proposed rule does not define ``targeted return'' or ``projected
return.'' We believe that these terms are best defined by their
commonly understood meanings, and do not intend to narrow or expand
inadvertently the wide variety of returns that may be considered
targets or projections. We generally would consider a target or
projection to be any type of performance that an advertisement presents
as results that could be achieved, are likely to be achieved, or may be
achieved in the future by the investment adviser with respect to an
investor.
    The proposed rule would apply to targeted or projected performance
returns ``with respect to any portfolio or to the investment services
offered or promoted in the advertisement.'' \301\ Accordingly,
projections for general market performance or economic conditions in an
advertisement would not be considered targeted or projected performance
returns. Similarly, an interactive financial analysis tool that offers
historical return information or investment analysis of a portfolio
based on past market data but does not project such returns forward
would not be deemed to be targeted or projected performance returns
under the proposed rule. Interactive tools that allow an investor to
select its own targeted or assumed rate of return and to project
forward a portfolio using that investor's selected rate of return also
would not be considered to be targeted or projected performance
returns, provided that the tool does not suggest or imply a return
rate. On the other hand, if the interactive tool provides anticipated
returns for the investment strategy being presented, the tool would be
considered to provide targeted or projected performance results and
would be subject to the proposed rule's conditions regarding
hypothetical performance.\302\
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    \301\ Proposed rule 206(4)-1(e)(5)(iii).
    \302\ FINRA permits ``investment analysis tools'' as a limited
exception from FINRA's general prohibition of projections of
performance, subject to certain conditions and disclosures. FINRA
rule 2214(b) defines ``investment analysis tool'' as ``an
interactive technological tool that produces simulations and
statistical analyses that present the likelihood of various
investment outcomes if certain investments are made or certain
investment strategies or styles are undertaken, thereby serving as
an additional resource to investors in the evaluation of the
potential risks and returns of investment choices.''
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    Targeted and projected performance returns can potentially mislead
investors, particularly if they are based on assumptions that are not
reasonably

achievable. For example, an advertisement may present unwarranted
claims based on assumptions that are virtually impossible to occur in
reality, such as an assumption that three or four specific industries
will experience decades of uninterrupted growth. Targets and
projections can easily be presented in such a manner to raise
unrealistic expectations of an advertisement's audience.\303\
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    \303\ In a reflection of the risks posed by projected returns,
FINRA's communications rule prohibits the prediction or projection
of performance in most cases. See FINRA rule 2210(d)(1)(F). FINRA's
prohibition does not apply to (i) a hypothetical illustration of
mathematical principles, (ii) certain investment analysis tools, and
(iii) a price target contained in a research report, under certain
conditions. See id.
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    Suitable reliance on targets or projections requires an analysis
and diligence of such assumptions in order for an investor to not be
misled into thinking that such targets or projections are guaranteed.
We recognize that some investors want to consider targeted returns and
projected returns (along with these underlying assumptions) when
evaluating investment products, strategies, and services. For example,
based on our staff's outreach and experience, we understand that Non-
Retail Persons in particular may have specific return targets that they
seek to achieve, and their planning processes may necessarily include
reviewing and analyzing the targets advertised by investment advisers
and the information underlying those targets.\304\ Specifically, an
analysis of these targets or projections can inform an investor about
an adviser's risk tolerances when managing a particular strategy.
Information about an adviser's targets or projections also can be
useful to an investor when assessing how the adviser's strategy fits
within the investor's overall portfolio.
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    \304\ For example, knowing whether one type of private fund
projects or targets a particular return over a particular time
period may assist a pension plan in determining whether to invest in
that type of private fund or to consider another type of private
fund projecting a different return. See, e.g., National Association
of State Retirement Administrators (NASRA) Issue Brief: Public
Pension Plan Investment Return Assumptions (Feb. 2019), available at
https://www.nasra.org/files/Issue%20Briefs/NASRAInvReturnAssumptBrief.pdf (``Funding a pension benefit requires
the use of projections, known as actuarial assumptions, about future
events. Actuarial assumptions fall into one of two broad categories:
demographics and economic.'').
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    We request comment on the proposed definition of ``hypothetical
performance'' and the specific types of hypothetical performance
addressed in the proposed definition.
     Is the proposed definition of ``hypothetical performance''
clear? If not, how should we modify this definition? For example,
should we clarify the treatment of indexes (including indexes sponsored
by or created by the adviser or its affiliate) and benchmarks under the
definition of hypothetical performance?
     Are there types of performance that investment advisers
currently present in advertising that would meet the proposed rule's
definition of ``representative model performance'' but should not be
treated as hypothetical performance under the proposed rule? What types
of performance and why should they not be treated as hypothetical
performance?
     Do commenters agree with the proposed rule's treatment of
targeted and projected returns as hypothetical performance? Should we
treat targeted and projected returns differently from hypothetical
performance? If so, why and how?
     Should we define ``targeted returns'' or ``projected
returns''? If so, how should we define them? Do commenters agree with
our discussion above about what should be considered a target or
projection? Should we provide in the rule exclusions for specific kinds
of presentations that would not be considered target or projected
returns? Why or why not?
     Should we prohibit hypothetical performance in
advertisements? Should performance results of portfolios that are
managed by an investment adviser, but without investing actual money,
be treated differently than other types of performance results under
the proposed rule?
     Are our beliefs correct about the risks of backtested and
representative performance and of targeted and projected returns? Are
there circumstances under which these types of hypothetical performance
do not present the risks we identified? Are there other risks that we
should consider?
     Are there types of performance that would meet the
proposed rule's definition of ``backtested performance'' but should not
be treated as such? What types and how should we modify the definition?
     Are there types of performance that would meet the
proposed rule's definition of ``representative performance'' but should
not be treated as such? What types and how should we modify the
definition?
     How do investment advisers currently present targeted or
projected returns in advertisements? Do investment advisers ever
disclose to investors when targeted or projected returns are met or are
not met, and the reasons why such returns are met or not met? Should we
require such disclosure? Why or why not?
     FINRA's communications rule prohibits the projection of
performance in most cases. Have broker-dealers had experience in
interpreting FINRA's rule with respect to the projection of
performance? Is there anything that we should consider in our treatment
of projected returns?
     Should we provide a specific exception for interactive
financial analysis tools from the proposed rule's approach to
performance of projected returns? If so, should we consider FINRA's
approach or another approach? What approach and why?
     In complying with the current rule, have investment
advisers addressed any of the risks of hypothetical performance we
describe above, or other risks of hypothetical performance? If so, how?
     Are there any specific disclosures that we should require
to prevent any type of hypothetical performance from misleading the
audience? If so, which disclosures should we require and why?
     Are there additional uses for hypothetical performance
generally, or any type of hypothetical performance specifically, that
benefit investors?
B. Conditions on Presentation of Hypothetical Performance
    Taking into account the risks and the potential utility of
hypothetical performance when investors have a need for such
performance and are able to subject it to sufficient independent
analysis and due diligence, the proposed rule would permit the
presentation of hypothetical performance in advertisements under
certain conditions. Together, these conditions are intended to address
the potential for hypothetical performance to be misleading. First, the
adviser must adopt and implement policies and procedures reasonably
designed to ensure that the hypothetical performance is relevant to the
financial situation and investment objectives of the person to whom the
advertisement is disseminated (the ``recipient''). Second, the adviser
must provide sufficient information to enable the recipient to
understand the criteria used and assumptions made in calculating such
hypothetical performance (the ``calculation information''). Third, the
adviser must provide (or, when the recipient is a Non-Retail Person,
offer to provide promptly) sufficient information to enable the
recipient to understand the risks and limitations of using hypothetical
performance in making investment decisions (the ``risk

information'').\305\ For purposes of this discussion, we refer to the
calculation information and the risk information collectively as
``underlying information.''
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    \305\ Proposed rule 206(4)-1(c)(1)(v)(C).
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    Policies and Procedures. The first condition for the presentation
of hypothetical performance would require the adviser to adopt and
implement policies and procedures ``reasonably designed to ensure that
the hypothetical performance is relevant to the financial situation and
investment objectives'' of the recipient.\306\ This proposed condition
is intended to ensure that the adviser provides hypothetical
performance only where the recipient has the financial and analytical
resources to assess the hypothetical performance and that the
hypothetical performance would be relevant to the recipient's
investment objective.
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    \306\ Proposed rule 206(4)-1(c)(1)(v)(A).
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    This condition would provide investment advisers with flexibility
to develop policies and procedures that best suit their investor bases
and operations and that target the types of hypothetical performance
the adviser intends to use in its advertisements as well as the
intended recipients of the hypothetical performance.\307\ For example,
an investment adviser that plans to advise a new private fund might
develop policies and procedures that take into account its experience
advising a prior fund for which it raised money from investors. That
experience might indicate that the prior fund's investors valued a
particular type of hypothetical performance because, for example, the
investors used it to assess the adviser's strategy and investment
process and had the resources to make that assessment. The adviser's
policies and procedures could then reflect its determination that this
type of hypothetical performance is relevant to the financial situation
and investment objectives of those investors or investors of a similar
type.
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    \307\ In this respect, this condition would mirror in part the
proposed definition of ``Non-Retail Advertisement,'' which would
require an adviser to adopt and implement policies and procedures
reasonably designed to ensure that Non-Retail Advertisements are
disseminated solely to Non-Retail Persons, as discussed above. See
supra footnotes 231-232 and accompanying text.
---------------------------------------------------------------------------

    Reasonably designed policies and procedures need not require an
adviser to inquire into the specific financial situation and investment
objectives of each potential recipient. Instead, such policies and
procedures could identify the characteristics of investors for which
the adviser has determined that a particular type or particular
presentation of hypothetical performance is relevant and a description
of that determination. In many cases, that determination could be made
on the basis of the adviser's past experience with investors belonging
to that group. For example, an adviser could determine that certain
hypothetical performance presentations are relevant to the financial
situation and investment objectives of certain types of investors,
based on routine requests from those types of investors in the past. An
adviser's experience could similarly provide it with an understanding
of the analytical resources available to investors of a particular
type. The adviser could then incorporate its understanding into its
policies and procedures.
    We understand that Non-Retail Persons in particular routinely
evaluate the types of performance that the proposed rule would treat as
hypothetical performance as part of their due diligence in hiring
investment advisers and that Non-Retail Persons believe that such
performance is relevant to their financial situation and investment
objectives.\308\ With appropriate analytical and other resources, these
investors may assess and conduct diligence on hypothetical performance
and the underlying assumptions and methodologies in light of market
conditions, investment policies, objectives and strategies, leverage,
and other factors that they believe to be important. For example, these
investors may routinely analyze backtested performance to assess how a
quantitative strategy would have performed under market conditions that
such investors expect might occur in the near future. Non-Retail
Persons also generally have the resources to obtain information that
can inform their assessment, and would be provided additional
information from the adviser under the conditions of the proposed
rule.\309\ Accordingly, an adviser could consider this experience when
designing policies and procedures to provide hypothetical performance
where it is relevant to the investor's financial situation and
investment objectives.
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    \308\ See Comment Letter of ILPA on the 2019 Concept Release
(Sept. 24, 2019) (stating that, in considering investments in
private funds, ``[l]arge institutional investors spend hours of due
diligence in undergoing their own manager selection processes.
Evaluating and considering the potential success of management and
teams is critical.'').
    \309\ See, e.g., proposed rule 206(4)-1(c)(1)(v)(B) (requiring
an investment adviser to provide certain information as a condition
of presenting hypothetical performance in an advertisement). The
provisions of paragraph (a) of the proposed rule, including the
prohibition of material claims or statements that are
unsubstantiated, would apply to targets and projections, as would
the general anti-fraud provisions of the Federal securities laws.
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    On the other hand, hypothetical performance may be less relevant to
the financial situation and investment objectives of investors that do
not have access to analytical and other resources to enable them to
analyze the hypothetical performance and underlying information. For
example, analysis of hypothetical performance may require tools and/or
other data to assess the impact of assumptions in driving hypothetical
performance, such as factor or other performance attribution, fee
compounding, or the probability of various outcomes. Without being able
to subject hypothetical performance to additional analysis, this
information would tell an investor little about an investment adviser's
process or other information relevant to a decision to hire the
adviser. Instead, viewing the hypothetical performance (without
analyzing and performing the necessary due diligence on the underlying
information) could mislead an investor to believe something about the
adviser's experience or ability that is unwarranted. We believe that
advisers should give closer scrutiny as to whether hypothetical
performance is relevant to those investors' financial situation and
investment objectives.
    An adviser could determine, based on its experience, that
hypothetical performance is not relevant to the financial situation and
investment objectives of Retail Persons and reflect such determination
in its policies and procedures. However, we believe that in some cases
an adviser may reasonably determine that hypothetical performance is
relevant to a particular Retail Person. To determine whether
hypothetical performance is relevant with respect to a Retail Person,
reasonably designed policies and procedures should include parameters
that address whether the Retail Person has the resources to analyze the
underlying assumptions and qualifications of the hypothetical
performance to assess the adviser's investment strategy or processes,
as well as the investment objectives for which such performance would
be applicable. In light of that, we believe that advisers generally
would not be able to include hypothetical performance in advertisements
that are directed to a mass audience or intended for general
circulation because such an advertisement would be available to all
investors, regardless of their financial situation or investment
objectives.
    Calculation Information. The second condition for the presentation
of

