16886 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

1Unless otherwise noted, when we refer to the 

Advisers Act, or any section of the Advisers Act, 

we are referring to 15 U.S.C. 80b, at which the 

Advisers Act is codified. When we refer to rules 

under the Advisers Act, or any section of those 

rules, we are referring to title 17, part 275 of the 

Code of Federal Regulations [17 CFR part 275], in 

which these rules are published. 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 275 

[Release Nos. IA–5955; File No. S7–03–22] 

RIN 3235–AN07 

Private Fund Advisers; Documentation 

of Registered Investment Adviser 

Compliance Reviews 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: The Securities and Exchange 

Commission (the ‘‘Commission’’ or the 

‘‘SEC’’) is proposing new rules under 

the Investment Advisers Act of 1940 

(the ‘‘Advisers Act’’ or the ‘‘Act’’). We 

propose to require registered investment 

advisers to private funds to provide 

transparency to their investors regarding 

the full cost of investing in private 

funds and the performance of such 

private funds. We also are proposing 

rules that would require a registered 

private fund adviser to obtain an annual 

financial statement audit of each private 

fund it advises and, in connection with 

an adviser-led secondary transaction, a 

fairness opinion from an independent 

opinion provider. In addition, we are 

proposing rules that would prohibit all 

private fund advisers, including those 

that are not registered with the 

Commission, from engaging in certain 

sales practices, conflicts of interest, and 

compensation schemes that are contrary 

to the public interest and the protection 

of investors. All private fund advisers 

would also be prohibited from 

providing preferential treatment to 

certain investors in a private fund, 

unless the adviser discloses such 

treatment to other current and 

prospective investors. We are proposing 

corresponding amendments to the 

Advisers Act books and records rule to 

facilitate compliance with these 

proposed new rules and assist our 

examination staff. Finally, we are 

proposing amendments to the Advisers 

Act compliance rule, which would 

affect all registered investment advisers, 

to better enable our staff to conduct 

examinations. 

DATES: Comments should be received on 

or before April 25, 2022. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s internet 

comment form (https://www.sec.gov/ 

rules/submitcomments.htm); or 

• Send an email to rule-comments@

sec.gov. Please include File Number S7– 

03–22 on the subject line. 

Paper Comments 

• Send paper comments to Vanessa 

A. Countryman, Secretary, Securities 

and Exchange Commission, 100 F Street 

NE, Washington, DC 20549–1090. 

All submissions should refer to File 

Number S7–03–22. This file number 

should be included on the subject line 

if email is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s website (https://

www.sec.gov/rules/proposed.shtml). 

Comments are also available for website 

viewing and printing in the 

Commission’s Public Reference Room, 

100 F Street NE, Washington, DC 20549, 

on official business days between the 

hours of 10:00 a.m. and 3:00 p.m. 

Operating conditions may limit access 

to the Commission’s public reference 

room. All comments received will be 

posted without change; we do not edit 

personal identifying information from 

submissions. You should submit only 

information that you wish to make 

available publicly. 

Studies, memoranda, or other 

substantive items may be added by the 

Commission or staff to the comment file 

during this rulemaking. A notification of 

the inclusion in the comment file of any 

such materials will be made available 

on the Commission’s website. To ensure 

direct electronic receipt of such 

notifications, sign up through the ‘‘Stay 

Connected’’ option at www.sec.gov to 

receive notifications by email. 

FOR FURTHER INFORMATION CONTACT: 

Christine Schleppegrell, Senior Counsel; 

Thomas Strumpf, Senior Counsel; 

Melissa Roverts Harke, Senior Special 

Counsel; Michael C. Neus, Private 

Funds Attorney Fellow; or Melissa S. 

Gainor, Assistant Director, Investment 

Adviser Rulemaking Office, or Marc 

Mehrespand, Branch Chief, Chief 

Counsel’s Office, at (202) 551–6787 or 

IArules@sec.gov, Division of Investment 

Management, Securities and Exchange 

Commission, 100 F Street NE, 

Washington, DC 20549–8549. 

SUPPLEMENTARY INFORMATION: The 

Securities and Exchange Commission 

(the ‘‘Commission’’) is proposing for 

public comment 17 CFR 275.206(4)–10 

(new rule 206(4)–10), 17 CFR 

275.211(h)(1)–1 (new rule 211(h)(1)–1), 

17 CFR 275.211(h)(1)–2 (new rule 

211(h)(1)–2), 17 CFR 275.211(h)(2)–1 

(new rule 211(h)(2)–1), 17 CFR 

275.211(h)(2)–2 (new rule 211(h)(2)–2), 

and 17 CFR 275.211(h)(2)–3 (new rule 

211(h)(2)–3) under the Investment 

Advisers Act of 1940 [15 U.S.C. 80b–1 

et seq.] (the ‘‘Advisers Act’’); 1 and 

amendments to 17 CFR 275.204–2 (rule 

204–2) and 17 CFR 275.206(4)–7 (rule 

206(4)–7) under the Advisers Act. 

Table of Contents 

I. Background and Need for Reform 

II. Discussion of Proposed Rules for Private 

Fund Advisers 

A. Quarterly Statements 

1. Fee and Expense Disclosure 

2. Performance Disclosure 

3. Preparation and Distribution of 

Quarterly Statements 

4. Consolidated Reporting for Certain Fund 

Structures 

5. Format and Content Requirements 

6. Recordkeeping for Quarterly Statements 

B. Mandatory Private Fund Adviser Audits 

1. Requirements for Accountants 

Performing Private Fund Audits 

2. Auditing Standards for Financial 

Statements 

3. Preparation of Audited Financial 

Statements 

4. Prompt Distribution of Audited 

Financial Statements 

5. Annual Audit, Liquidation Audit, and 

Audit Period Lengths 

6. Commission Notification 

7. Taking All Reasonable Steps To Cause 

an Audit 

8. Recordkeeping Provisions Related to the 

Proposed Audit Rule 

C. Adviser-Led Secondaries 

1. Recordkeeping for Adviser-Led 

Secondaries 

D. Prohibited Activities 

1. Fees for Unperformed Services 

2. Certain Fees and Expenses 

3. Reducing Adviser Clawbacks for Taxes 

4. Limiting or Eliminating Liability for 

Adviser Misconduct 

5. Certain Non-Pro Rata Fee and Expense 

Allocations 

6. Borrowing 

E. Preferential Treatment 

1. Recordkeeping for Preferential 

Treatment 

III. Discussion of Proposed Written 

Documentation of All Advisers’ Annual 

Reviews of Compliance Programs 

IV. Transition Period and Compliance Date 

V. Economic Analysis 

A. Introduction 

B. Economic Baseline 

1. Industry Statistics and Affected Parties 

2. Sales Practices, Compensation 

Arrangements, and Other Business 

Practices of Private Fund Advisers 

3. Private Fund Adviser Fee, Expense, and 

Performance Disclosure Practices 

4. Fund Audits and Fairness Opinions 

5. Books and Records 

6. Documentation of Annual Review Under 

the Compliance Rule 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16887 

2Section 202(a)(29) of the Advisers Act defines 

the term ‘‘private fund’’ as an issuer that would be 

an investment company, as defined in section 3 of 

the Investment Company Act of 1940 (15 U.S.C. 

80a–3) (‘‘Investment Company Act’’), but for section 

3(c)(1) or 3(c)(7) of that Act. We use ‘‘private fund’’ 

and ‘‘fund’’ interchangeably throughout this release. 

3See, e.g., Rule Implementing Amendments to the 

Investment Advisers Act of 1940, Investment 

Advisers Act Release No. 3221 (June 22, 2011) 

(‘‘Implementing Release’’); Reporting by Investment 

Advisers to Private Funds and Certain Commodity 

Pool Operators and Commodity Trading Advisors 

on Form PF, Investment Advisers Act Release No. 

3308 (Oct. 31, 2011). 

4 Dodd-Frank Wall Street Reform and Consumer 

Protection Act, section 913(h), Public Law 111–203, 

124 Stat. 1376 (2010). 

5The Financial Stability Oversight Council uses 

these and other tools to assess private fund impact 

on systemic risk. See also U.S. Securities and 

Exchange Commission, Division of Investment 

Management, Analytics Office, Private Fund 

Statistics, available at https://www.sec.gov/ 

divisions/investment/private-funds-statistics.shtml 

(providing a summary of private fund industry 

statistics and trends based on data collected 

through Form PF and Form ADV). Staff reports, 

statistics, and other staff documents (including 

those cited herein) represent the views of 

Commission staff and are not a rule, regulation, or 

statement of the Commission. The Commission has 

neither approved nor disapproved the content of 

these documents and, like all staff statements, they 

have no legal force or effect, do not alter or amend 

applicable law, and create no new or additional 

obligations for any person. The Commission has 

expressed no view regarding the analysis, findings, 

or conclusions contained therein. 

6Form ADV data current as of November 30, 

2021. 

7See Division of Investment Management: 

Analytics Office, Private Funds Statistics Report: 

First Calendar Quarter 2021 (Nov. 1, 2021) (‘‘Form 

PF Statistics Report’’), at 31, available at https://

www.sec.gov/divisions/investment/private-fundsstatistics/private-funds-statistics-2021-q1.pdf 

(showing aggregate portfolio turnover for hedge 

funds managed by large hedge fund advisers (i.e., 

advisers with at least $1.5 billion in hedge fund 

assets under management) as reported on Form PF). 

8See Form PF Statistics Report, supra at footnote 

7, at 15 (showing beneficial ownership of all funds 

by category as reported on Form PF). See also, e.g., 

Public Investors, Private Funds, and State Law, 

Baylor Law Review, Professor William Clayton 

(June 15, 2020) (‘‘Professor Clayton Article’’), at 354 

(noting that public pension plans have dramatically 

increased their investment in private funds). 

9See, e.g., OCIE National Examination Program 

Risk Alert: Observations from Examinations of 

Investment Advisers Managing Private Funds (June 

23, 2020) (‘‘EXAMS Private Funds Risk Alert 

2020’’), available at https://www.sec.gov/files/ 

Continued 

C. Benefits and Costs 

1. Overview and Broad Economic 

Considerations 

2. Quarterly Statements 

3. Prohibited Activities and Disclosure of 

Preferential Treatment 

4. Audits, Fairness Opinions, and 

Documentation of Annual Review of 

Compliance Programs 

5. Recordkeeping 

D. Effects on Efficiency, Competition, and 

Capital Formation 

1. Efficiency 

2. Competition 

3. Capital Formation 

E. Alternatives Considered 

1. Alternatives to the Requirement for 

Private Fund Advisers To Obtain an 

Annual Audit 

2. Alternatives to the Requirement To 

Distribute a Quarterly Statement to 

Investors Disclosing Certain Information 

Regarding Costs and Performance 

3. Alternative to the Required Manner of 

Preparing and Distributing Quarterly 

Statements and Audited Financial 

Statements 

4. Alternatives to the Prohibitions From 

Engaging in Certain Sales Practices, 

Conflicts of Interest, and Compensation 

Schemes 

5. Alternatives to the Requirement That an 

Adviser To Obtain a Fairness Opinion in 

Connection With Certain Adviser-Led 

Secondary Transactions 

6. Alternatives to the Prohibition From 

Providing Certain Preferential Terms and 

Requirement To Disclose All Preferential 

Treatment 

F. Request for Comment 

VI. Paperwork Reduction Act 

A. Introduction 

B. Quarterly Statements 

C. Mandatory Private Fund Adviser Audits 

D. Adviser-Led Secondaries 

E. Disclosure of Preferential Treatment 

F. Written Documentation of Adviser’s 

Annual Review of Compliance Program 

G. Recordkeeping 

H. Request for Comment 

VII. Initial Regulatory Flexibility Analysis 

A. Reasons for and Objectives of the 

Proposed Action 

1. Proposed Rule 211(h)(1)–1 

2. Proposed Rule 211(h)(1)–2 

3. Proposed Rule 206(4)–10 

4. Proposed Rule 211(h)(2)–1 

5. Proposed Rule 211(h)(2)–2 

6. Proposed Rule 211(h)(2)–3 

7. Proposed Amendments to Rule 204–2 

8. Proposed Amendments to Rule 206(4)– 

(7) 

B. Legal Basis 

C. Small Entities Subject to Rules 

D. Projected Reporting, Recordkeeping, and 

Other Compliance Requirements 

1. Proposed Rule 211(h)(1)–1 

2. Proposed Rule 211(h)(1)–2 

3. Proposed Rule 206(4)–10 

4. Proposed Rule 211(h)(2)–1 

5. Proposed Rule 211(h)(2)–2 

6. Proposed Rule 211(h)(2)–3 

7. Proposed Amendments to Rule 204–2 

8. Proposed Amendments to Rule 206(4)– 

(7) 

E. Duplicative, Overlapping, or Conflicting 

Federal Rules 

F. Significant Alternatives 

G. Solicitation of Comments 

VIII. Consideration of Impact on the 

Economy 

IX. Statutory Authority 

I. Background and Need for Reform 

In the wake of the 2007–2008 

financial crisis, Congress passed and the 

President signed the Dodd-Frank Wall 

Street Reform and Consumer Protection 

Act of 2010 (‘‘Dodd-Frank Act’’), which 

increased the Commission’s oversight 

responsibility for private fund advisers.2

Among other things, the Dodd-Frank 

Act amended the Advisers Act generally 

to require advisers to private funds to 

register with the Commission and to 

require the Commission to establish 

reporting and recordkeeping 

requirements for advisers to private 

funds for investor protection and 

systemic risk purposes.3 The DoddFrank Act also added section 211(h) to 

the Advisers Act, which, among other 

things, directs the Commission to 

‘‘facilitate the provision of simple and 

clear disclosures to investors regarding 

the terms of their relationships with 

. . . investment advisers’’ and 

‘‘promulgate rules prohibiting or 

restricting certain sales practices, 

conflicts of interest, and compensation 

schemes for investment advisers.’’ 4

Registration and reporting on both 

Form ADV and Form PF have been 

critical to increasing transparency and 

protecting investors in private funds 

and assessing systemic risk.5 They also 

have substantially improved our ability 

to understand private fund advisers’ 

operations and relationships with 

investors as private funds play an 

increasingly important role in the 

financial system and private funds 

continue growing in size, complexity, 

and number. There are currently 5,037 

registered private fund advisers with 

over $18 trillion in private fund assets 

under management.6 In addition, 

private funds and their advisers play an 

increasing role in the economy. For 

example, hedge funds engage in trillions 

of dollars in listed equity and futures 

transactions each month.7 Private equity 

and other private funds are involved in 

mergers and acquisitions, non-bank 

lending, and restructurings and 

bankruptcies. Venture capital funds 

provide funding to start-ups and early 

stage companies. Private funds and their 

advisers also play an increasingly 

important role in the lives of everyday 

Americans saving for retirement or 

college tuition. Some of the largest 

groups of private fund investors include 

state and municipal pension plans, 

college and university endowments, 

non-profit organizations, and high net 

worth individuals.8 Numerous investors 

also have indirect exposure to private 

funds through private pension plans, 

endowments, feeder funds established 

by banks and other financial 

institutions, foundations, and certain 

other retirement plans. 

During our decade overseeing most 

private fund advisers, our staff has 

examined private fund advisers to 

assess both the issues and risks 

presented by their business models and 

the firms’ compliance with their 

existing legal obligations.9 The 


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16888 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

Private%20Fund%20Risk%20Alert_0.pdf. As of 

December 17, 2020, the Office of Compliance, 

Inspections and Examinations (‘‘OCIE’’) was 

renamed the Division of Examinations (‘‘EXAMS’’). 

10See, e.g., In re Kohlberg Kravis Roberts & Co. 

L.P., Investment Advisers Act Release No. 4131 

(June 29, 2015) (settled action) (alleging private 

fund adviser misallocated more than $17 million in 

so-called ‘‘broken deal’’ expenses to its flagship 

private equity fund); In re Blackstone Management 

Partners L.L.C., et al., Investment Advisers Act 

Release No. 4219 (Oct. 7, 2015) (settled action) 

(alleging private fund advisers failed to inform 

investors about benefits that the advisers obtained 

from accelerated monitoring fees and discounts on 

legal fees); In re NB Alternatives Advisers LLC, 

Investment Advisers Act Release No. 5079 (Dec. 17, 

2018) (settled action) (alleging private fund adviser 

improperly allocated approximately $2 million of 

compensation-related expenses to three private 

equity funds it advised). 

11See, e.g., In the Matter of Diastole Wealth 

Management, Inc., Investment Advisers Act Release 

No. 5855 (Sept. 10, 2021) (settled action) (alleging 

private fund adviser failed to disclose to investors 

that the adviser periodically made loans to a 

company owned by the son of the principal of the 

advisory firm and that the private fund’s investment 

in the company could be used to repay the loans 

made by the adviser); In re Global Infrastructure 

Management, LLC, Investment Advisers Act Release 

No. 5930 (Dec. 20, 2021) (settled action) (alleging 

private fund adviser failed to properly offset 

management fees to private equity funds it managed 

and made false and misleading statements to 

investors and potential investors in those funds 

concerning management fee offsets); In the Matter 

of EDG Management Company, LLC, Investment 

Advisers Act Release No. 5617 (Oct. 22, 2020) 

(settled action) (alleging that private equity fund 

adviser failed to apply the management fee 

calculation method specified in the limited 

partnership agreement by failing to account for 

write downs of portfolio securities causing the fund 

and investors to overpay management fees); In the 

Matter of Mitchell J. Friedman, Investment Advisers 

Act Release No. 5338 (Sept. 4, 2019) (settled action) 

(alleging that the co-owner of a private fund 

advisory firm failed to disclose material conflicts of 

interest to the private fund it managed and misled 

two investors by misrepresenting an investment 

opportunity). 

12See, e.g., Securities and Exchange Commission 

v. Philip A. Falcone, Harbinger Capital Partners 

Offshore Manager, L.L.C. and Harbinger Capital 

Partners Special Situations GP, L.L.C., Civil Action 

No. 12 Civ. 5027 (PAC) (S.D.N.Y.) and Securities 

and Exchange Commission v. and (sic) Harbinger 

Capital Partners LLC, Philip A. Falcone and Peter 

A. Jenson, Civil Action No. 12 Civ. 5028 (PAC) 

(S.D.N.Y.), Civil Action No. 12 Civ. 5027 (PAC) 

(S.D.N.Y.), U.S. Securities and Exchange 

Commission Litigation Release No. 22831A (Oct. 2, 

2013) (‘‘Harbinger Capital’’) (private fund adviser 

granted favorable redemption and liquidity terms to 

certain large investors in a private fund without 

disclosing these arrangements to the fund’s board 

of directors and the other fund investors). See also 

17 CFR 275.206(4)–8 (rule 206(4)–8 under the 

Advisers Act). 

Commission also has pursued 

enforcement actions against private 

fund advisers for practices that have 

caused private funds to pay more in fees 

and expenses than they should have, 

which negatively affected returns for 

private fund investors, or resulted in 

investors not being informed of relevant 

conflicts of interest concerning the 

private fund adviser and the fund.10

Despite our examination and 

enforcement efforts, these activities 

persist.11

First, we continue to observe that 

private fund investments are often 

opaque; advisers frequently do not 

provide investors with sufficiently 

detailed information about private fund 

investments. Without sufficiently clear, 

comparable information, even 

sophisticated investors would be unable 

to protect their interests or make sound 

investment decisions. For example, 

some investors do not have sufficient 

information regarding private fund or 

portfolio company fees and expenses to 

make informed investment decisions, 

given those fees and expenses can be 

subject to complicated calculation 

methodologies (that often include the 

application of offsets, waivers, and other 

limits); may have varied labels across 

private funds; and can affect individual 

investors’ returns differently because of 

alternative fee arrangements set forth in 

side letter agreements. In addition, 

advisers often provide private fund 

investors with laundry lists of potential 

fees and expenses, without giving 

details on the magnitude and scope of 

fees and expenses charged. Beyond 

management fees, performance-based 

compensation, and the expenses 

charged directly to the funds, some 

private fund advisers and their related 

persons charge a number of fees and 

expenses to the fund’s portfolio 

companies. These can include 

consulting fees, monitoring fees, 

servicing fees, transaction fees, 

director’s fees, and others. At the time 

of the initial investment and as fund 

operations continue, many investors do 

not have sufficient information 

regarding these fee streams that flow to 

the adviser or its related persons and 

reduce the return on their investment. 

Investors also often lack sufficient 

transparency into how private fund 

performance is calculated. Advisers 

frequently present fund performance 

reflecting different assumptions, making 

it difficult to measure and compare data 

across funds and advisers or compare 

the fund’s performance to the investor’s 

chosen benchmarks, even where the 

assumptions are disclosed. For example, 

one adviser may show fund 

performance that reflects the use of a 

subscription line of credit initially to 

fund investments and pay expenses 

rather than investor capital. Another 

adviser may present only unlevered 

performance results that do not reflect 

the effect of a subscription line. More 

standardized requirements for 

performance metrics would allow 

private fund investors to make apples to 

apples comparisons when assessing the 

returns of similar fund strategies over 

different market environments and over 

time. More standardized requirements 

for performance information also would 

improve investors’ ability to interpret 

complex performance reporting, and 

assess the relationship between the fees 

paid in connection with an investment 

and the return on that investment as 

they monitor their investment and 

consider potential future investments. 

Similarly, investors may not have 

information regarding the preferred 

terms granted to certain investors (e.g., 

seed investors, strategic investors, those 

with large commitments, and 

employees, friends, and family). 

Advisers frequently grant preferred 

terms to certain investors that often are 

not attainable for smaller institutional 

investors or individual investors. In 

some cases, these terms materially 

disadvantage other investors in the 

private fund.12

This lack of transparency regarding 

costs, performance, and preferential 

terms causes an information imbalance 

between advisers and private fund 

investors, which, in many cases, 

prevents private bilateral negotiations 

from effectively remedying 

shortcomings in the private funds 

market. We believe that this imbalance 

serves only the adviser’s interest and 

leaves many investors without the tools 

they need to effectively protect their 

interests, whether through negotiations 

or otherwise. Moreover, certain advisers 

may only provide sufficiently detailed 

information following an investor’s 

admission to the fund when the primary 

bargaining window has closed, 

particularly for closed-end funds where 

investors have no, or very limited, 

options to withdraw. 

Enhanced information about costs, 

performance, and preferential treatment, 

would help an investor better decide 

whether to invest or to remain invested 

in a particular private fund, how to 

invest other assets in the investor’s 

portfolio, and whether to invest in 

private funds managed by the adviser or 

its related persons in the future. More 

standardized information would 

improve comparability among private 

funds with similar characteristics. This 

information also would help a private 

fund investor better monitor and assess 

the true cost of its investments, the 

value of the services for which the fund 

is paying, and potential conflicts of 

interest. For example, enhanced cost 

information could allow an investor to 

identify when the private fund has 

incorrectly, or improperly, assessed a 

fee or expense by the adviser contrary 

to the adviser’s fiduciary duty, 

contractual obligations to the fund, or 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16889 

13See, e.g., In the Matter of Bluecrest Capital 

Management Limited, Investment Advisers Act 

Release No. 5642 (Dec. 8, 2020) (settled action) 

(alleging that hedge fund adviser strategically reallocated its best performing personnel (traders) 

from its flagship hedge fund to its proprietary hedge 

fund, which followed an overlapping trading 

strategy and that hedge fund adviser failed to 

adequately disclose the existence of its proprietary 

hedge fund, the movement of traders, and related 

conflicts of interest); In the Matter of Monomoy 

Capital Management, L.P., Investment Advisers Act 

Release No. 5485 (Apr. 22, 2020) (settled order) 

(alleging that private fund adviser charged the 

fund’s portfolio company for the services of its inhouse operations group without fulling disclosing 

this practice). 

14See, e.g., SEC v. Joseph W. Daniel, Litigation 

Release No. 19427 (Oct. 13, 2005) and In re Joseph 

W. Daniel, Investment Advisers Act Release No. 

2450 (Nov. 29, 2005) (settled action) (alleging 

adviser failed to properly value holdings of its 

hedge fund client, which inflated the management 

fees investor paid); In the Matter of Swapnil Rege, 

Investment Advisers Act Release No. 5303 (July 18, 

2019) (settled action) (alleging that an employee of 

a private fund adviser mispriced the private fund’s 

investments, which resulted in the adviser charging 

the fund excess management fees). 15See, e.g., In the Matter of Lincolnshire 

Management, Inc., Investment Advisers Act Release 

No. 3927 (Sept. 27, 2014) (settled action) (alleging 

private equity adviser to two private funds 

misallocated expenses between the funds). 16See, e.g., EXAMS National Examination 

Program Risk Alert: Observations from 

Examinations of Private Fund Advisers (Jan. 27, 

2022) (‘‘EXAMS Private Funds Risk Alert 2022’’), 

available at https://www.sec.gov/files/private-fundrisk-alert-pt-2.pdf. 

disclosures by the fund or the adviser. 

Ultimately, this information would help 

investors better understand marketplace 

dynamics and potentially improve 

efficiency for future investments, for 

example, by expediting the process for 

reviewing and negotiating fees and 

expenses. More competition and 

transparency also could lower the costs 

of capital for portfolio companies 

raising money and increase returns to 

investors, potentially bringing greater 

efficiencies to this part of the capital 

markets. 

We also have continued to observe 

instances of advisers acting on conflicts 

of interest that are not transparent to 

investors, provide substantial financial 

benefits to the adviser, and potentially 

have significant negative impacts on the 

private fund’s returns.13 These issues 

are widespread in the private fund 

context because, in many cases, the 

adviser can influence or control the 

portfolio company and can extract 

compensation without the knowledge of 

the fund or its investors. In addition, 

private funds typically lack governance 

mechanisms that would help check 

overreaching by private fund advisers. 

For example, although some private 

funds may have limited partner 

advisory committees (‘‘LPACs’’) or 

boards of directors, these types of bodies 

may not have the necessary 

independence, authority, or 

accountability to oversee and consent to 

these conflicts or other harmful 

practices. Private funds also do not have 

comprehensive mechanisms for private 

fund investors to exercise effective 

governance, which is exacerbated by the 

fact that private fund advisers often 

provide certain investors with 

preferential terms that can create 

potential conflicts among the fund’s 

investors. Moreover, the interests of one 

or more private fund investors may not 

represent the interests of, or may 

otherwise conflict with the interests of, 

other investors in the private fund due 

to, among other things, business or 

personal relationships or other private 

fund investments. To the extent 

investors are afforded governance or 

similar rights, such as LPAC 

representation, certain fund agreements 

permit such investors to exercise their 

rights in a manner that places their 

interests ahead of the private fund or the 

investors as a whole. For example, 

certain fund agreements state that, 

subject to applicable law, LPAC 

members owe no duties to the private 

fund or to any of the other investors in 

the private fund and are not obligated to 

act in the interests of the private fund 

or the other investors as a whole. 

As an example of advisers acting on 

conflicts of interest, certain venture 

capital fund advisers use private funds 

to obtain a controlling or influential 

interest in a non-publicly traded early 

stage company and then instruct that 

company to hire the adviser or its 

related persons to provide certain 

services. In these circumstances, the 

adviser often sets the terms of the 

engagement, including the price paid for 

the services. In cases where the adviser 

causes the fund to overpay for services 

because the services were not negotiated 

in an arm’s-length process, the adviser’s 

practice of hiring its related persons 

harms investors by diminishing the 

private fund’s returns. For example, the 

adviser sometimes instructs the 

company to pay certain of the adviser’s 

bills, to reimburse the adviser for 

expenses incurred in managing its 

investment in the company, or to add to 

its payroll adviser employees who 

manage the investment. In contrast, 

outside of the private fund context, an 

adviser often uses private fund clients to 

buy shares in a company and may vote 

proxies or engage with management and 

the board, but absent taking some 

extraordinary steps, the adviser’s ability 

to influence or control the company is 

generally constrained. In addition, if the 

company is publicly traded, the 

adviser’s attempts to seize control or 

make a variety of other changes are 

generally visible to its clients and the 

public at large. 

Although many conflicts of interest 

can involve problematic sales practices 

or compensation schemes, some can be 

managed. For example, advisers have a 

conflict of interest with private funds 

and investors in those funds when they 

value the fund’s assets and use that 

valuation as the basis for the calculation 

of the adviser’s fees and fund 

performance.14 Similarly, advisers or 

their related persons have a conflict of 

interest with the fund and its investors 

when they offer existing fund investors 

the option to sell or exchange their 

interests in the private fund for interests 

in another vehicle advised by the 

adviser or any of its related persons (an 

‘‘adviser-led secondary transaction’’). In 

both of these examples, there are 

opportunities for advisers, funds, and 

investors to benefit, but there is also a 

potential for significant harm if the 

adviser’s conflicts are not appropriately 

handled, including diminishing the 

fund’s returns because of excess fees 

and expenses paid to the fund’s adviser 

or its related persons. In these cases, 

enhanced protections in the form of an 

annual private fund audit and a fairness 

opinion in connection with an adviserled secondary transaction would help 

address the concerns presented by these 

conflicts. 

Other conflicts of interest are contrary 

to the public interest and the protection 

of investors, and cannot be managed 

given the lack of governance 

mechanisms frequent in private funds as 

discussed above. For example, we have 

observed situations where the adviser 

causes one fund to bear more than its 

pro rata share of expenses related to a 

portfolio investment.15 In these 

circumstances, an adviser may unfairly 

allocate fees and expenses to benefit 

certain favored clients at the expense of 

others, indirectly benefiting the adviser. 

Through our examinations, our staff also 

has encountered instances where 

advisers seek to limit their fiduciary 

duty or otherwise provide that the 

adviser and its related persons will not 

be liable to the private fund or investors 

for breaching its duties (including 

fiduciary duties) or liabilities (that exist 

at law or in equity).16 We believe an 

adviser that seeks to limit its liability in 

such a manner harms the private fund 

(and, by extension, the private fund 

investors) by putting the adviser’s 

interests ahead of the interests of its 

private fund client. 

Accordingly, based on our experience 

overseeing private fund advisers, as well 

as private funds’ impact on our financial 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16890 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

17 Id. 

18Proposed rule 206(4)–7(b). 19Proposed rule 211(h)(1)–2. 

system, our economy, and American 

investors’ savings, there is a need to 

enhance the regulation of private fund 

advisers to protect investors, promote 

more efficient capital markets, and 

encourage capital formation. The 

Commission believes that many of the 

practices it has observed are contrary to 

the public interest and protection of 

investors and that these practices, if left 

unchecked, would continue to harm 

investors. 

In addition, given the lack of strong 

governance mechanisms at private 

funds, their compliance programs take 

on added importance in protecting 

investors.17 We are proposing an 

amendment to the Advisers Act 

compliance rule to require all SECregistered advisers, including those that 

do not manage private funds, to 

document the annual review of their 

compliance policies and procedures in 

writing.18 Based on staff experience, 

some investment advisers do not make 

and preserve written documentation of 

the annual review of their compliance 

policies and procedures, which our 

examination staff relies on to help it 

understand an adviser’s compliance 

program, determine whether the adviser 

is complying with the rule, and identify 

potential weaknesses in the compliance 

program. Advisers can also rely on 

written documentation of the annual 

review to promote an internal culture of 

compliance and accountability. We 

believe that requiring written 

documentation would focus renewed 

attention on the importance of the 

annual compliance review process and 

would result in records of annual 

compliance reviews that would allow 

our staff to assess whether an adviser 

has complied with the review 

requirement of the compliance rule. 

II. Discussion of Proposed Rules for 

Private Fund Advisers 

We are proposing a series of rules 

under the Advisers Act that would 

specifically address these practices by 

advisers to private funds. The goal of 

this package of proposed reforms is to 

protect those who directly or indirectly 

invest in private funds by increasing 

visibility into certain practices, 

establishing requirements to address 

certain practices that have the potential 

to lead to investor harm, and prohibiting 

adviser activity that we believe is 

contrary to the public interest and the 

protection of investors. While some of 

the investor protection concerns 

identified herein may relate to an 

adviser’s activities with regard to other 

client types (e.g., separately managed 

accounts, pooled vehicles that are not 

private funds as defined in the Advisers 

Act), the proposed reforms are designed 

to address concerns that arise out of the 

opacity that is prevalent in the private 

fund structure. We also are proposing 

corresponding amendments to the books 

and records requirements in rule 204–2. 

We request comment on the following 

aspects of the package of proposed 

reforms: 

• Are there certain activities that this 

package of proposed reforms would 

address in the private fund context that 

we should also address in other contexts 

(e.g., separately managed accounts)? 

Why or why not? 

• Are there certain activities in the 

private fund context that this package of 

proposed reforms is not addressing but 

that we should address? 

A. Quarterly Statements 

The proposed rule would require an 

investment adviser that is registered or 

required to be registered with the 

Commission to prepare a quarterly 

statement that includes certain 

information regarding fees, expenses, 

and performance for any private fund 

that it advises and distribute the 

quarterly statement to the private fund’s 

investors within 45 days after each 

calendar quarter end, unless a quarterly 

statement that complies with the 

proposed rule is prepared and 

distributed by another person.19 We 

believe that periodic statements 

detailing such information are necessary 

to improve the quality of information 

provided to fund investors, allowing 

them to assess and compare their 

private fund investments better. This 

information also would improve their 

ability to monitor the private fund 

adviser to ensure compliance with the 

private fund’s governing agreements and 

disclosures. While private fund advisers 

may currently provide statements to 

investors, there is no requirement for 

advisers to do so under the Advisers Act 

regulatory regime. 

We believe advisers should provide 

statements to help an investor better 

understand the relationship between the 

fees and expenses the investor bears and 

the performance the investor receives 

from the investment because of the 

opaque nature of the fees and expenses 

typically associated with private fund 

investments. For example, a private 

fund’s governing documents (e.g., 

limited partnership agreement, limited 

liability company agreement, or offering 

document) may include broad 

characterizations of the types of 

potential fees and expenses. In other 

cases, the fund’s governing documents 

may give the adviser significant 

discretion to determine which fees and 

expenses relate to, and should be borne 

by, the fund. Examples of broad fee and 

expense characterizations include ‘‘any 

and all fees and expenses related to the 

fund’s business or activities,’’ ‘‘any and 

all fees and expenses incurred in 

connection with the operation of the 

fund,’’ and ‘‘any and all fees and 

expenses that the adviser shall 

determine to be related to the 

establishment and operation of the 

fund.’’ These provisions do not provide 

investors sufficiently detailed 

information regarding what fees and 

expenses will be charged, how much 

those fees and expenses will be, and 

how often fees and expenses will be 

charged. 

We believe that periodic statements 

containing certain required information 

would allow investors to understand 

and monitor their private fund 

investments better. For example, 

investors could check fees and expenses 

paid directly or indirectly by the private 

fund against the private fund’s 

governing documents. This information 

may allow an investor to identify when 

the private fund is incorrectly, or 

improperly, assessed a fee or expense by 

the adviser contrary to the adviser’s 

fiduciary duty or the fund’s governing 

agreements or disclosures. As discussed 

in more detail below, the proposed 

quarterly statement also would improve 

transparency for investors into both the 

myriad ways an adviser and its related 

persons benefit from their relationship 

with the private fund and the scope of 

potential conflicts of interests. 

In addition, the proposed quarterly 

statement would allow a private fund 

investor to compare cost and 

performance information across its 

private fund investments. This 

information would help inform 

investment decisions, including 

whether to remain invested in certain 

private funds or to invest in other 

private funds managed by the adviser or 

its related persons. More broadly, this 

disclosure would help inform investors 

about the cost and performance 

dynamics of this marketplace and 

potentially improve efficiency for future 

investments. For example, if an investor 

owns interests in funds with similar 

investment strategies, the investor may 

be in a better position to negotiate lower 

fee rates for future investments because 

the investor would be aware of the rates 

charged by certain advisers in that 

segment of the market. 

We recognize that many private fund 

advisers contractually agree to provide 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16891 

20Section 3(c)(5)(C) of the Investment Company 

Act provides an exclusion from the definition of 

investment company for any person who is not 

engaged in the business of issuing redeemable 

securities, face-amount certificates of the 

installment type or periodic payment plan 

certificates, and who is primarily engaged in the 

business of purchasing or otherwise acquiring 

mortgages and other liens on and interests in real 

estate. 

fee, expense, and performance reporting 

to investors. For example, advisers may 

provide investors with financial 

statements, schedules, or other reports 

regarding the fund and its activities. 

However, not all private fund investors 

are able to obtain this information. 

Others may be able to obtain 

information, but it may not be 

sufficiently clear or detailed reporting 

regarding the costs and performance of 

a particular private fund. For example, 

some advisers report only aggregated 

expenses, or do not provide detailed 

information about the calculation and 

implementation of any negotiated 

rebates, credits, or offsets. Without 

clear, detailed disclosure, investors are 

unable to measure and assess the impact 

fees and expenses have on their 

investment returns. 

Reporting practices also vary across 

the private funds industry due to, 

among other things, different forms and 

templates. Because the proposed 

requirement of quarterly statements 

would involve a degree of 

standardization across the industry, we 

believe that investors would be able to 

find and compare key information 

regarding fees, expenses, and 

performance for funds with similar 

characteristics more easily than is the 

case today. This has the potential to, in 

our view, bring greater efficiencies to 

the marketplace by improving investor 

decision making. For example, investors 

likely would be able to compare adviser 

compensation across similar funds, 

which may assist investors in 

determining whether to negotiate or 

renegotiate economic terms or whether 

to invest or continue to invest in private 

funds managed by the adviser. 

The proposed quarterly statement 

requirement would provide fund-wide 

reporting. We believe this approach 

would help private fund investors 

compare the costs of investing across 

private funds. We are not proposing to 

require private fund advisers to provide 

personalized account statements 

showing each individual investor’s fees, 

expenses, and performance. The 

proposed quarterly statements are 

designed, in part, to allow individual 

private fund investors to use fund-level 

information to perform more personal, 

customized calculations. In addition, 

these proposed requirements do not 

prevent an adviser from providing (or 

causing a third party, such as an 

administrator, consultant, or other 

service provider, to provide), or an 

investor from negotiating, personalized 

reporting. In the registered fund context, 

fund-level reporting has, in our view, 

enabled retail investors to understand 

their investments better. We believe a 

comparable approach, but one that is 

more suitable to the needs of investors 

in private funds, is appropriate here. 

We request comment on the following 

aspects of the proposed rule: 

• Should we, as proposed, require 

advisers to private funds to prepare a 

quarterly statement providing 

standardized disclosures regarding the 

cost of investing in the private fund and 

the private fund’s performance and 

distribute the quarterly statement to the 

fund’s investors? Should we instead 

require advisers to provide investors 

with personalized information that takes 

into account the investors’ individual 

ownership stake in the fund in addition 

to, or in lieu of, a statement covering the 

private fund? If so, what information 

should be included in the personalized 

disclosure? For example, should the 

statement reflect specific fee 

arrangements, including any offsets or 

waivers applicable only to the investors 

receiving the statement? Do advisers 

currently provide personalized fee, 

expense, and performance disclosures? 

If so, what other types of information do 

advisers or funds typically include? Do 

they automate such disclosures? How 

expensive and complex would it be for 

advisers to create and deliver 

personalized disclosures? How useful 

would it be for investors to receive 

personalized disclosures? 

• Would investors find data regarding 

the private fund’s fees, expenses, and 

performance useful given that certain 

investors may have different economic 

arrangements with the adviser, such as 

fee breaks or expense caps? Should we 

require advisers to disclose in the 

quarterly statement whether investors 

are subject to different economic 

arrangements, whether documented in 

side letters or other written agreements 

or, to the extent applicable, as a result 

of different class terms? If so, should we 

require advisers to list the rates or 

otherwise show a range? 

• Should the quarterly statement rule 

apply to registered advisers to private 

funds as proposed or should it apply to 

all advisers to private funds? Should it 

apply to exempt reporting advisers? 

Should the rule include any exceptions 

for categories of advisers? If so, what 

conditions should apply to such an 

exception? 

• Should the rule require advisers to 

prepare and distribute the quarterly 

statements only to private fund 

investors, as proposed? Alternatively, 

should the rule require advisers to 

provide quarterly statements to 

investors in other types of pooled 

investment vehicles, such as a vehicle 

that relies on an exclusion from the 

definition of ‘‘investment company’’ in 

section 3 of the Investment Company 

Act other than section 3(c)(1) or 3(c)(7) 

of that Act? For example, should we 

require advisers to provide quarterly 

statements to investors in pooled 

investment vehicles that rely on the 

exclusion from the definition of 

‘‘investment company’’ in section 

3(c)(5)(C) of that Act? 20

• The proposed rule would require an 

adviser to distribute the quarterly 

statement to the private fund’s investors 

within 45 days after each calendar 

quarter end, unless such a quarterly 

statement is prepared and distributed by 

another person. Would this provision 

eliminate burdens where there are 

multiple advisers to the same fund, 

while still providing the fund’s 

investors with the benefits of the 

quarterly statement? Would the fund’s 

primary adviser typically prepare and 

distribute the quarterly statement in 

these circumstances? How would 

advisers that do not prepare and 

distribute a quarterly statement in 

reliance on another adviser demonstrate 

compliance with this requirement? 

• The proposed rule would require 

advisers to prepare and distribute a 

quarterly statement disclosing certain 

information regarding a private fund’s 

fees, expenses, and performance. Are 

there alternative approaches we should 

require to improve investor protection 

and bring greater efficiencies to the 

market? For example, should we 

establish maximum fees that advisers 

may charge at the fund level? Should we 

prohibit certain compensation 

arrangements, such as the ‘‘2 and 20’’ 

model? Should we prohibit advisers 

from receiving compensation from 

portfolio investments to the extent they 

also receive management fees from the 

fund? Should we require advisers to 

disclose their anticipated management 

fee revenue and operating budget to 

private fund investors or an LPAC or 

other similar body (despite the 

limitations of private fund governance 

mechanisms, as discussed above) on an 

annual or more frequent basis? Should 

we impose limitations on management 

fees (which are typically paid regardless 

of whether the fund generates a profit), 

but not impose limitations on 

performance-based compensation 

(which is typically tied to the success of 

the fund)? Should we prohibit 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16892 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

21Certain private fund advisers utilize a passthrough expense model where the private fund pays 

for most, if not all, expenses, including the adviser’s 

expenses, but the adviser does not charge a 

management fee. See infra section II.D.2. for a 

discussion of such pass-through expense models. 

22 Investors typically enter into agreements under 

which the private fund pays such compensation 

directly to the adviser or its affiliates. Investors 

generally bear such compensation indirectly 

through their investment in the private fund; 

however, certain agreements may require investors 

to pay the adviser directly. 

23See Hedge Fund Transparency: Cutting 

Through the Black Box, The Hedge Fund Journal, 

James R. Hedges IV (Oct. 2006) (stating that ‘‘the 

biggest challenges facing today’s hedge fund 

industry may well be the issues of transparency and 

disclosure’’), available at https://thehedgefund

journal.com/hedge-fund-transparency/; Fees & 

Expenses, Private Funds CFO (Nov. 2020) at 12 

(noting that it is becoming increasingly complicated 

for investors to determine what the management fee 

covers versus what is a partnership expense and 

stating that the ‘‘formulas for management fees are 

complex and unique to different investors.’’), 

available at https://www.troutman.com/images/ 

content/2/6/269858/PFCFO-FeesExpenses-Nov20- 

Final.pdf. 

24See, e.g., Letter from State Treasurers and 

Comptrollers to Mary Jo White, U.S. Securities & 

Exchange Commission (July 21, 2015), available at 

http://comptroller.nyc.gov/wp-content/uploads/ 

documents/SEC_SignOnPDF.pdf; see also Letter 

from Americans for Financial Reform Education 

Fund to Chairman Gary Gensler, U.S. Securities & 

Exch. Commission (July 6, 2021), available at 

https://ourfinancialsecurity.org/wp-content/ 

uploads/2021/07/Letter-to-SEC-re_-Private-Equity7.6.21.pdf . 

25See, e.g., In the Matter of Blackstone 

Management Partners, L.L.C., et. al., Investment 

Advisers Act Release No. 4219 (Oct. 7, 2015) 

(settled action). 

26See, e.g., In the Matter of Cherokee Investment 

Partners, LLC and Cherokee Advisers, LLC, 

Investment Advisers Act Release No. 4258 (Nov. 5, 

2015) (settled action). 

27See, e.g., In the Matter of Lincolnshire 

Management, Inc., Investment Advisers Act Release 

No. 3927 (Sept. 22, 2014) (settled action). 

28See EXAMS Private Funds Risk Alert 2020, 

supra footnote 9. 

management fees from being charged as 

a percentage of committed capital and 

instead only permit management fees to 

be based on invested capital, net asset 

value, and other similar types of fee 

bases? Should we prohibit certain 

expense practices or arrangements, such 

as expense caps provided to certain, but 

not all, investors? 

• Similarly, should we prohibit 

certain types of private fund 

performance information in the 

quarterly statement? For example, 

should we prohibit advisers from 

presenting performance with the impact 

of fund-level subscription facilities? 

Should we prohibit advisers from 

presenting combined performance for 

multiple funds, such as a main fund and 

a co-investment fund that pays lower or 

no fees? 

• Do private fund advisers or their 

related persons receive other economic 

benefits that the rule should require 

advisers to disclose in the quarterly 

statement? For example, should the 

quarterly statement also require 

disclosure and quantification of the 

kinds of economic benefits commonly 

received by advisers or their related 

persons from broker-dealers or other 

service providers to private funds, such 

as hedge funds? Why or why not? 

1. Fee and Expense Disclosure 

The proposed rule would require an 

investment adviser that is registered or 

required to be registered to prepare and 

distribute quarterly statements with 

certain information regarding fees and 

expenses, including fees and expenses 

paid by underlying portfolio 

investments to the adviser or its related 

persons. While the types of fees and 

expenses charged to private funds can 

vary across the industry, private funds 

are often more expensive than other 

asset classes because the scope and 

magnitude of fees and expenses paid 

directly and indirectly by private fund 

investors can be extensive. Investors 

typically compensate the adviser for 

managing the affairs of the fund, often 

in the form of management fees.21 On 

top of that, investors typically pay or 

otherwise bear performance-based 

compensation.22 A fund’s portfolio 

investments also may pay fees to the 

adviser or its related persons. For 

example, principals of the adviser may 

receive cash or non-cash 

compensation—such as equity awards 

or stock options—for serving as 

directors of a portfolio investment 

owned by the private fund. Portfolio 

investment compensation is typically in 

addition to compensation paid or 

allocated to the adviser or its related 

persons at the fund level, unless the 

fund’s governing documents require the 

adviser to offset portfolio investment 

compensation against other revenue 

streams or otherwise provide a rebate to 

investors. Compensation at the 

‘‘portfolio investment-level’’ is more 

common for certain private funds—such 

as private equity funds or real estate 

funds—and less common for others— 

such as hedge funds. 

Investors generally are required to 

bear all expenses related to the 

operation of the fund and its portfolio 

investments. In addition to expenses 

such as organizational and offering 

expenses, private fund investors also 

frequently bear expenses that vary based 

on the private fund’s strategy and 

contractual agreements. For example, 

hedge fund investors indirectly bear 

trading expenses. Investors in private 

equity and venture capital funds 

indirectly bear expenses associated with 

fund investments, such as deal sourcing 

and due diligence expenses, including 

for investments that are 

unconsummated. Investors in private 

funds with a real estate investment 

strategy also indirectly bear expenses 

related to property management, 

environmental reviews, and site 

inspections. These expenses generally 

are uncapped, and, unlike a fund’s 

performance-based compensation, 

private fund investors are typically 

required to bear them regardless of 

whether the fund or the applicable 

investment generates a positive return 

for investors. 

Investors often lack transparency 

regarding the total cost of such fees and 

expenses.23 For example, even though 

investors indirectly bear the costs 

associated with a portfolio investment 

paying fees to the adviser or its related 

persons, advisers often do not disclose 

the magnitude or scope of these fees to 

investors. Opaque reporting practices 

make it difficult for investors to measure 

and evaluate performance accurately 

and to make informed investment 

decisions.24 Moreover, such reporting 

practices may prevent private fund 

investors from assessing whether the 

type and amount of fees and expenses 

borne by the private fund comply with 

the fund’s governing agreements and 

can lead to problematic compensation 

schemes and sales practices with 

investors bearing excess or improper 

fees and expenses. The Commission has 

brought enforcement actions related to 

the disclosure and allocation of fees and 

expenses by private fund advisers. For 

example, we have alleged in settled 

enforcement actions that advisers have 

received undisclosed fees,25 improperly 

shifted expenses away from the 

adviser,26 and misallocated fees and 

expenses among private fund clients.27

Staff has observed similarly problematic 

compensation schemes and sales 

practices in its examinations of private 

fund advisers.28 For example, staff has 

observed advisers that charge private 

funds for expenses not permitted under 

the fund documents. Staff has also 

observed advisers improperly allocate 

shared expenses, such as broken-deal, 

due diligence, and consultant expenses, 

among private fund clients and their 

own accounts. 

We have seen a significant increase in 

investors seeking transparency 

regarding fees and expenses. For 

example, certain investors and industry 

groups have encouraged advisers to 

adopt uniform reporting templates to 

promote transparency and alignment of 

interests between advisers and 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16893 

29See, e.g., Institutional Limited Partners 

Association (‘‘ILPA’’) Reporting Template, available 

at https://ilpa.org/reporting-template/(stating that, 

since its release, more than one hundred and forty 

organizations have endorsed the ILPA reporting 

template, including more than twenty advisers). 

30Proposed rule 211(h)(1)–2(b). 

31See proposed rule 211(h)(1)–1 (defining 

‘‘reporting period’’ as the private fund’s calendar 

quarter covered by the quarterly statement or, for 

the initial quarterly statement of a newly formed 

private fund, the period covering the private fund’s 

first two full calendar quarters of operating results). 

To the extent a newly formed private fund begins 

generating operating results on a day other than the 

first day of a calendar quarter (e.g., January 1), the 

adviser should include such partial quarter and the 

immediately succeeding calendar quarters in the 

newly formed private fund’s initial quarterly 

statement. For example, if a fund begins generating 

operating results on February 1, the reporting 

period for the initial quarterly statement would 

cover the period beginning on February 1 and 

ending on September 30. 

32Proposed rule 211(h)(1)–2(b)(1). 

33We propose to define ‘‘performance-based 

compensation’’ as allocations, payments, or 

distributions of capital based on the private fund’s 

(or its portfolio investments’) capital gains and/or 

capital appreciation. This definition’s scope is 

broad and includes cash or non-cash compensation, 

including, for example, in-kind allocations, 

payments, or distributions of performance-based 

compensation. We believe that the broad scope of 

the definition, which would capture, without 

limitation, carried interest, incentive fees, incentive 

allocations, or profit allocations, among other forms 

of compensation, is appropriate given the various 

forms and types of performance-based 

compensation across the private funds industry. 

34Proposed rule 211(h)(1)–1. Form ADV also uses 

the same definition. The regulations at 17 CFR 

275.206(4)–2 (rule 206(4)–2) use a similar definition 

by defining related person to include any person, 

directly or indirectly, controlling or controlled by 

the adviser, and any person that is under common 

control with the adviser. 

35Proposed rule 211(h)(1)–1. The definition, in 

addition, provides that (i) each of an investment 

adviser’s officers, partners, or directors exercising 

executive responsibility (or persons having similar 

status or functions) is presumed to control the 

investment adviser; (ii) a person is presumed to 

control a corporation if the person: (A) Directly or 

indirectly has the right to vote 25% or more of a 

class of the corporation’s voting securities; or (B) 

has the power to sell or direct the sale of 25% or 

more of a class of the corporation’s voting 

securities; (iii) a person is presumed to control a 

partnership if the person has the right to receive 

upon dissolution, or has contributed, 25% or more 

of the capital of the partnership; (iv) a person is 

presumed to control a limited liability company if 

the person: (A) Directly or indirectly has the right 

to vote 25% or more of a class of the interests of 

the limited liability company; (B) has the right to 

receive upon dissolution, or has contributed, 25% 

or more of the capital of the limited liability 

company; or (C) is an elected manager of the limited 

liability company; or (v) a person is presumed to 

control a trust if the person is a trustee or managing 

agent of the trust. Form ADV also uses the same 

definition. 

investors.29 Despite these efforts, many 

advisers still do not voluntarily provide 

adequate disclosure to investors. The 

proposed quarterly statement rule 

would mandate them to provide it. 

a. Private Fund-Level Disclosure 

The proposed quarterly statement rule 

would require private fund advisers to 

disclose the following information to 

investors in a table format: 

(1) A detailed accounting of all 

compensation, fees, and other amounts 

allocated or paid to the adviser or any 

of its related persons by the private fund 

during the reporting period (‘‘adviser 

compensation’’); 

(2) A detailed accounting of all fees 

and expenses paid by the private fund 

during the reporting period other than 

those listed in paragraph (1) above 

(‘‘fund expenses’’); and 

(3) The amount of any offsets or 

rebates carried forward during the 

reporting period to subsequent quarterly 

periods to reduce future payments or 

allocations to the adviser or its related 

persons.30

The table would provide investors 

with comprehensive fee and expense 

disclosure for the prior quarterly period 

(or, in the case of a newly formed 

private fund’s initial quarterly 

statement, its first two full calendar 

quarters of operating results).31 We will 

discuss each of these elements in turn. 

Adviser Compensation. The proposed 

rule would require the fund table to 

show a detailed accounting of all 

adviser compensation during the 

reporting period, with separate line 

items for each category of allocation or 

payment reflecting the total dollar 

amount.32 The proposed rule is 

designed to capture all compensation, 

fees, and other amounts allocated or 

paid to the investment adviser or any of 

its related persons by the fund, 

including, but not limited to, 

management, advisory, sub-advisory, or 

similar fees or payments, and 

performance-based compensation.33

We believe requiring advisers to 

disclose all forms of adviser 

compensation as separate line items 

(without prescribing particular 

categories of fees) is appropriate because 

it would encompass the various forms of 

adviser compensation across the private 

funds industry. Many private funds 

compensate advisers with a ‘‘2 and 20’’ 

arrangement, consisting of a 2% 

management fee and a 20% share of any 

profits generated by the fund. Certain 

advisers, however, receive other forms 

of compensation from private funds in 

addition to, or in lieu of, such amounts. 

For example, certain advisers charge 

private funds administration fees or 

servicing fees. The proposal would help 

ensure disclosure of the various forms of 

adviser compensation, and the 

corresponding dollar amounts of each 

type of compensation, to current 

investors regardless of how an adviser 

characterizes the compensation and 

regardless of the different economic 

arrangements in place. This would 

allow investors to understand and 

assess the magnitude and scope of 

adviser compensation better and help 

validate that adviser compensation 

conforms to contractual agreements. 

In addition to compensation paid to 

the adviser, the proposed rule would 

require disclosure of compensation, 

fees, and other amounts allocated or 

paid to the adviser’s ‘‘related persons.’’ 

We propose to define ‘‘related persons’’ 

to include: (i) All officers, partners, or 

directors (or any person performing 

similar functions) of the adviser; (ii) all 

persons directly or indirectly 

controlling or controlled by the adviser; 

(iii) all current employees (other than 

employees performing only clerical, 

administrative, support or similar 

functions) of the adviser; and (iv) any 

person under common control with the 

adviser.34 The term ‘‘control’’ would be 

defined to mean the power, directly or 

indirectly, to direct the management or 

policies of a person, whether through 

ownership of securities, by contract, or 

otherwise.35

Many advisers conduct a single 

advisory business through multiple 

separate legal entities or provide 

services to a private fund through 

different affiliated entities. The 

proposed ‘‘related person’’ definition is 

designed to capture the various entities 

and personnel an adviser may use to 

provide advisory services to, and 

receive compensation from, private fund 

clients. We considered, but are not 

proposing, a broader definition of 

related persons to include additional 

entities related to the adviser or its 

personnel, such as entities the adviser 

or its personnel own a financial interest 

in but do not control. We are not 

proposing a broader definition because 

it would likely capture entities or 

persons outside of the ones advisers 

typically use to conduct a single 

advisory business. In addition, the 

proposed definition is consistent with 

the definition of related person used on 

Form ADV, which advisers have 

experience assessing as part of their 

disclosure obligations on that form. We 

believe that the proposed definition 

captures the relevant entities without 

being overly broad. 

Fund Fees and Expenses. The 

proposed rule would also require the 

fund table to show a detailed accounting 

of all fees and expenses paid by the 

private fund during the reporting 

period, other than those disclosed as 

adviser compensation, with separate 

line items for each category of fee or 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16894 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

36Proposed rule 211(h)(1)–2(b)(2). 

37See, e.g., Coming to Terms: Private Equity 

Investors Face Rising Costs, Extra Fees (Dec. 20, 

2021), available at https://www.wsj.com/articles/

coming-to-terms-private-equity-investors-facerising-costs-extra-fees-11640001604#:∼:text

=Coming%20to%20Terms%3A%20PrivateEquity%20Investors%20Face%20Rising%20

Costs%2C,and%20some%20expenses

%20are%20excluded%20from%20annual%20fees.; 

Key Findings ILPA Industry Intelligence Report 

‘‘What is Market in Fund Terms?’’ (2021) (‘‘ILPA 

Key Findings Report’’), available at https://ilpa.org/ 

wp-content/uploads/2021/10/Key-FindingsIndustry-Intelligence-Report-Fund-Terms.pdf. 

38Such practice is often not disclosed, or not 

fully disclosed, in private fund documents. 

39See ILPA Key Findings Report, supra footnote 

37. 

40Proposed rule 211(h)(1)–2(b). 

41The offset shifts some or all of the economic 

benefit of the fee from the adviser to the private 

fund investors. 

42Offsets, rebates, and waivers applicable to 

certain, but not all, investors through one or more 

separate arrangements would be required to be 

reflected and described prominently in the fundwide numbers presented in the quarterly statement. 

See proposed rule 211(h)(1)–2(d) and (g). 

43For example, certain investors, such as U.S. 

state pension plans, may be required to report 

complete information regarding fees and expenses 

paid to the adviser and its related persons. 

44Proposed rule 211(h)(1)–2(b)(3). 

45To the extent advisers are required to offset 

fund-level compensation (e.g., management fees) by 

portfolio investment compensation (e.g., monitoring 

fees), they typically do not reduce adviser 

compensation below zero, meaning that, in the 

event the monitoring fee offset amount exceeds the 

management fee for the applicable period, some 

fund documents provide for ‘‘carryforwards’’ of the 

unused amount. The carryforwards are used to 

offset the management fee in subsequent periods. 

expense reflecting the total dollar 

amount.36 Similar to the approach taken 

with respect to adviser compensation 

discussed above, the proposed rule 

would capture all fund fees and 

expenses paid during the reporting 

period including, but not limited to, 

organizational, accounting, legal, 

administration, audit, tax, due 

diligence, and travel expenses. 

We have observed two general trends 

in the private funds industry that 

support this approach. First, fund 

expenses have risen significantly in 

recent years for certain private funds 

due to, among other things, complex 

fund structures, global marketing and 

investment efforts, and increased 

service provider costs.37 Advisers often 

pass on such increases to the private 

funds they advise, without providing 

investors with detailed disclosure about 

the magnitude or type of expenses 

actually charged to the fund. Second, 

certain advisers have shifted expenses 

related to their advisory business to 

private fund clients.38 For example, 

some advisers charge private fund 

clients for salaries and benefits related 

to personnel of the adviser. Such 

expenses historically have been paid by 

advisers with management fee proceeds 

or other revenue streams, but are 

increasingly being charged as separate 

expenses that may not be transparent to 

fund investors.39

The proposed quarterly statement rule 

would require a detailed accounting of 

each category of fund expense. This 

would require advisers to list each 

specific category of expense as a 

separate line item, rather than permit 

advisers to group fund expenses into 

broad categories. For example, if a fund 

paid insurance premiums, administrator 

expenses, and audit fees during the 

reporting period, a general reference to 

‘‘fund expenses’’ on the quarterly 

statement would not satisfy the detailed 

accounting requirement. Instead, an 

adviser would be required to list each 

specific category of expense (i.e., 

insurance premiums, administrator 

expenses, and audit fees), and the 

corresponding dollar amount, 

separately. As with adviser 

compensation, we believe this approach 

would provide private fund investors 

with sufficient detail to validate that the 

fund expenses borne by the fund 

conform to contractual agreements. 

To the extent a fund expense also 

could be characterized as adviser 

compensation under the proposed rule, 

the proposed rule would require 

advisers to disclose such payment or 

allocation as adviser compensation and 

not as a fund expense in the quarterly 

statement. For example, certain private 

funds may engage the adviser or its 

related persons to provide services to 

the fund, such as consulting, legal, or 

back-office services. An adviser would 

disclose any compensation, fees, or 

other amounts allocated or paid by the 

fund for such services as part of the 

detailed accounting of adviser 

compensation. This approach would 

help ensure that investors understand 

the entire amount of adviser 

compensation allocated or paid to the 

adviser and its related persons during 

the reporting period. 

Offsets, Rebates, and Waivers. We are 

proposing to require advisers to disclose 

adviser compensation and fund 

expenses in the fund table both before 

and after the application of any offsets, 

rebates, or waivers.40 Specifically, the 

proposed rule would require an adviser 

to present the dollar amount of each 

category of adviser compensation or 

fund expense before and after any such 

reduction for the reporting period. 

Advisers may offset, rebate, or waive 

adviser compensation or fund expenses 

in a number of circumstances. For 

example, a private equity adviser may 

enter into a management services 

agreement with a fund’s portfolio 

company, requiring the company to pay 

the adviser a fee for those services. To 

the extent the fund’s governing 

agreement requires the adviser to share 

the fee with the fund investors through 

an offset to the management fee, the 

management fee would typically be 

reduced, on a dollar-for-dollar basis, by 

an amount equal to the fee.41 Under the 

proposed rule, the adviser would be 

required to list the management fee both 

before and after the application of the 

fee offset.42

We considered whether to require 

advisers to disclose adviser 

compensation and fund expenses only 

after the application of offsets, rebates, 

and waivers, rather than before and 

after. We recognize that investors may 

find the reduced numbers more 

meaningful, given that they generally 

reflect the actual amounts borne by the 

fund during the reporting period. We 

believe, however, that presenting both 

figures would provide investors with 

greater transparency into advisers’ fee 

and expense practices, particularly with 

respect to how offsets, rebates, and 

waivers affect adviser compensation. 

Transparency into fee and expense 

practices is important because it would 

assist investors in monitoring their 

private fund investments and, for 

certain investors, would ease their own 

efforts at complying with their reporting 

obligations.43 We also believe that 

advisers would have this information 

readily available and both sets of figures 

would be helpful to investors in 

monitoring whether and how offsets, 

rebates, and waivers are applied. 

In addition, we are proposing to 

require advisers to disclose the amount 

of any offsets or rebates carried forward 

during the reporting period to 

subsequent periods to reduce future 

adviser compensation.44 This 

information would allow investors to 

understand whether they are or the fund 

is entitled to additional reductions in 

future periods.45 Further, we believe 

that this information would assist 

investors with their liquidity 

management and cash flow models, as 

they would have greater insight into the 

fund’s projected cash flows and their 

obligations to satisfy future capital calls 

for adviser compensation with cash on 

hand. 

We request comment on all aspects of 

the proposed content of the fund fee and 

expense table, including the following 

items: 

• Should we require advisers to 

disclose all compensation and fund 

expenses as proposed? Do commenters 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16895 

46Proposed rule 211(h)(1)–2(b)(1) includes the 

following non-exhaustive list of adviser 

compensation: Management, advisory, subadvisory, or similar fees or payments, and 

performance-based compensation. Proposed rule 

211(h)(1)–2(b)(2) includes the following nonexhaustive list of fund expenses: Organizational, 

accounting, legal, administration, audit, tax, due 

diligence, and travel fees and expenses. 

agree with the scope of the proposal? 

Why or why not? 

• Would the proposed content result 

in fund-level fee and expense disclosure 

that is meaningful to investors? Are 

there other items that advisers should be 

required to disclose in the fund table? 

Are there any proposed items that we 

should eliminate? Would more or less 

information about the fees and expenses 

charged to the fund be helpful for 

investors? Are there any revisions to the 

descriptions of fees that would make the 

proposed disclosure more useful to 

investors? 

• Instead of the proposed approach, 

should we prescribe a template for the 

fund table? Would the increased 

comparability of a template be useful to 

investors? Would a template be flexible 

enough to accommodate changes in the 

types of fees and expenses as well as the 

types of offsets, rebates, or waivers used 

by private fund advisers? Would a 

template necessitate repeated updating 

as the industry evolves? 

• Should we include any additional 

definitions of terms or phrases for the 

fund table? Should we omit any 

definitions we have proposed for the 

fund table? 

• The proposed rule would require an 

adviser to include the compensation 

paid to a related person sub-adviser in 

its quarterly statement. For private 

funds that have sub-advisers that are not 

related persons, should we require a 

single quarterly statement showing all 

adviser compensation (at both the 

adviser and sub-adviser levels)? In cases 

where a non-related person sub-adviser 

does not prepare a quarterly account 

statement in reliance on the adviser’s 

preparation and distribution of the 

quarterly statement to the fund’s 

investors, how would advisers reflect 

the compensation paid to the subadviser and its related persons? Do 

commenters agree that such 

compensation would be captured as a 

fund expense? Should we require a 

separate table covering these fees and 

expenses, as well as a separate table 

showing portfolio investment 

compensation paid to the sub-adviser or 

its related person? How would advisers 

operationalize this requirement in these 

circumstances? 

• Should we adopt the proposed 

definitions of ‘‘related persons’’ and 

‘‘control’’ as proposed? Are they too 

broad? Are the proposed definitions 

broad enough? Should we add former 

personnel of the adviser or its related 

persons to the proposed definition? If 

so, for how long after a departure from 

the adviser or its related persons should 

such personnel fall into the definition? 

Should the definition of related person 

include family members of adviser 

personnel or persons who share the 

same household with adviser 

personnel? Should the definition 

capture any person directly or indirectly 

controlled by the adviser’s officers, 

partners, or directors (including any 

consulting firms controlled by such 

persons)? Should it capture operational 

partners, senior advisors, or other 

similar consultants of the adviser, the 

private fund, or its portfolio 

investments? Should we add any entity 

more than five percent of the ownership 

of which is held, directly or indirectly, 

by the adviser or its personnel? Should 

the definition include any person that 

receives, directly or indirectly, 

management fees or performance based 

compensation from, or in respect of, the 

fund; or any person that has an interest 

in the investment adviser or general 

partner (or similar control person) of the 

fund? If we adopt a different definition 

of ‘‘related person’’ than what is being 

proposed, should we use a different 

defined term (such as ‘‘related party’’) to 

avoid confusion given that the term 

‘‘related person’’ is defined in Form 

ADV? 

• For purposes of the definition of 

‘‘control,’’ are the control presumptions 

appropriate in this context? Should we 

eliminate or modify any of the 

presumptions? For example, should we 

eliminate aspects of the definition that 

may capture passive investors who do 

not have the power to direct the 

management or policies of the relevant 

entity? Why or why not? Should we add 

any additional control presumptions? 

For example, should an entity be 

presumed to be controlled by an adviser 

to the extent the adviser has authority 

over the entity’s budget or whether to 

hire personnel or terminate their 

employment? 

• The proposed rule includes a nonexhaustive list of certain types of 

adviser compensation and fund 

expenses.46 Would this information 

assist advisers in complying with the 

rule? Should we add any additional 

types? If so, which ones and why? 

• Do private fund advisers or their 

related persons receive other economic 

benefits that the rule should require 

advisers to disclose in the quarterly 

statement? For example, should we 

require hedge fund advisers to disclose 

the dollar amount of any soft dollar or 

similar benefits provided by brokerdealers that execute trades for the funds, 

or any benefits provided by hedge fund 

prime brokers? 

• Do commenters agree with the 

scope of the proposed definition of 

‘‘performance-based compensation’’? 

Should we specify the types of 

compensation that should be included 

in the definition? For example, should 

the definition specify that the term 

includes carried interest, incentive fees, 

incentive allocations, performance fees, 

or profit allocations? 

• Should we only require the table to 

disclose adviser compensation and fund 

expenses after the application of any 

offsets, rebates, or waivers, rather than 

before and after, as proposed? If so, 

why? 

• Should we define offsets, rebates, 

and waivers? If so, what definitions 

should we use and why? Are there any 

types of offsets, rebates, and waivers 

that we should not require advisers to 

reflect in the fund table? If so, which 

ones and why? To the extent that 

offsets, rebates, or waivers are available 

to certain, but not all, investors, are 

there any operational concerns with 

reflecting and describing those offsets, 

rebates, or waivers in the fund-wide 

numbers presented in the quarterly 

statement? Are there alternatives we 

should use? 

• Should we require advisers to 

disclose the amount of any offsets or 

rebates carried forward during the 

reporting period to subsequent periods 

to reduce future adviser compensation 

as proposed? Would this information be 

helpful for investors? Do advisers 

already provide this information in the 

fund’s financial statements or 

otherwise? 

• Should we require advisers to 

provide any additional disclosures 

regarding fees and expenses in the 

quarterly statement? In particular, 

should we require any disclosures from 

an investment adviser’s Form ADV Part 

2A narrative brochure (if applicable) to 

be included in the quarterly statement, 

such as more details about an 

investment adviser’s fees? 

• Should we tailor the disclosure 

requirements based on fund type? For 

example, should the requirements or 

format for hedge funds differ from the 

requirements and format for private 

equity funds? Are there unique fees or 

expenses for types of funds that advisers 

should be required to disclose or 

otherwise list as a separate line item? If 

so, how should we define these types of 

funds for these purposes? For example, 

should we use the definitions of such 

terms used on Form ADV? 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16896 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

47Management fee waiver arrangements often 

provide certain economic benefits for the adviser, 

such as the possibility of reducing and/or deferring 

certain tax obligations. 

48See proposed rule 211(h)(1)–1 (defining 

‘‘covered portfolio investment’’ as a portfolio 

investment that allocated or paid the investment 

adviser or its related persons portfolio investment 

compensation during the reporting period). 

49See proposed rule 211(h)(1)–1 (defining 

‘‘portfolio investment compensation’’ as any 

compensation, fees, and other amounts allocated or 

paid to the investment adviser or any of its related 

persons by the portfolio investment attributable to 

the private fund’s interest in such portfolio 

investment). 

50Proposed rule 211(h)(1)–2(c). 

51Proposed rule 211(h)(1)–1. 

52Certain investment strategies can involve 

complex transactions and the use of negotiated 

instruments or contracts, such as derivatives, with 

counterparties. Although such trading involves a 

risk that a counterparty will not settle a transaction 

or otherwise fail to perform its obligations under 

the instrument or contract and thus result in losses 

to the fund, we would generally not consider the 

fund to have made an investment in the 

counterparty in this context. We believe this 

approach is appropriate because any gain or loss 

from the investment generally would be tied to the 

performance of the derivative and the underlying 

reference security, rather than the performance of 

the counterparty. 

53See proposed rule 211(h)(1)–1 (defining 

‘‘covered portfolio investment’’). 

• Do any of the proposed 

requirements impose unnecessary costs 

or compliance challenges? Please 

provide specific data. Are there any 

modifications to the proposal that we 

could make that would lower those 

costs or mitigate those challenges? 

Please provide examples. 

• The proposed quarterly statement 

prescribes minimum fee and expense 

information that must be included. 

What are the benefits and drawbacks of 

prescribing the minimum disclosure to 

be included in the quarterly statement 

and otherwise permitting advisers to 

include additional information? Do 

commenters agree that we should allow 

advisers to include additional 

information? Would the inclusion of 

additional information affect whether 

investors review the quarterly 

statement? 

• Certain advisers use management 

fee waivers where the amount of 

management fees paid by the fund to the 

adviser is reduced in exchange for an 

increased interest in fund profits.47

Because fund agreements often 

document such waivers with complex 

and highly technical tax provisions, 

should we provide guidance to assist 

advisers in complying with the 

proposed requirement to describe the 

manner in which they are calculated or 

specify a methodology for such 

calculations? 

• Should we permit advisers to 

exclude expenses from the quarterly 

statement if they are below a certain 

threshold? Alternatively, should we 

permit advisers to group expenses into 

broad categories and disclose them 

under single line item—such as 

‘‘Miscellaneous Expenses’’ or ‘‘Other 

Expenses’’—if the aggregate amount is 

de minimis relative to the fund’s size? 

Why or why not? 

• The proposed rule would require 

the initial quarterly statement for newly 

formed funds to include start-up and 

organizational fees of the fund if they 

were paid during the reporting period. 

Instead, should the proposed rule 

exclude those fees and expenses? 

• Should the table provide fee and 

expense information for any other 

periods? For example, should we 

require advisers to disclose all adviser 

compensation and fund expenses since 

inception (in addition to adviser 

compensation and fund expenses 

allocated or paid during the applicable 

reporting period)? If so, should we 

require since-inception information 

only for certain types of funds, such as 

closed-end private funds, and not for 

other types of funds, such as open-end 

private funds? 

