\317\ See supra section II.A.2.c.
---------------------------------------------------------------------------

Benefits
    As a result of these performance disclosures, some investors would
find it easier to obtain and use information about the performance of
their private fund investments. They may, for example, find it easier
to monitor the performance of their investments and compare the
performance of the private funds in their portfolios to each other and
to other investments. In addition, they may use the information as a
basis for updating their choices between

different private funds or between private fund and other investments.
In doing so, they may achieve a better alignment between their
investment choices and preferences. Cash flow information would be
provided in a form that allows investors to compare the performance of
the fund (or a fund investment) with the performance of other
investments, such as by computing PME or other metrics.
    We understand that some investors receive the required performance
information under the baseline, independently of the proposed rule. For
example, some investors receive performance disclosures from advisers
on a tailored basis. Those investors may not experience easier access
to performance information from the proposal. They may, however,
benefit from standardization of the information in quarterly statements
across investors in a fund and across advisers. For example, the
standardization of the data that a fund provides to all of its
investors could benefit some investors by facilitating the development
and sharing of tools and methods for analyzing the data among the
various investors of the fund. In addition, to the extent that
investors share the complete, comparable data with consultants or other
intermediaries they work with (as is often current practice to the
extent permitted under confidentiality provisions), this may allow such
intermediaries to provide broader views across the private funds market
or segments of the market. This may facilitate better decision making
and capital allocation more broadly.
    The required presentation of performance information and the
resulting economic benefits would vary based on whether the fund is
determined to be a liquid fund or an illiquid fund. For example, for
private equity and other funds determined to be illiquid funds,
investors would benefit from receiving multiple pieces of performance
information, because the shortcomings discussed above that are
associated with each method of measuring performance make it difficult
for investors to evaluate fund performance from any singular piece of
performance information alone, such as IRR or MOIC.\318\ For hedge
funds, the primary benefit is the mandating of regular reporting of
returns by advisers, avoiding any potential biases associated with
hedge funds choosing whether and when to report returns.\319\ The
benefits from the proposed requirements are therefore potentially more
substantial for the funds determined to be illiquid funds, as the
breadth of the performance information that would be required under the
proposal for the private equity and other funds determined to be
illiquid funds is designed to address the shortcomings of individual
performance metrics. For both types of funds, because the factors we
propose to use to distinguish between liquid and illiquid funds align
with the current factors for determining how certain types of private
funds should report performance under U.S. GAAP, market participants
may be more likely to understand the presentation of performance.
---------------------------------------------------------------------------

    \318\ See supra section V.B.3.
    \319\ Id.
---------------------------------------------------------------------------

Costs
    The cost of the required performance disclosure by fund advisers
would vary according to the existing practices of the adviser and the
complexity of the required disclosure. For advisers who already (under
their current practice) incur the costs of generating the necessary
performance data, presenting and distributing it in a format suitable
for disclosure to investors, and checking the disclosure for accuracy
and completeness, the cost would likely be small. In particular, for
those advisers, the cost of the performance disclosure may be limited
to the cost of reformatting the performance information for inclusion
in the mandated quarterly report. However, we understand that some
advisers may face costs of changing their performance tracking or
reporting practices under the current rule. Some of these costs would
be direct costs of the rule requirements. Costs of updating an
adviser's internal controls or internal compliance system to verify the
accuracy and completeness of the reported performance information would
be indirect costs of the rule. We expect the bulk of the costs
associated with complying with this aspect of the proposed rules would
likely be most substantial initially rather than on an ongoing
basis.\320\
---------------------------------------------------------------------------

    \320\ The quantification of the direct costs associated with
completing performance disclosures is included in the analysis of
costs associated with fee and expense disclosures above.
---------------------------------------------------------------------------

    Some of these costs of compliance could again be affected by the
rule provision providing that advisers must consolidate the quarterly
statement reporting to cover substantially similar pools of assets.
These costs of compliance would be reduced to the extent that advisers
are able to avoid duplicative costs across multiple statements, but
would be increased to the extent that advisers must undertake costs
associated with calculating feeder fund proportionate interests in a
master fund, to the extent advisers do not already do so.
    The required presentation of performance, and the resulting costs,
would vary based on whether the fund is categorized as liquid or
illiquid. In particular, for funds determined to be liquid funds, the
cost is mitigated by the limited nature of the required disclosure, as
the proposal requires only annual total returns and cumulative total
returns for the current calendar year as of the end of the most recent
calendar quarter covered, while the more detailed required disclosures
for funds determined to be illiquid funds may require greater cost
(yielding, as just discussed, greater benefit).\321\ For both
categories of funds, because the factors we proposed to use to
distinguish between liquid and illiquid funds align with the current
factors for determining how certain types of private funds should
report performance under U.S. GAAP, and as a result, market
participants may be more familiar with these methods of presenting
information, which may mitigate costs.
---------------------------------------------------------------------------

    \321\ See supra section II.A.2.a and II.A.2.b.
---------------------------------------------------------------------------

    Under the proposed rule, these compliance costs may be borne by
advisers and, where permissible, could be imposed on funds and
therefore indirectly passed on to investors. For example, under current
practice, advisers to private funds generally charge disclosure and
reporting costs to the funds, so that those costs are ultimately paid
by the fund investors. Similarly, to the extent advisers currently use
service providers to assist with performance reporting (e.g.,
administrators), those costs are often borne by the fund (and thus
investors). To the extent not prohibited, we expect similar
arrangements may be made going forward to comply with the proposed
rule. Advisers could alternatively attempt to introduce substitute
charges (for example, increased management fees) in order to cover the
costs of compliance with the rule, but their ability to do so may
depend on the willingness of investors to incur those substitute
charges.
    Further, to the extent that the additional standardization and
comparability of the information in the required disclosures make it
easier for investors to compare and evaluate performance, the rule may
prompt some investors to search for and seek higher performing
investment opportunities. This could reduce the ability for advisers of
low-performing funds to attract additional capital. By the same
rationale, the rule may prompt some

investors to search for and seek higher performing investment
opportunities, further reducing the ability for advisers of low-
performing funds to attract additional capital.
3. Prohibited Activities and Disclosure of Preferential Treatment
    The proposed rules would prohibit a private fund adviser from
engaging in certain activities with respect to the private fund or any
investor in that private fund, including (i) charging certain
regulatory and compliance fees and expenses or fees or expenses
associated with certain examinations or investigations,\322\ (ii)
charging fees for certain unperformed services,\323\ (iii) certain non-
pro rata fee and expense allocations,\324\ (iv) borrowing money,
securities, or other fund assets, or receiving a loan or an extension
of credit, from a private fund client,\325\ (v) reducing the amount of
any adviser clawback by the amount of certain taxes,\326\ (vi) limiting
or eliminating liability for certain adviser misconduct,\327\ and (vii)
granting an investor in the private fund or a substantially similar
pool of assets preferential terms regarding liquidity or transparency
that the adviser reasonably expects to have a material, negative effect
on other investors in the fund or a substantially similar pool of
assets.\328\ In addition, we also propose to prohibit all private fund
advisers from providing any other preferential treatment to any
investor in the private fund unless the adviser provides written
disclosures to prospective and current investors.\329\ These
prohibitions would apply to activities of the private fund advisers
even if they are performed indirectly, for example, by an adviser's
related persons, recognizing that the potential for harm to the fund
and its investors arises independently of whether the adviser engages
in the activity directly or indirectly.\330\
---------------------------------------------------------------------------

    \322\ See supra section II.D.2.
    \323\ See supra section II.D.1.
    \324\ See supra section II.D.5.
    \325\ See supra section II.D.6.
    \326\ See supra section II.D.3.
    \327\ See supra section II.D.4.
    \328\ See supra section II.E.
    \329\ Id.
    \330\ See supra section II.D, II.E.
---------------------------------------------------------------------------

    We discuss the costs and benefits of each of these prohibitions and
requirements below. The Commission notes, however, that several factors
make the quantification of many of these economic effects of the
proposed amendments and rules difficult. For example, there is a lack
of data on the extent to which advisers engage in certain of the
activities that would be prohibited under the proposed rules, as well
as their significance to the businesses of such advisers. It is,
therefore, difficult to quantify how costly it would be to comply with
the prohibitions. Similarly, it is difficult to quantify the benefits
of these prohibitions, because there is a lack of data regarding how
and to what extent the changed business practices of advisers would
affect investors, and how advisers may change their behavior in
response to these prohibitions. Further, there is a lack of data on the
frequency with which advisers grant certain investors the preferential
treatment that would be prohibited under the proposed rules, as well as
the frequency with which preferential terms are currently disclosed to
other investors, as well as how and to what extent these disclosures
affect investor behavior. As a result, parts of the discussion below
are qualitative in nature.
Certain Fees and Expenses
    The proposal would prohibit a private fund adviser from charging
the fund for fees or expenses associated with an examination or
investigation of the adviser or its related persons by any governmental
or regulatory authority or for the regulatory and compliance fees and
expenses of the adviser or its related persons.\331\ The benefit to
investors would be to lower charges on the funds they have invested in,
which could increase returns, and potentially lower the cost of effort
to avoid and evaluate such charges, or a combination of these benefits.
To the extent that these charges, even when disclosed, create adverse
incentives for advisers to allocate expenses to the fund at a cost to
the investor, they represent a possible source of investor harm. For
example, when these charges are in connection with an investigation of
an adviser, it may not be in the fund's best interest to bear the cost
of the investigation.\332\ These fees may also, even when disclosed,
incentivize advisers to engage in excessive risk-taking, as the adviser
will no longer bear the cost of any ensuing government or regulatory
examinations or investigations.\333\ By prohibiting this activity,
investors would benefit from the reduced risk of having to incur costs
associated with the adviser's adverse incentives, such as allocating
inappropriate expenses to the fund. Investors would also be able to
search across fund advisers knowing that these charges would not be
assessed on any fund, which may lead to a better match between investor
choices of private funds and their preferences over private fund terms,
investment strategies, and investment outcomes. The magnitude of the
benefit would to some extent depend on whether advisers could introduce
substitute charges (for example, increased management fees), and the
willingness of investors to incur those substitute charges, for the
purpose of making up any revenue that would be lost to the adviser from
the prohibition. However, any such substitute charges would be more
transparent to the investor and would not create the same adverse
incentives as the prohibited charges, and so investors would likely
ultimately still benefit.
---------------------------------------------------------------------------

    \331\ See supra section II.D.2.
    \332\ Id.
    \333\ Fund adviser fees can allow the adviser to obtain
leverage, and thereby gain disproportionately from successes,
encouraging advisers to take on additional risk. See, e.g., Alon
Brav, Wei Jiang, and Rongchen Li, Governance by Persuasion: Hedge
Fund Activism and Market-Based Shareholder Influence, European
Corporate Governance Institute--Finance (Working Paper No. 797/2021)
(December 10, 2021), available at https://ssrn.com/abstract=3955116
or http://dx.doi.org/10.2139/ssrn.3955116.
---------------------------------------------------------------------------

