Confidentiality agreement

Confidentiality agreements are essential legal tools that hedge funds use to protect sensitive information while conducting necessary business. These contracts create legal frameworks that allow funds to share confidential information with potential investors, service providers, trading partners, and other third parties. At the same time, they maintain appropriate protection for proprietary trading strategies, investment positions, and operational details.

Hedge funds use confidentiality agreements in various business situations. Fund managers frequently require potential and existing investors to sign confidentiality agreements before providing access to fund-specific information about investments and strategies. They also require other business partners to sign these agreements.

The process works both ways. Funds and their managers may also need to sign confidentiality agreements to obtain information from third parties when evaluating potential investment opportunities.

In financing situations, confidentiality provisions become critical components of credit agreements. Funds are particularly concerned about revealing their trading strategies and market approaches, as well as the identities of their investors. Therefore, any credit agreement with a fund must include strong confidentiality provisions. Fund managers carefully negotiate the scope and exceptions to these protections.

Nearly all employees and partners at investment management firms sign confidentiality agreements as a condition of employment or partnership. These agreements typically require individuals to acknowledge that investment managers operate in highly competitive industries. Success depends significantly on maintaining the confidential and proprietary nature of business information.

Confidentiality obligations in these agreements generally require employees and partners to use confidential firm information only to advance the firm's business interests. They prohibit sharing such information with outside parties. This prohibition applies during employment or partnership and typically continues indefinitely after departure.

Exceptions are narrowly defined for legally required disclosures. These include disclosures required by court orders, regulatory authorities, or government agencies, as well as disclosures made with the firm's express written consent.

To maximize the likelihood of compliance and enforceability, confidentiality agreements typically define which information qualifies as confidential. Information concerning approaches, business plans, investment results, and portfolio holdings generally receives protection. However, this protection applies only if such information is not already widely known within the firm or the broader industry.

Fund managers typically use a tiered approach to information sharing with investors. They generally provide "top line" information to all investors. This typically includes basic facts such as the investor's status in the fund, the amount invested, the fund's general strategy, the names of key service providers, the fund's total assets under management, and the identity of the fund manager.

More sensitive information receives different treatment. Detailed performance data and specific information about portfolio holdings are usually provided only to investors who have signed confidentiality agreements. These agreements require investors to maintain the confidentiality of such materials.

Fund managers typically evaluate whether they can accommodate investor requests for increased transparency. They assess whether providing such information could harm the fund's competitive position or operational interests. Beyond general fiduciary considerations, funds should obtain confidentiality commitments from investors who receive additional reporting or transparency beyond standard disclosures.

Certain state pension plans and governmental entities are subject to public records disclosure requirements under the Freedom of Information Act of 1966. These entities may be required to publicly disclose information they receive from funds in response to public inquiries. Fund managers should carefully evaluate this disclosure risk when deciding whether to provide sensitive information to such investors.

In some cases, managers may choose to restrict information access, withhold certain sensitive materials, or include provisions allowing the manager to protect information from public disclosure through confidentiality protections.

For investors, confidentiality provisions in offer an important mechanism to maintain privacy. These provisions protect both their identity as fund investors and the specific terms governing their investment arrangements.

When negotiating confidentiality protections, fund managers must balance investor requests for anonymity against the fund's operational needs. Funds need to disclose investor identities to regulatory agencies, , custodians, and other counterparties. They also have obligations to provide most-favored-nation investors with information about preferential terms offered to other investors.

Most-favored-nation clauses ensure that if a fund offers better terms to one investor, it must offer those same terms to investors with most-favored-nation rights.

Credit agreements for hedge funds typically include assignment and participation provisions. These provisions allow lenders to transfer portions of a loan to other financial institutions. These provisions create particular confidentiality concerns for funds. Funds worry about competitors obtaining knowledge of their credit facility, borrowing needs, or leverage strategies.

The standard approach reflected in the Loan Syndications and Trading Association Model Credit Agreement permits disclosure of confidential information to prospective assignees and participants. However, this disclosure is subject to confidentiality protections substantially similar to those governing the original lender.

As a result, funds typically negotiate careful restrictions on which parties may receive assignments or participate in the credit facility. These restrictions prevent disclosures to competitors or other parties who might use the information to the fund's disadvantage.

Most are organized as corporations and hire third-party directors to serve on their boards. The relationship between third-party directors and funds is typically governed by director services agreements.

These agreements generally address several key areas: the scope of directors' responsibilities, compensation and fee arrangements, and protection from liability, confidentiality obligations, termination provisions, and the governing law applicable to the engagement.

Confidentiality agreements, non-compete agreements, and other employment policies that might restrict legally protected whistleblower activity must include appropriate carve-out language. This ensures compliance with federal securities laws.

The SEC's Rule 21F-17(a) under the prohibits any action that impedes an individual's ability to communicate directly with the SEC about potential securities law violations. This includes enforcement of confidentiality agreements that restrict such communications.

In enforcement actions that occurred through 2024, the SEC emphasized that effective whistleblower protections require explicit, affirmative language. This language must confirm that confidentiality obligations do not restrict individuals from voluntarily reporting to government authorities.

The SEC took the position that generic disclaimers stating "nothing in this agreement restricts your ability to report to regulators" are insufficient. Instead, agreements should affirmatively permit voluntary disclosure to the SEC and other authorities without any requirement to notify the fund or other employer before making such disclosure.

Additionally, agreements should not condition compensation or benefits on waiving the right to receive whistleblower awards from regulatory agencies.

These carve-outs must be clearly positioned near the confidentiality obligations themselves. They should not be located in a separate section where they might not be readily apparent to employees and other parties subject to the confidentiality restrictions.

Fund managers must remain aware of potential not to engage in selective disclosure of material information to particular investors. This is particularly important when preferential information rights have not been clearly disclosed to all investors.

For investors, confidentiality provisions negotiated through side letters provide valuable protection of their identity and the privacy of their investment terms.

When negotiating confidentiality provisions, fund managers should carefully consider whether the level of confidentiality an investor requests is operationally feasible. They must account for the fund's need to disclose investor identities to regulatory agencies, prime brokers, and custodians. They must also consider the fund's obligation to share preferential terms with other investors who possess most-favored-nation rights in their side letters.