hypothetical performance would require the adviser to provide
sufficient information to enable the recipient to understand the
criteria used and assumptions made in calculating the hypothetical
performance.\310\ With respect to criteria, investment advisers should
provide information that includes the methodology used in calculating
and generating the hypothetical performance. With respect to
assumptions, investment advisers should provide information that
includes any assumptions on which the hypothetical performance rests--
e.g., the likelihood of a given event occurring. We propose to require
advisers to provide this calculation information so that the recipient
is able to determine, in part, how much value to attribute to the
hypothetical performance. This calculation information also would
provide the recipient with insight into the adviser's operations. For
example, this information could allow the recipient to understand how
the adviser identifies the criteria and assumptions supporting the
hypothetical performance and accounts for them in generating that
performance. In addition, any disclosed calculation information might
be a basis for additional discussions between the recipient and the
investment adviser, which would add to the information available to the
recipient. Finally, this calculation information might enable the
recipient to attempt to replicate the hypothetical performance using
its own analytical tools or other resources, which might allow the
recipient to evaluate further the utility of the hypothetical
performance.\311\
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    \310\ Proposed rule 206(4)-1(c)(1)(v)(B).
    \311\ We believe that an ability to replicate the hypothetical
performance would be another indication of the adviser's operations
and methods, assuming that the recipient of the information also has
sufficient information about the risks and limitations of the
performance. That is, the recipient could determine that applying
the adviser's methodologies and assumptions can produce the same
results reflected in the hypothetical performance, which could
indicate the utility of those methodologies and assumptions and how
the adviser applies them.
---------------------------------------------------------------------------

    The proposed rule would require that calculation information be
provided to all investors receiving hypothetical performance, even to
Non-Retail Persons. We believe Non-Retail Persons should receive this
information and understand that, even with their access to resources,
Non-Retail Persons may struggle at times to receive sufficient
information from investment advisers explaining the methodology by
which hypothetical performance was calculated and generated.\312\
Without calculation information, we believe that such performance would
be misleading even to an audience with the analytical or other
resources necessary to evaluate it. Accordingly, the proposed rule
would require an adviser presenting hypothetical performance to provide
this calculation information to Non-Retail Persons.\313\
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    \312\ The proposed rule does not prescribe any particular
methodology or calculation for the different categories of
hypothetical performance, just as it does not prescribe
methodologies or calculations for actual performance. Instead, the
proposed rule would require investment advisers including
hypothetical performance in an advertisement to provide the
calculation information so that the recipient can understand how the
hypothetical performance was calculated.
    \313\ In addition, we would consider any calculation information
provided alongside the hypothetical performance to be a part of the
advertisement and therefore subject to the books and records rule.
See infra section II.C.7; see also supra footnote 106 and
accompanying text.
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    Calculation information should be tailored to the person receiving
it, though such tailoring could apply to general categories of persons,
such as Retail Persons or Non-Retail Persons. The amount of calculation
information and level of detail provided to a Retail Person may differ
significantly from the amount and level that would be sufficient to
enable a Non-Retail Person to understand it. For example, a Retail
Person may require additional explanations of certain key terms that
may be familiar to a Non-Retail Person. To determine what calculation
information to provide, an adviser would need to determine the type and
amount of calculation information that could be understood by the
recipient.\314\
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    \314\ This obligation would be similar to an adviser's
obligation to provide full and fair disclosure to its clients of all
material facts relating to the advisory relationship and of
conflicts of interest. See Standard of Conduct Release, supra
footnote 23, at n. 70 (stating that institutional clients
``generally have a greater capacity and more resources then retail
clients to analyze and understand complex conflicts and their
ramifications'').
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    Risk Information. Finally, the proposed rule would require the
adviser to provide--or, if the recipient is a Non-Retail Person, to
provide or offer to provide promptly--information to understand the
risks and limitations of using the hypothetical performance in making
investment decisions.\315\ With respect to risks and limitations,
investment advisers should provide information that would apply to both
hypothetical performance generally--e.g., the fact that hypothetical
performance does not reflect actual investments \316\--and to the
specific hypothetical performance presented--e.g., if applicable, the
fact that the hypothetical performance represents the application of
certain assumptions but that the adviser generated dozens of other,
lower performance results representing the application of different
assumptions. Risk information should also include any known reasons why
the hypothetical performance would have differed from actual
performance of a portfolio--e.g., the fact that the hypothetical
performance does not reflect cash flows in to or out of the portfolio.
This risk information would, in part, enable the recipient to
understand how much value to attribute to the hypothetical performance
in deciding whether to hire or retain the investment adviser.\317\
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    \315\ Proposed rule 206(4)-1(c)(1)(v)(C).
    \316\ With respect to backtested performance, one such general
risk and limitation would be the fact that backtested performance
represents the application of a strategy that was created after the
performance period shown in the results and, accordingly, was
created with the benefit of hindsight.
    \317\ In addition, we would consider any risk information
provided in connection with the hypothetical performance to be a
part of the advertisement and therefore subject to the books and
records rule. See infra section II.C.7; see also supra footnote 106
and accompanying text.
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    Just as with calculation information, risk information should be
tailored to the person receiving it, although it may be tailored to
general categories of persons.\318\ For example, sufficient information
for a Retail Person to understand the risks and limitations of the
advertised hypothetical performance may require charts, graphs, or
other pictorial representations, which may be unnecessary for a Non-
Retail Person.
---------------------------------------------------------------------------

    \318\ See supra footnote 314.
---------------------------------------------------------------------------

    In addition, the investment adviser must provide risk information
to Retail Persons in all cases, but for Non-Retail Persons an adviser
could either provide it or offer to provide it promptly. We believe
risk information is essential in mitigating the risk that hypothetical
performance may be misleading to Retail Persons. We believe that Non-
Retail Persons are more likely aware of the risks and limitations of
hypothetical performance, particularly when they are provided with the
calculation information that the proposed rule would require and could
analyze the hypothetical performance using their own assumptions.
Accordingly, the proposed rule would only require an adviser to provide
this risk information to a Non-Retail Person if the Non-Retail Person
accepts the offer for it.\319\ A Non-Retail Person may determine that
it has

no use for the risk information and may decline to accept the offer.
However, once the Non-Retail Person requests the risk information, the
proposed rule would require that the adviser provide it.
---------------------------------------------------------------------------

    \319\ Proposed rule 206(4)-1(c)(1)(v)(C) (permitting an adviser
to ``offer to provide promptly'' such information if the recipient
is a Non-Retail Person). However, this advertisement would continue
to be subject to the prohibitions in proposed rule 206(4)-1(a).
---------------------------------------------------------------------------

    In addition, any advertisement including hypothetical performance
would be required to comply with the provisions in proposed rule
206(4)-1(a). As a result, the proposed rule would prohibit advisers
from presenting hypothetical performance in a materially misleading
way.\320\ For example, we would view an advertisement as including an
untrue statement of material fact if the advertised hypothetical
performance reflected the application of methodologies, rules,
criteria, or assumptions that were materially different from those
stated or applied in the underlying information of such hypothetical
performance. In addition, we would view it as materially misleading for
an advertisement to present hypothetical performance that implies any
potential benefits resulting from the adviser's methods of operation
without clearly and prominently discussing any associated material
risks or other limitations associated with the potential benefits.\321\
Similarly, an advertisement presenting hypothetical performance that
includes an offer to provide promptly risk information to a Non-Retail
Person, pursuant to proposed rule 206(4)-1(c)(1)(v)(C), would be
materially false and misleading if the adviser subsequently failed to
make efforts to provide such information upon the Non-Retail Person's
request.\322\
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    \320\ See, e.g., supra footnotes 188-199 and accompanying text.
    \321\ Proposed rule 206(4)-1(a)(4). For example, if a
presentation of hypothetical performance implies that an adviser's
operations are structured so that the adviser can update its
investment models quickly, then the advertisement must discuss any
associated material risks from that implied benefit--e.g., that
quickly updating the investment model may result in the adviser
over-interpreting recent data and missing subsequent growth that the
adviser would have achieved if the model had not been updated.
    \322\ Proposed rule 206(4)-1(c)(1)(v)(C).
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    We request comment on the proposed conditions to presenting
hypothetical performance in advertisements.
     Should we prohibit the presentation of hypothetical
performance in any advertisement? Why or why not? Instead of a complete
prohibition, should we prohibit the presentation of hypothetical
performance, or specific types of hypothetical performance, under
specific circumstances? If so, what circumstances? Should we prohibit
the presentation of hypothetical performance in Retail Advertisements
but not in Non-Retail Advertisements (or vice versa)?
     Should we permit the presentation of hypothetical
performance in any advertisement without condition? Why or why not?
     Should we require, as proposed, that advisers adopt and
implement policies and procedures designed to ensure that hypothetical
performance is relevant to a recipient's financial situation and
investment objectives? Would such policies and procedures ensure that
hypothetical performance is only provided to those for whom it is
relevant? Would providing hypothetical performance only to those for
whom it is relevant help prevent such performance from being
misleading? Would advisers be able to make the determination that
hypothetical performance is relevant?
     Should we consider another standard other than
``relevant'' to a recipient's ``financial situation and investment
objectives'' to help protect against hypothetical performance being
provided to persons who would be misled by it? For example, should we
instead require that such performance be provided only to persons whom
the adviser reasonably believes may use such performance in considering
whether to hire or retain an adviser and that have sufficient access to
analytical and other resources to evaluate or test the assumptions
underlying the hypothetical performance so as to make the hypothetical
performance not misleading? Alternatively, should we limit the
distribution of this performance to persons whom the adviser reasonably
believes would use it in evaluating whether to hire or retain the
adviser? Alternatively, should we avoid limiting at all the
distribution of hypothetical performance, which some investors may find
useful?
     Should we instead consider categorical approaches--e.g.,
should we instead allow hypothetical performance to be provided to Non-
Retail Persons in all cases without requiring the adviser to adopt
policies and procedures? Should we allow its presentation to Non-Retail
Persons but prohibit its presentation to Retail Persons entirely?
     Are there specific disclosures that we should require to
decrease the likelihood that hypothetical performance, or specific
types of hypothetical performance, would be misleading--e.g.,
describing the fact that the performance was not generated by actual
portfolios of actual clients of the investment adviser and describing
the limitations of hypothetical performance? If so, should we identify
those and specifically require their disclosure?
     Are there specific disclosures that we should require to
decrease the likelihood that hypothetical performance would be
misleading to Retail Persons? If so, should we identify those and
specifically require those disclosures? Should we require different
disclosures for Retail Persons and Non-Retail Persons, or is the
tailoring implicitly permitted under the proposed rule's ``sufficient
information'' standard enough?
     Should we include any other requirements or conditions for
advertisements presenting hypothetical performance, or any specific
type of hypothetical performance? What other requirements or conditions
and why should we require them?
     Is there another approach that we should consider for
hypothetical performance being provided to Retail Persons? Are there
any types of hypothetical performance that are sufficiently similar to
actual results of a portfolio of an actual client that we should permit
their presentation in a Retail Advertisement or their dissemination to
Retail Persons without conditions?
     Are the proposed ``calculation information'' and ``risk
information'' provisions sufficiently clear based on our description
above? Should we require specifically that such information be designed
to allow the audience to replicate the hypothetical performance
presented? Why or why not?
     Would investment advisers face any compliance challenges
in complying with the proposed ``calculation information'' or ``risk
information'' provisions? Would there be circumstances in which
investment advisers might have to provide proprietary or sensitive
information? Should we take those challenges or circumstances into
account? If so, how?
     Should we require that the risk information be provided
(not just offered to be provided) to Non-Retail Persons as well as to
Retail Persons? Conversely, should we allow the calculation information
to be only offered to Non-Retail Persons (instead of requiring it to be
provided)?
     Under the current rule, have investment advisers taken the
same approach that we are proposing with respect to hypothetical
performance--i.e., providing or offering to provide specific
information? Have investors accepted any such offers or requested any
additional information? To what extent and under what circumstances
have any such investors been misled by

