and investor behavior enhance or diminish the welfare of specific
market participants. For example, if investors increased the amount of
regulatory assets under management as a result of the proposed rule, it
is not clear that investor welfare would have improved, without knowing
the extent to which the proposed rule also affected the quality of
investment advisers that investors chose. Some advisers might have to
advertise at a (net) cost due to competitive pressure; or they might
seek to increase their fees due to marketing, and the burden could be
partially transferred to investors. In addition, the total welfare
effects of the rule are distinct from the welfare effects on a specific
type of market participant.
    Instead of directly quantifying the effect brought by the proposed
rule in the market of investment advice, a close alternative is to
learn from a comparable market that is also advised by registered
investment advisers, i.e., the mutual fund market. The study mentioned
in section D.1 quantifies the effect of advertising on investor welfare
in the mutual fund market, which serves as a reference, though the
finalized effect of the proposed rule still will not be exactly the
same. We encourage commenters to provide data and information to help
quantify the benefits, costs, and the potential impacts of the proposed
rule on efficiency, competition, and capital formation. In those
circumstances in which we do not currently have the requisite data to
assess the impact of the proposal quantitatively, we have qualitatively
analyzed the economic impact of the proposed rule.
1. General Costs and Benefits of the Advertising Rule
    Broadly speaking, the proposed advertising rule expands the
definition of ``advertisement,'' and expands the set of permissible
elements in advertisements that an investment adviser can disseminate
relative to the baseline. This expanded set of permissible elements are
subject to additional required disclosures.
    The proposed rule would change the definition of ``advertisement''
to any communication, disseminated by any means, by or on behalf of an
investment adviser, that offers or promotes the investment adviser's
investment advisory services or that seeks to obtain or retain one or
more investment advisory clients or investors in any pooled investment
vehicle advised by the investment adviser. This would expand the set of
communications subject to the advertisement prohibitions, including
both the general anti-fraud prohibitions, as well as the specific
prohibitions of the proposed rule.
    In addition, the proposed general anti-fraud prohibitions would
prohibit certain advertising practices, and would include disclosure
requirements designed to prevent other misleading statements. By
reducing the potential for misleading or fraudulent statements in these
additional communications, the prohibitions of the proposed rule would
provide investors with protections. While expanding the set of
communications covered by the definition of ``advertisement'' and
subject to prohibitions applicable to all advertisements, the proposed
advertising rule permits some new elements in advertisements, and
provides advisers with additional flexibility in the creation and
dissemination of advertisements and communications, conditional on
meeting disclosure requirements designed to support investor
protection. At the same time, this additional flexibility for advisers
could impose costs on investors, particularly individuals with less
access to financial knowledge and resources, if new advertisements are
unrelated to the underlying performance of an investment adviser, or if
the disclosures cannot be properly digested by the recipients of the
advertisements--especially those without relevant financial knowledge
or resources. However, we anticipate that these costs would be limited
by the additional requirements for fair and balanced references to
specific investment advice and portrayals of advisers' performance in
advertisements. These new elements and the additional flexibility could
also lead to more spending on advertising, and these additional costs
could be passed through to investors.
    The proposed amendments would provide additional flexibility to
investment advisers in certain respects, but also impose additional
restrictions on certain types of advertisements that investment
advisers currently use. In evaluating whether to take advantage of the
flexibility provided by new amendments, investment advisers must weigh
the potential benefits of newly

permitted forms of communication against the compliance burdens of
additional disclosure requirements associated with those forms of
communication. Thus, an investment adviser that modifies its
advertisements as a result of the proposed rule has likely determined
the benefits of the modifications justify the costs. However, we
acknowledge that this does not necessarily mean that investment
advisers would experience a net benefit as a result of those provisions
of the proposed rules that provide additional flexibility. As we
discuss further below, there is a possibility that investment advisers
may also enter a costly ``arms race'' in advertising spending.
Investment advisers that modify their advertising might expend
resources on more expensive advertisements to compete against other
investment advisers that are also producing expensive advertisements,
without necessarily experiencing increases in revenues.
    Investment adviser advertising under the proposed rule will likely
include more information given the changes in information permitted by
the rule, with additional disclosures provided to protect
investors.\572\ On its face, an increase in information could improve
investor outcomes in several ways. The additional information in
advertisements could aid investors by increasing investor awareness of
different service providers' offerings, thus reducing search costs.
Reducing the cost of search may not only aid investors as they search
for investment advisers, but might also promote competition among
investment advisers if expanded options for advertising permits
investment advisers with higher ability to more credibly signal that
ability to potential investors and clients under the proposed rule. For
example, to the extent that third party ratings are correlated with
investment adviser ability, investment advisers would be able to
present these ratings to potential clients under the proposed rule, who
could, in turn use these ratings as part of their overall assessment of
the investment adviser as they consider entering into an advisory
relationship.
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    \572\ While we preliminarily believe that the advertising rule
will improve the information available to investors, there is a
possibility that investment advisers would not alter their
advertisements as a result of the rule.
---------------------------------------------------------------------------

    The proposed rule generally would require investment advisers to
include disclosures to provide investors with additional context that
would help them evaluate an investment adviser's claims. While
information contained in required disclosures might be useful to
investors, it is not clear to what extent investors, especially retail
investors, would have the financial knowledge, experience or access to
resources to (i) fully process these disclosures to assess an
investment adviser's claims, and (ii) fully account for an investment
adviser or solicitor's conflicts of interest when choosing among
investment advisers. Disclosures may reduce or eliminate information
awareness and acquisition costs, but individuals may still face
difficulties utilizing this information in their decision-making
process, which may also vary depending on the investor's level of
financial sophistication and access to expertise.
    In order to gauge the general effect of the proposed advertising
rule on the market for investment advice, the practices in a
neighboring market could lend some insight. Mutual funds, which are
managed by registered investment advisers, advertise to reach more
investors. Although mutual funds, private pooled investment vehicles,
and investment adviser separate account advisory services are not
subject to identical regulatory requirements, similarities among their
economic features lend themselves to comparison: Specifically, they all
may target similar types of clients and investors and all have an
information asymmetry problem between investors and financial service
providers.\573\
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    \573\ Note that while mutual funds are often marketed to retail
investors, private funds are marketed to at least accredited
investors and often to qualified purchasers.
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    Academic literature on marketing for mutual funds has examined: (i)
How advertising affects investors--both in terms of flows (cash to be
managed by financial service providers) and returns (return net of fees
back to investors); (ii) how marketing may help imperfectly informed
investors find better service providers, i.e., reduce search cost; and
(iii) the extent to which competition among financial service providers
generates wasteful spending on advertising. To the extent that the
market for mutual funds shares common features with the market for
private funds and for other types of investment adviser services,
evidence from the mutual fund industry may help us understand the
potential impact of the proposed advertising rule on the market for
investment advisory services and private funds.
    A positive relation between funds' marketing efforts and investor
flows (cash investment from investors) is well-documented among mutual
funds.\574\ Because marketing brings in more business and revenues for
asset managers, it is important to understand the expenditure
associated with marketing, especially its significance to investors. In
the context of mutual funds, marketing expenses \575\ contribute to an
advisory firm's total operational cost, and fund shareholders will bear
at least part of the cost in the form of fund expense, unless
shareholders switch to a similar fund with lower expenses. One study
observes that firms also choose to charge more fees to cover the
marketing cost as they engage in an ``arms race'' for a similar pool of
investors.\576\ While

some portion of the costs associated with this costly competitive
advertising spending would be absorbed by mutual fund advisers, other
portions would be passed on to investors. The authors argue that as
fees increase, investors with a high- search cost--usually those with
lower financial literacy--are more likely to suffer a (net) loss
because they are more likely to match with an asset manager with poor
ability, and because higher fees further reduce returns. Investors
equipped with financial knowledge or access to resources to fully
process the additional information conveyed in advertisements and
disclosures may perceive potential benefits of improved information and
match efficiency that justify higher fees.\577\ These results point to
potential inefficiencies that could result from the proposed rule if
the antecedents of the ``arms race'' result described in the academic
literature that are present between mutual funds and investors are also
present between investment advisers and their clients. However,
differences between these markets may limit the generalizability of
results from studies of mutual fund marketing to the potential impacts
of the proposed rule.
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    \574\ See Prem Jain and Joanna Wu, Truth in Mutual Fund
Advertising: Evidence on Future Performance and Fund Flows, 2 J. FIN
937 (2000) finding that advertising in funds increases flows
(comparing advertised funds with non-advertised funds closest in
returns and with the same investment objective). Reuter and
Zitzewitz (2006) find indirect evidence that advertising can
increase fund flows. Controlling for past media mentions and a
variety of fund characteristics, a single additional positive media
mention for a fund is associated with inflows ranging from 7 to 15
percent of its assets over the following 12 months. Jonathan Reuter
and Eric Zitzewitz, Do Ads Influence Editors? Advertising and Bias
in the Financial Media, 121 Q. JOURNAL ECON. 197 (2006). While
positive mentions significantly increase fund inflows, they do not
successfully predict returns to investors. Other papers, including
Gallaher, Kaniel and Starks (2006) and Kaniel and Parham (2016),
also find a significant and positive impact of advertising
expenditures and the resulting media prominence of the funds on fund
inflows. Steven Gallaher, Ron Kaniel and Laura T. Starks, Madison
Avenue Meets Wall Street: Mutual Fund Families, Competition and
Advertising (SSRN, Jan. 2006); Ron Kaniel and Robert Parham, WSJ
Category Kings--The Impact of Media Attention on Consumer and Mutual
Fund Investment Decisions, 123 J. FIN. ECON. 1 (2016).
    \575\ 12b-1 fees. A 12b-1 fee is an annual marketing or
distribution fee paid by a mutual fund. It is paid by the fund out
of fund assets to cover distribution expenses and sometimes
shareholder service expenses (see rule 17 CFR 270.12b-1). It is
considered to be an operational expense and, as such, is included in
a fund's expense ratio. The rule permits a fund to pay distribution
fees out of fund assets only if the fund has adopted a plan (12b-1
plan) authorizing their payment. ``Distribution fees'' include fees
paid for marketing and selling fund shares, such as compensating
brokers and others who sell fund shares, and paying for advertising,
the printing and mailing of prospectuses to new investors, and the
printing and mailing of sales literature. The SEC does not limit the
size of 12b-1 fees that funds may pay, although FINRA rules limit
the amount that may be charged by a fund sold by FINRA member
broker-dealers. Although some mutual fund managers also pay
marketing/service costs out of their own resources, the 12b-1 fee is
used as a close approximation for marketing expenses in the finance
literature, because both marketing and distribution costs are costs
incurred to promote the asset management service. In addition,
various shareholder services fees and administrative fees may be
paid outside 12b-1 plans (such as revenue sharing) may provide
additional compensation to distribution intermediaries. As a
consequence, the use of 12b-1 fees as a proxy for marketing costs
may understate the total payments made for marketing by funds and
their advisers.
    \576\ Roussanov, Ruan and Wei (2018) study the social welfare
(net investor welfare plus asset manager welfare) implications of
advertising. They find that marketing expenses are nearly as
important as price (i.e., expense ratio) or performance for
explaining fund size (AUM). Marketing increases funds' size (asset
under management) and brings in more revenue for all funds,
regardless of their performance. One extra basis point in marketing
fees prompted a 1.15 percent increase in AUM for funds with the best
returns, but even for those with the lowest returns it boosted a
fund's size by 0.97 percent. Nikolai Roussanov, Hongxun Ruan, and
Yanhao Wei, Marketing Mutual Funds (NBER Working Paper 25056, Sept.
2018).
    \577\ Some institutional investors will expend resources as part
of their own search costs. For example, some institutional investors
pay consultants to conduct RFPs for money managers or private funds.
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    The proposed rule defines a ``Non-Retail Advertisement'' as an
advertisement for which an investment adviser has adopted and
implemented policies and procedures reasonably designed to ensure that
the advertisement is disseminated solely to a ``qualified purchaser''
or a ``knowledgeable employee.'' As with the proposed definition of
``advertisement'' (see section 2.a), we expect the proposed definition
of ``Non-Retail Advertisement'' will alter the economic effects of the
proposed rule because the obligations of investment advisers differ for
Non-Retail Advertisements under certain circumstances. Thus, the
programmatic costs and benefits of certain elements of the proposed
rule will not only be determined by the scope of entities that are
considered non-retail investors, but will also be determined by the
extent to which the definition of non-retail investors is calibrated
appropriately relative to the proposal's substantive requirements.
    Although the staff is not aware of any direct research on the
Qualified Purchaser standard and its relationship with financial
literacy, multiple studies have found a strong positive correlation
between wealth and financial literacy.\578\ This evidence suggests that
the division of certain programmatic requirements may yield benefits by
tailoring the provisions of the proposed rule to the financial literacy
of the investors that would receive a respective advertisement. In
addition, Qualified Purchasers would likely have access to the
resources necessary to gain access to expertise and information.\579\
Similarly, the requirements for an employee to be a Knowledgeable
Employee strongly suggest that the employee has the experience with
investment management necessary to properly interpret the same
advertisements that a Qualified Purchaser would; and would furthermore
be able to obtain additional information the employee deems necessary
to interpret Non-Retail Advertisements.
---------------------------------------------------------------------------

