client, the disclosure must be clear and detailed enough for the client
to make an informed decision to consent to the conflict of interest or
reject it. Accordingly, while the fiduciary duty itself applies to all
clients of an adviser, the application of the fiduciary duty of an
adviser to a retail client can be different from the specific
application of the fiduciary duty of an adviser to a registered
investment company or private fund.\779\ Whether contractual clauses
that purport to limit an adviser's liability (also known as ``hedge
clauses'' or ``waiver clauses'') in an agreement with an institutional
client (e.g., private fund) would violate the Advisers Act's antifraud
provisions will be determined based on the particular facts and
circumstances.\780\ To the extent that a hedge clause creates a
conflict of interest between an adviser and its client, the adviser
must address the conflict as required by its duty of loyalty.
---------------------------------------------------------------------------

    \777\ See 2019 IA Fiduciary Duty Interpretation, supra footnote
558, at section I (reaffirming and clarifying the fiduciary duty
that an adviser owes to its clients under section 206 of the
Advisers Act).
    \778\ See id. and accompanying text.
    \779\ See 2019 IA Fiduciary Duty Interpretation, supra footnote
5, at n.87. See also In the Matter of Comprehensive Capital
Management, Inc., Investment Advisers Act Release No. 5943 (Jan. 11,
2022) (settled action) (alleging adviser included in its investment
advisory agreement liability disclaimer language (i.e., a hedge
clause), which could lead a client to believe incorrectly that the
client had waived a non-waivable cause of action against the adviser
provided by State or Federal law. Most, if not all, of the adviser's
clients were retail investors.).
    \780\ See 2019 IA Fiduciary Duty Interpretation, supra footnote
5, at n.31 (discussing the now-withdrawn Heitman no-action letter
that analyzed an indemnification provision in an institutional
client's investment management agreement).
---------------------------------------------------------------------------

    After considering comments on the waiver or indemnification
prohibition, we provide the following examples, partly based on staff
observations, of how this interpretation applies to certain facts and
circumstances. We have taken the position that an adviser violates the
antifraud provisions of the

Advisers Act, for example, when (i) there is a contract provision
waiving any and all of the adviser's fiduciary duties or (ii) there is
a contract provision explicitly or generically waiving the adviser's
Federal fiduciary duty, and in each case there is no language
clarifying that the adviser is not waiving its Federal fiduciary duty
or that the client retains certain non-waivable rights (also known as a
``savings clause'').\781\ A breach of the Federal fiduciary duty may
involve conduct that is intentional, reckless, or negligent.\782\
Finally, we believe that an adviser may not seek reimbursement,
indemnification, or exculpation for breaching its Federal fiduciary
duty because such reimbursement, indemnification, or exculpation would
operate effectively as a waiver, which would be invalid under the
Act.\783\
---------------------------------------------------------------------------

    \781\ In the Matter of Comprehensive Capital Management.,
Investment Advisers Act Release No. 5943 (Jan. 11, 2022) (settled
action). Also, we note that our staff has expressed the view that it
would violate the antifraud provisions of the Advisers Act for an
adviser to enter into a limited partnership agreement stating that
the adviser to the private fund or its related person, which is the
general partner of the fund, to the maximum extent permitted by
applicable law, will not be subject to any duties or standards
(including fiduciary or similar duties or standards) existing under
the Advisers Act or that the adviser can receive indemnification or
exculpation for breaching its Federal fiduciary duty. See, e.g.,
EXAMS Risk Alert: Observations from Examinations of Private Fund
Advisers (Jan. 27, 2022), at 5 (discussing hedge clauses).),
available at https://www.sec.gov/files/private-fund-risk-alert-pt-2.pdf. See also Comment Letter of the Institutional Limited Partners
Association on the Proposed Commission Interpretation Regarding
Standard of Conduct for Investment Advisers; Request for Comment on
Enhancing Investment Adviser Regulation (Aug. 6, 2018) at 6,
available at https://ilpa.org/wp-content/uploads/2018/08/ILPA-Comment-Letter-on-SEC-Proposed-Fiduciary-Duty-Interpretation-August-6-2018.pdf.
    \782\ See, e.g., 2019 IA Fiduciary Duty Interpretation, supra
footnote 5, at n.20 (explaining that claims arising under Section
206(1) of the Advisers Act require a showing of scienter but claims
under Section 206(2) of the Advisers Act are not scienter based and
can be adequately pled with only a showing of negligence).
    \783\ See supra section II.E.2.a) (Investigation Expenses)
(stating that charging fees and expenses related to a breach of an
adviser's Federal fiduciary duty to a private fund would effectively
operate as a waiver of such duty, which would be invalid under the
Act).
---------------------------------------------------------------------------

    We continue to not take a position on the scope or substance of any
fiduciary duty that applies to an adviser under applicable State
law.\784\ However, to the extent that a waiver clause is unclear as to
whether it applies to the Federal fiduciary duty, State fiduciary
duties, or both, we will interpret the clause as waiving the Federal
fiduciary duty.
---------------------------------------------------------------------------

    \784\ See 2019 IA Fiduciary Duty Interpretation, supra footnote
558.
---------------------------------------------------------------------------

G. Preferential Treatment

    We proposed to prohibit all private fund advisers, regardless of
whether they are registered with the Commission, from: (i) granting an
investor in a private fund or in a substantially similar pool of assets
the ability to redeem its interest on terms that the adviser reasonably
expects to have a material, negative effect on other investors in that
private fund or in a substantially similar pool of assets and (ii)
providing information regarding portfolio holdings or exposures of a
private fund or of a substantially similar pool of assets to any
investor if the adviser reasonably expects that providing the
information would have a material, negative effect on other investors
in that private fund or in a substantially similar pool of assets.\785\
We also proposed to prohibit these advisers from providing any other
preferential treatment to any investor in the private fund unless the
adviser delivers certain written disclosures to prospective and current
investors regarding all preferential treatment the adviser or its
related persons provide to other investors in the same fund.\786\ The
timing of the proposed rule's delivery requirements differed depending
on whether the recipient is a prospective or existing investor in the
private fund. For a prospective investor, the proposed rule required
the adviser to deliver the notice prior to the investor's investment.
For an existing investor, the notice was required to be delivered
annually, to the extent the adviser provided preferential treatment to
other investors since the last notice.
---------------------------------------------------------------------------

    \785\ Proposed rules 211(h)(2)-3(a)(1) and (2).
    \786\ Proposed rule 211(h)(2)-3(b).
---------------------------------------------------------------------------

    Some commenters supported the proposed rule.\787\ Some of these
commenters stated that the rule would benefit investors by increasing
transparency for all investors about the terms offered to other
investors \788\ and by ensuring that investors have the requisite
information to determine whether they are being harmed by agreements
between the adviser and other investors.\789\ Some commenters opposed
the proposed rule.\790\ Some commenters, including fund investors,
expressed concern that it would curtail their ability to enter into
side letters because advisers may refuse to offer certain
provisions.\791\ One commenter noted that this could negatively impact
smaller investors because they would not be able to ``piggy back'' off
of certain provisions negotiated by larger investors.\792\ Some
commenters also expressed concern that requiring advisers to determine
whether a provision has a material, negative effect on other investors
may cause advisers to assert regulatory risk as a way to justify the
adviser's rejection of fund terms required by applicable law, rule, or
regulation for public pension funds.\793\
---------------------------------------------------------------------------

    \787\ See, e.g., Meketa Comment Letter; Albourne Comment Letter;
NEBF Comment Letter; ILPA Comment Letter I; American Association for
Justice Comment Letter; AFSCME Comment Letter; Segal Marco Comment
Letter; Pathway Comment Letter.
    \788\ See AFSCME Comment Letter; American Association for
Justice Comment Letter.
    \789\ See United for Respect Comment Letter I; Healthy Markets
Comment Letter I.
    \790\ See AIC Comment Letter I; CCMR Comment Letter II; NYC Bar
Comment Letter II; IAA Comment Letter II; ICM Comment Letter;
Dechert Comment Letter; Comment Letter of Tech Council Ventures
(June 14, 2022); Proof Comment Letter; NVCA Comment Letter; Canada
Pension Comment Letter.
    \791\ See NYC Comptroller Comment Letter; NY State Comptroller
Comment Letter; Thin Line Capital Comment Letter; OPERS Comment
Letter.
    \792\ See Ropes & Gray Comment Letter.
    \793\ See NY State Comptroller Comment Letter; OPERS Comment
Letter; SIFMA-AMG Comment Letter I.
---------------------------------------------------------------------------

    After considering comments, we are adopting the preferential
treatment rule in a modified form.\794\ First, we are adopting the
prohibition on certain preferential redemption rights partly as
proposed, but with two exceptions: (i) for redemptions required by
applicable law, rule, regulation, or order of certain governmental
authorities and (ii) if the adviser has offered the same redemption
ability to all existing investors and will continue to offer the same
redemption ability to all future investors in the private fund or
similar pool of assets. These exceptions are designed to address
commenters' concerns that the rule would curtail their ability to
secure important side letter provisions, especially ones required by
applicable law. We also believe that the exception for terms offered to
all investors will continue to allow smaller investors to benefit from
rights negotiated by larger investors, such as different share classes
offering different redemption terms. Second, we are adopting the
prohibition on preferential information rights about portfolio holdings
or exposures, but with an exception where the adviser offers such
information to all other existing investors in the private fund and any
similar pool of assets at the same time or substantially the same time.
In response to commenters, this exception should allow advisers to
discuss their portfolio holdings during investor meetings so long as
all investors have access to the same information. Third, we are
limiting the advance written notice requirement to prospective
investors to apply only to

material economic terms. We are still requiring advisers to provide to
current investors comprehensive, annual disclosure of all preferential
treatment provided by the adviser or its related persons since the last
annual notice.
---------------------------------------------------------------------------

    \794\ Final rule 211(h)(2)-3.
---------------------------------------------------------------------------