the presentation of hypothetical performance? Have investors who have
requested additional performance results included persons other than
qualified purchasers and knowledgeable employees?
d. General Request for Comment on Performance Advertising
    We believe that the proposed rule's requirements with respect to
performance advertising are generally consistent with widely used,
internationally recognized standards of performance reporting, such as
GIPS. Accordingly, we believe that investment advisers will be able to
comply with both the provisions of the proposed rule and the
requirements of such standards, without undue burdens. We request
comment below on this issue.
     Are our beliefs correct that the proposed rule's
requirements are consistent with widely-used, internationally-
recognized standards of performance presentation, such as GIPS? Would
investment advisers find it difficult or impossible comply with both
the provisions of the proposed rule and the requirements of any such
standards in order to comply with the proposed rule's requirements? If
so, which requirements would create such difficulty or impossibility
and how? Should we address any such difficulty or impossibility? If so,
how? Should we adopt a more principles-based approach to afford
flexibility in the event that such private standards change?
    We request general comment on the proposed rule's requirements for
performance advertising.
     Are there specific concerns about performance advertising
that the proposed rule does not take into account that we should
consider? What specific concerns, and how should we take them into
account? Conversely, are there provisions of the proposed rule's
performance advertising provisions that address concerns you believe to
be unfounded?
     Should we consider removing some of the proposed rule's
requirements for performance advertising and instead rely on paragraph
(a) of the proposed rule and the general anti-fraud provisions of the
Federal securities laws to prevent the use of performance advertising
that is false or misleading? Why or why not? Are there additional
requirements that we should consider including in the proposed rule
with respect to performance advertising in order to supplement
paragraph (a)? What additional requirements and how would they
supplement paragraph (a)?
     Taken as a whole, are the disclosures required by the
proposed rule for performance advertising sufficient or insufficient?
Are there changes to these disclosures that we should consider in order
to make them more useful or meaningful for investors, whether natural
persons or institutions? What changes and how would they improve the
utility of the disclosures?
     Should we impose on Non-Retail Advertisements presenting
performance results the same or similar requirements that the proposed
rule imposes on Retail Advertisements? For example, should we require
Non-Retail Advertisements to present net performance or to present
performance results for certain specified periods of time? Why or why
not?
     Should we specify any types of information that advisers
may refrain from disclosing when responding to prospective investors
seeking the information that must be offered in advertisements? Are
advisers concerned that their competitors may seek to acquire such
information through requests responding to those offers? Do advisers
have any other concerns regarding competition that the proposed rule
may cause or should address?
6. Portability of Performance, Testimonials, Third Party Ratings, and
Specific Investment Advice
    Among the performance results that an investment adviser may seek
to advertise are those of portfolios or accounts for which the adviser,
its personnel, or its predecessor investment adviser firms have
provided investment advice in the past as or at a different entity. In
some cases, an investment adviser may seek to advertise the performance
results of portfolios managed by the investment adviser before it was
spun out from another adviser. Or an adviser may seek to advertise
performance achieved by its investment personnel when they were
employed by another investment adviser. This may occur, for example,
when a portfolio manager or team of portfolio managers leaves one
advisory firm and joins another advisory firm or begins a new advisory
firm. These predecessor performance results may be directly relevant to
an audience when the advertisement offers services to be provided by
the personnel responsible for the predecessor performance, even when
the personnel did not work during the period for which performance is
being advertised for the adviser disseminating the advertisement (the
``advertising adviser'').\323\
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    \323\ For purposes of this discussion, ``predecessor performance
results'' refers to all situations where an advertisement of an
investment adviser presents investment performance achieved by a
portfolio that was not advised at all times during the period shown
by the investment adviser.
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    However, predecessor performance results achieved by another
investment adviser, or by personnel of another investment adviser, may
be presented in a false or misleading manner by the advertising
adviser.\324\ For example, predecessor performance may be misleading to
the extent that the team that was primarily responsible for the
predecessor performance is different from the team whose advisory
services are being offered or promoted in the advertisement, including
when an individual who played a significant part in achieving the
predecessor performance is not a member of the advertising adviser's
investment team.\325\ Similarly, predecessor performance may be
misleading if the advertisement does not disclose that the predecessor
performance was achieved by different personnel, or by a different
advisory entity, than the personnel or entity whose services are being
offered or promoted. In some cases, the ability of an advertising
adviser to present predecessor performance that is not misleading may
be limited to the extent that that the advertising adviser lacks access
to the books and records underlying the predecessor performance.\326\
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    \324\ See current rule 206(4)-1(a)(5) (prohibiting the
publication, circulation, or distribution of any advertisement
``which contains any untrue statement of a material fact, or which
is otherwise false or misleading''). We have addressed this concern
in the presentation of performance results by RICs. See Instruction
4 to Item 4(b)(2) of Form N-1A; Instruction 11 to Item 27(b)(7) of
Form N-1A.
    \325\ See, e.g., Fiduciary Mgmt. Assocs., Inc., SEC Staff No-
Action Letter (Feb. 2, 1984).
    \326\ See Rule 204-2(a)(16).
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    Where an adviser selects portfolio securities by consensus or
committee decision making, it may be difficult to attach relative
significance to the role played by each group member, and so an
advertising adviser may face difficulties in deciding how to portray
performance results achieved by an adviser's committee in a manner that
is not misleading. Predecessor performance results may be misleading
where they were achieved by an investment committee at the predecessor
adviser, and the investment committee at the advertising adviser does
not have a substantial identity of personnel with the old
committee.\327\
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    \327\ See, e.g., Horizon Letter; see also Great Lakes Advisers,
Inc., SEC Staff No-Action Letter (Apr. 3, 1992) (stating the staff's
views that it may not be misleading for a successor adviser,
composed of less than 100 percent of the predecessor's committee, to
use the predecessor performance results so long as there is a
``substantial identity'' of personnel) (``Great Lakes Letter'').

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    Some circumstances under which predecessor performance results are
misleading may be addressed through specific provisions we have
included in the proposed rule. For example, depending on the facts and
circumstances, predecessor performance results may be misleading where
they exclude any accounts that were managed in a substantially similar
manner, or where they include any accounts that were not managed in a
substantially similar manner, at the predecessor firm. These
presentations may result in the inclusion or exclusion of performance
results in a manner that is neither accurate nor fair and
balanced.\328\ Predecessor performance results may be misleading where
the advertisement omits relevant disclosures, including that the
performance results were from accounts managed at another entity.
Predecessor performance results also may be misleading where, following
an internal restructuring of another adviser, an advertising adviser
does not operate in the same manner and under the same brand name that
existed before the restructuring.\329\ These predecessor performance
results may include an untrue or misleading implication about a
material fact relating to the advertising adviser.\330\
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    \328\ See proposed rule 206(4)-1(a)(6).
    \329\ See South State Bank, SEC Staff No-Action Letter (May 8,
2018) (conditioning the staff's statement that it would not
recommend enforcement action on representations including, for
example, that the successor adviser would operate in the same manner
and under the same brand name as the predecessor adviser). For
purposes of the discussion in this section II.A.6., we do not
consider a change of brand name, without more, by an investment
adviser to render its past performance as ``predecessor
performance.'' Likewise, a mere change in form of legal organization
(e.g., from corporation to limited liability company) or a change in
ownership of the adviser would likely not raise the concerns
described in this section.
    \330\ Proposed rule 206(4)-1(a)(3).
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    Accordingly, advertisements presenting predecessor performance
would be subject to the requirements imposed by the proposed rule on
all advertisements, including paragraph (a), and the more specific
performance advertising restrictions.\331\ We are requesting comment on
whether it would be appropriate to include in the proposed rule
additional provisions to address specifically the presentation of
predecessor performance results.
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    \331\ Proposed rule 206(4)-1(c). See also supra footnote 199 and
accompanying text.
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    Our staff has stated that it would not recommend that the
Commission take any enforcement action under section 206 of the
Advisers Act or the current rule if an advertising adviser presents
performance results achieved at another firm under certain conditions,
including on the basis of the adviser's representation that the
advertising adviser will keep the books and records of the predecessor
firm that are necessary to substantiate the performance results in
accordance with rule 204-2.\332\ We already require investment advisers
to keep copies of all advertisements containing performance data and
all documents necessary to form the basis of those calculations.\333\
We are considering how the books and records requirements should apply
to portability of performance and whether the revised rule should
explicitly require advertising advisers to have and keep the books and
records of a predecessor firm or consider instead other requirements
with respect to the records of performance of a predecessor firm
presented in an advertisement. For example, if books and records of a
predecessor firm are unavailable to an advertising adviser, it may be
possible for the advertising adviser to substantiate the performance of
the predecessor firm using information that was publicly available
contemporaneously with such performance and verified or audited by or
on behalf of the advertising adviser.
---------------------------------------------------------------------------

