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    The proposed rule recognizes the need for different performance
metrics for private funds based on certain fund characteristics, but
also imposes a general framework to ensure there is sufficient
standardization in order to provide useful, comparable information to
investors. An adviser would remain free to include other performance
metrics in the quarterly statement as long as the quarterly statement
presents the performance metrics prescribed by the proposed rule and
complies with the other requirements in the proposed rule. However,
advisers that choose to include additional information should consider
what other rules and regulations might apply. For example, although we
would not consider information in the quarterly statement required by
the proposed rule to be an ``advertisement'' under the marketing rule,
an adviser that offers new or additional investment advisory services
with regard to securities in the quarterly statement would need to
consider whether such information would be subject to the marketing
rule.\67\ An adviser would also need to consider whether performance
information presented outside of the required quarterly statement, even
if it contains some of the same information as the quarterly statement,
would be subject to, and meet the requirements of, the marketing rule.
Regardless, the quarterly statement would be subject to the anti-fraud
provisions of the Federal securities laws.\68\
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    \67\ See 17 CFR 275.206(4)-1 (rule 206(4)-1). A communication to
a current investor is an ``advertisement'' when it offers new or
additional investment advisory services with regard to securities.
    \68\ This would include the anti-fraud provisions of section 206
of the Advisers Act, rule 206(4)-8 under the Advisers Act, section
17(a) of the Securities Act, and section 10(b) of the Exchange Act
(and 17 CFR 240.10b-5 (rule 10b-5 thereunder)), to the extent
relevant.
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Liquid v. Illiquid Fund Determination
    The proposed performance disclosure requirements of the quarterly
statement rule would require an adviser first to determine whether its
private fund client is an illiquid or liquid fund, as defined in the
proposed rule, no later than the time the adviser sends the initial
quarterly statement.\69\ The adviser would then be required to present
certain performance information depending on this categorization. The
purpose of these definitions is to distinguish which of the two
particular performance reporting methods would apply and is most
appropriate, resulting in a more accurate portrayal of the fund's
returns over time and allowing for more standardized comparisons of the
performance of similar funds.
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    \69\ Proposed rule 211(h)(1)-2(e)(1). The proposed rule does not
require the adviser to revisit the determination periodically;
however, advisers should generally consider whether they are
providing accurate information to investors and whether they need to
revisit the liquid/illiquid determination based on changes in the
fund.
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    We propose to define an illiquid fund as a private fund that: (i)
Has a limited life; (ii) does not continuously raise capital; (iii) is
not required to redeem interests upon an investor's request; (iv) has
as a predominant operating strategy the return of the proceeds from
disposition of investments to investors; (v) has limited opportunities,
if any, for investors to withdraw before termination of the fund; and
(vi) does not routinely acquire (directly or indirectly) as part of its
investment strategy market-traded securities and derivative
instruments.\70\ We believe these factors are consistent with the
characteristics of illiquid funds and these factors would align with
the current factors for determining how certain types of private funds
should report performance under U.S. Generally Accepted Accounting
Principles (``U.S. GAAP'').\71\
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    \70\ Proposed rule 211(h)(1)-1 (defining ``illiquid fund'').
    \71\ See GAAP ASC 946-205-50-23/24.
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    Private funds that fall into the proposed ``illiquid fund''
definition are generally closed-end funds that do not offer periodic
redemption options, other than in exceptional circumstances, such as in
response to regulatory events. They also do not invest in publicly
traded securities, except for investing a de minimis amount of liquid
assets. We believe that many private equity, real estate, and venture
capital funds would fall into the illiquid fund definition, and
therefore, the proposed rule would require advisers to these types of
funds to provide performance metrics that recognize their unique
characteristics, such as irregular cash flows, which otherwise make
measuring performance difficult for both advisers and investors as
discussed below.
    We propose to define a ``liquid fund'' as any private fund that is
not an illiquid fund.\72\ Private funds that fall into the ``liquid
fund'' definition generally allow periodic investor redemptions, such
as monthly, quarterly, or semi-annually. They also primarily invest in
market-traded securities, except for a de minimis amount of illiquid
assets, and therefore determine their net asset value on a regular
basis. Most hedge funds would likely fall into the liquid fund
definition, and therefore, the proposed rule would require advisers to
these types of funds to provide performance metrics that show the year-
over-year return using the market value of the underlying assets. We
acknowledge, however, that there could be circumstances where an
adviser would determine a hedge fund is an illiquid fund because it
holds less liquid investments or has limited investors' ability to
redeem some or all of their interests in the fund. We also recognize
that some private funds may not neatly fit into the liquid or illiquid
designations. For example, a hybrid fund is a type of private fund that
can have characteristics of both liquid and illiquid funds, and whether
the fund is treated as a liquid or illiquid fund under the rule would
depend on the facts and circumstances.
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    \72\ Proposed rule 211(h)(1)-1 (defining ``liquid fund'').
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    In any case, the proposed rule would require advisers to provide
performance reporting for each private fund as part of the fund's
quarterly statement. The determination of whether a fund is liquid or
illiquid dictates the type of performance reporting that must be
included and, because it would result in funds with similar
characteristics presenting the same type of performance metrics, we
believe this approach would improve comparability of private fund
performance reporting for fund investors. As indicated below, we
welcome comment on whether these definitions lead to meaningful
performance reporting for different types of private funds in light of
the myriad fund strategies and structures.
    We request comment on the following aspects of the proposed
performance disclosure requirement:
     Should the proposed rule require advisers to include
performance

information in investor quarterly statements? Why or why not?
     Should the proposed rule require advisers to determine
whether a private fund is a liquid or illiquid fund and provide
performance metrics based on that determination? Alternatively, should
the rule eliminate the definitions and give advisers discretion to
provide the proposed performance metrics that they believe most
accurately portray the fund's returns?
     Should we define ``illiquid fund'' and ``liquid fund'' as
proposed or are there alternative definitions we should use? Are there
other terms we should use for these purposes? For example, should we
refer to the types of funds that would provide annual net total returns
under the rule as ``annual return funds'' and those that would provide
internal rates of return (IRR) and a multiple of invested cash (MOIC)
under the rule as ``IRR/MOIC funds''?
     Are the six factors used in the definition of ``illiquid
fund'' sufficient to capture most funds for which an annual net total
return is not an appropriate measure of performance? Are there any
factors we should add? For example, should we add a factor regarding
whether the fund produces irregular cash flows or whether the fund
takes into account unrealized gains when calculating performance-based
compensation? Should we add as a factor whether the private fund pays
carried interest? Are there factors we should eliminate?
     Should we define additional terms or phrases used within
the definition of ``illiquid fund,'' such as ``has as a predominant
operating strategy the return of the proceeds from disposition of
investments to investors''? Would this characteristic carve out certain
funds, such as real estate funds and credit funds, for which we
generally believe internal rates of return and a multiple of invested
capital are the appropriate performance measures? If so, why? Should we
eliminate or modify this characteristic in the definition of ``illiquid
fund''?
     Should the proposed rule define a ``liquid fund'' based on
certain characteristics? If so, what characteristics? For example,
should we define it as a private fund that requires investors to
contribute all, or substantially all, of their capital at the time of
investment, and invests no more than a de minimis amount of assets in
illiquid investments? If so, how should we define ``illiquid
investments''? Are there other characteristics relating to redemptions,
cash flows, or tax treatment that we should use to define the types of
funds that should provide annual net total return metrics?
     Will advisers be able to determine whether a private fund
it manages is a liquid or illiquid fund? For example, how would an
adviser classify certain types of hybrid funds under the proposed rule?
Should the rule include a third category of funds for hybrid or other
funds? If so, what definition should we use? Should we amend the
proposed definitions if we adopt a third category of funds (e.g.,
should we revise the definition of ``liquid fund'' given that the
proposal defines ``liquid fund'' as any private fund that is not an
illiquid fund)? If a fund falls within the third category, should the
rule require or permit the private fund to provide performance metrics
that most accurately portray the fund's returns?
     Are there scenarios in which an adviser might initially
classify a fund as illiquid, but the fund later transitions to a liquid
fund (or vice versa)? Should we provide additional flexibility in these
circumstances? Should the proposed rule require advisers to revisit
periodically their determination of a fund's liquidity status? For
example, should the proposed rule require advisers to revisit the
liquid/illiquid determination annually, semi-annually, or quarterly?
     How would an adviser to a private fund with an illiquid
side pocket classify the private fund under the proposed rule's
definitions for liquid and illiquid funds? For example, would the
adviser treat the entire private fund as illiquid because of the side
pocket? Why or why not? Should we permit or require the adviser to
classify the side pocket as an illiquid fund, with the remaining
portion of the private fund classified as a liquid fund?
     Instead of requiring advisers to show performance with
equal prominence, should the proposed rule instead allow advisers to
feature certain performance with greater prominence than other
performance as long as all of the information is included in the
quarterly statement? Why or why not?
a. Liquid Funds
    The proposed rule would require advisers to liquid funds to
disclose performance information in quarterly statements for the
following periods. First, an adviser to a liquid fund would be required
to disclose the liquid fund's annual net total returns for each
calendar year since inception. For example, a liquid fund that
commenced operations four calendar years ago would show annual net
total returns for each of the first four years since its inception.\73\
We believe this information would provide fund investors with a
comprehensive overview of the fund's performance over the life of the
fund and improve an investor's ability to compare the fund's
performance with other similar funds. As noted above, investors can use
performance information in connection with fee and expense information
to analyze the value of their private fund investments. The proposed
requirement would prevent advisers from including only recent
performance results or presenting only results or periods with strong
performance. For similar reasons, it also would require an adviser to
present these various time periods with equal prominence.
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    \73\ If a private fund's inception date were other than on the
first day of a calendar year, the private fund would show
performance for a stub period and then show calendar year
performance. For example, if the four-year period ended on October
31, 2021, and the fund's inception date was August 31, 2017, the
fund would show full calendar year performance for 2018, 2019, and
2020, and partial year performance in 2017.
---------------------------------------------------------------------------

    Second, the adviser would be required to show the liquid fund's
average annual net total returns over the one-, five-, and ten-calendar
year periods.\74\ However, if the private fund did not exist for one of
these prescribed time periods, then the adviser would not be required
to provide that information. Requiring performance over these time
periods would provide investors with standardized performance metrics
that would reflect how the private fund performed during different
market or economic conditions. These time periods would provide
reference points for private fund investors, particularly when
comparing two or more private fund investments, and would provide
private fund investors with aggregate performance information that can
serve as a helpful summary of the fund's performance.
---------------------------------------------------------------------------

    \74\ Proposed rule 211(h)(1)-2(e)(2)(i)(B).
---------------------------------------------------------------------------

