action) (alleging unregistered private fund adviser caused the fund
client to engage in conflicted transactions, including investments
and loans, without disclosure to or consent by investors); In the
Matter of Alumni Ventures Group, LLC, Investment Advisers Act
Release No. 5975 (Mar. 4, 2022) (settled action) (alleging exempt
reporting adviser that managed private funds breached its fiduciary
duty by causing private fund clients to lend to each other in
violation of the funds' governing documents and failing to disclose
conflicts of interest to the fund investors).
    \147\ This approach is consistent with another rule adopted
under section 206 of the Advisers Act, rule 206(4)-5, which applies
to SEC-registered advisers, advisers relying on the foreign private
adviser exemption, and ERAs. Rule 206(4)-5 was intended to combat
pay-to-play arrangements in which advisers are chosen based on their
campaign contributions to political officials rather than on merit.
Rule 206(4)-5 applies to an investment adviser registered (or
required to be registered) with the Commission or unregistered in
reliance on the exemption available under section 203(b)(3) of the
Advisers Act, or that is an exempt reporting adviser, as defined in
rule 17 CFR 275.204-4(a) under the Advisers Act.
---------------------------------------------------------------------------

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

solely with respect to the securitized asset funds they advise, as
``SAF advisers''). These advisers will not be required to comply with
the requirements of the final rules solely with respect to the
securitized asset funds (``SAFs'') that they advise.\148\
---------------------------------------------------------------------------

    \148\ If an investment adviser that is a SAF adviser also
advises other private funds that are not securitized asset funds,
the investment adviser will be subject to the final rules with
respect to such other private funds.
---------------------------------------------------------------------------

    Some commenters requested for all or some of the proposed rules not
to apply to advisers to securitization vehicles or vehicles that issue
asset-backed securities (in particular, collateralized loan obligations
(``CLOs'')).\149\ One commenter stated that the Commission did not
identify specific concerns with SAFs, the rules were generally not
applicable to SAFs, and that the rules did not address or contemplate
the critical differences between these types of vehicles and other
private funds.\150\ Another commenter stated that, although SAFs are
private funds, their structure and purpose are sufficiently distinct
from other types of funds that their advisers should be exempt from the
rules.\151\ This commenter stated that SAFs are unlike private funds in
several ways, including because: (i) SAFs do not issue equity but
rather issue notes at various seniorities that entitle holders to
interest payments and ultimate repayment of principal; (ii) SAFs do not
have general partners affiliated with their advisers but rather have
unaffiliated trustees as fiduciary agents of the SAF investors; and
(iii) their notes are held in street name and traded such that an
adviser does not necessarily know who the noteholders are.\152\
---------------------------------------------------------------------------

    \149\ See Comment Letter of Ropes & Gray LLP (Apr. 25, 2022)
(``Ropes & Gray Comment Letter''); LSTA Comment Letter; SIFMA-AMG
Comment Letter I; Comment Letter of Teachers Insurance and Annuity
Association of America (Apr. 25, 2022) (``TIAA Comment Letter'');
Comment Letter of Fixed Income Investor Network (Apr. 29, 2022)
(``Fixed Income Investor Network Comment Letter''); PIFF Comment
Letter; Comment Letter of Structured Finance Association (Apr. 25,
2022) (``SFA Comment Letter I''). Although commenters generally
focused on the application of the proposed rules to CLOs, certain
commenters clarified that their comments applied also more broadly
to securitization vehicles and vehicles that issue asset-backed
securities. See LSTA Comment Letter; SFA Comment Letter I; SIFMA-AMG
Comment Letter I; PIFF Comment Letter.
    \150\ See LSTA Comment Letter.
    \151\ See Ropes & Gray Comment Letter.
    \152\ See id.
---------------------------------------------------------------------------

    After considering comments, we are not applying the five private
fund adviser rules to SAF advisers.\153\ This approach avoids
subjecting SAF advisers to obligations that were designed to address
conduct we have observed in other parts of the private fund advisers
industry, including with respect to advisers to hedge funds, private
equity funds, venture capital funds, real estate funds, credit funds,
hybrid funds, and other non-securitized asset funds (``non-SAF
advisers''). We believe that the certain distinguishing structural and
operational features of SAFs have together deterred SAF advisers from
engaging in the type of conduct that the final rules seek to address.
We also believe that the advisory relationship for SAF advisers and
their clients presents different regulatory issues than the advisory
relationship for non-SAF advisers and their clients. The final rules
generally are not designed to take into account these differences,
which together sufficiently distinguish SAFs from other types of
private funds to warrant this approach.\154\ As a result, we do not
believe that the private fund adviser rules we are adopting here are
the appropriate tool to regulate SAF advisers.
---------------------------------------------------------------------------

    \153\ Except as specified, we are not altering the applicability
of the Advisers Act, or any rules adopted thereunder, to SAF
advisers. For example, Section 206 and rule 206(4)-8 will continue
to apply to SAF advisers with respect to SAFs (and any other private
funds) they advise. We are also not limiting the scope of advisers
subject to the Advisers Act compliance rule and thus all SEC-
registered advisers, including SEC-registered SAF advisers, must
document the annual review of their compliance policies and
procedures in writing.
    \154\ We will, however, continue to consider whether any
additional regulatory action may be necessary with respect to SAF
advisers in the future.
---------------------------------------------------------------------------

    Definition of Securitized Asset Fund
    The final rule will define SAF as ``any private fund whose primary
purpose is to issue asset backed securities and whose investors are
primarily debt holders.'' \155\ This definition, which is based on the
corresponding definition for ``securitized asset fund'' in Form PF and
Form ADV, is designed to capture vehicles established for the purpose
of issuing asset backed securities, such as collateralized loan
obligations. SAFs are special purpose vehicles or other entities that
``securitize'' assets by pooling and converting them into securities
that are offered and sold in the capital markets. The definition
therefore will not capture traditional hedge funds, private equity
funds, venture capital funds, real estate funds, and credit funds.\156\
These private funds should not meet the definition because they
typically have primarily equity investors, rather than debt investors,
and/or they do not have a primary purpose of issuing asset backed
securities. It is appropriate to apply the final rules to advisers with
respect to these private funds because they present the concerns the
final rules seek to address (i.e., lack of transparency, conflicts of
interest, and lack of governance).
---------------------------------------------------------------------------

    \155\ See final rule 211(h)(1)-1.
    \156\ We recognize that certain private funds have, in recent
years, made modifications to their terms and structure to facilitate
insurance company investors' compliance with regulatory capital
requirements to which they may be subject. These funds, which are
typically structured as rated note funds, often issue both equity
and debt interests to the insurance company investors, rather than
only equity interests. Whether such rated note funds meet the SAF
definition depends on the facts and circumstances. However, based on
staff experience, the modifications to the fund's terms generally
leave ``debt'' interests substantially equivalent in substance to
equity interests, and advisers typically treat the debt investors
substantially the same as the equity investors (e.g., holders of the
``debt'' interests have the same or substantially the same rights as
the holders of the equity interests). We would not view investors
that have equity-investor rights (e.g., no right to repayment
following an event of default) as holding ``debt'' under the
definition, even if fund documents refer to such persons as ``debt
investors'' or they otherwise hold ``notes.'' Further, we do not
believe that many rated note funds will meet the other prong of the
definition (i.e., a private fund whose primary purpose is to issue
asset backed securities), because they generally do not issue asset-
backed securities.
---------------------------------------------------------------------------

    In the context of requesting that the rule not apply with respect
to collateralized loan obligations, one commenter stated that the final
rule should use the following definition: any special purpose vehicle
advised by an investment adviser that (A) (i) issues tradeable asset-
backed securities or loans, the debt tranches of which are rated; and
(ii) has at least 80% of its assets comprised of leveraged loans and
cash equivalents; (B) is required by its governing transaction
documents to appoint an unaffiliated person to, among other things, (i)
calculate certain overcollateralization and interest coverage tests;
(ii) prepare and make available to investors reports on the CLO, and
(iii) make the indenture readily available to investors; and (C)
appoints an independent accounting firm to perform a series of agreed
upon procedures. Another commenter, when requesting exemptions or other
relief from the rules, generally referred to these vehicles as
``special purpose vehicles that issue asset backed securities,'' while
another commenter used the term ``collateralized loan obligations and
similar credit securitization products.''
    The definition in the final rule will include the types of funds
described by these commenters. The definition of SAFs in the final
rule, however, is one that many advisers are familiar with because it
is used in both Form PF and Form ADV. For example, Item 7.B. and
Schedule D of Form ADV ask whether the private fund is a securitized
asset

fund or another type of private fund, such as a hedge fund or private
equity fund.\157\ Also, under Form PF, certain advisers to securitized
asset funds are required to complete Section 1, which requires an
adviser to report certain identifying information about itself and the
private funds it advises.\158\ We also chose this definition because it
captures the core characteristics that differentiate these vehicles
from other types of private funds: vehicles that issue asset-backed
securities collateralized by an underlying pool of assets and that have
primarily debt investors. Thus, as discussed above, traditional private
funds, would not meet this definition.\159\
---------------------------------------------------------------------------

    \157\ See Form ADV, Section 7.B.(1) and Schedule D Private Fund
Reporting, Question 10.
    \158\ See Form PF, Section 1a, Question 3.
    \159\ We would also not view, depending on the facts and
circumstances, private credit funds that borrow from third party
lenders to enhance performance with fund-level leverage and invest
in underlying loans alongside the equity investors as meeting this
definition, even if they borrow an amount greater than the value of
the equity interests they issue.
---------------------------------------------------------------------------

Distinguishing SAF Characteristics and Features
    Although SAFs generally rely on the same exclusions from treatment
as an ``investment company'' under the Investment Company Act as other
types of private funds (i.e., sections 3(c)(1) and (7) thereunder), we
agree with commenters that certain fundamental structural and
operational differences together sufficiently distinguish them from
other types of private funds to warrant carving them out of the final
rules. These fundamental differences, when considered in combination
with the existing governance and transparency requirements of SAFs,
would cause much of the rules to be generally inapplicable and/or
ineffective with respect to achieving the rulemaking's goals. Below we
provide examples of these distinguishing features and how they relate
to certain aspects of the final rules.
    We agree with commenters that SAFs have structural features that
distinguish them from most other private funds that are relevant in
assessing the benefit of an audit to investors. Commenters stated that
Generally Accepted Accounting Principles (``GAAP'') financial
statements are not typically considered relevant for SAFs.\160\ One
commenter stated that GAAP's efforts to assign, through accruals, a
period to a given expense or income are not useful, and potentially
confusing, for SAF investors because principal, interest, and expenses
of administration of assets can only be paid from cash received.\161\
We recognize that vehicles that issue asset-backed securities are
specifically excluded from other Commission rules that require issuers
to provide audited GAAP financial statements.\162\ Previously, we have
stated that GAAP financial information generally does not provide
useful information to investors in asset-backed securities.\163\
Instead, SAF and other asset-backed securities investors have
historically been interested in information regarding characteristics
and quality of the underlying assets used to pay the notes issued by
the issuer, the standards for the servicing of the underlying assets,
the timing and receipt of cash flows from those assets, and the
structure for distribution of those cash flows.\164\ We continue to
believe that GAAP financial statements may be less useful to SAF
investors than they are for non-SAF investors.
---------------------------------------------------------------------------

    \160\ See LSTA Comment Letter; SFA Comment Letter I; Fixed
Income Investor Network Comment Letter; TIAA Comment Letter. This
view by commenters is consistent with the low rate of audits of U.S.
GAAP financial statements for SAFs. However, approximately 10% of
SAFs do get audits of U.S. GAAP financial statements from
independent auditors that are Public Company Accounting Oversight
Board (``PCAOB'')-registered and -inspected. See infra section
VI.C.1. Advisers to these funds would not be prohibited under the
final rules from continuing to cause the fund to undergo such an
audit of U.S. GAAP financial statements.
    \161\ See LSTA Comment Letter.
    \162\ See Asset-Backed Securities, Securities Act Release No.
8518 (Dec. 22, 2004) (adopting disclosure requirements for asset-
backed securities issuers) (https://www.sec.gov/rules/final/33-8518.htm).
    \163\ See id.
    \164\ See id.
---------------------------------------------------------------------------