• We recognize that certain private 

fund advisers may already provide 

quarterly account or similar statements 

to investors, such as advisers that rely 

on an exemption from certain disclosure 

and recordkeeping requirements 

provided by U.S. Commodity Futures 

Trading Commission regulations at 17 

CFR 4.7. How often are private fund 

advisers separately required to provide 

such quarterly statements, and how 

often do they do so even when not 

required? Would there be any overlap 

between the proposed quarterly 

statement and the existing quarterly 

account or similar statements currently 

prepared by advisers? 

b. Portfolio Investment-Level Disclosure 

The proposed quarterly statement rule 

would require advisers to disclose the 

following information with respect to 

any covered portfolio investment,48 in a 

single table covering all such covered 

portfolio investments: 

(1) A detailed accounting of all 

portfolio investment compensation 

allocated or paid by each covered 

portfolio investment during the 

reporting period; 49 and 

(2) The private fund’s ownership 

percentage of each such covered 

portfolio investment as of the end of the 

reporting period or, if the fund does not 

have an ownership interest in the 

covered portfolio investment, the 

adviser would be required to list zero 

percent as the fund’s ownership 

percentage along with a brief 

description of the fund’s investment in 

such covered portfolio investment.50

The proposed rule defines ‘‘portfolio 

investment’’ as any entity or issuer in 

which the private fund has invested 

directly or indirectly.51 This definition 

is designed to capture any entity or 

issuer in which the private fund holds 

an investment including through 

holding companies, subsidiaries, 

acquisition vehicles, special purpose 

vehicles, and other vehicles through 

which investments are made or 

otherwise held by the private fund.52 As 

a result, the proposed definition may 

capture more than one entity or issuer 

with respect to any single investment 

made by a private fund. For example, if 

a private fund invests directly in a 

holding company that owns two 

subsidiaries, the proposed definition 

would capture all three entities. 

Depending on a private fund’s 

underlying investment structure, an 

adviser may have to determine, in good 

faith, which entity or entities constitute 

the portfolio investment under the 

proposed rule. 

We considered, but are not proposing, 

using the term ‘‘portfolio company,’’ 

rather than ‘‘portfolio investment.’’ We 

believe that the term ‘‘portfolio 

company’’ would be too narrow given 

that some private funds do not invest in 

traditional operating companies. For 

example, certain private funds originate 

loans and invest in credit-related 

instruments, while others invest in more 

bespoke assets such as music royalties, 

aircraft, and tanker vessels. The 

proposed rule would define ‘‘portfolio 

investment’’ to apply to all types of 

private fund investments and structures. 

The proposed definition also is 

designed to remain evergreen, capturing 

new investment structures as they 

continue to evolve. 

We recognize, however, that portfolio 

investments of certain private funds 

may not pay or allocate portfolioinvestment compensation to an adviser 

or its related persons. For example, 

advisers to hedge funds focusing on 

passive investments in public 

companies may be less likely to receive 

portfolio-investment compensation than 

advisers to private equity funds focusing 

on control-oriented investments in 

private companies. Under the proposed 

rule, advisers would only be required to 

disclose information regarding covered 

portfolio investments, which we 

propose to define as portfolio 

investments that allocated or paid the 

investment adviser or its related persons 

portfolio investment compensation 

during the reporting period.53 We 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16897 

54Because advisers often use separate legal 

entities to conduct a single advisory business, the 

proposed rule would capture portfolio investment 

compensation paid to an adviser’s related persons. 

55See proposed rule 211(h)(1)–1 (defining 

‘‘portfolio investment compensation’’). 

56We believe that this information would be 

meaningful for investors regardless of whether the 

private fund has an equity ownership interest or 

another kind of interest in the covered portfolio 

investment. For example, if a private fund’s interest 

in a covered portfolio investment is represented by 

a debt instrument, the amount of portfolioinvestment compensation paid or allocated to the 

adviser may hinder or prevent the covered portfolio 

investment from satisfying its obligations to the 

fund under the debt instrument. 

57Proposed rule 211(h)(1)–2(c)(2). An adviser 

should also list zero percent as the ownership 

percentage if the fund has sold or completely 

written off its ownership interest in the covered 

portfolio investment during the reporting period. 

believe this approach is appropriate 

because the portfolio investment table is 

designed to highlight the scope and 

magnitude of any investment-level 

compensation as well as to improve 

transparency for investors into the 

potential conflicts of interest of the 

adviser and its related persons. If an 

adviser does not receive such 

compensation, we do not believe the 

adviser should have such a reporting 

obligation. Accordingly, the proposed 

rule would not require advisers to list 

any information regarding portfolio 

investments that do not fall within the 

covered portfolio investment definition 

for the applicable reporting period. 

These advisers, however, would need to 

identify portfolio investment payments 

and allocations in order to know 

whether they must provide the 

disclosures under this requirement. 

Portfolio Investment Compensation. 

The proposed rule would require the 

portfolio investment table to show a 

detailed accounting of all portfolio 

investment compensation allocated or 

paid by each covered portfolio 

investment during the reporting period, 

with separate line items for each 

category of allocation of payment 

reflecting the total dollar amount, 

including (though it is not limited to) 

origination, management, consulting, 

monitoring, servicing, transaction, 

administrative, advisory, closing, 

disposition, directors, trustees or similar 

fees or payments by the covered 

portfolio investment to the investment 

adviser or any of its related persons. An 

adviser should disclose the identity of 

each covered portfolio investment to the 

extent necessary for an investor to 

understand the nature of the conflicts 

associated with such payments. 

Similar to the approach taken with 

respect to adviser compensation and 

fund expenses discussed above, the 

proposed rule would require a detailed 

accounting of all portfolio investment 

compensation paid or allocated to the 

adviser and its related persons.54 This 

would require advisers to list each 

specific type of portfolio investment 

compensation, and the corresponding 

dollar amount, as a separate line item. 

We believe that this approach is 

appropriate given that portfolio 

investment compensation can take 

many different forms and often varies 

based on fund type. For example, 

portfolio investments of private credit 

funds may pay the adviser a servicing 

fee for managing a pool of loans held 

directly or indirectly by the fund. 

Portfolio investments of private real 

estate funds may pay the adviser a 

property management fee or a mortgageservicing fee for managing the real estate 

investments held directly or indirectly 

by the fund. 

We believe that this disclosure would 

inform investors about the scope of 

portfolio investment compensation paid 

to the adviser and related persons, and 

could help provide insight into some of 

the conflicts of interest some advisers 

face. For example, in cases where the 

adviser controls the portfolio 

investment, the adviser also generally 

has discretion over whether to charge 

portfolio investment compensation and, 

if so, the rate, timing, method, amount, 

and recipient of such compensation. 

Additionally, where the private fund’s 

governing documents require the 

adviser to offset portfolio investment 

compensation against other revenue 

streams or otherwise provide a rebate to 

investors, this information would also 

help investors monitor the application 

of such offsets or rebates. 

The proposed rule would require the 

adviser to disclose the amount of 

portfolio investment compensation 

attributable to the private fund’s interest 

in the covered portfolio investment.55

Such amount would not reflect the 

portion attributable to any other 

person’s interest in the covered portfolio 

investment. For example, if the private 

fund and another person co-invested in 

the same portfolio investment and the 

portfolio investment paid the private 

fund’s adviser a monitoring fee, the 

table would only list the total dollar 

amount of the monitoring fee 

attributable to the fund’s interest. We 

believe this approach is appropriate 

because it would reflect the amount 

borne by the fund and, by extension, the 

investors. This would be meaningful 

information for investors because the 

amount attributable to the fund’s 

interest typically reduces the value of 

investors’ indirect interest in the 

portfolio investment.56 Subject to the 

requirements of the proposed rule, 

advisers may, but are not required to, 

also list the portion of the fee 

attributable to any other investor’s 

interest in the portfolio investment. 

Similar to the approach discussed 

above with respect to adviser 

compensation and fund expenses, an 

adviser would be required to list the 

amount of portfolio investment 

compensation allocated or paid with 

respect to each covered portfolio 

investment both before and after the 

application of any offsets, rebates, or 

waivers. This would require an adviser 

to present the aggregate dollar amount 

attributable to the fund’s interest before 

and after any such reduction for the 

reporting period. Advisers would be 

required to disclose the amount of any 

portfolio investment compensation they 

initially charge and the amount they 

ultimately retain at the expense of the 

private fund and its investors. As with 

adviser compensation and fund 

expenses, we believe this approach 

would provide investors with sufficient 

detail to validate that portfolio 

investment compensation borne by the 

fund conforms to contractual 

agreements. 

Ownership Percentage. The proposed 

rule would require the portfolio 

investment table to list the fund’s 

ownership percentage of each covered 

portfolio investment that paid or 

allocated portfolio-investment 

compensation to the adviser or its 

related persons during the reporting 

period.57 The adviser would be required 

to determine the fund’s ownership 

percentage as of the end of the reporting 

period. We believe that this information 

would provide investors with helpful 

context of the amount of portfolio 

investment compensation paid or 

allocated to the adviser or its related 

persons relative to the fund’s 

ownership. For example, portfolio 

investment compensation may be 

calculated based on the portfolio 

investment’s total enterprise value or 

other similar metric. We believe that the 

fund’s ownership percentage would 

help private fund investors understand 

and assess the magnitude of such 

compensation, as well as how it affects 

the value of the fund’s investment. 

We recognize that calculating the 

fund’s ownership percentage may be 

difficult in certain circumstances, 

especially for funds that do not make 

equity investments in operating 

companies. For example, a private 

equity secondaries fund may own a 

preferred security or a hybrid 

instrument that entitles the fund to 


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16898 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

priority distributions until it receives a 

certain return on its initial investment. 

A direct lending fund may provide a 

loan to a company that entitles the fund 

to receive interest payments and a 

return of principal. If the fund does not 

have an ownership interest in the 

covered portfolio investment, such as 

when the fund holds a debt instrument, 

the adviser would be required to list 

zero percent as the fund’s ownership 

percentage, along with a brief 

description of the fund’s investment in 

the portfolio investment table, if the 

covered portfolio investment paid or 

allocated portfolio-investment 

compensation to adviser or its related 

persons during the reporting period. 

We request comment on all aspects of 

the proposed content of the portfolio 

investment table, including the 

following items: 

• Would the proposed rule provide 

portfolio investment compensation 

disclosure that is meaningful to 

investors? Should the rule require 

advisers to disclose additional or 

different information in the portfolioinvestment table? Would more 

information about the fees and expenses 

charged to portfolio investments be 

helpful for investors? 

• Should we include any additional 

definitions of terms or phrases for the 

portfolio-investment table? Should we 

omit any definitions we have proposed 

for the portfolio-investment table? 

• Is the proposed definition of 

‘‘portfolio investment’’ clear? Should we 

modify or revise the proposed 

definition? For example, should we 

define ‘‘portfolio investment’’ as any 

person whose securities are beneficially 

owned by the private fund or any 

person in which the private fund owns 

an equity or debt interest? Alternatively, 

should we define ‘‘portfolio 

investment’’ as any underlying 

company, business, platform, issuer, or 

other person in which the private fund 

has made, directly or indirectly, an 

investment? Should we permit advisers 

to determine, in good faith, which entity 

or entities constitute the portfolio 

investment for purposes of the quarterly 

statement rule? For example, a fund of 

funds may indirectly invest in hundreds 

of issuers or entities. Depending on the 

underlying structure, control 

relationship, and reporting, the fund of 

funds’ adviser may have limited 

knowledge regarding such underlying 

entities or issuers. Should we exclude 

such entities or issuers from the 

definition of portfolio investment for 

such advisers? Is there a different 

standard or test we should use? Should 

we require such adviser to conduct a 

reasonable amount of diligence 

consistent with past practice and/or 

industry standards? Why or why not? 

• As discussed above, to the extent a 

private fund enters into a negotiated 

instrument, such as a derivative, with a 

counterparty, we would not consider 

the private fund to have made an 

investment in the counterparty. Do 

commenters agree with this approach? 

Why or why not? Should we adopt a 

different approach for derivatives or 

other similar instruments generally? For 

purposes of determining whether the 

fund has made an investment in an 

issuer or entity, should we only include 

equity investments? Should we exclude 

derivatives? Why or why not? How 

should exchange-traded (i.e., not 

negotiated) derivatives, including swaps 

and options, be treated for purposes of 

the rule? 

• The proposed definition of portfolio 

investment would not distinguish 

among different types of private funds. 

Is our approach in this respect 

appropriate or should we treat certain 

funds differently depending on their 

strategy or fund type? If so, how should 

we reflect that treatment? For example, 

should we modify the definition with 

respect to a real estate fund to reflect 

that such a fund generally invests in real 

estate assets, rather than operating 

companies? Because a secondaries fund 

may indirectly invest in a significant 

number of underlying operating 

companies or other assets, should we 

limit the ‘‘indirect’’ component of the 

definition for such funds (or any other 

funds that may have indirect exposure 

to a significant number of companies or 

assets)? Why or why not? Would 

additional definitions be appropriate or 

useful? Should the proposed rule define 

the term ‘‘entity’’ and/or ‘‘issuer’’? If so, 

how? Should the proposed rule treat 

hedge funds, liquidity funds, and other 

open-end private funds differently than 

private equity funds and other closedend private funds? 

• Should we adopt the approach with 

respect to portfolio-investment 

compensation as proposed? Do 

commenters agree with the scope of the 

proposal? Why or why not? 

• The proposed rule includes nonexhaustive lists of certain types of fees. 

Would this information assist advisers 

in complying with the rule? Should we 

add any additional types? If so, which 

ones and why? 

• Should we require advisers to list 

each type of portfolio-investment 

compensation as a separate line item as 

proposed? Would this level of detail be 

helpful for investors with respect to 

portfolio-investment reporting? Given 

that many funds require a management 

fee offset of all portfolio-investment 

compensation, is this level of detail 

necessary or useful to investors? Should 

we instead require advisers to provide 

aggregate information for each covered 

portfolio investment? 

• Should the rule permit advisers to 

use project or deal names or other 

codes, and if so, what additional 

disclosures are necessary for an investor 

to understand the nature of the 

conflicts? 

• We considered only requiring 

advisers to disclose the amount of 

portfolio investment compensation after 

the application of any offsets, rebates, or 

waivers, rather than before and after. We 

believe the proposed approach would be 

more helpful for investors because 

investors would have greater insight 

into the compensation advisers initially 

charge and the amount they ultimately 

retain at the expense of the private fund 

and its investors. Do commenters agree? 

Why or why not? 

• Would information about a firm’s 

services to portfolio investments be 

helpful for investors? Are there any 

elements of the proposed requirements 

that firms should or should not include? 

If so, which ones and why? 

• We considered requiring advisers to 

disclose the total portfolio-investment 

compensation for the reporting period 

as an aggregate number, rather than 

providing the amount of compensation 

allocated or paid by each covered 

portfolio investment as proposed. 

However, we believe that investmentby-investment information would 

provide investors with greater 

transparency into advisers’ fee and 

expense practices and thus be more 

helpful for investors. Do commenters 

agree? Should we require advisers to 

report a consolidated ‘‘top-line’’ number 

that covers all covered portfolio 

investments? 

• Should we define the term 

‘‘ownership interest’’? If so, how should 

we define it? For purposes of the rule, 

should a private fund be deemed to hold 

an ‘‘ownership interest’’ in a covered 

portfolio investment only to the extent 

the fund has made an equity investment 

in the covered portfolio investment? 

Why or why not? What types of funds 

may not hold an ‘‘ownership interest’’ 

in a covered portfolio investment? 

• The proposed rule would require 

advisers to list the fund’s ownership 

percentage of each covered portfolio 

investment. Because the definition of 

‘‘portfolio investment’’ could capture 

more than one entity, will advisers be 

able to calculate the fund’s ownership 

percentage? Are there any changes to 

the proposed rule text that could 

mitigate this challenge? If a portfolio 

investment captures multiple entities, 


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58Proposed rule 211(h)(1)–2(d). 

59 Id. 

should we require advisers to list the 

fund’s overall ownership of such 

entities? If so, what criteria should 

advisers use to determine a fund’s 

overall ownership? 

• Should we require advisers to 

disclose how they allocate or apportion 

portfolio-investment compensation 

among multiple private funds invested 

in the same covered portfolio 

investment? If so, how should the 

portfolio investment table reflect this 

information? 

• Certain advisers have discretion or 

substantial influence over whether to 

cause a fund’s portfolio investment to 

compensate the adviser or its related 

persons. Should the requirement to 

disclose portfolio-investment 

compensation apply only to advisers 

that have such discretion or authority? 

Should such requirement apply if the 

adviser is entitled to appoint one or 

more directors to the portfolio 

investment’s board of directors or 

similar governing body (if applicable)? 

Is there another standard we should 

require? 

• We recognize that certain private 

funds, such as quantitative and 

algorithmic funds and other similar 

funds, may have thousands of holdings 

and/or transactions during a quarter and 

that those funds typically do not receive 

portfolio investment compensation. 

While the proposed rule would not 

require an adviser to include any 

portfolio investment that did not pay or 

allocate portfolio-investment 

compensation to the adviser or its 

related persons during the reporting 

period in its quarterly statement, these 

advisers would need to consider how to 

identify such portfolio investment’s 

payments and allocations for purposes 

of complying with this disclosure 

requirement. Should the rule provide 

any full or partial exceptions for such 

funds? Should we require investmentlevel disclosure for quantitative, 

algorithmic, and other similar funds 

only where they own above a specified 

threshold percentage of the portfolio 

investment? For example, should such 

funds only be required to provide 

investment-level disclosure where they 

own 25% or more ownership of any 

class of voting shares? Alternatively, 

should we use a lower ownership 

threshold, such as 20%, 10%, or 5%? 

Should we adopt a similar approach for 

all private funds, rather than just 

quantitative, algorithmic, and other 

similar funds? If so, what threshold 

should we apply? For instance, should 

it be 5%? Or 10%? A higher percentage? 

• Should we exclude certain types of 

private funds from these disclosures? If 

so, which funds and how should we 

define them? For example, should we 

exclude private funds that only hold (or 

primarily hold) publicly traded 

securities, such as hedge funds? 

• Should we require layered 

disclosure for the portfolio-investment 

table (i.e., short summaries of certain 

information with references and links to 

other disclosures where interested 

investors can find more information)? 

Would this approach encourage 

investors to ask questions and seek more 

information about the adviser’s 

practices? Are there modifications or 

alternatives we should impose to 

improve the utility of the information 

for private fund investors, such as 

requiring the quarterly statement to 

present information in a tabular format? 

• Are there particular funds that may 

require longer quarterly statements than 

other funds? Please provide data 

regarding the number of funds that have 

covered portfolio investments and, with 

respect to those funds, the number of 

covered portfolio investments per 

private fund. Should the Commission 

take into account the fact that certain 

funds will have more covered portfolio 

investments than other funds? For 

example, should we require funds that 

have more than a specific number of 

covered portfolio investments, such as 

50 or more covered portfolio 

investments, to provide only portfolioinvestment level reporting for a subset 

of their covered portfolio investments, 

such as a specific number of their 

largest holdings during the reporting 

period (e.g., their largest ten, fifteen, or 

twenty holdings)? 

• The proposed rule would require 

advisers to list zero percent as the 

ownership percentage if the fund has 

completely sold or completely written 

off its ownership interest in the covered 

portfolio investment during the 

reporting period. Instead, should we 

require or permit advisers to exclude 

any such portfolio investments from the 

table? Why or why not? 

• The proposed rule would require 

the adviser to disclose the amount of 

portfolio investment compensation 

attributable to the private fund’s interest 

in the covered portfolio investment that 

is paid or allocated to the adviser and 

its related persons. Should we require 

disclosure of portfolio compensation 

paid to other persons (such as coinvestors, joint venture partners, and 

other third parties) to the extent such 

compensation reduces the value of the 

private fund’s interest in the portfolio 

investment? 

c. Calculations and Cross References to 

Organizational and Offering Documents 

The proposed quarterly statement rule 

would require each statement to include 

prominent disclosure regarding the 

manner in which expenses, payments, 

allocations, rebates, waivers, and offsets 

are calculated.58 This would generally 

have the effect of requiring advisers to 

describe, for example, the structure of, 

and the method used to determine, any 

performance-based compensation set 

forth in the statement (such as the 

distribution waterfall, if applicable) and 

the criteria on which each type of 

compensation is based (e.g., whether 

compensation is fixed, based on 

performance over a certain period, or 

based on the value of the fund’s assets). 

We believe that this disclosure would 

assist private fund investors in 

understanding and evaluating the 

adviser’s calculations. 

To facilitate an investor’s ability to 

seek additional information, the 

quarterly statement also must include 

cross references to the relevant sections 

of the private fund’s organizational and 

offering documents that set forth the 

calculation methodology.59 References 

to these disclosures would be valuable 

so that the investor can compare what 

the private fund’s documents state the 

fund (and indirectly the investors) will 

be obligated to pay to what the fund 

(and indirectly the investors) actually 

paid during the reporting period and 

more easily determine the accuracy of 

the charges. For example, including this 

information on the quarterly statement 

would likely enable an investor to 

confirm that the adviser calculated 

advisory fees in accordance with the 

fund’s organizational and offering 

documents and to identify whether the 

adviser deducted or charged incorrect or 

unauthorized amounts. We believe this 

information also would allow the 

investor to assess the effect those fees 

and costs have had on its investment. 

We request comment on the following 

aspects of the proposed rule: 

• Should we allow flexibility in the 

words advisers use, as proposed, or 

should we require advisers to include 

prescribed wording in disclosing 

calculation methodology? If the latter, 

what prescribed wording would be 

helpful for investors? Does the narrative 

style work or are there other 

presentation formats that we should 

require? 

• Should we provide additional 

guidance or specify additional 

requirements regarding what type of 


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16900 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

60Proposed rule 211(h)(1)–2(e)(2). For example, 

the proposed rule would require an adviser to an 

illiquid fund to show gross internal rate of return 

with the same prominence as net internal rate of 

return. Similarly, the proposed rule would require 

an adviser to a liquid fund to show the annual net 

total return for each calendar year with the same 

prominence as the cumulative net total return for 

the current calendar year as of the end of the most 

recent calendar quarter covered by the quarterly 

statement. 

61See Investment Adviser Marketing, Investment 

Advisers Act Release No. 5653 (Dec. 22, 2021) 

(‘‘Marketing Release’’), at section II.A.2.a.iv (noting 

that the definition of ‘‘advertisement’’ includes a 

communication to a current investor that offers new 

or additional advisory services with regard to 

securities, provided that the communication 

otherwise satisfies the definition of 

‘‘advertisement.’’). 

62The marketing rule and its specific protections 

would generally not apply in the context of a 

quarterly statement. See Marketing Release, supra 

footnote 61, at sections II.A.2.a.iv and II.A.4. The 

compliance date for the Marketing Rule is 

November 4, 2022. 

63See infra section II.A.2.b. (Performance 

Disclosure: Illiquid Funds). 

64Private funds can have various types of 

complicated structures and involve complex 

financing mechanisms. As a result, an adviser may 

need to make certain assumptions when calculating 

performance for private funds, specifically illiquid 

funds. 

65See David Snow, Private Equity: A Brief 

Overview: An introduction to the fundamentals of 

an expanding, global industry, PEI Media (2007), at 

11 (discussing variations on private equity 

performance metrics). 

disclosure generally should or must be 

included to describe the manner in 

which expenses, payments, allocations, 

rebates, waivers, and offsets are 

calculated? For example, should we 

provide sample disclosures describing 

various calculations? Should the rule 

require advisers to restate disclosures 

from offering memoranda (if applicable) 

regarding the manner in which 

expenses, payments, allocations, 

rebates, waivers, and offsets are 

calculated in the quarterly statement? 

Do commenters believe that advisers 

would prefer to restate offering 

memoranda disclosures rather than 

drafting new disclosures to avoid 

conflicting interpretations of potentially 

complex fund terms? Should the rule 

only require advisers to provide a cross 

reference to the language in the fund’s 

governing documents regarding this 

information (e.g., identifying the 

relevant document and page or section 

numbers)? 

• Would providing cross references, 

as proposed, to the relevant sections of 

the private fund’s organizational and 

offering documents be helpful for 

investors? Would it permit investors to 

‘‘cross check’’ or evaluate the adviser’s 

calculations? Are there other 

alternatives that would achieve our 

objectives? 

2. Performance Disclosure 

In addition to providing information 

regarding fees and expenses, the 

proposed rule would require an adviser 

to include standardized fund 

performance information in each 

quarterly statement provided to fund 

investors. The proposed rule would 

require an adviser to a liquid fund (as 

defined below) to show performance 

based on net total return on an annual 

basis since the fund’s inception, over 

prescribed time periods, and on a 

quarterly basis for the current year. For 

illiquid funds (also defined below), the 

proposed rule would require an adviser 

to show performance based on the 

internal rate of return and a multiple of 

invested capital. The proposed rule 

would require an adviser to display the 

different categories of required 

performance information with equal 

prominence.60

It is essential that quarterly statements 

include performance in order to enable 

investors to compare private fund 

investments and comprehensively 

understand their existing investments 

and determine what to do holistically 

with their overall investment portfolio. 

A quarterly statement that includes fee, 

expense, and performance information 

would allow investors to monitor for 

abnormalities and better understand the 

impact of fees and expenses on their 

investments. For example, a quarterly 

statement that includes fee and expense, 

but not performance, information would 

not allow an investor to perform a costbenefit analysis to determine whether to 

retain the current investment or 

consider other options or, for an 

investor in an illiquid fund, to 

determine whether to invest in other 

private funds managed by the same 

adviser. In addition, current clients or 

investors may use fee, expense, and 

performance information about their 

current investments to inform their 

overall investment decisions (e.g., 

whether to diversify) and their view of 

the market. 

Although there are commonalities 

between the performance reporting 

elements of the proposed rule and the 

performance elements of our recently 

adopted marketing rule, the two rules 

satisfy somewhat different policy goals. 

Our experience has led us to believe 

that, while all clients and investors 

should be protected against misleading, 

deceptive, and confusing information, 

as is the policy goal of the marketing 

rule,61 the needs of current clients and 

investors often differ in some respects 

from the needs of prospective clients 

and investors, as detailed below. 

Current investors should receive 

performance reporting that allows them 

to evaluate an investment alongside 

corresponding fee and expense 

information. Current investors also 

should receive performance reporting 

that is provided at timely, predictable 

intervals so that an investor can monitor 

and evaluate its investment progress 

over time, remain abreast of changes, 

compare information from quarter to 

quarter, and take action where 

possible.62

Currently, there are various 

approaches to report private fund 

performance to fund investors, often 

depending on the type of private fund 

(e.g., the fund’s strategy, structure, target 

asset class, investment horizon, or 

liquidity profile). Certain of these 

approaches may be misleading without 

the benefit of well-disclosed 

assumptions, and others may lead to 

investor confusion. For example, an 

adviser showing internal rate of return 

with the impact of fund-level 

subscription facilities could mislead 

investors because that method of 

calculation would artificially increase 

performance metrics.63 An adviser 

showing private fund performance as 

compared to a public market equivalent 

(‘‘PME’’) in a case where the private 

fund does not have an appropriate 

benchmark could mislead investors to 

believe that the private fund 

performance will meet or exceed the 

performance of the PME. Certain 

investors may also mistakenly believe 

that their private fund investment has a 

liquidity profile that is similar to an 

investment in the PME or an index that 

is similar to the PME. 

Without standardized performance 

metrics (and adequate disclosure of the 

criteria used and assumptions made in 

calculating the performance),64

investors cannot compare their various 

private fund investments managed by 

the same adviser nor can they gauge the 

value of an adviser’s investment 

management services by comparing the 

performance of private funds advised by 

different advisers.65 Standardized 

performance information would help an 

investor decide whether to continue to 

invest in the private fund, if redemption 

is possible, as well as more holistically 

to make decisions about other 

components of the investor’s portfolio. 

Furthermore, we believe that proposing 

to require advisers to show performance 

information alongside fee and expense 

information as part of the quarterly 

statement would paint a more complete 

picture of an investor’s private fund 

investment. This would particularly 

provide context for investors that are 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16901 

66Private fund investors increasingly request 

additional disclosure regarding private fund 

performance, including transparency into the 

calculation of the performance metrics. See, e.g., 

GPs feel the strain as LPs push for more 

transparency on portfolio performance and fee 

structures, Intertrust Group (July 6, 2020), available 

at https://www.intertrustgroup.com/news/gps-feelthe-strain-as-lps-push-for-more-transparency-onportfolio-performance-and-fee-structures/; ILPA 

Principals 3.0, at 36 ‘‘Financial and Performance 

Reporting’’ and ‘‘Fund Marketing Materials,’’ 

available at https://ilpa.org/wp-content/flash/ 

ILPA%20Principles%203.0/?page=36. 

67See 17 CFR 275.206(4)–1 (rule 206(4)–1). A 

communication to a current investor is an 

‘‘advertisement’’ when it offers new or additional 

investment advisory services with regard to 

securities. 

68This would include the anti-fraud provisions of 

section 206 of the Advisers Act, rule 206(4)–8 under 

the Advisers Act, section 17(a) of the Securities Act, 

and section 10(b) of the Exchange Act (and 17 CFR 

240.10b–5 (rule 10b–5 thereunder)), to the extent 

relevant. 

69Proposed rule 211(h)(1)–2(e)(1). The proposed 

rule does not require the adviser to revisit the 

determination periodically; however, advisers 

should generally consider whether they are 

providing accurate information to investors and 

whether they need to revisit the liquid/illiquid 

determination based on changes in the fund. 

70Proposed rule 211(h)(1)–1 (defining ‘‘illiquid 

fund’’). 

71See GAAP ASC 946–205–50–23/24. 

72Proposed rule 211(h)(1)–1 (defining ‘‘liquid 

fund’’). 

paying performance-based 

compensation and would help investors 

understand the true cost of investing in 

the private fund. This proposed 

performance reporting would also 

provide greater transparency into how 

private fund performance is calculated, 

improving an investor’s ability to 

interpret performance results.66

The proposed rule recognizes the 

need for different performance metrics 

for private funds based on certain fund 

characteristics, but also imposes a 

general framework to ensure there is 

sufficient standardization in order to 

provide useful, comparable information 

to investors. An adviser would remain 

free to include other performance 

metrics in the quarterly statement as 

long as the quarterly statement presents 

the performance metrics prescribed by 

the proposed rule and complies with the 

other requirements in the proposed rule. 

However, advisers that choose to 

include additional information should 

consider what other rules and 

regulations might apply. For example, 

although we would not consider 

information in the quarterly statement 

required by the proposed rule to be an 

‘‘advertisement’’ under the marketing 

rule, an adviser that offers new or 

additional investment advisory services 

with regard to securities in the quarterly 

statement would need to consider 

whether such information would be 

subject to the marketing rule.67 An 

adviser would also need to consider 

whether performance information 

presented outside of the required 

quarterly statement, even if it contains 

some of the same information as the 

quarterly statement, would be subject to, 

and meet the requirements of, the 

marketing rule. Regardless, the quarterly 

statement would be subject to the antifraud provisions of the Federal 

securities laws.68

Liquid v. Illiquid Fund Determination 

The proposed performance disclosure 

requirements of the quarterly statement 

rule would require an adviser first to 

determine whether its private fund 

client is an illiquid or liquid fund, as 

defined in the proposed rule, no later 

than the time the adviser sends the 

initial quarterly statement.69 The 

adviser would then be required to 

present certain performance information 

depending on this categorization. The 

purpose of these definitions is to 

distinguish which of the two particular 

performance reporting methods would 

apply and is most appropriate, resulting 

in a more accurate portrayal of the 

fund’s returns over time and allowing 

for more standardized comparisons of 

the performance of similar funds. 

We propose to define an illiquid fund 

as a private fund that: (i) Has a limited 

life; (ii) does not continuously raise 

capital; (iii) is not required to redeem 

interests upon an investor’s request; (iv) 

has as a predominant operating strategy 

the return of the proceeds from 

disposition of investments to investors; 

(v) has limited opportunities, if any, for 

investors to withdraw before 

termination of the fund; and (vi) does 

not routinely acquire (directly or 

indirectly) as part of its investment 

strategy market-traded securities and 

derivative instruments.70 We believe 

these factors are consistent with the 

characteristics of illiquid funds and 

these factors would align with the 

current factors for determining how 

certain types of private funds should 

report performance under U.S. 

Generally Accepted Accounting 

Principles (‘‘U.S. GAAP’’).71

Private funds that fall into the 

proposed ‘‘illiquid fund’’ definition are 

generally closed-end funds that do not 

offer periodic redemption options, other 

than in exceptional circumstances, such 

as in response to regulatory events. 

They also do not invest in publicly 

traded securities, except for investing a 

de minimis amount of liquid assets. We 

believe that many private equity, real 

estate, and venture capital funds would 

fall into the illiquid fund definition, and 

therefore, the proposed rule would 

require advisers to these types of funds 

to provide performance metrics that 

recognize their unique characteristics, 

such as irregular cash flows, which 

otherwise make measuring performance 

difficult for both advisers and investors 

as discussed below. 

We propose to define a ‘‘liquid fund’’ 

as any private fund that is not an 

illiquid fund.72 Private funds that fall 

into the ‘‘liquid fund’’ definition 

generally allow periodic investor 

redemptions, such as monthly, 

quarterly, or semi-annually. They also 

primarily invest in market-traded 

securities, except for a de minimis 

amount of illiquid assets, and therefore 

determine their net asset value on a 

regular basis. Most hedge funds would 

likely fall into the liquid fund 

definition, and therefore, the proposed 

rule would require advisers to these 

types of funds to provide performance 

metrics that show the year-over-year 

return using the market value of the 

underlying assets. We acknowledge, 

however, that there could be 

circumstances where an adviser would 

determine a hedge fund is an illiquid 

fund because it holds less liquid 

investments or has limited investors’ 

ability to redeem some or all of their 

interests in the fund. We also recognize 

that some private funds may not neatly 

fit into the liquid or illiquid 

designations. For example, a hybrid 

fund is a type of private fund that can 

have characteristics of both liquid and 

illiquid funds, and whether the fund is 

treated as a liquid or illiquid fund under 

the rule would depend on the facts and 

circumstances. 

In any case, the proposed rule would 

require advisers to provide performance 

reporting for each private fund as part 

of the fund’s quarterly statement. The 

determination of whether a fund is 

liquid or illiquid dictates the type of 

performance reporting that must be 

included and, because it would result in 

funds with similar characteristics 

presenting the same type of performance 

metrics, we believe this approach would 

improve comparability of private fund 

performance reporting for fund 

investors. As indicated below, we 

welcome comment on whether these 

definitions lead to meaningful 

performance reporting for different 

types of private funds in light of the 

myriad fund strategies and structures. 

We request comment on the following 

aspects of the proposed performance 

disclosure requirement: 

• Should the proposed rule require 

advisers to include performance 


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16902 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

73 If a private fund’s inception date were other 

than on the first day of a calendar year, the private 

fund would show performance for a stub period and 

then show calendar year performance. For example, 

if the four-year period ended on October 31, 2021, 

and the fund’s inception date was August 31, 2017, 

the fund would show full calendar year 

performance for 2018, 2019, and 2020, and partial 

year performance in 2017. 

74Proposed rule 211(h)(1)–2(e)(2)(i)(B). 

information in investor quarterly 

statements? Why or why not? 

• Should the proposed rule require 

advisers to determine whether a private 

fund is a liquid or illiquid fund and 

provide performance metrics based on 

that determination? Alternatively, 

should the rule eliminate the definitions 

and give advisers discretion to provide 

the proposed performance metrics that 

they believe most accurately portray the 

fund’s returns? 

• Should we define ‘‘illiquid fund’’ 

and ‘‘liquid fund’’ as proposed or are 

there alternative definitions we should 

use? Are there other terms we should 

use for these purposes? For example, 

should we refer to the types of funds 

that would provide annual net total 

returns under the rule as ‘‘annual return 

funds’’ and those that would provide 

internal rates of return (IRR) and a 

multiple of invested cash (MOIC) under 

the rule as ‘‘IRR/MOIC funds’’? 

• Are the six factors used in the 

definition of ‘‘illiquid fund’’ sufficient 

to capture most funds for which an 

annual net total return is not an 

appropriate measure of performance? 

Are there any factors we should add? 

For example, should we add a factor 

regarding whether the fund produces 

irregular cash flows or whether the fund 

takes into account unrealized gains 

when calculating performance-based 

compensation? Should we add as a 

factor whether the private fund pays 

carried interest? Are there factors we 

should eliminate? 

• Should we define additional terms 

or phrases used within the definition of 

‘‘illiquid fund,’’ such as ‘‘has as a 

predominant operating strategy the 

return of the proceeds from disposition 

of investments to investors’’? Would 

this characteristic carve out certain 

funds, such as real estate funds and 

credit funds, for which we generally 

believe internal rates of return and a 

multiple of invested capital are the 

appropriate performance measures? If 

so, why? Should we eliminate or modify 

this characteristic in the definition of 

‘‘illiquid fund’’? 

• Should the proposed rule define a 

‘‘liquid fund’’ based on certain 

characteristics? If so, what 

characteristics? For example, should we 

define it as a private fund that requires 

investors to contribute all, or 

substantially all, of their capital at the 

time of investment, and invests no more 

than a de minimis amount of assets in 

illiquid investments? If so, how should 

we define ‘‘illiquid investments’’? Are 

there other characteristics relating to 

redemptions, cash flows, or tax 

treatment that we should use to define 

the types of funds that should provide 

annual net total return metrics? 

• Will advisers be able to determine 

whether a private fund it manages is a 

liquid or illiquid fund? For example, 

how would an adviser classify certain 

types of hybrid funds under the 

proposed rule? Should the rule include 

a third category of funds for hybrid or 

other funds? If so, what definition 

should we use? Should we amend the 

proposed definitions if we adopt a third 

category of funds (e.g., should we revise 

the definition of ‘‘liquid fund’’ given 

that the proposal defines ‘‘liquid fund’’ 

as any private fund that is not an 

illiquid fund)? If a fund falls within the 

third category, should the rule require 

or permit the private fund to provide 

performance metrics that most 

accurately portray the fund’s returns? 

• Are there scenarios in which an 

adviser might initially classify a fund as 

illiquid, but the fund later transitions to 

a liquid fund (or vice versa)? Should we 

provide additional flexibility in these 

circumstances? Should the proposed 

rule require advisers to revisit 

periodically their determination of a 

fund’s liquidity status? For example, 

should the proposed rule require 

advisers to revisit the liquid/illiquid 

determination annually, semi-annually, 

or quarterly? 

• How would an adviser to a private 

fund with an illiquid side pocket 

classify the private fund under the 

proposed rule’s definitions for liquid 

and illiquid funds? For example, would 

the adviser treat the entire private fund 

as illiquid because of the side pocket? 

Why or why not? Should we permit or 

require the adviser to classify the side 

pocket as an illiquid fund, with the 

remaining portion of the private fund 

classified as a liquid fund? 

• Instead of requiring advisers to 

show performance with equal 

prominence, should the proposed rule 

instead allow advisers to feature certain 

performance with greater prominence 

than other performance as long as all of 

the information is included in the 

quarterly statement? Why or why not? 

a. Liquid Funds 

The proposed rule would require 

advisers to liquid funds to disclose 

performance information in quarterly 

statements for the following periods. 

First, an adviser to a liquid fund would 

be required to disclose the liquid fund’s 

annual net total returns for each 

calendar year since inception. For 

example, a liquid fund that commenced 

operations four calendar years ago 

would show annual net total returns for 

each of the first four years since its 

inception.73 We believe this information 

would provide fund investors with a 

comprehensive overview of the fund’s 

performance over the life of the fund 

and improve an investor’s ability to 

compare the fund’s performance with 

other similar funds. As noted above, 

investors can use performance 

information in connection with fee and 

expense information to analyze the 

value of their private fund investments. 

The proposed requirement would 

prevent advisers from including only 

recent performance results or presenting 

only results or periods with strong 

performance. For similar reasons, it also 

would require an adviser to present 

these various time periods with equal 

prominence. 

Second, the adviser would be 

required to show the liquid fund’s 

average annual net total returns over the 

one-, five-, and ten-calendar year 

periods.74 However, if the private fund 

did not exist for one of these prescribed 

time periods, then the adviser would 

not be required to provide that 

information. Requiring performance 

over these time periods would provide 

investors with standardized 

performance metrics that would reflect 

how the private fund performed during 

different market or economic 

conditions. These time periods would 

provide reference points for private 

fund investors, particularly when 

comparing two or more private fund 

investments, and would provide private 

fund investors with aggregate 

performance information that can serve 

as a helpful summary of the fund’s 

performance. 

Third, the adviser would be required 

to show the liquid fund’s cumulative 

net total return for the current calendar 

year as of the end of the most recent 

calendar quarter covered by the 

quarterly statement. For example, a 

liquid fund that has been in operations 

for four calendar years (beginning on 

January 1) and seven months would 

show the cumulative net total return for 

the current calendar year through the 

end of the second quarter. We believe 

this information would provide fund 

investors with insight into the fund’s 

most recent performance, which 

investors could use to assess the fund’s 

performance during current market 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16903 

75See Form N–1A. This form requires registered 

investment companies to report to investors and file 

with the SEC documents containing the fund’s 

annual total returns by calendar year and the 

highest and lowest returns for a calendar quarter, 

among other performance information. 

76See infra section II.A.2.c (Prominent Disclosure 

of Performance Calculation Information). 

77See Form N–1A, Item 26(b). 78Proposed rule 211(h)(1)–2(e)(2)(ii). 

79Proposed rule 211(h)(1)–2(e)(2)(iii). 

80As discussed below, the proposed rule would 

also require advisers to prominently disclose the 

criteria used, and assumptions made, in calculating 

performance. This would include the criteria and 

assumptions used to prepare an illiquid fund’s 

unlevered performance measures. 

81We recognize that fund-level subscription 

facilities can be an important cash management tool 

for both advisers and investors. For example, a fund 

may use a subscription facility to reduce the overall 

number of capital calls and to enhance its ability 

to execute deals quickly and efficiently. 

conditions. This quarterly performance 

information also would provide helpful 

context for reviewing and monitoring 

the fees and expenses borne by the fund 

during the quarter, which the quarterly 

statement would disclose. 

We believe these performance metrics 

would allow investors to assess these 

funds’ performance because they 

ordinarily invest in market-traded 

securities, which are primarily liquid. 

As a result, liquid funds generally are 

able to determine their net asset value 

on a regular basis and compute the yearover-year return using the market-based 

value of the underlying assets. We have 

taken a similar approach with regard to 

registered funds, which also invest a 

substantial amount of their assets in 

primarily liquid underlying holdings 

(e.g., publicly traded securities).75 As a 

result, liquid funds, like registered 

funds, currently generally report 

performance on an annual and quarterly 

basis. Investors in a private fund that is 

a liquid fund would similarly find this 

information helpful. Most traditional 

hedge funds would likely fall into the 

liquid bucket and would need to 

provide disclosures regarding the 

underlying assumptions of the 

performance (e.g., whether dividends or 

other distributions are reinvested).76

We request comment on the following 

with respect to the proposed liquid fund 

performance requirement: 

• Should we require advisers to 

provide annual net total returns for 

liquid funds, as proposed? Would 

showing annual net total returns for 

each calendar year since a private fund’s 

inception be overly burdensome for 

older funds? Would performance 

information that is more than 10 years 

old be useful to investors? Why or why 

not? 

• Should the proposed rule define 

‘‘annual net total return’’ or specify the 

format in which advisers must present 

the annual net total returns? Should the 

proposed rule specify how advisers 

should calculate the annual net total 

return, similar to Form N–1A? 77

• The proposed rule would require 

advisers to provide performance 

information for each calendar year since 

inception and over prescribed time 

periods (one-, five-, and ten-year 

periods). Should the proposed rule 

instead only require an adviser to satisfy 

one of these requirements (i.e., provide 

performance each calendar year since 

inception or provide performance over 

the prescribed time periods)? For funds 

that have not been in existence for one 

of the prescribed time periods, should 

the proposed rule require the adviser to 

show the average annual net total return 

since inception, instead of the 

prescribed time period? 

• The proposed rule would require 

advisers to provide average annual net 

total returns for the private fund over 

the one-, five-, and ten-calendar year 

periods. However, the proposal would 

not prohibit advisers from providing 

additional information. Should we 

allow advisers to provide performance 

information for annual periods other 

than calendar years? 

• Should the proposed rule define 

‘‘average annual net total return’’ or 

specify the format in which advisers 

must present the average annual net 

total returns? 

• The proposed rule would require an 

adviser to provide ‘‘the cumulative net 

total return for the current calendar 

year.’’ Instead of using the word 

‘‘cumulative’’ net total return, should 

the rule use the phrase ‘‘year to date’’ 

net total return? 

• To the extent certain liquid funds 

quote yields rather than returns, should 

such funds be required or permitted to 

quote yields in addition to or instead of 

returns? 

b. Illiquid Funds 

The proposed rule would require 

advisers to illiquid funds to disclose the 

following performance measures in the 

quarterly statement, shown since 

inception of the illiquid fund and 

computed without the impact of any 

fund-level subscription facilities: 

(i) Gross internal rate of return and 

gross multiple of invested capital for the 

illiquid fund; 

(ii) Net internal rate of return and net 

multiple of invested capital for the 

illiquid fund; and 

(iii) Gross internal rate of return and 

gross multiple of invested capital for the 

realized and unrealized portions of the 

illiquid fund’s portfolio, with the 

realized and unrealized performance 

shown separately. 

The proposed rule also would require 

advisers to provide investors with a 

statement of contributions and 

distributions for the illiquid fund.78

Since Inception. The proposed rule 

would require an adviser to disclose the 

illiquid fund’s performance measures 

since inception. This proposed 

requirement would prevent advisers 

from including only recent performance 

results or presenting only results or 

periods with strong performance, which 

could mislead investors. We propose to 

require this for all illiquid fund 

performance measures under the 

proposed rule, including the measures 

for the realized and unrealized portions 

of the illiquid fund’s portfolio. 

The proposed rule would require an 

adviser to include performance 

measures for the illiquid fund through 

the end of the quarter covered by the 

quarterly statement. We recognize, 

however, that certain funds may need 

information from portfolio investments 

and other third parties to generate 

performance data and thus may not 

have the necessary information prior to 

the distribution of the quarterly 

statement. Accordingly, to the extent 

quarter-end numbers are not available at 

the time of distribution of the quarterly 

statement, an adviser would be required 

to include performance measures 

through the most recent practicable 

date, which we generally believe would 

be through the end of the quarter 

immediately preceding the quarter 

covered by the quarterly statement. The 

proposed rule would require the 

quarterly statement to reference the date 

the performance information is current 

through (e.g., December 31, 2021).79

Computed Without the Impact of 

Fund-Level Subscription Facilities. The 

proposed rule would require advisers to 

calculate performance measures for each 

illiquid fund as if the private fund 

called investor capital, rather than 

drawing down on fund-level 

subscription facilities.80 Such facilities 

enable the fund to use loan proceeds— 

rather than investor capital—to initially 

fund investments and pay expenses. 

This practice permits the fund to delay 

the calling of capital from investors, 

which has the potential to increase 

performance metrics artificially. 

Many advisers currently provide 

performance figures that reflect the 

impact of fund-level subscription 

facilities. These ‘‘levered’’ performance 

figures often do not reflect the fund’s 

actual performance and have the 

potential to mislead investors.81 For 


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16904 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

82Proposed rule 211(h)(1)–1. The proposed rule 

defines ‘‘unfunded capital commitments’’ as 

committed capital that has not yet been contributed 

to the private fund by investors, and ‘‘committed 

capital’’ as any commitment pursuant to which a 

person is obligated to acquire an interest in, or 

make capital contributions to, the private fund. See 

id. 

83We recognize that a private fund may guarantee 

portfolio investment indebtedness. In such a 

situation, if the portfolio investment does not have 

sufficient cash flow to pay its debt obligations, the 

fund may be required to cover the shortfall to 

satisfy its guarantee. Even though investors’ 

unfunded commitments may indirectly support the 

fund’s guarantee, the proposed definition would not 

cover such fund guarantees. Unlike fund-level 

subscription facilities, such guarantees generally are 

not put in place to enable the fund to delay the 

calling of investor capital. 

84The proposed rule nevertheless would require 

advisers to reflect the fees and expenses associated 

with the subscription facility in the quarterly 

statement’s fee and expense table. 

85For example, multiple of invested capital does 

not factor in the amount of the time it takes for a 

fund to generate a return, and internal rate of return 

assumes early distributions will be reinvested at the 

same rate of return generated at the initial exit. 

86Proposed rule 211(h)(1)–1 (defining ‘‘gross 

IRR’’ and ‘‘net IRR’’). 

87When calculating a fund’s internal rate of 

return, an adviser would need to take into account 

the specific date a cash flow occurred (or is deemed 

to occur). Certain electronic spreadsheet programs 

have ‘‘XIRR’’ or other similar formulas that require 

the user to input the applicable dates. The proposed 

requirement that an illiquid fund present its 

performance using an internal rate of return aligns 

with the U.S. GAAP criteria used to determine 

when a private fund must present performance 

using an internal rate of return in its audited 

financial statements. See U.S. GAAP ASC 946–205– 

50–23/24. 

88Proposed rule 211(h)(1)–1 (defining ‘‘gross 

MOIC’’ and ‘‘net MOIC’’). 

89See, e.g., IRR Function, available at https://

support.microsoft.com/en-us/office/irr-function64925eaa-9988-495b-b290-3ad0c163c1bc (noting 

that the internal rate of return is closely related to 

net present value and that the rate of return 

calculated by the internal rate of return is the 

interest rate corresponding to a zero net present 

value). 

90Proposed rule 211(h)(1)–2(e)(2)(ii). 

example, an investor could reasonably 

believe that levered performance results 

are similar to those that the investor has 

achieved from its investment in the 

fund. We believe that unlevered 

performance figures would provide 

investors with more meaningful data 

and improve the comparability of 

returns. 

We propose to define ‘‘fund-level 

subscription facilities’’ as any 

subscription facilities, subscription line 

financing, capital call facilities, capital 

commitment facilities, bridge lines, or 

other indebtedness incurred by the 

private fund that is secured by the 

unfunded capital commitments of the 

private fund’s investors.82 This 

definition is designed to capture the 

various types of subscription facilities 

prevalent in the market that serve as 

temporary replacements or substitutes 

for investor capital.83

We would generally interpret the 

phrase computed without the impact of 

fund-level subscription facilities to 

require advisers to exclude fees and 

expenses associated with the 

subscription facility, such as the interest 

expense, when calculating net 

performance figures and preparing the 

statement of contributions and 

distributions. This approach would 

cause the net returns for many funds to 

be higher than would be the case if such 

amounts were included. We believe that 

this approach is appropriate, however, 

because it is consistent with the policy 

goal of this aspect of the proposed rule 

(i.e., requiring advisers to show private 

fund investors the returns the fund 

would have achieved if there were no 

subscription facility).84 We request 

comment below on whether this 

approach is appropriate. 

Fund-Level Performance. The 

proposed rule would require an adviser 

to disclose an illiquid fund’s gross and 

net internal rate of return and gross and 

net multiple of invested capital for the 

illiquid fund. The proposed rule also 

would require an adviser to provide a 

statement of contributions and 

distributions for the illiquid fund 

reflecting the aggregate cash inflows 

from investors and the aggregate cash 

outflows from the fund to investors, 

along with the fund’s net asset value. 

We recognize that illiquid funds have 

unique characteristics, such as irregular 

cash flows, that make measuring 

performance difficult for both advisers 

and investors. We also recognize that 

internal rate of return and multiple of 

invested capital, each as discussed 

below, have their drawbacks as 

performance metrics.85 We believe, 

however, that these metrics, combined 

with a statement of contributions and 

distributions reflecting cash flows, 

would help investors holistically 

understand the fund’s performance, 

allow investors to diligence the fund’s 

performance, and calculate other 

performance metrics they may find 

helpful. When presented in accordance 

with the conditions and other 

disclosures required under the proposed 

rule, such standardized reporting 

measures would provide meaningful 

performance information for investors, 

allowing them to compare returns 

among funds and also to make moreinformed decisions. 

We propose to define ‘‘internal rate of 

return’’ as the discount rate that causes 

the net present value of all cash flows 

throughout the life of the private fund 

to be equal to zero.86 Cash flows would 

be represented by capital contributions 

(i.e., cash inflows) and fund 

distributions (i.e., cash outflows), and 

the unrealized value of the fund would 

be represented by a fund distribution 

(i.e., a cash outflow). This definition 

would provide investors with a timeadjusted return that takes into account 

the size and timing of a fund’s cash 

flows and its unrealized value at the 

time of calculation.87

We propose to define ‘‘multiple of 

invested capital’’ as (i) the sum of: (A) 

The unrealized value of the illiquid 

fund; and (B) the value of all 

distributions made by the illiquid fund; 

(ii) divided by the total capital 

contributed to the illiquid fund by its 

investors.88 This definition is intended 

to provide investors with a measure of 

the fund’s aggregate value (i.e., the sum 

of clauses (i)(A) and (i)(B)) relative to 

the capital invested (i.e., clause (ii)) as 

of the end of the applicable reporting 

period. Unlike the definition of internal 

rate of return, the multiple of invested 

capital definition would not take into 

account the amount of time it takes for 

a fund to generate a return (meaning 

that the multiple of invested capital 

measure would focus on ‘‘how much’’ 

rather than ‘‘when’’). 

We believe that the proposed 

definitions of internal rate of return and 

multiple of invested capital are 

generally consistent with how the 

industry currently calculates such 

performance metrics. For example, most 

advisers use electronic spreadsheet 

programs to calculate a fund’s internal 

rate of return. Such programs typically 

calculate the internal rate of return as 

the interest rate for an investment 

consisting of payments (cash outflows) 

and income (cash inflows) received over 

a period.89 However, we have observed 

certain advisers deviate from standard 

formulas, or make various assumptions, 

when calculating a private fund’s 

performance. Accordingly, we believe 

that prescribing definitions would 

decrease the risk of different advisers 

presenting internal rate of return and 

multiple of invested capital 

performance figures that are not 

comparable. Both definitions are 

designed to limit any deviations in 

calculating the standardized 

performance prescribed by the proposed 

rule. We believe that this approach is 

appropriate because it would provide a 

degree of standardization and provide 

investors with the relevant information 

to compare performance. 

An adviser would be required to 

present each performance metric on a 

gross and net basis.90 Under the 

proposed rule, an illiquid fund’s gross 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16905 

91See proposed rule 211(h)(1)–1 (defining ‘‘gross 

IRR,’’ ‘‘net IRR,’’ ‘‘gross MOIC,’’ and ‘‘net MOIC’’). 

92Proposed rule 211(h)(1)–1. 

93For example, an adviser would have to 

determine how to allocate fund organizational 

expenses between the realized and unrealized 

portions of the portfolio. 

performance would not reflect the 

deduction of fees, expenses, and 

performance-based compensation borne 

by the private fund.91 We believe that 

presenting both gross and net 

performance measures for the illiquid 

fund would prevent investors from 

being misled. We believe that gross 

performance would provide insight into 

the profitability of underlying 

investments selected by the adviser. 

Solely presenting gross performance, 

however, may imply that investors have 

received the full amount of such 

returns. The net performance would 

assist investors in understanding the 

actual returns received and, when 

presented alongside gross performance, 

the negative effect fees, expenses, and 

performance-based compensation have 

had on past performance. 

The proposed rule also would require 

an adviser to provide a statement of 

contributions and distributions for the 

illiquid fund. We believe this would 

provide private fund investors with 

important information regarding the 

fund’s performance because it would 

reflect the underlying data used by the 

adviser to generate the fund’s returns, 

which, in many cases, is not currently 

provided to private fund investors. Such 

data would allow investors to diligence 

the various performance measures 

presented in the quarterly statement. In 

addition, this data would allow the 

investors to calculate additional 

performance measures based on their 

own preferences. 

We propose to define statement of 

contributions and distributions as a 

document that presents: 

(i) All capital inflows the private fund 

has received from investors and all 

capital outflows the private fund has 

distributed to investors since the private 

fund’s inception, with the value and 

date of each inflow and outflow; and 

(ii) The net asset value of the private 

fund as of the end of the reporting 

period covered by the quarterly 

statement.92

For similar reasons to those discussed 

above, the proposed rule would require 

an adviser to prepare the statement of 

contributions and distributions without 

the impact of any fund-level 

subscription facilities. This would 

require an adviser to assume the private 

fund called investor capital, rather than 

drawing down on fund-level 

subscription facilities. To avoid double 

counting capital inflows, the amount 

borrowed under the subscription facility 

generally should be reflected as a capital 

inflow from investors and an equal 

dollar amount of actual capital inflows 

from investors generally should not be 

reflected on the statement. 

Realized and Unrealized 

Performance. The proposed rule also 

would require an adviser to disclose a 

gross internal rate of return and gross 

multiple of invested capital for the 

realized and unrealized portions of the 

illiquid fund’s portfolio, with the 

realized and unrealized performance 

shown separately. 

The value of the unrealized portion of 

an illiquid fund’s portfolio typically is 

determined by the adviser and, given 

the lack of readily available market 

values, can be challenging. For example, 

an adviser’s valuation policies and 

procedures for illiquid investments may 

rely on models and unobservable 

inputs. This creates a conflict of interest 

because the adviser is typically 

evaluated and, in certain cases, 

compensated based on the fund’s 

unrealized performance. Further, 

investors often decide whether to invest 

in a successor fund based on the 

predecessor fund’s performance. These 

factors create an incentive for the 

adviser to inflate the value of the 

unrealized portion of the illiquid fund’s 

portfolio. We believe highlighting the 

performance of the fund’s unrealized 

investments would assist investors in 

determining whether the aggregate, 

fund-level performance measures 

present an overly optimistic view of the 

fund’s overall performance. For 

example, if the performance of the 

unrealized portion of the fund’s 

portfolio is significantly higher than the 

performance of the realized portion, it 

may imply that the adviser’s valuations 

are overly optimistic or otherwise do 

not reflect the values that can be 

realized in a transaction or sale with an 

independent third party. 

The proposed rule would only require 

an adviser to disclose gross performance 

measures for the realized and unrealized 

portions of the illiquid fund’s portfolio. 

We believe that calculating net figures 

could involve complex and potentially 

subjective assumptions regarding the 

allocation of fund-level fees, expenses, 

and adviser compensation between the 

realized and unrealized portions of the 

portfolio.93 In our view, such 

assumptions would likely diminish the 

benefits net performance measures 

would provide. 

We request comment on the following 

with respect to the proposed illiquid 

fund performance requirement: 

• Are the proposed performance 

metrics appropriate? Why or why not? 

We recognize that advisers often utilize 

different performance metrics for 

different funds. Should we add any 

other metrics to the proposed rule? For 

example, should we require a public 

market equivalent or variations of 

internal rate of return, such as a 

modified internal rate of return that 

assumes cash flows are reinvested at 

modest rates of return or otherwise 

incorporates a cost of capital concept for 

funds that do not draw down all, or 

substantially all, of investor capital at 

the time of investment? If so, should we 

prescribe a benchmark for the cost of 

capital and reinvestment rates? 

• The proposed rule would not 

distinguish among different types of 

illiquid funds. Is our approach in this 

respect appropriate or should we treat 

certain illiquid funds differently? If so, 

how should we reflect that treatment? 

• Are there additional guardrails we 

should add to the proposed rule to 

achieve the policy goal of providing 

investors with comparable performance 

information? If so, please explain. Are 

there practices that advisers use or 

assumptions that advisers make, when 

calculating performance that we should 

require, curtail, or otherwise require 

advisers to disclose? 

• Although some investors receive 

certain annual performance information 

about a private fund if that fund is 

audited and distributes financial 

statements prepared in accordance with 

U.S. GAAP, we believe that the 

proposed rule’s performance 

information would be helpful for private 

fund investors because it would require 

performance information to be reported 

at more frequent intervals in a 

standardized manner. Do commenters 

agree? To the extent there are 

differences (e.g., the requirement that 

performance be computed without the 

impact of any fund-level subscription 

facilities), would investors find this 

confusing? Would disclosure regarding 

these differences help to alleviate 

investor confusion? 

• Would investor confusion or other 

concerns arise from requiring 

performance information in the 

quarterly statement as proposed? 

• What, if any, burdens would be 

associated with this aspect of the 

proposed rule? How can we minimize 

any associated burdens while still 

achieving our goals? 

• Are the proposed definitions 

appropriate and clear? If not, how 

should we clarify the definitions? 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16906 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

94The GIPS standards define ‘‘committed capital’’ 

as pledges of capital to an investment vehicle by 

investors (limited partners and the general partner) 

or the firm. The term ‘‘composite’’ is defined as an 

aggregation of one or more portfolios that are 

managed according to a similar investment 

mandate, objective, or strategy. The term 

cumulative is not defined in the GIPS standards. 

Global Investment Performance Standards (GIPS) 

For Firms: Glossary, CFA Institute (2020), available 

at https://www.cfainstitute.org/-/media/documents/ 

code/gips/2020-gips-standards-firms.pdf. 

95 Internal rate of return is referred to as moneyweighted return in the GIPS standards, and 

multiple of invested capital is referred to as 

investment multiple. 

Should we modify or eliminate any? 

Would additional definitions be 

appropriate or useful? For example, 

should we define any of the terms used 

in the definition of internal rate of 

return, such as ‘‘net present value’’ or 

‘‘discount rate’’? If so, what definitions 

should we use? 

• Are the definitions of gross IRR, 

gross MOIC, net IRR, and net MOIC 

appropriate? Should we provide further 

guidance or specify requirements in the 

proposed rule on how to calculate gross 

performance or net performance? If so, 

what guidance or requirements? Should 

we require advisers to adopt policies 

and procedures prescribing specific 

methodologies for calculating gross 

performance and net performance? Why 

or why not? When calculating net 

performance, are there additional fees 

and expenses that advisers should 

include? Alternatively, should we 

expressly permit advisers to exclude 

certain fees and expenses when 

calculating net performance figures, 

such as taxes incurred to accommodate 

certain, but not all, investor 

preferences? Why or why not? 

• Similarly, are the definitions of 

gross IRR and gross MOIC appropriate 

for purposes of calculating the 

performance metrics of the realized and 

unrealized portions of the illiquid 

fund’s portfolio? Should we modify 

such definitions to reference specifically 

the realized and unrealized portions of 

the portfolio, rather than only 

referencing the illiquid fund? For 

example, should the definition of MOIC 

be revised to mean, as of the end of the 

applicable calendar quarter: (i) The sum 

of (A) the unrealized value of applicable 

portion of the illiquid fund’s portfolio, 

and (b) the value of all distributions 

made by the illiquid fund attributable to 

the applicable portion of the illiquid 

fund’s portfolio; (ii) divided by the total 

capital contributed to the illiquid fund 

by its investors attributable to the 

applicable portion of the illiquid fund’s 

portfolio? Are there other variations we 

should impose? Why or why not? 

• The Global Investment Performance 

Standards (‘‘GIPS’’) are a set of 

voluntary standards for calculating and 

presenting investment performance. For 

purposes of calculating an illiquid 

fund’s performance under the proposed 

rule, are there any elements found in the 

GIPS standards that we should require? 

For example, should we require advisers 

to disclose composite cumulative 

committed capital,94 or should we 

require advisers to disclose performance 

with and without the impact of 

subscription facilities? Are there any 

definitions we should revise or propose 

to be consistent with the definitions 

used in the GIPS standards? For 

example, the GIPS standards define 

‘‘internal rate of return’’ as the return for 

a period that reflects the change in value 

and the timing and size of external cash 

flows and ‘‘multiple of invested capital’’ 

as the total value divided by since 

inception paid-in capital.95 If we were 

to adopt such definitions, do 

commenters believe that such 

definitions would result in different 

performance numbers for illiquid funds, 

as compared to the performance 

numbers that advisers would disclose 

under the proposed definitions? Why or 

why not? Please provide examples. 

• We recognize that advisers and 

their related persons typically invest in 

private funds on a ‘‘fee-free, carry-free’’ 

basis (i.e., they are not required to pay 

management fees or performance-based 

compensation). When calculating a 

fund’s performance, how should such 

interests be taken into account? Should 

we require advisers to exclude such 

interests from the calculations, 

especially the net performance figures? 

• The proposed rule would require 

advisers to calculate the various 

performance measures without the 

impact of any fund-level subscription 

facilities. Do commenters agree with 

this approach? Should the proposed 

rule require advisers to provide the 

same performance measures with the 

impact of fund-level subscription 

facilities? Why or why not? The 

proposed rule does not prohibit advisers 

from providing the same performance 

measures with the impact of fund-level 

subscription facilities. Should we 

prohibit advisers from doing so? 

• Should we define the term 

‘‘computed without the impact of any 

fund-level subscription facilities’’? 

Should we provide additional guidance 

or requirements regarding how advisers 

generally should or must calculate such 

performance measures? If so, what 

guidance or requirements should we 

provide? 

• We recognize that a fund-level 

subscription facility has the potential to 

have a greater impact on a fund’s 

internal rate of return as compared to its 

multiple of invested capital. Should 

advisers only be required to provide 

‘‘unlevered’’ internal rates of return and 

not ‘‘unlevered’’ multiples of invested 

capital? If the fund realizes an 

investment prior to calling any capital 

from investors in respect of such 

investment, how would an adviser 

calculate a multiple for such 

investment? 

• The proposed rule would require 

advisers to prepare the statement of 

contributions and distributions without 

the impact of any fund-level 

subscription facilities. Would this 

information be helpful for investors? 

Would advisers be able to prepare such 

a statement without making arbitrary 

assumptions? Why or why not? For 

example, would advisers need to make 

assumptions in calculating the preferred 

return (if applicable)? 

• The proposed rule would require 

only gross performance measures for the 

realized and unrealized portion of the 

illiquid fund’s portfolio. Should the 

proposed rule require net performance 

information as well? Would net 

performance measures be beneficial for 

investors despite the drawbacks 

discussed above? What assumptions 

should we require in calculating net 

information? What limitations, if any, 

would advisers face in providing net 

performance measures? 

• Should we define the phrases 

‘‘unrealized portion of the illiquid 

fund’s portfolio’’ and ‘‘realized portion 

of the illiquid fund’s portfolio’’? For 

example, should we define the realized 

portion to include not only completely 

realized investments but also 

substantially realized investments to the 

extent the fund’s remaining interest is 

de minimis? Why or why not? 

• Should we require advisers to 

disclose the dollar amounts of the 

realized and unrealized portions of the 

portfolio? Should we also require 

advisers to disclose such amounts as 

percentages? For example, if the value 

of the realized portion of the portfolio 

is $250 million and the value of the 

unrealized portion is $750 million, 

should we require advisers to disclose 

those amounts, both as dollar values 

and percentages (i.e., 25% ($250 

million) of the illiquid fund’s portfolio 

is realized, and 75% ($750 million) 

remains unrealized)? 

• The proposed rule would require 

advisers to provide cumulative 

performance reporting since inception 

of the illiquid fund each quarter. Is this 

the right approach? Should the 

proposed rule require performance since 

inception for each quarter or on an 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16907 

96Proposed rule 211(h)(1)–2(e)(2)(iii). 

97See also Marketing Release, supra at footnote 

61 (discussing clear and prominent disclosures in 

the context of advertisements). 

annual basis? Should the proposed rule 

remove the ‘‘since inception’’ 

requirement for quarterly reports and 

instead require performance for each 

quarter of the current year, and 

cumulative performance for the current 

year? If so, why or why not? 

• Should we prescribe specific 

periods for illiquid fund performance 

reporting? For example, should we 

prescribe one-, five-, and/or ten-year 

time periods? Instead, should we 

require that advisers always present 

performance since inception as 

proposed? Are there other periods for 

which we should require the 

presentation of performance results? Are 

there any specific compliance issues 

that an adviser would face in generating 

and presenting performance results for 

the required period? For example, 

would advisers have the requisite 

information to generate or support 

performance figures for older funds 

from the proposed recordkeeping 

requirements and/or performance 

presentation requirements? If not, 

should we provide an exemption for 

advisers that lack such information? 

• Liquid funds often have longer 

terms than illiquid funds. To the extent 

an illiquid fund has been in existence 

for an extended period of time, such as 

more than ten years, should the rule 

prescribe specific periods for 

performance reporting for such funds 

(e.g., one-, five-, and/or ten-year time 

periods)? 

• Should we require that advisers 

provide performance results current 

through the end of the quarter covered 

by the quarterly statement as proposed? 

In circumstances where quarter-end 

numbers are not available at the time of 

distribution of the quarterly statement, 

should we require an adviser to include 

performance measures through the most 

recent practicable date as proposed? 

Should we define, or provide additional 

guidance about, the term ‘‘most recent 

practicable date’’? If so, what definition 

or additional guidance should we 

provide? 

• Should the proposed rule require 

advisers to make certain, standard 

disclosures tailored to each of the 

performance metrics mandated in the 

proposed rule? For example, should we 

require advisers to illiquid funds that 

are required to display internal rate of 

return to disclose prominently that the 

returns do not represent returns on the 

investor’s capital commitment and 

instead only reflect returns on the 

investor’s contributed capital? Should 

we require advisers to disclose that an 

investor’s actual return on its capital 

commitment will depend on how the 

investor invests its uncalled 

commitments? 

• As noted above, we would generally 

interpret the phrase computed without 

the impact of fund-level subscription 

facilities to require advisers to exclude 

fees and expenses associated with the 

subscription facility, such as the interest 

expense, when calculating net 

performance figures and preparing the 

statement of contributions and 

distributions. Do commenters agree with 

this approach? Should we require 

advisers to include such amounts 

instead? Are there other assumptions 

advisers would need to make in 

calculating performance information 

that the rule should address? 

• The proposed rule would require 

the statement of contributions and 

distributions to reflect the private fund’s 

net asset value as of the end of the 

applicable quarter. Should we require 

advisers to provide additional detail 

regarding the unrealized value of the 

private fund? For example, should we 

require advisers to reflect the portion of 

such net asset value that would be 

required to be paid to the adviser as 

performance-based compensation 

assuming a hypothetical liquidation of 

the fund? 

• The statement of contributions and 

distributions generally reflects 

aggregate, fund-level numbers. Should 

we also require a statement of 

contributions and distributions for each 

underlying investment? Would a 

statement of each investment’s cash 

flows be useful to investors? Why or 

why not? Would such a requirement be 

too burdensome for certain advisers, 

especially advisers to private funds that 

have a significant number of 

investments? Should this requirement 

only apply to certain types of funds, 

such as private equity, venture capital, 

or other similar funds that may invest in 

operating companies? 

• Should we provide further guidance 

or specify requirements on how advisers 

generally should or must present 

performance? For example, should we 

require advisers to present the various 

performance metrics with equal 

prominence as proposed? Should we 

require advisers to present performance 

information in a format designed to 

facilitate comparison? Should we 

provide additional guidance or 

requirements regarding how an adviser 

should or must calculate the proposed 

performance metrics? Is there additional 

information that we should require 

advisers to disclose when presenting 

performance? 

• Should we provide further guidance 

or specify requirements in the rule on 

how advisers generally should or must 

treat taxes for purposes of calculating 

performance? For example, should the 

rule state that advisers may exclude 

taxes paid or withheld with respect to 

a particular investor or by a blocker 

corporation (but not the illiquid fund as 

a whole)? 

c. Prominent Disclosure of Performance 

Calculation Information 

The proposed rule would require 

advisers to include prominent 

disclosure of the criteria used and 

assumptions made in calculating the 

performance. Information about the 

criteria used and assumptions made 

would enable the private fund investor 

to understand how the performance was 

calculated and help provide useful 

context for the presented performance 

metrics. Additionally, while the 

proposed rule includes detailed 

information about the type of 

performance an adviser must present for 

liquid and illiquid funds, it is still 

possible that advisers would make 

certain assumptions or rely on specific 

criteria that the proposed rule’s 

requirements do not address 

specifically. 

For example, the proposed rule would 

require an adviser to display, for a 

liquid fund, the annual returns for each 

calendar year since the fund’s inception. 

If the adviser made any assumptions in 

performing that calculation, such as 

whether dividends were reinvested, the 

adviser should disclose those 

assumptions in the quarterly statement. 

As another example, for an illiquid 

fund, the proposed rule would require 

an adviser to display the net internal 

rate of return and net multiple of 

invested capital. In this case, the adviser 

should disclose the assumed fee rates, 

including whether the adviser is using 

fee rates set forth in the fund 

documents, whether it is using a 

blended rate or weighted average that 

would factor in any discounts, or 

whether it is using a different method 

for calculating net performance. The 

proposed rule requires the disclosure to 

be within the quarterly statement.96

Thus, an adviser may not provide the 

information only in a separate 

document, website hyperlink or QR 

code, or other separate disclosure.97 We 

believe that this information is integral 

to the quarterly statement because it 

would enable the investor to understand 

and analyze the performance 

information better and better compare 

the performance of funds and advisers 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16908 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

98See also ILPA Fee Reporting Template 

Guidance, Version 1.1 (Oct. 2016), at 6 (stating that 

‘‘ILPA recommends that the Template is provided 

on a quarterly basis within a reasonable timeframe 

after the release of standard reports.’’). 

99See proposed rule 211(h)(1)–1 (defining 

‘‘distribute’’). For purposes of the proposed rules, 

any ‘‘in writing’’ requirement could be satisfied 

either through paper or electronic means consistent 

with existing Commission guidance on electronic 

delivery of documents. See Marketing Release, 

supra footnote 61, at n.346. If any distribution is 

made electronically for purposes of these proposed 

rules, it should be done in accordance with the 

Commission’s guidance regarding electronic 

delivery. See Use of Electronic Media by Broker 

Dealers, Transfer Agents, and Investment Advisers 

for Delivery of Information; Additional Examples 

Under the Securities Act of 1933, Securities 

Exchange Act of 1934, and Investment Company 

Act of 1940, Release No. 34–37182 (May 9, 1996) 

[61 FR 24644 (May 15, 1996)]. 