    This prohibition would impose direct costs on advisers from the
need to update their charging and contracting practices to bring them
into compliance with the new requirements. Advisers would also incur
costs related to this prohibition, in connection with not being able to
charge private fund clients for the prohibited expenses. In addition,
advisers may incur indirect costs related to adapting their business
models in order to identify and substitute non-prohibited sources of
revenue. For example, advisers may identify and implement methods of
replacing the lost charges from the prohibited practice with the other
sources of fund revenue. These costs would likely be transitory.
    Further, as discussed above, we understand that certain private
fund advisers, most notably hedge funds and other funds determined to
be liquid funds,\334\ that utilize a pass-through expense model where
the private fund pays for most, if not all, of the adviser's expenses
in lieu of being charged a management fee. The proposed rules would
likely prohibit certain aspects of pass-through expense models or other
similar models in which advisers charge investors fees associated with
certain of the adviser's cost of being an investment adviser. These
expenses that would no longer be passed through to the fund could
represent additional costs to the fund adviser, unless the adviser

negotiates a new fixed management fee to compensate for the new costs.
In addition, any such fund restructurings that are undertaken would
likely impose costs that would be borne by advisers. The costs may also
be borne partially or entirely by the private funds, to the extent
permissible or to the extent advisers are able to compensate for their
costs with substitute charges (for example, increased management fees).
These costs would likely be transitory. In addition, investors may
incur costs from this prohibition that take the form of lower returns
from some fund investments, depending on the extent to which the
prohibition limits the adviser's efficiency or effectiveness in
providing the services that generate returns from those investments.
For example, in the case of pass-through expense models, fund advisers
who would have to bear new costs of providing certain services under
the prohibition may reduce or eliminate those services from the fund in
order to reduce costs, which may be to the detriment of the fund's
performance or lead to an increase of compliance risk.
---------------------------------------------------------------------------

    \334\ See, e.g., Welcome To Hedge Funds' Stunning Pass-Through
Fees, Seeking Alpha (January 24, 2017), available at https://seekingalpha.com/article/4038915-welcome-to-hedge-funds-stunning-pass-through-fees.
---------------------------------------------------------------------------

    Moreover, to the extent that re-structuring a pass-through expense
model of a hedge fund under the proposal diverts the hedge fund's
resources away from the hedge fund's investment strategy, this could
lead to a lower return to investors in hedge funds. The cost of lower
returns would be mitigated to the extent that investors can distinguish
and identify those funds that require restructuring as to how they
collect revenue from investors and use this information to search for
and identify substitute funds that have expense models that do not need
to be restructured under the rule and that do not present the investor
with reduced returns as a result of the rule. Investors would also need
to be able to evaluate whether these substitute funds would be likely
to present them with better performance than their current funds. Any
such search costs would be a cost of the rule. As a result, the cost to
investors may include a combination of the cost of lower returns and
the cost of avoiding such reductions in returns.
Fees for Unperformed Services
    In addition, the proposal would prohibit a private fund adviser
from charging a portfolio investment for monitoring, servicing,
consulting or other fees in respect of services that the adviser does
not, or does not reasonably expect, to provide to the portfolio
investment, such as through an accelerated payment. As discussed above,
these fees are likely to reflect conflicts of interest between the fund
and the adviser that are difficult for the investor to detect and
mitigate.\335\ For example, in receiving the accelerated payment,
discussed above, the adviser imposes a charge for services that it may
not provide.\336\ An adviser also may have an incentive to cause the
fund to exit a portfolio investment earlier than anticipated, which may
result in the fund receiving a lesser return on its investment.\337\
Because adviser misconduct in response to these incentives may be
difficult for investors to detect, full disclosure of this practice
does not resolve the conflict of interest. Under the proposed
prohibition, investors would be able to choose among fund advisers and
invest knowing that they would not face the costs of such conflicts of
interests, which also may lead to a better match between investor
choices of private funds and their preferences over private fund terms,
investment strategies, and investment outcomes.
---------------------------------------------------------------------------

    \335\ See supra section II.D.1.
    \336\ Id.
    \337\ See supra section II.D.1
---------------------------------------------------------------------------

    Investors would also benefit directly via lower costs from the
prohibition through the elimination of the fees charged to the fund's
portfolio investment.\338\ These cost savings could be partially
mitigated, however, to the extent that advisers are using portions of
the proceeds from the accelerated payment to cover costs of services
that benefit the fund client.\339\
---------------------------------------------------------------------------

    \338\ The portfolio investments themselves may also benefit
directly from no longer paying these fees.
    \339\ As discussed above, the proposal would not prohibit an
arrangement where the adviser shifts 100% of the economic benefit of
a portfolio investment fee to the private fund investors, whether
through an offset, rebate, or otherwise. See supra section II.D.1.
---------------------------------------------------------------------------

    This prohibition would impose direct costs on advisers from the
need to update their charging and contracting practices to bring them
into compliance with the new requirements. Advisers would also incur
costs related to this prohibition in connection with not being able to
receive these charges for unperformed services. For example, advisers
would incur costs in connection with not being able to receive the
accelerated payments, and as a result, advisers could attempt to
replace the accelerated payments with some new fee or charge. Advisers
could, therefore, incur transitory costs related to adapting their
business models in order to identify and substitute non-prohibited
sources of revenue. These costs may be particularly high in the short
term to the extent that advisers re-negotiate, re-structure and/or
revise certain existing deals or existing economic arrangements in
response to this prohibition.
    In addition, investors may incur some costs from this prohibition
that take the form of lower returns from certain fund investments,
depending on the extent to which the fund adviser's loss of revenue
from the prohibited activity diverts resources away from the fund's
investment strategy. For example, the loss of revenue under this
prohibition could cause some advisers to update their portfolio
investment strategies, so that they are less reliant on the prohibited
fees for revenue. The advisers could limit their portfolio investments
that are reliant on accelerated payments for revenue, for example. This
could lead to a cost to investors in the form of reduced returns from
those investments. Investors could mitigate this cost to the extent
that they can distinguish and identify those funds that require
restructuring as to how they collect revenue from investors and use
this information to search for and identify substitute funds that do
not present the investor with reduced returns as a result of the rule.
Investors would also need to be able to evaluate whether these
substitute funds would be likely to present them with better
performance than their current funds. These alternative search costs
would be a cost of the rule. As a result, the cost of the prohibition
to investors could thus include a combination of the cost of lower
returns and the cost of avoiding such reductions in returns.
Certain Non-Pro Rata Fee and Expense Allocations
    The proposal would prohibit a private fund adviser from charging
certain fees and expenses related to a portfolio investment (or
potential portfolio investment) on a non-pro rata basis when multiple
private funds and other clients advised by the adviser or its related
persons have invested (or propose to invest) in the same portfolio
investment.\340\
---------------------------------------------------------------------------

    \340\ See supra section II.D.5.
---------------------------------------------------------------------------

    These non-pro rata fee and expense allocations tend to adversely
affect some investors who are placed at a disadvantage to other
investors. We associate these practices and disadvantages with a
tendency towards opportunistic hold-up of investors by advisers,
involving exploitation of an informational or bargaining
advantage.\341\ The disadvantaged investors currently pay greater than
their pro rata shares of fees and expenses. The disparity may arise
from

differences in the bargaining power of different investors. For
example, a fund adviser may have an incentive to assign lower than pro
rata shares of fees and expenses to larger investors that bring repeat
business to the adviser and correspondingly lower pro rata shares to
the smaller investors paying greater than pro rata shares.
---------------------------------------------------------------------------

    \341\ See infra (discussing opportunism in the context of
certain preferential treatment).
---------------------------------------------------------------------------

    Investors could either benefit or face costs from the resulting
revised apportionment of expenses to the fund they are invested in,
based on whether their share of expenses is decreased or increased
under the rule. Investing clients in these portfolio investments paying
greater than pro rata shares of such fees and expenses would benefit as
a result of lowered fees. However, to the extent that a client was
previously able to obtain fee and expense allocations at rates less
than a pro rata apportionment, the client could incur higher fee and
expense costs in the future. Investors may not be aware of the extent
to which fees are charged on a non pro-rata basis. Even if disclosed,
the complexity of fee arrangements may mean that these arrangements are
hard to follow. More sophisticated investors may be aware that they
risk non pro-rata fees, but nonetheless be harmed by the uncertainty
from complex fee arrangements. Fund advisers may face a commitment
problem in that they and their clients might be better off if they
could commit to pro-rata arrangements; thus a prohibition could serve
as a net benefit to clients and advisers.\342\
---------------------------------------------------------------------------

    \342\ In a related setting, ex ante commitment to a financing
policy has been argued to raise value and lower the cost of capital.
See Peter DeMarzo, Presidential Address, Collateral and Commitment,
Journal of Finance, (July 15 2019).
---------------------------------------------------------------------------

    This prohibition would impose direct costs on advisers to updating
their charging and contracting practices to bring them into compliance
with the new requirements. These compliance costs may be particularly
high in the short term to the extent that advisers re-negotiate, re-
structure, and/or revise certain existing deals or existing economic
arrangements in response to this prohibition. Advisers may face
additional costs in the form of lower expenses and fees, to the extent
that less flexible pro-rata fee and expense allocations result in lower
average fees and expenses to the adviser or are more costly to
administer and monitor.
Borrowing
    The proposal prohibits an adviser, directly or indirectly, from
borrowing money, securities, or other fund assets, or receiving a loan
or an extension of credit, from a private fund client.\343\ In cases
where, as the Commission has observed, fund assets were used to address
personal financial issues of one of the adviser's principals, used to
pay for the advisory firm's expenses, or used in association with any
other harmful conflict of interest, \344\ then this prohibition would
increase the amount of fund resources available to further the fund's
investment strategy. Investors would benefit from any resulting
increased payout. In addition, investors would benefit from the
elimination or reduction of any need to engage in costly research or
negotiations with the adviser to prevent the uses of fund resources by
the adviser that would be prohibited. The prohibition also has the
potential to benefit investors by reducing moral hazard: If an adviser
borrows from a private fund client and does not pay back the loan, it
is the investors who bear the cost, providing the adviser with
incentives to engage in potentially excessive borrowing.
---------------------------------------------------------------------------

    \343\ See supra section II.D.6.
    \344\ Id.
---------------------------------------------------------------------------

    Advisers may experience costs as a result of this prohibition
related to any marginal increases in the cost of capital incurred from
new sources of borrowing, as compared to what was being charged by the
fund.
Reducing Adviser Clawbacks for Taxes
    The proposed rule would prohibit certain uses of fund resources by
the private fund adviser by prohibiting advisers from reducing the
amount of their clawback obligation by actual, potential, or
hypothetical taxes applicable to the adviser, its related persons, or
their respective owners or interest holders.\345\ Some investors would
benefit from this rule from effectively increasing clawbacks (and thus
investor returns) by actual, potential, or hypothetical tax rates.
Investors would also benefit from the elimination or reduction of any
need to engage in costly research or negotiations with the adviser to
prevent these uses of fund resources by the adviser. These benefits
would likely be more widespread, as such research or negotiations may
have been necessary at the start of fund lives even in cases where
investor returns were not ultimately impacted by tax treatments of
clawbacks. Advisers, however, may be unable to recoup the cost of the
tax payments made in connection with the excess distributions and
allocations affected by the rule, and therefore would face greater
costs when clawbacks do occur under the prohibition.
---------------------------------------------------------------------------

    \345\ See supra section II.D.3.
---------------------------------------------------------------------------

