private funds may differ from the costs of surprise examinations for
other investment advisers. Separately, the Commission staff recently
estimated costs associated with advisers who would be subject to
newly proposed surprise examination requirements. That analysis
relied on the high end of the range of surprise examination costs,
assuming costs of $162,000 annually. The Safeguarding Release also
cited a 2013 Government Accountability Office (GAO) study, which
examined 12 average-sized registered advisers, found that the cost
of surprise examinations ranged from $3,500 to $31,000. The GAO
noted that the costs of surprise examinations vary widely across
advisers and are typically based on the amount of hours required to
conduct the examinations, which is a function of a number of factors
including the number of client accounts under custody. See
Safeguarding Release, supra footnote 467. Given these wide ranges of
potential surprise examination costs, to be reasonable, we have not
deducted cost savings from forgone surprise examination costs from
our estimates of the quantified costs associated with the final
audit rule in this release.
---------------------------------------------------------------------------

    For funds that had received an audit by an auditor that is not
registered with the PCAOB, the costs of audits will also be offset by a
reduction in costs from no longer obtaining their previous audit,
although we anticipate that the cost of the required audit will likely
be greater because a PCAOB-registered and -inspected auditor who is
independent may cost more than an auditor that is not subject to the
same requirements. We requested comment on data that may facilitate
quantification of these offsets,\1634\ but no commenter offered any
such data.
---------------------------------------------------------------------------

    \1634\ Proposing Release, supra footnote 3, at 280-285.
---------------------------------------------------------------------------

    We also understand that the PCAOB registration and inspection
requirement may limit the pool of auditors that are eligible to perform
these services which could, in turn, increase costs, as a result of the
potential for these auditors to charge higher prices for their
services. The increase in demand for these services, however, may be
limited in light of the high percentage of funds already being audited
by such auditors.\1635\ Several commenters emphasized these costs,
stating that the proposed rule would substantially increase audit
prices, for example because there may be an insufficient number of
suitable auditors available.\1636\
---------------------------------------------------------------------------

    \1635\ Id.
    \1636\ See, e.g., AIC Comment Letter I; AIMA/ACC Comment Letter;
CFA Comment Letter I; SBAI Comment Letter, LaSalle Comment Letter.
---------------------------------------------------------------------------

    We are not convinced that there may be an insufficient number of
suitable auditors available. As shown in Figures 4 and 5 above, Form
ADV shows growth in the number of audits by PCAOB-registered and -
inspected independent private fund auditors of approximately 2,000 in
2020, approximately 3,000 in 2021, and approximately 6,000 in
2022.\1637\ In 2022, there were only approximately 8,000 private funds
that did not already undergo an audit from a PCAOB-registered and -
inspected independent auditor. Moreover, the limitation of the final
rules to not apply to advisers with respect to SAFs further alleviates
commenters' concerns.\1638\ Given that the rules will not apply to
advisers with respect to SAFs, the final mandatory audit rule will only
add approximately 5800 mandatory audits. These estimates are presented
for comparison purposes in Figure 7.
---------------------------------------------------------------------------

    \1637\ See supra section VI.C.4.
    \1638\ See supra section II.A.

---------------------------------------------------------------------------

[GRAPHIC] [TIFF OMITTED] TR14SE23.006

    In other words, the audit industry has already organically, of its
own accord, added a number of audits to its workload in the past year
commensurate with the workload that will be added by the final rule.
Moreover, the number of audits that will be added by the final rule is
of the same order of magnitude as the number of audits added
organically by the industry in each of the last several years. We
believe this indicates that the audit industry is equipped to expand to
meet the demand for additional audits without substantial additional
costs, and so we do not believe that supply constraints on auditors
because of the final rule will substantially increase the costs of
private fund audits. This pattern and conclusion holds by type of
private fund and by fund size.\1639\ However, approximately 1,500 of
these newly mandatory audits would be on funds of size $2 million and
under. To the extent that limited supply of auditors does increase the
cost of the rule, for example by resulting in increased prices of
audits, these costs may be particularly borne by advisers and investors
to these smaller funds.
---------------------------------------------------------------------------

    \1639\ Id.
---------------------------------------------------------------------------

    Several commenters further specify that the concern over a lack of
a sufficient number of suitable auditors will particularly apply to
funds that rely on Big Four auditing firms for various non-audit
services. Several commenters state that certain funds get an audit from
a Big Four firm because of their investors' demands, but none of the
Big Four firms meet the independence requirements associated with the
current custody rule for the fund.\1640\ As discussed above, less than
one percent of all funds get an additional surprise exam in addition to
an audit, which indicates that no more than one percent of funds are
managed by advisers who may face difficulty in getting an audit by an
independent firm.\1641\ Figure 6 above also further shows that only a
de minimis number of funds, namely 149 out of almost 50 thousand,
excluding securitized asset funds, are managed by advisers who may face
difficulty in securing a PCAOB-registered and -inspected auditor.\1642\
---------------------------------------------------------------------------

    \1640\ Id. See also, e.g., LaSalle Comment Letter; PWC Comment
Letter.
    \1641\ Id.
    \1642\ Id. Based on staff review of Form ADV data, these funds
range across all fund sizes and are not disproportionately larger or
disproportionately smaller funds.
---------------------------------------------------------------------------

    Because the case of funds that the adviser does not control and are
neither controlled by nor under common control with the adviser (e.g.,
where an unaffiliated sub-adviser provides services to the fund) only
requires the adviser to take all reasonable steps to cause the fund
undergo an audit that meets these elements,\1643\ many investors in
such funds will not bear any of the costs of the final rule.\1644\
Similarly, because the final mandatory audit rule will not require
advisers to obtain audits of CLOs and other SAFs, advisers to those
funds will not face any costs under the rules with respect to those
funds.\1645\ Lastly, as noted above, we do not apply substantive
provisions of the Advisers Act and its rules, including the mandatory
audit requirement, with respect to non-U.S. clients (including private
funds) of an SEC registered offshore investment adviser.\1646\ We
believe that this clarification will reduce many of the concerns
expressed by commenters regarding the difficulty for non-U.S. private
fund advisers finding an auditor in certain jurisdictions.
---------------------------------------------------------------------------

    \1643\ See supra section II.C.
    \1644\ See supra sections II.C, VI.C.4.
    \1645\ See supra section II.C.
    \1646\ See, e.g., Exemptions Adopting Release, supra footnote 9.
---------------------------------------------------------------------------

    The proposed Commission notification requirement is not present in
the final rule, and thus does not represent a new cost.\1647\ While one

commenter questioned the benefits of this notification requirement,
commenters did not address the costs of this notification requirement
in their comments.\1648\
---------------------------------------------------------------------------

    \1647\ See supra VI.C.4.
    \1648\ NYC Bar Comment Letter II.
---------------------------------------------------------------------------

    Because the final rule aligns the private fund mandatory audit
requirement with the custody rule audit requirement, advisers under the
final rule will also face lower costs than under the proposal by
avoiding any confusion associated with differences in the requirements
of the two rules. Several commenters stated that differences between
the two rules could create a risk of confusion.\1649\
---------------------------------------------------------------------------

    \1649\ See, e.g., IAA Comment Letter II; NYC Bar Comment Letter
II; AIC Comment Letter I.
---------------------------------------------------------------------------

    The indirect costs of the audit requirement will depend on the
quality of the financial statements of the funds newly subject to
audits. These costs may be relatively higher for the funds with lower
quality financial statements (i.e., the funds with the greatest benefit
from the audit requirement). The indirect costs from the independent
audit requirement may include costs of changing the fund's internal
financial reporting practices, such as improvements to internal
controls over financial reporting, to avoid potential harm to investors
from a misstatement. Further, because the requirement to have the
auditor registered with, and subject to the regular inspection by, the
PCAOB may limit the pool of accountants that are eligible to perform
these services,\1650\ the resulting competition for these services
might generally lead to an increase in their costs, as an effect of the
final rule. Commenters did not address these types of indirect costs in
their comments.
---------------------------------------------------------------------------

    \1650\ See supra footnote 1640 and accompanying text.
---------------------------------------------------------------------------

6. Adviser-Led Secondaries
    In addition, the final adviser-led secondaries rule will require
advisers to obtain fairness opinions or valuation opinions from an
independent opinion provider in connection with certain adviser-led
secondary transactions with respect to a private fund. In connection
with this opinion, the final rule also requires a summary of any
material business relationships the adviser or any of its related
persons has, or has had within the past two years, with the independent
opinion provider. The final adviser-led secondaries rule differs from
the proposal in that it allows a fund to obtain either a fairness
opinion or a valuation opinion in connection with certain adviser-led
secondary transactions instead of requiring a fairness opinion and
specifies a timeline for the delivery of this opinion to
investors.\1651\
---------------------------------------------------------------------------

    \1651\ See supra section II.C.8.
---------------------------------------------------------------------------

    This requirement will not apply to advisers that are not required
to register as investment advisers with the Commission, such as State-
registered advisers and exempt reporting advisers. This requirement
will also not apply where the transaction is a tender offer instead of
an adviser-led secondary transaction as defined in the rule, and so
neither the benefits nor the costs will apply in the case of tender
offers.\1652\ This will be the case if an investor is not faced with
the decision between (1) selling all or a portion of its interest and
(2) converting or exchanging all or a portion of its interest.\1653\
Generally, if an investor is allowed to retain its interest in the same
fund with respect to the asset subject to the transaction on the same
terms (i.e., the investor is not required to either sell or convert/
exchange), as many tender offers permit investors to do, then the
transaction will not qualify as an adviser-led secondary transaction.
We discuss the costs and benefits of this rule provisions below.
Several factors, however, make the quantification of many of the
economic effects of the final amendments and rules difficult. For
example, there is a lack of quantitative data on the extent to which
adviser-led secondaries with neither fairness opinions nor valuation
opinions differ in fairness of price from adviser-led secondaries with
either fairness opinions or valuation opinions attached. It would also
be difficult to quantify how investors and advisers may change their
preferences over secondary transactions once fairness opinions are
required to be provided. As a result, parts of the discussion below are
qualitative in nature.
---------------------------------------------------------------------------

    \1652\ Id.
    \1653\ Id.
---------------------------------------------------------------------------

Benefits
    The final rule's requirement that an adviser distribute a fairness
opinion or valuation opinion and summary of material business
relationships with the opinion provider in connection with certain
adviser-led secondary transactions may provide benefits to investors in
the specific context of adviser-led secondary transactions similar to
the effects of the mandatory audit rule.\1654\ This requirement will
provide an important check against an adviser's conflicts of interest
in structuring and leading these transactions. Investors will have
decreased risk of experiencing harm from mis-valuation of secondary-led
transactions. Further, anticipating a lower risk of harm from mis-
valuation when participating in such transactions, investors may be
more likely to participate. The result may be a closer alignment
between investor choices and investor preferences over private fund
terms, investment strategies, and investment outcomes. These benefits
will, however, be reduced to the extent that advisers are already
obtaining fairness opinions or valuation opinions as a matter of best
practice.
---------------------------------------------------------------------------

    \1654\ See supra section VI.D.5.
---------------------------------------------------------------------------

    While the final rule, in a change from the proposal, will also
allow for the use of a valuation opinion instead of a fairness opinion,
we understand that a valuation opinion will still provide investors
with a strong basis to make an informed decision.\1655\ A valuation
opinion is a written opinion stating the value (either as a single
amount or a range) of any assets being sold as part of an adviser-led
secondary transaction.\1656\ By contrast, a fairness opinion addresses
the fairness from a financial point of view to a party paying or
receiving consideration in a transaction.\1657\ One commenter stated
that the financial analyses used to support a fairness opinion and
valuation opinion are substantially similar.\1658\ Both types of
opinions generally yield implied or indicative valuation ranges.\1659\
---------------------------------------------------------------------------

    \1655\ See supra sections II.D.2, VI.C.4; see also Houlihan
Comment Letter.
    \1656\ Houlihan Comment Letter.
    \1657\ See supra sections II.D.2, VI.C.4
    \1658\ See supra sections II.D.2, VI.C.4
    \1659\ Id.
---------------------------------------------------------------------------

    Because the final rule differs from the proposal in that tender
offers will not be captured by the definition in the rule when the
investor is not faced with the decision between (1) selling all or a
portion of its interest and (2) converting or exchanging all or a
portion of its interest, advisers may have additional incentives to
structure transactions as tender offers instead of as adviser-led
secondary transactions.\1660\ That is, advisers may have additional
incentives to offer investors more choices than just a choice between
selling all or a portion of their interests and converting or
exchanging all or a portion of their interests. To the extent this
occurs, investors may benefit from having greater flexibility in such
transactions to, for example, continue to receive exposure to the
assets that are at issue in the transaction by retaining its interest
in the same fund on the same terms.\1661\
---------------------------------------------------------------------------

    \1660\ See supra section II.D.1.
    \1661\ Id.