    Third, the adviser would be required to show the liquid fund's
cumulative net total return for the current calendar year as of the end
of the most recent calendar quarter covered by the quarterly statement.
For example, a liquid fund that has been in operations for four
calendar years (beginning on January 1) and seven months would show the
cumulative net total return for the current calendar year through the
end of the second quarter. We believe this information would provide
fund investors with insight into the fund's most recent performance,
which investors could use to assess the fund's performance during
current market

conditions. This quarterly performance information also would provide
helpful context for reviewing and monitoring the fees and expenses
borne by the fund during the quarter, which the quarterly statement
would disclose.
    We believe these performance metrics would allow investors to
assess these funds' performance because they ordinarily invest in
market-traded securities, which are primarily liquid. As a result,
liquid funds generally are able to determine their net asset value on a
regular basis and compute the year-over-year return using the market-
based value of the underlying assets. We have taken a similar approach
with regard to registered funds, which also invest a substantial amount
of their assets in primarily liquid underlying holdings (e.g., publicly
traded securities).\75\ As a result, liquid funds, like registered
funds, currently generally report performance on an annual and
quarterly basis. Investors in a private fund that is a liquid fund
would similarly find this information helpful. Most traditional hedge
funds would likely fall into the liquid bucket and would need to
provide disclosures regarding the underlying assumptions of the
performance (e.g., whether dividends or other distributions are
reinvested).\76\
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    \75\ See Form N-1A. This form requires registered investment
companies to report to investors and file with the SEC documents
containing the fund's annual total returns by calendar year and the
highest and lowest returns for a calendar quarter, among other
performance information.
    \76\ See infra section II.A.2.c (Prominent Disclosure of
Performance Calculation Information).
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    We request comment on the following with respect to the proposed
liquid fund performance requirement:
     Should we require advisers to provide annual net total
returns for liquid funds, as proposed? Would showing annual net total
returns for each calendar year since a private fund's inception be
overly burdensome for older funds? Would performance information that
is more than 10 years old be useful to investors? Why or why not?
     Should the proposed rule define ``annual net total
return'' or specify the format in which advisers must present the
annual net total returns? Should the proposed rule specify how advisers
should calculate the annual net total return, similar to Form N-1A?
\77\
---------------------------------------------------------------------------

    \77\ See Form N-1A, Item 26(b).
---------------------------------------------------------------------------

     The proposed rule would require advisers to provide
performance information for each calendar year since inception and over
prescribed time periods (one-, five-, and ten-year periods). Should the
proposed rule instead only require an adviser to satisfy one of these
requirements (i.e., provide performance each calendar year since
inception or provide performance over the prescribed time periods)? For
funds that have not been in existence for one of the prescribed time
periods, should the proposed rule require the adviser to show the
average annual net total return since inception, instead of the
prescribed time period?
     The proposed rule would require advisers to provide
average annual net total returns for the private fund over the one-,
five-, and ten-calendar year periods. However, the proposal would not
prohibit advisers from providing additional information. Should we
allow advisers to provide performance information for annual periods
other than calendar years?
     Should the proposed rule define ``average annual net total
return'' or specify the format in which advisers must present the
average annual net total returns?
     The proposed rule would require an adviser to provide
``the cumulative net total return for the current calendar year.''
Instead of using the word ``cumulative'' net total return, should the
rule use the phrase ``year to date'' net total return?
     To the extent certain liquid funds quote yields rather
than returns, should such funds be required or permitted to quote
yields in addition to or instead of returns?
b. Illiquid Funds
    The proposed rule would require advisers to illiquid funds to
disclose the following performance measures in the quarterly statement,
shown since inception of the illiquid fund and computed without the
impact of any fund-level subscription facilities:
    (i) Gross internal rate of return and gross multiple of invested
capital for the illiquid fund;
    (ii) Net internal rate of return and net multiple of invested
capital for the illiquid fund; and
    (iii) Gross internal rate of return and gross multiple of invested
capital for the realized and unrealized portions of the illiquid fund's
portfolio, with the realized and unrealized performance shown
separately.
    The proposed rule also would require advisers to provide investors
with a statement of contributions and distributions for the illiquid
fund.\78\
---------------------------------------------------------------------------

    \78\ Proposed rule 211(h)(1)-2(e)(2)(ii).
---------------------------------------------------------------------------

    Since Inception. The proposed rule would require an adviser to
disclose the illiquid fund's performance measures since inception. This
proposed requirement would prevent advisers from including only recent
performance results or presenting only results or periods with strong
performance, which could mislead investors. We propose to require this
for all illiquid fund performance measures under the proposed rule,
including the measures for the realized and unrealized portions of the
illiquid fund's portfolio.
    The proposed rule would require an adviser to include performance
measures for the illiquid fund through the end of the quarter covered
by the quarterly statement. We recognize, however, that certain funds
may need information from portfolio investments and other third parties
to generate performance data and thus may not have the necessary
information prior to the distribution of the quarterly statement.
Accordingly, to the extent quarter-end numbers are not available at the
time of distribution of the quarterly statement, an adviser would be
required to include performance measures through the most recent
practicable date, which we generally believe would be through the end
of the quarter immediately preceding the quarter covered by the
quarterly statement. The proposed rule would require the quarterly
statement to reference the date the performance information is current
through (e.g., December 31, 2021).\79\
---------------------------------------------------------------------------

    \79\ Proposed rule 211(h)(1)-2(e)(2)(iii).
---------------------------------------------------------------------------

    Computed Without the Impact of Fund-Level Subscription Facilities.
The proposed rule would require advisers to calculate performance
measures for each illiquid fund as if the private fund called investor
capital, rather than drawing down on fund-level subscription
facilities.\80\ Such facilities enable the fund to use loan proceeds--
rather than investor capital--to initially fund investments and pay
expenses. This practice permits the fund to delay the calling of
capital from investors, which has the potential to increase performance
metrics artificially.
---------------------------------------------------------------------------

    \80\ As discussed below, the proposed rule would also require
advisers to prominently disclose the criteria used, and assumptions
made, in calculating performance. This would include the criteria
and assumptions used to prepare an illiquid fund's unlevered
performance measures.
---------------------------------------------------------------------------

    Many advisers currently provide performance figures that reflect
the impact of fund-level subscription facilities. These ``levered''
performance figures often do not reflect the fund's actual performance
and have the potential to mislead investors.\81\ For

example, an investor could reasonably believe that levered performance
results are similar to those that the investor has achieved from its
investment in the fund. We believe that unlevered performance figures
would provide investors with more meaningful data and improve the
comparability of returns.
---------------------------------------------------------------------------

    \81\ We recognize that fund-level subscription facilities can be
an important cash management tool for both advisers and investors.
For example, a fund may use a subscription facility to reduce the
overall number of capital calls and to enhance its ability to
execute deals quickly and efficiently.
---------------------------------------------------------------------------

    We propose to define ``fund-level subscription facilities'' as any
subscription facilities, subscription line financing, capital call
facilities, capital commitment facilities, bridge lines, or other
indebtedness incurred by the private fund that is secured by the
unfunded capital commitments of the private fund's investors.\82\ This
definition is designed to capture the various types of subscription
facilities prevalent in the market that serve as temporary replacements
or substitutes for investor capital.\83\
---------------------------------------------------------------------------

    \82\ Proposed rule 211(h)(1)-1. The proposed rule defines
``unfunded capital commitments'' as committed capital that has not
yet been contributed to the private fund by investors, and
``committed capital'' as any commitment pursuant to which a person
is obligated to acquire an interest in, or make capital
contributions to, the private fund. See id.
    \83\ We recognize that a private fund may guarantee portfolio
investment indebtedness. In such a situation, if the portfolio
investment does not have sufficient cash flow to pay its debt
obligations, the fund may be required to cover the shortfall to
satisfy its guarantee. Even though investors' unfunded commitments
may indirectly support the fund's guarantee, the proposed definition
would not cover such fund guarantees. Unlike fund-level subscription
facilities, such guarantees generally are not put in place to enable
the fund to delay the calling of investor capital.
---------------------------------------------------------------------------

    We would generally interpret the phrase computed without the impact
of fund-level subscription facilities to require advisers to exclude
fees and expenses associated with the subscription facility, such as
the interest expense, when calculating net performance figures and
preparing the statement of contributions and distributions. This
approach would cause the net returns for many funds to be higher than
would be the case if such amounts were included. We believe that this
approach is appropriate, however, because it is consistent with the
policy goal of this aspect of the proposed rule (i.e., requiring
advisers to show private fund investors the returns the fund would have
achieved if there were no subscription facility).\84\ We request
comment below on whether this approach is appropriate.
---------------------------------------------------------------------------

    \84\ The proposed rule nevertheless would require advisers to
reflect the fees and expenses associated with the subscription
facility in the quarterly statement's fee and expense table.
---------------------------------------------------------------------------

    Fund-Level Performance. The proposed rule would require an adviser
to disclose an illiquid fund's gross and net internal rate of return
and gross and net multiple of invested capital for the illiquid fund.
The proposed rule also would require an adviser to provide a statement
of contributions and distributions for the illiquid fund reflecting the
aggregate cash inflows from investors and the aggregate cash outflows
from the fund to investors, along with the fund's net asset value.
    We recognize that illiquid funds have unique characteristics, such
as irregular cash flows, that make measuring performance difficult for
both advisers and investors. We also recognize that internal rate of
return and multiple of invested capital, each as discussed below, have
their drawbacks as performance metrics.\85\ We believe, however, that
these metrics, combined with a statement of contributions and
distributions reflecting cash flows, would help investors holistically
understand the fund's performance, allow investors to diligence the
fund's performance, and calculate other performance metrics they may
find helpful. When presented in accordance with the conditions and
other disclosures required under the proposed rule, such standardized
reporting measures would provide meaningful performance information for
investors, allowing them to compare returns among funds and also to
make more-informed decisions.
---------------------------------------------------------------------------

    \85\ For example, multiple of invested capital does not factor
in the amount of the time it takes for a fund to generate a return,
and internal rate of return assumes early distributions will be
reinvested at the same rate of return generated at the initial exit.
---------------------------------------------------------------------------

    We propose to define ``internal rate of return'' as the discount
rate that causes the net present value of all cash flows throughout the
life of the private fund to be equal to zero.\86\ Cash flows would be
represented by capital contributions (i.e., cash inflows) and fund
distributions (i.e., cash outflows), and the unrealized value of the
fund would be represented by a fund distribution (i.e., a cash
outflow). This definition would provide investors with a time-adjusted
return that takes into account the size and timing of a fund's cash
flows and its unrealized value at the time of calculation.\87\
---------------------------------------------------------------------------

    \86\ Proposed rule 211(h)(1)-1 (defining ``gross IRR'' and ``net
IRR'').
    \87\ When calculating a fund's internal rate of return, an
adviser would need to take into account the specific date a cash
flow occurred (or is deemed to occur). Certain electronic
spreadsheet programs have ``XIRR'' or other similar formulas that
require the user to input the applicable dates. The proposed
requirement that an illiquid fund present its performance using an
internal rate of return aligns with the U.S. GAAP criteria used to
determine when a private fund must present performance using an
internal rate of return in its audited financial statements. See
U.S. GAAP ASC 946-205-50-23/24.
---------------------------------------------------------------------------

    We propose to define ``multiple of invested capital'' as (i) the
sum of: (A) The unrealized value of the illiquid fund; and (B) the
value of all distributions made by the illiquid fund; (ii) divided by
the total capital contributed to the illiquid fund by its
investors.\88\ This definition is intended to provide investors with a
measure of the fund's aggregate value (i.e., the sum of clauses (i)(A)
and (i)(B)) relative to the capital invested (i.e., clause (ii)) as of
the end of the applicable reporting period. Unlike the definition of
internal rate of return, the multiple of invested capital definition
would not take into account the amount of time it takes for a fund to
generate a return (meaning that the multiple of invested capital
measure would focus on ``how much'' rather than ``when'').
---------------------------------------------------------------------------

    \88\ Proposed rule 211(h)(1)-1 (defining ``gross MOIC'' and
``net MOIC'').
---------------------------------------------------------------------------