100See proposed rule 211(h)(1)–1 (defining 

‘‘control’’). 

without having to access other ancillary 

documents. As a result, investors should 

receive it as part of the quarterly 

statement itself. 

We request comment on this aspect of 

the proposal: 

• Should we require advisers to 

disclose the criteria used and 

assumptions made in calculating the 

performance as part of the quarterly 

statement as proposed? Is this approach 

too flexible? Should we instead 

prescribe required disclosures? 

• Should we require advisers to 

provide these disclosures prominently 

as proposed? Is there another disclosure 

standard we should use for these 

purposes? 

• Because we propose to require an 

adviser to provide these disclosures as 

part of each quarterly statement, 

investors would receive these 

disclosures quarterly. Would providing 

these disclosures every quarter reduce 

their salience? Should we require these 

disclosures only as part of the first 

quarterly statement that an adviser 

sends to an investor with amendments 

if the criteria used or assumptions made 

in calculating performance change? 

Should we permit hyperlinking to these 

disclosures after the initial quarterly 

statement? 

3. Preparation and Distribution of 

Quarterly Statements 

The proposed rule would require 

quarterly statements to be prepared and 

distributed to fund investors within 45 

days after each calendar quarter end. We 

believe quarterly statements would 

provide fund investors with timely and 

regular statements that contain 

meaningful and comprehensive 

information. We understand that most 

private fund advisers currently provide 

investors with quarterly reporting.98

For a newly formed private fund, the 

proposed rule would require a quarterly 

statement to be prepared and distributed 

beginning after the fund’s second full 

calendar quarter of generating operating 

results. Many private funds may not 

have performance information that is 

readily available within the first several 

months of operations. For example, a 

private equity fund might not begin 

investing until several months after the 

fund’s formation because the adviser is 

still identifying investments that align 

with the fund’s strategy. As another 

example, a hedge fund may hold initial 

investor capital in cash or cash 

equivalents, prior to commencing the 

fund’s investment strategy. Accordingly, 

we believe that the proposed 

requirements for newly formed funds 

would help ensure that investors receive 

comprehensive information about the 

adviser during the early stage of the 

fund’s life. The reporting period for the 

final quarterly statement would cover 

the calendar quarter in which the fund 

is wound up and dissolved. 

We propose to require quarterly 

statements to be distributed within 45 

days after the calendar quarter end. 

Based on our experience, we believe 

advisers generally would be in a 

position to prepare and deliver quarterly 

statements within this period. 

An adviser generally would satisfy the 

proposed requirement to ‘‘distribute’’ 

the quarterly statements when the 

statements are sent to all investors in 

the private fund.99 However, the 

proposed rule would preclude advisers 

from using layers of pooled investment 

vehicles in a control relationship with 

the adviser to avoid meaningful 

application of the distribution 

requirement. Advisers to private funds 

may from time to time establish special 

purpose vehicles (‘‘SPVs’’) or other 

pooled vehicles for a variety of reasons, 

including facilitating investments by 

one or more private funds that the 

advisers manage. In circumstances 

where an investor is itself a pooled 

vehicle that is controlling, controlled 

by, or under common control with the 

adviser or its related persons (a ‘‘control 

relationship’’), the adviser must look 

through that pool (and any pools in a 

control relationship with the adviser or 

its related persons, such as in a masterfeeder fund structure), in order to send 

to investors in those pools. Without 

such a requirement, the adviser would 

be essentially delivering the quarterly 

statement to itself rather than to the 

parties the quarterly statement is 

designed to inform.100 Outside of a 

control relationship, such as if the 

private fund investor is an unaffiliated 

fund of funds, this same concern is not 

present, and the adviser would not need 

to look through the structure to make 

meaningful delivery. The adviser would 

just distribute the quarterly statement to 

the adviser or other designated party of 

the unaffiliated fund of funds. We 

believe that this approach would lead to 

meaningful delivery of the quarterly 

statement to the private fund’s 

investors. 

We request comment on the quarterly 

statement preparation and distribution 

requirement of the proposed rule: 

• Should we require advisers to 

prepare and distribute statements to 

clients at least quarterly, or should we 

prescribe a different frequency? For 

example, should we require monthly, 

semi-annual, or annual statements? 

Should we mandate the same delivery 

frequency for all proposed statements 

under the rule? How would each of 

these approaches affect comparability 

and effectiveness of the information in 

those statements? Would a quarterly 

reporting obligation require advisers to 

value the fund’s investments more 

frequently than advisers currently do? 

• We understand that advisers may 

use a fund administrator or another 

person to distribute the quarterly 

statement. Is the proposed definition of 

‘‘distribute’’ broad enough to capture a 

fund administrator or another person 

acting under the direction and control of 

the adviser sending the quarterly 

statement on the adviser’s behalf? If not, 

should we broaden the definition? 

Instead of changing the definition of 

‘‘distribute,’’ should we require the 

adviser to distribute the quarterly 

statement, unless it has reason to 

believe that another person has 

distributed a required statement (and 

has a copy of each such statement 

distributed by such other person)? 

• The proposed rule would require 

advisers to distribute the quarterly 

statement within 45 days of a calendar 

quarter end. Is this period too long or 

too short for an adviser to prepare the 

quarterly statement while also ensuring 

timely delivery to investors? Should we 

instead adopt a flexible delivery 

standard, such as a requirement that the 

adviser distribute the quarterly 

statement ‘‘promptly’’? Why or why 

not? If we were to adopt a prompt 

delivery standard, should we define 

‘‘promptly’’? If so, how? If we should 

not define ‘‘promptly,’’ should we 

instead interpret that term to mean as 

soon as reasonably practicable? 

• We understand that preparing 

quarterly statements may require 

coordination with, and reliance on, 

third parties. This may be the case, for 

example, when a private fund itself 

invests in other private funds or 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16909 

101See rule 206(4)–2(a)(7) under the Advisers 

Act. 

102See rule 206(4)–2(d)(4) under the Advisers 

Act. 

portfolio companies. Should the rule 

allow different distribution timelines for 

different types of private funds (e.g., 

fund of funds, master feeder funds)? If 

so, why (e.g., do certain types of funds 

value assets more frequently than other 

types)? Should the proposed rule allow 

different distribution deadlines for 

underlying funds, depending on 

whether or not the underlying funds 

have the same adviser or an adviser that 

is a related person of the adviser 

distributing the quarterly statements? 

• Should the proposed rule bifurcate 

the timing of when certain information 

in the quarterly statement is required? 

For example, should the proposed rule 

require fee and expense information 

starting at the fund’s inception and then 

require performance information 

beginning later? If so, when should we 

require an adviser to start showing 

performance? 

• Should the proposed rule treat 

liquid and illiquid funds differently 

with regard to fee and expense versus 

performance reporting? For example, 

should the proposed rule require liquid 

funds to start distributing quarterly 

statements with performance reporting 

sooner than illiquid funds? If so, why 

and how much sooner? 

• As proposed, the rule would use 

‘‘operating results’’ as the trigger for 

quarterly statement distribution. Should 

we instead rely on another trigger to 

indicate when an adviser must start 

distributing quarterly statements to 

investors? For example, should the 

proposed rule instead require an adviser 

to start distributing quarterly statements 

when the private fund has financial 

statements that report operating results? 

If so, why? Should we define ‘‘operating 

results’’ or clarify what it means? 

• Should the proposed rule require an 

adviser to prepare and distribute an 

initial quarterly statement sooner than 

after the first two full calendar quarters 

of operating results? For example, 

should we require an adviser to prepare 

and distribute a quarterly statement 

after the first calendar quarter of the 

fund’s operations? Why or why not? If 

we required an adviser to prepare and 

distribute a quarterly statement earlier 

in the fund’s life, would this 

information be useful to investors? 

• The proposed rule would require 

advisers to prepare and distribute a 

quarterly statement after the private 

fund has two full calendar quarters of 

operating results and continuously each 

calendar quarter thereafter. An adviser 

would be required to provide 

information for any stub periods that 

precede its first two full calendar 

quarters of operating results (i.e., from 

the date of the fund’s inception to the 

beginning of the first calendar quarter 

during which the fund begins to 

produce operating results). Should the 

proposed rule explicitly address how 

advisers should handle stub periods? If 

so, how? 

• The proposed rule would require 

fee and expense reporting based on a 

fund’s calendar quarter and 

performance reporting based on a liquid 

fund’s calendar year. Should we instead 

use ‘‘fiscal quarter’’ and ‘‘fiscal year’’? 

Why or why not? 

• Are there certain types of advisers 

or funds that should be exempt from 

distributing the quarterly statement to 

investors? If so, which ones and why? 

Are there certain types of advisers or 

funds that should be required to 

distribute quarterly statements to 

investors? If so, which ones and why? 

• Instead of requiring advisers to 

distribute the quarterly statement to 

investors, should we require advisers to 

only distribute or make the quarterly 

statement available to investors upon 

request? Despite the limitations of 

private fund governance mechanisms, as 

discussed above, should we require 

advisers to distribute the quarterly 

statement to independent members of 

the fund’s LPAC, board, or other similar 

governance body? 

• Rule 206(4)–2 under the Advisers 

Act (the ‘‘custody rule’’) allows a client 

to designate an independent 

representative to receive on its behalf 

account statements and notices that are 

required by that rule.101 Under the 

custody rule, an ‘‘independent 

representative’’ is defined as someone 

who does not control, is not controlled 

by, and is not under common control 

with the adviser, among other 

requirements.102 Should we adopt a 

similar provision in the quarterly 

statement rule? Are there specific types 

of investors that need, or at present 

commonly designate, independent 

representatives to receive quarterly 

statements on their behalf? 

• Should we revise the definition of 

‘‘distribute’’ expressly to include 

distribution by granting investors access 

to a virtual data room containing the 

quarterly statement? Why or why not? 

• We considered requiring the 

proposed quarterly statement 

disclosures to be submitted using a 

structured, machine-readable data 

language. Such format may facilitate 

comparisons of quarterly statement 

disclosures across advisers and periods. 

Should we require advisers to provide 

quarterly statements in a machinereadable data language, such as Inline 

eXtensible Business Reporting Language 

(‘‘Inline XBRL’’)? Why or why not? 

Would such a requirement make the 

quarterly statements, and the 

information included therein, easier for 

investors to analyze? For example, 

would it be useful for investors to 

download quarterly statement 

information directly into spreadsheets, 

particularly for institutional investors 

that may have a significant number of 

private fund investments? Would a 

machine-readable data language impose 

undue additional costs and burdens on 

advisers? Please provide support for 

your response, including, where 

available, cost data. 

• If we adopt rules requiring a 

machine-readable data language, is the 

Inline XBRL standard the one that we 

should use? Are any other standards 

becoming more widely used or 

otherwise superior to Inline XBRL? 

What would the advantages of any such 

other standards be over Inline XBRL? 

4. Consolidated Reporting for Certain 

Fund Structures 

An adviser may form multiple funds 

to implement a single strategy. For 

example, an adviser may form a parallel 

fund for certain tax-sensitive investors, 

such as non-U.S. investors that prefer to 

invest through an entity taxed as a 

corporation—rather than a 

partnership—for U.S. Federal income 

tax purposes, that invests alongside the 

main fund in all, or substantially all, of 

its investments. An adviser may also 

form a feeder fund for tax-sensitive 

investors that invests all, or 

substantially all, of its capital into the 

main fund. Advisers often seek to 

structure the funds in a way that 

accommodates investor preferences. 

In some of these circumstances, we 

believe that consolidated reporting of 

the cost and performance information 

by all private funds in the structure 

would provide a more complete and 

accurate picture of the fees and 

expenses borne and performance 

achieved than reporting by each private 

fund separately. Due to the complexity 

of private fund structures, however, we 

believe a principles-based approach to 

the funds that must provide 

consolidated reporting is necessary. 

Accordingly, the proposed rule would 

require advisers to consolidate reporting 

for substantially similar pools of assets 

to the extent doing so would provide 

more meaningful information to the 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16910 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

103See proposed rule 211(h)(1)–2(f). See also 

infra Section II.E. 

104Proposed rule 211(h)(1)–2(g). 105Proposed rule 211(h)(1)–2(d). 

private fund’s investors and would not 

be misleading.103

For example, certain private funds 

utilize master-feeder structures. 

Typically, investors invest in onshore 

and offshore feeder funds, which, in 

turn, invest all, or substantially all, of 

their investable capital in a single 

master fund. The same adviser typically 

advises and controls all three funds, and 

the master fund typically makes and 

holds the investments. Because the 

feeder funds are conduits for investors 

to gain exposure to the master fund and 

its investments, the proposed rule 

would require the adviser to provide 

feeder fund investors with a single 

quarterly statement covering the 

applicable feeder fund and the feeder 

fund’s proportionate interest in the 

master fund on a consolidated basis, so 

long as the consolidated statement 

would provide more meaningful 

information to investors and would not 

be misleading. 

We request comment on the proposed 

consolidated reporting provision of the 

proposed rule: 

• Do commenters agree that the 

proposed rule should require advisers to 

consolidate reporting to cover related 

funds to the extent doing so would 

provide more meaningful information to 

investors and would not be misleading? 

Alternatively, should we prohibit 

advisers from consolidating information 

for multiple funds? Why or why not? 

Should the rule permit, rather than 

require, consolidated reporting? 

• Should we require advisers to 

provide a consolidated quarterly 

statement for funds that are part of the 

same strategy, such as parallel funds, 

feeder funds, and master funds? 

Alternatively, should these types of 

funds have separate reporting? For 

example, should feeder fund investors 

receive a quarterly statement covering 

the feeder fund and a separate quarterly 

statement covering the main fund or 

master fund? How should the rule 

address the fact that certain funds may 

have different expenses (e.g., an offshore 

fund may have director expenses while 

an onshore fund may not)? Should we 

require advisers to provide investors 

with a summary of any fund-specific 

expenses and the corresponding dollar 

amount(s)? Should such a requirement 

be triggered only if the fund-specific 

expense exceeds a certain threshold, 

such as a percentage of the fund size 

(e.g., .01%, .05%, or .10% of the fund’s 

size) or a specific dollar amount (e.g., 

$15,000, $30,000, or $50,000)? 

• As noted above, the proposal would 

require advisers to provide feeder fund 

investors with a consolidated quarterly 

statement covering the applicable feeder 

fund and the feeder fund’s 

proportionate interest in the master 

fund, to the extent doing so would 

provide more meaningful information to 

investors and would not be misleading. 

Do commenters agree with this 

approach? Alternatively, should we 

require advisers to provide consolidated 

reporting covering all feeder funds (and 

not just the applicable feeder fund) and 

the master fund? Why or why not? 

• We also recognize that certain 

private funds have multiple classes (or 

other groupings such as series or 

tranches) of interests or shares. The 

proposed rule would require the 

quarterly statement to present fundwide information. Would advisers face 

challenges in calculating fee, expense, 

and performance information if there 

are differences in fees, allocations, and/ 

or expenses between or among classes, 

series, or tranches? Should we require 

disclosure of class-specific fees and 

expenses, or of the differences among 

classes? Why or why not? Should we 

instead permit or require quarterly 

statements for multi-class private funds 

to present the proposed fee and expense 

and performance information on a classby-class basis, particularly if each class 

(or series or tranche) is considered a 

distinct private fund or separate legal 

entity (with segregated assets and 

liabilities) under applicable law? Would 

such an approach provide more 

meaningful information for investors in 

each of those classes, given the potential 

for different fee, allocation, and expense 

structures? Should we require quarterly 

statements for multi-class (or multiseries or multi-tranche) private funds to 

present class-by-class (or series-byseries or tranche-by-tranche) 

information to the extent each class (or 

series or tranche) holds different 

investments? 

• Should advisers only be required to 

distribute a class’ quarterly statement to 

interest holders of such class, or should 

all fund investors be entitled to receive 

such statement regardless of whether 

they are interest holders of the relevant 

class if the rule permits or requires 

class-specific quarterly statements for 

multi-class private funds? 

• Certain advisers provide combined 

financial statements covering multiple 

funds. Should we require or permit 

advisers to provide consolidated 

quarterly statements for funds that have 

combined financial statements? Why or 

why not? 

5. Format and Content Requirements 

The proposed rule would require the 

adviser to use clear, concise, plain 

English in the quarterly statement.104

For example, an adviser would not 

satisfy the proposed requirement for 

‘‘clear’’ disclosures unless those 

disclosures are made in a font size and 

type that is legible, and margins and 

paper size (if applicable) are reasonable. 

Likewise, to meet this standard, any 

information that an adviser chooses to 

include in a quarterly statement, but 

that is not required by the rule, would 

be required to be as short as practicable, 

not more prominent than the required 

information, and not obscure or impede 

an investor’s understanding of the 

mandatory information. 

In addition, the proposed rule would 

require an adviser to present 

information in the quarterly statement 

in a format that facilitates review from 

one quarterly statement to the next. As 

noted above, the quarterly statement is 

designed to allow an investor to monitor 

and assess the costs and performance of 

the fund over time. We anticipate that, 

quarter-over-quarter, an adviser would 

use a consistent format for a fund’s 

quarterly statements, thus allowing an 

investor to easily compare fees, 

expenses, and performance over each 

quarterly period. We also encourage 

advisers to use a structured, machinereadable format if advisers believe this 

format would be useful to the investors 

in their fund. 

The proposed format and content 

requirements would apply to all aspects 

of a quarterly statement, including the 

proposed requirements to disclose the 

manner in which expenses, payments, 

allocations, rebates, waivers, and offsets 

are calculated and to cross-reference 

sections of the private fund’s 

organizational and offering 

documents.105 We believe this approach 

would improve the utility of the 

quarterly statement by making it easier 

for investors to review and analyze. 

These requirements would support an 

investor’s ability to understand needed 

context provided in the quarterly 

statement regarding fees, expenses, and 

performance that allows investors to 

monitor their investments. For example, 

providing investors with clear and 

easily accessible cross-references to the 

fund governing documents would make 

it easier for the investor to monitor 

whether the fees and expenses in the 

quarterly statement comply with the 

fund’s governing documents. 

We believe the proposal strikes an 

appropriate balance in prescribing the 


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106For all of the recordkeeping rule amendments 

in this proposed rulemaking package, advisers 

would be required to maintain and preserve the 

record in an easily accessible place for a period of 

not less than five years from the end of the fiscal 

year during which the last entry was made on such 

record, the first two years in an appropriate office 

of the investment adviser. See rule 204–2(e)(1) 

under the Advisers Act. 

107Advisers already are required to retain 

performance calculation information under the 

existing books and records rule and therefore would 

be required to retain the performance calculation 

information required as part of the proposed 

quarterly statement rule. See rule 204–2(a)(16) 

under the Advisers Act (requiring advisers to retain 

performance calculation information). 

108Proposed rule 206(4)–10. The proposed rule 

would apply to all investment advisers registered, 

or required to be registered, with the Commission. 

109Proposed rule 206(4)–10; proposed rule 

211(h)(1)–1 (defining ‘‘control’’ and ‘‘distributed’’). 

content of the tables and performance 

information to be included in quarterly 

statements while taking a fairly 

principles-based approach to format. 

This would help provide investors with 

standardized information about their 

private fund investments, while 

affording advisers some flexibility to 

present the required information 

without being overly prescriptive or 

sacrificing readability. We considered, 

but are not proposing, to further 

standardize format, because we 

recognize this might result in investor 

confusion if an adviser includes 

inapplicable line items to satisfy our 

form requirements, while omitting 

additional relevant information that 

might be unique to a particular fund. 

Moreover, we were concerned that 

advisers would be unable to report on 

a consolidated basis if we further 

prescribed the format of the statements. 

We request comment on this aspect of 

the proposed rule: 

• Should the proposed quarterly 

statement rule include a provision on 

formatting and content? Why or why 

not? 

• Do commenters agree with the 

flexibility of the proposed format and 

content requirements, or should we 

prescribe wording? For example, should 

we require a cover page with prescribed 

wording? If so, what prescribed wording 

should we require? 

• To meet the rule’s formatting 

requirements, any information that an 

adviser chooses to include in a quarterly 

statement, but that is not required by the 

rule, would be required to be presented 

in a manner that is no more prominent 

than the required information. Should 

the rule, instead, require that advisers 

more prominently present information 

that is required by the proposed 

quarterly statement rule (as opposed to 

supplemental information that is merely 

permitted)? If an adviser chooses to 

include supplemental information, 

should we require that adviser to 

disclose what information in the 

quarterly statement is required versus 

that which is voluntary? 

6. Recordkeeping for Quarterly 

Statements 

We propose amending rule 204–2 (the 

‘‘books and records rule’’) under the 

Advisers Act to require advisers to 

retain books and records related to the 

proposed quarterly statement rule.106

These proposed amendments would 

help facilitate the Commission’s 

inspection and enforcement capabilities. 

First, we propose to require private fund 

advisers to retain a copy of any 

quarterly statement distributed to fund 

investors pursuant to the proposed 

quarterly statement rule, as well as a 

record of each addressee, the date(s) the 

statement was sent, address(es), and 

delivery method(s). Second, we propose 

to require advisers to retain all records 

evidencing the calculation method for 

all expenses, payments, allocations, 

rebates, offsets, waivers, and 

performance listed on any quarterly 

statement delivered pursuant to the 

proposed quarterly statement rule. 

Third, advisers would be required to 

make and keep books and records 

substantiating the adviser’s 

determination that the private fund it 

manages is a liquid fund or an illiquid 

fund pursuant to the proposed quarterly 

statement rule. We believe these 

proposed requirements would facilitate 

our staff’s ability to assess an adviser’s 

compliance with the proposed rule and 

would similarly enhance an adviser’s 

compliance efforts.107

We request comment on the proposed 

recordkeeping rule amendments: 

• Should we require advisers to 

maintain the proposed records or would 

these requirements be overly 

burdensome for advisers? Are there 

alternative or additional recordkeeping 

requirements we should impose? 

• Should we require advisers to retain 

a record of each addressee, the date(s) 

the statement was sent, address(es), and 

delivery method(s) for each quarterly 

statement, as proposed? Should we 

instead eliminate this requirement 

because of the potential burdens? 

• Should we provide more specific 

requirements regarding the records an 

adviser must maintain to substantiate its 

determination that a private fund is a 

liquid fund or an illiquid fund? 

Alternatively, should we leave the 

proposed rule as is and allow advisers 

flexibility in how they document this 

determination? 

B. Mandatory Private Fund Adviser 

Audits 

In addition to disclosure, we propose 

to require private fund advisers to 

obtain an annual audit of the financial 

statements of the private funds they 

manage.108 In addition to providing 

protection for the fund and its investors 

against the misappropriation of fund 

assets, we believe an audit by an 

independent public accountant would 

provide an important check on the 

adviser’s valuation of private fund 

assets, which often serve as the basis for 

the calculation of the adviser’s fees. 

The proposed audit rule would 

require a registered investment adviser 

providing investment advice, directly or 

indirectly, to a private fund, to cause 

that fund to undergo a financial 

statement audit that meets the terms of 

the rule at least annually and upon 

liquidation, unless the fund otherwise 

undergoes such an audit. Under the 

proposed rule: 

(1) The audit must be performed by an 

independent public accountant that 

meets the standards of independence in 

17 CFR 210.2–01(b) and (c) (rule 2–01(b) 

and (c) of Regulation S–X) that is 

registered with, and subject to regular 

inspection as of the commencement of 

the professional engagement period, and 

as of each calendar year-end, by, the 

Public Company Accounting Oversight 

Board (‘‘PCAOB’’) in accordance with 

its rules; 

(2) The audit must meet the definition 

of audit in 17 CFR 210.1–02(d) (rule 1– 

02(d) of Regulation S–X), the 

professional engagement period of 

which shall begin and end as indicated 

in Regulation S–X rule 2–01(f)(5); 

(3) Audited financial statements must 

be prepared in accordance with U.S. 

Generally Accepted Accounting 

Principles (‘‘U.S. GAAP’’) or, in the case 

of financial statements of private funds 

organized under non-U.S. law or that 

have a general partner or other manager 

with a principal place of business 

outside the United States (‘‘foreign 

private funds’’), must contain 

information substantially similar to 

statements prepared in accordance with 

U.S. GAAP and material differences 

with U.S. GAAP must be reconciled; 

(4) Promptly after completion of the 

audit, the private fund’s audited 

financial statements, which include any 

reconciliation to U.S. GAAP prepared 

for a foreign private fund, are 

distributed; and 

(5) The auditor notifies the 

Commission upon certain events.109

Additionally, for a fund that the 

adviser does not control and that is 

neither controlled by nor under 


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16912 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

110See, e.g., rule 206(4)–2(b)(4) under the 

Advisers Act; Custody of Funds or Securities of 

Clients by Investment Advisers, Investment 

Advisers Act Release No. 2176 (Sept. 25, 2003) [68 

FR 56692 (Oct. 1, 2003)] (‘‘Custody Release’’) 

(providing advisers to certain pooled investment 

vehicles with an exception to the surprise 

examination requirement if the pooled investment 

vehicles undergo an audit). Not all advisers are 

subject to the custody rule and even those that are 

subject to the custody rule are not required to 

obtain an audit in order to comply with the rule. 

111See generally Jenkinson, Sousa, Stucke, How 

Fair are the Valuations of Private Equity Funds? 

(2013), available at https://www.psers.pa.gov/ 

About/Investment/Documents/PPMAIRC%202018/ 

27%20How%20Fair%20are%20the

%20Valuations%20of%20Private%20Equity

%20Funds.pdf. See also In the Matter of Swapnil 

Rege, Investment Advisers Act Release No. 5303 

(July 18, 2019) (settled action) (alleging that an 

employee of a private fund adviser mispriced the 

private fund’s investments, which resulted in the 

adviser charging the fund excess management fees); 

SEC v. Southridge Capital Mgmt., LLC, Lit. Rel. No. 

21709 (Oct. 25, 2010) (alleging that adviser 

overvalued the largest position held by the funds 

by fraudulently misstating the acquisition price of 

the assets); see docket for SEC v. Southridge Capital 

Mgmt., LLC, U.S. District Court, District of 

Connecticut (New Haven), case no. 3:10–CV–01685 

(on September 12, 2016 the court granted the SEC’s 

motion for summary judgment and entered a final 

judgment in favor of the SEC in 2018). 

112See American Institute of Certified Public 

Accountants’ (‘‘AICPA’’) auditing standards, AU–C 

Section 540 and PCAOB auditing standards, AS 

2501. 113See rule 206(4)–2(b)(4) under the Advisers 

Act. 

114See proposed rule 206(4)–10(e). See AICPA 

auditing standard, AU–C Section 705, which 

establishes three types of modified opinions: A 

qualified opinion, an adverse opinion, and a 

disclaimer of opinion. 

115See rule 206(4)–2(a)(4)(iii) (requiring 

somewhat similar information in the context of a 

surprise examination). 

116See rule 206(4)–2(b)(3) and (6) (providing 

exceptions from the surprise examination 

requirement for fee deduction and where the 

adviser has custody solely because a related person 

has custody of a client’s funds or securities). 

common control with the adviser (e.g., 

where an unaffiliated sub-adviser 

provides services to the fund), such 

adviser would only need to take all 

reasonable steps to cause the fund to 

undergo an audit that would meet these 

elements. 

We have historically relied on 

financial statement audits to verify the 

existence of pooled investment vehicle 

investments.110 Financial statement 

audits also provide additional 

meaningful protections to private fund 

investors by increasing the likelihood 

that fraudulent activity or problems 

with valuation are uncovered, thereby 

providing deterrence against fraudulent 

conduct by fund advisers. For example 

as noted above, a fund’s adviser may use 

a high level of discretion and 

subjectivity in valuing a private fund’s 

illiquid investments, which are difficult 

to value. This creates a conflict of 

interest if the adviser also calculates its 

fees as a percentage of the value of the 

fund’s investments and/or an increase 

in that value (net profit), as is typically 

the case. Moreover, private fund 

advisers often rely heavily on existing 

fund performance when obtaining new 

investors (in the case of a private fund 

that makes continuous or periodic 

offerings) or fundraising for a new fund. 

These factors raise the possibility that 

funds are valued opportunistically and 

that the adviser’s compensation may 

involve fraud or deception, resulting in 

an inappropriate compensation 

scheme.111 A fund audit includes the 

evaluation of whether the fair value 

estimates and related disclosures are 

reasonable and consistent with the 

requirements of the financial reporting 

framework (e.g., U.S. GAAP), which 

may include evaluating the selection 

and application of methods, significant 

assumptions, and data used by the 

adviser in making the estimate.112 We 

believe that this would provide a critical 

set of additional protections by an 

independent third party. 

The proposed audit rule is based on 

the custody rule and contains many 

similar or identical requirements, 

although compliance with either rule 

would not automatically satisfy the 

requirements of the other.113 Although 

the financial statement audit performed 

under either rule would be the same, 

there are several differences between the 

two rules. The most notable difference 

between the two rules is the lack of 

choice about obtaining an audit under 

the proposed audit rule. Under the 

custody rule, an adviser is deemed to 

have satisfied that rule’s annual surprise 

examination requirement for a pooled 

investment vehicle client if that pool is 

subject to an annual financial statement 

audit by an independent public 

accountant, and its audited financial 

statements (prepared in accordance with 

generally accepted accounting 

principles) are distributed to the pool’s 

investors. Accordingly, an adviser may 

obtain a surprise examination under the 

custody rule instead of an audit. Private 

fund advisers complying with the 

proposed audit rule would not have a 

similar choice; they must obtain an 

audit. Based on our experience since 

introducing the custody rule’s audit 

provision, we have come to believe that 

audits provide substantial benefits to 

private funds and their investors 

because audits test assertions associated 

with the investment portfolio (e.g., 

completeness, existence, rights and 

obligations, valuation, presentation). 

Audits may also provide a check against 

adviser misrepresentations of 

performance, fees, and other 

information about the fund. 

Accordingly, the proposed audit rule 

would require registered private fund 

advisers, including those that currently 

opt to undergo a surprise examination 

for custody rule compliance purposes, 

to have their private fund clients 

undergo a financial statement audit. 

Another main difference between the 

requirements of the two rules is the 

requirement of the proposed rule for 

there to be a written agreement between 

the adviser or the private fund and the 

auditor pursuant to which the auditor 

would be required to notify our Division 

of Examinations upon the auditor’s 

termination or issuance of a modified 

opinion.114 There is not a similar 

obligation under the custody rule for an 

adviser that relies on the audit provision 

to satisfy the surprise examination 

requirement. Our experience in 

receiving similar information from 

accountants who perform surprise 

examinations under the custody rule 

has led us to conclude that timely 

receipt of this information—from an 

independent third party—would more 

readily enable our staff to identify 

advisers potentially engaged in harmful 

misconduct and who have other 

compliance issues.115 This also would 

aid the Commission in its oversight of 

private fund advisers. 

The other main difference between 

the two rules, aside from timing 

requirements for the distribution of 

audited financial statements under the 

two rules discussed below, relates to 

their scope. While both rules pertain to 

advisers that are registered or required 

to be registered with us, the custody 

rule also contains exceptions from the 

surprise examination requirement, 

which in turn make it unnecessary for 

an adviser to rely on that rule’s audit 

provision.116 In light of the different 

policy goals of these two rules, we are 

not proposing a parallel exception to the 

proposed audit rule. Moreover, in our 

experience, private fund advisers 

generally do not often rely on these 

exceptions. The proposed audit rule 

does, however, contain an exception in 

certain contexts where the adviser takes 

all reasonable steps to cause an audit, as 

described and for reasons discussed 

below, which does not exist in the 

custody rule. 

1. Requirements for Accountants 

Performing Private Fund Audits 

The proposed audit rule would 

include certain requirements regarding 

the accountant performing a private 

fund audit. First, we propose to require 

an accountant performing a private fund 

audit to meet the standards of 


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117See Revision of the Commission’s Auditor 

Independence Requirements, Release No. 33–7919 

(Nov. 21, 2000) [65 FR 76008 (Dec. 5, 2000)]. The 

custody rule requires all accountants performing 

services to meet the standards of independence 

described in rule 2–01(b) and (c) of Regulation S– 

X. See rule 206(4)–2(d)(3) under the Advisers Act. 

118For example, more than 90 percent of the total 

number of hedge funds and private equity funds 

currently undergo a financial statement audit. See 

infra Section V.B.4. 

119See PCAOB Adopts Interim Inspection 

Program for Broker-Dealer Audits and Broker and 

Dealer Funding Rules (June 14, 2011) (‘‘temporary 

inspection program’’), available at https://

pcaobus.org/News/Releases/Pages/06142011_

OpenBoardMeeting.aspx. See also Dodd-Frank Act 

Section 982. 

120Our staff took a similar position and has had 

several years to observe the impact on the 

availability of accountants to perform services and 

the quality of services produced by these 

accountants. See Robert Van Grover Esq., Seward & 

Kissel LLP, SEC Staff No-Action Letter (Dec. 11, 

2019) (extending the no-action position taken in 

prior letters until the date that a PCAOB-adopted 

permanent program, having been approved by the 

Commission, takes effect). 

121See, e.g., HFCAA Determination Report 

Pursuant to 15 U.S.C. 7214(i)(2)(A) and PCAOB 

Rule 6100 (Dec. 16. 2021), PCAOB Release No. 104– 

HFCAA–2021–001, available at 104-hfcaa-2021- 

001.pdf (azureedge.net) (publishing such list of 

firms as of December 2021). 

122Under the definition in rule 1–02(d) of 

Regulation S–X, an ‘‘audit’’ of an entity (such as a 

private fund) that is not an issuer as defined in 

section 2(a)(7) of the Sarbanes-Oxley Act of 2007 

means an audit performed in accordance with 

either the generally accepted auditing standards of 

the United States (‘‘U.S. GAAS’’) or the standards 

of the PCAOB. When conducting an audit of 

financial statements in accordance with the 

standards of the PCAOB, however, the auditor 

would also be required to conduct the audit in 

accordance with U.S. GAAS because the audit 

would not be within the jurisdiction of the PCAOB 

as defined by the Sarbanes-Oxley Act of 2002, as 

amended, (i.e., not an issuer, broker, or dealer). See 

AICPA auditing standards, AU–C Section 700.46. 

We believe most advisers would choose to perform 

the audit pursuant to U.S. GAAS only rather than 

both standards, though it would be permissible 

under the proposed audit rule to perform the audit 

pursuant to both standards. 

123See AICPA auditing standards, AU–C Section 

240. Audits performed under PCAOB standards 

provide similar benefits. See PCAOB auditing 

standards, AS 2401, which discusses consideration 

of fraud in a financial statement audit. 

124Among other things, rule 2–01(f)(5) of 

Regulation S–X indicates that the professional 

engagement period begins at the earlier of when the 

accountant either signs an initial engagement letter 

(or other agreement to review or audit a client’s 

financial statements) or begins audit, review, or 

attest procedures; and the period ends when the 

audit client or the accountant notifies the 

Commission that the client is no longer that 

accountant’s audit client. 

independence described in rule 2–01(b) 

and (c) of Regulation S–X in support of 

the Commission’s long-standing 

recognition that an audit by an 

objective, impartial, and skilled 

professional contributes to both investor 

protection and investor confidence.117

Second, the proposed rule would 

require the independent public 

accountant performing the audit to be 

registered with, and subject to regular 

inspection as of the commencement of 

the professional engagement period, and 

as of each calendar year-end, by, the 

PCAOB in accordance with its rules. 

Based on our experience with the 

custody rule, we believe registration and 

the periodic inspection of an 

independent public accountant’s system 

of quality control by the PCAOB provide 

investors with confidence in the quality 

of the audits produced under the 

proposed rule. 

We understand that this requirement 

may limit the pool of accountants that 

are eligible to perform these services 

because only those accountants that 

currently conduct public company 

issuer audits are subject to regular 

inspection by the PCAOB. Most private 

funds, however, are already undergoing 

a financial statement audit; therefore, 

the increase in demand for these 

services may be limited.118 Nonetheless, 

the resulting competition for these 

services might increase costs to 

investment advisers and investors. 

We understand that, as part of a 

temporary inspection program, the 

PCAOB inspects accountants auditing 

brokers and dealers, and identifies and 

addresses with these firms any 

significant issues in those audits.119

Similar to the inspection program for 

issuer audits, we believe that the 

temporary inspection program for 

broker-dealers provides valuable 

oversight of these accountants, resulting 

in better quality audits. Accordingly, we 

would consider an accountant’s 

compliance with the PCAOB’s 

temporary inspection program for 

auditors of brokers and dealers to satisfy 

the requirement for regular inspection 

by the PCAOB under the proposed 

independent public accountant 

engagements provision until the 

effective date of a permanent program 

for the inspection of broker and dealer 

auditors that is approved by the 

Commission.120

An independent public accounting 

firm would not be considered to be 

‘‘subject to regular inspection’’ if it is 

included on the list of firms that is 

headquartered or has an office in a 

foreign jurisdiction that the PCAOB has 

determined it is unable to inspect or 

investigate completely because of a 

position taken by one or more 

authorities in that jurisdiction in 

accordance with PCAOB Rule 6100.121

We recognize that there may be a 

limited number of PCAOB-registered 

and inspected independent public 

accountants in certain foreign 

jurisdictions. However, we do not 

believe that advisers would have 

significant difficulty in finding an 

accountant that is eligible under the 

proposed rule in most jurisdictions 

because many PCAOB-registered 

independent public accountants who 

are subject to regular inspection 

currently have practices in various 

jurisdictions, which may ameliorate 

concerns regarding offshore availability. 

2. Auditing Standards for Financial 

Statements 

Under the proposed audit rule, an 

audit must meet the definition in rule 

1–02(d) of Regulation S–X. Pursuant to 

that definition, financial statement 

audits performed for purposes of the 

proposed audit rule would generally be 

performed in accordance with the 

generally accepted auditing standards of 

the United States (‘‘U.S. GAAS’’).122

U.S. GAAS requires that an auditor 

evaluate and respond to the risk of 

material misstatements of the financial 

statements due to fraud or error.123

Among other benefits of this standard, 

audits performed in accordance with 

U.S. GAAS would help detect valuation 

irregularities or errors, as well as an 

investment adviser’s loss, 

misappropriation, or misuse of client 

investments. The proposed rule would 

require the professional engagement 

period of an audit performed under the 

rule to begin and end as indicated in 

Regulation S–X rule 2–01(f)(5).124

3. Preparation of Audited Financial 

Statements 

The proposed rule also generally 

would require the audited financial 

statements to be prepared in accordance 

with U.S. GAAP. Financial statements 

of private funds organized under nonU.S. law or that have a general partner 

or other manager with a principal place 

of business outside the United States 

would be required to contain 

information substantially similar to 

statements prepared in accordance with 

U.S. GAAP and any material differences 

would be required to be reconciled to 

U.S. GAAP. Requiring that financial 

statements comply with U.S. GAAP is 

designed to help investors receive 

consistent and quality financial 

reporting on their investments from the 

fund’s adviser. 

Financial statements that are prepared 

in accordance with accounting 

standards other than U.S. GAAP, would 

meet the requirements of the proposed 

audit rule so long as they contain 

information substantially similar to 

financial statements prepared in 

accordance with U.S. GAAP, material 

differences with U.S. GAAP are 

reconciled, and the reconciliation, 


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16914 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

125Proposed rule 206(4)–10(c) and (d). See also 

Custody Release, supra footnote 110, at n.41 (stating 

that an adviser may use such financial statements 

to qualify for the audit exception from the custody 

rule with respect to pools that have a place of 

organization outside the United States or a general 

partner or other manager with a principal place of 

business outside the United States, if such financial 

statements contain information that is substantially 

similar to financial statements prepared in 

accordance with U.S. GAAP and contain a footnote 

reconciling any material variations between such 

comprehensive body of accounting standards and 

U.S. GAAP). 

126See U.S. GAAP ASC 946. 

127Proposed rule 206(4)–10(d). 

128See proposed rule 211(h)(1)–1 (defining 

‘‘control’’ and ‘‘distribute’’). 

129As discussed above, differences between the 

two rules are unrelated to the financial statement 

audit itself. 

including supplementary U.S. GAAP 

disclosures, is distributed to investors as 

part of the audited financial 

statements.125 We believe that this 

approach would allow advisers 

flexibility to provide investors with 

financial statements that are prepared in 

accordance with applicable accounting 

standards. We believe a reconciliation to 

U.S. GAAP is necessary for private fund 

audits because U.S. GAAP, has industry 

specific accounting principles for 

certain pooled vehicles, including 

private funds.126 As a result, there could 

be material differences between other 

accounting standards and U.S. GAAP, 

for example in the presentation of a 

trade/settlement date, schedule of 

investments and financial highlights, 

that we would require to be reconciled. 

4. Prompt Distribution of Audited 

Financial Statements 

The proposed audit rule would 

require a fund’s audited financial 

statements to be distributed to current 

investors ‘‘promptly’’ after the 

completion of the audit.127 The audited 

financial statements would consist of 

the applicable financial statements 

(including any required reconciliation 

to U.S. GAAP, including supplementary 

U.S. GAAP disclosures), related 

schedules, accompanying footnotes, and 

the audit report. We considered but are 

not proposing to require the audited 

financials to be distributed within 120 

days of a private fund’s fiscal year end, 

similar to the approach under the 

custody rule. Based on our experience 

administering the custody rule, we 

believe that a 120-day time period is 

generally appropriate to allow the 

financial statements of an entity to be 

audited and to provide investors with 

timely information. We also understand, 

however, that preparing audited 

financial statements for some 

arrangements, such as fund of funds 

arrangements, may require reliance on 

third parties, which could cause an 

adviser to fail to meet the 120-day 

timing requirements for distributing 

audited financial statements regardless 

of actions it takes to meet the 

requirements. We also recognize there 

may be times when an adviser 

reasonably believes that a fund’s 

audited financial statements would be 

distributed within the required 

timeframe but fails to have them 

distributed in time under certain 

unforeseeable circumstances. For 

example, during the COVID–19 

pandemic, some advisers were unable to 

deliver audited financial statements in 

the timeframes required under the 

custody rule due to logistical 

disruptions. Accordingly, and in light of 

the fact that there is not an alternative 

method by which to satisfy the 

proposed rule as there is under the 

custody rule (i.e., undergo a surprise 

examination), we would require the 

audited financial statements to be 

distributed ‘‘promptly,’’ rather than 

pursuant to a specific deadline. This 

would provide some flexibility without 

affecting investor protection. 

Under the proposed audit rule, the 

audited financial statements (including 

any reconciliation to U.S. GAAP 

prepared for a foreign private fund, as 

applicable) must be sent to all of the 

private fund’s investors. In 

circumstances where an investor is itself 

a pooled vehicle that is in a control 

relationship with the adviser or its 

related persons, it would be necessary to 

look through that pool (and any pools in 

a control relationship with the adviser 

or its related persons, such as in a 

master-feeder fund structure), in order 

to send to investors in those pools.128

Without such a requirement, the audited 

financial statements would essentially 

be delivered to the adviser rather than 

to the parties the financial statements 

are designed to inform. Outside of a 

control relationship, such as if the 

private fund investor is an unaffiliated 

fund of funds, this same concern is not 

present, and it would not be necessary 

to look through the structure to make 

meaningful delivery. It would be 

sufficient to distribute the audited 

financial statements to the adviser to, or 

other designated party of, the 

unaffiliated fund of funds. We believe 

that this approach would lead to 

meaningful delivery of the audited 

financial statements to the private 

fund’s investors. 

5. Annual Audit, Liquidation Audit, and 

Audit Period Lengths 

Key to the effectiveness of the audit 

in protecting investors is timely and 

regular administration and distribution. 

Under the proposed audit provision, an 

audit must be obtained at least annually 

and upon an entity’s liquidation. The 

liquidation audit would serve as the 

annual audit for the fiscal year in which 

it occurs. Requiring the audit on an 

annual basis and at liquidation would 

help alert investors within months, 

rather than years, to any material 

misstatements identified in the audit 

and would raise the likelihood of 

mitigating losses or reducing exposure 

to other investor harms. Similarly, a 

liquidation audit would help ensure the 

appropriate and prompt accounting of 

the proceeds of a liquidation so that 

investors can take timely steps to 

protect their rights at a time when they 

may be vulnerable to misappropriation 

by the investment adviser. We believe 

that it becomes increasingly difficult to 

correct a material misstatement the 

longer it goes undetected. The proposed 

annual and liquidation audit 

requirements would address these 

concerns while also balancing the cost, 

burden, and utility of requiring frequent 

audits. 

The proposed annual audit 

requirement is consistent with current 

practices of private fund advisers that 

obtain an audit in order to comply with 

the custody rule under the Advisers Act, 

or to satisfy investor demand for an 

audit, and would provide investors with 

uniformity in the information they are 

receiving.129 When an investor receives 

audited financial statements each year 

from the same private fund, the investor 

can compare statements year-over-year. 

Additionally, the investor can analyze 

and compare audited financial 

statements across other private funds 

and similar investment vehicles each 

year. Further, we believe investors 

expect audited financial statements to 

include 12-month periods and rely on 

this uniform period to review and 

analyze financial statements year over 

year for the same private fund. 

With respect to liquidation, we 

understand that the amount of time it 

takes to complete the liquidation of a 

private fund may vary. A number of 

years might elapse between the decision 

to liquidate an entity and the 

completion of the liquidation process. 

During this time, the fund may execute 

few transactions and the total amount of 

investments may represent a fraction of 

the investments that existed prior to the 

start of the liquidation process. We 

further understand that a lengthy 

liquidation period can lead to 

circumstances where the cost of an 

annual audit represents a sizeable 

portion of the fund’s remaining assets. 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16915 

130Proposed rule 206(4)–10(e). 

131Form ADV Part 1A, Section 7.B.1, Q.23. 

132Proposed rule 206(4)–10(f). 

133Proposed rule 204–2(a)(21). See also supra 

footnote 106 (describing the record retention 

requirements under the books and records rule). 

While we considered additional 

modifications to the audit requirement 

for a private fund during liquidation, we 

are concerned that allowing for less 

frequent auditing (e.g., every 18 months 

or two years) during an entity’s 

liquidation may expose investors to 

abuse that could then go unnoticed for 

prolonged periods. Furthermore, it is 

our understanding that allowing for less 

frequent auditing during liquidation— 

for example, requiring an audit every 

two years in such circumstances—may 

not necessarily result in a meaningful 

cost reduction to advisers or investors. 

6. Commission Notification 

The proposed rule would require an 

adviser to enter into, or cause the 

private fund to enter into, a written 

agreement with the independent public 

accountant performing the audit to 

notify the Commission (i) promptly 

upon issuing an audit report to the 

private fund that contains a modified 

opinion and (ii) within four business 

days of resignation or dismissal from, or 

other termination of, the engagement, or 

upon removing itself or being removed 

from consideration for being 

reappointed.130 The accountant making 

such a notification would be required to 

provide its contact information and 

indicate its reason for sending the 

notification. The written agreement 

must require the independent public 

accountant to notify the Commission by 

electronic means directed to the 

Division of Examinations. Timely 

receipt of this information would enable 

our staff to evaluate the need for an 

examination of the adviser. We expect 

the Division of Examinations would 

establish a dedicated email address to 

receive these confidential transmissions 

and would make the address available 

on the Commission’s website in an 

easily retrievable location. 

As we noted above, there is not a 

similar obligation under the custody 

rule for an accountant to notify the 

Commission as there is for a surprise 

examination, although there is a 

requirement on Form ADV for a private 

fund adviser itself to report to the 

Commission whether it received a 

qualified audit opinion and to provide, 

and update, its auditor’s identifying 

information.131 However, our 

experience in receiving notifications 

from accountants who perform surprise 

examinations under the custody rule 

has led us to conclude that timely 

receipt of this information—from an 

independent third party—would more 

readily enable our staff to identify 

advisers potentially engaged in harmful 

misconduct and who have other 

compliance issues. This would bolster 

the Commission’s efforts at preventing 

fraudulent, deceptive, and manipulative 

activity and would aid oversight of 

private fund advisers. 

7. Taking All Reasonable Steps To 

Cause an Audit 

We recognize that some advisers may 

not have requisite control over a private 

fund client to cause its financial 

statements to undergo an audit in a 

manner that would satisfy all five 

elements (paragraphs (a) through (e)) of 

the proposed rule. This could be the 

case, for instance, where a sub-adviser 

is unaffiliated with the fund. Therefore, 

we are proposing to require that an 

adviser take all reasonable steps to 

cause its private fund client to undergo 

an audit that would satisfy the rule, so 

long as the adviser does not control the 

private fund and is neither controlled by 

nor under common control with the 

fund.132 What would constitute ‘‘all 

reasonable steps’’ would depend on the 

facts and circumstances. For example, a 

sub-adviser that has no affiliation to the 

general partner of a private fund that 

did not obtain an audit could document 

the sub-adviser’s efforts by including (or 

seeking to include) the requirement in 

its sub-advisory agreement. On the 

contrary, if the adviser is the primary 

adviser to the fund, even if it is not the 

general partner or a related person of the 

general partner, it would likely not be 

reasonable for the fund not to be audited 

in accordance with the rule. 

8. Recordkeeping Provisions Related to 

the Proposed Audit Rule 

Finally, the proposal would amend 

the Advisers Act books and records rule 

to require advisers to keep a copy of any 

audited financial statements, along with 

a record of each addressee and the 

corresponding date(s) sent, address(es), 

and delivery method(s) for each such 

addressee.133 Additionally, the adviser 

would be required to keep a record 

documenting steps taken by the adviser 

to cause a private fund client with 

which it is not in a control relationship 

to undergo a financial statement audit 

that would comply with the rule. This 

aspect of the proposal is designed to 

facilitate our staff’s ability to assess an 

adviser’s compliance with the proposed 

audit rule and to detect risks the 

proposed audit rule is designed to 

address. We believe it would similarly 

enhance an adviser’s compliance efforts 

as well. 

We request comment on all aspects of 

the proposed audit rule and related 

proposed amendments to the books and 

records rule, including the following 

items: 

• Would the proposed audit rule 

provide appropriate protection for 

investors? If not, please describe what, 

if any, modifications would improve 

investor protection. 

• The proposed audit rule bears many 

similarities to provisions of the custody 

rule; however, one notable difference is 

that there would be no option to, 

instead, undergo a surprise examination 

and rely on a qualified custodian to 

deliver quarterly statements. What 

would be the impact on advisers to 

private funds that are not relying on the 

custody rule’s audit provision? Are 

private funds undergoing similar audits 

of their financial statements for other 

reasons, or would this represent a new 

requirement for them? There also are no 

exceptions from the proposed rule, as 

there are in the custody rule, such as the 

exception from the surprise examination 

requirement for advisers whose sole 

basis for being subject to the rule is 

because they have authority to deduct 

their advisory fees. What would be the 

impact on advisers to private funds that 

are relying on this and other exceptions? 

Do many private fund advisers rely on 

the exception for fee-deduction? 

• Do commenters agree that the 

similarities of the audit requirements for 

the custody rule and for the proposed 

rule would ease the compliance burdens 

of advisers that would be required to 

comply with both? Should the rule 

provide that compliance with one rule 

would satisfy the requirements of the 

other, given the similarities of the two 

rules? Why or why not? 

• The application of the proposed 

rule to registered advisers to private 

funds seeks to balance our policy goal 

with the anticipated costs of the 

proposed measures. Do commenters 

agree with this approach? If not, what 

would be a more effective way of 

achieving our goals? 

• Should the rule apply to all 

advisers to private funds, rather than to 

just advisers to private funds that are 

registered or are required to be 

registered? Should it apply to exempt 

reporting advisers? Why or why not? 

• Similarly, should it apply in the 

context of all pooled investment vehicle 

clients (e.g., funds that rely on section 

3(c)(5) of the Investment Company Act), 

rather than just in the context of those 

that meet the Advisers Act definition of 

private fund? Should it apply more 

broadly to any advisory account with 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16916 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

134See generally Staff Responses to Questions 

About the Custody Rule, available at https://

www.sec.gov/divisions/investment/custody_faq_

030510.htm. 

financial statements that can be 

audited? Why or why not? 

• Should the rule provide any full or 

partial exceptions, such as when an 

adviser plays no role in valuing the 

fund’s assets, receives little or no 

compensation for its services, or 

receives no compensation based on the 

value of the fund’s assets? Should the 

rule provide exceptions for private 

funds below a certain asset threshold 

(e.g., less than $5 million)? A higher or 

lower amount? Should the rule provide 

exemptions for private funds that have 

only related person investors, or that 

have a limited number of investors, 

such as 5 or fewer investors? If yes, 

please identify which advisers or funds 

we should except, from which aspects 

of the proposed audit rule, and why. 

• Should the rule apply to a subadviser to a private fund? In situations 

where a fund has multiple advisers, is 

it clear that a single audit of the fund’s 

financial statements may satisfy the 

proposed audit rule for all of the 

advisers subject to the rule? 

• Should the alternative of ‘‘taking all 

reasonable steps’’ to cause a private 

fund client to be audited apply in any 

situation, rather than just in situations 

where the adviser is not in a control 

relationship with its fund client? Why 

or why not? Is it sufficiently clear how 

an investment adviser can establish that 

it has ‘‘taken all reasonable steps’’ to 

cause a private fund client to obtain an 

audit? 

• Should the rule require accountants 

performing the independent public 

audits to be registered with the PCAOB, 

as proposed? Should the rule limit the 

pool of accountants to those who are 

subject to inspection by the PCAOB, as 

proposed? If the rule does not include 

these requirements, should the rule 

impose any alternative or additional 

requirements on such accountants? If so, 

describe these additional requirements 

and explain why they are necessary or 

appropriate. 

• Do commenters agree that the 

availability of accountants to perform 

services for purposes of the proposed 

audit rule is sufficient and that even 

advisers in foreign jurisdictions (or with 

private fund clients in foreign 

jurisdictions) would not have significant 

difficulty in finding a local accountant 

that is eligible to perform an audit under 

the proposed rule? Do advisers have 

reasonable access to independent public 

accountants that are registered with, and 

subject to inspection by, the PCAOB in 

the foreign jurisdictions in which they 

operate? If not, how should the rule 

address this issue? 

• Should the rule require advisers to 

obtain audits performed under rule 1– 

02(d) of Regulation S–X, as proposed? If 

not, what other auditing standards 

should the rule allow? Are there certain 

non-U.S. auditing standards that the 

proposed rule should explicitly 

include? 

• Should the rule require private 

funds to prepare audited financial 

statements in accordance with generally 

accepted accounting principles, as 

proposed? Should the rule include any 

additional requirements regarding the 

preparation of financial statements? If 

so, what requirements, and why? 

• As proposed, should financial 

statements prepared in accordance with 

accounting standards other than U.S. 

GAAP for foreign private funds meet the 

requirements of the rule provided they 

contain information substantially 

similar to statements prepared in 

accordance with U.S. GAAP, material 

differences with U.S. GAAP are 

reconciled, and the reconciliation is 

distributed to investors along with the 

financial statements? If so, should we 

specify what ‘‘substantially similar’’ 

means? 

• Would there be unique challenges 

to complying with the rule for auditors 

and advisers to private funds in foreign 

jurisdictions? For example, might 

certain advisers or auditors face 

challenges in complying with the 

proposed rule’s Commission 

notification requirement, including 

because of applicable privacy and other 

local laws? If so, what would alleviate 

these challenges and still achieve the 

policy goals of the proposed audit rule? 

• Do commenters agree that the 

proposed rule’s requirement to 

distribute the audited financial 

statements promptly would provide 

appropriate flexibility regarding the 

timing of the distribution of audited 

financial statements? Should there 

nevertheless be an outer limit on the 

number of days an investment adviser 

has from its fiscal year end for the 

distribution of audited financial 

statements? If so, what should that limit 

be? Would it be more appropriate for 

distribution to be required within 120 

days of the end of the fund’s fiscal year, 

as under the custody rule? 

Alternatively, would a longer or shorter 

period be appropriate in most 

circumstances? Should the timeline for 

distributing audited financial statements 

align with the timeline for distributing 

quarterly statements under the proposed 

quarterly statement rule? Why or why 

not? We understand that funds of funds 

or certain funds in master-feeder 

structures (including those advised by 

related persons) have difficulty 

satisfying the 120-day requirement and 

that our staff has indicated they would 

not recommend enforcement if certain 

of these funds satisfy the distribution 

requirement within 180 or 260 days of 

the fund’s fiscal year end, depending on 

a variety of circumstances.134 If the rule 

contained a specific distribution 

deadline, would these types of funds 

need a separate deadline or other 

special treatment? 

• Instead of requiring prompt 

distribution of the audited financial 

statement to investors, should we 

require the statement to be distributed 

or made available to investors upon 

request? 

• Should the rule provide additional 

flexibility, such as for situations in 

which the adviser can demonstrate that 

it reasonably believed that it would be 

able to comply with the rule but failed 

due to certain unforeseeable 

circumstances? 

• Should the rule require annual 

audits, as proposed? Should the rule 

require an audit upon a private fund’s 

liquidation, as proposed? Should we 

modify either or both of these 

requirements? If so, how should we 

modify these requirements, and why? 

• Advisers would be required to 

comply with the proposed audit rule 

beginning with their first fiscal year 

after the compliance date and any 

liquidation that occurs after the 

compliance date. Advisers would also 

be required to obtain an audit annually. 

We understand that newly formed and 

liquidating funds may face unique 

challenges. For instance, the value 

provided by an audit of a very short 

period of time, such as a period of less 

than three-months (a ‘‘stub period’’), 

may be diminished because there is a 

lack of comparability in the information 

provided. In addition, we understand 

that the cost of obtaining an audit 

covering a few months can be similar to 

the cost of an audit covering an entire 

fiscal year. We further understand that 

when newly formed entities have few 

financial transactions and/or 

investments, obtaining an audit, relative 

to the investor protections ultimately 

offered by obtaining the audit, may be 

burdensome. Should the rule allow 

newly formed or liquidating entities to 

obtain an audit less frequently than 

annually to avoid stub period audits? 

Should the rule permit advisers to 

satisfy the audit requirement by relying 

on an audit on an interval other than 

annually when a fund is liquidating? 

For example, should we allow advisers 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16917 

135Proposed rule 211(h)(2)–2. The proposed rule 

would not apply to advisers that are not required 

to register as investment advisers with the 

Commission, such as state-registered advisers and 

exempt reporting advisers. 

136See, e.g., Private Equity International, GP-Led 

Secondaries Report (Feb. 28, 2021), available at 

https://www.privateequityinternational.com/gp-ledsecondaries-report-2021/ (noting one industry 

participant estimated that adviser-led secondary 

transactions accounted for $26 billion (or 44% of 

the secondary market) in 2020, while another 

estimated that they accounted for more than $30 

billion (or more than 50% of the secondary 

market)). 

to rely on an audit of a fund every two 

years during the liquidation process? 

• If the rule were to permit audits less 

frequently than on an annual basis, 

should it also include additional 

restrictions or requirements? If so, what 

restrictions or requirements, and why? 

For instance, should it require 

investment advisers to create and 

distribute alternative financial reporting 

for the fund to investors (e.g., cash-flow 

audit or asset verification)? 

Alternatively, or in addition to 

alternative financial reporting, should 

the rule require advisers to obtain a 

third-party examination? If so, what 

should the examination consist of, and 

why? For example, would allowing 

advisers to obtain an audit less 

frequently than annually during a 

liquidation raise investor protection 

concerns that additional requirements 

could address given the potential for a 

liquidation to last for an extended 

period? If so, what additional 

requirements, and why? For example, 

should advisers be required to provide 

notice to investors of their intent to 

liquidate an entity in these 

circumstances? Should advisers be 

required to obtain investor consent prior 

to satisfying the audit requirement by 

relying on audits on a less than annual 

basis? Should we set an outer limit for 

the period such an audit could cover 

(e.g., 15 months)? 

• Should the rule define 

‘‘liquidation’’ for purposes of the 

liquidation audit requirement? If so, 

how? For example, should we base such 

a definition on a certain percentage of 

assets under management of the entity 

from or over previous fiscal period(s) or 

a stated threshold based on an absolute 

dollar amount of the entity’s assets 

under management? Should we base the 

definition on a calculation of the ratio 

of the management fees assessed on 

assets under management of the entity 

or some other basis, for example, to 

detect whether an adviser is charging 

management fees on a very small 

amount of assets? 

• Are there risks posed to investors 

when an entity is liquidating that the 

proposed rule does not address? If so, 

please describe those risks. How should 

we modify the rule to address such 

risks? 

• Are there some types of investments 

that pose a greater risk of 

misappropriation or loss to investors 

during a liquidation that the rule should 

specifically address to provide greater 

investor protection? If so, please 

describe the investment type; the 

particular risk the investment type 

poses to investors during liquidation; 

and how to modify the proposed rule to 

address such investor risk. 

• We are not proposing the filing of 

a copy of the audit report or a copy of 

the audited financial statements with 

the Commission; should the rule 

contain such a requirement? Why or 

why not? 

• Would the requirement for an 

accountant to comply with the 

notification requirement change the 

approach that an accountant would take 

with respect to audits that normally are 

performed for purposes of satisfying the 

custody rule? If so, how? 

• Should we, as proposed, require 

advisers to enter into, or cause a private 

fund to enter into, a written agreement 

with the independent public accountant 

completing the audit to notify the 

Commission in connection with a 

modified opinion or termination? 

• Do commenters agree that the 

professional engagement period of an 

audit performed under the rule should 

begin and end as indicated in 

Regulation S–X rule 2–01(f)(5), as 

proposed? If not, why not? 

• As noted above, the proposed 

Commission notification provision bears 

some similarities to, and is drawn from 

our experience with, a similar custody 

rule requirement in the surprise 

examination context with which we 

believe advisers may likely already have 

some familiarity. The regulations in 17 

CFR 240.17a–5 (rule 17a–5) require a 

broker or dealer’s self-report to the 

Commission within one business day 

and to provide a copy to the accountant. 

The accountant must report to the 

Commission about any aspects of the 

broker or dealer’s report with which the 

accountant does not agree. If the broker 

or dealer fails to self-report, the 

accountant must report to the 

Commission to describe any material 

weaknesses or any instances of noncompliance that triggered the 

notification requirement. Should the 

audit rule contain similar requirements? 

Why or why not? Are private fund 

advisers and the accountants that 

perform private fund financial statement 

audits more familiar with Rule 17a–5’s 

notification requirement than the 

custody rule’s notification requirement? 

• Do commenters agree that the 

related proposed amendments to the 

books and records rule would facilitate 

compliance with the proposed audit 

rule? What additional or alternative 

amendments should the rule include, if 

any? 

C. Adviser-Led Secondaries 

We propose to require an adviser to 

obtain a fairness opinion in connection 

with certain adviser-led secondary 

transactions where an adviser offers 

fund investors the option to sell their 

interests in the private fund, or to 

exchange them for new interests in 

another vehicle advised by the adviser. 

This would provide an important check 

against an adviser’s conflicts of interest 

in structuring and leading a transaction 

from which it may stand to profit at the 

expense of private fund investors. The 

proposed adviser-led secondaries rule 

would prohibit an adviser from 

completing an adviser-led secondary 

transaction with respect to any private 

fund, unless the adviser distributes to 

investors in the private fund, prior to 

the closing of the transaction, a fairness 

opinion from an independent opinion 

provider and a summary of any material 

business relationships the adviser or 

any of its related persons has, or has had 

within the past two years, with the 

independent opinion provider.135

Investments in closed-end private 

funds are typically illiquid and require 

a long-term investor commitment of 

capital. Such funds generally do not 

permit investors to withdraw or redeem 

their fund interests prior to the end of 

the term. Open-end private funds may 

also limit or restrict an investor’s ability 

to withdraw or redeem its interest, for 

example, with side pockets or illiquid 

sleeves. Without the ability to cash out 

all or a portion of their interest from the 

fund, investors have historically sought 

liquidity by selling their interests on the 

secondary market to third parties. 

Advisers typically have a relatively 

minor role in such ‘‘investor-led’’ 

transactions, as investors engage in the 

transaction directly with the prospective 

purchaser. 

In recent years, advisers have become 

increasingly active in the secondary 

market. The number of ‘‘adviser-led’’ 

transactions has increased, with the deal 

value of such transactions representing 

a meaningful portion of the secondary 

market, particularly for closed-end 

private funds.136 Adviser-led 

transactions are similar to investor-led 

transactions in that they typically 

provide a mechanism for investors to 

obtain liquidity; however, they also 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16918 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

137An investor would typically obtain liquidity 

in the event it elects to sell—rather than roll—its 

fund interest. 

138Proposed rule 211(h)(1)–1. 

139We would not consider the proposed rule to 

apply to cross sales where the adviser does not offer 

the private fund’s investors the choice to sell, 

convert, or exchange their fund interest. 

140As a fiduciary, the adviser is obligated to act 

in the fund’s best interest and to make full and fair 

disclosure to the fund of all conflicts and material 

facts associated with the adviser-led transaction. 

See, e.g., Commission Interpretation Regarding 

Standard of Conduct for Investment Advisers, 

Investment Advisers Act Release No. 5248 (June 5, 

2019) [84 FR 33669 (July 12, 2019)], at 24–25 (‘‘2019 

IA Fiduciary Duty Interpretation’’). See also 

EXAMS Private Funds Risk Alert 2020, supra 

footnote 9. 

141Proposed rule 211(h)(1)–1 (defining ‘‘fairness 

opinion’’). 

142Proposed rule 211(h)(1)–1. 

143See supra section II.A for a discussion of the 

definition of ‘‘related person.’’ 

144Proposed rule 211(h)(2)–2. 

have the potential to provide additional 

benefits to advisers and investors. For 

example, an adviser-led transaction may 

seek to secure additional capital and/or 

time to maximize the value of fund 

assets. An adviser may accomplish this 

by permitting investors to ‘‘roll’’ their 

interests into a new vehicle that has a 

longer term and/or additional capital to 

invest.137

Adviser-led secondaries often are 

highly bespoke transactions that can 

take many forms. For purposes of the 

rule, we propose to define them as 

transactions initiated by the investment 

adviser or any of its related persons that 

offer the private fund’s investors the 

choice to: (i) Sell all or a portion of their 

interests in the private fund; or (ii) 

convert or exchange all or a portion of 

their interests in the private fund for 

interests in another vehicle advised by 

the adviser or any of its related 

persons.138 We generally would 

consider a transaction to be initiated by 

the adviser if the adviser commences a 

process, or causes one or more other 

persons to commence a process, that is 

designed to offer private fund investors 

the option to obtain liquidity for their 

private fund interests. However, 

whether the adviser or its related person 

initiates a secondary transaction 

requires a facts and circumstances 

analysis. We would generally not view 

a transaction as initiated by the adviser 

if the adviser, at the unsolicited request 

of the investor, assists in the secondary 

sale of such investor’s fund interest. 

This definition generally would 

include secondary transactions where a 

fund is selling one or more assets to 

another vehicle managed by the adviser, 

if investors have the option either to 

obtain liquidity or to roll all or a portion 

of their interests into the other vehicle. 

Examples of such transactions may 

include single asset transactions (such 

as the fund selling a single asset to a 

new vehicle managed by the adviser), 

strip sale transactions (such as the fund 

selling a portion of multiple assets to a 

new vehicle managed by the adviser), 

and full fund restructurings (such as the 

fund selling all of its assets to a new 

vehicle managed by the adviser). The 

proposed definition also would capture 

secondary transactions that may not 

involve a cross sale between two 

vehicles managed by the same 

adviser.139 For example, an adviser may 

arrange for one or more new investors 

to purchase fund interests directly from 

the existing investors as part of a 

‘‘tender offer’’ or similar transaction. 

While adviser-led transactions can 

provide liquidity for investors and 

secure additional time and capital to 

maximize the value of fund assets, they 

also raise certain conflicts of interest. 

The adviser and its related persons 

typically are involved on both sides of 

the transaction and have interests in the 

transaction that are different than, or in 

addition to, the interests of the private 

fund investors. For example, because 

the adviser may have the opportunity to 

earn economic and other benefits 

conditioned upon the closing of the 

secondary transaction, such as 

additional management fees or carried 

interest, the adviser generally has a 

conflict of interest in setting and 

negotiating the transaction terms. 

Ensuring that the private fund and the 

investors that participate in the 

secondary transaction are offered a fair 

price is a critical component of 

preventing the type of harm that might 

result from the adviser’s conflict of 

interest in leading the transaction.140

Accordingly, prior to the closing of the 

transaction, the proposed rule would 

require advisers to obtain a written 

opinion stating that the price being 

offered to the private fund for any assets 

being sold as part of an adviser-led 

secondary transaction is fair.141 This 

process would provide an important 

market check for private fund investors 

by providing some assurance that the 

price being offered is based on an 

underlying valuation that falls within a 

range of reasonableness. We understand 

that certain advisers obtain fairness 

opinions as a matter of best practice 

because investors often lack access to 

sufficient information, or may not have 

the capabilities or resources, to conduct 

their own analysis of the price. 

However, to the extent that this practice 

is not universal, the proposed rule 

would mandate it in connection with all 

adviser-led secondary transactions. 

To mitigate the potential influence of 

the adviser’s conflict of interest further, 

the rule would require these opinions to 

be issued only by an ‘‘independent 

opinion provider,’’ which is one that (i) 

provides fairness opinions in the 

ordinary course of its business and (ii) 

is not a related person of the adviser.142

The ordinary course of business 

requirement would largely correspond 

to persons with the expertise to value 

illiquid and esoteric assets based on 

relevant criteria. The requirement that 

the opinion provider not be a related 

person of the adviser would reduce the 

risk that certain affiliations could result 

in a biased opinion.143

We recognize, however, that other 

business relationships may have the 

potential to result, or appear to result, 

in a biased opinion, particularly if such 

relationships are not disclosed to 

private fund investors. For example, an 

opinion provider that receives an 

income stream from an adviser for 

performing services unrelated to the 

issuance of the opinion might not want 

to jeopardize its business relationship 

with the adviser by alerting the private 

fund investors that the price being 

offered is unfair (or by otherwise 

refusing to issue the fairness opinion). 

By requiring disclosure of such material 

relationships, the proposed rule would 

put private fund investors in a position 

to evaluate whether any conflicts 

associated with such relationships may 

cause the opinion provider to deliver a 

biased opinion. Thus, the proposed rule 

would require the adviser to prepare 

and distribute to private fund investors 

a summary of any material business 

relationships the adviser or any of its 

related persons has, or has had within 

the past two years, with the 

independent opinion provider. Whether 

a business relationship would be 

material under the proposed rule would 

require a facts and circumstances 

analysis; however, for purposes of the 

proposed rule, we believe that audit, 

consulting, capital raising, investment 

banking, and other similar services 

would typically meet this standard. 

The proposed rule would require an 

adviser to distribute the opinion and the 

material business relationship summary 

to investors.144 We believe that this 

proposed requirement would ensure 

that investors receive the benefit of an 

independent price assessment, which 

we believe will improve their decisionmaking ability and their overall 

confidence in the transaction. 

We request comment on all aspects of 

the proposed rule, including the 

following items: 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16919 

• Do commenters agree that adviserled secondary transactions can be of 

some benefit to a private fund and its 

investors? 

• Do commenters agree with the 

scope of the proposed rule? Should the 

rule apply to all investment advisers? 

Why or why not? What are the factors 

that weigh in favor of expanding the 

scope of the proposed rule to apply to 

a broader scope of advisers than 

proposed? Are there particular types of 

advisers that should or should not be 

subject to the rule? Should the rule only 

apply when the adviser or its related 

person is general partner (or equivalent) 

of a fund that is party to the transaction? 

• Should certain adviser-led 

transactions be exempt from the 

proposed rule? For example, if the 

adviser conducts a competitive sale 

process for the assets being sold, which 

ultimately leads to the price, should 

advisers still be required to obtain a 

fairness opinion? Do competitive bids 

typically represent net asset value? Do 

prospective purchasers typically bid at 

a discount to net asset value? Does net 

asset value always correspond to the 

current value of the assets being sold? 

Why or why not? Are there other price 

discovery processes that we should 

require to protect investors? 

• Should certain adviser-led 

transactions be exempt from the rule, 

such as adviser-led transactions 

involving liquid funds? For example, if 

the underlying assets being sold in the 

transaction are predominantly publicly 

traded securities, should advisers still 

be required to obtain a fairness opinion? 

Do such transactions present the same 

concerns as adviser-led secondary 

transactions involving illiquid funds 

where the underlying assets are 

typically illiquid and not listed or 

quoted on a securities exchange? Are 

there other hedge fund transactions that 

we should exempt from the rule, such 

as hedge fund restructurings where an 

adviser may be merging the portfolios of 

two different hedge funds and gives all 

affected investors the option to redeem 

or convert/exchange their interests into 

the new fund? Should the exemption 

depend on whether the price of the 

transaction is based on net asset value? 

Why or why not? 

• Are there other transactions for 

which we should require private fund 

advisers to obtain a fairness opinion? 

For example, should we require advisers 

to obtain a fairness opinion before 

certain cross transactions between 

private funds it manages? If so, which 

transactions? Should we provide certain 

cross transaction exemptions, such as 

exemptions for bridge financings or 

syndications where the selling fund 

transfers the investments within a short 

period at a price equal to cost plus 

interest? 

