investors face when searching for an investment adviser; specifically
the lack of information that investors may have about the ability and
potential fit of an investment adviser for the investor's preferences.
By setting up this economic framework, we can see how the
characteristics of the market for investment advice and its
participants can influence the costs and benefits of the final rule and
its impact on efficiency, competition, and capital formation.
Information Usefulness
    The usefulness of the information in investment adviser
advertisements is an important factor in determining how investors
decide with which investment advisers to engage. For the purposes of
the final rule, we use the term ``ability'' to refer to the usefulness
of advice an investment adviser provides. The ``potential fit'' of an
investment adviser refers to attributes that investors may have
specific preferences for, such as communication style, investment
style, or risk preference. For example, some investors would prefer an
investment adviser that does not proactively provide advice or suggest
investments, while others might prefer a more active communication and
management style.
    While the effectiveness and usefulness of an investment adviser's
advertisements can have direct effects on the quality of the matches
that investors make with investment advisers--in terms of both fit and
better returns from the investment--there may be important indirect
effects as well. If the final rule provides additional methods for
investment advisers to

credibly and truthfully advertise their ability and potential fit with
investors, investment advisers may have a greater marginal incentive to
invest more in the quality of their services, because advisers would
have additional methods to communicate their ability and potential fit
through advertisements. Additionally, because investors might be able
to better observe the relative qualities of competing investment
advisers, the final rule may also enhance competition among investment
advisers. In summary, to the extent that the final rule improves the
effectiveness and usefulness of investment adviser advertisements, the
final rule could also have a secondary effect of increasing competition
among investment advisers, and encourage investment in the quality of
services.
Information Access
    Investors generally have access to a variety of sources of
information on the ability and potential fit of an investment adviser.
Advertisements, word of mouth referrals, and independent research are
all ways in which investors acquire information about investment
advisers as they search for them. During this search, investors trade
off the benefits of finding a better investment adviser (in terms of
ability and potential fit) against the costs of searching for and
obtaining information about one. If the cost of searching is too high,
investors may contract with lower quality investment advisers on
average, because they cannot spend the resources to conduct a search
that would yield an investment adviser with higher ability or better
fit, or they might not be able to evaluate the quality of the
investment adviser they have found. Thus, higher search costs can
result in inefficiencies because the same expected quality of match
requires an investor to incur higher search costs. Similarly, for a
fixed amount of spending on a search, an investor is less able to find
information about investment advisers, and finds a lower expected
quality of match.
    Marketing can potentially mitigate inefficiencies associated with
the costs of searching for good products or suitable services. To the
extent that marketing provides accurate and useful information to
investors about investment advisers at little or no cost to investors,
marketing can reduce the search costs that investors bear to acquire
information and improve the ability of investors to identify high
quality investment advisers. Investors have a variety of preferences
regarding investment adviser characteristics such as investment
strategies or communication styles. Marketing can help communicate
information about an investment adviser's ability, and that may aid an
investor in selecting an investment adviser who is a good ``fit'' for
the investor's preferences.
    While marketing by or on behalf of investment advisers may reduce
search costs for potential investors, investment advisers' or
promoters' incentives may not necessarily be aligned with those of
potential investors. Such a misalignment could undercut the potential
gains to efficiency. For example, investment advisers have incentives
to structure their advertisements to gain potential investors,
regardless of whether their advertisements accurately reflect their
ability and indicate whether they offer a potential fit with an
investor's preferences. One commenter suggested, for instance, that
advisers may be incentivized to purchase positive testimonials or
endorsements, or otherwise curate content.\842\
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    \842\ See NASAA Comment Letter.
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    In addition, advertisements might make claims that are costly for
investors to verify or are inherently unverifiable. For example,
evaluating a claim that an investment adviser's strategy generates
``alpha'' or returns in excess of priced risk factors generally
requires information about the strategy's returns and permitted
holdings, as well as a model that attributes returns to risk factors.
While some investors may have ready access to these resources or
information, other investors may not. In some cases, an investor may be
unable to assess the plausibility of an investment adviser's claims. An
investment adviser might also state facts but omit the contextual
details that an investor would need to properly evaluate these facts.
    Several economic models suggest that the ability to control or
influence an investor's access to information can hamper the investor's
ability to process information in an unbiased manner, even if the
specific facts or information communicated to an investor are not
false.\843\ For example, this type of control or influence on
information can be as explicit as deletion or removal of unfavorable
ratings or reviews,\844\ or as implicit as a reordering of the ratings
or a suggestion of which ratings or reviews to read.\845\ Similarly,
promoters may overstate the quality of the investment adviser they are
promoting or their familiarity with the advisers' services, or hide
negative details that would have aided an investor when choosing an
investment adviser or private fund, given promoters' financial
incentive to recommend the adviser to the investor.
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    \843\ Luis Rayo and Ilya Segal, Optimal Information Disclosure,
118 J. POL. ECON. 949 (2010); Emir Kamenica and Matthew Gentzkow,
Bayesian Persuasion, 101 a.m. ECON. REV. 2590 (2011); Pak Hung Au
and King King Li, Bayesian Persuasion and Reciprocity: Theory and
Experiment, SSRN (June 5, 2018), available at https://ssrn.com/abstract=3191203; Jacob Glazer and Ariel Rubinstein, On Optimal
Rules of Persuasion, 72 ECONOMETRICA 1715 (2004) (``Glazer'').
    \844\ See id. for Segal and Rayo 2010, Kamenica and Gentzkow
2011, Au Li 2018.
    \845\ See Glazer, supra footnote 843.
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Information Evaluation
    There are considerable differences among investors and potential
investors in their ability to process and evaluate information
communicated by investment advisers. Many investors and prospective
investors may lack the financial literacy needed to evaluate and
interpret the types of financial information contained in investment
adviser advertisements. In 2010, the Dodd-Frank Act required the
Commission to study the financial literacy among retail investors,
including methods and efforts that could increase financial literacy
among investors.\846\ The Commission contracted with the Federal
Research Division at the Library of Congress to conduct a review of the
quantitative studies on the financial literacy of retail investors in
the United States.\847\ According to the Library of Congress Report,
studies show consistently that many American retail investors \848\
lack important elements of financial literacy. For example, studies
have found that many investors do not understand certain financial
concepts, such as compound interest and inflation. Studies have also
found that many investors do not understand other key

financial concepts, such as diversification or the differences between
stocks and bonds, and are not fully aware of investment costs and their
impact on investment returns.\849\ A 2016 FINRA survey found that 56
percent of respondents correctly answered less than half of a set of
financial literacy questions, and yet 65 percent of respondents
assessed their own knowledge about investing as high (between five and
seven on a seven-point scale).\850\ Moreover, the general lack of
financial literacy among some investors makes it difficult for those
investors to evaluate claims about financial services made in
advertisements, which increases the risk that such investors are unable
to effectively use the information in advertisements to find an
investment adviser that has high ability and is a good fit.\851\
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    \846\ U.S. Securities and Exchange Commission, Study Regarding
Financial Literacy Among Investors As Required by Section 917 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Aug.
2012), available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf. (``Financial Literacy Study'').
    \847\ See id. Although the report does not link American
investors specifically to those who would become clients of SEC-
registered investment advisers or investors in private funds, we
believe that the study may be indicative of the level of financial
literacy for prospective investors.
    \848\ The financial literacy studies in the Library of Congress
Report (2011) fall into three categories, depending on the
population or special topic under investigation. Most studies survey
the general population. For example, the FINRA Investor Education
Foundation's 2009 National Financial Capability study, which was
included in the Library of Congress Report, consisted of a national
sample of 1488 respondents. Other research included in the report
focus on particular subgroups, such as women, or specific age groups
or minority groups. A third type of study deals specifically with
investment fraud. These studies do not differentiate between
qualified purchasers, knowledgeable employees, and other investors.
Results from studies conducted on general populations may not apply
to private fund investors.
    \849\ See Financial Literacy Study, supra footnote 846.
    \850\ FINRA Investor Education Foundation, Investors in the
United States (2016).
    \851\ Annamaria Lusardi and Olivia S. Mitchell, The Economic
Importance of Financial Literacy: Theory and Evidence, 52 J. ECON.
LITERATURE 5 (2014).
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C. Baseline

1. Market for Investment Advisers for the Advertising Rule
a. Current Regulation
    The current rule 206(4)-1 imposes four broadly drawn limitations on
the content of advertisements that are ``directly or indirectly''
published, circulated, or distributed by investment advisers. In
addition to these specific prohibitions, the current rule prohibits any
advertisement that contains any untrue statement of a material fact, or
which is otherwise false or misleading. This prohibition operates more
generally than the specific prohibitions to address advertisements that
do not violate any of the specific prohibition but still may be
fraudulent, deceptive, or manipulative and, accordingly, may risk
misleading investors.
    For purposes of the advertising rule, the Commission currently
defines ``advertisement'' to be ``any notice, circular, letter or
written communication addressed to more than one person, or any notice
or other announcement in any publication or by radio or television,
which offers (1) any analysis, report, or publication concerning
securities, or which is to be used in making any determination as to
when to buy or sell any security, or which security to buy or sell, or
(2) any graph, chart, formula, or other device to be used in making any
determination as to when to buy or sell any security, or which security
to buy or sell, or (3) any other investment advisory service with
regard to securities.''
    Investment advisers owe a fiduciary duty under the Advisers Act,
which is enforceable under the Act's anti-fraud provisions in section
206.\852\ Section 206 of the Advisers Act prohibits misstatements or
misleading omissions of material facts and other fraudulent acts and
practices in connection with the conduct of an investment advisory
business.\853\
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    \852\ See Fiduciary Interpretation, supra footnote 88, at 6-7.
    \853\ See also section 17(a) of the Securities Act, section
10(b) of the Exchange Act and rule 10b-5 thereunder, and rule
206(4)-8 under the Advisers Act.
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b. Market Practice
    In addition to section 206 and rule 206(4)-1, investment advisers
have considered staff no-action letters in their advertising practices.
For example, the staff has issued no-action letters under rule 206(4)-
1(b), stating that, in general, the staff would not view a written
communication by an adviser to an existing client or investor about the
performance of the securities in the investor's account as an ``offer''
of investment advisory services but instead would view it as part of
the adviser's advisory services (unless the context in which the
performance or past specific recommendations are provided suggests
otherwise), and that the staff would not view communications by an
adviser in response to an unsolicited request by an investor,
prospective client, or consultant for specified information as an
advertisement.\854\
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    \854\ See ICAA letter, supra footnote 95.
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    The staff has also stated that it would not recommend enforcement
action under section 206(4) and rule 206(4)-1 on issues relating to
third-party ratings and testimonials. Specifically, the staff has
stated that it would not recommend enforcement action if certain
circumstances were present regarding the use of ratings or
testimonials, such as: (i) References to independent third-party
ratings that are developed by relying significantly on client surveys
or clients' experiences more generally; \855\ (ii) the use of ``social
plug-ins'' such as the ``like'' feature on an investment adviser's
social media site; \856\ and (iii) references regarding, for example,
an adviser's religious affiliation or moral character, trustworthiness,
diligence or judgement, in addition to more typical testimonials that
reference an adviser's technical competence or performance track
record.\857\ The Commission has also stated that an investment adviser
should consider the application of rule 206(4)-1, including the
prohibition on testimonials, before including hyperlinks to third-party
websites on its website or in its electronic communications.\858\ For
example, staff has stated that it would not recommend enforcement
action, under certain circumstances, when an adviser provided: (i) Full
and partial client lists; \859\ and (ii) references to unbiased third-
party articles concerning the investment adviser's performance.\860\
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    \855\ See Investment Adviser Association, SEC Staff No-Action
Letter (Dec. 2, 2005) (not recommending enforcement action if in
determining whether a third-party rating is a testimonial, the
adviser considers the criteria used by the third party when
formulating the rating and the significance to the ratings
formulation of criteria related to client evaluations of the
adviser); DALBAR, Inc., SEC Staff No-Action Letter (Mar. 24, 1998)
(not recommending enforcement action if an adviser used references
to third-party ratings that reflect client experiences, based on
certain representations and certain disclosures made, both of which
designed to ensure that the rating is developed in a fair and
unbiased manner and that disclosures provide investors with
sufficient context to make informed decisions).
    \856\ See, e.g., National Examination Risk Alert, Office of
Compliance, Inspections and Examinations (Jan. 4, 2012).
    \857\ See Gallagher and Associates, Ltd., SEC Staff No-Action
Letter (July 10, 1995) (where the staff reiterated its view that
rule 206(4)-1 prohibits testimonials of any kind concerning the
investment adviser); see also IM Guidance Update No. 2014-04, at
n.12 and accompanying text, in which staff partially withdrew its
Gallagher position.
    \858\ See Interpretive Guidance on the Use of Company websites,
Release No. IC-28351 (Aug. 1, 2008); see also Guidance on the
Testimonial Rule and Social Media, IM Guidance Update No. 2014-04,
at n.19 and accompanying text.
    \859\ See, e.g., Cambiar Investors, Inc., SEC Staff No-Action
Letter (Aug. 28, 1997) (stating it would not recommend enforcement
action when the adviser proposed to use partial client lists that do
no more than identify certain clients of the adviser, the Commission
staff stated its view that partial client lists would not be
testimonials because they do not include statements of a client's
experience with, or endorsement of, an investment adviser); see also
Denver Investment Advisors, Inc., SEC Staff No-Action Letter (July
30, 1993) (stating that partial client lists can be, but are not
necessarily, considered false and misleading under 206(4)-1(a)(5)).
    \860\ See New York Investors Group, Inc., SEC Staff No-Action
Letter (Sept. 7, 1982) (stating that in the staff's view an unbiased
third-party article concerning an adviser's performance is not a
testimonial unless the content includes a statement of a customer's
experience with or endorsement of the adviser).
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    Staff no-action letters have also stated that the staff would not
recommend enforcement action under rule 206(4)-1 for references to
specific investment advice in an advertisement, notwithstanding the
rule's general prohibition of the use of past specific recommendations.
An adviser that acts consistently with a staff no-action letter may
include past specific recommendations in an advertisement