    We believe that the proposed definitions of internal rate of return
and multiple of invested capital are generally consistent with how the
industry currently calculates such performance metrics. For example,
most advisers use electronic spreadsheet programs to calculate a fund's
internal rate of return. Such programs typically calculate the internal
rate of return as the interest rate for an investment consisting of
payments (cash outflows) and income (cash inflows) received over a
period.\89\ However, we have observed certain advisers deviate from
standard formulas, or make various assumptions, when calculating a
private fund's performance. Accordingly, we believe that prescribing
definitions would decrease the risk of different advisers presenting
internal rate of return and multiple of invested capital performance
figures that are not comparable. Both definitions are designed to limit
any deviations in calculating the standardized performance prescribed
by the proposed rule. We believe that this approach is appropriate
because it would provide a degree of standardization and provide
investors with the relevant information to compare performance.
---------------------------------------------------------------------------

    \89\ See, e.g., IRR Function, available at https://support.microsoft.com/en-us/office/irr-function-64925eaa-9988-495b-b290-3ad0c163c1bc (noting that the internal rate of return is
closely related to net present value and that the rate of return
calculated by the internal rate of return is the interest rate
corresponding to a zero net present value).
---------------------------------------------------------------------------

    An adviser would be required to present each performance metric on
a gross and net basis.\90\ Under the proposed rule, an illiquid fund's
gross

performance would not reflect the deduction of fees, expenses, and
performance-based compensation borne by the private fund.\91\ We
believe that presenting both gross and net performance measures for the
illiquid fund would prevent investors from being misled. We believe
that gross performance would provide insight into the profitability of
underlying investments selected by the adviser. Solely presenting gross
performance, however, may imply that investors have received the full
amount of such returns. The net performance would assist investors in
understanding the actual returns received and, when presented alongside
gross performance, the negative effect fees, expenses, and performance-
based compensation have had on past performance.
---------------------------------------------------------------------------

    \90\ Proposed rule 211(h)(1)-2(e)(2)(ii).
    \91\ See proposed rule 211(h)(1)-1 (defining ``gross IRR,''
``net IRR,'' ``gross MOIC,'' and ``net MOIC'').
---------------------------------------------------------------------------

    The proposed rule also would require an adviser to provide a
statement of contributions and distributions for the illiquid fund. We
believe this would provide private fund investors with important
information regarding the fund's performance because it would reflect
the underlying data used by the adviser to generate the fund's returns,
which, in many cases, is not currently provided to private fund
investors. Such data would allow investors to diligence the various
performance measures presented in the quarterly statement. In addition,
this data would allow the investors to calculate additional performance
measures based on their own preferences.
    We propose to define statement of contributions and distributions
as a document that presents:
    (i) All capital inflows the private fund has received from
investors and all capital outflows the private fund has distributed to
investors since the private fund's inception, with the value and date
of each inflow and outflow; and
    (ii) The net asset value of the private fund as of the end of the
reporting period covered by the quarterly statement.\92\
---------------------------------------------------------------------------

    \92\ Proposed rule 211(h)(1)-1.
---------------------------------------------------------------------------

    For similar reasons to those discussed above, the proposed rule
would require an adviser to prepare the statement of contributions and
distributions without the impact of any fund-level subscription
facilities. This would require an adviser to assume the private fund
called investor capital, rather than drawing down on fund-level
subscription facilities. To avoid double counting capital inflows, the
amount borrowed under the subscription facility generally should be
reflected as a capital inflow from investors and an equal dollar amount
of actual capital inflows from investors generally should not be
reflected on the statement.
    Realized and Unrealized Performance. The proposed rule also would
require an adviser to disclose a gross internal rate of return and
gross multiple of invested capital for the realized and unrealized
portions of the illiquid fund's portfolio, with the realized and
unrealized performance shown separately.
    The value of the unrealized portion of an illiquid fund's portfolio
typically is determined by the adviser and, given the lack of readily
available market values, can be challenging. For example, an adviser's
valuation policies and procedures for illiquid investments may rely on
models and unobservable inputs. This creates a conflict of interest
because the adviser is typically evaluated and, in certain cases,
compensated based on the fund's unrealized performance. Further,
investors often decide whether to invest in a successor fund based on
the predecessor fund's performance. These factors create an incentive
for the adviser to inflate the value of the unrealized portion of the
illiquid fund's portfolio. We believe highlighting the performance of
the fund's unrealized investments would assist investors in determining
whether the aggregate, fund-level performance measures present an
overly optimistic view of the fund's overall performance. For example,
if the performance of the unrealized portion of the fund's portfolio is
significantly higher than the performance of the realized portion, it
may imply that the adviser's valuations are overly optimistic or
otherwise do not reflect the values that can be realized in a
transaction or sale with an independent third party.
    The proposed rule would only require an adviser to disclose gross
performance measures for the realized and unrealized portions of the
illiquid fund's portfolio. We believe that calculating net figures
could involve complex and potentially subjective assumptions regarding
the allocation of fund-level fees, expenses, and adviser compensation
between the realized and unrealized portions of the portfolio.\93\ In
our view, such assumptions would likely diminish the benefits net
performance measures would provide.
---------------------------------------------------------------------------

    \93\ For example, an adviser would have to determine how to
allocate fund organizational expenses between the realized and
unrealized portions of the portfolio.
---------------------------------------------------------------------------

    We request comment on the following with respect to the proposed
illiquid fund performance requirement:
     Are the proposed performance metrics appropriate? Why or
why not? We recognize that advisers often utilize different performance
metrics for different funds. Should we add any other metrics to the
proposed rule? For example, should we require a public market
equivalent or variations of internal rate of return, such as a modified
internal rate of return that assumes cash flows are reinvested at
modest rates of return or otherwise incorporates a cost of capital
concept for funds that do not draw down all, or substantially all, of
investor capital at the time of investment? If so, should we prescribe
a benchmark for the cost of capital and reinvestment rates?
     The proposed rule would not distinguish among different
types of illiquid funds. Is our approach in this respect appropriate or
should we treat certain illiquid funds differently? If so, how should
we reflect that treatment?
     Are there additional guardrails we should add to the
proposed rule to achieve the policy goal of providing investors with
comparable performance information? If so, please explain. Are there
practices that advisers use or assumptions that advisers make, when
calculating performance that we should require, curtail, or otherwise
require advisers to disclose?
     Although some investors receive certain annual performance
information about a private fund if that fund is audited and
distributes financial statements prepared in accordance with U.S. GAAP,
we believe that the proposed rule's performance information would be
helpful for private fund investors because it would require performance
information to be reported at more frequent intervals in a standardized
manner. Do commenters agree? To the extent there are differences (e.g.,
the requirement that performance be computed without the impact of any
fund-level subscription facilities), would investors find this
confusing? Would disclosure regarding these differences help to
alleviate investor confusion?
     Would investor confusion or other concerns arise from
requiring performance information in the quarterly statement as
proposed?
     What, if any, burdens would be associated with this aspect
of the proposed rule? How can we minimize any associated burdens while
still achieving our goals?
     Are the proposed definitions appropriate and clear? If
not, how should we clarify the definitions?

Should we modify or eliminate any? Would additional definitions be
appropriate or useful? For example, should we define any of the terms
used in the definition of internal rate of return, such as ``net
present value'' or ``discount rate''? If so, what definitions should we
use?
     Are the definitions of gross IRR, gross MOIC, net IRR, and
net MOIC appropriate? Should we provide further guidance or specify
requirements in the proposed rule on how to calculate gross performance
or net performance? If so, what guidance or requirements? Should we
require advisers to adopt policies and procedures prescribing specific
methodologies for calculating gross performance and net performance?
Why or why not? When calculating net performance, are there additional
fees and expenses that advisers should include? Alternatively, should
we expressly permit advisers to exclude certain fees and expenses when
calculating net performance figures, such as taxes incurred to
accommodate certain, but not all, investor preferences? Why or why not?
     Similarly, are the definitions of gross IRR and gross MOIC
appropriate for purposes of calculating the performance metrics of the
realized and unrealized portions of the illiquid fund's portfolio?
Should we modify such definitions to reference specifically the
realized and unrealized portions of the portfolio, rather than only
referencing the illiquid fund? For example, should the definition of
MOIC be revised to mean, as of the end of the applicable calendar
quarter: (i) The sum of (A) the unrealized value of applicable portion
of the illiquid fund's portfolio, and (b) the value of all
distributions made by the illiquid fund attributable to the applicable
portion of the illiquid fund's portfolio; (ii) divided by the total
capital contributed to the illiquid fund by its investors attributable
to the applicable portion of the illiquid fund's portfolio? Are there
other variations we should impose? Why or why not?
     The Global Investment Performance Standards (``GIPS'') are
a set of voluntary standards for calculating and presenting investment
performance. For purposes of calculating an illiquid fund's performance
under the proposed rule, are there any elements found in the GIPS
standards that we should require? For example, should we require
advisers to disclose composite cumulative committed capital,\94\ or
should we require advisers to disclose performance with and without the
impact of subscription facilities? Are there any definitions we should
revise or propose to be consistent with the definitions used in the
GIPS standards? For example, the GIPS standards define ``internal rate
of return'' as the return for a period that reflects the change in
value and the timing and size of external cash flows and ``multiple of
invested capital'' as the total value divided by since inception paid-
in capital.\95\ If we were to adopt such definitions, do commenters
believe that such definitions would result in different performance
numbers for illiquid funds, as compared to the performance numbers that
advisers would disclose under the proposed definitions? Why or why not?
Please provide examples.
---------------------------------------------------------------------------

    \94\ The GIPS standards define ``committed capital'' as pledges
of capital to an investment vehicle by investors (limited partners
and the general partner) or the firm. The term ``composite'' is
defined as an aggregation of one or more portfolios that are managed
according to a similar investment mandate, objective, or strategy.
The term cumulative is not defined in the GIPS standards. Global
Investment Performance Standards (GIPS) For Firms: Glossary, CFA
Institute (2020), available at https://www.cfainstitute.org/-/media/documents/code/gips/2020-gips-standards-firms.pdf.
    \95\ Internal rate of return is referred to as money-weighted
return in the GIPS standards, and multiple of invested capital is
referred to as investment multiple.
---------------------------------------------------------------------------

     We recognize that advisers and their related persons
typically invest in private funds on a ``fee-free, carry-free'' basis
(i.e., they are not required to pay management fees or performance-
based compensation). When calculating a fund's performance, how should
such interests be taken into account? Should we require advisers to
exclude such interests from the calculations, especially the net
performance figures?
     The proposed rule would require advisers to calculate the
various performance measures without the impact of any fund-level
subscription facilities. Do commenters agree with this approach? Should
the proposed rule require advisers to provide the same performance
measures with the impact of fund-level subscription facilities? Why or
why not? The proposed rule does not prohibit advisers from providing
the same performance measures with the impact of fund-level
subscription facilities. Should we prohibit advisers from doing so?
     Should we define the term ``computed without the impact of
any fund-level subscription facilities''? Should we provide additional
guidance or requirements regarding how advisers generally should or
must calculate such performance measures? If so, what guidance or
requirements should we provide?
     We recognize that a fund-level subscription facility has
the potential to have a greater impact on a fund's internal rate of
return as compared to its multiple of invested capital. Should advisers
only be required to provide ``unlevered'' internal rates of return and
not ``unlevered'' multiples of invested capital? If the fund realizes
an investment prior to calling any capital from investors in respect of
such investment, how would an adviser calculate a multiple for such
investment?
     The proposed rule would require advisers to prepare the
statement of contributions and distributions without the impact of any
fund-level subscription facilities. Would this information be helpful
for investors? Would advisers be able to prepare such a statement
without making arbitrary assumptions? Why or why not? For example,
would advisers need to make assumptions in calculating the preferred
return (if applicable)?
     The proposed rule would require only gross performance
measures for the realized and unrealized portion of the illiquid fund's
portfolio. Should the proposed rule require net performance information
as well? Would net performance measures be beneficial for investors
despite the drawbacks discussed above? What assumptions should we
require in calculating net information? What limitations, if any, would
advisers face in providing net performance measures?
     Should we define the phrases ``unrealized portion of the
illiquid fund's portfolio'' and ``realized portion of the illiquid
fund's portfolio''? For example, should we define the realized portion
to include not only completely realized investments but also
substantially realized investments to the extent the fund's remaining
interest is de minimis? Why or why not?
     Should we require advisers to disclose the dollar amounts
of the realized and unrealized portions of the portfolio? Should we
also require advisers to disclose such amounts as percentages? For
example, if the value of the realized portion of the portfolio is $250
million and the value of the unrealized portion is $750 million, should
we require advisers to disclose those amounts, both as dollar values
and percentages (i.e., 25% ($250 million) of the illiquid fund's
portfolio is realized, and 75% ($750 million) remains unrealized)?
     The proposed rule would require advisers to provide
cumulative performance reporting since inception of the illiquid fund
each quarter. Is this the right approach? Should the proposed rule
require performance since inception for each quarter or on an