    However, in a change from the proposal, the final rule requires the
adviser to distribute to current investors a written notice of all
preferential treatment the adviser or its related persons has provided
to other investors in the same private fund (i) for an illiquid fund,
as soon as reasonably practicable following the end of the fund's
fundraising period and (ii) for a liquid fund, as soon as reasonably
practicable following the investor's investment in the private fund.
Fourth, we are changing the defined term ``substantially similar pool
of assets'' to ``similar pool of assets'' as used throughout the
preferential treatment rule so that the term better reflects the
breadth of the definition. Fifth, we are revising the rule text to
apply the disclosure obligations in final rule 211(h)(2)-3(b) to all
preferential treatment, including any preferential treatment granted in
accordance with final rule 211(h)(2)-3(a). We discuss each of these
changes and provisions below.
    Under section 211(h)(2) of the Advisers Act, the Commission shall
examine and, where appropriate, promulgate rules prohibiting or
restricting certain sales practices, conflicts of interest, and
compensation schemes for investment advisers that the Commission deems
contrary to the public interest and the protection of investors. Our
staff has examined private fund advisers to assess both the investor
protection risks presented by their business models in terms of
compensation schemes, conflicts of interest, and sales practices and
the firms' compliance with their existing legal obligations. As
discussed below, the Commission deems granting preferential treatment a
sales practice and conflict of interest under section 211(h)(2), that
is contrary to the public interest and the protection of investors and
is restricting the practice and conflict by (i) prohibiting investment
advisers from providing certain preferential treatment that the adviser
reasonably expects to have a material negative effect on other
investors and (ii) requiring investment advisers to disclose any other
preferential treatment to prospective and current investors. We believe
these activities give advisers an incentive to place their interests
ahead of their clients' (and, by extension, their investors'), and can
result in private funds and their investors, particularly smaller
investors that are not able to negotiate preferential deals with the
adviser and its related persons, being misled, deceived, or otherwise
harmed.
    Granting preferential treatment is a conflict of interest because
advisers have economic and/or other business incentives to provide
preferential terms to one or more investors (e.g., based on the size of
the investor's investment, the ability of the investor to provide
services to the adviser, or the potential to establish or cultivate
relationships that have the potential to provide benefits to the
adviser). These incentives have the potential to cause the adviser to
provide preferential terms to one or more investors that harm other
investors or otherwise put the other investors at a disadvantage. For
example, an adviser may agree to waive all or part of the
confidentiality obligation set forth in the private fund's governing
agreement for one investor. Such a waiver has the potential to harm
other investors because proprietary information may be made available
to third parties, such as competitors of the private fund, which could
negatively affect the fund's competitive advantage in, for example,
seeking and securing investments. There may be cases where preferential
information may be reasonably expected to have a material, negative
effect on other investors in the fund even when the preferred investor
does not have the ability to redeem its interest in the fund, and so
whether preferential information violates the final rule requires a
facts and circumstances analysis. For example, a private fund may make
an investment into an asset with certain trading restrictions, and then
later receive notice that the investment is underperforming. If the
private fund gives that information to a preferred investor before
others, the preferred investor could front-run other investors in
taking a (possibly synthetic) short position against the asset, driving
its price down, and causing losses to other investors in the fund. An
adviser could also operate multiple funds with overlapping investments
but offer redemption rights only for one fund containing its preferred
investors. An adviser granting preferential information to certain
investors in its less liquid fund, which those preferred investors
could use to redeem their interests in the more liquid fund, could harm
the investors in the less liquid fund even though the preferred
investors do not have redemption rights in the less liquid fund.
    Granting preferential treatment also involves a sales practice
under section 211(h)(2) of the Advisers Act. Advisers typically attract
preferred, strategic, or large investors to invest in the fund by
offering preferential terms as part of negotiating with those
investors. The adviser typically enters into a separate agreement,
commonly referred to as a ``side letter,'' with the particular investor
in connection with such investor's admission to a fund. Side letters
have the effect of establishing rights, benefits, or privileges under,
or altering the terms of, the private fund's governing agreement, which
advisers offer to certain prospective investors to secure their
investments in the private fund. Because advisers induce investors to
invest in the private fund based on those rights, benefits, or
privileges, the practice of granting preferential treatment is a sales
practice under section 211(h)(2).
    The practice of granting certain preferential treatment (or, in
some cases, granting preferential treatment without sufficient
disclosure) is contrary to the public interest and the protection of
investors because it can harm, mislead, or deceive other investors. For
example, to the extent an investor has negotiated limitations on its
indemnification obligations, other investors may be required to bear an
increased portion of indemnification costs. As another example, to the
extent an investor negotiates to limit its participation in a
particular investment, the aggregate returns realized by other
investors could be more adversely affected than otherwise by the
unfavorable performance of such investment. Moreover, other investors
will have a larger position in such investment and, as a result, their
holdings will be less diversified.
    Like the proposed rule, the final rule includes a prohibitions
component and a disclosure component that address activity across the
spectrum of preferential treatment. We recognize that advisers provide
a range of preferential treatment, some of which does not necessarily
have a material, negative effect on other fund investors. In this case,
we believe that disclosure effectively addresses our concerns related
to this practice because transparency will provide investors with
helpful information they otherwise may not receive. Investors can use
this information to protect their interests, including through
negotiations regarding new investments and re-negotiations regarding
existing investments, and make more informed business decisions. For
example, an investor could seek to limit its liability or otherwise
negotiate an expense cap if it knows that other investors have been
granted similar rights by the adviser. In

addition to informing current decisions, investors can use this
information to inform future investment decisions, including how to
invest other assets in their portfolio, whether to invest in private
funds managed by the adviser or its related persons in the future, and,
for a liquid fund, whether to redeem or remain invested in the private
fund. We are concerned that an adviser's current sales practices often
do not provide all investors with sufficient detail regarding
preferential terms granted to other investors so that these investors
can protect their interests and make informed decisions. We believe
that disclosure of preferential treatment is necessary to guard against
deceptive practices because it will ensure that investors have access
to information necessary to diligence the prospective investment and
better understand whether, and how, such terms affect the private fund
overall.
    Other types of preferential treatment, however, have a material,
negative effect on other fund investors or investors in a similar pool
of assets. We are prohibiting these types of preferential treatment
because they involve sales practices and conflicts of interest that are
contrary to the public interest and protection of investors. These
practices are contrary to the public interest because they have the
potential to harm private funds and their investors, which include,
among other investors, public and private pension plans, educational
endowments, non-profit organizations, and high net worth individuals.
\795\ In addition, these practices are further contrary to the
protection of investors to the extent that advisers stand to profit
from advantaging a subset of investors over the broader group of
investors. For example, in granting preferential terms to large
investors as a way of inducing their investment in the fund, the
adviser stands to benefit because its fees increase as fund assets
under management increase. Further, in negotiating preferential terms
with prospective investors, the interests of the adviser are not
necessarily aligned with those of the fund or the fund's existing
investors. This results in a conflict between the adviser's interests
in seeking to secure the investment, on the one hand, and the interests
of the fund (and its investors) to help ensure that the terms provided
to a prospective investor do not harm the fund or its existing
investors, on the other hand.
---------------------------------------------------------------------------

    \795\ See supra section I (discussing pension plan assets
invested in private funds).
---------------------------------------------------------------------------

    Section 206(4) of the Advisers Act also authorizes the Commission
to adopt rules and regulations that ``define, and prescribe means
reasonably designed to prevent, such acts, practices, and courses of
business as are fraudulent, deceptive, or manipulative.'' \796\ We have
observed instances of advisers granting preferential treatment to an
investor or a group of investors in a way that directly favors the
adviser's interest or seeks to win favor with the preferred investor in
hopes of inducing the preferred investor to take a certain action
desired by the adviser to the detriment of other investors.\797\ For
example, we have charged an adviser for engaging in fraud by secretly
offering certain investors preferential redemption and liquidity rights
in exchange for those investors' agreement to vote in favor of
restricting the redemption rights of the fund's other investors and by
concealing this arrangement from the fund's directors and other
investors.\798\ We have also charged an adviser for engaging in fraud
by contravening the fund's governing documents regarding liquidation
and allowing preferred investors to exit the fund at the then current
fair value in exchange for an agreement to invest in a similar fund
offered by the adviser.\799\ In another example, we have charged an
adviser for engaging in fraud by improperly failing to write down the
value of a hedge fund's private placement investments, even after some
of those companies had declared bankruptcy, while simultaneously
allowing certain investors to redeem their shares in the hedge fund
based on those inflated valuations.\800\ These cases typically involve
the adviser concealing its conduct by acting in contravention of the
private fund's governing documents or the adviser's policies and
procedures \801\ and by failing to disclose its conduct to other
investors or a fund governing body.\802\ These side arrangements with
preferred investors may also financially benefit the adviser, leaving
the remaining investors to bear the costs and market risk of any
remaining assets in the fund.\803\ Thus, this practice of granting an
investor in a private fund the ability to redeem its interest on terms
that the adviser reasonably expects to have a material, negative effect
on other investors is fraudulent and deceptive.
---------------------------------------------------------------------------

    \796\ Section 206(4) of the Advisers Act.
    \797\ See In the Matter of Aria Partners GP, LLC, Investment
Advisers Release No. 4991 (Aug. 22, 2018) (settled action);
Harbinger Capital, supra footnote 60; SEC v. Joseph W. Daniel,
Litigation Release No. 19427 (Oct. 13, 2005) (settled action); In
the Matter of Schwendiman Partners, LLC, Investment Advisers Act
Release Nos. 2083 (Nov. 21, 2002) and 2043 (July 11, 2002) (settled
action).
    \798\ See Harbinger Capital, supra footnote 60.
    \799\ See In the Matter of Schwendiman Partners, LLC, supra
footnote 797.
    \800\ See SEC v. Joseph W. Daniel, supra footnote 797.
    \801\ See, e.g., In the Matter of Aria Partners GP, LLC, supra
footnote 797.
    \802\ See, e.g., Harbinger Capital, supra footnote 60.
    \803\ See Harbinger Capital, supra footnote 60; see also In the
Matter of Schwendiman Partners, LLC, supra footnote 797.
---------------------------------------------------------------------------

    The final rule applies to preferential treatment provided through
various means, including written side letters. Side letters or side
arrangements are generally agreements among the investor, general
partner, adviser, and/or the private fund that provide the investor
with different or preferential terms than those set forth in the fund's
governing documents. Side letters generally grant more favorable rights
and privileges to certain preferred investors (e.g., seed investors,
strategic investors, those with large commitments, and employees,
friends, and family) or to investors subject to government regulation
(e.g., ERISA, BHCA, or public records laws). The final rule also
applies even if the preferential treatment is provided indirectly, such
as by an adviser's related persons, because granting of preferential
treatment also has the potential to harm the fund and its investors
when performed indirectly. For example, the rule applies when the
adviser's related person is the general partner (or similar control
person) and is a party (and/or caused the private fund to be a party,
directly or indirectly) to a side letter or other arrangement with an
investor, even if the adviser itself (or any related person of the
adviser) is not a party to the side letter or other arrangement. The
final rule will still apply under those circumstances because it
prohibits an adviser from providing preferential treatment directly or
indirectly.
    We are adopting the preferential treatment rule because all
investors would benefit from information regarding the preferred terms
granted to other investors in the same private fund (e.g., seed
investors, strategic investors, those with large commitments, and
employees, friends, and family) because, in some cases, these terms
disadvantage certain investors in the private fund, impact the
adviser's decision making (e.g., by altering or changing incentives for
the adviser), or otherwise impact the terms of the private fund as a
whole. This new rule will help investors better understand marketplace
dynamics and potentially improve efficiency for future investments, for
example, by expediting the process for reviewing and

negotiating fees and expenses. This has the potential to reduce the
cost of negotiating the terms of future investments.\804\
---------------------------------------------------------------------------

    \804\ See infra sections VI.D.4 and VI.E.
---------------------------------------------------------------------------

    Except in limited circumstances, the final rule prohibits
preferential information and redemption terms when the adviser
reasonably expects the terms to have a material, negative effect. Some
commenters argued that the ``adviser reasonably expects'' standard is
unworkable because an adviser cannot predict how others will react to
information \805\ and the adviser's decisions will be judged in
hindsight.\806\ Other commenters suggested only applying the
prohibition when the adviser ``knows'' the preferential treatment will
have a material, negative effect or imposing a good faith
standard.\807\ As proposed, we are adopting the rule with the
``reasonably expects'' standard, which imposes an objective standard
that takes into account what the adviser reasonably expected at the
time. This standard is designed to facilitate the effective operation
of the rule and to help ensure that preferential treatment granted to
one investor does not have deleterious effects on other investors. We
were not persuaded by commenters that argued the standard is unworkable
because an adviser cannot predict how others will react to information.
This standard does not require advisers to make such predictions;
rather, it requires advisers to form only a reasonable expectation
based on the facts and circumstances. We were also not persuaded by
commenters that stated the standard will result in adviser's decisions
being unfairly judged in hindsight. An adviser's actions will be judged
based on the facts and circumstances at the time the adviser grants or
provides the preferential treatment, as set forth in the final rule.
---------------------------------------------------------------------------

    \805\ See Haynes & Boone Comment Letter.
    \806\ See PIFF Comment Letter.
    \807\ See AIMA/ACC Comment Letter; Dechert Comment Letter.
---------------------------------------------------------------------------

    Other commenters asked us to provide more specificity around what
constitutes a ``material, negative effect,'' and they stated that if
advisers broadly interpret this term, then advisers could lack
incentive to offer certain side letter terms to investors, including,
for example, necessary investor-specific rights.\808\ Because many side
letter terms generally do not harm other investors and are not related
to liquidity rights (including investor-specific provisions relating to
tax, legal, regulatory, or accounting matters), we do not believe that
even a broad interpretation of this standard would discourage advisers
from offering such side letter terms to investors.
---------------------------------------------------------------------------