    \578\ See e.g., Annamaria Lusardi, Pierre-Carl Michaud, and
Olivia S. Mitchell, Optimal Financial Knowledge and Wealth
Inequality, 125 J. POL. ECON. 431 (2017); Jere R. Behrman et al.,
How Financial Literacy Affects Household Wealth Accumulation, 102 AM
ECON REV. 300 (2012). These papers found that financial literacy and
knowledge were related across the entire range of wealth, not just
at higher levels.
    \579\ See Section I.A supra.
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2. Specific Costs and Benefits of the Advertising Rule
a. Definition of Advertisements
    The proposed rule redefines an advertisement, and lists three items
that would not be considered an advertisement under the definition. Two
significant differences between the new definition and the current
rule's definition are (i) the inclusion of ``all communications''; and
(ii) the two purpose tests for determining whether a communication is
an advertisement--to ``offer or promote'' an investment advisory
service for ``the purpose of obtaining or retaining'' one or more
clients or investors in pooled investment vehicles.
    By determining the scope of communications that would be affected
by the proposed rule, the proposed definition of ``advertisement''
determines, in part, the costs and benefits of the regulatory program
set forth by the other components of the proposed 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
while also raising similar investor protection concerns, investment
advisers might use these alternative methods of communication to avoid
the costs associated with complying with the proposed rule. This would
mitigate the programmatic impact of the proposed substantive provisions
that would regulate advertisements. Conversely, if the scope of
communications that is captured by the proposed rule is too broad, and
captures communications not relevant for an investment adviser's
advertisements, the amendments may impose costs on investment advisers
while yielding insubstantial benefits.
i. Specific Provisions
    The proposed definition of ``advertisement'' would expand the scope
of communications subject to the requirements of rule 206(4)-1. In some
cases, we anticipate that the proposed rule would broaden the scope of
these communications. The proposed rule would cover all communications
disseminated by, or on behalf of, an investment adviser to offer or
promote the investment adviser's services.
    The ``all communications'' provision would bolster investor
protections by explicitly applying the substantive provisions of rule
206(4)-1 to communications not within the scope of the current rule.
Application of the proposed substantive requirements for advertisements
to these communications would yield programmatic costs and benefits
that would not accrue under the current definition of ``advertisement''
because the current definition of ``advertisement'' focuses solely on
written communications to more than one recipient.
    The proposed definition would include communications of any form,
with certain exceptions noted below. Broadening the definition of
``advertisement'' could bolster investor protections currently afforded
by the Advertising Rule, by updating the definition of
``advertisement'' to reflect the evolving forms of communication used
by investment advisers. The benefits that accrue to investors through
investor protections would vary depending on the type of communication
covered by the proposed rule.
    The additional burdens include mandated review and approval of
communications to investors to determine whether the communications
meet the rest of the definition of

``advertisement.'' Investment advisers may modify their communication
strategies in an effort to reduce the amount of communication that
could be deemed to fall within the proposed definition of
``advertisement,'' or that would be subject to the rule's review and
approval requirement. These strategic responses could, in turn, impose
costs on some investors, to the extent that these investors currently
rely on communications by investment advisers other than live oral
communications to inform their decisions. If investment advisers
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 if 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, prospective clients with less information from investment
advisers might choose an investment adviser that is a poorer quality
match for the investor, or may be discouraged from seeking investment
advice. To the extent that some investment advisers who already
restrict the use of communications newly regulated by the proposed rule
due to risk concerns over inability to monitor or document such
communications under the current rule, the change in the cost would be
diminished.
    The proposed definition of ``advertisement'' would also include
advertisements made ``by or on behalf of'' of an investment adviser.
This provision would expand the set of communications that would be
considered advertisements and subject those communications to the
provisions of the proposed rule. Including communications made ``on
behalf of'' an investment adviser into the set of regulated
advertisements would make it more costly for investment advisers to
avoid the provisions of the advertising rule by delegating or
outsourcing advertising communications to third-parties. In addition,
the extension of the rule to communications ``on behalf of'' investment
advisers could also create more costs and delays from reviewing and
ensuring the compliance of disclosures in such third-party
communications, which would likely provide a disincentive to use such
third-party communications. Including advertisements that are
considered ``on behalf of'' an investment adviser in the proposed rule
will help reduce the potential occurrence of misleading information
disseminated by a third party in certain circumstances. In addition,
applying the provisions of the proposed rule to these additional
communications could also yield programmatic costs and benefits, such
as potential improvement of the efficiency of the market for investment
advisers, among other effects.\580\
---------------------------------------------------------------------------

    \580\ For more, see supra section III.D.1.
---------------------------------------------------------------------------

    Under the proposed rule, content created by or attributed to third
parties could be considered by or on behalf of an investment adviser,
depending on the investment adviser's involvement. Some examples of
communications that would be included are: Positive reviews from
clients selectively picked by an adviser to be posted or attributed,
materials an adviser helps draft to be disseminated by solicitors or
other third-party promoters, endorsements organized by an adviser on
social media and etc. This proposed inclusion of communications
protects investors from being misled or deceived by third-party
promotional information from a source that may have conflicts of
interest. In addition, because communications ``on behalf of'' an
adviser are intended to reflect the application of the current rule to
communications provided by advisers through intermediaries, investment
advisers will comply with this element of the proposed rule through
policies and procedures they currently use in communicating with
prospective clients through intermediaries. Therefore, the additional
burden on investment advisers, if any, should be marginal. While we do
not anticipate that investors will bear any direct costs as a result of
this provision, investors may be directly affected if investment
advisers alter their advertising practices in a way that reduces the
information available to investors. For example, investment advisers
may reduce promotion of third-party reviews to avoid having to bear the
associated costs of disclosure and compliance. If this results in a
reduction in the amount of information available to investors, then
investors may be directly affected by this provision of the rule.
    The proposed definition of ``advertisement'' also includes
communications that ``offer or promote the investment adviser's
investment advisory services,'' which would help apply the proposed
rule not only to communications offering the services of the investment
adviser, but also to those promoting its services. Unlike the ``offer''
clause, the ``promote'' clause is not included in the current rule.
Under the proposed rule, promotional materials are advertisements, even
if the content does not explicitly ``offer'' investment advisory
services or participation in a pooled investment vehicle. Promotional
materials implicate many of the same investor protection concerns as
explicit offers of advice or offers of shares of pooled investment
vehicles to the extent that these materials are designed to persuade
potential clients to engage an investment adviser or invest in a pooled
investment vehicle. This change broadens the scope of advertisements
and extends the investor protection benefits of the advertising rule to
a larger volume of communications.
    However, because of this change, investment advisers would likely
incur costs to review and approve their communications with potential
and existing clients and investors, in an effort to determine which
constitute promotional materials. Depending on the outcome of this
assessment, an investment adviser may respond by reducing the amount of
information it disseminates to potential and existing clients and
investors, in turn reducing the amount of information available to
potential and existing clients and investors.
    Similarly, the provision ``for the purpose of obtaining or
retaining clients'' would help apply the proposed rule not only to
communications aimed at obtaining clients, but also to those aimed at
retaining existing clients. This revision is consistent with the
Commission's concerns under the current rule that communications to
existing clients may be used to mislead or deceive in the same manner
as communications to prospective clients. Given that this particular
provision mainly adds to the clarity of the regulation, we expect the
additional cost or benefit to be marginal. More generally, the
provision benefits investors to a different degree depending on whether
an investor is a new client or an existing client. An existing client
has the chance to observe the skills of an investment adviser directly
through their existing relationship. An existing client would thus have
more access to information about the investment adviser than a new
client, and hence may receive fewer benefits from the investor
protections provided by the proposed rule.
ii. Specific Exclusions
    Certain elements of the proposed definition of ``advertisement''

potentially narrow its scope and are designed to reduce the likelihood
that the proposed rule imposes costs or burdens on communications
unrelated to advertising or adds costs or burdens for communications
already regulated by the Commission as advertisements. In particular,
the rule permits four exceptions to the definition of
``advertisement.'' These exclusions include: (1) Non-broadcast live
oral communications; (2) responses to certain unsolicited requests; (3)
advertisements, other sales materials, and sales literature that is
already regulated under rules specifically applicable to RICs and BDCs;
and (4) any statutorily or regulatory required notice, filing, or other
communication. The first exclusion eliminates the current rule's ``more
than one person'' element and narrows the scope of the rule by
excluding all non-broadcast live oral communications, to one or more
persons; the second exclusion of responses to unsolicited requests
(other than those relating to hypothetical performance or relating to
any performance results presented to Retail Persons) is partly
consistent with our staff's historical approach when considering
whether or not to recommend enforcement action; \581\ the third
exclusion, for RICs and BDCs, is intended to acknowledge that
advertisements, other sales materials, and sales literature that are
about RICs and BDCs are regulated under the Securities Act and the
Investment Company Act and subject to the specific prescriptions of the
rules adopted thereunder; finally, the rule carves out several types of
communications that are required to be produced by existing regulatory
requirements. These four exclusions narrow the scope of communications
that would otherwise be subject to the programmatic costs associated
with the proposed rule, and thus avoid imposing costs and burdens on
investment advisers.
---------------------------------------------------------------------------

    \581\ We note that the exclusion for hypothetical performance or
for any performance results presented to Retail Persons is a
substantive change from current practice in reliance on staff
positions.
---------------------------------------------------------------------------