    This prohibition would impose direct costs on advisers of updating
their charging and contracting practices to bring them into compliance
with the new requirements. Advisers may also attempt to mitigate the
greater costs of clawbacks under the prohibition by introducing some
new fee, charge, or other contractual provision that would make up for
the lost tax reduction on the clawback, and they would then incur costs
of updating their contracting practices to introduce these new
provisions.
    Advisers may attempt to mitigate their increased costs associated
with clawbacks by reducing the risk of a clawback occurring. For
example, certain advisers may adopt new waterfall arrangements designed
to delay carried interest payments until later in the life of a fund,
in order to limit the possibility of a clawback or reduce the possible
sizes of clawbacks. In this case, investors would benefit from earlier
distributions of proceeds from the fund and reduced costs associated
with monitoring their potential need for a clawback. However, some fund
advisers are able to attract investors even though their fund terms do
not provide for full or partial clawbacks. To the extent such advisers
were able to update their business practices, for example by providing
for an advance on tax payments with no option for a clawback, this
would reduce the benefit of the proposal, as investors would continue
to receive the reduced clawback amounts and bear portions of the
adviser's tax burden. In either case, advisers would also bear
additional costs from the proposal of updating their business
practices.
    Advisers could, therefore, incur transitory costs related to
adapting their business models in order to identify and substitute non-
prohibited sources of revenue. These direct costs may be particularly
high in the short term to the extent that advisers re-negotiate, re-
structure, and/or revise certain existing deals or existing economic
arrangements in response to this prohibition.
Limiting or Eliminating Liability for Adviser Misconduct
    In addition, the proposal would prohibit an adviser to a private
fund, directly or indirectly, from seeking reimbursement,
indemnification, exculpation, or limitation of its liability by the
private fund or its investors for a breach of fiduciary duty, willful
misfeasance, bad faith, negligence, or recklessness in providing
services to the private fund.\346\ These practices, even

when disclosed and permissible under state law, may involve breaches of
fiduciary duty to the fund or investors, and possible harms to
investors, and so investors will likely benefit from their prohibition.
For example, because investors may be unable to anticipate willful
malfeasance by their fund advisers, they may be unable to anticipate
the costs associated with an adviser seeking reimbursement for its
malfeasance, even if the adviser discloses that possibility.\347\
Investors would therefore benefit from the elimination of fund
expenses, which would otherwise reduce investor returns, associated
with reimbursing or indemnifying the adviser for losses associated with
its malfeasance. These benefits may be diminished to the extent that
advisers are able to obtain alternative permissible sources of
compensation for these expenses from investors (for example, from
increased management fees), although this ability would likely be
limited.
---------------------------------------------------------------------------

    \346\ See supra section II.D.4.
    \347\ Id.
---------------------------------------------------------------------------

    Further, these contractual clauses may lead investors to believe
that they do not have any recourse in the event of such a breach. To
the extent that any such investors do not seek damages under this
belief, the contractual clauses eliminating liability for breach of
fiduciary duty would represent a harm to the investors. By prohibiting
these scenarios, this proposal could make such breaches of fiduciary
duty incrementally less likely to occur. Investors would therefore
benefit from a reduced need to engage in costly research or
negotiations with the adviser to prevent such breaches.
Certain Preferential Terms
    The proposal would prohibit a private fund adviser from providing
certain preferential terms to some investors that have a material
negative effect on other investors in the private fund or in a
substantially similar pool of assets. We associate these practices with
a tendency towards opportunistic hold-up of investors by advisers,
involving the exploitation of an informational or bargaining advantage
by the adviser or advantaged investor.\348\ The proposal would prohibit
a private fund adviser and its related persons from granting an
investor in the private fund or in a substantially similar pool of
assets the ability to redeem its interest on terms that the adviser
reasonably expects to have a material, negative effect on other
investors in that private fund or in a substantially similar pool of
assets.\349\ In addition, the proposal would prohibit an adviser and
its related persons from providing information regarding the private
fund's or a substantially similar pool of asset's portfolio holdings or
exposures to an investor that the adviser reasonably expects that
providing the information would have a material, negative effect on
other investors in that private fund or in a substantially similar pool
of assets.\350\
---------------------------------------------------------------------------

    \348\ See supra section II.E.
    \349\ Id.
    \350\ Id.
---------------------------------------------------------------------------

    Benefits may accrue from these prohibitions in two situations.
First, the prohibitions may benefit the non-preferred investors in
situations where advisers lack the ability to commit to avoid the
opportunistic behavior after entering into the agreement (or
relationship) with the investor. For example, similar to the case
regarding non-pro rata fee and expense allocations, an adviser with
repeat business from a large investor with early redemption rights and
smaller investors with no early redemption rights may have adverse
incentives to take on extra risk, as the adviser's preferred investor
could exercise its early redemption rights to avoid the bulk of losses
in the event an investment begins to fail. The adviser would then
continue to receive repeat business with the investors with
preferential terms, to the detriment of the investors with no
preferential terms.
    Investors who do receive preferential terms may also receive
information over the course of a fund's life that the investors can use
to their own gain but to the detriment of the fund and, by extension,
the other investors. For instance, if a fund was heavily invested in a
particular sector and an investor with early redemption rights learned
the sector was expected to suffer deterioration, that investor could
submit a redemption request, securing their funds early but forcing the
fund to sell assets in a declining market, harming the other investors.
In this situation, the prohibitions would provide a solution to the
hold-up problem that is not currently available. The rule would benefit
the disadvantaged investors by prohibiting such a situation, and so the
disadvantaged investors would be less susceptible to hold-up and
experience better performance on their fund investments as a benefit of
the proposed rule.
    Second, in situations where investors face uncertainty as to
whether the adviser engages in the prohibited practice, the benefit
from the prohibition would be to eliminate the costs to investors of
avoiding entering into agreements with advisers that engage in the
practice and the costs to investors from inadvertently entering into
such agreements.
    Specifically, in this second case, the prohibited preferential
terms would harm investors in private funds and cause investors to
incur extra costs of researching fund investments to avoid fund
investments in which the prospective fund adviser engages in these
practices (or costs of otherwise avoiding or mitigating the harm to
those disadvantaged investors from the practice). The benefit of the
prohibition to investors would be to eliminate such costs. It would
prohibit disparities in treatment of different investors in
substantially similar pools of assets in the case where the disparity
is due to the adviser placing their own interests ahead of the client's
interests or due to behavior that may be deceptive. Investors would
benefit from the costs savings of no longer needing to evaluate whether
the adviser engages in such practices. Investors and advisers also may
benefit from reduced cost of negotiating the terms of a fund
investment. Investors who would have been harmed by the prohibited
practices would benefit from the elimination of such harms through
their prohibition.
    The cost of the prohibitions would depend on the extent to which
investors would otherwise obtain such preferential terms in their
agreements with advisers and the conditions under which they make use
of the preferential treatment. Investors who would obtain and make use
of the preferential terms would incur a cost of losing the prohibited
redemption and information rights. This would include any investors who
might benefit from the ability to redeem based on negotiated exceptions
to the private fund's stated redemption terms, in addition to the
investors who might benefit from the hold-up problems discussed above.
In addition, advisers would incur direct costs of updating their
processes for entering into agreements with investors, to accommodate
what terms could be effectively offered to all investors once the
option of preferential terms to certain investors has been removed.
These direct costs may be particularly high in the short term to the
extent that advisers re-negotiate, re-structure and/or revise certain
existing deals or existing economic arrangements in response to this
prohibition.
    To the extent advisers respond to the prohibition by developing new
preferential terms and disclosing them to all investors, there may be
new costs to investors who do not receive these new preferential terms.
As discussed below, such costs would be mitigated by

the prohibition of such preferential terms unless appropriately
disclosed.
Prohibition of Other Preferential Treatment Without Disclosure
    The proposed rule also would prohibit other preferential terms
unless the adviser provides certain written disclosures to prospective
and current investors, and these disclosures must contain information
regarding all preferential treatment the adviser provides to other
investors in the same fund.\351\ This would reduce the risk of harm
that some investors face from expected favoritism toward other
investors, and help investors understand the scope of preferential
terms granted to other investors, which could help investors shape the
terms of their relationship with the adviser of the private fund.
Because these disclosures would need to be provided to prospective
investors prior to their investments and to current investors annually,
these disclosures would help investors shape the terms of their
relationship with the adviser of the private fund. This may lead the
investor to request additional information on other benefits to be
obtained, such as co-investment rights, and would allow an investor to
understand better certain potential conflicts of interest and the risk
of potential harms or other disadvantages.
---------------------------------------------------------------------------

    \351\ See supra section II.E.
---------------------------------------------------------------------------

    Disclosures of such preferential treatment would impose direct
costs on advisers to update their contracting and disclosure practices
to bring them into compliance with the new requirements, including by
incurring costs for legal services. These direct costs may be
particularly high in the short term to the extent that advisers re-
negotiate, re-structure and/or revise certain existing deals or
existing economic arrangements in response to this prohibition.
However, these costs may also be reduced by an adviser's choice between
not providing the preferential terms and continuing to provide the
preferential terms with the required disclosures, as the costs to some
advisers from not providing the preferential terms to investors may be
lower than the costs from the disclosure.
    As discussed below, for purposes of the PRA, we anticipate that the
disclosure of preferential treatment would impose an aggregate annual
internal cost of $128,902,375 and an aggregate annual external cost of
$32,550,000, or a total cost of $161,452,375 annually.\352\ To the
extent that advisers are not prohibited from categorizing all or a
portion of these costs as expenses to be borne by the fund, then these
costs may be borne indirectly by investors to the fund instead of
advisers.
---------------------------------------------------------------------------

    \352\ See infra section VI.E. As explained in that section, this
estimated annual cost is the sum of the estimated recurring cost of
the proposed rule in addition to the estimated initial cost
annualized over the first three years.
---------------------------------------------------------------------------

    To the extent that these disclosures could discourage advisers from
providing certain preferential terms in the interest of avoiding future
negotiations with other investors on similar terms, this prohibition
could ultimately decrease the likelihood that some investors are
granted preferential terms. As a result, some investors may find it
harder to secure such terms.
4. Audits, Fairness Opinions, and Documentation of Annual Review of
Compliance Programs
    The proposed audit rule would require an investment adviser that is
registered or required to be registered to cause each private fund that
it advises, directly or indirectly, to undergo a financial statement
audit that meets certain elements at least annually and upon
liquidation, if the private fund does not otherwise undergo such an
audit. These audits would need to be performed by an independent public
accountant that meets certain standards of independence and is
registered with and subject to regular inspection by the PCAOB, and the
statements would need to be prepared in accordance with U.S. GAAP or,
for foreign private funds, must contain information substantially
similar to statements prepared in accordance with U.S. GAAP, with
material differences with U.S. GAAP reconciled.\353\ The rule would
also require that auditors notify the Commission in certain
circumstances.
---------------------------------------------------------------------------

    \353\ Id.
---------------------------------------------------------------------------

    In addition, the rule would require advisers to obtain fairness
opinions from an independent opinion provider in connection with
certain adviser-led secondary transactions with respect to a private
fund. This requirement would not apply to advisers that are not
required to register as investment advisers with the Commission, such
as state-registered advisers and exempt reporting advisers. In
connection with this fairness opinion, the proposal would also require
a summary of any material business relationships the adviser or any of
its related persons has, or has had within the past two years, with the
independent opinion provider. The proposal would lastly require all
advisers, not just those to private funds, to document the annual
review of their compliance policies and procedures in writing.
    We discuss the costs and benefits of these rule provisions below.
The Commission notes, however, several factors make the quantification
of many of the economic effects of the proposed amendments and rules
difficult. For example, there is a lack of quantitative data on the
extent to which adviser-led secondaries without fairness opinions
differ in fairness of price from adviser-led secondaries with fairness
opinions attached. It would also be difficult to quantify how investors
and advisers may change their preferences over secondary transactions
once fairness opinions are required to be provided. As a result, parts
of the discussion below are qualitative in nature.
Benefits
    We recognize that many advisers already provide audited fund
financial statements to fund investors in connection with the adviser's
alternative compliance with the custody rule. However, to the extent
that an adviser does not currently have its private fund client undergo
a financial statement audit, investors would receive more reliable
information from private fund advisers as a result of the proposed
audit rule. The benefit to investors in securitized asset funds may be
relatively greater from the proposal, given the relatively lower
frequency with which securitized asset funds currently undergo
financial statement audits.\354\
---------------------------------------------------------------------------

    \354\ See supra section V.B.4.
---------------------------------------------------------------------------

    The audit requirement would provide an important check on the
adviser's valuation of private fund assets, which often serve as the
basis for the calculation of the adviser's fees. These audits would
likely detect valuation irregularities or errors, as well as an
investment adviser's loss, misappropriation, or misuse of client
investments. It may thereby limit some opportunities for advisers to
materially over-value investments. Audits provide substantial benefits
to private funds and their investors because audits also test other
assertions associated with the investment portfolio (e.g.,
completeness, existence, rights and obligations, presentation). Audits
may also provide a check against adviser misrepresentations of
performance, fees, and other information about the fund. Enhanced and
standardized regular auditing may therefore broadly improve the
completeness and accuracy of fund performance reporting, to the extent
these audits improve fund valuations of their ongoing investments.