    \808\ See Comment Letter of Structured Finance Association (June
13, 2022) (``SFA Comment Letter II''); ILPA Comment Letter I; RFG
Comment Letter II; AIMA/ACC Comment Letter; Schulte Comment Letter;
Meketa Comment Letter.
---------------------------------------------------------------------------

    Another commenter stated that the materiality of preferential
redemption terms or information rights should be assessed in the
``basic framework under the securities laws (i.e., whether there is a
substantial likelihood that a reasonable investor would consider such
terms significant in its decision to invest or remain in the fund).''
\809\ This commenter stated that such a standard would allow the
adviser to objectively assess the relevant facts and circumstances and
consider both quantitative and qualitative factors in determining
whether the prohibition should apply to the particular term. We
believe, however, that requiring only a ``materiality'' standard has
the potential to result in a broader prohibition than the one we
proposed, and we do not believe a broader prohibition is needed to
address the conduct that the rule is intended to address.\810\
---------------------------------------------------------------------------

    \809\ See AIMA/ACC Comment Letter.
    \810\ Information is material if there is a substantial
likelihood that the information would have been viewed by a
reasonable investor as having significantly altered the total mix of
information available. See TSC Industries, Inc. v. Northway, Inc.,
426 U.S. 438, 449 (1976).
---------------------------------------------------------------------------

    Commenters did not offer specific examples of what types of
activity or information would have a ``material, negative effect,'' and
we believe it is important for this standard to remain evergreen so
that it can be applied to various types of arrangements between
advisers and investors and fund structures. For example, we believe an
adviser could form a reasonable expectation that certain redemption
terms would have a material, negative effect on other fund investors if
a majority of the portfolio investments were not likely to be liquid.
    One commenter stated that requiring advisers to determine whether a
preferential term has a material, negative effect on other
``investors'' suggests that advisers are required to second-guess each
investor's individual circumstances rather than the impact such term
has on the private fund as a whole.\811\ This commenter argued that
such a requirement runs contrary to the DC Circuit Court's decision in
Goldstein v. SEC. However, the exercise of our statutory authority
under sections 211(h)(2) and 206(4) is consistent with the court's
ruling in Goldstein v. SEC because section 206(4) is not limited in its
application to ``clients'' and section 211(h) by its terms provides
protection to ``investors.'' A plain interpretation of the statute
supports a reading that the provision authorizes the Commission to
promulgate rules to directly protect investors generally (rather than
only the clients) and does not contradict the court's ruling in
Goldstein v. SEC.\812\
---------------------------------------------------------------------------

    \811\ See SIFMA-AMG Comment Letter I.
    \812\ See supra section I (Introduction and Background).
---------------------------------------------------------------------------

1. Prohibited Preferential Redemptions
    We proposed to prohibit a private fund adviser from, directly or
indirectly, granting an investor in the private fund or in a
substantially similar pool of assets the ability to redeem its interest
on terms that the adviser reasonably expects to have a material,
negative effect on other investors in that private fund or in a
substantially similar pool of assets.\813\
---------------------------------------------------------------------------

    \813\ Proposed rule 211(h)(2)-3(a)(1).
---------------------------------------------------------------------------

    One commenter stated that the proposed prohibition on preferential
redemption terms would establish helpful baseline protections for all
investors, including those who cannot negotiate for sufficient
protections \814\ due to bargaining power dynamics or lack of
information or resources. One commenter stated that this provision
would protect remaining fund investors who could find themselves
invested in a materially different portfolio after other, preferred
investors redeemed.\815\ Other commenters stated that the prohibition
on preferential redemption terms would limit investor choice \816\ and
suggested excluding scenarios in which an investor elects to receive
less liquidity in exchange for other rights or terms.\817\ Other
commenters stated that the treatment of multi-class funds is unclear
under the proposed rule.\818\ They expressed concern that the
prohibition would result in less liquidity for investors \819\ and that
investors should be permitted to negotiate favorable liquidity terms
since those investors might also negotiate other liquidity terms that
benefit all investors.\820\ Some commenters recommended that we not
move forward with the proposed prohibition \821\ and

instead require disclosure of preferential liquidity terms.\822\ These
commenters stated that a disclosure-based regime would be more
consistent with market practice,\823\ and it would avoid unintended
consequences, such as blanket bans on liquidity rights granted due to
certain laws (e.g., the U.S. Employee Retirement Income Security Act of
1974).\824\
---------------------------------------------------------------------------

    \814\ See ICCR Comment Letter.
    \815\ See United for Respect Comment Letter I.
    \816\ See SBAI Comment Letter; MFA Comment Letter I.
    \817\ See MFA Comment Letter I.
    \818\ See Comment Letter of Curtis (Apr. 25, 2022) (``Curtis
Comment Letter''); PIFF Comment Letter.
    \819\ See PIFF Comment Letter; Comment Letter of the Regulatory
Fundamentals Group (Dec. 3, 2022) (``RFG Comment Letter III'').
    \820\ See Ropes & Gray Comment Letter; RFG Comment Letter III.
    \821\ See NYC Comptroller Comment Letter; AIMA/ACC Comment
Letter; IAA Comment Letter II.
    \822\ See SBAI Comment Letter; NYC Bar Comment Letter II; RFG
Comment Letter III; Ropes & Gray Comment Letter; PIFF Comment
Letter.
    \823\ See Ropes & Gray Comment Letter.
    \824\ See PIFF Comment Letter; NYC Bar Comment Letter II; IAA
Comment Letter II.
---------------------------------------------------------------------------

    We understand, based on staff experience, that preferential terms
provided to certain investors or one investor do not necessarily
benefit the fund or other investors that are not party to the side
letter agreement and, at times, we believe these terms can have a
material, negative effect on other investors.\825\ For example,
selective disclosure of certain information may entitle the investor
privy to such information to avoid a loss (e.g., by submitting a
redemption request) at the expense of the non-privy investors.
---------------------------------------------------------------------------

    \825\ See, e.g., EXAMS Private Funds Risk Alert 2020, supra
footnote 188.
---------------------------------------------------------------------------

    After considering comments, we are adopting the prohibition on
certain preferential redemption terms, but with two exceptions. In
general, we believe that granting preferential liquidity rights on
terms that the adviser reasonably expects to have a material, negative
effect on other investors in the private fund or in a similar pool of
assets is a sales practice that is harmful to the fund and its
investors. An adviser can attract preferred investors to invest in the
fund by offering preferential terms, such as more favorable liquidity
rights.\826\ Such practices often have conflicts of interest, however,
that can harm other investors in the private fund. For example, in
granting preferential liquidity rights to a large investor, the adviser
stands to benefit because its fees increase as fund assets under
management increase. While the fund also may experience some benefits,
including the ability to attract additional investors and to spread
expenses over a broader investor and asset base and the ability to
raise sufficient capital to implement the fund's investment strategy
and complete investments that meet the fund's target investment size
(particularly for illiquid funds), there are scenarios where the
preferential liquidity terms harm the fund and other investors. For
example, if an adviser allows a preferred investor to exit the fund
early and sells liquid assets to accommodate the preferred investor's
redemption, the fund may be left with a less liquid pool of assets,
which can inhibit the fund's ability to carry out its investment
strategy or promptly satisfy other investors' redemption requests. This
can dilute remaining investors' interests in the fund and make it
difficult for those investors to mitigate their investment losses in a
down market cycle.\827\ These concerns can also apply when an adviser
provides favorable redemption rights to an investor in a similar pool
of assets, such as another feeder fund investing in the same master
fund. The Commission believes that the potential harms to other
investors justify this restriction.
---------------------------------------------------------------------------

    \826\ See, e.g., id. (Commission staff has observed advisers
provide side letter terms to certain investors, including
preferential liquidity terms).
    \827\ See In the Matter of Deccan Value Investors LP, et al.,
Investment Advisers Act Release No. 6079 (Aug. 3, 2022) (settled
action) (alleging that registered investment adviser mismanaged
significant redemptions by two university clients due in part to the
adviser's stated concern over the negative impact the redemptions
could have on non-redeeming clients and investors).
---------------------------------------------------------------------------

    In a change from the proposal, and after considering comments, we
are adopting two exceptions from this prohibition. First, an adviser is
not prohibited from offering preferential redemption rights if the
investor is required to redeem due to applicable laws, rules,
regulations, or orders of any relevant foreign or U.S. Government,
State, or political subdivision to which the investor, private fund, or
any similar pool of assets is subject. Commenters suggested that, if we
retain the rule, we should permit an exclusion from this rule with
respect to investors that are required to obtain such liquidity terms
because of regulations and laws (i.e., institution-specific
requirements).\828\ Some commenters argued that this exception is
necessary to prevent the fund or investors from suffering harm related
to legal or regulatory issues \829\ (e.g., certain investors may
require special redemption rights to comply with pay-to-play laws) and
to ensure that certain investors, such as pension plans, can continue
to invest in private funds.\830\ We do not intend for this prohibition
to result in the exclusion of certain investors from funds or in an
investor violating other applicable laws. For example, under this
exception, pension plan subject to State or local law may be required
to redeem its interest under certain circumstances, such as a violation
by the adviser of State pay-to-play, anti-boycott, or similar laws.
Advisers that use this exception will still be subject to the
disclosure obligations under rule 211(h)(2)-3(b). For example, with
respect to a pension plan that receives preferential redemption rights
under this exception, an adviser will need to disclose this
preferential treatment pursuant to rule 211(h)(2)-3(b). Certain
commenters suggested that we broaden the exception to include
redemptions pursuant to an investor's policies or resolutions.\831\ We
are concerned, however, that excluding redemptions pursuant to these
more informal arrangements could compromise the investor protection
goals of the rule and would incentivize investors to adopt policies or
resolutions to circumvent the rule. We also believe that any exception
from this rule should be narrowly tailored to limit potential harms to
other investors to those cases that are absolutely necessary. We
believe that redemption terms required by more informal arrangements,
such as policies or resolutions, would therefore not be permissible.
Accordingly, the final rule does not provide an exception for more
informal arrangements, such as policies and resolutions.
---------------------------------------------------------------------------

    \828\ See NYC Comptroller Comment Letter; SIFMA-AMG Comment
Letter I; OPERS Comment Letter; RFG Comment Letter III; AIC Comment
Letter II.
    \829\ See Chamber of Commerce Comment Letter; RFG Comment Letter
III; MFA Comment Letter I; Ropes & Gray Comment Letter; Dechert
Comment Letter; PIFF Comment Letter; SIFMA-AMG Comment Letter I;
Comment Letter of the Minnesota State Board of Investment (Apr. 25,
2022); OPERS Comment Letter; NYC Bar Comment Letter II; Meketa
Comment Letter; SIFMA-AMG Comment Letter I.
    \830\ See, e.g., Ropes & Gray Comment Letter; OPERS Comment
Letter; RFG Comment Letter II.
    \831\ See e.g., NY State Comptroller Comment Letter (stating
that investor policies applied consistently across similar
investments should be excepted); NYC Comptroller Comment Letter
(stating that investor policies requiring different liquidity terms
should be excepted).
---------------------------------------------------------------------------

    Second, an adviser is not prohibited from offering preferential
redemption rights if the adviser has offered the same redemption
ability to all other existing investors and will continue to offer such
redemption ability to all future investors in the same private fund or
any similar pool of assets. Several commenters supported giving
investors a choice of various liquidity options and disclosing this in
the fund's governing and offering documents.\832\ We understand that
advisers have many methods to provide different liquidity terms to
private fund investors, including through side letters as well as by
embedding these terms in the fund's governing documents.\833\