    One exclusion prevents the proposed rule from duplicating rules
already in place for RIC and BDC marketing, designed to ameliorate
investor protection concerns related to RIC and BDC marketing
practices. Therefore, the expected change in costs and benefits from
this exclusion under the proposed rule should be minimal, for both
investment advisers and investors. The proposed exclusion of all non-
broadcast live oral communications does not retain the current rule's
``more than one person'' element. To the extent that live oral
communications are addressed to a small audience, the proposed
amendment is consistent with the current rule.
    To the extent that broadcasting reaches potential clients at a
lower cost than direct conversations, the proposed exclusion would
probably not cause investment advisers to substitute direct
conversations for broadcast advertisements, and hence, there would be
no significant change in terms of investor protection either. However,
current technologies, such as software that supports live group video
and voice chats, may enable investment advisers to reach clients
without broadcasting. In addition, investment advisers that choose to
avail themselves of the exclusion for responses to unsolicited requests
would incur compliance costs associated with determining whether
requests for information are unsolicited. However, we note that the
proposed exclusion may benefit investors to the extent that investment
advisers' responses to unsolicited requests for performance results
would have still have to meet the specific performance advertising
requirements of the advertising rule, along with its associated costs
and benefits.\582\
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    \582\ See Section III.D.2.d infra.
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b. General Prohibitions
    The proposed rule prohibits advertisements that contain any untrue
statements of a material fact, or that omit a material fact necessary
in order to make the statement made, in the light of the circumstances
under which it was made, not misleading.\583\ We believe that the scope
of this aspect of the proposed rule is substantially the same as its
counterpart in the current rule, and thus we do not expect to see any
costs or benefits relative to the baseline. Notably, the current rule
contains an explicit prohibition on advertisements that contain
statements to the effect that a report, analysis, or other service will
be furnished free of charge, unless the analysis or service is actually
free and without condition, but the proposed rule removes this explicit
prohibition.\584\ As discussed above, we believe that this practice
would be captured by the proposed rule prohibition on untrue
statements. Given that the removal of this provision entails no
substantive change in prohibitions, we believe that the removal of this
provision will likewise generate no new costs or benefits.
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    \583\ Proposed rule 206(4)-1(a).
    \584\ See current rule 206(4)-1(a)(4); see also Dow Theory
Forecasts, Inc., SEC Staff No-Action Letter (May 21, 1986) (staff
declined to provide no-action recommendation where an offer for
``free'' subscription was subject to conditions).
---------------------------------------------------------------------------

    In addition, the proposed rule also contains several specific
prohibitions for advertisements that are not present in the current
rule. The prohibitions would apply to statements or communications
that, depending on the facts and circumstances, may already be
prohibited under the existing general prohibition in the rule of false
or misleading statements as well as other anti-fraud provisions of the
Federal securities laws. We anticipate that these changes will generate
new questions about the rule's application, which will impose costs on
investment advisers for legal advice. Similarly, the proposed rule
removes the current rule's prohibition of charts and graphs absent
certain disclosures, but the use of charts and graphs is still subject
to the general anti-fraud prohibition. While the revised rules may
allow certain additional advertising, changes to the rule may subject
investment advisers to legal and compliance costs when they comply with
the new standard.
    The proposed rule also prohibits including or excluding favorable
or unfavorable performance results, present performance time periods,
or referencing specific investment advice in a manner that is not
``fair and balanced.'' To the extent that investment advisers include
additional information to provide context for the performance results
in their advertisements because of the selective inclusion of
performance results and ``fair and balanced'' provisions, investors may
benefit from the additional information, as they may be better able to
evaluate the performance of investment advisers. While the additional
disclosures and statements necessary to ensure performance results do
not unfairly include or exclude performance results, and are fair and
balanced may impose costs on investment advisers and may cause them to
reduce the amount of information they provide, a ``fair and balanced''
presentation of performance might benefit both investors and investment
advisers with higher abilities. Investors will be better able to
evaluate investment advisers, and investment advisers who have higher
abilities but who could not reveal those abilities to the same extent
under the current rule would be better able to advertise their services
and performance relative to other investment advisers.
c. Testimonials, Endorsements, and Third-Party Ratings
    The proposed rule defines a testimonial as ``any statement of a

person's experience, as a client or investor, with the investment
adviser,'' and endorsements as ``any statement by a person other than a
client or investor indicating approval, support, or recommendation of
the investment adviser.'' Because of the similarity between
testimonials and endorsements, we will first discuss the costs and
benefits of these testimonials and endorsements together, and then
later discuss third-party ratings.
    Under the baseline, the current rule prohibits, but does not
define, the use of testimonials, and does not address endorsements
specifically. However, the staff through no-action letters has
indicated it would not recommend enforcement action to the Commission
when statements by non-clients (defined as endorsements in the proposed
rule) were treated as testimonials as defined by the current rule. The
proposed rule thus clarifies the distinction between statements made by
clients and non-clients, and permits the use of testimonials and
endorsements, provided that two disclosures are included with the
advertisement.
    Advertisements containing testimonials or endorsements must
disclose whether the person giving the testimonial or endorsement is a
client or a non-client, and whether he or she was compensated for his
or her testimonial or endorsement. Testimonials and endorsements can
play an important role in investor decisions by giving investors
information about an investment adviser's interactions with investors,
or the opinions of individuals who are not clients of the investment
adviser, but might nevertheless be persuasive to prospective investors.
To the extent that the quality of the testimonials and endorsements in
investment adviser advertisements is correlated with the ability or
potential fit of an investment adviser, investment advisers could
benefit more from the proposed rule.
    The ability to provide testimonials in advertisements may benefit
investment advisers by allowing investment advisers to show satisfied
clients or other individuals willing to endorse the investment adviser.
Investment advisers with higher ability will likely receive more
benefit from this provision, either because they will have to pay less
for a testimonial, or will have access to more positive testimonials.
However, given that the quality of a testimonial may be uncorrelated
with the ability or potential fit of an investment adviser's services,
the proposed rule may also create an ``arms race'' of testimonials in
advertisements, where investment advisers, regardless of ability,
increase spending on testimonials in advertisements to attract and
retain clients. In this case, permitting paid testimonials and
endorsements could leave both investment advisers and investors worse
off.
    Although including testimonials or endorsements in an advertisement
will entail costs for investment advisers to either identify or
compensate clients and non-clients, the Commission believes that
investment advisers will only choose to include testimonials and
endorsements in their advertisements if the expected benefits to their
revenue exceed the expected costs of doing so. However, as noted above,
competitive pressures may result in an inefficient level of advertising
expenditures.
    The proposed rule also includes provisions that require investment
advisers to disclose whether the person giving a testimonial or
endorsement is a client or former client. This disclosure could provide
investors with information about the potential bias of the person
offering a testimonial or endorsement, but also information about the
knowledge and experience a person might have to form a basis for his
statements. Research suggests that when investors receive disclosures
about the conflict of interest and the informational basis associated
with advisers, they are able to filter out some, but not all, of the
bias associated with these disclosures.\585\
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    \585\ 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 a.m.
ECON. REV. 423 (2011).These papers observed that when disclosure of
conflicts of interest was required, an adviser exaggerated the bias
in their advice to counteract the fact that their clients would
account for their conflict of interest.
---------------------------------------------------------------------------

    Testimonials and endorsements bear similarity in the appearance,
but differ in the source, of the promotional information. A testimonial
is from a client who has first-hand asset management experiences with
the investment adviser. Testimonials may be appealing to the
prospective clients since they appear to convey more reliable
information. However, an existing client might be incentivized to give
a positive review in exchange for better or additional service from the
adviser, even without any explicit compensation, which could compromise
the credibility of his testimonials, while keeping the conflict of
interest hidden. Meanwhile, endorsements are from non-clients, who may
not rely as much on the adviser's services as an existing client does.
The endorsements are, therefore, more likely to be arranged with
certain compensation. The disclosure of such compensation can highlight
the conflict of interests for prospective clients.
    The Commission estimates that the aggregate internal cost of
providing the disclosures associated with testimonials and endorsements
will be $337 per adviser per year, assuming each investment adviser
would use approximately 5 testimonials or endorsements per year.\586\
However, these estimates do not account for potential changes in
investment adviser behavior and advertising practices as a result of
the proposed rule, which are difficult to quantify. If 50 percent of
current registered investment advisers would use testimonials or
endorsements in advertisements, the aggregate internal cost of
preparing the disclosures is estimated to be $2,268,684 per year.\587\
If the proposed approach to testimonials and endorsements induces a
marketing ``arms race'' and close to 100 percent of current RIAs invest
in advertisements with 5 testimonials and endorsements per year, the
estimated cost of preparing the disclosures is nearly $4,537,368 in
aggregate. However, if the investment adviser believes that revenue
brought in by new testimonials and endorsements under the proposed rule
does not justify the cost of compliance with the rule, as related to
using these testimonials and endorsements, the increase in cost would
be minimal, as there would be no change in advertising practices
regarding testimonials and endorsements.
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    \586\ See section III.F.1 for more details.
    \587\ See footnote 625.
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    The proposed rule would also permit the use of third-party ratings
in advertisements, which are defined as ratings or rankings of an
investment adviser provided by a person who is not an affiliated person
of the adviser and provides such ratings or rankings in the ordinary
course of its business. To the extent that third-party ratings are
produced using methodologies that yield useful information for
investors, the proposed rules may improve the information available to
investors about investment advisers. The proposed rule would also
require that advertisements that include third-party ratings disclose:
(i) The date on which the rating was given and the period of time upon
which the rating was based; (ii) the identity of the third party that
created and tabulated the rating; and (iii) if applicable, any
compensation or anything of value that has been provided in connection
with obtaining or using the third-party rating.
    Economic models suggest that selective control of or the ability to

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.\588\ For example, this type of control or influence on
information can be as explicit as deletion or removal of unfavorable
testimonials,\589\ or as implicit as a reordering of the testimonials
or a suggestion of which testimonials to read.\590\ The additional
disclosures in the proposed rule might have two effects on investment
adviser advertisements. First, the disclosures might mitigate the
likelihood that retail investors will be misled by an investment
adviser's ratings. Providing the additional disclosures would provide
investors additional information to judge the context of a third-party
rating. Second, the fact that advertisements must also include such
disclosures may reduce the incentives of investment advisers to include
third-party ratings that might be stale or otherwise misleading.
Because third-party ratings included in an advertisement would be
required to have additional disclosures, investors are less likely to
be misled by the ratings, which reduces the incentive for investment
advisers to include misleading third-party ratings.
---------------------------------------------------------------------------

    \588\ Luis Rayo and Ilya Segal, Optimal Information Disclosure,
118 J. POL. ECON. 949 (2010); Emir Kamencia 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).
    \589\ See Id. for Segal and Rayo 2010, Kamenica and Gentzkow
2011, Au li 2018.
    \590\ See Glazer supra footnote 590.
---------------------------------------------------------------------------