    SAFs also have features that distinguish them from most other
private funds that are relevant in assessing the benefit of the
preferential treatment rule. Based on staff experience, SAFs typically
issue primarily tradeable, interest-bearing debt securities backed by
income-producing assets, unlike other private funds that typically
issue equity securities to investors. These debt securities are
typically structured as notes and issued in different tranches to
investors. The tranches offer different priority of payments subject to
a ``waterfall'' and defined levels of risk with upside participation
caps or limits, which are compensated through the payment of increasing
coupon rates on the more subordinated notes. Unlike investors in other
private funds, the noteholders are similarly situated with all of the
other noteholders in the same tranche and they cannot redeem or ``cash
in'' their note ahead of other noteholders in the same tranche. As a
result, in our experience, this structure has generally deterred
investors from requesting, and SAF advisers from granting, preferential
treatment. Thus, we do not believe that preferential treatment for SAFs
presents the same conflicts of interest and investor protection
concerns as it does for non-SAF funds.
    We also believe that the quarterly statement would generally not
provide meaningful information for SAF investors. For example, some
commenters highlighted that the performance information required to be
included in private fund quarterly statements would generally not
constitute relevant or useful information for SAF investors, because
the performance of a SAF, as a cash flow investment vehicle, primarily
depends on the cash proceeds it realizes from its portfolio assets, as
opposed to an increase in the value of its portfolio assets.\165\ These
commenters stated that, instead of the performance metrics required for
liquid or illiquid funds under the rules, a yield performance metric
and/or information regarding the SAF's cash distributions to investors
(as well as its ability to make future cash distributions) would more
appropriately reflect the specific cash flow structure of a SAF
investment; and these commenters pointed out that SAF investors already
receive this information, which is generally required to be
periodically reported to investors in detail in accordance with a SAF's
securitization transaction agreement. We agree with commenters that the
required performance metrics would be less useful to SAF investors than
they are for non-SAF investors, particularly in light of the detailed
information that SAF investors are generally already required to
receive. For example, because the performance reporting would report
performance at the SAF level, but investors sit in different tranches
along the SAF's distribution waterfall with different risk/return
profiles, the required performance reporting would likely be
uninformative with respect to any specific tranche.
---------------------------------------------------------------------------

    \165\ See LSTA Comment Letter; SFA Comment Letter I; SIFMA-AMG
Comment Letter I; TIAA Comment Letter.
---------------------------------------------------------------------------

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

are primarily purchased in the United States through a primary issuance
and subsequently resold and traded on the secondary market by qualified
institutional buyers pursuant to Regulation 144A. Because SAF interests
are, unlike interests in other types of private funds, primarily traded
on the secondary market, the interests are generally held in street
name by broker-dealers on behalf of the fund's investors, who are,
accordingly, not generally known by the fund or its investment adviser.
To address delivery obligations under the fund documents, a SAF's
independent collateral administrator typically establishes a website
that is accessible by noteholders where their required reports are
furnished, in accordance with the terms of the securitization
transaction agreement. As a result, a SAF adviser may not have the
necessary contact information for each noteholder of the SAF to satisfy
the distribution requirements.
    Finally, SAF advisers often have a more limited role in the
management of a private fund, and SAFs or their sponsors typically
engage more independent service providers than non-SAF funds. The
primary role of an adviser to a SAF is, in many cases, to select and
monitor the fund's pool of assets in compliance with certain portfolio
requirements and quality tests (such as overcollateralization,
diversification, and interest coverage tests) that are set forth in the
fund's securitization transaction agreements. In many cases, the SAF's
transaction agreement appoints an independent trustee to serve as
custodian for the underlying investments. The trustee and collateral
administrator are typically responsible for preparing detailed monthly
and quarterly reports for the investors regarding the SAF's assets and
expenses. We believe that these structural protections provide an
important check on the adviser's activity or otherwise limit the
actions the adviser can take to harm investors.
    For the reasons described above, we believe it is appropriate not
to apply all five private fund adviser rules to advisers with respect
to SAFs they advise.

B. Quarterly Statements

    Section 211(h)(1) of the Act states that the Commission shall
facilitate the provision of simple and clear disclosures to investors
regarding the terms of their relationships with brokers, dealers, and
investment advisers, including any material conflicts of interest. The
quarterly statement rule is designed to facilitate the provision of
simple and clear disclosures to investors regarding some of the most
important and fundamental terms of their relationships with investment
advisers to private funds in which those investors invest--namely what
fees and expenses those investors will pay and what performance they
receive on their private fund investments. These disclosures will allow
investors to better understand their private fund investments and the
terms of their relationship with the adviser to those funds.
    Several commenters stated that section 211(h)(1) of the Act does
not authorize the quarterly statement rule because details about past
performance of funds and fees paid to the adviser are not terms of the
relationship between investors and advisers.\166\ However, section
211(h)(1) of the Act does not limit a ``term'' of the relationship only
to the provisions in a contract, as these commenters assert.\167\ In
the private fund context, it is the adviser or its affiliated entities
that generally draft the private fund's private placement memorandum
and governing documents,\168\ negotiate fund terms \169\ with the
private fund investors, manage the fund, charge and/or allocate fees
and expenses to the private fund which are then paid by the private
fund investors, and calculate and present performance information to
the private fund investors. In this context, fees and performance are
essential to the relationship between an investor and an adviser. The
method used to calculate fees is typically set forth in the fund
contracts. However, based on Commission staff experience, fee and
performance disclosures are often not simple or clear, and investors
may have difficulty understanding them. As a result, advisers have
overcharged certain fees without investors recognizing it
immediately.\170\ Similarly, performance is a crucial term of the
relationship between an adviser and investors. Performance is
implicitly or explicitly part of the terms of many fund contracts to
the extent that advisers are often compensated in part based on the
performance of the private fund.\171\ The amount, calculation, and
timing of performance compensation are often negotiated by the adviser
and the investors and form the core economic term of their
relationship.
---------------------------------------------------------------------------

    \166\ See, e.g., AIC Comment Letter I; Comment Letter of the
National Venture Capital Association (Apr. 25, 2022) (``NVCA Comment
Letter I''); Citadel Comment Letter.
    \167\ See, e.g., AIC Comment Letter I; Citadel Comment Letter.
    \168\ Including, for many types of private funds, the private
fund operating agreement to which the adviser or its affiliate and
the private fund investors are typically both parties.
    \169\ Such fund terms include, for example, the formulas that
determine the amount of carried interest and management fees paid to
the adviser in addition to other key terms such as the length of the
life of the fund and the mechanics of fund governance.
    \170\ See, e.g., In re Global Infrastructure Management, LLC,
supra footnote 30 (alleging private fund adviser failed to properly
offset management fees to private equity funds it managed and made
false and misleading statements to investors and potential investors
in those funds concerning management fee offsets); In the Matter of
ECP Manager LP, Investment Advisers Act Release No. 5373 (Sept. 27,
2019) (settled action) (alleging that private equity fund adviser
failed to apply the management fee calculation method specified in
the limited partnership agreement by failing to account for write
downs of portfolio securities causing the fund and investors to
overpay management fees).
    \171\ This includes the private fund operating agreement to
which the adviser or its affiliate and private fund investors are
typically both parties.
---------------------------------------------------------------------------

    Calculating performance is also complicated, and methods generally
differ among advisers. Without comparable performance metrics and
methodologies, it can be unclear how different advisers perform against
one another. Performance calculations also generally are the product of
many assumptions and criteria, such as the manner in which management
fee rates are applied. Without simple and clear disclosures of such
assumptions and criteria, investors are at a disadvantage with respect
to understanding or being able to verify how their investments are
performing.\172\
---------------------------------------------------------------------------

    \172\ Put simply, performance is key to the terms of the
relationship between private fund investors and advisers because
private fund investors pay advisers to seek to generate investment
returns, and performance information allows investors to assess how
an adviser is fulfilling that obligation.
---------------------------------------------------------------------------

    Section 206(4) of the Act gives the Commission the authority to
prescribe means reasonably designed to prevent fraud, deception, and
manipulation. The quarterly statement rule is reasonably designed to
prevent fraud, deception, and manipulation because it requires advisers
to provide timely and consistent disclosures that will improve the
ability of investors to assess and monitor fees, expenses, and
performance. This will decrease the likelihood that investors will be
defrauded, deceived, or manipulated because they will be in a better
position to monitor the adviser and their respective investments, and
it increases the likelihood that any such misconduct will be detected
sooner.\173\ Moreover, the fee, expense and performance information in
the quarterly statement will improve investors' ability to evaluate the
adviser's conflicts of interest with respect to the fees and

expenses charged to the fund by the adviser and the performance metrics
that the adviser presents to investors.\174\
---------------------------------------------------------------------------

    \173\ See infra footnotes 177-178 (providing examples of
misconduct relating to fees, expenses, and performance).
    \174\ See supra section I (discussing conflicts of interest).
---------------------------------------------------------------------------

    Several commenters stated that Commission, in the proposal, failed
to define a fraudulent, deceptive, or manipulative act as required by
section 206(4) of the Act.\175\ Another commenter stated that the
Commission, in the proposal, failed to connect the proposed reporting
requirements to any actual fraudulent act.\176\ To the contrary, the
quarterly statement is designed to prevent fraudulent, deceptive, or
manipulative practices, including ones we have observed.\177\ For
example, if an adviser is charging investors a management fee and
simultaneously charging a portfolio company a monitoring or similar fee
without disclosing that fee to investors, we would view that as
fraudulent or deceptive because it involves an undisclosed conflict in
breach of fiduciary duty.\178\ Similarly, if an adviser is knowingly
using off-market assumptions (such as highly irregular valuation
practices that are not used by similarly-situated advisers) when
calculating performance without disclosing such to investors, we would
view that practice as deceptive.
---------------------------------------------------------------------------

    \175\ See, e.g., AIC Comment Letter I; NVCA Comment Letter.
    \176\ See Citadel Comment Letter.
    \177\ See, e.g., In the Matter of Sabra Capital Partners, LLC
and Zvi Rhine, Investment Advisers Act Release No. 5594 (Sept. 25,
2020) (settled order) (alleging that, among other things, an
investment adviser misrepresented the performance of a fund it
advised in updates sent to the fund's limited partners); In the
Matter of Finser International Corporation and Andrew H. Jacobus,
Investment Advisers Act Release No. 5593 (Sept. 24, 2020) (settled
order) (alleging that, among other things, an investment adviser
charged a fund it advised performance fees contrary to
representations made in the fund's private placement memorandum); In
the Matter of Omar Zaki, Investment Advisers Act Release No. 5217
(Apr. 1, 2019) (settled order) (alleging that, among other things,
an investment adviser repeatedly misled investors in a fund it
advised about fund performance); In the Matter of Corinthian Capital
Group, LLC, Peter B. Van Raalte, and David G. Tahan, Investment
Advisers Act Release No. 5229 (May 6, 2019) (settled order)
(alleging that, among other things, an investment adviser failed to
apply a fee offset to a fund it advised and caused the same fund to
overpay organizational expenses); In the Matter of Aisling Capital
LLC, Investment Advisers Act Release No. 4951 (June 29, 2018)
(settled order) (alleging an investment adviser failed to apply a
specified fee offset to a fund it advised contrary to the fund's
limited partnership agreement and private placement memorandum).
    \178\ See, e.g., In the Matter of Monomoy Capital Management,
L.P., Investment Advisers Act Release No. 5485 (Apr. 22, 2020)
(settled action); In the Matter of WCAS Management Corporation,
Investment Advisers Act Release No. 4896 (Apr. 24, 2018) (settled
action); In the Matter of Fenway Partners, LLC, et. Al., Investment
Advisers Act Release No. 4253 (Nov. 3, 2015) (settled action).
---------------------------------------------------------------------------