---------------------------------------------------------------------------

    Because the final rule specifies that the adviser-led secondaries
rule will not apply to advisers in the case of SAFs,\1662\ there will
be no accrual of benefits to investors associated with transactions
such as CLO re-issuances.\1663\ However, we believe these forgone
benefits are negligible, in particular because SAF re-issuances
typically specify that outstanding debt tranches are fully repaid at
par. The investor benefits from the adviser-led secondaries rule
primarily accrue from the check provided to investors against an
adviser's potential conflict of interest that could provide an
incentive for an adviser to mis-value assets when the answer is on both
sides of a transaction. Because investors are fully paid at par, there
is no risk of harm from the adviser mis-valuing the assets.\1664\
---------------------------------------------------------------------------

    \1662\ See supra section II.A.
    \1663\ See supra section II.C.8.
    \1664\ Id. Equity investors in SAFs may face risks of harm from
mis-valuations and may therefore have forgone benefits from not
applying the rules to advisers with respect to SAFs. However, equity
investors in SAFs are typically only a small portion of the fund,
include the adviser and its related persons themselves as well as
advisers to other large private funds, and do not typically include
pension funds. See supra sections VI.C.1, VI.C.2. These factors
mitigate the risks of any harm to the equity tranche, and so
mitigate the forgone benefits from not applying the rules to
advisers with respect to those funds.
---------------------------------------------------------------------------

    Some commenters agreed with the stated benefits of the final rule
as outlined in the Proposing Release, and generally supported it.\1665\
Other commenters were skeptical of the stated benefits of acquiring a
fairness opinion for all adviser-led secondary transactions as would
have been required by the proposal.\1666\ While acknowledging that
fairness opinions can be a useful tool in mitigating information
asymmetries between the adviser and their investors, these commenters
stated that funds often will not seek such an opinion because it would
provide little benefit to investors and would come at a high
cost.\1667\ The commenters argued further that in cases where funds did
not obtain a fairness opinion, other practices were in place to
guarantee investor protection consistent with the adviser's fiduciary
duty, such as a competitive bidding process or recent arms-length
transaction.\1668\ We recognize that there will be transactions for
which a fairness opinion or valuation opinion will provide less benefit
to investors because of the existence of these other mechanisms for
independent price valuation that may already be in place.
---------------------------------------------------------------------------

    \1665\ See, e.g., ILPA Comment Letter I; CFA Comment Letter I;
Morningstar Comment Letter.
    \1666\ See, e.g., PIFF Comment Letter; AIC Comment Letter II;
Ropes & Gray Comment Letter.
    \1667\ Id.
    \1668\ Id.
---------------------------------------------------------------------------

    However, we continue to believe that this requirement will, in many
cases, provide the above benefits to investors. Moreover, it is the
staff's understanding that adviser-led secondaries also occur during
times of stress, and may be associated with an adviser who needs to
restructure a portfolio investment.\1669\ In other instances, an
adviser may use an adviser-led secondary transaction to extend an
investment beyond the contractually agreed upon term of the fund that
holds it.\1670\ These may be particularly risky cases for investors as
the risk of a conflict of interest may be high, and so fairness
opinions or valuation opinions may provide particularly high benefits
in those cases. Lastly, we also believe that ensuring that such
opinions are delivered to investors in a time frame that would allow
them to use that information in their decision-making process will
increase the benefit of this rule to investors.
---------------------------------------------------------------------------

    \1669\ See supra section VI.C.4.
    \1670\ Id.
---------------------------------------------------------------------------

    Similar to the final mandatory audit rule, the benefits from
mandatory fairness opinions/valuation opinions are particularly
relevant for illiquid investments. Illiquid assets currently are where
we believe it is most feasible for adviser-led secondary transactions
to occur at unfair prices, and where there is broadly a higher risk of
investor harm from potential conflicts of interest or fraud and where
there is the greatest risk of asymmetry of information between
investors and the adviser. This is because currently, as discussed
above, advisers may use a high level of discretion and subjectivity in
valuing a private fund's illiquid investments, and the adviser further
may have incentives to bias the fair value estimates of the investment
to generate a more favorable price in the secondary transaction.\1671\
Because both liquid funds and illiquid funds may have illiquid
investments, investors in both types of funds will benefit, though the
benefits may be larger for investors in illiquid funds (as such funds
may have more illiquid investments than liquid funds and are more
likely to have adviser-led secondary transactions).
---------------------------------------------------------------------------

    \1671\ See supra section II.C.8.
---------------------------------------------------------------------------

    Because Form PF's recently adopted new quarterly reporting
requirements for private equity fund advisers will already collect
quarterly information on the occurrence of adviser-led secondaries
(after the effective date of the Form PF final amendments, albeit with
a definition of ``adviser-led secondary'' that is not identical to the
definition used for the adviser-led secondaries rule), any investor
protection benefits of the final rules may be mitigated to the extent
that Form PF is already a sufficient tool for investor protection
purposes.\1672\ However we do not believe the benefits will be
substantially mitigated, because Form PF is not an investor-facing
disclosure form. Information that private fund advisers report on Form
PF is provided to regulators on a confidential basis and is
nonpublic.\1673\ The benefits from the final rules accrue substantially
from fairness opinions and valuation opinions decreasing risks of
investors experiencing harm from mis-valuation of secondary-led
transactions. To the extent that advisers' incentives to independently
pursue fairness opinions and valuation opinions are increased by Form
PF's requirement (after the effective date of the new amendments) to
report adviser-led secondaries to the Commission, that change in
incentives from Form PF's amendments will reduce both the benefits and
costs of the final rules (since the final result is, regardless, the
adviser being incentivized to pursue a fairness opinion or valuation
opinion, no matter which rule was the predominating factor in the
adviser's decision).
---------------------------------------------------------------------------

    \1672\ See supra section VI.C.4.
    \1673\ See supra section VI.C.3.
---------------------------------------------------------------------------

Costs
    Costs would also be incurred related to obtaining the required
fairness opinion or valuation opinion and material business
relationship summary in the case of an adviser-led secondary
transaction. For purposes of the PRA, we estimate that 10% of advisers
providing advice to private funds conduct an adviser-led secondary
transaction each year and that the funds would pay external costs of
$100,565 for each fairness opinion or valuation opinion and material
business relationship summary.\1674\ Because only approximately 10% of
advisers conduct an adviser-led secondary transaction each year, the
estimated total fees for all funds per year would therefore be
approximately $52,796,625.\1675\ Further,

as discussed in section VII.E below, we anticipate that the fairness
opinion or valuation opinion and material business relationship summary
requirements would impose a cost of approximately $2,800,507.50 for
internal time annually.\1676\ These costs will be borne primarily,
though not exclusively, by closed-end illiquid funds,\1677\ as these
are the funds that most frequently have the adviser-led secondaries
considered by the rule. Because the final adviser-led secondaries rule
will not apply to advisers with respect to SAFs,\1678\ there will be no
accrual of costs to advisers associated with transactions such as CLO
re-issuances.\1679\
---------------------------------------------------------------------------

    \1674\ See infra section VII.D.
    \1675\ Id. One commenter's calculation of aggregate costs
associated with the adviser-led secondaries rule yields
substantially higher aggregate costs, but per-fund costs comparable
to those reflected here. The commenter's aggregate cost result is
driven by the commenter assuming that the adviser-led secondaries
rule's costs would be borne over 4,533 fairness opinions instead of
504, as was assumed by the Proposing Release. See LSTA Comment
Letter, Exhibit C. This assumption would require that approximately
90% of registered advisers undertake an adviser-led secondary each
year, as Form ADV data indicate there are currently approximately
5,000 registered advisers to private funds. See supra VI.C.1. We do
not believe this is a reasonable assumption and have continued to
assume approximately 10% of advisers conduct an adviser-led
secondary transaction each year.
    \1676\ Id. As discussed above, one commenter criticized the
quantification methods underlying these estimates, and we have
explained why we do not agree with that criticism. See supra
footnote 1366. Nevertheless, to reflect commenters' concerns, and
recognizing certain changes from the proposal, we are revising the
estimates upwards as reflected here and in section VII.B.
    \1677\ See supra section II.C.8.
    \1678\ See supra section II.A.
    \1679\ See supra section II.C.8.
---------------------------------------------------------------------------

    To the extent that certain hedge fund or other open-end private
fund transactions are captured by the rule, these funds and their
investors would also face comparable fees and costs. The costs
associated with obtaining fairness opinions or valuation opinions could
dissuade some private fund advisers from leading these transactions,
which could decrease liquidity opportunities for some private fund
advisers and their investors. Under current practice, some investors
bear the expense associated with obtaining a fairness opinion or
valuation opinion if there is one. We expect similar arrangements may
be made going forward to comply with the final rule, with disclosure
where required. Advisers could alternatively attempt to introduce
substitute charges (for example, increased management fees) to cover
the costs of compliance with the rule, but their ability to do so may
depend on the willingness of investors to incur those substitute
charges. We do not believe that specifying a timeline for delivery of
the opinion will significantly change the cost of compliance.
    Conversely, to the extent that advisers restructure their
transactions as tender offers to avoid being captured by the definition
of adviser-led secondary, private fund advisers and their investors may
be able to mitigate the costs of the final rule.\1680\
---------------------------------------------------------------------------

    \1680\ See supra section II.D.1.
---------------------------------------------------------------------------

    Some commenters highlighted the costs associated with obtaining a
fairness opinion.\1681\ These commenters also cited indirect
consequences as a result of the high costs of fairness opinions. One
commenter suggested that the time required to obtain and distribute a
fairness opinion could create ``unnecessary delay, which can put
transaction completion at risk.'' \1682\ Another stated that for some
transactions, a fairness opinion may not be available, which would
effectively bar the transaction even if the benefits of the transaction
to investors were large.\1683\ Another noted that opinion providers may
need to create or update a database of business relationships, and that
this cost may ultimately be borne at least partially by
investors.\1684\ However, many of these commenters stated that a
valuation opinion would be less costly in most circumstances.\1685\ We
believe that these commenters' concerns on costs are substantially
mitigated by the option in the final rule for a valuation opinion
instead of a fairness opinion, but at the margin these types of
indirect consequences may still occur.
---------------------------------------------------------------------------

    \1681\ MFA Comment Letter I; MFA Comment Letter I, Appendix A;
Ropes & Gray Comment Letter.
    \1682\ AIC Comment Letter I.
    \1683\ PIFF Comment Letter.
    \1684\ AIC Comment Letter I, Appendix 1.
    \1685\ MFA Comment Letter I; MFA Comment Letter I, Appendix A;
AIC Comment Letter I.
---------------------------------------------------------------------------