    \332\ See Horizon Letter; see also Great Lakes Letter, at n.3
(stating that rule 204-2(a)(16) ``applies also to a successor's use
of a predecessor's performance data'').
    \333\ Rule 204-2(a)(16).
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    We request comment on this aspect of the proposed rule. In
particular, we request comment on:
     Do commenters believe that we should include specific
provisions in the proposed rule to address the presentation of
predecessor performance results? Or do commenters believe that the
proposed rule, including the provisions of paragraph (a), will
sufficiently prevent the presentation of predecessor performance
results that are false or misleading? If we include specific provisions
to address the presentation of predecessor performance results, what
specific provisions should we include? How would those specific
provisions prevent the presentation of predecessor performance results
that is false or misleading?
     Should we impose conditions on an advertising adviser
seeking to present predecessor performance results achieved at a prior
advisory firm? Should we require that the individual or individuals who
currently manage accounts at the advertising adviser to have been
``primarily responsible'' for achieving the predecessor performance
results at the prior firm? If so, should we specify how ``primary
responsibility'' is determined?
     Should we address circumstances in which predecessor
performance results were achieved by portfolios managed by a committee
(as opposed to an individual) at the prior firm? Should we require that
if the portfolios at the predecessor firm were managed by a committee,
the accounts at the advertising adviser must be managed by a committee
comprising a substantial identity of the membership? Should we define
or provide additional guidance regarding the ``substantial identity''
required, or require that the committee comprises a specific percentage
or subset of members? Should we establish any specific requirements for
how much of a role an individual has to play on the committee at the
predecessor firm and on the committee at the advertising adviser?
     Is there any circumstance under which the membership of a
committee at a predecessor firm is so different from the membership of
a committee at the advertising adviser that any presentation of
performance results from the predecessor firm should be prohibited?
What are those circumstances?
     Should the proposed rule distinguish between predecessor
performance results on the basis of strategy--for example, between
fundamental and quantitative strategies? Are presentations of
predecessor performance results less likely to be misleading to the
extent that those results were generated by use of a proprietary,
algorithmic strategy that the advertising adviser ``owns'' and expects
to use going forward? Why or why not? Should the proposed rule
distinguish between predecessor performance results on the basis of
something other than strategy? What basis and why?
     Should we require any similarity between the accounts
managed at the predecessor firm and the accounts presented by the
advertising adviser--for example, having similar investment policies,
objectives, and strategies? A presentation of predecessor performance
results could be false or misleading if the accounts managed at the
predecessor firm are not sufficiently similar to the accounts that the
adviser currently manages such that the prior results would not provide
relevant information to the advertising adviser's prospective
clients.\334\ Should the Commission take this approach and include such
provision in the rule? If the Commission were to adopt this approach,
should we specify how that

similarity should be determined? Should we allow advertising advisers
to present any performance results from predecessor firms without
requiring that the advertising adviser determine whether the accounts
are similar or the results are relevant, and let investors evaluate the
relevance themselves? Would this approach be appropriate in Non-Retail
Advertisements and not Retail Advertisements? Why or why not?
---------------------------------------------------------------------------

    \334\ See, e.g., Horizon Letter.
---------------------------------------------------------------------------

     Should an investment adviser seeking to present
predecessor performance results be required to make any specific
representations or disclosures in the advertisement? Or elsewhere?
     Do commenters believe we should consider amendments to the
books and records rule to address the substantiation of performance
results from a predecessor firm? Do investment advisers encounter any
difficulties in accessing and retaining the books and records
substantiating the performance results of a predecessor firm? Are there
alternative books and records or other information that we could allow
advertising advisers to rely on or retain in order to satisfy their
obligations under the books and records rule with respect to
predecessor performance results? Are there other sources of records
that advisers currently rely on to substantiate performance results of
a predecessor firm?
     Do investment advisers encounter difficulties in
determining who ``owns'' the relevant performance results? That is, are
investment advisers able to agree who should be able to advertise the
prior performance results from the predecessor firm? How do investment
advisers make this determination? Should we adopt requirements to
clarify under what circumstances an advertising adviser may present
predecessor performance results?
     Should we clarify that an advertising adviser may continue
to advertise predecessor performance even if the personnel who achieved
the predecessor performance, and who are employed by the advertising
adviser, subsequently leave the advertising adviser? Why or why not?
    Our proposed rule would permit the use of testimonials and
references to specific investment advice given by an investment
adviser, unlike the blanket ban on their use under the current rule. As
a consequence, similar questions to that of performance portability may
arise about the use of testimonials and endorsements referring to a
predecessor entity, past third-party ratings, or specific investment
advice given at a previous firm. We believe that generally the same
framework that advisers apply to whether predecessor performance can be
carried forward, could also be applied when analyzing whether
testimonials, endorsements, third-party ratings, or specific investment
advice applicable to a predecessor entity could be used by an adviser
in advertisements.
    We request comment on issues related to the use of testimonials,
endorsements, third-party ratings, and specific investment advice
associated with predecessor entities.
     Should the same framework be used for these purposes as
that applicable when analyzing use of predecessor performance? Why or
why not? If advisers were not to use the existing performance
portability framework, how should we regulate the use of testimonials,
endorsements, third-party ratings, and specific investment advice from
a predecessor entity?
     Would maintaining books and records to substantiate the
applicability and relevance of testimonials, endorsements, third-party
ratings, and specific investment advice from a predecessor entity be
feasible for advisers?
     Should an adviser that seeks to use testimonials,
endorsements, third-party ratings, or specific investment advice from a
predecessor entity be required to make any specific disclosures or
representations in the advertisement explaining their source,
limitations, or relevance?
     Should we include specific requirements in the advertising
(or books and records) rule regarding the use of such predecessor
information? If so, what should we require?
7. Review and Approval of Advertisements
    The proposed rule would require an adviser to have an advertisement
reviewed and approved for consistency with the requirements of the
proposed rule by a designated employee before, directly or indirectly,
disseminating the advertisement, except for advertisements that are:
(i) Communications that are disseminated only to a single person or
household or to a single investor in a pooled investment vehicle; or
(ii) live oral communications that are broadcast on radio, television,
the internet, or any other similar medium.\335\ We are proposing this
requirement because we believe it may reduce the likelihood of advisers
violating the proposed rule. We are not proposing to require that
investment adviser advertisements be filed with or approved by the
Commission staff or a self-regulatory organization. Nonetheless, we
believe it is important that investment advisers have a process in
place designed to promote compliance with the proposed rule's
requirements. Requiring a written record of the review and approval of
the advertisement will allow our examination staff to better review
adviser compliance with the rule.
---------------------------------------------------------------------------

    \335\ Proposed rule 206(4)-1(d).
---------------------------------------------------------------------------

    The proposed rule would exclude communications that are
disseminated only to a single person or household or to a single
investor in a pooled investment vehicle from the review and approval
requirement. The proposed rule would exclude these one-on-one
communications, which may fall within the proposed definition of
``advertisement,'' from the scope of the review and approval
requirement to avoid placing a significant burden on an adviser's
individual communications with its current or potential investors. For
example, an employee of the adviser might otherwise submit each email
to a single investor for review before dissemination, to determine
whether it is an advertisement, and if so, whether it complies with the
proposed rule. We believe this could have an adverse effect on the
adviser's business due to the delay in communicating with investors. In
addition, we believe that requiring review and approval of each
communication could impose significant costs on an adviser because of
the staffing requirements such a requirement would entail. However, the
other provisions of the proposed rule would continue to apply. For
example, an adviser could not provide hypothetical performance to a
client in a one-on-one communication unless it complies with the
requirements of the proposed rule.\336\
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    \336\ See proposed rule 206(4)-1(c)(1)(v).
---------------------------------------------------------------------------

    Customizing a template presentation or mass mailing by filling in
the name of an individual investor or including other basic information
about the investor would not fall within the scope of this exception.
In such a case the communication is not sent only to a single person
because it is effectively a customized mass mailing.
    The proposed rule also would except live oral communications that
are broadcast on radio, television, the internet, or any other similar
medium from the review and approval requirement. We are excepting live
oral communications that are broadcast from the requirement because
they are extemporaneous, and therefore they cannot effectively be
reviewed and approved in advance. Nonetheless, to the extent live oral
communications that

are broadcast are also written or scripted, the scripts would be
subject to the review and approval requirement. If a live oral
communication that is broadcast is also recorded, and then later
disseminated by or on behalf of the adviser, then the broadcast would
qualify for the exception, but the recorded communication would not
qualify. In addition, any prepared materials, such as slides, used in
the live broadcast would not be subject to the exception and must be
reviewed.
    The proposed rule would allow any designated employee to conduct
the review and provide approval. This provision of the proposed rule is
intended to provide advisers with the flexibility to assign the
responsibilities of advertising reviews to any qualified employee. The
reviewer should be competent and knowledgeable regarding the proposed
rule's requirements. Advisers may designate one or more employees to
provide the required review and approval. We believe that designated
employees generally should include legal or compliance personnel of the
adviser. In general, we do not believe it would be appropriate for the
person who creates the advertisement to be the same person who reviews
and approves its use, as such overlap of personnel is likely to reduce
the utility and effectiveness of the review requirement. Nonetheless,
we recognize that certain small or single-person advisers may not have
separate personnel to create an advertisement and review it. We request
comment below on potential approaches to the review requirement for
such cases.
    Under the proposal, similar to new advertisements, updates to
existing advertisements would also require review and approval. It is
our understanding that the internal policies and procedures of most
advisers currently require such reviews for broadly disseminated
communications. In complying with the review requirement, advisers may
need to expand the scope of existing reviews to account for the
additional communications that may be included within the definition of
``advertisement'' under the proposed rule as discussed above.
    The proposed rule does not contain separate policy and procedure
requirements other than this review and approval requirement.\337\
Nonetheless, existing compliance policies and procedures requirements
in Advisers Act rule 206(4)-7 would apply to investment adviser
advertisements made pursuant to the proposed advertising rule.\338\ In
adopting rule 206(4)-7, the Commission stated that investment advisers
should adopt policies and procedures that address ``. . . the accuracy
of disclosures made to investors, clients, and regulators, including
account statements and advertisements.'' \339\ Investment advisers
would continue to be required to include policies and procedures
designed to prevent violations of the advertising rule in their
compliance programs if the proposed rule were adopted.
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    \337\ Compare FINRA rule 2210 which requires, in part, members
to establish written procedures designed to ensure that
communications comply with applicable standards; retail
communications (distributed or made available to 25 or fewer retail
investors within any 30 calendar-day period) be approved internally,
and certain communications must be filed with FINRA at least 10 days
prior to their first use. Rule 2210 does not require the review and
approval of correspondence. See rule 2210(b)-(c).
    \338\ Rule 206(4)-7 makes it unlawful for an investment adviser
to provide investment advice unless the adviser has adopted and
implemented written policies and procedures reasonably designed to
prevent violation[s] of the Advisers Act and rules that the
Commission has adopted under the Act, which would include revised
rule 206(4)-1 and its specific requirements. See rule 206(4)-7(a).
Rule 206(4)-7 also requires investment advisers to review, no less
than annually, the adequacy of the policies and procedures and the
effectiveness of their implementation, and to designate who is
responsible for administering the policies and procedures adopted
under the rule. See rule 206(4)-7(b)-(c).
    \339\ See Compliance Program Adopting Release, supra footnote
33, at 74716.
---------------------------------------------------------------------------

