Advisory firms often rely on long-standing Investment Management Agreement (IMA) templates that include liability waivers without revisiting whether those provisions remain consistent with current regulatory expectations. Yet language that regulators historically disfavored but somewhat tolerated has increasingly become a focus of regulatory scrutiny. Through recent guidance and enforcement actions, the SEC has made clear that so-called ‘hedge clauses’ – provisions that limit an adviser’s liability to gross negligence or willful misconduct, or that suggest clients waive certain legal rights – may mislead clients and conflict with an adviser’s fiduciary duty. Which means advisers face growing compliance risk from familiar, long-used contractual language that may no longer be consistent with current regulatory expectations.
In this guest post, Isaac Mamaysky, Partner of Potomac Law Group and Cofounder and COO of QuantStreet Capital, explains how to identify hedge clauses, why hedge clauses have become such a significant regulatory concern, and how advisers can revise their IMAs without raising compliance red flags.
At their core, hedge clauses attempt to limit an adviser’s liability by narrowing the circumstances under which a client can bring a claim. But under Sections 206(2) and 215(a) of the Investment Advisers Act, advisers cannot engage in misleading practices or require clients to waive compliance with Federal securities laws. The SEC’s longstanding concern is that hedge clauses may run afoul of both provisions at once by suggesting that clients have surrendered non-waivable rights and discouraging them from pursuing valid claims. This concern is especially pronounced for retail clients, for whom the SEC has said such clauses are “rarely, if ever” appropriate. And even attempts to soften the language – such as adding ‘savings clauses’ that preserve rights under Federal and state law – have not resolved the problem in enforcement actions.
Recent enforcement activity shows how firmly regulators have moved in this direction. Cases against advisory firms have found that common formulations – such as limiting liability to gross negligence, disclaiming responsibility for good-faith decisions, or requiring clients to indemnify the adviser – can violate antifraud provisions. Notably, this scrutiny has extended beyond retail relationships into some involving more sophisticated clients, along with a formal withdrawal of older guidance allowing a more case-by-case analysis. At the state level, many regulators have aligned with the SEC, with some jurisdictions explicitly prohibiting hedge clauses and others identifying them as common examination deficiencies. In practice, this creates a regulatory environment where the risk of retaining hedge-clause language may outweigh its intended legal benefit.
Removing hedge clauses does not leave advisers without ways to manage liability exposure. Instead, the regulatory framework points toward a more effective – and compliant – approach: clearly defining the scope of the advisory relationship. By specifying which services are and are not provided, allocating responsibilities between adviser and client, permitting reasonable reliance on client-provided information, and disclosing material investment risks, advisers can shape the contours of their fiduciary obligations without attempting to waive them. Because fiduciary duty applies to the services the adviser has agreed to undertake, narrowing the scope of the engagement can naturally limit liability exposure while remaining aligned with regulatory expectations.
Ultimately, the persistence of hedge clauses in many IMAs reflects inertia more than intent, but the regulatory landscape has shifted decisively. With examiners actively scrutinizing these provisions, the prudent path for most firms is to eliminate legacy waiver language and replace it with clear, well-structured agreements that accurately reflect the advisory relationship. In doing so, advisers can reduce compliance risk while also improving transparency around the services they provide – helping support stronger client understanding and a clearer fiduciary relationship!
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