7. Written Documentation of All Advisers' Annual Review of Compliance
Programs
    Amendments to rule 206(4)-7 under the Advisers Act will require all
advisers, not just those to private funds, to document the annual
review of their compliance policies and procedures in writing. These
requirements will apply to advisers with respect to their SAFs, and so
the benefits and costs below will apply even in the case of SAFs. We
discuss the costs and benefits of this amendment below. Several
factors, however, make the quantification of many of the economic
effects of the final amendments and rules difficult. As a result, parts
of the discussion below are qualitative in nature.
Benefits
    The rule amendment requiring all SEC-registered advisers to
document the annual review of their compliance policies and procedures
in writing will allow our staff to better determine whether an adviser
has complied with the review requirement of the compliance rule, and
will facilitate remediation of non-compliance. Because our staff's
determination of whether the adviser has complied with the compliance
rule will become more effective, the rule amendment may reduce the risk
of non-compliance, as well as any risk to investors associated with
non-compliance. Several commenters agreed with these benefits.\1686\
---------------------------------------------------------------------------

    \1686\ See, e.g., CFA Comment Letter I; IAA Comment Letter II;
Convergence Comment Letter; NRS Comment Letter.
---------------------------------------------------------------------------

    The commenters who disagreed with the rule amendment generally
emphasized the costs of the change, instead of questioning the
benefits, as discussed further below in this section. However, one
commenter stated that the amendment would be unnecessarily burdensome
and duplicative for asset managers that have multiple registered
investment advisers operating under a common compliance program \1687\
The commenter stated that, under the proposed amendment, RIAs in an
advisory complex would be producing multiple duplicative reports with
little variation, and where one or more of those advisers are advisers
to RICs, the report would largely be overlapping with and duplicative
of the 38a-1 compliance program written report.\1688\ While the
benefits of the produced reports may diminish with each marginal report
produced with little variation, the costs will likely also decrease. We
also do not believe that the marginal benefits of each report will be
de minimis: For RIAs in an advisory complex with many advisers,
producing each report may help advisers assess whether they have
considered any compliance matters that arose during the previous year,
changes in business activities, or changes to the Advisers Act or other
rules and regulations that may impact that particular adviser. Even if,
in certain cases, consideration of such issues produces a similar
report to a previous one, there may be broader benefits across the
industry from standardizing the practice of advisers making such
assessments throughout their entire advisory complex. Another commenter
compared the rule to Rule 38a-1 of the Investment Company Act, and
stated such a written documentation requirement is only relevant for
funds with retail investors. While we do not have the necessary data to
determine whether the benefits of such requirements, or similar
requirements, are higher for retail investors or other types of fund
investors we continue to believe the

above benefits will broadly accrue for investors to both types of
funds.
---------------------------------------------------------------------------

    \1687\ SIFMA-AMG Comment Letter I.
    \1688\ Id.
---------------------------------------------------------------------------

    The benefits from documentation of compliance programs will be
relevant for all investors, as the rule applies to all advisers that
are registered or required to register, not just private fund advisers.
In addition, the lack of legacy status for this rule amendment mean
that these benefits will accrue across all registered advisers.
Costs
    Lastly, the required documentation of the annual review of the
adviser's compliance program has direct costs that include the cost of
legal services associated with the preparation of such documentation.
As discussed below, for purposes of the PRA, we anticipate that the
requirement for all SEC-registered advisers to document the annual
review of their compliance policies and procedures in writing would,
for all advisers, impose cost of approximately $40,890,982 for internal
time, and approximately $3,525,579 for external costs.\1689\ One
commenter agreed that the rule would entail direct costs.\1690\ Other
commenters stated there would be indirect costs of the rule, such as
chilled communications between an adviser and compliance consultants or
outside counsel and less tailored compliance reviews.\1691\ The lack of
legacy status for this rule amendment mean that these costs will be
borne across all SEC-registered advisers.\1692\
---------------------------------------------------------------------------

    \1689\ See infra section VII.G.
    \1690\ NYC Bar Comment Letter II.
    \1691\ Curtis Comment Letter; SBAI Comment Letter.
    1 In connection with the written report required under rule 38a-
1, the Compliance Rule Adopting Release stated that ``[a]ll reports
required by our rules are meant to be made available to the
Commission and the Commission staff and, thus, they are not subject
to the attorney-client privilege, the work-product doctrine, or
other similar protections.'' See supra footnote 905.
    \1692\ There do not exist reliable data for quantifying what
percentage of private fund advisers today engage in this activity or
the other restricted activities. For the purposes of quantifying
costs, including aggregate costs, we have applied the estimated
costs per adviser to all advisers in the scope of the rule, as
detailed in section VII.
---------------------------------------------------------------------------

8. Recordkeeping
    Finally, the amendment to the Advisers Act recordkeeping rule will
require advisers who are registered or required to be registered to
retain books and records related to the quarterly statement rule,\1693\
to retain books and records related to the mandatory adviser audit
rule,\1694\ to support their compliance with the adviser-led
secondaries rule,\1695\ to support their compliance with the
preferential treatment disclosure rule,\1696\ and to support their
compliance with the restricted activities rule.\1697\ The benefit to
investors will be to enable an examiner to verify more easily that a
fund is in compliance with these rules and to facilitate the more
timely detection and remediation of non-compliance. These requirements
will also help facilitate the Commission's enforcement and examination
capabilities. Also beneficial to investors, advisers may react to the
enhanced ability of third parties to detect and impose sanctions
against non-compliance due to the recordkeeping requirements by taking
more care to comply with the substance of the rule. The lack of legacy
status for this rule provision means that these benefits will accrue
across all private funds and advisers.
---------------------------------------------------------------------------

    \1693\ See supra section II.B.5.
    \1694\ See supra section II.C.8.
    \1695\ See supra section II.D.5.
    \1696\ See supra section II.G.6.
    \1697\ See supra section II.E.
---------------------------------------------------------------------------

    These requirements will impose costs on advisers related to
maintaining these records. Several commenters stated that the
recordkeeping requirements would be burdensome.\1698\ In addition to
the compliance burden, commenters stated that the recordkeeping
requirements posed a risk of having proprietary data exposed to
hackers,\1699\ or that requiring the adviser to retain records
regarding prospective investors that do not ultimately invest in the
fund may conflict with other legal obligations applicable to the
adviser, resulting in additional legal costs.\1700\ With respect to the
written documentation of the adviser's annual reviews of its compliance
programs, commenters stated that the requirement to disclose the review
of the compliance program may have a chilling effect on outside
compliance consultants' willingness to prepare compliance reviews for
private fund advisers,\1701\ or may cause compliance reviews to be less
tailored to the adviser's specific risks.\1702\
---------------------------------------------------------------------------

    \1698\ See, e.g., AIMA/ACC Comment Letter; ATR Comment Letter.
    \1699\ ATR Comment Letter.
    \1700\ AIMA/ACC Comment Letter.
    \1701\ Curtis Comment Letter.
    \1702\ SBAI Comment Letter.
---------------------------------------------------------------------------

    While the final rules may result in some of these effects, we do
not have a basis for quantifying the cost of these effects, and no
basis was provided by the commenters. As discussed below, for purposes
of the PRA, we anticipate that the additional recordkeeping obligations
would impose, for all advisers, an annual cost of approximately
$22,430,631.25.\1703\ The lack of legacy status for this rule provision
means that these costs will be borne across all private funds and
advisers. Because the final rules with new recordkeeping components
will not apply to advisers with respect to CLOs and other SAFs, they
will not face any new recordkeeping requirements in the case of their
CLOs and SAFs, and so there will be no benefits or costs for investors
and advisers associated with those funds from the final recordkeeping
rules.\1704\
---------------------------------------------------------------------------

    \1703\ We have adjusted these estimates to reflect that the
final quarterly statement, audit, adviser-led secondaries,
restricted activities, and preferential treatment rules will not
apply to SAF advisers with respect to SAFs they advise as well. See
infra section VII.H. As discussed above, one commenter criticized
the quantification methods underlying these estimates, and we have
explained why we do not agree with that criticism. See supra
footnote 1366. Nevertheless, to reflect the commenter's concerns,
and recognizing certain changes from the proposal, we are revising
the estimates upwards as reflected here and in section VII.B.
    \1704\ See supra section II.A.
---------------------------------------------------------------------------

E. Effects on Efficiency, Competition, and Capital Formation

1. Efficiency
    The final rules will likely enhance economic efficiency by enabling
investors more easily to identify funds that align with their
preferences over private fund terms, investment strategies, and
investment outcomes, and also by causing fund advisers to align their
actions more closely with the interests of investors through the
elimination of prohibited practices.
    First, the final rules may increase the usefulness of the
information that investors receive from private fund advisers regarding
the fees, expenses, and performance of the fund, and regarding the
preferential treatment of certain investors of the fund through the
more detailed and standardized disclosures as well as consent
requirements discussed above.\1705\ These enhanced disclosures and
consent requirements will provide more information to investors
regarding the ability and potential fit of investment advisers, which
may improve the quality of the matches that investors make with private
funds and investment advisers in terms of fit with investor preferences
over private fund terms, investment strategies, and investment
outcomes. The enhanced disclosures may also reduce search costs, as
investors may be better able to evaluate the funds of an investment
adviser based on the information to be disclosed at the time of the
investment and in the quarterly statement.
---------------------------------------------------------------------------

    \1705\ See supra sections VI.D.1, VI.D.3. See also, e.g.,
Consumer Federation of America Comment Letter.

---------------------------------------------------------------------------

    Regarding preferential treatment, the final rules further align
fund adviser actions and investor interests by prohibiting certain
preferential treatment practices altogether (instead of only requiring
disclosure or consent), specifically prohibiting preferential terms
regarding liquidity or transparency that have a material, negative
impact on investors in the fund or a similar pool of assets.\1706\
Prohibiting these activities, and prohibiting remaining preferential
treatment activities unless certain disclosures are provided, may
eliminate some of the complexity and uncertainty that investors face
about the outcomes of their investment choices, further reducing costs
investors must undertake to find appropriate matches between their
choice of private fund and their preferences over private fund terms,
investment strategies, and investment outcomes.
---------------------------------------------------------------------------

    \1706\ See supra section II.F.
---------------------------------------------------------------------------

    While many of the final disclosure and consent requirements involve
making disclosures to and, in some cases, obtaining consent from only
current investors, and not prospective investors, the rule's
requirements may enhance efficiency through the tendency of some fund
advisers to rely on investors in current funds to be prospective
investors in their future funds. For example, when fund advisers raise
multiple funds sequentially, current investors can base their decisions
on whether to invest in subsequent funds based on the disclosures of
the prior funds.\1707\ As such, improved disclosures and consent
requirements can improve the efficiency of investments without directly
requiring disclosures to all prospective investors. Investors may
therefore face a lower overall cost of searching for, and choosing
among, alternative private fund investments.
---------------------------------------------------------------------------

    \1707\ See supra section VI.C.3.
---------------------------------------------------------------------------

    Lastly, the rules prohibit certain activities that represent
possible conflicting arrangements between investors and fund advisers,
with certain exceptions where certain disclosures regarding those
activities are made and, in some cases, where the required investor
consent is also obtained. To the extent that investors currently bear
costs of searching for fund advisers who do not engage in these
arrangements, or bear costs associated with monitoring fund adviser
conduct to avoid harm, then prohibiting these activities may lower
investors' overall costs of searching for, monitoring, and choosing
among alternative private fund investments. This may particularly be
the case for smaller investors who are currently more frequently harmed
by the activities being considered. The same effect may occur in the
case of the final rules' requirements for advisers to obtain audits of
fund financial statements. To the extent that investors currently bear
costs of searching for fund advisers who do have their funds undergo
audits, or bear costs associated with monitoring fund adviser conduct
to avoid harm when the adviser does not have the fund undergo an audit,
the final mandatory audit rule will enhance investor protection and
thereby improve the efficiency of the investment adviser search
process.
    The above pro-efficiency effects may also be strengthened by the
reduced risks of non-compliance and increased efficiency of the
Commission's enforcement and examination of non-compliance resulting
from the final amendments to the compliance rule for a written
documentation requirement and the amendments to the books and records
rule.\1708\
---------------------------------------------------------------------------

    \1708\ See supra sections VI.D.7, VI.D.8.
---------------------------------------------------------------------------