annual basis? Should the proposed rule remove the ``since inception''
requirement for quarterly reports and instead require performance for
each quarter of the current year, and cumulative performance for the
current year? If so, why or why not?
     Should we prescribe specific periods for illiquid fund
performance reporting? For example, should we prescribe one-, five-,
and/or ten-year time periods? Instead, should we require that advisers
always present performance since inception as proposed? Are there other
periods for which we should require the presentation of performance
results? Are there any specific compliance issues that an adviser would
face in generating and presenting performance results for the required
period? For example, would advisers have the requisite information to
generate or support performance figures for older funds from the
proposed recordkeeping requirements and/or performance presentation
requirements? If not, should we provide an exemption for advisers that
lack such information?
     Liquid funds often have longer terms than illiquid funds.
To the extent an illiquid fund has been in existence for an extended
period of time, such as more than ten years, should the rule prescribe
specific periods for performance reporting for such funds (e.g., one-,
five-, and/or ten-year time periods)?
     Should we require that advisers provide performance
results current through the end of the quarter covered by the quarterly
statement as proposed? In circumstances where quarter-end numbers are
not available at the time of distribution of the quarterly statement,
should we require an adviser to include performance measures through
the most recent practicable date as proposed? Should we define, or
provide additional guidance about, the term ``most recent practicable
date''? If so, what definition or additional guidance should we
provide?
     Should the proposed rule require advisers to make certain,
standard disclosures tailored to each of the performance metrics
mandated in the proposed rule? For example, should we require advisers
to illiquid funds that are required to display internal rate of return
to disclose prominently that the returns do not represent returns on
the investor's capital commitment and instead only reflect returns on
the investor's contributed capital? Should we require advisers to
disclose that an investor's actual return on its capital commitment
will depend on how the investor invests its uncalled commitments?
     As noted above, we would generally interpret the phrase
computed without the impact of fund-level subscription facilities to
require advisers to exclude fees and expenses associated with the
subscription facility, such as the interest expense, when calculating
net performance figures and preparing the statement of contributions
and distributions. Do commenters agree with this approach? Should we
require advisers to include such amounts instead? Are there other
assumptions advisers would need to make in calculating performance
information that the rule should address?
     The proposed rule would require the statement of
contributions and distributions to reflect the private fund's net asset
value as of the end of the applicable quarter. Should we require
advisers to provide additional detail regarding the unrealized value of
the private fund? For example, should we require advisers to reflect
the portion of such net asset value that would be required to be paid
to the adviser as performance-based compensation assuming a
hypothetical liquidation of the fund?
     The statement of contributions and distributions generally
reflects aggregate, fund-level numbers. Should we also require a
statement of contributions and distributions for each underlying
investment? Would a statement of each investment's cash flows be useful
to investors? Why or why not? Would such a requirement be too
burdensome for certain advisers, especially advisers to private funds
that have a significant number of investments? Should this requirement
only apply to certain types of funds, such as private equity, venture
capital, or other similar funds that may invest in operating companies?
     Should we provide further guidance or specify requirements
on how advisers generally should or must present performance? For
example, should we require advisers to present the various performance
metrics with equal prominence as proposed? Should we require advisers
to present performance information in a format designed to facilitate
comparison? Should we provide additional guidance or requirements
regarding how an adviser should or must calculate the proposed
performance metrics? Is there additional information that we should
require advisers to disclose when presenting performance?
     Should we provide further guidance or specify requirements
in the rule on how advisers generally should or must treat taxes for
purposes of calculating performance? For example, should the rule state
that advisers may exclude taxes paid or withheld with respect to a
particular investor or by a blocker corporation (but not the illiquid
fund as a whole)?
c. Prominent Disclosure of Performance Calculation Information
    The proposed rule would require advisers to include prominent
disclosure of the criteria used and assumptions made in calculating the
performance. Information about the criteria used and assumptions made
would enable the private fund investor to understand how the
performance was calculated and help provide useful context for the
presented performance metrics. Additionally, while the proposed rule
includes detailed information about the type of performance an adviser
must present for liquid and illiquid funds, it is still possible that
advisers would make certain assumptions or rely on specific criteria
that the proposed rule's requirements do not address specifically.
    For example, the proposed rule would require an adviser to display,
for a liquid fund, the annual returns for each calendar year since the
fund's inception. If the adviser made any assumptions in performing
that calculation, such as whether dividends were reinvested, the
adviser should disclose those assumptions in the quarterly statement.
As another example, for an illiquid fund, the proposed rule would
require an adviser to display the net internal rate of return and net
multiple of invested capital. In this case, the adviser should disclose
the assumed fee rates, including whether the adviser is using fee rates
set forth in the fund documents, whether it is using a blended rate or
weighted average that would factor in any discounts, or whether it is
using a different method for calculating net performance. The proposed
rule requires the disclosure to be within the quarterly statement.\96\
Thus, an adviser may not provide the information only in a separate
document, website hyperlink or QR code, or other separate
disclosure.\97\ We believe that this information is integral to the
quarterly statement because it would enable the investor to understand
and analyze the performance information better and better compare the
performance of funds and advisers

without having to access other ancillary documents. As a result,
investors should receive it as part of the quarterly statement itself.
---------------------------------------------------------------------------

    \96\ Proposed rule 211(h)(1)-2(e)(2)(iii).
    \97\ See also Marketing Release, supra at footnote 61
(discussing clear and prominent disclosures in the context of
advertisements).
---------------------------------------------------------------------------

    We request comment on this aspect of the proposal:
     Should we require advisers to disclose the criteria used
and assumptions made in calculating the performance as part of the
quarterly statement as proposed? Is this approach too flexible? Should
we instead prescribe required disclosures?
     Should we require advisers to provide these disclosures
prominently as proposed? Is there another disclosure standard we should
use for these purposes?
     Because we propose to require an adviser to provide these
disclosures as part of each quarterly statement, investors would
receive these disclosures quarterly. Would providing these disclosures
every quarter reduce their salience? Should we require these
disclosures only as part of the first quarterly statement that an
adviser sends to an investor with amendments if the criteria used or
assumptions made in calculating performance change? Should we permit
hyperlinking to these disclosures after the initial quarterly
statement?
3. Preparation and Distribution of Quarterly Statements
    The proposed rule would require quarterly statements to be prepared
and distributed to fund investors within 45 days after each calendar
quarter end. We believe quarterly statements would provide fund
investors with timely and regular statements that contain meaningful
and comprehensive information. We understand that most private fund
advisers currently provide investors with quarterly reporting.\98\
---------------------------------------------------------------------------

    \98\ See also ILPA Fee Reporting Template Guidance, Version 1.1
(Oct. 2016), at 6 (stating that ``ILPA recommends that the Template
is provided on a quarterly basis within a reasonable timeframe after
the release of standard reports.'').
---------------------------------------------------------------------------

    For a newly formed private fund, the proposed rule would require a
quarterly statement to be prepared and distributed beginning after the
fund's second full calendar quarter of generating operating results.
Many private funds may not have performance information that is readily
available within the first several months of operations. For example, a
private equity fund might not begin investing until several months
after the fund's formation because the adviser is still identifying
investments that align with the fund's strategy. As another example, a
hedge fund may hold initial investor capital in cash or cash
equivalents, prior to commencing the fund's investment strategy.
Accordingly, we believe that the proposed requirements for newly formed
funds would help ensure that investors receive comprehensive
information about the adviser during the early stage of the fund's
life. The reporting period for the final quarterly statement would
cover the calendar quarter in which the fund is wound up and dissolved.
    We propose to require quarterly statements to be distributed within
45 days after the calendar quarter end. Based on our experience, we
believe advisers generally would be in a position to prepare and
deliver quarterly statements within this period.
    An adviser generally would satisfy the proposed requirement to
``distribute'' the quarterly statements when the statements are sent to
all investors in the private fund.\99\ However, the proposed rule would
preclude advisers from using layers of pooled investment vehicles in a
control relationship with the adviser to avoid meaningful application
of the distribution requirement. Advisers to private funds may from
time to time establish special purpose vehicles (``SPVs'') or other
pooled vehicles for a variety of reasons, including facilitating
investments by one or more private funds that the advisers manage. In
circumstances where an investor is itself a pooled vehicle that is
controlling, controlled by, or under common control with the adviser or
its related persons (a ``control relationship''), the adviser must look
through that pool (and any pools in a control relationship with the
adviser or its related persons, such as in a master-feeder fund
structure), in order to send to investors in those pools. Without such
a requirement, the adviser would be essentially delivering the
quarterly statement to itself rather than to the parties the quarterly
statement is designed to inform.\100\ Outside of a control
relationship, such as if the private fund investor is an unaffiliated
fund of funds, this same concern is not present, and the adviser would
not need to look through the structure to make meaningful delivery. The
adviser would just distribute the quarterly statement to the adviser or
other designated party of the unaffiliated fund of funds. We believe
that this approach would lead to meaningful delivery of the quarterly
statement to the private fund's investors.
---------------------------------------------------------------------------

    \99\ See proposed rule 211(h)(1)-1 (defining ``distribute'').
For purposes of the proposed rules, any ``in writing'' requirement
could be satisfied either through paper or electronic means
consistent with existing Commission guidance on electronic delivery
of documents. See Marketing Release, supra footnote 61, at n.346. If
any distribution is made electronically for purposes of these
proposed rules, it should be done in accordance with the
Commission's guidance regarding electronic delivery. See Use of
Electronic Media by Broker Dealers, Transfer Agents, and Investment
Advisers for Delivery of Information; Additional Examples Under the
Securities Act of 1933, Securities Exchange Act of 1934, and
Investment Company Act of 1940, Release No. 34-37182 (May 9, 1996)
[61 FR 24644 (May 15, 1996)].
    \100\ See proposed rule 211(h)(1)-1 (defining ``control'').
---------------------------------------------------------------------------