provided the recommendations were selected using performance-based or
objective, non-performance-based criteria, and in either case, the
adviser's practices are consistent with a number of specific
representations articulated in the no-action letters.\861\ For example,
the staff stated that it would not recommend enforcement action if an
adviser included in an advertisement a partial list of recommendations
provided that, in general, the list: (i) Includes an equal number (at
least five) of best and worst-performing holdings; (ii) takes into
account consistently the weighting of each holding within the portfolio
(or representative account) that contributed to the performance during
the measurement period; (iii) is presented consistently from
measurement period to measurement period; and (iv) discloses how to
obtain the calculation methodology and an analysis showing every
included holding's contribution to the portfolio's (or representative
account's) overall performance.\862\
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    \861\ See, e.g., Scientific Market Analysis, SEC Staff No-Action
Letter (Mar. 24, 1976) (the staff would not recommend enforcement
action when an investment adviser offers a list of past specific
recommendations, provided that the adviser offers to provide the
list free of charge); and Kurtz Capital Management, SEC Staff No-
Action Letter (Jan. 18, 1988) (the staff would not recommend
enforcement action relating to an adviser's distribution of past
specific recommendations contained in third-party reports, provided
that the adviser sends only bona-fide unbiased articles).
    \862\ See The TCW Letter (not recommending enforcement action
based on certain representations such as presenting best and worst-
performing holdings on the same page with equal prominence;
disclosing that the holdings identified do not represent all of the
securities purchased, sold or recommended for the adviser's clients
and that past performance does not guarantee future results; and
maintaining certain records, including, for example, evidence
supporting the selection criteria used and supporting data necessary
to demonstrate the calculation of the chart or list's contribution
analysis).
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    The staff has also stated that it would not recommend enforcement
action if an adviser includes in an advertisement a partial list of
recommendations selected using objective, non-performance-based
criteria, provided that, in general: (i) The same selection criteria
are used consistently from measurement period to measurement period;
(ii) there is no discussion of the profits or losses (realized or
unrealized) of any specific securities; and (iii) the adviser maintains
certain records, including, for example, records that evidence a
complete list of securities recommended by the adviser in the preceding
year for the specific investment category covered by the advertisement
and the criteria used to select the specific securities listed in the
advertisement.\863\
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    \863\ See Franklin Letter (not recommending enforcement action
based on certain representations including that the adviser would
disclose in the advertisement that the specific securities
identified and described do not represent all of the securities
purchased, sold, or recommended for advisory clients, and that the
investor not assume that investments in the securities identified
and discussed were or will be profitable); see also supra footnote
204 (citing Clover Letter, Stalker Letter, and Eberstadt Letter
regarding untrue or misleading implications).
---------------------------------------------------------------------------

    Finally, the Commission has brought enforcement actions related to
the presentation of performance results in advertisements. For example,
we have alleged in settled enforcement actions that the performance
information that certain advisers included in their advertisements
failed to disclose all material facts, and thus created unwarranted
implications or inferences.\864\ Our staff has also expressed its views
as to the types of disclosures that would be necessary in order to make
the presentation of certain performance information in advertisements
not misleading.\865\ Our staff has taken the position that the failure
to disclose how material market conditions, advisory fee expenses,
brokerage commissions, and the reinvestment of dividends affect the
performance results would be misleading.\866\ Our staff has also
considered materially misleading the suggestion of potential profits
without disclosure of the possibility of losses.\867\
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    \864\ See, e.g., In the Matter of Van Kampen Investment Advisory
Corp., Release No. IA-1819 (Sept. 8, 1999) (settled order); In the
Matter of Seaboard Investment Advisers, Inc., Release No. IA-1431
(Aug. 3, 1994) (settled order).
    \865\ See, e.g., Clover Letter (not recommending enforcement
action provided that certain disclosures about included performance
results are made). Regarding mutual funds, our staff has stated that
it would not recommend enforcement action if an advertisement
included performance data from private accounts that are
substantially similar in size and investment strategy to the fund in
the fund's prospectus or sales literature if the prospectuses or
advertisements: (i) Disclose that the performance results are not
those of the fund and should be considered a substitute for such
performance; (ii) include the fund's performance results if such
results exist and; (iii) disclose all material differences between
the institutional accounts and the fund. See Nicholas-Applegate
Mutual Funds, SEC Staff No-Action Letter (Aug. 6, 1996); GE Funds,
SEC Staff No-Action Letter (Feb. 7, 1997); ITT Hartford Mutual
Funds, SEC Staff No-Action Letter (Feb. 7, 1997).
    \866\ See Clover Letter (not recommending enforcement action
provided that if an adviser compares performance to that of an
index, it would disclose all material factors affecting the
comparison) See also Investment Company Institute, SEC Staff No-
Action Letter (May 5, 1988); Association for Investment Management
and Research, SEC Staff No-Action Letter (Dec. 18, 1996) (not
recommending enforcement action provided that gross performance
results may be provided to clients so long as this information is
presented on a one-on-one basis or alongside net performance with
appropriate disclosure.) See Also Securities Industry Association,
SEC Staff No-Action Letter (Nov. 27, 1989) (not recommending
enforcement action provided that an adviser that advertises
historical net performance using a model fee makes certain
disclosures).
    \867\ See Clover Letter (stating staff's view that an adviser's
advertisement that suggests or makes claims about the potential for
profit without also disclosing the possibility of loss may be
misleading for purposes of rule 206(4)-1(a)(5)).
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    Our staff has taken the position that prior performance results of
accounts managed by a predecessor entity may be used so long as: (i)
The person responsible for such results is still the adviser; (ii) the
prior account and the present account are similar enough that the
performance results would provide relevant information; (iii) all prior
accounts that are being managed in a substantially similar fashion to
the present account are being factored into the calculation; and (iv)
the advertisement includes all relevant disclosures.\868\ More
recently, our staff has taken the position that, based on certain
representations, a surviving investment adviser following an internal
restructuring may continue to use the performance track record of a
predecessor advisory affiliate to the same extent as if the
restructuring had not occurred.\869\
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    \868\ See Horizon Letter; see also Great Lakes Letter (not
recommending enforcement action if a successor adviser, composed of
less than 100 percent of the predecessor's committee, used the
preceding performance information in their calculation when there
was a substantial identification of personnel, and noting that
without substantial identification of personnel in such a committee,
use of the data would be misleading even with appropriate
disclosure).
    \869\ See South State Bank Letter (the staff stated that it
would not recommend enforcement action on representations including,
for example, that the successor adviser would operate in the same
manner and under the same brand name as the predecessor adviser).
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    In addition, the Commission believes that many advisers currently
prepare and present GIPS standard-compliant performance information,
and also that many advisers currently prepare annual performance
information for investors. The GIPS standards require advisers to
provide certain reports to prospective clients at a specific time, and
the standards provide guidance on how advisers can determine whether a
potential investor qualifies as a ``prospective client.'' \870\
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    \870\ Global Investment Performance Standards (GIPS) for Firms
(2020), Provision 1.A.11. (requiring the firm to ``make every
reasonable effort to provide a GIPS Composite Report to all
Prospective Clients when they initially become Prospective
Clients''), and GIPS Standards Handbook for Firms (Nov. 2020),
Discussion of Provision 1.A.11. (stating that ``[i]t is up to the
firm to establish policies and procedures for determining who is
considered to be a prospective client. These include policies and
procedures for determining when an interested party becomes a
prospective client. An interested party becomes a prospective client
when two tests are met. First, the interested party must have
expressed interest in a specific composite strategy or strategies.
Second, the firm must have determined that the interested party
qualifies to invest in the respective composite strategy'').