While preferential liquidity terms provided via side letter are more
explicitly targeted to particular investors, we believe that favorable
liquidity terms provided through the fund's governing documents (i.e.,
by a fund offering different share classes, some with more favorable
liquidity terms than others) presents the same concerns that our final
rule seeks to address. Overall, we believe that this exception balances
our policy goals of protecting against potential fraud and deception
and certain conflicts of interest, while preserving investor choice
regarding liquidity and price. To qualify for the exception, an adviser
must have offered the same redemption ability to all other existing
investors and must continue to offer such redemption ability to all
future investors without qualification (e.g., no commitment size,\834\
affiliation requirements, or other limitations). For example, an
adviser offering a fund with three share classes, each with different
liquidity options but that are otherwise subject to the same terms
(Class A, Class B, and Class C), cannot restrict Class A to friends and
family investors if the adviser reasonably expects such liquidity
rights to have a material, negative effect on other investors.
---------------------------------------------------------------------------

    \832\ See AIMA/ACC Comment Letter; RFG Comment Letter III;
NACUBO Comment Letter; MFA Comment Letter I; SBAI Comment Letter;
SIFMA-AMG Comment Letter I; Segal Marco Comment Letter.
    \833\ This exception acknowledges that investors may prioritize
one term over another (e.g., an investor may be willing to pay
higher fees in exchange for better liquidity). Thus, we believe that
this exception is responsive to commenters who stated that the
Commission should provide an exception for scenarios in which an
investor elects to receive less liquidity in exchange for other
rights or terms.
    \834\ An adviser could not avail itself of this exception, for
example, if it offered a share class that is only available to
investors that meet a certain minimum commitment size.
---------------------------------------------------------------------------

    Advisers are prohibited from acting directly or indirectly under
the final rule.\835\ For example, an adviser could not avail itself of
the exception by offering Class A (annual redemption, 1% management
fee, 15% performance fee) and Class B (quarterly redemption, 1.5%
management fee, 20% performance fee) while requiring Class B investors
also to invest in another fund managed by the adviser, to the extent
the adviser reasonably expects such liquidity terms would have a
material, negative effect on other investors. We would interpret such
an incentive structure as failing to satisfy the requirement to offer
investors the same redemption ability as required under the final rule
because the obligation to invest in another fund managed by the adviser
serves to indirectly prevent investors from selecting Class B. We
similarly would interpret an arrangement where Class B investors
(quarterly redemption, 1.5% management fee, 20% performance fee) would
be required to agree to uncapped liability when the adviser has reason
to believe that certain investors (e.g., government entities) cannot
agree to uncapped liability, while Class A investors would not be
subject to such an obligation, as not satisfying the requirements of
the exception.
---------------------------------------------------------------------------

    \835\ See rule 211(h)(2)-3.
---------------------------------------------------------------------------

2. Prohibited Preferential Transparency
    We proposed to prohibit an adviser and its related persons from
providing information regarding the portfolio holdings or exposures of
the private fund or of a substantially similar pool of assets to any
investor if the adviser reasonably expects that providing the
information would have a material, negative effect on other investors
in that private fund or in a substantially similar pool of assets.\836\
---------------------------------------------------------------------------

    \836\ Proposed rule 211(h)(2)-3(a)(2).
---------------------------------------------------------------------------

    Some commenters supported the proposal,\837\ and one commenter
stated that all investors should receive basic information about
portfolio holdings.\838\ Others argued that the proposed rule could
negatively impact investors to the extent it would prohibit them from
receiving information required under applicable laws or
regulations.\839\ Certain commenters argued that the proposed rule
could harm investors if they are prohibited from receiving certain
information or material as members of the fund's limited partner
advisory committee.\840\ As with the proposed prohibition on
preferential liquidity, some commenters recommended that we not move
forward with this prohibition and instead allow preferential
information rights, if they are disclosed to other investors.\841\
---------------------------------------------------------------------------

    \837\ See Comment Letter of Pattern Recognition: A Research
Collective (Apr. 25, 2022) (``Pattern Recognition Comment Letter'');
Segal Marco Comment Letter.
    \838\ See Pattern Recognition Comment Letter.
    \839\ See Meketa Comment Letter; MFA Comment Letter I.
    \840\ See NYC Comptroller Comment Letter; NY State Comptroller
Comment Letter; RFG Comment Letter II.
    \841\ See NYC Bar Comment Letter II; SBAI Comment Letter.
---------------------------------------------------------------------------

    We have decided to adopt the prohibition on certain preferential
transparency as proposed but with an exception that is discussed below.
We continue to believe that selective disclosure of portfolio holdings
or exposures can result in profits or avoidance of losses among those
who were privy to the information beforehand at the expense of
investors who did not benefit from such transparency. In addition,
providing such information in a fund with redemption rights could
enable an investor to trade in a way that ``front-runs'' or otherwise
disadvantages the fund or other clients of the adviser. Granting
preferential transparency if the adviser reasonably expects that
providing the information would have a material, negative effect on
other investors in that private fund or in a substantially similar pool
of assets, for example through side letters, is contrary to the public
interest and protection of investors because it preferences one
investor at the expense of another. For example, if an adviser provides
preferential information about a hedge fund's holdings to one investor
as opposed to another investor, the investor with preferential
information may use that information to redeem from the hedge fund
during the next redemption cycle, even if both investors have the same
redemption rights. In addition, an adviser can have a conflict of
interest that may cause it to agree to provide preferential information
rights to a certain investor in exchange for something of benefit to
the adviser. For example, an adviser may agree to offer preferential
terms to a large financial institution that agrees to provide services
to the adviser. The rule is designed to neutralize the potential for
private fund advisers to treat portfolio holdings information as a
commodity to be used to gain or maintain favor with particular
investors.\842\
---------------------------------------------------------------------------

    \842\ See Selective Disclosure and Insider Trading, Securities
Act Release No. 7881 (Aug. 15, 2000) [65 FR 51715 (Aug. 24, 2000)].
---------------------------------------------------------------------------

    Selective disclosure to certain parties is a fundamental concern
often prohibited or restricted under other Federal securities laws. For
example, the Commission adopted Regulation FD to address selective
disclosure by certain issuers of material nonpublic information under
the Exchange Act. The Commission stated that selective disclosure
occurs when issuers release material nonpublic information about a
company to selected persons, such as securities analysts or
institutional investors, before disclosing the information to the
general public.\843\ This practice undermines the integrity of the
securities markets--both public and private--and reduces investor
confidence in the fairness of those markets.\844\
---------------------------------------------------------------------------

    \843\ See id.
    \844\ See infra section VI.D.4.
---------------------------------------------------------------------------

    Many commenters stated that the proposed rule would have a chilling
effect on ordinary course investor communications \845\ and that it was
unclear whether the proposed rule

would apply only to formal communications (e.g., side letters, other
written communications) or whether informal communications (e.g., oral
statements,\846\ such as phone conversations) would be included.\847\
Because advisers might fear liability under the proposed rule,
commenters stated that an outright prohibition on preferential
transparency might prevent advisers from providing investors with
important information desired by investors or, in some instances,
required by investors because of the operation of a law, rule,
regulation, or order.\848\ Commenters also expressed concern regarding
a lack of clarity under the ``material, negative effect''
standard.\849\ We have considered these concerns in adopting the rule.
While we understand commenter concerns that this prohibition could
chill adviser/investor communications, the rule serves a compelling
government interest in protecting all investors not just some
investors, ensuring confidence in the fairness and integrity of our
capital markets, and addressing conflicts of interest in private fund
structures, which have been historically opaque. We also believe that
the rule is closely drawn because it applies only in a narrow set of
circumstances: when the adviser reasonably expects that providing
information would have a material, negative effect on other investors
in the private fund or similar pool of assets.\850\ Any preferential
information that does not meet this criterion would only be subject to
the disclosure portions of this rule.\851\
---------------------------------------------------------------------------

    \845\ See MFA Comment Letter I; Haynes & Boone Comment Letter;
Dechert Comment Letter; RFG Comment Letter II; AIMA/ACC Comment
Letter.
    \846\ See RFG Comment Letter II.
    \847\ See MFA Comment Letter I; AIMA/ACC Comment Letter.
    \848\ See Dechert Comment Letter; RFG Comment Letter II.
    \849\ See Dechert Comment Letter; Haynes & Boone Comment Letter.
    \850\ We are clarifying that the final rule applies to all types
of communications: formal and informal as well as written, visual,
and oral.
    \851\ See final rule 211(h)(2)-3(b).
---------------------------------------------------------------------------

    In addition, any chilling effect is further reduced as, in a change
from the proposal, we are adopting an exception to this prohibition for
preferential information made broadly available by the adviser.
Specifically, the rule states that an adviser is not prohibited from
providing preferential information if the adviser offers such
information to all existing investors in the private fund and any
similar pool of assets at the same time or substantially the same time.
Although the disclosure-based exception we are adopting is not
identical to commenters' suggestions, we believe the final rule is
responsive to suggestions that the rule should be disclosure based
rather than prohibition based.\852\
---------------------------------------------------------------------------

    \852\ See SBAI Comment Letter; Schulte Comment Letter.
---------------------------------------------------------------------------

    As discussed above, we agree with commenters that it is important
for investors to be able to continue to receive information and,
without an exception, they may not be able to do so under the proposed
rule. As a result, the exception requires that when an adviser
discloses otherwise prohibited information to one investor, it must
also provide such information to all investors. This is designed to
help ensure that investors are treated fairly and that investors have
equal access to the same information. We believe that this exception
balances our policy goals while preserving the ability for investors to
access information that is important to their investment decisions. To
qualify for the exception, an adviser must offer the information to all
other investors at the same time or substantially the same time. For
example, an adviser could provide, to one current investor, ESG data
related to a specific portfolio company that the private equity fund
holds only if the adviser offers that same information to all other
investors in the private equity fund and any similar pools of assets.
To qualify for the exception, the adviser must offer to provide the
information to other investors at the same time or substantially the
same time.
    As with the redemptions prohibition, some commenters requested that
we provide an exception from this prohibition for preferential
information that an investor must obtain as a requirement of State or
other law.\853\ We do not believe it is necessary to grant such an
exception because advisers can now rely on the exception discussed
above by offering to disclose information to all investors. This
ensures that investors can still obtain necessary information, whether
required by law or contract, without sacrificing the policy goals of
the rule. We also believe that State laws generally require disclosure
of information that would not have a material, negative effect on other
investors, such as fee and expense transparency.\854\
---------------------------------------------------------------------------

    \853\ See NY State Comptroller Comment Letter; CalPERS Comment
Letter; Predistribution Initiative Comment Letter II; Ropes & Gray
Comment Letter; PIFF Comment Letter; NYC Comptroller Comment Letter;
AIMA/ACC Comment Letter; NY State Comptroller Comment Letter; IAA
Comment Letter II.
    \854\ See, e.g., section 7514.7 of the California Government
Code. This law requires California public investment funds to
disclose certain information annually in a report presented at a
meeting open to the public, such as the fees and expenses that the
California public investment fund paid directly to the alternative
investment vehicle; the California public investment fund's pro rata
share of carried interest distributed to the fund manager or related
parties; and the California public investment fund's pro rata share
of aggregate fees and expenses paid by all of the portfolio
companies held within the alternative investment vehicle to the fund
manager or related parties.
---------------------------------------------------------------------------

    The prohibition is narrowly drawn in that it applies only to
preferential information that would have a material, negative effect on
other investors in that private fund or in a similar pool of assets.
Commenters suggested that the preferential treatment rule should apply
only to open-end funds because the redemption ability in the open-end
fund structure makes it more likely for preferential information rights
to materially harm other investors.\855\ We agree that is easier to
trigger the material, negative effect provision in a scenario where
certain investors receive preferential information and an ability to
redeem their interests because those investors can exit the fund sooner
than others, potentially harming remaining investors. As a result, the
ability to redeem is an important part of determining whether providing
information would have a material, negative effect on other investors
and thus whether an adviser triggers the preferential information
prohibition. We would generally not view preferential information
rights provided to one or more investors in an illiquid private fund as
having a material, negative effect on other investors. We do not
believe, however, that a blanket exemption for all closed-end funds
would be appropriate because, for example, even closed-end funds offer
redemption rights in certain extraordinary circumstances. Whether
preferential information provided to an investor in a closed-end fund
violates the final rule requires a facts and circumstances analysis.
---------------------------------------------------------------------------

