Federal Fiduciary Duties and Private Equity The Search for Workable Standards

Abstract

The Dodd-Frank Wall Street Reform and Consumer Protection Act drastically changed the financial regulatory landscape in the United States. One noteworthy change was a near-elimination of the so-called “private adviser” exemption to the Investment Advisors Act of 1940. The biggest beneficiaries of this exemption were private equity sponsors and hedge fund managers. A result of this change is that most private equity fund advisers and hedge fund managers must now register as investment advisers with the Securities and Exchange Commission (the “SEC”) under the Investment Advisers Act and are subject to a myriad of rules and regulations.

The focus of this Note is the application of the fiduciary duties governing advisers required to register under the Investment Advisers Act to private equity sponsors. Problematically, these fiduciary duties do not emanate from the Act itself, but are the result of judicial interpretation. Largely because of this genesis, the substance of advisers’ fiduciary duties remains unclear. Importantly for private equity advisers, the bounds of their fiduciary duties were developed in the context of industries vastly different from modern private equity.

This Note argues that the existing “one-size-fits-all” scheme of fiduciary regulation under the Investment Advisers Act is inappropriate for the private equity industry. It examines three recent SEC orders against major industry players for violations of their fiduciary duties under the Investment Advisers Act and notes both their inconsistency and lack of guidance. Instead of this byzantine system of fiduciary regulation, a contractarian model would better serve both private equity sponsors and investors by allowing the parties themselves to define the bounds of the fiduciary relationship. This approach best reflects the bargaining power and financial sophistication of the parties and encourages the continued growth of the private equity industry.