The Managed Funds Association (the "MFA") commented on (i) the SEC's proposed interpretation of the standard of conduct for investment advisers and (ii) related letters by the Institutional Limited Partners Association ("ILPA Letter") and the American Investment Council ("AIC Letter"). The MFA's comments are a supplement to its letter from August 7, 2018.

The ILPA Letter and the AIC Letter take opposing positions, with the ILPA Letter advocating for the SEC to withdraw its Heitman Capital Management No-Action Letter (the "Heitman Letter"). In the Heitman Letter, SEC staff did not object to the use of "hedge clauses," limiting an investment adviser's obligation to indemnify an institutional client where the adviser had been "negligent" but not grossly negligent. The AIC Letter is a rebuttal to the ILPA Letter, arguing that the ILPA Letter reflects a misunderstanding of the fiduciary standard imposed by the Advisers Act. The MFA takes the side of the AIC in this debate.

Commentary / Steven Lofchie

Nobody's perfect. Requiring an investment adviser to indemnify its clients for any mistake that the adviser makes could easily bankrupt any small adviser doing business for a good-sized institutional client. A negligence standard may be particularly unfair as clients receive the benefit of mistakes in their favor, and are not required to net off positive mistakes (e.g., an adviser buys the wrong stock, but the stock goes up) against losses.

Institutional clients are perfectly capable of (i) understanding the difference between a negligence and gross negligence standard and (ii) making the economic decision to take their business elsewhere if they are not able to persuade any given adviser to concede on their preferred standard of care. As businesses go, the business of being an investment adviser is competitive, and institutional clients cannot claim that anyone has the market power to dictate a result.

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