    \855\ See NY State Comptroller Comment Letter; Top Tier Comment
Letter.
---------------------------------------------------------------------------

3. Similar Pool of Assets
    We proposed to define the term ``substantially similar pool of
assets'' as a pooled investment vehicle (other than an investment
company registered under the Investment Company Act of 1940 or a
company that elects to be regulated as such) with substantially similar
investment policies, objectives, or strategies to those of the private
fund managed by the adviser or its related persons.\856\
---------------------------------------------------------------------------

    \856\ Proposed rule 211(h)(1)-1.
---------------------------------------------------------------------------

    We are adopting the definition as proposed, but we are changing the
defined term to ``similar pool of assets'' so that the defined term
better reflects

the broad scope of the definition.\857\ This conforming change is
appropriate because we believe that, depending on the facts and
circumstances, the definition will likely capture vehicles outside of
what the private funds industry would typically view as ``substantially
similar pools of assets.'' For example, an adviser's healthcare-focused
private fund may be considered a ``similar pool of assets'' to the
adviser's technology-focused private fund under the definition. Thus,
we believe the appropriate term to use is ``similar,'' rather than
substantially similar pool of assets.
---------------------------------------------------------------------------

    \857\ In the marketing rule, we defined the term ``related
portfolio'' to mean ``a portfolio with substantially similar
investment policies, objectives, and strategies. . .'' (emphasis
added). In this final rule, the scope of similar pool of assets is
broader because the term includes a pooled investment vehicle with
``substantially similar investment policies, objectives, or
strategies. . .'' (emphasis added). We are removing the word
``substantially'' from the defined term in order to signal the
broader scope. See rule 206(4)-1I(15) under the Advisers Act.
---------------------------------------------------------------------------

    We are also excluding securitized asset funds from the definition
of similar pool of assets. We believe that this change is appropriate
because, as discussed above, we believe that certain distinguishing
structural and operational features of SAFs have prevented or deterred
SAF advisers from engaging in the type of conduct that the final rules
seek to address, such as the granting of preferential treatment.
    We believe the final definition provides the appropriate scope to
address our concerns, which include an adviser providing more favorable
terms to investors in another similar pool of assets to the detriment
of private fund investors.\858\ A comprehensive definition of ``similar
pool of assets'' will help prevent advisers from attempting to
structure around the preferential treatment prohibitions by, for
example, creating parallel funds solely for investors with preferential
terms.
---------------------------------------------------------------------------

    \858\ See, e.g., Proposing Release, supra footnote 3, at 168.
---------------------------------------------------------------------------

    Whether a pool of assets managed by the adviser is ``similar'' to
the private fund requires a facts and circumstances analysis. A pool of
assets with a materially different target return or sector focus, for
example, would likely not have substantially similar investment
policies, objectives, or strategies to those of the subject private
fund, depending on the facts and circumstances.
    The types of asset pools that would be included in this term would
include a variety of pools, regardless of whether they are private
funds. For example, this term would include limited liability
companies, partnerships, and other organizational structures,
regardless of the number of investors; feeders to the same master fund;
and parallel fund structures and alternative investment vehicles. It
would also include pooled vehicles with different base currencies and
pooled vehicles with embedded leverage to the extent such pooled
vehicles have substantially similar investment policies, objectives, or
strategies as those of the subject private fund. In addition, an
adviser would be required to consider whether its proprietary vehicles
meet the definition of ``similar pool of assets.'' We believe this
scope is appropriate, and we note our staff also has observed scenarios
where an adviser establishes investment vehicles that invest side-by-
side along with the private fund that have better liquidity terms than
the terms provided to investors in the private fund.\859\
---------------------------------------------------------------------------

    \859\ See EXAMS Private Funds Risk Alert 2020, supra footnote
188.
---------------------------------------------------------------------------

    This definition is designed to capture most commonly used private
fund structures (or similar arrangements) and prevent advisers from
structuring around the prohibitions on preferential treatment. For
example, in a master-feeder structure, some advisers create custom
feeder funds for favored investors. Without a broad definition of
similar pool of assets, the rule would not preclude such advisers from
providing preferential treatment to investors in these custom feeder
funds to the detriment of investors in standard commingled feeder funds
within the master-feeder structure.
    Many commenters argued that the proposed definition of
``substantially similar pool of assets'' was overbroad and suggested
that we narrow the definition.\860\ These commenters suggested that we
limit the definition to, for example, funds that invest side by side,
pari passu, with the main fund in substantially all investment
opportunities (which would, among other things, make it easier for
advisers to determine their compliance obligations under the rule and
prevent investors from being subject to limitations on liquidity and
information rights) \861\ and that we exclude co-investment vehicles
and separately managed accounts.\862\ In contrast, one commenter
suggested broadening the proposed definition beyond pooled vehicles to
include separately managed accounts because separately managed accounts
can pose similar risks to pooled vehicles.\863\ This rule is designed
to address the specific concerns that arise out of the lack of
transparency and governance mechanisms prevalent in the private fund
structure and protects underlying investors in those funds from being
disadvantaged as a result of preferential treatment given to underlying
investors in other similar pools because the adviser does not have a
fiduciary duty to those underlying investors. It is not designed to
protect against the adviser disadvantaging one client (a private fund)
as a result of preferential treatment given to another client (a
separately managed account client) because the fiduciary duty protects
against such preferential treatment. Accordingly, there is no need to
include separately managed accounts in the definition of ``similar pool
of assets.'' There are, however, certain circumstances in which a fund
of one or single investor fund can be a pooled investment vehicle and
therefore can fall within the definition of ``similar pool of assets.''
\864\
---------------------------------------------------------------------------

    \860\ See SIFMA-AMG Comment Letter I; NYC Bar Comment Letter II;
ILPA Comment Letter I; AIMA/ACC Comment Letter; PIFF Comment Letter;
SFA Comment Letter II; Ropes & Gray Comment Letter; Haynes & Boone
Comment Letter.
    \861\ See SIFMA-AMG Comment Letter I; NYC Bar Comment Letter II;
ILPA Comment Letter I; AIMA/ACC Comment Letter.
    \862\ See AIMA/ACC Comment Letter.
    \863\ See Anonymous (Mar. 2, 2022) at 1.
    \864\ See Exemptions Adopting Release, supra footnote 9, at 78-
79.
---------------------------------------------------------------------------

    Certain advisers offer existing investors, related persons, or
third parties the opportunity to co-invest alongside the private fund
through one or more co-investment vehicles established or advised by
the adviser or its related persons.\865\ These co-investment vehicles
may be set up for one or more specific investments. Co-investment
vehicles have the effect of increasing the capital available for the
adviser to complete a prospective investment. Commenters expressed
concern that the rule would impede the co-investment process because
the rule could be interpreted to prohibit selective disclosure of
portfolio holding information to investors with co-investing rights and
advisers would need to assess whether information provided to co-
investors triggers the prohibition.\866\ One commenter

suggested excluding co-investment vehicles from the definition.\867\
While we understand commenter concerns, we believe that we should adopt
the definition as proposed because excluding co-investment vehicles
that have substantially similar investment policies, objectives, or
strategies would expose investors to similar risks that the rule is
intended to address and potentially allow advisers to circumvent the
rule. Co-investment vehicles operate in a similar fashion as other
pooled investment vehicles that invest alongside the adviser's main
fund, such as parallel funds, because they typically enter and exit the
applicable investment(s) at substantially the same time and on
substantially the same terms as the adviser's main fund. Providing
investors in these vehicles with preferential information presents the
same risks and circumvention concerns as other pooled investment
vehicles captured by the definition. Thus, we do not believe that co-
investment vehicles should be treated differently.
---------------------------------------------------------------------------

    \865\ In some cases, advisers use co-investment opportunities to
attract new investors and retain existing investors. Advisers may
offer these existing or prospective investors the opportunity to
invest in co-investment vehicles with materially different fee and
expense terms than the main fund (e.g., no fees or no obligation to
bear broken deal expenses). These co-investment opportunities may
raise conflicts of interest, particularly when the opportunity to
invest arises because of an existing investment and the fund itself
would otherwise be the sole investor.
    \866\ See AIC Comment Letter II; Segal Marco Comment Letter
(stating that the proposed rule would require advisers to offer
every co-investment opportunity to every investor, which could
prevent private funds from maximizing value for investors).
    \867\ See AIMA/ACC Comment Letter.
---------------------------------------------------------------------------

4. Other Preferential Treatment and Disclosure of Preferential
Treatment
    We proposed to prohibit other preferential terms unless the adviser
provided certain written disclosures to prospective and current
investors.\868\ Specifically, we proposed to require an adviser to
provide to prospective private fund investors, prior to the investor's
investment in the fund, a written notice with specific information
about any preferential treatment the adviser or its related persons
provide to other investors in the same private fund.\869\ We also
proposed to require advisers to distribute an annual written notice to
current investors in a private fund where such notice provides specific
information about any preferential treatment the adviser or its related
persons provide to other investors in the same private fund since the
last written notice.\870\
---------------------------------------------------------------------------

    \868\ Proposed rule 211(h)(2)-3(b).
    \869\ Proposed rule 211(h)(2)-3(b)(1).
    \870\ Proposed rule 211(h)(2)-3(b)(2).
---------------------------------------------------------------------------

    We are adopting this aspect of the rule largely as proposed because
we are concerned that an adviser's current sales practices do not
provide all investors with sufficient detail regarding preferential
terms granted to certain investors. Increased transparency will better
inform investors about the breadth of preferential treatment, the
potential for those terms to affect their investment in the private
fund, and the potential costs (including compliance costs) associated
with these preferential terms. This disclosure will help investors
understand whether, and how, such terms present conflicts of interest
or otherwise impact the adviser's compensation schemes with the private
fund. The disclosure will also help prevent investors from being
potentially defrauded or deceived by preferential treatment that
negatively impacts their investment in the private fund.\871\
---------------------------------------------------------------------------

    \871\ As discussed above, investors can use this information to
protect their interests, including through negotiations regarding
new investments and renegotiations regarding existing investments,
and to make more informed business decisions. We believe that
disclosure of preferential treatment is necessary to guard against
deceptive and/or fraudulent practices because it will increase
investor access to information necessary to diligence the
prospective investment and better understand whether, and how, such
terms affect the private fund overall. For example, an investor
could seek assurances that it will not bear more than its pro rata
portion of expenses as a result of economic arrangements provided to
other investors As another example, disclosure of significant
governance rights provided to one investor, such as the ability to
terminate the investment period of the fund or remove the adviser,
will guard against other investors being misled about the terms of
their investment and how preferential treatment provided to certain,
but not all, investors impacts those terms.
---------------------------------------------------------------------------

    One commenter generally opposed the disclosure portion of the
preferential treatment rule because advisers may seek to deny investors
certain terms to avoid being required to disclose those concessions to
all investors.\872\ One commenter asserted that the disclosure
obligation could compromise the anonymity of investors.\873\ Other
commenters suggested narrowing the scope of the proposed rule by
requiring disclosure only of material preferential treatment.\874\ In
contrast, some commenters supported the disclosure requirements because
they said they would assist the investor in the negotiation
process.\875\
---------------------------------------------------------------------------

    \872\ See OPERS Comment Letter.
    \873\ See IAA Comment Letter II.
    \874\ See BVCA Comment Letter; Invest Europe Comment Letter;
GPEVCA Comment Letter.
    \875\ See RFG Comment Letter II; Healthy Markets Comment Letter
I.
---------------------------------------------------------------------------