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    Regarding the use of model performance results, the staff has taken
the position that such results are misleading under rule 206(4)-1(a)(5)
if the investment adviser does not make certain disclosures.\871\ The
Commission has also taken the position that the use of backtested
performance data may be misleading unless accompanied by disclosure
detailing the inherent limitations of data derived from the retroactive
application of a model developed with the benefit of hindsight.\872\
Moreover, staff have taken the position that the rule 204-2(a)(16)
requirement to keep records of documents necessary to form the basis
for performance data provided in advertisements also applies to a
successor's use of a predecessor's performance data.\873\
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    \871\ Id. See also In the Matter of LBS Capital Mgmt. Inc.,
Release No. IA-1644 (July 18, 1997) (settled order) (The Commission
brought an enforcement action and stated its view that the marketing
materials were misleading and that the Commission looks at
``investment sophistication or acumen'' of the recipients of an
advertisement will look into the identity of the intended recipient
of advertisement when determining if the results were misleading.).
    \872\ See In the Matter of Market Timing Systems, Inc., et al.,
Release No. IA-2047 (Aug. 28, 2002) (settled order) (The Commission
brought an enforcement action against, among others, a registered
investment adviser, asserting that its advertising was misleading
because it failed to disclose that performance results advertised
were hypothetical and generated by the retroactive application of a
model, and in other cases failed to disclose the relevant
limitations inherent in hypothetical results and the reasons why
actual results would differ); see also In the Matter of Leeb
Investment Advisers, et al., Release No. IA-1545 (Jan. 16, 1996)
(settled order) (The Commission brought an enforcement action
against, among others, a registered investment adviser, asserting
that advertising mutual fund performance using a market-timing
program based on backtested performance was misleading because the
program changed during the measurement period and certain trading
strategies were not available at the beginning of the measurement
period.). See also In the Matter of Schield Mgmt. Co., et al.,
Release No. IA-1872 (May 31, 2000) (settled order) (The Commission
brought an enforcement action against, among others, a registered
investment adviser, asserting that advertisements presenting
backtested results were misleading in violation of section 206(2)
and rule 206(4)-1 because, among other things, they failed to
disclose or inadequately disclosed that the performance was
backtested, and stating that labeling backtested returns
``hypothetical'' did not fully convey the limitations of the
performance.).
    \873\ Rule 204-2(a)(16); See Great Lakes Letter (not
recommending enforcement action and stating the staff's view that
the requirement in rule 204-2(a)(16) applies to a successor's use of
a predecessor's performance data.)
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    Certain investment advisers that must comply with the final rule
are also subject to other regulatory regimes that govern communications
and advertisements. For example, investment advisers that are also
registered as broker-dealers must comply with FINRA's rules.\874\ FINRA
rule 2210 governs broker-dealers' communications with the public,
including communications with retail and institutional investors, and
provides standards for the content, approval, recordkeeping, and filing
of communications with FINRA. In particular, FINRA's rule 2210(d)(6)
requires any retail communication or correspondence providing any
testimonial concerning the investment advice or investment performance
of a member or its products to prominently disclose: (i) The fact that
the testimonial may not be representative of the experiences of other
customers; (ii) the fact that the testimonial is no guarantee of future
performance or success; and (iii) if more that $100 is paid for the
testimonial, the fact that it is a paid testimonial. FINRA rule
2210(d)(6) also requires that if a testimonial in any type of
communication concerns a technical aspect of investing, the person
making the testimonial must have the knowledge and experience to form a
valid opinion. Regulation BI also applies to testimonials or
endorsements by promoters that are registered broker-dealers to the
extent such testimonials or endorsements are recommendations to retail
customers under that regulation. Additionally, communications to
investors in private funds are subject to various statutory and
regulatory anti-fraud provisions, such as rule 206(4)-8 under the
Advisers Act, section 17(a) of the Securities Act, section 10(b) of the
Exchange Act and rule 10b-5 thereunder.
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    \874\ Similarly, investment advisers registered with the
Commission may also be registered with the National Futures
Association and may be subject to additional compliance rules on
sales practices and promotional material. See NFA Compliance Rules
2-29 and 2-36. See also Municipal Securities Rulemaking Board rules
G-21(a) and G-40.
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c. Data on Investment Advisers
    Based on Form ADV filings, as of August 1, 2020, 13,724 investment
advisers were registered with the Commission. Of these registered
investment advisers (``RIAs''), 11,653 reported that they were ``large
advisory firms,'' with regulatory assets under management (``RAUM'') of
at least $90 million. 512 reported that they were ``mid-sized advisory
firms,'' with RAUM of between $25 million and $100 million, and 1,561
did not report as either, which implies that they have regulatory
assets under management of under $25 million.\875\
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    \875\ From Form ADV: A ``Large advisory firm'' either: (a) Has
regulatory assets under management of $100 million or more or (b)
has regulatory assets under management of $90 million or more at the
time of filing its most recent annual updating amendment and is
registered with the SEC; a ``mid-sized advisory firm'' has
regulatory assets under management of $25 million or more but less
than $100 million and either: (a) Not required to be registered as
an adviser with the state securities authority of the state where
they maintain their principal office and place of business or (b)
not subject to examination by the state securities authority of the
state where they maintain their principal office and place of
business.
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    Form ADV disclosures show $97.05 trillion in RAUM for all RIAs,
with an average of $7.07 billion and a median of $350 million. These
values show that the distribution of RAUM is skewed, with more RIAs
managing assets below the average, than above. The majority of RIAs
report that they provide portfolio management services for individuals
and small businesses.\876\ In aggregate, RIAs have over $97 trillion in
RAUM. A substantial percentage of RAUM at investment advisers is held
by institutional investors, such as investment companies, pooled
investment vehicles, and pension or profit-sharing plans.\877\ Based on
staff analysis of Form ADV data, 8,134 (59 percent) of RIAs have some
portion of their business dedicated to individual clients, including
both high net worth and non-high net worth individual clients.\878\ In
total, firms that have some portion of their business dedicated to high
net worth clients have approximately $44 trillion of RAUM,\879\ of
which $12 trillion is attributable to individual clients, including
both non-

high net worth and high net worth clients. Approximately 7,115 RIAs (52
percent) serve 35.4 million non-high net worth individual clients and
have approximately $5.2 trillion in RAUM attributable to the non-high
net worth clients, while nearly 7,694 RIAs (56 percent) serve
approximately 4.9 million high net worth individual clients with $7.5
trillion in RAUM attributable to the high-net worth clients. In
addition, there are 3,517 broker dealers registered with FINRA, 442
identify themselves as dually registered broker-dealers, and 2,394
investment advisers (17%) report an affiliate that is a broker-dealer.
---------------------------------------------------------------------------

    \876\ Of the 13,724 RIAs, 8,795 (64 percent) report in Item
5.G.(2) of Form ADV that they provide portfolio management services
for individuals and/or small businesses. In addition, there are
approximately 17,932 state-registered investment advisers.
Approximately 14,851 state-registered investment advisers are retail
facing (see Item 5.D. of Form ADV).
    \877\ See Table 1.
    \878\ We use the responses to Items 5(D)(a)(1), 5(D)(a)(3),
5(D)(b)(1), and 5(D)(b)(3) of Part 1A of Form ADV. If at least one
of these responses was filled out as greater than 0, the firm is
considered as providing business to retail investors. Form ADV Part
1A. Of the 8,134 investment advisers serving individual clients, 356
are also registered as broker-dealers. By high net worth (HNW)
individual, we are referring to an individual who is a ``qualified
client'' as defined in rule 205-3 under the Advisers Act. Generally,
this means a natural person with at least $1,000,000 in assets under
the management of an adviser, or whose net worth exceeds $2,100,000
(excluding the value of his or her primary residence). See rule 205-
3(d)(1); Order Approving Adjustment for Inflation of the Dollar
Amount Tests in Rule 205-3 under the Investment Advisers Act of
1940, Release No. IA-4421 (June 14, 2016).
    \879\ The aggregate RAUM reported for these investment advisers
that have retail investors includes both retail RAUM as well as any
institutional RAUM also held at these advisers.
---------------------------------------------------------------------------

2. Market for Solicitation Activity
a. Current Regulations
    The current solicitation rule makes paying a cash fee for referrals
of advisory clients unlawful unless the solicitor and the adviser enter
into a written agreement. A solicitor's written agreement with an
advisor must also contain an undertaking by the solicitor to perform
its duties under the agreement in a manner consistent with the
instructions of the investment adviser and the provisions of the
Advisers Act and the rules thereunder. In addition, among other
provisions, it requires the solicitor to provide the client with a
current copy of the investment adviser's Form ADV brochure and a
separate written solicitor disclosure document at the time of
solicitation.\880\ The solicitor disclosure must contain information
highlighting the solicitor's financial interest in the investor's
choice of an investment adviser.\881\ Further, advisers are required to
have a reasonable belief that solicitors are complying with these
contractual requirements.
---------------------------------------------------------------------------

    \880\ See rule 206(4)-3(a)(1)(ii).
    \881\ See rule 206(4)-3(b).
---------------------------------------------------------------------------

    In addition, the solicitation rule prescribes certain methods of
compliance, such as requiring an adviser to receive a signed and dated
acknowledgment of receipt of the required disclosures.\882\ The
solicitation rule also prohibits advisers who have engaged in certain
misconduct from acting as solicitors.\883\
---------------------------------------------------------------------------

    \882\ See rule 206(4)-3(a)(2)(iii)(B).
    \883\ See rule 206(4)-3(a)(1)(ii).
---------------------------------------------------------------------------

b. Data on Solicitors
    Given that there is no current registration requirement for
solicitors of investment advisers based on their solicitation activity,
our view on solicitation practices is through the disclosures made by
RIAs in Form ADV. As of August 1, 2020, 27 percent of RIAs reported
compensating any person besides an employee for client referrals.\884\
As shown in Figure [1], the share of RIAs that reported this type of
arrangement has declined since 2009. However, this figure does not
capture employees of an investment adviser that are compensated for
client referrals, who are solicitors under the solicitation rule. The
downward trend in Figure [1] may suggest that the use of solicitors is
declining through an overall decline in client referral activity.
Alternatively, the data presented in the figure is also consistent with
employers shifting their solicitation activities in-house.
---------------------------------------------------------------------------

    \884\ Response to Item 8(h)(1) of Part 1A of Form ADV.
    [GRAPHIC] [TIFF OMITTED] TR05MR21.000

c. RIAs to Private Funds
---------------------------------------------------------------------------

    \885\ Based on responses to Item 8(h)(1) of Part 1A of Form ADV.
---------------------------------------------------------------------------

    Based on Form ADV data from August 1, 2020, 4,925 RIAs report that
they are advisers to private funds, and 54 of these RIAs report that
they are a small entity.\886\ Of the RIAs that advise private funds,
1,641 RIAs report that they use the services of solicitors that are not
their employees or themselves (``related marketers'' in Form ADV).
Among the RIAs that hire solicitors, each RIA uses 3 solicitors on
average, while the median number of solicitors reported is 1, and the
maximum is 67. There are 343 RIAs that indicate that they have at least
one related marketer, and 206 of them indicate that they only rely on
related marketers. Among RIAs that report using a related marketer, the
average number of related marketers reported is 1.5, while the median
reported is 1 and the maximum is 24. 1,315 RIAs indicate that they have
at least one marketer that is registered with the SEC: The average
number of marketers, registered with the SEC as either IAs or BDs,
employed by these RIAs is 3.1, while the median number reported is 2
and the maximum is 67. Finally, 570 RIAs indicate that they have at
least one non-US marketer: The average number of non-US marketers

reported among these RIAs is 3.1, while the median is 1 and the maximum
is 60.\887\
---------------------------------------------------------------------------

    \886\ Form ADV Item 5.F.2 and Item 12.A.
    \887\ Data on solicitors (marketers) hired by RIAs to private
funds are collected from Form ADV Section 7.B(1) (28).
---------------------------------------------------------------------------

3. RIA Clients
    RIAs are required to report their specific number of clients in 13
different categories and a catch-all ``Other'' category.\888\ Based on
Form ADV data collected as of August 1, 2020, RIAs report having a
total of approximately 42 million clients, and $97 trillion in RAUM.
Individual investors constitute the majority (95 percent) of the RIA
client base. Columns 2 and 3 of Table 1 present the breakdown of the
RIA client base, and column 4 shows the total RAUM from each investor
category as of August 2020.
---------------------------------------------------------------------------

    \888\ Form ADV Item 5.D. of Part 1A.
---------------------------------------------------------------------------

    Non-high net worth (HNW) individuals comprise the largest group of
advisory clients by client number--83 percent of total clients. The
number of HNW individuals is only 12 percent of advisory clients, but
RAUM from HNW individuals makes up almost 8 percent of the industry-
wide RAUM ($97 trillion) in 2018, while RAUM from non-HNW individuals
accounts makes up about 5.4 percent.
---------------------------------------------------------------------------

    \889\ Data taken from Form ADV data.