• Should the scope of the fairness 

opinion be limited to the price, as 

proposed? Alternatively, should we 

require the fairness opinion to cover all, 

or certain other, terms of the 

transaction? For example, should we 

revise the definition of ‘‘fairness 

opinion’’ to a written opinion stating 

that the terms of the adviser-led 

secondary transaction are fair to the 

private fund? Why or why not? 

• Should the rule give investment 

advisers the option to obtain either a 

fairness opinion or a third-party 

valuation? Why or why not? What are 

the advantages and disadvantages of a 

third-party valuation as compared to a 

fairness opinion, and vice versa? 

• We request comment on the 

proposed use of ‘‘related person.’’ Do 

commenters agree that the fairness 

opinion should be issued by a person 

that is not a related person of the 

adviser? Should we adopt a different 

definition of ‘‘related person’’ than the 

one proposed? 

• The proposed rule would require an 

‘‘independent opinion provider’’ to 

provide fairness opinions ‘‘in the 

ordinary course of its business.’’ Do 

commenters agree with this approach? 

• Instead of requiring disclosure of 

any material business relationships 

between the adviser (or its related 

persons) and the independent opinion 

provider, should the rule prohibit firms 

with certain business relationships with 

the adviser, its related persons, or the 

private fund from providing the fairness 

opinion? For example, if a firm has 

provided consulting, prime broker, 

audit, capital raising, or investment 

banking services to the private fund or 

the adviser or its related persons within 

a certain time period—such as two or 

three years—should the rule prohibit 

the firm from providing the opinion? If 

so, should the rule include a threshold 

of materiality, regularity, or frequency 

for some or all of such services to trigger 

such a prohibition? 

• Should we require the independent 

opinion provider to have any specific 

qualifications, licenses, or registrations? 

• Should we define the term 

‘‘transaction’’ in the definition of 

‘‘adviser-led secondary transaction’’? If 

so, how should the rule define 

‘‘transaction’’? Should we reference the 

various types of adviser-led secondary 

transactions in the definition? For 

example, should ‘‘transaction’’ include 

only single asset transactions, strip sale 

transactions, and other similar 

secondary transactions? Should we 

include in the definition of ‘‘adviser-led 

secondary transaction’’ transactions 

initiated by the adviser’s related 

persons? 

• Should we define, or provide 

additional guidance regarding, the 

phrase ‘‘initiated by the investment 

adviser or any of its related persons’’? 

Should we define, or provide additional 

guidance regarding, the role the adviser 

would have to play in a secondary 

transaction for it to be considered an 

adviser-led transaction subject to the 

proposed rule? 

• Should the rule require the fairness 

opinion to state that the private fund 

and/or its investors may rely on the 

opinion? Why or why not? 

• Should we require the fairness 

opinion to be obtained on behalf of the 

private fund as proposed? Alternatively, 

should we require the fairness opinion 

to be obtained on behalf of the private 

fund investors? Are there characteristics 

of certain types of adviser-led 

transactions, such as tender offers, that 

would require the fairness opinion to be 

obtained on behalf of the private fund 

investors rather than the private fund? 

• Should the adviser be required to 

distribute a summary of any material 

business relationships the adviser or its 

related persons has, or has had within 

the past two years, with the 

independent opinion provider as 

proposed? Should we provide guidance 

or impose requirements regarding the 

level of detail advisers should include 

in the summary? For example, should 

we require advisers to disclose the total 

amount paid to the independent 

opinion provider by the adviser or its 

related persons, if applicable? Why or 

why not? Is two years the appropriate 

look-back period? Are there any other 

conflict disclosures we should require 

in the fairness opinion or otherwise 

require to be made available to 

investors? 

• Should we define ‘‘material 

business relationship’’ for purposes of 

the proposed rule? Should the rule 

include a threshold of regularity or 

frequency (in addition to or in lieu of 

the materiality threshold) for some or all 

of such relationships or services to 

trigger a disclosure requirement? 

• Should we require advisers to 

distribute the fairness opinion to 

investors as proposed? Alternatively, 

should we require advisers to only 

distribute or make the fairness opinion 

available to investors upon request? 

• We recognize that certain adviserled transactions may not involve 

investors rolling their interests into a 

new vehicle managed by the adviser. 

For example, an adviser may arrange for 

a new investor to offer to purchase fund 

interests directly from existing 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16920 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

145See supra footnote 106 (describing the record 

retention requirements under the books and records 

rule). 

146See High-End Bargaining Problems, Vanderbilt 

Law Review (forthcoming), Professor William 

Clayton (Jan. 8, 2022) at 9 (challenging ‘‘the idea 

that sophisticated parties will demand appropriate 

levels of disclosure and appropriate processes 

without any intervention by policymakers . . .’’). 

147See sections 206 and 211(h)(2) of the Act. 

148Any attempt to avoid any of the proposed 

rules’ restrictions, depending on the facts and 

circumstances, would violate section 208(d) of the 

Act’s general prohibitions against doing anything 

indirectly which would be prohibited if done 

directly. Section 208(d) of the Advisers Act. 

investors, such as a tender offer. Do 

commenters agree that the first prong of 

the definition would cover such 

transactions? Should the rule treat such 

transactions differently? 

• Should the rule apply to adviser-led 

transactions initiated by the adviser or 

its related persons as proposed? Is the 

definition of ‘‘related person’’ too broad 

in this context such that it would 

capture secondary transactions initiated 

by third parties unrelated to the adviser? 

Should we revise the definition of 

‘‘related person’’ to include an 

investment discretion requirement? 

Similarly, is the definition of ‘‘control’’ 

too broad in this context? 

• We recognize that, for certain 

adviser-led transactions, the closing of 

the underlying deal may not occur 

simultaneously with the closing of the 

new vehicle managed by the adviser. 

How should the rule take this into 

account, if at all? For example, should 

we clarify that, for purposes of the rule, 

an adviser would not be deemed to have 

completed an adviser-led secondary 

transaction until the underlying deal 

has closed (if applicable)? Alternatively, 

should we prohibit an adviser from 

calling investor capital prior to 

obtaining and distributing the fairness 

opinion? 

1. Recordkeeping for Adviser-Led 

Secondaries 

We propose amending rule 204–2 

under the Advisers Act to require 

advisers to retain books and records to 

support their compliance with the 

proposed adviser-led secondaries rule, 

which would help facilitate the 

Commission’s inspection and 

enforcement capabilities. We propose to 

require advisers to retain a copy of the 

fairness opinion and material business 

relationship summary distributed to 

investors, as well as a record of each 

addressee, the date(s) the opinion was 

sent, address(es), and delivery 

method(s).145 These proposed 

requirements would facilitate our staff’s 

ability to assess an adviser’s compliance 

with the proposed rule and would 

similarly enhance an adviser’s 

compliance efforts. 

We request comment on this aspect of 

the proposed rule: 

• Should we require advisers to 

maintain the proposed records or would 

these requirements be overly 

burdensome for advisers? Are there 

alternative or additional recordkeeping 

requirements we should impose? 

• Should we require advisers to retain 

a record of each addressee, the date(s) 

the statement was sent, address(es), and 

delivery method(s) as proposed? Why or 

why not? 

D. Prohibited Activities 

We are also proposing to prohibit a 

private fund adviser from engaging in 

certain sales practices, conflicts of 

interest, and compensation schemes that 

are contrary to the public interest and 

the protection of investors. We have 

observed certain industry practices over 

the past decade that have persisted 

despite our enforcement actions and 

that disclosure alone will not 

adequately address.146 As discussed 

below, we believe that these sales 

practices, conflicts of interest, and 

compensation schemes must be 

prohibited in order to prevent certain 

activities that could result in fraud and 

investor harm.147 We believe these 

activities incentivize advisers to place 

their interests ahead of their clients’ 

(and, by extension, their investors’), and 

can result in private funds and their 

investors, particularly smaller investors 

that are not able to negotiate preferential 

deals with the adviser and its related 

persons, bearing an unfair proportion of 

fees and expenses. The proposed rule 

would prohibit these activities 

regardless of whether the private fund’s 

governing documents permit such 

activities or the adviser otherwise 

discloses the practices and regardless of 

whether the private fund investors (or 

governance mechanisms acting on their 

behalf, such as limited partner advisory 

committees) have consented to the 

activities either expressly or implicitly. 

Also, the proposed rule would prohibit 

these activities even if they are 

performed indirectly, for example by an 

adviser’s related persons, because the 

activities have an equal potential to 

harm the fund and its investors 

regardless of whether the adviser 

engages in the activity directly or 

indirectly.148 As noted above, we 

believe these prohibitions are necessary 

given the lack of governance 

mechanisms that would help check 

overreaching by private fund advisers. 

Proposed rule 211(h)(2)–1 would 

prohibit an investment adviser to a 

private fund, directly or indirectly, from 

engaging in certain activities with 

respect to the private fund or any 

investor in that private fund, including: 

(i) Charging certain fees and expenses 

to a private fund or portfolio 

investment, including accelerated 

monitoring fees; fees or expenses 

associated with an examination or 

investigation of the adviser or its related 

persons by governmental or regulatory 

authorities; regulatory or compliance 

expenses or fees of the adviser or its 

related persons; or fees and expenses 

related to a portfolio investment on a 

non-pro rata basis when multiple 

private funds and other clients advised 

by the adviser or its related persons 

have invested (or propose to invest) in 

the same portfolio investment; 

(ii) Reducing the amount of any 

adviser clawback by the amount of 

certain taxes; 

(iii) Seeking reimbursement, 

indemnification, exculpation, or 

limitation of its liability by the private 

fund or its investors for a breach of 

fiduciary duty, willful misfeasance, bad 

faith, negligence, or recklessness in 

providing services to the private fund; 

and 

(iv) Borrowing money, securities, or 

other fund assets, or receiving an 

extension of credit, from a private fund 

client. 

This proposed rule would apply to all 

advisers to private funds, regardless of 

whether they are registered with the 

Commission or one or more states, 

exempt reporting advisers, or prohibited 

from registration. We believe that this 

scope is appropriate since we believe 

these activities are contrary to the 

public interest and the protection of 

investors and have the potential to lead 

to fraud. We are proposing this rule 

under sections 206 and 211 of the 

Advisers Act, which sections apply to 

all investment advisers, regardless of 

SEC-registration status. 

We request comment on the scope of 

the proposed rule, including the 

following items: 

• Should the rule apply to all 

advisers as proposed? Alternatively, 

should the rule apply only to SECregistered advisers? If so, why? 

• Should the rule only prohibit these 

activities with respect to an adviser’s 

private fund clients and the investors in 

those private funds? Should the rule 

apply more broadly or more narrowly? 

For example, should the rule apply to 

such activities with respect to all clients 

of an adviser? Should the rule apply to 

such activities with respect to persons 

to which the adviser offers coVerDate Sep<11>2014 18:08 Mar 23, 2022 Jkt 256001 PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 E:\FR\FM\24MRP3.SGM 24MRP3

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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16921 

149See, e.g., Exemptions for Advisers to Venture 

Capital Funds, Private Fund Advisers With Less 

Than $150 Million in Assets Under Management, 

and Foreign Private Advisers, Investment Advisers 

Act Release No. 3222 (June 22, 2011) [76 FR 39645 

(July 6, 2011)]; Marketing Release, supra footnote 

61, at n.199. 

150See Registration Under the Advisers Act of 

Certain Hedge Fund Advisers, Investment Advisers 

Act Release No. 2333 (Dec. 2, 2004) [69 FR 72054, 

72072 (Dec. 10, 2004)]. 

151Proposed rule 211(h)(2)–1(a)(1). 

152Monitoring fees frequently are based on a 

percentage of EBITDA (earnings before income, 

taxes, depreciation, and amortization). The 

agreements often renew automatically and typically 

include periodic fee increases. 

153Common triggering events include initial 

public offerings, dispositions, and change of control 

events. 

154Such incentive may be mitigated, in certain 

circumstances, to the extent the adviser’s 

performance-based compensation would also be 

reduced in whole or part by the receipt of these 

payments. 

155To the extent the adviser ultimately does not 

provide the services, however, the proposed rule 

would require the adviser to refund any prepaid 

amounts attributable to the unperformed services. 

See proposed rule 211(h)(2)–1(a)(1) (prohibiting an 

adviser from charging a portfolio investment for 

fees in respect of any services that the investment 

adviser does not provide to the portfolio 

investment). 

investment opportunities even if the 

adviser does not classify them as its 

clients? 

• We have historically taken the 

position that most of the substantive 

provisions of the Advisers Act do not 

apply with respect to the non-U.S. 

clients (including funds) of a registered 

offshore adviser.149 In taking this 

approach, the Commission noted that 

U.S. investors in an offshore fund 

generally would not expect the full 

protection of the U.S. securities laws 

and that U.S. investors may be 

precluded from an opportunity to invest 

in an offshore fund if their participation 

would result in full application of the 

Advisers Act and rules thereunder.150

Similarly, the proposed prohibited 

activities rule would not apply to a 

registered offshore adviser’s private 

funds organized outside of the United 

States, regardless of whether the private 

funds have U.S. investors. Do 

commenters agree that registered 

offshore advisers should not be subject 

to this rule with respect to their offshore 

private fund clients or offshore 

investors? Should other rules in this 

rulemaking package take the same 

approach, or a different approach, with 

respect to a registered offshore adviser’s 

offshore private fund clients? Please 

explain. 

• Instead of prohibiting these 

activities, should the rule prohibit these 

activities unless the adviser satisfies 

certain governance and other conditions 

(e.g., disclosure to investors in all 

relevant funds/vehicles, approval by the 

limited partner advisory committee (or 

other similar body) or directors)? 

Should the rule prohibit these activities 

unless the adviser obtains approval for 

them by a majority (by number and/or 

in interest) of investors? Should the rule 

permit non pro-rata fee and expense 

allocations if such practice is disclosed 

to, and consented by, co-investors? 

• Should we amend the books and 

records rule to require advisers to retain 

specific documentation evidencing 

compliance with the prohibited 

activities rule? For example, records 

showing how fees and expenses 

associated with an examination or 

investigation of the adviser or its related 

persons by governmental or regulatory 

authorities were paid or showing the 

allocations of fees and expenses related 

to a portfolio investment on an 

investment by investment basis? Would 

advisers be able to obtain or generate 

sufficient records to demonstrate 

compliance with all aspects of the 

proposed rule? Should we amend the 

books and records rule to require 

advisers to prepare a memorandum on 

an annual basis attesting to their 

compliance with each aspect of the 

proposed rule? 

1. Fees for Unperformed Services 

First, the prohibited activities rule 

would prohibit an investment adviser 

from charging a portfolio investment for 

monitoring, servicing, consulting, or 

other fees in respect of any services the 

investment adviser does not, or does not 

reasonably expect to, provide to the 

portfolio investment.151 These payments 

sometimes are referred to as 

‘‘accelerated payments.’’ 

An adviser typically receives 

management fees and performancebased compensation for providing 

advisory services to a fund. A fund’s 

portfolio investments may also make 

payments to the adviser and its related 

persons. For example, some private 

fund advisers enter into arrangements 

with a fund’s portfolio investments to 

provide management, consulting, 

financial, servicing, advisory, or other 

services. The adviser and the applicable 

portfolio investment would enter into a 

monitoring agreement or a management 

services agreement documenting the 

payment terms and the services the 

adviser will provide.152 Such 

agreements often include acceleration 

clauses, which permit the adviser to 

accelerate the unpaid portion of the fee 

upon the occurrence of certain 

triggering events, even though the 

adviser will never provide the 

contracted for services.153 The 

accelerated payments reduce the value 

of the portfolio investment upon the 

private fund’s exit and thus reduce 

returns to investors. 

Because the private fund (and, by 

extension, its investors) typically bears 

the costs of such payments indirectly 

and the adviser typically receives the 

benefit, the receipt of such fees gives 

rise to conflicts of interest between the 

fund (and, by extension, its investors), 

on the one hand, and the adviser, on the 

other hand. For example, the adviser 

receives the benefit of the accelerated 

fees without incurring any costs 

associated with having to provide any 

services. The private fund, however, 

may have a lower return on its 

investment because the accelerated 

monitoring fees may reduce the 

portfolio investment’s available cash, in 

turn reducing the investment’s value in 

advance of a public offering or sale 

transaction. An adviser also may have 

an incentive to cause the fund to exit a 

portfolio investment earlier than 

anticipated, which may result in the 

fund receiving a lesser return on its 

investment.154 Further, the potential for 

the adviser to receive these economic 

benefits creates an incentive for the 

adviser to seek portfolio investments for 

its own benefit rather than for the 

fund’s. We believe prohibiting this 

practice, which distorts the economic 

relationship between the private fund 

and the adviser, would help prevent the 

adviser from placing its own interests 

ahead of the private fund. 

In addition to these conflicts, we 

believe that charging a portfolio 

investment for unperformed services 

creates a compensation scheme that is 

contrary to the public interest and the 

protection of investors because such 

practice unjustly enriches the adviser at 

the expense of the private fund and its 

underlying investors who are not 

receiving the benefit of any services. 

Accordingly, the proposed rule would 

prohibit an adviser from charging these 

types of accelerated payments. 

The prohibited activities rule would 

not prohibit an adviser from receiving 

payment for services actually provided. 

The proposed rule also would not 

prohibit an adviser from receiving 

payments in advance for services that it 

reasonably expects to provide to the 

portfolio investment in the future. For 

example, if an adviser expects to 

provide monitoring services to a 

portfolio investment, the proposed rule 

would not prohibit the adviser from 

charging for those services.155 Rather, 

the proposed rule would prohibit 

compensation schemes where an 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16922 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

156Proposed rules 211(h)(2)–1(a)(2) and (3). This 

prohibition would include fees and expenses 

related to an examination or investigation of the 

adviser by the Commission, including the amount 

of any settlements or fines paid in connection 

therewith. 

157Certain private fund advisers utilize a passthrough expense model where the private fund pays 

for most, if not all, expenses, including the adviser’s 

expenses, but the adviser does not charge a 

management, advisory, or similar fee. We recognize 

that this aspect of the proposed rule would likely 

require advisers that pass on the types of fees and 

expenses we propose to prohibit to re-structure 

their fee and expense model. 

158Advisers may be liable under the antifraud 

provisions of the Federal securities laws if the 

private fund’s offering and organizational 

documents do not authorize such costs to be 

charged to the private fund. 

adviser charges for services that it does 

not reasonably expect to provide. 

We also do not intend to prohibit an 

arrangement where the adviser shifts 

100% of the economic benefit of any 

portfolio investment fee to the private 

fund investors, whether through an 

offset, rebate, or otherwise. We 

recognize that certain advisers offset 

management fees or other amounts 

payable to the adviser at the fund level 

by the amount of portfolio investment 

fees paid to the adviser. However, 

private funds with a 100% management 

fee offset would not comply with the 

proposed rule if there are excess fees 

retained by the adviser where no further 

management fee offset can be applied 

and the private fund investors are not 

offered a rebate or another economic 

benefit equal to their pro rata share of 

any such excess fees. 

We request comment on this aspect of 

the prohibited activities rule, including 

the following items: 

• Are there any scenarios in which 

we should permit an adviser to charge 

a fund’s portfolio investment for 

unperformed services? If so, please 

explain. 

• Should we prohibit an adviser from 

being paid in advance for services it 

reasonably expects to provide in the 

future? Why or why not? 

• As noted above, if an adviser is paid 

in advance, and reasonably expects to 

perform services, but ultimately does 

not provide the contracted for services, 

the proposed rule would require the 

adviser to refund the prepaid amount 

attributable to the unperformed services. 

Do commenters agree with this 

approach? Why or why not? 

• The proposed rule specifically 

references ‘‘monitoring, servicing, 

consulting, or other fees.’’ Do 

commenters agree with this list? Should 

we eliminate any? Are there additional 

or alternative types of remuneration that 

the rule should reference? 

• Do commenters agree that if an 

adviser shifts 100% of the economic 

benefit of any portfolio investment fee 

to the private fund investors, whether 

through an offset, rebate, or otherwise, 

the adviser would not violate the 

proposed rule? Why or why not? We 

recognize that certain tax-sensitive 

investors often waive the right to receive 

their share of any rebates of portfolio 

investment fees. How should the rule 

take into account such waivers, if it all? 

For example, to the extent one investor 

does not accept its share, should the 

rule require the adviser to distribute 

such amount to the other investors in 

the fund? Why or why not? 

• Should the rule instead permit an 

adviser to engage in this activity if the 

adviser satisfies certain disclosure, 

governance, and/or other conditions 

(e.g., disclosure to investors in all 

relevant funds/vehicles, approval by the 

LPAC (or other similar body) or 

directors)? 

• The proposed rule would prohibit 

compensation schemes where an 

adviser charges for services that it does 

not reasonably expect to provide. Is 

‘‘reasonably expect’’ the appropriate 

standard? Should we provide examples 

or guidance to assist advisers in 

complying with this standard? Does this 

standard have the potential to reduce 

the effectiveness of the rule? Are there 

other standards we should adopt? 

2. Certain Fees and Expenses 

The second and third elements of the 

prohibited activities rule would prevent 

an adviser from charging a private fund 

for fees or expenses associated with an 

examination or investigation of the 

adviser or its related persons by any 

governmental or regulatory authority, as 

well as regulatory and compliance fees 

and expenses of the adviser or its 

related persons.156

Advisers incur various fees and 

expenses in connection with the 

establishment and ongoing operations of 

their advisory business. Establishment 

fees and expenses often relate to the 

structuring and organization of the 

adviser’s business, including the 

adviser’s registration with financial 

regulators, such as the Commission. 

Ongoing fees and expenses often relate 

to the adviser’s overhead and 

administrative expenses, such as salary, 

rent, and office supplies. Ongoing 

expenses also may include those 

associated with an examination or 

investigation of the adviser or its related 

persons. 

The proposed rule would prohibit an 

adviser from charging a private fund for 

(i) fees and expenses associated with an 

examination or investigation of the 

adviser or its related persons by any 

governmental or regulatory authority, 

and (ii) regulatory or compliance fees 

and expenses of the adviser or its 

related persons, even where such fees 

and expenses are otherwise disclosed. 

We have seen an increase in private 

fund advisers charging these expenses 

to private fund clients. These types of 

expenses, which are a cost of being an 

investment adviser, should not be 

passed on to private fund investors, 

whether as a separate expense (in 

addition to a management fee) or as part 

of a pass-through expense model.157 For 

example, we believe advisers should 

bear the compliance expenses related to 

their registration with the Commission, 

including fees and expenses related to 

preparing and filing all items and 

corresponding schedules in Form ADV. 

Similarly, we believe that an adviser 

should bear any expenses related to 

state licensing and registration 

requirements applicable to the adviser 

and its related persons, including 

expenses related to registration and 

licensure of advisory personnel who 

contact or solicit investments from state 

pension or similar plans. 

We believe allocating these types of 

expenses to a private fund client is 

contrary to the public interest and is 

harmful to investors because they create 

an incentive for an adviser to place its 

own interests ahead of the private 

fund’s interests and unfairly allocate 

expenses to the fund, even where fully 

disclosed. For example, in some 

circumstances, an adviser may charge a 

fund significant fees and expenses in 

connection with an investigation that 

may not be in the fund’s best interest. 

Further, as discussed above, we believe 

the prohibited fees and expenses are 

related to forming and operating an 

advisory business and thus should be 

borne by the adviser and its owners 

rather than the private fund and its 

investors. 

We do not anticipate this aspect of the 

proposed prohibited activities rule 

would cause a dramatic change in 

practice for most private fund advisers, 

other than for certain advisers that 

utilize a pass-through expense model as 

noted above. We recognize, however, 

that advisers often charge private funds 

for regulatory, compliance, and other 

similar fees and expenses directly 

related to the activities of the private 

fund. The proposed rule would not 

change this practice. For example, the 

proposed rule would not prohibit an 

adviser from charging a private fund for 

all the costs associated with a regulatory 

filing of the fund, such as Form D.158 In 

addition, we acknowledge that it may 

not be clear whether certain fees and 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16923 

159Proposed rule 211(h)(2)–1(a)(4). Because 

performance-based compensation may be allocated 

or granted to individuals and entities otherwise 

unaffiliated with the adviser, the proposed 

definition is drafted broadly to capture any owner 

or interest holder of the adviser or its related 

persons. 

160Proposed rule 211(h)(1)–1. The proposed rule 

would not apply to any clawbacks by an adviser of 

incentive compensation under an arrangement 

subject to Section 956 of the Dodd-Frank Act and 

regulations thereunder. 

161Certain private funds refer to performancebased compensation as carried interest, incentive 

fees, incentive allocations, or profit allocations. 

162For alignment of interest purposes, advisers 

often invest their own capital in the fund alongside 

the third party capital. 

163For tax and other reasons, a related person of 

the adviser, rather than the adviser, often receives 

the performance-based compensation from the 

fund. 

164Fund agreements may require advisers to 

restore performance-based compensation under 

other fact patterns as well. For example, if an 

adviser has received performance-based 

compensation, but the investors have not received 

the requisite preferred return amount, the adviser 

may be subject to a clawback. Any such 

requirement to restore or otherwise return 

performance-based compensation under a private 

fund’s governing agreement would be covered by 

the proposed rule. See proposed rule 211(h)(1)–1 

(defining ‘‘adviser clawback’’ as any obligation of 

the adviser, its related persons, or their respective 

owners or interest holders to restore or otherwise 

return performance-based compensation to the 

private fund pursuant to the private fund’s 

governing agreements). 

expenses relate to the fund or the 

adviser, or it may not be clear until after 

a significant amount of time has passed 

in certain cases. In these circumstances, 

an adviser generally should allocate 

such fees and expenses in a manner that 

it believes in good faith is fair and 

equitable and is consistent with its 

fiduciary duty. 

We request comment on this aspect of 

the prohibited activities rule, including 

the following items: 

• Are there circumstances in which it 

would be appropriate in the public 

interest or for the protection of investors 

for a private fund to bear (i) regulatory 

or compliance expenses of the adviser 

or its related persons or (ii) expenses 

related to an examination or 

investigation of the adviser or its related 

persons? If so, please explain. Should 

we permit private funds to bear these 

fees and expenses if fully disclosed and 

consented to by the private fund 

investors and/or an LPAC (despite the 

limitations of private fund governance 

mechanisms, as discussed above)? 

Should we place any conditions on 

charging these fees and expenses, such 

as caps, management fee offsets, or 

detailed reporting requirements in the 

proposed quarterly statement? 

• The proposed rule would likely 

increase operating costs for advisers that 

have historically charged private funds 

for the types of fees and expenses 

covered by the proposed rules. 

Do commenters believe that advisers 

would increase management fees to 

offset such increase in operating costs? 

• Are there any additional types of 

fees or expenses that we should prohibit 

an adviser from charging to a private 

fund? Alternatively, are there fees and 

expenses that the rule should not 

prohibit? 

• Should we provide exceptions to 

the proposed rules for certain types of 

private funds and/or certain types of 

advisers? For example, should we 

permit a first-time fund adviser to 

charge regulatory and compliance 

expenses to the fund? If so, why? 

• Do commenters agree that many 

advisers do not currently charge private 

funds for the types of fees and expenses 

covered by the proposed rules and, as a 

result, the proposed rules would not 

cause a dramatic change in industry 

practice? Why or why not? To the extent 

commenters disagree, please provide 

supporting data. 

• Will advisers have difficulty in 

determining whether fees and expenses 

relate to the adviser’s activities versus 

the fund’s activities? Should we provide 

guidance to assist advisers in making 

such a determination? If so, what 

guidance should we provide? Should 

the rule list certain types of fees and 

expenses that relate to the adviser’s 

activities versus the fund’s activities? 

• As discussed above, we recognize 

that certain private fund advisers utilize 

a pass-through expense model. Should 

the rule provide any full or partial 

exceptions for advisers utilizing such 

models, particularly where the adviser 

does not charge any management, 

advisory, or similar fees to the private 

fund? 

3. Reducing Adviser Clawbacks for 

Taxes 

The fourth element of the prohibited 

activities rule would prohibit an adviser 

from reducing the amount of any 

adviser clawback by actual, potential, or 

hypothetical taxes applicable to the 

adviser, its related persons, or their 

respective owners or interest holders. 

We propose to define ‘‘adviser 

clawback’’ as any obligation of the 

adviser, its related persons, or their 

respective owners or interest holders to 

restore or otherwise return performancebased compensation to the private fund 

pursuant to the private fund’s governing 

agreements.159 We propose to define 

‘‘performance-based compensation’’ as 

allocations, payments, or distributions 

of capital based on the private fund’s (or 

its portfolio investments’) capital gains 

and/or capital appreciation.160

Investors typically seek to align their 

interests with the adviser’s interest by 

tying the adviser’s compensation to the 

success of the private fund. To 

accomplish this, many private funds 

provide the adviser with a 

disproportionate share of profits 

generated by the fund, often referred to 

as performance-based compensation.161

The adviser’s performance-based share 

of fund profits is often greater than the 

adviser’s ownership percentage in the 

fund.162 Although the percentage can 

vary, a common performance-based 

compensation percentage is 20%, 

meaning that, for each dollar of profit 

generated by the fund, the adviser is 

generally entitled to 20 cents and the 

fund investors are generally entitled to 

the remaining 80 cents. 

Because the profitability of a private 

fund will fluctuate over time, the 

amount of performance-based 

compensation to which the adviser is 

entitled will also fluctuate. For example, 

a fund may initially generate significant 

profits due to early realizations of 

successful investments, resulting in 

distributions to the adviser. However, 

the fund may subsequently dispose of 

unsuccessful investments, resulting in 

losses to the fund. Certain private funds 

include ‘‘clawback’’ mechanisms in 

their governing agreements, which 

require the adviser (or a related person 

of the adviser) 163 to restore 

distributions or allocations to the fund 

to the extent the adviser receives 

performance-based compensation in 

excess of the amount to which it is 

otherwise entitled under the fund’s 

governing agreement. Typically, this 

means that the adviser is required to 

return to the fund distributions or 

allocations representing more than a 

specified percentage (e.g., 20%) of the 

fund’s aggregate profits. The clawback 

mechanism is intended to ensure that 

the adviser and the investors ultimately 

receive the appropriate split of 

cumulative profits generated over the 

life of the fund or the applicable 

measurement period. 

Advisers and investors often negotiate 

whether the clawback amount should be 

reduced by taxes paid, or deemed paid, 

by the adviser or its owners.164 For 

example, if an adviser received $10 of 

‘‘excess’’ performance-based 

compensation, but the adviser or its 

owners paid $3 in taxes on such 

amount, investors often argue that the 

adviser should be required to return the 

‘‘pre-tax’’ amount ($10), while advisers 

argue that they should only be required 

to return the ‘‘post-tax’’ amount ($7). To 

support the post-tax position, advisers 

often argue that they should only be 

required to return the portion of excess 


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16924 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

165When the clawback occurs in a subsequent tax 

year, the ‘‘excess’’ performance-based compensation 

will likely have already been subject to tax in the 

year it was paid, even if the amount subject to the 

clawback is determined on a pre-tax basis. 166Private fund investors often seek to negotiate 

the waterfall arrangement, and the timing of 

performance-based compensation distributions, 

with the adviser. The issues relating to clawbacks 

often arise in the context of a waterfall arrangement 

that provides performance-based compensation to 

the adviser on a deal-by-deal basis (or modified 

versions thereof), versus a waterfall arrangement 

that is applied across the whole-fund with 

distributions going to investors until the investors 

recoup 100% of their capital contributions and 

receive a preferred return thereon. Both models 

should generally result in the adviser and the 

investors receiving the same split of fund profits 

over the life of the fund assuming the fund 

documents have a clawback mechanism. The main 

distinction between the two models is the timing of 

distributions or allocations of performance-based 

compensation to the adviser. Whole-fund waterfalls 

are often referred to in the private funds industry 

as European waterfalls; deal-by-deal waterfalls are 

often referred to as American waterfalls. 

167We recognize that an adviser (and its 

personnel) may be subject to a tax obligation 

whether or not the fund makes a distribution, 

payment, or allocation of performance-based 

compensation (e.g., tax allocations of income may 

precede or follow cash payments of performancebased compensation), including if the adviser 

places the performance-based compensation into 

escrow. 

168An ‘‘all-partner’’ giveback is typically a 

requirement for all investors to return or otherwise 

restore distributions to the fund. An adviser may 

use this mechanism for the purpose of satisfying 

fund obligations, liabilities, or expenses. 

169Because many entities that receive 

performance-based compensation are fiscally 

transparent for U.S. Federal income tax purposes 

and thus not subject to entity-level taxes, 

determining the actual taxes paid on ‘‘excess’’ 

performance-based compensation can be 

challenging, particularly for larger advisers that 

have not only a significant number of participants 

that receive such compensation but also have 

participants subject to non-U.S. tax regimes. To 

address this problem, advisers typically use a 

‘‘hypothetical marginal tax rate’’ to determine the 

tax reduction amount, which is usually based on 

the highest marginal U.S. Federal, state, and local 

tax rates. Advisers argue that this approach is a 

reasonable and cost-effective method for 

determining the tax reduction amount; investors 

argue that the hypothetical rate is too high and 

therefore reduces the clawback amount to their 

detriment. 

distributions they ultimately retain (and 

not the portion paid to any taxing 

authority). Advisers also argue that, to 

the extent the clawback occurs in any 

year subsequent to the year in which the 

performance-based compensation was 

paid, it may be burdensome or 

impractical for the adviser or its owners 

to amend tax returns from prior years or 

otherwise take advantage of loss 

carryforwards for future tax years.165

We believe that reducing the amount 

of any adviser clawback by taxes 

applicable to the adviser puts the 

adviser’s interests ahead of the 

investors’ interests and creates a 

compensation scheme that is contrary to 

the public interest and the protection of 

investors, even where such practice is 

disclosed. The interests of investors to 

receive their share of fund profits— 

without any adviser tax reductions— 

justifies the burdens on advisers, 

including the obligation to amend tax 

returns. Advisers typically have control 

over the methodology used to determine 

the timing of performance-based 

compensation distributions or 

allocations, such as any waterfall 

arrangement.166 Advisers also typically 

have control over whether the fund will 

make a distribution or allocation of 

performance-based compensation. 

Advisers thus have discretion to defer or 

otherwise delay payments, particularly 

if the adviser is concerned about the 

possibility of a clawback.167 Even if an 

adviser cannot defer or delay a payment, 

the adviser can escrow performancebased compensation rather than making 

a payment to its owners, which would 

allow the adviser to cover all or a 

portion of a clawback obligation that 

may arise in the future. Accordingly, the 

proposed rule would foster greater 

alignment of interest between advisers 

and investors by prohibiting advisers 

from unfairly causing investors to bear 

these tax costs associated with the 

payment, distribution, or allocation of 

‘‘excess’’ performance-based 

compensation. 

We request comment on this aspect of 

the proposed rule, including the 

following items: 

• Would this aspect of the proposed 

prohibited activities rule have our 

intended effect of ensuring that 

investors receive their full share of 

profits generated by the fund? Is there 

an alternative approach that would 

better produce this intended effect? For 

example, should we require advisers to 

return the entire amount of any adviser 

clawback, rather than only prohibiting 

advisers from reducing the clawback 

amount by actual, potential, or 

hypothetical taxes? Would this 

approach ensure that investors receive 

their full share of fund profits? 

• Would the proposed clawback 

provision result in more whole-fund 

waterfalls (commonly referred to as 

European waterfalls in the private funds 

industry), which generally delay 

payments of performance-based 

compensation until investors receive a 

return of all capital contributions? What 

other effects would this aspect of the 

proposed rule have on the industry, 

including with respect to adviser’s 

ability to attract, retain, and develop 

investment professionals? 

• Instead of the proposed clawback 

provision, should we prohibit deal-bydeal waterfall arrangements (commonly 

referred to as American waterfalls)? 

• We recognize that clawback 

mechanisms are more common for 

closed-end funds and less common for 

open-end funds. Should the rule 

separately address performance-based 

compensation for open-end private 

funds? If so, how should we address 

those funds? 

• Is the proposed definition of 

‘‘adviser clawback’’ clear? Are there 

ways in which the proposed definition 

is over- or under-inclusive? For 

example, should the definition include 

‘‘all-partner’’ givebacks or clawbacks 

(i.e., should advisers be prohibited from 

reducing the portion of an all-partner 

giveback attributable to their 

performance-based compensation by 

taxes paid or deemed paid)?168

• Is the proposed definition of 

‘‘performance-based compensation’’ 

clear? Is it too narrow or too broad? 

• What issues may advisers face in 

complying with this aspect of the 

proposed prohibited activities rule? In 

particular, what issues may result with 

respect to amending tax returns from 

prior years? 

• We recognize that this aspect of the 

proposed rule might result in delayed 

payments of performance-based 

compensation. For example, during the 

early stages of the fund, the adviser may 

be less inclined to distribute 

performance-based compensation to 

investment professionals that source or 

manage successful investments. How 

would this aspect of the proposed 

prohibited activities rule affect the 

intended incentive effects of 

performance-based compensation? 

• We recognize that many fund 

agreements clawback performancebased compensation on a post-tax basis. 

We considered, but are not proposing, a 

rule that would generally allow this 

practice to continue, but would prohibit 

advisers from using a hypothetical 

marginal tax rate to determine the tax 

reduction amount.169 We considered 

requiring advisers to use the actual 

marginal tax rates applicable to the 

adviser or its owners, rather than a 

hypothetical marginal tax rate. Our view 

is that this approach could be too 

burdensome for advisers. Do 

commenters agree? If we were to adopt 

this approach, how should we factor tax 

benefits realized by the adviser or its 

owners into the tax reduction amount? 

What operational challenges would 

advisers face under this alternative 

approach? For example, would the 

amount of time it may take to determine 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16925 

170See, e.g., EXAMS Private Funds Risk Alert 

2022, supra footnote 16 (discussing hedge clauses). 

See also Comment Letter of the Institutional 

Limited Partners Association on the Proposed 

Commission Interpretation Regarding Standard of 

Conduct for Investment Advisers; Request for 

Comment on Enhancing Investment Adviser 

Regulation (Aug. 6, 2018), File No. S7–09–18, at 6, 

available athttps://ilpa.org/wp-content/uploads/ 

2018/08/ILPA-Comment-Letter-on-SEC-ProposedFiduciary-Duty-Interpretation-August-6-2018.pdf. 

See also Protecting LLC Owners While Preserving 

LLC Flexibility, University of California, Davis Law 

Review, 51 U.C. Davis L. Rev. 2129, 2133, Professor 

Peter Molk (2018) (discussing scenarios in which an 

investor is induced to ‘‘sign away fundamental 

protections’’ without understanding the importance 

of those protections, without understanding the 

meaning of certain legal terms, and sometimes 

without reading the documents the investor signs). 

171See section 215(a) of the Advisers Act; 2019 

IA Fiduciary Duty Interpretation, supra footnote 

140 (stating that an adviser’s Federal fiduciary 

obligations are enforceable through section 206 of 

the Advisers Act and that the SEC would view a 

waiver of enforcement of section 206 as implicating 

section 215(a) of the Advisers Act. Section 215(a) 

of the Advisers Act provides that any condition, 

stipulation or provision binding any person to 

waive compliance with any provision of the title 

shall be void.). 

172See section 215(b) of the Advisers Act (stating 

that any contract made in violation of the Act or 

rules thereunder is void). 173See Professor Clayton Article, supra footnote 

7, at 309 (noting that ‘‘LPAs have been criticized for 

waiving and otherwise limiting managers’ fiduciary 

duties to their investors under state limited 

partnership law; for seeking to satisfy managers’ 

fiduciary duties under Federal law by providing 

generic and all-encompassing disclosures . . . for 

requiring investors to indemnify managers for 

liabilities resulting from an extremely broad array 

of conduct, including criminal acts committed by 

managers’’). See also The Private Equity Negotiation 

Myth, Yale Journal on Regulation Vol. 37:67, 

Professor William Clayton (2020), at p. 70 (noting 

that ‘‘large investors in private equity funds 

commonly use their bargaining power to negotiate 

for individualized benefits outside of fund 

agreements, where the benefit of the bargain is not 

shared with other investors in the fund . . . an 

investor can use its bargaining power to negotiate 

for individualized benefits before it negotiates for 

things that will benefit all investors in the fund.’’); 

ILPA Model Limited Partnership Agreement (July 

2020) (suggesting standard of care, exculpation, and 

indemnification language in order to reduce the 

cost, time and complexity of negotiating the terms 

of investment). 174Proposed rule 211(h)(2)–1(a)(6). 

the actual tax amount, which may not 

be determined until a significant 

amount of time has passed not justify 

the benefits? Do commenters believe 

that the use of a hypothetical marginal 

tax rate is a reasonable and costeffective method for determining the tax 

reduction amount, or do commenters 

believe that the hypothetical marginal 

tax rate is too high? Why or why not? 

Please provide data. 

4. Limiting or Eliminating Liability for 

Adviser Misconduct 

The fifth element of the proposed 

prohibited activities rule would prohibit 

an adviser to a private fund, directly or 

indirectly, from seeking reimbursement, 

indemnification, exculpation, or 

limitation of its liability by the private 

fund or its investors for a breach of 

fiduciary duty, willful misfeasance, bad 

faith, negligence, or recklessness in 

providing services to the private fund. 

Currently, many private funds and/or 

their investors enter into documents 

containing such contractual terms. Our 

staff has observed private fund 

agreements with waiver and 

indemnification provisions that have 

become more aggressive over time. For 

example, our staff recently encountered 

many limited partnership agreements 

that state that the adviser to the private 

fund or its related person, which is the 

general partner to the fund, to the 

maximum extent permitted by 

applicable law, will not be subject to 

any duties or standards (including 

fiduciary or similar duties or standards) 

existing under the Advisers Act, 

Delaware law, or Cayman Islands law or 

will not be liable to the fund or 

investors for breaching its duties 

(including fiduciary duties) or liabilities 

(that exist at law or in equity).170

While these contractual terms may be 

permissible under certain state laws, a 

waiver of an adviser’s compliance with 

its Federal antifraud liability for breach 

of fiduciary duty to the private fund or 

with any other provision of the Advisers 

Act or rules thereunder is invalid under 

the Act.171 The prohibited activities rule 

would specify the types of contractual 

provisions that would be invalid.172 For 

instance, it would prohibit an adviser 

from seeking indemnification for 

breaching its fiduciary duty, regardless 

of whether state or other law would 

permit an adviser to waive its fiduciary 

duty. The proposed rule would also 

prohibit an adviser from seeking 

reimbursement for its willful 

malfeasance. This scope of prohibitions 

is appropriate because these activities 

harm investors by placing the adviser’s 

interests above those of its private fund 

clients (and investors in such clients). 

By limiting an adviser’s responsibility 

for breaching the standard of conduct, 

the incentive to comply with the 

required standard of conduct is eroded. 

We believe such contractual provisions 

are neither in the public interest nor 

consistent with the protection of 

investors, particularly where investors 

are led to believe the adviser is 

contractually not obligated to comply 

with certain provisions of the Act or 

rules thereunder, or where investors 

with less bargaining power are forced to 

bear the brunt of such arrangements.173

We request comment on this aspect of 

the proposed rule, including the 

following items: 

• We have observed these types of 

contractual provisions among private 

fund advisers and their related persons; 

do advisers to clients other than private 

funds typically include these types of 

contractual provisions? 

• Are there other types of contractual 

provisions we should prohibit as 

contrary to the public interest and the 

protection of investors? 

• Should this aspect of the final 

prohibited activities rule prohibit 

limiting liability for ‘‘gross negligence,’’ 

or would prohibiting limitations of 

liability for ordinary negligence, as 

proposed, be more appropriate? Why? 

• Should the proposed rule prohibit 

contractual provisions that limit or 

purport to waive fiduciary duties and 

other liabilities in situations where state 

law permits such waivers? 

• Do commenters believe that the 

proposed rule would increase operating 

expenses for advisers? For example, 

would the proposed prohibition on 

receiving indemnification/exculpation 

for negligence cause an adviser’s 

insurance premium to increase? 

5. Certain Non-Pro Rata Fee and 

Expense Allocations 

The sixth element of the prohibited 

activities rule would prohibit an adviser 

from directly or indirectly charging or 

allocating fees and expenses related to 

a portfolio investment (or potential 

portfolio investment) on a non-pro rata 

basis when multiple private funds and 

other clients advised by the adviser or 

its related persons have invested (or 

propose to invest) in the same portfolio 

investment.174

An adviser may cause a private fund 

and one or more other vehicles to invest 

in an issuer or entity in which other 

related funds or vehicles have, or are 

concurrently making, an investment. 

For example, an adviser may form a 

parallel fund in a non-U.S. jurisdiction, 

such as Luxembourg, to accommodate 

certain European or other non-U.S. 

investors that invests alongside the 

adviser’s main fund in all, or 

substantially all, of its investments. An 

adviser also may form more bespoke 

structures for large or strategic investors, 

such as separate accounts, funds of one, 

and co-investment vehicles, that invest 

alongside other funds managed by the 

adviser that have similar or overlapping 

investment strategies. 

An adviser can face conflicts of 

interest where multiple clients (and/or 

other persons advised by the adviser) 

invest, or propose to invest, in the same 

portfolio investment, especially with 

respect to allocating fees and expenses 

among those clients (or such other 


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16926 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

175See EXAMS Private Funds Risk Alert 2020, 

supra footnote 9. See also, e.g., In the Matter of 

Rialto Capital Management, LLC, Investment 

Advisers Act Release No. 5558 (Aug. 7, 2020) 

(settled action) (alleging that adviser represented to 

the advisory committee, which included private 

fund investors as committee members, that it had 

data to support the adviser performing third-party 

services in house and charging the funds certain 

rates; and that the adviser misallocated fees for 

third-party services to the private funds when such 

fees also should have been allocated to the coinvestment vehicles managed by the adviser). 

176Because the proposed rule prohibits charging 

or allocating fees and expenses related to a portfolio 

investment (or potential portfolio investment) on a 

non-pro rata basis, advisers would not be prohibited 

from charging vehicles that invest alongside each 

other different advisory fees or other fund-level 

compensation. For example, a co-investment 

vehicle may pay lower management fees than the 

main fund. 

177The proposed rule would not prohibit an 

adviser from paying a fund’s pro rata portion of any 

fee or expense with its own capital. In addition, to 

the extent a fund does not have resources to pay 

for its share, the proposed rule would not prohibit 

an adviser from diluting such fund’s interest in the 

portfolio investment in a manner that is 

economically equal to its pro rata portion of such 

fee or expense. 

178On a more granular level, to the extent the 

adviser’s personnel have varying ownership 

percentages in the funds, such personnel may be 

subject to similar conflicts of interest in 

determining how to allocate fees and expenses. 

179 In some cases, advisers use co-investment 

opportunities to attract new investors and retain 

existing investors. Advisers may offer these existing 

or prospective investors the opportunity to invest 

in co-investment vehicles with materially different 

fee and expense terms than the main fund (e.g., no 

fees or no obligation to bear broken deal expenses). 

These co-investment opportunities may raise 

conflicts of interest, particularly when the 

opportunity to invest arises because of an existing 

investment and the fund itself would otherwise be 

the sole investor. 

180To the extent a potential co-investor has not 

executed a binding agreement to participate in the 

transaction through a co-investment vehicle (or 

another fund) managed by the adviser, the proposed 

rule would not prohibit the adviser from allocating 

‘‘broken-deal’’ or other fees and expenses 

attributable to such potential co-investor to a fund 

that would have participated in the transaction. 

Advisers may be liable under the antifraud 

provisions of the Federal securities laws if the 

private fund’s offering and organizational 

documents do not authorize such costs to be 

charged to the private fund. 

persons).175 We believe that any nonpro rata allocation of fees and expenses 

under these circumstances is contrary to 

the protection of investors because it 

would result in the adviser placing its 

own interest ahead of another’s, 

including in circumstances where the 

adviser indirectly benefits by placing 

the interests of one or more clients or 

investors ahead of another’s.176 For 

example, a fund may not have the 

resources to bear its pro rata share of 

expenses related to a portfolio 

investment (whether due to insufficient 

reserves, the inability to call capital to 

cover such expenses, or otherwise). If 

the adviser causes another fund to bear 

expenses attributable to such fund, the 

fund bearing more than a pro rata share 

would be supporting the value of the 

other fund’s investment.177 Because 

compensation structures in the funds 

may differ, an adviser may have an 

incentive to allocate fees and expenses 

in a way that maximizes its 

compensation. Further, an adviser’s 

ownership may vary fund by fund and 

thus may create an incentive to allocate 

fees and expenses away from the fund 

in which the adviser holds a greater 

interest.178

Moreover, we do not believe that fees 

and expenses attributable to 

unconsummated—or potential— 

portfolio investments should be treated 

differently than consummated 

investments, given that non-pro rata 

allocations in respect of 

unconsummated investments generally 

present the same concerns as discussed 

above with respect to consummated 

investments. If more than one fund 

would have participated in an 

investment that generated ‘‘broken deal’’ 

or other fees and expenses, our view is 

that all such funds should bear their pro 

rata share of such amount. 

We recognize that many advisers do 

not charge all their clients or potential 

co-investors for fees and expenses 

relating to unconsummated 

investments. For example, certain 

advisers offer existing investors, related 

persons, or third parties the opportunity 

to co-invest alongside the fund through 

one or more co-investment vehicles 

advised by the adviser.179 Many 

advisers do not charge co-investment 

vehicles or other co-investors for fees 

and expenses relating to 

unconsummated investments. Instead, 

such fees and expenses are generally 

borne by the adviser’s main fund that 

would have participated in the 

transaction, in which case the main 

fund would bear a disproportionate 

share of such amount. Such practice, 

however, places the interests of the 

other client and its underlying investors 

or of the other co-investors ahead of the 

interests of the main fund and its 

underlying investors. Because the other 

client would receive the benefit of any 

upside in the event the transaction goes 

through, we believe that such client 

should also generally bear the burden of 

any downside in the event the 

transaction does not go through. 

Accordingly, the proposed rule does not 

include an exception for these types of 

circumstances.180

We request comment on this aspect of 

the proposed prohibited activities rule, 

including the following items: 

• Should we prohibit non-pro rata fee 

and expense allocations as proposed? If 

not, under what circumstances would 

non-pro rata allocations be appropriate? 

For example, we recognize that advisers 

often have policies and procedures in 

place that permit the adviser to allocate 

fees and expenses in a fair and equitable 

manner (or similar standard), rather 

than on a pro rata basis; would this 

better achieve our policy goals? Why or 

why not? What specific protections are 

included in such policies and 

procedures? Should such protections be 

included in the rule? Why or why not? 

Should there be an exception to the 

prohibition where an adviser 

determines that it is in a private fund’s 

best interest to bear more expenses than 

another managed vehicle and the 

private fund’s investors agree? 

• Should the proposed rule apply to 

unconsummated—or potential— 

portfolio investments, as proposed? Do 

commenters agree that non-pro rata 

allocations of fees and expenses 

attributable to such investments present 

the same concerns as the ones discussed 

above with respect to consummated 

investments? Why or why not? 

• We recognize that many coinvestors do not agree to bear their pro 

rata share of broken or dead deal 

expenses. Would the proposed rule 

make it difficult for funds to 

consummate larger investments where 

co-investment capital is needed? Would 

the proposed rule cause funds to 

syndicate more deals post-closing once 

the adviser is confident that the deal 

will not fall through? 

• Should we include an exception for 

co-investment vehicles (or certain other 

vehicles) that invest alongside another 

fund managed by the adviser? If so, how 

should we define ‘‘co-investment 

vehicle’’? Should the rule treat singledeal co-investment vehicles differently 

than multi-deal co-investment vehicles? 

Why or why not? 

• Should we define ‘‘pro rata’’? 

Should ‘‘pro rata’’ be determined based 

on each client’s ownership (or 

anticipated ownership) of the portfolio 

investment? Will advisers interpret ‘‘pro 

rata’’ differently? 

• Where multiple funds invest in the 

same portfolio investment at different 

times, the first fund to invest may 

initially bear a higher level of fees and 

expenses than later funds. Should the 

proposed rule address fees and expense 

allocations among funds that invest at 

different times, and if so, how? If a 

significant amount of time has passed 

between the first fund’s investment and 

the later fund’s investment, should the 

later fund pay interest on its portion of 

fees and expenses? Should interest 

payments always apply when portfolio 

investments are made at different times? 


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181Proposed rule 211(h)(2)–1(a)(7). 

182See In the Matter of Monsoon Capital, LLC, 

Investment Advisers Act Release No. 5490 (Apr. 30, 

2020) (settled action) (alleging that the owner of a 

private fund adviser borrowed $1 million from a 

private fund client in order to settle a personal 

trade); Resilience Management, LLC, Investment 

Advisers Act Release No. 4721 (June 29, 2017) 

(settled action) (alleging that a private fund adviser 

borrowed money from funds in order to pay 

adviser’s expenses; and that the CEO of the adviser 

borrowed money to pay for personal expenses); SEC 

v. Philip A. Falcone, [U.S. District Court Southern 

District of New York, Consent] (Aug. 16, 2013) 

(hedge fund adviser borrowed from hedge fund at 

low interest rate in order to repay adviser’s personal 

taxes. Adviser failed to disclose the loan to 

investors for five months). 

183See In the Matter of Och-Ziff Capital 

Management Group, LLC, Investment Advisers Act 

Release No. 4540 (Sept. 29, 2016), at para. 3 (settled 

action) (alleging that a private fund adviser 

authorized the use of investor funds to pay bribes 

to foreign government officials in order to obtain or 

retain business for its parent company and its 

business partners). 

If not, how much time should lapse 

before interest applies? 

• The proposed rule would prohibit 

advisers from charging or allocating fees 

and expenses related to a portfolio 

investment (or potential portfolio 

investment) on a non-pro rata basis 

when multiple private funds and other 

clients advised by the adviser or its 

related persons have invested (or 

propose to invest) in the same portfolio 

investment. Is the scope of the phrase 

‘‘other clients advised by the adviser or 

its related persons’’ broad enough? 

Should we revise the proposed rule to 

cover any other clients, vehicles, or 

other persons advised by the adviser or 

its related persons? Alternatively, 

should we revise the rule to cover all coinvestment structures and 

arrangements? 

• We recognize that a transaction 

counterparty may request to only 

contract with one fund entity, which 

can result in one fund being liable for 

its own share as well as another fund’s 

share of any transaction obligations, 

including fees and expenses. If one fund 

would be responsible for the liability of 

another fund, those funds, in certain 

cases, contractually agree to bear their 

pro rata share, often times through a 

contribution or reimbursement 

agreement. Should we prohibit this 

practice and thus require each fund 

entity to contract directly with the 

counterparty? Alternatively, should we 

require certain governance and other 

protections, such as contribution or 

reimbursement agreements, if only one 

fund contracts directly with the 

counterparty? Why or why not? 

• As noted above, the proposed rule 

would not prohibit an adviser from 

charging different fund-level 

compensation, such as advisory fees, to 

vehicles that invest alongside each other 

in the same underlying portfolio 

investment. For example, a coinvestment vehicle may pay lower 

management fees than the main fund. Is 

it sufficiently clear that such 

arrangements would not be prohibited 

under the proposed rule? 

6. Borrowing 

The final element of the proposed 

prohibited activities rule would prohibit 

an adviser directly or indirectly from 

borrowing money, securities, or other 

fund assets, or receiving a loan or an 

extension of credit, from a private fund 

client (collectively, a ‘‘borrowing’’).181

We have observed many forms of 

borrowing among private fund advisers 

and their related persons, such as using 

fund assets as collateral in order to 

obtain a loan from a party other than the 

fund (i.e., borrowing against fund 

assets), accepting a loan offered by a 

private fund client, and taking 

advantage of a continuous line of credit 

extended by a private fund client. For 

example, the Commission has brought 

enforcement actions alleging that 

private fund advisers and their related 

persons have used fund assets to 

address personal financial issues of one 

of the adviser’s principals, to pay for the 

advisory firm’s expenses,182 or to bribe 

foreign government officials.183 In these 

circumstances, the adviser’s related 

person that is the general partner of the 

fund sometimes, for example, causes the 

fund to enter into the relationship with 

the adviser without the knowledge or 

consent of the private fund investors. 

When an adviser borrows from a 

private fund client, that adviser has a 

conflict of interest because it is on both 

sides of the transaction (i.e., the adviser 

benefits from the loan and manages the 

client lender). A private fund rarely has 

employees of its own. Its officers, if any, 

are usually employed by the private 

fund’s adviser. The fund typically relies 

on the investment adviser (and, in 

certain cases, affiliated entities) to 

provide management, investment, and 

other services and such persons usually 

have authority to take actions on behalf 

of the private fund without the consent 

or approval of any other person. This 

structure causes a conflict of interest 

between the private fund (and, by 

extension, its investors) and the 

investment adviser because the interests 

of the fund are not necessarily aligned 

with the interests of the adviser. For 

example, when determining the interest 

rate for the borrowing, an investment 

adviser’s interest in maximizing its own 

profit by negotiating (or setting) a low 

rate may conflict with its duty to act in 

the best interests of the fund. 

Moreover, this practice may prevent 

the fund client from using those assets 

to further the fund’s investment 

strategy. Even where disclosed (and 

potentially consented to by an advisory 

board, such as an LPAC), this practice 

presents a conflict of interest that is 

harmful to investors because, as a result 

of the unique structure of private funds, 

only certain investors with specific 

information or governance rights (such 

as representation on the LPAC) would 

potentially be in a position to negotiate 

or discuss the terms of the borrowing 

with the adviser, rather than all of the 

private fund’s investors. 

The proposed rule would not prevent 

the adviser from borrowing from a third 

party on the fund’s behalf or from 

lending to the fund. Private funds 

sometimes use subscription lines of 

credit, also known as credit facilities, to 

address financing needs. For example, 

some private funds use these facilities to 

address short-term financing needs 

when the fund makes investments or 

participates in a co-investment. Other 

private funds use such facilities for 

long-term financing purposes, for 

example, when an infrastructure fund 

decides to use a long-term facility 

during the development stage of a 

project before a capital call. In these 

circumstances, the adviser is not 

borrowing from the fund. Similarly, 

advisers sometimes lend money to a 

fund in order to address start-up costs 

or to manage other expenses (for 

example, an adviser may pay legal or 

operating expenses of several fund 

clients and then seek reimbursement 

once the expenses have been allocated 

among the advised private funds). 

Allowing advisers to continue this 

practice would provide private funds 

access to capital, especially when they 

are in the early stages of attracting 

investors. Advisers lending to private 

funds they manage on terms that do not 

include excessive interest rates or other 

abusive practices do not raise the same 

concerns that advisers borrowing from 

private funds they manage raises 

because there are fewer opportunities 

for abusive practices when the adviser 

is providing money to, rather than 

taking money from, the private fund. 

We request comment on this aspect of 

the proposed prohibitions rule, 

including the following: 

• Should we broaden the scope of the 

prohibition on borrowings to prevent a 

private fund adviser from borrowing 

from co-investment vehicles or other 

accounts that are not private funds? 


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16928 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

184See, e.g., In the Matter of Clean Energy Capital 

LLC, Investment Advisers Act Release No. 3955 

(Oct. 17, 2014) (settled action) (alleging that a 

private equity fund adviser caused the funds to 

borrow money from the adviser without providing 

notice to investors and by pledging the private 

equity funds’ assets as collateral). 

185Proposed rule 211(h)(2)–3(a)(1) and (2). 

186Proposed rule 211(h)(2)–3(b). 

187The proposed rule would prohibit certain 

types of preferential treatment and would require 

an adviser to disclose other types of preferential 

treatment that the adviser or its related persons 

(acting on their own behalf and/or on behalf of the 

fund) provide to investors. Therefore, the proposed 

rule typically would apply when the adviser’s 

related person is the general partner (or similar 

control person) and is a party (and/or caused the 

private fund to be a party, directly or indirectly) to 

a side letter or other arrangement with an investor, 

even if the adviser itself (or any related person of 

the adviser) is not a party to the side letter or other 

arrangement. 

188Proposed rule 211(h)(2)–3(a)(1). For purposes 

of the prohibitions in proposed rule 211(h)(2)– 

3(a)(1) or (2), whether an adviser could have a 

reasonable expectation that the preferential term 

would have a material, negative effect on other 

investors in the same private fund or in a 

substantially similar pool of assets would depend 

on the facts and circumstances. 

• Should we broaden the proposed 

prohibition to apply when an adviser 

lends to the fund? 184

• Should the proposed rule exclude 

certain activity from the prohibition 

(e.g., scenarios where a private fund 

makes tax advances or tax distributions 

to its general partner (or similar control 

person) to ensure that the general 

partner and its investment professionals 

are able to pay their personal taxes 

derived from the general partner’s 

interest in the fund)? If so, what activity 

should we exclude and why? 

• Are there situations in which a fund 

would agree to lend a start-up adviser 

money for initial costs and employee 

salaries? Are there situations in which 

a private fund client should be able to 

make a loan to a private fund adviser 

because the economic terms would be 

favorable to the private fund? How 

would we determine that the terms are 

favorable to the private fund? 

• Should the proposed rule be 

expanded to prohibit an adviser from 

borrowing against a private fund client’s 

bank account or other assets, where the 

lender may be a third party (rather than 

the private fund)? Why or why not? 

• Should we amend Form ADV and/ 

or Form PF to require advisers to report 

information about an adviser or its 

related person lending to, or borrowing 

from, private funds or other clients? 

Why or why not? For example, should 

we require advisers to report whether 

they engage in this practice and to 

provide an aggregate amount or range of 

such loans or borrowings? 

• Recognizing the limitations of 

private fund governance mechanisms, as 

discussed above, should we permit 

borrowing if it is subject to specific 

governance and other protections (e.g., 

advance disclosure to all investors, 

advance disclosure to an LPAC or 

similar body, consent of a governing 

body such as an LPAC, and/or consent 

of a majority or supermajority of 

investors)? Should we require private 

fund advisers to make ongoing 

disclosures to investors and/or 

governing bodies of the status of such 

borrowings? Why or why not? 

• Should the rule include any full or 

partial exclusions for certain 

transactions that may not involve 

conflicts of interest or that may involve 

certain third parties that ameliorate the 

conflicts of interest? For example, 

should we provide an exclusion if the 

terms of the borrowing are set by an 

independent third party and such third 

party has the authority to act on behalf 

of the fund in the event of a default by 

the adviser? Why or why not? 

• Do commenters envision 

unintended consequences of this 

proposed prohibition, such as in 

circumstances where an adviser’s 

related person has its own commercial 

relationship with the fund? 

• Should the rule prohibit (or 

otherwise restrict) advisers from lending 

to private funds they manage on terms 

that include excessive interest rates or 

other abusive practices? To what extent 

and under what circumstances does this 

practice occur? Does it raise similar 

concerns to borrowing? 

E. Preferential Treatment 

In order to address specific types of 

preferential treatment that have a 

material negative effect on other 

investors in the private fund or in a 

substantially similar pool of assets, we 

also propose to prohibit all private fund 

advisers, regardless of whether they are 

registered with the Commission, from 

providing preferential terms to certain 

investors regarding redemption or 

information about portfolio holdings or 

exposures.185 We also propose to 

prohibit these advisers from providing 

any other preferential treatment to any 

investor in the private fund unless the 

adviser provides written disclosures to 

prospective and current investors in a 

private fund regarding all preferential 

treatment the adviser or its related 

persons are providing to other investors 

in the same fund.186 Whether any terms 

are ‘‘preferential’’ would depend on the 

facts and circumstances. 

Side letters or side arrangements are 

generally agreements among the 

investor, general partner, adviser, and/ 

or the private fund that provide the 

investor with different or preferential 

terms than those set forth in the fund’s 

governing documents.187 Side letters 

generally grant more favorable rights 

and privileges to certain preferred 

investors (e.g., seed investors, strategic 

investors, those with large 

commitments, and employees, friends, 

and family) or to investors subject to 

government regulation (e.g., the 

Employee Retirement Income Security 

Act (‘‘ERISA’’), the Bank Holding 

Company Act, or public records laws). 

Advisers often provide these terms for 

strategic reasons that benefit the adviser. 

In some cases, these terms can also 

benefit the fund, for example, if the 

adviser signs a side letter with a large, 

early stage investor, then the fund will 

increase its assets. Increased fund assets 

may enable the fund to make certain 

investments, for example of a larger 

size, which ultimately benefits all 

investors. However, preferential terms 

do not necessarily benefit the fund or 

other investors that are not party to the 

side letter agreement and, at times, we 

believe these terms can have a material, 

negative effect on other investors. 

We recognize that advisers provide a 

range of preferential treatment, some of 

which does not necessarily 

disadvantage other fund investors. In 

this case, we believe that disclosure is 

appropriate because it would allow 

investors to make their own assessment. 

Other types of preferential treatment, 

however, have a material, negative effect 

on other fund investors or investors in 

a substantially similar pool of assets. We 

propose to prohibit these types of 

preferential treatment because they are 

sales practices that present a conflict of 

interest between the adviser and the 

private fund client that are contrary to 

the public interest and protection of 

investors. We have tailored the 

proposed rule to address these different 

ends of the spectrum. 

Prohibited Preferential Redemptions 

We propose to prohibit a private fund 

adviser, including indirectly through its 

related persons, from granting an 

investor in the private fund or in a 

substantially similar pool of assets the 

ability to redeem its interest on terms 

that the adviser reasonably expects to 

have a material, negative effect on other 

investors in that private fund or in a 

substantially similar pool of assets.188

Different types of private funds and 

other pooled vehicles offer different 

redemption opportunities, and an 

investor’s ability to exit or withdraw 

differs significantly depending on the 

fund’s or pool’s liquidity profile. While 

open-end private funds typically allow 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16929 

189See supra section II.E. (Preferential Treatment) 

(discussing side letters as a sales practice). 

190See EXAMS Private Funds Risk Alert 2020, 

supra footnote 9. 

191Proposed rule 211(h)(2)–3(a)(2). 

192See Professor Clayton Article, supra footnote 

7, at 316 (noting that large investors can often 

negotiate fee discounts or other side letter benefits 

that smaller investors would not receive). 

193See Selective Disclosure and Insider Trading, 

Securities Act of 1933 Release No. 33–7881 (Aug. 

15, 2000) [65 FR 51715 (Aug. 24, 2000)]. 194Proposed rule 211(h)(1)–1. 

for periodic redemptions, closed-end 

private funds typically do not permit 

investors to withdraw their investments 

without consent. We understand that 

some private fund advisers grant one or 

more investors more favorable 

redemption rights. For example, a large 

investor may negotiate, through a side 

letter or other side arrangement, to be 

able to redeem its interest in the fund 

before, or more frequently than, other 

investors. Advisers enter into such 

arrangements in exchange for, for 

example, a large investor agreeing to 

invest in the fund or a large investor 

agreeing to participate in a future 

fundraising of an investment vehicle 

that the adviser manages.189 Our staff 

also has observed scenarios where an 

adviser establishes investment vehicles 

that invest side-by-side along with the 

private fund that have better liquidity 

terms than the terms provided to 

investors in the private fund.190

We believe that granting preferential 

liquidity terms on terms that the adviser 

reasonably expects to have a material, 

negative effect on other investors in the 

private fund or in a substantially similar 

pool of assets is a sales practice that is 

harmful to the fund and its investors. In 

granting preferential liquidity rights to a 

large investor, the adviser stands to 

benefit because its fees increase as fund 

assets under management increase. As 

noted above, the adviser attracts 

preferred investors to invest in the fund 

by offering preferential terms, such as 

more favorable liquidity rights. While 

the fund also may experience some 

benefits, including the ability to attract 

additional investors and to spread 

expenses over a broader investor and 

asset base, there are scenarios where the 

preferential liquidity terms harm the 

fund and other investors. For example, 

if an adviser allows a preferred investor 

to exit the fund early and sells liquid 

assets to accommodate the preferred 

investor’s redemption, the fund may be 

left with a less liquid pool of assets, 

which can inhibit the fund’s ability to 

carry out its investment strategy or 

promptly satisfy other investors’ 

redemption requests. This can dilute 

remaining investors’ interests in the 

fund and make it difficult for those 

investors to mitigate their investment 

losses in a down market cycle. These 

concerns can also apply when an 

adviser provides favorable redemption 

rights to an investor in a substantially 

similar pool of assets, such as another 

feeder fund investing in the same master 

fund. The Commission believes that the 

potential harms to other investors justify 

this restriction. 

Prohibited Preferential Transparency 

We propose to prohibit an adviser and 

its related persons from providing 

information regarding the portfolio 

holdings or exposures of the private 

fund or of a substantially similar pool of 

assets to any investor if the adviser 

reasonably expects that providing the 

information would have a material, 

negative effect on other investors in that 

private fund or in a substantially similar 

pool of assets.191

Private fund advisers, in some cases, 

disclose information about portfolio 

holdings or exposures to certain, but not 

all, investors in the private fund or in 

a substantially similar pool of assets. 

For example, an investor may request 

certain information about characteristics 

of the fund’s holdings to satisfy the 

investor’s internal reporting obligations. 

An investor can negotiate to receive 

certain types of information that is not 

widely available to all investors; 

however, an investor’s success in 

obtaining such terms may depend on 

factors including the size of its capital 

commitment.192

Selective disclosure of portfolio 

holdings or exposures can result in 

profits or avoidance of losses among 

those who were privy to the information 

beforehand at the expense of investors 

who did not benefit from such 

transparency. In addition, such 

information could enable an investor to 

trade in portfolio holdings in a way that 

‘‘front-runs’’ or otherwise disadvantages 

the fund or other clients of the adviser. 

Granting preferential transparency, for 

example through side letters, presents a 

sales practice that is contrary to the 

public interest and protection of 

investors because it preferences one 

investor at the expense of another. An 

adviser may agree to provide 

preferential information rights to a 

certain investor in exchange for 

something of benefit to the adviser. The 

proposed rule is designed to neutralize 

the potential for private fund advisers to 

treat portfolio holdings information as a 

commodity to be used to gain or 

maintain favor with particular 

investors.193 We believe that this 

proposed prohibition would curtail 

activity that harms investors. 

Substantially Similar Pool of Assets 

The proposed rule would define the 

term ‘‘substantially similar pool of 

assets’’ as a pooled investment vehicle 

(other than an investment company 

registered under the Investment 

Company Act of 1940 or a company that 

elects to be regulated as such) with 

substantially similar investment 

policies, objectives, or strategies to those 

of the private fund managed by the 

adviser or its related persons.194

Whether a pool of assets managed by the 

adviser is ‘‘substantially similar’’ to the 

private fund requires a facts and 

circumstances analysis. A pool of assets 

with a materially different target return 

or sector focus, for example, would 

likely not have substantially similar 

investment policies, objectives, or 

strategies as the subject private fund, 

depending on the facts and 

circumstances. 

The types of asset pools that would be 

included in this term would include a 

variety of pools, regardless of whether 

they are private funds. For example, this 

term would include limited liability 

companies, partnerships, and other 

organizational structures, regardless of 

the number of investors; feeders to the 

same master fund; and parallel fund 

structures and alternative investment 

vehicles. It would also include pooled 

vehicles with different base currencies 

and pooled vehicles with embedded 

leverage to the extent such pooled 

vehicles have substantially similar 

investment policies, objectives, or 

strategies as those of the subject private 

fund. In addition, an adviser would be 

required to consider whether its 

proprietary accounts meet the definition 

of ‘‘substantially similar pool of assets.’’ 

This proposed definition is designed 

to capture most commonly used fund 

structures and prevent advisers from 

structuring around the prohibitions on 

preferential treatment. For example, in a 

master-feeder structure, some advisers 

create custom feeder funds for favored 

investors. Without a comprehensive 

definition of substantially similar pool 

of assets, the proposed rule would not 

preclude such advisers from providing 

preferential treatment to investors in 

these custom feeder funds to the 

detriment of investors in standard 

commingled feeder funds within the 

master-feeder structure. While similar 

concerns may exist for separately 

managed accounts, this proposed rule is 

designed to address the specific 

concerns that arise out of the lack of 


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16930 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

195Proposed rule 211(h)(2)–3(b). 

196See Juliane Begenau and Emil Siriwardane, 

How Do Private Equity Fees Vary Across Public 

Pensions?, Harvard Business School (2020), 

available at https://www.hbs.edu/faculty/Pages/ 

item.aspx?num=57534. 

197The Alternative Investment Fund Managers 

Directive (AIFMD) includes transparency 

obligations requiring disclosure to all investors of 

any preferential treatment received by a particular 

investor, including by way of a side letter. See 

AIFMD Art. 23. 

198We are not proposing to require the adviser to 

disclose the names or even types of investors 

provided preferential terms as part of this proposed 

disclosure requirement. 

199As a practical matter, a private fund that does 

not admit new investors or provide new terms to 

existing investors would not need to deliver an 

annual notice. However, an adviser that enters into 

a side letter after the closing date of the fund would 

need to disclose any covered preferential terms in 

the side letter to investors that are locked into the 

fund. 

200See supra section II.A.3 (Preparation and 

Distribution of Quarterly Statements). 

transparency and governance 

mechanisms prevalent in the private 

fund structure. 

Other Preferential Treatment 

The proposed rule also would 

prohibit other preferential terms unless 

the adviser provides certain written 

disclosures to prospective and current 

investors.195 We believe that certain 

types of preferential terms raise 

relatively minor concerns, if fully 

disclosed. However, we are concerned 

that an adviser’s current sales practices 

do not provide all investors with 

sufficient detail regarding preferential 

terms granted to other investors.196 For 

example, an adviser to a private equity 

fund may provide ‘‘excuse rights’’ (i.e., 

the right to refrain from participating in 

a specific investment the private fund 

plans to make) to certain private fund 

investors. Advisers sometimes grant 

excuse rights to accommodate an 

investor’s unique investment 

restrictions, such as a mandate to avoid 

investment in portfolio companies that 

do not meet certain environmental, 

social, or governance standards. This 

lack of transparency prevents investors 

from understanding the scope of 

preferential terms granted. The 

proposed rule would prohibit these 

terms unless the adviser provides 

information about them in a written 

notice. 