    We request comment on the quarterly statement preparation and
distribution requirement of the proposed rule:
     Should we require advisers to prepare and distribute
statements to clients at least quarterly, or should we prescribe a
different frequency? For example, should we require monthly, semi-
annual, or annual statements? Should we mandate the same delivery
frequency for all proposed statements under the rule? How would each of
these approaches affect comparability and effectiveness of the
information in those statements? Would a quarterly reporting obligation
require advisers to value the fund's investments more frequently than
advisers currently do?
     We understand that advisers may use a fund administrator
or another person to distribute the quarterly statement. Is the
proposed definition of ``distribute'' broad enough to capture a fund
administrator or another person acting under the direction and control
of the adviser sending the quarterly statement on the adviser's behalf?
If not, should we broaden the definition? Instead of changing the
definition of ``distribute,'' should we require the adviser to
distribute the quarterly statement, unless it has reason to believe
that another person has distributed a required statement (and has a
copy of each such statement distributed by such other person)?
     The proposed rule would require advisers to distribute the
quarterly statement within 45 days of a calendar quarter end. Is this
period too long or too short for an adviser to prepare the quarterly
statement while also ensuring timely delivery to investors? Should we
instead adopt a flexible delivery standard, such as a requirement that
the adviser distribute the quarterly statement ``promptly''? Why or why
not? If we were to adopt a prompt delivery standard, should we define
``promptly''? If so, how? If we should not define ``promptly,'' should
we instead interpret that term to mean as soon as reasonably
practicable?
     We understand that preparing quarterly statements may
require coordination with, and reliance on, third parties. This may be
the case, for example, when a private fund itself invests in other
private funds or

portfolio companies. Should the rule allow different distribution
timelines for different types of private funds (e.g., fund of funds,
master feeder funds)? If so, why (e.g., do certain types of funds value
assets more frequently than other types)? Should the proposed rule
allow different distribution deadlines for underlying funds, depending
on whether or not the underlying funds have the same adviser or an
adviser that is a related person of the adviser distributing the
quarterly statements?
     Should the proposed rule bifurcate the timing of when
certain information in the quarterly statement is required? For
example, should the proposed rule require fee and expense information
starting at the fund's inception and then require performance
information beginning later? If so, when should we require an adviser
to start showing performance?
     Should the proposed rule treat liquid and illiquid funds
differently with regard to fee and expense versus performance
reporting? For example, should the proposed rule require liquid funds
to start distributing quarterly statements with performance reporting
sooner than illiquid funds? If so, why and how much sooner?
     As proposed, the rule would use ``operating results'' as
the trigger for quarterly statement distribution. Should we instead
rely on another trigger to indicate when an adviser must start
distributing quarterly statements to investors? For example, should the
proposed rule instead require an adviser to start distributing
quarterly statements when the private fund has financial statements
that report operating results? If so, why? Should we define ``operating
results'' or clarify what it means?
     Should the proposed rule require an adviser to prepare and
distribute an initial quarterly statement sooner than after the first
two full calendar quarters of operating results? For example, should we
require an adviser to prepare and distribute a quarterly statement
after the first calendar quarter of the fund's operations? Why or why
not? If we required an adviser to prepare and distribute a quarterly
statement earlier in the fund's life, would this information be useful
to investors?
     The proposed rule would require advisers to prepare and
distribute a quarterly statement after the private fund has two full
calendar quarters of operating results and continuously each calendar
quarter thereafter. An adviser would be required to provide information
for any stub periods that precede its first two full calendar quarters
of operating results (i.e., from the date of the fund's inception to
the beginning of the first calendar quarter during which the fund
begins to produce operating results). Should the proposed rule
explicitly address how advisers should handle stub periods? If so, how?
     The proposed rule would require fee and expense reporting
based on a fund's calendar quarter and performance reporting based on a
liquid fund's calendar year. Should we instead use ``fiscal quarter''
and ``fiscal year''? Why or why not?
     Are there certain types of advisers or funds that should
be exempt from distributing the quarterly statement to investors? If
so, which ones and why? Are there certain types of advisers or funds
that should be required to distribute quarterly statements to
investors? If so, which ones and why?
     Instead of requiring advisers to distribute the quarterly
statement to investors, should we require advisers to only distribute
or make the quarterly statement available to investors upon request?
Despite the limitations of private fund governance mechanisms, as
discussed above, should we require advisers to distribute the quarterly
statement to independent members of the fund's LPAC, board, or other
similar governance body?
     Rule 206(4)-2 under the Advisers Act (the ``custody
rule'') allows a client to designate an independent representative to
receive on its behalf account statements and notices that are required
by that rule.\101\ Under the custody rule, an ``independent
representative'' is defined as someone who does not control, is not
controlled by, and is not under common control with the adviser, among
other requirements.\102\ Should we adopt a similar provision in the
quarterly statement rule? Are there specific types of investors that
need, or at present commonly designate, independent representatives to
receive quarterly statements on their behalf?
---------------------------------------------------------------------------

    \101\ See rule 206(4)-2(a)(7) under the Advisers Act.
    \102\ See rule 206(4)-2(d)(4) under the Advisers Act.
---------------------------------------------------------------------------

     Should we revise the definition of ``distribute''
expressly to include distribution by granting investors access to a
virtual data room containing the quarterly statement? Why or why not?
     We considered requiring the proposed quarterly statement
disclosures to be submitted using a structured, machine-readable data
language. Such format may facilitate comparisons of quarterly statement
disclosures across advisers and periods. Should we require advisers to
provide quarterly statements in a machine-readable data language, such
as Inline eXtensible Business Reporting Language (``Inline XBRL'')? Why
or why not? Would such a requirement make the quarterly statements, and
the information included therein, easier for investors to analyze? For
example, would it be useful for investors to download quarterly
statement information directly into spreadsheets, particularly for
institutional investors that may have a significant number of private
fund investments? Would a machine-readable data language impose undue
additional costs and burdens on advisers? Please provide support for
your response, including, where available, cost data.
     If we adopt rules requiring a machine-readable data
language, is the Inline XBRL standard the one that we should use? Are
any other standards becoming more widely used or otherwise superior to
Inline XBRL? What would the advantages of any such other standards be
over Inline XBRL?
4. Consolidated Reporting for Certain Fund Structures
    An adviser may form multiple funds to implement a single strategy.
For example, an adviser may form a parallel fund for certain tax-
sensitive investors, such as non-U.S. investors that prefer to invest
through an entity taxed as a corporation--rather than a partnership--
for U.S. Federal income tax purposes, that invests alongside the main
fund in all, or substantially all, of its investments. An adviser may
also form a feeder fund for tax-sensitive investors that invests all,
or substantially all, of its capital into the main fund. Advisers often
seek to structure the funds in a way that accommodates investor
preferences.
    In some of these circumstances, we believe that consolidated
reporting of the cost and performance information by all private funds
in the structure would provide a more complete and accurate picture of
the fees and expenses borne and performance achieved than reporting by
each private fund separately. Due to the complexity of private fund
structures, however, we believe a principles-based approach to the
funds that must provide consolidated reporting is necessary.
Accordingly, the proposed rule would require advisers to consolidate
reporting for substantially similar pools of assets to the extent doing
so would provide more meaningful information to the

private fund's investors and would not be misleading.\103\
---------------------------------------------------------------------------

    \103\ See proposed rule 211(h)(1)-2(f). See also infra Section
II.E.
---------------------------------------------------------------------------

    For example, certain private funds utilize master-feeder
structures. Typically, investors invest in onshore and offshore feeder
funds, which, in turn, invest all, or substantially all, of their
investable capital in a single master fund. The same adviser typically
advises and controls all three funds, and the master fund typically
makes and holds the investments. Because the feeder funds are conduits
for investors to gain exposure to the master fund and its investments,
the proposed rule would require the adviser to provide feeder fund
investors with a single quarterly statement covering the applicable
feeder fund and the feeder fund's proportionate interest in the master
fund on a consolidated basis, so long as the consolidated statement
would provide more meaningful information to investors and would not be
misleading.
    We request comment on the proposed consolidated reporting provision
of the proposed rule:
     Do commenters agree that the proposed rule should require
advisers to consolidate reporting to cover related funds to the extent
doing so would provide more meaningful information to investors and
would not be misleading? Alternatively, should we prohibit advisers
from consolidating information for multiple funds? Why or why not?
Should the rule permit, rather than require, consolidated reporting?
     Should we require advisers to provide a consolidated
quarterly statement for funds that are part of the same strategy, such
as parallel funds, feeder funds, and master funds? Alternatively,
should these types of funds have separate reporting? For example,
should feeder fund investors receive a quarterly statement covering the
feeder fund and a separate quarterly statement covering the main fund
or master fund? How should the rule address the fact that certain funds
may have different expenses (e.g., an offshore fund may have director
expenses while an onshore fund may not)? Should we require advisers to
provide investors with a summary of any fund-specific expenses and the
corresponding dollar amount(s)? Should such a requirement be triggered
only if the fund-specific expense exceeds a certain threshold, such as
a percentage of the fund size (e.g., .01%, .05%, or .10% of the fund's
size) or a specific dollar amount (e.g., $15,000, $30,000, or $50,000)?
     As noted above, the proposal would require advisers to
provide feeder fund investors with a consolidated quarterly statement
covering the applicable feeder fund and the feeder fund's proportionate
interest in the master fund, to the extent doing so would provide more
meaningful information to investors and would not be misleading. Do
commenters agree with this approach? Alternatively, should we require
advisers to provide consolidated reporting covering all feeder funds
(and not just the applicable feeder fund) and the master fund? Why or
why not?
     We also recognize that certain private funds have multiple
classes (or other groupings such as series or tranches) of interests or
shares. The proposed rule would require the quarterly statement to
present fund-wide information. Would advisers face challenges in
calculating fee, expense, and performance information if there are
differences in fees, allocations, and/or expenses between or among
classes, series, or tranches? Should we require disclosure of class-
specific fees and expenses, or of the differences among classes? Why or
why not? Should we instead permit or require quarterly statements for
multi-class private funds to present the proposed fee and expense and
performance information on a class-by-class basis, particularly if each
class (or series or tranche) is considered a distinct private fund or
separate legal entity (with segregated assets and liabilities) under
applicable law? Would such an approach provide more meaningful
information for investors in each of those classes, given the potential
for different fee, allocation, and expense structures? Should we
require quarterly statements for multi-class (or multi-series or multi-
tranche) private funds to present class-by-class (or series-by-series
or tranche-by-tranche) information to the extent each class (or series
or tranche) holds different investments?
     Should advisers only be required to distribute a class'
quarterly statement to interest holders of such class, or should all
fund investors be entitled to receive such statement regardless of
whether they are interest holders of the relevant class if the rule
permits or requires class-specific quarterly statements for multi-class
private funds?
     Certain advisers provide combined financial statements
covering multiple funds. Should we require or permit advisers to
provide consolidated quarterly statements for funds that have combined
financial statements? Why or why not?
5. Format and Content Requirements
    The proposed rule would require the adviser to use clear, concise,
plain English in the quarterly statement.\104\ For example, an adviser
would not satisfy the proposed requirement for ``clear'' disclosures
unless those disclosures are made in a font size and type that is
legible, and margins and paper size (if applicable) are reasonable.
Likewise, to meet this standard, any information that an adviser
chooses to include in a quarterly statement, but that is not required
by the rule, would be required to be as short as practicable, not more
prominent than the required information, and not obscure or impede an
investor's understanding of the mandatory information.
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    \104\ Proposed rule 211(h)(1)-2(g).
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    In addition, the proposed rule would require an adviser to present
information in the quarterly statement in a format that facilitates
review from one quarterly statement to the next. As noted above, the
quarterly statement is designed to allow an investor to monitor and
assess the costs and performance of the fund over time. We anticipate
that, quarter-over-quarter, an adviser would use a consistent format
for a fund's quarterly statements, thus allowing an investor to easily
compare fees, expenses, and performance over each quarterly period. We
also encourage advisers to use a structured, machine-readable format if
advisers believe this format would be useful to the investors in their
fund.
    The proposed format and content requirements would apply to all
aspects of a quarterly statement, including the proposed requirements
to disclose the manner in which expenses, payments, allocations,
rebates, waivers, and offsets are calculated and to cross-reference
sections of the private fund's organizational and offering
documents.\105\ We believe this approach would improve the utility of
the quarterly statement by making it easier for investors to review and
analyze. These requirements would support an investor's ability to
understand needed context provided in the quarterly statement regarding
fees, expenses, and performance that allows investors to monitor their
investments. For example, providing investors with clear and easily
accessible cross-references to the fund governing documents would make
it easier for the investor to monitor whether the fees and expenses in
the quarterly statement comply with the fund's governing documents.
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    \105\ Proposed rule 211(h)(1)-2(d).
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    We believe the proposal strikes an appropriate balance in
prescribing the