    For the purposes of estimating burdens in connection with the
Paperwork Reduction Act, we estimate that advisers would incur an
initial cost of $505.50 to draft and finalize the required disclosure
for each third-party rating they advertise. In addition, as many of
these ratings or rankings are done annually, an adviser would incur
ongoing, annual costs associated with this burden, which we estimate to
be 25 percent of the initial costs. In aggregate, because it is
uncertain how many investment advisers would find the benefit of using
third-party ratings in their advertisements justify the associated
compliance costs, the total cost of these disclosures across all
advisers is difficult to quantify.
d. Performance Advertising
    The proposed rule permits the inclusion of performance advertising,
but includes general requirements for its inclusion in advertisements,
and specific disclosures that must be made to investors. The rule also
includes specific restrictions that may apply, depending on whether an
advertisement is intended for retail or non-retail investors. First, we
discuss the several requirements for all advertisements with
performance advertising. Then, we discuss the specific restrictions and
requirements for Retail Advertisements.
    As part of the general prohibitions, the proposed rule would
prohibit any investment adviser from including favorable performance
results or excluding unfavorable performance results, or presenting
time periods for performance, if such selection results in a portrayal
of performance that is not fair and balanced, for all advertisements.
Although the inclusion of performance advertising may provide valuable
information to investors about an investment adviser's ability, absent
the current or proposed rule, investment advisers have the ability to
disclose positive information about their past performance in a
potentially misleading way. The proposed rule's prohibition on
including or excluding performance results in a manner that is not fair
and balanced, however, does not significantly differ from the baseline
prohibition on any untrue statement of a material fact, or which is
otherwise false or misleading, and thus will likely not have
significant costs or benefits associated with them.
    The proposed rule prohibits the use of gross performance in Non-
Retail Advertisements unless the advertisement also provides or offers
to provide promptly a schedule of fees or expenses to the investor.
Although the use of gross performance in advertising is not fraudulent,
it may be misleading to investors who are unaware that they should also
consider an investment adviser's net performance results when choosing
an investment adviser. By offering to provide the necessary schedule of
fees and expenses to investors, the provision would: (i) Remind
investors that fees and expenses are another important piece of
information to consider when choosing an investment adviser; and (ii)
give investors access to the fee and expense data to make a direct
calculation of the net performance. While we do not expect investors to
bear any direct costs from the use of gross performance, we note that
investors may bear costs associated with processing the information
that is included on the schedule that investment advisers must provide
or offer to provide promptly in order to allow the calculation of net
performance.
    The rule also prohibits the use of hypothetical performance in all
advertisements, unless the investment adviser adopts and implements
policies and procedures reasonably designed to ensure that the
hypothetical performance is relevant to the financial situation and
investment objectives of the person to whom the advertisement is
disseminated; provides sufficient information to enable such person to
understand the criteria used and assumptions made in calculating such
hypothetical performance; and provides (or, in the case of Non-Retail
Persons, provides or offers to provide promptly) sufficient information
to enable such person to understand the risks and limitations of using
such hypothetical performance in making investment decisions. To the
extent that advisers are required to revise their advertisements as a
result of the hypothetical performance requirements in rule 206(4)-1,
they may incur additional costs. These types of hypothetical
performance include representative performance, derived from
representative model portfolios that are managed contemporaneously
alongside portfolios managed for actual clients; backtested
performance, performance that is backtested by the application of a
strategy to market data from prior periods when the strategy was not
actually used during those periods; and targeted or projected returns
with respect to any portfolio or to the investment services offered or
promoted in the advertisement. As discussed above, the Commission
preliminarily believes that advertisements that contain hypothetical
performance are likely to be misleading to investors. However, the
Commission also recognizes that some persons may wish to know specific
details about an investment adviser's hypothetical performance, and the
required policies and procedures are designed to ensure that investment
advisers provide enough information for investors to understand and use
hypothetical performance in advertisements. Additionally, while
investment advisers must provide sufficient information for Retail
Person recipients to understand the risks and limitations of using such
hypothetical performance in making investment decisions, investment
advisers need only offer to provide promptly such information if the
recipient is a Non-

Retail Person. This difference in requirements reflects the different
of access to resources and expertise between Retail and Non-Retail
Persons, which may better equip Non-Retail persons to make appropriate
use of potentially confusing or misleading information.
    Investors may benefit from the additional information provided by
hypothetical performance advertising, if investment advisers provide
the required information and context to properly understand it and the
investor has the ability to analyze it and its limitations and
assumptions. We note that although investors would not any face direct
costs from the inclusion of hypothetical performance, they may face
indirect costs associated with processing and interpreting this new
information. Even if investors are provided with the necessary
information to contextualize hypothetical performance, investors would
need time and expertise to properly interpret hypothetical performance.
Moreover, investors that are unable to interpret the information
provided may be misled by hypothetical performance because of a lack of
resources or financial expertise. In this case, investors may incur
additional costs from the use of hypothetical performance in
advertising, associated with poorer matches with investment advisers.
Investment advisers may bear costs associated with screening potential
investors to determine whether an advertisement with hypothetical
performance is appropriate for them. However, we note that investment
advisers are unlikely to incur the costs of screening their potential
investors if they do not expect the benefits of hypothetical
performance advertising to exceed the costs associated with screening.
    The proposed rule would condition the presentation of ``related
performance'' in all advertisements on the inclusion of all related
portfolios. However, the proposed rule would allow related performance
to exclude related portfolios as long as the advertised performance
results are no higher than if all related portfolios had been included.
This allowed exclusion would be subject to the proposed rule's
requirement applicable to Retail Advertisements that the presentation
of performance results of any portfolio is conditioned on the inclusion
of results for 1-, 5-, and 10-year periods. The proposed rule would
allow related performance to be presented either on a portfolio-by-
portfolio basis or as one or more composites of all related portfolios.
Similarly, the proposed rule would condition the presentation of
extracted performance in all advertisements on the advertisement's
providing or offering to provide the performance results of all
investments in the portfolio from which the performance was extracted.
This prohibition is designed to prevent investment advisers from
``cherry-picking'' portfolios to provide a selective representation of
the investment adviser's performance. Such representations would also
be subject to the provisions of proposed rule 206(4)-1(a), including
the prohibition on including or excluding performance results, or
presenting performance time periods, in a manner that is not fair and
balanced.
    The proposed rule contains several provisions specific to Retail
Advertisements. These additional provisions generally reflect the lack
of access to resources that Retail Persons face, and are designed to
mitigate the potential costs that these provisions might impose on Non-
Retail persons. The proposed rule would condition the presentation of
gross performance results in Retail Advertisements on the advertisement
also presenting net performance results, requiring that they be
displayed with equal prominence as gross performance, and be calculated
over the same time periods. This requirement does not significantly
differ from current market practices as shaped by no-action letters,
and we preliminarily believe will not generate significant costs and
benefits to investment advisers or investors relative to the baseline.
    The proposed rule prohibits the presentation of performance results
of any portfolio in Retail Advertisements unless the results for one,
five, and ten year periods are presented as well. Each of the required
time periods must be presented with equal prominence and end on the
most recent practicable date. If the portfolio was not in existence in
any of these three periods, the lifetime of the portfolio can be
substituted. Under the baseline, there is no such requirement relating
to performance advertising. Requiring Retail Advertisements to include
this information would benefit investors by giving them more
standardized information about the performance and limiting the
potential that an investor could be unintentionally misled about an
investment adviser's performance through the investment adviser's
selection of performance periods. This requirement also does not
significantly differ from current market practices as shaped by no-
action letters, and we preliminarily believe will not generate
significant costs and benefits relative to the baseline.
i. Quantitative Estimates of Performance Advertising Costs
    In this section, we describe the quantitative estimates of the
provisions of the proposed rule associated with performance
advertising, and their relation to the economic costs and benefits of
the rule described above.
    For the purposes of our Paperwork Reduction Act analysis, we
estimate that investment advisers would incur an initial burden of 5
hours to comply with the proposed rules associated with gross
performance, for three portfolios each, resulting in a total cost of
$4,692 per adviser. We also estimate that investment advisers would
incur an ongoing internal cost burden of $3454 per adviser per year to
update their fee schedules, based on an estimate of an ongoing cost
burden of 10.25 hours per year, and an annual external cost of $500 per
year for printed materials. However, we note that many investment
advisers already make net performance calculations for their clients
under the baseline, and so the actual cost burden might be lower.
    In addition, the Paperwork Reduction Act analysis estimates that
investment advisers that choose to advertise related portfolio
performance will bear an initial cost of $8,425 per adviser. These
costs are based on an estimate of 25 hours to review portfolios to
determine which ones meet the definition of ``related portfolio.''
These advisers would also face an ongoing cost of $5,897 per adviser
per year, which reflects an estimated 5 hours of labor to update
presentations 3.5 times per year.
    Similarly, the Paperwork Reduction Act analysis estimates that
investment advisers that choose to advertise extracted performance will
bear an initial cost of $3,370 per adviser. These costs are based on an
estimate of 10 hours to review portfolios and calculate the performance
of the entire portfolio from which an extracted performance is taken.
In addition, the Paperwork Reduction Act analysis estimates these
advisers would incur an ongoing cost of $2359 per adviser per year,
which is based on an estimate of a 2 hour review conducted 3.5 times
annually.
    The Paperwork Reduction Act analysis estimates that investment
advisers that choose to advertise hypothetical performance will bear an
initial cost of $2,650 per adviser to develop policies and procedures
reasonably designed to ensure that hypothetical performance is relevant
to the financial situation and investment objectives of the person to
whom the