Increased transparency would better 

inform investors regarding the breadth 

of preferential treatment, the potential 

for those terms to affect their investment 

in the private fund, and the potential 

costs (including compliance costs) 

associated with these preferential 

terms.197 This disclosure would help 

investors shape the terms of their 

relationship with the adviser of the 

private fund. For example, they might 

also learn of similarly situated investors 

who are receiving a better deal with 

respect to fees or other terms. An 

investor also may learn that the adviser 

provided fee discounts to a large, early 

stage investor. Or, an investor may learn 

that the adviser granted a strategic 

investor the right to increase its 

investment in the fund even though the 

fund is closed to new investors or to 

additional investments by other existing 

investors. This may lead the investor to 

request additional information on other 

benefits that the adviser’s related 

persons or large investors receive, such 

as co-investment rights. An investor 

may then be able to understand better 

certain potential conflicts of interest and 

the risk of potential harms or other 

disadvantages. 

Under the proposed rule, an adviser 

would need to describe specifically the 

preferential treatment to convey its 

relevance. For example, if an adviser 

provides an investor with lower fee 

terms in exchange for a significantly 

higher capital contribution than paid by 

others, we do not believe that mere 

disclosure that some investors pay a 

lower fee is specific enough. Instead, we 

believe an adviser must describe the 

lower fee terms, including the 

applicable rate (or range of rates if 

multiple investors pay such lower fees), 

in order to provide specific information 

as required by the proposed rule. An 

adviser could comply with the proposed 

disclosure requirements by providing 

copies of side letters (with identifying 

information regarding the other 

investors redacted).198 Alternatively, an 

adviser could provide a written 

summary of the preferential terms 

provided to other investors in the same 

private fund, provided the summary 

specifically describes the preferential 

treatment. 

The timing of the proposed rule’s 

delivery requirements would differ 

depending on whether the recipient is a 

prospective or existing investor in the 

private fund. For a prospective investor 

the notice needs to be provided, in 

writing, prior to the investor’s 

investment. For an existing investor, the 

adviser would have to ‘‘distribute’’ the 

notice annually if any preferential 

treatment is provided to an investor 

since the last notice.199 An adviser 

would satisfy its distribution 

requirement to current investors by 

sending the written notice to all of the 

private fund’s investors. If an investor is 

a pooled investment vehicle that is in a 

control relationship with the adviser, 

the adviser must look through that pool 

in order to send the notice to investors 

in those pools.200 We believe this aspect 

of the proposed rule would require 

advisers to reassess periodically the 

preferential terms they provide to 

investors in the same fund, and 

investors would benefit from receiving 

periodic updates on preferential terms 

provided to other investors in the same 

fund. We also believe that providing 

this information annually would not 

overwhelm investors with disclosure. 

We request comment on this aspect of 

the proposed rule, including the 

following: 

• Should the proposed rule apply 

only to SEC-registered advisers and 

advisers that are required to be 

registered with the SEC instead of all 

advisers, as proposed? 

• Should we prohibit all preferential 

treatment instead of the proposed 

approach, which is to prohibit certain 

types of preferential treatment (i.e., 

liquidity and transparency terms that an 

adviser reasonably expects to have a 

material, negative effect) and prohibit 

all other types of preferential treatment 

unless disclosed? Why or why not? 

• Should the proposed prohibitions 

apply only to terms that the adviser 

reasonably expects to have a material, 

negative effect, as proposed? 

Alternatively, should the proposed 

prohibitions apply more broadly to 

terms that the adviser reasonably 

expects could have a material, negative 

effect? Why or why not? 

• Should we prohibit all preferential 

liquidity terms, rather than just those 

that the adviser reasonably expects to 

have a material, negative effect on other 

investors in that fund or in a 

substantially similar pool of assets? 

Why or why not? 

• Are there certain investors who 

require different liquidity terms (e.g., 

ERISA plans, government plans)? If so, 

which types of investors and what 

liquidity terms do they require? How do 

advisers currently accommodate such 

investors without disadvantaging other 

investors in the private fund? Should 

the proposed rule permit different 

liquidity terms for these investor types? 

If so, should the proposed rule impose 

restrictions in order to protect other 

private fund investors? If so, which 

types of restrictions? 

• Are there practices related to 

liquidity and redemption rights that the 

proposed rule should explicitly address 

(e.g., in-kind distribution of securities in 

connection with a redemption, sidepocketing of illiquid investments, 

discounting or eliminating the 

management fee while a fund suspends 


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201See proposed rule 211(h)(2)–3(b). 

202See CFA Institute Global Investment 

Performance Standards for Firms: Glossary, CFA 

Institute (2020) (defining ‘‘prospective investor’’). 

203 In an MFN clause, an adviser or its related 

person generally agrees to provide an investor with 

contractual rights or benefits that are equal to or 

Continued 

liquidity)? For example, should the 

proposed rule prohibit in-kind 

distribution of securities in connection 

with a redemption, side-pocketing 

illiquid investments, or discounting or 

eliminating the management fee while a 

fund suspends liquidity? Alternatively, 

should the proposed rule include an 

exception for these activities? 

• Should we prohibit all preferential 

transparency regarding holdings or 

exposures of the fund or pool, rather 

than just prohibiting preferential 

transparency regarding holdings or 

exposures that the adviser reasonably 

expects to have a material, negative 

effect on other investors in that fund or 

in a substantially similar pool of assets? 

Why or why not? 

• Should we define, or provide 

guidance on, when preferential 

redemption terms or preferential 

information rights would have a 

material, negative effect on other 

investors? If so, what should be some 

determining factors? Would it be 

relevant that the redemption terms 

would cause another investor to 

reconsider its investment decision? 

Please explain your answer. Should we 

clarify whether an adviser could 

disclose information about holdings or 

exposures of the fund or a substantially 

similar pool of assets on a delayed basis 

without violating the proposed 

prohibition? Should the proposed rule 

expressly require disclosure to investors 

after a specified period? If so, what 

period? 

• Are transparency concerns, 

especially with regard to information 

that could have an impact on an 

investor’s decision to redeem, more 

prominent with certain fund types (e.g., 

hedge funds, private equity funds)? If 

so, which types and why? 

• Should we exempt certain types of 

private funds from the written notice 

requirements of the proposed 

preferential treatment rule? 201 If so, 

which types of funds and why? 

• Should we restrict the use of side 

letters and side arrangements so that 

they can only be used to address certain 

matters such as, for example, legal, 

regulatory, or tax issues that are specific 

to an investor? 

• Should the rule’s prohibitions on 

preferential terms extend to a 

substantially similar pool of assets or 

apply only to each private fund 

separately? 

• The proposed definition of 

‘‘substantially similar pool of assets’’ 

would not include co-investments by a 

separately managed account managed 

by the adviser or its related persons. Is 

this definition too narrow? Why or why 

not? Would the proposed definition 

appropriately capture similar funds? 

Should it, for example, include 

circumstances where a private fund 

invests alongside a separately managed 

account? Why or why not? Should the 

definition include a co-investment 

vehicle that is structured as a pool of 

assets that invests in a single entity and 

where the private fund invests in the 

same entity? 

• Should we limit ‘‘substantially 

similar pool of assets’’ to pools the 

adviser or its related persons manage, as 

proposed? Is the proposed definition too 

broad or too narrow? The proposed 

definition would require the pool of 

assets to have substantially similar (i) 

investment policies, (ii) objectives, or 

(iii) strategies to those of the private 

fund. Should we change ‘‘or’’ to ‘‘and’’ 

and instead require that the pool satisfy 

all three requirements (i.e., have 

substantially similar investment 

policies, objectives, and strategies)? 

Should we instead require that the pool 

satisfy only two of the three criteria? For 

example, should the definition only 

require the pool of assets to have 

substantially similar objectives and 

strategies (and not policies) to those of 

the private fund? Are there other unique 

characteristics or factors, such as the 

target rate of return, the proposed 

definition should address? Should the 

definition exclude multi-share class 

private funds? If so, why? 

• Should we narrow the scope of the 

term ‘‘substantially similar pool of 

assets’’ to only include pooled vehicles 

that invest or generally invest pari passu 

with the private fund? Why or why not? 

• Do commenters agree that we 

should prohibit other preferential terms 

unless the adviser provides specific 

information regarding those terms to 

prospective and current private fund 

investors? Would these disclosures 

benefit these investors? Should we 

require advisers to provide additional 

information in the written notices? If so, 

what information? Should the rule 

specify what information is required to 

be included in the notice? 

• Instead of requiring advisers to 

provide or distribute the written notice, 

should we require advisers to only 

provide or distribute the written notice 

upon request? 

• With regard to current investors, the 

proposed rule would require advisers to 

disclose preferential treatment provided 

by the adviser or its related persons. 

Instead or in addition, should we 

require advisers to disclose preferential 

treatment that it has offered to other 

investors in the same fund? 

• Should we require advisers to 

provide advance written notice to 

prospective investors, as proposed? 

Should we define ‘‘prospective 

investor’’ in the proposed rule? If so, 

how should we define this term and 

why? For example, should we define 

‘‘prospective investor’’ as any person or 

entity that has expressed an interest in 

a private fund advised by the 

adviser? 202 If not, should we provide 

guidance regarding how advisers can 

identify prospective investors? Should 

we clarify how advisers that use 

intermediaries, investment consultants, 

or other third parties to introduce 

prospective investors would comply 

with the proposed rule? For example, 

should we state that advisers must treat 

the intermediaries, investment 

consultants, or other third parties as the 

prospective investor in these 

circumstances? Should the definition 

include prospective transferees? Why or 

why not? 

• The proposed rule would require 

the adviser to provide the written notice 

‘‘prior to the investor’s investment in 

the private fund.’’ Should we prescribe 

how far in advance of the investment an 

adviser must provide such notice? For 

example, should we require an adviser 

to provide the written notice at least two 

business days prior to the date of 

investment? Should such period be 

longer or shorter? If so, why? Should the 

proposed rule require advisers to 

provide notice to prospective investors 

within a certain number of days before 

the investor submits its complete 

subscription agreement (or equivalent)? 

Alternatively, should the proposed rule 

require the adviser to provide the notice 

at the time an investor receives the 

private fund’s offering and 

organizational documents (e.g., limited 

partnership agreement, private 

placement memorandum)? Should we 

instead require that notice be sent prior 

to some other action or event? If so, 

what action or event and why? Should 

the proposed rule require advisers to 

update disclosure they previously 

provided, for example, to include 

preferential treatment that an adviser 

granted after some investors decided to 

invest, but before closing? 

• What impact would the advance 

written notice requirement have on 

‘‘most favored nation’’ clauses (‘‘MFN 

clauses’’) granted to other fund 

investors? 203


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better than the rights or benefits provided to certain 

other investors. 

204Proposed rule 211(h)(2)–3(b). 

205See supra footnote 106 (describing the record 

retention requirements under the books and records 

rule). See also proposed amendments to rule 204– 

2(a)(7)(v). 

206Proposed rule 206(4)–7(b). 

207See Compliance Programs of Investment 

Companies and Investment Advisers, Investment 

Advisers Act Release No. 2204 (Dec. 17, 2003) [38 

FR 74714 (Dec. 24, 2003)] (‘‘Compliance Rule 

Adopting Release’’). When adopting the compliance 

rule, the Commission adopted amendments to the 

books and records rule requiring advisers to make 

and keep true a copy of the adviser’s compliance 

policies and procedures and any records 

documenting an adviser’s annual review of its 

compliance policies and procedures. The 

Commission noted that this recordkeeping 

requirement was designed to allow our examination 

staff to determine whether the adviser has complied 

with the compliance rule. See also rule 204– 

2(a)(17)(i)–(ii). 

208See Compliance Programs of Investment 

Companies and Investment Advisers, Investment 

Advisers Act Release No. 2107 (Feb. 5, 2003) [68 

FR 7038 (Feb. 11, 2003)] (‘‘Compliance Rule 

Proposing Release’’). 

209The Commission has identified instances 

where it alleged no annual review of the 

compliance program was conducted. See, e.g., In re 

du Pasquier & Co., Inc., Investment Advisers Act 

Release No. 4004 (Jan. 21, 2015) (settled action) 

(alleging that the adviser failed to annually review 

the adequacy of its compliance policies and 

procedures and the effectiveness of their 

implementation); In re Pekin Singer Strauss Asset 

Management Inc., et al., Investment Advisers Act 

Release No. 4126 (June 23, 2015) (settled action) 

(alleging that the adviser failed to complete timely 

annual compliance program reviews); In the Matter 

of Hudson Hous. Capital, LLC, Investment Advisers 

Act Release No. 5047 (Sept. 25, 2018) (settled 

action) (alleging that the adviser failed to review its 

policies and procedures at least annually); In the 

Matter of ED Capital Management, LLC, Investment 

Advisers Act Release No. 5344 (Sept. 13, 2019) 

(settled action) (alleging that the adviser failed to 

conduct the required annual reviews of its written 

policies and procedures). 

• Should the rule require disclosure 

of all preferential treatment, as 

proposed, or should the rule have a 

narrower or broader scope? 

• Should the proposed rule require 

the adviser to disclose how it 

memorialized the preferential treatment 

(e.g., formal written side letter, email)? 

• The proposed rule would require 

the adviser to provide written notice. 

Should the proposed rule instead allow 

advisers to disclose this information 

orally and keep a record evidencing 

such oral disclosure? Why or why not? 

• The proposed rule would require 

the adviser to provide notice on an 

annual basis to current investors, if the 

adviser or its related persons provided 

any preferential treatment to other 

investors in the same private fund since 

the last written notice. The proposed 

rule does not specify whether the 

adviser must provide this on a calendar 

year basis, the adviser’s fiscal year, or 

on a rolling annual basis. Should the 

rule specify precisely when the annual 

period begins and ends? Why or why 

not? If so, what should the beginning 

and ending dates be? Instead of an 

annual notice, should we require an 

adviser to provide the notice within 30 

days of providing any new preferential 

treatment to an investor in the fund? 

• Should we require an adviser to 

document the years during which it has 

not provided any preferential treatment 

and therefore need not distribute or 

provide a written notice to current 

investors or prospects, respectively? 

Why or why not? If an adviser has not 

provided preferential treatment to any 

investors, or has not done so during the 

applicable time period, should we 

require an adviser to send current 

investors and prospects a written notice 

confirming that it does not have any 

preferential treatment to disclose? Why 

or why not? 

• The proposed rule would require 

advisers to provide or distribute a 

written notice that provides ‘‘specific’’ 

information about preferential 

treatment. Should the proposed rule 

define ‘‘specific’’ or use another term to 

describe the required level of detail? 

1. Recordkeeping for Preferential 

Treatment 

We propose amending rule 204–2 

under the Advisers Act to require 

advisers registered with the Commission 

to retain books and records to support 

their compliance with the proposed 

preferential treatment rule.204 In 

connection with the written notices 

required by proposed rule 211(h)(2)–3, 

advisers would be required to retain 

copies of all written notices sent to 

current and prospective investors in a 

private fund pursuant to that rule.205 In 

addition, advisers would be required to 

retain copies of a record of each 

addressee and the corresponding dates 

sent, addresses, and delivery method for 

each addressee. These proposed 

requirements would facilitate our staff’s 

ability to assess an adviser’s compliance 

with the proposed rule and would 

similarly enhance an adviser’s 

compliance efforts. 

We request comment on this aspect of 

the proposed rule: 

• Would the proposed recordkeeping 

requirement be overly burdensome for 

advisers? Why or why not? 

• Would advisers face more difficulty 

retaining records regarding prospective 

investors as compared to retaining 

records for current investors? Would it 

be more difficult for advisers to keep 

track of prospective investors? For 

example, prospective investors may 

express interest in a private fund, but 

may not actually invest. Should we only 

require advisers to retain records 

regarding prospective investors that 

invest in the private fund? 

• The books and records rule under 

the Advisers Act applies to SECregistered advisers. Should we adopt a 

recordkeeping obligation that would 

require other advisers (such as exempt 

reporting advisers) to retain the written 

notices that proposed rule 211(h)(2)–3 

would require? Why or why not? 

III. Discussion of Proposed Written 

Documentation of all Advisers’ Annual 

Reviews of Compliance Programs 

We are proposing to amend the 

Advisers Act compliance rule to require 

all SEC-registered advisers to document 

the annual review of their compliance 

policies and procedures in writing.206

We believe that such a requirement 

would focus renewed attention on the 

importance of the annual compliance 

review process. In addition, we believe 

that the proposed amendment would 

result in records of annual compliance 

reviews that would allow our staff to 

determine whether an adviser has 

complied with the review requirement 

of the compliance rule.207

The compliance rule currently 

requires advisers to review, no less 

frequently than annually, the adequacy 

of their compliance policies and 

procedures and the effectiveness of their 

implementation. The annual review 

requirement was intended to require 

advisers to evaluate periodically 

whether their compliance policies and 

procedures continue to work as 

designed and whether changes are 

needed to assure their continued 

effectiveness.208 As we stated in the 

Compliance Rule Adopting Release, 

‘‘the annual review should consider any 

compliance matters that arose during 

the previous year, any changes in the 

business activities of the adviser or its 

affiliates, and any changes in the 

Advisers Act or applicable regulations 

that might suggest a need to revise the 

policies and procedures.’’ 

Based on staff experience, some 

investment advisers do not make and 

preserve written documentation of the 

annual review of their compliance 

policies and procedures. The 

compliance rule does not expressly 

require written documentation.209 Our 

examination staff relies on 

documentation of the annual review to 

help the staff understand an adviser’s 

compliance program, determine 

whether the adviser is complying with 

the rule, and identify potential 

weaknesses in the compliance program. 

Without documentation that the adviser 


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210The adviser would be required to maintain the 

written documentation of its annual review in an 

easily accessible place for at least five years after 

the end of the fiscal year in which the review was 

conducted, the first two years in an appropriate 

office of the investment adviser. See rule 204– 

2(a)(17)(ii) and (e)(1). 

211While business development companies (as 

defined in the Investment Company Act) are 

exempt from the registration provisions of that Act, 

we include them within the term ‘‘registered funds’’ 

for ease of reference. See 15 U.S.C. 80a–2(a)(48); 15 

U.S.C. 80a–6(f). Rule 38a–1(a)(3) under the 

Investment Company Act requires a registered fund 

to review, no less frequently than annually, the 

adequacy of the policies and procedures of the 

registered fund and of each investment adviser, 

principal underwriter, administrator, and transfer 

agent and the effectiveness of their implementation. 

Rule 38a–1(d) under the Investment Company Act 

requires a registered fund to maintain any records 

documenting the fund’s annual review. 

212Rule 38a–1(a)(4)(iii) under the Investment 

Company Act. For purposes of rule 38a–1, a 

‘‘material compliance matter’’ is defined as any 

compliance matter about which the registered 

fund’s board of directors would reasonably need to 

know to oversee fund compliance, including 

violations of the Federal securities laws by the 

registered fund. See rule 38a–1(e)(2) under the 

Investment Company Act. 

213Our staff has observed that registered funds 

also generally retain these reports with their board 

meeting minutes, which aids our staff’s ability to 

assess compliance with rule 38a–1. See rule 31a– 

1(b)(4) under the Investment Company Act 

(requiring registered investment companies to 

maintain and keep current certain books, accounts, 

and other documents, including minute books of 

directors’ or trustees’ meetings; and minute books 

of directors’ or trustees’ committee and advisory 

board or advisory committee meetings). 

214 In connection with the written report required 

under rule 38a–1, the Compliance Rule Adopting 

Release stated that ‘‘[a]ll reports required by our 

rules are meant to be made available to the 

Commission and the Commission staff and, thus, 

they are not subject to the attorney-client privilege, 

the work-product doctrine, or other similar 

protections.’’ See Compliance Rule Adopting 

Release, supra footnote 207, at n.94. 

215Staff also has observed delays in production 

of other non-privileged records. Delays undermine 

the staff’s ability to conduct examinations, and may 

be inconsistent with production obligations. 

conducted the review, including 

information about the substance of the 

review, our staff has limited visibility 

into the adviser’s compliance practices. 

The proposed amendment to rule 

206(4)–7 would establish a written 

documentation requirement applicable 

to all advisers.210

Proposed rule 206(4)–7(b) does not 

enumerate specific elements that 

advisers must include in the written 

documentation of their annual review. 

The written documentation requirement 

is intended to be flexible to allow 

advisers to continue to use the review 

procedures they have developed and 

found most effective. For example, some 

advisers may review the adequacy of 

their compliance policies and 

procedures (or a subset of those 

compliance policies and procedures) 

and the effectiveness of their 

implementation on a quarterly basis. In 

such a case, we believe that the written 

documentation of the annual review 

could comprise written quarterly 

reports. 

The regulations in 17 CFR 270.38a–1 

(rule 38a–1 under the Investment 

Company Act), the compliance rule 

applicable to registered investment 

companies and business development 

companies (collectively ‘‘registered 

funds’’), do not require written 

documentation of a registered fund’s 

annual review of its compliance policies 

and procedures.211 However, rule 38a– 

1 requires a registered fund’s CCO to 

provide a written report to the registered 

fund’s board of directors, at least 

annually, that addresses: (i) The 

operation of the compliance policies 

and procedures of the registered fund 

and each investment adviser, principal 

underwriter, administrator, and transfer 

agent of the registered fund; (ii) any 

material changes made to those policies 

and procedures since the date of the last 

report; (iii) any material changes to the 

policies and procedures recommended 

as a result of the registered fund’s 

annual review of its policies and 

procedures; and (iv) each material 

compliance matter that occurred since 

the date of the last report.212 With 

registered funds, written accountability 

has been helpful to ensure compliance 

with the Federal securities laws, and the 

proposed requirements for investment 

advisers are intended to provide similar 

benefits.213 The proposed required 

written documentation of the annual 

review under the compliance rule is 

meant to be made available to the 

Commission and the Commission staff 

and, therefore, should promptly be 

produced upon request.214 Commission 

staff has observed claims of the 

attorney-client privilege, the workproduct doctrine, or other similar 

protections over required records, 

including any records documenting the 

annual review under the compliance 

rule, based on reliance on attorneys 

working for the adviser in-house or the 

engagement of law firms and other 

service providers (e.g., compliance 

consultants) through law firms.215

Attempts to shield from, or 

unnecessarily delay production of any 

non-privileged record is inconsistent 

with prompt production obligations and 

undermines Commission staff’s ability 

to conduct examinations. Prompt access 

to all records is critical for protecting 

investors and to an effective and 

efficient examination program. 

We request comment on the proposed 

amendments to the compliance rule: 

• Should we expressly require 

advisers to document the annual review 

of their compliance policies and 

procedures in writing, as proposed? If 

not, why? 

• Should we specify certain elements 

that must be included in the written 

documentation of the annual review? 

For example, should we require the 

written documentation to address 

matters similar to those that are required 

in the chief compliance officer’s written 

report to a registered fund’s board of 

directors pursuant to rule 38a–1 under 

the Investment Company Act? Despite 

the limitations of private fund 

governance mechanisms, as discussed 

above, should we require the new 

documentation to be provided to 

LPACs, directors, or other governing 

bodies of private funds? Why or why 

not? 

• Are there alternate means to 

document an adviser’s annual review of 

its compliance program? 

• Are there exceptions to the written 

documentation requirement that we 

should adopt? 

IV. Transition Period and Compliance 

Date 

We are proposing a one-year 

transition period to provide time for 

advisers to come into compliance with 

these new and amended rules if they are 

adopted. Accordingly, we propose that 

the compliance date of any adoption of 

this proposal would be one year 

following the rules’ effective dates, 

which would be sixty days after the date 

of publication of the rules in the Federal 

Register. 

Staff in the Division of Investment 

Management is reviewing staff 

statements, including staff no-action 

letters and staff interpretative letters, to 

determine whether any statements, or 

portions thereof, should be withdrawn 

or modified in connection with any 

adoption of this proposal. Upon the 

adoption of any rule, some letters and 

other staff statements, or portions 

thereof, may be moot, superseded, or 

otherwise inconsistent with the rule 

and, therefore, would be withdrawn or 

modified. If interested parties believe 

that certain letters or other staff 

statements, or portions thereof, should 

be withdrawn or modified, they should 

identify the letter or statement, state 

why it is relevant to the proposed rule, 

how it or any specific portion thereof 

should be treated, and the reason 

therefor. Interested parties also should 

explain any concerns with the 

withdrawal or modification of any staff 

statements and letters on this topic. 

We request comments on the 

proposed transition period: 

• Do commenters agree that a oneyear transition period following each 


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16934 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

216See proposed rules 206(4)–10, 211(h)(1)–2, 

211(h)(2)–2. As discussed above, the proposed rules 

that pertain to registered investment advisers apply 

to all investment advisers registered, or required to 

be registered, with the Commission. See supra 

section II. 

217See proposed rules 204–2(a)(20), (21), (22), 

and (23). 

218See proposed rules 211(h)(1)–2(d). 

219See proposed rule 204–2(a)(7)(v) (imposing 

recordkeeping requirements for notices required 

under the proposed preferential treatment rule). 

rule’s effective date if adopted is 

appropriate? Should the period be 

shorter or longer? For example, would 

six months be an appropriate amount of 

time? Alternatively, would eighteen 

months be necessary? 

• Should the transition period be the 

same for all of the proposed new and 

amended rules if adopted? Should we 

have different compliances dates for 

each proposed rule? Why or why not, 

and for which rules? 

• Should the transition period be the 

same for all advisers subject to the 

proposed rules, if adopted? 

Alternatively, should we adopt a tiered 

transition period for smaller or larger 

entities? For example, should we 

provide an additional six months in the 

transition period for smaller entities (or 

some other shorter or longer period)? 

How should we define smaller entities 

for this purpose? 

• Should advisers to certain fund 

types have a longer (or shorter) 

transition period? Would compliance 

with some or all of the proposed rules 

be more complex for advisers to certain 

fund types, such as private equity, 

venture capital, real estate or other 

similar closed-end private funds, than 

for advisers to other fund types, such as 

hedge funds or other similar open-end 

private funds? 

• The proposed quarterly statement 

rule would require advisers to report 

performance since the fund’s inception. 

Should we allow funds that existed 

before the compliance date of the 

proposed rule to include performance 

information only for periods beginning 

on or after the proposed rule’s 

compliance date? Should the proposed 

rule include a maximum period of time 

that funds that are in existence as of the 

compliance date must look back in 

order to report performance, fees, and 

expenses? Is it common practice for 

older funds (e.g., hedge fund incepted 

30 years ago) to retain records to 

support that performance? Would it be 

burdensome for advisers to provide 

since-inception performance 

information? 

V. Economic Analysis 

A. Introduction 

We are mindful of the costs imposed 

by, and the benefits obtained from, our 

rules. Whenever we engage in 

rulemaking and are required to consider 

or determine whether an action is 

necessary or appropriate in the public 

interest, section 202(c) of the Advisers 

Act requires the Commission to 

consider, in addition to the protection of 

investors, whether the action would 

promote efficiency, competition, and 

capital formation. The following 

analysis considers, in detail, the 

potential economic effects that may 

result from this rulemaking, including 

the benefits and costs to market 

participants as well as the broader 

implications of the proposed rules for 

efficiency, competition, and capital 

formation. 

Where possible, the Commission 

quantifies the likely economic effects of 

its proposed amendments and rules. 

However, the Commission is unable to 

quantify certain economic effects 

because it lacks the information 

necessary to provide estimates or ranges 

of costs. Further, in some cases, 

quantification would require numerous 

assumptions to forecast how investment 

advisers and other affected parties 

would respond to the proposed 

amendments and rules, and how those 

responses would in turn affect the 

broader markets in which they operate. 

In addition, many factors determining 

the economic effects of the proposed 

amendments and rules would be firmspecific and thus inherently difficult to 

quantify, such that, even if it were 

possible to calculate a range of potential 

quantitative estimates, that range would 

be so wide as to not be informative 

about the magnitude of the benefits or 

costs associated with the proposed 

rules. Many parts of the discussion 

below are, therefore, qualitative in 

nature. As described more fully below, 

the Commission is providing a 

qualitative assessment and, where 

feasible, a quantified estimate of the 

economic effects. 

B. Economic Baseline 

The economic baseline against which 

we evaluate and measure the economic 

effects of the proposed rules, including 

its potential effects on efficiency, 

competition, and capital formation, is 

the state of the world in the absence of 

the proposed rules. We consider the 

current business practices and 

disclosure practices of private fund 

advisers, as well as the current 

regulation and the forms of external 

monitoring and investor protections that 

are currently in place. In addition, in 

considering the current business and 

disclosure practices, we consider the 

usefulness of the information that 

investment advisers provide to investors 

about the private funds in which those 

investors invest, including information 

that may be helpful for deciding 

whether to invest (or remain invested) 

in the fund, monitoring an investment 

in the fund (in relation to fund 

documents and in relation to other 

funds), and other purposes. We further 

consider the effectiveness of the 

disclosures in providing useful 

information to the investor. For 

example, fund disclosures can have 

direct effects on investors by affecting 

their ability to assess costs and returns 

and to identify the funds that align with 

their investment preferences and 

objectives. Disclosures can also help 

investors monitor their private fund 

advisers’ conduct, depending in part on 

the extent to which private funds lack 

governance mechanisms that would 

otherwise help check adviser conduct. 

Disclosures can therefore influence the 

matches between investor choices of 

private funds and preferences over 

private fund terms, investment 

strategies, and investment outcomes, 

with more effective disclosures resulting 

in improved matches. 

1. Industry Statistics and Affected 

Parties 

The proposed quarterly statement, 

audit, and adviser-led secondary rules 

would apply to all SEC registered 

investment advisers (‘‘RIAs’’) with 

private fund clients.216 Proposed 

amendments to the books and records 

rule would also impose corresponding 

recordkeeping obligations on these 

advisers.217 The proposed performance 

requirements of the quarterly statement 

rule would vary according to whether 

the RIA determines the fund is a liquid 

fund, such as a hedge fund, or an 

illiquid fund, such as a private equity 

fund.218 According to Form ADV data, 

there are 5,139 such RIAs with private 

fund clients. 

The proposed prohibited activity and 

preferential treatment rules would apply 

to all advisers to private funds, 

regardless of whether the advisers are 

registered with or reporting as exempt 

reporting advisers (‘‘ERAs’’) to the 

Commission or one or more state 

securities commissioners or are 

otherwise not required to register. 

Proposed amendments to the books and 

records rule would also impose 

corresponding recordkeeping 

obligations on private fund advisers if 

they are registered with the 

Commission.219 Based on Form ADV 

data, this would include approximately 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16935 

220See infra footnote 416 (with accompanying 

text). 

221See e.g., Lucian Bebchuk, Alma Cohen, and 

Scott Hirst, The Agency Problems of Institutional 

Investors, Journal of Economic Perspectives (2017). 

See also John Morley, The Separation of Funds and 

Managers: A Theory of Investment Fund Structure 

and Regulation, 123 Yale Law Journal 1231–1287 

(2014); Paul G. Mahoney, Manager-Investor 

Conflicts in Mutual Funds, 18 Journal of Economic 

Perspectives 161–182 (2004). 

222We observe that LPACs tend to be limited in 

their ability to receive disclosures about, oversee, or 

provide approval or consent for addition, private 

funds also do not have comprehensive mechanisms 

for such governance by fund investors. 

223Form ADV Item 5.F.2 and Item 12.A. 

12,500 advisers to private funds, across 

RIAs and ERAs.220

The proposed amendments to the 

compliance rule would affect all RIAs, 

regardless of whether they have private 

fund clients. According to Form ADV 

data, there are 15,283 RIAs, across both 

those who do and do not have private 

fund clients. 

The parties affected by these various 

proposed rules would include the 

private fund advisers, advisers to other 

client types (with respect to the 

proposed amendments to the 

compliance rule), private funds, private 

fund investors, certain other pooled 

investment vehicles and clients advised 

by private fund advisers and their 

related persons, and others to whom 

those affected parties would turn for 

assistance in responding to the 

proposed rules. Private fund investors 

are generally institutional investors 

(including, for example, retirement 

plans, trusts, endowments, sovereign 

wealth funds, and insurance 

companies), as well as high net worth 

individuals. In addition, the parties 

affected by these various proposed rules 

could include private fund portfolio 

investments, such as portfolio 

companies. For example, certain types 

of fees, such as accelerated payment 

fees, would no longer be able to be 

charged to those portfolio companies. 

The relationships between the 

affected parties are governed in part by 

current rules under the Advisers Act, as 

discussed in Section V.B.3. In addition, 

relationships between funds and 

investors generally depend on fund 

governance.221 Private funds typically 

lack fully independent governance 

mechanisms, such as an independent 

board of directors or LPAC with direct 

access to fund information, that would 

help monitor and govern private fund 

adviser conduct and check possible 

overreaching. Although some private 

funds may have LPACs or boards of 

directors, these types of bodies may not 

have the necessary independence, 

authority, or accountability to oversee 

and consent to these conflicts or other 

harmful practices as they may not have 

sufficient access, information, or 

authority to perform a broad oversight 

role. Moreover, the interests of one or 

more private fund investors may not 

represent the interests of, or may 

otherwise conflict with the interests of, 

other investors in the private fund due 

to business or personal relationships or 

other private fund investments, among 

other factors. To the extent investors are 

afforded governance or similar rights, 

such as LPAC representation, certain 

fund agreements permit such investors 

to exercise their rights in a manner that 

places their interests ahead of the 

private fund or the investors as a whole. 

For example, certain fund agreements 

state that, subject to applicable law, 

LPAC members owe no duties to the 

private fund or to any of the other 

investors in the private fund and are not 

obligated to act in the interests of the 

private fund or the other investors as a 

whole.222

Based on Form ADV filing data 

between October 1, 2020, and 

September 30, 2021, 5,139 RIAs and 

4,900 ERAs reported that they are 

advisers to private funds.223 Based on 

Form ADV data, hedge funds and 

private equity funds are the most 

frequently reported private funds among 

RIAs, followed by real estate and 

venture capital funds, as shown. In 

comparison to RIAs, ERAs have fewer 

assets under management and are more 

frequently venture capital (VC) funds, 

followed by private equity funds and 

hedge funds, with real estate funds more 

uncommon. 

PRIVATE FUNDS REPORTED

Registered investment advisers Exempt reporting advisers 

Private 

funds Feeder funds Gross assets (billions) 

Private 

funds Feeder funds Gross assets (billions) 

Any private funds .................................... 44,378 12,789 17,470.7 23,940 2,606 5,014.2 

Hedge funds ..................................... 11,508 6,731 8,409.1 2,007 1,318 1,980.9 

Private equity funds ......................... 18,820 3,803 5,086.0 6,104 645 1,457.3 

Real estate funds ............................. 4,174 963 804.2 876 187 119.3 

Venture capital funds ....................... 2,065 163 290.4 13,860 285 996.3 

Securitized asset funds .................... 2,273 81 864.0 96 ........................ 48.4 

Liquidity funds .................................. 86 7 328.8 11 ........................ 133.4 

Other private funds .......................... 5,452 1,048 1,688.1 986 171 278.6 

* Source: Form ADV submissions filed between October 1st, 2020 and Sep 30th, 2021. Funds that are listed by both registered investment advisers and SEC-exempt reporting advisers are counted under both categories separately. Gross assets include uncalled capital commitments on 

Form ADV. 


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16936 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

224The number of private equity funds reported 

by RIAs on Form ADV during this period grew from 

12,819 to 18,820, or by 47 percent. The number of 

hedge funds reported by RIAs grew from 11,114 to 

11,508, or by 3.5 percent. 

225As of September 30, 2021. As noted above, the 

assets under management of registered private fund 

advisers has since continued to grow, exceeding 

$18 trillion as of November 31, 2021. See supra 

footnote 6. 

226See Form ADV data. 

227See 2019 IA Fiduciary Duty Interpretation, see 

also supra footnote 140. Investment advisers also 

have antifraud liability with respect to prospective 

clients under section 206 of the Advisers Act, 

which, among other aspects, applies to transactions, 

practices, or courses of business which operate as 

a fraud or deceit upon prospective clients. 

228 Id. 

229 Id. 

230See supra section II.D.1. 

Also based on Form ADV data, the 

market for private fund investing has 

grown dramatically over the past five 

years. For example, the assets under 

management of private equity funds 

reported by RIAs on Form ADV during 

this period grew from $2.6 trillion to 

$5.1 trillion, or by 96 percent. The 

assets under management of hedge 

funds reported by RIAs grew from $6.1 

trillion to $8.4 trillion, or by 38 

percent.224 The assets under 

management of all private funds 

reported by RIAs grew by fifty-five 

percent over the past five years from $11 

trillion to over $17 trillion,225 while the 

number of private funds reported by 

RIAs grew by thirty-one percent from 

33.8 thousand to 44.4 thousand. The 

assets under management of all private 

funds reported by ERAs grew by one 

hundred fifty percent over the past five 

years from $2 trillion to over $5 trillion, 

while the number of private funds 

reported by ERAs grew by forty percent 

from 3.5 thousand to 4.9 thousand, as 

shown in the figure below.226

Advisers have a fiduciary duty to 

clients, including private fund clients, 

that is comprised of a duty of care and 

a duty of loyalty enforceable under the 

antifraud provision of Section 206.227

The duty of care includes, among other 

things: (i) The duty to provide advice 

that is in the best interest of the client, 

(ii) the duty to seek best execution of a 

client’s transactions where the adviser 

has the responsibility to select brokerdealers to execute client trades, and (iii) 

the duty to provide advice and 

monitoring over the course of the 

relationship.228 The duty of loyalty 

requires that an adviser not subordinate 

its client’s interests to its own.229

Private fund advisers are also prohibited 

from engaging in fraud under the 

general antifraud and anti-manipulation 

provisions of the Federal securities 

laws, including Section 10(b) of the 

Exchange Act (and rule 10b-5 

thereunder) and Section 17(a) of the 

Securities Act. 

Private fund advisers are also subject 

to rule 206(4)–8 under the Advisers Act, 

which prohibits investment advisers to 

pooled investment vehicles, which 

include private funds, from (1) making 

any untrue statement of a material fact 

or omitting to state a material fact 

necessary to make the statements made, 

in the light of the circumstances under 

which they were made, not misleading, 

to any investor or prospective investor 

in the pooled investment vehicle; or (2) 

otherwise engaging in any act, practice, 

or course of business that is fraudulent, 

deceptive, or manipulative with respect 

to any investor or prospective investor 

in the pooled investment vehicle. There 

are no particularized requirements, 

however, that deal with many of the 

revised requirements in this proposal. 

For example, there is no regulation 

requiring an adviser to disclose multiple 

different measures of performance to its 

investors, to refrain from borrowing 

from a private fund client, to obtain a 

fairness opinion from an independent 

opinion provider when leading 

secondary transactions, or to disclose 

preferential treatment of certain 

investors to other investors. 

In the absence of more particularized 

requirements, we have observed 

business practices of private fund 

advisers that enrich advisers without 

providing any benefit of services to the 

private fund and its underlying 

investors or create incentives for an 

adviser to place its own interests ahead 

of the private fund’s interests. For 

example, as discussed above, some 

private fund advisers have entered into 

arrangements with a fund’s portfolio 

investments to provide services which 

permit the adviser to accelerate the 

unpaid portion of fees upon the 

occurrence of certain triggering events, 

even though the adviser will never 

provide the contracted-for services.230

These fees enrich advisers without 

providing the benefit of any services to 


khammond on DSKJM1Z7X2PROD with PROPOSALS3EP24MR22.058</GPH>

Private funds reported by RIAs Private funds reported by ERAs 

.-Gross Assets (Trillions) -Number of Private Funds 11111111111!111 Gross Assets (Trillions) -Number of Private Funds 

50,000 $20 6,000 $6 

45,000 $18 

~ 40,000 $16- ~5,000 

C Ill C iii 

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~ 0 

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11s,ooo $6 Ill - Ill 

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i 10,000 

(,!) ::, (,!) 

$4 z 1,000 $1 

$2 

0 $0 $0 

2017 2018 2019 2020 2021 2017 2018 2019 2020 2021 

2. Sales Practices, Compensation Arrangements, and Other 

Business Practices of Private Fund Advisers 
Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16937 

231See supra section II.D.2. 

232See, e.g., Eli Hoffmann, Welcome To Hedge 

Funds’ Stunning Pass-Through Fees, Seeking Alpha 

(Jan. 24, 2017), available at https://seekingalpha.

com/article/4038915-welcome-to-hedge-fundsstunning-pass-through-fees. 

233See supra section II.D.3. 

234See supra section II.D.4. 

235See supra section II.D.3. 

236See supra section II.D.6. 

237 Id. 

238See supra section II.E. 

239 Id. 

240 Id. 

241See supra section II.D.5. 

242 Id. 

243See supra footnote 10 (with accompanying 

text). 

244 Id. 

245A study of leveraged buyout transactions from 

1990–2012 found that accelerated monitoring fees 

had been charged in 28 percent of leveraged buyout 

transactions, representing 15 percent of total fees 

charged in those transactions. See Ludovic 

Phalippou, Christian Rauch, and Marc Umber, 

Continued 

the private fund and its underlying 

investors. 

We have also seen a trend in the 

industry where certain advisers charge a 

private fund for fees and expenses 

incurred by the adviser in connection 

with the establishment and ongoing 

operations of its advisory business.231

We recognize, for example, that certain 

private fund advisers, most notably for 

hedge funds that utilize a ‘‘passthrough’’ expense model, employ an 

arrangement where the private fund 

pays for most, if not all, of the adviser’s 

expenses, and that in exchange, the 

adviser does not charge a management, 

advisory, or similar fee (but does charge 

an incentive or performance fee on net 

returns of the private fund).232 Under 

these or other similar circumstances in 

which advisers charge private funds fees 

associated with the adviser’s cost of 

being an investment adviser, investor 

returns are reduced by the amount of 

the adviser’s overhead and operating 

costs. 

Some investors may not anticipate the 

performance implications of these 

disclosed costs, or may avoid 

investments out of concern that such 

costs may be present. For those 

investors, this could lead to a mismatch 

between investor choices of private 

funds and their preferences over private 

fund terms, investment strategies, and 

investment outcomes, relative to what 

would occur in the absence of such 

unexpected or uncertain costs. 

In addition, our staff has observed 

instances in which advisers have 

entered into agreements that reduce the 

amount of clawbacks by taxes paid, or 

deemed to be paid, by the adviser or its 

owners,233 and instances in which 

limited partnership agreements limit or 

eliminate liability for adviser 

misconduct.234 While these agreements 

are negotiated between fund advisers 

and investors, as discussed above 

advisers often have discretion over the 

timing of fund payments, and so may 

have greater control over risks of 

clawbacks than anticipated by 

investors.235 As such, reducing the 

amount of clawbacks by actual, 

potential, or hypothetical taxes therefore 

passes an unnecessary and avoidable 

cost to investors. This cost denies 

investors the restoration of distributions 

or allocations to the fund that they 

would have been entitled to receive in 

the absence of an excess of performancebased compensation paid to the adviser 

or a related person. These clawback 

terms can therefore reduce the 

alignment between the fund adviser’s 

and investors’ interests. Lastly, the 

elimination of liability for adviser 

misconduct could reduce or eliminate 

investor recoveries of losses in 

connection with misconduct, which 

could make such misconduct more 

likely to occur. 

We have also observed some cases 

where private fund advisers have 

directly or indirectly (including through 

a related person) borrowed from private 

fund clients.236 This practice carries a 

risk of investor harm because the fund 

client may be prevented from using 

borrowed assets to further the fund’s 

investment strategy, and so the fund 

may fail to maximize the investor’s 

returns. This risk is relatively higher for 

those investors that are not able to 

negotiate or directly discuss the terms of 

the borrowing with the adviser, and for 

those funds that do not have an 

independent board of directors or LPAC 

to review and consider such 

transactions.237

The staff also has observed harm to 

investors from disparate treatment of 

investors in a fund. For example, our 

staff has observed scenarios where an 

adviser grants certain private fund 

investors and/or investments in 

substantially similar pools of assets with 

better liquidity terms than other 

investors.238 These preferential liquidity 

terms can disadvantage other fund 

investors or investors in a substantially 

similar pool of assets if, for instance, the 

preferred investor is able to exit the 

private fund or pool of assets at a more 

favorable time.239 Similarly, private 

fund advisers, in some cases, disclose 

information about a private fund’s 

investments to certain, but not all, 

investors in a private fund, which can 

result in profits or avoidance of losses 

among those who were privy to the 

information beforehand at the expense 

of those kept in the dark.240 Currently, 

many investors need to engage in their 

own research regarding what terms may 

be obtained from advisers, as well as 

whether other investors are likely to be 

obtaining better terms than those they 

are initially offered. 

The staff also has observed harm to 

investors when advisers lead multiple 

private funds and other clients advised 

by the adviser or its related persons to 

invest in a portfolio investment.241 In 

those instances, the staff observed 

advisers allocating fees and expenses 

among those clients on a non pro rata 

basis, resulting in some fund clients 

(and investors in those funds) being 

charged relatively higher fees and 

expenses than other clients.242 Advisers 

may make these decisions in order to 

avoid charging some portion of fees and 

expenses to funds with insufficient 

resources to bear its pro rata share of 

expenses related to a portfolio 

investment (whether due to insufficient 

reserves, the inability to call capital to 

cover such expenses, or otherwise) or 

funds in which the adviser has greater 

interests. 

We understand that it can be difficult 

for investors to have full transparency 

into the scenarios described above 

relating to conflicts of interest. For 

example, the Commission has pursued 

enforcement actions against private 

fund advisers where the adviser failed 

to inform investors about benefits that 

the advisers obtained from accelerated 

monitoring fees.243 Further, the 

Commission also has pursued 

enforcement actions against private 

fund advisers in other circumstances in 

which investors were not informed of 

relevant conflicts of interest.244

While our staff has observed that 

some advisers have begun to more fully 

disclose sales practices, conflicts of 

interests, and compensation schemes to 

investors and the practices that are 

associated with them, we believe that it 

may be hard even for sophisticated 

investors with full and fair disclosure, 

to understand the future implications of 

terms and practices related to these 

practices at the time of investment and 

during the investment. Further, some 

investors may find it relatively difficult 

to negotiate agreements that would fully 

protect them from bearing unexpected 

portions of fees and expenses or from 

other decreases in the value of 

investments associated with the abovedescribed practices. For example, some 

forms of negotiation may occur through 

repeat-dealing that may not be available 

to some smaller private fund 

investors.245 For any investors affected 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
16938 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

Private Equity Portfolio Company Fees, 129 Journal 

of Financial Economics, 559–585 (2018). 

246See supra section II.E. 

247Advisers generally are required to update 

disclosures on Form ADV on both an annual basis, 

or when information in the brochure becomes 

materially inaccurate. Additionally, although 

advisers are not required to deliver the Form ADV 

Part 2A brochure to private fund investors, many 

private fund advisers choose to provide the 

brochure to investors as a best practice. 

248While the marketing rule became effective as 

of May 4, 2021, the Commission has set a 

compliance date of November 4, 2022 (eighteen 

months following the effective date) to give advisers 

sufficient time to comply with the provisions of the 

amended rules. As a result, while some advisers 

may have begun to comply with the marketing rule, 

some advisers may not currently be in compliance 

with the marketing rule. As discussed above, the 

marketing rule and its specific protections would 

generally not apply in the context of a quarterly 

statement. See supra footnote 62. 

249See supra section II.B.1 (regarding the role of 

governance mechanisms in the relationship 

between the fund and the investors). 

250See, e.g., William W Clayton, Public Investors, 

Private Funds, and State Law, 72 Baylor Law 

Review 294 (BYU Law Research Paper No. 20–13) 

(July 2020), available at: https://ssrn.com/ 

abstract=3573773. 

251One observer of the variation in reporting 

practices across funds has suggested the use of a 

standardized template for this purpose. See, e.g., 

Reporting Template, The Institutional Limited 

Partners Association, available at https://ilpa.org/ 

reporting-template/. ILPA is a trade group for 

investors in private funds. 

252See supra section II.A.1, II.A.2. 

253 Id. 

254See supra section II.A. 

by these issues, including potentially 

sophisticated investors, there may be 

mismatches between investor choices of 

private funds and preferences over 

private fund terms, investment 

strategies, and investment outcomes, 

relative to what would occur in the 

absence of such unexpected or 

uncertain costs. 

Our staff has also observed that 

investors are generally not provided 

with detailed information about these 

preferential terms.246 This lack of 

transparency prevents investors from 

understanding the scope or magnitude 

of preferential terms granted, and as a 

result, may prevent such investors from 

requesting additional information on 

these terms or other benefits that certain 

investors, including the adviser’s related 

persons or large investors, receive. In 

this case, these investors may simply be 

unaware of the types of contractual 

terms that could be negotiated. To the 

extent this lack of transparency affects 

investor choices of where to allocate 

their capital, it can result in mismatches 

between investor choices of private 

funds and their preferences over private 

fund terms, investment strategies, and 

investment outcomes. 

3. Private Fund Adviser Fee, Expense, 

and Performance Disclosure Practices 

Current rules under the Advisers Act 

do not require advisers to provide 

quarterly statements detailing fees and 

expenses (including fees and expenses 

paid to the adviser and its related 

persons by portfolio investments) to 

private fund clients or to fund investors. 

The custody rule does, however, 

generally require advisers whose private 

fund clients are not undergoing a 

financial statement audit to have a 

reasonable basis for believing that the 

qualified custodians that maintain 

private fund client assets provide 

quarterly account statements to the 

fund’s limited partners. Those account 

statements may contain some of this 

information, though in our experience 

adviser fees and expenses typically are 

not presented with the level of 

specificity the proposed quarterly 

statement rule would require. In 

addition, Form ADV Part 2A (the 

‘‘brochure’’) requires certain 

information about an adviser’s fees and 

compensation. For example, Part 2A, 

Item 6 of Form ADV requires an adviser 

to disclose in its brochure whether the 

adviser accepts performance-based fees, 

whether the adviser manages both 

accounts that are charged a 

performance-based fee and accounts 

that are charged another type of fee, and 

any potential conflicts. Although the 

brochure is not required to be delivered 

to investors in a private fund, the 

information on Form ADV is available 

to the public, including private fund 

investors, through the Commission’s 

Investment Adviser Public Disclosure 

(‘‘IAPD’’) website.247 We understand 

that many prospective fund investors 

obtain the brochure and other Form 

ADV data through the IAPD public 

website. 

Similarly, there currently are no 

requirements under current Advisers 

Act rules for advisers to provide 

investors with a quarterly statement 

detailing private fund performance. 

Although our recently adopted 

marketing rule contains requirements 

that pertain to displaying performance 

information and providing information 

about specific investments in adviser 

advertisements, these requirements do 

not compel the adviser to provide 

performance information to all private 

fund clients or investors. Rather, the 

requirements apply when an adviser 

chooses to include performance or 

address specific investments within an 

advertisement.248

Within this framework, advisers have 

exercised discretion in responding to 

the needs of private fund investors for 

periodic statements regarding fees, 

expenses, and performance or similar 

information on their current 

investments.249 Broadly, current 

investors in a fund rely on this 

information in determining whether to 

invest in subsequent funds and 

investment opportunities with the same 

adviser, or to pursue alternative 

investment opportunities. When fund 

advisers raise multiple funds 

sequentially, they often consider current 

investors to also be prospective 

investors in their subsequent funds, and 

so may make disclosures to motivate 

future capital commitments. This has 

led to the development of diverse 

approaches to the disclosure of fees, 

expenses, and performance.250 A private 

fund adviser may agree, contractually or 

otherwise, to provide disclosures to a 

fund investor, and on the details of 

these disclosures, at the time of the 

investment or subsequently. A private 

fund adviser also may provide such 

information in the absence of an 

agreement. The format, scope and 

reporting intervals of these disclosures 

vary across advisers and private 

funds.251 Some disclosures provide 

limited information while others are 

more detailed and complex. Investors 

may, as a result, find it difficult to 

assess and compare alternative fund 

investments, which can make it harder 

to allocate capital among competing 

fund investments or among private 

funds and other potential investments. 

Limitations in required disclosures by 

advisers may therefore result in 

mismatches between investor choices of 

private funds and their preferences over 

private fund terms, investment 

strategies, and investment outcomes. 

While a variety of practices are used, 

as the market for private fund investing 

has grown, some patterns have emerged. 

We understand that most private fund 

advisers currently provide current 

investors with quarterly reporting, and 

many private fund advisers 

contractually agree to provide fee, 

expense, and performance reporting to 

current investors.252 Further, advisers 

typically provide information to existing 

investors about private fund fees and 

expenses in periodic financial 

statements, schedules, and other reports 

under the terms of the fund 

documents.253

However, reports that are provided to 

investors may report only aggregated 

expenses, or may not provide detailed 

information about the calculation and 

implementation of any negotiated 

rebates, credits, or offsets.254 Investors 

may use the information that they 

receive about their fund investments to 

monitor the expenses and performance 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16939 

255To the extent that a private fund’s securities 

are offered pursuant to 17 CFR 230.500 through 

230.508 (Regulation D of the Securities Act) and 

such offering is made to an investor who is not an 

‘‘accredited investor’’ as defined therein, that 

investor must be provided with disclosure 

documents that generally contain the same type of 

information required to be provided in offerings 

under Regulation A of the Securities Act, as well 

as certain financial statement information. See 17 

CFR 230.502(b). However, private funds generally 

do not offer interests in funds to non-accredited 

investors. 

256See supra section II.A.1. 

257See, e.g., David Snow, Private Equity: A Brief 

Overview, PEI Media (2007), available at https://

www.law.du.edu/documents/registrar/adv-assign/

Yoost_PrivateEquity%20Seminar_

PEI%20Media’s%20Private%20Equity%20- 

%20A%20Brief%20Overview_318.pdf. See also 

supra footnote 166. 

258 Id. 

259 Id. 

260Waterfalls (especially deal-by-deal waterfalls) 

typically have clawback arrangements to ensure 

that advisers do not retain carried interest unless 

investors recoup their entire capital contributions 

on the whole fund, plus a preferred return. The 

result is that total distributions to investors and 

advisers under the two waterfalls can be equal (but 

may not always be), conditional on correct 

implementation of clawback provisions. In that 

case, the key difference in the two arrangements is 

that deal-by-deal waterfalls result in fund advisers 

potentially receiving their performance-based 

compensation faster. However, some deal-by-deal 

waterfalls may also require fund advisers to escrow 

their performance-based compensation until 

investors receive their total capital contributions to 

the fund plus their preferred return on the total 

capital contributions. These escrow policies can 

help secure funds that may need to be available in 

the event of a clawback. Id. 

261Ludovic Phalipoou, An Inconvenient Fact: 

Private Equity Returns & The Billionaire Factory 

University of Oxford, Said Business School, 

(Working Paper), (June 10, 2020), available at 

https://ssrn.com/abstract=3623820 or http://

dx.doi.org/10.2139/ssrn.3623820. 

262 Id. See also Division of Investment 

Management: Analytics Office, Private Funds 

Statistics Report: Fourth Calendar Quarter 2015, at 

5 (July 22, 2016), available at https://www.sec.gov/ 

divisions/investment/private-funds-statistics/ 

private-funds-statistics-2015-q4.pdf. 

from those investments. Their ability to 

measure and assess the impact of fees 

and expenses on their investment 

returns depends on whether, and to 

what extent, they are able to receive 

detailed disclosures regarding those fees 

and expense and regarding fund 

performance. Some investors currently 

do not receive such detailed disclosures, 

and this reduces their ability to monitor 

the performance of their existing fund 

investment or to compare it with other 

prospective investments. 

In other cases, adviser reliance on 

exemptions from specific regulatory 

burdens for other regulators can lead 

advisers to make certain quarterly 

disclosures. For example, while we 

believe that many advisers to hedge 

funds subject to the jurisdiction of the 

U.S. Commodity Futures Trading 

Commission (‘‘CFTC’’) rely on an 

exemption provided in CFTC Regulation 

§ 4.13 from the requirement to register 

with CFTC as a ‘‘commodity pool 

operator,’’ some may rely on other CFTC 

exemptions, exclusions or relief. 

Specifically, we believe that some 

advisers registered with the CFTC may 

operate with respect to a fund in 

reliance on CFTC Regulation § 4.7, 

which provides certain disclosure, 

recordkeeping and reporting relief and 

to the extent that the adviser does so, 

the adviser would be required to, no less 

frequently than quarterly, prepare and 

distribute to pool participants 

statements that present, among other 

things, the net asset value of the exempt 

pool and the change in net asset value 

from the end of the previous reporting 

period. 

In addition, information about 

advisers’ fees and about expenses is 

often included in advisers’ marketing 

documents, or included in the fund 

documents. Many advisers to private 

equity funds and other funds that would 

be determined to be illiquid funds 

under the proposed rule provide 

prospective investors with access to a 

virtual data room for the fund, 

containing the fund’s offering 

documents (including categories of fees 

and expenses that may be charged), as 

well as the adviser’s brochure and other 

ancillary items, such as case studies.255

These advisers meet the contractual and 

other needs of investors for updated 

information by updating the documents 

in the data room. Many advisers to 

funds that would be considered liquid 

funds under the proposed rule, such as 

hedge funds, tend not to use data rooms. 

They instead take the approach of 

sending email or using other methods to 

convey updated information to 

investors. For instance, prior to closing 

on a prospective investor’s investment, 

some advisers send out pre-closing 

email messages containing updated 

versions of these and other documents. 

While these data rooms and email 

communications are therefore limited in 

their use for disclosing ongoing fees and 

expenses over the life of the fund, 

prospective investors at the start of the 

life of a fund, or at or before the time 

of their investment, may use this 

information in conducting due 

diligence, in deciding whether to seek to 

negotiate the terms of investment, and 

ultimately in deciding whether to invest 

in the adviser’s fund. 

The adviser’s and related persons’ 

rights to compensation, which are set 

forth in fund documents, vary across 

fund types and advisers and can be 

difficult to quantify at the time of the 

initial investment. For example, 

advisers of private equity funds 

generally receive a management fee 

(compensating the adviser for bearing 

the costs relating to the operation of the 

fund and its portfolio investment) and 

performance-based compensation 

(further incentivizing advisers to 

maximize investor value).256

Performance-based compensation 

arrangements in private equity funds 

typically require that investors recoup 

capital contributions plus a minimum 

annual return (called the ‘‘hurdle rate’’ 

or ‘‘preferred return’’), but these 

arrangements can vary according to the 

waterfall arrangement used, meaning 

that distribution entitlements between 

the adviser (or its related persons) and 

the private fund investors can depend 

on whether the proceeds are distributed 

on a whole-fund (known as Europeanstyle) basis or a deal-by-deal (known as 

American-style) basis.257 In the wholefund (European) case, the fund typically 

allocates all investment proceeds to the 

investors until they recoup 100% of 

their capital contributions attributable 

to both realized and unrealized 

investments plus their preferred return, 

at which point fund advisers typically 

begin to receive performance-based 

compensation.258 In the deal-by-deal 

(American) case (or modified versions 

thereof), it is common for investment 

proceeds from each portfolio investment 

to be allocated 100% to investors until 

investors recoup their capital 

contributions attributable to that 

specific investment, any losses from 

other realized investments, and their 

applicable preferred return, and then 

fund advisers can begin to receive 

performance-based compensation from 

that investment.259 Under the deal-bydeal waterfall, advisers can potentially 

receive performance-based 

compensation earlier in the life of the 

fund, as successful investments can 

deliver advisers performance-based 

compensation before investors have 

recouped their entire capital 

contributions to the fund.260

Management fee compensation figures 

and performance-based compensation 

figures are not widely disclosed or 

reported,261 but the sizes of certain of 

these fees have been estimated in 

industry and academic literature. For 

example, one study estimated that from 

2006–2015, performance-based 

compensation alone for private equity 

funds averaged $23 billion per year.262

Private fund fees increase as assets 

under management increase, and the 

private fund industry has grown since 

2015, and as a result private equity 

management fees and performancebased compensation fees may together 


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263Private equity management fees are currently 

estimated to typically be 1.76 percent and 

performance-based compensation is currently 

estimated to typically be 20.3 percent of private 

equity fund profits. See, e.g., Ashley DeLuce and 

Pete Keliuotis, How to Navigate Private Equite Fees 

and Terms, Callan’s Research Cafe ́ (October 7, 

2020), available at https://www.callan.com/

uploads/2020/12/2841fa9a3ea9

dd4dddf6f4daefe1cec4/callan-institute-privateequity-fees-terms-study-webinar.pdf. Private equity 

net assets under management as of the fourth 

quarter of 2020 were approximately $4.2 trillion. 

Division of Investment Management: Analytics 

Office, Private Funds Statistics Report: Fourth 

Calendar Quarter 2020 at 5 (August 4, 2021), 

available at https://www.sec.gov/divisions/ 

investment/private-funds-statistics/private-fundsstatistics-2020-q4.pdf. Total fees may be estimated 

by multiplying management fee percentages by net 

assets under management, and by multiplying 

performance-based compensation percentages by 

net assets under management and again by an 

estimate of private equity annual returns, which 

may conservatively be assumed to be approximately 

10 percent. See, e.g., Michael Cembalest, Food 

Fight: An Update on Private Equity Performance vs. 

Public Equity Markets, J.P. Morgan Asset and 

Wealth Management (June 28, 2021), available at 

https://privatebank.jpmorgan.com/content/dam/

jpm-wm-aem/global/pb/en/insights/eye-on-themarket/private-equity-food-fight.pdf. 264See Division of Investment Management: 

Analytics Office, Private Funds Statistics Report: 

Fourth Calendar Quarter 2020 at 5 (August 4, 2021), 

available at https://www.sec.gov/divisions/

investment/private-funds-statistics/private-fundsstatistics-2020-q4.pdf. 

265For example, hedge fund management fees are 

currently estimated to typically be 1.4 percent per 

year and performance-based compensation is 

currently estimated to typically be 16.4 percent of 

hedge fund profits, approximately consistent with 

private equity fees. See, e.g. Leslie Picker, Two and 

Twenty is Long Dead: Hedge Fund Fees Fall Further 

Below Onetime Industry Standard, CNBC, available 

at https://www.cnbc.com/2021/06/28/two-andtwenty-is-long-dead-hedge-fund-fees-fall-furtherbelow-one-time-industry-standard.html (citing HRF 

Microstructure Hedge Fund Industry Report Year 

End 2020). Hedge funds as of the fourth quarter of 

2020 were represented another approximately $4.7 

trillion in net assets under management. See 

Division of Investment Management: Analytics 

Office, Private Funds Statistics Report: Fourth 

Calendar Quarter 2020 at 5 (August 4, 2021), 

available at https://www.sec.gov/divisions/

investment/private-funds-statistics/private-fundsstatistics-2020-q4.pdf. 

266See e.g., Ludovic Phalippou, Christian Rauch, 

and Marc Umber, Private Equity Portfolio Company 

Fees, 129 (3) Journal of Financial Economics, 559– 

585 (2018). 

267See supra section II.A.1. There may be certain 

economic arrangements where only certain 

investors to the fund receive credits from rebates. 

268See e.g., Juliane Begenau and Emil 

Siriwardane, How Do Private Equity Fees Vary 

Across Public Pensions?, 20–073 Harvard Business 

School (Working Paper) (January 2020) (Revised 

February 2021) (concluding that a sample of public 

pension funds investing in a sample of private 

equity funds would have received an average of an 

additional $8.50 per $100 invested had they 

received the best observed fees in the sample); 

Tarun Ramadorai and Michael Streatfield, Money 

for Nothing? Understanding Variation in Reported 

Hedge Fund Fees, Paris December 2012 Finance 

Meeting EUROFIDAI–AFFI Paper, (March 28, 2011) 

(finding that a sample of hedge fund advisers, 

management fees ranging from less than .5 percent 

to over 2 percent and finding incentive fees ranging 

from less than 5 percent to over 20 percent, with 

no detectible difference in performance by funds 

with different management fees and only modest 

evidence of higher incentive fees yielding higher 

returns), available at https://ssrn.com/

abstract=1798628 or http://dx.doi.org/10.2139/ 

ssrn.1798628. 

269See supra section II.A.1, II.D.1. 

270As discussed above, certain factors are 

currently used for determining how certain types of 

private funds should report performance under U.S. 

GAAP. See supra footnote 71 (with accompanying 

text). 

271See supra section II.A.2.b. 

272 Id. 

273 Id. 

274 Id. 

275See e.g., James F. Albertus & Matthew Denes, 

Distorting Private Equity Performance: The Rise of 

Fund Debt, Frank Hawkins Kenan Institute of 

Private Enterprise Report (June 2019), available at 

https://www.kenaninstitute.unc.edu/wp-content/ 

uploads/2019/07/DistortingPrivateEquity

Performance_07192019.pdf. 

276See e.g., Oliver Gottschalg and Ludovic 

Phalippou, The Truth About Private Equity 

Performance, Harvard Business Review (Dec. 2007), 

available at https://hbr.org/2007/12/the-truthabout-private-equity-performance. 

currently total over $100 billion dollars 

in fees per year.263 Private equity 

represents $4.2 trillion of the $11.5 

trillion dollars in net assets under 

management by private funds,264 and so 

total fees across the private fund 

industry may be over $200 billion 

dollars in fees per year.265

In addition, advisers or their related 

persons may receive a monitoring fee for 

consulting services targeted to a specific 

asset or company in the fund 

portfolio.266 Whether they ultimately 

retain the monitoring fee depends, in 

part, on whether the fund’s governing 

documents require the adviser to offset 

portfolio investment compensation 

against other revenue streams or 

otherwise provide a rebate to the fund 

(and so indirectly to the fund 

investors).267 There can be substantial 

variation in the fees private fund 

advisers charge for similar services and 

performances.268 Ultimately, the fund 

(and indirectly the investors) bears the 

costs relating to the operation of the 

fund and its portfolio investments.269

Regarding performance disclosure, 

advisers typically provide information 

about fund performance to investors 

through the account statements, 

transaction reports, and other reports. 

Some advisers, primarily private equity 

fund advisers, also disclose information 

about past performance of their funds in 

the private placement memoranda that 

they provide to prospective investors. 

Many standardized industry methods 

have emerged that private funds rely on 

to report returns and performance.270

However, each of these standardized 

industry methods has a variety of 

benefits and drawbacks, including 

differences in the information they are 

able to capture and their susceptibility 

to manipulation by fund advisers. 

For private equity and other funds 

that would be determined to be illiquid 

under the proposed rules, standardized 

industry methods for measuring 

performance must contend with the 

complexity of the timing of illiquid 

investments. One approach that has 

emerged for computing returns for 

private equity and other fund that 

would be determined to be illiquid 

funds is the internal rate of return 

(‘‘IRR’’).271 As discussed above, an 

important benefit of IRR that drives its 

use is that IRR can reflect the timing of 

cash flows more accurately than other 

performance measures.272 All else 

equal, a fund that delivers returns to its 

investors faster will have a higher IRR. 

However, current use of IRR to 

measure returns has a number of 

drawbacks, including an upward bias in 

the IRR that comes from a fund’s use of 

leverage, assumptions about the 

reinvestment of proceeds, and a large 

effect on measured IRR from cash flows 

that occur early in the life of the pool. 

For example, as discussed above, some 

private equity funds borrow extensively 

at the fund level.273 This can cause IRRs 

to be biased upwards. Since IRRs are 

based in part on the length of time 

between the fund calling up investor 

capital and the fund distributing profits, 

private equity funds can delay capital 

call-ups by first borrowing from fundlevel subscription facilities to finance 

investments.274 This practice has been 

used by private equity funds to 

artificially boost reported IRRs, but 

investors must pay the interest on the 

debt used and so can potentially suffer 

lower total returns.275

As for reinvestment assumptions, the 

IRR as a performance measure assumes 

that cash proceeds have been reinvested 

at the IRR over the entire investment 

period. For example, if a private equity 

or other fund determined to be illiquid 

reports a 50% IRR but has exited an 

investment and made a distribution to 

investors early in its life, the IRR 

assumes that the investors were able to 

reinvest their distribution again at a 

50% annual return for the remainder of 

the life of the fund.276

Although IRR remains one of the 

leading standardized methods of 

reporting returns at present, these and 

other drawbacks make IRR difficult as a 

singular return measure, especially for 

investors who likely may not 

understand the limitations of the IRR 

metric, and the differences between IRR 

and total return metrics used for public 

equity or registered investment funds. 

Several other measures have emerged 

for measuring the performance of 


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277See e.g., Robert Harris, Tim Jenkinson and 

Steven Kaplan, Private Equity Performance: What 

Do We Know?, 69 (5) Journal of Finance 1851 (Mar. 

27, 2014), available at https://onlinelibrary.

wiley.com/doi/full/10.1111/jofi.12154; Steven 

Kaplan and Antoinette Schoar, Private Equity 

Performance: Returns, Persistence, and Capital 

Flows, 60 (5) Journal of Finance (Aug. 2005), 

available at http://web.mit.edu/aschoar/www/ 

KaplanSchoar2005.pdf. 

278See supra section II.A.2.b. 

279 Id. 

280 Id. 281See e.g., Ludovic Phalippou and Oliver 

Gottschalg, The Performance of Private Equity 

Funds, 22 (4) The Review of Financial Studies 

1747–1776 (Apr. 2009). 

282See e.g., Philippe Jorion and Christopher 

Schwarz, The Fix Is In: Properly Backing Out 

Backfill Bias, 32 (12) The Society For Financial 

Studies 5048–5099 (Dec. 2019); see also Nickolay 

Gantchev, The Costs of Shareholder Activism: 

Evidence From A Sequential Decision Model, 107 

Journal of Financial Economics 610–631 (2013). 

283See, e.g., Ludovic Phalippou and Oliver 

Gottschalg, The Performance of Private Equity 

Funds, 22 (4) The Review of Financial Studies, 

1747–1776 (Apr. 2009); Michael Cembalest, Food 

Fight: An Update on Private Equity Performance vs. 

Public Equity Markets, J.P. Morgan Asset and 

Wealth Management (June 28, 2021), available at 

https://privatebank.jpmorgan.co/content/dam/jpmwm-aem/global/pb/en/insights/eye-on-the-market/ 

private-equity-food-fight.pdf. 

284See supra section II.B; rule 206(4)–2(b)(4). The 

staff has stated that, in order to meet the 

requirements of rule 206(4)–2(b)(4), these financial 

statements must be prepared in accordance with 

U.S. GAAP or, for certain non-U.S. funds and nonU.S. advisers, prepared in accordance with other 

standards, so long as they contain information 

substantially similar to statements prepared in 

accordance with U.S. GAAP, with material 

differences reconciled. See Staff Responses to 

Questions About the Custody Rule, available at 

https://www.sec.gov/divisions/investment/custody_

faq_030510.htm. 

285See, e.g., AS 2301: The Auditor’s Responses to 

the Risks of Material Misstatement, PCAOB, 

available at https://pcaobus.org/oversight/ 

standards/auditing-standards/details/AS2301; AU– 

C Section 240: Consideration of Fraud in a 

Financial Statement Audit, AICPA (2021), available 

at https://us.aicpa.org/content/dam/aicpa/

research/standards/auditattest/

downloadabledocuments/au-c-00240.pdf. 

286Rule 206(4)–2(a)(4) requires that an adviser 

that is registered or required to be registered under 

Section 203 of the Act with custody of client assets 

to obtain an annual surprise examination from an 

independent public accountant. An adviser to a 

pooled investment vehicle that is subject to an 

annual financial statement audit by a PCAOBregistered independent public accountant that is 

Continued 

private equity and other funds that 

would be determined to be illiquid 

under the proposal. These measures 

compensate for some of the 

shortcomings of IRR at the cost of their 

own drawbacks. Multiple of invested 

capital (MOIC), used by private equity 

funds, is the sum of the net asset value 

of the investment plus all the 

distributions received divided by the 

total amount paid in. MOIC is simple to 

understand in that it is the ratio of value 

received divided by money invested, 

but has a key drawback that, unlike IRR, 

MOIC does not take into account the 

time value of money. Another measure, 

Public Market Equivalent (‘‘PME’’), also 

used by private equity and other funds 

determined to be illiquid, is sometimes 

used to compare the performance of a 

fund with the performance of an 

index.277 The measure is an estimate of 

the value of fund cash flows relative to 

the value of a public market index. 

Relative to a given benchmark, 

differences in PME can indicate 

differences in the performance of 

different private fund investments. 

However, the computation of the PME 

for a fund requires the availability of 

information about fund cash flows 

including their timing and magnitude. 