    The rule requires an investment adviser that is registered or
required to be registered with the Commission to prepare a quarterly
statement that includes certain information regarding fees, expenses,
and performance for any private fund that it advises and distribute the
quarterly statement to the private fund's investors, unless a quarterly
statement that complies with the rule is prepared and distributed by
another person.\179\ If the private fund is not a fund of funds, then a
quarterly statement must be distributed within 45 days after the end of
each of the first three fiscal \180\ quarters of each fiscal year and
90 days after the end of each fiscal year.\181\ If the private fund is
a fund of funds, then a quarterly statement must be distributed within
75 days after the first, second, and third fiscal quarter ends and 120
days after the end of the fiscal year of the private fund.
---------------------------------------------------------------------------

    \179\ Final rule 211(h)(1)-2.
    \180\ See infra section II.B.3 for a discussion of the change to
fiscal time periods for the quarterly statement rule.
    \181\ Final rule 211(h)(1)-2.
---------------------------------------------------------------------------

    Many commenters supported the quarterly statement rule as proposed
and agreed that it would provide increased transparency to private fund
investors who may not currently receive sufficiently detailed,
comprehensible, or regular fee, expense, and performance information
for each of their private fund investments.\182\ These commenters
generally indicated that the quarterly statement rule would provide
increased comparability between private funds and accordingly would
enable private fund investors to make more informed investment
decisions, as well as potentially lead to increased competitive market
pressures on the costs of investing in private funds. Some commenters
indicated that the rule's establishment of a required baseline of
recurring reporting would allow investors to focus their negotiation
priorities with private fund advisers on other matters, such as fund
governance, and could also provide investors with greater confidence
when choosing to allocate capital to private fund investments.\183\ One
commenter suggested that the quarterly statement requirement would
particularly help smaller or less sophisticated investors who may
receive less timely or complete information than investors that possess
greater negotiating power.\184\ Other commenters did not support this
quarterly statement rule (or parts of the rule, as discussed
below).\185\ Of these commenters, a number suggested that this
quarterly statement requirement would increase costs for private funds
that would ultimately be passed on to investors.\186\ Some commenters
stated that the quarterly statement rule may not provide meaningful
information or would confuse investors because the required information
would not be personalized to investors, may not be appropriate for
certain types of private funds, or may differ from other information
already provided to private fund investors.\187\ Other commenters
stated that the rule is unnecessary and duplicative, as advisory firms
already provide similar or otherwise sufficient reporting, and
investors are generally able to negotiate for and receive additional
disclosure that may be appropriate for their particular needs.\188\
---------------------------------------------------------------------------

    \182\ See, e.g., Comment Letter of National Education
Association and American Federation of Teachers (Apr. 12, 2022)
(``NEA and AFT Comment Letter''); Comment Letter of the American
Federation of Teachers New Mexico (Apr. IFT Comment Letter Comment
Letter of the National Conference on Public Employee Retirement
Systems (Apr. 25, 2022) (``NCPERS Comment Letter''); Better Markets
Comment Letter; Comment Letter of Ohio Federation of Teachers (Apr.
25, 2022) (``OFT Comment Letter''); Comment Letter of American
Federation of State, County and Municipal Employees (Apr. 25, 2022)
(``AFSCME Comment Letter''); Consumer Federation of America Comment
Letter; Public Citizen Comment Letter; Comment Letter of National
Council of Real Estate Investment Fiduciaries (Apr. 25, 2022)
(``NCREIF Comment Letter''); Comment Letter of New York State
Insurance Fund (Apr. 25, 2022) (``NYSIF Comment Letter''); NYC
Comptroller Letter; Comment Letter of AFL-CIO (Apr. 25, 2022)
(``AFL-CIO Comment Letter''); Comment Letter NASAA Comment Letter.
    \183\ See, e.g., DC Retirement Board Comment Letter; ILPA
Comment Letter I; Comment Letter of National Electrical Benefit Fund
Investments (Apr. 25, 2022) (``NEBF Comment Letter''); OPERS Comment
Letter.
    \184\ See Healthy Markets Comment Letter I.
    \185\ See, e.g., Comment Letter of Andreessen Horowitz (June 15,
2022) (``Andreessen Comment Letter''); NVCA Comment Letter; SIFMA-
AMG Comment Letter I.
    \186\ See, e.g., IAA Comment Letter II; AIC Comment Letter I;
Comment Letter of Roubaix Capital (Apr. 12, 2022) (``Roubaix Comment
Letter'').
    \187\ See, e.g., AIC Comment Letter I; IAA Comment Letter II;
Ropes & Gray Comment Letter.
    \188\ See, e.g., AIMA/ACC Comment Letter; Comment Letter of
Dechert LLP (Apr. 25, 2022) (``Dechert Comment Letter''); AIC
Comment Letter I. One commenter stated that the Commission made no
attempt to review the investor disclosures provided by open-end
funds in order to evaluate whether the proposal would meaningfully
increase transparency. See Citadel Comment Letter. On the contrary,
Commission staff regularly reviews open- and closed-end fund
investor disclosures as part of the Commission's examination program
and that experience informs this rulemaking. See, e.g., OCIE
National Examination Program Risk Alert: Observations from
Examinations of Investment Advisers Managing Private Funds (June 23,
2020) (``EXAMS Private Funds Risk Alert 2020''), available at
https://www.sec.gov/files/Private%20Fund%20Risk%20Alert_0.pdf. As of
Dec. 17, 2020, the Office of Compliance, Inspections and
Examinations (``OCIE'') was renamed the Division of Examinations
(``EXAMS'').

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    As stated elsewhere, we have observed that private fund investments
are often opaque; advisers frequently do not provide investors with
sufficiently detailed information about private fund investments.\189\
Without sufficiently clear, comparable information, even sophisticated
investors may be unable to protect their interests or make sound
investment decisions. Accordingly, we are adopting the quarterly
statement rule, in part, because of the lack transparency in key areas
including private fund fees and expenses, performance, and conflicts of
interest.
---------------------------------------------------------------------------

    \189\ See Proposing Release supra footnote 3, at n. 9-11.
---------------------------------------------------------------------------

    While we acknowledge that quarterly statements may increase costs,
we believe these costs are justified in light of the benefits of the
rule.\190\ As discussed above, investors will benefit from increased
transparency into the fees and expenses charged to the fund, as well as
the conflicts they present, on a timely basis. Investors will also
benefit from mandatory timely updates regarding fund performance if
they were not already receiving them.\191\ We also disagree with
commenters' concerns regarding quarterly statements failing to provide
meaningful information. The quarterly statement will present a baseline
level of information in a clear format and will help private fund
investors to monitor and assess the true cost of their investments
better. For example, the enhanced cost information may allow an
investor to identify when the private fund has incorrectly, or
improperly, assessed a fee or expense by the adviser. We also disagree
with certain commenters' concerns that the quarterly statement may not
be appropriate for certain types of private funds. We believe that the
fee, expense, and performance information required in the quarterly
statement is a fundamental disclosure that is relevant to all types of
private funds.
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    \190\ See infra section VI.D.2.
    \191\ Furthermore, even if investors are already receiving
timely updates regarding fund performance for the funds in which
they are currently invested, they may also benefit from no longer
needing to expend resources negotiating for it for funds in which
they wish to invest in the future. As the quarterly statement rule
requires this baseline of performance information, investors will be
able to focus their resources on negotiating for more bespoke
reporting or other important rights in new funds.
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    Moreover, we anticipate the costs of compliance with this rule may
be of limited magnitude in light of the fact that many private fund
advisers already maintain and, in many cases, already disclose similar
information to investors.\192\ Relatedly, we acknowledge that many
private fund advisers contractually agree to provide fee, expense, and
performance reporting to investors already. However, not all private
fund investors are able to obtain this information. Other investors may
be able to obtain relevant information, but the information may not be
sufficiently clear or detailed regarding the costs and performance of a
particular private fund to enable an investor to understand, monitor
and make informed investment decisions regarding its private fund
investments. For instance, some advisers report only aggregated
expenses, or do not provide detailed information about the calculation
and implementation of any negotiated rebates, credits, or offsets,
which does not allow an investor to identify the actual extent and/or
types of costs incurred and to evaluate their validity. Other investors
may not have sufficient information regarding private fund fees and
expenses in part because those fees and expenses have varied
presentations across private funds and are subject to complicated
calculation methodologies, which similarly prevents an investor from
meaningfully assessing those fees and expenses and comparing private
fund investments. Private fund investors are increasingly interested in
more disclosure regarding private fund performance, including
transparency into the calculation of the performance metrics.\193\
Providing investors with simple and clear disclosures regarding fees,
expenses, and performance will allow investors to understand better
their private fund investments and the terms of their relationship with
the adviser.\194\
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    \192\ See infra sections VI.C.3, VI.D.2.
    \193\ See, e.g., GPs feel the strain as LPs push for more
transparency on portfolio performance and fee structures, Intertrust
Group (July 6, 2020), available at https://www.intertrustgroup.com/news/gps-feel-the-strain-as-lps-push-for-more-transparency-on-portfolio-performance-and-fee-structures/; ILPA Principals 3.0,
(2019), at 36 ``Financial and Performance Reporting'' and ``Fund
Marketing Materials,'' available at https://ilpa.org/wp-content/flash/ILPA%20Principles%203.0/?page=36.
    \194\ Section 211(h)(1) of the Advisers Act directs the
Commission to facilitate the provision of simple and clear
disclosures to investors regarding the terms of their relationships
with investment advisers.
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    We also disagree with commenters that suggested the quarterly
statement would confuse investors. For example, some commenters
asserted that standardized quarterly statement disclosures could
confuse investors because the required information may not reflect an
investor's actual, particularized investment experience in a fund.\195\
However, investors will benefit from receiving a baseline level of
simple and clear disclosures regarding fee, expenses, and performance.
For example, private fund advisers currently use different metrics and
specifications for calculating performance, which makes it difficult
for investors to compare information across funds and advisers, even
when advisers disclose the assumptions they used. More standardized
requirements for performance metrics will allow private fund investors
to compare more easily the returns of similar fund strategies over
different market environments and over time. Simple and clear
information about costs and performance that is provided on a regular
basis will help an investor better decide whether to continue the terms
of its relationship with the adviser, whether to remain invested in a
particular private fund where the fund allows for withdrawals and
redemptions, whether to invest in private funds managed by the adviser
or its related persons in the future, and how to invest other assets in
the investor's portfolio.
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    \195\ See, e.g., AIC Comment Letter I; IAA Comment Letter II.
---------------------------------------------------------------------------

    Certain commenters argued that the quarterly statement requirement
would be particularly burdensome for small and emerging advisers.\196\
We first observe that the quarterly statement rule is only applicable
to investment advisers that are registered or required to be registered
with the Commission. Thus, some private fund advisers, including those
solely advising less than $150 million private fund assets under
management and those with less than $100 million in regulatory assets
under management registered with, and subject to examination by the
States, will not be subject to the quarterly statement rule. Second, we
understand that firms vary in the extent to which they devote resources
specifically to compliance. It is important for all investors in
private funds advised by SEC-registered advisers to receive
sufficiently detailed, comprehensible, and regular information to
enable investors to monitor whether fees and expenses are being
mischarged and to ensure that accurate performance information is being
clearly presented. We view sufficient fee, expense, and performance
information under the rule as together forming, and each as an
essential component of, the basic set of information that is generally
necessary for private fund investors to evaluate accurately and
confidently their private

fund investments. Accordingly, we are not providing any exemptions to
the quarterly statement rule for small or emerging advisers.
---------------------------------------------------------------------------

    \196\ See, e.g., AIC Comment Letter I; Lockstep Ventures Comment
Letter; SBAI Comment Letter.
---------------------------------------------------------------------------

