Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews

Federal RegisterSep 14, 2023

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-6383; File No. S7-03-22]

RIN 3235-AN07

Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is adopting new rules under the Investment Advisers Act of 1940 (“Advisers Act” or “Act”). The rules are designed to protect investors who directly or indirectly invest in private funds by increasing visibility into certain practices involving compensation schemes, sales practices, and conflicts of interest through disclosure; establishing requirements to address such practices that have the potential to lead to investor harm; and restricting practices that are contrary to the public interest and the protection of investors. These rules are likewise designed to prevent fraud, deception, or manipulation by the investment advisers to those funds. The Commission is adopting corresponding amendments to the Advisers Act books and records rule to facilitate compliance with these new rules and assist our examination staff. Finally, the Commission is adopting amendments to the Advisers Act compliance rule, which affect all registered investment advisers, to better enable our staff to conduct examinations.

DATES:

Effective date:

These rules are effective November 13, 2023.

Compliance date:

See Section IV.

Comments due date:

Comments regarding the collection of information requirements within the meaning of the Paperwork Reduction Act of 1995 should be received on or before October 16, 2023.

FOR FURTHER INFORMATION CONTACT:

Shane Cox, Robert Holowka, and Neema Nassiri, Senior Counsels; Tom Strumpf, Branch Chief; Adele Murray, Private Funds Attorney Fellow; Melissa Roverts Harke, 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 is adopting rule 17 CFR 275.206(4)-10 (final rule 206(4)-10), 17 CFR 275.211(h)(1)-1 (final rule 211(h)(1)-1), 17 CFR 275.211(h)(1)-2 (final rule 211(h)(1)-2), 17 CFR 275.211(h)(2)-1 (final rule 211(h)(2)-1), 17 CFR 275.211(h)(2)-2 (final rule 211(h)(2)-2), and 17 CFR 275.211(h)(2)-3 (final rule 211(h)(2)-3) under the Investment Advisers Act of 1940 [15 U.S.C. 80b-1

et seq.

] (“Advisers Act”);

and amendments to 17 CFR 275.204-2 (final amended rule 204-2) and 17 CFR 275.206(4)-7 (final amended rule 206(4)-7) under the Advisers Act.

Unless 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.

Table of Contents

I. Introduction

A. Risks and Harms to Investors

B. Rules To Address These Risks and Harms

C. The Commission Has Authority To Adopt the Rules

II. Discussion of Rules for Private Fund Advisers

A. Scope of Advisers Subject to the Final Private Fund Adviser Rules

B. 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

C. 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. 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 Audit Rule

D. Adviser-Led Secondaries

1. Definition of Adviser-led Secondary Transaction

2. Fairness Opinion or Valuation Opinion

3. Summary of Material Business Relationships

4. Distribution of the Opinion and Summary of Material Business Relationships

5. Recordkeeping for Adviser-Led Secondaries

E. Restricted Activities

1. Restricted Activities With Disclosure-Based Exceptions

(a) Regulatory, Compliance, and Examination Expenses

(b) Reducing Adviser Clawbacks for Taxes

2. Restricted Activities With Certain Investor Consent Exceptions

(a) Investigation Expenses

(b) Borrowing

F. Certain Adviser Misconduct

1. Fees for Unperformed Services

2. Limiting or Eliminating Liability

G. Preferential Treatment

1. Prohibited Preferential Redemptions

2. Prohibited Preferential Transparency

3. Similar Pool of Assets

4. Other Preferential Treatment and Disclosure of Preferential Treatment

5. Delivery

6. Recordkeeping for Preferential Treatment

III. Discussion of Written Documentation of All Advisers' Annual Reviews of Compliance Programs

IV. Transition Period, Compliance Date, Legacy Status

V. Other Matters

VI. Economic Analysis

A. Introduction

B. Broad Economic Considerations

C. 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, Fairness Opinions, and Valuation Opinions

5. Books and Records

6. Documentation of Annual Review Under the Compliance Rule

D. Benefits and Costs

1. Overview

2. Quarterly Statements

3. Restricted Activities

4. Preferential Treatment

5. Mandatory Private Fund Adviser Audits

6. Adviser-Led Secondaries

7. Written Documentation of All Advisers' Annual Review of Compliance Programs

8. Recordkeeping

E. Effects on Efficiency, Competition, and Capital Formation

1. Efficiency

2. Competition

3. Capital Formation

F. 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 Restrictions 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 or

Valuation 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

VII. Paperwork Reduction Act

A. Introduction

B. Quarterly Statements

C. Mandatory Private Fund Adviser Audits

D. Restricted Activities

E. Adviser-Led Secondaries

F. Preferential Treatment

G. Written Documentation of Adviser's Annual Review of Compliance Program

H. Recordkeeping

I. Request for Comment Regarding Rule 211(h)(2)-1

VIII. Final Regulatory Flexibility Analysis

A. Reasons for and Objectives of the Final Rules and Rule Amendments

1. Final Rule 211(h)(1)-1

2. Final Rule 211(h)(1)-2

3. Final Rule 206(4)-10

4. Final Rule 211(h)(2)-1

5. Final Rule 211(h)(2)-2

6. Final Rule 211(h)(2)-3

7. Final Amendments to Rule 204-2

8. Final Amendments to Rule 206(4)-7

B. Significant Issues Raised by Public Comments

C. Legal Basis

D. Small Entities Subject to Rules

E. Projected Reporting, Recordkeeping, and Other Compliance Requirements

1. Final Rule 211(h)(1)-1

2. Final Rule 211(h)(1)-2

3. Final Rule 206(4)-10

4. Final Rule 211(h)(2)-1

5. Final Rule 211(h)(2)-2

6. Final Rule 211(h)(2)-3

7. Final Amendments to Rule 204-2

8. Final Amendments to Rule 206(4)-7

F. Significant Alternatives

Statutory Authority

I. Introduction

The Commission oversees private fund advisers, many of which are registered with the SEC or report to the SEC as exempt reporting advisers. Despite the Commission's examination and enforcement efforts with respect to private fund advisers, such advisers continue to engage in certain practices that may impose significant risks and harms on investors and private funds. Consequently, there is a compelling need for the Commission to exercise its congressional authority for the protection of investors.

Based on the Commission's extensive experience overseeing private fund advisers, the Commission is adopting carefully tailored rules to address the risks and harms to investors and funds, while promoting efficiency, competition, and capital formation.

See infra

section I.C.

See infra

section VI.E.

See also

Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, Investment Advisers Act Release No. 5955 (Feb. 9, 2022) [87 FR 16886 (Mar. 24, 2022)] (“Proposing Release”); Reopening of Comment Periods for “Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews” and “Amendments Regarding the Definition of `Exchange' and Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities,” Investment Advisers Act Release No. 6018 (May 9, 2022) [87 FR 29059 (May 12, 2022)]; Resubmission of Comments and Reopening of Comment Periods for Certain Rulemaking Releases, Investment Advisers Act Release No. 6162 (Oct. 7, 2022) [87 FR 63016 (Oct. 18, 2022)]. The Commission voted to issue the Proposing Release on Feb. 9, 2022. The release was posted on the Commission website that day, and comment letters were received beginning that same date. The comment period closed on Nov. 1, 2022. We have considered all comments received since Feb. 9, 2022.

Background

Private funds are privately offered investment vehicles that pool capital from one or more investors and invest in securities and other instruments or investments.

Each investor in a private fund invests by purchasing securities (which are generally issued by the fund in the form of interests or shares) and then participates in the fund through the securities that it holds. Private funds are generally advised by investment advisers that are subject to a Federal fiduciary duty as well as the antifraud and other provisions of the Act.

A private fund adviser, which often has broad discretion to provide investment advisory services to the fund, uses the money contributed by investors to make investments on behalf of the fund.

Section 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. Securitized asset funds are excluded from the term “private funds” for purposes hereof, unless stated otherwise.

See infra

section II.A (Scope of Advisers Subject to the Final Private Fund Adviser Rules) for a discussion of the application of the final rules to securitized asset funds.

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)] (“2019 IA Fiduciary Duty Interpretation”).

Congress expanded the Commission's role overseeing private fund advisers and their relationship with private funds and their investors in the wake of the 2007-2008 financial crisis, when it passed, and the President signed, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”). While the antifraud provisions of section 206 already applied to private fund advisers and the Commission already had brought enforcement actions against private fund advisers before the enactment of the Dodd-Frank Act, Congress increased the Commission's oversight responsibility of private fund advisers. Among other things, Congress amended the Advisers Act generally to require advisers to private funds to register with the Commission and to authorize the Commission to establish reporting and recordkeeping requirements for advisers to private funds for investor protection and systemic risk purposes.

Specifically, Title IV of the Dodd-Frank Act repealed an exemption from registration contained in section 203(b)(3) of the Advisers Act—known as the “private adviser exemption”—on which many private fund advisers, including those to private equity funds, hedge funds, and venture capital funds,

had relied.

In addition to eliminating this provision, Congress directed the Commission to adopt more limited exemptions for advisers that solely advise private funds, if the adviser has assets under management in the United States of less than $150 million, or that solely advise venture capital funds.

Section 203(b)(3) of the Act, as amended by the Dodd-Frank Act, also provides an exemption from registration for certain foreign private advisers. As a result, private fund advisers outside of these narrow exemptions became subject to the same regulatory oversight and other Advisers Act requirements that apply to other SEC-registered investment advisers.

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, § 403, 404, 124 Stat, 1378, 1571-72 (Jul. 2010), codified at 15 U.S.C. 80b-4(b).

Private equity funds, hedge funds, and venture capital funds are further described below.

See

Dodd-Frank Act, section 403.

See

Dodd-Frank Act, sections 407 and 408; 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)] (“Exemptions Adopting Release”). The Dodd-Frank Act also provided the Commission with the ability to require the limited number of advisers to private funds that did not have to register to file reports about their business activities.

Increasing Importance of Private Funds and Their Advisers to Investors

Investment advisers' private fund assets under management have steadily increased over the past decade, growing from $9.8 trillion in 2012 to $26.6 trillion in 2022.

Similarly, the number of private funds has increased from 31,717 in 2012 to 100,947 in 2022.

Additionally, private funds and their advisers play an increasingly important role in the lives of millions of

Americans planning for retirement.

While private funds typically issue their securities only to certain qualified investors, such as institutions and high net worth individuals, individuals have indirect exposure to private funds through those individuals' participation in public and private pension plans, endowments, foundations, and certain other retirement plans, which all invest directly in private funds. For example, public service workers, including law enforcement officers, firefighters, public school educators and community service workers, participate in these retirement plans and other vehicles and thus have exposure to private funds. Many pension plans, endowments, and non-profits invest in private funds to meet their internal return targets, to diversify their holdings, and to provide retirement security or other benefits for their stakeholders.

In particular, public pension plans face a stark funding gap

and many have turned to private funds in an attempt to address underfunding problems.

As a result, the 26.7 million working and retired U.S. public pension plan beneficiaries are more likely to have increased exposure to private funds.

The Commission staff have also observed a trend of rising interest in private fund investments by smaller investors with less bargaining power, such as the growth of new platforms to facilitate individual access to private investments with small investment sizes, or non-institutional investor groups pooling funds to invest in private funds, or other means by which smaller individual investors can access private investments.

See

Form ADV data (inclusive of assets attributable to securitized asset funds).

Id.

(inclusive of securitized asset funds).

See

Division of Investment Management: Analytics Office, Private Funds Statistics Report: Third Calendar Quarter 2022 (April 6, 2023) (“Form PF Statistics Report”), at 15,

available at https://www.sec.gov/files/investment/private-funds-statistics-2022-q3.pdf

(showing beneficial ownership of all funds by category as reported on Form PF).

See also, e.g.,

Comment Letter of Healthy Markets Association (Apr. 15, 2022) (“Healthy Markets Comment Letter I”) (discussing the growing number of private funds and increasing allocations that public pension plans and endowments are making to private funds); Comment Letter of Better Markets, Inc. (Apr. 25, 2022) (“Better Markets Comment Letter”) (discussing the growth of the private markets and the exposure of millions of Americans to the private markets, including through pension plans). The comment letters on the Proposing Release are available at

https://www.sec.gov/comments/s7-03-22/s70322.htm

States on average have less than 70% of the assets needed to fund their pension liabilities with that figure for some states reaching as low as 34%.