Regardless of the performance 

measure applied, another fundamental 

difficulty in reporting the performance 

of funds determined to be illiquid is 

accounting for differences in realized 

and unrealized gains. Funds determined 

to be illiquid funds generally pursue 

longer-term investments, and reporting 

of performance before the fund’s exit 

requires estimating the unrealized value 

of ongoing investments.278 There are 

often multiple methods that may be 

used for valuing an unrealized illiquid 

investment. As discussed above, the 

valuations of these unrealized illiquid 

investments are typically determined by 

the adviser and, given the lack of readily 

available market values, can be 

challenging. Such methods may rely on 

unobservable models and other 

inputs.279 Because advisers are typically 

evaluated (and, in certain cases, 

compensated) based on the value of 

these illiquid investments, unrealized 

valuations are at risk of being inflated, 

such that fund performance may be 

overstated.280 Some academic studies 

have found broadly that private equity 

performance is overstated, driven in 

part by inflated accounting of ongoing 

investments.281

Other approaches tend to be used for 

evaluating the performance of hedge 

funds and other liquid funds. In 

particular, a fund’s alpha is its excess 

return over a benchmark index of 

comparable risk. A fund’s Sharpe ratio 

is its excess return above the risk-free 

market rate divided by the investment’s 

standard deviation of returns. Many, but 

not all, hedge funds disclose these and 

other performance measures, including 

net returns of the fund. Many hedge 

fund-level performance metrics can be 

calculated by investors directly using 

data on the fund’s historical returns, by 

either combining with publicly 

available benchmark index data (in the 

case of alpha) or by combining with an 

estimate of the standard deviation of the 

fund’s returns (in the case of the Sharpe 

ratio). Despite these detailed methods, 

public data on hedge fund performance 

reporting may also be biased, because 

hedge funds choose whether and when 

to make their performance results 

publicly available.282

While the Commission believes that 

many advisers currently select from 

these varying standardized industry 

methods in order to prepare and present 

performance information, the difficulty 

in measuring and reporting returns on a 

basis comparable with respect to risk, 

coupled with the potentially high fees 

and expenses associated with these 

funds, can present investors with 

difficulty in monitoring and selecting 

their investments. Specifically, without 

disclosure of detailed performance 

measures and accounting for the impact 

of risk, debt, the varying impact of 

realized and unrealized gains, 

performances across funds can be highly 

overstated or otherwise manipulated, 

and so impossible to compare.283

4. Fund Audits and Fairness Opinions 

Currently under the custody rule, 

some private fund advisers may obtain 

financial statement audits as an 

alternative to the requirement of the rule 

that an RIA with custody of client assets 

obtain an annual surprise examination 

from an independent public 

accountant.284 This incentivizes 

registered private fund advisers to have 

the financial statements of their private 

fund clients audited. Advisers of funds 

that obtain these audits, regardless of 

the type of fund, are thus able to 

provide fund investors with reasonable 

assurances of the accuracy and 

completeness of the fund’s financial 

statements and, specifically, that the 

financial statements are free from 

material misstatements.285

Also under the custody rule, an 

adviser’s choice for a fund to obtain an 

external financial statement audit (in 

lieu of a surprise examination) may 

depend on the benefit of the audit from 

the adviser’s perspective, including the 

benefit of any assurances that an audit 

might provide investors about the 

reliability of the financial statement. 

The adviser’s choice also may depend 

on the cost of the audit, including fees 

and expenses. 

Based on Form ADV data and as 

shown below, more than 90 percent of 

the total number of hedge funds and 

private equity funds that are advised by 

RIAs currently undergo a financial 

statement audit, though such audits are 

not necessarily always by a PCAOBregistered independent public 

accountant that is subject to regular 

inspection.286 Other types of funds 


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subject to regular inspection is not, however, 

required to obtain an annual surprise examination 

if the vehicle distributes the audited financial 

statements prepared in accordance with generally 

accepted accounting principles to the pool’s 

investors within 120 days of the end of its fiscal 

year. See rule 206(4)–2(b)(4). 

287See supra section V.B.3. 

288For example, annual financial statements may 

not include both gross and net IRRs and MOICs, 

separately for realized and unrealized investments, 

and without the impact of fund-level subscription 

facilities. Annual financial statements may also 

vary in the level of detail provided for portfolio 

investment-level compensation. See, e.g., 

Illustrative Financial Statements: Private Equity 

Funds, KPMG (November 2020), available at 

https://audit.kpmg.us/content/dam/advisory/en/

pdfs/2020/financial-statements-private-equityfunds-2020.pdf; Illustrative Financial Statements: 

Hedge Funds, KPMG (November 2020), available at 

https://audit.kpmg.us/content/dam/advisory/en/ 

pdfs/2020/financial-statements-hedge-funds2020.pdf. 

289See supra section II.B. 

290See rule 204–2 under the Advisers Act. 

291See rule 204–2(e)(1) under the Advisers Act. 

292Advisers Act rule 206(4)–7. 

293 Id. 

advised by RIAs undergo financial 

statement audits with similarly high 

frequency, with the exception of 

securitized asset funds, of which fewer 

than 20 percent are audited according to 

the recent ADV data. 

Fund type Total funds Unaudited 

funds 

Unaudited 

% 

Audited 

% 

Hedge Fund ..................................................................................................... 11,508 431 3.7 96.3 

Liquidity Fund .................................................................................................. 86 10 11.6 88.4

Other Private Fund .......................................................................................... 5,452 545 10.0 90.0

Private Equity Fund ......................................................................................... 18,820 1,167 6.2 93.8 

Real Estate Fund ............................................................................................. 4,174 518 12.4 87.6 

Securitized Asset Fund .................................................................................... 2,273 1,931 85.0 15.0

Venture Capital Fund ....................................................................................... 2,065 380 18.4 81.6 

Unique Totals ........................................................................................... 44,378 4,982 11.2 88.8 

Source: Form ADV, Schedule D, Section 7.B.(1) filed between Oct 1st, 2020 and Sep 30th, 2021. 

These audits, while currently valuable 

to investors, do not obviate the issues 

with fee, expense, and performance 

reporting discussed above.287 First, as 

shown in the table above, not all funds 

advised by RIAs currently undergo 

annual financial statement audits. 

Second, statements regarding fees, 

expenses, and performance tend to be 

more frequent, and thus more timely, 

than audited annual financial 

statements. Lastly, more frequent fee, 

expense, and performance disclosures 

can include incremental and more 

granular information that would be 

useful to investors and that would not 

typically be included in an annual 

financial statement.288

Regarding fairness opinions, our staff 

has observed a recent rise in adviser-led 

secondary transactions where an adviser 

offers fund investors the option to sell 

their interests in the private fund or to 

exchange them for new interests in 

another vehicle advised by the 

adviser.289 We understand that some, 

but not all, advisers obtain fairness 

opinions in connection with these 

transactions that typically address 

whether the price offered is fair. These 

fairness opinions provide investors with 

some third-party assurance as a means 

to help protect participating investors. 

5. Books and Records 

The books and records rule includes 

requirements for recordkeeping to 

promote, and facilitate internal and 

external monitoring of, compliance. For 

example, the books and records rule 

requires advisers registered or required 

to be registered under Section 203 of the 

Act to make and keep true, accurate and 

current certain books and records 

relating to their investment advisory 

businesses, including advisory business 

financial and accounting records, and 

advertising and performance records.290

Advisers are required to maintain and 

preserve these records in an easily 

accessible place for a period of not less 

than five years from the end of the fiscal 

year during which the last entry was 

made on such record, the first two years 

in an appropriate office of the 

investment adviser.291

6. Documentation of Annual Review 

Under the Compliance Rule 

Under the Advisers Act compliance 

rule, advisers registered or required to 

be registered under Section 203 of the 

Act must review no less frequently than 

annually the adequacy of their 

compliance policies and procedures and 

the effectiveness of their 

implementation. Currently, there is no 

requirement to document that review in 

writing.292 This rule applies to all 

investment advisers, not just advisers to 

private funds.293 We understand that 

many investment advisers routinely 

make and preserve written 

documentation of the annual review of 

their compliance policies and 

procedures, even while the compliance 

rule does not require such written 

documentation. Many advisers retain 

such documentation for use in 

demonstrating compliance with the rule 

during an examination by our Division 

of Examinations. However, based on 

staff experience, we understand that not 

all advisers make and retain such 

documentation of the annual review. 

C. Benefits and Costs 

1. Overview and Broad Economic 

Considerations 

Private fund investments can be 

opaque, and we have observed that 

investors lack sufficiently detailed 

information about fund fees and 

expenses and the preferred terms 

granted to certain investors and often 

lack sufficient transparency into how 

private fund performance is calculated. 

In addition, we have observed that 

certain sales practices, conflicts of 

interest, and compensation schemes are 

either not transparent to investors or can 

be harmful and have significant negative 

effects on private fund returns. 

The proposed rules would (a) require 

registered investment advisers to 

provide certain disclosures in quarterly 

statements to private fund investors, (b) 

require all investment advisers, 

including those that are not registered 

with the Commission, to make certain 

disclosures of preferential terms offered 

to prospective and current investors, (c) 

prohibit all private fund advisers, 

including those that are not registered 

with the Commission, from engaging in 

certain activities with respect to the 

private fund or any investor in that 

private fund, (d) require a registered 

private fund adviser to obtain an annual 

financial statement audit of a private 

fund and, in connection with an 

adviser-led secondary transaction, a 

fairness opinion from an independent 

opinion provider, and (e) impose further 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16943 

294See supra section V.B.3. 295The relationship between an adviser and its 

client or a fund and its investor is generally one 

where the principal (the client, here a fund) relies 

on an agent (the investment adviser) to perform 

services on the principal’s behalf. See Michael C. 

Jensen & William H. Meckling, Theory of the Firm: 

Managerial Behavior, Agency Costs and Ownership 

Structure, 3 Journal of Financial Economics 305– 

360 (1976). To the extent that principals and their 

agents do not have perfectly aligned preferences 

and goals, agents may take actions that increase 

their well-being at the expense of principals, 

thereby imposing ‘‘agency costs’’ on the principals. 

Principals may seek contractual solutions to the 

principal-agent problem, although these solutions 

may be limited in the presence of information 

asymmetry. 

296The potential for exploitation can be reduced 

to the extent that investors have strong rights of 

exit. See, e.g., John Morley, The Separation of 

Funds and Managers: A Theory of Investment Fund 

Structure and Regulation, 123 (5) Yale Law Journal 

1228–1287 (2014), available at https://openyls.law.

yale.edu/bitstream/handle/20.500.13051/4449/ 

123YaleLJ.pdf?sequence=2&isAllowed=y. 

297Results from studies of other markets suggest 

that mandatory disclosures can cause managers to 

focus more narrowly on maximizing investor value. 

See, e.g., Michael Greenstone, Paul Oyer, and 

Annette Vissing-Jorgensen, Mandated Disclosure, 

Stock Returns, and the 1964 Security Acts 

Amendments, 121 (2) The Quarterly Journal of 

Economics 399–460 (May 2006). 

298For example, private equity fund agreements 

often allow the adviser to raise capital for new 

funds before the end of the fund’s life, as long as 

all, or substantially all, of the money in prior fund 

has been invested. See, e.g., Gompers and Lerner 

(2004) and Morley (2014, at 1254). 

requirements, including certain 

requirements that apply to all fund 

advisers, to enhance the level of 

regulatory and other external 

monitoring of private funds and other 

clients. 

Without Commission action, private 

funds and private fund advisers would 

have limited abilities and incentives to 

implement effective reform. First, it may 

be difficult for private funds to adopt a 

common, standardized set of detailed 

disclosures and practices. This is 

because investors and advisers compete 

and negotiate independently of each 

other, and also because of the 

substantial complexity of information 

that fund advisers maintain on their 

funds and may potentially disclose. For 

example, and as discussed above, 

developing an industry standard on fee 

and expense disclosures would require 

independent and competing investors 

and advisers to determine which of 

management fees, fund expenses, 

performance-based compensation, 

monitoring fees, and more should be 

disclosed and at what frequency.294

Investors and advisers would face 

substantial costs in developing a single 

industry standard that encompasses all 

of the dimensions considered in this 

proposal. 

Second, fund adviser incentives to 

develop and implement reforms, such as 

developing more detailed disclosures, 

are limited by principal-agent problems 

that are inherent to the relationship 

between fund advisers and clients.295

Advisers to private funds can 

potentially engage in opportunistic 

behavior (‘‘hold up’’) toward the client 

in which they exploit their 

informational advantage or bargaining 

power over the client, after the client 

has entered into the relationship.296

Advisers may also face scenarios in 

which they have conflicts of interest 

between certain investors and their own 

interests (or ‘‘conflicting 

arrangements’’), reducing their 

incentives to act in the investors’ best 

interests. Advisers may not have 

sufficient incentives and abilities to 

commit to a solution to these problems 

with existing governance mechanisms. 

These problems of information 

asymmetry and post-contractual holdup are amplified by the inherent 

discretion that private fund advisers 

have over what information to disclose 

to prospective investors and the 

complexity of the disclosures that they 

provide. In addition, the incentives of 

advisers to provide investors with 

transparency are limited and may 

depend on the investor’s scale of 

operations or relationship with the 

adviser. For example, the adviser of a 

private fund may choose not to disclose 

to smaller investors information 

regarding the preferred terms that are 

granted to larger investors, even when 

those terms are material to smaller 

investor’s choices regarding the fund 

investment.297

These issues carry costs and risks of 

investor harm in financial markets. The 

relationship between fund adviser and 

investor can provide valuable 

opportunities for diversification of 

investments and an efficient avenue for 

the raising of capital, enabling economic 

growth that would not otherwise occur. 

However, the current opacity of the 

market can prevent even sophisticated 

investors from optimally obtaining 

certain terms of agreement from fund 

advisers, and this can result in investors 

paying excess costs, bearing excess risk, 

receiving limited and less reliable 

information about investments, and 

receiving contractual terms that may 

reduce their returns relative to what 

they would obtain otherwise. The 

proposed rules provide a regulatory 

solution that addresses these problems 

and enhances the protection of 

investors. Moreover, the proposed rules 

do so in a way that does not deprive 

fund advisers of compensation for their 

services: Insofar as the proposed rules 

shift costs and risks back onto fund 

advisers, the rules strengthen the 

incentives of advisers to manage risk in 

the interest of fund investors and, in 

doing so, does not preclude fund 

advisers from responding by raising 

prices of services that are not prohibited 

and are appropriately, transparently 

disclosed. 

Effects. In analyzing the effects of the 

proposed rules, we recognize that 

investors may benefit from access to 

more useful information about the fees, 

expenses, and performance of private 

funds. They also may benefit from more 

intensive monitoring of funds and fund 

advisers by third parties, including 

auditors and persons who prepare 

assessments of secondary transactions. 

Finally, investors may benefit from the 

prohibition of certain sales practices, 

conflicts of interest, and compensation 

schemes that result in investor harm. 

We recognize that the specific 

provisions of the proposed rules would 

benefit investors through each of these 

basic effects. 

More useful information for investors. 

Investors rely on information from fund 

advisers in deciding whether to 

continue an investment, how strictly to 

monitor an ongoing investment or their 

adviser’s conduct, whether to consider 

switching to an alternative, whether to 

continue investing in subsequent funds 

raised by the same adviser, and how to 

potentially negotiate terms with their 

adviser on future investments.298 By 

requiring detailed and standardized 

disclosures across certain funds, the 

proposal would improve the usefulness 

of the information that current investors 

receive about private fund fees, 

expenses, and performance, and that 

both current and prospective investors 

receive about preferential terms granted 

to certain investors. This would enable 

them to evaluate more easily the 

performance of their private fund 

investments, net of fees and expenses, 

and to make comparisons among 

investments. Finally, enhanced 

disclosures would help investors shape 

the terms of their relationship with the 

adviser of the private fund. The rules 

may also improve the quality and 

accuracy of information received by 

investors through the proposed audit 

requirement, both by providing 

independent checks of financial 

statements, and by potentially 

improving advisers’ regular performance 

reporting, to the extent that regular 

audits improve the completeness and 

accuracy of fund adviser valuation of 

ongoing investments. 

Enhanced external monitoring of fund 

investments. Many investors currently 

rely on third-party monitoring of funds 


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16944 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

299See supra section V.B.1. 

300See supra section II.A. 

301See supra section II.A.4. 

302See supra section V.B.3. 

303See supra section II.A.1.a. 

304See supra section II.A.1.b. 

305See supra section II.A.1.c. 

for prevention and timely detection of 

specific harms from misappropriation, 

theft, or other losses to investors. This 

monitoring occurs through audits and 

surprise exams or audits under the 

custody rule, as well as through other 

audits of fund financial statements. The 

proposal would expand the scope of 

circumstances requiring third-party 

monitoring, and investors would benefit 

to the extent that such expanded 

monitoring increases the speed of 

detection of misappropriation, theft, or 

other losses and so results in more 

timely remediation. Audits may also 

broadly improve the completeness and 

accuracy of fund performance reporting, 

to the extent these audits improve fund 

valuations of their ongoing investments. 

Even investors who rely on the 

recommendations of consultants, 

advisers, private banks, and other 

intermediaries would benefit from the 

proposal, to the extent the 

recommendations by these 

intermediaries are also improved by the 

protections of expanded third-party 

monitoring by independent public 

accountants. 

Prohibitions of certain activities that 

are contrary to public interest and to the 

protection of investors. Certain 

practices, even if appropriately 

disclosed or permitted by private fund 

offering documents, represent potential 

conflicts of interest and sources of harm 

to funds and investors. Because many of 

these conflicts of interest and sources of 

harm may be difficult for investors to 

detect or negotiate terms over, full 

disclosure of the activities considered in 

the proposal would not likely resolve 

the potential investor harm. Further, as 

discussed above, private funds typically 

lack fully independent governance 

mechanisms more common to other 

markets that would help protect 

investors from harm in the context of 

the activities considered.299 The 

proposal would benefit investors and 

serve the public interest by prohibiting 

such practices. 

The costs of the proposed rules would 

include the costs of meeting the 

minimum regulatory requirements of 

the rules, including the costs of 

providing standardized disclosures and, 

for some funds, refraining from 

prohibited activities, and obtaining the 

required external financial statement 

audit and fairness opinions. Additional 

costs would arise from the new 

compliance requirements of the 

proposed rules. For example, some 

advisers would update their compliance 

programs in response to the requirement 

to make and keep a record of their 

annual review of the program’s 

implementation and effectiveness. 

Certain fund advisers may also face 

costs in the form of declining revenue, 

declining in compensation to fund 

personnel and a potential resulting loss 

of employees, or losses of investor 

capital. However, some of these costs, 

such as declining compensation to fund 

personnel, would be a transfer to 

investors depending on the fund’s 

economic arrangement with the adviser. 

Below we discuss these benefits and 

costs in more detail and in the context 

of the specific elements of the proposal. 

2. Quarterly Statements 

We are proposing to require a 

registered investment adviser to prepare 

a quarterly statement for any private 

fund that it advises, directly or 

indirectly, that has at least two full 

calendar quarters of operating results, 

and distribute the quarterly statement to 

the private fund’s investors within 45 

days after each calendar quarter end, 

unless such a quarterly statement is 

prepared and distributed by another 

person.300 The rule provides that, to the 

extent doing so would provide more 

meaningful information to the private 

fund’s investors and would not be 

misleading, the adviser must 

consolidate the quarterly statement 

reporting to cover, as defined above, 

substantially similar pools of assets.301

We discuss the costs and benefits of 

this proposal to require a quarterly 

account statement below. The 

Commission notes, however, that it is 

generally difficult to quantify these 

economic effects with meaningful 

precision, for a number of reasons. For 

example, there is a lack of quantitative 

data on the extent to which advisers 

currently provide information that 

would be required to be provided under 

the proposed rule to investors. Even if 

these data existed, it would be difficult 

to quantify how receiving such 

information from advisers may change 

investor behavior. In addition, the 

benefit from the requirement to provide 

the mandated performance disclosures 

would depend on the extent to which 

investors already receive the mandated 

information in a clear, concise, and 

comparable manner. As discussed 

above, however, we believe that the 

format and scope of these disclosures 

vary across advisers and private funds, 

with some disclosures providing limited 

information while others are more 

detailed and complex.302 As a result, 

parts of the discussion below are 

qualitative in nature. 

Quarterly Statement—Fee and Expense 

Disclosure 

The proposed rule would require an 

investment adviser that is registered or 

required to be registered and that 

provides investment advice to a private 

fund to provide to each of the private 

fund investors with a quarterly 

statement containing certain 

information regarding fees and 

expenses, including fees and expenses 

paid by underlying portfolio 

investments to the adviser or its related 

persons, is distributed to the fund’s 

investors. The quarterly statement 

would include a table detailing all 

adviser compensation to advisers and 

related persons, fund expenses, and the 

amount of offsets or rebates carried 

forward to reduce future payments or 

allocations to the adviser or its related 

persons.303 Further, the quarterly 

statement would include a table 

detailing portfolio investment 

compensation and, for portfolio 

investments in which portfolio 

investment compensation was received, 

certain ownership percentage 

information.304 The proposed quarterly 

statement rule would require each 

quarterly statement to be distributed 

within 45 days, include clear and 

prominent, plain English disclosures 

regarding the manner in which all 

expenses, payments, allocations, 

rebates, waivers, and offsets are 

calculated, and include cross-references 

to the sections of the private fund’s 

organizational and offering documents 

that set forth the applicable calculation 

methodology.305

Benefits 

The effect of this requirement to 

provide a standardized minimum 

amount of information in an easily 

understandable format would be to 

lower the cost to investors of monitoring 

fund fees and expenses, lower the cost 

to investors of monitoring any 

conflicting arrangements, improve the 

ability of investors to negotiate terms 

related to the governance of the fund, 

and improve the ability of investors to 

evaluate the value of services provided 

by the adviser and other service 

providers to the fund. 

For example, investors could more 

easily compare actual investment 

returns to the projections they received 

prior to investing. As discussed above, 

any waterfall arrangements governing 


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306See supra section V.B.3. 

307 Id. 

308See supra footnote 24 (with accompanying 

text). 

309See, e.g., StepStone, Uncovering the Costs and 

Benefits of Private Equity (Apr. 2016), available at 

https://www.stepstonegroup.com/wp-content/ 

uploads/2021/07/StepStone_Uncovering_the_

Costs_and_Benefits_of_PE.pdf. 

310See supra section V.B.3. 

311See supra footnotes 25–27 (with 

accompanying text). 

fund adviser compensation may be 

complex and opaque.306 As a result, 

investor returns from a fund may be 

affected by whether investors are able to 

follow, and verify, payments that the 

fund is making to investors and to the 

adviser in the form of performancebased compensation, as these payments 

are often only made after investors have 

recouped the applicable amount of 

capital contributions and received any 

applicable preferred returns from the 

fund. This information may also help 

investors evaluate whether they are 

entitled to the benefit of a clawback. 

This may particularly be the case for 

deal-by-deal waterfalls, where advisers 

may be more likely to be subject to a 

clawback.307 As discussed above, even 

sophisticated investors have reported 

difficulty in measuring and evaluating 

compensation made to fund advisers 

and determining if adviser fees comply 

with the fund’s governing 

agreements.308 Any such investors 

would benefit to the extent that the 

required disclosures under the proposal 

address these difficulties. 

Investors may also find it easier to 

compare alternative funds or other 

investments. As a result, some investors 

may reallocate their capital among 

competing fund investments and, in 

doing so, achieve a better match 

between their choice of private fund and 

their preferences over private fund 

terms, investment strategies, and 

investment outcomes. For example, 

investors may discover differences in 

the cost of compensating advisers across 

funds that lead them to move their 

assets into funds (if able to do so) with 

less costly advisers or other service 

providers. Investors may also have an 

improved ability to negotiate expenses 

and other arrangements in any 

subsequent private funds raised by the 

same adviser. Investors may therefore 

face lower overall costs of investing in 

private funds as a benefit of the 

standardization. In addition, an investor 

may more easily detect errors by reading 

the adviser’s disclosure of any offsets or 

rebates carried forward to subsequent 

periods that would reduce future 

adviser compensation. This information 

would make it easier for investors to 

understand whether they are entitled to 

additional reductions in future periods. 

Because the rule requires disclosures 

at both the private-fund level and the 

portfolio level, investors can more easily 

evaluate the aggregate fees and expenses 

of the fund, including the impact of 

individual portfolio investments. The 

private fund level information would 

allow investors to more easily evaluate 

their fund fees and expenses relative to 

the fund governing documents, evaluate 

the performance of the fund investment 

net of fees and expenses, and evaluate 

whether they want to pursue further 

investments with the same adviser or 

explore other potential investments. The 

portfolio investment level information 

would allow investors to evaluate the 

fees and costs of the fund more easily 

in relation to the adviser’s 

compensation and ownership of the 

portfolio investments of the fund. For 

example, investors would be able to 

evaluate more easily whether any 

portfolio investments are providing 

compensation that could entitle 

investors to a rebate or offset of the fees 

they owe to the fund adviser. This 

information would also allow investors 

to compare the adviser’s compensation 

from the fund’s portfolio investments 

relative to the performance of the fund 

and relative to the performance of other 

investments available to the investor. To 

the extent that this heightened 

transparency encourages advisers to 

make more substantial disclosures to 

prospective investors, investors may 

also be able to obtain more detailed fee 

and expense and performance data for 

other prospective fund investments. As 

a result of these required disclosures, 

investor choices over private funds may 

more closely match investor preferences 

over private fund terms, investment 

strategies, and investment outcomes. 

The magnitude of the effect depends 

on the extent to which investors do not 

currently have access to the information 

that would be reported in the quarterly 

statement in an easily understandable 

format. While many advisers not 

required to send quarterly statements 

choose to do so anyway, existing 

quarterly statements are not 

standardized across advisers and may 

vary in their level of detail. For 

example, we understand that many 

private equity fund governing 

agreements are broad in their 

characterization of the types of expenses 

that may be charged to portfolio 

investments and that investors receive 

reports of fund expenses that are 

aggregated to a level that makes it 

difficult for investors to verify that the 

individual charges to the fund are 

justified.309 Further, as discussed above, 

we believe that some investors in hedge 

funds operating in reliance on the 

exemption set forth in CFTC Regulation 

4.7 may currently receive quarterly 

statements that present, among other 

things, the net asset value of the exempt 

pool and the change in net asset value 

from the end of the previous reporting 

period.310 While this could have the 

effect of mitigating some of the benefits 

of the proposed rule, we do not believe 

that reports provided to investors 

pursuant to CFTC Regulation § 4.7 

require all of the information, nor their 

standardized presentation, as required 

under the proposed rule. The magnitude 

of the effect also depends on how 

investors would use the fee and expense 

information in the quarterly statement. 

In addition, reports of fund expenses 

often do not include data about 

payments at the level of portfolio 

investments, information about the 

extent to which fees and expenses are 

allocated to a given fund versus other 

similar funds and co-investment 

accounts, or about how offsets are 

calculated, allocated and applied. Lack 

of disclosure has been at issue in 

enforcement actions against fund 

managers.311

Costs 

The cost of the proposed changes in 

fee and expense disclosure would 

include the cost of compliance by the 

adviser. For advisers that currently 

maintain the records needed to generate 

the required information, the cost of 

complying with this new disclosure 

requirement would be limited to the 

costs of compiling, preparing, and 

distributing the information for use by 

investors and the cost of distributing the 

information to investors. We expect 

these costs would generally be ongoing 

costs. Advisers would also incur costs 

associated with determining and 

verifying that the required disclosures 

comply with the format requirements 

under the proposed rule, including 

demands on personnel time required to 

verify that disclosures are made in plain 

English regarding the manner in which 

calculations are made and to verify that 

disclosures include cross-references to 

the sections of the private fund’s 

organizational and offering documents. 

This also includes demands on 

personnel time to verify that the 

information required to be provided in 

tabular format is distributed with the 

correct presentation. Advisers may also 

choose to undertake additional costs of 

ensuring that all information in the 

quarterly statements is drafted 


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16946 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

312See infra section VI.B. As explained in that 

section, this estimated annual cost is the sum of the 

estimated recurring cost of the proposed rule in 

addition to the estimated initial cost annualized 

over the first three years. 

313See supra section II.A.2.a. 

314See supra section II.A.2.b. 

315 Id. 

316 Id. 

317See supra section II.A.2.c. 

consistently with the information in 

fund offering documents, to avoid 

inconsistent interpretations across fund 

documents and resulting confusion for 

investors. Many of these costs we would 

expect would be borne more heavily in 

the initial compliance phases of the rule 

and would wane on an ongoing basis. 

Some of these costs of compliance 

could be reduced by the rule provision 

providing that advisers must 

consolidate the quarterly statement 

reporting to cover substantially similar 

pools of assets, avoiding duplicative 

costs across multiple statements. 

However, in other cases the rule 

provision requiring consolidation may 

further increase the costs of compliance 

with the proposed rules, not decrease 

the costs of compliance. For example, in 

the case where a private fund adviser is 

preparing quarterly statements for 

investors in a feeder fund, and therefore 

consolidating statements between a 

master fund and its feeder funds, the 

consolidation may require the adviser to 

calculate the feeder fund’s proportionate 

interest in the master fund on a 

consolidated basis. The additional costs 

of these calculations of proportionate 

interest in the master fund, to the extent 

the adviser does not already undertake 

this practice, may offset any reduced 

costs the adviser receives from not being 

required to undertake duplicative costs 

across multiple statements. 

There are other aspects of the rule that 

would impose costs. The proposed rule 

would require each portfolio investment 

table to list the fund’s ownership 

percentage of covered portfolio 

investments as of the end of the 

reporting period and impose recordkeeping and timing requirements. The 

costs associated with implementing this 

requirement are likely to vary among 

advisers depending on the current 

record keeping and disclosure practices 

of the adviser. These costs are likely to 

be initially higher, but could also vary 

over time. In addition, some advisers 

may choose to update their systems and 

internal processes and procedures for 

tracking fee and expense information in 

order to better respond to this disclosure 

requirement. The costs of those 

improvements would be an indirect cost 

of the rule, to the extent they would not 

occur otherwise, and they are likely to 

be higher initially than they would be 

on an ongoing basis. 

Preparation and distribution of 

Quarterly Statements. As discussed 

below, for purposes of the Paperwork 

Reduction Act of 1995 (‘‘PRA’’), we 

anticipate that the compliance costs 

associated with preparation and 

distribution of quarterly statements 

(including the preparation and 

distribution of fee and expense 

disclosure, as well as the performance 

disclosure discussed below) would 

include an aggregate annual internal 

cost of $200,643,858 and an aggregate 

annual external cost of $112,403,250, or 

a total cost of $313,047,108 annually.312

For costs associated with potential 

upgrades to fee tracking and expense 

information systems, funds are likely to 

vary in the intensity of their upgrades, 

because for example some advisers may 

not pursue any system upgrades at all, 

and moreover the costs may be pursued 

or amortized over different periods of 

time. Advisers are similarly likely to 

vary in their choices of whether to 

invest in increasing the quality of their 

services. For both of these categories of 

costs, the data do not exist to estimate 

how funds or investors may respond to 

the reporting requirements, and so the 

costs may not be practically quantified. 

Under the proposed rule, these 

compliance costs may be borne by 

advisers and, where permissible, could 

be imposed on funds and therefore 

indirectly passed on to investors. For 

example, under current practice, 

advisers to private funds generally 

charge disclosure and reporting costs to 

the funds, so that those costs are 

ultimately paid by the fund investors. 

Also, currently, to the extent advisers 

use service providers to assist with 

preparing statements (e.g., fund 

administrators), those costs often are 

borne by the fund (and thus indirectly 

investors). To the extent not prohibited, 

we expect similar arrangements may be 

made going forward to comply with the 

proposed rule. Advisers could 

alternatively attempt to introduce 

substitute charges (for example, 

increased management fees) in order to 

cover the costs of compliance with the 

rule, and their ability to do so may 

depend on the willingness of investors 

to incur those substitute charges. 

Further, to the extent that the 

additional standardization and 

comparability of the information in the 

required disclosures makes it more 

difficult to charge fees higher than those 

charged for similar adviser services or 

otherwise to continue current levels and 

structures of fees and expenses, the 

proposal may reduce revenues for some 

advisers and their related persons. 

These advisers may respond by 

reducing their fees or by differentiating 

their services from those provided by 

other advisers, including by, for 

example, increasing the quality of their 

services in a manner that could attract 

additional capital to funds they advise. 

To the extent these reduced revenues 

result in reduced compensation for 

some advisers and their related persons, 

those entities may become less 

competitive as employers. However, this 

cost is likely to be mitigated because 

some advisers may attract new capital 

under the proposal, and so those 

advisers and their related persons may 

become more competitive as employers. 

Quarterly statement—Performance 

Disclosure 

Advisers would also be required to 

include standardized fund performance 

information in each quarterly statement 

provided to fund investors. Specifically, 

the proposed rule would require an 

adviser to a fund considered a liquid 

fund under the proposed rule to 

disclose the fund’s annual total returns 

for each calendar year since inception 

and the fund’s cumulative total return 

for the current calendar year as of the 

end of the most recent calendar quarter 

covered by the quarterly statement.313

For funds determined to be illiquid 

funds under the proposed rule, the 

proposed rule would require an adviser 

to show the internal rate of return (IRR) 

and multiple of invested capital (MOIC) 

(each, on a gross and net basis), the 

gross IRR and the gross MOIC for the 

unrealized and realized portions of the 

portfolio (each shown separately), and a 

statement of contributions and 

distributions.314 Each would be 

computed without the effect of any fund 

level subscription facilities.315 The 

statement of contributions and 

distributions would provide certain 

cash flow information for each fund.316

Further, advisers would be required to 

include clear and prominent plain 

English disclosure of the criteria used 

and assumptions made in calculating 

the performance.317

Benefits 

As a result of these performance 

disclosures, some investors would find 

it easier to obtain and use information 

about the performance of their private 

fund investments. They may, for 

example, find it easier to monitor the 

performance of their investments and 

compare the performance of the private 

funds in their portfolios to each other 

and to other investments. In addition, 

they may use the information as a basis 

for updating their choices between 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16947 

318See supra section V.B.3. 

319 Id. 

320The quantification of the direct costs 

associated with completing performance 

disclosures is included in the analysis of costs 

associated with fee and expense disclosures above. 321See supra section II.A.2.a and II.A.2.b. 

different private funds or between 

private fund and other investments. In 

doing so, they may achieve a better 

alignment between their investment 

choices and preferences. Cash flow 

information would be provided in a 

form that allows investors to compare 

the performance of the fund (or a fund 

investment) with the performance of 

other investments, such as by 

computing PME or other metrics. 

We understand that some investors 

receive the required performance 

information under the baseline, 

independently of the proposed rule. For 

example, some investors receive 

performance disclosures from advisers 

on a tailored basis. Those investors may 

not experience easier access to 

performance information from the 

proposal. They may, however, benefit 

from standardization of the information 

in quarterly statements across investors 

in a fund and across advisers. For 

example, the standardization of the data 

that a fund provides to all of its 

investors could benefit some investors 

by facilitating the development and 

sharing of tools and methods for 

analyzing the data among the various 

investors of the fund. In addition, to the 

extent that investors share the complete, 

comparable data with consultants or 

other intermediaries they work with (as 

is often current practice to the extent 

permitted under confidentiality 

provisions), this may allow such 

intermediaries to provide broader views 

across the private funds market or 

segments of the market. This may 

facilitate better decision making and 

capital allocation more broadly. 

The required presentation of 

performance information and the 

resulting economic benefits would vary 

based on whether the fund is 

determined to be a liquid fund or an 

illiquid fund. For example, for private 

equity and other funds determined to be 

illiquid funds, investors would benefit 

from receiving multiple pieces of 

performance information, because the 

shortcomings discussed above that are 

associated with each method of 

measuring performance make it difficult 

for investors to evaluate fund 

performance from any singular piece of 

performance information alone, such as 

IRR or MOIC.318 For hedge funds, the 

primary benefit is the mandating of 

regular reporting of returns by advisers, 

avoiding any potential biases associated 

with hedge funds choosing whether and 

when to report returns.319 The benefits 

from the proposed requirements are 

therefore potentially more substantial 

for the funds determined to be illiquid 

funds, as the breadth of the performance 

information that would be required 

under the proposal for the private equity 

and other funds determined to be 

illiquid funds is designed to address the 

shortcomings of individual performance 

metrics. For both types of funds, 

because the factors we propose to use to 

distinguish between liquid and illiquid 

funds align with the current factors for 

determining how certain types of 

private funds should report performance 

under U.S. GAAP, market participants 

may be more likely to understand the 

presentation of performance. 

Costs 

The cost of the required performance 

disclosure by fund advisers would vary 

according to the existing practices of the 

adviser and the complexity of the 

required disclosure. For advisers who 

already (under their current practice) 

incur the costs of generating the 

necessary performance data, presenting 

and distributing it in a format suitable 

for disclosure to investors, and checking 

the disclosure for accuracy and 

completeness, the cost would likely be 

small. In particular, for those advisers, 

the cost of the performance disclosure 

may be limited to the cost of 

reformatting the performance 

information for inclusion in the 

mandated quarterly report. However, we 

understand that some advisers may face 

costs of changing their performance 

tracking or reporting practices under the 

current rule. Some of these costs would 

be direct costs of the rule requirements. 

Costs of updating an adviser’s internal 

controls or internal compliance system 

to verify the accuracy and completeness 

of the reported performance information 

would be indirect costs of the rule. We 

expect the bulk of the costs associated 

with complying with this aspect of the 

proposed rules would likely be most 

substantial initially rather than on an 

ongoing basis.320

Some of these costs of compliance 

could again be affected by the rule 

provision providing that advisers must 

consolidate the quarterly statement 

reporting to cover substantially similar 

pools of assets. These costs of 

compliance would be reduced to the 

extent that advisers are able to avoid 

duplicative costs across multiple 

statements, but would be increased to 

the extent that advisers must undertake 

costs associated with calculating feeder 

fund proportionate interests in a master 

fund, to the extent advisers do not 

already do so. 

The required presentation of 

performance, and the resulting costs, 

would vary based on whether the fund 

is categorized as liquid or illiquid. In 

particular, for funds determined to be 

liquid funds, the cost is mitigated by the 

limited nature of the required 

disclosure, as the proposal requires only 

annual total returns and cumulative 

total returns for the current calendar 

year as of the end of the most recent 

calendar quarter covered, while the 

more detailed required disclosures for 

funds determined to be illiquid funds 

may require greater cost (yielding, as 

just discussed, greater benefit).321 For 

both categories of funds, because the 

factors we proposed to use to 

distinguish between liquid and illiquid 

funds align with the current factors for 

determining how certain types of 

private funds should report performance 

under U.S. GAAP, and as a result, 

market participants may be more 

familiar with these methods of 

presenting information, which may 

mitigate costs. 

Under the proposed rule, these 

compliance costs may be borne by 

advisers and, where permissible, could 

be imposed on funds and therefore 

indirectly passed on to investors. For 

example, under current practice, 

advisers to private funds generally 

charge disclosure and reporting costs to 

the funds, so that those costs are 

ultimately paid by the fund investors. 

Similarly, to the extent advisers 

currently use service providers to assist 

with performance reporting (e.g., 

administrators), those costs are often 

borne by the fund (and thus investors). 

To the extent not prohibited, we expect 

similar arrangements may be made 

going forward to comply with the 

proposed rule. Advisers could 

alternatively attempt to introduce 

substitute charges (for example, 

increased management fees) in order to 

cover the costs of compliance with the 

rule, but their ability to do so may 

depend on the willingness of investors 

to incur those substitute charges. 

Further, to the extent that the 

additional standardization and 

comparability of the information in the 

required disclosures make it easier for 

investors to compare and evaluate 

performance, the rule may prompt some 

investors to search for and seek higher 

performing investment opportunities. 

This could reduce the ability for 

advisers of low-performing funds to 

attract additional capital. By the same 

rationale, the rule may prompt some 


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322See supra section II.D.2. 323See supra section II.D.1. 324See supra section II.D.5. 325See supra section II.D.6. 326See supra section II.D.3. 

327See supra section II.D.4. 

328See supra section II.E. 

329 Id. 

330See supra section II.D, II.E. 

331See supra section II.D.2. 

332 Id. 

333Fund adviser fees can allow the adviser to 

obtain leverage, and thereby gain disproportionately 

from successes, encouraging advisers to take on 

additional risk. See, e.g., Alon Brav, Wei Jiang, and 

Rongchen Li, Governance by Persuasion: Hedge 

Fund Activism and Market-Based Shareholder 

Influence, European Corporate Governance 

Institute—Finance (Working Paper No. 797/2021) 

(December 10, 2021), available at https://ssrn.com/ 

abstract=3955116 or http://dx.doi.org/10.2139/

ssrn.3955116. 

334See, e.g., Welcome To Hedge Funds’ Stunning 

Pass-Through Fees, Seeking Alpha (January 24, 

2017), available at https://seekingalpha.com/ 

article/4038915-welcome-to-hedge-funds-stunningpass-through-fees. 

investors to search for and seek higher 

performing investment opportunities, 

further reducing the ability for advisers 

of low-performing funds to attract 

additional capital. 

3. Prohibited Activities and Disclosure 

of Preferential Treatment 

The proposed rules would prohibit a 

private fund adviser from engaging in 

certain activities with respect to the 

private fund or any investor in that 

private fund, including (i) charging 

certain regulatory and compliance fees 

and expenses or fees or expenses 

associated with certain examinations or 

investigations,322 (ii) charging fees for 

certain unperformed services,323 (iii) 

certain non-pro rata fee and expense 

allocations,324 (iv) borrowing money, 

securities, or other fund assets, or 

receiving a loan or an extension of 

credit, from a private fund client,325 (v) 

reducing the amount of any adviser 

clawback by the amount of certain 

taxes,326 (vi) limiting or eliminating 

liability for certain adviser 

misconduct,327 and (vii) granting an 

investor in the private fund or a 

substantially similar pool of assets 

preferential terms regarding liquidity or 

transparency that the adviser reasonably 

expects to have a material, negative 

effect on other investors in the fund or 

a substantially similar pool of assets.328

In addition, we also propose to prohibit 

all private fund advisers from providing 

any other preferential treatment to any 

investor in the private fund unless the 

adviser provides written disclosures to 

prospective and current investors.329

These prohibitions would apply to 

activities of the private fund advisers 

even if they are performed indirectly, 

for example, by an adviser’s related 

persons, recognizing that the potential 

for harm to the fund and its investors 

arises independently of whether the 

adviser engages in the activity directly 

or indirectly.330

We discuss the costs and benefits of 

each of these prohibitions and 

requirements below. The Commission 

notes, however, that several factors 

make the quantification of many of 

these economic effects of the proposed 

amendments and rules difficult. For 

example, there is a lack of data on the 

extent to which advisers engage in 

certain of the activities that would be 

prohibited under the proposed rules, as 

well as their significance to the 

businesses of such advisers. It is, 

therefore, difficult to quantify how 

costly it would be to comply with the 

prohibitions. Similarly, it is difficult to 

quantify the benefits of these 

prohibitions, because there is a lack of 

data regarding how and to what extent 

the changed business practices of 

advisers would affect investors, and 

how advisers may change their behavior 

in response to these prohibitions. 

Further, there is a lack of data on the 

frequency with which advisers grant 

certain investors the preferential 

treatment that would be prohibited 

under the proposed rules, as well as the 

frequency with which preferential terms 

are currently disclosed to other 

investors, as well as how and to what 

extent these disclosures affect investor 

behavior. As a result, parts of the 

discussion below are qualitative in 

nature. 

Certain Fees and Expenses 

The proposal would prohibit a private 

fund adviser from charging the fund for 

fees or expenses associated with an 

examination or investigation of the 

adviser or its related persons by any 

governmental or regulatory authority or 

for the regulatory and compliance fees 

and expenses of the adviser or its 

related persons.331 The benefit to 

investors would be to lower charges on 

the funds they have invested in, which 

could increase returns, and potentially 

lower the cost of effort to avoid and 

evaluate such charges, or a combination 

of these benefits. To the extent that 

these charges, even when disclosed, 

create adverse incentives for advisers to 

allocate expenses to the fund at a cost 

to the investor, they represent a possible 

source of investor harm. For example, 

when these charges are in connection 

with an investigation of an adviser, it 

may not be in the fund’s best interest to 

bear the cost of the investigation.332

These fees may also, even when 

disclosed, incentivize advisers to engage 

in excessive risk-taking, as the adviser 

will no longer bear the cost of any 

ensuing government or regulatory 

examinations or investigations.333 By 

prohibiting this activity, investors 

would benefit from the reduced risk of 

having to incur costs associated with the 

adviser’s adverse incentives, such as 

allocating inappropriate expenses to the 

fund. Investors would also be able to 

search across fund advisers knowing 

that these charges would not be assessed 

on any fund, which may lead to a better 

match between investor choices of 

private funds and their preferences over 

private fund terms, investment 

strategies, and investment outcomes. 

The magnitude of the benefit would to 

some extent depend on whether 

advisers could introduce substitute 

charges (for example, increased 

management fees), and the willingness 

of investors to incur those substitute 

charges, for the purpose of making up 

any revenue that would be lost to the 

adviser from the prohibition. However, 

any such substitute charges would be 

more transparent to the investor and 

would not create the same adverse 

incentives as the prohibited charges, 

and so investors would likely ultimately 

still benefit. 

This prohibition would impose direct 

costs on advisers from the need to 

update their charging and contracting 

practices to bring them into compliance 

with the new requirements. Advisers 

would also incur costs related to this 

prohibition, in connection with not 

being able to charge private fund clients 

for the prohibited expenses. In addition, 

advisers may incur indirect costs related 

to adapting their business models in 

order to identify and substitute nonprohibited sources of revenue. For 

example, advisers may identify and 

implement methods of replacing the lost 

charges from the prohibited practice 

with the other sources of fund revenue. 

These costs would likely be transitory. 

Further, as discussed above, we 

understand that certain private fund 

advisers, most notably hedge funds and 

other funds determined to be liquid 

funds,334 that utilize a pass-through 

expense model where the private fund 

pays for most, if not all, of the adviser’s 

expenses in lieu of being charged a 

management fee. The proposed rules 

would likely prohibit certain aspects of 

pass-through expense models or other 

similar models in which advisers charge 

investors fees associated with certain of 

the adviser’s cost of being an investment 

adviser. These expenses that would no 

longer be passed through to the fund 

could represent additional costs to the 

fund adviser, unless the adviser 


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335See supra section II.D.1. 336 Id. 337See supra section II.D.1 338The portfolio investments themselves may 

also benefit directly from no longer paying these 

fees. 339As discussed above, the proposal would not 

prohibit an arrangement where the adviser shifts 

100% of the economic benefit of a portfolio 

investment fee to the private fund investors, 

whether through an offset, rebate, or otherwise. See 

supra section II.D.1. 

340See supra section II.D.5. 

341See infra (discussing opportunism in the 

context of certain preferential treatment). 

negotiates a new fixed management fee 

to compensate for the new costs. In 

addition, any such fund restructurings 

that are undertaken would likely impose 

costs that would be borne by advisers. 

The costs may also be borne partially or 

entirely by the private funds, to the 

extent permissible or to the extent 

advisers are able to compensate for their 

costs with substitute charges (for 

example, increased management fees). 

These costs would likely be transitory. 

In addition, investors may incur costs 

from this prohibition that take the form 

of lower returns from some fund 

investments, depending on the extent to 

which the prohibition limits the 

adviser’s efficiency or effectiveness in 

providing the services that generate 

returns from those investments. For 

example, in the case of pass-through 

expense models, fund advisers who 

would have to bear new costs of 

providing certain services under the 

prohibition may reduce or eliminate 

those services from the fund in order to 

reduce costs, which may be to the 

detriment of the fund’s performance or 

lead to an increase of compliance risk. 

Moreover, to the extent that restructuring a pass-through expense 

model of a hedge fund under the 

proposal diverts the hedge fund’s 

resources away from the hedge fund’s 

investment strategy, this could lead to a 

lower return to investors in hedge 

funds. The cost of lower returns would 

be mitigated to the extent that investors 

can distinguish and identify those funds 

that require restructuring as to how they 

collect revenue from investors and use 

this information to search for and 

identify substitute funds that have 

expense models that do not need to be 

restructured under the rule and that do 

not present the investor with reduced 

returns as a result of the rule. Investors 

would also need to be able to evaluate 

whether these substitute funds would be 

likely to present them with better 

performance than their current funds. 

Any such search costs would be a cost 

of the rule. As a result, the cost to 

investors may include a combination of 

the cost of lower returns and the cost of 

avoiding such reductions in returns. 

Fees for Unperformed Services 

In addition, the proposal would 

prohibit a private fund adviser from 

charging a portfolio investment for 

monitoring, servicing, consulting or 

other fees in respect of services that the 

adviser does not, or does not reasonably 

expect, to provide to the portfolio 

investment, such as through an 

accelerated payment. As discussed 

above, these fees are likely to reflect 

conflicts of interest between the fund 

and the adviser that are difficult for the 

investor to detect and mitigate.335 For 

example, in receiving the accelerated 

payment, discussed above, the adviser 

imposes a charge for services that it may 

not provide.336 An adviser also may 

have an incentive to cause the fund to 

exit a portfolio investment earlier than 

anticipated, which may result in the 

fund receiving a lesser return on its 

investment.337 Because adviser 

misconduct in response to these 

incentives may be difficult for investors 

to detect, full disclosure of this practice 

does not resolve the conflict of interest. 

Under the proposed prohibition, 

investors would be able to choose 

among fund advisers and invest 

knowing that they would not face the 

costs of such conflicts of interests, 

which also may lead to a better match 

between investor choices of private 

funds and their preferences over private 

fund terms, investment strategies, and 

investment outcomes. 

Investors would also benefit directly 

via lower costs from the prohibition 

through the elimination of the fees 

charged to the fund’s portfolio 

investment.338 These cost savings could 

be partially mitigated, however, to the 

extent that advisers are using portions of 

the proceeds from the accelerated 

payment to cover costs of services that 

benefit the fund client.339

This prohibition would impose direct 

costs on advisers from the need to 

update their charging and contracting 

practices to bring them into compliance 

with the new requirements. Advisers 

would also incur costs related to this 

prohibition in connection with not 

being able to receive these charges for 

unperformed services. For example, 

advisers would incur costs in 

connection with not being able to 

receive the accelerated payments, and as 

a result, advisers could attempt to 

replace the accelerated payments with 

some new fee or charge. Advisers could, 

therefore, incur transitory costs related 

to adapting their business models in 

order to identify and substitute nonprohibited sources of revenue. These 

costs may be particularly high in the 

short term to the extent that advisers renegotiate, re-structure and/or revise 

certain existing deals or existing 

economic arrangements in response to 

this prohibition. 

In addition, investors may incur some 

costs from this prohibition that take the 

form of lower returns from certain fund 

investments, depending on the extent to 

which the fund adviser’s loss of revenue 

from the prohibited activity diverts 

resources away from the fund’s 

investment strategy. For example, the 

loss of revenue under this prohibition 

could cause some advisers to update 

their portfolio investment strategies, so 

that they are less reliant on the 

prohibited fees for revenue. The 

advisers could limit their portfolio 

investments that are reliant on 

accelerated payments for revenue, for 

example. This could lead to a cost to 

investors in the form of reduced returns 

from those investments. Investors could 

mitigate this cost to the extent that they 

can distinguish and identify those funds 

that require restructuring as to how they 

collect revenue from investors and use 

this information to search for and 

identify substitute funds that do not 

present the investor with reduced 

returns as a result of the rule. Investors 

would also need to be able to evaluate 

whether these substitute funds would be 

likely to present them with better 

performance than their current funds. 

These alternative search costs would be 

a cost of the rule. As a result, the cost 

of the prohibition to investors could 

thus include a combination of the cost 

of lower returns and the cost of avoiding 

such reductions in returns. 

Certain Non-Pro Rata Fee and Expense 

Allocations 

The proposal would prohibit a private 

fund adviser from charging certain fees 

and expenses related to a portfolio 

investment (or potential portfolio 

investment) on a non-pro rata basis 

when multiple private funds and other 

clients advised by the adviser or its 

related persons have invested (or 

propose to invest) in the same portfolio 

investment.340

These non-pro rata fee and expense 

allocations tend to adversely affect some 

investors who are placed at a 

disadvantage to other investors. We 

associate these practices and 

disadvantages with a tendency towards 

opportunistic hold-up of investors by 

advisers, involving exploitation of an 

informational or bargaining 

advantage.341 The disadvantaged 

investors currently pay greater than 

their pro rata shares of fees and 

expenses. The disparity may arise from 


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342 In a related setting, ex ante commitment to a 

financing policy has been argued to raise value and 

lower the cost of capital. See Peter DeMarzo, 

Presidential Address, Collateral and Commitment, 

Journal of Finance, (July 15 2019). 

343See supra section II.D.6. 

344 Id. 

345See supra section II.D.3. 346See supra section II.D.4. 

differences in the bargaining power of 

different investors. For example, a fund 

adviser may have an incentive to assign 

lower than pro rata shares of fees and 

expenses to larger investors that bring 

repeat business to the adviser and 

correspondingly lower pro rata shares to 

the smaller investors paying greater than 

pro rata shares. 

Investors could either benefit or face 

costs from the resulting revised 

apportionment of expenses to the fund 

they are invested in, based on whether 

their share of expenses is decreased or 

increased under the rule. Investing 

clients in these portfolio investments 

paying greater than pro rata shares of 

such fees and expenses would benefit as 

a result of lowered fees. However, to the 

extent that a client was previously able 

to obtain fee and expense allocations at 

rates less than a pro rata apportionment, 

the client could incur higher fee and 

expense costs in the future. Investors 

may not be aware of the extent to which 

fees are charged on a non pro-rata basis. 

Even if disclosed, the complexity of fee 

arrangements may mean that these 

arrangements are hard to follow. More 

sophisticated investors may be aware 

that they risk non pro-rata fees, but 

nonetheless be harmed by the 

uncertainty from complex fee 

arrangements. Fund advisers may face a 

commitment problem in that they and 

their clients might be better off if they 

could commit to pro-rata arrangements; 

thus a prohibition could serve as a net 

benefit to clients and advisers.342

This prohibition would impose direct 

costs on advisers to updating their 

charging and contracting practices to 

bring them into compliance with the 

new requirements. These compliance 

costs may be particularly high in the 

short term to the extent that advisers renegotiate, re-structure, and/or revise 

certain existing deals or existing 

economic arrangements in response to 

this prohibition. Advisers may face 

additional costs in the form of lower 

expenses and fees, to the extent that less 

flexible pro-rata fee and expense 

allocations result in lower average fees 

and expenses to the adviser or are more 

costly to administer and monitor. 

Borrowing 

The proposal prohibits an adviser, 

directly or indirectly, from borrowing 

money, securities, or other fund assets, 

or receiving a loan or an extension of 

credit, from a private fund client.343 In 

cases where, as the Commission has 

observed, fund assets were used to 

address personal financial issues of one 

of the adviser’s principals, used to pay 

for the advisory firm’s expenses, or used 

in association with any other harmful 

conflict of interest, 344 then this 

prohibition would increase the amount 

of fund resources available to further the 

fund’s investment strategy. Investors 

would benefit from any resulting 

increased payout. In addition, investors 

would benefit from the elimination or 

reduction of any need to engage in 

costly research or negotiations with the 

adviser to prevent the uses of fund 

resources by the adviser that would be 

prohibited. The prohibition also has the 

potential to benefit investors by 

reducing moral hazard: If an adviser 

borrows from a private fund client and 

does not pay back the loan, it is the 

investors who bear the cost, providing 

the adviser with incentives to engage in 

potentially excessive borrowing. 

Advisers may experience costs as a 

result of this prohibition related to any 

marginal increases in the cost of capital 

incurred from new sources of 

borrowing, as compared to what was 

being charged by the fund. 

Reducing Adviser Clawbacks for Taxes 

The proposed rule would prohibit 

certain uses of fund resources by the 

private fund adviser by prohibiting 

advisers from reducing the amount of 

their clawback obligation by actual, 

potential, or hypothetical taxes 

applicable to the adviser, its related 

persons, or their respective owners or 

interest holders.345 Some investors 

would benefit from this rule from 

effectively increasing clawbacks (and 

thus investor returns) by actual, 

potential, or hypothetical tax rates. 

Investors would also benefit from the 

elimination or reduction of any need to 

engage in costly research or negotiations 

with the adviser to prevent these uses of 

fund resources by the adviser. These 

benefits would likely be more 

widespread, as such research or 

negotiations may have been necessary at 

the start of fund lives even in cases 

where investor returns were not 

ultimately impacted by tax treatments of 

clawbacks. Advisers, however, may be 

unable to recoup the cost of the tax 

payments made in connection with the 

excess distributions and allocations 

affected by the rule, and therefore 

would face greater costs when 

clawbacks do occur under the 

prohibition. 

This prohibition would impose direct 

costs on advisers of updating their 

charging and contracting practices to 

bring them into compliance with the 

new requirements. Advisers may also 

attempt to mitigate the greater costs of 

clawbacks under the prohibition by 

introducing some new fee, charge, or 

other contractual provision that would 

make up for the lost tax reduction on 

the clawback, and they would then 

incur costs of updating their contracting 

practices to introduce these new 

provisions. 

Advisers may attempt to mitigate their 

increased costs associated with 

clawbacks by reducing the risk of a 

clawback occurring. For example, 

certain advisers may adopt new 

waterfall arrangements designed to 

delay carried interest payments until 

later in the life of a fund, in order to 

limit the possibility of a clawback or 

reduce the possible sizes of clawbacks. 

In this case, investors would benefit 

from earlier distributions of proceeds 

from the fund and reduced costs 

associated with monitoring their 

potential need for a clawback. However, 

some fund advisers are able to attract 

investors even though their fund terms 

do not provide for full or partial 

clawbacks. To the extent such advisers 

were able to update their business 

practices, for example by providing for 

an advance on tax payments with no 

option for a clawback, this would 

reduce the benefit of the proposal, as 

investors would continue to receive the 

reduced clawback amounts and bear 

portions of the adviser’s tax burden. In 

either case, advisers would also bear 

additional costs from the proposal of 

updating their business practices. 

Advisers could, therefore, incur 

transitory costs related to adapting their 

business models in order to identify and 

substitute non-prohibited sources of 

revenue. These direct costs may be 

particularly high in the short term to the 

extent that advisers re-negotiate, restructure, and/or revise certain existing 

deals or existing economic arrangements 

in response to this prohibition. 

Limiting or Eliminating Liability for 

Adviser Misconduct 

In addition, the proposal would 

prohibit an adviser to a private fund, 

directly or indirectly, from seeking 

reimbursement, indemnification, 

exculpation, or limitation of its liability 

by the private fund or its investors for 

a breach of fiduciary duty, willful 

misfeasance, bad faith, negligence, or 

recklessness in providing services to the 

private fund.346 These practices, even 


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347 Id. 

348See supra section II.E. 

349 Id. 350 Id. 

when disclosed and permissible under 

state law, may involve breaches of 

fiduciary duty to the fund or investors, 

and possible harms to investors, and so 

investors will likely benefit from their 

prohibition. For example, because 

investors may be unable to anticipate 

willful malfeasance by their fund 

advisers, they may be unable to 

anticipate the costs associated with an 

adviser seeking reimbursement for its 

malfeasance, even if the adviser 

discloses that possibility.347 Investors 

would therefore benefit from the 

elimination of fund expenses, which 

would otherwise reduce investor 

returns, associated with reimbursing or 

indemnifying the adviser for losses 

associated with its malfeasance. These 

benefits may be diminished to the 

extent that advisers are able to obtain 

alternative permissible sources of 

compensation for these expenses from 

investors (for example, from increased 

management fees), although this ability 

would likely be limited. 

Further, these contractual clauses may 

lead investors to believe that they do not 

have any recourse in the event of such 

a breach. To the extent that any such 

investors do not seek damages under 

this belief, the contractual clauses 

eliminating liability for breach of 

fiduciary duty would represent a harm 

to the investors. By prohibiting these 

scenarios, this proposal could make 

such breaches of fiduciary duty 

incrementally less likely to occur. 

Investors would therefore benefit from a 

reduced need to engage in costly 

research or negotiations with the adviser 

to prevent such breaches. 

Certain Preferential Terms 

The proposal would prohibit a private 

fund adviser from providing certain 

preferential terms to some investors that 

have a material negative effect on other 

investors in the private fund or in a 

substantially similar pool of assets. We 

associate these practices with a 

tendency towards opportunistic hold-up 

of investors by advisers, involving the 

exploitation of an informational or 

bargaining advantage by the adviser or 

advantaged investor.348 The proposal 

would prohibit a private fund adviser 

and its related persons from granting an 

investor in the private fund or in a 

substantially similar pool of assets the 

ability to redeem its interest on terms 

that the adviser reasonably expects to 

have a material, negative effect on other 

investors in that private fund or in a 

substantially similar pool of assets.349 In 

addition, the proposal would prohibit 

an adviser and its related persons from 

providing information regarding the 

private fund’s or a substantially similar 

pool of asset’s portfolio holdings or 

exposures to an investor that the adviser 

reasonably expects that providing the 

information would have a material, 

negative effect on other investors in that 

private fund or in a substantially similar 

pool of assets.350

Benefits may accrue from these 

prohibitions in two situations. First, the 

prohibitions may benefit the nonpreferred investors in situations where 

advisers lack the ability to commit to 

avoid the opportunistic behavior after 

entering into the agreement (or 

relationship) with the investor. For 

example, similar to the case regarding 

non-pro rata fee and expense 

allocations, an adviser with repeat 

business from a large investor with early 

redemption rights and smaller investors 

with no early redemption rights may 

have adverse incentives to take on extra 

risk, as the adviser’s preferred investor 

could exercise its early redemption 

rights to avoid the bulk of losses in the 

event an investment begins to fail. The 

adviser would then continue to receive 

repeat business with the investors with 

preferential terms, to the detriment of 

the investors with no preferential terms. 

Investors who do receive preferential 

terms may also receive information over 

the course of a fund’s life that the 

investors can use to their own gain but 

to the detriment of the fund and, by 

extension, the other investors. For 

instance, if a fund was heavily invested 

in a particular sector and an investor 

with early redemption rights learned the 

sector was expected to suffer 

deterioration, that investor could submit 

a redemption request, securing their 

funds early but forcing the fund to sell 

assets in a declining market, harming 

the other investors. In this situation, the 

prohibitions would provide a solution 

to the hold-up problem that is not 

currently available. The rule would 

benefit the disadvantaged investors by 

prohibiting such a situation, and so the 

disadvantaged investors would be less 

susceptible to hold-up and experience 

better performance on their fund 

investments as a benefit of the proposed 

rule. 

Second, in situations where investors 

face uncertainty as to whether the 

adviser engages in the prohibited 

practice, the benefit from the 

prohibition would be to eliminate the 

costs to investors of avoiding entering 

into agreements with advisers that 

engage in the practice and the costs to 

investors from inadvertently entering 

into such agreements. 

Specifically, in this second case, the 

prohibited preferential terms would 

harm investors in private funds and 

cause investors to incur extra costs of 

researching fund investments to avoid 

fund investments in which the 

prospective fund adviser engages in 

these practices (or costs of otherwise 

avoiding or mitigating the harm to those 

disadvantaged investors from the 

practice). The benefit of the prohibition 

to investors would be to eliminate such 

costs. It would prohibit disparities in 

treatment of different investors in 

substantially similar pools of assets in 

the case where the disparity is due to 

the adviser placing their own interests 

ahead of the client’s interests or due to 

behavior that may be deceptive. 

Investors would benefit from the costs 

savings of no longer needing to evaluate 

whether the adviser engages in such 

practices. Investors and advisers also 

may benefit from reduced cost of 

negotiating the terms of a fund 

investment. Investors who would have 

been harmed by the prohibited practices 

would benefit from the elimination of 

such harms through their prohibition. 

The cost of the prohibitions would 

depend on the extent to which investors 

would otherwise obtain such 

preferential terms in their agreements 

with advisers and the conditions under 

which they make use of the preferential 

treatment. Investors who would obtain 

and make use of the preferential terms 

would incur a cost of losing the 

prohibited redemption and information 

rights. This would include any investors 

who might benefit from the ability to 

redeem based on negotiated exceptions 

to the private fund’s stated redemption 

terms, in addition to the investors who 

might benefit from the hold-up 

problems discussed above. In addition, 

advisers would incur direct costs of 

updating their processes for entering 

into agreements with investors, to 

accommodate what terms could be 

effectively offered to all investors once 

the option of preferential terms to 

certain investors has been removed. 

These direct costs may be particularly 

high in the short term to the extent that 

advisers re-negotiate, re-structure and/or 

revise certain existing deals or existing 

economic arrangements in response to 

this prohibition. 

To the extent advisers respond to the 

prohibition by developing new 

preferential terms and disclosing them 

to all investors, there may be new costs 

to investors who do not receive these 

new preferential terms. As discussed 

below, such costs would be mitigated by 


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351See supra section II.E. 

352See infra section VI.E. As explained in that 

section, this estimated annual cost is the sum of the 

estimated recurring cost of the proposed rule in 

addition to the estimated initial cost annualized 

over the first three years. 

353 Id. 354See supra section V.B.4. 

the prohibition of such preferential 

terms unless appropriately disclosed. 

Prohibition of Other Preferential 

Treatment Without Disclosure 

The proposed rule also would 

prohibit other preferential terms unless 

the adviser provides certain written 

disclosures to prospective and current 

investors, and these disclosures must 

contain information regarding all 

preferential treatment the adviser 

provides to other investors in the same 

fund.351 This would reduce the risk of 

harm that some investors face from 

expected favoritism toward other 

investors, and help investors 

understand the scope of preferential 

terms granted to other investors, which 

could help investors shape the terms of 

their relationship with the adviser of the 

private fund. Because these disclosures 

would need to be provided to 

prospective investors prior to their 

investments and to current investors 

annually, these disclosures would help 

investors shape the terms of their 

relationship with the adviser of the 

private fund. This may lead the investor 

to request additional information on 

other benefits to be obtained, such as coinvestment rights, and would allow an 

investor to understand better certain 

potential conflicts of interest and the 

risk of potential harms or other 

disadvantages. 

Disclosures of such preferential 

treatment would impose direct costs on 

advisers to update their contracting and 

disclosure practices to bring them into 

compliance with the new requirements, 

including by incurring costs for legal 

services. These direct costs may be 

particularly high in the short term to the 

extent that advisers re-negotiate, restructure and/or revise certain existing 

deals or existing economic arrangements 

in response to this prohibition. 

However, these costs may also be 

reduced by an adviser’s choice between 

not providing the preferential terms and 

continuing to provide the preferential 

terms with the required disclosures, as 

the costs to some advisers from not 

providing the preferential terms to 

investors may be lower than the costs 

from the disclosure. 

As discussed below, for purposes of 

the PRA, we anticipate that the 

disclosure of preferential treatment 

would impose an aggregate annual 

internal cost of $128,902,375 and an 

aggregate annual external cost of 

$32,550,000, or a total cost of 

$161,452,375 annually.352 To the extent 

that advisers are not prohibited from 

categorizing all or a portion of these 

costs as expenses to be borne by the 

fund, then these costs may be borne 

indirectly by investors to the fund 

instead of advisers. 

To the extent that these disclosures 

could discourage advisers from 

providing certain preferential terms in 

the interest of avoiding future 

negotiations with other investors on 

similar terms, this prohibition could 

ultimately decrease the likelihood that 

some investors are granted preferential 

terms. As a result, some investors may 

find it harder to secure such terms. 

4. Audits, Fairness Opinions, and 

Documentation of Annual Review of 

Compliance Programs 

The proposed audit rule would 

require an investment adviser that is 

registered or required to be registered to 

cause each private fund that it advises, 

directly or indirectly, to undergo a 

financial statement audit that meets 

certain elements at least annually and 

upon liquidation, if the private fund 

does not otherwise undergo such an 

audit. These audits would need to be 

performed by an independent public 

accountant that meets certain standards 

of independence and is registered with 

and subject to regular inspection by the 

PCAOB, and the statements would need 

to be prepared in accordance with U.S. 

GAAP or, for foreign private funds, must 

contain information substantially 

similar to statements prepared in 

accordance with U.S. GAAP, with 

material differences with U.S. GAAP 

reconciled.353 The rule would also 

require that auditors notify the 

Commission in certain circumstances. 

In addition, the rule would require 

advisers to obtain fairness opinions 

from an independent opinion provider 

in connection with certain adviser-led 

secondary transactions with respect to a 

private fund. This requirement would 

not apply to advisers that are not 

required to register as investment 

advisers with the Commission, such as 

state-registered advisers and exempt 

reporting advisers. In connection with 

this fairness opinion, the proposal 

would also require a summary of any 

material business relationships the 

adviser or any of its related persons has, 

or has had within the past two years, 

with the independent opinion provider. 

The proposal would lastly require all 

advisers, not just those to private funds, 

to document the annual review of their 

compliance policies and procedures in 

writing. 

We discuss the costs and benefits of 

these rule provisions below. The 

Commission notes, however, several 

factors make the quantification of many 

of the economic effects of the proposed 

amendments and rules difficult. For 

example, there is a lack of quantitative 

data on the extent to which adviser-led 

secondaries without fairness opinions 

differ in fairness of price from adviserled secondaries with fairness opinions 

attached. It would also be difficult to 

quantify how investors and advisers 

may change their preferences over 

secondary transactions once fairness 

opinions are required to be provided. As 

a result, parts of the discussion below 

are qualitative in nature. 

Benefits 

We recognize that many advisers 

already provide audited fund financial 

statements to fund investors in 

connection with the adviser’s 

alternative compliance with the custody 

rule. However, to the extent that an 

adviser does not currently have its 

private fund client undergo a financial 

statement audit, investors would receive 

more reliable information from private 

fund advisers as a result of the proposed 

audit rule. The benefit to investors in 

securitized asset funds may be relatively 

greater from the proposal, given the 

relatively lower frequency with which 

securitized asset funds currently 

undergo financial statement audits.354

The audit requirement would provide 

an important check on the adviser’s 

valuation of private fund assets, which 

often serve as the basis for the 

calculation of the adviser’s fees. These 

audits would likely detect valuation 

irregularities or errors, as well as an 

investment adviser’s loss, 

misappropriation, or misuse of client 

investments. It may thereby limit some 

opportunities for advisers to materially 

over-value investments. Audits provide 

substantial benefits to private funds and 

their investors because audits also test 

other assertions associated with the 

investment portfolio (e.g., completeness, 

existence, rights and obligations, 

presentation). Audits may also provide 

a check against adviser 

misrepresentations of performance, fees, 

and other information about the fund. 

Enhanced and standardized regular 

auditing may therefore broadly improve 

the completeness and accuracy of fund 

performance reporting, to the extent 

these audits improve fund valuations of 

their ongoing investments. 


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355See supra section V.B.4. 

356See, e.g., Daniel Aobdia, The Impact of the 

PCAOB Individual Engagement Inspection 

Process—Preliminary Evidence, 93 (4) The 

Accounting Review 53–80 (2018) (concluding that 

‘‘engagement-specific PCAOB inspections influence 

non-inspected engagements, with spillover effects 

detected at both partner and office levels’’ and that 

‘‘the information communicated by the PCAOB to 

audit firms is applicable to non-inspected 

engagements’’); Daniel Aobdia, The Economic 

Consequences of Audit Firms’ Quality Control 

System Deficiencies, 66 (7) Management Science 

(July 2020) (concluding that ‘‘common issues 

identified in PCAOB inspections of individual 

engagements can be generalized to the entire firm, 

despite the PCAOB claiming that its engagement 

selection process targets higher-risk clients’’ and 

that ‘‘[PCAOB quality control] remediation also 

appears to positively influence audit quality’’). 

357 Id. 

358This requirement does not exist under the 

custody rule, and as a result, the benefits and costs 

associated with this requirement would extend to 

even those investors and funds for which advisers 

are already distributing audits under the custody 

rule. 

359See supra section II.B. 

360See supra section V.B.4. 

Investors who are not currently 

provided with audited fund financial 

statements, and who would be under 

the proposal, may, as a result, have 

additional confidence in information 

regarding their investments and, in turn, 

the fees being paid to advisers. Further, 

this additional confidence may facilitate 

investors’ capital allocation decisions. 

Anticipating a lower risk of harm from 

a private fund investment, investors 

may be more likely to invest in private 

funds and participate in the resulting 

returns. 

As discussed above, currently not all 

financial statement audits are 

necessarily conducted by a PCAOBregistered independent public 

accountant that is subject to regular 

inspection.355 The proposed audit rule’s 

requirement that the independent 

public accountant performing the audit 

be registered with, and subject to regular 

inspection by, the PCAOB, is likely to 

improve the audit and financial 

reporting quality of private funds.356

Higher quality audits generally have a 

greater likelihood of detecting material 

misstatements due to fraud or error, and 

we further believe that investors would 

likely have relatively greater confidence 

in the quality of audits conducted by an 

independent public accountant 

registered with, and subject to regular 

inspection by, the PCAOB.357 Lastly, we 

believe that the proposed audit rule’s 

requirement to promptly distribute the 

audited financial statements to current 

investors would allow investors to 

evaluate the audited financial 

information in the audit in a timely 

manner. 

In addition, investors would benefit 

from enhanced regulatory oversight as a 

result of the requirement for the adviser 

to engage the auditor to notify the 

Commission under some conditions.358

The proposed requirement for the 

auditor to report terminations and 

modified opinions privately to the SEC 

would enable the SEC to receive more 

timely, complete, and independent 

information in these circumstances and 

to evaluate the need for an examination 

of the adviser. As a result, the SEC 

would be able to allocate its resources 

more efficiently. This could lead to a 

higher rate of detection of fund adviser 

activities that lead to harms from 

misstatements and a greater potential for 

mitigation of such harms. Anticipating 

this, fund advisers would have stronger 

incentives to avoid such harmful 

activities. 

