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ILPA turns to SEC to fix one-sided limited partnership agreements

Out of 80 investors surveyed in late 2018, 69% had seen reduced fiduciary duties in LPAs.

The Institutional Limited Partners Association and 35 of its members have written to the Securities and Exchange Commission, challenging it to take action against a trend that they say is leaving investors exposed by limited partnership agreements.

ILPAs members have been increasingly facing efforts by general partners to diminish their fiduciary duties in LPAs, Chris Hayes, senior policy counsel at the association, told pfm. A private fund advisers’ fiduciary duty is an obligation to put their limited partners’ best interests first before their own when making investments and other actions involving the investors’ money.

The SEC declined to comment on ILPA’s approach.

In a survey ILPA conducted in late 2018 of more than 80 limited partners, 69 percent said they had seen a reduction of fiduciary duties reflected in LPAs, with 54 percent seeing this with an increased frequency.

“One of the areas that shows up in is […] the increased use of what is called ‘sole discretion language,’ where the manager can act in their own interest rather than in the interests of the fund,” Hayes said. The language “pops up quite a bit in many of these more recent LPAs. […] It’s an increased trend that’s being pushed to shift liability from the manager to the investor in [the] LPA.”

Through the use of this and other vague language, private fund advisers are able to conceal any conflicts of interest that they are aware of, ILPA claims. This is a trend that few are aware of because of the confidential nature of the agreements, Hayes said.

Among various suggested rule changes, ILPA urged the regulator to rescind the Heitman Capital Management No-Action Letter, issued in 2007. Managers are able to request a no-action letter from the SEC, which is an agreement that the agency won’t seek enforcement if the GP takes a certain action specified in the request. If a GP is aware of a possible conflict of interest, it is possible for them to use the no-action letter to protect themselves.

“The issue with the Heitman letter is that it overturned many years of SEC precedent; basically it now permitted these things called hedge clauses to be in the LPA,” Hayes said. “Previously, these hedge clauses were a per se violation of the Advisers Act, so just having one would be a violation of the Advisers Act […] and so the no-action letter now allowed you to insert these indemnification provisions in the LPA.”

One of ILPA’s issues with the Heitman letter, Hayes explained, is that hedge clause indemnification provisions in the LPAs can require investors to compensate the manager for any costs incurred for fines that occur “up to a level of gross negligence.”

When SEC enforcement actions result in a settlement, which most do, typically the SEC doesn’t “go back to the LPs to seek money for the fines, but we think the SEC should make a clear statement that that’s their policy,” Hayes said.

ILPA is also asking for clarity on the standard of care owed to institutional investors by investment advisers, meaning advisers have a duty to act and provide advice that is in the best interest of the client.

The letter was released with the intention of getting the SEC’s attention before it releases the final version of its standards of conduct package in September 2019. If the agency doesn’t take ILPA’s requests into account, it will explore other opportunities to try addressing the issue of fiduciary duty, including potential legislation.