See, e.g.,

Professor Clayton Public Investors Article,

supra

footnote 12; Sarah Krouse,

The Pension Hole for U.S. Cities and States is the Size of Germany's Economy,

Wall Street J. (July 30, 2018),

available at https://www.wsj.com/articles/the-pension-hole-for-u-s-cities-and-states-is-the-size-of-japans-economy-1532972501

; Pew Charitable Trusts, Issue Brief, The State Pension Funding Gap: 2017 (June 27, 2019),

available at https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2019/06/the-state-pension-funding-gap-2017

See, e.g.,

Healthy Markets Comment Letter I; UBS Wealth Management USA, US Economy: Public Pension Plans Tilt Toward Alternatives (Jan. 12, 2023),

available at https://www.ubs.com/us/en/wealth-management/insights/market-news/article.1582725.html

(discussing State and local pension funds' increasing allocation to private funds over last two decades).

See National Data,

Public Plans Data,

available at https://publicplansdata.org/quick-facts/national/#:~:text;=Collectively%2C%20these%20plans%20have%3A,members%20and%2011.7%20million%20retirees

See infra

section VI.C.1.

Role of Investment Advisers in Private Fund Structure and Organization

While there are many different ways that private funds are structured and organized, private funds typically rely on an investment adviser (or affiliated entities, such as the fund's general partner or managing member) to provide management, investment, and other services, and such person usually has delegated authority to take actions on behalf of the private fund without the consent or approval of any other person. A private fund rarely has employees of its own—its officers, if any, are usually employed by the private fund's adviser. As a result, it is the adviser or its affiliated entities who generally draft the private fund's private placement memorandum and governing documents,

negotiate fund terms with the private fund investors, select and execute investments, charge or allocate fees and expenses to the private fund, and provide information on the private fund's activities and performance to private fund investors. Advisers are also often involved in marketing the private fund to prospective investors, including marketing to current investors in other private funds managed by the adviser.

Including the private fund operating agreement to which the adviser or its affiliate and the private fund investors are typically both parties.

Investors in a private fund generally pay both fees and expenses to the private fund adviser and/or its related persons. Investors typically, directly or indirectly through the fund interests they hold, pay management fees

and

performance-based compensation to the adviser of the private fund or the adviser's related person (

e.g.,

a general partner or managing member). Additionally, investors directly or indirectly bear the fees and expenses associated with the fund and the fund's investments. It is also not uncommon for a private fund's underlying portfolio investments to pay the adviser (or a related person) monitoring, transaction or other fees and expenses, which can be, but are not always, offset against the management fees paid to the adviser.

In certain cases, advisers also negotiate with investors to have investors pay certain of the adviser's own expenses (such as certain compliance costs of the adviser).

Compensation at the underlying “portfolio investment-level” is more common for certain private funds, such as private equity, venture capital or real estate funds, and less common for others, such as hedge funds.

There are many different types of private funds. Two broad categories of private funds are hedge funds and private equity funds. Hedge funds tend to invest in more liquid assets and generally allow investors the opportunity to voluntarily withdraw their interests with certain limitations, including for example, restrictions on timing and notice requirements and, for certain funds, the amount that can be redeemed at one time or over a period of time. Private equity funds, on the other hand, tend to invest in illiquid assets and generally do not permit investors to voluntarily withdraw their interests in the fund. Hedge funds engage in trillions of dollars in listed equity and futures transactions each month,

while private equity funds tend to focus on private investments, whether through mergers and acquisitions, non-bank lending, restructurings, and other transactions. Hedge funds have over nine trillion dollars in gross asset value and private equity funds have over six trillion.

Beyond hedge funds and private equity funds, there are other categories of private funds, some of which overlap with these two. For example, venture capital funds are in many ways structurally similar to private equity funds and provide funding to start-up and early-stage companies. As another example, real estate private funds generally invest in illiquid real estate assets, and as such typically do not permit investors to withdraw their interests in the fund voluntarily. Venture capital and real estate private funds have over one trillion dollars in gross asset value.

See

Form PF Statistics Report,

supra

at footnote 12, at 31 (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).

See id.

See

id. See infra

section II.A (Scope of Advisers Subject to the Final Private Fund Adviser Rules) for a discussion of securitized asset funds as well.

Need for Further Commission Oversight

With over a decade since the Dodd-Frank Act required private fund advisers to register with us, the Commission now has extensive experience in overseeing and regulating private fund advisers. Form ADV and Form PF reporting have been critical to improving our ability to understand private fund advisers' operations and relationships with funds and investors as private funds continue growing in size, complexity, and number.

The information from these forms has enabled us to enhance our assessment of private fund advisers for purposes of targeting examinations and responding to emerging trends. For example, the Commission's Division of Examinations stated in its 2023 examination priorities that it will continue to focus on registered private fund advisers, including such advisers' conflicts of interest and calculations and allocations of fees and expenses.

This information has also improved our ability to identify practices that could harm private fund investors and has helped us not only promote compliance but also detect, investigate, and deter fraud and other misconduct.

Form ADV has also increased transparency to investors.

See

Securities and Exchange Commission's Division of Examinations 2023 Examination Priorities (Feb. 7, 2023),

available at https://www.sec.gov/files/2023-exam-priorities.pdf

In the course of this oversight of private fund advisers, we have observed three primary factors that contribute to investor protection risks and harms: lack of transparency, conflicts of interest, and lack of governance mechanisms.

We have observed that these three factors contribute to significant investor harm, such as an adviser incorrectly, or improperly, charging fees and expenses to the private fund, contrary to the adviser's fiduciary duty, contractual obligations to the fund, or disclosures by the adviser.

The Commission has pursued enforcement actions against private fund advisers for fraudulent practices related to fee and expense charges or allocations that are influenced by the advisers' conflicts of interest.

For example, the Commission has brought a settled action alleging private fund advisers misallocated more than $17 million in so-called “broken deal” expenses to an adviser's flagship private equity fund

and improperly allocated approximately $2 million of compensation-related expenses to three private equity funds that an adviser managed.

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. Despite these enforcement and examination efforts, problematic practices persist.

For example, the Commission has brought charges against private fund advisers for failing to disclose material conflicts of interest to a private fund that an adviser managed as well as misleading its investors by misrepresenting an investment opportunity,

and for failing 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.

Additionally, any risks and harms imposed by private fund advisers on private funds and their investors indirectly expose the investors' individual stakeholders and beneficiaries (

e.g.,

public service workers, law enforcement officers, firefighters, public school educators, and community service workers) to the same risks and harms.

To the extent that these issues negatively affect the efficiency with which investors search for and match with advisers, the alignment of investor and adviser interests, investor confidence in private fund markets, or competition between advisers, then the final rules may improve efficiency, competition, and capital formation in addition to benefiting investors.

See infra

sections VI.B, VI.E.

See, e.g.,

Comment Letter of Consumer Federation of America (Apr. 25, 2022) (“Consumer Federation of America Comment Letter”).

See, 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) (alleging that the adviser received undisclosed fees) (“In the Matter of Blackstone”);

In the Matter of Lincolnshire Management, Inc.,

Investment Advisers Act Release No. 3927 (Sept. 22, 2014) (settled action) (alleging that the adviser misallocated fees and expenses among private fund clients) (“In the Matter of Lincolnshire”);

In the Matter of Cherokee Investment Partners, LLC and Cherokee Advisers, LLC,

Investment Advisers Act Release No. 4258 (Nov. 5, 2015) (settled action) (alleging that the adviser improperly shifted expenses related to an examination and an investigation away from itself).

Id.

See In the Matter of re Kohlberg Kravis Roberts & Co. L.P.,

Investment Advisers Act Release No. 4131 (June 29, 2015) (settled action) (“In the Matter of Kohlberg Kravis Roberts & Co.”).

See In re NB Alternatives Advisers LLC,

Investment Advisers Act Release No. 5079 (Dec. 17, 2018) (settled action) (“In the Matter of NB Alternatives Advisers”).

See, e.g., 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 Energy Capital Partners Management, LP,

Investment Advisers Act Release No. 6049 (June 15, 2022) (settled action) (alleging that the adviser allocated undisclosed and disproportionate expenses to a private fund client) (“In the Matter of Energy Capital Partners”);

In the Matter of Insight Venture Management, LLC,

Investment Advisers Act Release No. 6322 (June 20, 2023) (settled action) (alleging that the adviser failed to disclose a conflict of interest relating to its fee calculations and overcharged management fees) (“In the Matter of Insight

”

See In the Matter of Mitchell J. Friedman,

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

See In the Matter of Diastole Wealth Management, Inc.,

Investment Advisers Act Release No. 5855 (Sept. 10, 2021) (settled action).

Accordingly, we proposed a series of new rules under the Advisers Act to protect investors, promote more efficient capital markets, and encourage capital formation.

After considering comments, the Commission is adopting rules with modifications that make the rules less restrictive and more flexible, while still providing investors with the protections to which they are entitled. The adopted rules will help address risks and harms to investors in a carefully tailored way that promotes efficiency, competition, and capital formation, as well as investor protection.

See

Proposing Release,

supra

footnote 3.

A. Risks and Harms to Investors

These rules and amendments are important enhancements to private fund adviser regulation because they protect the adviser's private fund clients and those who invest in private funds by increasing visibility into certain activities, curbing practices that lead to harm to funds and their investors, and restricting adviser activity that is contrary to the public interest and the protection of investors. The private fund adviser reforms are designed specifically to address the following three factors for risks and harms that are common in an adviser's relationship with private funds and their investors: lack of transparency, conflicts of interest, and lack of effective governance mechanisms for client disclosure, consent, and oversight.

Lack of Transparency.

Private fund investments are often opaque, and advisers do not frequently or consistently provide investors with sufficiently detailed information about the terms of the advisers' relationships with funds and their investors. For example, there are no specific requirements for the information that private fund advisers must disclose to private fund investors about the funds'

investments, performance, or incurred fees and expenses, notwithstanding the applicability of the antifraud provisions of the federal securities laws and any relevant requirements of the marketing rule and private placement rules. Rather, information and disclosure about these items and the terms of an investment in a private fund are generally individually negotiated between private fund investors and the fund's adviser. Since private fund structures can be complex and involve multiple entities that are related to, or otherwise affiliated with, the adviser, absent specifically negotiated disclosure, it may be difficult for investors to understand the conflicts embedded within these structures and the overall compensation received by the adviser. Without specific information, even sophisticated investors cannot understand the fees and expenses they are paying, the risks they are assuming, and the performance they are achieving in return.

Investors have received reduced returns due to improperly charged fees and expenses,

and they must sometimes choose between expending resources to negotiate for detailed fee and expense or performance reporting or using their bargaining power to improve the economic, informational, or governance terms of the investors' relationships with funds and their advisers.

See, e.g., In the Matter of Insight, supra

footnote 30 (alleging that, due to lack of disclosure, investors were unaware of the extent of the conflict of interest associated with an adviser's permanent impairment criteria and that the adviser charged excessive management fees).

See infra

section II.B.

See, e.g.,

Comment Letter of Ohio Public Employees Retirement System (Apr. 25, 2022) (“OPERS Comment Letter”); Comment Letter of Institutional Limited Partners Association (Apr. 25, 2022) (“ILPA Comment Letter I”).

Conflicts of Interest.

These rules address many of the problems raised by the conflicts of interest commonly present in private fund adviser practices. Conflicts of interest can harm investors, such as when an adviser grants preferential redemption rights to entice a large investor that will increase overall management fees to commit to a private fund, and then, when the fund experiences a decline, such preferential redemption rights allow a large investor to exit the private fund before and on more advantageous terms than other investors. Investors are also harmed by not being informed of conflicts of interest concerning the private fund adviser and the fund, which reduces the information available to investors to guide their investment decisions.

There is a trend of rising interest in private funds by smaller investors with less bargaining power, who may be particularly impacted by these practices, including where advisers grant preferential terms to larger investors that may exacerbate conflicts of interest as well as the risks of resulting investor harm.

See, e.g., In the Matter of Insight, supra

footnote 30 (alleging that the adviser charged excess management fees and failed to disclose a conflict of interest to investors relating to its fee calculations).

See infra

sections VI.B, VI.C.1.