content of the tables and performance information to be included in
quarterly statements while taking a fairly principles-based approach to
format. This would help provide investors with standardized information
about their private fund investments, while affording advisers some
flexibility to present the required information without being overly
prescriptive or sacrificing readability. We considered, but are not
proposing, to further standardize format, because we recognize this
might result in investor confusion if an adviser includes inapplicable
line items to satisfy our form requirements, while omitting additional
relevant information that might be unique to a particular fund.
Moreover, we were concerned that advisers would be unable to report on
a consolidated basis if we further prescribed the format of the
statements.
    We request comment on this aspect of the proposed rule:
     Should the proposed quarterly statement rule include a
provision on formatting and content? Why or why not?
     Do commenters agree with the flexibility of the proposed
format and content requirements, or should we prescribe wording? For
example, should we require a cover page with prescribed wording? If so,
what prescribed wording should we require?
     To meet the rule's formatting requirements, any
information that an adviser chooses to include in a quarterly
statement, but that is not required by the rule, would be required to
be presented in a manner that is no more prominent than the required
information. Should the rule, instead, require that advisers more
prominently present information that is required by the proposed
quarterly statement rule (as opposed to supplemental information that
is merely permitted)? If an adviser chooses to include supplemental
information, should we require that adviser to disclose what
information in the quarterly statement is required versus that which is
voluntary?
6. Recordkeeping for Quarterly Statements
    We propose amending rule 204-2 (the ``books and records rule'')
under the Advisers Act to require advisers to retain books and records
related to the proposed quarterly statement rule.\106\ These proposed
amendments would help facilitate the Commission's inspection and
enforcement capabilities. First, we propose to require private fund
advisers to retain a copy of any quarterly statement distributed to
fund investors pursuant to the proposed quarterly statement rule, as
well as a record of each addressee, the date(s) the statement was sent,
address(es), and delivery method(s). Second, we propose to require
advisers to retain all records evidencing the calculation method for
all expenses, payments, allocations, rebates, offsets, waivers, and
performance listed on any quarterly statement delivered pursuant to the
proposed quarterly statement rule. Third, advisers would be required to
make and keep books and records substantiating the adviser's
determination that the private fund it manages is a liquid fund or an
illiquid fund pursuant to the proposed quarterly statement rule. We
believe these proposed requirements would facilitate our staff's
ability to assess an adviser's compliance with the proposed rule and
would similarly enhance an adviser's compliance efforts.\107\
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    \106\ For all of the recordkeeping rule amendments in this
proposed rulemaking package, advisers would be required to maintain
and preserve the record in an easily accessible place for a period
of not less than five years from the end of the fiscal year during
which the last entry was made on such record, the first two years in
an appropriate office of the investment adviser. See rule 204-
2(e)(1) under the Advisers Act.
    \107\ Advisers already are required to retain performance
calculation information under the existing books and records rule
and therefore would be required to retain the performance
calculation information required as part of the proposed quarterly
statement rule. See rule 204-2(a)(16) under the Advisers Act
(requiring advisers to retain performance calculation information).
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    We request comment on the proposed recordkeeping rule amendments:
     Should we require advisers to maintain the proposed
records or would these requirements be overly burdensome for advisers?
Are there alternative or additional recordkeeping requirements we
should impose?
     Should we require advisers to retain a record of each
addressee, the date(s) the statement was sent, address(es), and
delivery method(s) for each quarterly statement, as proposed? Should we
instead eliminate this requirement because of the potential burdens?
     Should we provide more specific requirements regarding the
records an adviser must maintain to substantiate its determination that
a private fund is a liquid fund or an illiquid fund? Alternatively,
should we leave the proposed rule as is and allow advisers flexibility
in how they document this determination?
B. Mandatory Private Fund Adviser Audits
    In addition to disclosure, we propose to require private fund
advisers to obtain an annual audit of the financial statements of the
private funds they manage.\108\ In addition to providing protection for
the fund and its investors against the misappropriation of fund assets,
we believe an audit by an independent public accountant 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.
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    \108\ Proposed rule 206(4)-10. The proposed rule would apply to
all investment advisers registered, or required to be registered,
with the Commission.
---------------------------------------------------------------------------

    The proposed audit rule would require a registered investment
adviser providing investment advice, directly or indirectly, to a
private fund, to cause that fund to undergo a financial statement audit
that meets the terms of the rule at least annually and upon
liquidation, unless the fund otherwise undergoes such an audit. Under
the proposed rule:
    (1) The audit must be performed by an independent public accountant
that meets the standards of independence in 17 CFR 210.2-01(b) and (c)
(rule 2-01(b) and (c) of Regulation S-X) that is registered with, and
subject to regular inspection as of the commencement of the
professional engagement period, and as of each calendar year-end, by,
the Public Company Accounting Oversight Board (``PCAOB'') in accordance
with its rules;
    (2) The audit must meet the definition of audit in 17 CFR 210.1-
02(d) (rule 1-02(d) of Regulation S-X), the professional engagement
period of which shall begin and end as indicated in Regulation S-X rule
2-01(f)(5);
    (3) Audited financial statements must be prepared in accordance
with U.S. Generally Accepted Accounting Principles (``U.S. GAAP'') or,
in the case of financial statements of private funds organized under
non-U.S. law or that have a general partner or other manager with a
principal place of business outside the United States (``foreign
private funds''), must contain information substantially similar to
statements prepared in accordance with U.S. GAAP and material
differences with U.S. GAAP must be reconciled;
    (4) Promptly after completion of the audit, the private fund's
audited financial statements, which include any reconciliation to U.S.
GAAP prepared for a foreign private fund, are distributed; and
    (5) The auditor notifies the Commission upon certain events.\109\
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    \109\ Proposed rule 206(4)-10; proposed rule 211(h)(1)-1
(defining ``control'' and ``distributed'').
---------------------------------------------------------------------------

    Additionally, for a fund that the adviser does not control and that
is neither controlled by nor under

common control with the adviser (e.g., where an unaffiliated sub-
adviser provides services to the fund), such adviser would only need to
take all reasonable steps to cause the fund to undergo an audit that
would meet these elements.
    We have historically relied on financial statement audits to verify
the existence of pooled investment vehicle investments.\110\ Financial
statement audits also provide additional meaningful protections to
private fund investors by increasing the likelihood that fraudulent
activity or problems with valuation are uncovered, thereby providing
deterrence against fraudulent conduct by fund advisers. For example as
noted above, a fund's adviser may use a high level of discretion and
subjectivity in valuing a private fund's illiquid investments, which
are difficult to value. This creates a conflict of interest if the
adviser also calculates its fees as a percentage of the value of the
fund's investments and/or an increase in that value (net profit), as is
typically the case. Moreover, private fund advisers often rely heavily
on existing fund performance when obtaining new investors (in the case
of a private fund that makes continuous or periodic offerings) or
fundraising for a new fund. These factors raise the possibility that
funds are valued opportunistically and that the adviser's compensation
may involve fraud or deception, resulting in an inappropriate
compensation scheme.\111\ A fund audit includes the evaluation of
whether the fair value estimates and related disclosures are reasonable
and consistent with the requirements of the financial reporting
framework (e.g., U.S. GAAP), which may include evaluating the selection
and application of methods, significant assumptions, and data used by
the adviser in making the estimate.\112\ We believe that this would
provide a critical set of additional protections by an independent
third party.
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    \110\ See, e.g., rule 206(4)-2(b)(4) under the Advisers Act;
Custody of Funds or Securities of Clients by Investment Advisers,
Investment Advisers Act Release No. 2176 (Sept. 25, 2003) [68 FR
56692 (Oct. 1, 2003)] (``Custody Release'') (providing advisers to
certain pooled investment vehicles with an exception to the surprise
examination requirement if the pooled investment vehicles undergo an
audit). Not all advisers are subject to the custody rule and even
those that are subject to the custody rule are not required to
obtain an audit in order to comply with the rule.
    \111\ See generally Jenkinson, Sousa, Stucke, How Fair are the
Valuations of Private Equity Funds? (2013), available at https://www.psers.pa.gov/About/Investment/Documents/PPMAIRC%202018/27%20How%20Fair%20are%20the%20Valuations%20of%20Private%20Equity%20Funds.pdf. See also In the Matter of Swapnil Rege, Investment Advisers
Act Release No. 5303 (July 18, 2019) (settled action) (alleging that
an employee of a private fund adviser mispriced the private fund's
investments, which resulted in the adviser charging the fund excess
management fees); SEC v. Southridge Capital Mgmt., LLC, Lit. Rel.
No. 21709 (Oct. 25, 2010) (alleging that adviser overvalued the
largest position held by the funds by fraudulently misstating the
acquisition price of the assets); see docket for SEC v. Southridge
Capital Mgmt., LLC, U.S. District Court, District of Connecticut
(New Haven), case no. 3:10-CV-01685 (on September 12, 2016 the court
granted the SEC's motion for summary judgment and entered a final
judgment in favor of the SEC in 2018).
    \112\ See American Institute of Certified Public Accountants'
(``AICPA'') auditing standards, AU-C Section 540 and PCAOB auditing
standards, AS 2501.
---------------------------------------------------------------------------

    The proposed audit rule is based on the custody rule and contains
many similar or identical requirements, although compliance with either
rule would not automatically satisfy the requirements of the
other.\113\ Although the financial statement audit performed under
either rule would be the same, there are several differences between
the two rules. The most notable difference between the two rules is the
lack of choice about obtaining an audit under the proposed audit rule.
Under the custody rule, an adviser is deemed to have satisfied that
rule's annual surprise examination requirement for a pooled investment
vehicle client if that pool is subject to an annual financial statement
audit by an independent public accountant, and its audited financial
statements (prepared in accordance with generally accepted accounting
principles) are distributed to the pool's investors. Accordingly, an
adviser may obtain a surprise examination under the custody rule
instead of an audit. Private fund advisers complying with the proposed
audit rule would not have a similar choice; they must obtain an audit.
Based on our experience since introducing the custody rule's audit
provision, we have come to believe that audits provide substantial
benefits to private funds and their investors because audits test
assertions associated with the investment portfolio (e.g.,
completeness, existence, rights and obligations, valuation,
presentation). Audits may also provide a check against adviser
misrepresentations of performance, fees, and other information about
the fund. Accordingly, the proposed audit rule would require registered
private fund advisers, including those that currently opt to undergo a
surprise examination for custody rule compliance purposes, to have
their private fund clients undergo a financial statement audit.
---------------------------------------------------------------------------

    \113\ See rule 206(4)-2(b)(4) under the Advisers Act.
---------------------------------------------------------------------------

    Another main difference between the requirements of the two rules
is the requirement of the proposed rule for there to be a written
agreement between the adviser or the private fund and the auditor
pursuant to which the auditor would be required to notify our Division
of Examinations upon the auditor's termination or issuance of a
modified opinion.\114\ There is not a similar obligation under the
custody rule for an adviser that relies on the audit provision to
satisfy the surprise examination requirement. Our experience in
receiving similar information from accountants who perform surprise
examinations under the custody rule has led us to conclude that timely
receipt of this information--from an independent third party--would
more readily enable our staff to identify advisers potentially engaged
in harmful misconduct and who have other compliance issues.\115\ This
also would aid the Commission in its oversight of private fund
advisers.
---------------------------------------------------------------------------