    In addition to general comments on the proposed quarterly statement
rule, commenters made specific suggestions or sought clarification on
discrete parts of the proposal.\197\ One commenter asked the Commission
to clarify that investors may negotiate reporting in addition to what
is required in the quarterly statements.\198\ We confirm that the
quarterly statements represent a baseline level of reporting that is
required for covered private fund advisers. The quarterly statement
rule itself does not restrict or limit the kinds of additional
reporting for which private fund investors may negotiate.
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    \197\ One commenter requested the Commission clarify that a
registered U.S. sub-adviser would not need to comply with the
quarterly statement rule with respect to a private fund whose
primary adviser is not subject to the rule. See AIMA/ACC Comment
Letter. However, the final rule does not include an exception for
such advisers. We believe that the requested exception would
diminish the effectiveness of the rule, as the fact that one adviser
may not be subject to the final rule does not negate the need for
the private fund and its underlying investors to receive the benefit
of a quarterly statement.
    \198\ See NYC Comptroller Comment Letter.
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    Some commenters suggested that we require investor-specific or
class-specific reporting in addition to fund-level reporting.\199\
While we recognize the utility to investors of investor-level
reporting, we do not believe that requiring investor-level reporting in
quarterly statements is essential to this rulemaking. First, the
quarterly statements are designed, in part, to allow individual private
fund investors to use fund-level information to perform the types of
personalized or otherwise customized calculations that underlie
investor-specific reporting. Second, we understand that, even if
private fund advisers provide investors with investor-specific
reporting, many investors would still need to perform personalized or
otherwise customized calculations to satisfy their own internal
requirements.\200\ Third, the fund-level reporting requirements do not
prevent an adviser from providing (or causing a third party, such as an
administrator, consultant, or other service provider, to provide)
personalized information, as well as other customized information, to
supplement the standardized baseline level (i.e., the mandatory floor)
of fund-level information required to be included in the quarterly
statements, provided that such additional information complies with the
other requirements of the final rule, the marketing rule,\201\ and
other disclosure requirements, each to the extent applicable. We are
requiring what we view as essential baseline, fund-level information,
allowing investors to focus their time and bargaining resources on
requests for any more personalized information they may need, which may
vary from investor to investor.
---------------------------------------------------------------------------

    \199\ See, e.g., ILPA Comment Letter I; Healthy Markets Comment
Letter I; OPERS Comment Letter; NYSIF Comment Letter.
    \200\ For example, an investor may seek to analyze the
performance of each of a fund's individual portfolio investments to
better understand the nature of such fund's performance as well as
the adviser's skill at investment selection and management at a more
granular level.
    \201\ See rule 206(4)-1. A communication to a current investor
can be an ``advertisement,'' for example, when it offers new or
additional investment advisory services with regard to securities.
---------------------------------------------------------------------------

    Similarly, while we recognize the value of class-level reporting,
requiring class-level reporting on quarterly statements is not
necessary for the same reasons as those discussed above for investor-
specific reporting. Additionally, requiring class-level reporting would
not increase comparability across different advisers. For example, an
investor might be in substantially different classes in funds advised
by different advisers and thus might have difficulty comparing class-
level reporting across these funds.\202\
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    \202\ Any class-based assumptions or criteria used to calculate
fund-level performance should be prominently disclosed as part of
the quarterly statements. For example, if an adviser uses a
management fee rate that is averaged across different classes to
compute fund-level performance, it should be prominently disclosed
in the quarterly statement. See infra section II.B.2.c.
---------------------------------------------------------------------------

    Commenters suggested that we should allow investors to waive this
quarterly statement requirement.\203\ However, if we were to allow
investors to waive the quarterly statement requirement, then some
private fund advisers may require investors to do so as a precondition
to investing in a fund. Furthermore, even if a private fund adviser
does not explicitly require such a waiver as a precondition to
investment, a private fund adviser could attempt to anchor negotiations
around a waiver by including one in a private fund's subscription
agreement and thereby compelling investors to choose between expending
resources to negotiate for quarterly statements or for other important
terms related to fund governance and investor protection. Such an
outcome would undermine improving transparency for these private fund
investors and would fail to address the harms that the rule is intended
to address.
---------------------------------------------------------------------------

    \203\ See, e.g., BVCA Comment Letter; Comment Letter of the
German Private Equity and Venture Capital Association (June 2, 2022)
(``GPEVCA Comment Letter'').
---------------------------------------------------------------------------

    Some commenters suggested requiring statements annually instead of
quarterly.\204\ Other commenters suggested requiring statements semi-
annually.\205\ Another commenter suggested requiring these statements
more frequently than quarterly for liquid funds as many liquid funds
currently provide monthly statements.\206\ It is our understanding that
most private funds (liquid and illiquid) report at least quarterly.
Accordingly, we believe that requiring quarterly reporting is well
suited to enhance investors' ability to compare performance as well as
fee and expense information across liquid and illiquid private funds
because many private investors are accustomed to receiving and
reviewing quarterly reports. Monthly or more frequent reporting may
also not provide sufficiently more meaningful information to justify
imposing the burdens for private funds that do not already provide such
frequent reporting.\207\ All private funds, including liquid funds, may
provide additional reporting on a more frequent basis than quarterly.
On the other hand, we believe that annual or semi-annual statements are
too infrequent and such infrequency would make it difficult for
investors to monitor their investments. Receiving a year or six months'
worth of fee and expense information at one time would make it more
burdensome for investors to parse (particularly, because some of those
outlays may be a year or six months old) and to help ensure that fees
are being charged appropriately. Similarly, because a fund's
performance can change drastically over the course of a year or six
months, investors often need more frequent and regular performance
reporting to make informed investment decisions and to balance their
own portfolio. We believe that quarterly reporting strikes the right
balance between sufficient frequency to enable investor analysis and
decision making and mitigation of burdens on advisers.
---------------------------------------------------------------------------

    \204\ See, e.g., Schulte Comment Letter; Invest Europe Comment
Letter; BVCA Comment Letter.
    \205\ See, e.g., Ropes & Gray Comment Letter; MFA Comment Letter
I; AIMA/ACC Comment Letter.
    \206\ See RFG Comment Letter II.
    \207\ For example, it is our understanding that the majority of
private equity funds currently provide quarterly reporting. Since
private equity funds generally invest on a longer time horizon, we
do not expect that monthly reporting would inherently provide more
beneficial information for investors than quarterly reporting and it
would entail substantial additional administrative costs.

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1. Fee and Expense Disclosure
    The rule requires an investment adviser that is registered or
required to be registered to prepare and distribute quarterly
statements for any private fund that it advises with certain
information regarding the fund's fees and expenses and any compensation
paid or allocated to the adviser or its related persons by the fund, as
well as any compensation paid or allocated by the fund's underlying
portfolio investments. The statement will provide investors in those
funds with comprehensive fee and expense disclosure for the prior
quarterly period (or, in the case of a newly formed private fund's
initial quarterly statement, its first two full fiscal quarters of
operating results).
    Many commenters generally supported the fee and expense disclosure
requirement for the quarterly statements and agreed that establishing a
standardized baseline level (i.e., a ``floor'') of fee and expense
disclosure would enhance the basic transparency, comparability and
investors' understanding and oversight of their private fund
investments.\208\ Some commenters criticized it on various grounds, as
discussed in more detail below, including that the fee and expense
disclosure requirement as proposed would be overly broad, costly, and
burdensome.\209\ Certain commenters relatedly suggested that current
fee and expense disclosure practices are sufficient because investors
can already negotiate for the types of reporting that would meet their
needs.\210\
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    \208\ See, e.g., ILPA Comment Letter I; Comment Letter of the
Council of Institutional Investors (Apr. 7, 2022) (``CII Comment
Letter''); Comment Letter of the Seattle City Employees'' Retirement
System (Apr. 19, 2022) (``Seattle Retirement System Comment
Letter''); OFT Comment Letter; United for Respect Comment Letter I;
Public Citizen Comment Letter; Comment Letter of the Los Angeles
County Employees Retirement Association (July 28, 2022) (``LACERA
Comment Letter''); OPERS Comment Letter; NCPERS Comment Letter;
Comment Letter of Take Medicine Back (Apr. 25, 2022) (``Take
Medicine Back Comment Letter''); Comment Letter of Segal Marco
Advisors (Apr. 25, 2022) (``Segal Marco Comment Letter''); Comment
Letter of the Illinois State Treasurer (May 12, 2022) (``IST Comment
Letter''); AFL-CIO Comment Letter; Comment Letter of Morningstar,
Inc. (Apr. 25, 2022) (``Morningstar Comment Letter''); Comment
Letter of CFA Institute (June 24, 2022) (``CFA Comment Letter II'').
    \209\ See, e.g., Comment Letter of Impact Capital Managers, Inc.
(Apr. 25, 2022) (``ICM Comment Letter''); MFA Comment Letter I;
Comment Letter of Americans for Tax Reform (Apr. 23, 2022) (``ATR
Comment Letter'').
    \210\ See ICM Comment Letter; AIMA/ACC Comment Letter; Dechert
Comment Letter; AIC Comment Letter I.
---------------------------------------------------------------------------

    Although the required fee and expense disclosure in the quarterly
statement will impose some additional costs, it is essential that
investors receive this information in a timely, detailed, and
consistent manner. Private funds are often more expensive than other
asset classes because the scope and magnitude of fees and expenses paid
directly and indirectly by private fund investors can be extensive and
complex. Although the types of fees and expenses charged to private
funds can vary across the industry, investors typically compensate the
adviser for managing the affairs of a private fund, often in the form
of management fees \211\ and performance-based compensation.\212\ A
fund's portfolio investments also may pay fees to the adviser or its
related persons.\213\ The quarterly statement will help ensure
disclosure of these fees and expenses, and the corresponding dollar
amounts, to current investors on a consistent and regular basis, which
will allow investors to understand and assess the cost of their private
fund investments.
---------------------------------------------------------------------------

    \211\ Certain private fund advisers utilize a pass-through
expense model where the private fund pays for most, if not all,
expenses, including the adviser's expenses, but the adviser does not
charge a management fee. See infra section II.E.1. for a discussion
of such pass-through expense models.
    \212\ Investors typically enter into agreements under which the
private fund pays such compensation directly to the adviser or its
affiliates. Investors generally bear such compensation indirectly
through their investment in the private fund; however, certain
agreements may require investors to pay the adviser or its
affiliates directly.
    \213\ See Proposing Release, supra footnote 3, at 24-26
(describing the types of fees and expenses private fund investors
typically pay or otherwise bear, including portfolio-investment
level compensation paid to the adviser or its affiliates).
---------------------------------------------------------------------------

    We disagree with the suggestion from some commenters that current
fee and expense disclosure practices are sufficient. We understand that
some fund investors have struggled to obtain complete and usable
expense information, including when institutionally required to do so,
for example, by the laws applicable to State and municipal plan
investors.\214\ Many investors also generally lack transparency
regarding the total cost of fees and expenses.\215\ For instance, even
though investors can indirectly end up bearing the costs associated
with a portfolio investment paying fees to the adviser or its related
persons, some advisers may not disclose the magnitude or scope of these
fees to investors. Opaque reporting practices make it difficult for
investors to measure and evaluate performance accurately, to assess
whether an adviser's total fees are justified, and to make better
informed investment decisions.\216\ Moreover, opaque reporting
practices may prevent private fund investors from assessing whether the
types and amount of fees and expenses borne by the private fund comply
with the fund's governing agreements or whether disclosures regarding
fund fees and expenses accurately describe the adviser's practices or
instead may be misleading. The Commission has brought enforcement
actions related to the disclosure, misallocation and mischarging of
fees and expenses by private fund advisers. For example, we have
alleged in settled enforcement actions that advisers have received
undisclosed fees,\217\ received inadequately disclosed compensation
from fund portfolio investments,\218\ misallocated expenses away from
the adviser to private fund clients,\219\ mischarged a performance fee
to a private fund client contrary to investor disclosures,\220\ failed
to offset certain fees or other amounts against management fees as set
forth in fund documents,\221\ and directly or indirectly misallocated
fees and expenses among private fund and other clients.\222\

Commission staff has observed similarly problematic practices in its
examinations of private fund advisers.\223\ For example, Commission
staff has observed advisers that charge private funds for expenses not
permitted under the fund documents.\224\ Commission staff has also
observed advisers allocating expenses, such as broken-deal, due
diligence, and consultant expenses, among private fund clients, other
clients advised by an adviser or its related persons, and their own
accounts in a manner that was inconsistent with disclosures to
investors.\225\ Investors are less able to monitor effectively whether
such fee and expense misallocations are occurring and to respond
effectively to this information without sufficiently timely, regular,
and detailed fee and expense information.
---------------------------------------------------------------------------