Certain conflicts of interest between advisers and private funds also involve sales practices or compensation schemes that are problematic for investors. For example, advisers have a conflict of interest with private funds (and, indirectly, 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. Similarly, advisers have a conflict of interest with the fund (and, indirectly, its investors) when they offer existing fund investors the choice between selling and exchanging their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons as part of 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 managed appropriately, including diminishing the fund's returns because of excess fees and expenses paid to the fund's adviser or its related persons.

Emerging Trends in the Evolving Continuation Fund Market, Private Equity Law Report (July 2022),

available at https://www.pelawreport.com/19285026/emerging-trends-in-the-evolving-continuation-fund-market.thtml

(stating that the market volume for private fund secondaries increased from $37 billion in 2016 to $132 billion in 2021 and that “much of that growth was driven by an explosion in GP-led continuation fund activity”).

Lack of Governance Mechanisms.

These rules are designed to respond to harms arising out of private fund governance structures. In a typical private fund structure, the private fund is the adviser's client and investors in the private fund are not clients of the adviser (unless investors have a separate advisory relationship with the adviser in addition to their investment in the private fund). The adviser (or its related person) commonly serves as the general partner or managing member (or similar control person) of the fund. Because the adviser (or its related person) acts on behalf of the fund client and is typically not required to obtain the input or consent of investors in the fund, the governance structure of a typical private fund is not designed to prioritize investor oversight of the adviser and general partner or managing member (or similar control person) or investor policing of conflicts of interest.

For example, although some private funds may have limited partner advisory committees (“LPACs”) or boards of directors, these types of bodies may not have sufficient independence, authority, or accountability to oversee and consent to these conflicts.

Such LPACs or boards of directors do not have a fiduciary obligation to the private fund investors. Moreover, private fund advisers often provide certain investors with preferential terms, such as representation in an LPAC, that can create potential conflicts among the fund's investors. 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 LPAC representation or similar rights, certain fund agreements may 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.

A fund's LPAC or board typically acts as the decision-making body with respect to conflicts that may arise between the interests of the third-party investors and the interests of the adviser. In certain cases, advisers seek the consent of the LPAC or board for conflicted transactions, such as transactions involving investments in portfolio companies of related funds or where the adviser seeks to cause the fund to engage a service provider that is affiliated with the adviser.

The rules we are adopting are designed to protect private fund investors by addressing private fund advisers' conflicts of interest, sales practices, and compensation schemes. Such protection is necessary because investors face difficulties in negotiating for reformed practices, including stronger governance structures, because of the bargaining power held by advisers and by investors who benefit from current adviser practices, such as investors who receive preferential treatment from their advisers.

In addition, as discussed above, the indirect exposure of the general public to the risks of private fund investments

heightens the need for specific rulemaking to address these concerns.

See infra

section VI.B.

B. Rules To Address These Risks and Harms

The Commission proposed rules to address the risks and harms to investors and funds, and we received many comment letters on the proposal.

A number of commenters supported the proposal and stated that it would have an overall positive impact on the industry.

Some commenters stated that it would establish baseline protections for investors, such as increased transparency and standardized reporting.

Other commenters expressed frustration with the conflicts of interest in the private funds industry

and supported prohibitions on certain unfair practices.

One commenter stated that the rules, if adopted, “would implement a variety of essential improvements in the regulation of the private funds markets, making this increasingly important financial sector substantially more fair and transparent.”

Another commenter stated that the proposed rules are essential to protect the right of investors to access information critical to making informed investment decisions, especially because private market investments will likely play an increasingly growing role in the asset allocations and funding targets of institutional investors.

In contrast, other commenters opposed the proposal and expressed concern that it would negatively impact the industry by stifling capital formation and reducing competition.

Certain commenters asserted that the proposed requirements would overburden advisers (especially smaller advisers) with compliance costs, which may ultimately be passed on to investors, directly or indirectly.

These and other comments are discussed more fully below. The final rules include modifications in response to concerns raised and provide additional flexibility and tailoring to the rules as proposed, while preserving the needed investor protections.

See

Proposing Release,

supra

footnote 3.

See, e.g.,

Comment Letter of United for Respect (Apr. 12, 2022) (“United for Respect Comment Letter I”); Comment Letter of Private Equity Stakeholder Project (Apr. 25, 2022); Comment Letter of Trine Acquisition Corp. (Apr. 21, 2022) (“Trine Comment Letter”).

See, e.g.,

Comment Letter of InvestX (Mar. 18, 2022) (“InvestX Comment Letter”); Comment Letter of American Association for Justice (Apr. 25, 2022) (“American Association for Justice Comment Letter”); OPERS Comment Letter.

See, e.g.,

Comment Letter of Public Citizen (Apr. 15, 2022) (“Public Citizen Comment Letter”); Comment Letter of the Comptroller of the State of New York (Apr. 25, 2022) (“NY State Comptroller Comment Letter”); Comment Letter of Comptroller of the City of New York (Apr. 21, 2022) (“NYC Comptroller Comment Letter”).

See, e.g.,

Comment Letter of General Treasurer of Rhode Island, For the Long Term and Illinois State Treasure, For the Long Term (June 13, 2022) (“For the Long Term Comment Letter”); Comment Letter of the Regulatory Fundamentals Group (Apr. 25, 2022) (“RFG Comment Letter II”); United for Respect Comment Letter I.

See

Better Markets Comment Letter.

See

Comment Letter of District of Columbia Retirement Board (Apr. 22, 2022) (“DC Retirement Board Comment Letter”).

See, e.g.,

Comment Letter of the Private Investment Funds Forum (Apr. 25, 2022) (“PIFF Comment Letter”); Comment Letter of the Alternative Investment Management Association Limited and the Alternative Credit Council (Apr. 25, 2022) (“AIMA/ACC Comment Letter”); Comment Letter of the Securities Industry and Financial Markets Association Asset Management Group (Apr. 25, 2022) (“SIFMA-AMG Comment Letter I”).

See, e.g.,

Comment Letter of Lockstep Ventures (Apr. 26, 2022) (“Lockstep Ventures Comment Letter”); Comment Letter of Thin Line Capital (Apr. 21, 2022) (“Thin Line Capital Comment Letter”); Comment Letter of Blended Impact (Apr. 24, 2022) (“Blended Impact Comment Letter”).

The Quarterly Statement Rule.

The Commission proposed a rule to require SEC-registered advisers to private funds to provide investors with periodic information about private fund fees, expenses, and performance.

The Commission is adopting the rule with changes in response to comments:

See infra

section II.B for a discussion of the comments on this aspect of the rule.

The final quarterly statement, audit, adviser-led secondaries, restricted activities, and preferential treatment rules do not apply to investment advisers with respect to securitized asset funds they advise.

See infra

section II.A (Scope of Advisers Subject to the Final Private Fund Adviser Rules).

○ Advisers to illiquid funds are required to calculate performance information with and without the impact of subscription facilities, rather than only without;

○ We have refined the definition of illiquid fund to be based primarily on withdrawal and redemption capability;

○ Instead of requiring advisers to present liquid fund performance since inception, we are only requiring a 10-year lookback; and

○ We are allowing additional time for delivery of fourth quarter statements and additional time for delivery of all statements for funds of funds.

As discussed more fully below, we are adopting the quarterly statement rule because we see this lack of transparency in many areas, including investment advisers' disclosure regarding private fund fees, expenses, and performance. For example, some private fund investors do not have sufficient information regarding private fund fees and expenses because those fees and expenses have varied labels across private funds and are subject to complicated calculation methodologies.

Increased transparency on fees can also help address conflicts of interest concerns. For example, some private fund advisers and their related persons charge a number of fees and expenses to the fund's portfolio companies, and it may be difficult for investors to track fee streams that flow to the adviser or its related persons and reduce the return on their investment.

See

Proposing Release,

supra

footnote 3, at section I.

Investors will also benefit from increased transparency into how private fund performance is calculated. Currently, private fund advisers use different metrics and specifications for calculating performance, which makes it difficult for investors to compare data across funds and advisers, even when advisers disclose the assumptions they used. More standardized requirements for performance metrics will allow private fund investors to compare more effectively the returns of similar fund strategies over different market environments and over time. In addition, they 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.

The Audit Rule.

The Commission is adopting the requirement that an SEC-registered adviser cause each private fund that it advises to undergo an annual audit; however, in a change from the proposal, we are requiring the audit to comply with the audit provision under 17 CFR 275.206(4)-2 of the Advisers Act (“rule 206(4)-2” “custody rule”).

To address the valuation concerns described above and more fully below,

we are requiring SEC-registered advisers to cause the private funds they manage to obtain an annual audit. By addressing the concerns that arise in the valuation process, the rule will help prevent fraud and deception by the adviser.

See infra

section II.C for a discussion of the comments on this part of the rule.

See infra

section II.C.

The Adviser-led Secondaries Rule.

The final rule will require SEC-registered advisers conducting an adviser-led secondary transaction to satisfy certain requirements; however, in a change from the proposal, advisers may obtain a fairness opinion

a valuation opinion under the final rule.

SEC-registered advisers conducting an adviser-led secondary transaction must

also prepare and distribute a written summary of any material business relationships between the adviser or its related persons and the independent opinion provider. By requiring that investors receive a third-party opinion and a written summary of any material business relationships before deciding whether to participate in an adviser-led secondary transaction, the final rule will help prevent investors from being defrauded, manipulated, and deceived when the adviser is on both sides of the transaction.

See infra

section II.C.8 for a discussion of the comments on this part of the rule.

The Restricted Activities Rule.

The final rule will address concerns about five activities with respect to private fund advisers.

In a change from the proposal, while the restricted activities rule (referred to as the prohibited activities rule in the proposal) prohibits advisers from engaging in certain activity, the final rule includes certain disclosure-, and in some cases, consent-based exceptions. As a result, advisers generally are not flatly prohibited from engaging in the following activities,

so long as they provide appropriate specified disclosure and, in some cases, obtain investor consent:

See infra

sections II.E and II.F for a discussion of the comments on this part of the rule.

As discussed in greater detail below, this does not change the applicability of any other disclosure and consent obligations, whether under law, rule, regulation, contract, or otherwise. For example, the adviser, as a fiduciary, is obligated to act in the fund's best interest and to make full and fair disclosure of all conflicts and material facts which might incline an investment adviser—consciously or unconsciously—to render advice which is not disinterested such that a client can provide informed consent to the conflict.

See

2019 IA Fiduciary Duty Interpretation,

supra

footnote 5.

○ Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser or its related persons by any governmental or regulatory authority; however, regardless of any disclosure or consent, an adviser may not charge or allocate fees and expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction for violating the Investment Advisers Act of 1940 or the rules promulgated thereunder;

○ Charging or allocating to the private fund any regulatory or compliance fees or expenses, or fees or expenses associated with an examination, of the adviser or its related persons;

○ Reducing the amount of an adviser clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders;

○ 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, where such non-pro rata allocation is fair and equitable; and

○ Borrowing money, securities, or other private fund assets, or receiving a loan or an extension of credit, from a private fund client.

In a change from the proposal, we are not adopting the prohibition on fees for unperformed services because we believe this activity generally already runs contrary to an adviser's obligations to its clients under the Federal fiduciary duty. We are also not adopting the indemnification prohibition that we proposed because much of the activity that it would have prohibited is already prohibited by the Federal fiduciary duty and antifraud provisions.

The Preferential Treatment Rule.

The Commission is adopting a preferential treatment rule that prohibits advisers from providing preferential treatment with respect to redemption rights and portfolio holdings or exposure information, in each instance, that the adviser reasonably expects would have a material, negative effect on other investors, and requires disclosure of all other types of preferential treatment.

In a change from the proposal, the final rule includes certain exceptions from the redemptions prohibition (

i.e.,

if the redemption right is required by law or offered to all other existing investors) and information prohibition (

i.e.,

if the information is offered to all other existing investors) and limits the proposed requirement to provide advance written notice of preferential treatment to only apply to material economic terms (as opposed to all investment terms). Like the proposal, however, the final rule requires advisers to provide comprehensive post-investment disclosure.

See infra

section II.G for a discussion of the comments on this part of the rule.

We are also adopting the preferential treatment rule, in part, because all investors will benefit from increased transparency regarding the preferred terms granted to certain investors in the same private fund (

e.g.,

seed investors, strategic investors, those with large commitments, and employees, friends, and family). In some cases, these terms materially disadvantage other investors in the private fund or otherwise impact the terms applicable to their investment.