advertisement is disseminated. We estimated these policies and
procedures would require 5 hours per adviser to implement. In addition,
each adviser that chooses to advertise hypothetical performance would
face an ongoing annual cost of $2,650 per year to evaluate the
relevance of hypothetical performance to an investor, based on an
estimated 20 instances of hypothetical performance advertising per
year, with each instance taking .25 hours to evaluate. The Paperwork
Reduction Act analysis also estimates that an adviser would also incur
an initial cost of $5,392 to preparing the information sufficient to
understand the criteria used and assumptions made in calculating, as
well as risks and limitations in using, hypothetical performance, based
on an initial hour burden of 16 hours. Finally, the Paperwork Reduction
Act analysis estimates that an adviser that advertises using
hypothetical performance will face an ongoing cost burden of $3,538 per
adviser per year to update its hypothetical performance information.
This estimate is based on an estimate of 3 hours per update and 3.5
updates annually. Overall, the internal cost burden is estimated to be
$8,042 per adviser, initially, and $6188 per adviser per year on an
ongoing basis. These costs are estimated on a per adviser basis, and
the aggregate costs to investment advisers will be highly dependent on
whether they choose to advertise hypothetical performance. However,
investment advisers are likely to only incur the costs associated with
hypothetical performance if the gains in their expected revenue exceed
their expected costs.
e. Compliance and Recordkeeping
    The proposed rules expand the set of communications for which
records must be kept and require that investment advisers retain the
records for advertisements disseminated to one or more individuals. In
contrast, current rules require investment advisers to keep records of
communications disseminated to more than ten individuals. In addition,
the proposed rules require that a designated employee approve in
writing each advertisement, and that the investment adviser retain
records of these written approvals. These requirements are intended to
ensure sufficient oversight of advertising activities by investment
advisers.
    Requiring a written record of the review and approval of all
advertisements, regardless of the size of the intended audience, allows
our examination staff to better review adviser compliance with the rule
and reduces the likelihood of misleading or otherwise deficient
advertisements. We also expect these provisions will impose costs on
investment advisers, who will need to expend labor and other resources
to create processes for compliance with the written approval
requirement and amend processes for retaining records for
advertisements distributed to between one and ten individuals. In our
Paperwork Reduction Act analysis below, we estimate the hourly cost
associated with the review and approval of new advertisements to be
about $671.25 and the cost to update an existing advertisement to be
about $223.75.\591\ For the proposed recordkeeping amendments that
correspond to proposed changes to the advertising rule, we estimate
that the incremental cost aggregated across all advisers would be
approximately $8,530,157.\592\ However, the proposed rules could also
result in reduced communications and advertisements to investors if
investment advisers decide to restrict written and recorded
communications to reduce the costs associated with creating processes
for review and approval. Restricting the amount of communication could,
in turn, impose costs on existing clients and investors to the extent
that existing clients would not receive valuable information about
investment advisers' services. Similarly, prospective investors might
receive less information that would be useful in searching for an
investment adviser, which could lead to lower quality matches with
investment advisers, or which could discourage investors from seeking
investment advice altogether. This effect is impossible to quantify, as
it depends on the reactions of market participants to the proposed
rule, and there are no similar rules to compare how investment advisers
adjusted their behavior. The requirement to retain a written record and
approval of advertisements may impose additional costs on investment
advisers who use third parties for advertisements, given the costs of
ensuring that third parties' communications comply with the rule, and
the potential liability to the investment adviser. Alternatively,
investment advisers may reduce their use of third parties for
advertisements and communications, to reduce the cost and risk
associated with the recordkeeping and compliance provisions of the
proposed rule.
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    \591\ See section IV.B.5. for details.
    \592\ In PRA we estimate a 10-hour per advertisement incremental
burden for investment advisers associated to recordkeeping
amendments that correspond to proposed changes to the advertising
rule, including the expanded definition of ``advertisement''.
Further we assume that 100 percent of 13,643 investment advisers
would be subject to the proposed amendments, and each of them would
disseminate 1 new advertisement per year. 17 percent of the
compliance to the proposed rule is assumed to be performed by
compliance clerks, whose hourly cost is $70, and 83 percent by
general clerks, whose hourly cost is $62 (data is from the
Securities Industry and Financial Markets Association's Office
Salaries Data 2013 Report, modified to account for an 1,800-hour
work-year, inflation, bonuses, firm size, employee benefits and
overhead). The annual incremental cost is therefore (17% x $70 + 83%
x $62) * 10 * 13,643 = $8,530,157.
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    Additionally, we note that dual registrants, with dually licensed
personnel, will have to bear costs associated with determining which
communications were made in a broker-dealer or investment adviser
capacity. Not only do these processes impose costs on investment
advisers, these processes also delay communication between investment
advisers and their investors, which can impose additional costs on each
of them. Alternatively, dual registrants with dually licensed personnel
may instead implement a single review and approval process for all
communications of dually licensed personnel, to avoid the burden of
determining which communications are made in a broker-dealer or
investment adviser capacity. This alternative review and approval might
incur lower costs than the proposed rules to the extent that dual
registrants have already implemented elements of the review and
approval process.
3. Costs and Benefits of the Proposed Amendments to the Solicitation
Rule
    The proposed rule expands the current rule to cover solicitation
arrangements involving all forms of compensation as well as to
solicitors for private funds; eliminates certain duplicative disclosure
requirements for solicitors and broadens the scope of the rule's
disqualification of certain persons as solicitors while adding a
conditional carve-out. In this section, we discuss the costs and
benefits of each provision of the proposed amendments to the
solicitation rule.
a. Scope of Covered Compensation
    Rule 206(4)-3 currently prohibits an adviser from paying a cash
fee, directly or indirectly, to a solicitor with respect to
solicitation activities unless the adviser complies with the terms of
the rule. The proposed rule's more expansive scope would include the
many forms of non-cash compensation that solicitors might receive from
advisers or their funds for solicitation, which generate nearly
identical conflicts of interest as cash compensation. For example,
advisers

use brokerage--a form of non-cash compensation--to reward brokers that
refer them to investors. This presents advisers with conflicts of
interest as the brokers' interest may not be aligned with investors'
interest.
    Under the proposed rule, the programmatic costs and benefits of the
proposed solicitation rule amendments--the disclosure requirements, the
requirements to enter into a written agreement, the adviser's
supervision requirement, and the statutory disqualification of certain
persons--would apply to solicitors that receive non-cash compensation.
Also, the programmatic costs and benefits of these rules would flow to
investors that these non-cash compensated solicitors refer. The
solicitation rule's extension to non-cash compensated solicitors would
extend the benefits of investor protection through the disclosure
requirements, the written agreement requirements, the adviser
supervision requirement, and the statutory disqualification to
investors that are solicited by noncash compensated solicitors. In
addition, to the extent that the rule improves investor confidence in
the recommendations of non-cash compensated solicitors, another
programmatic benefit of the rule is that it may improve the efficiency
of matches between investment advisers and investors.
    The expansion of the solicitation rule to non-cash compensated
solicitors would also impose programmatic costs on additional
solicitors, investment advisers, and investors. The expanded scope of
the solicitation rule would impose the disclosure requirements and its
associated costs onto non-cash compensated solicitors, as well as
investment advisers who hire them. Investment advisers and solicitors
may pass of some portion of the cost to investors.
b. Private Funds
    The proposed rule would also broaden the scope of the current
solicitation rule to cover solicitors who solicit on behalf of private
funds. Under the baseline, solicitors that solicit on behalf of private
funds are primarily subject to the anti-fraud provisions of the Federal
securities laws and rules applicable to private fund offerings made in
reliance on Regulation D. However, private funds also make offerings
under section 4(a)(2) of the Securities Act, which does not have
Federal disqualification provisions, and solicitors for such funds
would only be subject to state disqualification provisions. While we
currently do not have data to directly observe the number and size of
private funds that rely on section 4(a)(2), the Commission's recently
published Concept Release on the Harmonization of Exempt Offerings and
a recent white paper by Commission staff suggest that the overall
amount of capital raised outside of Regulation D, including by private
funds, is relatively small.\593\ We request additional data or other
information from commenters that would help estimate the number and
size of private funds that could be affected by the proposed amendment
to the solicitation rule.
---------------------------------------------------------------------------

    \593\ Concept Release on the Harmonization of Exempt Offerings
(Table 2) shows the total number of other exempt offerings, which
includes the amount raised under section 4(a)(2), Rule 144A and
Regulation S, available at https://www.sec.gov/rules/concept/2019/33-10649.pdf; Vladimir Ivanov and Scott Bauguess, Capital Raising in
the U.S.: An Analysis of Unregistered Offerings Using the Regulation
D Exemption, 2009-2012 (August 2018) (Figure 1) shows the total
amount raised under Regulation S, section 4(a)(2), regulation
crowdfunding offerings and Regulation A offerings, available at
https://www.sec.gov/files/DERA%20white%20paper_Regulation%20D_082018.pdf.
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    Extending the scope of the current solicitor rule to solicitors
that target investors or prospective investors in private funds that
are not otherwise covered by the disqualification requirements in
Regulation D would extend both the benefits of the disclosure and
disqualification requirements of the solicitation rule, to the extent
such requirements differ from state requirements, to private fund
investors. Specifically, these requirements could enhance investor
protection for private fund investors by providing them with the
solicitor's compensation and conflict of interest disclosures, which
would provide private fund investors additional information when
considering a solicitor's recommendation. In addition, the
disqualification requirements would protect private fund investors from
disqualified solicitors, to the extent that the proposed rule's
disqualification requirements differ from ``bad actor''
disqualification and applicable state requirements. Likewise, extending
this scope would extend the costs of such disclosure and
disqualification requirements to advisers, solicitors, and affected
private fund investors. The costs of disclosure would stem from
compliance and recordkeeping procedures, and advisers would need
policies and procedures to establish a reasonable basis to believe that
solicitors are not disqualified. While we believe that advisers and
solicitors will directly bear the costs of these provisions, we expect
that some portion of these costs will be passed along to investors in
private funds.
c. Disclosure
    In addition to changing the scope of application of the
solicitation rule, the proposed amendments would change elements of the
Commission's program for regulation of solicitation arrangements. The
proposed rule would eliminate the current rule's written agreement
requirement that the solicitor deliver the adviser's Form ADV brochure
to a prospective client, as this represents a duplicative requirement
because the adviser is also required to deliver its brochure to clients
under rule 204-3. As noted above, however, the Commission stated in the
solicitation rule's 1979 adopting release that the solicitor's delivery
of the adviser's brochure could satisfy the investment adviser's
obligation to deliver it under rule 204-3. To the extent that both
advisers and solicitors currently deliver the adviser's Form ADV
brochure, this proposed rule's elimination of the requirement that the
solicitor deliver the adviser's Form ADV brochure would reduce the
compliance burden for advisers and solicitors. Currently, rule 204-3
does not require delivery of Form ADV by investment advisers for
private funds, although some choose to do so. Additionally, we note
that by eliminating the obligation to deliver the adviser's Form ADV
brochure, the information contained in the delivery may not have as
much of an impact on an investor's decision to begin a relationship
with an investment adviser.
    The proposed rule would permit the solicitor or the adviser to
deliver the solicitor's disclosure at the time of any solicitation
activities (or in the case of a mass communication, as soon as
reasonably practicable thereafter). Permitting additional flexibility
in the timing of the solicitor's disclosure might reduce the costs
associated with these disclosures, and improve the quality of
communications that solicitors have with potential investors. However,
allowing the adviser rather than the solicitor to deliver the solicitor
disclosure might reduce the effectiveness of the disclosure if
simultaneously paired with other disclosures provided by the adviser.
    The proposed rule would generally maintain the current rule's
solicitor disclosure requirement, with some modifications to clarify
the requirement and to accommodate disclosure of non-cash compensation,
which can be difficult to quantify. The proposed rule would also remove
the requirement that the solicitor's disclosure be written, permitting
the use of electronic and

recorded media to disclose details of the solicitation arrangements. To
the extent that presentation of these disclosures in different formats
changes their salience to investors, they might support or erode the
benefits of the solicitor disclosure requirement. The ability to permit
the use of electronic and recorded media may lower the cost of delivery
of solicitation arrangements, and may improve the ability of investors
to read and understand these disclosures. However, if these disclosures
are bundled with a variety of other disclosures and information
provided through the same medium, it may reduce the salience of this
particular disclosure, and thus might reduce the benefits associated
with the disclosure.
    The proposed rule would require the solicitor to provide,
contemporaneously with the solicitation, separate disclosures related
to the terms of compensation and any material conflicts of interest, as
well as the amount of any additional cost to the investor as a result
of solicitation. This disclosure would draw the client's attention to
the solicitor's inherent bias in recommending an adviser that is
compensating it for the referral. However, conflict of interest
disclosures may not necessarily lead to optimal decisions by investors.
The Commission's Financial Literacy Study surveyed investors and found
``many of the online survey respondents indicated that they understand
existing fee and compensation information, for example, as disclosed in
a typical Brochure, but the quantitative research data suggest
otherwise. Many of the online survey respondents on the Brochure panel
who claimed to understand fee and compensation disclosure in the
Brochure, in fact, did not.'' \594\
---------------------------------------------------------------------------

    \594\ See Financial Literacy Study, supra footnote 524.
---------------------------------------------------------------------------

    In addition, the Financial Literacy Study also found that
respondents had difficulty interpreting disclosures related to
conflicts of interest.\595\ These findings are consistent with academic
literature that describes the difficulties of financial disclosure. For
example, one study shows that, in an experimental setting, even when
subjects were told of the bias of their advisers, they did not fully
discount their advice.\596\ In addition, these papers and others \597\
find that mandating disclosure from biased advisers may have the
unintended consequence of making the biased adviser appear honest and
increasing an investor's trust in them.
---------------------------------------------------------------------------

    \595\ ``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 524.
    \596\ 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 a.m.
ECON. REV. 423 (2011).
    \597\ 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).
---------------------------------------------------------------------------