    \214\ See, e.g., LACERA Comment Letter.
    \215\ See Hedge Fund Transparency: Cutting Through the Black
Box, The Hedge Fund Journal, James R. Hedges IV (Oct. 2006),
available at https://thehedgefundjournal2006).com/hedge-fund-
transparency/ (stating that ``the biggest challenges facing today's
hedge fund industry may well be the issues of transparency and
disclosure''); Fees & Expenses, Private Funds CFO (Nov. 2020)), at
12, available at https://www.troutman.com/images/content/2/6/269858/PFCFO-FeesExpenses-Nov20-Final.pdf (noting that it is becoming
increasingly complicated for investors to determine what the
management fee covers versus what is a partnership expense and
stating that the ``formulas for management fees are complex and
unique to different investors.''); see also, e.g., ILPA Comment
Letter I; For the Long Term Comment Letter; NCPERS Comment Letter;
Comment Letter of Americans for Financial Reform Education Fund
(Apr. 25, 2022) (``AFREF Comment Letter I'').
    \216\ See, e.g., Letter from State Treasurers and Comptrollers
to Mary Jo White, U.S. Securities and Exchange Commission (July 21,
2015), available at http://comptroller.nyc.gov/wp-content/uploads/documents/SEC_SignOnPDF.pdf; see also Letter from Americans for
Financial Reform Education Fund to Chairman Gary Gensler, U.S.
Securities and Exchange Commission (July 6, 2021), available at
https://ourfinancialsecurity.org/wp-content/uploads/2021/07/Letter-to-SEC-re_-Private-Equity-7.6.21.pdf.
    \217\ See, e.g., In the Matter of Blackstone, supra footnote 26.
    \218\ See, e.g., In the Matter of Monomoy Capital Management,
L.P., Investment Advisers Act Release No. 5485 (Apr. 22, 2020)
(settled action).
    \219\ See, e.g., In the Matter of Cherokee Investment Partners,
LLC and Cherokee Advisers, LLC, supra footnote 26; In the Matter of
Yucaipa Master Manager, LLC, Investment Advisers Act Release No.
5074 (Dec. 13, 2018) (settled action).
    \220\ See, e.g., In the Matter of Finser International
Corporation, et al., Investment Advisers Act Release No. 5593 (Sept.
24, 2020) (settled action).
    \221\ See, e.g., In the Matter of Corinthian Capital Group, LLC,
et al., Investment Advisers Act Release No. 5229 (May 6, 2019)
(settled action).
    \222\ See, e.g., In the Matter of Lincolnshire, supra footnote
26 (alleging that an investment adviser that misallocated expenses
between its private funds' portfolio companies and violated its
fiduciary duty to the private funds); In the Matter of Rialto
Capital Management, LLC, Investment Advisers Release No. 5558 (Aug.
7, 2020) (settled action); In the Matter of Energy Capital Partners,
supra footnote 30.
    \223\ See EXAMS Private Funds Risk Alert 2020, supra footnote
188.
    \224\ See id.
    \225\ See id.
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    Some commenters suggested requiring an expense ratio to help
provide context as to the relative magnitude of a fund's expenses.\226\
Although expense ratios may be helpful in certain circumstances in
providing a top-line cost figure, they may be less helpful in others.
For instance, if an adviser is misallocating certain smaller expenses,
an expense ratio may obscure this practice if overall changes to the
top-line cost figure are not obvious. Additionally, expense ratios may
fail to capture some of the nuances of private fund fee and expense
structures, such as with respect to the current and future impact of
offsets, rebates and waivers, and investors might not otherwise receive
sufficient disclosure on such fee and expense structures. The focus of
this disclosure requirement is to require a private fund adviser to
provide its private fund investors regularly and in a timely manner
with at least a baseline level of consistent and detailed fee and
expense information, so that private fund investors are generally
better able to assess and monitor effectively the costs of investing in
private funds managed by the adviser.\227\ If investors receive this
information reliably, they will be better able to calculate their own
applicable expense ratios.
---------------------------------------------------------------------------

    \226\ See MFA Comment Letter I; NCREIF Comment Letter.
    \227\ Although certain kinds of expense ratios are required in
the registered funds context, we understand that fees and expenses
are more likely to vary over time in the private fund space. For
example, a private equity fund may incur a disproportionate amount
of expenses early in its life when it is making the majority of its
investments and incur fewer expenses during the middle part of its
life when it is focused on holding these investments. The use of an
expense ratio in these periods may overstate or understate,
respectively, the expense burdens over the life of the fund.
---------------------------------------------------------------------------

    Furthermore, as stated above, advisers under the rule will remain
able to provide, and investors are free to request and negotiate for,
disclosure of expense ratios, as well as other information, to
supplement the standardized baseline level (i.e., the mandatory floor)
of fund fee and expense disclosure required in the quarterly
statements, provided that such additional information complies with the
other requirements of the final rule, the marketing rule,\228\ and
other disclosure requirements, each to the extent applicable.
---------------------------------------------------------------------------

    \228\ See supra footnote 201.
---------------------------------------------------------------------------

(a) Private Fund-Level Disclosure
    The quarterly statement rule will require private fund advisers to
disclose the following information to investors in a table format:
    (1) A detailed accounting of all compensation, fees, and other
amounts allocated or paid to the adviser or any of its related persons
by the private fund (``adviser compensation'') during the reporting
period;
    (2) A detailed accounting of all fees and expenses allocated to or
paid by the private fund during the reporting period other than those
listed in paragraph (1) above (``fund expenses''); and
    (3) The amount of any offsets or rebates carried forward during the
reporting period to subsequent quarterly periods to reduce future
payments or allocations to the adviser or its related persons.\229\
---------------------------------------------------------------------------

    \229\ Final rule 211(h)(1)-2(b).
---------------------------------------------------------------------------

    The table is designed to provide investors with comprehensive fund
fee and expense disclosure for the prior quarterly period (or, in the
case of a newly formed private fund's initial quarterly statement, its
first two full fiscal quarters of operating results).\230\ We discuss
each of these elements in turn below.
---------------------------------------------------------------------------

    \230\ See final rule 211(h)(1)-1 (defining ``reporting period''
as the private fund's fiscal quarter covered by the quarterly
statement or, for the initial quarterly statement of a newly formed
private fund, the period covering the private fund's first two full
fiscal quarters of operating results). To the extent a newly formed
private fund begins generating operating results on a day other than
the first day of a fiscal quarter (e.g., Jan. 1), the adviser should
include such partial quarter and the immediately succeeding fiscal
quarters in the newly formed private fund's initial quarterly
statement. For example, if a fund begins generating operating
results on Feb. 1, the reporting period for the initial quarterly
statement would cover the period beginning on Feb. 1 and ending on
Sept. 30.
---------------------------------------------------------------------------

    Adviser Compensation. Substantially as proposed, the rule will
require the fund table to show a detailed accounting of all adviser
compensation during the reporting period, with separate line items for
each category of allocation or payment reflecting the total dollar
amount, as proposed.\231\ The rule is designed to capture all forms and
amounts of compensation, fees, and other amounts allocated or paid to
the investment adviser or any of its related persons by the fund,
including, but not limited to, management, advisory, sub-advisory, or
similar fees or payments, and performance-based compensation, without
permitting the exclusion of de minimis expenses, the general grouping
of smaller expenses into broad categories, or the labeling of expenses
as miscellaneous.
---------------------------------------------------------------------------

    \231\ Final rule 211(h)(1)-2(b)(1).
---------------------------------------------------------------------------

    Many commenters generally supported the requirement to report
adviser compensation on the quarterly statements.\232\ Some commenters
suggested that this requirement would be overly burdensome, in
particular due to the breadth of certain aspects of the requirement (as
discussed below), or that current market practices are sufficient.\233\
---------------------------------------------------------------------------

    \232\ See, e.g., CII Comment Letter; Seattle Retirement System
Comment Letter; IST Comment Letter.
    \233\ See, e.g., ICM Comment Letter; Comment Letter of Alumni
Ventures (Apr. 25, 2022) (``Alumni Ventures Comment Letter''); MFA
Comment Letter I.
---------------------------------------------------------------------------

    Many private funds compensate advisers with a ``2 and 20'' or
similar arrangement, consisting of a 2% management fee and a 20% share
of any profits generated by the fund. Certain advisers, however,
receive other forms or amounts of compensation from private funds in
addition to, or in lieu of, such arrangements.\234\ Requiring advisers
to disclose all forms of adviser compensation as separate line items
without prescribing particular categories of fees is appropriate
because this requirement will encompass the various and evolving forms
of adviser compensation across the private funds industry.
---------------------------------------------------------------------------

    \234\ See Proposing Release, supra footnote 3, at 28-29
(describing the types of adviser compensation private fund investors
typically pay or otherwise bear).
---------------------------------------------------------------------------

    In addition to compensation paid to the adviser, the rule requires
the fund table to include disclosure of compensation, fees, and other
amounts allocated or paid to the adviser's ``related persons.'' We are
defining ``related persons'' to include: (i) all officers, partners, or
directors (or any

person performing similar functions) of the adviser; (ii) all persons
directly or indirectly controlling or controlled by the adviser; (iii)
all current employees (other than employees performing only clerical,
administrative, support or similar functions) of the adviser; and (iv)
any person under common control with the adviser.\235\ The term
``control'' is defined to mean the power, directly or indirectly, to
direct the management or policies of a person, whether through
ownership of securities, by contract, or otherwise.\236\ We are
adopting both definitions as proposed.
---------------------------------------------------------------------------

    \235\ Final rule 211(h)(1)-1. Form ADV uses the same definition.
The regulations at 17 CFR 275.206(4)-2 (rule 206(4)-2) use a similar
definition by defining related person to include any person,
directly or indirectly, controlling or controlled by the adviser,
and any person that is under common control with the adviser.
    \236\ Final rule 211(h)(1)-1. The definition, in addition,
provides that: (i) each of an investment adviser's officers,
partners, or directors exercising executive responsibility (or
persons having similar status or functions) is presumed to control
the investment adviser; (ii) a person is presumed to control a
corporation if the person: (A) directly or indirectly has the right
to vote 25% or more of a class of the corporation's voting
securities; or (B) has the power to sell or direct the sale of 25%
or more of a class of the corporation's voting securities; (iii) a
person is presumed to control a partnership if the person has the
right to receive upon dissolution, or has contributed, 25% or more
of the capital of the partnership; (iv) a person is presumed to
control a limited liability company if the person: (A) directly or
indirectly has the right to vote 25% or more of a class of the
interests of the limited liability company; (B) has the right to
receive upon dissolution, or has contributed, 25% or more of the
capital of the limited liability company; or (C) is an elected
manager of the limited liability company; or (v) a person is
presumed to control a trust if the person is a trustee or managing
agent of the trust. Form ADV uses the same definition.
---------------------------------------------------------------------------

    Many advisers conduct a single advisory business through multiple
separate legal entities and provide advisory services to a private fund
through different affiliated entities or personnel. The ``related
person'' and ``control'' definitions are designed to capture the
various entities and personnel that an adviser may use to provide
advisory services to, and receive compensation from, private fund
clients. Some commenters supported broadening the ``related person''
and ``control'' definitions to include, for example, unaffiliated
service providers that provide payments to an adviser or over which an
adviser has economic influence, former personnel and family members,
operational partners, senior advisors, or similar consultants of an
adviser, a private fund, or its portfolio investments, and/or any
recipient of fund management fees or performance-based
compensation.\237\ Other commenters supported adopting definitions that
are consistent with advisers' existing reporting obligations,\238\ with
one commenter suggesting that adopting different definitions could
capture irrelevant persons or entities and create unnecessary
confusion.\239\ We are adopting definitions that are consistent with
the definitions of ``related person'' and ``control'' used on Form ADV
and Form PF, which advisers already have experience assessing as part
of their disclosure obligations on those forms, and which capture the
entities and personnel that advisers typically use to conduct a single
advisory business and provide advisory services to a private fund.
---------------------------------------------------------------------------