This new rule will help investors better understand marketplace dynamics and potentially improve efficiency for future investments, for example, by expediting the process for reviewing and negotiating adviser's fees and expenses.

See, e.g., Securities and Exchange Commission

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

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).

The Annual Review Rule.

As proposed, the final rule will amend the annual review component of Advisers Act rule 206(4)-7 (“compliance rule”) to require all SEC-registered advisers to document their annual review in writing, and we are adopting this rule as proposed.

We are adopting this requirement for two key reasons. First, written documentation of the annual review may help advisers better assess whether they have considered any compliance matters that arose during the previous year, any changes in the adviser's or an affiliate's business activities during the year, and any changes to the Advisers Act or other rules and regulations that may suggest a need to revise an adviser's policies and procedures. Second, the availability of written documentation of the annual review should allow the Commission and the Commission staff to determine if the adviser is regularly reviewing the adequacy of the adviser's policies and procedures.

See infra

section III for a discussion of the comments on this part of the rule.

The Recordkeeping Rule.

As proposed, the final rule will amend the Advisers Act recordkeeping rule to require advisers who are registered or required to be registered to retain books and records related to the quarterly statement rule, the audit rule, the adviser-led secondaries rule, and the preferential treatment rule.

In a change from the proposal, we are also amending the Advisers Act recordkeeping rule to require advisers who are registered or required to be registered to retain books and records related to the restricted activities rule.

We are adopting these requirements to enhance advisers' internal compliance efforts and to facilitate the Commission's enforcement and examination capabilities by improving our staff's ability to assess an adviser's compliance with the final rule.

See infra

sections II.B.6, II.C.8, II.D.5, and II.G.6 for discussions of the comments on this part of the rule.

The recordkeeping requirements associated with the restricted activities rule align with the modifications from the prohibited activities rule in the proposal. See

infra

section II.E for a discussion of the comments on this part of the rule.

C. The Commission Has Authority To Adopt the Rules

The Commission regulates investment advisers under the Advisers Act.

For the reasons we discussed in the Proposing Release and throughout this release, our adoption of these private fund adviser rules is a proper exercise of our rulemaking authority under the Advisers Act to prevent fraudulent, deceptive, and manipulative conduct, facilitate the provision of simple and clear disclosures to investors, and prohibit or restrict certain sales practices, conflicts of interest, and compensation schemes.

Under Federal law, an investment adviser is a fiduciary, and this fiduciary duty is made enforceable by the antifraud provisions of the Advisers Act.

See

2019 IA Fiduciary Duty Interpretation,

supra

footnote 5.

See

Advisers Act, sections 206 and 211(h).

We have authority under section 206(4) to adopt rules “reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive or manipulative.”

Among other things, section 206(4) permits the Commission to adopt prophylactic rules against conduct that is not itself necessarily fraudulent.

The Dodd-Frank Act expanded the Commission's oversight responsibility for private fund advisers.

It also added section 211(h) of 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 “examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.”

As applied here, a sales practice includes any conduct by an investment adviser, or on its behalf, to induce or solicit a person to invest, or continue to invest, in a private fund client advised by the adviser or its related persons. For instance, an adviser offering preferential terms to certain private fund investors to attract, or retain, their investment in the private fund is a “sales practice.” As the Commission has previously stated, a conflict of interest means an interest that might incline an adviser, consciously or unconsciously, to render advice that is not disinterested.

Conflicts of interest can arise when an adviser's own interests conflict with, or are otherwise different than, its client's interests or when the interests of different clients conflict.

For instance, an adviser has a conflict of interest in an adviser-led secondary transaction because the adviser and its related persons typically are involved on both sides of the transaction. As applied here, a compensation scheme includes any arrangement through which an investment adviser is compensated—directly or indirectly—for providing services to its clients (

e.g.,

performance-based compensation). An example of a problematic compensation scheme is when an adviser opportunistically values a private fund to increase the adviser's compensation.

15 U.S.C. 80b-6(4).

S. REP. NO. 1760, 86th Cong., 2d Sess. 4, 8 (1960). The Commission has used this authority to adopt several rules addressing abusive marketing practices, political contributions by investment advisers, proxy voting, compliance procedures and practices, deterring fraud with respect to pooled investment vehicles, and custodial arrangements including an audit provision. Rule 206(4)-1; 275.206(4)-2; 275.206(4)-6; 275.206(4)-7; and 275.206(4)8. Section 206(4) was added to the Advisers Act in Public Law 86-750, 74 Stat. 885, at sec. 9 (1960).

See

H.R. REP. NO. 2197, 86th Cong., 2d Sess., at 7-8 (1960) (“Because of the general language of section 206 and the absence of express rulemaking power in that section, there has always been a question as to the scope of the fraudulent and deceptive activities which are prohibited and the extent to which the Commission is limited in this area by common law concepts of fraud and deceit . . . [Section 206(4)] would empower the Commission, by rules and regulations to define, and prescribe means reasonably designed to prevent, acts, practices, and courses of business which are fraudulent, deceptive, or manipulative. This is comparable to Section 15(c)(2) of the Securities Exchange Act [15 U.S.C. 78o(c)(2)] which applies to brokers and dealers.”).

See also

S. REP. NO. 1760, 86th Cong., 2d Sess., at 8 (1960) (“This [section 206(4) language] is almost the identical wording of section 15(c)(2) of the Securities Exchange Act of 1934 in regard to brokers and dealers.”). The Supreme Court, in

United States

O'Hagan,

interpreted nearly identical language in section 14(e) of the Securities Exchange Act [15 U.S.C. 78n(e)] as providing the Commission with authority to adopt rules that are “definitional and prophylactic” and that may prohibit acts that are “not themselves fraudulent . . . if the prohibition is `reasonably designed to prevent . . . acts and practices [that] are fraudulent.' ”

United States

O'Hagan,

521 U.S. 642, 667, 673 (1997). The wording of the rulemaking authority in section 206(4) remains substantially similar to that of section 14(e) and section 15(c)(2) of the Securities Exchange Act.

See also

Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Investment Advisers Act Release No. 2628 (Aug. 3, 2007) [72 FR 44756 (Aug. 9, 2007)] (“Prohibition of Fraud Adopting Release”) (stating, in connection with the suggestion by commenters that section 206(4) provides us authority only to adopt prophylactic rules that explicitly identify conduct that would be fraudulent under a particular rule, “We believe our authority is broader. We do not believe that the commenters' suggested approach would be consistent with the purposes of the Advisers Act or the protection of investors.”).

See

the discussion of the Dodd-Frank Act above in the introductory portion of section I.

Dodd-Frank Act, section 913(g).

See

2019 IA Fiduciary Duty Interpretation,

supra

footnote 5, at 23.

See id.,

at 26.

Sections 206(4) and 211(h) of the Advisers Act are the principal authority for all of the five new rules to regulate the activities of investment advisers to private funds. The new rules are within the Commission's legal authority under those sections of the Advisers Act as a means reasonably designed to prevent fraudulent or deceptive acts and practices, facilitate simple and clear disclosures to investors, and prohibit or restrict certain sales practices, conflicts of interest, and compensation schemes in the market for advisory services to private funds. The quarterly statement rule is designed to facilitate the provision of simple and clear disclosures to private fund investors regarding some of the most important and fundamental terms of their relationships with investment advisers—namely what fees and expenses those investors will pay and what performance they receive for their private fund investments. The audit rule is designed to help prevent the fraud, deception, or manipulation that might result from material misstatements in financial statements, and it is intended to address the conflicts of interest and potential compensation schemes that may result from an adviser valuing assets and charging fees related to those assets. When advisers offer investors the choice between selling and exchanging their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons as part of an adviser-led secondary transaction, advisers have a conflict of interest with the fund and its investors, and the adviser-led secondaries rule is designed to address this concern. The restricted activities rule is designed to prohibit certain activities that involve conflicts of interest and compensation schemes that are contrary to the public interest and the protection of investors unless such activities are disclosed to, and in some cases, consented to, by investors. Finally, the preferential treatment rule addresses our concern that an adviser's current sales practices do not provide all investors with sufficient detail regarding preferential terms granted to other investors, and we believe that disclosure (and in some cases prohibition) of preferential treatment is necessary to guard against fraudulent and deceptive practices. We have examined a range of alternatives to

our proposal, carefully considered all comments, and made revisions to the proposed rules where we concluded it was appropriate. The final rules represent an appropriate response to the developments we discuss above regarding the market for private fund advisory services.

Some commenters supported the Commission's legal foundation for the rulemaking.

For example, one commenter stated that all of the reforms in the proposal are fully within the Commission's ample legal authority to regulate advisers.

Another commenter emphasized that, importantly, the Commission's legal authority under section 211(h) is broad.

Other commenters, however, questioned the Commission's authority to promulgate the proposed rules

and argued that the rules undermine congressional intent regarding the regulation of private funds.

Some commenters argued that Congress, in drafting section 913(g) of the Dodd-Frank Act,

did not intend to apply section 211(h) of the Advisers Act to private fund advisers and instead intended this section to only apply to retail investors.

Commenters also stated that the legislative history surrounding section 913(g) and section 211(h) support a narrower reading that limits these provisions to retail customers and clients.

Another commenter stated that Congress would have provided clear congressional authorization to empower the Commission to materially alter the regulatory regime for private funds if it intended to do so.

See, e.g.,

Consumer Federation of America Comment Letter; Better Markets Comment Letter.

See

Better Markets Comment Letter.

See

Consumer Federation of America Comment Letter.

See, e.g.,

Comment Letter of Stuart Kaswell (Apr. 18, 2022) (“Stuart Kaswell Comment Letter”); Comment Letter of the Center for Capital Markets Competitiveness, U.S. Chamber of Commerce (Apr. 25, 2022) (Chamber of Commerce Comment Letter”); Comment Letter of the Managed Funds Association (Apr. 25, 2022) (“MFA Comment Letter I”); Comment Letter of American Investment Council (July 27, 2022) (“AIC Comment Letter III”).

See, e.g.,

Comment Letter of Brian Cartwright, Jay Clayton, Joseph A. Grundfest, Paul G. Mahoney, Harvey L. Pitt, Adam Pritchard, James S. Spindler, Robert B. Stebbins, J.W. Verret, and Charles Whitehead (Apr. 25, 2022) (“Cartwright et al. Comment Letter”); MFA Comment Letter I (stating that the legislative history surrounding Section 211(h), and Section 913 of the Dodd-Frank Act demonstrates that Section 211(h) was clearly intended to address the relationship between retail clients and their advisers).

Section 913(g)(2) of the Dodd-Frank Act added section 211(h) to the Advisers Act.

See, e.g.,

AIMA/ACC Comment Letter; MFA Comment Letter I (stating that Section 913 focused on harmonizing and standardizing the standard of conduct with respect to retail customers and clients and therefore section 913(g) should also be narrowly interpreted to apply to this subset of the investor community). Another commenter asserted that, in amending the Advisers Act to add section 211(h), it was intended to only apply to retail customers because it was part of section 913 of the Dodd-Frank Act and, further, that this interpretation is supported by section 913 of the Dodd-Frank Act permitting promulgation of a best interest standard for retail customers under the section 211(g) amendment to the Advisers Act to include certain terms that this commenter asserted would be restricted by this rulemaking but permitted under section 211(g).

See

Comment Letter of the Committee on Private Investment Funds and the Committee on Investment Management Regulation of the New York City Bar Association (Apr. 25, 2022) (“NYC Bar Comment Letter II”) (pointing to section 211(g) stating under such a best interest standard “any material conflicts of interest shall be disclosed and may be consented to by the customer” and “receipt of compensation based on commission or fees shall not, in and of itself, be considered a violation of such standard”).

See, e.g.,

AIMA/ACC Comment Letter; MFA Comment Letter I. Some commenters stated that analysis of provisions in section 913 of the Dodd-Frank Act supports a reading that it was enacted in response to a concern that retail investors did not appreciate the distinction between broker-dealers and advisers.

See, e.g.,

Stuart Kaswell Comment Letter; NYC Bar Comment Letter II.