    In considering their compliance policies and procedures, advisers
should consider methods of preventing the dissemination of
advertisements that might violate the rule. Advisers could document in
their policies and procedures the process by which they determine that
an advertisement complies with the proposed rule, as well as any
significant changes to that process over time. For example, an adviser
may wish to document the process by which it determines that
advertisements that contain investment recommendations are fair and
balanced and consistent with the rule (such as by using objective non-
performance based standards) and if it changes that process, may wish
to consider documenting the reasons for such changes.
    We request comment on our approach to the proposed review and
approval requirement.
     As proposed, should we require a designated employee of an
investment adviser to review and approve advertisements? Should we
require that this review be conducted by only legal or compliance
personnel of the adviser? Should we require that only employees of an
adviser that are senior management be eligible to be designated as
reviewers? Should we permit outside third parties, such as law firms or
compliance consultants, to conduct these reviews?
     Should the rule prohibit the same individual who created
the advertisement from reviewing and approving it? If so, how would
small advisers, which may only have one individual qualified to create
and review advertisements, comply with this requirement? Should the
rule except them from the approval requirement, similar to the
exception under rule 204A-1(d) of the Advisers Act for small advisers
with only one access person from having that person approve his or her
own personal security investments, provided they keep sufficient
records?
     Should we include the proposed one-on-one communications
exception to the requirement to review and approve advertisements? Is
this necessary for advisers to communicate freely with investors? Is
there another way to reduce the burden of reviewing individual
communications before dissemination while reducing the likelihood that
advisers may violate the proposed rule? Should the exception apply to
communications with more than one investor? If so, how many?
     Should we except live oral communications that are
broadcast from the review and approval requirement as proposed? Are
there any other types of advertisements that we should except from the
requirement?
     Should we require any specific compliance procedures in
the advertising rule itself in addition to review and approval?
     Should we require that the review and approval process
differ or be more or less comprehensive based on the audience that the
advertisement is directed towards? If so, how?
8. Proposed Amendments to Form ADV
    We are also proposing to amend Item 5 of Part 1A of Form ADV to
improve information available to us and to the general public about
advisers' advertising practices.\340\ Item 5 currently requires an
adviser to provide

information about its advisory business.\341\ We propose to add a
subsection L (``Advertising Activities'') to require information about
an adviser's use in its advertisements of performance results,
testimonials, endorsements, third-party ratings, and its previous
investment advice.
---------------------------------------------------------------------------

    \340\ This section discusses the Commission's proposed rule and
form amendments that would affect advisers registered with the
Commission. We understand that the state securities authorities
intend to consider similar changes that affect advisers registered
with the states, who are also required to complete Form ADV Part 1B
as part of their state registrations. We will accept any comments
and forward them to the North American Securities Administrators
Association (``NASAA'') for consideration by the state securities
authorities. We request that you clearly indicate in your comment
letter which of your comments relate to these items.
    \341\ Exempt reporting advisers (that are not also registering
with any state securities authority) are not required to complete
Item 5 of Part 1A. Accordingly, our proposed subsection L of Item 5
of Part 1A would not be required for such advisers. See, e.g.,
Instruction 3 to Form ADV: General Instructions (``How is Form ADV
organized'').
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    Specifically, we would require an adviser to state whether any of
its advertisements contain performance results, and if so, whether all
of the performance results were verified or reviewed by a person who is
not a related person.\342\ We would also require an adviser to state
whether any of its advertisements includes testimonials or
endorsements, or includes a third-party rating, and if so, whether the
adviser pays or otherwise provides compensation or anything of value,
directly or indirectly, in connection with their use.\343\ Compensation
or anything of value is not limited solely to cash, but could also
include non-cash compensation. Finally, we would require an adviser to
state whether any of its advertisements includes a reference to
specific investment advice provided by the adviser.\344\
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    \342\ Proposed Form ADV, Part 1A, Item 5.L(1). The term
``related person'' would have the meaning currently ascribed to it
in the Form ADV Glossary (``Any advisory affiliate and any person
that is under common control with your firm.'') Italicized terms are
defined in the Form ADV Glossary.
    \343\ Proposed Form ADV, Part 1A, Item 5.L(2) and (3). The
Glossary to proposed Form ADV would define ``testimonial'' as ``any
statement of a client or investor's experience with the investment
adviser;'' ``endorsement'' as ``any statement by a person other than
a client or investor indicating approval, support, or recommendation
of the investment adviser;'' and ``third-party rating'' as ``a
rating or ranking of an investment adviser provided by a person who
is not an affiliated person of the adviser and provides such ratings
or rankings in the ordinary course of its business.'' These
definitions would be consistent with our proposed amendments to rule
206(4)-1.
    \344\ Proposed Form ADV, Part 1A, Item 5.L(4).
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    Our staff would use this information to help prepare for
examinations of investment advisers. This information would be
particularly useful for staff in reviewing an adviser's compliance with
the proposed amendments to the advertising rule, including the proposed
restrictions and conditions on advisers' use in advertisements of
performance presentations and third-party statements.
    We request comment on the proposed amendments to Part 1A of Form
ADV.
     Should we require more or less detailed information about
advisers' advertising practices? If so, what additional information
should we require, or what should we remove from the disclosure
requirement, and why?
     Should we require more information about advisers' use of
performance results in advertisements? For example, for advisers that
use performance results in advertisements that are verified or reviewed
by someone other than a related person, should we require the advisers
to provide the name and contact information of such reviewer on a
corresponding schedule? Why or why not?
     For advisers that have their performance results verified
or reviewed by a person who is not a related person, does such
verification or review apply to all of the advisers' performance
results, or only to some of the performance results? Please explain.
Should we require that advisers state if they have any of their results
verified by such a third party?
     Should we require advisers to state the particular types
of performance results they use in advertisements, such as related
performance, hypothetical performance, or another type of performance
(and if so, what type of performance)? Should we require them to state
to whom they direct specific types of advertisements (for example,
Retail Persons or Non-Retail Persons)? Why or why not?
     Should we require advisers to disclose that they provide
hypothetical performance to investors? If so, should we require
advisers to provide descriptions of such hypothetical performance or
any information about how they calculate hypothetical performance?
     Should we require advisers to state whether their use of
performance, testimonials, endorsements, third-party ratings, or
specific investment advice includes information from predecessor or
other firms? If so, should we require any additional information about
the predecessor or other firm, such as a name and contact, and an
affirmation that such firm permits the adviser's use of the performance
results (if applicable) and affirms its accuracy?
     Should we require advisers to state how they advertise
performance results (e.g., on social media, through testimonials,
endorsements or third-party ratings, seminars, television
advertisements, private placement materials, or through periodic client
updates)? Why or why not, and if so, should we require advisers to
provide more detail about the methods they use to advertise performance
results, such as the name of the website or social media platform, or
the name of the endorser? Why or why not?
     Should we require an adviser to state any other
information about the compensation it provides in connection with the
adviser's use of testimonials, endorsements, and third-party ratings in
advertisements, such as the amount or range of compensation? If so,
what type of information about the compensation should we require, and
why? Would such additional information be helpful to investors? Why or
why not?
     Should we require advisers to state the approximate
percentage of their testimonials, endorsements, or third-party
statements in advertisements that are current (within a specific time
frame) versus not current (within a specific time frame)? Why or why
not, and if so, what should those time frames be?
     Should we require advisers to state how they advertise
testimonials, endorsements, third-party ratings, or specific investment
advice (e.g., on social media, through seminars, television
advertisements, or through periodic client updates)? Why or why not,
and if so, should we require advisers to provide more detail about the
methods they use to advertise testimonials, endorsements, third-party
ratings, or specific investment advice such as the name of the website
or social media platform? Why or why not? Should we require any other
information, and if so, what types of information should we require?
     Is it clear what ``specific investment advice'' means in
the context of the proposed amendment to Form ADV?
     Even though Part 1A of Form ADV currently requires
advisers to report information about client referrals, including the
existence of cash and non-cash compensation that the adviser or a
related person gives to or receives from any person in exchange for a
client referral, should we also require additional information about
client referrals and solicitation, as discussed infra Section II.B? If
so, what additional information should we require, and why? For
example, should we require all registered investment advisers to
include the names of, and other specified information about, their
current solicitors on a separate schedule, similar to our requirements
for advisers to private funds to provide information about their
marketers (including solicitors)? \345\ Should we

require advisers to report the amount of compensation paid for
referrals (on an aggregate basis, per referral, or based on another
metric)? If a firm employs several solicitors, should we only require
information about the firm's top 5 (or 10, or another number)
solicitors, measured by number of client referrals made in the past
year or some other measure, such as assets under management the
referrals generate for the adviser? Please explain. Should we require
advisers to private funds to provide additional information in Section
7.B of Schedule D of Form ADV about their private fund marketing
arrangements? If yes, what additional information should we require,
and why?
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    \345\ See Section 7.B.(1) (Private Fund Reporting) of Schedule D
to Form ADV Part 1A (requiring advisers to private funds to list,
among other things, the name of their marketer (including any
solicitor), whether the marketer is a related person of the
advisers, whether the marketer is registered with the Commission,
the location of the marketer's office used principally by the
private fund, whether or not the marketer markets the private fund
through one or more websites, and if so, the website address(es)).
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     Should we require advisers to describe their advertising
practices in their Form ADV brochure in addition to, or instead of, the
proposed Part 1A subsection L (``Advertising Activities'')? Why or why
not, and if so, what information should we require advisers to describe
in their brochure about their advertising activities?
B. Proposed Amendments to the Solicitation Rule
    We are proposing to amend the solicitation rule, rule 206(4)-3, in
part to reflect regulatory changes and the evolution of industry
practices since we adopted the rule in 1979. Among other changes we
discuss below, we are proposing to expand the rule to cover
solicitation arrangements involving all forms of compensation, rather
than only cash compensation. It would also apply to the solicitation of
existing and prospective clients and investors rather than only to
``clients.'' Our proposal would also eliminate certain existing
requirements where the purpose of the requirements can be achieved
under other rules under the Act. Specifically, it would eliminate the
requirements that the solicitor deliver the adviser's brochure and that
the adviser obtain client acknowledgments of the solicitor disclosure.
Our proposal would revise the rule's written agreement requirement and
solicitor disclosure requirement, the partial exemptions for impersonal
investment advice and affiliated solicitors, and the solicitor
disqualification provision. It also would provide a conditional carve-
out from the provision for certain disciplinary events, and it would
add two additional exemptions to the rule for de minimis compensation
and nonprofit programs. Accordingly, we propose to revise the title of
rule 206(4)-3 from ``Cash payments for client solicitations'' to
``Compensation for solicitations.''
1. Scope of the Rule: Who is a Solicitor?
    We propose to retain, with certain revisions, the current rule's
definition of ``solicitor,'' which is ``any person who, directly or
indirectly, solicits any client for, or refers any client to, an
investment adviser.'' \346\ In a change from the current definition,
the proposed definition would also include persons who solicit
investors in private funds.\347\ As with the current rule, a solicitor
might be a firm (such as a broker-dealer or a bank), an individual at a
firm who engages in solicitation activities for an adviser (such as a
bank representative or an individual registered representative of a
broker-dealer), or both. A solicitor may, in some circumstances,
because of its solicitation activities, be acting as an investment
adviser within the meaning of section 202(a)(11) of the Act, or as a
broker or dealer within the meaning of section 202(a)(11) of the Act or
section 3(a)(4) or 3(a)(5) of the Exchange Act, respectively. Such
person may be subject to statutory or regulatory requirements under
Federal law, including the requirement to register as an investment
adviser or as a broker-dealer pursuant to the Act or section 15(a) of
the Exchange Act, respectively, and/or state law and certain FINRA
rules.\348\ This is a facts and circumstances determination. Some
solicitors may not be acting as investment advisers under the Act as a
result of their solicitation activities. Others may be prohibited from
registering with the Commission as an investment adviser, such as if
they have insufficient assets under management,\349\ or they may be
able to rely on an exception from registration, such as for certain
advisers to private funds.\350\ Similarly, a solicitor also may be able
to rely on an exception or exemption from broker-dealer registration,
including that provided by rule 3a4-1 under the Exchange Act.
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    \346\ Rule 206(4)-3(d)(1); proposed rule 206(4)-3(c)(4).
Depending on the facts and circumstances, a person providing advice
as to the selection or retention of an investment adviser may be an
``investment adviser'' within the meaning of section 202(a)(11) of
the Act and may also have an obligation to register under the Act.
Accordingly, we are proposing to no longer take the position, as in
1979 when the Commission adopted the rule, that ``a solicitor who
engages in solicitation activities in accordance with paragraph
(a)(2)(iii) of the rule . . . will be, at least with respect to
those activities, an associated person of an investment adviser and
therefore will not be required to register individually under the
Advisers Act solely as a result of those activities.'' 1979 Adopting
Release, supra footnote 27. We also stated in the 1979 Adopting
Release that ``[t]he staff of the Commission is prepared to consider
no action inquiries regarding the registration of solicitors.'' Id.
Subsequently, our staff has indicated in staff no-action letters
that it would not recommend enforcement action if a solicitor
performing solicitation activities pursuant to the solicitation rule
did not register as an ``investment adviser'' under the Act. See,
e.g., Cunningham Advisory Services, Inc., SEC Staff No-Action Letter
(Apr. 27, 1987) and Koyen, Clarke and Assoc. Inc., SEC Staff No-
Action Letter (Nov. 10, 1986) (in both of these staff no-action
letters, the staff cited the Commission's statement quoted in the
text accompanying this footnote as support for the staff's position
that would not recommend enforcement action to the Commission if
each solicitor proceeded as outlined in its letter without
registering as an investment adviser). See also Charles Schwab &
Co., SEC Staff No-Action Letter (Dec. 17, 1980) (solicitor's
incoming letter to the staff referenced the Commission's statement
quoted to in the text accompanying this footnote to support the
solicitor's argument that it was not required to register as an
adviser, and the Commission staff stated that it would not recommend
enforcement action to the Commission if the solicitor proceeded as
outlined in its letter without registering as an investment
adviser). As discussed in section II.D., staff in the Division of
Investment Management is reviewing staff no-action and
interpretative letters to determine whether any such letters should
be withdrawn in connection with any adoption of this proposal. If
the rule is adopted, some of the letters may be moot, superseded, or
otherwise inconsistent with the rule and, therefore, would be
withdrawn.
    \347\ See infra section II.B.3.
    \348\ See Standard of Conduct Release, supra footnote 23
(stating that ``[a]n adviser's fiduciary duty applies to all
investment advice the investment adviser provides to clients,
including advice about investment strategy, engaging a sub-adviser,
and account type.'').
    \349\ See section 203A of the Act. These advisers may be
required to register, instead, with one or more states, or they may
be exempt from the prohibition, such as advisers who would be
required to register in 15 or more States. See rule 203A-2(d).
    \350\ See sections 203(b) and (l) under the Act, as well as
rules 203(l)-1 and rule 203(m)-1.
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    Depending on the facts and circumstances, a person providing a
compensated testimonial or endorsement in a registered investment
adviser's advertisement (a ``promoter'') may also be a solicitor, and
both the proposed advertising rule and solicitation rule may apply to a
person's promotional activities. In our view, relevant considerations
might include compensation (e.g., incentive-based compensation such as
payment per referral would likely mean the promoter is also a
solicitor); communication control (e.g., the less control an adviser
has over the content or dissemination of an promoter's communication,
the more likely the promoter is also a solicitor); and the extent to
which the referral to the adviser is directed to a particular client or
private fund investor. For example, if the adviser pays a third-