                        Table 1--Investor Categories by Clients, RAUM, and Advisers \889\
----------------------------------------------------------------------------------------------------------------
                                                                       RAUM
       Investor categories            Clients       Clients (%)     (billions)       RAUM (%)        Advisers
----------------------------------------------------------------------------------------------------------------
Non-HNW individuals.............      35,433,736          83.451       $5,228.92            5.39           7,115
HNW individuals.................       4,916,781          11.580        7,465.29            7.69           7,694
Other investment advisers.......         863,785           2.034        1,250.71            1.29             548
Corporations or other businesses         321,471           0.757        2,674.23            2.76           3,320
Pension and profit sharing plans         386,897           0.911        6,504.54            6.70           3,933
Other...........................         279,025           0.657          970.50            1.00             951
Pooled Investment Vehicles                83,942           0.198       25,883.53           26.68           5,354
 (PIVs)--Other..................
State/municipal entities........          24,761           0.058        3,565.01            3.67             970
Charities.......................          99,968           0.235        1,189.66            1.23           3,302
Banking or thrift institutions..           9,833           0.023          992.93            1.02             281
Insurance companies.............          12,070           0.028        6,257.69            6.45             711
PIVs--Investment companies......          26,520           0.062       33,362.03           34.39           1,583
Sovereign Wealth Funds and                 1,643           0.004        1,544.11            1.59             213
 Foreign official institutions..
PIVs--Business development                   159          0.0004          132.15            0.14              87
 companies......................
----------------------------------------------------------------------------------------------------------------

    A number of surveys show that individuals \890\ predominantly find
their current financial firm or financial professional from personal
referrals by family, friends, or colleagues, rather than through
advertisements.\891\ For instance, a 2008 study conducted by RAND
reported that 46 percent of survey respondents indicated that they
located a financial professional from personal referral, although this
percentage varied depending on the type of service provided (e.g., only
35 percent of survey participants used personal referrals for brokerage
services). After personal referrals, RAND 2008 survey participants
ranked professional referrals (31 percent), print advertisements (4
percent), direct mailings (3 percent), online advertisements (2
percent), and television advertisements (1 percent), as their source of
locating individual professionals. The RAND 2008 study separately
inquired about locating a financial firm,\892\ in which a smaller group
of respondents reported selecting a financial firm (of any type) based
on: Referral from family or friends (29 percent), professional referral
(18 percent), print advertisement (11 percent), online advertisements
(8 percent), television advertisements (6 percent), direct mailings (2
percent), with a general ``other'' category (36 percent).
---------------------------------------------------------------------------

    \890\ The surveys generally use ``retail investors'' to refer to
individuals that invest for their own personal accounts.
    \891\ See Angela A. Hung, et al., Investor and Industry
Perspectives on Investment Advisers and Broker-Dealers, RAND
Institute for Civil Justice Technical Report (2008), available at
https://www.rand.org/content/dam/rand/pubs/technical_reports/2008/RAND_TR556.pdf (``RAND 2008''), which discusses a shift from
transaction-based to fee-based brokerage accounts prior to certain
regulatory changes at the time; see also Financial Literacy Study,
supra footnote 846.
    \892\ Only one-third of the survey respondents that responded to
``method to locate individual professionals'' also provided
information regarding locating the financial firm.
---------------------------------------------------------------------------

    The Commission's 2012 Financial Literacy Study provides similar
responses, although it allowed survey respondents to identify multiple
sources from which they obtained information that facilitated the
selection of the current financial firm or financial professional.\893\
In the 2012 Financial Literacy Study,\894\ 51 percent of survey
participants received a referral from family, friends, or colleagues.
Other sources of information or referrals came from: Referral from
another financial professional (23 percent), online search (14
percent), attendance at a financial professional-hosted investment
seminar (13 percent), advertisement (e.g., television or newspaper)
(11.5 percent), other (8 percent), while approximately 4 percent did
not know or could not remember how they selected their financial firm
or financial professional. Twenty-five percent of survey respondents
indicated that the ``name or reputation of the financial firm or
financial professional'' affected the selection decision.
---------------------------------------------------------------------------

    \893\ See Financial Literacy Study, supra footnote 846.
    \894\ The data used in the 917 Financial Literacy Study comes
from the Siegel & Gale, Investor Research Report (July 26, 2012),
available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part3.pdf.
---------------------------------------------------------------------------

D. Costs and Benefits of the Final Rule and Form Amendments

    The Commission is adopting a final combined marketing rule by
amending rule 206(4)-1, which is related to advertisements, and
eliminating rule 206(4)-3, which deals with solicitation. The final
rule changes the definition of advertisement and generally expands the
set of permitted advertisements. It includes general prohibitions of
certain advertising practices, and will (i) impose requirements of or
restrictions on investment adviser performance in advertisements, and
(ii) permit investment advisers to use certain features in an
advertisement, such as testimonials, endorsements, and third-party
ratings, subject to certain conditions, such as disclosing

information that would help investors evaluate the advertisement.
    The marketing rule, among other things, also applies disclosure,
oversight, and disqualification requirements to compensated
testimonials or endorsements, including those directed at prospective
investors in private funds. The Commission is also adopting amendments
to Form ADV that are designed to provide additional information
regarding advisers' marketing practices and amendments to the Advisers
Act books and records rule to correspond to the features of the
marketing rule. The final rule reflects market developments since 1961
and 1979, when rules 206(4)-1 and 206(4)-3, respectively, were adopted,
as well as practices addressed in staff no-action letters. These market
developments include advances in communication technology and marketing
practices that did not exist at the time the rules were adopted and may
fall outside of the scope of the current rules. As a result, the
current rule is less effective at mitigating some information and
search problems investors face when searching for investment advisers
than when it was initially written.\895\
---------------------------------------------------------------------------

    \895\ See infra section III.B.
---------------------------------------------------------------------------

    Advertisements falling in the two categories of communications
defined as advertisements in the final rule are currently subject to
different regulatory baselines and market practices. We discuss the
costs and benefits of specific provisions of the final rule, taking
care to note whether a cost or benefit applies to the first or the
second prong of advertisement, or both.
1. Quantitative Estimates of Costs and Benefits
    The economic effects of the final rule are generally difficult to
quantify for several reasons. First, there is little to no direct data
suggesting how investment advisers and promoters might alter their
marketing practices as a result of the final rule or mitigate the
compliance burdens related to the final rule, and commenters did not
provide any. It is difficult to quantify the impact that specific
provisions of the final rule will have on adviser behavior because the
final rule may influence adviser behavior in opposing directions. For
example, it might motivate advisers to provide more information to
potential investors that helps such investors more accurately evaluate
those advisers' abilities and potential fit with such investors'
preferences. Alternatively, the rule may introduce compliance burdens
that disincentivize the creation of communications that fall within the
definition of advertisement. This could reduce the amount of
information that advisers provide to potential investors through
advertisements.
    Second, it is difficult to quantify the impact that the specific
provisions of the final rule will have on investor behavior because the
final rule may influence investor behavior in opposing directions.
Disclosures might provide additional context for investors to make
better decisions when choosing investment advisers; alternatively, they
might not be used by investors, or might make them overconfident when
making decisions.\896\ Without knowing the magnitude of these opposing
effects, it is not possible to quantify the effects of specific
provisions of the final rule.
---------------------------------------------------------------------------

    \896\ See infra section III.B.
---------------------------------------------------------------------------

    Finally, it is difficult to quantify the extent to which certain
changes in adviser, promoter, and investor behavior enhance or diminish
the welfare of specific market participants. For example, if investors
increased the amount of advisers' RAUM as a result of the final rule,
it is not clear to what extent investor welfare would have improved,
without knowing the extent to which the final rule also affected the
quality of investment advisers with whom investors chose to invest.
Further, if RAUM increased as advisers increased their marketing and
incurred higher marketing expenditures, a portion of these expenditures
could be transferred to investors through fees offsetting, in part, any
increase in investor welfare.
    Some commenters directly addressed the cost estimates in the
proposal.\897\ Two of these commenters stated that the proposal
underestimated the number of advertisements that investment advisers
use under the current rule.\898\ One commenter stated that heavy
advertisers would be expected to create new advertisements 50 times per
year, and update their advertisements 250 times per year.\899\ One
commenter broadly criticized the cost estimates as too low, and also
specifically criticized the proposal's estimates of the number of
advertisements that advisers would distribute.\900\ In response to
commenters, we have adjusted our estimates of the annual number of
advertisements that investment advisers will create.\901\
---------------------------------------------------------------------------

    \897\ See Fidelity, IAA, MFA/AIMA Comment Letters.
    \898\ See Fidelity, IAA Comment Letters.
    \899\ See Fidelity Comment Letter
    \900\ See IAA Letter Comment Letter.
    \901\ See infra section IV.B.
---------------------------------------------------------------------------

    One commenter made several critiques of the cost estimates.\902\
The commenter separated its expected costs into three categories--
implementation costs, ongoing costs, and management resource drain,
arguing that the proposal failed to recognize whole types of costs. The
commenter broadly criticized many of the quantitative estimates in the
proposal as significantly underestimating the cost burden on investment
advisers. The commenter specifically criticized the cost estimates for
third-party rankings, hypothetical performance, and Form ADV changes,
but did not provide additional estimates or data to use. Many of the
quantitative estimates in the proposal were for the Paperwork Reduction
Act (``PRA''), which are a subset of the total economic costs of the
rule. Many of these total costs are difficult to quantify, for reasons
mentioned above. However, given the commenter's feedback on the
categories and types of costs that the rules will impose on investment
advisers, we have updated our analysis of the costs of the rule, as
well as our PRA-related quantitative cost estimates.
---------------------------------------------------------------------------

    \902\ See MFA/AIMA Comment Letter.
---------------------------------------------------------------------------

    In the following sections, we have quantified some elements of the
overall cost of the general anti-fraud prohibitions as part of the
Commission's Paperwork Reduction Act obligations. These are costs
associated with the collection of information that are generated by the
final rule, but do not represent the entire cost of each provision.
2. Definition of Advertisement
    The final rule's definition of advertisement contains two prongs.
The first prong generally captures traditional advertising, and changes
the scope of communications that fall within the scope of the final
rule. The first prong includes, among other communications,
communications made to investors and potential investors in private
funds advised by the adviser. The second prong generally includes the
cash-compensated solicitation activity that occurs currently under rule
206(4)-3. In addition, the second prong will include non-cash
compensated communications made by promoters and compensated
solicitation activity for private fund investors.
    This definition of ``advertisement'' determines the scope of
communications affected by the final rule, which determines, in part,
the costs and benefits of the regulatory program set forth by the other
components of the final rule (the ``programmatic effects''). For
example, if

the definition of ``advertisement'' is not sufficiently broad and
excludes communications that could serve as a substitute for
advertisements and that raise similar investor protection concerns,
investment advisers might use these alternative communications to avoid
the costs associated with complying with the final rule. This would
reduce the effect of changes to the substantive provisions to the
advertising rule that would regulate advertisements. Conversely, if the
scope of communications captured by the final rule is too broad and
captures communications that do not aim to attract clients, the
amendments may impose costs on investment advisers while yielding
insubstantial benefits.
    In response to the final rule's definition of advertisement,
investment advisers and promoters might modify their communication
strategies in an effort to reduce the amount of communication that
could be deemed to fall within the definition of ``advertisement.''
These strategic responses could, in turn, impose costs on some clients
or investors, to the extent that they currently rely on communications
by investment advisers or promoters that are advertisements to inform
their decisions.\903\ If investment advisers or promoters respond by
reducing the amount of such communications, both prospective and
existing investors may need to search more intensively for information
about investment advisers than they currently do or, alternatively,
base their choice of financial professional on less information. This
could result, for example, in inefficiencies to the extent that an
existing client of an investment adviser is unaware of the breadth of
services the investment adviser provided and incurs costs to open a new
account with another investment adviser to obtain certain services.
Similarly, a prospective client that receives less information from
investment advisers and promoters might ultimately choose an investment
adviser that is a poorer match for them or might be discouraged from
seeking investment advice. These potential costs to investors depend on
the extent to which the final rules cause investment advisers and
promoters to reduce their advertisements.
---------------------------------------------------------------------------