    Investors who are not currently provided with audited fund
financial statements, and who would be under the proposal, may, as a
result, have additional confidence in information regarding their
investments and, in turn, the fees being paid to advisers. Further,
this additional confidence may facilitate investors' capital allocation
decisions. Anticipating a lower risk of harm from a private fund
investment, investors may be more likely to invest in private funds and
participate in the resulting returns.
    As discussed above, currently not all financial statement audits
are necessarily conducted by a PCAOB-registered independent public
accountant that is subject to regular inspection.\355\ The proposed
audit rule's requirement that the independent public accountant
performing the audit be registered with, and subject to regular
inspection by, the PCAOB, is likely to improve the audit and financial
reporting quality of private funds.\356\ Higher quality audits
generally have a greater likelihood of detecting material misstatements
due to fraud or error, and we further believe that investors would
likely have relatively greater confidence in the quality of audits
conducted by an independent public accountant registered with, and
subject to regular inspection by, the PCAOB.\357\ Lastly, we believe
that the proposed audit rule's requirement to promptly distribute the
audited financial statements to current investors would allow investors
to evaluate the audited financial information in the audit in a timely
manner.
---------------------------------------------------------------------------

    \355\ See supra section V.B.4.
    \356\ See, e.g., Daniel Aobdia, The Impact of the PCAOB
Individual Engagement Inspection Process--Preliminary Evidence, 93
(4) The Accounting Review 53-80 (2018) (concluding that
``engagement-specific PCAOB inspections influence non-inspected
engagements, with spillover effects detected at both partner and
office levels'' and that ``the information communicated by the PCAOB
to audit firms is applicable to non-inspected engagements''); Daniel
Aobdia, The Economic Consequences of Audit Firms' Quality Control
System Deficiencies, 66 (7) Management Science (July 2020)
(concluding that ``common issues identified in PCAOB inspections of
individual engagements can be generalized to the entire firm,
despite the PCAOB claiming that its engagement selection process
targets higher-risk clients'' and that ``[PCAOB quality control]
remediation also appears to positively influence audit quality'').
    \357\ Id.
---------------------------------------------------------------------------

    In addition, investors would benefit from enhanced regulatory
oversight as a result of the requirement for the adviser to engage the
auditor to notify the Commission under some conditions.\358\ The
proposed requirement for the auditor to report terminations and
modified opinions privately to the SEC would enable the SEC to receive
more timely, complete, and independent information in these
circumstances and to evaluate the need for an examination of the
adviser. As a result, the SEC would be able to allocate its resources
more efficiently. This could lead to a higher rate of detection of fund
adviser activities that lead to harms from misstatements and a greater
potential for mitigation of such harms. Anticipating this, fund
advisers would have stronger incentives to avoid such harmful
activities.
---------------------------------------------------------------------------

    \358\ This requirement does not exist under the custody rule,
and as a result, the benefits and costs associated with this
requirement would extend to even those investors and funds for which
advisers are already distributing audits under the custody rule.
---------------------------------------------------------------------------

    The proposal's requirement that an adviser distribute a fairness
opinion and summary of material business relationships with the opinion
provider in connection with certain adviser-led secondary transactions
may provide similar increases in investor confidence in the specific
context of adviser-led secondary transactions. This requirement would
provide an important check against an adviser's conflicts of interest
in structuring and leading these transactions. Investors would have
decreased risk of experiencing harm from mis-valuation of secondary-led
transactions. Further, anticipating a lower risk of harm from mis-
valuation when participating in such transactions, investors may be
more likely to participate. The result may be a closer alignment
between investor choices and investor preferences over private fund
terms, investment strategies, and investment outcomes. These benefits
would, however, be reduced to the extent that advisers are already
obtaining fairness opinions as a matter of best practice.
    Finally, this proposed rule amendment would require all SEC-
registered advisers to document the annual review of their compliance
policies and procedures in writing. This would allow our staff to
better determine whether an adviser has complied with the review
requirement of the compliance rule, and would facilitate remediation of
non-compliance. Because our staff's determination of whether the
adviser has complied with the compliance rule will become more
effective, the rule may reduce the risk of non-compliance, as well as
any risk to investors associated with non-compliance.
    These benefits from mandatory audits and fairness opinions are
particularly relevant for illiquid investments. Illiquid assets
currently are where we believe it is most feasible for financial
information to have material misstatements of investment values, for
adviser-led secondary transactions to occur at unfair prices, and where
there is broadly a higher risk of investor harm from potential
conflicts of interest or fraud. This is because currently, as discussed
above, advisers may use a high level of discretion and subjectivity in
valuing a private fund's illiquid investments, and the adviser further
may have incentives to bias the fair value estimates of the investment
upwards in order to generate larger fees.\359\ Because both funds
determined to be liquid funds and illiquid funds may have illiquid
investments, investors in both types of funds will benefit, though the
benefits may be larger for investors in illiquid funds (as such funds
may have more illiquid investments than liquid funds and are more
likely to have adviser-led secondary transactions). The benefits from
documentation of compliance programs will be relevant for all
investors, as the rule applies to all fund advisers, not just private
fund advisers.
---------------------------------------------------------------------------

    \359\ See supra section II.B.
---------------------------------------------------------------------------

Costs
    As discussed above, we recognize that many advisers already provide
audited financial statements to fund investors in connection with the
adviser's alternative compliance with the custody rule.\360\ To the
extent that an adviser does not currently have its private fund client
undergo the required financial statement audit, there would be direct
costs of obtaining the auditor, providing the auditor with resources
needed to conduct the audit, the audit fees, and promptly distributing
the audit results to current investors. We recognize that the proposed
audit rule's requirement to promptly distribute the audited financial
statements to current investors after the audit's completion may also
impose compliance costs, which would be mitigated by the flexibility of
the proposal's requirement for prompt distribution, relative to a
requirement for distribution to occur by a a specific deadline. Under
current practice, the costs of undergoing a financial statement audit
are often paid by the fund, and therefore, ultimately, by the fund
investors, though in some cases the costs may be partially or fully
paid by the adviser. To the extent not prohibited, we expect similar
arrangements may be made going forward to comply with the proposed
rule: In some instances, the fund will bear the audit expense, in
others the

adviser will bear it, and there also may be arrangements in which both
the adviser and fund will share the expense.\361\ Advisers could
alternatively attempt to introduce substitute charges (for example,
increased management fees) in order to cover the costs of compliance
with the rule, but their ability to do so may depend on the willingness
of investors to incur those substitute charges.
---------------------------------------------------------------------------

    \360\ See supra section V.B.4.
    \361\ See infra section VI.C.
---------------------------------------------------------------------------

    As discussed below, based on Form ADV filings, as of November 30,
2021, there were 5,037 registered advisers providing advice to private
funds, and we estimate that these advisers would, on average, each
provide advice to 9 private funds.\362\ We further estimate that the
audit fee for the required private fund audit would be $60,000 per fund
on average.\363\ For purposes of the PRA, the estimated total auditing
fees for all funds would therefore be approximately $2,720 million
annually.\364\ We further anticipate that the audit requirement would
impose for all funds approximately 92,479.32 hours of internal annual
burden hours and a cost of approximately $27.6 million for internal
time.\365\ However, some funds would obtain the required financial
statement audits in the absence of the proposal. The cost of the
proposed audit requirement would therefore depend on the extent to
which funds currently receive audits and, if so, whether their auditors
are registered with the PCAOB.
---------------------------------------------------------------------------

    \362\ See infra section VI.C.
    \363\ See infra footnote 420. The audit fee for an individual
fund may be higher or lower than this estimate, with individual fund
audit fees varying according to fund characteristics, such as the
jurisdiction of the assets, complexity of the holdings, the firm
providing the services, and economies of scales.
    \364\ See infra section VI.C.
    \365\ Id.
---------------------------------------------------------------------------

    For example, all or a portion of the costs described in this
section may be disproportionately borne by advisers or investors (or
both) to securitized asset funds,\366\ given that fewer securitized
asset funds currently undergo financial statement audits than other
categories of funds.\367\ We believe that the costs incurred may
approximate 10% of these amounts, because across all types of funds,
approximately 90% of funds are currently audited in connection with the
fund adviser's alternative compliance under the custody rule.\368\
However, because a large portion of funds who do not currently undergo
financial statement audits are securitized asset funds, to the extent
that audits for securitized asset funds are more costly than for other
fund types (for example, if it is more burdensome to audit financial
statements that primarily contain securitized assets), then the costs
of the proposal may be greater than 10% of the amounts described above.
---------------------------------------------------------------------------

    \366\ As noted above, to the extent not prohibited, we expect
that in some instances, the fund will bear the audit expense, in
others the adviser will bear it, and there also may be arrangements
in which both the adviser and fund will share the expense.
    \367\ See supra section V.B.4.
    \368\ Id.
---------------------------------------------------------------------------

    For advisers that had been complying with the surprise examination
requirement of the custody rule and do not have other clients (e.g.,
separately managed accounts) for which a surprise exam must be
obtained, the costs of the audit performed in accordance with the
proposed audit rule would be offset by the reduction in costs from no
longer obtaining a surprise examination. To the extent that audits cost
more than surprise examinations, the offset may be only partial, and to
the extent that an adviser must continue to undergo a surprise
examination because it has custody of non-private fund client funds and
securities, there likely would be no offset. For funds that had
received an audit by an auditor that is not registered with the PCAOB,
the costs of the audit performed in accordance with the proposed audit
rule would also be offset by the reduction in costs from no longer
obtaining their previous audit, although we anticipate that the cost of
the required audit would likely be greater because a PCAOB-registered
and -inspected auditor may cost more than an auditor that is not
subject to the same level of PCAOB oversight.
    We also understand that the PCAOB registration and inspection
requirement may limit the pool of auditors that are eligible to perform
these services which could, in turn, increase costs, as a result of the
potential for these auditors to charge higher prices for their
services. The increase in demand for these services, however, may be
limited in light of the high percentage of funds already being
audited.\369\ The Commission notification requirement of the proposed
audit rule would represent a new cost, regardless of whether their
private fund clients are already undergoing a financial statement
audit. We anticipate that accounting firms would increase their fees as
a result of this new obligation and perceived liability. For advisers
who had been undergoing a surprise examination for purposes of the
custody rule, there may not be as great of an increase in costs in
light of similar requirements in connection with those examinations
under that rule.
---------------------------------------------------------------------------