    In response to commenter concerns, we are making three changes to
the proposal. First, we are limiting the advance written notice
requirement to ``any preferential treatment related to any material
economic terms'' rather than requiring advance disclosure of all
preferential treatment. Commenters stated that the advance notice
requirement would impede the closing process because it would
incentivize investors to wait until the last minute to invest in order
to maximize the amount of information they receive about the terms
other investors negotiated.\876\ They asserted that, because of the
dynamic nature of negotiations leading up to a closing (i.e., advisers
simultaneously negotiate with multiple investors), it would be
impractical for an adviser to provide advance written notice to a
prospective investor because doing so would result in a repeated cycle
of disclosure, discussion, and potential renegotiation.\877\ Several
commenters argued that the most favored nations (``MFN'') clause
process addresses the policy concerns raised by the proposed rule,\878\
and they suggested that instead of applying the rule to funds that
offer MFN rights to investors, especially closed-end funds, we should
allow such funds to adopt a best-in-class MFN process.\879\ In an MFN
clause, an adviser or its related person generally agrees to provide an
investor with contractual rights or benefits that are equal to or
better than the rights or benefits provided to certain other investors,
subject to certain exceptions. Closed-end fund investors are typically
entitled to elect these rights or benefits after the end of the private
fund's fundraising period, and open-end fund investors are typically
entitled to elect these rights or benefits after the closing of their
investment. As a result, adopting a best-in-class MFN process would not
provide prospective investors with information that they can act upon
when negotiating the terms of their investment because investors would
not receive such information until after the closing of their
investment. Some commenters supported limiting any advance disclosure
requirement to certain key terms with more comprehensive disclosure to
follow post investment.\880\
---------------------------------------------------------------------------

    \876\ See AIC Comment Letter I.
    \877\ See MFA Comment Letter I; PIFF Comment Letter; Chamber of
Commerce Comment Letter; AIMA/ACC Comment Letter; Correlation
Ventures Comment Letter; SIFMA-AMG Comment Letter I; ATR Comment
Letter; Ropes & Gray Comment Letter.
    \878\ See NY State Comptroller Comment Letter.
    \879\ See ILPA Comment Letter I; BVCA Comment Letter; Invest
Europe Comment Letter; GPEVCA Comment Letter.
    \880\ See Ropes & Gray Comment Letter; PIFF Comment Letter.
---------------------------------------------------------------------------

    While we understand commenter views about the timing concerns
associated with advance disclosure, we believe that it is crucial for
prospective investors to have access to certain information before they
invest. This is designed to prevent investors from being misled because
it will provide them with transparency regarding how the terms may
affect their investment, how the terms may affect the adviser's
relationship with the private fund and

its investors, and whether the terms create any additional conflicts of
interest.\881\ To address commenter concerns about timing and impeding
the closing process, the final rule will limit advance disclosure to
those terms that a prospective investor would find most important and
that would significantly impact its bargaining position (i.e., material
economic terms, including, but not limited to, the cost of investing,
liquidity rights, fee breaks, and co-investment rights \882\). One
commenter stated that the final rule should not apply to preferential
terms an adviser offers to investors and instead should apply only to
preferential terms actually provided.\883\ We agree with this
interpretation of the scope of the disclosure obligations under this
aspect of the rule and believe this is clear from the rule text.\884\
---------------------------------------------------------------------------

    \881\ For example, to the extent a private equity manager sought
to limit or narrow the fund's overall investment strategy via a side
letter provision with one investor, the other investors would likely
be misled about the fund's actual investment strategy.
    \882\ Co-investment rights will generally qualify as a material,
economic term to the extent they include materially different fee
and expense terms from those of the main fund (e.g., no fees or no
obligation to bear broken deal expenses). Even if co-investment
rights do not include different fee and expense terms, and for
example, are offered to provide an investor with additional exposure
to a particular investment or investment type, investors often
negotiate for those rights and give up other terms in the bargaining
process in order to secure access to co-investment opportunities. As
a result, co-investment terms generally will be material given their
impact on an investor's bargaining position.
    \883\ See AIMA/ACC Comment Letter.
    \884\ See, e.g., final rule 211(h)(2)-3(b) (referring to
preferential treatment ``the adviser or its related persons provide.
. .'' (emphasis added).
---------------------------------------------------------------------------

    Second, we are requiring advisers to disclose all other
preferential treatment, in writing, to current investors on the
following timeline: for illiquid funds, as soon as reasonably
practicable following the end of the private fund's fundraising period,
and for liquid funds, as soon as reasonably practicable following the
investor's investment in the private fund.\885\ This change is in
response to commenter concerns that requiring advisers to disclose all
preferential treatment would impede the closing process. As a result,
we are allowing advisers to wait until after an investor has invested
in the fund to disclose the remaining preferential terms (i.e., all
preferential terms that are not material economic terms). Although
investors may not receive this information until after the closing of
their investment, this information will nonetheless enable investors to
protect their interests more effectively and make more informed
investment decisions with a broader understanding of market terms,
including with respect to negotiations of new investments with the
adviser or renegotiations (or liquidations, if applicable) of existing
investments. This change also addresses a commenter's suggestion that
any final rule account for the different negotiating processes for
open-end and closed-end funds.\886\
---------------------------------------------------------------------------

    \885\ The disclosure requirements are not limited to an
investor's initial investment in the fund. For example, if an
existing investor increases its investment in the fund, the adviser
is required to disclose all preferential treatment to such investor
following such additional investment in accordance with the
timelines set forth in the rule.
    \886\ See ILPA Comment Letter I.
---------------------------------------------------------------------------

    An example of preferential treatment that the final rule prohibits
unless it is disclosed post investment and/or pursuant to the annual
notice requirement is if an adviser to a private equity fund provides
``excuse rights'' (i.e., the right to refrain from participating in a
specific investment the private fund plans to make) to certain private
fund investors.\887\ We believe that post-investment and annual
disclosure is important because it helps investors learn whether other
investors are receiving a better or different deal and whether any such
arrangements pose potential conflicts of interest, potential harms, or
other disadvantages (e.g., to the extent other investors are excused
from participating in certain types of investments, such as alcohol-
related investments, the participating investors may become over
concentrated in such investments).
---------------------------------------------------------------------------

    \887\ This example assumes that the relevant excuse rights are
not material economic terms required to be disclosed pre-investment
by final rule 211(h)(2)(3)-(b)(1).
---------------------------------------------------------------------------

    Third, we are revising the rule text to apply the disclosure
obligations in final rule 211(h)(2)-3(b) to all preferential treatment,
including any preferential treatment granted in accordance with final
rule 211(h)(2)-3(a). Specifically, we are removing the reference to
``other'' from the first sentence in rule 211(h)(2)-3(b) to avoid the
implication that the preferential treatment granted pursuant to the
disclosure exceptions in final rule 211(h)(2)-3(a) would not be
captured. This change is a necessary clarification because the granting
of preferential treatment with respect to redemption rights or fund
portfolio holdings or exposures information would have been prohibited
under proposed rule 211(h)(2)-3(a) and, accordingly, there would have
been nothing to disclose under proposed rule 211(h)(2)-3(b) with
respect to these types of preferential treatment. Transparency into
these terms will better inform investors regarding the breadth of
preferential treatment, the potential for such terms to affect their
investment in the private fund, and the potential costs associated with
these preferential terms. Moreover, such disclosure may assist
investors in determining whether the adviser offered the same
redemption ability or information to all investors in the private fund,
if applicable.
    We are adopting the annual written notice requirement as proposed.
One commenter supported the ability of an adviser to choose when to
provide the annual disclosure as long as the adviser provides it on an
annual basis.\888\ Some commenters suggested that the final rule only
require annual disclosure (instead of also requiring pre-investment
disclosure).\889\ We believe that the annual notice requirement will
require advisers to reassess periodically the preferential terms they
provide to investors in the same fund, and investors will benefit from
receiving periodic updates on preferential terms provided to other
investors in the same fund (e.g., investors will benefit because they
will be able to assess whether such preferential treatment presents new
conflicts for the adviser). We also believe that providing this
information annually will not overwhelm investors with disclosure.
---------------------------------------------------------------------------

    \888\ See AIMA/ACC Comment Letter.
    \889\ See RFG Comment Letter II; Ropes & Gray Comment Letter;
PIFF Comment Letter.
---------------------------------------------------------------------------

    We were not persuaded by commenters who urged us not to adopt this
portion of the rule on the basis that advisers may use it to deny
investors certain terms. Continuing to allow advisers to negotiate
undisclosed side arrangements with certain investors that may impact
other investors would be contrary to the public interest and the
protection of investors because such arrangements can harm, mislead, or
deceive other investors. It would also be inconsistent with promoting
transparency into such arrangements. Moreover, even if advisers cease
to offer certain provisions to investors, we believe the benefits
associated with disclosure of preferential treatment justify such
incremental burden.
    Like the proposed rule, the final rule will require an adviser to
describe specifically the preferential treatment to convey its
relevance. One commenter argued that advisers should not be required to
disclose the exact fees or other contractual terms that they negotiated
and instead disclosure that some investors received preferential fees
should be sufficient.\890\ We do not believe that mere disclosure of
the fact that other investors are paying lower

fees is specific enough. For example, if an adviser provides an
investor with lower fee terms in exchange for a significantly higher
capital contribution than paid by others, an adviser must describe the
lower fee terms, including the applicable rate (or range of rates if
multiple investors pay such lower fees), in order to provide specific
information as required by the rule. An adviser could comply with the
disclosure requirements by providing copies of side letters (with
identifying information regarding the other investors redacted).\891\
Alternatively, an adviser could provide a written summary of the
preferential terms provided to other investors in the same private
fund, provided the summary specifically describes the preferential
treatment. We believe information about fee arrangements such as those
described in the example immediately above qualify as information about
material economic terms that the adviser must disclose prior to the
prospective investor's investment.
---------------------------------------------------------------------------

    \890\ See SBAI Comment Letter.
    \891\ Advisers are not required to disclose the names or even
types of investors provided preferential terms as part of this
disclosure requirement. Thus, we do not believe commenters' concerns
regarding investor confidentiality are supported.
---------------------------------------------------------------------------

5. Delivery
    As proposed, the timing of the final rule's delivery requirements
differs depending on whether the recipient is a prospective or current
investor in the private fund. For a prospective investor the notice
needs to be provided, in writing, prior to the investor's investment in
the fund. For a current investor, the adviser must ``distribute'' the
notice as soon as reasonably practicable after the end of the fund's
fundraising period (for illiquid funds) or as soon as reasonably
practicable following the investor's investment in the fund (for liquid
funds).\892\ Also, for a current investor, the adviser must distribute
an annual notice if any preferential treatment is provided to an
investor since the last notice.\893\ This includes preferential
information provided to any transferees during such period. If an
investor is a pooled investment vehicle that is in a control
relationship with the adviser, the adviser must look through that pool
in order to send the notice to investors in those pools.\894\
---------------------------------------------------------------------------

    \892\ Final rule 211(h)(2)-3(b)(2).
    \893\ As a practical matter, a private fund that does not admit
new investors or provide new terms to existing investors does not
need to deliver an annual notice. However, an adviser that enters
into a side letter after the closing date of the fund must disclose
any preferential terms in the side letter to investors that are
locked into the fund.
    \894\ See supra section II.B.3 (Preparation and Distribution of
Quarterly Statements).
---------------------------------------------------------------------------

    We are not adopting a requirement for advisers to distribute the
various notices within a specified deadline (e.g., five days after an
investor's investment in the fund or five days after year end). Because
notices for certain funds, especially funds that provide extensive or
complex preferential treatment, may take more time to prepare, a one-
size-fits-all approach is not appropriate for purposes of this
rule.\895\ We believe that the ``as soon as reasonably practicable'' is
the appropriate standard because it emphasizes the need for the notices
to be distributed to investors without delay to help ensure their
timeliness while affording advisers a limited degree of flexibility.
Whether a written notice is furnished ``as soon as reasonably
practicable'' will depend on the facts and circumstances. While this
standard imposes no specific time limit, we believe that it would
generally be appropriate for advisers to distribute the notices within
four weeks.
---------------------------------------------------------------------------

