May 10, 2018 - Last month, the Securities and Exchange Commission (“SEC”) issued a two-part release (the “Release”) that, as described below, could impact investment managers – including loan managers..  The first part proposes an interpretation (the “Proposed Interpretation”) regarding the standard of conduct the SEC expects from investment advisers.  The Proposed Interpretation purports to reflect the SEC’s current views of the standards of behavior that apply to investment advisers. However, some elements, according to Cleary Gottlieb, appear to “reflect a higher standard of conduct than is currently required under federal law.”  The second part of the Release requests comments regarding enhanced investment adviser regulation (the “Proposed Enhancements”).  Compliance with some of these enhancements could be quite expensive and burdensome, especially for smaller investment advisers.  We will describe the most salient points of the Proposed Interpretation below and focus on the Proposed Enhancements next week.

The Proposed Interpretation states that, at bottom, the relationship between the investment adviser and its client is that of a fiduciary.  The adviser has a duty of care which requires that it (i) provide advice that is in the client’s best interest, (ii) seek best execution, and (iii) provide advice and monitoring throughout the life of the relationship.  Advisers also have a duty of loyalty not to favor one client over another or its interests over those of its clients.  In that connection, the SEC believes that advisers should seek to avoid conflicts and make fair and full disclosure where such conflicts exist.  None of this is surprising.  However, the Proposed Interpretation also says that “the investment adviser cannot disclose or negotiate away, and the client cannot waive, the federal fiduciary duty.”

The above language does not mean that there can be no conflicts and that conflicts cannot generally be addressed through disclosure.  However, as Cadwalader notes, “any disclosure must be clear and detailed enough for a client to provide informed consent with respect to a conflict.”  But disclosure is not always sufficient.  The Proposed Interpretation states that “it would not be consistent with an adviser’s fiduciary duty to infer or accept a conflict where either (i) the facts or circumstances indicate that the client did not understand the nature and import of the conflict, or (ii) the material facts concerning the conflict could not be disclosed.”  In other words, according to Akin Gump, “the SEC expects an investment adviser that cannot obtain effective consent … to eliminate the conflict or be able to mitigate the conflict so that it becomes a conflict that can be disclosed and consented.”  According to Katten, the Proposed Interpretation is “largely ambiguous on the circumstances in which the SEC would deem disclosure and consent to be insufficient to cure an adviser’s conflict” and anticipates that commenters will seek further guidance in this regard.

The LSTA will work with its members and other trade associations in addressing the issues raised by the Release.