    The proposed rule also increases the flexibility of the delivery of
solicitor disclosures. The proposed rule would permit a solicitor's
disclosures to be delivered by either the investment adviser or the
solicitor, and would eliminate the requirement that investors
acknowledge receipt of the solicitor's disclosures. Allowing solicitor
disclosures to be delivered by either the investment adviser or the
solicitor would give the investment adviser additional flexibility in
determining the best method for delivery of the disclosure. In
addition, eliminating the requirement to acknowledge the receipt of a
disclosure would reduce the costs imposed on investors and solicitors
by those disclosures, especially if the solicitor's disclosures are
delivered by the investment adviser itself. However, these
acknowledgements can be a useful tool for an investment adviser to
monitor solicitors' compliance with disclosure requirements.
Specifically, acknowledgements help to ensure that a solicitor that is
soliciting clients on and adviser's behalf is making the correct
disclosures. Therefore, an investment adviser might still require
investors to acknowledge receipt of a solicitor's disclosure, even if
not required by the proposed rule to do so.
d. Exemptions
    The proposed solicitation rule includes exemptions from the written
agreement and adviser oversight and compliance requirements when a
solicitor is one of the investment adviser's partners, officers,
directors, or employees, or is a person that controls, is controlled
by, or is under common control with the investment adviser, or is a
partner, officer, director or employee of such a person, so long as the
affiliation between the solicitor and the adviser is readily apparent
or disclosed to the client or private fund investor at the time of
solicitation and the adviser documents the solicitor's status at the
time that both parties enter into a solicitation arrangement. This
proposed approach to in-house solicitors may reduce compliance costs
associated with the use of in-house solicitors. At the same time, we do
not expect this approach to erode investor protections to the extent
that advisers already have a responsibility to oversee in-house
personnel. Moreover, the proposed rule would remove the written
agreement requirement for solicitation of impersonal investment advice.
This change is unlikely to reduce the benefits of the solicitation rule
because even under the current rule, the adviser and solicitor are
exempt from the rule's disclosure requirements, the specific
requirements of the written agreements and the supervision
provisions.\598\
---------------------------------------------------------------------------

    \598\ See supra footnote 425.
---------------------------------------------------------------------------

    The proposed rule also includes a de minimis compensation exemption
if the investment adviser's compensation payable to the solicitor is
$100 or less during the preceding twelve months. This would streamline
compliance for certain solicitation arrangements, and could
particularly ease compliance burdens for smaller advisers that provide
de minimis compensation to multiple solicitors. Although this exemption
could result in a higher likelihood that investors are solicited by
persons who would be ineligible solicitors, we do not anticipate
substantial erosion of investor protection benefits, because we believe
that de minimis compensation likely implies little incentive to defraud
potential clients or private fund investors. The proposed approach
would also exempt certain types of nonprofit programs from the
substantive requirements of the solicitation rule. To the extent that
the conditions of the nonprofit exemption mitigate compensation-related
conflicts and the incentive of a solicitor to favor one adviser over
another, we do not anticipate the exemption to erode investor
protection benefits of the solicitation rule.
e. Ineligible Solicitors
    The proposed amendments define ``ineligible solicitor'' to mean a
person, who at the time of the solicitation, is subject to a
disqualifying Commission action or has any disqualifying event, both
terms defined by the proposal. The definition further encompasses

employees, officers, or directors of an ineligible solicitor, any
person directly or indirectly controlling or controlled by an
ineligible solicitor, and, as appropriate, all general partners or all
elected managers of an ineligible solicitor. That ineligibility under
the proposed amendments, which attaches at the time of solicitation
should support investor protection because the time of the solicitation
is likely when investors are most vulnerable to fraud. The breadth of
the definition of ineligible solicitor may protect investors from
solicitation by persons that share economic incentives to defraud
investors with solicitors that are subject to a disqualifying
Commission action or has any disqualifying event. The definition of
ineligible solicitor could impose compliance costs on investment
advisers to the extent that they must inquire potential solicitor's
history to form a reasonable belief that the potential solicitor does
not have any disqualifying Commission actions, disqualifying events,
and affiliations in their history.
    The provisions of the carve-out from disqualification are similar
to conditions in staff no-action letters in which the staff stated that
it would not recommend enforcement action to the Commission under
section 206(4) and rule 206(4)-3 if the solicitor's practices were
consistent with those conditions. While broadening the scope of
solicitors subject to disqualification would reduce the number of
personnel available to advisers to serve as solicitors, and potentially
the cost of obtaining referrals, these disqualified persons are
arguably the most likely to engage in fraudulent or misleading
behavior.\599\ This change in scope might reduce the likelihood of
investors being harmed by disqualified persons serving as solicitors.
---------------------------------------------------------------------------

    \599\ Egan, M., G. Matvos and A. Seru, study the misconduct
among broker-dealer representatives in their paper ``The Market for
Financial Adviser Misconduct'' and find that representatives with
misconduct are more likely to be reemployed by the firms that have
higher rates of misconduct in general. The Commission is not aware
of any data on misconduct in the solicitation market. See supra
footnote 532.
---------------------------------------------------------------------------

    The proposed rule also contains provisions that would change the
definition of ineligible solicitors, and add a limited conditional
carve-out from disqualification. Currently, the rule flatly bars
advisers from making payments to certain disqualified solicitors. The
proposal would change this flat bar to a requirement that the adviser
cannot compensate a solicitor, directly or indirectly, for any
solicitation activity if the adviser knows, or, in the exercise of
reasonable care, should have known, that the solicitor is an ineligible
solicitor. This change likely would have the effect of reducing burdens
on advisers in making this disqualification determination to the extent
that they reduce their efforts to not make payments to ineligible
solicitors, but instead can rely on exercising reasonable care to
conclude that they are not doing so. Nonetheless, we believe that
advisers will generally use many of the same mechanisms that they use
today to determine whether disqualified person is an ineligible
solicitor under the proposed rule, and thus do not expect that they
would incur significant additional costs or realize significant savings
in complying with this proposed requirement.
f. Compliance and Oversight
    As a result of changes to both the advertising and solicitation
rules, an investment adviser may face additional costs associated with
compliance and oversight when determining the extent to which a
person's activities constitute solicitation rather than a compensated
testimonial or endorsement (or both). As a result of the proposed
solicitation rule's expansion to cover non-cash compensation, and the
proposed advertising rule's changes to permit endorsements and
testimonials in advertisements with certain disclosures, an investment
adviser might incur costs associated with determining whether persons
that are compensated for testimonials or endorsements do or do not
engage in activities that would fall within the scope of the
solicitation rule, and vice versa.
    Currently, it is reported that about 27 percent of investment
advisers registered with the Commission (3,655 RIAs) compensate persons
other than employees to obtain one or more clients.\600\ This number
includes advisers that use cash as well as non-cash compensation. In
addition, of the 976 RIAs that report that they only compensate their
employees to obtain clients, some might still be subject to the
requirement to disclose the affiliation at the time of solicitation if
the affiliation is not readily apparent. Moreover, currently some
advisers might not consider directed brokerage as a type of non-cash
compensation, which would further increase the number of investment
advisers and solicitors affected by the proposed rule. In addition to
the investment advisers that comply with the current rule,
approximately 1,590 registered investment advisers to private funds
would likely be newly subject to the proposed rule (about 210 of such
advisers report that they solely use solicitors that are ``related
persons'' of the firm, and would be eligible to use the proposed rule's
partial exemption for affiliated solicitors if the affiliation is
readily apparent). Finally, advisers that use nonprofit programs for
solicitation would be exempt from the rule, but would be subject to
collection of information only with respect to limited disclosures.
Overall, we estimate that 6,432 registered investment adviser would be
subject to the proposed collection of information for the purposes of
the Paperwork Reduction Act; \601\ 5,704 investment advisers and their
solicitors would experience the full programmatic costs of the proposed
rule, and 728 RIAs and their solicitors would bear a partial
programmatic cost due to the partial exemptions.
---------------------------------------------------------------------------

    \600\ See details in footnote 696.
    \601\ See details in section IV.C, and footnote703.
---------------------------------------------------------------------------

    The proposed amendments to rule 206(4)-3 would apply to the
solicitation of current and prospective investors in any private fund,
rather than only to ``clients'' of the investment adviser. We do not
have the data on the number of solicitors an average investment adviser
currently use, but advisers to private funds report using 2.9
``marketers'' on average, with a median of one and a maximum of
79.\602\ Therefore, we estimate that the number of solicitors affected
by the proposed rule would be in the range of 17,517 \603\ to 21,075
\604\ per year, assuming that each adviser would use three solicitors,
on average, five percent of all RIAs would use directed brokerage as a
type of non-cash compensation, and one percent of RIAs would use
nonprofit programs for solicitation. The number of clients or investors
each solicitor approaches per year varies, therefore the total cost to
investment advisers and solicitors would be hard to quantify. In
section

IV.C, assuming that each solicitor would have ten referrals subject to
the proposed rule, we estimate the total ongoing burden to be
approximately $22,654,596.\605\ However, according to the data from
investment advisers to private funds, investment advisers do not
necessarily engage new solicitors every year, and many solicitors work
for multiple advisers at the same time. Therefore, the total ongoing
cost could be more or less than the number estimated. For the proposed
recordkeeping amendments that correspond to proposed changes to the
solicitation rule, we estimate that the proposed amendments would
increase the burden of each investment adviser that would be subject to
the solicitation rule by $95.\606\ As discussed above, approximately
6,432 investment advisers would be subject to the proposed rule, and
therefore we estimate a total annual cost of $611,297 across the market
to comply with the recordkeeping requirements of the proposed
solicitation rule.
---------------------------------------------------------------------------

    \602\ The numbers are based on responses to Section 7.B.(1)
28(a) as of December 31, 2018.
    \603\ The number is calculated as: 3 x [3,655 (number of
advisers that compensate non-employees) + 673 (5 percent of RIAs
that would use directed brokerage as a type of compensation)-4
(advisers provide only impersonal investment advisory services) +
1590 (advisers to private funds)-210 (advisers to private funds that
only use solicitors that are ``related persons'') + 135 (1 percent
of RIAs that use nonprofit programs for solicitation)].
    \604\ The number is calculated as: 3 x [3,655 (number of
advisers that compensate non-employees) + 976 (number of advisers
that compensate only employees to obtain more clients, but might be
subject to disclosures) + 673 (5 percent of RIAs that would use
directed brokerage as a type of compensation)-4 (advisers provide
only impersonal investment advisory services) + 1590 (advisers to
private funds) + 135 (1 percent of RIAs that use nonprofit programs
for solicitation)].
    \605\ See table in section IV. C. for details.
    \606\ 17 percent of the compliance to the proposed rule is
assumed to be performed by compliance clerks, whose hourly cost is
$70, and 83 percent by general clerks, whose hourly cost is $62
(data is from the Securities Industry and Financial Markets
Association's Office Salaries Data 2013 Report, modified to account
for an 1,800-hour work-year, inflation, bonuses, firm size, employee
benefits and overhead). In PRA, it is also estimated that all
advisers that would use the proposed solicitation rule would incur
an estimated 1.5 hour in complying with the recordkeeping
requirements related to the solicitation rule. The total incremental
cost is calculated as 1.5 x ($70 x 17% + $62 x 83%) = $95.04, per
adviser.
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E. Efficiency, Competition, Capital Formation