The proposal’s requirement that an 

adviser distribute a fairness opinion and 

summary of material business 

relationships with the opinion provider 

in connection with certain adviser-led 

secondary transactions may provide 

similar increases in investor confidence 

in the specific context of adviser-led 

secondary transactions. This 

requirement would provide an 

important check against an adviser’s 

conflicts of interest in structuring and 

leading these transactions. Investors 

would have decreased risk of 

experiencing harm from mis-valuation 

of secondary-led transactions. Further, 

anticipating a lower risk of harm from 

mis-valuation when participating in 

such transactions, investors may be 

more likely to participate. The result 

may be a closer alignment between 

investor choices and investor 

preferences over private fund terms, 

investment strategies, and investment 

outcomes. These benefits would, 

however, be reduced to the extent that 

advisers are already obtaining fairness 

opinions as a matter of best practice. 

Finally, this proposed rule 

amendment would require all SECregistered advisers to document the 

annual review of their compliance 

policies and procedures in writing. This 

would allow our staff to better 

determine whether an adviser has 

complied with the review requirement 

of the compliance rule, and would 

facilitate remediation of noncompliance. Because our staff’s 

determination of whether the adviser 

has complied with the compliance rule 

will become more effective, the rule 

may reduce the risk of non-compliance, 

as well as any risk to investors 

associated with non-compliance. 

These benefits from mandatory audits 

and fairness opinions are particularly 

relevant for illiquid investments. 

Illiquid assets currently are where we 

believe it is most feasible for financial 

information to have material 

misstatements of investment values, for 

adviser-led secondary transactions to 

occur at unfair prices, and where there 

is broadly a higher risk of investor harm 

from potential conflicts of interest or 

fraud. This is because currently, as 

discussed above, advisers may use a 

high level of discretion and subjectivity 

in valuing a private fund’s illiquid 

investments, and the adviser further 

may have incentives to bias the fair 

value estimates of the investment 

upwards in order to generate larger 

fees.359 Because both funds determined 

to be liquid funds and illiquid funds 

may have illiquid investments, investors 

in both types of funds will benefit, 

though the benefits may be larger for 

investors in illiquid funds (as such 

funds may have more illiquid 

investments than liquid funds and are 

more likely to have adviser-led 

secondary transactions). The benefits 

from documentation of compliance 

programs will be relevant for all 

investors, as the rule applies to all fund 

advisers, not just private fund advisers. 

Costs 

As discussed above, we recognize that 

many advisers already provide audited 

financial statements to fund investors in 

connection with the adviser’s 

alternative compliance with the custody 

rule.360 To the extent that an adviser 

does not currently have its private fund 

client undergo the required financial 

statement audit, there would be direct 

costs of obtaining the auditor, providing 

the auditor with resources needed to 

conduct the audit, the audit fees, and 

promptly distributing the audit results 

to current investors. We recognize that 

the proposed audit rule’s requirement to 

promptly distribute the audited 

financial statements to current investors 

after the audit’s completion may also 

impose compliance costs, which would 

be mitigated by the flexibility of the 

proposal’s requirement for prompt 

distribution, relative to a requirement 

for distribution to occur by a a specific 

deadline. Under current practice, the 

costs of undergoing a financial 

statement audit are often paid by the 

fund, and therefore, ultimately, by the 

fund investors, though in some cases the 

costs may be partially or fully paid by 

the adviser. To the extent not 

prohibited, we expect similar 

arrangements may be made going 

forward to comply with the proposed 

rule: In some instances, the fund will 

bear the audit expense, in others the 


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361See infra section VI.C. 

362See infra section VI.C. 

363See infra footnote 420. The audit fee for an 

individual fund may be higher or lower than this 

estimate, with individual fund audit fees varying 

according to fund characteristics, such as the 

jurisdiction of the assets, complexity of the 

holdings, the firm providing the services, and 

economies of scales. 

364See infra section VI.C. 

365 Id. 

366As noted above, to the extent not prohibited, 

we expect that in some instances, the fund will bear 

the audit expense, in others the adviser will bear 

it, and there also may be arrangements in which 

both the adviser and fund will share the expense. 

367See supra section V.B.4. 

368 Id. 369 Id. 

370The Sarbanes-Oxley Act authorizes the 

PCAOB to inspect registered firms for the purpose 

of assessing compliance with certain laws, rules, 

and professional standards in connection with a 

firm’s audit work for public company and brokerdealer clients. However, the PCAOB currently has 

only a temporary inspection program for brokerdealer clients. 

371See infra section VI.D; footnote 430. The 

fairness opinion fee for an individual fund may be 

higher or lower than this estimate, with individual 

fund audit fees varying according to the complexity, 

terms, and size of the adviser-led secondary 

transaction, as well as the nature of the assets of the 

fund. 

372See supra section II.C; see also infra section 

VI.D. 

adviser will bear it, and there also may 

be arrangements in which both the 

adviser and fund will share the 

expense.361 Advisers could alternatively 

attempt to introduce substitute charges 

(for example, increased management 

fees) in order to cover the costs of 

compliance with the rule, but their 

ability to do so may depend on the 

willingness of investors to incur those 

substitute charges. 

As discussed below, based on Form 

ADV filings, as of November 30, 2021, 

there were 5,037 registered advisers 

providing advice to private funds, and 

we estimate that these advisers would, 

on average, each provide advice to 9 

private funds.362 We further estimate 

that the audit fee for the required 

private fund audit would be $60,000 per 

fund on average.363 For purposes of the 

PRA, the estimated total auditing fees 

for all funds would therefore be 

approximately $2,720 million 

annually.364 We further anticipate that 

the audit requirement would impose for 

all funds approximately 92,479.32 hours 

of internal annual burden hours and a 

cost of approximately $27.6 million for 

internal time.365 However, some funds 

would obtain the required financial 

statement audits in the absence of the 

proposal. The cost of the proposed audit 

requirement would therefore depend on 

the extent to which funds currently 

receive audits and, if so, whether their 

auditors are registered with the PCAOB. 

For example, all or a portion of the 

costs described in this section may be 

disproportionately borne by advisers or 

investors (or both) to securitized asset 

funds,366 given that fewer securitized 

asset funds currently undergo financial 

statement audits than other categories of 

funds.367 We believe that the costs 

incurred may approximate 10% of these 

amounts, because across all types of 

funds, approximately 90% of funds are 

currently audited in connection with 

the fund adviser’s alternative 

compliance under the custody rule.368

However, because a large portion of 

funds who do not currently undergo 

financial statement audits are 

securitized asset funds, to the extent 

that audits for securitized asset funds 

are more costly than for other fund 

types (for example, if it is more 

burdensome to audit financial 

statements that primarily contain 

securitized assets), then the costs of the 

proposal may be greater than 10% of the 

amounts described above. 

For advisers that had been complying 

with the surprise examination 

requirement of the custody rule and do 

not have other clients (e.g., separately 

managed accounts) for which a surprise 

exam must be obtained, the costs of the 

audit performed in accordance with the 

proposed audit rule would be offset by 

the reduction in costs from no longer 

obtaining a surprise examination. To the 

extent that audits cost more than 

surprise examinations, the offset may be 

only partial, and to the extent that an 

adviser must continue to undergo a 

surprise examination because it has 

custody of non-private fund client funds 

and securities, there likely would be no 

offset. For funds that had received an 

audit by an auditor that is not registered 

with the PCAOB, the costs of the audit 

performed in accordance with the 

proposed audit rule would also be offset 

by the reduction in costs from no longer 

obtaining their previous audit, although 

we anticipate that the cost of the 

required audit would likely be greater 

because a PCAOB-registered and 

-inspected auditor may cost more than 

an auditor that is not subject to the same 

level of PCAOB oversight. 

We also understand that the PCAOB 

registration and inspection requirement 

may limit the pool of auditors that are 

eligible to perform these services which 

could, in turn, increase costs, as a result 

of the potential for these auditors to 

charge higher prices for their services. 

The increase in demand for these 

services, however, may be limited in 

light of the high percentage of funds 

already being audited.369 The 

Commission notification requirement of 

the proposed audit rule would represent 

a new cost, regardless of whether their 

private fund clients are already 

undergoing a financial statement audit. 

We anticipate that accounting firms 

would increase their fees as a result of 

this new obligation and perceived 

liability. For advisers who had been 

undergoing a surprise examination for 

purposes of the custody rule, there may 

not be as great of an increase in costs in 

light of similar requirements in 

connection with those examinations 

under that rule. 

The indirect costs of the independent 

audit requirement would depend on the 

quality of the financial statements of the 

funds newly subject to audits. These 

costs may be relatively higher for the 

funds with lower quality financial 

statements (i.e., the funds with the 

greatest benefit from the audit 

requirement). The indirect costs from 

the independent audit requirement may 

include costs of changing the fund’s 

internal financial reporting practices, 

such as improvements to internal 

controls over financial reporting, to 

avoid potential harm to investors from 

a misstatement. Further, we understand 

that the requirement to have the auditor 

registered with, and subject to the 

regular inspection by, the PCAOB may 

limit the pool of accountants that are 

eligible to perform these services 

because only those accountants that 

conduct public company issuer audits 

are subject to regular inspection by the 

PCAOB.370 The resulting competition 

for these services might generally lead 

to an increase in their costs, as an effect 

of the proposal. 

Costs would also be incurred related 

to obtaining the required fairness 

opinion and material business 

relationship summary in the case of an 

adviser-led secondary transaction. For 

purposes of the PRA, we estimate that 

10% of advisers providing advice to 

private funds conduct an adviser-led 

secondary transaction each year and 

that the funds would pay external costs 

of $40,849 for each fairness opinion and 

material business relationship 

summary.371 Because only 

approximately 10 percent of advisers 

conduct an adviser-led secondary 

transaction each year, the estimated 

total fees for all funds per year would 

therefore be approximately $20.6 

million.372 Further, as discussed in 

section VI.D below, we anticipate that 

the fairness opinion and material 

business relationship summary 

requirements would impose 

approximately 3,528 hours of internal 


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373See infra section VI.D. 

374See supra section II.C. 

375See infra section VI.F. 

376See supra section II.A.5. 

377See supra section II.B.8. 

378See supra section II.C.1. 

379See supra section II.E.1. 

380See infra section VI.G. 

381See supra section V.C.2, V.C.3. 

382See supra section II.E. 

383See supra section V.B.3. 

annual burden hours and a cost of 

approximately $1,219,499 for internal 

time annually.373 These costs will be 

borne primarily, though not exclusively, 

by closed-end funds determined to be 

illiquid funds,374 as these are the funds 

that most frequently have the adviserled secondaries considered by the rule. 

To the extent that certain hedge fund 

transactions are captured by the rule, 

these funds and their investors would 

also face comparable fees and costs. 

The costs associated with obtaining 

fairness opinions could dissuade some 

private fund advisers from leading these 

transactions, which could decrease 

liquidity opportunities for some private 

fund advisers. Under current practice, 

some investors bear the expense 

associated with obtaining a fairness 

opinion if there is one. To the extent not 

prohibited, we expect similar 

arrangements may be made going 

forward to comply with the proposed 

rule. Advisers could alternatively 

attempt to introduce substitute charges 

(for example, increased management 

fees) in order to cover the costs of 

compliance with the rule, but their 

ability to do so may depend on the 

willingness of investors to incur those 

substitute charges. 

In addition, the required 

documentation of the annual review of 

the fund compliance program has direct 

costs that include the cost of legal 

services associated with the preparation 

of such documentation. As discussed 

below, for purposes of the PRA, we 

anticipate that the requirement for all 

SEC-registered advisers to document the 

annual review of their compliance 

policies and procedures in writing 

would, for all advisers, impose 44,496 

hours of internal annual burden hours at 

a cost of approximately $18.9 million 

for internal time, and approximately 

$4.1 million for external costs.375

5. Recordkeeping 

Finally, the proposed amendment to 

the recordkeeping rule would require 

advisers who are registered or required 

to be registered to retain books and 

records related to the proposed 

quarterly statement rule,376 to retain 

books and records related to the 

mandatory adviser audit rule,377 to 

support their compliance with the 

proposed adviser-led secondaries 

rule,378 and to support their compliance 

with the proposed preferential treatment 

disclosure rule.379 The benefit to 

investors would be to enable an 

examiner to verify more easily that a 

fund is in compliance with these 

proposed rules and to facilitate the more 

timely detection and remediation of 

non-compliance. These requirements 

would also help facilitate the 

Commission’s enforcement and 

examination capabilities. Also 

beneficial to investors, advisers may 

react to the enhanced ability of third 

parties to detect and impose sanctions 

against non-compliance due to the 

recordkeeping requirements by taking 

more care to comply with the substance 

of the rule. 

These requirements would impose 

costs on advisers related to maintaining 

these records. As discussed below, for 

purposes of the PRA, we anticipate that 

the additional recordkeeping obligations 

would impose, for all advisers, 40,800 

hours of internal annual burden hours 

and that the annual cost would be 

approximately $2.8 million.380

D. Effects on Efficiency, Competition, 

and Capital Formation 

1. Efficiency 

The proposed rules would likely 

enhance economic efficiency by 

enabling investors more easily to 

identify funds that align with their 

preferences over private fund terms, 

investment strategies, and investment 

outcomes, and also by causing fund 

advisers to align their actions more 

closely with the interests of investors 

through the elimination of prohibited 

practices. 

First, the proposed rules could 

increase the usefulness of the 

information that investors receive from 

private fund advisers regarding the fees, 

expenses, and performance of the fund, 

and regarding the preferential treatment 

of certain investors of the fund through 

the more detailed and standardized 

disclosures discussed above.381 These 

enhanced disclosures would provide 

more information to investors regarding 

the ability and potential fit of 

investment advisers, which may 

improve the quality of the matches that 

investors make with private funds and 

investment advisers in terms of fit with 

investor preferences over private fund 

terms, investment strategies, and 

investment outcomes. The enhanced 

disclosures may also reduce search 

costs, as investors may be better able to 

evaluate the funds of an investment 

adviser based on the information to be 

disclosed at the time of the investment 

and in the quarterly statement. 

Regarding preferential treatment, the 

proposed rules further align fund 

adviser actions and investor interests by 

prohibiting certain preferential 

treatment practices altogether (instead 

of only requiring disclosure), 

specifically prohibiting preferential 

terms regarding liquidity or 

transparency that have a material, 

negative impact on investors in the fund 

or a substantially similar pool of 

assets.382 Prohibiting these activities, 

and prohibiting remaining preferential 

treatment activities unless disclosure is 

provided, may eliminate some of the 

complexity and uncertainty that 

investors face about the outcomes of 

their investment choices, further 

reducing costs investors must undertake 

to find appropriate matches between 

their choice of private fund and their 

preferences over private fund terms, 

investment strategies, and investment 

outcomes. 

In addition, the proposed rules’ 

requirements for advisers to obtain 

audits of fund financial statements 

would enhance investor protection and 

thereby improve the efficiency of the 

investment adviser search process. 

While many proposed disclosure 

requirements involve disclosures only 

to current investors, and not prospective 

investors, the proposed rule’s disclosure 

requirements may enhance efficiency 

through the tendency of some fund 

advisers to rely on investors in current 

funds to be prospective investors in 

their future funds. For example, when 

fund advisers raise multiple funds 

sequentially, current investors can base 

their decisions on whether to invest in 

subsequent funds based on the 

disclosures of the prior funds.383 As 

such, improved disclosures can improve 

the efficiency of investments without 

directly requiring disclosures to all 

prospective investors. Investors may 

therefore face a lower overall cost of 

searching for, and choosing among, 

alternative private fund investments. 

Lastly, the proposed rules prohibit 

various activities that represent possible 

conflicting arrangements between 

investors and fund advisers. To the 

extent that investors currently bear costs 

of searching for fund advisers who do 

not engage in these arrangements, or 

bear costs associated with monitoring 

fund adviser conduct to avoid harm, 

then prohibiting these activities may 

lower investors’ overall costs of 

searching for, monitoring, and choosing 

among alternative private fund 


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384 Id. 

385See supra section V.C.2. 386See supra section V.D.2. 

investments. This may particularly be 

the case for smaller investors who are 

currently more frequently harmed by 

the activities being considered. 

There may be losses of efficiency from 

the proposed rules to prohibit various 

activities, and from any changes in fund 

practices in response to the proposed 

rules, to the extent that investors 

currently benefit from those activities or 

incur costs from those changes. For 

example, investors who currently 

receive preferential terms that would be 

prohibited under the proposal may have 

only invested with their current adviser 

because they were able to secure 

preferential terms. With those 

preferential terms removed, those 

investors may choose to re-evaluate the 

match between their choice of adviser 

and their overall preferences over 

private fund terms, investment strategy, 

and investment outcomes. Depending 

on the results of this re-evaluation, 

those investors may choose to incur 

costs of searching for new fund advisers 

or alternative investments. 

2. Competition 

The proposed rules may also affect 

competition in the market for private 

fund investing. As discussed above, 

private fund adviser fees may currently 

total in the hundreds of billions of 

dollars per year.384 Enhanced 

competition from additional 

transparency may lead to lower fees or 

may direct investor assets to different 

funds, fund advisers, or other 

investments. 

First, to the extent that the enhanced 

transparency of certain fees, expenses, 

and performance of private funds under 

the proposal may reduce the cost to 

some investors of comparing private 

fund investments, then current investors 

evaluating whether to continue 

investing in subsequent funds may be 

more likely to reject future funds raised 

by their current adviser in favor of the 

terms of competing funds, including 

new funds that advisers may offer as 

alternatives that they would not have 

offered absent the increased 

transparency. 

To the extent that this heightened 

transparency encourages advisers to 

make more substantial disclosures to 

prospective investors, investors may 

also be able to obtain more detailed fee 

and expense and performance data for 

other prospective fund investments, 

strengthening the effect of the proposal 

on competition.385 Advisers may 

therefore update the terms that they 

offer to investors, or investors may shift 

their assets to different funds. 

Second, because enhanced 

transparency of preferential treatment 

will be provided to both current and 

prospective investors, there may be 

reduced search costs to all investors 

seeking to compare funds on the basis 

of which investors receive preferential 

treatment. For example, some funds 

may lose investors who only 

participated in the fund because of the 

preferential terms they received. We 

anticipate that investors withdrawing 

from a fund because of a loss of 

preferential treatment would redeploy 

their capital elsewhere, and so new 

advisers would have a new pool of 

investment capital to pursue. 

3. Capital Formation 

We believe the proposed rules would 

facilitate capital formation by causing 

advisers to more efficiently manage 

private fund clients, by prohibiting 

activities that may currently deter 

investors from private fund investing 

because they represent possible 

conflicting arrangements, and by 

enabling investors to choose more 

efficiently among funds and fund 

advisers. This may reduce the cost of 

intermediation between investors and 

portfolio investments. To the extent this 

occurs, this would lead to enhanced 

capital formation in the real economy, 

as portfolio companies would have 

greater access to the supply of financing 

from private fund investors. This would 

contribute to greater capital formation 

through greater investment into those 

portfolio companies. 

The proposed rules may also enhance 

capital formation through their 

competitive effects by inducing new 

fund advisers to enter private fund 

markets.386 To the extent that existing 

fund advisers reduce their fees in order 

to compete more effectively, or to the 

extent that existing pools of capital are 

redirected to fund advisers who 

generate enhanced returns for their 

investors (for example, advisers who 

generate larger returns, less correlated 

returns across different investment 

strategies, or returns with more 

favorable risk profiles), the competitive 

effects of the proposal may provide new 

opportunities for capital allocation and 

potentially spur new investments. 

Similarly, and in addition to lower 

costs of intermediation between 

investors and portfolio investments, the 

proposed rules may directly lower the 

costs charged by fund advisers to 

investors by improving transparency 

over fees and expenses. The proposed 

rules may also enhance overall investor 

returns (for example, as above, larger 

returns, less correlated returns across 

different investment strategies, or 

returns with more favorable risk 

profiles) by improving transparency 

over performance information, 

prohibiting conflicting arrangements, 

and requiring external financial 

statement audits and fairness opinions. 

To the extent these increased investor 

funds from lower expenses and 

enhanced returns are redeployed to new 

investments, there would be further 

benefits to capital formation. 

There may be reduced capital 

formation associated with the proposed 

rules to prohibit various activities, to 

the extent that investors currently 

benefit from those activities. For 

example, investors who currently 

receive preferential terms that would be 

prohibited under the proposal may 

withdraw their capital from their 

existing fund advisers. Those investors 

may have less total capital to deploy 

after bearing costs of searching for new 

investment opportunities, or they may 

redeploy their capital away from private 

funds more broadly and into 

investments with less effective capital 

formation. 

E. Alternatives Considered 

1. Alternatives to the Requirement for 

Private Fund Advisers To Obtain an 

Annual Audit 

First, the Commission could consider 

broadening the application of this rule 

to, for example, apply to all advisers to 

private funds, rather than to only 

advisers to private funds that are 

registered or required to be registered. 

Extending the application of the 

proposed audit rule to all advisers and 

in the context of these pooled 

investment vehicles would increase the 

benefits of helping investors receive 

more reliable information from private 

fund advisers associated with the rule. 

Investors would, as a result, have greater 

assurance in both the valuation of fund 

assets and, because these valuations 

often serve as the basis for the 

calculation of the adviser’s fees, the fees 

charged by advisers. However, the 

extension of the proposed rule to apply 

to all advisers would likely impose the 

costs of obtaining audits on smaller 

funds advised by unregistered advisers. 

For these types of funds, the cost of 

obtaining such an audit may be large 

compared to the value of fund assets 

and fees and the related value to 

investors of the required audit, and so 

this alternative could inhibit entry of 

new funds, potentially constraining the 

growth of the private fund market. 


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387See supra section V.C.4. 

388For funds determined to be liquid funds, 

disclosure of performance information for each 

portfolio investment may be of comparatively lower 

incremental benefit to investors, because such 

funds typically have a much larger number of 

investments. To the extent that investors’ 

preferences over different liquid funds depend on 

more fund outcomes than their total return on their 

aggregate capital contributions, for example a 

preference for fund advisers with uncorrelated 

returns across different portfolio investments, then 

this alternative could provide similar additional 

benefits. 

389See supra section V.B.3. See, e.g., Robert 

Harris, Tim Jenkinson and Steven Kaplan, Private 

Equity Performance: What Do We Know?, 69 (5) 

Journal of Finance 1851 (Mar. 27, 2014), available 

at https://onlinelibrary.wiley.com/doi/full/10.1111/ 

jofi.12154; Steven Kaplan and Antoinette Schoar, 

Private Equity Performance: Returns, Persistence, 

and Capital Flows, 60 (5) Journal of Finance (Aug. 

2005), available at http://web.mit.edu/aschoar/ 

www/KaplanSchoar2005.pdf. 

390See supra section II.A.1.b. 

Second, instead of broadening the 

proposed audit rule, we could consider 

narrowing the rule by providing full or 

partial exemptions. For example, we 

could exempt smaller funds or we could 

exempt an adviser from compliance 

with the rule where an adviser plays no 

role in valuing the fund’s assets, 

receives little or no compensation for its 

services, or receives no compensation 

based on the value of the fund’s assets. 

We could also exempt advisers of hedge 

funds and other funds determined to be 

liquid funds. Further, we could provide 

an exemption for private funds below a 

certain asset threshold, for funds that 

have only related person investors, or 

for funds that are below a minimum 

asset value or have a limited number of 

investors. 

These exemptions could also be 

applied in tandem, for example by 

exempting only advisers to hedge funds 

and other funds determined to be liquid 

funds below a certain asset threshold. 

For each of these categories, we could 

consider partial instead of full 

exemptions, for example by requiring an 

audit only every two (or more) years 

instead of not requiring any annual 

audits at all. Further, the benefits of the 

rule may not be substantial for funds 

below a minimum asset value, where 

the cost of obtaining such an audit 

would be relatively large compared to 

the value of fund assets and fees that the 

rule is intended to provide a check on. 

We believe, however, that this 

narrower alternative with the above 

exemptions to the proposed audit rule 

would likely not provide the same 

investor protection benefits. Many of the 

investor protection benefits discussed 

above are specifically associated with 

the general applicability of the proposed 

audit rule.387

Finally, instead of requiring an audit 

as described in the proposed audit rule, 

we could consider requiring that 

advisers provide other means of 

checking the adviser’s valuation of 

private fund assets. For example, we 

could consider requiring that an adviser 

subject to the proposed audit rule 

provide information to substantiate the 

adviser’s evaluation to its LPAC or, if 

the fund has no LPAC, then to all, or 

only significant investors in the fund. 

We believe that such methods for 

checking an adviser’s methods of 

valuation would be substantially less 

expensive to obtain, which could reduce 

the cost burdens associated with an 

audit. 

However, we believe that these 

alternatives would likely not 

accomplish the same investor protection 

benefits as the proposal to require an 

audit. As an immediate matter, limiting 

the requirement like so would 

undermine the broader goal of the 

proposal to standardize information 

made available to different investors. 

We believe, more generally, that these 

checks would not provide the same 

level of assurance over valuation and, 

by extension, fees, to fund investors as 

an audit. As discussed above, we have 

historically relied on financial statement 

audits to verify the existence of pooled 

investment vehicle investments. 

2. Alternatives to the Requirement To 

Distribute a Quarterly Statement to 

Investors Disclosing Certain Information 

Regarding Costs and Performance 

The Commission could also consider 

requiring that additional and more 

granular information be provided in the 

quarterly statements that we are 

proposing be sent by registered 

investment advisers to investors in 

private funds. For example, we could 

require that these statements include 

investor-level capital account 

information, which would provide each 

investor with means of monitoring 

capital account levels at regular 

intervals throughout the year. Because 

this more specific information would 

show exactly how fees, expenses, and 

performance have affected the investor, 

it could, effectively, further reduce the 

cost to an investor of monitoring the 

value of the services the adviser 

provides to the investor. We believe, 

however, that requiring capital account 

information for each investor would 

substantially increase costs for funds 

associated with the preparation of these 

quarterly statements. 

We could also, for example, require 

disclosure of performance information 

for each portfolio investment. For funds 

determined to be illiquid funds in 

particular, we could require advisers to 

report the IRR for portfolio investments, 

assuming no leverage, as well as the 

cash flows for each portfolio 

investment.388 Given the cash flows, 

end investors could compute other 

performance metrics, such as PME, for 

themselves. In addition, this 

information would give investors means 

of checking the more general 

performance information provided in a 

quarterly statement, and would, further, 

allow investors to track and evaluate the 

portfolio investments chosen by an 

adviser over time. Cash flow disclosures 

for each portfolio investment would 

enable an investor to construct measures 

of performance that address the MOIC’s 

inability to capture the timing of cash 

flows, avoid the IRR’s assumptions on 

reinvestment rates of early cash flow 

distributions, and avoid the IRR’s 

sensitivity to cash flows early in the life 

of the pool.389 Investors would also be 

able to compare performance of 

individual portfolio investments against 

the compensation and ownership 

percentage and other data that advisers 

would be required to disclose for each 

portfolio investment under the 

proposal.390

While we believe that advisers would 

have cash flow data for each portfolio 

investment available in connection with 

the preparation of the standardized fund 

performance information required to be 

reported pursuant to the proposed rule, 

calculating performance information for 

each portfolio investment in accordance 

with the rule could add significant 

operational burdens and costs, which 

would vary depending on factors that 

include the number of portfolio 

investments held by a private fund. The 

operational burden and cost would also 

depend on whether the alternative 

proposal required both gross and net 

performance information for each 

portfolio investment, which would 

determine whether the information 

reflected the impact of fund-level fees 

and expenses on the performance of 

each portfolio investment. Requiring 

both gross and net performance 

information for each portfolio 

investment would be of greater use to 

investors, but would come at a higher 

operational burden and cost, as 

providing net performance information 

would require more complex 

calculations to allocate fund fees and 

expenses across portfolio investments. 

Lastly, to the extent that advisers were 

required to disclose cash flows for each 

portfolio investment without the impact 

of fund-level subscription facilities, this 

calculation may be more burdensome 

than the single calculation required to 


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16958 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

391See supra section II.A.2. 392For example, the compensation model for 

hedge funds can provide fund advisers with 

embedded leverage, encouraging greater risk-taking. 

See, e.g., Alon Brav, Wei Jiang, and Rongchen Li, 

Governance by Persuasion: Hedge Fund Activism 

and Market-Based Shareholder Influence, European 

Corporate Governance Institute—Finance (Working 

Paper No. 797/2021), available at https://ssrn.com/ 

abstract=3955116 or http://dx.doi.org/10.2139/ 

ssrn.3955116. 393See supra footnote 99. 

make the required fund-level 

performance information disclosures 

without the impact of fund-level 

subscription facilities. 

As a final granular addition to 

performance disclosures, the 

Commission could require the reporting 

of a wider variety of performance 

metrics for hedge funds and other funds 

determined to be liquid funds, similar to 

the detailed disclosure requirements for 

funds determined to be illiquid funds. 

These could include requirements for 

funds determined to be liquid funds to 

report estimates of fund-level alphas, 

betas, Sharpe ratios, or other 

performance metrics. We believe that for 

investors of funds determined to be 

liquid funds, absolute returns are of 

highest priority, and furthermore 

investors may calculate many of these 

additional performance metrics 

themselves by combining fund annual 

total returns with publicly available 

data. Therefore, we believe these 

additional reporting requirements 

would impose additional costs with 

comparatively little benefit. 

Further, the Commission could also 

consider requiring less information be 

provided to investors in these quarterly 

statements. For example, instead of 

requiring the disclosure of 

comprehensive fee and expense 

information, we could require that 

advisers disclose only a subset of these, 

including investments fees and 

expenses paid by a portfolio company to 

the adviser. These fees in particular may 

currently present the biggest burden on 

investors to track, and requiring the 

disclosure of only these fees could 

reduce some costs associated with the 

effort of compiling, on a quarterly basis, 

information regarding management fees 

more generally. We believe, however, 

that if we did not require 

comprehensive information, investors 

would not derive the same utility in 

monitoring fund performance. 

We could also consider requiring that 

comprehensive information regarding 

fees and performance be reported on 

Form ADV, instead of being disclosed to 

investors individually. Reporting 

publicly on Form ADV would continue 

to allow investors to monitor 

performance, while also allowing public 

review of important information about 

an adviser. However, because the 

information we propose to require 

under the rule is tailored to what we 

believe would serve existing investors 

in a fund, we believe that direct delivery 

to investors would better reduce 

monitoring costs for investors. Further, 

as discussed above, prospective 

investors have separate protections, 

including against misleading, deceptive, 

and confusing information in 

advertisements as set forth in the 

recently adopted marketing rule.391

Instead of requiring disclosure of 

comprehensive fee and expense 

information to investors, we could 

consider prohibiting certain fee and 

expense practices. For example, we 

could prohibit charging fees at the fund 

level in excess of a certain maximum 

amount that we could determine to be 

what investors could reasonably 

anticipate being charged by an adviser. 

This could, effectively, protect investors 

from unanticipated charges, and reduce 

monitoring costs to investors. Further, 

we could prohibit certain compensation 

arrangements, such as the ‘‘2 and 20’’ 

model or compensation from portfolio 

investments, to the extent the adviser 

also receives management fees from the 

fund. Prohibition of the ‘‘2 and 20’’ 

model would cause investors to 

reallocate their capital way from funds 

that employ this model and toward 

other types of funds. It may cause 

advisers to consider and adopt more 

efficient models for private fund 

investing in which the adviser gets a 

smaller fee and the investor gets a larger 

share of the gross fund returns, and in 

which investors are generally better 

off.392 We could also consider 

restricting management fee practices, for 

example by imposing limitations on 

sizes of management fees, or 

requirement management fees to be 

based on invested capital or net asset 

value rather than on committed capital. 

However, the benefits of prohibiting 

certain fee and expense practices 

outright would need to be balanced 

against the costs associated with 

limiting an adviser and investor’s 

flexibility in designing fee and expense 

arrangements tailored to their 

preferences. We believe that any such 

prohibitions would, accordingly, need 

to be carefully tailored. 

Similarly, instead of requiring 

disclosure of comprehensive 

performance information to investors, 

we could consider prohibiting certain 

performance disclosure practices. For 

example, instead of requiring disclosure 

of performance without the effect of 

fund-level subscription facilities, we 

could consider prohibiting advisers 

from presenting performance with the 

effect of such facilities. Similarly, we 

could consider prohibiting advisers 

from presenting combined performance 

information for multiple funds, such as 

a main fund and a co-investment fund 

that pays lower or no fees. We believe 

that the required disclosures present the 

correct standardized, detailed 

information for investors to be able to 

evaluate performance, but we do not 

believe there are harms from advisers 

electing to disclose additional 

information. As such, we think the 

benefits of prohibiting any performance 

disclosure practices would likely be 

negligible, while there could be 

substantial costs to investors who value 

the information that would be 

prohibited under this alternative. 

Finally, the Commission could 

consider broadening the application of 

this rule to, for example, apply to all 

advisers to private funds, rather than to 

only advisers to private funds that are 

registered or required to be registered. 

Extending the application of the 

proposed rule to all advisers would 

increase the benefits of helping 

investors receive more detailed and 

standardized information regarding fees, 

expenses, and performance. Investors 

would, as a result, have better 

information with which to evaluate the 

services of these advisers. It is, however, 

not clear to us that these benefits would 

also be realized in contexts where fund 

performance is not as heavily relied 

upon when obtaining new investors, as 

is the case for private funds. Further, the 

extension of the proposed rule to apply 

to all advisers would likely impose the 

costs of compiling, preparing, and 

distributing quarterly statements on 

smaller funds advised by unregistered 

advisers. For these types of funds, these 

quarterly statement costs may be large 

compared to the value of fund assets 

and fees and the related value to 

investors of the required audit. 

3. Alternative to the Required Manner of 

Preparing and Distributing Quarterly 

Statements and Audited Financial 

Statements 

The proposed rules would require 

private fund advisers to ‘‘distribute’’ 

quarterly statements and audited annual 

financial statements to investors in the 

private fund, and this requirement 

could be satisfied through either paper 

or electronic means.393 The Commission 

could consider requiring private fund 

advisers to prepare and distribute the 

required disclosures electronically using 

a structured data language, such as the 


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394See, e.g., Y. Cong, J. Hao, and L. Zou, The 

Impact of XBRL Reporting on Market Efficiency, 28 

J. Info. Sys. 181 (2014) (finding support for the 

hypothesis that ‘‘XBRL reporting facilitates the 

generation and infusion of idiosyncratic 

information into the market and thus improves 

market efficiency’’); Y. Huang, J.T. Parwada, Y.G. 

Shan, and J. Yang, Insider Profitability and Public 

Information: Evidence From the XBRL Mandate 

(Working Paper, 2019) (finding XBRL adoption 

levels the informational playing field between 

insiders and non-insiders). 

395See, e.g., Updated Disclosure Requirements 

and Summary Prospectus for Variable Annuity and 

Variable Life Insurance Contracts, Release No. IC– 

33814 (Mar. 11, 2020) [85 FR 25964 at 26041 (Jun. 

10, 2020)] (Noting that an Inline XBRL requirement 

for certain variable contract prospectus disclosures, 

which are publicly available, would include 

informational benefits stemming from use of the 

Inline XBRL data by parties other than investors, 

including financial analysts, data aggregators, and 

Commission staff. While the required disclosures in 

this proposal would not be provided to the public 

or the Commission, such benefits would not accrue 

from an Inline XBRL requirement for the required 

disclosures). 

396See supra section V.C.3. 

397See supra section V.B.1. 

Inline eXtensible Business Reporting 

Language (‘‘Inline XBRL’’). 

An Inline XBRL requirement for the 

disclosures could benefit private fund 

investors with access to XBRL analysis 

software by enabling them to more 

efficiently access, compile, and analyze 

the disclosures in quarterly statements 

and audited annual financial 

statements, facilitating calculations and 

comparisons of the disclosed 

information across different time 

periods or across different portfolio 

investments within the same time 

period. For any such private fund 

investors who receive disclosures from 

multiple private funds, an Inline XBRL 

requirement could also facilitate 

comparisons of the disclosed 

information across those funds. 

An Inline XBRL requirement for the 

proposed disclosures would diverge 

from the Commission’s other Inline 

XBRL requirements, which apply to 

disclosures that are made available to 

the public and the Commission, thus 

allowing for the realization of 

informational benefits (such as 

increased market efficiency and 

decreased information asymmetry) 

through the processing of Inline XBRL 

disclosures by information 

intermediaries such as analysts and 

researchers.394 Under the current 

proposal, the required disclosures 

would not be provided to the public or 

the Commission for processing and 

analysis. Thus, the magnitude of benefit 

resulting from an Inline XBRL 

alternative for the disclosure 

requirements in this proposal may be 

lower than for other rules with Inline 

XBRL requirements.395

Compared to the proposal, an Inline 

XBRL requirement would result in 

additional compliance costs for private 

funds and advisers, as a result of the 

requirement to select, apply, and review 

the appropriate XBRL U.S. GAAP 

taxonomy element tags for the required 

disclosures (or pay a third-party service 

provider to do so on their behalf). In 

addition, private fund advisers may not 

have prior experience with preparing 

Inline XBRL documents, as neither 

Form PF nor Form ADV is filed using 

Inline XBRL. Thus, under this 

alternative, private funds may incur the 

initial Inline XBRL implementation 

costs that are often associated with 

being subject to an Inline XBRL 

requirement for the first time (including, 

as applicable, the cost of training inhouse staff to prepare filings in Inline 

XBRL and the cost to license Inline 

XBRL filing preparation software from 

vendors). Accordingly, the magnitude of 

compliance cost resulting from an Inline 

XBRL requirement under this proposal 

may be higher than for other rules with 

Inline XBRL requirements. 

4. Alternatives to the Prohibitions From 

Engaging in Certain Sales Practices, 

Conflicts of Interest, and Compensation 

Schemes 

The Commission could also consider 

prohibiting other activities, in addition 

to those currently prohibited in the 

proposed rule. For example, we could 

prohibit advisers from charging private 

funds for expenses generally understood 

to be adviser expenses, such as those 

incurred in connection with the 

maintenance and operation of the 

adviser’s business. To the extent that the 

performance of these activities is 

outsourced to a consultant, for example, 

and the fund is charged for that service, 

advisers may be effectively shifting 

expenses that would be generally 

recognized as adviser expenses to 

instead be fund expenses. The 

prohibition of such charges could 

reduce investor monitoring costs. We 

believe, however, that identifying the 

types of charges associated with 

activities that should never be charged 

to the fund would likely be difficult. As 

a result, any such prohibition could risk 

effectively limiting an adviser’s ability 

to outsource certain activities that could 

be better performed by a consultant, 

because under the prohibition the 

adviser would not be able to pass those 

costs on to the fund. 

Further, the Commission could 

consider providing an exemption for 

funds utilizing a pass-through expense 

model from the prohibition on charging 

fees or expenses associated with certain 

examinations, investigations, and 

regulatory and compliance fees and 

expenses. This would allow advisers to 

avoid the costs associated with restructuring any arrangements not 

compliant with the prohibition, given 

the proposed rules would likely prohibit 

certain aspects of these expense 

models.396 We believe, however, that 

any exemption would need to be 

carefully balanced against the risk that 

it would continue to subject the fund to 

an adviser’s incentive to shift its fees 

and expenses to the fund to reduce its 

overhead and operating costs. 

We could also consider requiring 

detailed and standardized disclosures of 

the activities under consideration, 

instead of prohibiting the activities 

outright. This alternative may be 

desirable to the extent that certain 

investors would be willing to bear the 

costs of these activities in exchange for 

certain other beneficial terms, and 

would be willing to give informed 

consent to fund advisers engaging in the 

practices under consideration. However, 

we do not believe that disclosure 

requirements would achieve the same 

benefit of protecting investors from 

harm, because many of the practices are 

deceptive and result in obscured 

payments, and so may be used to 

defraud investors even if detailed 

disclosures are made. Moreover, as 

discussed above, private funds typically 

lack fully independent governance 

mechanisms more common to other 

markets that could help protect 

investors from harm in the context of 

the activities considered.397

We could, therefore, consider 

exceptions that allow certain prohibited 

activities if disclosed and if appropriate 

governance or other protections are in 

place. For example, we could consider 

requiring a fund’s LPAC (or other 

similar body) or directors to give 

approval to any of the activities under 

consideration before the adviser may 

pursue them. Similarly, we could 

require advisers to obtain approval for 

any of the activities under consideration 

by a majority (either by number or by 

interest) of investors. However, we 

believe that allowing such activities, 

even under such governance, would not 

achieve all of the same benefits of 

protecting investors, by the same logic 

that many of the practices are deceptive 

and result in obscured payments, and so 

may be used to defraud investors even 

if disclosed and governed. 

5. Alternatives to the Requirement That 

an Adviser To Obtain a Fairness 

Opinion in Connection With Certain 

Adviser-Led Secondary Transactions 

The Commission could consider 

requiring advisers to obtain a third party 


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398Moreover, the costs to liquid fund advisers are 

more likely to be limited, as many secondary 

transactions by liquid fund advisers are not adviserled and so would not necessitate a fairness opinion. 399See supra section II.E. 

valuation in connection with certain 

adviser-led secondary transactions, 

instead of a fairness opinion. We believe 

that these third party valuations would 

likely involve more diligence of the 

proposed transaction than the reviews 

conducted in connection with obtaining 

a fairness opinion, and therefore, 

requiring these valuations could provide 

even greater assurances to investors that 

the terms of the transaction are fair to 

their interests. However, we believe that 

obtaining a third-party valuation would 

likely be significantly more costly to 

obtain. If these costs could be passed on 

to participants in these transactions, it 

could make them less attractive to 

investors as a means to obtain liquidity. 

We could also consider changing the 

scope of this rule. For example, we 

could consider broadening the 

application of this rule to, for example, 

apply to all advisers, including advisers 

that are not required to register as 

investment advisers with the 

Commission, such as state-registered 

advisers and exempt reporting advisers. 

Investors would, as a result, receive the 

assurance of the fairness of more 

adviser-led secondary transactions. The 

extension of the proposed rule to apply 

to all advisers would, however, likely 

impose the costs of obtaining fairness 

opinions on smaller funds advised by 

unregistered advisers, and for these 

types of funds, the cost of obtaining 

such opinions would likely be relatively 

large compared to the value of fund 

assets and fees that the rule is intended 

to provide a check on, which could 

discourage them from undertaking these 

transactions. This could ultimately 

reduce liquidity opportunities for fund 

investors. Alternatively, we could 

provide exemptions from the rule. For 

example, an exemption could be 

provided where the adviser undertakes 

a competitive sale process for the assets 

being sold or for certain advisers to 

hedge funds or other funds determined 

to be liquid funds for whom the 

concerns regarding pricing of illiquid 

assets may be less relevant. These 

exemptions would reduce the costs on 

advisers associated with obtaining the 

fairness opinion, which could 

ultimately reduce costs for investors. 

However, we believe that any such 

exemptions could reduce the benefits of 

the proposed rule associated with 

providing greater assurance to investors 

of the fairness of the transaction. We 

believe that, even under circumstances 

where the adviser has conducted a 

competitive sales process, the effective 

check on this process provided by the 

fairness opinion would benefit 

investors. Further, even for advisers to 

hedge funds or other funds determined 

to be liquid funds who are advising 

funds with predominantly highly liquid 

securities, we believe that a fairness 

opinion would be beneficial to investors 

because the conflicts of interest inherent 

in structuring and leading a transaction 

may, despite the nature of the assets in 

the fund, harm investors.398

6. Alternatives to the Prohibition From 

Providing Certain Preferential Terms 

and Requirement To Disclose All 

Preferential Treatment 

Instead of requiring that private fund 

advisers provide investors and 

prospective investors with written 

disclosures regarding all preferential 

treatment the adviser or its related 

persons provided to other investors in 

the same fund, the Commission could 

consider prohibiting all such terms. 

This could provide investors in private 

funds with increased confidence that 

the adviser’s negotiations with other 

investors would not affect their 

investment in the private fund. We 

preliminarily believe, however, that an 

outright prohibition of all preferential 

terms may not provide significant 

additional benefits beyond prohibitions 

on providing certain preferential terms 

regarding redemption or information 

about portfolio holdings or exposures. 

As discussed above, we believe that 

certain types of preferential terms raise 

relatively few concerns, if disclosed.399

Further, an outright prohibition of all 

preferential terms may limit the 

adviser’s ability to respond to an 

individual investor’s concerns during 

the course of attracting capital 

investments to private funds. 

Further, we could consider 

prohibiting all preferential terms 

regarding redemption or information 

about portfolio holdings or exposures, 

rather than just those that the adviser 

reasonably expects to have a material, 

negative effect on other investors in that 

fund or in a substantially similar pool 

of assets. This could increase the 

investor protections associated with the 

rule, by eliminating the risk that a term 

not reasonably expected to have a 

material negative effect on investors 

could, ultimately, harm investors. We 

believe, however, that this alternative 

would likely provide more limited 

benefits and would increase costs 

associated with the rule similar to the 

above alternatives, for example by 

limiting the adviser’s ability to respond 

to an individual investor’s concerns 

during the course of attracting capital 

investments to private funds. 

In addition, for preferential terms not 

regarding redemption or information 

about portfolio holdings or exposures, 

we could consider requiring advisers to 

private funds to provide disclosure only 

when the term has a material negative 

effect on other fund investors. This 

could reduce the compliance burden on 

advisers associated with the costs of 

disclosure. We believe, however, that 

limiting disclosure to only those terms 

that an adviser determines to have a 

material negative effect could reduce an 

investor’s ability to recognize the 

potential for harm from unforeseen 

favoritism toward other investors, 

relative to a requirement to disclose all 

preferential treatment. 

F. Request for Comment 

The Commission requests comment 

on all aspects of the economic analysis 

of the proposed rule. To the extent 

possible, the Commission requests that 

commenters provide supporting data 

and analysis with respect to the 

benefits, costs, and effects on 

competition, efficiency, and capital 

formation of adopting the proposed 

amendments or any reasonable 

alternatives. In particular, the 

Commission asks commenters to 

consider the following questions: 

• What additional qualitative or 

quantitative information should the 

Commission consider as part of the 

baseline for its economic analysis of 

these amendments? 

• Has the Commission accurately 

characterized the costs and benefits of 

proposed rule? If not, why not? Should 

any of the costs or benefits be modified? 

What, if any, other costs or benefits 

should the Commission take into 

account? If possible, please offer ways of 

estimating these costs and benefits. 

What additional considerations can the 

Commission use to estimate the costs 

and benefits of the proposed 

amendments? 

• Has the Commission accurately 

characterized the effects on competition, 

efficiency, and capital formation arising 

from the proposed rules? If not, why 

not? 

• Has the Commission accurately 

characterized the economic effects of 

the above alternatives? If not, why not? 

Should any of the costs or benefits be 

modified? What, if any, other costs or 

benefits should the Commission take 

into account? Are there other reasonable 

alternatives to the proposed 

amendments? What are the economic 

effects of any other alternatives? 

• Are there data sources or data sets 

that can help the Commission refine its 


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400 44 U.S.C. 3501 et seq. 

estimates of the costs and benefits 

associated with the proposed 

amendments? If so, please identify 

them. 

• How would the proposed delivery 

of the quarterly statement affect the 

reporting practices of advisers, 

including the costs and benefits of these 

statements? Would advisers add the 

required report to the report that they 

currently provide to investors? Would 

advisers substitute the required report 

for an existing report? Explain. 

• What are the benefits to investors of 

obtaining the information that would be 

required under the proposal in a 

standardized format that would enable 

them to make comparisons across 

alternative fund investments? Explain. 

Would the benefits to investors vary 

based on the investor’s scale of 

operations, relationship with the 

adviser, or other factors? Explain. Please 

provide data, if available, to support 

your answer along with details 

regarding data sources and 

interpretation of statistics, where 

appropriate. 

• Would the proposed rules 

strengthen the bargaining power of 

investors in negotiating with private 

fund advisers? If so, under what 

circumstances, and for what types of 

funds and investors would this effect 

occur? How would it affect other 

investors who do not gain bargaining 

power as a result of the proposed rules? 

Please explain your answer and provide 

supporting data, if possible. 

• What would the aggregate total cost 

(including but not limited to the audit 

fee) be of complying with the new audit 

requirement, separately, for (a) funds 

that currently receive audits and (b) 

funds that would newly receive an audit 

under the proposed rule? For each, what 

is the current per-fund cost of an audit? 

Is the per-fund cost different between 

the funds that currently receive audits 

and would newly receive audits? If yes, 

explain Please include an explanation of 

any differences between the funds that 

currently receive an audit and the funds 

that would newly receive an audit that 

would explain the differences in their 

per-fund audit costs. Provide 

quantitative evidence to support your 

explanation, if available. 

• Would the proposed rules introduce 

new fixed costs of compliance? Would 

they cause private funds or fund 

advisers to consolidate their operations 

to economize on those costs? Please 

explain. Provide quantitative evidence 

to support your explanation, if 

available. 

• To what extent do funds currently 

provide quarterly statements to 

investors, and what is the cost of 

providing these statements? How are 

they delivered? How do investors use 

them? What are the contents of these 

statements currently? How do the 

current contents compare with the 

contents that would be required under 

the proposed rule? Explain. 

• We believe that the information in 

the new quarterly statements would 

supplement the information that 

investors currently receive about their 

fund investments and that advisers 

would not respond to the proposal by 

discontinuing any reports to investors. 

Is this correct? Why or why not? Please 

explain. 

• What fee and expense information 

is currently available to investors for use 

in comparing investment opportunities 

among similar funds (sponsored by the 

same adviser or different advisers)? How 

does this information differ from the 

information that advisers would be 

required to provide under the proposed 

rule? In what way does the lack of this 

information affect investor choice or the 

ability of investors to monitor fund 

performance net of fees and expenses? 

• What performance information is 

currently available for investors for use 

in comparing investment opportunities 

among similar funds (sponsored by the 

same adviser or different advisers)? How 

does this information differ from the 

information that advisers would be 

required to provide under the proposed 

rule? 

• How frequently do advisers 

currently engage in each of the activities 

that would be prohibited under the 

proposed rule? Does this frequency vary 

depending on the type of adviser or 

investor? For each practice, what is the 

current business purpose of the activity 

and how else might that purpose be 

achieved (if the activity were 

prohibited)? Please provide quantitative 

evidence on the magnitude of the 

activity, e.g., how much money do 

advisers and related persons receive 

from the fee and expense arrangements 

that would be prohibited? 

• What is the economic effect on 

investors, currently, of the activities we 

propose to prohibit under the proposed 

rule? What empirical evidence is there 

that those activities make investors 

worse off? 

• What data exists regarding the costs 

to investors of conflicts of interest in 

connection with adviser-led secondary 

transactions where an adviser offers 

fund investors the option to sell their 

interests in the private fund, or to 

exchange them for new interests in 

another vehicle advised by the adviser? 

How do costs vary according to the 

presence or absence of the disclosure 

that would be required under the 

proposed rule? 

• From what sources do investors 

receive information about fund 

performance: (a) When comparing 

alternative prospective fund 

investments and (b) for evaluating the 

performance of an ongoing und 

investment? For example, do investors 

obtain this information directly from the 

advisers or from a third party? If from 

a third party, from what source does the 

third party obtain the fund performance 

information, and what is the cost of this 

information? How does the source vary 

with the fund type or third party, if at 

all? 

• How frequently and under what 

conditions are private fund investors 

(current and prospective) unable to 

obtain information from fund advisers 

or third parties on the fund 

performance? 

• Do investors rely on IRR and MOIC 

for evaluating the performance of funds 

determined to be illiquid funds? What 

additional information do investors use 

to evaluate illiquid fund performance? 

How frequently do they rely on this 

information? From what sources do they 

currently obtain this information? 

• How do investors who do not have 

access to this information evaluate 

illiquid fund performance? What 

alternative sources of information do 

they rely upon? 

• Do investors rely on annual total 

returns for evaluating the performance 

of funds determined to be liquid funds? 

When evaluating performance partway 

through a current year, do investors rely 

on cumulative total return for the 

current calendar year? What additional 

information do investors use to evaluate 

liquid fund performance? How 

frequently do they rely on this 

information? From what sources do they 

currently obtain this information? 

• How do investors who do not have 

access to this information evaluate 

liquid fund performance? What 

alternative sources of information do 

they rely upon? 

VI. Paperwork Reduction Act 

A. Introduction 

Certain provisions of our proposal 

would result in new ‘‘collection of 

information’’ requirements within the 

meaning of the Paperwork Reduction 

Act of 1995 (‘‘PRA’’).400 The proposed 

amendments would also have an impact 

on the current collection of information 

burdens of rules 206(4)–7 and 204–2 

under the Advisers Act. The title of the 

new collection of information 


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16962 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

401See proposed rule 211(h)(1)–2. 

402See proposed rule 211(h)(1)–2(d). 

403See Form ADV, Part 1A, Schedule D, Section 

7.B.(1). 

404See Form ADV, Part 1A, Schedule D, Section 

7.B.(1). 

405See Form ADV, Part 1A, Schedule D, Section 

7.B.(1).A., #13. 

requirements we are proposing are 

‘‘Rule 211(h)(1)–2 under the Advisers 

Act,’’ ‘‘Rule 206(4)–10 under the 

Advisers Act,’’ ‘‘Rule 211(h)(2)–2 under 

the Advisers Act,’’ and ‘‘Rule 211(h)(2)– 

3 under the Advisers Act.’’ The Office 

of Management and Budget (‘‘OMB’’) 

has not yet assigned control numbers for 

these new collections of information. 

The titles for the existing collections of 

information that we are proposing to 

amend are: (i) ‘‘Rule 206(4)–7 under the 

Advisers Act (17 CFR 275.206(4)–7)’’ 

(OMB control number 3235–0585) and 

(ii) ‘‘Rule 204–2 under the Advisers Act 

(17 CFR 275.204–2)’’ (OMB control 

number 3235–0278). The Commission is 

submitting these collections of 

information to OMB for review and 

approval in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. An agency 

may not conduct or sponsor, and a 

person is not required to respond to, a 

collection of information unless it 

displays a currently valid OMB control 

number. 

We discuss below the new collection 

of information burdens associated with 

new rules 211(h)(1)–2, 206(4)–10, 

211(h)(2)–2, and 211(h)(2)–3 as well as 

the revised existing collection of 

information burdens associated with the 

proposed amendments to rules 206(4)– 

7 and 204–2. Responses provided to the 

Commission in the context of 

amendments to rules 206(4)–7 and 204– 

2 would be kept confidential subject to 

the provisions of applicable law. 

Because the information collected 

pursuant to new rules 211(h)(1)–2, 

211(h)(2)–2, and 211(h)(2)–3 requires 

disclosures to existing investors and in 

some cases potential investors, these 

disclosures would not be kept 

confidential. Proposed new rule 206(4)– 

10 requires the collection of two types 

of information: one type (the audited 

financial statements) would be 

distributed only to investors in the 

private fund, and the other 

(notifications to the Commission) would 

be kept confidential subject to the 

provisions of applicable law. 

B. Quarterly Statements 

Proposed rule 211(h)(1)–2 would 

require an investment adviser registered 

or required to be registered with the 

Commission to prepare a quarterly 

statement that includes certain 

standardized disclosures regarding the 

cost of investing in the private fund and 

the private fund’s performance for any 

private fund that it advises, directly or 

indirectly, that has at least two full 

calendar quarters of operating results, 

and distribute the quarterly statement to 

the private fund’s investors within 45 

days after each calendar quarter end, 

unless such a quarterly statement is 

prepared and distributed by another 

person.401 The quarterly statement 

would provide investors with fee and 

expense disclosure for the prior 

quarterly period or, in the case of a 

newly formed private fund initial 

account statement, its first two full 

calendar quarters of operating results. It 

would also provide investors with 

certain performance information 

depending on whether the fund is 

categorized as a liquid fund or an 

illiquid fund.402

The collection of information is 

necessary to provide private fund 

investors with information about their 

private fund investments. The quarterly 

statement would allow a private fund 

investor to compare standardized cost 

and performance information across its 

private fund investments. We believe 

this information would help inform 

investment decisions, including 

whether to remain invested in certain 

private funds or to invest in other 

private funds managed by the adviser or 

its related persons. More broadly, this 

disclosure would help inform investors 

about the cost and performance 

dynamics of this marketplace and 

potentially improve efficiency for future 

investments. 

Each requirement to disclose 

information, offer to provide 

information, or adopt policies and 

procedures constitutes a ‘‘collection of 

information’’ requirement under the 

PRA. This collection of information is 

found at 17 CFR 275.211(h)(1)–2 and is 

mandatory. The respondents to these 

collections of information requirements 

would be investment advisers that are 

registered or required to be registered 

with the Commission that advise one or 

more private funds. 

Based on Investment Adviser 

Registration Depository (IARD) data, as 

of November 30, 2021, there were 

14,832 investment advisers registered 

with the Commission. According to this 

data, 5,037 registered advisers provide 

advice to private funds.403 We estimate 

that these advisers would, on average, 

each provide advice to 9 private 

funds.404 We further estimate that these 

private funds would, on average, each 

have a total of 67 investors.405 As a 

result, an average private fund adviser 

would have, on average, a total of 603 

investors across all private funds it 

advises. As noted above, because the 

information collected pursuant to 

proposed rule 211(h)(1)–2 requires 

disclosures to private fund investors, 

these disclosures would not be kept 

confidential. 

We have made certain estimates of 

this data solely for the purpose of this 

PRA analysis. The table below 

summarizes the initial and ongoing 

annual burden estimates associated with 

the proposed account statement rule. 

TABLE 1—RULE 211(h)(1)–2 PRA ESTIMATES

Internal 

initial 

burden 

hours 

Internal annual 

burden hours Wage rate 1 Internal time cost Annual external cost 

burden 

PROPOSED ESTIMATES 

Preparation of account statements.9 11 hours 2 ................ $382 (blended rate for compliance attorney ($373), assistant general counsel 

($476), and financial reporting manager 

($297)).

$4,202 ..................... $4,030.3

Distribution of account statements 

to existing investors.

1.5 3.5 hours 4 ............... $64 (rate for general clerk) ....................... $224 ........................ $930.5


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406See proposed rule 206(4)–10. 

407See Form ADV, Part 1A, Schedule D, Section 

7.B.(1). 

408See Form ADV, Part 1A, Schedule D, Section 

7.B.(1). 

409See Form ADV, Part 1A, Schedule D, Section 

7.B.(1).A., #13. 

TABLE 1—RULE 211(h)(1)–2 PRA ESTIMATES—Continued 

Internal 

initial 

burden 

hours 

Internal annual 

burden hours Wage rate 1 Internal time cost Annual external cost 

burden 

Total new annual 

burden per private 

fund.

14.5 hours ............... .............................................................. $4,426 ..................... $4,960. 

Avg. number of private funds per adviser.9 private funds ........ .............................................................. 9 private funds ........ 9 private funds. 

Number of PF advisers.5,037 advisers ......... .............................................................. 5,037 advisers ......... 2,518.6

Total new annual burden.657,328.5 hours ...... .............................................................. $200,643,858 .......... $112,403,250. 

Notes: 

1The Commission’s estimates of the relevant wage rates are based on salary information for the securities industry compiled by the Securities 

Industry and Financial Markets Association’s Office Salaries in the Securities Industry 2013. The estimated figures are modified by firm size, employee benefits, overhead, and adjusted to account for the effects of inflation. See Securities Industry and Financial Markets Association, Report 

on Management & Professional Earnings in the Securities Industry 2013 (‘‘SIFMA Report’’). 2This includes the internal initial burden estimate annualized over a three-year period, plus 8 hours of ongoing annual burden hours and takes 

into account that there would be four statements prepared each year. The estimate of 11 hours is based on the following calculation: ((9 initial 

hours/3 years) + 8 hours of additional ongoing burden hours) = 11 hours. 3This estimated burden is based on the sum of the estimated wage rate of $496/hour, for 5 hours, ($2,480) for outside legal services and the 

estimated wage rate of $310/hour, for 5 hours, ($1,550) for outside accountant assistance, and it assumes that there would be four statements 

prepared each year. The Commission’s estimates of the relevant wage rates for external time costs, such as outside legal services, takes into 

account staff experience, a variety of sources including general information websites, and adjustments for inflation. 4This includes the internal initial burden estimate annualized over a three-year period, plus 3 hours of ongoing annual burden hours that takes 

into account that there would be four statements prepared each year. The estimate of 3.5 hours is based on the following calculation: ((1.5 initial 

hours/3 years) + 3 hours of additional ongoing burden hours) = 3.5 hours. 5This estimated burden is based on the estimated wage rate of $310/hour, for 3 hours, for outside accounting services, and it assumes that 

there would be four statements distributed each year. See supra footnote 409 (regarding wage rates with respect to external cost estimates). 6We estimate that 50% of advisers will use outside legal and accounting services for these collections of information. This estimate takes into 

account that advisers may elect to use outside these services (along with in-house counsel), based on factors such as adviser budget and the 

adviser’s standard practices for using such outside services, as well as personnel availability and expertise. 

C. Mandatory Private Fund Adviser 

Audits 

Proposed rule 206(4)–10 would 

require investment advisers that are 

registered or required to be registered to 

cause each private fund they advise, 

directly or indirectly, to undergo a 

financial statement audit at least 

annually and upon liquidation that 

complies with the proposed rule, unless 

the fund otherwise undergoes such an 

audit.406 We believe that proposed new 

rule 206(4)–10 would protect the fund 

and its investors against the 

misappropriation of fund assets and that 

an audit performed by an independent 

public accountant would provide an 

important check on the adviser’s 

valuation of private fund assets, which 

often serve as the basis for the 

calculation of the adviser’s fees. The 

collection of information is necessary to 

provide private fund investors with 

information about their private fund 

investments and the Commission uses 

this information in the context of its 

examination and oversight program. 

Each requirement to disclose 

information, offer to provide 

information, or adopt policies and 

procedures constitutes a ‘‘collection of 

information’’ requirement under the 

PRA. This collection of information is 

found at 17 CFR 275.206(4)–10 and is 

mandatory to the extent the adviser 

provides investment advice to a private 

fund. The respondents to these 

collections of information requirements 

would be investment advisers that are 

registered or required to be registered 

with the Commission that advise one or 

more private funds. All responses 

required by the proposed audit rule 

would be mandatory. One response type 

(the audited financial statements) would 

be distributed only to investors in the 

private fund and would not be 

confidential, and the other (notifications 

to the Commission) would be kept 

confidential subject to the provisions of 

applicable law. 

Based on IARD data, as of November 

30, 2021, there were 14,832 investment 

advisers registered with the 

Commission. According to this data, 

5,037 registered advisers provide advice 

to private funds.407 We estimate that 

these advisers would, on average, each 

provide advice to 9 private funds.408 We 

further estimate that these private funds 

would, on average, each have a total of 

67 investors.409 As a result, an average 

private fund adviser would have, on 

average, a total of 603 investors across 

all private funds it advises. 

We have made certain estimates of 

this data, as discussed below, solely for 

the purpose of this PRA analysis. The 

table below summarizes the initial and 

ongoing annual burden estimates 

associated with the proposed rule’s 

reporting requirement. 


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16964 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

410See proposed rule 211(h)(2)–2. 

TABLE 2—RULE 206(4)–10 PRA ESTIMATES

Internal 

initial 

burden 

hours 

Internal annual 

burden hours Wage rate1 Internal time cost Annual external cost 

burden 

PROPOSED ESTIMATES 

Distribution of audited financial 

statements 2.

0 1.12 hours 3 ............. $153.33 (blended rate for intermediate 

accountant ($175), general accounting 

supervisor ($221), and general clerk 

($64)).

$171.73 ................... $60,000.4

Preparation of the 

written agreement 5.

6 1.25 0.92 hours 7 ............. $476 (rate for assistant general counsel) $437.92 ................... $0. 

Total new annual 

burden per private 

fund.

2.04 hours ............... .............................................................. $609.65 ................... $60,000.8

Avg. number of private funds per adviser.9 private funds ........ .............................................................. 9 private funds ........ 9 private funds. 

Number of advisers 5,037 advisers ......... .............................................................. 5,037 advisers ......... 5,037 advisers. 

Total new annual burden.92,479.32 hours ...... .............................................................. $27,637,263.40 ....... $2,719,980,000. 

Notes: 

1. See SIFMA Report supra Note 1 to Table 1 Rule 211(h)(1)–2 PRA Estimates. 

2. The proposed audit provision would require an adviser to obtain an audit at least annually and upon an entity’s liquidation. To the extent not 

prohibited, we anticipate that, in some cases, the fund will bear the audit expense, in other cases the adviser will bear it, and in other instances 

both the adviser and fund will share the expense. The liquidation audit would serve as the annual audit for the fiscal year in which it occurs. See 

proposed rule 206(4)–10. 

3. This estimate takes into account that the financial statements must be distributed once annually under the proposed audit rule and that a liquidation audit would replace a final audit in a year. Based on our experience with similar requirements under the custody rule, we estimate the 

hour burden imposed on the adviser relating to the distribution of the audited financial statements with respect to the investors in each fund 

should be minimal, approximately one minute per investor. See Custody of Funds or Securities of Clients by Investment Advisers, Investment 

Advisers Act Release No. 2968 (Dec. 30, 2009) [75 FR 1455 (Jan. 11, 2010)] (‘‘Custody Rule 2009 Adopting Release’’), at 59–60. We estimate 

that the average private fund has 67 investors. 

4. Based on our experience, we estimate that the party (or parties) that bears the audit expense would pay an average audit fee of $60,000 

per fund. We estimate that individual fund audit fees would tend to vary over an estimated range from $15,000 to $300,000, and that some fund 

audit fees would be higher or lower than this range. We understand that the price of the audit has many variables, such as whether it is a liquid 

fund or illiquid fund, the number of its holdings, availability of a PCAOB-registered and -inspected auditor, economies of scale, and the location 

and size of the auditor. 

5. The proposed rule would require the adviser or the private fund to enter into an agreement with the independent public accountant. The 

agreement would require the independent public accountant that completes the audit to notify the Commission by electronic means directed to 

the Division of Examinations promptly upon certain events. See proposed rule 206(4)–10(e). 

6. For purposes of this PRA we assume that, regardless of whether the adviser or the fund enters into the written agreement, the accountant 

would incur the hour burden of preparing the agreement. We also assume that, if the fund was party to the agreement, the fund would delegate 

the task of reviewing the agreement to the adviser. This estimate also assumes that the adviser would enter into a separate agreement for each 

private fund, even if multiple funds use the same auditor. We believe that written agreements are commonplace and reflect industry practice 

when a person retains the services of a professional such as an accountant, and they are typically prepared by the accountant in advance. We 

therefore estimate that each adviser would spend 1.25 hours to add the required provisions to, or confirm that the required provisions are in, the 

written agreement. 

7. This includes the internal initial burden estimate annualized over a three-year period, plus 0.5 hours of ongoing annual burden hours, and it 

assumes annual reassessment and execution: ((1.25 initial hours/3 years) + 0.5 hours of additional ongoing burden hours) = 0.92 hours. 

8. We assume the same frequency of these cost estimates as for the internal annual burden hours estimate. 

D. Adviser-Led Secondaries 

Proposed rule 211(h)(2)–2 would 

prohibit an adviser registered or 

required to be registered from 

completing an adviser-led secondary 

transaction with respect to any private 

fund, unless the adviser, prior to the 

closing of the transaction, distributes to 

investors in the private fund a fairness 

opinion from an independent opinion 

provider and a summary of any material 

business relationships the adviser or 

any of its related persons has, or has had 

within the past two years, with the 

independent opinion provider.410 We 

believe that this proposed requirement 

would provide an important check 

against an adviser’s conflicts of interest 

in structuring and leading a transaction 

from which it may stand to profit at the 

expense of private fund investors and 

would help ensure that private fund 

investors are offered a fair price for their 

private fund interests. Specifically, this 

requirement is designed to help ensure 

that investors receive the benefit of an 

independent price assessment, which 

we believe will improve their decisionmaking ability and their overall 

confidence in the transaction. The 

collection of information is necessary to 

provide investors with information 

about securities transactions in which 

they may engage. 

Each requirement to disclose 

information, offer to provide 

information, or adopt policies and 

procedures constitutes a ‘‘collection of 

information’’ requirement under the 

PRA. This collection of information is 

found at 17 CFR 275.211(h)(2)–2 and is 

mandatory. The respondents to these 

collections of information requirements 

would be investment advisers that are 

registered or required to be registered 

with the Commission that advise one or 

more private funds. Based on IARD 

data, as of November 30, 2021, there 

were 14,832 investment advisers 

registered with the Commission. 

According to this data, 5,037 registered 

advisers provide advice to private 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16965 

411See Form ADV, Part 1A, Schedule D, Section 

7.B.(1). 412See supra section V.B. 

413See proposed rule 211(h)(2)–3(b). 

414See proposed rule 211(h)(2)–3(b)(1). 

415See proposed rule 211(h)(2)–3(b)(2). 

416The following types of private fund advisers, 

among others, would be subject to the proposed 

rule: Unregistered advisers (i.e., advisers that are 

not SEC registered but have a registration 

obligation, and those that may be prohibited from 

registering with us), foreign private advisers, and 

advisers that rely on the intrastate exemption from 

SEC registration and/or the de minimis exemption 

from SEC registration. However, we are unable to 

estimate the number of advisers in each of these 

categories because these advisers do not file reports 

or other information with the SEC and we are 

unable to find reliable, public information. As a 

result, the above estimate is based on information 

from SEC-registered advisers to private funds, 

exempt reporting advisers (at the state and Federal 

levels), and state-registered advisers to private 

funds. These figures are approximate. 

funds.411 Of these 5,037 advisers, we 

estimate that 10%, or approximately 504 

advisers, conduct an adviser-led 

secondary transaction each year. Of 

these advisers, we further estimate that 

each conducts one adviser-led 

secondary transaction each year. As a 

result, an adviser would have 

obligations under the proposed rule 

with regard to 67 investors.412 As noted 

above, because the information 

collected pursuant to proposed rule 

211(h)(2)–2 requires disclosures to 

private fund investors, these disclosures 

would not be kept confidential. 

We have made certain estimates of 

this data solely for the purpose of this 

PRA analysis. The table below 

summarizes the annual burden 

estimates associated with the proposed 

rule’s requirements. 

TABLE 3—RULE 211(h)(2)–2 PRA ESTIMATES

Internal initial 

burden hours 

Internal annual 

burden hours Wage rate 1 Internal time cost Annual external cost burden 

PROPOSED ESTIMATES 

Preparation/Procurement of fairness 

opinion.

0 4 hours 2 ............ $376.66 (blended rate for compliance attorney 

($373), assistant general counsel ($476), and 

senior business analyst ($281)).

$1,506.64 .......... $40,000.3

Preparation of material business relationship summary.0 2 hours .............. $424.50 (blended rate for compliance attorney 

($373) and assistant general counsel ($476)).

$849 .................. $496.4

Distribution of fairness opinion and 

material business relationship summary.

0 1 hour ................ $64 (rate for general clerk) .................................... $64 .................... $0. 

Total new annual burden per private 

fund.

........................ 7 hours .............. ................................................................................ $2,419.64 .......... $40,849. 

Number of advisers ........................... ........................ 504 advisers 5 .... ................................................................................ 504 advisers ...... 504 advisers. 

Total new annual burden ............ ........................ 3,528 hours ....... ................................................................................ $1,219,498.56 ... $20,587,896. 

Notes: 

1See SIFMA Report supra Note 1 to Table 1 Rule 211(h)(1)–2 PRA Estimates. 2 Includes the time an adviser would spend gathering materials to provide to the independent opinion provider so that the latter can prepare the fairness opinion. 

3This estimated burden is based on our understanding of the general cost of a fairness opinion in the current market. The cost will vary based on, among other 

things, the complexity, terms, and size of the adviser-led secondary transaction, as well as the nature of the assets of the fund. 4This estimated burden is based on the estimated wage rate of $496/hour, for 1 hours, for outside legal services at the same frequency as the internal burden 

hours estimate. The Commission’s estimates of the relevant wage rates for external time costs, such as outside legal services, takes into account staff experience, a 

variety of sources including general information websites, and adjustments for inflation. 5We estimate that 10% of all registered private fund advisers conduct in an adviser-led secondary transaction each year. 

E. Disclosure of Preferential Treatment 

Proposed rule 211(h)(2)–3 would 

prohibit all private fund advisers from 

providing preferential terms to certain 

investors regarding redemption or 

information about portfolio holdings or 

exposures.413 The proposed rule would 

also prohibit these advisers from 

providing any other preferential 

treatment to any investor in the private 

fund unless the adviser provides written 

disclosures to prospective and current 

investors in a private fund regarding all 

preferential treatment the adviser or its 

related persons are providing to other 

investors in the same fund. For 

prospective investors, the proposed new 

rule would require advisers to provide 

the written notice prior to the investor’s 

investment in the fund.414 For current 

investors, the proposed new rule would 

require advisers to distribute an annual 

update regarding any preferential 

treatment provided since the last notice, 

if any.415

The proposed new rule is designed to 

protect investors and serve the public 

interest by requiring disclosure of 

preferential treatment afforded to 

certain investors. The proposed new 

rule would increase transparency in 

order to better inform investors 

regarding the breadth of preferential 

terms, the potential for those terms to 

affect their investment in the private 

fund, and the potential costs (including 

compliance costs) associated with these 

preferential terms. Also, this disclosure 

would help investors shape the terms of 

their relationship with the adviser of the 

private fund. The collection of 

information is necessary to provide 

private fund investors with information 

about their private fund investments. 