See

AIC Comment Letter III. We disagree. For the reasons discussed in the Proposing Release and throughout this release, our adoption of these private fund adviser rules is a proper exercise of our rulemaking authority under the Advisers Act to prevent fraudulent, deceptive, and manipulative conduct, facilitate the provision of simple and clear disclosures to investors, and prohibit or restrict certain sales practices, conflicts of interest, and compensation schemes. This commenter also asserted that before finalizing a number of rulemaking proposals affecting private fund advisers, including the proposal underlying this final rule, we must (i) “publish a reasonable assessment of the cumulative effects” of these rules, (ii) reopen the comment periods for these rules “to provide the public an opportunity to assess holistically the Commission's proposals”, and (iii) “with the benefit of an appropriate analysis and public comment,” finalize these rules “holistically” taking into account “not just the expected effects on investors and our capital markets but also practical realities such as adoption timelines as well as information technology requirements.” Comment Letter of the American Investment Council (Aug. 8, 2023) (“AIC Comment Letter IV”). This commenter asserted that failing to do so “would be a violation of the Commission's obligations under the Administrative Procedures Act.” The effects of any final rule may be impacted by recently adopted rules that precede it. Accordingly, each economic analysis in each adopting release considers an updated economic baseline that incorporates any new regulatory requirements, including compliance costs, at the time of each adoption, and considers the incremental new benefits and incremental new costs over those already resulting from the preceding rules. That is, the economic analysis appropriately considers existing regulatory requirements, including recently adopted rules, as part of its economic baseline against which the costs and benefits of the final rule are measured.

See infra

sections VI.C, VI.D.1, and VI.E.2 below.

Section 913 of the Dodd-Frank Act contains numerous sub-parts, several of which specifically pertain to “retail customers,” which Congress defined as “a natural person, or the legal representative of such natural person, who (1) receives personalized investment advice about securities from a broker or dealer or investment adviser; and (2) uses such advice primarily for personal, family, or household purposes.”

Congress also mentioned private fund investors in Section 913, specifically indicating in adding section 211(g) of the Advisers Act that “the Commission shall not ascribe a meaning to the term `customer' that would include an investor in a private fund[.]”

In the same provision, in adding section 211(h) of the Advisers Act entitled “Other Matters,” Congress spoke of “investors,” and in so doing gave no indication that it was referring to “retail customers,” a term it had defined and used in various other sub-parts.

The “Other Matters” provision likewise contains no instruction to the Commission to include or exclude private fund investors from the term “investors”; in fact, it does not mention “private fund investors” at all.

This provision makes no mention of “retail” customers, “retail” clients, or “retail” investors, and therefore does not by its plain meaning apply to only

retail

investors. While commenters seek to read a “retail” limitation into the statute, that view is unsupported by the plain text of the statute.

Dodd-Frank Act, Section 913(a).

Dodd-Frank Act, Section 913(g)(2).

Id.

Another commenter similarly argued that, because Congress added section 211(e) to the Advisers Act requiring the promulgation of rules to establish the form and content of certain reports regarding private funds required to be filed with the Commission under subsection 204(b) of the Advisers Act, it “is inconceivable that Congress intended Section 211(h) to grant the broad private fund disclosure authority it claims when Congress spoke with such precision [in adding section 211(e)] within the same section of the Advisers Act.”

Contrary to this commenter's assertion, we find again that the juxtaposition of such provisions within the amendments Congress made to 211 of the Advisers Act show Congress knew when it wanted to limit a provision to private fund advisers, when it wanted to limit a provision to retail customers, and when it wanted to apply a provision to all investment advisers and investors. Another commenter asserted that Congress only intended to regulate the activities of private funds and their investment advisers in Title IV of the Dodd-Frank Act, and not in Title IX of the Dodd-Frank Act, and thus section 211(h) cannot be read to apply to private fund

advisers.

We disagree. While Title IV contains a number of provisions specific to private fund advisers, there are many other provisions of the Dodd-Frank Act applicable to private fund advisers outside of that title, and while Title IX contains provisions that affect all investment advisers, there is no indication that Congress intended to restrict its coverage to exclude private fund advisers except where it explicitly does so.

See

Stuart Kaswell Comment Letter II.

See

NYC Bar Comment Letter II.

For example, there is nothing limiting the remit of the Investor Advisory Committee mandated by section 911 of the Dodd-Frank Act from considering investors in private funds and section 911 requires that such committee include representation of the interests of institutional investors, including pension funds, and thus many of the investors in private funds. There is also nothing to suggest the study of the examination of investment advisers under section 914 of the Dodd-Frank Act should exclude examination of private fund advisers. Finally, there is nothing under section 915 of the Dodd-Frank Act (codified as section 4(g) of the Exchange Act), which mandated the creation of an Investor Advocate at the Commission, to limit its remit to non-private fund advisers—indeed section 915 of the Dodd-Frank Act specifically refers to “retail investors” in some subsections and “investors” in others, showing Congress chose the application of its directives and grants of authority quite specifically.

Compare

section 4(g)(4)(A) of the Exchange Act (providing the Investor Advocate shall “assist retail investors in resolving significant problems such investors may have with the Commission or self-regulatory organizations”) with section 4(g)(4)(B) of the Exchange Act (providing the Investor Advocate shall “identify areas in which investors would benefit from changes in the regulations of the Commission or the rules of self-regulatory organizations”).

Some commenters challenged our ability to rely on sections 211(h) and 206 of the Advisers Act on the grounds that our use of such authority directly conflicts with Congress's intent in enacting the Investment Company Act of 1940 (“Investment Company Act”).

Specifically, commenters stated that the rules are an attempt to regulate private funds despite the fact that Congress explicitly excluded such funds from the definition of an “investment company” and therefore excluded them from regulation under the Investment Company Act. The final rules, however, regulate the activities of investment advisers to private funds, over whom the Commission has been given substantial authority, while the substantive provisions of the Investment Company Act, and rules thereunder, regulate investment companies. These final rules are not an indirect mechanism for regulating private funds because the rules focus on the adviser and do not apply to or restrict the private fund itself. For example, the rules do not dictate or limit the ability of private funds to engage in excessive leverage or borrowing,

do not regulate fund payment of redemption proceeds or require funds to comply with specific rules to maintain liquidity sufficient to meet redemptions,

do not regulate layering of fees or fund structures,

or changes in investment policies,

and do not impose a governance structure

the way that the Investment Company Act, and rules thereunder, impose such limitations on registered funds and their operations.

See, e.g.,

Comment Letter of the Loan Syndications and Trading Association (Apr. 25, 2022) (“LSTA Comment Letter”); Comment Letter of Citadel (May 3, 2022) (“Citadel Comment Letter”).

See

15 U.S.C. 80a-18 and 17 CFR 270.18c-1, 17 CFR 270.18c-2, 17 CFR 270.18f-1, 17 CFR 270.18f-2, and 17 CFR 270.18f-4 under the Investment Company Act.

See

15 U.S.C. 80a-22 and 17 CFR 270.22e-4 under the Investment Company Act.

See

15 U.S.C. 80a-12.

See

15 U.S.C. 80a-13.

See

15 U.S.C. 80a-10 (independence of directors) and 15 U.S.C. 80a-16 (election of directors).

One commenter stated that Congress amended the Advisers Act to address private fund adviser registration and did not authorize a disclosure system for private funds or allow the Commission to circumvent that by putting the obligation on advisers.

We disagree. In amending the Advisers Act in connection with requiring most private fund advisers to register, Congress enacted other requirements specific to private fund advisers. For example, section 204(b) of the Act, entitled “Records and Reports of Private Funds,” specifically authorizes the Commission to require registered investment advisers to maintain such records of, and file with the Commission such reports regarding, private funds advised by the investment adviser, as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk by the Financial Stability Oversight Council and to provide or make available to the Council those reports or records or the information contained therein. It further provides that the records and reports of any private fund to which an investment adviser registered under this title provides investment advice shall be deemed to be the records and reports of the investment adviser. Congress thus appears to have squarely contemplated, for example, that reports regarding private funds would be achieved by putting the obligation on advisers. Even further, in amending the Advisers Act to require registration of private fund advisers, Congress did not mandate or restrict the Commission from applying rules adopted under the Advisers Act to these advisers. It did not indicate that a registered private fund adviser should be more or less subject to the Commission's rules under the Advisers Act than any other registered adviser simply because its clients are private funds.

Where Congress intended for certain private fund advisers to be treated differently from other registered investment advisers, it has been specific.

See

Stuart Kaswell Comment Letter.

See, e.g.,

17 CFR 275.204A-1 (rule 204A-1) (requiring registered advisers to adopt codes of ethics); 17 CFR 275.205-3 (permitting investment advisers to charge performance fees to certain clients); 17 CFR 275.206(4)-1 (rule 206(4)-1) (regulating registered adviser marketing); rule 206(4)-2 (regulating the custody practices of registered advisers); 17 CFR 275.206(4)-5 (rule 206(4)-5) (prohibiting registered advisers and certain advisers exempt from registration from engaging in certain pay to play activities); rule 206(4)-8 (prohibiting advisers to pooled investment vehicles from making false or misleading statements to, or otherwise defrauding, investors or prospective investors in those pooled vehicles).

For example, the various exemptions in section 203(b), the venture capital exemptions in section 203(l), and the private fund exemption in section 203(m).

See also

section 211(a) of the Act (“The Commission shall have authority from time to time to make, issue, amend, and rescind such rules and regulations and such orders as are necessary or appropriate to the exercise of the functions and powers conferred upon the Commission elsewhere in this title, including rules and regulations defining technical, trade, and other terms used in this title, except that the Commission may not define the term `client' for purposes of paragraphs (1) and (2) of section 206 to include an investor in a private fund managed by an investment adviser, if such private fund has entered into an advisory contract with such adviser.”)

Some commenters stated that the rules are inconsistent with precedent treating the Advisers Act as a disclosure-based regime, that the 2019 IA Fiduciary Duty Interpretation re-affirmed the practice of consent through disclosure, and that the Commission is abandoning this approach in favor of acting as a merit regulator.

The Advisers Act sets forth specific requirements for advisers, including advisers to private funds, and confers specific rulemaking authority to the Commission in sections 206(4) and 211(h). Nowhere in these sections or in the Advisers Act more broadly did Congress provide that the Advisers Act is purely a disclosure-based regime or that the Commission's rulemaking authority with respect to the Advisers Act is limited to disclosure-based rules. Furthermore, other statutory provisions of the Advisers Act are explicit when restricting the Commission's rulemaking authority to require disclosure compared to imposing other obligations. Indeed, while section 211(h)(1) of the Act specifies that the Commission shall facilitate the provision of certain

disclosures, the very next subsection (section 211(h)(2) of the Act) provides that the Commission shall examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes. The authority granted to the Commission under section 206(4) of the Act, which enables the Commission to promulgate rules to define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative, also makes no mention of disclosure.

See, e.g.,

Comment Letter of American Investment Council (June 13, 2022) (“AIC Comment Letter II”); SIFMA-AMG Comment Letter I.

Similarly, the 2019 IA Fiduciary Duty Interpretation addressed advisers' fiduciary duties to their fund clients but did not state or seek to imply that advisers to private funds were otherwise exempt from the specifically worded provisions in the Advisers Act. We are not seeking to amend or change the Commission's existing rules or past interpretations of the Advisers Act with respect to private fund advisers. Rather, in this rulemaking, we are seeking to employ the rulemaking authority in sections 206(4) and 211(h) of the Act, as Congress set forth, to address the types of harms Congress specifically identified in those sections.

Other commenters argued that the Commission cannot rely on section 206 because the Commission has neither proposed to define fraudulent practices nor demonstrated how the rules would prevent fraud.

Section 206(4) gives the Commission the authority to prescribe means reasonably designed to prevent fraud, and we are employing the authority that Congress provided us in section 206(4). As detailed below in the discussion of the final rules in section II of the release, the rules we are adopting today are reasonably designed to prevent fraud, deception, or manipulation because, for example, requiring advisers to provide enhanced disclosure around potential and actual conflicts of interest decreases the likelihood that investors will be defrauded by certain practices, many of which involve conflicts of interest.

In addition, preventing advisers from engaging in certain activities, in some cases unless they provide disclosure, is another means to prevent fraud, deception, or manipulation.

See, e.g.,

Citadel Comment Letter (discussing indemnification clauses); NYC Bar Comment Letter II.