    \895\ We recognize that the quarterly statement rule includes
specified distribution timelines. The primary reason for this is to
help ensure that investors can monitor their investments with
regular and consistent disclosures from the adviser. Moreover, this
flexible standard acknowledges that there will likely be more
variance in the time required to prepare these notices as compared
to the quarterly statements.
---------------------------------------------------------------------------

    One commenter suggested that we require advisers to provide the
preferential treatment disclosures only upon request to reduce the
burden on advisers and require investors to consider what information
is important to them.\896\ We believe that requiring advisers to
provide and distribute the disclosures under this rule is essential to
placing investors in the best position to negotiate the terms of their
investment (with regard to the advance disclosure) and, with regard to
the post-investment and annual disclosures, in the best position to
consider and negotiate future investment opportunities, including with
the adviser providing the disclosures. We are concerned that,
especially with the advance disclosure requirement, requiring investors
to first request information that they believe is essential to their
negotiation process would serve only to disadvantage these investors
both from a time and information perspective. Requiring investors to
request this information could change the relationship dynamics between
the adviser and investors. For example, an adviser may decide not to
allow an investor with significant information requests to invest in
the adviser's future funds. Similarly, investors may hesitate to
request information (even though the rules permit them to) for fear of
burdening the adviser or potentially increasing the fees and expenses
charged to the fund. We are not prescribing the method of delivery
(e.g., electronic, data room, via mail) for the written notices.\897\
---------------------------------------------------------------------------

    \896\ See AIMA/ACC Comment Letter.
    \897\ See AIMA/ACC Comment Letter (suggesting that the final
rule allow advisers to make the written notices available via a data
room, where appropriate). If delivery of the required disclosure is
made electronically, it should be done in accordance with the
Commission's guidance regarding electronic delivery. See Use of
Electronic Media Release, supra footnote 435; see also supra section
II.B.3 (discussing the distribution requirements).
---------------------------------------------------------------------------

6. Recordkeeping for Preferential Treatment
    We proposed amending rule 204-2 under the Advisers Act to require
advisers registered with the Commission to retain books and records to
support their compliance with the proposed preferential treatment
rule.\898\ Some commenters supported this amendment to the
recordkeeping rule and stated that the recordkeeping obligation would
ensure compliance with the rule as well as support the completeness and
accuracy of records.\899\ Another commenter stated that advisers should
not be required to retain records if the prospective investor does not
ultimately invest in the fund since, in that case, the prospective
investor would not have received any preferential treatment.\900\ From
a practical standpoint, advisers may find it more burdensome to sort
out prospective investors who did not ultimately invest from prospects
that did invest in the fund. This commenter also stated that requiring
an adviser to retain records from a prospective investor that does not
invest in the fund could conflict with other legal obligations an
adviser has (e.g., data protection rules in another jurisdiction).\901\
We recognize that advisers and their related persons may have to
navigate different or potentially competing obligations under other
laws, including data protection laws and marketing laws applicable in
other countries; however, we do not believe that such other obligations
warrant removing this requirement. Advisers will need to determine
whether, and how, they can engage prospective

investors based on the facts and circumstances and applicable law.
---------------------------------------------------------------------------

    \898\ Proposed rule 211(h)(2)-3(b).
    \899\ See CFA Comment Letter I; Convergence Comment Letter.
    \900\ See AIMA/ACC Comment Letter.
    \901\ See id.
---------------------------------------------------------------------------

    Regardless of whether the investor actually receives any
preferential treatment, this recordkeeping obligation is necessary to
help ensure that advisers complied with the preferential treatment
rule. Many advisers track which prospective investors have been
contacted and what documents have been provided to them, whether
through a virtual data room or otherwise. They also typically require
placement agents or other third parties that are distributing fund
documents on their behalf to retain an investor log, which typically
includes prospective investors. Accordingly, we believe that the
benefits justify the burdens associated with the rule.
    We are adopting these amendments as proposed, and advisers are
required to retain copies of all written notices sent to current and
prospective investors in a private fund pursuant to the preferential
treatment rule.\902\ In addition, advisers are required to retain
copies of a record of each addressee and the corresponding dates sent.
In a change from the proposal, we are not requiring private fund
advisers to make and retain records of the addresses or delivery
methods used to disseminate any such written notices.\903\ These
requirements will facilitate our staff's ability to assess an adviser's
compliance with the rule and will enhance an adviser's compliance
efforts.
---------------------------------------------------------------------------

    \902\ See supra footnote 452 (describing the record retention
requirements under the books and records rule).
    \903\ See the discussion of recordkeeping requirements above in
section II.B.6.
---------------------------------------------------------------------------

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

    We are adopting the proposed amendments to the Advisers Act
compliance rule to require all SEC-registered advisers to document the
annual review of their compliance policies and procedures in writing,
as proposed.\904\ This requirement focuses attention on the importance
of the annual compliance review process. In addition, we believe that
the amendments will result in records of annual compliance reviews that
allow our staff to determine whether an adviser has complied with the
review requirement of the compliance rule.\905\
---------------------------------------------------------------------------

    \904\ Final amended rule 206(4)-7(b).
    \905\ See Compliance Programs of Investment Companies and
Investment Advisers, Investment Advisers Act Release No. 2204 (Dec.
17, 2003) [38 FR 74714 (Dec. 24, 2003)] (``Compliance Rule Adopting
Release''). When adopting the compliance rule, the Commission
adopted amendments to the books and records rule requiring advisers
to make and keep true a copy of the adviser's compliance policies
and procedures and any records documenting an adviser's annual
review of its compliance policies and procedures. The Commission
noted that this recordkeeping requirement was designed to allow our
examination staff to determine whether the adviser has complied with
the compliance rule. See also final amended rule 204-2(a)(17)(i) and
(ii).
---------------------------------------------------------------------------

    The amendment to the compliance rule requires advisers to review
and document in writing, no less frequently than annually, the adequacy
of their compliance policies and procedures and the effectiveness of
their implementation. The annual review requirement was intended to
require advisers to evaluate periodically whether their compliance
policies and procedures continue to work as designed and whether
changes are needed to assure their continued effectiveness.\906\ As we
stated in the Compliance Rule Adopting Release, ``the annual review
should consider any compliance matters that arose during the previous
year, any changes in the business activities of the adviser or its
affiliates, and any changes in the Advisers Act or applicable
regulations that might suggest a need to revise the policies and
procedures.''
---------------------------------------------------------------------------

    \906\ See Compliance Programs of Investment Companies and
Investment Advisers, Investment Advisers Act Release No. 2107 (Feb.
5, 2003) [68 FR 7038 (Feb. 11, 2003)].
---------------------------------------------------------------------------

    Based on staff experience, we understand that some investment
advisers do not make and preserve written documentation of the annual
review of their compliance policies and procedures. Our examination
staff relies on documentation of the annual review to help the staff
understand an adviser's compliance program, determine whether the
adviser is complying with the rule, and identify potential weaknesses
in the compliance program. Without documentation that the adviser
conducted the review, including information about the substance of the
review, our staff has had limited visibility into the adviser's
compliance practices. The amendment to rule 206(4)-7 establishes a
written documentation requirement applicable to all advisers subject to
the compliance rule.\907\
---------------------------------------------------------------------------

    \907\ The adviser is required to maintain the written
documentation of its annual review in an easily accessible place for
at least five years after the end of the fiscal year in which the
review was conducted, the first two years in an appropriate office
of the investment adviser. See rule 204-2(a)(17)(ii).
---------------------------------------------------------------------------

    Some commenters supported this rule,\908\ while other commenters
opposed it.\909\ Commenters who supported the rule explained that
written documentation of the annual review has been widely adopted as a
standard practice by investment advisers and would not have a large
impact.\910\ The commenters that opposed it indicated that it may
increase costs,\911\ and deter an adviser from having compliance
consultants or outside counsel.\912\ A commenter that generally
supported the rule cautioned that a prescriptive approach could lead to
less tailored compliance reviews.\913\
---------------------------------------------------------------------------

    \908\ CFA Comment Letter I; IAA Comment Letter II; Convergence
Comment Letter; Comment Letter of National Regulatory Services, a
ComplySci Company (Apr. 25, 2022) (``NRS Comment Letter'').
    \909\ ATR Comment Letter; NYC Bar Comment Letter II; SBAI
Comment Letter.
    \910\ See generally SBAI Comment Letter and IAA Comment Letter
II.
    \911\ NYC Bar Comment Letter II.
    \912\ Curtis Comment Letter.
    \913\ SBAI Comment Letter.
---------------------------------------------------------------------------

    Although we acknowledge commenters' concerns, we continue to
believe that written documentation of the annual review is necessary
for three key reasons. First, written documentation of the annual
review may help advisers better assess whether they have considered any
compliance matters that arose during the previous year, any changes in
the adviser's or an affiliate's business activities during the year,
and any changes to the Advisers Act or other rules and regulations that
may suggest a need to revise an adviser's policies and procedures.
Second, the availability of written documentation of the annual review
should allow the Commission and the Commission staff to determine if
the adviser is regularly reviewing the adequacy of the adviser's
policies and procedures. Third, clients and investors conducting due
diligence may request written documentation of the annual review to
assess whether the adviser applies a structured framework and rigor to
its compliance program.
    We do not believe the amended rule will significantly increase
costs for advisers. Since adopting the annual review requirement,\914\
the Commission has observed that most advisers already document this
review in writing. Some advisers may see benefits in the form of
increased efficiency because of the written documentation of an annual
review each year. Having written documentation year over year provides
the adviser a starting point so that advisers, internal service
providers (e.g., internal auditors), external service providers (e.g.,
compliance consultants), or outside counsel can be more targeted when
conducting future annual reviews. And, in instances where an adviser
hires external service providers or

outside counsel to participate in the annual review, the adviser may
take steps to defray any potential costs. For example, some advisers
may choose to have their employees document a summary of results as
explained to them by service providers or outside counsel, rather than
request that the service provider or outside counsel produce a written
summary.
---------------------------------------------------------------------------

    \914\ See Compliance Rule Adopting Release, supra footnote 905.
---------------------------------------------------------------------------

    Nor do we believe that the amended rule will deter an adviser from
using service providers (e.g., compliance consultants) or outside
counsel. Since early 2004, advisers have had an obligation to review,
at least annually, the adequacy and effectiveness of their policies and
procedures.\915\ Many advisers that already document the annual review
in writing communicate with service providers or outside counsel,
either throughout the entire annual review or for discrete issues.
Nothing in this rule prohibits advisers from seeking the guidance of
service providers or outside counsel during their annual review.
Although this rule will now require that the adviser document the
annual review in writing, it still provides advisers the flexibility to
determine the scope of that review, including when, if at all, and how
to communicate with service providers or outside counsel.
---------------------------------------------------------------------------

    \915\ Id.
---------------------------------------------------------------------------

    One commenter stated that the amendment would be unnecessarily
burdensome and duplicative for asset managers that have multiple
registered investment advisers operating under a common compliance
program.\916\ The commenter stated that, under the proposed amendment,
advisers in an advisory complex would be producing multiple duplicative
reports with little variation.\917\ While the benefits of the produced
reports may diminish with each marginal report produced with little
variation, the costs will likely also decrease. We also do not believe
that the marginal benefits of each report will be de minimis. For
advisers in an advisory complex with many advisers, producing each
report may help advisers assess whether they have considered any
compliance matters that arose during the previous year, changes in
business activities, or changes to the Advisers Act or other rules and
regulations that may impact that particular adviser. Even if, in
certain cases, consideration of such issues produces a similar report
to a previous one, there may be broader benefits across the industry
from standardizing the practice of advisers making such assessments
throughout their entire advisory complex.\918\
---------------------------------------------------------------------------

    \916\ SIFMA-AMG Comment Letter I.
    \917\ Id.
    \918\ See infra section VI.D.7 (Benefits and Costs--Written
Documentation of All Advisers' Annual Review of Compliance
Programs).
---------------------------------------------------------------------------