    There may be losses of efficiency from the rules prohibiting
various activities, and from any changes in fund practices in response
to the rules, to the extent that investors currently benefit from those
activities or incur costs from those changes. For example, investors
who currently receive preferential terms that will be prohibited under
the final rules may have only invested with their current adviser
because they were able to secure preferential terms. With those
preferential terms removed, those investors may choose to reevaluate
the match between their choice of adviser and their overall preferences
over private fund terms, investment strategy, and investment outcomes.
Depending on the results of this reevaluation, those investors may
choose to incur costs of searching for new fund advisers or alternative
investments.
    Other risks to efficiency may arise from the scope of the final
rules, for example the private fund adviser rules not applying to
advisers with respect to their CLOs and other SAFs. Because advisers to
SAFs will face no costs under the private fund adviser rules with
respect to their SAFs, more advisers may choose to structure their
funds as an SAF so as to avoid the costs of the rules. To the extent
this choice by advisers only occurs because advisers are incentivized
to reduce their compliance costs, but those advisers would have greater
skill or comparative advantage in advising other types of private
funds, the effect the final rules have on adviser choice of fund
structure may reduce efficiency.\1709\ Similarly, advisers
restructuring their funds to meet the definition of SAF may be viewed
as a potentially costly form of regulatory arbitrage. We believe these
effects will be mitigated by (1) the definition of SAFs that includes
the fund primarily issuing debt, which is a structure we believe
advisers who normally issue equity will not want to use just to lower
their compliance costs and avoid the restrictions and prohibitions in
the private fund adviser rules, and (2) the fact that any advisers
considering restructuring their funds to be SAFs will need to be
confident that they are able to compete existing SAFs to attract SAF
investors. However, at the margin, these risks of reduced efficiency
may occur.
---------------------------------------------------------------------------

    \1709\ A policy in which advisers are incentivized only to
pursue fund structures that align with their individual desires
(e.g., their comparative advantage, or the needs of their
investors), is described in economics as ``incentive compatible.''
The risk to efficiency from distorting adviser incentives may be
viewed as a risk of reducing the incentive compatibility of the
final rules. See, e.g., Andreu Mas-Colell, et al., Chapter 13,
Microeconomic Theory (Oxford Univ. Press, 1995), for a discussion of
incentive compatibility.
---------------------------------------------------------------------------

    The limited scope regarding SAF advisers may also result in a rule
with lower efficiency gains relative to a rule with no such limitation.
This is because the efficiency gains from the rule accrue, in part,
from the enhanced comparability and transparency across private funds,
and comparability effects are strongest when a rule is applied across
all types of funds. The limitation may make SAFs less comparable to
other types of funds, which may yield lower efficiency benefits when
investors search across fund types for an adviser. However, we believe
that the distinct features that we understand CLOs and other SAFs
already have today likely result in investors already viewing CLOs and
other SAFs as distinct types of investments and not comparable to an
equity interest in other funds.\1710\ To the extent that few, or no,
investors would compare SAFs and other types of private funds on the
basis of the required reporting elements of the private fund adviser
rules, then the loss of any efficiency benefits from reduced
comparability is minimal. Moreover, many advisers to SAFs, in
particular advisers to CLOs, typically provide extensive reporting and
transparency already, such as regular reporting of every asset in the
fund's portfolio and their current market valuation. This furthers the
likelihood that the loss of efficiency gains from forgoing the final

rules' transparency benefits with respect to advisers to SAFs will be
minimal.\1711\
---------------------------------------------------------------------------

    \1710\ See supra sections II.A, VI.C.2, VI.C.3.
    \1711\ See supra section VI.C.3.
---------------------------------------------------------------------------

    There may also be a risk of the transparency benefits of the rule
getting reduced by advisers restructuring their funds to be SAFs to
meet the exclusion under the final rules. Any adviser restructuring
their fund into a SAF to reduce their compliance costs or avoid the
restrictions and prohibitions in the private fund adviser rules would
result in a fund less comparable to other types of private funds.
However, these risks are also likely to be mitigated by the fact that
any such adviser would need to compete with the existing CLO and
broader SAF landscape. In particular, any such adviser seeking to
attract investors to a new SAF would likely need to arrange for or
issue independent collateral administrator reports that, like existing
CLOs and other SAFs, detail all cash flows associated with the assets
in their fund portfolio and list all market values of the assets in
their fund portfolio.\1712\ An adviser who restructures a fund into a
SAF but meets the same typical transparency practices as existing CLOs
and other SAFs would not result in any substantial loss of transparency
benefits associated with the final rule.
---------------------------------------------------------------------------

    \1712\ See supra section VI.C.3.
---------------------------------------------------------------------------

    Many commenters emphasized the risks to potential losses of
efficiency and questioned the possible benefits to efficiency.\1713\
Some commenters emphasized particular provisions of the rule as bearing
substantial risks to efficiency, such as the proposed prohibition on
pass-through of certain fees and expenses.\1714\ Other commenters
raised broad concerns that the entire regime would reduce efficiency by
restricting the ability of market participants to freely negotiate
contractual terms among themselves.\1715\ Other commenters stated
broadly that the Proposing Release economic analysis had failed to
consider important ways in which the proposed rules may affect
efficiency.\1716\ We believe many of commenters' concerns are mitigated
by the revisions to the final rules as compared to the proposed rules,
such as the provision of certain exceptions for many of the proposed
activities where certain disclosures are made and, in some cases, where
the required investor consent is also obtained. However, at the margin
there may still be risks of reduced efficiency.
---------------------------------------------------------------------------

    \1713\ See, e.g., AIMA/ACC Comment Letter; AIC Comment Letter I,
Appendix 1; AIC Comment Letter I, Appendix 2; PIFF Comment Letter.
    \1714\ See, e.g., AIC Comment Letter I, Appendix 1.
    \1715\ AIC Comment Letter I, Appendix 2.
    \1716\ See, e.g., AIC Comment Letter I, Appendix 2.
---------------------------------------------------------------------------

2. Competition
    The final rules may also affect competition in the market for
private fund investing.
    First, to the extent that the enhanced transparency of certain
fees, expenses, and performance of private funds under the final rules
may reduce the cost to some investors of comparing private fund
investments, then current investors evaluating whether to continue
investing in subsequent funds with their current adviser may be more
likely to reject future funds raised by their current adviser in favor
of the terms of competing funds offered by competing advisers,
including new funds that advisers may offer as alternatives that they
would not have offered absent the increased transparency, or competing
advisers whom the investor would not have considered absent the
increased transparency, including newer or smaller advisers. For
example, we understand that subscription facilities can distort fund
performance rankings and distort future fundraising outcomes,\1717\ and
so the enhanced disclosures around the impact of subscription
facilities on performance may change how investors compare prospective
funds in the future. To the extent that this heightened transparency
encourages advisers to make more substantial disclosures to prospective
investors, investors may also be able to obtain more detailed fee and
expense and performance data for other prospective fund investments,
strengthening the effect of the rules on competition.\1718\ Advisers
may therefore update the terms that they offer to investors, or
investors may shift their assets to different funds.
---------------------------------------------------------------------------

    \1717\ See supra sections VI.C.3, VI.D.2; see also, e.g.,
Schillinger et al., supra footnote 1213; Enhancing Transparency
Around Subscription Lines of Credit, supra footnote 1001.
    \1718\ See supra section VI.D.1.
---------------------------------------------------------------------------

    Second, because enhanced transparency of preferential treatment
will be provided to both current and prospective investors, there may
be reduced search costs to all investors seeking to compare funds on
the basis of which investors receive preferential treatment. For
example, some advisers may lose investors from their future funds if
those investors only participated in that adviser's prior funds because
of the preferential terms they received. We anticipate that investors
withdrawing from a fund because of a loss of preferential treatment
would redeploy their capital elsewhere, and so new advisers would have
a new pool of investment capital to pursue.
    These pro-competitive effects of the rule will directly benefit
private funds with advisers within the scope of the final rules and
investors in those funds.\1719\ Investors in funds whose advisers are
outside the scope of the final rules, and those funds' advisers, may
also benefit, to the extent private fund advisers outside the scope of
the rule revise their terms to compete with private fund advisers
inside the scope of the rules. As discussed above, private fund adviser
fees may currently total in the hundreds of billions of dollars per
year.\1720\ These two sources of enhanced competition from additional
transparency may lead to lower fees or may direct investor assets to
different funds, fund advisers, or other investments.
---------------------------------------------------------------------------

    \1719\ See supra sections VI.B, VI.D.1.
    \1720\ See supra section VI.C.3.
---------------------------------------------------------------------------

    The above pro-competitive effects may also be strengthened by the
reduced risks of non-compliance and increased efficiency of the
Commission's enforcement and examination of non-compliance resulting
from the final amendments to the compliance rule for a written
documentation requirement and the amendments to the books and records
rule.\1721\
---------------------------------------------------------------------------

    \1721\ See supra sections VI.D.7, VI.D.8.
---------------------------------------------------------------------------

    However, certain commenters expressed concerns that there may be
negative effects on competition as well. Commenters stated that various
individual components of the rule could reduce competition, such as the
prohibition on reducing clawbacks for taxes (by delaying performance-
based compensation that may increase employee turnover) \1722\ and the
adviser-led secondary rule to the extent that advisers forgo conducting
adviser-led secondaries instead of undertaking the cost of a fairness
opinion.\1723\ We believe that many of these commenters' concerns have
been mitigated by the revisions to the final rules relative to the
proposal, such as the exceptions for reducing clawbacks for taxes when
certain disclosures are made and the allowance for a valuation opinion
instead of a fairness opinion for adviser-led secondaries.
---------------------------------------------------------------------------

    \1722\ AIMA/ACC Comment Letter.
    \1723\ Comment Letter of the California Alternative Investments
Association, Connecticut Hedge Fund Association, New York
Alternative Investment Roundtable Inc., Palm Beach Hedge Fund
Association, and Southeastern Alternative Funds Association (Apr.
25, 2022) (``CAIA Comment Letter'').
---------------------------------------------------------------------------

    Some commenters also stated restrictions on preferential treatment

may reduce co-investment activity,\1724\ or may hinder smaller
advisers' abilities to secure initial seed or anchor investors.\1725\
Commenters argued that smaller, emerging advisers often need to provide
anchor investors significant preferential rights.\1726\ Other
commenters stated broadly that the Proposing Release economic analysis
had failed to consider important ways in which the proposed rules may
affect competition.\1727\
---------------------------------------------------------------------------

    \1724\ Ropes & Gray Comment Letter.
    \1725\ See, e.g., Carta Comment Letter; Meketa Comment Letter;
Lockstep Ventures Comment Letter; NY State Comptroller Comment
Letter.
    \1726\ Id.
    \1727\ See, e.g., AIC Comment Letter I, Appendix 2; PIFF Comment
Letter.
---------------------------------------------------------------------------

    We believe that the concerns with respect to preferential treatment
for smaller advisers will be mitigated in part by the fact that smaller
advisers are only prevented from offering anchor investors preferential
redemption rights and preferential information that the advisers
reasonably expects to have a material negative effect on other
investors. Therefore, these potential harms to competition will be
mitigated to the extent that smaller, emerging advisers do not need to
be able to offer anchor investors preferential rights that have a
material negative effect on other investors to effectively compete, and
to the extent that smaller emerging advisers are able to compete
effectively by offering anchor investors other types of preferential
terms. We have also provided certain legacy status, namely regarding
contractual agreements that govern a private fund and that were entered
into prior to the compliance date if the rule would require the parties
to amend such an agreement, for all advisers under the prohibitions
aspect of the preferential treatment rule and all aspects of the
restricted activities rule requiring investor consent.\1728\ We have
lastly included several exceptions from the final rules on preferential
treatment, such as an exception from the prohibition on providing
certain preferential redemption terms when those terms are offered to
all investors.\1729\ At the margin, however, some advisers,
particularly smaller or emerging advisers, may find it more difficult
to compete without offering preferential redemption rights or
preferential information that will now be prohibited.
---------------------------------------------------------------------------

    \1728\ See supra section IV.
    \1729\ See supra section II.G.
---------------------------------------------------------------------------