party promoter per referral to engage in a largely unscripted social
media campaign to promote the adviser's services, or pays such a person
to review and provide its view of the adviser's services on a blog,
website, or social media page (e.g., a social media ``influencer''), we
would consider the promoter to be providing an endorsement and acting
as a solicitor and would apply both rules, including the proposed
advertising rule's general prohibitions of certain advertising
practices and its additional tailored requirements for testimonials and
endorsements.\351\ We believe that, as a practical matter, an adviser
subject to both rules in such a situation would substantially satisfy
its advertising rule disclosure obligation for testimonials and
endorsements by adhering to the solicitation rule disclosure
requirement (e.g., the requirement to disclose the solicitor's
compensation).\352\ The overall effect, therefore, would be to apply a
heightened set of safeguards where someone providing an endorsement
crosses the line into solicitation. We believe heightened safeguards
would generally be appropriate for a solicitation because a solicitor's
incentives to defraud an investor would be greater than a
promoter's.\353\ This is because a solicitor typically will receive
compensation based on the referrals made, while the compensation to a
promoter for an advertisement containing an endorsement or testimonial
may be less likely based on such incentive compensation.
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    \351\ See supra section II.A.4 for a discussion of how an
adviser may satisfy the disclosure requirements applicable to third-
party statements and ratings in the context of a third-party
promoters.
    \352\ The proposed solicitation would generally require that
either the adviser or solicitor deliver the solicitor disclosure.
See infra section II.B.4. If the solicitor (and not the adviser)
delivers the solicitor disclosure, the adviser itself would still be
required to make the disclosures required under the proposed
advertising rule for testimonials and endorsements to the extent
that the solicitor's referral also constitutes a testimonial or
endorsement.
    \353\ But see section II.B.7.c (discussing the proposed
exemption for de minimis compensation).
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    We request comment on the above, particularly:
     Should the rule generally retain the current definition of
``solicitor,'' as proposed, with some modifications to apply to persons
who solicit investors in certain types of pooled investment vehicles,
as discussed below? Why or why not? If not, how should the rule define
``solicitor''? Have any interpretive issues arisen regarding the
current rule's definition that we could clarify? If so, what are they
and how should we address them?
     What factors or considerations should apply when
evaluating a promoter's (such as a social media influencer's) status as
either an endorser or solicitor or both, and why? Do commenters agree
that relevant considerations should include compensation and
communication control? Should we also consider the extent to which a
communication is targeted to a particular investor? Why or why not?
     Should we modify the definition of ``solicitor'' so that
it is limited to persons whose solicitation activities are directed at
specific investors (e.g., through one-on-one meetings and personalized
communications)? Why or why not? Should we modify the definition of
``solicitor'' so that is limited to persons to whom the adviser
provides incentive-based compensation, directly or indirectly, as
compensation for solicitation activities? Why or why not? Should we add
both of these modifications to the rule? Do these types of
solicitations present greater conflicts of interest for the solicitor
than other solicitation arrangements, necessitating greater disclosure
to the investor? Should we distinguish testimonials and endorsements
under the proposed advertising rule from solicitations under this
proposed rule? If so, how?
     For compensated solicitation arrangements that would also
be subject to the proposed advertising rule, would the application of
both rules together result in any conflicting obligations or otherwise
create practical difficulties in compliance with the rules? Or would
advisers be able to leverage their compliance with one rule to satisfy
the other rule's requirements?
2. Expanding the Rule To Address All Forms of Compensation
    Rule 206(4)-3 currently prohibits an adviser from paying a cash
fee, directly or indirectly, to a solicitor with respect to
solicitation activities unless the adviser complies with the terms of
the rule.\354\ The proposed rule would continue to apply to cash
payments to a solicitor, including a percentage of assets under
management, flat fees, retainers, hourly fees and other methods of cash
compensation.
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    \354\ Rule 206(4)-3(a).
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    The proposed rule would also apply to non-cash compensation
provided to solicitors--an adviser would be prohibited from paying a
solicitor any form of compensation, directly or indirectly, for any
solicitation activities unless the adviser complies with the terms of
the rule.\355\ Since the adoption of the current rule, we have gained a
broader understanding of the different types of compensation that
advisers use in referral arrangements, including compensation for
referring investors to private fund advisers.\356\ For example,
advisers may direct client brokerage to reward brokers that refer them
investors.\357\ In addition, other solicitation arrangements, such as
refer-a-friend programs in which advisers compensate current investors
to solicit other investors, can involve both cash and non-cash
compensation.\358\ The provision of non-cash compensation for referrals
creates the same conflicts of interest as cash compensation for
referrals--the solicitor has an economic interest in steering the
investor to the adviser and may be biased by this interest. We believe
that investors should be made aware of the solicitor's conflict of
interest regardless of the form of compensation.\359\
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    \355\ Proposed rule 206(4)-3(a) (``As a means reasonably
designed to prevent fraudulent, deceptive, or manipulative acts,
practices, or courses of business within the meaning of section
206(4), it is unlawful for an investment adviser that is registered
or required to be registered under section 203 of the Act to
compensate a solicitor, directly or indirectly, for any solicitation
activities, unless the investment adviser complies with paragraphs
(1) through (3) of [paragraph (a)].'').
    \356\ We now require advisers to report to the Commission, and
to disclose to clients, the existence of any cash or non-cash
compensation they provide for client referrals, including sales
awards or other prizes. See Item 8.H of Form ADV, Part lA; Item 14
of Form ADV, Part 2A. In addition, registered investment advisers
that report to the Commission on Form ADV information about their
private funds, are required to report information about marketers
used for such private funds (e.g., placement agents, consultants,
finders, introducers, municipal advisers, other solicitors, or
similar persons), but this information does not include the
compensation paid to such marketers. See Item A.28 of Section
7.B.(1) of Schedule D to Form ADV Part 1A.
    \357\ In 1979 when we adopted the rule, we limited the rule to
cash payments, expressly reserving judgment about then-emerging
arrangements under which broker-dealers might offer investment
advisers certain services, including client referrals, in exchange
for the adviser directing client trades to the broker-dealer. See
1978 Proposing Release, supra footnote 27, at text accompanying n.3;
1979 Adopting Release, supra footnote 27, at n.6 and accompanying
text. Advisers are currently required to disclose to clients in the
Form ADV brochure if they consider, in selecting or recommending
broker-dealers, whether they or a related person receives client
referrals from a broker-dealer or third party. See Item 12.A.2 of
Form ADV Part 2A.
    \358\ In refer-a-friend programs, advisers often provide
soliciting investors cash and non-cash compensation such as free or
lower-fee investment advisory services, investment adviser
subscription services, and gift cards. However, we are proposing a
de minimis exemption, as discussed below, which would exempt
qualifying refer-a-friend arrangements from the rule.
    \359\ Concerns underlying non-cash compensation in the context
of sales activity are also reflected in other Commission rules. See,
e.g., Regulation Best Interest, Release No. 34-86031 (June 5, 2019)
(``Regulation Best Interest Release'') (adopting rule 15l-1 under
the Exchange Act, requiring broker-dealers to establish written
policies and procedures reasonably designed to identify and
eliminate any sales contests, sales quotas, bonuses, and non-cash
compensation that are based on the sale of specific securities or
the sale of specific types of securities within a limited period of
time, noting that these compensation practices create high-pressure
situations for associated persons to increase the sales of specific
securities or specific types of securities within a limited period
of time and thus compromise the best interests of their retail
customers).