    The amended rule does not enumerate specific elements that advisers
must include in the written documentation of their annual review. The
written documentation requirement is intended to be flexible to allow
advisers to continue to use the review procedures they have developed
and found most effective. For example, some advisers may review the
adequacy of their compliance policies and procedures (or a subset of
those compliance policies and procedures) and the effectiveness of
their implementation on a quarterly basis. In such a case, we believe
that the written documentation of the annual review could comprise
written quarterly reports. Some commenters suggested that we offer
flexibility in the approach to the written annual review
requirement.\919\ We have previously stated our views regarding the
areas that we expect an adviser's policies and procedures to address,
at a minimum, if they are relevant to the adviser.\920\ We understand
that some advisers may choose to document the annual review of their
written policies and procedures: (i) in a lengthy written report with
supporting documentation; (ii) quarterly documentation, aggregated at
year end; (iii) a presentation to the board or another governing body,
such as a limited partner advisory committee (LPAC); (iv) a short
memorandum summarizing the findings; and (v) informal documentation,
such a compilation of notes throughout the year.\921\ There are a
number of other ways that an adviser may choose to document its annual
review.\922\ This rule does not prescribe a specific format of the
written documentation, instead, allowing an adviser to determine what
would be appropriate.
---------------------------------------------------------------------------

    \919\ NSCP Comment Letter; AIMA/ACC Comment Letter; SIFMA-AMG
Comment Letter I.
    \920\ Compliance Rule Adopting Release, supra footnote 905.
    \921\ See generally NSCP Comment Letter.
    \922\ See generally NSCP Comment Letter (describing a wide range
of ``other responses'' for how advisers currently document their
annual review in writing).
---------------------------------------------------------------------------

    A commenter suggested that we should require advisers to provide
the written documentation to the private fund's LPAC.\923\ The
commenter argued that this would provide evidence that the adviser has
a systematic process in place to identify and address changes in the
adviser's business model. While an adviser may choose to share the
results of its annual review with the LPAC, or even investors in the
fund, we are not requiring this. We do not believe that LPAC delivery
is required to help ensure that advisers periodically evaluate whether
their compliance policies and procedures continue to work as designed
and whether changes are needed to assure their continued effectiveness.
---------------------------------------------------------------------------

    \923\ Convergence Comment Letter.
---------------------------------------------------------------------------

    The required written documentation of the annual review under the
compliance rule is meant to be made available to the Commission and the
Commission staff and therefore should promptly \924\ be produced upon
request.\925\ Commission staff has observed improper claims of the
attorney-client privilege, the work-product doctrine, or other similar
protections over required records, including any records documenting
the annual review under the compliance rule, based on reliance on
attorneys working for the adviser in-house or the engagement of law
firms and other service providers (e.g., compliance consultants)
through law firms.\926\ Attempts to improperly shield from, or
unnecessarily delay production of any non-privileged record is
inconsistent with prompt production obligations and undermines
Commission staff's ability to conduct examinations. Prompt access to
all records is critical for protecting investors and to an effective
and efficient examination program.
---------------------------------------------------------------------------

    \924\ We have previously stated that ``[w]hile the ``promptly''
standard [for producing books and records] imposes no specific time
limit, we expect that a fund or adviser would be permitted to delay
furnishing electronically stored records for more than 24 hours only
in unusual circumstances. At the same time, we believe that in many
cases funds and advisers could, and therefore will be required to,
furnish records immediately or within a few hours of request.''
Electronic Recordkeeping by Investment Companies and Investment
Advisers, Investment Advisers Act Rel. No. 1945 (May 24, 2001).
    \925\ In connection with the written report required under rule
38a-1, the Compliance Rule Adopting Release stated that ``[a]ll
reports required by our rules are meant to be made available to the
Commission and the Commission staff and, thus, they are not subject
to the attorney-client privilege, the work-product doctrine, or
other similar protections.'' See Compliance Rule Adopting Release,
supra footnote 905.
    \926\ Compliance Rule Adopting Release, supra footnote 905, at
n.94. Staff also has observed delays in production of other non-
privileged records. Delays undermine the staff's ability to conduct
examinations and may be inconsistent with production obligations.
See OCIE National Examination Program Risk Alert: Investment Adviser
Compliance Programs (Nov. 19, 2020) (``EXAMS Investment Adviser
Compliance Programs Risk Alert 2020''), available at https://www.sec.gov/files/Risk%20Alert%20IA%20Compliance%20Programs_0.pdf
(the staff has observed instances of advisers failing to respond in
a timely manner to requests for required books and records).

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IV. Transition Period, Compliance Date, Legacy Status

    For the audit rule and the quarterly statement rule, we are
adopting an 18-month transition period for all private fund advisers.
For the adviser-led secondaries rule, the preferential treatment rule,
and the restricted activities rule, we are adopting staggered
compliance dates that provide for the following transition periods: for
advisers with $1.5 billion or more in private funds assets under
management (``larger private fund advisers''), a 12-month transition
period and for advisers with less than $1.5 billion in private funds
assets (``smaller private fund advisers''), an 18-month transition
period. Compliance with the amended Advisers Act compliance rule will
be required 60 days after publication in the Federal Register.
    We proposed a one-year transition period to provide time for
advisers to come into compliance with these new and amended rules. Some
commenters suggested adopting a longer transition period, such as 18
months,\927\ two years,\928\ or at least three years,\929\ while other
commenters have called for a swifter implementation.\930\ Commenters
also suggested an extended transition period for smaller or newer
managers.\931\ Although we considered a longer transition period for
all private fund advisers, we have concerns that activity involving
problematic sales practices, compensation schemes, and conflicts of
interest would persist during any extended transition period to the
detriment of investors.
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    \927\ SIFMA-AMG Comment Letter I; Schulte Comment Letter; PIFF
Comment Letter; CFA Comment Letter I; NSCP Comment Letter.
    \928\ MFA Comment Letter I; SBAI Comment Letter; AIC Comment
Letter II.
    \929\ AIMA/ACC Comment Letter; Chamber of Commerce Comment
Letter.
    \930\ Comment Letter of Los Angeles City Employees' Retirement
System (Apr. 12, 2022) (``LACERS Comment Letter'').
    \931\ ILPA Comment Letter I. See also SEC Small Business Capital
Formation Advisory Committee letter to Chair Gensler (Feb. 28, 2023)
(expressing concern that the proposal could adversely impact small
funds that attract sophisticated investors for small companies'
growth).
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Audit Rule and Quarterly Statement Rule

    We believe that the audit rule and the quarterly statement rule
warrant longer transition periods because they may require advisers to
enter into new, or renegotiate existing, contracts with third-party
service providers, such as accountants and administrators.
    First, for the mandatory audit requirement, commenters suggested
that the Commission extend, for at least one additional year, the
transition period to allow private funds and their auditors enough time
to properly assess auditor independence requirements.\932\ Under the
mandatory private fund adviser audit rule, there will not be an option
for a surprise examination as there is under the current custody rule.
That is, a private fund adviser will not be able to satisfy the
requirements of the audit rule by undergoing a surprise examination
that would comply with the custody rule. In light of these
considerations, we believe that additional time of up to 18 months is
appropriate to allow advisers time to either hire an audit firm that
meets the SEC independence requirements or cause the auditor to cease
providing any services that impair independence for purposes of the SEC
independence requirements.
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    \932\ E&Y Comment Letter.
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    Second, under the quarterly statement requirement, commenters
expressed concern that one year may not be enough time to come into
compliance with a new rule as many advisers will need to find new
reporting vendors or renegotiate agreements with existing vendors to
implement the required rule changes \933\ and create and update
reporting templates.\934\ Commenters also highlighted that advisers may
need additional time to make the necessary adjustments to their
operational and compliance systems.\935\ Based on these comments, we
have also decided to allow up to 18 months to comply with the quarterly
statement requirement. We believe this transition period will provide
an appropriate period of time that balances the needs of advisers to
engage third parties and amend existing forms, with the needs of
investors to receive this information.
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    \933\ Curtis Comment Letter; NRS Comment Letter; see generally
NSCP Comment Letter.
    \934\ SBAI Comment Letter; REBNY Comment Letter; see generally
AIC Comment Letter I.
    \935\ AIC Comment Letter I; see also Chamber of Commerce Comment
Letter (advisers may need to build and implement compliance
structures and systems to address new elements of the rules).
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Adviser-Led Secondaries, Preferential Treatment, and Restricted
Activities Rules

    Commenters requested an extended transition period for smaller or
newer managers, stating that smaller or newer managers may require more
time to modify practices to come into compliance.\936\ We agree with
these commenters that smaller private fund advisers will likely need
additional time to modify existing practices, policies, and procedures
to come into compliance. Accordingly, we are providing staggered
compliance dates, with a longer transition period for smaller private
fund advisers. The compliance date for larger private fund advisers
will provide for a 12-month transition period, while the compliance
date for smaller private fund advisers will provide for an 18-month
transition period. This additional time will allow smaller private fund
advisers, and their service providers, to adequately address the
various new requirements under the rules and promote a smooth and
efficient implementation of the rules. We believe that, by allowing a
longer transition period for smaller advisers, the costs of compliance
would be lessened by the sharing of industry knowledge from larger
advisers that were required to comply at least six months earlier. For
example, smaller advisers would be afforded more time to assess which
parts of the implementation process can be performed in house versus
those that must be outsourced and to identify, and negotiate with,
appropriate service providers. Smaller private fund advisers will also
likely receive the benefit of model forms and templates developed by
larger private fund advisers and their service providers, which may
reduce costs for smaller private fund advisers.
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    \936\ ILPA Comment Letter I; CVCA Comment Letter.
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    We are differentiating between larger private fund advisers and
smaller private fund advisers based on private fund assets under
management, calculated as of the last day of the adviser's most
recently completed fiscal year. An adviser's private fund assets under
management are the portion of such adviser's regulatory assets under
management that are attributable to private funds it advises.\937\ We
chose to use the term ``private fund assets under management'' because
many advisers are familiar with such term under Form PF. Investment
advisers registered (or required to be registered) with the Commission
with at least $150 million in private fund assets under management
generally must file Form PF.\938\ Accordingly, we believe that private
fund assets under management is appropriate to use here because many
advisers will already be familiar with how to calculate their private
fund assets under management.
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    \937\ Regulatory assets under management are calculated in
accordance with Part 1A, Instruction 5.b of Form ADV.
    \938\ See 17 CFR 275.204(b)-1.
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    One commenter suggested differentiating between advisers based on
specific parameters (e.g., assets

under management).\939\ Another commenter suggested using a combination
of specific metrics, such as employee headcount and assets under
management, to determine if a firm meets the threshold for being a
larger private fund adviser.\940\ We considered using metrics other
than, or in addition to, private fund assets under management for
purposes of this threshold, but we anticipate that they would be more
likely to lead to adverse incentives or otherwise be less reliable
metrics. For instance, if we were to define larger private fund
advisers based on number of employees, advisers may be incentivized to
outsource operations and minimize compliance personnel. Also, unlike
private fund assets under management, employee headcount attributable
to an adviser's private funds is generally not tracked or reported to
the Commission.\941\ We believe that private fund assets under
management is the appropriate metric because it is less likely to
create adverse incentives and is more likely to be tracked and reported
by private fund advisers than other metrics.
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    \939\ ILPA Comment Letter I.
    \940\ Predistribution Initiative Comment Letter II.
    \941\ We note that Form ADV, Part 1, Item 5 requires an adviser
to disclose certain information regarding its employees, including
the number of full- and part-time employees.
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    We believe that $1.5 billion in private fund assets under
management is the appropriate threshold for a tiered compliance date
for smaller private fund advisers.\942\ The threshold is designed so
that the group of larger private fund advisers will be relatively small
in number but represent a substantial portion of the assets of the
private funds industry. For example, we estimate that approximately
1,478 SEC registered investment advisers each managing at least $1.5
billion in private fund assets represent approximately 75% of private
fund assets under management advised by registered private fund
advisers and exempt reporting advisers.\943\ Similarly, we estimate
that approximately 491 exempt reporting advisers each managing at least