    \237\ See, e.g., Comment Letter of Convergence (Apr. 23, 2022)
(``Convergence Comment Letter''); Comment Letter of XTP
Implementation Services, Inc. (Apr. 25, 2022) (``XTP Comment
Letter'').
    \238\ See, e.g., AIMA/ACC Comment Letter; SBAI Comment Letter;
SIFMA-AMG Comment Letter I.
    \239\ See AIMA/ACC Comment Letter.
---------------------------------------------------------------------------

    One commenter suggested that the rule's reference to ``sub-advisory
fees'' in the non-exhaustive list of compensation types covered by the
adviser compensation disclosure requirement is inappropriate, because
sub-advisory fees are generally not paid to the sub-adviser by a
private fund and instead are often paid out of the management fee or
other adviser compensation received by the fund's primary adviser from
the fund.\240\ As proposed, the rule requires disclosure of any adviser
compensation allocated or paid to the adviser or any of its related
persons, including, without limitation, a related person that is a sub-
adviser to the private fund, to the extent that the compensation to the
related person is allocated or paid by the fund. Accordingly, the rule
does not require sub-advisory fees allocated or paid to a related
person solely by the fund's adviser (and not by the fund) to be
disclosed as a separate item of adviser compensation. Another commenter
suggested that the rule should require disclosure of sub-advisory fees
to unrelated sub-advisers, in addition to related person sub-
advisers.\241\ Compensation to unrelated sub-advisers is required to be
separately disclosed as a fund fee and expense under 17 CFR 211(h)(1)-
2(b)(2) (final rule 211(h)(1)-2(b)(2)), to the extent that such
payments are allocated to or paid by the fund.
---------------------------------------------------------------------------

    \240\ See id. This commenter also stated that disclosing sub-
adviser fees separately could disincentivize sub-advisers from
offering discounted or reduced fees to private funds. The final rule
will not require separate disclosure of sub-adviser fees to the
extent such fees are not paid by the fund, as discussed below.
Nevertheless, this comment could also be understood to apply to any
disclosure of sub-adviser compensation, including the disclosure of
sub-adviser fees that are paid or allocated to the sub-adviser by
the fund, which, as discussed below, will be required disclosure
under the final rule. In this regard, although sub-adviser
compensation, similar to any other adviser compensation, may be
subject to upward or downward fee pressures as a result of the
disclosure of compensation information, we believe that increased
transparency and comparability with respect to the sub-adviser (and
other adviser) compensation borne by a private fund is essential to
generally enable private fund investors to make more informed
investment decisions, and that this information could also lead to
increased competitive market pressures on the costs of investing in
private funds.
    \241\ See NASAA Comment Letter.
---------------------------------------------------------------------------

    Substantially as proposed, we are defining ``performance-based
compensation'' as allocations, payments, or distributions of capital
based on a private fund's (or its investments') capital gains, capital
appreciation, and/or profit.\242\ Commenters generally did not provide
comments with respect to the proposed definition of ``performance-based
compensation.'' We are, however, making two non-substantive, technical
changes to this definition. First, we are revising the definition to
include not only capital gains and capital appreciation but also
profit. This change will capture performance-based compensation that
may be calculated based on other types or measures of investment
performance, such as investment income. Second, the parenthetical in
the definition now references ``or any of its investments'' rather than
``or its portfolio investments,'' because the value of the fund's
investment (i.e., the value of the fund's interest in a portfolio
investment entity or issuer) will typically determine whether the
adviser is entitled to performance-based compensation, rather than the
value of the portfolio investment entity or issuer itself. The broad
scope of this definition, which captures, without limitation, carried
interest, incentive fees, incentive allocations, or profit allocations,
among other forms of compensation, is appropriate in light of the
various and evolving forms of performance-based compensation received
by private fund advisers. This definition also covers both cash and
non-cash compensation, including, for example, allocations, payments,
or distributions of performance-based compensation that are in-kind.
---------------------------------------------------------------------------

    \242\ Final rule 211(h)(1)-1.
---------------------------------------------------------------------------

    Fund Fees and Expenses. The rule requires the table to show a
detailed accounting of all fees and expenses allocated to or paid by
the private fund during the reporting period, other than those
disclosed as adviser compensation, with separate line items

for each category of fee or expense reflecting the total dollar amount,
substantially as proposed.\243\ In a change from the proposal, we are
revising this requirement to capture not only amounts ``paid by'' the
private fund but also fees and expenses ``allocated to'' the private
fund during the reporting period.\244\ This clarification is necessary
to avoid potentially misleading investors in light of the various ways
that a private fund may be caused to bear fees and expenses.
Additionally, this change is consistent with the requirement in rule
211(h)(1)-2(b)(1), as proposed and adopted, to disclose compensation
allocated or paid to the adviser or any of its related persons by the
private fund during the reporting period.
---------------------------------------------------------------------------

    \243\ Final rule 211(h)(1)-2(b)(2).
    \244\ Cf. CFA Comment Letter II (noting that proposed rule
211(h)(1)-2(b)(2) could be read to ``not capture fees and expenses
that have been accrued and not yet paid'').
---------------------------------------------------------------------------

    Similar to the approach taken with respect to adviser compensation
discussed above, the rule captures all fund fees and expenses allocated
to or paid by the fund during the reporting period, including, but not
limited to, organizational, accounting, legal, administration, audit,
tax, due diligence, and travel expenses. The rule's capturing of all,
rather than limited categories of, fund fees and expenses is
appropriate because this requirement will encompass the various and
evolving forms of private fund fees and expenses. Advisers must list
each category of expense as a separate line item under the rule, rather
than group fund expenses into broad categories that obfuscate the
nature and/or extent of the fees and expenses borne by the fund. For
example, if a fund paid insurance premiums, administrator expenses, and
audit fees during the reporting period, a general reference to ``fund
expenses'' on the quarterly statement will not satisfy the rule's
detailed accounting requirement. Instead, an adviser is required to
separately list each category of expense (i.e., in the example above,
insurance premiums, administrator expenses, and audit fees) and the
corresponding total dollar amount.
    A number of commenters generally supported this requirement to
report all fees and expenses paid by the private fund during the
reporting period on the quarterly statements.\245\ Some commenters
suggested that this requirement would be too costly or that existing
market practices make this requirement unnecessary.\246\
---------------------------------------------------------------------------

    \245\ See, e.g., OFT Comment Letter; Comment Letter of Meketa
Investment Group (Mar. 21, 2022) (``Meketa Comment Letter'');
Comment Letter of the Teacher Retirement System of Texas (Apr. 25,
2022) (``TRS Comment Letter'').
    \246\ See, e.g., AIC Comment Letter I; Dechert Comment Letter;
ATR Comment Letter.
---------------------------------------------------------------------------

    We have observed two general trends among private fund advisers
that support the rule's approach to adviser disclosure of fund fees and
expenses. First, we have observed certain advisers shift certain
expenses related to their advisory business to private fund
clients.\247\ For example, some advisers charge private fund clients
for salaries and benefits related to personnel of the adviser. Such
expenses have traditionally been paid by advisers with their management
fee proceeds or other revenue streams but are increasingly being
charged as separate fund expenses, in addition to the management fee,
and the full nature and extent of these expenses may not be clearly
disclosed and transparent to fund investors.\248\ Second, expenses have
risen significantly in recent years for certain private funds due to,
among other things, advisers' use of increasingly complex fund
structures, the expansion of global marketing and investment efforts by
advisers, and increased service provider costs.\249\ Advisers often
pass on such increases to the private funds they advise without
providing investors detailed disclosure about the magnitude and type of
expenses actually charged to, or directly or indirectly borne by, the
fund. Without this information, however, investors are less able to
effectively assess and monitor the costs of investing in private funds
managed by an adviser.
---------------------------------------------------------------------------

    \247\ See supra footnote 219 and accompanying text.
    \248\ See Key Findings ILPA Industry Intelligence Report, ``What
is Market in Fund Terms?'' (2021), at 18-19 (``ILPA Key Findings
Report''), available at https://ilpa.org/wp-content/uploads/2021/10/Key-Findings-Industry-Intelligence-Report-Fund-Terms.pdf (stating
that ``the importance of elevated transparency for [private fund
investors] related to fees and expenses'' is underscored by the
recent trend of ``cost shifting'' certain expenses traditionally
borne by private fund advisers to their private fund clients).
    \249\ See, e.g., id.; see also Coming to Terms: Private Equity
Investors Face Rising Costs, Extra Fees, Wall Street Journal (Dec.
20, 2021), available at https://www.wsj.com/articles/coming-to-terms-private-equity-investors-face-rising-costs-extra-fees-11640001604.
---------------------------------------------------------------------------

    Some commenters stated that we should allow advisers to group
smaller expenses generally into broad categories or disclose them as
``miscellaneous'' expenses.\250\ Other commenters requested that we
allow exemptions for de minimis amounts in the fee and expense section
of the quarterly statement.\251\ In contrast, one commenter suggested
that we specifically not permit advisers to exclude de minimis expenses
or group small expenses into broad categories.\252\ We are not allowing
advisers to exclude de minimis expenses, generally group small expenses
into broad categories, or label expenses as miscellaneous. Private fund
investors need detailed accounting of fees and expenses to understand
fully the costs of their private fund investments. If we were to allow
advisers to group small expenses generally into broad categories, they
might be able to obscure certain costs from investors, including those
that could raise conflict of interest issues. Similarly, advisers might
use a de minimis exception to avoid disclosing individual expenses
that, in aggregate, could be significant. These alternative approaches
would not provide private fund investors with sufficient detail to
assess and monitor whether that the private fund expenses borne by the
fund conform to contractual agreements and the private fund's terms.
---------------------------------------------------------------------------

    \250\ See, e.g., AIC Comment Letter II; Comment Letter of CFA
Institute (Apr. 25, 2022) (``CFA Comment Letter I''); IAA Comment
Letter II.
    \251\ See, e.g., AIC Comment Letter I; PIFF Comment Letter;
Ropes & Gray Comment Letter.
    \252\ See Convergence Comment Letter.
---------------------------------------------------------------------------

    As discussed above,\253\ some commenters suggested that section
211(h)(1) of the Act, which states that the Commission shall facilitate
the provision of simple and clear disclosures to investors regarding
the terms of their relationships with investment advisers, does not
authorize the rule's quarterly disclosure requirement with respect to
fund fees and expenses. These commenters generally asserted that
ongoing fund fee and expense reporting does not constitute disclosure
of the terms of the relationship between private fund investors and
private fund advisers for purposes of section 211(h)(1) of the Act and
that such terms are instead disclosed only at the outset of the
relationship between a private fund investor and a private fund
adviser; namely, in the terms set forth in a private fund's contractual
documents.\254\ Although we recognize that the methodology for
calculating fund fees and expenses is typically set forth in a fund's
contractual documents, as discussed above, investors must also receive
simple and clear disclosures of the actual fees and expenses borne by
their fund in order to be able to understand and confirm effectively
the

accuracy of the terms of their relationship with a private fund
adviser.
---------------------------------------------------------------------------

    \253\ See supra footnotes 166-169 and accompanying text.
    \254\ See, e.g., AIC Comment Letter I; NVCA Comment Letter;
Citadel Comment Letter.
---------------------------------------------------------------------------

    To the extent that a fund expense also could be characterized as
adviser compensation under the rule, the rule requires advisers to
disclose such payment or allocation as adviser compensation as opposed
to a fund expense in the quarterly statement. For example, certain
private funds may engage the adviser or its related persons to provide
non-advisory services to the fund, such as consulting, legal, or back-
office services. The rule requires advisers to disclose any
compensation, fees, or other amounts allocated or paid by the fund for
such services, whether advisory or non-advisory, as part of the
detailed accounting of adviser compensation. This approach will help
ensure that investors understand the entire amount of adviser
compensation allocated or paid to the adviser and its related persons
during the reporting period by the fund.
    Offsets, Rebates, and Waivers. We are requiring advisers to
disclose adviser compensation and fund expenses in the fund table both
before and after the application of any offsets, rebates, or
waivers.\255\ Specifically, the rule requires an adviser to present the
dollar amount of each category of adviser compensation or fund expense
\256\ before and after any such reduction for the reporting
period.\257\ In addition, the rule requires advisers to disclose the
amount of any offsets or rebates carried forward during the reporting
period to subsequent periods to reduce future adviser
compensation.\258\ We are adopting this portion of the rule as
proposed.
---------------------------------------------------------------------------