Each requirement to disclose 

information, offer to provide 

information, or adopt policies and 

procedures constitutes a ‘‘collection of 

information’’ requirement under the 

PRA. This collection of information is 

found at 17 CFR 275.211(h)(2)–3 and is 

mandatory. The respondents to these 

collections of information requirements 

would be all investment advisers that 

advise one or more private funds. Based 

on IARD data, as of November 30, 2021, 

there were 12,500 investment advisers 

that provide advice to private funds.416

We estimate that these advisers would, 

on average, each provide advice to 7 

private funds. We further estimate that 

these private funds would, on average, 

each have a total of 63 investors. As a 

result, an average private fund adviser 

would have a total of 441 investors 

across all private funds it advises. As 

noted above, because the information 

collected pursuant to proposed rule 

211(h)(2)–3 requires disclosures to 

private fund investors and prospective 

investors, these disclosures would not 

be kept confidential. 

We have made certain estimates of 

this data solely for the purpose of this 

PRA analysis. The table below 

summarizes the initial and ongoing 

annual burden estimates associated with 


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16966 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

417See proposed rule 206(4)–7(b). 

the proposed rule’s policies and procedures and annual review 

requirements. 

TABLE 4—RULE 211(h)(2)–3 PRA ESTIMATES

Internal initial 

burden hours 

Internal annual 

burden hours Wage rate 1 Internal time cost Annual external 

cost burden 

PROPOSED ESTIMATES 

Preparation of written notice .............. 4 3.3 hours 2 ......... $424.50 (blended rate for compliance attorney 

($373) and assistant general counsel ($476)).

$1,400.85 .......... $496.3

Provision/distribution of written notice 0.25 1.13 hours 4 ....... $64 (rate for general clerk) .................................... $72.32..

Total new annual burden per private fund......................... 4.43 hours ......... ................................................................................ $1,473.17 .......... $496. 

Avg. number of private funds per adviser......................... 7 private funds .. ................................................................................ 7 private funds .. 7 private funds. 

Number of advisers ........................... ........................ 12,500 advisers ................................................................................ 12,500 advisers 9,375 advisers.5

Total new annual burden ............ ........................ 387,625 hours ... ................................................................................ $128,902,375 .... $32,550,000. 

Notes: 

1See SIFMA Report, supra Note 1 to Table 1 Rule 211(h)(1)–2 PRA Estimates. 2This includes the internal initial burden estimate annualized over a three-year period, plus 2 hours of ongoing annual burden hours and assumes notices would be 

issued once annually to existing investors and once quarterly for prospective investors. The estimate of 3.3 hours is based on the following calculation: ((4 initial 

hours/3 years) + 2 hours of additional ongoing burden hours) = 3.3 hours. The burden hours associated with reviewing preferential treatment provided to other investors in the same fund and updating the written notice takes into account that (i) most closed-end funds would only raise new capital for a finite period of time and thus 

the burden hours would likely decrease after the fundraising period terminates for such funds since they would not continue to seek new investors and would not continue to agree to new preferential treatment for new investors and (ii) most open-end private funds continuously raise capital and thus the burden hours would likely 

remain the same year over year since they would continue to seek new investors and would continue to agree to preferential treatment for new investors. 3This estimated burden is based on the estimated wage rate of $496/hour, for 1 hours, for outside legal services at the same frequency as the internal burden 

hours estimate. The Commission’s estimates of the relevant wage rates for external time costs, such as outside legal services, takes into account staff experience, a 

variety of sources including general information websites, and adjustments for inflation. 4This includes the internal initial burden estimate annualized over a three-year period, plus 1.05 hours of ongoing annual burden hours. The estimate of 1.13 hours 

is based on the following calculation: ((0.25 initial hours/3 years) + 1.05 hours of additional ongoing burden hours) = 1.13 hours. 5We estimate that 75% of advisers will use outside legal services for these collections of information. This estimate takes into account that advisers may elect to 

use outside legal services (along with in-house counsel), based on factors such as adviser budget and the adviser’s standard practices for using outside legal services, as well as personnel availability and expertise. 

F. Written Documentation of Adviser’s 

Annual Review of Compliance Program 

The proposed amendment to rule 

206(4)–7 would require investment 

advisers that are registered or required 

to be registered to document the annual 

review of their compliance policies and 

procedures in writing.417 We believe 

that such a requirement would focus 

renewed attention on the importance of 

the annual compliance review process 

and would help ensure that advisers 

maintain records regarding their annual 

compliance review that will allow our 

staff to determine whether an adviser 

has complied with the compliance rule. 

This collection of information is 

found at 17 CFR 275.206(4)–7 and is 

mandatory. The Commission staff uses 

the collection of information in its 

examination and oversight program. As 

noted above, responses provided to the 

Commission in the context of its 

examination and oversight program 

concerning the proposed amendments 

to rule 206(4)–7 would be kept 

confidential subject to the provisions of 

applicable law. 

Based on IARD data, as of November 

30, 2021, there were 14,832 investment 

advisers registered with the 

Commission. In our most recent PRA 

submission for rule 206(4)–7, we 

estimated a total hour burden of 

1,152,663 hours, and the total annual 

external cost burden is $0. 

The table below summarizes the 

initial and ongoing annual burden 

estimates associated with the proposed 

amendments to rule 204–2. 

TABLE 5—RULE 206(4)–7 PRA ESTIMATES

Internal annual 

burden hours Wage rate 1 Internal time cost 

Annual external 

cost burden 

PROPOSED ESTIMATES 

Written documentation of annual review.3 hours 2 ........... $424.50 (blended rate for compliance attorney 

($373) and assistant general counsel ($476)).

$1,273.50 ......... $551.3

Number of advisers .......................... 14,832 advisers ......................................................................... 14,832 advisers 7,416 advisers.4

Total new annual burden .......... 44,496 hours .... .............................................................................. $18,888,552 ..... $4,086,216. 

Notes: 

1See SIFMA Report, supra Note 1 to Table 1 Rule 211(h)(1)–2 PRA Estimates. 2We estimate that these proposed amendments would increase each registered investment adviser’s average annual collection burden under 

rule 206(4)–7 by 3 hours. 3This estimated burden is based on the sum of the estimated wage rate of $496/hour, for 0.5 hours, ($248) for outside legal services and the 

estimated wage rate of $310/hour, for 0.5 hours, ($155) for outside accountant assistance. 4We estimate that 50% of advisers will use outside legal services for these collections of information. This estimate takes into account that advisers may elect to use outside legal services (along with in-house counsel), based on factors such as adviser budget and the adviser’s standard 

practices for using outside legal services, as well as personnel availability and expertise. 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16967 

418See proposed rule 204–2. 419See proposed rule 204–2(a)(20)(i) and (ii) and 

(a)(22). 

420See proposed rule 204–2(a)(21)(i). 

421See proposed rule 204–2(a)(21)(ii). 

422See proposed rule 204–2(a)(23). 

423See proposed rule 204–2(a)(7)(v). 

424 Id. 

425See Form ADV, Part 1A, Schedule D, Section 

7.B.(1). 

426See Form ADV, Part 1A, Schedule D, Section 

7.B.(1). 

427See Form ADV, Part 1A, Schedule D, Section 

7.B.(1).A., #13. 

428Supporting Statement for the Paperwork 

Reduction Act Information Collection Submission 

for Revisions to Rule 204–2, OMB Report, OMB 

3235–0278 (Aug. 2021). 

G. Recordkeeping 

The proposed amendments to rule 

204–2 would require advisers to private 

funds to retain books and records 

related to the proposed quarterly 

statement rule, the proposed audit rule, 

the proposed adviser-led secondaries 

rule, and the proposed preferential 

treatment rule.418 These proposed 

amendments would help facilitate the 

Commission’s inspection and 

enforcement capabilities. 

Specifically, the proposed books and 

records amendments related to the 

quarterly statement rule would require 

advisers to (i) retain a copy of any 

quarterly statement distributed to fund 

investors as well as a record of each 

addressee, the date(s) the statement was 

sent, address(es), and delivery 

method(s); (ii) retain all records 

evidencing the calculation method for 

all expenses, payments, allocations, 

rebates, offsets, waivers, and 

performance listed on any statement 

delivered pursuant to the proposed 

quarterly statement rule; and (iii) make 

and keep books and records 

substantiating the adviser’s 

determination that the private fund it 

manages is a liquid fund or an illiquid 

fund pursuant to the proposed quarterly 

statement rule.419

The proposed books and records 

amendments related to the proposed 

audit rule would require advisers to 

keep a copy of any audited financial 

statements along with a record of each 

addressee and the corresponding date(s) 

sent, address(es), and delivery 

method(s) for each such addressee.420

Additionally, the proposed rule would 

require the adviser to keep a record 

documenting steps it took to cause a 

private fund client with which it is not 

in a control relationship to undergo a 

financial statement audit that would 

comply with the rule.421

The proposed books and records 

amendments related to the proposed 

adviser-led secondaries rule would 

require advisers to retain a copy of any 

fairness opinion and summary of 

material business relationships 

distributed pursuant to the proposed 

rule along with a record of each 

addressee and the corresponding date(s) 

sent, address(es), and delivery 

method(s) for each such addressee.422

The proposed books and records 

amendments related to the proposed 

preferential treatment rule would 

require advisers to retain copies of all 

written notices sent to current and 

prospective investors in a private fund 

pursuant to rule 211(h)(2)–3.423 In 

addition, advisers would be required to 

retain copies of a record of each 

addressee and the corresponding dates 

sent, addresses, and delivery method for 

each addressee.424

The respondents to these collections 

of information requirements would be 

investment advisers that are registered 

or required to be registered with the 

Commission that advise one or more 

private funds. Based on IARD data, as of 

November 30, 2021, there were 14,832 

investment advisers registered with the 

Commission. According to this data, 

5,037 registered advisers provide advice 

to private funds.425 We estimate that 

these advisers would, on average, each 

provide advice to 9 private funds.426 We 

further estimate that these private funds 

would, on average, each have a total of 

67 investors.427 As a result, an average 

private fund adviser would have, on 

average, a total of 603 investors across 

all private funds it advises. 

In our most recent PRA submission 

for rule 204–2,428 we estimated for rule 

204–2 a total hour burden of 2,764,563 

hours, and the total annual external cost 

burden is $175,980,426. This collection 

of information is found at 17 CFR 

275.204–2 and is mandatory. The 

Commission staff uses the collection of 

information in its examination and 

oversight program. As noted above, 

responses provided to the Commission 

in the context of its examination and 

oversight program concerning the 

proposed amendments to rule 204–2 

would be kept confidential subject to 

the provisions of applicable law. 

The table below summarizes the 

initial and ongoing annual burden 

estimates associated with the proposed 

amendments to rule 204–2. 

TABLE 6—RULE 204–2 PRA ESTIMATES

Internal annual 

burden hours 1 Wage rate 2 Internal time cost 

Annual 

external cost 

burden 

PROPOSED ESTIMATES 

Retention of account statement and 

calculation information; making and 

keeping records re liquid/illiquid 

fund determination.

0.25 hours ........ $68 (blended rate for general clerk ($64) and 

compliance clerk ($72)).

$17 ................... $0 

Avg. number of private funds per adviser.9 private funds .. ................................................................................ 9 private funds .. 0 

Number of advisers ........................... 5,037 advisers .. ................................................................................ 5,037 advisers .. 0 

Sub-total burden ......................... 11,333.25 hours ................................................................................ $770,661 .......... 0 

Retention of written notices re preferential treatment.0.5 hours .......... $68 (blended rate for general clerk ($64) and 

compliance clerk ($72)).

$34 ................... 0 

Avg. number of private funds per adviser.7 private funds .. ................................................................................ 7 private funds .. 0 

Number of advisers ........................... 5,037 advisers .. ................................................................................ 5,037 advisers .. 0 

Sub-total burden ......................... 17,629.5 hours ................................................................................ $1,198,806 ....... 0 

Retention and distribution of audited 

financial statements.

0.25 hours ........ $68 (blended rate for general clerk ($64) and 

compliance clerk ($72)).

$17 ................... 0 


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16968 Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 

429 5 U.S.C. 603(a). 

430See proposed rule 211(h)(1)–1. 

431See proposed rule 211(h)(1)–2. 

TABLE 6—RULE 204–2 PRA ESTIMATES—Continued 

Internal annual 

burden hours 1 Wage rate 2 Internal time cost 

Annual 

external cost 

burden 

Avg. number of private funds per adviser.9 private funds .. ................................................................................ 9 private funds .. 0 

Number of advisers ........................... 5,037 advisers .. ................................................................................ 5,037 advisers .. 0 

Sub-total burden ......................... 11,333.25 hours ................................................................................ $770,661 .......... 0 

Retention and distribution of fairness 

opinion and summary of material 

business relationships.

1 hour ............... $68 (blended rate for general clerk ($64) and 

compliance clerk ($72)).

$68 ................... 0 

Avg. number of private funds per adviser that conduct an adviser-led 

transaction.

1 private fund ... ................................................................................ 1 private fund ... 0 

Number of advisers ........................... 504 advisers 3 ... ................................................................................ 504 advisers 4 ... 0 

Sub-total burden ......................... 504 hours ......... ................................................................................ $34,272 ............ 0 

Total burden ........................ 40,800 hours .... ................................................................................ $ 2,774,400 ...... 0 

Notes: 

1 Hour burden and cost estimates for these proposed rule amendments assume the frequency of each collection of information for the substantive rule with which they are associated. For example, the hour burden estimate for recordkeeping obligations associated with the amendments to proposed rule 204–2(a)(20) and (22) would assume the same frequency of collection of information as under proposed rule 211(h)(1)– 

2. 2See SIFMA Report, supra Note 1 to Table 1 Rule 211(h)(1)–2 PRA Estimates. 3See supra section V.D. 4 Id. 

H. Request for Comment 

We request comment on whether 

these estimates are reasonable. Pursuant 

to 44 U.S.C. 3506(c)(2)(B), the 

Commission solicits comments in order 

to: (1) Evaluate whether the proposed 

collection of information is necessary 

for the proper performance of the 

functions of the Commission, including 

whether the information will have 

practical utility; (2) evaluate the 

accuracy of the Commission’s estimate 

of the burden of the proposed collection 

of information; (3) determine whether 

there are ways to enhance the quality, 

utility, and clarity of the information to 

be collected; and (4) determine whether 

there are ways to minimize the burden 

of the collection of information on those 

who are to respond, including through 

the use of automated collection 

techniques or other forms of information 

technology. 

Persons wishing to submit comments 

on the collection of information 

requirements of the proposed 

amendments should direct them to the 

OMB Desk Officer for the Securities and 

Exchange Commission, 

MBX.OMB.OIRA.SEC_desk_officer@

omb.eop.gov, and should send a copy to 

Vanessa A. Countryman, Secretary, 

Securities and Exchange Commission, 

100 F Street NE, Washington, DC 

20549–1090, with reference to File No. 

S7–03–22. OMB is required to make a 

decision concerning the collections of 

information between 30 and 60 days 

after publication of this release; 

therefore a comment to OMB is best 

assured of having its full effect if OMB 

receives it within 30 days after 

publication of this release. Requests for 

materials submitted to OMB by the 

Commission with regard to these 

collections of information should be in 

writing, refer to File No. S7–03–22, and 

be submitted to the Securities and 

Exchange Commission, Office of FOIA 

Services, 100 F Street NE, Washington, 

DC 20549–2736. 

VII. Initial Regulatory Flexibility 

Analysis 

The Commission has prepared the 

following Initial Regulatory Flexibility 

Analysis (‘‘IRFA’’) in accordance with 

section 3(a) of the Regulatory Flexibility 

Act (‘‘RFA’’).429 It relates to the 

following proposed rules and rule 

amendments under the Advisers Act: (i) 

Proposed rule 211(h)(1)–1; (ii) proposed 

rule 211(h)(1)–2; (iii) proposed rule 

206(4)–10; (iv) proposed rule 211(h)(2)– 

1; (v) proposed rule 211(h)(2)–2; (vi) 

proposed rule 211(h)(2)–3; (vii) 

proposed amendments to rule 204–2; 

and (viii) proposed amendments to rule 

206(4)–7. 

A. Reasons for and Objectives of the 

Proposed Action 

1. Proposed Rule 211(h)(1)–1 

We are proposing new rule 211(h)(1)– 

1 under the Advises Act (the 

‘‘definitions rule’’), which would 

contain numerous definitions for 

purposes of proposed rules 211(h)(1)–2, 

206(4)–10, 211(h)(2)–1, 211(h)(2)–2, and 

211(h)(2)–3.430 We chose to include 

these definitions in a single rule for ease 

of reference, consistency, and brevity. 

2. Proposed Rule 211(h)(1)–2 

We are proposing new rule 211(h)(1)– 

2 under the Advisers Act, which 

requires any investment adviser 

registered or required to be registered 

with the Commission that provides 

investment advice to a private fund that 

has at least two full calendar quarters of 

operating results to prepare and 

distribute a quarterly statement to 

private fund investors that includes 

certain standardized disclosures 

regarding the cost of investing in the 

private fund and the private fund’s 

performance.431 We believe that 

providing this information to private 

fund investors in a simple and clear 

format is appropriate and in the public 

interest and will improve investor 

protection and investor decision 

making. The reasons for, and objectives 

of, proposed rule 211(h)(1)–2 are 

discussed in more detail in section II.A, 

above. The burdens of this requirement 

on small advisers are discussed below 

as well as above in sections V and VI, 

which discuss the burdens on all 

advisers. The professional skills 

required to meet these specific burdens 

also are also discussed in section VI. 


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Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 / Proposed Rules 16969 

432See proposed rule 211(h)(2)–1(a). 

433See proposed rule 211(h)(2)–3. 

434See proposed rule 211(h)(2)–3(b). 

3. Proposed Rule 206(4)–10 

We are proposing new rule 206(4)-10 

under the Advisers Act, which would 

generally require all investment advisers 

that are registered or required to be 

registered with the Commission to have 

their private fund clients undergo a 

financial statement audit at least 

annually and upon liquidation 

containing certain prescribed elements, 

which are described above in section 

II.B. The proposed rule is designed to 

provide protection for the fund and its 

investors against the misappropriation 

of fund assets and to provide an 

important check on the adviser’s 

valuation of private fund assets, which 

often serve as the basis for the 

calculation of the adviser’s fees. The 

reasons for, and objectives of, the 

proposed audit rule are discussed in 

more detail in section II.B, above. The 

burdens of these requirements on small 

advisers are discussed below as well as 

above in sections V and VI, which 

discuss the burdens on all advisers. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

4. Proposed Rule 211(h)(2)–1 

Proposed rule 211(h)(2)-1 would 

prohibit all private fund advisers from, 

directly or indirectly, engaging in 

certain sales practices, conflicts of 

interest, and compensation schemes that 

are contrary to the public interest and 

the protection of investors. Specifically, 

the rule would prohibit an adviser from: 

(1) Charging certain fees and expenses 

to a private fund or portfolio investment 

(including accelerated monitoring fees, 

fees or expenses associated with an 

examination or investigation of the 

adviser or its related persons by 

governmental or regulatory authorities, 

regulatory or compliance expenses or 

fees of the adviser or its related persons, 

or fees and expenses related to a 

portfolio investment (or potential 

portfolio investment) on a non-pro rata 

basis when multiple private funds and 

other clients advised by the adviser or 

its related persons have invested (or 

propose to invest) in the same portfolio 

investment); (2) reducing the amount of 

any adviser clawback by the amount of 

certain taxes; (3) seeking 

reimbursement, indemnification, 

exculpation, or limitation of its liability 

by the private fund or its investors for 

a breach of fiduciary duty, willful 

misfeasance, bad faith, negligence, or 

recklessness in providing services to the 

private fund; and (4) borrowing money, 

securities, or other fund assets, or 

receiving a loan or an extension of 

credit, from a private fund client.432

Each of these prohibitions is described 

in more detail above in section II.D. As 

discussed above, we believe that these 

sales practices, conflicts of interest, and 

compensation schemes must be 

prohibited. The proposed rule would 

prohibit these activities regardless of 

whether the private fund documents 

permit such activities or the adviser 

otherwise discloses the practices and 

regardless of whether the private fund 

investors have consented to the 

activities. Also, the proposed rule 

would prohibit these activities even if 

they are performed indirectly, for 

example by an adviser’s related persons, 

because the activities have an equal 

potential to harm investors regardless of 

whether the adviser engages in the 

activity directly or indirectly. The 

reasons for, and objectives of, the 

proposed rule are discussed in more 

detail in section II.D, above. The 

burdens of these requirements on small 

advisers are discussed below as well as 

above in sections V and VI, which 

discuss the burdens on all advisers. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

5. Proposed Rule 211(h)(2)–2 

We are proposing new rule 211(h)(2)– 

2 under the Advisers Act, which 

generally would make it unlawful for an 

adviser that is registered or required to 

be registered with the Commission to 

complete an adviser-led secondary 

transaction with respect to any private 

fund, where an adviser (or its related 

persons) offers fund investors the option 

to sell their interests in the private fund, 

or to convert or exchange them for new 

interests in another vehicle advised by 

the adviser or its related persons, unless 

the adviser, prior to the closing of the 

transaction, distributes to investors in 

the private fund a fairness opinion from 

an independent opinion provider and a 

summary of any material business 

relationships the adviser or any of its 

related persons has, or has had within 

the past two years, with the 

independent opinion provider. The 

specific requirements of the proposed 

rule are described above in section II.C. 

The proposed rule is designed to 

provide an important check against an 

adviser’s conflicts of interest in 

structuring and leading a transaction 

from which it may stand to profit at the 

expense of private fund investors. The 

reasons for, and objectives of, the 

proposed rule are discussed in more 

detail in section II.C above. The burdens 

of these requirements on small advisers 

are discussed below as well as above in 

sections V and VI, which discuss the 

burdens on all advisers. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

6. Proposed Rule 211(h)(2)–3 

Proposed rule 211(h)(2)–3 would 

prohibit a private fund adviser, directly 

or indirectly, from (1) granting an 

investor in a private fund or in a 

substantially similar pool of assets the 

ability to redeem its interest on terms 

that the adviser reasonably expects to 

have a material, negative effect on other 

investors in that private fund or in a 

substantially similar pool of assets; or 

(2) providing information regarding the 

portfolio holdings or exposures of the 

private fund, or of a substantially 

similar pool of assets, to any investor if 

the adviser reasonably expects that 

providing the information would have a 

material, negative effect on other 

investors in that private fund or in a 

substantially similar pool of assets.433

The proposed rule would also prohibit 

these advisers from providing any other 

preferential treatment to any investor in 

a private fund unless the adviser 

provides written disclosures to 

prospective and current investors in the 

private fund regarding all preferential 

treatment the adviser or its related 

persons provided to other investors in 

the same fund.434 These requirements 

are described above in section II.E. The 

proposed rule is designed to eliminate 

sales practices that present a conflict of 

interest between the adviser and the 

private fund client that are contrary to 

the public interest and protection of 

investors. The disclosure elements of 

the proposed rule are designed to also 

help investors shape the terms of their 

relationship with the adviser of the 

private fund. The reasons for, and 

objectives of, the proposed rule are 

discussed in more detail in section II.E, 

above. The burdens of these 

requirements on small advisers are 

discussed below as well as above in 

sections V and VI, which discuss the 

burdens on all advisers. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

7. Proposed Amendments to Rule 204– 

2 

We are also proposing related 

amendments to rule 204–2, the books 

and records rule, which sets forth 

various recordkeeping requirements for 

registered investment advisers. We are 


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435 17 CFR 275.0–7(a) (Advisers Act rule 0–7(a)). 

436Based on SEC-registered investment adviser 

responses to Items 5.F. and 12 of Form ADV. 

437See section 203(l) of the Advisers Act and 17 

CFR 275.203(m)–1 (rule 203(m)–1 thereunder). 438 In order for an adviser to be an SEC ERA it 

would first need to have an SEC registration 

obligation, and an adviser with that little in assets 

under management (i.e., assets under management 

that is low enough to allow the adviser to qualify 

as a small entity) would not have an SEC 

registration obligation. 

439See section 202(a)(30) of the Advisers Act 

(defining ‘‘foreign private adviser’’). 

proposing to amend the current rule to 

require investment advisers to private 

funds to make and keep records relating 

to the quarterly statements required 

under proposed rule 211(h)(1)–2, the 

financial statement audits performed 

under proposed rule 206(4)–10, fairness 

opinions required under proposed rule 

211(h)(2)–2, and disclosure of certain 

types of preferential treatment required 

under proposed rule 211(h)(2)–3. The 

reasons for, and objectives of, the 

proposed amendments to the books and 

records rule are discussed in more detail 

in sections II.A, II.B, II.C, II.E, V, above. 

The burdens of these requirements on 

small advisers are discussed below as 

well as above in sections V and VI, 

which discuss the burdens on all 

advisers. The professional skills 

required to meet these specific burdens 

also are discussed in section VI. 

8. Proposed Amendments to Rule 

206(4)–(7) 

We are proposing amendments to rule 

206(4)–7 to require all SEC-registered 

advisers to document the annual review 

of their compliance policies and 

procedures in writing, as described 

above in section III. The proposed 

amendments are designed to focus 

renewed attention on the importance of 

the annual compliance review process 

and would better enable our staff to 

determine whether an adviser has 

complied with the review requirement 

of the compliance rule. The reasons for, 

and objectives of, the proposed rule are 

discussed in more detail in section III, 

above. The burdens of these 

requirements on small advisers are 

discussed below as well as above in 

sections V and VI, which discuss the 

burdens on all advisers. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

B. Legal Basis 

The Commission is proposing new 

rules 211(h)(1)–2, 211(h)(2)–1, 

211(h)(2)–2, 211(h)(2)–3, and 206(4)–10 

under the Advisers Act under the 

authority set forth in sections 203(d), 

206(4), 211(a), and 211(h) of the 

Investment Advisers Act of 1940 (15 

U.S.C. 80b–3(d), 80b–6(4) and 80b–11(a) 

and (h)). The Commission is proposing 

amendments to rule 204–2 under the 

Advisers Act under the authority set 

forth in sections 204 and 211 of the 

Investment Advisers Act of 1940 (15 

U.S.C. 80b–4 and 80b–11). The 

Commission is proposing amendments 

to rule 206(4)–7 under the Advisers Act 

under the authority set forth in sections 

203(d), 206(4), and 211(a) of the 

Investment Advisers Act of 1940 (15 

U.S.C. 80b–3(d), 80b–6(4), and 80b– 

11(a)). 

C. Small Entities Subject to Rules 

In developing these proposals, we 

have considered their potential impact 

on small entities that would be subject 

to the proposed rules and amendments. 

Some of the proposed rules and 

amendments would affect many, but not 

all, investment advisers registered with 

the Commission, including some small 

entities, the proposed amendments to 

rule 206(4)–7 would affect all 

investment advisers that are registered, 

or required to be registered, with the 

Commission, including some small 

entities, and proposed rules 211(h)(2)–1 

and 211(h)(2)–3 would apply to all 

advisers to private funds (even if not 

registered), including some small 

entities. Proposed rule 211(h)(1)–1 

would affect all advisers, including all 

that are small entities, regardless of 

whether they are registered or advise 

private funds. Under Commission rules, 

for the purposes of the Advisers Act and 

the RFA, an investment adviser 

generally is a small entity if it: (1) Has 

assets under management having a total 

value of less than $25 million; (2) did 

not have total assets of $5 million or 

more on the last day of the most recent 

fiscal year; and (3) does not control, is 

not controlled by, and is not under 

common control with another 

investment adviser that has assets under 

management of $25 million or more, or 

any person (other than a natural person) 

that had total assets of $5 million or 

more on the last day of its most recent 

fiscal year.435

Other than the proposed definitions 

rule, prohibitions rule and preferential 

treatment rule, our proposed rules and 

amendments would not affect most 

investment advisers that are small 

entities (‘‘small advisers’’) because those 

rules apply only to registered advisers, 

and small registered advisers are 

generally registered with one or more 

state securities authorities and not with 

the Commission. Under section 203A of 

the Advisers Act, most small advisers 

are prohibited from registering with the 

Commission and are regulated by state 

regulators. Based on IARD data, we 

estimate that as of November 30, 2021, 

approximately 594 SEC-registered 

advisers are small entities under the 

RFA.436 All of these advisers would be 

affected by the proposed amendments to 

the compliance rule, and we estimate 

that approximately 29 advise one or 

more private funds and would, 

therefore, be affected by the proposed 

quarterly statement rule, audit rule, and 

secondaries rule. 

The proposed prohibited activities 

rule and the proposed preferential 

treatment rule, however, would have an 

impact on all investment advisers to 

private funds, regardless of whether 

they are registered with the 

Commission, one or more state 

securities authorities, or are 

unregistered. It is difficult for us to 

estimate the number of advisers not 

registered with us that have private fund 

clients. However, we are able to provide 

the following estimates based on IARD 

data. As of November 30, 2021, there are 

5,022 ERAs, all of whom advise private 

funds, by definition.437 All ERAs would, 

therefore, be subject to the rules that 

would apply to all private fund 

advisers. We estimate that there are no 

ERAs that would meet the definition of 

‘‘small entity.’’ 438 We do not have a 

method for estimating the number of 

state-registered advisers to private funds 

that would meet the definition of ‘‘small 

entity.’’ 

Additionally, the proposed prohibited 

activities rule and the proposed 

preferential treatment rule would apply 

to other advisers that are not registered 

with the SEC or with the states and that 

do not make filings with either the SEC 

or states. This includes foreign private 

advisers,439 advisers that are entirely 

unregistered, and advisers that rely on 

the intrastate exemption from SEC 

registration and/or the de minimis 

exemption from SEC registration. We 

are unable to estimate the number of 

advisers in each of these categories 

because these advisers do not file 

reports or other information with the 

SEC and we are unable to find reliable, 

public information. As a result, our 

estimates are based on information from 

SEC-registered advisers to private funds, 

exempt reporting advisers (at the state 

and Federal levels), and state-registered 

advisers to private funds. 

The proposed definitions rule would 

affect all advisers, but not unless the 

adviser is also affected by one of the 

rules discussed above. It has no 

independent substantive requirements 

or economic impacts. Therefore, the 

number of small advisers affected by 

this rule is accounted for in those 


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440This includes the internal time cost and the 

annual external cost burden and assumes that, for 

purposes of the annual external cost burden, 50% 

of small advisers will use outside legal services, as 

set forth in the PRA estimates table. 

441This includes the internal time cost and the 

annual external cost burden, as set forth in the PRA 

estimates table. 442See supra section VI.C. 

discussions and not separately and 

additionally delineated. 

D. Projected Reporting, Recordkeeping, 

and Other Compliance Requirements 

1. Proposed Rule 211(h)(1)–1 

Proposed rule 211(h)(1)–1 would not 

impose any reporting, recordkeeping, or 

other compliance requirements on 

investment advisers because it has no 

independent substantive requirements 

or economic impacts. The rule would 

not affect an adviser unless it was 

complying with proposed rule 

211(h)(1)–2, 206(4)–10, 211(h)(2)–1, 

211(h)(2)–2, or 211(h)(2)–3, each of 

which is discussed below. 

2. Proposed Rule 211(h)(1)–2 

Proposed rule 211(h)(1)–2 would 

impose certain compliance 

requirements on investment advisers, 

including those that are small entities. 

It would require any investment adviser 

registered or required to be registered 

with the Commission that provides 

investment advice to a private fund that 

has at least two full calendar quarters of 

operating results to prepare and 

distribute quarterly statements with 

certain fee and expense and 

performance disclosure to private fund 

investors. The proposed requirements, 

including compliance and related 

recordkeeping requirements that would 

be required under the proposed 

amendments to rule 204–2 and rule 

206(4)–7, are summarized in this IRFA 

(section VII above). All of these 

proposed requirements are also 

discussed in detail, above, in section II, 

and these requirements and the burdens 

on respondents, including those that are 

small entities, are discussed above in 

sections V and VI (the Economic 

Analysis and Paperwork Reduction Act 

Analysis, respectively) and below. The 

professional skills required to meet 

these specific burdens are also 

discussed in section VI. 

As discussed above, there are 

approximately 29 small advisers to 

private funds currently registered with 

us, and we estimate that 100 percent of 

these advisers would be subject to the 

proposed rule 211(h)(1)–2. As discussed 

in our Paperwork Reduction Act 

Analysis in section V above, the 

proposed rule 211(h)(1)–2 under the 

Advisers Act, which would require 

advisers to prepare and distribute 

quarterly statements, would create a 

new annual burden of approximately 

130.5 hours per adviser, or 3,784.5 

hours in aggregate for small advisers. 

We therefore expect the annual 

monetized aggregate cost to small 

advisers associated with our proposed 

amendments would be $1,802,466.440

3. Proposed Rule 206(4)–10 

Proposed rule 206(4)–10 would 

impose certain compliance 

requirements on investment advisers, 

including those that are small entities. 

All registered investment advisers that 

provide investment advice, including 

small entity advisers, would be required 

to comply with the proposed rule’s 

requirements to have their private fund 

clients undergo a financial statement 

audit (at least annually and upon 

liquidation) and distribute audited 

financial statements to private fund 

investors. The proposed requirements, 

including compliance and related 

recordkeeping requirements that would 

be imposed under proposed 

amendments to rule 204–2 and rule 

206(4)–7, are summarized in this IRFA 

(section VII.A. above). All of these 

proposed requirements are also 

discussed in detail, above, in section II, 

and these requirements and the burdens 

on respondents, including those that are 

small entities, are discussed above in 

sections V and VI (the Economic 

Analysis and Paperwork Reduction Act 

Analysis, respectively) and below. The 

professional skills required to meet 

these specific burdens are also 

discussed in section VI. 

As discussed above, there are 

approximately 29 small advisers to 

private funds currently registered with 

us, and we estimate that 100 percent of 

these advisers would be subject to the 

proposed rule 206(4)–10. As discussed 

above in our Paperwork Reduction Act 

Analysis in section V above, proposed 

rule 206(4)–10 under the Advisers Act 

would create a new annual burden of 

approximately 18.36 hours per adviser, 

or 532.44 hours in aggregate for small 

advisers. We therefore expect the annual 

monetized aggregate cost to small 

advisers associated with our proposed 

amendments would be 

$15,819,118.65.441

4. Proposed Rule 211(h)(2)–1 

Proposed rule 211(h)(2)–1 would 

impose certain compliance 

requirements on investment advisers, 

including those that are small entities. 

Proposed rule 211(h)(2)–1 would 

prohibit all private fund advisers from 

engaging in certain sales practices, 

conflicts of interest, and compensation 

schemes that are contrary to the public 

interest and the protection of investors. 

Specifically, the rule would prohibit an 

adviser from: (1) Charging certain fees 

and expenses to a private fund or 

portfolio investment (including 

accelerated monitoring fees, fees or 

expenses associated with an 

examination or investigation of the 

adviser or its related persons by 

governmental or regulatory authorities, 

regulatory or compliance expenses or 

fees of the adviser or its related persons, 

or fees and expenses related to a 

portfolio investment (or potential 

portfolio investment) on a non-pro rata 

basis when multiple private funds and 

other clients advised by the adviser or 

its related persons have invested (or 

propose to invest) in the same portfolio 

investment); (2) reducing the amount of 

any adviser clawback by the amount of 

certain taxes; (3) seeking 

reimbursement, indemnification, 

exculpation, or limitation of its liability 

by the private fund or its investors for 

a breach of fiduciary duty, willful 

misfeasance, bad faith, negligence, or 

recklessness in providing services to the 

private fund; and (4) borrowing money, 

securities, or other fund assets, or 

receiving a loan or an extension of 

credit from a private fund client. All of 

these proposed requirements are also 

discussed in detail, above, in section II, 

and these requirements and the burdens 

on respondents, including those that are 

small entities, are discussed above in 

section V (the Economic Analysis) and 

below. 

As discussed above, there are 

approximately 29 small advisers to 

private funds currently registered with 

us, and we estimate that 100 percent of 

these advisers would be subject to the 

proposed rule 211(h)(2)–1. As discussed 

above, we estimate that there are no 

ERAs that would meet the definition of 

‘‘small entity’’ and we do not have a 

method for estimating the number of 

state-registered advisers to private funds 

that would meet the definition of ‘‘small 

entity.’’ 442

5. Proposed Rule 211(h)(2)–2 

Proposed rule 211(h)(2)–2 would 

impose certain compliance 

requirements on investment advisers, 

including those that are small entities. 

The rule generally would make it 

unlawful for an adviser that is registered 

or required to be registered with the 

Commission to complete an adviser-led 

secondary transaction with respect to 

any private fund, where an adviser (or 

its related persons) offers fund investors 


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443Similar to the PRA analysis, we assume that 

10% (∼3) of all small advisers will conduct an 

adviser-led secondary transaction on an annual 

basis. 

444This includes the internal time cost and the 

annual external cost burden, as set forth in the PRA 

estimates table. 

445See supra section VI.C. 

446The following types of private fund advisers, 

among others, would be subject to the proposed 

rule: Unregistered advisers (i.e., advisers that are 

not SEC registered but have a registration 

obligation), foreign private advisers, and advisers 

that rely on the intrastate exemption from SEC 

registration and/or the de minimis exemption from 

SEC registration. However, we are unable to 

estimate the number of advisers in each of these 

categories because these advisers do not file reports 

or other information with the SEC and we are 

unable to find reliable, public information. As a 

result, the above estimate is based on information 

from SEC-registered advisers to private funds, 

exempt reporting advisers (at the state and Federal 

levels), and state-registered advisers to private 

funds. These figures are approximate. 

447This includes the internal time cost and the 

annual external cost burden and assumes that, for 

purposes of the annual external cost burden, 75% 

of small advisers will use outside legal services, as 

set forth in the PRA estimates table. 

the option to sell their interests in the 

private fund, or to convert or exchange 

them for new interests in another 

vehicle advised by the adviser or its 

related persons, unless the adviser, prior 

to the closing of the transaction, 

distributes to investors in the private 

fund a fairness opinion from an 

independent opinion provider and a 

summary of any material business 

relationships the adviser or any of its 

related persons has, or has had within 

the past two years, with the 

independent opinion provider . The 

proposed requirements, including 

compliance and related recordkeeping 

requirements that would be imposed 

under proposed amendments to rule 

204–2 and 206(4)–7, are summarized in 

this IRFA (section VII above). All of 

these proposed requirements are also 

discussed in detail, above, in section II, 

and these requirements and the burdens 

on respondents, including those that are 

small entities, are discussed above in 

sections V and VI (the Economic 

Analysis and Paperwork Reduction Act 

Analysis, respectively) and below. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

As discussed above, there are 

approximately 29 small advisers to 

private funds currently registered with 

us, and we estimate that 100 percent of 

these advisers would be subject to 

proposed rule 211(h)(2)–2. As discussed 

above in our Paperwork Reduction Act 

Analysis in section V above, proposed 

rule 211(h)(2)–2 under the Advisers Act 

would create a new annual burden of 

approximately 7 hours per adviser, or 21 

hours in aggregate for small advisers.443

We therefore expect the annual 

monetized aggregate cost to small 

advisers associated with our proposed 

amendments would be $129,805.92.444

6. Proposed Rule 211(h)(2)–3 

Proposed rule 211(h)(2)–3 would 

impose certain compliance 

requirements on investment advisers, 

including those that are small entities. 

Proposed rule 211(h)(2)–3 would 

prohibit a private fund adviser, 

including indirectly through its related 

persons, from (1) granting an investor in 

the private fund or in a substantially 

similar pool of assets the ability to 

redeem its interest on terms that the 

adviser reasonably expects to have a 

material, negative effect on other 

investors in that private fund or in a 

substantially similar pool of assets; and 

(2) providing information regarding the 

private fund’s portfolio holdings or 

exposures of the private fund or of a 

substantially similar pool of assets to 

any investor if the adviser reasonably 

expects that providing the information 

would have a material, negative effect 

on other investors in that private fund 

or in a substantially similar pool of 

assets. The rule would also prohibit 

these advisers from providing any other 

preferential treatment to any investor in 

the private fund unless the adviser 

provides written disclosures to 

prospective and current investors in the 

private fund regarding all preferential 

treatment the adviser or its related 

persons provided to other investors in 

the same fund. The proposed 

requirements, including compliance and 

related recordkeeping requirements that 

would be imposed under proposed 

amendments to rule 204–2 and 206(4)– 

7, are summarized in this IRFA (section 

VII above). All of these proposed 

requirements are also discussed in 

detail, above, in section II, and these 

requirements and the burdens on 

respondents, including those that are 

small entities, are discussed above in 

sections V and VI (the Economic 

Analysis and Paperwork Reduction Act 

Analysis, respectively) and below. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

As discussed above, there are 

approximately 29 small advisers to 

private funds currently registered with 

us, and we estimate that 100 percent of 

these advisers would be subject to the 

proposed rule 211(h)(2)–3. As discussed 

above, we estimate that there are no 

ERAs that would meet the definition of 

‘‘small entity’’ and we do not have a 

method for estimating the number of 

state-registered advisers to private funds 

that would meet the definition of ‘‘small 

entity.’’ 445 As discussed above in our 

Paperwork Reduction Act Analysis in 

section VI above, proposed rule 

211(h)(2)–3 under the Advisers Act 

would create a new annual burden of 

approximately 31.01 hours per adviser, 

or 899.29 hours in aggregate for small 

advisers.446 We therefore expect the 

annual monetized aggregate cost to 

small advisers associated with our 

proposed amendments would be 

$374,569.51.447

7. Proposed Amendments to Rule 204– 

2 

The proposed amendments to rule 

204–2 would impose certain 

recordkeeping requirements on 

investment advisers to private funds, 

including those that are small entities. 

All registered investment advisers to 

private funds, including small entity 

advisers, would be required to comply 

with recordkeeping amendments. While 

all SEC-registered investment advisers, 

and advisers that are required to be 

registered, are subject to rule 204–2 

under the Advisers Act, our proposed 

amendments to rule 204–2 would only 

impact private fund advisers that are 

SEC registered. The proposed 

amendments are summarized in this 

IRFA (section VII above). The proposed 

amendments are also discussed in 

detail, above, in section II, and the 

requirements and the burdens on 

respondents, including those that are 

small entities, are discussed above in 

sections V and VI (the Economic 

Analysis and Paperwork Reduction Act 

Analysis, respectively) and below. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

As discussed above, there are 

approximately 29 small advisers to 

private funds currently registered with 

us, and we estimate that 100 percent of 

advisers registered with us would be 

subject to the proposed amendments to 

rule 204–2. As discussed above in our 

Paperwork Reduction Act Analysis in 

section VI above, the proposed 

amendments to rule 204–2 under the 

Advisers Act, which would require 

advisers to retain certain copies of 

documents required under proposed 

rules 206(4)–10, 211(h)(1)–2, 211(h)(2)– 

2, and 211(h)(2)–3 would create a new 

annual burden of approximately 9 hours 

per adviser, or 261 hours in aggregate 

for small advisers. We therefore expect 

the annual monetized aggregate cost to 

small advisers associated with our 


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448This includes the internal time cost and the 

annual external cost burden, as set forth in the PRA 

estimates table. 

449This includes the internal time cost and the 

annual external cost burden and assumes that, for 

purposes of the annual external cost burden, 50% 

of small advisers will use outside legal services, as 

set forth in the PRA estimates table. 

proposed amendments would be 

$17,748.448

8. Proposed Amendments to Rule 

206(4)–7 

Proposed amendments to rule 206(4)– 

7 would impose certain compliance 

requirements on investment advisers, 

including those that are small entities. 

All registered investment advisers, and 

advisers that are required to be 

registered, would be required to 

document the annual review of their 

compliance policies and procedures in 

writing. The proposed requirements are 

summarized in this IRFA (section VII 

above). All of these proposed 

requirements are also discussed in 

detail, above, in section III, and these 

requirements and the burdens on 

respondents, including those that are 

small entities, are discussed above in 

sections V and VI (the Economic 

Analysis and Paperwork Reduction Act 

Analysis, respectively) and below. The 

professional skills required to meet 

these specific burdens also are 

discussed in section VI. 

As discussed above, there are 

approximately 29 small advisers 

currently registered with us, and we 

estimate that 100 percent of these 

advisers would be subject to the 

proposed amendments to rule 206(4)–7. 

As discussed above in our Paperwork 

Reduction Act Analysis in section VI 

above, these amendments would create 

a new annual burden of approximately 

3 hour per adviser, or 87 hours in 

aggregate for small advisers. We 

therefore expect the annual monetized 

aggregate cost to small advisers 

associated with our proposed 

amendments would be $44,921.449

E. Duplicative, Overlapping, or 

Conflicting Federal Rules 

There are no duplicative, overlapping, 

or conflicting Federal rules with respect 

to the specific requirements of proposed 

rule 211(h)(1)–1, 211(h)(1)–2, 211(h)(2)– 

1, 211(h)(2)–2, 211(h)(2)–3, or the 

proposed amendments to rule 204–2 or 

rule 206(4)–7. We recognize that private 

fund advisers are prohibited from 

making misstatements or materially 

misleading statements to investors 

under rule 206(4)–8. To the extent there 

is any overlap between the proposed 

rules and rule 206(4)–8, we believe that 

any additional costs to advisers to 

private funds would be minimal, as they 

can assume that conduct that would 

raise issues under any of the specific 

provisions of the proposed rules would 

also be prohibited under rule 206(4)–8. 

To the extent there is any overlap 

between the requirements of proposed 

rule 211(h)(1)–2 and Form ADV Part 2, 

it is minimal, and it is complementary, 

not contradictory. For example, Form 

ADV Part 2 requires advisers to disclose 

what fees the adviser charges, such as a 

2% management fee based on its clients’ 

assets that it manages. The proposed 

rule would require advisers to disclose 

what amount was actually charged to a 

private fund client (e.g., $200,000). 

There is significant duplication and 

overlap of the requirements of proposed 

rule 206(4)–10 and rule 206(4)–2 

because proposed rule 206(4)–10 is 

drawn from the option to comply with 

rule 206(4)–2’s account statement and 

surprise examination requirements by 

having pooled investment vehicle 

clients undergo a financial statement 

audit and distribute the financial 

statements to the investors in the pools. 

Similarities between these rules should 

result in minimal new compliance 

burdens for private fund advisers that 

have chosen to comply with the audit 

provision of rule 206(4)–2, however. For 

private fund advisers that have not 

chosen to comply with the audit 

provision of rule 206(4)–2, proposed 

rule 206(4)–10 will result in new 

compliance burdens, but not ones that 

contradict rule 206(4)–2. These advisers 

can choose to mitigate, as much as 

possible, their compliance burdens by 

electing to comply with rule 206(4)–2’s 

audit provision in lieu of the account 

statement and surprise examination 

requirements, though this option may be 

limited for some advisers if they also 

have clients for which the adviser is 

unable to choose to rely on the audit 

provision of the custody rule. We 

believe these additional compliance 

burdens are justified because an audit 

by an independent public accountant 

would provide an important check on 

the adviser’s valuation of private fund 

assets, which often serve as the basis for 

calculating the adviser’s fees. 

F. Significant Alternatives 

The RFA directs the Commission to 

consider significant alternatives that 

would accomplish the stated objective, 

while minimizing any significant 

adverse impact on small entities. In 

connection with the proposed rules and 

rule amendments, the Commission 

considered the following alternatives: (i) 

The establishment of differing 

compliance or reporting requirements or 

timetables that take into account the 

resources available to small entities; (ii) 

the clarification, consolidation, or 

simplification of compliance and 

reporting requirements under the 

proposed rules and rule amendments for 

such small entities; (iii) the use of 

performance rather than design 

standards; and (iv) an exemption from 

coverage of the proposed rules and rule 

amendments, or any part thereof, for 

such small entities. 

Regarding the first and fourth 

alternatives, we do not believe that 

differing compliance or reporting 

requirements or an exemption from 

coverage of the proposed rules and rule 

amendments, or any part thereof, for 

small entities, would be appropriate or 

consistent with investor protection. 

Because the protections of the Advisers 

Act are intended to apply equally to 

clients of both large and small advisory 

firms, it would be inconsistent with the 

purposes of the Act to specify different 

requirements for small entities under 

the proposed rules and rule 

amendments. 

Regarding the second alternative, the 

proposed prohibited activities rule and 

the proposed preferential treatment rule 

are particularly intended to provide 

clarification to all private fund advisers, 

not just small advisers, as to what the 

Commission considers to be conduct 

that would be prohibited under section 

206 of the Act and contrary to the public 

interest and protection of investors 

under section 211 of the Act. Despite 

our examination and enforcement 

efforts, this type of inappropriate 

conduct persists; these proposed rules 

will provide clarity of our views of this 

conduct to all private fund advisers. 

Similarly, we also have endeavored to 

consolidate and simplify the 

compliance with both proposed rules, as 

well as disclosure requirements under 

the proposed preferential treatment rule, 

for all private fund advisers. 

Regarding the third alternative, we do 

not consider using performance rather 

than design standards to be consistent 

with our statutory mandate of investor 

protection with respect to preventing 

fraudulent, deceptive, or manipulative 

acts, or inappropriate sales practices, 

conflicts of interest or compensation 

schemes, by investment advisers. 

G. Solicitation of Comments 

We encourage written comments on 

matters discussed in this IRFA. In 

particular, the Commission seeks 

comment on: 

• The number of small entities that 

would be affected by the proposed rule; 

and 


khammond on DSKJM1Z7X2PROD with PROPOSALS3
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450Public Law 104–121, Title II, 110 Stat. 857 

(1996) (codified in various sections of 5 U.S.C., 15 

U.S.C. and as a note to 5 U.S.C. 601). 

• whether the effect of the proposed 

rule on small entities would be 

economically significant. 

Commenters are asked to describe the 

nature of any effect and provide 

empirical data supporting the extent of 

the effect. 

VIII. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 450 we must advise 

OMB whether a proposed regulation 

constitutes a ‘‘major’’ rule. Under 

SBREFA, a rule is considered ‘‘major’’ 

where, if adopted, it results in or is 

likely to result in (1) an annual effect on 

the economy of $100 million or more; 

(2) a major increase in costs or prices for 

consumers or individual industries; or 

(3) significant adverse effects on 

competition, investment or innovation. 

We request comment on the potential 

impact of the proposed rules and 

amendments on the economy on an 

annual basis. Commenters are requested 

to provide empirical data and other 

factual support for their views to the 

extent possible. 

IX. Statutory Authority 

The Commission is proposing new 

rules 211(h)(1)–1, 211(h)(1)–2, 

211(h)(2)–1, 211(h)(2)–2, 211(h)(2)–3, 

and 206(4)–10 under the Advisers Act 

under the authority set forth in sections 

203(d), 206(4), 211(a), and 211(h) of the 

Investment Advisers Act of 1940 [15 

U.S.C. 80b–3(d), 80b–6(4) and 80b–11(a) 

and (h)]. The Commission is proposing 

amendments to rule 204–2 under the 

Advisers Act under the authority set 

forth in sections 204 and 211 of the 

Investment Advisers Act of 1940 [15 

U.S.C. 80b–4 and 80b–11]. The 

Commission is proposing amendments 

to rule 206(4)–7 under the Advisers Act 

under the authority set forth in sections 

203(d), 206(4), and 211(a) of the 

Investment Advisers Act of 1940 [15 

U.S.C. 80b–3(d), 80b–6(4), and 80b– 

11(a)]. 

List of Subjects in 17 CFR Part 275 

Administrative practice and 

procedure, Reporting and recordkeeping 

requirements, Securities. 

Text of Proposed Rules 

For the reasons set forth in the 

preamble, the Commission is proposing 

to amend title 17, chapter II of the Code 

of Federal Regulations as follows: 

PART 275—RULES AND 

REGULATIONS, INVESTMENT 

ADVISERS ACT OF 1940 

■ 1. The authority citation for part 275 

continues to read in part as follows: 

Authority: 15 U.S.C. 80b–2(a)(11)(G), 80b– 

2(a)(11)(H), 80b–2(a)(17), 80b–3, 80b–4, 80b– 

4a, 80b–6(4), 80b–6a, and 80b–11, unless 

otherwise noted. 

* * * * * 

Section 275.204–2 is also issued under 15 

U.S.C. 80b–6. 

* * * * * 

■ 2. Amend § 275.204–2 by: 

■ a. Removing the period at the end of 

paragraph (a)(7)(iv)(B) and adding ‘‘; 

and’’ in its place; and 

■ b. Adding paragraphs (a)(7)(v) and 

(a)(20) through (23). 

The additions read as follows: 

§ 275.204–2 Books and records to be 

maintained by investment advisers. 

(a) * * * 

(7) * * * 

(v) Any notice required pursuant to 

§ 275.211(h)(2)–3 as well as a record of 

each addressee and the corresponding 

date(s) sent, address(es), and delivery 

method(s) for each such addressee. 

* * * * * 

(20)(i) A copy of any quarterly 

statement distributed pursuant to 

§ 275.211(h)(1)–2, along with a record of 

each addressee and the corresponding 

date(s) sent, address(es), and delivery 

method(s) for each such addressee; and 

(ii) All records evidencing the 

calculation method for all expenses, 

payments, allocations, rebates, offsets, 

waivers, and performance listed on any 

statement delivered pursuant to § 275. 

211(h)(1)–2. 

(21) For each private fund client: 

(i) A copy of any audited financial 

statements prepared and distributed 

pursuant to § 275.206(4)–10, along with 

a record of each addressee and the 

corresponding date(s) sent, address(es), 

and delivery method(s) for each such 

addressee; or 

(ii) A record documenting steps taken 

by the adviser to cause a private fund 

client that the adviser does not control, 

is not controlled by, and with which it 

is not under common control to undergo 

a financial statement audit pursuant to 

§ 275.206(4)–10. 

(22) Documentation substantiating the 

adviser’s determination that a private 

fund client is a liquid fund or an illiquid 

fund pursuant to § 275. 211(h)(1)–2. 

(23) A copy of any fairness opinion 

and material business relationship 

summary distributed pursuant to 

§ 275.211(h)(2)–2, along with a record of 

each addressee and the corresponding 

date(s) sent, address(es), and delivery 

method(s) for each such addressee. 

* * * * * 

■ 3. Amend § 275.206(4)–7 by revising 

paragraph (b) to read as follows: 

§ 275.206(4)–7 Compliance procedures 

and practices. 

* * * * * 

(b) Annual review. Review and 

document in writing, no less frequently 

than annually, the adequacy of the 

policies and procedures established 

pursuant to this section and the 

effectiveness of their implementation; 

and 

* * * * * 

■ 4. Section 275.206(4)–10 is added to 

read as follows: 

§ 275.206(4)–10 Private fund adviser 

audits. 

As a means reasonably designed to 

prevent such acts, practices, and courses 

of business as are fraudulent, deceptive, 

or manipulative, an investment adviser 

that is registered or required to be 

registered under section 203 of the 

Investment Advisers Act of 1940 shall 

cause each private fund that it advises, 

directly or indirectly, to undergo a 

financial statement audit as follows at 

least annually and upon liquidation, if 

the private fund does not otherwise 

undergo such an audit: 

(a) The audit is performed by an 

independent public accountant that meets 

the standards of independence described in 

17 CFR 210.2–01(b) and (c) [Rule 2–01(b) and 

(c) of Regulation S–X] and that is registered 

with, and subject to regular inspection as of 

the commencement of the professional 

engagement period, and as of each calendar 

year-end, by, the Public Company 

Accounting Oversight Board in accordance 

with its rules; 

(b) The audit meets the definition in 17 

CFR 210.1–02(d) [Rule 1–02(d) of Regulation 

S–X], the professional engagement period of 

which shall begin and end as indicated in 

Rule 2–01(f)(5) of Regulation S–X; 

(c) Audited financial statements are 

prepared in accordance with U.S. Generally 

Accepted Accounting Principles (‘‘U.S. 

GAAP’’) or, in the case of financial 

statements of private funds organized under 

non-U.S. law or that have a general partner 

or other manager with a principal place of 

business outside the United States (‘‘foreign 

private funds’’), contain information 

substantially similar to statements prepared 

in accordance with U.S. GAAP and material 

differences with U.S. GAAP are reconciled; 

(d) Promptly after the completion of the 

audit, the private fund’s audited financial 

statements, which includes any 

reconciliation to U.S. GAAP prepared for a 

foreign private fund, including 

supplementary U.S. GAAP disclosures, as 

applicable, are distributed; 

(e) Pursuant to a written agreement 

between the independent public accountant 


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and the adviser or the private fund, the 

independent public accountant that 

completes the audit notifies the Commission 

by electronic means directed to the Division 

of Examinations: 

(1) Promptly upon issuing an audit report 

to the private fund that contains a modified 

opinion; and 

(2) Within four business days of 

resignation or dismissal from, or other 

termination of, the engagement, or upon 

removing itself or being removed from 

consideration for being reappointed; 

(f) For a private fund that the adviser does 

not control and is neither controlled by nor 

under common control with, the adviser is 

prohibited from providing investment advice, 

directly or indirectly, to the private fund if 

the adviser fails to take all reasonable steps 

to cause the private fund to undergo a 

financial statement audit that meets the 

requirements of paragraphs (a) through (e) of 

this section; and 

(g) For purposes of this section, defined 

terms shall have the meanings set forth in 

§ 275.211(h)(1)–1. 

■ 5. Section 275.211(h)(1)–1 is added to 

read as follows: 

§ 275.211(h)(1)–1 Definitions. 

For purposes of §§ 275.206(4)–10, 

275.211(h)(1)–2, 275.211(h)(2)–3, 

275.211(h)(2)–1, and 275.211(h)(2)–2: 

Adviser clawback means any 

obligation of the adviser, its related 

persons, or their respective owners or 

interest holders to restore or otherwise 

return performance-based 

compensation to the private fund 

pursuant to the private fund’s governing 

agreements. 

Adviser-led secondary transaction 

means any transaction initiated by the 

investment adviser or any of its related 

persons that offers private fund 

investors the choice to: 

(1) Sell all or a portion of their 

interests in the private fund; or 

(2) Convert or exchange all or a 

portion of their interests in the private 

fund for interests in another vehicle 

advised by the adviser or any of its 

related persons. 

Committed capital means any 

commitment pursuant to which a 

person is obligated to acquire an interest 

in, or make capital contributions to, the 

private fund. 

Control means the power, directly or 

indirectly, to direct the management or 

policies of a person, whether through 

ownership of securities, by contract, or 

otherwise. For the purposes of this 

definition, control includes: 

(1) Each of an investment adviser’s 

officers, partners, or directors exercising 

executive responsibility (or persons 

having similar status or functions) is 

presumed to control the investment 

adviser; 

(2) A person is presumed to control a 

corporation if the person: 

(i) Directly or indirectly has the right 

to vote 25% or more of a class of the 

corporation’s voting securities; or 

(ii) Has the power to sell or direct the 

sale of 25% or more of a class of the 

corporation’s voting securities; 

(3) A person is presumed to control a 

partnership if the person has the right 

to receive upon dissolution, or has 

contributed, 25% or more of the capital 

of the partnership; 

(4) A person is presumed to control a 

limited liability company if the person: 

(i) Directly or indirectly has the right 

to vote 25% or more of a class of the 

interests of the limited liability 

company; 

(ii) Has the right to receive upon 

dissolution, or has contributed, 25% or 

more of the capital of the limited 

liability company; or 

(iii) Is an elected manager of the 

limited liability company; or 

(5) A person is presumed to control a 

trust if the person is a trustee or 

managing agent of the trust. 

Covered portfolio investment means a 

portfolio investment that allocated or 

paid the investment adviser or its 

related persons portfolio investment 

compensation during the reporting 

period. 

Distribute, distributes, or distributed 

means send or sent to all of the private 

fund’s investors; provided that, if an 

investor is a pooled investment vehicle 

that is controlling, controlled by, or 

under common control with (a ‘‘control 

relationship’’) the adviser or its related 

persons, the adviser must look through 

that pool (and any pools in a control 

relationship with the adviser or its 

related persons) in order to send to 

investors in those pools. 

Fairness opinion means a written 

opinion stating that the price being 

offered to the private fund for any assets 

being sold as part of an adviser-led 

secondary transaction is fair. 

Fund-level subscription facilities 

means any subscription facilities, 

subscription line financing, capital call 

facilities, capital commitment facilities, 

bridge lines, or other indebtedness 

incurred by the private fund that is 

secured by the unfunded capital 

commitments of the private fund’s 

investors. 

Gross IRR means an internal rate of 

return that is calculated gross of all fees, 

expenses, and performance-based 

compensation borne by the private 

fund. 

Gross MOIC means a multiple of 

invested capital that is calculated gross 

of all fees, expenses, and performancebased compensation borne by the 

private fund. 

Illiquid fund means a private fund 

that: 

(1) Has a limited life; 

(2) Does not continuously raise 

capital; 

(3) Is not required to redeem interests 

upon an investor’s request; 

(4) Has as a predominant operating 

strategy the return of the proceeds from 

disposition of investments to investors; 

(5) Has limited opportunities, if any, 

for investors to withdraw before 

termination of the fund; and 

(6) Does not routinely acquire 

(directly or indirectly) as part of its 

investment strategy market-traded 

securities and derivative instruments. 

Independent opinion provider means 

an entity that: 

(1) Provides fairness opinions in the 

ordinary course of its business; and 

(2) Is not a related person of the 

adviser. 

Internal rate of return means the 

discount rate that causes the net present 

value of all cash flows throughout the 

life of the fund to be equal to zero. 

Liquid fund means a private fund that 

is not an illiquid fund. 

Multiple of invested capital means, as 

of the end of the applicable calendar 

quarter: 

(1) The sum of: 

(i) The unrealized value of the illiquid 

fund; and 

(ii) The value of all distributions 

made by the illiquid fund; 

(2) Divided by the total capital 

contributed to the illiquid fund by its 

investors. 

Net IRR means an internal rate of 

return that is calculated net of all fees, 

expenses, and performance-based 

compensation borne by the private 

fund. 

Net MOIC means a multiple of 

invested capital that is calculated net of 

all fees, expenses, and performancebased compensation borne by the 

private fund. 

Performance-based compensation 

means allocations, payments, or 

distributions of capital based on the 

private fund’s (or its portfolio 

investments’) capital gains and/or 

capital appreciation. 

Portfolio investment means any entity 

or issuer in which the private fund has 

directly or indirectly invested. 

Portfolio investment compensation 

means any compensation, fees, and 

other amounts allocated or paid to the 

investment adviser or any of its related 

persons by the portfolio investment 

attributable to the private fund’s interest 

in such portfolio investment, including, 

but not limited to, origination, 

management, consulting, monitoring, 

servicing, transaction, administrative, 


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advisory, closing, disposition, directors, 

trustees or similar fees or payments. 

Related person means: 

(1) All officers, partners, or directors 

(or any person performing similar 

functions) of the adviser; 

(2) All persons directly or indirectly 

controlling or controlled by the adviser; 

(3) All current employees (other than 

employees performing only clerical, 

administrative, support or similar 

functions) of the adviser; and 

(4) Any person under common control 

with the adviser. 

Reporting period means the private 

fund’s calendar quarter covered by the 

quarterly statement or, for the initial 

quarterly statement of a newly formed 

private fund, the period covering the 

private fund’s first two full calendar 

quarters of operating results. 

Statement of Contributions and 

Distributions means a document that 

presents: 

(1) All capital inflows the private 

fund has received from investors and all 

capital outflows the private fund has 

distributed to investors since the private 

fund’s inception, with the value and 

date of each inflow and outflow; and 

(2) The net asset value of the private 

fund as of the end of the reporting 

period. 

Substantially similar pool of assets 

means a pooled investment vehicle 

(other than an investment company 

registered under the Investment 

Company Act of 1940 or a company that 

elects to be regulated as such) with 

substantially similar investment 

policies, objectives, or strategies to those 

of the private fund managed by the 

investment adviser or its related 

persons. 

Unfunded capital commitments 

means committed capital that has not 

yet been contributed to the private fund 

by investors. 

■ 6. Section 275.211(h)(1)–2 is added to 

read as follows: 

§ 275. 211(h)(1)–2 Private fund quarterly 

statements. 

(a) Quarterly statements. As a means 

reasonably designed to prevent such 

acts, practices, and courses of business 

as are fraudulent, deceptive, or 

manipulative, an investment adviser 

that is registered or required to be 

registered under section 203 of the 

Investment Advisers Act of 1940 shall 

prepare a quarterly statement that 

complies with paragraphs (a) through (g) 

of this section for any private fund that 

it advises, directly or indirectly, that has 

at least two full calendar quarters of 

operating results, and distribute the 

quarterly statement to the private fund’s 

investors within 45 days after each 

calendar quarter end, unless such a 

quarterly statement is prepared and 

distributed by another person. 

(b) Fund table. The quarterly 

statement must include a table for the 

private fund that discloses, at a 

minimum, the following information, 

presented both before and after the 

application of any offsets, rebates, or 

waivers for the information required by 

paragraphs (b)(1) and (2) of this section: 

(1) A detailed accounting of all 

compensation, fees, and other amounts 

allocated or paid to the investment 

adviser or any of its related persons by 

the fund during the reporting period, 

with separate line items for each 

category of allocation or payment 

reflecting the total dollar amount, 

including, but not limited to, 

management, advisory, sub-advisory, or 

similar fees or payments, and 

performance-based compensation; 

(2) A detailed accounting of all fees 

and expenses paid by the private fund 

during the reporting period (other than 

those listed in paragraph (b)(1) of this 

section), with separate line items for 

each category of fee or expense 

reflecting the total dollar amount, 

including, but not limited to, 

organizational, accounting, legal, 

administration, audit, tax, due 

diligence, and travel fees and expenses; 

and 

(3) The amount of any offsets or 

rebates carried forward during the 

reporting period to subsequent periods 

to reduce future payments or allocations 

to the adviser or its related persons. 

(c) Portfolio investment table. The 

quarterly statement must include a 

separate table for the private fund’s 

covered portfolio investments that 

discloses, at a minimum, the following 

information for each covered portfolio 

investment: 

(1) A detailed accounting of all 

portfolio investment compensation 

allocated or paid to the investment 

adviser or any of its related persons by 

the covered portfolio investment during 

the reporting period, with separate line 

items for each category of allocation or 

payment reflecting the total dollar 

amount, presented both before and after 

the application of any offsets, rebates, or 

waivers; and 

(2) The fund’s ownership percentage 

of each such covered portfolio 

investment as of the end of the reporting 

period, or zero, if the fund does not have 

an ownership interest in the covered 

portfolio investment, along with a brief 

description of the fund’s investment. 

(d) Calculations and cross references. 

The quarterly statement must include 

prominent disclosure regarding the 

manner in which all expenses, 

payments, allocations, rebates, waivers, 

and offsets are calculated and include 

cross references to the sections of the 

private fund’s organizational and 

offering documents that set forth the 

applicable calculation methodology. 

(e) Performance. (1) No later than the 

time the adviser sends the initial 

quarterly statement, the adviser must 

determine that the private fund is an 

illiquid fund or a liquid fund. 

(2) The quarterly statement must 

present the following with equal 

prominence: 

(i) Liquid funds. For a liquid fund: 

(A) Annual net total returns for each 

calendar year since inception; 

(B) Average annual net total returns 

over the one-, five-, and ten- calendar 

year periods; and 

(C) The cumulative net total return for 

the current calendar year as of the end 

of the most recent calendar quarter 

covered by the quarterly statement. 

(ii) Illiquid funds. For an illiquid 

fund: 

(A) The following performance 

measures, shown since inception of the 

illiquid fund through the end of the 

quarter covered by the quarterly 

statement (or, to the extent quarter-end 

numbers are not available at the time 

the adviser distributes the quarterly 

statement, through the most recent 

practicable date) and computed without 

the impact of any fund-level 

subscription facilities: 

(1) Gross IRR and gross MOIC for the 

illiquid fund; 

(2) Net IRR and net MOIC for the 

illiquid fund; 

(3) Gross IRR and gross MOIC for the 

realized and unrealized portions of the 

illiquid fund’s portfolio, with the 

realized and unrealized performance 

shown separately; and 

(4) A statement of contributions and 

distributions for the illiquid fund. 

(B) [Reserved] 

(iii) The quarterly statement must 

include the date as of which the 

performance information is current 

through and prominent disclosure of the 

criteria used and assumptions made in 

calculating the performance. 

(f) Consolidated reporting. To the 

extent doing so would provide more 

meaningful information to the private 

fund’s investors and would not be 

misleading, the adviser must 

consolidate the reporting required by 

paragraphs (a) through (e) of this section 

to cover substantially similar pools of 

assets. 

(g) Format and content. The quarterly 

statement must use clear, concise, plain 

English and be presented in a format 

that facilitates review from one 

quarterly statement to the next. 


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(h) Definitions. For purposes of this 

section, defined terms shall have the 

meanings set forth in § 275.211(h)(1)–1. 

■ 7. Section 275.211(h)(2)–1 is added to 

read as follows: 

§ 275.211(h)(2)–1 Private fund adviser 

prohibited activities. 

(a) An investment adviser to a private 

fund may not, directly or indirectly, do 

the following with respect to the private 

fund, or any investor in that private 

fund: 

(1) Charge a portfolio investment for 

monitoring, servicing, consulting, or 

other fees in respect of any services that 

the investment adviser does not, or does 

not reasonably expect to, provide to the 

portfolio investment; 

(2) Charge the private fund for fees or 

expenses associated with an 

examination or investigation of the 

adviser or its related persons by any 

governmental or regulatory authority; 

(3) Charge the private fund for any 

regulatory or compliance fees or 

expenses of the adviser or its related 

persons; 

(4) Reduce the amount of any adviser 

clawback by actual, potential, or 

hypothetical taxes applicable to the 

adviser, its related persons, or their 

respective owners or interest holders; 

(5) Seek reimbursement, 

indemnification, exculpation, or 

limitation of its liability by the private 

fund or its investors for a breach of 

fiduciary duty, willful misfeasance, bad 

faith, negligence, or recklessness in 

providing services to the private fund; 

(6) Charge or allocate fees and 

expenses related to a portfolio 

investment (or potential portfolio 

investment) on a non-pro rata basis 

when multiple private funds and other 

clients advised by the adviser or its 

related persons have invested (or 

propose to invest) in the same portfolio 

investment; and 

(7) Borrow money, securities, or other 

private fund assets, or receive a loan or 

an extension of credit, from a private 

fund client. 

(b) For purposes of this section, 

defined terms shall have the meanings 

set forth in § 275.211(h)(1)–1. 

■ 8. Section 275.211(h)(2)–2 is added to 

read as follows: 

§ 275.211(h)(2)–2 Adviser-led secondaries. 

(a) As a means reasonably designed to 

prevent fraudulent, deceptive, or 

manipulative acts, practices, or courses 

of business within the meaning of 

section 206(4) of the Act (15 U.S.C. 80b– 

6(4)), it is unlawful for any investment 

adviser that is registered or required to 

be registered under section 203 of the 

Act to complete an adviser-led 

secondary transaction with respect to 

any private fund, unless the adviser: 

(1) Obtains, and distributes to 

investors in the private fund, a fairness 

opinion from an independent opinion 

provider; and 

(2) Prepares, and distributes to 

investors in the private fund, a written 

summary of any material business 

relationships the adviser or any of its 

related persons has, or has had within 

the past two years, with the 

independent opinion provider, in each 

case, prior to the closing of the adviserled secondary transaction. 

(b) For purposes of this section, 

defined terms shall have the meanings 

set forth in § 275.211(h)(1)–1. 

■ 9. Section 275.211(h)(2)–3 is added to 

read as follows: 

§ 275.211(h)(2)–3 Preferential treatment. 

(a) An investment adviser to a private 

fund may not, directly or indirectly, do 

the following with respect to the private 

fund, or any investor in that private 

fund: 

(1) Grant an investor in the private 

fund or in a substantially similar pool 

of assets the ability to redeem its 

interest on terms that the adviser 

reasonably expects to have a material, 

negative effect on other investors in that 

private fund or in a substantially similar 

pool of assets; or 

(2) Provide information regarding the 

portfolio holdings or exposures of the 

private fund, or of a substantially 

similar pool of assets, to any investor if 

the adviser reasonably expects that 

providing the information would have a 

material, negative effect on other 

investors in that private fund or in a 

substantially similar pool of assets. 

(b) An investment adviser to a private 

fund may not, directly or indirectly, 

provide any other preferential treatment 

to any investor in the private fund 

unless the adviser provides written 

notices as follows: 

(1) Advance written notice for 

prospective investors in a private fund. 

The investment adviser shall provide to 

each prospective investor in the private 

fund, prior to the investor’s investment 

in the private fund, a written notice that 

provides specific information regarding 

any preferential treatment the adviser or 

its related persons provide to other 

investors in the same private fund. 

(2) Annual written notice for current 

investors in a private fund. The 

investment adviser shall distribute to 

current investors, on at least an annual 

basis, a written notice that provides 

specific information regarding any 

preferential treatment provided by the 

adviser or its related persons to other 

investors in the same private fund since 

the last written notice provided in 

accordance with this section, if any. 

(c) For purposes of this section, 

defined terms shall have the meanings 

set forth in § 275.211(h)(1)–1. 

By the Commission. 

Dated: February 9, 2022. 

Vanessa A. Countryman, 

Secretary. 

[FR Doc. 2022–03212 Filed 3–23–22; 8:45 am] 

BILLING CODE 8011–01–P 


khammond on DSKJM1Z7X2PROD with PROPOSALS3