    \369\ Id.
---------------------------------------------------------------------------

    The indirect costs of the independent audit requirement would
depend on the quality of the financial statements of the funds newly
subject to audits. These costs may be relatively higher for the funds
with lower quality financial statements (i.e., the funds with the
greatest benefit from the audit requirement). The indirect costs from
the independent audit requirement may include costs of changing the
fund's internal financial reporting practices, such as improvements to
internal controls over financial reporting, to avoid potential harm to
investors from a misstatement. Further, we understand that the
requirement to have the auditor registered with, and subject to the
regular inspection by, the PCAOB may limit the pool of accountants that
are eligible to perform these services because only those accountants
that conduct public company issuer audits are subject to regular
inspection by the PCAOB.\370\ The resulting competition for these
services might generally lead to an increase in their costs, as an
effect of the proposal.
---------------------------------------------------------------------------

    \370\ The Sarbanes-Oxley Act authorizes the PCAOB to inspect
registered firms for the purpose of assessing compliance with
certain laws, rules, and professional standards in connection with a
firm's audit work for public company and broker-dealer clients.
However, the PCAOB currently has only a temporary inspection program
for broker-dealer clients.
---------------------------------------------------------------------------

    Costs would also be incurred related to obtaining the required
fairness opinion and material business relationship summary in the case
of an adviser-led secondary transaction. For purposes of the PRA, we
estimate that 10% of advisers providing advice to private funds conduct
an adviser-led secondary transaction each year and that the funds would
pay external costs of $40,849 for each fairness opinion and material
business relationship summary.\371\ Because only approximately 10
percent of advisers conduct an adviser-led secondary transaction each
year, the estimated total fees for all funds per year would therefore
be approximately $20.6 million.\372\ Further, as discussed in section
VI.D below, we anticipate that the fairness opinion and material
business relationship summary requirements would impose approximately
3,528 hours of internal

annual burden hours and a cost of approximately $1,219,499 for internal
time annually.\373\ These costs will be borne primarily, though not
exclusively, by closed-end funds determined to be illiquid funds,\374\
as these are the funds that most frequently have the adviser-led
secondaries considered by the rule. To the extent that certain hedge
fund transactions are captured by the rule, these funds and their
investors would also face comparable fees and costs.
---------------------------------------------------------------------------

    \371\ See infra section VI.D; footnote 430. The fairness opinion
fee for an individual fund may be higher or lower than this
estimate, with individual fund audit fees varying according to the
complexity, terms, and size of the adviser-led secondary
transaction, as well as the nature of the assets of the fund.
    \372\ See supra section II.C; see also infra section VI.D.
    \373\ See infra section VI.D.
    \374\ See supra section II.C.
---------------------------------------------------------------------------

    The costs associated with obtaining fairness opinions could
dissuade some private fund advisers from leading these transactions,
which could decrease liquidity opportunities for some private fund
advisers. Under current practice, some investors bear the expense
associated with obtaining a fairness opinion if there is one. To the
extent not prohibited, we expect similar arrangements may be made going
forward to comply with the proposed rule. Advisers could alternatively
attempt to introduce substitute charges (for example, increased
management fees) in order to cover the costs of compliance with the
rule, but their ability to do so may depend on the willingness of
investors to incur those substitute charges.
    In addition, the required documentation of the annual review of the
fund compliance program has direct costs that include the cost of legal
services associated with the preparation of such documentation. As
discussed below, for purposes of the PRA, we anticipate that the
requirement for all SEC-registered advisers to document the annual
review of their compliance policies and procedures in writing would,
for all advisers, impose 44,496 hours of internal annual burden hours
at a cost of approximately $18.9 million for internal time, and
approximately $4.1 million for external costs.\375\
---------------------------------------------------------------------------

    \375\ See infra section VI.F.
---------------------------------------------------------------------------

5. Recordkeeping
    Finally, the proposed amendment to the recordkeeping rule would
require advisers who are registered or required to be registered to
retain books and records related to the proposed quarterly statement
rule,\376\ to retain books and records related to the mandatory adviser
audit rule,\377\ to support their compliance with the proposed adviser-
led secondaries rule,\378\ and to support their compliance with the
proposed preferential treatment disclosure rule.\379\ The benefit to
investors would be to enable an examiner to verify more easily that a
fund is in compliance with these proposed rules and to facilitate the
more timely detection and remediation of non-compliance. These
requirements would also help facilitate the Commission's enforcement
and examination capabilities. Also beneficial to investors, advisers
may react to the enhanced ability of third parties to detect and impose
sanctions against non-compliance due to the recordkeeping requirements
by taking more care to comply with the substance of the rule.
---------------------------------------------------------------------------

    \376\ See supra section II.A.5.
    \377\ See supra section II.B.8.
    \378\ See supra section II.C.1.
    \379\ See supra section II.E.1.
---------------------------------------------------------------------------

    These requirements would impose costs on advisers related to
maintaining these records. As discussed below, for purposes of the PRA,
we anticipate that the additional recordkeeping obligations would
impose, for all advisers, 40,800 hours of internal annual burden hours
and that the annual cost would be approximately $2.8 million.\380\
---------------------------------------------------------------------------

    \380\ See infra section VI.G.
---------------------------------------------------------------------------

D. Effects on Efficiency, Competition, and Capital Formation

1. Efficiency
    The proposed rules would likely enhance economic efficiency by
enabling investors more easily to identify funds that align with their
preferences over private fund terms, investment strategies, and
investment outcomes, and also by causing fund advisers to align their
actions more closely with the interests of investors through the
elimination of prohibited practices.
    First, the proposed rules could increase the usefulness of the
information that investors receive from private fund advisers regarding
the fees, expenses, and performance of the fund, and regarding the
preferential treatment of certain investors of the fund through the
more detailed and standardized disclosures discussed above.\381\ These
enhanced disclosures would provide more information to investors
regarding the ability and potential fit of investment advisers, which
may improve the quality of the matches that investors make with private
funds and investment advisers in terms of fit with investor preferences
over private fund terms, investment strategies, and investment
outcomes. The enhanced disclosures may also reduce search costs, as
investors may be better able to evaluate the funds of an investment
adviser based on the information to be disclosed at the time of the
investment and in the quarterly statement.
---------------------------------------------------------------------------

    \381\ See supra section V.C.2, V.C.3.
---------------------------------------------------------------------------

    Regarding preferential treatment, the proposed rules further align
fund adviser actions and investor interests by prohibiting certain
preferential treatment practices altogether (instead of only requiring
disclosure), specifically prohibiting preferential terms regarding
liquidity or transparency that have a material, negative impact on
investors in the fund or a substantially similar pool of assets.\382\
Prohibiting these activities, and prohibiting remaining preferential
treatment activities unless disclosure is provided, may eliminate some
of the complexity and uncertainty that investors face about the
outcomes of their investment choices, further reducing costs investors
must undertake to find appropriate matches between their choice of
private fund and their preferences over private fund terms, investment
strategies, and investment outcomes.
---------------------------------------------------------------------------

    \382\ See supra section II.E.
---------------------------------------------------------------------------

    In addition, the proposed rules' requirements for advisers to
obtain audits of fund financial statements would enhance investor
protection and thereby improve the efficiency of the investment adviser
search process. While many proposed disclosure requirements involve
disclosures only to current investors, and not prospective investors,
the proposed rule's disclosure requirements may enhance efficiency
through the tendency of some fund advisers to rely on investors in
current funds to be prospective investors in their future funds. For
example, when fund advisers raise multiple funds sequentially, current
investors can base their decisions on whether to invest in subsequent
funds based on the disclosures of the prior funds.\383\ As such,
improved disclosures can improve the efficiency of investments without
directly requiring disclosures to all prospective investors. Investors
may therefore face a lower overall cost of searching for, and choosing
among, alternative private fund investments.
---------------------------------------------------------------------------

    \383\ See supra section V.B.3.
---------------------------------------------------------------------------

    Lastly, the proposed rules prohibit various activities that
represent possible conflicting arrangements between investors and fund
advisers. To the extent that investors currently bear costs of
searching for fund advisers who do not engage in these arrangements, or
bear costs associated with monitoring fund adviser conduct to avoid
harm, then prohibiting these activities may lower investors' overall
costs of searching for, monitoring, and choosing among alternative
private fund

investments. This may particularly be the case for smaller investors
who are currently more frequently harmed by the activities being
considered.
    There may be losses of efficiency from the proposed rules to
prohibit various activities, and from any changes in fund practices in
response to the proposed rules, to the extent that investors currently
benefit from those activities or incur costs from those changes. For
example, investors who currently receive preferential terms that would
be prohibited under the proposal may have only invested with their
current adviser because they were able to secure preferential terms.
With those preferential terms removed, those investors may choose to
re-evaluate the match between their choice of adviser and their overall
preferences over private fund terms, investment strategy, and
investment outcomes. Depending on the results of this re-evaluation,
those investors may choose to incur costs of searching for new fund
advisers or alternative investments.
2. Competition
    The proposed rules may also affect competition in the market for
private fund investing. As discussed above, private fund adviser fees
may currently total in the hundreds of billions of dollars per
year.\384\ Enhanced competition from additional transparency may lead
to lower fees or may direct investor assets to different funds, fund
advisers, or other investments.
---------------------------------------------------------------------------

    \384\ Id.
---------------------------------------------------------------------------

    First, to the extent that the enhanced transparency of certain
fees, expenses, and performance of private funds under the proposal may
reduce the cost to some investors of comparing private fund
investments, then current investors evaluating whether to continue
investing in subsequent funds may be more likely to reject future funds
raised by their current adviser in favor of the terms of competing
funds, including new funds that advisers may offer as alternatives that
they would not have offered absent the increased transparency.
    To the extent that this heightened transparency encourages advisers
to make more substantial disclosures to prospective investors,
investors may also be able to obtain more detailed fee and expense and
performance data for other prospective fund investments, strengthening
the effect of the proposal on competition.\385\ Advisers may therefore
update the terms that they offer to investors, or investors may shift
their assets to different funds.
---------------------------------------------------------------------------

    \385\ See supra section V.C.2.
---------------------------------------------------------------------------

    Second, because enhanced transparency of preferential treatment
will be provided to both current and prospective investors, there may
be reduced search costs to all investors seeking to compare funds on
the basis of which investors receive preferential treatment. For
example, some funds may lose investors who only participated in the
fund because of the preferential terms they received. We anticipate
that investors withdrawing from a fund because of a loss of
preferential treatment would redeploy their capital elsewhere, and so
new advisers would have a new pool of investment capital to pursue.
3. Capital Formation
    We believe the proposed rules would facilitate capital formation by
causing advisers to more efficiently manage private fund clients, by
prohibiting activities that may currently deter investors from private
fund investing because they represent possible conflicting
arrangements, and by enabling investors to choose more efficiently
among funds and fund advisers. This may reduce the cost of
intermediation between investors and portfolio investments. To the
extent this occurs, this would lead to enhanced capital formation in
the real economy, as portfolio companies would have greater access to
the supply of financing from private fund investors. This would
contribute to greater capital formation through greater investment into
those portfolio companies.
    The proposed rules may also enhance capital formation through their
competitive effects by inducing new fund advisers to enter private fund
markets.\386\ To the extent that existing fund advisers reduce their
fees in order to compete more effectively, or to the extent that
existing pools of capital are redirected to fund advisers who generate
enhanced returns for their investors (for example, advisers who
generate larger returns, less correlated returns across different
investment strategies, or returns with more favorable risk profiles),
the competitive effects of the proposal may provide new opportunities
for capital allocation and potentially spur new investments.
---------------------------------------------------------------------------

    \386\ See supra section V.D.2.
---------------------------------------------------------------------------

    Similarly, and in addition to lower costs of intermediation between
investors and portfolio investments, the proposed rules may directly
lower the costs charged by fund advisers to investors by improving
transparency over fees and expenses. The proposed rules may also
enhance overall investor returns (for example, as above, larger
returns, less correlated returns across different investment
strategies, or returns with more favorable risk profiles) by improving
transparency over performance information, prohibiting conflicting
arrangements, and requiring external financial statement audits and
fairness opinions. To the extent these increased investor funds from
lower expenses and enhanced returns are redeployed to new investments,
there would be further benefits to capital formation.
    There may be reduced capital formation associated with the proposed
rules to prohibit various activities, to the extent that investors
currently benefit from those activities. For example, investors who
currently receive preferential terms that would be prohibited under the
proposal may withdraw their capital from their existing fund advisers.
Those investors may have less total capital to deploy after bearing
costs of searching for new investment opportunities, or they may
redeploy their capital away from private funds more broadly and into
investments with less effective capital formation.

