SEC Brings Hedge Clause Case

Background:

• On September 3, 2024, the SEC resolved an administrative proceeding with a private fund and retail manager, citing violations of the Custody Rule, the Compliance Rule, and the improper use of a hedge clause. This note focuses solely on the hedge clause issue highlighted in the SEC Order.¹

Key Facts:

• Hedge Clauses: The SEC maintains that federal fiduciary duties cannot be waived or altered by any agreement. A hedge clause is a clause that appears to limit liability in an agreement, and it may be considered misleading if not accompanied by a clarifying disclosure (a “savings clause”) indicating that fiduciary duties are non-waivable.
  
• Hedge Clause Violations: The SEC noted the following hedge clauses as being violative:
  • “Neither [THE MANAGER] nor any of its employees, officers, directors or any person acting on their behalf (each, and “Indemnitee”) shall be liable to Client for any action or inaction that results in any cost, claim, liability, damage, loss or expense suffered in connection with the services covered herein, if the Indemnitee believed in good faith at the time of its action or inaction that its conduct was in the interests of Client, and such conduct did not constitute gross negligence, willful misconduct or a breach of applicable law. The indemnification provided for herein shall be available only as and to the extent that it is not prohibited by applicable law governing rights of indemnification.”
    • Analysis: The highlighted text could be viewed as a savings clause but was deemed insufficient by the SEC.
      
  • “Except for gross negligence or willful malfeasance, or violation of applicable law, neither [THE MANAGER], nor any of its [sic] respective directors, employees, shareholders, officers or affiliates shall be liable hereunder for any action performed or omitted to be performed or for any errors of judgment in managing the Account. Federal Securities Laws and certain state securities laws impose liabilities under certain circumstances on persons who act on good faith, and therefore nothing herein shall in any way constitute a waiver or limitation of any rights which Client may have under any federal or state securities laws (or ERISA, if Client has a qualified plan there under).” (emphasis in original)
    • Analysis: The highlighted text could be viewed as a savings clause but was deemed insufficient by the SEC.
      
• “None of the Indemnified Parties shall be liable to any Limited Partner or the Partnership for honest mistakes of judgment, or for action or inaction, taken in good faith in respect of the Partnership, or for losses due to such mistakes, action, or inaction, or to the negligence, dishonesty, or bad faith of any employee, broker, or other agent of the Partnership, provided that such employee, broker, or agent was supervised and selected, engaged, or retained with reasonable care. . . Notwithstanding any of the foregoing to the contrary, the provisions of this paragraph 15.3 and the immediately following paragraph 15.4(a) shall not be construed so as to relieve (or attempt to relieve) any person (except in the case of members of the Advisory Committee and their Constituent Limited Partners, who need only have acted in good faith in order to receive the benefit of exculpation under this paragraph 15.3) of any liability by reason of “gross negligence” or intentional wrongdoing (including fraud or other intentional criminal conduct) or to the extent (but only to the extent) that such liability may not be waived, modified, or limited under applicable law, but shall be construed so as to effectuate the provisions of such paragraphs to the fullest extent permitted by law. The Partners acknowledge and agree that certain provisions of this Agreement expressly or implicitly waive, reduce, redefine or otherwise modify fiduciary duties of the General Partner and the other Indemnified Parties (as defined below) arising under applicable law. It is the express intention of the Limited Partners that such waiver, reduction, redefinition or other modification be fully enforceable and binding upon the Partners. Accordingly, each Limited Partner hereby irrevocably: (i) waives any and all current and future claims (and right to assert such claims) against the General Partner and the other Indemnified Parties for any breach of fiduciary duty that would otherwise arise under applicable law but would be inconsistent with the terms of this Agreement; and (ii) agrees to fully reimburse the General Partner and any other applicable Indemnified Party for any and all losses, expenses, costs or other damages resulting from any waived claim brought by,through, or on behalf of such Limited Partner.”
  • Analysis: There is no savings clause present in this paragraph.
• “A Manager shall not be liable to the Company, a series, or to any Member for any loss or damage sustained by the Company, such series or Member, unless the loss or damage shall have been the result of fraud, deceit, gross negligence, willful misconduct or a wrongful taking by the Manager.”
  • Analysis: There is no savings clause present in this paragraph.

_{¹ In the Matter of Clearpath Partners LLC File No. 3-22046}