1. Advertising
a. Efficiency
    By generally altering and updating the set of permissible
advertisement types, the proposed rules have the potential to improve
the information in investment adviser advertisements. Improving the
information available in investment adviser advertisements could
improve the efficiency of the market for investment advice in two ways.
First, the proposed rule could increase the overall amount of
information in investment adviser advertisements. This could either be
directly through the provisions of the proposed rule, or indirectly,
through competition between investment advisers through advertisements.
Second, the proposed rule could increase the overall quality of
information about investment advisers. To the extent that the proposed
rules mitigate misleading or fraudulent advertising practices,
investors may be more likely to believe the claims of investment
adviser advertisements. Investment advisers, as a result, may include
more relevant or useful information in their advertisements, in lieu of
misleading or irrelevant statements.
    The information from testimonials, performance data, and third-
party ratings can potentially provide valuable information for
investors. Better informed investors could improve the efficiency of
the market for investment advice, as they may be better able to
evaluate investment advisers based on the information in their
advertisements.\607\
---------------------------------------------------------------------------

    \607\ For more, see Section III.B.
---------------------------------------------------------------------------

    Although the proposed rule requires additional disclosures when
investment advisers include certain elements in their advertisements,
the value of these disclosures to investors depends critically on
whether they are able to utilize the disclosures to fully understand
the proper context of an adviser's claims. By providing enough
information to investors in the required disclosures to enable them to
evaluate an adviser's advertisements, these disclosures would
effectively mitigate the potential that advertisements mislead
investors, and improve their ability to find the right investment
adviser for their needs. But, to the extent that the proposed rule does
not provide investors with the context necessary to make sound
financial decisions, then the proposed rule might lead to a reduction
in the efficiency of advertisements.
    In addition to considering the role that advertisements may play in
reducing information asymmetries and the role that information
asymmetries play in the risks associated with advertising, we also
consider the efficiency of advertisements in reducing these information
asymmetries. In particular, one potential consequence of the proposed
rule is that investment advisers increase the amount of resources they
allocate to advertising their services. While additional spending on
advertisements may facilitate matching between investment advisers and
investors, under some circumstances, this additional spending may be
inefficient if the benefits of better matches fall short of the
resources required to facilitate better matches. Although there is not
much data on the efficiency of investment adviser advertising
practices, academic literature provides us with evidence of potential
inefficiencies related to advertising in a neighboring market: Mutual
funds. We recognize that investment advisers to mutual funds are
subject to some legal requirements and may operate in distribution
channels that are different from those applicable to investment
advisers offering direct advisory services and pooled investment
vehicles such as those covered by the proposed rule, but we think it is
nevertheless useful to understand how advertising by mutual funds
affects mutual fund investors, while keeping in mind how similarities
and differences between these settings impact the generalizability of
results drawn from mutual fund advertising.
    The literature on marketing for mutual funds documents a positive
correlation between funds' marketing efforts and investor flows (cash
investment from investors). Researchers find that marketing expenses
are nearly as important as price (i.e., expense ratio) or performance
for explaining fund size (AUM), and the effect is larger among top
performers than funds with lower returns. However, mutual funds also
charge more fees to cover marketing costs as they engage in an ``arms
race'' to attract assets from the same pool of investors.\608\ As fees
increase, investors with a higher search cost who are less likely to
search for lower-fee funds--usually investors with lower financial
literacy--are more likely to end up paying higher fees for funds.
Further, less sophisticated investors might be matched with a lower
quality asset manager to begin with, and a higher fee further reduces
their realized returns. While some portion of the costs associated with
this costly competitive advertising spending would be absorbed by
mutual fund management or advisers, other portions would be passed on
to investors.\609\
---------------------------------------------------------------------------

    \608\ See Roussanov, Ruan and Wei (2018), supra footnote 576.
    \609\ Id. The authors observe that in aggregate, although the
additional flexibility in advertisement improved information and
match efficiency, the costs associated with this advertising ``arms
race'' exceeded those benefits.
---------------------------------------------------------------------------

    Although the study's authors examine mutual funds and not
investment advisers, both mutual funds and investment advisers target
similar groups of clients, have similar fee structures, and exhibit
similar information asymmetry problems between investors and financial
service or product providers. However, mutual funds differ from
investment adviser services in ways that might limit the conclusions we
could make about investment adviser advertisements. First, mutual funds
operate under specific advertising rules that do not apply to
investment advisers marketing direct advisory services or to the

marketing of pooled investment vehicles, and the content of mutual fund
advertisements may substantively differ from those of investment
advisers and pooled investment vehicles. Second, mutual funds sell both
financial products and services, while investment advisers primarily
sell services, and investors may have different considerations and
objectives when evaluating mutual funds compared to investment
advisers, or their respective advertisements. Finally, advertising may
be a less important determinant of client AUM for investment advisers
in the context of the proposed rules, because investors that work with
investment advisers may have different financial knowledge and
resources, making an ``arms race'' less likely.
b. Competition
    As discussed earlier, the proposed rule might result in an increase
in the efficiency of investment adviser advertisements, providing more
useful information to investors about the abilities of an investment
adviser than advertisements under the baseline, which would allow them
to make better decisions about which investment advisers to choose. In
this case, investment advisers might have a stronger incentive to
invest in the quality of their services, as the proposed rule would
permit them more flexibility to communicate the higher quality of their
services by providing additional information about their services. This
would promote competition among investment advisers based on the
quality of their services, and result in a benefit for investors.
    However, the proposed rule might instead provide investment
advisers with a stronger incentive to invest in the quality of their
advertisements rather than the quality of their services. This would
promote inefficient competition among investment advisers based on the
quality of their advertisements rather than the quality of their
services, which would waste the resources of investment advisers. In
addition, to the extent that higher quality advertisements generated by
this ``arms race'' are uncorrelated with the services of an investment
adviser's services, investors may be harmed if they enter relationships
with investment advisers based on the quality of their advertisements,
rather than their services. Although the direct costs of advertisements
would be borne by the investment adviser, it is possible that some
portion of the costs of advertisement will be borne by investors.\610\
---------------------------------------------------------------------------

    \610\ Firms that face a change in costs will bear some portion
of these costs directly, but will also pass a portion of the cost to
their consumers through the price. In a competitive market, the
portion of these costs that firms are able to pass on to consumers
depends on the relative elasticities of supply and demand. For
example, if demand for investment adviser services is elastic
relative to supply of investment adviser services, investment
advisers will be limited in their ability to pass through costs. For
more, see Mankiw, Gregory, Principles of Economics, 2017.
---------------------------------------------------------------------------

c. Capital Formation
    To the extent that the proposed rules result in improved matches in
the market for investment advice, potential investors may be drawn to
invest additional capital, which would promote capital formation.
However, if as a result of the proposed rule, investment advisers may
compete with each other based on their advertisements, rather than the
quality of their services, advertisements overall would become less
efficient in their ability to allow investment advisers to effectively
advertise their ability. If the service matches between investors and
investment advisers decline as a result of the proposed rule, investors
may divert capital from investment to other uses, thus hindering
capital formation.
2. Solicitation
a. Efficiency
    The proposed solicitation rule expands the scope of provisions for
solicitors, by covering all forms of compensation. The rule also scopes
in solicitors for private funds, applying the disclosure and
disqualification requirements of the solicitation rule to broker-
dealers that currently are only subject to bad actor provisions from
Regulation D. In addition, the rule would continue to require
disclosures to make salient the nature of the relationship between a
solicitor and the investment advisers. These provisions could improve
the efficiency of the market for investment advisers by ensuring that
the provisions of the solicitation rule apply to all forms of conflicts
of interest for solicitors. If investors are aware of these conflicts
of interest through disclosures, they may be better able to interpret
their interactions with solicitors and choose an investment adviser
that is of higher quality, or a better match. The proposed rule also
removes the acknowledgement requirement for solicitor disclosures, and
permits either investment advisers or solicitors to deliver the
solicitor disclosure, as well as the timing of that delivery. These
provisions will lower the cost of making these disclosures for
solicitors and investors, and improve the efficiency of the
solicitation process.
b. Competition
    The proposed solicitation rule expands the scope of solicitor
relationships that are covered by the provisions of the rule. By
scoping non-cash compensation into the scope of the rule, the proposed
rule could improve competition among investment advisers and solicitors
by ensuring that all forms of compensation for solicitors are subject
to the same requirements. Under the proposed rule, solicitors that
prefer cash compensation for their activities would not be unfairly
burdened with the requirements of the rule relative to solicitors that
prefer or accept non-cash compensation.
c. Capital Formation
    Although there are no provisions in the proposed solicitation rule
that directly affect capital formation, the proposed rule could still
indirectly affect capital formation through its effect on the
efficiency of investors' choice of investment advisers, and investor
confidence in the quality of solicitors. The proposed rule's expansion
of the scope of compensation might improve the efficiency of the
ultimate choice of investment adviser that investors make. In addition,
the proposed rule expands the set of disqualifying events that would
bar an individual from becoming a solicitor, which may improve an
investor's confidence in a solicitor's recommendation of an investment
adviser. In addition, the proposed rule also specifies a set of events
that are not disqualifying, such as orders that impose sanctions with
respect to acts or omissions but do not bar, suspend, or prohibit the
person from acting in any capacity under the Federal securities laws.
These effects could improve investor confidence in the quality of
solicitors, and lead investors to allocate more of their resources
towards investment, thus promoting capital formation.

F. Reasonable Alternatives Considered

1. Reduce Specific Limitations on Investment Adviser Advertisements
    One alternative to the proposed advertising rule would be to reduce
the specific limitations on investment adviser advertising, and rely on
the general prohibitions to achieve the programmatic costs and benefits
of the rule. For example, this might include reducing the specific
limitations on the different types of hypothetical performance or
testimonials and

endorsements. We note that the specific prohibitions of the proposed
rule are prophylactic in nature, and that many of the advertising
practices described in the specific prohibitions would also be
prohibited under the general prohibitions on fraud and deceit. However,
we note that the removal of the specific prohibitions may create
uncertainty about what types of advertisements would fall under the
general prohibition of false or misleading advertisements.
2. Not Have an Advertising Rule and Rely on Section 206
    Under our proposed approach, as a means reasonably designed to
prevent fraudulent, deceptive, or manipulative acts, practices, and
courses of business, we would amend rule 206(4)-1 generally to prohibit
certain conduct and restrict certain specific identified advertising
practices. Alternatively, we could not restrict any specific practices,
and instead rely solely on the general prohibitions against fraud or
deceit in section 206 of the Advisers Act and certain rules thereunder.
Under such an approach, a rule specifically targeting adviser
advertising practices might be unnecessary. In the absence of an
advertising rule, however, an adviser might have not sufficient clarity
and guidance on whether certain advertising practices would likely be
fraudulent and deceptive. As a consequence, advisers may bear costs in
obtaining such guidance or may otherwise restrict their advertising
activities unnecessarily in the absence of such clarity and guidance
that would be provided through a rule, and may reduce their advertising
as a result. In addition, under such an approach, investors may also
not obtain some of the benefits associated with the proposed rule. For
example, in the absence of a specific advertising rule, investors would
not obtain the benefits associated with the comparability of
performance presentations provided in the proposed rule, or the
requirement to provide performance over a variety of periods so that a
client or investor may sufficiently evaluate the adviser's performance.
Investors and clients would also not benefit from the specific
protections against the potential for misleading hypothetical
performance contained in the proposed rule, such as the requirement to
have policies and procedures designed to ensure that such performance
is relevant to the financial situation and investment objectives of the
client or investor and includes sufficient disclosures to enable
persons receiving it to understand how it is calculated and the risks
and limitations of relying on it. Though some advisers might provide
such information even in the absence of the proposed specific
requirements to help ensure that they do not violate section 206 of the
Act, others may not. As a consequence, this approach may benefit
certain advisers by allowing them to avoid the costs of the specific
requirements of the proposed rule, but may come at the cost of ensuring
adequate disclosure to some investors, and may result in them not
gaining the benefit of the other protections of the rule.
3. Define Non-Retail Investors as Accredited Investors or Qualified
Clients
    Another alternative to the proposed rule would be to include in the
definition of Non-Retail Persons ``accredited investors,'' as defined
in rule 501(a) of Regulation D under the Securities Act of 1933
(``Securities Act''), or ``qualified clients.'' Both of these
alternative standards would expand the set of investors that would be
considered non-retail investors, and would expand the set of investors
subject to the programmatic costs and benefits of the rule that affect
non-retail advertisements, while reducing the set of investors subject
to the programmatic costs and benefits of the rule that affect retail
advertisements. Although these alternatives would expand the set of
advertisements and information available to investors who are
accredited investors (or qualified clients) but are not qualified
purchasers or knowledgeable employees, these alternatives would also
deny investors the protections associated with the additional
limitations for performance advertisements for retail investors. As we
described earlier, we believe that the qualified purchaser and
knowledgeable employee standards provide a more appropriate standard
for determining whether an investor has sufficient access to analytical
and other resources, and bargaining power to receive different
treatment under the proposed rule.\611\
---------------------------------------------------------------------------

