In Heitman Capital Management, LLC, February 12, the staff of the Securities and Exchange Commission reversed its previous position that hedge clauses purporting to limit an adviser’s liability to acts involving gross negligence or willful malfeasance are in violation of Sections 206(1) and 206(2) of the Investment Advisers Act of 1940 because they may lead unsophisticated clients into believing they have waived non-waiveable rights even if the hedge clause provides that rights under federal or state law cannot be waived.

The new standard is whether, depending upon all of the surrounding facts and circumstances, such a waiver operates as a fraud or deceit on the client. When a client is unsophisticated in the law, factors the SEC staff would consider include: (i) was the clause written in plain English; (ii) was the hedge clause individually highlighted and explained during an in-person meeting with the client; and (iii) was enhanced disclosure provided the client to explain instances in which the client may still have a cause of action. The presence and sophistication of an intermediary assisting the client in his dealings with the investment adviser and the nature and extent of the intermediary’s assistance to the client are additional factors to be taken into consideration.