The audit rule increases the likelihood that fraudulent activity or problems with valuation are uncovered, thereby deterring advisers from engaging in fraudulent conduct. Similarly, the quarterly statement rule increases the likelihood that fraudulent activity or problems with fees, expenses, and performance are uncovered, thereby deterring advisers from engaging in fraudulent conduct. The adviser-led secondaries rule is designed to ensure that the private fund and investors that participate in the secondary transaction are offered a fair price, which is a critical component of preventing the type of harm that might result from the adviser's conflict of interest in leading the transaction. The restricted activities rule and preferential treatment rule prevent advisers from engaging in certain activities that could result in fraud and investor harm, unless advisers make appropriate disclosures or obtain consent, as applicable.

Some commenters stated that the “sales practices,” “conflicts of interest” and “compensation schemes” referenced in section 211(h) should be read and understood all together in the context of an advisory relationship, not as a list of distinct items, but as sales practices that lead to conflicts of interest with associated compensation schemes, and that the word “certain” also underscores the limited reach of these terms' combined meaning.

100

These commenters' reading would effectively eliminate “conflicts of interest” and “compensation schemes” from the statutory language and reduce section 211(h)(2) to refer only to certain sales practices. We see no basis for reading out of the statute words Congress specifically chose to include. First, by providing a specific list of items in section 211(h) that the Commission “shall examine and, where appropriate, promulgate rules,” Congress intended for the Commission to address this particularized set of scenarios—“sales practices, conflicts of interest, and compensation schemes”—via rulemaking. Accordingly, we have sought to identify clearly which of these scenarios we are attempting to address in each rule that is based on our rulemaking authority under section 211(h). Second, we agree that “certain” indicates that 211(h) does not apply to all sales practices, conflicts of interest and compensation schemes, but rather only those that, after examination, the Commission deems contrary to the public interest and protection of investors. Following our examination, as described in this release, these rules aim to restrict only sales practices, conflicts of interest and compensation schemes that we believe are harmful to investors. There are other examples of sales practices, conflicts of interest and compensation schemes in the private fund industry that are not addressed in this rulemaking, some of which we do not currently view as rising to the level of concern set forth in section 211(h).

100

See, e.g.,

Comment Letter of American Investment Council (Apr. 25, 2022) (“AIC Comment Letter I”); Citadel Comment Letter.

Some commenters offered their own interpretations of the term “sales practices.”

101

A commenter interpreted the plain meaning of “sales practice” to be “a mode or method of making sales,”

102

while another commenter interpreted “sales practice” to be “a repeated or customary manner of promoting or selling goods.”

103

Some commenters suggested cold calling as an example of a “sales practice.”

104

Yet another commenter interpreted “sales practice” to apply only to “an adviser's marketing or promotion of its funds.”

105

We agree that such interpretations involve a sales practice, and we have taken them into consideration in interpreting this term. Our interpretation is appropriate because it is sufficiently broad to capture sales practices as they continue to evolve in the industry but not so broad as to capture operational activities that are independent of sales functions. Likewise, our interpretation of “sales practice” is not so narrow that it would exclude conduct that should be within scope. For example, the term would not exclude conduct because it is not “repeated” or “customary.” Similarly, it would not exclude activity that follows a period of marketing or promotion when an adviser takes steps to effectuate an investment.

101

See, e.g.,

Comment Letter of Haynes and Boone, LLP (Apr. 25, 2022) (“Haynes & Boone Comment Letter”); Comment Letter of Committee on Capital Market Regulation (Oct. 17, 2022) (“CCMR Comment Letter II”); Citadel Comment Letter.

102

See

AIC Comment Letter I.

103

See

CCMR Comment Letter II.

104

See, e.g.,

AIC Comment Letter I; Citadel Comment Letter.

105

See

Haynes & Boone Comment Letter.

Likewise, the staff has broadly interpreted the term “compensation,” explaining that “the receipt of any economic benefit, whether in the form of an advisory fee or some other fee relating to the total services rendered, commissions, or some other combination of the foregoing” would satisfy the “for compensation” prong of the definition of investment adviser set forth in Section 202(a)(11) of the Advisers Act.

106

A commenter suggested that fees and expenses being passed on to investors, such as accelerated monitoring fees, costs related to governmental or regulatory investigations, compliance expenses, and costs related to obtaining external financing, should be characterized as “compensation schemes.”

107

Another

commenter suggested that we distinguish between “compensation” and “reimbursement” for purposes of defining a “compensation scheme.”

108

Previously, our staff has explained that the receipt of any economic benefit to a person providing a variety of services to a client, including investment advisory services, qualifies as “compensation.”

109

It has consistently recognized that reimbursements covering only the cost of services are “compensation.”

110

And staff has viewed “compensation” as including indirect payments for investment advisory services.

111

We similarly broadly interpret the term “compensation scheme” for purposes of this rulemaking to include any manner in which an investment adviser is compensated and receives economic benefit—directly or indirectly—for providing services to its clients.

112

106

Applicability of the Advisers Act of 1940 to Financial Planners, Pension Consultants, and Other Persons Who Provide Others with Investment Advice as a Component of Other Financial Services, Investment Advisers Act Release No. 1092 (Oct. 8, 1987) (“Release 1092”).

See also

SIFMA-AMG Comment Letter I.

133

AIMA/ACC Comment Letter.

134

See, e.g.,

BVCA Comment Letter; Invest Europe Comment Letter.

135

See

Exemptions Adopting Release,

supra

footnote 9, at 77 (stating that disregarding an offshore adviser's activities for purposes of the private fund adviser exemption reflects our long-held view that non-U.S. activities of non-U.S. advisers are less likely to implicate U.S. regulatory interests and that this territorial approach is in keeping with general principles of international comity);

See also

Comment Letter of NASAA on Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles; Accredited Investors in Certain Private Investment Vehicles (Dec. 27, 2006) (“NASAA supports the application of the proposed rule to advisers registered or required to register at the state level.”).

145

See, e.g.,

NASAA Comment Letter (stating that “the Proposal appropriately prohibits these activities for all PFAs [private fund advisers], not only those registered or required to be registered with the SEC”); Healthy Markets Comment Letter I; Consumer Federation of America Comment Letter (both stating that the prohibited activities rule should also apply with respect to an offshore private fund managed by an offshore SEC-registered investment adviser where such fund has U.S. investors).

We are not narrowing the scope of the restricted activities and preferential treatment rules to exclude ERAs, State-regulated advisers, advisers relying on the foreign private adviser exemption, or advisers that are otherwise unregistered. The sales practices, conflicts of interest, and compensation schemes addressed by the restricted activities rule and the preferential treatment rule can lead to advisers placing their interests ahead of their clients' (and, by extension, their investors') interests, and can result in significant harm to the private fund and its investors. As a result, all of these advisers are subject to the restricted activities rule and the preferential treatment rule. A number of our enforcement cases against advisers to private funds based on conflicts of interests have been brought against advisers that are not registered under the Advisers Act,

146

and we believe this demonstrates a need to apply these rules to unregistered private fund advisers.

147

146

See, e.g., In the Matter of SparkLabs Global Ventures Management, LLC,

Investment Advisers Act Release No. 6121 (Sept. 12, 2022) (settled action) (alleging unregistered advisers that managed private funds breached their fiduciary duty by causing private fund clients to lend to each other in violation of the funds' governing documents and failing to disclose conflicts of interest to the funds);

In the Matter of Augustine Capital Management, LLC,

Investment Advisers Act Release No. 4800 (Oct. 26, 2017) (settled action) (alleging unregistered private fund adviser caused the fund client to engage in conflicted transactions, including investments and loans, without disclosure to or consent by investors);

In the Matter of Alumni Ventures Group, LLC,

Investment Advisers Act Release No. 5975 (Mar. 4, 2022) (settled action) (alleging exempt reporting adviser that managed private funds breached its fiduciary duty by causing private fund clients to lend to each other in violation of the funds' governing documents and failing to disclose conflicts of interest to the fund investors).

147

This approach is consistent with another rule adopted under section 206 of the Advisers Act, rule 206(4)-5, which applies to SEC-registered advisers, advisers relying on the foreign private adviser exemption, and ERAs. Rule 206(4)-5 was intended to combat pay-to-play arrangements in which advisers are chosen based on their campaign contributions to political officials rather than on merit. Rule 206(4)-5 applies to an investment adviser registered (or required to be registered) with the Commission or unregistered in reliance on the exemption available under section 203(b)(3) of the Advisers Act, or that is an exempt reporting adviser, as defined in rule 17 CFR 275.204-4(a) under the Advisers Act.

Investment Advisers to Securitized Asset Funds

The final quarterly statement, restricted activities, adviser-led secondaries, preferential treatment, and audit rules do not apply to investment advisers with respect to securitized asset funds (we refer to these advisers,

solely with respect to the securitized asset funds they advise, as “SAF advisers”). These advisers will not be required to comply with the requirements of the final rules solely with respect to the securitized asset funds (“SAFs”) that they advise.

148

If an investment adviser that is a SAF adviser also advises other private funds that are not securitized asset funds, the investment adviser will be subject to the final rules with respect to such other private funds.

Some commenters requested for all or some of the proposed rules not to apply to advisers to securitization vehicles or vehicles that issue asset-backed securities (in particular, collateralized loan obligations (“CLOs”)).

149

One commenter stated that the Commission did not identify specific concerns with SAFs, the rules were generally not applicable to SAFs, and that the rules did not address or contemplate the critical differences between these types of vehicles and other private funds.

150

Another commenter stated that, although SAFs are private funds, their structure and purpose are sufficiently distinct from other types of funds that their advisers should be exempt from the rules.

151

This commenter stated that SAFs are unlike private funds in several ways, including because: (i) SAFs do not issue equity but rather issue notes at various seniorities that entitle holders to interest payments and ultimate repayment of principal; (ii) SAFs do not have general partners affiliated with their advisers but rather have unaffiliated trustees as fiduciary agents of the SAF investors; and (iii) their notes are held in street name and traded such that an adviser does not necessarily know who the noteholders are.

152

149

See

Comment Letter of Ropes & Gray LLP (Apr. 25, 2022) (“Ropes & Gray Comment Letter”); LSTA Comment Letter; SIFMA-AMG Comment Letter I; Comment Letter of Teachers Insurance and Annuity Association of America (Apr. 25, 2022) (“TIAA Comment Letter”); Comment Letter of Fixed Income Investor Network (Apr. 29, 2022) (“Fixed Income Investor Network Comment Letter”); PIFF Comment Letter; Comment Letter of Structured Finance Association (Apr. 25, 2022) (“SFA Comment Letter I”). Although commenters generally focused on the application of the proposed rules to CLOs, certain commenters clarified that their comments applied also more broadly to securitization vehicles and vehicles that issue asset-backed securities.

See

LSTA Comment Letter; SFA Comment Letter I; SIFMA-AMG Comment Letter I; PIFF Comment Letter.

150

See

LSTA Comment Letter.

151

See

Ropes & Gray Comment Letter.

152

See id.

After considering comments, we are not applying the five private fund adviser rules to SAF advisers.

153

This approach avoids subjecting SAF advisers to obligations that were designed to address conduct we have observed in other parts of the private fund advisers industry, including with respect to advisers to hedge funds, private equity funds, venture capital funds, real estate funds, credit funds, hybrid funds, and other non-securitized asset funds (“non-SAF advisers”). We believe that the certain distinguishing structural and operational features of SAFs have together deterred SAF advisers from engaging in the type of conduct that the final rules seek to address. We also believe that the advisory relationship for SAF advisers and their clients presents different regulatory issues than the advisory relationship for non-SAF advisers and their clients. The final rules generally are not designed to take into account these differences, which together sufficiently distinguish SAFs from other types of private funds to warrant this approach.

154

As a result, we do not believe that the private fund adviser rules we are adopting here are the appropriate tool to regulate SAF advisers.

153

Except as specified, we are not altering the applicability of the Advisers Act, or any rules adopted thereunder, to SAF advisers. For example, Section 206 and rule 206(4)-8 will continue to apply to SAF advisers with respect to SAFs (and any other private funds) they advise. We are also not limiting the scope of advisers subject to the Advisers Act compliance rule and thus all SEC-registered advisers, including SEC-registered SAF advisers, must document the annual review of their compliance policies and procedures in writing.

154

We will, however, continue to consider whether any additional regulatory action may be necessary with respect to SAF advisers in the future.