    \611\ See supra section III.D.
---------------------------------------------------------------------------

4. Further Bifurcate Additional Requirements
    Some of the proposed rule's substantive provisions vary depending
on the type of investor that the investment adviser reasonably expects
to receive the advertisement.\612\ One alternative to the proposed rule
would be to further bifurcate requirements of the proposed rule that
currently apply to all advertisements. For example, one alternative
considered prohibiting hypothetical performance in Retail
Advertisements, but not in Non-Retail Advertisements, provided that
certain disclosures were made.
---------------------------------------------------------------------------

    \612\ See supra footnote 3.
---------------------------------------------------------------------------

    Evidence from academic research suggests that that the investors in
the market for broker-dealer services are highly segmented in their
financial literacy and access to resources. One paper finds that less
sophisticated investors are served by broker-dealers that are likely to
engage in misconduct, while more sophisticated investors have the
financial knowledge and resources to avoid such firms.\613\ Although
misconduct by investment advisers is not directly addressed by the
proposed rule, the fact that certain market segments are susceptible to
misconduct suggests that the lack of financial knowledge or access to
resources may also leave them susceptible to false or misleading
statements in advertisements or solicitations.
---------------------------------------------------------------------------

    \613\ See The Market for Financial Adviser Misconduct, supra
footnote 532. The paper uses the term ``financial advisors,'' to
refer to broker-dealer representatives. The authors argue that
broker-dealer representatives target different groups of investors
and that this segmentation permits firms with high tolerance for
misconduct on the part of their associated persons to coexist with
firms maintaining clean records in the current market. They find
that misconduct is more common among firms that advise retail
investors, and in counties with low education, elderly populations
and high incomes (when controlling for other characteristics).
Although the paper does not divide the studied population by the
Qualified Purchaser or Knowledgeable Employee standards, the
relationship between client base and adviser misconduct nonetheless
provides relevant information about the potential effects of the
rule.
---------------------------------------------------------------------------

    Tailoring additional requirements to suit the segmented nature of
the market for financial advice may yield benefits to investor
protection for investors with lower financial literacy or access to
resources, as advertisements directed towards these specific market
segments vulnerable to misleading statements would face additional
requirements. Similarly, advertisements not directed towards those
segments would benefit from additional flexibility and information
contained in these advertisements. However, increasing the bifurcation
of requirements in the proposed rule might also impose additional costs
on investment advisers, who may need to expend additional resources to
create advertisements that complied with two increasingly different
sets of requirements.
5. No Bifurcation
    Another alternative to the proposed rule would be to have no
bifurcation in the requirements for Retail Advertisements and Non-
Retail Advertisements. In this alternative, all

advertisements would be subject to a single set of requirements,
regardless of the intended audience. A lack of bifurcation in
requirements for advertisements may mean that a single set of
requirements for investment adviser advertisements may be unable to
meet the needs of investors with high and low levels of financial
sophistication simultaneously. Investors with high levels of financial
sophistication might face unnecessarily strict requirements for
advertisements, or investors with low levels of financial
sophistication might not be sufficiently protected from fraudulent or
misleading advertisements. To the extent that a bifurcated set of
requirements in the proposed rule is able to correctly distinguish the
financial sophistication of investors, each set of advertisement
requirements in the proposed rule will be more appropriately tailored
to their respective type of investor.
6. Hypothetical Performance Alternatives
    One alternative to the proposed rule's treatment of hypothetical
performance would be to prohibit all forms of hypothetical performance
in all advertisements. This alternative would eliminate the possibility
that investors are misled by hypothetical performance, but also
eliminates the possibility that investors might gain useful information
from some types of hypothetical information. While a prohibition on
hypothetical performance might improve the efficiency of investment
adviser advertising by reducing the chance that investors are misled by
advertisements, efficiency can also be reduced if investors are unable
to receive relevant information about the investment adviser.
    Conversely, another alternative would be to permit all hypothetical
performance in all advertisements, without any conditions or
requirements. This may permit relevant hypothetical performance to
reach investors, and although hypothetical performance poses a high
risk of misleading investors, such statements would still be subject to
the general prohibitions.
7. Alternatives to Proposed Amendments to Rule 206(4)-3
    We are proposing an exemption wherein the amended solicitation rule
would not apply if the solicitor has performed solicitation activities
for the investment adviser during the preceding twelve months and the
investment adviser's compensation payable to the solicitor for those
solicitation activities is $100 or less (or the equivalent value in
non-cash compensation). We considered the alternative of not having any
de minimis exemption. Although this alternative would expand the scope
of compensation covered by the solicitation rule, potentially extending
the costs and benefits of the proposed solicitation rule to these
solicitation activities, we believe the solicitor's incentives to
defraud an investor are significantly reduced when receiving de minimis
compensation, and that the need for heightened safeguards is likewise
reduced.
    Conversely, we considered the alternative of proposing a higher
threshold for a de minimis exemption. However, we drew from other rules
applicable to certain dual registrants and broker-dealers, and chose a
$100 threshold (or the equivalent value in non-cash compensation) over
a trailing one-year period. We believe that proposing an aggregate $100
de minimis amount over a trailing year period is consistent with our
goal of providing an exception for small or nominal payments. Regarding
the trailing period, we understand that a very engaged solicitor who is
paid even a small amount per referral could potentially receive a
significant amount of compensation from an adviser over time even if
the solicitor receives less than $100 per each individual referral. In
such a case we believe that investors should be informed of the
conflict of interest and gain the benefit of the other provisions of
the rule.
    We also considered the alternative of not applying the proposed
amended solicitation rule to the solicitation of existing and
prospective private fund investors. Under this alternative, the rule
would apply only to the adviser's clients (including prospective
clients), which are generally the private funds themselves, and would
not apply to investors in private funds. However, while investors in
private funds may often be financially sophisticated, they may not be
aware that the person engaging in the solicitation activity may be
compensated by the adviser, and we believe investors in such funds
should be informed of that fact and the related conflicts. In addition,
we believe that our proposal to apply the solicitation rule to
investors in private funds would be consistent with the proposed
advertising rule. We believe that harmonizing the scope of the
solicitation rule with the advertising rule to the extent possible
should ease compliance burdens.

IV. Paperwork Reduction Act Analysis

A. Introduction

    Certain provisions of our proposal would result in new ``collection
of information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\614\ The proposed amendments would
have an impact on the current collection of information burdens of
rules 206(4)-3 and 204-2 under the Investment Advisers Act (``the
Act'') and Form ADV. The title of the new collection of information we
are proposing is ``Rule 206(4)-1 under the Investment Advisers Act.''
OMB has not yet assigned a control number for ``Rule 206(4)-1 under the
Investment Advisers Act.'' The titles for the existing collections of
information that we are proposing to amend are: (i) ``Rule 206(4)-3
under the Investment Advisers Act of 1940 (17 CFR 275.206(4)-3)'' (OMB
number 3235-0242); (ii) ``Rule 204-2 under the Investment Advisers Act
of 1940'' (OMB control number 3235-0278); and (iii) ``Form ADV'' (OMB
control number 3235-0049). The Commission is submitting these
collections of information to the Office of Management and Budget
(``OMB'') for review and approval in accordance with 44 U.S.C. 3507(d)
and 5 CFR 1320.11. An agency may not conduct or sponsor, and a person
is not required to respond to, a collection of information unless it
displays a currently valid OMB control number.
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    \614\ 44 U.S.C. 3501 et seq.
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    We discuss below the new collection of information burdens
associated with the proposed amendments to rule 206(4)-1, as well as
the revised existing collection of information burdens associated with
the proposed amendments to rules 206(4)-3 and 204-2, and Form ADV.
Responses provided to the Commission in the context of its examination
and oversight program concerning the proposed amendments to rule
206(4)-1, rule 206(4)-3, and rule 204-2 would be kept confidential
subject to the provisions of applicable law. Responses to the
disclosure requirements of the proposed amendments to Form ADV, which
are filed with the Commission, are not kept confidential. In addition,
because the information collected pursuant to rule 206(4)-3 requires
solicitor disclosures to investors, these disclosures would not be kept
confidential. The Commission also intends to use a Feedback Flier to
obtain information from investors about the proposed rule.\615\ The
Feedback

Flier is included in this proposal as Appendix B hereto.
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    \615\ The Commission has determined that this usage is in the
public interest and will protect investors, and therefore is not
subject to the requirements of the Paperwork Reduction Act of 1995.
See section 19(e) and (f) of the Securities Act. Additionally, for
the purpose of developing and considering any potential rules
relating to this rulemaking, the agency may gather from and
communicate with investors or other members from the public. See
section 19(e)(1) and (f) of the Securities Act.
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B. Rule 206(4)-1

    Proposed rule 206(4)-1 states that, as a means reasonably designed
to prevent fraudulent, deceptive, or manipulative acts, practices, or
courses of business within the meaning of section 206(4) of the Act, it
is unlawful for any investment adviser registered or required to be
registered under section 203 of the of the Act, directly or indirectly,
to disseminate any advertisement that violates any of paragraphs (a)
through (d) of the proposed rule, which include the proposed rule's
general prohibitions. For example, an adviser could not refer in an
advertisement to its specific investment advice if the presentation is
not ``fair and balanced,'' \616\ and an adviser cannot make a material
claim or statement that is unsubstantiated.\617\ The proposed rule also
contains conditions on testimonials, endorsements and third-party
ratings.\618\ Those conditions would require that advertisements
containing testimonials, endorsements, or third-party ratings contain
certain disclosures and, for third-party ratings, comply with other
conditions. Our proposal would recognize that while consumers and
businesses often look to the experiences and recommendations of others
in making informed decisions, there may be times when these tools are
less credible or less valuable than they appear to be. We believe that
with tailored disclosures and other safeguards discussed herein,
advisers could use testimonials, endorsements and third-party ratings
in advertisements to promote their accomplishments with less risk of