E. Alternatives Considered

1. Alternatives to the Requirement for Private Fund Advisers To Obtain
an Annual Audit
    First, the Commission could consider broadening the application of
this rule to, for example, apply to all advisers to private funds,
rather than to only advisers to private funds that are registered or
required to be registered. Extending the application of the proposed
audit rule to all advisers and in the context of these pooled
investment vehicles would increase the benefits of helping investors
receive more reliable information from private fund advisers associated
with the rule. Investors would, as a result, have greater assurance in
both the valuation of fund assets and, because these valuations often
serve as the basis for the calculation of the adviser's fees, the fees
charged by advisers. However, the extension of the proposed rule to
apply to all advisers would likely impose the costs of obtaining audits
on smaller funds advised by unregistered advisers. For these types of
funds, the cost of obtaining such an audit may be large compared to the
value of fund assets and fees and the related value to investors of the
required audit, and so this alternative could inhibit entry of new
funds, potentially constraining the growth of the private fund market.

    Second, instead of broadening the proposed audit rule, we could
consider narrowing the rule by providing full or partial exemptions.
For example, we could exempt smaller funds or we could exempt an
adviser from compliance with the rule where an adviser plays no role in
valuing the fund's assets, receives little or no compensation for its
services, or receives no compensation based on the value of the fund's
assets. We could also exempt advisers of hedge funds and other funds
determined to be liquid funds. Further, we could provide an exemption
for private funds below a certain asset threshold, for funds that have
only related person investors, or for funds that are below a minimum
asset value or have a limited number of investors.
    These exemptions could also be applied in tandem, for example by
exempting only advisers to hedge funds and other funds determined to be
liquid funds below a certain asset threshold. For each of these
categories, we could consider partial instead of full exemptions, for
example by requiring an audit only every two (or more) years instead of
not requiring any annual audits at all. Further, the benefits of the
rule may not be substantial for funds below a minimum asset value,
where the cost of obtaining such an audit would be relatively large
compared to the value of fund assets and fees that the rule is intended
to provide a check on.
    We believe, however, that this narrower alternative with the above
exemptions to the proposed audit rule would likely not provide the same
investor protection benefits. Many of the investor protection benefits
discussed above are specifically associated with the general
applicability of the proposed audit rule.\387\
---------------------------------------------------------------------------

    \387\ See supra section V.C.4.
---------------------------------------------------------------------------

    Finally, instead of requiring an audit as described in the proposed
audit rule, we could consider requiring that advisers provide other
means of checking the adviser's valuation of private fund assets. For
example, we could consider requiring that an adviser subject to the
proposed audit rule provide information to substantiate the adviser's
evaluation to its LPAC or, if the fund has no LPAC, then to all, or
only significant investors in the fund. We believe that such methods
for checking an adviser's methods of valuation would be substantially
less expensive to obtain, which could reduce the cost burdens
associated with an audit.
    However, we believe that these alternatives would likely not
accomplish the same investor protection benefits as the proposal to
require an audit. As an immediate matter, limiting the requirement like
so would undermine the broader goal of the proposal to standardize
information made available to different investors. We believe, more
generally, that these checks would not provide the same level of
assurance over valuation and, by extension, fees, to fund investors as
an audit. As discussed above, we have historically relied on financial
statement audits to verify the existence of pooled investment vehicle
investments.
2. Alternatives to the Requirement To Distribute a Quarterly Statement
to Investors Disclosing Certain Information Regarding Costs and
Performance
    The Commission could also consider requiring that additional and
more granular information be provided in the quarterly statements that
we are proposing be sent by registered investment advisers to investors
in private funds. For example, we could require that these statements
include investor-level capital account information, which would provide
each investor with means of monitoring capital account levels at
regular intervals throughout the year. Because this more specific
information would show exactly how fees, expenses, and performance have
affected the investor, it could, effectively, further reduce the cost
to an investor of monitoring the value of the services the adviser
provides to the investor. We believe, however, that requiring capital
account information for each investor would substantially increase
costs for funds associated with the preparation of these quarterly
statements.
    We could also, for example, require disclosure of performance
information for each portfolio investment. For funds determined to be
illiquid funds in particular, we could require advisers to report the
IRR for portfolio investments, assuming no leverage, as well as the
cash flows for each portfolio investment.\388\ Given the cash flows,
end investors could compute other performance metrics, such as PME, for
themselves. In addition, this information would give investors means of
checking the more general performance information provided in a
quarterly statement, and would, further, allow investors to track and
evaluate the portfolio investments chosen by an adviser over time. Cash
flow disclosures for each portfolio investment would enable an investor
to construct measures of performance that address the MOIC's inability
to capture the timing of cash flows, avoid the IRR's assumptions on
reinvestment rates of early cash flow distributions, and avoid the
IRR's sensitivity to cash flows early in the life of the pool.\389\
Investors would also be able to compare performance of individual
portfolio investments against the compensation and ownership percentage
and other data that advisers would be required to disclose for each
portfolio investment under the proposal.\390\
---------------------------------------------------------------------------

    \388\ For funds determined to be liquid funds, disclosure of
performance information for each portfolio investment may be of
comparatively lower incremental benefit to investors, because such
funds typically have a much larger number of investments. To the
extent that investors' preferences over different liquid funds
depend on more fund outcomes than their total return on their
aggregate capital contributions, for example a preference for fund
advisers with uncorrelated returns across different portfolio
investments, then this alternative could provide similar additional
benefits.
    \389\ See supra section V.B.3. See, e.g., Robert Harris, Tim
Jenkinson and Steven Kaplan, Private Equity Performance: What Do We
Know?, 69 (5) Journal of Finance 1851 (Mar. 27, 2014), available at
https://onlinelibrary.wiley.com/doi/full/10.1111/jofi.12154; Steven
Kaplan and Antoinette Schoar, Private Equity Performance: Returns,
Persistence, and Capital Flows, 60 (5) Journal of Finance (Aug.
2005), available at http://web.mit.edu/aschoar/www/KaplanSchoar2005.pdf.
    \390\ See supra section II.A.1.b.
---------------------------------------------------------------------------

    While we believe that advisers would have cash flow data for each
portfolio investment available in connection with the preparation of
the standardized fund performance information required to be reported
pursuant to the proposed rule, calculating performance information for
each portfolio investment in accordance with the rule could add
significant operational burdens and costs, which would vary depending
on factors that include the number of portfolio investments held by a
private fund. The operational burden and cost would also depend on
whether the alternative proposal required both gross and net
performance information for each portfolio investment, which would
determine whether the information reflected the impact of fund-level
fees and expenses on the performance of each portfolio investment.
Requiring both gross and net performance information for each portfolio
investment would be of greater use to investors, but would come at a
higher operational burden and cost, as providing net performance
information would require more complex calculations to allocate fund
fees and expenses across portfolio investments. Lastly, to the extent
that advisers were required to disclose cash flows for each portfolio
investment without the impact of fund-level subscription facilities,
this calculation may be more burdensome than the single calculation
required to

make the required fund-level performance information disclosures
without the impact of fund-level subscription facilities.
    As a final granular addition to performance disclosures, the
Commission could require the reporting of a wider variety of
performance metrics for hedge funds and other funds determined to be
liquid funds, similar to the detailed disclosure requirements for funds
determined to be illiquid funds. These could include requirements for
funds determined to be liquid funds to report estimates of fund-level
alphas, betas, Sharpe ratios, or other performance metrics. We believe
that for investors of funds determined to be liquid funds, absolute
returns are of highest priority, and furthermore investors may
calculate many of these additional performance metrics themselves by
combining fund annual total returns with publicly available data.
Therefore, we believe these additional reporting requirements would
impose additional costs with comparatively little benefit.
    Further, the Commission could also consider requiring less
information be provided to investors in these quarterly statements. For
example, instead of requiring the disclosure of comprehensive fee and
expense information, we could require that advisers disclose only a
subset of these, including investments fees and expenses paid by a
portfolio company to the adviser. These fees in particular may
currently present the biggest burden on investors to track, and
requiring the disclosure of only these fees could reduce some costs
associated with the effort of compiling, on a quarterly basis,
information regarding management fees more generally. We believe,
however, that if we did not require comprehensive information,
investors would not derive the same utility in monitoring fund
performance.
    We could also consider requiring that comprehensive information
regarding fees and performance be reported on Form ADV, instead of
being disclosed to investors individually. Reporting publicly on Form
ADV would continue to allow investors to monitor performance, while
also allowing public review of important information about an adviser.
However, because the information we propose to require under the rule
is tailored to what we believe would serve existing investors in a
fund, we believe that direct delivery to investors would better reduce
monitoring costs for investors. Further, as discussed above,
prospective investors have separate protections, including against
misleading, deceptive, and confusing information in advertisements as
set forth in the recently adopted marketing rule.\391\
---------------------------------------------------------------------------

    \391\ See supra section II.A.2.
---------------------------------------------------------------------------

    Instead of requiring disclosure of comprehensive fee and expense
information to investors, we could consider prohibiting certain fee and
expense practices. For example, we could prohibit charging fees at the
fund level in excess of a certain maximum amount that we could
determine to be what investors could reasonably anticipate being
charged by an adviser. This could, effectively, protect investors from
unanticipated charges, and reduce monitoring costs to investors.
Further, we could prohibit certain compensation arrangements, such as
the ``2 and 20'' model or compensation from portfolio investments, to
the extent the adviser also receives management fees from the fund.
Prohibition of the ``2 and 20'' model would cause investors to
reallocate their capital way from funds that employ this model and
toward other types of funds. It may cause advisers to consider and
adopt more efficient models for private fund investing in which the
adviser gets a smaller fee and the investor gets a larger share of the
gross fund returns, and in which investors are generally better
off.\392\ We could also consider restricting management fee practices,
for example by imposing limitations on sizes of management fees, or
requirement management fees to be based on invested capital or net
asset value rather than on committed capital. However, the benefits of
prohibiting certain fee and expense practices outright would need to be
balanced against the costs associated with limiting an adviser and
investor's flexibility in designing fee and expense arrangements
tailored to their preferences. We believe that any such prohibitions
would, accordingly, need to be carefully tailored.
---------------------------------------------------------------------------