    \903\ To the extent that broker-dealers and other third parties
disseminate communications that are defined as advertisements under
the final rule, including with respect to private funds, they may
incur compliance costs associated with the final rule. These
compliance obligations generally will be separate from any
compliance obligations incurred under the requirements of the
Exchange Act, the rules promulgated thereunder, and FINRA rules.
---------------------------------------------------------------------------

    As discussed above, some of the affected parties whose
communications will be newly defined as advertisements under the final
rule may also be registered broker-dealers whose communications are
subject to other regulatory regimes that govern communications and
advertisements, including those under FINRA rules and, in some cases,
Regulation BI. As a result, these parties will incur new compliance
obligations with respect to communications subject to the final rule,
and may incur incremental costs similar to other parties whose
communications are also newly-subject to the rule. In general, however,
to the extent that these parties may leverage existing compliance
methods similar to those that they currently use, the programmatic
effects of including these communications within the final rule's
definition of advertisement may be mitigated.
    Below, we address the costs and benefits associated with
determining the scope of communications affected by the final rule
through specific elements of the final rule's definition of an
advertisement.\904\ We address the costs and benefits of the two prongs
of the definition separately.
---------------------------------------------------------------------------

    \904\ The specific costs and benefits of the rule's changes to
the substantive prohibitions and conditions applicable to
advertisements are discussed in later sections. See infra section
II.D.3-8.
---------------------------------------------------------------------------

a. Communications Other Than Compensated Testimonials or Endorsements
    The first prong includes within the definition of an advertisement
any direct or indirect communication an investment adviser makes to
more than one person, or to one or more persons if the communication
includes hypothetical performance information, and that offers the
investment adviser's investment advisory services with regard to
securities to prospective clients or investors in a private fund
advised by the investment adviser or offers new investment advisory
services with regard to securities to current clients or investors in a
private fund advised by the investment adviser. It also excludes (a)
extemporaneous, live, oral communications, regardless of whether they
are broadcast; (b) any information contained in a statutory or
regulatory notice, filing, or other required communication, provided
that such information is reasonably designed to satisfy the
requirements of such notice, filing, or other required communication;
and (c) a communication that includes hypothetical performance that is
provided: (i) In response to an unsolicited investor request or (ii) to
a private fund investor in a one-on-one communication.
i. Any Direct or Indirect Communication an Investment Adviser Makes
    The first prong includes communications directly or indirectly made
by the adviser, regardless of whether they are prepared and
disseminated by the adviser or by a third party. Prong one includes
communications disseminated by an adviser that incorporate statements
or content prepared by a third party, such as positive reviews from
clients selectively picked by an adviser to be posted or attributed,
materials an adviser helps draft to be distributed by third-party
promoters, and endorsements organized by an adviser on social media.
This provision (the phrase ``directly or indirectly'') does not differ
from the current rule, and we therefore do not anticipate any
significant costs or benefits to be generated directly by this
provision.
    The first prong defines advertisements as communications made to
more than one person, or to any number of persons if the communication
includes hypothetical performance information that is not provided in
response to an unsolicited investor request or to a private fund
investor in a one-on-one communication. Because the definition's
limitation to communications to more than one person does not differ
from the current rule, we generally do not anticipate any significant
costs or benefits to be generated directly by this part of the
rule.\905\ However, the inclusion of one-on-one communications with
hypothetical performance information (except for hypothetical
performance information that is provided in response to an unsolicited
investor request or to a private fund investor) in the definition of
advertisement represents a change from the current rule.\906\ We expect
that

this change could produce costs and benefits with respect to these one-
on-one communications that are similar to those described below that
are associated with prong one's inclusion of communications that offer
investment advisory services to prospective investors, including for
review and monitoring of communications.
---------------------------------------------------------------------------

    \905\ The final rule does contain a related compliance and
recordkeeping requirement that requires investment advisers to
retain records of communications addressed to more than one person,
which we discuss in further detail later. See infra section III.D.8.
    \906\ The rule excludes from the first prong of the
advertisement definition a communication that includes hypothetical
performance that is provided in response to an unsolicited investor
request for such information or to a private fund investor in a one-
on-one communication. See rule 206(4)-1(e)(1)(i)(C). Because the
current advertising rule excludes one-on-one communications from the
definition of advertisement, we do not anticipate that this
exclusion will result in significant costs or cost savings for
advisers.
---------------------------------------------------------------------------

    While the current definition of advertisement includes
communications directly or indirectly made by the adviser, it only
explicitly covers written, radio, or television advertisements. As a
result, the first prong of the definition could cover additional
communications with prospective clients as compared to the current
definition. This change will further extend the investor protection and
benefits of the final rule.\907\ Investment advisers will also incur
costs directly as a result of this change, which may include dedicating
personnel time, or conducting training for personnel to determine the
extent to which the substantive content of one of these newly-covered
types of communication subjects it to the final rule.\908\
---------------------------------------------------------------------------

    \907\ See, e.g., infra sections III.D.3; III.D.4; III.D.5.
    \908\ See supra section III.D.1 and footnote 902.
---------------------------------------------------------------------------

    These costs may be mitigated to the extent that investment advisers
may be able to leverage existing oversight methods similar to those
that they currently use, including those used by dual-registrant
advisers or promoters who are also broker-dealers in connection with
compliance with FINRA's rules,\909\ for example, in communicating with
prospective clients through intermediaries. Additionally, investment
advisers might reduce certain types of communications to avoid having
to bear these costs of complying with the final rule, which may
mitigate the benefits of additional information in advertisements
available to investors.\910\
---------------------------------------------------------------------------

    \909\ See supra section II.A.2.b.i.
    \910\ The final rule contains a related compliance and
recordkeeping requirement that requires investment advisers to
retain records of communications addressed to more than one person,
which we discuss in further detail later. See infra section III.D.8.
---------------------------------------------------------------------------

ii. Offers the Investment Adviser's Investment Advisory Services With
Regard to Securities to Prospective Clients or Investors in a Private
Fund Advised by the Investment Adviser
    Prong one also includes communications that offer the investment
adviser's investment advisory services with regard to securities to
prospective clients or investors in a private fund advised by the
investment adviser. This prong will expressly apply to communications
to prospective investors in private funds. By including communications
that offer the adviser's investment advisory services with regard to
securities to private fund investors, the final rule will provide more
specificity (and certainty) regarding what we believe to be untrue or
misleading statements that advisers must avoid in their advertisements,
which may reduce compliance costs for some investment advisers. On the
other hand, to the extent that an adviser's current practices differ
from the final rule, an investment adviser may incur some increased
costs to review and monitor its communications with potential investors
for general compliance purposes. An investment adviser may respond by
reducing the number of these advertisements or the amount of
information it distributes to potential investors. This could, in turn,
reduce the amount of information available to potential investors in
these private funds. An investment adviser to a private fund also may
respond by not seeking potential investors likely to have less money to
invest in the private fund, reducing investment opportunities for these
investors.
iii. Offers New Investment Advisory Services With Regard to Securities
to Current Clients or Investors in a Private Fund Advised by the
Investment Adviser
    The final definition of advertisement under the first prong also
includes communications that offer new investment advisory services
with regard to securities to existing clients or investors in a private
fund advised by the investment adviser. Investment advisers will incur
costs similar to those described above that are associated with prong
one's inclusion of communications that offer investment advisory
services to prospective investors, including for review and monitoring
of communications. However, to the extent that an adviser uses a single
set of communications aimed at both new and existing clients, these
costs may be mitigated because the adviser may incur only a single set
of costs for both prospective and existing investors.
b. Compensated Testimonials and Endorsements
    The second prong of the final definition of advertisement includes
testimonials or endorsements for which compensation is provided,
excluding any information contained in a statutory or regulatory
notice, filing, or other required communication, provided that such
information is reasonably designed to satisfy the requirements of such
notice, filing, or other required communication. The baseline for these
advertisements is generally shaped by the current solicitation rule,
which obligates advisers to enter into written agreements with
solicitors to require them to act in a manner consistent with the
Advisers Act and rules, including the current advertising rule.\911\
Under the current solicitation rule, investment advisers must have a
reasonable belief that solicitors are complying with this written
agreement. Furthermore, solicitations of private fund investors are not
subject to the current solicitation rule.
---------------------------------------------------------------------------

    \911\ Under the cash solicitation rule, certain affiliated
advisers are not required to satisfy all of the elements of the
written agreement. See rule 206(4)-3(a)(2)(ii) and (iii).
---------------------------------------------------------------------------

    Prong two will scope in non-cash compensated testimonials and
endorsements and compensated testimonials and endorsements to private
fund investors, including communications from solicitors for impersonal
advisory services, and, as a result, will extend the investor
protection benefits of the final rule to the investors who receive
these communications. Similarly, it will impose certain costs on
advisers and persons who are solicitors under the current rule,
including costs associated with oversight of these communications not
currently subject to the rule, including endorsements to private fund
investors.\912\ Advisers may respond by reducing the number of these
advertisements or the amount of information they distribute to
potential investors. Similarly, advisers to private funds also may
respond by not seeking potential investors likely to have less money to
invest in the private fund, reducing investment opportunities for these
investors.
---------------------------------------------------------------------------

    \912\ See infra sections III.D.3-8 for discussion of the direct
costs and benefits of the requirements of the rule.
---------------------------------------------------------------------------

    Prong two does not contain the same exclusion for one-on-one
communications as prong one. Oversight of one-on-one communications
will likely involve greater costs for investment advisers compared to
those addressed to more than one person because one-on-one
communications have the potential for more variety and volume in their
content. However, one-on-one solicitations are subject to the current
solicitation rule. Therefore, there will likely be incrementally
greater costs for advisers overseeing promoters under the final rule.
Of these incremental costs,

