The various duties owed by private equity fund managers to their clients are often referred to collectively as “fiduciary duty”, as if that were a term that has a clear and consistent meaning. In reality, fiduciary duty means different things in different jurisdictions and in different contexts and, as a blanket statement of legal obligations, implies little more than a special relationship that has trust and confidence at its heart. Although fiduciaries have certain duties imposed on them by law, and may face tougher consequences if they breach those duties, the precise nature and extent of their duties can vary considerably.
It is perhaps not surprising, therefore, that final guidance on the meaning of fiduciary duty issued this month by the US regulator, the SEC, has revealed some disagreement among market participants. The SEC’s important guidance focuses on the federal duty that applies to investment advisers under the Investment Advisers Act and says that it “reaffirms – and in some cases clarifies” certain aspects of that duty. (For a more detailed note on the SEC’s release, please click here.)
This federal duty is, of course, only part of the story. The SEC guidance, although it might provide an inspiration for other law-makers and regulators, is only directly relevant to fund managers regulated by the Investment Advisers Act (including, strictly speaking, US and non-US fund managers that are Exempt Reporting Advisers). Importantly, the SEC makes no comment on the meaning of fiduciary duty as a matter of state-level US partnership law, nor on the question of whether such state-level duties are capable of exclusion or limitation. That is particularly important because the regulated firm only owes this federal duty to its client(s) – generally the fund, and not the ultimate investors in the fund.
But the Advisers Act’s version of fiduciary duty is an important part of the story for many firms, and two aspects of the guidance particularly stand out to a non-US audience. The first is the SEC’s insistence that an adviser’s fiduciary duty is shaped by the nature of the relationship between the parties. Fiduciary duties – even if, as under the Advisers Act, they cannot be waived or excluded – need to be interpreted and applied in context, and (for example) may differ depending on the contractual terms of appointment and whether the client is a retail or institutional investor.
This flexible approach to the application of fiduciary duty is, in fact, one of its hallmarks in much of the common law world, and is important to investors and fund managers – especially as investors increasingly want to move managers away from focusing only on financial returns and towards wider consideration of their impact on the wider world. Specifically, the SEC recognises that institutional clients are different, and that is important context. Such investors “generally have greater capacity and more resources than retail clients to analyze and understand complex conflicts and their ramifications”, and their objectives are commonly “shaped by [their] specific investment mandates”. They should therefore be treated somewhat differently than retail clients, who may not be in a position to make properly informed decisions about their own best interests.
This concept of informed consent also underlies a second key part of the SEC interpretation. In addressing the duty of loyalty, the SEC looks carefully at the question of conflicts of interest and says that it requires an investment adviser to “eliminate or make full and fair disclosure of all conflicts of interest which might incline an investment adviser – consciously or unconsciously – to render advice which is not disinterested such that a client can provide informed consent to the conflict” [emphasis added]. The final version of the guidance seems to reject the notion that some conflicts are too complex to be addressed by disclosure, and instead focuses on the content of the disclosure, saying that it must be full and fair, and acknowledging that it is not enough to disclose in cases where the adviser ought reasonably to have been aware “that the client did not understand the nature and import of the conflict”. It seems clear that the sophistication of the client will be relevant in applying this test. It also seems clear, in the context of a private fund, that the ultimate investors – although not the firm’s “clients” – are the targets of these conflicts disclosures.
The SEC’s guidance has elicited a lot of attention in the US, and will be of interest to many European fund managers as well. In acknowledging the flexibility and context-specific nature of fiduciary duties, the SEC is reiterating a familiar mantra, often repeated in the common law courts. But legal certainty requires some clear guidance for market participants on specific common applications – especially when market participants disagree – and, to that extent, the SEC interpretation is certainly helpful.