    \392\ For example, the compensation model for hedge funds can
provide fund advisers with embedded leverage, encouraging greater
risk-taking. See, e.g., Alon Brav, Wei Jiang, and Rongchen Li,
Governance by Persuasion: Hedge Fund Activism and Market-Based
Shareholder Influence, European Corporate Governance Institute--
Finance (Working Paper No. 797/2021), available at https://ssrn.com/abstract=3955116 or http://dx.doi.org/10.2139/ssrn.3955116.
---------------------------------------------------------------------------

    Similarly, instead of requiring disclosure of comprehensive
performance information to investors, we could consider prohibiting
certain performance disclosure practices. For example, instead of
requiring disclosure of performance without the effect of fund-level
subscription facilities, we could consider prohibiting advisers from
presenting performance with the effect of such facilities. Similarly,
we could consider prohibiting advisers from presenting combined
performance information for multiple funds, such as a main fund and a
co-investment fund that pays lower or no fees. We believe that the
required disclosures present the correct standardized, detailed
information for investors to be able to evaluate performance, but we do
not believe there are harms from advisers electing to disclose
additional information. As such, we think the benefits of prohibiting
any performance disclosure practices would likely be negligible, while
there could be substantial costs to investors who value the information
that would be prohibited under this alternative.
    Finally, the Commission could consider broadening the application
of this rule to, for example, apply to all advisers to private funds,
rather than to only advisers to private funds that are registered or
required to be registered. Extending the application of the proposed
rule to all advisers would increase the benefits of helping investors
receive more detailed and standardized information regarding fees,
expenses, and performance. Investors would, as a result, have better
information with which to evaluate the services of these advisers. It
is, however, not clear to us that these benefits would also be realized
in contexts where fund performance is not as heavily relied upon when
obtaining new investors, as is the case for private funds. Further, the
extension of the proposed rule to apply to all advisers would likely
impose the costs of compiling, preparing, and distributing quarterly
statements on smaller funds advised by unregistered advisers. For these
types of funds, these quarterly statement costs may be large compared
to the value of fund assets and fees and the related value to investors
of the required audit.
3. Alternative to the Required Manner of Preparing and Distributing
Quarterly Statements and Audited Financial Statements
    The proposed rules would require private fund advisers to
``distribute'' quarterly statements and audited annual financial
statements to investors in the private fund, and this requirement could
be satisfied through either paper or electronic means.\393\ The
Commission could consider requiring private fund advisers to prepare
and distribute the required disclosures electronically using a
structured data language, such as the

Inline eXtensible Business Reporting Language (``Inline XBRL'').
---------------------------------------------------------------------------

    \393\ See supra footnote 99.
---------------------------------------------------------------------------

    An Inline XBRL requirement for the disclosures could benefit
private fund investors with access to XBRL analysis software by
enabling them to more efficiently access, compile, and analyze the
disclosures in quarterly statements and audited annual financial
statements, facilitating calculations and comparisons of the disclosed
information across different time periods or across different portfolio
investments within the same time period. For any such private fund
investors who receive disclosures from multiple private funds, an
Inline XBRL requirement could also facilitate comparisons of the
disclosed information across those funds.
    An Inline XBRL requirement for the proposed disclosures would
diverge from the Commission's other Inline XBRL requirements, which
apply to disclosures that are made available to the public and the
Commission, thus allowing for the realization of informational benefits
(such as increased market efficiency and decreased information
asymmetry) through the processing of Inline XBRL disclosures by
information intermediaries such as analysts and researchers.\394\ Under
the current proposal, the required disclosures would not be provided to
the public or the Commission for processing and analysis. Thus, the
magnitude of benefit resulting from an Inline XBRL alternative for the
disclosure requirements in this proposal may be lower than for other
rules with Inline XBRL requirements.\395\
---------------------------------------------------------------------------

    \394\ See, e.g., Y. Cong, J. Hao, and L. Zou, The Impact of XBRL
Reporting on Market Efficiency, 28 J. Info. Sys. 181 (2014) (finding
support for the hypothesis that ``XBRL reporting facilitates the
generation and infusion of idiosyncratic information into the market
and thus improves market efficiency''); Y. Huang, J.T. Parwada, Y.G.
Shan, and J. Yang, Insider Profitability and Public Information:
Evidence From the XBRL Mandate (Working Paper, 2019) (finding XBRL
adoption levels the informational playing field between insiders and
non-insiders).
    \395\ See, e.g., Updated Disclosure Requirements and Summary
Prospectus for Variable Annuity and Variable Life Insurance
Contracts, Release No. IC-33814 (Mar. 11, 2020) [85 FR 25964 at
26041 (Jun. 10, 2020)] (Noting that an Inline XBRL requirement for
certain variable contract prospectus disclosures, which are publicly
available, would include informational benefits stemming from use of
the Inline XBRL data by parties other than investors, including
financial analysts, data aggregators, and Commission staff. While
the required disclosures in this proposal would not be provided to
the public or the Commission, such benefits would not accrue from an
Inline XBRL requirement for the required disclosures).
---------------------------------------------------------------------------

    Compared to the proposal, an Inline XBRL requirement would result
in additional compliance costs for private funds and advisers, as a
result of the requirement to select, apply, and review the appropriate
XBRL U.S. GAAP taxonomy element tags for the required disclosures (or
pay a third-party service provider to do so on their behalf). In
addition, private fund advisers may not have prior experience with
preparing Inline XBRL documents, as neither Form PF nor Form ADV is
filed using Inline XBRL. Thus, under this alternative, private funds
may incur the initial Inline XBRL implementation costs that are often
associated with being subject to an Inline XBRL requirement for the
first time (including, as applicable, the cost of training in-house
staff to prepare filings in Inline XBRL and the cost to license Inline
XBRL filing preparation software from vendors). Accordingly, the
magnitude of compliance cost resulting from an Inline XBRL requirement
under this proposal may be higher than for other rules with Inline XBRL
requirements.
4. Alternatives to the Prohibitions From Engaging in Certain Sales
Practices, Conflicts of Interest, and Compensation Schemes
    The Commission could also consider prohibiting other activities, in
addition to those currently prohibited in the proposed rule. For
example, we could prohibit advisers from charging private funds for
expenses generally understood to be adviser expenses, such as those
incurred in connection with the maintenance and operation of the
adviser's business. To the extent that the performance of these
activities is outsourced to a consultant, for example, and the fund is
charged for that service, advisers may be effectively shifting expenses
that would be generally recognized as adviser expenses to instead be
fund expenses. The prohibition of such charges could reduce investor
monitoring costs. We believe, however, that identifying the types of
charges associated with activities that should never be charged to the
fund would likely be difficult. As a result, any such prohibition could
risk effectively limiting an adviser's ability to outsource certain
activities that could be better performed by a consultant, because
under the prohibition the adviser would not be able to pass those costs
on to the fund.
    Further, the Commission could consider providing an exemption for
funds utilizing a pass-through expense model from the prohibition on
charging fees or expenses associated with certain examinations,
investigations, and regulatory and compliance fees and expenses. This
would allow advisers to avoid the costs associated with re-structuring
any arrangements not compliant with the prohibition, given the proposed
rules would likely prohibit certain aspects of these expense
models.\396\ We believe, however, that any exemption would need to be
carefully balanced against the risk that it would continue to subject
the fund to an adviser's incentive to shift its fees and expenses to
the fund to reduce its overhead and operating costs.
---------------------------------------------------------------------------

    \396\ See supra section V.C.3.
---------------------------------------------------------------------------

    We could also consider requiring detailed and standardized
disclosures of the activities under consideration, instead of
prohibiting the activities outright. This alternative may be desirable
to the extent that certain investors would be willing to bear the costs
of these activities in exchange for certain other beneficial terms, and
would be willing to give informed consent to fund advisers engaging in
the practices under consideration. However, we do not believe that
disclosure requirements would achieve the same benefit of protecting
investors from harm, because many of the practices are deceptive and
result in obscured payments, and so may be used to defraud investors
even if detailed disclosures are made. Moreover, as discussed above,
private funds typically lack fully independent governance mechanisms
more common to other markets that could help protect investors from
harm in the context of the activities considered.\397\
---------------------------------------------------------------------------

    \397\ See supra section V.B.1.
---------------------------------------------------------------------------

    We could, therefore, consider exceptions that allow certain
prohibited activities if disclosed and if appropriate governance or
other protections are in place. For example, we could consider
requiring a fund's LPAC (or other similar body) or directors to give
approval to any of the activities under consideration before the
adviser may pursue them. Similarly, we could require advisers to obtain
approval for any of the activities under consideration by a majority
(either by number or by interest) of investors. However, we believe
that allowing such activities, even under such governance, would not
achieve all of the same benefits of protecting investors, by the same
logic that many of the practices are deceptive and result in obscured
payments, and so may be used to defraud investors even if disclosed and
governed.
5. Alternatives to the Requirement That an Adviser To Obtain a Fairness
Opinion in Connection With Certain Adviser-Led Secondary Transactions
    The Commission could consider requiring advisers to obtain a third
party

valuation in connection with certain adviser-led secondary
transactions, instead of a fairness opinion. We believe that these
third party valuations would likely involve more diligence of the
proposed transaction than the reviews conducted in connection with
obtaining a fairness opinion, and therefore, requiring these valuations
could provide even greater assurances to investors that the terms of
the transaction are fair to their interests. However, we believe that
obtaining a third-party valuation would likely be significantly more
costly to obtain. If these costs could be passed on to participants in
these transactions, it could make them less attractive to investors as
a means to obtain liquidity.
    We could also consider changing the scope of this rule. For
example, we could consider broadening the application of this rule to,
for example, apply to all advisers, including advisers that are not
required to register as investment advisers with the Commission, such
as state-registered advisers and exempt reporting advisers. Investors
would, as a result, receive the assurance of the fairness of more
adviser-led secondary transactions. The extension of the proposed rule
to apply to all advisers would, however, likely impose the costs of
obtaining fairness opinions on smaller funds advised by unregistered
advisers, and for these types of funds, the cost of obtaining such
opinions would likely be relatively large compared to the value of fund
assets and fees that the rule is intended to provide a check on, which
could discourage them from undertaking these transactions. This could
ultimately reduce liquidity opportunities for fund investors.
Alternatively, we could provide exemptions from the rule. For example,
an exemption could be provided where the adviser undertakes a
competitive sale process for the assets being sold or for certain
advisers to hedge funds or other funds determined to be liquid funds
for whom the concerns regarding pricing of illiquid assets may be less
relevant. These exemptions would reduce the costs on advisers
associated with obtaining the fairness opinion, which could ultimately
reduce costs for investors. However, we believe that any such
exemptions could reduce the benefits of the proposed rule associated
with providing greater assurance to investors of the fairness of the
transaction. We believe that, even under circumstances where the
adviser has conducted a competitive sales process, the effective check
on this process provided by the fairness opinion would benefit
investors. Further, even for advisers to hedge funds or other funds
determined to be liquid funds who are advising funds with predominantly
highly liquid securities, we believe that a fairness opinion would be
beneficial to investors because the conflicts of interest inherent in
structuring and leading a transaction may, despite the nature of the
assets in the fund, harm investors.\398\
---------------------------------------------------------------------------

    \398\ Moreover, the costs to liquid fund advisers are more
likely to be limited, as many secondary transactions by liquid fund
advisers are not adviser-led and so would not necessitate a fairness
opinion.
---------------------------------------------------------------------------