    \255\ Final rule 211(h)(1)-2(b).
    \256\ For example, an adviser must show any placement agent fees
or excess organizational expenses before and after any management
fee offset.
    \257\ Offsets, rebates, and waivers applicable to certain, but
not all, investors through one or more separate arrangements are
required to be reflected and described prominently in the fund-wide
numbers presented in the quarterly statement. See final rule
211(h)(1)-2(d) and (g). Advisers are not required to disclose the
identity of the subset of investors that receive such offsets,
rebates, or waivers.
    \258\ Final rule 211(h)(1)-2(b)(3).
---------------------------------------------------------------------------

    Advisers may offset, rebate, or waive adviser compensation or fund
expenses in a number of circumstances. For example, a private equity
adviser may enter into a management services agreement with a fund's
portfolio company, requiring the company to pay the adviser a fee for
those services. To the extent that the fund's governing agreement
requires the adviser to share the fee with the fund investors through
an offset to the management fee, the management fee would typically be
reduced, on a dollar-for-dollar basis, by an amount equal to the
fee.\259\ Under the final rule, the adviser would be required to list
the management fee both before and after the application of the fee
offset.
---------------------------------------------------------------------------

    \259\ The offset shifts some or all of the economic benefit of
the fee from the adviser to the private fund investors.
---------------------------------------------------------------------------

    Some commenters generally supported the requirement that advisers
disclose adviser compensation and fund expenses both before and after
the application of any offsets, rebates, or waivers.\260\ Some
commenters suggested that advisers should only be required to disclose
adviser compensation and fund expenses after the application of any
offsets, rebates, or waivers, because information regarding adviser
compensation and fund expenses before the application of any offsets,
rebates, or waivers does not reflect actual investor experience and
accordingly could confuse or be of little or no value to
investors.\261\ One commenter stated that we should consider excepting
de minimis offsets, rebates, or waivers from this requirement.\262\
---------------------------------------------------------------------------

    \260\ See, e.g., Morningstar Comment Letter; CFA Comment Letter
II; RFG Comment Letter II.
    \261\ See, e.g., IAA Comment Letter II; PIFF Comment Letter.
    \262\ See Ropes & Gray Comment Letter.
---------------------------------------------------------------------------

    We considered whether to require advisers to disclose adviser
compensation and fund expenses only after the application of offsets,
rebates, and waivers, rather than before and after. We recognize that
investors may find the reduced numbers more meaningful, given that they
generally reflect the actual amounts borne by the fund during the
reporting period. However, after considering comments, we believe that
presenting both figures will provide investors with greater
transparency into advisers' fee and expense practices, particularly
with respect to how offsets, rebates, and waivers affect adviser
compensation. Transparency into fee and expense practices is important,
even with respect to de minimis amounts, because it will assist
investors in monitoring their private fund investments and, for certain
investors, will ease their own efforts at complying with their
reporting obligations.\263\ Advisers should have this information
readily available, and both sets of figures will be helpful to
investors in monitoring whether and how offsets, rebates, and waivers
are applied.
---------------------------------------------------------------------------

    \263\ For example, certain investors, such as U.S. State pension
plans, may be required to report complete information regarding fees
and expenses paid to the adviser and its related persons. See LACERA
Comment Letter.
---------------------------------------------------------------------------

    In addition, we are requiring advisers to disclose the amount of
any offsets or rebates carried forward during the reporting period to
subsequent periods to reduce future adviser compensation.\264\ This
information will allow investors to understand whether they are or the
fund is entitled to additional reductions in future periods.\265\
Further, this information will assist investors with their liquidity
management and cash flow models, as they should have greater insight
into the fund's projected cash flows and their obligations to satisfy
future capital calls for adviser compensation with cash on hand.
---------------------------------------------------------------------------

    \264\ Final rule 211(h)(1)-2(b)(3).
    \265\ To the extent advisers are required to offset fund-level
compensation (e.g., management fees) by portfolio investment
compensation (e.g., monitoring fees), they typically do not reduce
adviser compensation below zero, meaning that, in the event the
monitoring fee offset amount exceeds the management fee for the
applicable period, some fund documents provide for ``carryforwards''
of the unused amount. The carryforwards are used to offset the
management fee in subsequent periods.
---------------------------------------------------------------------------

(b) Portfolio Investment-Level Disclosure
    The quarterly statement rule requires advisers to disclose a
detailed accounting of all portfolio investment compensation \266\
allocated or paid by each covered portfolio investment \267\ during the
reporting period in a single table. We proposed, but in response to
commenters are not adopting, a requirement that advisers disclose the
private fund's ownership percentage of each covered portfolio
investment. We discuss each of these aspects of the final rule below.
---------------------------------------------------------------------------

    \266\ See final rule 211(h)(1)-1 (defining ``portfolio
investment compensation'' as any compensation, fees, and other
amounts allocated or paid to the investment adviser or any of its
related persons by the portfolio investment attributable to the
private fund's interest in such portfolio investment).
    \267\ See final rule 211(h)(1)-1 (defining ``covered portfolio
investment'' as a portfolio investment that allocated or paid the
investment adviser or its related persons portfolio investment
compensation during the reporting period).
---------------------------------------------------------------------------

    The rule defines ``portfolio investment'' as any entity or issuer
in which the private fund has invested directly or indirectly, as
proposed.\268\ This definition is designed to capture any entity or
issuer in which the private fund holds an investment, including through
holding companies, subsidiaries, acquisition vehicles, special purpose
vehicles, and other vehicles through which investments are made or
otherwise held by the private

fund.\269\ As a result, the definition may capture more than one entity
or issuer with respect to any single investment made by a private fund.
For example, if a private fund invests directly in a holding company
that owns two subsidiaries, this definition captures all three
entities.
---------------------------------------------------------------------------

    \268\ Final rule 211(h)(1)-1.
    \269\ Certain investment strategies can involve complex
transactions and the use of negotiated instruments or contracts,
such as derivatives, with counterparties. Although such trading
involves a risk that a counterparty will not settle a transaction or
otherwise fail to perform its obligations under the instrument or
contract and thus result in losses to the fund, we would generally
not consider the fund to have made an investment in the counterparty
in this context. This approach is appropriate because any gain or
loss from the investment generally would be tied to the performance
of the derivative and the underlying reference security, rather than
the performance of the counterparty.
---------------------------------------------------------------------------

    One commenter supported the proposed definition of ``portfolio
investment.'' \270\ Other commenters proposed alternative definitions,
such as to broaden the definition to cover broken deal expenses \271\
or to narrow the definition to refer only to an issuer of securities in
which the private fund has directly invested.\272\ One commenter
suggested limiting the definition of ``covered portfolio investment''
to portfolio investments over which the adviser has ``discretion or
substantial influence'' to compensate the adviser or its related
persons.\273\
---------------------------------------------------------------------------

    \270\ See Convergence Comment Letter.
    \271\ See CFA Comment Letter II (observing that the proposed
definition would not cover broken deal expenses). We understand that
broken deal fees are often associated with situations in which
ownership of a potential portfolio investment is in flux. Because
the definition of ``portfolio investment'' under the rule includes
only entities or issuers in which a private fund has invested
(whether directly or indirectly), the rule's portfolio investment
compensation requirements would not generally apply to compensation,
such as a broken deal fee, from only a potential portfolio
investment. A broken deal fee from an unconsummated portfolio
investment transaction would thus generally not constitute portfolio
investment compensation under the rule, which instead defines
``portfolio investment'' and ``portfolio investment compensation''
to broadly cover compensation that could reduce the value of a
private fund's assets. However, to the extent that a fund bears a
broken deal expense, rule 211(h)(1)-2(b)(2) will require its
disclosure as a fund fee or expense. Because this information will
thus be reported as a fund fee or expense under the rule whenever a
fund's assets are actually reduced by broken deal expenses, we
believe it is unnecessary to also require disclosure of this
information as a type of portfolio investment compensation through
changes to the definition of ``portfolio investment'' under the
rule.
    \272\ See AIMA/ACC Comment Letter.
    \273\ See PIFF Comment Letter; cf. infra footnote 287.
---------------------------------------------------------------------------

    Many commenters discussed how the proposed definitions of
``portfolio investment'' and ``covered portfolio investment'' would
impact advisers to funds of funds. Some commenters suggested that we
exclude from these definitions funds of funds and other pooled vehicles
that invest indirectly through underlying funds or unaffiliated
structures.\274\ In contrast, another commenter stated that we should
not exempt funds of funds because advisers to funds of funds should be
able to provide the required information.\275\ Despite commenter
concerns, we are adopting these definitions as proposed in order to
capture, and improve investor transparency into, portfolio investment
compensation arrangements that pose potential or actual conflicts of
interest for the adviser, without exception for advisers of fund of
funds. A fund of funds adviser should be in a position to determine
whether an entity paying the adviser, or a related person, is a
portfolio investment of the fund of funds under the final rule. For
example, the fund of funds adviser can request information from the
payor regarding whether certain underlying funds hold an investment in
the payor. The fund of funds adviser can also request a list of
investments from the underlying funds to determine whether any of those
underlying portfolio investments have a business relationship with the
adviser or its related persons. However, we recognize that, despite
their best efforts, certain fund of funds advisers may lack information
or may not be given information in respect of underlying entities, and
depending on a private fund's underlying investment structure, a fund
of funds adviser may have to rely on good faith belief to determine
which entity or entities constitute a portfolio investment under the
rule. An adviser may consider documenting this determination, as well
as its initial and ongoing diligence efforts to determine whether a
portfolio investment has compensated the adviser or its related
persons, in its records.
---------------------------------------------------------------------------

    \274\ See AIC Comment Letter I; PIFF Comment Letter.
    \275\ See Convergence Comment Letter.
---------------------------------------------------------------------------

    We recognize that portfolio investments of certain private funds
may not pay or allocate portfolio investment compensation to an adviser
or its related persons. For example, advisers to hedge funds focusing
on passive investments in public companies may be less likely to
receive portfolio investment compensation than advisers to private
equity funds focusing on control-oriented investments in private
companies. Under the final rule, advisers are required to disclose
information regarding only covered portfolio investments, which are
defined as portfolio investments that allocated or paid the investment
adviser or its related persons portfolio investment compensation during
the reporting period, as proposed.\276\ We believe this approach is
appropriate because the portfolio investment table is designed to
highlight the scope and magnitude of any investment-level compensation
and to improve transparency for investors into the potential and actual
conflicts of interest of the adviser and its related persons. If an
adviser or its related person does not receive investment-level
compensation under the final definition of covered portfolio
investment, the adviser will not have a related disclosure obligation
under the rule. Accordingly, the rule does not require advisers to list
any information regarding portfolio investments that do not fall within
the covered portfolio investment definition for the applicable
reporting period. These advisers, however, need to identify portfolio
investment payments and allocations in order to determine whether they
must provide the disclosures under this requirement.
---------------------------------------------------------------------------

    \276\ See final rule 211(h)(1)-1 (defining ``covered portfolio
investment'').
---------------------------------------------------------------------------

    Portfolio Investment Compensation. The rule requires the portfolio
investment table to show a detailed accounting of all portfolio
investment compensation allocated or paid by each covered portfolio
investment during the reporting period, with separate line items for
each category of allocation or payment reflecting the total dollar
amount, including, but not limited to, origination, management,
consulting, monitoring, servicing, transaction, administrative,
advisory, closing, disposition, directors, trustees or similar fees or
payments by the covered portfolio investment to the investment adviser
or any of its related persons. An adviser should generally disclose the
identity of each covered portfolio investment to the extent necessary
for an investor to understand the nature of the potential or actual
conflicts associated with such payments.
    Similar to the approach taken with respect to adviser compensation
and fund expenses discussed above, the rule requires a detailed
accounting of all portfolio investment compensation paid or allocated
to the adviser and its related persons.\277\ This will require advisers
to list as a separate line item each category of portfolio investment

compensation \278\ and the corresponding total dollar amount.
---------------------------------------------------------------------------