    Commenters also stated more generally that increased compliance
costs on advisers may reduce competition by causing advisers to close
their funds and reducing the choices investors have among competing
advisers and funds.\1730\ To the extent heightened compliance costs
cause certain advisers to exit, or forgo entry, competition may be
reduced. This may particularly occur through the compliance costs
associated with mandatory audits, as those costs are likely to fall
disproportionately and have a disproportionate impact on funds managed
by smaller advisers, and funds advised by smaller advisers facing new
increased compliance costs may be among those most likely to exit the
market in response to the final rules.\1731\ As discussed above,
approximately 25% of funds with less than $2 million in assets under
management that are advised by RIAs and will have to undergo an audit
as a result of the final rule.\1732\
---------------------------------------------------------------------------

    \1730\ See, e.g., Weiss Comment Letter; AIC Comment Letter I;
AIC Comment Letter I, Appendix 1; AIC Comment Letter I, Appendix 2;
MFA Comment Letter II. Some commenters cite to the 2023 Consolidated
Appropriations Act, citing, e.g., ``an important provision urging
the SEC to redo its economic analysis of the Private Fund Adviser
proposal to `ensure the analysis adequately considers the disparate
impact on emerging minority and women-owned asset management firms,
minority and women-owned businesses, and historically underinvested
communities.' '' See, e.g., Comment Letter of Steven Horsford (May
3, 2023); CCMR Comment Letter IV. See also, e.g., supra footnotes
1358, 1477, 1555 and accompanying text, and section VI.D.5.
    \1731\ See supra section VI.D.5.
    \1732\ See supra sections VI.C.4, VI.D.5. Figure 4 illustrates
that approximately 4,800 out of almost 6,400 funds of size between
$0 and $2 million already undergo an audit that will be required by
the final rule, leaving approximately 25% of funds of that size that
will have to undergo an audit as a result of final rule.
---------------------------------------------------------------------------

    However, the effects on the smallest advisers will be mitigated
where those advisers do not meet the minimum assets under management
required to register with the SEC.\1733\ Some registered advisers may
therefore have the option of reducing their assets under management to
forgo registration, thereby avoiding the costs of the final rule that
only apply to registered advisers, such as the mandatory audit rule.
While advisers responding in this way may negatively affect capital
formation,\1734\ the option for advisers to respond to the rule in this
way may mitigate negative competitive effects, as advisers reducing
their size to forgo registration will still leave them as a partial
potential competitive alternative to larger advisers (albeit a less
effective competitive alternative than they represented as registered
advisers).
---------------------------------------------------------------------------

    \1733\ See supra section II.C.
    \1734\ See infra section VI.E.3.
---------------------------------------------------------------------------

    As discussed above, some commenters also expressed concerns that
the loss of smaller advisers would result in reduced diversity of
investment advisers, based on an assertion that most women- and
minority-owned advisers are smaller and associated with first time
funds.\1735\ These commenters' concerns are consistent with industry
literature, which finds that, for example, while 7.2% of U.S. private
equity firms are women-owned, those firms manage only 1.6% of U.S.
private equity assets, indicating that women-owned private equity firms
are disproportionately smaller entities.\1736\ Similar patterns hold
for minority-owned firms and for other types of private funds.\1737\ To
the extent compliance costs or other effects of the rules cause certain
smaller advisers to exit, the rules may result in reduced diversity of
investment advisers. The potential reduced diversity of investment
advisers may also have downstream effects on entrepreneurial diversity,
as minority-owned venture capital and buyout funds are three-to-four
times more likely to fund minority entrepreneurs in their portfolio
companies.\1738\ However, because these effects are strongest for
venture capital, these effects may be mitigated wherever an adviser's
funds are sufficiently concentrated in venture capital that they may
forgo SEC registration and thus forgo many of the costs of the final
rules.
---------------------------------------------------------------------------

    \1735\ See supra section VI.B; see also, e.g., AIC Comment
Letter I, Appendix 1; AIC Comment Letter I, Appendix 2; NAIC Comment
Letter.
    \1736\ See, e.g., Knight Foundation, Knight Diversity of Asset
Managers Research Series: Industry (Dec. 7, 2021), available at
https://knightfoundation.org/reports/knight-diversity-of-asset-managers-research-series-industry/.
    \1737\ Id.
    \1738\ Johan Cassel, Josh Lerner & Emmanuel Yimfor, Racial
Diversity in Private Capital Fundraising (Sept. 18, 2022), available
at https://ssrn.com/abstract=4222385.
---------------------------------------------------------------------------

    As stated above, some commenters stated that the proposed private
fund adviser rules and other recently proposed or adopted rules would
have interacting effects, and that the effects should not be analyzed
independently.\1739\ These commenters stated in particular that the
combined costs of multiple ongoing rulemakings would harm investors by
making it cost-prohibitive for many advisers to stay in business or for
new advisers to start a business, and that this effect would further
harm competition by creating new barriers to entry.\1740\ As stated
above, Commission acknowledges that the effects of any final rule may
be impacted by recently adopted rules that

precede it.\1741\ With respect to competitive effects, the Commission
acknowledges that there are incremental effects of new compliance costs
on advisers that may vary depending on the total amount of compliance
costs already facing advisers and acknowledges costs from overlapping
transition periods for recently adopted rules and the final private
fund adviser rules.\1742\ In particular, the Commission acknowledges
these sources of heightened costs from the recent adoption of
amendments to Form PF.
---------------------------------------------------------------------------

    \1739\ See supra section VI.D.1.
    \1740\ See, e.g., MFA Comment Letter II; MFA Comment Letter III;
AIC Comment Letter IV.
    \1741\ See supra section VI.D.1.
    \1742\ Id.
---------------------------------------------------------------------------

    To the extent advisers respond to these costs by exiting the
market, or by forgoing entry, competition may be negatively affected.
In particular, competition may be negatively affected because smaller
advisers may be more likely than larger advisers to respond to new
compliance costs by exiting or by forgoing entry. To the extent smaller
or newer advisers attempt to respond to new compliance costs by passing
them on to their funds, this may hinder their ability to compete, as
larger advisers may be more able to lower their own profit margins
instead of passing some or all of their new costs on to funds and
investors.
    We have also responded to commenter concerns by providing for a
longer transition period for smaller advisers. The costs of having
multiple ongoing rulemakings primarily accrue during transition
periods, when advisers may have to revise processes, procedures, or
fund documents with multiple new rulemakings in mind. In consideration
of those costs, we are providing that advisers with less than $1.5
billion in assets under management will have 18 months to comply with
the adviser-led secondaries, preferential treatment, and restricted
activities rules, compared to the 12 months for larger advisers.\1743\
Since smaller advisers are those most likely to either exit the market
(or fail to enter) in response to high compliance costs, we believe
staggered transition periods that reduce the costs of coming into
compliance for advisers reduce the risks of multiple concurrent
rulemakings negatively impacting competition. In particular, since the
effective date for the new Form PF current reporting is December 11,
2023, the 18-month compliance period means smaller advisers will have
over a year after the effective date of Form PF current reporting to
come into compliance with the final private fund adviser rules. The
legacy status discussed above,\1744\ namely regarding contractual
agreements that govern a private fund and that were entered into prior
to the compliance date if the rule would require the parties to amend
such an agreement, for all advisers under the prohibitions aspect of
the preferential treatment rule and all aspects of the restricted
activities rule requiring investor consent,\1745\ is also responsive to
commenter concerns on compliance costs. We have lastly responded to
commenter concerns on compliance costs by offering certain disclosure-
based exceptions and, in some cases, certain consent-based exceptions
rather than outright prohibitions.\1746\
---------------------------------------------------------------------------

    \1743\ See supra section IV.
    \1744\ See supra footnote 1728 and accompanying text.
    \1745\ See supra section IV.
    \1746\ See supra section II.E.
---------------------------------------------------------------------------

    To the extent these effects occur, competition may be reduced, but
these potential negative effects on competition must be evaluated in
light of (1) the other pro-competitive aspects of the final rules, in
particular the pro-competitive effects from enhancing transparency,
which are likely to help smaller advisers effectively compete and may
therefore benefit those advisers,\1747\ and (2) the other benefits of
the final rules.
---------------------------------------------------------------------------

    \1747\ To the extent that smaller or newer advisers benefit from
these pro-competitive effects, because smaller or newer advisers are
disproportionately women-owned and minority-owned, these benefits
will therefore disproportionately accrue to women- and minority-
owned advisers. See supra footnote 1736 and accompanying text.
---------------------------------------------------------------------------

3. Capital Formation
    Commenters emphasized the risks that the rules may reduce capital
formation through several different types of arguments. Several
commenters made general statements that the high compliance costs of
the rule may negatively affect capital formation.\1748\ Many of these
commenters further specified that the harms to smaller advisers would
reduce capital formation.\1749\ Some commenters stated that particular
aspects of the rule risk reduced capital formation, such as the
mandatory audit rule, the charging of regulatory/compliance expenses
rule, and the prohibition on limitation of liability rule.\1750\ Other
commenters stated broadly that the Proposing Release economic analysis
had failed to consider important ways in which the proposed rules may
affect capital formation.\1751\
---------------------------------------------------------------------------

    \1748\ See, e.g., AIMA/ACC Comment Letter; Thin Line Comment
Letter; ICM Comment Letter; Ropes & Gray Comment Letter; SBAI
Comment Letter; AIC Comment Letter I; AIC Comment Letter I, Appendix
2; CAIA Comment Letter; NYPPEX Comment Letter.
    \1749\ See, e.g., Thin Line Capital Comment Letter; ICM Comment
Letter; Ropes & Gray Comment Letter; SBAI Comment Letter.
    \1750\ Utke and Mason Comment Letter; Convergence Comment
Letter; Comment Letter of True Venture (June 14, 2022); Andreessen
Comment Letter.
    \1751\ See, e.g., AIC Comment Letter I, Appendix 2; NYPPEX
Comment Letter.
---------------------------------------------------------------------------

    While we believe we have resolved certain of these concerns in the
final rules, in particular by revising the restricted activities in the
final rules relative to the proposal, the final rules still carry a
risk that capital formation may be negatively affected. The Proposing
Release stated that there may be reduced capital formation associated
with the final rules to prohibit various activities, to the extent that
investors currently benefit from those activities.\1752\ For example,
investors who currently receive preferential terms that will be
prohibited under the final rue may withdraw their capital from their
existing fund advisers. Those investors may have less total capital to
deploy after bearing costs of searching for new investment
opportunities, or they may redeploy their capital away from private
funds more broadly and into investments with less effective capital
formation.
---------------------------------------------------------------------------

    \1752\ Proposing Release, supra footnote 3, at 265-266.
---------------------------------------------------------------------------

    In further response to commenter concerns, we have also reexamined
the risks of reduced capital formation in two ways related to the scope
of the final rule. In particular, we have examined in two ways how the
adviser incentives induced by the boundaries of the scope of the rules
may carry unintended consequences of changes to adviser behavior that
could risk reducing capital formation.
    First, as discussed above, all of the elements of the final rule
will in general not apply with respect to non-U.S. private funds
managed by an offshore investment adviser, regardless of whether that
adviser is registered.\1753\ This aspect of the scope of the rule may
increase incentives for advisers to move offshore and to limit their
activity to non-U.S. private funds. Doing so may reduce U.S. capital
formation, to the extent it is more difficult for certain domestic
investors, especially more vulnerable investors, to deploy capital to
such funds.
---------------------------------------------------------------------------

    \1753\ See supra section II.
---------------------------------------------------------------------------

    Second, the quarterly statements, mandatory audit, and adviser-led
secondaries rules will not apply to ERAs.\1754\ This aspect of the
scope of the rule may increase incentives for advisers to limit their
activity in such a way that allows them to forgo registration. In
particular, advisers may

seek to keep their total RAUM under $150 million or may devote more of
their capital to venture fund activity.
---------------------------------------------------------------------------

    \1754\ Id.
---------------------------------------------------------------------------