the increase in costs is attributable less to the inclusion of one-on-
one communications and more to the expansion in compensation type (from
cash to non-cash) and the expanded types of persons who would be
promoters under the final rule as compared to solicitors under the
current solicitation rule.
    Extending the scope of the rule to communications made by
solicitors who receive non-cash compensation may have further benefits
for investors. Because solicitations provided in connection with non-
cash compensation that solicitors might receive generate nearly
identical conflicts of interest to solicitations provided in connection
with cash compensation, prong two may reduce the risk that investors
might be unaware of such conflicts for a larger set of communications.
For example, many advisers use brokerage--a form of non-cash
compensation--to reward brokers that refer them to investors. This
practice presents advisers with conflicts of interest as the brokers'
interests may not be aligned with investors' interests. Including non-
cash compensated testimonials and endorsements in the definition of
advertisement would also give cash and non-cash compensation more equal
regulatory treatment for these purposes, which will enhance competition
between promoters that accept non-cash compensation and those that
accept cash compensation. Additionally, to the extent that investment
advisers currently direct order flow to broker-dealers with lower
execution quality, the final rule's inclusion of non-cash compensation
into the definition of advertisement could potentially affect quality
of execution. If the final rule's requirements for non-cash
compensation impose regulatory burdens that reduce the usage of
directed brokerage towards brokers with lower quality of execution,
these investment advisers might instead choose brokers with higher
execution quality, which could result in a benefit for their investors.
    The extent of additional benefits and costs attributed to prong two
of the definition will be mitigated to the extent that solicitors
previously entered into written agreements obliging them to act in a
manner consistent with the Advisers Act and its rules, including the
current advertising rule. As a result of such agreements, the
additional costs and benefits of the final rule's substantive
provisions for these solicitors will generally be limited to changes in
the programmatic effects of the final rule as compared to the current
advertising rule. Any solicitors making communications subject to the
final rule who did not previously enter into such a contract will,
however, incur these costs fully and also incur costs associated with
the creation of written agreements. The benefits and costs attributed
to prong two may also be mitigated to the extent that advisers and
promoters were previously complying with the current solicitation rule
with respect to endorsements to private fund investors and to the
extent that some aspects of the final rule overlap with the scope of
rule 206(4)-8 under the Advisers Act, section 17(a) of the Securities
Act, or section 10(b) and rule 10b-5 under the Exchange Act.
c. Exclusions From the Definition of Advertisement
    The first prong of the definition of an advertisement excludes
extemporaneous, live, oral communications. The current rule does not,
however, include these communications unless they are broadcast by
radio or television. As a result, to the extent that some
extemporaneous, live, oral communications were previously transmitted
by radio or television or otherwise subject to the current advertising
rule, the first prong of the definition could cover fewer of these
communications with investors than the current definition. While this
change could reduce investor protection and benefits of the final rule
to investors with respect to these communications, it may also reduce
the costs associated with the fact that advisers might avoid making any
extemporaneous communications because of the difficulties in ensuring
that they comply with the requirements of the rule.
    Both prongs of the definition of advertisement contain an exception
for any statutorily or regulatory required notice, filing, or
communication, provided that such information is reasonably designed to
satisfy the requirements of such notice, filing, or other required
communication. These exceptions are designed to reduce the likelihood
that the final rule imposes costs or burdens on communications
unrelated to advertising, or adds costs or burdens for communications
already regulated by the Commission. The current advertising rule does
not exclude statutory or regulatory notices, so the final rule will
entail a reduction in costs for investment advisers to the extent they
currently bear costs to comply with the advertising rule for their
statutory or regulatory notices. Advisers will, however, continue to
incur potential liability for these statements under applicable anti-
fraud provisions.
3. General Prohibitions
    The final rule generally prohibits certain marketing practices as a
means reasonably designed to prevent fraudulent, deceptive, or
manipulative acts. In general, we anticipate that the introduction of
these general prohibitions will generate new interpretive questions
regarding whether a particular communication is prohibited, which will
impose compliance costs on investment advisers, including costs of
legal advice and managerial resources, on an initial and ongoing basis.
In addition, promoters for investment advisers will bear similar
compliance costs, such as for legal advice and managerial
resources.\913\
---------------------------------------------------------------------------

    \913\ See supra section III.D.1 and footnote 902.
---------------------------------------------------------------------------

    Below, we analyze the costs and benefits of these general
prohibitions.\914\ The baseline for analyzing different types of
advertisements may, however, be different. While advertisements as
defined under the final rule will be subject to a single set of
prohibitions and requirements, under the baseline, the same
advertisements as defined by the final rule may be subject to different
regulatory requirements. For example, solicitors that receive cash
compensation are currently subject to the solicitation rule and,
because they have entered into written agreements that oblige them to
act in a manner consistent with the Advisers Act and its rules, the
advertising rule. However, some communications that meet the definition
of an advertisement do not currently fall under the solicitation rule
or the advertising rule. For example, non-cash compensated promoters,
and promoters for an adviser's impersonal advisory services currently
are not subject to the requirements of rule 206(4)-3, while under the
final rule certain of their communications would be defined as
advertisements and subject to the general prohibitions. Further,
communications to prospective and current investors in private funds
are currently subject to rule 206(4)-8, section 17(a) of the Securities
Act,

section 10(b) of the Exchange Act, and rule 10b-5 thereunder.
---------------------------------------------------------------------------

    \914\ In addition to the general prohibitions discussed below,
the final rule specifically prohibits (i) any untrue statement of a
material fact, or omission to state a material fact necessary in
order to make the statement made, in the light of the circumstances
under which it was made, not misleading and (ii) otherwise
materially misleading statements. These provisions prohibit
statements that would be prohibited by the current advertising rule
and rule 206(4)-8, for example, and as a result, we do not believe
that these provisions will generate significant costs or benefits.
---------------------------------------------------------------------------

    We have quantified a subset of the costs associated with the
general anti-fraud prohibition, specifically, the burden of information
collection costs estimated for the purposes of the Paperwork Reduction
Act. The general anti-fraud prohibitions do not create any collection
of information burdens, with one exception. The prohibition on
unsubstantiated statements of material fact might cause investment
advisers to create records to substantiate statements either
contemporaneously or after the fact, and we estimate the costs of this
collection. We estimate these costs to be $657 for each investment
adviser per year, for a total cost of $9,016,668 per year.\915\
---------------------------------------------------------------------------

    \915\ See infra section IV.B.1.
---------------------------------------------------------------------------

a. Unsubstantiated Material Statements of Fact
    The final rule contains a prohibition on material statements of
fact that an investment adviser does not have a reasonable basis for
believing that it will be able to provide substantiation on demand by
the Commission. Investment advisers would need to gather materials
needed to substantiate the material statements of fact made in
advertisements only if requested by the Commission. Currently, there is
no express prohibition of making statements in advertisements that the
adviser does not have a reasonable basis for believing it will be able
to substantiate on demand, in the current rule or the general anti-
fraud provisions.
    This prohibition will benefit current and prospective investors by
reducing the likelihood that advisers will make material statements of
fact in advertisements that are not able to be substantiated, a
practice which could potentially mislead investors. Additionally, the
prohibition could incentivize investment advisers to invest additional
resources to substantiate material statements of fact. Some commenters
noted that a substantiation requirement would be burdensome,\916\ and
we recognize that there will be costs associated with this requirement
for advisers. We note, however, that commenters raised these concerns
about the proposed requirement, which was not limited to material
statements of fact. Nonetheless, there may, for example, be costs to
determine whether a statement is a material statement of fact, whether
the adviser has a reasonable basis to believe that it will be able to
substantiate the statement upon demand, or how statements or facts
would be substantiated on demand. These costs could include, among
other things, personnel time for review and documentation, as well as
direct costs when demanded by the Commission, which might entail
personnel time to prepare materials for the Commission. Further, while
an adviser may choose to substantiate the material fact after it has
received the demand from the Commission, we recognize that some
advisers may choose to create such records contemporaneously with the
advertisement for sake of efficiency or to manage their compliance
risk, which will cause them to incur compliance costs.
---------------------------------------------------------------------------

    \916\ See, e.g., MFA/AIMA Comment Letter I; FPA Comment Letter;
NVCA Comment Letter; Fried Frank Comment Letter.
---------------------------------------------------------------------------

    Compliance costs may, however, be mitigated to the extent that
advisers currently retain records that effectively substantiate
performance advertising \917\ and, upon inquiry by the staff or the
Commission, demonstrate that the adviser's statements are not untrue
statements of material fact, consistent with the Advisers Act and its
rules. These costs may be further mitigated to the extent that advisers
believe there are external sources that support the material statements
of fact they make in advertisements, which they also believe will be
available at the time of any subsequent demand by Commission staff. We
expect that this may be the case for some of the material facts, and
costs may be further mitigated to the extent that advisers do not
prepare this support in advance of such demand.
---------------------------------------------------------------------------

    \917\ See supra footnote 221.
---------------------------------------------------------------------------

    We recognize that the costs associated with substantiation might
induce some investment advisers to avoid making material statements of
fact that are too costly to substantiate. This could yield benefits for
clients or investors, to the extent that any such advertisement not
made has an increased risk of being misleading. These decisions could,
however, have costs to clients or investors to the extent that they
would receive less information about an adviser, and costs to advisers
to the extent that they forgo some communications to clients or
investors.
b. Untrue or Misleading Implications or Inferences
    The final rule contains a prohibition on information that would
reasonably be likely to cause an untrue or misleading implication or
inference to be drawn concerning a material fact relating to the
investment adviser. There is no provision in the current advertising
rule that expressly prohibits this type of information, though in staff
no-action letters, the staff has stated its view that in some
circumstances an advertisement may be false or misleading if it
implies, or a reader would infer from it, something false.\918\
Further, the current advertising rule and rule 206(4)-8 each generally
prohibit misleading statements.
---------------------------------------------------------------------------

    \918\ See supra section II.B.2; III.C.1.b.
---------------------------------------------------------------------------

    To the extent that advisers or promoters do not already omit
information that would reasonably be likely to cause an untrue or
misleading implication or inference, this prohibition to be drawn
concerning a material fact relating to the investment adviser will
benefit current and prospective investors by removing this type of
information from advertisements, which has the potential to mislead
investors and impair their ability to find an investment adviser. In
addition, because this prohibition will generally require the adviser
to consider the context and totality of information presented such that
it would not reasonably be likely to cause any misleading implication
or inference to be drawn concerning a material fact relating to the
investment adviser, the prohibition will entail compliance costs to
investment advisers and promoters, including those related to
interpretation of the application of the new rule. We expect, however,
that the costs and benefits of the prohibition will likely be
mitigated, to the extent that advisers and promoters currently exclude
from their communications this type of information.
c. Failure To Provide Fair and Balanced Treatment of Material Risks or
Other Limitations
    The final rule contains a prohibition on advertisements which
discuss any potential benefits to clients or investors connected with
or resulting from the investment adviser's services or methods of
operation without providing fair and balanced treatment of any
associated material risks or other limitations associated with the
potential benefits. Currently, while Form ADV requires disclosure of
certain material risks, there is no provision in the current
advertising rule, rule 206(4)-8, the other rules under the Advisers
Act, or in the Advisers Act itself that explicitly requires such
treatment.
    This prohibition will benefit current and prospective investors by
requiring material risks and other limitations to be presented in a
fair and balanced manner included in advertisements. This could provide
such investors with additional, higher quality, information about

investment advisers and additional context for the claims they make in
their advertisements. This information would allow investors to find
better matches with investment advisers, and would reduce the costs
associated with the search for investment advisers.
    This prohibition, however, may cause advisers and promoters to
incur costs associated with changes to compliance processes, and
investment advisers might incur costs to adjust their advertising
materials to discuss material risks and limitations in a fair and
balanced manner, including changes in formatting and tailoring
disclosures based on the form of the communication. To the extent that
investment advisers already prepare similar disclosure in existing
communications with investors or in connection with the preparation of
Form ADV Part 2, we expect the costs of compliance to be mitigated.
    One commenter expressed concern that this prohibition would expand
the amount of required disclosures and overwhelmingly lengthen
advertisements.\919\ We recognize that this prohibition will have costs
associated with changes to the formatting of advertisements associated
with the additional information, including with respect to
communications made to prospective and current investors in private
funds advised by the investment adviser. Further, we recognize that the
associated costs might induce some investment advisers and promoters to
avoid making some types of claims to the extent that they will require
extensive discussion of the associated material risks or other
limitations. This could have costs to investors to the extent that they
would receive less information about an adviser, and costs to advisers
to the extent that they forgo some communications to investors. This
could, however, yield benefits for investors, to the extent that any
such advertisement not made has an increased risk of being misleading.
---------------------------------------------------------------------------

