  • Consider including language that makes it clear nothing in the investment management agreement constitutes a waiver or limitation of any client's rights under state or federal law  

Consider taking out the "limitation of liability" section in the investment management agreement and be more specific about an adviser's duties. Consider the following language (tailored to meet your firm’s agreement):  


Under this agreement, the Adviser has a fiduciary duty to the Client, which requires the Adviser to act in good faith with the degree of care, skill, prudence and diligence under the circumstances that a prudent person acting in a fiduciary capacity would use, in providing investment advice and managing the Client's assets. The Client also has some responsibility. Specifically, if the Client provides the Adviser with written or oral instructions, the Adviser is entitled to rely on those instructions and is not responsible for any loss arising from following those instructions. Additionally, the Custodian and broker-dealers that Adviser uses to execute transactions for the Client's Account have a duty to follow the Adviser's instructions. The Adviser is not responsible for losses to the Client's account because of the Custodian's or broker-dealer's failure to follow these instructions. 

How we help 

Compliance teams need continuous support and knowledge sharing to stay on top of regulatory initiatives. Our team helps you navigate the evolving regulatory landscape while considering the complexity of your firm’s unique compliance requirements. 

Our advisory services can assist your firm with building and maintaining an effective compliance program that meets the SEC’s regulatory requirements. Contact us to learn more. 

Listen to our 2023 Regulatory Outlook webcast on demand 

We recently hosted a webcast to review the regulatory changes that will likely have implications on compliance programs in 2023, and provide recommendations to prepare for these changes. Our experts discussed rule proposals and adoption, examination and enforcement trends, and regulatory guidance. Watch our webcast for more insights to help you prepare your compliance program for this year’s focus areas.

Watch now