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    The rule would, therefore, be applicable to non-cash compensation,
including, but not limited to, directed brokerage, sales awards or
other prizes, training or education meetings, outings, tours, or other
forms of entertainment, and free or discounted advisory services.\360\
Compensation could also include the adviser providing investment advice
that directly or indirectly benefits the solicitor. For example, if the
solicitor is a broker-dealer or affiliated with a broker-dealer, an
adviser's payment for solicitation could be the adviser's
recommendation that its investors purchase the solicitor's proprietary
investment products or products that the adviser knows have revenue
sharing or other pecuniary arrangements with the solicitor or its
affiliate, if the adviser directly or indirectly makes these
recommendations in exchange for the solicitor's solicitation
activities. Broker-dealers or dual registrants that receive brokerage
for solicitation of client accounts in wrap fee programs that they do
not sponsor would be subject to the proposed solicitation rule if they
solicit those clients to participate in the wrap fee program.
Compensation provided by the adviser may occur before or after the
solicitor engages in its referral activities, but regardless of when
the compensation for solicitation is provided, such compensation would
be within the scope of the proposed rule.
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    \360\ We would not consider attendance at training and education
meetings, including company-sponsored meetings such as annual
conferences, to be non-cash compensation, provided that free
attendance at these meetings or trainings is not provided in
exchange for solicitation activities. For example, if free
attendance at a conference is conditioned upon a solicitor referring
a certain number of investors to an investment adviser, such
attendance would be non-cash compensation. Advisers already are
required to identify non-cash referral arrangements pursuant to rule
206(4)-7, the compliance rule, and advisers' disclosure obligations.
See, e.g. Item 8.H (1) of Form ADV, Part 1A (requiring advisers to
disclose whether they or any related person, directly or indirectly,
compensates any person that is not an employee for client referrals,
and instructing advisers to consider all cash and non-cash
compensation that the adviser or a related person gave to or
received from any person in exchange for client referrals, including
any bonus that is based, at least in part, on the number or amount
of client referrals).
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    We request comment on our proposed treatment of compensation under
the solicitation rule.
     Should the rule be extended to cover all forms of
compensation (including non-cash), as proposed? Should some forms of
non-cash compensation be excepted from the proposed rule? If so, which
ones and why?
     Are there any forms of non-cash compensation paid for
investor solicitations that should be specifically prohibited under the
rule, or subject to additional conditions (in lieu of or in addition to
the proposed rule's requirements)? If so, which forms of non-cash
compensation should be prohibited under the rule, and/or what
conditions should apply to their use in solicitations for investors?
     Should the rule define ``compensation,'' or include
examples of direct and indirect compensation for solicitation
activities? If so, what should the definition include, and what
examples should we include?
     How should the rule apply to an adviser that directs
client brokerage in exchange for client referrals? Should the proposed
rule apply any additional conditions in these circumstances?
     Does the proposed rule clearly distinguish compensation
that is for solicitation from ordinary compensation an adviser pays to
a broker-dealer for bona fide execution services for an adviser's
clients and is unrelated to a solicitation arrangement between the
adviser and the broker-dealer? If not, how should the rule clarify this
distinction?
     Should the rule include any cap on the amount of
compensation (cash or non-cash) paid to solicitors, and if so, what
should that cap be? Why or why not? If so, should such a cap vary
depending on the type of investor solicited (such as a Retail Person or
a Non-Retail Person), or the type of compensation arrangement? For
example, should there be a cap on the percentage of assets under
management an adviser may pay a solicitor for solicitation, or an
absolute cap per solicitation arrangement in terms of dollar amount, or
both, and if so, what should they be? Should there be a cap on the
amount of compensation for the solicitation of investors in private
funds that is different from a cap on the amount of compensation for
advisory clients, and if so what should they be? Should the rule
include a cap on, or any other parameters regarding, the length of time
over which they are paid (such that, for example, solicitors do not
continue to receive fees even after they are no longer in business as a
solicitor, or after they become subject to disciplinary action that
would result in their disqualification as a solicitor under the rule)?
3. Compensation for the Solicitation of Existing and Prospective
Investors
    Our proposal would expand the scope of the rule to the solicitation
of existing and prospective private fund investors.\361\ We believe
this would increase protections to such investors primarily by making
them aware of a solicitor's financial interest in the investor's
investment in a private fund and prohibiting the use of disqualified
solicitors under the proposed rule. While investors in private funds
may often be financially sophisticated, they may not be aware that the
person engaging in the solicitation activity may be compensated by the
adviser, and we believe investors in such funds should be informed of
that fact and the related conflicts.
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    \361\ See proposed rule 206(4)-3(c)(2)-(4).
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    Our proposal to apply the solicitation rule to investors in private
funds, and not just to the adviser's clients, which are generally the
private funds themselves, would be consistent with the proposed
advertising rule.\362\ Similar to the scope of our proposed advertising
rule, the proposed amendments would not apply the solicitation rule to
solicitations of existing and prospective investors in RICs and
BDCs.\363\ Unlike for private funds, the primary policy goal of the
proposed solicitation rule is already satisfied by other regulatory
requirements applicable to RICs and BDCs: Prospective investors in RICs
and BDCs sold through a broker-dealer or other financial intermediary
already receive disclosure about the conflicts of interest that may be
created as a result of the fund or its related companies paying the
intermediary for the sale of its shares and related services.\364\

Moreover, we believe RIC and BDC investors are typically sought through
advertisements or investment advice, each of which is already subject
to other regulatory requirements.\365\ Finally, we believe that
harmonizing the scope of the solicitation rule with the advertising
rule to the extent possible should ease compliance burdens.
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    \362\ See supra footnote 66 (citing Goldstein v. SEC, 451 F.3d
873 (D.C. Cir. 2006)); see also Mayer Brown LLP, SEC Staff No-Action
Letter (Jul. 28, 2008) (Commission staff stated, in the context of
stating it would not recommend enforcement action under rule 206(4)-
3, the staff's view that the cash solicitation rule generally does
not apply to a registered investment adviser's cash payment to a
person solely to compensate that person for soliciting investors or
prospective investors for, or referring investors or prospective
investors to, an investment pool managed by the adviser because such
an investor is not a ``client'').
    \363\ See supra footnote 63 and accompanying text. The
advertising rule's proposed RIC and BDC exclusion would not apply to
communications that are not subject to rule 156 or 482. See supra
section II.A.2.c.iii.
    \364\ See Item 8 of Form N-1A; see also FINRA Rule 2341(l)(4)
(generally prohibiting member firms from accepting any cash
compensation from an investment company, an adviser to an investment
company, a fund administrator, an underwriter or any affiliated
person (as defined in section 2(a)(3) of the Investment Company Act)
of such entities unless such compensation is described in a current
prospectus of the investment company). For RICs and BDCs not sold
through an intermediary, such as funds purchased directly by
investors, the purchasing investors would not be ``referred'' or
``solicited'' and thus the solicitation rule would be inapplicable.
    \365\ See supra footnote 7 (discussing rules 156 and 482); see
also Standard of Conduct Release, supra footnote 23.
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    We request comment below on whether the proposed rule should apply
to the solicitation of some or all investors in pooled investment
vehicles:
     Should the proposed rule apply to solicitation of
investors in private funds? Why or why not? If we do not apply the
solicitation rule to solicitations for investments in private funds,
would section 206(4) of the Act and rule 206(4)-8, together with
section 17(a) of the Securities Act and section 10(b) of the Exchange
Act and rule 10b-5 thereunder, sufficiently protect investors that are
solicited to invest in private funds to the extent that section 206(4)
and rule 206(4)-8 may not apply to the solicitation? \366\ Why or why
not?
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    \366\ See supra footnote 67and accompanying text (discussing
rule 206(4)-8, which prohibits advisers from (i) making false or
misleading statements to investors or prospective investors in hedge
funds and other pooled investment vehicles they advise, or (ii)
otherwise defrauding these investors or prospective investors).
---------------------------------------------------------------------------

     If we include solicitation of investors in private funds
in the proposed solicitation rule, in order to comply with the proposed
rule, either the solicitor or the adviser would deliver the solicitor
disclosure directly to current and prospective investors in private
funds and the solicitation arrangement would be subject to the proposed
rule's disqualification provisions. Are there other conditions that we
should impose on such solicitations?
     Should we further extend the requirements of the proposed
rule to apply to solicitation activities with respect to RICs and BDCs?
Why or why not?
     Should the proposed rule apply to other types of pooled
investment vehicles, such as funds that are excluded from the
definition of ``investment company'' by reason of section 3(c)(5) of
the Investment Company Act or rule 3a-7 thereunder? \367\ Why or why
not?
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    \367\ 15 U.S.C. 80a-3(c)(5)(C). Section 3(c)(5)(C) of the
Investment Company Act generally excludes from the definition of
``investment company'' any person who is primarily engaged in, among
other things, ``purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate.'' The exclusion
provided by section 3(c)(5)(C) sometimes is used by issuers of
mortgage-backed securities. See generally Companies Engaged in the
Business of Acquiring Mortgages and Mortgage-Related Instruments,
Release No. IC-29778 (Aug. 31, 2011) [76 FR 55300 (Sept. 7, 2011)]
(concept release and request for comment on interpretive issues
under the Investment Company Act), at nn.4 and 5. Rule 3a-7 provides
that certain issuers of asset-backed securities are not investment
companies for purposes of the Investment Company Act.
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4. Solicitor Disclosure
    Proposed rule 206(4)-3 would prohibit an adviser from compensating
solicitors unless the adviser and solicitor have, in the written
agreement, designated the solicitor or the adviser to provide to
investors at the time of any solicitation activities (or in the case of
a mass communication, as soon as reasonably practicable thereafter), a
separate disclosure containing specified information (the ``solicitor
disclosure'').\368\ The proposal would require that the solicitor
disclosure state: (A) The name of the investment adviser; (B) the name
of the solicitor; (C) a description of the investment adviser's
relationship with the solicitor; (D) the terms of any compensation
arrangement, including a description of the compensation provided or to
be provided to the solicitor; and (E) any potential material conflicts
of interest on the part of the solicitor resulting from the investment
adviser's relationship with the solicitor and/or the compensation
arrangement.\369\ It would also require disclosure of the amount of any
additional cost to the investor as a result of solicitation.\370\
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    \368\ Proposed rule 206(4)-3(a)(1)(iii). This section discusses
the disclosure component of the proposed rule's written agreement
requirement (other than disclosure of applicable disciplinary
events). See infra sections II.B.5 (discussing the other components
of the proposed rule's written agreement requirement); and II.B.8
(discussing the proposed rule's disqualification provisions).
    \369\ Proposed rule 206(4)-3(a)(1)(iii).
    \370\ Proposed rule 206(4)-3(a)(1)(iii)(F).
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    This proposed disclosure is derived from the current rule's
required disclosure.\371\ However, it would include a new requirement
to disclose any potential material conflicts of interest on the part of
the solicitor resulting from the investment adviser's relationship with
the solicitor and/or the compensation arrangement. In addition, unlike
the current rule, the proposed rule would permit either the solicitor
or the adviser to deliver the solicitor disclosure, rather than
requiring that the solicitor deliver it, provided the written agreement
designates the party responsible for delivering the disclosure. We are
also proposing to remove the current rule's requirement that the
solicitor disclosure be ``written.'' These proposed changes are
discussed below.
---------------------------------------------------------------------------