    \277\ Because advisers often use separate legal entities to
conduct a single advisory business, the rule will capture portfolio
investment compensation paid to an adviser's related persons.
    \278\ This includes cash or non-cash compensation, including,
for example, stock, options, and warrants.
---------------------------------------------------------------------------

    The rule requires advisers to disclose the amount of portfolio
investment compensation attributable to a private fund's interest in a
covered portfolio investment.\279\ Such amount should not reflect the
portion attributable to any other person's interest in the covered
portfolio investment. For example, if the private fund and another
person co-invested in the same portfolio investment and the portfolio
investment paid the private fund's adviser a monitoring fee, the table
would list the total dollar amount of the monitoring fee attributable
only to the fund's interest in the portfolio investment. In addition to
the required disclosure under the rule relating to the fund's interest
in the portfolio investment, advisers may, but are not required to,
list the portion of the fee attributable to any other person's interest
in the portfolio investment. This approach is appropriate because it
will reflect the amount borne by the fund and, by extension, the
investors. This will be meaningful information for investors because
the amount attributable to the fund's interest generally reduces the
value of investors' indirect interest in the portfolio investment.\280\
---------------------------------------------------------------------------

    \279\ See final rule 211(h)(1)-1 (defining ``portfolio
investment compensation'').
    \280\ This information should be meaningful for investors
regardless of whether the private fund has an equity ownership
interest or another kind of interest in the covered portfolio
investment. For example, if a private fund's interest in a covered
portfolio investment is represented by a debt instrument, the amount
of portfolio-investment compensation paid or allocated to the
adviser may hinder or prevent the covered portfolio investment from
satisfying its obligations to the fund under the debt instrument.
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    Similar to the approach discussed above with respect to adviser
compensation and fund expenses, an adviser is required to list the
amount of portfolio investment compensation allocated or paid with
respect to each covered portfolio investment both before and after the
application of any offsets, rebates, or waivers. This will require an
adviser to present the aggregate dollar amount attributable to the
fund's interest before and after any such reduction for the reporting
period. Advisers will be required to disclose the amount of any
portfolio investment compensation that they initially charge and the
amount that they ultimately retain at the expense of the private fund
and its investors.
    We continue to believe that this approach is appropriate given that
portfolio investment compensation can take many different forms and
often varies based on fund type. For example, portfolio investments of
private credit funds may pay the adviser a servicing fee for managing a
pool of loans held directly or indirectly by the fund. Portfolio
investments of private real estate funds may pay the adviser a property
management fee or a mortgage-servicing fee for managing the real estate
investments held directly or indirectly by the fund.
    This disclosure will help inform investors about the scope of
portfolio investment compensation allocated or paid to the adviser and
related persons and provide insight to investors into the nature of
some of the potential or actual conflicts of interest their private
fund advisers face. For example, in cases where an adviser controls a
fund's portfolio investment, the adviser also generally has discretion
over whether to charge portfolio investment compensation and, if so,
the rate, timing, method, amount, and recipient of such compensation.
Additionally, where the private fund's governing documents require the
adviser to offset portfolio investment compensation against other
revenue streams or otherwise provide a rebate to investors, this
information will help investors monitor the application of such offsets
or rebates.
    As with adviser compensation and fund expenses, this approach
should provide investors with sufficient detail to validate that
portfolio investment compensation borne by the fund conforms to
contractual agreements.
    Some commenters supported this portfolio investment compensation
reporting requirement, stating that it will increase transparency.\281\
Other commenters suggested that this requirement will be overly
burdensome or unnecessary.\282\ Some commenters similarly suggested
that this portfolio investment compensation disclosure requirement will
be overly broad in its application, as described below.\283\ One
commenter stated that each private fund is itself a ``related person''
of the adviser, so any amounts paid to a fund (e.g., dividends on
equity investments or interest and fees on debt investments) would be
reportable under the rule as drafted, even though the fund's investors
receive 100% of the benefit.\284\ Another commenter requested that we
clarify that the definition of ``portfolio investment compensation''
excludes fund-level fees and other compensation paid by a subsidiary of
the fund in accordance with the fund's governing documents.\285\
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    \281\ See, e.g., OFT Comment Letter; LACERA Comment Letter; XTP
Comment Letter.
    \282\ See, e.g., AIC Comment Letter I; Comment Letter of the
Goldman Sachs Group, Inc. (Apr. 25, 2022) (``Goldman Comment
Letter''); IAA Comment Letter II.
    \283\ See, e.g., MFA Comment Letter I; PIFF Comment Letter.
    \284\ See MFA Comment Letter I.
    \285\ See PIFF Comment Letter. This commenter also suggested
that including adviser compensation paid by a subsidiary of the fund
as portfolio investment compensation will result in duplicate
disclosure of these compensation amounts. To the extent that a
subsidiary of the fund compensates the investment adviser on behalf
of the fund, whether such compensation amounts should be disclosed
in the fund table or the portfolio-investment table will depend on
the facts and circumstances and, in particular, whether the
subsidiary is an entity or issuer in which the fund has invested
(i.e., a portfolio investment). However, such compensation amounts
would not need to be disclosed twice (unless the adviser discloses
such compensation amounts before and after the application of any
offsets, rebates, or waivers, if applicable).
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    To clarify, this portfolio investment compensation disclosure
requirement does not include distributions representing profit or
return of capital to the fund, in each case, in respect of the fund's
ownership or other interest in a portfolio investment (e.g.,
dividends). This disclosure requirement is intended generally to
capture potentially or actually conflicted compensation arrangements
where the fund's interest in a portfolio investment may be negatively
impacted by that portfolio investment's allocation or payment of
portfolio investment compensation to the fund's adviser or its related
persons, such as when an adviser or its related person charges a
monitoring fee to a portfolio investment of a fund it advises,
including when such charges are made in accordance with the fund's
governing documents. Although investors may contractually agree, per a
fund's governing documents and with appropriate initial disclosure, to
an adviser's ability to receive portfolio investment compensation,
investors may be misled with respect to the magnitude and scope of such
compensation to the extent that an adviser does not disclose
information relating to the total dollar amount of such compensation
after the fact.
    The rule requires an adviser to include the portfolio investment
compensation paid to a related person, including, without limitation, a
related person that is a sub-adviser, in its quarterly statement.
Because portfolio investment compensation to related sub-advisers
presents the same conflicts of interest concerns discussed above with
respect to portfolio investment compensation to advisers, the portfolio
investment compensation disclosure requirements under the rule extends
to portfolio investment compensation to an

adviser or any of its related persons, including a related sub-adviser,
as proposed.
    Some commenters stated that we should require only aggregate
portfolio investment-level disclosure and not each instance of
portfolio investment compensation in order to provide more helpful
information to investors, reduce costs and compliance burdens for
advisers, or to avoid potentially causing portfolio companies to
decline private fund investments.\286\ Although we recognize that it
could be simpler or less burdensome for certain advisers to provide
aggregate information, it is important that investors are made aware of
each instance of portfolio investment compensation to the adviser.
Investors should be able to analyze each such instance and raise any
potential concerns about these compensation schemes with the adviser.
Aggregated information could provide investors with a sense of the
magnitude of such compensation schemes, but investors may not be able
to understand the nature and scope of the conflicts associated with
portfolio investment compensation to the adviser.
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    \286\ See, e.g., PIFF Comment Letter; CFA Comment Letter I;
Goldman Comment Letter.
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    Several commenters stated that the requirement to disclose
portfolio investment compensation should be limited to circumstances in
which an adviser has the discretion or authority to cause a portfolio
investment to compensate the adviser or its related persons, as those
are the circumstances in which conflicts of interest would arise.\287\
In contrast, another commenter supported our proposed approach and
stated that advisers should be required to report portfolio investment
compensation regardless of whether they have such discretion or
authority over a portfolio investment.\288\ Other commenters suggested
that the portfolio investment compensation disclosure requirement
should exclude portfolio investment compensation to an adviser's
related persons that are operationally and otherwise independent of the
adviser, stating that some advisers have related persons who negotiate
with advisers or their affiliates on an arm's-length basis and would
not represent their interests when negotiating with a portfolio
investment.\289\ Although we understand that conflicts of interest
issues are heightened when an adviser has the discretion or authority
to control a portfolio investment (and in the context of portfolio
investment compensation to a related person, to control such related
person), we recognize that potential or actual conflicts of interest
are not limited to scenarios where an adviser has such control and may
arise, for instance, where an adviser does not have control but has
substantial influence over a portfolio investment (or in the context of
portfolio investment compensation to a related person, over such
related person) and the portfolio investment is compensating the
adviser or its related persons.\290\ As a result, we believe that it is
necessary to provide investors with comprehensive information regarding
payments of portfolio investment compensation allocated or paid to an
adviser or its related person, without limitation to circumstances in
which an adviser has discretion or authority over the portfolio
investment (or over the related person, as applicable).
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    \287\ See, e.g., AIMA/ACC Comment Letter; SIFMA-AMG Comment
Letter I; SBAI Comment Letter; see also supra footnote 273.
    \288\ See Convergence Comment Letter.
    \289\ See, e.g., AIC Comment Letter I; Goldman Comment Letter.
    \290\ An adviser may be subject to a potential or actual
conflict of interest arising out of its substantial influence over a
portfolio investment, for example, if a fund it advises owns a
sizeable but non-controlling share of the investment or if the
portfolio investment is otherwise dependent on the adviser to
operate its business. More broadly, we have recognized that an
adviser is generally subject to a potential or actual conflict of
interest with an advisory client when it has a conflicting interest
that ``might incline [the] investment adviser--consciously or
unconsciously--to render advice which was not disinterested.'' IA
Fiduciary Duty Release, supra footnote 58, at 23.
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    Some commenters raised concerns about potential confidentiality
issues if advisers are required to disclose the names of portfolio
investments as part of this portfolio investment compensation
disclosure.\291\ Although we appreciate these confidentiality concerns,
we believe that many investors may likely already know the names of the
fund's portfolio investments. Even if investors do not know this
information, investors are typically subject to contractual obligations
to maintain the confidentiality of this information. Further, as stated
above, advisers should generally disclose the identity of each covered
portfolio investment to the extent necessary for an investor to
understand the nature of the potential or actual conflicts associated
with such payments. To the extent the identity of any covered portfolio
investment is not necessary for an investor to understand the nature of
the conflict, advisers may use consistent code names (e.g., ``portfolio
investment A'').
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    \291\ See, e.g., PIFF Comment Letter; AIMA/ACC Comment Letter.
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    Ownership Percentage. We proposed but are not adopting a
requirement that the portfolio investment table include a list of the
fund's ownership percentage of each covered portfolio investment. At
proposal, we stated that we believed this information would provide
investors with helpful context for the amount of portfolio investment
compensation paid or allocated to the adviser or its related persons
relative to the fund's ownership. For example, if portfolio investment
compensation is calculated based on the portfolio investment's total
enterprise value, then investors would be able to compare the amount of
portfolio investment compensation relative to the fund's ownership
percentage.
    One commenter indicated that these ownership percentages would not
be helpful for investors in practice.\292\ Another commenter stated
that calculating and recording ownership percentages of portfolio
investments would be onerous and costly.\293\ Another commenter
suggested that we should require advisers to disclose these ownership
percentages only if the adviser has discretion or substantial influence
to cause the accompanying portfolio investment compensation to be paid
to the adviser.\294\ In contrast, one commenter suggested expanding the
ownership percentage disclosure obligation to cover any economic right,
interest, or benefit that the fund has in a company.\295\ Although we
maintain that these ownership percentages might provide illustrative
information for investors in certain circumstances, like the one noted
above, we recognize that they might be misleading or unhelpful in other
cases. For instance, if a fund owns voting stock in a company with a
significant amount of non-voting stock, then the ownership percentage
might appear low relative to the amount of control that the fund's
adviser actually exerts. Similarly, if a fund owns only a debt interest
in a portfolio investment, its ownership percentage would be
represented as zero even if the debt interest is substantial enough
that the fund's adviser can exact some sort of compensation for itself.
We do not want investors to misestimate the degree to which advisers
are able to influence portfolio investments to provide compensation.