Definition of Securitized Asset Fund

The final rule will define SAF as “any private fund whose primary purpose is to issue asset backed securities and whose investors are primarily debt holders.”

155

This definition, which is based on the corresponding definition for “securitized asset fund” in Form PF and Form ADV, is designed to capture vehicles established for the purpose of issuing asset backed securities, such as collateralized loan obligations. SAFs are special purpose vehicles or other entities that “securitize” assets by pooling and converting them into securities that are offered and sold in the capital markets. The definition therefore will not capture traditional hedge funds, private equity funds, venture capital funds, real estate funds, and credit funds.

156

These private funds should not meet the definition because they typically have primarily equity investors, rather than debt investors, and/or they do not have a primary purpose of issuing asset backed securities. It is appropriate to apply the final rules to advisers with respect to these private funds because they present the concerns the final rules seek to address (

i.e.,

lack of transparency, conflicts of interest, and lack of governance).

155

See

final rule 211(h)(1)-1.

156

We recognize that certain private funds have, in recent years, made modifications to their terms and structure to facilitate insurance company investors' compliance with regulatory capital requirements to which they may be subject. These funds, which are typically structured as rated note funds, often issue both equity and debt interests to the insurance company investors, rather than only equity interests. Whether such rated note funds meet the SAF definition depends on the facts and circumstances. However, based on staff experience, the modifications to the fund's terms generally leave “debt” interests substantially equivalent in substance to equity interests, and advisers typically treat the debt investors substantially the same as the equity investors (

e.g.,

holders of the “debt” interests have the same or substantially the same rights as the holders of the equity interests). We would not view investors that have equity-investor rights (

e.g.,

no right to repayment following an event of default) as holding “debt” under the definition, even if fund documents refer to such persons as “debt investors” or they otherwise hold “notes.” Further, we do not believe that many rated note funds will meet the other prong of the definition (

i.e.,

a private fund whose primary purpose is to issue asset backed securities), because they generally do not issue asset-backed securities.

In the context of requesting that the rule not apply with respect to collateralized loan obligations, one commenter stated that the final rule should use the following definition: any special purpose vehicle advised by an investment adviser that (A) (i) issues tradeable asset-backed securities or loans, the debt tranches of which are rated; and (ii) has at least 80% of its assets comprised of leveraged loans and cash equivalents; (B) is required by its governing transaction documents to appoint an unaffiliated person to, among other things, (i) calculate certain overcollateralization and interest coverage tests; (ii) prepare and make available to investors reports on the CLO, and (iii) make the indenture readily available to investors; and (C) appoints an independent accounting firm to perform a series of agreed upon procedures. Another commenter, when requesting exemptions or other relief from the rules, generally referred to these vehicles as “special purpose vehicles that issue asset backed securities,” while another commenter used the term “collateralized loan obligations and similar credit securitization products.”

The definition in the final rule will include the types of funds described by these commenters. The definition of SAFs in the final rule, however, is one that many advisers are familiar with because it is used in both Form PF and Form ADV. For example, Item 7.B. and Schedule D of Form ADV ask whether the private fund is a securitized asset

fund or another type of private fund, such as a hedge fund or private equity fund.

157

Also, under Form PF, certain advisers to securitized asset funds are required to complete Section 1, which requires an adviser to report certain identifying information about itself and the private funds it advises.

158

We also chose this definition because it captures the core characteristics that differentiate these vehicles from other types of private funds: vehicles that issue asset-backed securities collateralized by an underlying pool of assets and that have primarily debt investors. Thus, as discussed above, traditional private funds, would not meet this definition.

159

157

See

Form ADV, Section 7.B.(1) and Schedule D Private Fund Reporting, Question 10.

158

See Form PF, Section 1a, Question 3.

159

We would also not view, depending on the facts and circumstances, private credit funds that borrow from third party lenders to enhance performance with fund-level leverage and invest in underlying loans alongside the equity investors as meeting this definition, even if they borrow an amount greater than the value of the equity interests they issue.

Distinguishing SAF Characteristics and Features

Although SAFs generally rely on the same exclusions from treatment as an “investment company” under the Investment Company Act as other types of private funds (

i.e.,

sections 3(c)(1) and (7) thereunder), we agree with commenters that certain fundamental structural and operational differences together sufficiently distinguish them from other types of private funds to warrant carving them out of the final rules. These fundamental differences, when considered in combination with the existing governance and transparency requirements of SAFs, would cause much of the rules to be generally inapplicable and/or ineffective with respect to achieving the rulemaking's goals. Below we provide examples of these distinguishing features and how they relate to certain aspects of the final rules.

We agree with commenters that SAFs have structural features that distinguish them from most other private funds that are relevant in assessing the benefit of an audit to investors. Commenters stated that Generally Accepted Accounting Principles (“GAAP”) financial statements are not typically considered relevant for SAFs.

160

One commenter stated that GAAP's efforts to assign, through accruals, a period to a given expense or income are not useful, and potentially confusing, for SAF investors because principal, interest, and expenses of administration of assets can only be paid from cash received.

161

We recognize that vehicles that issue asset-backed securities are specifically excluded from other Commission rules that require issuers to provide audited GAAP financial statements.

162

Previously, we have stated that GAAP financial information generally does not provide useful information to investors in asset-backed securities.

163

Instead, SAF and other asset-backed securities investors have historically been interested in information regarding characteristics and quality of the underlying assets used to pay the notes issued by the issuer, the standards for the servicing of the underlying assets, the timing and receipt of cash flows from those assets, and the structure for distribution of those cash flows.

164

We continue to believe that GAAP financial statements may be less useful to SAF investors than they are for non-SAF investors.

160

See

LSTA Comment Letter; SFA Comment Letter I; Fixed Income Investor Network Comment Letter; TIAA Comment Letter. This view by commenters is consistent with the low rate of audits of U.S. GAAP financial statements for SAFs. However, approximately 10% of SAFs do get audits of U.S. GAAP financial statements from independent auditors that are Public Company Accounting Oversight Board (“PCAOB”)-registered and -inspected.

See infra

section VI.C.1. Advisers to these funds would not be prohibited under the final rules from continuing to cause the fund to undergo such an audit of U.S. GAAP financial statements.

161

See

LSTA Comment Letter.

162

See

Asset-Backed Securities, Securities Act Release No. 8518 (Dec. 22, 2004) (adopting disclosure requirements for asset-backed securities issuers) (

https://www.sec.gov/rules/final/33-8518.htm

163

See id.

164

See id.

SAFs also have features that distinguish them from most other private funds that are relevant in assessing the benefit of the preferential treatment rule. Based on staff experience, SAFs typically issue primarily tradeable, interest-bearing debt securities backed by income-producing assets, unlike other private funds that typically issue equity securities to investors. These debt securities are typically structured as notes and issued in different tranches to investors. The tranches offer different priority of payments subject to a “waterfall” and defined levels of risk with upside participation caps or limits, which are compensated through the payment of increasing coupon rates on the more subordinated notes. Unlike investors in other private funds, the noteholders are similarly situated with all of the other noteholders in the same tranche and they cannot redeem or “cash in” their note ahead of other noteholders in the same tranche. As a result, in our experience, this structure has generally deterred investors from requesting, and SAF advisers from granting, preferential treatment. Thus, we do not believe that preferential treatment for SAFs presents the same conflicts of interest and investor protection concerns as it does for non-SAF funds.

We also believe that the quarterly statement would generally not provide meaningful information for SAF investors. For example, some commenters highlighted that the performance information required to be included in private fund quarterly statements would generally not constitute relevant or useful information for SAF investors, because the performance of a SAF, as a cash flow investment vehicle, primarily depends on the cash proceeds it realizes from its portfolio assets, as opposed to an increase in the value of its portfolio assets.

165

These commenters stated that, instead of the performance metrics required for liquid or illiquid funds under the rules, a yield performance metric and/or information regarding the SAF's cash distributions to investors (as well as its ability to make future cash distributions) would more appropriately reflect the specific cash flow structure of a SAF investment; and these commenters pointed out that SAF investors already receive this information, which is generally required to be periodically reported to investors in detail in accordance with a SAF's securitization transaction agreement. We agree with commenters that the required performance metrics would be less useful to SAF investors than they are for non-SAF investors, particularly in light of the detailed information that SAF investors are generally already required to receive. For example, because the performance reporting would report performance at the SAF level, but investors sit in different tranches along the SAF's distribution waterfall with different risk/return profiles, the required performance reporting would likely be uninformative with respect to any specific tranche.

165

See

LSTA Comment Letter; SFA Comment Letter I; SIFMA-AMG Comment Letter I; TIAA Comment Letter.

As another example, the “distribution” requirements under the final rules would likely be impracticable for most SAF advisers. Unlike other private funds that are primarily purchased, with respect to U.S. persons, through a primary issuance pursuant to Regulation D, which generally restricts a security's transferability and does not contemplate an investor's resale of the security to a third party, SAF interests

are primarily purchased in the United States through a primary issuance and subsequently resold and traded on the secondary market by qualified institutional buyers pursuant to Regulation 144A. Because SAF interests are, unlike interests in other types of private funds, primarily traded on the secondary market, the interests are generally held in street name by broker-dealers on behalf of the fund's investors, who are, accordingly, not generally known by the fund or its investment adviser. To address delivery obligations under the fund documents, a SAF's independent collateral administrator typically establishes a website that is accessible by noteholders where their required reports are furnished, in accordance with the terms of the securitization transaction agreement. As a result, a SAF adviser may not have the necessary contact information for each noteholder of the SAF to satisfy the distribution requirements.

Finally, SAF advisers often have a more limited role in the management of a private fund, and SAFs or their sponsors typically engage more independent service providers than non-SAF funds. The primary role of an adviser to a SAF is, in many cases, to select and monitor the fund's pool of assets in compliance with certain portfolio requirements and quality tests (such as overcollateralization, diversification, and interest coverage tests) that are set forth in the fund's securitization transaction agreements. In many cases, the SAF's transaction agreement appoints an independent trustee to serve as custodian for the underlying investments. The trustee and collateral administrator are typically responsible for preparing detailed monthly and quarterly reports for the investors regarding the SAF's assets and expenses. We believe that these structural protections provide an important check on the adviser's activity or otherwise limit the actions the adviser can take to harm investors.

For the reasons described above, we believe it is appropriate not to apply all five private fund adviser rules to advisers with respect to SAFs they advise.

B. Quarterly Statements

Section 211(h)(1) of the Act states that the Commission shall facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with brokers, dealers, and investment advisers, including any material conflicts of interest. The quarterly statement rule is designed to facilitate the provision of simple and clear disclosures to investors regarding some of the most important and fundamental terms of their relationships with investment advisers to private funds in which those investors invest—namely what fees and expenses those investors will pay and what performance they receive on their private fund investments. These disclosures will allow investors to better understand their private fund investments and the terms of their relationship with the adviser to those funds.

Several commenters stated that section 211(h)(1) of the Act does not authorize the quarterly statement rule because details about past performance of funds and fees paid to the adviser are not terms of the relationship between investors and advisers.

166

However, section 211(h)(1) of the Act does not limit a “term” of the relationship only to the provisions in a contract, as these commenters assert.

167

In the private fund context, it is the adviser or its affiliated entities that generally draft the private fund's private placement memorandum and governing documents,

168

negotiate fund terms

169

with the private fund investors, manage the fund, charge and/or allocate fees and expenses to the private fund which are then paid by the private fund investors, and calculate and present performance information to the private fund investors. In this context, fees and performance are essential to the relationship between an investor and an adviser. The method used to calculate fees is typically set forth in the fund contracts. However, based on Commission staff experience, fee and performance disclosures are often not simple or clear, and investors may have difficulty understanding them. As a result, advisers have overcharged certain fees without investors recognizing it immediately.

170

Similarly, performance is a crucial term of the relationship between an adviser and investors. Performance is implicitly or explicitly part of the terms of many fund contracts to the extent that advisers are often compensated in part based on the performance of the private fund.

171

The amount, calculation, and timing of performance compensation are often negotiated by the adviser and the investors and form the core economic term of their relationship.

166

See, e.g.,

AIC Comment Letter I; Comment Letter of the National Venture Capital Association (Apr. 25, 2022) (“NVCA Comment Letter I”); Citadel Comment Letter.

167

See, e.g.,

AIC Comment Letter I; Citadel Comment Letter.