    \371\ Rule 206(4)-3(a)(2)(iii)(A)(3) and (b).
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    When we adopted the cash solicitation rule, we noted our belief
that separate solicitor disclosure was necessary to ensure that the
investor's attention would be directed to the fact that the adviser
pays the solicitor a cash referral fee and the incentives it may
create.\372\ We continue to believe that separate, targeted disclosure
of the salient terms of the compensated arrangement provided at the
time of the solicitation, would draw the investor's attention to the
solicitor's bias in recommending an adviser directly or indirectly
compensating it for the referral. While advisers themselves are
required to disclose to clients their compensation arrangements,
including compensation for client referrals and the related conflicts
of interest, we believe that the separate solicitor disclosure to
investors would put investors on notice of the solicitor's conflict of
interest in the compensated solicitation arrangement.\373\
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    \372\ 1979 Adopting Release, supra footnote 27, at n.14.
    \373\ See, e.g., Item 14 of Form ADV Part 2A (requiring advisers
to disclose to advisory clients information about their referral
arrangements, including a description of the arrangement and the
compensation); Item 12 (requiring advisers to disclose to advisory
clients their conflicts of interest regarding brokerage for client
referrals); see also Item 10.C Form ADV Part 2A (requiring advisers
to disclose to advisory clients their conflicts of interest
regarding certain relationships with related persons). Advisers are
not required to deliver Form ADV to private fund investors that are
not otherwise advisory clients. Therefore, private fund investors
may not receive the information required in these items of Form ADV.
However, to satisfy advisers' obligations as fiduciaries or address
potential liabilities under the antifraud provisions of the
securities laws, advisers may also need to disclose to clients and
private fund investors information not specifically required by Part
2 of Form ADV or in more detail than the brochure items might
otherwise require.
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    We support firms wishing to use electronic and recorded media in
preparing disclosure for investors, including electronic formatting and
graphical, text, audio, video, and online features.\374\ Under our
proposal, if the solicitor disclosure states the information required
by the proposed rule, it could be presented in a written format or any
other electronic or

recorded media format.\375\ Irrespective of the format, however, the
adviser would be required, under the Act's books and records rule, to
make and keep true, accurate and current copies of the solicitor
disclosure delivered to investors under the solicitation rule.
Accordingly, under the proposed rule the solicitor disclosure could not
be delivered orally unless the oral disclosure is recorded and
retained.
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    \374\ See Form CRS Release, supra footnote 227, at n.144 and
accompanying text.
    \375\ If the disclosure is made in writing, we have stated that
an ``in writing'' requirement could be satisfied either through
paper or electronic means consistent with existing Commission
guidance on electronic delivery of documents. See Regulation Best
Interest Release, supra footnote 359, at text accompanying footnotes
499-500. If delivery of the solicitor disclosure is made
electronically, it should be done in accordance with the
Commission's guidance regarding electronic delivery. See Use of
Electronic Media by Broker-Dealers, Transfer Agents, and Investment
Advisers for Delivery of Information; Additional Examples Under the
Securities Act of 1933, Securities Exchange Act of 1934, and
Investment Company Act of 1940, Release No. 34-37182 (May 9, 1996)
[61 FR 24644 (May 15, 1996)]; see also Use of Electronic Media,
Release No. 34-42728 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)];
and Use of Electronic Media for Delivery Purposes, Release No. 34-
36345 (Oct. 6, 1995) [60 FR 53458 (Oct. 13, 1995)]. See also Form
CRS Release, supra footnote 227, at nn.678 and 153 and accompanying
text.
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    Our proposal would continue to require that the disclosure be
separate. Because solicitors may prefer to deliver multiple
communications to investors at once, we believe that this requirement
would preserve the salience and impact of the disclosure to investors.
Under our proposed rule, therefore, a solicitor could deliver the
required solicitor disclosure with other communications, provided that
the content and presentation of the solicitor disclosure is not
combined with other content, such as any legal disclaimers and
marketing messages. For example, a firm could deliver a solicitor
disclosure to an investor via an email that contains other information
by attaching the solicitor disclosure as a separate attachment.
However, it would not be effective disclosure to merely include a
hyperlink to disclosures available elsewhere.
    We are proposing to permit either the adviser or the solicitor to
deliver the solicitor disclosure, rather than requiring the solicitor
to deliver the disclosure, provided that the written agreement
designates the party responsible for its delivery. We believe that this
provision would continue to promote investor protection, while
providing firms with greater flexibility in meeting the rule's
requirements. It would place the fact of the solicitor's interest in
front of the investor at the time the investor is solicited so that the
investor is provided the necessary tools to evaluate any potential bias
on the part of the solicitor.
    The proposed rule would require the solicitor disclosure to include
the investment adviser's name, the solicitor's name, and a description
of the investment adviser's relationship with the solicitor.\376\ The
current rule requires similar disclosures.\377\ We are proposing these
requirements because they provide important information and context to
investors. The name of the adviser is a key part of any solicitation:
Without disclosing the adviser's name, investors would not know to whom
they are being referred. The name of the solicitor is important so the
investor can seek to assess the reputation or other qualifications of
the solicitor. Disclosure of the relationship between the adviser and
the solicitor is important to give the investor context--that--when
combined with the other proposed disclosures about the compensated
nature of the solicitation--would inform investors about the
solicitor's bias in referring the adviser. For example, this disclosure
would inform an investor that the solicitor is an employee of the
adviser, or an employee or person associated with the adviser's
affiliate, or is an unaffiliated third party, as applicable in each
case. If the solicitor is a current client, as for example in refer-a-
friend solicitation arrangements that would exceed the proposed de
minimis exemption, the solicitor disclosure would need to state this
fact.
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    \376\ Proposed rule 206(4)-3(a)(1)(iii)(A)-(C).
    \377\ The current rule requires disclosure of the name of the
solicitor; the name of the investment adviser; and the nature of the
relationship, including any affiliation, between the solicitor and
the investment adviser. Rule 206(4)-3(b)(1)-(3).
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    The proposed rule would also require disclosure of the terms of any
compensation arrangement, including a description of the compensation
provided or to be provided to the solicitor.\378\ The current rule
requires similar disclosure.\379\ As required under the current rule,
if a specific amount of cash compensation were being paid, that amount
would be required to be disclosed.\380\ As we stated when we adopted
the rule and as we would continue to require for cash compensation:
``if, instead of a specific amount, the solicitor's compensation was to
take the form of a percentage of the total advisory fee over a period
of time, that percentage and the time period would have to be
disclosed.'' \381\ Furthermore: ``[i]f all, or part, of the solicitor's
compensation is deferred or is contingent upon some future event, such
as the client's continuation or renewal of the advisory relationship or
agreement, such terms would also have to be disclosed.'' \382\ For
compensation that is non-cash, the solicitor disclosure should describe
the terms of any compensation arrangement, including a description of
the compensation provided or to be provided to the solicitor. If the
value of the non-cash compensation is readily ascertainable, the
solicitor disclosure generally should include that amount. We discuss
examples below.
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    \378\ Proposed rule 206(4)-3(a)(1)(iii)(D). The appropriateness
of the compensation should be determined by the adviser, in light of
the fiduciary duties an adviser owes its clients, based upon a
general standard of reasonableness under the circumstances. See,
e.g., Mid-States Capital Planning, Inc. SEC Staff No-Action Letter
(pub. avail. Apr. 11, 1983); Shareholder Service Corporation SEC
Staff No-Action Letter (pub. avail. Feb. 3, 1989).
    \379\ The current rule requires that the solicitor disclosure
contain a statement that the solicitor will be compensated for his
solicitation services by the investment adviser, and the terms of
such compensation arrangement, including a description of the
compensation paid or to be paid to the solicitor. Rule 206(4)-
3(b)(4) and (5).
    \380\ 1979 Adopting Release, supra footnote 27, at text
accompanying nn.15 and 16.
    \381\ Id.
    \382\ Id.
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    We believe that disclosure of the terms of the compensation,
including a description of the compensation provided or to be provided
to the solicitor, would be important to convey to the investor the
solicitor's incentive to refer it to the adviser, whether the
compensation is cash or non-cash. The incentive to solicit investors is
often more or less material to an investor's evaluation of the referral
depending on the type and magnitude of the compensation. Solicitors
that receive little compensation may have less incentive to make
referrals than a solicitor that receives higher compensation for the
referrals. The incentive might also vary based on the structure of the
compensation arrangement. A solicitor that receives a flat or fixed fee
from an adviser for a set number of referrals might have a different
incentive in referring to the adviser than a solicitor that receives a
fee, such as a percentage of the investor's assets under management,
for each investor that becomes a client of, or an investor with, the
adviser. Furthermore, trailing fees (i.e., fees that are continuing)
that are contingent on the investor's relationship with the adviser
continuing for a specified period of time present additional
considerations in evaluating the solicitor's incentives. The proposed
rule's requirement to disclose ``the terms of any compensation
arrangement, including a description of the

compensation provided or to be provided to the solicitor'' should
include, for trailing fee arrangements, disclosure of not only the fact
that the solicitor continues to be compensated after the investor
becomes a client of, or investor with, the adviser, but also the period
of time over which the solicitor continues to receive compensation for
such solicitation. A longer trailing period can present a greater
incentive to solicit the investor, as a solicitor may be more inclined
to refer an investor that will continue to pay the solicitor for a
longer period of time.
    In some directed brokerage arrangements, the solicitor and the
adviser have arranged for the adviser to direct brokerage to the
solicitor as compensation for solicitation of investors for, or
referral of investors to, the adviser. In these cases, the solicitor
disclosure should state the terms of this arrangement, including a
description of the compensation provided or to be provided to the
solicitor. As part of the disclosure of the terms of the compensation,
the solicitor disclosure should state the range of commissions that the
solicitor charges for investors directed to it by the adviser.
Furthermore, if the solicitation is contingent upon the solicitor
receiving a particular threshold of directed brokerage (and other
services, if applicable) from the adviser, the disclosure should say
so. Additional disclosure would be required, for example, if the
solicitor and the adviser agree that as compensation for the
solicitor's solicitation activities on behalf of the adviser, the
adviser's directed brokerage activities would extend to other investors
such as the solicited investor's friends and family.
    In refer-a-friend solicitation arrangements that would be subject
to the proposed rule, the compensation component of the solicitor
disclosure would include the amount the solicitor receives per
solicitation (e.g., $10 or an equivalent gift card). The proposed
rule's requirement to disclose ``the terms of any compensation
arrangement, including a description of the compensation provided or to
be provided to the solicitor'' should include, for refer-a-friend and
other solicitation arrangements, disclosure of the time at which the
solicitor would receive compensation for solicitation activities (e.g.,
upon solicitation of the investor or upon the solicited investor
becoming a client of, or an investor with, the adviser).
    The solicitor disclosure would be required to include compensation
that the adviser provides directly or indirectly to the solicitor for
any solicitation activities.\383\ For example, if an individual
solicits an investor, and the adviser compensates another person for
such solicitation (such as an employer or another entity that is
associated with the individual), the solicitor disclosure would need to
include this compensation. If a solicitor, such as a broker-dealer,
refers investors to advisers that recommend the solicitor's or its
affiliate's proprietary investment products or recommend products that
have revenue sharing or other pecuniary arrangements with the solicitor
or its affiliate, the solicitor disclosure should say so.\384\
Regardless of whether the adviser enters into a solicitation agreement
with an individual or the individual's firm, compensation to the firm
for solicitation would constitute compensation for solicitation under
the rule, as it would be likely to affect the solicitor's salary,
bonus, commission or continued association with the firm.
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    \383\ See proposed rule 206(4)-3(a), stating that ``As a means
reasonably designed to prevent fraudulent, deceptive, or
manipulative acts, practices, or courses of business within the
meaning of section 206(4), it is unlawful for an investment adviser
that is registered or required to be registered under section 203 of
the Act to compensate a solicitor, directly or indirectly, for any
solicitation activities, unless the investment adviser complies with
paragraphs (1) through (3) [of paragraph (a)].'' (emphasis added).
    \384\ See also Standard of Conduct Release, supra footnote 23,
at 23 (``an adviser must eliminate or at least expose through full
and fair disclosure all conflicts of interest which might incline an