    As part of our analysis in response to commenter concerns on risks
of reduced capital formation, we have investigated the potential
likelihood of advisers responding to differences in RIA and ERA
requirements under the final rules by examining how advisers respond to
differences in RIA and ERA requirements today. In particular, if there
is evidence today that certain private fund advisers respond to
different requirements for RIAs and ERAs by avoiding crossing the
threshold of $150 million in private fund assets, we may expect that
the increasing differential for RIAs and ERAs under the final rules
will, at the margin, impede capital formation by inducing advisers to
keep their assets under $150 million. Figure 8 examines the joint
distribution of assets under management by (1) RIAs and (2) ERAs
relying on the size exemption for advisers with only private funds and
less than $150 million in RAUM. The figure does not demonstrate any
evidence of disproportionately fewer advisers just above the $150
million threshold compared to the proportion of advisers with less than
$150 million in assets.\1755\ This may indicate that it is unlikely
that some advisers who would otherwise have had assets between $150
million and $200 million will instead seek to stay under the $150
million threshold. However, because the rule will strengthen the
difference in compliance requirements for RIAs and ERAs, the final rule
may strengthen this incentive for advisers to keep assets under $150
million, which may negatively affect capital formation. Any such impact
of this mechanism may also be limited by the fact that there are
differences in RIA and ERA requirements only for the quarterly
statements, mandatory audit, and adviser-led secondaries rules, because
the restricted activities rules and preferential treatment rules apply
to both RIAs and ERAs.
---------------------------------------------------------------------------

    \1755\ Rather, the figure demonstrates an approximately
continuous downward trend in the proportion of advisers as size
increases.
[GRAPHIC] [TIFF OMITTED] TR14SE23.007

    In addition, as discussed above, some advisers to venture capital
funds have recently registered as RIAs to be able to have their
portfolio allocations outside of direct equity stakes in private
companies exceed 20%.\1756\ These types of advisers may in the future
limit their portfolio allocations outside of direct equity stakes in
private companies to forgo registration. Again, the impact of this
differential in RIA and ERA requirements may be limited, as it is only
driven by the quarterly statements, mandatory audit, and adviser-led
secondaries rules, because the restricted activities rules and
preferential treatment rules apply to both RIAs and ERAs.
---------------------------------------------------------------------------

    \1756\ See supra section VI.C.1.
---------------------------------------------------------------------------

    Lastly, certain elements of the rules provide for certain relief to
funds of funds. For example, the quarterly statement rule requires
advisers to private funds that are not funds of funds to distribute
statements within 45 days after the first three fiscal quarter ends of
each fiscal year (and 90 days after the end of each fiscal year), but
advisers to funds of funds are allowed 75 days after the first three
quarter ends of each fiscal year (and 120 days after fiscal year
end).\1757\
---------------------------------------------------------------------------

    \1757\ See supra section II.B.3.
---------------------------------------------------------------------------

    However, we also continue to believe the final rules will
facilitate capital formation by causing advisers to manage private fund
clients more efficiently, by restricting or prohibiting activities that
may currently deter investors from private fund investing because they
represent possible conflicting arrangements, and by enabling investors
to choose more efficiently among funds and fund advisers.\1758\
---------------------------------------------------------------------------

    \1758\ These and other pro-capital formation effects of the rule
may also be strengthened by the reduced risks of non-compliance and
increased efficiency of the Commission's enforcement and examination
of non-compliance resulting from the final amendments to the
compliance rule for a written documentation requirement and the
amendments to the books and records rule. See supra sections VI.D.7,
VI.D.8.

---------------------------------------------------------------------------

    This may reduce the cost of intermediation between investors and
portfolio investments. To the extent this occurs, this may lead to
enhanced capital formation in the real economy, as portfolio companies
will have greater access to the supply of financing from private fund
investors. This may contribute to greater capital formation through
greater investment into those portfolio companies.
    The final rules may also enhance capital formation through their
competitive effects by inducing new fund advisers to enter private fund
markets.\1759\ To the extent that existing fund advisers reduce their
fees to compete more effectively with new entrants, or to the extent
that existing pools of capital are redirected to new fund advisers, or
fund advisers who have reduced fees to compete, and the advisers
receiving redirected capital generate enhanced returns for their
investors (for example, advisers who generate larger returns, less
correlated returns across different investment strategies, or returns
with more favorable risk profiles), the competitive effects of the
final rules may provide new opportunities for capital allocation and
potentially spur new investments.
---------------------------------------------------------------------------

    \1759\ See supra section VI.E.2.
---------------------------------------------------------------------------

    Similarly, the final rules may enhance capital formation by
inducing new investors to enter private fund markets. Restricting
activities that represent conflicting arrangements, requiring mandatory
audits and mandatory fairness or valuation opinions for adviser-led
secondaries, and heightened transparency around fee/expense/performance
information may increase investor confidence in the safety of their
investments.\1760\ To the extent investor confidence is heightened,
especially for smaller or more vulnerable investors, those investors
may increase their willingness to invest their capital. With respect to
the final rules on prohibitions for certain preferential information,
the Commission has recognized these effects in prior rulemakings. As
discussed above, specifically, the Commission has stated that investors
in many instances equate the practice of selective disclosure with
insider trading, and that the inevitable effect of selective disclosure
is that individual investors lose confidence in the integrity of the
markets because they perceive that certain market participants have an
unfair advantage.\1761\ More generally, as discussed above, one
academic study found that the passing of regulation requiring advisers
to hedge funds to register with the SEC reduced hedge fund misreporting
of results to investors, hedge fund misreporting increased on the
overturn of that legislation, and that the passing of the Dodd-Frank
Act (which removed an exemption from registration on which advisers to
hedge funds and other private funds had relied), resulted in higher
inflows of capital to hedge funds, indicating that hedge fund investors
view regulatory oversight as protecting their interests and that
regulatory oversight increases investor confidence and willingness to
invest in hedge funds.\1762\
---------------------------------------------------------------------------

    \1760\ See supra sections VI.D.2, VI.D.3, VI.D.4, VI.D.5.
    \1761\ See supra section VI.D.4.
    \1762\ See supra section VI.B; see also Stephen G. Dimmock &
William Christopher Gerken, Regulatory Oversight and Return
Misreporting by Hedge Funds (May 7, 2015), available at https://ssrn.com/abstract=2260058.
---------------------------------------------------------------------------

    Similarly, and in addition to lower costs of intermediation between
investors and portfolio investments, the final rules may directly lower
the costs charged by fund advisers to investors by improving
transparency over fees and expenses. The final rules may also enhance
overall investor returns (for example, as above, larger returns, less
correlated returns across different investment strategies, or returns
with more favorable risk profiles) by improving transparency over
performance information, restricting or prohibiting conflicting
arrangements, and requiring external financial statement audits and
fairness opinions. To the extent these increased investor funds from
lower expenses and enhanced returns are redeployed to new investments,
there may be further benefits to capital formation.

F. Alternatives Considered

    Several commenters stated their view that the Commission had not
considered sufficient alternatives in its proposal.\1763\ We believe we
have considered many potential alternatives to the final rules. Several
of the alternatives considered at proposal, or recommended by
commenters, have been implemented as part of the final rules. We have
further considered below several alternatives identified by commenters.
---------------------------------------------------------------------------

    \1763\ Citadel Comment Letter; AIMA/ACC Comment Letter; AIC
Comment Letter I, Appendix 2. One commenter cites three broad
alternatives and criticizes the Proposing Release for not
considering them: A ``Null Alternative,'' a ``CLO Exemption
Alternative,'' and a ``Qualified Investor Alternative.''1 LSTA
Comment Letter, Exhibit C. We disagree with the commenter that the
Proposing Release did not consider the Null Alternative, as the
Commission's economic analysis compares costs and benefits relative
to the economic baseline, and the economic baseline captures a Null
Alternative. See supra sections VI.C, VI.D. We also disagree with
the commenter that a Qualified Investor Alternative would be a
reasonable alternative to consider, as not applying the rule to
advisers with respect to funds that can only be accessed by certain
investors would have substantial negative consequences such as
incentivizing advisers to restrict access to their funds. Moreover,
the final rules are designed to protect even sophisticated
investors. We have considered the commenter's CLO Exemption
Alternative, and are not applying the five private fund rules to SAF
advisers with respect to SAFs they advise. See supra section II.
---------------------------------------------------------------------------

1. Alternatives to the Requirement for Private Fund Advisers To Obtain
an Annual Audit
    First, the Commission could have broadened the application of this
rule to, for example, apply to all advisers to private funds, rather
than to only advisers to private funds that are registered or required
to be registered. Extending the application of the final audit rule to
all advisers and in the context of these pooled investment vehicles
would increase the benefits of helping investors receive more reliable
information from private fund advisers subject to the rule. Investors
would, as a result, have greater assurance in both the valuation of
fund assets and, because these valuations often serve as the basis for
the calculation of the adviser's fees, the fees charged by advisers.
However, an extension of the rule to apply to all advisers would likely
impose the costs of obtaining audits on smaller funds advised by
unregistered advisers. For these types of funds, the cost of obtaining
such an audit may be large compared to the value of fund assets and
fees and the related value to investors of the required audit, and so
this alternative could inhibit entry of new funds, potentially
constraining the growth of the private fund market.
    Second, instead of broadening the audit rule, we considered
narrowing the rule by providing further full or partial exemptions. For
example, we could have exempted advisers from obtaining audits for
smaller funds or we could exempt an adviser from compliance with the
rule where an adviser receives little or no compensation for its
services or receives no compensation based on the value of the fund's
assets. We could also have exempted advisers to hedge funds and other
liquid funds or funds of funds. Further, we could have provided an
exemption to advisers from obtaining audits for private funds below a
certain asset threshold, for funds that have only related person
investors, or for funds

that are below a minimum asset value or have a limited number of
investors. Several commenters provided arguments for such
exemptions.\1764\ Another commenter argued more generally that the
entirety of the private fund rulemaking should narrowly focus on
private funds with more vulnerable or smaller investors, implicitly
arguing for a narrowing of all components of the rule, including the
audit rule.\1765\
---------------------------------------------------------------------------

    \1764\ See, e.g., PIFF Comment Letter; ILPA Comment Letter I;
Ropes & Gray Comment Letter.
    \1765\ AIC Comment Letter I, Appendix 2.
---------------------------------------------------------------------------

    These exemptions could also have been applied in tandem, for
example by exempting only advisers to hedge funds and other liquid
funds below a certain asset threshold. For each of these categories, we
considered partial instead of full exemptions, for example by requiring
an audit only every two (or more) years instead of not requiring any
annual audits at all. Further, the benefits of the rule may not be
substantial for funds below a minimum asset value, where the cost of
obtaining such an audit would be relatively large compared to the value
of fund assets and fees that the rule is intended to provide a check
on.
    We believe, however, that this narrower alternative with the above
exemptions to the final audit rule would likely not provide the same
investor protection benefits. Many of the investor protection benefits
discussed above are specifically associated with the general
applicability of the audit rule.\1766\ One commenter stated that the
time and expense of an audit should be commensurate with the scale of
the fund, removing the rationale for exempting smaller advisers.\1767\
We also believe that new rules with exemptions for certain types of
funds and advisers, in general, distort incentives faced by advisers
when determining their desired business model. Exemptions for hedge
funds or funds of funds would, at the margin, induce certain advisers
contemplating launching a private equity fund to instead launch a hedge
fund or fund of funds, and we factor in such distortions of incentives
into considerations of exemptions for final rules.
---------------------------------------------------------------------------

    \1766\ See supra section VI.D.5.
    \1767\ See Healthy Markets Comment Letter I.
---------------------------------------------------------------------------

    Moreover, we have already recognized that some advisers may not
have requisite control over a private fund client to cause its
financial statements to undergo an audit in a manner that satisfies the
mandatory private fund adviser audit rule.\1768\ Those advisers will be
required under the final rule to take all reasonable steps to cause
their private fund clients to undergo an audit. As a final matter, the
rule already is only applicable to RIAs and does not apply to ERAs,
including those ERAs with less than $150 million in assets under
management in the U.S.\1769\
---------------------------------------------------------------------------