168

Including, for many types of private funds, the private fund operating agreement to which the adviser or its affiliate and the private fund investors are typically both parties.

169

Such fund terms include, for example, the formulas that determine the amount of carried interest and management fees paid to the adviser in addition to other key terms such as the length of the life of the fund and the mechanics of fund governance.

170

See, e.g., In re Global Infrastructure Management, LLC, supra

footnote 30 (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 ECP Manager LP,

Investment Advisers Act Release No. 5373 (Sept. 27, 2019) (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).

171

This includes the private fund operating agreement to which the adviser or its affiliate and private fund investors are typically both parties.

Calculating performance is also complicated, and methods generally differ among advisers. Without comparable performance metrics and methodologies, it can be unclear how different advisers perform against one another. Performance calculations also generally are the product of many assumptions and criteria, such as the manner in which management fee rates are applied. Without simple and clear disclosures of such assumptions and criteria, investors are at a disadvantage with respect to understanding or being able to verify how their investments are performing.

172

Put simply, performance is key to the terms of the relationship between private fund investors and advisers because private fund investors pay advisers to seek to generate investment returns, and performance information allows investors to assess how an adviser is fulfilling that obligation.

Section 206(4) of the Act gives the Commission the authority to prescribe means reasonably designed to prevent fraud, deception, and manipulation. The quarterly statement rule is reasonably designed to prevent fraud, deception, and manipulation because it requires advisers to provide timely and consistent disclosures that will improve the ability of investors to assess and monitor fees, expenses, and performance. This will decrease the likelihood that investors will be defrauded, deceived, or manipulated because they will be in a better position to monitor the adviser and their respective investments, and it increases the likelihood that any such misconduct will be detected sooner.

173

Moreover, the fee, expense and performance information in the quarterly statement will improve investors' ability to evaluate the adviser's conflicts of interest with respect to the fees and

expenses charged to the fund by the adviser and the performance metrics that the adviser presents to investors.

174

173

See infra

footnotes 177-178 (providing examples of misconduct relating to fees, expenses, and performance).

174

See supra

section I (discussing conflicts of interest).

Several commenters stated that Commission, in the proposal, failed to define a fraudulent, deceptive, or manipulative act as required by section 206(4) of the Act.

175

Another commenter stated that the Commission, in the proposal, failed to connect the proposed reporting requirements to any actual fraudulent act.

176

To the contrary, the quarterly statement is designed to prevent fraudulent, deceptive, or manipulative practices, including ones we have observed.

177

For example, if an adviser is charging investors a management fee and simultaneously charging a portfolio company a monitoring or similar fee without disclosing that fee to investors, we would view that as fraudulent or deceptive because it involves an undisclosed conflict in breach of fiduciary duty.

178

Similarly, if an adviser is knowingly using off-market assumptions (such as highly irregular valuation practices that are not used by similarly-situated advisers) when calculating performance without disclosing such to investors, we would view that practice as deceptive.

175

See, e.g.,

AIC Comment Letter I; NVCA Comment Letter.

176

See

Citadel Comment Letter.

177

See, e.g., In the Matter of Sabra Capital Partners, LLC and Zvi Rhine,

Investment Advisers Act Release No. 5594 (Sept. 25, 2020) (settled order) (alleging that, among other things, an investment adviser misrepresented the performance of a fund it advised in updates sent to the fund's limited partners);

In the Matter of Finser International Corporation and Andrew H. Jacobus,

Investment Advisers Act Release No. 5593 (Sept. 24, 2020) (settled order) (alleging that, among other things, an investment adviser charged a fund it advised performance fees contrary to representations made in the fund's private placement memorandum);

In the Matter of Omar Zaki,

Investment Advisers Act Release No. 5217 (Apr. 1, 2019) (settled order) (alleging that, among other things, an investment adviser repeatedly misled investors in a fund it advised about fund performance);

In the Matter of Corinthian Capital Group, LLC, Peter B. Van Raalte, and David G. Tahan,

Investment Advisers Act Release No. 5229 (May 6, 2019) (settled order) (alleging that, among other things, an investment adviser failed to apply a fee offset to a fund it advised and caused the same fund to overpay organizational expenses);

In the Matter of Aisling Capital LLC,

Investment Advisers Act Release No. 4951 (June 29, 2018) (settled order) (alleging an investment adviser failed to apply a specified fee offset to a fund it advised contrary to the fund's limited partnership agreement and private placement memorandum).

178

See, e.g., In the Matter of Monomoy Capital Management, L.P.,

Investment Advisers Act Release No. 5485 (Apr. 22, 2020) (settled action);

In the Matter of WCAS Management Corporation,

Investment Advisers Act Release No. 4896 (Apr. 24, 2018) (settled action);

In the Matter of Fenway Partners, LLC, et. Al.,

Investment Advisers Act Release No. 4253 (Nov. 3, 2015) (settled action).

The rule requires 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, unless a quarterly statement that complies with the rule is prepared and distributed by another person.

179

If the private fund is not a fund of funds, then a quarterly statement must be distributed within 45 days after the end of each of the first three fiscal

180

quarters of each fiscal year and 90 days after the end of each fiscal year.

181

If the private fund is a fund of funds, then a quarterly statement must be distributed within 75 days after the first, second, and third fiscal quarter ends and 120 days after the end of the fiscal year of the private fund.

179

Final rule 211(h)(1)-2.

180

See infra

section II.B.3 for a discussion of the change to fiscal time periods for the quarterly statement rule.

181

Final rule 211(h)(1)-2.

Many commenters supported the quarterly statement rule as proposed and agreed that it would provide increased transparency to private fund investors who may not currently receive sufficiently detailed, comprehensible, or regular fee, expense, and performance information for each of their private fund investments.

182

These commenters generally indicated that the quarterly statement rule would provide increased comparability between private funds and accordingly would enable private fund investors to make more informed investment decisions, as well as potentially lead to increased competitive market pressures on the costs of investing in private funds. Some commenters indicated that the rule's establishment of a required baseline of recurring reporting would allow investors to focus their negotiation priorities with private fund advisers on other matters, such as fund governance, and could also provide investors with greater confidence when choosing to allocate capital to private fund investments.

183

One commenter suggested that the quarterly statement requirement would particularly help smaller or less sophisticated investors who may receive less timely or complete information than investors that possess greater negotiating power.

184

Other commenters did not support this quarterly statement rule (or parts of the rule, as discussed below).

185

Of these commenters, a number suggested that this quarterly statement requirement would increase costs for private funds that would ultimately be passed on to investors.

186

Some commenters stated that the quarterly statement rule may not provide meaningful information or would confuse investors because the required information would not be personalized to investors, may not be appropriate for certain types of private funds, or may differ from other information already provided to private fund investors.

187

Other commenters stated that the rule is unnecessary and duplicative, as advisory firms already provide similar or otherwise sufficient reporting, and investors are generally able to negotiate for and receive additional disclosure that may be appropriate for their particular needs.

188

182

See, e.g.,

Comment Letter of National Education Association and American Federation of Teachers (Apr. 12, 2022) (“NEA and AFT Comment Letter”); Comment Letter of the American Federation of Teachers New Mexico (Apr. IFT Comment Letter Comment Letter of the National Conference on Public Employee Retirement Systems (Apr. 25, 2022) (“NCPERS Comment Letter”); Better Markets Comment Letter; Comment Letter of Ohio Federation of Teachers (Apr. 25, 2022) (“OFT Comment Letter”); Comment Letter of American Federation of State, County and Municipal Employees (Apr. 25, 2022) (“AFSCME Comment Letter”); Consumer Federation of America Comment Letter; Public Citizen Comment Letter; Comment Letter of National Council of Real Estate Investment Fiduciaries (Apr. 25, 2022) (“NCREIF Comment Letter”); Comment Letter of New York State Insurance Fund (Apr. 25, 2022) (“NYSIF Comment Letter”); NYC Comptroller Letter; Comment Letter of AFL-CIO (Apr. 25, 2022) (“AFL-CIO Comment Letter”); Comment Letter NASAA Comment Letter.

183

See, e.g.,

DC Retirement Board Comment Letter; ILPA Comment Letter I; Comment Letter of National Electrical Benefit Fund Investments (Apr. 25, 2022) (“NEBF Comment Letter”); OPERS Comment Letter.

184

See

Healthy Markets Comment Letter I.

185

See, e.g.,

Comment Letter of Andreessen Horowitz (June 15, 2022) (“Andreessen Comment Letter”); NVCA Comment Letter; SIFMA-AMG Comment Letter I.

186

See, e.g.,

IAA Comment Letter II; AIC Comment Letter I; Comment Letter of Roubaix Capital (Apr. 12, 2022) (“Roubaix Comment Letter”).

187

See, e.g.,

AIC Comment Letter I; IAA Comment Letter II; Ropes & Gray Comment Letter.

188

See, e.g.,

AIMA/ACC Comment Letter; Comment Letter of Dechert LLP (Apr. 25, 2022) (“Dechert Comment Letter”); AIC Comment Letter I. One commenter stated that the Commission made no attempt to review the investor disclosures provided by open-end funds in order to evaluate whether the proposal would meaningfully increase transparency.

See

Citadel Comment Letter. On the contrary, Commission staff regularly reviews open- and closed-end fund investor disclosures as part of the Commission's examination program and that experience informs this rulemaking.

See, 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/

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

. As of Dec. 17, 2020, the Office of Compliance, Inspections and Examinations (“OCIE”) was renamed the Division of Examinations (“EXAMS”).

As stated elsewhere, we have observed that private fund investments are often opaque; advisers frequently do not provide investors with sufficiently detailed information about private fund investments.

189

Without sufficiently clear, comparable information, even sophisticated investors may be unable to protect their interests or make sound investment decisions. Accordingly, we are adopting the quarterly statement rule, in part, because of the lack transparency in key areas including private fund fees and expenses, performance, and conflicts of interest.

189

See

Proposing Release

supra

footnote 3, at n. 9-11.

While we acknowledge that quarterly statements may increase costs, we believe these costs are justified in light of the benefits of the rule.

190

As discussed above, investors will benefit from increased transparency into the fees and expenses charged to the fund, as well as the conflicts they present, on a timely basis. Investors will also benefit from mandatory timely updates regarding fund performance if they were not already receiving them.

191

We also disagree with commenters' concerns regarding quarterly statements failing to provide meaningful information. The quarterly statement will present a baseline level of information in a clear format and will help private fund investors to monitor and assess the true cost of their investments better. For example, the enhanced cost information may allow an investor to identify when the private fund has incorrectly, or improperly, assessed a fee or expense by the adviser. We also disagree with certain commenters' concerns that the quarterly statement may not be appropriate for certain types of private funds. We believe that the fee, expense, and performance information required in the quarterly statement is a fundamental disclosure that is relevant to all types of private funds.

190

See infra

section VI.D.2.

191

Furthermore, even if investors are already receiving timely updates regarding fund performance for the funds in which they are currently invested, they may also benefit from no longer needing to expend resources negotiating for it for funds in which they wish to invest in the future. As the quarterly statement rule requires this baseline of performance information, investors will be able to focus their resources on negotiating for more bespoke reporting or other important rights in new funds.

Moreover, we anticipate the costs of compliance with this rule may be of limited magnitude in light of the fact that many private fund advisers already maintain and, in many cases, already disclose similar information to investors.

192

Relatedly, we acknowledge that many private fund advisers contractually agree to provide fee, expense, and performance reporting to investors already. However, not all private fund investors are able to obtain this information. Other investors may be able to obtain relevant information, but the information may not be sufficiently clear or detailed regarding the costs and performance of a particular private fund to enable an investor to understand, monitor and make informed investment decisions regarding its private fund investments. For instance, some advisers report only aggregated expenses, or do not provide detailed information about the calculation and implementation of any negotiated rebates, credits, or offsets, which does not allow an investor to identify the actual extent and/or types of costs incurred and to evaluate their validity. Other investors may not have sufficient information regarding private fund fees and expenses in part because those fees and expenses have varied presentations across private funds and are subject to complicated calculation methodologies, which similarly prevents an investor from meaningfully assessing those fees and expenses and comparing private fund investments. Private fund investors are increasingly interested in more disclosure regarding private fund performance, including transparency into the calculation of the performance metrics.

193

Providing investors with simple and clear disclosures regarding fees, expenses, and performance will allow investors to understand b

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