    \114\ See proposed rule 206(4)-10(e). See AICPA auditing
standard, AU-C Section 705, which establishes three types of
modified opinions: A qualified opinion, an adverse opinion, and a
disclaimer of opinion.
    \115\ See rule 206(4)-2(a)(4)(iii) (requiring somewhat similar
information in the context of a surprise examination).
---------------------------------------------------------------------------

    The other main difference between the two rules, aside from timing
requirements for the distribution of audited financial statements under
the two rules discussed below, relates to their scope. While both rules
pertain to advisers that are registered or required to be registered
with us, the custody rule also contains exceptions from the surprise
examination requirement, which in turn make it unnecessary for an
adviser to rely on that rule's audit provision.\116\ In light of the
different policy goals of these two rules, we are not proposing a
parallel exception to the proposed audit rule. Moreover, in our
experience, private fund advisers generally do not often rely on these
exceptions. The proposed audit rule does, however, contain an exception
in certain contexts where the adviser takes all reasonable steps to
cause an audit, as described and for reasons discussed below, which
does not exist in the custody rule.
---------------------------------------------------------------------------

    \116\ See rule 206(4)-2(b)(3) and (6) (providing exceptions from
the surprise examination requirement for fee deduction and where the
adviser has custody solely because a related person has custody of a
client's funds or securities).
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1. Requirements for Accountants Performing Private Fund Audits
    The proposed audit rule would include certain requirements
regarding the accountant performing a private fund audit. First, we
propose to require an accountant performing a private fund audit to
meet the standards of

independence described in rule 2-01(b) and (c) of Regulation S-X in
support of the Commission's long-standing recognition that an audit by
an objective, impartial, and skilled professional contributes to both
investor protection and investor confidence.\117\ Second, the proposed
rule would require the independent public accountant performing the
audit to be registered with, and subject to regular inspection as of
the commencement of the professional engagement period, and as of each
calendar year-end, by, the PCAOB in accordance with its rules. Based on
our experience with the custody rule, we believe registration and the
periodic inspection of an independent public accountant's system of
quality control by the PCAOB provide investors with confidence in the
quality of the audits produced under the proposed rule.
---------------------------------------------------------------------------

    \117\ See Revision of the Commission's Auditor Independence
Requirements, Release No. 33-7919 (Nov. 21, 2000) [65 FR 76008 (Dec.
5, 2000)]. The custody rule requires all accountants performing
services to meet the standards of independence described in rule 2-
01(b) and (c) of Regulation S-X. See rule 206(4)-2(d)(3) under the
Advisers Act.
---------------------------------------------------------------------------

    We understand that this requirement may limit the pool of
accountants that are eligible to perform these services because only
those accountants that currently conduct public company issuer audits
are subject to regular inspection by the PCAOB. Most private funds,
however, are already undergoing a financial statement audit; therefore,
the increase in demand for these services may be limited.\118\
Nonetheless, the resulting competition for these services might
increase costs to investment advisers and investors.
---------------------------------------------------------------------------

    \118\ For example, more than 90 percent of the total number of
hedge funds and private equity funds currently undergo a financial
statement audit. See infra Section V.B.4.
---------------------------------------------------------------------------

    We understand that, as part of a temporary inspection program, the
PCAOB inspects accountants auditing brokers and dealers, and identifies
and addresses with these firms any significant issues in those
audits.\119\ Similar to the inspection program for issuer audits, we
believe that the temporary inspection program for broker-dealers
provides valuable oversight of these accountants, resulting in better
quality audits. Accordingly, we would consider an accountant's
compliance with the PCAOB's temporary inspection program for auditors
of brokers and dealers to satisfy the requirement for regular
inspection by the PCAOB under the proposed independent public
accountant engagements provision until the effective date of a
permanent program for the inspection of broker and dealer auditors that
is approved by the Commission.\120\
---------------------------------------------------------------------------

    \119\ See PCAOB Adopts Interim Inspection Program for Broker-
Dealer Audits and Broker and Dealer Funding Rules (June 14, 2011)
(``temporary inspection program''), available at https://pcaobus.org/News/Releases/Pages/06142011_OpenBoardMeeting.aspx. See
also Dodd-Frank Act Section 982.
    \120\ Our staff took a similar position and has had several
years to observe the impact on the availability of accountants to
perform services and the quality of services produced by these
accountants. See Robert Van Grover Esq., Seward & Kissel LLP, SEC
Staff No-Action Letter (Dec. 11, 2019) (extending the no-action
position taken in prior letters until the date that a PCAOB-adopted
permanent program, having been approved by the Commission, takes
effect).
---------------------------------------------------------------------------

    An independent public accounting firm would not be considered to be
``subject to regular inspection'' if it is included on the list of
firms that is headquartered or has an office in a foreign jurisdiction
that the PCAOB has determined it is unable to inspect or investigate
completely because of a position taken by one or more authorities in
that jurisdiction in accordance with PCAOB Rule 6100.\121\ We recognize
that there may be a limited number of PCAOB-registered and inspected
independent public accountants in certain foreign jurisdictions.
However, we do not believe that advisers would have significant
difficulty in finding an accountant that is eligible under the proposed
rule in most jurisdictions because many PCAOB-registered independent
public accountants who are subject to regular inspection currently have
practices in various jurisdictions, which may ameliorate concerns
regarding offshore availability.
---------------------------------------------------------------------------

    \121\ See, e.g., HFCAA Determination Report Pursuant to 15
U.S.C. 7214(i)(2)(A) and PCAOB Rule 6100 (Dec. 16. 2021), PCAOB
Release No. 104-HFCAA-2021-001, available at 104-hfcaa-2021-001.pdf
(azureedge.net) (publishing such list of firms as of December 2021).
---------------------------------------------------------------------------

2. Auditing Standards for Financial Statements
    Under the proposed audit rule, an audit must meet the definition in
rule 1-02(d) of Regulation S-X. Pursuant to that definition, financial
statement audits performed for purposes of the proposed audit rule
would generally be performed in accordance with the generally accepted
auditing standards of the United States (``U.S. GAAS'').\122\ U.S. GAAS
requires that an auditor evaluate and respond to the risk of material
misstatements of the financial statements due to fraud or error.\123\
Among other benefits of this standard, audits performed in accordance
with U.S. GAAS would help detect valuation irregularities or errors, as
well as an investment adviser's loss, misappropriation, or misuse of
client investments. The proposed rule would require the professional
engagement period of an audit performed under the rule to begin and end
as indicated in Regulation S-X rule 2-01(f)(5).\124\
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    \122\ Under the definition in rule 1-02(d) of Regulation S-X, an
``audit'' of an entity (such as a private fund) that is not an
issuer as defined in section 2(a)(7) of the Sarbanes-Oxley Act of
2007 means an audit performed in accordance with either the
generally accepted auditing standards of the United States (``U.S.
GAAS'') or the standards of the PCAOB. When conducting an audit of
financial statements in accordance with the standards of the PCAOB,
however, the auditor would also be required to conduct the audit in
accordance with U.S. GAAS because the audit would not be within the
jurisdiction of the PCAOB as defined by the Sarbanes-Oxley Act of
2002, as amended, (i.e., not an issuer, broker, or dealer). See
AICPA auditing standards, AU-C Section 700.46. We believe most
advisers would choose to perform the audit pursuant to U.S. GAAS
only rather than both standards, though it would be permissible
under the proposed audit rule to perform the audit pursuant to both
standards.
    \123\ See AICPA auditing standards, AU-C Section 240. Audits
performed under PCAOB standards provide similar benefits. See PCAOB
auditing standards, AS 2401, which discusses consideration of fraud
in a financial statement audit.
    \124\ Among other things, rule 2-01(f)(5) of Regulation S-X
indicates that the professional engagement period begins at the
earlier of when the accountant either signs an initial engagement
letter (or other agreement to review or audit a client's financial
statements) or begins audit, review, or attest procedures; and the
period ends when the audit client or the accountant notifies the
Commission that the client is no longer that accountant's audit
client.
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3. Preparation of Audited Financial Statements
    The proposed rule also generally would require the audited
financial statements to be prepared in accordance with U.S. GAAP.
Financial statements of private funds organized under non-U.S. law or
that have a general partner or other manager with a principal place of
business outside the United States would be required to contain
information substantially similar to statements prepared in accordance
with U.S. GAAP and any material differences would be required to be
reconciled to U.S. GAAP. Requiring that financial statements comply
with U.S. GAAP is designed to help investors receive consistent and
quality financial reporting on their investments from the fund's
adviser.
    Financial statements that are prepared in accordance with
accounting standards other than U.S. GAAP, would meet the requirements
of the proposed audit rule so long as they contain information
substantially similar to financial statements prepared in accordance
with U.S. GAAP, material differences with U.S. GAAP are reconciled, and
the reconciliation,

including supplementary U.S. GAAP disclosures, is distributed to
investors as part of the audited financial statements.\125\ We believe
that this approach would allow advisers flexibility to provide
investors with financial statements that are prepared in accordance
with applicable accounting standards. We believe a reconciliation to
U.S. GAAP is necessary for private fund audits because U.S. GAAP, has
industry specific accounting principles for certain pooled vehicles,
including private funds.\126\ As a result, there could be material
differences between other accounting standards and U.S. GAAP, for
example in the presentation of a trade/settlement date, schedule of
investments and financial highlights, that we would require to be
reconciled.
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    \125\ Proposed rule 206(4)-10(c) and (d). See also Custody
Release, supra footnote 110, at n.41 (stating that an adviser may
use such financial statements to qualify for the audit exception
from the custody rule with respect to pools that have a place of
organization outside the United States or a general partner or other
manager with a principal place of business outside the United
States, if such financial statements contain information that is
substantially similar to financial statements prepared in accordance
with U.S. GAAP and contain a footnote reconciling any material
variations between such comprehensive body of accounting standards
and U.S. GAAP).
    \126\ See U.S. GAAP ASC 946.
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4. Prompt Distribution of Audited Financial Statements
    The proposed audit rule would require a fund's audited financial
statements to be distributed to current investors ``promptly'' after
the completion of the audit.\127\ The audited financial statements
would consist of the applicable financial statements (including any
required reconciliation to U.S. GAAP, including supplementary U.S. GAAP
disclosures), related schedules, accompanying footnotes, and the audit
report. We considered but are not proposing to require the audited
financials to be distributed within 120 days of a private fund's fiscal
year end, similar to the approach under the custody rule. Based on our
experience administering the custody rule, we believe that a 120-day
time period is generally appropriate to allow the financial statements
of an entity to be audited and to provide investors with timely
information. We also understand, however, that preparing audited
financial statements for some arrangements, such as fund of funds
arrangements, may require reliance on third parties, which could cause
an adviser to fail to meet the 120-day timing requirements for
distributing audited financial statements regardless of actions it
takes to meet the requirements. We also recognize there may be times
when an adviser reasonably believes that a fund's audited financial
statements would be distributed within the required timeframe but fails
to have them distributed in time under certain unforeseeable
circumstances. For example, during the COVID-19 pandemic, some advisers
were unable to deliver audited financial statements in the timeframes
required under the custody rule due to logistical disruptions.
Accordingly, and in light of the fact that there is not an alternative
method by which to satisfy the proposed rule as there is under the
custody rule (i.e., undergo a surprise examination), we would require
the audited financial statements to be distributed ``promptly,'' rather
than pursuant to a specific deadline. This would provide some
flexibility without affecting investor protection.
---------------------------------------------------------------------------