    \1768\ See supra section II.C.7.
    \1769\ See supra section II.C, VI.D.5.
---------------------------------------------------------------------------

    As a last alternative, instead of requiring an audit as described
in the audit rule, we considered requiring that advisers provide other
means of checking the adviser's valuation of private fund assets. For
example, we considered requiring that an adviser subject to the audit
rule provide information to substantiate the adviser's evaluation to
its LPAC or, if the fund has no LPAC, then to all, or only significant
investors in the fund. We believe that such methods for checking an
adviser's methods of valuation would be substantially less expensive to
obtain, which could reduce the cost burdens associated with an audit.
    However, we believe that these alternatives would likely not
accomplish the same investor protection benefits as the audit rule as
adopted. As an immediate matter, limiting the requirement in this way
would undermine the broader goal of the rule to protect investors
against misappropriation of fund assets and providing an important
check on the adviser's valuation of private fund assets. We believe,
more generally, that these checks would not provide the same level of
assurance over valuation and, by extension, fees, to fund investors as
an audit. As discussed above, we have historically relied on financial
statement audits to verify the existence of pooled investment vehicle
investments.\1770\ Commenters did not address these alternatives,
either by expressing support for them or criticizing them, and
generally focused their suggestions on either (1) abandoning the audit
rule entirely, or (2) narrowing it by providing exemptions.
---------------------------------------------------------------------------

    \1770\ See supra section II.C.
---------------------------------------------------------------------------

2. Alternatives to the Requirement To Distribute a Quarterly Statement
to Investors Disclosing Certain Information Regarding Costs and
Performance
    The Commission also considered requiring additional and more
granular information to be provided in the quarterly statements that
registered investment advisers will be required to provide to investors
in private funds. For example, we could have required that these
statements include investor-level capital account information, which
would provide each investor with means of monitoring capital account
levels at regular intervals throughout the year. Because this more
specific information would show exactly how fees, expenses, and
performance have affected the investor, it could, effectively, further
reduce the cost to an investor of monitoring the value of the services
the adviser provides to the investor. We believe, however, that
requiring capital account information for each investor would
substantially increase costs for funds associated with the preparation
of these quarterly statements. We do not believe that the policy goals
of the rule would be achieved by further increasing the costs of the
rule, including potential harms to competition and capital
formation.\1771\
---------------------------------------------------------------------------

    \1771\ See supra sections VI.D.2, VI.E.
---------------------------------------------------------------------------

    We could also, for example, have required disclosure of performance
information for each portfolio investment. For illiquid funds in
particular, we could have required advisers to report the IRR for
portfolio investments, assuming no leverage, as well as the cash flows
for each portfolio investment.\1772\ Given the cash flows, end
investors could compute other performance metrics, such as PME, for
themselves. In addition, this information would give investors means of
checking the more general performance information provided in a
quarterly statement, and would, further, allow investors to track and
evaluate the portfolio investments chosen by an adviser over time. Cash
flow disclosures for each portfolio investment would enable an investor
to construct measures of performance that address the MOIC's inability
to capture the timing of cash flows, avoid the IRR's assumptions on
reinvestment rates of early cash flow distributions, and avoid the
IRR's sensitivity to cash flows early in the life of the pool.\1773\
Investors would also be

able to compare performance of individual portfolio investments against
the compensation and other data that advisers would be required to
disclose for each portfolio investment.\1774\
---------------------------------------------------------------------------

    \1772\ For liquid funds, disclosure of performance information
for each portfolio investment may be of comparatively lower
incremental benefit to investors, because such funds typically have
a much larger number of investments. However, investors may have
preferences among different liquid funds that depend on more fund
outcomes than their total return on their aggregate capital
contributions. For example, investors could have a preference for
fund advisers whose portfolio investments have returns that are not
correlated with each other (meaning portfolio investments with
returns that are not disproportionately likely to be similar in
magnitude or disproportionately likely to be similar in whether they
are positive or negative). A portfolio with correlated returns
across investments may, for example, represent lower diversification
and greater risk than a portfolio with uncorrelated returns across
investments. For investors with such preferences, this alternative
could provide similar additional benefits.
    \1773\ See supra section VI.C.3; see, e.g., Harris et al., supra
footnote 1221; Schoar et al., supra footnote 1221.
    \1774\ See supra section II.B.1.b).
---------------------------------------------------------------------------

    While we believe that advisers would have cash flow data for each
portfolio investment available in connection with the preparation of
the standardized fund performance information required to be reported
pursuant to the quarterly statement rule, calculating performance
information for each portfolio investment could add significant
operational burdens and costs. Because these costs would vary based on
the number of portfolio investments held by a private fund, such a rule
would distort adviser incentives by incentivizing them to take on fewer
portfolio investments. The operational burden and cost would also
depend on whether the alternative rule required both gross and net
performance information for each portfolio investment, which would
determine whether the information reflected the impact of fund-level
fees and expenses on the performance of each portfolio investment.
Requiring both gross and net performance information for each portfolio
investment would be of greater use to investors, but would come at a
higher operational burden and cost, as providing net performance
information would require more complex calculations to allocate fund
fees and expenses across portfolio investments. Lastly, to the extent
that advisers were required to disclose cash flows for each portfolio
investment with and without the impact of fund-level subscription
facilities, this calculation may be more burdensome than the single
calculation required to make the required fund-level performance
information disclosures with and without the impact of fund-level
subscription facilities.
    As a final granular addition to performance disclosures, the
Commission could have required the reporting of a wider variety of
performance metrics for hedge funds and other liquid funds, similar to
the detailed disclosure requirements for illiquid funds. These could
have included requirements for liquid funds to report estimates of
fund-level alphas, betas, Sharpe ratios, or other performance metrics.
We believe that for investors in liquid funds, absolute returns are of
highest priority, and furthermore investors may calculate many of these
additional performance metrics themselves by combining fund annual
total returns with publicly available data. Commenter concerns also
indicate that further standardized required reporting would continue to
raise costs,\1775\ but may only provide diminishing marginal benefit.
Therefore, we believe these additional reporting requirements would
impose additional costs with comparatively little benefit.
---------------------------------------------------------------------------

    \1775\ See supra section VI.D.2.
---------------------------------------------------------------------------

    As discussed above, one commenter suggested requiring DPI and RVPI
instead of MOIC for realized and unrealized investments.\1776\ As an
initial matter, since the final rules require calculation of unrealized
and realized IRR,\1777\ we do not believe that DPI and RVPI
calculations will be any less incrementally costly than unrealized and
realized MOIC, because unrealized and realized MOIC uses the same
denominators as unrealized and realized IRR. Moreover, we have
discussed above that these metrics may be potentially less effective at
highlighting overly optimistic valuations of unrealized investments.
This is because the denominator of RVPI includes all paid-in capital,
not just capital contributed in respect of unrealized investments, and
so the comparatively large denominator in RVPI may dwarf the effect of
overvaluations of unrealized investments, while unrealized MOIC may
highlight those overvaluations.\1778\
---------------------------------------------------------------------------

    \1776\ See supra sections II.B.2, VI.D.2.
    \1777\ Id.
    \1778\ Id.
---------------------------------------------------------------------------

    Further, the Commission also considered requiring less information
be provided to investors in these quarterly statements. For example,
instead of requiring the disclosure of comprehensive fee and expense
information, we could have required that advisers disclose only a
subset of these, including investments fees and expenses paid by a
portfolio company to the adviser. These fees in particular may
currently present the biggest burden on investors to track, and
requiring the disclosure of only these fees could reduce some costs
associated with the effort of compiling, on a quarterly basis,
information regarding management fees more generally. While we believe
some commenters would support such an alternative, based on the lower
cost,\1779\ we believe if we did not require comprehensive information,
investors would not derive the same utility in monitoring fund
performance.
---------------------------------------------------------------------------

    \1779\ See supra section VI.D.2.
---------------------------------------------------------------------------

    We also considered requiring that comprehensive information
regarding fees and performance be reported on Form ADV, instead of
being disclosed to investors individually. Reporting publicly on Form
ADV would continue to allow investors to monitor performance, while
also allowing public review of important information about an adviser.
One commenter suggested that advisers should be required to report
information about borrowing from the fund on Form ADV and Form
PF,\1780\ and certain other commenters generally supported requiring
advisers to make data collected under the rule publicly
available.\1781\ Disclosure to the Commission, either on Form ADV or
Form PF, would provide the Commission with information that would
enable the Commission to assess whether there are risks to investors,
including risks of misappropriation from a fund. However, because the
information required under the rule is tailored to what we believe
would serve existing investors in a fund, we believe that direct
delivery to investors would better reduce monitoring costs for
investors. Further, as discussed above, prospective investors have
separate protections, including against misleading, deceptive, and
confusing information in advertisements as set forth in the recently
adopted marketing rule.\1782\
---------------------------------------------------------------------------

    \1780\ Convergence Comment Letter.
    \1781\ See, e.g., AFSCME Comment Letter; Comment Letter of
National Employment Law Project (Apr. 25, 2022).
    \1782\ See supra section II.B.2.
---------------------------------------------------------------------------

    Instead of requiring disclosure of comprehensive fee and expense
information to investors, we considered prohibiting certain fee and
expense practices. For example, we could have prohibited charging fees
at the fund level in excess of a certain maximum amount that we could
determine to be what investors could reasonably anticipate being
charged by an adviser. This could, effectively, protect investors from
unanticipated charges, and reduce monitoring costs to investors.
Further, we could have prohibited certain compensation arrangements,
such as the ``2 and 20'' model or compensation from portfolio
investments, to the extent the adviser also receives management fees
from the fund. Prohibition of the ``2 and 20'' model might cause
advisers to consider and adopt more efficient models for private fund
investing in which the adviser gets a smaller fee and the investor gets
a larger share of the gross fund returns, and in which investors are
generally better off.\1783\ We also considered restricting management
fee practices, for example by imposing limitations on sizes of
management fees, or requiring management fees to be based on invested
capital or net asset

value rather than on committed capital. However, the benefits of
prohibiting certain fee and expense practices outright would need to be
balanced against the costs associated with limiting an adviser and
investor's flexibility in designing fee and expense arrangements
tailored to their preferences. There are benefits to flexible
negotiations between advisers and investors, and that the final rule
should not endeavor to create a rigid private fund contract that
governs all possible outcomes of an investment.\1784\ We also believe
that our policy choice has benefited from taking into consideration the
market problem that the policy is designed to address.\1785\ We believe
that such further prohibitions would too severely restrict the
flexibility of negotiations between advisers and investors, and also
that such prohibitions would not be tailored to the market problems
that this final rule is designed to address.
---------------------------------------------------------------------------

    \1783\ For example, the compensation model for hedge funds can
provide fund advisers with embedded leverage, encouraging greater
risk-taking. See, e.g., Brav, et al., supra footnote 1427.
    \1784\ See supra section VI.B, VI.D.1; see also, e.g., AIC
Comment Letter I, Appendix 1.
    \1785\ See supra section VI.B; see also, e.g., Clayton Comment
Letter II.
---------------------------------------------------------------------------