    \919\ See MFA/AIMA Comment Letter I.
---------------------------------------------------------------------------

d. Anti-Cherry Picking Provisions: References to Specific Investment
Advice and Presentation of Performance Results
    The final rule contains two other provisions designed to address
concerns about investment advisers presenting potentially cherry-picked
information to investors in advertisements.
    The first prohibits reference to specific investment advice where
such advice is not presented in a manner that is fair and balanced.
Currently, there is a per se prohibition against past specific
recommendations in the advertising rule, though the current rule allows
reference to past specific recommendations in an advertisement where
the advertisement offers to furnish a list of all recommendations made
by such investment adviser in the last year. Further, the staff has
indicated that it would not recommend enforcement action under rule
206(4)-1 under certain circumstances.\920\
---------------------------------------------------------------------------

    \920\ See infra section II.C.1.b.
---------------------------------------------------------------------------

    The first provision replaces the current advertising rule's per se
prohibition of past specific recommendations with a principles-based
prohibition on presentations of specific investment advice that is not
presented in a manner that is ``fair and balanced.'' We believe that
this change will provide benefits to advisers and promoters by
providing additional clarity on which market practices are prohibited.
Further, it will provide benefits to current and prospective investors
related to potentially expanding the circumstances under which advisers
may provide information regarding past specific advice to investors. In
addition, investors may be able to better evaluate presentations of
past or current specific advice because of the rule's requirement for
fair and balanced presentation. This shift in approach might impose
costs on investment advisers and promoters related to compliance, who
will need to devote personnel time to evaluate whether a potential
presentation of specific investment advice is fair and balanced.\921\
These compliance costs may be mitigated to the extent that advisers
currently present past or current specific recommendations in a ``fair
and balanced'' manner. Further, these costs may also be mitigated to
the extent that an adviser currently complies with FINRA's rule 2210,
which requires that broker communications be ``fair and balanced.''
\922\
---------------------------------------------------------------------------

    \921\ See supra section III.D.1 and note 902.
    \922\ See supra section II.B.5.a.
---------------------------------------------------------------------------

    The second anti-cherry-picking provision prohibits presentations of
performance results, or performance time periods that are not presented
in a fair and balanced manner. Currently, there is no express provision
in the advertising rule requiring presentation of performance results
in this manner, though the staff has stated views regarding certain
circumstances in which the staff may view a presentation of performance
results as misleading, including, for example, where an adviser failed
to disclose how material market conditions, advisory fee expenses,
brokerage commissions, and reinvestment of dividends affect the
performance results.\923\
---------------------------------------------------------------------------

    \923\ See supra section III.C.1.b.
---------------------------------------------------------------------------

    This provision may yield benefits to current and prospective
investors by reducing the likelihood that they are misled by
advertisements, and requiring the provision of information to evaluate
an investment adviser that is presented in a fair and balanced manner.
We recognize, however, that the standard in this rule will impose costs
on advisers and promoters. Two commenters, for example, indicated that
the ``fair and balanced'' standard may be difficult in
application.\924\ We recognize that this ``fair and balanced''
component for the second provision also represents a shift towards a
principles-based approach, which could impose compliance costs on
investment advisers, who might need to devote personnel time to update
compliance processes.\925\
---------------------------------------------------------------------------

    \924\ Consumer Federation Comment Letter; NASAA Comment Letter.
    \925\ See supra section III.D.1 and infra section IV.A.
---------------------------------------------------------------------------

    These costs and benefits may be mitigated, however, to the extent
that advisers already ensure that their advertisements are fair and
balanced in presentation of performance results in order to ensure that
they are not misleading under the current advertising rule or other
applicable anti-fraud provisions.
    These costs might, however, induce some investment advisers to
avoid presenting performance results altogether. This could have costs
to investors to the extent that they would receive less information
about an adviser's performance, and may make finding an investment
adviser more difficult or costly for some investors. Additionally, this
could impose costs on advisers to the extent that they forgo some
communications to investors. This reduction in performance advertising,
however, could yield benefits for investors, to the extent that any
such advertisement not made has an increased risk of misleading
investors.
4. Conditions Applicable to Testimonials and Endorsements, Including
Solicitations
    The final rule prohibits the use of testimonials and endorsements
unless they comply with certain disclosure, oversight, and
disqualification requirements, substantially as originally proposed for
solicitors. The costs and benefits of this provision of the final rule
differ depending on whether the testimonial or endorsement is
compensated or uncompensated.

    To clarify the change from the baseline for each type of
advertisement, we analyze the costs and benefits of imposing these
conditions on testimonials and endorsements that are not compensated.
We then separately analyze the costs and benefits of these conditions
for testimonials and endorsements that are compensated. As described
above, the baseline for each type of advertisement is different, making
the extent of the effects of the changes effected by the rule different
for advisers, depending on whether they are complying with the current
advertising rule and the current solicitation rule.\926\
---------------------------------------------------------------------------

    \926\ See supra section III.D.3.
---------------------------------------------------------------------------

    We have quantified a subset of the costs associated with
requirements for testimonials and endorsements, specifically, the
burden of information collection costs estimated for the purposes of
the Paperwork Reduction Act.\927\ The disclosure and oversight
provisions of the requirements for testimonials and endorsements will
entail information collection costs, and investment advisers will incur
initial implementation costs. We estimate that investment advisers will
incur an initial implementation cost of $1,060 for each adviser, or
$7,273,720 in total.\928\ We estimate that investment advisers will
incur an ongoing internal cost of $5,729 per year per adviser, $500
external cost for those advisers that deliver disclosures by postal
service, and $39,998,598 in total.\929\ We therefore estimate a total
industry cost in the first year of $47,272,318.\930\
---------------------------------------------------------------------------

    \927\ See infra section IV.B.2.
    \928\ Initial cost burden estimate of $1,060 from section
IV.B.2. 13,724 x \1/2\ = 6,862 affected investment advisers. $1,060
x 6,862 = $7,273,720.
    \929\ Ongoing cost estimate includes disclosure, oversight, and
annual costs from section IV.B.2. $5,679 x 6,862 + $500 external
cost x 6,862 advisers x 20% mail use = $39,998,598.
    \930\ This number is based on the following calculation:
$7,273,720 + $39,998,598 = $47,272,318.
---------------------------------------------------------------------------

a. Communications Other Than Compensated Testimonials or Endorsements
    The current advertising rule prohibits, but does not define,
testimonials and does not address endorsements. In contrast to the
current advertising rule, the final rule prohibits advisers from using,
or compensating promoters for testimonials and endorsements, unless
certain requirements are met, and distinguishes statements made by
investors from those made by non-investors.
    In general, we believe that the ability of advisers to advertise
testimonials and endorsements will give investors additional
information about the views of clients and non-clients with an
investment adviser, which could improve the matches between investors
and investment advisers. Additionally, the ability to use testimonials
and endorsements in advertisements might incentivize investment
advisers to further improve the quality of the services they provide,
because investment advisers will be better able to advertise any
improvements in their services. We discuss the costs and benefits of
the requirements that must be met in order to include a testimonial or
endorsement in an advertisement below.
i. Disclosures
    The final rules impose disclosure requirements on investment
advisers that make use of testimonials and endorsements and on persons
giving testimonials and endorsements, unless subject to an
exemption.\931\ Under the final rule, an investment adviser must
disclose, or reasonably believe that the person giving the testimonial
or endorsement discloses, (i) clearly and prominently, (A) whether the
person giving the testimonial or endorsement is a client or a non-
client, as applicable, (B) that cash or non-cash compensation was
provided for the testimonial or endorsement, if applicable, and (C) a
brief statement of any material conflicts of interests; (ii) the
material terms of the person's compensation arrangement, if any,
including a description of the compensation provided or to be provided
to the person for the testimonial or endorsement; and (iii) a
description of any material conflicts of interest the person may have
that result from the investment adviser's relationship with such person
and/or any compensation arrangement. These disclosures must be
delivered at the time the testimonial or endorsement is disseminated.
---------------------------------------------------------------------------

    \931\ See supra section II.C.5 (discussing partial exemptions
from disclosure requirements).
---------------------------------------------------------------------------

    These disclosures can aid investors by providing information and
context with which to evaluate a promoter's claims. Investors may
benefit from receiving information about the experiences of other
investors or other people. In addition, the requirement that the
advertisement clearly and prominently disclose the client status of the
promoter, the fact of compensation, and a brief statement of material
conflicts of interests will increase the salience of these disclosures,
and increase the likelihood that they are incorporated into an
investor's decisions. Testimonials and endorsements may benefit
investment advisers by allowing them to show satisfied clients or other
persons willing to support the investment adviser.
    However, the positivity of a testimonial or endorsement may not
always reflect the investment adviser's ability or the adviser's
potential ``fit'' for investors. The final rule may, therefore, lead
investment advisers, regardless of ability, to inefficiently increase
spending on testimonials or endorsements in advertisements to attract
clients. In this case, the fees that result from higher advertising
spending could mitigate the benefits that the additional information in
testimonials and endorsements might provide to investors. Additionally,
to the extent that market practices have developed in such a way that,
under circumstances described in staff no-action letters, market
participants already include information in advertisements that would
be a testimonial under the final rule, the costs and benefits of the
final rule's testimonials and endorsements provision will be decreased
in magnitude relative to the baseline.
    The final rule's requirement for disclosure of client or non-client
status of the promoter, material terms of compensation, and material
conflicts of interest, will provide useful information to prospective
clients about the potential credibility and incentives of the provider
of the testimonial or endorsement. This provision might also yield
benefits for investors if investment advisers or their promoters are
incentivized to mitigate their conflicts of interest or otherwise
improve the quality of their services as a result of the disclosures.
This might improve the efficiency of the investment adviser search
process by improving the quality of the matches between investors and
investment advisers, both because of the additional information about
promoters' incentives and because it may lead investment advisers to
alter their arrangements to mitigate conflicts of interest.
    However, conflict of interest disclosures may not necessarily lead
to optimal decisions by investors. For example, the Commission's
Financial Literacy Study surveyed investors about their understanding
of fees as disclosed in a typical brochure, finding that many
respondents had difficulty interpreting certain disclosures that are
relevant to evaluating conflicts of interest.\932\ These

findings are consistent with academic literature that describes
investors' difficulty in understanding financial disclosure. For
example, one study shows that, in an experimental setting, even when
subjects were told of the bias of persons who were giving them advice,
participants did not fully adjust their behavior to reflect the
disclosed bias.\933\ In addition, these papers and others \934\ find
that mandating disclosure from biased persons may have the unintended
consequence of making these persons appear honest and increase trust in
them. While the context of these studies is not specific to investment
advisers, promoters, or in certain cases, of financial advice
generally, they provide evidence that suggests that disclosures might
not fully mitigate the incentive problems generated by conflicts of
interest. Additionally, advisers or their promoters may incur legal and
compliance costs in connection with reviewing existing disclosures and
drafting new disclosures to comply with the final rule.
---------------------------------------------------------------------------

    \932\ ``For instance, they had difficulty calculating hourly
fees and fees based on the value of their assets under management.
They also had difficulty answering comprehension questions about
investment adviser compensation involving the purchase of a mutual
fund and identifying and computing different layers of fees based on
the amount of assets under management. Moreover, many of the online
survey respondents on the point-of-sale panel had similar
difficulties identifying and understanding fee and compensation
information described in a hypothetical point-of-sale disclosure and
account statement that would be provided to them by broker-
dealers.'' See Financial Literacy Study, supra footnote 846.
    \933\ See Daylian M. Cain, et al., The Dirt on Coming Clean:
Perverse Effects of Disclosing Conflicts of Interest, 34 J. L. Stud.
1 (2005); George Loewenstein, et al., The Limits of Transparency:
Pitfalls and Potential of Disclosing Conflicts of Interest, 101 Am.
Econ. Rev. 423 (2011).
    \934\ See e.g., Steven Pearson, et al., A Trial of Disclosing
Physicians' Financial Incentives to Patients, 166 Archives of
Internal Medicine 623 (2006); Sunita Sah, George Loewenstein &
Daylian M. Cain, The Burden of Disclosure: Increased Compliance With
Distrusted Advice, 104 J. Personality & Soc. Psychol. 289 (2013).
---------------------------------------------------------------------------

ii. Oversight and Compliance
    The final rule has an oversight and compliance provision that
requires the investment adviser to have a reasonable basis for
believing that a testimonial or endorsement complies with the
rule.\935\ This provision is designed to help ensure that
communications made by promoters comply with the provisions of the
final rule. This requirement will entail costs for both advisers and
their promoters to devote staff and managerial resources, enter into
new written agreements or amend existing written agreements, and update
their processes to the extent necessary for oversight and compliance of
testimonials and endorsements under the final rule.
---------------------------------------------------------------------------