    \127\ Proposed rule 206(4)-10(d).
---------------------------------------------------------------------------

    Under the proposed audit rule, the audited financial statements
(including any reconciliation to U.S. GAAP prepared for a foreign
private fund, as applicable) must be sent to all of the private fund's
investors. In circumstances where an investor is itself a pooled
vehicle that is in a control relationship with the adviser or its
related persons, it would be necessary to look through that pool (and
any pools in a control relationship with the adviser or its related
persons, such as in a master-feeder fund structure), in order to send
to investors in those pools.\128\ Without such a requirement, the
audited financial statements would essentially be delivered to the
adviser rather than to the parties the financial statements are
designed to inform. Outside of a control relationship, such as if the
private fund investor is an unaffiliated fund of funds, this same
concern is not present, and it would not be necessary to look through
the structure to make meaningful delivery. It would be sufficient to
distribute the audited financial statements to the adviser to, or other
designated party of, the unaffiliated fund of funds. We believe that
this approach would lead to meaningful delivery of the audited
financial statements to the private fund's investors.
---------------------------------------------------------------------------

    \128\ See proposed rule 211(h)(1)-1 (defining ``control'' and
``distribute'').
---------------------------------------------------------------------------

5. Annual Audit, Liquidation Audit, and Audit Period Lengths
    Key to the effectiveness of the audit in protecting investors is
timely and regular administration and distribution. Under the proposed
audit provision, an audit must be obtained at least annually and upon
an entity's liquidation. The liquidation audit would serve as the
annual audit for the fiscal year in which it occurs. Requiring the
audit on an annual basis and at liquidation would help alert investors
within months, rather than years, to any material misstatements
identified in the audit and would raise the likelihood of mitigating
losses or reducing exposure to other investor harms. Similarly, a
liquidation audit would help ensure the appropriate and prompt
accounting of the proceeds of a liquidation so that investors can take
timely steps to protect their rights at a time when they may be
vulnerable to misappropriation by the investment adviser. We believe
that it becomes increasingly difficult to correct a material
misstatement the longer it goes undetected. The proposed annual and
liquidation audit requirements would address these concerns while also
balancing the cost, burden, and utility of requiring frequent audits.
    The proposed annual audit requirement is consistent with current
practices of private fund advisers that obtain an audit in order to
comply with the custody rule under the Advisers Act, or to satisfy
investor demand for an audit, and would provide investors with
uniformity in the information they are receiving.\129\ When an investor
receives audited financial statements each year from the same private
fund, the investor can compare statements year-over-year. Additionally,
the investor can analyze and compare audited financial statements
across other private funds and similar investment vehicles each year.
Further, we believe investors expect audited financial statements to
include 12-month periods and rely on this uniform period to review and
analyze financial statements year over year for the same private fund.
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    \129\ As discussed above, differences between the two rules are
unrelated to the financial statement audit itself.
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    With respect to liquidation, we understand that the amount of time
it takes to complete the liquidation of a private fund may vary. A
number of years might elapse between the decision to liquidate an
entity and the completion of the liquidation process. During this time,
the fund may execute few transactions and the total amount of
investments may represent a fraction of the investments that existed
prior to the start of the liquidation process. We further understand
that a lengthy liquidation period can lead to circumstances where the
cost of an annual audit represents a sizeable portion of the fund's
remaining assets.

While we considered additional modifications to the audit requirement
for a private fund during liquidation, we are concerned that allowing
for less frequent auditing (e.g., every 18 months or two years) during
an entity's liquidation may expose investors to abuse that could then
go unnoticed for prolonged periods. Furthermore, it is our
understanding that allowing for less frequent auditing during
liquidation--for example, requiring an audit every two years in such
circumstances--may not necessarily result in a meaningful cost
reduction to advisers or investors.
6. Commission Notification
    The proposed rule would require an adviser to enter into, or cause
the private fund to enter into, a written agreement with the
independent public accountant performing the audit to notify the
Commission (i) promptly upon issuing an audit report to the private
fund that contains a modified opinion and (ii) within four business
days of resignation or dismissal from, or other termination of, the
engagement, or upon removing itself or being removed from consideration
for being reappointed.\130\ The accountant making such a notification
would be required to provide its contact information and indicate its
reason for sending the notification. The written agreement must require
the independent public accountant to notify the Commission by
electronic means directed to the Division of Examinations. Timely
receipt of this information would enable our staff to evaluate the need
for an examination of the adviser. We expect the Division of
Examinations would establish a dedicated email address to receive these
confidential transmissions and would make the address available on the
Commission's website in an easily retrievable location.
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    \130\ Proposed rule 206(4)-10(e).
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    As we noted above, there is not a similar obligation under the
custody rule for an accountant to notify the Commission as there is for
a surprise examination, although there is a requirement on Form ADV for
a private fund adviser itself to report to the Commission whether it
received a qualified audit opinion and to provide, and update, its
auditor's identifying information.\131\ However, our experience in
receiving notifications from accountants who perform surprise
examinations under the custody rule has led us to conclude that timely
receipt of this information--from an independent third party--would
more readily enable our staff to identify advisers potentially engaged
in harmful misconduct and who have other compliance issues. This would
bolster the Commission's efforts at preventing fraudulent, deceptive,
and manipulative activity and would aid oversight of private fund
advisers.
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    \131\ Form ADV Part 1A, Section 7.B.1, Q.23.
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7. Taking All Reasonable Steps To Cause an Audit
    We recognize that some advisers may not have requisite control over
a private fund client to cause its financial statements to undergo an
audit in a manner that would satisfy all five elements (paragraphs (a)
through (e)) of the proposed rule. This could be the case, for
instance, where a sub-adviser is unaffiliated with the fund. Therefore,
we are proposing to require that an adviser take all reasonable steps
to cause its private fund client to undergo an audit that would satisfy
the rule, so long as the adviser does not control the private fund and
is neither controlled by nor under common control with the fund.\132\
What would constitute ``all reasonable steps'' would depend on the
facts and circumstances. For example, a sub-adviser that has no
affiliation to the general partner of a private fund that did not
obtain an audit could document the sub-adviser's efforts by including
(or seeking to include) the requirement in its sub-advisory agreement.
On the contrary, if the adviser is the primary adviser to the fund,
even if it is not the general partner or a related person of the
general partner, it would likely not be reasonable for the fund not to
be audited in accordance with the rule.
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    \132\ Proposed rule 206(4)-10(f).
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8. Recordkeeping Provisions Related to the Proposed Audit Rule
    Finally, the proposal would amend the Advisers Act books and
records rule to require advisers to keep a copy of any audited
financial statements, along with a record of each addressee and the
corresponding date(s) sent, address(es), and delivery method(s) for
each such addressee.\133\ Additionally, the adviser would be required
to keep a record documenting steps taken by the adviser to cause a
private fund client with which it is not in a control relationship to
undergo a financial statement audit that would comply with the rule.
This aspect of the proposal is designed to facilitate our staff's
ability to assess an adviser's compliance with the proposed audit rule
and to detect risks the proposed audit rule is designed to address. We
believe it would similarly enhance an adviser's compliance efforts as
well.
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    \133\ Proposed rule 204-2(a)(21). See also supra footnote 106
(describing the record retention requirements under the books and
records rule).
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    We request comment on all aspects of the proposed audit rule and
related proposed amendments to the books and records rule, including
the following items:
     Would the proposed audit rule provide appropriate
protection for investors? If not, please describe what, if any,
modifications would improve investor protection.
     The proposed audit rule bears many similarities to
provisions of the custody rule; however, one notable difference is that
there would be no option to, instead, undergo a surprise examination
and rely on a qualified custodian to deliver quarterly statements. What
would be the impact on advisers to private funds that are not relying
on the custody rule's audit provision? Are private funds undergoing
similar audits of their financial statements for other reasons, or
would this represent a new requirement for them? There also are no
exceptions from the proposed rule, as there are in the custody rule,
such as the exception from the surprise examination requirement for
advisers whose sole basis for being subject to the rule is because they
have authority to deduct their advisory fees. What would be the impact
on advisers to private funds that are relying on this and other
exceptions? Do many private fund advisers rely on the exception for
fee-deduction?
     Do commenters agree that the similarities of the audit
requirements for the custody rule and for the proposed rule would ease
the compliance burdens of advisers that would be required to comply
with both? Should the rule provide that compliance with one rule would
satisfy the requirements of the other, given the similarities of the
two rules? Why or why not?
     The application of the proposed rule to registered
advisers to private funds seeks to balance our policy goal with the
anticipated costs of the proposed measures. Do commenters agree with
this approach? If not, what would be a more effective way of achieving
our goals?
     Should the rule apply to all advisers to private funds,
rather than to just advisers to private funds that are registered or
are required to be registered? Should it apply to exempt reporting
advisers? Why or why not?
     Similarly, should it apply in the context of all pooled
investment vehicle clients (e.g., funds that rely on section 3(c)(5) of
the Investment Company Act), rather than just in the context of those
that meet the Advisers Act definition of private fund? Should it apply
more broadly to any advisory account with

financial statements that can be audited? Why or why not?
     Should the rule provide any full or partial exceptions,
such as when 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? Should the rule
provide exceptions for private funds below a certain asset threshold
(e.g., less than $5 million)? A higher or lower amount? Should the rule
provide exemptions for private funds that have only related person
investors, or that have a limited number of investors, such as 5 or
fewer investors? If yes, please identify which advisers or funds we
should except, from which aspects of the proposed audit rule, and why.
     Should the rule apply to a sub-adviser to a private fund?
In situations where a fund has multiple advisers, is it clear that a
single audit of the fund's financial statements may satisfy the
proposed audit rule for all of the advisers subject to the rule?
     Should the alternative of ``taking all reasonable steps''
to cause a private fund client to be audited apply in any situation,
rather than just in situations where the adviser is not in a control
relationship with its fund client? Why or why not? Is it sufficiently
clear how an investment adviser can establish that it has ``taken all
reasonable steps'' to cause a private fund client to obtain an audit?
     Should the rule require accountants performing the
independent public audits to be registered with the PCAOB, as proposed?
Should the rule limit the pool of accountants to those who are subject
to inspection by the PCAOB, as proposed? If the rule does not include
these requirements, should the rule impose any alternative or
additional requirements on such accountants? If so, describe these
additional requirements and explain why they are necessary or
appropriate.
     Do commenters agree that the availability of accountants
to perform services for purposes of the proposed audit rule is
sufficient and that even advisers in foreign jurisdictions (or with
private fund clients in foreign jurisdictions) would not have
significant difficulty in finding a local accountant that is eligible
to perform an audit under the proposed rule? Do advisers have
reasonable access to independent public accountants that are registered
with, and subject to inspection by, the PCAOB in the foreign
jurisdictions in which they operate? If not, how should the rule
address this issue?
     Should the rule require advisers to obtain audits
performed under rule 1-02(d) of Regulation S-X, as proposed? If not,
what other auditing standards should the rule allow? Are there certain
non-U.S. auditing standards that the proposed rule should explicitly
include?
     Should the rule require private funds to prepare audited
financial statements in accordance with generally accepted accounting
principles, as proposed? Should the rule include any additional
requirements regarding the preparation of financial statements? If so,
what requirements, and why?
     As proposed, should financial statements prepared in
accordance with accounting standards other than U.S. GAAP for foreign
private funds meet the requirements of the rule provided they contain
information substantially similar to statements prepared in accordance