    Similarly, instead of requiring disclosure of comprehensive
performance information to investors, we considered prohibiting certain
performance disclosure practices. For example, instead of requiring
disclosure of performance with and without the effect of fund-level
subscription facilities, we considered prohibiting advisers from
presenting performance with the effect of such facilities unless they
also presented performance without the effect of such facilities.
Similarly, we considered prohibiting advisers from presenting combined
performance information for multiple funds, such as a main fund and a
co-investment fund that pays lower or no fees. Commenters did not
generally either support or criticize this alternative. However, while
we believe that the required disclosures present the correct
standardized, detailed information for investors to be able to evaluate
performance, we do not believe there are harms from advisers electing
to disclose additional information, and we again believe investors and
advisers should have the flexibility to negotiate for that additional
information if they believe it would be valuable. As such, we think the
benefits of prohibiting any performance disclosure practices would
likely be negligible, while there could be substantial costs to
investors who value the information that would be prohibited under this
alternative.
    Finally, the Commission considered broadening the application of
this rule to, for example, apply to all advisers to private funds,
rather than to only private fund advisers that are registered or
required to be registered. Extending the application of the final rule
to all advisers would increase the benefits of helping investors
receive more detailed and standardized information regarding fees,
expenses, and performance. Investors would, as a result, have better
information with which to evaluate the services of these advisers.
However, the extension of the final rule to apply to all advisers would
likely impose the costs of compiling, preparing, and distributing
quarterly statements on smaller funds advised by unregistered advisers.
For these types of funds and advisers, these quarterly statement costs
may be large compared to the value of fund assets and fees and the
related value to investors of the required audit, and thus extending
the rule to those advisers would further increase the costs of the
rule, potentially increasing any potential harms to competition or
capital formation.
3. Alternative to the Required Manner of Preparing and Distributing
Quarterly Statements and Audited Financial Statements
    The final rules will require private fund advisers to
``distribute'' quarterly statements and audited annual financial
statements to investors in the private fund, and this requirement could
be satisfied through either paper or electronic means.\1786\ The
Commission considered requiring private fund advisers to prepare and
distribute the required disclosures electronically using a structured
data language, such as the Inline eXtensible Business Reporting
Language (``Inline XBRL'').
---------------------------------------------------------------------------

    \1786\ See supra sections II.B.3, II.C.3.
---------------------------------------------------------------------------

    An Inline XBRL requirement for the disclosures could benefit
private fund investors with access to XBRL analysis software by
enabling them to more efficiently access, compile, and analyze the
disclosures in quarterly statements and audited annual financial
statements, facilitating calculations and comparisons of the disclosed
information across different time periods or across different portfolio
investments within the same time period. For any such private fund
investors who receive disclosures from multiple private funds, an
Inline XBRL requirement could also facilitate comparisons of the
disclosed information across those funds.
    An Inline XBRL requirement for the final disclosures would diverge
from the Commission's other Inline XBRL requirements, which apply to
disclosures that are made available to the public and the Commission,
thus allowing for the realization of informational benefits (such as
increased market efficiency and decreased information asymmetry)
through the processing of Inline XBRL disclosures by information
intermediaries such as analysts and researchers.\1787\ Under the final
rules, the required disclosures will not be provided to the public or
the Commission for processing and analysis.\1788\ Thus, the magnitude
of benefit resulting from an Inline XBRL alternative for the disclosure
requirements in the final rule may be lower than for other rules with
Inline XBRL requirements.\1789\
---------------------------------------------------------------------------

    \1787\ See, e.g., Y. Cong, J. Hao & L. Zou, The Impact of XBRL
Reporting on Market Efficiency, 28 J. Info. Sys. 181 (2014) (finding
support for the hypothesis that ``XBRL reporting facilitates the
generation and infusion of idiosyncratic information into the market
and thus improves market efficiency''); Y. Huang, J.T. Parwada, Y.G.
Shan & J. Yang, Insider Profitability and Public Information:
Evidence From the XBRL Mandate, Working Paper (2019) (finding XBRL
adoption levels the informational playing field between insiders and
non-insiders).
    \1788\ See supra section II.C.6.
    \1789\ See, e.g., Updated Disclosure Requirements and Summary
Prospectus for Variable Annuity and Variable Life Insurance
Contracts, Investment Company Act Release No. 33814 (Mar. 11, 2020)
[85 FR 25964, at 26041 (June 10, 2020)] (stating that an Inline XBRL
requirement for certain variable contract prospectus disclosures,
which are publicly available, would include informational benefits
stemming from use of the Inline XBRL data by parties other than
investors, including financial analysts, data aggregators, and
Commission staff). While the required disclosures in the final rules
would not be provided to the public or the Commission, such benefits
would not accrue from an Inline XBRL requirement for the required
disclosures.
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    Compared to the final rule, an Inline XBRL requirement would result
in additional compliance costs for private funds and advisers, as a
result of the requirement to select, apply, and review the appropriate
XBRL U.S. GAAP taxonomy element tags for the required disclosures (or
pay a third-party service provider to do so on their behalf). In
addition, private fund advisers may not have prior experience with
preparing Inline XBRL documents, as neither Form PF nor Form ADV is
filed using Inline XBRL. Thus, under this alternative, private funds
may incur the initial Inline XBRL implementation costs that are often
associated with being subject to an Inline XBRL requirement for the
first time (including, as applicable, the cost of training in-house
staff to prepare filings in Inline XBRL and the cost to license Inline
XBRL filing preparation software from vendors). Accordingly, the
magnitude of compliance costs resulting from an

Inline XBRL requirement under this final rule may be higher than for
other rules with Inline XBRL requirements.
4. Alternatives to the Restrictions From Engaging in Certain Sales
Practices, Conflicts of Interest, and Compensation Schemes
    The Commission also considered restricting other activities, in
addition to those currently restricted in the final rule. For example,
we could have restricted advisers from charging private funds for
expenses generally understood to be adviser expenses, such as those
incurred in connection with the maintenance and operation of the
adviser's business. To the extent that the performance of these
activities is outsourced to a consultant, for example, and the fund is
charged for that service, advisers may be effectively shifting expenses
that would be generally recognized as adviser expenses to instead be
fund expenses. The restriction of such charges and the enhancement of
disclosures or consent practices around those costs could reduce
investor monitoring costs. We believe, however, that identifying the
types of charges associated with activities that should never be
charged to the fund would likely be difficult. As a result, any such
restriction could risk effectively limiting an adviser's ability to
outsource certain activities that could be better performed by a
consultant, because under the restriction the adviser would not be able
to pass those costs on to the fund.
    Further, the Commission considered providing an exemption for funds
utilizing a pass-through expense model from the restriction on charging
fees or expenses associated with certain examinations, investigations,
and regulatory and compliance fees and expenses. This would allow
advisers to avoid the costs associated with restructuring any
arrangements not compliant with the restriction, including the costs
associated with having to make enhanced disclosures of those
expenses.\1790\ We believe, however, that any exemption would need to
be carefully balanced against the risk that it would continue to
subject the fund to an adviser's incentive to shift its fees and
expenses to the fund to reduce its costs without disclosure to
investors.
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    \1790\ See supra section II.E.
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    The Commission also considered requiring consent for all of the
restricted activities instead of just investigation expenses and
borrowing.\1791\ However, we believe there are economic reasons for
each of the other restricted activities to not pursue these additional
requirements. As discussed above, we believe whether expense pass-
through arrangements risk distorting adviser incentives to pay
attention to compliance and legal matters may vary from adviser to
adviser and may vary according to the type of expense.\1792\ For
regulatory, compliance, and examination expenses, the risk may be
comparatively low, and requiring investor consent or prohibiting the
activity altogether may not be necessary. With respect to clawbacks, as
many commenters stated, because this practice is widely implemented and
negotiated, we do not believe there is a risk of investors being
unable, today, to refuse to consent to this practice and being harmed
as a result of being unable to consent to this practice.\1793\ With
respect to non-pro rata allocations of expenses, commenters stated that
investors may also often benefit from these co-investment
opportunities, or that expenses may be generated disproportionately by
one fund investing in a portfolio company.\1794\ Because these valid
reasons for non-pro rata allocations of expenses may occur, a further
restriction on non-pro rata allocations of expenses may have
substantial unintended negative effects in terms of limiting these
valid occurrences of non-pro rata allocations, even when a non-pro rata
allocation would be fair and equitable. For example, in the case of an
expense generated disproportionately by one fund in a portfolio
company, that fund could refuse to consent to being charged greater
than a pro rata share of expenses when it could be charged a pro rata
share of expenses. In that instance, the consent requirement could
result in other funds in the portfolio investment being overcharged.
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    \1791\ Id.
    \1792\ See supra sections VI.C.2, VI.D.3.
    \1793\ See supra sections VI.C.2, II.E.1.b).
    \1794\ See supra section VI.C.2.
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    We lastly considered prohibiting all of the activities outright
instead of providing for certain exceptions for when advisers make
certain disclosures and, in some cases, also obtain the required
investor consent. However, as discussed above, we are convinced by
commenters that our concerns with certain of these activities will be
substantially alleviated, so long as advisers satisfy the disclosure
requirements and, in some cases, consent requirements provided for in
the final rules.\1795\ We are also convinced by commenters that
outright prohibitions would involve substantial indirect costs via
unintended consequences of the rules. For example, we are convinced
that an outright prohibition of reducing adviser clawbacks for taxes
carries a risk of advisers forgoing offering adviser clawbacks
altogether, including in circumstances that benefit investors.\1796\ We
are similarly convinced by comments that the restricted activities can
provide bona fide benefits for investors that would be lost under an
outright prohibition. For example, we are convinced that non-pro rata
allocations of fees and expenses in certain cases can still be fair and
equitable, if disclosed and if consent is obtained,\1797\ and that many
advisers borrow from funds to finance activities that are to the
benefit of investors.\1798\
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    \1795\ See supra section II.E.
    \1796\ See supra sections II.E.1.b), VI.D.3.
    \1797\ See supra section II.E.1.b).
    \1798\ See supra section II.E.2.b).
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5. Alternatives to the Requirement That an Adviser To Obtain a Fairness
Opinion or Valuation Opinion in Connection With Certain Adviser-Led
Secondary Transactions
    The Commission also considered changing the scope of the
requirement for advisers to obtain a fairness opinion or valuation
opinion in connection with adviser-led secondary transactions.
    For example, we considered broadening the application of this rule
to, for example, apply to all advisers, including advisers that are not
required to register as investment advisers with the Commission, such
as State-registered advisers and exempt reporting advisers. Under that
alternative, investors would receive the assurance of the fairness of
more adviser-led secondary transactions. An extension of the final rule
to apply to all advisers would, however, likely impose the costs of
obtaining fairness opinions or valuation opinions on smaller funds
advised by unregistered advisers, and for these types of funds, the
cost of obtaining such opinions would likely be relatively large
compared to the value of fund assets and fees that the rule is intended
to provide a check on. This could discourage those advisers from
undertaking these transactions. This could ultimately reduce liquidity
opportunities for fund investors.
    We also considered consent requirements for the rule, where instead
of requiring advisers to obtain a fairness opinion or valuation
opinion, advisers would have been required to obtain investor consent
prior to implementing an adviser-led secondary transaction. We
considered this alternative because the market friction in these
transactions bears certain similarities to the case

when advisers borrow from funds, where we are requiring consent: in
both cases, the conflict of interest arises because the adviser is on
both sides of a transaction.\1799\
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    \1799\ See supra section VI.C.4.
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    However, as discussed in the baseline, unlike the case of adviser
borrowing, there is a heightened risk of this conflict of interest
distorting the terms or price of the transaction, and it may be
difficult for disclosure practices or consent practices alone to
resolve these conflicts.\1800\ This is because in an adviser-led
secondary there may be limited market-driven price discovery processes
available to investors. For example, we considered the case where, if a
recent sale improperly valued an asset, an adviser could be
incentivized to initiate a transaction with the same valuation, which,
depending on the terms of the transaction, may benefit the adviser at
the expense of the investors. Because of cases like this, and the other
cases we have discussed above, we do not consider consent requirements
to be a necessary policy choice given the market failure at
issue.\1801\
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    \1800\ Id.
    \1801\ Id.
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    We also considered providing exemptions from the rule. An exemption
could be provided where the adviser undertakes a competitive sale
process for the assets being sold or for certain advisers to hedge
funds or other liquid funds for whom the concerns regarding pricing of
illiquid assets may be less relevant. Several commenters requested such
exemptions.\1802\ These exemptions would reduce the costs on advisers
associated with obtaining the fairness opinion or valuation opinion,
which could ultimately reduce costs for investors. However, while this
alternative would reduce costs, we believe that any such exemptions
could reduce the benefits of the final rule associated with providing
greater assurance to investors of the fairness of the transaction. We
believe that, even under circumstances where the adviser has conducted
a competitive sales process, the effective check on this process