But the SEC might expand beyond traditional disclosure, according to a comment letter by Stanford Law School professor and former SEC commissioner Joseph Grundfest. Grundfest argues that the SEC’s proposed prohibitions on certain contract terms in investment advising go far beyond disclosure and impose substantive regulatory obligations. This development presents multiple problems for the SEC, he argues.

Grundfest notes that the investors likely to be affected by this rule would be sophisticated investors who know what to expect when negotiating an investment advisory agreement, even though one of the goals of SEC regulation is to protect unsophisticated investors. So these investors—who put money into venture capital firms, private equity funds, and hedge funds—would receive greater protections than unsophisticated investors, which Grundfest argues would create “internal contradictions” between the levels of protections for different kinds of investors.

As an example of how the rules would set up such contradictions, Grundfest uses the prohibition of contract terms that allow indemnification for “a breach of fiduciary duty, willful misfeasance, bad faith, negligence, or recklessness.” Grundfest asserts that U.S. state and federal law allow indemnification and let sophisticated investors take greater risks than unsophisticated investors. Some foreign jurisdictions also allow waiver of certain protections for “sufficiently sophisticated investors,” so the SEC could create a glaring break with market rules already set up by state legislatures, the U.S. Congress, and foreign nations.