6. Alternatives to the Prohibition From Providing Certain Preferential
Terms and Requirement To Disclose All Preferential Treatment
    Instead of requiring that private fund advisers provide investors
and prospective investors with written disclosures regarding all
preferential treatment the adviser or its related persons provided to
other investors in the same fund, the Commission could consider
prohibiting all such terms. This could provide investors in private
funds with increased confidence that the adviser's negotiations with
other investors would not affect their investment in the private fund.
We preliminarily believe, however, that an outright prohibition of all
preferential terms may not provide significant additional benefits
beyond prohibitions on providing certain preferential terms regarding
redemption or information about portfolio holdings or exposures. As
discussed above, we believe that certain types of preferential terms
raise relatively few concerns, if disclosed.\399\ Further, an outright
prohibition of all preferential terms may limit the adviser's ability
to respond to an individual investor's concerns during the course of
attracting capital investments to private funds.
---------------------------------------------------------------------------

    \399\ See supra section II.E.
---------------------------------------------------------------------------

    Further, we could consider prohibiting all preferential terms
regarding redemption or information about portfolio holdings or
exposures, rather than just those that the adviser reasonably expects
to have a material, negative effect on other investors in that fund or
in a substantially similar pool of assets. This could increase the
investor protections associated with the rule, by eliminating the risk
that a term not reasonably expected to have a material negative effect
on investors could, ultimately, harm investors. We believe, however,
that this alternative would likely provide more limited benefits and
would increase costs associated with the rule similar to the above
alternatives, for example by limiting the adviser's ability to respond
to an individual investor's concerns during the course of attracting
capital investments to private funds.
    In addition, for preferential terms not regarding redemption or
information about portfolio holdings or exposures, we could consider
requiring advisers to private funds to provide disclosure only when the
term has a material negative effect on other fund investors. This could
reduce the compliance burden on advisers associated with the costs of
disclosure. We believe, however, that limiting disclosure to only those
terms that an adviser determines to have a material negative effect
could reduce an investor's ability to recognize the potential for harm
from unforeseen favoritism toward other investors, relative to a
requirement to disclose all preferential treatment.

F. Request for Comment

    The Commission requests comment on all aspects of the economic
analysis of the proposed rule. To the extent possible, the Commission
requests that commenters provide supporting data and analysis with
respect to the benefits, costs, and effects on competition, efficiency,
and capital formation of adopting the proposed amendments or any
reasonable alternatives. In particular, the Commission asks commenters
to consider the following questions:
     What additional qualitative or quantitative information
should the Commission consider as part of the baseline for its economic
analysis of these amendments?
     Has the Commission accurately characterized the costs and
benefits of proposed rule? If not, why not? Should any of the costs or
benefits be modified? What, if any, other costs or benefits should the
Commission take into account? If possible, please offer ways of
estimating these costs and benefits. What additional considerations can
the Commission use to estimate the costs and benefits of the proposed
amendments?
     Has the Commission accurately characterized the effects on
competition, efficiency, and capital formation arising from the
proposed rules? If not, why not?
     Has the Commission accurately characterized the economic
effects of the above alternatives? If not, why not? Should any of the
costs or benefits be modified? What, if any, other costs or benefits
should the Commission take into account? Are there other reasonable
alternatives to the proposed amendments? What are the economic effects
of any other alternatives?
     Are there data sources or data sets that can help the
Commission refine its

estimates of the costs and benefits associated with the proposed
amendments? If so, please identify them.
     How would the proposed delivery of the quarterly statement
affect the reporting practices of advisers, including the costs and
benefits of these statements? Would advisers add the required report to
the report that they currently provide to investors? Would advisers
substitute the required report for an existing report? Explain.
     What are the benefits to investors of obtaining the
information that would be required under the proposal in a standardized
format that would enable them to make comparisons across alternative
fund investments? Explain. Would the benefits to investors vary based
on the investor's scale of operations, relationship with the adviser,
or other factors? Explain. Please provide data, if available, to
support your answer along with details regarding data sources and
interpretation of statistics, where appropriate.
     Would the proposed rules strengthen the bargaining power
of investors in negotiating with private fund advisers? If so, under
what circumstances, and for what types of funds and investors would
this effect occur? How would it affect other investors who do not gain
bargaining power as a result of the proposed rules? Please explain your
answer and provide supporting data, if possible.
     What would the aggregate total cost (including but not
limited to the audit fee) be of complying with the new audit
requirement, separately, for (a) funds that currently receive audits
and (b) funds that would newly receive an audit under the proposed
rule? For each, what is the current per-fund cost of an audit? Is the
per-fund cost different between the funds that currently receive audits
and would newly receive audits? If yes, explain Please include an
explanation of any differences between the funds that currently receive
an audit and the funds that would newly receive an audit that would
explain the differences in their per-fund audit costs. Provide
quantitative evidence to support your explanation, if available.
     Would the proposed rules introduce new fixed costs of
compliance? Would they cause private funds or fund advisers to
consolidate their operations to economize on those costs? Please
explain. Provide quantitative evidence to support your explanation, if
available.
     To what extent do funds currently provide quarterly
statements to investors, and what is the cost of providing these
statements? How are they delivered? How do investors use them? What are
the contents of these statements currently? How do the current contents
compare with the contents that would be required under the proposed
rule? Explain.
     We believe that the information in the new quarterly
statements would supplement the information that investors currently
receive about their fund investments and that advisers would not
respond to the proposal by discontinuing any reports to investors. Is
this correct? Why or why not? Please explain.
     What fee and expense information is currently available to
investors for use in comparing investment opportunities among similar
funds (sponsored by the same adviser or different advisers)? How does
this information differ from the information that advisers would be
required to provide under the proposed rule? In what way does the lack
of this information affect investor choice or the ability of investors
to monitor fund performance net of fees and expenses?
     What performance information is currently available for
investors for use in comparing investment opportunities among similar
funds (sponsored by the same adviser or different advisers)? How does
this information differ from the information that advisers would be
required to provide under the proposed rule?
     How frequently do advisers currently engage in each of the
activities that would be prohibited under the proposed rule? Does this
frequency vary depending on the type of adviser or investor? For each
practice, what is the current business purpose of the activity and how
else might that purpose be achieved (if the activity were prohibited)?
Please provide quantitative evidence on the magnitude of the activity,
e.g., how much money do advisers and related persons receive from the
fee and expense arrangements that would be prohibited?
     What is the economic effect on investors, currently, of
the activities we propose to prohibit under the proposed rule? What
empirical evidence is there that those activities make investors worse
off?
     What data exists regarding the costs to investors of
conflicts of interest in connection with adviser-led secondary
transactions where an adviser offers fund investors the option to sell
their interests in the private fund, or to exchange them for new
interests in another vehicle advised by the adviser? How do costs vary
according to the presence or absence of the disclosure that would be
required under the proposed rule?
     From what sources do investors receive information about
fund performance: (a) When comparing alternative prospective fund
investments and (b) for evaluating the performance of an ongoing und
investment? For example, do investors obtain this information directly
from the advisers or from a third party? If from a third party, from
what source does the third party obtain the fund performance
information, and what is the cost of this information? How does the
source vary with the fund type or third party, if at all?
     How frequently and under what conditions are private fund
investors (current and prospective) unable to obtain information from
fund advisers or third parties on the fund performance?
     Do investors rely on IRR and MOIC for evaluating the
performance of funds determined to be illiquid funds? What additional
information do investors use to evaluate illiquid fund performance? How
frequently do they rely on this information? From what sources do they
currently obtain this information?
     How do investors who do not have access to this
information evaluate illiquid fund performance? What alternative
sources of information do they rely upon?
     Do investors rely on annual total returns for evaluating
the performance of funds determined to be liquid funds? When evaluating
performance partway through a current year, do investors rely on
cumulative total return for the current calendar year? What additional
information do investors use to evaluate liquid fund performance? How
frequently do they rely on this information? From what sources do they
currently obtain this information?
     How do investors who do not have access to this
information evaluate liquid fund performance? What alternative sources
of information do they rely upon?

VI. Paperwork Reduction Act

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'').\400\ The proposed amendments would
also have an impact on the current collection of information burdens of
rules 206(4)-7 and 204-2 under the Advisers Act. The title of the new
collection of information

requirements we are proposing are ``Rule 211(h)(1)-2 under the Advisers
Act,'' ``Rule 206(4)-10 under the Advisers Act,'' ``Rule 211(h)(2)-2
under the Advisers Act,'' and ``Rule 211(h)(2)-3 under the Advisers
Act.'' The Office of Management and Budget (``OMB'') has not yet
assigned control numbers for these new collections of information. The
titles for the existing collections of information that we are
proposing to amend are: (i) ``Rule 206(4)-7 under the Advisers Act (17
CFR 275.206(4)-7)'' (OMB control number 3235-0585) and (ii) ``Rule 204-
2 under the Advisers Act (17 CFR 275.204-2)'' (OMB control number 3235-
0278). The Commission is submitting these collections of information to
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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    \400\ 44 U.S.C. 3501 et seq.
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    We discuss below the new collection of information burdens
associated with new rules 211(h)(1)-2, 206(4)-10, 211(h)(2)-2, and
211(h)(2)-3 as well as the revised existing collection of information
burdens associated with the proposed amendments to rules 206(4)-7 and
204-2. Responses provided to the Commission in the context of
amendments to rules 206(4)-7 and 204-2 would be kept confidential
subject to the provisions of applicable law. Because the information
collected pursuant to new rules 211(h)(1)-2, 211(h)(2)-2, and
211(h)(2)-3 requires disclosures to existing investors and in some
cases potential investors, these disclosures would not be kept
confidential. Proposed new rule 206(4)-10 requires the collection of
two types of information: one type (the audited financial statements)
would be distributed only to investors in the private fund, and the
other (notifications to the Commission) would be kept confidential
subject to the provisions of applicable law.

B. Quarterly Statements

    Proposed rule 211(h)(1)-2 would require an investment adviser
registered or required to be registered with the Commission to prepare
a quarterly statement that includes certain standardized disclosures
regarding the cost of investing in the private fund and the private
fund's performance for any private fund that it advises, directly or
indirectly, that has at least two full calendar quarters of operating
results, and distribute the quarterly statement to the private fund's
investors within 45 days after each calendar quarter end, unless such a
quarterly statement is prepared and distributed by another person.\401\
The quarterly statement would provide investors with fee and expense
disclosure for the prior quarterly period or, in the case of a newly
formed private fund initial account statement, its first two full
calendar quarters of operating results. It would also provide investors
with certain performance information depending on whether the fund is
categorized as a liquid fund or an illiquid fund.\402\
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    \401\ See proposed rule 211(h)(1)-2.
    \402\ See proposed rule 211(h)(1)-2(d).
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    The collection of information is necessary to provide private fund
investors with information about their private fund investments. The
quarterly statement would allow a private fund investor to compare
standardized cost and performance information across its private fund
investments. We believe this information would help inform investment
decisions, including whether to remain invested in certain private
funds or to invest in other private funds managed by the adviser or its
related persons. More broadly, this disclosure would help inform
investors about the cost and performance dynamics of this marketplace
and potentially improve efficiency for future investments.
    Each requirement to disclose information, offer to provide
information, or adopt policies and procedures constitutes a
``collection of information'' requirement under the PRA. This
collection of information is found at 17 CFR 275.211(h)(1)-2 and is
mandatory. The respondents to these collections of information
requirements would be investment advisers that are registered or
required to be registered with the Commission that advise one or more
private funds.
    Based on Investment Adviser Registration Depository (IARD) data, as
of November 30, 2021, there were 14,832 investment advisers registered
with the Commission. According to this data, 5,037 registered advisers
provide advice to private funds.\403\ We estimate that these advisers
would, on average, each provide advice to 9 private funds.\404\ We