    \935\ In addition, the final rule requires that an investment
adviser have ``a written agreement with any person giving a
compensated testimonial or endorsement that describes the scope of
the agreed-upon activities and the terms of the compensation for
those activities.'' However, the rule does not contain this
requirement in the case of uncompensated testimonials and
endorsements or where de minimis compensation is provided to the
promoter. For example, promoters providing testimonials or
endorsements in refer-a-friend programs might not be subject to
these requirements depending on the amount of compensation provided
in such programs.
---------------------------------------------------------------------------

b. Compensated Testimonials or Endorsements
    The current solicitation rule prohibits advisers from providing
solicitors with cash compensation, unless certain requirements are
satisfied. Among these requirements is a requirement that the adviser
enter into a written agreement requiring the solicitor to act in a
manner consistent with the Advisers Act and its rules. Non cash-
compensated solicitations are not subject to the solicitation rule,
however. To the extent that non-cash compensated testimonials and
endorsements are viewed as advertisements made directly or indirectly
by an adviser, they may be subject to the current advertising rule,
including its general prohibition on testimonials if applicable.
Solicitations of private fund investors are not subject to the current
solicitation rule, though they are subject to rule 206(4)-8 and are
likely subject to restrictions applicable to private placements under
the Federal securities laws. Persons who would be promoters under the
final rule that are registered broker-dealers and FINRA members, such
as those who transact in privately issued securities, are also subject
to FINRA rules applicable to communications, including restrictions on
the use of compensated testimonials, and may be subject to Regulation
BI.
    We believe that the costs and benefits of the conditions on the use
of testimonials and endorsements in an advertisement will have similar
costs and benefits to those described above,\936\ though these effects
will be mitigated to the extent that the adviser was complying with the
current solicitation rule. To some extent these effects will also be
mitigated to the extent the promoter is a registered broker-dealer and
FINRA member; such a promoter could adapt existing compliance systems,
for instance, but will need to modify for any differences under the two
regulatory constructs.
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    \936\ See supra section III.D.4.a.
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i. Disclosures
    We expect similar costs and benefits of the disclosure requirements
for compensated testimonials and endorsements as described above for
non-compensated testimonials and endorsements. For example, we expect
investors to benefit from new disclosures, as mitigated to the extent
that, for example, conflict of interest disclosures may not necessarily
lead to optimal decisions by investors. Further, disclosures may impose
compliance costs on advisers and promoters similar to those described
above, including costs to draft new disclosures in connection with, for
example, advertisements by non-cash compensated promoters and in
connection with compensated testimonials or endorsements made to
prospective or current investors in private funds advised by the
adviser.
    However, these costs and benefits may be mitigated with respect to
compensated testimonials or endorsements for four reasons. First, these
costs may be mitigated for communications made by cash-compensated
solicitors, given the disclosure requirements under the current
solicitation rule. Currently, cash compensated solicitors must provide
disclosures to clients pursuant to rule 206(4)-3(b), as well as provide
the investment adviser's Form ADV brochure and their disclosure
statement to potential investors. As a result, we expect that these
costs will be mitigated to the extent that this type of information is
already known and accessible to the investment adviser and promoter,
and to the extent that similar information is already provided under
the current solicitation rule. Further, the final rule's requirement to
provide disclosure at the time the testimonial or endorsement is
disseminated is similar to the current solicitation rule's requirement
to deliver disclosure at the time of any solicitation activities.
Second, the final rule exempts from these disclosure requirements
certain affiliates of the adviser, provided that the affiliation is
readily apparent or disclosed to the client or investors at the time
the testimonial or endorsement is disseminated.
    Third, the costs and benefits of this provision may be mitigated
because the final rule includes exemptions from these disclosure
requirements. First, there is an exemption from these requirements when
a broker-dealer provides a testimonial or endorsement to a retail
customer that is a recommendation subject to Regulation BI. Second,
when a broker-dealer provides a testimonial or endorsement to an
investor that is not a retail customer as defined by Regulation BI,
there is an exemption from the requirements to disclose the material
terms of any compensation arrangement and a description of any material

conflicts of interest. As a result, the extent of the effects of this
exemption on investors will vary. Where the testimonial or endorsement
is a recommendation to a retail customer subject to Regulation BI,
broker-dealers, including those that are also registered as investment
advisers, acc will have to comply with the Disclosure Obligation under
Regulation BI and will not also be subject to disclosure requirements
under the final rule. Although these investors will not receive the
investor protection benefits of the marketing rule disclosures, the
recommendation will be subject to Regulation BI requirements under the
baseline. With respect to testimonials or endorsements by a broker-
dealer to investors that are not retail customers (as defined by
Regulation BI), although we believe such investors will be able to
request from the broker-dealer other information about the
solicitation, some may not. These exemptions may, therefore, result in
a reduction of costs and benefits of the disclosure provisions for
testimonials and endorsements to these investors.
    These exemptions might also make advisers more likely to compensate
a broker-dealer as a promoter rather than promoters that are not
broker-dealers, which would give these broker-dealers a competitive
advantage. Further, with respect to communications made by broker-
dealers that are not so exempted, costs for promoters who are broker-
dealers may also be mitigated to the extent that broker-dealers are
already preparing similar disclosures in order to comply with other
disclosure obligations.\937\
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    \937\ See supra section II.C.2.
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    Finally, because there is no Form ADV brochure delivery requirement
under the final rule, as compared to the current solicitation rule, we
anticipate a reduction in costs associated with cash-compensated
promoters no longer being subject to this requirement. We expect that
this will not result in a loss of benefits to clients, however, because
they will still receive the brochure from advisers as a result of
advisers' delivery obligations. We recognize, however, that investment
advisers and persons who are currently cash-compensated solicitors will
bear costs as a result of the replacement of the current rule's
disclosure requirements with the final rule's disclosure requirements.
ii. Oversight and Compliance
    Investment advisers must have a reasonable belief that the
solicitors comply with the provisions of the Advisers Act and rules
under the current solicitation rule, and we therefore expect the
magnitude of the costs and benefits from the application of the
testimonials and endorsements requirements related to oversight and
compliance to be relatively small for advisers complying with the
current rule and for promoters that are cash solicitors under the
current solicitation rule.
    Under the current solicitation rule, investment advisers must make
a bona fide effort to ascertain whether the cash-compensated solicitor
has complied with the provisions of its written agreement with the
adviser and must have a reasonable basis for so believing. As described
above, the final rule has an oversight and compliance provision that
requires the investment adviser to have a reasonable basis for
believing that a testimonial or endorsement complies with the rule, and
as applicable here, the adviser must also have a written agreement with
the person giving a testimonial or endorsement that describes the scope
of the agreed upon activities when making payments for compensated
testimonials and endorsements that are above the de minimis threshold.
This provision will help ensure that communications made by promoters
comply with the provisions of the final rule. Further, this requirement
would entail costs for both advisers and their promoters to devote
personnel time and managerial resources to enter into written
agreements and update the processes necessary for oversight and
compliance of testimonials and endorsements.
    These benefits and costs may, however, be mitigated for several
reasons. First, to the extent that advisers with cash-compensated
solicitors are already substantially performing this oversight in
connection with their compliance with rule 206(4)-3's oversight
requirements, the rule will not have these full effects. Second, for
private placements of private fund shares, the written private
placement agreement could meet the written agreement requirement.
Third, the final rule includes certain exemptions from the requirement
to enter into a written agreement with the adviser. The first such
exemption applies where de minimis compensation is provided to the
promoter. For example, promoters providing testimonials or endorsements
in refer-a-friend programs will likely be eligible for this exemption.
The second such exemption applies to certain affiliates of the adviser,
provided that the affiliation is readily apparent or disclosed to the
client or investors at the time the testimonial or endorsement is
disseminated.
iii. Disqualification
    The final rule contains disqualification provisions which prohibit
an adviser from compensating a person, directly or indirectly, for any
testimonial or endorsement if the adviser knows, or, in the exercise of
reasonable care, should have known, that the person is an ineligible
person at the time the testimonial or endorsement is disseminated. The
rule defines an ``ineligible person'' to mean a person, who is subject
to a disqualifying Commission action or disqualifying event, and
certain of that person's employees and other persons associated with an
ineligible person. The definition further encompasses, as appropriate,
all general partners or all elected managers of an ineligible person.
Ineligible Persons and Disqualifying Events
    Currently, the solicitation rule categorically bars advisers from
making cash payments to certain disqualified persons. The final rule's
disqualification provisions generally expand the set of ineligible
persons by including certain disciplinary actions that are not part of
the current solicitation rule. For example, under the final rule a
disqualifying event is expanded to also include generally actions of
the CFTC and self-regulatory organizations. It also newly includes
Commission cease and desist orders from committing or causing a
violation or future violation of any scienter-based anti-fraud
provision of the Federal securities laws, and Section 5 of the
Securities Act.
    The final rule's prohibition on compensating such ineligible
persons could yield benefits for investors by prohibiting investment
advisers from hiring promoters most likely to abuse investors' trust--
that is, promoters who have been subject to certain Commission opinions
or orders, other regulatory actions, civil actions, or convictions for
certain conduct. This prohibition could, however, also yield costs for
advisers. For example, an adviser may not be able to hire a solicitor
that the adviser otherwise feels to be best able to promote its
service. This may reduce the number of persons available to advisers to
serve as promoters, increase the cost of obtaining referrals for
investment advisers, and impose costs on those promoters who are
disqualified. The application of the final rule's definition of
ineligible person could also impose additional compliance and search
costs on investment advisers. For example, investment advisers will
need to check that a promoter is not an ineligible

person. In addition, to the extent the disqualification provisions
under the new rule result in an increase in the number of disqualified
persons as compared to the current rule, the number of available
potential promoters would fall, which could increase the difficulty of
finding a promoter for an adviser.
    We expect that the benefits and costs of this provision may be
mitigated for a number of reasons. First, to the extent a solicitor is
currently cash-compensated and currently subject to the solicitation
rule, the final disqualification provisions are not entirely new, and
only those changes from the solicitation rule's disqualification
provisions, including new bars on persons subject to CFTC and self-
regulatory organization orders, will have any economic effects.
    Second, the final rule includes certain exemptions from this
requirement. The first such exemption is available for promoters who
receive de minimis compensation. The second exemption is available for
promoters that are brokers or dealers registered with the Commission in
accordance with section 15(b) of the Exchange Act, provided they are
not subject to statutory disqualification under the Exchange Act.
Broker-dealers currently have similar provisions that protect investors
by disqualifying certain individuals from acting as a broker-dealer.
This exemption may further have the effect of making it more likely
that an adviser will compensate a broker-dealer as a promoter. In
addition, persons that are covered by rule 506(d) of Regulation D under
the Securities Act with respect to a rule 506 securities offering and